A report released in late January by US based research firm Viceroy, alleging that Capitec Bank is misrepresenting the quality of their loan book and inflating their loan writing ability, caused the bank’s share price to plummet 25% in a few hours. Since then calm has been restored but the accusations linger and the question remains: how safe are the funds of its depositors?
The market consensus is that Viceroy’s attack might shed light on some problems at the bank but grossly sensationalized the facts in order to profit from their report. Retail deposits are generally thought not to be in danger.
A rolling loan gathers no loss
Viceroy gained credibility for their Steinhoff report (released the day after CEO Markus Jooste’s resignation) that exposed significant accounting irregularities that have severely damaged the giant company.
Viceroy’s 3 man team, led by Fraser Perring, claim that it is highly suspicious that Capitec was not only surviving but was thriving in a market sector that had mostly destroyed its competitors. Capitec, which operates mainly in the unsecured low-income loan market, has been a long time darling of the JSE and is rated as one of the best banks in the world (by earnings/share, customer satisfaction and innovation).
The 33 page report cast Capitec as a “loan shark” with “massively understated” impairments. It further called for the Reserve Bank to immediately place the bank under curatorship.
It important to keep in mind that Viceroy are not an independent research house. They take financial bets that they hope will profit from the release of their reports. Capitec CEO, Gerrie Fourie, said that the research group has links to at least three hedge funds and operates unfettered by any regulation. Two out of their nine investigations involve SA companies.
The report’s main claim is that Capitec is writing new loans to defaulting customers to roll over arrear loans and avoid defaults, making the bank appear in better health than it really is. As they eloquently say: “a rolling loan gathers no loss”
Fourie denies that the bank engages in this practice and maintains that the quality of the loan book stems from the bank’s conservative write-off policy (90 day arrear loans are completely written off). He said that the bank only rolls or gives new loans to paid-up clients.
Viceroy counters that customers get money from secondary lenders like stokvels, pay up their arrears, after which they are given fresh loans to settle up the old ones. Their assessment is that an R11 billion loan write-off, about 25% of the R40 billion loan book (equivalent to 15% of Capitec’s total assets), would reflect the real position of the bank. Fourie has dismissed this and points to Viceroy’s flawed understanding and analysis of the bank’s key metrics.
One for all and all for one
Capitec have issued detailed rebuttals, which major players in the financial markets have tended to accept.
The Reserve Bank’s position is that Capitec is solvent, well capitalised and has adequate liquidity and that the bank meets all prudential requirements.
National Treasury had been in constant contact with the Registrar of Banks since the report was released, and is satisfied with the assurance from the South African Reserve Bank. They also requested that the FSB should initiate a market abuse investigation into the conduct of Viceroy.
Notably, ratings agency S&P Global, did not alter its rating of Capitec after analyzing the Viceroy report.
Moreover, Capitec’s most ardent local critics have come out against the Viceroy report. A significant part of the story, poorly covered by the media, is that investment firm, Benguela (BGFM), had sent a letter to Capitec management two weeks prior to the release of the Viceroy report. The letter followed an in-depth study of the bank and raised similar concerns that “revolve around the rescheduling of arrears and the impact these have had on the reported financial performance of the business.” Following Capitec’s detailed response, addressing all of Benguela’s concerns, the investment firm came to Capitec defense. Benguela wrote in a statement that they were “comfortable with the extensive explanations” and that (paraphrased) the claim that Capitec should be placed under immediate curatorship is shocking and irresponsible. If there was evidence of such enormity, better to approach the regulators directly. It is unfair to publicly challenge a company’s business practices without first giving it a chance to reply. Casting fear and doubt because one has taken a short position is totally unacceptable. Just like the irregularities that a researcher may be seeking to expose, so too, the false attack on a company could do severe damage to other investors’ interest. Our position is that Capitec has certain practices that are questionable but is healthy and certainly not about to fail. Even with our worst case assumptions, we cannot arrive at the Viceroy Impairment provision of R11 billion. We can’t even get to 50% of that on our numbers.
Show me the money
South Africa is the only G20 country without depositor’s insurance. Depositor’s insurance protects retail depositors up to a maximum amount ($250,000 in the US) in the event of a bank collapse. The South African Reserve Bank is working closely with the banking industry to launch depositors insurance in South Africa (with protection expected to be up to R100,000). However even without formal depositor insurance in past bank failures, depositors have been protected.
Bank failures are rare in South Africa. The 2002 collapse of Saambou, a relatively small bank, led to government stepping in to guarantee the deposits and prevent a run on other smaller banks.
The risk to depositors at African Bank, when it failed in 2015, was negligible. Total retail deposits were miniscule at R100M and the Reserve Bank protected those funds. So even if Capitec was to fail, it seems likely based on history that depositors would be protected by the Reserve Bank or the Government.
Furthermore, Capitec have themselves built up significant capital buffers that should provide significant protection to depositors. A Bank’s Capital Adequacy Ratio, measures the safety of depositor’s funds. It is the ability of the bank to protect depositor’s money by absorbing losses. Think of it as the crumple zone of a motor vehicle that absorbs the forces of an impact before they reach the passenger zone. Shareholders’ investments would be lost first before the impact reaches the funds of depositors.
Capitec’s Capital Adequacy Ratio of 34% is 3.5 times the minimum of 10% set by the South African Reserve Bank. In addition, it’s R40bl loan book is only 50% of its total assets compared to an average of 71% across the big four banks, giving it more scope to absorb write offs.
To illustrate how well capitalised the bank is: 63% of the loan book could go bad without retail deposits being at risk. Shareholders equity would be wiped out first, followed by trade creditors and then wholesale deposits before retail deposits would be touched.
Another important metric that has not been widely reported is the more balanced nature of Capitec’s income streams. Transaction fee income is a significant 40% of net income, a key Metric which shows that Capitec has matured from a micro-lender into more of an all-rounder. The average is 43% across the big four.
Modern financial institutions are fragile by nature. The system still largely requires trust to function effectively. Unfounded panics causing bank runs can kill even the most solvent of banks. This became evident in the 2008 financial crisis, where some of the world’s biggest and strongest financial institutions were wiped out. Capitec has successfully managed to weather the Viceroy storm over the last few weeks and demonstrated its resilience. Its solid capital adequacy ratios, the Reserve Bank’s implicit guarantee to protect depositors and effective communication have ensured that it retains the trust of South African savers.