Reiterating Buy recommendations on AFRIBK 2020s: African Bank’s USD-denominated 2020 bonds now yield over 10%. We do not believe the recent underperformance relative to peers is justified. We are keeping our Buy recommendations on the AFRIBK 6% Feb 2020 and AFRIBK 8.125% Oct 2020 securities. Profitability improved significantly in the last reporting period – profit for the year rose to ZAR303mn from ZAR178mn in FY 17. In addition, the Group is close to finalising a liquidity-support arrangement with its shareholders. We think this should be positive for AFRIBK bonds. The termination of the partnership with MMI did result in a small charge and does mean the group has lost a potential income stream. However, we think improvements in the core business should help address concerns about this. On the results call, the CEO showcased the new omni-channel platform, which we think should contribute to performance improvements. Further, the Group remains open to other partnerships. Recent headlines regarding African Phoenix may have also impacted performance of AFRIBK bonds. We note that this business is largely separate, and do not believe planned changes at African Phoenix should impact AFRIBK bond valuations.
Significant improvement in bottom line result: Costs rose by just 1% yoy, but the lender reported a 47% increase in provisions, and the effective tax rate was higher than in the previous year. However, strong net interest income offset all this and FY 18 net income was 70% higher than in 2017. AFRIBK management expects 2019 and 2020 to be challenging years. However, the Group has reiterated its 2021 targets, which include a return on equity of over 15% and a credit-loss ratio of less than 13%.
Very strong net interest income: Interest income was 17% higher than in the previous year, at over ZAR7.6bn, while interest expense fell by one-quarter, reflecting lower funding costs. As a result, net interest income rose to ZAR5.6bn from ZAR3.8bn in the previous year. Collection fees fell yoy, partly reflecting the decline in the size of the Residual Debt Services (RDS Ltd) book. Further, credit card fees declined, as the bank continued its move towards higher-quality clients. Overall, operating revenue of ZAR6.8bn was 26% higher than in the previous year, driven by stronger net interest income.
Cost/income ratio was less than 40%: Operating expense of almost ZAR2.7bn was only ZAR20mn higher than in 2017. Staff costs were flat yoy (at ZAR1.2bn) and collection costs fell, while rental and maintenance and IT costs, and professional fees all increased. The cost/income ratio was 10ppts lower than in 2017, at 39.7%.
Coverage higher than at end-17: Loans classed as ‘CD4 or higher’ at African Bank Ltd totalled ZAR5.3bn, up from ZAR4.6bn at end-March and ZAR3.9bn a year ago. Positively, however, total coverage improved to 75% from 52% at end-September 2017 (our calculations). Write-offs increased, reflecting a change in recency criteria (to five months from six months). However, bad debt recoveries from on and off balance sheet problem exposures were higher than in the previous year. The bank disclosed that IFRS 9 will lead to another change in write-off criteria. The full impact of this new accounting standard is expected to be published next year.