FirstRand Limited (FSR) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the FirstRand pre-close investor call. [Operator Instructions] Please note that this call is being recorded. I'd now like to turn the conference over to Sam Moss. Please go ahead.

Thank you very much. Good afternoon, everybody, unless people are joining from the U.S. in which case good morning. We have Alan, Harry and Mary on this call. We're going to make a few opening remarks and then I think we're going to go straight to Q&A. So I'm going to first hand over to Alan Pullinger, CEO. Thank you.

Thanks, Sam, and good afternoon to everybody on the call. I'm going to give some brief comments on the macro environment, then Harry will just run through some of the balance sheet line items and some of the income statement line items, and then I'll make some closing comments around some of the franchises and how they're feeling and then we'll go into Q&A. So kicking straight off with some comments on global macros. I mean, I think you're all aware that the war in Ukraine, and the China COVID policy have definitely impacted commodity prices, probably to a greater extent and for longer than we expected. And off the back of that global inflation has been higher than we've expected. You've seen global central banks respond to tighter monetary policy a lot more aggressively. And the higher inflation and tighter monetary policy is weighing on financial markets, and then, of course, economic growth. Just on the U.K., inflation has certainly turned out higher than we anticipated, and the growth outlook in the U.K., as a consequence, deteriorated. We do think the interest rate outlook, the risk now has shifted to the upside, but already, we can see that the BOE is being mindful of the negative impact that interest rates may have on the growth outlook in that market. With respect to our portfolio in broader Africa, most of the countries in the portfolio are experiencing higher inflation and then as a consequence, tighter monetary policy. But in some of the countries, similar to South Africa, the negative impact of high inflation and rates is partially being offset by the positive terms of trade for the economy and for the FirstRand. So definitely, we see a benefit to the commodity producers and then a lot more pain for the commodity consumers. In South Africa, our inflation expectations now have lifted. We have brought forward our interest rate hiking expectations. So there's a degree of front-loading there, although we continue to see the terminal repo rate in South Africa around between 6% and 6.5%, and we don't really see it expanding beyond that. Some of the sectors agricultural and manufacturing have benefited certainly from the global commodity price levels. We've seen a big benefit to the fiscus revenue overruns in the terms of trade, of course, are very strong. And we spoke about it at the interims and we've seen continued positive developments on the structural reform front. So we hope that those continue to gain some traction. Harry, maybe you just want to quickly touch on the balance sheet and income statement.

Great. Thanks, Alan. Good afternoon, everyone. Let's start off with advances. When we presented our interim results, we stated that the credit cycle is gaining momentum. This has proved to be ongoing, and we continue to grow advances. Retail growth largely driven by mortgages and vehicle finance on the WesBank and a marginal uptick in unsecured space. Momentum in commercial advances continued actually to what you're seeing in December, although clearly, the growth rate order slowed marginal. On the corporate lending side, strong activity and momentum in the corporate market, but corporates by and large, I mean, there's different sectors, but by and large, remain cash flush. And I think the headwinds that Alan spoke about our metro is probably worrying on their minds as well. In the U.K. market, MotoNovo's strong momentum growth continued for residential mortgages also reflecting net book growth, especially in the last quarter. Deposits, deposit store being continuing a strong trajectory of deposit growth. And clearly, that then benefits overall liquidity. Then going into some of the income statement lines, let's start with interest income. Clearly, with the growth in advances that underpins the group's interest income. But yes, there is a lag in terms of when the income comes to the P&L. The rate hikes and everyone is going to ask the questions, yes, it does benefit our endowment income. But just to remind everyone, not at 100% of it because we had largely hedged the previous rate cuts. And hence, we effectively earn that interest income in prior periods, and there's a base impact in our numbers. Then moving on to some of the noninterest revenue side. We've definitely seen continued improvement in customer activity levels, which is driving growth in our fee and commission income. Insurance income overall, on a net basis, also benefiting from the premium growth and certainly lower claims in our life portfolio. Private equity is at a similar level to the first 6 months. And before anyone asked to your 88 announcements, yes, it's in a public space, but that might conclude before June 30. It is still subject to some of the regulatory approvals. On OpEx, we have significant discussion on our OpEx at interims. The cost growth at interim which was 4%, we did flag that it was as no easy to get and we did also guide to say the cost number in the full period, the cost growth will be higher. I mean this includes the hiring clearly of more skilled staff, especially in our tech and data space and largely also the normalization of variable Rem given the improved performance and our investment in our business as we have continued. Lastly, on the impairments line, we are certainly seeing continuation and decline in NPL and the improvement in our net over the last 6 months. As per earlier macro discussion, we are not expecting material impact to the provisions, largely as a group continued to maintain the conservative provisioning levels. So the change more negative on macros wouldn't necessarily impact at this point in time. On that, I'll conclude and hand over back to you, Alan.

Thanks, Harry. And let me just -- I'll canter through some of our franchises quickly. Just FNB, we've continued to see a growth in net active customers, similar to what we saw at the interim. So that has been very pleasing for us. On credit in retail and commercial, we are back to our credit appetite across pretty much all products, except for unsecured. So that's not fully back to where appetite was. And that's really a function of some discretionary customer spend, which we think is going to come under pressure. FNB announced their headline fee increases for transactional products, effective July 1. So certainly, that is -- those fee increases were above levels seen in the past couple of years. But as a general comment, still below inflation. As I said, those will be effective from the new financial year. Moving to R&D, pipeline is looking decent. However, there's certainly headwinds on -- around the macros on the minds of corporates, and there is some risk that I think there will be a move to a more cautious outlook. We've already seen some commentary around IPOs and that probably planned for the next couple of months. And I think those are kind of being put on hold for the moment. R&D's flow business in markets has performed well, and the corporate bank has continued to win some clients. Moving to WesBank. We have seen a slight improvement in the environment, although the new car stock issues remain. Impairments are lower for the business, and WesBank appetite has increased, although they are starting to be a little bit more cautious around some of the higher risk categories. On insurance, we've seen a continued gain in new business. Very pleasingly lapses have also decreased and claims have been lower than anticipated. So that's all good. For the earnings from that business, short-term insurance, we launched that probably 18 months ago, that continues to gain momentum. So it's really good to continue to invest, obviously, in that business and the product rollout. Capital and liquidity both remain strong. We really have delivered strategically on all our balance sheet provisions, capital and liquidity metrics we set for ourselves. So we are, I think, in good shape there. Just on Aldermore, the new CEO is well settled in. The strategy refresh has been completed. We've done a fairly significant refresh of the executive staff complement that the CEO there has managed and I think we are feeling better about going in through the next financial year. So I think with that, it's probably best now just to go straight into Q&A. Thanks very much.

[Operator Instructions] The first question comes from Waleed Mohsin from Goldman Sachs.

One topic I wanted to explore a little bit more is the sensitivity of credit quality and the credit growth to the potential front-loading of interest rates. And I was wondering how you think about it, especially given that some of the growth has come in floating rate products such as mortgages? So how do you think about the sensitivity of credit quality on the book as well as growth to rates? Or put differently at what level of rates would you start getting a little bit nervous around asset quality of growth?

Waleed, let me take that question. So let's just talk about rates and how you manage origination around that. So firstly, is when Alan said, get to 6% to 6.5% repo, that is still below where we were pre-COVID. So clearly, from a rate view, that impact we can manage, but this environment compared to pre-COVID environment is a far more higher inflation environment. Now the inflation pieces, especially over the last 6 months, we probably didn't get the absolute level rate lands correct. I don't think any economies got it there. But the trajectory was clearly known. And in our affordability details, we have put that into the test. So we're not concerned from that. Clearly, if international rate hikes are much more faster and steeper while South Africa is to react, we will clearly react in terms of our origination. On credit quality, we're very comfortable. So if you look at what we've written in the last 6 months or even the last year, I think probably in the last year, we were criticized to have not written significantly into the rebound, and we were clear that we would wait for recovery and write into recovery. So this environment wasn't necessarily contemplated, but I would make a similar statement to what I made previously on Aldermore side, fortuitous, it probably grew slightly less. And overall, we still -- and on the provision side, we only do update model 6 months. So we updated in November, still on a conservative basis, as most of you would have seen what we reported. So there's negative change in models to FLI, we're not expecting to have a material impact.

Yes. Waleed, just to sort of add to that, I think -- I mean, Harry uses the word fortuitous, but I mean we have been discerning around origination. And we spoke about targeting the lower risk cohorts. And the reason for that wasn't a shift to lower risk per se, but it was where we felt credit capacity set in retail credit. And then as Harry said, I mean, we do originate around affordability checks. We normally would build in probably 200 basis points into where current rates are around affordability. So I think -- and certainly, there's nothing that is showing up in any of the early vintages that we're seeing that causes concern.

The next question comes from James Starke from RMB Morgan Stanley.

My question is on inflation. I mean can you please give us some color on how the more recent inflation developments, particularly thinking about food and fuel? And how long these take to feed through into your asset quality metrics, and then perhaps if you can sort of break that down between what we can expect in the SA from a sort of pass-through duration perspective as well as the inflationary impacts on your U.K. business from an asset quality perspective?

So first...

Harry, you can go first, I will follow it.

So James, if you look at -- so the first question we get is, how can the Northern Hemisphere inflation has been peaking already prior to now. And South Africa is definitely on the lag. Some of it is to do with the extra trade balances, higher commodity prices. But also, you've got to take note of the fact that South African corporates have always been in inflationary environment, and they've largely hedged some of the -- and in particular, the food manufacturers largely hedged some of their forward contracts. But as you would expect, where hedging will be between 3 to 6 months. So this was known and clearly economically, we put that discussion into origination piece. So yes, the fact that maybe market today spread of 6.3% is a shock. But in fact, the trajectory was known. And you will see full inflation in SA coming into play, and that's expectation and we highlighted. Then to the credit quality, so as you're writing business, you make sure you have the rate buffer and inflation buffer. We're going to get it 100% right. No, you always have a link to origination strength as you're writing. And it depends how quick and how steep inflation goes. Then there's knock on effect. Right now, we're still not of the view that inflation gets into double digits. I think the latest house view of us is that we peak at about 7%, 7.5% overall inflation. I think that is manageable. But James, I mean, if you ask 5 people what their view on inflation or interest rate hikes, you might get actually 10 answers because it'll always be this but that. So the business is really defending right now in terms of which cohorts of quality customers you're going to write advantage to.

Yes. And James, just to add, I mean, just to Harry's point, I mean it's -- we have a view, it's not because we got the answer. It's just a view and so you need to have a view to write business. I think the issue -- I mean, the issue that we're facing in South Africa is that headline inflation is really kind of being driven by food and fuel. And these are global issues that are impacting those two. And because it's food and fuel, I mean the risk is that it translates into a cost of living crisis. I mean we do think that -- and what we would be more worried about is if we see core inflation starting to lift. So at the moment, it's headline inflation, but hasn't translated yet into core inflation. I think if core inflation has to start lifting, I think you see a more aggressive response from SARB around policy rates. So yes, I mean, that's the view, as Harry said, I mean, you take it into account in origination. But our view is certainly that -- and we're already seeing some of the early signs certainly in the U.S. where it looks like the Fed may have got on top of inflation. It's still very, very early days for that. So do we think that we will start seeing inflation coming down in the U.S. quite 2 years probably the U.K. is probably 2 months longer before that happens. And we think, certainly, our outlook around inflation here is we could see the next CPI print in South Africa around 7%. We would think that the one thereafter would probably be 7% again. But then our expectation is it would start to come down. We certainly don't have any hot sectors that need to be cooled from policy rates. So demand is still weak in South Africa. So we do see these things as being transitory. And as I say, at the moment, we are not terribly concerned around core inflation, but it's something that obviously we're going to keep an eye on.

And then, James, I just want to make a last statement under IFRS 9, so I answered the question in terms of origination. But clearly, my comments are on looking at what the current macro assumptions are that will go into the models. And that will try and as best as models can do predict your in-force book around the macro view. Now there's a corridor in which you can over-predict, under-predict, and I'm still comfortable that I'm not expecting a step-up necessarily to the coverages we had at November largely because we were intentionally conservative at level compared to model.

And as you don't expect the current trend necessarily to emerge into adverse asset quality metrics in the next sort of 6 to 12 months provided it moderates. I mean, would that be a fair summary?

Yes.

The next question comes from Jacques Conradie from Peregrine Capital.

And maybe just a question on the future. I'd like to see if you have a read on when the rate hikes become incrementally negative for first hand. I mean you got such a massive endowment with the first few percent, certainly must be net positive especially after the hedges freely run off. And I mean, even another 2% from year which the market seems to expect, I mean, is still fairly moderate versus SA history. I mean do you have a read at the 2% to net positive, where do we get negative 3%, 4%? What would need to happen for you to really be worried about the level of rates?

Yes, Jacques, I mean just to touch on the question that Waleed had, I mean consumer finance in South Africa is pretty much all floating. So the consumer is exposed to the interest rates. I mean, I guess, I mean we had a conversation around this earlier today. I mean, even at a repo rate of 6.5%, you're talking about a prime lending rate of about 10%. I mean, we think if that's kind of where it ends up, that is still going to be, I think, acceptable and manageable. I think if we start seeing prime interest rates materially moving above 10%, I think that's going to be an issue. But could we get to 10% for sure, we can. I mean I think -- I mean pre-COVID where the repo rate was 7%, I think, somewhere around 7%. So prime would have been 10%, 10.5%. So I think if we get back to sort of lending rates around that, I mean, I think that's going to be manageable. But as I said, above that. So I think a repo rate above 6.5%. The issue also is -- I mean, it's not sort of the -- it's how long the policy rate stays high. If it gets to 6%, 6.5%, 7% and then it quickly comes down, I think that's fine. But I think a repo rate above 6.5% for a sustained period, I think it's going to start having an impact.