SA banks are reporting a bad-debt bloodbath - but it may look worse than it really is
- The banks are reporting a massive surge in provisions for bad debt, as their clients can't afford to repay loans amid the coronavirus crisis.
- This is partly a result of strict accounting measures following the financial crisis, and all of the projected bad debts may not materialise.
- Absa may be among the worst hit during the crisis, although Capitec has the highest level of non-performing loans.
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On Monday, Absa became the latest bank to post a horrific increase in bad debts amid the coronavirus fall-out.
Its home loans’ impairment charge – basically a provision for potential write-offs - grew by an unbelievable 1,090% to R1.750bn in the six months to end-June, while vehicle and asset finance credit impairments rose 289% to R2.129bn. The impairment charge on credit cards and overdrafts jumped by 156% to R5.107bn. Absa gave payment relief on loans to customers representing R217bn, or 22% of total loans.
This contributed to a 93% fall in headline earnings to R559 million, and the bank says it probably won't pay a dividends this year.
Last week, Standard Bank reported a 44% fall in its headline profit to R7.5 billion, warning that impairment charges for potential bad debts in its personal and business banking division rose to R8.6 billion - 2.3 times more than the charge for the same period in 2019.
Nedbank and FirstRand (which owns FNB) still need to report their detailed results, but both warned of large increases in credit impairments as widespread retrenchments and business bankruptcies wreak havoc on debt repayments.
But that’s not all. The banks are also hit by steep cuts in interest rates, which are now at the lowest level in almost half a century.
Intuitively, lower interest rates should have a positive impact on banks – after all, lower rates entice more people to borrow money. However, lower rates mean that banks see their net interest rate margin shrink. These margins are the difference between the interest the bank receives on its loans and investments, and the interest it has to pay to its clients/depositors. Typically, when interest rates fall fast, this squeezes its margins.
In fact, Absa says it takes a R250 million (pre-tax) hit for every rate cut of 50 basis points.
On the surface, then, banks are facing a perfect storm of a massive external shock to a dismal local economy, with lower interest rates adding to their woes.
However, the real picture may not be quite as dismal.
The IFRS impact
Following the financial crisis in 2008, global financial authorities forced banks to make much more stringent provisions for loans.
Banks had to adopt new International Financial Reporting Standards (IFRS), and were forced to almost double the capital they hold compared to the loans granted, says Kokkie Kooyman, one of the founder members of Denker Capital, which manages the award-winning Denker Global Financial Fund. Kooyman was named Fund Manager of the Year four years in a row in the financials category by the UK-based publication Investment Week.
The new so-called IFRS 9 standard also requires banks to make provisions for large impairments on higher-risk loans – in case they default.
So, much of the massive impairments that banks are reporting are a result of IFRS 9, and not all of the money will have to be written off, says Kooyman. “This is a big once-off accounting provision.”
“These impairments are mechanistic – and might not be operational. It is not yet clear what the banks’ actual experience will be,” agrees Liam Hechter, an analyst at Anchor Capital.
In fact, both Standard Bank and Absa were able to grow their profit if the impact of the provisions were excluded, says Hechter. Standard Bank still managed a return on capital of 9.5% even after provisions, while Absa saw strong lending growth throughout lockdown, adds Kooyman. And thanks to conservative provisions, the banks have more than enough capital to survive the storm – Standard, for example, has around R66 billion in excess capital (above the minimum statutory requirement), Kooyman says.
And while Capitec has the highest percentage of “non-performing” loans (clients are behind on instalments) compared to total loans – around 9% - it is also is by far the best capitalised, and its cost-to-income ratio is also the lowest.
But key will be what happens next: whether businesses and consumers can afford to start repaying loans and credit after their payment holidays are over.
“We will probably only know how bad the situation is by November,” says Kooyman.
He thinks that the banks have probably seen the worst of the pandemic, and that there will be a surge in credit demand as companies gear up following the lockdown. However, South African banks will probably suffer more than their global counterparts as government struggles with a fiscal crisis and can’t afford to pump up the local economy.
Hechter says it’s clear from the banks’ commentaries that a V-shaped recovery is not expected
“We are probably in for a protracted period of sub optimal economic performance. It is unlikely that any of the banks will return to pre-Covid profit levels for a number of years. Banks are all creatures of the economy.”
Not all banks are equal
Kooyman believes FirstRand should emerge from the crisis with the least damage, while Absa will take the biggest hit and will suffer from the highest ratio of non-performing loans.
According to Denker’s other indicators – including capital to assets, and cost to income – Absa also scores the worst.
FirstRand has a more diversified business than Absa, and Kooyman commends its management and “credit extension culture”.
Hecther also believes that FirstRand is the best-run financial company.
But he says that their exposure to Africa may help Absa and Standard Bank. “Nedbank is the most vulnerable because it is the least diversified.”
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