Abil: Devil’s in the detail – asset manager

I instinctively dislike lenders who work in the unsecured segment of the market. They are promising hope to desperate people, but know that what they are actually selling is only going to get many of their customers into deeper financial trouble. Aside from the moral issues, it stands to reason that people who are sucked into a cycle of escalating repayments will reach a point where they have no capacity left to make good on their financial promises. For a while, it looked like the well-paid executives at Abil were about to start drowning in a mess of their own making. But its share price rose earlier this week indicating that some investors think the bad times are behind the company and it could start delivering good returns. If you are pondering whether to add African Bank Investments Ltd, or Abil (JSE:ABL), shares to your portfolio, listen to what Feroz Basa of Old Mutual's investment boutique Electus makes of this Johannesburg-listed share. He was a guest on the CNBC Power Lunch. – JC 

ALEC HOGG: South Africa's largest unsecured lender Abil is experiencing a tough time. Feroz Basa, who is a Portfolio Manager at Old Mutual Investment Group Electus, joins us for some analysis on the bank. Feroz, thanks for being with us. Yesterday afternoon, Gugu chatted with Leon Kirkinis from Abil and the question that stays with me is she asked whether he thought he was the right guy to continue running the company. He said the board unanimously believes so and he feels up to the task, too. Do you?

FEROZ BASA:  Yes, I think if you look at the result, it's reasonable for shareholders to question whether he's the right man or not. If you look at what's happening at Ellerines and at the banks specifically, there will be question marks around that. It's more of a board decision to determine whether he's done his job correctly and whether he's the right man.

ALEC HOGG: So we should be asking the members of the board of Abil how they can justify retaining a Chief Executive who's been there throughout the period where they really have taken some pretty poor decisions.

FEROZ BASA:  Yes, if you look at Ellerines – hindsight is always a perfect science – Ellerines lost R400m in this half. If you go back to that acquisition, lots of goodwill has been written off, so that's been a bad strategy. In addition, the strategy around the bank to extend the terms on the loans as well as to increase the loan book in a time when arguably, unsecured lending was in a bubble: that proved to be an incorrect decision. You can see all the provisions that need to be made because of that book. Yes, I think there are definitely question marks. The board and shareholders need to decide whether this is the correct base for the business and whether the team that they have in place, is the right one to take them going forward.

ALEC HOGG: You've told us about the bad strategies. Have there been any good ones?

FEROZ BASA:  Look, what they're doing now, slowing the loan growth, looking at recapitalising the business – they've done that already, making the general provision so that the book is covered more than 80 percent: those are all the good strategies that they're taking to bank. My biggest concern is still what's happening in Ellerines. The furniture market is tough. There's overcapacity in the industry. The consumers are under significant pressure, so that's going to be the one thing, which will determine whether African Bank is an opportunity or not. Until you have the clarified as well the regulatory issues around the insurance, those are the key issues that are going to be driving the share price, going forward.

GUGULETHU MFUPHI: Feroz, if investors should still be concerned about Ellerines, what reason do they have to be optimistic about the deal with Edcon?

FEROZ BASA:  If I go back and I say Ellerines is a problem…If I look at the Edcon deal, to me it doesn't make sense either. I agree with you guys. That could be problematic. The main thing is what's this business going to look like in five years' time? Is there still a market for unsecured lending? Yes, I think there is. There'll always be a need for those unsecured loans. The bank – looking at it going forward -, once you normalise the returns and you have a properly recapitalised business, it should be a good business going forward. The unknowns are those losses in Ellerines and we all know that the business is up for sale. What potential buyers are there for Ellerines when it's making close to R800m on annualised losses? That's the big trick in ABIL.

ALEC HOGG: Feroz, I spent a couple of years in banking and one of the big things one has to guard against in a bank, is bank managers who take a stressed client and lend him more money over a longer period so that he can repay the loan that he can't repay anyway. From the outside, it looks like this is exactly what Abil has done not just for a few clients, but also on a massive scale. I put that to you: what is to tell us…what is to show us that these guys have (a) learned their lessons and (b) what have they actually been doing right if they've been doing that all the time?

FEROZ BASA: If you go back over two years and you look at the whole sector, term has been increased across the sector. We had guys coming in and consolidating loans, so they would take all your unsecured loans, consolidate them, and incorporate them into one. I think that was the start of increase in terms. What African Bank did in their initial strategy, was to take their good clients and increase the term on those good clients. The problem is that everybody else was also lending to those clients, and good clients who are over-indebted as you say, become bad clients. I think that caught them out. Where they thought they were taking their good clients on the books and increasing the term, there were other guys lending to those clients as well and eventually, the client has so much debt that he can't pay that back anymore. That's what caught them out in this business.

GUGULETHU MFUPHI: Feroz, following your analysis of the numbers yesterday, we saw an increase in impairments. Will there be a need for Abil to raise more capital?

FEROZ BASA:  If you look at their core Tier-1 ratio post these general provisions, it's sitting around 17.7 percent, so their target is 18 percent. It came down from 20 percent, so they're below their target. The big provision they made does cover them, but the new loans that they've written… If any of those were as bad as the previous ones, they would definitely need to come back for capital. As it stands, it seems as though the provisions are intact and the coverage of the book is there, so if things don't deteriorate any further, I don't think they'll need to come back to shareholders for capital.

GUGULETHU MFUPHI: If I were an ABIL shareholder, it sounds to me like you're telling me to 'sell, sell, sell, and run away' – very…bad, that kind of strategy and a growth strategy. Is that the gist of this conversation, Feroz?

FEROZ BASA:  It's a very good question. I'm not a holder of Abil, and I'm not going to be buying. If I were a shareholder, one of the things I would concentrate on is Ellerines. What is their strategy there? Are there potential buyers? Can they get that business at least to break even? That could become a black hole where you have to pay those…where you have to fund those losses for the next couple of years because you have a huge infrastructure. There are costs associated with that infrastructure. There are huge leases that you can't get out of overnight, so I would deal with that first. The second issue is clarity around the one part of the business that's been doing well, which is linked to insurance. Those profits all fall to the bottom line, so any regulation there would affect those profits significantly. If I were a shareholder, those are the two things I'd need clarity on. In addition, if I'm sitting from the onset, looking to buy Abil at R6.32…what premium am I prepared to pay for that business, and can they reach acceptable returns on that investment?

GUGULETHU MFUPHI: Well Feroz, I think we get it in a nutshell. You're not a shareholder. I'm not a shareholder. Alec – not a shareholder. I think you all know what to do. Well, I thank you so much Feroz Basa, Portfolio Manager at Old Mutual Investment Group Electus.