There's not an analyst in town who hasn't predicted one of the past few years to be the year for banks. But investors just don't seem to be interested. Those who have not fled equities altogether are putting their cash into resources and industrials. And they certainly have beaten the banks on share performance.
Those punting the banks index have a sound sales story. SA banks are at historic lows in value terms - p:e lows not seen since the 1980s and earnings and dividend yields at 10-year highs.
"We're beginning to sound like a stuck record," says Kokkie Kooyman, financial services fund manager at Coronation Fund Managers.
He and many others point to the cocktail that should be making the banks sector ebullient. SA's economic growth levels are, relative to the developed world anyway, strong - though recent rand strength may change that. Growth is always good for banks, because they finance the expansion. More cash in customers' pockets also means they can service their debts more easily . Inflation is falling, helping banks to widen their margins; credit extension numbers are declining, giving banks room to do more lending; and inflation, hence interest rates, is subsiding, reducing credit defaults and providing further opportunity to expand lending.
But perhaps there is method in the market's madness. Some analysts paint a bleaker picture .
It's not banks alone that are cheap, says one - everything is cheap. So, in a sector auction, why choose banks over, say, resources or industrials (nobody bothers to include IT and "new economy" stocks anymore).
However, some say banks are looking better than other sectors. Resources and industrials are highly geared to the rand. Gold and platinum stocks are great while the rand is falling through the floor, or at least a steady one-way bet. And the same applies to export-orientated manufacturing, captured in the industrial sectors.
But that world has been turned upside down with the rand strength of the past year. Banks' earnings are not particularly sensitive to the currency, making them look better now than in the world of a one-way rand bet.
So there are clearly other issues at play. One is the regulatory bogeyman, with issues like the Community Reinvestment Bill, which would like to force banks to lend into unprofitable markets, and a financial sector charter bubbling below the surface of the industry. The charter will never have as catastrophic an effect as it did on mining shares last year - simply because the banks sector cannot afford that level of uncertainty. It won't just be investors left crying, but the whole financial system. Still, investors are nervous about government's apparent penchant for expecting the banking sector to solve all its problems.
As finance minister Trevor Manuel quipped at a recent Institute of Bankers dinner, if you want to get a banker's attention, just mention the word "charter". It is expected that a financial services charter, which would include insurers and asset managers, would encourage banks to finance empowerment and extend services to low-income South Africans.
Then there's the thorny issue of equity ownership. The big four banks have been hoping to make up for a lack of equity transfer with empowerment in other areas. Investec's deal in May, transferring 25% of the equity of the SA part of the group to black hands, has no doubt weakened the argument that equity transfer is too risky for a bank, and too expensive. But that deal cost just over R800m; an equivalent stake in the likes of Standard Bank would cost more than R10bn.
The charter will have far-reaching consequences for the way banks do their business. If government plays its part in accepting some of the risk of financing the empowerment deals necessary to drive its agenda, the charter will not necessarily be negative for banks' earnings.
The charter is still some way off, and must pin down exact targets. There are also likely to be arguments over the differing roles of banks, asset managers and insurers . The work so far, though, has been entirely industry-driven. Government is keeping its hands off.
Government is making life difficult in another way. Setting the Reserve Bank inflation targets has made monetary policy much more conservative. As a result, banks are unable to ride on credit binges by the private sector. The hawkish monetary authorities intervene as soon as they see inflationary pressures mounting - and private-sector credit extension is one leading indicator of inflation. No matter what happens to inflation numbers, the Reserve Bank won't allow the debt-spending binges that allowed banks to grow their advances book rapidly in decades gone by.
Some have speculated that the declining interest rate environment is also good for banks' interest income. It's a basic theoretical point - if interest rates come down, bad debts are alleviated because existing borrowers find it easier to make repayments. In addition, it is easier to sign up new borrowers. But the evidence in the SA market suggests otherwise. If bad debt rates were going to decline because of falling interest rates, we would expect them to have increased during the interest rate rally in the past year. But they haven't. Some suggest this is because most marginal businesses were killed in the 1998 interest rate spikes and the subsequent bad-debt squeeze on banks. Corporate clients are in general much better at handling the current interest rate spike.
The prospect of interest rate cuts is not all good news for the banks. "It's a two-edged sword," says FirstRand Bank CEO Paul Harris . "You should have bad debts coming down [and clients] could borrow a little bit more. But on the other side there are endowment effects - you get less on the capital that you are investing." The two effects cancel each other out.
In addition, new borrowing may be tempered by government's staunch stance against inflation.
There's also bad news in the stronger rand. Many bank clients have jumped on the export bandwagon, and borrowed heavily to increase capacity while the rand did its dip. Now they face unprofitable rand prices again, which may turn into dire straits for them, and a bad-debt boom for the banks. Investec CEO Stephen Koseff, though, says the bank has not noticed any significant spike in borrowing from export-orientated clients. Standard Bank financial director Simon Ridley says the bank is watching the effects of rand strength on clients carefully, but no trend is clear.
Banks have also had to improve their service delivery, particularly on the retail side. Competitive pressure has forced them to provide service through the Internet, telephone banking, high-end personal banking and ATMs, all the while maintaining an expensive branch structure.
"Customers want the full range, and you have to offer it. If [the use of] those services increases less than inflation, the cost [to the bank] increases," says Harris.
There is more reason to be concerned about the noninterest side of the income statement. Banks have driven growth primarily through noninterest revenue for the past seven years. Relative to interest income, other income has grown from 65% to 114%. Some of that growth has been from broadened service offerings, particularly insurance. But a substantial component has been driven by increased charges to banking customers. Naturally investors are starting to ask how sustainable that is . Add the impact of possible consumer and political pressure, and noninterest revenue is looking unreliable.
"I think that question has been asked for the past 10 or 15 years - where is growth going to come from? - and growth has been there," says Harris.
There is another positive to the bigger banks' earnings prospects: decreased competition. Before the disappearance of Saambou and BoE, the six biggest banks held 85% of the market. But smaller banks provided significant competition to earnings margins. Banks like Brait, Saambou and Corpcapital often offered the highest deposit interest rates in the market. They forced the larger banks to increase their deposit rates, and that put pressure on interest margins. Until the collapse of Saambou, banks like Internet bank 20twenty were putting pressure on the fee side as well.
That competitive pressure has been relieved by the collapse of Saambou, the acquisition of BoE by Nedcor, and the cancellation of the banking licences of Brait, Corpcapital and African Merchant Bank. Now the five big domestic banks control 91% of the assets in the domestic banking industry.
Foreign banks like Citibank and JP Morgan have grown deposits and assets rapidly, but still do not make up for the midsized and small banks of the late 1990s.
The only other banks of significant size are Sanlam-controlled Gensec and African Bank, which have under 2% of the industry's assets between them. Neither is likely to compete aggressively for deposits, having cheaper access to funding through paper debt (African Bank) or head-office capital (Gensec).
Of course, in the irrational world of stock markets, banks are as subject to sentiment as any other sector. A rerating of bank shares could happen if investors turned against resources and industrials.
If you do decide the banks index is the place to put your cash, the counters have done different things.
There's little doubt that Standard Bank has marched its way to the top of analysts' choices (see page 66). FirstRand and Absa are also safe bets, depending on the price at the time, while Nedcor, thanks to earnings disappointments and the inherent risk of its merger with BoE, is on the "avoid" list.
Investec, listed in the specialised finance index (printed here in addition to the banks index), is suffering from its dependence on global equity markets. African Bank, which is defying sceptics with its microlending banking model, has regained momentum since the market suffered the collapse of Unifer and Saambou. Its model is looking for now like a world beater and earnings look solid for the future.
Beyond those, only minnows Mercantile, Capitec and Sasfin are listed banks. Mercantile has developed a steady trend of losing money and doesn't offer investors any real case. Sasfin has remained reasonably profitable and avoided the graveyard in which Corpcapital, Brait, AMB and Cadiz have handed back their licences. It has yet to capitalise on its stand-alone position in the small bank market, though. In Capitec's brief life, it has shown it can handle the microlending market.
Investec is in cost-cutting mode, and at current prices offers value. It will not have a real renaissance until the next equity bull market arrives . To a lesser extent, the same applies to all banks. And that could be a painful four to five years away.
