Banking universe not quite on the brink of
a seismic shift
Now may not be the time to pick up shares
A lot can happen in three months.
In just three months South Africa’s political and economic woes appeared to lift, and with it rose the share prices of banks.
This was unsurprising really as banks are considered a barometer for the economy. Three months ago, the economy was thought to be in the doldrums, hamstrung by political instability, policy uncertainty and the threat of further credit ratings downgrades.
Three months ago Cyril Ramaphosa was elected president of the African National Congress in a race that came down to the wire. Considered the business-friendly candidate, his victory and intentions to tackle corruption, the mismanagement of state-owned enterprises, stimulatation of economic growth and job creation, represented a potentially brighter future for South Africa.
Cyril Ramaphosa, President of ANC
Nhlanhla Nene, Minister of Finance
The markets lapped up the changing of the guard. The rand raced to a nine-month high as it appeared Ramaphosa would seal the deal, even gaining around 2% just minutes before the results announcement. The yield on the ten-year bond, which is inversely correlated to banking stocks, moved down to below 9%, and the banking index closed more than 8% higher in the immediate aftermath of Ramaphosa’s victory.
The banking index has since been supported by Jacob Zuma’s early resignation as president of the country, continued rand strength, an improvement in the inflation outlook, higher than expected GDP growth in 2017, a “tough but hopeful” 2018 budget, significant upswings in business and consumer confidence, and Nhlanhla Nene’s reinstatement as minister of finance.
In just three months, the economy and banking universe has shifted dramatically and there is reason to be optimistic about South Africa’s growth outlook. But as FirstRand recently reminded us, it is likely to take some time before this new wave of optimism will be seen in the economy and in the results of banking groups.
The latest results posted by the Big Four Banks show the effects of a low growth environment. Economic growth, as registered by Stats SA, stood at 1.3% in 2017.
An analysis by EY, shows headline earnings growth by the six listed banks – Barclays Africa, Capitec, FirstRand,
Investec, Nedbank and Standard Bank – fell to a 10-year low during the 2017 calendar year. Cumulative headline earnings grew 5.7% to R83 billion, up from R78.5 billion in 2016.
Research by the consulting firm shows that each 1% rise in GDP results in a 5% increase in headline earnings.
Of the Big Four, Standard Bank reported the fastest growth in earnings over 2017 calendar year, with headline earnings per share (HEPS) increasing by 14% to R16.40 during the financial year ended December 2017. Rival Nedbank’s HEPS inched up 2.2% to R24.52 while Barclays Africa’s fell 4% to R17.16 over the same period. FirstRand, whose reporting period differs, achieved a 6% increase in HEPS to R2.24 during the six months to December 2017.
The quality of earnings growth posted by the Big Four varies, said Simbarashe Chimanzi, an equity investment analyst at JM Busha Investment Group. “FirstRand and Standard Bank impressed us with strong top line growth, underpinned by solid non-interest revenue growth and in SBK’s case, a resilient performance on the continent. Nedbank and Barclays earnings growth remains a concern as it was not driven by top line expansion but mainly improved impairments and cost control.”
Standard Bank reported the fastest growth in earnings over 2017 calendar year
FirstRand achieved a 6% increase in HEPS to R2.24 during the six months to December 2017
The impairments ratio across the board improved to 0.68 in 2017, from 0.75 previously and remained the five-year average of 0.8, EY found.
At the same time credit extension by the major banks fell to a 10-year low but the taps have not run dry, said Ernest van Rooyen, Financial Services Africa Partner at EY. “Year-on-year, there is still growth [in adavances] but the growth is at a very low rate, particularly to the consumer…The banks have not closed the taps, they are still lending and they are looking to grow in a responsible manner that can mitigate credit risk.”
Ernest van Rooyen, Financial Services Africa Partner at EY
Source: EY South Africa Banking Results 2017
The slowdown in credit extension to consumers is said to be linked to a 2016 amendment to the National Credit Act, which introduced affordability assessment regulations, as well as more stringent lending criteria by the banks themselves.
Despite the wave of optimism sweeping through the country, thanks in part to the events over the past three months, banks don’t expect credit growth to increase significantly until there is an uptick in economic activity. And for now, they are by no means preparing to ease their own lending criteria.
“We apply the three C’s of lending and risk management: we
look at the character of the borrower, check their cashflows and make sure that they have got capital and security. If they tick those three boxes we lend,” said Sim Tshabalala, chief executive of Standard Bank.
FNB chief executive Jacques Celliers said the bank is not yet calibrated to take on more risk but would continue to extend credit to its client set that does not require taking on more risk. “We are in the sweet spot category in our client base. We have got enough growth that we don’t have to look into taking more risk. We are privileged that we have got such a good customer base.”
Sim Tshabalala, chief executive of Standard Bank.
Jacques Celliers, chief executive of FNB
Based on GDP growth expectations of 1.5% and population growth of around 2%, the population is getting poorer on a per capita r real basis and so banks are not going to be “free and easy” in advancing credit in such an environment, said independent analyst Ian Cruickshanks.
“Banks want to grow. It is part of their strategy to grow but it is not a strategy of growing at all costs. There were some hard lessons learnt by the banks before the global financial crisis
and I suspect banks won’t go back to chasing market share for the sake of market share,” added van Rooyen.
According to Neelash Hansjee, a banking analyst at Old Mutual Equities, the effects of political change and improving confidence should filter through to the financial results pf banks by year-end, provided structural challenges in the economy are addressed and if there is a reduction in uncertainty, which will help corporates make firm investment decisions.
“We apply the three C’s of lending and risk management: we look at the character of the borrower, check their cashflows and make sure that they have got capital and security. If they tick those three boxes we lend,” said Sim Tshabalala, chief executive of Standard Bank.
Barclays earnings growth remains a concern as it was not driven by top line expansion.
Adrian Cloete, a portfolio manager at PSG Wealth, said banks will likely to see the effects of change in their wealth and investment management businesses first, as clients will look to invest portions of discretionary income rather than sit on cash.
Thereafter favourable amendments to regulation such as the mining charter and a commitment to structural reforms by government should lead to advances growth in the Corporate and Investment Banking divisions. Growth in Retail and Business Banking is likely to come with job creation, he said.
Until such a time, there is unlikely to be another significant run in the share prices of listed banks.
Thanks to the recent rally, shares in banks are now fair to fully valued and there is “no margin of safety in the shares anymore”, said Cloete.
Valuations of banks with significant exposure to SA
At current levels, Chimanzi said JM Busha prefers to be market neutral on banks. “If you strip out the shock events such as Nenegate that pulled back the banking index in the recent past, you would expect the Index to be trading at current levels from a technical perspective. We believe banks are at their fair values and will move sideways until earnings momentum catches up with the price momentum,” he added.
Banking shares should form a part of any well balanced long-term portfolio, but at current levels now is not
the time to start picking up shares, said Cruickshanks. According to him foreign investors, who are net buyers of domestic banking shares, are likely to remain sensitive to politics and credit ratings decisions which may affect share prices.
“In the first two and a half months of the year, there has been R46 billion in foreign inflows, of which R29 billion went to equities and R17 billion to bonds. That is massive if you consider the average is around R60 billion a year. What happens if those investors change their minds?” ■