Sep 18, 2017

Following the release of the H1’2017 results by banks, we undertook an analysis on the Kenyan Banking sector to point out any material changes from the Q1’2017 Banking Report. In our H1’2017 Banking Report, we analyze the results of the listed banks in order 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 “Transitioning to a more Disciplined and Efficient Sector” as the banking sector takes a more disciplined approach, following rising non-performing loans and the capping of interest rates, while also employing cost rationalization measures in a bid to enhance efficiency under the current operating environment of loan and deposit pricing regulatory framework. Below are some of the themes that shaped the banking sector in the first half of 2017:

1. Consolidation – Consolidation in the banking sector continued to gather pace, with weaker banks (that don’t serve a niche, or don’t have a clear deposit gathering strategy), being forced to merge or be acquired. During the first half of the year, Diamond Trust Bank Kenya (DTBK) completed the acquisition of Habib Bank (K) Limited (HBL), setting the platform for more consolidation this year. As highlighted in our Cytonn Weekly #47/2016these 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. We would have expected even a lot more consolidation by now, and we are surprised that some of the smaller banks have managed to stay independent this long. It is notable that acquisitions are also happening at much cheaper valuations, with earlier bank acquisition announcements, such as Fina, K-Rep and Equatorial Commercial Bank having been at 3.2x, 1.8x and 2.3x P/B, respectively, while recent acquisitions are happening at between 0.8x to 1.7x P/B, and hence it is a great time to be an acquirer. Below is the summary of the transaction metrics of some of the acquisitions that have happened in the banking sector.

Acquirer	Bank Acquired	Book Value at Acquisition (Kshs bn)	Transaction Stake	Transaction Value (Kshs bn)	P/BV Multiple	Date
Diamond Trust Bank Kenya	Habib Bank Limited Kenya	2.38	100.0%	1.82	0.8x	Mar-17
SBM Holdings	Fidelity Commercial Bank	1.75	100.0%	2.75	1.6x	Nov-16
M Bank	Oriental Commercial Bank	1.80	51.0%	1.30	1.4x	Jun-16
I&M Holdings	Giro Commercial Bank	2.95	100.0%	5.00	1.7x	Jun-16
Mwalimu SACCO	Equatorial Commercial Bank	1.15	75.0%	2.60	2.3x	Mar-15
Centum	K-Rep Bank	2.08	66.0%	2.50	1.8x	Jul-14
GT Bank	Fina Bank Group	3.86	70.0%	8.60	3.2x	Nov-13
Average			80.3%		1.8x

 

2. Regulation – The effects of the Banking (Amendment) Act 2015 have been felt in the first half of 2017, with banks recording a decline in core EPS by 13.8% and private sector credit growth slowing to 2.1% in May, compared to 5.4% when the Banking (Amendment) Act 2015 came into play. The amendment stipulates a deposit and loan-pricing framework, with (i) a cap on lending rates at 4.0% above the Central Bank Rate (CBR), and (ii) a floor on the deposit rates at 70% of the CBR. The Central Bank of Kenya (CBK) has signaled its intention to push for the repeal of the interest rates cap law that has been in effect for a year now, due to the negative effect it has had on private sector credit growth and the expected negative impact to the economy. This comes after a recent credit survey by the CBK showed that most commercial banks (54.0%) revealed that interest rate capping negatively affected their lending to SMEs.
3. Asset Quality – The banking sector has witnessed a deterioration in asset quality over the past year, with the gross non-performing loans rising by 17.9% to Kshs 170.4 bn from Kshs 144.5 bn in H1’2016 and this has led to an increase in provisioning levels to 54.0% from 48.8% in H1’2016. We are seeing banks becoming more selective, prudent and conservative in terms of loan disbursement, since with the current pricing framework, it is difficult to price riskier clients within the loan limit cap in the cost of loans. This has led banks to reduce their unsecured and micro loans to small businesses, which are deemed risky.
4. Cost Rationalization – The focus for the banking sector in 2017 will inevitably be on adjusting business models to conform to the Banking (Amendment) Act 2015. To this effect, banks have already taken proactive measures aimed at increasing operational efficiency in response to the challenging operating environment, such as laying off staff, closure of branches, reviewing operating hours for some branches, or outright sales in the case of struggling Tier III banks. Going forward, we are likely to witness banks’ push for efficiency gather pace to balance off the expected reduction in absolute profitability going forward as they shy away from the physical branch model, which is very expensive compared to other alternative channels such as digital platforms.

Kenya Banking Sector Restructuring
	Bank	Staff Retrenchment	Branches Closed
1.	Sidian Bank	108	-
2.	Equity Group	400	7
3.	Ecobank	-	9
4.	Family Bank	Unspecified	-
5.	First Community Bank	106	-
6.	Bank of Africa	-	12
7.	National Bank	Unspecified	-
8.	NIC Bank	32	Unspecified
9.	Standard Chartered Bank Kenya	300	4
10.	KCB Group	223	Unspecified
11.	Barclays Bank	301	7
12.	I&M Holdings	-	Unspecified
	TOTAL	1,470	39

 

Based on the above, we believe the sector is shaping up to prudence in operations, as can be seen through the increased loan loss provisioning levels, as banks adjust their business models under the current regulatory framework.

Below are H1’2017 key operating metrics for listed banks in Kenya:

Listed Banks H1'2017 Earnings and Growth Metrics
Bank	Core EPS Growth		Deposit Growth		Loan Growth		Net Interest Margin		Loan to Deposit Ratio		Investments in Government Securities to Deposit Ratio
	H1'2017	H1'2016	H1'2017	H1'2016	H1'2017	H1'2016	H1'2017	H1'2016	H1'2017	H1'2016	H1'2017	H1'2016
KCB Group	(0.2%)	11.2%	1.3%	(2.2%)	16.7%	8.4%	8.7%	8.1%	84.3%	73.2%	24.0%	21.1%
DTB Kenya	(5.8%)	11.3%	18.6%	24.7%	7.2%	10.2%	6.8%	7.6%	74.7%	82.6%	41.1%	36.4%
Equity Group	(7.8%)	18.0%	13.6%	6.5%	(1.5%)	13.6%	9.7%	10.8%	73.1%	84.3%	37.2%	24.6%
NIC Bank	(11.9%)	2.9%	18.9%	6.5%	4.1%	3.6%	7.1%	7.7%	87.7%	100.1%	33.3%	25.9%
Stanbic	(12.1%)	22.2%	12.5%	(2.7%)	8.0%	0.3%	5.3%	5.6%	75.1%	78.2%	38.6%	36.3%
Barclays Bank	(13.3%)	(10.2%)	3.2%	11.9%	6.8%	14.8%	10.1%	10.7%	86.8%	83.8%	27.9%	26.0%
I&M Holdings	(17.9%)	23.0%	10.3%	13.1%	9.1%	7.6%	7.7%	7.7%	89.5%	90.5%	31.3%	35.5%
Co-op Bank	(25.4%)	18.7%	2.7%	12.0%	14.2%	8.0%	8.8%	8.9%	88.4%	79.5%	26.0%	29.2%
StanChart	(34.4%)	34.8%	17.6%	16.9%	(1.1%)	(7.3%)	8.4%	9.5%	50.4%	59.9%	47.6%	49.2%
National Bank	(42.2%)	(70.0%)	3.4%	(1.6%)	(12.0%)	(9.3%)	6.9%	7.2%	57.7%	67.8%	38.1%	29.5%
HF Group	(74.0%)	26.3%	(6.0%)	6.2%	(1.3%)	7.0%	5.7%	6.7%	89.3%***	92.1%	9.2%	9.3%
Weighted Average*	(13.8%)*	15.5%*	14.4%**	8.5%**	9.3%	7.7%	7.7%	8.4%	77.9%	81.1%	32.2%	29.4%
*The weighted average is based on Market Cap as at 31st August, 2017 **Based on cumulative growth of listed banking sector
***For Housing Finance, given their primary business of mortgage provision, we used the Loans to Loanable funds ratio. The Loan to Deposit ratio is at 141.3%

Key takeaways from the table above include:

• The listed banks recorded a 13.8% decline in core EPS, compared to a growth of 15.5% in H1’2016. All the banks recorded negative growth, with KCB Group registering the least decline, a 0.2% decline, on the back of a 2.9% growth in Net Interest Income (NII),
• Deposits grew at 14.4% during the first half of the year, a faster rate than loans, which grew by 9.3%. The loan growth came in lower as private sector credit growth slowed to 2.1% in H1’2017, below the government’s set target of 18.3%, with banks adopting a more prudent credit risk assessment framework to ensure quality loan books, which saw the loan to deposit ratio drop to 77.9% from 81.1% in H1’2016. This means that even as deposits were growing, banks were not lending,
• Following the Banking Act (Amendment) 2015, banks saw their net interest margins (NIM) drop in H1’2017, which declined to 7.7% from 8.4% in H1’2016,
• Exposure to government securities recorded an increase as indicated by investment in government Securities to deposit ratio, which increased to 32.2% from 29.4% in H1’2016 as banks allocated more funds towards the government, with government securities considered risk free, depriving the private sector of credit in the process,
• The increase in the gross non-performing loan (NPL) ratio to 11.5% from 10.1% in H1’2016 highlights increased risks around asset quality in the sector, with banks having taken a prudent approach with the adoption of IFRS 9, and
• Listed banks recorded a decline on return on average equity to 18.1% from 20.6% in H1’2016, as the banks’ profitability was affected by the capping of interest rates, which suppressed net interest income in the first half of the year.

The LDR has declined to 77.9% from 89.9% in 2016, with banks adopting a more prudent credit risk assessment framework to ensure quality loan books

Bank’s NIMs have declined to 7.7% from 8.8% in 2016, following the capping of interest rates, and this has affected the profitability of these banks as the current regulatory framework has compressed margins

Kenya’s listed banks recorded negative EPS growth of 13.8% in H1’2017 compared to an average growth of 15.5% in H1’2016. The poor performance was primarily on the back of an 8.1% decline in NII following the capping of interest rates, with KCB Group the only bank recording growth in NII, a 2.9% rise, following a 20.8% decline in interest expense, as the bank managed to contain its cost of funding. The Banking Act (Amendment) 2015 was introduced with a view of making loans cheap and accessible but this has not been the case, with private sector credit growth slowing to 2.1% in the first half of 2017, way below the government set target of 18.3%, as banks channel funds more actively towards government securities, with exposure in government securities coming in at 32.2% in H1’2017 from 29.4% in H1’2016, depriving the private sector of credit.

Rate cap came into effect in August 2016 when private sector credit growth was at 5.4% as highlighted above, with the decline before that as a result of a challenging operating environment

In addition to the capping of interest rates being the primary reason for the poor performance by banks in H1’2017: (i) banks with operations in South Sudan such as Equity Group, KCB Group, Co-operative Bank and Stanbic Holdings have continued to be adversely affected by political instability in the country, which has led to hyperinflation and devaluation of the South Sudanese Pound, and (ii) increased loan loss provisioning due to concerns around banking sector loan book quality, has seen the banking sector continue to record sluggish performance in H1’2017.

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.

CYTONN’S H1’2017 BANKING REPORT – COMPOSITE RANKINGS
Bank	Franchise Value Total Score	Total Return Score	Weighted  Score	H1‘2017 Rank	Q1‘2017 Rank
KCB Group	53.0	2	22.4	1	1
Co-operative Bank	49.0	7	23.8	2	2
DTB	64.0	4	28.0	3	3
NIC Bank	75.0	1	30.6	4	5
Equity Group	67.0	8	31.6	5	6
I&M Holdings	72.0	6	32.4	6	4
Barclays Bank	78.0	4	33.6	7	7
Stanbic Holdings	85.0	9	39.4	8	8
SCBK	84.0	10	39.6	9	8
HF Group	108.0	3	45.0	10	10
NBK	119.0	11	54.2	11	11

Major changes include:

• Equity Group climbed up 1 spot to Position 5 from Position 6 in our Q1’2017 Banking Sector Report, due to impressive NIM at 9.7%, above industry average of 8.6%, and a Return on average Equity of 19.7%, above the industry average of 18.1%, with the bank adequately diversified with Non-Funded income at 42.0%, higher than the industry average of 31.3%,
• SCBK dropped 1 position to Position 9 from Position 8 in our Q1’2017 Banking Sector Report, due to a low intrinsic valuation, coming in at 10^th.  The bank was also weighed down by high non-performing loans at 13.1%, versus an industry average of 11.5%.

For a comprehensive analysis on the ranking and methodology behind it, see our Cytonn H1’2017 Banking Sector Report.