Hands-off the banking sector

The dust never seems to settle in the banking sector in Zimbabwe, one sector that has been accused of any possible act of sabotage under the sun in Zimbabwe. In 2006-8, the accusations of fuelling the foreign exchange parallel market, creating artificial cash shortages, turning the stock market into a casino and others too many to mention kept the blame game in motion as hyperinflation saw prices of goods doubling on a daily basis. Not all of the accusations were without basis however as a few lousy banks were caught pants down as the Reserve Bank took further steps to prove some of the allegations. However, objective evaluation of the wider accusations always led one to more bigger challenges in the economy beyond the scope of banking, to which banks responded by engaging in ‘depression-bursting techniques’ to stay afloat just like any rational economic player in the economy who has survived to date.

Now the accusations have surfaced, aimed at big banks accused of stashing away cash instead of lending to the needy economy that is running on very thin working capital base relative to the needs of the industry. These accusations, considering the income challenges that the banks are facing in Zimbabwe today and coupled with lack of alternative assets in the market, seem to be largely bizarre. Reading through the accusations, there is one conclusion one can make; only banks with brainless credit risk policies will be found sitting on disproportionate large amounts of non-interest earning cash, whilst only stupid banks will lend every coin they have on their balance sheets and collapse tomorrow. That closes the analysis.

Without any other interest earning asset portfolio existing other than the loans and advances today in Zimbabwe’s banking sphere, and with banks facing huge operational costs and adjustment challenges, any bank with sizeable deposits is in a better shape to meet obligations to staff, shareholders and clients through creating assets on the balance sheet via loans and advances. It therefore would be bizarre to find a bank sitting on excessive cash balances. Doing so would be too is too risk averse and such banks don’t deserve a place in the market. The other balancing side of the coin however gives better insight to policy makers and interest groups that may want to blame the banks for not lending every coin of their deposit. And that is the issue of liquidity. Traditionally, the RBZ acted as the lender of last resort whereby banks in short positions would get accommodated, whilst at the same time the interbank market has always been active with TBs being used to secure such transactions. Today there is virtually no accommodation from the RBZ for banks in need of liquidity because the central bank itself has no sufficient buffers of currencies, whilst on the same note the interbank market is sticky as few bankers’ acceptances are acceptable as security amongst banks. The listed companies, whose shareholders cannot respond to right issues as they have equally been decimated by a decade long hyper-inflation, have swooped on the credit markets, suffocating the smaller unlisted companies since their bankers’ acceptances are deemed liquid to some extent.

The market is therefore very illiquid, and those in the know understand the disastrous impact of running a bank with a very high loan-to-deposit ratio in a market that is as illiquid as Zimbabwe’s. That bank may not live long to be recognised as a bank that made the difference. True, the economy needs to resuscitate production, but the deposits in the banking sector at around $500 million in May 2009 are too thin to meet the needs of the thirsty economy. As long as Fidelity Printers is not printing US$ and with the RBZ having to rely on legitimate built-up of reserves, it will take a long time for the RBZ to accumulate sufficient foreign currency buffers to oil operations of the interbank market. And as long as the interbank market is not efficient, whilst the accommodation policy of the RBZ is dead, the banks have therefore every right to maintain huge liquidity buffers. Unfortunately because of the market dynamics, this liquidity portfolio will be in the form of cash. Considering the painful adjustment mechanism companies are going through, bad loans are now a potential threat in the banking sector that had gone for the last 5 successive years with the lowest loan loss ratio in the world due to inflation that kept borrowing the most lucrative thing. Banks therefore have to balance the liquidity issue and solvency needs, more so now they need to boost capital levels to the new requirements around $12 million after losing all the capital to inflation.

With this complete picture in mind, the banking sector in Zimbabwe is treading on one of the most difficult paths in its history, and criticism that does not take into account the intricacies of these liquidity dynamics will largely miss the point. Instead, the government should scrutinise itself and evaluate what it has done to assist in credit creation. Instead, the issue of reducing the statutory reserves to zero should be a key priority in a market that is sitting on arguably the lowest deposit base in Africa relative to its capacity.

Elsewhere, the challenges are more or less the same. The huge disparity between the lending rates and repo rates in Tanzania and South Africa have been misconstrued by some policy makers as inhibiting the interest rate pass through, hence undermining the efficiency of monetary policy to influence real economic activities. In Tanzania, with the banking sector sitting on total deposits of about $5 billion and $6.1 billion in assets, the big banks have about 50% of balance sheets in loans and advances and a sizeable 16% in government securities. What has attracted attention is the average annualised cost of borrowing of about 20% per annum compared to mild annual inflation running at 11.3% year-on year ( May). The sector has been accused of reaping off borrowers and therefore inhibiting credit extension mainly to the small companies that are in the growth phase. The call to reduce interest rates in Tanzania would be very difficult for banks that would likely see more bad loans as the economy feels strains of collapsed global prices of cotton, Tanzanite and the negative impacts of slowing tourism activities. The government securities, in particular the one year TBs, aren’t attractive anymore for the banks considering the yields have been coming down sharply over the last 10 months, from as high as 18% in October 2007 to the current yields averaging 11%, closely matching inflation that has been coming down in line with commodity prices cooling off.

In SA, the debate sparked by Tito Mboweni with the big banks seems to reinforce the general notion in many African counties that the banks are insensitive to needs of the wider economy, and will go an extra mile in maximising profit. As SA’s Reserve Bank has been hastening the cuts in repo rate to make credit more available in the recession-hit economy, the banks have not been reducing their lending rates at the same pace, attracting attention of the central bank. The efficiency of monetary policy is very important in SA, Africa’s biggest economy with total assets in the banking sector at around $300 billion. With one of the highest loan to GDP ratio on the continent at 78%, the transmission mechanism of monetary policy would need to be more efficient to allow policy makers to manage wider macroeconomic risks and shocks in the quest of maintaining sustainable inflation and unemployment levels. The decision on 25 June by the SA’s Reserve Bank to keep the repo rate unchanged at 7.5% brought even more special interest groups such as Cosatu in condemning the high interest rates, this time the anger being directed at the Reserve Bank for failing to stimulate the economy.

Whilst many African economies are still far from accommodating consumer loans on banks’ balance sheets, SA runs deeper, with home loans and mortgages to total assets at about 31%. This ratio is not significantly different from zero for banks in Tanzania, Zimbabwe, Angola, Mozambique and Zambia, making the interest rate debate in these economies less emotional. Combined with household debt at about 75% of disposable income, the interest rate factor becomes an important issue in SA’s macro-economic framework. In most of the debates around bank interest rates however, many fail to understand the link between the central banks’ provision of liquidity to the banks and the determination of the lending rates based on the repo rate. As long as banks are not borrowing from the central banks to manage their short positions, it will always be difficult for the lending rates to be very responsive to the policy rates. And in such instances, moral suasion would need to do the trick

Green shoots emerging on Zimbabwe’s economic landscape

The major economic indicators point to a brighter future ahead for Zimbabwe, although the major debate would be on how bright things are going to be. GDP growth rate, having contracted by another 14% in 2008, is set rise this year on the back of tangible reforms. The disastrous impact of excessive money printing, illogical price controls and fixed exchange rate that characterized the foundations of the chaotic policy making framework of yesteryear have silently been replaced by silent and steadfast dollarized economy that is self-regulating, in the process taking away the rent-seeking behavior that emanated from seignorage revenue.

The stock market, in itself a barometer of confidence in an economy that has no other known measures of business confidence, has been bullish of late. This bullish trend, although nothing when compared to the mad bulls that characterized 2007 and 2008 on the back of excessive broad money supply growth from a currency that has since died a natural death, is a believable measure of confidence. Between 2004 and early 2009, the Zimbabwe Stock exchange surged and contracted on the whims of market liquidity conditions. These excessive liquidity conditions emanated from surplus positions on the money market from the so called ‘sanctions bursting activities’, ASPEF, BACOSSI facilities and other laxative sterilization strategies of the RBZ that drove the stock market to new records daily, which records were meaningless when converted to real value creation.

That era has passed, and with little doubt, the government and RBZ have little influence in determining the direction of the ZSE on a daily basis as before. Liquidity conditions today definitely play a major role as before, with more flows into the economy translating into share prices gravitating towards their realistic values. The major difference however is that today’s liquidity inflows are emanating from real economic activities compared to irrational explosion of monetary exuberance of the past. All major sources of liquidity inflows into the economy are showing a positive trajectory, from donor funds via exports to external lines of credit flowing in. These are the sources of liquidity that will be more important in oiling the operations of the stock market from the primary trading perspective, whilst constructive impact of these flows on the real economy through increasing productive capacity and bolstering purchasing power reinforces the secondary value perception of listed companies.

Zimbabwe’s productive capacity remains very low below 20% in many extractive and manufacturing industries, whilst the savings rate that has fallen into negative territory due to a decade of hyperinflation is not making the comeback on the real demand side any easier. As the world today warily looks for signs of ‘green shoots’ in the global economy that might signal the beginning of the end to the recession, the return of the majority of the Zimbabwean civil service to work, albeit on $100 per month, is in itself a sign of the first green shoots in the economy that need constant watering until the new plants develop deep roots to weather the dry winters of tomorrow on their own. Notwithstanding the unemployment rate still very high above 80% , whilst the average monthly wages that have improved slightly to around $100 from its lowest of about $40 in 2008, the turning wheels of change in the economy that are seeing pricing predictability are encouraging signs of a positive future. Embracing these positive developments, the industrial index is up 144% from 16 March, whilst the mining index has jumped by a staggering 242% over the same period.

The temptations of fiscal indiscipline that drove budget deficits to above 80% and 100% of GDP in 2007 and 2008 respectively (taking into account unbudgeted RBZ quasi-fiscal activities) and swept the foundations of the economy into a big mess are now in the rear-mirror as the central government cannot print USD and would have to rely on cash budgeting going forward. Bilateral and Multi-lateral support will be low and slower due to the challenges in the global economy, but the official flows that are now reported above US$1 billion are positive signs of part of the global players acknowledging the existence of potential and the need to alleviate suffering in a nation with a bright future.

Notwithstanding the positive signs of progress emanating from dollarisation, arbitrage opportunities continue to present themselves in one form or the other, in the process reflecting the deep scarcity of capital to kick-start the recovery process. Reflecting the huge scarcity of cash for working capital purposes, the cost of borrowing on the USD has risen to as high as 79.5% annualised as lending is now done between 2% to anything up to 5% flat on 30-day cycles. This is far pricey compared to the dollar base rate in African around 10% per annum. Whatever happens however, the banks in Zimbabwe today are not losing capital in buying Treasury Bills (TBs) as they have done over the last decade, and Kenyan banks buying the negative yielding TBs from the Central Bank of Kenya may need to learn from the tragedy of Zimbabwean banks before it is too late. As capital positions of banks strengthen gradually, whilst more inflows from abroad bolster their lending capacity, the cost of capital will surely begin to soften and bring relief to many Zimbabwean producers who are battling with competitiveness against producers in South Africa who are now enjoying favorable borrowing costs and more abundant working capital. The recovery of the Zimbabwean economy without sufficient capital, skills, and favorable commodity prices, will take 5 years and longer, but the positive side is that the recovery has started and what is key is to manage the process and not let loose.

Mining Counters Trading at attractive Discounts on the Zimbabwe Stock Exchange

The series of sectoral analysis on the Zimbabwe Stock Exchange continues. Today's focus shifts to the mining counters. Globally, mines are cutting on production and exploration due to plummeting commodity prices. With the exception of gold and to some extent uranium, the global mining landscape is a sad story. From the miners of rare Tanzanite in Tanzania, to the glitter of diamonds at Debswana in Botswana, the sad news of production cuts and layoffs continue to dominate the landscape. Commodity rich Africa is facing a challenge that is set to slow down and in some instances, reverse the strong growth that had characterized the last five years. Zambia, whose economic prospects swing with in tandem with the international copper prices, has been hit very hard. And since October 20 last year, life has never been the same for Zambian economy.

Copper prices have collapsed by more than 50% from the July 2008 peak of $8940 per tonne. With two thirds of Zambia’s export earnings coming from copper, the exchange rate has responded and collapsed by about 48% to the current $1/KW5592 over the same period. The Lusaka Stock Exchange (LuSE) which had benefited from huge liquidity inflows from largely the exports that sustained a sharply appreciating exchange rate (whilst the local inflation pushed the kwacha share prices upwards) attracted huge attention in 2007 when it bagged a whopping 108% return in US$ terms. It joined the Shanghai Stock Exchange among the league of the best stock markets in 2007. Its a pity today that all who bet on the Kwacha and the LuSE since October 2008 have lost out as the gold train derails. The only benefit coming from the crushing copper prices in Zambia has been less power cuts. The mining sector that used to consume about 49% of the internal generation is cooling off, leaving enough capacity in the national grid to feed other industries and users that would ordinarily suffer when the copper fundamentals are solid. At least Zambia can afford to export to Zimbabwe, thanks to the global crisis.

Angola, whose GDP growth rate rocketed past the 15% mark in 2007 and 2008, joins its league of oil and diamond commodity-rich African countries that have seen fortunes getting darker by the day. It would have to painfully scale down ambitious infrastructure and other social programs as the major sources of revenue have hit a bad patch. Having promised many deliverables in the run-up to the elections, the President of Angola sees the need to kick start an awareness program to educate the citizens of ‘the seriousness of the situation’, of course to manage expectations. Its preparation to host the 2010 Africa Cup of Nations soccer tournament has not come at the right time in its history. There is however a silver lining. Due to the shallow financial markets and the absence of mortgage financing, the property market in Angola, just like the Tanzanian one, has kept its glitter.

Zimbabwe mines missed the global commodity rally of the last five years because of administrative pricing and implicit taxation on the back of many schemes by policy makers that negatively exploited the sector. With that, they missed the biggest opportunity in a century to beef up the physical capital and strengthen their financial reserves. The threat and confusion regarding indigenization scared off potential exploration in other areas, whilst power challenges and the associated illogically exchange rate regime left big scars on the mining landscapes that are much more visible than the dump sites the mines created! Today the exchange rate issue could be over, but without a sustainable price and with no capital to de-water and retool, many of the mines will remain closed. The Mhangura and Inyati copper mines missed a lifetime opportunity when copper prices buoyed exploration and production in Zambia’s copper belt and the rest of the world. Zimbabwe’s copper production has sustained a sharp decrease from as high as 27 000 tonnes in 1980 to as low as 2500 tonnes in 2005, and sadly it will not recover now the prices have slumped and the lines of credit have dried.

For its huge coal reserves, massive operational infrastructure, coking ovens and thermal electricity generation coal in the face of the regional power shortages, Hwange continues to fail to impress investors on the Zimbabwe Stock Exchange and has traded around $25 million market cap for some time. But it’s definitely a good buying opportunity.

The glitter of Rio Zim remains to shine only on Renco mine as Murowa Diamonds stares into the eyes of waning global affection for diamonds. The dollarisation and subsequent policy changes that saw the abolition of the RBZ surrender requirements will put RioZim gold production in favorable light, but its nickel and diamond fundamentals remain challenged. The overall future for the company is much better notwithstanding the challenges. The portfolio comprising coal, metals, gold and diamonds is diversified enough to allow RioZim to inject more capital into higher yielding activities and create value for shareholders in the long term. The sentiment driven gold price, which continues to be buoyed by negative global prospects, will put RioZim gold mining activities in better shape. And should it meet at least its 2007 gold production of about 645kgs, RionZim would be a step stronger in turning strong positive cash flows at a time the banks are not easily loosening the funding towards working capital and other capital projects in the mining sector. Whatever prospects of gold and coal one can look at with the current market cap of Rio Zim around $24 million, it doesn’t need much analysis to see the value that many will scramble for sooner. The fortunes of Falgold follow more or less the same trends.

Opportunities on Zimbabwe Stock Exchange?

After a decade of hyper inflation and the death of a currency in Zimbabwe, many had waited for the signs of the turnaround to pounce on discounted assets that would instantly create value for the holders. With the Government of National Unity, some international investors are taking keen interest on Zimbabwe, with many positioning to grab gems still swathed in the rubbles of the decade-long economic collapse. Few however will be lucky to find them to create instant wealth. The stock market could have been the easiest route.

The greatest challenge however is the valuation mechanism. What is the fair value of Tedco today for example? On 03 January 1995, its market cap was US$10 million and now it’s trading steadily around US$2.4 million. PGI, valued at US$58 million then, has collapsed to US$13 million currently. It’s more or less the same scenario globally, with P/E ratios at their worst in three decades. Global stock markets have collapsed, with banking and oil stocks having been severely battered by the global recession, and picking value in Zimbabwe today is not going to be easy guesswork. P/E ratios, which ceased to make sense in 2001 in Zimbabwe, will not be making sense either today because there are no earnings to talk about, and they might be none to talk about the next 18 months. Today the Zimbabwe stock exchange is trading in US$ yet the last reported earnings are in ZW$ that died a long time ago and have since been laid to rest in peace.

Which sectors are likely to lead in value creation for investors in Zimbabwe? Banking comes into mind first because of the current global upheaval. Let’s evaluate the banking sector. History in the last two years showed that, on the back of sectoral indexation investment strategy on the Zimbabwe Stock Exchange, the banking sector created good value for investors ahead of the manufacturing, mining, retail index etc. How much value can one create by snapping the seemingly cheap banking stocks on the Zimbabwe Stock Exchange today? Is it hilarious or sad that FBC Holdings has a market capitalization of only about $3.5 million? Mind you this establishment has a building society and commercial bank. To get a license for these two entities from the RBZ one needs to demonstrate they have no less than $22.5 million. One may forgive NMB for its going value at about $4.2 million since its likely target market has been decimated by inflation.

The middle and lower upper class levels don’t exist in numbers that warrant a bank to get a license for those, at least for now. ZB, for all its name, wide branch network and track record, is trading at around $7.4 million. Maybe name and track record matter no more for investors, especially with the collapse of Lehman Brothers in fair weather when it had survived the ghastly winds of the Great Depression and World War 2. CBZ and Barclays are no different from the rest. Does it explain why ABC has been trading at about 35% of its value on the Botswana Stock Exchange? Are these trading figures closer to the truth for now or it’s a case of the stock market failing to reflect fundamentals?

The banking sector in Zimbabwe is arguably at its weakest point since its establishment from the earnings perspective. The balance sheets have little value to generate meaningful profits for stockholders. The worry of liquidity risk that kept banks closer to poor-yielding TBs more than any other asset the past 3 years has wiped balance sheet values. Now the local currency is dead, and with that death, the little amounts of TBs on bank balance sheets, although now very insignificant, have become valueless. Stock market is usually for long-term value creation, so the challenges facing banking stocks today may not matter for investors.

So how about the recovery side going forward? Interest income is going to be very thin on the next two or so years as the banks have little or no deposits to lend simply because the banking public has no foreign currency to leave in the banks. With the majority of the working class earning below $150 per month, what hope is there that soon the deposits will grow to meaningful levels, even if the reserve ratio at the RBZ is going to be put at 0%? Slim. On the other side, the few banks that will access commercial lines of credit to stimulate their lending activities will assume greater risk. The margins are too tight. The real cost of capital in Africa is still very high notwithstanding the LIBOR at historic lows. The base rate for dollar transactions is around 8% in Africa today, and with the higher country risk tagged to Zimbabwe, the total cost could be anything around 11%. The few banks that will clinch lines of credit will find loading a meaningful spread difficult.

Non-performing loans, not known to Zimbabwean banks in the last 5 years, all of a sudden will become a real risk to manage when lending starts generally to pick up. Zimbabwean bankers have for years now seen far less than 1% of their loan books going bad, all benefiting from inflation that made borrowers winners always. The real cost of borrowing improved from minus 87% to minus 99% between 2004 and 2008 respectively, implying borrowing the equivalent of US$1 in 2008 saw one paying back around $0.01 at the end of the year, cost plus interest. That is cheap money in all standards. No one could default, and the non-performing loans were almost non-existent on bank loan books. With the dollarized economy, the reality of bad loans will haunt banks, and more prudence will be required. Regionally, bad loans are quite a worrying aspect. In Uganda the banking sector saw non-performing loans at 9.3% in 2008, whilst in Tanzania they stood at a modest 6.7%. SA banks, though still on the low side, are seeing a deteriorating profile especially from the home loans segment and consumer loans. ABSA saw more than 100% increase in its impairment charge to US$580 million, whilst First Rand had non-performing loans standing around US$1.9 billion, about 4.2% of its loan book in December 2008. Zambian banks are likely to suffer the same fate as the revision of growth prospects for 2009 to around 5% due to contraction in copper mining activities, slowdown in tourism and manufacturing will most likely expose the banking sector this year.

What about other the future of other income? The emotions characterizing the biting economic hardships will keep ledger fees at their most minimum. When no meaningful lending is happening because the deposit base is thin, the arrangement fees and commission income will not be significant enough to change the earnings fortunes of the sector. The perennial running battles between the banks and RBZ regarding the former straying into the stock market could be over, and the banks are less likely to report any gains on their equity portfolios. Besides, many by now would have liquidated these to provide the liquidity needed to kick-start lending, reviving the corporate banking divisions that had virtually closed.

What then about banking stocks? Buy, hold or sell? Banking stocks are tricky. Banks have little, if no residual values at all. One cannot put value from that perspective. The earnings perspective will give one better chance to evaluate the potential of the upside. I have faith in the banking stocks. As long as their values are trading at these levels, there is huge upside potential that unfortunately will take time to realize. It’s beyond doubt that the stocks are trading at levels that have a potential for creating a huge upside when liquidity begins to flow more freely in the global markets. Foreign capital is what will most likely generate significant buying activity on the ZSE more than domestic inflows. I would give the banking stocks seven out of ten as potential ‘pick’. Traditional-minded banking models are likely to start the value creation cycle when it eventually starts. ZB, Barclays, and CBZH have long-term potential based on their wide retail networks. The few banks that rely on wholesale funding will find the going tougher. But don’t be fooled by the results coming through for December 2008 in making buying decisions into the future. These results have blatant distortions from the ZW$ activities that characterized the previous trading period. Some banks will command huge market shares on the back of probably ASPEF or BACOSSI funds that one or two clients of theirs accessed towards the reporting period.

These have since evaporated and some of these banks could be sobering to the reality of elusive real deposits that simply aren’t there. As the economy begins to take shape, more cheap deposits will accrue and create a base upon which to lend and create value for the shareholders. But that is about 2 years from now assuming the momentum of recovery continues. Bilateral and multilateral financial arrangements to bail the economy, because they are usually at concessionary rates, will bring the much needed boost in banking earnings quicker than via organic growth.

For banks stockholders, it’s highly likely that the banks will not declare any dividend the next three years, so stay put for capital appreciation. On the other hand, banking shareholders should expect always to be following their rights in injecting more capital to keep their banking companies afloat. If anything, the economy needs a lot of money to kick start and being a shareholder in a bank means you are prepared to continue pumping in money into your company to assist the economy. Every company is looking at accessing working capital, and the banks are not meeting the challenge. Loans and lines of credit will hasten the recovery process, but the bigger bargain would come from the government getting debt cancellation and substantial donor funds. HonorableTendai Biti should sharpen his tongue and bargain for debt cancellation and push for more banks and micro-finance companies to operate in the economy.

As I have always preached, licensing more banks that could be deep pocketed will assist the economy towards faster recovery, and the multiplier effect will pull up the rest of the banking sector. Next week let’s cross over to the mining sector and see if there is any good news for investors. Remember Hwange, for all its massive infrastructure, huge coal reserves and the surging sweet demand for electricity as the region gets darker by the night, is only trading around $25 million market cap.