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Land reform:

do banks have anything to fear?

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Renier de Bruyn

Investment Analyst

The surge of optimism generated by the election of Cyril Ramaphosa as South Africa’s new president in February was replaced by uncertainty and fear less than two weeks later – the result of Parliament passing a motion brought by the EFF to pursue land expropriation without compensation (EWC) – and a review of Section 25 of the Constitution. Depending on how this is implemented, the banking sector would be particularly vulnerable, with outcomes ranging from relatively benign to systemic failure of our financial system.

Given our country’s legacy of apartheid and the general failure of the ANC government’s land reform programmes, the issue of unequal land ownership undeniably remains a huge economic and social challenge that needs to be addressed urgently.

The exact mechanics of how government plans to carry out EWC remain unclear, with mixed statements coming from politicians across the spectrum. The wording of the parliamentary motion, as well as personal undertakings by the President, make it clear that EWC should ‘not undermine future investments in the economy, or damage agricultural production or food security’ and ‘must not cause harm to other sectors of the economy’.

One may well wonder whether this isn’t wishful thinking on the part of politicians, who are often disconcertingly ignorant of the unintended consequences of their actions. We should, however, be grateful that at least the government is giving some regard to the potentially negative ramifications of EWC.

BANKS DIRECTLY EXPOSED

The industry most at risk if EWC is implemented on a large scale, and not in terms of the current ambit of the Constitution, is the banking sector. The banks are directly exposed to EWC through financing provided to farmers, companies and households, which may be unable to repay their loans under those circumstances.

While our big four banks have only 1-3% of their total loan books exposed to agricultural clients, the uncertainty of the potential scope of EWC (‘property’ in Section 25 of the Constitution is not limited to land), may result in a much larger portion of loan books being affected. The Banking Association of South Africa estimates that loans of around R1.6 trillion are directly exposed to property in South Africa.

A bank acts as a financial intermediary by channelling savings from depositors, such as households or pension funds, to borrowers. There’s usually a mismatch between the terms of a bank’s deposits and its loans, which makes it extra vulnerable to a financial shock or even just a confidence crisis leading to mass withdrawals by depositors.

The Land Bank noted in its most recent annual report that if EWC were to materialise without protection of the Bank’s rights as a creditor, it would immediately have to repay R9 billion of its funding subject to a clause on expropriation, as an ‘event of default’. This would have repercussions for its entire R41 billion funding base, leading to a collapse of the Bank and likely requiring a substantial government bailout.

Mass EWC impacting the collateral supporting bank loans would create systemic risk to the South African financial system, with disastrous economic consequences. These include higher inflation, unemployment and interest rates, falling property prices and a protracted recession, to name but a few. In short, an inconsiderate, mass-scale ‘land grab’ would probably lead to a failure of our banking system. It would be devastating to our economy and certainly detrimental to the cause of the poor that EWC is trying to benefit.

LAND REFORM SUCCESS STORY

On the other hand, a successful and integrated land reform programme may be beneficial to our economy in the long term. Brazil is a good example of successful agrarian land reform after a colonial past. The country has dramatically increased its agricultural production over the past 30 years, while transforming land ownership – today Brazil is one of the world’s most competitive food exporters.

Court-approved expropriation of unproductive land with fair compensation to the owners formed part of the Brazil reforms. Importantly, coherent government policy provided support to the development and modernisation of the whole food production value chain, including new farmers, in the form of research support and funding mechanisms. New farmers received title deeds to their land, which provided secure  tenure and allowed for their property to be used as loan collateral.

Returning to our banks, the impact of EWC will depend on how it’s pursued, with a wide range of potential outcomes, ranging from relatively benign to systemic failure. The severe economic consequences on all South Africans of a financial meltdown would be too great a price to pay for any rational government. I’m therefore of the view that market forces will compel government to carry out land reform in a responsible manner.

A number of reputable legal experts have publicly said the government can pursue land reform successfully without the need to amend the property rights enshrined in the Constitution in its current form, and that an amendment would only create unnecessary uncertainty, which will hamper investment and constrain economic growth.

PROTECTING PORTFOLIOS

When we craft portfolios, we try to position them around our base case view of the world, but we always maintain appropriate diversification to protect portfolios against unexpected results (tail risk). With regard to the EWC debate, my base case view is that based on our banks’ systemic importance to the economy, government won’t implement land reform in a way that would jeopardise their rights as a creditor.

With dividends reinvested, the FTSE/JSE Banks Index has outperformed the All Share Index over the past 15 years by about 2% per year, despite this period including the world’s biggest financial crisis since the Great Depression. From current valuations and given our base case views, we continue to expect appropriate risk-adjusted returns from the sector over the medium term.

In our house view equity portfolio, we reduced our exposure to banks earlier this year on valuation grounds, following their strong share price performances. The sector has subsequently pulled back and valuation levels now again appear more attractive. We currently have around 10% direct and indirect exposure (through Remgro) to South African banks in this portfolio.

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