annual report 2008

The RWG is responsible for identifying, evaluating and monitoring all significant risks facing the business. Members of the RWG are responsible for integrating risk management into the day-to-day activities of the business and ensuring that the staff are aware and accountable for managing risk and maintaining internal control.

The group is exposed to financial risks being credit risk, market risk (including currency, interest rate and price risks) and liquidity risk. The group manages the overall risk by focusing on minimising the potential adverse effects of these risks on the group’s financial performance.

The group’s primary business is that of a credit retailer. As such, credit risk features as the dominant financial risk. It provides the foundation of the group’s profitability, yet the mismanagement of credit risk will threaten the ongoing sustainability of the business.

Due to its pervasive and strategic importance, credit policies are continually evaluated by the Executive Committee to ensure that they are in line with prudent lending practices, yet maintain the group’s overall profitability and return on assets. The responsibility for the implementation of these policies rests with the Chief Operating Officer, Credit Risk executive and their teams.

The credit granting systems enables the group to determine its appetite for risk. In determining the acceptable level of risk, the potential loss is weighed up against the revenue potential using the predictive behavioural models inherent in the credit-granting system. The group monitors any variances from the level of risk that has been adopted and adjusts the credit-granting process on a dynamic basis.

The group manages its risk effectively by assessing the borrower’s ability to service the proposed monthly instalment. However, collateral exists in that ownership is retained until the customer settles the account in full.

In addition, a payment rating system manages the customer’s payment profile. A payment rating is applied to each customer individually and is based on the customer’s payment history relative to their contractual arrangements. This payment rating is integral to the calculation of the doubtful debt provision in terms of IAS 39. IAS 39 requires that all impaired receivables are carried at their net present value of the expected cash flows from such accounts, discounted at the original effective rate implicit in the credit agreement.

Treasury management is carried out by the chief financial officer and senior members of the finance team under policies approved by the Audit and Risk Committee (“the Committee”). The Committee provides written treasury policies covering cash management, foreign exchange management, interest rate management and investment risk.

The group’s attitude to treasury risk can be summarised as follows:

• investment risk: maximise returns at an acceptable level of risk
• foreign exchange risk: eliminate transaction risk and net investment risk as far as practically possible
• interest rate risk: manage short-term volatility

Imports of merchandise

Merchandise is sourced from foreign suppliers, particularly in the Far East. In order to minimise exposure to foreign currency fluctuations, forward cover is taken out to cover forward purchase commitments made with foreign suppliers. The group strives to maintain forward cover for the next six to nine months’ purchase commitments.

During the year, 26.6% (2007: 24.6%) of the purchases were in foreign denominated currencies. Below is a summary of the amounts payable under forward contracts:

Below is a sensitivity analysis of the effect of currency movements of 5% and 10% on the year-end value of our net investment in Botswana:

Linked policy investment

The principal objective of interest rate management is to:

• minimise the impact of interest rate volatility on profits in the short-term
• ensure that the group is protected from volatile interest rate movements for the medium to long-term

As part of the process of managing floating rate interest-bearing debt, the interest rate characteristics of borrowings are positioned according to the expected movements in interest rates. The Chief Financial Officer may recommend to the Audit and Risk Committee (“the committee”) the use of fixed interest debt and interest rate swaps as circumstances dictate. The use of such instruments must be specifically approved by the committee.

Interest rate profiles are analysed by the changes in its borrowing levels and the interest rates applicable to the facilities available to the group. The sensitivity analysis for a 50 basis points change in the interest is set out below, assuming the current level of borrowings at year-end is maintained throughout the year:

Interest rate profile

The interest rate profile of financial instruments are as follows:

Monarch holds investments in order to meet the insurance liabilities and solvency margins required by the Short-term Insurance Act of 1998. The investments are managed by Sanlam Investment Management (Pty) Ltd (“Sanlam”) on Monarch’s behalf.

The overall management objectives of the portfolio is:

• preservation of capital over the long term
• managing market risk over the short to medium term
• ensure the portfolio is adequately diversified

Monarch’s board controls the investment strategy adopted by Sanlam. At each of the board’s quarterly meetings, a comprehensive report from Sanlam is presented and discussed. Particular emphasis is placed on:

• current market conditions and future expectations
• asset allocations considering the above
• returns under each asset category
• detailed reviews of the equity portfolio and the positioning of the bond portfolio
• recommendations of the asset manager going forward

The Monarch board considers the recommendations of the asset managers. The investment strategy is then formulated for the following quarter and authority is given to the Chief Financial Officer to implement the strategy. The performance of this portfolio is presented to the group’s Audit and Risk Committee on a quarterly basis.

The market risk of the fixed security portfolio is monitored through the modified duration of the portfolio, a measure which approximates the movement in the fair value of such securities relative to interest rate movements. The modified duration of the fixed income portfolio at the respective year-ends and the JSE All Bond Index are as follows:

Management monitors the group’s cash flows through the monitoring of actual inflows and outflows against forecasted cash flows and the utilisation of borrowing facilities. A quarterly analysis is presented to the Audit and Risk Committee.

• settlement of customer’s outstanding balance in the event of death or disability,
• replacement of customer’s goods in the event of damage or theft of goods, and
• settlement of customer’s account, should the customer become unemployed after three months subsequent to the sale

The risk under the insurance contract is the possibility that the insured events as detailed above occur and the uncertainty of the amount of the resulting claim. By the very nature of the insurance contract, this risk is random and therefore unpredictable.

The principal risk that the group faces is that the actual claims exceed the amount of the insurance provisions. This could occur because the frequency or severity of claims are greater than estimated. Insurance events are random and the actual number of claims will vary from year to year from the estimated claims provision established using historical claims patterns.

The frequency and severity of claims can be affected due to unforeseen factors such as patterns of crime, AIDS and employment trends. The group manages these risks through its underwriting strategy, adequate reinsurance arrangements and proactive claims handling. The geographical spread of the group ensures that the underwritten risks are well-diversified. No significant concentrations of insurance risks exist.

A proportional reinsurance arrangement has been entered into by Monarch to facilitate the transfer of 40% of the risk under these policies to an external reinsurer. Catastrophe cover has been placed with third-party insurers and reinsurers in order to reduce the potential impact of a single event on the earnings and capital of Monarch. Due to the nature of the insurance risk, claims can be measured reliably. Past experience has indicated that claims provision estimates approximate the actual claims costs. The insurance result is dependent on the trend in the group’s merchandising sales. There is no significant insurance business other than with the group’s customers.

Monarch has met all the requirements of the Short-term Insurance Act regarding its insurance liabilities, solvency margins, prescribed assets and asset spread.

The fair value of interest swaps and collars is calculated as the present value of the estimated future cash flows. The fair value of forward exchange contracts is determined using quoted forward exchange rates at the balance sheet dates.

The carrying value of trade receivables and trade and other payables are assumed to approximate their fair values.

Consistent with others in the industry, capital is monitored on the basis of the gearing ratio. This ratio is calculated as net debt divided by equity capital. Net debt is calculated as total interest-bearing borrowings less cash and cash equivalents.

During the 2008 financial year, the strategy was to maintain the gearing between 20% and 30%, which in the current credit conditions is considered to be prudent. The gearing rates at 31 March 2008 and 31 March 2007 were as follows: