There is nothing rational about market movements right now.
After a 28% decline on Wednesday, shares in Capitec Bank slid a further 31% on Thursday morning to trade just above the R550 level. Shares in the bank closed at 15% lower than Wednesday at R682.50. This brings the drop over the past two days to 39%.
In that time, the bank has lost R49 billion in market value. It is likely that derivative structures caused the steep and rapid declines as margin calls were triggered at various levels through trading on Wednesday and Thursday.
In a “general statement” to the market on Thursday afternoon, Capitec states: “Globally, markets are in economic turmoil due to the effects of Covid-19, and many companies, including the banks, have seen big declines in their share prices.”
It says it believes “that the sharp decline in the Capitec ordinary share price since [Wednesday] may be attributable to the following technical reasons”:
- International shareholders are impacted by the continued weakening of the rand which, over and above the declining share price, further motivated the disposal of their Capitec shares.
- The algorithms applied by professional traders enforce disposal of a share when the price of that share declines below a certain limit.
- Banks that are counterparties to collar transactions are inclined to sell the underlying share when contracted limits are breached.
Simplistically, the concern in the market seems to be about the quality of the bank’s unsecured lending book. As at end-August, it had gross loans and advances totalling R60.25 billion. However, its provision totalled R12.85 billion, equal to 21.3% of the book. Even on up-to-date loans, it provides for 6.4% immediately. This, however, has decreased from 7.3% in August 2018.
Given the impact of the Covid-19 pandemic, there is an expectation that defaults on these unsecured loans will skyrocket. Using the aftermath of the 2008 financial crisis as a guide, bad debts across a number of loans and vintages never really exceeded 10% (this level was only breached on shorter-term loans of 12 months). Bad debts on 18-month and 24-month loans peaked at 8%, while on 36-month loans never got to that level.
There is an argument to be made that Capitec may actually be better off than other banks, in relative terms.
A decade ago, this was a bank significantly more reliant on interest income than on non-interest income (net fee income).
|Net lending, investment and insurance income||R6.306 billion||R2.259 billion*|
|Net transaction fee income||R3.529 billion||R0.295 billion (R295 million)|
* Previously disclosed as net interest income and net loan fee income
In 2009, net interest income (including loan charges) was nearly eight times the non-interest income reported by the bank. In the last financial year, this was not even 1.8 times. By 2019, Capitec was able to cover 91% of operating expenses with net transaction fee income and funeral income.
In its statement, Capitec Bank notes speculation around the impact of Covid-19 on its unsecured book, but says: “Shareholders are reminded of the following important features of Capitec’s business model as highlighted in the FY2020 interim results published on SENS on 26 September 2019″:
- Only 1.1 million of Capitec Bank’s 12.6 million active clients (9%) have credit with Capitec Bank.
- Capitec’s business model is well diversified and income is strengthened by transaction fee income and funeral cover sales. Net transaction fee and funeral income contribute 46% of net income and covers 91% of operating expenses.
- There has been a significant migration in Capitec Bank’s client base to the middle and higher income segment. 81% of credit granted in August 2019 was to clients with a gross salary of over R10 000 per month, and 47% to clients with a gross salary of over R20 000 per month.
- The bank has a strong retail deposit base.
Given recent events, questions about Capitec’s ability to grow at the same rates as it has been able to in an economy that is widely expected to contract this year are justified.
After all, this is a bank that has managed to almost-metronomically produce earnings growth in excess of 20% each year.
Even for the most recent financial year (ended February 29, 2020), which includes a recession of at least six months, Capitec expects headline earnings to increase by between 18% and 21%.
At a share price of R1 300 a year ago (end February 2019), the bank’s price-to-earnings (PE) ratio was 28.5. The bank has always enjoyed far higher ratings than other banks, given its historical earnings growth.
With share price movements in recent days, the PE ratio (factoring in 20% growth in earnings) now sits at under 13 (close to 12.5).
One concern that seems to have missed the broader market is around the lending book of Mercantile Bank, which Capitec acquired last year. In its acquisition announcements, Capitec noted that: “Mercantile’s core business offer is banking for established small to medium sized enterprises and entrepreneurs.”
Mercantile says it focuses on the following industries: finance, business and professional services, manufacturing and engineering, wholesale, retail, trade and franchising, and transport and logistics.
With the fundamental disruption to the economy caused by Covid-19, many of these businesses are already under severe strain and defaults are likely to increase significantly (albeit off a somewhat low base).
Mercantile had total on-balance sheet exposures (excluding derivatives and security financial transactions, but including collateral) of R13.446 billion as at end-November. Previously, as at June 30, 2019, Mercantile reported impairments of R220 million on total loans of R13.246 billon.
Notably, this is one area of its business that Capitec does not reference in its statement at all. This could possibly be due to the fact that it is still far too early to quantify potential losses or provisions.
Capitec says its liquidity position as of Thursday “remains strong” and its liquidity ratios “remain in line” with that published on December 12, 2019, being:
- Capital adequacy ratio – 28.4%
- Liquidity coverage ratio – 1 444%
- Net stable funding ratio – 186%
- Leverage ratio – 16.6%
It also notes that its “excess deposit base has grown by more than 5%” from August 31, 2019.
Finally, Capitec Bank says: “Management continuously assesses changes in the economy and trading conditions and make appropriate adjustments to business and granting models as required. This is particularly relevant in these uncertain times.”
The bank will report its results for the year ended February 29 on April 14.