Q&A with Mark Herskovits, executive director: capital management
Q: FROM A CAPITAL MANAGEMENT PERSPECTIVE, WHAT ARE THE KEY COMPONENTS OF THE TRANSFORMATIONAL EQUITY DEAL BETWEEN SANTACO AND SA TAXI?
Firstly, the strategic importance of this deal cannot be overstated. It provides SANTACO and its members, who are key stakeholders in the minibus taxi industry, with access to a substantial part of the industry value chain in SA Taxi's business. The 10% trickle dividend income flow into infrastructure and development projects will enhance the sustainability of the industry and stands to improve the experience of commuters. From a commercial perspective, we expect significant financial benefits as a direct result of the transaction, along with operational benefits from an enhanced relationship with SANTACO.
The capital management team's focus for the transaction was raising capital to fund SANTACO's investment. Approaching two of our largest debt funders, Standard Bank of South Africa and Futuregrowth Asset Management, was a natural fit as they understand our business and our ability to manage risk in providing developmental credit in a unique industry. Also, the transformational nature of the equity deal and its importance at a national level made it an attractive proposition for these long-standing funding partners.
Of the R1.7 billion paid for the 25% stake in SA Taxi, Standard Bank and Futuregrowth are co-funding R1.2 billion as the senior funders. SA Taxi is facilitating the transaction by providing subordinated vendor finance of R521 million, which reduces risk for the senior funders. It is important to note that the transaction is based on a full value for SA Taxi, with no discount applied to the shares.
The beneficiary structure will ensure that ownership and associated economic benefits of the investment cascade down to provincial levels as the beneficiaries comprise the broad-based provincial taxi councils.
For Transaction Capital and SA Taxi, it was crucial that SANTACO received independent advice during the negotiations. Accordingly, ENSafrica acted as advisors to SANTACO over the course of the transaction.
The transaction has been structured to account for the unique characteristics of the industry to achieve broad-based benefits, and its scale and potential impact are unmatched. I believe that the deal has challenged conceptual boundaries on transformation in South Africa, and represents the kind of initiative that is required to achieve sustainable shared value in our economy.
Q: WHAT HIGHLIGHTS HAVE THERE BEEN FOR SA TAXI IN CAPITAL MANAGEMENT?
We issued two tranches of Moody's credit rated and JSE-listed debt through the Transsec 3 securitisation programme over the year, with an initial R505 million in November 2017 and a R505 million tap issuance in June 2018. We continue to see strong demand and pricing for SA Taxi debt issuances, with the total Transsec 3 issuance oversubscribed by 2.6 times and more than 80 basis points cheaper than Transsec 2's total issuance.
Also, after the financial year end, we received board approval for USD100 million in debt funding through the African Development Bank in October 2018. The deal is comparable to the funding received last year from the development finance institutions (DFIs) in the United States, in that it shows confidence in our investment proposition. It also recognises SA Taxi's ability to manage the risk of developmental credit in a specialised industry, while delivering measurable social impact. The African Development Bank specifically noted that the loan facility is aligned to its High 5 priorities, which include "Improving the Quality of Life for the People of Africa through improved safety and roadworthiness for commuters", as well as being aligned to its "Private Sector Development Strategy, SME support agenda and the Green Growth Initiative".
SA Taxi's funding requirements for the 2019 financial year are secured, with a diversified funding base of 44 distinct debt investors.
Q: ARE TCRS' CAPITAL FUNDING REQUIREMENTS CHANGING?
The funding dynamics for TCRS are different, and traditionally TCRS has not been as capital intensive as SA Taxi. This dynamic will remain going forward; however, with the trend of greater volumes of NPLs being acquired as principal, TCRS will have slightly higher capital requirements than in the past. As a result, the capital management team is working with the division on a revised capital management strategy. As capital was previously raised separately in each of the main balance sheet businesses within TCRS, the new strategy includes changes to the legal and commercial structure by raising capital for the division collectively.
We anticipate that this will achieve better efficiency and cost of capital for TCRS. It will also present an enhanced proposition for investors.
Q: WHAT PROGRESS IS BEING MADE IN THE CAPITAL MANAGEMENT STRATEGY ACROSS THE GROUP?
We continue to focus on investing equity capital, conservatively leveraged with local and international debt, into accurately assessed asset classes to achieve superior risk-adjusted returns. In addition, Transaction Capital is conservatively geared with debt capital accessed through diversified funding structures that are attractive to a broad range of local and international investors who have an in-depth understanding of the underlying businesses and their asset classes.
Due to the dynamics at play in the South African economy, we are seeing lower levels of borrowing by businesses and higher risk aversion to debt being issued, especially by state-owned enterprises who are traditionally the biggest borrowers in the local market. This is resulting in a shortage of quality paper for investors. However, it is good news for companies like Transaction Capital who continue to grow and manage credit risk effectively, as it drives demand for our debt both locally and internationally.
With strong liquidity and approximately R1 billion excess capital on its balance sheet post the SANTACO equity transaction, the group is shifting its focus to optimising capital management from a cost and capital structure perspective. A more disciplined approach to funding, along with demand for our paper, means that we are in a position to be more discerning in the capital we access. As a result, we can manage capital requirements to strike the optimal balance between the right type of funding at the right terms for the right asset classes, according to the unique needs of each division.
Diversification across debt investors, funding structures and geography remains important. For instance, while the African Development Bank loan has a relatively higher cost of capital (predominantly due to the swap costs and longer duration of the debt), it provides the security of a large quantum of funding over an eight-year period, which is unavailable in the local market. With this type of funding in place, we are in a position to be more selective in accessing other funding.
On the other hand, the Transsec 3 issuance has continued the trend of raising cheaper funding for SA Taxi, which enhances our strategy to lower the cost of capital. However, capital management across the group requires that we balance the quantum and tenor of debt capital that we raise with the optimisation of capital structures according to the specific needs of each business.
The demand dynamics in the market and the group's strong performance have enabled this philosophical shift to optimal capital usage for Transaction Capital. Lowering the cost of capital through enhanced capital management stands to improve the group's margins and benefit its clients through more competitive rates. However, considering the time required to arrange large funding transactions and the tenor of these loans, the capital management team will follow a phased approach over time as we become stricter on our selection.
Despite ongoing pressure in the South African economy, Transaction Capital raised approximately R4.9 billion in 2018 from 45 separate funding transactions and added 10 new investors. Group average cost of borrowing improved to 11.8% (2017: 12.0%), with the margin above the repo rate at 5.2%. The foreign debt component remained stable at 20%, which is fully hedged to the Rand.
Our capital adequacy position remains robust at 30.9%, comprised of 22.9% equity and 8.0% subordinated debt.
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Q: HAVE THE CHALLENGING ECONOMIC CONDITIONS IMPACTED THE GROUP'S CREDIT RATINGS?
Our ratings performance remains strong and unchanged from last year; the Transsec 3 senior notes are rated Aaa.za(sf) by Moody’s and Transaction Capital’s R2 billion note programme is rated A-(za) by Global Credit Ratings Co. (GCR). Subsequent to year end, several ratings of Transsec 1 and 2 were upgraded by S&P Global and Transaction Capital was placed on positive ratings watch by GCR as a result of the announcement of the equity transaction with SANTACO.
Q: WHAT IS THE KEY FACTOR UNDERPINNING THE CAPITAL MANAGEMENT TEAM'S ABILITY TO MAINTAIN ROBUST ACCESS TO CAPITAL MARKETS?
It has been another successful year for capital management and the group. Besides the capital markets dynamics mentioned earlier, where a shortage of quality paper is supporting demand for debt issued by Transaction Capital, the group’s ability to sustain performance in a challenging environment is key.
Also, our ability to manage the risks that come with providing developmental credit while delivering real and measurable social impact is critical in attracting funding from DFIs.
As mentioned above, we are now in a privileged position to be more discerning in the debt we access. This is based on the strength of our investment proposition and should allow us to reduce the cost of capital over time.