This week I had a successful Zoom webinar on the impact of Covid-19 pandemic on banks. The webinar had one simple proposition; that the pandemic could hurt banks’ income statement in 2020. And judging by first quarter results, that proposition is brewing.
In the quarter, banks’ pre-tax earnings declined by 11 per cent year-on-year, primarily driven by a 154 per cent year-on-year surge in loan impairment losses. Between the third quarter of 2019 and first quarter this year, banks have booked impairment losses totalling Sh43 billion.
The smaller-sized Tier III banks were the worst hit, with the combined pre-tax profit declining by 65 per cent year-on-year, while the larger Tier one and medium-sized Tier two banks saw pre-tax earnings decline by nine per cent and 20 per cent year-on-year respectively.
But a more critical point is that loan books will not grow. After the repeal of the Banking (Amendment) Act 2016, there was hope of a V-shaped recovery in loan-book growth momentum.
But that hope has been dashed with the economy seemingly still frozen: from supply chain disruptions, enterprise productivity degradation, negative global crude oil prices to balance of payment crises. This can only imply that credit risks will remain elevated. As at first quarter, about 13 per cent of loans were classified as non-performing. All factors considered, my projection is that about 18 per cent of loans could be classified as non-performing by the close of 2020.
And as credit risks crystallise, banks are staring at mounting losses on existing loans and will be in no mood to continue underwriting a frozen economy (at the risk of their capital).
In fact, loan repayment moratoria that banks are giving to customers will negatively impact cash flows; which is why some of them have had to withdraw dividend pay-out to shareholders (Equity Bank and NCBA withdrew outright dividend proposals). And I see no signs of dividends in 2021 (so good luck to those investors who use dividend discount model to value banks).
In 2020, the projection is that loan impairment losses will rise by over 60 per cent as banks recognise more non-performing loans. This will likely bite between two to three per cent off return on equity in 2020.
Which means that once again, banks will not be able to meet their cost of equity. For investors, this may mean continued discounting of bank stock prices.
Already the Callstreet-10 banking Index, a market capitalisation weighted index that tracks 10 listed banking stocks, has lost 18 per cent year-to-date (having returned 36 per cent in 2019 thanks to a strong rally in the fourth quarter of the year).
Another focus will now be on capital and the question is; do banks have enough capital to survive impacts of the pandemic. I would have loved to see stress testing, under different scenarios, by the central bank’s financial stability experts.
Nonetheless, industry capital adequacy ratio look fine at around 18 per cent; which, essentially, means that so far so good. Indeed, for now, and in the absence of empirics, it may be difficult to tell whether banks have enough capital to survive impacts of the pandemic, except for the usual culprits.
But I still would urge the Central Bank of Kenya to further stress test bank internal capital adequacy assessment process (ICAAP) documents for 2020 through to 2021.
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