Dear Investors, Hold On the Banking Sector – Genghis Capital

“We recommend a HOLD on the banking sector. We note that the challenging business environment, occasioned by regulatory constraints, coupled with weakened asset quality, serve as impediments to growth,” said analysts from Genghis Capital.

According to the analysts, the Kenyan banking sector is still facing existing uncertainty with the interest rate cap ceiling but said that the sector is resilient.

Genghis has picked on KCB Group as their top pick in the sector with a Target Price of 62.52 shillings and potential upside of 39.6 percent from the current market price.

KCB Group is currently trading at the sector average of 1.2x P/B, despite having an ROE of 21.9 percent the highest in the listed banking sector space.

Further, key performance metrics enhance KCB Group’s fundamental capability: Non-Performing Loans (NPL) ratio (6.9 percent), Net Interest Margin (NIM) (8.2 percent) and an attractive dividend yield (7.8 percent).

“Additionally, we recommend a SELL on Standard Chartered Bank of Kenya with a Target Price of 193.88 shillings, an 8.5 percent potential downside from the current market price,” said Genghis.

Analysts are of the opinion that the Standard Chartered Bank’s conservative strategy will continue to curtail growth, with FY19F bottom-line performance expected to decline (-6.3 percent PAT).

Analysts also have remained concerned about the asset quality of Standard Chartered Bank, noting that the NPL ratio remains the highest, which despite the expected improvement, may not result in major deceleration in the ratio.

“However, the bank’s dividend yield (9.0 percent) continues to rank the highest (alongside Barclays). We project that provisions will rise by an average 52.9 percent y/y in 2019 as the base effect brought about by the day one IFRS 9 write-off will have already come into effect, meaning provisions (and coverage levels) are expected to rebound to the FY17 levels,” they added.

The banking sector’s Net Interest Margin (NIM) is expected to remain relatively unchanged at 7.6 percent due to the sector’s focus on investment in the lower yielding government securities, balanced by a moderate recovery in the loan book and CoF management.

The Cost-to-income (CTI) ratio for the sector is expected to shift downwards moderately to 46.7 percent as banks adjust their business models in a bid to enhance operational efficiency.

“We expect Non-Interest Revenue (NIR) contribution to rising gradually in 2019, averaging 33.5 percent for banks under our coverage. We project a 35bps y/y decline in the average NPL ratio under coverage to 9.5% in FY19F,” added Genghis.

The asset quality in the sector is projected to improve gradually on account of more stringent credit profiling. Following the High Court Ruling, we view this as an opportune time for the National Assembly to address the interest rate cap law.

Analysts anticipate a modification of the rate cap while enhancing clarity in the provisions and expect positive sentiment on the counters but we remain cautiously optimistic as increased bank lending to the SME segment and risky borrowers may not be fully actualized with the implementation of IFRS 9, coupled with the challenging business environment.

“We see M&A activity picking up in 2019 and 2020. As a case study, Nigeria underwent reforms in 2005 and studies suggest the banking sector is more stable, in addition to promoting increased competition, efficiency, and a platform to enhance economic growth.”

Kenya should follow a similar path and this could be achieved by increasing the core capital requirement to KES 5.0Bn from KES 1.0Bn (a proposal previously rejected in parliament), which would reduce the number of banks by half (c. 20). Additionally, consolidation would serve to strengthen the capital market.