Equity Bank’s regional growth drive runs into crunch times

Equity’s push to spread to the rest of East Africa the banking model that has pushed it to the top of the industry in Kenya appears to be facing challenges.

That is the picture coming from Uganda, where the bank’s half-decade performance has recorded a slow start, reversing its profitability trend to losses.

South Sudan, which had shown promising prospects, is facing hitches on the lending front, although it has recorded promising business on transactions.

And a market report released last month by Citi Research, a division of Citigroup Global Markets, shows that Equity is struggling to replicate its successful Kenya model to the rest of East Africa.

Another report by Standard Investment Bank (SIB) calls for the bank to re-evaluate its model to reflect the changing market dynamics.

Above sector returns

“Over the past five years, Equity has consistently delivered above-sector returns. Key to this enviable track record has been the bank’s strong rooting in banking the micro and low income segment… while the low income segment has sustained build-up in liabilities, Equity is increasingly being forced to look at the corporate market to grow its assets,” noted analysts at Standard Investment.

Equity began operations in Uganda after acquiring Uganda Micro Finance Limited (UML) at Sh1.7 billion and converting it into a commercial bank in December 2008. It went to South Sudan in 2009 and Rwanda last year.

An analysis of its investment shows that the bank has injected Sh7.9 billion in its regional subsidiaries since 2008, with Uganda claiming the lion’s share of Sh4.9 billion (62 per cent).

“From this significant investment in international expansion, Equity Bank has made a combined loss (before tax) of Sh30 million over the past four years,” said Citi Research.

Uganda alone recorded losses amounting to Sh886 million over four years, with much of the recovery coming from South Sudan, which posted a Sh915 million pre-tax profit while Rwanda posted Sh59 million loss.

While in South Sudan the bank seems to be doing well, recording a 52 per cent return on capital, analysis on income sources shows that the business of lending has suffered, leaving the lender to rely on operating income as the only positive contributor to the bottom line.

Interest income, generated from lending money, which is the core of banking business, stood at Sh1 million in 2009, Sh57 million in 2010, and negative-Sh291 million in 2011.

“We see this as particularly concerning when one considers that its total assets in South Sudan were Sh2.1 billion in 2009, Sh6.5 billion in 2010, and Sh17.8 billion in 2011. We believe there is a need to improve its banking income in Sudan,” the analysts at Citi Research noted. It is the same trend with Rwanda.

A situation where the bank is paying more to maintain deposits than it generates from lending was also reflected in the group’s results for nine months to September 2012. The bank’s management highlighted this in the notes that accompanied the third quarter results.

“Despite a moderate growth of 10 per cent in customer deposits to Sh164 billion… interest expense on customer deposits grew by 123 per cent, reflecting the high cost of funding,” said the report.

The bank’s borrowed fund almost doubled to Sh22.26 billion in nine months to September from Sh11.4 billion in 2011. Equity Bank Uganda had by the end of 2011 Sh798 million, equivalent to 9 per cent of its total assets, in short-term external borrowings and an additional Sh66 million from the group.

Our efforts to get the latest figures on regional performance were unsuccessful after the bank management failed to honour its promise to send the breakdown by the time we went to press.

However, Equity Bank CEO James Mwangi remains optimistic. In Rwanda and Tanzania, where the bank started operations this year, Equity says it is still waiting to break even. In South Sudan, performance has surpassed the management’s expectations, according to Mr Mwangi.

“We have seen South Sudan doing very well in terms of performance, outperforming Kenya in terms of return on equity and assets. We have seen Uganda turn around. And, we have seen, on an operational basis, Tanzania and Rwanda teething towards breaking even,” he said.

While the East African expansion is a done deal and much of what remains is to try and make the most of the investment, analysts are more worried about the bank’s announcement that it plans to export this model to the rest of Africa to fulfil Mr Mwangi’s dream of making Equity a Pan-African bank.

The call to go Pan-African was re-ignited last month when Equity tapped former Kenya Wildlife Service director Julius Kipng’etich to fill the newly created position of chief operating officer.

The bank indicated that it had set its sights on countries like Nigeria, Ghana, South Africa, and Congo. To finance this expansion, it announced that it plans to conduct a secondary IPO next year to raise cash.

“In our opinion, Equity Bank needs to focus on delivering on its East African expansion strategy before going Pan-African,” Citi Research says.

The bank now seems to have heeded the caution to slow down its expansion plans, announcing a U-turn on its Pan-African ambition last week.

It said it would instead consolidate its operations within East Africa — Kenya, Uganda, Tanzania, Rwanda, and South Sudan.

“The growth prospects for the bank are very strong. There is still a huge number of people in East Africa who don’t have bank accounts. Basically, only 20 per cent of East Africans have bank accounts, while 80 per cent don’t. That really becomes a huge opportunity for the bank. That informed the decision to move into those regions,” said Mr Mwangi.

Kenya has a banked population of 28 per cent, Uganda 9 per cent, Rwanda 6 per cent, and Tanzania 12 per cent. Less than 1 per cent of South Sudanese operate accounts.

Even in the Kenya market, there are those who feel that Equity Bank may need to re-evaluate its model if it is to regain high profit growth prospects.

Called for a re-focus

Analysts at Standard Investment Bank are among those who have called for a re-focus from the micro and low income segment to mainstream banking, noting that this could augur well for the bank’s future earnings and asset quality given the high risk of its target mass market.

Although the bank has consistently delivered above-sector returns in the past five years by focusing mainly on the mass market, SIB analysts recommend that it puts more focus on the small medium enterprise (SME) and corporate market segments to grow its assets.

“In our view, the move by mainstream banks to increase their presence in micro and SME banking space will serve to expedite Equity’s transition to mainstream banking,” the report said.

A change in focus could help turn around the bank’s fortunes in its subsidiaries — Tanzania and Rwanda, where it is yet to turn profitable, and in Uganda where it has made losses since its entry.

While Equity has remained largely focused on growing a volume-based business, targeting the micro or low income, other tier one banks operating in all the regional markets — Kenya Commercial Bank, Standard Chartered Bank, and Barclays Bank — have grown a sizeable pool of middle-high income customers, “offering considerable cross-selling opportunities”, according to the Standard Investment analysts.

The concerns about non-performing loans is, however, discounted by an analysis by Renaissance Capital contained in a report released mid last month praising Equity’s credit control model, saying it mirrors some of the best models globally. In risk profiling, the report said Equity has 12 years of customer data, which allows it to do extensive analysis on borrowers’ ability to repay.

The report also points out that Equity’s biggest risk lies not in its core business, but in the corporate sector, where it is making an entry.

“Contrary to what we often hear, in our opinion the key risk in the (Equity loan) book lies in the corporate book, not the consumer or small enterprise book. The corporate book is highly concentrated — it is made up of a small number of loans with high face values,” the Renaissance Capital research, released early last month, said.

But it is not just the banking model that is raising concern; the bank’s inability to retain key staff has also raised the alarm. It has had four heads of finance in four years, with none completing a full calendar year.

Less than one year stints

The trend has been reflected in the credit and risk departments, where three heads have left in the past three years after stints of less than a year. The three departments conduct critical functions, making the high turnover a matter for concern.

Mr Mwangi, said there has been misconception about the exits, explaining that the bank has more than 400 senior management executives to drive its growth agenda in the region.

“If we got two or three leaving, the percentage would be negligible. It is not necessarily true that everybody who is hired will fit in the organisation. If you find a ‘mis-fit’, then the best thing is separation,” he said.