Rating Action

Johannesburg, 22 November 2019 – GCR Ratings (“GCR”) has affirmed the South African national scale long term and short term issuer ratings on the Industrial Development Corporation of South Africa (‘IDC’, ‘the entity’) at AA+_(ZA) and A1+_(ZA) respectively, under the recently released Criteria for Rating Financial Institutions, May 2019. The outlook is stable.

On May 22, 2019 GCR announced that it had released new criteria for all banks and bank-like entities. This methodology is titled Criteria for Rating Financial Institutions. As a result, all affected ratings were placed ‘Under Criteria Observation’. Subsequently, GCR has finalised the ratings on IDC under this new methodology. As a result, the ratings above have been removed from ‘Under Criteria Observation’ and the ratings revised in line with the new methodology.

Rating Rationale

The ratings on South Africa based IDC reflect its protected government role as South Africa’s industrial development finance institution, supported by full government ownership and a strong history of support. We also factor in very high levels of capitalisation, relatively weak asset quality and high market risks, wholesale-led funding and adequate liquidity.

The competitive position of the entity is a strong positive ratings factor. Essentially, this assessment reflects the entity’s protected position and government role as one of a handful of South Africa’s development-led financial institutions. There also appears to be limited overlap between the mandate of the IDC and other leading development finance institution (“DFI”) in South Africa. The IDC is mandated to develop and support domestic industrial capacity, empower the South African population and promulgate balanced economic growth. Whilst it mostly has a domestic mandate, the IDC can and does lend into the wider African continent. At FY19, around 20-25% of loans were extended to corporations outside the country. As a result, the IDC is modestly exposed to the comparatively higher risk operating environment of the African continent.

Overall, we believe that the entity has a successful track-record in fulfilling its mandate. The IDC underwrites with cognisance of the development agenda and is able to track and communicate its developmental impact. After a decade of fulfilling a counter-cyclical role, with 95% growth in total Company assets over the last ten years, the IDC is looking to shift strategy slightly towards the protection of its balance sheet. However, the DFI will balance this goal with continuing to reach its mandate. Its development strategies over the next 12-18 months remain broadly the same, with perhaps more focus on labour intensive industries and more crowding in of the private sector into developmental projects.

The strong capitalisation of the IDC is highly supportive of the ratings. Based on Company figures, the IDC had a GCR leverage ratio (GCR total Capital to on and off-balance sheets) of 55% at FY19, which compares very well to the other financial institutions. We expect the entity to maintain the highest levels of capitalisation over the next 12-18months and beyond, due to management’s stated aim to maintain its debt to equity at below the 60% level. We also factor in asset growth of around 10% over this period, which is expected to broadly be in line internal capital generation. The IDC is not a profit maximising entity, although it has a strong history of internally generating its own capital with no historic recourse to National Government for support. Over the past two years, internal capital generation has averaged around 13% for the company, excluding the positive impact of the Sasol shares, which is considered to be fairly good, considering the strong leverage position of the Company. Nevertheless, we note the fact that capital generation is heavily supported by dividends and fair value gains from its investments, which are considered to be less-stable sources of income. At FY19, market sensitive income accounted for around 85% of adjusted revenues. This risk is exacerbated somewhat by high equity investment concentrations, especially in the listed space. Although subject to change, GCR estimates that the top ten listed investments accounted for around 50-55% of total investments and 40-45% of total equity in FY19.

The risk profile is a negative ratings factor, which is typical for a development led institution, due to its focus on high and early stage credit risks and high market risk exposure, through the entity’s sizeable listed and unlisted equity book (see above). In regards to credit risk, we believe that the cost of risk (new loan loss provisions (including recoveries and write-offs) to average customer loans) will average around 6.5% over the next few years, balancing the struggling economy and a much higher focus on collections and recoveries of bad debts.

Loan book concentrations are quite high in comparison to the domestic South African banks, with the top twenty loans accounting for approximately 50% of total loans, and the mandate assuring relatively large industry concentrations. Although foreign currency lending represents a moderate 20-25% of total loans (predominantly reflecting the lending exposure outside South Africa), this is viewed to be high in a South African banking context. Although the entity tends to lend to borrowers with hard currency receivables, they are not always matched to external sources (for example, loans to exporters would carry a more secure natural hedge) and therefore there is some currency risk in the loan book. Positively, the IDC manages its translation and asset liability currency risk well. Operational risk and interest rate risks are well monitored and managed, exposing the IDC to limited risk.

We consider the funding & liquidity profile to be a neutral ratings factor. Funding is derived from domestic (75% of total funds, all in ZAR) and international (25%, typically USD and to a lesser extent EUR) wholesale funds. There are a few moderately large single-name funding concentrations, but funding is fairly well-diversified for a South African issuer that is dependent on the wholesale market. Positively, the maturity profile is well staggered across the next 8 years. All funding is senior unsecured, with no asset encumbrances in place. Liquidity is adequate, benefitting from being well monitored, and the presence of large undrawn committed facilities. Including some of the development-led listed equity investments, we believe liquid assets cover around 0.75x total wholesale funding at FY19. We consider covenant risk to be limited.

Outlook

The outlook is stable. We expect the entity to continue fulfilling its mandate and remaining the primary tool for government goals in domestic industrial development. We also expect the entity to continue internally generating capital at around the same pace of asset growth, although this is exposed to the vagaries of the market and struggling domestic economy. Overall, we anticipate a slight improvement in asset quality over the outlook horizon (12-18 months), as the entity improves collections and tightens its underwriting standards.

Rating Triggers

An upgrade is considered to be unlikely, but could be triggered by significantly stronger asset quality fundamentals, as long as the entity can prove it is not denigrating the development agenda of the institution. A downgrade is also remote, although an unanticipated deterioration in capitalisation or asset quality, alongside less robust liquidity could bring the ratings down.

Analytical Contacts

Related Criteria and Research

Ratings History

Industrial Development Corporation of South Africa

Risk Score Summary

Glossary

Salient Points of Accorded Ratings

GCR affirms that a.) no part of the rating was influenced by any other business activities of the credit rating agency; b.) the ratings were based solely on the merits of the rated entity, security or financial instrument being rated; and c.) such ratings were an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

The credit ratings have been disclosed to the rated party. The rating was solicited by, or on behalf of, the rated entity, and therefore, GCR has been compensated for the provision of the ratings. The rated entity participated in the rating process via face-to-face management meetings, and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible. The information received from the entities and other reliable third parties to accord the credit rating included:

Audited financial results as at 31 December 2018;

Management accounts for 2019;

Budgeted financial statements for 2019;

Latest internal and/or external audit report to management;

A breakdown of facilities available and related counterparties