Ratio Magazine :: The Inside Track to East Africa’s Economies - Kenya: Faida Investment Bank Recommendation: Equity Bank Limited

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Kenya: Faida Investment Bank Recommendation: Equity Bank Limited

Wednesday, 08 October 2008

Ratio Magazine is showcasing banking sector research from Faida Investment Bank (FIB). In this follow up piece to the overview of the banking sector, FIB’s Head of Research, David Mataen, assesses Equity Bank as an investment proposition.

Equity Bank Limited

Equity Bank Business Review

The bank’s business model is based on Grameen Bank’s, focusing on high volumes and low margins based on simplifying and demystifying financial intermediation.
In December 2007, Helios EB Investors, a hedge fund, invested in the bank KES11.4bn in a seven-year long term investment that provided the bank with badly needed core capital to finance the fast-paced growth and expansion. This action moved the bank’s core capital from KES2.2bn to KES15.5bn, instantly becoming the most capitalised bank in the region. As a result, Helios is now the single biggest investor in the bank, holding some 24.99% of its equity.
In June 2007, the bank acquired the biggest minority stake (20%) in a strategic investment in Housing Finance, the nation’s biggest mortgage lender. Together with British American Investment Company (BAIC), they form a strategic partnership as anchor shareholders in Housing Finance, creating a wider customer base and opening new possibilities for composite financial services.
Within the year, the bank borrowed KES4.52bn in tier two capital from various international development financial institutions in order to diversify its funding base, and support its evolving corporate lending business.

Company Operations

In figures: The bank opened 29 new branches in 2007, installed 150 new ATM machines to bring the total to 350, and recruited 1,029 new staff to ensure effective service delivery.
It entered into partnerships with leading retail stores such as Nakumatt, Tuskys and Uchumi to roll out 660 point of sale (POS) terminals. This has enabled it to increase its outreach nationwide to ease customer access to its various products and services.
It extended banking hours by one and half hours weekdays and one hour all Saturdays.
The bank launched several innovative deposit products in the year, and enhanced the use of its ATM card as debit and charge card, as well as for cash withdrawals at retail outlets and service stations.
Themed loan products targeting the youth and women were also rolled out in the year.
Leveraging off its strategic investment and relationships with Housing Finance and British American Investment Company, the bank launched “Hekima Milele”, a mortgage and investment product riding on the assembled competitive advantage of the three institutions.
The bank obtained principle membership to Visa, the largest international card association, which has enabled it to issue Visa cards and use its ATMs as points of sale for Visa transactions.
As the bank continues to increase and benefit from economies of scale, its efficiency ratio is improving tremendously. At 53% in June, it is now one of the best in the industry.
Efficient asset allocation has left the bank with one of the highest loans/deposit ratios in the sector at 72%. Government securities/deposits is also high at 27%. These are backed by borrowing borrowings of KES7.2bns in the books.
While the bank continues to boast some of the lowest cost of funds at 1.49%, it is not the lowest it has seen as an institution thanks to the long-term borrowings that were accessed at commercial terms.
However, the bank continues to enjoy good, and often expanding, net interest margins owing to the pace of its expansion that has taken it to places banking was non-existent before.

Future Outlook

The strategic investment in a large minority stake (20%) in Housing Finance, Kenya’s leading mortgage finance company, spawns tremendous revenue opportunities, cost synergies and scale advantages. The revenue opportunities accruing to the bank are as follows: the opportunity to include Housing Finance-backed mortgage products in its product mix; to be able to lend medium term deposits to Housing Finance at a much higher interest margin than attainable from treasuries or deposits with other institutions. The resulting interest spread would accrue to Equity as marginal income on existing assets.
Cost synergies include shared services i.e. service delivery channels (making ATMs inter-operable, combine card centre), debt recovery staff and initiatives; marketing efforts. Scale advantages accruing to Housing Finance would benefit Equity Bank in as much they help Housing Finance’s business grow. The best example is the flexibility of capital backing that will enable Housing Finance to participate in club bonds and innovative financing initiatives i.e. asset securitizations.
The bank’s liquidity levels are fairly high, indicating that more aggressive lending is to be expected in the coming months, while the treasury will also be expected to increase its money markets activities. On the flipside, interest on deposits can be expected to continue falling as the bank strives to maintain net interest margins. We expect the bank to increasingly push non-interest attracting deposit products in the market place.
The bank raised KES11bns in fresh equity late last year. We expect it to continue the branch network advance it is making in Kenya, and to reinforce its search for acquisition candidates within the region. Tanzania, Rwanda and South Sudan are on the radar screen for the remainder of this year and next.
We expect the bank to retire the subordinated debt entirely or a substantial part of it before the end of this year, as it is currently capital heavy.

Summary of the Investment Value

The banking sector continues to perform well as hitherto unbanked sections of the economy become formalized and get drawn into the cash economy, and trade within the region and with international partners continues to increase.
Opportunities for fee-based models are opening up and increasing: i.e. IPO financing; foreign exchange trading; inter-network remittances; increased POS services terminations.
Automation is helping rationalize operating costs in the sector, making it possible to access and enjoy economies of scale and improved productivity.
The bank’s growing lending book, efficient operations and high net interest margins make for extremely highly profitable growth going forward.
Non-loan related non-interest income is yet to develop, and though the bank may be facing competitive challenges, the potential to mine its vastly growing client-base for fee-based business is enormous.
Buying into Housing Finance should improve Equity Bank’s liabilities deployment, boost trading margins, diversify asset classes and cap operating costs while fueling new growth.
The bank’s loan portfolio has grown at a compounded annual growth rate of 114% in the past five years; total income has grown at a CAGR of 193% in the same period. Return on capital employed has also grown very impressively to become the best in the sector.
We believe the bank’s growth trajectory is sustainable in the short and medium term up to a maximum of three years. It is not sustainable in the long term as competition will compete away the advantages it now enjoys. However, we expect the bank thereafter to continue to grow at above sector average rates in the long term.
We expect cost to income ratio to come down considerably as the bank has enough core capital reserve to finance expansion rather than utilize internally generated funds.
As the lending book grows, and economic conditions continue to wobble, we expect loan loss provisioning to grow to 7% of net operating income in the next to years.
The bank has just started paying dividends, and we expect this policy to sustain on a progressive basis until it comes in line with other commercial bank’s payout levels. This should help defend the share price in the future.

Recommendation We estimate six months forward PE at 11.5x and eighteen months forward PE OF 6.9X. We therefore recommend investment in the stock of this bank as a VERY STRONG BUY

The above summary is an abridged version of Faida Investment Bank’s research. For the full document, including data, contact David Mataen, Head of Research, Faida Investment Bank (FIB), on This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

For David's overview of the banking sector, read Kenya: Faida Investment Bank on Kenya’s Banking Sector: Ready for Take Off

Also read Kenya: Faida Investment Bank Recommendation: Kenya Commercial Bank
Kenya: Faida Investment Bank Recommendation: Barclays Bank Limited

Disclaimer: The information contained herein is obtained from sources that to the best of our knowledge are reliable. As such, neither Faida Investment Bank nor Ratio Magazine/Africa Business Insight are responsible or liable for any factual errors arising thereof. Any opinions expressed herein are ours and may change anytime at no notice.

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