SA bank shares have been among the favoured stock picks of local fund managers for much of the past year, but many argue that local lenders still offer good investment value, despite a rapidly darkening global and local economic backdrop.
With local interest rates tracking global borrowing costs higher, SA bank stocks are expected to benefit as the endowment effect induced by tighter monetary policy enables them to earn higher revenues from their loan books. However, the question is whether banks can continue to grow earnings — both from interest income and other sources — faster than their costs in an environment where rising food prices are stoking inflation-driven growth fears.
The worsening global economic backdrop, which has a direct impact on an SA economy battered by everything from Covid-19 to floods, riots and load-shedding, doesn’t bode well for banks’ retail and corporate clients. While investors tend to argue that one should look through short-term market “noise”, the longer-term outlook for SA bank stocks looks somewhat murky, despite recent earnings guidance suggesting investors can expect solid earnings when lenders start reporting results in coming months.
“In the short to medium term, we expect most banks to continue to benefit from the positive endowment effect, but at some point the economics catch up with you as inflation starts to eat into consumers’ disposable income,” said Craig Pheiffer, chief investment strategist at Sasfin. “For at least the remainder of this year, that positive endowment effect will outweigh the negative economics at play, but longer term, people’s appetite for credit will dissipate as businesses and households hunker down in the slower growth environment.”
Nevertheless, analysts are expecting banks’ balance sheets to show reasonable asset growth, which had benefited over the last two years as consumers took advantage of rate cuts in the wake of Covid-19’s initial onset to stock up on mortgage and asset finance. With rates now rising, the endowment impact of those interest-earning loans will boost banks’ net interest income, which typically accounts for about half their revenue.
In the short to medium term, we expect most banks to continue to benefit from the positive endowment effect, but at some point the economics catch up with you as inflation starts to eat disposable income.
— Craig Pheiffer, chief investment strategist at Sasfin
On the non-interest revenue side, transactional and fee income should continue to normalise in line with the post-pandemic recovery in economic activity. Nevertheless, the weak economic climate is likely to act as a drag on investment banking fees as mergers and acquisitions and other corporate investment remains somewhat muted.
Income from banks’ financial markets trading units will likely benefit from the market volatility in the first half of 2022, despite coming off a strong base in 2021. Insurance income is expected to continue to normalise, thanks to reduced mortality claims from Covid-19, a factor that will easily counteract any negative impacts from the recent KwaZulu-Natal flooding, given that banks have far larger exposure to life cover than to property and casualty insurance.
All of these positives underscore why most investors still see SA banks offering good value. Peter Armitage, CEO of Anchor Capital, says he’s pencilling in a 15% return on local bank stocks for each of the next two 12-month cycles, based on an internal rate-of-return (IRR) calculation using banks’ current share prices.
“With dividend yields of 7% to 9%, you only need capital growth of about 7% to get the 15% return,” he said. “Increasing interest rates are good for bank earnings — this is good unless rates go up too much, which results in higher credit provisions.”
Chris Steward, financials sector head at global asset manager Ninety One, also feels SA banks’ shares are “looking fairly cheap on a price-earnings and dividend yields basis.”
Yet Steward does have some concerns about local banks’ ability to manage costs as staff incentives edge upwards in line with improved earnings and ongoing inflationary pressures. While banks’ credit quality is generally still sound and balance sheet provisions ample relative to history, there are some worries that impairment charges could pick up if stagflation — the dreaded combination of low growth and high inflation — takes hold.
“There’s still reasonable value in the banks given expectations of good earnings growth this year and modest earnings growth next year,” said Steward. “What would change the picture, would be if inflation becomes a significantly bigger problem than the market expects, requiring a more draconian policy response from central banks.”
A bank-by-bank analysis
1) FIRSTRAND
Expected reporting date: September 15 2022
Reporting period: the year to end-June 2022
FirstRand, the largest banking group in SA, is somewhat of out of step with its peers as it is the only lender set to report full-year results in the current reporting cycle. But with an underlying portfolio that spans retail lending (FNB and WesBank); corporate-and-investment banking (RMB); asset management (Ashburton) and UK exposure (Aldermore and MotoNovo), it is undisputedly SA’s premier blue-chip banking stock.
The group said in June that it sees headline earnings per share (heps) rising 20% to 576.6c supported by credit uptake in both its retail and commercial segments. Radebe Sipamla, an investment analyst at Mergence Investment Managers, says he expects the group’s net interest income (NII) and revenue to come in quite strongly, while insurance income will bounce back as Covid-19 provisions unwind further. The group’s FNB-driven retail footprint will also continue to support its typically strong return on equity (ROE).
2) STANDARD BANK
Expected reporting date: August 19 2022
Reporting period: half-year to end-June 2022
Standard Bank is arguably SA’s most-complex banking group due to its Africa-wide footprint, which necessitates navigating a range of regulatory regimes. That makes steering the “Big Blue” quite a challenge for a management team that has also been grappling with systems outages and union challenges for a series of staff dismissals.
Sipamla says he feels Standard Bank’s loan growth has been “softer” than he expected, but expects non-interest revenue to surprise on the upside thanks to the group’s strong global markets business, which is engaged in financial markets trading. The corporate-and-investment banking franchise is also a reliable fee generator, but questions remain on Standard Bank’s retail banking business, which faces increasingly savvy competition.
“The problem for Standard Bank is on their retail banking business, which they need to sort out, because it has a big impact on ROE,” says Sipamla.
Analysts will also be watching Standard Bank’s results to get a sense of how the integration of insurance group Liberty is going and how that might impact on future revenue.
3) CAPITEC
Expected reporting date: September 29 2022
Reporting period: half-year to end-August 2022
With 18.1-million customers and counting, it is only a matter of time before Capitec permanently supplants Standard Bank as SA’s second-biggest lender by market value. While it has achieved that already for short spurts, it hasn’t managed to hold on to second place for long. But with Capitec quietly expanding into business banking and adding new product lines beyond its traditional reliance on unsecured lending, it seems fait accompli that the mass-market lender will soon take up a permanent position behind FirstRand in the local banking pecking order.
One thing Sipamla likes about Capitec is its ability to leverage its very strong data capabilities to adjust its credit extension in response to observed fluctuations in underlying economic activity. He also sees Capitec’s gradual move away from extending short-term loans of between one and six months in favour of longer-dated credit via the access facility as a positive that helps lower the group’s risk profile.
Interestingly, Sipamla says rising borrowing won’t impact Capitec as much as one might expect, as the interest rates on a significant portion of its loan book are fixed. He also sees lower mortalities benefiting their funeral insurance earnings, which he expects will deliver about 30% profit growth.
4) ABSA
Expected reporting date: August 15 2022
Reporting period: half-year to end-June 2022
Absa has been rather internally focused in recent years due to its protracted Barclays separation and subsequent brand and strategy refresh. It’s also been rocked by a series of executive dramas of which the departure of former CEO Daniel Mminele was the most severe. But with much of that behind Absa, its newly appointed CEO Arrie Rautenbach will be more outwardly focused on expanding Absa’s market share, which took a knock during the Barclays years.
Always a dominant player in the local retail-banking market, Absa will need to decide whether it’s willing to invest heavily to develop its capabilities in the rest of Africa, which span both retail and corporate-and-investment banking. To achieve that, Sipamla says Absa will have to either invest heavily in its physical presence or ramp up digitisation.
“But even then they face stiff competition, especially in East Africa where MPesa is so dominant,” says Sipamla.
5) NEDBANK
Expected reporting date: August 10 2022
Reporting period: half-year to end-June 2022
Nedbank is somewhat unique among local banks in that its corporate-and-investment banking accounts for about half its earnings, a factor that could pose a challenge in an economic climate where corporates are reluctant to invest. That’s probably why Nedbank has said it is specifically targeting corporates looking to invest in their own electricity sources via the 100MW embedded power-generation allowance.
While Nedbank has significant property exposure, Sipamla says it is mostly very high quality, which will keep its credit loss ratios on the real estate book in check, despite the post-pandemic troubles faced by the sector. While the bank is making steady progress on rebuilding its retail-banking market share, it is doing so at a time of increasing competition.
“On the retail front, Nedbank probably doesn’t get as much credit as it should, but it’s still a comparatively smaller part of the business and faces a lot of competition from the likes of Capitec and FNB,” says Sipamla.
6) INVESTEC
Expected reporting date: November 17 2022
Reporting period: six-months to end-September 2022
The specialist banker of SA’s well-heeled has been investing heavily in its UK operations for a number of years with mixed results. But with the unwinding of its Ninety One stake and the rationalisation of its local private-equity business, Investec will have abundant capital to plot further UK expansion and ongoing enhancement of its SA offering.
“Investec has invested a lot in its UK business and that is starting to pay off — they’re picking up clients and their wealth-and-investment business there continues to grow,” says Sipamla. “It’s going to take them time to scale that up, but they’re making good progress. I think Investec is going to surprise people.”
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