Bloomberg News - South African Banks Prepare for Worst as Junk Rating Looms

South African banks are preparing for the worst when it comes to the threat of another downgrade of the country’s debt.

“FirstRand anticipated the downgrades since 2015 and has been working on a number of proactive strategies to mitigate the impact,” said Andries du Toit, the treasurer at Johannesburg-based FirstRand Ltd., the country’s second-biggest bank by assets. The measures included adjusting credit origination, and boosting liquidity and capital buffers, he said.

The credit ratings of the continent’s largest lenders such as Standard Bank Group Ltd., Barclays Africa Group Ltd., Nedbank Group Ltd. and FirstRand are inextricably tied to that of South Africa, where they make most of their profit. Banks also need to hold sovereign bonds for regulatory purposes, meaning that any increase in the government’s borrowing costs immediately causes the capital the companies need to support lending to become more expensive.

In a move that may help establish a sizable offshore base, FirstRand last month offered to buy all of the U.K.’s Aldermore Group Plc for about 1.1 billion pounds ($1.4 billion). Although the purchase of the challenger to some of Britain’s biggest lenders won’t save FirstRand from higher costs in South Africa, it’s a step to creating a platform to source offshore funding and to earn income in a currency other than rand. 

FirstRand increased its total Tier 1 capital levels to 17.1 percent as of the end of June compared with 16.9 percent a year earlier.

Pending Reviews

At stake for the nation’s lenders is the credit assessment on the country’s local-currency bonds, which account for 90 percent of the government’s issued debt. S&P Global Ratings and Moody’s Investors Service, which are both due to announce their latest reviews on Nov. 24, still rate rand-denominated debt as investment grade.

A change in either one of those evaluations could see South Africa removed from some indexes tracked by global investors, triggering outflows and pushing up borrowing costs. While the ratings companies could wait until after the ruling African National Congress’s conference next month to decide on who will replace President Jacob Zuma, the agencies may be swayed to act sooner after National Treasury on Oct. 25 said that the budget deficit will widen and debt levels will climb.

The country’s foreign-currency debt was downgraded to junk by S&P and Fitch Ratings Ltd. after former Finance Minister Pravin Gordhan was fired by President Jacob Zuma at the end of March.

“Banks are cyclical investments so will be impacted by any downturn as a result of a sovereign downgrade and the resultant impact on the economy and our clients,” said Mike Davis, Nedbank Group Ltd.’s executive for balance-sheet management. “We have, however, been aware of this risk for a long while and are well prepared for such an event should it happen.”

Nedbank, majority held by London-based insurer Old Mutual Plc, has been applying conservative lending policies with high levels of provisions, high capital buffers and diversified funding sources, Davis said. The lender had a core equity tier 1 ratio of 12.3 percent at the end of June from 12.1 percent a year earlier, and compared with 11.3 percent in December 2015.

‘Front-Loaded’

The lender has no plans to raise additional funding in the market this year, having “front-loaded” earlier in 2017 in anticipation of a credit downgrade, said Davis. Only about 8 percent of its funding is raised in bond markets, with the bulk of it provided by deposits. Barclays Africa didn’t respond to emailed requests for comment.

Even with operations across 19 other countries on the continent, Standard Bank still would not be able to achieve credit ratings above that of its home market, which accounts for about 70 percent of its revenue, according to data compiled by Bloomberg.

The rating of a bank “is linked by credit-rating agencies to sovereign exposures it holds,” said Arno Daehnke, the finance director of Johannesburg-based Standard Bank, Africa’s largest lender. “It is difficult to pierce the sovereign ceiling, even after the consideration of foreign-asset holdings.”

The pressure on the banks has been evident in their slowing profit growth and lackluster share prices. The six-member FTSE/JSE Africa Banks Index has climbed 1.3 percent this year, compared with the all-share gauge’s 18 percent rally to a record high.

“The bank undertakes scenario planning on an ongoing basis, including the possibility of a downgrade of the sovereign local-currency rating to sub-investment grade,” Standard Bank’s Daehnke said. “The bank accesses a diverse source of retail and wholesale funding markets, and the mix is not expected to change materially in the next two to six months.”