By Seerat Sandhu (The Claremont Colleges), Cameron Caldwell (University of Glasgow), Chirag Gupta (New York University)
Overview of the deal
Standard Bank Group Ltd.’s South African unit sold a $200 million green bond to the International Finance Corp. This deal is the largest green bond sale to ever take place in Africa. The proceeds of these notes would be directed towards SBG’s defined impact areas which aim to achieve the objectives of the United Nations’ Sustainable Development Goals (UN SDGs) pertaining to affordable and clean energy along with economic growth.
Standard Bank Group’s CEO Sim Tshabalala states their primary objective with this deal is to drive “Africa’s growth with minimal adverse impact.” Tshabalala believes this initiative will encourage similar, socially responsible investments and expects its clients to transition to green and sustainable products. The bond issuance reflects SBG’s strategic focus on sustainable finance and their social, economic, and environmental values.
Macroeconomic Trends
With an increasing shift towards sustainable debt, after record sales in 2019 and as investors begin to factor environmental concerns when making investment decisions, green bond issuances have certainly grown in popularity over the last few years. Commercial banks currently make up 45% of South Africa’s financing for renewable energy and energy-efficient projects. Indeed, the country has a “climate-smart investment potential” of $588 billion within the next decade. Such figures signify a good growth potential for Standard Bank. However, an unknown amount of this investment could be related to greenwashing cases in the region, so the actual amount of investment will most likely be less.
Many firms are cautious with investment activities in South Africa as the region is subject to high volatility due to political and economical instability. South African Banks have a high sovereign exposure due to the government securities they are required to hold as a result of liquidity requirements. Hence, the linked credit profiles of the South African Banks and the government are both highly interdependent. Subdued economic growth and high-cash reserving requirements are inhibiting loan growth in the South African Market. Fitch Ratings revised South Africa’s GDP forecast to -5.5% for 2020 due to the coronavirus crisis. They predict GDP contraction of 2.5% in 2020 and growth of 1.1% in 2021 which is drastically below the required amount to reduce poverty and unemployment levels.
2020 poses risks due to the uncertainty surrounding Covid-19. Debt-relief measures announced by banks will not only affect margins but also mask the extent of asset-quality deterioration. The South African Reserve Bank (SARB) recently cut the repo rate by 100bp to 5.25% and announced a range of additional liquidity support measures, including government bond purchases in the secondary market. The banks have solid funding and liquidity profiles, underpinned by large customer deposit funding bases and limited external funding reliance. However, with operations largely concentrated in the riskier South African markets, banks are exposed to heightened downside risks to asset quality, earnings and capital metrics. South Africa is entering a period of much lower global growth and is in an economically vulnerable position.
Company details
SBG Ltd and its subsidiaries comprise the largest financial services group in Africa by assets and have been operating for 157-years in South Africa. SBG has been listed on the Johannesburg Stock Exchange since 1970, with secondary listings on the A2X and the Namibian Stock Exchange. They operate in 27 countries across the world and offer multiple banking, wealth, and investment-related products.
Founded in: 1862
Headquartered in: Simmonds Street in Johannesburg President and CEO: Sim Tshabalala Number of Employees: 50,691
Market Cap: 9,497.4 USD (ZAR 164,874.9 mm; 1 USD = 17.360 ZAR as of June 30, 2020)
EV: 19,266.202 USD (ZAR 269,088; 1 USD=13.986 ZAR as of December 31, 2019)
LTM Revenue: (ZAR 122,908.0)
EV/Revenue: 2.03x
LTM EV/EBITDA: N/A as of year-end 2019
Table: Current Debt Structure of Standard Bank Group (Capital IQ)
Bond Details of Standard Bank Group
Credit ratings for Standard Bank Africa
Moody’s downgraded the Baseline Credit Assessment (BCA) to Ba1 from Baa3 for Standard Bank Group along with four major banks of the region. This is a result of the weakening macro profile of the region caused by challenges in the operating environment. These challenges indicate an increasing cost of risk and predict deterioration of profitability and asset quality. Due to the bank’s high sovereign exposure, the banks' debt ratings are sensitive to change in their respective IDRs, VRs and National Ratings, where applicable. The credit rating agency has also downgraded the long-term issuer ratings of Standard Bank Group to Ba2 from Ba1. The downgrade of these ratings is caused by a structural subordination of SBG’s creditors to those of its main subsidiary SBSA.
Table: Credit Ratings of Standard Bank Group (Capital IQ)
Table: Bond Structure of Standard Bank (Cbonds.com)
Projections and Assumptions
Why was this deal done?
SBG’s sustainable goal is expected to drive Africa’s economic and social growth. Standard Bank supports the Paris Agreement on climate change and is a founding signatory of the UN Principles for Responsible Banking. In accordance with these principles, SBG has an obligation to adopt firm and comprehensive policies and frameworks to enable the transition to a more sustainable economy. Standard Bank aims to reduce greenhouse gas emissions by 742,000 tons annually or 3.7 million tons over a five year period. Through the Green Bond Deal, the company seeks to foster financial inclusion and job creation, as well as contribute to enterprise growth and improve the region’s employment rate.
The bank is also trying to mitigate the risks that Covid-19 could potentially have in terms of the outbreak on the markets and the country’s workforce, rising geopolitical and social unrest, and weather-related disasters which can weaken SBGs’ operations. This further incentivised Standard Bank Group to attain funds to insulate itself from a future decline in profitability post-pandemic.
“The bond showcases the role capital markets can play in mobilizing climate-smart finance and we hope it will inspire more companies in South Africa to unlock investment for climate-related projects”
Kevin Njiraini, IFC Regional Director for Southern Africa and Nigeria
Short-term Analysis
Migration to a more sustainable business model will increase expenses and will be particularly challenging to fulfil in the South African Market. A new set of proposed resolutions require the bank to adopt a hard-line policy concerning lending to fossil fuel activities and ventures with climate risk.
Covid-19 has huge economic costs as the current market trends have reduced business and consumer confidence. Revenue reduction will contribute to a weaker operating environment for the bank and hinder earnings. A reduction in loan offerings and repayments will decrease their bottom lines as borrowers would be unwilling to pay higher prices, and the returns received by banks will diminish. The negative outlook on the banks is aligned with the outlook on the sovereign rating which reflects downside risks around economic growth and fiscal metrics that could lead to an even more rapid and sizable increase in the debt burden, further lowering debt affordability and potentially weakening South Africa's access to funding.
Standard Bank, with the largest market share in the region of 24%, lies in the centre of anticipated economic challenges including a decline in client activity, lower interest rates (which will put pressure on margins) and rising credit losses. These factors threaten banks' earnings, asset quality and capitalisation.
Pie Chart: Market Share by Total Assets for Banks in South Africa (Standard Bank)
Long-term Analysis
The 10-year green bond facility, privately placed by IFC, is compliant with the International Green Bond Principles and will enable Standard Bank Group’s Sustainable Finance Business Unit to on-lend to and finance climate-smart projects in South Africa. Consequently, they can invest in projects like renewable energy, energy efficiency, water efficiency and green buildings. According to IFC estimates, such projects have the potential to create far-reaching health benefits in the African continent.
Climate change is bringing a remarkable upturn in South Africa where private investors are increasingly investing in environmental efficiency projects. Standard Bank Group’s results for the 2019 financial year indicate growth of its core operations, although the constrained macroeconomic environment has impacted the results negatively. As the African continent is one of the most affected regions by consequences of global warming, the bank’s push towards sustainability will increase their profitability, competitiveness and margins.
ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). As the weak economy strains borrower cash flows and makes it more difficult for borrowers to meet their loan obligations, SBG can expect a deterioration of their loan ratio and declining profitability metrics over the next 12 to 18 months.
Financial Ratio Analysis
Return on assets has remained stable over the last 6 years which means the proportion of Income to total assets has remained similar
ROE and ROCE are declining which suggests that Standard Bank is becoming marginally less efficient at increasing shareholder wealth
Increasing margin ratios suggest profitability is improving
Asset quality and NPL ratios suggest the un-likelihood of Standard Bank declaring bankruptcy in the short-run due to the company’s credit and financial profile
Table: Financial Ratio Trends of Standard Bank Group (Cbonds.com)
Risks and Uncertainties
Due to a lack of sufficient data, increased litigation, and changing climate policies, it is difficult for Standard Bank Group to potentially estimate the monetary impact of climate-related risks. Consequently, the company needs to adapt quickly to remain competent, which might result in revenue headwinds and declining ROE, which is expected to remain below the 18-20% target range in 2020. The transition to a lower-carbon economy might take longer in developing countries where a lack of access to affordable and reliable energy could constrain socio-economic development.
Additionally, the bond issuance occurred in a market experiencing a surge in the use of digital channels such as online and mobile banking. These trends pose technological risks such as cybercrime, data breaches, and third party attacks which can result in SBG losing their market share because of defamation to the bank, increased public relations expenses, and will make the issuance unprofitable.
Additionally, Covid-19 presents challenges for the integration of the new policies in SGB’s business model and adds to the threat of declining market share. Downside risk will come from a weakening in the banks' standalone credit profiles, especially any material deterioration in asset quality, profitability and capital in the challenging economic environment. The 21-day 'lockdown' that started on March 27 will exacerbate the negative shock to the banks' environment which was already affected by the country's very weak economic outlook. However, the bank’s pre-provision income should be sufficient to absorb rising loan losses. The absence of tangible progress combined with structural constraints and low customer confidence is bound to impact SBG negatively.
Business disruptions continue to remain high risk for Standard Bank Group, especially because they work at the centre of the African economy. South Africa is particularly exposed to the pandemic because of its highly dense and vulnerable communities, falling commodity prices, disruption to tourism, mining activity and manufacturing, and pressure on the country's public finances. Overall, such trends affect their growth prospects and increase unnecessary expenses.
“We hope it will catalyze interest in green investments from other actors in the country”
Adamou Labara, IFC South Africa Country Manager
Will they be able to repay?
Standard Bank Group’s profitability and asset quality metrics are expected to deteriorate. Standard Bank has a total outstanding debt of $7,322 million as of December 31, 2019, with Total Principal worth $2,358.4 million. Standard Bank has upcoming coupon payments in July 2020 and other callable securities maturing between the 2022-2024 period. Apart from this, its 5-year securities are set to mature on July 18, 2025, followed by the maturity of the green bonds in 2030. Standard Bank was also fined $30 million for its lax money-laundering prevention mechanisms. Such fines and increasing debt balances, upcoming bond and coupon repayments, and declining cash reserves suggest that the impending cash flows for Standard Bank will be crunched, making repayments difficult and threatening their ability to finance this proposition efficiently. Though they are not expected to go bankrupt, the bank needs to aggressively increase its revenues to be able to meet these obligations. The outlook on all national long-term ratings is negative, in line with the negative outlook on the respective banks' local-currency long-term issuer default ratings.