Having undergone a series of consolidations, and operating in a region with a young, largely unbanked population, Africa’s banks are attracting the attention of investors from all over the world. However, choosing where to invest remains a challenge.

By James King | 4/01/2016 9:00 am

As investment opportunities go, banks in Africa are a good bet. Today, the growth momentum of the continent’s banking sector is attracting the interest of international lenders, private equity groups and sovereign wealth funds, among others, who are looking to capitalise on the high returns on offer. With growing frequency, these investors are executing big-dollar deals to gain an all important foothold in the continent’s market.

This trend marks an encouraging departure from the resource-dominated investments of previous years. In a reflection of Africa’s social and economic development, investment flows are becoming more diverse as new growth stories begin to emerge. For the continent’s financial services sector, and its banks in particular, these developments bode well.

Opportunities abound

“The Africa opportunity has traditionally been thought of in terms of natural resources. More recently, it has become a consumer-driven play, propelled by the dynamics around urbanisation, income growth and consumption,” says Philip Lindop, head of African investment banking at Barclays Africa.

These changing investment preferences have emerged as awareness of the opportunities in the African banking sector have grown. Over the past decade, the continent’s regulators have tightened up capital requirements, leading to a consolidation of lenders in many jurisdictions. According to Mr Lindop, this has created a greater number of top-tier institutions suitable for acquisition.

Indeed, many banks across Africa are still in need of additional funding. Slower economic growth across the region in recent years, coupled with lower commodity prices and a more stringent regulatory environment, are all feeding into the banks’ need to recapitalise. These trends have emerged as many global lenders, particularly from the US and Europe, have been winding down their presence across Africa.

“When you consider who will be investing in these opportunities, it’s unlikely to be some of the bigger European banks. Many of them have sizeable non-performing loan positions to deal with so I doubt they will be putting an Africa strategy at the top of their agenda,” says Linklaters’ Mr Bedford.

Filling the void

As the demands of Basel III requirements, as well as other regulatory burdens, take their toll, a new wave of investors are looking to fill the vacuum. This includes one of the world’s largest private equity firms, the Carlyle Group, and the Middle East’s largest bank by total assets, Qatar National Bank. Collectively, this new cast of players are leaving their mark on the landscape of Africa’s financial services sector. In doing so, they are capitalising on one of the most dynamic growth stories in the world today.

“A few years ago it was primarily South African banks that were looking to expand across the continent. Now there is clearly interest from non-African investors too,” says Chris Low, group managing director of Letshego, a financial services group with a presence across sub-Saharan Africa.

Indeed, data from Dealogic points to the growing interest from overseas investors. Between 2010 and 2015, a total of 59 mergers or acquisitions involving non-African investors and African banks occurred. The total value of these deals hit just over $7.5bn.

Investors are also making the most of the attractive prices on offer as, for a number of reasons, the valuations of banks across Africa have declined in recent times. “In particular, weaker oil prices, tighter monetary policy, more stringent regulations and political dynamics have played their part. These more attractive valuations have stimulated investor interest, specifically [in terms of] private equity and some international banks,” says Adesoji Solanke, a sub-Saharan Africa banking analyst with Renaissance Capital.

Long-term prospects

While attractive valuations have played their part, most investors are keeping an eye on the longer term fundamentals underpinning Africa’s banking sector. According to data from the World Bank, just 34% of adults in sub-Saharan Africa have a bank account, up from the 24% recorded just three years earlier. Additionally, the number of people aged 18 or under is expected to hit 1 billion by the year 2050, while the continent’s total population is expected to hit 2.8 billion by 2060.

On the ground, the prospects are even more promising. “In aggregate terms, banking penetration is extremely low across the continent. But when you remove east and southern Africa from the equation, you find that lending is driven by corporate activity elsewhere. So when it comes to retail lending, the figure is even lower,” says Mr Lindop.

As The Banker’s Top 100 African Bank’s ranking (see page 56) makes clear, the returns enjoyed by the continent’s top lenders are enviable. In 2014, the return on assets of the continent’s biggest banks by Tier 1 capital was 2.2%, while their return on capital was 27.6%. This performance was achieved as total asset growth hit 5% and aggregate Tier 1 capital growth climbed by 3.6% for the year.

“Considering the fundamentals underpinning many African economies, if you can invest in a well-managed and solvent bank with a solid balance sheet then some highly profitable exit routes are likely to open up,” says Mr Bedford.

The hunt for attractive exits is underpinning the recent drive by a number of private equity groups to secure a position in Africa’s banking sector. In November 2014, the Carlyle Group invested $147m in Nigeria’s Diamond Bank, equivalent to a stake of about 18%. This follows a massive spike in interest from the private equity sector in Africa more generally. According to the Emerging Markets Private Equity Association, about $4.2bn was raised to invest in Africa in 2014 alone.

QNB’s move

In general most investors, including banks and other investment vehicles, have an eye on securing longer term operational control of their acquisitions. “On the whole I would expect most investors to pursue minority stakes in African banks only as an entry point. These will likely be executed with the option to pursue a majority stake through another route further down the line,” says Mr Low.

In September 2014, Qatar National Bank (QNB), the Middle East’s largest lender by total assets, bought a 23.5% stake in Ecobank Transnational Incorporated (ETI), the bank with the largest footprint in Africa, in two successive transactions at a value of $220m and $283m. This followed QNB’s 2013 acquisition of Société Générale’s Egyptian unit for $2bn in 2013.

QNB has set itself a target of becoming a “Middle East and Africa icon” by 2017. This strategy is driven in part by increasing competition in the bank’s home market. Meanwhile, the collapse in the price of oil has forced the Qatari government and government-related entities to withdraw some of their deposits, slowing overall deposit growth, as non-essential capital spending has also been cut. These trends, and others, have led to lower growth opportunities in the domestic market.

QNB’s overseas loan book is expected to grow by about 25% per year between 2014 and 2017, compared with just 6% in Qatar, according to research from HSBC. As such, most analysts expect the lender to aggressively pursue further international expansion. Indeed, various sources believe the Qatari lender will ultimately seek to gain full control of ETI in the coming years. How this might transpire, in light of South African lender Nedbank’s recent acquisition of a 20% stake in Ecobank, is being carefully watched.

Diamond’s search 

Meanwhile, former Barclays chief executive Bob Diamond has led a push into the African banking sector through investment vehicle Atlas Mara. In partnership with Uganda’s Ashish Thakkar, whose Mara Group holds a 20% stake in the venture, the ambition is to create sub-Saharan Africa’s ‘premier financial institution’. To achieve this, Atlas Mara is buying up positions in some of Africa’s most promising banking markets.

To date, the group has made five acquisitions with a value of about $500m, providing it with a presence in seven countries. With further acquisitions expected, the aim is to be present in 10 to 15 African countries in the coming years. Yet, the case of Atlas Mara also exposes some of the challenges facing foreign investors who are entering Africa’s banking market.

Since an initial public offering on the London Stock Exchange in December 2013, Atlas Mara has lost about half of its share value. A number of factors have contributed to this decline, from lower commodity prices, to regulatory pressures, to slower economic growth across the region.

“Investing in Africa is difficult since the operating environment changes significantly from one jurisdiction to another. You have to have an understanding of the practical reality on the ground and that takes time,” says Mr Low.

What is more, getting to grips with issues of risk management and loan quality is a further stumbling block. A number of banks in the so-called tier-two and tier-three smaller economies still suffer from legacy non-performing loan positions, while the regulatory environment in these jurisdictions can often be difficult to navigate. Though investors can look to enter more developed markets, this approach comes with its own challenges.

“Investment opportunities in Africa are difficult. You can either enter a market that is more developed and better regulated but face tougher competition, or you can invest in more frontier destinations where operating conditions are more challenging and business volumes are lower but where there is a clearer path in terms of the competition,” says Stuart Bedford, a partner with Linklaters in London.

Tech advancements

Moreover, Africa’s banking landscape is characterised by a high degree of technological innovation. This has emerged partly as a result of the entrepreneurial dynamism that colours much of the continent. But it also has a lot to do with the structure of many markets. Here, both the physical and human geography of a number of African countries lends itself to particular products and services geared around mobile banking.

“Investors need to consider issues around technology and innovation very carefully. It is clear to us that some of the mobile and non-traditional banking channels being developed in Africa are more advanced than in most markets around the world,” says Mr Low.

As such, a further challenge facing investors is combining cutting-edge technology and a low-cost base so that they are able to provide these services in a commercially effective way, according to Mr Low. Data from the World Bank indicates that Africa leads the world in terms of mobile money accounts. About 12% of adults in sub-Saharan Africa have such an account against a worldwide average of 2%.

Above and beyond these operational considerations, issues of regulatory and political risk remain paramount. The sacking of South Africa’s finance minister, Nhlanhla Nene, in early December 2015 is a case in point. Arguably one of the most highly respected public sector figures on the continent, Mr Nene was abruptly relieved of his position by South Africa’s president, Jacob Zuma, in favour of little-known candidate who in turn was replaced just a few days later.

With speculation that the move was politically motivated, it has cast a dark shadow over the continent’s second largest economy. Moreover, that such an incident could occur in the most politically and economically developed state in sub-Saharan Africa speaks of the difficulties to be encountered elsewhere for investors and financial institutions alike.

“Banks are now deemed to be systemically important to both economic development and financial inclusion across the continent. Clearly, strong and independent regulators and institutions are required to oversee their development,” says Mr Lindop.

Where to choose? 

Looking ahead, as opportunities remain abundant, selecting an appropriate investment in Africa may be the biggest challenge of all. “This broader [investment] trend is set to continue. In Nigeria, for example, you have a situation where, unless there is an ease in the capital regulations, some banks will be looking for additional capital in testing market conditions,” says Mr Solanke at Renaissance Capital.

Here, the continent’s investment potential requires weighing up the various pros and cons behind each opportunity. This includes considerations around operating in different economic communities and political zones, including the Southern African Development Community, as well as issues around investing in Africa’s linguistic, demographic and economic centres of power. In the case of the larger banking markets, including South Africa, Nigeria and Kenya, which fall under many of these categories, growing investor awareness has stoked fierce competition.

As margins in these more dominant economies compress, a greater number of longer term opportunities may open in Africa’s smaller markets and among its less sizeable lenders. “Looking forward, there is a lot of opportunity in some of the smaller economies, particularly in the East African Community. [But] there can be a high risk in terms of buying into tier-two and tier-three institutions in Africa,” says Mr Low.

Nevertheless, there may be other ways for investors to tap into the continent’s rising consumer wallet. With larger markets and traditional banking operations expected to become increasingly competitive in the coming years, microfinance lending has the potential to emerge as a new investment opportunity. According to the Microfinance Information Exchange, the number of active microfinance borrowers across sub-Saharan Africa was 4.7 million in 2013, while the gross loan portfolio stood at $7.1bn across the countries that reported data.

A number of microfinance private equity funds now straddle the African continent, while dedicated microfinance providers continue to grow in terms of their reach and scale. But beyond the business case, the implications of greater financial inclusion for the continent’s social, economic and political development are commensurately large. Providing greater numbers of people with financial services will in turn lead to the formalisation of regional economies as well as increased and more inclusive growth.

What is more, greater levels of foreign investment can only help to stimulate, as well as accelerate, the development of products and services in the continent’s financial sector. A broader suite of financial offerings will promote consumer engagement with the continent’s banking sector and create a strong cycle of inclusion, growth and prosperity. With the prospect of further international investments into African banks remaining likely, the outlook for the continent’s financial services sector, as well as a more inclusive growth model, is positive.

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