<BAD LOANS RISING
As the real estate walls come tumbling down
Recently, the press has been awash with stories of how borrowers are struggling to repay their loans. Some say that even the dreaded auctioneers are no longer at ease. It is becoming increasingly difficult for them to sell some of the properties offered to the market at auction prices. If such information is factual, this is a harbinger of tough times ahead.
The question therefore is: What happened? Why the sudden spike in non-performing loans? Are they a product of a tough business environment or weak credit risk management practices? This is a hot topic of discussion that has attracted great interest from many credit risk practitioners and researchers. The jury is still out. However, the English say, “an ounce of prevention is worth a pound of cure.” It is evident that institutions that can craft a robust and reliable credit risk management system stand a better chance of facing the daunting challenge.
The latest quarterly report by the Central Bank of Kenya shows that the number of non-performing loans continues to soar. The CBK said that as at the end of October 2018, the ratio of NPLS to the total gross loans was 12.3 per cent. The international credit rating agency, Moody's picked up the issue of the high number of NPLS in the Kenyan banking sector in a recent report. It attributed the deterioration of asset quality to weak credit risk management practices and noted that delays in paying contractors and suppliers by the government have aggravated the situation.
It cannot be denied that some key changes in the international financial reporting sector will impact the financial system even further. As of January 1, the requirements of International Financial Reporting Standards (IFSR) 9 came into force. Regulators may offer a few concessions, but the reality is that an agile lender must prepare for the worstcase scenario.
The expected increase in loan provisions will lead to lower profits while the tighter requirements of Basel 3 demand higher capital adequacy ratios. An increase in NPLS will lead to an increase in risk weighted assets, which leads to a lower capital adequacy ratio.
This is not a challenge unique to the Kenyan financial system. It is global. Mid last year, the World Bank Group organised a two-day conference in Vienna, Austria whose only agenda was to come up with a comprehensive approach to resolve the rise of NPLS. The conference attracted enormous attention from many countries that acknowledged that the high levels of NPLS are a challenge that must be addressed. Such conferences and meetings demonstrate how significant the issue of asset quality is to the performance of the individual banks and the entire financial system — nationally and globally.
Various stakeholders, including central banks, take a keen interest in the performance of loan assets and related credit facilities. This is because a properly functioning banking system translates into a stronger financial system and ultimately demonstrates the solid nature of the economy. If the banking system is bullish, the general economy is exposed to huge economic and infrastructural developments. A strong economy leads to an increase in employment opportunities, economic growth and immense political capital for a country's leadership.
Loans or credit facilities are the major stock-in-trade of many commercial banks or lending financial institutions. A lender faces several challenges: First, how to raise sufficient funds to ensure they remain in business. Second, perhaps the toughest, is to ensure loans are repaid within the pledged time frames.
Banks must study changes in the economic environment where they are operating. Different countries will face different economic challenges. Changes in the inflation rates, GDP growth rates, levels of interest rates, foreign exchange rates, among other key economic fundamentals, could change the business environment.
However, according to CBK figures, the real estate sector continues to generate the biggest chunk of NPLS in the banking sector. This changes from one market to another. According to the Central Bank of Nigeria, the oil and gas industry accounts for about 30 per cent of the total gross loans and about 47 per cent of the NPLS in that country's banking sector.
Many factors have been blamed for the volatile nature of real estate business in Kenya. Some analysts have opined that the capping of interest rates introduced in 2016 was one of the major reasons. But how could a drop in the lending rates, which was expected to lead to a growth in credit through affordable loans, be counterproductive? Why would such a change impact the real estate sector in a country where the total stock of mortgages is a measly 30,000?
Others have attributed the slowdown in the real estate market to an oversupply of housing units. Another school of thought would ask why we talk about oversupply of housing units in a country where the annual deficit in housing, according to the World Bank Group, is two million units? These figures must be more granular. When one discusses housing deficit, it is important to indicate which segment of the market is affected by the oversupply. Is it the highend, middle or lower segments of the pyramid?
Undoubtedly, the construction business is sensitive to changes in the market. That would explain why very few commercial banks have an appetite to finance big projects. It is a complex and highly specialised business where small changes in key variables can swing a project from being profitmaking to loss making.
Proper appraisal of real estate projects is paramount and projected revenue needs to be as realistic as possible. These estimates must also be stress tested to ascertain how the worst-case scenario would look like in case of adverse changes in the business environment.
Proper monitoring of such projects is critical to ensure any changes on key variables are noted in good time and appropriate corrective measures taken.
The financier must always be cognisant of the fact that the loan repayment for such a project will only be possible once it is successfully implemented and sold or rented out. Failure to adhere to these simple procedures will guarantee a white elephant project that will end up being a non-performing loan. Could this be the reason most of the NPLS are emanating from this sector of the economy? Time will tell.