And the most attractive bank is…

Maurice Oduor shares a light moment with Faith Maina and Ian Kagiri during the Cytonn H1' 2018 Banking Sector Report

Banking performance for first half of the year paints a bright picture for KCB Group, which has retained its top position since 2016, as the most attractive bank in Kenya according to Cytonn Investments Report. This is attributed to a strong franchise and intrinsic value scores.

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.

Housing Finance Group though, ranked lowest overall, ranking last in the franchise value score.

Ian Kagiri, an investment analyst at Cytonn Investments said that the Kenyan banking sector has fared relatively well in the face of a challenging operating environment, following the capping of interest rates, coupled with increasingly tighter regulation.

“Banks will continue to put more emphasis on alternative revenue streams to boost their Non-Funded Income and adopt an efficient operating model through alternative banking channels and digitization in order to remain profitable under the tough operating environment of compressed margins,” Kagiri said.

Themed “Growth and Efficiency aided by Technology, amid deteriorating Asset Quality”, the report analyzed the results of the listed banks using their first six months of 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.

“We have looked at four key focus areas, which are regulation, diversification, technology and asset quality in this report. With a tighter regulatory environment following the capping of interest rates and adoption of IFRS 9, diversification of revenue, cost management and asset quality management will prove to be the key growth drivers for players in the banking sector,” he said, anticipating the banking sector to record a recovery in earnings compared to 2017, buttressed by the ongoing economic recovery from the harsh operating environment experienced last year due to the General Elections and the prolonged drought.

This is coming at a time when experts overwhelmingly believe that the effects of the aforementioned have spilled over to the current year, as shown by the deterioration in the industry’s asset quality, largely attributed to several sectors such as manufacturing, retail and real estate. After the implementation of IFRS 9 in January 2018, which takes a forward-looking approach to credit assessment and provisioning requirements, people abreast with the financial sector argue that banks with poor asset quality will likely witness a depletion of their capital bases as they have to set aside provisions for both the performing and non-performing loans.

“With the deteriorating asset quality, evidenced by the rising non-performing loans, we expect banks to continue employing prudent loan disbursement policies, and consequently tightening their credit standards, in order to address the concerns around asset quality, in a bid to protect their profitability. 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 functions. We have seen banks adjusting their business models with lending skewed mainly towards collateralized lending and working capital financing,” said Faith Maina, a financial expert.

KCB Group ranked 1st on the back of a high return on average equity of 21.9%, compared to an industry average of 19.5%, as well as high efficiency, with a Cost to Income Ratio of 52.0%, compared to an industry average of 55.7%. Equity Group ranked 2nd, recording the highest return on equity at 23.9%, the second best Net Interest margin at 8.8%, above the industry average of 8.1%, and the third best efficient bank with a Cost to income Ratio of 52.8%, above the industry average of 55.7%.

Co-operative Bank rose 2 positions to 4 from position 6 in Q1’2018, owing to its optimal loan to deposit ratio of 84.6%, above the industry average of 73.6%, a relatively high net interest margin of 8.6%, above the industry average of 8.1%, and the highest capitalization with a tangible common ratio of 16.8%, above the industry average of 14.4%.

Kenya’s listed banks recorded a 19.0% growth in core EPS growth in H1’2018 (EPS is what informs how much money the company is making in profits per share of stock), compared to a decline of 14.4% in H1’2017, and a 5-year average growth of 6.7%. Only NIC Group and Housing Finance Group recorded declines in core EPS, registering declines of 2.1% and 95.7%, respectively. Deposits grew at 10.0% y/y, a faster rate than loans, which grew by 3.8%. The loan growth came in lower as private sector credit growth remained low at an average of 2.5%, in the 8 months to August 2018 below the five-year average of 13.0%, with banks adopting a more prudent credit risk assessment framework to ensure quality loan books so as to manage the rising non-performing loans.