Ugandan Banks_BUY Stanbic_HOLD DFCU

UGANDAN BANKS

We reiterate our BUY on Stanbic; Initiate DFCU with a HOLD We look at the Ugandan banking system, Stanbic Bank Uganda (Stanbic) and DFCU bank (DFCU). Key takeaways are:

Growth of the financial services sector and banking should

be supported by the growing wealth level and expanding

population. The low penetration level provides vast

potential, in our view. The banking assets/GDP is only

30.8% while deposits/GDP and loans/GPD ratios are 19.2%

and 13.1% respectively. The relatively strong GDP growth

provides a fillip to banks’ top lines.

The industry’s average Return on Equity (ROE) of 31%

(CY05-CY08) is supported by a relatively high Return on

Assets (ROA) rather than leverage. The high ROA is

underpinned by high net interest margins (NIM), averaging

11.5% (05-08). The system’s liquidity is fair, with a

loan/deposit ratio (LDR) of 72% vs. a cap of 80%.

The system remains largely inefficient with a low level of

non-interest income (NII) and a NII/operating income ratio

of below 20%. The industry carries ample capital, with a

total Capital Adequacy Ratio (CAR) of 21%. However, we

remain concerned with the credit risks and the “poor”

coverage ratio which impair the quality of earnings.

We revisit our Stanbic forecasts and valuation. We reiterate

our BUY recommendation with a new FY11 target price of

Ugx340, providing a potential total return of 49.8%. We

believe Stanbic is well placed to protect its market share.

We initiate coverage on DFCU Bank with a HOLD. Our FY11

target price is Ugx833. Our primary concerns are the

inconsistency in performance, relatively poor retail deposit

franchise and the comparatively lower ROE (vs. industry).

There is hope, but only after dealing with legacy issues in

their entirety in our view.

Peter Mushangwe Puleng Kgosimore +27 11 551 3675 [email protected]

September 2, 2010

African Markets: Equity

Industry View: Positive

SBU: BUY DFCU: HOLD

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Contents page

Executive Summary 2

Salient country information 4

1. Industry Overview 5

1.1 Penetration, deposits and credit growth 5

1.2 Liquidity, profitability and efficiency 10

1.3 Credit risks and capital adequacy 18

1.4 Economics and politics 24

2. Stanbic Uganda, FY11 Ugx344, BUY 26

2.1 Company description: One of the strongest franchises 26

2.2 Analysis: Low cost deposit base is key 26

2.2 Valuation: A deserved premium 32

3. DFCU Initiation of coverage, FY11 Ugx833, HOLD 34

3.1 Company description: One of the oldest franchises 34

3.2 Analysis: Low CASA to affect margins 35

3.2 Valuation: Hope after addressing legacy issues 41

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Executive Summary

We like Uganda banking sector on structural growth...: The

Uganda banking system is lowly penetrated with deposit/GDP and

loan/GDP ratios of 19.2% and 13.1% respectively, yet population

and wealth levels (as measured by the GDP per capita income) are

increasing. The system’s LDR is 72% which provides some room

for NIM support through changes in asset mix in the short term.

Loans and advances were only 42% in CY08. The system carries

excessive capital in our view, with a total CAR ratio of 21%

(HY09). Despite having 22 commercial banks, the system is fairly

concentrated with the top 5 banks making up more than 50% of

the industry assets and deposits.

...and positive macro-outlook...: We remain positive on

economic growth given the oil and mineral discoveries as well as

our expectations of continued government (central and municipal)

investment in infrastructure. We expect Uganda to maintain a GDP

growth rate at greater than 6% for the next 3 years. We remain

convinced that the difference between Kenya and Uganda in

banking will narrow, and as penetration and per capita move

towards convergence with Kenya, we foresee significant

opportunities in the Ugandan banking system given the higher

population growth.

...but the credit risks and the volatile non-performing loans

(NPLs) coverage ratios are a worry, in addition to pressure

on NIMs: The industry’s NPLs have been growing at a faster rate

than loan growth since CY05. The NPL/loan ratio peaked at 4.1%

in CY07, declined to 2.1% in CY08 before rebounding to 4.0% in

H09. We note that the CY08 ratio decline was a result of an

enormous 33% reduction in NPLs in that year. As a result, the

provision/NPL ratio also recovered to over 100% in CY08 before it

worsened to 72% in HY09. While we believe there is some

cyclicality to NPLs, we are concerned with the volatility in the

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coverage ratio. We would prefer the Bank of Uganda (BoU) to

prescribe a minimum coverage level. We also see pressure on

NIMs. Vigorous deposit mobilisation strategies as a result of rising

competition will increase the cost of deposits. We anticipate an

increase in wholesale and fixed deposits in the system.

Follow up on Stanbic Bank Uganda with a BUY

recommendation: The high ROE, a strong retail deposit franchise

and high liquidity levels motivates our BUY recommendation. The

bank has room to change its assets mix (i.e. increasing the LDR)

to protect its interest spread and NIM. The bank’s ROA is high

(FY09 = 5.1%; our FY10 forecast is 3.5%). We expect the bank to

continue to widen the ‘jaws’. Our FY11 price target is Ugx340,

implying a potential total return of 49.8%. The ROE outlook is

positive despite a slowdown in earnings growth in FY10. BUY

Initiate DFCU bank with a HOLD recommendation: While we

believe that DFCU can be the local brand that can break the

hegemony of the international banks in the system, we remain

concerned with the poorer retail deposit franchise, the lower ROEs

(and ROAs) and the execution risks (the Group was restructured

and has witnessed a couple of Managing Directors and Board

Chairmen in the past five years). The jaws are also not opening up

fast enough, in our view, with operating income registering a

compounded annual growth rate (CAGR) of 18% versus a CAGR of

15% for operating expenses. Our fair Price-to-book value ratio

(PBVR) which we obtain using an ROE of 25.8%, growth rate of

15.7% and a Cost of Equity (CoE) of 18.95% is 2.1X. Our FY11

price target is Ugx833, which provides a potential total return of

8.4%. HOLD

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Salient country information.

Fig 1: Key country information

2001 2002 2003 2004 2005 2006 2007 2008

GDP at market prices (current),ugxbn 10,907 12,438 13,972 16,026 18,172 21,187 24,709 29,824

GDP, US$bn (current) 5.8 6.2 6.6 7.9 9.2 9.9 11.9 14.4

Real GDP growth,% 8.5% 6.5% 6.8% 6.3% 10.8% 8.4% 9.0% 7.0%

Population,mn 25.11 25.97 26.87 27.82 28.82 29.85 30.93 32.04

Per capita income, US$ 232.6 239.4 245.8 284.9 320.1 333.5 385.3 450.6

Household final consumption,ugxbn 8,396 9,587 10,291 11,818 14,139 16,303 18,835 23,963

Government consumption,ugxbn 1,820 1,959 2,133 2,326 2,568 2,695 2,721 3,014

Gvnt. Consumption/GDP 16.7% 15.8% 15.3% 14.5% 14.1% 12.7% 11.0% 10.1%

Financial indicators

Bank rate,% 8.3% 19.6% 12.9% 15.7% 13.6% 16.6% 16.2% 10.7%

Lending rate,% 17.6% 18.3% 20.9% 18.1% 18.6% 19.4% 20.2% 22.2%

91-day TB rate,% 5.3% 17.7% 6.3% 8.9% 7.0% 9.4% 8.2% 7.9%

M2 growth,% 25.2% 17.5% 10.2% 12.1% 18.9% 16.8% 30.3% 26.1%

Private sector credit,ugxbn 661.7 848.6 1,010.0 1,150.2 1,475.5 1,812.9 2,830.5 3,654.7

Private sector credit growth,% 28% 19% 14% 28% 23% 56% 29%

UGX/US$, average 1,754.6 1,882.9 1,934.9 1,737.7 1,825.2 1,780.0 1,696.5 1,911.2

Macro indicators

Inflation,% (average p.a) -2.0% 5.7% 5.0% 8.0% 6.6% 7.4% 7.4% 14.1%

Imports/GDP 16.2% 17.1% 17.6% 17.2% 19.8% 21.0% 24.1% 25.3%

Exports/GDP 7.6% 7.7% 9.3% 9.6% 10.5% 12.6% 17.8% 19.4%

Current Acc/GDP (exc.grants) -12.8% -12.2% -8.5% -8.5% -11.1% -10.8% -9.6% -10.3%

Fiscal deficit/Surplus/GDP 7.4% 9.0% -10.4% -8.7% -7.1% -7.0% -4.6% 6.2%

GDP by economic activity

Agriculture, forestry and fishing 23.1% 22.1% 21.1% 20.2% 18.3% 22.3% 21.2% 23.7%

Mining and quarrying 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3%

Manufacturing 7.1% 7.0% 7.0% 7.2% 6.9% 7.1% 7.3% 7.5%

Electricity 1.4% 1.3% 1.3% 1.3% 1.1% 2.0% 2.0% 1.7%

Water 2.4% 2.3% 2.2% 2.2% 2.0% 2.5% 2.5% 2.4%

Construction 10.9% 11.7% 12.0% 13.0% 14.4% 13.2% 13.5% 12.3%

Services 48.3% 48.6% 49.1% 49.0% 49.6% 47.0% 47.3% 46.4%

o/w Financial services 2.0% 2.1% 1.9% 2.1% 2.5% 2.7% 3.2% 3.5%

o/w Post & telecommunications 1.2% 1.6% 1.9% 2.0% 2.3% 3.0% 3.2% 3.4%

Growth rates

Agriculture, forestry and fishing 7.1% 2.1% 1.6% 2.0% 0.5% 0.1% 1.3% 2.6%

Mining and quarrying 12.2% 9.5% 8.0% 11.6% 14.7% 9.6% 9.1% 3.8%

Manufacturing 6.7% 4.4% 6.3% 9.5% 7.3% 5.6% 7.6% 7.2%

Electricity -1.7% 3.7% 7.7% 2.1% -6.5% -4.0% 5.4% 4.2%

Water 3.0% 3.9% 4.2% 3.9% 2.4% 3.5% 3.8% 4.1%

Construction 10.1% 14.6% 10.0% 14.9% 23.2% 13.2% 10.8% 2.2%

Services 11.0% 7.4% 7.9% 6.2% 12.2% 8.0% 10.2% 9.4%

o/w Financial services 32.6% 13.2% 0.0% 13.0% 31.7% -11.9% 24.1% 21.1%

o/w Post & telecommunications 76.5% 40.4% 28.6% 11.8% 26.2% 29.2% 22.6% 32.2%

Source: BoU, IMF, Legae Securities

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1. Industry overview

1.1 Penetration, deposit and credit growth.

Healthy fundamentals; low penetration, growing per capita

income and increasing population: In our view, exposure to

the Ugandan banks is motivated by the low penetration level.

Despite the recent improvements in penetration and levels of

intermediation (i.e. in the past decade), the banking assets/GDP

ratio and other penetration indicators remain low. The banking

assets/GDP, the deposit/GDP and the loans/GDP ratios are 31%,

19% and 13% respectively. Banking assets have grown by a CAGR

of 27% between FY05 and FY08, to reach UGX7.6trn. Loans and

advances showed stronger growth with a CAGR of 39% over the

same period to reach UGX3.2trn (FY08). System deposits, which in

our view is critical to supporting loan growth, went up by a lower

rate of 22% (reasonably high nonetheless), to UGX4.7trn. (see Fig

2)

While the penetration level has increased in Uganda, as indicated

by the private sector credit/GDP ratio that doubled from CY02 level

of around 6% to around 12% by CY09 (see Fig 3), the penetration

remains low when compared to economies/markets like Kenya and

Nigeria. In our opinion, the low level of private debt is the principal

attraction to assuming banking assets risks in the country.

We expect further penetration to be supported by the growing per

capita income and the growing population. As we have mentioned

in some of our reports, we favour banking systems (and banks

that operate) in markets with 1) growing per capita income, 2) low

penetration rates; and 3) growing population. Uganda boasts one

of the youngest populations in the world. About 48% of its

population is under the age of 15 years. Population Datasheet

expects Uganda’s population to grow to 53.4mn by 2025 before

leaping to 91.3mn by 2050. The per capita income is expected to

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increase by 40% between now and 2015. In our view, these

factors should support relatively stronger growth in the system.

(see Fig 4).

Already, we notice strong private sector credit growth. Private

credit has registered strong annual growth rate, peaking at 56% in

CY08 before declining to 29%. (HY09). This is about 7pp above the

average growth rate of 22% from CY95. (see Fig 5). Despite the

global economic weakness, the system still manages to grow

private sector credit. This indicates muted external-driven demand

as the low debt levels of the households support strong internal

demand, to a large extent. We do not see concerns relating to

deleveraging at both private sector and public sector level. Short-

term loan growth, however, could be impaired by the Credit

Reference Bureau implementation which lengthens loan processing

time frame.

Loans and deposits have also maintained strong growth rates.

Between CY00 and CY08, shilling denominated deposits and loans

and advances have expanded by CAGR of 19.7% and 21.4%

respectively. Foreign currency based liabilities has increased to

US$667mn (HY09) from US$213mn in HY00 – a CAGR of 46%.

(see Fig 6). In our view, the growth of foreign deposits indicates

increasing confidence in the system, to an extent.

The system’s LDR increased gradually, as growth of loans and

advances outpaced the growth of deposits. The LDR reached 71%

in 3Q08 before retreating to 69% for FY08. (see Fig 7). The shilling

LDR has since increased to 74% (HY09) although the US$LDR is

lower at 59%. We estimate the system’s LDR at 72%. Our

discussions with various bank managers indicate a general target

LDR of 75%, 5pecetange points (pp) below the maximum of 80%

allowed by the BoU.

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Fig 2: The low penetration is the major attraction

16.2% 16.3%17.1%

19.2%

7.5%9.0%

10.0%

13.1%

23.0%24.5%

26.5%

30.8%

0%

5%

10%

15%

20%

25%

30%

35%

2005 2006 2007 2008

Banking assets/GDP

Deposit/GDP

Loans/GDP

‐

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2005 2006 2007 2008

Banking assets,UGXbnDeposits,UGXbnLoans and advances,UGXbn

Source: BoU, Legae Securities

Fig 3: Penetration has increased but remains low

5%

6%

7%

8%

9%

10%

11%

12%

2002 2003 2004 2005 2006 2007 2008 2009

Private sector credit/GDP

12%

13%

13%

14%

14%

15%

15%

16%

16%

17%

17%

2002 2003 2004 2005 2006 2007 2008 2009

M2/GDP


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Fig 4: Growing per capita income and population should support industry growth

Banking assets = Banking assets X CapitaCapita

GDP X Banking assets X CapitaCapita GDP

per capita penetration populationincome

Brazil

Chile

ChinaJapan

Kenya

Korea

Nigeria

South Africa

Uganda

US

UK

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0 5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000

banking assets/GDP

per capita income, US$

Per capita income expected to increase by over 40% to US$667

Lowpenetration provides incumbents with relatively higher returns for longer

Populationis expected to reach 53.4mn by 2025. Uganda's 48% of thepopulation is<15 years

Source: BoU, Population Datasheet 2010, Legae Securities

Fig 5: Private sector growth spiked between ’07 and ’08.

0%

10%

20%

30%

40%

50%

60%

Jun‐95

Nov‐96

Mar‐9

8

Aug‐99

Dec‐00

Apr‐0

2

Sep‐03

Jan‐05

Jun‐06

Oct‐07

Mar‐0

9

private sector credit growth

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jun‐95

Nov‐96

Mar‐98

Aug‐99

Dec‐00

Apr‐0

2

Sep‐03

Jan‐05

Jun‐06

Oct‐07

Mar‐09

M2 growth


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Fig 6: Loans and deposits have maintained strong growth since ’96.

0

100

200

300

400

500

600

700

800

Jan‐95

Jan‐96

Jan‐97

Jan‐98

Jan‐99

Jan‐00

Jan‐01

Jan‐02

Jan‐03

Jan‐04

Jan‐05

Jan‐06

Jan‐07

Jan‐08

Jan‐09

Forex liabilities, US$mn

Forex Assets,US$mn

‐

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Jan‐96

Jan‐97

Jan‐98

Jan‐99

Jan‐00

Jan‐01

Jan‐02

Jan‐03

Jan‐04

Jan‐05

Jan‐06

Jan‐07

Jan‐08

Jan‐09

Private sector loans,ugxbnshillings deposits,ugxbn


Fig 7: Incremental liquidity is 8pp, but the system has room to grow deposits

‐4%

‐2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Jun‐05

Sep‐05

Dec‐05

Mar‐06

Jun‐06

Sep‐06

Dec‐06

Mar‐07

Jun‐07

Sep‐07

Dec‐07

Mar‐08

Jun‐08

Sep‐08

Dec‐08

Quarterly growth rates loans and advancesdeposits

30%

40%

50%

60%

70%

80%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

System LDR


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1.2 Liquidity, Profitability and Efficiency

Liquidity; LDR has deteriorated but remains well below

80%: The system’s LDR has increased to 72%. The shilling LDR

moved from 39% in HY02 to 47% in HY05 and 50% in HY07. It

reached 74% in HY09. Deposits grew faster than credit between

CY01 and CY06 but have since lagged loan growth since HY08. In

increasing their loan books, banks have been depleting their liquid

assets. The industry liquid assets/total assets ratio shrunk by 10pp

from 27% in HY97 to 17% in HY09 (see Fig 8). Notwithstanding

the deterioration on LDR to 72%, the system is one of the few that

is structurally strong and can still sell down government securities

to fund loan growth, even though its only 8pp. Most systems

depend on capital raising to fund loans.

We note that the system’s dependence on demand deposits

continues to reduce. We believe this is an indication of a general

awareness in financial products in the market; hence more

deposits are turning into time or savings deposits. The savings

deposits earn a slightly higher interest rate at 2.4% (vs. 1.3% for

demand deposits), while time deposits earn a materially higher

rate of around 10%. (see Fig 9 and Fig 10). However, we do not

think that the days of relatively cheap deposits for banks with

strong franchises are over. The system has not yet exhausted the

positive effects of consumer banking to the cost of its liabilities. As

a result banks that can continue to gain CASA market share,

particularly by providing rural banking and services outside major

cities, should be able to support interest spreads and NIMs.

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Fig 8: The system’s liquidity has weakened as penetration increased

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

0.8%

Jun‐96

Jun‐97

Jun‐98

Jun‐99

Jun‐00

Jun‐01

Jun‐02

Jun‐03

Jun‐04

Jun‐05

Jun‐06

Jun‐07

Jun‐08

Jun‐09

LDR for LC and US$ "balance sheets"

LDR,LC

LDR,US$

0%

5%

10%

15%

20%

25%

30%

35%

40%

Jun‐97

Jun‐98

Jun‐99

Jun‐00

Jun‐01

Jun‐02

Jun‐03

Jun‐04

Jun‐05

Jun‐06

Jun‐07

Jun‐08

Jun‐09

Liquid assets/total assets


The ill-developed pension sector also inadvertently force depositors

to shift more of their ‘savings’ deposits to fixed/term deposits in

order to earn relatively higher interest income. As the financial

markets deepen, more “savings” deposits will reach the system

through institutions (i.e. unit trusts, life plans contributions etc)

thus further increasing the percentage of fixed deposits in the

system.

The ratio of the demand deposits/total deposits has continued to

decline. About 61% of the system deposits were demand type in

CY95 and this has since reduced to 34% in HY09. (see Fig 9). The

costs of time deposits have also increased considerably, indicating

the effects of competition in deposit gathering. The cost of shilling-

denominated time deposits has increased from 5.3% in HY04 to

10.7% in HY09. US$ denominated time deposits cost has also

increased from 2.7% to 3.9% over the same period. (see Fig 10).

Overall, we believe the system does not face major liquidity and

funding issues. In our view, the 80% cap on LDR is a prudent

measure. The system’s LDR is still below the 80%. The low

exposure to external funding and capital markets is also a major

advantage for the system’s liquidity as they both tend to be

volatile.

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Fig 9: The system is increasingly becoming depended on time deposits

25%

30%

35%

40%

45%

50%

55%

60%

65%

Jun‐95

Jun‐96

Jun‐97

Jun‐98

Jun‐99

Jun‐00

Jun‐01

Jun‐02

Jun‐03

Jun‐04

Jun‐05

Jun‐06

Jun‐07

Jun‐08

Jun‐09

Time & Savings/Total deposits

Demand/Total deposits

25%

27%

29%

31%

33%

35%

37%

39%

41%

43%

Jun‐95

Jun‐96

Jun‐97

Jun‐98

Jun‐99

Jun‐00

Jun‐01

Jun‐02

Jun‐03

Jun‐04

Jun‐05

Jun‐06

Jun‐07

Jun‐08

Jun‐09

Demand/M2

Time & Savings/M2


Fig 10: The cost of time deposits has increased the most

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Demand Savings Time Lending

Costs of deposits andlending rates: shilling

Jun‐09

Jun‐04

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Demand Savings Time Lending

Costs of deposits and lending rates: US$

Jun‐09

Jun‐04


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Profitability; high but there are headwinds: The Ugandan

system has managed to consistently grow profitability, rising from

Ugx30bn in CY05 to Ugx70bn in CY08, a CAGR of 34.5%. The

system enjoys an average quarterly growth rate of 5% (CY05-

CY08). (see Fig 11).

The system’s strong profit level is underpinned by strong interest

spreads and NIM, and a low level of consumer debt. The interest

spread on local currency is as high at 18% while on the US$ it is

around 9.2%. The ROE is high at an average of 31% (CY03-CY08).

ROE declined to 25% for FY08, which we feel is still relatively

plausible given the high level of capital. In our view, the reduction

was a result of the lag between the ingress new equity (i.e. new

banks) and the time they will take to lever their balance sheets.

This under-leverage depresses the ROE. The ROA remain strong at

3.5% (FY08), slightly below the average ROA of 3.7% (03-08).

(see Fig 12). Even for HY09, ROA and ROE remain strong at 3.2%

and 20.3% respectively.

The major headwinds come from pressure on NIM. The

system’s NIM has reduced from levels >14% pre-2006 to oscillate

around 11%. Liabilities interest rates have relatively been sticky,

despite a slight uptick. However, interest rates on assets are more

volatile. So far, banks seem to be able to neutralise the increasing

cost of deposits by hiking their lending rates. (see Fig 13).

However, we are not very bullish on NIM expansion given the

moral suasion by the BoU to encourage commercial banks to

reduce their lending rates and stimulate economic growth. The

lending rate is also 1.5pp higher than its average (04-08) which

points to limited upward potential, particularly as inflation outlook

remains benign.

The other risk comes from little room for expansion in the LDR. At

72%, and with an implied LDR of 75% (as guided by most bank

managers in our discussions), there is little room for banks to

carry more loans (higher yields = better NIMs) on their balance

sheets without growing their deposits. The vigorous deposit

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gathering which we expect could continue to push up the cost of

deposits, compounding the risks of NIM compression. We do not

anticipate the cost of deposits (in particular fixed deposits)

reversing the current upward trend. We expect NIM to narrow to

levels between 5% and 7% from the current 11.3% by CY12.

The system’s high ROA is not sustainable in our view. Uganda’s

banking system has one of the highest ROAs (see Fig 14).

Pressure is evident, with the ROA having declined from 4.3% in

CY04, to 3.5% in CY08 and 3.2% in HY09. We expect the

industry’s narrowing spread to put pressure on ROA. Due to

pressure on the ROA, leverage becomes important, and banks with

capacity to increase leverage should get premium valuations.

Lower leverage has resulted in relatively subdued ROE.

Fig 11: System profitability grew by a CAGR of 34.5% between CY05 and CY08

‐15%

‐10%

‐5%

0%

5%

10%

15%

20%

25%

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Quarterly profit growth,% Growth rate

average

0

10

20

30

40

50

60

70

80

2005 2006 2007 2008

Profits, UGXbn


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Fig 12: High ROA and ROE, NIM is still healthy

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

10%

15%

20%

25%

30%

35%

40%

2003 2004 2005 2006 2007 2008

ROA,RHS

ROE

5%

8%

11%

14%

17%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

NIM


Fig 13: Interest spreads remain wide but we expect cost of deposits to put pressure

21.2%

18.8%

2.4%

0%

5%

10%

15%

20%

25%

Mar‐04

Jun‐04

Sep‐04

Dec

‐04

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

Mar‐09

Jun‐09

Interest rates in shilling

Weighted deposit rateLending rateinterest spread

9.2%

10.4%

1.2%

0%

2%

4%

6%

8%

10%

12%Mar‐04

Jun‐04

Sep‐04

Dec

‐04

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

Mar‐09

Jun‐09

Interest rates on US$

Weighted deposit rateLending rateinterest spread


of 44

Fig 14:The system has one of the highest ROAs, subdued ROE on low leverage (HY2009)

0%

5%

10%

15%

20%

25%

30%

35%

40%

Nigeria

India

Egypt

Brazil

Mexico

Morocco

Ghana

RSA

Chile

Uganda

Kenya

Indonisia

Moza'que

ROE

0%

1%

1%

2%

2%

3%

3%

4%

Egypt

India

Rwanda

China

Brazil

Chile

Mexico

Morocco

RSA

Nigeria

Indonesia

Ghana

Kenya

Uganda

ROA

Source: IMF, Legae Securities

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Efficiency; the major weakness of the system: The Uganda

banking systems remains relatively inefficient. The cost/income

ratio is 8pp above the generally accepted 60% with an average of

68% between 2005 and 2008. The NII/total income ratio continue

to decline, despite it being low already when compared to other

frontier banking systems. (see Fig 15). For FY08, the NII/total

income ratio was only 15%. The low penetration in cheaper

banking products that encourage volumes in transactional services

(e.g. credit cards, internet and telephone banking) is the primary

hindrance, in our view. Expansion of fees on loans and advances

face resistance given the high interest rates. The overdependence

on interest income could lead to higher volatility in earnings

despite the spread being relatively stable thus far. We are rather

surprised at the deterioration of the NII contribution to operating

income as we expected technology and launching of retail products

to provide a fillip to NII. We also foresee banks benefiting

somewhat from new technological platforms (mobile money

transfers, for example), enhancing NII.

Fig 15: Ugandan banking system remain largely inefficient

58%

60%

62%

64%

66%

68%

70%

72%

74%

76%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

cost/income

average

5%

7%

9%

11%

13%

15%

17%

19%

21%

23%

25%

0

50

100

150

200

250

300

350

Mar‐05

Jun‐05

Sep‐05

Dec‐05

Mar‐06

Jun‐06

Sep‐06

Dec‐06

Mar‐07

Jun‐07

Sep‐07

Dec‐07

Mar‐08

Jun‐08

Sep‐08

Dec‐08

NII,UGXbn

Total income,UGXbn

NII/Total income, RHS


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1.3 Credit risks and capital adequacy

Credit risks; our primary concern: The system’s credit risk

profile worsened during the period of gluttony (between 2006 to

2008), peaking at 4.1% in CY07. It then declined to 2.2% in FY08

before rebounding to 4.0% in HY09. NPLs have outpaced loan

growth by a wide margin before a significant improvement in CY08

that saw NPLs receding by 33%, hence the reduction in the

NPLs/Gross loans ratio. (see Fig 16 and Fig 17). We are sceptical

of the massive drop in the NPLs level in CY08 given the rebound in

the ratio. System NPLs reduced from Ugx100bn in 1Q08 to

Ugx74.8bn in 4Q08 while advances went up from Ugx2.3trn to

Ugx3.2trn over the same period.

The system’s NPLs coverage ratio has also been declining, with the

improvement registered in 4Q08 being an effect of the colossal

drop in NPLs. In our view, a low coverage ratio is better than a

high one that is a result of low NPLs. The system’s coverage ratio

ricocheted to over 100% (CY08) before it declined to 72% in

HY09. (see Fig 18). This is a major concern to us. Uganda is one

of the systems with poor coverage ratios, well below the

theoretical 100%. We are unsure if there is a delay in NPLs

recognition, leading to the decline in NPLs (i.e. NPLs

underreporting) or it was an aggressive release of reserves when

cycle of excessive lending (CY05-CY08) faded. As shown below

NPLs have been growing at a faster rate than loans provisions until

CY08. (see Fig 16).

Large loans/total loans ratio has, however, improved, which in our

view is commendable as it diversifies the system credit risks. Large

loans/total exposure ratio has reduced from 42% in CY05 to 24%

in CY08. Insider loans/core capital has not really improved in a

material manner. Insider loans tend to be concentrated in banks

that have weak corporate governance (ignoring genuine staff

loans). While this ratio indicated an improvement between CY06

and CY08, the ratio is above its mean. (see Fig 19). Higher

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profitability levels in that period led to the improvement rather

than insider loans abating in absolute value. Between 1Q08 and

4Q08, insider loans increased by a higher rate than system loans

at 51% versus 39%.

In terms of sector exposures, 20% of the loans and advances is

trade related. Manufacturing constitute 15.2% of the industry book

while building and construction is 11.4%. We expect oil and gas,

transport and electricity to support growth going forward in

addition to the other sectors. The system credit risk is well

diversified in our opinion. (see Fig 20).

Fig 16: The system is well capitalised, leverage ratio has been falling

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

NPLs/Gross loans

0%

100%

200%

300%

400%

500%

600%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

Growth of NPLs vs. loans NPLs growth

Loans growth


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Fig 17: NPL coverage ratio have reverted to >100%, but mainly as a result of NPLs

0

20

40

60

80

100

120

140

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

NPLs,UGXbn

Provisions,UGXbn

1.1

0.7

1.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

NPL coverage


Fig 18: Low coverage levels of the system, and most African banking systems is a concern

0%

2%

4%

6%

8%

10%

12%

14%

16%

Chile

China

India

Nigeria

Mexico

Indonesia

Uganda

Brazil

Morocco

RSA

Rwanda

Kenya

Egypt

Ghana

NPL/Loans

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

RSA

Nam

ibia

Nigeria

Rwanda

Uganda

Morocco

Swaziland

Egypt

Indonesia

China

Brazil

Mexico

Chile

Provisions/NPLs


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20%

25%

30%

35%

40%

45%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

Large loans/Total exposure

3.5%

4.2%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Mar‐05

Jun‐05

Sep‐05

Dec

‐05

Mar‐06

Jun‐06

Sep‐06

Dec

‐06

Mar‐07

Jun‐07

Sep‐07

Dec

‐07

Mar‐08

Jun‐08

Sep‐08

Dec

‐08

Insider loans/core capital


Fig 20: System industry exposure (2009)

4.5%

15.2%

20.6%

6.4%11.4%

0.3%

41.5%

Industry expsoure, %

Agriculture ManufacturingTrade Transport & ElectiricityBuidling & construction Mining and QuarryingOther

10.7 163.1

233.3

414.7

549.3

746.6

1,504.0

Industry exposure, UGXbn

Min. & Quarrying Agric.Trans. & Electricity Build. & constructionManufac. TradeOther


of 44

Capital adequacy; excessive levels, but it is not a new thing:

We believe the industry carries enough capital buffer above the

minimum required by the regulator (which also carries a buffer

against the Basel 2 requirements). At the end of CY08, the system

had a total CAR of 21% versus a regulatory requirement of 12%

and 2pp higher than CY07. For HY09, the total CAR remained at

21%. (see Fig 21 and Fig 22). Given the global financial system

weakness, this is understandable to a greater extent although we

believe that the 9pp buffer is too high. This could also be a result

of new capital flows from the new banks that has not yet been

sweated. We nonetheless note that excess capital is not a new

issue in Uganda. The banking crisis of the late 90s/early 00s could

be the reason for fear of low capital levels.

The system’s leverage ratio has continued to decline, again being a

result of new banks that have not yet levered their balance sheets

enough, in our opinion. However, the leverage ratio has gradually

declined from 15X in CY03 to 11X in CY07. The leverage ratio

reduced to 7.5X in HY09, making Uganda one of the least

leveraged systems. (see Fig 22). The key benefits of this low

leverage are 1) there is lower risk of equity issuance that could

create headwinds to ROE, or even erode it (i.e. dilution), and 2)

new entrance’s ability to gain market share would be constrained

as the incumbents are well capitalised and can expand their

balance sheets to protect market share on both the asset and

liability side.

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12%

8%

17%18% 18%

19%21%

14.1%

18.8%

16.8% 16.4%

17.7%

18.7%

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

19.0%

21.0%

23.0%

2003 2004 2005 2006 2007 2008

core capital/RWAtotal capital/RWAMin. core capitalMin. total capital

3

5

7

9

11

13

15

17

0

1000

2000

3000

4000

5000

6000

7000

8000

2003 2004 2005 2006 2007 2008

Total assets,UGXbn

Total equity,UGXbn

Leverage ratio, RHS


Fig 22: One of the best capitalised systems (June 2009).

5%

7%

9%

11%

13%

15%

17%

19%

21%

23%

China

India

RSA

Chile

Egypt

Morocco

Mexico

Indones…

Ghana

Brazil

Kenya

Rwanda

Uganda

Nigeria

Capital/RWA

0

2

4

6

8

10

12

14

16

18

20

Rwanda

Nigeria

Ghana

Uganda

Indonesia

Mexico

Brazil

Malaysia

Kenya

RSA

Chile

Morocco

Egypt

China

Leverage


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1.4 Economics and Politics

Sterling growth so far, we remain positive: Uganda has

registered sterling GDP growth rates between CY00 and CY09

within an average real growth rate of 7.4%. While the growth rate

comes from a low base, IMF’s expectations of an economy of

>US$25bn by CY15 would make Uganda an important market in

the region. The per capita income is also expected to show a

strong growth rate, exceeding US$600 by CY15. The demographic

makeup provides support to a robust upward growth trend.

Sources of vulnerability are poor infrastructure, donor

dependence and political risks: Poor infrastructure (road

network, electivity and power, sanitation etc) is a major holdback

to growth despite it being a growth theme that investors can ride

on. The twin deficit of a current account and fiscal deficits is a risk

to currency stability in our view. The country heavily depends on

donor support, notwithstanding the improvements that have been

made in that space so far. Current account deficit in CY09

deteriorated to 10.3% from 7.8% when grants are excluded. A

reduction in the donor support could lead to a depreciation of the

local currency, which inevitably would increase inflationary

pressures given the imports dependence.

Relationship with the West intact, recent terror attacks

could strengthen them: The key to donor support is the

relationship with the Western countries. In our view, the

incumbent president, Mr Museveni has played it well so far. Mr

Museveni is expected to seek re-election in 2011. Relationship

with major donor countries is generally non-antagonistic. Recent

terror attacks in Uganda could strengthen the relationships.

We remain concerned by the benign global economic

recovery though. Our economist expects globally recovery to be

protracted, although he does not see higher chances of a double-

dip. We think that agriculture and trade will be the major

casualties, and this will filter into the system’s loan book.

of 44

Fig 23: The Ugandan economy is expected to continue grow strongly.

0

5

10

15

20

25

30

0

100

200

300

400

500

600

700

800

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

GDP,US$bn

per capita income, US$,LHS

0

2

4

6

8

10

12

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

GDP real growth


Fig 24: Inflation rate expected to remain <10%, current account deficit to reduce

‐4

‐2

0

2

4

6

8

10

12

14

16

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

Inflation rate,%

‐7

‐6

‐5

‐4

‐3

‐2

‐1

0

1

2000 2002 2004 2006 2008 2010 2012 2014

current account % of GDP

Source: IMF, BoU, Legae Securities

Fig 25: Population is the bright spot for Uganda

33.8

53.4

91.3

0

10

20

30

40

50

60

70

80

90

100

2010 2025 2050

Population,mn

42%

43%

44%

45%

46%

47%

48%

49%

50%

51%

Niger

Uganda

Burkina Faso

DRC

Zambia

Malaw

i

Afghanista

n

Chad

Somalia

Tanzania

World's youngest population; Ages<15yrs

Source: Population Datasheet 2010, Legae Securities

of 44

2. Stanbic Uganda, Follow up, BUY

2.1 Company description: One of the strongest franchises

Stanbic Bank Uganda is a subsidiary of Stanbic Africa Holdings, which is

in turn owned by Standard Bank Group. The bank has the widest branch

network in Uganda, and is the biggest bank by assets and deposits

(estimated market share of >20%). The bank entered into a

partnership with MTN and has launched the first mobile transfer services

in Uganda.

The bank’s main operating segments are 1) the Corporate and

Investment bank which involves corporate banking, investment banking,

global markets and trade finance operations, and 2) the personal and

business banking which involves transactional products, vehicles asset

finance, mortgage finance, card products, bancassurance and SMEs

banking operations.

Stanbic is the biggest local listed company with a market cap of

US$550mn. The free float is 20%.

2.2 Analysis: low cost deposits base is key; high ROE that can still be levered

Fig 26: CAMEL analysis

2005 2006 2007 2008 2009 2010F 2011F 2012FC:CAR 15.5% 15.5% 13.0% 14.2% 16.3% 12.6% 13.2% 14.1%C:Leverage ratio 10.5 12.5 10.8 9.8 8.9 11.6 10.4 9.9A:Impairement charge/Advances 0.0% 0.8% 0.8% 0.5% 1.0% 1.8% 1.1% 0.8%A:Provisions/NPL n/m 249.6% 139% 67.6% 60.1% 60.0% 60.0% 60.0%M:Cost/Income 65.4% 64.9% 60.3% 52.2% 50.9% 53.0% 51.0% 51.0%M:Burden ratio 18.8% 15.7% 17.3% 16.8% 17.5% 14.1% 14.0% 13.7%E:NIM 12.8% 8.5% 10.5% 11.7% 13.5% 9.4% 9.8% 9.2%E:NIR/Total Income 34.9% 40.9% 41.2% 40.1% 36.7% 45.0% 42.4% 46.3%L:LDR 33.4% 38.0% 44.5% 56.7% 63.5% 65.0% 70.0% 75.0%L:Cash +equiv./Customer deposits 66.6% 62.4% 58.9% 48.0% 50.5% 49.4% 51.2% 54.9%

Source: Company reports, Legae Securities

of 44

Capital adequacy: In our view, Stanbic is a well capitalised bank

with a CAR of 16.2% (HY10). This is 4.2pp above 12%, the

minimum required by the regulator. The Tier 1 capital is also

strong at 13.5%, which is 5.5pp above the minimum requirement

of 8%. The bank is not highly leveraged. In fact, leverage ratio

has declined from 10.5X in FY05 to 8.9X in FY09. The leverage

ratio is largely in line with the system’s ratio. In our view, Stanbic,

just like the system, is not materially exposed to the regulatory

risks related to leverage limits that could be brought about by

Basel 3.

Asset growth and quality deteriorated in HY10, but we think

it has peaked: While seemingly good, as the numbers are still

low, we are concerned by the growing credit risks. We note that

the impairment charge has grown at 51% while loans and

advances have only expanded by 40% between CY06 and CY09.

This is 11pp higher. For HY10, credit impairment went up by 17%.

As a percentage of loans and advances, we expect the ratio to

peak at 1.8% this year before declining to 1.1% in FY11 and 0.8%

in FY12.

Coverage ratio worsened, but still fair at 60%: The declining

coverage ratio is also a major apprehension although it is still fair

at 60% (FY09). The problem is our inability to know the Stanbic’s

acceptable coverage ratio as management did not provide

guidance. We note that had coverage ratio been maintained at a

theoretical level of 100%, provision would have grown by 79%,

almost double the growth rate of the loan and advances. The profit

would decline to UGX88.9bn, a knock of UGX6.4bn, reducing

earnings growth rate to a mere 13% rather than the reported

21%. Should the bank increase the coverage ratio to a generally

acceptable range of between 70% and 80%, the knock on earnings

could be material. In our opinion, cutting coverage ratios is equal

to re-risking, which would therefore imply an increase in our

discount rate.

of 44

Sector exposures indicate a significant increase in mortgage

loan writing; exposure to corporates continue to grow at a

lower rate: Property loans and mortgage showed the strongest

growth rates (ignoring other loans) escalating by 71.5% and

57.6% respectively between CY08 and CY09. Both are relatively

coming from low bases, with property loans increasing from a

mere Ugx28bn (<5% of gross loans) to UGX48bn. (5.1% of total

loans). Mortgage loans’ base is also low, being UGX42.4bn. (6.6%

of gross loans). Mortgage loans went up by 19% from FY09’s

Ugx62.2bn to Ugx73.8bn in HY10. Growth of corporate loans is

muted at just 0.7% from Ugx344.7bn to Ugx347.2bn. (CY08-

CY09). Corporate loan growth recovered in HY10 to grow by 5.8%

to Ugx418bn but continue to lag mortgage loan growth. In our

view, building strong relationships with the SMEs and households

is important for the bank to diversify its credit risks. We continue

to be concerned with the possible excessive multi-borrowing at

corporate level.

Fig 27: Sector exposures show strong growth on mortgages and property loans

Growth =47%Growth =19%

Growth =58%

Growth =0.7%

Growth =72%

0

50

100

150

200

250

300

350

400

450

mortgage installment and lease finance

other loans corporate loans Property finance

Sector exposures,UGXbn

2009

2008

7%

10%

41%

37%

5%Sector exposures,%

mortgageinstallment and lease financeother loanscorporate loansProperty finance


Cost management and earnings composition: The bank’s

cost/income ratio (efficiency ratio) had a balanced improvement,

reducing from 65.4% in FY05 to 50.9% in FY09. This is

comfortably above the industry’s average of 68% (CY05-08) and

of 44

66% (FY08). It is also 9pp above the general rule of thumb of

60%. We are impressed by the bank’s high NII which provides a

supplement to earnings. NII/total income is a satisfying 36% for

FY09 and we expect it to increase to 45% in FY10. The NII/total

income ratio has an average of 39% between CY05 and CY09 – a

superior number to the industry average by a wide margin. The

burden ratio also indicates the bank’s non-interest expenses that

are covered by non-interest income. It shows an improvement

from 18.8% in FY05 to 17.5% in FY09. The declining burden ratio

indicates that the non-interest income is growing at a faster rate

than the non-interest expense, albeit faintly.

We should also highlight that the bank’s available-for-sale (AFS)

portfolio has remained stable at an average of 23% of total assets.

(FY05-FY09). The held-to-maturity (HTM) portfolio has been run

down to zero in FY09. The trading portfolio, which has income

statement effects, remains below 5% of total assets, and is also

fairly stable. We believe that the absence of major movements in

these portfolios as a way to manipulate earnings and the book

value highlights better earnings quality, to an extent.

NIM: the edge in low-cost deposits is key: The bank’s NIM is

high at 13.5% for FY09. This is 70bp above 12.8% that the bank

enjoyed in CY05, and 2.5pp above the industry average. In our

view, the bank is well positioned to continue to enjoy high NIM, as

it can benefit from its widespread branch network for relatively

cheaper deposits. The bank has managed to increase its current

and demand deposits/total deposits ratio by 2pp from 69% in FY08

to 71% in FY09. (see Fig 28). The caveat, in our view, is that it

could enjoy the benefit of charging a lower rate (weighted) on its

loans and advances as it seeks to gain or maintain market share

on the asset side. Nevertheless, we expect NIM to reduce to 9.4%

for FY10 and remain below 10% in our forecast period.

Liquidity: high but government securities to put pressure on

spreads as TB rates continue to decline: In our view, the bank

carries ample liquidity to support its loan book growth. The LDR of

of 44

63.5% (FY09) provides sufficient cushion to the regulators’ cap of

80%. This is notwithstanding the fact that the LDR has increased

significantly from 33.4% in FY05. The bank’s liquid assets/total

assets ratio is also healthy at 32.9%. We also believe that the

bank has capacity to raise more debt, having successfully issued

the first tranche of UGX30bn. Subordinated debt/total equity is

only 18.5%. There are no debt maturities to put pressure on

funding as the issue matures post CY15.

Fig 28: With increasing competition, SBU’s access to cheaper deposits is key

1,029.85

230.97

198.61

Amount, UGXbn

Current and demand accounts Savings accounts Fixed deposits

71%

16%

14%

Contribution,%

Current and demand accounts Savings accounts Fixed deposits


ROE decomposition: Below we provide a decomposition of the

ROE, principally indicating the asset yields, margins and leverage

levels. Stanbic has enjoyed strong outperformance against the

industry. For example, the bank’s ROE in CY05 was 50.4% against

the industry’s 28.6%; in CY07 the Stanbic had an ROE of 43.3%

versus the industry’s 31.4%; and for FY09, the bank attained an

ROE of 45.1% compared to the system’s 25%.

The bank has enjoyed strong ROAs: This has been on the

back of high asset yields and high margins. Although we expect

asset yields to remain relatively high, we expect them to decline

when compared to history. In our view, yields will fall to below

12%.

of 44

Leverage should support ROE going forward, otherwise

ROE to decline: We expect the bank to slightly increase its

leverage in order to maintain the ROE at around 40%. Our

forecasts indicate a decline of the ROE to 40.3% for FY10, which

is still relatively high. (see Fig 29).

The bank’s “Jaws” has been opening, with operating

income growing by a CAGR of 19.1% versus a CAGR of 11.8%

for operating expenses. Net interest income, however, shows

strain as interest expense grew by a higher rate than interest

income. (see Fig 30)

Fig 29: ROE decomposition

2005 2006 2007 2008 2009 2010F 2011F 2012FAsset yield: Revenue/Total Assets 13.8% 12.0% 13.8% 14.0% 14.4% 11.7% 11.8% 11.9%Margin: Net income/Revenue 34.6% 26.0% 29.0% 35.1% 35.3% 29.8% 33.3% 34.2%

ROA 4.8% 3.1% 4.0% 4.9% 5.1% 3.5% 3.9% 4.1%Leverage: Total Assets/Equity 11 12 11 10 9 12 10 10

ROE 50.4% 39.0% 43.3% 48.3% 45.1% 40.3% 40.9% 40.2%


Fig 30: “JAWS” continue to widen, but interest expense growth has outstripped interest income growth.

CAGR = 19.1%

CAGR = 11.8%

‐

50

100

150

200

250

300

2005 2006 2007 2008 2009

Operating income,UGXbn

Operating costs,UGXbn

CAGR = 19.0%

CAGR =21.4%

0

5

10

15

20

25

0

50

100

150

200

250

2005 2006 2007 2008 2009

Interest income,UGXbninterest expense, UGXbn, RHS


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2.3 Valuation: A deserved premium

Below we highlight our salient assumptions in our earnings and balance

sheet models. (see Fig 31). We:

reduce the interest income/interest earning assets to 10.5% for

FY10 and decrease it to 10% by FY12. Interest income grows by

9% for FY10. The high level of government securities on the bank’s

balance sheet have the natural consequence of putting a drag on

interest income;

increase the cost of interest paying liabilities to 1.8% from 1.3%

FY10 and maintained it at 1.5% thereafter. We see increasing

competition on the liability side (the growth in fixed deposit type is

an indication of the competition to an extent);

raise our impairments/advances ratio to 1.8% for FY10 before

reducing it to 1.1% for FY11 and 0.8% for FY12. In our opinion,

there is still some stress in the system credit-wise;

enlarge the operating expenses/operating income to 35%. The

bank continues to invest in distribution channels (37 new ATMs

and 3 branches are expected this year).

increase the LDR slightly to 65% for FY10 before it sequentially

progressed to 70% and 75% for FY11 and FY12. We see deposits

increasing by a 35% this year. We grow net profit by -4% for

FY10, before recovering by 29% and 24% for FY11 and FY12 in

that order.

Fig 31: Our key assumptions

2005 2006 2007 2008 2009 2010F 2011F 2012FInterest income/IEA 12.3% 9.2% 10.7% 12.0% 13.1% 10.5% 10.5% 10.0%Interest expense and similar charges/IPL -1.1% -1.0% -1.0% -1.2% -1.3% -1.8% -1.5% -1.5%Net fee and Commission/TA 4.7% 4.1% 4.5% 3.9% 3.5% 2.8% 3.0% 3.5%Net Trading Income/TA 0.2% 0.8% 1.2% 1.8% 1.8% 2.5% 2.0% 2.0%Other Operating Income/TA 0.2% 0.1% 0.1% 0.0% 0.0% 0.0% 0.1% 0.1%Impairment charge for credit/Advances 0.0% -0.8% -0.8% -0.5% -1.0% -1.8% -1.1% -1.3%Employee benefits and expense/Operating -20.6% -20.1% -19.2% -17.6% -17.6% -18.0% -18.0% -18.0%Other operating expenses/Operating incom -44.8% -44.8% -41.1% -34.6% -33.3% -35.0% -33.0% -33.0%Share of profit of associate/TA 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%Taxation/PBT 0.0% -21.7% -23.1% -24.4% -22.9% -25.0% -25.0% -25.0%

Deposit growth 11% 13% 20% 20% 13% 35% 12% 13%Loan/Deposit ratio 33% 38% 45% 57% 64% 65% 70% 75%


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Valuation; high ROE and ability to protect market share

deserve premium valuation: We use the fundamental PBVR to

estimate the value of Stanbic. Using an average ROE of 40.5%,

(within our forecast period), a growth rate of 14.5% and a CoE of

18.8% we obtain a fair PBVR of 6X. This ratio looks excessive

prima facie, but we believe the high ROE and ability to protect

market share (indicated by the growth rate) warrant a premium

valuation. Investors should not be overly concerned by our

negative growth in earnings for FY10; the ROE outlook remains

intact!

Our FY10 price target is Ugx267; FY11 is Ugx340: We

multiply out justified PBVR with our book value estimates for FY10

and FY11. Our FY11 price target of Ugx340 provides potential total

return of 49.8%. We therefore reiterate our BUY recommendation

on the stock.

Fig 32: Price/Book Valuation

Price/Book Valuation

Average ROE 40.5%Average growth rate 14.5%CoE 18.8%Justified PBVR 6.04 FY11 BV 56.3Price Target 340.4Current Price 235.0Potential capital gain 44.9%FY11 Div. Yield forecast 4.9%Potential total return 49.8%

CoE calculationR208 Yield 8.3%ERP 6.0%

14.3%Country risk 3.0%Specific risk 1.5%

18.80%

Source: Legae Securities

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3. DFCU Limited, Initiate, HOLD

3.1 Company Description: One of the oldest franchises

DFCU Limited is commercial bank offering a wide range of products. The

company was registered in 1964 as a development finance institution. In

2002, the company bought Global Trust Bank and renamed it DFCU

Bank, and thus commenced to offer commercial banking services.

The bank has 24 branches, with considerable a concentration of the

branches in Kampala (12 branches). The Bankom interbank switch,

however, allows its clients to have access to other banks’ ATMs, at a

cost of course.

The bank has built a relatively strong franchise in long-term loans and

finance. DFCU’s partnerships with developmental institutions such as

OPEC Fund for International Development, PROPARCO, NORFUND, IFC,

European Investment Bank, Netherlands Developmental Finance

Company, NSSF among others has made it a strong source of long-term

finance and loans from local borrowers. As at the end of CY09,

Ugx158.9bn, about 30% of the Group’s total liabilities, and 45% of total

customer deposits were “borrowed funds”, mainly from the above

institutions.

As at the end of CY09, the Group’s major shareholders were 1) CDC

Group plc (60.02%); 2) National Social Security Fund (10.93%); 3)

NORFUND (10.06%); 4) National Insurance Corporation (2.82%) and 5)

Investec Asset Management (2.27%).

We are a bit concerned with the high turnover at senior management

level. Messrs Cormick, Katuntu, Kibirige and Mortimer assumed leading

roles at the bank within the past 5 years. Board chairmanship has also

transferred from Dr Kalema, to Dr Moyo and now to Mr Irwin (in an

acting capacity). While there has been restructuring, this apparent

instability clouds long-term strategy.

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3.2 Analysis: Low CASA to affect margins; earnings momentum and coverage ratios a plus though

Fig 33: CAMEL analysis

2004 2005 2006 2007 2008 2009 2010F 2011F 2012FC: Equity/Loans 33.2% 26.5% 25.3% 27.1% 22.1% 23.5% 19.1% 18.1% 17.5%C: Assets/Equity 7.24 6.58 7.43 7.25 7.92 7.99 9.24 9.25 9.51 A: Provisions/Loans 0.3% 0.7% 2.1% ‐0.7% 2.8% 1.4% 1.0% 0.8% 0.8%A: Provision/Impairments n/a n/a 30.2% 14.2% 49.9% 67.6% 70.0% 70.0% 70.0%M:Cost/Income 56.1% 54.1% 66.6% 72.9% 57.5% 56.3% 57.0% 57.0% 55.0%M:Burden Ratio 7.5% 8.9% 9.2% 10.2% 7.9% 7.0% 6.8% 6.6% 6.0%E:NIM 11.2% 14.4% 15.5% 15.8% 14.0% 14.0% 13.5% 12.8% 12.0%E:NIR/Income 25.6% 22.8% 20.6% 17.3% 13.9% 12.8% 14.1% 13.7% 15.0%L:LDR 53.9% 75.1% 65.4% 62.5% 68.0% 63.3% 66.0% 70.0% 70.0%L:Cash+equi./Total deposits 13.6% 11.4% 18.5% 32.8% 33.1% 34.4% 24.7% 27.6% 30.4%


Capital adequacy; like most it is well capitalised: The Group

is well capitalised, with a total CAR and core CAR of 18% and 17%

respectively. Despite a 16% increase of capital in the absolute

value, mounting from Ugx65.8bn in FY08 to Ugx76.6bn in FY09,

the risk weighted assets (RWA) increased accordingly, maintaining

the CAR constant. RWA increased to Ugx388.9bn in FY09 from

Ugx331.3bn in FY08. In terms of leverage, the bank has room to

perk up, in our view. While there has been a steady increase in the

leverage, from 7.2X in FY04 to 7.9X in FY09, we believe the

balance sheet can be leveraged further to levels around 10X.

Asset growth, credit risks and profitability: The Group lost

significant market share in FY07 when its loans and advances

declined by 6% from Ugx206.4bn to Ugx193.7bn. This was the

year when the system registered a year-on-year growth rate of

26%. Currently, DFCU has the 7th biggest loan book.

We believe that DFCU needs to build a strong retail deposit

franchise. In order to do that, the Group would need to rump up

its branch network. We believe that convenience will become a key

issue as system penetration increases. DFCU has 26 branches,

with two more expected to be opened this year. Management’s

target is 45 branches by FY14. The fact that the bank still need to

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build a branch network could affect earnings growth in the medium

term. However, we expect internet and mobile banking platforms

to aid penetration to the retail segment. According to

management, internet banking will be launched 3Q10 while mobile

banking will be launched 1Q11. In our view, there is hope in

deposit mobilisation, despite our concerns with increasing fixed

deposits. Deposits ascended by 21% from Ugx364.6bn in FY09 to

Ugx419.4bn in HY10.

In terms of credit risks, the bank’s increasing coverage ratio

is a positive...: The Group benefited from poor coverage ratio of

below 50% upto-FY08. The coverage ratio has since increased to

an acceptable 67% in FY09. The impairments/loans ratio also

increased materially in FY08 to 2.8%. It has since improved to

1.4% for FY09. We expect impairments on new and recent loans

(2008 onwards) to remain higher than the historical average of

1.1%. The increase in the loans related to trade could also see

some delinquencies coming through in the future due to the slow

recovery in the global economy.

...and the write-backs from a written-off book of about

Ugx19.6bn lessen the pressure on earnings: According to

management, the recovery of the written off book (the corollary of

the pre-2006 gluttony when the loan-book grew by 45%) is

proceeding as per their expectations. As a result, management

expects write-backs to outweigh allowances for bad debts this year

and provides an impetus to earnings. For HY10, the allowance for

impairments of loans and advances was a positive Ugx680mn.

Loan book well diversified by sector: In terms of sector

exposure, the loan book is well diversified. The biggest exposure is

trade related with a 19% exposure. (FY09). (see Fig 34).

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Fig 34: Sector exposures, well diversified

2%

5%7%

8%

13%

19%

46%

Sector exposures,2009

Agriculture Construction Manufacturing Transport

Mortgages Trade Other

3%6%

9%

10%

12%

19%

41%

Sector exposures,2008

Agriculture Transport Manufacturing Construction

Mortgages Trade Other


Deposit/liability structure will be key in sustaining NIM and

spreads: One of our main concerns with the Bank is the

substantial rise in the fixed deposits. Fixed deposits increased by

80.4% in FY09 to Ugx140.4bn. Fixed deposits now constitute 41%

of the bank’s deposits, a 10pp increase from 31% in FY08. (see Fig

35 and Fig 36). Our worry is that fixed deposits are expensive and

as we mentioned before, the cost of time deposits has increased

by 5.3pp from 5.29% in FY08 to 10.72%. Additionally, fixed

deposits increases funding risk, albeit manageable. This is because

they are more actively managed than retail deposits. We are

concerned that once DFCU build a reputation as the “better

paying” bank in the industry, it will be difficult for it to source

cheaper deposits. The consequence is the narrowing interest

spreads and interest margins. The borrowings from developmental

institutions, while long-term and less expensive on an absolute

basis, are generally less profitable. The borrowings enjoy an

average spread of 6% (versus 10% for ordinary deposits). They,

nonetheless, provide stability to the interest spreads. Management

indicates an intention to grow savings deposits in their HY10 result

presentation.

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Fig 35: The bank’s has increased its fixed income deposits

45,950

140,400

160,288

‐

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

180,000

Savings Fixed Demand

Deposit structure,2009

14.4%

25.1%

80.4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Demand Savings Fixed

Deposit type growth,2009


Fig 36: The bank’s has increased its fixed income deposits

13%

41%

46%

Deposits structure,09


14%

31%55%

Deposits structure,08



Liquidity; LDR below the 80%, plenty liquidity despite our

concerns with the liability structure: Notwithstanding our

concerns with the deposits/liability structure of DFCU, which we do

not envy, the Bank has ample liquidity to grow its loan book. We

calculate two LDRs, one excluding the borrowed funds (from

developmental institutions), and both LDRs show improvements.

The LDR (using pure customer deposits) shows an improvement

from 101% to 90%. Including borrowed funds, the LDR is a

pleasing 60% from 70% in FY08. (62% for HY10). The cash and

cash equivalents/customer deposits ratio is also high at 35%,

despite a deterioration from 55% in FY08. (see Fig 35). In FY09,

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customer deposits grew by 36% versus a 15% growth rate in

loans and advances and this trend continues as deposits surpassed

loans growth in HY10 by 9pp.

Fig 37: The ‘two LDRs’ are converging

0.3

0.5

0.7

0.9

1.1

1.3

1.5

2004 2005 2006 2007 2008 2009 2010F 2011F 2012F

LDR (customer deposits)

LDR (funding liabilities)

0%

10%

20%

30%

40%

50%

60%

70%

2004 2005 2006 2007 2008 2009 2010F 2011F 2012F

Cash+equiv./Customer deposits

Cash+equiv./Funding liabilities


ROE decomposition: DFCU has enjoyed relatively weaker ROEs

than the industry. For example, in CY04 industry ROE was 37.6%

vs. 20.8% for DFCU; CY06 system ROE was 25.7% against DFCU’s

13.7%; and in CY08 again the industry outperformed DFCU with

ROEs of 25% and 21% for the industry and DFCU in that order.

Management’s target ROE is 30%.

ROA has been weaker than the industry: The ROA has

been the main differentiator to ROE. DFCU’s ROA has been

weaker at an average of 2.7% versus the industry’s average

ROA of 3.6% (CY04-CY08). This has mainly been a result of the

lower asset yields and margins when compared to the industry

(and Stanbic). In our view, the poor retail franchise, and

therefore higher costs of deposits have negatively affected

margins.

Leverage has room to pick up, and management

indicates a target ROA of 4%: We would have expected

management to work on leveraging the balance sheet further

and enhance ROE. However, management indicated that their

target ROA is 4%. We are unconvinced, given the industry

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concerns we highlighted before, but management points to

efficiency benefits that should improve yields and margins.

The jaws have not opened up as fast (when compared to

Stanbic). Operating income has grown by a CAGR of 18%, just

3pp above the CAGR of 15% for operating expenses (FY04-

FY09). Growth of net interest expense has also outpaced growth

of interest income with CAGR of 24% and 22% respectively. In

our view, a stronger retail franchise would have been supportive

of operating income through NII. Management guidance shows

a target of 45% as NII/operating income ratio within the next 5

years. Regional expansion is expected to aid.

Fig 38: ROE decomposition

2004 2005 2006 2007 2008 2009 2010F 2011F 2012FAsset yield: Revenue/Assets 9.7% 12.1% 10.7% 11.6% 11.2% 10.3% 9.8% 9.4% 8.7%Margin: Net income/Revenue 29.6% 31.0% 17.2% 19.3% 23.6% 30.6% 29.8% 28.4% 29.6%ROA 2.9% 3.7% 1.8% 2.2% 2.6% 3.2% 2.9% 2.7% 2.6%Leverage:Assets/Equity 7.2 6.6 7.4 7.3 7.9 8.0 9.2 9.2 9.5ROE 20.8% 24.6% 13.7% 16.3% 21.0% 25.2% 26.8% 24.8% 24.7%


Fig 39: “JAWS” are not very impressive

CAGR = 18%

CAGR = 15%

‐

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2004 2005 2006 2007 2008 2009

Ugx,bn

Operating revenue

Operating expenses

CAGR = 24%

CAGR = 22%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

2004 2005 2006 2007 2008 2009

Interest income

interest expense


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3.2 Valuation: There is hope after addressing the legacy issues.

Below we draw attention to the major assumptions we employed in our

earnings and balance sheet models. (see Fig 40). We:

reduce the interest income/interest earnings assets ratio by

100bps to 13% for FY10. We expect yields to continue to decline

to reach 12% by FY12. Interest income increase by 15% in FY10;

increase the interest cost of interest paying liabilities to 6% on

account of increasing competition. Interest expense increases by

44% for FY10. The interest spread declines to 6.5% by FY12;

raise the fee and commission income/loans from 2.3% in FY09 to

2.5% in FY10. This grows fee income by 39% for FY10.

Management is implementing strategies to increase non-interest

income, and internet and mobile platforms should provide a lift;

increase the operating expenses/operating income to 57% and

reduce it by 2pp to 55% in FY12;

note our effective tax rate is relatively low (when compared to

corporate tax rate of 30%). DFCU is enjoying tax benefits on three

main ways 1) the high investment in government securities which

subjects interest income to a 15% tax rate; 2) the tax losses

carry-forward that still provides tax benefits. According to

management, about Ugx1bn tax loss is yet to be exploited.

Fig 40: Key assumptions

2004 2005 2006 2007 2008 2009 2010F 2011F 2012FInterest income/IEA 11.2% 14.4% 15.5% 15.8% 14.0% 14.0% 13.0% 12.5% 12.0%Interest expense/IEL ‐3.7% ‐4.4% ‐5.7% ‐6.5% ‐4.6% ‐5.2% ‐6.0% ‐5.5% ‐5.5%Fee and commission/Loans 4.9% 4.1% 3.9% 3.4% 2.6% 2.3% 2.5% 2.8% 3.3%Other income/Loans 1.5% 2.0% 0.7% 0.9% 1.2% 1.1% 1.2% 1.2% 1.2%Op. expense/Op. Income ‐56.1% ‐54.1% ‐66.6% ‐72.9% ‐57.5% ‐56.3% ‐57.0% ‐57.0% ‐55.0%Provisions/Loans ‐0.3% ‐0.7% ‐2.1% 0.7% ‐2.8% ‐1.4% ‐1.0% ‐0.8% ‐0.8%Taxation/PBT ‐30.4% ‐27.0% ‐25.7% ‐31.6% ‐16.0% ‐15.6% ‐15.0% ‐20.0% ‐25.0%

Deposit growth ‐15.2% 7.8% 8.5% 56.4% 36.1% 35.0% 23.9% 28.2%Loan/Funding liabilities 54% 75% 65% 62% 68% 63% 66% 70% 70%


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Valuation; a PBVR of 2.1X is fair for lower ROE in our view:

We apply the same valuation method we used for Stanbic. The

only difference is that we increased DFCU’s CoE to 18.95% to

reflect our concerns with its relatively poor retail deposit franchise

and inconsistent performance. (execution/strategic risks). We

obtain a fair PBVR of 2.1X.

FY11 price target is Ugx833; potential total return is not

good enough: We obtain a FY11 price of Ugx833, which provides

a potential total return of 8.4%. (see Fig 41). In our view, the

bank is well placed to break the hegemony of the international

banks in the system, and offers a turnaround story, but we do not

envisage it happening within our forecast period. We would be

happier to BUY when the legacy issues are addressed and there is

clarity on regional expansion. We expect DFCU’s ROE to lag

Stanbic despite a stronger earnings momentum.

Fig 41: Price/Book Valuation Model

Average ROE 25.8%Average growth rate 15.7%CoE 19.0%Justified PBVR 2.1FY11 BVPS 390.5Price Target 832.7Current Price 805FY11 Div. Yield 5.0%Potential total return 8.4%

CoE CalculationR208 Yield 8.20%ERP 6%

14.20%Country risk 3.0%Specific risk 1.75%

18.95%

Source: Legae Securities

Legae Securities (Pty) Ltd

Member of the JSE Securities Exchange

1st Floor, Building B, Riviera Road Office Park, 6-10 Riviera

Road, Houghton, Johannesburg, South Africa

P.O Box 10564, Johannesburg, 2000, South Africa

Tel +27 11 551 3601, Fax +27 11 551 3635

Web: www.legae.co.za, email: [email protected]

Analyst Certification and Disclaimer

I/we the author (s) hereby certify that the views as expressed in this

document are an accurate of my/our personal views on the stock or sector

as covered and reported on by myself/each of us herein. I/we furthermore

certify that no part of my/our compensation was, is or will be related,

directly or indirectly, to the specific recommendations or views as expressed

in this document

This report has been issued by Legae Securities (Pty) Limited. It may not be

reproduced or further distributed or published, in whole or in part, for any

purposes. Legae Securities (Pty) Ltd has based this document on information

obtained from sources it believes to be reliable but which it has not

independently verified; Legae Securities (Pty) Limited makes no guarantee,

representation or warranty and accepts no responsibility or liability as to its

accuracy or completeness. Expressions of opinion herein are those of the

author only and are subject to change without notice. This document is not

and should not be construed as an offer or the solicitation of an offer to

purchase or subscribe or sell any investment.

Important Disclosure

This disclosure outlines current conflicts that may unknowingly affect the

objectivity of the analyst(s) with respect to the stock(s) under analysis in

this report. The analyst(s) do not own any shares in the company under

analysis.

Disclaimer & Disclosure

Ugandan Banks_BUY Stanbic_HOLD DFCU

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