As the public debate around Standard Gauge Railyway (SGR) funding and its attendant costs continues to emit varied nuances, the broader debate we need to have is whether the exchequer can continue funding large infrastructure projects without exerting significant pressures on the fiscus. On October 2, 2018, I spoke at the East Africa gathering of Bonds, Loans and Sukuk, an event that brings together debt market players (both sell and buy sides). The thrust of the funding discussions gravitated around the role of pension industry in providing liquidity for infrastructure financing. The funding question also descends into the ongoing debate around the recently statutized National Housing Development Fund which is meant to help the State realise its affordable housing agenda. It will be funded through a defined contributory scheme in which an employee will contribute 50 basis points of their income with the employer expected to match it-upto to a maximum of sh5,000 (or just about $50). But the scheme and concerns expressed on the scheme from different quarters stems from the fact that, on the face of it, it appears to lack sufficient ringfencing mechanisms. But that notwithstanding, it can best be viewed as a Stately response to a market failure; a failure that has been incubated by a misalignment in goals between infrastructure project sponsors and pension liquidity. Kenya’s pension fund industry has come of age, with total assets, for the first time, crossing the Sh1 trillion (or $10bn) mark in 2017, from a measly Sh44 billion in 2001 (or the equivalent of $600 million at the time). Expectedly, investments are still dominated by traditional assets, namely Government securities (Treasury bonds and bills), quoted equities (stocks) and property. Indeed, the three traditional asset classes accounted for 77 percent of the pension funds’ investments at the close of 2017. Not such a great cocktail, right? There is a narrative behind the cocktail. Pension funds are constantly faced with a trilemma-Profitability, Liquidity and Security. Profitability is all about investing to achieve highest returns, liquidity rotates around the ability to answer to liabilities as at and when they fall due; and security is all about capital preservation. In short, pensions don’t hold risk capital. Additionally, pension funds are overseen by a group of persons known as trustees, who are persons appointed by a pension scheme to hold a scheme’s assets for the benefit of scheme members. At the core of it, they make investment decisions, in conjunction with fund managers. However, in a lot of cases, the trustees’ dexterity in matters investments may not be sound, yet they are expected to build and preserve pension wealth. On the sell-side, project sponsors are driven by a single objective-to secure funding, contemptuous of bankability of their projects. Really they often pay little attention. Resultantly, this misalignment designates the Sh1 trillion pension funds as liquidity so near, yet so far. Broadly, it is clear that pension funds need to play a leading role in large infrastructure financing-such as housing. It is still a matter of public debate on how to bridge this divide-and I have few ideas. From closed-door debates, such as the Bonds, Loans and Sukuk forum, project sponsorships must now entail a series of addressing the pension funds’ trilemma. In other words, projects must be significantly de-risked in order to enhance their bankability. Part of the solution involves wrapping the projects with enhanced credit guarantees from Sovereigns or other AAA-rated corporate guarantee providers. Such wraps provide second line defense incase first line defense, which are project cashflows and charges (fixed of floating) on project assets, are breached-and go a long way in addressing the security component of the trilemma. Further, there is no doubt that project internal rates of return (IRR) are attractive, given their risky nature; however, according to pension funds, projects must also address liquidity turnaround component of their trilemma. The nature of pension is such that you always have to answer to liabilities as they fall due. For real estate projects, a real estate investment trust (REIT) offers the turnaround. However, it remains a tough call for non-real estate projects-such as roads, airports or power projects. Quite broadly, this lack of liquidity points to a need for a public secondary loans market. Such a market can offer an on-demand exit for a wide variety of loans, such as project loans. Effectively, project sponsors, whether Sovereign or private, must crack this nut and present the best structure to pension funds. Otherwise it is quite evident that there exist a misalignment in goals between project sponsorship and pension funds that will continue to make pension liquidity appear so near yet so far.

A summarized version of this article first appeared in the Business Daily’s Market Curve Column on October 5, 2018.

Insurance and its main concept-that of distributing risk(s)-has been around since Edward Lloyd first opened the doors of his London coffee. Over time, the world of insurance has evolved, and so has its offerings-from the plausible to the most ludicrous. The Showbiz world has demonstrated this, with Hollywood celebrities insuring body parts. But the corporate world has nearly touched its elasticity limits.

From investment banks betting against their own clients, to hedge funds (and other savvy individuals) betting on sovereign defaults (and commoditizing the same bets). And if you thought you’ve had enough, wait for it. There has been an increasing trend for blue chip companies to take out a keyman policy against their Chief Executive Officers (CEOs). What’s that? Basically, it’s a compensatory protection that a company takes out against possible damages to the brand arising out of its CEO leaving. Upon crystallization, the company gets paid (and not the CEO).

The whole premise is simple. A CEO, being a brand custodian, on behalf of shareholders (of course), is the face of brand success and often gets cobbled together. Uncobbling that tie up, whether prematurely or not, is perceived or presumed to be injurious to the brand and would require some form of monetary compensation. But that premise only holds true under two sets of circumstances: (i) when the CEO has cultivated a cult-like personality in the organization; and/or (ii) when the company’s decision-making has been centralized around the CEO.

The presence of those two sets of premises not only elevate ‘keyman’ risks, but also makes it difficult to run the company in the absence of the CEO. Fully aware of the risk elevations, some companies have mastered the art of de-risking by having distributed keymen. One such company is Safaricom, Kenya’s telco giant. In October 2017, the Safaricom’s Board announced that its CEO Bob Colllymore would be taking a long medical leave to seek treatment for an illness which, on privacy grounds, the Board did not disclose. The leave came just when the company was a month into the second half of its 2017/18 fiscal calendar. To fill the void, the Board tasked Chief Financial Officer (CFO), Mr. Sateesh Kamath with the primary Executive role(s) supported by Director of Strategy and Innovation, Mr. Joseph Ogutu.

In the second half of its fiscal year, Safaricom posted strong numbers: (i) it added 70,000 in additional subscribers; (ii) total revenues rose 4% half-on-half to Kenya Shillings (Kshs.) 119.3 billion; (iii) Earnings before Interest, Tax, Depreciation and Amortization (EBITDA) rose 8% half-on-half to Kshs.58.6 billion; and (iv) the company generated Kshs.54 billion in gross cash. For cash-intensive businesses like Telcos, and Safaricom by extension, EBITDA is a vital key measure of the underlying health of a company’s operating performance and allows watchers of the company (sell-side analysts, individual and institutional investors) to smoothen out the noise(s) around potential impacts of non-operating factors such as tax environments, accounting and financing decisions. During the company’s full year investor briefing, nearly six months later, Bob Collymore announced return from his sick leave. And from these second half numbers, it is fiscally evident that Bob Collymore’s six-month leave absence did not affect the company’s operating performance. This then offers two critical lessons on management of keyman risks.

First, companies should focus on anchoring their brands on core corporate principles (and tenets). The role of effective enforcement and management of corporate principles is then vested in the CEO. This then insulates the brand from CEO turnovers. Second, companies should place emphasis on building well-functioning internal systems that have the rigor of fiscal conveyor belts, to the extent that a temporary absence of a CEO doesn’t ground its operations.

It appears 2017 was the year of lazy banking across Sub-Saharan Africa (SSA). But before I start raising your hairs, let me provide a bit of background on this. Modern day banking is founded on Fractional Reserve Banking (FRB)-where commercial banks take deposits from the public, keep a fraction with central banks (in the form of mandatory reserve requirements) and lend the rest.

Conceptually, commercial banks borrow from depositors at low rates and lend at higher rates. This is the intermediation role that banks play in any economy. Effectively, they play the vital role of reallocating capital from surplus capital owners (or depositors) to those seeking capital deficit financing (borrowers). However, in this capital reallocation game, commercial banks aren’t ordinarily expected to lend to central Governments as part of its business strategy-except as part of liquidity management (both for regulatory and internal requirements).

Because customer loans are illiquid, partly because SSA still lacks an active secondary market for loans, banks always need to maintain certain portion of their asset books in near-cash (or liquid) form, ostensibly to take care of depositors who may want their money back. The lazy banking designation stems from the fact that a bank dumps this intermediation role by preferring to invest depositors’ money in Government bonds at relatively low returns and negligible default risk(s). This is exactly what transpired in 2017.

During the year, commercial banks’ asset-book growth momentum seemingly stagnated. Indeed, across a sample of 21 markets across the SSA region (excluding South Africa), total banking sector assets declined by 100 basis points year-on-year in USD terms. While there is a minor element of exchange rates in that decline, much of the decline was driven by the fact that on-balance sheet risk-weighted assets, which account for about 60 percent of total assets, equally declined. Instead, growth was driven by banks’ purchase of Government-issued debt securities (bills and bonds).

Across the 21 markets, the share of Government securities rose sharply by a staggering 300 basis points year-on-year to stand at 21 percent as at end-2017. At the same time, growth in loans remained flat year-on-year. Nominally, commercial banks invested a staggering USD8.7 billion in Treasury bills and bonds and literally no liquidity went into lending to the real economy. In a way, you could say banks were justified. First, there was a sustained elevation in credit risks across SSA. Indeed, across the region, commercial banks’ loan non-performance, as measured by the ratio of gross non-performing loans (gross NPL) to gross loans, weakened by 110 basis points year-on-year to 7.5 percent as at end-2017, in USD terms.

Behaviorally, banks have tended to tighten risk admissibility criteria in times of stress. Consequently, commercial banks across the region, in a synchronized pattern, generally slowed down the pace at which they lent. Data from the April 2018 edition of SSA regional economic outlook by the International Monetary Fund (IMF), which shows that annual private sector credit growth in SSA plunged to 3.3 percent in 2017, from 12.5 percent in 2016, corroborates this. Second, Governments’ aggressive fiscal deficit financing actions from domestic debt markets played a much greater role. By deepening domestic borrowing, a number of Governments in the region effectively crowded out the private sector.

For instance, in Zimbabwe, the Government’s penchant for borrowings saw commercial banks’ holding of Government securities rise from just 7 percent of total assets as at end-2014 to a staggering 30 percent as at end-2017. The fact that Zimbabwe’s economy remained dollarized offered additional incentives for banks. Nigeria and Ghana classically demonstrated the crowding-out effect. In Nigeria, the Central Bank of Nigeria (CBN) mopped up excess local currency liquidity by selling to banks shorter-dated securities (technically known as CBN bills) whose price tags averaged at about 20 percent and attracted zero tax.

In Ghana, the interest rate on a 12-month local currency Treasury instruments averaged at 16.5 percent; and while it compared unfavorably to the 2016 average of 23 percent, it still represented a significant premium for banks to avoid taking real risks. Consequently, banks’ holding of Government securities rose from 23 percent of total assets as at end-2015 to 30 percent of total assets as at end-2017. Lending to central governments, by way of purchasing Treasury-issued debt instruments, often presents three core advantages: (i) little or no operational costs attached to it; (ii) zero risk-weighting; and (iii) in some jurisdictions, like Nigeria and Ghana, zero tax implications. However, the story for Kenya’s banks was a little different as the key driver of elevated purchases of Government-issued local currency debt was the interest rate cap, which basically established a roof on commercial banks’ ability to price credit risks, both perceived and real.

As the 2018 clock continues to run down, the two lazy banking incentives aren’t submerged yet; (i) the de-elevation of credit risks seems to be unfolding at a snail pace (at least in the first half of 2018); and (ii) Governments’ fiscal trajectories still remains weak, at least when you look at key countries like Kenya, Nigeria, Zimbabwe and Ghana. However, there exists a classic dochotomic situation. So, while the incentives aren’t submerged, yield curves across the region are troughing in, presenting price risks. This effectively means commercial banks will have to reposition their balance sheets to reflect the dichotomy. This will be a tough call.

The real value of Kenya Airways Share price is Kshs.1.00; market irrationality to blame for current overvaluation

Are investors always rational? This is a question that has been subject of a number of academic studies and theories. Top of the list of theories is the famous Efficient Market Hypothesis (EMH), which evolved in the 1960’s from Eugene Fama’s Ph.D dissertation. It states that at any given time, asset prices fully reflect all available information.

The basis of the EMH is the simple economic theory of competitive markets. Indeed basic economic theory teaches that arbitrage competition among investors and their profit motive will create efficient markets. As new information is dribbled into the marketplace, all investors will act on it rationally to adjust price to a new intrinsic value. Should price deviate from its true value, so-called ‘noise’ arbitrageurs will compete to bring that price back to that value at which the price will be at equilibrium with its value. But there are two cardinal problems here, especially in as far as information dissemination is concerned.

First, we have the problem of information asymmetry-where a certain group of market participants have information that another party doesn’t. It always happens. Second, we have the problem of interpretation. The information maybe too numerous and too complex, and, thus, not easily or inexpensively interpreted. Information interpretation and decision making is subject to cognitive bias and limits. Indeed, the new science of behavioral finance studies the irrational behavior of investors and how they interpret information.

Some of the results have shown illogical behavior, such as comfort in crowds-also called herding-and overconfidence based on little information. I have always known the stock market to dribble a certain dose of irrationality, but not to the extent that investors have continued to display on Kenya Airways (or KQ) stock. In 2017, Kenya Airways restructured its balance sheet in a rather benignly complex transaction. The whole objective of the transaction’s entirety was to equitize the company’s unsecured lenders as well as re-equitize Government’s cash and non-cash advances.

The Government remains the largest shareholder. To achieve this, it needed to tweak its share capital to create room. So the company first split the par value of its shares from Kshs.5 a share to Kshs.0.25 a share. This shrank the existing nominal value of its issued and fully paid share capital to Kshs.374million, from sh7.48 billion-and representing a 95 percent dilution. Out of each ordinary share, they then created 19 deferred shares via a share split, to the extent that the process hatched 28.4 billion shares. It’s a process that appeared to technically create new shares, yet it didn’t.

The deferred shares have been stripped of core privileges typical of ordinary shares. Indeed according to the Extra-ordinary General meeting (EGM) notice supplied by Kenya Airways in July 2017, holders of the deferred shares were stripped of the following privileges: (i) receipt of any dividend or any distribution; (ii) receipt of a share certificate in respect of the relevant shareholding; and (iii) receipt of notice of, nor to attend, speak or vote at, any general meeting of the company.

What a deferred ownership. Summed up with the non-deferred shares, the company’s new issued and fully paid shares surged to 29.9 billion shares-or, as I aforementioned, the equivalent of 95 percent dilution. Suddenly, existing shareholders, who owned the non-deferred shares, found themselves in the super-minority cabin. It is from the deferred shares pool that the company allocated its lenders, including Government, quasi-ownership as well as allocate additional ownership to one of its key owners-Royal Dutch Airlines.

The Government of Kenya was allocated a total of 13.5 billion shares, increasing its overall ownership to 45 percent. Royal Dutch Airlines (or KLM) was allocated a total of 3.7 billion shares, increasing its overall equity in the company, diluting its shareholding to 12.4 percent, from 26.7 percent. KQ Lenders Co. Ltd, the vehicle formed to consolidate equity allocation to the unsecured lenders, who consisted of eleven local banks, was allocated a total of 10.6 billion shares, split into two: the first portion of 8.3 billion shares was a straight direct equity in Kenya Airways by the vehicle. However, the unsecured lenders, who were owed a total of $220.7 million, did not convert the entirety of the outstanding.

Instead, the direct equity of 8.3 billion shares was swapped for $170.7 million of debt. The balance of $50million debt was transformed into a mandatorily convertible instrument scheduled to fall due over a two financial year periods, beginning 2018. In that respect, slightly over two billion shares have been allocated. Finally, the company’s employees, under an Employee Ownership Scheme (ESOP), were allocated the balance of 568.6 million shares. Because of the voluminous nature of handling nearly 30 billion shares, a first for any listed company in Kenya, the company decided to consolidate its shares in the ratio of one share for every four shares-an action referred to as reverse split.

This also explains why holders of the company’s shares pre-restructuring suddenly had their holdings in the Central Depository System (CDS) shrank by a quarter. The net effect of all this balance sheet restructuring was the initial listing of 6.8 billion Kenya Airways shares at the Nairobi Securities Exchange (NSE) on November 29, 2017-which would later fall to the current level of 5.68 billion shares. But here is the madness. Because pre-restructuring investors had their worth cut into quarter, the market’s immediate reaction was to adjust the market price to the equivalent of previous worth-while ignoring changed dynamics of the company. First, the company’s listed shares surged from nearly 1.5 billion shares to the current 5.68 billion shares.

These are tradable shares by all means. Further, the par value of the company’s shares, after the reverse split, dropped to Sh1.00 from previous sh5.00. At the point trading on the company’s shares were being suspended-the suspension had to be effected to enable adjustment in the share adjustment after the entire process-there existed a parity between par value and market value. On that basis alone, the company’s market price post-suspension was worth Sh1.00 a share. Secondly, the market ought to further discount the company on two accounts: (i)significant share overhang which typically represents as a much as 20 percent downside-this discounting is hinged on the fact that there exists potential dilutive impacts if the new blocks allocated to the employees and the lenders’ vehicle were to be released to the market; and (ii) government discount on account of its increased ownership of the company from 29.8 percent to 45%. The market has typically assigned anything between 25-30 percent government discount-and the discounting is premised on the fact that Governments tend to interfere with businesses without notice. Consequently, if you factor in these discounts as well as the prior par value-market price parity, the stock is massively overpriced solely on the basis of investor irrationality.

Insurance companies in East Africa are served business on a silver platter, literally!
Insurance is an interesting business in East Africa, for two reasons. First, insurance in the region is driven by non-life (or general) business. Out of the USD2.4 billion worth of total gross premiums earned by insurers in Kenya, Uganda and Tanzania in 2016, non-life premiums accounted for 67 percent (or USD1.6 billion) while life premiums accounted for the balance.

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