Business Daily (Nairobi)
Morris Aron
12 May 2008
Eyebrows were raised in a few boardrooms last week after it emerged that Housing Finance, the country's leading mortgage lender, would go ahead with a Sh2.3 billion share sale later this month.
The pressing question, it later emerged, was why HF would want to raise money from its shareholders, despite having Equity, arguably the most liquid bank in Kenya as its partner.
Ever since it emerged last year that Equity Bank was set to acquire a 20 per cent stake in HF, it was expected that the cash limitations that have been holding back the ambitious mortgage lender would soon be a thing of the past.
Equity at one point did little to tone down this expectation by saying it would commit Sh7 billion to help Housing Finance expand its home loans business.
That announcement was taken to either mean that HF no longer needed to sell new shares to its members as it had all along predicated the share sale on the need to finance a five-year strategic plan or that Equity would consider making a full blown bid for the mortgage lender to increase its stake to 51 per cent. This would make HF a subsidiary of Equity Bank.
At the moment, owning a fifth of HF does not seem to add any value more than the bragging rights of having concluded a small merger and acquisition deal for Equity shareholders. At the current ownership threshold, the international accounting rules that guide the preparation of financial statements by CPAs only allow Equity to account for its stake in HF as an investment-whose value is boosted by a rising share price and dividend payments.
For this investment to contribute meaningfully into Equity's revenue and profits, the firm would have to buy more shares into HF to a threshold where it can account for it as a subsidiary (51 per cent) and increase its ability to leverage on its huge balance sheet and access to capital.
Pulling off such a deal would not be complicated because both companies share common shareholders, but it would be a pricey affair. Whether Equity's principle investors would be willing to unlock (cash) the value of their holding in HF and give the former a chunky bite into the mortgage lenders revenues is an issue that has not been put on the table.
At the moment, though HF shares have risen 67 per cent in the last one year, driven by the speculation of an Equity takeover, the mortgage lenders, is in a lacklustre business that has shrank from a revenue base of Sh1.9 billion in 2003 to Sh861 million in 2007.
Profits have grown from Sh51 million in that period to Sh74 million, which is a far cry, compared to other businesses of its size.
As HF has grappled with many legacy problems from its troubled lending book that has resulted in billions of loans being written off and mounting competition, it has not paid a dividend in nearly a decade.
The loan write offs which pulverized HF's reserves over the years heavily crippled HF's balance sheet and in turn reduced its ability to use its balance sheet-with interest earning assets worth Sh9.6 billion-to lend more aggressively and fend off competition from wealthier commercial banks that have invaded its space.
The tie up with Equity was meant to cure all these problems.
It is against this background that the announcement of the Capital Markets Authority approval for the rights- through which 115 million new shares will be sold at a price of Sh20 each - was received with some murmurs in financial circles.
Why has a marriage that appeared to meet all the strategic fit criteria take so long to take off? According to HF managing director Frank Ireri, things are on course.
Since an announcement appeared in the media that Equity Bank was willing to invest money in Housing Finance to fund low cost housing schemes some time last year, everybody's concern has been how the bank had intended to carry out the activity.
Several proposals emerged including options of a shareholders loan or a long-term deposit.
It is now emerging that the proposition-which has since left Housing Finance asking how such a deal was ever possible and Equity Bank refusing to confirm or deny the announcement-would have been impossible in the first place under the Central Bank of Kenya regulatory guidelines on additional deposits as restricted by core capital reserve at the company's disposal.
Mr Ireri said HF had first to meet its capital adequacies and disclosures requirements set by CBK through the rights issue before any considerations for loans or advances if any was needed.
"It was prudent that we first carry out the rights issue to raise capital to meet disclosure requirements and to support our five year strategic plan launched a while ago, "he said.
CBK regulations bar financial institutions from taking deposits above 12.5 per cent of its core capital and Housing Finance before the rights issue announcement, was almost approaching this ceiling.
At the same time, financial institutions are not allowed to lend above eight per cent of their core capital by the regulatory authority.
Latest HF financial reports indicate that the company was only one per cent above the statutory minimum allowing it to take up more customer deposits or loans with less than one per cent above the allowable minimum fraction of its core capital it could lend out.
The firm's liquidity ratio was also at the minimum statutory requirement of 20 per cent.
With such an outlook, HF was in dire need of a way to build its capital base, but without any form of loans until it had balanced its books and was still in need of more capital for its expansion plan, analysts say.
The rights issue announced a couple of days ago would see the company generate an additional Sh2.3 billion to boost its balance sheet.
The issue is informed by the need to boost its core capital to allow HF grow its deposits and lending, which has been sluggish in the past year.
Mr Ken Kinyua, the business director of development told the Business Daily in an earlier interview that until the rights issue was done, they would be in no position to move forward with their growth projections.
"We need to increase the size of our balance sheet to allow us to increase our lending," he said, adding that the size of the bank's balance-before the proceeds of the rights issue are included--couldn't support the growth plan.
Though Equity has refused to comment on the matter, analysts believe that the announcement, coupled with the recent acquisition of 20 per cent shareholding in HF, shows the interest with which the institution is keen to enter the low and middle income mortgage bracket-either through Housing Finance or with any other partner.
Commercial banks have recently shown interest in the mortgage sector, driven by high liquidity, which has eroded margins for short-term financial contracts.
Barclays Bank, Standard Chartered Bank and Stanbic Bank are all moving big into home lending with the Kenya Commercial Bank the only big player with a home finance subsidiary in Savings and Loan.
Housing Finance-which is the biggest mortgages provider accounting for 42 per cent of the market share-is the only established mortgage company that has operated in the industry for a long time without being a subsidiary of a commercial bank.
An African Alliance research last year said there were dominant issues that favoured a strategic link between Equity and HF.
The report argued that Kenya had far too many banks that are inefficient and do not compete effectively. However, the key to making money will be tapping into the low end of the market that is currently underserved by the big banks.
In HF, equity has an expert outlet which is now only constrained by capital and a low branch network. These limitations are more than made up for by over four decades of experience in the mortgage business and a Sh6.3 billion lending book. This would be a crucial asset that can be easily exploited by a bigger player. In a strategic fit, this is matched by Equity's experience in lending to the low-end market.
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