Major Banks Analysis , September 2019

SA’s major banks deliver resilient growth in spite of a challenging operating environment

Combined headline earnings up 0.2% since 2H18 (up 5.3% against 1H18), combined ROE of 18.5% (19.0% in 2H18), net interest margin of 4.32% (4.36% in 2H18) and cost-to-income ratio of 55.1% (56.8% in 2H18)

• Positive results in a low growth environment under stress: In a low growth environment restrained by the slow pace of structural reforms and lower consumer confidence, the major banks earnings continue to increase above nominal GDP levels. Heightened credit risk driven by economic conditions and subdued client activity have contributed to earnings pressure.
•  Focus on digital strategies continue: Migration of transactional volumes from physical to electronic channels is now firmly entrenched - with the mobile app emerging as the key platform driving digital transactional volumes. All of the major banks have highlighted efforts in relation to digital platforms, while continuing to digitise in-branch experiences.
• Turning regulatory change into strategic advantage: As the banks respond to the evolving regulatory landscape, it is clear that they are contemplating regulatory change more astutely. Leading banks actively spend time analysing regulatory change in the context of how they can make regulation work for them - searching for opportunities to drive efficiencies, optimise IT architecture, or better calibrate product design - beyond just the compliance imperative.
• African operations outside South Africa remain key: The earnings contribution from the banks’ regional operations continues to make significant contributions to group results, as the banks seek to capitalise on further diversifying and building-out their franchises.

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PwC’s Major Banks Analysis presents the highlights of the combined local currency results of Absa, FirstRand, Nedbank and Standard Bank. The analysis identifies common trends shaping the banking industry, building on previous PwC analyses for a period of over a decade.

Overview

An analysis of the results of the major banks for the period ended 30 June 2019 reveals a picture of a domestic economy under stress in a low growth environment and restrained as a result of the slow pace of structural reforms. Banks are, by virtue of their role as financial intermediaries, sensitive to stresses in the domestic economy. Current lacklustre economic conditions translated into heightened credit risks and subdued client activity across all customer segments, and contributed to earnings pressure over 1H19. 

Other major players in the local banking market have launched extensive transactional banking marketing campaigns over the last six months, focusing relentlessly on differentiated digital offerings and offering attractive interest rates on savings products - in an effort to capture wallet share of the South African consumer.

We also see a continued focus on product design, digital channels and innovation strategies, including by new entrants to the market, to provide easier and wider access to digital banking, differentiated loyalty and rewards programmes, more competitive pricing and, ultimately, holistic financial services offerings. This backdrop of increased competitiveness in the domestic banking market presents exciting opportunities for the South African customer, who stands to benefit from more frequent, customised and fit-for-purpose innovations. 

External environment

Taking a look at the global economic backdrop, it is clear that a year can be a long time in macroeconomics. Twelve months ago, the Federal Reserve, the US central bank, was raising interest rates regularly; the Eurozone was enjoying a multi-year boom; and the global economy was witnessing its fastest period of growth for a decade. Since then, trade tensions between the US and China have increased, European growth has slipped from above to below trend and recoveries in several major emerging markets have faltered. 

These developments adversely affected global trade volumes, and manifest in weaker conditions in most commodity-exporting developing economies, including those in Sub-Saharan Africa, as a result of stagnant commodity prices. 

Domestically, the South African economy encountered a range of challenges in early 2019, including poor rainfall in parts of the country affecting the agricultural sectors and, notably, large-scale electricity supply shortages and load-shedding which adversely impacted key export-oriented sectors.

Increased unemployment levels, rising fuel prices and stagnant to slowing personal income growth combined to erode household purchasing power, while inflation drifted slightly higher. 

On a positive note, Statistics South Africa released the latest GDP data, which showed that the South African economy expanded in the last quarter. The largest contributor to the quarterly GDP recovery was a rebound in mining activity. 

Results highlights

Reflecting on the major banks results for the period to 30 June 2019 against a challenging backdrop, Costa Natsas, PwC Africa's Financial Services Leader noted, “Despite a challenging economic context, the major banks continue to report earnings growth, which remains a testament to the credibility and diversity of their franchises, product sets and management teams.”

Highlights from the major banks results include:

• Although performances between the individual banks varied, on a combined basis the four major banks posted headline earnings of R42.49bn, which grew 5.3% against 1H18, but only 0.2% against 2H18. To some extent, this reflects the effects of slower than expected GDP growth over 1H19, relatively muted corporate credit demand and generally lower activity on the part of SA Inc.
• Underpinned by their digital strategies to drive transactional volumes and therefore fee income (albeit a lower per unit revenue than physical channels), non-interest revenue grew 3.7% against 1H18, but fell 0.8% against 2H18
• Tight cost control and a disciplined approach to cost management is an area that the banks have consistently focused on over recent reporting periods. The outcome of their efforts is reflected in the major banks combined results through operating expenses growing 7% against 1H18, but falling 1.6% against 2H18, resulting in an overall positive operating leverage experience (operating income grew faster than costs) for 1H19.
• The combined cost-to-income ratio fell by roughly 170bps at 1H19 to 55.1% when compared to 2H18 and remained flat against 1H18. Staff costs continue to comprise the majority of overall group costs, reflecting both the inflationary environment as well as the demand for critical talent in response to increasing specialisation in the areas of risk, compliance and IT. At the same time, we continue to see increases in IT expenditure as the banks’ direct investments in their applications and systems infrastructure towards further digitising their platforms. 
• The major banks remain robustly capitalised, comfortably above regulatory minima across all capital tiers, while generating commendable returns. During the current period, the combined common equity tier 1 capital ratio improved marginally by 3bps to 12.3% while the combined ROE shrunk by 28bps to 18.3% against 1H18 (18.8% against 2H18). However, strong double-digit ROEs across all the major banks continues to remain well above ROEs generated by global peers in developed markets.
• Notwithstanding the subdued economic conditions that prevailed over 1H19, the aggregate loan book registered growth of 9% against 2H18 (and a more moderate 3.7% against 1H18). The theme we had previously observed of retail credit demand outpacing corporate lending continued in the current period for some banks, with growth mainly attributable to the business banking products and credit cards.
• Some banks noted continuing challenges by corporate borrowers in the mining and construction industries, as well as certain large-cap corporate counters in the telecommunications industry, while persistent challenges to the SOE lending books remained as a result of certain SOE counters coming considerable financial stress in the current period.
• Although an increase can be noted in credit loss ratios (‘CLR’), banks continue their persistent focus on credit. The major banks reported a combined credit loss ratio of 0.78% (0.72% at 1H18). Most of the banks commented that impairment levels remain at the bottom end of the longer term range. As IFRS 9 is now fully embedded in the major banks results, the effects on total non-performing (Stage 3) loans, which comprised 3.9% of gross advances (3.7% and 3.9% at 1H18 and 2H18 respectively), tracked higher compared to pre-IFRS 9 levels which was expected as a result of certain technical features of the Standard and commented on in previous periods by the banks upon their IFRS 9 transitions. 
• Non-performing loans remain well provided for, with a coverage ratio of 45.0% (46.5% at 2H18), while performing advances (Stage 1) have coverage ratios of 0.6% (0.6% at 2H18). For those exhibiting characteristics of significant increases in credit risk since origination (Stage 2), the credit loss was reported at 7.1% (6.6% at 2H18). Certain major banks experienced an uptick in their personal loans and credit card impairments levels over the period under review.

Francois Prinsloo, Banking and Capital Markets Leader for PwC Africa says: “Overall, the major banks diversification strategies across franchises, regions and portfolios has been central to their ability to achieve growth against difficult trading conditions. We continue to expect the banks to be acutely focused on the continued build-out, ongoing refinement and customer-centric digital strategies, particularly in the context of new and emerging technologies.”

Outlook

All of the major banks commented, in a clear chorus, on the significance of the structural challenges currently facing South Africa, the implications these have on further sovereign downgrades and the extent to which the domestic economy is constrained as a result. Consequently, they highlighted the need for urgency in structural and economic reform, including policy certainty in reforming state-owned entities, land reform and mining rights, as well as energy supply.

Against what is expected to be a challenging medium term operating environment, subdued domestic economic growth and a risk-on macroeconomic outlook at the global level, the major banks continue to remain sharply focused on executing on their key strategic initiatives. These include continuing to build-out their diversified franchises and their African operations outside South Africa to leverage the green shoots of improving economic activity in key Sub-Saharan economies, optimising business models, fine-tuning their product mix, retaining and attracting key skills, and driving greater opportunities for seamless cross-sell and up-sell of intersecting banking and insurance products across their platforms.

In a challenging South African economic context and a vigorous competitive environment, we see leading banks as being those that calibrate banking product features, pricing structures and their overall touchpoints with customers, across all channels, in a highly differentiated manner.

Key to the realisation of this nuanced approach to banking will be the effective accumulation, enrichment and leverage of customer data that resides within the banks, and those that can seamlessly harness this data to underpin personalised customer engagement and overall bank strategy.