Credit Trends: Kenyan Banks Adapting to a lower business growth environment

JEAN-FRANCOIS TREMBLAY, ASSOCIATE MANAGING DIRECTOR JULY 2017 CHRISTOS THEOFILOU, ASSISTANT VICE PRESIDENT – ANALYST Moody’s financial institutions footprint in Africa As of June 2017, Moody’s rates over 40 FIs across 12 African countries

Angola Banco Angolano de Investimentos (B1 RUR, b3) Letshego Holdings Limited (Ba3 Stable) Botswana Botswana Development Corporation (Baa2 Stable, b1) DR of Congo Rawbank (B3 Stable, b3) Bank of Alexandria SAE (B2 Stable, b3) Banque du Caire SAE (B3 Stable, caa1) Egypt Banque Misr SAE (B3 Stable, caa1) Commercial International Bank (Egypt) SAE (B3 Stable, b3) National Bank of Egypt SAE (B3 Stable, caa1) Ghana GCB Bank Limited (B3 Stable, b3) KCB Bank Limited (B1 Stable, b1) Kenya Equity Bank Kenya Limited (B1 Stable, b1) Co-operative Bank of Kenya Limited( B1 Stable, b1) Mauritius Commercial Bank Limited (Baa3 Stable, ba1) Mauritius SBM Bank (Mauritius) Ltd. (Baa3 Stable, ba1) BMCE Bank (Ba1 Stable, ba3) Morocco Credit du Maroc (Ba1 Positive, ba3) Access Bank Plc (B1 Stable, b2) Sterling Bank Plc (B2 Stable, b3) Bank of Industry (B1 Stable) - GRI Nigeria Zenith Bank (B1 Stable, b1) Guaranty Trust Bank Plc (B1 Stable, b1) First Bank of Nigeria Limited (B2 Negative, b3) United Bank for Africa Plc (B1 Stable, b2) ABSA Bank Limited (Baa3 Negative, baa3) Bidvest Group Limited (Baa3 Negative) Development Bank of Southern Africa (Baa3 Negative, ba2) FirstRand Bank Limited (Baa3 Negative, baa3) Industrial Development Corp. of South Africa (Baa3 Negative, ba2) Tanzania CRDB Bank Plc (B1 Stable, b2) Investec Bank Ltd (Baa3 Negative, baa3) South Africa National Microfinance Bank plc (B1 Stable, b1) Land and Agricultural Development Bank (Baa3 Negative, ba3) Tunisia Amen Bank (B1 Negative, b3) Mercantile Bank Limited (Ba3 Stable) Limited (Baa3 Negative, baa3) Arab Tunisian Bank (Ba3 Stable, b1) Real People Investment Holdings (Pty) Ltd (Ca No outlook) Banque de Tunisie (Ba3 Negative, b1) Standard Bank Group Limited (Ba1 Negative) Banque Internationale Arabe de Tunisie (Ba3 Negative, b2) The Standard Bank of South Africa Limited (Baa3 Negative, baa3) Societe Tunisienne de Banque (B1 Negative, caa3)

Banking Sector Credit Trends: Kenyan Banks 2 Kenya’s Growth Continues to Outpace Regional Average

Real GDP Growth Rate for Kenya and The Sub-Saharan African Region

Sub-Sharan Afrrican GDP Growth Kenya's GDP Growth 7.0%

5.9% 6.0% 6.0% 5.7% 5.8% 5.8% 5.4%

5.0% 4.6% 5.3% 5.1%

4.0% 4.3%

3.5% 3.0% 3.4%

2.6% 2.0%

1.0% 1.4%

0.0% 2012 2013 2014 2015 2016 2017F 2018F

Source: IMF, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 3 Kenyan Banks’ Dilemma: To lend or not to lend?

Trends in Kenya’s key interest rates

364-day TBR Average Lending Rate Average Deposit Rate Inflation Rate Lending Rate Cap

21%

19% 17.7%

17%

15% 13.6%

13% 11.7%

11% 10.3%

9%

6.4% 7.1% 7%

5% Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

Source: of Kenya, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 4 Poll: What is your view on the interest rate caps?

A. The interest rate caps are working and will remain as they are. B. The interest rate caps have had unintended consequences, but I don’t see them changing. C. The interest rate caps have had unintended consequences and will likely be revised.

Banking Sector Credit Trends: Kenyan Banks 5 Asset Quality has Deteriorated for Kenyan Banks

Trends in problem to gross loans across economic sectors

2015 2016 Mar-17 30%

25% 24.2%

20% 17.3% 14.5% 15% 13.1% 9.5% 10.7% 10.4% 9.5% 9.1% 9.3% 9.1% 10% 8.0% 8.3% 6.6% 7.1% 7.1% 6.2% 4.9% 4.7% 4.7% 4.5% 2.8% 5% 3.2% 3.5% 2.6%

0%

Source: , Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 6 Business Models Differ For the Three Rated Banks

Latest Book Breakdown by Segment

Large Enterprises Consumer SME Micro Enterprises Agriculture

100% 4% 3% 1% 2% 2% 5% 7% 90% 11%

80%

19% 70% 38% 55% 60%

50%

40%

30% 63% 23% 52% 20%

10% 14%

0% KCB Group Equity Bank Co-op Bank Source: Banks’ financial statements and investor presentations, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 7 Equity Bank is Most Affected by Recent Challenges

Trends in asset quality and lending rates during 2016 and 1Q 2017

KCB Bank Equity Bank 10% 9.5% 9% 7.9% 8% 7.0% 7% 6% 5% 4.1% 4.2% 4% 3% 2.6% 2% 1.3% 0.8% 1% 0% % Increase in NPLs Since YE2015 Current NPLs to Gross Loans (March 2017)

Average Lending Rates KCB Bank Equity Bank Co-op Bank 18% 16.8% 17% 16% 15.3% 15% 14% 14.8% 12.7% 13% 12% 11.5% 11% 11.4% Q1 2016 Q2 2016 Q3 2016 Q4 2016 Q1 2017 Source: Banks’ financial statements and investor presentations, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 8 Equity Bank Nonetheless Reacted and Has High Buffers Latest Key Financial Indicators for the Three Rated Kenyan Bank

Liquid Banking Assets / Tangible Banking Assets Net Loans to Deposits 100% 91.2% 90% 87.9% 80% 72.3% 70% 60% 50% 39.1% 40% 28.7% 30% 24.7% 20% 10% 0% KCB Bank Equity Bank Co-op Bank

KCB Bank Equity Bank Co-op Bank b1-rated global peers 7% 6.1% 5.8% 6% 5.5% 5% 4.3% 4% 3.5% 3.5% 3% 2.1% 2% 0.7% 1% 0% Net Income % Average Total Assets Pre Provisions Income % Average Total Assets Source: Banks’ financial statements, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 9 Poll: Do you believe a banking sector consolidation trend will continue amongst banks?

A. No, if anything the number of banks will grow. B. Yes, moderately. Some small banks will need to consolidate to remain viable but a large number will likely remain in operation. C. Yes, Kenya needs a much smaller number of banks and the regulatory authorities should take measures to accelerate the trend.

Banking Sector Credit Trends: Kenyan Banks 10 Some Regional Countries Have Weaker Asset Quality

NPLs/ provisioning coverage is weakening compared to peers

NPLs % Gross Loans (latest) (latest) Provisions % NPLs (latest) (RHS) 20% 70%

18% 60% 16%

14% 50%

12% 40% 10% 30% 8%

6% 20%

4% 10% 2%

0% 0% Botswana DR of the Ghana Kenya Mauritius Nigeria South Africa Tanzania Congo Source: IMF, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 11 Resilient Profitability to Absorb Rising Credit Losses

Kenyan banks show relative profitability strength compared to SSA peers

RoAA RoAA - global median RoAE - global median (RHS) RoAE (RHS) 5.0% 30%

4.5% 25% 4.0%

3.5% 20% 3.0%

2.5% 15%

2.0% 10% 1.5%

1.0% 5% 0.5%

0.0% 0% Botswana DRC Ghana Kenya Mauritius Nigeria South Africa Tanzania Source: IMF, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 12 Solid Capital to Absorb any Unexpected Losses

Kenyan banks show relative capital strength compared to SSA peers

Bank Capital % Assets (latest) Regulatory Capital % RWAs (latest) 25%

20%

15%

10%

5%

0% Botswana DRC Ghana Kenya Mauritius Nigeria South Africa Tanzania

Source: IMF, Moody’s Investors Service

Banking Sector Credit Trends: Kenyan Banks 13 Appendix

Banking Sector Credit Trends: Kenyan Banks 14 Moody’s Related Research

Press Release Moody's assigns first-time ratings to Kenya's Equity Bank and Co-op Bank

Credit Opinions KCB Bank Kenya Limited – Semiannual Update, March 2017 (1064565) Co-operative Bank of Kenya Limited – First Time Ratings, June 2017 (1080563) Equity Bank of Kenya Limited – First Time Ratings, July 2017 (1079231)

Other Research Sub-Saharan Africa: Foreign-currency shortages are subsiding but will take time to overcome, May 2017 (1070939) Banks – Africa: 2017 Outlook – Stable: Resilient Earnings, High Capital Buffers and Ample Local Currency Funding Counterbalance High Asset risks, December 2016 (1053446) KCB Bank Kenya and CRDB Bank (Tanzania): Peer Comparison – Strengths Are Similar But Stronger Operating Conditions Lift KCB’s Standalone Credit profile, October 2016 (1038290) Banking System Overview, February 2016 (1014070) Banks - Africa - Gaps in Banking Regulation and Supervision Are Progressively Being Addressed (1053880)

Banking Sector Credit Trends: Kenyan Banks 15 Moody’s Rates KCB Bank Kenya at B1/ Stable

KCB Bank Kenya Local Currency Deposits B1/ NP Baseline Credit Assessment b1 Outlook Stable Counterparty Risk Assessment Ba3(cr)/ NP(cr) Foreign Currency Deposits B2/ NP

KCB compares favorably with b1-rated peers

KCB Bank Kenya Limited (BCA: b1) Median b1-rated banks 18% 35% 16% 30% 14% 25% 12% 10% 20% 8% 15% 6% 10% 4% 3.9% 5% 2% 6.2% 15.4% 6.9% 25.6% 0% 0% Asset Risk: Capital: Profitability: Net Funding Structure: Liquid Resources: Liquid Problem Loans/ Tangible Common Income/ Tangible Market Funds/ Banking Assets/Tangible Gross Loans Equity/Risk-Weighted Assets Tangible Banking Assets Banking Assets Assets Solvency Factors (LHS) Liquidity Factors (RHS) Source: KCB Bank Kenya Limited and KCB Group, Moody’s Investor Services

Banking Sector Credit Trends: Kenyan Banks 16 Moody’s Rates Equity Bank Kenya Limited at B1/ Stable

Equity Bank Kenya Local Currency Deposits B1/ NP Baseline Credit Assessment b1 Outlook Stable Counterparty Risk Assessment Ba3(cr)/ NP(cr) Foreign Currency Deposits B2/ NP

Equity Bank compares favorably with b1-rated peers Equity Bank Kenya Limited (BCA: b1) Median b1-rated banks 12% 40% 10% 35% 30% 8% 25% 6% 20% 15% 4% 4.2% 10% 2% 6.1% 11.2% 11.7% 35.6% 5% 0% 0% Asset Risk: Capital: Profitability: Net Funding Structure: Market Liquid Resources: Liquid Problem Loans/ Tangible Common Income/ Tangible Funds/ Tangible Banking Assets/Tangible Gross Loans Equity/Risk-Weighted Assets Banking Assets Banking Assets Assets Solvency Factors (LHS) Liquidity Factors (RHS)

Source: Equity Bank Kenya Limited and Equity Group Holding Limited, Moody’s Investor Services

Banking Sector Credit Trends: Kenyan Banks 17 Moody’s Rates Cooperative Bank of Kenya at B1/ Stable

Co-op Bank Kenya Local Currency Deposits B1/ NP Baseline Credit Assessment b1 Outlook Stable Counterparty Risk Assessment Ba3(cr)/ NP(cr) Foreign Currency Deposits B2/ NP

Co-op Bank compares favorably with b1-rated peers Cooperative Bank of Kenya Limited (BCA: b1) Median b1-rated banks 18% 35% 16% 30% 14% 25% 12% 10% 20% 8% 15% 6% 10% 4% 3.3% 5% 2% 4.2% 16.3% 6.6% 26.5% 0% 0% Asset Risk: Capital: Profitability: Net Funding Structure: Market Liquid Resources: Liquid Problem Loans/ Tangible Common Income/ Tangible Funds/ Tangible Banking Assets/Tangible Gross Loans Equity/Risk-Weighted Assets Banking Assets Banking Assets Assets Solvency Factors (LHS) Liquidity Factors (RHS)

Source: Co-operative Bank of Kenya, Moody’s Investor Services

Banking Sector Credit Trends: Kenyan Banks 18 Banks have chosen different responses to lending caps

Year-on-Year Change in Balance Sheet as at end March 2017

KCB Bank Equity Bank Co-op Bank 162% 60%

50%

40%

30%

20% 18% 16% 15% 12% 10% 7% 5%

0%

-10% -9% -13% -20% Customer Deposits Growth Net Loans Growth Government Securities Growth

Banking Sector Credit Trends: Kenyan Banks 19 Year-on-Year Change in Profitability During Q1 2017

Equity Bank most impacted but partly buffered by improved NIR and Efficiency

KCB Bank Equity Bank Co-op Bank 80% 65% 60%

40% 26% 20% 20% 8% 5% 5% 0% 0% -2% -2% -2% -2% -5% -3% -9% -6% -20% -12% -22%

-40% -38%

-60% Net Interest Income Non-Interest Income Total Operating Operating Expenses Loan Loss Provisions Net Income Income

Banking Sector Credit Trends: Kenyan Banks 20

Jean-Francois Tremblay Christos Theofilou, CFA Associate Managing Director AVP-Analyst Tel: +44.20.7772.5653 Tel: +357.25.693.004 [email protected] [email protected]

Banking Sector Credit Trends: Kenyan Banks 22 This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

© 2017 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, and affiliates (collectively, “MOODY’S”). All rights reserved. licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND ITS RATINGS AFFILIATES other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any (“MIS”) ARE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, contingency within or beyond the control of, MOODY’S or any of its directors, officers, employees, agents, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND MOODY’S PUBLICATIONS MAY representatives, licensors or suppliers, arising from or in connection with the information contained herein or INCLUDE MOODY’S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, the use of or inability to use any such information. CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY’S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY’S IN ANY FORM OR MANNER VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY’S OPINIONS INCLUDED IN WHATSOEVER. MOODY’S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY’S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK Moody’s Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody’s Corporation AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY’S ANALYTICS, INC. CREDIT (“MCO”), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, RATINGS AND MOODY’S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR debentures, notes and commercial paper) and preferred stock rated by Moody’s Investors Service, Inc. have, FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT AND DO NOT prior to assignment of any rating, agreed to pay to Moody’s Investors Service, Inc. for appraisal and rating PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain NEITHER CREDIT RATINGS NOR MOODY’S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN policies and procedures to address the independence of MIS’s ratings and rating processes. Information INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY’S ISSUES ITS CREDIT RATINGS AND regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities PUBLISHES MOODY’S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY than 5%, is posted annually at www.moodys.com under the heading “Investor Relations — Corporate THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. Governance — Director and Shareholder Affiliation Policy.” MOODY’S CREDIT RATINGS AND MOODY’S PUBLICATIONS ARE NOT INTENDED FOR USE BY Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian RETAIL INVESTORS AND IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS License of MOODY’S affiliate, Moody’s Investors Service Pty Limited ABN 61 003 399 TO USE MOODY’S CREDIT RATINGS OR MOODY’S PUBLICATIONS WHEN MAKING AN 657AFSL 336969 and/or Moody’s Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER applicable). This document is intended to be provided only to “wholesale clients” within the meaning of section PROFESSIONAL ADVISER. 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY’S that you are, or are accessing the document as a representative of, a “wholesale ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, client” and that neither you nor the entity you represent will directly or indirectly disseminate this document or COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE its contents to “retail clients” within the meaning of section 761G of the Corporations Act 2001. MOODY’S REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN securities of the issuer or any form of security that is available to retail investors. It would be reckless and WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY inappropriate for retail investors to use MOODY’S credit ratings or publications when making an investment PERSON WITHOUT MOODY’S PRIOR WRITTEN CONSENT. decision. If in doubt you should contact your financial or other professional adviser. All information contained herein is obtained by MOODY’S from sources believed by it to be accurate and Additional terms for Japan only: Moody's Japan K.K. (“MJKK”) is a wholly-owned credit rating agency reliable. Because of the possibility of human or mechanical error as well as other factors, however, all subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody’s Overseas Holdings Inc., a information contained herein is provided “AS IS” without warranty of any kind. MOODY'S adopts all necessary wholly-owned subsidiary of MCO. Moody’s SF Japan K.K. (“MSFJ”) is a wholly-owned credit rating agency measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization (“NRSRO”). MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are MOODY’S is not an auditor and cannot in every instance independently verify or validate information received assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain in the rating process or in preparing the Moody’s publications. types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 To the extent permitted by law, MOODY’S and its directors, officers, employees, agents, representatives, and 3 respectively. licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and or the use of or inability to use any such information, even if MOODY’S or any of its directors, officers, municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such applicable) have, prior to assignment of any rating, agreed to pay to MJKK or MSFJ (as applicable) for losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or appraisal and rating services rendered by it fees ranging from JPY200,000 to approximately JPY350,000,000. damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY’S. MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

Banking Sector Credit Trends: Kenyan Banks 23