Harbinger Andrew Canter unpacks Abil’s collapse: Disastrous management

A year ago Futuregrowth CIO Andrew Canter raised the ire of Abil's executive management by publicly criticising the bank's operating methods. Although he lightened his fund's holdings, the lack of liquidity in local Abil bonds meant Futuregrowth was unable to completely eliminate its exposure – is still suffered losses, although far lower than most other players. In this interview with Alec Hogg, Canter takes us through the Abil disaster, laying much of the blame on poor management including a "non executive" CEO. – LF

ALEC HOGG: This undictated special podcast is brought to you by Futuregrowth Asset Management. Andrew Canter, the Chief Investment Officer at Futuregrowth joins us now. The big news Andrew, unquestionably, in the past week – in fact it's not quite a week ago – that Leon Kirkinis left Abil with immediate effect. Of course, it's been 'all fall down' since then.

ANDREW CANTER: Hi Alec. Indeed, it's been a rather tumultuous week, although I must say that given the events of the last couple of years, it wasn't altogether as sudden as it appears to have been.

ALEC HOGG: Yes, I've just had a chat with Jean Pierre Verster from 36One. They made R100m in shorting the equities, but it seems as though there was a completely different story on the bonds.

ANDREW CANTER: Well, it's hard to short bonds in the first case. Normally, one wouldn't do that. They made R100m by being short – with the equity not being long. I think the evolution from the story from the troubles of the last couple of years with the micro lending industry, the personal unsecured loans, and the bad debts that were coming through, Abil did do a rights issue with the shareholders last year, and it just turned out not to be enough. The bad debts just kept coming. As lenders, there was no way out. You're holding a two-year bond and you just can't get rid of a two-year bond. There was no secondary market, so you have to ride the bus all the way to the end of the line.

ALEC HOGG: What happened to the value of those bonds in the secondary market?

ANDREW CANTER: There was no trade. It was very interesting. We watched it very closely because we were looking at it and wondering if the market was really affecting value, and at that point a couple of weeks ago, we determined that it wasn't and there was just no trade. That's not unusual in the corporate bond market in South Africa. Things are sucked away in portfolios and either forgotten about, or just not transacted again.

ALEC HOGG: But the international market did seem to have a fairly active secondary market.

ANDREW CANTER: Indeed, the Abil bonds that were listed offshore – particularly the Swiss bonds – were trading, although 'trading' is probably a loose term. It's probably more like bids and offers. The trade was as low as 40/45 cents on the Euro, but it gives an indication of where the market was seeing value before the Reserve Bank stepped in. As you know, we ended up with the Reserve Bank Resolution: the senior lenders – holders of money market instruments and bonds, and not depositors – are getting 90 cents on the Rand, so for the R1m of debt you held, you would get R900, 000.00 of new debt. On the other hand, the depositors – the man on the street who had a bank account – is going to be paid in full, 100 cents on the Rand and he'll still have access to his accounts.

ALEC HOGG: So the losers are those who bought shares on the stock market.

ANDREW CANTER: Absolutely, although I must say, let's be clear: the bank is geared ten times. There's an awful lot more debt out there than equity, so ten cents on the Rand on R50bn of debt is R5bn loss. By no means did the lenders get away scot-free. If the lenders were to some extent, irresponsible for funding bad business, indeed, we've paid for it. Our investors have paid for it. It's come through in money market funds, income funds, and pension funds, so it's a real loss. Obviously, the shareholders lost a lot more equity capital, but they should. The shareholders should always lose first and lose all before you start losing money as a senior lender.

ALEC HOGG: And they pretty much have. There was a recent bond issue in the Swiss market. Was that issued at 100 cents on the Rand?

ANDREW CANTER: Yes, it was but it was at a higher yield. I can't remember the yield right now, but it was issued at a higher coupon, which would match it to 100 cents on the Euro.

ALEC HOGG: What would have pressed the price down so much to 40 – 45 cents on Euro? Now the Reserve Bank's come in…

ANDREW CANTER: Keep in mind that up to the Reserve Bank stepping in over the weekend and coming up with a resolution, there was a lot of uncertainty. This business could have gone into a liquidation process with waiting for the man on the street to pay back his personal loans so the lenders were paid back. You could have had continued people just refusing to pay their loans and have further non-performing loans in the book. You could have had much greater losses, had the Reserve Bank not stepped in. That's one of the really interesting things: the word 'bailout' comes up. As I said, the shareholders were wiped out. The subordinated debt in this business has been wiped out. I would assume the pref-shareholders are also wiped out. Senior lenders have lost money, so there is no bailout.

The Reserve Bank actually stepped in to stop the losses, and in a suitable way. They used taxpayers' money, but in a very safe and suitable way, to control what could have been an uncontrolled situation. I think they've acted very well.

ALEC HOGG: That seems to be the consensus.

ANDREW CANTER: Well, I think everybody was facing the weekend with some trepidation. Everybody knew that the walls were falling down and we knew the Reserve Bank had been looking at it for quite a long time. It looked like there was a consensus of factors between the banking industry that doesn't like to see a bank failure, the Reserve Bank that doesn't like to see a bank failure, and the lenders who don't really want to take over and run a failing bank. It is probably a consensus. After the fact, everybody whinges and moans that they lost ten cents on the Rand, but all thing considered, I think it's a pretty fair starting point.

ALEC HOGG: Ten cents on the Rand. Then clearly, from what the market was suggesting on Friday, it's a bargain.

ANDREW CANTER: It's a better outcome. That's right. I must say though, that it's been a good bank, which has good performing assets available and a bad bank, which has your non-performing loans. I do believe the senior lenders will still have residual claim to that bad bank. We've lost money. We should be paid first, before any money goes back to the shareholders. I'm sorry. I should say that the Reserve Bank should be paid first – their capital back –, then the senior lenders, and then if there's any left, the subordinate lenders, pref-holders, and shareholders. I don't expect there'll be any recovery for those in the lower trenches. When I say we've lost ten cents on the Rand for a start, we are hoping there'll be some residual recovery from the bad bank.

ALEC HOGG: Do you have any exposure?

ANDREW CANTER: Sure, and it's not unusual. The whole industry did. We did foresee the problems, you may recall. About a year ago, we came out publicly, quite hostile to the industry about their practises, so we had been cutting exposures for three years and our funds were well below one percent – almost all of our funds -, so it's not a big loss. However, any loss is a bad thing for a pension fund investor or a unit trust investor. To that extent, it's difficult and embarrassing, but at least we were able to minimise it and manage it within funds as much as we could, keeping in mind that there was no liquid market to sell these instruments.

ALEC HOGG: Yes, you were very aggressive at the time and I recall those who'd gone short – not only of Abil, but also particularly of Capitec – were using what you said, to tar the whole industry with the same brush. Are you feeling as concerned about Capitec?

ANDREW CANTER: It's a very interesting phenomenon and study. Why, in the same segment in the same market at roughly the same time, has Capitec continued to perform well, while Abil has fallen off the cliff? The answer is no, I'm not as worried about Capitec. For the first answer, we're still talking about the first generation management of Capitec. These are the guys that started the business. They're still fully invested in it. They're still managing it and running it. They're conservative and most importantly, their reserving policy is much more robust than Abil's. They weren't pretending they didn't have bad debts. They were reserving much more proactively and aggressively. Branches were taking deposits and getting payments of people's payslips into Capitec accounts to repay Capitec loans. It's much better than Abil relying on debit order payments, so it's a much better run organisation and while the share price has come off a bit, it hasn't come off that much.

I don't think this is a systemic micro lender sector collapse that we're going to see – and there are other micro lenders. I think this was a combination of an industry that's having a bad patch, which is entirely suitable under the circumstances, but very bad management. Abil, despite all the warnings and discussions, just drove this airplane into the side of the mountain.

ALEC HOGG: And yet, the CEO had been there for 23 years. Now it comes out that some people were concerned that he always saw the glass as half-full, but if anyone knew the business, he must have.

ANDREW CANTER: Indeed, but one gets the sense that over the years their management has turned over, drifted away, and gone to do other things. I have to assume that over the last few years, Leon was not hands on. He was a non-executive CEO, if that's not an oxymoron of some sort, and there were some terrible decisions made. One of the things that my team noted here just last week – we live in Claremont in Cape Town – just last week, Abil was having Post Office drops done, soliciting for deposits. They've been doing that through SMS's, emails, and advertising for the last few weeks. Even as they knew they were failing, they were soliciting deposits from the public. It's really shocking behaviour. That's the worst kind of 'taking advantage of people on the lending side' and then, when things go sour, take advantage of people on the borrower side.

It's the kind of thing that really leads you to deeply question the integrity of the people you're talking about.

ALEC HOGG: Indeed. There's been all kinds of talk about criminal charges perhaps, against the management, and even implementing these very strict laws that there are in the Companies Act. Might we see something come from that or is it as per usual, 'the South Africans forgive and forget'?

ANDREW CANTER: Well, I think we must be careful about the words 'as per usual'. If you're dealing with an outright fraud – and I don't think we are here. I want to be very clear. – There've been no indications of fraud. There's mismanagement and arguably, integrity questions, but I don't think it's going to have any allegations of out-and-out fraud or theft. Business do fail and one has to be cautious of throwing around threats of criminal proceedings when what's really going on here is a civil matter. Money's been lost by bad management. That's not something you're going to be thrown in jail for. Your reputation is rubbished. I think we have to wait and see how the chips fall, but there've been enough auditors crawling all over this business in the last few years, that I'd be surprised if an actual, genuine fraud comes out of this.

ALEC HOGG: What's likely to happen from here? I'm sure many bondholders who are sitting on the sidelines, hoping that they can claw back some of the money.

ANDREW CANTER: There are a couple of different approaches. One can say 'we must take our lumps. Let's put it in the market. Let's move on and let Abil do its clean-up job', or you could 'lawyer-up, engage attorneys, and start negotiating with the Reserve Bank'. Frankly, I think the Reserve Bank has the upper hand. They have the legal and regulatory authority to do what they've done and more, by the way, if they were to so choose. They've come with a comprehensive package and sure, I think people will engage attorneys. I think they will try to improve their relative positions. As I say, the senior lenders will be looking to get residual claims out of the bad bond book in addition to 90 cents on the Rand, and I think that's reasonable. However, I think this thing's pretty much over and the dust has to settle.

ALEC HOGG: Is there anything we can learn from it?

ANDREW CANTER: Oh, absolutely. There are skeins of things we can learn from it. We can use it as a study of new generation bank failures. In the old days, you expected the Government to somehow, bail it out so nobody lost money. This is the new generation, man. Everybody's lost money. This is how it's going to be in the future, so that's a big and important lesson about how we invest in banks. Banks do fail. It's not that unusual. We think it's unusual because we tend to put it out of our minds, but on average, over time a bank fails in South Africa every 18 to 24 months. It's scary, actually. That's a big lesson and it has to do with how you price…when you make deposits at banks and buy bank bonds, how we price for that risk. We have to price for future haircuts or what I call 'bail ins' where we use capital.

ALEC HOGG: And the other issue here that hasn't really been touched on: there've been some significant BEE shareholders, who have been trading the stock on the Equity Express platform. I presume they're going to lose the lot as well.

ANDREW CANTER: Well, presumably. They're shareholders and they took the risk. They hoped to get rich, but that's the nature of shares. They can go up ten times, but man, they can go to zero.

ALEC HOGG: Andrew Canter is the Chief Investment Officer at Futuregrowth. This undictated special podcast was brought to you by Futuregrowth Asset Management.