Despite its new look logo and name, BLC Bank is one of Lebanon’s oldest banks, and also historically quite prestigious by domestic standards. Previously named Banque Libanaise pour le Commerce, BLC was founded by the Abou Jaoudeh family in the early 1950s.
Prior to the Lebanese civil war, the bank was a major private and commercial bank appreciated by both Arabs and Lebanese and was considered as one of the safest havens for Gulf investors’ petrodollars. After the civil war, the bank appeared to take off in a major way, becoming the second bank in Lebanon after Banque Audi to issue Global Depositary Receipts (GDRs) and one of the first banks to list its ordinary shares on the newly re-opened Beirut Stock Exchange. The GDR issue, a form of shares carrying no-voting rights and denominated in US dollars, was carried out in an opportunistic way, with the bank taking advantage back in 1997, of the major demand by international investors for emerging market stocks. The issue was then over-subscribed, selling like hot cakes, as investors were encouraged by the success Banque Audi encountered with its own GDR issue in the last quarter of 1995.
However, this investor enthusiasm for Lebanese banks’ GDRs did not take into account the substantial non-performing loans portfolio that had accumulated over the war and post-war period. At the time of the GDR, the bank had no developed internal infrastructure, including a performing management information system, a rating and scoring system, or even enough managerial capabilities to put in place a well thought out and realistic operational strategy as well as financial goals. The bank had a nascent credit department, which at the time had problems getting information on the non-performing loans portfolio, let alone solving it.
The non-performing loans problem was further highlighted when Byblos Bank attempted to merge with BLC in 1998. Byblos staff in charge of carrying out a due diligence report of BLC found out that the level of problematic loans was very high and had a potential for further deterioration. The resulting collapse of the Byblos-BLC merger deal pushed BLC into the realm of the notorious Union Bank of Lebanon group (UBL), which then included many smaller banks of dubious quality. BLC became the main bank of this group, inheriting further problem loans, while staff hired at the time of the GDR issue left the bank. The final straw came when the UBL group fell deep into messy mismanagement, which bordered on embezzlement, taking BLC down with it into the abyss.
The collapse of the UBL group and the failure by shareholders to recover the situation forced the Banque du Liban (BDL) to step in and take over both capital and management. Were it not for the BDL, the failure of a major bank such as BLC would have seriously shaken the Lebanese banking sector and with it the entire economy.
The BDL, which was keen to avoid such a situation, appointed Shadi Karam, a banker specialized in rescuing banks to oversee its recovery. Karam’s mandate was to turn around this once prestigious domestic institution, with the aim of putting it back on its feet within a few years, eventually selling it to strategic investors for a profit.
Five years on and the bank appears to have been successfully restructured and re-capitalized. By the end of 2004, BLC Bank (as it was renamed) was the 12th largest bank in Lebanon in terms of assets of $1.82 billion and customer deposits of $1.52 billion. The image of the bank was modernized through a new logo and a move to a new, more efficient, head office, while capitalization was strengthened to reach $30.18 million at year-end 2004. The re-capitalization by the central bank as well as by profits generated in the last two fiscal years (2003 and 2004), was essential in bringing back the bank from a negative net worth situation.
Moving on up
The bank’s equity moved from a negative net worth of $18.24 million in 2002 to a positive equity of $23.32 million in 2003, and $30.18 million in 2004. The bank’s equity was negative in 2002, as a net loss of $99.84 million was recorded for the year. The bank’s new management and the BDL had decided back in 2002, to provision significantly against non-performing loans and carry out a capital injection the following year to restore a positive net worth situation. However, at the end of 2004, the bank’s equity was still regarded to be largely insufficient, as the BIS capital adequacy ratio stood, at 6.57% well below the 12% regulatory minimum set out by the BDL for the Lebanese banking sector. The equity to assets and equity to loans ratios were abysmal at 1.6% and 11.15% respectively.
Economic capital, or the level capital that is necessary to cover up all types of risks (mainly credit risk) on the balance sheet, was also widely insufficient at the end of 2004. The exposure to Lebanese sovereign risk was too high at the end of 2004, with government debt securities accounting for 54% of total assets. With the Basel II capital regulations starting to be implemented in Lebanon by 2008 and risk weightings on Lebanese government securities shooting up to 100% (from a current 0% to 20%), the bank’s economic capital is clearly insufficient. However, it is worth noting that this economic capital problem has been found across all emerging market banks, including all Lebanese banks, and is slowly being understood.
On the profitability side, BLC has much improved since that terrible year of 2002, when it was forced to allocate almost $50 million to loan loss reserves, producing as a result a record net loss of $99.8 million. This loss, which wiped out the bank’s equity completely, was turned around within a year, when net results went back into the black at $5.52 million. Net profits even increased substantially in 2004, by almost 200% to $15.86 million, as the bank essentially wrote back around $13 million of loan loss reserves. 2003 profits were mainly due to significant non-interest sources of income of $15.2 million, as well as a significant improvement in net interest margins. The bank’s net interest margin ratio (net interest income divided by earning assets), improved by 2.6% in 2003, and 2.7% in 2004, and was in line with the sector average. The return on the average assets ratio (net income divided by average assets) or ROA also improved sharply from 0.41% in 2003, to 0.95% in 2004, which also compared well with the rest of the banking sector.
It would be worth noting however, that the bank’s profitability in the past couple of years was largely due to interest income received from investments in government debt securities (41% of total interest income), as well as from placements in other banks at relatively favorable rates (42% of total interest income). Interest income received from lending to the private sector accounted for only 17% of total interest income, while non-interest income had decreased by 37% to $9.5 million in 2004, as the bank had significantly less trading income during that year. A return on equity (net income divided by average equity) or ROE was irrelevant at 70.7% in 2004, and reflected the gross under-capitalization of the bank, instead of significant returns to investors.
BLC’s loan portfolio, including loan loss reserves and non-performing loans, accounted for only 14.8% of total assets, which reflects the general state of the Lebanese banking sector. Like all Lebanese banks, BLC allocated a small proportion of its funding to loans, preferring instead to rely on high yielding government debt securities, which are rated B- by Standard & Poor’s and B3 by Moody’s. Despite their low rating, government securities have never defaulted and have a solid track record of stability and yields. Any bank ignoring the benefits of allocating a substantial proportion of its funding to government securities would see its profitability suffer and the amount of non-performing loans increase. Profitability would not only suffer as a result of lower and less stable yields out of lending within a difficult operating environment, but also as a result of a consistent need for high loan loss provisioning.
BLC’s non-performing loans, which are mainly made up of sub-standard and doubtful loans accounted for 66% of gross loans in 2004, compared to a sector average of 25%. Although this figure is way too high, it improved significantly from an 89% level in 2003. Normally, a heavy under-capitalization and similar level of non-performing loans would have meant that the bank is technically bankrupt. But in this case, the owner is the central bank, which is ready to inject capital when necessary, and the proportion of loans to total assets is too small to have a serious impact. Nevertheless, BLC’s loan loss reserves covered almost 90% of non-performing loans in 2004, which is higher than the market average of around 76%.
Liquidity and funding
In line with Lebanese banking practices, BLC’s main funding comes in the form of customer deposits. These accounted for 84% of total assets in 2004 and were mostly savings and time deposits, which, in Lebanon, tend to be stable over the long-term and are usually renewed at their maturity. These deposits are obviously more expensive than current accounts, but are regarded as the main funding option in the country anyway. The bank’s extensive branch network, both domestically and abroad, is a significant factor behind the stability, diversity, and recurrent nature of the customer deposit base.
The bank’s other funding comes in the form of soft loans of $101.2 million from the BDL, as well as inter-bank deposits of $90.14 million. Although these funds accounted for only 11% of total funds in 2004, they were still essential for the bank’s profitability, as they reduced interest expenses. In any case, a prospective buyer of BLC would have to aim at diversifying revenues further, such as starting to access the capital markets, and work on a more sophisticated asset/liability management model. The bank will have to access longer term funding in order to reduce its endemic maturity mismatches, which are reflected in short-term deposits being used to lend over the long-term or to buy illiquid, longer-term debt securities.
BLC has one of the larger branch networks in Lebanon with 35 domestic branches and four branches in the United Arab Emirates in Dubai, Abu Dhabi, Ras Al Khaimah and Sharjah. The bank also has an affiliate in Paris, BLC Bank France SA, and local finance company, BLC Finance SAL, which used to carry out domestic investment banking activities. For example, it was BLC Finance that arranged for the Beirut Stock Exchange listing of Abou Khalil Supermarkets back in the late 1990s.
Such a large network by Lebanese standards, plus the ever so valuable branches in the UAE, provides any prospective buyer with strong distribution and deposit raising capabilities. This is particularly true if the buyer is a Lebanese bank, with a need to diversify its revenues by product and geographically. The domestic branch network would not only provide a foreign bank with a significant presence within the Lebanese banking sector, but also with an immediately strong market share locally in terms of deposits and the distribution of banking products, particularly retail products.
It is clear that such a franchise, with its brand name and historical presence as one of Lebanon’s oldest banks, would warrant a certain price to any prospective institutional buyer. The foreign branches in particular, if well managed, would provide a good indication of future profitability, as they give the chance to diversify revenues and funding geographically and reduce the exposure to Lebanese risk. However, it is imperative for any prospective institutional buyer to realize that he will have to inject capital on top of paying for the price of the franchise, if the bank is to have decent economic capital in the future, and comply with central bank regulatory standards. For the moment, it is clear that a buyer would need to inject at least around $30 million in additional capital, as well as carry out more loan loss provisioning of around $40 million to $50 million over a certain period of time, if non-performing loans and current risks are to be covered. In other words, the buyer would have to add around $100 million to the proposed price if the bank is to have an adequate financial structure and solvability.
With Basel II looming on the horizon and risk weighting expected to shoot to the sky for both government debt securities and loans (some risk weightings are expected to reach up to 600% depending on the probabilities of default), more capital will be needed as soon as 2008.