TANZANIA SECURITIES LIMITED EQUITY ANALYSIS COMPANY: NMB BANK PLC

TANZANIA SECURITIES LIMITED EQUITY ANALYSIS COMPANY: NMB BANK PLC October 2018 Analysts: Happy Msale Thomas Samkyi Email: happy@tim.co.tz thomas@tanzaniasecurities.co.tz 1

Tanzania Economic Growth Outlook Gross Domestic Product (GDP): Tanzania s economy has continued to record strong performance in recent years with real GDP growing at an average rate of around 7% p.a. between 2013 and 2017. Real GDP grew by 7.1% in 2017, up from 7.0% in 2016, supported by improvement in infrastructure, stability of power supply and favorable weather conditions. The highest growth rates were recorded in mining and quarrying, water supply, transport and storage, information and communication and construction activities. The Bank of Tanzania (BOT) estimates a GDP growth rate of 7.2% in 2018. (Source: BOT) Currency: The local currency was relatively stable in 2017, depreciating slightly by 3% to settle at TZS/USD 2230.07 as per the BOT-quoted exchange rates. In 2018, from January to September the currency depreciated by 2% settling at TZS/USD 2277.46 according to the same source. We envisage that the currency will remain stable, with only slight fluctuations for the rest of 2018. Interest rates: Interest rates in 2017 fell sharply, caused by an increase in demand for government securities, both Treasury bills and Treasury bonds. The increase in demand was due to, among other reasons, (i) the government s directive that public institutions should transfer their fixed deposit and operating accounts from commercial banks to the BOT, and (ii) a sharp increase in banks non-performing loans. These in turn led public institutions and banks respectively to direct most of their funds to government securities. The 182 days Treasury bill fell by more than 900 basis points from 14.53% in January 2017 to 5.35% in December 2017. In 2018, interest rates continued with the downward trend. However, in the month of May, the 182 days Treasury bill seemed to have reached its turning point at a low of 2.67%. By September 2018, the Weighted Average Yield of the 182 days Treasury bill had risen to 5.03%, which although lower than the rate achieved in January, indicates an upward trend. While lower interest rates are expected to cause banks to lower the interest rates for loans for their customers, an overall increase in nonperforming loans in the banking sector has led to the opposite effect. Interest rates are market determined. The BOT however plans to institute a benchmark interest rate (the Central Bank Rate, CBR) under the interest rate based monetary policy framework in financial year 2018/19, which is intended to guide short-term inter-bank lending rates and thereby influence the marginal cost of funds for commercial banks. (Source: BOT). This is likely to lower overall lending rates by banks. Lower lending rates may encourage an increase in borrowing by banks customers, and if this borrowing is directed to investment, it will have positive effects on economic growth. The Stock Market: The DSE index grew by 9% in 2017 to settle at 2396.23 as of the year end while the TSI index, which only captures the domestic companies gained by 7% to settle at 3919.25. In 2018 at the end of September, the DSE index had fallen by 12% to settle at 2312.77 while the TSI index had gained by 1% to settle at 3950.14. We can attribute the low performance of the Dar es Salaam Stock market, especially the domestic listed companies to the slowdown in economic activity which has led to most companies reporting reduced profitability. 2

Inflation: Inflation averaged 5.33% in 2017, which is close to the BOT targeted level of 5%. Inflation continued with the downward trend in 2018 and in September, it stood at 3.4% from 4% attained in January 2018. We predict that inflation will remain at low levels (single digits) and lower than the 5% targeted BOT rate for the rest of the year (Source: National Bureau of Statistics (NBS)) External Debt Stock: External debt stock increased by 7.4% at the end of April 2018, from USD 18,651.1 million recorded at the end of June 2017, out of which public debt accounted for 78.4%. In nominal terms, the ratio of external debt to nominal GDP was 40.6% at the end of April 2018, out of which public debt to GDP ratio was 31.8%. The present value of external debt to GDP ratio was 19.7% using data at the end of June 2017, which is below the international sustainability threshold of 40.0%. The current debt levels are still within manageable limits, but will likely to be a cause for concern in future if the levels continue to increase (Source: BOT) Balance of Payments: Gross official reserves have been enough to cover at least four months of imports since January 2017 up to July 2018 consistent with the East African Community s targeted level for member states. Gross official reserves amounted to USD 5,392.4 million at the end of July 2018 that was enough to cover 5.5 months of projected import of goods and services, excluding imports financed by foreign direct investment. Going forward, it is expected that enough reserves will be maintained to cover at least four months of imports. (Source: BOT) The Banking Sector The financial system in Tanzania is dominated by banks. Financial system assets amounted to 43% percent of GDP in September 2015, with the banking sector accounting for 71% of the total. Other major parts of the system are the pensions funds (nearly 27% of total financial assets), insurance companies (just below 2%) and collective investment schemes (less than 1%). (Source: International Monetary Fund (IMF)) Tanzania had 57 licensed banks in 2016, more than any other East African country. Many of the banks are majority foreign-owned (Source: IMF, 2016), though the top two banks by assets are majority locally-owned. These top two banks control about 40% of total banking assets. 2017 was a challenging year for the banking industry and this has carried on to 2018. Most banks reported falling profits and increasing non-performing loans while small banks had challenges meeting capital adequacy requirements. Several banks have been facing liquidity shortages. Overall, the ratio of core capital to total risk weighted assets and off-balance sheet exposures was 18.7% at the end of April 2018, which is well above the minimum legal requirement of 10%. In the same period, the ratio of liquid assets to demand liabilities stood at 39.1%, above the minimum regulatory requirement of 20%. With effect from August 2017, the BOT directed banks to maintain capital conservation buffer and implement capital charge for operational risk. In this regard, while the minimum core and total capital ratios will remain 10% and 12% respectively, banks and financial institutions shall be required to maintain capital conservation buffer of 2.5% of riskweighted assets and off-balance sheet exposures. (Source: BOT). 3

Non-Performing Loans: The quality of the banking sector s assets has deteriorated as reflected by the ratio of nonperforming loans (NPLs) to gross loans. NPLs reached 11.3% at the end of April 2018 compared with 10.6% recorded at the end of June 2017 and 10.8% at the end of the corresponding period in 2017. (BOT) Regulatory Interventions in Banks: In January 2018, the BOT revoked banking licenses of 5 small banks which were undercapitalized and failed to increase capital to the regulatory minimum level after the lapse of a five-year moratorium. These were Covenant Bank for Women (Tanzania) Limited, Efatha Bank Limited, Njombe Community Bank Limited, Kagera Farmers Cooperative Bank Limited, and Meru Community Bank Limited. The banks have been placed under the Deposit Insurance Board for liquidation. Later in 2018, the BOT endorsed the government s decision to merge state-owned Twiga Bancorp, Tanzania Women s Bank and Tanzania Postal Bank to address undercapitalization of both Twiga and Tanzania Women s Bank. Twiga Bancorp had been put under statutory management since 2016. In August 2018, the BOT placed Bank M (T) Plc under statutory management as it was facing critical liquidity problems and was thus unable to meet maturing obligations. NATIONAL MICROFINANCE BANK NMB NMB is the largest bank in Tanzania by profitability, and a close second in terms of loan portfolio, total assets, customer deposits and number of branches. Its loans and assets market share are roughly 20% of the Tanzanian banking industry. The main competitor is CRDB Bank Plc and together they roughly control 40% of the banking assets in Tanzania. To date, NMB enjoys over 2.8 million customers having grown from 600,000 customers in 2005; over 800 ATMs (up from no ATMs at all10 years ago) and this is equivalent to 40% percent of all ATMs in Tanzania. The bank had 3,785 agency banking agents as of December 2017. NMB s Past Performance CRITERION FY13 FY14 FY15 FY16 FY17 CAGR Number of shares Mil 500 500 500 500 500 Pre-tax profit Tzs Mil 187,863 223,548 215,853 223,752 139,814-7% Profit after Tax Tzs Mil 133,638 154,512 148,813 156,153 95,609-8% Dividend Tzs Mil 45,000 52,000 52,000 52,000 32,000-8% Market Capitalization Tzs Mil 1,320,000 1,710,000 1,250,000 1,375,000 1,375,000 1% Price per share Tzs 2640 3420 2500 2750 2750 1% Book value per share Tzs 912 1132 1325 1506 1593 15% Earnings per share Tzs 267 310 298 312 191-8% Dividends per share Tzs 90 104 104 104 64-8% Price Earnings Ratio x 9.9 11.0 8.4 8.8 14.4 10% Dividend Yield % 3% 3% 4% 4% 2% -9% Dividend Payout % 34% 34% 35% 33% 34% 0% Price to book value x 2.9 3.0 1.9 1.8 1.7-12% ROE % 33% 30% 24% 22% 12% -22% Cost to income % 52% 53% 57% 58% 57% 2% NPLs % 3% 3% 2% 5% 6% 25% Source: Published Financials, DSE data & TSL Analysis 4

NMB, which had been posting positive performance in the past, experienced a slight dip in profitability in 2015 and a massive decline in profitability in 2017.in 2017, Pretax profit and profit after tax declined by 38% and 39% respectively relative to the preceding year, to settle at TZS 140 billion and TZS 96 billion respectively. The main reason for the decline in profitability in 2017 was a fourfold increase in provision for impairment losses, to TZS 130 billion. The bank has experienced a declining Return on Equity (ROE) from a high of 33% in 2013 to 12% in 2017. Its cost to income ratio has slightly increased, from 52% in 2013 to 57% in 2017. The bank has maintained a dividend payout ratio of around 34%, and due to declined profits, its Dividend per share dropped to TZS 64 in 2017, from TZS 104 in 2016. The latter was also the same dividend rate paid in the previous three years. Nonperforming loans which had averaged 3% in the past jumped to 6.4% in 2017. One of the main contributing factors to the increase in NMB s NPLs in 2017 has been defaults on the Salaried Workers Loans (SWL) portfolio because of large-scale dismissals of civil servants stemming from a government audit of its employees. The audit led to the identification and termination of ghost workers, employees with forged and/or missing certificates as well as those with standard seven certificates in positions that require minimum of form four certificates. Additionally, a few corporate borrowers were not able to meet their repayment obligations due to challenges in the business environment. Sectors that were impacted include trade, transport and logistics, construction, hotels and leisure. (Source: NMB Annual report 2017). Historical Financial Highlights CRITERION FY13 FY14 FY15 FY16 FY17 CAGR Loan & Advances Tzs Mil 1,614,292 1,986,162 2,457,282 2,774,464 2,771,732 14% Government securities Tzs Mil 820,744 736,352 672,540 724,197 919,099 3% Total Assets Tzs Mil 3,295,110 3,888,668 4,576,513 4,938,281 5,499,527 14% Deposits from customers Tzs Mil 2,577,946 3,005,585 3,564,770 3,737,211 4,272,058 13% Interest income Tzs Mil 355,686 416,490 436,719 548,993 585,512 13% Interest expenses Tzs Mil -25,893-39,264-68,529-102,194-120,291 47% Provision for impairment Tzs Mil -23,766-16,589-13,009-30,240-130,996 53% Operating income Tzs Mil 413,330 497,251 515,522 567,899 493,100 5% Operating expenses Tzs Mil -225,467-273,703-299,669-344,147-353,286 12% Net earnings Tzs Mil 133,638 154,512 148,813 156,153 95,609-8% Source: Published Financials & TSL Analysis The bank s balance sheet has consistently increased as can been seen above, reaching total assets of TZS 5.5 Trillion in 2017. On a compounded level, the bank posted a 14% increase in its lending activities, 14% on its total asset base and 13% on its deposits to settle at TZS 2.8 Trillion, TZS 5.5 Trillion, and TZS 4.3 Trillion respectively in 2017. Top line interest income had a Compounded annual growth rate (CAGR) of 13% compared to a CAGR of 47% of interest expense. Provisions for impairment had a 53% CAGR to TZS 130 billion in 2017 while Net Earnings had a CAGR of -8%, in the five years since 2013 settling at TZS 96 billion. 5

Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 NMB S Price Trends NMB was first listed on the Dar es Salaam Stock Exchange (DSE) in 2008 at the price of TZS 600/= per share and was trading at TZS 2,750/= per share as of the end of September 2018, marking a 358% share value increase. The graph below shows the share price movement since January 2013 to September 2018. From the graph, it can be noted that NMB reached its highest point of TZS 4,780 per share in October 2014. It can also be noted that since September 2016, the closing price of NMB has remained at TZS 2,750 to date. Although NMB has been trading at lower levels, as per the new DSE rules, the per day volume traded has not been enough to cause the closing share price to fall further. 6000 NMB Share prices January 2013- September 2018 5000 4000 3000 2000 1000 0 Source: Dar es Salaam Stock Exchange and TSL estimates 6

Comparative Bank Analysis NMB CRDB CRITERION FY 2017 FY 2017 Interest income (Tzs mil) 585,512 560,344 Net Interest income 465,221 409,716 Operating income 471,556 467,969 Net Income (Tzs Mil) 95,609 36,212 Price per share 19/07/18 2,750 160 EPS 190.64 13.90 DPS 64 5 Issued Shares (Mil) 500 2,612 ROE 12% 5% P/E as of 31/12/17 14.43 11.51 P/B as of 31/12/17 1.73 0.57 ROE 12% 5% Dividend yield 2% 3% Cost to income ratio 58% 67% NPL ratio (%) 6.4% 12.6% Tier 1 Capital Ratio 16.9% 14.0% Total Capital Ratio 17.6% 17.0% Source: Published financials, DSE data & TSL analysis NMB s main competitor is CRDB Bank Plc. Both banks are listed on the Dar es Salaam Stock Exchange (DSE). While NMB has a strong retail client base, CRDB has a strong corporate client base. However, in recent years, NMB has been trying to increase its corporate client base while CRDB has been trying to increase its retail client base. In 2017, NMB maintained its position as the most profitable bank. Its Interest Income was TZS 586 billion which was only 4% higher than that achieved by CRDB, Yet NMB s Net Interest Income was 14% higher than CRDB s TZS 465 billion. As a result, NMB s Net Income was higher by a massive 164% from the TZS 36 billion achieved by CRDB. Although the DPS of NMB was 13 times higher than the TZS 5 paid by CRDB bank, NMB s dividend yield was lower. NMB had a dividend yield of 2% while CRDB had a dividend yield of 3%. At 58% and 6.4%, NMB s Cost to Income ratio and NPLs are lower than the 67% and 13% respectively achieved by CRDB Bank. More interesting is the 12% ROE of NMB, which is more than double the 5% ROE achieved by CRDB. The superior performance of NMB over CRDB is not restricted to the year 2017. Although NMB and CRDB Bank have roughly the same market share of around 20% each and together they control the banking industry in Tanzania, NMB has had stronger performance than CRDB since the former was listed. Below is a graphical comparison of NMB and CRDB profitability between 2008 and 2017. 7

Figures in TZS billions Net Income for CRDB Bank and NMB Bank 134 155 149 129 156 49 48 54 41 46 47 72 38 97 81 84 96 70 96 36 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 NMB Bank CRDB Bank Source: Published financials & TSL analysis From the above graph, we can note that NMB has consistently recorded higher profits than CRDB during the ten years period analyzed. Headwinds Revokement of licenses of 5 major banks in early 2018, and the placing of Bank M under statutory management has led to a run by depositors for safety to major banks. As a result, cost of funds for banks such as NMB is likely to decrease as they are viewed as big banks with stability. The strong retail base of NMB Bank Plc, as 67% of the bank s loan book in 2017 was composed of retail clients. These clients usually have a lower default rate than corporate clients and would have contributed to the historically low NPLs of NMB. NMB s diversification into new business segments has improved its risk profile and enabled it to gain market share in these segments. Its Agribusiness loan portfolio grew by 53% in 2017 to settle at TZS 96 billion. NMB has increasingly been adopting new technology in product design and delivery, thereby strengthening its competitive position in the market. In 2017 NMB was licensed by the Capital Markets & Securities Authority (CMSA) as a Custodian Bank, and presently setting up an investment advisory function that will also be CMSA-regulated. Re-alignment of the structure at NMB s head office and introduction of several key roles to support the strategy and technology drive means that the bank is well-positioned to implement its strategic plans. The wide branch network continues to make NMB the bank of choice for administration of civil service payments and hence a competitive position in deposits and retail loans. 8

Tailwinds Implementation of the Treasury Single Account in 2016 has led to an increase in the cost of funds due to a decline in the markets liquidity. The government s expenditure controls have made some businesses that were reliant on state procurements unable to meet their revenue projections, loan service obligations, borrowing capabilities and subsequent growth plans. Challenges in the business environment have led to a decline in the demand for banking services generally; and caused some borrowers to default on their repayment obligations. NMB has been trying to increase its Small and Medium Enterprises (SME) loan portfolio in recent years. Though this drive will lead to diversification of revenues, SMEs are known to be a major contributor to NPLs of banks and at the same time they have not been exempted from the challenging business environment affecting the economy. The effort might therefore lead to a further increase in NMB s NPL levels. The departure of one of the NMB top executives responsible for retail business and his joining CRDB as its new CEO portends intensified competition between the two leading banks. Valuation P/B Valuation Historical Average x 2.1 Comparable banks average x 1.2 Weighted average x 1.6 BV per share TZS 1,849 Per share Value TZS 3,005 Fair Value per share TZS 3,000 Current Price TZS 2,750 Upside % 9% Price to Book (P/B) Valuation This approach tries to arrive at the value of NMB stock based on a weighted average P/B value of NMB s historic average and the P/B multiple of comparable companies. P/B is a ratio of the stock price to its book value per share. As a measure of net asset value per share, book value per share is usually viewed as appropriate for valuing companies composed chiefly of liquid assets. We computed the historic NMB P/B value to be 2.1 times and that of comparable banks to be 1.2 times. The weighted average P/B value is 1.6 times which brings a per share value of TZS 3,005. The Fair value of NMB, when rounded up is therefore TZS 3,000 - an upside of 9%. Equity and Market Highlights Ticker NMB Recommendations BUY Current Price 2750 Fair Value 3000 Upside/ (Downside) 9% Book value per share 1593 Dividend yield 2% 1-Yr Forward P/B 1.6 1-Yr Forward P/E 9.5 Issued Shares (Mil) 500 ROE 2017 12% 5-year Average ROE 24% ROA 2017 2% 5-year Average ROA 3% Earnings per share 2017 (TZS) 191 9

Our View: Mid-term BUY We recommend a Mid-term BUY position on NMB. We believe the fundamentals of NMB bank are still strong, and since they are also backed by the government they are poised for continued profitability. Our valuation model comes up with a share price of TZS 3,000 which is a 9% upside from the current market price. Assumptions We have assumed the following: That the historical trend of price to book value can reasonably be used to project NMB s future price to book value. That gross loans and advances will grow at approximately the same rate as the growth of the economy. Since NMB is a major retail bank, it can still maintain relatively higher interest rates charged on these loans. The relatively large (TZS 130 billion) increase in loan impairment charges that was experienced in 2017 was a once off charge, and in future NMB will revert to its normalized loan impairment charges, hence an increase in the forecasted net profits after tax in 2018 as compared to 2017. NMB Bank will maintain its dividend payout ratio of approximately 34% in the future. Financial Projections CRITERION FY18E FY19E FY20E Number of shares Mil 500 500 500 Pre-tax profit Tzs Mil 225,751 222,463 217,044 Profit after Tax Tzs Mil 158,026 155,724 151,931 Dividend Tzs Mil 53,763 52,980 51,689 Market Capitalization Tzs Mil 1,502,378 1,816,205 1,960,679 Price per share Tzs 3005 3632 3921 Book value per share Tzs 1.6 1.8 1.7 Earnings per share Tzs 316 311 304 Dividends per share Tzs 108 106 103 Price Earnings Ratio x 9.5 11.7 12.9 Dividend Yield % 4% 3% 3% Dividend Payout % 34% 34% 34% Price to book value x 1.6 1.8 1.7 ROE % 18% 16% 14% Cost to income % 64% 66% 68% NPLs % 6% 6% 6% Source: TSL Estimates 10

Cautionary Note It should be noted that it is now about two years since the closing price of NMB changed. From September 2016 to the time of writing this report, the NMB share price has remained stagnant at TZS 2,750. This is largely attributed to the DSE s Rule requiring at least 0.01% of the listed shares to have traded during a trading day to effect a change in the closing price of the shares. We are aware that the Capital Markets and Securities Authority (CMSA) and the DSE have been receiving stakeholder concerns on how the Rule has negatively affected liquidity of some share prices listed on the stock market such as the NMB share. As a result of the situation mentioned above, we can confidently state that the current share price does not reflect the true market-determined value of NMB. A possible explanation could be that it has been mostly retail investors that have been active in trading NMB shares. Most of the purchases by these retail investors have been below the current price of TZS 2,750. It should also be noted that since a share cannot fall below 15% of the previous day s closing price, then this will imply that the minimum price at which NMB can currently trade is at TZS 2,340. If the authorities amend this Rule, we are likely to see a fall in the NMB share price, to reflect the level at which most of these retail investors are willing to trade. With enough liquidity of the shares, it is our view that such a fall in price will be temporary before market forces work to discover the right level. If on the other hand the Rule is not amended, it is likely the price will remain at TZS 2,750 for a longer period. Outlook The strong fundamentals of NMB still suggest that the stock should be trading at a higher level, at close to TZS 3,000 per share. However, recent developments in the banking sector have caused investors to be wary, and the fall in dividends of NMB in 2017 caused investors to want to exit. This may be a good time for long term investors to invest in the stock as we believe that its sound management and its 2020 Vision of transforming to a digital bank will reflect in good performance in the future. Analysts stock ratings are defined as follows: Buy: The stock is of good value, is currently underpriced and has strong fundamentals Hold: The stock is correctly valued with little upside or downside pricing Sell: The stock is currently overpriced; its total return is expected to underperform; it has weak fundamentals and challenging operating environment 11

Important Disclosures Tanzania Securities Ltd policy is to update research reports/notes as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Tanzania Securities Ltd s policy is only to publish research notes that are impartial, independent, clear, fair and not misleading. The Research Analyst identified in this research report certifies, with respect to the companies or securities analyzed that: 1) The views expressed in this report accurately reflect his personal views about all the subject companies and securities and 2) no part of his compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Note: This document does not constitute an offer, or solicitation of an offer, for the sale or purchase of any security. Whist every care has been taken in preparing this document, no representation, warranty or undertaking (expressed or implied) is given and no responsibility or liability is accepted by Tanzania Securities or any employee of Tanzania Securities as to the accuracy of the information contained and opinions expressed herein. 12