Major Banks Analysis

SA’s major banks produce positive financial results despite continuing operating and economic headwinds

Combined headline earnings up 0.5% since 2H17 (12.1% since 1H17), combined ROE of 18.8% (18.6% in 2H17 and 17.9% in 1H17), net interest margin of 4.36% in 1H18 (4.63% in 2H17 and 4.56% in 1H17) and cost-to-income ratio of 55.1% (55.7% in 2H17 and 55.5% in 1H17)

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 and issues currently shaping the banking industry, building on previous PwC analyses over the last nine years.

SA’s major banks delivered a resilient set of financial results for the reporting period ended 30 June 2018, despite various operating and economic headwinds that characterised the period. It is evident from the results of the major banks that they have continued to spend considerable time and cost on their digital strategies, refining and simplifying products and enhancing their loyalty programmes to continue to reward clients - all in a focused effort to attract a greater share of customer wallet.  

A notable contributor to the earnings trend for the period has been the positive contributions of the major banks’ businesses in markets in the rest of Africa outside South Africa, aided by stronger client activity on the part of large corporates in some territories, but offset by a stronger rand upon conversion for local results. Costa Natsas, Banking and Capital Markets Industry Leader for PwC Africa says: “Overall, the positive contribution from the banks’ operations in markets outside South Africa fits in with core features of their strategies to diversify earnings geographically and strategically, as well as within their overall product mix, which we have commented on in recent periods. This diversification strategy across their franchises, regions and portfolios now makes a broader positive impact in the major banks results, and we expect this to continue going forward.”

The more competitive environment between the banks and the continued transition of customers to digital channels has become increasingly visible on the combined major banks’ results, in the form of lower transactional fees and commissions in retail banking, competitive pressures in deposit pricing and depressed margins in the trading businesses. At the same time, interest rate margins have been impacted by economic and regulatory factors leading to, on average, higher liquidity and funding related costs during the period. On a relative basis, the rand was stronger in the first six months of 2018, which partially offset the strong performance of many of the banks’ operations outside South Africa.

These competitive pressures are set to increase in the next few months, as the market anticipates the launch of new entrants and wider product offerings from existing banks. Discovery Bank announced earlier this week that it will acquire FirstRand’s effective and economic interest in the Discovery Card loan book and has indicated it is expected to publically launch the bank in the fourth quarter of 2018. In addition, indications are that TymeDigital, Bank Zero and the SA Post Bank are drawing closer to their public launches, having recently obtained banking license approvals, while African Bank also announced its intentions to move further into the transactional banking space. At the same time, in recent weeks we have seen growing interest in the banking market from non-bank financial services players. Old Mutual highlighted the growth it has achieved in the transactional accounts space and commented that there are opportunities to compete in the transactional banking market.

Johannes Grosskopf, Financial Services Leader for PwC Africa says: “The major banks remain resilient and continue to have robust capital adequacy levels which have been a feature of the South African banking system over many years”.

In the current period, the effects of slower revenue growth and an increase in the combined impairment charge as a result of the transition to IFRS 9 for those banks with December year-ends, were offset by disciplined cost management.

As always, the results should be seen in the context of the macro and domestic economic environment during the period against which they were achieved.

Reflecting on the operating environment over the period to June 2018, economic growth at a global level continued to be less synchronised than expected – while trade tensions and global risk aversion led to increased volatility and currency pressures in some emerging market territories, including South Africa. Foreign exchange rates declined in many Sub-Saharan African countries in which the major banks operate, which had the effect of reducing overall banking group results, while in South Africa, on average, the rand was stronger over the period.

The positive domestic economic sentiment that characterised the start of 2018 abated quickly, as markets, businesses and consumers factored in the effects of negative economic news, political risks and lower commodity prices than the comparative period (with the exception of Brent Crude) – amid broader concerns of policy uncertainty and the finances of state-owned enterprises.

Various domestic factors - including the increased VAT rate and higher fuel costs – negatively impacted discretionary spending during the period for both South African businesses and consumers, and this also manifested in relatively subdued overall loan growth for the period. Statistics South Africa (“StatsSA”) reported in July that consumer price inflation increased from 4.4% year-on-year in May to 4.6% in June – attributed primarily with faster increases in the cost of transport. The latest inflation number is the highest reading since November 2017, but is in line with the median forecast of local economists. The most recent SA GDP numbers released earlier this week (which we comment on briefly below) confirms these pressures.

Highlights from the major banks 30 June 2018 results:

  • Analysing the major banks results year-on-year (against 1H17) and period-on-period (2H17) presents a tale of two halves - which is borne out in starkly different pictures and reflect a number of factors that adversely influenced the combined financial performance in the first six months of 2018. Key among these factors was a reduction in net interest income of 0.5%, slower non-interest revenue growth of 2.4% and an increase in the impairment charge of 3.7% against December 2017.
  • Although there were divergent performances between the individual banks at 30 June 2018, on a combined basis, the four major banks posted headline earnings of R40.4bn, which grew 12.1% year on year (against 1H17) and 0.5% against 2H17.
  • In spite of market uncertainty and subdued household and business confidence levels through the period, the major banks’ aggregate loan book registered growth of 7.9% against 2H17 (and 9.5% against 1H17).
  • The theme of corporate credit demand outpacing retail generally continued in the current period, and was aided by good conversion of the deal pipeline in renewables financing by the banks’ investment banking franchises. However, delays in planned public infrastructure spending and late payment of existing project work were cited as some of the reasons for corporate loan books growing less than expected. Banks with exposures in the corporate sector noted continuing challenges in the mining, construction and cement industries, which affected some counterparties in these sectors. On a positive note, the major banks noted improvements in the health of corporates in the oil and gas sector - coming on the back of stable oil prices at elevated levels to a few periods prior.
  • Retail banks noted continuing increases in levels of debt counselling clients and impairments were increased due in part to the impact of time delays experienced when repossessing secured assets due to customers delaying repossession on legal grounds.  
  • A strong focus on the quality of originated assets is another theme that persisted in the current period, with the major banks reporting a resilient combined credit loss ratio of 0.72% and a prudent impairment coverage ratio of 65.8% at June 2018 (compared to a credit loss ratio of 0.75% and an impairment coverage ratio of 66.5% at December 2017).
  • Total non-performing loans comprise 3.7% of gross advances at 30 June 2018 (3% at both 1H and 2H17). It is however important to note that previously reported impairment ratios in respect of performing and non-performing portfolios (determined under IAS 39) are not directly comparable to similar ratios under IFRS 9.
  • Disciplined cost control and a sharp focus on optimisation initiatives remained high on the agenda of bank management teams in a slower revenue-generation environment. In spite of this, the current period continued the theme of “negative jaws” (as total costs grew faster than operating income) which we observed at both June and December 2017.
  • Reflecting the banks’ focus on cost management, the combined cost-to-income ratio dipped to 55.1% at June 2018 (compared to 55.8% and 55.5% at December and June 2017 respectively). Since we began our SA Major Banks Analysis nine years ago, the combined cost-to-income ratio remained in the 54%-56% range, illustrating the structural challenge in moving the needle on this important ratio. This challenge highlights the balance that the banks need to strike between executing on their strategic priorities – which include ongoing investments in system architecture, digitising internal and customer experiences, shoring up cyber defenses in an age of heightened cyber risk, broad enterprise risk management solutions to cater to a new breed of emerging risks and data related spend – while managing overall group costs.
  • From a solvency perspective, the major banks remain robustly capitalised, comfortably above regulatory minima. During the current period, combined ROE grew by 15 bps to 18.8% against December 2017 (17.9% at 30 June 2017). At the same time, we continue to observe a focus by the major banks in monitoring and reporting the ‘economic spread’ – which is the value created to shareholders after adjusting for the cost of equity.
  • IFRS 9 was used by the majority of the reporting banks in reporting impairment charges for the period. While IFRS 9 implementation efforts consumed large programmes of work and significant management time during recent periods, we anticipate IFRS 9 impairment models to continue to be refined over coming periods in the areas of determination of write-off periods, application of macroeconomic modelling methodologies and in the accumulation and retention of data in certain portfolios.
  • IFRS 9 not only impacted the impairment charge of the major banks but also had other effects - through, for example, the net interest margin (due to changes in the recognition of interest income on defaulted loans, which, under IFRS 9, are no longer presented in the interest line). The major banks’ ROE as at 30 June 2018 also benefited from the IFRS 9 transitional adjustment charge (through reduced equity as a result of the transition impact taken directly to retained earnings).

Strategically, the major banks continue to comment on many of the themes we have noted previously – including digitising and integrating legacy processes through robotic process automation efforts, and channel and product innovation to deliver richer customer experiences. At the same time, they are also taking steps to get ahead of regulatory changes – including embedding IFRS 9 from 1 January 2018 (for those banks with December year-ends), and initiating programmes to deeply analyse the package of prudential reforms issued by the Basel Committee on Banking Supervision in December 2017. These reforms are collectively referred to as ‘Basel IV’ by the industry in recognition of the scale of the changes on banks’ risk-weighted assets and the downstream implications on capital demand, product-pricing, data, systems infrastructure and, inevitably, overall bank strategy.

Interestingly, we have noted a rapid rise globally in the concept of “Open Banking” – which is the opening of internal bank data and processes to external parties via digital channels through regulatory initiatives. While it is uncertain to what extent, or when, a similar concept will affect the South African banking market, the major banks have also noted this trend and will likely pay attention to lessons learnt through its introduction in other jurisdictions - which have shown that taking a wait-and-see approach increases the cost, risk and disruption of the change. “Although it is relatively early days, we have seen in these territories that the benefits of open banking to banks appear to be more data, better decisions, greater access and better services for their customers, while at the same time potentially increasing the competitive environment” Natsas says.

As expected, the major banks remain sharply focused on adapting their long-term strategies to reflect these dynamic consumer, competitor, societal and regulatory shifts – including a continued behavioural migration underway by banking customers toward digital channels. We expect that this relentless focus on the customer - across the corporate, commercial and retail banking segments - will persist over coming periods and will influence the re-engineering of the major banks’ internal back-end processes to optimise, modernise and digitise their capabilities.

While 2018 kicked-off with a renewed sense of optimism, and the outlook for the next six months of the year reported by most banking management teams at the time of announcing their results was positive, this optimism has been somewhat dampened by recent readings of the domestic economy. StatsSA reported on 4 September that the South African economy contracted by 0.7% quarter-on-quarter (on a seasonally adjusted and annualised basis) during Q2-2018. The rand reacted negatively to these readings and weakened to above R15 to the US dollar. The second consecutive quarterly contraction in economic activity resulted in the South African economy being only 0.4% year-on-year larger in Q2-2018 compared to the same time last year.

“While resolving key policy issues remain a potential obstacle to fixed investment, business confidence and overall economic growth, the banks appear to have appetite to grow judiciously while being mindful of competitive pressures”, Grosskopf says. Balancing return profiles across their franchises and risk appetite levels against a challenging economic backdrop will remain a major strategic priority for bank management teams. We therefore expect to see sharp focus on the execution of overall bank strategy, relentless optimisation and digitisation efforts across the banks’ balance sheets and earnings drivers, a tight hand on cost management and ongoing investment in infrastructure, people and IT systems.

At the same time, and particularly in view of the continued rise of digital, non-bank financial services competitors, we maintain our view that the major banks will seek to continue to further integrate the use of ‘bots’, analytics and artificial intelligence to make their operations leaner and discover deeper insights that can improve the end-to-end customer experience. Both locally and globally, there are a range of economic, competitive and wider social challenges that lie ahead which may directly impact the banking industry. Our view is that leading banks will continue to focus on simplifying operating models and becoming more deeply connected to the customer and community, creating an ecosystem, in a digitised and differentiated manner.


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Sanchia Temkin

Senior Manager, PwC South Africa

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