July 09, 2012

South Africa|Equity|Banks

NEUTRAL
CONSTRUCTIVE
Recommendations
Price ASA FSR NED SBK CPI 13500 2698 17775 11311 21400 FY 12 TP Potential 14234 2880 15854 12560 22645 5.4% 6.7% -10.8% 11.0% 5.8% Rating OLD SELL HOLD HOLD HOLD HOLD NEW HOLD HOLD SELL OVERWEIGHT HOLD

BANKS
Run harder to stand still: The next key issue for Absa to address is liquidity
Why we remain agnostic to Absa: In our earlier report (see Where are we on a 5-year cycle? Are the below midcycle PBVRs justified?, dated February 12, 2012) we highlighted the primary issues that made us agnostic to Absa as; 1) the second-rate liability structure (higher dependence on interbank deposits; and the high loan/deposits ratio (LDR); 2) peer-inferior debt distribution; and 3) peer-inferior non-performing loans (NPLs) coverage ratio. Post the trading update; we expect the bank to increase its NPL coverage ratio. However, we remain concerned by the liquidity/funding issues which put pressure on interest spreads and to an extent should restrain asset growth, especially relative to peers. ...and income drivers remain under pressure: 1) loan growth: is constrained by a) the high LDR; b) further runoff of real estate portfolio that will dilute core loan growth; and c) lower unsecured exposure; 2) margin expansion: will be limited by a) the high LDR that restrains opportunities for asset mix changes and reduces deposit pricing power; b) the low interest rate environment; and c) pressure to maintain/retain top quality corporate clients in an environment where lending is under pressure; 3) fee income: will stall on a) lower loan volume growth and b) pressure on fee margins due to migration to internet and mobile platforms; and 4) credit costs: as indicated in the trading update, increasing impairments will erode 1H12 earnings by 0%-10%. Other primary variables, namely operating expenses and capital seem to be under control. The liquidity position in focus: We underscore that Absas front-loaded debt distribution does not compare favourably vs. peers such as FirstRand and Standard Bank. While it provides the bank an opportunity to roll-over maturing debt at relatively lower rates (given the interest rate regime), the Groups liability structure still puts pressure on funding, and dilute the banks deposit pricing power. This should lead to pressure on interest spreads. Strategic positioning and recommendations: The real risk related to events in London is possible changes in Absas strategic direction. We have witnessed it occurring to other SSA-ex Barclays operations, where strategies changed as regimes changed in London. Coupled with a rather cloudy story on Absas SSA-ex story, lack of clarity on the retail unsecured market and the recent management attrition; we remain sceptical of the optimality of Absas strategic positioning despite our upgrade to HOLD. We downgrade NED to SELL. We maintain HOLD on FSR.

Share price performance

YTD return
FSR 30%

NED

23%

JSE Banks

18%

SBK

15%

MSCI EM Banks

2%

ASA

-4% -5% 0% 5% 10% 15% 20% 25% 30% 35%

-10%

Valuation: Price/Earnings Ratios

PER 15 14 13 12 11 10 9 8 7 6 ASA FSR SBK NED JSE Banks Current JSE Banks 10 yr Av.

Valuation: Price/Book Ratios

Price/Tang. Book 2.5 2.3 2.1 1.9 1.7 1.5 1.3 1.1 0.9 0.7 0.5 NED ASA SBK FSR JSE Banks Current JSE Banks 10 Yr Av.

Peter Mushangwe

+27 11 551 3675 peterm@legae.co.za

1. Liquidity/Funding Analysis: Often overlooked but liquidity is a material constraint for Absas growth
In our earlier reports we highlighted why we believed the inferior liquidity/funding profile for Absa i.e. higher LDR, front loaded debt distribution, and material dependence on the interbank market (~15% of deposits vs. peers <5%) would restrain asset growth/reduce interest spreads, especially in light of possible intensification in deposit gathering. We indicate the primary issues related to Absas liquidity/funding profile below: Inferior debt distribution: As indicated on Fig 1, about 58% of Absas outstanding debt is maturing between now and CY15. This is ~12 percentage points (pps) and 15pps worse than FirstRand and Standard Bank respectively. The consequences of this inferior debt distribution are two fold 1) it puts pressure on funding, reducing Absas deposit pricing power. The result is possible higher deposits rates, thus putting pressure on the interest spread. The interest spread is a better measure of profitability than the NIM for a bank with a high LDR, in our opinion, as the banks ability to pursue higher yielding assets is constrained; and 2) the current low interest rate environment can provide an opportunity to roll-over the maturing debt at lower rates. Nonetheless, the roll-over risk remains. (see Fig 1 Fig 2). Inferior loan/deposit ratio: The banks ability to expand its book ultimately depends on its internal liquidity i.e. the ability to fund asset growth by customer deposits. For Absa, the >100% LDR shows that the bank relies more on external financing (e.g. interbank, NCDs and debt) more than peers. In light of the liquidity requirements i.e. more liquid balance sheets for banks than was the case in the past, this high LDR will likely restrain asset growth as the bank attempts to build a more liquid balance sheet. (see Fig 3). Conclusion on liquidity: 1) The consequences of both a more front-loaded debt distribution and the high LDR are a) a restraint to to asset growth; b) put pressure on deposit pricing. Both lead to inferior interest spreads, especially as this point when we believe banks are competing fiercely to retain their blue-chip clients and under pressure to offer good terms to retain blue chip clients (i.e. pressure on yields; and 2) the relative higher employment of NCDs vs. FirstRand and Standard Bank indicates that Absa over-expanded its asset base relative to its internal funding capabilities. Absas deposits structure is not worse off vs. peers, but we are concerned that strong deposit franchise currently built by peers will negatively affect the deposit structure as well. Absas poorer interest spread is reflective of the banks inferior deposits/funding cost. (see Fig 4). Strategy risk: Absas strategy lacks clarity vs. peers. We believe the primary risk given events in London is the possible changes in strategy. We have noticed changes in strategies for other Barclays operations ex-RSA, particularly Kenya and Zimbabwe (then meaningful operations in SSA) as regimes in London changed. (see Fig 7).
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Fig 1: Absa has a more front-loaded debt distribution than peers except Nedbank, with 58% maturing between now and CY15.

ASA Cumulative maturity up to 2012 2013 2014 2015 2017 2020 2025 2030 >2035 Rmn 8 840 12 329 20 928 27 702 35 672 41 697 44 143 47 524 0 % of bonds outstanding 18.6% 25.9% 44.0% 58.2% 75.0% 87.6% 92.8% 99.9% 0.0% Rmn 1 880 7 672 16 040 21 112 31 509 38 418 65 733 44 778 45 645

FSR % of bonds outstanding 4.1% 16.8% 35.1% 46.3% 69.0% 84.2% 144.0% 98.1% 100.0% Rmn 2 830 10 127 15 235 24 770 29 634 32 228 32 358 0 0

NED % of bonds outstanding 8.7% 31.3% 47.1% 76.5% 91.6% 99.6% 100.0% 0.0% 0.0% Rmn 8 132 22 222 30 081 39 678 65 208 75 556 87 158 91 018 92 016

SBK % of bonds outstanding 8.8% 24.2% 32.7% 43.1% 70.9% 82.1% 94.7% 98.9% 100.0%

Source: Bloomberg, Legae Calculations Fig 2: Absas heavy maturities this year provide opportunities for roll-overs at lower cost but the roll-over risk remains.
10 000 Maturity 9 000 8 000 7 000 6 000 5 000 4 000 4 000 3 000 2 000 1 000 0
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2025 2026 2028 2033

9 000

ASA debt distribution

8 000 7 000 6 000 5 000

Maturity

FSR debt distribution

3 000 2 000 1 000 0

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2026 2028 2031 2033 2038 2042 2045

12 000 Maturity 10 000

16 000

NED Debt distribution

14 000 12 000

Maturity

SBK Debt distrubution

8 000

10 000 8 000 6 000

6 000

4 000 2 830 2 000 4 000 2 000 0

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2026 2027 2028 2029 2049

0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2024

Source: Bloomberg, Legae Calculations

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Fig 3: The high LDR and funding gap reduces deposit pricing power and leads to higher dependence on interbank and other professional type of deposits which are relatively more expensive.
160% 150% 140% 130% 120% 110% 100% 90% 80% 70% 60% 2006 2007 2008 2009 2010 2011 2012F 2013F -300 000 2006 2007 2008 2009 2010 2011 -200 000 -100 000 ASA FSR NED SBK -

ASA Funding gap (customer deposits less loans and advances)

-50 000

-150 000

-250 000

Source: Company reports, Legae Calculations

Fig 4: leading to inferior interest spreads. NIM can remain high due to the high LDR

ASA 5-Year history Yield on Loans: Interest income/Loans Cost of deposits : Interest expense/Deposits therefore interest spread 11.0% -9.3% 1.8% Av. Forecast 9.5% -5.4% 4.0% 5-year history 10.4% -5.0% 5.4%

FSR Av. Forecast 8.2% -3.5% 4.7%

NED SBK 5-year Av. 5-year Av. history Forecast history Forecast 10.5% -6.6% 3.9% 9.5% -4.9% 4.6% 10.1% -5.6% 4.5% 8.1% -3.3% 4.8%

Source: Company reports, Legae Calculations

Fig 5: Absas strategic positioning remains a little behind when compared to peers.
Well capitalised ABSA FirsRand NedBank Standard Bank Low LDR Growing Retail unsecured exposure Meaningful IB exposure Meaningful SSA exposure Bold management

Source: Company reports, Legae Calculations

Page 4 of 8

2. Forecasts and recommendations: A mixed bag but no easy upside

Market cutting expectations...: Compared to Nov. 2011, when we first issued our FY12 forecasts, the market has reduced its ASA earnings forecasts by 3%. We reduce our forecast by 9.1%. We have been below consensus on concerns raised before and we remain below consensus but now by a 7.5%. The market has also reduced its earnings forecast on FSR by 5.9% vs. our 3.7% for FY12 while it has increased expectations on NED by 5.9% vs. our cut of 0.2% as we had initially been above consensus. We remain above consensus on SBK despite our material cut of 5.2%. (see Fig 7). and despite our above expectation forecast on NED, we downgrade to SELL: We remain unconvinced by NEDs current valuation levels. NED has the worst debt distribution (front loaded and not as widespread) and despite an LDR of <100%, it has the 2nd worst of the Big 4 Banks. Credit risks are also an issue although the high NPL coverage ratio provides some comfort and can offer uplift to earnings through write-backs. Nedbanks corporate skewed loan book could suffer worse from declining interest rates as corporates often negotiate better terms, and would benefit less when interest rates recover as the corporate rates tend to be stickier than consumer rates. However, in the short term, the stock may continue to benefit from the current positive momentum. ASA moving into an attractive risk/return segment but we remain on the side-lines: Every cloud has a silver lining. We believe 1H12 and FY12 earnings will be insufficient to impress a market looking for performance but the stock has plunged post its trading statement and is now trading at a reasonable discount to peers - at trailing PER of 10x vs. an average of ~13x for peers. (see Fig 8). On a forward basis (Legae estimate) a forward PER of 9x compares favourably vs. an average of 11.7x for peers. We continue to watch the stock, further decrease in the price will provide entry opportunities. FSR remains HOLD on valuation risks: We are above consensus on SBK. For FSR, we maintain our HOLD recommendations as we believe at current valuation, our expectations are priced-in. FSR has risen ~30% on a YTD while SBK has increased by 15% - both meaningful returns given the JSE ALSI return of only 7%. (see Fig 9). The JSE Banks index has also outperformed the MSCI EM Banks index, increasing risks from a foreign investor perspective. Nonetheless, we upgrade SBK to O/weight Valuation a mixed bag; Higher CAR/lower leverage the reason for divergence: As we indicated in our previous reports, the divergence between the book-based and earnings-based valuations is the currently higher CAR/lower leverage that depresses ROEs. The lower than history Price/book value ratios are therefore justified, in our view. Our based case for the Top 4 banks is an average ROA of 1.5% and an average leverage ratio of 11.5x, leading to an average ROE of 17.5%. This is 3pps to 5pps above the CoE, but is less than the previous spread of >5pps.
Page 5 of 8

Fig 6: Recommendations - We downgrade NED to SELL and upgrade ASA to HOLD

Price ASA FSR NED SBK CPI 13500 2698 17775 11311 21400

FY 12 TP Potential 14234 2880 15854 12560 22645 5.4% 6.7% -10.8% 11.0% 5.8%

Rating OLD SELL HOLD HOLD HOLD HOLD NEW HOLD HOLD SELL OVERW EIGHT HOLD

Source: Bloomberg, Legae Calculations

Fig 7: Forecasts We revise our ASA forecasts, we are now 7.5% below consensus. Consensus on NED has moved towards our initial expectations

Legae est.

Consensus

Revision level Legae 2012 -8.1% -3.7% -0.2% -5.2% Market 2012 -3.1% -5.8% 5.9% -0.5%

LS vs Consenus

Nov. 2011 Current Nov. 2011 Current 2012 ASA FSR NED SBK 1 497 221 1 642 1 073 2012 1 376 213 1 639 1 017 2012 1 535 227 1 542 990 2012 1 488 214 1 632 985

-7.5% -0.5% 0.4% 3.2%

Source: Bloomberg, Legae Calculations

Fig 8: Valuation - A mixed bag; Shares look unattractive on a PER basis but attractive on a PBVR basis
PER 15 2.5 14 13 12 11 10 9 1.1 8 7 6 ASA FSR SBK NED 0.9 0.7 0.5 NED ASA SBK FSR 2.3 2.1 1.9 1.7 1.5 1.3 JSE Banks Current JSE Banks 10 yr Av. Price/Tang. Book JSE Banks Current JSE Banks 10 Yr Av.

Source: Bloomberg, Legae Calculations

Page 6 of 8

Fig 9: Performance - FSR has outperformed its peers meaningfully, making us apprehensive despite the strength of the franchise. The JSE banks index has outperformed the ALSI and the MSCIE EM Banks index.
YTD return
FSR 30% 1.3 NED 23% 1.4 JALSH JSE Banks

1.2

JSE Banks

18%

1.1

SBK

15%

1.0

MSCI EM Banks

2%

0.9

ASA

-4% -5% 0% 5% 10% 15% 20% 25% 30% 35%

0.8
7-Jun-11 28-Jun-11 19-Jul-11 9-Aug-11 30-Aug-11 20-Sep-11 11-Oct-11 1-Nov-11 22-Nov-11 13-Dec-11 3-Jan-12 24-Jan-12 14-Feb-12 6-Mar-12 27-Mar-12 17-Apr-12 8-May-12 29-May-12 19-Jun-12

-10%

Source: Bloomberg, Legae Calculations

Page 7 of 8

Legae Securities (Pty) Ltd

Member of the JSE Securities Exchange 6A Sandown Valley Crescent, Sandown, Johannesburg, 2196, South Africa P.O Box 650361, Benmore, 2010, South Africa Tel +27 11 722 7330, Fax +27 11 722 7330 Web: www.legae.co.za email: research@legae.co.za

Analyst Certification and Disclaimer I/we the author (s) hereby certify that the views as expressed in this document are an accurate of my/our personal views on the stock or sector as covered and reported on by myself/each of us herein. I/we furthermore certify that no part of my/our compensation was, is or will be related, directly or indirectly, to the specific recommendations or views as expressed in this document This report has been issued by Legae Securities (Pty) Limited. It may not be reproduced or further distributed or published, in whole or in part, for any purposes. Legae Securities (Pty) Ltd has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Legae Securities (Pty) Limited makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion herein are those of the author only and are subject to change without notice. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment. Important Disclosure This disclosure outlines current conflicts that may unknowingly affect the objectivity of the analyst(s) with respect to the stock under analysis in this report. The analyst(s) do not own any shares in the company under analysis.