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One wintry day in 2011, Sandile Khowane, a food service supervisor at the department of health, walked into Capitec ’s Ulundi branch and waited in a queue.
Once at the front, he sat down opposite bank employee Lungile Khanyile. “I am experiencing financial difficulty,” Khowane began. “How much can I get?” Khanyile took Khowane’s Capitec bank card and salary slip, which showed he earned a net salary of R7,650, and hammered some figures into her computer. There’s good news, she said: you can get almost R74,000.
That same day Khowane got the cash.
The exact circumstances around the loan, as well as Khowane’s admitted financial position, would later become the subject of a legal palaver which left Capitec embarrassed and a magistrate worried about the bank’s business model.
In a scathing ruling two years later, Vryheid magistrate Ellen Gröpp found the bank guilty of reckless lending, saying Khanyile failed to conduct an adequate credit assessment. She ruled that Khowane was hopelessly overindebted and the bank couldn’t provide proof that it had even conducted a credit check to see if he could afford it.
Khowane was surprised to find out that Capitec had calculated his total monthly income, including “household income”, at R16,259 — more than double his net pay.
Said Gröpp: “Capitec’s assessment model leaves much to be desired and has to be reassessed. The way it goes about [obtaining] information with regards to additional and household income is of great concern.”
She declared the credit agreement “reckless” and set it aside.
Capitec, SA’s fifth-largest bank — now worth R64bn — has gone out of its way to pitch the Khowane story as not reflective of a bigger problem.
“These magistrate’s court cases are dependent on the specific evidence of the witnesses in each case and cannot be seen as a general ruling on compliance,” says Carl Fischer, Capitec ’s head of corporate affairs. “It is one case among many similar cases we have won in other magistrate’s courts.”
Fischer says the Khowane ruling wasn’t worth the cost of appealing.
And yet, that dispute has begun to assume a greater resonance in light of new accusations of “reckless lending” which have emerged in the past two weeks.
Lobby group Summit Financial Partners has lodged court papers in the Stellenbosch magistrate’s court in which it claims the bank has exhibited a pattern of reckless lending when it comes to two of its “multi-loans”.
If Summit succeeds in these two cases, it plans to launch a “class action” lawsuit against Capitec on behalf of hundreds of miners employed at Anglo American Platinum.
Fischer says the two new cases represent just a fraction of Capitec ’s R40bn loan portfolio. Perhaps, but important questions have been raised about the bank’s wider credit assessment processes, as well as how well it manages its risks — a crucial question considering its typical customer is young, relatively poor and with little education.
This is unsettling for Capitec ’s shareholders, who have minted it for years as the small bank from Stellenbosch outpaced and outperformed its larger rivals. If proved true, the accusations that it contravened the National Credit Act threaten to end the bank’s golden run, finally breaking the seemingly inexorable trajectory of the bank that “broke banking” as we know it.
To get a sense of just how ludicrously successful Capitec has been until now, consider the numbers.
Those investors who had the foresight to stick R10,000 into Capitec shares when it listed in 2002 (at R1.80/share) would now have more than R4.7m (dividends included) — a dizzying 46,900% return.
Even FirstRand, another market darling, would only have been able to turn that R10,000 into R152,331 over that time.
Fischer says the steep share price rise “probably shows the level of market scepticism in the early formative years of the bank, where no-one believed it would be able to compete with the four large traditional banks”.
Under its pioneering CEO and cofounder Riaan Stassen, who retired in December 2013 and was replaced by Gerrie Fourie, Capitec became the little bank that could. It took on the “big four” and beat even the most optimistic projections.
Client numbers surged from 706,000 people a decade ago to 7.3m today — and they’re still adding 100,000 every month, according to Fischer.
“We took what clients disliked in banking and credit provision and innovated the processes, to make it simpler, quicker, more convenient and lower-cost,” says Fischer. “This has appealed strongly to the entire market at all income levels.”
Whereas its rivals hobbled through two banking crises, Capitec sailed through them.
And when its larger unsecured lending competitor African Bank tumbled into curatorship in August 2014, Capitec confounded doomsayers who predicted it would take a similar bad-debt knock.
It was a reasonable concern, however. After all, Capitec — like African Bank — had also lent to many poorer people. So pundits weren’t clear why one should implode while the other breezed through the credit crunch.
Part of the answer lies in the fact that Capitec was much more conservative than, say, African Bank about setting aside cash to cover for bad debts.
Another part of the answer is that Capitec has a number of strings to its bow, running a transactional bank account into which customers deposit cash that the bank can on-lend through its lending business. African Bank, by contrast, was a one-dimension business, lending money to customers that it had borrowed from big institutions.
And when those funders lost confidence in African Bank, it was curtains.
Capitec, by contrast, is perhaps SA’s greatest (and fastest) banking success story.
A decade ago, nobody deposited their salaries into Capitec accounts. Today, 3.3m South Africans do just that, and the bank holds R37.7bn in savings. Still, Capitec makes most of its money from lending, with 56c out of every rand coming from its credit business.
Which shows how astoundingly profitable unsecured lending has been for the bank.
Capitec ’s return on equity sits at 28%, higher than FirstRand (23.4%), Barclays Africa (17%), Nedbank (15.7%) and Standard Bank (15.3%).
Research by Macquarie First South reveals the profile of the average Capitec bank client.
It is more black than the other banks (80% of customers are black, 12% coloured and 5% white); younger (56% are younger than 34); generally poorer (more than 50% earn less than R5,000/month); and less educated (42% don’t have matric).
In other words, while other banks have paid lip service to the notion of providing financial services to SA’s “unbanked” or “unbankable”, Capitec has inserted itself into the epicentre of the complex monopoly of SA’s big four banks, and has done what it said it would do.
For investors, Capitec was the Black Swan event that disrupted the banking landscape.
This is precisely why the new claims of “reckless lending” and questions about the quality of its customer base are so alarming for investors.
The Stellenbosch court case, when it is eventually heard, won’t be pretty. Rather like first seeing how sausages are made, many might be shocked to see how Capitec works.
It’ll shine a harsh spotlight on the rough end of the market where Capitec operates, lending out money to the desperate at interest rates which won’t sit easily with academics who speak approvingly of “extending credit to the unbanked” without considering the chunk of flesh extracted in exchange.
Summit has taken issue with Capitec ’s “multiloan” products, which the bank (perhaps stung by questions over these loans) stopped offering in February.
The multiloan product allowed customers to get a maximum of 12 loans a year — short-term loans that people routinely used to tide themselves over to payday.
It was akin to a “payday loan”, which critics consider an abuse of the needy poor.
The crux of the issue, however, is that Capitec charged an “initiation fee” on each of these 12 “loans” even though they were part of a pre-approved package.
For a while, it was a big boon for Capitec. Its short-term loan book enjoyed blistering growth since 2013, rising 214% compared with the 100% growth in “other loans” and 52% growth for loans repayable between 13 and 36 months.
The stories told by customers illustrate how punitive these loans could be.
In one case, a computer technician called Emile whose “household income” Capitec calculated at R7,540 in October 2014, was given a number of these multiloans.
It worked like this: Capitec did an initial credit assessment for the first loan but, every month afterwards, the technician could access subsequent loans by simply answering three questions on an ATM.
These were: did your income fall; did your expenses rise; were you behind on payments? But if you answered “no”, Capitec did nothing to verify this. The National Credit Act, however, says banks must take reasonable steps to assess a customer’s means, prospects and obligations.
Every month, Capitec would levy a new “initiation fee” on these loans too.
Emile, whose income was R13,923 in August, says he managed to get R13,946 in credit over a period of nearly two years, just by answering these three questions.
Summit has also gathered complaints by Capitec employees detailing how they were “pressured” to urge consumers to use their multiloan products.
The Financial Mail was unable to verify this. One former employee contacted by us says there was no such pressure.
“During my tenure with the bank, I did not experience any of this,” he says.
“We just contacted clients who were not utilising [the multiloan facility] to check if they still wanted the facility. That’s all.”
Capitec ’s staff aren’t exactly well-paid. Macquarie First South estimates that the bank’s nonmanagement staff earn, on average, R148,000 a year.
In Summit’s second case, it has asked the Western Cape high court to order Capitec to provide the proof of income, credit report, quotations, and the affordability assessments used to grant another client loans totalling R54,898. That client, Izak, was unable to keep up with his repayments so the debts compounded. Soon, he’d racked up five default judgments to the tune of R33,289.
If the Stellenbosch court agrees that Capitec has been “reckless”, this will open the door to a wider class action that could be exceptionally damaging for the bank.
Clark Gardner, who runs Summit along with former African Bank financial director Dave Woollam, says he has been fighting Capitec for three years now.
“We first engaged with management, sought alternative remedies that were recently closed by Capitec, planned the attack, and obtained all the relevant documents from our clients to be included in our class action,” says Gardner.
Gardner says that if the court agrees on the first two cases, Summit will launch a “class action” against the bank on behalf of mineworkers at Anglo American Platinum who were given these “multiloans” during the 2014 strike on the platinum belt.
The strike led to desperation. Mineworkers weren’t paid for five months in what was SA’s longest unprotected strike. With nowhere left to turn, they went to Capitec.
Was it reckless to lend to them? It’s hard to say for sure, but in one case, a mineworker rang up R4,412 in Capitec “multiloans” soon after the strike began — when there seemed no end in sight.
If Summit does launch a class action suit, it’ll be precedent-setting: no-one has launched such a bid against a bank before.
But Capitec ’s Fischer says the bank has won many such cases, and isn’t worried.
Asked why customers took the bank to court, he says: “I cannot comment on what motivates consumers to go to court regarding credit.
“We do know that in many instances it is instigated by debt counsellors.”
Perhaps, but it says much that their clients were in such dire financial straits that they had to approach a debt counsellor in the first place.
Again, Fischer brushes this off, arguing that all banks deal with complaints. “This is always the challenge of service delivery, in an industry that requires complex administrative processes,” he says.
Either way, there are many people on the other side of those loans who are buckling under the strain of too much debt.
As much as Capitec puts a brave face on its bad debt, its financial statements paint a different story.
Recently, there has been a sharp spike in “rescheduled loans” — loans where a customer can’t repay a debt, so the bank will “reschedule” that loan over a longer period, reducing the scheduled repayment amounts.
Worryingly, Capitec ’s annual report for the year to February showed a 75% surge in “rescheduled loans” — a clear sign of distress among their clients.
This has alarmed investment bank JPMorgan, which follows Capitec ’s fortunes closely. Analysts John Storey and Behrin Naidoo asked for a meeting with Capitec management to explain this.
They learnt that Capitec appeared to have a “strong incentive” to reschedule loans instead of writing them off, the analysts say in a note to clients.
The rescheduling of loans has a number of implications. For one, it means the amount of loans being written off drops. Last year, loans written off dropped from R4.4bn to R4bn.
Macquarie First South suggests that about 60% of these “rescheduled” current accounts are very likely to be “cured” in future.
Though the bank’s prudent risk management policies have kept it on top of the problem, the ship may capsize if SA’s economic growth slows further.
Says JPMorgan: “The sizeable increase in rescheduled loans is a departure from management’s usually conservative approach, but strengthened provisioning, higher coverage and strong collections largely ameliorate these concerns”.
Nonetheless, JPMorgan says it does “expect asset quality metrics to deteriorate as the economy slows”.
On this issue, Fischer says it’s nothing to be concerned about, but rather a consequence of the bank’s shift to offering shorter-term, higher-margin loans.
“It reduces the risk profile of your total book,” he says. “We simply adjust our credit models to be more stringent, which would shorten the term and reduce amounts extended to clients, on average.”
The problem was that many customers couldn’t cope with these shorter loans.
“Clients may choose a shorter term with a higher repayment amount, but later experience a negative cost event and need to soften the monthly cash flow effect of the particular loan,” says Fischer.
“This typically happens in tighter economic times, where, for example, incentives or bonuses are not (paid).”
He’s right that the bank has shortened its loan terms in a major way (see graphic).
For its past financial year, the number of loans that must be repaid within 12 months grew sharply. In 2013, only 20% of its loans were for less than 12 months, while 46% had to be repaid in five years to seven years.
Today, 32% fall into the 12 months or earlier category, while only 9% fall into the five-to-seven-year group.
That’s a major change, illustrating that Capitec saw some worrying signs of risk in its loan book.
Analysts have taken a rather dim view of Capitec ’s long-term prospects. Of the 11 analysts who follow the share, seven rate it a “sell”, largely because the price is so high.
Overall, the analysts believe Capitec ’s share price is likely to hit R507.57 within the next 12 months. That’s 6.8% below its current levels.
Last month, analysts from Macquarie First South said in a report that Capitec ’s share price wasn’t “reflecting the sharp decline in earnings growth momentum”.
For this reason, the brokerage recommended investors sell the share, as it was trading above its fair value.
Avior Capital Markets said in a research report last month that even though it expects earnings to grow by 20% a year over the next five years, “the share is expensive at current levels”.
Among other risks, Avior highlighted the low level of SA’s GDP, as well as new rules on unsecured lenders.
There are other serious headwinds. These include finance minister Pravin Gordhan’s austerity measures, which are likely to knock the salaries of government employees, who make up 40% of Capitec ’s borrowers.
Another 10% of Capitec ’s borrowers are mineworkers — also a risk, considering the wave of layoffs in the mining sector.
Yet Capitec ’s management continues with business as usual, eager to show the market it got it wrong — again.
“As a newcomer in the banking industry, Capitec Bank has had the opportunity to redesign both banking and credit provision from scratch,” says Fischer.
It’s done that pretty well until now. But for it to regain its lustre as the golden boy of the market, Capitec will need to show that it can keep growing at a breakneck pace — without breaking the rules.
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