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Guarding a fragile future

Banks shudder as the government grabs for their profits

by Thomas Schellen
Guarding a fragile future

It could have been a very boring report. In the big picture of Lebanese banking, the classic performance parameters are rather well behaved this year. Assets of commercial banks stood at $166.5 billion at the end of March according to Banque du Liban (BDL), Lebanon’s central bank — up by $1.68 billion from the end of 2013 and up by 7.1 percent year on year. Private sector deposits, which started 2014 with outflows after an atypically high inflow of more than $3 billion in December, returned to a more regularly paced increase of $840 million in March and ended the first quarter at $136.6 billion. This represented 6.6 percent growth when compared with the end of Q1 2013.

When widening the view over the previous 12 months, sector data were not staging any alarming deviations from their long-term growth trajectories either, as proven by the full-year data for 2013. In simple terms, growth of banking assets, deposits and loans did not go AWOL in the otherwise growth-averse economy of 2013.

The banks’ good health 

[pullquote]“2014 is not going to be a year of profitability for the banking sector”[/pullquote]

Economists of Lebanon’s top banks corroborated the story told by the numbers, describing banking sector growth up to the first quarter of 2014 as satisfactory overall. “The sector has been resilient to regional turmoil, and specifically Syrian turmoil, in terms of growth and financial soundness,” said Marwan Barakat, head of research at Bank Audi, citing growth of deposits in 2013 as 8.5 percent, or $13 billion.

This rate of growth was sufficient to meet the needs of Lebanon’s public and private sector borrowing, Barakat explained. “We need for our deposits to grow 5 percent [annually] in order to be able to provide loans to the public and private sector and thus meet the financing needs of the entire domestic economy. Despite the crisis that affected Lebanon for the past three years, deposits growth was above that mark and thus banks have been able to finance the economy while keeping liquidity at a good level.”

Not only was deposits growth commensurate with the nation’s financing needs, the lending activity of Lebanese banks was also good, said Marwan Mikhael, head of research at BLOM Bank. Total lending to the private sector at the end of February 2014 stood at $47 billion, up around 9 percent year on year and representing 28.5 percent of total banking assets, he said, putting the ratio into perspective of the domestic economy by enthusing, “It is not that we are not lending; our lending is at around 100 percent of GDP.”

Loan to deposits ratios (LDRs) of Lebanese banks, which stand around 35 percent for the sector according to Mikhael, often appear extra slim in comparison to most countries where LDRs of 80 to 100 percent are common. However, Lebanese bankers do not tire in explaining that this is only because the banking sector’s deposit base is more than three times GDP, meaning that the sector’s theoretical full lending power is too large for the size of the domestic economy.

Nassib Ghobril, chief economist of Byblos Bank, confirmed the positive sentiment in difficult economic terrain and summarized the state of Lebanese banks in 2014 as being still “very solid, very liquid, highly capitalized and very well managed.”

From a perspective of financial investments via the securities market, banking stocks look better than real estate, said the head of research at FFA Private Bank, Nadim Kabbara. “We as FFA Research currently favor the banking sector over the real estate sector. If someone told me, ‘I want to put money into the Lebanese capital markets,’ I would guide them more to the banking sector than to the real estate sector,” he said, explaining that “while real estate sector shares, namely Solidere, can be interesting to the patient, long-term investor, the economy has not been doing so well there. In the banking sector, at least we are seeing some growth of their balance sheets.”

A wrench in the works

[pullquote]the new taxation would be detrimental to the Lebanese economy and … could go as far as turning investors away from contributing to banks’ capitals because of lower return prospects[/pullquote]

Noting the quiet nature of Lebanon’s stock market and given that the banking sector has, in the words of BLOM’s Mikhael, “been shielded to an extent from the slowdown in the Lebanese economy since 2011,” and is overall “the most stable sector in the entire economy,” this year’s banking narrative by Executive could have been less than engaging to most audiences.

But the sector’s story has developed an explosive potential in the past few weeks, ever since banks were targeted as a potential fount of revenue in filling the state’s gap in financing the salaries of Lebanese public servants (see “Don’t kill the banks“). The fiscal desire to tap into banking profits to the tune of an extra $250 to $300 million via inventive taxation measures is the stuff for a great debate between proponents and opponents of the plans.

Another bit of relevant news is the fact that FATCA, the US tax administration’s tentacle reaching out to American citizens around the world to ensure that they pay their dues back home, is scheduled to affect Lebanese banks beginning next month (see “Lebanon’s financial sector braces for FATCA“).

In terms of profit outlooks, compliance with an ever increasing number of international demands will cost banks a pretty penny, which comes on top of the taxation challenge which bankers perceive as discriminatory. In the opinions of every last banking insider queried by Executive in the past two months, the new taxation would be detrimental to the Lebanese economy and in the view of some experts could go as far as turning investors away from contributing to banks’ capitals because of lower return prospects. Some go so far as to argue the new measures might even discourage entrepreneurs in general because of the perceived injustice and unpredictability of tax innovations.


Expectations for 2014

These concerns notwithstanding, the banking sector’s outlook for 2014 is not hugely different from what was seen in the first quarter and in 2013 before that. “2014 is not going to be a year of profitability for the banking sector,” said Bank Audi’s Barakat, pointing out that net profits in the first two months of 2014 registered a 17 percent decline. He added that he does not expect this decline to continue but also does not expect an increase for full-year profits relative to 2013.

From Mikhael’s perspective, the Lebanese banking sector is stable and it is unlikely that there will be shocks affecting the sector in 2014. “There could be an uptick in the sector if there is stability that favors the economic performance of the whole country,” he said, adding that prospects for lending growth do exist but will depend on political stability and security. “Otherwise it will continue more or less like 2013.”

[pullquote]“It is not that we are not lending; our lending is at around 100 percent of GDP.”[/pullquote]

Byblos’ Ghobril expects prospects for lending to be impacted by the complicated political schedule. He said, “If we ask where lending opportunities to the private sector will come from this year, you firstly don’t have many new major projects or greenfield foreign direct investment projects. The public private partnership law is on hold and Lebanon faces a whole series of political deadlines starting with the presidential elections that has to be followed by government formation, and then by parliamentary elections in November and yet another government formation,” adding that “these political deadlines tend to put businesses into wait-and-see mode.”

In his view, for new growth to occur it does not suffice that the past three years had been marked by weakening indicators on many fronts. “Some people have a theory that the current situation will favor growth from a very low base but I don’t subscribe to that,” he emphasized. “According to the latest surveys for the Bank Byblos/American University of Beirut Consumer Confidence Index, there was a small pickup in confidence levels in Q1 of 2014 but the current levels are still not sufficient.”

Enough profitability?

That leaves the question of expectations for profitability. FFA’s Kabbara voiced concern that stalling of economic growth in the past year has resulted in behavior of banks that was not perfectly conducive for higher profitability. “We are not seeing much growth in the balance sheets of banks in Lebanon from domestic activity, but we are seeing more competition that is putting pressure on interest margins because banks are competing to originate loans or obtain deposits. My concern is not so much on the funding side but more on the allocation side of that capital. Banks here are very conservative in nature and that has helped Lebanon during the past financial crisis, but we are also seeing a lot of the capital being deployed into short-term liquidity such as interbank placements or deposits and reserves at BDL. This is understandable but has impacted the bottom line of banks,” he said.

[pullquote]The chances for a groundbreaking change in Lebanese realities may be ultra-thin, but cannot be dismissed — and the banking sector cannot discount the possibility of positive change.[/pullquote]

According to FFA research notes, which only cover the three largest Lebanese banks, Audi, BLOM and Byblos, first-quarter net profits of Audi and BLOM in year-on-year comparison were flat at $86 million and $88 million while Byblos net profits went down 11 percent year on year to $31 million. The three banks’ return on equity (RoE) ratios under a trailing twelve months methodology was estimated by FFA to be 9.2 percent for Byblos, around 11.1 percent for Audi and 15 percent for BLOM.

RoE ratios are watched by investors checking on the performance of their investments and are important for the Lebanese banking sector because RoE and similar ratios such as return on assets as well as asset quality measures such as the non-performing loans ratio are more indicative than headline growth figures on assets and deposits when it comes to assessing the profitability and health of a bank or listed company.

According to Barakat, the RoE ratios of the Lebanese banking sector, recently at 12 to 12.5 percent, have been “satisfactory but not high” when compared with emerging market and regional peers. Provisions for doubtful loans have gone up, “but not significantly,” he added. “The asset quality is still good with a non-performing loans ratio of 3.3 percent.”

Bank Audi’s economist nonetheless warned that the fall of RoE ratios over the past three years is cause for concern. “We need to maintain capitalization levels and to do so, we have to attract shareholders. If capitalization of banks is affected, the attractiveness for deposits could be affected, and deposits are important to have the financial means to finance the deficit,” Barakat explained.


Impact of Fed’s new rates

The Lebanese profitability ratios have been impacted by factors that include the cost of maintaining high liquidity in an international interest rate environment that has been kept low by the policy of the US Federal Reserve for more than five years. As this scenario will likely start to change in 2015 based on the Fed’s recent announcements, Barakat said he expects the environment of increasing interest rates to allow Lebanon’s banks to hike their profitability. “We are going to improve our yield on assets while our cost of funding, which is what we are paying on our deposits, will increase, but not at the same pace. Accordingly we will be able to improve our interest margins and spreads starting in 2015,” he said.

[pullquote]“Since 2008 the international interest rate environment was not very favorable for our banks to place liquidity in international markets because interest rates are near zero”[/pullquote]

Ghobril concurred that Lebanese banks are on the lookout for interest rates to start moving up. But he noted also that the Fed’s anticipated changes in interest rate policies take on a different and potentially much riskier dimension under a macroeconomic angle. “Since 2008 the international interest rate environment was not very favorable for our banks to place liquidity in international markets because interest rates are near zero, but this environment was favorable for managing Lebanon’s public finances,” he said.

“If the Fed starts increasing interest rates as planned sometime in 2015, the increase first of all appears set to be very gradual and there will be no direct effect on liquidity placements of local banks and there also will be a time lag between the rise of interest rates in the US and the arrival of higher rates in Lebanon. But we have to be ready. The years of near-zero interest rates will soon be over and we have to be prepared for it,” Ghobril cautioned (see “Fiscal flood“).

In the opinion of BLOM’s Mikhael, the scenario for Lebanon’s economy in the short term does not extend to a recession. He told Executive that “around one percent” of real GDP growth in 2014 is his worst-case expectation if the security and political situation do not make progress. A benign environment of domestic stability could in the best case generate 2.5 to 3 percent growth this year and 4 to 5 percent growth in 2015, he said, because even under a positive scenario of domestic political improvements and reforms in public finance, growth will take some time to materialize.

Web of dependencies

The chances for a groundbreaking change in Lebanese realities may be ultra-thin, but cannot be dismissed — and the banking sector cannot discount the possibility of positive change. Rebuilding in Syria, if peace were possible in 2015, would generate new opportunities for the banking sector and the economy in general.

In long-term context of the banking sector’s evolution, 2013 and the year to date reflect that the sector exists in a web of double cross-dependencies with opposing aspects. On the one hand, the sector’s need for a stable domestic operating environment and monetary stability mandates careful management of the relationship with the Lebanese state and its financing needs. On the other hand, the need to act internationally becomes more critical each year, from having to attract both capitalization and deposits to the survival necessities of deploying assets into profitable foreign operations and to being able to interact with the global banking system even in the presence of growing compliance demands.

The costs of both dependencies are significant and the entire sector is feeling them more strongly in 2014 than perhaps in some previous periods. But this is the price that will not disappear.

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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

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