Egyptian banks face further pressure from COVID-19 fallout

Dubai: Egyptian banks face asset-quality deterioration and continued pressure on profitability through 2021 amid the economic fallout of the pandemic according to Fitch Ratings.

The economic impact of the pandemic is weakening Egypt’s growth momentum. Fitch Ratings expects real GDP growth to slow to 3 per cent in the fiscal year to end-June 2021 from 5.6 per cent in 2019 given the negative impact on key sectors, including tourism, trade, transportation and the Suez Canal, which represent around 23 per cent of GDP.

Rising loan impairments amid the difficult economic environment and low interest rates have resulted in declining profitability of banks.

“We expect continued pressure on operating profitability due to lower interest rates and higher loan impairment charges as borrower support measures end. We do not expect this to lead to capital erosion, but capitalisation remains a credit weakness given banks’ high exposure to the sovereign and large individual obligors,” said Zeinab Abdalla, Director at Fitch in a note/

Regulatory capital ratios are inflated by the zero risk-weighting on local-currency sovereign debt.

Asset quality

Fitch said the Central Bank of Egypt’s (CBE) forbearance (loan deferrals and restructurings) measures are masking the underlying asset quality problems.

Support measures included six months’ deferrals of interest and principal payments for borrowers between March and September 2020. Unlike other jurisdictions, the CBE’s credit moratorium was extended to all obligors unless they opted out of the scheme. Significant portions (up to 80 per cent) of the loan books of some banks were under the credit moratorium but some corporates have started opting out due to high interest expense accruals.

The impact on banks’ asset-quality metrics will not be fully visible before mid-year as some exposures were restructured beyond the expiry of the CBE’s credit extension in September due to borrowers’ still constrained cash-flows and debt service capacity.

The IMF Article IV report (February 2021) on Egypt quotes the CBE as saying that loan restructuring after the end of the six-month moratorium has been limited. However, Fitch believes that demand for restructuring could increase, especially from smaller corporates given challenging business conditions.

The rating agency believes that the CBE’s support measures could understate the real level of problem (particularly stage 3) loans in the sector.

Inflated credit growth

Credit growth reported in Egypt’s banking sector hugely inflated because of the credit deferrals. The CBE expanded its EGP100 billion lending programme at subsidised rates of 5 per cent to 8 per cent to corporates in the manufacturing, agriculture and tourism sectors. Combined with the six months’ deferrals of loan repayments, this contributed to the 26 per cent loan growth in during the first nine months of 2020, up from only 4 per cent in 2019.

The recently announced CBE circular requesting banks to increase their SME lending to 25 per cent of their loan portfolios from 20 per cent may support credit growth but could compromise banks’ underwriting standards and increase their exposure to volatile sectors in a weaker operating environment.

“We expect loan growth in the high single digits in 2021, supported by a lower interest rate environment, but credit demand is likely to be driven by short-term working capital facilities. Capex financing is expected to pick up in 2022 on the back of recovering economic growth, potentially higher foreign investment and reduced uncertainty regarding the pandemic,” said Abdalla.

Vulnerable forex liquidity

Although foreign currency liquidity has been improving, Fitch expects vulnerabilities to persist A significant part of foreign investments in Egyptian sovereign local currency T-bills and bonds (portfolio inflow) is done through the banks, notably public-sector banks.

Typically, foreign investors would provide foreign currency to banks and banks would in turn buy government bonds in local currency. Banks tend to park the largest part of this foreign currency inflow in (liquid) offshore inter-bank placements but some would also use a small portion to grant (less liquid) foreign currency domestic lending. This inflates the banks’ foreign liquidity ratios as the vast majority of the FC inflow is invested in liquid assets. When foreign investors exit (i.e. portfolio outflows), the positive impact on the banks’ FC liquidity ratios can reverse sharply and quickly.

The banking sector’s foreign currency liquidity came under pressure in March and April 2020 due to $17 billion portfolio outflows from Egypt as foreign portfolio investors withdrew from local currency government debt at the start of the pandemic. These withdrawals resulted in Egypt’s foreign currency reserves dropping by $9.5 billion to USD36 billion between February and end-May and in the depletion of banks’ net foreign assets.

Further consolidation

Fitch expects Egypt’s banking sector will witness further consolidation. The remaining domestic banks (excluding subsidiaries of international banks) have very fragmented market shares and weak franchises.

“We expect to see further mergers and acquisitions (M&A) in the banking sector. There is a strong appetite from Gulf Cooperation Council (GCC) banks to expand in Egypt given the sector’s attractive profitability even for those with small market shares,” said Abdalla.