Author: Ryan van Breda
The South African listed credit is a c. 1.1trn nominal market (excluding government paper), consisting of c. 2 484 listed debt instruments issued by 103 issuers. The market is dominated by bank and financial issuers who account for c. R407bn (37% of the issuance), while State Owned Enterprises (SOEs) account for R246bn (22%) followed by the corporate sector of R158bn (14%). The rest of our market consists of credit-linked notes (CLNs) at R120bn (11%), structured notes at R105bn (9.7%), securitisations at R46bn (4.2%), municipal bonds at R7.9bn (0.7%), and issuers of asset-backed commercial paper at R2.8bn (0.2%). Listed credit instruments are a widely deployed investment instrument in many specialist fixed income portfolios, and corporate debt funding plays a vital role in the capital structure of a firm, especially in the funding structure of South African banks.
To form an investment view on the South African listed credit market, one has to examine how the market has evolved; the current dynamics at play, and the key factors which we expect will drive the market in the near future. Despite 2024 being a record issuance year for non-government bonds (excluding commercial paper (CP), CLNs and structured notes) in our listed credit market, appetite for credit continues to remain robust. Demand cannot keep up with supply and listed credit continues to price tighter – and so the tug of war persists.
Making sense of current pricing
Credit spreads have reached record lows across most sub-sectors in our listed credit market (excluding Municipalities (Muni’s) and SOEs) [Figure 1]. Credit spreads are now trading below pre-COVID levels, despite various economic headwinds at play and despite the tightly held nature of these listed bonds by the institutional market adopting a buy-to-hold strategy.
When considering current pricing, the questions on our minds are:
- Will demand continue to drive credit spreads even lower this year?
- Could credit spreads finally be approaching the bottom end of their all-time lows?
We believe that demand will continue to drive credit spreads lower this year, however we anticipate that credit spreads will reach their floor this year and start normalising towards the end of the year.
A credit spread (simplistically in theory) represents the compensation required by an investor, over and above an appropriate benchmark (such as JIBAR/ZARONIA, or a fixed rate government bond), for investing in a particular issuer. Credit spreads increase for longer-dated bonds given the higher risk of default and greater compensation required for investing for a longer time-horizon by investor on an inflation adjusted basis.
Figure 1: Average spread moves across sectors
Source: Standard Bank Research, JSE
A tailwind for increased bank credit issuances is on the horizon and its impact on credit pricing
The requirements of South African banks to commence the issuance of First Loss After Capital (FLAC) instruments (instruments initially proposed in 2013) from their holding companies (Holdco) opposed to their operating companies (the banking entity, the Opco), should at least anchor general credit spreads going forward.
FLAC instruments are governed by Prudential Standard RA03 which requires banks designated as Systemically Important Financial Institutions (SIFI’s)[1], to enhance their loss-absorption capacity through the issuance of FLAC. FLAC instruments will be issued internally by the bank Opco to its Holdco and issued externally to third party investors by the Holdco.
FLAC instruments represent a senior non-preferred concurrent or unsecured claim on the free residue of the insolvent estate after unsecured creditors are settled in full.
To meet the requirements of the standard, SIFI banks are required to build up their FLAC over the next five years, with implementation initially proposed from 1 January 2025 (now shifted to 1 January 2026). The quantum of FLAC issuance required to meet compliance with the standard will completely replace the issuance of senior unsecured bank Opco bonds in time.
FLAC issuance is expected to price higher (given its structural features and where in the banking group it is being issued). As a result, we believe that general credit spreads should at least normalise higher towards the end of this year (given banking credit will price higher in time), given the projected phase-out of bank Opco bond issuances and their replacement by bank Holdco issuances in time. Until we see FLAC issuance coming to the market, we expect demand to continue exceeding supply, with pricing likely to tighten further this year relative to 2024 [Figure 1].
[1] SIFIs designated by the Governor of the Reserve Bank currently include Absa Bank Limited, Capitec Bank Limited, FirstRand Bank Limited, Investec Bank Limited, Nedbank Limited and The Standard Bank of South Africa Limited.
Credit issuance back to pre-COVID levels
When considering comparative statistics of the listed non-government credit market (excluding CP, CLNs and structured notes), 2024 was a record year on many fronts [Figure 2]:
- Approximately R170billion was issued (the last time this occurred was in 2019);
- Corporates raised a record c.R49bn (surpassing the previous high in 2019) and;
- The banking sector saw an all-time issuance high of c.R86bn or 50% of overall issuance (a new high both in absolute terms and as a percentage of total annual issuance since 2015). And all of this occurred with bank and corporate credit spreads (excluding (Muni’s) and (SOEs)) at all-time lows against a backdrop of various economic headwinds.
Figure 2: Listed gross term issuance by sector on the JSE
Source: JSE, RMB Global Markets Research (31 December 2024)
Demand and the impact on supply
Despite 2024 being a record year for non-government issuance, demand for paper has far outstripped supply, with no failed auctions occurring in 2024. This can be seen in the level of auction bid/cover ratios which have ranged from 1x and upwards [Figure 3]. This ratio is a measure of demand over supply where 1x means demand equals supply, and 2x where demand is double that of supply. We have continued to see this state of play in various public auctions during the first two months of 2025, where senior bank bond auction cover ratios have ranged between 3x to 4.75x. At the same time, senior bank credit spreads continue to tighten further which is a trend we expect to persist for the remainder of the year given the strong demand for bank Opco bonds. These are due to be phased out with FLAC instrument implementation which will take place from the beginning of 2026.
Figure 3: Primary market issuance
Source: Standard Bank Research analysis, Auction feedback, JSE (as at January 2025)
Supply dynamics and the impact on price
In a public auction bond issuers inherently control the supply of their bonds as advised by their arrangers. In the current game of tug-of-war between market demand and supply of the bonds on offer, the only real winners are those players who accept lower credit spreads in order to be allocated bonds at the lowest winning bid. This dynamic results in auctions clearing at, or even below the lower end of the pricing guidance. This in turn sets a new low price precedent for upcoming auctions of the season. The prize in this form of investing shifts to obtaining an allocation, rather than optimising the return achieved!
Not only are credit spreads tighter (on average) in the clearing auctions with bid/cover ratios significantly in excess of 1x, but clearing pricing is also considerably tighter for longer-dated bond tenors. In other words, excess demand is reducing compensation not only for pure credit risk on specific issuers, but for term risk as well. This is great for issuers but presents challenges for investors. As the interplay between demand, supply and price plays out, we believe publicly available supply will continue to fall. This is largely due to the market’s ongoing bifurcation with private placements (conflicts of interests aside) being more prevalent, a trend we expect to persist.
In 2024, c.36% (c.R61bn of cR170bn) of all bond issuance was privately placed. These bilateral private placements not only reduce supply in public auctions but also contribute to lower credit-spreads for public issues. This reinforces the downward trajectory as lower credit spreads feed their way back into setting a lower pricing guidance for upcoming public auctions (at least for the same issuer). And so, given this public private interplay, the tug-of-war between demand, supply and price continues.
A private placement is a bilateral transaction between an investor (normally an institutional investor) but can also include: a commercial bank or an arranger, and an issuer, where the investor agrees to subscribe for the bond and the issuer agrees to issue the bond at a bilaterally negotiated price. The pricing of the bond (credit spread) over the relevant benchmark, is bilaterally agreed amongst the parties and not determined by public auction dynamics.
Another elegant battle: institutional investors vs commercial banks
Issuers have chosen not to fully absorb the demand on offer via their public auctions, as evidenced by the high bid to cover ratios [Figure 3]. Instead, they continue to stagger their public and private waltz between investors, banks and arrangers. At the same time, another battle is being waged publicly between the commercial banks and the institutional investor market, given the formers’ participation in public auctions.
We have seen that in 2024, commercial banks have (on average) received higher final allocations in public auctions than their initial bid amounts (in percentage terms). This suggests that the commercial banks must be pricing lower relative to institutional investors in these public auctions. For example, a commercial bank might bid for 20% of a bond issuance but ultimately be allocated more than 40% of the total offering. Whilst this dynamic has decreased since 2023, commercial banks were still allocated approximately 20% of the aggregate final public auction bond allocations on offer equating to c.R34bn (excluding the private placement market). Given that commercial banks participate in public auctions for various reasons, including strategic funding opportunities in the listed market and for meeting Basel III requirements to hold High Quality Liquid Assets (HQLA), the debate around bank participation in public auctions hinges on the trade-off between price versus enhanced liquidity (via the trading book).
As the commercial banks compete with the institutional investor market, it is common cause that the institutional investor market competes with itself in setting the price of credit. And the battle between demand, supply and price continues!
Institutional investors managing unit trust retail asset classes in the ASISA fixed income and multi-asset (balanced and income fund) categories have seen a notable increase in flows over the last couple of years. To put this into perspective:
- The total size of the interest-bearing category is approximately c.R729bn.
- The income fund category currently stands at c.R323bn.
- The multi-asset (balanced fund) category, excluding high-equity funds, is c.R399bn.
- This totals approximately c.R1.45tn, accounting for 43% of the entire collective investment scheme (CIS) industry assets (c.R3.3tn).
If we assume that the entire listed non-government credit market (excluding CP, CLNs and structured notes) 2024 issuance of c.R170bn is invested in these funds (noting that this analysis excludes the direct AUM within the Pension and Long-Term Insurance sector), the entire 2024 issuance amounts to a mere 11.7% allocation in credit, reinforcing our belief that demand well exceeds supply.
HQLA (High Quality Liquid Assets)
In South Africa, the set of HQLA-eligible assets currently comprises (i) banknotes and coin; (ii) highly rated non-government debt; (iii) central bank reserves; (iv) government and SARB rand-denominated debt; and (v) government and SARB foreign exchange-denominated debt (for specific exposures). To satisfy the LCR (Liquidity Coverage Ratio), banks must hold sufficient unencumbered HQLA to meet all outflow demands, for a period of 30 calendar days, during episodes of stress.
Perpetua’s view on the listed credit market and where do we see value
Despite credit spreads being at multi-year lows and the persistent search for yield driving bid-cover ratios higher, the ever-increasing supply of funds chasing fewer investment opportunities continues to keep the market well bid.
As fundamental valuation-driven investors, we follow a disciplined, risk-adjusted approach in seeking sustainable returns that adequately compensate for risk. Credit spreads and overall valuations do not reflect the level of risk we believe is inherent in the market. Given current market pricing, we do not currently find compelling value in listed credit and, as a result, remain underweight credit within Perpetua’s fixed income portfolios. At present we opt to invest in the swap and derivative markets for yield enhancement.
For example, on a risk-adjusted basis, current yields for liquid domestic AAA-rated non-credit linked corporate bank structured risk with moderate duration, offer more attractive returns than the prevailing credit market pricing. This approach has benefited the performance of the Perpetua Flexible Fixed Interest Fund which, with its modified duration of 3.47, is currently delivering a yield of Jibar (7.558%) +3.2% on a nominal actual compounded annualised basis (naca) (approximately 11%).
Until we see a meaningful adjustment in pricing that aligns risk with sustainable potential returns, we will maintain our cautious stance. We continue to monitor the South African listed credit market keenly looking to assess the entry point where we believe that the asymmetry of returns shifts in favour of investors overs issuers.