The environment in which Lebanon's banks have been operating has been challenging, meaning that despite their steady growth a backdrop of uncertainty is influencing policy. And they are also having to contend with a public backlash regarding profits from a central bank swap offer, writes Edward Russell-Walling.

Blom Bank

Lebanese banking has been admirably durable in the face of adversity: steadily profitable and a dependable source of funds for public and private borrowers. In the past year, however, being pilloried as a public enemy has put its stoicism to the test.

In many ways, 2016 was a year of business as usual for the country's banks – or what has come to feel like usual – with low growth, regional uncertainty and, until late in the year, political stasis. Investment as a proportion of gross domestic product fell to a low of 23%, down from 31% in 2010, before the war in Syria began. So bankers welcomed, as much as anyone, the election of a new president in October, the formation of a new government and the ministerial endorsement of a budget.

Positive move

“Having a functional government, and a parliament that is convening and passing laws, is a positive,” says Saad Azhari, chairman and general manager at Beirut-based Blom Bank. “We’re not completely out of the woods – there is still the question of [parliamentary] elections – but things are moving in the right direction.”

He notes that the pick-up in economic activity that immediately followed the presidential election in October diminished somewhat in the new year as political tensions rose over the new electoral law. What he calls the “mood of not agreeing” has had a generally negative effect on consumer and investor confidence in Lebanon.

The best outcome now, Mr Azhari believes, would be rapid elections under a “good” new law (see article on Lebanon's economy, p78). The next best would be a new law with elections postponed for a few months. Less desirable, in descending order, would be elections under the old law, an extension of the existing parliament or, worst of all, continued parliamentary paralysis.

Business as usual in Lebanon also meant banks performing rather well, despite an unhelpful domestic backdrop. Their combined assets in 2016 grew by 9.9% to reach $204.3bn. Private sector deposits increased by 7.2% to $162.5bn, while loans to the private sector grew 5.5% to $57.2bn.

Net profits among the 14 largest banks rose in 2016 by an average 11.9%, according to Lebanese data provider Bankdata Financial Services. It said average return on assets rose from 1.02% to 1.08%, and average return on equity from 11.47% to 11.77%. Those are conservative returns compared with some other markets, but that is the price of soundness and liquidity.

Bank Audi led the profit stakes, with its net profits up 16.6% at $470m. Blom Bank followed with an 8.7% rise to $463m and Fransabank came third with net profits of $201m, an increase of 11.8%.

Further afield...

The general feeling among bankers is that their industry’s growth will continue at an acceptable pace during 2017, given the more positive political and economic tone, but that this will still be something of a transitional period. “The uncertainties should be settled this year, and 2018 should be much better,” says Mr Azhari.

One feature of Lebanese banking in recent years has been to offset restraints at home by expanding abroad into risky but underbanked markets. This has been a successful strategy in many cases, but in 2016 exchange rate risk bit back as currencies in certain jurisdictions plunged. These included, most notably, Turkey, where in October the lira began sliding to record lows against the US dollar; and Egypt, which unpegged its currency from the dollar in November.

Bank Audi, Lebanon’s largest bank by assets, now has a presence in 10 other countries. The most important are Turkey and Egypt, and the effect of currency depreciation in both was “very material”, according to vice chairman and group strategy director Freddie Baz. “Our regional franchise is now as important as Lebanon in our assets and earnings,” he says.

Even after depreciation, at the end of March 2017, non-Lebanese entities accounted for 42% of total assets and 45% of net earnings at Bank Audi, but without depreciation, those figures would have exceeded 60%.

Blom Bank’s Egyptian business was likewise hit, with the size of its balance sheet shrinking, even though profits increased in both Egyptian pounds and dollars. “Profits weren’t sharply affected, because the devaluation happened at the end of the year and we take the average exchange rate,” says Mr Azhari. “We expect a bigger effect in 2017.”

Because of the war in the country, Blom has deconsolidated its Syrian operation and written off its entire investment of some $80m, he adds. His bank was not alone and, in general, the exposure of Lebanese banks to Syria has been fully covered, via provisioning, write-downs or deconsolidation. Bank Audi has written off its investments in both Syria and Sudan.

Worth the risk?

Today, only four Lebanese banks still have branches or subsidiaries in Syria, according to the Association of Banks in Lebanon (ABL). They are: Bank Bemo, Banque Libano-Française, Byblos Bank and Fransabank.

Rather more remain exposed to Iraq, where some are still expanding and most have had to raise capital – to $25m by the end of 2016 and $50m by the end of this year. The 10 Lebanese banks in Iraq include three with Syrian exposure – Byblos Bank, Banque Libano-Française and Fransabank – as well as the likes of Bank Audi, BankMed and Blom Bank.

“Our presence in Syria has been shrinking since the start of hostilities,” says Maurice Iskandar, head of international at Banque Libano-Française. “We now own just 49% of a local Syrian bank and its operations are ring-fenced.”

Banque Libano-Française has one branch in Iraq, where it met the minimum capital requirements for the end of 2016. Mr Iskandar says the bank is adopting a cautious approach to Iraq for now. “While we had plans to develop our network further, these are on hold until we see further developments,” he adds. “But we continue to finance and to work with our Lebanese clients or those linked to Lebanese partners.”

With the damage some banks were sustaining outside Lebanon, it was just as well that they could take advantage of the contentious pounds-for-dollars swap offer by the central bank, Banque du Liban (BdL), in 2016 (see interview with central bank governor Riad Salamé, p76). Bank Audi’s Syrian and Sudanese write-off, for example, amounted to a not insubstantial $201m. Yet it was able to cover that out of the $630m in exceptional fees and commissions it enjoyed from the BdL transactions, a sum which more than doubled its 2015 non-interest income.

“De facto, banks with bigger balance sheets and more access to liquidity and foreign exchange will benefit more than the others,” says Mr Baz, referring to the BdL swap volumes. “That’s why we had the lion’s share.”

The bank set off the rest of this exceptional income against goodwill impairment and intangible asset write-offs, free provisions and an $87m exceptional tax payment triggered by the swaps. The BdL had instructed banks not to distribute these gains, but to use them for provisioning and recapitalisation.

Windfall profits

Other banks enjoyed the BdL’s largesse in proportional amounts, and the total profit to those who participated was reported to be $5.5bn. Ratings agency Moody’s declared their use of the gains to bolster their balance sheets was credit positive.

But the idea of these windfall profits did not necessarily go down well outside banking circles. There began what some bankers describe as a campaign against the central bank governor, the BdL and the banks. “Major politicians were calling banks the ‘mafia’,” one disgruntled banker recalls.

“There was an increase in populism for a limited period,” says Makram Sader, secretary-general of the ABL. “The political class failed to initiate and implement good policies for the Lebanese people, so they wanted a scapegoat. Like any other country, it was easy to choose bankers.”

The campaign, if such it was, took on a hard edge with calls to hit banks in their pockets by taxing them. The Council of Ministers discussed a windfall tax on the swap profits, but was eventually told this would not be legal. As it is, the banks will be paying $850m in standard corporation tax (at the proposed new rate of 17%) on their extraordinary gains.

Tax hikes?

The budget now waiting for parliamentary ratification is thought to increase the tax on interest on deposits from 5% to 7%. Another proposal involved taxing bank portfolios of Treasury bills and certificates of deposit. “The opinion of the Ministry of Justice was that it does not have that right because it is not in the contract when you buy Treasury bills,” says Mr Sader.

Bank Audi entered the fray with a study on tax evasion, which showed that the government was failing to collect $4.2bn a year in unpaid taxes, electricity bills and property registration fees. The bank’s chief economist told reporters that reforms and improvements in tax collection were needed before any increase in taxes.

George Corm, a former Lebanese finance minister, suggests that the Ministry of Finance, the central bank and the private banking sector should all agree to decrease the average interest rate paid by the state on its debt by about 1% on any new issues.

This would save the state hundreds of millions of dollars over time. It would affect banks’ profitability “only a little bit”, he says. But the banks could decrease by a small amount the rates they pay on deposits, which are higher than anywhere else in the world, and this would end the discussions on how to tax them more.

Consolidation hopes

There has been a degree of consolidation in Lebanese banking, though not as much as some would like. Mr Sader says there is no will among the big banks to merge and that, among the smaller ones, it is often more a matter of social anthropology than finance. “Some families who own small and medium-sized  banks are wealthier than the bank,” he says. “The bank projects a good image for the family, so they keep it.”

One notable acquisition now under way is Blom Bank’s purchase of HSBC’s Lebanese business, which has some 200 employees in three branches and slightly under $1bn in assets. Agreed at the end of 2016, the deal is due to complete in June and the “very reasonable” price, according to Mr Azhari, is in the tens of millions of dollars.

The attractions for Blom included a strong position in trade finance and no exposure to government. Mr Azhari thinks one of the attractions for HSBC was that Blom wanted to keep all the employees. "We reckon if we keep the employees, that will help us to keep the clients," he says.

Blom’s overall strategy is to expand further in the Arab world and in cities where Arabs like to be, such as London and Paris. This is the first bank it has bought in Lebanon.

Fransabank is altogether more acquisitive at home, having made half-a-dozen or more purchases in the past 25 years. The latest was Ahli International Bank, with nine branches, in 2014. The result is that today Fransabank boasts the largest local branch network in Lebanon, with 124 branches strategically spread nationwide, according to Fransabank chairman Adnan Kassar.

“About 40 banks have disappeared during the past 25 years as banks with a solid capital and management base have acquired small banks with financial problems,” says Mr Kassar. “We believe that this consolidation in the Lebanese banking sector will continue in the coming decade.”

Among the reasons he gives are the huge number of banks, with tough competition compounded by rising costs, shrinking interest margins and more rigorous regulatory and IT demands.

The de-risking problem

Another pressure on smaller Lebanese banks is the practice of de-risking, whereby relationships are being terminated with respondent banks in jurisdictions thought risky by international lenders. The ABL clocks up many air miles to London, New York and Paris, explaining how Lebanese banks do their compliance and risk business, and how they adhere to international standards. “Today we have a lot of credibility with the international market,” says Mr Sader.

Banque Libano-Française’s Mr Iskandar believes that there are solutions to the de-risking problem. “One measure is to have more clarity on the part of foreign governments about sanctions regimes, to prevent overreaction by correspondent banks,” he says. “And then technology can help to put in place credible data bases that banks can tap into and share.”

That would enable banks to screen transactions to ensure they are legitimate. “The danger in the current environment is of not catching the bad transactions, while pushing the good ones underground,” adds Mr Iskandar.

Back in the marketplace, Audi Bank’s Mr Baz believes that, with the Lebanese economy running at only 75% of full capacity, there are still a lot of prospects for organic growth. “The retail market is still underserviced in Lebanon,” he says.

Lebanon has a similar per capita income to Turkey and Mexico, at about $12,000 a year. The breakdown of loans in Turkey and Mexico is roughly 55% retail and consumer to 45% corporate and commercial, while in Lebanon it is two-thirds corporate to one-third retail. “So there’s a lot of room to grow organically in the retail business,” says Mr Baz.

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