The majority of SA bank shares had stellar runs in 2022. Emerging relatively unscathed from the Covid-19 pandemic, they benefited from the endowment effect of steadily rising interest rates, which translated into higher loan repayments that enhanced their earnings.
That saw the JSE banks index rise 11.7% in 2022 and 17.7% on a total returns basis, which factors in dividends as well as capital appreciation of the share.
However, local analysts say the cumulative 425 basis points (bps) in rate hikes since November 2021, which has sent benchmark borrowing costs to levels last seen 14 years ago, will begin to translate into higher impairments. While local lenders have also been largely unscathed by the US banking crisis and the Swiss government-brokered merger between UBS and Credit Suisse, not everyone agrees that SA lenders are entirely insulated.
“The early warning indicators of deteriorating credit quality have started to manifest,” said Chris Steward, sector head of financials at asset manager Ninety One. “We’re somewhere near that inflection point where incremental increases in interest rates, the benefit that it brings to banks in terms of higher margins and increased endowment, is going to start to be outweighed by incremental deterioration in credit quality.”
One of the first local banks to exhibit credit-related symptoms due to the higher rates environment is Absa, the second-best performing bank stock in 2022 thanks to a 27.11% rally. Only niche lender Investec outperformed it with a 31.1% rally in 2022. On the other end of the spectrum, Capitec was the only SA bank stock to fall last year with an 8.2% drop, perhaps reflecting the market’s concern about the effect of higher rates on lower-income consumers.
Credit impairments
While Absa’s headline earnings rose by double digits in the year to end-December 2022, its credit impairments jumped 61% to R13.7bn. While at least R2.7bn of that was due to losses on Ghana’s sovereign bonds, SA retail credit impairments increased across all loan categories, with writedowns on personal loans rising the fastest at 49%.
Standard Bank was also affected by rising impairments despite delivering record earnings in the year to end-December, which resulted in the highest dividend in its 161-year history. Africa’s largest lender by assets booked a 22% rise in credit impairment charges in 2022 at R12.1bn, of which about R900m related to Ghana’s sovereign debt issues.
That’s probably why Standard Bank’s share price has remained virtually flat so far this year, despite an almost 20% rally in 2022.
Even staid Nedbank saw a 28% rise in 2022 impairments in its retail and business banking franchise, which climbed to R6.61bn, though this was countered by a 43% drop in impairments in its corporate and investment banking unit, which took a comparatively modest hit of R805m.
If the economy is in the doldrums the financial performance of the banks will weaken from this point.
— Rashaad Tayob, a portfolio manager at Foord Asset Management
But with SA’s economy flirting with recession there’s a strong likelihood that impairments could worsen. Load-shedding caused GDP to contract 1.3% in the fourth quarter, while both the Reserve Bank and Fitch Ratings are forecasting just 0.2% growth in the economy in 2023.
“If the economy is in the doldrums the financial performance of the banks will weaken from this point,” said Rashaad Tayob, a portfolio manager at Foord Asset Management. “If the economy continues to dwindle then it’s inevitable that impairments will be a problem.”
Tayob is one of the few SA analysts who believe local investors should pay closer attention to the issues that led to the collapse of Silicon Valley Bank (SVB) and Signature Bank in the US. While Tayob accepts that SA banks are “reasonably well capitalised” and have solid risk management frameworks, he warns that a severe shock to the financial system could have downstream implications.
Chief among his concerns is the cumulative R157bn in subordinated debt instruments that has been issued by local banks (see graphic). These debt instruments are issued to help maintain healthy capital ratios, since these subdebt instruments can help buffer a lender’s capital stack without diluting shareholders.
Standard Bank has nearly R40bn in subordinated debt outstanding, while both Absa and FirstRand are at around the R33bn mark. Tayob argues that the speed with which SA’s benchmark rates have gone from just 3.5% in November 2021 to 7.75% now could expose hidden vulnerabilities in the local banking sector, particularly if there is a sudden shock such as a grid collapse or a spike in political risk that results in severe financial market volatility.
“Investors in their chase for yield, especially in SA, have been buying these subordinated debt instruments over the past 10 years or so [and] are ignoring the fact that they can be written down, because they’re attracted by the yield,” says Tayob. “What you’ve seen recently with the banking crisis in the US with SVB, and then Credit Suisse as well ... the subordinated debt got written off and investors lost all their capital.”
As the name suggests, subordinated debt is paid off only after other creditors have been repaid in the event of a bank collapse. However, Tayob says that under Basel III subordinated debt can be written off entirely if regulators find themselves having to bail out a bank.
“I don’t think fixed-income investors have really taken proper cognisance of the fact that these are writedown instruments and you can lose the full amount of capital,” he says. “You’re sitting with an instrument which can go down 100%, and I think investors are not really fully aware of that.”
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