Jordan’s banks have been highly profitable in recent years, capitalising on a strong operating environment and demonstrating resilience to toxic financial pressures swirling through the region’s banking system.

But earnings are now feeling the effect of higher credit costs, while a weaker economy last year has acted as a further drag on performances. Jordan’s banks will feel the impact on the bottom line of a sluggish real estate market and a volatile stock exchange, which have eroded the comfort zone provided by generally solid financial fundamentals.

Economic slowdown in Jordan

The country’s Qualifying Industrial Zones as well as exports of potash and phosphates experienced marked reductions because of reduced demand in the US and India.

“The real estate and construction sectors have contracted and forced credit demand to regress as well. That said, I believe that as the economy progresses and attains once again its threshold and sustainable levels, demand will get back on track. Credit will expand accordingly, helped by the continued monetary easing policies that are in place,” says Abdel Hamid Shoman, executive chairman of Arab Bank, the country’s largest institution. 

Capitalisation levels in Jordan are healthy, providing a cushion for growth and absorption of possible loan losses

Anouar Hassoune, Moody’s Investors Service

A culture of prudence has served the sector well. “Capitalisation levels in Jordan are healthy, providing a comfortable cushion for growth and for the absorption of possible loan losses,” says Anouar Hassoune, senior credit officer at Moody’s Investors Service. 

Nevertheless, Moody’s expects the country’s banks to be challenged by reduced earnings capacity and higher credit costs. Declines in the value of securities in late 2008 are also expected to have an adverse impact on the bottom line.

In the short-run, says Shoman, the banking sector must gear up for the recovery following the contracted performance during the past two years. “The financial crisis adversely affected economic growth and credit extension as revealed by the marked contraction in gross domestic product (GDP) from about 7 per cent in 2008 to 3 per cent in 2009. As expected, a slower economy reduced demand for credit relative to accumulating deposits and other banking products. This trend persisted despite the deployment of quantitative easing policies that cut interest rates four times since the start of the global financial crisis,” he says.

Jordan should be proud of its banking sector, which has the highest market cap to GDP of Arab countries

Abdel Hamid Shoman, Arab Bank

A focus on banking reform has helped to improve the sector’s asset quality over recent years. The regulator, the Central Bank of Jordan (CBJ), insists that they maintain high levels of capital. All banks are now comfortably above the CBJ’s 12 per cent minimum capital requirement, with a sector average capital adequacy ratio of 19 per cent. As the economy improves – the CBJ is forecasting real GDP growth of up to 4 per cent for 2010 – banks could reap the benefits of robust credit policies and risk management functions maintained during the boom years.

However, it may take more time for the improvement to make itself felt on the ground. “2009 was a difficult year, and 2010 seems to be a continuation of that. We expect flat revenues and controlled costs,” says Shoman. “Hopefully the economy and interest rate environment will pick up in 2011.”

Conservative policies allowed banks to increase liquidity to JD4.3bn ($6.1bn) in 2009, from JD1.4bn at end-2008. This compares with a pre-crisis average liquidity level of JD400m. Their prudence has also been reflected in restrained lending over the past year. Bank credit grew by only JD200m in the nine months from the end of 2008 to the end of September 2009, compared with the average 10-15 per cent lending increase seen in recent years.  

Like their counterparts throughout the region, Jordan’s banks have not been minded to reactivate lending policies, despite much public clamour for them to do so. Although the central bank has repeatedly cut base rates, the average bank interest rate for loans and advances at the end of 2009 was 9.07 per cent, not much lower than the 2008 average of 9.48 per cent.  

Debt provisioning

Deposits have held up well, increasing by 11 per cent to the end of 2009 over the previous year. This growth is attributed to the CBJ’s policy of permitting a relatively wide interest rate differential against the dollar in favour of the dinar. Foreign reserves at the central bank now exceed $11bn, compared with just $5bn three years ago. However, the sector has been through a tough year in 2009, with profits at all but one bank – the retail-focused Cairo Amman Bank – falling.

Though much has been made of the sector’s relative insulation from the negative effects of sub-prime write-downs, provisioning has taken a significant bite out of banking sector profits. 

Arab Bank, which reported a 26 per cent decline in pre-tax profit to $783m in 2009, was adversely affected by a decline in volumes and margins and increased loan impairment charges. This reflects a number of major impaired loans, including exposures to the Saad and AH al-Gosaibi groups in Saudi Arabia, as well as to Dubai World. Arab Bank’s non-performing loans (NPLs) rose from $40.4m to $204m in 2009.

Arab Bank accounts for more than 50 per cent of the Jordanian banking system’s assets, so its performance will shape the wider sector.  

The bank is confident NPLs have reached their peak. “Even though there has been a rise in NPLs to 6 per cent, Arab Bank’s NPLs are considered at a very healthy low ratio of normally 3.3 per cent,” says Shoman. “Our NPL coverage is about 60 per cent and will be built up by the end of the year. With securities, such as collaterals and mortgages, though, it is comfortably above 100 per cent. A good portion of our NPLs are fully provided for, but are kept on the books for collection considerations. We feel that NPLs have reached their peak.”

Most banks have set aside higher provisions to cover possible defaults and NPLs. The country’s ratio of NPLs to total loans rose from 4.2 per cent in 2008 to 6.4 per cent by the end of 2009. 

The Housing Bank for Trade & Finance, Jordan’s second-largest bank and largest by branch network, with 101 branches, reported a 34 per cent fall in net profits last year to JD66.6m, despite a 6 per cent growth in income. The bank’s allocation of JD65m as provisions for NPLs last year ate into its profit margins. 

Retail banking sector in Jordan

Despite the deterioration in asset quality, Moody’s says the recent rise in NPLs does not mean a return to the higher levels seen between 2002 and 2005, though much depends on the prospects for a recovery in the property market and a better performance for the Amman bourse. 

Cairo Amman Bank’s bucking of the downward profit trend reflects that institution’s relatively lower exposure to the corporate sector. Despite an across-the-board decline in sector profits last year, net income at Cairo Amman Bank – which has a large footprint in the Palestinian Territories – rose 25.9 per cent to JD25.5m in 2009, due to strong retail growth. More than 60 per cent of Cairo Amman Bank’s loan book is focused on retail so it has managed to hedge against any corporate clients defaulting.

Jordan Kuwait Bank has maintained the lowest NPL ratio in the sector for the past seven years, but even it was forced to hike provisioning from 0.5 per cent of gross credit facilities in 2008, to 3 per cent in 2009. Not that it is panicking.

“Yes, our provisions increased in 2009, but everything is relative – our NPL numbers are still lowest in Jordan and our return on equity and on capital for 2009 is still very healthy,” says Haythem Buttikhi, assistant general manager of Jordan Kuwait Bank.

The bank reported an 11.5 per cent fall in pre-tax profits to $85.3m in 2009, but is looking forward to a turnaround this year. “In 2009 we were pessimistic. We were afraid of volatility and the effect of the international situation and probably for the first four or five months of 2009 we were doing virtually no lending. But in 2010, things are different,” says Buttikhi. “Last year saw a lot of shifting in strategy and tightening cost structure and expenditure, so really 2010 is looking better and we feel the worst is behind us.”

Jordan’s banks should start to reap the benefits of the robustness of their respective credit policies and risk management functions maintained during the boom years. Retail remains a relatively underserved portion of the banking market. More than 70 per cent of credit facilities granted by listed commercial banks were directed to the corporate segment in 2008. Only 12 per cent went to the retail segment.

This should change as banks target the consumer sector. “In terms of growth, we see a high potential for our consumer banking, which is still relatively new and makes up about 30 per cent of our business,” says Shoman.

Banks have seen their avenues for earnings growth closed off in the past year. They remain liquid and most hold a large amount of deposits overnight with the central bank, but this is yielding only low rates of return. The current overnight rate is just 2 per cent, compared with 5 per cent one year ago.

“For the fifth time since the financial crisis started in September 2008, Jordan’s central bank lowered interest rates in February 2010. Banks are certainly willing to lend out per their widely announced policy, helped by the private-public government-appointed committee to facilitate lending during the downturn. However, the real culprit has been the sluggish demand for credit, which was sharply curtailed under pressure from … the global recession,” says Shoman.

State borrowing

Yet low interest rates provide a strong incentive for banks to be competitive in winning corporate business. “One factor helping us is that the government has stopped growing. When the crisis happened, there was a shift in strategy and increasingly the government started borrowing from Jordanian banks,” says Buttikhi.

At that point, it made sense to subscribe to government paper, rather than lend to corporate entities. “That has now stopped, mainly because the government realised it was competing with the private sector and this was affecting private-sector growth negatively,” says Buttikhi. 

Banks will be looking to enter 2011 with healthier income statements, hoping that the years of prudence will have enabled them to weather the worst of the current storm. The tough part will be to revitalise corporate lending and drive the kind of virtuous cycle that will bolster loan book quality and deliver the robust earnings profiles that were once the preserve of the local banking sector. 

“Jordan should be proud of its banking sector, which has the highest market capitalisation to GDP of Arab countries,” says Shoman. “Despite the challenges Jordan’s banking sector faces, its soundness is best illustrated by the fact that while many global banks collapsed and many others received direct capital injections from their governments, the number of collapsed banks in Jordan was zero and no Jordanian banks received direct capital injection.”