Bad loans eat into banks’ profit levels

If there was a story that has dominated the banking sector over the last two years, it is the events that led to the eventual acquisition of some assets and liabilities of Crane Bank by Dfcu.
On the sidelines, however, the banking sector seems to have moved on with several indicators pointing to an economy still facing challenges.

In as much as profitability rose by an average of 11.3 per cent to Shs745b as of December 31, 2017, defaulting customers unlikely to meet their obligations expanded.
Banks wrote-off Shs220b worth of loans, an increase of 44 per cent. Loan write-offs indicate just how toxic some borrowers have become and banks are either unable to make recoveries or difficult to collect.
Such loans are removed from the balance sheet because they do not tell the reality of the assets the banks hold.

Why would bank write-offs rise?
Speaking in an interview, Wilbrod Owor, the Uganda Bankers’ Association (UBA) executive director, noted the trend in the banking sector was reflective of what the economy was in 2017.
The economy slowed in 2016 and stretched into 2017.

However, there are signs of recovery riding on a nearly 7 per cent growth in the second half of 2017, according to data from Uganda Bureau of Statistics.
The improved growth, however, is yet to translate into better prospects for borrowers.
Several businesses continue to struggle to meet payment obligations while others are still struggling to access credit facilities.

Increase in write-offs signal why banks on average only grew their lending by 1.5 per cent to Shs11.5 trillion in 2017.
Certainly, this suggests, banks exercised cautious, lending less and put focus on the long-term outlook for improving economic conditions.

According to an analysis of the banking sector financial statements, Diamond Trust Bank, Stanbic Bank, Dfcu and Bank of Baroda registered combined write-offs of more than Shs20b for the year ending December 31, 2017. Dfcu had the highest increase in write-offs from Shs5b to Shs27.2b, an indicator of a toxic loan book it inherited from Crane Bank.
Debt write-offs are the extreme measures taken by banks after they have concluded that recoveries might either be expensive or could never happen at all.

Default rates falling
There are, however, customers that often delay making payments within the stipulated time in the loan agreements. If delays to make a payment stretch to three months, the bank will classify such as a loan as non-performing.
According to data from the financial statements, 5.95 per cent of all loans in the banking sector are non-performing (NPL).
This was an improvement from 2016 when 10.47 per cent of loans were NPLs. It should also be noted that in 2016, there was an inclusion of Crane Bank, which accounted for nearly 50 per cent of all industry NPLs.
In 2017, total NPLs decreased marginally by 0.3 per cent to Shs606b – this figure is not inclusive of the exact NPLs posted by Stanbic Bank.

Stanbic did not publish NPLs when it released financial results for 2017. The highest NPLs were recorded by Barclays Bank at Shs107b or at least 10.3 per cent of its loan book.
Dfcu’s NPLs also grew to Shs96.6b – again reflecting the Crane Bank loan book it took on – or 7.3 per cent of its loan book.
Standard Chartered Bank presented the most interesting scenario. The bank reduced its loan book significantly – by 12.6 per cent – and also saw total NPLs reduce by 30 per cent to Shs78.6b.
The challenge though is that because the bank lent less, the NPLs as a percentage of total loans remain high - 13 per cent.
With the several exceptions, there is a more positive outlook since NPLs are falling from the historical highs recorded in 2016.

According to Owor, in the absence of significant credit growth last year, there was limited movement of NPLs because of the tough conditions within the economy.
All these, he says, are a reflection of the economic situation last year.
A similar sentiment is shared by Fabian Kasi, the Centenary Bank managing director, who saw the bank record growth in NPLs.
“Slow growth in the economy which grew at 3.5 per cent compared to the projection of 5 per cent, made it difficult to grow credit due to subdued and difficulties in paying back loans, which led to a 4.5 per cent in NPLs,” Kasi says.

Cautious lending
With a combination of factors as already stated, some banks opted to become cautious. The role of banks is to facilitate business growth. When businesses need financing, they will go to a bank and borrow. In 2017, some banks took a more cautious outlook and decided to lend less. In essence, they did not facilitate business growth that much.
Lending only grew by 1.5 per cent to Shs11.5 trillion. Even with the decline in interest rates from an average of 22.5 percent at the start of 2017, to 20.28 in December 2017, borrowing was still low.

Instead, banks retreated to safety nets such as lending to government.
“We took a more cautious outlook in 2017. The option was to ensure we don’t up a lot of risk with borrowers considering [high rateof ] NPLs. This led to reduced income levels and impacted profitability. With improving economic conditions, this could change,” says Varghese Thambi, the Diamond Trust Bank managing director.
Interest income, the cash-cow for many banks (for most banks, it contributes in excess of 80 per cent of income) grew at a low rate. In an environment where lending rates to the private sector declined and yields on government securities also dropped, interest income was bound to decline.

For banks such as Equity that opted to take a risk on private sector, there was noticeable growth in interest income.
“Following the reduction in interest rates in the market and the reduction in the Central Bank Rate, the bank (Centenary Bank) reduced its prime interest rate to 21 per cent leading to a reduction in the growth of funded income,” says Fabian Kasi.
Interestingly, as lending slowed for the sector, banks were mobilising deposits.
The rate of deposits growth in the sector was 12 per cent to Shs18 trillion. That means the ratio of deposits to lending was 70 per cent.

BANKS STILL PROFITABLE
Whereas income from interest earning declined, according to Patrick Mweheire, the Stanbic chief executive officer, the bank’s lending to the private sector grew to 8.6 per cent higher than the industry average.
“The banking sector suffered interest margin compressions because yields on government securities were collapsing and the reducing Central Bank Rate (CBR),” he says, highlighting that even under such circumstances the bank registered impressive profits.
Despite distressed economic indicators, banks continue to be profitable and continue to expand their capital bases.
Overall, banks posted after-tax profits of Shs745b - a rise of 14.2 per cent. Only five banks out of 24 made losses in 2017.