RCS GROUP
Schalk van der Merwe
The RCS Group is an operationally independent consumer finance business that provides a broad range of financial services under its own brand and in association with a number of retail entities in South Africa, Namibia and Botswana. The RCS Group is majority owned by the Foschini group (55%) with The Standard Bank of South Africa holding the balance of the shares (45%).
The RCS Group is structured into two operating business units named Transactional Finance and Fixed Term Finance. The operating units are supported by a number of shared services. In addition, the RCS Group has an investment interest of 60% in an independent data management company named Effective Intelligence.
The Transactional Finance business unit is focused on facilitating credit sales for retailers at point of sale. Retail credit sales are supported in one of two ways:
- through an own-branded general-purpose private label card known as the RCS Card that is accepted at 13 500 retail outlets countrywide; and
- by managing private label and co-branded retail credit programmes for retailers under their own brands on an outsourced basis.
Currently the private label portfolio consists of the Queenspark card as well as in-store credit offerings in Game and Dion Wired stores. The co-branded card programme comprises the recently acquired AD Spitz and Cape Union Mart portfolios.
The Fixed Term Finance business unit provides personal loans and insurance products under the RCS brand to existing RCS Group, Foschini group and external customers through direct marketing methods.
The RCS Group is functionally separate from FG Financial Services and it has its own governance structure, branding, field of operation, management team, budgets and profit models. The decision to differentiate the businesses was taken at the establishment of the RCS business in 1999 in order to ensure that the Foschini group’s focus on its traditional trading activities was not lost, and that all profits and costs associated with the RCS business would be clearly ring-fenced.
REVIEW OF THE YEAR
The RCS Group delivered positive full-year results despite the continued challenging market conditions, against a backdrop of muted credit extension and slower retail turnover.
PROFITABILITY
The overall performance of the RCS Group resulted in an increase of 11,5% in profit before tax which represents a positive improvement on published results at the half-year. The profit improvement is especially pleasing given the significant reduction in interest yield caused by the decline in the repo rate over the last 17 months. The profitability breakdown is as follows:
| 2010 | % | 2009 | |
| RCS Group profitability | Rm | change | Rm |
| Interest income | 798,4 | 4,4 | 765,0 |
| Credit income | 343,8 | 13,5 | 302,9 |
| Total credit income | 1 142,2 | 7,0 | 1 067,9 |
| Net bad debts | (352,4) | 11,1 | (317,1) |
| Operating costs | (378,6) | 7,1 | (353,5) |
| EBIT | 411,2 | 3,5 | 397,3 |
| Interest paid | (185,3) | (4,9) | (194,8) |
| Profit before tax | 225,9 | 11,5 | 202,5 |
| RCS Group profitability statistics | 2010 | 2009 | |
| Interest as percentage of total revenue | 70 | 72 | |
| Cost-to-income ratio | 33 | 33 | |
| Profit before tax as percentage of average debtors (net margin) | 8,4 | 8,8 |
Interest income was spurred by growth in the overall debtors’ book despite further reductions in the repo rate during the year. The introduction of risk-based pricing across all portfolios enhanced the credit income line and allowed a greater measure of alignment between risks and income at the level of individual customers. Insurance income also contributed in greater proportion to revenue during the year.
Net bad debt showed reasonable growth compared to prior years. The net bad debt number includes setting aside appropriate increases in provisions to ensure that RCS maintains an acceptable cover rate for non-performing loans. This resulted in an increase in non-performing loan provision cover over prior years. Operating costs are well under control and the cost-to-income ratio remains very healthy.
Overall there has been some margin erosion during the year. The 0,4% reduction in the margin of profit before taxation should however be seen against the 2,5% drop in repo rates during the year, as well as the annualised impact of a further 2,5% drop in the repo rate in the last three months of the previous year. The fall in the repo rate effectively translates to an 11% drop in rates that RCS can charge based on the capping formula laid down in the National Credit Act. The reduction of only 0,4% in the margin of net profit before tax over the year reflects the fact that RCS was able to make up some of the loss of interest margin through other income streams and improved operating efficiencies.
A divisional breakdown of the profit shows that the Transactional Finance business unit has seen strong growth in profits compared to the previous year. The key factors leading to this increase in profitability were improvements in net bad debt costs, the introduction of risk-based pricing models across the unit’s portfolios, positive book growth in the private label and co-branded portfolios, and tight control of costs.
The Fixed Term Finance business unit showed muted profit growth compared to prior years. The main factors which limited growth in profits were slower advances, increased write-off because of lagged roll from strong book growth in the previous year and reduced acquisitions of new accounts in the third quarter of the year. The scale-back in activity was required in order to manage cash resources during the peak trading period of November to January. A positive contributor to profit growth in the Fixed Term Finance business unit has been insurance business. Insurance as a product category holds much promise for growth in future profits in the RCS Group.
Overall, the management team is pleased with the positive profit growth achieved during the year, which reversed the negative trend of the previous two years.
| 2010 | 2009 | ||
| RCS Group profit contribution | Rm | % change | Rm |
| Transactional Finance | 73,8 | 52,3 | 48,4 |
| Fixed Term Finance | 153,4 | 3,1 | 148,7 |
| Other investments | (1,3) | (123) | 5,4 |
| Profit before tax | 225,9 | 11,5 | 202,5 |
| RCS Group | 2010 | 2009 |
| Asset quality statistics | ||
| Number of active accounts (’000) | 643 | 678 |
| Net debtors’ book (Rm) | 2 628 | 2 471 |
| Arrear debt as percentage of total debt | 14,4 | 17,1 |
| Non-performing loans as percentage of total debt | 10,1 | 12,0 |
| Net bad debt write-off as percentage of turnover (cards) | 9,3 | 12,8 |
| Net bad debt write-off as percentage of debtors’ book | 12,3 | 14,1 |
| Doubtful debt provision as percentage of debtors’ book | 9,2 | 8,9 |
| Provisions as percentage of non-performing loans | 90,8 | 73,7 |
| Debt: equity ratio | 63,5 | 66,7 |
| Percentage of applicants granted credit on card portfolios | 34,4 | 36,8 |
ASSET QUALITY
One of the key goals of the RCS Group during the past year was to improve the overall asset quality of the portfolios under management. The table above reflects some of the key statistics relating to asset quality.
All key measures of the quality of the debtors’ book show positive trends year on year. In percentage terms, these include:
- improved arrears;
- reduced non-performing loans;
- lower write-off in the cards portfolios; and
- lower write-off in the overall debtors’ book.
Despite an improving position in non-performing loans, the provision for doubtful debts has been raised from 8,9% to 9,2% of book as a prudent measure. Cover for non-performing loans changed from 73,3% in the previous year to 90,9%. There are two key reasons for this change. The first is the acquisition of two new portfolios, Cape Union Mart and AD Spitz, which required specific new prudent provisions. Secondly, the Massdiscounters portfolio grew significantly, necessitating increased provisions to ensure that sufficient cover will be in place once book growth starts to taper down.
The RCS Group has set a target of at least 80% of cover for non-performing loans and will review this target annually in line with changes in the composition of portfolios. This supports a strategy to manage the asset quality in line with the expectations of investors in any of the RCS fund-raising programmes, as well as to maintain and strengthen the existing credit rating.
FUNDING
Historically the primary source of funding used by the RCS Group was a term funding facility provided by its shareholders. During the year a project was initiated to diversify the sources of funding beyond the shareholders. This included fund-raising activities in the capital markets.
In this context one of the significant achievements of the year was the completion of a rating process and the launch of a R2 billion domestic medium-term note (DMTN) programme.
The rating process was completed by Moody’s in January 2010 with a rating of Baa1.za (long term) and P2.za (short term) with a negative outlook. The reasons for the negative outlook included uncertainty about the ability of the RCS Group to raise funding in the capital markets, its ability to grow profits positively and the general outlook for the South African consumer finance market.
The RCS Group went to market with its DMTN programme in March 2010 and was able to raise R303 million of funding in a mixture of long-term (four years) and short-term (12 months) paper. Subsequent to the year-end, an additional R250 million has been placed on a seven-year term. Following this successful launch the RCS Group expects to go to the capital markets periodically during the next year.
DIVISIONAL OVERVIEW
Transactional Finance
Overall, the Transactional Finance business unit (TF) had a good year, with growth being achieved in total account numbers, turnover and book size. It should be recalled that this unit manages three categories of portfolios, the RCS card portfolio, the private label portfolio and a co-branded portfolio.
The RCS card portfolio experienced a decline in card numbers, turnover and book size when compared to previous years. The decline in numbers was deliberately caused as part of a strategy to apply more stringent criteria in the qualification of new accounts. The decline in book size was a consequence of a decline in retail turnover in merchant outlets and is in line with reductions in general retail expenditure in the durable and semi-durable retail sector. Despite difficult trading conditions it proved possible to continue expanding the merchant network and the general-purpose RCS Card is now accepted nationally in 13 500 merchants’ outlets across a variety of industries. Several national retailers were added to the merchant network during the year, notably the Edgars Group, AD Spitz and Cape Union Mart.
Growing the private label portfolio continues to be a strategic goal of the RCS Group. Currently the RCS Group manages and owns the Queenspark, Game and Dion Wired private label portfolios. The Massdiscounters portfolio, consisting of the Game and Dion Wired private label cards, showed significant growth. This was mainly attributable to the launch of a new private label card product in the business of both these merchants. Since this launch in September 2009 the take-up of cards has been very good and growth in both sales and book volumes has been significant. Various initiatives to improve efficiencies and reduce the cost-to-income ratio of this portfolio were also started. The Queenspark portfolio also continued to perform well and there was good growth in account numbers, turnover and book size.
During the year the AD Spitz and Cape Union Mart retail card books were purchased from First National Bank. Upon taking over the portfolios the RCS Group launched a new card offering into these merchant groups. The offering entails a co-branded card that carries the retailer’s brand on its face but allows purchases to be made not only at that retailer but also at the broader merchant network served by the RCS Group. This offering is particularly suited to smaller retail groups where running a full-scale private label offering is not financially viable. It is anticipated that the co-branded portfolio will expand with the addition of a selected number of quality brands in the next year.
Fixed Term Finance
The Fixed Term Finance business unit (FTF) focuses on the term lending and insurance portfolios. It provides personal loans and complementary insurance products to existing RCS customers, to the Foschini group’s customer base and to the public at large. It operates primarily on a direct marketing basis. Customers are attracted by the convenience and simplicity of the RCS products, with a large part of the sales process being handled telephonically. The high level of cross-selling and repeat business attests to the efficacy of this business model.
The personal loan portfolio declined in account numbers and book size over the year. As is indicated in the profit review section, new account activity was curtailed during the third quarter in order to optimise the management of cash resources available in the business during the peak retail trading period of November to January. The reduction in account numbers was also influenced by deliberate action in setting more stringent qualifying criteria for new accounts. An adjustment to the term lending criteria made in the second quarter also affected the book size. Its result was a reduction in the average outstanding term of the book and a consequent faster pay-down by customers.
The RCS Group also has a home loan business which is an origination model in partnership with SA Home Loans and is an extremely small component of the overall business. During the year all origination activities in this portfolio were stopped as a result of very difficult trading conditions in the home loan origination market. The home loan origination model is currently being reviewed and it is anticipated that if feasible new origination will be selectively resumed in the next year.
The insurance business consists primarily of credit life insurance products that are sold in conjunction with various credit products offered by the RCS Group. The insurance portfolio showed good year-on-year growth through the introduction of a number of new credit life offerings. The claims history on all insurance portfolios remained well within industry limits. During the year non-credit life-based insurance products were cross-sold to a portion of the RCS Group’s customer base and initial take-up has been very encouraging. Steady expansion of this portfolio during the next year is expected.
PROSPECTS
Despite the positive gains during the year a number of broader market challenges are still present:
- mass middle market consumer budgets remain under strain, resulting in muted demand for
credit, as well as for durable and semi-durable goods;
- capital markets, while becoming more accessible, remain tight, with pricing at a premium;
- the competitive landscape continues to intensify as the pool of available creditworthy customers gradually declines; and
- pricing limitations continue to prevail in the current interest rate environment because of the interest-capping formula under the National Credit Act.
Against this backdrop the RCS Group anticipates that the business will achieve moderate growth in the next year.
Gains made in improving the quality of assets will be maintained and greater operational efficiencies will be achieved as the transactional finance model is leveraged to its full extent.
It is expected that the private label and co-branded portfolios will see the addition of a number of new programmes during the next year. Furthermore, investigations into the possibility of extending the transactional finance model into southern Africa are under way, with Namibia and Botswana currently being considered.
The Fixed Term Finance business has resumed a more aggressive strategy to acquire personal loan customers, testing a number of new channels in the process. It is anticipated that the insurance business will extend its gains with expanded product offerings.
SUSTAINABILITY
In terms of internal resource management, investing in talent development is an ongoing focus. Commitment to promoting employment equity in the company is demonstrated at the highest level with the CEO of the RCS Group chairing an employment equity committee and monitoring the company’s performance towards meeting employment equity targets. The company management and employment equity committee are exploring strategies to address the ongoing challenge of attracting suitable candidates into the business, notably at senior management levels.
The RCS Group invests in a range of activities aimed at ensuring the well-being of its employees and has a low level of staff turnover at 2,25% during the financial year in review.
The company’s on-site occupational health facility employs an occupational health nursing practitioner, a medical doctor and a social worker. The majority of visits (78%) to the clinic are for primary health purposes and 22% are occupational health related. A notable achievement this year was an increase in the number of HIV-related visits to the clinic, due to an increased awareness campaign around voluntary counselling and testing. Almost half of the company’s employees know their HIV status and treatment for those testing positive is provided free of charge.
RCS Group is active in developing strategies and promoting efforts aimed at reducing the Foschini group’s environmental footprint, notably around reduced electricity consumption. The company has engaged external consultants to calculate its carbon footprint, focusing on both direct and indirect emissions, with a view to consolidating efforts to monitor and improve its environmental performance.
The company continues to be proactively involved in community development initiatives, investing over R800 000 in a range of initiatives during the financial year in review. Prominent projects include supporting TSiBA, a free tertiary education facility based in Cape Town, providing bursaries for children supported through sport by the JAG Foundation and the Karl Westvig Bursary Fund, and supporting employees by providing bursaries for their children at primary school.
