Cape Town – Most of the local and foreign investors seem to have lowered their expectations for a sovereign credit ratings downgrade as is evident in the rand strength and South Africa’s 10-year bond yields close to 8.2%, said Nkareng Mpobane, fund manager at Ashburton Investments in a company note. 

Foreign investors have been buying South African banking stocks on the back of the cheapest valuations relative to emerging-market peers since 2011, despite South Africa’s sovereign credit rating being downgraded to junk by S&P Global Ratings and Fitch following President Jacob Zuma’s Cabinet reshuffle on March 31, which saw the removal of finance minister Pravin Gordhan and his deputy, Mcebisi Jonas. 

“Moody’s however has not yet downgraded South Africa and has placed the country on a 90-day review. The ratings agency has South Africa ranked two notches above junk status at Baa2, with a negative outlook.

In the wake of the Cabinet reshuffle and the subsequent downgrades by S&P and Fitch the rand initially lost close to 10% of its value touching the R14/$ level. It has since recovered significantly in the aftermath of the recent turbulence and traded at R13.00/$ at 06:30 on Tuesday.

READ: Banks lose R61bn on Gordhan ouster, downgrade

In the immediate aftermath of the Cabinet reshuffle and ratings downgrade, the six-member bank index declined by over 10%, resulting in a loss of R61bn. 

Mpobane, noted that there are short-term, medium-term and long-term risks in the banking sector that investors need to be cognisant of though. 

Short-term risks 

There could be a readjustment of share prices of banks in the short term. “Higher bond yields mean that when one is calculating the shares a higher discount factor would be used, resulting in a lower valuation.” 

Both FirstRand and Standard Bank, he said, are trading at multiples below their three year mean. Prior to the latest pressures, Mpobane said, these shares were deemed to be fairly valued. “Recent price weakness however suggest that they are now attractively priced.” 

READ: Stay invested despite downgrades, say analysts 

Ashburton doesn’t foresee that any of the banks would need to cut dividends on a two-year outlook, except Barclays Group Africa where its management has indicated there would be a higher dividend cover ratio. 

The recent price pressure means that dividend yields in the banking sector now range between 5.5% to 7.5%. 

Medium-term risks

On the medium term, the banking sector’s profitability may be affected. “With the latest downgrades we are likely to factor in continued deterioration of the rand, higher inflation and flat interest rates with risks to the upside,” Mpobane said. 

In such an environment Ashburton expects diminished economic growth as business confidence wanes, which in turn poses employment risks. 

READ: Downgrades, politics could trip up recent economic gains 

As far as banks are concerned, Mpobane said he would closely monitor the top-line growth drivers of net interest income and non-interest revenues. 

“Impairments would also likely worsen as South Africa moves deeper into sub-investment grade, depending on the inflation rate and the South African Reserve Bank’s response to that.” 

Ashburton however expects the banking sector to remain “relatively resilient” from an earnings perspective in the 2017 financial year as higher banking fees would be passed on to consumers. 

Long-term risks

Mpobane noted that South Africa’s banks are well capitalised. 

The sector averages approximately 13% on the Common Equity Tier 1 (CET1) scorecard, while the minimum regulatory requirement is 10.375% for a particular financial year. 

(The Tier 1 common capital ratio shows how well a bank can withstand financial stress and remain solvent.) 

Mpobane said the banking sector’s risk-weighted assets will be re-priced following the recent downgrades of South Africa’s banks (on the back of the sovereign credit ratings downgrade). 

READ: Can you still bank on SA's banks? 

Although banks’ funding is an important aspect of the longer term assessments of the sector, banks have consistently been building up sources of stable funding and liquidity with minimal adverse impacts to their margins. 

“We would expect the sector would be able to pass on the higher costs of funding to the consumer, within reason,” Mpobane said.