Lending boom
Few heads were turned by the first quarter results of Lebanon’s banks. As expected, rankings and market shares were maintained, deposits continued to grow 2.5 percent for the quarter, and customers continued to convert their foreign currency into Lebanese lira in order to take advantage of the 325 basis point spread in favor of local currency.
“There are no surprises,” said Salim Sfeir, chairman and general manager of Bank of Beirut. “Each of the banks is maintaining its market share. It is very difficult to penetrate other banks’ share or boundaries.”
Yes indeed, all is quiet on the Lebanese banking front. Perhaps a little too quiet.
After the record deposits of 2009, Lebanese banks are dishing out credit like ice cream on a hot summer day.
Banks issued $2.3 billion in additional loans to the private sector in the first quarter of 2010, according to Marwan Barakat, head of economic research at Bank Audi, who called the growth “unprecedented.”
According to data from Banque du Liban (BDL), Lebanon’s central bank, as of February 2010 retail lending constituted 22.3 percent of total lending in the financial sector. Lending to consumers has been on an upward trajectory since February of 2009, when retail lending constituted 18.7 percent of total lending.
Loan to deposit ratios have also ticked up in the last year, with the alpha bank average rising from 28.84 percent at the end of 2009 to 30.6 percent in the first quarter of 2010. These figures are still quite low by any standards, with many UAE banks’ ratios straining to drop below 100 percent from a sector-wide average of 122.8 percent at the beginning of 2009, according to Credit Suisse.
Still, if Lebanon’s banking sector is to tout its resilience throughout the financial crisis as it does, it should not compare its solvency ratios to a market clearly working from a different playbook.
These increases are due to falling interest rates, especially in local currency, which made up 77 percent of first quarter loan growth, according to Bank Audi.
Lending rates in Lebanese lira have been falling steadily since January of 2009, with the average rate decreasing by 138 basis points since that time, falling from 10.07 percent at the beginning of 2009 to 8.69 percent in March 2010.
On top of the declining rates, the central bank circulars of last summer — which lifted reserve requirements on certain loan categories — sent some LL loans down to rates of around 5 percent, making them much more appetizing for borrowers.
Players in the banking sector are pleased with the lending growth, as they should be. Consumer lending is good for the economy at large, enabling consumption and spending. Those players further state that Lebanese banks have the skills to mitigate the risk associated with strong retail lending.
“Its manageable. I believe the central bank has regulated this industry, following and controlling the expansion, and I think that the banks have strong risk management,” said Walid Raphael, general manger at Banque Libano-Francaise. “What we have seen is absolutely healthy.”
But if banks are moving into a new era of robust retail lending, the safeguards in place will need to be revisited to ensure that the accompanying risk is mitigated.
“Banks do have to be careful, of course, because there is a lot of liquidity in the market, and you don’t have a lot of investment opportunities. Then there is the high cost of maintaining strong liquidity,” said Alain Tohme, deputy general manager at Byblos Bank. “There is probably sometimes a tendency, when you have a lot of liquidity, to over-lend. But so far it has not happened. The loan to deposit ratios in the sector are still very healthy.”
However, one sector receiving significantly more loans than the rest could well be cause for concern. And according to central bank data, that sector may be real estate.
“We should be worried about any kind of concentration,” said George Abou Jaoude, chairman and general manger of Lebanese Canadian Bank. “The problem is that the medial activity in Lebanon is real estate.”
Real estate is Lebanon’s bread and butter. Sfeir said that the real estate industry is to Lebanon what the stock market is to the United States; everyone has their hands in it in some way. In fact, according to the central bank, the combination of lending to construction, real estate renting and mortgages represented 37 percent of financial institutions’ lending as of February 2010.
“Its not a question of aggression,” said Sfeir, “It’s a question of whether the market is becoming real estate oriented. The banks are serving a demand more than creating a demand.”
But whether abundant credit is creating or reacting to demand, growth in real estate-related financing must be monitored closely after it crashed and burned financial institutions in other global markets.
“I don’t want to be the bad guy, but of course we have to encourage many other activities,” said Abou Jaoude. “But this is not the job of the banks. It is the job of the government to give incentives and to help other activities like small industry and a little bit of agriculture and software production.”
Still, bankers say that the market is yet to show all the hallmarks of a real estate bubble.“We don’t have real estate trading in apartments, so all of the apartments sold are to be lived in,” said Abou Jaoude. “There cannot be a bubble unless we have a lot of apartments unsold or sold to traders.”
High levels of leverage in the real estate sector are, of course, the biggest indicator of potential fallout; an issue which bankers insist is not a concern, despite the central bank’s lending figures.
Banks are restricted in their lending to developers, with the maximum credit issued to a development project capped at 60 percent by the central bank. However, there are no caps on the loan-to-value ratio when it comes to mortgages, though bankers say that full credit is a rarity.
“It is true that over the last year the ratio [of real estate loans to total lending] has increased compared to before, but I think it is manageable,” said Byblos Bank’s Tohme.
And with prices rising as they have been, the value of mortgages is growing too. Abou Jaoude said that today’s land prices are the “highest that Lebanon has ever seen.”
“In some areas here, the prices are as much as in Manhattan,” said Tohme, though he doesn’t think prices will increase further.
Industry players seem unanimous in their belief that the market will soon correct itself and that prices will not continue to rise.
“I think we should have reached the top in terms of prices. I don’t see them continuing to increase,” said Raphael. But if this correction doesn’t materialize, Lebanese banks need to prepare for both the spoils and perils of a new era of lending.
After the record deposits of 2009, Lebanese banks are dishing out credit like ice cream on a hot summer day
A snapshot of 2010’s first quarter
— Walid Raphael
Government paper
Call it a love affair, called a symbiotic relationship, call it Stockholm syndrome: whatever you call it, Lebanese banks are irrefutably tethered to the finances of the country’s debt-laden government.
Bankers are never shy to say that they support Lebanon; that in effect the banks are Lebanon. But they make a point of carefully tiptoeing around their real sentiments toward the sovereign entanglement in which they find themselves.
Lebanese banks held $29.5 billion in claims on the public sector as of March 2010, with $18.3 billion of this in treasury bills from the Ministry of Finance.
It is no secret that the banks need government paper as a way of soaking up their excess liquidity, a motivation made even stronger in the recent years by record deposit conversions and a dollarization on the funding side of the balance sheet that decreased from 69.6 percent in March 2008 to 63.3 percent in March 2010, the lowest in 10 years.
Bank Audi estimated that for the first quarter of 2010, foreign currency to Lebanese lira conversions totaled $3 billion. At the same time, overall deposits increased by $2.4 billion or 2.5 percent in the first quarter of 2010, growing from $95.8 billion to $98.1 billion: nearly three times the country’s gross domestic product.
Without the local currency lending demand, bankers say that they have no better option but to put these funds to work in the form of treasury bills.
“What are the options that we have? We are giving loans but not everybody wants to take loans in Lebanese pounds,” said Saad Azhari, chairman and general manager of BLOM Bank.
The thirst of Lebanese banks for treasury bills was never more evident than earlier this year when they suddenly became unavailable. In March 2010, Finance Minister Raya Hassan decided to temporarily suspend T-bill auctions, as she noted that her ministry’s account at the central bank was sufficiently funded.
“It’s good to have reserve, obviously, and the approach I am adopting is to have in my treasury account, three months worth of future maturities, whether in Eurobonds or T-bills,” Hassan said to Executive in March.
The decision caused outrage from the banks, leading one banker to express their “anger and confusion.” According to Hassan, part of this reaction was due to an erroneous statement from central bank Governor Riad Salameh, stating that auctions would be suspended indefinitely. Salameh then began to issue short-term certificates of deposit, but this did not quell the banks’ ire. The banks’ addiction to government paper was clear.
Meanwhile, the credit ratings of Lebanese banks are effectively capped and can only rise with the sovereign ratings due to their massive exposure to the public sector. Bank Audi, BLOM Bank, Byblos Bank and Bank of Beirut all received ratings upgrades from Moody’s Investor Service in April, in conjunction with a sovereign upgrade. All four banks saw their long-term foreign currency deposit ratings increase from B2 to B1, still defined as “speculative,” “subject to high credit risk” and not investment grade, according to Moody’s.
But many bankers dismiss the ratings agencies’ low opinion of Lebanese banks.
“This is a consequence and not a force. This penalty has no [effect] on our market,” said Salim Sfeir, chairman and general manager of Bank of Beirut.
Some go further, rejecting not only the weight of such ratings, but also their valuation of Lebanon’s sovereign risk.
Lebanese banks continue to invest in their own sovereign, as opposed to participating in sovereign bond issues abroad. According to the Ministry of Finance, the government paid out $4 billion in interest on the public debt in 2009 and, according to the finance ministry’s proposed budget for 2010, that figure will increase to $4.34 by the end of this year.
With the banks holding approximately 57 percent of the public debt, the earning potential is clear.
“We don’t look at those asset classes as being bad. We don’t share rating agencies’ views,” said Freddie Baz, chief financial officer at Bank Audi. “We don’t look at the sovereign risk as being a real risk. We don’t have any concern about the final outcome. The risk-reward is very enticing and we are getting nice returns on these securities.”
But treasury bill yields have been decreasing since the summer of 2006 and could soon lose their status as the gainful placement for lira liquidity.
The average yield on the 5-year paper dropped 36 basis points from 7.74 percent at end-2009 to 7.38 percent at end-February. And with rampant international expansion dominating the strategy of Lebanon’s banks, it may soon be time to reconsider the agencies’ proclamations as credit ratings may become more prized.
take loans in Lebanese pounds”
—Saad Azhari
Expansion and consolidation
Put on the back burner by political instability, Lebanese banks’ international expansion plans are now back in full force. But for most banks, ‘manifest destiny’ banking is more of a necessity than a mark of ambition, begging the question: would the sector benefit from consolidation?
With $95.8 billion in private sector deposits by the end of 2009, record high funds have exhausted the capability of Lebanon’s economy to absorb the plentiful liquidity in Lebanese banks, causing them to look to international markets for new growth opportunities.
“It is indeed difficult to find use for all the funds we are receiving so the only way to continue this expansion and to continue to grow our balance sheet is to continue to fund clients outside of the country,” said Walid Raphael, general manger of Banque Libano-Francaise.
Lebanese Banks are currently present in 27 countries throughout Europe, Africa and, of course, the Middle East, generally following their existing clients to other countries in which they do business.
Though central banks the world over are strengthening restrictions on foreign banks entering the market, due to the hit their domestic banks took during the financial crisis, Alain Tohme, deputy general manger at Byblos Bank, said that the Middle East’s banking markets are still quite open and welcoming to banks with expertise and good relationships with international organizations.
“Central banks are usually receptive to Lebanese banks entering because they know we [will be] investing in those countries,” said Tohme. “We are creating jobs in those countries. We are taking young people from universities, training and educating them and giving them jobs in the sector. And we are also participating in the development of their economies by financing trading and industrial activities.”
Lebanon’s Central Bank Governor Riad Salameh, a long-time advocate of international expansion, told Executive that Lebanese banks are now earning 20 percent of their profits from foreign operations and that he would like to see that rise to 50 percent in coming years.
This move should raise the credit ratings of Lebanese banks, which are currently hog-tied to the sovereign rating of Lebanon.
market, because then it will be a real monopoly”
— Salim Sfeir
Crowded at home
But global domination will not solve the oversaturation of Lebanon’s home market, where the more than big enough banking sector has locked each bank into its market share ranking so tightly that some say they will never change without consolidation.
Salameh said he will accept no mergers within Lebanon’s 11 alpha banks, but would support mergers between alpha and beta banks. His edict is a controversial one, garnering both fervent support and aggravated opposition from banks’ management.
Salim Sfeir, chairman and general manager of Bank of Beirut agrees with Salameh’s fear that a mega-merger would snuff out competition in the market.
“Our market is small and it’s to nobody’s advantage to see one bank having a very big share of the market, because then it will be a real monopoly,” said Sfeir.
Tohme agreed that large banks coming together could be to the detriment of the market, but said that this logic should be restricted to the top five or six banks. He also said market saturation could be improved if the central bank raised minimum capital levels for banks, which he says stands at approximately $7 million, a number out of line with regional standards. According to Tohme, banks opening in Syria are required to have minimum capital of $40 million, with the minimum increasing after a certain number of years of operation.
But along with those who are protective of Lebanon’s natural market, comes those who are dissatisfied with relying on only organic growth.
Bank Audi CFO Freddie Baz says that Lebanese banks will never be able to reach the level of regional status they deserve without such mega-mergers, dismissing mergers between tiers as inconsequential.
“For lobsters, acquiring shrimps? We are not talking about consolidation anymore. Real consolidation is lobsters getting together because this is what generates significant cost synergies,” said Baz. “Just imagine a merger between two of the top five in Lebanon, which are today executing similar regional expansion strategies, which exist almost in the same countries, which have almost the same profile of domestic networks — huge overlaps which could generate significant cost savings.”
So it seems that the need for consolidation is in the eye of the beholder, and as long as that beholder is Riad Salameh, Baz’s dream may never come true.
“I can understand, but I feel very frustrated,” said Baz.
We are not talking about consolidation anymore. Real consolidation is lobsters getting together
because this is what generates significant cost synergies, ”
— Freddie Baz
A new romance
The notorious risk aversion of Lebanese banks and the drastic need for infrastructure development in the country they champion is making for something of an awkward time as they move on from a casual dalliance to meeting the parents of government securities.
Since the presentation of the finance ministry’s budget for 2010, chatter about private sector cooperation in infrastructure projects has been increasing, marked by high level meetings between government officials and bank executives. And while all parties agree that there is a definite need for public projects to begin without adding to the country’s mounting public debt, details have yet to materialize and the bankers are hesitant to jump into what could be a costly date.
Public-private partnership (PPP) projects have been heralded as a fail-safe way for the banks to make billions in revenues, but the expense of building a road or bridge and the time associated with such large projects present somewhat of an asset-liability mismatch that they would want to see mitigated before projects begin.
Saad Azhari, chairman and general manager of BLOM Bank, told Executive that most bank funding is short-term, which limits their ability to lend large amounts in the medium and long terms.
“There is a difference between buying a treasury bill that you can sell on any day and giving a loan for 20 years where it takes five to seven years to build something,” said Azhari, adding that politicians may see PPP deals as more straightforward and appealing than they really are.
The name of the game, therefore, in convincing banks to fund such projects, is cash-flow.
“At the end of the day what drives my decision in granting a loan is the capacity of any project to generate enough cash-flow to reimburse itself. So we will deal on a case by case basis,” said Freddie Baz, chief financial officer at Bank Audi.
While acknowledging the good PPP will do for Lebanon, he said that the decision to participate would ultimately be based solely on the financial merits of such deals.
“If they want to promote projects which by definition are not profitable and are not capable of generating enough cash-flow to reimburse themselves, we won’t finance them,” said Baz.
Along with good planning and well-structured deals, help from outside entities for both financing and advice will play a large part of the future of PPPs according to Alain Tohme, deputy general manger at Byblos Bank. “Lebanese banks cannot do it on their own,” he said.
BOT – or build, operate, transfer – is the deal structure most discussed, as it offers the highest profit for the private sector and therefore the best opportunities for the banks. But these plans require an amount of delegation from the public sector, which bankers seem unconvinced that the government will be willing to grant.
“Since I came into this business, I always said that the public sector should shrink: this is the key to reform,” said Chairman and General Manager of Lebanese Canadian Bank George Abou Jaoude. “This is the way to get a better Lebanon – through the shrinking of the public sector politicians would have less say, then the culture of Lebanese society would go back to the right path.”
Tohme said that PPP should only go forward, “provided that the government gives a clear role for the private sector… and there are clear regulations, clear directives and accountability.”
Of course, even if lucrative and sound plans are devised, the question of realization is always an issue in a country with a bureaucracy as intractable as Lebanon’s.
Baz likened PPP projects to the Loch Ness monster: everyone has heard about them, but no one has seen them.
Still, despite hesitation and a hint of pessimism, the banking sector seems to agree that PPP is the only solution to Lebanon’s stalled infrastructure development.
“At the end of the day you have to take a tough political decision to say we have to go down this road. If we don’t go down this road, nothing will go forward,” said Tohme.
“It’s manageable. I believe the central bank has regulated this industry, following and controlling the expansion, and I think the banks have strong risk management”
— George Abou Jaoude
