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S&P downgrade negative for SA banks

‘There is no way to sugar coat the fact that this is bad for the economy’ – Stuart Theobald.

S&P Global recently announced that it has lowered its rating on eight South African financial institutions following its decision to downgrade the country’s long-term foreign currency sovereign credit rating.

Since SA has been downgraded to BB from BB+, the agency said it could not keep financial institutions above the foreign currency sovereign ratings, given the direct and indirect impact that sovereign distress would have on domestic banks’ operations – which includes their ability to service foreign currency obligations.

Simply put, the downgrade follows mechanically from the sovereign downgrade.

“The sovereign credit rating is effectively a ceiling for all other rated entities in the country, so when the ceiling gets lowered, everyone gets lowered too,” says financial analyst at Intellidex, Stuart Theobald.

This is not a positive thing for South Africa’s economy, despite S&P noting a stable outlook on these banks and SA.

Downgrade impact 

S&P said that despite the operating environment, the banking sector has outperformed expectations.

In June 2017, Moody’s downgraded the credit rating of five banks, namely, Standard Bank, FirstRand, Absa, Nedbank and Investec. They were downgraded to the same level as the country with the same negative outlook. The downgrade, according to Moody’s, came after the weakening of the South African government’s credit profile.

Prior to that, in April this year, Fitch took the decision to downgrade five big South African banks to BB+ from BBB-.

This came after Moody’s cut South Africa’s credit rating to sub-investment grade and S&P lowered SA’s foreign debt to ‘junk’. It then downgraded major banks following the controversial cabinet reshuffle, in late March, which saw President Jacob Zuma remove former finance minister, Pravin Gordhan.

Theobald said the downgrade would naturally make it more expensive for banks to raise funding from international investors.

“A downgrade hurts the perception of the credit worthiness of the banks. That means they will have to pay relatively more to raise money from international investors,” he said.

He explained that a credit rating would mean that potential funders would have to consider whether to extend lines of credit or buy the bonds of the banks.

“It will largely be relied on by international investors who might buy the banks’ bonds in South Africa or, when banks issue in international markets, buy the bonds there,” he added.

Risks

Even without the credit downgrade, Theobald said there are still other international factors that could sway international investor potential.  

“At the moment, there is considerable global appetite for risky assets, including sub-investment grade bonds. So there will still be a market for bank bonds even after the downgrade,” he said.

He said a change to monetary policies of major developed markets could have a bigger impact on demand than the downgrades do.

S&P noted in its statement that there are factors that pose a risk for banks.

“Domestic households pose the most significant source of risk for the banks because of their relatively high debt and low wealth levels compared with other emerging markets.”

Funding

South Africa’s Reserve Bank remains independent and South African banks rely on concentrated short- to medium-term wholesale funding from non-bank financial institutions (NBFIs). S&P said this system-wide risk is reduced (to a degree), by the fact that if in a crisis, rand liquidity will remain in the country because of resident exchange controls.

Theobald said going forward, the banks are able to manage the downgrade effect on them to some extent.

“I’m sure many of them would have already raised what they intended to raise earlier this year, because the risk of a downgrade was clear,” he said.

The option to switch to other forms of funding, is available to them, for instance attracting more deposits.

The downgrades would have inevitably had a marginal impact on banks’ overall cost of funding. This in turn would put upward pressure on interest rates, which adds to the pressure that comes from government’s own increased cost of borrowing.

Theobald said higher the cost of funding inevitably means there will be less borrowing to finance investment or consumption, and therefore less economic growth.

“So there is no way to sugar coat the fact that this is bad for the economy,” he said.

According to S&P the major banks are not exposed to large-scale refinancing risk or a reversal of investor sentiment, because of their lack of exposure to international funding.

“We believe that the lower sovereign ratings and ratings on the banks could limit access to external funding, whether it be through pricing or availability,” said S&P.

S&P’s specific actions on the banks:

Capitec Bank was lowered to BB from BB+ and affirmed the B short-term issuer credit rating – with a stable outlook. The agency has improved Capitec’s risk position to moderate from weak. They attribute this to the robust levels of provisioning and strong earnings, despite high credit losses due to the focus on unsecured consumer lending.

“We believe that the bank will continue to generate strong earnings and robust capital levels over the 12-18 month period,” S&P said.

FirstRand was also lowered in line with the sovereign rating. It was lowered to ‘BB from BB+’ with a stable outlook.

S&P lowered the Nedbank Ltd long-term issuer credit rating to ‘BB’ from ‘BB+’ and affirmed the ‘B’ short-term issuer credit rating. The outlook is also stable.

Investec Bank’s long-term issuer credit rating was lowered to ‘BB’ from ‘BB+’ and affirmed the ‘B’ short-term issuer credit rating. “The bank has demonstrated a superior credit loss ratio to all South African-rated peers over the past six years, with an average cost of risk below 0.5%, compared with a sector average of 1.1%-1.3%,” said S&P. “We believe Investec Bank’s cost of risk bottomed out at 0.3% in 2016, but we fully expect losses to continue to outperform those of domestic peers,” they added.

For Absa Bank Ltd S&P lowered their long-term South Africa national scale rating to ‘zaAA-‘ from ‘zaAA’ and affirmed the ‘zaA-1+’ short-term national scale rating. “We expect the group will continue to perform in line with our expectations for the South African banking sector, posting a cost of risk of 1% and nonperforming loans of about 4.4% over the next 12-18 months, in line with our expectations for the sector average,” said S&P in its report.  

Barclays Africa Group Ltd, the non-operating holding company of the Barclays Africa Group, was lowered in their long-term South Africa national scale rating to ‘zaBBB+’ from ‘zaA-‘ and affirmed the ‘zaA-2’ short-term national scale rating. 

BNP Paribas Personal Finance South Africa Ltd is a consumer finance and financial services provider, offering credit cards, loans, and insurance under its own brand name and in association with a number of retailers in South Africa, Namibia, and Botswana.

S&P lowered the national scale ratings on BNP Paribas Personal Finance South Africa Ltd in line with the sovereign national scale ratings.

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Coming to think of it, it gives a whole new perspective to the assurance that one’s invested capital is 100% safe in a product like a Fixed Deposit or Money Market at any local bank….hmmm.

Yes, sure….your capital is always guaranteed in such cash-products….but having said that, that being at a non-investment grade/junk-status financial institution?

“It makes you think, doesn’t it?” (Sorry, I couldn’t resist this old slogan)

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