FirstRand Limited (FSR) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the FirstRand Pre-Close Investor Call. [Operator Instructions] Also note that this event is being recorded. I would now like to turn the conference over to Sam Moss. Please go ahead.

Thank you very much. Good afternoon, everybody. Thanks for dialing in. I have the full complement for FirstRand team here this afternoon. I've got Alan Pullinger, Harry Kellan, Mary Vilakazi and Simonet Terblanche. So we're ready to take any questions. But first, Alan would like to make a few opening remarks before we hand over to Q&A. So I'm now handing over to Alan Pullinger. Thank you.

Thanks, Sam, and good afternoon to everybody on the call. I'm going to make some fairly extensive comments. And then hopefully, I'll cover a lot of areas. And then I guess that will spark some questions. All right, let's just to begin, I mean, we very much are on track with regards to the guidance that we gave to the market in September, both from a gross and a return perspective. Briefly -- very briefly on the macros, I mean, our view of global macros, as we've seen, rates have been hiked significantly and there are -- now, I think, telling signs that this rising inflation in the global markets has been arrested. So it does look like that the medicine being issued by Central Banks is working. But unfortunately, that is going to come at the cost of global growth, and we can see that, that is falling in a number of key markets. With respect to the domestic situation, we do think inflation has peaked again. We've seen a response from the Central Bank and today, another 75 basis points. But there is now, from our perspective, growing confidence that debt affordability in South Africa will remain on the highway. Just touching on operating performance. Starting with the South African operations, we're pleased with the level of growth momentum across all of our businesses. We are back to pre-COVID credit appetite levels and the strong pickup in lending that we signaled at the year-end has continued. It still mainly is coming from corporate advances, retail secured and then commercial portfolios. There's also been a slight uptick in our unsecured lending. The deposit franchise that continues to outperform our expectations and the rate hikes do assist with endowment income, although this will be lower on a sector relative basis, given our endowment investment hedging program. These drivers have resulted in a higher growth rate in net interest income for the first 6 months of the year compared to the previous financial year to June '22. Margins are trending a bit lower. It's a function of new business origination mix i.e., more secured and unsecured credit quality tilt that we spoke about at the year-end and then also higher funding costs as we make increasing use of institutional funding. However, rate hikes and the results and endowment benefit will continue to provide some underpin to margins. With regards to noninterest revenue, as already flagged, the private equity realization of Studio 88 was concluded in September and that will obviously make a large contribution to our NIR growth. In terms of underlying operational noninterest revenue, we continue to see an improvement in customer activity levels, which together with the fee increases that went in July, have contributed to fee and commission income growth. In addition, FNB continues to grow customers, both in retail and commercial, and RMB's noninterest revenue growth has been supported by structuring activities and trading. Insurance income is also benefiting from premium growth in the period and lower claims in our Life portfolio. Turning now to the U.K. operations. Advances have grown since June but in response to the difficult macro covered earlier, Aldermore has curtailed new business production, particularly in residential mortgages and MotoNovo given the affordability pressures from inflation and interest rates combined with a rapid increase in funding costs. Currently, there is no indication of strain in the book outside of expectations given growth to date. However, Aldermore, originates largely a fixed rate book with mortgage loans at an average of 2 years. And so we can expect mortgage repricing consequences during Quarter 3 and Quarter 4 and the expected affordability pressures on U.K. households are likely to weigh on credit portfolios in the U.K. spring. Collections capacity in our U.K. businesses have been boosted. Looking at costs. As guided at the year-end, the cost growth in the first half of this financial year will be higher than the growth rate in the second half of the 2022 financial year. And this is mainly due to salary increases, which were in the range of 6% to 6.5%, and that would have come through in August. Normalization of the group's LTI and STI, which continues given the group's continued improved performance and continued investment in scaling new business initiatives. Turning to impairments. To date, we have seen -- continue to see a net decline in arrears and nonperforming loans. Despite some large corporate counters, in particular, Rebosis and I think more materially [ Tonga ] being relegated to nonperforming loans. However, these were both largely provided for at our June year-end. Given the increased levels of new business, we do expect origination strain, and we see this in Stage 2 areas. Given the growth in advances, we do have an increase in Stage 1 absolute provisions. The macro environment, interest rates and inflation have worsened since June, and this plays out FLI modeling and this is particularly relevant, I think, in Aldermore. However, as already mentioned, we expect the U.K. to normalize as the market turmoil abates. Overall, given our well-signaled origination approach, we are still expecting to see a benefit on the impairment line. Important to highlight that the group continues to maintain a conservative level of provisioning. But then just to conclude on this introduction, we're expecting in the financial year, we would exceed the 2019 net income after cost of capital or NIACC. And we are seeing that start to emerge in the first half. The group continues to generate capital, given the high ROE, and it maintains its strong liquidity position. And then with those comments, I think we'll go to Q&A. Thanks very much.

[Operator Instructions] Our first question is from Harry Botha of Anchor StockBrokers.

Just a question regarding the interest rate sensitivity upside South Africa. Can you comment on how much comes from the U.S. dollar and from the African operations? And maybe how much hedging takes place on the Aldermore exposure considering the comments you had on the last results call regarding -- I think it was about ZAR 20 million movement per 100 basis points for Aldermore. And then maybe just a second question regarding the note you made about unsecured lending picking up. Do you see that kind of catching up to the market growth rates fairly soon? Can you maybe just comment on the risk appetite there.

Okay. Thanks, Harry. Over to you.

All right. Thank you for that. Let's just start with Africa. So unlike our hedging/investment strategy Alan talked about earlier. Africa doesn't have that mechanism activated. So i.e., the endowment portfolio is largely invested overnight. So when you see it actually on the right-hand side in broader Africa, you will see that benefit play out in terms of the NII against the endowment both capital as well as deposits. So that is definitely supporting the business performance in broader Africa. Then on the U.K. side, what -- when you announces mortgages, 2 years fixed and even MotoNovo is largely a fixed book, they clearly soft that out in terms of the funding. Where the sensitivity does come in is normally around some of the pipeline. So you only hedge once the flow comes out in terms of payout. So there's a little bit of a [indiscernible]. So the ZAR 20 million, effectively, you can just multiply that by the basis point, increase in [indiscernible]. But what you will see is, there's always an ineffective portion of hedging that interest rate fixed variable, i.e., they pay variable on the deposit book. And when we have a rapid rate increase now, you actually get some of the benefit. Although it doesn't come into NII per se, it's sitting as ineffective hedge portion. So that does support a little bit around the funding cost, but not significant enough to the pressure that Alan's talking about [indiscernible]. And then lastly on the unsecured, Harry. So yes, we have increased appetite largely to pre-COVID level. And what you have to understand is that when you look at consumer assay and on average, Alan's comment in terms of the -- back at the highway in terms of data disposable income spot on, but average is also hiked quite a little bit. So what other doubts in the middle and lower earning capacities, inflation, interest rate hikes does play to take out some of the affordability. So that will play actually more into slightly lower. So hence, you won't see it coming back to the growth rate that you still be covered. But against our customer base, we are confident that effectively go in and you'll see nuances across FNB customer base versus direct access. I think direct access will probably be slightly lower growth rate relative to FNB.

[Operator Instructions] Our next question is from James Starke of RMB Morgan Stanley.

Just if you could expand a bit on asset quality in U.K. I mean you mentioned it's in line with expectations. Are you able to share those expectations? Or if not, I mean, how should we think about losses, perhaps relative to sort of the peak of COVID uncertainty back in 2020? Or would it be worse than that? And then how you see all of this playing out in terms of Aldermore's ROE compared to what was printed back in June?

So James, [indiscernible] I mean, that's a bit of a crystal ball, and I'll explain that to you now. Let me start with asset quality piece. So what you would expect is this rapid rate hikes actually haven't played into the installment increases. Given that as the mortgages tier and say -- and MotoNovo largely fixed, effectively, you see those being flat rated in terms of installment payments. But in an average 2 years, that's why we're saying in spring next year because I'm saying you're always writing a business for 2 years, the average is 1 year in terms of that. So half the book will basically come up for repricing during the Quarter 3 and 4 of the financial year. So that repricing will come in at a higher rate, given the increase in rate cycle and tier cost of funding. Now that will definitely play into in U.K. costs of living against those businesses, people, except our play in and take away effectively the free cash flow around that. Hence, when is what you expect some of the impact of this inflation/rate hikes to flow into in terms of asset quality. So right now, when you say in line with expectation, that is in line with the origination strain that you expect given the book growth over right until June and will grow too now. So the roll rates haven't materially increased. I just see a slight pickup, but not significantly. That's in line with what we'd expect given the environment. So is there an increase in [indiscernible] increase in arrears without a doubt, but that's normal origination and origination strength, but we are expecting that to play out. And your next question is actually the reason I said crystal ball is, if you tell me right now actually, in fact, last month, the SLI, the model will pick up in a U.K. market pre the mini budget or the budget discussion, significant volatility given the turmoil there. So that would mean that place -- that macro environment plays quite hard into the model. Clearly, not all of that would be booked because we do know there's a stabilization expected but then we get to June. But the level of stabilization and how much of that volatility is taken out in a macro view, actually quite difficult to predict between now and June next year. And that is the answer that I cannot tell you relative to June 20. Right now, we -- in all of our houses, saying, actually -- and we've seen stability far more quicker according to budget. So we're not expecting it to be similar steep increase [indiscernible] but James, please don't hold me against that because right now, no one predicted the term of the same level on politics in the U.K., and it's hard to see how that plays out to June fee.

Yes, James, I mean, let me just add, I think, on that, I mean, there are the early signs of a pickup in delinquencies. So I mean, again, it's what we expect. But our sense is that this is a trend that's going to continue. And then as I say, kind of April next year is probably when I think it's going to manifest, I think, more visibly in the portfolio. The other thing that we can pick up in our customer base. Remember, we're not offering transactional accounts. So we can't see necessarily the cash flow that our customers are sitting on. But what we can monitor is the extent to which our customer base is making use of credit. And we have seen a pickup in our customer base where they are accessing, if you like, personal loans in that U.K. market. So that is a sign. I think that you can see that there's obviously some cash flow pressure happening in our base. I think the two sort of data points we're keeping a close eye on are our property prices. So we do think property prices maybe over the next 18 months could fall about 8%. We don't see it as a permanent fall, but we are expecting a dip of around sort of 8%, and then it would slowly come back and normalize after that. And again, there's -- it's often what we've seen in the U.K. around a structural shortage, which kind of puts up an underpin to property prices. And then the other thing we're looking at, of course, is vehicle prices. So far, second-hand vehicle prices certainly in the sort of the price points we play are holding up. But again, I think it's something that we're keeping a close eye on.

If I could supplement that, I mean, are you able to give some color on maybe the loan to value or large outstanding balance on our more housing book?

On the -- James, I don't have the booklet at June, but it hasn't materially changed from what we normally print at the back of it in terms of their loan to value. Remember on the [indiscernible] the loan to value is quite low because it's more of a portfolio rise, like 3 or 4 properties, so their loan to value on that is on the low end on buy-to-let. On the owner-occupied or the normal rate mortgages, the LTV will be on the upper end. I mean I can't remember now offhand, but I'll just try and see if I can get a book in discount, like changes the back of the booklet, it hasn't materially changed. And then Simonet is just listening to me. It is probably better to actually look at our Pillar 3 reporting on the website because that has probably more granular insight. And I'm not expecting any debt to change from June to now significantly, James.

The next question is from Stephan Potgieter of UBS.

Most of my questions have been answered already, but just one on the net interest margin. You mentioned net interest income is picking up in terms of growth rate. Did I hear correctly, as you said that the margin is contracting on what you reported in the full year.

So Stephan, I'll take that one. Yes. And I mean -- and we were guiding it to be flat to marginal on other side of it. And Alan's covered most of it, but I just do the component pieces. Without a doubt the half endowment/capital endowment, that gives you the benefit. So we see that in the increase of margins. Then with the impact of the growth in advances book so that the denominator is definitely growing. So total assets are growing. However, the growth in advances is coming in from 2 things towards lower margin. One, secured -- retail pharma secured relative to unsecured, which you have seen [indiscernible] into June. So that flows into the income now. Definitely corporate. So in corporate, it's definitely more lower margin business compared to on the retail side. So that also plays into decreasing net, so that's the mix piece that we're talking about, so mixing towards lower-margin business. Clearly, the benefit of that is in the impairment line. So that's why we're confident, impairment line, but our margin decreases. And then we did say quality sell. So when he is writing, lower-risk businesses or medium risk businesses, clearly, the risk price customers. Therefore, your margin on that is lower. But similarly, your impairments are going to be lower as well, so risk-adjusted margin is where we look at. So those are both things mix plus quality time is negative. And your fee is -- we did also guide to say despite -- I mean we've seen strong growth in our deposit book, but similarly on advances side, so [ crude ] treasury has increased and not significantly, but you would have seen decrease of institutional funding. Now the increase is coming in. And clearly, institutional funding is more than your retail deposit franchise. So you see that play into it. So net-net, that is a little bit more decrease compared to the endowment [indiscernible] That's why it's a marginal decrease on overall net interest margin.

Just maybe a follow-up on that. In the U.K., the Aldermore, is the overall margin contracting or actually expanding slightly?

So their overall margins will be contracting. So a, the in-force book, you effectively hedge. So your variable funding is hedged into fixed against your fixed books on mortgages and MotoNovo. So that actually kind of locks in your margin and at your hedging piece. But the comment I made earlier on is when you've got your pipeline, you only effectively hedge once you have the cash out of the door. Now there is delay and sometimes in a couple of weeks on mortgages and maybe sometimes a couple of months. It depends on some of the processes. And then in that time frame, you will have negative margin screen given the rapid increase in funding rates that you have seen given the right times. So that will then put pressure on their piece. And because some of the ineffective hedge portion that would mitigate some of the earnings, that's just in NIR, it plays negative into the margin piece, but you see the benefit in NIR, given that piece. So the total drop in margin doesn't flow to the bottom line to the same extent given that in effect of the hedge portion.

The next question is from Ross Krige of Investec.

Just 2 questions from me. First, on the SA retail operations. If you could just talk about from an asset quality perspective, the experience versus what you are modeling, it sounds pretty positive on the basis of that -- you still have a pretty positive view on the cycle in terms of credit assurance. And then secondly, just overall, clearly, the macro trends you've talked to have worsened in U.K. and South Africa. So I'm just wondering how -- whether that changes what you were commenting on in September in terms of where the credit loss ratio could land. I think you were talking about potentially being handed through the cycle range in FY '23.

Yes. So Ross, let me start with the bottom line. We're still confident that it's going to be lower than through the cycle range. We still think it will increase above where it was in June and it's an effective increase. We said over in September over the next 2 to 3 years, getting to the bottom end of our PTC range. So that hasn't materially changed. We -- asset quality piece, we've not seen any significant degeneration in asset quality, the roll rates given the asset book without a doubt. And you can understand why because when we built in quality that we written into lower-risk, medium versus June, you see that benefit flow. Is there some of the defaults? Without a doubt, but nothing towards where you would expect given where you see inflation and rate hike cycle. Now -- so that's on the U.K. piece. However, on the SA piece in terms of retail quality. What impacts do you expect on impairment charge, is effectively the FLI [ price. ] So what FLI does is if you think about it, higher interest rates play into the model to say forward-looking, we expect more default role. Even though you don't see it, it's your forward-looking information. And those -- the macro view in your -- as you quite predicted has worsened to what you expect in June. So you'll see that play out in a credit impairment charge because of that. But I don't think it's big enough to relatively change the trajectory to be marginally uptick on that because of the benefit of effectively the risk mitigation in terms of what we have written to date and without a doubt, secured has definitely a lower loss given default and unsecured. So that also benefits around that. So it's effectively playing into the benefit of the strategy we explained in September.

Yes. I mean -- so I would just add, I mean, around the sort of the macros have deteriorated, it's probably more a function or a tallying of the growth story as opposed to anything about our risk view. So interest rates, even at these levels are kind of -- we are still kind of normalizing back to 2019 level. So we don't see these interest rates as being restrictive at all on a sort of consumer indebtedness basis. But I just think it's the performance of the economy, has probably been [ dealt ] in terms of kind of outlook.

The next question is from Chris Steward of Ninety One.

Just a further clarification, if you can, from my side, please. If we leave the U.K. business aside, just focused on the South African operations. I'm still a little confused as to your commentary with regard to margins and specifically risk-adjusted margins. I guess would your expectation be for a decline -- and let's talk for the full year because your impairment charges are heavily weighted towards the first half last year. So if you look at the SA operations, would your expectations be that your risk-adjusted margin would be declining on a year-on-year basis in this environment?

So Chris, no and [ park FLI ] because the problem with FLI is the model piece. So when we look at risk-adjusted margins, we're looking at effectively not just building up the provision stock because that gives the volatility in terms of the model. Risk-adjusted margin against the business we have written, it's actually in line with -- largely in line with what you are seeing. In some pockets, actually slightly marginally better because actually, we expected similar, probably more roll rates, which has an M&A. [ It's not ] to say that by the time June, it doesn't come in. So on that piece, is, Chris, yes, we're not far off what we were guiding around on a risk-adjusted basis. Unfortunately, with FLI and that will actually be -- I mean we'll see a little bit in December, but ultimately, the big one because of big adjustment that goes through the process is towards our April, May modeling with audit and final views on macros. That may play slightly negative, but that's a provision buildup stock, not necessarily against the in-force book per se. Because I don't know if I am...

That you would expect, I guess?

No, of course, not. But I mean, that doesn't matter. If you look at your margin for the second half, you would anticipate there to be some further tailwind even if the [ 75 hike ] we saw today is the last one, which may well not be -- you would expect to see a further tailwind to margins in the second half even in the [ event, ] I guess, that some of your FLI effects start to push your impairment charge up in the second half?

So our whole view is that we're expecting top rent to be 75, so we've probably got 25 basis points to go, and we will see how the team measures that. So Chris, what I would [ dive ] if you got in November now, that 75 basis points there for 6 months rolled into June tick, it's going to give you the benefit for roughly half of the endowment book. So it's effectively a 37.5 basis points on that piece and then we issued averaging of the rate hikes to not to come into December. So yes, that gives you the tailwind. And then if we -- let's just say we chose the dividend [indiscernible] we don't get the tail, we may have, but then we talk to them, slightly benefits on the FLI depending on the rate. So you get [indiscernible] around about that. Chris, we're out about. So when we're looking -- when I'm talking about margins, yes, I know we're talking to point in time, but I always look at margins effectively on a forward basis in June. So largely, the commentary is still along where we see to June. I mean December, December also, there's a number of days [indiscernible] So June to June, we are expecting that you see the margin going impacted. But one of the things that Alan mentioned earlier on is that actually, our deposit franchise growth has been better than what we had expected. I mean we had already incorporated customer growth that we have seen up to June. So that both the franchise is outperforming relative to our expectations, right? That gives me a little bit of benefit to the margin because we're not drawing down an institutional to the same extent as before in June. But I mean you're going to get that in terms of the strings. That's why we're still saying marginal highway flattish to marginal up or down kind of thing.

[Operator Instructions] The next question is from [indiscernible] of Citi.