Wednesday, August 27, 2008

Equity Bank: The revolution and the law of diminishing marginal returns

From a failing micro-mortgage building society--->successful mould breaking microfinance--->very strong retail bank---> what next?

The law of diminishing marginal returns states that all things being equal, the rate of change will increase initially, will then level off before starting to decrease. After doubling profits continously since 2000, Equity investors and watchers will be waiting for 2009 to see if the bank is going to be able to maintain the furious rate of growth. In effect, with projected Ksh3.9bn for 2008, Equity would have to hit Ksh7.8bn for 2009 to maintain an increase of 100% in profits.

Impossible? Yes?

The bank is giving the target every shot and is now moving to answer the what next? question posed above.

1. Equity in 2009 and beyond will almost certainly be operating a model akin to the universal banking model that only CFC Stanbic has in Kenya or East Africa for that matter. The bank will be a:

  • Retail bank: provider of the probably the largest selection of retail banking products. The bank is working to shush all the noises about loong queues in its branches. Its scaling up its mobile banking offering and moving ATMs to supermarkets and other outlets. It will presumably also try to bring in HFCK into the fold at last by offering it the distribution channel as well as products (Hekima Milele product being done jointly with Britak is ground-breaking in some respects).
  • Investment bank: Initially I think this will just be the brokerage offering plus custody service layered on top. Its already doing the custody business very profitably (made something in the region of Ksh1.5bn from Safcom IPO). According to this piece in the Standard, it's talking to around 6 firms in the NSE about buying an investment bank licence.

  • Insurer: Its already got a couple of products in the market. The next move might well be a formal distribution agreement with BRITAK which was until Helios came along, its largest shareholder. The fit in terms of culture is actually very good. The deal would only be a win-win if Equity gets a cut of upfront-premium and repeat premiums for distribution rather becoming an originator of insurance products because embedded values come into play.

Can the model work for Equity where its failed for many others? Please note that before Stanbic came along, CFC results tended to go up and down somewhat primarily because of its CFC Life business. In the west, the universal banking model is now besmirched given that the two largest writedowns have come from universal banks (Citigroup and UBS). Quite simply, it boils down to risk management and lack of management knowledge of investment banking. Risk management is something that Equity has had to work hard on and will need to do so to be a success. Nyaga and FT should be pointers of what can happen otherwise.

2. Regional bank: Though UML is small (83k depositors and around Ksh2bn in deposits), Equity' plan is to replicate its retail banking success in Kenya across M7's country. Its also advertising for hires to help open its first branch in South Sudan though I suspect that'll be very gradual business growth. The regional banking strategy will only see returns in the long-term i.e. 2/3 years time.

In the meantime, the bank will be looking for its brokerage and insurance businesses to bring the bacon home.

PS: My 2009 forecast is Ksh6.2bn i.e around 60% growth from 2008 close of Ksh3.9bn.

PPS: The shareprice perfomance over the same period will be affected by this messy announcement.

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