Will our banks be able to withstand the escalating SOE crisis?

South African banks are already buffering up to weather the loss of confidence in the South African economy – with expected low growth, policy uncertainty and poor governance in state-owned entities (SOEs) compounded by global tensions, political uncertainty in sub-Saharan Africa and the climate crisis.

They must now be feeling nervous as zombie SOEs begin to hit the wall.

Because it is so difficult to get a handle on the dire financial situation of the many SOEs, and the total amount of government guarantees issued, it is difficult for any financial institution to plan for the possibility of government knocking on the door, demanding money.

It is also highly unlikely that the government has any idea of the clauses contained in SOE loan agreements (and other fine print), such as a default clause requiring annual financial statements to be published on time.

It is obvious from the R3.5 billion loan to South African Airways (SAA) coerced out of the Development Bank of Southern Africa (DBSA) that government does not have its own funds, and that National Treasury has put a stopper on funds being taken out of the Special Appropriation Act for “urgent needs”.

Read: Concern that DBSA will divert infrastructure funds to SAA

This is the beginning of the state now turning to SOEs, the Government Employees Pension Fund, and of course, South Africa’s well-run financial institutions.

It is to be noted that DBSA’s debt-to-equity ratio (excluding R20 billion callable capital) is 138.1% at March 31, 2019 (2018: 156.2%). The expected credit losses amounted to R1.4 billion (2018: R623 million). I calculated the ratio to be 1.9% (2018: 0.83%).

In my view, the full amount of R3.5 billion loan to SAA will have to be impaired in March 2020.

South Africa is facing a future with uncertain outcomes.

Read: SOEs’ results proof of massive problems

How ready are our banks to weather a credit downgrade, customer nervousness, and pressure from government to further “invest” in government projects (cost of corruption)?

South Africa need not wait for the next credit crisis, we are in one.

Looking at five banks only, South Africa’s banking industry is in fine shape.

Below is a table showing the regulatory requirements mandated by Basel III (The Basel Capital Accord was introduced by the Bank of International Settlements in 2001 to standardise the risk management practices of international financial institutions.

Capital ratios (%) 1 2 3 4 5 6
  CET1 Tier 1 Total LCR CLR NSFR
Basel III 8 8 10.5 100   100
Standard Bank Dec-18 13.5 13.5 16 116.8 0.56 118.6
FirstRand Jun-19 13.4 14 16.8 133 0.95 117
ABSA Dec-18 12 12 14.9 116.7 0.73 110.1
Nedbank Dec-18 11.7 12.5 14.8 109.4 0.53 114
Investec Mar-19 10.5 11.2 14.4 135.6 0.28 115.6

1. Common equity tier (CET1): security instruments have the highest level of subordination

2. Tier 1: additional Tier 1 capital

3. Total capital adequacy

4. Liquidity coverage (LCR)

5. Credit loss ratio (CLR): measures impairment charges as a percentage of average loans and advances, incorporates full IFRS 9 impact

6. Net stable funding (NSFR): stable funding that covers the duration of long-term assets.

The above banks do not indicate whether they have already granted loans to any SOEs. But Investec, in its 2019 annual report, states that it “reviewed the group’s exposure to state-owned entities and related risk appetite”.

So far, the credit loss exposure (CLE) of the above banks remains below 1%.

However, the CLE will escalate if banks are forced to bail out SOEs. And this could put the stability of our banking system at risk.

Standard Bank chair Thulani Gcabashe, in the bank’s 2018 annual report, referred to the “enormous destruction of value that has taken place, in both the private and public sectors, when leaders choose to abandon decency”. CEO Sim Tshabalala warns “that economic growth must be inclusive if it is not to be derailed by populist policies and institutional decay”.

In this new decade, it is apparent that this destruction of value will continue unabated.

Read: Eskom and SAA: The SOE project has failed

Apart from Eskom and SAA, what other SOEs are running into trouble and will be at risk of defaulting on loans?

A key SOE, but one that doesn’t hog the headlines, is Trans-Caledon Tunnel Authority (TCTA), which is mandated with financing and implementing bulk raw water infrastructure projects. It has not produced its 2019 annual report. 

Read: Trans-Caledon Tunnel Authority – another audit delayed

In response to my recent query for an update on the status of the 2019 report, it replied: “The TCTA Annual Report has not been published as yet. In line with Parliamentary process the report can only be published after it has been tabled in Parliament. It is expected that this will happen after the opening of Parliament.”

Note, TCTA’s financiers expect the authority to comply with contractual agreements (some of which require annual reports to be published on time), and to report on good governance (obviously in the annual financial statements).

In 2018, the carrying cost of market liabilities (not fair value which is discounted), was sitting at R29.7 billion. If a loan defaults, it is unlikely that the tariff receipts will cover this.

In its 2018 annual report, TCTA noted the “default risk of potential failure to raise adequate funding for the redemption of the WS05 bond, following an abandoned auction, and compounded by the disruption of revenue from DWS [Department of Water and Sanitation]”.

And the update on this? Patience.

We will have to wait for the belated 2019 annual report to be filed in parliament. Or for one of the loans to default.

Some pre-emptive planning by government would be nice.

The government is floundering and has no idea how to rein in errant SOEs.

In its ignorance, it is most probably eyeing the market capitalisation of banks, thinking it can tap into this.

Source: moneyweb.co.za