Cash Solutions Speed Insights 2020

By Nedgroup Investments

In the absence of the 9th Nedgroup Investments Treasurers’ Conference, our experts offer some top down perspectives, insights as well as feedback from our liquidity fund managers who are at the coalface of the money markets as we navigate month two of lockdown.

Our cash funds have grown by more than R25 billion year to date with more than R350 billion of transactions to end April. The ratings on all four of our funds were reaffirmed on the 1st of April. Our Prime Money Market Fund has a AAA rating, the Core Income Fund has a AA rating with an Assets Under Management (AUM) of R51 billion, our Money Markey Fund with an AUM of R19 billion has a AA+ rating and our Corporate Money Market Fund with R46 billion AUM also has a AA+ rating. Yields have remained attractive despite the recent 200bps rate cut with expectations of another 50bps cut later this month.

Below are summaries of the recording, to listen to the full conversation, go to Nedgroup Investments Insights on Apple Podcast, Google Podcast and Spotify.

Banks and financial systems in the current environment – Mike Brown (CEO, Nedbank

We’re fortunate to have a banking system that works well, has been tested and has performed better than many of its global counterparts in other crises. We have a system that is well regulated; has been able to earn reasonable returns in a vanilla banking environment; the Rand based funding pool is a stable, closed system, which is balanced daily by the clearing banks and the Reserve Bank; and the Banking Association of South Africa (BASA) is very effective. In the current environment, National Treasury, the SARB, the financial services conduct authority and BASA meet weekly. The SARB also meets weekly with the treasurers of the big five clearing banks.

The SARB has been very proactive on the regulatory front with a reduction in the liquidity coverage ratios from 100% to 80%. This enables banks to support the real economy and not have to put any excess deposits they receive into high-quality liquid assets. There has been a reduction in required capital buffers enabling banks to use that capital in these difficult times, and the guidance note on dividends, which preserves capital. There has also been a directive on the restructuring of problem accounts where Covid19 matters have resulted in cash flow challenges. This is an attempt to reduce pro-cyclicality across both our retail and corporate portfolios. This week saw the launch of the R200 billion SME Scheme, the first R100 billion of which was announced yesterday. This was essentially the National Treasury acting through the SARB and using commercial banks as a distribution mechanism to try and increase the velocity of money supply across the system. All of the loans made by the banks will be 100% funded through a special repo with the loss sharing arrangement agreed at 94% to National Treasury and 6% to banks.

We’ve seen significant changes to the repo system. On 20 March, the SARB introduced two daily supplementary repos at 10am and 1pm, affirming their willingness to inject liquidity into the system on an overnight basis. They also agreed to maintain their usual 7-day repo. They further encouraged banks to share more amongst each other by reducing the rate that banks earn when they deposit money back with the SARB to repo minus 200bps. From 25 March, they added a longer dated weekly repo with up to three months and the ability to extend that to twelve months. The SARB recently removed the 10am supplementary repo as a sign of some normality returning.

The banks entered this crisis in much better shape than the GFC. South African banks went into this crisis with capital levels 40% higher than for the GFC. While no one knows the shape and depth of this crisis, with the GFC, the banks were the cause of the crisis, whereas now health is the cause that impacts the economy, which then impacts banks. Governments and regulators know that banks are part of the solution in helping customers and clients with cash flow shortfalls through this crisis. Nedbank entered the Covid-19 crisis with a set 1 capital level of 11.5%, liquidity coverage catio of 125%, a net stable funding ratio of 113% and sources of quick liquidity across the Nedbank balance sheet in excess of R225 billion. We know that there are challenging times ahead for our economy, but the banking sector, working alongside our regulators, is well prepared to play it part in managing through this crisis.

Political overview – JP Landman (Political and Trend Analyst)

Despite the rumours and fake news over the last few weeks, none of which is true, Cyril Ramaphosa is stronger than ever and solidified his position with the Covid-19 crisis. Before lockdown, his popularity rating was 62%, which was 10% higher than the ANC’s popularity rating. His public approval rating, measured over a recent three-week period, was 82%, so he is not about to be toppled.

The budget took place 11 weeks ago, so what changes have happened?  Salary increases were going to be limited to 1.5%. In April, actual salary increases were zero despite unions threatening to go to court, which has yet to happen. SAA asked for more funding, which was refused. SA Express was allowed to go insolvent and private sector advisors have now been appointed for the Landbank. All this tells us that there has been a holding of the line as far as prudent fiscal policies go. This was also confirmed in the fair and appropriate fiscal and monetary response to Covid-19. There has been no political pressure on the SARB and finally a decision to go to the IMF, World Bank and the BRICS bank. These instances show a consistent line of middle of the road thinking in both fiscal and monetary policy, which is an indicator of where the political leadership of the country is and is a good indicator going forward.

I see two priorities for Cyril Ramaphosa. The first is the economy, where he will do everything he can to get economic growth back and secondly, to build a more capable state. A ‘benefit’ of this crisis is the realization that we have to up our game if we want to go anywhere.

Relationship with Blackrock - Phil Curley and Geeta Sharma (Blackrock Global Lending and Liquidity Group)

Blackrock offers Nedgroup corporate clients with offshore cash the option of investing in a US dollar short-term money market fund, which focuses on capital preservation and liquidity. The fund is classed as a low volatility ltnav fund, so will always have a nav of one. The fund has a maximum weighted average maturity of 60 days. The fund’s current AUM is $41 billion with a net yield of just over 50bps.

Credit on our minds - Jones Gondo (Senior Research Analyst - Credit, Nedbank CIB)

We find ourselves in a macroeconomic environment with high systemic risk, a lot of uncertainty and skittish financial flows with the potential to threaten financial stability. All the central banks have put in liquidity backstops, even in South Africa, to ensure that the financial plumbing in the short term is functional and that panic eases. South Africa’s two rating downgrades feed into the baking system. It hampers our ability to raise money in the markets, particularly on the dollar side, which has become far more expensive now that we’re speculative grade. While the central bank has tried to offer relief on capital and liquidity, rating migration risk results in pricing for credit in the market that has higher spreads. While baseline rates might be coming down because of easing financial conditions, we are still concerned about the pace of credit and money supply going into the economy to generate growth. In this scenario, we would expect that we will start to see in the next six to 12 months rating downgrades on corporates based on lower earnings, access to liquidity in the markets and higher cost of capital. The drivers of credit deterioration over the last 12-18 months are still in play and the inability to implement reforms still weighs on us. The credit outlook is still very negative on the sovereign side. In March we had net outflows of about $3.6 billion. Because the passive money is now out, South Africa has to fight like every other emerging market for a dwindling amount of USD liquidity. We have to tell a story that we are willing to be reformist and have fiscal discipline, which should help to flatten the curve and fund this deficit, and lower the cost of capital in the economy in the medium to long run.

Economic forecast - Nicky Weimar (Group Chief Economist, Nedbank

The way we implemented the lockdown has been unique and therefore uniquely damaging. Our lockdown did not take into account that supply chains run across multiple products, industries and sectors, so moving from level 5 to level 4 have not really brought about any meaningful economic activity. If sensible changes, such as e-commerce and opening up of whole supply chains across the primary, secondary and tertiary sectors were made and we see, with immediate effect, the changes anticipated in the next few day, we could emerge from this lockdown with some semblance of a functioning economy intact. We need to accept that the consequences are going to be relatively severe and the impact could be prolonged. We only see the economy gaining some momentum in Q4 this year with a GDP forecast of a 7% contraction and only about 3% growth in 2021, followed by GDP growth receding to below 2% in the outer years. The damage from the Covid crisis will, therefore, be enduring. Companies that faced enormous financial strain in the lockdown will postpone or scrap fixed investment first, so capex will not bounce back in 2021. We see fixed investment contracting by more than 16% this year and a further 1% next year and only recovering from 2022 onwards. Company failures and cost-cutting exercises, such as job losses, scrapping bonuses, etc. will also have an enduring effect. We forecast about 1.6 million job losses and it will take up to three years before employment levels return to pre-crisis levels. We also expect disposable income to decline, in both nominal and real terms and that will take about two years to return to pre-crisis levels.

While this is a very gloomy picture, there is some good news. Inflation is forecast to moderate significantly and will probably hit a low of 1.7% in June, rising to 3% in December, averaging 2.8% this year. Next year, off this low base, it will climb to about 4%. We expect a 100bps cut in interest rates next week Thursday. The worst news is in the value of the Rand, which we think is at its bottom. We think that structural reforms in the year ahead will probably be fairly superficial and slow. South Africa’s risk has been rerated and our risk premium has increased to a higher level. We will always be a speculative bet as there is too much risk to our fiscal metrics for investors’ liking, so we see the Rand pulling back to around R17.18 to the USD at the end of the year and thereafter depreciating at a far more moderate rate.

Cash Solutions’ liquidity funds – Ray Wallace (Chief Investment Officer, Taquanta Asset Managers)

The funds have weathered the storm really well, emerging much stronger and ready for what’s to come. This crisis has been around liquidity and now that we’ve been able to get through the liquidity crisis, what are the credit risks going forward? Cash is a great place to be for the next while. It gives you flexibility and the ability to move and adapt to any conditions that arise. If you’re sitting on cash, the choice is between holding a fixed deposit or a longer-dated NCD, especially fixed-rate ones, versus a money market or income fund. A 1-year fixed NCD will give you 4.9% while an income fund is currently yielding on a running yield, 6.6%, which is about 170 bps pick-up for diversified bank risk. Following the recent 2% rate cut, the current fund yield of 6.6% will go down to 5.5%. If we have another rate cut of 50bps next week, we would expect an additional 50bps reduction in fund yield over the next three months, with a further 50bsp cut taking the yield down to 5%, still higher than 4.9%. Given the current uncertainty, cash is something that you can be adapted to a changing environment very quickly. Income funds give you flexibility and liquidity, which is going to be king going forwards for at least the next six months. The next thing that will be king is the credit that you hold.