Equity Bank versus KCB: Who will control the future?

By Jevans Nyabiage and Emmanuel Were

Kenya: The tale of KCB and Equity Bank is bound to get most interesting this year as the two largest Kenyan banks by assets race to dominate business in the region.

On Thursday last week, both KCB and Equity Bank released their results for the financial year ended 2013. 

KCB went first with a morning brief and reported a 17.5 per cent increase in net profits to Sh14.34 billion. Equity Bank followed in the afternoon, after trading at the stock market had closed, to report a 9.9 per cent increase in net profits to Sh13.28 billion.

Yes, indeed KCB had stayed ahead of its rival Equity Bank for a fourth straight year.

But going forward, the most pertinent question is, which of these two banks will control the future?

This is a question that needs to be thought through and digested by investors, shareholders, investment bankers, the regulators in the region and the general public.

This is because whichever of these two banks edges ahead will not only control banking as we know it today, but also all facets of financial transactions — how you pay for your public transport, how do you manage your wealth, where and how you get and pay for insurance, and how you finance and manage your business.

Rags to riches

To understand who will control the future, one has to absorb the words of famed writer George Orwell: “Who controls the past controls the future: who controls the present controls the past.”

Equity Bank controls the past with its rags-to-riches story that has become a Kenyan export; the institution re-wrote the history of banking.

But KCB controls the present, staying ahead in profits compared to Equity Bank. 

However, which of the two will control the future is a question that might even baffle the great Orwell.

To try and answer that, one needs to look at a bit of the present, the past and take a sneak peek into the future. 

Presently, KCB is riding on a high. The bank’s net profits for the full year ended December 2013 rose to Sh14.34 billion, making it the most profitable bank listed at the Nairobi Securities Exchange. 

But what really powered KCB to maintain its lead over Equity Bank for a fourth straight year was its cost-cutting measures.

One of the biggest expenses that KCB drastically reduced was its loan loss provision. This provision is an expense set aside as an allowance that some loans will be defaulted on and the bank will have to take the hit.

KCB’s bad debt charge in the full year 2013 was Sh2.9 billion, down from the previous year’s Sh3.7 billion. 

Analysts are worried about this because KCB’s gross non-performing loans (NPLs) — the loans an individual or business has not repaid over 90 days — were rising. The bank’s NPLs increased by 30.4 per cent to Sh19.2 billion.

Worried

Ideally, this means that if KCB’s bad debt charge for the full year 2013 should have been rising as its NPLs rise.

“We remain concerned about KCB Bank’s provisioning, which has been declining despite the rise in NPLs and which remains below the sector average,” said Kestrel Capital analysts in a report.

One analyst who spoke on condition of anonymity estimated that had KCB been prudent enough in its bad debt provisioning, the bank’s net profit would have been four per cent lower at Sh13.8 billion.

“This should be a big concern to the bank and to regulators because they are not providing adequately for the bad loans,” said the analyst.

The foreseeable danger with KCB providing less for bad loans is that when interest rates rise, ordinary citizens and SMEs will start defaulting on their loans, which will affect its bottom line.

Already, central banks in Europe and America are weighing the option of ending the era of cheap money by raising interest rates.

In fact, the World Bank has already warned of the rise in interest rates globally. Its newly released Global Economic Prospects (GEP) report cautions that developing countries might catch a cold if developed countries sneeze from the effects of high interest rates.

Many market watchers foresee an inevitable, steady rise in interest rates, but nobody is certain of when this will happen.

On the converse, Equity Bank has been increasing its provisions for bad debts. The bank increased its provision to Sh2.4 billion in 2013, compared with Sh1.6 billion the previous year.

This could be an indication that Equity is taking a more cautious approach to guard against a rise in interest rate. This is especially since the bank, which has seven million customers, the largest of any bank, draws most of its earning from doling out unsecured loans at high interest rates to low-income earners.

When inflation or the cost of money rises, these low-income earners are among the hardest hit as they try to make their ends meet on daily wages. 

Equity Bank’s thinking could be to sacrifice the present by putting in place high provisions for future loan defaults. 

 Another aspect that kept KCB ahead was a huge drop in its interest expense after it retired some expensive deposits.

KCB’s interest expense dropped 30 per cent to Sh8.6 billion in the full year to 2013, down from Sh12.4 billion the previous year. KCB changed tack and decided not to take deposits from corporate clients, whose financial muscle allows them to negotiate for better rates on their deposits.

Cheap deposits

The bank turned to technology to help it mobilise cheaper deposits through the launch of M-Benki in the latter part of last year. M-Benki allows customers to open accounts using their M-Pesa accounts. This is helping KCB get retail clients who hardly earn any interest on the money in their accounts.

Technology is also helping KCB cut its cost to income ratio. 

Also, after finally concluding the early retirement of staff and paying off those who opted to leave the bank in 2013, KCB’s costs declined.

In 2013, for every Sh100 in revenues KCB generated, Sh54 was eaten up by costs, but this was an improvement from the Sh57.4 that went to costs in 2012.

KCB might also have its tail up at the moment because of the injection of new blood in the bank.

CEO Joshua Oigara, 40, has now settled in his office after serving his first full year. He is also building a management team that is in his age group and eager to build the bank in the wider Eastern Africa region by venturing into Ethiopia, Djibouti and possibly the Democratic Republic of Congo.

KCB even poached two executives, Mr Samuel Makome and Mr Collins Otiwu, from Equity Bank. Mr Makome heads KCB’s Kenyan unit while Mr Otiwu is the group chief financial officer.

“In our view, KCB’s recently assembled senior executive team seems to have gelled well. We remain optimistic the team will sustain the bank’s transformative momentum pivoted around product innovation and improved staff productivity,” said Standard Bank Investment analysts in a research report.

Equity Bank, on its part, remains in the firm grip of James Mwangi, its CEO and a major shareholder. He helped bring the bank back from the intensive care unit to its feet when it was saddled with losses as a building society. 

Regional influence

Equity’s succession planning is not clear, though. But of late, the bank has been recruiting from multinational companies, an indicator that it wants to fully professionalise.

KCB also leads Equity Bank in terms of making money outside Kenya. KCB earned Sh2.1 billion from its operations outside Kenya, while Equity Bank’s subsidiaries contributed Sh1.2 billion.

Operations in South Sudan were the difference between the two.

KCB somehow navigated through the chaos in the country, while Equity Bank took a hit, with a huge chuck of bad debts coming from its operations in the new state.

However, while KCB might be leading in many facets presently, Equity Bank is better placed in two aspects.

First is in its core business. The core business for banks is to take deposits from customers and then lend this money to clients. Whichever bank has a higher interest margin — the difference between the interest rate at which the bank lends to clients and the rate at which it pays for the deposits — sets itself up well for strong growth.

Equity Bank’s interest margin at the end of December 2013 was 12 per cent compared to KCB’s 10 per cent.

And secondly, Equity is keeping a lid on its costs. For every Sh100 it gets in revenue, only Sh48 is taken up in costs compared to KCB’s Sh54.

Whereas KCB is a larger business — it has assets worth Sh391 billion compared to Equity’s Sh277 billion — it is the latter that seems to be achieving a better return on its assets and also on shareholders’ cash.

Going by the results for the period ended December 2013, for every Sh100 shareholders put into Equity Bank, they got a return of Sh28 in profits.

This is a higher return than KCB’s, where every Sh100 yielded Sh24 in profits. In financial jargon, this measure is called a return on equity.

Historically, Equity Bank has been catching up with KCB in terms of profits generated in relation to the size of the bank. 

Six years ago, in 2008, Equity Bank was less than half KCB’s size when measured in terms of assets — the loans it has given out and Government securities it holds. Today, Equity Bank is 71 per cent the size of KCB by the same measure.

So what does the future hold, and who between Equity Bank and KCB will control it?

The need for financial services is growing in the country as more Kenyans, and East Africans, earn more money. With this, more people will need insurance services, the stock market will be an avenue for generating wealth, and the affluent will want a bank that advises them on where to put their wealth and also provides them with products that grow their income. 

There are other opportunities as well: the capital-intensive oil and gas sector will require financing, and the transport sector and Government want to go into paperless banking.

Whichever bank captures these opportunities and comes up with a channel of delivering such services will pull ahead of the other. 

This is why Equity Bank and KCB are going big on mobile banking, cashless transactions and reviving their investment banking arms.

Equity Bank is coming to terms with the fact that the Safaricom and Commercial Bank of Africa partnership in M-Shwari, a facility where users of M-Pesa can save and borrow money through their mobile phones, is threatening their micro loans market.

CBA has increased the number of its deposit accounts to six million as of early February this year, up from 34,884 in 2011. M-Shwari customers deposit an average of Sh200 million a day. 

CBA and Safaricom charge an interest rate of 7.5 per cent per month, creating a high margin business that could make Equity Bank turn green with envy.

Equity and Safaricom have not had the best of relations after their M-Kesho deal, which was going to be quite similar to M-Shwari, flopped in 2012 because of a lack of agreement and suspicion between the two.

So Equity Bank has sought a mobile phone services license, and was in talks with collapsed mobile operator yuMobile. The bank plans to ride on the infrastructure of an existing telecom operator, such as Airtel, Safaricom or Orange, to roll out mobile telephone services.

Mobile future

In a book exploring the history of M-Pesa, Mr John Staley, Equity Bank’s chief officer for finance, innovation and technology, is quoted saying the success of such mobile banking services lies in controlling the SIM cards used by subscribers.

“If we are going to provide mobile services to customers, we need to access SIM cards .…Whoever controls the SIM card controls the ecosystem,” said Mr Staley in the book, Money, Real Quick: Kenya’s Disruptive Mobile Money Innovation, by Tonny Omwansa and Nicholas Sullivan.

Most likely Equity Bank will build relations with Airtel and Telkom Kenya because of its love-hate relationship with Safaricom.

Although Equity has partnerships with both Airtel and Telkom Kenya, it still doesn’t have the numbers it needs. The bank has 2.8 million mobile banking customers, up from 1.3 million in 2011.

The bank has also sought other partnerships for payments. It has entered a deal with Google to offer prepaid cards for use in the transport system as the sector moves to adopt cashless payments from mid this year. The service with Google is called Bebapay.

And then there is its heavy investment in technology.

Unknown to many Kenyans, Equity Bank has been building one of the biggest data centres in Sub-Saharan Africa at its Upper Hill, Nairobi, headquarters.

This data centre will store a huge volume of data on the transactions of its customers. From these transactions, Equity will be able to analyse the information and see what more can it sell to a client.

It promises to be one of the biggest big data projects in SSA, according to a previous interview Business Beat had with Mr Staley.

Imagine an Equity Bank client who has signed up for the Bebapay card, mobile banking and has an ATM card. Equity would be able to tell the nature and frequency of this client’s  transactions, and from the data, tailor make loan products for him or her.

In August last year, Equity, through its subsidiary Equity Investment Bank, acquired stockbroker Francis Thuo and Partners, giving it a seat at the NSE.

Apart from facilitating the buying and selling of shares, Equity Investment Bank will also be eyeing the space of advising small and medium enterprises on growth, borrowing and even facilitating their mergers and acquisitions.

With the rise of foreign companies’ interested in buying out East African firms, this provides a good opportunity for the bank to earn fees from advisory services and transactions.

Good relationship

On its part, KCB enjoys a good working relationship with Safaricom. That is why, insiders say, the bank was able to roll out M-Benki in record time last year.

M-Benki is a mobile banking platform targeted at the unbanked that allows customers to open a bank account without physically visiting a banking hall. The platform allows customers to open and operate an account with as little as Sh1. KCB is aiming to open three million accounts by the end of this year through the service.

The institution might be reluctant to beat the same path as Equity in seeking its own mobile phone services licence because of its relationship with Safaricom. This might limit its ability to offer more services, but it could save the bank the need for investment.

KCB has also revived its investment banking arm — KCB Capital — as it also eyes the opportunity to advise on raising capital, and mergers and acquisitions in Kenya and beyond. This will set it up for competition with Equity Bank.

As things stand at the NSE, Equity is trading at Sh32.25 per share compared with KCB’s Sh43.75.

This puts Equity at a price to earnings ratio of 8.9, meaning that investors are paying Sh8.9 for each shilling the bank earns in net profits.

This is much cheaper than the Sh9.3 investors interested in KCB are paying for each shilling the bank earns in net profits.

Kestrel recommends investors buy both Equity and KCB shares.

And when KCB moves to its new headquarters right opposite Equity Bank’s in Upper Hill within this year, or by end of 2015, Mr Oigara will likely look out his window and see Mr Mwangi, and the two gentlemen will smile. The new future of banking will have started taking shape.

bizbeat@standardmedia.co.ke