FirstRand keeps its head above water

Shareholders would have cried like hungry babies if FirstRand, or any other bank, announced an increase of only 5% in earnings a few years ago. Currently, they seem relieved against the backdrop of a very difficult economic and business environment.

FirstRand announced that headline earnings increased by 5% to R27.9 billion in the financial year to June and headline earnings per share by the same percentage to R4.97 – which actually means that the banking group’s income only kept pace with inflation over the last year.

However, a closer look at the results shows that this is still a very credible performance with strong underlying growth in operations, as measured by banks’ all-important indicators of interest income and revenue from fees and commissions.

Net interest income increased by a solid 18% to R60.3 billion and total non-interest income grew by 6% to R44.3 billion. These figures show that the underlying operations performed quite well.

FirstRand CEO Alan Pullinger bemoans the challenging operating environment, but says the underlying growth momentum in FNB and Rand Merchant Bank remains strong. The UK banking interests, Aldermore, also performed well, while WesBank coped well in a difficult market.

FirstRand, like many other companies, says the economy remains weak on account of high government debt, which curtails government spending and creates risks for investors, while ongoing inefficiencies at large state-owned entities and a lack of government capacity is effectively ‘crowding out’ the private sector. With GDP growing at only 1%, both household and corporate income remains under pressure.

The difficult conditions can be seen clearly in the figures of vehicle and asset financing subsidiary WesBank. Pullinger points out that new vehicle sales decreased by 5% last year and sales are back to 2011 levels. “People are keeping cars longer. Demand for car financing fell and WesBank opted to focus on good-quality business.”

FNB produced the bulk of the profits, contributing 63% to total earnings of R27 billion. Year-on-year growth in FNB was also still healthy at 11% compared with the previous financial year.

RMB contributed 25%. Management noted that RMB’s earnings decreased, as its private equity business entered an investment cycle. Investment in new private equity ventures usually brings higher costs, with income following only years later.

Of particular interest is Aldermore, the specialist UK bank that FirstRand is quietly growing. Pullinger remarks that the UK economy is growing faster than the SA economy, even if the spectre of Brexit is bringing “a lot of drama”.

Aldermore’s loan book grew by 18% to ₤10.6 billion and deposits increased by 15% to ₤8.3 billion. FirstRand merged its UK vehicle financing interest (MotoNovo) with Aldermore, which added another ₤370 million to the balance sheet.

Aldermore offers significant upside to FirstRand, as management describes it as a “bank with a small share of large profit pools in the UK”. For instance, Aldermore’s market share in mortgage bonds is estimated at less than 1% spread across the whole of the UK.

Shareholders are sure to gloss over the local pedestrian economy while they look forward to the potential returns from the UK if Aldermore succeeds in growing its market share.

When looking at FirstRand’s income statement, it is noticeable that only three line items totalling R10 billion spoiled a very attractive document.

Impairments due to non-performing loans increased sharply, operating expenses rose, and a lot more tax was paid.

Closely related to economic activity, the impairment charge increased by 23% or nearly R2 billion to R10.5 billion. Bad debts are still small relative to the overall book, but non-performing loans increased to 3.3%, compared with 2.3% a year ago.

The increase of 14% in operating cost exceeded the increase of 11% in operating income by a wide margin. The group’s total operating expenses exceeded R54.1 billion, which is R6.5 billion higher than in the previous financial year and thus hit operational profit by R6.5 billion.

However, Pullinger said in a presentation of the group’s results that the cost-to-income ratio decreased to below 50% for the first time and every effort will be made to keep it there. The group is, for instance, looking at enhancing its digital offering to reduce operating costs.

Last, but not least, FirstRand paid much more tax than in the previous year. Indirect tax jumped by R200 million and income tax by nearly R1.4 billion – for a total tax bill of a staggering R10 billion.

No wonder Pullinger says that SA’s treasury, in his view, does not have a tax problem. “Tax in SA is really very high. SA sits with an expenditure problem of poor allocation of tax revenue.”

He adds: “Government needs to cut back and spend money more effectively. Every rand spent must make a social and economic contribution to the country, or it will bankrupt the nation.”

He is nevertheless optimistic about the bank’s prospects in the near future. “The group is executing some very exciting strategies that will provide a runway for growth and enable us to deliver on our promises to shareholders, even in a challenging environment.”

Shareholders seemed happy and FirstRand’s share price increased with the rest of the banking sector through the course of the day. It is comfortably higher than its recent low of R55 a few weeks ago, closing trade on Thursday at R61. However, it is still a way off the June high of R70, but the fairly high price/earnings ratio of 14.7 times shows that investors are confident about the future too.

FirstRand share price

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