Samira Mensah Trevor Barsdorf South Africa Banking Sector 2021 Outlook: Sahil Tribhowan Benjamin Young Still Beset By Pandemic Woes Feb. 11, 2021 Key Takeaways – WeakWeak economic economic growth growth prospects prospects and and large large fiscal fiscal deficit deficit will will weigh weigh on on banks’ banks’ performance performance in in 2021. 2021. After After a a sharp sharp recession recession in in which whichGDP shrank GDP shrank by an byestimated an estimated 7.3% 7.3%in 2020, in 2020,we expect we expect GDP to GDP grow to bygrow 3.6% by 3.6%in 2021. in 2021. – TheThe government government focused focused its its attention attention on on the the pandemic pandemic but but is is still still formulating formulating vaccination vaccination plans. plans. Strict Strict lockdowns lockdowns are are unlikel unlikelyy t too return,return ,but but we we do do not not expect expect vaccines vaccines to to be be more more widely widely available available until until the the second second half half of of 2021. 2021. – WeWe forecast forecast that that the the growth growth of of credit credit to to the the private private sector sector will will be be subdued subdued in in 2021. 2021 .Credit Credit leverage leverage (private (private sector sector credit credit t too G GDP)DP) in in the theeconomy economy will will remain remain high high at aboutat about 80% 80% of GDP of GDP after after gradually gradually declining declining through through 2020 2020-2021.-2021. – EarningsEarnings proved proved resilient resilient in in the the face face of of rising rising credit credit losses losses in in 2020 2020--2021.2021 .We We estimate estimate that that credit credit losses losses rose rose to to about about 1.8% 1.8% in in 2020 2020and will and moderate will moderate to 1.4% to 1.4% in 2021; in 2021; nonperforming nonperforming loans loans comprised comprised 6% of 6% total of totalloans loans over thisover period. this period. – AlthoughAlthough top top--tiertier banks banks are are exposed exposed to to wholesale wholesale short short--termterm deposits, deposits, these these largely largely stem stem from from domestic domestic nonbank nonbank financial financial institutions.institutions .We We expect expect liquidity liquidity coverage coverage ratios ratios to to exceed exceed the the 80% 80% minimum minimum set set by by South South African African Reserve Reserve Bank Bank (SARB) (SARB) in in A2020 April 2020.. – WeWe consider consider the the regulatory regulatory framework framework supports supports stability stability in in the the banking banking sector. sector .We We expect expect SARB SARB to to lift lift regulatory regulatory forbearance forbearance measuresmeasures around around capital capital relief relief and and liquidity liquidity support support only only gradually. gradually. The The Prudential Prudential Authority Authority took took swift swift action action to to support support th thee banking bankingsector and sector the andstability the stability of the capital of the markets.capital markets. – ThisThis will, will, in in turn, turn, support support banks’ banks’ strong strong regulatory regulatory capital capital levels, levels, despite despite high high earnings earnings pressure pressure from from higher higher loan loan impairme impairmentsntsinin 20202020--2021.2021. COVID-19 Caused Economic Growth And Fiscal Consolidation To Stall – Strict lockdown measures in 2020 triggered a sharp economic contraction. The government is focusing on managing the spread of the virus; its vaccination plan has yet to be finalized. – Signs of recovery emerged in third-quarter 2020 and we expect a moderate rebound in 2021. – This will, in turn, support slow fiscal consolidation in 2021- 2023. Nevertheless, real GDP will return to pre-pandemic levels only in 2023. Real GDP Will Not Return To Pre-Pandemic Levels Until 2023 4 Real GDP growth 2 0 Real GDP per capita 2015 2016 2017 2018 2019 2020F 2021F 2022F 2023F growth (2) % (4) (6) (8) (10) F--Forecast. Source: S&P Global Ratings. 3 Lending Growth Will Remain Subdued – We forecast credit to the private sector will grow by only 2%-4% in 2021. – Both lenders and borrowers have been reluctant to use the government’s South African rand (ZAR) 200 billion loan guarantee scheme to support small and midsize enterprises (SMEs) during the pandemic. – Corporate lending growth has moderated over the past five years and mortgage growth has been stable. Private Sector Credit To GDP Dipped In 2020, But Remains High Unsecured Lending Grew Faster Than Secured Lending Consumer Credit Mortgages Corporate Total HH lending 88 18 16 86 14 84 12 10 82 8 80 6 Credit growth by asset class (%) 4 78 Private sector credit to GDP (%) (%) GDP to credit sector Private 2 76 0 2017 2018 2019 2020F 2021F 2013 2014 2015 2016 2017 2018 2019 F--Forecast. Source: S&P Global Ratings. HH--Household. Source: South African Reserve Bank. 4 High Credit Risks Show Few Signs Of Fading – Systemwide provisioning levels have improved since 2017, partly because nonperforming loans now include more unsecured lending, and the rules about impairment charges changed with IFRS 9. – The shift toward unsecured lending changed the nature of leverage and pressured household income, creating a significant source of risk. – Historically, provisioning at the major banks was moderate, given the level of economic risks and the high household debt metrics. Banking Sector Credit Losses Spiked In 2020 Top-Tier Banks’ Nonperforming Loans And Coverage By Provisions 2.00 FirstRand LLR/NPL (left scale) NedBank LLR/NPL (left scale) Standard Bank LLR/NPL (left scale) Absa LLR/NPL (left scale) 1.80 FirstRand NPL ratio (right scale) NedBank NPL ratio (right scale) 1.60 100 10 1.40 80 8 1.20 1.00 60 6 (%) 0.80 LLR/NPL (%) LLR/NPL 0.60 40 4 ratio NPL 0.40 20 2 0.20 New loan loss provisions/average loans 0.00 0 0 2017 2018 2019 2020F 2021F 2016 2017 2018 2019 2020 Source: S&P Global Ratings. LLR--Loan loss ratio. NPL--Nonperforming loans. Source: S&P Global Ratings. 5 Banks Have Learned To Accommodate Pockets Of Economic Stress – Commercial real estate has shown growing signs of stress since 2017. Structural shifts have caused an increase in office vacancies which, combined with an extension of the current lockdown measures, could weigh on performance to beyond 2021. – The sluggish economic recovery and loss of income will magnify household debt in 2021, causing higher losses for banks from vehicle and asset finance and personal loans. – More positively, moderate interest rates have kept residential house prices stable since 2015. SARB cut benchmark rates three times in 2020 but, given banks’ muted risk appetites, we don’t expect bubbles to develop in the mortgage market. Secured Lending Accounts For The Majority Of Banks’ Retail Commercial Real Estate Exposures Are Largely Income Producing Exposures Corporate Project finance Personal loans / overdraft / RCF Retail mortgages Object finance Commodities finance Income producing commercial real estate HVCRE and construction loans Credit cards Vehicle and asset finance 60 80 70 50 60 40 50 % % 30 40 30 20 20 10 10 0 0 Investec Nedbank Absa Standard FirstRand Investec Nedbank FirstRand Standard Absa Ltd Ltd Group Bank Ltd Ltd Ltd Ltd Bank Group Ltd Group Ltd Group Ltd Ltd HVCRE--Highly volatile commercial real estate. SME--Small and midsize enterprises. Source: S&P Global RCF--Revolving credit facility. Source: Company financials. Data at December 2019 for Absa, Nedbank, Ratings. Standard Bank, and FirstRand; March 2020 for Investec. 6 South African Banks Maintained Its Capitalization Through The Crisis Top-Tier South African Banks Have Strong Regulatory Capital – We expect top-tier banks’ Tier 1 ratio to reduce by about 100 basis points in 2020. CET1 ratio AT1 ratio Tier 2 ratio – The Prudential Authority lowered the 2A CET1 requirements Tier 1 requirements CAR total 18 capital buffer (systemic risk buffer) to zero to help banks navigate the stress period and 16 allowed banks to draw down on their 14 conservation buffer, if needed. These capital relief measures were intended to support 12 banks in extending credit during time of stress, 10 rather than to distribute dividends. The % regulator advised banks to suspend dividend 8 payments in 2020, but allowed them to pay 6 dividends that had already been approved for distribution in 2020. 4 – Drawdown on conservation buffers must be 2 precleared with the PA, to ensure that banks 0 are not aggressively lending and remain well Nedbank Group Standard Bank Investec Ltd. Group Absa Group FirstRand Group capitalized. South African banks are unlikely Group to make use of the conservation buffer thanks CET1--Common Equity Tier 1. AT1--Additional Tier 1. CAR--Capital adequacy ratio. Source: Banks' Pillar III reports, June 30, 2020. to resilient earnings. We expect most of these Requirements are national minimums. Source: Company financials. Data as of December 2019 for Absa, Nedbank, Standard Bank, and buffers to be reinstated after 2022. FirstRand; March 2020 for Investec. 7 Funding Remains Stable And External Refinancing Risk Is Limited – The South African banking sector is largely funded by customer deposits and domestic wholesale short-term deposits; contractual savings tend to be dominated by professional money managers. – Domestic rand liquidity was preserved during 2020 by resident exchange controls, which mitigate banks' exposure to institutional funding. – Major banks are not exposed to large-scale refinancing risk or a reversal of investor sentiment because they do not rely on international funding. South African Banks’ Funding Profile Improved Prior To The Foreign Currency Liabilities Are Limited For The Sector Pandemic Net banking sector external debt as a % of systemwide domestic loans 72 Liabilities in foreign currency as a % of systemwide liabilities 70 6 68 4 66 2 % 64 0 % (2) 62 (4) 60 (6) 58 (8) 56 2017 2018 2019 2020F 2021F 2017 2018 2019 2020F 2021F F--Forecast.