KCB Group Retains Its Position as the Most Attractive Bank in Kenya

Cytonn Investments has today released its Q3’2018 Banking Sector Report, which ranks KCB Group as the most attractive bank in Kenya, a position it has retained since FY’2016, supported by a strong franchise value and intrinsic value score. The franchise score measures the broad and comprehensive business strength of a bank across 13 different metrics, while the intrinsic score measures the investment return potential. National Bank of Kenya ranked lowest overall, ranking last in both the franchise value score and intrinsic score.
“The Kenyan banking sector continues to show its resilience in the face of a challenging operating environment. The report, themed ‘Deteriorating Asset Quality Dampens Growth, analyzed the results of the listed banks using their Q3’2018 unaudited results 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,” said Caleb Mugendi, Senior Investment Analyst at Cytonn Investments. “The increased emphasis on operating efficiency by banks seems to be bearing fruit, with the listed banking sector’s operating efficiency improving, supported by revenue expansion as well as cost containment. The continued focus on alternative banking channels continues to boost their Non-Funded Income (NFI), thereby supporting the banks’ top line revenue under the tough operating environment of compressed interest margins”, added Caleb. “We have looked at four key focus areas, which are regulation, diversification, consolidation and asset quality in this report. With a tighter operating environment, diversification of revenue, cost management and asset quality management will prove to be the key growth drivers for players banking sector.”
“With the deteriorating asset quality, evidenced by the rising non-performing loans mainly in the manufacturing, retail and real estate sectors, we expect banks to continue employing prudent loan disbursement policies, and consequently tightening their credit standards, in order to address these concerns around asset quality.  This poses a challenge, as it points to reduced intermediation in the banking sector, between the depositors and the credit consumers, one of the banking sector’s main function.” said Faith Maina, Investment Analyst at Cytonn Investments. “We have seen banks adjusting their business models with lending skewed mainly towards collateralized lending and working capital financing,” added Faith. “The tough operating environment has made it hard for the smaller banks that do not serve a niche to operate. Therefore, going forward, we are likely to see increased consolidation activity, as larger banks acquire the smaller players in the sector, who are constrained in capital. We may also see mergers and strategic partnerships between banks, aimed at creating larger entities with sufficient capital bases to pursue growth as well as increase their respective competitive edge, which will ensure the sector’s overall stability,” added Faith.
KCB Group ranked 1st on the back of a high return on average equity of 21.7%, compared to an industry average of 18.8%, as well as high operating efficiency, ranking second, with a Cost to Income Ratio (CIR) of 52.8%, compared to an industry average of 56.3%. Equity Group ranked 2nd, recording the highest Return on Average Equity at 22.3%, the second best NFI to total operating income ratio at 40.2%, above the industry average of 34.5%, and ranking 1st in the intrinsic value score. Equity Group’s ranking was largely pulled back by its expensive market valuation, with a price to tangible book (P/TBv) of 1.8x, compared to an industry average of 1.3x or KCB Group’s 1.2x.
Stanbic Holdings rose 3 positions to position 6 from position 9 due to an improved franchise value score, with the bank having the lowest NPL ratio of 7.2%, lower than the industry average of 9.9%, the highest deposits per branch of Kshs 7.0 bn, which was above the industry average of Kshs 2.9 bn, and the highest NFI to total operating income ratio of 46.5%, above the 34.5% industry average.
Kenya’s listed banks recorded a 16.2% growth in core EPS in Q3’2018, compared to a decline of 9.3% in Q3’2017. NIC Group and HF Group were the only banks that recorded declines in core EPS, with NIC recording a decline of 3.3%, and HF recording a decline to a loss per share of Kshs 0.9 from a core earnings per share of Kshs 0.5 in Q3’2017. Deposits grew at 7.4% y/y, a faster rate than loans, which grew by 4.2%, with funds channeled towards government securities that recorded a high growth of 17.8% y/y. The loan growth came in lower as private sector credit growth remained low, at an average of 4.4% in the 10 months to October 2018, below the five-year average of 12.5%, with banks adopting a more prudent credit risk assessment framework to ensure quality loan books so as to manage the rising non-performing loans, and the associated cost of risk. The sector’s operational efficiency improved, as shown by the decline in the cost to income ratio to 56.3% from 59.4% in Q3’2017, supported by the improving total operating income, and lower costs, aided by the lower cost of risk due to reduced provisioning levels.

Table 1: Cytonn’s Q3’2018 Banking Report Rankings

Source: Cytonn Research

Table 2: Cytonn’s Q3’2018 Listed Banks Earnings and Growth Metrics

Key takeaways from the table above include:

  1. Listed banks have recorded a 16.2% average increase in core Earnings per Share (EPS), compared to a decline of 9.3% in Q3’2017. NIC Group and HF Group were the only banks that recorded declines in core EPS, with NIC recording a decline of 3.3%, and HF recording a decline to a loss per share of Kshs 0.9 from a core earnings per share of Kshs 0.5 in Q3’2017. National Bank recorded the highest growth of 303.2% y/y, that was realized after adding back the exceptional items expense of Kshs 0.5 bn incurred in Q3’2018,
  2. The sector recorded weaker deposit growth, which came in at 7.4%, slower than the 13.8% growth recorded in Q3’2017. Despite the slower deposit growth, interest expenses increased by 12.5%, indicating banks have been mobilizing expensive deposits, as well as taking up borrowed funds from international financial institutions, thereby driving up the interest expense, ,
  3. Average loan growth was anemic coming in at 4.2%, which was lower than 6.1% recorded in Q3’2017, indicating that there was an even slower credit extension in the economy, due to sustained effects of the interest rate cap. Government securities on the other hand recorded a growth of 17.8% y/y, which was faster compared to the loans, and faster than 10.3% recorded in Q3’2017. This indicates that banks’ continued preference towards investing in government securities, which offer better risk-adjusted returns. Interest income increased by 6.1%, compared to a decline of 5.8% recorded in Q3’2017, as banks adapted to the interest rate cap regime, with increased allocations in government securities. The Net Interest Income (NII) thus grew by 3.8% compared to a decline of 7.3% in Q3’2017,
  4. The average Net Interest Margin in the banking sector currently stands at 8.0%, down from the 8.5% recorded in Q3’2017, despite the Net Interest Income increasing by 3.8% y/y. The decline was mainly due to the faster 17.8% increase in allocation to relatively lower yielding government securities,
  5. Non-funded Income grew by 5.9% y/y, slower than 10.9% recorded in Q3’2017. The growth in NFI was weighed down as total fee and commission growth was flat, growing by 0.6%, slower than the 10.5% growth recorded in Q3’2017. The growth in fee and commission income continued to be subdued by the slow loan growth, and,
  6. The sector continued to improve on its operational efficiency, with the Cost to Income Ratio (CIR) improving to an average of 56.3% from 59.4% in Q3’2017, buoyed by an improvement in operating income, which outpaced the operational expenses increments. Cost containment was also aided by reduced cost of risk demands, owing to lower provisioning levels. It is worth noting that some banks reduced their specific provisioning levels, even after experiencing a deterioration in asset quality. This is largely due to the fact that the first year of implementation of IFRS 9, banks are allowed to pass the effect of asset quality through the balance sheet, hence reducing the specific provisioning demands for the period, even after the implementation of IFRS 9.

Cytonn Investments is an independent investment management firm, with offices in Nairobi – Kenya and D.C. Metro – U.S. We are primarily focused on offering alternative investment solutions to individual high net-worth investors, global and institutional investors and Kenyans in the diaspora interested in the high-growth East-African region. We currently have over Kshs 82.0 billion of investments and projects under mandate, primarily in real estate.

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