Moody's Investors Service has today assigned first-time ratings to Kenya Commercial Bank Limited (KCB): B1/Not Prime global local and foreign currency issuer ratings; B1/Not Prime local-currency deposit ratings; B2/Not Prime foreign currency deposit ratings (constrained by Kenya's B2 country ceiling for such foreign currency deposits); and a b1 standalone baseline credit assessment (BCA) and b1 adjusted BCA. The outlook on the long-term issuer and deposit ratings is stable. Moody's also assigned a Counterparty Risk Assessment (CR Assessment) of Ba3(cr)/Not Prime(cr).
KCB's ratings reflect its (1) solid profitability metrics; (2) strong capital buffers; and (3) deposit-based funding structure, with high levels of liquid assets. These strengths are balanced against the bank's high asset risk, amid elevated non-performing loans (NPLs) and credit costs, and structural challenges in Kenya's operating environment (captured in Moody's macro profile assessment). KCB's standalone baseline credit assessment of b1 is currently placed at the same level as the B1 government bond rating.
RATINGS RATIONALE
Moody's methodology starts with an assessment of a bank's operating environment. Within this context, KCB's ratings reflect (1) its solid profitability metrics, supported by a strong domestic franchise, that positions the bank well to take advantage of Kenya's strong growth potential; (2) the bank's capital buffers that allow it to absorb higher-than-expected loan losses; and (3) its deposit-based funding structure and high levels of liquid assets. These strengths are balanced by the bank's high asset risk, amid elevated NPLs and credit costs, while the bank's credit profile is also closely correlated to the government of Kenya's creditworthiness given high direct government related exposures.
KENYA'S MACRO PROFILE
Moody's methodology starts with an assessment of KCB's operating environment, which is based on the rating agency's assessment of Kenya's macro profile, where the bank conducts most of its business. Risks stemming from KCB's regional operations (in five East African countries, including Tanzania, Uganda, Rwanda, Burundi and South Sudan) are moderated given their currently small contribution (less than 10% of net profit and around 12% of loans).
Moody's assigns a 'Weak -' macro profile score to Kenya. Moody's macro profile assessment reflects Kenya's strong economic growth prospects. Moody's expects real gross domestic product (GDP) growth to pick up to 5.6% in 2015 and 6.3% in 2016, supported by continuous efforts to diversify the economy, to improve infrastructure, and to expand information and communication technology. At the same time, Kenyan banks benefit from a supply of stable, low-cost customer deposits and healthy liquidity buffers, which support their financial stability. These strengths are balanced against the relatively small size of the economy and low GDP per capita, a high incidence of corruption, and a moderate susceptibility to event risk (given a history of domestic political instability and security-related challenges). Kenya's macro profile also incorporates Moody's assessment that credit risks are currently elevated, owing to a large numbers of untested new loans (given high loan growth recently) and rising interest rates that could weigh on borrowers' repayment capacity. For more details on Kenya's macro profile, please refer to www.moodys.com.
SOLID PROFITABILITY METRICS SUPPORTED BY KCB'S STRONG DOMESTIC FRANCHISE AND BUSINESS GROWTH PROSPECTS
KCB's ratings reflect its strong profitability metrics supported by a strong domestic franchise, business growth prospects and strategic initiatives. During the first half of the year 2015 (H1 2015), the bank reported pre-provision and net profits of 6.1% and 3.5% of average assets, respectively. KCB's profitability metrics benefited from recent efficiency improvements amid a staff transformation programme, and the bank's continued focus on operational efficiency and leveraging on the revamp and expansion of its lower-cost alternative distribution channels.
KCB is well placed to further grow its profitability by leveraging on Kenya's robust growth potential, amid its strong franchise as East Africa's largest bank, with domestic market shares in Kenya of 12%-13% in terms of assets, loans and deposits, and as the country's largest branch network. KCB's strategic initiatives also support growth potential. KCB has been strengthening its corporate product offering, management team and IT reliability and capacity in order to improve customer service and offer a more complete product suite to cross-sell to existing and new clients. In addition, KCB is targeting an additional five million retail customers in 2015 and to triple mobile transactions and its agency footprint over the next few years.
CAPITAL BUFFERS CAN ABSORB UNEXPECTED LOSSES
KCB's ratings also capture its strong capital buffers that can absorb unexpected loan losses. Moody's expects the bank's capital levels to remain at broadly the current levels amid a solid internal capital generation and a potential rights issue, which Moody's expects over the next 12 months. As of June 2015, KCB's tangible common equity stood at 16.9% of adjusted risk-weighted assets and its adjusted Tier 1 ratio stood at 11.9% (compared with a regulatory Tier 1 ratio of 14.6%). Moody's uses its standard adjustments whereby it risk-weights government securities (at 100%) based on their rating.
DEPOSIT BASED FUNDING AND HIGH LIQUIDITY BUFFERS A STRENGTH
KCB's deposit-funded profile is a further credit strength supporting the ratings, with deposits accounting for 91% of total liabilities as of June 2015. Moody's expects KCB to maintain its leading, deposit-funded domestic franchise over the next few years supported by the country's largest branch network. The bank also maintains a prudent net loans-to-deposit ratio (June 2015: 72%) and healthy liquidity buffers, with liquid assets (cash, central bank, interbank balances, and investments) accounting for 34% of adjusted tangible banking assets as of June 2015.
While funding is a credit strength, the bank does maintain high deposit concentrations from the government. The bank therefore faces the downside risk that the government at some point will reignite its intentions to manage more efficiently the idle and excess funds of government and public sector entities. As such, the introduction of a Treasury Single Account presents a downside risk to the bank's funding profile and could lead to approximately 6.5%-10% of deposits from its Kenyan operation being withdrawn from the bank.
HIGH ASSET RISK AMID WEAK NPL LEVELS AND STRUCTURAL CHALLENGES
These strengths are balanced by KCB's high asset risk, given high NPLs and elevated credit risks. As of June 2015, the bank's NPLs-to-gross loans ratio stood at 6.4% (excluding interest in suspense). Going forward, Moody's expect credit risks to remain elevated given 1) the high loan growth in the banking system in recent years (20.4% compound annual growth rate between 2012 and 2014); 2) weaknesses in the structuring of loans to certain projects/entities; 3) rising interest rate environment, which will likely weigh on borrowers' repayment capacity; while 4) certain sectors continue to be affected by external shocks like agriculture (bad weather), tourism (lower arrivals) and construction (delays in payments to contractors).
Despite these concerns, Moody's notes that KCB has a fairly diversified loan book across segments, economic sectors and without undue concentrations to the country's largest corporates. In addition, while KCB's provisioning is low, the bank holds an additional credit risk reserve in capital (increasing the provisioning coverage to 67%, from 37% under IFRS provisions as of June 2015, excluding interest in suspense) and its profitability provides a strong recurring buffer to absorb losses with NPLs at just 66% of annualised pre-provision income during H1 2015. Risk management improvements have also been implemented over the past few years, in particular stronger risk management processes and practices, underwriting standards, and enhanced recovery practices.
KCB's majority Kenyan operations and high sovereign-related exposures, however, do link the bank's creditworthiness to that of the government of Kenya. Exposures to Kenyan sovereign accounted for around 123% of tangible common equity or 176% of Tier 1 Capital.
COUNTERPARTY RISK ASSESSMENT
KCB's CR Assessment is positioned at Ba3(cr) -- one notch above the adjusted baseline assessment of b1 and therefore above the deposit ratings -- reflecting Moody's view that its probability of default is lower than that of deposits. CR Assessments are opinions of how counterparty obligations are likely to be treated if a bank fails and relates to a bank's contractual performance obligations (servicing), derivatives (e.g., swaps), letters of credit, guarantees and liquidity facilities. Senior obligations represented by the CR Assessment will be more likely preserved in order to limit contagion, minimise losses and avoid disruption of critical functions.
FOREIGN CURRENCY DEPOSIT RATINGS
KCB's B2/Not Prime foreign currency deposit ratings are constrained by Kenya's B2 country ceiling for such foreign currency deposits. These country ceilings intend to capture foreign currency transfer and convertibility risks.
WHAT COULD MOVE THE RATING -- UP/DOWN
A reduction in KCB's NPLs and a strengthening in its provisioning coverage would place upwards pressure on the bank's ratings. However, given the bank's high direct government-related exposures that closely link its credit profile to the B1 rated Kenyan government, a rating upgrade will need to be preceded by an upgrade in the sovereign rating and an improvement in the overall operating environment.
Negative pressure on KCB's ratings could arise if operating/macro conditions deteriorate, leading to an increase in the credit risks embedded in the bank's loan and securities portfolios, and a potential drop in profitability and capital metrics. Downward pressure on KCB's ratings could also develop if there is a weakening the bank's funding profile. Finally, the bank's ratings would also be under pressure if the credit profile of the sovereign were to weaken.
The bank is currently assessing possible changes to its organizational structure, which may involve a move towards a holding financial institution scheme. It is too early to assess the potential implications of any re-organization of KCB's businesses at this time.
