Moody’s downgrades the five largest South African banks to Baa3; outlook negative

Rating action follows the sovereign rating’s downgrade to Baa3

Moody’s Investors Service, (“Moody’s”) has

today downgraded to Baa3 (negative outlook) from Baa2 (Rating Under

Review outlook), the long-term local- and foreign-currency deposit

ratings of the five largest South African banks: The Standard Bank of

South Africa Limited, FirstRand Bank Limited, Absa Bank Limited, Nedbank

Limited, and Investec Bank Ltd.. The rating agency has also downgraded

Standard Bank Group Limited’s long-term local- and foreign-currency

issuer ratings to Ba1 from Baa3, and affirmed all banks’ national scale

ratings. A full list of the banks’ ratings affected by today’s rating

action is at the end of this press release.

This rating action concludes the review initiated on 4 April 2017, and

follows the weakening of the South African government’s credit profile,

as captured by Moody’s similar rating action on the sovereign rating on

9 June 2017. For further information, refer to the sovereign press

release (https://www.moodys.com/research/–PR_367769). The rating action

also takes into account the reduced capacity of the government to provide

support to banks in case of need.

RATINGS RATIONALE

WEAKENING CREDIT AND MACRO PROFILE OF THE SOUTH AFRICAN GOVERNMENT EXERTS

PRESSURE ON BANKS

The primary driver for today’s rating downgrades is the challenging

operating environment in South Africa, characterized by a pronounced

economic slowdown, and weakening institutional strength that has led

Moody’s to lower South Africa’s Macro Profile score to ‘Moderate-‘ from

‘Moderate’. The lower Macro Profile exerts pressure on the individual

factors on banks’ scorecards, and implies that the country’s banks need

stronger loss-absorption and liquidity buffers to withstand the headwinds

and in order to remain at the same rating levels.

The rating agency expects GDP growth of only 0.8% in 2017 and 1.5% in

2018, from 0.3% in 2016, levels significantly below the government’s

target growth. These challenging economic conditions, combined with

potentially weaker investor confidence, volatility in asset prices, and

higher funding costs will likely pressure banks’ earnings and asset

quality metrics going forward, and challenge their resilient financial

performance so far.

In addition, the banks’ high sovereign exposure, mainly in the form of

government debt securities held as part of their liquid assets

requirement, links their credit profile to that of the government. The

top five banks’ overall sovereign exposure, including loans to

state-related entities, averages more than 150% of their capital bases,

according to South African Reserve Bank’s (SARB) regulatory returns

(BA900) as of March 2017. In view of the correlation between sovereign

and bank credit risk, these banks’ standalone credit profile and ratings

are constrained by the rating of the government. As a result, the

baseline credit assessments (BCA) assigned to The Standard Bank of South

Africa Limited, FirstRand Bank Limited, Nedbank Limited, and Investec

Bank Ltd have been downgraded to baa3 from baa2, while the BCA of baa3

for Absa Bank Limited has been affirmed, already capturing the downside

risks emanating from its sovereign exposure.

IMPACT OF GOVERNMENT SUPPORT ON ABSA BANK LIMITED’S DEPOSIT RATINGS

Today’s rating action also reflects the weaker capacity of the government

to provide support to banks, in case of need. Specifically, Absa Bank

Limited’s deposit rating previously benefitted from a one-notch

government support uplift, which was removed, given the downgrade of the

sovereign that indicates the government’s reduced capacity to provide

support despite the bank’s systemic importance. As a result, the rating

agency has aligned its government support assumptions for all five

commercial banks, resulting in no rating uplift from their corresponding

BCAs and positioning their deposit ratings at par with the government’s

Baa3 bond rating.

NEGATIVE OUTLOOK REFLECTS SOVEREIGN OUTLOOK AND CHALLENGES AHEAD

The negative outlook assigned to all the banks’ ratings is primarily

linked to the negative outlook on the sovereign rating, which is itself

partly driven by the weak economic environment. The weakening credit

quality of sovereign bonds weighs on the banks’ own creditworthiness

given their large holdings of government securities.

Likewise, although Moody’s expects banks’ financial fundamentals to

largely remain robust, the weak economic environment increases the

downside risks for the banks’ asset quality and core capital levels. The

relatively weak economic growth points to potentially higher impairments

for the banks, especially on the retail front, exerting some pressure on

their earnings and testing the resilient performance they have

demonstrated in recent years. However, Moody’s does not anticipate that

the asset quality deterioration will compromise materially banks’

recurring earnings, and expects banks will maintain healthy capital

levels.

AFFIRMATION OF NATIONAL SCALE RATINGS

According to Moody’s, the decision to affirm the banks’ national scale

ratings (NSRs) follows the recalibration of South Africa’s NSR mappings,

triggered by the downgrade of South Africa’s government bond rating.

Moody’s NSRs are intended as relative measures of creditworthiness among

debt issues and issuers within a country, enabling market participants to

better differentiate relative risks. Although the fundamental

creditworthiness of the five largest South African banks has

deteriorated, their relative credit positioning within South Africa has

not materially changed, hence the decision to affirm the NSRs outlined

towards the end of this press release.

INDIVIDUAL BANKS’ MAIN RATING DRIVERS

– The Standard Bank of South Africa Limited (SBSA) and Standard Bank

Group Limited (SBG)

The BCA of baa3 assigned to SBSA is underpinned by its resilient earnings

profile and Moody’s expectation that this trend will continue in

2017-18, following operating income growth of around 9% in 2016 and

lower credit loss ratio at 0.87% in 2016 from 0.92% in 2015. The rating

agency expects that the bank’s operating expenses will be contained going

forward, after an increase of 12% in 2016 due to certain one-off items

that caused its cost-to-income ratio to increase to 59% in 2016 from

57.6% in 2015. SBSA’s capital base remains comfortable with a reported

Common Equity Tier 1 (CET1) ratio (including unappropriated Q1 2017

profits and following payment of the final 2016 dividend) of 12.7% in

March 2017, while the non-performing loans as a proportion of gross loans

(NPLs) improved slightly to 3.0% in 2016 from 3.1% in 2015.

SBG’s issuer rating of Ba1 (downgraded from Baa3) is positioned one notch

lower than the deposit ratings of its fully owned main banking subsidiary

SBSA, reflecting the structural subordination of SBG’s creditors to

those of SBSA. SBG also remains well capitalized with a CET1 ratio of

13.4% as of March 2017, while its credit loss ratio was marginally higher

at 1% in December 2016 reflecting the higher risk profile of its exposure

to the rest of Africa.

– FirstRand Bank Limited (FRB)

FRB’s standalone credit profile is driven by the solid performance of its

various operating franchises amid challenging operating conditions,

resulting in an 18% year-on-year growth in its normalised earnings in

the first six-months as of December 2016 (the bank’s fiscal year-end is

as of 30 June 2017). The bank’s NPL ratio increased marginally to 2.36%

in December 2016 from 2.31% in December 2015, but remains the lowest

among its local peers. Total NPL coverage ratio is also the highest at

79% as of December 2016, and its credit loss ratio remained manageable at

0.79% despite its higher exposure towards the more risky retail segment.

Moody’s expects some elevated pressure on the bank’s NPLs in the next

12-18 months, although this is unlikely to significantly impact its

overall performance in view of the bank’s stringent underwriting

standards. FRB reports the strongest capitalisation among the five

largest South African banks, with a CET1 ratio of 14.1% as of December

2016, about 50 basis points higher than reported in December 2015.

– Absa Bank Limited

Absa Bank Limited’s Baa3 deposit rating is in line with the bank’s

baseline credit assessment (BCA) of baa3. The bank’s baa3 BCA reflects

consistently solid net profitability with net income to assets ratio of

around 1%. At the same time, capitalization has improved with a reported

CET1 ratio at 11.6% as of December 2016 up from 10.5% as of December

2015. Absa Bank’s NPL ratio of 3% of gross loans is broadly in line with

similarly-rated international peers, despite the increase in the cost of

risk to 1.04% from 0.89% in 2015 predominantly due to a large single

name exposure.

– Nedbank Limited

Nedbank’s BCA of baa3 reflects its strong year-on-year profit growth of

21% in 2016, although Moody’s expects that the challenges in the economy

will exert some pressure on the bank’s financial performance over the

next 12-18 months due to potentially lower business activity and higher

impairments. While credit costs have remained below the bank’s

expectations as of December 2016, there has been a slight uptick in

non-performing loans to 2.8%, from 2.5% in 2015. At the same time,

Moody’s acknowledges the increase in the bank’s common equity Tier 1

ratio to 12.3% as of March 2017, from 10.5% in March 2016, and the

strengthening of its liquidity metrics with a daily average liquidity

coverage ratio of 101% during the first three months of 2017.

– Investec Bank Limited (IBL)

IBL’s strong asset quality, abundant liquidity and high leverage ratio

drive its BCA of baa3. Although the bank’s financial performance for the

year ending March 2017 was not as strong as previous years (around 7%

decline in profit after tax), this was largely driven by the change in

accounting treatment of investment income from fair value to equity

accounting. The rating agency notes that the bank’s core income,

including net interest income, net fee and commission income and trading

income, was in fact higher by around 10.3% as of March 2017. In addition,

Moody’s expects the bank’s asset quality to continue to be the strongest

among its local peers, with reported gross NPLs to gross loans of only

1.54% in March 2017. IBL’s credit loss ratio continued to be a low 0.29%,

supported by its larger exposure to non-household borrowers who have

displayed better capacity to withstand high interest rates. The bank’s

reported CET1 ratio was 10.8% as of March 2017, but its 7.6% leverage

ratio is the highest among its local peers.

WHAT COULD MOVE THE RATINGS UP/DOWN

As indicated by the negative outlook on the sovereign rating, any

deterioration in the creditworthiness of South Africa would exert

downward pressure on the banks’ ratings, in view of their sizeable

holdings of sovereign debt securities. In addition, the banks’ ratings

could be downgraded if operating conditions worsen more than currently

anticipated, leading to significantly higher loan loss provisions that

prompt deterioration in the banks’ earnings and capital metrics that

exceed the rating agency’s expectations.

Conversely, any upwards rating momentum of the banks’ ratings is

currently limited as their BCAs are constrained by the sovereign rating.