This year is shaping up as the year of retail banking. Consumers are loading up on debt at a pace not seen since the early 1990s.
A year ago, a debate raged on what the impact of low interest rates would be. It was commonly accepted that interest rates were on a downward curve, and the 5,5 percentage point drop during 2003 vindicated this view. The prime rate at the time of going to press, at 11,5%, is the lowest since 1981. On the one hand, banks' interest margins are squeezed by low rates. Banks pay nothing for their own capital, which makes up at least 10% of their funding, so an interest rate drop is an absolute cut on margins earned on that cash. On the other hand, consumers are more likely to borrow at lower rates. The question a year ago was whether volumes would beat the margin squeeze.
Fast-forward a year and the volume side has won hands down. Consumer confidence, reflected in retail spending, asset finance and property prices, has been spectacular. Instalment credit (mainly consumer car finance), credit cards and mortgages were each up 17% in the year to March. A year ago those measures were up 11% on the previous year. The banks' statistics reflect others in the market - retail spending was up 20% in the first quarter, according to Stats SA. The National Association of Automobile Manufacturers of SA says retail motor sales were up a whopping 27% in the year to May. Property prices were up 24,3% in May from a year earlier, the biggest increase in 20 years.
The banks index has outpaced the all share index (Alsi) by a small margin. That margin increases substantially when Nedcor - which had its worst year in two decades, thanks to bad debt and poor earnings reporting - is removed. The share prices of Absa, Standard Bank and FirstRand were all up around 40% in the year to May, with Standard Bank leading the pack. Investec's share price, which was at historic lows a year ago, appreciated by 40% despite its limited exposure to the retail market. The Alsi was up 36% in the same period, held back by resource stocks.
The question facing banks is how long the party will last. Rocketing oil prices are putting inflationary pressures on the economy and this may push the Reserve Bank to raise rates. Recovering global markets and a strong rand could also add inflationary pressure. Private-sector credit extension is another factor. More cautious commentators now expect to see a rates increase of one percentage point by the end of 2004.
Some banks are turning to caution. Absa CEO-designate Steve Booysen says a significant amount of lending has been made to the emerging black market - consumers who have entered the economy at the bottom of the cycle and geared themselves fully. An interest-rate spike could hurt them badly. The banks are well aware of the pain inflicted when interest rates spiked in 1998 - the bad debt losses that followed began to abate only last year. A squeeze on consumer borrowing could put an end to positive consumer sentiment.
There are indications that banks are quietly tightening up on the quality of security held against retail lending.
Corporate and investment banking has been less exciting, despite the flash of life in equity markets. The JSE has stagnated this year after a great run last year. Investec, whose fortunes depend heavily on equity markets, has seen an improvement in earnings from investment banking, though CEO Stephen Koseff says the bears are still out. "Everyone is still listening for bad news."
One area of action has been black economic empowerment. The banks are subject to the financial-sector empowerment charter , which is driving bank initiatives such as bringing in black shareholders and extending financial services into rural areas. Absa and Investec have both struck deals which envisage significant black shareholdings in the next few years.
And banks' investment banking arms have all been busy with transactions for clients. Empowerment is certainly driving deal flow, but it's less clear that it is driving bank earnings. One senior investment banker tells the FM that the problem is that usually only one side of an empowerment deal is paying for it. That limits the fees a banker can earn.
In addition, when a bank finances an empowerment deal, it is taking on more risk - typically, lending is on a nonrecourse basis, so the only security is the value of the equity in a target company. If a transaction fails because the equity appreciation does not cover the cost of debt, that will leave the banks holding security worth far less than the amount they lent.
Banks try to mitigate that risk by buying put options from the target holding company to hedge their exposure. Nedcor now faces settling the options held by financiers of the Peoples Bank empowerment deal. The pressure will mount on banks and other financial institutions to increase their financing of empowerment and they are counting on government to help reduce the risks.
Corporate banking is showing signs of life. The SA Chamber of Business's business confidence index is at its highest level since it began in 1985. Empowerment is likely to be much easier in a vigorously growing economy. GDP growth of 3,1% in the first quarter was better than expected and will support confidence. It was the 22nd quarter of positive growth - a record. Economists are predicting a 2,5% growth figure for 2004.
It adds up to a positive story for banks, provided the retail trend continues and exuberant lending does not come back to haunt the banks. There is potential for growth in the corporate sector and the indicators predict it will be realised. Investors with faith in the performance of the real economy should look to banks as a way to get in on the act. Standard Bank and FirstRand, which both have broad corporate and retail exposure, are probably the best way to do it.
