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South Africa’s “Big Four” banks – FirstRand, Standard Bank, Barclays Africa and Nedbank – have shown surprising resilience in a tough economic environment, which has been exacerbated by immense political pressure over the closure of the politically connect Gupta family’s bank accounts, the uncertainty over finance minister Pravin Gordhan’s job, and the constant risk of a sovereign credit rating downgrade to junk.
Despite the challenges, most of the banks have recovered lost ground over the past year, and share prices are trading again near (or in the case of Nedbank, in excess) of five-year highs reached early in 2015. Over the past 12 months, Nedbank has returned 47% to shareholders; Standard Bank 25.57%; FirstRand 16.2% and Barclays Africa 13.9%, according to Bloomberg.
Restructuring plans at Old Mutual, the major shareholder in Nedbank, have benefitted the bank’s share price, while Barclays Africa has seen its share performance dampened in part by plans by its majority owner, Barclays plc, to exit its stake in the business to comply with regulatory requirements. Capitec and Investec – two niche competitors in the sector and therefore not directly comparable to the Big Four – saw their share prices return 40.8% and -11.9% respectively over the past year.
Banks’ performance is generally closely tied to the state of the economy. Over the long term, each 1% rise in GDP in SA sees a 5% rise in bank headline earnings, says Andy Bates, Financial Services Africa leader at EY. In 2016, SA’s six biggest banks (the Big Four, as well as Capitec and Investec) managed to grow headline earnings by 6.6%, compared with GDP growth of only 0.3%. However, the combined headline earnings growth was the lowest since 2009, and was significantly lower than the 16.5% achieved in 2015, according to EY.
Challenges on the continent
The decline in headline earnings growth is partly due to increased operating costs and a muted performance by operations in the rest of Africa, EY said. Operations outside SA have been hurt by low commodity prices, foreign exchange volatility and political uncertainty, PwC said in its major banks analysis.
These operations accounted for about 13.5% of combined headline earnings of the Big Four banks in the second half of 2016, down from 15.7% the previous year, PwC said.
While the exposure of local banks to growing African markets positions it well to leverage the continent’s growing need for banking services, disappointing economic conditions in several African countries in 2016 obstructed banks’ ability to lend profitably last year.
In Kenya, the introduction of interest rate caps saw reduced lending in the country, while struggling commodity prices dampened lending appetite in several nations with large quantities of natural resources, including oil-rich Nigeria.
Out of the woods?
Observing that 2016 saw the banking sector recovering from the “crisis” valuation levels of the prior 12 months, Old Mutual Equities banking analyst Neelash Hansjee says the sector’s resilience over the past year was largely the result of an improving political landscape and the avoidance of a downgrade of SA’s sovereign credit rating by agencies. (Banks cannot have a higher credit rating than the country where they are based, and a downgrade to sub-investment grade will have a negative impact on a country’s financial markets and the cost of borrowing.)
“While economic conditions remain tough, this reflects an improving trend for 2017 from the 2016 trough, which is supportive for the banking sector. The recent banking reporting showed that companies and consumers are holding up well in challenging times. Bad debts remain contained, and in some cases are improving, as a result of a proactive stance by the banks,” she tells finweek.
Results drivers
Typically, banks derive revenue from two main sources: net interest income, which is boosted by higher interest rates; and non-interest revenue, such as fees, commissions and trading revenues.
The size and quality of a bank’s loan book is therefore seen as a key driver of its financial performance, with analysts keeping a close eye on credit impairment charges and the total credit loss ratio (the total credit impairments as a percentage of the gross loan book). Other key areas to watch are operating expenses, particularly the cost-to-income ratio, and the bank’s capital position, which is regulated to ensure the stability of the banking sector.
Banks typically report the common equity tier 1 ratio, which measures a bank’s core equity capital compared with its total risk-weighted assets. The ratio offers an indication of how well a bank can withstand financial stress and remain solvent, with a minimum ratio of 7% generally indicating a well-capitalised bank, according to Investopedia.com.
Looking at the Big Four, net interest revenue increased by 9.9% year-on-year to R86.7bn in the second half of 2016, according to PwC, as banks benefitted from a noticeable interest margin hike across all banks. The South African Reserve Bank increased rates by 75 basis points in the first half of 2016.
Despite lending risks and an inclination by the industry to retain modest banking fees, non-interest income remained strong over the year, with the non-interest income of the country’s Big Four rising 0.9% to R65.66bn in the second half of 2016. (See the sidebar for a breakdown of the Big Four’s individual performance.)
This is in line with less credit granted, fewer new transactional customers and slowing corporate demand for credit. Total impairments increased by 0.1% year-on-year from the second half of 2015 to nearly R13.4bn in the second half of 2016, substantially below the R17.2bn impaired in the first half of last year.
According to EY Africa Knowledge leader Graham Thompson, SA banks’ restraint in extending loans is a feature likely to remain throughout 2017, along with less favourable lending terms.
“Banks have been re-pricing product portfolios for a while now. A good example is home loans, which have moved from a lending rate of prime minus two to around prime. Banks are more selective in the loans they grant, and price for risk,” he comments.
The corporate comeback
Banking profits, meanwhile, remain evenly diversified between the retail and corporate segments, with corporate and investment banking (CIB) exceeding that of retail and business banking (RBB) for the first time since the global financial crisis.
CIB increased its share of overall earnings from 31.1% in 2015 to 33.7% in 2016, while wealth’s contribution to total earnings fell to R6.6bn as a result of lower demand for life insurance products and weaker stock markets.
“The increase in CIB’s contribution indicates that corporate clients are busier and more confident,” says Bates, adding that contribution from the greater Africa region declined from 2015 on the back of weak economic conditions in West Africa and interest rate caps in Kenya.
Transactional banking earnings increased by a modest 0.1%, denoting that fewer people are opening new accounts, while earnings from card lending narrowed by 2% to R4.9bn – an expected downturn in the midst of a tough retail and consumer environment.
Nothing comes free
While banks managed cost pressures well in 2016, Bates cautions that information technology (IT) and amortisation charges will continue to rise rapidly and will account for a large and rising share of overall expenses.
Spend on IT grew 18.2% year-on-year to R19.9bn, while depreciation and amortisation shot up by 20.7% to R8.3bn.
“Banks are increasingly looking at investment in robotics, financial (fintech) and robotic automation, which will one day see the automation of manual banking processes currently undertaken by staff. Robotics may change the cost trajectory over the medium term, but an upfront expense will be required,” he says.
Outlook
An improved global and regional growth outlook – sub-Saharan Africa’s GDP growth is estimated at 2.8% this year, thanks to improved global trade, higher commodity prices and improved rainfall in a number of countries – is likely to have a positive impact on banks’ performance this year. In SA, the Reserve Bank is forecasting GDP growth of 1.1% this year, while Nigeria’s economy is also expected to return to positive growth.
However, key risks remain, including policy uncertainty in the US, the outcome of Brexit negotiations and the future of the EU. In SA, key risks include the possibility of a ratings downgrade in June, while stable interest rates will likely continue to “constrain household consumption and fixed investment”, Standard Bank warned.
This is a shortened version of the cover story that originally appeared in the 30 March edition of finweek. Buy and download the magazine here.
