This may sound like I’m about to wax lyrical about Bitcoin. Trust me, that’s the last thing you’ll ever read about from me. I write about real assets i.e. the kind that generate cash flows.
There was a time when the smartest kids at university fought over jobs at banks. Investment banking careers, like corporate advisory or proprietary trading, were the ultimate. A select group of intellectual rockstars would generate incredible profits, drive fast cars and travel the world.
That was the reality in the boom years, particularly during the 90s (I was just a kid) and in the years after the Dot Com Bubble burst at the turn of the millennium. So, when I decided what to study and which career to pursue, I did it with the benefit of reading about the exciting world of investment banking.
I finished university in 2010 (giving away some ghostly personal facts now) – just in time to enter the Lost Decade in South Africa. These days, the intellectual rockstars work longer hours than ever before, get 10% of the bonuses that they used to and spend their weekends wondering if they can reinvent themselves with a job at Amazon Web Services.
I’ve heard stories from a Stanford MBA graduate of how the students would boycott campus visits from Goldman Sachs. Sure, that isn’t the situation at Harvard on the East Coast closer to banking hubs rather than sunny California, but it does say something about the current state of play.
What went wrong with banking?
Crushed by compliance
To be fair, bankers stuffed everything up in 2008. Wall Street’s finest created a web of risks so intricate that only a handful understood them. If you’ve ever watched The Big Short, you’ll know that the smartest people of the lot managed to make a fortune by betting that the house of cards would collapse.
And collapse it did, triggered by the capitulation of the US sub-prime mortgage market. In other words, people were granted home loans (often multiple mortgages on the same property) and never stood a chance of paying it back. The banks assumed the debt would not be collected, but also assumed that increasing house prices meant their debt was safe.
Sounds crazy, right? It was. It seemed like a terrible financial crisis at the time, but recent events make it seem tame in comparison.
This was unacceptable to regulators in America and Europe, particularly a Democrat Obama administration that quickly set about suffocating the banking industry. In the wake of the collapse of Lehman Brothers, the Dodd-Frank reforms came into place and banking was never the same again.
Capital controls were tightened, which made it totally uneconomical for banks to engage in the most profitable (but riskiest) activities. Private equity investments by banks were sold. Proprietary trading desks were closed (trading with the bank’s money vs. flow trading on behalf of clients). Entire teams were retrenched and kicked out of deposit-taking banks.
The Boiler Room turned into a lukewarm room, as dealing rooms became little more than glorified phone answering services. I’m being overly harsh of course, but the contrast between then and now is vast.
Life without investment banking super-profits
Banks still have investment banking interests. They structure deals, advise on transactions, lend to corporates with bespoke terms and offer hedging products on top. The service offering is there, but the sad reality is that the market is nothing like it used to be.
When last did you see a large listing on the JSE? After the ridiculous property sector capital raising bonanza of 2014 – 2016, have you seen many capital raises? I’m not talking about death bed rights issues. I’m talking about capital raising for sexy reasons, like a terrific acquisition opportunity.
South African corporates are like deers in the headlights, scared to invest in South Africa but equally nervous of investing in the UK, Australia or Nigeria, all of which have chewed up and spat out high-flying management teams.
Investment banking lives on as an industry, but the swashbuckling 20-something dealmaker in a Porsche has been replaced by a respectable 35-year old compliance specialist in a silver Lexus Hybrid.
Retail banks were swimming without shorts
As the tide went out and investment bankers were spat out by the sea like a Joburger with a rented surfboard on a tough day in Muizenberg, retail banking came into the spotlight. This is the traditional form of banking, where they take your money on deposit and lend it to other people to buy assets, earning a margin on the deal.
Simple? Yes. Profitable? Not especially so, unless you run a tight ship with a clear strategy.
Historically, Capitec has cleaned up in this space. With a simple model and cutting-edge systems, Capitec swept away the likes of Nedbank and Absa who were trying to win lower income customers but had no clear value proposition to do it beyond sponsoring soccer.
FNB differentiated itself under the leadership of Michael Jordaan, attracting tech-savvy customers who were buying their tablets from their bank instead of the iStore. Standard Bank has more of an international flavour and is the only bank I hold shares in.
At the other end of the spectrum is the likes of Investec as a private banking specialist, which can be a profitable model when combined with wealth management services. RMB is great in that space as well.
Retail banks, regardless of which end of the market they serve, all require the same thing: a growing economy with consumers and businesses who have stable income sources and a desire to borrow money. Without that, it’s an ugly model.
Seeking outperformance? Look elsewhere.
Banks will exist for a long time to come, but there’s no reason why South African banks should outperform the market. Competition is fierce, the South African consumer is weak and economic growth is pedestrian.
There is also the growing threat of substitution. Banking services may be necessary, but retail banks aren’t. There are already a host of disruptors in the market that offer alternative lending products, savings solutions and money transfer through non-traditional means.
Absa just confirmed a 82% decrease in headline earnings for the first half of its financial year. A whopping R14.7bn provision was recognised for bad debts and analysts are worried that it may not be enough, since Absa gave payment holidays on loans worth R216bn (22% of loans and advances).
Meanwhile, the CFO of Nedbank has decided that she’s had enough of this industry. Raisibe Morathi, a highly respected and capable leader, will pack her bags to take up the CFO role at Vodacom. She will be replaced by Mike Davis who headed up the Balance Sheet Management division. He’s also excellent and comes with a wealth of Nedbank knowledge, but I find it particularly interesting that Raisibe has shifted industry entirely.
The telecommunications companies have evolved with the proliferation of the smartphone. So much more than just providing a cellphone tower, Vodacom has huge influence over the device in your hand. That device is your link to the world and the ultimate distribution channel for all consumer companies.
Raisibe’s share-based remuneration won’t be much to cry over – Nedbank is down nearly 50% this year. Vodacom is up 16% year-to-date but is flat over 5 years.
It’s been a horrible few years on the JSE for most companies, but I suspect that Vodacom has better prospects for the next 5 years than Nedbank does.
Raisibe seems to think so and she would know better than most.