Credit Ratings Agency, Fitch Ratings has intimated that South Africa’s sovereign rating of BB-/Negative still presents a key pressure on the country’s bank ratings, as banking sector data for year-end 2020 published by the South African Reserve Bank indicates.
The South African Reserve Bank data showed that the effects of the pandemic on the sector’s asset quality and earnings remained resilient throughout the period. Regarding the sector’s ratings by Fitch, the impact of the pandemic on asset quality and earnings in the period was expected and is reflected in current ratings.
According to Fitch Ratings, the ratio of impaired loans increased from 3.9 percent at year-end 2019 to 5.2 percent at year-end 2020 as the economic fallout of the pandemic, lockdown measures and rising unemployment pressured corporate and retail borrowers’ repayment capacity.
Also, debt reliefs offered to customers covered averagely about 20% of gross loans at the end of the first half of 2020 across the four largest banking groups- Nedbank Group Ltd., Standard Bank Group Ltd., Absa Group Ltd., First Rand Ltd. This led to the increase in impaired loans and cushioned the impact of the pandemic on asset quality. However, the Credit Ratings Agency expects that the impaired loans ratio will increase further to 6.5 percent at year-end 2021 due to the relaxation of debt relief measures, rising unemployment and a challenging business environment.
Furthermore, bank profitability was largely stressed in 2020, with the sector’s operating return on risk-weighted assets declining to 1.2 percent from 2.8 percent in 2019. This was driven by a surge in loan impairment charges and, to a lesser extent, pressure on net interest margins and non-interest income.
The increase in loan impairment charges, which was concentrated in the second quarter and gradually declined in the second half, was driven by specific provisions against impaired loans and substantial provisions incurred as a result of positive and forward-looking macroeconomic expectations and management overlays.
Fitch also expects the operating return on risk-weighted assets to improve to 2.3 percent in 2021 as the pace of provisioning slows. However, a recovery to pre-pandemic levels will not occur before 2022 as loan impairment charges will remain high, low interest rates will pressure net-interest margins and declining demand will stifle revenue generation.
The banking sector’s common equity Tier 1 (CET1) capital ratio recovered to 12.6 percent at year-end 2020 from 12.1 percent at end of the first half of 2020, having declined following the onset of the pandemic. Based on this, Fitch expects capital ratios to remain stable in 2021, despite higher risk-weighted assets as asset quality weakens. Subdued loan growth, a recovery in earnings and continued dividend prudence will support capital ratios, which are comfortably above regulatory requirements. Funding and liquidity will remain stable and are a rating strength for South African banks given their solid deposit franchises and low reliance on external funding.
However, the ratings of all South African banks covered by the Credit Ratings Agency remain constrained by South Africa’s sovereign rating, Fitch notes, given the concentration of their activities in South Africa and high sovereign exposure relative to capital. Sovereign exposure in terms of South African debt securities was equivalent to double the banking sector’s equity for the close of year, 2020. Thus, the negative outlooks on the banks’ ratings reflect that on the South African sovereign.
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