Bloodshed at African Bank

Storm clouds are gathering over African Bank, which shed R4.4-billion in value in just more than a week as investors deserted the monster microlender.

Calls are mounting for CEO Leon Kirkinis to resign. Confidence in the unsecured lender hit new lows after a series of shock announcements led analysts to question the bank's prospects.

Last Friday, African Bank Investments (Abil) alarmed the market by revealing that it expects a basic loss of R4.3-billion to R4.5-billion for the six months to March.

This surprised pundits because the bank had raised R5.5-billion only five months ago in a rights issue meant to give it the cash to climb out of its hole.

Since May 1, shortly before last week's announcement, Abil's share price has bled 23.4%, a value plunge of R4.4-billion. This has motived a unanimous about-turn by those analysts who hadn't already thrown in the towel and issued a sell rating.

Now, analysts at BofA Merrill Lynch, Deutsche Bank and Macquarie First South say the bank might have to go cap-in-hand to shareholders for yet more cash to keep it afloat.

But, with the market bewildered and having lost faith in the bank, a second rights offer would have to be offered at a massive discount to Abil's share price. Analysts are scratching their heads to figure out how a severely weakened Abil can stay afloat.

"For shareholders, it's a bad position to be in - though from a systemic point of view I don't think the Reserve Bank would want it to fall over," said Sean Ashton, chief investment officer at Anchor Capitol. "Their capital position is once again impaired. From a share price position at R10 you are still paying a meaningful premium to its book value."

Even though Abil's share price sunk to R9.50 on Friday, Merrill Lynch analyst John Storey, who has been warning investors to stay away from the stock for two years, said the price could sink another 30% to R6.50 a share.

In a report this week, Deutsche Bank analyst Stefan Swanepoel did an about-turn by advising investors to sell Abil shares, saying its value was closer to R9 a share. Swanepoel said the market was "exasperated with Abil's recurring once-off" write-offs.

Macquarie First South, which had earlier warned of more bad news to come, is valuing Abil's shares at closer to R8.60. Renaissance Capital said Abil's latest update "took bad and made it worse".

This week, Abil refused to answer Business Times' questions, saying it was "unable" to do so until after the results were published next week.

But, in a conference call this week, Kirkinis was at pains to assure investors that the worst was over.

"We will start to see signs of the change in the first half of 2014 and then in 2015," he said.

Speaking of his recovery programme, Kirkinis said: "We are under no illusion about how tough it is going to be ... what is required is equal measures of resilience and courage."

Experts say that Abil's problems are attributable to management failing to implement adequate risk forecasting models to predict the huge increase in the number of loans going bad as borrowers struggle to escape from dire indebtedness.

Compounding the problem is that Abil hasn't had the cash to cover the spike in bad debt of its customers, which meant it burnt close to R5-billion in cash in just five months - money meant to be used to help it grow.

Though Abil is now more conservatively positioned after setting aside an extra R2.5-billion to cover bad debts, the loss of these billions has returned the bank to the weak capital position it was in before the last rights issue.

With faith in management at a low, analysts said they believed the bank was "delicately positioned" and "standing on the precipice".

Abil is now at close to the minimum amount of cash it must hold as a reserve to cover risk-weighted assets - and is poorly covered in comparison with its peers in terms of provision against future impairments.

Storey said Abil's provision for non-performing loans was 66% of its loan book - the industry average is 80%.

Abil, he said, now needed more capital. "We estimate that to plug a few holes they need R1-billion to R2-billion," said Storey.

"If they have more losses in the second half of the financial year, they will need a lot more than that - probably up to R4-billion".

It is not known whether shareholders would be willing to give the bank more cash, having coughed up R5.5-billion so recently.

"The market is not going to give them another chance . they had their chance and they didn't raise enough money," said Storey.

Should Abil decide on another rights issue, it will probably have to offer a heavily discounted price of R4 to R5 a share - which would mean a big loss in shareholder value.

Storey believes African Bank hit the wall because it "started extending the repayment terms of loans".

"If you think about taking out an unsecured loan of R200000 over 84 months, it is just ludicrous in terms of what the client will have to pay back," he said.

As Abil lent out bigger amounts repayable over longer periods it failed to develop the risk forecasting models needed to predict how many of the loans would go bad.

This mismatch in risk led to Abil's non-performing loans growing to R16.6-billion - 28% of its total R59-billion in advances.

Said Storey: "That is really what it comes down to: not covering their non-performing loans adequately ... the loss rates they are seeing are a lot higher than they had predicted and that is what is [hitting] earnings."

Another problem is that to get the cash it needs to make loans Abil raises debt in the wholesale market. If funders raise the interest rate they are charging Abil for this cash the lender would have to raise its rates to borrowers - which would hurt its ability to compete with rivals such as Capitec.

The price Abil is paying for credit is starting to increase, but has not yet reached a "turning point". If sentiment among Abil's funders worsened, which it would if there were a ratings downgrading, it would find it harder to find funding .

As Abil treads a very tight funding line, concern is growing that the response to the crisis by Leon Kirkinis's management team has missed the mark.

Considering the massive spike in non-performing loans, analysts expected Abil to shrink - not expand - its loan book. Instead, it has done just the opposite.

"They basically got R5.2-billion in the rights issues, and in December they had one of their biggest months ever in terms of loan disbursement[s]," said Storey

Analysts say lending more to a struggling market in an attempt to "grow out of the problem" seems risky.

To make things worse, a new set of regulations covering "affordability assessments" and insurance on loans is about to come into force.

Storey said this adds to the risk of investing in a business that has already got question marks over the quality of its assets.

"This is why we are still telling our clients and potential investors to be careful. Our valuation on Abil is closer to R6.50 a share, which suggests 30% down from current levels."

Abil is also in trouble because it was too ready to grant credit, in some instances equal to 80% of the client's disposable income.

One banking executive, who asked not to be named, said this laxity creates a vicious cycle. "As the population becomes over-indebted, less and less people qualify for credit and the lenders get more and more desperate to lend to the remaining people.

"What we are seeing here is a movie that has played out countless times before," he said.

The bank executive said that Abil had blamed everyone but itself, refusing to take responsibility for what happened.

"They have blamed the market, other credit providers or the environment for what has happened.

"When you control 35% of a market, these arguments do not hold and, until they have looked in the mirror and acknowledged their role in this process, solutions will be hard to find."