April 4, 2011 Equities | South Africa

FY12 TP 17499c CAPITEC BANK

HOLD (prev. HOLD)
Solid footing but rich valuation
ƒ Meeting with management affirm our long-term
favourable outlook; we maintain our HOLD, FY12
Target price (TP) 17499c: Capitec (CPI SJ) remains a
superior long-term position, in our view, as it remains
favourably structurally positioned. Management still believe
there are significant opportunities in the micro-finance (and
unsecured lending) segment. They do not see considerable
headwinds related to competition and the Consumer
Protection Act (CPA) (and we do as indicated by our
assumptions) although they highlighted that the CPA could
negatively affect fixed deposits mobilisation as it grants
depositors the right to terminate their fixed term deposits.
This could increase the cost and sensitivity of banks’ funding
operations. The pursuit of lower-cost delivery channels has
been constructive to the bank’s cost base. The strategy of
partnering with retailers, especially the smaller ones, and
thus reduce costs related to branch network continues in
order to attain a high volume-low cost business model.
According to management, the idea is to attain scale such
that volume (asset rotation) will be more important in
determining the bank’s profitability than margin. While
management shows a high level of conviction in their
business model, investors continue to be sceptical of
probable weakening growth and credit risks yet there was
lack of discussion on expected growth due to ambiguity (i.e.
no hard number related to growth of deposits or loans) but
extensive discussion on credit risks.
ƒ The share price has been extremely volatile in the past few
weeks. After it declined to 13925c on March 15, 2010 and
our subsequent recommendation change to BUY as the
potential upside ascended to >20%, the share price rallied
materially that the opportunity has already disappeared in a
space of <3 weeks. After meeting management and making
slight changes to our assumptions, we maintain our HOLD
with our FY12 TP changing negligibly to 17499c. At current
price, valuation risk remains high, in our view.
ƒ After meeting with management, we carry out 3 main
exercises. We 1) take a critical look at credit risks and
provision policies. We note that Capitec’s provision policy is
highly conservative that non-performing loans (NPLs)
overhang risk is insignificant. 2) expand our Return on
Peter Mushangwe
Equity (ROE) beyond the three usual factors (i.e. rotation,
Lawrence Madzwara
margin and leverage). We observe that the cost of liabilities
+27 11 551 3675
is rising while asset rotation is falling; and 3) revise our
peterm@legae.co.za
assumptions. Our assumptions remain conservative relative
to history and management guidance although we increase
our deposits growth rate post management discussion.
1. Credit risks: Identifying and
dissecting the fears

ƒ Investors are concerned by credit risks but wrongly so: We

note that investors are concerned by two principal issues 1) credit
risks (hence lower conviction on earnings going forward,
warranting the view that the share is expensive; and 2) low level
of external liquidity (of the share). In this report, we focus on the
former as management indicated that they do not pay much
consideration to the level of the share price but pay considerable
attention to the bank’s risks. In highlighting what we think are key
issues in credit risk analysis related to Capitec, and our relatively
constructive stance on credit risk (which we discuss below), we are
not implying there is nothing that could go wrong. There are
always “unknowns”. We identify the following main issues related
to Capitec’s credit risk exposures:
ƒ Capitec’s provisioning model is conservative...: Capitec has
an extraordinarily conservative provisioning policy. Key to note is
that there are more banks that under-provide than over-provide,
mainly because bank managers operate on the assumptions that
provisions are only triggered by NPLs, except in extra-ordinary
circumstances or when accelerated provision is enforced by
regulators. In a period of strong loan growth (i.e. Capitec) this
assumption could prove fatal to future earnings. In our view,
Capitec management’s accelerated provision policy shows that
they understand the nature of their loans (credit risk-wise) and the
expected losses. We concur with management that provisions
should be established for losses expected and not just realised i.e.
NPLs. As indicated below, Capitec’s provision policy has been
extremely conservative. (see Fig 1). 1) The general provision level
for Capitec is higher at between 2%-5% vs. a typical range of
0.5%-2% for mainstream banks, which is a generally accepted
practice. We believe that given the higher credit risks, higher
general provisions are worthy; 2) Specific provisions are
particularly aggressive, with loans in arrears by one month and
two months provided for 30% and 60% respectively. General
industry practice does not provide for such loans, often referred to
as “past due loans”. NPL recognition often kicks in at 90 days in
arrears, at which point Capitec writes off the loan. Generally,
acceptable practice would provide for 50% of unsecured loans and
then 100% if the unsecured loan runs to 180 days in arrears. (see
Fig 2).
ƒ ...hence the high loans in arrears coverage ratio: Due to the
fact that 1) besides general provisions, specific provision are
established when loans are not yet classified as NPLs (i.e. +90
days in arrears) and 2) loans are written off when they are in
arrears for +90 days, the coverage ratio for Capitec is high. (see
Fig 2). Generally investors would be more comfortable with banks

Page 1 of 16
 that have high coverage ratios than otherwise as it reduces NPL
overhang risk to a large extent (i.e. higher earnings visibility and
lower downside risk resulting from future bad debts) as well as
supports the quality of earnings. (i.e. current earnings are not
inflated by dubious interest accruals as banks generally
discontinue accruing interest when the loan is classified as NPL).
The arrears coverage ratio of 135% gives us comfort although the
caveat is that it would tend to be volatile due to performance of
loans in arrears. The more they are written off, the lower the
arrears figure could be and the higher the coverage ratio would be.
This is not to undermine the prudence in writing off bad loans
when they exceed 90 days in arrears. In fact, Capitec effectively
does not recognise the general definition of NPL as it would write
off at the point it should start making provisions.
ƒ Capitec’s credit risk has been declining over the past 5
years: The loans in arrears/gross loans ratio, which would indicate
the extent to which loans are going bad (rather than the provision
which is a largely management estimate figure) has been steadily
declining since FY07 (11.6%) to FY11 (5.7%). Loans in arrears
growth rate has also lagged gross loans and advances growth rate
which is a positive. Loans and advances have expanded by a CAGR
of ~86% while loans in arrears have grown by ~60%. Provisions
grew by a higher rate than loans in arrears at 66%. Given the
short term nature of the loans, a large part could be repaid before
reaching a FY cycle. As a result, management prefers to watch the
loan impairment expense/instalment ratio. This ratio has also been
improving. For 3-month product, the ratio has improved to 1.2%
in FY11 from 1.6% in FY07. The 48-month product’s ratio has also
improved from 50.8% in FY10 to 30.3% in FY11. (see Fig 3). The
bank’s high provision policy for new loans means that the ratio for
new longer term loans is higher. While this market segment (low
income and unsecured) is highly risky, Capitec benefits from low
levels of asset concentration although concentration and
correlation risks could be noteworthy at clients’ employer level.

Fig 1: Higher general provisions accelerated specific provisions and write-offs...

Capitec's Provision Generally Acceptable

Loan status practice Provision practice
2%-5% as general
Not in arrears 0.5% -2% as general provisions
provisions
1 month in arrears ~30% no provision
2 months in arrears ~60% no provision
3 months in arrears ~98% 50% of balance
> 3 months in arrears write off 100% provision for >180 days

Source: Capitec’s general provision policy provided by management, Legae Securities

Page 2 of 16
Fig 2: ...ensures higher arrears coverage ratios

Rand,mn 2007 2008 2009 2010 2011 CAGR

Gross loans and advances 914 2,192 3,238 5,607 10,916 85.9%
Loans  in arrears 106 247 326 350 626 55.9%
Loan provision 111 171 256 382 845 66.1%
Arrears/Gross loans 11.6% 11.3% 10.1% 6.2% 5.7%
Arrears coverage  105% 69% 79% 109% 135%
Growth rates
Gross loans and advances 140% 48% 73% 95%
Loan arrears 133% 32% 7% 79%
Loan provision 54% 50% 49% 121%
Coverage ratio change,pps ‐35% 9% 31% 26%

Source: Company reports, Legae Securities

Fig 3: Impairments/Instalment ratio: Credit quality has been improving

Product tenor 2007 2010 2011

1 month 1.6% 1.4% 1.2%
3 month 3.2% 3.8% 4.8%
6 month 6.9% 5.2% 5.4%
12 month 13.1% 10.9% 9.5%
18 month 24.3% 11.5% 11.2%
24 month 21.7% 11.5% 12.9%
36 month 14.4% 11.4%
48 month 50.8% 30.3%
60 month 153.8%

Source: Company reports, Legae Securities

ƒ The net impairment charge is what hits the income

statement, and it is a sum of new provisions and write
backs: Getting to what matters most - the earnings - we know
that the net impairment charge (also referred to as bad debt
charge) is what knocks the profit/loss account (some banks deduct
the whole provision amount). We know that theoretically,
provisions have a considerable impact to earnings (i.e. net
impairment (bad debt) charge = new provisions minus provisions
released (i.e. no longer required) minus recoveries on write-offs;
giving the rand value of loans written-off). Capitec’s financial data
shows a gross loan impairment figure (which presumably should
be new provisions minus provision release). The bank’s
conservative provision policy (i.e. accelerated provisioning) has
negative accounting impact to earnings. The bound in gross

Page 3 of 16
 impairment is a result of strong provision and conservative
provision release. Given that the other portion of ‘write backs’,
namely recovery has been enjoying volatile growth rates
(especially relative to loan growth) and the recoveries/arrears
ratio is fairly stable below 20%, we believe a conservative release
of unwanted provisions is in order. In terms of the net impairment
variable, we believe the bank is generous in its treatment of major
segments (i.e. new provisions and release of unwanted
provisions). Despite the high credit risks in its market segment,
the NPL overhang risk is almost non-existent, in our view. As we
mentioned before, earnings visibility is increased by the bank’s
provision policy. (see Fig 4).
ƒ Conclusion on credit risks: We accept that the sources of the
bank’s risks are risky. The high required Capital Adequacy Ratio
(CAR) by regulators points to Capitec’s elevated risks. We believe
comparable lower quality assets (credit risk) and limited access to
funding when compared to mainstream and bigger banks (funding
risk) are the primary risks. Balance sheet mismatches is a risk, but
in this case we see it as a constructive risk as it is supportive to
liquidity management. In our view, it seems as if management are
aware of the bank’s credit risks, and often seek to show pro-
activeness that reduces future risks to earnings.

Fig 4: Net impairments: Inflated by higher provision; We covet the prudence.

Rand,mn 2007 2008 2009 2010 2011 CAGR

Gross loan impairment  183 265 514 620 1088 56%
less  recoveries on write off ‐22 ‐35 ‐46 ‐72 ‐100 46%
Net impairment charge 161 230 468 548 988 57%
Growth rates, %
Gross loan impairment  44.8% 94.0% 20.6% 75.5%
less  recoveries on write off 59.1% 31.4% 56.5% 38.9%
Net impairment charge 42.9% 103.5% 17.1% 80.3%
Ratio, %
Recoveries/Arrears 20.8% 14.2% 14.1% 20.6% 16.0%
Net impairment/Gross loans 17.6% 10.5% 14.5% 9.8% 9.1%

Source: Company reports, Legae Securities

Page 4 of 16
2. CAMEL and ROE : Where could be
the weaknesses?

ƒ Below we discuss the key CAMEL indicators. With the exception of

asset quality, which is taken care of by higher provisions and
higher capital levels, we believe that the CAMEL ratios are strong.

ƒ Capital: We believe the bank currently carries ample capital.

However, while a reported CAR of 38% (vs. 25% required by
regulators) looks high on face value, for continued strong
growth in Risk Weighted Assets (RWAs) we believe this >10%
buffer could soon run thin. Focus could also turn more to
tangible (book) equity (i.e ability to absorb losses) than risk-
based capital given the vulnerability of the bank’s loan book
(unsecured) to negative economic conditions. Nonetheless, we
note that subordinated debt (Tier 2 capital) at R420mn is ~11%
of the Tier 1 capital, providing room for further expansion of the
Tier 2 capital. The bank also possesses opportunities to raise
capital by issuing BEE shares (as we notice no such shareholder
exist yet). The bank’s internal capital generation has also been
strong, with retained earnings expanding from R142.3mn in
FY05 to R1.267bn by FY11.
ƒ Asset quality: We discussed and highlighted our opinions
related to asset quality in Section 1. We believe the industry is
risky, hence the regulators require a higher CAR of 25% for
Capitec. However, we take comfort in the provision policy of the
bank that provides higher arrears coverage ratios and
accelerates writing-off NPLs. (please refer to section 1 above).
ƒ Management/Efficiency: The cost/income ratio (efficiency
ratio) has improved from 66% in FY06 to 48% in FY11
notwithstanding the increase in branch network, ATMs and
headcount. The burden ratio, which measures the amount of
non-interest expense covered by non-interest income, has
improved to 24% from 41% in FY06.
ƒ Earnings/Profitability: There are two main developments we
expect 1) interest spreads and NIM will compress due to higher
cost of deposits (as the bank increases its retail fixed deposits)
and asset yields decline on competition; 2) fee income to play a
more important role due to rising number of customers and
increasing transactional value (as the bank migrates to higher
income segments contrasted to history). The asset sensitive
balance sheet could however benefit from a reversal in interest
rates (our Economist expects interest rates to start increasing in
1Q12) although the migration of the loan book to longer-dated
loans could diminish the impact. The ROA, despite a
deterioration, has been strong (5.5% for FY11 from 11% in
FY06) but the ROE could be higher should one consider the low
leverage as a result of higher CAR requirement.

Page 5 of 16
 ƒ Liquidity and funding: The LDR increased to 96% as loans
and advances growth (+93%) outpaced deposits growth
(+42%) considerably for FY11. This deterioration weakens the
bank’s internal funding ability. The encouraging aspect, despite
the deterioration in the LDR, is that the balance sheet is asset
sensitive (i.e. loans and advances average duration < average
deposits duration) so the liquidity gaps are mostly positive or
small when negative. However, the liquid assets/total assets
ratio declined from 27% in FY10 to 20% in FY11 despite an
increase of the liquid assets to R2.8bn. We believe the bank is
building a strong deposit franchise which should support its
liquidity and funding. This is indicated by the high organic core
deposits momentum. Retail deposits growth has been pleasing
with retail fixed deposits increasing from R265mn in FY09 to
R2.3bn by FY11, (before FY09 the bank was not accepting
deposits of fixed nature) while retail call deposits have
registered a 5-year CAGR of 133% to R3.954bn by FY11. The
CPA could, however, increase both the cost and sensitivity of
Capitec’s (and the system) funding operations. We believe the
controlled migration to relatively affluent customer bracket
could support further strong growth in deposits (i.e. deposit
balances could increase). Growing fixed term retail funding
remains central to management’s deposit mobilisation strategy.
ƒ Debt distribution is not a major worry, according to
management: Management is confident that they can raise
wholesale deposits should the need arise. A maturity of R490mn
this year is not a worry to management, so we figured.
Management indicated a strong likelihood of a roll-over. Next
year’s R1.027bn maturity could probably be more concerning. It
is 13% of retail deposits. If the bank fails to refinance the bond
in the wholesale market, it would need to grow retail deposits
by a minimum of 13% just to fill up that liquidity gap. However,
we believe the improving spread of Capitec’s debt is
confirmation/an indicator of reasonable appetite for CPI SJ
paper in the debt markets. (see Fig 5).
Fig 5: Debt distribution: Some heavy maturity in FY12; Spread contracting

2,500  6.2
Capitec swap spread (mat.  2016) average
CY Maturities, Rmn
Cumulative maturities,  Rmn
6.0
1,962 
2,000 
1,812 
1,652  1,652  5.8
1,512  1,512 
1,500 
5.6

1,022 
1,000  5.4

490 
490  5.2
500 

140  160  150 

5.0
0 0
Dec‐09

Dec‐10
Aug‐10

Oct‐10
Jan‐10

Apr‐10

Jan‐11
Nov‐09

Feb‐10

May‐10

Sep‐10

Nov‐10

Feb‐11
Jun‐10

Jul‐10
Mar‐10

Mar‐11

‐
2011 2012 2013 2014 2015 2016 2017

Source: Bloomberg, Legae Securities

Page 6 of 16
ƒ ROE decomposition: Cost of liabilities is rising, and asset
rotation is falling: Our ROE has consistently been different, and
relatively poorer to the one reported by management. However,
for consistency we continue to use our method. (we also use the
same method for other banks under our coverage, so comparison
is not an issue). We decompose the ROE beyond the traditional
asset rotation, asset margin and leverage variables. (see Fig 6).
We expand the ROA’s asset rotation and the expense ratio further
as we seek to gain more insight in bank’s strengths and
weaknesses. We note that :
ƒ The interest expense ratio: The interest expense ratio has
been increasing due to the rising cost of liabilities and
increasing volume of interest bearing liabilities. According to
management, the introduction of fixed term deposits had a
major impact to this figure. However, in FY11, the cost of
liabilities declined slightly to 8.0% which is still considerably
higher than the 5.1% enjoyed in FY05. The volume of interest
bearing liabilities has increased materially between FY06
(42.6%) and FY11 (74.4%). In our view, the rising interest
expense ratio is logical as the bank has been growing its deposit
franchise and introduced fixed term deposits;
ƒ The total expense ratio: Despite a rising interest expense
ratio, the total expense ratio has been moving in contrast. The
expense ratio has consistently declined, mainly due to the
technological leverage benefits hence the non-interest expense
ratio has substantially declined from 64.2% in FY06 to 19.9% in
FY11. Efficient use of branch network is crucial to the decline of
this ratio. The staff costs/total costs is ~50%;
ƒ The interest income ratio: The ratio has declined, which is
expected given the impact of the NCA, competition, and the
internal objective by management to gradually reduce the cost
of credit. Yield on assets reduced from 76.2% in FY06 to 23.5%
by FY11, notwithstanding the increase in the loans/assets ratio
to 84% in FY11 from 44.2% in FY06. The industry has been
eating away the super profits, and will continue to, in our view.
ƒ Asset rotation: In spite of Capitec’s strong position in
unsecured lending, asset rotation has materially reduced. This is
logical given the rising penetration in the unsecured lending
space. Nonetheless, the non-interest income ratio has
increased, expanding from 17.1% in FY06 to peak at 35.2% in
FY08 before declining in FY11 to <20%. While we are not overly
constructive on asset rotation, we expect the rising number of
clients to support non-interest income.
ƒ ROA, Leverage and ROE: The higher decline of the asset
rotation relative to the expense ratio resulted in the ROA
declining from 11% in FY06 to 5.5% in FY11. Our benign asset
rotation outlook means that we do not expect an immediate
rebound in ROA, despite continued benefits in efficiency and the
expense ratio. Leverage has increased but remains low in both
absolute and relative terms, primarily due to the higher CAR

Page 7 of 16
 required by the regulators. The ROE remains appealing,
particularly given the appreciable ROA rather than leverage.

Fig 6: ROE decomposition – cost of liabilities rising, asset rotation falling but ROA remain strong
2006 2007 2008 2009 2010 2011 2012F 2013F 2014F
Cost of liabilities : int. exp/Average liabilities ‐7.9% ‐7.9% ‐7.3% ‐10.2% ‐8.7% ‐8.0% ‐9.0% ‐8.8% ‐8.6%
Composition of liabilities: liab./aTA 49.6% 51.2% 54.5% 66.8% 78.3% 78.4% 78.5% 81.5% 82.8%
Volume of int. bearing liabilities: IBL/aTA 66.9% 62.4% 67.0% 90.1% 107.4% 91.9% 93.4% 93.5% 92.3%
Interest expense/Average Total assets ‐3.9% ‐4.1% ‐4.0% ‐6.8% ‐6.8% ‐6.3% ‐7.1% ‐7.2% ‐7.1%
Non interest expense/Average Total assets ‐64.2% ‐46.4% ‐39.3% ‐35.7% ‐24.7% ‐19.9% ‐17.7% ‐17.2% ‐16.9%
Impairment charge/Average Total Assets ‐9.3% ‐9.4% ‐9.0% ‐11.8% ‐7.6% ‐8.3% ‐8.7% ‐8.3% ‐7.9%
Expense ratio: Expense/Average Total assets ‐77.4% ‐59.9% ‐52.3% ‐54.3% ‐39.1% ‐34.5% ‐33.4% ‐32.8% ‐31.8%
Income tax/Average Total assets ‐4.9% ‐4.4% ‐3.7% ‐3.5% ‐2.7% ‐2.4% ‐2.2% ‐2.1% ‐2.3%
Yield on assets: Int. income/assets 76.2% 56.2% 28.9% 30.7% 24.4% 23.5% 20.5% 19.3% 18.6%
Composition of assets: Loans/aTA 44.2% 46.7% 78.8% 75.4% 72.3% 84.2% 91.2% 90.0% 87.2%
Volume of earning assets: IEA/aTA 100.8% 107.3% 102.9% 113.7% 107.8% 107.9% 100.1% 96.5% 95.3%
Interest income/Average Total assets 76.2% 56.2% 28.9% 30.7% 24.4% 23.5% 20.5% 19.3% 18.6%
Noninterest income/Average Total assets 17.1% 17.7% 35.2% 35.1% 23.5% 18.8% 20.2% 20.3% 20.9%
Other income/Average total assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Asset rotation: Revenue/Average Total assets 93.3% 74.0% 64.0% 65.8% 48.0% 42.3% 40.7% 39.6% 39.5%
Return on Average Assets 11.0% 9.7% 8.0% 8.0% 6.2% 5.5% 5.1% 4.8% 5.4%
Leverage: Av. Total assets/av. Equity 2.0 2.3 2.5 3.4 5.1 5.0 5.0 5.7 6.1
Return on Av. Equity : Expanded method 21.8% 21.8% 20.3% 27.3% 31.7% 27.5% 25.4% 27.6% 33.0%
Return on Av. Equity: Total earnings/Av. total equity 22.2% 19.9% 19.6% 24.3% 28.7% 25.3% 23.6% 25.9% 31.3%
Return on Av. Equity: Ord. earnings/Av. Ord equity 22.2% 20.9% 20.9% 25.9% 30.8% 26.9% 24.9% 27.0% 32.3%

Source: Company reports, Legae Securities

Page 8 of 16
3. Assumptions and valuation

ƒ Assumptions: Inferior to history but on trend, and

conservative to management guidance: Our CAMEL and ROE
analysis informs our assumptions. Key issues we note are 1) the
cost of liabilities is rising, and we expect it to continue to increase
as the fixed deposits mobilisation gathers pace; 2) asset rotation
has been reducing on declining interest income/earning assets. We
therefore take this trend into consideration for our assumptions.
Balance sheet items: 1) Deposit growth. We reduce the
growth of retail deposits (both fixed and call) despite our
conviction that management are building a robust deposit
franchise. Note that retail deposits/total deposits ratio has now
reached management’s target of 60%. We increased wholesale
funding growth to 35% although it remains below the historical
growth rate by a wide margin. Compared to our initial forecasts,
we reasonably increased our deposit growth rate post
management meeting. 2) Loans: We model loans and advances
using the LDR. We expect the LDR to slightly exceed 100% this
year as some of the capital raised could be lend out. (some will go
towards branch network development etc). Management do not
foresee major headwinds to loan growth. Our average loan growth
forecast of 37% is below the average growth rate of 94% between
FY06 and FY11.
Income statement items: We reduce the interest
income/earnings assets to an average of 20%, and increase the
interest expense/bearing liabilities to 8%. Important to highlight
here is that we follow the trend. Management believe that a
rebound in interest rates could provide a fillip to interest income,
and the growing deposit franchise could lead to lower cost of
deposits, nevertheless. We reduce the loan fee income ratio but
increased the transaction fee income ratio as we expect the bank
to leverage its growing deposit franchise (and the rising number of
clients). We reduce the net impairments/loans ratio to 9.5% for
FY12; average 9.3% for our forecast period. (FY06 21.0%; FY11
9.8%) as we expect improved economic condition to aid write-
backs (release of provisions and recoveries). We reduced the
banking operations ratio to 11.5% and maintained it at that level
for the forecasting period. (see Fig 7).
Growth rates: Our assumptions crystallise into an earnings
growth rate of 34% for FY12 (vs. prev. 33%) to R876.2mn and a
CAGR of 34% over our forecasting horizon. Our earnings growth
rate is supported by strong growth in transactional income (+93%)
while we are rather cautious, when compared to history, on net
interest income growth (+13%) in FY12. We expect the balance
sheet to grow by a 32% CAGR, supported by strong loan and
advances and deposits (37% and 36% respectively). (see Fig 8).

Page 9 of 16
Fig 7: Salient balance sheet and income statement assumptions
2006 2007 2008 2009 2010 2011 2012F 2013F 2014F
Key balance sheet assumptions
Wholesale deposits ‐1.9% 498.9% 84.8% 167.4% 117.1% 7.8% 35.0% 30.0% 25.0%
Retail call deposits 141.8% 3.0% 52.0% 55.1% 79.6% 67.6% 50.0% 30.0% 20.0%
Retail fixed deposits n/a n/a n/a n/a 333.2% 101.7% 75.0% 55.0% 35.0%
Total deposits      594,996           896,000    1,474,000   3,261,000    7,163,000  10,203,000     15,290,400      20,890,770         26,358,210
Loan/deposit ratio 76.4% 89.6% 137.0% 91.4% 72.9% 98.7% 103.0% 100.0% 98.0%
Loans and advances      454,661           803,260    2,019,200   2,981,685    5,225,139  10,071,466     15,749,112      20,890,770         25,831,046
Key income statement assumptions
Interest income/Interest Earning Assets 75.6% 52.4% 28.1% 27.0% 22.6% 21.7% 20.5% 20.0% 19.5%
Interest expense/Interest Bearing liabilities ‐6.7% ‐7.8% ‐6.9% ‐8.3% ‐6.8% ‐7.4% ‐8.0% ‐8.0% ‐8.0%
Loan fee income/Loans 0.0% 9.6% 28.5% 30.1% 18.9% 11.4% 10.0% 10.0% 10.0%
Transaction fee income/Total Assets 3.5% 4.3% 5.7% 5.7% 5.3% 6.1% 8.5% 9.0% 10.0%
Fee expense/Total Assets ‐2.3% ‐2.7% ‐3.0% ‐2.9% ‐2.2% ‐2.4% ‐2.6% ‐2.7% ‐2.6%
Net impairment charge/Loans ‐21.0% ‐20.1% ‐11.4% ‐15.7% ‐10.5% ‐9.8% ‐9.5% ‐9.3% ‐9.0%
Other income/Total Assets 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Banking op. expense/Total Assets ‐40.0% ‐27.7% ‐26.0% ‐21.4% ‐14.4% ‐12.6% ‐11.5% ‐11.5% ‐11.5%
Non‐banking op. expense/Total Assets ‐0.5% ‐0.3% ‐0.3% ‐0.3% ‐0.2% ‐0.2% ‐0.3% ‐0.2% ‐0.2%
Income tax expense/Profit Before Tax ‐30.6% ‐31.4% ‐29.4% ‐30.1% ‐30.1% ‐30.2% ‐30.3% ‐30.2% ‐30.0%

Source: Company reports, Legae Securities

Page 10 of 16
Fig 8: Salient balance sheet and income statement growth rates

2007 2008 2009 2010 2011 2012F 2013F 2014F

Interest income           967,528        740,063   1,212,896    1,763,966       2,808,543        3,544,167        4,478,728           5,504,374
Interest expense            ‐69,836      ‐101,449     ‐269,621      ‐490,636         ‐751,360      ‐1,223,232      ‐1,671,262          ‐2,108,657
Net interest income           897,692        638,614       943,275    1,273,330       2,057,183        2,320,935        2,807,466           3,395,717
Net fee income           111,557        653,400   1,035,709    1,281,573       1,683,595        2,759,347        3,760,162           5,003,445
Loan fee income             76,943        574,584       897,502        986,199       1,151,864        1,574,911        2,089,077           2,583,105
Transaction fee income             93,671        168,361       281,548        507,438          883,040        1,708,513        2,368,712           3,289,993
Fee expense            ‐59,057        ‐89,545     ‐143,341      ‐212,064         ‐351,309          ‐524,078          ‐697,627             ‐869,652
Net impairment charge         ‐161,271      ‐230,879     ‐467,727      ‐547,731         ‐988,177      ‐1,496,166      ‐1,932,396          ‐2,324,794
Income from operations           856,690    1,095,291   1,533,051    2,029,495       2,775,471        3,624,713        4,688,462           6,140,844
Banking operation expense         ‐606,705      ‐762,540 ‐1,063,672
   ‐1,368,324     ‐1,812,499      ‐2,311,518      ‐3,026,687          ‐3,783,492
Non-banking operating expense              ‐6,808           ‐8,405        ‐12,696        ‐18,815           ‐22,672            ‐56,427            ‐65,289                ‐78,183
Operating income before tax           243,177        324,346       456,683        642,356          940,300        1,256,768        1,596,486           2,279,169
Profit for the year           166,924        229,065       319,332        449,224          656,024           876,158        1,113,835           1,594,402
Dividends             49,200          61,400         91,100        166,796          270,825           343,454            436,623               625,006
EPS                   194                259               363                524                   686                    919                1,169                    1,673
Loans and advances           803,260    2,019,200   2,981,685    5,225,139    10,071,466     15,749,112      20,890,770         25,831,046
Total Assets       2,191,642    2,936,372   4,969,422    9,488,223    14,439,517     20,100,159      26,319,021         32,899,930
Deposits at amortized costs           842,172    1,475,696   3,298,897    7,360,325    10,449,883     15,290,400      20,890,770         26,358,210
Total liabilities       1,074,185    1,718,945   3,563,221    7,760,246    10,989,004     16,130,996      21,694,923         27,338,324
Share capital           647,363        647,363       674,369        682,219       1,918,677        1,918,677        1,918,677           1,918,677
Retained Earnings           313,049        415,458       601,099        906,991       1,276,336        1,791,517        2,446,452           3,383,960
Ordinary share capital           962,851    1,062,821   1,251,595    1,573,371       3,191,544        3,710,194        4,365,129           5,302,637
Total Equity       1,117,457    1,217,427   1,406,201    1,727,977       3,450,513        3,969,163        4,624,098           5,561,606
Growth rates
Interest income 23.4% ‐23.5% 63.9% 45.4% 59.2% 26.2% 26.4% 22.9%
Interest expense 74.2% 45.3% 165.8% 82.0% 53.1% 62.8% 36.6% 26.2%
Net interest income 20.7% ‐28.9% 47.7% 35.0% 61.6% 12.8% 21.0% 21.0%
Net fee income 646.6% 485.7% 58.5% 23.7% 31.4% 63.9% 36.3% 33.1%
Loan fee income n/m 646.8% 56.2% 9.9% 16.8% 36.7% 32.6% 23.6%
Transaction fee income 111.4% 79.7% 67.2% 80.2% 74.0% 93.5% 38.6% 38.9%
Fee expense 101.1% 51.6% 60.1% 47.9% 65.7% 49.2% 33.1% 24.7%
Net impairment charge 68.6% 43.2% 102.6% 17.1% 80.4% 51.4% 29.2% 20.3%
Non‐banking gross profit 22.3% 36.3% 66.6% 13.9% 7.3% 80.6% 30.9% 25.0%
Income from operations 27.5% 27.9% 40.0% 32.4% 36.8% 30.6% 29.3% 31.0%
Banking operation expense 21.3% 25.7% 39.5% 28.6% 32.5% 27.5% 30.9% 25.0%
Operating income before tax 46.4% 33.4% 40.8% 40.7% 46.4% 33.7% 27.0% 42.8%
Income tax expense 50.0% 25.0% 44.2% 40.6% 47.2% 33.9% 26.8% 41.9%
Profit for the year 44.8% 37.2% 39.4% 40.7% 46.0% 33.6% 27.1% 43.1%

Cash and cash equivalents 79.2% ‐40.8% 145.0% 69.5% 10.7% ‐45.8% ‐2.4% 59.5%

Loans and advances 76.7% 151.4% 47.7% 75.2% 92.8% 56.4% 32.6% 23.6%
Total Assets 75.2% 34.0% 69.2% 90.9% 52.2% 39.2% 30.9% 25.0%

Deposits 56.6% 75.2% 123.5% 123.1% 42.0% 46.3% 36.6% 26.2%

Total liabilities 56.3% 60.0% 107.3% 117.8% 41.6% 46.8% 34.5% 26.0%
Share capital 86.1% 0.0% 4.2% 1.2% 181.2% 0.0% 0.0% 0.0%
Retained Earnings 45.4% 32.7% 44.7% 50.9% 40.7% 40.4% 36.6% 38.3%
Ordinary share capital 70.8% 10.4% 17.8% 25.7% 102.8% 16.3% 17.7% 21.5%
Total Equity 98.2% 8.9% 15.5% 22.9% 99.7% 15.0% 16.5% 20.3%

Source: Company reports, Legae Securities

Page 11 of 16
ƒ Valuation: We reduce our sustainable growth rate from 15%
to 14.25%, FY12 TP increase slightly to 17499c, remains a
HOLD: Our FY12 TP did not change materially, despite our
downward revision in the growth rate (the ROE increase
compensated for it. Our moderate upward adjustment to deposits
led to an increase in loans and advances, and consequently
profitability), moving slightly to 17499c. (a product of our Justified
Price/Book value ratio of 4.4X and our FY12 Book value per share
of 3972c). (see fig 9). At the current price of 16730c (c.o.b April 1
2010), the upside potential remains within our HOLD band. We
would BUY on weakness. Our FY12 TP shows an implied forward
PER of 19X vs. the current price’s forward PER of 18.2X (FY12
Legae EPS estimate).
ƒ Why revise the growth rate? Estimating sustainable growth rate
is often subjective and debatable, yet it is a key input in valuation.
Generally, investors apply an attainable nominal GDP growth rate
(the upper end of South Africa often being 12% i.e. 6% real GDP
growth plus 6% inflation rate). Some investors apply an implied
long-term growth rate obtained as a product of the retention ratio
and the sustainable ROE. For Capitec, using a sustainable ROE of
28.6% and a retention ratio of 60% (we notice a dividend
coverage ratio has consistently been ~2.5X i.e. 40% payout ratio),
this sustainable long-term growth rate would be 17.2%. We
reduce the growth rate mainly to reflect our concerns related to
competition and capital level. At some point, we know Capitec will
face ‘mid-life crisis’, hence our cautious approach to growth when
contrasted to the theoretical growth rate although it is still 2.25pps
above the upper nominal GDP growth rate expectation.
ƒ Valuation risk remains high (see sensitivity analysis, Fig
10), but growth outlook is intact as well: In our view,
valuation risk remains high (relative to mainstream banks), but we
believe the growth outlook remains intact in our forecast period. In
fact the put-off is the valuation risk, in our view. (see Fig 10).
Sensitivity analysis shows no ‘easy upside’ at all, in our opinion.
The PER at 1.7X the Banks PER and 1.8X the Small Cap Index PER
looks set for a reduction, particularly relative to history. After a
robust expansion in the PER to trade outside its µ+1δ region, it
has contracted but remains at precarious levels. Valuation risks vs.
other small cap companies also look colossal. However, despite
trading at a PER >1.6X the Bank’s index PER, Capitec is now
trading closer to its traditional premium to the banks Index PER.
(see Fig 11).
ƒ Share price has rallied and strongly outperformed, good
news priced-in: The strong rally of the share price since mid-09
and strong out-performance of the Banks Index and the Small Cap
index points to pricing-in of most of our good news. The share
price is susceptible to a correction as well.

Page 12 of 16
 Fig 9: Valuation model: Our Justified PBVR is 4.4X

Average ROE 28.65%
Sustainable growth rate 14.25%
Cost of Equity 17.5%
 Justified PBVR (ROE ‐ g)/(CoE ‐g) 4.4
2012 BVPS 3972.9
FY12 Target price  17499
Current share price 16730
Potential capital gain 4.6%
Forecast Dividend yield 2.1%
Potential total return 6.7%

Source: Company reports, Bloomberg, Securities

Fig 10: Sensitivity analysis: No more “easy upside”.

Growth rate
ROE 8.00% 9.75% 10.25% 12.00% 14.25% 15.00%
15.0% 2921 2684 2595 2159 911
25.0% 7094 7797 8061 9356 13061 15765
28.65% 8619 9665 9974 11985 17499 21524
30.0% 9181 10330 10793 12955 19135 23648
35.0% 11268 12911 13525 16554 25210 31531

Source: Company reports, Legae Securities

Fig 11: The PE relative to the Banks and Small cap indices and history shows no easy upside as well

35
PER relative to Banks and Small cap indices Relative to Banks Index Relative to Small cap index PER relative to history PER Av. PER +1STD ‐1STD
2.5 Av. Relative to Bank Av. Relative to Small caps
30

25
2.0

20

1.5
15

10
1.0
5

0.5 0
Apr‐05

Apr‐06

Apr‐07

Apr‐08

Apr‐09

Apr‐10

Apr‐11
Jul‐05

Jul‐06

Jul‐07

Jul‐08

Jul‐09

Jul‐10
Oct‐05

Oct‐06

Oct‐07

Oct‐08

Oct‐09

Oct‐10
Jan‐05

Jan‐06

Jan‐07

Jan‐08

Jan‐09

Jan‐10

Jan‐11
Oct‐05

Oct‐06

Oct‐07

Oct‐08

Oct‐09

Oct‐10
Apr‐05

Apr‐06

Apr‐07

Apr‐08

Apr‐09

Apr‐10

Apr‐11
Jan‐05

Jan‐06

Jan‐07

Jan‐08

Jan‐09

Jan‐10

Jan‐11
Jul‐05

Jul‐06

Jul‐07

Jul‐08

Jul‐09

Jul‐10

Source: I-Net, Legae Securities

Page 13 of 16
 Apr‐11
Jan‐11
Oct‐10

Page 14 of 16
Jul‐10
Apr‐10
13.1

1.8
2.4

Jan‐10 Mar‐11
Oct‐09 Jan‐11
Jul‐09
Nov‐10
Capitec
Fig 12: Performance, PERs and Dividend yields: Investors have been and are paying for growth...

Apr‐09
Fig 13: ...and the outperformance has been phenomenal, pricing in most of our good news.

Sep‐10
Jan‐09
Oct‐08 Jul‐10
Small Cap Index

Jul‐08 May‐10
Apr‐08 Mar‐10
Jan‐08
Jan‐10
Oct‐07
Nov‐09
Jul‐07
Banks Index

Sep‐09
Apr‐07
Jan‐07 Jul‐09
Oct‐06 May‐09
Jul‐06
Mar‐09
Apr‐06
Capitec
Jan‐09
Dividend yields, %

Jan‐06
Nov‐08
Oct‐05
Jul‐05
Sep‐08
Apr‐05 Jul‐08

Small Cap Index
Jan‐05 May‐08
8

Mar‐08
Apr‐11 Jan‐08
Source: I-Net, Legae Securities

Source: I-Net, Legae Securities

Jan‐11
Nov‐07
Oct‐10
Sep‐07
Capitec

Jul‐10

Banks Index
Jul‐07
Apr‐10
Jan‐10 May‐07
Small Cap index

Oct‐09 Mar‐07
Jul‐09 Jan‐07
Apr‐09
Nov‐06
Jan‐09
Sep‐06
Oct‐08
Banks Index

Jul‐06
Jul‐08
Apr‐08 May‐06
Jan‐08 Mar‐06
Oct‐07 Jan‐06
Jul‐07
Nov‐05
Apr‐07
Sep‐05
Jan‐07
Jul‐05
Oct‐06
Jul‐06 May‐05
Apr‐06 Mar‐05
Jan‐06 Jan‐05

8.0

6.0

4.0

2.0

0.0
16.0

14.0

12.0

10.0
Oct‐05
Jul‐05

PERs
Apr‐05
Jan‐05

35

30

25

20

15

10

0
Disclaimer & Disclosure

Legae Securities (Pty) Ltd

Member of the JSE Securities Exchange

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Road, Houghton, Johannesburg, South Africa

P.O Box 10564, Johannesburg, 2000, South Africa

Tel +27 11 551 3601, Fax +27 11 551 3635

Web: www.legae.co.za, email: research@legae.co.za

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document are an accurate of my/our personal views on the stock or sector
as covered and reported on by myself/each of us herein. I/we furthermore
certify that no part of my/our compensation was, is or will be related,
directly or indirectly, to the specific recommendations or views as expressed
in this document

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representation or warranty and accepts no responsibility or liability as to its
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and should not be construed as an offer or the solicitation of an offer to
purchase or subscribe or sell any investment.

Important Disclosure
This disclosure outlines current conflicts that may unknowingly affect the
objectivity of the analyst(s) with respect to the stock(s) under analysis in
this report. The analyst(s) do not own any shares in the company under
analysis.