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NTANDO THUKWANA: We look at South Africa’s banking sector now. With the economy so battered and consumers feeling the pinch from the higher interest rates, the environment is quite ripe for consumers to turn to credit to make ends meet. But despite banks earning more from interest some of their share prices have not done so well.
I have Craig Metherell, a banking sector analyst from Denker Capital, with us. Craig, the banks have largely underperformed the JSE Benchmark Index over the past year, despite earning more from interest. What are some of the reasons behind those share price movements?
CRAIG METHERELL: Hi, Ntando, thanks for having me on the call and good evening to everyone. Yes, you are correct. The banks have underperformed over the past 12 months. I think we must remember that the last 12 months have been dominated by sizeable exposures in the index, the likes of Prosus/Naspers and some of the other rand hedges, Richemont, Anheuser-Busch and a lot of the resource stocks, especially gold. I think the important thing to remember is that markets look forward, so the expectations of higher interest rates would have already been priced in long before the last 12 months if we look at those performance numbers.
If you extend your period over two years, the banks have actually significantly outperformed. The JSE is up 17% over the last year – that’s on a price basis, and the banks are only marginally up over the last 12 months. But if you extend that beyond two years, it’s a different picture. So markets looked forward obviously post-Covid, with interest rates expected to rise and obviously very strong buffers from the provisions raised during Covid. They then started reporting very healthy numbers.
That has obviously changed somewhat, especially as we’ve seen some of the other stocks rebound quite strongly in the last 12 months, outside of the banking sector for various reasons, whether it be the gold price rally driving some of those gold counters or some of the things – even Naspers and Prosus – China reopening also helping there.
So it’s important to remember that looking forward now I think with higher interest rates starting to constrain customers, you’re going to have concerns around credit losses rising. Obviously the banks – Absa in particular – have had issues around Ghanaian exposure. And then I think you must also just throw in the global contagion around banks. We are largely immune to what’s going on in the US banking sector, for example, but I think sentiment towards banks may have been dented a little bit because of that.
NTANDO THUKWANA: Sure. And how long do the banks stand to continue benefiting from these high interest rates? When do we start seeing signs of a distressed consumer filtering through their results and maybe their share-price performances?
CRAIG METHERELL: Look, I think you could argue that you’re already starting to see some of those stresses coming through just on the consumer side. Already in the full year results of some of the banks they were at least guiding for credit loss ratios to be towards the higher end of their through-the-cycle target ranges. Capitec [has been] the most recent to report, certainly showing signs of that stress coming through.
Now, the hedge against rising credit costs is obviously higher interest rates. So the benefit you get from call it the endowment effect from high interest rates and what that does to net interest income growth does offset the risk of rising credit losses.
If you take, say, Nedbank for example, they disclose a figure of net interest income sensitivity of a R1.6 billion gain for every 1% move in interest rates. Now the point that one must consider is that it takes time for, call it, the front book, or new credit to kind of roll through the balance sheet, and obviously the full benefits of higher interest rates to be derived from that newer credit that has been written. So the term is ‘front book versus back book,’ and as the back book at low interest rates rolls off, you get the benefit of the front book at these higher interest rates.
So again, on Nedbank in Q4 last year you saw an almost 20 basis-point rise in their net interest margin, which had largely been flat in the three quarters leading up to Q4. Those are the figures they disclosed. And they’re certainly guiding for that strong net interest income growth to run further into 2023. The 50 basis-point hike [in March] was a surprise … So you’ll see a little further benefit there throughout 2023. But certainly the environment does look tough for the consumer.
To your first question around share price performance, I think the market’s looking forward and saying that despite the higher interest rates we are concerned around asset quality and rising provisions.
NTANDO THUKWANA: Yes. Unfortunately I’m going to single out Capitec. They’ve had such a terrible time and in fact have posted a huge reversal from their performance a couple of years ago. They’ve shed almost 20% of their value over a year. Why is it that they have posted such significant losses?
CRAIG METHERELL: Let’s just be clear that the losses are on the share price and not in the income statement. They’ve still reported some decent numbers. In their latest results they showed headline earnings growth of 15%, and the franchise looks strong. Client numbers are growing, still in double digits. I think that is 11% up. So the results aren’t disappointing. It’s just, again to that point around expectations and given the high multiple that it’s been trading at over time. And when I refer to high multiple points, if you look at it from a price-to-book or price-to-tangible-book point of view, even a price-to-earnings ratio, it’s been richly valued compared to its peers because it has come in and attacked the incumbents and it has gone into spaces that some of the incumbent banks have not been willing to tread. That has obviously yielded very, very promising growth over the years, and is largely justifying its higher rating.
In the last couple of reporting periods this growth seems to have moderated somewhat. I think there are some questions around the sustainability of that. Even in the H1 results last year there was evidence of perhaps fee growth slowing, and it has been a very rich fee generating business. Credit growth has started to slow because of the tough environment that we’ve already chatted about … and I think there’s some questions around the rollout of the business bank. Obviously lots to do there. It has taken some time; they’ve gone through the rebrand. Opex [operating expenses] growth has been relatively high as a result and I just think that the market is now kind of saying, ‘Wait, hang on, maybe the 20% earnings growth in the past is unsustainable, and we need to reassess’ – and therefore the stock has derated.
NTANDO THUKWANA: And how have the likes of Investec, Standard Bank and Absa managed to buck the trend? They operate in the same environment as Capitec, albeit serving a different type of customer. But I look at the share price of Investec over a year and it’s up over 34%. What are some of the reasons that they’ve been able to move in the opposite direction to some of their peers who are lagging behind them?
CRAIG METHERELL: I think you’ve got to focus on the starting points. Capitec’s starting point was very strong, very positive, lots of momentum behind it. Investec and Absa as well, and even Standard Bank to an extent. But just to talk about Investec and Absa, I don’t want to say they were in a turnaround phase. There are slightly different scenarios.
Absa’s separation from Barclays meant that the shackles were released, so to speak. They could really focus on what they wanted to do in South Africa and pursue growth that they weren’t able to do under the Barclays venture that they were a part of. Separating from that has certainly yielded very positive results. They did benefit from their hedge in place that drove strong pre-provision operating profits as interest rates declined. And then, given the turnaround and [being] able to sustain that strong growth, that was reflected in the share price.
Investec has been through a couple of issues in the past – some trading losses and some poor performances here and there, obviously also with the stake in Ninety One. With the unbundling of that there’s been a lot going on and the management team have been very, very focused under Fani Titi. They use the words of ‘focused’, ‘disciplined’ and are really trying to create shareholder value through whatever means they can. They talk about their capital generation plans and so on, and they’ve turned around the performance of the business – both in the UK and in South Africa.
Obviously, the latest announcement would be the decision to sell the wealth business to Rathbones and there they’re trying to unlock value as well. So you’ve seen return on tangible equity go from 7% to 12%, and they target a return on equity of between 12% and 16%. They’ve started to reap the benefits of that disciplined and focused approach of theirs. That’s driven the rerating and the share price from what were quite significant lows, which is why you’ve seen the share price performance that you’ve seen.
NTANDO THUKWANA: Sure. You mentioned the Ghanaian debt crisis as being a challenge for someone like Absa. But there have been some concerns on the African continent for banks, and I wonder what your top concerns are for banks exposed in the African region? There’s a war in Sudan which is also a point of concern.
CRAIG METHERELL: I think the concern that we have in Africa, broadly speaking, is just around the repatriation of money out of these markets. That has been a concern for a number of years. It’s not only the banks that are exposed to this problem, but it’s certainly something that we are very mindful of, and it is something that we take into account and give careful consideration to.
If you think of the two banks with the largest exposures, Absa and Standard Bank, Standard Bank, certainly from an earnings point of view, is the most exposed to Africa. But arguably Absa has been the most exposed to some of the issues in Ghana.
You can see some risks rising in Kenya. There have even been various discussions around the African continent countries, and discussions with the IMF around restructuring government debt and so on. That’s obviously a massive concern. It does constrain growth; it leads to currency depreciation. It affects your operating expenditures. You kind of look at your weighted average inflation across the group [and] it’s something that Standard Bank is acutely exposed to, given its broader exposure to Africa. That’s something that we also closely watch because it can create headwinds at times. You could argue that Standard Bank and the Q1 result benefited from a weaker rand, given the translation effects there. But, all in all, when you look at some of the debt situations of these countries and the challenges they face, the official currencies that you see equated on whatever information source you use [are] not a fair reflection of what’s actually happening on the ground, when you look at maybe what’s happening on the parallel markets or the black markets, to use that term.
Those are some of the concerns we have.
NTANDO THUKWANA: Any more concerns for the industry as a whole, not specific to Africa, but just generally? Also, do you maybe see any other opportunities that the banks should be looking at, at the moment?
CRAIG METHERELL: I think we’ve touched on some of the concerns. We certainly are aware of the pain that the consumer is facing. South Africa is really constrained at the moment if you factor in all the risks around load shedding as we head into a deeper winter period, and what that’s going to mean for growth. It certainly is going to have knock-on effects.
The retailers have been under pressure. All these factors culminate in making it a difficult environment for growth and the banking sector is very closely correlated to the macroeconomic state of a country.
So obviously, South Africa not being in a great position right now does mean rising risks to that outlook, and that constrains opportunities for the banks. We still think the banks are doing a great job. They’re all led by very capable management teams who are highly regarded and are focused on generating shareholder value. You could touch on Nedbank, for example, with its capital optimisation plan. These are some of the things that maybe from a shareholder’s point of view we like, because when the banks are undervalued and they’re sitting on high levels of capital it’s a good way to optimise things. It also kind of does improve RoEs [returns on equity], although artificially, so to speak.
But from an opportunity set point of view in terms of growth it is hard. I think that is reflected in valuations at the moment, and it’s not necessarily doom and gloom because over time the banks have generated very, very attractive returns. The way we like to speak is [of] ‘returns on capital above the cost of capital’. And that through the cycle is something that South African banks generally do, and that certainly makes us very interested in what’s happening at the moment. But we are mindful of the operating environment being tough.
NTANDO THUKWANA: Sure. Thank you very much, Craig, for your time and your insights. That was Craig Metherell, a banking analyst at Denker Capital.
