SA Major Banks Analysis

SA’s major banks feel the effects of an unprecedented operating environment

Combined headline earnings of R43.6 billion declined 48.4% against FY19, combined ROE of 8.3% (17.8% at FY19), net interest margin of 387 bps (426 bps at FY19), credit loss ratio of 180 bps (80 bps at FY19), cost-to-income ratio of 56.4% (55.6% at FY19)

Operating under severely constrained macroeconomic conditions and considerable uncertainty, the major banks delivered a financial performance in FY20 that reflects the challenges of an unprecedented year. Anchored in anxious public health concerns related to the COVID-19 pandemic, depressed business and consumer confidence levels combined to produce the largest annual fall in domestic economic activity in nearly seven decades. 

Many of the central themes we highlighted in our 30 June 2020 Major Banks Analysis prevailed throughout the year, as unpacked below:

Credit impairment charges soared relative to FY19, as forward-looking impairment models and post-model adjustments sought to capture the scale of the crisis on loan portfolios. The dramatic increase in impairments contributed as the primary factor to the steep fall in combined headline earnings

and returns, which now compare to 2012 levels.

• The robust capital and liquidity positions with which the major banks entered the crisis were maintained above regulatory required levels in FY20, providing risk capacity and supporting their ability to navigate turbulent operating conditions.
• “The branch is dead. Long live the branch!” With the undeniable flight to digital and mobile banking platforms – a trend that pre-dates the pandemic – 2020 saw record volumes of banking transactions conducted through lower-cost digital channels across all customer segments. The major banks recognise, however, that while the size, scope and configuration of the physical branch network will change, they will continue to play a central, albeit different, part in their overall channel and distribution strategies going forward.
• Early in the crisis, the major banks shifted strategic focus from managing profitability and delivering stakeholder returns to managing operational stability and ensuring balance sheet resilience. These efforts resulted in both technology infrastructure and customer service levels holding up without major incident in spite of a sudden pivot to remote working and strong demands on systems. Demands on systems and IT architecture came from, both, facilitating the business of the major banks, as work was conducted remotely, and in supporting higher digital transaction volumes.
• The major banks’ trusted brands, geographic diversity and integrated and growing product set across the financial services spectrum aided their ability to demonstrate operational and balance sheet resilience through crisis conditions. This enabled them to focus efforts on supporting customers, colleagues and communities.
• In a year characterised by uncertainty, new ways of working and of doing business, tight cost control and a changing variable cost composition resulted in operating expenses being well-managed. However, the combined cost-to-income ratio deteriorated as revenue growth did not keep pace with cost growth.
• Broader change topics such as the sustainability agenda now feature prominently in strategic thinking. With expectations for operating uncertainty to prevail, the major banks continue to seek out ways to adapt business models to respond to the changing operating environment, while managing a dynamic risk environment.
• To foster customer loyalty in a competitive market, expand access to financial services, leverage technology and create seamless customer experiences, the major banks acknowledge the need to be continuously relevant to how customers engage and transact, and are willing to reward loyalty and embrace partnerships to achieve this. Platform-based banking, increasingly led by digital channels, data-driven targeting and offering a multitude of applications, is likely to foster a new era in how the major banks deliver financial services. The need to be agile and ‘speed to market’ will not be a temporary phenomena.

PwC’s Major Banks Analysis highlights key themes from the combined local currency results of Absa, FirstRand, Nedbank and Standard Bank. 

External environment: When the history books complete the accounting for 2020, it will recount a profound period – one that altered the trajectory of lives and livelihoods, societies and economies, businesses and households – on a global scale. Financial services, and banking in particular, function at the epicentre of the broader economic context and therefore banks’ financial performance is closely tied to the economies in which they operate.

The South African economy has laboured under structural constraints, deteriorating growth trends, worrying unemployment levels and limited fiscal space that have been well documented long before COVID-19. Quantifying the domestic economic performance of 2020, as Stats SA notes, makes for sobering reading. While the 7% contraction in the South African economy in 2020 represents a cardiac arrest driven by crisis conditions, it does not diminish the declining domestic economic trends that have prevailed for more than a decade.

Concerningly, inflation-adjusted South African GDP per capita peaked in 2014 and has since been declining, highlighting the extent to which struggling economic growth has battled to keep pace with population growth. South Africa was in some form of lockdown for 279 days in 2020, triggering GDP per capita to decrease to a level last seen in 2005.

In 2020, the South African economy registered average inflation of 3.3% – its lowest in 16 years. This context provided space for monetary easing and allowed the SARB to cut market interest rates to levels not seen in 50 years. Low inflation and aggressive rate cuts reflect the extent of weakness in the domestic economy, which 2020 starkly illuminated.

Some green shoots were observed in the 4th quarter, with the BER/RMB Business Confidence Index increasing notably from a reading of 24 in Q3-20 to 40. Even at this level, a majority of South African businesses were unsatisfied with prevailing business conditions while household and consumer confidence remained depressed.

Globally, no economy or demographic group was spared in 2020, prompting extraordinary monetary policy and legislative relief in some of the largest economies and creating a backdrop of volatile global markets.

Results highlights: Against this context, Costa Natsas, PwC Africa's Financial Services Leader, noted:

“The severe disruptions and risks brought about by the COVID-19 pandemic are clearly evident in the major banks’ results for the year ended 31 December 2020. The tragedy of numbers is that they cannot fully capture the dire human, social and economic costs caused by the pandemic. However, these results show that deteriorated economic outlooks and customer impacts played out in sharp declines in earnings due to adverse credit conditions.”

Highlights from the major banks’ results include:

• Driven by a steep increase in credit impairment charges of 2.5 times against FY19, the major banks’ combined headline earnings and ROEs fell to 2012 levels. The second half of 2020 saw credit performance and business volumes faring relatively better than expected and as compared to the first half as lockdown restrictions eased, although far worse than pre- pandemic levels. Consistent with their results announcements in June 2020 and pre-year end close guidance, some banks did not declare an ordinary dividend for FY20, citing capital preservation and the uncertain earnings outlook.
• While the extent of credit impairments played out differently across loan portfolios, geographies and industries, the steep increase is both undeniable and unsurprising. There is often a temptation to compare credit impairment levels between crises – and in this case to the global financial crisis of 2008/09. Such a comparison is difficult due to the fundamental change in the accounting rules that govern impairments today (IFRS 9), which is premised on expected credit loss principles and therefore heavily influenced by macroeconomic outlooks.
• On the back of increased impairments, the combined credit loss ratio (credit impairment charge for the reporting period as a percentage of average advances) deteriorated. Total loan book growth of 5.3% was registered for FY20 across various portfolios between operations in SA and regionally. On a rolling six-month basis, total lending contracted 2.5% in the second half of 2020. Non-performing loan formation also increased sharply in FY20, amounting to 5.6% of total loan portfolios (4.9% at FY19).
• Deposit growth benefited from cautious household and consumer behaviour, as savings increased amidst the uncertain environment and prudent cash management strategies were employed by corporate treasurers. Total deposits showed the effects of two fundamentally different periods – growing 9.9% against FY19 but 0.4% against 1H20.
• A notable highlight that can be drawn from the major banks’ FY20 results is the relatively stronger contribution from regional operations outside South Africa. While some emerging concern has arisen over the possibility of lagging COVID-19 case numbers in key African markets and therefore their earnings’ prospects going forward, the geographic diversity of the major bank’s earnings (specifically from their regional operations) reflects the strong focus by management on the non-SA operations for over a decade.

Francois Prinsloo, Banking and Capital Markets Leader for PwC Africa says: “While the major banks’ FY20 results are reflective of an intensely challenging operating environment, they also reveal their resilience. Contemplating how the pandemic and the associated uncertainty and risks may play out, it is clear that purposeful, technology-enabled and customer-centric strategies will feature prominently in the major banks’ areas of focus going forward.”

Outlook: Our economics team expects the global economy to expand by 4.7% in 2021, a forecast heavily conditional on a successful deployment of effective COVID-19 vaccines and accommodative fiscal, financial and monetary conditions. By the end of 2021, or early 2022, we expect the global economy to trend to its pre-pandemic level of output.

At the domestic level, this picture looks starkly different as an uneven recovery pattern among South Africa’s key trading partners and geographic neighbours is likely. At one end of the spectrum is China, already larger than its pre-pandemic size, while on the other are advanced economies that are either service-based (e.g. the UK and France) or focused on exporting capital goods (e.g. Germany and Japan), which are unlikely to recover to their pre-crisis levels by 2021’s end.

Consensus among many economists is that the South African economy is expected to register GDP growth in 2021. However, much of this growth will reflect base effects arising from the large 2020 contraction. PwC’s baseline forecast is for GDP growth of 3.4% in 2021, which is broadly consistent with the major banks' 2021 SA GDP forecasts. In addition to expectations of a third wave of COVID cases and associated lockdown levels, this outlook assumes the negative impact of continued load-shedding.

We expect that a return to pre-pandemic GDP is at least a few years away. Through this crisis, however, the major banks have demonstrated their intent to be part of the solution and, in doing so, accelerated digital strategies and fostered greater levels of public trust. 

Rivaan Roopnarain, PwC Africa Banking Partner notes: “While considerable uncertainty, both from a public health and from an economic standpoint is expected to prevail, the major banks have shown their ability to respond purposefully to crisis conditions. For the majority of the major banks’ management teams and their people, 2020 will have been the most difficult and complex year on record. With various outlook scenarios dependent on a range of variables, the common consensus is that of more uncertainty ahead.”

Some of the major banks have cautiously indicated in their results announcements that they are hopeful to have seen the bottom from an earnings perspective. Early indicators emanating in Q1-21 show a sliver of positivity – with increased client activity, retail credit collections and early-stage debt relief showing a few promising trends.

As forward-looking expectations drove credit impairments in 2020, the major banks will hope that earnings trends return to more business as usual levels as impairments stabilise. Consequently, a strong focus on credit collections is likely to be a key theme of activity in 2021. Importantly however, just as data, models and expectations drove credit impairments in 2020, it will be data, collections and experience that will inform how impairment models adapt to changes in the environment going forward. Forthcoming data reads will therefore be closely tracked by the major banks to gain a fuller appreciation of credit performance.

Positive indicators come with heavy caution – as some commentators note that there is little to no pent-up demand seen on the immediate horizon: in their view, the economy is simply too weak and unemployment too high to contemplate what a meaningful recovery might look like.

In spite of the consensus for uncertainty to prevail, the characteristics that will support the major banks’ earnings profiles and drive growth into the future will be premised on a clear corporate and competitive purpose, a relentless mission to execute on strategies and leveraging technology and data-driven insights.