Cytonn Investments’ H1’2015 Banking Report

Following the release of the H1’2015 results by banks, Cytonn Investments carried out an analysis on Kenya’s banking sector to decipher any material changes from our Q1’2015 banking report. The aim of the analysis is to answer the question: from an equity investor point of view, which is the most attractive listed bank to invest in for the long-term?

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 are 11 in number.

As at H1’ 2015, the banking sector recorded a slow-down in growth, growing at 8.3% compared to 15.6% in 2014, with the slowdown being attributed to poor economic performance on the back of increased non performing loans and the uncertainty in the interest rate environment. On the PAT y/y growth, National Bank of Kenya (NBK) and Co-operative bank registered the highest growth of 123.0% and 32.3%, respectively. NBK’s growth was due to a robust growth in non-funded income of 227%, driven mainly by sale of property.

Net Interest Income (NII) grew by 18.8%, supported by a 30.6% growth in the loan book and 6.4% increase in deposits. Co-operative Bank’s performance was driven by a 19% y/y growth in NII, to Kshs. 11.8 bn from Kshs. 9.9 bn in H1’2014. Total operating expenses declined by 4% y/y to Kshs. 9.0 bn, bringing the cost to income ratio (CIR) to 47%, from 59% in H1’2014.

CfC Stanbic and Standard Chartered registered the largest declines of 42% and 36%, respectively. CfC’s decline was largely attributed to a decline in non-funded income (NFI), which declined by 33% y/y to Kshs. 3.3 bn thereby diluting the effect of the 2.0% increase in net interest income (NII). Standard Chartered banks results were weighed down by a 51.2% increase in loan loss provisions. NII declined a marginal 0.1% y/y, while NFI fell by 31.2% y/y on account of a one off Kshs. 1.2 bn gain last year owing to the bank’s sale of property

On the operating environment, increases in the Kenya Banker’s Reference Rate by 133 bps to 9.87% has resulted in an upward repricing of loans, raising the risk that more loans issued might fall into a non-performing territory. Discussions with various bank management teams indicate that a further increase of 300 bps in the KBRR will see a negative impact on the NPLs in the industry.

Other challenges in the banking industry include the Consumer Protection Act, that allows customers to prepay their loans and not be subject to a charge, and the Banking Act that allows customers who had placed term deposits to recall them before maturity and only be charged the foregone interest payment. This has affected commercial bank’s asset liability matching, and poses further risks in the medium term.

Some of the developments in the banking sector include:

Increase in interest rates: The KBRR increased by 133 bps to 9.87% largely as a result of an increase in the CBR by 300 bps to 11.5%. This will raise interest on all loans pegged on the KBRR;
Lower earnings growth: Banks recorded the slowest year on year growth in 6 years of 8.3% during H1’2015, as compared to 15.6% in H1’ 2014;
Core Capital: Rejection of increase in Core Capital Requirements to Kshs. 5 bn as proposed in the 2015/2016 Budget, which would have seen 20 commercial banks make shareholders’ cash calls, merge or sell equity stakes to comply with the law. Parliament rejected the proposal to increase core capital in banks to Kshs. 5 bn by 2018;
Dubai Bank Liquidation: Dubai bank was placed under receivership with the Kenya Deposit Insurance Corporation (KDIC) for failure to meet statutory requirements since July and for failure to honour a Kshs. 48.2 mn financial obligation due to Bank of Africa. The KDIC further recommended that the bank be liquidated.
Cytonn Investments’ banking report examines the health and future expected performance of the bank, by looking at metrics for profitability, efficiency, growth, asset quality, liquidity, revenue diversification, capitalization and intrinsic valuation. In total, we looked at 13 different metrics to rank the banks.

It is notable that CFC Stanbic registered the biggest ranking deterioration in the H1’2015 Cytonn Banking Report. The bank declined from Rank #1 in Q1’2015 to Rank #8 in H1’2015 because of a high cost to income ratio of 60.0% vs. an industry average of 48.1%, and low net interest margin of 5.3% vs. an industry average of 8.3%.

An excerpt of the Cytonn Banking Report