South Africa’s development finance system facing strategic challenge – IDC
MINING WEEKLY / 18 JUNE 2020 - 15.01 / MARTIN CREAMER
JOHANNESBURG (miningweely.com) – South Africa’s development finance system is facing a strategic challenge, says IDC CEO TP Nchocho.
Nchocho and some members of the IDC executive team conversed with Mining Weekly in a Zoom interview to among other things, reinforce the IDC’s key messages, address policy and strategic questions as well as clarify the often misunderstood mandate of this development finance institution.
During the course of the interview, it became clear that in the context of Covid-19, the pressure on South Africa’s development finance system is intensifying, hence their conversations with government on possible support measures, such as blended financing.
The IDC views the Black Industrialist Scheme as a practical example of how government can complement the work of development finance institutions (DFIs) to realise viable projects. For example, if a project requires R100-million, the development finance institution advances R60-million of that in the form of debt and the government advances the other R40-million in the form of an industrial finance grant from government coffers. This would allow the DFIs to continue to advance their mandate at a time of economic recovery while also managing their risk.
“If you take the Land Bank, IDC, Development Bank of Southern Africa, the National Empowerment Fund, there are massive expectations that are going to be directed at them in terms of supporting economic recovery,” said Nchocho, who has led the IDC for just over a year, having joined the corporation in January 2019 from the Land Bank, where he was also CEO.
“The question that arises is: How is government going to support us so that we don't extend our risk taking so much that we trip over and destroy ourselves?
“It’s going to be a very delicate act of balancing investment decision-making while at the same time extending risk as far as possible in order to support economic growth,” Nchocho said in the interview with Mining Weekly.
The IDC is owned by the South African government under the supervision of the Department of Trade, Industry and Competition.
Forty-five per cent of its investments are in manufacturing, 16% in electricity generation, 21% in mining, 16% in services and 2% in agriculture.
Nchocho communicated with Mining Weekly to reinforce the key messages of the IDC and its role in order to foster greater understanding of DFIs and to address policy and strategic questions that are often misunderstood.
The first point Nchocho made during his conversation with Mining Weekly was that the IDC Act was amended after 1994 “to promote the economic empowerment of historically disadvantaged communities and persons” under Section 3(c).
“These transformation imperatives are absolutely central to the way we do business. Transformation and empowerment are in the IDC’s strategic and operational DNA,” Nchocho emphasised.
The IDC’s performance numbers in terms of investments and support for the previously disadvantaged show its incredible transformational track-record, but at times it is perceived as not doing enough.
The second point made by Nchocho during his conversation with Mining Weekly was the IDC is funded from its internally generated proceeds from the clients it finances. To generate additional funds, it periodically sells shares that it holds, for example, in both listed and unlisted equities, to draw R2-billion to R3-billion into the organisation in any given year, and then to reinvest that money into new projects.
Thirdly, the IDC runs a borrowing programme by going to the open money market (banks and bond market) to borrow money.
“This configuration of how we are funded requires that we run a good, high impact entity which is equally sustainable financially. We have to make sound investment decisions,” he explained.
The IDC Act instructs the IDC to make investment decisions on the basis of economic merit. There has to be financial sustainability in what it does. It has to manage its relationships with the credit ratings agencies, which rate the IDC yearly.
“We have to maintain an investment grade rating and they check our earnings profile. When we make investment decisions, or decisions to decline investment, or decisions to take tough action against clients in order to collect money, these decisions are taken in the context of assuring financial sustainability and because we need to run a self-funding organisation,” he pointed out.
Very important is the strategic orientation of the IDC. The organisation has, rightfully in Nchocho’s view, pursued a counter cyclical way of investing in the last five to seven years or so, which involves putting money into businesses even in an economic environment of low growth.
Even during periods of declining gross domestic product, it supports business to create capacity in the economy. As a result, it has a far greater propensity than a normal commercial bank to face higher risk, and this shows in its numbers.
The IDC’s worsening loss ratios at the end of 2019 reflected this strategic orientation that the corporation has been on for some years. It has taken risk positions considerably greater than those taken by commercial banks.
It has done so to support the economy, create jobs and drive transformation, but its propensity for taking risk, Nchocho stated, had deliberately been positioned on the high side. This is important, because that is what DFIs are supposed to do.
The organisation is not in any financial danger, but its loss ratios have been creeping up over a period, which Nchocho pointed out to emphasise the lengths to which the IDC has been going to support the economy.
In mining, the IDC’s exposure to the sector is close to R40-billion of its total exposure of R120-billion.
Highlighted in recent weeks has been the IDC’s R6.5-billion exposure to Kalagadi Manganese, the second largest exposure in the IDC’s entire investment book, in which there are a multiplicity of lesser exposures to mining.
The massive investment that the IDC has made in Kalagadi Manganese, which is opposing the business rescue court application that the IDC has made for it, arises after a long relationship that began in 2006 with IDC’s initial investment of R60-million into a bankable feasibility study, with many things happening along the way.
But the long and short of it is that after spending billions of rands on Kalagadi, it has had to tell the court that Kalagadi is unable to service its debt and has defaulted on its loans.
IDC cited three main reasons for this:
Firstly, the mine had not been able to ramp up production. After mining operations began in 2018, the plan was to ramp up to steady state in the second half of 2019, but it had not been able to reach even half of the planned production and cash flow has been impacted as a result.
Secondly, there was a need to strengthen the management team. Kalagadi had taken steps to do so but lenders believe the steps taken are not adequate.
Thirdly, governance improvements were needed at board level and the board’s committees needed to function better.
“We know that the narrative in the media is that the IDC is trying to chuck out the founding owner of Kalagadi. There’s absolutely no such thing. All that IDC wants is sound governance,” Nchocho emphasised.
IDC’S OWN GOVERNANCE
Nchocho contended that the IDC had always been on the good side of governance, with a well-constituted board. Many of the board members are seasoned business executives and include the likes of Busi Mabuza, former AngloGold Ashanti CEO Bobby Godsell, former Eskom CEO Brian Dames, Advocate Thandi Orleyn, Lael Bethlehem, Nimrod Zalk, Philisiwe Mthethwa, André Kriel, Dr Sizeka Magwentshu-Rensburg and Nomavuso Mnxasana.
“These people bring credibility to the IDC’s board and they support the executive a lot and they hold us to high standards. The IDC is a well governed corporation. We don’t have any doubts in that regard.
“Every organisation has problems. There will always be one or two wrong things done and disciplines may have to be imposed but you won't find maladministration and financial maleficence in the IDC.
“We are challenged a lot by the big subsidiaries that we have owned historically. For instance, Foskor, the former units of Scaw Metals, including Cast Products SA. We’re heavily challenged by those companies because unfortunately they’re not on a sustainable path and they are a big drain on the IDC, not only financially but also in terms of management time.
“Last year the board of Foskor was changed. It’s now chaired by Bobby Godsell, a hard-hitting person at that level. There’s also been a total revamp of the management team. The company has since embarked on a clear path to turn around the business, which we are supporting as the majority shareholder.
“There’ve been a couple of changes in the IDC leadership team, and I think there will continue to be. People come and go. We lost our chief risk officer but have recruited a new one, also a person coming from a major financial institution. She’s starting duty now on July 1.
“Changes do happen at executive level, but we have new successors with equal if not even stronger capabilities. For us, and I made this point earlier on, there is a strategic challenge arising for the development finance system in South Africa,” Nchocho emphasised.
Meanwhile, at the level of Kalagadi, the IDC has not ceased reiterating that it remains fully committed to exploring all its options to protect the future of the mining company.
Its application asserts that Kalagadi is unable to service its debt, namely R3-billion to IDC and R2.9-billion to the African Development Bank. Having funding to cover operating costs alone is insufficient.
In a recent statement issued by the IDC to Mining Weekly, it stated that Kalagadi’s default on its loans and guarantee instruments was placing the business – including its 1 153 employees – in jeopardy.
“We believe that a court will come to a similar conclusion. As both shareholder and lender, IDC was obliged to respond,” it stated in the release.
“We maintain that business rescue is the best option and are seeking a court date for this matter to be ventilated. At the same time, we are reserving our options in terms of other avenues that may be available, as part of a determined effort to protect the future of the mine and the future of our investment,” read an excerpt from the statement.
As stated in the business rescue application, Kalagadi’s mineral base was a world-class asset and this entity had the potential to become a world-class mining operation.
Further in the statement, the IDC emphasised that Kalagadi could be rescued and must be rescued, not only because of its economic significance, but also because of what it represented as a black economic empowerment initiative and because of its contribution to the regional economy of the Northern Cape.
“We need to emphasise that our commitment and support to economic transformation is well documented. As a responsible lender whose mandate is to contribute to the economic and industrial development of the country, IDC subscribes strongly to dictates of corporate governance," it stated.
The IDC added that it has been a key driver of government’s broad-based black economic empowerment programme – which, among other factors, had led to the establishment of Kalahari Manganese.
According to the IDC, it has made significant strides in driving transformation over the last five years, as evidenced by the fact that R42-billion out of R72-billion approved as funding in the previous five years has been to black-empowered and black-owned companies with the bulk of this, R24-billion, to black-owned companies that had black shareholdings of more than 50%.
Disclaimer - The views expressed here are not necessarily those of the BEE CHAMBER