Co-op Bank has released its 3Q23 results, posting a 7.6%y/y rise in EPS to KES 3.14 with net income coming in at KES 18.4bn.
The improved performance came on the back of a 2.5%y/y rise in net interest income (NII) to KES 32.8bn while non-funded income (NIR) ticked up 2.1%y/y to KES 20.6bn.
NII was supported by a 14.3%y/y climb in interest income from loans and advances to KES 31.8bn as the loan book grew by 12.8%y/y to KES 378.1bn.
The top-line was also boosted by a more than doubling in income from interbank lending as interbank rates surged to decade highs of 17% in 3Q23.
Deposit growth was minute, up only 0.2%y/y to KES 432.8bn pointing to the increased struggle by banks to attract funds, with several banks now aggressively advertising for short-term deposits. Despite the minimal deposit growth, interest expense on deposits jumped 27.5%y/y following the rate hikes by the CBK.
As a result, weighted average interest rates (WAIR) on deposits rose 83bps to 4.2% – the highest level in the lender’s history since 2Q16. The top line was also weighed down by a more than doubling (2.3x) in interest expenses on borrowed funds, largely from development finance institutions. Important to note, that banks changed the benchmark rates to SOFR from LIBOR at the end of June 2023.
NIR growth was weighed by a 25.0%y/y drop in foreign exchange income to KES 2.5bn. The reduced FX margins signal an improved FX market following interventions by the CBK to revive it (introduction of an FX code) as well as probes on certain banks on alleged price fixing by the Competition Authority of Kenya. Co-op Bank has previously noted that the majority of its customers are not heavy importers nor exporters hence also likely the reason for the decline in FX income.
Operating costs before impairments rose marginally by 3.7%y/y to KES 24.8bn largely on higher staff costs, which were up 12.4%y/y to KES 12.4bn. Subsequently, the lender’s cost-to-income (CTI) ratio rose to 46.4% from 45.8%. We reiterate that we think that the lender is lagging in terms of loan loss provisioning and we expect to see a considerable uptick in provisions in 4Q23, thus slower profit growth. Loan loss provisions were down 26.5%y/y despite an uptick in the Gross non-performing loan (NPL) ratio to 14.9% from 14.0% in 3Q22.
Notably, the bank’s return on average equity (ROaE) remained unchanged y/y at 22.7%.
Capital ratios remained solid, all growing y/y while liquidity ratios remained sufficient at an excess of 30.3% above the statutory minimum.
Net interest margins (NIMs) remained resilient, sliding by a marginal 0.3% despite interest expense growth (+41.3%) outpacing interest income growth (+12.9%).
Subsidiary contribution save for the Kenyan banking units improved from 5.6% in 3Q22 to 6.3% in 3Q23, likely pointing to improvements in the bancassurance and wealth management business lines.
The lender had a negative jaws ratio of 1.4% pointing to efficiency constraints. However, we do note that the bank has put efforts into reducing its discretionary spending evidenced by a 10.4% dip in other operating expenses.
The bank seems to not have received its risk-based pricing model approved. This limits how it can price riskier borrowers, thereby potentially limiting margin growth.
Deposits were down 6.7%q/q and may continue to come under pressure following the directive by the government on a treasury single account in which government agencies should not maintain public funds in a bank account for more than 24 hours. We note that government deposits accounted for 10.9% of Co-op’s total deposits as of 1H23, equating to KES 50.6bn.
Outlook and Recommendation
Geographical concentration – we reiterate that the lender is heavily reliant on the Kenyan unit, which accounts for 93.6% of total profitability. This exposes it to vulnerability in the event of weaknesses in the Kenyan economy as currently being witnessed.
The war in Sudan is also posing risks to the bank given that it accelerated the depreciation of the South Sudanese pound and sped up the hyperinflation in the country.
Positively, having a solid customer base from Savings and Credit Co-operative Societies, growing investment and bancassurance business, settlement service for the Nairobi Coffee Exchange, strong loan book growth, commendable return on equity, and healthy ratios, boost our confidence on the counter.
The lender is looking to increase its SME business through on-lending from recent KES 15bn funding from a DEG-led consortium. In addition, the counter serves as a defensive stock (price stability) in the current environment in which valuations on most listed counters have fallen considerably.
The lender is on track to meet its guidance except for its NPL ratio and cost of funds guidance, currently at 14.9% and 4.2%, above the targeted 14.0% and 3.5% respectively.
The bank is trading at a trailing 0.65x P/B (tangible) and a forward P/E ratio of 2.84x compared to the industry’s 0.5x P/B and 3.3x P/E. Having declined 5.8% in the past 12 months, the stock has outperformed the NASI (-29.4%) and NSE 20 (-12.0%) indices. We maintain our BUY recommendation, with an estimated upside of about 16%, also noting that the lender has the second highest dividend yield amongst listed banks after StanChart, at 13.3%.