During a recent economic overview webinar, Gary Garrett, Managing Executive of Property Finance: Nedbank Corporate and Investment Banking (CIB), was joined by Anél Bosman, Managing Executive of Nedbank CIB, and Nicky Weimar, Nedbank Group Chief Economist, to gain renewed insights into the immediate liquidity requirements of the clients of Nedbank CIB, and the trends that are likely to emerge around property values in the near future.
CIB as role player and new opportunities
In response to Covid-19, the various types of relief that Nedbank provided have included temporary capital holidays, a short-term roll-up of interest, liquidity facilities, the extension of tenures, and the condonement of covenant breaches. CIB has engaged with clients over this period – in particular, clients in the listed sector – to gain a better understanding of rental collections during the lockdown period. They found that immediate liquidity positions were better than expected.
Accurately gauging the future of property values is challenging, but in consulting with clients, the general consensus is that values are likely to drop. The exact quanta cannot be determined yet, and there are varying views on what these are likely to be. According to Gary, values are likely to reduce over the next 24 months and will predominantly be driven by reduced cashflows rather than significant adjustments to capitalisation and discount rates.
At the beginning of the nationwide lockdown, the Banking Association South Africa (Basa) tried to give clarity across the banking sector on various issues that were raised by the property industry. These included how banks were planning to look at values in the short term, deal with covenant breaches, handle maturing facilities, and provide relief to clients experiencing cashflow issues during this time.
Three business pillars can be identified within the Nedbank CIB structure, namely South African debt, property partners and African debt business. Gary feels confident about the emergence of new opportunities across all these pillars and believes that Nedbank CIB has a risk appetite to do new deals.
Equity, bonds and the Rand view
AnéI echoes the sentiment that these are turbulent times, but also a time where good relationships are formed, strengthened and amplified, having done no less than 950 restructures for property finance clients.
CIB did 220 000 foreign exchange trades, executed 2,1 million equity trades, approximately 420 000 foreign exchange payments, and settled more than R4 trillion across the vostro accounts. Furthermore, many payments were made to Covid-19 relief recipients, and in doing so, people in our country were helped. The role that banks play both as funders and settlement agents of financial services has been highlighted during this time.
Worryingly, the risk premium of South Africa has changed significantly. Anél points out that in the past, equity markets in South Africa traded at around an 11% premium to the rest of the emerging markets, while currently the country is trading at a 26% discount. This is the result of weaker growth, policy uncertainty and the management of companies where various factors now necessitate the need for a risk premium.
However, Anél is positive that over the next six to nine months, the rand is likely to strengthen. The rand view is currently based on international cashflows, which will bring short-term relief. Looking at equity markets, there has been interesting movements with strong rallies in technology. Earnings have been holding up well, and due to reduced interest rates, the discounted cashflows have increased.
The bond market tells a different story. There will likely be some rotation between equities and bonds, as a result of concerns around the return and the funding requirements of governments, which will lead to more volatility going forward.
To curb the negatives Nedbank CIB will use its financial expertise to promote social development in the fight against inequality, while catering for the needs of clients by supporting them in the fight to protect business and save jobs.
Where we are, how we are faring, and what the future holds
Nicky agrees that Covid-19 has disrupted production, consumption and global trade in a very dramatic way. The International Monetary Fund and World Bank forecast this to be one of the steepest and deepest recessions on record. The reality is that the world has not yet reached the peak of the pandemic.
Europe seems to have Covid-19 under control and has largely opened their economies. Even though there has been a slight uptick in the number of new cases, there has not been a clear acceleration. In Australia there has been clear evidence of a second wave, while Asian countries seem to be experiencing slight, but manageable increases. Africa will likely follow the Asian trajectory.
South Africa has been in recession for three quarters. Growth shrunk by 0,8% in the third quarter of 2019, by 1,4% in the final quarter, and then the recession deepened in the first quarter of 2020, with the growth domestic product (GDP) contracting by 2%. Covid-19 landed in an economy that was already under substantial strain, which means that earnings and profits are going to be under pressure.
For most businesses, this will shift the attention to saving costs. A wise move would be to delay or cut down on capital expenditure in anticipation of operating below capacity. To curb cashflow problems companies will most likely also look at reducing wages and wage increases, as well as scrapping all bonuses. Furthermore, retrenchments will also become a consideration. CIB estimates that this will result in approximately 1,6 million job losses. Households will also be affected by a reduction, or complete loss, of disposable income.
Nicky warns that South Africa should brace itself for a GDP contraction of 38% quarter on quarter, largely due to a complete halt of economic activity under level 5 lockdown restrictions. How quickly the economy recovers will depend on South Africa’s ability to reabsorb job losses to reinject expenditure, as well as the recovery of fixed investment.
The initial plunge is likely to be followed by recovery. This trend has been observed in mining, manufacturing, retail and vehicle sales. By June, vehicle sales had bounced back to 73% of pre-Covid-19 numbers, and retail has also been performing well since May, with an 88% recovery. Only once the second-quarter plunge and the third-quarter bounceback can be compared, will the true impact of Covid-19 on job creation and fixed investment be measurable.
On the downside, our ability to navigate our way around this crisis is greatly reduced compared with the 2007 global financial crisis, due to our government’s weak fiscal position. This is a result of government expenditure that has been growing and accelerating for an extended period of time. This will affect taxpayers’ income, which in turn, will have a negative impact on tax revenue.
Government will face numerous challenges as a result. These include social welfare grants, old-age pension and a shortfall in terms of budget allocation towards education. The main problem is that a minimal amount of government spending goes towards infrastructure. The bulk is spent on civil servants’ wages. Public sector pay has also outpaced inflation since 2016, and comprises 40% of tax revenue.
In terms of the public debt burden, a sustainable cutting is approximately 60% of GDP, which is why government will attempt to contain spending, cut public sector wages, root out corruption, and in the process, reduce the budget deficit. The public debt burden currently stands at 87%, so Covid-19 has hit South Africa at the worst possible time. The country is operating through the current crisis with a much higher risk premium.
Nicky goes on to explain that the structural composition of our economy is completely misaligned with the nature of our resources. To nurse our economy back to health, this needs to be addressed. The size of government is too large in relation to our economy. Furthermore, South Africa is faced with the problem of a private sector that is too capital-intensive in a capital-scarce country. The flipside of the coin is that the private sector is too skills-intensive in a country with shortages of skilled labour and a surplus of unskilled and semi-skilled labour.
To make matters worse, government policy has actively reinforced these misalignments. State-owned enterprises provide our economic infrastructure. This informs the cost structure of any company. As a country, we do not have cost-effective and reliable energy sources. The mining industry is especially affected by this due to the vast amount of energy it uses.
Inadequate road and rail infrastructure are another issue that hampers growth. While our port infrastructure is adequate, it is hugely expensive. The United Nations estimates that our port tariffs are 300% above the global average. The exorbitant price of data is also counterproductive, as it raises production costs. This erodes the country’s ability to provide competitive prices.
We also have a mountain of red tape. South Africa’s legislative and regulatory environment places restrictions on capital in a country that needs fixed investment and has inadequate savings. To facilitate structural change, this needs to be reset – starting with resolving South Africa’s electricity crisis.
Nicky does not believe that monetary policy is a problem. South Africa has an inflation-targeting monetary policy regime. The South African Reserve Bank (SARB) has indicated that the ideal inflation rate to strive for is 4,5%. They have been targeting this number very successfully. At the moment, inflation is very low, and this has facilitated dramatic cuts in interest rates of 275 basis points since the start of this year.
What the country needs more of is a revival in fixed-investment growth in the private sector.
The stagnation is caused by the implosion and fixed-investment activity by the public sector – especially state-owned enterprises and more recently, government as well. Since 2009, government has punted a public sector infrastructure expansion programme. This has yet to materialise, but there have been many initiatives between government and the private sector of late, which is encouraging.
At the May monetary policy committee meeting, the forecasting model for interest rates, it was indicated that there is still scope for another 50 basis point cut before the end of this year. However, the SARB seems reluctant to go this route. Nicky observes that the reason for this could might be a lower, but as yet unflattened yield curve.
Generally speaking, interest rates will be low and steady over the next three years and the world economy, on average, is estimated to shrink by anything between 3% and 6%, leading to a worldwide recession.