namibia banking sector dynamics - deloitte
TRANSCRIPT
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Namibia Banking Sector Dynamics October 2019
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Table of Contents Introduction ..................................................................................................................... 3
Background ...................................................................................................................... 5
Interest Rates ................................................................................................................... 6
Funding ............................................................................................................................ 8
Credit ............................................................................................................................. 10
A spread issue ................................................................................................................ 12
Pulling it all together ...................................................................................................... 13
Recent Developments and Outlook ................................................................................. 18
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Introduction From late 2015 to mid-2017, Namibia’s banking sector came under pressure, fuelled largely by slowing deposit growth, increasingly expensive marginal funding costs and low liquidity. However, by mid-2017 it appeared that the situation was easing, that the industry had once again become cash-flush and less of a market price-taker when it came to accessing funding. This was true until late 2018, when at first glance it appeared that liquidity had once again come under severe pressure and indeed we entered 2019 with the banks reporting their highest ever use of the repurchase (repo) window at the central bank and the lowest levels of commercial bank liquidity in at least a decade, back to when our records began.
Source: Bank of Namibia, Cirrus Securities
Source: Bank of Namibia, Cirrus Securities
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Liquidity, Repos and BoN Bills
BoN Bills Repos Monthly Average Liquidity
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Oct
-15
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16
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16
Jul-1
6
Oct
-16
Jan-
17
Apr-
17
Jul-1
7
Oct
-17
Jan-
18
Apr-
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Jul-1
8
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-18
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Apr-
19Monthly Liquidity
Monthly Min. Monthly Max.
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However, despite the alarming sounding nature of the above, substantial changes have taken place both in the broader Namibian economy, as well as in the banking sector specifically, which mean that this recent period of low-liquidity is not the worry that the previous such episode may have been.
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Background Historically, the Namibian banking system has generally had surplus liquidity, meaning that the banks have had liquid assets in excess of their regulatory minimum requirements. However, over recent years, excess liquidity levels have fallen to the point where commercial banks have been converting less (but still reasonably) liquid assets on their balance sheets into short-term liquidity through the repurchase window at the central bank. While the details and method for these repurchases vary across the world, their use is fairly standard. Contrary to popular perception, the repo window at the central bank is not a crisis window, but a legitimate short-term funding window from which commercial banks can borrow at the “repo rate” as administered by the Monetary Policy Committee of the Central Bank. This enables commercial banks to access short-term liquidity to meet their minimum liquidity requirements, by borrowing against certain high-quality collateral. This collateral is basically Government issued (risk-free) debt, as well as the Bank of Namibia Bills, Government guaranteed debt and investment grade debt securities of State-Owned Enterprises. In other countries the repurchase window may allow commercial banks to repo more than just high-quality, low-risk assets, however the more risky the assets, the larger the haircut imposed on the asset value from a collateral perspective.
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Interest Rates Over the past decade, global interest rates have been at historically low levels, with a handful of advanced economies entering into negative-rate territory. What this means is that issuers of debt can fund themselves relatively cheaply, while buyers of debt earn little (or indeed pay) for the privilege of keeping their funds safe. This is completely counter-intuitive, as interest rates could historically be considered to be the price required by the owner of capital in order that they forego their own consumption today, in favour of income that allowed them to consume a greater amount in future. Nevertheless, while Namibia’s interest rates did not go negative, from late 2012 until mid-2014, these rates were at historically low levels.
Source: Bloomberg, Cirrus Securities The implication of these low interest rates were many-fold. Firstly, they meant that the cost of funding for commercial banks, particularly given the surplus liquidity in the economy as a whole and demand for local assets, was relatively cheap. At the same time, the rate at which the banks could on-lend was relatively low, and thus the purchasers of bank credit, mainly private sector companies and households, were able to borrow extensively. And borrow they did – from the start of the interest rate cuts in late 2008 until the first interest rate hike in mid-2014, total credit extended to the private sector almost doubled, increasing by 95.5%, from net-credit outstanding of N$32.6 billion, to some N$63.7 billion, with year-on-year growth peaking at 18.5% in 2012. While this growth trend has subsequently slowed dramatically (from mid-2015), total outstanding private sector credit now stands at N$99.4 billion.
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4.0%
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14.0%
16.0%
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p-00
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p-10
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-11
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p-12
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p-14
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-15
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p-16
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-17
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18Se
p-18
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Repo Rates
ECB RSA UK USA Namibia
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Source: Bank of Namibia, Cirrus Securities
0.0%1.0%2.0%3.0%4.0%5.0%6.0%7.0%8.0%
0.0%2.0%4.0%6.0%8.0%
10.0%12.0%14.0%16.0%18.0%20.0%
Jan-
11
May
-11
Sep-
11
Jan-
12
May
-12
Sep-
12
Jan-
13
May
-13
Sep-
13
Jan-
14
May
-14
Sep-
14
Jan-
15
May
-15
Sep-
15
Jan-
16
May
-16
Sep-
16
Jan-
17
May
-17
Sep-
17
Jan-
18
May
-18
Sep-
18
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Credit Growth and Interest Rates
Credit Growth (YoY) Repo Rate (RHS)
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Funding A further and related matter of interest is bank funding more generally, as in order for credit to be extended by commercial banks, funding is required. After approximately half a decade of strong funding growth in the Namibian banking sector, from 2015 to the present, a marked deterioration in growth can be seen. In early 2017, however, a short-term upswing in funding growth was witnessed, which lasted from mid-2017 till mid-2018. While at the time this may have appeared to be a turn in the then-established downward trend, it is now apparent that this move was a temporary move away from trend, rather than a reversal thereof. This short-term growth was likely driven by a number of specific factors that resulted in two things, firstly, an indirect injection of capital into the banking system through a large inflow of external funds into the local economy and thus the banking sectors. Secondly, the direct injection of funds into one of the commercial banks as a result of a large transaction with the Government Institution’s Pension Fund which came hand-in-hand with substantial, cheap funding for the banking group. Due to the interbank market, surplus highly-liquid funding in one bank should, in theory, mean that highly liquid funding is available across the sector. However, following this short-lived growth blip, bank funding growth has once again fallen, reaching lows last seen in 2011. Moreover, the funding growth that can be seen is driven as much by debt issuance, as by deposit growth. Indeed, deposit growth has been extremely low over recent months (at or below inflation levels), with the now anomalous 9% print in February the most notable growth print in recent times. This is perhaps not surprising given that the economy continues to languish and many institutions and households are likely to be drawing down on savings, however, it does mean that the banks have to look elsewhere for funding growth should they wish to grow loan extension again. This basically means that banks will need to look to elsewhere. Source: Bank of Namibia, Cirrus Securities
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31-Ja
n-10
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ay-1
030
-Sep
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130
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230
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-12
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330
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430
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-14
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530
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31-Ja
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31-M
ay-1
630
-Sep
-16
31-Ja
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31-M
ay-1
730
-Sep
-17
31-Ja
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31-M
ay-1
830
-Sep
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31-Ja
n-19
31-M
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Banking Sector Funding
Deposits Borrowings
Bank Funding -Deposits & Borrowings Bank Funding Growth (RHS)
Deposit Growth (RHS)
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A banks cost of funding is essentially the rate the bank is charged to acquire funds to extend on to their clients. There are various elements that make up the funding mix of the bank and the nature of each specific component dictates the rate at which it is lent to the bank. Naturally, banks seek the cheapest source of funding in order to maximise the spread between what they are charged and what they charge their clients. Generally, the cheapest form of funding is retail funding or funding that originates from a banks’ customers and their deposits with the bank i.e. current account deposits, savings deposits, call account deposits etc. However, in order to maximise returns and sate the credit appetite of the market, banks need, at times, to make use of the more expensive funding offered by other institutions, also known as wholesale funding. Retail funding rates are largely determined by the market forces of supply and demand. Should demand for funding increase and supply wanes, banks tend to pay more in order to attract this type of funding. The opposite is true in the reverse situation. The two most significant rates for wholesale funding in Namibia are the Johannesburg Interbank Average Rate (JIBAR) and the repo rate. The JIBAR is the daily calculated average rate South African banks are willing to lend to each other over the short-term. Most commercial debt funding raised by the domestic banks have interest terms that are JIBAR linked (i.e. JIBAR +2%). The repo rate is the interest rate that the central bank (Bank of Namibia) lends money to private banks through the repo system as described earlier. One of the key functions of Bank of Namibia is to maintain the value of the currency and maintaining the peg to the South African Rand. One of the most important tools at the disposal of the central bank in achieving this end is the repo rate.
Source: Bloomberg, Cirrus Securities Although the above graph would suggest that there have not been wild swings as seen in the late 1980’s, it is important to understand how great an impact a change in funding rates has on the overall interest expense paid. Due to the multiplier effect, a one percentage point decrease in the repo rate from 6.75% to 5.75% would essentially result in a 14.8% decrease in interest payments for central bank funding (1-{5.75%/6.75%}).
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12.0%
Jan-
09
Jun-
09
Nov
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Apr-
10
Sep-
10
Feb-
11
Jul-1
1
Dec-
11
May
-12
Oct
-12
Mar
-13
Aug-
13
Jan-
14
Jun-
14
Nov
-14
Apr-
15
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15
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16
Jul-1
6
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-17
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Mar
-18
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18
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Funding Rates
JIBAR 1 Month JIBAR 3 Month JIBAR 6 Month
JIBAR 12 Month Namibian Repo Rate
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Credit A sovereign credit rating is essentially an indication of a government’s capability to service the debt it issues as well as providing a measure of the political risk. Credit ratings are offered by various credit rating agencies that make use of several metrics to determine a countries investment risk. These metrics include, but are not limited to, size of debt service payments relative to export revenue; monetary stability and fiscal flexibility; the size of the debt burden; economic prospects; as well as the outlook for the political landscape. An implicit consideration is also a countries’ track record regarding their debt service payments and whether there is any historical evidence that could inform an outlook on future behaviour. Highly indebted market participants (government, businesses, individuals) face grave challenges at the best of times and especially during volatile markets. High debt service payments relative to revenues limits one’s capacity to deploy capital into income generating activities that can reap future benefits. Volatile markets affect income streams that hinder the ability to adequately provide for future debt service payments as well as interest rate volatility that would impact interest rate payments should they be linked to a benchmark i.e. JIBAR. Foreign currency denominated debt in volatile markets can also be a risk should the debt not be sufficiently hedged, as exchange rate fluctuations can have marked impacts in the resulting payments. For the private sector, debt is the cheapest form of funding and provides a tax shield but (due to the immediate and regular nature of the payments) can be one of the hardest forms of funding to service. Being overly indebted, as is the case in most Namibian households, substantially increases your risk profile and makes it far more difficult to achieve funding through a mainstream retail bank. Significant cash reserves on hand is not a luxury afforded to most Namibians, making it necessary for them to seek out funding in order to pay for their planned capital expenditures. Should one not meet the requirements mandatory for mainstream banking funding, the options afforded to them are difficult and few. For large, more established businesses the capital markets are at their disposal and capital can be raised through initial public offerings or rights issues. Venture capital funding is difficult to acquire and more expensive due to the much higher rate of return that potential investors would expect in order to provide capital. For smaller funding requirements, micro-lenders and payday lenders do provide funding under extremely onerous terms that would require substantially high returns in order to justify the use of such expensive funding. Unfortunately, credit provided by payday lenders and micro lenders is rarely used for revenue generating capital expenditure and is mainly used to cover living expenditures for individuals. An examination of the Namibian micro-lending industry makes for an interesting thought experiment around the validity of the relatively high interest rates charged. The primary rationale for these high interest rates is the idea that small, unsecured, cash loans to individuals carry with them a larger inherent risk of non-payment. Increased risk taken on by the lender requires them to have increased rates of return in order for them to justify extending credit.
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An analysis of the latest financials of the largest domestic micro-lenders by market share reveal non-performing loans in line with the industry average of NPL’s recorded by local retail banks. This would suggest that the inherent risk attributed to these loans should be in line with the risk loans and advances of retail banks carry and as a consequence should lower the required rate of return. This is further justified by the fact that these micro-loans are largely being extended to government employees with the companies making use of government deduction codes of their clients to legally ensure that they are paid prior to the clients’ salary reaching their account. Government retrenchments are rare and difficult to enact while government not paying its employees is even rarer. Additionally, these microloans are generally fully insured in the event of non-payment through cell captive arrangements which put the micro-lender in the enviable position of carrying very little risk.
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A spread issue As the economy slows and as deposit growth slows, in order to be able to lend, the commercial banks become increasingly reliant on debt funding. Although this still makes up a small portion of the total funding of the industry, it makes up an ever larger percent of the marginal funding received. However, as this funding tends to be more expensive than conventional deposits, the banks are, predictably, more cautious about its use. Not only is the margin for error on bad-loans less, but the inherent duration miss-match between funding (even debt funding) and many loan-forms (e.g. mortgage and vehicle) may not be worth the additional net-interest income. This situation appears to have been exacerbated by the fact that while the market determined cost of capital, and thus funding, has increased dramatically since 2013, the repo rate increases over the same period have been substantially slower. As a result, a wider-than-normal spread has opened up between the one-year Treasury bill (a short-term base rate) and the repo rate. As this repo rate is the benchmark lending rate, the effective spread between the price at which banks fund themselves in a low-or-no-growth deposit environment, vs the price they lend at, has been compressed.
Source: Cirrus Securities
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TB-Repo Spread
Spread 364D TB Repo Rate
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Pulling it all together So over the past few years, Namibian commercial banks have found themselves in a situation where funding has become increasingly hard and increasingly expensive to come by. A situation has arisen where liquidity has been squeezed and where lending has been forced to slow. However, this situation has brought about a potentially large change in market dynamics, which change has yet to be fully capitalised upon. Following a scare in 2016, and as the economy slowed and credit conditions deteriorated, the sector became less and less willing to extend loans, resulting in slow improvements in the sector-wide loan-to-funding ratio. This improvement was despite the fact that funding growth has been on a downward trajectory. As a result, the sector loan-to-deposit ratio has improved from a high of 104% to 96%, while the loan-to-funding ratio has gone from 92% at its recent peak, to just 84% at the last print.
Source: Bank of Namibia, Cirrus Securities What this means is that the banks are not using additional funding to purchase loans but are rather deploying this funding elsewhere. As can be seen in the below chart, the growth in loans and advances has, over recent years, been marginally below the growth in total assets. However, growth in treasury bills and other Government debt stock, has been substantially more buoyant.
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Loan to Funding Ratios
Loan to deposit ratio Loan to funding ratio
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Source: Bank of Namibia, Cirrus Securities Indeed, for much of the period through mid-2017, commercial banks were the main buyers of the sizable volumes of net treasury bills issued by Government, with rolling 12-month net purchases peeking out at just under N$5 billion in mid-2018.
Source: Bank of Namibia, Cirrus Securities
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Sector Asset Growth (Select lines)
Asset Growth Loans and Advances Growth Treasury Bill Holdings Growth
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Mill
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Rolling 12m Net TB Issuance
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Source: Bank of Namibia, Cirrus Securities The reason that the sector has been purchasing treasury bills and to a lesser extent, other Government debt, is likely manifold. As the economy has slowed, the credit quality of the marginal loan issued is likely to be worse than was the case previously. As a result, the banks are cautious about extending loans on as liberal a basis as they did when the economy was booming and interest rates were low. Add to this that we see signs of moderate to aggressive deflation in parts of the mortgage-market, the single largest component of most banks loan-book, and the cautious approach to further loans becomes self-explanatory. However, there are other strong arguments for these purchases and potential value to be unlocked. As the banks have purchased these Government debt securities, their stock of assets that can be offered to the repurchase window at the central bank have increased, meaning that the commercial banks have access to liquidity and funding through this window if required, thus helping to alleviate concerns around potential liquidity issues in the immediate and foreseeable future. As a result, when looking below the surface of the liquidity figures, we see a picture substantially less worrying than the headline liquidity statistics may otherwise appear. Indeed, if needed, commercial banks can turn a large stock of treasury bills into liquid assets in a single day, and moreover, do so at an extremely favourable rate. As the spread between the repo rate and the market determined rate of capital has widened, the incentive to utilise the repo facility has increased, and again predictably, so too has its use. Indeed by the end of 2018, the banking sector had more than N$8 billion worth of surplus assets available for repo, if required.
-60.0%-40.0%-20.0%0.0%20.0%40.0%60.0%80.0%100.0%120.0%140.0%
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01-Ja
n-15
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ar-1
501
-May
-15
01-Ju
l-15
01-S
ep-1
501
-Nov
-15
01-Ja
n-16
01-M
ar-1
601
-May
-16
01-Ju
l-16
01-S
ep-1
601
-Nov
-16
01-Ja
n-17
01-M
ar-1
701
-May
-17
01-Ju
l-17
01-S
ep-1
701
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-17
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01-M
ar-1
801
-May
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01-Ju
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01-S
ep-1
801
-Nov
-18
N$
000
Banks Buying TBs
YoY Net Issuance of TBs YoY Net Purchase of TBs by Banks Banks as % of Net Issuance (RHS)
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Source: Bank of Namibia, Cirrus Securities
Source: Bank of Namibia, Cirrus Securities However not only is this funding side of the industry balance sheet in better condition than was the case a few years ago, but this ability to use the repo facility and a willingness to do so is a key aspect of a functioning banking system, and indeed capital markets. As long as there is a reasonable spread between the repo and treasury bill rates, there exists an arbitrage opportunity for commercial banks which may well serve the economy positively, at least in the short term. The reason for this is that the banks can borrow from the central bank at the administered repo rate and use these borrowed funds to purchase treasury bills at the prevailing market price for treasury bills. The spread between these two rates has varied over time, however, is currently in the range of 1.39% on the longest dated Treasury bill – the 364 day bill. This means that the banks can pocket the spread between the two, provided they can manage the duration mismatch between the instruments and the inherent risk of funding that reprices frequently on assets that reprice less frequently (a larger risk the
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ay-1
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ay-1
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n-18
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N$'
000
Average Liquid Asset Surplus
Surplus/(Deficit) Liquid assets required to be held Average daily liquid assets held
0
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Jan-
08
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0
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-11
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12
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N$
Mill
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Selected liquid assets
Treasury Bills of the Government of Namibia
Stocks, securities, bills and bonds of the Government of Namibia
17 | P a g e
longer the duration treasury bill purchased with the borrowed funds). However, this should not be a concern, as managing duration mismatch is one of, if not the, main job of a bank (banks receive relatively cheap short-term funding and on-lend this more expensively longer-term – it is hard to imagine that you would commit to depositing your funds in the bank for 20 years, and yet you will not think twice about taking out a 20-year mortgage loan). Moreover, this can be done in close to perpetuity – utilise treasury bills to collateralise borrowing from the central bank to purchase treasury bills to use as collateral to borrow further from the central bank – the cycle continues ad-infinitum. This use of the repo facility and the arbitrage that exists between the administered cost of capital and the interest that can be earned on the benchmark market determined cost of capital is actually a useful tool for the central bank and likely the broader economy. By allowing the banks to borrow at these lower-than-market rates, the central bank should be able to influence market rates for capital. As the banks run the aforementioned arbitrage cycle, the interest rates on government debt should be reduced to the point where the spread between the marginal capital cost and the marginal income generated, when considering the excess duration on assets (91 day or more) vs liabilities (one week, rolling), no longer make sense, given the interest rate risk associated with rapidly repricing funding rates and fixed rates of income. Over this period of arbitrage, however, the economy will have experienced a monetary injection. This is due to the fact that each time the repo facility is used, the central bank converts government debt into cash on the commercial bank balance sheet (the commercial bank creates a currency in circulation liability, offset by a collateralised loan asset). In effect, this can bring about an effective “lubrication” of an economy that is short of cash and indirectly, contribute to a growth recovery.
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Recent Developments and Outlook Banking sector funding growth remains under some pressure, with late 2018 figures showing some of the lowest levels of growth since 2011. Moreover, the funding growth that can be seen is not in the form of relatively cheap deposits, but rather in the form of more expensive borrowings. However, unlike the 2016 funding and liquidity squeeze, the current situation is perhaps somewhat less worrying, at least as far as funding and liquidity is concerned. Generally, the outlook for funding across the country is likely to improve, as will the liquidity situation. However, much like the event of 2017, where funding growth recovered, this change has likely come about as a result of transitory factors, in this instance, changes to pension fund regulation being most prominent. Changes to the local-asset requirements for pension funds means that a substantially larger portion of the savings of pensioners and to-be-pensioners must be invested in “genuine” local assets (as opposed to dual listed equity, where the funds are not generally directly invested in Namibia) than has ever been the case in history. By the end of 2019, it is estimated that N$67 billion Namibia Dollars of pension fund money alone, will have to be invested in these “genuine” local assets. This is an approximate 75% increase in the local assets that had to be invested locally just two years ago, although actual local asset investments may indeed have been higher than the effective regulatory minimum.
Moreover, from a liquidity perspective, the commercial banking space is substantially better off than was the case in 2016, despite top-level liquidity statistics appearing to be worse than at any point in recent history. In this vein, the arbitrage opportunity between the repo rate and current Treasury bill rates needs to be utilised by the banks in order to bring in the yield
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curve, give effect to the administered rate of capital and lubricate the local economy. Should this happen, we expect to see some improvement in commercial bank financial performance, but also in a reduction of the cost of capital across the board, a potential shot-in the arm for the ailing economy. In short, the current concerns that exist in the banking sector should have much less to do with the funding side of the balance sheet and much more to do with the asset side. Deflation in the property market has become the industry’s largest risk, no longer the cost or availability of funding.
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