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

“However, while earnings have recovered to pre-pandemic levels, we are yet to see these businesses return to their trendline earnings growth of 11.5% per annum exhibited since 1995,” says Davids. 

Most recently, the fallout from the pandemic impacted earnings in the sector, mainly through bad debts and high provisioning. However, Davids says since the historic lows of March 2020, banking shares have posted a stellar recovery, outperforming the JSE All Share Index by 42% over the period.

One of the biggest advantages the sector boasts is a captive market since banks are intricately linked to a functional economy. 

The funding of renewable infrastructure has also proved a new source of revenue. 

Praven Subramoney, chief executive of FNB Home and Structured Lending Solutions, says 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 switch their home loan to FNB and release equity in the property, will receive 61,000 eBucks that can be used towards the purchase of solar – and the bank will also pick up  the bond cancellation and bond registration costs.

“Homeowners opting to use their home loan or secured credit facility to finance a solution of this nature need to weigh up the financing costs versus the savings in monthly electricity and water costs, which usually yield a positive net return after 4-7 years, dependent on the cost of the solution purchased,” he says.

Kyle Durham, head of Alternative Energy Solutions at FNB Commercial, says a solar energy solution increases the value of a property by embedding business continuity to it, and simultaneously reducing dependence on the country’s public power utility or municipalities, while cutting operating expenses. 

There is also the potential for being paid for selling that generated solar energy into the national grid, as occurs already in some municipalities in South Africa and elsewhere in the world.

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

Chief executive Mike Brown told Bloomberg that the bank’s lending towards the government’s Renewable Independent Power Producer Programme – aimed at boosting privately generated electricity in the nation – may jump to about R50-billion in the “short to medium term” from R29-billion.

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

“In recent years, we’ve seen several low-cost digital banks (with no bricks-and-mortar branch network) – powered by newer financial technologies – enter the market with the aim of disrupting the industry. 

“The challenger banks’ competitive advantage is that they can automate the transactional side of banking and offer lower fees, putting pressure on traditional banks’ non-interest revenue. 

“This 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 grown client numbers, the 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 own the profit pool and have the resources to defend their position.

Davids says bank earnings are driven by three elements:

• Net interest income. This is dependent on how much money banks lend out (their loan book) and the spread on interest rates between what they charge borrowers on loans and the rates they pay savers on their deposits, known as net interest margin.
• Non-interest revenue. This smaller, but not insignificant, portion of earnings is the banks’ ability to generate revenue through the economy wherever money flows. Every time you swipe a card or use a virtual card to purchase goods or a service, draw money at an ATM or buy electricity through a banking app, your bank earns fees (not forgetting the account fee).
• Bad debts. This element accounts for the cyclicality of banks’ earnings. The effect of bad debts on earnings is usually a function of the economic environment. The economic recessions of 2008 and 2020 saw a notable decline in the otherwise resilient earnings that underlie banks. 

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

“There’s a direct link between a change in interest rates and the profitability of banks, known as the endowment effect: when interest rates are rising, banks make more money seen through the net interest income line on the income statement,” he says.

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

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

Despite all of the positives, Sanlam Private Wealth is of the opinion that, going forward, bank stocks might not continue to see the same level of outperformance demonstrated recently.

“The global energy crisis, rising rates, consumer fragility and South Africa’s impending greylisting by the Financial Action Task Force will start to weigh on the sector as investors consider the repercussions for local growth. 

“Even though the banks are exhibiting resilient earnings and are well capitalised, they are particularly exposed to tail risks given their gearing and reliance on general consumer and business confidence. 

“The high levels of volatility of banking share prices during economic and political uncertainty do, however, create opportunities for investors,” Davids concludes. BM/DM