A retrospective

Accounting for blessings

Photo by: Greg Demarque/Executive
Reading Time: 8 minutes

It is understandable that Freddie Baz, the chief strategist of Lebanon’s largest bank, Bank Audi, presented a divergent view from the central bank’s narrative explaining the latter’s financial engineering (see story and infographic). Whereas the analysis picture drawn by Banque du Liban (BDL) focused on the very positive impacts of this quantitative easing measure, Baz emphasizes that there was no crisis that could explain the size of the operation. (He suspects mundane pragmatism to be involved in the operation and to account for the large size to which it has grown.) “It is very opportunistic. If I have to be candid, no central bank will miss the opportunity to beef up foreign reserves when they are available. Because once it needs the reserves, it might not find them,” he says, reasoning that the boosting of reserves is in line with a central bank’s raison d’être.

Although noting that no one is privy to what the strategies of Lebanon’s central bank governor are, Baz speculates, “he [might have] said, ‘as long as there is appetite, let’s do a little bit more [of the reserves-boosting transactions] and since I don’t have any more Eurobonds, [commercial banks] will get certificates of deposits (CD) from the central bank’.”

This perspective appears very logical when seen against the performance of the largest banking group in Lebanon. Bank Audi’s results in 2016 were impressive even before the (not yet audited) income from the bank’s participation in the financial engineering was recognized in the third quarter financial report.

For a view on the bank, it is instructive to revisit what the equity research team of FFA Private Bank wrote about Bank Audi’s half-year results. “Bank Audi posted net profits at USD 115 million (+5 percent QoQ, +13 percent YoY) with diluted EPS at USD 0.27 (+12 percent QoQ, +16 percent YoY), both above our respective $111 million and $0.25 FFA estimates,” the bank observed. The analysts further said that the bank’s results exceeded their expectations in terms of total operating income, and also by “significantly higher” trading & investment income, and, to a lesser extent, in terms of net interest income. Net fees & commissions income, on the other hand, were below FFA mid-year estimates by about 10 percent.

Three months later, FFA acknowledged that Audi’s net profits and operating income still were higher than the analysts’ expectations by a significant margin. FFA also noted a leap in “exceptional fees and commission income,” which stood at $689.9 million and thus greatly exceeded the FFA estimate of $69.3 million, which according to FFA was “resulting from BDL debt swap transactions.”

Making the most

According to Bank Audi’s publicly disclosed numbers, total assets at the end of September 2016 stood at $45.3 billion, up from $42.3 billion at the end of last year. Net-interest income improved 11.4 percent year-on-year to $739.1 million; non-interest income was reported at slightly over $1 billion, which compares to $335.1 million during the first nine months of 2015 (a 201 percent jump); 9 million profits after tax were $541.5 million, versus $280.5 million in the same period of last year; the net profits were $350.3 million, up 15.2 percent year on year – but that must be taken with the knowledge that the bank wrote off $191.2 million in regard to its operations in Syria and Sudan from its after-tax profit. At a 15 percent rate of increase, if this rate or even a few percentage points less in profit growth were to be achieved by year-end, Bank Audi’s net earnings for 2016 currently look like they are going to be the highest in the past five years (2012 was hitherto the year with the highest net, at $384 million) and thus set a new record.

As far as the impacts of the financial engineering in the income statement, the bank identified $642.9 million of its non-interest income as having been generated by BDL exchange transactions and $86.8 million in exceptional tax expenses from the same operation. Overall income tax expenses jumped 111 percent to $164.6 million. In the field of operating expenses, the bank reported a 50 percent increase to $814.7 million, of which it attributed $217.9 million to “exceptional expenses related to good-will expenses and one-offs.”

Whether in presentations of its own main indicators (assets, loans, deposits, earnings and earnings per common share), of other ratios per share, or in comparison of stock market ratios with averages for MENA, emerging markets and the world, Bank Audi looks healthy, solvent and attractive. In Baz’s words, “We have been showing the same magnitude of increases in terms of results. We had increases by two digits in our profits in Q1 and H1 with respect to the corresponding period of last year. I believe that the full year results will be along the same lines of improvement.”

He emphasized that financial engineering was “by definition” forbidden – by way of a central bank circular – to affect the bank’s bottom line. Nonetheless, it seems unmistakable that Lebanon’s largest bank made great use of the central bank’s financial engineering offer, which Baz acknowledges by comparing the banking sector to a family with children of different levels of intelligence, of which Bank Audi was “among the wisest kids.”

Christmas bells may be ringing at Bank Audi in light of these performance results, even if they are not going to be distributed as dividends. What will not be ringing, however, would be alarm bells either at Bank Audi or the other top banks in Lebanon. Both other listed banks covered by FFA, BLOM and Byblos, achieved higher than expected profits according to the Q2 and Q3 reports. In the case of Byblos, the bottom line was helped by a reversal in provisions and in case of BLOM, profit improvements were mainly linked to “higher-than-expected trading and investment income,” which in turn was based on capital gains from BDL debt swap transactions, FFA said.

Affected by the economy’s pains

However, this does not mean that the banking sector was decoupled from the sluggishness seen all over the economy. Whereas financial performance of leading banks in 2016 to date “maintained its good standards,” according to the sector review by Dany Baz (see comment), it was also noted that assets and deposits by the end of June had registered only slow growth (in the low single digits), even as the third quarter saw an acceleration in domestic activity.

This side of the year’s banking picture – that is dominated by subdued performance outside of the exceptional financial engineering environment – is confirmed by Walid Raphael, chairman and general manager of Banque Libano-Française (BLF), which uniformly ranked eighth in the sector by indicators such as assets, deposits, loans and profits, as well as by Tarek Khalife, chairman of Creditbank, ranked 14th in the sector by assets and deposits, but 10th in terms of loans.

[pullquote]With a view to the wellbeing of the Lebanese economy…bankers have their eyes focused on positive elements and potential[/pullquote]

As Raphael tells Executive, 2016 was in line with BLF’s budget and results were in line with the previous year, or slightly better. “It has been a very challenging year in terms of business because of the slowdown of the economy in general and because of the situation across the region, but also worldwide,” he explains. This difficult environment is something that Raphael moreover expects to carry on for another one or two years, even as he credits the central bank’s financial engineering to have been done in a very clever way and to have created a very strong position for BDL.

The results of 2016 are not yet on the books, but it was a difficult year for all banks in Lebanon. Banking had a slowdown and this affected most financials. Growth in lending portfolios stagnated and this growth is the real indicator of health,” says Khalife, adding that results of the banking sector are only looking better this year because “makeup was slapped on.”

He reasons that banks are not achieving a high rate of return, considering the risk that they have to carry, when compared with other sectors such as the real estate sector. Khalife also says that non-recurrent incomes like those originating from the central bank’s financial engineering are very helpful as a short-term boost, but one should analyze the health of the banking sector without taking non-recurrent incomes into account. “I don’t see a disaster on the horizon in 2017, but we cannot count on non-recurrent events such as financial engineering to boost our results. I hope people in banking won’t depend on it,” he cautions.

Evidently neither the sector’s overall subdued growth nor the exceptional outcomes produced by financial engineering provide the full picture of the sector in 2016, which saw some banks withdraw from the market, while others claimed to have achieved a turning point towards improving their position. One such lender was Banque Misr Liban (BML), whose executive general manager, Fadi Daoud, tells Executive that they have reached exactly this state. “We performed very well with the swaps, [in which] we did well compared to our peer group. In our regular business, we also did well. We will close the year with 25 to 30 percent more profit than last year,” he enthuses.

Daoud acknowledges that BML is still in the second tier, or beta group, in terms of the bank’s size by deposits, but says it has embarked on a steady path of growth with developments of new products, upgrades to its information technology – already having inaugurated a new core banking system in 2016 – and its human capital (including creation of a new communications department and corporate social responsibility program), plus plans to regularly roll out new branches. “We are opening two new branches in 2016. We are continuing our growth by opening two branches per year, so we will be 20 this year and 22 next year,” he says.

Political consensus as hope factor

With a view to the wellbeing of the Lebanese economy, or rather the chance for its improvement in the next year and further into the decade, bankers have their eyes focused on positive elements and potential.

“Political normalization is essential. We always say in Lebanon that we can live with a political vacuum but it is much better without [one]. The fact that the presidential election happened, and now political life is being restored, with the functioning of constitutional bodies, this is definitely a positive development,” Baz exclaims and adds that he does not believe the country’s political, social, and economic environment to be suited for the political gamesmanship of earlier times. “I don’t believe that the environment is supportive for continuing the same political games of the old days. There is something new that happened in the fact that [different political forces and leaders] were all together agreeing on something,” he opines.

“I see two signs that are very important: one is the renewal of the mandate of the central bank governor, which will provide stability, and [secondly] a budget. We expect that we finally will have a budget, and this will definitely help the investors and all players to be more confident. We have been without a [state] budget for over 10 years now and I think this will be the first move to show that there is really awareness and a commitment for change,” declares Raphael.

He adds that banks, in his opinion, will be ready to contribute to solve Lebanon’s economic problems. “We know very well what the problems of our economy are and we also know what the solutions to our problems are. Also, if there is the political will, we have the means to solve the problems and find the right financing,” he adds.

Khalife concurs that all banks are hoping for a positive turn in the Lebanese economy. If there are even just signs of a turnaround, he believes the banking sector will be heartened and gain new courage as it is able to sustain another one or two years until an actual improvement materializes in government finances, due to revenue outlooks from the oil & gas sector and from achievement of structural reforms that will help lowering corruption and improving fiscal incomes.

According to Khalife, banks are lending to the Lebanese state at prevailing rates simply because they have no other choice. Since there is no bank that would refuse deposits, they have to give to the state what they cannot lend. The state’s need for finance in his analysis is a consequence of many factors that are not brought on by the banking sector. “I don’t see why Lebanon has a constant deficit. The Lebanese model is a productive model and there will be a better tomorrow if corruption is cleared out,” he says.

Optimism by bankers about the political turnaround and reconstruction in the country is no wonder, of course. In some sense, the country at the brink of 2017 exudes a profound tiredness with political stalemates and brinkmanship of power cliques and entrenched groups that may have aimed for zero-sum outcomes in their favor (scenarios where they come out as winners of power), but only produced no-win situations for the nation and economy. A continuation of the status quo of 2015 and 2016 is not what any sentient stakeholder in the Lebanese economy wants.

Thomas Schellen

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