A collection of Futuregrowth thought leadership pieces, media articles and interviews.

STUART THEOBALD: Bond holders can wield a mop in clean-up

30 Oct 2017


State-owned companies are vulnerable to the views of bond investors, even when public condemnation of mismanagement and corruption goes unheeded


Are bond investors the last line of defence against the looting of state-owned companies (SOCs)?

Controversial finance director Anoj Singh was booted from Eskom only after a major bond investor, the Development Bank of Southern Africa (DBSA), insisted. It had within its power the ability to recall R15bn after Eskom received a qualified audit opinion. Several other investors, such as Futuregrowth, have publicly condemned the behaviour of some SOCs and ministers. In September, the Old Mutual subsidiary sounded the alarm after Umgeni Water’s board and CEO were suddenly fired by Water and Sanitation Minister Nomvula Mokonyane without following proper procedure.

It meant that the water utility’s R7bn capital spending plans were left in the hands of an acting CEO and the minister. After Futuregrowth sounded the alarm, the Cabinet rushed to appoint an interim board. SOCs are vulnerable to the views of bond investors, even when public condemnation of mismanagement and corruption goes unheeded.

The February budget anticipated that SOCs would collectively be raising R102bn from the financial markets. That is unlikely to be reached. Large borrowers like Transnet and Eskom have failed to meet targets in auctions conducted in 2017. Transnet raised R1bn in its latest financial year compared with R4.3bn the year before and in recent auctions, it has received offers of only a 20th of what it planned. Banks and other off-market lenders are likely to see things the same way.

The refusal by several banks to roll over loans to South African Airways (SAA) in the past few months has forced a more urgent effort to sort out the airline, including the firing, eventually, of chairwoman Dudu Myeni.

The banks are going to be similarly reticent about continuing to support the other SOCs. Lenders, however, have limited ability to organise themselves. Unlike shareholders, they can’t usually call for general meetings. Legally, they get a formal say in the affairs of a company only if it goes into liquidation, in which case they can work with other creditors to try to recover their exposures.

Occasionally, bond holders have additional rights in terms of covenants to their lending agreements, such as those the DBSA had in the event of a qualified audit opinion at Eskom.

But in the normal course of events, bond holders seldom know who else has lent to the company, so they can’t collectively try to force change. And when bond placements are arranged, it tends to be the arranging banks that set the terms of the issue rather than the investors that buy bonds. The lack of interest from the bond markets for SOC debt is a big headache for the government. If the companies can’t raise debt, the alternative is to turn to their shareholder for funding. As the medium-term budget last week made clear, the government’s finances are under unprecedented strain.

It is already setting new records for debt it is taking on relative to GDP. Revenue collection is weak, while unplanned spending has ballooned. More ratings downgrades are likely and will push the government’s local currency debt into junk status, increasing its cost again. Even the Chinese are not likely to see things very differently. They won’t lend without iron-clad conditions. In the situation, there are only two choices — sort out the problems with SOCs to regain the faith of lenders or force investors to buy the bonds through legislation.

There are some exceptions that prove what can happen when things are done properly. The Land Bank in September raised R1bn in a bond auction — after initially intending to raise only R750m — because interest was so strong. Perversely, the unattractiveness of other SOCs has made the Land Bank relatively more attractive, but it shows that good management does result in positive support from the bond market.

Forcing investors to support public bond issues by prescribing assets may well be highly politically unpopular. The opposition to the government’s threats to raid the Public Investment Corporation’s assets to bail out SAA, including threats by Cosatu to strike, would probably be many times more strident were the government to attempt to raid private sector pensions.

It has been done before. The apartheid government compelled pension funds to put 53% of their assets into government debt until 1989. But things are different now. SA is a much more open economy and many more pensions are defined contribution rather than defined benefit, so members are directly exposed to the performance of assets in the fund.

Many of those members, from mine workers to the 400,000 employees in the financial sector, are unlikely to quietly accept a pension raid. The path of least political resistance may well end up being to sort out the SOCs, even given the need to placate the enormous patronage needs that are served by the SOCs, and meet the demands of lenders.

Transnet and Eskom have been avoiding the bond market but can’t do so forever. They were once able not only to issue bonds that were many times oversubscribed locally but internationally too. It has been done before and with the right leadership, they can do so again.

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