In the aftermath of certain of the SA financials reporting lately, we find ourselves increasingly watching the financial sector of the JSE with a degree of intrigue – its underperformance relative to the balance of the market over the last year being the key issue (see the graph below).
Investec reported very average numbers and Abil was rather disappointing. These are not isolated results domestically.
Banks have had it bad across the globe
Looking at financials globally, they have proven to be the Achilles heel for the financial system as their thirst for capital at the most inopportune times has created the enormous financial imbalances we are currently being subjected to. In SA this has, fortunately, not been the case as our banks have held up well after their participation in the irrational credit binge was more of a dip, than a plunge.
Thus whilst domestic banks have so far not seen serious balance sheet wobbles, their income statements have hardly been a pleasure to observe since the crisis and this has been ascribable to the manner in which they saturated the domestic credit market for more than a decade. They bloated consumers with debt and the continued overhang is undeniable.
The problem with financials generally, and I’m referring in particular to banks around the world, is that since the global financial crisis, they have not really been properly tested again. The markets have actually behaved themselves beautifully. We make this point because investors are savvy – they know that whilst financials might look cheap superficially by historical metrics, the concern is that when the earth shakes again, deep balance sheet fissures could and most likely will reappear. Of further concern is the fact that governments, and in particular the still heavily-indebted taxpayers, are no longer in a position to bail out these institutions as was the case two years ago. The system is plugged with leverage but it is now spread more evenly at the top and bottom of the pyramid – governments and consumers, rather than merely at the centre – financial institutions.
Global bank valuations now more attractive
Analysts across the world are not, however, in the game of predicting market corrections and, with their bank profit predictions, they are assuming markets behave. On consensus numbers, global bank valuations globally seem very compelling. Bank profits are expected to grow annually by almost 20% for the next two years and in many markets banks are trading on single digit P/E’s or low double digit P/E’s. Average price to books for global banks do not look excessive at 2.3 times 2011 numbers, and in quite a few markets this is closer to 1 times with developed Europe trading below book at 0.7 times. Whilst in many cases the dividend on banks is notional as they simply will not be in a position to fund a dividend, the consensus yield for 2011 for all the banks globally is 3.2%.
In South Africa the price to book for 2011 is 1.7 times which is really not that high, and ROE’s will be in the mid teens – not bad, but significantly lower than the mid 20’s which was the case pre-crisis. South Africa looks fairly priced and ranks mid-table when compared with global peers. What at least we can be relatively sure of in SA, is that dividends will be paid.
Concerns continue domestically
What concerns us, however, about our banks here is that whilst bottom line earnings are improving as bad debts reduce, we are not exactly seeing much in the form of top-line growth – its generally single digit growth by most of the banks. A large part of our domestic banks’ turnover has traditionally been in the mortgage space, but this business is morbidly slow at present and the SA housing market is hardly showing signs of a zest for life. Domestic debt levels are probably still just too high to spur the kind of advances growth which we have become accustomed to in low rate cycles in the past.
We’re looking for top-line growth
At PSG Asset Management we have had very little, and at times no, exposure to the big four banks and now find ourselves faced with a rising rate cycle which is hardly bank friendly, albeit the fact that a well managed bank can open-up lending margins given time and this would have a positive endowment affect. That said, bank ratings are meandering lower, whilst other parts of the market are very lofty! Given time, we may well be re-looking at adding these investments to the portfolios we manage with a renewed interest. Our acid test will be the emergence of sustainable, convincing top line growth.