Land Bank: the SOE crisis outta nowhere

• South Africa
• Agriculture, Debt, Development Finance Institution, Land Bank, SOE, State-Owned Enterprise
• April 28, 2020

Another day, another SOE crisis, right?

This one is a little different.

Before delving into the reasons for the current crisis at the Land Bank, let’s take a brief look at its background.

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Development Finance Institutions (DFIs)

DFIs are set up to support private sector initiatives in key sectors.

Certain sectors are of such importance to a country (like agriculture and its impact on food security) that government chooses not to leave the sector’s fortunes up to the whims of private markets and their cycles.

Unfortunately, in South Africa, most sectors would be better off if government left them alone.

What does the Land Bank do?

The Land and Agricultural Development Bank of South Africa (Land Bank for short) has been around since 1912. It certainly isn’t an ANC invention, but it is a state-owned enterprise (SOE).

The importance of this SOE cannot be stressed enough. The Land Bank offers specialist loans and insurance products to emerging farmers as well as more established agricultural players who embark on meaningful transformation initiatives.

It isn’t a handout. It’s simply a well-structured financial support mechanism.

The Land Bank’s last available financial report indicated R44bn in loans outstanding to the agriculture sector. Collateral over these loans stood at R70bn, which sounds good in theory, but R48bn of that was land and buildings. This creates a very tricky situation from a risk perspective, as an overall downturn in agriculture would leave the Land Bank owning farms that it cannot sell.

These are the sorts of things that stop commercial banks from taking on this level of risk. It’s therefore difficult to see how transformation could be meaningfully progressed in the agriculture industry without this kind of support. From a sustainability perspective, food security needs to be widely owned by experienced people who have access to support.

Regardless of whether you support B-BBEE as a concept, the reality is that this is part of the ANC’s mandate and they appear to have made a hash of it in the agriculture space.

A funding model at odds with its mandate

Interestingly, the Land Bank executes a government mandate but has to do so with primarily private sector funding.

The Land Bank raises its own capital in global markets, either from international DFIs (e.g. with a mandate to support agriculture in Africa) or from general investors in the open market.

DFI funding would be the ultimate source of funding for Land Bank, as it ties in with the mandate of supporting emerging farmers. Measures of success would go further than the financial return earned on the loan. Jobs created and total agricultural produce would likely also be considered.

DFI funding isn’t always available or sufficient for the task at hand. The Land Bank needs to supplement this with private sector funding from investors who demand commercial returns that reflect the underlying risk of the sector.

The debt issued by Land Bank would be rated by those pesky credit ratings agencies (e.g. Moody’s) who stubbornly continue to put the needs of their clients above the needs of a government with mismanaged finances.

Ahem.

Development finance has limitations as an investment class

The reality of development finance is that these emerging farmers couldn’t obtain this type of support from commercial banks on a purely arm’s length basis. The industry is incredibly risky and therefore so are the loans.

Properly reflecting these risks would require the interest rates on the loans to be higher, which would significantly hurt the likelihood of success for these farmers.

Expecting a development institution like Land Bank to survive entirely off private sector funding is only realistic where a country’s financial trajectory is headed in the right direction. Investors need to feel good about South Africa in general in order to support the Land Bank.

When the debt ball stops rolling…

In February, the alarm bells started ringing. National Treasury provided Land Bank with a R5.7bn guarantee.

COVID-19 hit and so did the Moody’s downgrade of South Africa’s sovereign debt to junk. The follow-on had to be a downgrade for institutions operating in South Africa, as a great business operating in a rubbish bin still has a junky smell and flavour to it.

So, Land Bank was also downgraded at the end of March, along with the Development Bank of South Africa (DBSA) and the Industrial Development Corporation (IDC) for good measure.

Corporates who don’t need to frequently issue new debt aren’t highly impacted by a downgrade. In stark contrast, banks are constantly issuing new debt to keep themselves funded. The business of a bank is to lend money out, so it needs to borrow all the time.

With the Moody’s downgrade, suddenly the pool of investors for the Land Bank’s debt started to look a lot shallower. Liquidity dried up and the Land Bank simply couldn’t pay what was owed to creditors in April on medium-term debt notes.

It’s worth noting that the commercial banks were also downgraded after the sovereign downgrade. Nobody escapes the pain.

Um, now what?

Some SOEs are simply a drain on the fiscus with limited chance of a turnaround. Others are genuinely an essential service, like the Land Bank.

It isn’t clear what negotiations are taking place with note holders, but reports suggest that creditors to the tune of R13bn are demanding repayment.

Obviously, Land Bank doesn’t have that kind of money. Government will have to figure it out.

The Government Employees Pension Fund (GEPF) has become a favourite source of unofficial SOE bailout money for the ANC, but they have already lent over R6.6bn to the Land Bank based on (limited) financial disclosure. The IDC and DBSA would be next in the queue, but they have their own downgrade challenges to think about.

The good news is that Land Bank makes a profit, unlike most SOEs. A real one. Not only does it provide an essential service, but it provides it profitably. This is a liquidity crisis, not a profitability or management crisis. The problem stems directly from the junk downgrade, which is entirely the responsibility of government.

They broke the Land Bank, now they must fix it.