The Sh31.4bn bad loans trap in KCB and NBK deal

A Sh31.4 billion bad debts load is among the priority items that KCB Group #ticker:KCB will have to grapple with in the planned merger with the National Bank of Kenya (NBK) #ticker:NBK , the lender has told shareholders in a circular revealing details of the ongoing buy-out transaction.

NBK’s bad debts have over the years piled up to nearly half of the bank’s loan book of Sh60.4 billion, pushing the lender into losses and eating into its capital reserves.

KCB says it will move to aggressively recover the bad loans, signalling tough times ahead for defaulters who are likely to face the auctioneer’s hammer.

KCB has also said that it will write off some of the non-performing loans, indicating readiness to take a profit hit in the initial years as it moves to clean up NBK’s books.

KCB has valued NBK at Sh5.6 billion in the share swap transaction that is still subject to regulators’ approval. Both banks are listed on the Nairobi Securities Exchange (NSE).

“NBK’s loan book has a non-performing loan (NPL) ratio in the region of 49 percent as at December 31, 2018,” KCB says in its takeover document submitted to NBK shareholders.

“Post-acquisition, KCB plans to employ all possible legal measures to recover as well as write down key NPLs, and subsequently put in place effective loan portfolio management measures to maintain a favourable loan portfolio quality.”

Besides the aggressive loan recoveries, KCB is also ready to inject Sh7.5 billion capital into NBK to shore up its liquidity and fund its growth during the first two years when it shall operate independently before merging with the country’s biggest bank by assets.

NBK has a past legacy of bad loans dished out to politically-correct individuals without any collateral, who later defaulted on the debts.

Former CEO of the bank the late Reuben Marambii was appointed to rescue the lender in 1999 when it had accumulated more than Sh5 billion in losses and was surviving on the Central Bank of Kenya’s support.

Twelve years after Mr Marambii’s takeover the lender had returned to good health and even paid its shareholders a dividend, but the good run did not last long after his exit as the dud loans started piling up again.

The current non-performing debt portfolio is a deterioration on the 2017 figures, when the gross loan book and gross bad debt stood at Sh61.8 billion and Sh27.6 billion respectively.

The size of bad debt has risen sharply from Sh7.2 billion in 2014 when it amounted to just 11 percent of the total loan book of Sh65.6 billion.

The rate of loan defaults at NBK is about four times the banking industry’s average of 12.8 percent. The lender’s bad loan book has been blamed on a history of mismanagement and loose lending practices.

Prominent individuals including politicians took large loans from NBK, mostly during the President Daniel arap Moi administration, and deliberately failed to repay them, according to records tabled in Parliament.

NBK made no meaningful attempts to recover the loans as its management was heavily influenced by the politics of the day.

The bank was established in 1968 as a fully-owned government institution, with the State reducing its stake over the years to the present 22.5 percent but retaining control.

More recent leadership of NBK was also accused of mismanagement. The bank’s former managing director, Munir Ahmed, for instance, was accused of cooking books to mis-represent the lender’s true financial position.

He was accused, for instance, of understating loan provisions and erroneously reporting that the bank had earned income amounting to Sh847.9 million from the sale of assets in the quarters ended June and September 2015, according to court documents.

The bank’s defaults have eaten into its capital, leaving it in breach of most capital adequacy ratios and other prudential regulations.

“The financial institution has been in breach of regulatory capital since 2015, and is likely in breach of other non-capital related ratios such as single obligor, insider lending to core capital and ratio of non-core assets to core capital,” Standard Investment Bank (SIB) said in its role as the ongoing transaction’s independent advisor.

“While there is a plan in place to achieve regulatory compliance with regards to capital ratios, this has not been realised. It remains one of the key threats to the company.”

KCB says its takeover price reflects a discount to NBK’s share price and book value to take into account the fact that it will need to recapitalise the business.

KCB has valued NBK at Sh5.6 billion or Sh3.8 per share.

The proposed share swap is to be implemented at the rate of 10 NBK shares for each KCB stock.

SIB says NBK has a value of up to Sh9 billion or Sh6.1 per share, indicating that 7.05 shares of NBK should entitle an investor to one KCB share.

“Based on the valuation analysis, the indicative exchange ratio proposed of one (1) ordinary share of KCB for every ten (10) ordinary shares of NBK may not be adequate,” SIB says in its report.

“We however note that NBK is operating at way below the required regulatory capital level which exposes the company to considerable risk of regulatory action.”

The government, which has declined to provide NBK with new capital, says the lender’s merger with KCB is the only way it will avoid being shut down by the Central Bank of Kenya for flouting capital adequacy ratios.