Kenyan banks are trapped in purgatory as suspense holds

I have been a bank analyst for years but I must say that it is always a herculean task trying to make an investment call on lenders when their balance sheets are trapped in purgatory as they are right now.

Purgatory is, according to the belief of some Christians, an intermediate state after physical death for expiatory purification though there is disagreement whether such a state exists.

And here is what I mean: Central Bank liquidity support, widespread loan restructurings which has so far masked credit problems, the needle not moving much when it comes to actual loan delinquencies and seemingly liquid balance sheets, all paint a picture of a stationary pendulum.

You just cannot tell, with certainty, whether the pendulum will resume motion and swing towards heaven or remain stationary.

That said, there is a lot of expiation to be done before any transition happens.

First, according to the Central Bank of Kenya (CBK), total loans amounting to Sh1.38 trillion (or 46.5 percent of the total banking sector loan book of Sh2.97 trillion) had been restructured by the end of October, in line with the emergency measures it announced at the onset of the coronavirus pandemic to provide relief to borrowers.

What is a restructured loan anyway (if not a bad loan sitting in purgatory)?

Going by the CBK figures, my back-of-the-envelope calculations suggest that more than half of loans are non-performing. And income statements have provided some evidence.

Net earnings for the nine-month period ending September 2020 declined to Sh60 billion compared to the Sh93.5 billion they earned in a similar period of 2019.

The decline has been primarily driven by a surge in impairment costs on bad loans, which rose from Sh23.8 billion to Sh70 billion in the same period.

Larger Tier one banks have been the worst hit with their net earnings declining by 33 percent in the same period as impairment costs nearly tripled.

But the evidence from income statements is also not exhaustive because much of the income accruing from these restructured loans have not been frozen in line with prudence (and are still reflected in banks’ income statements).

There is also a visible dislocation in growth between balance sheets and income statements. While loan-books grew by eight percent year-on-year, loan-book revenues expanded by just two percent, which could imply that either (i) margins have softened significantly (which is plausible); or (ii) interest capitalisation maybe inflating loan-books, given the widespread restructurings.

Secondly, economic growth prospects aren’t looking rosy (despite optimism being expressed by leading lights) with another contraction in output in 2021 still a reality.

This has two negative impacts: (i) because banks are generally sensitive to the accumulation or cause of any output contraction risks, the potential for future losses remains elevated; and (ii) loan volumes will remain depressed as demand-side constraints persist.

I guess my point here is that it will be difficult to make calls on banks while their balance sheets are still trapped in purgatory. For one, you don’t know whether they will expiate fast enough to heaven or they will remain trapped.

But it is increasingly looking like they must prepare for a prolonged stay and utilise the time to (i) ring-fence their balance sheets from future losses by raising more secondary capital; and (ii) buy more market share on the cheap.

@GeorgeBodo