Local banks hold out well but are under more pressure
Bad loans drag down profit
August 26, 2009
By Ethel Hazelhurst
Banks, which were largely responsible for tipping the world into recession late last year, have apparently shrugged off their misfortunes.
A year after the bankruptcy of US bank Lehman Brothers and two years after the run on British bank Northern Rock, bank shares are rising steadily and could rise further.
The JSE banks index has risen 17 percent since the trough early in March, despite high levels of bad debt and the prospect of only a muted economic recovery over the next year. The index hit an intraday high of 34 225 yesterday, up from its low point of 29 167.
Kokkie Kooyman, a fund manager at Sanlam Investment Management, said there were two reasons for the comeback.
"One is that valuations fell too low. The second reason is that investors are looking to June results next year, which should see profit growth of 30 percent to 40 percent."
He said banks' prospects left room for shares to rise another 10 percent, before they could be described as fair value.
The rise in local bank shares is modest compared with the recovery in other countries. Kooyman said US banking shares rose about 26 percent over the past six months, and in other emerging markets, "like Turkey, they have risen as much as 125 percent".
However, Kooyman noted, local banks' non-performing loans (NPLs) "have shot up this year while the provision charge in the income statement has not. This leaves South African banks looking underprovided relative to banks in most other countries."
For example, Standard Bank's non-performing loans, as a percentage of loans, have leapt from 1.5 percent in 2007 to 5.5 percent while its reserves as a percentage of non-performing loans have fallen from 0.75 percent to 0.44 percent.
He was concerned next year's profit growth would be "constrained by the need to first rebuild reserve coverage. If this is the case, then maybe the market has run too far ahead of itself and will wait before it closes the gap to fair value."
Neville Chester, a senior portfolio manager at Coronation Fund Managers, said banks were going through a bad patch.
"On the one hand they had to contend with rising levels of bad debt due to the previous high level of interest rates.
"On the other hand, falling interest rates have squeezed their margins," he said.
Banking margins are eroded towards the end of the downward leg of the interest rate cycle as banks have to pay relatively more for longer-term funding as investors anticipate a reversal in the interest rate cycle, but much of their lending activity remains linked to the benchmark prime rate.
The impact has been seen in banks' falling profits. Standard Bank's first-half earnings fell 24 percent, while Absa's interim net profit fell 39 percent.
However, the adverse point in the cycle is likely to end in the first half of next year when bad debts start falling as a percentage of total lending.
Chester predicted banks would record increased profitability when they presented their results for the first half of next year.
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