Investing in South Africa’s bank is straightforward and considered a stable thing to do, right? Not quite. Investing in SA banks can be complex. We start by looking at how you can get exposure to First National Bank (FNB) and ask experts what their thoughts are about the bank and its holding company.
Chantal Marx, FNB investment analyst, clarified that FNB’s holding company FirstRand, is listed on the Johannesburg Stock Exchange (JSE). It is through this listing that investors are able to invest in FNB. “Clients can invest in FirstRand and other shares through FNB Share Invest or via our stockbroking services through FNB Securities,” revealed Marx.
According to Marx, shareholders participate in capital appreciation of the share price and receive a bi-annual dividend payment.
A look at FNB’s shares
It’s been a couple of years since the financial crisis but investors are still cautious about bank stocks overall. They remember how some banks in Europe and the United Kingdom had to be bailed out by the public so that they would not collapse. While South Africa’s banks weren’t as badly affected by the financial crisis there were still concerns about them, particularly over their exposure to loans.
However, Paul Khweyane, from GT247.com, feels that out of all the major banks in South Africa, including Barclays Group Africa (Absa), Standard Bank Group Ltd and Nedbank Group Ltd, FNB is the best choice. “FNB is our top pick with a fair value of R44 and a target price of R51.”
When it comes to FNB’s exposure to loans Khweyane points out that the bank has done more to protect itself than it’s rivals: “The company has the best performing loans in the sector with a coverage of over 100%, which is above it’s bad debt charge of 0.77% (also best in the sector). They also have good returns from their vehicle finance and unsecured lending, even though these have higher bad debts they have higher margins. They have a 100% portfolio provision coverage which would protect them against any rise in their bad debt ratio. The other banks have a coverage of around 60%.
“Compared to its peers, it’s better positioned to withstand a deteriorating credit market with a relatively flexible cost to structure.”
However, Khweyane highlighted that comparing the banks is a rather broad area as the different banks have different focuses. For example, Standard Bank has a large investment division mainly focused on Africa, while FirstRand (FNB) is more retail focused on South Africa.
Banks may be creating more of a buffer following the lessons they have learned since the financial crisis. But that’s not to say that investors aren’t in for a rollercoaster ride if they invest in the likes of FNB. “Over the last year, FirstRand’s share price has fallen by 15%, however, the share has already returned by 7.7% year to date. The banking sector has generally performed poorly over the last twelve month period and has only recently been able to recover from the losses suffered in December. Banking stocks fell sharply in response to the firing of Finance Minister Nene on 9 December 2015 – resulting in a blowout in both the rand and bond yields.
“Weakness in the share price has resulted in the sector – and FirstRand – becoming more affordable relative to the expected earnings trajectory and dividend payments. The sector currently appears to offer reasonable value,” says Marx.
Investing in the banking sector
Khweyane highlighted that the country is in the midst of an interest rate raising cycle by the South African Reserve Bank (SARB). This is due to the country’s weak economic environment, as well as a host of other external factors.
“In an interest raising environment, banks generally benefit in the short term from the endowment effect which comes from rising net interest margins which partially offsets raising impairments. However, as interest rates continue to rise and inflation [possibly] rises above 7% [the danger is that] the ability for clients to afford credit instalments will deteriorate which will result in an increase in bad debts and thus income will reduce,” says Khweyane.
There are a number of operating challenges that banks may be facing. There is the continuing weakening economic environment, as well as high unemployment which could impact people’s ability to afford their credit instalments. Furthermore, there is the country’s electricity problem which is impacting productivity, as well as the draught, which may both have an impact on the lending books of banks.
According to Khweyane, these factors and the current interest rate raising cycle poses a measurable risk to banks.
Tips for investing in the banking sector
Khweyane offers a few tips to those wanting to invest in the banking sector. He highlights that it depends on your investment horizon and what you want to achieve, but important factors to consider are:
- A strong management team: “Because of the highly leveraged nature of banks any small operational mistake would be amplified and can lead to erosion in capital and ‘meaningful’ losses. A strong management team can be a key differentiator for any bank in the long run,” reveals Khweyane.
For example, in 2003 Nedbank reported a 98% decline in earnings followed by a R5 billion rights issue underwritten by Old Mutual, notes Khweyane. In 2004, Tom Boardman took over the position of CEO at the bank and things started to turn around. Boardman immediately appointed a new management team, and over ten years they achieved earnings growth of 15.7%, dividend growth of 24% and a tangible net asset value growth of 14.1%. During this time key staff left Nedbank, however, they were replaced with internal candidates, which Khweyane believes“demonstrates a strong succession plan which is a critical ingredient in banking.”
- Prudent provisioning: This refers to the bank provisioning for doubtful debts, as it allows the bank to protect itself from unforeseen losses. The provision made is at the discretion of the bank’s management, again showing the importance of the quality of the management team.
- Strong capital position: Following the 2008 global financial crisis, banks are required to have adequate capital “to be able to handle any unforeseen adverse economic movements,” highlights Khweyane.
In addition to the above points, other factors that investors would look at, according to Khweyane, include:
- Return on equity: Investors may look at the appreciation in the share price. This could happen due to a number of reasons. Depending on an investor’s investment horizon, “they might see a move higher in the short term but long term the share might depreciate – but still paying dividends for example,” says Khweyane.
- Dividend yield: Rather than a return on equity, investors may look for the dividend yield of a company, which might lead them to invest in a bank that has a high dividend yield.
“There are a number of factors that an investor would look at depending on what their objective is,” emphasises Khweyane.
Before making any decisions regarding investments and finances, speak to an authorised financial advisor to find the best solution for you and your needs.