Sep 4, 2016

Following the release of the H1’2016 results by banks, we undertook an analysis on the Kenyan Banking sector to point out any material changes from the Q1’2016 banking report. In this report, we recommend to investors 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 regulated, yet innovative environment” as the issues facing the banking sector, which is undergoing a transition, still persist. There are some key areas of transition, which will change the banking landscape in Kenya going forward:

1. Increased Regulation – There has been a number of regulatory developments that seek to introduce more regulation within the banking sector. These include;
   1. The Banking Act (Amendment) Bill, 2015 - The bill was signed into law effectively capping loan rates at 4.0% above the base rate with a floor on deposit pricing at 70% of the base rate. As highlighted in our Cytonn Report #34, we analysed the potential impact of the law to the general economy and came up with the potential winners and losers of this regime,
   2. Amendment of The Kenya Deposit Insurance Corporation Act – The Parliament has passed a bill that requires Treasury to be consulted by CBK before a bank is placed under receivership,
   3. Internal Capital Adequacy Assessment Process (ICAAP) - The Central Bank of Kenya (CBK) has developed draft guidelines on ICAAP that seeks to enable banks and mortgage finance institutions in determining the level of capital adequate to cover for their respective risks. Under the guideline all banks and mortgage finance institutions are required to formulate their own ICAAP that ensures that overall internal capital levels are adequate and consistent with their strategies, business plans, risk profiles and operating environments.
2. Sector Realignment– The banking sector continues to be characterised by sector realignment, through;
   1. Strategic Initiatives - Banks have continued to diversify their businesses into non-bank services; I&M Holdings has acquired Burbidge Capital, as it seeks to grow its business into transaction advisory. KCB Group has opened KCB Capital to tap into the same space
   2. Innovative Banking – In order to continue recording strong revenue growth, in post interest rate cap environment, banks will have to come up with innovative products, with possibilities of focus on transaction based banking, which could be targeted towards meeting specific customer needs and hence protecting their NIMs. In our view, we see innovation in terms of product offerings and cost containment being the key differentiator in this regime of price control.

Based on the above, we think consolidation is going to happen in the near-term to acquire the weaker banks. But we think 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 to prime clients and investing balance of deposits in government. Subprime clients will need to find non-bank financial solutions.

Below are the operating metrics for listed banks in Kenya: 

H1'2016 Listed Banking Sector Metrics
Bank	Core EPS Growth	Deposit Growth	Loan Growth	Net Interest Margin	NPL Ratio	Cost to Income*	ROaE	ROaA
Standard Chartered	34.8%	16.9%	(7.3%)	9.5%	12.8%	39.0%	18.4%	3.2%
HF Group	26.3%	6.2%	7.0%	6.7%	9.8%	52.3%	12.6%	1.9%
I&M Bank	22.6%	13.1%	7.6%	7.2%	4.9%	34.2%	25.3%	3.9%
CFC Bank	22.2%	(2.7%)	0.3%	5.5%	3.2%	60.0%	11.7%	2.3%
Co-op Bank	18.7%	12.0%	8.0%	9.1%	4.5%	45.3%	24.7%	3.7%
Equity Group	18.0%	6.5%	13.6%	10.8%	4.7%	50.0%	26.9%	4.5%
KCB Group	13.6%	(2.2%)	8.4%	8.7%	9.0%	47.9%	24.7%	3.7%
DTB Bank	11.3%	24.7%	10.2%	9.1%	4.0%	38.3%	20.7%	2.6%
NIC Bank	2.9%	6.5%	3.6%	7.4%	10.6%	35.3%	17.8%	2.8%
Barclays Bank	(10.2%)	11.9%	14.8%	10.7%	5.6%	51.8%	21.1%	3.2%
National Bank	(70.0%)	(1.6%)	(9.3%)	7.2%	11.3%	64.6%	(20.9%)	(2.1%)
H1'2016 Weighted Average	15.8%	8.9%	7.3%	9.2%	6.7%	45.7%	20.6%	3.1%
H1'2015 Weighted Average	4.7%	25.1%	19.8%	8.7%	3.6%	48.0%	23.8%	3.4%
Average is Market cap weighted
*Without Loan Loss Charge

With GDP growth prospects for 2016 at 5.8%, Kenya’s listed banks recorded improved EPS growth in H1’2016 of 15.8% compared to the H1’2015 growth of 4.7%. This was on the back of an improved macroeconomic environment, which saw interest rates decline to below historical average levels as evidenced by the interbank and the 91-day T-bill rates declining to 2.3% and 7.1%, respectively. With the banking sector contributing 10.1% to GDP, a strong growth exhibited by the sector is beneficial to drive the economy as the private sector is not crowded out and as banks can afford to take up some risk and loan out more to the sector. However, as a result of the interest rate cap, we might witness contraction of the private sector credit growth as banks opt to loan to the government which is considered risk free.

The growth currently witnessed in the sector is as a result of the sector’s ability to develop products that respond to the needs of Kenyans, such as (i) convenience and efficiency through alternative banking channels such as mobile and agency banking, (ii) increased financial inclusion and banking the informal market, and (iii) a demographic boost in Kenya, such as a growing middle class, which has led to increased demand for intermediary services such as banking. Going forward, banks will most likely cut down on taking interest earning deposits and push consumers to transactional accounts, lend to a smaller segment of prime clients and direct more funding to government securities; we will likely see growth in non-bank finance sector, which is not under the ambit of the Banking Act.

There are three takeaways from the table above:

• The sector recorded a 15.8% core EPS growth, with all banks recording double digit growth except NIC Bank, Barclays Bank and National bank which grew at 2.9%, (10.2%) and (70.0%), respectively,
• Banks registered high growth in non-performing loans, with the NPL ratio at 6.7% in H1’2016 compared to 3.5% in H1’2015, and,
• National Bank was the only bank that reported negative return on equity.

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 H1'2016 BANKING REPORT RANKINGS
Banks	Franchise Value Total Score	Total Return Score	Weighted H1'2016 Score	H1'2016 rank	Q1'2016 rank
Equity	52.0	4.0	23.2	1	2
KCB Group	59.0	1.0	24.2	2	1
Co-operative Bank	60.0	3.0	25.8	3	3
I&M	69.0	6.0	31.2	4	5
Diamond Trust Bank	71.0	5.0	31.4	5	6
Standard Chartered	72.0	10.0	34.8	6	7
Barclays	75.0	9.0	35.4	7	4
CfC Stanbic	83.0	8.0	38.0	8	9
NIC	87.0	7.0	39.0	9	8
Housing Finance	105.0	2.0	43.2	10	10
NBK	123.0	11.0	55.8	11	11

Major changes include:

• Barclays bank dropped to position 7 from position 4 as per the Q1’2016 Banking Sector report, mainly driven by a poor total return score, having an upside of 4.6%
• Equity Group emerged top, having been position 2 as per the Q1’2016 Banking Sector report driven by a strong franchise score, where it emerged top.

For a comprehensive analysis on the ranking and methodology behind it, see our Cytonn H1’2016 Banking Sector Report

 

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted- as the facts may change from time to time. This publication is meant for general information only, and is not a warranty, representation or solicitation for any product that may be on offer. Readers are thereby advised in all circumstances, to seek the advice of an independent financial advisor to advise them of the suitability of any financial product for their investment purposes.