South Africa downgrades leave banks losing war of attrition
South Africa’s drift further into junk means it’s time for investors to bail out of the country’s banks.
“Impregnable bank franchises might start to really crack when the second COVID-19 wave intensifies,” says Paul Hollingworth, banking analyst and managing director of Creative Portfolios in London. “The banking sector may well be more fragile than we thought.”
Hollingworth was still bullish on South African banks in April, when he argued that they were historically cheap versus emerging-market peers. Standard Bank and First Rand were “investment grade banks trading at a junk rating,” he said then.
Today, the “great fear” is that South Africa’s debt burden and interest payments may rise “faster and for longer than anticipated,” writes Hollingworth. “This would further put back growth initiatives and related reforms, pressure expenditure and revenues, and generate volatility in interest rates.” Any reduced access to international funding could trigger a fully fledged banking crisis and a run on the banks, he says.
South African banks, especially Capitec, are now too expensive, Hollingworth argues in analysis published on Smart Karma. “We do not believe that an investor should pay 1.88 times book value for First Rand, let alone 5.9 times book value for Capitec,” he writes.
- In fair value terms, Capitec is “off radar” while First Rand and Standard Bank are “relatively rich” versus the rest of the world.
- “Nedbank is the cheapest of the South Africa banks but to be honest they are struggling,” he says.
- An IMF rescue package in 2021 may create trading opportunities in South Africa’s banks at lower share prices, he says.
For now, better value in emerging market banks is to be found in Pakistan and Bangladesh, he adds.
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South Africa lost its last investment-grade rating in March. Fitch and Moody’s made further downgrades last Friday. Moody’s now rates South Africa two notches below investment grade, while Fitch’s rating is three levels below. Both agencies have negative outlooks.
- “Banks were always seen as proxies for economies,” says Hollingworth.
- “We had hoped for a culture change with President Ramaphosa but the reforms have been too little too late. Maybe he is unable to enact real positive change. Someone needs a decade to undo what Zuma did.”
Despite all the talk about COVID-19 being a catalyst for digital banking, customer experience at South African banks has been worsening rather than improving.
- The banks “could have done a better job in getter more of the client base to adopt digital banking channels sooner”, says Nolwandle Mthombeni, an analyst at Mergence Investment Managers in Cape Town.
- “Our banks are still reliant on the branch network”, she adds. “There remains an opportunity for entrants to take market share from the incumbents.”
BrandsEye’s annual South African Banking Sentiment Index published this month shows a sharp deterioration in customer attitudes to their banks. During COVID-19, 47.3% of priority customer conversation on social media went unanswered by the banks.
- Nedbank suffered a 33-point decline in its net sentiment reading to a six-year low.
- Capitec is the incumbent bank with the highest net sentiment. Yet it still had overall negative reading due to the unreliability of its app.
- Neither have the new entrants cracked it yet. As it struggles to become fully operational, Discovery Bank had the highest proportion of customers threatening to quit on social media.
- BrandsEye collected more than 2 million social media posts from consumers about South African banks from September 2019 to August 2020.
Investors looking for a COVID-19 banking recovery play need to look outside South Africa.