Following the release of Viceroy’s report into Capitec on Tuesday morning, boutique asset manager Benguela Fund Managers has made public an extensive letter it sent to Capitec’s chief financial officer, Andre du Plessis, in which it raises very similar concerns. The letter was sent to Du Plessis on January 19.
“Our concerns revolve around the rescheduling of arrears and the impact these have had on reported financial performance of the business,” wrote Benguela’s chief investment officer, Zwelakhe Mnguni. “We believe this practice has distorted the true performance of your business and warrants some review.”
Rescheduling, also known as restructuring, refers to the practice of offering new payment plans to clients who are struggling to meet their obligations. This benefits both the lender and the client, as the client is essentially given another chance to pay back what they owe.
However, Benguela believes that Capitec’s restructuring practices may be distorting its performance.
“Since inception, Capitec held a high reputation of being a prudent, cautious and a conservative participant in the unsecured loan market,” Mnguni noted. “It is this discipline that enabled Capitec to prosper when competitors like African Bank and Blue Financial Services floundered as a result of their ill-discipline.” However, “having had a look at the recently-introduced (2H2013) practice of arrear loan rescheduling we are concerned that Capitec could be following in the steps of its failed peers.”
Benguela pointed out that on a rolling 12 month basis, rescheduled arrears account for 76% of actual total arrears.
“We do not believe that this demonstrates the reported conservative business ethos in Capitec’s lending practices,” wrote Mnguni. “It is downright aggressive to reschedule 76% of arrears.”
Possibly reckless
The fund manager also questioned whether this wasn’t an indication of reckless lending, echoing the sentiment expressed by Viceroy:
“Clients in arrears are already struggling to repay their Capitec loans, it would appear that they are being issued new loan contracts to start afresh despite their impaired ability to honour their existing obligations,” Mnguni noted. “We believe that it is near impossible for 77% of the clients in arrears to successfully apply for rescheduling especially when it was reported that more stringent rule changes applied to the rescheduling policy: As a result, it does appear to be reasonable conclusion that some form of reckless lending may be taking place within Capitec’s arrears loan book.”
Benguela went on to highlight that Capitec’s bad debts had picked up materially since it introduced loan rescheduling in 2013.
“We believe that this is a symptom of the aggressive rescheduling of arrears,” Mnguni noted.
He also raised its concerns about how rescheduled loans are reported as ‘new sales’.
“The trailing 12-month rescheduled loans now contribute over 16% to new sales and by extension lending and interest income,” Mnguni noted. “In the past four years, an average of 98% of gross loan book growth came from rescheduled arrears. It is indisputable that without rescheduling the arrears, Capitec’s reported loan book and revenues would have been stagnant for the past four years. This is material to a large degree.”
In other words, all of the growth in ‘new sales’ reported by Capitec since the 2013-2014 financial year can be put down to rescheduled loans. These are, however, existing loans just offered on different terms.
“We would like to enquire about whether the board is aware of how material the rescheduling practice has been in the reported growth of the loan book, revenues and profits?” Mnguni wrote. “In addition we are curious to know what the board has done about this aggressive level of rescheduling?”
Governance issues
Benguela further pointed out that any rescheduled loan requires a new contract, and every new contract incurs an initiation fee. This may be creating an undue incentive to reschedule loans, as it allows for clients to be charged this fee a second time. The fund manager estimates that these origination fees from rescheduled loans “contributed on average about 5% per annum to Capitec’s profits before tax”.
The fund manager also raised concerns that the material impact that these rescheduling practices were having on the bank’s financials raised serious governance issues.
“It is of grave concern that the rescheduling has contributed materially to two key executive incentive key performance indicators (KPIs): Heps growth and return on equity (ROE),” wrote Mnguni. “The rescheduling is therefore a hugely conflicted and material contributor to performance incentives. Given that the losses on rescheduled loans are not disclosed, it is difficult for shareholders to understand the role played by rescheduling on bad debts in the past. We believe that the board has to urgently close this loophole and at the extreme clawback the performance incentives that were achieved through rescheduling of loans and advances.”
Finally, Benguela also registered its concern that, as a microlender, Capitec faces particular sociopolitical risks that cannot be ignored.
“There is a real risk of a social backlash under the impression that Capitec is profiteering from the miseries of their struggling clients,” Mnguni pointed out. “This may bring political and regulatory scrutiny to the business.”
Benguela asked Capitec to respond to its letter within two weeks. The bank has committed to doing so.
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