South Africa’s banking industry is healthier and stronger than expected and its banks are well positioned for whatever uncertainties and challenges might confront them in 2022. This, in a nutshell, is the conclusion of a study by GCR Ratings into the banking sector.

Vinay Nagar, senior analyst of financial institutions at GCR Ratings, noted several times during a presentation of the research into the finances of the banking industry on Wednesday that the country’s banks are “remarkably healthy”.

"They were well positioned going into 2020 and emerged stronger from 2021 than expected,” he said.

“Despite the tough operating conditions over the past two years, the core metrics of capitalisation, liquidity and asset quality remain strong for all the major banks.

“All key indicators have shown an improving trend.”

Nagar warned that there are still risks, the biggest of which are increasing inflationary pressures and the continued low economic growth rate.

“Events of the last week might also exacerbate the economic situation,” said Nagar, referring to the Russian offensive to pull Ukraine back into its fold.

However, he found little to complain about when it comes to SA banks. Noting that banks faced huge uncertainties in 2020 – credit losses increased, with numbers doubling when Covid-19 emerged – the quality of banks’ loan books was better than expected in 2021.

“This will support profitability in 2022".

A look at the upsides

Nagar listed the main reasons for his positive view:

Asset quality has improved with credit losses expected to be well contained between 0.8% and 1% in 2022, while non-performing loans have been reducing. GCR Ratings expects this to decrease further in 2022, to an average of 5% for the industry.
Regulatory capital metrics ended 2021 at three-year highs (Tier 1 capital at 15%).
Liquidity strength remains intact with a liquidity coverage ratio of above 140%.
After the significant dip in 2020, earnings bounced back in 2021. Banks look set to maintain the profit momentum in 2022.
An independent and well-run central bank – the South African Reserve Bank (Sarb) – has supported stability through the period of stress.
Nagar said it is encouraging to see that credit losses have been declining from the high levels of 2020, noting that this might be as a result of the major banks focusing on higher income households.

GCR Ratings based its expectation – of credit losses of less than 1% of outstanding loans and the decrease in non-performing loans back to normal levels – on the modest level of corporate debt among SA companies and the noticeable deleveraging of high and high-middle income households.

“While interest rates are increasing, rates are still low compared to historic levels,” said Matt Pirnie, head of ratings at GCR Ratings, adding that future rates will obviously depend on inflation and subsequent monetary policy

Bank reserves

The agency’s research also found that banks have created suitable reserves, with GCR saying it did not find significant exposure to a particular industry or to a specific corporate.

Even exposure to state-owned enterprises (SOEs) raised no red flags.

“Loans portfolios are not directly exposed to SOEs,” said Nagar.

The amount of loans that banks had to restructure during the Covid-19 crisis also declined sharply as the economy recovered.

“Restructured loans reduced significantly from the 2020 peak of R613 billion as at July 2020 to R60 billion in July 2021. It is only 2% of the total loan book of the industry.”

A few negatives

Nagar cautioned that there are a few negatives, such as the lingering effect of the pandemic on lower and middle income groups, their high debt levels, high unemployment, and the spectre of higher inflation.

He also highlighted that the tourism and tourism-related industries, both large employers, are still in dire straits.

“Despite these negatives, we maintain our views on asset quality,” he said.

The improvement in banks’ balance sheets led to a “return of profits”.

“Following the large dip in earnings in 2020, banking sector profitability bounced back strongly in 2021. We believe profitability will return to pre-pandemic levels in 2022.”

The sector’s return of equity declined from 14.4% in 2019 to below 7% in 2020. It has already recovered to around 13.8% in 2021.

GCR Ratings based its positive profit outlook on the view that activity in the banking sector will continue to improve, and expects loans to grow by between 5.5% and 6% in 2022.

Nagar said SA banks are in the fortunate position that non-interest income (fees and commissions) historically covers a big part of operating expenses, while largely maintaining their cost to income ratio below 60%.

“Banks have always been able to deliver good and consistent profits under normal operating conditions,” he added, referring to GCR Ratings’ base scenario for 2022.

“We expect the rising interest rate cycle to be positive for banks earnings.”

Nagar had good news for investors holding banking shares. “Banks are bound to resume dividend payments. They would not want to keep excess capital on their balance sheets, especially in view of the expected increase in loan growth.”

It was noticeable that both Nagar and Pirnie referred several times during the presentation to the positive effect of the Sarb’s strict governance of the banking industry.

“As a result, the SA banking sector remains strong, despite the challenging economic environment.”

Pirnie said the outlook for the local economy is “gloomy” and that the persistently low economic growth is and continues to be the biggest risk factor.

“There was a rebound in the economy, but it was only a rebound and not a return to growth. Everybody watching this presentation [is] aware of the challenges, such as load shedding. The boom in commodities has helped, but it will not last forever,” he said.

“However, the banking sector is in very good shape.”

Rebound in banking shares

Investors partial to bank shares are bound to agree. Prices of bank shares have recovered strongly since the market slump in March 2020, with price-earnings (PE) ratios back to “normal” levels.

While these statistics are not directly comparable due to different year-ends, the table gives an indication of what investors can expect and how the banks’ prospects are rated.

An outstanding feature of the numbers is that the dividend yields are below historic levels as banks only recently, and cautiously, resumed paying dividends.