New Trends in Capital

Financing

October 2005

October 05 2

Capital Market• Government, Corporate, Parastatal and Municipal bonds• Listed on BESA• Generally requires a public rating to be done• Daily price and trades

Institutional Market• Direct investment by non-banking parties• Form of loans• INCA, DBSA, DFI’s

Banking Market• Major 5 banks

Different Markets and Their Features

October 05 3

• The listed SA Debt Capital Market (“DCM”) is R610 billion strong market – BESA has seen issuance in total for the year to date of approx R30 billion

• Borrowers in the listed debt capital market have historically been Banks and State Owned Enterprises (“SOE’s”)

• In recent times, issuance size has decreased (previously R1bn per issue, of late there have been smaller issuances)

• However funding from the capital markets should be sourced for larger funding requirements due to the costs involved

• Spreads have also tightened and the low interest rate environment has made funding through the DCM more attractive

• Investors in the Bond Markets seek long term capital bullet repayment profiles

Debt Capital Market Update

October 05 4

Options available in the Capital marketsMerits of a Domestic Medium Term Note programme (DMTN) vs. a Standalone Bond

Issue]

Debt Capital Market

DMTN Stand-Alone Issue

Total authorized debt is specified under DMTN Authorized amount is specific to a particular issue

More than one bond can be issued under the programme, each having its own characteristics

Only one bond at a time can be issued under this method

Can issue bonds and commercial paper under the same programme Can only issue either bond or commercial paper

Bonds issued under the programme can have different maturities

Only one bond, per issue, with a single maturity (excl. bonds with optionality) can be issued

Incorporate financials by reference Incorporate financials by reference

One set of documents (BESA, legal, etc) for all the issues under the programme A set of documents for each issue

Authorized listed amount. Only need Board of Directors' authorization once.

Need Board of Directors' authorization for every issue.

Less administration Repeated administration

Flexibility Lack of flexibility

October 05 5

DMTN vs. Standalone Issue Costs

DMTN Standalone Issue

1. Initial Listing * R 30 000 R 30 000

2. Admin Fee R 1 000 N/A

Annual Revision Fees

3. Base Fee

< R250m R 2 000 R 2 000

> R250m < R1bn R 6 000 R 6 000

> R1bn R 12 000 R 12 000

4. Surcharge Fee

R1bn issue R 4 444 R 4 444

5. Legal Legal costs once off Legal costs per issue

6. Printing Printing costs per issue per pricing supplement

Printing costs per issue per offering circular

* Flat rate for DMTN programme but formula applies to Standalone Issue with cap at R30 000

October 05 6

• Advisor/ Structuring Role

• Implementation Role – legal, rating agencies, accounting/tax, credit enhancement, investors

• Underwriting and market-making Role

Expert Services Required

October 05 7

Background on Institutional market

Institutional market • DBSA• INCA• DFI’s

• Not regulated by the Banks Act and has little statutory costs to comply with.

• DBSA focusing more on developmental funding • FirstRand Group has 36% stake in INCA

October 05 8

Banking Market• Big 5 banks• Raise funds cheaper due to good credit ratings but has statutory costs as a result

of regulation• History of Regulations

• Pre 1992 No legislated capital holding requirements

• 1992 – Basle I - Legislated for capital holding requirementsMinimum Capital holding – 8% of risk weighted assets

SARB - Municipalities – 0 % risk weighting (0% of 8%)Margin for ROE = 0% x 8% x shareholder exp ROE

Result: All municipality risk was the same – NIL risk. Weak municipalities advantaged.

• 2000 – SARB - Capital holding 10 % of risk weighted assetsMunicipalities – 100 % of 10% risk

weightingMargin for ROE = 100% x 10% x

shareholders exp ROEResult All municipality risk is the same i.e 100%

risk weighting. Strong municipalities penalised.

• 2006 – Basle II - Capital holdings based on economic risk.Depends on rating of counterparty and securityResult – Correct pricing for risk and security

Background on Banking Market

October 05 9

Developments in the Municipal MarketDevelopments in the Municipal Market

• In the past year there has been renewed and increased activity from the municipal sector in terms of long term borrowings

• Financial Services Charter (“FSC”) requirements put pressure on financial institutions, life companies and Banks to invest in Transformational Infrastructure with a focus on local government as the agent of delivery

• This has resulted in a very aggressive pricing competition in an attempt to acquire such assets – pure Bank on-balance sheet funding has not proven to be advantageous due to the statutory costs involved

• Hence structured, tailor-made products are required which sources capital market funding either directly or indirectly

October 05 10

• There is a more cost effective solution for municipalities to gain capital market funding through Bank structuring (indirect capital market funding) on terms more suited to municipalities e.g. amortised cashflows with less onerous requirements than direct capital market funding

• Although not publicly noted, Banks have been utilising structures that tap into the capital market via Asset Backed Commercial Paper Conduits to enable them to price more competitively

• Conduits are used extensively by most international banks to provide clients with direct access to the capital markets where the client does not want the cost of setting up its own capital market programme(s)

• Viewed as on-balance sheet Bank funding by the Municipalities

Bank Funding

October 05 11

Direct vs. Indirect Capital Market Funding

RMB

ConduitMunicipality Capital Market Investors

RMB sets up the conduit and provides it with liquidity and credit enhancement

Conduit issues commercial paper

Conduit provides funding

Direct Funding e.g. Bond Issue/s, DMTN, Commercial Paper

Indirect Funding via RMB

October 05 12

• Conduits are set up to fund highly rated counterparties/borrowers (AA- or better rating)

• Ratings slightly below AA- can be included into the conduit – however tailor-made structuring is required

• Such structuring could include the participation of credit enhancement from Foreign Development Finance Institutions e.g. European Investment Bank, Proparco etc

Requirements for Indirect Capital Market Funding

October 05 13

• CPI-linked debt has the advantages of:• Offering the municipality longer maturities than term

facilities (20 year funding is achievable)• Being comparatively cheaper due to investor demand • The reference government CPI-linked bonds which

represents the base cost is at its lowest levels (R197 trading around 3.25%)

• This translates into a real funding rate of approximately 5%

• Providing a more efficient funding tool especially where revenue increases are linked to the consumer price index

• Providing the municipality with finance diversification

Alternative Bank Structures – CPI Funding

October 05 14

Buyers and Sellers of Inflation

• Sellers of CPI-linked instruments in SA include• Government• TCTA• Toll Road Consortiums (N1, N3, N4E, N4W, Chapman’s

Peak)• Corporates as part of a DMTN programme

• Buyers of CPI-linked instruments in SA are:• Pension Funds• Life Companies• Collective Investment Schemes• Banks

Alternative Bank Structures

October 05 15

• Forbes PadayacheeTel: 011 282 1079 Cell: 082 854 8777Fax: 011 282 8109 e-mail: forbes.padayachee@rmb.co.za

• Laurent ScholtzTel: 011 282 8108 Cell: 083 381 1334Fax: 011 282 8109 e-mail: laurent.scholtz@rmb.co.za

RMB’s Team