Geza Ulole
JF-Expert Member
- Oct 31, 2009
- 59,219
- 79,480
[h=1]Kenyan banks figures too good to be true[/h]
Clients at a banking hall. With interest rates continuing to climb, the outlook for the banking sector remains negative. File
Kenyan commercial banks had a great year in 2010 from investing in Treasury and corporate bonds interest rates were low, predictable, and the government was a willing borrower with banks as eager lenders.
Now, the banks are suffering a terrible hangover. Interest rates rose sharply in the first six months of 2011, and accelerated to September as the Central Bank scrambled to make sense of what was happening to the Kenya shilling.
CBKs policy response was to raise interest rates to keep the lid on rising inflation and support the shilling, which has sunk to an all-time low to the dollar.
As banks face up to the reality of the rate hike, there are questions as to whether they have adequately disclosed their losses in holding or trading bonds in their half-year results to June.
When interest rises, bond prices fall and vice versa. Rising interest rates in 2011 have seen bond prices fall, meaning commercial banks have made losses, but most seem to have glossed over the figures according to analysts.
A more open disclosure by the banks about the impact of the recent movement in interest rates would have certainly contributed to the discussion on the party and the hangover, said Cannon Asset Managers in their latest market outlook report.
With interest rates continuing to climb and the peak still to be witnessed, our outlook for the banking sector remains negative, they added.
According to International Financial Reporting Standards, global accounting rules used throughout East Africa, banks are allowed to hold bonds in two baskets: Until they mature, accounting for interest earned in any given period as income and never recognising any capital gains or losses that might result from movements in interest rates in the financial markets; then there are bonds that banks buy to speculate in the financial markets in order to take advantage of movements in currencies, inflation and interest rates. The value of these bonds are called available-for-sale and are linked to the prevailing prices in the financial markets and the capital gains or losses deducted directly on the income statement.
According to accounting rules, the bonds in these two baskets should never be mixed, and if the ones in the held-to-maturity category are as much as touched, they are said to be tainted and must be classified as available-for-sale. Shifting bonds from one basket to the other can give banks significant scope to fudge earnings and lie to shareholders. This is why analysts worry that Kenyan banks could be playing games.
If the banks did not fully or adequately disclose their exposure, it means some will have to do so in the second half with the possibility of reporting an earnings drop.
Depending on the level of exposure, it could lead to earnings surprises in the second half of the year, said Judd Murigi, head of research at African Alliance East Africa.
It goes with the integrity of internal financial reporting. They should make this adjustment on half-year results instead of waiting for the full year results, said Mr Murigi.
In their report, Cannon Asset Managers gave strong ratings to Standard Chartered Bank and National Bank of Kenya because the two banks disclosed the losses from trading their bond portfolio. This was reflected in their profit and loss statement where Stanchart and NBK booked losses in their profit and loss account.
NIC Bank, Barclays and Co-operative Bank received a medium score because the losses in their bond portfolio were charged against the cash they hold in their reserve of profits from previous years. The result is that these three banks overstated their current profits and distorted the picture of their earnings power by offsetting their trading losses against profits of yesteryears.
However, the three banks did not discuss the extent of their losses in their half-year 2011 announcement.
If they are passing the losses through the reserves, then they should be adequately provided for, said Daniel Ndungu, a portfolio manager at Cannon Asset Managers. It might not be a straightforward thing to determine unless you get more information on their trading books, like at which yield they bought the bonds. Even in annual reports, you cannot get the information.
NIC Bank declined to comment. BBK said their bond portfolio is not affected because they hold most of their bonds to maturity. Co-op Bank did not respond to questions from The EastAfrican.
I&M, whose shares trade over the counter, KCB, Equity Bank and DTB Bank received a poor score because the adequacy for provisions on their losses from trading in bonds could not be assessed.
Equity and DTB were noted to have changed their trading books from held to maturity which cushions them against fluctuations in interest rate movements. Equity Bank did not respond to questions from The EastAfrican.
Experts in bond trading said the rationale of changing the bond portfolio from those which are held for trading to those held to maturity should be questioned based on the banks intentions.
The important question to ask is how they move from one to the other, said James Murigu, a bond expert, on the banks moving from one portfolio to another.
The East African: - Business |Kenyan banks
Kenyan commercial banks had a great year in 2010 from investing in Treasury and corporate bonds interest rates were low, predictable, and the government was a willing borrower with banks as eager lenders.
Now, the banks are suffering a terrible hangover. Interest rates rose sharply in the first six months of 2011, and accelerated to September as the Central Bank scrambled to make sense of what was happening to the Kenya shilling.
CBKs policy response was to raise interest rates to keep the lid on rising inflation and support the shilling, which has sunk to an all-time low to the dollar.
As banks face up to the reality of the rate hike, there are questions as to whether they have adequately disclosed their losses in holding or trading bonds in their half-year results to June.
When interest rises, bond prices fall and vice versa. Rising interest rates in 2011 have seen bond prices fall, meaning commercial banks have made losses, but most seem to have glossed over the figures according to analysts.
A more open disclosure by the banks about the impact of the recent movement in interest rates would have certainly contributed to the discussion on the party and the hangover, said Cannon Asset Managers in their latest market outlook report.
With interest rates continuing to climb and the peak still to be witnessed, our outlook for the banking sector remains negative, they added.
According to International Financial Reporting Standards, global accounting rules used throughout East Africa, banks are allowed to hold bonds in two baskets: Until they mature, accounting for interest earned in any given period as income and never recognising any capital gains or losses that might result from movements in interest rates in the financial markets; then there are bonds that banks buy to speculate in the financial markets in order to take advantage of movements in currencies, inflation and interest rates. The value of these bonds are called available-for-sale and are linked to the prevailing prices in the financial markets and the capital gains or losses deducted directly on the income statement.
According to accounting rules, the bonds in these two baskets should never be mixed, and if the ones in the held-to-maturity category are as much as touched, they are said to be tainted and must be classified as available-for-sale. Shifting bonds from one basket to the other can give banks significant scope to fudge earnings and lie to shareholders. This is why analysts worry that Kenyan banks could be playing games.
If the banks did not fully or adequately disclose their exposure, it means some will have to do so in the second half with the possibility of reporting an earnings drop.
Depending on the level of exposure, it could lead to earnings surprises in the second half of the year, said Judd Murigi, head of research at African Alliance East Africa.
It goes with the integrity of internal financial reporting. They should make this adjustment on half-year results instead of waiting for the full year results, said Mr Murigi.
In their report, Cannon Asset Managers gave strong ratings to Standard Chartered Bank and National Bank of Kenya because the two banks disclosed the losses from trading their bond portfolio. This was reflected in their profit and loss statement where Stanchart and NBK booked losses in their profit and loss account.
NIC Bank, Barclays and Co-operative Bank received a medium score because the losses in their bond portfolio were charged against the cash they hold in their reserve of profits from previous years. The result is that these three banks overstated their current profits and distorted the picture of their earnings power by offsetting their trading losses against profits of yesteryears.
However, the three banks did not discuss the extent of their losses in their half-year 2011 announcement.
If they are passing the losses through the reserves, then they should be adequately provided for, said Daniel Ndungu, a portfolio manager at Cannon Asset Managers. It might not be a straightforward thing to determine unless you get more information on their trading books, like at which yield they bought the bonds. Even in annual reports, you cannot get the information.
NIC Bank declined to comment. BBK said their bond portfolio is not affected because they hold most of their bonds to maturity. Co-op Bank did not respond to questions from The EastAfrican.
I&M, whose shares trade over the counter, KCB, Equity Bank and DTB Bank received a poor score because the adequacy for provisions on their losses from trading in bonds could not be assessed.
Equity and DTB were noted to have changed their trading books from held to maturity which cushions them against fluctuations in interest rate movements. Equity Bank did not respond to questions from The EastAfrican.
Experts in bond trading said the rationale of changing the bond portfolio from those which are held for trading to those held to maturity should be questioned based on the banks intentions.
The important question to ask is how they move from one to the other, said James Murigu, a bond expert, on the banks moving from one portfolio to another.
The East African: - Business |Kenyan banks
