Ideas & Debate

Why investors are wrong on bank stock valuations

nse

A broker trades at the Nairobi Securities Exchange. Commercial bank stocks have recorded some of the highest gains at the NSE this year. FILE

Commercial bank stocks have recorded some of the highest gains at the Nairobi Securities Exchange (NSE) this year. The average price index of Kenya’s banking stocks has jumped by 50 per cent since January.

A notable trend, however, is that there appears to be a disconnect between listed banks’ key operational performance indicators and the performance of their stocks, which suggests that investors might not be getting the valuations of banking stocks right.

First, performance figures show that the lenders’ bottom lines are under immense pressure.

Third quarter results for the five listed banks that have so far released their results (Co-operative, Diamond Trust, Equity, KCB and National banks) show that consolidated after-tax profit declined by 12 per cent in the three months ended September 30, compared to the three months ended June 30.

During the same period, total operating costs grew faster than revenues (13 per cent versus four per cent).

Secondly, growth in non-performing assets for the five banks is outperforming growth in earning assets.

At the close of the third quarter, bad loans grew by 39 per cent year-to-date compared to a growth of 16 per cent for the interest bearing assets like government bonds — both held to maturity and for sale, loans and advances to customers and deposit placements with other banks.

The third interesting observation is that while total loans for the five banks grew by 12 per cent quarter-on-quarter, interest income derived from loans and advances to customers grew by five per cent.

That disconnect in the growth of the two variables just serves to demonstrate the fact that banks continue to sit on significant levels of non-performing assets that remain unclassified — ideally they are supposed to reclassify non-performing assets and effectively suspend all the interest pertaining to them.

This demonstrates the fact that the banks’ bottom line has been under immense pressure this year, growth in earning assets continued to wobble, non-performing assets could be higher than previously thought yet bank stock prices are up strongly since the year began.

In fact, the average price index of the five banks has returned 46 per cent since the year began. This begs the big question, what has been driving bank stocks?
Perhaps it’s down to the fact that Kenyan banks remain the most profitable in sub-Saharan Africa in return-on-equity terms.

But investors should now be worried about the declining financial fundamentals of the lenders. In fact, there could be more risks to shareholder wealth if non-performing assets were to continue growing at the same rate in the next 12 months.

Increased provisioning for these bad loans and subsequent write-offs would mean, on a worst case scenario, a deep cut in dividend payouts to shareholders.