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Sanlam Private Wealth investment analyst Gary Davids points out that there has been a notable recovery in earnings in the sector over the past year.

“However, while earnings have returned to pre-pandemic levels, we have yet to see these companies return to their earnings growth trend of 11.5% per year since 1995,” Davids says.

More recently, the fallout from the pandemic has impacted earnings in the sector, mainly due to bad debts and high provisioning. However, according to Davids, since all-time lows in March 2020, bank stocks have shown a dramatic recovery, outperforming the JSE All Share Index by 42% over the period.

One of the biggest advantages of the sector is a captive market since banks are intimately linked to a functioning economy.

Funding for renewable infrastructure has also proven to be a new source of revenue.

Praven Subramoney, managing director of FNB Home and Structured Lending Solutions, explains that the bank offers access to secured credit to purchase and install various home solutions such as a grid-tied solar system or a solar hybrid solution with battery installation.

As an incentive, homeowners who choose to transfer their home loan to FNB and release the equity in the property will receive 61,000 eBucks that can be used to purchase solar energy – and the bank will also support the cancellation fees and registration obligations.

“Homeowners who choose to use their home loan or secured credit facility to finance a solution of this nature must weigh the financing costs against the savings on monthly electricity and water costs, which typically generate a positive net return after 4 to 7 years, depending on the cost of the purchased solution,” he says.

Kyle Durham, head of alternative energy solutions at FNB Commercial, says a solar energy solution increases the value of a property by building in business continuity and simultaneously reducing dependence on utility power. electricity or municipalities across the country, while reducing operating expenses.

There is also the possibility of being paid for the sale of solar energy generated in the national grid, as is already happening in some municipalities in South Africa and elsewhere in the world.

In August this year, Nedbank revealed that it intended to double its lending to green energy projects over the next two years.

Chief executive Mike Brown told Bloomberg that the bank’s lending to the government’s Renewable Independent Power Producers program – aimed at boosting private sector-generated electricity in the country – could rise from $29 billion. rand to around 50 billion rand in the “short to medium term”.

However, Davids notes that financial inclusion is low, with a large informal sector currently driven by cash transactions.

“In recent years, we have seen several low-cost digital banks (without physical branch networks) – powered by new financial technologies – enter the market with the aim of disrupting the industry.

“The competitive advantage of challenger banks is that they can automate the transactional side of banking and offer lower fees, which puts pressure on traditional banks’ noninterest income.

“It has increased competition as more previously excluded people are drawn into the financial system, increasing the size of the pie for everyone,” he says.

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While these offerings have increased the number of customers, large traditional banks still account for more than 95% of loans and deposits within the banking system.

The big players – Capitec, FNB, Standard Bank, Nedbank and Absa – continue to hold the profit pool and have the resources to defend their position.

Davids says bank revenues are determined by three elements:

  • Net interest income. It depends on how much money banks lend (their loan portfolio) and the interest rate differential between what they charge borrowers on loans and the rates they pay savers on their deposits, called net interest margin.
  • Non-interest income. This smaller, but not insignificant part of profits is the ability of banks to generate revenue in the economy wherever money flows. Every time you swipe a card or use a virtual card to buy a good or service, withdraw money from an ATM, or buy electricity through a banking app, your bank collects a fee (not to mention the fees of account).
  • Bad debts. This element explains the cyclicality of bank profits. The effect of bad debts on revenue is generally a function of the economic environment. The economic recessions of 2008 and 2020 led to a notable decline in the otherwise resilient earnings that underpin banks.

“South African banks are currently in a sweet spot of profitability, as they are benefiting from rising rates but not yet experiencing the pain of rising bad debts.

“There is a direct link between a change in interest rates and the profitability of banks, known as the endowment effect: when interest rates rise, banks make more money, seen through the line from net interest income to the income statement,” he says.

Davids explains that the endowment effect is accentuated by several factors, one of which is “lazy” deposits – where customers leave their money in a savings or checking account that pays a low interest rate (for example, Standard Bank at 3.85%), and the bank then lends it to another customer at prime (currently 9.75%), earning the difference. The interest rates earned on these lazy deposits generally do not adjust as quickly or evenly to the prime rate.

These deposits have increased by more than 30% since December 2019, representing around 60% of total deposits in the banking system, according to data from the South African Reserve Bank. The prime rate has increased from 7% to 9.75% since October 2021 and is expected to increase further in the coming months.

Despite all the positives, Sanlam Private Wealth believes that going forward, banking stocks may not continue to show the same level of outperformance demonstrated recently.

“The global energy crisis, rising rates, consumer fragility and the impending gray listing of South Africa by the Financial Action Task Force will begin to weigh on the sector as investors consider impact on local growth.

“Even though banks are showing resilient earnings and are well capitalized, they are particularly exposed to tail risks given their leverage and dependence on general consumer and business confidence.

“High levels of volatility in bank stock prices during times of economic and political uncertainty, however, create opportunities for investors,” Davids concludes. BM/DM

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