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Management Discussion And Analysis

3.0. Economic Environment

3.1. Domestic Operating Environment

The year 2013 has extended Lebanon’s economic sluggishness witnessed since the beginning of the regional turmoil. A continuing economic slowdown is being reported within the context of the adverse spillover effects of the Syrian conflict on investment, tourism and foreign trade. Real GDP has displayed a low, though positive, growth for the third consecutive year, estimated at between 1.5% and 2.5% by the IMF and the Central Bank of Lebanon, amidst continuing regional tensions and lingering domestic uncertainties.

The performance of real sector indicators was mixed throughout the past year. Among indicators that witnessed progressions in 2013, we mention electricity production (+9.9%), delivery of cement (+10.4%), merchandise at the Port (+14.4%), new car sales (+1.8%) and passengers at the Airport (+5.7%). Among indicators that witnessed regressions over the year, we mention construction permits (-10.9%), value of property sales (-2.4%) and number of tourists (-6.7%).

The quantity theory of money confirms the sluggishness in economic growth. The annual increase in money supply (+6.3%) was offset by a contracting velocity of money (-6.1%) and an average price inflation (2.6%). The contracting velocity is the result of a tiny growth in cleared checks of 1.9% within the context of an increase in average deposits by 8.4% in 2013. The moderation of inflation is technically tied to the fact that the Lebanese economy is operating at the flat Keynesian side of the Aggregate Supply curve amidst excess capacity and large output gap.

At the external level, exports dropped by 12.2% in 2013, as exports through Syria dropped by 21.3% year-on-year amid the insecurity of shipping routes for Lebanon’s land exports. Imports almost maintained their previous year’s figure within the context of a lingering economic slowdown. While inflows were up by 5.9% in 2013, the balance of payments has reported a deficit of USD 1.1 billion, following a deficit of USD 1.5 billion during the previous year. At the monetary level, the monetary situation has been reporting considerable resilience, with no pressures on the currency, and with BDL foreign currency assets growing to USD 35.3 billion by end-December 2013. The current level of BDL foreign assets, equivalent to 78.3% of LP Money Supply and 20 months of imports.

Lebanon's Major Economic Indicators (USD Million)

Within this environment, the Lebanese banking sector witnessed a relatively strong activity growth during the year 2013, in an overall tough operating environment characterised by sluggish economic conditions and ensuing pressures on fee income generation and a low interest rate context pressurising interest margins and spreads. Total sector activity, measured by the aggregation of assets of banks operating in Lebanon, progressed by 8.5% over the covered period to reach USD 164.8 billion at year-end 2013.

Banking activity in Lebanon remains favoured primarily by customers’ deposits, which rose by 9.0% in the year 2013, moving from USD 125.0 billion at end-December 2012 to USD 136.2 billion at end-December 2013. The USD 11.2 billion increase in deposits further reinforces banks’ funding base, with deposits accounting for 83% of the aggregate balance sheet, and proved 21% higher than the deposit growth recorded over the year 2012, which is a satisfactory performance given the economic sluggishness and politico-security tensions, and only 3% lower than the prior five-year average growth.

The breakdown of deposits reveals that the growth recorded in the year 2013 is mostly owed to foreign currency deposits, which were responsible for about 81% of total growth in the sector. The growth in FX deposits was almost double relative to the previous year, reaching USD 9.1 billion in 2013. In parallel, local currency deposits continue to grow, albeit at a more moderate pace than during the previous year, with the equivalent of USD 2.1 billion in new deposits during 2013.

With additional liquidity at hand and relatively low leverage as reflected by a loan-to-deposit ratio at 35%, Lebanese banks had enough financial flexibility to extend new waves of credit throughout the year despite the weak growth momentum across the Lebanese economy. Banks’ lending activity grew by 9.0% in the year 2013, with new loans totalling USD 3.9 billion and almost exclusively to the benefit of the resident sector, almost the same as in the previous year though 15% lower in volumes when compared to the prior five-year average lending growth, thus shedding light on banks’ cautiousness and selective approach with regards to new loans.

Lebanese banks, known for their prudent risk philosophy, were actually keen to maintain their strong asset quality, with a non-performing loan ratio of merely 3.4% of total loans at end-December 2013 as per BDL statistics and with loan loss provisions representing 75% of non-performing loans. In parallel, Lebanese banks also display adequate capitalisation ratios, with the total Basel II capital adequacy ratio at 12.2% at end-December 2013 according to the latest BDL figures, higher than the minimum requirement, and thus providing banks with adequate buffers to withstand potential pressures on their capital base.

Last but not least, Lebanese banks were able to grow their net profits though at a relatively modest pace year-to-date. Net profits rose to USD 1,640 million in 2013, growing by 4.1% over the previous year, thus somehow reversing the relative contractionary trend that was prevailing in the past two years. On the basis of average assets of USD 158.4 billion and average equity of USD 13.4 billion over the year 2013, ROAA posted an annual ratio of 1.0% and ROAE registered 12.2%, both considered satisfactory returns relative to regional and global benchmarks.

Lebanon's Banking Sector Activity Indicators (USD Million)

3.2. Operating Environment in the MENA Region

At the regional level, the operating environments were varying in the different markets of presence of the Bank in the region, namely in the Near East, in North Africa, in GCC and in Turkey, the new market of presence of Bank Audi.

The near-term economic performance for the Middle East and North Africa region has weakened. Growth in the MENA region is set to have declined to 2¼ percent last year as per IMF estimates. With respect to MENA’s oil importers, the economic recovery in those countries, of which several countries of presence of Bank Audi, has once again been delayed. Heightened security concerns, rising political uncertainty, and delays in reforms continue to weigh on confidence, preventing a recovery in investment and economic activity in many countries. The devastating civil war in Syria has sparked concerns about regional spillovers, further complicating economic management. While there are nascent signs of improvement in tourism, exports, and foreign direct investment in some countries, the economic recovery in the MENA oil importers remains sluggish, with growth of about 3 percent in 2013, significantly below the growth rates necessary to reduce persistent unemployment and improve living standards.

With respect to MENA’s oil exporters, domestic oil supply disruptions and lower global demand are set to markedly reduce growth in MENA oil exporters to about 2 percent this year after several years of strong performance. By contrast, the non-oil economy continues to expand at a solid pace in most countries, supported by high levels of public spending and a gradual recovery of private sector credit growth.

At the banking level, the MENA region has been reporting a satisfactory 9.6% growth in deposits and an 8.3% growth in loans in 2013, driven mainly by oil exporters, while oil importers barely saw their deposit and loan bases growing. Not less importantly, the latter’s net banking profitability remained under pressure within the context of relatively tough operating conditions in their respective economies underlined by narrowing net interest margins, growing provisioning requirements and slow fee income growth generation at large.

Banking Sector in The MENA Region Activity Indicators (USD Billion)

The main regional markets where Bank Audi is present besides Lebanon are Jordan, Syria and Egypt. Jordan’s economic performance was mixed in 2013. It has been undergoing the effect of the regional turmoil on the level of sluggish tourism and dampened exports. Exports actually stagnated and the number of tourists fell by 13.8% during 2013. Domestic activity has been yet partly supported by the Central Bank’s expansionary stance, along with a series of government driven projects. While consumption has been sluggish on the overall, gross fixed investment is set to have grown by 4.2% in 2013, as the government has recently simplified procedures in order to attract additional foreign investment. FDI inflows rebounded by 20% in the first nine months of 2013, due to a recovery of investment from Arab Gulf states. Within this environment, real GDP in Jordan has reported 2.7% year-on-year growth in the first three quarters of 2013, as per the Central Bank. At the banking sector level, consolidated assets of domestic banks rose by 9.1% between end-2012 and end-2013. Deposits grew by 10.7%, while credit facilities grew by 6.5% over the same period. Listed Jordanian banks reported a 15.9% rise in profits in the first three quarters of 2013, amidst significant growth in net claims on the public sector, coupled with relatively improving operating conditions.

Syria’s economy continues to struggle with immense losses across all activity components, with a strong impact on all economic sectors which accumulated significant losses since the start of the uprising. According to the UNDP, the civil war has resulted in a total loss of almost USD 50 billion to GDP in current prices since 2010. Economic activity continues to remain in contractionary mode as most sectors reported significant losses since the start of the uprising. The EIU forecasted a 19% contraction in the Syrian economy in 2013. The country’s inflation rate reached 59.1% in 2013 due to shortages and wide-ranging subsidy reductions. Throughout 2013, the Syrian Pound depreciated by 76.5% against the US dollar, owing to the collapse in export revenue, sanctions and a shortage of foreign exchange. At the banking sector level, Syrian private banks witnessed a drop in deposit and loan levels compared to 2012. In US Dollar terms, deposits and loans were down by 26.4% and 53.2% respectively in the first nine months of 2013 from year-end 2012.

In Egypt, the second revolution in July has opened a fresh chapter in Egypt’s troubled political transition and hopes for economic recovery after nearly three years of heavy losses. A referendum on an amended constitution mid-January 2014 was widely backed by voters and is set to pave the way for parliamentary and presidential elections. The grounds for optimism are easy to identify. The changeover has triggered the release of aid from Gulf states that had been sceptical before. Egypt’s foreign reserves reached USD 17.0 billion at end-December 2013, up by USD 2.0 billion since year-end 2012. The country has received USD 7 billion out of USD 13.9 billion pledged by Kuwait, Saudi Arabia and the UAE. The influx of Gulf aid and the resultant stabilisation of the Egyptian Pound prompted the Central Bank to lower key interest rates three times during the second half of 2013 by a total of 150 bps. Banks operating in Egypt posted an activity growth of 16.4% in local currency terms between end-2012 and end-November 2013 (+7.5% in USD terms). The aggregated net profits of eight listed banks of the sector rose by 19.8% in USD terms during the first nine months of 2013, suggesting a reinforcement of banking sector profitability at large.

3.3. Operating Environment in Turkey

Turkey is the other new market of presence of Bank Audi since end 2012 and which displayed mixed macro performance in 2013. Despite political tensions throughout the year, Turkey’s growth has improved, with a rotation back to domestic demand-led growth, the IMF forecasting it at 3.8% for 2013 following an estimate of 2.2% for 2012. This was mainly tied to a household consumption-led recovery on the back of weak capital formation in the private sector. While inventory re-stocking made a large contribution to growth, private sector fixed capital investment remained weak, offset only by a large contribution from public investment. Exports also stagnated in 2013, following positive growth rates seen in previous years. The end of year political turmoil coincided with the announcement of the start of Fed tapering, causing the Lira to depreciate despite stepped-up Central Bank FX interventions, closing the year at TL/USD 2.15, thus depreciating by 20.4% in 2013. At the banking sector level, banks have managed to navigate the recent domestic and global market turmoil with minimal impact on their balance sheets. When expressed in USD terms, assets grew by 4.9% in of 2013 and loans grew by 10.7%, while profits contracted by 2.3% over the period.

Turkey Main Macro & Banking Aggregates (USD Billion)

3.4. Operating Environment in West Europe

West Europe had a slightly better year in 2013 than the previous ones, with macroeconomic conditions starting to ameliorate and financial conditions somewhat easing. Economic activity actually picked up during the second half of the year, with the region starting to recover from one of the worst slumps in recent history, and business confidence began to improve against the backdrop of better external demand. But with unemployment still near highs and indebtedness ratios elevated in some countries, private consumption spending is witnessing a slow recovery process, while private investment continues to be constrained by weak growth prospects and companies’ wait-and-see attitude. Meanwhile, though easing relative to the previous year, fiscal consolidation continues to be a drag on aggregate demand.

Within this context, banking activity in West Europe continued to be confronted to a tough operating environment. While banks have gone a long way toward their restructuring process and financial market uncertainties were reduced following the announcement of an upcoming banking union across the continent, they are continuing to shed assets and reduce leverage amidst sluggish economic conditions. As a matter of fact, asset quality concerns kept credit risks elevated, somehow hampering banks’ lending conditions which remained subdued amid relatively constrained appetite for risk on behalf of both borrowers and lenders, thus adding to the tight margin environment and weighing on their profitability metrics.