Banks battle to recover debt as bad loans surge

The average commercial bank lending rate climbed to  13.5 per cent as of July. [iStockphoto]

At the beginning of the year, bankers started noticing that the post-election enthusiasm was beginning to die down.

Kenya had experienced peaceful elections and a smooth transition, which had injected a sense of optimism into the economy.

Going by their 2022 full year financial results, banks’ loan defaults had slowed by Sh18.2 billion, indicating that businesses were on the recovery path and upbeat after the country had avoided a contractionary political period and would therefore ride the wave into the new year.

However, as early as January 2023 indications started emerging that the political negotiation was far from over. The worst drought in 40 years as well as international shocks on high US Federal Reserve rates were all signaling red lights.

Over and above all these headwinds, global energy prices started to rise at the same time as food prices reacted to supply chain disruptions caused by the Russia-Ukraine war.

Bankers, being at the forefront of the economy dealing with homes and businesses, importers and exporters as well as government began to experience rising defaults, reversing the positivity that had been witnessed at the end of last year.

Since then, the amount of bad loans has gone up nearly 20 percent or Sh90 billion to Sh586.2 billion, sending shockwaves in the industry when it almost touched Sh600 billion in May 2023.

Banks quickly reacted in different ways with some opting to seize businesses and recover their funds, resulting in court fights as businesses fought back ferociously.

KCB Bank has been one of the most aggressive in safeguarding shareholders value by going after recoveries. The lender has seized English Point Marina, Pinewood Beach Resort and Spa and, together with Absa Kenya, sought to take over Savannah Cement.

Equity Bank attempted to seize two listed companies, TransCentury and East African Cables. At the centre of the takeover was a defaulted loan of Sh4.8 billion by the two companies.

Over the last couple of months, Equity Bank has also placed other companies under administration including Tuskys, Kigali Business Centre, and Dickways Construction. Also in Equity’s bad books are Sumoko Down Town Enterprises and Sea Angel Petrol.

Regional lender NCBA sought to place Multiple Hauliers under administration. Together with Co-operative Bank, NCBA is pursuing Kaluworks. The lender also wants to take over Royal Swiss Bakery jointly with KCB and First Community banks.

Lenders are also pursuing Hashi Energy, Mulleys Supermarkets, Invesco, Explico and Amaco Insurance companies, an indication of a depressed economy.

Even as companies struggled to meet their loan repayments, the Central Bank of Kenya (CBK) which had initially hesitated to increase interest rates, started hiking the Central Bank Rate aggressively following the change of leadership at the helm of the regulator.

Increase cost

This meant that banks needed to increase the cost of loans which would ultimately push even more companies into default.

According to data from CBK, the average commercial bank lending rate climbed to a 65-month high of 13.5 per cent as of July, the highest level since February 2018.

A recent CBK survey indicated more than a quarter of chief executives expect to cut jobs before the end of the year on increased operating costs and softened demand for goods and services.

The CBK CEO’s Survey that targeted the chief executives of more than 1,000 private sector firms through online questionnaires, showed 26.3 per cent of respondents expected to cut their workforce in the second half of the year while 63.5 per cent would not be hiring.

“Optimism regarding growth prospects for the Kenyan economy weakened with respondents citing the combined impact of the high cost of living and the weakening Shilling as growth-constraining factors,” said the survey report.

Banks raced to stabilise operations of small businesses and ward off mass loan defaults in the wake of a barrage of shocks, restructuring the facilities to pass on the cost over time rather than raising rates, which could fuel defaults further.

Lenders began reaching out to SMEs with support packages including extending repayment periods and connecting some with affordable suppliers of imported goods.

Banks said they were emboldened by the statistics that showed that of the 6,572 MSME loans valued at Sh122.5 billion that were restructured last year, over 90 per cent were being serviced.

But the defaults just kept coming, forcing them to anticipate further dud loans in the industry and to begin setting aside part of the profits to cover for the said loans.

Bank provisioning for bad loans, part of the profits set aside to ensure defaults for the top seven lenders who control the sector in Kenya, doubled from Sh12.9 billion in the first three months of 2022 to Sh24.9 billion this year, signaling tough times ahead for the bankers.

As the largest lender by assets, KCB is practically exposed to virtually the entire economy. The current bad loan crisis has only underscored what the bank had started dealing with even before the rest of the industry players could catch up.

In May 2022, KCB appointed Paul Russo to head the bank in a move that had precedence on picking an insider after Joshua Oigara was also elevated in the same way in 2013.

The choice was not coincidental: Mr Russo was a bad loans expert. In 2016, he took charge of Chase Bank when KCB was given the role of overseeing the collapsed lender’s process.

He did a good job there, giving him another opportunity in 2019 to run the newly acquired National Bank of Kenya (NBK) before coming back to KCB as the Group CEO.

The bank’s non-performing loans had grown from Sh2.2 billion in 2012 to Sh32.4 billion by June 2019.

NBK had also lost customer deposits and had suffered from historical credit losses on loans and advances that ate up its capital.

By the time of its acquisition by KCB, it was operating on negative capital ratios and had breached all regulatory requirements.

Under Russo’s watch, NBK managed to improve its NPL ratio to 17.4 per cent compared with the 21.5 per cent it had reported in the half year ended June 2022, attributed to recovery efforts led by a special committee put in place to address the defaults.

When Russo took over KCB, it was clear that part of his assignment was to clean KCB’s bad loans, some of which were historical stretching back to the 1990s.

Out of KCB Kenya’s 19.6 per cent non-performing loans ratio in June 2023, the bulk of it (13.3 per cent) is composed of legacy NPLs older than two years. NPLs less than two years old account for only 6.3 per cent.

Setting up a special loans recovery team was the first assignment by Russo which has been mandated to make legal claims, advise on bad loans and provision for possible defaults as a move to clean the books.

This was a costly yet necessary move and was partly responsible for a 48 per cent increase in operational cost in the first half of this year to Sh40.4 billion mainly contributed by legacy legal claims, staff restructuring expenses at KCB Bank Kenya and expenses related to the acquisition of TMB in DRC Congo.

The bank more than doubled loan loss provisions in the first half of 2023 up by 136 per cent to Sh10 billion.

“Profitability was under pressure in the first half from increased funding costs on higher market deposit rates, prudent provisioning on legacy credit facilities, and provisions for legacy legal claims at NBK,” said Russo.

Improved ratio

The expenditure is beginning to yield fruitswith the NPL ratio improving by 4.1 percentage points in one year to June 2023 from 21.5 percent to 17.4 percent.

Recoveries more than offset the impact of currency depreciation and downgrades during the period.

Improvement in NPL stock was noted in the tourism, building and construction, and transport sectors.

The strategic move to focus on bad loans is bound to help KCB stay ahead of the curve in the industry, allowing it to grow despite the current tough operating environment.

KCB continues to grow evidenced by strong revenue and balance sheet growth - growing revenues 22 per cent in the first half of the year driven by new business lines, deepening of digital channels and market-leading value propositions.

Its balance sheet expanded by 54 per cent to Sh1.9 trillion driven by the consolidation of TMB and new business lines.

KCB added Sh32 billion in shareholder wealth in one year to June 2023. Raised total shareholder equity to Sh211 billion driven by sustained profitability.

While the bank has taken huge stock price discounts at the bourse, its strategy around NPLs is strong.

Currently, price-to-book valuations for nine out of the 11 listed banks show they have a price to book ratio of less than one, meaning they are undervalued.

Out of these listed lenders, six have seen their share prices fall since the beginning of the year, while five have recorded an appreciation.