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Loan products to manage liquidity stress when broad-based black economic empowerment (BEE) enterprises invest in productive assets.

Investments in productive assets by broad-based black economic empowerment (BEE) enterprises in
South Africa (SA) during the 1990s have been constrained, in part, by a lack of access to capital. Even if
capital can be sourced, BEE businesses often face a liquidity problem, as conventional, equally
amortized loan repayment plans do not take into account the size and timing of investment returns, or
there are lags in the adjustment of management to such new investments. The aim of this dissertation,
therefore, is to compare five alternative loan products to the conventional fixed repayment (equally
amortized) loan (FRL) that lenders could offer to finance BEE investments in productive assets that are
faced with liquidity stress, namely: the single payment non-amortized loan (SPL); the decreasing
payment loan (DP); the partial payment loan (PPL); the graduated payment loan (GPL); and the deferred
payment loan (DEFPLO-2). This is done firstly by comparing loan repayment schedules for the six loans
using a loan principal of R200 000, repaid over 20 years at a nominal contractual annual interest rate of
10%. Secondly, data from five actual BEE loan applications to ABSA Bank and Ithala in KwaZulu-Natal
(KZN) during 2003 are used to compare how the FRL, SPL, DP, GPL, and DEFPLO-l, affect
investment profitability, and both the borrower's and the lender's cash-flows, assuming that the lender
sources funds from a development finance wholesaler.
Results for the first part of the study show that the SPL has smaller initial annual repayments than the
FRL (R20 000 versus R23 492) that ease liquidity stress in the early years after asset purchase, but
requires a nominal balloon repayment of both interest and principal in year 20 of R220 000. The SPL is
also the most costly loan, with total nominal and real repayments that are R130 162 and R43 821,
respectively, more than the FRL. The PPL has the lowest total nominal and real repayments assuming
that the borrower can make the nominal balloon repayment in year 5 of R202 173. If not, the ending
balance of the loan in year 4 would have to be refinanced at current market interest rates. In this
situation, the PPL uses very similar financing terms to that of the variable rate long-term loans already
used in SA, and thus may not be a useful option to consider for BEE investments facing a liquidity
problem. Interest rates may have risen over the last four years of the loan, encouraging lenders to add a
premium into the interest rate for the refinanced loan, which could worsen the liquidity position of the
BEE enterprise. The DP requires higher initial nominal annual loan repayments (R6 508 more than the
FRL) that do not ease the liquidity problem in the early years of operation. The DP loan, however, has total nominal and real repayments that are R59 838 and R23 118, respectively, less than the FRL. A
GPL with diminishing, finite interest-rate subsidy seems to have the most potential to ease the BEE
investment's liquidity stress. The 17YRGPL used to buy land had total nominal and real repayments that
were R84 634 and R67 726 (after subsidy), respectively, less than the FRL. If the GPL was used to
purchase machinery-type assets, then the 6YRGPL would have required total nominal and real
repayments of R13 957 and R12 596, respectively, less than the FRL. Finally, the DEFPLO-2 loan
required a total nominal repayment of R531 128 (R61 290 more than the FRL) and a total real
repayment of R345 358 (R26 095 more than the FRL). Clearly, the GPL and DEFPLO-2 loan repayment
schedules can partly resolve the liquidity problem in the early years (assuming no major income shocks),
although the DEFPLO-2 plan requires higher total repayments than the FRL. The question remains
whether lenders would be prepared to implement these two financing plans for BEE investments in
productive assets, where the funds to finance the diminishing, finite interest-rate subsidy or the
deferment would be sourced, and how the interest-rate subsidy would affect asset values.
In the second part of the study, the profitability of the five proposed BEE investments in KZN during
2003 was compared for the five loan products using the Net Present Value (NPV) and the Internal Rateof-
return (lRR) capital budgeting procedures. The loan terms, interest rates, principal and characteristics
of each BEE firm are different with current rates of return on equity varying by business type.
Companies A (five-year loan) and C (10-year loan) are agribusinesses with a higher expected current
rate of return of 8% on machinery investments, while companies B (eight-year loan), D (15-year loan),
and E (20-year loan) invest in farmland with a lower expected current annual rate of return of 5%. The
five business plans may not be representative in a statistical sense of all BEE firms in KZN, but were
used because they were readily available. Initially it was assumed that donor/grant funds from a
development finance wholesaler were lent to an intermediary (like a commercial bank), which in turn,
could finance the five investments using any of the five alternative loans, with the lender's repayment to
the wholesaler being via a FRL. It was then assumed that the lender could repay its borrowed funds
using the same loans, or combinations of them, that it had granted to these companies. Results show that
GPLs and DEFPLs can resolve the liquidity problem associated with investments like land in the early
years after purchase provided that projected business performance is adequate, while the SPL and GPL
are preferred for BEE projects with stronger initial cash-flows like machinery investments. The study
also shows that the loan product that best improves the borrower's liquidity is not always best suited to
the lender. In most cases, the GPL suited the borrower, but in four of the five cases, the lender would prefer the SPL and to repay the wholesaler using the SPL. The SPL, however, is unlikely to be used,
given the large negative real net cash-flows that it generates when the final payments are due.
Recent SA experience with the GPLs (interest rate subsidies funded by private sector sugar millers via
Ithala) and the DEFPLs (via the Land Reform Empowerment Facility (LREF) which is a wholesaler of
funds in SA) suggests that there is scope to alleviate the liquidity problem if a wholesaler of funds can
offer such terms to private banks and venture capital investors who then on-lend to finance BEE asset
investments that are otherwise considered relatively high credit risks. This would shift the liquidity
problem away from the client to the wholesaler of the funds, but requires access to capital at favourable
interest rates. Such capital could be sourced from dedicated empowerment funds earmarked by the
private sector, donors and the SA government.
The lesson for policymakers is that broad-based BEE could be promoted in other farm and non-farm
sectors in SA using similar innovative loan products to complement cash grant funds via financial
intermediaries, bearing in mind the limitations of the GPL and DEFPL - such as how to finance the
subsidy or deferment, and the impact of income shocks. Donor and National Empowerment Fund capital
could be used to allocate grants to provide previously disadvantaged individuals with own equity and
also to fund finite, diminishing interest-rate subsidies via GPLs, or to fund DEFPLs (many LREF loans
have been leveraged by a cash grant component). This could create an incentive for public/private
partnerships, as public/donor funds could be then used to attract private sector funds to finance broadbased
BEE investments in SA that satisfy empowerment criteria. The five case studies did not show how
the GPLs and DEFPLs could make all profitable (positive net present value) but financially infeasible
(returns do not match the size and timing of the lender's financing plan) BEE investments in productive
assets under the FRL feasible, except for Company E that showed a positive NPV and IRR when the
19YRGPL was used. They did, however, show how the alternative loans could improve liquidity for
investments with either strong or poor cash-flows. The financiers consulted to source case studies in
KZN in 2003 at the time of the study could not provide the researcher with any profitable, but
financially infeasible, BEE business plans. This raises some concern about how effective these
empowerment loan products could be in the future as there is uncertainty over how many potential BEE
investments in productive assets in SA are likely to be profitable but financially infeasible. Further
research is thus needed to assess the impact of these alternative loans on a wider range of broad-based
BEE investments, particularly non-farm projects, than considered in this dissertation. / Thesis (M.Agric.Mgt.)-University of KwaZulu-Natal, Pietermaritzburg, 2005.

Identiferoai:union.ndltd.org:netd.ac.za/oai:union.ndltd.org:ukzn/oai:http://researchspace.ukzn.ac.za:10413/4076
Date January 2005
CreatorsFinnemore, Gareth Robert Lionel.
ContributorsDarroch, Mark Andrew Gower., Lyne, Michael Charles.
Source SetsSouth African National ETD Portal
LanguageEnglish
Detected LanguageEnglish
TypeThesis

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