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December 06, 2011

African markets|Equity|Banks

Denial is futile: Short-term risks, yes, but long-term opportunities exist
The Diamonds and the Dogs in our universe: We segregate the Sub Sahara Africa ex RSA (SSA) banks under our coverage into four segments, namely; 1) the banks that create value and are cheap; 2) the banks that create value but are expensive; 3) the banks that destroy value and are expensive; and 4) the banks that destroy value but are cheap. Value creating banks Return on Equity ratios (RoE) is greater than the Cost of Equity (CoE) in our forecasting period; and relatively cheap shares are those trading below the regression line. (PBVR = y = 2.0664x 0.7584 where x = ROE/COE) Cheap and value creating banks: We note that in Kenya most of the banks create economic value i.e. the RoE/CoE is >1x. Cheap and value creating banks in Kenya are KCB and Equity Bank. Cooperative Bank sits on the margin when it comes to valuation. In Nigeria, only GT Bank creates value and is relatively cheap. Cheap but value destroying banks: These banks RoE/CoE ratio is <1x, but they show relative under valuation. Most of the Nigerian banks destroy shareholders value (in our forecasting period). In this segment we have First Bank, Zenith Bank and UBA. Value creating but expensive banks: The banks RoE/CoE ratio is >1x, but they are relatively expensive. We note Standard Chartered (Kenya) and Stanbic Uganda. Barclays (Kenya) and DFCU also create value but are marginally overvalued. Value destroying and expensive banks: These banks RoE/CoE <1x yet they trade at a relative premium to peers. Diamond Bank and Access Bank are the two banks in this segment although the latters overvaluation is marginal. (see Fig 1(a). Assumptions vs. 5-year history: We provide graphical presentation showing our average 3-year forecasts vs. the recent 5-year cycle on 1) loan growth; 2) credit costs and 3) ROE. We believe these are the decisive assumptions. Conclusion on Kenyan banks: Loan growth is mixed. Cooperative and StanCharts credit costs are on the low-end of the 5-year cycle. However, despite that, Cooperatives ROE is at the peak of the cycle. KCBs ROE is also at the peak but the credit cost is mid-cycle. Conclusion on Nigerian banks: The loan growth rates are below mid-cycle. Access Banks lower end credit cost yet the ROE is at mid-cycle level provides some risks. Diamonds credit loss ratio is higher than mid-cycle. The remaining banks credit cost ratios are below mid-cycle, on average.

Peter Mushangwe Lawrence Madzwara +27 11 551 3675

Explaining the contradiction to our Target prices (TPs) and recommendations: Fig 1(a) shows the relative attractiveness of the bank shares in our universe, employing the Justified Price/Book value ratio (PBVR) and the ROE/CoE ratio. For Nigeria, all our Justified PBVR are <1x, except for GT Bank, indicating the continued value destructive situation in the Nigerian banking system. In Kenya and Uganda, our Justified PBVR are on average >1x. As a result, our TPs for Nigerian banks whose Justified PBVRs are <1x are products of our FY12 book value per share (BVPS) and a multiple of 1. (see Fig 1(b). We believe valuing these banks at 1x FY12 BVPS is the best reference case given the regulatory improvements in the system. We note that KCB, Equity Bank and GT Bank are cheap relative to peers, and are also value creative. However, UBA, First Bank and Zenith Bank are cheap but value destroying banks, hence our BUY recommendations are explained by our application of a 1x to their FY12 BVPS. Access Bank and Diamond Bank are relatively expensive and value destructive while StanChart and Stanbic Uganda are value creative banks that are relatively expensive. Recommendation changes: In Kenya we have upgraded Cooperative Bank to HOLD from SELL. Despite our concerns related to its limited ROE upside potential, the share price has declined significantly, pushing up the potential gain (now at ~14) into our HOLD territory. We have also upgraded Stanbic Uganda to BUY from HOLD despite its inferior valuation metrics relative to peers. We have maintained all our other recommendations for now. However, for StanChart Kenya, we have revised our FY12 TP downward to Kes173. We have changed our FY12 loan/deposits ratio to 75% (prev. 80%) and increased our impairment/loans ratio to 1% (prev. 0.8%). We have maintained our CoE assumption of 18.5%. Our other new TPs (after changing credit cost assumptions) for Cooperative Bank, Equity Bank and KCB are Kes13.05; Kes20.39 and Kes21.08 receptively. In Uganda we also increased the credit costs of the two banks, resulting in new TPs of Ugx136 and Ugx1139 for Stanbic and DFCU in that order. Salient caveat: Our analysis attempts to screen the best and worst exposures in our coverage universe, notwithstanding that some investor may not look at the SSA systems holistically. The primary caveat to this analysis is the different regulatory frameworks/environments. While we attempt to capture perceived regulatory risks through the required return, comparing banks from different systems remain fairly risky. The regression equation that we used to differentiate the bank relies on market-based PBVRs. These market-based PBVR could be positively/negatively affected by market specific issues to include liquidity and sentiment. On the other hand, the ROE/CoE ratio is implicitly reflective of Legaes views.

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Fig 1(a): Distinguishing the Diamonds from the Dogs

3.5 PBVR 3.0 y = 2.0664x - 0.7584 R = 0.8196


Expensive; value destroying banks

Expensive; value creating banks

StanChart Barclays; DFCU



Kenya Equity Coop

GT Banks


1.0 Access


Zenith First Bank





-0.5 0.2 0.4 0.6 0.8 RoE/CoE 1.0 1.2 1.4 1.6 1.8

Cheap; value destroying banks

Cheap; value creating banks

Source: Company reports, Legae Estimates Fig 1(b): We are buying all Nigerian banks in our universe; Buying KCB and Equity in Kenya
Stock Nigeria Access Ticker Bloomberg AC C ESS NL Current Target Potential Price Price NGN 4.80 NGN 10.43 117.3% BUY BUY Room to grow RWAs in the upturn cycle; Short term ALM benefits. Poorer deposit structure a risk; M&A risks Strong NIM and deposit structure, possible rerating after strong underperformance; Asset quality remains an issue; Liquidity ratio building up but C AR on lower end. Higher unsecured book; Strong footprint and remains a key player; Normalization of cost/income ratio beneficial; Best-in-class ROE due to efficiency; Our Justified PBVR > current, higher PBVR than peers can scare some investors; Our Buy recommendation based on low valuation risk with submean PBVR ; Strategic/execution risks remain C onservative bank but consistent; Ample room to grow RWAs; Strong asset quality and deposit structure. Our core holding. Old rating Current Rating Stock views





























Zenith Kenya Barclays C ooperative Equity KC B Stanchart Uganda Stanbic DFC U


11.50 KES 11.80 12.00 17.50 14.95 155.00 UGX 100 1000

15.60 KES 13.71 13.05 20.39 21.08 173.10 UGX 136 1139




16.2% 8.8% 16.5% 41.0% 11.7%



Strong franchise but no regional play; C onstrained asset growth despite high C AR (in pursuit of quality assets); Disconnect between ROE and valuation and a poorer ROE structure; Higher leverage vs. peers; higher NPL overhang; Strong franchise in a strong market segment; regional play to become value accretive in a material manner. Elevated NPL risks; Regional markets no more a drag on local earnings; Strong mortgage player; Asset quality issues arising Pure Kenyan play, most efficient bank in the system leading to a stronger ROA; losing market share and poorer C AR

35.6% 13.9%



#1 bank that could find it difficult to grow RWAs meaningfully; High relative valuation risk Improving deposit mix; strong local franchise that can break the internationals hegemony yet lower valuation risk; Asset quality concerns.

Source: Company reports, Legae Estimates

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1. Kenya: Macro risks escalating but there are pockets of value

We have noticed material macro-risks in Kenya catalysed by a combination of reasons including politics (elections due next year) and the poor global economic performance. Interest rates have increased materially since our initiation, with the bank rate now at 18%, and lending rates >20%, creating headwinds to both loan growth and nonperforming loans (NPLs) formation, particularly into FY12 and FY13. However, there is no evidence yet that the high interest rate environment has tamed credit growth. Credit growth in September 2011 was 30.1% y/y vs. 20.5% in January. In fact it does not seem to us that there is a strong historical comovement between credit growth and lending rates. The systems healthy interest spread shows that credit demand has not deteriorated significantly. The cost of deposits is increasing, but banks are managing to maintain spreads. (see Fig 2). This heightens our concerns related to future NPLs. We are particularly concerned that banks will restructure their loans (particularly by increasing the tenor of loans) and reduce reported NPLs, limiting the usefulness of the system NPLs situation in CY12. However, we should also note that the asset quality of Kenyan banks has structurally improved in the past decade. Nonetheless, we have revised our credit cost assumptions for FY12 and FY13. Below we discuss how our 3 year forecasts compare to the recent 5-year cycle: Loan growth: Our Kenyan loan growth forecasts are mixed. For Equity Bank, Cooperative Bank and KCB, the average loan growth rates are at the bottom of the range. While this could provide reasonable upside potential especially should GDP growth expand, we note that Equity Banks wide range, with a high of >100% y/y growth rate could limit the potential. In addition, these growth rates are still considerably high at >20%. StanCharts growth rate is at the peak of its 5-year cycle, and given the inferior CAR, the risk is more skewed to the downside than upside. Barclays growth rate is at the mid-cycle level. Note that we model the loans as a product of the loan/deposit ratio and our deposit forecasts. Credit costs: Initially we expected a general improvement in credit costs as the effect of the recession waned, but we are identifying some macro risks, to include Europe, that could make credit costs persistently high. We have revised our credit costs assumptions for Cooperative Bank, Equity Bank, KCB and StanChart while we maintained our initial forecast for Barclays. We are concerned that for Stanchart and Cooperative Bank the credit costs remain at the lower end of the 5-yr cycle. The risks to Cooperative bank are higher given the recent strong loan growth. We also see the extremely wide range, with a high of 5% and a low of 1.2% for Cooperative Bank as an indicator of inferior credit risk management in our 5yr cycle. For Equity bank, our average forecast is on the upper-end of the cycle. We expect Barclays and KCB to be at the mid-cycle level, on average.

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Return on Equity: For Barclays and Equity bank, our ROE forecasts are in the mid-cycle. However, for Cooperative and KCB, we are at the peak of the cycle range. For Stanchart we are at the trough, suggesting potential room for expansion, but loan growth could constrain it. Conclusion on Kenyan banks: With a low-end through the cycle credit cost ratio, but an ROE that is at the 5-year peak, Cooperative Bank shows significant risks. An increase in the credit costs will significantly limit expansion in the ROE, with the ROE at the high-end of the cycle already. The risk of a more robust credit growth than we anticipated is meaningful given Kenyas macropicture and the Banks recent loan-book growth. Equity Banks high credit costs relative to the recent 5-year history, and yet a mid-cycle ROE could provide some upside should system credit cost remain benign. (see Fig 3 - Fig 5).
Fig 2: Credit growth remains strong despite rising rates. System interest spread is still healthy.
35% Domestic credit growth 30% 15.0% 25% 20% 13.0% 15% 10% 5% 9.0% 0% -5% -10% -15%
Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jul-11

Lending rate


Av. Lending rate less Av.deposit rate



Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11

Source: Central Bank of Kenya, Legae Calculations

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Fig 3: Loan growth - Our assumptions are generally on the lower range of the 5-yr cycle
Barclays 42.5% -13.5% 14.8% Cooperative 39.1% 17.7% 23.0%
3-yr forecast 100%

High Low 3-yr forecast


Equity 102.4% 23.5% 20.8%

KCB 45.5% 20.8% 22.6%

StanChart 30.9% 6.4% 24.6%






-20% Barclays Cooperative Equity KCB StanChart

Source: Company reports, Legae Calculations Fig 4: Credit costs Cooperative and StanChart are on the low end of the range
Barclays 0.5% 1.4% 1.0% Cooperative 5.0% 0.8% 1.2% Equity -0.1% 2.4% 2.2% KCB 0.6% 1.5% 1.2% StanChart 0.5% 1.4% 0.9%

Low High 3-yr forecast


3-yr forecast

5.0% Concerns for Coop and Stanchart as our forecasts are at the low-end of their 5-yr cycle





0.0% Barclays -1.0% Cooperative Equity KCB StanChart

Source: Company reports, Legae Calculations

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Fig 5: ROE Cooperative and KCB are above their mid-cycle levels, Barclays and Equity are at their mid-cycle level while StanChart is at the bottom end of the range

High Low 3-yr forecast

40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Barclays

Barclays 33.7% 25.2% 28.5%

Cooperative 22.6% 16.6% 22.7%

Equity 34.2% 12.7% 25.1%

KCB 22.5% 18.1% 21.7%

StanChart 33.8% 26.0% 26.7%

3-yr forecast

Concerns for Coop and KCB as our ROE forecasts are at the top-end of the 5-yr cycle





Source: Company reports, Legae Calculations

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2. Nigeria: Bet noir but ROEs should recover to above mid-cycle level
In Nigeria, bank shares continue to be the poison of the stock market. The negative sentiment continues, with significant share price declines on a YTD basis (see section 3). Earlier on we had increased our rates of required return for all our Nigerian banks in order to capture the negative sentiment. We maintain that stance although a contraction in CoEs could be a meaningful upside risk to valuations in our forecasting period. We remain constructive on a medium- to long-term basis as we expect regulatory risks to continue to reduce. We concede that on the short-term, market risk remains significant. Loan growth: All our Nigerian banks loan growth rates are below their mid-cycle levels. We are not concerned though as we have noticed a great amount of atonement from bank managers. The growth rates are also still high in absolute terms (an average of 26% in the next 3 years) despite being inferior when compared to the 5-year cycle peaks. Credit costs: Access Banks credit cost forecast is at the trough when compared to its 5-year cycle. Diamond bank, while not at the peak, remains above the mid-cycle level while First Bank, GT Bank, UBA and Zenith ratios remain below mid-cycle level. Return on Equity: We are concerned by GT Bank and Zenith Banks ROEs that are at the peak of the recent 5-year cycle. This could limit further expansion in the ROEs, particularly given the soft global economic outlook. The peaking ROEs also point to substantial improvements to the banks operating conditions/environments which may not be necessarily accurate. Access Bank, First bank and UBA have ROEs that are generally in line with the mid-cycle level. Conclusion on Nigerian banks: GT Banks low-end credit cost yet the ROE is at the high-end of its 5-year cycles creates some risks to valuation (i.e. elevated downside risks to the ROE should credit conditions worsen). Access Banks credit cost is also on the low-end of the range with a mid-cycle ROE. On the other hand, Diamond Banks low-end ROE could benefit from improvements in the credit cost ratio which is still higher than its mid-cycle level. Zenith Banks ROE is at the peak of the cycle, but the mid-cycle rather than low-end level credit cost is supportive. First banks credit cost is slightly below mid-cycle, pushing the ROE slightly above mid-cycle. (see Fig 6 - Fig 8).

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Fig 6: Loan growth Generally below mid-cycle range but still high in absolute terms
Access High Low 3-yr forecast 250% 234.4% 2.8% 21.3% Diamond 138.1% 3.1% 31.5% First 131.4% 6.0% 28.1% GT Bank 149.0% 5.3% 27.1% UBA 191.6% 3.7% 24.4% Zenith 63.0% 2.1% 28.0%

3-yr forecast





0% Access Diamond First GT Bank UBA Zenith

Source: Company reports, Legae Calculations Fig 7: Credit costs Varying among banks, Access on the low-end of the range
Acess Low Hi gh 3-year forecast 8% 3-year forecast 7% 6% 5% 4% 3% 2% 1% 0% Acess Diamond First Bank GT Bank UBA Zenith*
Access' low end loan loss ratio is a risk

Diamond 0.1% 3.8% 3.1%

First Bank 0.2% 1.9% 0.7%

GT Bank 0.2% 3.5% 0.7%

UBA 0.2% 1.9% 0.7%

Zenith* 1.2% 6.9% 3.2%

1.1% 4.3% 1.3%

* Zenith's ratios are provisions/loans; others are loan loss ratios

Source: Company reports, Legae Calculations

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Fig 8: ROE GT Bank and Zeniths ROE are at the peak of the cycle, providing limited potential expansion of the ROE
Acess High Low 3-yr forecast 30% 3-yr forecast 25%
We are concerned by the significant downside risks to GT and Zenith ROEs

Diamond 13.3% 1.2% 4.3%

First Bank 24.0% 1.0% 16.7%

GT Bank 26.4% 13.0% 28.1%

UBA 23.7% 0.4% 12.7%

Zenith 16.1% 6.1% 18.2%

21.4% 2.6% 11.0%





0% Acess Diamond First Bank GT Bank UBA Zenith

Source: Company reports, Legae Calculations

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Justified PBVR and CoE: Fig 9 below shows our Justified PBVR ratios and the CoE for the the banks in our universe. Our Nigerian banks have the highest CoEs at an average of >20%. The average ROEs for the Nigerian banks is however <20%, making our Justified PBVR largely <1x. Only GT Banks Justified PBVR is >1x at 2.4x. However, it is important to note that forward PBVR are also undemanding, in our view. Our average FY12 forward PBVR is 0.7x, with a high of 1.8x for GT Bank and a low of 0.3x for Diamond Bank. The Kenyan banks are largely creating value in our forecasting period, with an average ROE of > the average CoE of 18.85%. KCB has the lowest Justified PBVR at 1.4x, while Stanchart has the highest at 2.8x. The average FY12 forward PBVR is 1.6x. StanChart has the highest forward PBVR of 2.3x and KCB has the lowest at 0.9x. (see Fig 9). On a YTD basis, the universe has performed poorly: Our SSA banks coverage universe has performed poorly on a YTD basis, with losses across the board except for DFCU (Uganda). The poor performance of the local currencies vs. the US$ exacerbated the losses. On average, the banks lost 36.5% of shareholder value in US$ terms. UBA leads the pack of losers, with a US$ capital loss of 67%. The top performer is DFCU, with a US$ return of 11.2%. (see Fig 10).

Fig 9: Valuation Nigerian banks ROEs to rebound, albeit slowly. Kenyan Banks CoEs could increase as macro and regulatory risks rise.
Stock Price/Earnings 2011F Nigeria Access Diamond First Bank GTBank UBA Zenith Average Kenya Barclays C ooperative Equity KC B Stanchart Average Uganda DFCU Stanbic Average 8.6 10.4 9.5 7.1 8.0 7.5 6.0 6.8 6.4 2.5 3.2 2.8 2.0 2.5 2.3 2.0 2.1 2.0 3.0% 3.4% 3.2% 3.1% 3.4% 3.2% 3.0% 3.3% 3.2% 28.8% 31.5% 28.5% 30.3% 32.9% 27.5% 2.9 4.7 3.8 18.99% 19.80% 19.40% 8.8 6.4 6.3 4.8 10.3 7.3 7.3 5.9 5.4 4.2 8.8 6.3 6.6 5.2 4.6 3.0 7.4 5.4 2.5 1.6 1.7 1.0 2.6 1.9 2.1 1.3 1.4 0.9 2.3 1.6 1.9 1.1 1.1 0.7 2.1 1.4 4.4% 3.5% 5.6% 2.9% 2.9% 3.8% 4.4% 3.2% 5.4% 2.9% 2.9% 3.8% 4.3% 3.1% 5.2% 3.3% 2.9% 3.7% 28.0% 24.8% 26.9% 20.6% 25.3% 29.4% 22.2% 24.7% 20.2% 26.6% 28.1% 21.1% 23.7% 24.2% 28.0% 2.8 1.8 2.1 1.4 2.9 2.2 18.00% 19.50% 19.00% 19.25% 18.50% 18.85% 5.0 13.3 4.9 7.7 4.7 5.8 6.9 3.5 5.6 3.9 6.3 3.6 4.9 4.6 3.1 3.5 3.0 5.2 2.3 4.0 3.5 0.4 0.4 0.8 2.0 0.4 1.0 0.8 0.4 0.3 0.6 1.8 0.4 0.9 0.7 0.4 0.3 0.5 1.6 0.4 0.8 0.7 1.4% 0.4% 2.1% 3.9% 0.9% 2.6% 1.9% 1.6% 0.8% 1.9% 3.8% 1.0% 2.6% 1.9% 1.6% 1.0% 2.1% 3.9% 1.4% 2.6% 2.1% 9.0% 2.8% 15.7% 25.9% 9.2% 16.4% 11.7% 6.2% 16.6% 27.9% 11.6% 18.0% 12.2% 8.9% 17.9% 30.6% 17.4% 20.2% 0.3 0.2 0.7 2.4 0.5 0.9 0.82 20.80% 22.05% 20.30% 19.30% 20.80% 19.30% 20.43% 2012F 2013F Price/Book Value 2011F 2012F 2013F Return on Assets 2011F 2012F 2013F Return on Equity 2011F 2012F 2013F Justfied PBVR CoE

13.2% 15.3% 17.9%

25.1% 24.6% 25.0%

30.2% 29.4% 30.2%

Source: Company reports, Legae Calculations

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Fig 10: US$ returns DFCU Uganda outperforms peers in our universe; UBA is the worst performer
20% 10% 0% -10% -20% -30% -40% -50% -60% -70% -80%











GT Bank


Source: Company reports, Legae Calculations


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Disclosure & Disclaimer

Legae Securities (Pty) Ltd Member of the JSE Securities Exchange 1st Floor, Building B, Riviera Road Office Park, 6-10 Riviera Road, Houghton, Johannesburg, South Africa P.O Box 10564, Johannesburg, 2000, South Africa Tel +27 11 551 3601, Fax +27 11 551 3635 Web:, email:
Analyst Certification and Disclaimer I/we the author (s) hereby certify that the views as expressed in this document are an accurate of my/our personal views on the stock or sector as covered and reported on by myself/each of us herein. I/we furthermore certify that no part of my/our compensation was, is or will be related, directly or indirectly, to the specific recommendations or views as expressed in this document This report has been issued by Legae Securities (Pty) Limited. It may not be reproduced or further distributed or published, in whole or in part, for any purposes. Legae Securities (Pty) Ltd has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; Legae Securities (Pty) Limited makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion herein are those of the author only and are subject to change without notice. This document is not and should not be construed as an offer or the solicitation of an offer to purchase or subscribe or sell any investment. Important Disclosure This disclosure outlines current conflicts that may unknowingly affect the objectivity of the analyst(s) with respect to the stock under analysis in this report. The analyst(s) do not own any shares in the company under analysis.