Dr Freddie Baz, Bank Audi’s CFO and Chief Strategist talked to Executive about the current situation for banks in Lebanon and future prospects for the sector.
E How do you view the expansion of Lebanese banks in the region. Do you believe they can compete with foreign players?
When we started expanding in the region, we tended to favor acquiring local financial institutions well established in each country. This approach has been particularly helpful in closed markets where Central Bank authorities have decided to stop granting new licenses. In such markets, which usually encourage consolidation through mergers and acquisitions, we have and continue to look for an inorganic growth. As an illustration, we are considering consolidation in Jordan, a market where many opportunities are available as middle size banks show good profitability ratios. However, our initial strategy has been to grow organically. In Syria, we were able to build close to $700 million in deposits during our first year of operation. This year, deposits would reach to $1.5 billion. In Jordan, we have been able to build a customer franchise deposit base of $600 million in less than two and half years. Our bank’s 2007 consolidated balance sheet boasts $17.5 billion in assets, of which $3.5 billion stem from three foreign markets — Syria, Egypt and Jordan.
This example illustrates the reality of a few Lebanese banks, which have been able to build customer and account portfolio franchises. In parallel, Arab banks have enough liquidity to acquire other financial institutions but they do not have the necessary expertise to build institutions organically, which is a know-how proper to Lebanese banks.
E Is the Lebanese banking sector considered as attractive for other regional financial institutions?
A few years ago, stocks of Lebanese banks were considered quite affordable. Prices have, however, improved in recent months, although they still remain very attractive. The large banks, mainly Audi and BLOM, used to be traded at ten or twelve times their earning, a figure that has increased to 15 or 17 times. This figure is quite high against the backdrop of the current situation. In spite of the improvement of trading multiples, Lebanese banks still feature the cheapest assets in the region. If one takes the example of the NBK acquisition of Al Watani, which was bought at 50% of asset value, current trading multiples of Lebanese banks are still estimated at only 18% of their assets. Cheap prices and large assets inherent to the Lebanese banking sector will certainly stimulate the appetite of foreign banks. Another enticing factor is that large Lebanese financial institutions have billions in assets and are extremely well established in terms of footprint. In addition to their know-how, Lebanese banks are operating both in emerging and frontier markets. The latter category, which includes countries such as Sudan, offers massive profit potentials. With price to assets at less than 20% and a wide network of branches in more than ten countries, Lebanese banks are certainly exposed to takeovers. The management is thus faced with two choices, either to acquire or be acquired.
E So are you saying that Lebanese banks are still undervalued?
What determines the real value of a bank is its operating environment, namely the political and economic framework. Political stability tends to boost confidence. This in turn affects aggregate demand, consumption and investment levels, which reflect on GDP growth rates. This process takes a chain form. In my opinion, there is a very strong correlation between commercial bank transactions and GDP growth rate. If one takes a quick glance at the Lebanese economy, one notices that there is a wide gap between actual GDP and potential GDP, which is estimated at around $34 billion — $10-11 billion of yearly additional income compared with actual levels. If the economy is allowed to thrive, banks will grow and their trading multiples will be within the region’s prices to assets and prices to equity. For investors to eye a particular market, they need to have a clear vision for a limited period of three to five years.
E How risky has the sovereign debt become for Lebanese banks?
The sovereign debt has been diluted due to the large bank assets. When Prime Minister Hariri was assassinated, Lebanon was faced with a $2.2 billion outflow in deposits. Since then, deposits of Lebanese banks have grown by $16.6 billion. The war with Israel generated an immediate outflow of $3.1 billion dollars in deposits. Nonetheless, since July 2006 Lebanese bank deposits have witnessed an increase of $12 billion. In the meantime, subscription to public debt has remained constant, meaning that exposure of Lebanese banks is plummeting with time. Only a few years ago bonds in foreign currency reached a percentage of 30% in terms of deposits in foreign currency; this figure has dropped to 12 % for the sector and to 9% at Audi in recent years.
E Do you believe that growth in deposits can be partly attributed to an accumulation of interest?
Last year’s growth can be attributed to the convergence of two main elements — soaring oil prices and the repercussions of the subprime crisis. Rising oil prices have impacted on the money transfers made by the Lebanese diaspora residing in the Gulf. In 2001, the Arab region’s GDP amounted to about $600 billion; it doubled in 2007 reaching $1.2 trillion with an oil price at $88. In years to come, the growing oil price will certainly reflect on banking sector assets. On the other hand, the subprime crisis has also encouraged Lebanese who lost confidence in foreign banks to divert some of their funds to Lebanon. The outlook for Lebanon seems to be quite positive for now, as witnessed in the growth of $1.8 billion in deposits in the first two months of 2008.
E Lebanese banks are very reliant on Lebanese living abroad. How does this market particularity shape your strategies and products?
Bank Audi’s main objective is to be among the top five banks in the region. We do not especially target the Lebanese diaspora, which seeks us naturally. On the contrary, we want to create and develop a sound customer base in all of our locations and hence focus our attention on the local population, namely Egyptians in Egypt or Syrians in Syria. We are a universal bank at the service of Arab citizens.
E Do you foresee a specialization in the banking scene, with each bank focusing on a particular market segment?
All banks pretend to adopt a universal bank approach, given they have the proper expertise. We are a universal bank: we boast 400,000 retail accounts, one third of our deposit base is constituted by accounts with balances in excess of $1 million each, some of the top fifty companies in the region are featured among our clients. Our Capital Markets department manages $5-6 billion in yearly turnover on Lebanese stocks and bonds. As you can see, we have been able to reconcile between two market dimensions, mass and elite. A universal bank is built on expertise, which in turn generates market share. Nonetheless, our approach also differs from one market to the other. While we may opt for the universal bank approach in certain markets, we may choose a more specialized one in another.
E Do you think the Lebanese banking scene has become overcrowded?
Not really. Lebanon may have become overcrowded in terms of numbers of banks. But when one takes a close look at banking coverage ratios, such as number of accounts per household or residents per branch, they still lag behind. In my opinion, the Lebanese retail market is still in its infancy. There are huge potentials in terms of organic growth for banks in the retail market. For Lebanon to close the gap between actual and potential GDP, billions of dollars of loans will be required. The Lebanese banking sector has always been very concentrated. Years ago, the first 20 Lebanese banks represented 80% of the market. This figure has dropped to about 70% to 75% today. Among the alpha banks, size varies greatly from one institution to the other, the top two banks weighing as much as the last five.
E Many economists have criticized Lebanese banks on the premise that they tend to finance the government instead of the private sector. Do you agree?
In Lebanon, the proportion of consolidated loans to GDP is almost one-to-one, an extremely high ratio beyond any acceptable ceiling. However, due to the importance of the consolidated deposits of banks to GDP, among the highest worldwide, the contribution of banks to the private sector seems to be dwarfed in comparison. In reality there is no crowding-out effect. When it comes to loan segmentation, the banking sector is only reflecting the reality of the market. In addition, Lebanese SMEs need to be managed more like companies and less like mom-and-pop-shops, by developing proper audits and processes in order to be able to secure larger amounts of loans.