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By WARREN BEECH, NICK VELTMAN AND KOKETSO MOLOPE, Published in BANKING & FINANCE IN AFRICA FEATURE

South Africa’s mining industry has always been a cornerstone of the economy, and it has, particularly in recent years, been a key contributor to transformation, growth and development. As with all other stakeholders, mining companies have been affected by COVID-19 outbreaks. The implementation of the national lockdown has resulted in limited commercial activity, and mining projects either slowing down or being put on hold indefinitely. Publically available information suggests that mining activity slowed down by 21,5% during the period 1 January 2020 to 31 March 2020. Views have been expressed that this is the biggest drop in six years, with manganese, iron ore and chromium being the biggest contributors to this decline.

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In this article we address the challenges and opportunities confronting the mining industry from a banking and finance perspective, against the backdrop of the harsh economic consequences brought about by the COVID-19 pandemic. In particular, we address how the traditional forms of financing have been replaced by alternative arrangements.

Traditional forms of financing in the mining sector

When it comes to raising capital, mining companies have, historically, tended to apply traditional forms of financing, including equity financing, royalty financing, asset sales and debt financing. Each of these forms of financing attract certain advantages and disadvantages:

Equity financing

Equity financing usually pertains to the sale of shares in a business. Whilst equity financing is flexible because it does not typically include a fixed repayment structure, it comes with shareholder equity being diluted, resulting in the potential loss of operational control.

Royalty financing

Mining companies that want to avoid the risk of shareholder equity dilution and loss of operational control can opt for royalty financing. Royalty financing is achieved by way of a lender obtaining rights to a percentage of revenue of the borrower’s product/service in advance. Royalty financing does not typically require a fixed repayment structure, and alleviates the risk of any loss of operational control. The contracting parties also share a common investment objective, which aids in cementing the relationship between borrower and lender.

Asset sales

Mining companies also have the option of selling non-core mining assets to raise capital. While asset sales aid in avoiding shareholder equity dilution, this form of financing is only preferred when mining companies have non-core assets which enjoy a high value.

Debt financing

In simple terms, borrowing money from banks and/or funders is referred to as debt financing. Debt financing has assisted many companies who want their current shareholder equity to remain unaffected. However, this form of financing can become the most volatile form of financing during the COVID-19 pandemic as it comes with rigid payment structures, which increases the borrower’s risk of defaulting on its repayments.

Debt relief measures

During the national lockdown the Minister of Trade, Industry and Competition published regulations to provide various relief measures within the banking sector. These regulatory relief measures include the restructuring of loans (i.e. the deferring or reducing of repayments) available to debtors who were in good standing prior to the implementation of the national lockdown. The SARB’s Prudential Authority has also come to the rescue of borrowers by temporarily amending Directive 7 of 2015 on Restructured Exposures, directing against higher capital requirements being imposed on restructured loans. Financial institutions have implemented internal policies and structures to try to assist borrowers during this harsh economic climate.

Competition Law and block exemptions

The Minister has also adopted a block exemption for the banking sector, which would otherwise have been prohibited from certain actions under the Competition Act 89 of 1998. The block exemption permits parties in the banking sector, such as the Payments Association of South Africa (PASA) and the Banking Association of South Africa (BASA), to coordinate efforts on operational issues in order to formulate and adopt industry policies on payment holidays and debt relief measures, to assist borrowers during the COVID-19 crisis.

Contractual considerations

Debt financing comes with onerous contractual obligations as opposed to the other forms of financing mentioned. It is imperative, therefore, that mining companies carefully consider certain clauses that may affect their present contractual terms. These contractual terms include ratios such as debt service cover ratios (the measurement of a borrower’s available cash flow to service current debt obligations) which provide lenders with the ability to detect any financial distress of a mining company, as the borrower, and to avoid reckless lending. The adverse effects of the national lockdown have resulted in a reduction of revenue, and it is possible that this, in turn, will lead to the subsequent breach of the contractual term(s) between mining companies and the lender (which would entitle the lender to accelerate the loan and enforce any security rights obtained from the agreement). It is advisable that mining companies and their lenders consider relevant clauses in the agreement when engaging on the restructuring of any debts.

Repo rate effects

Fortunately (and unfortunately), the repo rate decreased from 6.5% to 3.5% on 23 July, making it easier for mining companies, who have elected variable interest rates linked to the prime rate, to service their debt obligations.

It should be noted that the reduction in the repo rate also affects the maximum lending rate prescribed by the National Credit Act (34 of 2005), and the prescribed rate of interest insofar as unpaid debts are concerned – these debts will carry a lower interest rate if unspecified.

Proposals: Non-Traditional finance transactions in the mining sector during COVID-19

Given the present economic climate, it is becoming more challenging for mining companies to access the traditional forms of funding and equity. Mining companies are beginning to adopt non-traditional forms of finance such as vendor financing and streaming transactions to meet their financial needs.

Vendor financing

Vendor financing is the lending of money by a vendor (lender) to a customer (borrower) to purchase that specific vendor’s product or service offering. This form of financing typically takes place by way of deferring loans from the vendor. A simple scenario would be where a foreign mining entity wishes to conduct business in South Africa but requires BBEEE capabilities to maximise its trading practices, and subsequently collaborates with a local mining entity that is BBEEE compliant for the purpose of selling a portion of its shares to the incola entity. The portion of shares would be repaid by the incola entity by way of, for example, allocating a portion of the incola’s revenue to the foreign entity. The vendor will also collect interest on the deferred payments.

Because the vendor is providing goods/services without immediate payment, it goes without saying that trust is an essential component in a vendor finance transaction.

This form of financing allows borrowers, such as mining companies, to purchase essential goods or services without having to secure traditional forms of financing. Vendor financing also helps mining companies to build a strong credit history and gives it a competitive edge against its rivals.

Vendor financing has become a key method of funding disposal of assets, from mining companies, to purchasers, and has been used extensively in BBEEE transactions.

Streaming arrangements

A streaming arrangement is where a company (streaming company) advances upfront payment (usually in the form of a monetary deposit) to a mining company in order to secure future delivery of specific ore, typically gold, and then later pays the balance for each unit of ore received. This monetary deposit is then reduced upon delivery.

The streaming arrangement can be structured in such a way that the monetary deposit advanced constitutes deferred revenue rather than a debt. The mining company’s obligations are typically unsecured, however, streaming companies may demand that security be provided to reduce the risk.

Streaming transactions are useful during a time when the COVID-19 outbreak has led to economic uncertainty, as it provides mining companies with a way of raising capital outside of the traditional forms of funding.

Another advantage of streaming transactions is that it allows mining companies to raise funds before production starts, which results in production taking place much more quickly than having to obtain traditional forms of funding. Similar to debt financing and asset sales, streaming transactions avoid the dilution of shareholder equity, and tend to be more flexible than debt financing.

So, what do streaming companies gain out of this? A streaming company is able to invest in mining companies without having to incur the operational risks.

They are able to invest in numerous mining companies locally and internationally, which further diversifies their investment portfolio and alleviates the risk of the failure of one mining company affecting its entire investment portfolio.

In addition, a streaming company, in return, typically receives a percentage of revenue or production from the mine (a royalty).

While these royalties are usually a fixed percentage of the mining company’s production, they can also differ in percentage over the life of the operation.

Streaming or pre–payment options (typically by off-takers and coal marketing companies) have also become popular in coal mining because they allow quicker development of the collieries, and provide the holder of the mining right with required working and operating capital.

Comments on government financial assistance measures in relation to mining companies

Minister Tito Mboweni tabled a Supplementary Budget Speech on 24 June, to address the economic downturn caused by the COVID-19 pandemic. In his speech, he mentions that the COVID-19 loan guarantee scheme provided R10 billion in its first month and that many more applications are being processed. The loan guarantee scheme includes a business restart option, which is available to all businesses, including those with a turnover of more than R300 million. However, the Ministry is currently finalising amendments to the turnover limit, which could exclude businesses that do not meet the revised turnover limit. This might mean that mining companies could be excluded from seeking relief from the COVID-19 loan guarantee scheme. At this stage, it remains unclear whether mining companies will be included in the scheme or, alternatively, whether special provisions will be made to assist players in the mining industry.

On the other hand, the Industrial Development Corporation (IDC) has allocated R3 billion to support businesses during the COVID-19 pandemic. This allocated amount will be in the form of two facilities, namely the IDC Distressed Funding and the Essential Suppliers Intervention.

The IDC Distressed Funding will basically provide debt and guarantees. The fund, which can only be used to fund shortfalls, is only available to South African businesses that, inter alia, demonstrate strong business fundamentals and are considered to be viable. The fund, however, excludes the refinancing of existing facilities and the risk has to be shared with other funders, and not just the IDC, and will thus prove to be too limiting for mining companies’ needs.

The Essential Suppliers Intervention facility appears to be more a flexible funding structure for businesses in that the facility includes the provision of short-term loan facilities and revolving credit facilities. A business will qualify for assistance if, inter alia:

  1. 1.it demonstrates historical profitability;
  2. is an accredited supplier;
  3. has a contract or purchase order with the South African government or a similarly large customer for essential services.

Whilst the South African government has introduced certain measures to support businesses during the COVID-19 pandemic, it would be preferable for specific provisions to be made to support and fund mining companies during this time, particularly because the mining sector faces unique challenges. It contributes significantly to growth, development and transformation, and it contributes significantly to the country’s GDP and labour sector.

The challenges brought about by the COVID-19 pandemic make it imperative for mining companies to adapt to the current economic landscape and to adopt non-traditional forms of funding in order to remain viable, and to ensure the continuity of South Africa’s mines.

Beech and Veltman are Directors of and Molope a Senior Associate with Beech Veltman.