Some startling revelations have been made in the recently released Myburgh Report on the demise of African Bank (and its holding company, ABIL), including allegations of incompetence, drunkenness, conflicts of interest and hubris of certain Board members.
The advent of Good Bank
The successful launch of Good Bank on April 4 2016 concluded an extended period of negotiation and compromise between African Bank’s curator, senior bondholders, subordinated bondholders, the South African Reserve Bank (SARB) and the new shareholders.
When Good Bank was launched on April 4 senior and subordinated bondholders effectively swapped out their exposure in the old African Bank for new instruments in Good Bank.
The rough outcome of the negotiated compromise was that for every R100 of senior debt held in old African Bank, senior investors received R10 in cash, R80 in new Good Bank senior notes and suffered a R10 write-off. Investors also received interest that had accrued during the curatorship, reduced by legal costs that were allocated proportionately across all senior bondholders.
From a lender’s perspective, the injection of new capital from the new shareholders, the appointment of a new management team and a new strategy are all welcome developments. Importantly, the Good Bank starts life with a book of consumer loans which are performing – e.g. all the defaulted loans made by African Bank are left behind in the old bank (Note: That is why it’s called “Good Bank” – not because we are convinced of its business model or competitive positioning).
Initial interactions with the new CEO and some of his management team indicate that Good Bank’s diversification into transactional banking should help alleviate some of the mistakes that arose from the old African Bank’s reliance on a single product, being the provision of unsecured loans.
However, the existing over-indebtedness of many South Africans and the deteriorating economic climate (low growth, higher inflation, high unemployment), will act as a brake on Good Bank’s future prospects.
Further, over the almost two years since old African Bank was placed in curatorship, Capitec Bank (and other lenders) have been eating away at Good Bank’s potential client base, which we believe has the potential to further constrain Good Bank’s ability to successfully execute on their strategy.
Good Bank bonds are mispriced
One advantage that Good Bank has over its competitors is that, thanks to the negotiated compromise reached with senior and subordinated bondholders, its funding costs are, for the moment, lower than where they should be.
Notwithstanding the significant cash and new capital in Good Bank, we believe that the weak economy and a lack of track record by Good Bank points to a higher risk profile and for this, we believe that the interest rate paid by Good Bank should have been higher. In addition, the rates on the new instruments were not linked in any way to their new term to maturity.
Issuing at the original credit spreads has also meant that some portfolios may experience further mark-to-market losses on the Good Bank bonds as and when these bonds reprice in the secondary market.
The subsequent trading in Good Bank bonds since issue serves to confirm our view that the bonds in Good Bank were issued at credit spreads that are too low for the risk profile and term – the credit margin earned by bondholders on Good Bank senior bonds have all moved higher in the limited trade that has taken place since issuance.
Turning to the Myburgh Report, one of the less surprising (to us) conclusions was about old African Bank’s woefully inadequate provisioning and high (and ultimately, unsustainable) credit growth. The Myburgh Report highlights this as being one of the reasons for African Bank’s failure. This was identified by Futuregrowth as far back as 2012 and part of the reason we started reducing our client fund exposures from that date.
What was revealing about the Myburgh Report was the extent of corporate governance failures within ABIL and African Bank.
Leon Kirkinis’s reported domination of the Board of ABIL and African Bank, the lack of seeming proper authority and disclosure around the purchase of Ellerines and the ongoing financial support provided by African Bank to the furniture retailer (at a time when African Bank itself was under severe financial strain), all point to multiple and significant corporate governance failures, despite ABIL’s glossy integrated reports which purport to paint a picture of ABIL as a model corporate citizen.
The report is fairly scathing of the lack of required care and skill exercised by the directors of African Bank in approving the loans from the bank to Ellerines, and in fact concludes that the directors of the Bank Board acted “in breach of their fiduciary duty to the bank; did not act for the benefit of the bank and did not act in the best interests of the bank”.
Questions also arise for us around the continued acceptance by ABIL’s Board of the chief risk officer’s position. The continued acceptance of the appointment (which lasted ten years) of a Chief Risk Officer who was, according to Myburgh, unqualified for the job – and reportedly incapacitated due to a severe drinking problem – is surprising.
Indeed, we are aware SARB was monitoring African Bank well before its failure, and we might question their acceptance of this continued appointment (even accepting that SARB is not responsible for the management of any of the South African banks that fall under their supervision).
What we can learn
The dust has yet to settle on this saga and for pension fund investors there are some key learnings from these events. While it is very difficult for any investor to know the detailed inner workings of a company, there are some telling signals that can be picked up from the annual financial statements (absent outright fraud which is harder to detect without a forensic audit).
Good analysis – including financial, operational, strategic, competitive, environmental, social and governance assessments – is key to uncovering what may really be happening in a company. Ongoing dissonance between what management says and the numbers are key flags in our analytical process at Futuregrowth and something we had identified as a problem from as early as 2012.
A healthy dose of cynicism and scepticism is needed by investors to see through the sometimes overly optimistic picture that management portrays. Proper risk identification and analysis can uncover many of these inconsistencies which investors need to be aware of and ensure are properly priced into their investment decision-making.
FAIS disclaimer: Futuregrowth Asset Management (Pty) Ltd (“Futuregrowth”) is a licensed discretionary financial services provider, FSP 520, approved by the Registrar of the Financial Services Board to provide intermediary services and advice in terms of the Financial Advisory and Intermediary Services Act 37 of 2002. The fund values may be market linked or policy based. Market fluctuations and changes in exchange rates may have an impact on fund values, prices and income and these are therefore not guaranteed. Past performance is not necessarily a guide to future performance. Futuregrowth has comprehensive crime and professional indemnity in place. Performance figures are sourced from Futuregrowth and I-Net Bridge (Pty) Ltd. GIPS disclaimer: Futuregrowth Asset Management (Pty) Limited (“Futuregrowth), a subsidiary of Old Mutual Investment Group Holdings (Pty) Limited is a specialist investment company which manages the full range of interest bearing and developmental investments in an ethical and sustainable way. Futuregrowth claims compliance with the Global Investment Performance Standards (GIPS®). Contact Futuregrowth at +27 21 659 5300 to obtain a list of composite descriptions and/or a presentation that complies with the GIPS® standards. The investment returns reflected are supplemental information as they are not calendar year returns and are gross-of-fees. Currency: ZAR