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CHIEF EXECUTIVE’S REPORT
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IT IS PLEASING TO REPORT ON THE IMPROVING PERFORMANCE AND PROSPECTS OF THE GROUP AS I COMPLETE MY FIRST FULL YEAR AS CHIEF EXECUTIVE. WE HAVE MADE ENCOURAGING PROGRESS DURING 2010 AND OUR YEAR-ON-YEAR PERFORMANCE RELATIVE TO THAT OF OUR PEERS IS GOOD, ALTHOUGH OUR ABSOLUTE FINANCIAL PERFORMANCE REMAINS BELOW MANY OF OUR MEDIUM- TO LONG-TERM TARGETS MOSTLY AS A RESULT OF THE ELEVATED CREDIT LOSS RATIO. While the economic recovery remains fragile, we believe the worst of a very difficult cycle for banks is behind us. SA banks and regulators have emerged from the crisis with their reputations enhanced on the global front. In this report I focus primarily on the group’s performance, strategy, sustainability
and prospects for 2011 and beyond. The Chairman in his report has covered several
issues on a macrolevel as well as commented specifically on governance, sustainability The adoption of the King III principles on integrated sustainability reporting ensures that we not only report on our performance in financial and economic terms, but also across the key tenets of environmental, social and cultural sustainability. |
2010 PERFORMANCE IN REVIEW
Improved results in recovering economic conditions
2010 saw the group’s headline earnings grow for the first time since 2007 when the
banking sector globally and locally was hit by a crisis of unprecedented magnitude
in recent times. The 14,6% growth in headline earnings for the financial year was
marginally above our expectations outlined to shareholders in the third-quarter
trading update. Earnings momentum built during the year, with earnings in the second
half up 27% on the first half following strong fourth-quarter performance. These
results were driven by the improving economic conditions, the group’s strategic focus
on growing non-interest revenue (NIR) and efficient management of costs.
Interest rates are currently at their lowest levels in over three decades, which is creating strong endowment pressure and have resulted in a reduction in net interest income (NI) of R925 million. It is, however, most encouraging that we experienced the first signs of improving impairments, particularly in the retail home loan portfolios that were so badly impacted during the downturn. Overall impairment charges improved by R446 million. We often speak about endowment pressure being short-term pain for longer-term gain’ and it is pleasing to see some gains emerging in an impairment trend we believe is likely to improve into 2011.
We have demonstrated tight cost discipline over a number of years and this has been balanced with investment in the sustainable growth of our business. In the past year headline earnings grew by almost 15%, with comparable expense growth being contained at 8,5%, despite the challenges of wage settlements above the level of inflation. Pleasingly we expanded our distribution network by adding 409 ATM s, 17 branches, 13 personal loans branches, 70 personal loans kiosks and a further 69 points of presence in retail outlets.
While year-on-year growth rates are pleasing, our performance in absolute terms, as measured by return on equity relative to our cost of equity, remains below medium- to long-term targets owing to the endowment effect of lower rates on NI, a high credit loss ratio and insufficient transactional income.
NIR is a key focus area and comparable growth of 10,5% before fair-value adjustments should be a strong result relative to that of our peers. While the ratio of NIR to expenses has improved to 79,6%, there remains a great deal of work to be done to achieve our medium- to long-term target of 85%.
The R3 billion invested in 2009 to acquire the remaining 49,9% of Imperial Bank and full ownership of the wealth management joint ventures is proving to be a solid investment for our shareholders. This is evidenced through the contribution of Motor Finance Corporation (MFC) to Nedbank Retail’s improved performance and the excellent growth and returns achieved within Nedbank Wealth. It is important to note that the integration of Imperial Bank was completed without any job losses.
The group maintained its well-capitalised balance sheet, with core Tier 1 capital at 10,1% (2009: 9,9%). Advances grew by 5,5%, with market share gains in most lending classes besides home loans. We have taken a strategic decision to reduce home loan market share in the current environment and focus rather on the quality of the home loan portfolio, given the challenging economics in this product line.
Net asset value per share grew by 8,0% to 9 831 cents. This is a pleasing result given the increase in the average number of shares in issue following the acquisition of the joint ventures from Old Mutual and scrip dividend payments last year.
PERFORMANCE OF BUSINESS CLUSTERS
Our business clusters delivered strong NIR growth, improved
impairment levels and contained costs below the original forecasts
that we gave to the market.
The banking clusters’ results were impacted by the increased allocation of central costs and negative endowment earnings from lower average interest rates, which were 198 basis points lower when compared with 2009. The capital optimisation exercises in Nedbank Retail and Nedbank Business Banking continued and resulted in more efficient use of capital. The lower levels of capital used resulted in lower endowment-related interest revenue in these clusters.
Nedbank Retail reported an encouraging improvement in impairments, particularly in home loans, and solid NIR growth.
Impairments improved in most businesses, with Nedbank Corporate, Nedbank Wealth and Nedbank Business Banking again recording credit loss ratios within or below through-the-cycle target ranges. Nedbank Capital incurred a higher level of impairments in its private equity portfolio.
The businesses generated strong growth in core fee and commission income, driven primarily by volume growth, new primary clients and a number of innovative products focused on growing NIR. Nedbank Capital recorded improved trading income, particularly in the equity businesses. Nedbank Wealth performed very well and increased both headline earnings and the return on ordinary shareholders’ funds (ROE). The business benefited from the integration of the former joint ventures and strong growth in new business, particularly in insurance and asset management.
Nedbank Retail delivered a turnaround in performance, with headline earnings increasing from a loss of R27 million to a R760 million profit. ROE at 4,6% (2009: -0,2%) remains well below the cost of equity, resulting in economic losses for the cluster. The stabilisation of Retail, combined with the repositioning of the cluster to an integrated and client-centred business, should contribute to a sustainable momentum in earnings growth and a return to economic profit in the next three to four years.
VISION AND GROWTH STRATEGY
During the year we refined our vision to ‘building Africa’s most
admired bank by our staff, clients, shareholders, regulators and
communities’. To be Africa’s most admired bank we need to become
South Africa’s most admired bank and, while we made progress in
2010, we still have much work ahead. This vision also highlights the
increasing focus on growing our business reach across the African
continent and not just in South Africa.
To achieve our vision we need to deliver the following key strategic drivers:
REPOSITION NEDBANK RETAIL
Nedbank Retail is both our biggest challenge and our biggest
opportunity. The management team has worked hard in 2010 to
develop a strategy to ensure sustainable growth in Retail. This
essentially covers three areas: harnessing the strengths of Nedbank
by building on corporate and business banking relationships to grow
Retail; growing primary clients by focusing on households, the youth
and small businesses, and integrating the high-net-worth offering
under Nedbank Wealth; and managing for value by elevating all risk
management practices and adopting a more discerning approach to
home loans origination, which will lead to reductions in market share
but improved economics on new business written.
NON-INTEREST REVENUE GROWTH
NIR levels are below those of our peers, which results in our ROE
and valuation in price-to-book terms being lower than that of our
peers. The 11% growth in NIR in 2010 reflects progress in all areas of
electronic banking, mobile products, equity trading and new products
in Nedbank Wealth, including the introduction of credit life cover
in the MFC portfolio. We continue to work on product innovation,
system enhancements and bundling to enhance NIR growth.
PORTFOLIO TILT
This strategy relates to the allocation of scarce resources such as
capital and liquidity to the business to measure them effectively and
enable us proactively to grow businesses we believe are strategically
attractive and generate higher levels of economic profit. Importantly,
with reward mechanisms appropriately linked to performance, short-term
incentive payments in 2010 were 17% higher, which is largely
in line with headline earnings growth of 15%, together with some
out performance on non-financial measures.
BUILDING AFRICA’S MOST ADMIRED BANK
Based on the current distribution of economic profit pools in
financial services on the continent, to be Africa’s most admired bank
we firstly need to be South Africa’s most admired bank. Our strategy
for the rest of Africa is built on four pillars:
- Growing and expanding the operations in the five countries in which we operate, where we need to achieve ROEs greater than in South Africa.
- Expanding the advisory business of Nedbank Capital, including structured trade finance, with the emphasis on mining, telecommunications and infrastructure.
- Strengthening our alliance with Ecobank to provide clients with a one-bank experience in 35 African countries (we have made solid progress in 2010 by attracting a number of new clients).
- Being alert to acquisition opportunities that align with our strategy, culture and financial return hurdles.
BECOMING CLIENT-DRIVEN
Our clients are the reason we are in business. We continually strive
to improve service levels across the bank by putting our clients at
the centre of everything we do. In the past year we have improved
scores and ratings in leading independent client service and banking
industry surveys across the retail and wholesale businesses.
As discussed earlier, we also made a significant investment in extending our retail distribution channels and footprint. Nedbank Retail attracted some 96 000 new primary clients, increasing the total client base to 4,5 million. The number of Mzansi clients reached 1 million. In partnership with Vodacom, Nedbank launched the M-PESA mobile banking solution in South Africa, which is a complementary product to Mzansi as an entry-level offering that is affordable and easy to use.
One of the group’s strategic objectives is to become client-driven and, in striving to achieve this, we aim to transform retail banking to be more client-focused, become the leader in business banking and the public sector bank of choice, and maintain our position as a top-two wholesale bank.
EXECUTIVE REMUNERATION
In the aftermath of the global financial crisis there has been a
heightened focus from shareholders and other stakeholders on
remuneration practices. Several of the high-profile companies
that failed during the crisis could no doubt claim to have had
remuneration policies that linked reward to performance and
drove shareholder value creation. However, their practices clearly
rewarded short-term performance and ignored behaviour and risk
management that would ensure the longer-term sustainability of
the business.
We believe our remuneration practices are aligned with the interests of all stakeholders in a manner that does not encourage excessive risk taking. Quantitative and qualitative performance targets are linked to variable remuneration to drive the correct behaviour.
Nedbank Group is well positioned in relation to emerging best practice in financial services remuneration. Corporate performance targets were introduced into the long-term incentive schemes for all staff as far back as 2007, and we have had compulsory deferral and clawback arrangements for short-term incentives since 2009. In line with the spirit of King II the group introduced a split in long-term incentive allocations in 2010, where a portion is allocated for performance, with associated performance targets, and a portion for retention only, with time-based vesting.
Importantly, our remuneration practices are aligned with the performance of the business within the board-approved risk appetite and contribute to the achievement of the group’s business objectives. The disclosure in our Remuneration Report has been further enhanced and can be found here.
SUSTAINABILITY
Nedbank Group’s approach to integrated sustainability is holistic
and as such balances stakeholder interests across the following areas:
- Economic sustainability – ensuring the delivery of lasting stakeholder value.
- Environmental sustainability – minimising usage of, and impact on, natural resources.
- Social sustainability – building societal capital in southern Africa.
- Cultural sustainability – developing a resilient corporate culture.
ACHIEVING CARBON NEUTRALITY
In September 2009 we announced our commitment to working
towards carbon neutrality and less than a year later became the
first African bank – and the first large SA corporate – to achieve
zero carbon status.
Our decision to pursue carbon neutrality was not one to achieve short-term marketing advantage. It was the culmination of more than 20 years of focusing on environmental issues and positioning ourselves as the green and caring bank.
Stakeholders should note that we have not achieved neutrality by simply buying carbon offsets. The process included ongoing awareness and behaviour change, supported by intensity reduction targets and driving operational efficiencies that have been incorporated into performance scorecards.
The cost of achieving carbon neutrality is two-fold. Direct costs relating to carbon credits purchased and the indirect costs to achieve intensity reduction targets. As a result of the carbon reduction initiatives and operational efficiencies achieved, Nedbank Group saved R36 million over three years. This highlights that, in addition to the environmental and social benefits, carbon neutrality is economically sustainable. However, carbon neutrality is not an end in itself and we are committed to reducing our footprint even further and maintaining our carbon-neutral status.
We also plan to focus more closely on water issues in 2011, as water is becoming a major sustainability challenge in South Africa. Our focus will include water quality, supply and access.
ACCELERATING TRANSFORMATION
On the transformation front we were pleased to be rated as
the third most empowered company in the 2010 Financial Mail
Top Empowerment Companies Survey with a score of 86,6
[based on the 2009 Department of Trade and Industry (dti) scores]. This survey covers the top 200 companies listed on JSE Limited.
Nedbank is the only bank with level 2 contributor status based on
scores from the dti Codes of Good Practice. Nedbank Group was
rated first against its peers in every category, except ownership,
where we were ranked second.
In 2010 we improved our overall score to 89,5, notwithstanding the integration of Imperial Bank and slower headcount growth as well as less attrition.
BASEL III DEVELOPMENTS
The majority of the Basel III proposals have recently been finalised,
although some significant aspects remain to be completed in 2011.
In South Africa the details of exactly how Basel III will be adopted
will be determined by the South African Reserve Bank in due course.
For Nedbank Group the impact of the new capital requirements is expected to be manageable. On a Basel III pro forma basis for 2010 the group is in a position to absorb the Basel III capital implications, with all capital ratios still remaining above the top end of current internal target ranges. These should improve further by the end of 2013 from projected earnings, continuing capital and risk-weighted asset optimisation, and the impact of the group’s active portfolio management strategy.
Once Basel III has been finalised, Nedbank Group will review its target capital ratios. In respect of the two proposed liquidity ratios, the liquidity coverage ratio for implementation in 2015 and the net stable funding ratio (NSFR) for implementation in 2018, the impact of compliance by the SA banking industry would be punitive if implemented as they currently stand, particularly the NSFR in the light of structural constraints within the SA financial market. This is the case for many emerging-market jurisdictions around the world, and the negative effect on economic growth and employment would be significant. The group anticipates that a pragmatic approach to this issue will be applied prior to the finalisation in 2018.
PROSPECTS FOR 2011
Nedbank Group is well placed for earnings growth in 2011.
The group will continue to invest to generate sustainable NIR
growth, underpinned by ongoing cost optimisation and efficiency
improvements. Growing the bank’s overall franchise and maintaining
momentum on the turnaround in the Retail Cluster, supported by
a liquid and well-capitalised balance sheet, are key to delivering
sustainable growth.
Margins should widen slightly, given that interest rates are expected to remain unchanged, and hence the negative effect of assets re pricing quicker than liabilities out to three months will decrease. In addition, the cost of term liquidity is expected to decline as more expensive deposits mature and as below-trend economic growth continues, albeit at higher levels than last year. Overall advances growth is expected to be in the mid to upper single digits.
Impairments are expected to continue reducing in line with the improved quality of assets supported by asset pricing on new advances that appropriately reflects risk and the related cost of funds. The credit loss ratio is currently expected to decrease, but to remain above the group’s target range for 2011.
Transactional volumes are expected to increase as the economy improves and the group focus on growing primary clients is maintained.
GROUP TARGETS
The group’s medium- to long-term financial targets remain
unchanged. These targets, together with an outlook for performance
for 2011, are detailed in the Financial Report. The high credit loss
ratio and the impact of endowment were the key factors in most
of the targets not being met in 2010, as expected at this point in
the cycle. Based on the group’s current macroeconomic outlook,
management expects to achieve all these targets by 2013 as the
credit loss ratio unwinds and the NIR/expense ratio improves.
FINANCIAL DRIVERS
Against this background we expect asset growth in line with nominal
gross domestic product in the mid to upper single digits and some
margin expansion, assuming no further cuts in interest rates.
Impairments should decrease, but the credit loss ratio is estimated to remain above 1%, which is the top of our target range.
The momentum in NIR is expected to continue with double-digit growth before any fair-value movements. We will continue to invest in our business and optimise costs in a way that we anticipate will lead to a positive ‘jaws ratio’ and a small reduction in the efficiency ratio.
On the capital front we will operate above current targets in anticipation of Basel III.
ACKNOWLEDGEMENTS
Nedbank Group performed well in 2010, which in many ways was a
difficult year for the business, and I thank all my fellow stakeholders
for their role in delivering these results.
I thank our Chairman, Reuel Khoza, for his guidance and the benefit of his wisdom during my first year as Chief Executive, as well as my board colleagues for their commitment and active participation in the group’s affairs. I have also been fortunate to benefit from the counsel of Tom Boardman, who has remained on the board as a non-executive director, which has ensured continuity and facilitated a seamless succession process.
It is a privilege to lead a fantastic executive team at Nedbank. The team members work well together and I thank them for their support. During the year Ciko Thomas and John Bestbier joined the Group Executive Committee, while sadly we said farewell to Shirley Zinn and Saks Ntombela who resigned from the group. Early in 2011 we welcomed Abe Thebyane as Group Executive, Human Resources, to the team.
After a tough period for the banking sector our staff members are beginning to see the results of their efforts, which have not always been evident in the performance in recent years. Thank you for your loyalty and commitment as, together, we strive to build Africa’s most admired bank.
