Debt provisions slash banks’ earnings
Results marred by need to cover default risks due to lockdown
● It seemed like a bloodbath. Standard Bank’s first-half headline earnings fell 44%; Absa’s declined 82%; Nedbank’s were down 69%. Yet surprisingly, perhaps, all three emphasised their resilience and profitability — and in many ways that was true.
A lockdown that was one of the world’s toughest hit their transaction volumes and fee income, while sharp cuts in interest rates hit their interest income — and with the economy in shock and more than 80% of staff working from home, the business of banking was far from normal.
Yet Absa and Standard increased their operating profits by 9% and 4% respectively for the six months to end-June, before taking bad debt provisions into account, while Nedbank’s were down only slightly.
But it was those bad debt provisions that were the story of this results season. And with the different banks taking somewhat different views on the future, the market will be watching closely over the next few seasons whether they will prove to have been too optimistic — or too pessimistic.
Banks have always had to set aside provisions to cover themselves for loans that are at risk of default, and there’s always been a good measure of judgment involved.
What’s different now, though, is a newish accounting standard that requires them explicitly to take a subjective view on the future. They must set aside provisions for expected bad debts over the life of the loans they’ve made, depending on how they see the macroeconomic outlook and future job losses, and how they anticipate these will affect their customers and hence their loan books. This is over and above provisions based on specific loans that look in danger of default.
At virtual investor presentations and media briefings, much was heard about the “judgmental overlay” by management that is now required, which in the case of the three banks that have reported so far has accounted for as much as a third of total bad debt charges. And what bankers will admit behind the (virtual) scenes is that this basically means they have to take a guess at the future — in an environment so unprecedented and uncertain that economic forecasting itself requires plenty of guesswork.
Standard, Absa and Nedbank all hiked their bad debt provisions — or so-called credit impairment charges — by eye-watering amounts, which slashed their earnings. The increases were steepest in personal and business banking divisions, in areas such as mortgage loans to households, and the portfolio mix of loans at each bank will have influenced the process.
But whereas Standard and Nedbank more than doubled their charges, Absa more than trebled its charges. Standard lifted its credit loss ratio to 169 basis points from 76 points a year ago and Nedbank’s ratio went from 70 to 194 basis points, well above the peak during the global financial crisis. But Absa took its credit loss ratio to a much higher 277 basis points, from 79 a year ago.
So is Absa more pessimistic about the economic outlook — or more realistic? Does it have more reason than its rivals to worry about the quality of its loan book, or is it simply being ultra-cautious?
The thing about banks is that if the debts they expect to go bad don’t end up that way, the charges they have deducted now from their income statements can be brought back later, boosting profits in future years.
But if there might be a temptation to “kitchen sink” provisions now, Absa’s new CEO Daniel Mminele said there was none of that. “I am very comfortable about the discipline and governance that informed what we decided in our credit impairment committee to arrive at robust numbers, and we have been transparent about the scenarios we used,” he said in an interview.
Analysts speculate that Absa, prior to Mminele’s arrival, may have written a lot of new business too cheaply, in a bid to regain market share, and that loan books in some of its African operations — especially those in tourism-oriented countries — may also have been hit hard by the Covid crisis. Whereas Standard’s African operations in 20 countries came to its rescue, lifting headline earnings by 11% while the South African operation’s earnings fell by 72%, at Absa the Africa region showed strong revenue growth but had to hike impairments fivefold, with earnings down 67%.
In Nedbank’s case, analysts are concerned the bank may have under-provided against its sizeable commercial property portfolio, though outgoing CFO Raisibe Morathi said in an interview that portfolio is “very strongly collateralised” with a loan-tovalue ratio of just 48%.
Generally speaking, said Anchor portfolio manager Stephan Engelbrecht, if he had to choose he would much rather be in a bank that had over-provided than one that underprovided. The test would come with whether and how fast the banks can start reducing bad debt charges in the second half of the year. “I don’t think any one of them did not raise enough provisions, but the question is how sticky the provisions will be.”
A critical question is how customers will behave once the extensive debt relief the banks have provided for their individual and business and corporate customers during the lockdown starts coming to an end. The numbers of customers run into the hundreds of thousands and the size of the loan books on which relief was granted into the hundreds of billions of rands.
And all the banks cite the debt relief they had already provided voluntarily since March as a key reason the take-up of the government-backed business loan scheme, launched in May, has been so slow.
With the immediate crisis now subsiding, banks are reviewing their strategies for a very different world. Absa’s focus has shifted from growth to protecting its balance sheet, Mminele said, but he will be taking proposals to the board on a strategy for the group that is more digital and entrepreneurial.
At Standard, CEO Sim Tshabalala will be looking for opportunities for further expansion on the continent. Nedbank will be looking for opportunities to create new streams of revenue and enhance operations.
All the banks have seen a much quicker than expected jump in digital banking and digital will be key.
But as Nedbank CEO Mike Brown said, “forecast risk in this environment is high”. And after a horror first half, the banks will be waiting to see how the second half plays out.
I don’t think any did not raise enough provisions, but the question is, how sticky the provisions will be
Stephan Engelbrecht
Anchor portfolio manager