According to the latest data from Central Bank of Kenya, the country's banks recorded a 97% yoy increase in profit before tax (PBT) for the first two months of Q2 21 (April and May). In the first five months of 2021, PBT increased 42% yoy, which is still a strong performance for the banks. We believe the performance was mainly on the back of three factors:
Lower provision charges given that Q2 20 saw banks accelerate their cost of risk to counter the asset quality weakness related to Covid-19.
We believe banks recorded lower costs in Q2 21 as most have transitioned their office models to work-from-home or a hybrid, thus reducing the cost of having physical offices.
Non-interest revenue likely ticked up on account of increased transaction volumes and resumption of charges on digital channels.
Net interest margin may be negatively impacted by lower lending
According to the regulator, gross loans to deposits ratio fell to 73% in May 2021 from 77% in May 2020, with banks preferring to direct funds to government securities and not lending. With rates being lower on government securities compared to loans, we expect net interest margins to narrow for banks in Q2 21.
On loan yields, the Central Bank of Kenya has still been working with banks and has yet to approve loan pricing models for banks. As it is, banks in most cases have had to charge loan interest rates closer to the loan rate cap levels of Central Bank Rate + 400bps.
Though there was optimism that lending rates would pick back up after the loan rate cap was lifted, this has been stalled by the regulator dragging its feet on approving new pricing models. As it is, it remains unclear when banks can have new pricing models in place.
Asset quality remains weak with NPL ratio at 14.2% in May 2021
Following a 16% yoy rise in gross NPLs, the NPL ratio increased to 14.2% in May 2021 from 13.0% in May 2020. The NPL ratio is trailing behind the regulator’s expected 16.0% level predicted for June 2021, but was in line with our expectations. We believe the asset quality decline was largely related to the lockdown implemented towards the end of Q1, when Kenya was facing its third wave of the Covid-19 pandemic.
Our outlook for asset quality in 2021 remains cautiously optimistic. We believe the country is unlikely to face another lockdown as the president has shifted gears on Covid-19 management and is now focusing on stepping up vaccine supply as opposed to lockdowns.
We expect improvement to also arise from improved economic performance as exports recover and the country resumes normal operations in most sectors, except for tourism and hotels. On the downside, banks can no longer restructure loans for clients and thus there may be some uptick in NPLs in H2 21 as they can no longer be restructured.
Balance sheet growth showing a positive trend
Loan book growth was 6% yoy for May 2021 while deposit growth was 12% yoy, evidence of the increasing liquidity in the market. In its recent monetary policy committee meeting, the regulator highlighted that private sector credit growth was at 7.7% yoy in June 2021. We note that private sector credit growth has been gaining momentum over the past quarter with private sector participants looking forward to better performance in Q3 21.
While we believe the Central Bank target for private sector credit growth of 10.2% for FY 21 is achievable, we are concerned that election jitters and the continuation of Covid-19 might impact growth negatively.
Transaction growth set to boost non-interest revenue
After the ban on charges on digital transactions was lifted and higher transaction limits were retained by the Central Bank of Kenya, overall transaction volumes have been increasing. Earlier in Q1 21, we had noted that digital payments had recorded a significant uptick as Covid-19 warranted less use of cash transactions.
We also noted that agency transaction values (which grew 52% yoy in H1 21) were boosted by Covid-19 causing an accelerated shift to cashless transactions. We believe the combination of the resumption of charges on digital channels and increased transaction values on digital channels will result in higher non-interest income in Q2 21 for banks. We expect outperformance from Tier 1 banks which have the largest market share in terms of retail clients as well as digital channel infrastructure and investment.
KCB remains our top pick with a TP of KES54.00
Among our covered Kenya banks, KCB is our top pick and our recommendation is based on expected higher fees and commission income from increased transaction values and higher transaction numbers. The bank is also set to benefit from higher fee income from government-related collections as it streamlines National Bank of Kenya’s operations.
Net interest margin is set to remain above peers on account of the low cost of funds from its retail customers and it also benefits from National Bank of Kenya’s cheap government deposits. The bank so far has minimal cost pressure aside from continued investment in streamlining National Bank of Kenya’s operations, but this is coming to an end in the medium term.
KCB's high NPL levels remain a concern however. Although KCB has accelerated provisions, the recovery of the bank's NPLs may take until 2023 as Covid continues to impact the economy and businesses are expected to withhold investments in the run-up to Kenya's general election in 2022.