In its newly released Q4 19 House Price Index, the Kenya Bankers Association (KBA) notes that house prices in Kenya have fallen for a fourth consecutive quarter. Hass Consult (real estate agents) add that rental prices have been declining too. These trends have huge implications for asset quality and for the banks we cover, given their exposure to the real estate and building construction sectors. Moreover, with the economy remaining weak, there is little chance that asset quality will improve significantly this year.
Figure 1: House Price Index has declined since mid-18 (Q1 13 = 100)
According to the KBA, the downward trend is in line with the softening of the economy and is a manifestation of the interplay between weak demand, driven by tepid disposable income growth, and supply-side conditions. The KBA also notes that there is a rising number of distressed properties, which is weighing on house prices. This has led to sellers and landlords reducing prices and rents.
These price and rent reductions have led to mortgages becoming loss making for borrowers, as they are unable to rent out homes to match their mortgage payments, due to the oversupply of units. Rental yields softened to 5.7% in 2019 from 6.5% in 2000, and are projected to continue falling, on account of oversupply and low income levels.
For the banking sector, this has meant:
- Borrowers continue to face difficulties repaying mortgages;
- Real estate developers are unable to sell their properties as soon as they expect;
- Property sales in the secondary market are now at lower prices, with potential buyers remaining on the sidelines, hoping for further price reductions; and
- Distressed developers may not be able to attract renters in the event that banks convert their properties to rentals rather than for sale.
Kenya banks asset quality to remain under pressure
At end-March 2019, the real estate and building and construction segments accounted for 19% of total gross loans in Kenya. And the two segments combined accounted for 21% of gross NPLs at Kenya banks – the real estate segment had an NPL ratio of 12.6% at end-March 2019, while the building and construction segment had a ratio of 19.6%.
In our view, given the continued softening of house prices, the oversupply of office, residential and commercial space and the slow rate of disposable income growth, we expect the asset quality of the real estate segment to remain weak. Moreover, any improvement in the NPL ratios in these sectors will remain hampered by the legal system, with banks barred from selling property at lower-than-market prices and the transferring of property still a very slow process.
Figure 2: Distribution of loans and NPL ratios
Source: Central Bank of Kenya
Stanbic and KCB most exposed to mortgage sector
In our universe of banks, Stanbic and KCB have the highest exposure to the mortgage sector, with 16.5% and 14.8% of total loan books held in mortgages, respectively, according to the Central Bank of Kenya. Given the poor disclosure on Kenya banks on loan distribution, the extent of other real estate/building and construction NPLs is hard to estimate. However, Co-operative Bank and Diamond Trust Bank have 14% and 26%, respectively, of their total loan books held in real estate, building and construction, as per their disclosures. And total lending to real estate and building and construction accounts for 19% of total loans in Kenya.
With our universe of banks accounting for 62% of total gross loans in Kenya, we make the assumption that overall exposure for our banks to the real estate and building and construction mirrors sector data, at an average 20%. This drives our view that asset quality will remain weaker than historical levels.
We could see some improvement, but this will mainly come from the personal and trade segment, which are likely to improve given increased access to credit. Overall, with the economy remaining weak, there is little indication that asset quality will see a significant improvement in 2020.
That being said, we maintain our existing views on Kenya banks stocks, as those views incorporate our assumption that asset quality will not improve significantly.
Figure 3: Banks' mortgage books as a percentage of total gross loans
Source: Central Bank of Kenya