EDINBURGH — Short-seller Viceroy released an explosive research report on South African stock market darling Capitec earlier this week, claiming that the financial services company is in such a dire state that the government should immediately place it into curatorship. Viceroy says it believes Capitec is “a loan shark with massively understated defaults masquerading as a community microfinance provider”. Some local analysts have slammed Viceroy for producing a report in its own self-interest. But Viceroy isn’t the only investment firm that has been questioning Capitec’s financials. Black-owned Benguela Global Fund Managers has had Capitec under the microscope for some time. The Benguela team reckons that, although Viceroy has produced a report designed to benefit its own trading objectives, the controversial document contains some allegations that resonate with Benguela’s concerns about Capitec. Benguela Global Fund Managers’ chief investment officer Zwelakhe Mnguni sets out the shortcomings of the Viceroy report and Capitec’s financial reports for his clients. Capitec appears to have misled investors. His letter is republished here on BizNews, with his kind permission. – Jackie Cameron
Snapshot from Viceroy Report:
Based on our research and due diligence, we believe that Capitec is a loan shark with massively understated defaults masquerading as a community microfinance provider. We believe that the South African Reserve Bank & Minister of Finance should immediately place Capitec into curatorship.
Capitec Bank Holdings Limited (JSE: CPI) is a South Africa-focused microfinance provider to a majority low-income demographic, yet they out-earn all major commercial banks globally including competing high-risk lenders. We don’t buy this story. Viceroy believes this is indicative of predatory finance which we have corroborated with substantial on-the-ground discussions with Capitec ex-employees, former customers, and individuals familiar with the business. Read the Viceroy report on Capitec.
Dear Benguela Clients
Today was another dramatic day in the market due to a report released by Viceroy that was highly critical of Capitec Bank’s accounting and business practices. The stock fell to an intraday low of R705.00 (i.e. down 25%) before recovering to close at R915.92 (down 1.5%).
- During the press conference, we were mentioned as one of the companies that had written to Capitec to raise concerns around certain issues. We confirm this to be the case.
- We wrote to Capitec on the 19th of Jan 2018 (almost two weeks prior to the release of the Viceroy report).
However we need to clarify a few things about how we approach company engagements:
- Our approach to company engagement: While our engagement with companies is never a secret, our approach is always to give companies a chance to respond to our questions and concerns before making the details of such engagement public outside our existing clients.
- Purpose of engagement: As part of our investment research we have a policy to engage with companies prior to investment or disinvestment around issues/questions/concerns be it: financial, environmental, social or governance. Capitec was no different. Even if we currently don’t own Capitec and never owned shares in it in the past four years, we continue to review their financials and valuation on an ongoing basis to identify the best entry levels in the stock. We are not a hedge fund and never had any association with a hedge fund. Our research is conducted on a confidential basis as it comprises our competitive advantage.
- Investment approach: Benguela is a long-only fund manager whose research is aimed at finding direct investment opportunities in listed assets. So we never make money on falling share prices and if we are invested in a security we would get hurt by falling share prices.
- Embargoed stock: During our engagements with companies we don’t trade in the stock under review as this heightens the risk of being accused of price manipulations should our research come out as it did in the case of Capitec.
- Our focus area in Capitec’s engagement: Our engagement with Capitec centred around their rescheduling of arrear loans. The letter is detailed and is based entirely on publicly available information contained mostly in Capitec annual reports. While we generally keep these engagements secret until some time after engagement we are deviating from this norm for transparency purposes – see attached letter.
While shareholder activism should be welcome in our market, we have some serious reservations on the Viceroy approach and several assertions in their report:
- It is totally unfair to challenge a company’s business practices without giving it a right of reply. This is the professional standard of practice
- While corporate shenanigans should be publicised to ensure that our market is not infested with another story of accounting irregularities as we’ve seen with Steinhoff, we need to be cautious not to allow price manipulators into our market. Shorting a stock is not illegal but giving it bad publicity because one has shorted or intends to short a stock is totally unacceptable. Like the irregularities that a researcher may be seeking to expose, the false attack on a company could do some serve damage to other investors’ interest. This should not be allowed at all.
- The assertion that Capitec “should be placed under immediate curatorship” by the Reserve Bank and Minister of Finance is shocking and irresponsible.
- If Viceroy has evidence of such enormity it would have been better to approach the regulators directly or the police as we have done in the case of Steinhoff.
- As a result, Benguela totally condemns the Viceroy approach to raising governance issues and it appears to be motivated by pure greed than actual interest in the company. There is also a question that needs to be asked about Viceroy’s intense focus on the SA market. Is our company disclosure so good that it is easier to find issues in our stocks than in stocks listed in other major global exchanges. It is particularly baffling when one considers that the JSE is less than one percent of the global market and the company shorting stocks is US based.
- Viceroy relied heavily on information that is not necessarily accessible to the general public (e.g. interviewing ex-employees). Benguela would only go to such extreme measures if we fail to secure the cooperation of the companies we seek to interview.
- As indicated our concerns are around the rescheduling of arrear loans only their related financial impact and how these are reported on in the annual financial statements.
- Having look at the financials in detail, we can confirm that from our analysis there is no reason to be concerned about Capitec’s liquidity or solvency. Our position is that Capitec is a healthy bank with certain practices that are questionable but certainly not a bank about to collapse. Even with our worst case assumptions, we cannot arrive at the Viceroy Impairment provision of R11 billion. We cant even get to 50% of that on our numbers.
Having highlighted what we see as the shortcomings in the Viceroy report we believe that Capitec has to unemotionally address the substantive issues raised by ourselves and Viceroy:
- Benguela’s position on the financial effects of rescheduled arrears: The rescheduled arrears should attract the same impairment provisions as they would have in any case had they been left in arrears. This would ensure that loans don’t get shifted into rescheduled arrears to lower the impairment put through the books. This is irrespective of the circumstances behind the rescheduling.
- Benguela’s Social concerns: Benguela is totally against the possibility of Capitec clients being caught in a debt spiral as a result of Capitec’s rescheduling policy. We would also be totally against clients being charged origination fees on rescheduling. During today’s press conference, Capitec has suggested that this is not the practice. We find this hard to believe as it raises questions of whether affordability tests are conducted prior to rescheduling. It would be unsustainable for Capitec to incur origination expenses (e.g. credit record checks) with no matching revenues. Based on the Gross rescheduled arrears (6 months) of R1.6 billion in 2017 and average loan size of R7 761, we estimate that there were approximately 203 908 arrear loans rescheduled.
- Benguela’s position on disclosure: It is our strongest belief that disclosing only loans rescheduled in the last six months can be misleading to investors as rehabilitation itself takes 6 months. We also would like to see disclosure on bad debts from the rescheduled arrears to fully satisfy ourselves that the rescheduled arrears are not the key driver of the substantial rise in write-offs in the last few years
- Inconsistencies: As highlighted in our letter there seems to be inconsistencies between the rising percentage of book classified as high risk and the impairments in all rescheduled a loans. Viceroy seems to corroborate this by showing that competitors of Capitec are experience much higher non-performances in their books of circa 30% vs 10% for Capitec. This gap is huge irrespective of how well Capitec writes credit. It therefore needs a thorough explanation
- Viceroy’s questions on JP Verster participation in both the fund management industry and Capitec are justified and warrants a review. JP is a good acquaintance to Benguela and an industry colleague. We don’t see why he should be at Capitec.
- Yes we have some questions and concerns on Capitec but it is certainly not at risk of bankruptcy.
- However we believe that all substantive issues raised by stakeholders must be addressed irrespective of the flaws in their approach.
- Benguela doesn’t own shares in Capitec at the moment
To demonstrate our transparency and fairness to all, I have copied the Capitec CFO and CEO in this email.
Zwelakhe Mnguni, Chief Investment Officer, Benguela Global Fund Managers.
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