In a very challenging operating environment for the six months to 31December 2008, FirstRand Limited’s proforma normalised earnings decreased 23% to R4.6 billion with a normalised Return on Equity (“ROE”) of 17% compared to 26% in the comparative period. The results are in line with the trading update provided to the market in December 2008.
The FirstRand Banking Group’s corporate and commercial franchises, which operate in the local primary and secondary markets, provided solid performances. However, the retail franchises showed strain due to the current negative consumer credit cycle. The total banking portfolio produced R4.1 billion of normalised earnings, representing a 21% decline on the comparative period. Its normalised ROE declined to 17% from 26% in 2007.
The Momentum Group delivered a strong operational performance with good new business growth and improving profit margins. However approximately 65% of Momentum’s operating profit is exposed to equity market performance through asset based fees, which declined significantly in line with equity market weakness. Momentum’s conservative capital management strategy of not exposing its capital to equity market volatility immunised its earnings to some extent against the impact of falling markets. Normalised earnings reduced 19% to R740 million from R913 million in 2007, although the ROE remained robust at 23%.
Commenting on the results, FirstRand CEO Paul Harris said:
“The banking environment both locally and globally remained very tough in the reporting period. The Group’s results reflect solid operating performances from all the local franchises given the credit cycle, however they were partly offset by underperformance in the trading and investment portfolios that are exposed to the international capital markets. Notwithstanding these circumstances the diversified nature of our portfolio ensured that we made a reasonable profit in very difficult market conditions.”
Two factors negatively impacted the profitability of the Banking Group. The first was the slowing advances growth and increasing bad debts at FNB and WesBank. The second factor was losses in RMB’s Equity Trading division and certain offshore debt and investment portfolios.
The overall bad debt charge amounted to 1.64% of advances (retail 2.41% and wholesale 0.66%) which compares favourably with the 1.65% to 1.75% range previously communicated to the market. In order to reduce potential earnings volatility in the future a number of measured strategic actions were taken on the credit portfolios to enhance the risk return characteristics. A natural consequence of this was a loss of market share in some retail markets.
In RMB the client facing franchises operating in primary markets, Investment Banking and Fixed Income, Currencies and Commodities produced strong profitability. However Equity Trading incurred losses as a result of the Dealstream default and the de-risking of its portfolio in a weak market. In addition certain offshore debt and investment portfolios that were affected by the weaker global markets incurred losses, some of which were mark to market losses which could reverse as fixed interest assets mature. Overall RMB contributed R1.9 billion to profits albeit 20% down on the comparative period.
Commenting on prospects Harris said that asset quality deterioration and bad debts remained in line with expectations given the cycle. “ While interest rates have probably peaked, the deterioration in the credit cycle will continue into 2009 and may be exacerbated by further stress in the real economy resulting in further job losses and a continued decline in asset values. Lower interest rates will initially negatively impact profits as interest earned on capital reduces. However bad debts should start to decline during 2010 as lower interest rates relieve the pressure on the consumer.
“Consequently, earnings from the Group’s local retail franchises will remain under pressure in the second half of the year, however the local investment and corporate banking activities are expected to remain resilient.
”In these circumstances the policy of reducing earnings volatility by de-risking investment and trading portfolios and thereby preserving capital may contribute to lower profits in the short term but is prudent in the prevailing market conditions. A continued focus on protecting our origination franchises will position the Group to take advantage of the recovery when it materialises."
“Given the above scenario the performance for the 12 months to 30 June 2009 will be similar to the first half.”