When Co-operative Bank of Kenya (COOP) announced last week that they were hiring global consulting firm, McKinsey & Company, for advice on improving operational efficiency, investors took notice. The stock has jumped 12.4% since the news appeared.
So why are investors so excited? How much scope does COOP — Kenya’s fifth-largest bank in terms of market capitalization — have to streamline its operations? And how might such restructuring impact the bottom line?
First, it’s important to note that COOP isn’t the only Kenyan bank to call in “The Firm.” Less than a month ago, Equity Bank (EQTY) also revealed that it had asked McKinsey to advise it on strategy. And, in 2011, KCB Bank Group (KCB) brought them in to assist with a restructuring that eventually slashed the bank’s management payroll by 42%.
Quite simply, McKinsey is very good at what it does, and its growing roster of blue chip clients in East Africa is testament to this.
To get a sense of what they might be able to do for COOP, let’s take a look at how well Kenyan banks presently manage the cost of doing business.
The chart below shows each Kenyan bank’s cost-to-income ratio over the first six months of 2014. We calculate the cost-to-income ratio by dividing total operating expenses by total operating income.
Kenya’s Most Efficient Listed Banks
[table id=198 /]
Judging from the data above, it would seem that McKinsey’s consultants have lots of fat to trim at COOP.
The bank keeps less than 42 shillings as pre-tax income for every 100 shillings it generates in the form of net interest income and fees. Meanwhile, the lean, mean banking machine that is I&M Holdings (IMH) keeps nearly 61 shillings for each 100 shillings of operating income.
If COOP could cut its cost-to-income ratio to 50% (a level that remains well above its most efficient peers), it would result in a 20.1% boost to pre-tax profit. That’s nothing to sneeze at.
But how realistic is it to expect such a reduction in expenses?
Salary Costs at Kenyan Banks
Well, for most banks, the biggest cost of doing business (apart from interest expense) is staff compensation. Thus, this is what McKinsey will likely try to slash first.
The table below compares the proportion of operating income that each Kenyan bank spends on staff salaries and compensation.
[table id=199 /]
As you can see, COOP’s wage bill isn’t nearly as bloated as that of National Bank of Kenya (NBK), but it’s not exactly svelte either. The leanest banks on the list reap more than five shillings of operating income for every one shilling they pay out in the form of salaries. COOP gets just four shillings.
Look for this gap to narrow over the next year or two. If McKinsey can help COOP bring staff costs down to 20% of operating income, downsizing alone could boost pre-tax earnings by nearly 12%.
This will doubtless mean hardship for some of Cooperative Bank of Kenya’s 4,177 employees, but it will also give the bank more flexibility to lower its lending rates, putting growth capital within reach of more Kenyan households and businesses.
What Do You Think?
Did it surprise you that Co-operative Bank of Kenya ranks as one of Kenya’s least efficient banks? COOP shares now trade at a price-to-book ratio of 2.7. Considering the potential impact of cost-cutting, does the stock look like a good buy to you at today’s prices? Let’s hear your thoughts in the comments.