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Company Information
BloombergTi cker CPISJ
CurrentPrice(cents) 10,100
12monthPriceTarget 12,162
MarketCap,Rbn 8.33
Shareso uts ta nd in g,mn 8 2.9 83
Potential capitalgain 20.42%ForwardDiv Yield 2.71%Forecasttotal return 23.13%
ImpliedPER,X 23.9ImpliedPBVR,X 6.4YTDcapitalreturn 27%
52WeekReturn 179%
Salient information
Rand,mn 2009 2010 2011F 2012F 2013F
NII, 943 1,273 1,598 2,055 2,427
Netfee i nco me 1, 036 1, 282 1, 605 2, 047 2, 457
EPS,cents 357 509 683 874 1,028
Loansandadvances 2,982 5,225 7,176 10,573 13,994
D ep os it s 3, 317 7, 360 9 ,568 12, 439 15, 549
BVPS,ce nts 1, 489 1,910 2,325 2,850 3, 466
NIM 19.0% 13.4% 13.1% 13.1% 12.4%
Cost/Income 54% 54% 53% 52% 51%
LDR 90% 71% 75% 85% 90%
ROE 25.5% 28.6% 31.5% 32.9% 31.8%
ForwardPER,X 14.8 11.6 9.8
ForwardPBVR,X 4.3 3.5 2.9
Returns vs. Banks & ALS Indices
12%
11%
13.5%
39.3%
7%
6%
12.9%
38.7%
27%
32%
60%
174%
0% 50% 100% 150% 200%
YTD
3Months
6Months
1Year
Capitec
ALSI
BanksIndex
CAPITEC BANK
Valuation looks steep, but grow th
outlook is the differentiating factor
We initiate coverage on Capitec Bank with a BUY
recommendation. In section 1 of this report, we provide an
analysis of the banking sector, comparing it to other
Emerging markets (EMs) and/ or history where necessary.
In section 2, we carry out our company analysis (Capitec
Bank), presenting our forecasts and their basis. We also
show our valuation model and provide an environmental,
social and governance (ESG) comment.
Overall, the banking industry structure, and the borrowers
profile, particularly households, are poor and w eak. In that
light, we do not like:
the high penetration rates. The loan/GDP and deposit/GDPratios are high at 96% and 93% respectively. This provides
little room for excess loan growth above GDP growth
without catalysing liquidity problems in the long-term;
the high debt/disposable income level which makes thehousehold borrowers profile poor in our view. South Africas
debt/disposable income ratio is around 80%, which does not
compare favourably against history and other EMs; the poor outlook for major loan growth factors. Only per
capita income screens positively for loan growth; and
the increasing funding gap that could create liquidityproblems in the long-term. The funding gap is R329bn, and
could grow to R500bn by 2012. The Loan-to-deposit ratio
(LDR) is already above 100% at 103% and the leverage
multiple is 15X.
Initiation of coverage: We initiate coverage on Capitec with a
BUY recommendation. Our 12-month price target is R122,
providing a potential total return of 23.1%. While the share price
has re-rated strongly from April last year, and has outperformedthe Banks Index and the All Share Index by wide margins, we
believe there is some value on the table. We are convinced that
the bank commands a strong position in its market segment. It
has strong capital and liquidity levels that can be deployed to
grow loans and profitability, and has an experienced management
team.
Peter Mushangwe
Puleng Kgosimore+27 11 551 [email protected]
Please refer to the back of this report to
view our disclaimer and disclosure
April 19 2010 Equity Report
RECOMMENDATION
BUY
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Page 1 of 54
Contents page
Executive Summary 2
1. Industry Analysis 5
1.1 We loath high penetration, but we like high H-Index 5
1.2 Credit risks: Slower NPL formation to aid profitability 11
1.3 Liquidity risks: Funding gap is increasing 15
1.4 Capital risks: Adequate capital levels 19
1.5 Profitability: We carry loan growth worries 20
1.6 Why the micro-market could be the winner 23
1.7 The macro story: So far so good 27
2. In itiation of Coverage 31
2.1 Capitec Bank: Initiating with a BUY 31
2.2 Company Analysis 34
2.3 Financial Forecasts and Valuation 45
2.4 Corporate governance and other ESG issues 50
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The Executive Summary.
Initiating w ith a BUY, our 12-month price target is R122: We
initiate coverage on Capitec Bank, [Bloomberg CPI SJ] with a BUY
recommendation. Our primary method is the Justified
Price/Earnings ratio (PER), which we estimate at 17.8X. We
multiply the Justified PER by our FY11 earnings per share (EPS) to
get a 12-month price target of R122. This provides a potential total
return of 23.1%. Our secondary valuation method, the Discounted
Future Earnings (DFE) provides a fair value of R113, giving a
potential total return of 14.7% from the current price. We use aCost of Equity (CoE) of 17.5% to discount the earnings and an exit
PER of 13X for our terminal value (TV).
Good company, but bad stock?: To an extent, we were caught
between the high valuation risk argument and our earnings
outlook. Our analysis points out the strength of franchise and the
strong growth outlook. But the relatively high trailing PER created
some discomfort. However, we become more convinced that our
earnings outlook is a stronger argument for exposure. Our
recommendation is underpinned by our forecast of strong excess
earnings, in spite of our conservative estimates (relative to history
and management guidance). Our forward PER reduces to 9.8X in
FY13. For investors (and not speculators), the risk/reward profile is
still appealing, in our view.
What w e like about Capitec: We like the 100% exposure to the
high-margins, low income segment, and the experienced
management. The low income segment is less leveraged when
compared to the mainstream banks general customers. This,
supported by the recent pace of deposits gathering should provide
above system loan growth. The high cash level, low leverage and
low LDR provide room for stronger loan growth for Capitec when
compared to the industry. The Net Interest Income (NII) growth
rates are strong and Net interest margins (NIM) are healthy. Net
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fee income has increased materially, with high growth rates.
Management is also experienced in our opinion, and has managed
to control both credit and operating costs. The ROE outlook is solid
in our view.
What w e do not like about Capitec: The unwanted side-effects
of a rapid credit expansion, and to low income segments is the
higher credit risks. Capitecs overdue accounts/loan ratio is higher
than the industrys average. We also do not covet the apparent
high valuation risk of the share. The trailing PER of 19.7X does not
compare positively against the Banks Index PER (I-net) of 14.5X,
notwithstanding the strong earnings growth outlook.
The industrys high penetration is a significant negative in
our view : The high penetration rates provide modest upside
potential in system loan growth beyond GDP growth without
negative impact on the systems liquidity. The systems banking
assets/GDP and loans/GDP ratios are 126% and 96% respectively.
The deposit/GDP ratio is 93%. While both the loan/GDP and
deposit/GDP ratios are still below 100%, the loan/deposit ratio is
above 100% at 103%;
But the high concentration level reduces competitivepressures: The high concentration level reduces competition,
particularly for the Big 4 banks. The Herfindahl Index (H-Index) is
above 0.18 indicating high market share concentration. The Top 4
banks market share is 84.4% (2008, and based on banks balance
sheets). Theoretically, the system is oligopolistic;
System credit risks increased in CY2008-9 but we expect
slower non-performing loans (NPL) formation to aid
profitability hereafter: With the recovery of the economy, we
expect system NPL formation to reduce. There is increasingpositive management guidance in terms of credit risks,
(notwithstanding Standard Banks famous guidance that NPLs
have not peaked yet). Our view is that the pace of both rand and
percentage growth should slow this year. In our opinion, the major
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sector to watch is the real estate which makes up 44% of the
industrys loan book.
Sector liquidity risks worry us as the funding gap is
increasing and the LDR is now over 100% : The systems LDR
is high at 103% and the funding gap is increasing. The funding gap
is R329bn, about 14% of GDP. Our estimation indicates that by
2012, the funding gap will be close to R500bn. As the funding gap
increases, the system will depend more and more on foreign
funding and the interbank market, which are both volatile. The low
savings rate is also unconstructive to the systems long-term
liquidity. South Africas savings/GDP ratio is below 20% compared
to about 50% for China, for example.
The industry is profitable, and the average ROE is 15.8%
since FY02: The industrys average NIM ratio is stable at 3.3%
since FY00 while the average interest rate spread is 3.4%.
Industry profitability has increased by a compounded annual
growth rate (CAGR) of 19.4% between FY04 and FY08. The
industrys average ROE (CY02-CY08) is 15.8%.
The system has enough capital: The strong capital position
allows further loan growth. The local system escaped the liquiditycrunch (2007-2009) without major victims. Banks remained
relatively well capitalised, despite the higher leverage (15X) when
compared to history. We believe there is no need for consolidation
in order to strengthen the system.
Why the Micro-finance market could be the winner: In our
view, the micro-finance sector can perform better than
mainstream due to 1) lower debt levels by the lower income
consumer which provide room for further borrowing, 2) the
defensiveness of assets when compared to the main streamsystem. Micro-banks exposure to structured credit products and
capital markets is minimal if not non-existent, 3) lower
concentration levels on both the asset (loans) and liability
(deposits) side of the balance sheet. This reduces credit and
liquidity risks, 4) higher NIM and interest rate spreads.
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1. Industry Analysis
1.1 We loath the high penetration rates, but we like thehigh H-Index.
The South African banking industry is highly penetrated. Both the
loan/GDP and deposit/GDP ratios are high, at 96% and 93%
respectively. (see Fig 1). The banking sector has experienced strong
growth, and the industry balance sheet has expanded significantly.
Loans and advances, particularly to households, pushed the systems
asset growth. Mortgage and credit card advances went up by a CAGR of
20.5% and 21.9% between CY03 and CY09 respectively. Theloans/banking assets ratio ascended by 11 percentage points (pp) from
70.1% in CY03 to 81.4% by CY06. The ratio slowed in CY08 to 73% but
has since recovered to 75.5% by CY09.
The banking sector assets/GDP ratio rose to 135% in CY08 from 85% in
CY00. South Africas penetration levels on both the asset and liability
side are high when compared to other EMs. In our view, this provides
modest upside potential to industry players in the long-term, particularly
when compared to other EMs...
...but the benefits come from a highly concentrated market. The
banking industry is highly concentrated with an H-Index of over 0.18.
(based on balance sheet size). The market share of the Big 4 banks
averages 84.4% since CY03. This is 14.9pp above the 69.5% market
share of the Big 4 banks in CY01 (see Fig 2). In our judgement, the
barriers to entry, particularly regulatory and capital requirements,
create further impediments to competition. Theoretically, the industry is
oligopolistic as the H-Index is above 0.18. When the industry is not
fragmented, one would expect it to carry less competitive pressures.
However, we believe the high concentration level does not bode well for
smaller competitors who should find it difficult to create necessary
economies of scale and compete hence a differentiated focus strategy
becomes imperative. For the Big 4, this is visibly an important
positive.
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Fig 1: The industrys penetration rates are high. Growth potential is w eaker relative to other EMs.
10%
10%
30%
50%
70%
90%
110%
Nigeria Turkey Russia Brazil Chile RSA
2009
Loans/GDP
Deposits/GDP
0.55
0.65
0.75
0.85
0.95
1.05
1.15
2003 2004 2005 2006 2007 2008 2009
Loans/GDP
Deposits/GDP
Source: IMF, UNCTAD, Bloomberg, SARB, Legae Calculations
Fig 2: The Top 4 banks dominate the market... ... and the H-Index has worsened since 2002
69.5%
74.0%
87.0%
83.6% 83.4%84.1%
85.1%
84.4%
50.0%
55.0%
60.0%
65.0%
70.0%
75.0%
80.0%
85.0%
90.0%
2001 2002 2003 2004 2005 2006 2007 2008
0.175
0.170
0.182
0.184 0.184
0.1900.189
0.160
0.165
0.170
0.175
0.180
0.185
0.190
0.195
2002 2003 2004 2005 2006 2007 2008
HIndex
Source: SARB, Legae Calculations
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South Africas debt/ disposable income ratio is high. The ratio rose
steeply from around 50% in 2002 to around 80% in 2007 and has since
stabilised around that value. Higher debt/disposable income levels make
the industry less appealing. The high levels of debt/disposable income
affect banks in two main ways; 1) it limits the expansion of loan books
as demand is constrained 2) it leads to higher default rates particularly
in times of economic stress as there would be little room for borrowers
to manoeuvre when income falls. Needless to say, both are detriment to
the bottom line. Compared to other EMs such as Russia and China,
South Africa screens poorly on the debt/disposable income ratio. For
example, Russias debt/disposable income ratio in 2008 is estimated at
23%. Our view is that this will have a negative impact on loan growth as
households have little capacity to carry more debt. (See Fig 3)
Fig 3: Debt/ disposable income ratio rose steeply in CY02... ...and compares poorly against EMs e.g Russia
30.0
40.0
50.0
60.0
70.0
80.0
90.0
1980/01
1982/03
1985/01
1987/03
1990/01
1992/03
1995/01
1997/03
2000/01
2002/03
2005/01
2007/03
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
2004 2005 2006 2007 2008
RSA
Russia
Source: SARB, IMF, Legae Calculations
Despite the relatively poor profile of the South African borrower,the system registered strong loan growth from CY2000 to
CY2009. Loan and advances went up by a CAGR of 17.5% over the
period. Deposits registered a weaker CAGR of 15.4% over the same
period. The LDR went up from 87% in CY00 to 103% by CY09. (see Fig
4).
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It is important to note that the loans and advances grow th rate
outpaced the deposits growth rate since CY2003 (see Fig 4).
Starting in 2H08, however, the deposit growth rate outpaced the loan
growth rate. The loan growth rate receded on 1) effects of a tighter
monetary policy, 2) stringent risk-based lending procedure that were
both self induced and National Credit Act (NCA) induced and 3) lower
loan demand as the economy started to show signs of weaknesses.
The systems total loans and advances grow th plunged in 2009,
and so did the deposit growth rate. While strong quarterly growth
in loans and advances was registered in CY06 and CY07 (29% and 22%
respectively), growth rate receded in CY08 to 12.3% and turned
negative in CY09 at -2.6%. The deposits growth rate also tumbled from
16.7% in CY08 to 0.4% in CY09. The simple average quarterly growth
rates for loans and advances and deposits since CY95 is 7.1% and 7.3%
correspondingly. (see Fig 5).
Anecdotal data indicates that banks have eased, or are easing
credit standards. Coupled with the expected recovery and the
relatively lower interest rate environment, we would expect loan growth
to recover somewhat, especially as demand from corporates may firm.
We do not expect loan growth to recover to pre-crisis levels, mainly
because the household borrowers profile is weak. Furthermore,
notwithstanding the recovery, consumer and business confidence levels
are still below the pre-crisis levels.
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Fig 4: Loan & deposit growth was strong upto 2007... ...LDR has been >100% since 2003
500
1,000
1,500
2,000
2,500
10%
0%
10%
20%
30%
40%
50%
60%
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
Loans,Rbn(RHS)
Deposits,Rbn(RHS)
Loangrowth
Depositsgrowth
87%
83%
79%
106%104%
106%
110%111%
106%
103%
70%
75%
80%
85%
90%
95%
100%
105%
110%
115%
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: SARB, Legae Calculations
Fig 5: Loan growth plunged in 2008... ... and so did the total deposit grow th
7.1%
2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
Feb95
Feb96
Jan97
Jan98
Dec98
Dec99
Nov00
Nov01
Oct02
Oct03
Sep04
Sep05
Aug06
Aug07
Jul08
Jul09
Totalloansgrowth,q/q
average
7.3%
2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
16.0%
Mar95
Feb96
Jan97
Jan98
Dec98
Dec99
Nov00
Nov01
Oct02
Oct03
Sep04
Sep05
Aug06
Aug07
Jul08
Jul09
Totaldepositsgrowth, q/q
average
Source: SARB, Legae Calculations
South Africas three major loan growth factors screen poorly, in
our opinion. The three major factors we identify are 1) penetration
level 2) population growth and 3) per capita income. South Africa
screens poorly on 1 and 2. The penetration rate is high, as we have
already indicated, and the high debt/disposable income ratio
exacerbates the situation. Population growth rate is also weak. South
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Africas population is expected to grow to 51.5mn by 2025, according to
the Population Data Sheet 2009. The country has one of the lowest
fertility rates in the Sub-Sahara Africa and the high HIV prevalence
negatively affects population growth. Population growth rate is a long-
term theme in our view, but it still screens poorly. The only constructive
factor is the per capita income with an expected growth of 19.3%
between 2009 and 2014, expanding from US$5,635.2 to US$6,724. This
also ranks relatively well against EMs. (IMF forecasts)
Loan growth faces substantial headwinds in our view . Even in this
relatively low interest rate environment, which should spur loan
demand, the high leverage level of the borrowers still provides
significant risk to loan growth. Strong household loan growth (between
CY03 and CY08) might lead to banks restraining their loan growth rates.
Credit cards loans, for example went up by a CAGR of 22.4% between
CY03 and CY09. The growth could be an indication of credit penetration
into less credit-worthy segments. It could also be a sign of growing
exposure to the existing clients. Both would not be good for credit risks.
Our view, therefore, is that taking loan growth for granted this year and
even next year, could be risky.
But deposits growth is better placed for a rebound. On the liability
side, we expect a stronger rebound in deposits than loans. Transaction
accounts could increase due to 1) slowdown in leverage by households
which should increase savings in the medium term 2) lazy deposits
amid diminished risk appetite due to the uncertainty in economic
recovery.
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1.2 Credit risks analysis: Slower NPL formation to aidprofitability
The systems credit quality deteriorated starting CY07. Credit
quality started to deteriorate in 2H07, and by CY08 the rand amount of
the overdue accounts had increased by a CAGR of 41% from R21.9bn in
CY04. As a percentage of advances, the overdue accounts ratio went up
from a low of 1.1% in 2H06 to 3.8% in 2H09. The average overdue
accounts/total advances ratio from CY04 to CY08 is 1.8%. (see Fig 6)
As the economy recovers, leverage becomes a more important
factor to profitability. As the economy move from recession to
recovery, the differentiating factors in banking move from strength of
balance sheets to leverage, in our opinion. Recovery in loan demand,
albeit low, would be both constructive to NIM expansion, but banks that
can leverage stand a better chance to exploit it.
NPL formation to peak in 1H10, in our view . Slower NPL formation
due to better and improving economic conditions and the low interest
rate environment mean credit risks going forward should be soft,
especially when compared to the CY08 and CY09 levels. There is
increasing positive management guidance on asset quality despite
Standard Banks famous guidance that the NPLs have not peaked yet.
The low interest rate environment allows banks to restructure
problematic loans at lower cost and/or expanding the tenors of loans.
We expect NPL formation to peak in 1H10.
Provision levels have started to reduce. Systems overdue accounts
should still remain above the average 1.8% this year, but the pace of
growth should reduce. We, therefore, believe that CY10 will show an
improvement, but remain a fairly tough year due to the poor profile of
South Africas household borrowers. The restructuring of loans,
especially where tenors are extended effectively understate the NPLs.
While we could not get data to provide an insightful analysis concerning
the systems restructuring portfolio, academic research in the US has
shown than about 50% of the loan restructured become NPLs a year
later.
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Real estate sector is the key focus area for credit risk
monitoring: For CY10, our view is that loan recovery is inescapable,
albeit slow. Already, the loan/total assets ratio has rebounded although
it is still below the 2005-2007 levels. The key focus area in our
judgment is the real estate sector. The systems highest exposure is in
this segment as indicated by the high weight it represents as a
percentage of total loans and advances. Credit card exposure is the
smallest despite general concerns about its quality. Credit card loan
growth declined from a peak of 47.4% in CY05 to 2.8% in CY09. In rand
term, the exposure enlarged by a CAGR of 21.9% from R16.9bn in CY03
to R55.7bn in CY09. The growth in this segment could be greatly
hampered by high household debt levels. The highest credit risk
exposure for banks is the real estate as about 44.5% of loans are
mortgage loans. The mortgage loans/GDP ratio has increased from 26%
in CY03 to 43% in CY09, despite the decreasing growth rate of
mortgage loans since CY2006. (see Fig 7 and Fig 8). Nonetheless, the
recovering real estate sector should reduce risk.
Regulatory risk is one of the greatest risks in the short- to
medium-term, in our opinion. In our view, despite our expectation of
improving credit risks, the key headwind will come from regulatory risks.
As we indicated, our opinion is that at this stage of the recovery,
leverage is more important to banks in order for them to capture the
recovery and enhance bottom line. How much leverage banks will be
allowed to assume by regulators is the major question, not only in the
local market but even internationally. We do not expect regulatory risk
in the Developed Markets (DM) to have the same and immediate impact
to the local market but the international banking sector faces long-term
structural changes that should eventually affect local banks in the long-
term.Basel committee consultative documents already point to
regulatory changes: In December 2009, the Basel Committee
governing body issued key elements of the reform programme for
consultations. The key elements were:
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raising the quality, consistency and transparency of banks
capital bases;
strengthening the framework of the risk coverage of capital;
introduction of leverage ratio as a supplementary measure to
Basel ii risk-based framework;
introduction of a series of measures to promote the building of
capital buffers in good times; and
introduction of a global minimum liquidity standard for
internationally active banks that include a 30-day liquidity
coverage ratio underpinned by a longer-term structural liquidity
ratio.
The major aim is to strengthen, and potentially raise the minimum
capital requirements and maintaining ample liquidity. Higher capital
levels and higher liquidity levels than is the case now would
result in lower credit growth.
Fig 6: Overdue accounts/ advances went up in 2008... ...and in rand-term it reached R87.3bn
0
10
20
30
40
50
60
70
80
90
100
2004 2005 2006 2007 2008
Overdueamounts,Rbn
1.8%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Mar04
Jun
04
Sep
04
Dec
04
Mar05
Jun
05
Sep
05
Dec
05
Mar06
Jun
06
Sep
06
Dec
06
Mar07
Jun
07
Sep
07
Dec
07
Mar08
Jun
08
Sep
08
Dec
08
overdueacc/advances
average
Source: SARB, Legae Calculations
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Fig 7: Total loans/ total assets ratio is recovering... ...and mortgages continue to dominate loan book
60%
65%
70%
75%
80%
85%
2003 2004 2005 2006 2007 2008 2009
33.6%37.7% 39.8% 40.3%
41.4% 41.9% 44.5%
1.8%2.0%
2.4% 2.6% 2.7%2.5%
2.5%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2003 2004 2005 2006 2007 2008 2009
Mortgage l oan s Cr ed itcardsdebto rs o ver dr af ts o ther
Source: SARB, Legae Calculations
Fig 8: The mortgage loans/ GDP ratio has stabilised at >40% . Growth in credit card loans tumbled in 2008-9
24.9%
47.4%
40.8%
25.5%
4.0%2.8%
10%
0%
10%
20%
30%
40%
50%
60%
2004 2005 2006 2007 2008 2009
26%
29%
34%
39%
43% 42% 43%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
2003 2004 2005 2006 2007 2008 2009
Mortgageloans/GDP
Mortgageloangrowth
Source: SARB, Legae Calculations
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1.3 Liquid ity risks analysis: The funding gap is increasing
Funding gap is growing fast, and LDR is high . The South African
banking system stood the 2008-2009 liquidity tsunami with no
noticeable victims. Liquidity positions of banks remain strong, but we
are beginning to be concerned with the growing funding gap, (customer
loans and advances less customer deposits) which has now grown to
R329bn. The LDR at 103% is not beneficial to liquidity and loan growth
in the short-term. The local interbank markets have become crucial in
funding the systems loan book. Needless to say, the interbank market
is volatile as a source of funding, and we recall the demise of LehmanBrothers among others who became victims of over-reliance on the
interbank market. We also highlight that during the last credit cycle
downturn (2001-mid 2003), both the funding gap and the LDR dropped
but this time around they held up.
Funding gap could reach R500bn by 2012 . The current funding gap
is R329bn, which is about 14% of GDP. The industry funding gap will
grow to R491bn should it continue to grow at 7.8% which is the average
growth rate since CY02. Assuming that the funding gap will grow at a
subdued rate of 1.8%, like was the case in CY09, then the gap willincrease to R466bn by CY12. (see Fig 9)
The system heavily relies on wholesale deposits. The industry
currently relies heavily on wholesale deposits, which is a concern to us
in terms of liquidity and impact to NIM. Wholesale deposits are not only
actively managed, and thus more volatile and more expensive, but they
also increase the degree of concentration risk. Investor-awareness,
where people invest their savings through money market funds instead
of ordinary deposit products could partly explain this high reliance on
the wholesale market. The comforting feature of the system funding
structure is that long-term deposits continue to rise, increasing from
13.9% in CY02 to 23.3% in CY09. (see Fig 10).
Low household savings rate could aggravate liquidity risks in the
long term. The lower savings ratio for South Africa is a negative for the
sectors long-term liquidity. Lower savings in a market that has had high
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loan growth rates in the recent past leads to higher LDR. This could
ultimately result in liquidity problems. Countries with high savings
ratios, like China, tend to have lower LDR. The high savings rate(s) in
China (Asia) act(s) as a buffer to leverage. (see Fig 11).
We note that some of the major local banks (i.e. Standard Bank and
First Rand) established relationships with Chinese banks. Although this
has often been analysed in terms of possibilities of deal flows, especially
of trade finance and corporate finance nature, the other invaluable
benefit we identify is access to liquidity. Liquidity could be accessed
through direct credit lines or syndicated loans. We believe no-one will
drop the cash out of a helicopter, especially in light of the 2008-09
liquidity crunch, but the benefits will outweigh the costs, in our opinion.
Fig 9: The industry funding gap has worsened to >R300bn... ...and could hit R500bn by 2012
350
300
250
200
150
100
50
0
Jun
95
Jan
96
Aug
96
Mar
97
Oct97
May
98
Dec
98
Jul99
Feb
00
Sep
00
Apr
01
Nov
01
Jun
02
Jan
03
Aug
03
Mar
04
Oct04
May
05
Dec
05
Jul06
Feb
07
Sep
07
Apr
08
Nov
08
Jun
09
550
500
450
400
350
300
250
200
2010/06
2010/12
2011/06
2011/12
2012/06
2012/12
1.8%growth, av.for09
6.8%growth, av.since06
7.2%growth, av.since02
Source: SARB, Legae Securities
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Fig 10: Wholesale deposits make the highest contribution to funding but lon g-term deposits are rising
13.9% 11.7% 12.9% 14.2% 16.3% 17.6% 20.2% 20.6%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2002 2003 2004 2005 2006 2007 2008 2009Otherdemandde p. Savi ngs Shor tte rm M ed iumte rm L ongterm
47%
28%
18%
3%3%
2%
Wholesaledeposists
Commercialdeposits
Householddeposits
Localcapitalmarkets
Foreignfunding
Other
Source: SARB, Legae Calculations
Fig 11: The gross savings/ GDP ratio is low for RSA... ...but the LDR is high
0%
20%
40%
60%
80%
100%
120%
140%
LATAM CEE RSA Asiaex Japan
LDR
Average
0%
10%
20%
30%
40%
50%
60%
China India Japan Europe Australia USA RSA
Source: IMF, UNCTAD, SARB, Legae Calculations
Interbank assets increased from CY04 levels, but reduced in
CY09. The ratio of interbank assets/total deposits peaked in 2007-2008
before softening in CY09. In our view, the decline in this ratio could
have been catalysed by some form of risk aversion in the interbank
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market during the peak of the global crisis, notwithstanding the
soundness of the local system when compared to the DMs. The volatility
of the interbank market deposits, negatively affect Asset and Liability
management (ALM) strategies which could have an indirect impact on
profitability while the higher cost of such deposits have a direct impact
through lower NII.
Non-residents deposits/ total deposits increased in 2008-9. The
ratio of non-residents deposits/total assets, which was below its average
of 4.6% (between 1992 and 2009) also started to migrate upwards
towards the average in CY06. By CY09, the ratio slightly exceeded the
average at 4.7%. The other period when the system had a ratio higher
than 4.6% was from 1997 to 2001 when the ratio peaked at 6.9% in
1998. (see Fig 12). Given South Africas relatively higher ranking in
banking soundness, one may assume this was a confidence indication,
but we note that in rand terms non-resident deposits declined by 28.9%
from R102.9bn to R73.2bn in CY09.
Fig 12: Interbank assets/ total deposits ratio Non-residents deposits/ total deposits
5.0%
5.5%
6.0%
6.5%
7.0%
7.5%
8.0%
8.5%
9.0%
2003 2004 2005 2006 2007 2008 2009
0%
1%
2%
3%
4%
5%
6%
7%
8%
90%
91%
92%
93%
94%
95%
96%
97%
98%
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
residents deposits/total deposits,LHS
nonresidentsdeposits/total deposits
average(nonresidentsdeposits/total deposits)
Source: SARB, Legae Calculations
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1.4 Capital risks: Capital is adequate, no need forarranged marriages
The system is well-capitalised, and did not seek capital during
the 2008-2009 crisis. In order to retain assets and more-so grow
them on the balance sheet, the bank must be optimally funded by
capital. Because government debt is zero-risk weighted asset, during
periods of liquidity crisis, banks buy government bonds in order to
improve capital levels. While the credit profile deteriorated in South
Africa, there was no stampede for quality as was witnessed in the DMs.
The systems capital position worsened in CY08 as capital fell in rand-
terms from R202.1bn in CY07 to R175.9bn. The capital/assets ratio
declined in unison. However, in CY09, the systems capital recovered
and increased to R198.1bn. (see Fig 13)
We believe in the near-term there is no need for consolidation in
order to strengthen the system.
But the system is more leveraged relative to history. System
leverage increased by 5.4 points in CY08. The leverage ratio that was
relatively stable at around 12.5X since between CY03 and CY07 climbed
to 18X in CY08 before it declined slightly to 15.0X in CY09. (see Fig 13)
Fig 13: Industry capital level has recovered,Rmn but leverage is high relative to history
50,000
80,000
110,000
140,000
170,000
200,000
230,000
2003 2004 2005 2006 2007 2008 2009
12.812.2
12.7 12.7 12.6
18.0
15.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
2003 2004 2005 2006 2007 2008 2009
capital/total loans
capital/total assets
leverageratio,RHS
Source: SARB, Legae Calculations
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1.5 Profitability analysis: Better earnings to come withbetter times but we carry loan growth w orries
Profitability was strong between 2004 and 2008. The system
profitability has increased materially during the past five years, pushing
up ROAs and ROEs. System net profit jumped from R17.4bn in CY04 to
R35bn in CY08, a CAGR of 19.1%. This is the period when loan growth
was highest since CY95, with an average annual growth rate of 9.9%
versus average growth rates of 7.6% since CY95 and 7.9% since CY00.
Although loan growth reduced in 2H08, the growth was in excess of
10% since 2H04, peaking at 15.1% in 2H06.
Profitability declined in CY2009. In 2009, profitability slumped but
we expect a rebound driven by accelerating revenue growth and falling
bad debts. Costs could be a headwind should rehiring recover, otherwise
efficiencies and cost management benefits of 2009 should be tailwinds.
System average ROE is 15.8 since CY02, despite a material jump
in 2008. The systems ROE jumped significantly in CY08 to 28.7% from
18.1% the previous year. The average ROE from CY02 to CY08 is
15.8%. The ROA also rose strongly to 1.6% in CY08 from 0.8% in CY02.
In our opinion, the oligopolistic nature of the industry could sustain ROE
around the 2003-2007 level. (see Fig 14). It is also important to
highlight that the system average ROE, and more-so 2008 ROE is
greater than the cost of funds, which allows the sector to create value to
its shareholders.
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Fig 14: The systems net profit rose by CAGR19.1% (CY04-08) (Rbn). ROA and ROE w ent up accordingly
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.6%
1.8%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
2002 2003 2004 2005 2006 2007 2008
ROE
average ROE
ROA,RHS
17.4218.58
26.38
31.80
35.00
5
10
15
20
25
30
35
40
2004 2005 2006 2007 2008
CAGR=19.1%
Source: SARB, Legae Calculations
Average system NIM is 3.3%. System NIM has shown a steady
decline over the years, from 4.1% in CY00 to 2.7% in CY06 before
recovering to 3.6% in CY08. We see headwinds in CY10 NIM due to
lower loan growth and lower interest rates, despite the relative stable
interest spread.
Interest rate spread is stable at 3.4%.The interest rate spread has
remained largely stable, oscillating around 3.4% since CY00. (see Fig
15). The ability by banks to maintain this spread regardless of the
interest rate policy indicates the importance of loan growth and credit
management to profitability in the system. However, with the prime rate
now at 10%, and the REPO at 6.5%, we would expect pressure on
interest spread this year, particularly as liquidity is not plentiful as
indicated by the growing funding gap and LDR.
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Fig 15: The NIM (% ) average 3.3% since 2000 Interest spread average 3.4%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
2000 2001 2002 2003 2004 2005 2006 2007 2008
interestrate
earned
interestratepaid
interestspread
3.3
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2000 2001 2002 2003 2004 2005 2006 2007 2008
NIM
average
Source: SARB, Legae Calculations
Major long-term profitability factors screen indifferently. The
major factors to profitability in our view are 1) loan growth, 2) interest
margins/spreads, 3) credit costs and operating costs i.e. management
of the cost/income ratio. These items drive the ROE in the long-term.
We investigate how these drivers may play out in the short-term.
Loan growth: As we indicated already, we believe loan growthwill be muted this year. Corporate lending could recover, but
households are still carrying a lot of debt. A sticky
unemployment rate reduces the potential for strong loan
growth.
Interest rate spreads: We expect the interest rate spread to
remain stable. The holdback to spread and NIM expansion even
when interest rates start to go up is the currently fixed spread
of the prime rate at 3.5% above REPO rate. The SARB and
Banking Association recently confirmed that there is no need tochange this policy. However, borrowers continue to be price
takers even when credit standards are loosening. The spread
could therefore slightly improve should interest rates rise.
Credit and operating costs: As we mentioned before, we
expect an improvement in credit costs. Our opinion is that
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lower NPL formation and write-backs could aid profitability,
especially in 2H10. Banks that suffered most in CY2009 should
benefit better on write backs. Banks have managed also to
contain operating costs. We do not expect significant rehiring
that could negatively affect the cost/income ratios.
System earnings could rebound impressively this year. We,
however, believe that it will be invariably associated with recovery in
capital markets and trading conditions than core commercial banking
operations. Groups with investment banks should benefit more in our
view. However, trading income tend to be more volatile.
1.6 Why the micro-market could be the winner?
The micro-finance institutions principally provide financial services to
low-income consumers, including self-employed and small business
enterprise (SMEs) as well as those that are out of formal employment.
Below we indicate what we believe to be the major phases of banking
products, and the relationship to income levels. (see Fig 16). On a global
scale, countries with higher per capita incomes have higher demand for
products in phases 3 in addition to products in phases 1 and 2 while
those with low show a higher concentration in phases 1 and 2.
Taking the same concepts to the local market, higher income earners
have higher demand for products in phases 3 and 4 in addition to
products in phases 1 and 2. Low income earners have higher demand
for products in phases 1 and 2.
The major takeaway is the fact that the phases are inversely related to
population. There are more people needing phases 1 and 2 products
than there are requiring phase 4 products. This often makes phases 1
and 2 lower margin products as banks would benefit from higher
transaction volumes. However, the oligopolistic nature of the local
market ensures that relatively higher margins can be sustained in
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phases 1 and 2 as well. Lower penetration in the low income segment
also enables micro-banks to enjoy relatively strong margins.
Micro-banks and other micro-finance institutions, on the
contrary provide unsecured products in phases 1 and 2, and that
often gives them a competitive advantage.
Fig 16: The Banking phases and relationships to income levels
Mainstreambanking,dominatedbytheBig4.
Savingsandloanaccounts Currentaccounts Creditcards Wealthmngmnt
Paymentservices Debitcards Consumerfinance Advisoryservices
Mortgages Otherunsecuredproducts
Othersecuredproducts
Lowendinstitutionse.g.MFIs,Abil,Capitec Topendbankse.g.Investec
Phase1 Phase2 Phase3 Phase4
Asincomeincreases,demand for newproducts,advisoryandwealthmanagementservicesincreases...
...butthe numberofpeople, whichaffectsvolumes,decreasesasonemovesupthe phases
Source: Legae Securities
There are various reasons why we believe that the microfinance market
may stand to benefit, and end up the winner given the high leverage
levels of the consumers. We highlight them below:
Lower debt levels for lower income consumers: As indicated on Fig
17 below, the lower income segments are less leveraged when
compared to the middle and upper income groups. Stringent risk-based
lending by the main stream banks often result in the exclusion of the
lower income group. Mostly, they lack collateral and require more tailor-
made products than generic ones. The lower debt levels in this income
group provide room for banks that are willing to assume higher credit
risks to expand their loan books.
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Fig 17: Lower income people are less leveraged. Debt/ disposable income
0%
20%
40%
60%
80%
100%
120%
140%
160%
0to50 51to100 101to300 301to500 501to750 750+incomeperyear inrands,000
Source: FirstRand results presentation, Legae Calculations
Defensiveness of assets: Micro-banks assets tend to be defensive
when compared to main stream banks. Micro-lending, especially to
Small and Medium Enterprises (SMEs) focus on basic requirements oflife, e.g. food, education, shelter etc. The Micro-banks also have limited
exposure to structured and credit products which were principal drivers
of losses in the DMs banking system in CY09. Exposure to capital
markets and investment banking which is suffering from legacy risk is
also minimal. Micro-borrowers also tend to have an incentive in
maintaining a good repayment history and relationships as they have
few sources of finance. In our view, earnings visibility is crucial given
the sub-par economic growth.
Higher NIM and interest spreads: Micro-banks NIM and spreads arehigher than the mainstream banks. Lending rates are higher due to
obvious reasons of elevated risks of the borrowers, but lower coverage
of the micro-borrowers by the mainstream banks also provide pricing
power to the micro-banks. Average NIM for MFI is around 8% while for
mainstream banks the average is less than 4%.
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Lower concentration risks: Most micro-banks are not dominated by a
few big depositors or borrowers. Due to the small value of deposits and
loans, concentration risk on both the asset and liability side is materially
reduced. The fragmentation of depositors and borrowers also works in
favour of micro-banking as it reduces the pricing power of both
borrowers and depositors.
Less volatile deposits: The tenors of micro-deposit tend to be longer
than deposits in the mainstream banking. There is also less reliance, if
at all, on the inter-bank market. This, combined with the lower
concentration risks, makes effecting Asset and Liability Management
(ALM) strategies easier than for mainstream banks. The other benefit is
that local depositors are becoming more concerned with banking fees,
and in a downturn, such worries are elevated. Micro-banks tend to be
more efficient and less expensive in term of banking fees when
compared to mainstream banks.
There are risks nonetheless. The major risks we perceive are:
Downscaling by mainstream banks: The Big 4 banks have capacity
and ability to downscale into the lower income segment. In fact some of
the banks have launched products that intend to capture this market
segment, especially on the liability side of the balance sheet.
Inability to benefit from government spending: The micro-banks
stand least to benefit from government expenditure. Exposure to
government infrastructure projects in terms of lending is almost nil.
Higher risk customers: The risk profile of the customers carry higher
risks notwithstanding the defensiveness of SMEs industries and other
micro-borrowers. SMEs tend to suffer worse during recession or
economic downturn periods as they have thin capital and cash flow
levels.Regulatory risks: The Micro-finance industry is broad and regulatory
changes continue to take place. For most micro-finance institutions that
are registered banks, the risk is however cowed.
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1.7 The macro story: So far so good, but nothing extra-ordinary
The macro-story of South Africa is good thus far, having started to pick
up the steam, and confidence levels rising. GDP growth is expected to
recover to 2.9% (Bloomberg consensus) (IMF = 1.8%). Along with it we
would expect a positive effect to 1) loan demand and 2) loan provision
levels. (see Fig 18)
The high loans/GDP ratio of South Africa relative indicates that the
economy is more leveraged than its peers. The question that becomes
important is: would the economy manage to increase its leverage in a
deleveraging world? There is still capacity to leverage, (Spain, one of
the so-called PIIGS had a ratio of about 160% in CY09), but we are
cautious of this leverage.
The feared double-dip risk seems to have waned. Internationally,
consumer and jobs data remain mixed, but with risk on the upside.
Locally, customers are happier than in 2008-2009. The confidence index
has rebounded and so has the Kagiso purchasing managers index.
Capacity utilisation level has also recovered. (see Fig 20 and Fig 21)
Our worry is that the double deficit that the country carries could
create risks, especially to the currency in the medium term. The
positive is that the current account deficit has narrowed. The relatively
high interest rates when compared to other EMs are also supportive of
the famous carry-trade. The fiscal deficit hit its highest at 20.5% of
GDP in 2Q09. To an extent, this was not a deliberate deficit expansion,
but a cyclical one. (expenditure/GDP ratio rose, but revenue fell much
worse hence creating a wider deficit). We would expect it to narrow as
the economy gain traction and revenue recover. (see Fig 22 and Fig 23)
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Economies are becoming healthy again ...
Fig 18: South Africas GDP growth expected to recover... ...along with the rest of the world
2008 2009 2010 2011
World 3.0% 0.8% 3.9% 4.3%
Advancedeconomies 0.5% 3.2% 2.1% 2.4%
USA 0.4% 2.5% 2.7% 2.4%
Euro 0.6% 3.9% 1.0% 1.6%
Germany 1.2% 4.8% 1.5% 1.9%
Japan 1.2% 5.3% 1.7% 2.2%
UK 0.5% 4.8% 1.3% 2.7%
EM 6.1% 2.1% 6.0% 6.3%
China 9.6% 8.7% 10.0% 9.7%
India 7.3% 5.6% 7.7% 7.8%
Brazil 4.2% 2.3% 3.7% 3.8%
Russia 5.6%9.0% 3.6% 3.4%
Africa 5.2% 1.9% 4.3% 5.3%1.8%
2.9%
3.5%
2.2%
1.8%
3.8%
3.0%
2.0%
1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
2009 2010 2011
Bloombergconsensus
IMFforecasts
Source: IMF, Bloomberg, Legae Calculations
...and GDP recovery should see some recovery in loans
Fig 19: GDP growth vs. loan growth Loans and deposit outpaced GDP growth since 2000
0.01
0.02
0.03
0.04
0.05
0.06
0.05
0.10
0.15
0.20
0.25
0.30
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
Loansandadvancesgrowth
GDPgrowth,RHS
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2000 2001 2002 2003 2004 2005 2006 2007 2008
Loans
GDP
Deposits
Source: SARB, Legae Calculations
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Happy customers are good for business...
Fig 20: Business confidence is increasing... ...and leading indicators show a better future
20
15
10
5
0
5
10
15
20
25
0
10
20
30
40
50
60
70
80
90
100
1995/
12/01
1996/
11/29
1997/
11/29
1998/
11/29
1999/
11/29
2000/
11/29
2001/
11/29
2002/
11/29
2003/
11/29
2004/
11/29
2005/
11/29
2006/
11/29
2007/
11/29
2008/
11/29
2009/
11/29
BusinessConfidenceindex,RMB
ConsumerConfidence,FNB,RHS
8%
6%
4%
2%
0%
2%
4%
6%
8%
10%
70
80
90
100
110
120
130
1995/12/01
1996/08/01
1997/04/01
1997/12/01
1998/08/01
1999/04/01
1999/12/01
2000/08/01
2001/04/01
2001/12/01
2002/08/01
2003/04/01
2003/12/01
2004/08/01
2005/04/01
2005/12/01
2006/08/01
2007/04/01
2007/12/01
2008/08/01
2009/04/01
2009/12/01
Leadingindicators index
change,%,RHS
Source: I-Net, Legae Calculations
...and the cash registers are recovering after the 2008-9collapse.
Fig 21: Kagiso PMI has rebounded... ...and capacity utilisation shows some recovery
72
74
76
78
80
82
84
86
88
90
1999/06
2000/03
2000/12
2001/09
2002/06
2003/03
2003/12
2004/09
2005/06
2006/03
2006/12
2007/09
2008/06
2009/03
2009/12
30
35
40
45
50
55
60
65
1999/10
2000/04
2000/10
2001/04
2001/10
2002/04
2002/10
2003/04
2003/10
2004/04
2004/10
2005/04
2005/10
2006/04
2006/10
2007/04
2007/10
2008/04
2008/10
2009/04
2009/10
Source: Bloomberg, Legae Calculations
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...but reliance on debt to finance the appetite of customers,business and government could be a risk
Fig 22: But we are concerned with the tw in deficit, % of GDP and the Current account deficit,Rmn q/ q
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
2.0%
4.0%
15.0%
17.0%
19.0%
21.0%
23.0%
25.0%
27.0%
29.0%
31.0%
33.0%
2004:Q4
2005:Q1
2005:Q2
2005:Q3
2005:Q4
2006:Q1
2006:Q2
2006:Q3
2006:Q4
2007:Q1
2007:Q2
2007:Q3
2007:Q4
2008:Q1
2008:Q2
2008:Q3
2008:Q4
2009:Q1
2009:Q2
2009:Q3
Surplus/(Deficit),RHS
Revenue
Expenditure
30000
25000
20000
15000
10000
5000
0
5000
10000
2003/03
2003/06
2003/09
2003/12
2004/03
2004/06
2004/09
2004/12
2005/03
2005/06
2005/09
2005/12
2006/03
2006/06
2006/09
2006/12
2007/03
2007/06
2007/09
2007/12
2008/03
2008/06
2008/09
2008/12
2009/03
2009/06
2009/09
2009/12
2010/03
Source: SARB, Legae Calculations
...and unemployment rate remains high. Negative hiringis yet to rebound despite some stabilisation
Fig 23: Unemployment rate remain sticky, %, although gross earnings grow th rate seem to have rebounded.
10.0%
5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
2005/02
2005/09
2006/03
2006/10
2007/04
2007/11
2008/06
2008/12
2009/07
grossearnings
numberofemployees
20
22
24
26
28
30
32
2000/03
2000/09
2001/03
2001/09
2002/03
2002/09
2003/03
2003/09
2004/03
2004/09
2005/03
2005/09
2006/03
2006/09
2007/03
2007/09
2008/03
2008/09
2009/03
2009/09
Source: I-Net, Legae Calculations
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2.1 Initiation of coverage
2.1 Capitec Bank: In itiating w ith a BUY, fair value of R121.Short term valuation risks are evident, but better growth
outlook is the differentiating factor, our potential upside is
22.7%.
Fig 24: Company and salient balance sheet and income statement information
RECOMMENDATION BUY Rand,mn 2009 2010 2011F 2012F 2013F
BloombergTicker CPISJ NII, 943 1,273 1,598 2,055 2,427
CurrentPrice(cents) 10,100 Netfee i ncome 1, 036 1,282 1, 605 2,047 2,457
Fair
Value
(cents) 12,121 EPS,
cents 357 509 683 874 1,028MarketCap,Rbn 8.33 Loansandadvances 2,982 5,225 7,176 10,573 13,994
Sharesoutstanding,mn 82.983 Deposi ts 3,317 7,360 9,568 12,439 15,549
Potentialcapitalgain 20.01% BVPS,cents 1,489 1,910 2,325 2,850 3,466
ForwardDivYield 2.71% NIM 19.0% 13.4% 13.1% 13.1% 12.4%
Forecasttotalreturn 22.72% Cost/Income 54% 54% 53% 52% 51%
ImpliedPER,X 23.8 LDR 90% 71% 75% 85% 90%
ImpliedPBVR,X 6.3 ROE 25.5% 28.6% 31.5% 32.9% 31.8%
YTDcapitalreturn 27% ForwardPER,X 14.8 11.6 9.8
52WeekReturn 179% ForwardPBVR,X 4.3 3.5 2.9
Source: Company reports, Bloomberg, Legae Calculations
We in itiate coverage w ith a BUY recommendation, our fair value
is R121 giving a potential total return of 22.7%: We use the
Discounted Future Cashflow (DFE). Our terminal value is R13.6bn which
we obtain by growing the FY13 earnings by our long-term growth rate
and capitalise it by the exit PER of 13X. We estimate a CoE of 17.5%,
(vs. 17.6% implied by the Dividend Discount Model (DDM)). Our DFE
method indicates a fair value of R113, offering a potential total return of
14.7%. Our DFE value gives an implied PER of 22X which is higher than
our Justified PER of 17.8X. The Forward PER ratio, however, declines to
9.8X by FY13.
Our recommendation is also motivated by the high excess earnings
which we forecast in the next three years and the potential total return
that is greater than our CoE. In our view, the exposure to the low
income segment that has lower debt levels compared to the middle and
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upper class should deliver stronger top line growth compared to the
mainstream banks. In our opinion, the risk-reward profile is appealing
for investors (and not speculators!).
Possible catalysts: The possible catalysts for the share price are 1)
continued stronger loan growth, and profitability as the bank run down
its cash resources and further deploy its capital; 2) stronger recovery in
the economy that should lead to strong loan growth and material
reduction in bad debts, and 3) higher NII and transaction fee income
than we have anticipated.
The risks to our valuation: The major risks to our valuation are 1)
the exit PER is higher than a general rule of thumb of between 7X and
10X for mainstream banks, 2) we estimate our long-term growth rate at
14.9%. This is higher than the expected nominal GDP growth rate,
assuming inflation rate is contained within the target band of 3% to 6%.
Risks to share price performance in the short-term : Capitecs
share price has rallied, and rallied strongly since January 2009. Over the
past 12 months, the share price has outperformed the Banks Index (I-
Net) and the All share index by 134.6% and 135.3% respectively. On a
year-to-date basis, the outperformance is also strong at 12% and 7%
against the Banks Index and All Share Index in that order. This out-
performance is greater when one considers that Capitec is part of the
Banks Index. (see Fig 25). In our opinion, the base of valuation is
always relative. Even the so-called absolute valuation models are
effectively relative due to the use of the market metrics as a proxy.
(e.g. beta coefficient when calculating the CoE is relative to the market).
A de-rating by the market could be explained by this concern. Local
sector sell-off catalysed by the Goldman Sachs growing investigations
could also create headwinds to the price.
Capitecs PER is trading above its historical average: The trailingPER chart for Capitec looks intimidating. The current trailing PER at
19.7X is 42% above its long-term average PER of 13.9X. The long-term
relationship between the Banks Index PER and Capitec, however, seems
to be holding up. In January 2009, Capitecs PER was 1.38X that of the
Banks Index. By the end of 2009, the ratio has expanded to 1.48X but
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it reduced to 1.36X currently. (see Fig 26).We doubts further multiple
expansions for both the industry, given the muted economic recovery.
Fig 25: Capitecs share has significantly outperformed the m arket and could create sh ort-termrisks to the share price
27%
32%
60%
174%
7%
6%
12.9%
38.7%
12%
11%
13.5%
39.3%
0% 50% 100% 150% 200%
YTD
3Months
6Months
1Year
Capitec
ALSIBanksIndex
0.9
1.0
1.1
1.2
1.3
1.4
2009/12 2010/01 2010/02 2010/03
BankIndex
ALSI
Capitec
Source: I-Net, Legae Calculations, prices as cob 15/04/10
Fig 26: The PER is above its average since listing, but the relationships against other banks is
holding up.
0
5
10
15
20
25
30
35
2002/09
2003/02
2003/07
2003/12
2004/05
2004/10
2005/03
2005/08
2006/01
2006/06
2006/11
2007/04
2007/09
2008/02
2008/07
2008/12
2009/05
2009/10
2010/03
PER
Average
0
5
10
15
20
25
30
35
2002/09
2003/02
2003/07
2003/12
2004/05
2004/10
2005/03
2005/08
2006/01
2006/06
2006/11
2007/04
2007/09
2008/02
2008/07
2008/12
2009/05
2009/10
2010/03
CapitecPER
BanksIndex
PER
Source: I-Net, Legae Calculations
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Who is Capitec? Capitec Bank Holdings Limited (Capitec or the Group)
is a holding company for Capitec Bank. Capitec Bank is a registered
commercial bank that targets the micro-borrowers. The bank focuses on
providing retail banking services based on the principles of simplicity,
affordability, accessibility and personal service. Loans are granted to
employed individuals (no corporate loans) and strictly on an unsecured
basis. The average loan amount is R2,239 (FY10). Deposits are also
strictly from individuals, with the exception of deposits raised by
issuances of bonds and from other bilateral organisations. The bank has
401 branches (FY10) and a network of 1,238 ATMs, comprising of 417
own ATMs and 821 partnership ATMs. As at the end of FY10, the bank
had no loss-making branches. New branches often turn to profit within
4 months. The 38 branches that were added in FY09 are already
profitable a major accomplishment in our opinion!
2.2 Company analysis
Strong market position: Capitec enjoys a strong position in the lower
income segments of retail banking. It has also managed to create a
reputation and set out industry standards (e.g. paperless banking)
which, in our opinion, are important traits to reduce competitive
pressure. We believe that Capitec has developed advantageous
relationships with its customers that competitors could find difficult to
imitate in the short- to medium-term. Nonetheless, we expect growth in
both asset and profitability to slow when compared to history in the next
3 years. Our expectations are contradictory to managements outlook on
this matter.
Profitability growth has been excellent so far: Historical
performance has been excellent with a 5-year CAGR of 33% and 46%
for income from operations and profit after tax respectively. The
profitability has been supported by a strong growth in both NII and fee
income at a CAGR of 19% and 210% in that order. In rand-terms, net
profit (before preference dividends went up from R67.4mn in FY05 to
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R449.2mn in FY10. The NII ascended from R527.1mn to R1,273.3mn
between FY05 and FY10.
Balance sheet growth supported profitability: The banks total
assets climbed from R805mn in FY05 to R9.5bn in FY10 a CAGR of
64%. Given the lower penetration ratio in the low-income segment, we
expect stronger growth when compared to the industry average in the
medium term. In our view, Capitec can gain market share in two main
ways: 1) by consolidating its position in its low-income segment market
and reduce market share erosion, particularly from main stream banks
that are downscaling 2) by providing products to the relatively higher
income levels than its current market concentration, especially on the
liability side. Management has indicated that they could pursue the
relatively well-off market. The bank intends to open branches in more
affluent areas in order to provide convenience to its middle-income
customers. Loan and advances indicated a strong expansion, with a
CAGR of 91% between FY05 and FY10. Deposits growth was also strong
over the period with a CAGR of 101%.
Fig 27: Historical performance has been excellent
Incomestatement 2006 2007 2008 2009 2010
CARG
(0510)
InterestIncome 44.1% 23.4% 23.5% 63.9% 45.4% 26.5%
interestexpense 137.3% 74.2% 45.3% 165.8% 82.0% 96.2%
Netinterestincome 41.1% 20.7% 28.9% 47.7% 35.0% 19.3%
Netfee income 237.8% 646.6% 485.7% 58.5% 23.7% 210.7%
Nonbankingincome 47.0% 22.3% 36.3% 66.6% 13.9% 36.0%
Incomefromoperations 36.9% 27.5% 27.9% 40.0% 32.4% 32.8%
Bankingexpense 29.4% 21.3% 25.7% 39.5% 28.6% 28.8%
Profitaftertax 71.1% 44.8% 37.2% 39.4% 40.7% 46.1%
Balancesheet
Cashandequivalents 60.5% 79.2% 40.8% 145.0% 69.5% 47.9%
Loan
&
Advances 118.7% 76.7% 151.4% 47.7% 75.2% 90.6%Totalassets 55.4% 75.2% 34.0% 69.2% 90.9% 63.8%
Depositsatamortizedcost 141.8% 56.6% 75.2% 123.5% 123.1% 101.3%
Totalliabilities 107.2% 56.3% 60.0% 107.3% 117.8% 87.8%
Totalequity 19.1% 98.2% 8.9% 15.5% 22.9% 29.6%
Source: Company reports, Legae Calculations
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The banks capital position is excessive, in our view , but ample
capital should support loan growth. The bank is well capitalised, to
an extent that we are concerned by under-utilisation of the capital. In
FY09, the capital adequacy ratio was 43%. The ratio reduced to 37% in
FY10, but remains high in our view. Managements target ratio is 25%,
and they are convinced that as a small bank they need a strong buffer.
To an extent we agree. The leverage ratio is also low at only 5.5X
(FY10) against the systems average of 15X. The positive takeaway is
that both situations provide the bank with ample room to grow its loan
book at a higher rate than the industry.
Quality of assets - short-term loans reduces the risks : The quality
of assets is weaker when compared to the mainstream banks,
notwithstanding the defensiveness of the assets in the micro-finance
industry. For example, the loans past due/advances is 10.1% versus the
industrys 3.9% (FY09). The ratio declined to 6.2% in FY2010.
Recoveries are however significantly higher due to the stringent
collection methods and better understanding and working relationships
with clients.
The bank writes off the total amount (capital + interest) for all loans
whose instalments are in arrears for 90 days. The impairment
charge/instalments ratio grows with tenor. For example, in FY10, the
ratio for 6-month loans was 3.8% (an improvement from 4.3% the
previous year) while for 36-month loans the ratio stands at 14.4% (an
improvement from 21.7% in FY09). (see Fig 28). We are not overly
concerned with the asset quality.
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Fig 28: impairment charges/ instalments ratio has improved
1.4%3.8%
5.2%
10.9% 10.8% 11.5%
14.4%
50.8%
1.4%
4.3%
6.7% 12.7% 11.4%12.7%
21.7%
0%
10%
20%
30%
40%
50%
60%
0 3 6 9 12 15 1 8 21 24 2 7 30 33 36 3 9 42 4 5 48
months
2010
2009
19.0%
11.6%11.2%
10.1%
6.2%
0%
4%
8%
12%
16%
20%
2006 2007 2008 2009 2010
Source: Company reports, Legae Calculations
Management boasts strong experience: The Chairman of the board
is the founder, and boasts strong experience in the commercial banking
industry going back to 1995. The CEO and the Financial Director joined
the group in 2000 (the founding year). Most members of the executive
committee have been with the group since 2000. Looking at the ratiosthat we think provide insight to management ability, the cost/income
ratio and the efficiency ratio are showing improvements. The
cost/income ratio (banking activities) declined from 73% in FY05 to 54%
in FY10. Managements long-term target is a maximum of 40%. This will
be achieved through both efficiency and revenue enhancement. The
Efficiency ratio improved from 74% in FY05 to 62%, just 2pp above our
preferred ratio of 60% (generally accepted as the optimal ratio). The
loan/employee and deposit/employee expanded by a CAGR of 60% and
61% respectively between FY05 and FY10, pointing to management
capability.
Revenues and earnings - transaction fee income and loan fee
income will be key: The NIM has reduced materially, from 65% in
FY05 to 13% in FY10. It is, however, still close to 10pp above the
industry average. The profitability is driven by the high interest spread
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(16% for FY2010). The contribution of the non-interest income to the
banks revenue has increased significantly to 50% from 11% in FY07,
showing rising volumes. (see Fig 29). This is the impact of the
increasing branch network and consequent customer volumes. For
example, savings accounts jumped by 201% from 375,000 in FY06 to
1,129,000 in FY09. Active clients stood at 2.1mn by end of FY10.
Number of loans written also climbed from 2.65mn in FY06 to 3.86mn in
FY10. In our opinion, transaction fee income and loan fee will be key for
revenue and earnings growth, given the falling interest spread.
Fig 29: Fee income contribution has improved substantially. NIM and int. spread have reduced
98% 94%84%
46% 44% 46%
2%0%
7%
42% 42% 36%
0% 6% 9% 12% 13% 18%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010
Transactionfee
Loanfee
NII
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010
NIM
Interestspread
Source: Company reports, Legae Calculations
Liquidity is abundant, and asset composition is used to manage
liquidity and credit risks: High liquidity was good during the crisis
period, but we expect it to be deployed. The banks liquidity level is
high. Cash as a percentage of total loans and assets is 51% and 31%
respectively. The banks LDR at 71% (FY10) is 32pp below the systems
average. Managements deposit gathering strategy is centred on long-
term fixed deposits. The fixed deposit products now make up 16% of
the total deposits from 8% in FY09. (see Fig 30). The negative is that
some products are expensive time deposits that could depress NIM.
There is a concern of higher dependence in wholesale deposits but it is
consistent with the current industry pattern. The wholesale deposits are
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also fixed in nature, and have a minimum tenor of 6 months. Wholesale
deposit constitutes 50% of the total deposits. Retail savings type of
deposits has also increased from 32% in FY09 to 40% in FY10. In our
view the bank has plenty liquidity.
Concentration risk is insignificant on both the asset and liability
side: Concentration risk could be harmful to liquidity. Retail deposits
concentration risk is negligible as the bank deposits gathering strategies
are not targeted at mainstream corporate deposits. Management
estimate the highest value from a single retail depositor at R2.8mn. On
the asset side, where concentration risk could be harmful to credit risk
exposure, it is also unimportant. Loans are spread over many small-
value borrowers.
Fig 30: Retail fixed deposits/ total deposits ratio increased from 8% in 09 to 16% in 10.
50%
32%
16%
3%
wholesale
retailsavings
retailfixed
other51%
40%
8%1%
wholesale
retailsavings
retailfixed
other
Source: Company reports, Legae Calculations
About 26% (25% net) of the loan book has a maturity of 90 days or
less. Before 2010, no loan tenor exceeded 36 months, but the bank
introduced a 4-year loan in 2009. (i.e. FY10 for Capitec). This 4-year
product now constitutes 5% of the banks loan sales. (see Fig 31).
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Fig 31: Maturity profile of loans in Rmn and as % of total loans. High concentration on ST
2,2
65
1,019
494
1,049
646
1,063
1,635
473
500
1,000
1,500
2,000
2,500
1m 3m 6m 12m 18m 24m 36m 48m
R,mn
months
2008
2009
2010
26%
12%
6%
12%
7%
12%
19%
5%
0%
5%
10%
15%
20%
25%
30%
35%
0 3 6 9 12 15 18 2 1 24 2 7 30 33 36 3 9 42 45 4 8months
20082009
2010
Source: Company reports, Legae Calculations
Interest rate risk analysis The gap is positive and will benefit
from rising interest rates: The Banks liability duration is longer than
its asset duration. The objective of an asset sensitive balance sheet is
the flexibility in liquidity and credit risks management. Managements
strategy of trying to reduce deposit volatility by attracting long-term
deposits intensifies the gap. R1.035bn of the R2.522bn deposits raised
between March 2008 and November 2009 carries a floating interest rate,
which is linked to the JIBAR 90-day rate. The positive gap is
unconstructive to interest rate declines as more assets are exposed to
re-pricing risk than liabilities, negatively affecting NII. The consoling
factor is that further interest rate decline probabilities have significantly
reduced, in our view. As interest rate start going up, the bank will
benefit from this positive gap.
Positive gap could aid profitability by about R36.5mn should
rates go up by 2.0% . We simulate the gap effect to NII by a 200 basis
points upward interest rate change. Our calculations indicate that the
positive gap will enhance profitability by about R36.5mn, should interest
rate rebound by 2% this year. (see Fig 32).
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Fig 32: The positive Gap will enhance profitability if interest rates rise.
12m
Assets,Rmn 2,680 1,663 3,151 2,013
Liabilities,Rmn 3,062 523 849 3,495
PeriodicFundinggap,Rmn 382 1,140 2,302 1,482
Cumulativegap,Rmn 382 758 3,060 1,578
Ratechange 2.0% 2.0% 2.0% 2.0%
ImpacttoNII,Rmn 7.33 12.67 31.02 0.09
CumulativeNII,Rmn 7.33 5.34 36.36 36.45
Source: Company reports, Legae Calculations
Balance sheet funding and dividend policy: The banks ability to
finance growth is important. The balance sheet is currently 78% deposit
funded (vs. 66% in FY09). As we already mentioned, the banks
deposits, especially loans and bonds are fairly of long-term nature,
providing stability to funding. Some of the long bonds include 1) R90mn
with 14 years to maturity 2) R250mn unlisted bond with a 12year
tenor and 3) a R150mn 7-year bond.
Ordinary equity makes up 17% while preference shares form 2%. (see
Fig 33).The dividend payment policy is guided by a 2.5X earnings coverage
ratio. This means a retention ratio of 60%. We believe this will be an
important source of funding for the banks balance sheet as well.
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Fig 33: Deposits/ total liabilities and equity has increased from 66% in FY09 to 78% in FY10
66%
25%
3%5%
Deposits Ordinaryequity Prefer enc eshares O ther
78%
17%
2%4%
Deposits Ordinaryequity Prefer ences har es O th er
Source: Company reports, Legae Calculations
CAMEL indicators are strong, in our view : Below we present some of
the CAMEL analytical ratios. In our opinion, the CAMEL ratios are strong,
despite the fact that the banks asset quality is worse than the
mainstream banks. The management of bad debts is tighter and the
efficiency ratio has improved considerably. (see Fig 34)
Fig 34: Selected CAMEL ratios. The bank strong in our view
CAMELRatios 2005 2006 2007 2008 2009 2010 2011F 2012F 2013F
C:TotalAssets/TotalEquity 1.7 2.2 2.0 2.4 3.5 5.5 5.8 6.2 6.5
C:Equity/Totalloans 228% 124% 139% 60% 47% 33% 29% 24% 22%
A:Recoveries/Baddebts 33% 38% 14% 17% 10% 20% 20% 20% 20%
A:Impairmentcharge/Loans 19% 21% 20% 11% 16% 10% 9% 8% 8%
M:Cost/Income(bankingactivities) 73% 66% 60% 59% 54% 54% 53% 52% 51%
M:Efficiencyratio 74% 70% 66% 66% 61% 62% 63% 62% 62%
E:NIM 65% 59% 41% 22% 19% 13% 13% 13% 12%
E:Feesandcomm./Op.income 1% 2% 11% 51% 52% 50% 50% 50% 50%
L:Loans/Deposits 74% 76% 90% 132% 90% 71% 75% 85% 90%
L:Cash
&
Equiv./Total
assets 45% 47% 48% 21% 30% 27% 25% 20% 18%
Source: Company reports, Legae Calculations. Total Equity includes preference equity
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ROE decomposition: Our ROE calculations show a different ROE, lower
than reported by the company. We calculate our Du-Pont ROE based on
year-end figures instead of average values or beginning values. While
average and beginning values are theoretically more robust for purposes
of performance measurement, ending values are consistent with
industry practice. The equity multiplier increased from 1.7X in FY05 to
6X in FY10 while the ROA has gradually decreased from 8% in FY05 to
5% in FY10. The asset turnover component of the ROA has fallen faster
than the expense ratio between FY05 and FY10, hence the falling ROA.
The ROE improved from 14.2% in FY05 to 28.6% in FY10 due to the
rising equity multiplier. We expect the ROE to increase slightly to 31.8%
by FY13 due to further leverage. (see Fig 35)
The interest spread has declined from 89% in FY05 to 16% in FY10. We
expect the spread to reduce to 13% by FY13. (see Fig 35).
Fig 35: ROE decomposition and interest rate spreads. Leverage has been constructive to R OE.
2005 2006 2007 2008 2009 2010 2011F 2012F 2013F
Operatingincome/Total assets 61% 54% 39% 37% 31% 21% 21% 21% 19%
Expenses/Total assets 49% 40% 28% 26% 22% 15% 14% 14% 13%
Taxes/Totalassets 4% 4% 3% 3% 3% 2% 2% 2% 2%
ROA 8% 9% 8% 8% 6% 5% 5% 5% 5%
TotalAssets/Equity 1.7 2.2 2.3 2.8 4.0 6.0 6.3 6.6 6.8
ROE 14.2% 20.4% 17.3% 21.6% 25.5% 28.6% 31.5% 32.9% 31.8%
Interestspread
Interestincome/Earningasse ts 95.3% 75.6% 52.4% 28.1% 27.0% 22.6% 23.0% 22. 5% 21.3%
Int.expense/Int.bearingliabilities 6.0% 6.7% 7.8% 6.6% 8.1% 6.7% 8.0% 8.3% 8.3%
Interestspread 89.3% 68.9% 44.6% 21.4% 18.9% 16.0% 15.0% 14.3% 13.0%
Source: Company reports, Legae Calculations. Equity excludes preference equity
Expense decomposition: Looking at the banks cost structure, the
major highlight is the increase in the interest expense/total assets ratio
from 2.1% in FY05 to 5.4% in FY09. The ratio declined marginally in
FY10 to 5.2%. The provisions/total assets ratio also went up to 9.4% in
FY09 from 7.9% in the previous year, but reduced significantly in FY10
to 5.8%. The non-interest expense/total assets ratio improved from