Equity Group yesterday revealed that it more than doubled its investment in government debt to a record Sh100.6 billion last year, offering insights into how the bank reacted to last September’s coming into force of a law capping interest rates.
The Nairobi Securities Exchange-listed firm, which now has the biggest portfolio of government bonds, T-Bills and reverse repos, held Sh42.8 billion of the assets the previous year.
James Mwangi, the group chief executive, described the shift to treasuries as a no-brainer in an environment where lending margins are compressed at a spread of seven per cent, interest rates capped at 14 per cent and the rate on interest-bearing deposits set at a minimum of seven per cent.
“These are the highest-yielding assets with zero risk. Government debt is tradeable, cash is not a problem and they account for liquidity,” Mr Mwangi said when announcing the bank’s annual results.
The accumulation of treasuries saw Equity’s liquidity ratio rise to 47.6 per cent, one of the highest in the banking industry, and which it says is a key factor in navigating an environment in which the interest rates are controlled.
Equity’s take-up of government securities was more than seven times the margin by which Kenya’s biggest bank by assets, KCB, raised its holdings of government debt.
KCB’s treasury paper holdings increased 18 per cent to Sh90.9 billion in the same period.
The rate on reverse repo — short-term debt instruments through which the Central Bank of Kenya reduces money supply in the economy — has stayed around 10 per cent in recent months.
Interest on T-Bills and bonds range from eight per cent to 15.7 per cent, depending on the tenor of the particular instrument.
Chasing risk-free returns saw Equity cut its ordinary loan book 1.4 per cent to Sh266 billion compared to Sh269.8 billion per cent a year earlier, reflecting the extent to which the bank reduced its lending to individuals and small businesses with the capping of interest rates.
Mr Mwangi said control of interest rates starting September last year had distorted credit markets.
“The government is borrowing at a higher rate than it wants the private sector to borrow,” he said, noting that the capping of interest rates was unfair in that it sets a single price for all credit risks.
Mr Mwangi said the Banking (Amendment) Act 2015 had effectively killed the market mechanism that set interest rates based on a borrower’s relative risk and return prospects.
In that hierarchy, sovereign debt is deemed safest because of the government’s power to tax and print money. Blue-chip firms with pristine balance sheets come second in a continuum that ends with small businesses and individuals with insecure jobs paying the highest interest rates.
Equity said its loans to micro enterprises had the highest default rate of 9.5 per cent, followed by SMEs (7.1 per cent), large enterprises (5.9 per cent), and agriculture and consumer (5.7 per cent).
Mr Mwangi said long-term lending to big borrowers is a particular challenge since the interest rate is now set through a series of short-term cycles based on the Central Bank Rate (CBR) currently standing at 10 per cent.
Equity last year scaled down its mobile-based lending, cutting the repayment period from the previous maximum of one year to three months in the wake of defaults that saw it report a 4.1 per cent net profit drop in the year ended December.
The bank made a net profit of Sh16.6 billion in the period compared to Sh17.3 billion the year before on the back of a 173 per cent increase in loan loss provision to Sh6.6 billion.
The provision, precipitated by a doubling of gross non-performing loans to Sh18.7 billion, contributed to a 21.8 per cent increase in total operating expenses to Sh39.1 billion.
The Equity board declared a dividend of Sh2 per share, same as the payout for the previous year. This amounts to an aggregate payout of Sh7.5 billion, the second-largest in the financial services industry after KCB’s Sh9.1 billion.
The bank’s proposed dividend will be paid on June 2 to shareholders on record as of April 14. The bank’s share price fell 4.3 per cent yesterday to close at Sh27.75 as investors reacted to the results which saw its return on equity fall to 21.5 per cent from 25.5 per cent.
At that price, the stock’s impending dividend represents a yield of 7.2 per cent, one of the highest at the NSE after Barclays (11.3 per cent) and KCB (10.1 per cent).
Despite the loan book shrinkage, Equity managed to grow its total interest income 19.2 per cent to Sh51.8 billion thanks to the increased investment in treasuries, whose income jumped 80 per cent to Sh7.8 billion.
Interest expenses rose 7.4 per cent despite customer deposits growing at a faster rate of 11.5 per cent to Sh337.1 billion, indicating a reduction in the rates paid to depositors as well as the portion of interest-bearing accounts. Equity’s non-interest income grew 1.2 per cent to Sh22.2 billion.