OREANDA-NEWS. S&P Global Ratings said todaythat it has affirmed its 'BB+/B' long - and short-term counterparty credit ratings on South Africa-based Capitec Bank Ltd. The outlook is negative.

At the same time, we affirmed our 'zaA/zaA-2' South Africa national scale ratings on the bank.

Capitec's financial performance continues to be strong despite low economic growth and acute pressures facing domestic households in South Africa.

We anticipate economic growth in South Africa to be 0.6% in 2016, after a number of external and domestic factors converge. External factors include weak external demand and adverse terms of trade, and domestic factors include drought, subdued mining and manufacturing output, restrained household spending, and structural constraints from infrastructure bottlenecks, plus thewidening socio-economic gap. Over the longer term, we expect growth will return to a still-modest 1.5%-2.1% range.

Furthermore, the weaker exchange rate and higher electricity prices have fueled inflation and the central bank is consequently in a slow monetary tightening cycle. As a result, we expect that the ratio of debt service to disposable income of South African households will rise to 10.2%-10.4% in 2016, the highest level since 2008. In light of this, we think household assetquality across the sector will deteriorate once again in 2016-2017.

As an unsecured lender, Capitec is more exposed to domestic inflationary and employment pressures than changes in interest rates, in our view. This is largely due to the nature of the loan book, a significant part of which is fixed rate and of small-to-medium loan size. As a result, the current slowdownin economic activity and the higher inflationary environment should add an element of stress to the bank's loan portfolio in 2016-2017, and might limit transactions and account turnover of the bank's retail deposit base.

In our opinion, credit losses (new loan loss provisions to average customer loans) and charge-offs (net charge-offs to average customer loans) are set to increase to 11.5%-12.0% and 8.5%-10.0%, respectively, in 2016, which is just above the bank's normalized averages. However, we believe Capitec's strong monitoring, surveillance, and early risk identifiers will help the bank mitigate large future losses in the portfolio. For example, the bank's recent shift to shorter-term lending and lending to high-income clients in 2016 showsstrong portfolio management, in our opinion.

Positively, the bank enjoys a robust earnings buffer, with a long-term averagereturn on equity of over 25%, which compares well with domestic banking peers and means that the bank can tolerate a degree of growth in credit losses and/or a reduction in fee income before capital is eroded. Over the past five years, new loan loss provisions had eroded around one-third of operating revenues and non-interest expenses another one-third, which has meant that thebank has had the ability to strongly generate internal capital. This opinion is supported by the fact that since it last raised capital in late 2012, the bank has grown its balance sheet by 64% and equity by 60% (from Feb. 28, 2013,to Feb. 29, 2016), while maintaining a dividend of 40% of net income. On Feb. 29, 2016, the bank had an S&P Global Ratings risk-adjusted capital (RAC) ratioof 15.5%, which is more than double that of most South African banks. We also believe the loss cushion is further supported by robust reserving, with loan loss reserves covering around 12.5% of the total loan book, which is around 100 basis points above the bank's normalized credit losses.

We still think Capitec's lack of business diversity is a weakness that could expose the bank's capital and earnings to additional regulatory and economic pressures through the cycle. However, the rise in the bank's customer base anddeposit/transaction franchise moderates this weakness and supplies much-neededearnings diversification.

Capitec's funding structure and liquidity continues to compare well with thoseof its South African banking sector peers. It is one of the only banks in South Africa that met the fully loaded net stable funding ratio required underBasel III, before the recent national discretionprovided by the South African Reserve Bank (SARB). We still factor in additional depositor confidence sensitivity for Capitec relative to its large peers, as noted by a relatively high cost of funds versus the top-tier South African banks. However, we expectdeposit insurance from the SARB in the next 12-18 months, which may close the pricing and confidence gap.

The negative outlook reflects the economic and industry risk trend for the South African banking industry. We could lower our ratings on all of the banksin South Africa if credit risks start to materialize more actively. These risks could stem from weakening asset quality, or increases in inflation and interest rates that start to strain the ratio of debt service to disposable income of households beyond our current expectations.

We could lower the ratings on Capitec if the RAC ratio fell below 15% on a sustainable basis, either from higher-than-anticipated credit losses, higher dividends, or lower revenues. Furthermore, if the bank's asset quality deteriorated (with a cost of risk above 15%), or if it became more exposed to wholesale funding concentrations, we could also lower the rating.

We currently consider an upgrade of Capitec to be highly unlikely in the next 12 months. Any positive rating action would follow a material transformation of the bank's business mix to diversify business lines and revenues.