In this report, we revisit the investment case for CRDB. We upgrade our recommendation to Buy (from Hold) with our new target price of TZS514 (previously TZS155) suggesting an ETR of 84%.
At our target price, we are valuing the Tanzanian bank at 1.0x 2022f PB and 5.7x 2022f PE. We see this as a fair valuation given the projected average ROE of 17.7% over our forecast horizon to FY 25f. At the current price, the bank is trading at 0.6x 2022f PB and 3.3x 2022 PE.
The increase in our valuation reflects:
The roll forward in our valuation model.
CRDB’s strategic changes in business model, which now focuses on:
the higher-margin retail segment, which we expect to offer margin support despite cost of funds pressure.
a slowdown in its expansion drive, which we expect to deliver greater efficiency.
a turnaround to profitability in the Burundi segment (a strong forex revenue source and potential digital banking fee-income earner).
improved asset quality, driven both by regulation and a change in loan book structure.
With the increasing adoption of digital channels, we expect fee income growth to be driven by digital channels. We forecast a CAGR of 16% for fee income through to FY 25f. So far, mobile and agency channels account for 37% of fee income and we believe these will be the main growth drivers.
With the expansion project having come to an end and the regulator pushing for a lower cost/income ratio, we expect the cost/income ratio to fall to 51.0% in FY 25f from 59.8% in FY 20.
Risks to our recommendation:
Political disruption in Burundi may impact CRDB Burundi’s earnings. CRDB Burundi currently accounts for 7% of net income.
The planned expansion into Congo may impact earnings negatively in the initial years.
Higher than expected write-offs in a bid to meet the 5.0% NPL ratio limit may result in a higher than anticipated cost of risk.
In the past decade, CRDB has been going through a transition from a predominantly corporate bank to a more retail-focused entity. With that shift came the need for expansion, and CRDB focused on enhancing its footprint between 2013 and 2017. With the advent of digital banking, CRDB launched agency, mobile and internet banking, and these have become the key transaction channels.
With the foray into the retail segment, the bank’s loan book structure changed, with allocation to the high-risk agriculture segment falling. The bank also expanded regionally and set up in Burundi in 2012, with plans underway to expand into Congo in the medium term. While the transition process has been marked by high costs, weak asset quality and losses in the regional unit, things have stabilised in recent years and the bank is now reaping the fruits of its transformation. We discuss the key changes in strategic direction in this report.
What we believe the new strategic direction will deliver:
1) Fee income to be a key driver of non-interest revenue
We expect fee income to account for 27% of total income by FY 25f, from 21% in FY 20. The bank’s digital banking channels accounted for 47% of fee income in FY 20 vs 19% in FY 15. Mobile, card and agency banking have continually recorded superior transaction volume growth and we expect this to be maintained despite an increase in taxes which were later lowered by 30%.
Tanzania has a low financial inclusion rate, with about 13% of the adult population being banked. We expect the country’s financial inclusion to improve, driven by digital channels, thereby allowing room for the banks to grow fee income from those digital channels.
Overall, we expect the CAGR on non-interest revenue to FY 25f to be 12%. There is however room for non-interest revenue to surprise from strong forex income from Burundi, increased trading income from government securities and higher than expected income from the bank’s insurance unit.
In our forecasts however, we have opted to remain conservative on these three elements due to their erratic nature and un-established growth trend.
2) Greater efficiency with cost/income ratio forecast to hit 51% in FY 25f from 60% in FY 20
CRDB’s expansion strategy between 2012 and 2017 increased its number of branches from 106 in 2012 to 255 in 2017. With this now having ended and the bank now opting to pursue digital banking, we expect cost growth to remain in line with inflation with the only major expense being technology spend. We expect CAGR for operating expenses to average 7% to FY 25f.
3) Higher than historical asset quality resulting in lower than historical cost of risk
We forecast NPL ratio to average 4.2% over our forecast period, lower than the 9.3% 5-year historical average. The regulator has set a 5.0% regulatory limit for banks and requires non-performing loans to be written off within one year. While this leaves the banks with less risk on their loan books, we expect the write-offs to result in cost of risk averaging 2.0% over our forecast period, which is lower than the 3.3% 5-year historical average.
4) Slight margin recovery
We forecast net interest margin to decline from 10.7% in FY 20 to 9.6% in FY 23f as the Tanzania market faces deposit gathering challenges, brought about by the treasury single account arrangement, regulators’ expansionary monetary policy direction and higher yields on government securities leading to an uptick in cost of funds.
This will partially erode the net interest margin gains made by the bank in shifting its loan book to more retail lending from low margin corporate loans (now accounting for 36% of the loan book in FY 20 from 70% in FY 12). We expect margins to recover slightly to 10.0% in FY 25f as we believe the bank will increase allocation to loan assets to cover for the pressure on cost of funds. We expect net interest income CAGR to FY 25f to be 10%.
We value CRDB using a two-stage dividend discount valuation methodology. We calculate an intrinsic value as per the methodology below.
To calculate our fair-value estimate for CRDB, we apply a two-stage dividend discount model using the profitability drivers discussed in various segments of this note, as well as a cost of equity (CoE) of 18% which we derive using a risk-free rate of 13%, an equity risk premium of 5% and a beta of 1.0x. Our valuation is in local currency, and we apply a terminal growth rate of 7%.
Our two-stage dividend discount model:
Stage 1: Standard five-year dividend discount model. Between FY 21 and FY 25, we estimate the present value of dividends using the profitability drivers discussed in this note.
Stage 2: We determine the terminal value as the perpetual growth rate in the bank’s book value based on 2023’s mid-cycle ROE of 16.5% and a terminal growth rate assumption of 7%.
Fee income to be a key income driver
Over our forecast period to FY 25f, we expect CAGR for fee and commission income to be 16%. Our view is based on:
1) Tanzania’s low financial inclusion levels
28% of Tanzania's adult population is financially excluded, which is worse than East African peers (although this may have improved slightly as the latest data is from 2017). One of the challenges is Tanzania's vast size, which has meant low penetration of financial services.
Between 2013 and 2017, CRDB focused on increasing its branch network to enhance its reach among the unbanked population. This strategy has now shifted to using digital channels (agencies, mobile banking and internet banking) to enhance reach. We believe the vast unbanked population offers CRDB room for client growth across its platforms.
2) Digital channels now account for 47% of fee and commission income
As of FY 20, mobile banking accounted for 25% of fee income with agency and card banking accounting for 10% and 20% of fee income respectively. In the past five years, mobile banking fee income has recorded a CAGR of 30%, while agency and card banking fees have had a CAGR of 97% and 10% respectively.
In our view, three elements will continue to drive strong digital fee income: 1) increasing the client base as financial inclusion improves; 2) increasing the product suite of digital channels; and 3) continued adoption of digital channels as formal transaction channels by both private and government institutions.
A potential threat to the bank's digital fee income remains the regulatory push for higher taxes. However, given the government more than doubled taxes on mobile banking in 2021, we see minimal risk of further rises in the medium term.
Asset quality is now better than historical levels
CRDB has traditionally had a weaker NPL ratio relative to its competitor NMB. However, we believe the tide is turning and we expect better asset quality than previously, based on:
1. The new structure of the loan book
CRDB’s loan book was primarily domiciled in the NPL-heavy agriculture and corporate segment. However, as at FY 20, the agriculture segment accounted for just 13% of the loan book compared to 24% in FY 12. The corporate segment now accounts for 36% of the loan book as of FY 20, compared to 70% of the loan book in FY 12. With the reduction in exposure to these two NPL-prone segments, we expect the bank’s lower NPL ratios to be sustainable. Even with this, management is still keen on growing the SME loan book, which tends to have weak asset quality.
As at FY 20, the SME sector (which accounts for 12% of the loan book) had an NPL ratio of 7%. In our view, this planned increase in exposure is likely to result in a weaker NPL ratio and hence we expect the NPL ratio to tick up from 3.8% in FY 21f to 4.5% in FY 25f, which is still below historical levels.
2. 2018 regulatory changes which allowed earlier write-offs and increased restructuring
In Q1 18, in a bid to get the industry NPL ratio down to 5.0%, the Bank of Tanzania introduced new regulations on how NPLs are handled, which have been positive for asset quality:
Allowing banks to restructure loans up to four times, as opposed to two times previously. This enabled banks to delay the recognition of NPLs.
Giving banks permission to upgrade NPLs to performing status once the institution has received at least two consecutive payments from the borrower. This is down from four consecutive payments previously.
Requiring banks to write-off loans that have been non-performing for at least four quarters, instead of the earlier twelve quarters.
These three regulations aided CRDB in reducing its NPL ratio from 13.8% in FY 17 to 4.4% in FY 20. The regulator is still keen that the NPL ratio remains below 5.0% and we do not expect these regulations to be retracted in the medium term.
The downside of these regulations however is erratic performance in cost of risk, due to write-offs and recoveries. In our view, following the clean-up of the loan book, where write-off levels were an average of 60% of NPLs, we expect write-off levels to fall to an average 40% over our forecast period.
As a result, we expect cost of risk to remain high (but below the 5-year historical average of 3.3%) at an average of 2.0%. Management is targeting a coverage level of between 75% and 80%. In our estimates, we expect the high cost of risk to elevate coverage levels from 75% in FY 21f to 97% in FY 25f.
3. President Samia Suluhu’s leadership has so far been positive for the economy, compared to predecessor John Magufuli
We have noted before that the policy shift under new President Samia Suluhu Hassan has been a positive for the country.
When President Magufuli took over the leadership in 2015, banks were negatively impacted by rash decisions made to clean up government. These decisions included laying off some civil servants, removing some allowances for civil servants, halting payments to suppliers as the government registers were cleaned up, and increasing tax bills due to backdating the taxes owed by firms.
While these decisions were great for the country in the long run, the uncoordinated and rushed method of decision-making by the former president resulted in a significant rise in NPLs between 2016 and 2018. Even though the new president is still keen on reforms, her approach has involved stakeholders in decision-making and hence key changes are likely to be more staggered and less disruptive. President Samia Suluhu has also taken time to mend trade relationships regionally and improve international relations, which has opened opportunities for Tanzanian firms. As such, we expect the stable macroeconomic environment to support asset quality.
Improved cost efficiency, but CRDB still has room for improvement
During the initial expansion years, the bank recorded a steadily increasing cost/income ratio, from 56.0% in 2012 to a high of 66.7% in 2017, due to the associated expansion costs. Part of the benefit of the expansion drive was increased access to retail clients, with the bank able to serve clients through digital channels and physical branches as well. Now that the expansion drive has ended, we expect the bank to continue its trend of a downward tapering of its cost/income ratio.
The regulator has already set a 55% limit on cost/income ratio for banks. In response, management is undertaking a branch rationalisation programme, having cut its number of branches from 255 in 2017 to 243 in 2020, mainly because some branches were not profitable and were unable to scale sufficiently. We expect this to help reduce the cost burden for the bank in the coming years as clients are shifted to digital channels.
Additionally, on staff costs, we expect minimum pressure as the new cost/income directive will likely hinder hiring. We expect the bank to encourage voluntary retirement and implement a hiring freeze. As such, we forecast staff cost growth to be below inflation. We do not expect any further significant operating cost addition for the bank going forward. We therefore forecast cost/income to fall to 51.1% in FY 25f from 59.8% in FY 20f.
Expect pressure on net interest margin, but we anticipate stability as a result of the new client base
CRDB’s net interest margin has been erratic in the past five years due to three main reasons:
1) Implementation of the Treasury Single Account (TSA) in 2016 resulted in tight liquidity conditions in the market. CRDB was primarily handling central government deposits and served several government institutions and agencies. With these deposits now not fully available, CRDB instead relied on expensive deposits from other banks and borrowing from the central bank, which shrank margins. This still presents a challenge to the bank and the overall industry, with the banks now forced to mobilise retail deposits.
2) The regulator pursuing an expansionary monetary policy which led to lower asset yields. Following the implantation of the TSA and Magufuli’s policies which disrupted the lending market, Tanzania’s private sector credit growth had fallen significantly. In a bid to encourage private sector credit growth, the regulator pursued a lower interest rate environment to boost lending. In 2020 when the pandemic hit, Tanzania’s regulator reduced the base rate to encourage private sector borrowing.
President Suluhu is particularly keen on lowering interest rates and in the past nine months there has been talk of capping the interest rates on loans. But given the failure of such a policy in Kenya, we do not see a risk of Tanzania following the loan interest rate cap model. Nevertheless, we expect the regulator to maintain a low-rate environment to support the economy as it recovers from the impact of the Covid pandemic.
3) Increased competition. NMB Bank, CRDB’s main competitor, has been growing its appetite for the corporate market, increasing the pricing competition for loans. CRDB has also been growing in the retail space which has also required some pricing competition to attract and retain clients. With the two banks converging in strategy outlook, pricing competition is likely to suppress rates going forward as each bank tries to defend its client base.
While the bank tackles these challenges, we expect the shift to retail lending to offer some margin support even as lending rates are expected to remain subdued. CRDB’s loan book as at FY 20 is 36% corporate, compared to 70% in FY 12. With this new distribution, the bank’s loan yield has continued to rise steadily, which we believe will compensate for the expected increase in cost of funds. In addition, we expect the bank to increase allocation to loan assets from an average loan to total assets ratio of 53% in the past five years to an average of 58% by FY 25F, to further defend margins.
We expect net interest margin challenges, but the new loan book structure that favours high yield retail lending means we do not expect the bank to experience the sub 9.0% net interest margins experienced in the early 2010’s on account of the heavy corporate book.
Risks to our recommendation:
Political disruption in Burundi may impact CRDB Burundi’s earnings. CRDB Burundi currently accounts for 7% of net income.
Planned expansion into Congo may impact earnings negatively in the initial years. In 2020, the CRDB board approved management's plans to expand into Congo. The bank has also received approval from the regulator to proceed with the expansion. Management noted that the expansion will be a greenfield expansion. While Congo remains underpenetrated in terms of financial services and hence offers a revenue opportunity for the bank, earnings could be negatively impacted as has been the case in Burundi.
Regulatory risk. In the recent past, both the government and the regulator have put forward policies that have significantly impacted the banking sector. Currently, the government is keen on lowering overall interest rates in the market. While we believe a rate cap is unlikely, banks are not entirely out of the woods yet in terms of regulations that may impact loan yields. As mentioned above, digital transactions remain a soft target for taxation. In our view though, given the more than doubling of tax rates in 2021, we believe it is unlikely that even higher taxes will be imposed. Overall, however, Bank of Tanzania seems to be keen on managing the sector via regulation as opposed to providing oversight. This concerns us with regards to regulatory development.
Higher than expected write-offs in a bid to meet the 5.0% NPL ratio limit may result in higher than anticipated cost of risk. In our forecasts, we assume lower than historical write-off levels with the assumption that the bank has completed the major loan book clean-up that began in 2018. In the event that there are higher write-offs, cost of risk may be higher than expected, hence reducing earnings.
Tanzania macroeconomic update
Following the death of the former president, John Magufuli, in March 2021, Tanzania has moved in a new direction under the leadership of President Samia Suluhu. The country is now reporting Covid-19 cases and has initiated vaccination, with about 1.5% of the population being fully vaccinated. This was a key demand required by the IMF to secure further funding from the institution. Though the extent of the Covid impact is difficult to assess, GDP growth recorded a slowdown to 4.8% yoy in 2020 from 7.0% yoy growth in 2019. So far, the new government has not been keen to implement stringent measures that would impact the economy negatively. The World Bank estimates GDP growth will remain above 5.0% until 2026.
Tanzania’s inflation rate remains below 5.0%, with the only major concern being rising food prices. Even then, this is being offset by lower rent, transport and cooking fuel prices. The government updated the inflation methodology in Q1 21 with the new base year being 2020, which is more reflective of accurate inflation and overall price measures over the medium term. The World Bank estimates inflation will remain below 4.0% in the medium term, which we expect to offer economic support.
Both the current account deficit and fiscal deficit remain low compared to East African peers, at 1.8% and 1.1% in 2020 respectively. Relative to East Africa peers, Tanzania possesses a lower debt burden, potential higher revenue growth rates (though this comes off a low base) and higher development spending, presenting an opportunity for the country to be an exciting investment destination for the region.
Suluhu’s government has focused on reform measures for trade and infrastructure, which so far have marked a move away from Magufuli’s erratic, authoritarian and non-business-friendly policies. Though the damage done under Magufuli’s rule will not be undone overnight, President Samia Suluhu is on the right track in steering Tanzania towards mending trade relationships, kick-starting infrastructure and encouraging trade with global entities.
With Tanzania’s economic outlook now turning in a positive direction and plenty of headroom for growth, we believe this will offer CRDB a launchpad for its next phase of growth.