Since launching in 2001, Capitec Bank Holdings Ltd. has become South Africa's largest bank by customers and the consumer-focused lender aims to achieve similar success among business clients following its 3.56 billion rand acquisition of Mercantile Bank Holdings Ltd.

Mercantile Bank specializes in lending to small and medium-sized companies and the deal will strengthen Capitec's revenue stability and earnings diversification, S&P Global Ratings wrote in a note.

"Rather than move into business banking organically, Capitec has opted to make a sizeable acquisition, which is not something it has done before, so we'll have to see how well the integration goes," said Thato Mashigo, a portfolio manager at Johannesburg's Sanlam Private Wealth.

"It's a way to get immediate exposure to a different segment, especially as the South African consumer is under some significant pressure. While there's a cyclical downturn in Capitec's main business it could be a new growth area for the bank."

South Africa has struggled with slow economic growth for several years, and unemployment is running at more than 27%.

Full-service bank

Buying Mercantile signals Capitec's intention to become more of a full-service retail and business bank, said Harry Botha, a banking analyst at Cape Town's Avior Capital Markets.

"Mercantile isn't very profitable and from a systems perspective is inefficient, so there's plenty of scope for Capitec to upgrade these systems to make them more efficient and enhance the products to make them more competitive," he said.

Still, Avior has a "sell" recommendation on Capitec's stock, which reflects the company's stretched valuations following its remarkable market performance since listing on Johannesburg's bourse in 2002 at 2.75 rand per share. The stock ended 2019 at more than 1,400 rand per share.

Capitec's price-to-earnings ratio stood at about 28.6 on Jan. 21, far higher than those of the historical big four banks — Standard Bank Group Ltd., FirstRand Ltd., Absa Group Ltd. and Nedbank Group Ltd. — and it is now the country's third-largest bank by market capitalization as well its largest by customers.

"Over the past 15 years, Capitec has taken a lot of market share away from the big four," said Mashigo. At first its main attraction was that it offered unsecured lending while the established banks focused on secured lending such as mortgages and vehicle loans.

It also undercut its rivals by offering lower deposit charges and lower monthly fees, costs which had previously made banking prohibitively expensive for low-income groups, Mashigo said.

Capitec claims that in the six months to Aug. 31 its clients saved 227 million rand thanks to lower banking fees. It said it has more than 12 million active customers, 6.8 million of whom use its digital banking services.

Yet its nationwide branch network is also important, serving 6 million customers monthly.

'Capitec's whole play is simplicity'

Of these branches, 122 have no cashiers, with customers instead using "self-help" functions. Branches tend to be small and low-cost, targeting low-income consumers, so Capitec, which scores highest in South Africa's Customer Satisfaction Index for Banking, was able to quickly expand its network to reach previously unbanked sections of society.

It has also succeeded with innovative products, for example selling more than 1 million funeral policies since May 2018.

"Capitec's whole play is simplicity — its app looks very basic compared to other banks, but it's incredibly light, fast and straightforward to use," said Carl Thomen, chief customer officer at NONA, a Cape Town-based software design and development company specializing in fintech.

"The app is rarely updated because data is very expensive here and the mass market can't easily pay those costs. The operating system is far superior to other banks in terms of functionality — the others are slow, and they often crash or are offline for maintenance. Capitec's whole app strategy is well thought through."

Around 4.7 million Capitec customers access its digital services via a special low-tech service for basic mobile phones, which works over 2G networks.

"It's largely used in rural areas where connectivity is poor, data costs are high, and people are generally suspicious of technology," said Thomen.

Strong retail performance

The bank's net income from retail banking soared to 5.30 billion rand in the year to Feb. 28, 2019, from 2.56 billion rand in the year to end-Feb. 2015. Its retail banking assets and total revenues nearly doubled over the same period.

"Capitec has demonstrated it can very successfully run an unsecured lending business through the ups and downs of the economic cycle," Botha said.

"I've been surprised how much Capitec has been able to grow in recent times considering the economic squeeze on consumers and how the bank has moved away from its low-income, mass market consumer and shifted more towards higher-income consumers."

Botha said there is still "strong growth potential" in its core business, with much of that coming from increasing revenue per user. But that is expected to slow down over the coming five years, and Capitec needed the Mercantile acquisition to offer additional products, he added.

Capitec's gross loan book was 60.25 billion rand, up 17% year over year. But problems loans as a proportion of total loans surged to 17.93% in its second quarter of the 2020 financial year, up from 4.73% a year earlier.

"Capitec is conservative in terms of provisioning for doubtful debts, so as soon as nonpayment begins the bank will provision for possible default," added Mashigo.

"While doubtful debts have increased, you'd imagine Capitec could recover some of this money. If it were to continue it would be a long-term concern, but it's a cyclical issue that's affecting a lot of companies."

As of Jan. 20, US$1 was equivalent to 14.51 South African rand.