Why Capitec should be very, very afraid

The decision to dish out huge unsecured loans for longer periods, at a time when bad debt is breaking through new levels, has raised eyebrows among experts.

Analysts fear SA's youngest bank could face a nasty surprise

Capitec Bank CEO Riaan Stassen is a drummer, and his bank has played a tune that attracted many customers in recent years. But is the music coming to an end?

The group's decision to dish out huge unsecured loans for longer periods, at a time when bad debt is breaking through new levels, has raised eyebrows among experts.

"They are taking a stab in the dark," said one analyst. He cautioned that Capitec had never offered these type of loans before so it did not know its clients' willingness to repay these loans over prolonged periods or how the economy would perform in future.

Capitec financial director André du Plessis wrote in the bank's annual report, which came out this month, that loans repayable over longer than 12 months had grown 80% - up sharply from 67% last year.

These longer loans attracted 347000 new customers to the bank. By contrast, loans repayable in less than 12 months fell 19% during the year.

The Stellenbosch-based bank has been vocal in saying it will tighten its lending criteria - but it has not done so noticeably, while its peers have.

Rival African Bank turned off the taps much earlier, and paid dearly for that decision, as its share price was pounded this week when the extent of bad debt in its loan book emerged.

This week, Stassen repeated his bank's commitment to being prudent, saying he did not foresee that his bank would continue lending as aggressively "for the next two years".

While other banks are treading carefully, Capitec lent a staggering R7.8-billion to new customers - a 58% jump on the previous year.

First Avenue Asset Management's head of financials and retail, Matthew Warren, warned that Capitec's "way of dealing with a problem is to put it off and make it bigger".

This approach contrasts with African Bank's, which recently hiked provision for bad debts sharply, raising the alarm about a collapse in the unsecured lending market. African Bank started tightening its loans-granting procedure last year, which led to slower growth and higher bad debt as a percentage of its loans.

African Bank CEO Leon Kirkinis chose not to continue writing new loans to cover bad debt. As a consequence, it reported a 26% drop in its half-year earnings this week. It also cut the period of loans it granted.

Warren said Capitec's extended loan terms were its response to pressure on its customers, while expanding earnings. Capitec had already grown its "extended loan book" - loans repayable within 61 months to 84 months - to more than a third of new loan sales.

According to Warren, it can only continue to behave like this as long as the economy performs reasonably. If there is a sudden slowdown, Capitec could be living on borrowed time.

His argument is based on the fact that loans granted between 2007 - a year after the National Credit Act came into force - to the middle of last year increased significantly.

But Stassen told Business Times this week he did not believe Capitec was in the same position as African Bank as Capitec has made greater provision to cover bad loans.

Afena Capital portfolio manager Khaya Gobodo reckoned Capitec could afford to be more aggressive as it had made higher provisions as a buffer for bad debt.

But he echoed Warren saying that if it turned out that Capitec was wrong in its reading of the credit market, it was likely to run into a tough time.

African Bank financial director Nithia Nalliah said his bank would not give more credit to customers just because rivals did. He was comfortable with the decision to tighten the taps and "err on the side of caution".

Afrifocus Securities research head Johann Scholtz said if Capitec shut off the taps completely it would put the entire sector at risk because no one would be able to borrow money to repay their existing loans.

If it was true that people were taking out new loans to repay old loans, as suggested, that would be worrying.

Capitec began as an unsecured lender, but in recent years grew its transactional banking side significantly, taking market share from the big banks.

But the jury is still out on the quality of its new customers.

Warren believes that if Capitec had not been so loose in its lending criteria, it would not be gaining market share so quickly. "It will pay for that in troubled loans," he said.

Over the past five years, Capitec's lending activities grew 30.5% a year, from R1.4-billion to R3.9-billion, while transactional fee income grew 65% to R2.1-billion.

Last year, Capitec wrote off R1.7-billion in bad debt - sharply up from the R1-billion previously. It also set aside R2.7-billion as an "impairment" for doubtful debt.

But because it continued to lend aggressively, this R2.7-billion amounted to only 8.9% of its total R30.6-billion lending book, up only marginally from 8.4%. Had Capitec shut off the taps like African Bank, it would have been another story entirely.

Had Capitec kept its loan book at the R18.4-billion level it reached in February 2012, that R2.7-billion impairment would have amounted to a rather more worrying 14.6% of its loans.

Nedbank's CEO Mike Brown believes huge loans, paid over longer periods is "a sign of froth". Nedbank's unsecured loans remained flat in the first quarter of this year - a sign that the bank chose not to lend aggressively to this market.

Last year, Nedbank lifted provisions for unsecured loans by R330-million.

Brown said that as long as there were players willing to grant big loans for longer periods, the "merry-go-round" would continue.

Part of the fallout in bad debt comes from labour unrest as more workers strike for higher wages.

At Capitec, for example, the mining industry makes up 7% of its loans book. Workers who ended up fired, docked pay or taking out huge loans in the expectations of giant pay increases found themselves unable to repay their microloans.

Backlash shocks African Bank

IT HAS been a rough two weeks for African Bank CEO Leon Kirkinis as the extent of bad debt in the risky unsecured lending sector became brutally clear.

The country's biggest unsecured lender shed 42% of its value - a whopping R9.5-billion - in two weeks, since it issued a profit warning. The bank's share price is now at a 15-year low in a year when the banks index gained 6.6%.

This week, Kirkinis apologised to shareholders for "surprising" them with the extra provisions his bank set aside to cover bad debts. "The recent turn of events took us [African Bank] by surprise," he said.

African Bank's financial director, Nithia Nalliah, said that while the bank expected a negative reaction, the extent of the market backlash "shocked" it.

Earnings fell 26%, and its return on equity fell to 13.9% from 20.3% the year before. The cut in dividend from 85c to 25c also left investors unimpressed.

Said Kirkinis: "We see no signs that things will get any easier."

Nalliah said: "Yes, we disappointed. We have made some mistakes. We have taken on a little more risk than we should have."