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Middle EastDecember 12 2012

Jordan: a brighter future or more of the same?

Ongoing regional instability has taken its toll on Jordan’s banks, which are feeling the impact of a sharp slowdown in the real estate and construction sectors. But with the central bank receiving praise for its response to the crisis, what are the country’s prospects for recovery?
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Jordan: a brighter future or more of the same?

The Arab Spring uprisings that have swept across the Middle East and north Africa region since early 2011 have brought about no shortage of historic events. Against a backdrop of toppled dictators, mounting death tolls and even military intervention by Nato, it is easy to understand why Jordan’s political upheaval has garnered considerably fewer headlines than its neighbours.

Unlike leaders in neighbouring countries, Jordan’s King Abdullah II has reacted almost immediately and positively to the calls for change. In response to the first wave of protests in January 2011, King Abdullah dismissed both his cabinet and prime minister in February and within a week a new government was formed. In August 2011, he approved a list of constitutional amendments and revisions. In October the same year, he once again fired his government and appointed a new cabinet.

“This year’s events have opened the way to positive change, but in many places also created painful economic dislocations,” said King Abdullah at a World Economic Forum meeting held in Jordan in October 2011. “Strategies are urgently needed.”

The ruler’s expedient approach has helped Jordan fare considerably better than other countries in the region. Even so, Jordan’s economy is highly correlated to swings in regional economic cycles. Consequently, the Arab Spring, combined with the slowdown brought on by the global financial crisis, has had a dramatic impact on Jordan's performance over the past few years. This has led to a marked reduction in its key revenue drivers, particularly foreign workers’ remittances, services, real estate and foreign direct investment.

As a result, growth in gross domestic product (GDP) contracted sharply from a peak of 7.2% in 2008 to 2.3% in 2010, before climbing marginally to a level of 2.4% in 2011. Jordan recorded a budget deficit of more than $1.4bn in the same year, more than 5% of the country’s GDP, while unemployment stood at about 13%.

Impact on banks

This negative macroeconomic environment has inevitably taken a toll on Jordan's banking industry, which comprises 26 institutions. The sector’s net external debt position deteriorated from 14.4% at the end of 2007 to an almost break-even level of 0.1% at the end of 2011. Consequently, the banks have struggled to generate profits; their net income before tax grew by a marginal 1.3% in 2011 to $1.1m.

In its Banking Industry Country Risk Assessment report published in October 2012, ratings agency Standard & Poor’s assigned Jordan a score of seven to reflect its opinion that the country has “a very high risk in economic resilience and credit risk in the economy”. The assessment is scored on a scale from one to 10, ranging from what S&P views as the lowest risk banking systems to the highest risk, and is based on two main areas of analysis: economic risk and industry risk.

“We are still seeing a negative trend in the banking sector,” says Paul-Henri Pruvost, the primary credit analyst on S&P's Jordan report. “We are monitoring the quality of lending and while non-performing loans (NPLs) are now stabilising, we view negatively the fact that there is no convincing pick-up to be expected in terms of economic growth at the sovereign level, with real GDP growth expected to remain in the low single digits over 2013."

Overexposure to real estate

While the sector-wide NPL ratio has fallen considerably from 7.5% in 2010 to the current 4.5%, Jordan is a well-diversified economy and banks are continuing to feel the effects of a slowdown across all sectors, especially construction and real estate, retail and exports.

In particular, banks remain highly exposed to the construction and real estate markets – together constituting an estimated 35% of banks’ total lending in June 2012 – which have arguably been the hardest hit. 

In an interview with The Jordan Times in October 2012, Ahmad Tarawneh, president of the Jordan Contracting Construction Association, described the past four years as the most difficult he has seen and said that the volume of projects carried out by local construction firms had declined by 80% since 2008. Mr Tarawneh warned that a prolonged slowdown would destroy the sector.

The slowdown in the real estate market has seen banks pull back from allocating credit to this sector – previously a key revenue driver – and also led to a deterioration in asset quality. Real estate mortgages currently comprise 19.7% of total credit facilities at the Housing Bank for Trade and Finance (HBTF), the country's second largest lender, with the bank forecasting an increase in provisioning in 2012. 

HBTF's group loan loss provision charge in 2011 was $65.2m, which the bank is forecasting to increase to $85.9m in 2012. Meanwhile, HBTF plc's provisions for 2011 were $53.5m, forecast to rise to $66.2m in 2012.

“We are continuing to build provisions for existing NPLs as per the central bank’s regulations until each NPL is 100% provided for, within a four-year period, depending on the collateral,” says Omar Malhas, general manager of HBTF. “However, the group also includes a bank in Syria, for which we are building provisions.”

Shrinking liquidity

Mr Pruvost at S&P says: “Prior to the downturn, Jordan was experiencing a construction boom with a significant proportion of Jordanian expatriates who are working in the Gulf Co-operation Council repatriating their earnings and investing in their home real estate market. However, clients have been experiencing difficulties in repaying loans and Jordanian companies have seen their liquidity shrinking because of cash-flow issues.”

Customers have also been depositing less money at the banks, according to one senior banker. “In Jordan, the savings ability of the banks' customers has shrunk due to economic inflation and therefore there were not many deposits to finance long-term loans or mortgages. At the end of the day, banks want to select the customers with a high profile,” says Abdul Alawi, general manager of Jordan Commercial Bank. 

The combination of reduced deposits and customer difficulty servicing loans has created an overall negative investment climate and subdued banks’ appetite to lend. “What we’re seeing is that banks have adopted a cautious approach to lending because of the uncertain economic environment and the lack of high-yielding investment opportunities,” says Mr Pruvost.

“As a result, Jordanian banks' exposure to their government has been growing steadily since 2007, especially as banks shied away from lending in a risky environment and the government needed financing. We consider this a potential negative credit factor.” 

Government exposure

Indeed, domestic banks have been acting as the government's main creditor, while Jordan’s budget deficit rose from 5.4% of GDP in 2010 to 6.2% of GDP in 2011. The country’s debt-to-GDP ratio stood at about 65% at the end of 2011, as higher energy and commodity bills increased expenses. As a net oil importer, Jordan has acutely felt the recent sharp increase in the price of oil; its oil import bill rose by $1bn on an annual basis in 2011.

Concurrently, banks' exposure to the government grew steadily from about 9% of consolidated banking assets and 0.7 times their own capital at the end of 2007 to a respective 21% and 1.4 times as of September 2012.

In an effort to stimulate growth, the Central Bank of Jordan began lowering interest rates on loans extended to banks in May 2012, with interest rates becoming the rediscount rate on the day loans are extended to banks, minus a 2% margin. The move is aimed at facilitating industrial development by encouraging financing to manufacturers, especially small and medium-sized enterprises. Furthermore, while Jordan’s banks are usually prohibited from lending in foreign currency, the central bank has made an exception for export or re-export financing.

Amid all the upheaval, Jordan’s central bank has been praised by both industry insiders and observers for monitoring the situation and regulating accordingly. The general consensus is that the government is taking positive steps to improve future economic performance.

The new cabinet that was appointed by King Abdullah in October included a finance minister tasked with putting a cap on the country’s widening budget deficit. Indeed, the 2012 to 2014 national budget is centred around tightening the fiscal purse strings with the intended goal of reducing the budget deficit to 4.6% in 2012 and then further to 3.5% by 2014. 

“The government of Jordan is seeking to conduct a comprehensive reform programme covering all aspects of the economy,” says Mr Alawi. “Reforms have been proposed to the tax law and are currently under review by the parliament. However, their approval has been delayed, awaiting the next parliamentary election at the end of January 2013.”

Recovery mode

In spite of the prevailing economic and political uncertainty, the Jordanian banking sector started to show signs of recovery in 2012. The overall declining trend in NPLs has meant that banks are becoming more confident about extending credit to the private sector, with credit growing by about 10% on an annualised basis over the first 10 months of 2012. Meanwhile, private sector deposits grew by about 5% over the same period, versus 9% for the full year in 2011. 

Banks are now also starting to cut back on their allocation of provisions. The sector’s provisioning levels stood at $917m in 2011, and while full-year figures were not available when The Banker went to press, provisioning charges for the first three quarters of 2012 stood at $296m compared with $328m for the same period of 2011. As a result, banks are recording an uptick in profits. Arab Bank, the country’s largest lender, recorded a 13% annualised increase in net profit to $484.5m for the first nine months of 2012, while HBTF saw profits rise by 3.8% to $110.9m.

“Banks are profitable enough to allocate provisions, but we view negatively the fact that there’s no convincing pick-up in growth at the sovereign level,” says Mr Pruvost, hence partly why S&P has assigned a negative outlook to Jordan’s sovereign credit rating.

“We think there could be a further deterioration over the next six to 12 months, and there is still a lot of uncertainty and question marks surrounding a further negative impact on the banking system in light of the uncertain economic prospects at the sovereign level. The situation is pretty fluid, but I think it is fair to say that any immediate growth will hinge on the recovery prospects of neighbouring economies,”  adds Mr Pruvost.

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Read more about:  Middle East , Jordan , Middle East , Syria