Small banks are likely to be sold off at knock-down prices as past acquirers struggle to turn around the businesses amid declining returns.
Standard Investment Bank (SIB) analysts say that questions abound as to whether past acquisitions have presented value for money for the purchasers given that many seem to be facing headwinds in turning around operations.
“Valuations have dropped off a cliff post the interest rate cap legislation in 2016, in line with the plunging return on equity multiples,” says SIB in latest analysis.
“Future acquisitions may occur at significant discounts to book unless value can be demonstrated.”
Some of the recent transactions have been that of Giro Commercial Bank, which was absorbed by I&M Bank #ticker:I&M in 2016 at price to book (PB) ratio of 2.2, while Habib Bank Kenya was taken in by Diamond Bank Kenya #ticker:DTK 2017 at 0.85x PB.
SIB says whereas consolidation is almost inevitable in the sector, many smaller banks lack the relevant efficiencies for long-term profitability. This has made it difficult for bigger players to turn them around upon acquisition.
“We remain suspicious of some transactions that have occurred in this space as purchasers seem to struggle immensely to turn around the operations, although market conditions have worsened for the small lenders after the interest rate cap,” said SIB.
Mwalimu Sacco, which purchased Equatorial Commercial Bank and rebranded to Spire Bank falls in this category, according to SIB.
SIB analysis say Spire bank performance raises concern around the level of due diligence that was undertaken by the teachers’ union.
Small banks, categorised as tier III lenders, have also borne the biggest brunt of non-performing loans (NPLs), further eroding their value.
SIB data shows that as at end of 2017, the average NPL ratio for tier III lenders was 18 per cent, being 5.7 per cent higher than industry’s average.
In addition, tier III banks’ profitability pressure has mounted in interest rate cap era due to their failure to adjust to the realities of a more challenging market.
Prior to rate cap, profit before tax (PBT) had contracted by 41.9 per cent to Sh3.2 billion between financial year 2013 and 2016.
This pales in comparison to tier I and tier II lenders whose cumulative PBT grew by 30.3 per cent and 12.2 per cent respectively over the same period.
Since Central Bank of Kenya revised peer grouping in 2010, 2017 marked the first time tier III banks collectively reported a loss (Sh2 billion in PBT. SIB tips this trend to continue with third quarter of 2018 having left them with 17.5 per cent drop in PBT year-on-year.