What is the Land Bank?
The Land and Agricultural Development Bank of South Africa (the Land Bank) is a state-owned company (SOC), which falls under the oversight of National Treasury. The Land Bank is involved in funding the agricultural value chain in South Africa, but unlike other commercial banks, it has a joint mandate. Firstly, the Land Bank is involved in funding commercial agriculture and its supply chain and secondly, it has a mandate to fund emerging farmers in the form of developmental finance with the aim of transforming the South African agricultural industry and value chain.
The latest available financial information on the Land Bank is the financial statements for the year ended 31 March 2019 (FY2019) as well as unaudited interim results for the six months ended 30 September 2019 (H1 2020). During FY2019, the Land Bank disbursed R5 billion worth of developmental loans with its total developmental loan book amounting to R7.9 billion, or 17% of its overall loan book (an increase from a 12% share as at FY2018).
Is governance at the Land Bank sound?
The Land Bank was one of only a few SOCs which could access debt capital markets during the height of the governance concerns experienced at SOCs under the tenure of the prior administration (more specifically 2016 – 2018). This is evidenced by the ability of the Land Bank to raise in excess of
R14 billion in senior unsecured bonds since 2016 to the end of April 2020 without the requirement of a government guarantee.
This ability to access capital markets was testament to the appropriate governance frameworks implemented by the Land Bank over the last number of years. These governance frameworks were put in place by strong executive management teams which were relatively stable over the past number of years. The executive management teams were also ably supported by a well-constituted board with relevant experience across industries applicable to the mandate of the Land Bank.
In addition, the Land Bank recorded very low levels of irregular, fruitless and wasteful expenditure as per recent integrated reports, which also points to appropriate controls being in place.
However, during 2019, a number of senior executives parted ways with the Land Bank which resulted in some instability at the senior management level. This leadership change took place at a time when the agricultural industry was experiencing severe droughts which impacted the ability of the Land Bank’s customers to service their loans.
Permanent management (CEO and CFO) were appointed in February 2020, but with the challenges such as the drought, credit rating downgrades of the Land Bank as well as the sovereign, it has been a difficult introduction for the team. There is currently no clear indication of a deterioration in governance at the Land Bank and we are of the opinion that the new management team should be given an opportunity to see the entity through this very difficult time.
What is the financial position of the Land Bank?
During FY2019, the Land Bank delivered an acceptable financial performance. Net interest margin deteriorated marginally to 2.7% (FY2018: 3.0%) mainly due to delayed disbursements due to changing weather patterns as well as increased non-performing loans (NPLs). These loans increased to 8.8% (FY2018: 6.7%) mainly due to the ongoing drought experienced in the North West and Western Free State. A focus on operating costs enabled the cost-to-income ratio to improve to 57.1%
(FY2018: 60.5%). Further, the Land Bank maintained sufficient levels of capitalisation during FY2019 at a level of 16.4% (FY2018: 17.3%).
The H1 2020 results indicated continued strain in the agricultural industry, but the Land Bank still retained acceptable capitalisation levels of 15.9%, while NPLs increased to 9.9%.
Although we expect further increases in NPLs during FY2020 and some downward movement in capitalisation levels (mainly due to the continued drought in the affected regions), based on the information available, we continue to view the Land Bank as being in an acceptable financial position from a solvency perspective. This will, however, become clearer once the financial results for FY2020 are released.
How is the Land Bank funded?
The Land Bank funds its commercial book and its developmental book separately. The commercial loan book is funded through a combination of short-term and long-term funding from institutional investors and commercial banks. The developmental book is mainly funded by loans from development finance institutions (DFIs). The funding from DFIs may require government guarantees to back the funding, while the proceeds are ring-fenced and have strict disbursement conditions and reporting requirements.
As at FY2019, the Land Bank had in excess of R42 billion of funding with just over R22 billion maturing within a 12-month period. This indicates that the Land Bank had 50% of its funding on a short-term basis compared to almost 70% about five years ago. The Land Bank therefore had made progress in terming out its funding profile to more closely match the maturity of its advances into the agricultural sector. As at H1 2020, the Land Bank reported that further progress was made on this front, with short-term funding reducing to 48.8% of its total funding.
As at FY2019, the Land Bank had diversified its funding base. The Public Investment Corporation (PIC) and other SOCs accounted 24.2% of the Land Bank’s funding. Institutional investors accounted for 38.9% of the funding base and South African domiciled banks accounted for 17.5% of total funding. International banks accounted for 7.4% of Land Bank’s funding.
What was the liquidity profile of the Land Bank?
Given the reliance on short-term funding, the Land Bank faces a material debt roll-over requirement on an annual basis. During FY2019, R43.5 billion of Land Bank’s funding matured, with R39.5 billion being rolledover (the elevated amount is due to a number of exposures having to be rolled more than once during a twelve month period). The balance was funded through new debt raised of c.R11 billion.
The additional funding raised was used to prepay R3.1 billion of funding.
In addition to the above, the Land Bank created a sinking fund (amounting to c.R1 billion) to deal with pending debt maturities. Further, the Land Bank had access to c.R5.85 billion of liquidity as at FY2019 consisting of R3.2 billion cash on hand, R2.15 billion in undrawn committed facilities and R0.5 billion of uncommitted facilities. As at H1 2020, the Land Bank reported that available liquidity amounted to c.R9.15 billion consisting of R6.5 billion cash on hand, R2.15 billion in undrawn committed facilities and R0.5 billion of uncommitted facilities.
Based on the above, Land Bank illustrated a historic ability to manage its debt maturities and also maintained some liquidity to address liquidity events at short notice.
What triggered the default by the Land Bank?
The Land Bank first issued a Stock Exchange News Service (SENS) announcement on 20 April 2020 informing noteholders that a potential event of default occurred on its notes.
At the time, the potential event of default was potentially triggered under a Cross Default clause as a result of the Land Bank failing to make a payment due to a lender under the terms of a revolving credit facility (the Affected RCF). The non-payment of this amount constitutes an event of default under the Affected RCF. In the event that the amount involved constitutes Material Indebtedness as defined under the terms and conditions of the notes, the cross-default clause would have been triggered on the notes.
This was followed by a further SENS announcement on 23 April 2020 where the Land Bank confirmed that the amount which was not paid under the Affected RCF fell below the cross-default threshold on the notes, meaning it did not constitute a Material Indebtedness and as a result, no event of default has occurred on notes. The SENS announcement did, however, state that the Land Bank anticipates further defaults to occur under debts which fell due on 23 April which will result in a Material Indebtedness and the cross-default threshold being breached.
The Land Bank issued a further SENS announcement on 24 April 2020 where it confirmed that the event of default occurred on the notes.
How did the Land Bank get here?
The events unfolding at the Land Bank seem to have been triggered by its reliance on short-term funding and potential inability to roll these exposures along with other maturities due to rising uncertainty in South Africa and more specifically the agricultural sector.
The inability to roll maturities is likely the culmination of the following factors:
· Reporting of increased pressure on NPLs as at H1 2020;
· Downgrade of the Land Bank’s international scale and national scale credit ratings to Ba1 (BB+ equivalent) and Aa3.za (AA-.za equivalent) by Moody’s on 21 January 2020;
· Further downgrade of the Land Bank’s international scale credit rating to Ba2 (BB equivalent), while the national scale rating was maintained at Aa3.za (AA-.za equivalent) by Moody’s on 31 March 2020. Importantly this rating downgrade by Moody’s was as a result of Moody’s downgrading the sovereign rating of South Africa on 27 March 2020; and
· Ongoing uncertainty in the agricultural industry in South Africa due to a number of factors such as the drought, shifting seasons, foot and mouth outbreaks, along with the additional pressure of the COVID-19 outbreak on the economy.
What has the Land Bank done in response to the default?
As part of the SENS announcement issued on 24 April 2020, the Land Bank confirmed that it is experiencing a liquidity shortfall and is engaging with various stakeholders (including the noteholders) to address the challenge. In addition, the Land Bank requested noteholders to form a co-ordinated group. Noteholders have taken the Land Bank up on this request and has formed a co-ordinated group with the Association for Savings and Investment South Africa (ASISA) taking the lead.
In response to the event of default, the Land Bank will appoint a financial advisor to assist with the development of a business plan and to negotiate the restructuring of its financial indebtedness with funders.
The Land Bank also announced that it will approach funders for the following:
- Raising up to R5 billion of new funding to meet its medium-term liquidity requirements;
- Request a deferral of all interest and capital payments which fall due within the next six months for a period of twelve months;
- Conclude a combined standstill/deferral agreement with all stakeholders to govern the standstill/deferrals; and
- Waivers of the current defaults and potential additional defaults arising from the proposed standstill/deferrals.
How Land Bank bonds reacted?
A summary of the latest available (as at 29 April 2020) spreads and valuations on the floating rate notes issued by Land Bank is presented below:
The table indicates that spreads on a number of the Land Bank bonds have widened following the confirmation of an event of default. From a valuation perspective, the largest adjustment is c.6%. Importantly, these levels are mostly based on broker screen offers rather than physical trades, as liquidity in the debt capital markets has reduced significantly since the COVID-19 lockdown.
Where to from here?
Usually the events that culminate in an event of default has its origins in the deterioration of the capital structure of a business (solvency). In such cases, the borrower will experience difficulty in raising additional funding, which in turn will lead to an eventual liquidity crisis. At the Land Bank, it seems that its liquidity challenges (driven by a combination of internal and external factors as noted above) was the main driver of the event of default.
In addition to the above, there are a number of factors at play which may assist the Land Bank in obtaining the required deferrals/standstills and liquidity funding they are seeking. The key considerations which will act in favour of the Land Bank are as follows:
- The Land Bank currently has R4.3 billion in government guarantees which can be utilised to raise additional funding to address the liquidity issues.
- The Land Bank is a strategic SOC given that it accounts for just below 30% of funding to the agricultural value chain in South Africa. It also has a developmental mandate which is aimed at transforming the agricultural sector.
- Government has indicated that it will continue to support the Land Bank during this time.
Ashburton Investments is part of the noteholder group established through the ASISA initiative to co-ordinate noteholders and is actively working to protect the capital of our investors. Although there is still a lot of additional information required and extended discussions to be held with the Land Bank and government, based on information which is currently in the public domain, we do not expect to incur material capital losses in this situation.
We are of the opinion that the Land Bank has a strategic and important role to play in securing the food supply of the country as well as driving the transformation of the agricultural sector in South Africa. In light of this, we expect government and the Land Bank will look to interact with funders in a constructive manner to achieve a solution to the long-term benefit of all stakeholders.