Kenya Banking Sector 1H11Review

2 September 2011

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Key Contacts
Research Francis Mwangi, CFA fmwangi@sib.co.ke Eric Musau emusau@sib.co.ke Deris Mogoi dmogoi@sib.co.ke Tel: +254 (20) 22 20 225 Call Centre: +254 (20) 22 28 963 E-mail: research@sib.co.ke www.sib.co.ke Head of Trading Tony Waweru twaweru@sib.co.ke Equity and Foreign Sales Eric Ruenji eruenji@sib.co.ke

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Summary
Banking sector performance for the first 6 months to June 2011 remained strong. Sector PBT rose 16.7% y/y, while sector total assets increased 26.7% y/y to KES 1.9tn (USD 20.4bn). The period was mainly characterised by; lower NIM due to rising deposit rates, lower NIR due to decline in fair value gains from treasury holdings, improved CTI as most banks focused on cost containment and further decline in NPL due to tightening credit policies and adoption of credit reference bureaus. Total sector loans and deposits grew 30.7% (18.4% year to June) and 16.7% respectively (loan growth was stronger than expected). Equity Bank continued to outperform y/y while BBK underperformed. Small-caps, DTB and NIC, impressed q/q mainly supported by cost containment, returns from regional operations and asset growth supported by strong SME and asset finance operations, respectively. While it posted weaker than expected earnings, StanCharts loan growth was significantly higher than expected. KCB remains our top large-cap pick while Diamond Trust remains our small-cap pick. At current prices NIC remains the most attractive on a PB and rolling PE basis . YTD, KCB has outperformed (-13%) while NBK has underperformed (-39.8%) . Sector outlook remains positive; stable NIMs as banks re-price loans, cost containment through adoption of agency banking, positive returns from regional operations & scope for loan asset growth in SME and mortgage sectors. Current sector PB & rolling PE remain attractive at 2.2x and 8.5x, respectively. However, our key concern remains the lack of a concrete monetary policy as the CBK seeks to reign in inflation and guard against further depreciation of the KES (see slide on interest rates for further discussion)
EPS % y/y -2.0% 6.5% 41.3% 57.4% 15.2% 36.0% -11.9% % q/q 37.8% 28.4% 1.5% 3.3% 57.3% 8.8% -47.7% Total assets % y/y % q/q 2.2% -1.2% 23.7% 3.3% 23.4% -2.7% 39.9% 11.6% 24.2% 6.7% 24.0% 6.3% 16.8% 5.5% Advances % y/y 0.3% 34.8% 35.8% 43.2% 32.0% 32.2% 66.7% % q/q 1.2% 13.1% 3.9% 13.4% 10.9% 10.4% 22.2% Customer Deposits % y/y % q/q -1.6% -0.6% 12.4% 3.1% 19.2% -3.9% 44.3% 14.2% 23.1% 9.2% 26.1% 8.2% 10.4% 7.6%

1H11 performance Barclays Bank KCB Co-operative Equity Diamond Trust NIC StanChart

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Key 1H11 ratios

Bank Barclays Bank KCB Co-operative Equity Diamond Trust NIC StanChart Average
*Annualised

Price (KES) 12.9 19.4 14.2 19.0 95.0 32.5 200.0

PB 2.6 1.5 2.5 2.4 1.9 1.5 3.2 2.2

Rolling PE 10.0 7.4 8.9 7.9 7.6 6.5 11.2 8.5

ROE* 27.2% 21.1% 33.0% 32.6% 26.7% 24.3% 27.8%

ROA* 6.6% 4.1% 5.0% 6.9% 4.4% 4.7% 4.5%

NPL ratio 6.5% 10.0% 4.1% 4.1% 1.0% 3.7% 0.9% 4.3%

Coverage 87.0% 55.6% 64.0% 51.0% 94.6% 76.2% 57.6% 69.4%

Improved PB and PE sector rating on the back of strong price declines (PB rating mainly affected by fair value losses on AFS securities ) Stable ROE and ROA measures as competition intensifies Lower NPL ratios due to stringent credit policies, and increased recoveries Coverage ratios remain low, especially for KCB & Equity Bank with larger unsecured loan books

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Domestic credit - segmentation & quality

30.7% & 18.4% growth in advances y/y & year to June, respectively Year to June, energy & water sector recorded highest growth in credit Households account for largest portion of sector lending (27.3% of total). NPLs from the sector improve by 133bp y/y to 6.4% Tourism sector posts strongest improvement in loan quality (however overall sector loan quality remains high NPL ratio of 7.4%) We expect strong growth in credit to real estate, building & construction and trade business (most SMEs mainly categorised under trade sector) KCB & Equity Bank most exposed to impairments from personal household sector. NIC Bank least exposed

Advances & NPL per sector Agriculture Manufacturing Building & Construction Mining Energy & water Trade Tourism Transport & communication Real estate Financial services Personal/household

1H10 1H11 Gross loans NPL ratio Gross loans NPL ratio 46.4 11.9% 57.6 8.5% 118.7 5.9% 151.2 4.6% 22.7 6.6% 33.0 5.2% 9.6 1.0% 16.1 0.6% 24.4 1.2% 38.5 0.5% 151.3 8.9% 198.5 5.9% 18.7 13.9% 24.4 7.4% 66.6 5.6% 88.3 4.2% 92.2 7.6% 130.8 5.1% 42.8 5.1% 48.7 3.3% 235.5 7.7% 296.0 6.4% 828.9 7.4% 1,083.1 5.4%

Gross loan Gross Loan % share %ch y/y %ch Jan-June 1H10 1H11 24.1 16.6 5.6% 5.3% 27.4 20.9 14.3% 14.0% 45.4 30.4 2.7% 3.0% 67.7 34.2 1.2% 1.5% 57.8 42.6 2.9% 3.6% 31.2 17.4 18.3% 18.3% 30.5 23.2 2.3% 2.3% 32.6 23.8 8.0% 8.2% 41.9 22.6 11.1% 12.1% 13.8 6.6 5.2% 4.5% 25.7 12.3 28.4% 27.3% 30.7 18.4

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1H11 Key theme - interest rates

12.0%

Year to June, monetary tightening intensified with shortterm yields increasing by an average 700bp. Inter-bank rates rose >500bp. Higher rates failed to curb inflation which rose to 14.5% (June) from 4.5% in December (current rate for August 16.7%). Banks took advantage of arbitrage opportunities by borrowing through the discount window at 6.5% and investing in T-Bills at rates >8% and/or lending in the interbank market. To close the arbitrage window CBK came-up with strict rules limiting use of the discount window & most important use of borrowed funds (i.e. proceeds cannot be used for; interbank lending or forex trading). CBK also developed a pricing formula that ensures that the discount window rate, remains above the interbank and TBill rates. In our view, under current conditions (surge in inter-bank rates and restrictive borrowing from the discount window, KCB & BBKs 2H11 earnings are most exposed from an arbitrage perspective, while NIC with the highest ratio of deposits from other banks to total deposits & lowest liquidity ratio is most exposed from an operational perspective
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10.0% 8.0% 6.0%

4.0%
2.0% 0.0% Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Inter-Bank rates
16.0%
14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

Average 91 day T-bill

Average 182 day T-bill

Inter-Bank rates Average bank deposit rates

Average Bank lending rates

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Other economic indicators.

35.00% 30.00% 25.00% 20.00% 35.0% 30.0% 25.0% 20.0%

15.00% 10.00%
5.00% 0.00%

15.0% 10.0%
5.0% 0.0%

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

CPI
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Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11

y/y growth in domestic credit Money supply M3 y/y expansion %

Money supply M3 y/y expansion %

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Continued ..Forex & BOP

40.0% 30.0% 20.0%

400 300 200 100

3-Jan-05 3-Jan-06 3-Jan-07 3-Jan-08 3-Jan-09 3-Jan-10 3-Sep-08 3-Sep-09 3-May-05 3-May-06 3-May-07 3-May-08 3-May-09 3-May-10 3-Sep-10
3-Sep-05 3-Sep-06 3-Sep-07

10.0%
0.0%
3-Jan-11
3-May-11

-10.0% -20.0%

0 -100
-200 -300 BOP Exports Imports 1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11

-30.0%
-40.0% -50.0% -60.0%

USD

GBP

EURO

JPY
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Price performance
Overall, YTD, listed banks have under-performed the NSE posting average 26.4% decline against 24.3% decline for the NSE20 Index. YTD, KCB has outperformed (-13%) while NBK has underperformed (39.8%) . More recently, on a 1 month basis, Equity Bank has underperformed (17.4%) while Co-op Bank has outperformed (-5.3%)
Co-op SCB NIC NBK
6 months 3months 1month YTD

KCB HF Equity DTB CFC Stanbic BBK

-50.0% -40.0% -30.0% -20.0% -10.0% 0.0%

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5 year sector performance review

Banking sector Total assets (USD bn) % growth Total loans (USD bn) % growth Total deposits (USD bn) % growth Loans/GDP (%) Deposits/GDP (%) Loans/deposits (%) Sector NPL Ratio Equity/assets Interest spread Core Capital/ TRWA* Number of branches Population per branch (000) Deposit accounts (m) 2005 8.4 0.0% 4.5 0.0% 6.9 0.0% 23.9 36.8 64.8% 18.1% 12.9% 8.7% 15.3% 534 65.7 2006 10.5 24.3% 5.5 23.0% 8.3 20.3% 24.4 36.8 66.2% 14.9% 12.9% 9.4% 0.0% 575 62.8 3.3 2007 14.1 34.9% 7.4 33.9% 10.5 26.3% 27.1 38.6 70.2% 8.1% 13.6% 8.8% 18.0% 740 50.3 4.7 2008 16.7 18.4% 8.8 20.1% 12.3 17.2% 29.4 40.9 72.0% 7.3% 13.9% 9.5% 18.0% 887 43.2 6.4 2009 17.0 1.7% 8.9 1.2% 12.8 4.0% 30.4 43.4 70.1% 6.8% 14.5% 9.7% 19.0% 996 39.6 8.7 2010 20.6 21.1% 10.7 19.7% 15.3 19.5% 33.4 47.5 70.2% 5.4% 15.9% 10.2% 20.0% 1,063 38.0 11.8

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