27 March 2002

South Africa: Old Mutual Turns Bullish On Banks

Johannesburg — South African banking shares on Wednesday came under pressure after substantially worse than expected Producer Price Inflation figures raised fears about rising interest rates impacting on bad debts. The Reserve Bank Monetary Policy Committee was widely expected to raise interest rates by 1% at its next meeting in June, but that might be brought forward to curb inflation.

Economists have expressed their surprise at the 13.2% increases in prices at the factory gate, and fund manager at Investec Asset Management, John Stopford said the impact on consumer prices down the line would be a major concern to the Reserve Bank.

Despite the immediate negative reaction by South Africa's biggest banks, Old Mutual Asset Managers Financial Services director Peter Linley expects their earnings to show core earnings growth of between 15-20% in the current financial year, and said two banks were particularly well positioned to benefit.

The sector has been negatively impacted by four main events during 2002. The collapse of microlender Unifer, sent shock waves through Absa and the bottom end of the market. That subsequently led to a run on deposits at Saambou which was put into curatorship and later a run on BOE deposits, halted only after government guarantees that desposits were safe. Fourthly, the weak rand has led to inflationary pressures and rising interest rates.

The JSE Bank Index is currently 25% below its June 2001 peak, and like Piet Viljoen at Investec Asset Management, Linley says the shares are at their cheapest levels in more than five years.

"Confidence in the domestic banking system remains high - we have not seen a stepped-up demand for cash which would cause a sudden withdrawal of funds from the banking system," Linley said. "Instead, depositors have withdrawn funds from institutions exposed to the microlending sector and deposited their funds with better run institutions."

Linley believes Stanbic and First Rand are currently offering the best value to investors in the banking sector. Both are on price earnings multiples of about 9 and are trading around a 20% discount to the JSE Financial and Industrial Index.

"If one allows for a Price/Earnings re-rating of 10 percent and a 15 - 20 percent rise in earnings there could up an upside price potential of over 25 percent," Linley said. He argues higher profits will come from increased non-interest income such as current account fees and commissions and trading.

All of South Africa's big banks closed the day down on Wednesday with BOE and Stanbic 4% weaker, Absa, First Rand Nedcor and Investec were all around 3% worse off.

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