Dec 13, 2015

Following the release of the Q3’2015 results by banks, we carried out an analysis on Kenya’s banking sector to decipher any material changes from our H1’2015 banking report. In our analysis of the banking sector we seek to recommend to our investors which banks are the most attractive and stable for investment from a franchise value and from a future growth opportunity perspective.

In Kenya there are a total of 42 commercial banks, 12 microfinance banks and 1 mortgage finance institution. The Central Bank of Kenya regulates all banks. The Capital Markets Authority has additional oversight over the listed banks, which currently stands at 11.

Amongst the listed banks, we were able to categorize the banks into 4 main buckets based on their Q3’15 performance:

• Negative growth banks: CFC Stanbic and Standard Charted
• Anemic growth banks, with below 10% growth: HF Group, NIC and Barclays
• The stable growth banks with 10% and above growth: Equity, KCB, I&M, and DTBK
• The strong growth, with above 20% growth: NBK and Coop. It is notable that all strong growth banks were mainly driven by either cost containment initiatives or one-off gains, leading to revenue growth outpacing expense growth, resulting into strong PAT growth

Growth in the banking sector is being driven by alternative service delivery channels, cost containment initiatives, expansion both regionally and domestically, and the growing retail segment. 

Some of the developments in the banking sector during Q3’2015 include:

1. Volatility in interest rates: In the third quarter of 2015, interest rates were volatile with the interbank rate and 91- day T-bill touching highs of 25.8% and 22.5%, respectively. At the beginning of the third quarter the MPC raised the CBR to 11.5%, and has since then remained unchanged
2. Low loan uptake: Given the expensive cost of financing loans, commercial banks reported lower loan uptake by their customers. Banks also struggled in mobilizing deposits as investors preferred investing in treasury instruments which offered attractive yields during that period. Industry Deposits remained relatively flat at Kshs 2.6 tn in September 2015
3. Lower earnings growth: Kenyan banks recorded lower earnings growth, driven by the challenging economic environment which has reduced appetite for credit
4. Dubai Bank Liquidation: Dubai bank was placed under receivership with the Kenya Deposit Insurance Corporation (KDIC) for failure to meet statutory requirements. The KDIC further recommended that the bank be liquidated
5. Moratorium on the licensing of new banks: The Central Bank of Kenya announced a moratorium on the licensing of new banks with the exception of cases related to amalgamation and acquisition that were already ongoing at the time of issuing this directive. In our opinion, with the number of commercial banks at 42, there are advantages such as enhanced financial inclusion but also strains the thoroughness and diligence of the regulatory supervision
6. Imperial Bank put under receivership: Imperial Bank was closed and put under receivership, due to what was described as “unsafe and unsound business practices”. The KDIC effected a joint agreement with Kenya Commercial Bank and Diamond Trust Bank that allowed 89% of depositors access to their deposits to a maximum of Kshs 1 mn. This is a clear indication that the bank may not reopen.

Cytonn’s analysis covers the health and future expected performance of the financial institution, by highlighting their performance using metrics to measure profitability, efficiency, growth, asset quality, liquidity, revenue diversification, capitalization and intrinsic valuation. In total, we looked at 13 different metrics to rank the banks.

1. Net interest margin: We used the net interest margin as a bank’s measure of core profitability;
2. Return on average common equity: We used the return on average common equity as a measure of profitability that flows to equity holders;
3. Price/Earnings growth ratio: We used the price/earnings growth ratio to determine relative valuation considering each bank’s expected growth rates;
4. Loans to deposit ratio: We used the loans to deposit ratio as a bank’s measure of liquidity;
5. Cost to income ratio: We used the cost to income ratio as a bank’s measure of efficiency;
6. Deposits per branch: We used a bank’s deposits per each branch as a measure of efficiency and proficiency in deposit gathering;
7. Price to tangible book value: We used a bank’s price to tangible book value as a measure of relative valuation;
8. Tangible common equity ratio: We used the tangible common equity ratio as a measure of a bank’s permanent capitalization levels;
9. Non-performing loans to total loans ratio: We used a bank’s non-performing loans to total loans ratio as a measure of a bank’s asset quality and credit risk;
10. NPL Coverage: We used a bank’s provisions to non-performing loans as a measure of a bank’s credit risk;
11. Non-interest income to revenue: We used the ratio of non-interest income to revenue as a measure of a bank’s revenue diversification;
12. Camel rating: We used our own camel rating system to assess the overall safety and soundness of the banks. We incorporated a Governance Score into our analysis, which measures the bank’s internal controls, strength, integrity and experience of the board and management, and quality of strategic shareholders;
13. Intrinsic Valuation: We used our analyst’s projections of the future performance of the banks to derive their intrinsic valuation.

Based on these metrics, we were able to rank the listed banks from number 1 to number 11, and get the bank that is likely to deliver the best return over a

It is notable that Diamond Trust Bank registered the biggest ranking improvement in the Q3’2015 Cytonn Banking Report, rising to #2 from #8 in H1’2015 based on its second highest upside of 23.7%. This was boosted by an increase in the banks’ growth rate to 18.4% owing to (i) their regional expansion strategy, and (ii) increased focus on more efficient channels of distribution like agency banking. The banks’ high quality loan book and risk management also boosted its franchise value.

Notes

1. Franchise Value Total Score: In this ranking, the banks are ranked by health, by looking at metrics for profitability, efficiency, growth, asset quality, liquidity, revenue diversification and capitalization. Banks are assigned scores ranging from 1, which is the best performing bank in the metric, till 11, which is the worst performing bank. The scores from each bank are then summated, with the bank with the lowest total score emerging on top, and that with the highest score emerging at the bottom.
2. Total Return Score: Potential upside for each bank based on the intrinsic valuation, and the current market price. The bank with the highest upside was ranked 1st, and that with the lowest upside, or greatest downside, was ranked last. Cytonn’s Analysts carry out this valuation, arriving at the estimate of intrinsic value of each bank based on underlying aspects of the business, in terms of both tangible and intangible factors, and future growth expectations. This value may or may not be the same as the current market value.
3. Weighted Q3’2015 Score: Using the Franchise Value and Total Return, banks are given a score. Franchise value was assigned a weighting of 40%, while the intrinsic value was assigned a 60% weight.
4. Q3’2015 Rank: The bank with the lowest Weighted Q3’2015 Score was ranked first, and that with the highest score was ranked last.
5. H1’2015 Rank: The H1’2015 rank was the rank as at half year and was based on both franchise value and total return score.

The full release of the rankings and how each bank performed across the metrics is in the Cytonn Banking Report Q3’2015. See link: Cytonn Banking Report Q3'2015


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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.