The tense political standoff is leaving few areas of Lebanese life untouched. Even the country’s commercial banks, traditionally the cornerstone of the fragile economy, are looking nervously into the future. Byblos Bank chairman Francois Bassil has warned that profits may be hit if the presidential election is delayed, given that the bank may be forced to increase provisioning on non-performing loans. Bassil, who also chairs the Association of Banks in Lebanon, has voiced concerns that the value of treasury bills (T-bills) – the source of a majority of banks’ income – could drop by up to 50 per cent if the presidential election does not take place on time, because government institutions would be prevented from functioning properly.

Political vacuum

‘If we end up with no president at the end of the constitutional deadline, and two cabinets, that could increase already significant levels of uncertainly in the market,’ says Nassib Ghobril, head of research at Byblos. ‘The prices of eurobonds would decline the longer the crisis continues. We are not faced with that nightmare scenario yet, but we would not be surprised if prices of eurobonds declined in an extended political vacuum.’

Moody’s Investors Service has already delivered a stark warning about local banks’ dependence on a poorly rated sovereign – rated B3 by Moody’s. The ratings agency issued a negative outlook for rated Lebanese banks in September, reflecting the fragile political environment and the high sovereign exposure. About 28 per cent of the banking system’s interest income originates from Lebanese T-bills, with about 45 per cent of total interest income derived from sovereign-related investment and placements with Banque du Liban (BdL – central bank). Such a high level of dependence on government paper is worrying, warns Moody’s, since any disruption in the latter’s payment capacity is likely to significantly jeopardise bank revenues. And yet it may not happen. Profitability is fairly strong, with BdL governor Riad Salameh anticipating 6-7 per cent average net income for local banks in 2007. Profits grew by nearly 7 per cent in the first seven months of the year, reaching£Leb 682,000 million, according to BdL figures. Consolidated balance sheets grew by 10 per cent in the period to almost£Leb 119 trillion. A strong retail deposit base has endowed a robust funding profile. ‘About 70-80 per cent of total deposits are from individuals or small businesses,’ says Nondas Nicolaides, bank analyst at Moody’s. ‘We think having a strong retail deposit base constitutes strong funding for these banks.’ That deposit base has proved largely immune to political shocks over the past few years, although the dollarisation of deposit rates, standing at a high of 76 per cent in May 2007, reflects the political and economic turmoil of the past two years. ‘There have been some ups and downs in terms of dollarisation and some level of capital flight, but they were able to replenish those deposits,’ says Nicolaides. ‘The strongest credit feature of Lebanese banks is their strong retail deposit base.’ The high yields from government securities continue to provide a healthy line of income for Lebanese banks, but ceilings are being hit. Analysts say Lebanese banks have already reached the limit on how much government paper they can subscribe to, so increasing numbers of banks are tending to roll over what is existing on their books rather than expose themselves to more government debt. ‘Whatever matures they tend to roll over, instead of investing an incremental amount of money in government securities,’ says Nicolaides. ‘That dynamic might change in the next five to 10 years if there is an improvement in the fiscal position, with government exposure likely to account for a smaller proportion of the total balance sheet – but that will not happen in the short term.’ Lebanese banks have built up other revenue-generating franchises in recent years. Retail is a clear focus for many banks, which have to some extent anticipated a decline in exposure to government securities. Credit Libanais grew its retail customers’ portfolio by 8 per cent in 2006, expanding retail sales by 10.6 per cent and revenues by 6 per cent, to account for 37 per cent of the group’s consolidated net banking income at the end of the year, says Fadlo Choueiri, head of corporate finance and economic research at the bank. Personal loans increased by more than 20 per cent in 2006. ‘The sustained increase in the demand for personal, consumer, housing and SME [small and medium-sized enterprise] loans owe, in the first place, to the prevailing economic environment, which fosters the principle of small-scale borrowing with less stringent lending conditions,’ says Choueiri. However, the asset quality of Lebanese banks has been affected by the lacklustre performance of the corporate sector, which itself mirrors the dull growth of the Lebanese economy. ‘This should lead to more conservative lending policies by Lebanese banks in the medium term until more stable and solid economic conditions emerge, and thus limit profit margins unless compensated by a diversification in their product mix,’ says Choueiri.

Regional expansion

The scarcity of quality domestic lending opportunities remains a major structural hazard. The Lebanese banking system’s loan book comprised a low 23.2 per cent of total assets at the end of May 2007, following a downward trend over the past few years. Banks are unlikely to ditch their conservative lending strategies until macroeconomic conditions improve.

This has prompted Lebanese banks to consider regional expansion in the past couple of years, in an effort to exploit the high returns on offer in emerging markets such as Syria, Jordan, Iraq, Yemen and Sudan. This has led to a series of acquisitions. This year, Banque Audi picked up Egypt’s Cairo Far East Bank for£Leb 142,000 million, confirming its focus on external growth. According to Moody’s, expanding foreign operations diversifies banks’ income and funding streams, while boosting their business franchise in captive markets – constrained as they are by the relatively small size of Lebanon. Private banking and trade finance activities carried out at these branches generate non-interest income in the form of fees and commissions, an area that most Lebanese banks are looking to enhance.

Investment opportunities

Blom Bank, the largest Lebanese institution, now draws about one-third of its income from outside the country. This new line of business has proliferated on the back of the large number of Lebanese expatriates throughout the Middle East and North Africa, reasserting the link between the Lebanese diaspora and the home country.

International construction projects are now securing facilities from Lebanese banks. ‘Bank lending is improving because banks are lending to Lebanese companies doing business abroad, or lending for projects abroad, especially in the Gulf,’ says Ghobril. The underlying strategy is to exploit developing regional markets and reap the benefits of promising banking prospects in these emerging markets, given the high liquidity overhang at domestic banks, and the limited domestic investment opportunities. Foreign expansion will prove a material long-term, rather than near-term, source of support for Lebanese banks. Yet other overseas sources will help boost bank performances. A sustained increase in foreign remittances will also continue to alleviate the risk of migrating deposits outside of the country as political tensions escalate, says Choueiri. The other main medium-term challenge facing Lebanon’s banking fraternity is consolidation. The sheer size of the local banking market – 52 banks servicing a country with a labour force of barely 1.5 million – defies logic. Despite some domestic merger and acquisition (M&A) activity, such as the acquisition of BLC Bank by Fransabank, there is significant scope for consolidation. The process has been incentivised by the central bank, with long-term soft loans being offered in an effort to cut a swathe through the large number of small, family-owned institutions crowding the market. With stringent Basel II regulatory requirements also pending, it will become even more difficult for small players to prosper. But bankers warn there are few attractive opportunities. In any case, the country’s banking assets are already highly concentrated, with the top 10 banks accounting for about 70 per cent of local market share. There appears little appetite for picking up small, underperforming assets. ‘We have branches that are bigger than many banks and we are growing at the size of three or four of them,’ says Fadi Osseiran, general manager at Blominvest. ‘There is no compelling reason to buy one now.’ A smaller, more efficient banking sector will clearly help commercial banks withstand political unrest. Instability will continue to chip away the asset quality of the loan portfolios at Lebanese banks and as the country enters a dangerous new phase, additional provisioning levels will be needed, affecting profitability. But in Lebanon, there is always an upside. Bankers are not likely to lose their nerve, even if the political climate appears far from clement for boosting income levels. Looking ahead, a small improvement in regional stability and better macroeconomic news will spawn new investment projects, from which Lebanese banks can benefit. The overseas expansion, meanwhile, represents a canny exploitation of Lebanon’s extensive foreign relationships. Such ties will stand the sector in good stead as banks are called on to steady a rocky ship of state.