The last 2 weeks of February have been earnings season for commercial banks in Africa’s second largest copper hotspot. Before delving into the actual analysis the Kwacha Arbitrageur and the Cynical investor (co-authors) provide a brief synopsis of the economic environment in the red metal producer in 2019. Grappling with energy bottlenecks compounding its balance sheet vulnerabilities adding pressure to the fiscals, Zambia’s growth was trimmed to under 2.2%. Energy price risks of a brace in nature characterised by fossil fuel and electricity price volatility spiraled inflation to double digit closing the year at 11.7% as the Kwacha demand curve repriced higher to 28% in the 1 year and 33.5% in the 5 year pushing cost of funding higher. Adding to interest risk were currency risks that manifested in currency bears weighed by sanguine dollar appetite for external debt service, petroleum and agriculture funding in an environment where the central bank was and remains an off taker of dollars to help shore up falling reserves which have plummeted to below one and half yards in dollars, an import cover of less that 1.6 months leaving the country vulnerable to external shocks. Sovereign ratings for both foreign and local currency issuer ratings sank deeper into junk to Caa2/CCC+/CCC with negative outlook by Moody’s/Standards and Poors/Fitch which caused a massive sell off in the dollar bond market widening credit default spreads to between 1,650 – 2,200 above 10 year US treasuries.
Profitability skew persistently uneven. According to the full year 2019 prudential results for the entire banking industry, aggregate profitability grew 25.7% to K1.67billion with the after tax earnings skew housing 93.3% of PAT in 7 commercial banks. Stanbic Bank led the after tax earnings curve with a record K499.3million while ABSA Zambia PLC rallied to second place with K244.7million. Zanaco bank PLC (K231.2million) took third place with Bank of China within a K30million vicinity at K202.9million. Indo Zambia was exceptional making a debut in fifth place at K188.6million displacing Stanchart at K117.8million. The kurtosis statistical skew remains concerning leaving 6.7% of aggregate after tax earning to be shared among 11 banks. Ideally this could be an early warning sign for the need for aggregation or amalgamation in the industry an issue that is constantly ignored by the regulator.
Elevated govie yields ebbed appetite for security investments. Aggregate income expanded 15.24% to K9.59billion with key contributors being SBZ (K1.72billion), Zanaco (K1.58billion), ABSA (K1.24billion) and SCB (K0.98billion). Interest income rallied by a 28.6% margin to K9.68billion on the back of 26.2% climb in earnings from investment in government securities to K3.99billion and a 27.9% in income from credit extension through loans and advances to K5.05billion. The shape of the Kwacha yield curve reflects a crowding out effect autopsy through the allocation skew of liquidity housing in fixed income securities as opposed to domestic credit. Commercial banks credit pricing behavior is influenced strongly by yields on government security rather than the benchmark interest rate also known as the monetary policy rate.
Unwarranted fee weighed fees and commission lines. Overall non-interest income accelerated by a modest 3.8% to K3.7billion backed by a 5.8% sag in fees and commission to K2.1billion and a 26.8% levitation on foreign exchange trading income to K1.4billion. Leaders in this faculty were Zanaco (K0.69billion), SBZ (K0.61billion), ABSA (K0.57billion) and FNB (K0.44billion) while ABSA Zambia and Stanbic were market leaders in the trading income race.
Could this be the genesis of the expensive deposit era. Interest expenses widened 55.6% to K3.16billion exacerbated by a 60.1% widening in interest paid on deposits suggesting an steep uptick in funding costs, a downside effect of an elevated government security demand curve reflecting fiscal posture. This could also signal liquidity strains especially that historically an energy crisis precedes a liquidity crisis. To attract surplus units to keep deposits in the bank, term returns must be at premiums above the yield curve. ABSA (K474.5million) had the highest interest cost with Zanaco (K464.4million), SCB (K351.3million), AtlasMara (K336.4million) and SBZ (K259.3million).
Chinese subsidiary banks run the leanest models. Of the top earners Bank of China (BOC) recorded a cost to income ratio of 27% while the others in the top 5 headlined 51% for ABSA, 58.5% for SBZ and 76% for Zanaco.
IFRS9, recoveries and downgrade risk. Credit impairments eased 13.9% to K622.6million due to a cocktail of reasons that include recoveries offsetting downgrade risk effects affecting most international banks that run models that reflect country risk ratings. International Financial Reporting Standards (IFRS9) is another key determinant of impairment reporting for the industry. The drivers of the impairment stock were ABSA Zambia and Stanchart accounting for 53% of the industry. It is however vivid that local indigenous banks do not apply country risk reflective models because if they did the industry inpairement number would be far higher than reported. We recommend that the regulator levels the playing field by addressing this skew.
Is industry capital adequate? Using regulatory capital as a percentage of credit assets both off and on balance sheet an analysis on the top after tax earners reveals a 19.69% for SBZ and BOC respectively a very unique case for the two banks that run the largest off balance sheet risk that backs infrastructure projects positioned with the current times. It explains why the two banks are market leaders in trade finance product offerings accounting for 60% of the industries contingent liabilities which are international financial institution (A – rated) backed mitigating the risk exposures. International Financial Reporting Standard requires that all risk on and off balance sheet is quantified. Other players on the top 5 scoreboard such as ABSA (25.5%), Zanaco (15.3%) and SCB (16.7%) have varying ratio levels reflecting lower off balance sheet risk (a component the denominator) and varying regulatory capital stock. At aggregate level banks remains fairly well capitalised with a few outliers that may be struggling. Another key ratio we analyse is the credit impairment to funded credit assetswhich was significant for ABSA at 3.93% and SCB at 3.28% a reflection of impairments raised matched with the size of the loans and advances.
Commercial banking outlook for 2020. A more turbulent environment is forecast with greater latitude for premiums above rising inflation manifesting in higher government security yields. Rising interest rate risk will support interest income but curtail domestic credit growth through crowding out effect. With very low ammunition for the central bank to sell dollars on the open market, Kwacha bears are likely to persist and generally breed cost push inflationary pressure through high fuel and inputs costs. This could weigh asset liability mixes for banks that have foreign currency denominated balance sheets. Risks to growth will highly likely increase cost burden on consumers which could be a big driver for non performing loans to ebb higher than the 10% appetite. All things constant the central bank has latitude to tighten liquidity further but at the expense of gross domestic product growth. We expect more cash reserve requirement strategy than hikes in the benchmark interest rate this year.
(Note that the aggregated prudentials do not include 4Q19 Citibank and Investrust data which has since not been published).
The Kwacha Arbitrageur and Cynical Investor