Is African Bank ready to fly yet?

Remember African Bank? If you watched any of President Ramaphosa’s lockdown speeches, you were definitely given a refresher. We don’t know what they paid for those ads, but it was probably the most valuable advertising space anywhere in South Africa at the time.

Long before that, African Bank had been on an aggressive campaign, advertising at airports and all over the place really. It worked: retail deposits grew by 158% in the 12 months to March 2020. It turns out that offering “South Africa’s best interest rate” is effective.

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A quick refresher on how banks work

In the traditional sense, banks borrow money from depositors and lend it to borrowers. The bank pays a low deposit rate and charges a higher interest rate to those borrowing money on the other side. The difference is called net interest income.

Bank fees, insurance income and all the other clever ways to pay for head offices in Sandton are collectively called non-interest revenue.

In order for African Bank to pay high deposit rates, the bank must lend money at high rates too. In this initial phase of African Bank’s recovery, the primary focus has been on personal loans and credit cards (unsecured debt), products which are expensive for borrowers because they are higher risk (no underlying assets as security to the bank).

It’s interesting to note that the average depositor has nearly R88,000 on deposit at African Bank (41,000 customers with deposits of R3.6bn). The average personal loan and credit card customer has an outstanding loan from African Bank of around R30,000 (1 million customers with total loans of R30bn).

So, the profile of the average depositor is totally different to the average loan customer. African Bank is a conduit through which those with spare cash are lending to those who are cash-strapped.

That’s how banking works.

A quick refresher on how badly it can go wrong

Back in August 2014, African Bank was placed into curatorship. It was horrifically broken. Aggressive accounting and business practices eventually caught up with them.

Curator Tom Winterboer was appointed and did a wonderful job, navigating the so-called Good Bank back to safe waters. The Good Bank was recapitalised and relaunched in April 2016 as African Bank Limited. Shareholders include the South African Reserve Bank (50%), Government Employees Pension Fund (25%) and a consortium of banks with the remaining 25%.

You’ve heard of “too big to fail” right? This was “too important to fail” and makes sense in a banking system that entirely depends on consumers trusting the banks as a safe place to put their money.

I’m sure Winterboer and his team look back on this with pride. They genuinely carved out a sustainable bank. In fact, things are looking so strong that Business Day reported this week that African Bank is now seriously looking at making acquisitions to bulk up the business.

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Can they afford to be chasing acquisitions?

Although African Bank isn’t a listed company, it releases full financial results like a listed company would.

All the banks have taken enormous pain this year. African Bank’s year-end is September so we will have to wait and see how bad things got, but these statements about acquisitions are hot off the press so the company is obviously feeling confident about its financial position.

The interim period ended in March, so African Bank has already recognised significant write-downs (R614m) from the pandemic. Remember that write-downs are based on a snapshot view of the book. It’s particularly harsh when an economic shock is recognised in an interim period, as a full impairment charge is taken but there are only six months of profits to try offset it.

It’s also worth mentioning that this management team won’t be shy to recognise write-downs on the book. Aggressive provisioning (i.e. not enough write-downs) broke African Bank previously and this management team will have no desire (or mandate from shareholders) to fly close to the sun.

Interim profit before write-downs was R503m for the 6 months, a return on equity (ROE) of 9.2% (vs. 10.9% for the comparable period in the previous financial year). After write-downs, the bank slipped into a loss.

Capitec’s pre-pandemic ROE was 28%; that’s over three times higher than African Bank.

African Bank is therefore stable financially, but isn’t growing or generating profits to an extent that will get private investors queuing up for a slice of the action. African Bank needs to evolve strategically and the best way to do that will be through acquisitions.

The balance sheet is strongly prepared for this. With R5.4bn in cash resources in March and a 40.1% capital adequacy ratio, African Bank’s balance sheet is relatively unleveraged by banking standards. Capitec’s capital adequacy ratio is around 30%.

This is part of why African’s Bank’s ROE is lower – there’s a lot more E (equity) in relative terms than there is in other banks.

What should they be looking to buy?

African Bank needs more customers and specifically transactional banking customers. African Bank’s MyWorld transactional offering only attracted 258,000 accounts in 10 months. For perspective, Tyme Bank adds over 110,000 accounts every month.

Transactional banking clients are critical because the bank earns fees from them and pays much lower deposit rates on account balances. This is the core of Capitec’s strategy and success story.

Alternatively, African Bank may wish to diversify by taking on a bank with a corporate and business banking foothold. Capitec has done this with its acquisition of Mercantile Bank.

There aren’t many choices

Banks are thin on the ground.

I think Grindrod would be only too happy to sell Grindrod Bank. The NAV of the bank is around R1.6bn, so it would be a meaningful acquisition for African Bank without betting the entire farm on one acquisition. It would mark a change in strategy for African Bank, but that’s perhaps not a bad thing.

If African Bank simply wants a broader base of retail customers, then Tyme Bank could be a good choice. Perhaps  African Rainbow Capital wouldn’t mind showing shareholders that it does sometimes get things right, by turning a profit on the Tyme investment and walking away to invest the cash elsewhere. ARC reckons its 35.2% stake is worth R927 million so this is also a manageable play for African Bank.

Another option could be FinBond, the JSE-listed mutual bank with a market cap under R1bn. FinBond has significant business interests in America, which would give African Bank some international exposure. There are three major shareholders in FinBond so it also wouldn’t be the hardest deal to get approved from a shareholder perspective.

Bidvest Bank is perhaps also on the list, but Bidvest has a great business there and I would be surprised if they let the bank go.

Time will tell. It really does seem like some consolidation in this space is on the horizon, especially given South Africa’s low-growth environment.

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