Asset and liability management
Forecasting and scenario analysis
The IDC is a going concern. Due to the current state of the economy, we expect profitability to be under pressure in the short to medium term. Our efforts to ensure sustainable development in the South African economy require that the Corporation remains financially sustainable.
We have sufficient liquidity to meet our current obligations and are confident that, for the foreseeable future, we can raise enough funding through a combination of new debt and internally generated funds (profits, repayments on existing facilities or equity divestments) to invest in new advances in the economy.
Managing impairments is key to ensuring our financial sustainability. We will continue to implement initiatives to ensure that impairments remain within acceptable levels. The Board has emphasised that implementing the 2016–2018 corporate plan and all the approved initiatives to continue our operations, we need to remain a going concern and financially sustainable. As a result, the IDC regards financial sustainability as a material issue.
Five-year financial overview – extract from the Group’s annual financial statements
Review of financial performance
Revenue for the year decreased by 2% to R19 599 million (2014: R20 021 million). Revenue of R6 269 million from Scaw was 3% lower than the previous financial year (R6 452 million) due to lower demand as a result of protracted industrial action in the mining and metal sectors.
Revenue from Foskor was up by 4% from the previous year to R5 331 million, due mainly to the favourable impact of the Rand/ US Dollar exchange rate on selling prices. Interest income of R2 206 million was 2% above the previous year due to an increase in loans and advances during the year. Lower dividends received, mainly from Kumba Iron Ore Limited on the back of the depressed iron ore prices, decreased dividends received by 17% compared to the previous year.
Revenue: 2011 to 2015
Operating profit for the year was down to R1 011 million (2014: R2 513 million) due mainly to an increase in financing costs as a result of increased borrowings and a decrease in dividends, as indicated above.
Impairments for the Group decreased by R65 million, from R1 597 million to R1 532 million, still reflecting the difficult trading conditions persisting in the South African economy.
Financing costs increased by 37% to R1 402 million due to increased borrowings during the year. Operating expenses (excluding impairments) increased by 8% from R4 089 million to R4 416 million. This was due mainly to higher distribution costs at Foskor. We made a capital profit of R640 million from the disposal of certain unlisted investments during the year compared to only R1 million in the previous year.
During the 2015 financial year, we received R284 million from the South African Government to fund sefa (2014: R231 million).
The Export Credit Insurance Corporation of South Africa Limited (ECIC) operates an interest make-up scheme through which compensation is made to participating lenders for interest rate risk, liquidity risk, basis risk and credit risk assumed in the funding of ECIC-insured export credit loans. This scheme is implemented by the South African Government to promote the export of South African goods and services. The IDC received R39 million from the scheme during the past financial year (2014: R36 million).
Operating profit: 2011 to 2015
Income from equity accounted investments
The equity-accounted investments showed a significant improvement in performance during the reporting period, with the Group’s share of profits at R656 million compared to a loss of R310 million in 2014. This turnaround is encouraging,
Income /(losses) from equity accounted investments: 2011 to 2015
Loans, advances and investments
The IDC advanced R10.9 billion in new loans, advances and investments during the year, down slightly from the R11.1 billion in 2014. This resulted in loans and advances growing to R22.4 billion (net of repayments) from R20.8 billion and investments to R28.2 billion from R28.1 billion (net of disposals and preference share redemptions).
The revaluation of investments to fair value decreased from R64.2 billion to R44.9 billion, due mainly to the decrease in the value of listed equities following downward trends in the oil and iron ore prices.
The growth in our borrowings portfolio was aligned with our strategy to fund growth in the loans and advances book predominantly from borrowings. Borrowings for the year grew to R24.0 billion from R21.4 billion in 2014.
During the past financial year, we continued our public bond issuances under the IDC Domestic Medium-Term Note programme (DMTN), with an additional issuance of R1 billion. Similar to investor response to the inaugural issue in October 2013, this issuance was also well received, with the bond 1.7 times oversubscribed and issued over three-, five- and ten-year maturity periods. The three- and five-year bonds are at variable interest rates and the ten-year bond is at a fixed interest rate. The pricing of the bond issuance reflected investors’ confidence in the IDC’s creditworthiness. We will continue our bond issuance programme as part of our funding sources diversification strategy.
We continue to borrow from our traditional sources, namely commercial banks and DFIs such as Proparco, KfW, African Development Bank, Agence Française de Développement, European Investment Bank and China Development Bank. The private placement bonds we issued to the Public Investment Corporation (PIC) for green initiatives and the Unemployment Insurance Fund (UIF) for creating and sustaining jobs, continue to be tapped. Cumulatively, R2 billion has been issued under the PIC bond and R4 billion under the UIF bond.
Overall, our debt activity during the year included R6.6 billion sourced from public bonds, private placements, commercial banks and DFIs, with repayments of R3.2 billion. We continue to service our debt, while maintaining excellent relationships with our lenders and investors.
Borrowings: 2011 to 2015
Total assets, capital and reserves and debt/equity
Total assets declined from R138.6 billion in 2014 to R122.3 billion during the review period as a result mainly of the decrease in the fair value of Sasol Limited (due largely to lower oil prices) and Kumba Iron Ore Limited (due mainly to lower iron ore prices). Our borrowings grew in line with the growth in loans and advances. Higher debt levels and lower reserves increased the debt/equity ratio from 20.1% in 2014 to 26.8% in 2015.
Total assets, capital and reserves and debt/equity ratio (%): 2011 to 2015
Impairments (IDC company)
The impairments level increased steadily over the past five years in value terms, from R5.4 billion in 2011 to R10.2 billion in 2015. A 4% increase occurred in cumulative impairments between the 2014 and 2015 financial years. As a ratio of the total outstanding financing book at cost, impairment levels decreased from 18.2% in the previous year to 16.7% during the period under review. The impaired level remains within the threshold of 20% as set by the IDC Board. Impairments at market value continued on an increasing trend to 8.8%.
Growth in IDC’s book compared to growth in impairments: 2011 to 2015
The increasing impairment levels are aligned with our risk appetite and role in supporting high-risk sectors and businesses largely unattractive to commercial financiers. The trend also reflects our renewed focus on funding early-stage projects and start-up operations. Despite the rising trend in cumulative impairments, the impairment charge to the income statement of R1.8 billion for the year ended 31 March 2015 was 0.6% higher than the charge reported at financial year-end in 2014.
Key factors that contributed to the rising impairments included the change in commodity prices and deterioration in trading conditions. Many IDC clients experienced challenges in their operating environments. Globally, the mining industry faced serious challenges due to steep slide in commodity prices and a longer than anticipated recovery period. In South Africa, electricity shortages affected the mining and metals industries, which reduced manufacturing production capacity and discouraged investment in those sectors.
Prospects of recovery in the local mining and metals sectors were hampered by protracted labour unrest and a challenging regulatory environment. Our role as a development financier was to stimulate business growth with new funding and restructuring and minimise the impact of job losses on society.
We compiled a comprehensive list of impairment initiatives to mitigate the rising trend of impairments. This was approved by the IDC Board’s Risk and Sustainability Committee for implementation in the 2015/16 financial year.
The IDC Executive Management Committee and the Board Risk and Sustainability Committee receive reports every quarter on impairments and credit risk measures.
Capital at risk (IDC company)
Capital at risk is defined as total capital outstanding (excluding commitments) for facilities with repayment arrears of over 60 days. Capital at risk for the year ended 31 March 2015 was R5.8 billion compared to R4.9 billion in March 2014. Despite the increase in capital at risk in absolute terms, as a percentage of the IDC’s loan book at cost, it remained constant at 23% due to growth in the IDC’s loan book.
Capital at risk: 2011 to 2015
As at 31 March 2015, approximately R1 billion of the total capital at risk was attributable to the Metals and Machinery SBU, due indirectly to the instability in the mining industry and the slow recovery of the automotive industry.
Non-performing loans (IDC company)
Non-performing loans provide insight into the ageing of the arrears in the loan book and is defined as the capital portion of the loan book in arrears for over 90 days. As at 31 March 2015, non-performing loans had increased to R5.4 billion (2014: R4.7 billion), an increase of 16% over the previous financial year. As a percentage of the loan book at cost, the non-performing loans have remain at 22% for the last three years.
Non-performing loans: 2011 to 2015
We are currently implementing initiatives to contain an increase in non-performing loans. The Investment Monitoring Committee (IMC) meets quarterly to follow up on clients in this category and is responsible for ensuring that appropriate action is taken timeously to protect the IDC’s interests.
Our Post-Investment Monitoring and Risk Management departments have been mandated to increase their participation in the post-investment monitoring cycle through better collaboration with our operational units and the Workout and Restructuring Department (W&R).
The IDC Impairment Policy ensures that clients in this category are transferred to W&R to facilitate the effective restructuring of loans in the interest of the IDC.
Write-offs (IDC company)
The IDC writes off investments only after, inter alia, viable turnaround and restructuring options have been exhausted fully and the exposure is regarded as unrecoverable.
During the year under review, R1.4 billion was written off (2014: R519 million), an increase of 162% over the previous year.
The Textiles (57%) and Forestry (19%) SBUs accounted for 76% of the write-offs. The reasons related mainly to poor management, market penetration, as well as fraud and the mismanagement of funds in the funded entities.
Written-off businesses have a low probability of recovery, while in some instances we recoup already written-off amounts. The trend in write-offs over the past five years is illustrated in the chart below.
Write-offs: 2011 to 2015 (net of recoveries)
Clients at workout and restructuring (IDC company)
The primary objective of the Workout and Restructuring Department (W&R) is to minimise the risk of failure of our business partners. We proactively identify high-risk business partners who are financially distressed or unable to meet their financial commitments.
W&R applies suitable and practical commercial solutions to minimise the risk of failure, such as restructuring and turnaround. This includes business rescue interventions for clients with reasonable prospects of viability who qualify for rehabilitation. Qualifying clients, mainly with cash flow constraints, are assisted to restructure their balance sheets. Clients who need major operational interventions to become viable again are assisted with turnaround support. W&R also optimises financial recovery of IDC exposure by negotiating settlements/disposals.
Clients at Workout and Restructuring (IDC company)
The W&R portfolio remained flat at R10 billion as at March 31st 2015. This represented 308 clients compared to 329 in the prior year. The W&R portfolio represented 16% of our exposure at cost and 26% of our business partners. For the year under review, the R10 billion W&R portfolio consisted of clients mainly in mining (20%), metals (14%), textiles (13%), media (13%) and agroindustries (10.7%), with the remaining balance attributable to other SBUs. In 2015, 53 clients were transferred to W&R.
Business rescue continues to be faced with challenges including delays in filing for business rescue, inadequate business rescue practitioners, use of business rescue as a delay tactic and unavailability of Post-Commencement Funding. As at 31 March 2015, we had 10 clients in business rescue.
The W&R strategy focuses mainly on turnaround, business rescue and restructuring for clients with a reasonable prospect of being rescued. This enhances the development of industrial capacity.
Asset and liability management
Liquidity risk refers to an inability by the Group to meet its obligations promptly for all maturing liabilities, increase in financing assets, including commitments and any other financial obligations (funding liquidity risk), or do so at materially disadvantageous terms (market liquidity risk).
Liquidity risk is governed by the Asset and Liability Management Policy. The Asset and Liability Committee (ALCO) provides the objective oversight and makes delegated decisions related to liquidity risk exposures.
Sources of liquidity risk include:
- Unpredicted accelerated drawdowns on approved financing or call-ups of guarantee obligations
- Inability to roll and/or access new funding
- Unforeseen inability to collect what is contractually due to the Group
- Liquidity stress at subsidiaries and/or other SOEs
- A recall without due notice of on-balance sheet funds managed by the Group on behalf of third parties
- A breach of covenant(s), resulting in the forced maturity of borrowing(s)
- Inability to liquidate assets in a timely manner with minimal risk of capital losses
The Corporate Treasury manages liquidity on a day-to-day basis within Board-approved treasury limits to ensure that:
- Sufficient, readily-available liquidity to meet probable operational cash flow requirements for a rolling three-month period is available at all times, and
- Excess liquidity is minimised to limit the consequential drag on profitability
- Liquidity coverage ratios aim to ensure that suitable levels of unencumbered high-quality liquid assets are held to protect against unexpected, yet plausible, liquidity stress events. Two separate liquidity stresses are considered. Firstly, an acute threemonth liquidity stress that impacts strongly on both funding and market liquidity, and secondly, a protracted twelve-month liquidity stress with a moderate effect on both funding and market liquidity. Approved high-quality liquid assets include cash, near-cash, committed facilities, as well as a portion of the Group’s listed equity investments after applying forced-sale discounts.
Structural liquidity mismatch ratios aim to ensure adequate medium- to long-term liquidity mismatch capacity by maintaining a stable funding profile. This is done by restricting, within reasonable levels, potential future borrowing requirements as a percentage of total funding-related liabilities. A robust funding structure reduces the likelihood of deterioration in the Group’s liquidity position should sources of funding be disrupted. The structural liquidity mismatch is based on conservative cash flow profiling with the added assumption that liquidity, in the form of high-quality liquid assets, are treated as readily available (i.e. recognised in the first-time bucket).
Market risk is the risk that the value of a financial position or portfolio will decline due to adverse movements in market rates. In respect of market risk, the Group is exposed to interest rate risk, exchange rate risk and equity price risk. Market risk is governed by the Asset and Liability Management Policy and ALCO provides the objective oversight and makes delegated decisions related to market risk exposures.
Interest rate risk
Interest rate risk is the risk that adverse changes in market interest rates may cause a reduction in the IDC’s future net interest income and/or economic value of its shareholders’ equity. The IDC’s interest rate risk is a function of its interest-bearing assets and liabilities.
The primary sources of interest rate risk include:
- Repricing risk: as a result of interest-bearing assets and liabilities that reprice within different periods. This includes the endowment effect due to an overall quantum difference between interest-bearing assets and liabilities
- Basis risk: as a result of the imperfect correlation between interest rate changes (spread volatility) on interest-bearing assets and liabilities that reprice within the same period
- Yield curve risk: as a result of unanticipated yield curve shifts (i.e. twists and pivots)
- Optionality: as a result of embedded options in assets (i.e. prepayment) and liabilities (i.e. early settlement), which may be exercised based on interest rate considerations
The sensitivity to interest rate shocks and/or changes in interest-bearing balances is measured by means of earnings and economic value approaches. The former quantifies the impact on net interest income over the next twelve months and latter gauges the impact on the fair market value of assets, liabilities and equity.
Exchange rate risk
Exchange rate risk is the risk that adverse changes in exchange rates may cause a reduction in the IDC’s future earnings and/or its shareholders equity.
In the normal course of business, the IDC is exposed to exchange rate risk through its trade finance book and exposure to investments in and outside Africa. The risk is divided into:
Translation risk, which refers to the exchange rate risk associated with the consolidation of offshore assets and liabilities or the financial statements of foreign subsidiaries for financial reporting purposes.
Transaction risk, which arises where the IDC has cash flows/ transactions (i.e. a monetary asset or liability, off-balance sheet commitment or forecasted exposure) denominated in foreign currencies whose values are subject to unanticipated changes in exchange rates.
Any open (unhedged) position in a particular currency gives rise to exchange rate risk. Open positions can be short (we need to buy foreign currency to close the position) or long (we need to sell foreign currency to close the position) with the net open foreign currency position referring to the sum of all open positions (spot and forward) in a particular currency. For purposes of hedging, net open foreign currency positions are segmented into the following components:
- All exposures related to foreign currency denominated lending and borrowing
- All foreign currency denominated payables in the form of operating and capital expenditure, as well as foreign currency denominated receivables in the form of dividends and fees
Equity price risk is the risk that adverse movements in equity prices may cause a reduction in the value of the Group’s investments in listed and/or unlisted equity investments and therefore includes future earnings and/or value of shareholders’ equity.
Sources of equity price risk include:
- Systematic risk or volatility in relation to the market as a whole
- Unsystematic risk or company-specific risk factors
The investment portfolio’s beta is used as an indication of systematic, non-diversifiable risk. Due to the long-term nature of the Group’s investments, unsystematic risk is managed through diversification.
Sensitivity analysis were performed on the Group’s equity portfolio to determine the possible effect on the fair value should a range of variables change, such as cash flow, earnings and net asset values. These assumptions were built into the applicable valuation models.
Our Asset and Liability Management and Risk Management practices, together with regular scenario planning, assist management to ensure that this objective is achieved.
We expect 2016 to be another challenging year as a result of a difficult set of conditions in the South African economy and modest growth globally.
Profitability could be impacted significantly in the year ahead due mainly to lower dividend income forecasts. Despite the decline in total assets, our balance sheet remains strong and we intend growing our balance sheet further during the next five years, with advances of between R77 billion and R94 billion in total over that period. This will be funded from borrowings of between R69 billion and R84 billion and share sales of up to R2 billion, with the balance funded through internally generated funds. Gearing levels are expected to increase over the next few years, in line with the strategy to utilise more debt funding.
Value added statement (IDC company)