The macro economy is key to future growth
ONE OF THE BASICS when it comes to investing is that markets traditionally love low interest rates. Access to cheap capital encourages borrowing and the growth generated through that process leads to economic expansion and the ability of borrowers to make good on their debt obligations. Theoretically, bank shares run hard when interest rates are low. Clients are more inclined to borrow and also retain the ability to repay their debts in good times. Popular wisdom has it that it’s usually a good time to sell banks when the interest rate cycle perks up.
The precipitous drop in the SA Reserve Bank’s repo rate from 12% in 2008 to 5,5% was as speedy as it was dramatic and seriously hurt endowment income – the interest banks earn on their own capital. The decline in prime lending rates to more than 40-year lows – from 15,5% to 9% – should also have led to a kick-start in loan growth.
But despite the lowest interest rates for more than four decades, South Africans remain heavily indebted, with the average household debt to disposable income ratio being 78%. Those who can afford it are taking advantage of lower debt servicing costs to pay down their liabilities rather than taking on new credit. However, most South Africans find themselves constrained by the National Credit Act’s onerous affordability rules and are prevented by law from borrowing more – even if they want to.
While that’s been good for banks – in that it’s helped them unwind their considerable bad debt books and bring defaults closer to historical norms from their 2008/2009 highs – the reality is loan books have been shrinking in real terms rather than expanding, which is bad news for future earnings prospects.
Growth from lending is stuttering, interest owed on outstanding debt shrinking and endowment income has fallen in a heap. For every 50 basis point move in rates it translates into billions in interest revenue throughout the banking sector.
While low rates are usually good news for banks over the long term, analysts have been pinning their hopes on a turnaround in fortunes on a number of factors: a recovery in loans growth, an improvement in bad debts, higher endowment income and greater cost containment. For example, analysts have been hoping for a modest uptick in interest rates. Nothing so dramatic as to halt the bad debt unwind, but in the absence of any other profit drivers enough to have a positive endowment effect.
If recent Reserve Bank comments are anything to go by, lower rates are likely to be around for longer. “One can’t really see any increase in rates until there’s a recovery in borrowing,” says Stanlib chief investment officer Andrew Vintcent, who adds investors will also be looking at the respective banks’ impairment positions, their ability to contain costs and whether there are signs credit growth is imminent when banks report results to end-June over the next few weeks.
As far as cost cutting goes, Standard Bank has been the only one of SA’s Big Four to actively disclose how it’s trimming down through the sale of assets, such has Russia’s Troika Dialog and cutting back on staff while keeping a check on executive salaries and bonuses as it strives for zero cost growth in 2011.
“The wild card in those results will be how successfully the various investment banking divisions have conducted their trading activities. RMB has done a number of deals this year that should boost FirstRand, and Standard Bank’s traders have been effective over recent years in generating income where other divisions have struggled,” says Vintcent.
“The interesting upside for patient investors is that if we don’t see an uptick in loan growth then there will be an excess capital build up, which could either come back to investors in the form of special dividends or even a reduction in dividend cover.”
Investors waiting for banks’ results to June need to ascertain four key factors: costs, loan growth, the bad debt unwind and the likelihood of a modest increase in rates to drive the endowment effect.
“Patience will be rewarded,” says Vintcent.