Why we sold Sidian Bank to a Nigerian lender at a loss
When Centum bought K-Rep Bank, they had no idea that Kenya would be hit by a series of bank meltdowns, an interest rate cap law and a new risk-based lending model that would make the market micro-loans they were targeting. not viable.
Centum held a 1.8% stake in K-Rep and exposure to Platinum microfinance and they believed that a bank with strong chama (business club) clients such as K-Rep could offer immense lending potential at the bottom of the market at very attractive rates.
The investment firm’s CEO, James Mworia, said the bank was very profitable at the time with the highest return on equity in the market of 30% and he believed that to scale it and create a brand of niche under the Sidian Bank brand would be very lucrative.
The trader who thinks he’s a structured thinker who takes all the facts into account before placing a bet, admits that there are limits to foreseeing the unforeseen events that have undermined the bank’s potential.
Mr Mworia said the collapse of Imperial and Chase Bank first hit them with liquidity problems and 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 chosen to exit with a marginal loss by recovering as much of its investment as possible.
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Centum Investment, which bought a majority stake in K-Rep and gradually increased its stake in Sidian through capital injections by investing 4.7 billion shillings in the bank, sold it to Nigeria’s largest lender, Access Bank, for 4.3 billion shillings.
“We initially bought the bank at 2.7 billion shillings and then invested capital, which brought our investments to 4.7 billion shillings. However, every year we revalue the bank and at the point of sale we take it up to 2.5 billion shillings after forecasting revaluation losses on our books,” he said.
Mr Mworia said the decision to exit was rational after years of trying to adapt to changing dynamics in the banking sector.
Just after pouring money into renaming the bank, upgrading systems and hiring a new management team, the banking industry was hit by the collapse of Imperial Bank and Chase Bank.
What that did was that the cost of funding for tier two and tier three banks increased dramatically, and they started having liquidity issues.
Sidian was also very dependent on wholesale deposits because the challenge in the microfinance segment is that they are largely net borrowers, they weren’t savers so now you have to get expensive wholesale deposits from institutions to finance the bank.
Then the interest rate cap came into effect and that meant it was no longer profitable to offer microloans because they couldn’t assess the risk. After all, Sidian was largely doing unsecured lending.
Mr Mworia says when the cap came it took almost 1.3 billion shillings out of revenue and turned the bank into a loss-making institution because it had a fixed cost structure.
He says they found themselves in a tough spot and chose to adapt by moving away from microfinance lending and now becoming a more SME-focused corporate bank.
This meant they needed new leadership and Mr Mworia fell back on data assessing all the smaller banks to see which one was doing well on deposits and unfunded income.
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When they did a ranking, Credit Bank came out on top and that’s how they got Chege Thumbi about five years ago which brought the bank’s resurgence back to profitability.
However, this took time and required additional resources, Centum had to make additional capital investments and equity injections to sustain the growth of the institution and support the systems.
“Once you went to the SME bank, now you’re focused on small business lending, you have to support them with the digital tools and if you look we won the award for the best app on the market, which speaks to the business and the brand we’ve built,” he said.
They increased the balance sheet from 10 billion shillings to around 43 billion shillings and brought the bank back to net profitability of 117 million shillings in the first quarter of this year.
In 2019, the rate cap was removed, but the Central Bank of Kenya wanted to make sure lenders were no longer charging exorbitant prices.
The regulator introduced a new risk-based regime, which meant that a borrower ideally got the same rate whether they borrowed from Sidian or KCB, as pricing is based on customer risk, not cost. form the bank.
Mr Mworia said that in a situation where you cannot pass the cost of being small on to the customer, the smaller you are, the less efficient you are because the cost of people and systems is the same, but the cost of funds is higher for smaller players.
So the only way out is to increase revenue, especially on the unfunded revenue side, be more efficient in your cost structure, or grow the business.
However, banking is a capital intensive business, for you to scale, every shilling backs Sh8 of assets, so for you to scale you need to invest money.
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Mr Mworia said Centum had three options, either stay put and stagnate below its potential, which meant years without dividends and with limited capital that may require additional funds.
They could strive to be tier 2 with over 10 billion shillings in capital, but that would mean investing 800 million shillings a year for three years and keeping all profits in the bank before they could scale up with a return of up to 16% of equity.
The other option was to get a strategic buyer with an established banking network that would need fewer resources to scale.
“Now we had these three choices and imagine this is your pension fund and you are the chairman of the investment committee, which 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 the banks are trading, the price to book is around 1.1 and 0.2.
“We said if we can get a price at the top of the market, we’re happy to get out. We therefore exited at 1.1 price-to-book ratio, at the high end of the market. Then that other investor can now come in and take advantage of their synergies and take the institution to the next level,” he said.
Then from their point of view, because stock prices are now very low in the market, with this liquidity they can redeploy buy stakes in blue chips which pay high dividends as well as fixed income in the meantime market conditions improve.