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Kenya Banking Sector Q3’2016 Report

By Cytonn Research Team, December 4, 2016

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 3rd 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.
  1. 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: 

Q3'2016 Listed Banking Sector Metrics

Bank

Core EPS Growth

Deposit Growth

Loan Growth

Net Interest Margin

NPL Ratio

Cost to Income*

ROaE

ROaA

1.

Standard Chartered Bank

24.5%

19.8%

14.1%

9.7%

11.3%

40.1%

18.5%

3.3%

2.

Stanbic Bank

24.1%

22.8%

1.9%

7.8%

5.9%

57.4%

22.3%

3.0%

3.

Co-op Bank

22.3%

1.7%

6.9%

9.7%

4.3%

47.2%

18.2%

3.0%

4.

Equity Group

17.7%

4.8%

3.0%

11.0%

5.9%

49.2%

25.7%

4.7%

5.

I&M Bank

16.5%

9.9%

4.5%

7.9%

4.7%

33.8%

24.9%

3.8%

6.

KCB Group

16.1%

(7.3%)

4.9%

9.2%

8.1%

47.7%

21.9%

3.2%

7.

DTB Bank

11.4%

29.9%

5.4%

6.8%

4.2%

38.0%

16.0%

2.4%

8.

HF Group

7.8%

10.8%

4.3%

6.4%

10.0%

55.0%

19.5%

3.2%

9.

NIC Bank

(6.4%)

2.4%

0.7%

6.3%

12.3%

36.4%

15.5%

2.8%

10.

Barclays Bank

(5.1%)

13.4%

14.3%

10.9%

6.3%

51.5%

20.6%

3.4%

11.

 National Bank

(76.9%)

6.2%

(15.5%)

7.5%

41.5%

68.6%

(52.4%)

(3.3%)

Q3'2016 Weighted Average

15.1%

7.7%

6.3%

9.4%

7.0%

46.2%

21.0%

3.5%

Q3'2015 Weighted Average

9.7%

16.7%

17.9%

8.7%

5.6%

48.6%

23.6%

3.8%

 

Average is Market cap weighted 

 

*Without Loan Loss Charge

 

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.

CYTONN’S Q3'2016 BANKING REPORT RANKINGS

Bank

Franchise Value Total Score

Total Return Score

Weighted Q3'2016 Score

Q3'2016 rank

H1'2016 rank

1.

Equity Group

53.0

4.0

23.6

1

1

2.

KCB Group

60.0

1.0

24.6

2

2

3.

Co-operative Bank

59.0

7.0

27.8

3

3

4.

I&M Holdings

67.0

6.0

30.4

4

4

5.

Diamond Trust Bank

64.0

9.0

31.0

5

5

6.

Barclays Bank

71.0

8.0

33.2

6

7

7.

Stanbic Holdings

87.0

2.0

36.0

7

8

8.

Standard Chartered Bank

76.0

10.0

36.4

8

6

9.

NIC Bank

90.0

3.0

37.8

9

9

10.

HF Group

107.0

5.0

45.8

10

10

11.

National Bank

124.0

11.0

56.2

11

11

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

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Disclaimer: The views expressed in this publication, are those of the writers where particulars are not warranted. This publication, which is in compliance with Section 2 of the Capital Markets Authority Act Cap 485A, is meant for general information only, and is not a warranty, representation, advice or solicitation of any nature. Readers are advised in all circumstances to seek the advice of a registered investment advisor.
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© 2017 Cytonn Investments Management Ltd