African Bank: “Just where did I put that side pocket?”
Paul Crawford, Fairtree Capital – a partner of MET Collective Investments.
Although investors effectively forced African Bank Investment Limited (ABIL) into curatorship almost a year ago, there remains no concrete clarity on how debt financiers are to be treated going forward. This has financial ramifications to unit trust investors and although ABIL debt instruments were widely held across collective investment scheme (CIS) portfolios, the responses of the management companies (managers) varied. Some managers took a company-wide approach, while others allowed the portfolio manager, arguably the person with the broadest knowledge of the risk case at hand, to decide on the appropriateness of different responses. Perhaps the responses were correlated with the portfolios’ proportional exposure to ABIL, but responses, and subsequent treatment of those exposures, have varied considerably.
The demise of ABIL has been exhaustively debated in the press and this article will in no way offer opinion on the root of that demise, or the trade in the equity securities in the few days before the announcement by the SA Reserve Bank Governor Gill Marcus on 10 August 2014 that the bank was to be put into curatorship.
The Johannesburg Securities Exchange (JSE) responded promptly and trade in local debt securities was suspended from 11 August 2014 in an attempt to protect potential buyers who may have been inadvertently unaware of the ABIL crisis and subsequent curatorship. Although trade in ABIL bonds ceased on 11 August 2014, the JSE has continued to produce closing prices in their daily mark-to-market files. These arm’s length exchange-sourced prices could continue to form the primary source of valuation of ABIL securities across many portfolios in South Africa. Of the 16 ABIL debt securities still listed, but suspended, on the JSE not one is market below 100%. Senior, subordinated, inflation-linked all remain above par. This is obviously incorrect and is a very poor reflection on the very mark-to-trade basis that is adopted to value instruments listed on the exchange. If trade has been suspended, how exactly can the exchange remark instruments using a mark-to-trade methodology?
It is a forgone conclusion that CIS portfolios that have not inferred prices, or used a mark-to-model valuation technique, will have had to revalue the ABIL securities lower given the slow diffusion of information from the curator. Write downs of assets result in lower unit prices depending on the extent of the write down and asset valuation as a proportion of the underlying portfolio.
The effects of these write downs on unit prices will vary from CIS portfolio to portfolio depending on exactly how each manager handled the ABIL curatorship. Some ABIL even handled the outcome differently per portfolio. Some portfolios continued to provide market values of exposures by using offshore traded prices and inferring local prices, others wrote the exposures down, sometimes even to zero, while others created new portfolios or side pockets where investor exposures to ABIL were unable to be liquidated or realised. Essentially investors’ assets were unrealisable – in stark contrast to what CIS portfolio investors have been used to up until that time.
On 15 August 2014, the Registrar of Collective Investment Schemes allowed CIS managers to create side pockets, or new sub-funds, to hold ABIL debt. At that time, 50 specific portfolios chose to invoke the side pocket, thus ensuring that should investors liquidate their investments, that such actions could not prejudice the remaining investors in that particular portfolio. This action would also ensure that any benefit from better-than-expected recoveries of ABIL value would be borne by the investors that held the units at the time of curatorship. Those 50 portfolios, amounting to an original value of more than R 4.6 billion, remain frozen and not free to trade. Investors who were transferred such units are unable to realise those amounts and have no real way of establishing market value of their holdings.
Some portfolios that had ABIL instruments opted not to create side pockets and continued to revalue the securities on an active basis, the offshore listed US dollar-based bonds continue to trade actively and sold off long before the hobbled bank was eventually put into curatorship. The offshore market seemed to have a closer handle on the goings on at ABIL than local investment managers and have continued to trade the securities after the curatorship. In fact, local CIS portfolios that have exposures to US dollar bonds have a reliable daily mark-to-market process provided by offshore exchanges. Offshore markets seem to be quite aware of the peculiarities of trading in securities that are in deep distress and seem able to price for the conclusion of the curatorship. It is a pity that South African retail investors are unable to access such sophisticated investment managers.
At the moment, exactly what bond holders are due to receive upon the re-launch of the new entity (the so called “Good Bank”) still remains unclear.
But it appears that the curator’s proposal is, broadly speaking, as follows:
• Senior debt holders take a 10% write off of capital in the new entity
• Subordinated debt holders take a 62.5% write off of claim in the new entity
The announcements remain unclear on how missed coupons, or interest accruals, will be handled. Will the missed coupons be repaid at all, will they be repaid on the original or proposed reduced amount, should money market instruments be adjusted for the increase in market interest rates? Will the managers allow investors to liquidate their retention holdings once the trade suspension is lifted or will they be forced to hold the retention funds to the maturity of the underlying instruments? Will all senior debt holders receive exposure to the same rescheduled instrument or will different tenors be treated differently? If there are several bonds issued, will they all have the same coupon or will they increase with increasing maturity and, if so, on what basis? Obviously, at the moment, there are more questions than answers and perhaps given the fragility of the situation, it may be better for all that information to be diffused slowly into the market.
Fairtree has used publicly available information on the ABIL Retention Funds to attempt to ascertain approximately what the ramifications of the ABIL restructure will mean to investors. Of the original 50 retention funds, the company was able to trace information on 42. In value terms of the original R4.646 billion, the company was able to source price information on R4.592 billion, or about 98.8% of that original value. Fairtree believes this is quite a representative sample of the total outstanding retention fund amount.
Of the 42 portfolios, Fairtree has information on the following:
• Four were classified as Money Market Funds and each portfolio has retained a 100% valuation of the underlying securities. From an exposure perspective, these portfolios amount to about R699 million or 15% in value of the sample.
• Five other portfolios have not changed the valuations of ABIL instruments. These portfolios collectively amount to about R700.5 million. In total, around 30% of the original ABIL holdings that were transferred to retention funds have not been re-marked at all.
• 27 of the 42 portfolios have marked the instruments higher in valuation. In money terms, 69% of the total original R4.646 billion has been revalued higher. The original R3.16 billion now has an implied value of R3.37 billion or about 6.9% higher. One portfolio appears to have marked the holding up by 34%.
• Six portfolios have revalued the ABIL holdings lower. In money terms, this accounts for a rather measly 0.75% of the original amount or about R35.1 million. This amount has been revalued to R18.8 million or around 54% of the original. The spread of write downs is wide with one portfolio marking the exposure down to 24% of the original value. Unfortunately, this seemingly more appropriate methodology of write down has only been adopted by very few and very small in market value portfolios.
To conclude, the question surrounding the ability of managers to create new portfolios to warehouse failed investments needs further attention. One could argue that the creation of such sick pockets may be a tacit admission that risk exposures were excessive and subsequent losses may have led to wholesale liquidations of units, resulting in even bigger exposures being held by the remaining unit holders – that seemed to be the reason for the creation of those side pockets. But that tacit admission, of perhaps a lack of risk management, could be considered in a bad light by investors. Side pocketing seems to work well to protect manager income streams rather than underlying investors and the lack of consistency in mark-to-market methodologies seems worrisome. Just how will investors be able to exit their retention fund holdings, will they be free to trade at some stage in the future or will they remain locked until the maturities of the underlying securities? Will all “Retention Fund Unit Holders” be treated the same? In some cases, the valuations of current ABIL debt holdings may be written up – a positive outcome for unit holders, while the majority of affected investors should see a devaluation of their assets once finality of when and what the new entity will deliver to current investors is announced by the curator.
