South African Bank profits to slump as credit losses soar

South African banks' 1H20 results will confirm a slump in operating profits due to a surge in credit losses caused by the coronavirus pandemic, Fitch Ratings says.

However, the results are unlikely to trigger rating downgrades unless they are significantly worse than our expectations. We downgraded all South African banks to 'BB'/Negative in March, reflecting the likely impact of the pandemic on their operating environment and financial metrics (see here).

The sector's operating profit fell 63.3% yoy in the first five months of 2020, with loan impairment charges of ZAR37.7 billion already exceeding the 2019 full-year total (ZAR34.6 billion). The loan impairment charges, when annualised, were equivalent to 2.4% of average gross loans, compared with 1.0% for 2019, and 72% of preimpairment profit, compared with 28% for 2019.

Fitch believes South African banks are, to varying degrees, prudently recognising credit losses early, which should shield their future profitability. The 1H20 results will also show a decline in core revenue due to lower interest rates, modest loan growth, and subdued client activity, but pre-impairment operating profit will have been helped by trading gains and cost control.

Banks' IFRS 9 expected credit losses (ECL) began to increase markedly in March, on the prospect of a sharp economic contraction as the pandemic took hold. Stage 2 loans are likely to have increased significantly in 2Q20, which will push ECL higher as Stage 2 loans require banks to recognise lifetime ECL.

The ECL reported at end-1H20 will depend greatly on each bank's own view of the likely depth of the economic downturn and the shape of the recovery. Fitch forecasts that South Africa's economy will contract by 6.7% in 2020 and then grow by 3.9% in 2021.

Stage 3 loans are unlikely to have increased significantly in 2Q20 given government measures to support both the economy and borrowers during lockdown, but we expect them to increase in 2H20 as debt relief and other measures are gradually withdrawn and some segments of the economy struggle to recover.

We expect banks to operate with slightly lower capital ratios in 2020 but to maintain moderate buffers over regulatory requirements.