Global Bank Equity Specialist, Creative Portfolios

Paul Hollingworth

Global Bank Equity Specialist

Creative Portfolios

Thematic (Sector/Industry)

South africa Financials / Thematic (Sector/Industry)

South African banks look vulnerable to another downshift in value as the market prices their deep "junk" status. It is not just the short-term that concerns us but the medium-term.Fitch has lowered South Africa's rating to 'BB-' from 'BB', while Moody's lowered it to 'Ba2' from 'Ba1'. Fitch sees the country's GDP to remain below 2019 levels even in 2022 as the debt burden increases pressure on public finances. South Africa is likely to see more downgrades in the future since Moody's and Fitch have cut their sovereign rating outlook on the country to negative.There is a sense that once impregnable bank franchises might start to really crack when the 2nd Covid wave intensifies. Credit conditions are tightening. Risk-averse banks are being crowded out and the Sovereign-Bank nexus is an issue. Given the steep yield curve, banks are holding off from funding investment in the real economy. The Banking Sector may well be more fragile than we thought.<div class="content-highlight">
PH Scores are subpar as it stands: FirstRand at 2.47, Capitec and Nedbank at 3.3, and Standard Group at 4%. This is a signal of lower share prices ahead and as a country represents the lowest Scores globally. The fundamental trends and value-quality characteristics are eroding fast. 
The PH Score™ is a fundamental momentum-quantamental score that scores banks according to changes in value-quality. The Score encompasses Profitability, Operating Efficiency, Liquidity, Capital, Asset Quality, and Coverage as well as a valuation variable. Scores lie between 0 and 10, with higher scores representing more positive signs. The PH Score™ was back tested over 2007-17 for global banks and conclusively shows progressively higher returns across quintiles ranked by Score. 
</div>Valuations still look too elevated on a relative basis (versus other global banks) rather than on an historical basis versus EM. But South Africa's history is just that, history. We are uneasy about extrapolating from a very different time.We do not believe that an investor should pay 1.88 BV for First Rand, let alone 5.9 BV for Capitec. Even Standard Group trades above BV. On a FV basis, Capitec is "off radar" while Standard Group and FirstRand stand at 15% and 20%, respectively, which is relatively rich versus the world.We do not doubt that there may be trading opportunities at lower share price levels (on a fully-fledged IMF package next year, beyond recent emergency deal) but we do not see sustainable upside in the current environment unless the social-political context changes greatly and reforms can really take root.

South African banks look vulnerable to another downshift in value as the market prices their deep "junk" status. It is not just the short-term that concerns us but the medium-term.Fitch has lowered South Africa's rating to 'BB-' from 'BB', while Moody's lowered it to 'Ba2' from 'Ba1'. Fitch sees the country's GDP to remain below 2019 levels even in 2022 as the debt burden increases pressure on public finances. South Africa is likely to see more downgrades in the future since Moody's and Fitch have cut their sovereign rating outlook on the country to negative.There is a sense that once impregnable bank franchises might start to really crack when the 2nd Covid wave intensifies. Credit conditions are tightening. Risk-averse banks are being crowded out and the Sovereign-Bank nexus is an issue. Given the steep yield curve, banks are holding off from funding investment in the real economy. The Banking Sector may well be more fragile than we thought.
PH Scores are subpar as it stands: FirstRand at 2.47, Capitec and Nedbank at 3.3, and Standard Group at 4%. This is a signal of lower share prices ahead and as a country represents the lowest Scores globally. The fundamental trends and value-quality characteristics are eroding fast. 
The PH Score™ is a fundamental momentum-quantamental score that scores banks according to changes in value-quality. The Score encompasses Profitability, Operating Efficiency, Liquidity, Capital, Asset Quality, and Coverage as well as a valuation variable. Scores lie between 0 and 10, with higher scores representing more positive signs. The PH Score™ was back tested over 2007-17 for global banks and conclusively shows progressively higher returns across quintiles ranked by Score. 
Valuations still look too elevated on a relative basis (versus other global banks) rather than on an historical basis versus EM. But South Africa's history is just that, history. We are uneasy about extrapolating from a very different time.We do not believe that an investor should pay 1.88 BV for First Rand, let alone 5.9 BV for Capitec. Even Standard Group trades above BV. On a FV basis, Capitec is "off radar" while Standard Group and FirstRand stand at 15% and 20%, respectively, which is relatively rich versus the world.We do not doubt that there may be trading opportunities at lower share price levels (on a fully-fledged IMF package next year, beyond recent emergency deal) but we do not see sustainable upside in the current environment unless the social-political context changes greatly and reforms can really take root.

South African Banks: More Downside, I'm Afraid