The Covid-19 crisis and the resultant economic shutdown is different to other crises - we know what caused it, that it will end and we will normalise when it is safe to do so.
The 2008 crisis was very US centric whereas this is global, which is worse in that everyone is affected. The sell down though has been sharper and more ferocious than anything we’ve seen, especially with bank valuations.
Compared to 2008, the market has acted very quickly. While there has not been any increase in bad debt yet, large banks have raised provisions substantially, which could indicate how bad they think it will get. These provisions were raised across their credit card, energy & gas and commercial real estate portfolios. So far, banks have come through this crisis very well with very good capital ratios.
As an example, for every R100 that Capitec lends, they have R22 in reserve. So 22% of every loan can go bad before they go into a loss. Their capital ratio is even higher with every loan covered by 40% capital. This gives an idea of the amount of reserves and capital that has been built up over the last 10 years in this sector.
Bank valuations post the shutdown
In the financial sector, ABSA & Nedbank have been hard hit. At the bottom of the 2008 crisis, Nedbank traded at a price to tangible NAV of 1.3 times and ABSA at 1.6. Currently, Nedbank is trading at 0.6 with a 40% discount to NAV and ABSA is trading at 0.88 with a 12% discount to NAV. We feel the market is unjustifiably negative in Nedbank’s case but, it is to some extent as a result of their large exposure to commercial real estate and Ecobank in Nigeria. If normalisation happens by 2022, Nedbank is on track for a 19% dividend yield, which will still grow every year, but shows just how low the current valuation is.
Globally, except in the US, banks have been asked not to pay dividends for at least 6 months. The market in Europe totally over reacted to this news and the selloff was brutal, up to 15% in one day. The market totally ignored the fact that dividends were merely on hold and as a result, when normalisation does come, there’s going to be a huge scramble for those dividends and the share price has consequently been reacting sharply.
Contributors & detractors in the Nedgroup Investments Financials Fund to date
The contributors are, in many cases, those who have benefitted from the lockdown. This includes Santam who has benefitted from low claims ratios resulting from significantly less cars on the road during lockdown and over the Easter weekend. We have a position of 4,5% in Santam, our highest position to date. JSE has also done well with no bad debts and an increase in their trading volume. Finally, the Denker Global Financial Fund, where we have a 20% investment did poorly in dollar terms, but thanks to the fall in the Rand it has been a relative contributor for us.
The biggest detractors whose shares were sold down the most were Nedbank and ABSA. We also believe the market overreacted, but this is the normal kneejerk reaction with investors selling what they perceive as the more-at-risk banks.
Our top local stocks in the portfolio are Sanlam, FirstRand and JSE followed by Standard Bank, Investec, PSG and Santam. Globally, our top holdings are JP Morgan, Essent and Citigroup.
Risk management philosophy
Over the years we have increasingly focused on quality of management. Looking back at banks from 2006-2012, the ones who came through were the ones with the highest capital reserves and lowest cost to income ratios. Generally we’ve been selling those we’ve been most uncertain of and will continue to look for certainty, best franchise and best track record.
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