Big four banks still offer cheap route to stability

The big four banks are easily the most liquid of the South Africa Inc shares on the JSE. They remain controlled by domestic shareholders. And all four are widely held.

It could have been just the big three from 1999, when Nedcor (now Nedbank Group) under CEO Richard Laubscher made a hostile bid for Standard Bank. The move was blocked by then finance minister Trevor Manuel.

Somebody seems to have decided that four is the optimal number of large commercial banks. The British, Australian and Canadian authorities agree with Manuel. When UK high street giant Barclays took over Absa in 2004, it was forced to keep Absa listed on the JSE. It finally sold the last of its Absa holding in 2022. 

Until recently FirstRand was the darling of the sector, with easily the largest market capitalisation. But, unusually, it is facing a challenge on two fronts: a resurgent Standard Bank, run by the highly respected Sim Tshabalala; and a surge in popularity for challenger bank Capitec.

Truffle Asset Management points out that while the market caps of Capitec, FirstRand and Standard Bank are similar, at about R400bn, the price-to-book valuation multiples between the three banks vary significantly. Price-to-book is an important metric for valuing banks. It helps investors assess whether a stock is fairly priced, as it shows how much investors are willing to pay for each unit of the company’s NAV.

Truffle says Capitec is trading at a 12-month forward price-to-book value of 6.6, making it one of the most highly valued banks in the world. And this is way above the two “imperial banks” — Barclays (which exited South Africa for the first time in 1986 and is now FirstRand) and Standard Bank, which, jointly, have hundreds of years of history behind them.

None of the mature big four banks — FirstRand, Standard Bank, Nedbank and Absa — can be expected to grow either their top or bottom line much faster than South Africa’s GDP.

But even with pedestrian growth prospects, laggard Absa looks cheap. At times over the past five years it has traded at a price-to-book of 0.75 — a rating you would expect from an incompetently run operation about to go out of business, neither of which is true of Absa.

All the big four face pressure from Capitec on fee income, as South Africa’s transactional fees are out of line with international counterparts — notably the UK’s fee-free transactional banking model.

The only bank in the JSE banks sector that’s almost impervious to Capitec is Investec, as it has negligible client overlap with Capitec — though, attracted by Capitec’s low fees, some of Investec’s 100,000 transactional clients have moved their primary accounts over.

Absa’s low rating is an outlier. Standard Bank is trading at 1.4 times book and the more highly rated FirstRand on 1.8. Usually, FirstRand’s value on the JSE is about R50bn-R80bn ahead of Standard Bank, as the so-called “Big Blue” is usually perceived to be a stodgier and more bureaucratic group. But mainly because of the uncertainty around FirstRand’s MotoNovo business in the UK (see box), these banks have been trading at parity.

Under outgoing CEO Gerrie Fourie, Capitec maintained earnings growth well ahead of the competition, not least by diversifying into nonbanking value-added services and insurance.

David Holland, an analyst at Fractal Value Advisors, says Capitec is a world-class bank. It is generating some of the best operating returns in the banking world and without reckless leverage.

He points out that Capitec has been beating its cost of equity by the proverbial mile, while growing its asset base. “The combination of high operating returns and asset growth has resulted in exponential growth of economic profits.”

Economic profit was popularised by FirstRand, which before the emergence of Capitec was considered “best in class” in the banking sector. Holland says FirstRand also generates high-quality operating returns, but they have been slipping, and asset growth has been muted.

Chris Logan, chief investment officer of activist investor Opportune Investments, says FirstRand’s economic profit growth has stalled along with its market performance.

Says Logan (who works closely with Holland): “My clients have made a lot of money from the greater RMB group for many years.” First National Bank (as Barclays was rebranded after the British left in 1986) was quite a sleepy business when it was controlled by Anglo American until 1998, says Logan.

But it had been a very strong performer since then, when FNB and Rand Merchant Bank merged. Logan says an entrepreneurial-owner culture dominated FirstRand until about five years ago, when the influence of founders Laurie Dippenaar, GT Ferreira and Paul Harris started to fade.

Holland adds that Capitec’s challenge is that it is priced to maintain its extraordinary combination of high operating returns and asset growth. He says Capitec must remain disciplined and risk-savvy as it seeks new opportunities for growth. “It’s a nice problem to have, but a serious consideration for the board. They cannot rest on their laurels. If operating returns slip, the stock will get punished.”

Capitec has set a high benchmark for the sector. The most popular and reliable measure of banking profitability is return on equity (ROE), calculated by dividing net income by shareholders’ equity. The relative newcomer’s ROE is much higher than the competition’s, and an important reason for the stratospheric Capitec share price.   

Superior earnings growth, especially in capital-light revenue streams, enabled Capitec to achieve ROE of 29% against FirstRand’s 21%.

Logan says FirstRand remains an above-average bank, but the other three of the big four are catching up. Standard Bank, in particular, has reached 18.5% ROE. Standard also has much more extensive insurance and asset management interests than FirstRand, through its wholly owned Liberty Life and Stanlib Asset Management units.

Truffle argues that the big four’s valuations are not expensive, and dividend yields remain attractive. They are quite logically priced, with the weakest, Absa, offering a yield of 8.6%, Nedbank 8%, Standard Bank 6.4% and FirstRand 5.8%. Investors aren’t buying Capitec for income, as it pays out just 1.8% — the second most miserable in the financial sector after Discovery on 1.1%.

The big four are primarily plays on South Africa Inc, the exception being Standard Bank, which generates about 45% of earnings from the rest of Africa. Since Absa took over the Barclays Africa network in 2012, it generates about 28% of earnings from Africa. Only FirstRand has a meaningful exposure to hard currency earnings, as UK-based Aldermore generates about 10% of its bottom line.

As Tshabalala often points out, bank growth is dependent on the macro environment. It has been pedestrian over the past decade, with poor GDP growth and limited policy certainty and stability.

Changes of leadership can still make a difference — notably when Michael Jordaan, under Dippenaar’s supervision, turned FNB into South Africa’s sexiest and most profitable retail bank.

Absa, easily the least well rated of the big four, has turned a page after the appointment in March of former Standard Bank deputy CEO Kenny Fihla as CEO-designate. He will take office in July.

Irina Schulenburg, an analyst at Old Mutual Investment Group, says Fihla should bring some stability to a bank which has gone through a revolving door of CEOs and acting CEOs. “He’s a very strong appointment with a proven track record — though mainly in corporate and investment banking, so the market will be very focused on how he chooses to address Absa’s main problem, which is retail banking.”

Schulenburg adds that FirstRand CEO Mary Vilakazi has delivered a solid first set of results, though overshadowed by the pending case concerning its British vehicle finance unit MotoNovo.

Vilakazi says FirstRand has no regrets about the purchase of the UK specialist bank Aldermore, which provides 10% of group earnings and a diversity of income. It invested in the UK at a time when its competitors were focusing on Africa, with mixed results.

Nedbank, for example, is in the process of exiting its 20% stake in West African lender Ecobank, to focus on opportunities in East and Southern Africa. The likely buyer would be the other large strategic investor in Ecobank, the Qatari sovereign wealth fund.

Vilakazi says FirstRand has adopted an organic rather than acquisitive growth strategy in Africa, and one that will maintain its relatively high ROE relative to its traditional competitors, though not to Capitec.

FirstRand is incrementally becoming a more centralised business. She says there is increased co-operation between FNB, which operates in the retail and commercial sectors, and RMB, in the corporate and investment sectors.

Last year FNB boss Jacques Celliers was moved sideways to manage the group’s financial technology efforts and FirstRand group finance director (FD) Harry Kellen was moved over to run FNB. While Kellen has more personality than a typical bean counter, and is well respected in banking circles, he brings a style that is different to that of his more flamboyant predecessors, Celliers and particularly Jordaan, who was once described on an FM cover as South Africa’s answer to Steve Jobs.

Vilakazi took over from Alan Pullinger as FirstRand group CEO last year. She was previously deputy CEO in charge of nonbanking and FD of Metropolitan Life, which FirstRand acquired in 2010. Vilakazi points out that there has been a strategy to grow the high-margin FNB commercial loan book, which until recently was third in the sector after Standard Bank and Absa.

She is confident that, in spite of the threat from Capitec and virtual banks such as TymeBank, FirstRand is holding its own in the middle- to higher-income sector, with 8.8-million main-banked customers, a similar number to Capitec’s. Growing the customer base is a key performance indicator for the management team, Vilakazi says.

FirstRand still has a much larger balance sheet — with total assets of R2.37-trillion, the bank is almost 10 times the size of Capitec (R238bn). FirstRand still lags behind Standard Bank, however, which is almost R1-trillion larger with R3.26-trillion, according to Denker Capital’s Kokkie Kooyman.

Vilakazi says: “We have products aimed across the market, with a range of account fees going down to almost zero.” This is supposed to make FirstRand appeal to a much wider client base than the Stellenbosch upstart, Capitec.

The banking environment remains subdued. Truffle believes that with South Africa’s GDP growing at about 1% in FY2025, loan growth will remain subdued for the remainder of this year.

The good news is that credit loss ratios continue to normalise, helping earnings growth. And many fund managers, including Truffle, expect South Africa’s GDP growth to pick up next year on the back of structural reforms and the rollout of infrastructure projects.

Kooyman, who runs the Denker Capital Global Financials Fund, says that of the big four, Nedbank has the most room to grow. Nedbank CFO Mike Davis says that with about 3.7-million main-banked retail customers, it would certainly like to increase its client base. Its loan book of R914bn is barely half that of the rest of the big four, with a bias towards commercial property finance.

Nedbank was bailed out by Old Mutual in 2004 after some strategic mistakes. But under CEOs Tom Boardman and Mike Brown — who both came over when Nedbank acquired BOE in 2002 — it steadily rebuilt its reputation. Both took a low-key approach, making realistic promises and delivering on these.

Jason Quinn, who took over at Nedbank from Brown in May 2024, has maintained the same nonflamboyant approach. Quinn was previously Absa FD and, like many members of the banking community, had a spell as acting Absa CEO. Davis says Quinn is fitting in well in the Nedbank culture. At 49, he should provide stability, with many potential years at the helm ahead of him.

Truffle argues in its research that historically Absa has had a lending-led approach and has neglected noninterest revenue growth. 

“Absa tended to prioritise loan growth and market share gains, rather than lending at prices and to counterparts where such loans can generate economic profit,” says Truffle banks analyst Sophié-Marié van Garderen. “We think this is slowly changing and that should benefit future ROE and economic profit.” 

The fund manager says that, typically, the higher a bank’s ratio of capital-light noninterest revenue to total revenue, the higher its potential ROE. Van Garderen argues that to improve capital-light revenue or value-added services, it’s critical for Absa and Nedbank to grow their main-banked client market share and increase their level of digital penetration.

Davis says Nedbank is well aware of the need to be competitive in digital. In its 2024 annual results, the bank announced that retail digital transaction volumes and values grew by 7% and digitally active retail clients increased by 7% to 3.1-million. Kooyman says Nedbank’s strong capital position supports either a special dividend or share buybacks.

Absa interim CEO Charles Russon, previously head of the group’s corporate and investment banking business, says the bank fully concedes it has been a disappointing performer and needs a change in strategy. “We are dealing with our shareholders in a transparent manner and we have to rebuild trust.”

Russon says Absa became too much of a product-driven house, in which retail clients did not have a single point of contact. Under previous CEO Arrie Rautenbach, retail and business banking was split, with everyday banking for transactional needs; there was a separate silo for the secured home loan and vehicle finance businesses; and relationship banking was responsible for private banking and commercial business.

“With the silo structure, which is now being dismantled, it was hard for us to look at the client holistically,” says Russon.

He argues that while retail and business banking in South Africa still accounts for about 60% of Absa group earnings, the strength of the corporate and investment business (CIB) is underrated by the market — particularly in corporate banking. Absa still lags RMB and Standard Bank CIB in investment banking, while Nedbank’s substantial commercial property finance franchise is its competitive advantage.

Ultimately, the big four banks are good proxies for the South African economy, and when sentiment was weak before the May 2024 election they were available at fire-sale prices. Even though they aren’t so cheap today they should remain as anchors for a balanced long-term share portfolio.

For stock pickers there’s plenty to weigh up: investors could pay a premium for Capitec’s sprightly growth prospects or take the solid value proposition for Absa, where a dismissive market rating is placated by a sumptuous yield. Or there is the low-risk option of Standard Bank’s solidly dependable offering, the delicate yield and growth combination at Nedbank — or backing FirstRand to rekindle its market-leading ways.

CAVEAT MOTONOVO

FirstRand’s UK vehicle finance business, MotoNovo Finance, is at the heart of a series of legal appeals related to the mis-selling of car finance products. The cases concern car dealers failing to disclose the commission they receive on finance agreements.

The only other JSE-listed bank to be affected by these cases — though to a lesser extent — is Investec.

There are numerous cases in the UK hinging on whether car dealers owe customers a fiduciary duty — that is, whether they have to act in the customer’s best interest on finance arrangements.

The cases focus on whether commission arrangements between dealers and banks were fully disclosed to customers, with the British Court of Appeal finding that car sales firms could only lawfully receive commission if customers had given “fully informed consent”. 

MotoNovo and FirstRand appealed the Court of Appeal’s decision to the Supreme Court. The hearing was held from April 1 to 3; the result is pending. 

The Financial Conduct Authority (FCA, equivalent to South Africa’s Financial Sector Conduct Authority) is considering a redress scheme to compensate customers who may have been overcharged on car finance agreements, potentially affecting millions of consumers.

The FCA considers motor dealers to be credit brokers and the practice in the UK has been that it is the dealers and not the lenders that are obliged to disclose commissions.