Companies

Equity breaks into corporate debt market with Sh5bn City Hall loan

Kenya’s big banks are shaping up for a fresh market war following Equity Bank’s announcement that it had struck a record Sh5 billion loan deal with City Hall – marking its entry into corporate lending.

Equity, which turned the consumer lending market on its head with its small and unsecured loans model, has also teamed up with six other lenders to offer a $164 million (Sh13 billion) syndicated loan to Rift Valley Railways — the firm that has a 25- year concession to run the Kenya-Uganda railway.

The RVR loan deal, which insiders say is to be concluded in the next four months, means Equity will contribute at least Sh1.5 billion, making its intentions for the corporate debt market clear.

It remains to be seen whether the bank will replicate its personal loans market revolution in the corporate debt market where it has had no presence.

The small, but highly lucrative corporate debt market, has been dominated by a few big banks with the level of capitalisation required to offer big loans.

In the past seven years, these banks watched, almost helplessly, as Equity went to the bottom end of market borrowers and grew to become Kenya’s biggest bank by customer base and the country’s fourth largest bank by assets.

In the corporate debt market, Equity will be competing for the big borrowers whose numbers have been diminishing as most corporations choose to raise money from bonus and rights issues helped by the recent build-up of retained earnings.

lenders

Though the City Hall loan opens a new channel for Equity Bank to grow its interest income, it also moves the lender close to the single borrower limit raising questions as to what safeguards are in place to mitigate default risk in such a highly indebted public entity.

Single borrower

Equity has total core capital of Sh19.9 billion – meaning it can lend up to Sh4.98 billion to a single borrower according to financial results for the year that closed on December 31, 2010.

Helios put Sh11 billion into Equity at the end of 2007 in a deal that helped it acquire a 24.99 per cent in mortgage lender Housing Finance following the exit of CDC, a British government investment group.

Analysts said that even if Equity raised its core capital to the requisite minimum of Sh20 billion to qualify for the Sh5 billion loan limit to a single borrower, lending such a huge amount to a highly indebted entity such as City Hall is fraught with high level of risk.

Kenya’s banking law that was enacted in 1994 after a number of banks collapsed in a row limits loans to individual borrower to 25 per cent of core capital.

But analysts also acknowledged the long-term relationship between the bank and City Hall that may have offered comfort to the lender, especially with the presence of a guarantee.

“One would think that there is some form of guarantee from the government in this but there remains high level risk in the event of change in the list of officials who approved the guarantee,” said John Kamunya, the head of research at Dyer and Blair Investment Bank. “The government would need to guarantee such a loan but in the absence of such, the risk goes up,” said Mr Kamunya.

Equity has not indicated that there is any form of guarantee for the loan.

Kenya’s public debt has risen to 51 per cent of the gross domestic product in the past one year from about 48 per cent in mid 2010, signalling that more public resources have to be spent of debt servicing if the country is come down within the internationally recommended threshold of 40 per cent of GDP.

People familiar with the City Hall deal say the loan is being offered to help the Nairobi City Council to service another debt and help unlock money that has been held because of failure to pay the debt.

The loan comes only a few months after Local government minister Musalia Mudavadi warned local authorities – including City Hall – against accumulating debt they cannot repay.

The Nairobi City Council is heavily indebted to a large number of entities, including the National Social Security Fund and the National Hospital Insurance Fund that are claiming billions of shillings from the local authority in non-remitted statutory deductions.

Given that the new cash will attract interest at the rate of 10 per cent, analysts said the bonds market could be the first casualty of Equity’s entry into the corporate debt market.

The highest yield (returns) for bonds stands at about 10 per cent with the 30-year bond as the only one with yields above 10 per cent.

This means that the banks are getting closer to matching the bond market but minus the heavy cost of compliance that borrowers incur in the bonds market.

Equity loan to City Hall is the second in three years.

The bank offered the NCC a Sh3 billion in 2007 – just before its listing by introduction at the Nairobi Stock Exchange to finance construction of branded kiosks and giving it a micro-business face.

Equity Bank did not respond to a request for comment on the outcome of the project including the repayments.

Francis Mwangi, an investment analyst from the African Alliance Investment Bank, sees Equity’s move as prudent in the bank’s quest to grow its loans book and to utilize the huge cash pile it has been sitting on since Helios pumped in Sh11 billion.

“Equity as has huge capital reserves that its retail clients would likely not exhaust and needed a corporate deal like this one to use its vast reserves,” said Mr Mwangi.

The loan is expected to earn Equity Bank some Sh500 million in interest income in the first year alone – a figure that will decline over the remaining term of the loan.

By the end of last year, Equity had in excess of Sh72 billion in customer loans and advances that earned it a total of Sh12.8 billion in interest income.

The new credit facility adds an additional Sh5 billion to Equity’s loan book, which stands at just about half of the bank’s total assets valued at Sh133 billion at the end of last year.

Risky borrower

Mr Mwangi says that though the City Council might appear as a high risky borrower, it has regular cash flows including revenue from parking fees against whose strength the bank extended the loan.

“It must be expected that the bank did due diligence before lending to the council because it has regular cash flow making it easy to project on its earnings,” said Mr Mwangi.

Wilson Irungu, the general manager at NIC Capital, said that the loan offers Equity an opportunity to lend to a quasi-government institution that is a lower-risk client than a retail borrower.

The deal also looks more attractive compared to a similar five-year government paper, where the last offer floated in January is paying a coupon rate of 7.96 per cent.

“City Hall has billions of assets and a regular cash flow which more than account for the collateral against which the loan could have been extended,” he said adding “This is a higher yielding loan for the bank than investing in a corresponding T-bond.”

Equity has had to look beyond its retail customers for growth, having bought a 24 pert cent in home lending firm Housing Finance for a Sh7 billion investment that has offered it exposure to mortgage business which is generally characterised by bigger loan amounts- an average of Sh6.6 million.

City Hall has lately been involved in consolidation of its debts as a way of cleaning up its books as it prepares to float a Sh100 billion infrastructure bond.

Among the recent moves meant to reduce on its outstanding debts that runs into billions of shillings, is the debt swap agreement with telephone service provider Orange/Telkom that has seen the Sh111 million debt drop to just about Sh8 million.

It hopes to use the loan to settle a Sh2.3 billion debt that it owes the local authorities’ provident fund, Local Authorities Provident Transfer Fund.

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