Big banks’ third quarter earnings were below par

The top eight large banks doubled their net earnings year-on-year in the third-quarter of 2021 to Sh28 billion, being the second consecutive quarter that net earnings have surged. Upon further review, however, these profits don’t look quite as robust.

Three-quarters of the pre-tax earnings was not really ‘earned’ but came from write-backs of impairment losses recognized in 2020, the result of accounting maneuvers. Broadly, for banks, the concept of impairment of financial assets refers to the amount by which the carrying amount of an asset exceeds its recoverable amount.

Essentially, every loan issued to a customer is meant to pay for itself and produce profits. If a loan, due to macroeconomic factors, were unable to pay for itself and produce profits then its carrying value exceeds recoverable amount and this difference has to be reflected in income statements through impairment loss.

As performance improves and the recoverable amount begins to rise, the impairment losses are released. This is purely an accounting maneuver, which was the case for the eight large banks. However, the other 31 banks painted a contrary picture and did not release prior impairment recognitions; and consequently reported a business-as-usual performance in the quarter.

Makes you wonder the kind of economic scenarios modelling by the big banks over the next two years, given the continued Covid-19 pandemic overhang on the domestic economy and the looming election cycle. But that’s quite a debatable crystal ball.

In any case, it is increasingly looking like Covid-19 is here for some time.

Nonetheless, if it is true that the worst of the pandemic is over for their borrowers then why aren’t loan books growing? By the close of September 2021, private sector credit grew by a paltry 7.4 percent in annual terms. Instead, the pile-up of government debt, which is currently paying up to ~13 percent, continues.

At the close of the quarter, the ratio of government debt securities to total assets for the large banks rose to a third, the highest since I started keeping records. On the flipside, the ratio of customer loans to total assets dropped to 51 percent, the lowest since I started counting.

This shift in allocation can also be seen through the high liquidity ratios. Average industry liquidity ratios rose to 60 percent (from 57 percent at the close of second-quarter) while for the large banks, it stood at 55 percent. So, they are not growing loan books, yet they are signaling that the risk environment has improved. A classical dichotomy right there.

As I opined in my previous article, banks have deployed excess capital to guarantee less capital-intensive banking activities and they need to return some of the excess capital to shareholders in the form of dividends (or even buybacks).

Buying government debt with a capital adequacy ratio (CAR) of 18 percent is an inefficient use of capital (as buying of government securities requires zero capital allocation). Furthermore, for the fourth consecutive year, banks will not meet their cost of capital in 2021.

With annualised return on equity holding steady at 15 percent as at September against cost of equity of around 18 percent, economic returns on bank capital are still likely to be negative 2021.

For instance, Equity Bank #ticker:EQTY , the largest balance sheet in the region, has seen its capital adequacy ratio stabilise at 20 percent between 2015 and 2020 while return on average equity dropped to 16 percent from 24 percent in the same period.

KCB #ticker:KCB , the largest domestic balance sheet, equally printed a drop in return on average equity from 24.2 percent in 2015 to 14 percent in 2020 while, at the same time, its capital adequacy rose from 16.9 percent to 21.6 percent in the same period. You should have been shorting banks.

Bodo is a bank analyst