Head­winds ahead

The macro econ­omy is key to fu­ture growth

Finweek English Edition - - INSIGHT - BRUCE WHIT­FIELD brucew@fin­media24.com

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.


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