Announcements Criteria Research

GCR lowers the South African Financial Institutions’ Sector Risk Score to ‘7.5’, from ‘8’

Johannesburg, 25 June 2020 – GCR Ratings (“GCR”) has lowered the South African Financial Institutions’ sector risk score to ‘7.5’, from ‘8’ previously.

The Financial Institutions Sector Risk Scores are available for download at gcrratings.com/risk-scores/.

The GCR Financial Institutions Sector Risk Assessment

The Financial Institutions sector risk score (ranging from 0 to 15) is a key factor in the operating environment component score. The core of the GCR Ratings Framework is based on GCR’s opinion that an entity’s operating environment largely frames its creditworthiness. As a result, the operating environment analysis anchors the underlying risk score for the GCR rating methodology. GCR combines elements of the country risk and sectoral risk analysis, blended across countries for entities operating across multiple jurisdictions, to anchor an insurer to its current operating conditions. For more details on any of the above, please read the related criteria and research listed below.

GCR periodically publishes updated “Financial Institutions Sector Risk Scores”, which supersede previous publications. The publication titled “GCR Financial Institutions Sector Risk Scores, 24 June 2020”, available at https://gcrratings.com/risk-scores/, supersedes the article published on 23rd May 2020.

Financial Institutions Sector Risk Scores

South African Financial Institutions Sector Risk score: ‘7.5’. Country Risk Score 7[1], Mapping Table 7.0 to 7.5

GCR has lowered the South African Financial Institution sector risk score to 7.5 from 8. The onset of the COVID-19 pandemic has compounded an already strained operating environment, with the South African Reserve Bank (SARB) projecting a 7% GDP contraction in 2020.

Given the early indicators from the banks, we expect credit losses will increase to between 1.5%-1.7% for the top tier banks, rising to over 2% for the sector has a whole; largely because the 2nd and 3rd tier unsecured and SME lenders will have a disproportionate impact on sector wide credit losses in comparison to their size.

South African households appear to be in a relatively good space to service debt, due to the reduction in household leverage over the past 10 years and the positive impact on affordability from lower interest rates. However, the reduction in employment and disposable income will bring up credit losses materially across most of the banks. Given the dynamics of the population, and the flat real estate industry over the past 5 years, we expect unsecured and semi-secured lending (over half of total household liabilities) to be the major source of credit losses.

SME lending will also face a great deal of pressure, with credit losses climbing significantly. However, this book represents only about 7.5% of total banking sector loans. More positively, the overall corporate sector is expected to just about navigate through these challenging times, albeit with pockets of vulnerability, due to the modest levels of leverage. Going forward, GCR views the hospitality, tourism, and discretionary retail sectors as the most at risk, due to enforced restrictions on population movement and social gatherings by the South African government caused by the COVID-19 pandemic. We estimate that these vulnerable sectors represent around 10% of the total loan books for the banking sector.

The return on equity and return on assets of the South African banking system moderated to 13.5% and 1.06% in March 2020 from 15.68% and 1.27% in March 2019 respectively, and we expect profitability to deteriorate further by the year end. This opinion reflects the lower interest rate environment, lower business transactions and higher cost of risk. Positively, the coverage of operating costs by relatively risk-free non-interest income underlines some stability for banks. With regards to capitalisation, we expect the tier one ratio to range between the 12.75% and 13.25% by year end 2020 (13.6% as of year-end 2019).

On a positive note, the sector risk score compares favourably to regional peers, due to the sound risk management of the top tier banks (which account for just over 90% of total industry assets) which will continue to underpin the sectors stability. The strong regulatory framework (through early adoption of international risk management practices) has also allowed for a build-up of good capital and liquidity buffers over the years, and while profitability will weaken, capital preservation will be aided by dividend suspensions and possibly lower credit growth that will keep leverage under control. The absence of any build-up in foreign currency mismatches due to regulatory exchange controls has meant that the depreciation and volatility of the South African rand during this period has not had a material impact on the sector. Furthermore, the reserve bank has stepped in to inject liquidity into the system and relax regulatory guidelines in order to provide some stability to the system and ensure banks can continue to fulfil their primary objectives of providing credit to the economy. This has stabilised liquidity in the system, at least in the short term, but medium-term risks remain given the uncertain course of the pandemic and implications thereof.

Analytical contacts

Analyst

Vinay Nagar

Senior Credit Analyst

Johannesburg, ZA

Vinay@GCRratings.com

+27 11 784 1771

     

Analyst

Matthew Pirnie

Group Head of Ratings

Johannesburg, ZA

MatthewP@GCRratings.com

+27 11 784 1771

Related criteria and research

Criteria for the GCR Ratings Framework, May 2019

Criteria for Rating Financial Institutions, May 2019

GCR Ratings Scales, Symbols & Definitions, May 2019

GCR Country Risk Scores, May 2020

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