Executive Summary

Fixed Income: T-bill yields were on an upward trend during the month of November, closing at 8.3%, 10.4% and 10.8%, from 8.0%, 10.3% and 10.6% for the 91, 182 and 364-day papers, respectively, at the end of October. Kenya?s inflation rate for the month of November increased slightly to 6.7%, from 6.5% recorded in October, driven by an increase in food, transport and energy prices which rose 1.2%, 0.6% and 0.1% m/m, respectively;

Equities: The Kenyan equities market registered mixed trends during the month, with NASI and NSE 25 declining by 0.3% and 0.6%, respectively, while NSE 20 gained 1.3%. Listed banks released Q3?2016 results, recording core earnings per share (EPS) growth of 15.1%;

Private Equity: The month of November was characterized by (i) increased fundraising activity by private equity firms, (ii) exits by private equity firms, especially in Kenya, and (iii) increased investment in the fin-tech, FMCG and health sectors across Africa;

Real Estate: The Land Index Report by Property Reality Company (PRC) indicated that Ruaka Town recorded a 125.0% land price appreciation over the last one-year, as a result of the infrastructure development in Kiambu County. The Tourism Regulatory Authority classified a further eight hotels in Nairobi under the five-star rating;

Focus of the Week: Following the release of the Q3?2016 results by banks, we undertook an analysis on the Kenyan Banking sector to point out any material changes from the H1?2016 results. In this report, we analyse the results of the listed banks in the past quarter so as to determine which banks are the most attractive and stable for investment from both a franchise value and future growth (intrinsic value) perspective.

Company Updates

• Following the fourth quarter 2016 Board of Directors meeting, Cytonn Investments has released unaudited accounts, for the 10-month period ended 31^st October 2016. Financial performance has been strong, with balance sheet growth of 72.2%, with total assets growing to Kshs 11.3 bn from Kshs 6.5 bn at the start of 2016. In addition to strong balance sheet growth, we continue to make strategic investments in our distribution expansion, processes and talent. For more information, please see Cytonn Financials
• Caleb Mugendi, our Investments Analyst, discussed National Bank of Kenya?s Q3?2016 results and Mauritian firms such as Axis and SBM Holdings spending USD 50.0 mn in mergers and acquisitions in Kenyan firms in 2016. See Caleb on CNBC
• John Ndua, our Investment Analyst, discussed the appointment of 5 members to the Central Bank of Kenya Board, Chase Bank?s readiness to seek for a new strategic investor, and the impending withdrawal of largest foreign investors from Tanzania. See John on CNBC
• To celebrate our clients, and say thank-you for a successful year of investments and partnerships, Cytonn Investments this week hosted a cocktail party at Villa Rosa Kempinski to celebrate the achievements of the year. The party was filled with dance, along with karaoke sessions, that saw attendants put their vocals to the test and walk away with gift vouchers. See Event Note
• Cytonn Real Estate?s Research and Deal Origination (RDO) team held a briefing on deal origination and site acquisition strategy for Real Estate Agents at the Nairobi Club. The aim of the briefing was to ensure real estate agents are on the same page with Cytonn?s site acquisition strategy. See Event Note
• We continue to see very strong interest in our Private Wealth Management training, which is at no cost, and held bi-weekly by Cytonn Private Wealth, but is open only to pre-screened participants. To register for the training kindly use this link: See training
• To invest in any of our current or upcoming real estate projects, please visit Cytonn Real Estate. We continue to see very strong interest in our products:
  • The Alma, which is now 55.0% sold and has delivered an annualized return of 55.0% p.a. for investors who bought off-plan. See The Alma. We will be having site visits to showcase this iconic development every two weeks, right after the wealth management trainings. If interested in attending the site visit, email clientservices@cytonn.com
  • Amara Ridge is currently 100.0% sold. See Amara Ridge
  • We have 12 investment-ready projects, offering attractive development returns and buyer's targeted returns of around 25.0% p.a. See further details here: Summary of investment-ready projects
• We continue to beef up the team with several ongoing hires: Careers at Cytonn.

Fixed Income

Treasury bill subscriptions remained high during the month of November, with overall subscriptions increasing to 121.7%, from 112.6% in October. Yields on T-bills were on an upward trend, closing the month at 8.3%, 10.4% and 10.8%, from 8.0%, 10.3% and 10.6% in October for the 91, 182 and 364-day papers, respectively. We note that the levels of T-bill subscription have started declining, with this week?s overall subscription decreasing to 105.5%, compared to 113.5% recorded the previous week, with the subscription rates on the 91, 182 and 364-day papers decreasing to 141.6%, 113.4% and 73.6% from 147.8%, 115.6% and 88.6%, respectively, as a result of investors looking to lock-in attractive yields in the secondary bonds market. Despite the drop experienced in subscription levels during the week, yields on the 91, 182 and 364-day T-bills were on an upward trend, coming in at 8.4%, 10.5% and 10.9% from 8.3%, 10.4% and 10.8%, respectively, the previous week. The 182-day paper continues to offer the highest return on a risk-adjusted basis, but investors are now keeping short.

The 91-day T-bill is currently trading below its 5-year average of 10.4%. As stated in our Cytonn Weekly #46, the decline on the 91-day paper is largely attributed to the expected low interest rate environment as a result of (i) reduced pressure from the government borrowing program, given they are ahead of their pro-rated domestic borrowing target, and (ii) increased liquidity in the market brought about by the enactment of the Banking (Amendment) Act, 2015. The government has this far borrowed Kshs 147.3 bn domestically, against a pro-rated target of Kshs 101.6 bn considering the current domestic borrowing target of Kshs 229.6 bn. However, it is important to note that the government is in the process of revising its domestic borrowing target upwards to Kshs 294.6 bn, which if passed by Parliament will take the pro-rated borrowing target to Kshs 130.3 bn, meaning that the government will still be ahead of the borrowing target. Key to note is that as indicated in our Cytonn Weekly #42, the interest rates have bottomed out and we expect them to persist at the current levels.

During the month, the Kenyan Government re-opened two bonds, a 15-year and 20-year with effective tenors of 6.0 years and 11.6 years, respectively, to raise a combined Kshs 30.0 bn for budgetary support. Yields on the bonds came in at 13.6% and 14.3%, which were in line with our recommended bidding range of between 13.0% - 13.5% and 13.8% - 14.2% for the 15-year and 20-year, respectively. As recommended in our Cytonn Weekly #46, investors participation was skewed towards the 15-year bond, which received bids worth Kshs 14.5 bn, compared to Kshs 8.4 bn for the 20-year bond, since the 15-year bond offers the best returns on a risk-adjusted basis. We continue to note the inconsistency between what Central Bank is forcing banks to do by reducing interest rates, and the higher yield that government is accepting in treasury securities auction. For this auction, it is hard to see why a banking institution would lend to an individual at 14.0% as opposed to the government at 14.3%. This will lead to further crowding out of the private sector, as the government is a safer investment, further reducing credit growth to the private sector.

Given the rise in yields on government securities during the month of November, secondary bond market turnover declined by 2.6% to Kshs 33.1 bn from Kshs 34.0 bn recorded in October. Below are graphs for the secondary bond market activity, in terms of both yield and turnover.

According to Bloomberg, yields on the 5-year and 10-year Eurobonds increased by 0.6% and 0.8%, respectively, to 5.0% and 7.7% from 4.4% and 6.9% the previous month, respectively, as a result of global strengthening of the dollar, prompting investors to demand higher yields for frontier market investments. Since the mid-January 2016 peak, yields on the Kenya Eurobonds have declined by 3.8% and 1.9%, respectively, for the 5-year and 10-year Eurobonds, due to improving macroeconomic conditions. This is an indication that Kenya remains an attractive investment destination.

The Kenya Shilling depreciated against the dollar by 0.4% during the month, to close at 101.9, compared to 101.5 in October. The weakening of the shilling during the month was mainly driven by the dollar strength globally after (i) the Fed Chair indicated a possibility of a rate hike in December 2016, and (ii) markets adjusting positively to the conclusion of the US election, where Donald Trump was elected as the next United States President. On a YTD basis, the shilling has appreciated by 0.4% against the dollar. However, during the month, the level of months of import cover declined below the 1-year average of 4.9 months, to close November at 4.8 months, down from 5.1 months at the close of October. As stated in our Cytonn Weekly #45, this is quite worrying as the rate of decrease in the reserve could be an indication that the CBK is using a lot of reserves to support the shilling; this is a worrying statistic when considered alongside global dollar strength.

The inflation rate for the month of November increased by 20 bps to 6.7% from 6.5% in October, in line with our projection that the inflation rate would remain within the range of 6.5% - 6.7%. The rise was driven by (i) an increase in food prices, which rose 1.2% m/m, (ii) transport prices, which rose 0.6% m/m on account of an increase in the pump prices of petrol and diesel, and (iii) a 0.1% rise in prices for housing, water, electricity, gas and other fuels, which is attributed to an increase in house rents and kerosene, that outweighed a notable decline in the cost of cooking gas. Going forward, we expect inflationary pressure to be contained within the government target annual range of 2.5% - 7.5%, despite the possible upward pressure from the food component of the CPI basket.

The Monetary Policy Committee (MPC) met on Monday 28^th November 2016 to review the prevailing macroeconomic conditions and give direction on the Central Bank Rate (CBR). The MPC maintained the CBR at 10.0%, which was in line with our expectations as per our MPC Note. The Committee noted that the key economic indicators driving the decision were:

• The stability of the foreign exchange market despite (i) volatility in the global financial markets following US elections, and (ii) seasonal increase in demand by corporates financing dividend payments,
• The CBK's foreign exchange reserves currently standing at 4.8 months of import cover as well as precautionary Arrangements with the IMF have continued to provide an adequate buffer against short-term shocks,
• The banking system liquidity and distribution stabilized with the liquidity ratio for commercial banks averaging 43.6% in October, from 41.9% in August, with the capital adequacy ratio standing at 19.1% in October,
• On the interest rate caps, the Committee noted that the available data was inadequate to facilitate conclusive analysis of their impact on the monetary policy and economy at large,
• The economy continues to exhibit strong growth, having registered a growth of 6.2% in H1'2016 compared to 5.9% in H1'2015, and
• On the private sector credit growth, which was observed to have stabilized at 4.6% in the month of October, is largely attributable to structural factors in the banking sector rather than monetary policy.

Going forward, we expect the MPC to take key note of the impact of interest rate capping on the banking sector and the economy, especially given the fact that private sector credit growth is currently at an 8-year low.

During the month, the International Monetary Fund (IMF) reported that Kenya?s current account deficit improved by 1.3% to 5.5% as at September 2016, from 6.8% recorded in 2015, with the improvement mainly attributed to (i) lower oil prices, (ii) improved tea and horticultural exports brought about by high prices in the international markets, (iii) a pickup in the tourism sector, and (iv) higher remittance inflows. Key to note is that:

• Horticultural exports increased over the first eight-months of the year, by 11.5% to Kshs 56.8 bn from Kshs 50.9 bn registered previously,
• Diaspora remittances increasing by 14.5% over the first six-months of the year, to Kshs 86.2 bn from Kshs 75.3 bn registered previously,
• After the first seven-months of the year, imports stood at Kshs 807.2 bn with exports at Kshs 347.1 bn, representing an improvement of 20.3% to a trade gap of Kshs 460.1 bn, as compared to Kshs 577.6 bn registered over the same period in 2015.

Despite the narrowing current account deficit, the IMF has urged Kenya to cut down on the fiscal deficit.  In line with the recommendation from IMF, the government in the most recent 2016 Budget Review and Outlook Paper (BROP) proposed to cut down on foreign borrowing and hence (i) improve external debt sustainability, and (ii) enhance low risk towards external debt distress.

Key to note is that despite the drop in current account deficit, we are of the view that the current account position might come under pressure especially given that the Oil Producing and Exporting Countries (OPEC) have agreed to cut down on the supply, which will result in an increase in oil prices.

Private sector credit growth in Kenya slowed for the 15^th consecutive month in October with the International Monetary Fund (IMF) warning that this will probably act as a drag on the country?s economic expansion next year. This has also prompted Treasury to revise Kenya?s 2017 GDP growth to 6.0% from 6.5% previously. Credit to the private sector grew 4.6% in October, the slowest pace since June 2008, the year that the economy grew just 0.2%. The significant decline in private sector credit growth can be attributed to the following reasons;

• The enactment of the Banking (Amendment) Act, 2015, which capped lending rates at 4.0% above the Central Bank Rate, which has seen banks prefer to lend to government at higher yields than at 14.0% to the private sector, an example being the recent bond auction that saw the 20-year bond yield 14.3%, leading to crowding out of the private sector,
• Commercial lending rates have been persistently high averaging 17.5% for the past one-year compared to 16.0% in 2015,
• The increase in NPLs discouraged banks from lending to private sector and preferred risk free Government papers. According to Central Bank?s Credit Officer Survey Report as at June 2016, the industry?s NPLs increased by 12.6% y/y from Kshs 169.4 bn to Kshs 190.7 bn in June 2016.

Going forward, as highlighted in Cytonn Weekly #46, we do not expect the private sector credit growth to pick up as the loan pricing framework brought about by the Banking Amendment Act 2015 is rigid and does not accommodate borrowers who cannot fit within the 4% above the Central Bank Rate, which currently stands at 10%. Key to note is that concerns arise on how much impact the declining credit growth will have on economic growth for the year, which is projected at 6.0%. We expect that at some point in the not too distance future, once the political pressures have abated, we shall start seeing some movement towards reviewing or even all together repealing the Banking (Amendment) Act 2015.

Below is a chart highlighting private sector credit growth against commercial lending to government, and the recent addition being the October 2016 growth number at 4.6% year-on-year:

The Government is ahead of its domestic borrowing for this fiscal year having borrowed Kshs 147.3 bn for the current fiscal year against a target of Kshs 101.6 bn (assuming a pro-rated borrowing throughout the financial year of Kshs 229.6 bn budgeted for the full financial year). It is important to note, however, that the government is in the process of revising its domestic borrowing target upwards to Kshs 294.6 bn which will take the pro-rated borrowing target to Kshs 130.3 bn, and the government will still be ahead of the borrowing target. Interest rates, which had reversed trends due to the enactment of The Banking Act (Amendment), 2015, appear to have bottomed out and we expect them to persist at the current levels. It is due to this that we think it is prudent for investors to be biased towards short-term fixed income instruments given the prevailing interest rates environment.

Equities

During the month of November, the equities market registered mixed trends with NASI and NSE 25 declining by 0.3% and 0.6%, respectively, while NSE 20 gained by 1.3%, taking their YTD performances to (19.6%), (13.9%) and (6.2%), for the NSE 20, NSE 25, and NASI, respectively. The monthly equities market performance was driven by losses in large caps led by Diamond Trust Bank, Equity Group and Standard Chartered which lost 5.8%, 2.6% and 1.0%, respectively. However, there were gains in large caps led by Barclays and KCB which gained by 11.7% and 9.9%, respectively.

During the week, the market registered a downward trend with NASI, NSE 20 and NSE 25 declining by 0.7%, 0.5% and 1.4%, respectively. The top mover for the week was Safaricom, accounting for 44.9% of the market activity. Since the February 2015 peak, the market has been down 41.0% and 23.0% for the NSE 20 and NASI, respectively.

Equities turnover increased by 32.5% during the month to USD 102.6 mn (translating to an average daily turnover of USD 4.7 mn) from USD 77.4 mn (equivalent to an average daily turnover of USD 3.9 mn) in October 2016. Foreign investors were net buyers for this month with net inflows of USD 4.3 mn, compared to net outflows of USD 1.3 mn witnessed in October 2016.

The market is currently trading at a price to earnings (PE) ratio of 10.9x, versus a historical average of 13.7x, with a dividend yield of 6.4% versus a historical average of 3.5%. The charts below indicate the historical PE and dividend yields of the market.

During the month, there were a number of company releases, headlined by the release of Q3?2016 banking results. The listed banking sector stocks registerted core earnings per share (EPS) growth of 15.1% y/y, as can be summarised in the table below. For a detailed analysis of Kenya?s Banking Sector, please refer to our Focus of the Week and our Q3?2016 Banking Report.

*Average Market Cap Weighted

Other companies to release earnings during the month of November include:

• East African Portland Cement released their FY?2016 results: Core earnings per share declined by 42.1% y/y to Kshs 46.1 from Kshs 79.5 in FY?2015, attributed to an increase in operating expenses of 24.4% that outpaced the increase in operating revenue of 5.3%. Adjusting for the inventory provision of Kshs. 790 mn, operating expenses declined 5.8% to Kshs 2.5 bn in FY'2016, resulting in a 31.1% decline in core EPS to Kshs 54.8 from Kshs 79.5 in 2015. For a more comprehensive analysis, see Cytonn Weekly #45

• Centum released H1?2017 results: Core earnings per share grew by 0.4% y/y to Kshs 2.7 from Kshs 2.6 in Q3?2015. This was mainly driven by driven by a 1.3% increase in operating revenue, which outpaced a 4.0% decline in operating expenses. For a more comprehensive analysis, see Cytonn Weekly #46
• Family Bank released Q3?2016 results: Core earnings per share declined by 48.2% decline to Kshs 11.5, from Kshs 22.2 in Q3'2015, resulting in the bank issuing a profit warning for the FY?2016 results. This was as a result of a 29.3% increase in total operating expenses, which outpaced the 0.8% growth in total operating revenue to Kshs 7.3 bn. For a more comprehensive analysis, see Cytonn Weekly #47

In other focus areas, Nairobi Securities Exchange (NSE) issued a profit warning for FY?2016. NSE sighted the decline in prices of stock trading on the equities market, whose activity contributes approximately 53.0% of NSE?s total income, as the main reason for the decline in profit. This comes on the back of the securities exchange posting a 4.5% EPS decline in FY?2015.

Despite the profit warning, we still expect stronger market earnings growth in 2016 as compared to 2015 supported by a more favourable macroeconomic environment, with our expectations for 2016 earnings growth being 12.5%. Listed banks, contributing approximately half of NSE?s market capitalisation, to date have reported average core EPS growth of 15.1%.

In a move to enhance trading, the Central Depository & Settlement Corporation (CDSC) is set to launch a new trading platform in April 2017, which will allow trades to be settled in one-day. CDSC is additionally looking to add listed equities from other African countries, starting with Nigeria. Currently, the NSE settlement is T+3, in which transactions are completed in three-days. This move will (i) enhance the number of transactions carried out in a day, hence increase liquidity in the market, (ii) make the pricing of bonds and listed equities easier as it will improve price discovery mechanisms in the securities exchange, and (iii) increase both foreign and local investor participation.

Below is our equities recommendation table. Key changes for the month include:

• Housing Finance moved from a ?Buy? recommendation with an upside of 42.1%, to a ?Hold? recommendation with an upside of 7.3%, following revision of the banking sector valuations given the release of the Q3?2016 results,
• Liberty moved from a ?Sell? with a downside of 0.4%, to a ?Lighten? recommendation with an upside of 2.2% following a 2.9% m/m price decrease,

We remain ?neutral with a bias to positive? for investors with a short to medium-term investments horizon and ?positive? for investors with long-term investments horizon.

Private Equity

During the month of November, there were a number of fundraising activities by private equity firms, and exits by private equity firms, especially in Kenya. The month also witnessed increased investment in the fin-tech, FMCG and health sectors across Africa.

On the exits and acquisitions:

• LeapFrog Investments acquired an unknown majority stake in Goodlife Pharmacy at USD 22.0 mn from Catalyst, with Catalyst having only purchased Goodlife 2-years ago, purchasing the brand then known as Mimosa Pharmacies. The move by LeapFrog to invest in healthcare was driven by, among other factors: (i) low health insurance penetration, (ii) increased utilisation of services, and (iii) limited access and affordability of quality health care. For more information, see our Cytonn Weekly #47
• SBM Holdings Ltd of Mauritius is set to acquire the entire share capital of Kenya?s Fidelity Commercial Bank for Kshs 1.3 bn and will additionally inject Kshs 1.5 bn as growth capital into the bank, all these subject to regulatory approvals in Kenya and Mauritius. SBM Group has an asset base of Mauritian Rupee 146.2 bn as at Q3'2016, that equates to around Kshs 416.7 bn, and its banking arm, SBM Bank, has an international footprint in India, Madagascar, and a representative office in Myanmar. Fidelity Bank started as a commercial bank in Kenya 20-years ago, has 14 branches in Kenya and is ranked 31 out of 41 Kenyan lenders with a market share of 0.4%. For more information, see our Cytonn Weekly #47 and Note on Fidelity Acquisition.
• Actis was exiting from Umeme, a Ugandan electricity distribution company, by offloading 232 million shares equivalent to 14.3% of the issued ordinary shares to the Uganda Social Security Fund, who have already bought 122 million shares, and other institutional investors. This will leave the National Social Security Fund as the majority shareholder in the electricity distributor, with 23.0% shareholding.

On the fundraising front:

• International Finance Corporation (IFC) is set to commit USD 10.0 mn to Maris Capital?s planned USD 70.0 mn investment vehicle, Africa Logistic Properties (ALP). ALP is looking to invest its funds in developing and managing Grade-A warehouses in Sub-Saharan Africa. In its first investment phase, the Nairobi based Maris Capital plans to develop three new projects at key strategic points around the Kenyan Capital. In future phases, the firm plans to develop other warehousing assets in other parts of Kenya and Sub-Saharan African Region. For more information, see our Cytonn Weekly #45
• Impact Investment firm Capria Ventures has relaunched the Emerging Managers Fund, a USD 100.0 mn fund-of-funds launched in June this year. The fund will invest in early-stage equity and debt fund managers in Africa. For more information, see our Cytonn Weekly #45

On the FMCG sector front:

• Weetabix Food Company has acquired a 50.1% controlling stake in Weetabix East Africa from Kenyan businessman Ahsan Manji, the founder of House of Manji. The remaining stake of 49.9% was taken up by Pioneer Foods Group, a South African based food manufacturer.  The partnership is seen to be: (i) strategic considering the two multinational companies have been competitors in the East African market for long, (ii) opportunistic as they will work together to capitalize on the rising demand for breakfast cereals in the region and especially in Kenya, which alone has a demand of over 2.8 mn kilograms a year since 2014, and (iii) in line with Weetabix Food Company?s international growth strategy and aligned also to Pioneer Foods? growth sales of their product range in Africa. For more information, see our Cytonn Weekly #46

On the Fin-tech sector front:

Cactus Capital announced investments into seed and growth stage African technology ventures, Flutterwave and E-Factor. Flutterwave is a San Francisco-based team of African entrepreneurs, financial services technologists and mobile payment experts that provides end-to-end payments technology and infrastructure to payment service providers, global merchants, licensed money transfer operators and Pan-African banks from Africa with one application program interface (API) integration. E-Factor is a South African-based fintech company, which has created a digital factoring platform where companies can sell their receivable invoices through an auction to investors with the highest bid. The investments in Fintech have been driven by: (i) Broad range of reforms across Africa in recent years in the process of transitioning economies to a digital age, (ii) infrastructure initiatives in Africa that are opening new avenues of commerce, and (iii) new efforts towards regional integration. For more information, see our Cytonn Weekly #46

Private equity investment activity in Africa has continued to improve, as evidenced by the increase in the number of fundraises, exits and deal volumes in the region. Preference is still skewed towards financial services, energy, real estate, healthcare, education, and IT sectors although infrastructure, Fast Moving Consumer Goods (FMCG) industries have now gained traction. We remain bullish on PE as an asset class in Sub-Saharan Africa given (i) the abundance of global capital looking for investment opportunities in Africa, (ii) attractive valuations in the private sector, and (iii) strong economic growth projections, compared to global markets.

Real Estate

As indicated in our Cytonn Weekly #47, Property Reality Company (PRC) released their Land Index Report, which indicated that Ruaka Town in the Nairobi Metropolis recorded the highest increase in land prices at 125.0% over the last one-year, citing development of infrastructure, particularly the Northern by-pass and the Western by-pass earmarked for development.

Other Metropolis Towns, such as Kiserian and Utawala also recorded rapid land price appreciation of 42.0% and 32.0%, respectively, with Kamulu and Malili towns experiencing a price stagnation. We expect a sustainable demand for land especially in areas where infrastructure growth is expected, as well as other amenities such as electricity, water and security.

Additionally, the Kenya Bankers Association (KBA) released a Housing Price Index, which indicated the continued increase in house prices, with appreciations of 2.2% in Q3?2016, from Q2?2016. This was an increase compared to the 1.7% growth recorded in the previous quarter. The report indicates apartments continued to dominate the market in terms of supply as compared to standalone units. This was reflected in the increase in prices whereby apartments indicated a price increase of between 1.8% to 3.4% depending on locality, whereas the maisonettes in high-end areas increased by 4.0%. This could be an indication of a possible oversupply of apartments by the players in the real estate market. The opportunity however lies in the affordable housing sector, which is largely undersupplied.

As a response to this, the government through PPP partnerships will begin the Public-Private Urban Renewal Project involving development of more than 14,000 units in Ngara, Pangani, Ngong Road and other areas in Nairobi, is set to begin in January 2017. However, we are yet to see a PPP in Kenya take-off and be established.

In the hospitality sector, Simba Corporation, the organisation behind the Villa Rosa Kempinski, announced plans to open a 3-star hotel in Naivasha under their Acacia Hotel Chains to cater for business travellers. For more information, see our Cytonn Weekly #46.

Earlier on during the month, the Tourism Regulatory Authority completed its ranking of hotels within the Nairobi Metropolis, with the following establishments qualifying for star ratings as below. For more information, see the Classified Enterprises Tourism Reports

Some of the 5-star rated hotels include: - Villa Rosa Kempinski, Hemingways Nairobi, Sankara Nairobi, Fairmont The Norfolk, The Sarova Stanley, Radisson Blu Hotel, Dusit D2 and Tribe Hotel, the 4-star rated establishments include Crowne Plaza, Ole Sereni, House of Waine and Weston Hotel.

The increased investments in town hotels can be associated with the need to provide conference and accommodation facilities for international delegates that frequent the city. There is positive outlook for business hotels in Nairobi as well as in The Maasai Mara region as indicated in our Hospitality Report

In bid to improve transparency in the land ministry with the aim of increasing development, the State hosted the National Land Summit at State House Nairobi. The deliberations made during the summit included (i) registering all land buying companies and register afresh the existent stock, (ii) issuing 3-million title deeds by December 2017, and (iii) digitization of land transaction in the 47 Kenyan Counties. If implemented, this will be an incentive to all those seeking to invest in real estate especially due to the security of tenure resultant of issuing of title deeds.

Kenya Banking Sector Q3?2016 Report

Following the release of the Q3?2016 results by banks, we undertook an analysis on the Kenyan Banking sector to point out any material changes from the H1?2016 Banking Report. In our Q3?2016 Banking Report, we analyse the results of the listed banks in the past quarter so as to determine which banks are the most attractive and stable for investment from a franchise value and from a future growth opportunity perspective.

The report is themed ?Transition continues, to a more stable sector, in an era of increased regulation? as the issues facing the banking sector in Kenya persist. There are some key areas of transition, which will change the banking landscape in Kenya going forward:

1. Consolidation ? Consolidation in the banking sector continues to gather pace, with weaker banks being forced to merge or be acquired. Also, foreign entities are increasingly seeking to enter the Kenyan banking sector, highlighting the attractive investment opportunity in the financial services sector in the country. Key issues to note here include;
   1. Increased consolidation in the Industry, mainly through acquisitions ? The Central Bank of Kenya announced the proposed acquisition of Fidelity Commercial Bank by SBM Holdings, subject to regulatory approvals in both Kenya and Mauritius. If this deal goes through, it will be the 3^rd successful local bank acquisition in the Kenya this year, after the acquisition of Giro Commercial Bank and Oriental Commercial Bank by I&M Holdings and Bank M, respectively. For foreign financial services players seeking access to Kenya?s banking sector, acquisitions remain the primary route given the moratorium on new banking licenses by Central Bank of Kenya. As highlighted in our Cytonn Weekly #47 these cases of consolidation in the banking sector will lead to fewer, but larger banks, which are more stable and can withstand shocks in the economy,
   2. Entry of foreign banks into the local banking space ? Kenya?s banking sector has amongst the highest return on equity, with listed banks? ROaE at 21.0%, attracting foreign investors, witnessed by the foreign entities bid to buy Chase Bank, that is in receivership. Going forward, we expect to see more foreign banks targeting the Kenyan banking sector and this will have to be through acquisition, following the moratorium of licensing new banks, that has put 2 banks, (i) Dubai Islamic Bank, and (ii) Mayfair Bank, that were operating under a provisional license into a state of uncertainty.

2. Regulation ? There has been a number of regulatory developments that seek to introduce more regulation within the banking sector. These include;
   1. Price controls have been put in place, following enactment of the Banking (Amendment) Act 2015 ? Banks lowered the rates charged on loans to 14.0%, which is 4.0% above the CBR, while interest paying deposits are at a minimum of 70.0% of the CBR. This reduction of banks? yield on assets and increased cost of funding are likely to compress net margins, and effectively result in reduced profitability. However, Kenyan banks have been directing funding towards government, which have been yielding in excess of the 14.0% cap placed on loans.
   2. Provisioning ? Banks recorded an increase in loan loss provisioning, with an average growth of 93.8% in Q3?2016, representing stricter regulation on any non-performing loan. The increased level of provisioning will improve the level of asset quality, while forcing banks to adopt a more stringent risk assessment framework, which is essential for a stable banking industry.

Based on the above, we believe consolidation is going to continue in the sector as weaker banks are acquired by the more stable banks. The strong banks will be able to protect their margins by simply limiting any interest paying accounts in favour of transaction accounts, and limiting loans only to prime clients and investing balance of deposits in government. We are also likely to see more foreign entities entering the Kenyan banking sector through such acquisitions.

Below are the operating metrics for listed banks in Kenya: 

Key takeaways from the table above include:

• The sector recorded a 15.1% core EPS growth, compared to a growth of 9.7% in Q3?2015. All banks recorded double digit EPS growth except HF Group, NIC Bank, Barclays Bank and National Bank, which grew at 7.8%, (6.4%), (5.1%) and (76.9%), respectively. Though there could be some negative effects on EPS growth as result of the interest rate cap, though this is not expected to significantly affect banks? earnings for the year 2016,
• KCB was the only bank to record a drop in deposit growth, however we note that customer deposits declined by 7.3%, as a result of the impact of the devaluation of the South Sudan business. Considering the Kenyan business alone, deposits grew by 14.0%,
• Banks registered high growth in non-performing loans, with the NPL ratio at 7.0% in Q3?2016 compared to 5.6% in Q3?2015, and,
• National Bank was the only bank that reported negative return on equity and return on assets.

Kenya?s listed banks recorded improved EPS growth in Q3?2016 on the back of an improved macroeconomic environment, which saw interest rates decline to below historical average levels as evidenced by the 91-day T-bill rates declining to 8.4%, compared to its 5-year average of 10.4%. With GDP growth prospects for 2016 at 6.0%, and the banking sector contributing 10.1% to GDP, a strong growth exhibited by the sector is beneficial to drive economic growth. However, as cited in our Cytonn Weekly #47 and Cytonn Weekly #46, credit to the private sector has been on a consecutive decline for 15-months, with the International Monetary Fund (IMF) warning that this will probably drag the country?s economic expansion next year. Going forward, we do not expect lending to the private sector to pick up due to the rigidity in loan pricing brought about by the Banking (Amendment) Act, and the crowding-out of the private sector as banks prefer to lend at higher rates to the government.

The growth currently witnessed in the sector is as a result of (i) banks? exploring different avenues of revenue generation such as bancassurance to increase their non-funded income, now that interest income  is likely to be compressed after operationalization of the Banking (Amendment) Act 2015, (ii) adoption of technology through integration with mobile application platforms and internet banking, which has led to increased efficiency and uptake of banking services, and (iii) rapid growth of the retail segment and the middle class, which has led to increased consumption expenditure and increased percentage of population requiring intermediary services, such as banking services.

As per our analysis on the banking sector, from a franchise value and from a future growth opportunity perspective, below is the comprehensive ranking of the listed banks.

Major changes include:

• Standard Chartered Bank fell 2 positions to position 8 from position 6 in our H1?2016 Banking Sector Report as a result of its franchise value being weighed down by the bank?s loan to deposit ratio at 60.5%, against a preferential range of 80.0% - 90.0%, and high levels of non-performing loans,
• Stanbic Holdings rose 1 spot to position 7 from position 8 in our H1?2016 Banking Sector Report, boosted by a higher Intrinsic Value score as the bank has the highest revenue diversification with a revenue mix of 58:42 Funded to Non-Funded income.

For a comprehensive analysis on the ranking and methodology behind it, see our Cytonn Q3?2016 Banking Sector Report