Hot on the heels of the African Bang implosion and rescue, Moody’s, the aptly named international ratings agency, has downgraded Capitec Bank. Here’s their reasoning and the response from the South African Reserve Bank (SARB):
Limassol, August 15, 2014 — Moody’s Investors Service has today downgraded Capitec Bank Limited’s (Capitec) deposit ratings to Ba2/NP from Baa3/P-3, and its national-scale issuer ratings to Baa1.za/P-2.za from A2.za/P-1.za. In addition, the rating agency downgraded the bank’s standalone bank financial strength rating (BFSR) to D, equivalent to a ba2 baseline credit assessment (BCA), from D+/ba1. Concurrently, all ratings were placed on review for further downgrade, with the exception of the short-term Not-Prime ratings.
The two-notch downgrade of the deposit ratings reflects two elements. First, Moody’s view of the lower likelihood of systemic support from South African authorities to protect creditors, following the recent decision of the South African Reserve Bank (SARB) to include a bail-in of senior unsecured bondholders and wholesale depositors as part of the restructuring plan for African Bank Limited. Second, the lowering of the bank’s standalone BCA to reflect the rating agency’s heightened concerns regarding the risk inherent in Capitec’s consumer lending focus, owing to weaker economic growth, reduced consumer affordability and high consumer indebtedness that are leading to higher credit costs for the bank.
The review for downgrade will focus on a forward-looking assessment of the shock absorption capacity afforded by Capitec’s strong capital and liquidity buffers against risks stemming from the on-going challenging operating conditions in South Africa’s unsecured lending market, which are likely to weigh on the bank’s financial performance, and the risk of a deterioration of the funding conditions for unsecured lenders in South Africa.
REDUCED SYSTEMIC SUPPORT
The downgrade of Capitec’s deposit ratings takes into account the removal of one notch of uplift for external support that was previously incorporated. Moody’s considers that the likelihood of systemic support for Capitec, if needed, to fully protect senior creditors and depositors is now materially lower than previously thought, as implied by SARB’s recent approach in resolving a similarly sized bank with a similar business model.
In Moody’s opinion, SARB’s willingness to proceed with a burden-sharing restructuring plan for African Bank Limited, involving debt holders and wholesale depositors, is a clear indication of a reduction in the likelihood of systemic support in a manner that would fully protect creditors. In this recent case of a peer institution, senior bondholders and wholesale depositors sustained losses of 10%, with subordinated bondholders incurring significantly higher losses. As a result, Moody’s believes that the level of systemic support previously incorporated in Capitec’s ratings is no longer appropriate.
HEIGHTENED CONCERNS REGARDING INHERENT CONSUMER LENDING RISKS
The lowering of the standalone BCA reflects Moody’s heightened concerns regarding the inherent risks of Capitec’s consumer lending focus, owing to weaker economic growth, reduced consumer affordability and high consumer indebtedness that have resulted to higher credit costs for the bank.
Despite the gradual diversification of Capitec’s revenue base, amid its expanding transactional banking business, unsecured consumer lending continues to make-up the bulk of the bank’s loan book. While Moody’s acknowledges Capitec’s sound provisioning and underwriting policies, this narrow undiversified lending focus remains affected by the recent economic slowdown, given reduced consumer affordability and high consumer indebtedness. Capitec’s loan loss provisions over gross loans increased to 11.8% for the year-ended February 2014 from 8.7% the previous year.
RATIONALE FOR FURTHER REVIEW
The review for further downgrade reflects Moody’s forward-looking concerns that the challenging operating environment in South Africa’s unsecured lending market may weigh on Capitec’s financial performance. Capitec’s earnings will likely come under pressure amid increased loan loss provisions as consumers come under stress. South Africa’s slowing economy (GDP quarter-on-quarter growth declined by -0.6% in Q1 2014) and labour unrest, coupled with the highly leveraged consumers (household debt to disposable income of a high 74.5% in Q1 2014), higher inflation (6.6% in June 2014) and a rising cost of living will continue to weigh on consumers’ loan affordability.
Moody’s acknowledges Capitec’s very strong buffers in the form of capital (Tier 1 of 30.6% in February 2014), and high provisions and earnings (pre-provision income to risk-weighted assets of 22.7% for the year-ended February 2014) to absorb such increased loan losses compared to peers. However, the rating agency believes that Capitec is exposed to the deteriorating operating conditions and the inherent risks to its core business. For the year-ending February 2014, net impairment charges absorbed 59% of pre-provision profits (2013: 55%).
Moody’s also believes that recent events related to African Bank signal potentially higher downside risks for funding towards unsecured lenders in South Africa. While Moody’s recognizes that around two thirds of Capitec’s funding is in the form of household deposits, it still maintains a reliance on wholesale funding. The recent developments could negatively impact both Capitec’s wholesale and retail deposit funding profile and related cost going forward, particularly in the context of pressure on financial fundamentals from the challenging operating conditions for unsecured lenders.
FACTORS TO BE CONSIDERED IN THE RATING REVIEW
The review for downgrade of Capitec’s ratings will focus on a forward-looking assessment of (1) the risk of asset quality deterioration and higher credit costs; (2) the bank’s recurring earnings-generating capacity in light of challenging operating conditions; and (3) the bank’s ability to maintain its current capital levels and funding sources in the challenging operating environment.
WHAT COULD MOVE THE RATINGS DOWN/UP
Capitec’s ratings could be downgraded, if (1) its business model and loan growth generates elevated credit and liquidity-management risks; or (2) Moody’s considers that the current challenging operating conditions will materially affect its asset quality, capital base and earnings power.
The rating review for downgrade indicates that there is limited upside potential for Capitec’s ratings over the near-term.
Moody’s National Scale Credit Ratings (NSRs) are intended as relative measures of creditworthiness among debt issues and issuers within a country, enabling market participants to better differentiate relative risks. NSRs differ from Moody’s global scale credit ratings in that they are not globally comparable with the full universe of Moody’s rated entities, but only with NSRs for other rated debt issues and issuers within the same country. NSRs are designated by a “.nn” country modifier signifying the relevant country, as in “.mx” for Mexico. For further information on Moody’s approach to national scale credit ratings, please refer to Moody’s Credit rating Methodology published in June 2014 entitled “Mapping Moody’s National Scale Ratings to Global Scale Ratings”.
The principal methodology used in this rating was Global Banks published in July 2014. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.
Headquartered in Stellenbosch, South Africa, Capitec Bank Limited had total assets of ZAR46.2 billion ($4.3 billion) as of February 2014.
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South African Reserve Bank (SARB)
Statement by Hlengani Mathebula,
Head of Group Strategy and Communications
The South African Reserve Bank (SARB) notes the decision by Moody’s Investors Service (Moody’s) to downgrade Capitec Bank Limited (Capitec) by two notches, and place it on review for a further downgrade. While the Bank respects the independent opinion of rating agencies, we do not agree with the rationale given in taking this step.
Two reasons are given for the rating action: a lower likelihood of sovereign systemic support based on decisions recently taken in relation to African Bank Limited (African Bank), and heightened concerns regarding the risk inherent in Capitec’s consumer lending focus.
With regard to the first point, it is important to reiterate that the approach taken by the SARB to any resolution to address systemic risk will always be based on the circumstances and merits of the particular prevailing situation. Decisions will also be informed, as was the case with African Bank, by principles contained in the Key Attributes for Effective Resolution Regimes proposed by the Financial Stability Board (FSB), which have the objective that a bank should be able to fail without affecting the system. This is in keeping with evolving international best practice.
In the case of African Bank bond holders and wholesale depositors are taking a 10 per cent haircut, which is generally regarded as being very positive given that the trades following the announcement of African Bank’s results were taking place at around 40 per cent of par. Therefore in fact substantial support was provided, not reduced. Moreover, all retail depositors were kept whole and are able to access their accounts fully.
The Moody’s statement justifies the rating action further on the basis that Capitec follows a similar business model to African Bank. This is incorrect, the two lenders do not share the same business model. While both are active in the unsecured segment of the market, Capitec follows a very conservative approach to risk and prudent provisioning practices, and considerable diversification has been taking place in a steady manner in product, client and revenue streams.
As part of its regular supervisory engagement, the Bank Supervision Department recently conducted a review of both the provisioning methodology and level of impairments in Capitec Bank and found both to be acceptable. Impairments stand at around 6 percent, with a coverage ratio of bad debts of 167 percent as at February 2014. Capitec’s capital adequacy stands at 40 percent, well above the regulatory requirement. It has a large cash holding and two thirds of funding comes from retail deposits.
The South African banking sector remains healthy and robust, and Capitec’s publically available data on the BA900 returns, which are submitted monthly and published on the SARB’s website, indicate the continued good growth that the bank is experiencing.