How stable is SA’s banking system?

Credit rating agency Moody’s Investors Service last week changed its outlook on the South African banking system from negative to stable, citing the resilience of financial metrics and creditworthiness over the next 12-18 months despite weakening operating conditions.

Moody’s examined seven commercial banks in South Africa that are presently below investment grade. Its rating upgrade follows the release of bleak macroeconomic data in South Africa that leaves the 2019 economic outlook in the balance.  

Its report, Banking System Outlook – South Africa, highlighted stability in business and revenues despite the economy’s slow economic growth.

South Africa’s GDP in the second quarter of 2018  largely disappointed, with a decline of 0.7% on a quarter-on-quarter seasonally adjusted annualised (qqsaa) basis ushering the economy into a technical recession. The latest figures follow a downward revision of Q1 2018 GDP figures from -2.2% to -2.6%. Nonetheless, an aggregate GDP figure would not be a fair representation of the latest Moody’s report given its sectoral focus.

Spill-over risk

Technically, South Africa is in a recession. Q2 2018 GDP figures show the agricultural sector dipped by 29.2% qqsaa, while the manufacturing, trade and government sectors contracted by -0.3%, -1.9% and -0.5% respectively. The financial sector, however, grew by 1.9%, contributing 0.4% to the overall figure. The spill-over risk to the financial sector as a whole is evident given the weighted contraction of manufacturing, trade and government sectors totalling about 45% of nominal GDP.

Despite the Moody’s report focusing solely on the financial sector, contraction of other sectors can still spill over into the banking space. “Bad GDP numbers will obviously affect the banking sector at some stage,” says market analyst Wayne McCurrie of Ashburton Investments. “I don’t think it’s direct or immediate, but it will affect the banking space.”

 Slow retail sales growth

At the lower end of the market, July’s retail sales growth disappointed, with year-on-year figures weakening to 1.3% in July from 1.8% in June. This might seem like a negligible facet of the economy, but Stats SA notes that South Africans spent R31 900 per second in retail stores in 2017. This means that the retail industry generated sales worth R1 trillion at current prices, in 2017 alone. With a contraction in retail sales, consumer-centric banks are bound to feel the pressure.

“Household debt is still at high levels, leaving consumers vulnerable to interest rate hikes, and this can be seen in increasing levels of non-performing loans in the half-year results released by the banks,” says Tsitsi Hatendi-Matika, head of retail investment at Absa. “The banks will remain under pressure until the consumer gets some sustained and significant relief.”

Moody’s senior credit officer vice-president Nondas Nicolaides acknowledges the risk: “We generally believe that the retail sector is more vulnerable to the current slowing economic conditions and that banks with higher exposure to households and especially unsecured retail loans are likely to sustain higher losses in this context.”

Gloomy PMI

The Purchasing Managers’ Index (PMI) is an important indicator in macro-economic predictions as it sheds light on economic expectations in the near term. By analysing new orders, inventory levels, production, supplier deliveries and employment, the PMI gives insight on manufacturing output. August’s PMI collapsed 8.1 points to 43.4, the lowest reading in over a year, indicating the likelihood of a contraction in manufacturing production. This year’s PMI readings have been rather spread, with July at 51.5 (above the key 50 neutral mark) and June at 47.9.

With mixed PMI figures, manufacturing activity will be affected along with credit to the manufacturing sector, which will affect banks’ revenues.

“South African corporates are sitting on the sidelines given the policy uncertainty on the mining charter and [the] land reform [process], which undermine business and investor confidence,” says Nicolaides. “We expect banks’ profitability to come under pressure over the next 12 to 18 months, which will be mainly driven by margin pressure and negative jaws [income growth rate minus expenses growth rate].”

Hatendi-Matika adds: “The drop in PMI was mainly driven by a sharp fall in demand for new work, resulting in a decline in business activity. Input costs are on the rise and the picture remains challenging for manufacturers. The banking sector is affected when business activity is impacted, therefore the outlook remains challenging.”

Stagnant credit extension

“If you look at the run-up to the financial crisis, credit extension was in double-digit growth,” notes Isaah Mhlanga, executive chief economist at Alexander Forbes Investments, pointing out that 5% is “nothing” compared to double-digit growth.

Private sector credit extension growth has averaged 5.4% year-on-year so far this year, barely keeping up with inflation. Despite climbing to 5.7% in June from May’s 4.6%, it dropped again in July to 5.4%. 

Companies felt the headwinds too, with company credit extension slowing to 5.9% year-on-year in July.

“Company credit extension is showing decelerating general loans and advances, coupled with softer mortgages and investment,” says Hatendi-Matika. “These make up a significant portion of the reading and signal softer credit extension in that segment.”