Wednesday, 12 December 2018

South Africa feels the heat

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  • South Africa feels the heat

These are tough times for South Africa, with economic growth slowing drastically. The effect on the pace of activity in the debt capital markets has been profound.

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Until recently South Africa was the economic powerhouse of the region. Only a decade ago it boasted 40% of the GDP of the 48 countries that make up Sub-Saharan Africa (SSA). Having shaken off apartheid in 1994, and with the totemic Nelson Mandela at the helm, it was a template of how things should be done.

As if in echo of concerns about Nelson Mandela’s health, the economic news from South Africa has been less cheery too. While much of SSA has seen GDP grow at more than 6% a year, South Africa’s has been a more modest 2%.

Output has been declining: over the past five years gold production has fallen 21%, according to the Chamber of Mines of South Africa. Earlier in the year, an intensifying rivalry between the National Union of Mineworkers and the Association of Mineworkers and Construction Union left more than 60 people dead and caused concerns among foreign investors. Gill Marcus, governor of the central bank, on 19 September admitted that growth this year had been “overshadowed by protracted work stoppages”.

South Africa’s credit rating has also taken a knock, with downgrades to Triple B from the three major agencies.

“Subdued growth, coupled with rising corruption and worsening government effectiveness, have constrained the government’s ability to improve living standards, reduce the 25.5% unemployment rate and redress historical inequalities as rapidly as the population demands,” Fitch said in a statement.

Hitting hard

The prospect of an end to quantitative easing in the US has also hit South Africa hard. The rand-US dollar exchange rate, which stood at 8.17 in August last year, passed 10 on August 19 and hit a four year high of 10.50 on August 28, according to Reuters. It has weakened by a weighty 17% this year. Even though there was a pick up after the Federal Reserve’s decision to maintain its bond-buying programme towards the end of September, the rand is still 15% down against the dollar this year, according to Reuters. On February 5, the South Africa 5.875% May 2022s yielded 3.537%, or mid-swaps plus 153bp. At the end of August they had risen to 5.266%, or mid-swaps plus 238.55bp, according to TradeWeb.

This has all kicked into touch what was looking like a record year for South African debt. Both the domestic corporate bond market and the muni market had been beacons of optimism amid the gloom.

In the first quarter of the year R5.65bn (US$570m) was raised by companies in the corporate bond market, matching the total for the last six months of 2012, according to Standard Bank. “At that stage we thought we were going to see record issuance this year,” said Megan McDonald, head of debt primary markets at Standard Bank. “Corporate debt was the star of 2012, and we thought it was going to be same again.”

Full-year expectations have had to be tempered dramatically in light of macroeconomic challenges. In early July the IMF cut South Africa’s economic growth forecast to 2% for 2013 down from the 2.8% it had predicted in April. Meanwhile, inflation is creeping up: the Reserve Bank of South Africa had already raised CPI expectations to average 5.9% this year, up from an earlier estimate of 5.3%. Then in July it hit 6.3%, breaching the central bank’s 6% upper target for the first time in 15 months.

Those economic troubles have caused considerable reassessment of expected corporate debt issuance. In July, R114bn was still seen as achievable this year. This was shy of last year’s record-breaking R123.8bn, but still considerably higher than 2011’s R86.3bn, according to Rand Merchant Bank. Now all bets are off and bankers vie to see how low they can pitch expectations.

At the end August, it emerged that year-to-date foreigners had invested only R31.6bn in portfolio purchases for South African corporate debt, compared with R66.5bn in the same period last year, according to Citigroup.

Down the credit curve

Basel III drove issuance in the first quarter, encouraging companies to raise money in the primary debt markets instead of via bank loans, but this is not the whole picture. Issuance came from new names, and those further down the credit curve. Of corporate debt issuance in 2012, Single A rated companies made up 27% of volume – double that of 2011 – while Triple B names were up to 8%.

So while issuance volumes have slowed, at least the market has developed in terms of its diversity and willingness to take on risk.

“Back in 1998, the South African bond market was dominated by government paper and state-owned companies,” said McDonald. “Seven years ago or so it was mostly highly rated corporations, names like Anglo-American. It is a sign of a more mature market that in the last few years we have seen Single A rated and Triple B rated names.”

“We are starting to see a move down the credit rating curve because large local corporates are starting to look outside South Africa for their funding needs – they are looking for dollars and euros,” said Barry Martin, co-head DCM at Rand Merchant Bank.

Logistical group Imperial, for example, has been expanding rapidly throughout Sub- Saharan Africa, in mid-May acquiring a 49% stake in MDS, a leading logistics provider in Nigeria. With eyes across the continent, so far Imperial has only sold a R750m private placement in the domestic market this year.

Other corporates remain focused on the domestic market. In April alone Standard Bank led five domestic corporate bond issuances with a value of R6.1bn, among them healthcare company Netcare; cement company PPC; Mercedes Benz and the South African subsidiary of SABMiller sold R1bn 7.125% five year paper. All were significantly oversubscribed, in PPC’s case by almost five times.

Miserable take-up

But even aside from ructions in the global market, there have been two flies in the ointment. The first was the disastrously failed bond auction by state-owned transport utility Transnet in early June. An attempted R750m sale of 22-year paper offering only a 100bp–150bp pick-up over equivalent government debt saw a miserable take up of only R122m. With egg over its face, Transnet was forced to pull the deal.

“The deal was completely mispriced,” said one banker, contrasting its performance with a subsequent Transnet issue, where an auction of a planned R1bn three-year deal at Jibar plus 110bp raised R3.3bn. Indeed, after that, Transnet priced another R1.5bn five-year bond at Jibar plus 130bp at the end of August.

The second, rather more significant fly is the case of engineering company First Strut, which defaulted in August with R925m of three-year floating-rate notes outstanding. It has the dubious honour of being South Africa’s first listed corporate bond. Bankers are swift to distance themselves from the problem: the liquidation of First Strut’s parent company and the subsequent murder of chairman Jeff Wiggill in Soweto in June reads more like a sub-plot from a Hollywood blockbuster than an indictment of South African corporate debt. “It is a very isolated and strange problem,” said one banker.

But this has hit the market hard. Aside from the more generalised outflow from emerging debt, First Strut has made a sale of high-yield bonds much more difficult. Indeed, the pipeline for high-yield names has completely shut down.

Muni magic

While the attention in H1 this year was on corporate issuance, municipal bond issuance had been successful. The sector saw R2.9bn issuance in the first half of the year, putting it on course to challenge the record-breaking R4.2bn raised in 2008, in the run up to the 2010 FIFA World Cup.

Ekurhuleni Metro’s R800m 15-year amortising bond stood out, as did the City of Tshwane, which raised R1.39bn through two inaugural bonds, one 10-year and one 15-year. Both came via Standard, pricing at 275bp and 220bp over equivalent government debt respectively to yield 10.20% and 9.11%.

The latter two bonds mark the city’s intention to raise more funding via debt capital markets, according to Tshwane executive mayor, Kgosientso Ramokgopa. “The city will continue to tap into a much wider portfolio of investors and break its tradition of using only bank loans to finance its long-term capital expenditure,” he said. “We are living in a dynamic environment in which the diversification of funding has become very crucial.”

But with the continued slide in demand for credit – South African credit growth eased for the third month in a row in July (from 8.9% to 7.4%) – the slowest pace since April 2012, according to the Reserve Bank – again nothing has been seen since then.

“We are seeing some renewed interest in sovereign bonds, but if you lose a month or two when appetite is low, you can’t always take back what you have lost,” said Rand Merchant Bank’s Martin.

Some heart can be taken from the fact that South Africa is still able to raise money internationally. It sold a US$2bn 5.975% 12-year bond in mid-September. But this is small beer. Now economists are starting to suggest that there is little chance of a pick up even in the medium term, let along the short term. The H1 reports from domestic banks all warn of a slowdown and renewed strike action called for at the beginning of September raises the threat of further violence and further losses on the FTSE/JSE Africa Gold Mining Index which has already dropped 44% this year. The outlook is anything but rosy.

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