Caught between public uprising and public debt

Banking in the Gulf may still be subdued, but that's preferable to the pressures felt by some neighbours in the region.

Counterparts in Egypt, Lebanon and Syria, most obviously, are caught up in a complex web of regional political turmoil, dwindling economic growth and rising sovereign debt.

The fortunes of the banking sector in these countries are linked to their close economic relations, cross-border operations and interwoven regional politics. Analysts say the sector outlook remains grim in all three cases.

Lebanon's political turbulence was compounded by a wave of popular uprisings that swept through the region from the beginning of this year. The excessive exposure of the country's banks to domestic government debt, their huge dependence on foreign deposits for funding, and political turmoil in neighbouring Syria as well have combined to weaken their balance sheets.

Lebanese banks have a "long-term vulnerability" to their dependence on foreign depositors and on Lebanon's debt-servicing capacity, the London-based Economist Intelligence Unit said in a recent report.

Most foreign investors have avoided Lebanon's bond market because of its growing debt — at 134 per cent of annual economic output, the highest in the Arab world, according to the International Monetary Fund's data.

Lebanese banks hold about 70 per cent of the nation's debt, which is rated B1 by Moody's Investors Service, four notches below investment grade, and B by Standard and Poor's, the fifth-highest junk rating.

Last month Moody's changed its rating outlook to negative from stable on the stand-alone bank financial-strength ratings of four Lebanese banks: Bank Audi; Blom Bank; Bank of Beirut and Byblos Bank.

"The negative outlook on the system's two largest banks — Bank Audi and Blom Bank — reflects material exposures to Egypt and Syria. Byblos Bank's exposure to [such] countries is more moderate, while Bank of Beirut's is limited," Moody's said in its recent rating update.

Political uncertainties and mounting government debt burdens are likely to impact the banks' performance. "For the Lebanese banks we expect single-digit revenue growth, [with] realised bond gains helping net earnings," said Jaap Meijer, head of banks research and senior analyst at AlembicHC.

Dwindling numbers

As the turmoil in Syria continues, the Lebanese economy has already taken a hit because of the dwindling tourist numbers, and because of a dip in cross-border trade in Lebanese villages that rely on Syrian goods and services. In addition, more than 30 per cent of Lebanon's exports are transported over land through Syria.

Exports to Syria fell 17 per cent in the first half of this year compared with the same period a year earlier. The budget deficit jumped 41 per cent to 1.83 trillion Lebanese pounds (Dh4.41 billion), the Finance Ministry said in July.

In the first six months of 2011 the real estate sector — which had already shown signs of a slowdown in 2010 — recorded a contraction in transaction volumes.

As a result, Lebanese economic growth in 2011 is projected to slow to around 2.5 per cent from over 7 per cent in the past four years, and weaken credit conditions.

Analysts say further deterioration in neighbouring Syria would be bound to spill over to business sentiment in Lebanon. Simply, Lebanese banks' operating environment heightens the risks to asset quality and performance.

According to Nassib Ghobril, chief economist and head of the economic research and analysis department at Byblos Bank, the banking sector is always affected by threats to the economy, but the most damaging is the psychological aspect. "The impact is on investor sentiment and confidence," he said.

One of the biggest fallouts of sinking confidence is the risk of rich Lebanese expatriates withdrawing their deposits, a mainstay of Lebanese banks' funding sources. "Growth in bank deposits may slow to 7 per cent this year after expanding 10 per cent in 2010," Central Bank Governor Riad Salameh said earlier this month.

Ironically, some analysts suggest this shortfall will be covered through an inflow of money from Syria. According to unofficial estimates, $20 billion (Dh73.4 billion) left Syria since the uprising started, and most of it ended up in Lebanese banks.

However, Makrem Sader, Secretary-General, Association of Banks in Lebanon, rejects that figure. "These numbers were exaggerated. Deposits in commercial banks operating in Lebanon have increased during the first five months of this year, but only at a rate of three per cent," he said.

In Egypt banks are facing prospects of a decrease in deposits and an unprecedented rise in loan losses due to the economic downturn and an excessive concentration of risk in sovereign debt.

Moody's revised its outlook on Egypt's banking system to negative from stable on the basis of the growing exposure to lower-rated Egyptian sovereign debt, in addition to the political situation affecting the economy.

The ratings agency said it expected a decline in tourism, foreign direct investment, incoming fund flows and private consumption, reducing Egypt's economic growth to around 2 per cent in the next 12 to 18 months.

"These adverse economic conditions are likely to challenge the banking system's asset quality and business prospects as well as its profitability and internal capital-generation capacity," it said in a report.

Moody's measured the exposure of Egyptian banks to sovereign debt at a high 26 per cent of banking sector assets, saying it was likely to rise further as the government turned to banks to finance its growing deficit.

Although analysts do not see any imminent sovereign default risk, most Egyptian commercial banks are facing concentration risk from excessive holding of sovereign debt. "This adversely impacts commercial lending in the country. We expect overall bank lending in the country to decline more than 1 per cent this year," AlembicHC reported.

Valuation slump

A recent study by Zawya Equity Capital Markets Research showed that the economic impact of the revolution had an all-encompassing effect on all sectors of the Egyptian economy, with the valuations of listed stocks declining sharply. Travel and leisure was one of the worst-hit sectors (54 per cent decline), followed by the real estate sector (down 29 per cent). That slump in the valuations of stocks and real estate prices is likely soon to be reflected in banks' rising non-performing loans.

Mass protests ended Hosni Mubarak's 30-year rule in February. Egypt is currently ruled by a military council that recently faced a new wave of public protest against the administration of justice relating to corruption charges against the former political elite. In the context of the ensuing volatile political situation, analysts expect the economic environment to remain challenging for banks.

Lebanon on the other hand has grown accustomed to political instability, uncertainty and turmoil. With the 15-year civil war, the assassination of former Prime Minister Rafik Hariri in 2005, the 2006 war between Israel and Hezbollah, and, most recently, the collapse of the government in January 2011, the Lebanese banking system has survived and even thrived through challenging times.

But with the political situation in Syria deteriorating by the hour, Lebanon's economy and banking system are braced for one more round of upheaval, which analysts think could prove costly.

The writer is Deputy Business Editor, Gulf News.