Freddy Baz : Chief strategic advisor, Banque AUDI

In a broad ranging interview, Banque Audi

E In the latest Banque Audi report, you state that Lebanon was a “no growth environment in 2005,” but that it was able to “avoid a recessionary trap.” How were we able to do this and what if any role did the banks play?

What we wanted to highlight is that we are not in a bad situation but we are witnessing a coincidental stagnation after the high growth of 2004, in which we saw 6% real growth as reported by the IMF and the central bank among others. But after the dramatic events we witnessed in February, it was normal that the real sectors would take a hit in terms of overall confidence and its impact on aggregate demand for investment and consumption. So no surprises there, but paradoxically, while there was this stagnation, the financial sector witnessed a very interesting improvement. Sure, the impact of the assassination hit all areas of the financial sector: stocks, bonds currencies, especially currencies, when we saw great pressure on the lira, but after the demonstrations and the flag waving and the demands for Syrian withdrawal and the UN resolutions, most markets adjusted, showing a high appetite for Lebanese paper. Stocks and bonds have improved significantly and banks’ stocks have increased by 100%. Solidere shares hit $5 but bounced back to $13.5; spreads on Eurobonds decreased after some initial widenings, and the FX markets recovered by May, allowing the central bank to recoup one third of the dollars it used to defend the lira. So we are witnessing a disconnection between the real sector and the financial sector of the economy in which the investors and consumers are in a wait-and-see mode; which is normal. It would have been worrying if the financial sector had been equally stagnant. We are in a two-speed economy. There is a traditional time lag of 18 months in these scenarios. We can look forward to a better 2006, and definitely a better 2007, in terms of real growth and GDP.

E The share of T-bills and Lebanese sovereign debt in the portfolios of Lebanese banks remained high in 2005. Will Lebanese banks ever break out of their lending cycle to the government and embark on a fully-fledged retail and corporate banking culture?

You ask the question as if the banks only lend to the public sector and not the private sector. Let me tell you that the consolidated lending portfolio to the private sector is almost equal to the GDP. This is the highest exposure in the emerging markets. The South East Asian Banks in the late 1990s were never exposed like us. They were at 65% to 80% of GDP. We are at 100% of GDP in terms of consolidated private sector loans. We are not under-lending. This is a misconception. Because of our funding which is three times GDP we are obliged to use it for alternative uses, we just can’t lend it all to the private sector. That would make our private sector be lending three-times the GDP, which is unacceptable by any standards. For us to increase our private sector loan exposure the economy should grow. We believe the actual size of the economy, which is measured by GDP, is not a reflection of its potential size which we believe to be higher by a minimum of 40%. If we assume the actual GDP to be around $20 billion, the potential GDP would be close to $30 billion, probably $28 billion. If the environment is there to narrow the gap between actual and potential GDP, then, while our level of exposure will remain the same, that is “1 x GDP,” there will be room for an additional $8 billion of lending to the private sector.

E But surely we have a chicken and the egg scenario. What comes first, the funding or the growth?

I see your point, but in Lebanon auto financing ratios are very high, so we have to start seeing investors putting their own money first and then we will lend. Together we will trigger GDP growth rates. So it is up to the investors to show their own commitment by putting their own funds on the table and we will support them. However, I want to stress that Banque Audi has been active in its corporate lending in 2005.

E Are there any sectors with potential that you are watching with interest?

We are not a development bank. We are a private bank. We do not look at sectors of activity with a high leverage on growth, but we lend our money where we believe there is wealth, where risk is limited in the nature of the business and more importantly where there is a contribution of the company to the generation of wealth in Lebanon and the GDP. When we lend to the private sector, we lend to medium to big enterprises which in the case of Lebanon, the top 100 companies probably generate 75% of GDP. This lending is more secured than to smaller companies and while they should not be neglected, they will not get a higher share of lending than their contribution to the generation of wealth in the country.

E Banque Audi is still ranked No. 2 in terms of assets and deposits. Is the bank satisfied with its performance this year?

You say No. 2. Yes it is true in terms of absolute figures, but what does a differential of $200 million on a basis of $11 billion [of assets]? It’s not even 2% and this is the difference between the top two banks, which is how I like to refer to us.

E Well you are ranked first in other areas.

Of course, we are first in terms of lending to the private sector. We have to highlight it and show our commitment to the domestic economy. Our job is not just to collect deposits and buy securities. We are first in terms of footings. We are first in loans. We are first in Tier One capital and this is as important as total capital. Rating agencies base their calculations on Tier One capital.

E Then what are the areas you would want to address in 2006? What are the plans for revenue diversification and regional expansion? Which areas of banking appear most promising?

I believe we have the best revenue diversification, not only among our direct peers but in the whole industry and this did not happen overnight. It is the result of a huge restructuring launched in 1995, diversifying our business lines to diversify our assets and sources of income to improve our immunity against any reversal trends. We launched retail banking and private banking capital market activities. To do so, we triggered the consolidation process in the Lebanese banking sector. We closed five acquisitions. We improved our human capital. Today 52% of our staff are university graduates, 15% are MBAs and we have 15 PhDs. We launched the first GDR in the region, the first five-year private euro bonds in the region in 1995, and 1997; a ten-year subordinated note issue, a ten-year euro CD issue and four preferred share issues. In the last four years, we have witnessed an average growth rate in our assets and earnings of 30% per year. So our restructuring allowed us to consolidate our market positioning and to ensure a higher asset and profit growth rate than our direct peers. More importantly, if you look to the breakdown of our income, over different businesses we have a much better balanced breakdown today than any of our peers whereby non-interest income is 45% of total income. This is our immunity against reversal trends and it comes from private banking, bancassurance, and capital market activities. In the last four years, our trading floor has seen a turnover of $4.5 billion. We are the most important market maker on Lebanese stocks and bonds.

E Moving onto regional expansion, how were Banque Audi’s plans for a Syrian banking operation developing in the last quarter of 2005? What is the outlook for 2006, given the uncertain political situation in that country? And what are Banque Audi’s ambitions for the Egyptian market?

Firstly, I would like to give a brief preamble because our activities are not just restricted to those two markets. Our internal restructuring, which translated into high asset growth rates, led Banque Audi to a size today of $11 billion in terms of assets. This is $880 million in equity, $15 billion of footings and we represent 55% of Lebanon’s GDP and when you reach such an important size in the local market you have to go beyond boundaries because you have become too big for your country. We wanted to continue this growth by developing new markets rather than new business lines. First, we went into Jordan where we were granted a license for ten branches. Seven are operational and in 2006, they will all be operational. It doesn’t mean we can’t open more in future. What is of interest is that after 14 months in Jordan, we could build $300 million of assets, which is higher than the size of many operating banks in Jordan who have been there years longer than us, in some cases ten years. We had a good business plan that we will duplicate for all the other markets in which we want to expand.

E Including Syria?

In Syria we launched our operation in September [2004], but there was some delay because we were the first to apply … [and] we decided within the course of the application to double our capital and it took us back to the beginning of the process. We have four branches that are almost ready and we want to build a substantial network in Syria with 30 branches within a short period. It’s too early to give you figures but all I can say is that we are very optimistic. Now, given the [political] concern you expressed, we have not felt it on the ground. It is as if the business community is disconnected from politics. It does not mean that they are not part of the country but life does not stop. Sanctions we believe will not target the Syrians as a whole. We believe there is an immunity concerning business but any unforeseen dramatic developments will have a limited impact on the overall turnover and not diminish overall opportunities. Anyway, the stories of substantial Syrian withdrawals from Lebanese banks are not very accurate and we certainly did not witness this phenomenon at Banque Audi.

E Moving to Egypt, Banque Audi is understood to be one of six potential buyers for the Cairo and Far East Bank. The Egyptian central bank has given the go-ahead for Audi to conduct due diligence on this bank. What are Audi’s ambitions for the Egyptian market?

Before [answering] that I would like to add that three months ago we have been granted a fully-fledged license for Iraq, among the eight licenses that have been granted so far and we have a plan to open in Iraq in the north.

E How soon?

Definitely in 2006. Now in Egypt it is true that so far, we have not succeeded with an acquisition, but I would like to remind you that Audi put in a bid on the Egyptian American Bank in 2003, but it didn’t materialize because there was a new law that made medium-sized banks very expensive in Egypt and consequently they have not become very interesting for us. Today we are looking for platforms to grow organically in Egypt and Cairo and Far East Bank is one that we are looking at but there are three or four others too. We will try to close what is the best deal for Audi, not necessarily Cairo and Far East Bank but that is the bank that is in the news.

E Are there other areas Audi is looking at?

We are looking at certain North African countries as well as niche roles we can play in the Gulf markets, especially in corporate finance and private banking where [Lebanese bankers] have strengths. We have limitations and this is the only area where we can compete. To try to be competitive in retail or commercial banking [within the GCC] is impossible.

E How important is trust in the sector for international confidence in Lebanon as a receiver of financial aid especially with a donor conference looming?

It is an important asset but whenever the donors meet it has nothing to do with the private companies in this country. But as long as you have strong and well-established financial institutions, it will improve the overall perception of the country. A country with a solid financial sector has more of a reason to ask for assistance but it is not directly related; we are talking about public versus private. We have a banking sector that endured two decades of war and a time when we had two governments but one central bank – the central bank was never divided.

E How important is any national reform program to the banking sector?

Anything, which will improve the overall efficiency of the economy, is welcomed by the banking sector because at the end of the day we are organically linked to the economy. Reform – economic, financial, and political – by definition improves the overall efficiency of the economy. Privatization will improve efficiency. Look at how deteriorated the service [of cellphones] is nowadays. Such a weak level of quality although [the cellphone sector] is managed by two private companies. They are not motivated.

E With Basel II looming can we see an eventual consolidation of the banking sector?

Not at the level of big banks because we are over capitalized. But it will affect a certain number of middle sized or small banks but this is a positive trend because we need to further consolidate. As far as I am concerned, we have not yet really witnessed real consolidation in Lebanon although the number of banks has dropped by around 25 or thereabouts. Real consolidation is not lobsters eating shrimps; it is lobsters eating lobsters, more mega mergers between the big banks to be able to compete with big international banks in a post [peace] settlement era. I think within the top 10 banks there is a potential for three mega mergers.

E To be more robust regionally?

Of course! You have banks like NTB, Arab Bank or NBK from Kuwait with equity amounting to the consolidated equity of the Lebanese banking sector.