US President Barack Obama is not the only person with cause to feel happy about the current outlook for Lebanon - the country's leading bankers are also in buoyant mood.

While Obama celebrates the re-election of the pro-Western alliance of political parties in June, Lebanese finance houses are enjoying an average 16.2 per cent increase in net profits for the first quarter of the year to $252.2m, which was reported the same month. These results follow a record-breaking 2008, when the leading group of Lebanese banks, those with deposits of more than $2bn, reported a 33.4 per cent increase in net profits.

For the first quarter of 2009, Byblos Bank reports a 19 per cent increase in net income to $24.96bn. Banque Audi, Lebanon's largest bank in terms of assets, reports 12 per cent profit growth to $61m, compared with $54m in the final quarter of 2008. This follows a recorded 19.1 per cent growth in net profits to $238m for 2008 as a whole.

Blom Bank, Lebanon's second-largest bank by assets, records a 12 per cent increase in profits for the first quarter of 2009, to $63.35m. This follows a 22.9 per cent growth in profits for 2008 as a whole, from $205m to $251m.

Joe Sarrouh, adviser to Lebanon's Fransabank, says there are two main sources of confidence in Lebanon's banks this year. "The first is that the banks were not seriously affected by the international finance system's crash; the second is the national election in June," he says. "For the first time, there were no major incidents and everyone respected the outcome."

Steady returns

Lebanon's economy this year is unlikely to experience a growth rate similar to 2008, when it expanded by 8 per cent. The government forecasts that gross domestic product (GDP) will grow by 4 per cent this year.

The banking sector's strong performance as the backbone of the local economy has reassured policymakers about the country's overall economic prospects.

Beirut's banks are nonetheless prepared for a slower year. "We expect Lebanese banks to remain profitable and make good money in 2009, compared with regional and international banks, but to have perhaps a slower growth in profits, owing mainly to the sharp drop of return on foreign currency liquid placements domestically and abroad, as these placements represent about 22 per cent of the consolidated balance sheet of banks," says Makram Sader, secretary general of the Association of Banks in Lebanon.

Traditionally, Lebanese banks have followed the conservative banking policies of Lebanon's central bank, Banque du Liban. Finance houses have not been allowed to speculate in risky packages of bundled debts, and at least 30 per cent of a bank's assets has to be in cash.

This approach is now paying off in what are difficult economic times for the rest of the world. "These moderate returns have always been there compared with much higher returns abroad, as a conservative policy has been pursued by Lebanese banks regarding investment in asset-backed securities and high-risk financial derivatives," says Sader.

In other words, Lebanese banks have not taken unmeasured risks nor invested in high-risk assets; they have maintained high liquidity levels as a way to manage the risks posed by an unstable regional environment.

Stringent risk programmes are supported by Banque du Liban, the tight regulatory oversight of which has helped the banking sector withstand regional political shocks over the years. Riad Salameh, governor of the central bank, will persist with this prudent approach. Salameh is urging commercial banks to maintain high levels of liquidity, even if it is at the expense of profits, and encouraging banks to take advantage of their strong profits in 2008 to strengthen their capital reserves.

To do this, they are expected to limit dividend distribution to 25 per cent of profits, though some banks may exceed this limit by up to 2 per cent, depending on their solvency level.

Expatriate deposits

Generally, solvency ratios - which assess a bank's ability to repay loans - among Lebanon's finance houses are strong. In 2008, the average Lebanese bank solvency ratio reached 18 per cent when calculated according to Basel I Accord criteria, and about 12 per cent when based on Basel II rules. These figures are healthy compared with the 8 per cent minimum solvency level required by the Basel regulations.

Liquidity growth continued through 2008 amid a shift from dollar liquidity to local currency, as depositors chased the higher interest rates on the Lebanese pound, up to 7.1 per cent, compared with the US Federal Reserve rate of 0.25 per cent.

But continued vigilance is needed. "Although the leveraging of the banking sector is reasonable, banks face material risks, not least due to the level of government securities they carry on their balance sheets," says Stathis Kyriakides, bank analyst at ratings agency Moody's Investors Service.

The banks' ability to pull in deposits, mainly from expatriate Lebanese, of which there are about 5 million, according to conservative estimates, is another source of confidence. For the first quarter of 2009, Banque Audi reported inflows from non-residents of about $15m.

"Deposit growth is looking fairly strong and that is the real strength of the sector," says Kyriakides.

In May, Salameh projected overall bank deposit growth of 7-10 per cent for 2009, but this now looks pessimistic. According to the Association of Lebanese Banks, the banks' total deposits increased by 6.3 per cent from the end of December 2008 to the end of April 2009, an annualised rate of 18.8 per cent, compared with growth of 4.3 per cent in the first four months of 2008. Deposits for the non-resident private sector increased by 12.4 per cent in the same period.

Overall, non-resident foreign currency deposits reached $11.7bn at the end of April 2009, increasing by 12.2 per cent from the end of 2008 and by 30.4 per cent year on year. The conversion of foreign currency to local currency deposits has continued to replenish the central bank's foreign currency reserves, which currently stand at an historical high of $24bn.

Lebanese banks' impressive deposit growth has sometimes obscured their lending activities. "Last year, all the analysts were focusing on the big increase in the deposit rate, which at $10.5bn for the year was a historic high," says Freddie Baz, group chief financial officer and strategy director at Banque Audi. "The yearly average for the preceding five years was closer to $5bn. No one was looking at the asset side of the balance sheet. Local banks increased their lending to the private sector by $4.5bn last year, which goes a long way towards explaining the high GDP growth rate."

The largest Lebanese banks started this year with a cautious outlook, setting budgets for flat earnings growth. Six months later, that pressure has lifted. "We can now comfortably say that the leading banks will register an increase in net earnings," says Baz.

Most of the big banks have boosted earnings in recent years by rapidly expanding their overseas branch networks, participating in financing opportunities in emerging markets - for example, Byblos Bank has a presence in Sudan - as well as in more mature GCC states. Banque Audi officially launched a Qatar office in March last year, while Blom Bank opened its Doha office in October.

Now Beirut bankers predict the focus for activity will become more domestic. "One recent phenomenon we have witnessed before is that Gulf real estate developers, which used to bring most of the funding with them, are now seeking financing from the Lebanese market," says Sarrouh. "This is new."

Developers are seeking to have at least a portion of their funding denominated in local currency. "It is a structural change in the build of borrowing in Lebanon," says Sarrouh.

A post national election feel-good factor may further boost growth, leading to more lending opportunities within the country. The Asso-ciation of Lebanese Banks says the stability brought by the election result, and a strong outlook for the tourism sector, could drive GDP growth of 5-6 per cent, compared with the 4 per cent predicted by the government at the beginning of this year.

"Lebanese bankers will obviously accompany these developments in extending more credit to domestic activity," says Sader. "The latest measures taken by the authorities in Lebanon to subsidise new loans from the beginning of 2009 are likely also to increase banks' loans to the domestic economy."

Historically, Lebanese banks have earned much of their income from servicing the state's debt - commercial bank assets are still concentrated on sovereign lending, which accounts for 55 per cent of assets - leaving them exposed to the charge of letting their loan books stagnate by failing to lend enough to the local private sector.

Bankers say this is starting to change. "Foreign investors often talk as if the local market is saturated, but that is not the case," says Baz. "In Lebanon, there is a productivity output gap - the difference between the actual level of national output and its potential level - estimated at 40 per cent of potential output. In order for that to be closed, it needs a new wave of lending to the domestic private sector."

Organic growth

Local banks increased lending to the private sector by $4.5bn last year, suggesting there are still domestic organic growth opportunities for them. The retail banking segment in particular is in its infancy and should provide a substantial revenue lift for Lebanese banks.

Much of the local banks' firepower has been focused on regional lending in recent years. Banque Audi has built a massive regional corporate lending portfolio of $1.5bn, while a host of other banks have rolled out branch networks across the region.

That explosive geographic expansion has come to an end and banks will now focus on consolidating their overseas positions. "The expansion will go on, not in terms of growing footprints, but consolidating their presence and growing organically and horizontally in these environments," says Sarrouh.

One market in which many Lebanese banks have an interest is Syria. Fransabank, for example, opened its first branch in Syria in May 2008 and now has three - two in Damascus and one Aleppa - with plans to open four more in the next two years. Syria, so often a cause for friction between Lebanon's communities, represents a major growth opportunity for its banks.

The possibility that the Obama administration will lift trade sanctions against Syria in 2010 could give the market a boost. Having laid the foundations with their investments in branch networks over the past five years, Lebanese banks are ready to capitalise on any revival in Syria's economy.