Eskom default risks contagion
The South African Reserve Bank has flagged the risks that the weak state-owned enterprises (SOEs) pose not only to the government’s finances but also to the broader financial system and other companies.
The warning came ahead of media reports confirming fears that Eskom is facing a liquidity crisis if it cannot raise funding in the coming months.
According to the South African Reserve Bank (SARB), the exposure of the country’s four largest banks — FirstRand, Standard Bank, Absa and Nedbank — to public sector entities or state-owned companies amounts to R112.7-billion. This came to 2.3% of their gross credit exposure in July this year, according to Hendrik Nel, the head of the Reserve Bank’s financial stability department.
But the banking sector’s total exposure to these entities has declined by 4.5% since December last year.
The Reserve Bank said in its recent financial stability review that the financial condition of the SOEs has deteriorated markedly, which could lead them to defaulting on their debt obligations. This could not only affect government finances adversely but also those of financial institutions exposed to the SOEs.
The review highlighted the risks of fiscal slippage and SOEs’ underperformance particularly in relation to further credit ratings downgrades.
“A default by an SOE could have a negative impact on credit risk premia of other government-guaranteed SOE liabilities as well as sovereign debt, so the direct impact is not only on the banking system,” Nel said.
The banks’ credit ratings are limited by the sovereign rating, which acts as a ceiling for their ratings.
“Should the South African banking sector’s credit be downgraded, there is also a potential negative indirect effect on the risk-free rate used to calculate the cost of capital for other South African corporates,” he said.
The government has provided R350-billion in guarantees to the power utility and has committed a reported R275-billion.
“In the event of Eskom defaulting on its credit, the full amount would be recalled due to the cross-default clauses applicable in SOE debt issuances,” Nel said.
The government has also guaranteed Eskom’s purchase agreements with independent power producers.
“If Eskom were to default due to its inability to pay back its debt, then there is a possibility that the R125-billion exposure to the independent power producers could also become due for payment,” Nel said.
But the implications do not end there.
The Government Employees’ Pension Fund (GEPF) holds almost R86-billion in Eskom bonds and bills through the Public Investment Corporation (PIC), which has raised concerns about the GEPFs exposure.
To complicate matters, the GEPF is a defined benefit fund, which means the employer — in this case the state — underwrites the fund and is liable for any gaps between the benefits due to beneficiaries and the money available to the fund.
One banking industry source said there is an insufficient appreciation of the systemic risk Eskom poses.
Even if banks are within their rights to call in their loans, the source said, they are unlikely to do so because it could trigger a default, which in turn would require the government to step in, which does not have the resources to do so.
“This is where the systemic problem arises,” the source said. How lenders begin to reduce their exposure to Eskom is “a very delicate process, which cannot really be co-ordinated”.
A solution also requires a level of depth and experience that Eskom’s management does not have, and which the treasury is “losing fast”.
But Elena Ilkova, a credit analyst at Rand Merchant Bank, said all banks have prudential limits to their exposure to individual entities to avoid concentration risk in their books. “It is part of normal risk management, and the SARB would be paying close supervisory attention to such concentration risk.”
Although there is undoubtedly some exposure to Eskom, it should be at a level that each of the banks and the Reserve Bank are comfortable with, she said, adding that it can be managed, and banks, depending on the transaction, often have collateral guarding against such exposures.
Jan Meintjes, a portfolio manager at Denker Capital, also said Eskom’s liquidity difficulties are unlikely to pose a systemic risk to the banking sector.
The risks are more likely to play out in the broader financial issues facing the government, including the effects on the country’s credit rating and the interest rates the government will have to pay on its debt.
The solution to Eskom’s issues appeared to lie with its request for a tariff increase, said Meintjes. Eskom has applied to the National Energy Regulator of South Africa for a 20% increase in the price of electricity.
The treasury says it is working with the public enterprises department and Eskom to address the issues that affect the entity’s liquidity.
Several funding initiatives have been identified to improve Eskom’s liquidity, it says.
The government is addressing Eskom’s governance to improve investor confidence, and is discussing Eskom’s lenders’ concerns with them.
The company’s plight was highlighted after EE Publishers and Fin24 revealed the extent of the problems at the entity.
Eskom did not respond to the Mail & Guardian’s questions, but earlier this week it said in a statement, although its liquidity levels are “not at the desired levels”, they are sufficient to fulfil its commitments.
But, according to the publications, Eskom said in a draft board report that without further funding it would have only R1.2-billion in liquid assets by the end of November, although its target was R20-billion. By the end of January 2018 the company would be R5-billion in the red.
Eskom is in discussions with the banks to obtain short-term bridging finance but the report indicates the banks are reluctant to do so without governance issues being addressed
Cut capital expenditure
A final research report, published this week by Meridian Economics, found that Eskom should decommission some of its older coal-fired power stations and curtail the Kusile construction programme to save costs.
The report found that, if three older power stations — Grootvlei, Hendrina and Komati — are decommissioned, this could save Eskom as much as R12.6-billion. This and stopping the completion of Kusile units five and six could save between R15-billion and R17-billion, the report found.
But, in the face of Eskom’s worsening financial state, even more drastic steps may have to be considered because of the systemic risk to the state and the entire economy, said Meridian Economics director Grové Steyn.
Drastically curtailing Eskom’s power-station capital programme beyond Kusile unit five and six might be the only way to restore its solvency, he said.
This will come at a high cost, including the penalties paid to construction companies, but, in the “increasingly likely scenario of such a national crisis, this strategy could contribute to rapidly improving Eskom’s cash-flow situation and lender confidence in Eskom and the state”. — Lynley Donnelly