Sub-Saharan Africa: Rising risks, rising attraction

It’s taken time but in the last few years sub-Saharan Africa has started to shrug off the poverty stricken image that dogged it in recent decades. ‘Africa rising’ formed the basis of an investment thesis and capital slowly started to flow into a continent with stunning demographics and seven of the 10 fastest growing economies in the world. 

And money follows money, so as Africa grew more popular with private equity funds, the credit guys have started to get in on the action too. 

While more people are buying the consumer-led growth story playing out in a number of African countries, credit providers struggle with lingering negative risk perceptions as investors expect double-digit return profiles for anything that carries the continent’s name. 

Debt managers raising money in the space have had to educate investors that the risks of lending to an upper-tier African corporate are lower than similarly-rated borrowers in developed markets. 

For Investec, which began investing in sub-Saharan credit four years ago and recently reached a final close of $226.5 million on its debut fund, the fundraising breakthrough came in 2012. A slew of mid-market debt funds were raising money and the South African asset manager was able to point to the developed market single B-rated borrower universe and highlight that investors could get similar returns lending to African companies that, despite similar ratings profiles, benefited from larger enterprise values and better market positioning. 

Contrasted with the public high-yield market, which offers returns of roughly Libor plus 4 percent, Investec’s running yields of 7-8 percent over Libor from stronger credits made even more sense, says Steven Loubser, portfolio manager on the vehicle. “You’re not really comparing apples with apples, but it was a good reference and you can see the value proposition. As a manager you have to do badly, or risks need to be really high to chew through that extra 3 or 4 percent,” he says. 

THE PLAYERS

Investec’s fundraising was boosted in 2013 when two development finance institutions (DFIs), Dutch investor FMO and the UK’s CDC backed the debut vehicle. DFI money lends emerging market managers a lot of credibility as government-sponsored institutions have strong governance criteria alongside commercial return demands. 

CDC’s investment director for debt and financial institutions, Jeremy Burke, says Investec’s pitch was compelling at a time when his institution was just starting to look at debt strategies. The UK-government supported DFI has invested with few credit managers and in Africa it’s unlikely to do so again. Burke says CDC has built the expertise in-house and is executing its own deals in the less popular ends of sub-Saharan Africa in-line with its combined development and commercially viable criteria. 

“In Africa, we’ve a growing pipeline of transactions in different sectors with a wide range of structures. We’ve recently done debt deals across Africa in sectors as diverse as power, trade finance, telecoms, petrochemicals and financial institutions and we’re now looking at real estate in Angola,” says Burke.

Quickest to spy the sub-Saharan opportunity were the South Africans. The country has a well-developed financial sector and most of the South African banks have launched some kind of drive into the rest of the continent to seek market share, following in the footsteps of Standard Bank and Standard Chartered – both of which have longstanding footprints across the continent.

Liberty Group, an insurer which is part of the Standard Bank Group, has also recognised the opportunity and last year hired Jonathan de la Pasture, formerly head of syndicated loans at Barclays in Johannesburg, to lead its move into sub-Saharan debt. De la Pasture has overseen the growth of Libfin’s (the insurer’s investment arm) African debt portfolio to around $300 million. The firm aims to grow that to between 10-15 percent of its overall credit portfolio, around $600 million, de la Pasture says. 

“We are very comfortable that the credit profile of the types of entities that we are investing into in Africa are strong and that the pricing is reflective of the risk and generates good returns for us,” he adds. 

So convinced are de la Pasture and his team that they are now considering raising third-party capital to invest alongside Liberty’s cash. 

THE STRATEGY

Of course individual managers and direct investors have their own criteria and targets but most sub-Saharan lenders focus on US dollar-denominated debt. The bulk of this financing is in the form of senior secured loans, often sourced from the syndicated bank-led market. In sub-Saharan Africa, debt managers work alongside banks, rather than disintermediating them. 

The play excludes the currency-risk that many emerging market investment strategies suffer from. And being illiquid investments, typically held to maturity, the ebbs and flows of the more hot money-driven sovereign bond markets are also mitigated. 

Nigeria and Kenya, on opposite sides of the continent, are the two largest markets which produce the strongest dealflow. Ghana is also high up the investment list for credit managers, as are Zambia, Mozambique and Angola. Tanzania and Uganda also produce some flow, while lower down the risk curve are Botswana and Namibia.

That’s a list of just 10 countries out of the 54 on the continent and doesn’t cover every potential investment jurisdiction. It does cover the most active markets with the most developed financial sectors. And while these countries will share some characteristics, there are also major differences in risk profiles and dominant sectors. 

In Ghana, the IMF intervened recently with a programme which market observers say is working well. The country became an oil producer in the last 10 years, but, as one of the world’s largest producers of cocoa, remains dependent on soft commodity prices. In contrast, Botswana is small, has a deep financial sector and is one of the best managed economies on the continent.

This diversity is one of the benefits of a sub-Saharan debt strategy, says Loubser.

Recent commodity price falls and the run on oil prices have hit a number of African economies. Nigeria, the continent’s biggest oil producer, has felt the impact as a slew of local producers and oil services firms, such as Oando, have taken hits. 

When Loubser and his team see stress in one area, the strategy offers enough diversity that Investec can look elsewhere. 

For Liberty’s de la Pasture, that at the moment means Kenya. “Now that there is a good track-record of some IPPs getting closed [in Kenya], that’s certainly a market where I could see us getting involved in a longer-dated project now that the framework is proven,” he says. 

It’s not an independent power project, but Kenya Pipeline Company (KPC) recently signed a $350 million syndicated loan. KPC is popular with lenders because, until recently, the firm had zero debt on its balance sheet while throwing-off strong cashflows. The new loan will help finance the company’s new pipeline between the capital Nairobi and Mombasa, the country’s trade centre and port city. 

THE RISKS

While being able to pick and choose from a range of jurisdictions has its upside, African markets as a whole face wider issues. 

“There is definitely an opportunity, which will grow in the right conditions. But there are still significant barriers that are putting investors off,” says Burke. 

As well as exposure to commodity prices, as an emerging market sub-Saharan Africa is exposed to the impact of rich world monetary policy and investor whims – another taper tantrum like that seen in 2013 would damage emerging markets. 

Asked about defaults, Loubser likens them to buses: the firm had not seen any ahead of three high-profile cases – London Mining, African Minerals and Afren – two of which Investec dodged. In response to the increased commodity risk, Investec has reduced its oil and gas exposure from around 4 percent to less than 3 percent, he adds.

The headwinds facing emerging markets as the US and other affluent nations turn off the quantitative easing taps and hike interest rates should not be underestimated. 

That said, senior secured US dollar-denominated debt to companies providing essential services to growing and increasingly affluent populations is far from the worst bet in the world. As with most strategies, the judgment of managers will prove key to successful outcomes in a more difficult environment. 

African debt is not for everyone but that could also be part of the attraction. As more money swivels into mid-market leveraged loans in the US and Europe, neglected corners and niche strategies will benefit from flying under the radar.