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Banks may be through the worst of the downturn

26 August 2009 Ernst & Young

At a media briefing hosted today, Ernst & Young lead Banking & Capital Markets director, Emilio Pera provided perspective on the banking sector in the current market environment. Pera believes that there are signs that banks may be through the worst part of the economic downturn, and that credit impairment trends appear to have troughed. ‘Going forward’, he says, ‘there are some indications that banks are again starting to extend credit, certainly more so than we have seen in the past 18 months.’

The media briefing was focused on banks identifying opportunities in the current economic environment. Continues Pera, ‘Whilst times are definitely the bleakest banks have endured for well over a decade, there are nevertheless opportunities that present themselves in current times. We have seen across the globe, banks have been forced to re-assess their business models, consider exiting unprofitable markets, and ensuring a more holistic view of institutional risks, something which may not have been considered all that important in the past. In addition, we have seen banks re-examine unprofitable business units, such as mortgages, and re-look at their distribution costs in these areas, with a view to ensuring a return to profits in these problem markets.’ This was due to substantially reduced capital availability and increased cost of funding terms.

Locally, our banks have been through a similar process. High interest rates were already prevalent prior to the onset of the global liquidity crisis impacting our shores, and in fact, it could be argued that to some extent this, together with the National Credit Act probably helped banks minimise the impact of the global downturn. Even so, says Pera, ‘South African banks have most definitely felt the impact of higher capital costs, and restricted capital availability. In addition, credit impairments have whittled away bottom line profits, predominantly in the retail segment, but the corporate market too.’

‘Undoubtedly’, he continues, ‘the recession has proved a double-whammy to the banking sector, with the corporate sector proving to be less resilient to the economic downturn than initially estimated. Usually, our banks benefit from diversified revenue flows in that slow retail markets are often offset by strong corporate earnings and vice-versa. However, at this point in the cycle, we are seeing slower profits in both the retail and corporate market segments.’

However, he adds, ‘ our banking industry has not recorded any losses in the two major market segments, with both retail and corporate banking still reflecting profits, just at lower levels. This is in stark contrast to the major global banks that have declared substantial losses over a few consecutive quarters (although suggestions are that the worst has past).

Furthermore, a breakdown of the retail banking segment indicates that there are a number of product portfolios that are not performing well at all. The mortgage portfolio is under tremendous pressure, with an estimated loss of in excess of R2bn between the big 4 banks at the half-year mark. Vehicle finance loans are also proving problematic to the banks, and have a similar credit impairment impact, resulting in unprofitable bottom-line profits.

Pera also commented on the fact that banks have received a lot of negative publicity about their perceived exacerbation of the recession through a reluctance to lend. ‘There have been a number of lobby groups calling for banks to lend more generously. But they forget that banks are compelled to lend responsibly via the National Credit Act. Any reckless lending on the part of banks would be self-defeating for the banking sector, because banks must ensure that loan repayments are affordable for consumers. The real issue lies with squeezed consumer income, which has been hurt by high inflation, high interest rates (albeit moderating), and rising unemployment.’

This in turn, has resulted in high levels of credit impairments, which directly hurts the bottom-line, and which more than anything else, is squeezing sector profitability. Resumption in consumer income levels will allow banks to open the credit taps once again. Until then, banks are likely to be very cautious, given their already high level of non-performing loans.

Pera also comments on the impact of the global crisis on the rest of Africa; ‘typically a number of economies in Africa are single-resource dependent, and given the impact of the crisis on global commodity prices, it is no surprise that Africa has not fared well. The major economies of Nigeria and Kenya, have seen their currencies come under pressure, and this in turn has led to capital flight by global investors, not too dissimilar to what South Africa experienced in the last quarter of 2008. In the interim, SA has seen a strengthening currency, as resource demand recovered, while in Kenya and Nigeria, currencies continue to hover at weak levels.’

For one thing, notes Pera, ‘there was substantial over-exposure by banks to the oil and gas sector in Nigeria, as well as high capital market exposure. There is no real equivalent of sector over-exposure in SA, although there were question marks about whether BEE was not perhaps our own subprime crisis waiting to unfold.’

In concluding, Pera notes that any regulatory changes under consideration could benefit the industry overall, not only in South Africa, but across the African continent. Nigeria is the most pertinent example of a country where the banking regulatory landscape is likely to change fundamentally over the short term, as regulators move to return calm to their market. Well considered regulatory changes may not be a bad thing anywhere, provided they are not knee-jerk reactions. Thus far South Africa is leading the continent’s banking sector out of recession, having troughed sooner than most other players on the continent.’

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