Following the release of the Q12017 results by banks, we undertook an analysis on the Kenyan Banking sector to point out any material changes from the FY2016 Banking Report. In our Q12017 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 Consolidation and prudence in a challenging operating environment as the banking sector is witnessing increased consolidation while remaining prudent following rising non-performing loans and the capping of interest rates. Below are some of the themes that shaped the banking sector in the first quarter in 2017:
- Consolidation Consolidation in the banking sector continued to gather pace, with weaker banks being forced to merge or be acquired. During the year, Diamond Trust Bank Kenya (DTBK) announced plans to acquire Habib Bank (K) Limited (HBL) setting the platform for more consolidation this year, with the acquisition subject to regulatory approval in both Kenya and Pakistan. According to reports emerging recently, KCB Group has expressed interest to acquire the National Bank of Kenya (NBK) through a share swap, buying out 70.0% of the bank in the first phase, with a full acquisition to follow. 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.
| Acquirer | Bank Acquired | Book Value at Acquisition (Kshs bns) | Transaction Stake | Transaction Value (Kshs bns) | 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 |
- Regulation The effects of the Banking (Amendment) Act 2015 have been felt in the first quarter of 2017, with banks recording a decline in core EPS by 8.6% and private sector credit growth slowing to 4.0% compared to 5.4% when the amendment 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. In January 2017, the International Monetary Fund (IMF) expressed concerns about interest rate capping and its negative effect on private sector credit growth and banking sector earnings, noting that it may be necessary to repeal the act as maintaining the same would end up taking a toll on Kenyas financial sector stability. Meanwhile, the Central Bank (CBK) has come out and stated that it is finalizing a study on the effects of the law and its impact on the economy, while working closely with the Kenya Bankers Association (KBA).
- Asset Quality The banking sector has witnessed a deterioration in asset quality over the past year, with the gross non-performing loan (NPL) ratio rising to 11.6% from 8.1% in Q12016. This has led to an increase in provisioning levels to 54.1% from 47.2% in Q12016. We are seeing banks becoming more selective in terms of loan disbursement, since with the current pricing framework, it is difficult to price in risk in the cost of loans.
Based on the above, we believe consolidation is going to continue in the sector as weaker banks are acquired by the more stable banks, and foreign entities enter the Kenyan banking sector through acquisitions, while also through setting up new operations following the lifting of the moratorium to license new banks. Banks that have common significant shareholders are likely to merge and operate as one entity given the tough operating environment. The sector is shaping up to prudence in operations in the wake of increased loan loss provisioning and the capping of interest rates.
Below are Q12017 key operating metrics for listed banks in Kenya:
| Listed Banks Q1'2017 Earnings and Growth Metrics | ||||||
| Bank | Core EPS Growth | Deposit Growth | Loan Growth | Net Interest Margin | Loan to Deposit Ratio | Exposure to Government Securities |
| Diamond Trust Bank | 8.8% | 22.1% | 4.8% | 7.2% | 74.9% | 39.1% |
| KCB Group | (3.2%) | 7.9% | 14.3% | 9.1% | 86.6% | 23.2% |
| NIC Bank | (3.9%) | 6.8% | 3.9% | 7.9% | 98.7% | 26.4% |
| Equity Group | (5.6%) | 16.1% | (4.8%) | 10.3% | 75.4% | 32.5% |
| Co-op Bank | (6.0%) | 6.9% | 15.0% | 9.5% | 87.9% | 23.0% |
| Stanbic Bank | (9.3%) | 20.0% | 11.4% | 6.9% | 88.4% | 22.4% |
| I&M Bank | (16.9%) | 14.3% | 8.8% | 8.0% | 86.2% | 34.7% |
| Barclays Bank | (19.8%) | 7.6% | 10.7% | 10.2% | 92.8% | 24.2% |
| Standard Chartered Bank | (20.5%) | 11.1% | 6.5% | 9.0% | 57.0% | 47.2% |
| Housing Finance Group | (73.1%) | (6.4%) | 2.2% | 6.2% | 142.7% | 11.1% |
| National Bank of Kenya | (82.2%) | (6.7%) | (12.3%) | 7.5% | 62.7% | 38.2% |
| Q1'2017 Weighted Average* | (8.6%) | 11.7% | 7.1% | 9.2% | 81.2% | 30.0% |
| Q1'2016 Weighted Average* | 13.6% | 10.8% | 15.7% | 9.3% | 85.1% | 26.0% |
| * The weighted average is based on Market | ||||||
Key takeaways from the table above include:
- The listed banks recorded an 8.6% decline in core EPS, compared to a growth of 13.6% in Q12016. All the banks recorded negative growth except for Diamond Trust Bank, which recorded a growth of 8.8%, due to flat performance in NII, meaning it was the least affected bank in Q12017, following the capping of interest rates,
- Deposits grew at a faster rate than loans during the first quarter of the year, which is the reverse of what was witnessed in Q12016. The loan growth came in lower as private sector credit uptake slumped to 4.0% in Q12017, with banks adopting a more prudent credit risk assessment framework to ensure healthy loan books, which saw the loan to deposit ratio drop to 81.2% from 85.1% in Q12016,
- Despite the Banking Act (Amendment) 2015, banks managed to preserve their net interest margins (NIM) in Q12017, which declined marginally to 9.2% from 9.3% in Q12016, despite net interest income (NII) declining by 11.3% y/y,
- Exposure in government securities rose to 30.0% from 26.0% in Q12016 as banks allocated more funds towards the government following the capping of interest rates, depriving the private sector of credit in the process,
- The increase in the gross non-performing loan (NPL) ratio to 11.6% from 8.1% in Q12016, 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 16.8% from 17.6% in Q12016, as the banks profitability was affected by the capping of interest rates, which suppressed net interest income in the first quarter of the year.
Kenyas listed banks recorded negative EPS growth of 8.6% in Q12017 compared to an average growth of 13.6% in Q12016. The poor performance was primarily on the back of an 11.3% decline in NII following the capping of interest rates, which stipulates a rigid deposit and loan-pricing framework. 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 4.0% in the first quarter of 2017, way below the government set target of 18.3%, as banks channel funds more actively towards government securities, depriving the private sector credit.
Rate cap came into effect in August 2016 when private sector credit growth was at 5.4% as highlighted above
The focus for the banking sector in 2017 will inevitably be on adjusting business models to conform to the Banking (Amendment) Act 2015, with banks taking 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 Tier III banks. Barclays Bank was the latest bank to report laying off staff, with 171 employees laid off in 2016, following reports that KCB Group laid off 223 employees within the same period, bringing to 11 the number of banks that have announced downsizing plans since the implementation of the interest rate cap. 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 physical branches model, which are 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 | - |
| 9. | Standard Chartered Bank Kenya | 300 | - |
| 10. | KCB Group | 223 | - |
| 11. | Barclays Bank | 171 | - |
Despite the capping of interest rates being the primary reason for the poor performance by banks in Q12017, 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. These, coupled with increased loan loss provisioning due to concerns around banking sector loan book quality, has seen the banking sector record a sluggish performance in Q12017.
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.
| CYTONNS Q12017 BANKING REPORT COMPOSITE RANKINGS | |||||
| Bank | Franchise Value Total Score | Total Return Score | Weighted Score | Q12017 Rank | FY 2016 Rank |
| KCB Group | 56.0 | 3 | 24.2 | 1 | 1 |
| Co-operative Bank | 53.0 | 8 | 26.0 | 2 | 2 |
| DTB | 64.0 | 1 | 26.2 | 3 | 4 |
| I&M Holdings | 69.0 | 4 | 30.0 | 4 | 6 |
| NIC Bank | 76.0 | 2 | 31.6 | 5 | 9 |
| Equity Group | 71.0 | 10 | 34.4 | 6 | 3 |
| Barclays Bank | 79.0 | 6 | 35.2 | 7 | 7 |
| SCBK | 75.0 | 9 | 35.4 | T8 | 5 |
| Stanbic Holdings | 78.0 | 7 | 35.4 | T8 | 8 |
| HF Group | 119.0 | 5 | 50.6 | 10 | 10 |
| NBK | 117.0 | 11 | 53.4 | 11 | 11 |
Major changes include:
- Equity Group dropped by 3 spots to Position 6 from Position 3 in our FY2016 Banking Sector Report, being weighed down by an expensive valuation based on Price to Tangible Book Valuation at 2.0x, above industry average of 1.1x, and low deposits per branch at Kshs 1.3 bn, below the industry average of Kshs 2.6 bn, indicating a lower level of efficiency in utilizing its extensive branch network to mobilize deposits,
- NIC Bank rose 4 positions to Position 5 from Position 9 in our FY2016 Banking Sector Report due to an improved intrinsic value, rising to Position 2 from Position 9 in FY2016, given its current cheap valuation. The stock is currently trading at a P/B and P/E of 0.7x and 5.0x, versus industry averages of 1.4x and 7.2x, respectively. The bank was also boosted by its franchise value, with the bank having the lowest Cost to Income ratio, coming in at 39.3% below the industry average of Kshs 53.3%.
For a comprehensive analysis on the ranking and methodology behind it, see our Cytonn Q12017 Banking Sector Report.
