Global Credit Rating affirms KCB Group’s AA(KE), Outlook Stable

Global Credit Ratings (“GCR”) has accorded the above credit ratings to KCB Bank Kenya Limited (“KCB Bank”; “the bank”) based on the following key criteria:

KCB Bank was established on 1 January 2016 as a result of the corporate restructure of Kenya Commercial Bank Limited (renamed KCB Group Plc) which, prior to January 2016, operated both as a licensed bank and a holding company for its subsidiaries. The newly formed KCB Bank took over the banking business in Kenya together with its assets and liabilities, and is a wholly owned subsidiary of KCB Group Plc (“KCB Group”, “the group”), accounting for 84.8% of the group’s consolidated assets and 97.9% of pre-tax profit at FY16. The accorded ratings reflect KCB Bank’s established domestic market position, risk appropriate capitalisation, sound liquidity position, resilient earnings performance and support from its shareholders.

The bank reported total and Tier 1 capital adequacy ratios of 19.9% (FY15: 15.4%) and 16.9% (FY15: 14.1%) respectively at FY16, which were well above regulatory capital minima, providing an ample capital cushion for loss absorption and growth. However, IFRS 9 (set to be implemented in 2018) is expected to lead to higher provisioning and earlier recognition of credit losses. KCB management expects a transitional increase in balance sheet provisions in line with IFRS 9 requirements. In 2017, an assessment is being conducted with the help of external consultants, to assess the likely impact on earnings and regulatory capital.

Asset quality remained under pressure in the period under review with gross non-performing loans (“NPLs”) rising to 7.8% of gross loans at FY16 (FY15: 6.0%), driven by some single name defaults in the corporate and government/parastatal books. The domestic banking industry average gross NPL ratio stood at 9.1% at end-December 2016 (2015: 6.8%). KCB Bank’s specific provisions covered 33.5% of NPLs at FY16 (FY15: 32.6%), pre-collateral. NPLs net of specific provisions were 22.3% of regulatory capital at FY16 (FY15: 21.3%). NPL recovery efforts are ongoing and the bank has established processes for early detection of problem loans.

Notwithstanding higher credit costs and operating expenses, the bank reported a pre-tax profit of KES28.5bn for FY16 (up 21.5% from FY15), supported by loan book expansion, reduced funding costs, growth in fee and commission income, and gains from the sale of available-for-sale securities. Overall, the ROaE and ROaA increased to 24.4% (FY15: 21.6%) and 4.1% (FY15: 3.9%) in FY16 respectively. However, GCR expects Kenyan banks’ annuity income from loans to contract in FY17 in an environment of reduced pricing flexibility. This follows enactment into law of the Banking (Amendment) Act 2016, which established a ceiling on commercial banks’ lending rates and a floor on deposit rates effective from 14 September 2016. The full impact of interest rate caps/floors will become clearer in FY17. KCB has increased focus on growing non-interest income and cost reduction to support earnings growth.

The bank maintained an average net liquid assets to customer deposits ratio of 32.1% during FY16 (FY15: 30.3%), which was well above the minimum requirement of 20%.

Improved asset quality trends driven by low credit losses and sound underwriting, and steady operating (capital, liquidity and earnings) metrics given the increasingly challenging operating environment, would further strengthen KCB’s financial profile. Furthermore, the bank’s ratings (currently the highest for a Kenyan bank accorded by GCR) could benefit from a material positive change in the Group’s support assessment. Sustained pressure on profitability stemming from a sharp rise in loan loss provisions and a higher susceptibility to economic/regulatory changes and competitive pressures, or a marked decline in liquidity or capitalisation, could lead to negative rating action.