On a recent research trip to Nairobi for Africa Capital Group, I had the opportunity to meet with several publicly traded banks, including Barclays Kenya, Equity Bank, and KCB. What contrasts all these banks with the major banks in the US and Europe is their conservative loan-to-deposit ratios, which on average fall in the 70-85% range vs. 85-120% for their Western counterparts (with the European banks at the riskiest end of that range). Similarly, Kenyan banks enjoy higher net interest margins (10-13% vs. 3-5% in the US) and lower cost-income ratios. Though investors face macro-economic risks in terms of inflation and exchange rates, on a company level the banks look decidedly healthier in Kenya than the too-big-to fail banks in the developed world.
Whereas the large US banks have grown in recent years, it has been merely a reshuffling of the existing deposits and loans into fewer and fewer hands. Profitability is driven by fees rather than net interest margins and public confidence in our banking system remains at a nadir. JPMorgan Chase (JPM), Bank of America (BAC), and Citigroup (C) seem to be less in the business of earning net interest margins and more in the business of generating net fee margins, whereby they collect record fees from customers and pay out record fees in the form of fines and settlements to the government and other plaintiffs. For a markedly more positive outlook, driven by fundamentals rather than the interaction between implicit government guarantees, fines and fees, Kenyan banks are worth a look.
First on my itinerary was Barclays Kenya, which is one of the more conservative banks in Kenya. Its loan-to-deposit ratio is 80% and it chose not to compete for deposits in 2012 as it felt deposits had become too expensive. As a result, its deposits market share has contracted slightly. Looking over a longer period, however, it has grown nicely, doubling its balance sheet to 118 billion Kenyan Shillings (USD 1.39 billion) in 6 years. Its non-performing loans are at 7% and trending down and their loan impairment stands at 1% and is stable. With new (tighter) banking regulations in the works, it is well positioned relative to more aggressive competitors. Barclays' greater Africa strategy is also being reconfigured to a more centralized structure as opposed to the current decentralized set-up whereby local countries report separately to London. This might allow Barclays to become a little less conservative and position itself more opportunistically in order to capitalize on the prospects for growth that abound across the continent.
Next on the itinerary was Equity Bank. This bank is one of the market's favorites and for good reason: it has a great business model. Whereas other banks compete with each other, Equity Bank believes its largest competitor is the mattress. As stuffing your money under the mattress has a lousy real rate of return and questionable safety of principal, Equity Bank enjoys a lower and more stable cost of funds than other banks that cater to a more affluent clientele. Additionally, it has one of the lowest cost-income ratios at 49%, as it uses agents rather than branches. It now has 50% of the banking customers in Kenya. I asked whether their international expansion is putting pressure on the cost-income ratio and the answer was a firm "no." In fact, some of its new East African markets have even lower cost structures than Kenya. Not much to not like here; the trick is to find a good entry point, valuation wise. One should not be too cheap, however, as often the entrenched market leaders in high growth economies will continue to do well as the pie expands.
The last bank I met with was Kenya Commercial Bank, generally referred to as KCB. Though not as big as Equity Bank, KCB has a robust 14-18% market share in Kenya, depending on what metric you use. With 18% of shares held by the Kenya national social security fund, 51% by local institutional investors, and 7% by domestic retail investors, the bank has a fairly large local ownership constituency. At present, KCB has a significant liquidity ratio of 35.5%, though they are trying to bring that down modestly. With its eyes on East Africa, the bank is focused on expanding in five other countries, including Uganda, Rwanda, Burundi, South Sudan, and Tanzania. In South Sudan its market share is 42%, in Rwanda it is 8% and its minimum target in any country is 5%. Only Tanzania is a bit disappointing at present, with the bank holding only a 4% market share. Not unlike Equity Bank, KCB also sees its future tied to mobile banking and has been piloting the agency model in Rwanda, where it has 4,100 agents. Though not as efficient as Equity Bank, KCB's cost-income ratio has been trending positively, declining from 67% to 60% to 57% in recent years, with a target of 50% in the near term.
With the (opportunity) cost of capital so much greater in sub-Saharan Africa than in more developed markets, it is no surprise that banks represent a large slice of the investable universe. In Kenya, as is often the case in other major African markets as well, the banks tend to have more conservative balance sheets than their too-big-to-fail brethren in the developed world. Coupled with higher net income margins and greater growth prospects they provide attractive opportunities for foreign investors. Investors should keep in mind, however, that part of the reason behind the conservative balance sheets is the historic precedent of volatile and high inflation rates, which have only recently moderated. To the extent that inflation is kept in check and banks don't have to compete too hard for deposits, the future for Kenyan banks looks very bright indeed.
Although Kenyan banks do not trade on any US exchange, US investors can get exposure through an ETF such as Market Vectors Africa Index (AFK), which holds Equity Bank. Of course, buying the fund just to own Equity Bank wouldn't make much sense, but one should keep in mind that banks in other sub-Saharan Africa countries are driven by similar fundamentals. From that perspective, AFK would provide meaningful access, with a 42% weighting in financials. To the extent that one wants to invest directly in sub-Saharan Africa banks, several South African names with pan-African banking footprint are available in the US market, such as Standard Bank (OTC:SGBLY), Nedbank (OTC:NDBKY), and Old Mutual (OTC:ODMTY). In the case of the latter, one would get insurance exposure as well, which is another attractive market in Africa and perhaps a worthy topic for a future article.