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Cape Town - The debate about the build-up to the SA Reserve Bank (Sarb) placing African Bank under curatorship continues among Fin24 users.
Fin24 user Mark Riddle wrote to say to him the real question regarding the bailout of African Bank should be about who traded down the share value since March.
Fin24 asked Kokkie Kooyman, global fund manager of Sanlam Investment Management Global, to put it into perspective.
To Fin24 user Frank, however, it is of more interest to know who would have bought all these shares and why. He writes:
I, with great interest, read Mark Riddle's question and Kokkie Kooyman's reply regarding who traded down the African Bank shares.
My question now is: Who were the buyers of such large volumes of shares and why?
What would your motivation be to acquire shares, which you know will have little or no value at all, unless there is an underlying motive for future gains.
READ: Warning against overreaction to banks' downgrade
Fin24 again asked Kooyman to shed some light on the matter. He responds:
The short answer is: The buyers thought that the share represented good value with significant turnaround potential.
I'll give a bit more insight into why they thought so, but first a few comments:
- I'm basing my answer on observations of similar situations in the past. I’m not close enough to this situation to make comments about who bought or sold African Bank shares;
- Logic dictates that, besides value-based managers buying, there would have been hedge funds covering their shorts as the price was falling;
- In terms of volumes traded: Bear in mind that the value traded is more important than the volume traded.
For example: To buy 1% exposure at R1 per share one has to buy ten times the number of shares when the share was trading at R10.
Why buy the shares "which you know will have little or no value"?
Professional fund managers base their investment decisions on the difference between share price and the intrinsic value of a share.
The size of the investment will be determined by the degree of certainty about the upside.
Therefore, fund managers with large holdings might sell to reduce exposure as uncertainty increases.
At the same time other fund managers, who had no exposure, might decide the price has fallen enough to warrant a small investment.
In the end the determination of “intrinsic value” is based on financial models, but the answer the models gives depends on the assumptions made.
The assumptions are just that, namely assumptions, because one is looking into the future.
However, the assumptions are based on the company’s and other similar companies' histories.
Therefore, over the past 15 years, in South Africa and internationally, unsecured lenders have on average had a bad debt write-off of 13%.
The worst situation on our global database was African Bank, who in 2004 had classified 50% of its loan book as non-performing - after acquiring the Saambou book.
Yet, even then it eventually only had to write-off a much lower percentage (about 20% in 2004) and managed to collect a sizeable portion of the provisioned book over time.
This was after the Unifer and Saambou debacle, when the whole industry had been lending recklessly and many lenders had up to six different loans.
So, an analyst would have made assumptions in his or her model about what percentage of African Bank’s book was non-performing and in doing that would have been guided by managements' press releases and research by other credit providers.
The analyst would have been influenced by the fact that African Bank did "tick a lot of boxes":
- A long track record of generating very high returns on capital (ROE);
- A ten year history of paying good dividends;
- An experienced management team, who had real ownership (Leon Kirkinis was a substantial shareholder);
- A bank that had come through the Saambou and Unifer crisis very well;
- And finally, the bank had already raised capital earlier in the year.
There were warning signs
One of the warning signs was about two months ago, when its debt was downgraded to junk status.
At that stage I said "that management had lost control over their destiny and were going to be forced into another rights issue".
The common belief, however, at that stage was that African Bank would not need another rights issue, and if they did - this would be about R2bn.
As you know, in the end they needed more than R8.5bn - a figure very, very few analysts expected.
I must add, personally I also never anticipated that a rights issue of that size would be required and based on our own models was considering whether to buy African Bank if it fell below R6 at the time.
The assumptions proved to be wrong on mainly two points:
- The quality of the book had deteriorated far more than almost anybody had thought possible.
Analysts were underestimating the effect that the strikes were having on unemployment and the effect that would have on the ability of lenders to repay;
- Secondly, the size of a further rights issue, as well as the price at which a rights issue would be done.
It gets technical here:
But for a rights issue to succeed in stressed circumstances the shares have to be offered at a large discount to the price at the time.
The lower the issue price, the more shares that have to be issued to raise the required capital.
So, as the share price falls, the situation gets progressively worse.
This was an outlier event and in a way a perfect storm that few analysts or fund managers foresaw.
Conclusion
It is always dangerous to judge risk with hindsight. With the information available now, it seems obvious the shares had little value.
But prior to the fall in the share price, the view was that Abil would need possibly one more small rights issue and after that you would own a bank with excess capital, an adequately provided book and that in three years' time the bank would be generating an ROE of 20%+ again.
Summary
Investors follow a process to deal with the uncertainties of the future. The assumptions made are based on analysing as much historical data as possible.
The process will work 7 to 9 times out of 10. But every now and then, the “unforeseen outlier” occurs and you get it wrong.
Since 2003 African Bank proved to be an excellent investment up to Marikana.
Had you decided in 2003 unsecured lending is bad business, you would have missed both African Bank and one of the best performing shares over the past 10 years in South Africa: Capitec.
- Fin24
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