Integrated Annual Report
2020

Q&A with Mark Herskovits, chief investment officer

with MARK HERSKOVITS / CHIEF INVESTMENT OFFICER

What were the key drivers for the capital management activities undertaken at group level during the year?

  • At the start of the pandemic, we took urgent action to ensure that we had the capital strength and flexibility to support the group and subsidiaries throughout the crisis, especially given initial uncertainty on its likely impact and duration. In addition to the successful debt negotiations undertaken with SA Taxi’s funders, we approached two of the group’s long-standing and trusted debt funders in South Africa to secure a R400 million standby liquidity facility that we could access if the subsidiaries needed additional funding support at any stage during the crisis.

    Thankfully, the resilience of both divisions and the cooperation of SA Taxi’s funders meant that we did not need to access that facility at all. It was a cautious approach informed by our long-held conservative capital management philosophy, but ultimately it removed any funding concerns from play, to allow us to focus on other priorities across the group.

    The second key capital management initiative at group level was an equity capital raise in June 2020, in which we raised R560 million in an accelerated bookbuild process. It was a proactive equity raise and well timed given the recovery in the Transaction Capital share price after the initial dip in April that affected almost all local and international counters. Our proactive approach also meant that we were ahead of the local market, and we achieved an R18.20 issue price, an impressive 2.2% premium to the pre-launch 30 business day volume-weighted average price as at market close on 17 June 2020. It bolstered our balance sheet in a challenging operating environment and gave us the headroom to continue pursuing strategic growth opportunities, specifically initiatives in TCRS and TC Global Finance.


Transaction Capital’s balance sheet strength was key to enabling the WeBuyCars transaction. Is such a large acquisition a departure from its long-held conservative capital management approach?

  • Not at all. The undeployed capital held prior to COVID-19, the equity raise in June 2020 and the additional R329 million equity raise in September 2020 to part-fund the WeBuyCars investment meant that we were in a position to pay R900 million of our own cash and only needed to access an additional R220 million from existing debt facilities. Being conservative in the management of capital and pursuing opportunities for growth are not mutually exclusive. We believe that WeBuyCars represents a really smart investment for the group.

    As mentioned by David Hurwitz, the WeBuyCars investment fulfils the acquisition criteria that form part of our strategic objectives in almost every instance. The business is high growth but capital light and with minimal debt is strongly cash generative. This will facilitate healthy cash flow generation and dividend income to Transaction Capital.

    With strong prospects for growth, WeBuyCars will further enhance our ability to generate superior risk-adjusted returns. I believe the transaction will initially see a subtle change in the view of the group by our funders and shareholders. Although funding structures are ringfenced across the different areas of the group, funders and shareholders do take into account the strength and health of the group as a whole, as well as its overall strategy and prospects. The stronger the group becomes, the more benefits flow to every subsidiary and business in the group.

    The WeBuyCars investment came as a surprise to some parts of the market, but as with all new developments in the group, we continue engaging with the market on its prospects for Transaction Capital as well as the value we can bring to WeBuyCars. The rise in Transaction Capital’s share price certainly indicates an overall positive market response. Ultimately the proof of its worth will be in its ability to create significant value for funders and shareholders in the group over time.

    The key pillars of our capital management approach remain unchanged:

    FUNDING PHILOSOPHY
    INNOVATIVE THINKING
    ENGAGED DEBT INVESTORS
    JUDICIOUS RISK MITIGATION
    OPTIMAL CAPITAL STRUCTURES
    • Innovative thinking is encouraged and cultivated to develop pioneering funding solutions.
    • Recurring investment by debt investors motivated by performance, ease of transaction and appropriate risk-adjusted returns.
    • Transparent and direct relationships with long-standing funding partners, where necessary facilitated by valued intermediaries.
    • Optimal liquidity management between asset and liability cash flows.
    • Effective management of interest rate, currency and rollover risk.
    • Controlled exposure to short-term and bullet instruments.
    • Diversification by geography, capital pool, debt investor and funding mandate.
    • Proactively managing valuable capital and funds raised across the group.
    • Bespoke funding structures to meet investment requirements and risk appetite of a range of debt investors, while also targeting an optimal weighted average cost of capital.
    • No cross-collateralisation between structures.

How has COVID-19 impacted capital management in SA Taxi?

  • The broad economic and regulatory implications of the lockdown had a marked impact on minibus taxi operators and through that, on our business, so it has been a very challenging year for the capital management team.

    SA Taxi provided relief programmes for clients in good standing to defer repayment of loan instalments and insurance premiums during April 2020, as well as specific payment relief to approximately 3 000 qualifying clients for May and June 2020. The payment relief totalled approximately R400 million, which reduced collections levels in that period and strained cash flows. We were proactive in approaching SA Taxi’s funders from the onset of the pandemic, securing various forms of debt accommodation through direct negotiation with our funders. The few funding vehicles across SA Taxi which were impacted each required a slightly different solution, but all of them had the same aim: to take cash flow pressure off the business by delaying capital payments, while continuing to service interest payments and maintaining our obligations to our funders.

    In allowing these amendments, our funders directly supported SA Taxi’s ability to extend payment relief to our clients, and our incredible funder support stands as one of the highlights of the year for me. The funders recognised that the impact of the pandemic was unavoidable, and their unanimous willingness to support SA Taxi shows that they understand the defensiveness of the business model, and are confident in the ability of the management team to return the business to its long-term track record of growth.

    SA Taxi entered the crisis with a strong balance sheet, healthy capital buffer and a track record of great performance, and we have consistently applied ourselves to building transparent and valued relationships with our funding partners over the years. That has built a foundation of trust with our funders, which ultimately formed the basis of their support of the business through the pandemic.

    Funders were also inundated with requests from many companies for relief or debt restructuring in the early days of the pandemic. Transaction Capital took a proactive approach by opening discussions immediately and providing solid and considered proposals on the structure of the relief we sought. I think that helped us immensely in ensuring a positive outcome and in further reinforcing our position as a valuable investment for them. And in many of the conversations with our funders, we were reassured that Transaction Capital remained one of their lowest concerns across all their investments.

    Our funding partners appreciate that SA Taxi’s market positioning is strong, and that represents a vote of confidence in the ability of the management team to take the necessary steps to ensure the business comes through this crisis intact and positioned for growth.

Did your ability to measure, analyse and act on operational data build a level of comfort for funding partners?

  • Yes. There was an intense focus on ongoing engagements with funders, to the extent of weekly calls with a number of our partners to keep them updated on performance and forecasts. That was driven by the uncertainty across all markets, locally and internationally, and across the group we were constantly engaged in testing and updating models and forecasts as the pandemic unfolded.

    It is the kind of environment where close to real-time information is essential, and having access to accurate data and meaningful daily metrics meant that we reinforced our credibility with funders. This included the collections rates that are tracked at a granular level by Transaction Capital Recoveries and the telematics data on minibus taxi activity across SA Taxi’s fleet. Robust data formed the basis for open and transparent engagement on the challenges facing the group and its divisions, as well as the opportunities emerging for them.

    The crisis really brought to the fore the strength of our relationships across our stakeholder base. But my team and I are particularly grateful that when we most needed it of our funders, we received unanimous support across our funder base in South Africa and internationally.

While funders understand the relevance of SA Taxi’s business model, were they concerned about the resilience of the minibus taxi industry itself?

  • Funders did have questions on the impact of the crisis – in all its forms – on the industry. Given the scale and unprecedented nature of the pandemic, it was an uncertain environment for everyone, in every industry. Also, healthcare and economic impacts were constantly shifting, and there were differences in local, national and regional characteristics of infection rates and containment efforts. While our initial estimates of the impact on minibus taxi activity and recovery proved inaccurate, we kept our funders informed on updates to our forecasts as well as the evidence of the gradual recovery we have seen in the months since the hard lockdown has been lifted.

    It’s now absolutely clear that the industry remains indispensable to economic activity in South Africa. Minibus taxis were the only form of public transport that continued to operate during the lockdown, and it was quick to adapt to lower commuter volumes resulting from the suspension of normal business and social activity. And in step with the recovery of the industry, SA Taxi has already resumed a positive trajectory toward pre-COVID-19 levels of activity.

Was there a trade-off between the cost of funding and securing liquidity?

  • In this kind of operating environment, cost of funding becomes secondary. We expected a cost increase and that transpired, but it was more than offset by the 300 basis points in interest rates cuts by the South African Reserve Bank. In SA Taxi, on a total basis, our cost of funding actually reduced to 9.8% (2019: 11.1%) due to the base rate shift, although our credit margin increased.

    Across the group, the cost of borrowing reduced to 9.6%.

    COST OF BORROWING – GROUP 1. Calculated using Transaction Capital’s average cost of borrowing (including bank overdrafts) and the South African Reserve Bank’s average repo rate for the period.

    COVID-19 has driven an increase in the level of gearing at SA Taxi due to the combination of the payment relief measures lowering earnings, slower capital debt repayments by SA Taxi and raising additional debt facilities to maintain liquidity.

    That being said, the recovery in collections activity is already evident, and the increasing relevance of SA Taxi’s business model and the minibus taxi industry’s position as an essential service substantiate our view that we will be able to build capital adequacy back to normal levels over the medium term.

    We continue to carefully track our performance relative to gearing levels. SA Taxi remains adequately capitalised, with a Tier I capital adequacy ratio of 15.7% and R2.7 billion of equity. Its access to liquidity remains unfettered with more than R4.0 billion of new debt facilities concluded since 1 April 2020. Ample liquidity is available in undrawn debt facilities to fund loan origination into 2022.

    The group’s medium-term target for a capital adequacy mix target of 20% tier 1 and 5% tier 2 capital has been impacted by the crisis, and we expect it will take longer to reach these levels. Nonetheless, the fundamentals of the business remain sound and we are already on track to reverse the negative impacts of COVID-19.

In terms of the sovereign rating downgrade in South Africa, has that impacted Transaction Capital’s access to funding?

  • The downgrades were expected even before the compounding economic impact of COVID-19, and it is certainly of concern for the country as a whole. However, it does not present specific concerns to us from a funding perspective. The sovereign rating is watched by international funders, but SA Taxi’s international funding partners are all developmental finance institutions (DFIs), with a higher tolerance for risk than normal commercial funders. In a sense, the socioeconomic mandates of DFIs become more pressing in the challenging economic environment caused by COVID-19, and especially in supporting companies with a clear and proven social impact.

    As an example, SA Taxi was able to close a USD100 million facility with the African Development Bank in April 2020 at the height of the lockdown. The division enjoys strong support from DFIs due to the combination of its strong commercial position and meaningful social impact, specifically in empowering SMEs through financial inclusion and supporting the sustainability of the minibus taxi industry.

What was the impact of COVID-19 on capital management in TCRS?

  • As we have discussed before, funding dynamics for TCRS are different as the division requires far less capital than SA Taxi.

    Like SA Taxi, TCRS was in a strong capital position prior to the pandemic, and due to the flexibility of its operations, it was able to implement measures like work-from-home to resume most business activity veryquickly. Key here was the swift resumption of collections activity in the core businesses, which forms the bulk of cash generation. As a result, sufficient cash flows were generated throughout the crisis and we did not need to approach funders to change covenants or defer payments. The crisis has shown the level of resilience in TCRS and its ability to withstand stress from a funding perspective.

    We have provided extensive communication to the market on the impact to the carrying value of purchased book debts in TCRS, with further detail in the CFO’s report.

In terms of capital deployment, what are the priorities moving forward?

  • TC Global Finance remains a key growth vector for the group. We are actively looking to grow our investment portfolio in Europe and will be deploying capital in those activities in the new financial year. We are also cautiously pursuing growth in Australia in the acquisition of NPL Portfolios. In South Africa, we anticipate that the increasing pressure on consumer-facing entities will drive their appetite to sell NPL Portfolios. While it is taking longer than initially anticipated for these books to come to market, our balance sheet is healthy, so we can take up those opportunities when they materialise.

COVID-19 has stress tested the group’s capital management philosophy. Is it still fit for purpose in supporting the group’s growth ambitions?

  • The crisis has proven that our conservative and proactive approach is still entirely appropriate. The diversity of funders and funding sources served us well as we were not reliant on a small number of overexposed funders, especially given that funders were also negatively impacted by the pandemic. And as mentioned, we had unanimous support across our funding base due to us making proactive and reasonable requests for debt accommodations or new facilities as required.

    The group’s approach to capital management ensured that we had sufficient liquidity to sustain our operations despite revenue pressures. Uninterrupted access to funding and a strong balance sheet have also allowed us to continue pursuing avenues for growth. While we have not been immune to the economic impact, our capital management philosophy has been proven to be robust; it has provided the foundation for us to balance a conservative and entrepreneurial approach in the midst of a black swan event.

    We ended the financial year with a strong capital and funding position. But these have been immensely challenging times for our operations, and it will take years for the global economy to recover from the impact of the pandemic. We recognise that there is hard work to do in the years ahead.

    Our focus on maintaining good governance processes has also not been dampened by the crisis. The asset and liability committee continued to assess our performance against well-defined policies and risk tolerances across funding, structural and market liquidity risk, interest rate risk, currency risk and counterparty credit risk. Our resilience in the face of COVID-19 has demonstrated that our risk management approach is robust, and I acknowledge the dedication, expertise and hard work of our specialist teams in the capital management function and across our operations.

    STRONG BALANCE SHEET POSITION WITH UNFETTERED ACCESS TO LIQUIDITY
    ASSETS
    R23.4 billion
    Total assets
    R16.1 billion
    Total assets

    R11.4 billion
    Net loans and advances
    R5.1 billion
    Total assets

    R2.5 billion

    Purchased book debts
    R1.4 billion
    Total assets

    R423 million
    Inventories

    R428 million
    Properties
    LIABILITIES
    R17.0 billion
    Total liabilities

    R14.6 billion
    Senior and subordinated debt
    R13.4 billion
    Total liabilities

    R12.2 billion
    Senior and subordinated debt
    R3.4 billion
    Total liabilities

    R1.9 billion
    Senior debt
    R0.8 billion
    Total liabilities

    Majority relates to property backed mortgage loans and trade creditors
    Available debt facilities R1 billion approved undrawn facilities at holding company level to fund strategic growth initiatives. Available undrawn facilities covering loan origination requirements into 2022. Available undrawn facilities covering acquisition of NPL Portfolios into 2022. Undrawn facilities available.
    EQUITY
    R6.4 billion
    Total equity

    28.5%
    Capital adequacy ratio

    24.8% equity
    3.7% subordinated debt
    R2.7 billion
    Total equity

    20.9%
    Capital adequacy ratio

    15.7% equity
    5.2% subordinated debt
    R1.7 billion
    Total equity

    3.0 times
    Leverage
    R0.6 billion
    Total equity

    54.0%
    Return on equity
    Robust balance sheet with ample capacity to fund organic growth Group liquidity position remains robust, underpinned by a conservative capital
    strategy with:
    • Well capitalised balance sheets.
    • Positive liquidity mismatch.
    • Unfettered access to liquidity.
    • Growth initiatives to acquire NPL Portfolios in South Africa and Australia, and credit-related alternative assets in Europe remain valid and fully funded.
    Capital-light business model with:
    • Robust balance sheet with minimal leverage.
    • High cash conversion rates.
    DIVERSIFIED DEBT FUNDING STRATEGY
    DEBT STRUCTURE
    Pass-through structures
    Warehousing facilities
    Private structured finance
    (majority being international DFIs)
    On-balance sheet and syndicated loans
    2020 BALANCE OUTSTANDING
    R4.6 billion
    R1.5 billion
    R5.5 billion
    R2.4 billion
    COMPOSITION
    ~33%
    ~11%
    ~39%
    ~17%
    DEBT INVESTORS
    21 debt investors
    • Banks
    • Institutional investors
    • Fixed income funds and asset managers
    • DFIs and impact funders
    Two debt investors
    • Banks
    16 debt investors
    • DFIs and impact funders
    • Banks
    • Fixed income funds and asset managers
    Nine debt investors
    • Banks
    • Institutional investors
    • Fixed income funds and asset managers
    INSTRUMENTS
    • Rated and listed securitisation notes
    • Private or bilateral loans and debentures
    • Asset-backed loans
    • Private bilateral
    • Syndicated loans
    • Overdraft and working capital facilities
    COVENANTS
    • No accelerated repayment covenants
    • Interest rate step-up after year five
    • No fixed repayment profile
    • Debt repayment matched to collections on asset pool
    • No accelerated repayment covenants
    • Revolving structure
    • No fixed repayment profile
    • Debt serviced from collection on or sale of asset pool
    • Fixed repayment profile
    • Debt serviced from collection on asset pool

    Capital repayment relief in two quarterly payments between 1 April 2020 and 30 September 2020
    DIVERSIFICATION BY DEBT INVESTOR CATEGORY AND CAPITAL POOL
    DIVERSIFICATION BY FUNDING STRUCTURE AND INSTRUMENT
    DIVERSIFICATION BY GEOGRAPHY
    POSITIVE LIQUIDITY MISMATCH