Despite challenging conditions at home and abroad, Jordan’s banking sector is showing resilience. But non-performing loan rates have risen, forcing lenders to increase provisioning. Published in MEED, 13 June 2012
At the end of May, the ratings of Jordan’s two largest banks, Arab Bank and the Housing Bank for Trade & Finance, were cut by Moody’s Investors Service. Arab Bank’s rating fell by one notch to Baa2, while its smaller rival’s dropped by two notches to Ba2, putting it at the same level as Jordan’s sovereign rating.
The downgrades were recognition of the tough operating environment faced by banks in the country. The Jordanian economy is being buffeted by political turmoil both at home and the near abroad. As a result, its gross domestic product (GDP) is expected to grow by just 2.8 per cent this year, according to the Washington-headquartered IMF, well below the regional average of 4.2 per cent. Arab Bank and Housing Bank account for some 39 per cent of the country’s bank assets and their exposure to the weak local economy is the reason for the action by Moody’s.
Of the two, it is Housing Bank that is more exposed, as Arab Bank has a far more extensive international network. But Stathis Kyriakides, an assistant vice-president at Moody’s, says the outlook for both banks’ ratings is negative, meaning they could be cut more in the future.
Other market observers do not appear overly troubled by this. Investors on the Amman Stock Exchange (ASE) took the downgrades in their stride. Arab Bank’s share price fell in the wake of the ratings cut, but that was merely the continuation of a downward trend that has been evident since late April. Housing Bank’s shares did not budge from the price of JD8.25 ($11.64) that they have remained at since mid-May.
In relative terms, the banking sector has outperformed other industries over recent years. The banking index on the ASE has fallen by about 16 per cent since the start of 2011, dropping from 3,931 points to 3,300 by 4 June this year. While hardly a stellar performance, this is better than the record for the market as a whole, which has lost 22 per cent of its value over that time, falling from 2,396 to 1,864 points.
Of the 15 banks listed on the bourse, only Jordan Islamic Bank, the country’s third largest, has seen its share price improve over that time, but only by a fraction of a dinar; the others have all dropped.
The reason the banking sector has not fallen as much as others is that, in many ways, the country’s banking system is performing quite well, given the tough conditions it is dealing with. One measure of that is the growth in assets managed by the country’s licenced banks, which have been rising fairly consistently since at least the mid-1970s and continues to do so.
At the end of March, the banking sector’s assets were JD38bn, some 7.5 per cent more than at the same time last year, according to figures from the Central Bank of Jordan. In addition, there has been steady growth each year in deposits and loans.
Their resilience is evident in the most recent financial results from the country’s banks. For the first quarter of this year, Arab Bank saw net profit rise 10 per cent compared with the same period last year to $204.5m, while net profit at Housing Bank was up by 5 per cent year on year to JD34m in the first quarter. Among the smaller banks, there were further positive signs. Capital Bank, for example, made a net profit of JD7m in the first quarter of 2012, its best quarterly performance to date.
In its most recent report on Jordan, published in April, the IMF judged the country’s banking system to be sound, helped by prudent regulation by the Central Bank of Jordan and relatively conservative lending policies. Despite the problems facing the wider economy, the banks are generally profitable, as was evident in the first quarter results, and well capitalised. In addition, they tend to rely on local deposits rather than international wholesale markets as their most important source of funding.
However, there are also some serious weaknesses. Non-performing loan rates have been climbing, reaching 8.5 per cent of outstanding loans by mid-2011. This has forced banks to increase the provisions they are making for bad debts and the overall economic picture means this could worsen in the coming years, according to Paul Cashin, who headed up the IMF’s Article IV mission to Jordan earlier this year.
“There is a risk that banks could be exposed to increased non-performing loans and provisioning requirements over the medium term, as Jordan’s growth path is likely to remain below trend in the period to 2015,” he said at the end of the visit in February.
The central bank has also undergone some turmoil, with three different governors appointed since Umayya Toukan ended his nine-year term in 2010. The current governor, Ziad Fariz, was given the job in January this year, following short stints by Faris Sharaf and then Mohammad Said Shahin.
A weaker banking sector could cause knock-on problems for the government. Amman needs a vibrant local financial industry to help fund its spending programme. Even though it has been taking measures to trim fuel and electricity subsidies this year, such actions are politically difficult and the government is still expected to run a sizeable budget deficit of about 5.2 per cent of GDP for 2012.
According to media reports in May, Jordan has turned to both the IMF and Saudi Arabia for help, seeking $2bn from the IMF and $3bn from Riyadh. Jordan’s key position in the region’s political scene means international support is likely to be forthcoming, according to Said Hirsh, Middle East economist at London-based Capital Economics, but that will not provide a long-term solution to its problems.
Amman has also been tapping in to the local debt market more. The value of the government’s domestic debt pile - which consists of outstanding government bonds and bills along with the credit facilities provided by local banks and others - has been creeping up. In January, it surpassed JD10bn and by the end of March it had risen to JD10.6bn.
The cost of that debt has also been rising. This year, the National Electric Power Company has issued JD300m of bonds, which are due to mature in 2017 and carry a coupon rate of more than 7.7 per cent. The government itself has issued two five-year treasury bonds, worth a total of JD125m, which carry a coupon of 7.489 and 7.75 per cent respectively. Compare those rates to the ones that the government was paying at the start of January 2011, when the coupon rate on treasury bonds was below 4.4 per cent, and it is clear that the government is being squeezed from all sides and needs as many friends as it can get in the debt market.
One danger is that some banks could find themselves dangerously overexposed to government debt. Indeed, that was one of the key reasons behind the downgrading of Housing Bank in May, according to Kyriakides.
“The two-notch lowering of Housing Bank’s standalone credit assessment is driven by the linkages between the bank’s credit profile and sovereign credit risk,” he says. “This reflects the bank’s high exposure to Jordanian government debt, which is equivalent to over 200 per cent of Tier 1 capital, and moderate geographical diversification outside of Jordan.”
Arab Bank is far more diversified and its exposure to government debt is a more manageable 40 per cent of its Tier 1 capital. While it is the largest bank in Jordan, controlling some 24 per cent of assets, a similar level of deposits and 17 per cent of loans, its greatest strength is its international reach. The bank has operations in 30 countries across five continents and although Jordan is still its most important market, it accounts for a minority of its business.
It is difficult to judge just how well it is performing in its home market as the bank gives little information about its performance on a country-by-country basis. The data that is available points to a fairly flat performance last year, with a 0.4 per cent fall in assets in Jordan over the course of 2011 to $10.35bn and a 0.3 per cent increase in revenues to $367m.
While other banks may have performed better, they still trail far behind Arab Bank in terms of scale and are unlikely to be able to challenge its dominance in the market in the near term.
“Arab Bank is still the bank to beat in Jordan,” says one banking analyst. “I wouldn’t say the lead of Arab Bank is being challenged. If the gap is being closed in any area, it will mainly be driven by Arab Bank deciding not to aggressively compete in that part of the market.”
It is notable that, despite the downgrade by Moody’s, Arab Bank is one of the few banks in the region that continues to be rated higher than its sovereign. Other banks in Jordan can only hope that sovereign rating does not dip any further, dragging them down too.