African Bank took the unusual step of buying out a furniture retailer earlier this year in a move the bank said would give it a competitive leg-up in the changing South African banking market. CEO Leon Kirkinis tells William Cain how the bank is dealing with the demands of a different type of retail banking.
African Bank CEO Leon Kirkinis has shrugged off criticisms of the bank’s acquisition of retailer Ellerines – and says it will succeed or fail on whether it delivers value to customers. African Bank, a consumer lender specialising in unsecured credit, took over the furniture chain in a ZAR9.16 billion ($1.19 billion) deal in January.
While many banks establish joint ventures with retailers as a way to provide consumer finance, insurance and other financial services to customers, this takeover was unusual because it also saw African Bank put itself in charge of operating Ellerines’ furniture business.
The bank, which has assets of around ZAR26.7 billion, recently published its first set of results including the Ellerines’ business – and initial indications regarding the success of the deal are mixed.
The bank has been one of the industry’s most profitable banks as measured by return on assets (ROA) – its pre-acquisition 2007 profit of ZAR2.1 billion on assets of ZAR11.8 billion gave it an ROA of 17.8 percent – but, according to RBI estimates, that looks likely to fall as a result of the acquisition.
Critics have questioned the timing of the deal with the South African economy weakening, while others have concerns about whether it is possible for a bank to effectively run a retail furniture chain. Some have said the deal was not earnings accretive and also point to an increase in the bank’s non-performing loans, which rose 16 percent in the bank’s interim results – although NPLs as a percentage of gross advances fell slightly.
A question of timing
On the timing of the deal, Kirkinis told RBI: “It’s precisely when times are tougher that the customer looks for value. You can sit and debate strategies in the boardroom and sound like a genius, but the reality is the strategy only matters to the customer. How many mergers and acquisitions around the world, so-called synergy-based deals, make no damned difference to the customer?
“It’s absolutely critical that this deal, if it is to succeed or fail, it must do so for one reason: did it deliver value for customers. And there’s nothing better than a tough environment to find out whether you’re delivering value to customers, because that’s exactly when they’re looking for – value.”
He added execution risk was a “real issue” and said the bank would mitigate by concentrating on a few core areas, rather than trying to fix too many things at once. The deal has been watched with interest by some of South Africa’s top banking executives, and their attention is likely to be focused on two key areas: how the bank deals with the differences in collections, and credit granting.
One senior executive told RBI: “I think there’s a lot of interest among South African banks to establish something of a consumer finance house, very much the Cetelem, BNP Paribas type of approach they have in certain countries in Europe and Brazil.
“There’s a lot of keen interest about what is happening in that part of the market to see whether a bank lender and furniture retailer can partner up and find out whether there’s value in the sum of the parts.”
Collections at Ellerines are based on a cash collection basis within the stores, where customers pay off their monthly instalments in cash. African Bank collects its payments direct from client’s bank accounts which Kirkinis said, when extended to Ellerines, would offer greater convenience to customers.
“There are some who say you need the customers to come into branches to re-sell,” Kirkinis added, “but I think that is an urban legend, personally.”
Centralising the collections process is not possible for all customers as a significant part of the South African population do not have bank accounts. Unbanked customers would have to continue paying instalments in-store. Around 15 percent of Ellerines’ customers fit into this category.
The two businesses’ credit granting systems are also very different, with Ellerines pricing for credit much higher than African Bank’s. Kirkinis said the cost of credit for Ellerines customers would fall as a result.
He added: “Also, there will be a more differentiated underwriting process to the risk. Broadly, the retailers do not have a lot of differentiation in the different risk categories, but we have up to 50 different risk groups and therefore prices will be different.
“We want to operate on the basis of trying to eliminate any cross-subsidisation that happens between the different risk categories, so every customer pays a different price for the risk.”
African Bank is the biggest provider of microfinance in South Africa, with 550 African Bank branches, a further 1,270 Ellerines stores and around 3 million clients, including Ellerines customers.
Distribution was a big factor in the deal, and has effectively given African Bank the largest proprietary branch network in the country. In time, the bank plans to use them as selling points for its products.
Kirkinis said: “We will have a process in those branches. The focus will be on the core offering of selling furniture on credit, but in time we will evolve to offer more services in the stores.”
Areas of growth
The bank’s main products are credit cards, instalment credit, store credit, overdrafts and personal and micro-loans.
It measures its market in share-of-wallet terms on those products, and estimates its share to be around 25.5 percent, although its share in the overall lending market is much smaller. It estimates the size of its market is currently ZAR82 billion and will reach ZAR100 billion by 2010.
Credit cards have been identified as an important part of the bank’s future growth. It wants to take advantage of fast growth at the lower end of the income scale, where account openings have been increasing 19 percent per annum over the last six years.
Ellerines offered credit to a wider range of segments than African Bank did in the past, particularly among lower income groups where it offered credit to customers who were informally employed and who might also have been without bank accounts. Kirkinis sees this as an opportunity to gain experience in areas of the market where the bank has not operated before.
The bank also has some innovative products, including a card which can be issued immediately in-branch following an application – which Kirkinis said is a first in the South African market.
African Bank’s half-yearly results, published in June, were the first to include the Ellerines business. It was incorporated into the group’s accounts from the start of the second quarter.
Profit before tax was ZAR1.24 billion, up 33 percent on the previous year. Gross advances increased to ZAR18.6 billion from ZAR9 billion a year earlier – and the lender aims to increase that figure to ZAR25 billion by 2009. Interest income on advances increased 30 percent to ZAR1.97 billion, non-interest income increased 130 percent to ZAR706 million.
As a non-deposit taking organisation, the bank is more sensitive than its more traditional rivals to the increased cost of wholesale funding – the bank said this would be one of the key issues it faced in the near future – and the cost has gone up from 9.2 percent in the first half of 2007 to an estimated 10.5 to 11 percent for FY2008.
Its main target is long-term wholesale funding from large financial institutions. African Bank has adopted a conservative approach to liquidity risk, and aims to maintain a two-to-one gap between the average maturity of its assets and average maturity of liabilities. It also maintains a cash buffer of at least three months’ worth of maturing liabilities.
African Bank has existed for 44 years. Prior to 1988 it was a small commercial bank with its roots in the underbanked, disadvantaged market. It was bought in 1988 by Theta Group, merged with three of the group’s loan finance companies, and its deposit taking business and other non-core assets were phased out.
Since then it has emerged as South Africa’s largest unsecured lender, with gross advances of ZAR18.6 billion following the deal with Ellerines.
Kirkinis said the bank did not have any plans to relaunch its deposit taking business, despite the more difficult funding environment.
Elsewhere in the South African market both Absa and Standard Bank have similar arrangements with retailers, but they stopped short of buying an entire franchise, preferring instead to take on only the financial services side of operations. They are both joint ventures, meaning the retailer maintains a stake in the success of the agreement.
The bank-retailer business model is an attractive one because of the increasing complexity of the South African regulatory environment and the level of expertise and skills required to run a financial services business, which banks are generally better placed to fulfil. Banks also benefit from increased access to existing and new customers through retail store distribution channels.
Still awaiting regulatory approval
Absa acquired its 50 percent plus one share stake in Woolworths Financial Services (WFS) in mid-April and is still waiting for regulatory approval on the ZAR875 million ($109.5 million) deal. It is also subject to a restructure of WFS to include all existing financial service products at Woolworths, a food and clothing retailer in South Africa.
The WFS business, which has a credit account base of 1.6 million customers, includes store cards, personal loans and Visa credit cards, as well as insurance products.
Standard Bank partnered with Edcon, one of South Africa’s leading retailers, in 2005 and also works with another retailer, Foschini Group.
Kirkinis said the main reason behind African Bank’s move was that financial services made around 70 percent of Ellerines’ profit and was subsidising the furniture selling side of the business.
As a result, a buyout of just the financial services unit only would mean paying “more than you could justify” and would result in a joint venture between bank and retailer which Kirkinis said “has never worked in South Africa”.