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Can you bank on banking stocks now?

South African banks have found themselves in the crosshairs for quite some time now given the persisting low-growth environment and stream of political noise.

However, according to Neelash Hansjee, a banking analyst at Old Mutual Equities, while a tough economy will take its toll on banks – especially with regards to their revenues – the larger South African banking sector has remained relatively resilient.

“The banking sector remains fairly protected by their strong balance sheets and the diversification of their earnings. However, there are significant risks on the horizon for the South African banks, namely a local currency downgrade by credit rating agencies and a crisis of confidence with the possibility of a low growth environment for longer.

“The direct impact of a local currency downgrade is an increase in the funding costs for banks which would introduce some margin pressure. This may get passed on to the consumer through higher borrowing costs. The indirect impact is the greater levels of uncertainty it creates for the economy – a crisis of confidence.

“The crisis of confidence has been rising through political and economic uncertainty. Leaders and companies are uncertain on how to act as it becomes difficult to have visibility on the way forward. This has filtered through into confidence levels, investment and growth. Hence a growing risk is a lower growth environment for longer.”

These risks have been driven by compounding political uncertainty and an increasingly challenging economic environment. Hansjee says that a more cautious stance is being taken in valuing South African banking stocks.

“We are taking a more conservative view, given the current operating environment for banks. Lower growth and lower interest rates are likely to slow revenue as margins get snipped and credit quality may deteriorate from here, placing pressure on earnings. However, capital positions have strengthened over the year and dividends can be sustained in a low-growth environment which provide an attraction. A higher risk premium is therefore being built in to our valuations, to take account for the higher level of uncertainty.”

Based on these valuations, Hansjee says that while there may still be opportunities in bank stocks over the remaining portion of the year, we may not see the same level of outperformance that has been demonstrated in recent months.

“Bank valuation metrics have trended towards their long-term averages. They were cheaper about a year ago and their outperformance shown over the last three months or so.”

Given its ability to withstand the tough environment, Hansjee concludes that the outlook for the banking sector as a whole remains challenging but offer some resilience against a tough outlook relative to other companies.

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