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 into the economy.
Managing impairments, however, is key to ensuring our financial sustainability. We have implemented and will continue to implement initiatives to ensure that impairments remain within acceptable levels.
The Board has emphasised that in order to implement the 2017 to 2019 corporate plan, and all the approved initiatives to continue our operations, we will need to remain a going concern and financially sustainable. As a result, we regard financial sustainability as a material matter.
Five-year financial overview – extract from the Company’s Annual Financial Statements
Five-year financial overview – extract from the Group’s Annual Financial Statements
REVIEW OF FINANCIAL PERFORMANCE
The 2016 financial year was a challenging one for the global economy, South Africa and the IDC Group. Most subsidiaries and associated companies are feeling the strain of the unfavourable economic environment. The Group made a consolidated profit of R223 million compared to a profit of R1.7 billion in 2015.
Group Revenue for the year has decreased by 1% to R19.4 billion from R19.6 billion in 2015.
Scaw’s performance has continued to deteriorate during the current year. Full year revenue of R5.7 billion from Scaw is 10% lower than the previous financial year (R6.3 billion) due to continuing difficult trading conditions within the steel sector and slower growth in China (the largest consumer of steel), the increasing cost of electricity, and low spending by the mining sector due to falling commodity prices and subdued growth in the local economy.
Management has initiated several interventions aimed at improving performance. Some of these are:
- improving of efficiency through process reviews;
- focusing on core business and selling non-core assets;
- restructuring of the company balance sheet;
- a proposed further reduction of the workforce, which the company is currently discussing with labour unions, and
- a repositioning of the company as the main exporter to the African continent.
Substantial cost savings are expected from these initiatives, with more benefits expected to flow from the Strategic Equity Partner implementation.
Revenue from Foskor is up by 11% from the previous year to R5.9 billion, mainly due to the favourable impact on selling prices of the Rand/US Dollar exchange rate.
Interest income of R2.4 billion is 7% above that of the previous year due to an increase in loans and advances during the year and a higher interest rate environment for the IDC Company.
Dividends received are 12% lower compared to the previous financial year. Kumba Iron Ore Limited did not declare any dividends during the period as a result of the extended depressed iron ore prices, compared to a dividend of R969 million declared in 2015.
The negative impact this had on dividend income was partially offset by a dividend in specie of R684 million received from BHP Billiton upon the demerger of South32 Limited. On 19 August 2015, BHP Billiton announced a plan to unbundle its non-core portfolio (aluminium, coal, manganese, nickel, silver and lead assets) into South32, a global metals and mining company formed specifically for that purpose. Shareholders have retained their BHP Billiton shareholding and received an in specie distribution of shares in South32 on a pro rata 1:1 basis, for no consideration.
The operating loss for the year is R494 million (2015: R1 billion profit) mainly due to an increase in impairments and a decrease in dividends as indicated on the previous page.
Impairments for the Group significantly increased by R1.6 billion, from R1.5 billion to R3.2 billion, still reflecting the difficult trading conditions persisting in the South African economy. The main reasons for the increase in impairments in the current financial year were the adverse macro-economic environment and the protracted commodities prices slump. The impact of the weakening Rand, interest rate hikes and the drought also had a negative impact on some exposures. The Company has embarked on various initiatives to contain any further increases in impairments, and we are confident that these interventions will be effective in curbing the growth in impairments, and allow us to continue to play our counter-cyclical role in the economy.
Financing costs have decreased by 6% to R1.3 billion due to exchange rate gains, as a result of the weakening of the Rand during the year. Operating expenses (excluding impairments) marginally increased by 3% from R4.4 billion to R4.5 billion. This is mainly due to cost-efficiency initiatives. We made a capital profit of R453 million from the disposal of certain listed and unlisted investments during the year compared to R640 million in the previous year.
During 2015 we received R406 million from the South African government to fund the Small Enterprise Finance Agency (sefa) (2015: R284 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. We received R41 million from the scheme during the past financial year (2015: R39 million).
INCOME FROM EQUITY-ACCOUNTED INVESTMENTS
With the Group’s share of profits standing at R557 million, our equity-accounted investments have shown a slight decline in performance during the reporting period, compared to a profit of R656 million in 2015. The continued positive impact is encouraging, given the protracted pressure on commodity prices.
LOANS, ADVANCES AND INVESTMENTS
We have advanced R11.4 billion in new loans, advances and investments during the year, up from R10.9 billion in 2015. This resulted in loans and advances growing to R23.9 billion (net of repayments) from R22.4 billion and investments increasing from R28.2 billion to R33 billion (net of disposals and preference share redemptions).
The revaluation of investments to fair value decreased from R44.9 billion to R38.6 billion, mainly due to the decrease in the value of listed equities following downward trends in the oil, platinum, manganese, steel and iron ore prices.
The largest declines in market values were as a result of our BHP Billiton, Kumba Iron Ore and Mozal investments, all affected by the commodities slump. We are committed to diversifying our portfolio over the medium term in order to minimise the risk of concentration towards commodities, and to invest in a diverse portfolio with more stable growth prospects.
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 R28 billion from R24 billion in 2015.
During the past financial year, we continued with our public bond issuances under the IDC Domestic Medium-Term Note (DMTN) programme. This resulted in additional issuances of R1.5 billion in May 2015 and R2 billion in November 2015. Investors responded positively to these issuances, with the bonds 2.3 times and 2.1 times over subscribed respectively.
The demand and pricing of the bond issuances reflected investors’ confidence in the Corporation’s creditworthiness and financial standing. We will continue our bond issuance programme as part of our funding sources diversification strategy. This strategy will also be informed by the local and international market conditions, pricing and available liquidity in these financial markets. Traditional sources – both local and international commercial banks and Development Financial Institutions (DFIs) – will also be explored as part of our funding sources. The DFIs with which we have bilateral agreements are Kreditanstaltfür Wiederaufbau (KfW) Development Bank, African Development Bank (ADB), Agence Française de Développement (AfD)/Proparco, European Investment Bank (EIB), China Development Bank (CDB) and China Construction Bank (CCB).
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 permanent jobs, continue to be tapped. Cumulatively, R4 billion has been utilised under the PIC bond. Our debt funding activity during the year included R7.8 billion sourced from public bonds, private placements, commercial banks and DFIs, with repayments of R3.2 billion. We continue to meet our financial obligations emanating from these funding sources while maintaining excellent relationships with our lenders and investors.
TOTAL ASSETS, CAPITAL AND RESERVES AND DEBT/EQUITY
Total assets declined from R122.3 billion in 2015 to R121.3 billion during the review period mainly as a result of the decrease in the fair value of BHP Billiton and Kumba Iron Ore Limited, largely due to lower iron ore prices. Our borrowings have grown in line with the growth in loans and advances. Higher debt levels and lower reserves increased the debt/equity ratio from 27% in 2015 to 33% in 2016.
IMPAIRMENTS (IDC COMPANY)
The increasing impairment levels, although aligned with our risk appetite and our role in supporting high-risk sectors and businesses, remain largely unattractive to commercial financiers. The impairment charge to the income statement of R3.6 billion for the year ended 31 March 2016 was 99% higher than the charge reported at financial year end in 2015.The impairments level has increased steadily over the past five years in value terms, from R6.8 billion in 2012 to R11.8 billion in 2016. A 15% increase occurred in cumulative impairments between the 2015 and 2016 financial years. As a ratio of the total outstanding financing book at cost, however, impairment levels increased marginally from 16.7% in the previous year to 16.9% during the period under review. Impairment levels for the portfolio at market values increased from 8.8% to 10.1%. The impairment level remains within the threshold of 20% as set by the Board.
Key factors that contributed to the rising impairments included the decline in commodity prices and deterioration in trading conditions. Many of our clients experienced challenges in their operating environments. Globally, the mining industry faced serious challenges due to steep slides in commodity prices and a longer-than-anticipated recovery period.
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 to 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 Board’s Risk and Sustainability Committee and implemented during the 2016 financial year.
The Executive Management and Board Risk and Sustainability Committees receive reports on impairments and credit risk measures quarterly.
WRITE-OFFS (IDC COMPANY)
The IDC writes off investments only after, inter alia, viable turnaround and restructuring options have been fully exhausted and the exposure is regarded as unrecoverable.
During the year under review, R2.1 billion was written off (2015: R1.3 billion), an increase of 57% over the previous year.
The Media (52%) and Textiles (16%) SBUs accounted for 68% of the write-offs, for reasons relating mainly to some business partners' poor management and market penetration, as well as fraud and the mismanagement of funds.
Written-off exposures 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 following chart.
ASSET AND LIABILITY MANAGEMENT
Liquidity risk refers to the inability of the Group to meet its obligations promptly for all maturing liabilities, or the increase in financing assets, including commitments and any other financial obligations (funding liquidity risk), or to do so on 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
- The inability to roll and/or access new funding
- The 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)
- An 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 three-month liquidity stress that impacts strongly on both funding and market liquidity, and secondly, a protracted 12-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 forcedsale discounts.
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 changes in market interest rates may cause a reduction in our future net interest income and/or economic value of our shareholders’ equity. Our interest rate risk is a function of our 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.
- Optionality, as a result of embedded options in assets (ie 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 12 months, while the 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 our future earnings and/or our shareholders’ equity. In the normal course of business, we are exposed to exchange rate risk through our trade finance book and exposure to investments in the rest of 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 we have cash flows/ transactions (i.e. a monetary asset or liability, off-balance sheet commitment or forecast 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
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 the 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 our investments, unsystematic risk is managed through diversification.
Sensitivity analyses were performed on our 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 in ensuring that this objective is achieved.
Value added statement (IDC Company)
We expect 2017 to be another challenging year as a result of modest growth locally and 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 it 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 disposal of investments, 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.