Kenya’s listed banks resilient as return on equity rises to 19.2%

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Kenyan listed banks had an improved performance on aggregate in the first quarter of 2019 as they recorded improved profitability in a relatively tough operating environment, a survey by Cytonn Investment has revealed.

During the quarter, return on equity rose to 19.2 per cent from 18.4 per cent in Q1 2018, with equity group having the highest at 22.8 per cent, Cytonn’s Q1’2019 Banking Sector Review indicates.

The report, themed ‘Consolidation and Diversification to drive Growth’, analyzed the Q1’2019 results of the listed banks.

“We note that the increased emphasis on operating efficiency by banks seems to be bearing fruit, with the listed banking sector’s operating efficiency improving year-on-year, which was further supported by a recovery in interest revenue, largely supported by the asset re-allocation to government securities, and increased lending to specific segments”, said Caleb Mugendi, investment Associate at Cytonn Investments.

“The continued focus on alternative banking channels continues to boost banks’ Non-Funded Income (NFI), as well as reduce the staff and branch expenses. There are four key drivers in the sector namely; 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 in the banking sector,” Mugendi added.

However with the deteriorating asset quality, evidenced by the rising non-performing loans, banks are expected to continue employing prudent loan disbursement policies, and consequently tighten their credit standards, in order to address these concerns around asset quality.

This is in the wake of a credit crunch in the market occasioned by the interest rate law, which caps lending by commercial banks at four percentage points above the Central Bank of Kenya (CBK) rate, currently at nine per cent.

READ:Why banks in Kenya will lend at a maximum 13%

“The tough operating environment has made it hard for the smaller banks that do not serve a niche. Therefore, as has been the case recently, we are likely to see more consolidation activity, as larger banks acquire the smaller players in the sector, who are constrained in capital, as they seek to grow their market share, penetrate new market segments and expand their product offerings,” notes Ian Kagiri, Investment Analyst at Cytonn Investments.

According to Kagiri, the market is up for more mergers and strategic partnerships between banks, aimed at creating larger entities with sufficient capital base to pursue growth as well as increase their respective competitive edge and pricing power.

READ:How mergers are shaping up Kenya’s banking industry

“The residual effect will be a stable sector with well capitalized players able to catalyze economic growth as well as withstand any systemic shocks,” the Investment Analyst notes.

Key indicators

Listed banks in the country recorded a 12.2% average increase in core Earnings Per Share (EPS), compared to a growth of 14.4 per cent in Q1’2018, with the relatively lower performance attributed to the base effect, as the sector was coming from a relatively poor performance in Q1’2017, which was an 8.6 per cent decline.

Deposit growth came in at 11.0 per cent, faster than the 9.4 per cent  growth recorded in Q1’2018.

Despite the relatively fast deposit growth, interest expenses rose by 2.5 per cent compared to 11.4 per cent  in Q1’2018, indicating that banks have been mobilizing relatively cheaper deposits.

Furthermore, in September 2018, an implementation of the Finance Act 2018 saw the removal of the minimum interest rate payable on deposits, which stood at 70.0 per cent of the Central Bank Rate (CBR). This helped mitigate high increments in interest expense, despite the relatively fast deposit growth.

Average loan growth came in at 7.7 per cent which was faster than the 6.1 per cent  recorded in Q1’2018, indicating that there was an improvement in credit extension, with banks targeting select segments such as corporate entities, and Small and Medium Enterprises (SMEs).

Government securities on the other hand recorded a growth of 16.1 per cent year-on-year which was faster compared to the loans, albeit slower than 25.0 per cent recorded in Q1’2018.

This highlights banks’ continued preference towards investing in government securities, which offer better risk-adjusted returns.

Interest income increased by 3.6 per cent compared to a growth of 9.3 per cent recorded in Q1’2018.

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The slower growth in interest income despite the increased allocations to both loans and government securities may be attributable to the decline in yields on loans owing to the 100-basis points decline in the CBR, and the decline in yields on government securities, and consequently, the Net Interest Margin (NIM) declined to 8.0 per cent  from 8.1 per cent in Q1’2018, Cytonn indicates.

During the quarter under review, Non-Funded Income grew by 10.7 per cent year-on-year faster than 9.5 per cent recorded in Q1’2018.

The growth in NFI was supported by the 11.2 per cent average increase in total fee and commission income, albeit slower than the 12.2 per cent growth recorded in Q1’2018.

The fee and commission income growth continues to be subdued by the implementation of the Effective Interest Rate (EIR) model under IFRS 9 in 2018, which requires banks to amortize the fees and commissions on loans, over the tenor of the loan.

The relatively slower loan growth, a majority of which is to corporates, also inhibited the growth in fee and commission income loans, as corporates tend to be charged relatively lower commission rates, and,

The sector continued to record an improvement in operating efficiency, as shown by the improvement in the Cost to Income Ratio (CIR) to 53.8 per cent, from 56.6 per cent in Q1’2019, indicating that the raft of cost rationalization measures adopted by banks in the onset of the capped interest rate regime, have borne fruit.

Martin Mwita is a business reporter based in Kenya. He covers equities, capital markets, trade and the East African Cooperation markets.

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