Following Standard & Poor’s (S&P) Global decision to downgrade South Africa’s sovereign debt rating to junk this week, the group has followed through and done the same to South African banks.
The reasoning behind the banking downgrade is fairly straight forward – S&P said it cannot rank local banks above the foreign currency rating in the country.
All South Africa’s major banks are affected by the downgrade, including Absa, Nedbank, Investec, FirstRand and BNP Paribas.
“The lowering of the ratings on South Africa reflects our view that political and institutional stability in the country has weakened. However, amid slow economic growth and political turbulence, South African banks have been performing resiliently,” S&P said.
“The sector’s average return on assets improved to 1.3% in 2016 from 1.1% the previous year, while total capital adequacy increased to 15.7% from 14.2%. We anticipate that credit losses for the top-tier banks will stabilize at 0.8%-1.0% in 2017.
“However, if decreasing investor confidence materially damages the local currency, sparking rising inflation and interest rates, banks’ credit losses could accelerate toward the year’s end, due to the over-leveraged South African households and pressure on their disposable income to service their debt.
“Accordingly, this could erode the top-tier banks’ profitability, resulting in lower returns on equity in 2017 than the currently anticipated 15%-19%.”
S&P on Monday cut South Africa’s credit rating to sub-investment grade, which will make any future loans sought by government much more expensive, with high interest rates.
The cut also impacts some international investors, where they are blocked – through company or national policy – from investing in junk countries.
According to analysts, the junk rating cut could remove as much as R140 billion investment from the country.
The rating cut followed a cabinet reshuffle by president Jacob Zuma, which resulted in former finance minister Pravin Gordhan and his deputy, Mcebisi Jonas, being fired.
Apart from an immediate drop in the rand, analysts say that the move wiped R132 billion from South Africa’s markets, with GDP growth prospects being revised downwards (to as low as 0.2% for 2016).
According to S&P, the main reasoning behind the downgrade was likely policy shifts as the country’s political instability takes hold.
Despite their resilience throughout South Africa’s turbulent past year or so, SA banks will now also bear the brunt of the downgrade, and will find it more difficult to service foreign currency obligations.
The downgrade will also spread to South Africa’s major metros, which will exacerbate service delivery issues and unemployment.