The Central Bank of Kenya announced that it will not be extending the regulations allowing restructuring of loans. The allowance to restructure was implemented in March 2020 and it allowed banks to save on capital as some borrowers facing weakness could be extended moratoriums and restructured loans which reduced the need to make loan loss provisions for them.
The end of this allowance was expected, in our view. On the downside, we expect NPLs to tick up as from Q2 21, driven by restructured loans being classified regularly and weak asset quality from a weaker economic environment.
Backdating the regulation, as from 2 March 2021, banks are expected to resume standard procedures for loan classification. Borrowers whose loans were performing before 2 March 2020 but were restructured and subsequently went into arrears, will have three months (up to 3 June 2021) to regularise their loans.
According to the regulator, 57% of loans had been restructured as at end of February 2021. However, after payoffs and resumption of payments, the outstanding amount of restructured loans stood at 19% of total industry loans. The regulator noted that over 95% of loans that are outstanding are meeting repayments, in accordance with the new schedules accorded to them. This is positive as it points to less risk of NPLs stemming from the lifting of the restructured loans. The restructured loans will however keep their new terms and hence can continue to make repayments.
In the regulators’ recent briefing, the Central Bank Governor noted that with the new Covid lockdown in place in Kenya, the regulator has not completely ruled out reinstating the Covid relief measures. In the regulator’s view, the present lockdown is less stringent than the one the country had in 2020, with the President creating wider blocks of counties within which movement is allowed. As such, the impact on private sector activity is expected to be more selective, rather than widespread.
Central Bank of Kenya estimates NPL ratios to peak at 16% in June 2021, a better outcome than the 17% the regulator had estimated earlier. NPL ratio as of February was 14.7% with gross NPLs net of provisions as a percent of gross loans standing at 5.8% as of February 2021.
We believe the central bank is unlikely to extend these measures because:
We agree with the central bank that the new Covid regulations include wider blocks of counties, which will allow for much more movement of goods and people than was the case in 2020. As a result, the key economic hubs still have enough traffic and activity to support trade, albeit at a lower rate. The industries that will face the most negative impact are the services industry and education, which have so far faced a shutdown. We expect these to be the key contributors to NPLs rising in Q2 21.
We do not expect the new regulations to last for an extended period as there is not much support for the lockdown on the ground. There have already been lobby groups petitioning the president to re-open the economy, with the push for faster deployment of vaccines being the key agenda. In our view, this lockdown is likely to be lifted in the coming weeks, thereby aiding an economic rebound. As a result, we do not believe the regulator will need to reinstate the relief measures.
Improving availability of vaccines, especially to key front-line workers, and continued roll-out to the wider public should help reduce the spread of the virus. As vaccines continue to be more available, the overall economic risk of Covid-19 also reduces and as such reduces the need for reinstatement of support measures.
With that in mind, while the outlook for the banking sector still remains unclear as different banks handle the restructured loans differently, we expect the following outcomes:
A rise in NPL ratio in Q2 21 in line with Central Bank of Kenya expectations. Some of the restructured loans may fail to fully recover and will need to be downgraded to non-performing loans status. Some banks have already downgraded some loans in the restructured bucket, while others have not.
Cost of risk will likely be lower than FY 20, but we still expect the cost of risk to be higher than historical levels as banks will need to accommodate the formation of new NPLs.
Clearer view of real asset quality. The experience of FY 20 was that banks have all handled the restructures rather differently, with almost every management team noting a positive outlook for FY 21. It has been difficult to clearly break down what has been placed in the restructured loans segment and the removal of this allowance will enable a clearer view of both asset quality and loan loss provisions.