Major political crises usually have disastrous consequences for most economies. But some countries have the resilience to withstand extraordinary circumstances. In the past two years, Lebanon, still recovering from the devastation of the 1975-1991 civil war, was savaged by two new shocks, the assassination of prime minister Rafiq Hariri in early 2005 and the Israeli-Hizbullah war of July 2006.
These pivotal events and the more recent blockade of constitutional institutions, which led to more deaths in Beirut in January, could be expected to paralyse a normal economy and its banking sector. But not so in Lebanon.
Despite all this calamity, the confidence of the Lebanese in their country and their financial institutions has not withered away. Damaged for sure, but as Riad Salameh, governor of the Banque du Liban (central bank) explains to The Banker: “Banks have been attracting more deposits in 2006 and total customer deposits rose 5.2% to reach $65bn, which is over three times the size of GDP [gross domestic product]. Despite the circumstances we are still seeing an active banking sector.” While a reported $3bn of deposits fled the country during the war with Israel, these deposits were reported to have returned in force once the hostilities ended.
Increased deposits are not the only indicator of the resilience of the banking sector. The consolidated balance sheets of all banks jumped by 8.3% to $76.2bn in 2006 and the combined profits of the banks in Lebanon rose a stunning 28.4% to a record $669m. While the sector is composed of 28 locally owned banks, two specialised banks and 18 branches of foreign banks, it is dominated by a handful of local banks led by Blom Bank, the Audi Saradar Group and Byblos Bank. These three accounted for more than 60% of profits in 2006 and they have combined market shares of close to 50% in both assets and deposits.
So how do the banks produce record profits when GDP growth tumbled from a positive 6% in 2004 to 1% in 2005 after the Hariri assassination, and is estimated to have fallen to a negative 5% in 2006 after the Israeli war?
Human tragedy
Paul Wolfowitz, president of the World Bank, noted at the January Paris III donors conference (see below) that on top of the human tragedy of the July war, Lebanon suffered $2.4bn in direct damages and $800m in indirect damages, while 120,000 people lost their jobs and face the risk of sliding into poverty.
For Lebanese banks, the past 30 years or more have been full of turbulence and strife. They are used to difficult conditions but the banking sector has also developed some unique coping mechanisms. Over the years, banks have tended to channel surplus liquidity into Lebanese government securities, which has provided a double- edged sword: an element of safety but also high direct exposure to the sovereign. Lebanese banks in general are the major source of government financing, as they hold the majority of outstanding government debt.
Public debt at the end of 2006 stands at just over $40bn, with foreign debt half that at $20bn. This public debt figure is estimated at about 180% of GDP, a relatively high ratio and a key concern for the country. While the banks have done well out of their intermediary government financing role and thereby have reduced their relative exposure to the riskier private sector, banks are seeking to limit their appetite for government debt.
But at present, the government exposure provides a convenient cushion. As Standard & Poor’s commented recently on the biggest bank, Blom Bank: “Claims on private sector credit at Blom Bank represent less than 15% of assets. The low proportion of loans to assets mitigates any concerns on asset quality.”
In explaining the structure of the banks’ portfolios, Mr Salameh says: “In the past eight years, the banks’ share of government debt has declined from 78% to 50% today.” This decline is part of the central bank’s strategy to completely deregulate and broaden the banks’ opportunities, both outside Lebanon and by the use of various international syndications and paper.
Guiding hand
The governor, a figure trusted by all political players and a possible candidate in the country’s presidential elections later this year, has played a significant personal role in forging a sense of stability in the banking sector. He modestly notes: “The central bank has been able to disassociate the political from the monetary environment. We have been able to sustain regular payments on debt without any delays or defaults and we have been able to keep a stable currency which has provided definite backing to the solidarity of the banks.”
Keeping the currency stable has been critical and although the dollarisation of deposits was high at the end of 2006 at 76.2%, compared with 73.1% at the end of 2005, the governor is confident that stability will be maintained. “I do not foresee a change in the exchange rate. The markets have found an equilibrium,” the governor notes, adding that the central bank’s record foreign holdings of $13bn plus $6bn in gold and other assets also provides a reasonable deterrent against conversion and exchange rate swings.
Meanwhile, the bigger banks, well aware of the political uncertainties and dangers in the domestic market, are raising capital and looking for expansion in the region, especially in Syria, Jordan and Egypt but extending to Yemen, Sudan and Algeria and also the Gulf area. This is being encouraged by the central bank, as Mr Salameh notes: “If banks can get 50% of their profits from abroad it will be better for them.”
Blom Bank, the biggest, with assets, according to published unaudited figures, growing by 19.3% in 2006 to reach $14.2bn, had a record year, despite events, producing net profits growth of 31.1% to reach $180.3m. Blom also produced the highest return on equity of the big banks at 16.8%, well above the industry average of 12%.
Following its acquisition of Egypt’s Misr Romanian Bank in December 2005, Blom is significantly expanding its operations in Egypt as well as looking elsewhere. Vice-chairman Saad Azhari says that after making a $10m profit in its first year, Blom intends to double its current 10 branches in Egypt to 20 by the end of 2007. He sees strong opportunities in retail, brokerage and car loans, where it is already number two.
Elsewhere, Blom is looking to strengthen its already strong franchise in Syria, it is opening its fourth branch in Jordan, and applying for licences in Algeria, the Qatar Financial Centre and also an investment banking licence in Saudi Arabia. The Saudi operation is expected to begin in late 2007 with capital of SR250m ($70m) owned 60% by Blom. With operations in 10 countries already, Mr Azhari is optimistic that Blom’s banking expertise can be attractive in many markets.
At Bank Audi, only marginally smaller than its fierce rival Blom with end 2006 assets of $14.2bn, the strategy and performance are similar. Audi produced net profits of $165m in 2006 with a return on equity of 13.3%.
In 2006, Audi set out a new platform for expansion through a massive $725m increase in equity of which $600m of common stock was brought by Egypt’s EFG Hermes Holding in January and $125m of preference shares were issued in September. Audi’s equity was boosted by 76% to $1.7bn. Audi general manager Samir Hanna makes clear the capital increase enabled the bank to “go regional” and he sees huge potential for retail in various countries where the middle market is largely untapped.
Expansion into Egypt
In Egypt, Audi acquired the small Cairo Far East Bank in March 2006 and is using it for a major push into the Egyptian banking sector. From its current three branches, Audi plans to open a spectacular 37 new branches this year, opening at least three a month starting in March. The capital for this Egyptian venture is to be raised to $200m and Mr Hanna expects Audi to have 60 branches in Egypt by the end of 2009 with expected assets of $4bn. This massive effort represents a major strategic exercise in staffing and logistics and other bankers warn that Audi may be overpaying significantly to achieve its grand plan.
Elsewhere, Audi acquired 75% of the National Bank of Sudan last year and expects to have a 17-branch network with huge prospects in two years. In Saudi Arabia, an investment banking arm, Audi Saudi Arabia, was launched in December, 2006; Audi, however, had been thwarted in its earlier attempts to buy the 40% stake of Saudi Hollandi Bank, owned by ABN AMRO, which has been up for sale but is still not sold.
Audi has its sights on establishing in Algeria and has applied for a licence; it is also keen to expand its existing franchises in Jordan and Syria, and is expected to begin operations in the Qatar Financial Centre in the second quarter of this year.
Byblos Bank, which saw a 14.4% increase in net profits to $79.4m in 2006, is also on the regional trail and looking at expansion in Sudan, Syria and Iraqi Kurdistan. Vice-chairman Semaan Bassil notes that Byblos aims to have 40% of its income and assets from outside Lebanon within five years and in 2006 doubled the bank’s outside contribution to reach 20%. “Lebanon has a bright future if there is political stability but we need to diversify away from Lebanon, we can export Lebanese expertise.”
Foreign escapades
Other smaller banks are also expanding abroad. In August last year, BankMed, owned by the Hariri family, bought a 41% stake in Turkey’s relatively small MNG Bank in a joint venture acquisition with Jordan’s Arab Bank. And seventh ranked Banque Libano-Française (BLF) last year completed an acquisition in Syria; deputy general manager Walid Raphael explains that 15% of BLF’s activities are now in Syria.
No one can predict the future in Lebanon but the banks and the central bank have been resilient enough to withstand the severe shocks of recent years. With political stability still elusive at home the banks have embarked on a regional expansion to significantly diversify their sources of income. With the considerable banking expertise that exists in the country, the Lebanese again look likely to make a success out of adversity.
PERILOUS PATH TO PARIS III IMPLEMENTATION
As the international donor conference in Paris in late January pledged a more than expected $7.6bn in support of Lebanon’s reconstruction and debt efforts, the donations were overshadowed by renewed outbreaks of sectarian violence in Beirut between Sunni and Shia elements.
While Paris III, the third such event since 2001, was deemed a great success, the Sunni-led, pro-western government of prime minister Fouad Siniora was facing violent protests from the opposition trying to bring down his government.
As at mid-February, the prospect of the government implementing its planned reforms as announced in Paris was being blocked by the domestic political deadlock. With opposition Hizbullah camped out in city-centre Beirut, determined to unseat the Siniora government, the need for a political solution is essential if the Paris III reform process is to become a reality. No side wants a return to civil war but a solution needs to be found to unblock the current impasse in government and to implement reforms.
Paris III gave an important vote of confidence to the Siniora government and Lebanon but local bankers are keen that the government actually delivers on its reform programme. The $7.6bn of pledges came from more than 40 countries and financial institutions, with Saudi Arabia leading the way with $1.1bn, followed by the US ($770m), France and the EU (both €500m).
The pledges provide Lebanon with some initial relief but the bulk of the commitments ($4.4bn) will be linked to the reform process which needs political agreement.
Central bank governor Riad Salameh explains to The Banker: “The up-front payment of $2bn will help the government meet its obligations in foreign [debt] without recourse to local markets and this will improve liquidity in the system.” In addition, Mr Salameh added that the International Monetary Fund (IMF) has accepted the Lebanese government’s reform programme, which provides confidence locally and avoids the fear of excessive IMF ‘haircuts’ or exchange policies.
In addition to the $4.4bn of disbursements that will require reforms to take place, international financial institutions such as the IFC and the European Investment Bank (EIB) have pledged $1.2bn. With the margins between Lebanese and US bonds declining and credit default swaps tightening, officials believe the financial markets have genuinely welcomed the results of Paris III.
Now that the financial platform for reconstruction and reform is in place it is now necessary to resolve the political logjam and allow the presidency and the council of ministers to work together.
While agreement is possible between the various parties in Lebanon, the disruptive influence of many regional and international forces remains hard to assess and therefore the results are hard to predict. But it is not for want of international support.
