Profits ‘Я’ Us

Following years of low profitability Lebanese banks are making money again by expanding their reach abroad.

Joseph Kaï | Executive

The alpha bankers had a good year. Profits for 2014 showed surprising strength by growing 9.13 percent year on year to LBP 2.8 trillion ($1.9 billion) for the 14 banks with deposits of over $2 billion each. Individual profit champions were BLOM Bank, at $29 billion the sector’s number two by assets, with $365 million, and sector leader Bank Audi, whose profits amounted to $350 million on assets of $42 billion.

In terms of their shares in total alpha group profits, the two largest banks look like a tag team that is set apart from the other 12 alpha banks — just as they constitute a category of their own in terms of assets, deposits and lending power. According to sector monitor Bankdata, BLOM and Audi between the two booked a tad over 38 percent of profits in the alpha group, which on its part represents well over 80 percent of Lebanese banking activity. While the top two drew closer together in reported profits — in terms of their individual shares in group profits, the gap between them narrowed from 2.8 percent in 2013 to 0.8 percent in 2014 — the two, more noteworthily, have in common that their profit growth was mainly derived from units abroad. 

According to Freddie Baz, chief financial officer at Bank Audi, the banking group’s year on year increase in consolidated profits in 2014 amounted to 15 percent, but this was not because of the bank’s domestic profits performance, which Baz characterized as “more or less stagnant.”

“We have [a] 15 percent increase in earnings and 16 percent increase in [consolidated] assets and this is due to the good diversification that we have put in place, where Egypt and Turkey are contributing more and more to the assets and earnings growth,” Baz tells Executive. 

In cold, hard alpha group numbers, the growth rates of 2014 profits were 2.8 percent domestically in Lebanon versus a thundering 64 percent abroad, says Marwan Mikhael, chief economist at BLOMInvest. “While the increase in domestic net profits at alpha banks came [in] at about $33 million, from $1.53 billion to $1.56 billion, these banks realized a much larger increase at their foreign entities, from $192 million to $315 million.” 

Alpha banks expanded their contribution of foreign units to consolidated profits by six percentage points, from 11 percent in 2013 to 17 percent in 2014, according to Mikhael. As for BLOM group, he adds, “We realized about 22 percent of our total profit from foreign entities in 2014, compared to 17 percent in 2013.”

A third bank with a fast growing franchise in a foreign market, Bank of Beirut, tells Executive that its “foreign entities have greatly contributed to the increase in consolidated profits during 2014” to the point that “our revenue from ‘foreign related operations’ stands now at around 38 percent of the total sum.”

Domestic activity is still responsible for about 85 percent of all Lebanese banking profits

Profiting from the treasury

This encouraging picture also means that domestic activity is still responsible for about 85 percent of all Lebanese banking profits. Semaan Bassil, general manager of Byblos Bank, confirms that reality. He explains, “The major driver of profits [overall] in the banking industry, besides private sector lending which has been stagnant, is lending to the Lebanese government. If you look at the loan to asset ratio in our case, for example, the loans amount to a small portion of assets and the rest is placed either with the central bank, correspondent banks or the treasury. It is the treasury portfolio and the deposits with the central bank that are the major sources of income for the banking sector, whether for Byblos or for other banks. This is very clear and transparent.”

The chair of Lebanon’s most recent riser into alpha group ranks, Creditbank’s Tarek Khalife, concurs that the sphere of T-bills, certificates of deposit and eurobonds remains the main engine of banking profits. “The economy is not moving up and I can’t believe that banks can grow their profit lines when the economy is not budging; any new profit is going to be either irregular or based on some sort of subsidized exercise such as T-bills.” 

According to him, profits moreover can be a different consideration and priority for a big bank that is comparatively sated and mainly wants to satisfy shareholder interest, versus a bank that is hungrier for growth under a domestic expansion strategy. “You have to take into account [whether] you are a bank that is moving and acquiring market share faster than others around you. For us at Creditbank, there was no significant change in profitability [in 2014], but because of the bank’s growth momentum we don’t look at profitability alone,” Khalife tells Executive. 

Overall, the rise in collective net profits at the top of the banking sector in 2014 was a very positive surprise for a sector that has been exposed for three years running to a national economy advancing below its needs, to security concerns in the immediate region, to various political and economic disruptions in other countries with cross border presence and, to a lesser extent, a global economic environment where the International Monetary Fund characterized growth in various World Economic Outlooks with descriptors ranging from “sluggish” and “low gear” to “uneven” and beset with “downside risks” and “imbalances”. 

This positive picture is reinforced by comparing profit developments in 2014 with those from 2013. Total alpha group profits in 2013 were clocked at $1.72 billion, and had been flat from the previous year. According to Bankdata’s annual publication Bilanbanques, year on year growth of profits for the alpha group in 2013 was 0.1 percent and growth for the entire sector was 0.5 percent. This uninspiring performance was part of a series of uneven results that had seen profits swing from strong double digit growth experiences between 2008 and 2010 to a 4.7 percent contraction in 2011 and smallish growth in the next two years. 

“The alpha group’s 9.1 percent surge in profits in 2014 … appears to have been fueled by a variety of strategies and factors”

Roads to profits differ…

The alpha group’s 9.1 percent surge in profits in 2014, however, represented no uniform upward movement but rather appears to have been fueled by a variety of strategies and factors. 

In terms of the main revenue streams, net interest income on the one hand and fee and commission income on the other, Bank Audi recorded gains on both with $142 million in additional interest income in 2014, according to Baz. These originated mainly from the operations in Lebanon, Turkey and Egypt, as well as $110 million in additional fees and commissions generated also mainly in these three countries, plus in the private banking unit. 

Baz explains, “Most of those fees and commissions are recurrent revenues generated by core businesses, as witnessed by 21 percent growth in fees and commissions related to commercial and corporate banking, a 34 percent increase in fees and commissions related to private banking, and a 23 percent fees and commissions increase related to retail and personal banking. We are seeing important growth in fees and commissions relating to core businesses because of the startup profile of Odeabank, our unit in Turkey, and because of the growth strategy in Egypt. You cannot achieve those growth levels in Lebanon as a mature market.” 

Bank Audi Group is working in parallel efforts on increased generation of fee based income, on improving operating conditions, spreads and cutting costs in relative terms. “In absolute terms, our cost base in Lebanon in 2015 shows a slight decrease with respect to 2014. Some inefficient expenses have been replaced by more productive expenses. We think in marginal terms, meaning we expect a return for each dollar of additional expense. This return should be higher than the outstanding cost to income ratio,” Baz elaborates.

Fees and commissions income at Byblos Bank fell in relative terms because of profit growth concentration on sovereign issues, highlights Bassil. “Although [the bank’s income from fees and commissions] has gone down slightly in absolute terms, in relative terms, it has gone much lower because if you do well in Lebanese treasury transaction activities, the percentage [contribution of fee based income] goes down,” he says. 

At Bank of Beirut, whose profit growth of 21 percent to $176 million in 2014 was one of the strongest in the alpha group, chair Salim Sfeir points to what he describes as “quality growth across all main financial indicators” as the backbone of the bank’s achievement. “The main driver of the outstanding growth was the increase in operating income of around $55 million, coupled with efficient cost control and low credit risk cost,” he specifies, and adds that Bank of Beirut’s higher asset quality and income stream diversification was greatly helped by the group’s choice of expanding into investment grade countries, such as Australia. 

For the BLOM and Audi groups, the diversification in growth markets abroad is where they see most potential

…And so do the maps aiming for further profit growth

For the BLOM and Audi groups, the diversification in growth markets abroad is where they see most potential in 2015. “I think our growth of profits outside of Lebanon is sustainable because the countries where we are realizing these double digit profit increases are under banked. Egypt for example is an under banked country,” says BLOM’s Mikhael. 

He assesses profit growth prospects in Lebanon as more subdued, primarily because of the economy. “If there is an upswing in the economy, then there will be an improvement. [However,] we are looking at different regional markets where we can grow, because in the end the Lebanese market is small and over banked, first, and second, the domestic situation is not always conducive to growth,” Mikhael explains.

Audi will seek to push further advantages in the Lebanese lending market by exploiting its differential of holding the banking sector’s largest foreign currency deposit base and also wants to continue conquering market shares in Turkey and Egypt. In Egypt, Baz says, “We have been able to slightly outperform the industry. This has allowed us to increase our market share, supporting our new three year business plan that aims at doubling the size of [Bank Audi Egypt] organically in terms of assets and earnings, add new products and services, and expand the network by some 18 branches.” 

Creditbank, which has been pursuing the domestic lending road with vigor, and consistently has the highest loans to deposits ratio (2014: 57 percent) in the alpha group, will continue with this strategy. “It is a deliberate policy that we are more productive than other banks. We are concentrated on the private sector and we believe this will serve us well when [interest] rates go up, because your relationships and assets are linked to Libor,” Khalife says. The bank has an additional growth prospect on the backburner, which is its unit in Armenia. This subsidiary has been fully imbued with the bank’s culture and is being developed as Creditbank’s stepping stone into the markets of the Caucasus region, which according to Khalife is “very rich and underserved with banking.”

According to Bank of Beirut’s Sfeir, the bank will focus on expanding its business on the virtues of a conservative risk management approach and high level of capitalization. “The conservation of liquidity via a diversified and stable funding base has been the bank’s sound policy. Net non performing loans over total assets registered 0.22 percent, earning us the top spot in loan quality ratios among peers,” he says. In further pursuit of diversification, the bank is aiming for the medium term to increase its share of revenue from foreign operations to 50 percent and in the short term has identified opportunities in Africa which it intends to explore. 

BankMed, the fifth strongest player in the Lebanese banking scene, has growth plans that range from expanding its lending in the retail, SME and microfinance fields in Lebanon to growing into more markets abroad, possibly in Egypt. 

Byblos Bank also has set its sights on diversified growth abroad and in Lebanon. In thinking far across borders, the bank has scrutinized a number of opportunities during recent years, even though no optimal opportunity has popped up for a while. “We are already present in very difficult and remote markets,” says Byblos’ Bassil. “We are equipped for [new opportunities] and even if we have not acquired any business assets or banks since 2010, this doesn’t mean that we have not looked at different opportunities. We did study several cases, but if you are not convinced of the risk, you do not go.”

“We are therefore preparing ourselves to be leaner and much more customer services oriented and efficient when the economy picks up”

In the domestic market, the bank aims at lending. “This helps the bank make a profit, build provisions, increase its capital, and invest in training and process improvement. This is important to us, and Byblos is going after real lending to SMEs and consumers,” Bassil says, adding that this aspiration for increased lending to SMEs and consumers is impeded by the current economic environment in Lebanon and the region. “We are therefore preparing ourselves to be leaner and much more customer services oriented and efficient when the economy picks up,” he concludes.

Looking beyond profits

Irrespective of the varied strategies for diversification and growth that several alpha group banks shared with Executive, these top lenders — and presumably the entire ranks of the Lebanese banking industry — face a hefty number of challenges and risks, jointly as well as individually. 

Adverse developments in local interest rate spreads vis-à-vis Libor and negative carry, the cost of having to fund lending at higher interest rates than the banks could generate from the activity, have weighed on profitability for several years. According to Audi’s Baz, spreads have moved against Lebanese banks to the tune of rising from twice the reference rate to much higher multiples, i.e. banks that used to offer 5.5 or 6 percent or twice the interest of what depositors could get at a US bank, now pay 3 percent while benchmarks are 30 to 35 basis points. “I do not consider it wise and healthy for banks to pay close to 10 times the benchmark. This development was correlated with drops in reference rates after 2008 and the negative carry for Lebanese banks has been amounting to hundreds of millions of dollars every year,” he says.

In Byblos Bank’s experience, the pressure has been mounting as the Lebanese government lowered borrowing costs. “Today, if you are paying 6 percent on the Lebanese pound and receive 5 percent on T-bills, you have a problem. It is normal that the client who is borrowing in Lebanese pounds wants to pay a lower interest rate, and the deposit client wants a higher rate. The bank cannot satisfy both and has to do something. Lowering the cost of operations [as we are doing] is not enough. Most of our income is still being made from treasury bills and bonds — and thus banks are pressured to reduce the cost of deposits to make up for the drop in lending to the government,” Bassil explains.

Having an extensive rural retail network, which when compared with dollar deposits rates in the sector has generated a comparatively high inflow of Lebanese pound deposits to Byblos Bank, has motivated the bank to try and draw in more dollar clients even at the cost of eventually losing some Lebanese pound clients, Bassil says, but concedes that this is a challenge. “This is not easy in the very competitive environment we are in, because to attract dollar deposits from other banks is very difficult.” 

Being able to lend out more funds in the — higher interest generating — Lebanese pound loans provides a partial release from the pressure and has been aided by the central bank’s economic stimulus packages of 2013 and 2014, says Nassib Ghobril, Byblos Bank’s chief economist. “But this notwithstanding, large LBP deposits are still sitting in the banks and remain unused,” he notes.

Offering lower interest rates on deposits is another remedy and has been recommended earlier this year by the Association of Banks in Lebanon. In Baz’s view, that would be a prudent recommendation for banks to implement. “I am not saying that we have to kill the depositors, but there is definitely room to reduce the USD interest [paid on deposits] by a minimum of 50 basis points,” he argues. “If depositors want high interest, they can convert to local currency. I understand that there is some risk of volatility and this explains why the interest rate on local currency represents two times the interest rate on the US dollar. [But the] interest rate on local currency is today at 6 percent, so there is room to decrease by one percentage point. If it is 2.5 percent on deposits in US dollars and 5 percent on local currency, that would be a reasonable representation of volatility risk.”

BLOM’s Mikhael says that banks would like to lower deposit rates but find this difficult because of the intense competition they operate under in the currently sluggish economy. Any attempts to lower interest rates on deposits will also be made harder by the anticipated hike in interest rates by the Federal Reserve in the United States. “It will be difficult to lower deposit rates when the US rates are increasing, especially given the dollar peg of the Lebanese pound. But I also don’t expect Lebanese banks to increase deposit rates when the US will hike interest rates,” he says. 

According to Ghobril no big developments with positive impacts on Lebanese banks are currently on the horizon. “What is to be noticed is that dollar deposit rates have not declined, and I don’t see that happening as interest rates on the US dollar are expected to rise in the third quarter. Beyond that, the increasing borrowing needs of our government are dictating interest rates. As long as there is a wide fiscal deficit, the government will continue to have high borrowing needs and will continue to rely on banks to finance the deficit; therefore interest rates will continue to be high.”

A concern that was high on the agenda of banks in 2014, the issue of double taxation of bank incomes, is currently not as high on the scare lists of most bankers, apparently because of the stagnation of all things political. However, the stagnation of politics is itself the headache. With a broad consensus, bankers tell Executive that they do not expect a quick solution to the presidential paralysis and are even less trusting in the outlook for substantial political reforms which would be needed for giving the economy a true confidence boost.

“As things stand, we have stability without resilience and borrowing without reforms”

While politics and the economy remain in the doldrums, the outlook for the sustainability of banking profits is unclear. As Ghobril says, even the profit gains of 2014 did not translate into improvements in the returns on average assets and average equity. “You cannot look at the dollar figures and profits alone. You have to look at the ratios, at the return on average assets and at the return on average equity. These have stagnated and the return on assets is less than 1 percent for the first time in I don’t know how many years, at 0.97 percent for the sector and the return on equity in 2014 was also slightly lower than in 2013,” he says.

In angling for profits in 2015, banks according to Ghobril can rely on the government needs, given that the Ministry of Finance did not only issue $2.2 billion worth of eurobonds already, but aims to issue another $2 billion. The dilemma is, of course, that this form of the state’s money hunger is a negative indicator for ratings agencies and not a positive signal at all except for the comfort of knowing that the system is stable and the government can obtain that much money at very favorable interest rates, Ghobril says. “If they were implementing reforms, they would not need to borrow so much. As things stand, we have stability without resilience and borrowing without reforms.”

Thomas Schellen

Thomas Schellen is Executive's editor-at-large. He has been reporting on Middle Eastern business and economy for over 20 years.

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