Figure 1: Size of debt capital market excluding government bonds (just short of R1t or 25% of the total market).                           Source: Prescient Portal as at February 2022

Gross term issuances in 2021 amounted to R110bn versus R90bn in 2020, the year of the global pandemic, which saw the lowest level of issuance in a decade. To put this decline into perspective, these issuance numbers should be compared to the R168bn reported for 2019, a better reflection of issuance during the prevailing economic conditions. During 2021, as is the usual case, issuance was centred predominantly around financial sector issuance (R54b), followed by corporates with R32bn. 

Figure 2: Size of non-bank debt capital market.

  Source: Prescient Portal as at February 2022

Over the last few years, the capital market’s muted activity has resulted from more than just the pandemic. Unemployment, lacklustre economic growth, and various economic uncertainties have contributed to issuers’ reluctance to issue debt, accompanied by the perceived risk associated with a public market issuance failure. In light of the above, if one considers the non-financial sectors, which includes corporates, State Owned Entities (SOEs) and property issuers, we have in fact seen no growth at all. 

But things appear to be slowly changing as we start seeing green shoots in various sectors, and as a result, debt issuers do appear more open than before to approach the market for funding needs. Importantly, this is supported by our analysis of South African credit default probabilities, has started to “normalise”, as shown below:

Figure 3: PIM Analysis of South African default probabilities.

Source: Prescient Portal as at end January 2022

This bodes well for debt capital market investors given the excess supply of capital that continues to be available to support companies, where suitable.

Market themes during 2021:

As an active market participant across sectors, our summary view of the themes at play during 2021 were as follows: 

• There was a significant increase in the issuance of “sustainability”-linked bonds. While the impact of spreads has not yet been seen, it has meant that these issuers could attract improved interest from additional pockets of funding.
• During 2020 we saw a significant amount of shorter-dated issuances (R68bn). With the gradual improvement in economic conditions and increased appetite from investors for, we saw an increase in terms of debt.
• There continues to be a robust private placement market which operates successfully alongside public market activity.
• Muted activity from SOE issuers for various reasons ranging from the perceptions of the Land Bank restructure, to issues noted by the Auditor General across names, and also, in our view, the watchful eye being cast by investors on SOE reform initiatives.
• Demand for credit continues to exceed supply thereof.
• Stabilisation of credit profiles as we emerge from the global pandemic.

A key area of concern – a shrinking State-Owned Entity Market

The State-Owned Entity (SOE) sector, a key contributor to the South African debt capital market, was once again muted, with issuance during 2021 reported at R10bn. If one considers net issuance for this sector, the graph below highlights the shrinking nature thereof.

Figure 4: Total Size of SOE Market

Source: Prescient Portal as at February 2022

Given their developmental mandates, the importance of their role in South Africa’s infrastructure narrative cannot be under emphasised. While it is hard to attribute all of the reasons for the above, it is our view that investors continue to harbour negative sentiment to SOE issuers. 

While we remain circumspect on the sector as a whole, and look at each opportunity presented very carefully, our analysis shows that while elevated, there has been a stabilisation of default probabilities across the sector, as noted below:

Figure 5: Prescient Credit Cycle Indicator

Source: Prescient Portal as at end January 2022

While still early days, we have recently seen an uptick in both primary and secondary SOE market activity, with successful issuances by both the Development Bank of South Africa at the end of 2021, and then Transnet in early 2022 evidence thereof. 

Looking Ahead: 

From a market perspective, 2021 was an interesting one given the themes noted above, and importantly in terms of finding suitable and appropriate opportunities for our funds in the year following the pandemic, where issuance levels were still constrained. 

Looking ahead to 2022, while we are expecting similar themes to emerge as in 2021, we believe that there is potential for an improvement to issuance levels. This is driven by our analysis on scheduled maturities/redemptions in 2022 which we have calculated at R133bn, R15b over that of 2021. Further to this, green shoots are emerging as we see gradual signs of economic recovery, which offers the potential for expansionary activity in certain areas. To date, corporates have been reticent to take on additional gearing (or debt) because of the lack of economic activity. 

The above, coupled with continued pent up investor demand for bankable opportunities should result in improved activity as we gradually move to the post-pandemic world and trading conditions continue to improve. 

Prescient Approach: 

Our investment philosophy is a systematic one – our approach is rational, rules and evidence based, and is data driven, all feeding into a strong process. In doing so, we attempt to remove natural human biases from our investment decisions. 

Key to our approach is the consideration of the credit cycle, which we consider through the lens of our proprietary Prescient Credit Cycle Indicator (PCCI). 

The PCCI dynamically shows the relationship between macroeconomic variables and the default probability of issuers. Further to this, we consider market valuations, as measured by our market implied spread curve. By combining these, we are able to express a risk/return view, not only on a consolidated South African basis, but on a per sector basis as well. This allows us to appropriately position thematically. 

Figure 6: Prescient Credit Cycle Indicator

Source: Prescient Portal as at February 2022

The current Prescient credit theme is determined by a combination of the output of our PCCI, our consideration of individual counterparty default probabilities, and finally, the yields offered on these opportunities and is one of “elevated risk levels with suppressed yields”. 

While our credit cycle indicator suggests continued improvements to credit conditions, notably as we move towards a “post-pandemic world”, we continue to be very selective in what we buy. We thus continue to target investments in defensive sectors predominantly, and remain cognisant of term, duration and importantly, credit spread duration. 

It is our view that credit investing requires a more active rather than passive approach, given the idiosyncratic nature of corporate capital structures and individual securities, liquidity considerations, and the importance of understanding of the legal and regulatory frameworks. ESG principles also need to be embedded into the process, given the importance of ensuring borrower sustainability and fully incorporating sustainability thinking into the default probability assessment. 

Further to this, given the nuanced nature of credit investing, we are of the view that navigating credit cycles, credit events and various market conditions requires a “hands-on” approach. This, as we have shown through the construction of our portfolios over time, requires a blend of a qualitative and quantitative approach to investing.  DM/BM

Author: Conway Williams – Head of Credit, Prescient Investment Management

Disclaimer:

• Prescient Investment Management (Pty) Ltd is an authorised financial services provider (FSP 612).
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