Equity Group announced FY 20 results with EPS declining 12% yoy to KES5.20
Unlike other Tier 1 banks, Equity opted not to issue a dividend for FY 20, with management highlighting a notable decline in the bank’s capital position following the increase in risk-weighted assets in H1 20 especially. For the Kenya unit, Tier 1 was at 12.4%, from 13.1% in FY 19 and compared with a regulatory limit of 10.5%. CAR stood at 16.2% from 17.4% in FY 19 and against a regulatory limit of 14.5%. Equity Group’s capital buffer is below other Tier 1 banks, Co-op Bank and KCB, and we believe this may result in continued below-peer dividend payment going forward.
NPL ratio now at 11.0% with the bank having restructured 32% of its loan portfolio in FY 20
Of the restructured loans, about 5% has been downgraded to NPL status. 23% of the book is still under moratorium with the terms on these loans soon expiring, with the regulator having stopped restructuring of loans from March 2021. Management remains confident that the remaining 23% of the restructured book will resume normal payments.
Management also believes the ‘third wave’ of Covid-19 in the country will die down in about 2-3 months with vaccines now available. As such, management does not expect Covid-19 disruption to be at similar levels as in 2020. In our view, we still expect the ‘third wave’ to impact the economy negatively given the strain experienced in health centres. Management expects the NPL ratio to be 7-10% in FY 21, but we believe the bank is likely to record higher NPL levels than this.
Cost of risk in FY 20 was 6.1%, management expects this to fall to 2.0-3.0% in FY 21
The bank has a coverage level of 59.7%, 16.6% and 1.1% for stage 3, stage 2 and stage 1 loans respectively. In our view, we believe the bank should target a higher coverage level for stage 3 loans given the high exposure to SME loans that are often not backed by collateral and face undercapitalisation and risk of closure.
Net interest income increased 23% yoy
Net interest income was boosted by high loan book growth of 30% yoy, which masked the decline in net interest margin (7.2% in FY 20 vs 8.3% in FY 19). Real loan book growth was however about 28% excluding FX adjustments and interest accumulation on loans under moratorium. Management expects net interest margin to settle between 7.0% and 8.0% in FY 21. We believe the bank will likely achieve the lower band of the target as yields on loans are unlikely to rise and the regulator remains keen on an expansionary monetary policy.
Management expects loan book growth of 25-30% in FY 21 compared to 30% yoy in FY 20
We believe this growth is likely ambitious as Kenya has gone into another lockdown similar to March last year, suggesting a slow Q2 21 for loan growth. We also expect slow loan growth in 2H 20 with the country getting into election season. Deposit growth is expected to be 20-25% yoy, up from 53% yoy in FY 20.
Non funded income grew 27% yoy driven by forex trading income (+77% yoy)
This came mainly from diaspora remittances (which contributed 32% of all forex traded by the bank). Equity Group is the market leader for diaspora remittances in Kenya. Bond trading income tripled in the year with the bank making use of its high investment in government securities. Management has a non-funded income contribution of 38-43%, compared with FY 20’s 41%. We see this as a reasonable target considering the bank’s historical average non-funded income to total income contribution of above 40%.
Regional subsidiaries contribution now at 34% with management targeting 25-30% in FY 21
This is still lower than management’s medium-term target of 40%. Tanzania with a -1.1% ROA and -7.9% ROE remains the problem subsidiary, with the NPL ratio for the unit at 35.4%. We had expected the bank to write-off most of these loans in line with other large banks in the market. And with the change in leadership in the country after President Magufuli's death earlier this month, the outlook for Tanzania’s economy is unclear.
We retain our Buy on Equity Group with an unchanged target price of KES46.0
We expect the share price to come under pressure in the short term on account of investors responding negatively to the lack of dividend payment. However, in our view, Equity Group can re-capitalise its business from retained earnings and we consider the lack of dividend payment to be a temporary issue for investors. The bank still has a strong position in its non-funded income, where the bank has a market-leading position in both diaspora remittances and digital banking revenue. Net interest margin is likely to be sustained by its ability to mobilise cost of funds. Cost/ income ratio remains low at 48.5%, with continued improvements in the subsidiary units cost structure likely to deliver returns at the group level.