Presented by Stanlib

South African Banking sector investments: STANLIB Absolute Return Strategies

Partner

 ·9 Mar 2021

By Vaughan Henkel, Portfolio Manager, STANLIB Absolute Return Strategies

Government’s need to finance its fiscal shortfall is not promising, in the longer term, for consumer spending in South Africa. But we believe the market’s current short/medium term outlook on banks is too negative.

• Click here to learn more about STANLIB.

Our initial view was predicated on a “back to some form of normalcy” likelihood in client behaviour (credit growth, bad debt provisions and credit experience), coupled with the banks’ credit loss ratio in 2020/1 being almost 20% above the level during the 2008/9 Global Financial Crisis. The thesis is:

• The South African consumer outlook is poor, however…
• Banks’ share price performance has been extremely poor.
• Banks’ provisions are very large but are primarily backed by assets which limit banks’ losses.
• The outcome will be less severe than early extreme forecasts.
• Earnings will be revised upwards as the outcome becomes less negative.

Bank stocks are traditionally value stocks, so they may also benefit from style rotation, which is currently front of most investor’s minds.

Economics (fundamental view)

The current environment is extremely challenging for countries and consumers as a result of the COVID-19-induced lockdowns and their economic impact.

1. Consumer Income – wages and jobs

About 80% of the banks’ personal loan book is derived from mortgage loans and instalment finance (mainly vehicles) which, by definition, are sought by higher-income clients.

Although the latest South African Quarterly Labour Force Survey (QLFS) shows 1.4 million fewer people were employed in Q4 2020 than in Q4 2019 (pre-COVID-19), we argue this will have a lesser impact on bank clients, as they are typically Decile 9 or 10 earners.

The vast majority of highly-skilled workers received full pay, so they would be able to service their debt levels, after three percentage points of interest rate cuts.

2. Bank Provisions

Banks’ provisions were larger than during the GFC.

Given massive global support and the shorter-term impact of the crisis (governments were quick to shut economies globally and relatively quick to open them again), it appears that the provisions were more than sufficient.

3. Potential losses if consumers default

Although consumers are under pressure from job losses, 80% of the banks’ personal loan book is secured either by property (primarily houses) or by assets (primarily vehicles).

Having assessed the potential losses of default on the banks’ mortgage, vehicle and general loans against the security that they hold, we believe that the earnings forecasts contain material upside. On average, the Big Five banks (including Capitec) at mid-2020 held provision levels at 90% of their profits.

Valuation

Price: earnings (PE) is a simple value indicator and allows the widest comparisons across multiple sectors. Comparing the PE of financial shares (largely banks) against the ALSI PE, we note:

• Although the Financials PE has re-rated from March 2020, it is still lower than its history, excluding the GFC and the 1997/8 Asian and Russian crises.
• Relative to the broader ALSI, Financials are the cheapest they have been since the GFC and at the end of 2015 (when SA’s Finance Minister was removed).

Momentum – Price and Earnings

The Banks Index is now above its 200-day moving average and shorter moving averages are supportive.

The JBNKS Index (Bloomberg Index of Banks) has now turned positive in terms of three-month earnings revisions (December 2020).

The change in earnings revisions (although still negative before November) was trending upwards from the lows in May of 2020 (Source: Bloomberg).

Sentiment

The BoFA ML fund managers’ survey, which provides insight into the views of the majority of South African fund managers, showed managers are c10% overweight banks, which is in line with the historical average range of 5% to 20%.

Volatility

South African volatility is 20.2% (three-month at-the-money implied), which is 0.4 standard deviations above average (five-year average), so it is slightly elevated but not materially so. This is down on a three- and six-month basis.

Liquidity

Bank liquidity is more than adequate for most funds to transact, as this is a large and liquid sector. For example, the market cap of the Big Four South African banks ranges from R59 billion for Nedbank to R258 billion for FirstRand.

Conclusion

The Absolute Return team has a positive view on South African banks, based on the following factors:

• Fundamentals for banks offer support in the context of job losses (limited upper end), wage experience for upper income consumers, large bank provisions relative to history, interest rate cuts and a positive view on the loss given default expectations.
• The valuation for banks is cheap relative to history and relative to the ALSI index. While this offers limited value for the shorter term, it can lead to significant returns.
• Momentum, both price and earnings, is supportive.
• Neither sentiment, volatility nor liquidity is particularly risky for this investment at present.

This is a summary of an article by Portfolio Manager, Vaughan Henkel. We would highly recommend reading the full article on STANLIB.com, by clicking here.