Stephen Gunnion
9 January 2009
Johannesburg — BANKS are in for another bumpy ride this year, as bad debts brought on by high interest rates over the past couple of years and a difficult trading environment erode their profits.
However, as interest rates and inflation ease, the tide should turn in favour of banks and this may reflect in their share prices.
Trading updates from SA's large banks -- released late last year -- reveal that profits are under pressure due to the deterioration in the macroeconomic environment and worsening credit conditions. This has led to higher impairment charges, particularly in home loans and vehicle financing.
However, despite the economic gloom that was sparked by the subprime market in the US and quickly spread to the financial sector, South African banks have fared relatively well, with little of the fallout that has brought a number of global financial giants to their knees. And while their share prices have taken a beating along with the rest of the market, the JSE's banking sector still outperformed the overall market last year, falling 15% compared to the all share's 26% drop.
Neville Chester, senior portfolio manager at Coronation Fund Managers, says the share prices of the four large banks do not reflect the full extent of interest rate cuts that are expected this year.
"If you compare their performance to other interest rate- sensitive shares such as clothing retailers, they have underperformed," Chester says.
"That' s partly due to poor sentiment about banking globally."
The scale of rate cuts this year -- and whether the Reserve Bank reduces the rate of borrowing gradually or surprises with a large cut -- will help to determine sentiment towards banking shares, Chester says. Global sentiment towards banks will also help drive the local sector.
"They are trading on below 1,5 times price-to-book, so on a long-term basis they are attractive and, unlike banks around the world, they are still solidly profitable," Chester says.
He says the environment for banks is likely to remain tough this year, as bad debts in their mortgage portfolios continue to increase. Mortgage bad debts usually lag the cycle, while bad debts in unsecured credit portfolios such as credit cards -- where consumers tend to default on payments first -- lead the cycle.
He says there are already signs of bad debts on unsecured credit topping out.
However, as rates are reduced over the course of the year, Chester says investors will start to look ahead to banks' performances next year and recognise the growth opportunities.
Imara SP Reid analyst Steve Meintjes is also positive on banking stocks, expecting them to perform in line with the broader market this year.
He says it is difficult to determine to what extent the expected interest rate cuts and easing inflation have already been discounted in banks' share prices.
Meintjes says if inflation falls faster than expected, it could give the Reserve Bank scope to cut interest rates more aggressively, which could lead to an outperformance for bank shares.
The financial sector charter, which, it is hoped, will be gazetted within the next few months, is another challenge for banks.
Black ownership of banks is one of the obstacles that has held up the charter. The charter says banks must have 10% direct black ownership, but labour and communities want the figure increased to 15%.
Chester says the global financial crisis shows that shareholders of banks need to be in a position to provide capital in times of crisis. Empowerment shareholders are often in debt and not cash flush. "Hopefully, the issues around banking capital that have been shown will make people realise that you cannot have highly leveraged institutions owning banks," he says.
While changes to the banking system following the release of the full banking inquiry report by the Competition Commission will provide a further hurdle for banks, Chester says most analysts have already factored in the effect this will have on some of the banks noninterest income. He says this will be mostly on retail lines, which account for 25%-40% of the business of the big four banks, and is unlikely to have a significant effect on overall earnings.
The commission's recommendations, released in December, focus on pricing, penalty fees, ATMs and access to the payments system, among other things.
"Clearly one has to be a little bit cautious to the extent the outcome of Competition Commission (recommendations) affects non-interest revenue," says Meintjes.
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