12 July 2018 – So we can carry on writing our “prolific” research reports, here is Viceroy Research’s comment on the Intellidex report:
It is our belief that Capitec management have continued to mislead investors since our previous correspondence with the company.
End-of-financial-year announcements in 2018 are reflective deteriorating business conditions and corroborate the continuity of several intentionally misleading accounting practices we have reported in the past.
We have again entertained Capitec’s invitation to field questions regarding its business.
An open letter to Capitec’s Audit Committee can be downloaded below:
In this instance, we are addressing the audit committee with our concerns, as they relate to broader financial reporting transparency and flawed management analysis, corroborating our previous analysis of unsustainable business practices.
Our continued review of Capitec’s practices and financial results leads us to believe management’s delivery of analysis to stakeholders is extremely misleading, and not at all reflective of declining business fundamentals.
This report will follow issues we have raised in previous reports and correspondence with management. You can find all of these reports on our website:
A perfect example of why Viceroy don’t “engage with management” – they don’t answer our questions.
Viceroy issued an open letter to Capitec’s board of directors on 20 February 2018, responding to their invitation to engage with management and field our questions.
A full copy of our letter can be found here:
Capitec replied to our letter on 22 February, 2018 via email, however provided no straightforward responses to any of our questions. At best, Viceroy received numerous largely insignificant statistics and tangential statements.
Capitec’s full response to our letter is attached to this report as Annexure 1.
Viceroy has been criticized for not engaging with management prior to publication of our reports. Capitec’s response is a prime example of why we choose not to. We maintain our recommendation that Capitec should be subject to an external, independent regulatory investigation, which we believe will result in Capitec being placed in curatorship in order to protect its consumers.
Capitec has opened an invitation to address Viceroy’s questions.
We believe our reports have clearly conveyed our concerns with Capitec, but have happily condensed our research into questions.
We look forward to Capitec’s response.
On January 30, 2018 Viceroy Research released our report on Capitec (JSE:CPI) citing a need for large impairments and regulatory intervention.
The issues expressed by Viceroy have been reflected in a letter from Benguela Global Fund Managers to Capitec also raising concerns about Capitec’s lending practices. This report presents the results of Viceroy’s further investigation into Capitec and a rebuttal of Capitec’s responses to Viceroy and Benguela.
- Since the publication of our last report, Capitec has disclosed that an extraordinarily large portion of its subprime, highly indebted customers who miss payments on their loans are somehow able to find the money to “catch up” or “cure” their arrears. This is suspicious.
- Numerous former Capitec staff and 5 prominent debt counselling firms with proprietary datasets on South African unsecured lending support our thesis that this “curing” method is how Capitec hides the disastrous underlying performance of its loan book. If a borrower in arrears is able to beg or borrow the funds from a secondary lender to pay down their arrears and make themselves “current”, Capitec immediately offers them a new, larger loan. The borrowers use this new, larger Capitec loan to pay off the secondary lender used to cover the arrears.
- Analysis of tens of thousands of Capitec borrowers’ datasets within debt counselling firms show consumers were able to get new loans after paying down their arrears the day prior. Thus, we can state empirically that this practice is still occurring. We contrast this with the lending criteria of a Standard Bank or Absa where there is a “cooling off” period before a borrower formerly in arrears can seek a new loan – to prevent exactly this behavior. By offering upsized loans to people who have just cleared their arrears, Capitec management is able to say with a straight face that they do “not lend into arrears”. This is TRUE in fact – but not in substance.
- While the borrower is getting more and more indebted and is still unable to pay their debts, lending to people who were immediately prior in allows Capitec to artificially generate “cures”, unsustainably increase its loan book, charge massive initiation fees and create a façade of quality within its consumer base.
- Well over half (70% – 80%) of Capitec consumers in debt counselling were issued new loans prior to repaying their existing loans.
- Viceroy have obtained communications from Capitec Head Office dated 8 February 2018 to local branches advising that it has amended the number of allowable loans per customer. Reading between the lines, Capitec appear to be tightening or relaxing lending rules in order to achieve the greatest possible return as opposed to the consumers ability to repay those loans.
- Viceroy has obtained evidence of Capitec intentionally abusing the debit order system to ensure its debits take priority ahead of other lenders.
- Following the publication of our last statement several media outlets have reported on CEO Gerrie Fourie’s purchase of ZAR 1.5m of Capitec shares on the open market, presenting this as a show of faith in the company. We believe this is intentionally narrow-minded when viewed in the context of the net market sale of ZAR 49m worth of Capitec shares by Fourie in 2017. Collectively, directors sold ZAR 406m Capitec shares on market in 2017 alone.
- We respond systematically to Capitec’s poorly constructed rebuttal of our prior report.
Capitec’s behavior has led to material overstatement of the quality of the book and substantial under-provisioning. We note the South African Reserve Bank (SARB) described Capitec as being liquid and solvent on the basis “of the available information”. Evidence suggests the available information is being deliberately distorted by Capitec management and we believe that as a matter of prudential supervision the SARB must investigate the lending practices at Capitec. We are providing this data to SARB and the NCR.
Viceroy continues to believe that Capitec is fundamentally uninvestable and reiterate our recommendation that an investigation by an independent body is launched in the face of the evidence presented in our research.
Viceroy comments on information available to the South African Reserve Bank regarding Capitec:
In response to Viceroy’s recent report on Capitec (JSE:CPI), the South African Reserve Bank (SARB) decided to vouch for Capitec. Indeed, it decided to stake its reputation on the accuracy of the company’s accounts. Below is their statement in full:
“The South African Reserve Bank (SARB) notes a report by a US based fund manager. As part of our mandate, we monitor the safety and soundness of all banks, including Capitec Bank Limited (Capitec). According to all the information available, Capitec is solvent, well capitalised and has adequate liquidity. The bank meets all prudential requirements.”
The South African Reserve Bank has a responsibility to determine whether the information provided to them – and on which they base their regulatory decisions is accurate. We do not think it is.
The SARB has, at this point, a responsibility to perform a full regulatory inspection of Capitec. Viceroy remains firm in its belief that this will result in SARB placing Capitec into curatorship.
Viceroy will shortly respond to Capitec’s press release in relation to our report.
Based on our research and due diligence, we believe that Capitec is a loan shark with massively understated defaults masquerading as a community microfinance provider. We believe that the South African Reserve Bank & Minister of Finance should immediately place Capitec into curatorship.
Capitec Bank Holdings Limited (JSE: CPI) is a South Africa-focused microfinance provider to a majority low-income demographic, yet they out-earn all major commercial banks globally including competing high-risk lenders. We don’t buy this story. Viceroy believes this is indicative of predatory finance which we have corroborated with substantial on-the-ground discussions with Capitec ex-employees, former customers, and individuals familiar with the business.
Viceroy’s extensive due diligence and compiled evidence suggests that indicates Capitec must take significant impairments to its loans which will likely result in a net-liability position. We believe Capitec’s concealed problems largely resemble those seen at African Bank Investments (JSE: AXL) prior to its collapse in 2014.
We think that it’s only a matter of time before Capitec’s financials and business unravel, with macro headwinds creating an exponential risk of default and bankruptcy.
This report will provide underlying information and analysis we believe supports the following conclusions:
- Reconciliation of loan book values, maturity profiles and cash outflows imply Capitec is either fabricating new loans and collections, or re-financing ~ZAR 2.5bn – 3bn (US$200m-$240m) in principal per year by issuing new loans to defaulting clients.
- Legal documents obtained by Viceroy show Capitec advising and approving loans to delinquent customers in order to repay existing loans. These documents also show Capitec engaging in reckless lending practices as defined by South Africa’s National Credit Act. This corroborates Viceroy’s loan book analysis.
- As a consequence of re-financing delinquent loans, Viceroy believes Capitec’s loan book is massively overstated. Viceroy’s analysis against competitors suggests an impairment/write-off impact of ZAR 11bn will more accurately represent the delinquencies and risk in Capitec’s portfolio.
- Legal experts that we have spoken to believe that the outcome of an upcoming reckless and predatory lending test case in March 2018 will be used to trigger a multi-party litigation refund (class action). We believe that, at a minimum, Capitec will be required to refund predatory origination fees primarily related to multi-loan facilities; an estimated ZAR 12.7bn.
- Viceroy’s investigations suggest that Capitec’s prohibited and discontinued multi-loan facility lives on, rebranded as a “Credit Facility”. Former Capitec employees have corroborated this. Despite its perception as an affordable lender, Capitec’s implied interest rates are significantly true of the maximum allowable rates in South Africa.
- South Africa’s microfinancing sector has been the graveyard of numerous Capitec competitors who chased the same meteoric growth Capitec displays, largely due to low acceptance and mass delinquencies. We see no operational difference between Capitec and its ill-fated predecessors, including African Bank.
- Former employees consider the business to still be an outright loan-shark operation, where fees are key. Some former employees believe they were fired for not deceiving borrowers and failing to meet rescheduling targets on impaired/defaulting loans.
- Jean Pierre Verster, chairman of Capitec’s audit committee, is/was indirectly short Capitec through Steinhoff. We believe this is an oversight, and understand Verster to be an excellent analyst on the short side. We encourage Verster to raise the concerns within this report to company auditors and recognize Capitec’s resemblance to his previous African Bank short.
Given what we believe is a massive overstatement of financial assets and income, together with opaque reporting of loan cash flow and reckless lending practices, we believe Capitec is simply uninvestable and accordingly have not assigned a target price.