When Centum was buying K-Rep Bank, they did not have an idea Kenya will be hit by a series of banking collapses, a law capping interest rates and a new risk-based lending model that would make the micro-loan market they were targeting unviable.
Centum had 1.8 percent stake in K-Rep and exposure in Platinum microfinance and they figured a bank with a strong chama (business club) customers such as K-Rep could offer immense potential in lending to the bottom of the market at very attractive rates.
The investment firm’s CEO, James Mworia, says the bank was very profitable at the time with the highest return on equity in the market of 30 percent and he figured scaling it and building a niche brand under the Sidian Bank brand would be very lucrative.
The dealmaker who fancies he is a structured thinker who takes into account all the facts before placing a bet, admits there are limits to predicting the unforeseen events that took the sting out of the bank’s potential.
Mr Mworia said the collapse of Imperial and Chase Bank hit them first with liquidity challenges, the then the rate cap meant they could not lend to risky markets – their niche market.
Eight years later after constantly draining more money to keep capital ratios just above Central Bank of Kenya requirements, Centum has opted to exit at a marginal loss getting back as much of their investment as they could.
Centum Investment, which bought a majority stake in K-Rep, and progressively increased shareholding in Sidian through capital injections investing Sh4.7 billion in the bank has sold it to Nigeria’s biggest lender Access Bank for Sh4.3 billion.
“We initially bought the bank at Sh2.7 billion and subsequently put in capital that brought our investments to Sh4.7 billion. However, every year we re-valued the bank and at the point of sale we were carrying it at Sh2.5 billion having provided for revaluation losses through our books,” he said.
Mr Mworia said the decision to exit was rational after years of trying to adjust to changing dynamics in the banking industry.
Just after putting in money to rebrand the bank, upgrade systems and hire a new management team, the banking sector was hit by the collapse of Imperial Bank and Chase Bank.
What that did was the cost of funding tier-two and tier-three banks increased significantly, and they began to have liquidity challenges.
Sidian was also very reliant on wholesale deposits because the challenge in the microfinance segment is that they are largely net borrowers, they were not savers, so you now have to get expensive wholesale deposits from institutions to finance the bank.
Then the interest rate cap came in and it meant that it was no longer profitable to offer microloans because they could not price the risk. After all, Sidian was largely doing unsecured lending.
Mr Mworia says when the cap came it took out almost Sh1.3 billion of the revenue and moved the bank into a loss-making institution because it had a fixed cost structure.
He says they found themselves in a difficult situation and they opted to adapt pivoting away from microfinance lending to now being a more SME-focused enterprise bank.
That meant they needed new leadership and Mr Mworia fell back to data assessing all small banks to see which one was doing well on deposits and non-funded income.
When they did a ranking, the Credit Bank came on top and that is how they got Chege Thumbi about five years ago who drove the bank’s resurgence back to profitability.
However, this took time and required extra resources, Centum had to make additional capital investments and equity injections to support the growth of the institution and support the systems.
“Once you go to SME banking you are now focused on lending to small businesses, you need to support them with the digital tools and if you look we have won the award for having the best App in the market, which speaks to the business and the brand we have built,” he said.
They grew the balance sheet from the Sh10 billion up to around Sh43 billion and turned the bank round to profitability netting Sh117 million in the first quarter of this year.
In 2019, the rate cap was removed, but the Central Bank of Kenya wanted to ensure lenders no longer charged exorbitant prices.
The regulator introduced a new risk-based regime, which meant a borrower ideally got the same rate whether they borrowed from Sidian or KCB because the pricing is based on the risk of the customer and not the cost of the bank.
Mr Mworia said in a situation where you cannot pass off the cost of being small to the customer, the smaller you are the less efficient you are because the cost of people and systems is the same yet the cost of funds is higher for smaller players.
So the only way out is to increase products, especially on the non-funded income side, be more efficient in your cost structure or scale up the business.
However, banking is a capital-intensive business, for you to scale, each shilling is supporting Sh8 of assets so for you to scale you have to put in money.
Mr Mworia said Centum had three options, either to stay put and stagnate below potential, which meant years without dividends and with thin capital that may require additional funds.
They could strive to be tier-two with more than Sh10 billion capital but that would mean investing Sh800 million annually for three years and retaining all profits at the bank before they can attain scale with a return of up to 16 percent of equity.
The other option was to get a strategic buyer with an established bank network who would need lesser resources to scale.
“Now we had those three choices and imagine this is your pension fund and you are the chair of the investment committee, what option would you take?”
Mr Mworia said the exit was a rational decision, at a fair price when you look at the market and where banks are trading the price to book is about 1.1 and 0.2.
“We said is if we can get a price at the upper end of the market then we are happy to exit. So we exited at 1.1 price-to-book, at the higher end of the market. Then that other investor now can come and now leverage their synergies and move the institution to the next level,” he said.
Then from their perspective, because share prices are now very low in the market, with that liquidity they can re-deploy buying stakes at blue chips which are yielding high dividends as well as fixed income as they wait for market conditions to improve.