Local banks have in the last week been releasing their financial results for the first half of 2021, and the growth in their profitability at a time when the country is still grappling with the Covid-19 pandemic has stuck out like a sore thumb.
Rather than killing banks, the pandemic seems to have made them stronger. Slightly over a year since Kenya recorded its first case of Covid-19, banks appear to be on steroids.
KCB Bank more than doubled its net profits to Sh15.3 billion in the first six months of the year, compared to a profit after tax of Sh7.6 billion in the same period last year.
Equity Bank nearly doubled its profit after tax, which jumped by 98 per cent to Sh17.9 billion compared to a net profit of Sh9.1 billion by end of June 2020.
Co-operative Bank, another large lender that has already released its results, might not have posted huge profits but the trend, going by data on profit before tax captured by Central Bank of Kenya (CBK) in the first five months, points to unprecedented growth for banks.
CBK data show that lenders recorded a profit before tax of Sh96.4 billion in the first half of this year, a growth of 60.7 per cent compared to Sh60 billion that they made in the same period last year.
After a tumultuous 2020, bank shareholders, some of whom have gone for two years without getting a piece of the profits, are now positioning themselves for a bumper harvest.
So, where is the money coming from when the rest of the economy is just hankering on?
The truth is that the economy has started to show signs of recovery, but it is far from its pre-pandemic potential.
As the economy re-awakens and borrowers who had difficulties servicing their loans begin to repay their debts, billions of shillings that banks had set aside as insurance against possible defaults have been freed, swelling the lenders’ bottom lines.
This insurance cash is known as loan-loss provision. Where principal or interest is due and goes unpaid for 90 days, CBK requires banks to provision for it just in case the borrower defaults.
Last year, not only did banks experience a surge in non-performing loans (NPLs) owing to a difficult economic environment — with many people losing their jobs or taking pay cuts — but they were also forced to roll over loans for borrowers who had been adversely affected by the Covid-19 pandemic.
Since March 2020, loans amounting to Sh1.7 trillion were restructured by end of February 2021, accounting for nearly 60 per cent of the banking sector’s gross loans, according to CBK data.
CBK’s prudential guidelines require banks to provision for all those restructured loans. And they did.
Loan-loss provision increased by an average of 244 per cent among the eight largest banks to Sh32.3 billion in the first half of 2020.
In 2019, the banks had only set aside a total of Sh9.7 billion as insurance against possible defaults.
Equity Bank, which quickly recalled a dividend payout for 2019 that had been approved, saw its loan-loss provision grow by 769 per cent from just under a billion to Sh8 billion.
Provisions by Standard Chartered increased four-fold from Sh380 million to Sh1.6 billion while KCB’s increased by 266 per cent to Sh11 billion from Sh3 billion.
Diamond Bank increased its provision by 248 per cent and Absa Kenya by 228 per cent.
This wall of provision ate into banks’ profitability last year, with the CBK data showing that profit before tax declined by a third from Sh85.8 billion in June 2019 to Sh60 billion last year.
But this changed when the economy started to recover and CBK ended the loan repayment moratorium after a year.
A lot of these loans have since started performing, which means that borrowers are now servicing them normally.
For KCB, the 102 per cent profit growth came on the back of a reduction in impaired loans, including close to 90 per cent of the Sh105 billion that the lender had restructured.
This unlocked nearly Sh4.4 billion that had been set aside as insurance against possible defaults.
Equity Bank said that out of the Sh171 billion that had been restructured due to the outbreak of the Covid-19 pandemic last year, Sh103 billion is being paid on time.
This saw it cut loan-loss provisioning by 66 per cent to Sh2.6 billion in contrast with Sh7.6 billion that had been set aside in the preceding similar period.
With borrowers religiously servicing their debts, interest income has gone up.
Ronak Gadhia, director for sub-Saharan Banks at EFG Hermes, an investment bank, noted in an earlier interview with The Standard that the main driver for the improvement in performance is a decline in loan-loss provisions.
He said that last year, loan-loss provisions increased significantly due to a rise in NPLs as a fraction of total loans following the outbreak of the Covid-19 pandemic.
“While loan-loss provisions in financial year 2021 remain relatively high compared to pre-pandemic levels, they are much lower than financial year 2020 levels,” said Gadhia.
“Profitability is also being supported by improving efficiency as banks increasingly adopt digitisation strategies and modest loan growth.”
And it does not end there. Because the funds that had been set aside for possible defaults had already been taxed last year, banks will not be paying taxes on the recovered bad debt charges.
In the event of the loans being written off, banks will still claim back the taxes they paid on the insurance funds as an expense that had been subjected to the 30 per cent corporate income tax.
Last year was generally tough for Kenyan banks, whose profitability declined by almost a third on account of a surge in bad debt charge which almost tripled to Sh110.7 billion from Sh39.6 billion in 2019, according to CBK data.
But it was even worse for the 21 smaller banks. Their losses increased to Sh3 billion from Sh2 billion.
“This was attributable to eight banks making losses at a higher magnitude in 2020 compared to seven banks that made losses at a lower magnitude in 2019,” said CBK in its Banking Supervision Report of 2021.
So harsh was the situation for the tier-three lenders that Kingdom Bank, formerly Jamii Bora, was forced to get a Sh21 billion facility from CBK to keep it afloat, its parent company Co-operative Bank revealed in its annual report.
With profits sagging, most of the lenders withheld dividends.
Absa was the first top bank to withdraw dividend payout after its net profit dipped by 43.8 per cent on account of rising loan impairments.
“The directors did not recommend a dividend payout because Covid-19 is still here with us and we are expecting a big third wave,” said Absa Bank chief finance officer Yusuf Omari.
“Until vaccinations have been done, we are still skeptical to say we are already on the recovery.”
Equity shareholders would go for two financial years without dividend, with the second-largest bank by market size withdrawing the payout it had announced last year after the country announced its first case of Covid-19.
At least four banks paid dividend amounting to Sh13.1 billion for the year ending December 31, 2020 — Co-operative Bank, KCB, NCBA and Stanbic.
This is despite some of them being among the six of the 11 listed banks that issued profit warnings, meaning they expected their profits to decline by at least a quarter.
The huge bad debt charges were a double tragedy for banks. The accounting standard considers the money set aside to insure against default as an expense that should not be taxed.
But the tax laws speak differently. And because the taxman always has his way, banks paid taxes on the billions that they had set aside.
This resulted into what is known as deferred tax credit.
Robert Waruiru, a senior tax manager at KPMG East Africa, described deferred tax as an accounting concept that tries to measure how much tax credit or liability one will have in future.
If you have a deferred tax credit then it means in the future you will pay less tax, but if you have a deferred tax liability it means that you will pay more.
“If borrowers don’t pay, accounting rules require you to be prudent as a bank to say: ‘I have lent Robert some money, but from the way he is behaving, I don’t think he will pay me,’” said Waruiru.
This means the bank is likely to lose the money and so it provisions for loss.
“That provision for loss, for tax purposes, is not allowed,” Waruiru said. “The taxman, when looking at your profitability will completely disregard that loss and, therefore, you will have to pay taxes on that.”
If the borrower actually defaults, then the bank will be allowed to take that expense in the year that the loss was made.
“They will then pay less corporation tax because they have been allowed an expense which they had not even incurred in that year. Because they had incurred it in the previous year,” said the tax manager.
“When you recover the loan, then the taxman has nothing to tax because, remember, he had already taxed it. So you save that 30 per cent as well.”
A double tragedy for banks is now a double win for them.
As the impaired loan accounts start performing (which means more interest income), banks also recover the billions in bad debt charges which will not be taxed, swelling their bottom lines.
The result has been increased bank profitability, which means improved shareholder value.
NCBA Group chief economist Raphael Agung said that while the economy might not have fully recovered in the period under review, it is faring much better compared to April last year when the country went into lockdown.
“If you look at April 2020 and 2021, at the macro-level there are two differences just in terms of economic activities,” he said.
Even as the country started enforcing the social distance rules, Agung said, CBK immediately instructed banks to give distressed borrowers a debt repayment holiday of between six and 12 months.
Besides foregoing the income from interest and principal payments, banks were also not charging restructuring fees which they would have done under normal circumstances.
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