Egypt Banking Sector

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Egypt Banking Sector

  1. 1. Global Research Banking Egypt Egypt Banking Sector Heating Competition ... September 2008
  2. 2. Global Investment House KSCC Sharq, Global Tower P.O. Box 28807 Safat 13149 Kuwait Tel: (965) 295 1000 Fax: (965) 295 1005 E-mail: research@global.com.kw http://www.globalinv.net Global Investment House stock market indices can be accessed from the Bloomberg page GLOH and from Reuters Page GLOB Omar M. El-Quqa, CFA Executive Vice President omar@global.com.kw Phone No: (965) 295 1110 Faisal Hasan, CFA Head of Research fhasan@global.com.kw Phone No: (965) 295 1270 Mahmoud Soheim Manager-Egypt Research msoheim@global.com.kw Phone No:(202) 37609526 Cherine Fayez Farkouh, CFA Financial AnalystSenior Financial cfarkouh@globalinv.com.eg Phone No: (202) 37609526 Naveed Ahmed Financial Analyst nahmed@global.com.kw Phone No: (965) 295 1280
  3. 3. Table of Contents Investment Summary .......................................................................................................... 1 Economic Overview ............................................................................................................ 4 Background on the Banking Sector ................................................................................... 8 Financial Performance of the Banking Sector ............................................................... 15 Peer Group Comparison .................................................................................................. 28 Banking Sector Outlook ................................................................................................... 33 Valuation & Recommendation ........................................................................................ 34 Players Profile Commercial International Bank .................................................................................. 37 National Societe Generale Bank ................................................................................. 58 Credit Agricole-Egypt ............................................................................................... 78 The Egyptian Gulf Bank ............................................................................................ 98 Export Development Bank of Egypt ......................................................................... 115
  4. 4. Global Research - Egypt Global Investment House Investment Summary The Egyptian banking sector has gone through major reforms in the last few years. The main reasons triggering such reforms were to eliminate disturbed banks and to enhance the assets quality and capital adequacy of the banking sector. The problem rose when the large four public banks, constituting approximately 50% of the sector’s total assets in 2003, had a huge amount of Non Performing Loans “NPLs”, resulting mainly from extending large portions of loans to distressed public enterprises, in addition to having a lack of adequate risk management practices. Therefore, the government decided to restructure the banking system through several methods. One of which was to sell stakes of public banks in other joint ventures in order to solve the NPLs problem. Another form was to amend regulations concerning the minimum required paid-in capital and the capital adequacy ratio. A consolidation trend prevailed in the banking sector, during the last few years. Small banks and poor performers were easy acquisition targets, as they couldn’t abide by the regulations modified by the Central Bank of Egypt “CBE”, while foreign banks were involved in such actions, in an attempt to enter the Egyptian banking sector, especially after the government’s announcement that no banking licenses will be granted for the time being. This foreign interest in the Egyptian banking sector reflects how the sector is perceived as having a promising growth potential, given the fact that there is a low banking penetration rate and many of the Egyptians do not have banking accounts. Besides, a large proportion of the population is in the youth age, lying between 20 and 45 years old, implying a potential growth of demand from this group. Another factor drawing the foreign interest is the continuing growth of the economy, which was reflected on many sectors. This growth, in turn, provided an improved business climate and encouraged investments by Egyptians and foreigners as well. The result was greater lending opportunities necessary to finance emerging projects, boosting the performance of the banking sector and implying promising aspects. Foreign interest was illustrated by the participation of foreign players, whether international or regional banks in the bids that took place to acquire stakes in the Egyptian banks. These banks include BNP Paribas, Barclays, Piraeus, Credit Agricole, Societe Generale, BLOM and Audi. Foreign banks expressed their desire to enter the Egyptian banking sector by offering higher premiums in bids over local banks. The latest acquisitions that took place in 2007 were the acquisition of a 51.3% stake in the National bank for Development by Abu Dhabi Islamic Bank, as well as the acquisition of a 98.1% stake in Al Watany Bank of Egypt by the National Bank of Kuwait. Another attempt by the Egyptian government to enhance the performance of the banking system was the privatization of Bank of Alexandria in 2006, where the Italian Intesa San Paolo Bank acquired an 80% stake in the Bank, reflecting again the attractiveness of the banking sector in Egypt. Banque du Caire was about to be privatized, but the deal was cancelled in June 2008, as the presented bids did not match the value set by the government for the Bank. It is worth September 2008 Egypt Banking Sector 1
  5. 5. Global Research - Egypt Global Investment House mentioning that there were 5 International and regional banks competing to acquire a stake in the Bank, which was set to be a maximum of 67% of the Bank’s shares. These banks were the Saudi Samba Bank, the National Bank of Greece, the British Standard Chartered Bank, a consortium composed of the Jordanian Arab Bank group and the Saudi Arab National Bank, and another consortium led by Mashreq Bank. The Saudi Samba Bank and the British Standard Chartered Bank did not participate in the auction, as they did not present bids. On the other hand, the three remaining banks presented their bids, with the highest price being that presented by the National Bank of Greece, amounting to US$1.4bn. Surprisingly, the government declined to sell the Bank’s stake at that price, revealing that the Bank’s intrinsic value is much higher. As for the regulatory intervention in the banking system, the CBE has moved towards targeting inflation through employing a tight monetary policy and assigning the Monetary Policy Committee “MPC”, which main responsibility was to set each six weeks the deposit and lending rates at the CBE. This is done in accordance to the prevailing rate of inflation. Given the economic growth that the country is witnessing, along with skyrocketing food and energy prices internationally and in the local market, inflation reached 23.6% in August 2008, forcing the CBE to raise its rates to reach 11.5% and 13.5% in September 2008, respectively. Our outlook for the Egyptian banking sector is positive, on the back of the promising prospects of the Egyptian economy and the resulting attractive investment climate. This climate is expected to spur projects in various sectors along with attracting foreign investments, representing enormous lending opportunities for banks in Egypt. Additionally, there are still plenty of hidden opportunities in the sector. These are represented by many segments that do not participate extensively in the banking activity. The most apparent opportunities rely in the retail segment, which is almost unexploited. Large percentage of the population has no banking accounts. This represents a great potential for Egyptian banks, as they can capitalize on growth opportunities in this segment, given the growing demographics and the fact that more than half of the population is in the working age. Hence, demand from this segment is huge and is expected to increase furthermore. This is one of the reasons that triggered almost all private banks to announce the expansion of their branches in 2007 to satisfy larger client base. Other untapped segments are the mortgage lending and lending to the Small and Medium Enterprises (SMEs). These segments constitute a minor fraction of the banks’ loans due to the high risks associated with them. However, the latest government regulations concerning the registration of the housing units and the SMEs, along with the establishment of the credit bureau are expected to boost lending to such segments. Another key driver for potential growth is the fierce competition existing among local players. Though the number of banks was reduced from 62 banks in 2000 to 41 banks now, local lenders compete harshly to gain more market shares, through introducing new products and services, as well as investing in their infrastructural system. The growth of the banking activity over the last few years supports our positive vision for the banking sector. This is expressed by the development of the total deposits and loans in the 2 Egypt Banking Sector September 2008
  6. 6. Global Research - Egypt Global Investment House sector. Total deposits (including government deposits) grew at a CAGR of 14.6% over the period from 2002/03 to 2006/07, reaching LE658.2bn, while total loans increased at a CAGR of 5.6% during the same period, reaching LE352.4bn in 2006/07. Table 01: “Global” Valuation Matrix Upside Price (LE) Target (LE) Reco. Potential BVPS* (LE) EPS* (LE) P/BV* (x) P/E* (x) CIB 46.9 49.0 Hold 4.5 14.6 5.0 3.2 9.5 NSGB 30.0 34.3 Buy 14.4 13.2 4.0 2.3 7.5 CAE 15.2 17.0 Buy 11.8 5.8 1.7 2.6 8.7 EGBE (US$) 2.6 2.0 Sell -22.5 0.9 0.1 2.8 23.0 EDBE 21.1 20.6 Hold -2.2 12.8 2.9 1.6 7.2 Source: Global Research, market prices as of September 7th, 2008. * Based on 2008E for all banks and 2008/09E for EDBE, adjusted for goodwill and extraordinary items, if any. September 2008 Egypt Banking Sector 3
  7. 7. Global Research - Egypt Global Investment House Economic Overview The Economy is Still Gaining Momentum Following the sound performance of the Egyptian cabinet led by Prime Minister Ahmed Nazif since 2004, the Egyptian economy has strengthened and showed positive signs. Effective means were carried out resulting in a buoyant GDP growth and major improvements in various sectors. The government implemented several economic reforms including privatization, cutting tax rates, attracting foreign investments, financial sector reforms, as well as public and private sector reforms. These reforms were reflected by a better investment climate. Nominal GDP went up at a CAGR of 14.1% during the 5-year period from 2001/02 to 2006/07, whereas real GDP witnessed a 5.1% CAGR over the same period. Considering y- o-y growth, nominal GDP grew by 18.4% in 2006/07, reaching LE731.2bn, while real GDP increased by 7.1%, reaching LE486.5bn. Moreover, nominal GDP grew by 21.0% y-o-y, over the 9M period ending March 2008, as it reached LE652.7bn, compared to LE539.4bn, realized in the same period of the previous year. The development in the general economy was transmitted to a better standard of living for Egyptians, as the per capita GDP rose at a CAGR of 6.3% in the last five years and at 16.8% y-o-y, from US$1,460 in 2005/06 to US$1,706 in 2006/07. Contributing Sectors The sectors that showed major contribution to the GDP in 2006/07 were the agriculture sector with 13.8% of GDP, the extractive industry (compromising petroleum and natural gas), contributing to 15.2%, whilst the manufacturing industry alone constituted 16.8% of GDP. Finally, the wholesale and retail trade portion of GDP was 11.4%. The extensive efforts of the Egyptian government resulted in better than planned figures, as the actual fiscal deficit in 2006/07 amounted to LE54.7bn, compared to an estimated figure of LE62.2bn. Such decline was a result of the 9.9% increase in the actual revenues over the budgeted figure, reaching LE180.2bn instead of LE163.9bn, which was a consequence of an 8.2% rise in tax revenues. The actual fiscal deficit realized in 2006/07 represented 7.5% of GDP, compared to 8.2% in 2005/06, showing evidence of the significant efforts implemented by the government. Current Account Egypt has proven competitiveness in the export market illustrated by the increase of the exports by 19.3% y-o-y in 2006/07, reaching US$22.0bn and a 25.3% CAGR from 2001/02 to 2006/07. It is worth mentioning that the major component of exports in 2006/07 included fuels, mineral oil and products, constituting 46.6% of total exports. Finished goods, in turn, attributed to 34.2% of total exports in the same year. The major export market for Egypt in 2006/07 was the European Union, with a share of 33.8%. The second highest market was the USA with a 31.1% share, followed by Asia, with 4 Egypt Banking Sector September 2008
  8. 8. Global Research - Egypt Global Investment House 13.5%. Exports to the USA, growing by 21.4% from 2005/06 to 2006/07, have significant importance in the external trade market for Egypt. One of the main reasons that led to increasing exports to the USA was the Qualified Industrial Zones (QIZ) Protocol that Egypt entered in 2004, which helped boost exports to the USA, given the fact that Egypt could export goods to the USA without quota or duties. Exports to the Arab countries were 12.4% in the same year, while the remaining 9.2% of total exports were distributed among Europe, Africa and other countries. On the other hand, imports grew by 24.3% y-o-y in 2006/07, realizing US$37.8bn. The major portion of imports was directed to the intermediate goods, which constituted 27.6% of the total Egyptian imports, then came the investment goods with 26.0%, while consumer goods reached 14.0%. It is worthy to note that the major export markets were the same main import markets, the European Union, the USA and Asia, with 34.4%, 21.8% and 15.9% of total imports, respectively. The fact that imports reached US$37.8bn in 2006/07, while exports reached only US$22.0bn, resulted in a preliminary trade deficit of US$15.8bn. Fortunately, this deficit was compensated by a 39.8% increase in the services account, which was mainly attributed to receipts from transportation, especially from the Suez Canal, as well as growth in investment income. Such improvements in the services account along with the 27.3% y-o-y increase of net transfers, contributed to a rise in the current account surplus by 53.9% y-o-y in 2006/07, reaching US$2.7bn, compared to US$1.8bn recorded the previous year. In March 2008, exports proceeds surged by 31.1% y-o-y, reaching US$20.8bn. This incline was pushed by the 35.4% increase in oil exports and the 27.4% rise in other exports. As for imports, they amounted to US$37.6bn, realizing a y-o-y growth of 43.1%. This was attributed to the significant surge in oil imports, growing by 138.1% y-o-y, reaching US$6.8bn, along with the 31.5% rise in other imports, amounting to US$30.8bn. The fact that growth in imports surpassed that of exports resulted in an increase in the trade deficit balance, reaching US$16.8bn, compared to US$10.4bn, over the same period a year before. It is worth mentioning that this deficit was compensated by a surplus in the service and transfers accounts by US$10.9bn and US$6.4bn, respectively. This led to a surplus in the current account, amounting to US$488.4mn. September 2008 Egypt Banking Sector 5
  9. 9. Global Research - Egypt Global Investment House Accelerated Inflation After the floatation of the Egyptian pound in 2003 and the enhanced confidence in the Egyptian economy, as a result of the economic reforms adopted by the government, the demand for investing in Egypt increased, causing an appreciation of the local currency against the US$ starting from 2005. The exchange rate reached LE5.5:US$1 in Nov 2007, compared to LE5.8:US$1 in 2005. Fortunately, the appreciation of the Egyptian pound did not negatively affect the Egyptian exports, as shown earlier. In 2005, the Central Bank of Egypt moved towards inflation targeting. For this purpose, it established the Monetary Policy Committee, which was scheduled to meet every six weeks to identify the corridor range, representing the overnight deposit and lending rates at the CBE, which were set initially at 9.5% and 12.5%, respectively. In June 2006, rates were reset at 8.0% and 10.0%. Since then, these rates have been moving according to the development of the inflation rate. In April 2008, the inflation reached 16.4%, while deposit and lending rates reached 10.0% and 12.0% in May 2008, respectively. In May 2008, the government announced the removal of tax exemption on treasury bills, private schools and universities, as well as extensive energy consuming industries, operating under the free-zones system, mainly fertilizers, cement, steel and petrochemicals. In addition, energy subsidies have been reduced for all energy intensive industries. Moreover, new fees were imposed on car licensing, with different categories according to the engines types. Later on, the tax exemption on newly issued treasury bonds was also removed. These decisions were reflected on higher inflation, reaching 23.6% in August 2008, pushing the MPC to further raise the corridor range, which reached 11.5% and 13.5% in September 2008, respectively. Hikes in inflation during the last few years were also a result of the increased money supply in the Egyptian economy, which was illustrated by the jump of the Domestic Liquidity (M2) by 18.3% in 2006/07, reaching LE662.7bn. This could be attributed to the 20.1% growth in Narrow Money Supply (M1) and the 17.8% rise in Quasi Money. These rises were a result of the growth realized in the economy, which triggered the development of many investment projects, leading to the current increase in liquidity witnessed in the banking system. On the other side, interest rates reflected a slight decrease over the period from 2003/04 to 2006/0 7, where deposit rate for less than one year declined to 6.9% in June 2007 from 7.77%. Also, the lending rate for less than one year went down from 13.27% to 12.60%. 6 Egypt Banking Sector September 2008
  10. 10. Global Research - Egypt Global Investment House Outlook for the Egyptian Economy Our outlook for the Egyptian economy is positive given the strong growth realized since the appointment of the current cabinet in 2004. The achievements made in various sectors of the economy and the thriving investment climate are all signs of continuing development in the years to come. The continuous efforts of the government towards improving the economy’s growth support our positive vision for the Egyptian economy, as the government announced many objectives to be achieved within the 5-year governmental plan ending mid 2012. Such objectives are represented by shifting the annual GDP growth to 8%, decreasing inflation to 6%, reducing unemployment to 5.5% down from 9% along with other objectives, which if achieved should bring fruitful benefits to the Egyptian economy. We believe such objectives could be realized relying on the fact that the Egyptian cabinet has proven to be successful in reaching planned goals. Currently, the main challenges facing the Egyptian economy are the rising inflation rate and the weakening US Dollar. Up till now, the government has been successful in dealing with both problems, which are more external than internal. September 2008 Egypt Banking Sector 7
  11. 11. Global Research - Egypt Global Investment House Background on the Egyptian Banking Sector Banking Structure Development The first Egyptian bank was the National Bank of Egypt “NBE”, which was established in 1898, with a capital of GB£1mn. It used to perform the duties of a central bank in the 1950’s. Banque Misr “BM” was then established in 1920 followed by Banque du Caire “BdC” in 1952 and Bank of Alexandria “BoA” in 1957. The Central Bank of Egypt “CBE” was established in 1961. During the 1960’s, banks were nationalized and NBE acted as a commercial bank, while still carrying out some of the duties that were not covered by the CBE at that time. The open door policy adopted in Egypt in the 1970’s to attract foreign investments resulted in an expansion of the banking system, which was composed at that time of 4 public banks, 3 investment banks and 19 specialized banks. Meanwhile, the banking law was established, identifying the three types of banks, along with the functions of each type. The banking structure swelled significantly since then and until the 1990’s, as the number of banks soared from 26 to 63 banks in 1999. The branch network also expanded from 527 to 2,434 branches. As a result of the consolidation movement that took place in the sector during the last few years, represented by mergers and acquisitions actions, and the fact that 7 branches of foreign banks ended their business in Egypt, the number of banks shrank to 41 by 2007 and the branch network expanded to compromise currently 3,252 branches in order to cover larger client base. Table 02: Banking Structure Development Commercial End of June Investment Banks Specialized Banks Total # of Banks Banks 1970 5 0 20 25 1975 4 3 19 26 1980 19 29 4 52 1985 43 33 4 80 1990 44 33 4 81 1995 28 32 4 64 2000 28 31 3 62 2005 27 22 3 52 2006 23 17 3 43 Source: CBE, Global Research Chart 01: Banking Structure in 2006/07 It is worthy to note that the private and Off-Shore Banks Public Sector joint venture banks constituted 68.3% 17.1% 14.6% of the total number of banks in 2006/07, whereas off-shore banks and public banks’ shares were 17.1 and 14.6%, respectively. Private and Joint Ventures 68.3% Source: CBE, Global Research 8 Egypt Banking Sector September 2008
  12. 12. Global Research - Egypt Global Investment House Poor Performance Triggered Reforms… The Egyptian banking sector was dominated by the four large public banks NBE, BM, BdC and BoA. As a result of long existence in the Egyptian market and accordingly, having huge number of branches serving greater share of the population compared to the private banks, the public banks constituted approximately half of the sector’s assets in 2003. This being the case along with the fact that these banks provided large portion of their loans to public enterprises had negatively impacted the performance of the four banks and resulted in a combined non-performing loans/ total assets ratio of approximately 12% in 2002. That said, the Egyptian government was urged to alleviate the banking system’s turmoil, realizing its importance in the development of the economy. Therefore it devoted significant efforts to make major reforms in the sector, including amendments in some regulations, accompanied by privatization and consolidation actions. The main objective behind these reforms was to improve the sector’s efficiency, in terms of asset quality as well as capital adequacy. Public Banks Being the Primary Concern… The Government adopting several reforms tools, began with selling stakes of public banks in joint venture banks to curb the problem of hefty bad debts. The following table summarizes the public stakes sold over the period from 2004 to 2007. Table 03: Sale of Public Banks’ Stakes in Joint Ventures Divested Public Bank Acquirer Acquired Shares in Joint Ventures Ripplewood Consortium Commercial International Bank National Bank of Egypt Arab Banking Corporation International Suez Canal Bank Societe Generale National Societe Generale Bank Banque Misr National Societe Generale Bank Misr International Bank BLOM Bank Egypt Romania Bank Arab African International Bank Misr America International Bank Banque du Caire Audi Cairo Far East Union National Bank Alexandria Commercial and Maritime Bank of Alexandria Barclays Cairo Barclays Piraeus Egypt Commercial Bank Credit Agricole Egypt American Bank Shareholders in Delta International Bank Delta International Bank National Investment Bank Misr Iran Development Bank Source: Ministry of Finance, Global Research In 2005, Non-performing Loans “NPLs” owed by public enterprises to public banks amounted to LE 26bn. The government paid as fractional settlements for these loans LE6.9bn in January 2006 and LE9.1bn in December 2006, with the remaining amount to be finalized by 2009, according to the government’s plan. Moreover, the government has appointed skilled management and staff, along with improving internal processes of state-owned banks, in order to raise their competitiveness. September 2008 Egypt Banking Sector 9
  13. 13. Global Research - Egypt Global Investment House Notable Reforms to the Whole System… Aiming at enhancing the banking system’s competitiveness in terms of adequate capital together with improving the capabilities of banks to meet default on their loans, the government has set regulations for increasing the minimum required paid-in capital and capital adequacy ratio. Additionally, the government enhanced the role of the CBE in regulating the sector and assigned it more responsibilities. As an additional attempt to control NPLs for the whole banking system, the CBE issued a decree in September 2004 to establish a unit in the CBE to monitor the banks’ NPLs books and asked banks to establish a similar internal unit. The role of the CBE would be to continuously monitor these units to make sure that they are well implemented and well performing to deal with NPLs. The efforts performed by this unit resulted in the settlement of 67% of NPLs in private banks over the period from 2004 to March 2007. Recently, a credit bureau, under the supervision of the CBE, has been established with the aim of providing information to banks regarding personal and financial information on borrowers, as well as their financial history, including loans defaults, bankruptcies, court judgments and late payments. Other positive information such as timely settlements is also included. The objective of establishing this bureau was to facilitate time saving procedures. According to this process, borrowers will not have to wait for a long time until the bank investigates their financial position and approves loans’ requests. Furthermore the risk of default will diminish by providing banks with accurate information that will help them in their decision making. Moreover, the government motivated the consolidation of the sector through privatization, mergers and acquisitions to get rid of disturbed banks. Consolidation Dominated the Sector… The Government aimed at consolidating the banking sector in order to increase the players’ competitiveness and eliminate lowly performers. An important factor contributing to the consolidation of the banking sector was the amendments of regulations by the CBE. According to the Unified Banking Law of 2003, the minimum required paid-in capital was raised to LE500mn from LE100mn. In addition, the capital adequacy ratio was raised from 8% to 10% of the risk-weighted assets. It is worthy to note that this law gave the CBE more responsibilities as a regulatory organization, where the governor directly reports to the country’s President. Meanwhile, these amended regulations spurred local banks, especially small ones and poor performers to opt for mergers and acquisitions in order to conform to the new laws. 10 Egypt Banking Sector September 2008
  14. 14. Global Research - Egypt Global Investment House Table 04: Banks’ Mergers during the Period from 2004 to 2007 First Bank Second Bank New Entity Date American Express Bank (Branches in Egyptian American Bank Egyptian American Bank Sep-04 Egypt) Misr Exterior Bank Banque Misr Banque Misr Sep-04 Credit Lyonnais Branch Credit Agricole Indosuez Calyon Mar-05 Misr America International Bank Arab African International Bank Arab African International Bank Sep-05 Mohandes Bank National Bank of Egypt National Bank of Egypt Oct-05 Bank of Commerce and Development National Bank of Egypt National Bank of Egypt Dec-05 Nile Bank with Islamic International United Bank of Egypt United Bank of Egypt Jun-06 Bank for Investment and Development Egyptian American Bank Calyon Credit Agricole Egypt Sep-06 Misr International Bank National Societe Generale Bank National Societe Generale Bank Nov-06 Banque du Caire Banque Misr Banque Misr Feb-07 Source: Ministry of Finance, Global Research Foreigners Chasing Opportunities in the Sector… Foreign banks have shown continuous interest in the booming banking sector in Egypt in the last few years. This was due to a number of reasons, the majority of which were a pure result of the economic reforms, as well as the banking reforms that Egypt is currently witnessing. Such reforms helped boost the banks’ profitability over the last few years, along with decreasing NPLs gradually and entailing good lending prospects. The major inducement for the foreign interest was the escalating demographics in Egypt and its resulting potential for the retail segment, as the population rose at a CAGR of 2% over the last 5 years, reaching 75mn in 2006/07, with a high percentage of youth, almost in the working age group. We believe that a wide range of the population in Egypt has a low or even zero banking penetration. This could be attributed to the low income levels, the lack of awareness of the importance of participation in banking activities, in addition to the informal job market. Foreign attention was thus stimulated by the short of saturation of the retail segment in an attempt to capitalize on the huge unfulfilled demand. In addition, foreign players were enticed to participate in mergers and acquisitions, especially after the Government’s announcement regarding not granting any new banking licenses. The foreign interest was divulged by the flow of international foreign and Arab banks acquisitions of local lenders since the banking sector reforms were initiated in 2004. It began when the British bank Barclays acquired from banque du Caire its 40% remaining stake in Cairo Barclays. Other foreign banks that acquired stakes in the sector over the last few years were Credit Agricole, Societe Generale, Piraeus, BLOM Bank, Abu Dhabi Islamic Bank and National Bank of Kuwait. Yet there was a larger range of foreign banks that revealed their interest in the Egyptian banking sector and strived to obtain stakes in it, but they did not reach their target to win the related bids. September 2008 Egypt Banking Sector 11
  15. 15. Global Research - Egypt Global Investment House Table 05: Most important Acquisitions over the Period from 2005 to 2007 Deal Acquisition Acquisition BV per BV P/BV Acquired Bank Acquirer % Value Date Price (LE) share Weights * (LEmn) Misr America Arab African May-05 100.0 239.5 239.5 146.0 18.2% 1.6 International Bank International Egyptian Commercial Piraeus Jun-05 88.0 20.0 169.0 18.0 2.2% 1.1 Bank** Arab International Suez Canal Bank Aug-05 16.8 10.0 48.2 29.4 3.7% 0.3 Bank Misr International NSGB Sep-05 90.7 43.2 2,204.0 21.4 2.7% 2.0 Bank Misr Romania *** BLOM Bank Dec-05 99.4 11.8 590.0 13.7 1.7% 0.9 Egyptian American Credit Agricole Feb-06 74.6 45.0 2,176.6 11.8 1.5% 3.8 Bank A consortium led by CIB**** Feb-06 18.7 53.5 1,302.5 16.3 2.0% 3.3 Ripplewood Holdings Cairo Far East Audi Bank Mar-06 99.7 205.3 540.1 70.6 8.8% 2.9 Misr Iran National Investment Apr-06 29.9 223.4 107.7 411.8 51.4% 0.5 Development Bank Bank Delta International A consortium led by Aug-06 89.3 37.0 1,652.0 11.5 1.4% 3.2 Bank Ahli United Bank Alexandria Union National Bank Aug-06 94.8 23.0 244.5 15.3 1.9% 1.5 Commercial Maritime Bank of Alexandria San Paolo Dec-06 80.0 72.0 9,215.0 10.4 1.3% 6.2 National Development Abu Dabi Islamic Jul-07 51.3 11.0 159.1 11.2 1.4% 1.0 Bank Bank A consortium led Al Watany Bank of by National Bank of Dec-07 98.1 77.0 5,660.2 13.8 1.7% 5.6 Egypt Kuwait Total 801.3 100% Average P/BV (Simple) 2.3 Average P/BV (Weighted) 1.3 Source: News Announcements, Global Research * P/BV Calculation (Equity less net profit of the year /outstanding number of shares). **In June 2005, Piraeus acquired around 69% of the Egyptian Commercial Bank, bringing its total stake to 88.0%. ***In December 2005, Blom Bank acquired around 84% of Misr Romania Bank, in which it originally owned 12.5%, bringing its total stake to 96.7%.Later on, it raised its stake to 99.4%. ****Currently, the Consortium’s stake in CIB is 5.6% Two Major Acquisition Bids in 2007… The year 2007 witnessed two acquisitions of local lenders by Arab banks mainly from the GCC countries, attracted by the positive sentiment on the Egyptian banking sector. In June 2007, the CBE announced its approval for three foreign banks to conduct due diligence on Al Watany Bank of Egypt. The three banks were National Bank of Kuwait “NBK”, Commercial Bank of Kuwait and the Greek EFG Eurobank. NBK won the bid and acquired 70.3mn shares of Al Watany Bank of Egypt at LE77.0 per share in November 2007, implying a P/BV of 5.6x. In addition, NBK acquired a 2.1% additional stake in the Bank in December 2007, where its total stake reached 98.1%. 12 Egypt Banking Sector September 2008
  16. 16. Global Research - Egypt Global Investment House In July 2007, a consortium led by Abu Dhabi Islamic Bank acquired 51.3% of the National Development Bank at LE11 per share, which was close to the share’s book value. The National Development Bank had NPLs of LE2bn, exceeding 50% of the Bank’s total loans, which- according to the acquirer- will be covered over a 5-year period, during which no cash dividends will be distributed. It is worth mentioning that the Egyptian Gulf Bank and the Arab Investment Bank are potential acquisition targets, due to their relatively low market shares, low capital base and modest performance, compared to large peers in the market. One of the Big Four Privatized… The foreign appetite in the Egyptian banking sector was again revealed in the privatization deal of BoA. In February 2006, the government announced its intention to privatize BoA, the smallest bank of the large four public banks, through selling a stake of 75-80% of the Bank’s shares to a strategic investor, 15-20% to the general public through an IPO and 5% to be allocated to the Bank’s employees. There were 13 banks that submitted requests to purchase the announced stake, comprising international, regional and local banks, of which 8 banks presented preliminary offers. The CBE allowed 6 of these banks to perform due diligence on BoA, among which were Mashreq Bank, Intesa San Paolo Bank, Arab Bank, CIB and BNP Paribas. The final purchase offers presented were from 4 European and Arab banks not including any local bank. Finally, in October 2006, the Italian Bank Intesa San Paolo won the bid and acquired after 2 months, 80% of the Bank’s shares at a total of LE9.2bn (US$1.6bn), representing US$12.6 per share, which was more than 5.5 times the share’s book value. The second highest premium was presented by the Arab Bank, which offered LE7.9bn (US$1.4bn). The government is currently awaiting the right time to offer the remaining 15% of BoA shares through an IPO. The privatization of BoA revealed the foreign players will to acquire a local bank at a high premium, just to ensure a seat in an under-banked country with robust growth potential. Privatization of BdC Postponed Surprisingly… Still attracting foreign lenders, the government was about to privatize the third largest public bank “BdC”. The story began in May 2007 when the government announced the merge of BdC with BM. Three months later, it was announced that BdC, which captures a 6% market share in terms of total deposits and also of total assets of the banking sector, would be privatized. The privatization would have occurred through selling a maximum stake of 67% to a strategic investor, offering a 28% stake through an IPO in the stock exchange, with the 5% remaining stake to be distributed among the Bank’s employees. Among 14 financial advisory institutions, JP Morgan was assigned responsible for the sale. The preliminary offers presented, amounting to 12 offers illustrated the flow of foreign interest to gain presence in the market. These offers were represented by the Arab Bank Consortium, Deutsch Bank, Mashreq Bank, Kuwait’s Noor Financial Investment Company, Commercial Bank of Kuwait and other foreign and Arab banks. In March 2008, the CBE announced the short-list consisting of 5 banks that were allowed to make the due diligence on BdC, these banks were the Saudi Samba Bank, the National Bank of Greece, the British Standard Chartered Bank, a consortium composed of the Jordanian Arab Bank group and the Saudi Arab National Bank, and another consortium led by Mashreq Bank. September 2008 Egypt Banking Sector 13
  17. 17. Global Research - Egypt Global Investment House Surprisingly, the deal was cancelled in June 2008 and it was announced that the privatization of the Bank would be postponed, as the bids presented were below the minimum price set for acquisition. Two of the competing banks, Saudi Samba Bank and the British Standard Chartered Bank, were disqualified and did not participate in the bid. National Bank of Greece presented the highest bid, at US$1.4bn, followed by Mashreq Bank and the consortium composed of the Jordanian Arab Bank group and the Saudi Arab National Bank, presenting a price of US$0.9bn and US$0.8bn, respectively. Though the cancellation of the deal was surprising and raised questions regarding the reasons for not undergoing the privatization procedures, this event ensures the existence of inherent opportunities in the Banking sector, as the government viewed that the presented bids did not meet the real value of the Bank. Furthermore, the government announced that it was not planning to privatize the two remaining public banks (NBE and BM) in the coming five years to let the banks strengthen their institutional performance. 14 Egypt Banking Sector September 2008
  18. 18. Global Research - Egypt Global Investment House Financial Performance of the Banking Sector Performance Positively Affected by Reforms The reforms taking place in the Egyptian banking sector since 2004 had positively influenced the performance of the banks in terms of improved consolidated assets and liabilities and resulting performance ratios. The period under analysis in our report is from 2002/03 to 2006/07 to show how the adopted reforms positively affected the banks’ performance. We will analyze the development of the consolidated assets, liabilities, deposits, loans of the banking sector, along with some performance indicators. Increased Money Supply The acceleration of the Egyptian economy, accompanied by the banking sector reform program, stimulated investments in various business sectors leading to an increase in the money supply in the market, which was translated into the incline of the consolidated assets and liabilities of the banking system. Domestic Liquidity (M2) increased by 18.3% y-o-y in 2006/07, reaching LE662.7bn, compared to LE560.4bn in 2005/06. Narrow Money Supply (M1), represented by currency in circulation and demand deposits in local currency, rose by 20.1%, reaching LE131.3bn, while Quasi Money, which consisted of time and saving accounts in local currency along with demand, time and saving deposits in foreign currency, moved up by 17.8% reaching LE531.4bn in the same year. Chart 02: Domestic Liquidity Development LEmn 700,000 600,000 500,000 400,000 300,000 200,000 100,000 - 2002/03 2003/04 2004/05 2005/06 2006/07 M1 Quasi Money Source: CBE, Global Research Vast Funding Base… The increased money supply in the banking system was reflected in rising figures of the aggregate assets and liabilities. The funding base, representing the key driver for the banks’ good performance has ameliorated in 2006/07 by 23.2% y-o-y, reaching LE937.9bn, compared to LE761.6bn in 2006. September 2008 Egypt Banking Sector 15
  19. 19. Global Research - Egypt Global Investment House Table 06: Aggregate System’s Liabilities In LEmn 2002/03 2003/04 2004/05 2005/06 2006/07 Capital 18,155 20,346 22,949 27,112 33,037 Reserves 11,805 11,454 12,419 13,418 12,552 Provisions 40,099 44,584 49,541 54,950 53,469 Long-term loans and bonds 14,866 15,012 14,254 17,526 26,351 Obligations to banks in Egypt 35,579 29,933 22,671 21,488 82,619 Obligations to banks abroad 16,247 10,332 12,262 8,770 10,006 Total deposits 403,144 461,697 519,649 568,841 649,953 Other liabilities 38,043 40,078 49,883 49,457 69,936 Total Liabilities 577,938 633,436 703,628 761,562 937,923 Source: CBE, Global Research Since 2002/03, total deposits have been the major component of the banking system liabilities, reaching around LE650bn in 2006/07 and representing 69.3% of total liabilities. Chart 03: Composition of Aggregate Liabilities-2006/07 Capital 3.5% Other liabilities 7.5% Reserves 1.3% Provisions 5.7% Long-term loans and bonds 2.8% Obligations to banks in Egypt 8.8% Obligations to banks abroad 1.1% Total deposits 69.3% Source: CBE, Global Research Deposits Moving Up… The aggregate deposits balance of the banking system, including government deposits, grew at a 15.2% y-o-y in 2006/07. The main driver behind the increase in total deposits was the escalating non-government deposits, which grew by 18.8% y-o-y in 2006/07, reaching approximately LE581.3bn and representing 88.3% of the total deposits. 16 Egypt Banking Sector September 2008
  20. 20. Global Research - Egypt Global Investment House Chart 04: Government and Non-Government Deposits Growth LEbn 700 600 500 400 300 200 100 0 2002/03 2003/04 2004/05 2005/06 2006/07 Total Government Deposits Total Non-Government Deposits Source: CBE, Global Research It is worth mentioning that deposits in local currency represented 71.6% of total deposits in the banking system in 2006/07, while deposits in foreign currency represented 28.4% in the same year. The household sector contributes to 75.5% of total non-government deposits in local currency and 62.9% in foreign currency. The private sector comes second with 18.2% in local currency and 31.4% in foreign currency. Chart 05: Non-Government Deposits in Local Chart 06: Non-Government Deposits in Foreign Currency in 2006/2007 (Including cheques and Currency in 2006/2007 (Including cheques and drafts) drafts) Non-Residents Public Sector Non-Residents Public Sector 0.8% 5.5% 1.4% 4.3% Private Sector Private 18.2% Sector 31.4% Household Household Sector Sector 75.5% 62.9% Source: CBE, Global Research Rise in Deposits Reflected on Total Assets … The aggregate banking system figures in 2006/07 illustrate remarkable growth in total assets on the back of the realized incline in the sources of funds, namely deposits. Total assets grew by 23.2% y-o-y, reaching LE937.9bn. Looking at the components of assets, we realize that the securities and investments in treasury bills declined by 9.2% in 2006/07 and the loans and discount balances went up by the same percentage, which can be explained by the decrease in treasury bills yields, which was compensated by the increase in lending rates. September 2008 Egypt Banking Sector 17
  21. 21. Global Research - Egypt Global Investment House Table 07: Aggregate System’s Assets In LEmn 2002/03 2003/04 2004/05 2005/06 2006/07 Cash 5,557 5,412 6,594 6,813 7,705 Securities and investments in treasury bills 111,337 137,431 170,659 193,965 176,098 Balances with banks in Egypt 110,874 116,290 124,986 121,695 217,363 Balances with banks abroad 29,798 43,290 51,204 72,554 124,366 Loans and discount balances 284,722 296,199 308,195 324,041 353,746 Other assets 35,650 34,814 41,990 42,494 58,645 Total Assets 577,938 633,436 703,628 761,562 937,923 Source: CBE, Global Research Loans and advances have always captured the lion’s share of the banking system’s total assets. The growth in total assets in 2006/07 was mainly driven by the acceleration of the loans and discount balances, constituting 37.7% of the total aggregate asset base of the sector. Chart 07: Composition of Aggregate Assets-2006/07 Other assets 6.3% Cash 0.8% Securities and investments in treasury bills 18.8% Loans and discount balances 37.7% Balances with banks in Egypt 23.2% Balances with banks abroad 13.3% Source: CBE, Global Research Growing Loans Books… Egyptian banks benefited strongly from the large available funding base to expand their lending capabilities in 2006/07. Loans books witnessed a y-o-y growth of 9.1%, which was stimulated by the reforms that have been occurring in Egypt over the past few years, impacting various sectors, where the need rose for loans to fund necessary investments. Alternatively, the reforms that took place in the banking system positively affected the banks’ performance and enhanced their ability to fulfill required loans. 18 Egypt Banking Sector September 2008
  22. 22. Global Research - Egypt Global Investment House Chart 08: Loans Growth LEbn 360 350 340 330 320 310 300 290 280 2002/03 2003/04 2004/05 2005/06 2006/07 Source: CBE, Global Research Government loans in 2006/07 accounted for a minor fraction of the total loans in the banking system, representing only 7.6% and amounting to LE26.7bn, while the major component, consisting of 92.4% of total loans consisted of non-government loans reaching LE325.8bn. On the other hand, loans denominated in local currency represented 70.3% of the total loans in the same year. Most of the non-government loans in 2006/07 went to the industrial sector, as this sector contributed to 31.3% of the non-government loans in local currency and 41.1% in foreign currency. Then comes the services sector with 26.3% of loans in local currency and 36.7% in foreign currency. It is worthy to note that the retail lending represented only 17.0% of the total loans in 2006/07, which could be explained by the huge risk associated with lending to individuals compared to institutions, as probability of default is much higher. Besides, information on the financial position of borrowers was not yet available, but should be accessible shortly, as the credit bureau that will be responsible for gathering data on the financial position of the banks’ clients has been recently established. When such information will be available, retail lending is expected to ameliorate, especially with the huge unfulfilled demand for loans in the household sector. Chart 09: Non-Government Loans in Local Currency- Chart 10: Non-Government Loans in Foreign Currency- 2006/07 2006/07 Agriculture Sector Household & External Agriculture Sector 2.9% Sector 8.1% 1.0% Household & External Sector 23.7% Industry Sector 31.3% Industry Sector Services Sector 41.1% 36.7% Services Sector 26.3% Trade Sector 15.8% Trade Sector 13.2% Source: CBE, Global Research September 2008 Egypt Banking Sector 19
  23. 23. Global Research - Egypt Global Investment House Projected Banking Figures… We assumed future figures of the Egyptian banking system based on the forecasted figures of GDP by the International Monetary Fund. We took the average of the annual M2 as a % of GDP to project future balances of M2. We also projected future deposits balances based on the annual average of deposits/M2. It is worth mentioning that we have added a slight premium to this ratio to take into account the expected increase in deposits balances, as a result of the amendments on the corridor range. In addition, we projected future loans based on the average of the annual loans/deposits ratio, with a minor incline to reflect the increase that is expected to occur in loans balances as well. Table 08: Projected Figures of the Banking System In LEmn Jun-05 Jun-06 Jun-07 Jun-08 E Jun-09 E Jun-10 E Jun-11 E GDP 538,528.0 617,676.4 731,201.6 857,633.0 1,005,339.0 1,161,365.0 1,337,537.0 M2 493,884.0 560,356.0 662,688.0 780,617.6 915,059.6 1,057,074.4 1,217,426.2 % of GDP 91.7% 90.7% 90.6% 91.0% 91.0% 91.0% 91.0% % change y-o-y 13.5% 18.3% 17.8% 17.2% 15.5% 15.2% Deposits (including 521,745.0 571,461.0 658,215.0 819,648.4 960,812.5 1,109,928.1 1,278,297.5 government deposits) % of M2 105.6% 102.0% 99.3% 105.0% 105.0% 105.0% 105.0% % change y-o-y 9.5% 15.2% 24.5% 17.2% 15.5% 15.2% Loans 308,195.0 324,041.0 353,746.0 463,148.4 576,487.5 665,956.9 766,978.5 Loans/Deposits 59.1% 56.7% 53.7% 56.5% 60.0% 60.0% 60.0% % change y-o-y 5.1% 9.2% 30.9% 24.5% 15.5% 15.2% Source: International Monetary Fund, CBE and Global Research Performance Indicators As illustrated in the previous section, the banking reforms have positively influenced the performance of the banking sector, which was shown by the acceleration of the aggregate banking system figures over the period from 2002/03 to 2006/07. To highlight the effect of these reforms, we will present some performance indicators, including interest rate spread, a couple of profitability ratios and loans/deposits ratio. Interest Rate Spread The interest rate spread is the best indicator to show banks’ performance, as it illustrates the income generated from core banking activities. This income is generated through realizing a spread between the lending rate and the cost of funds, represented by interest rates on different deposits. The spread has been relatively stable over the last 4 years, as the rates are more or less moving together in the same direction. Banks generate additional income through other sources, one of which is reaping fees and commissions from lending activities and contingent liabilities offered to clients, in addition to fees from investment banking activities. Banks have other sources of income, but these are volatile. These sources encompass dividend income, gains on sale of financial investments, profits realized from foreign exchange operations, financial investments valuation differences and other items. 20 Egypt Banking Sector September 2008
  24. 24. Global Research - Egypt Global Investment House Chart 11: Interest Rate Spread % 14 13 12 11 10 9 8 7 6 5 2003/04 2004/05 2005/06 2006/07 Less than three-months deposits Less than six-months deposits Less than one year deposits Loans of one year or less Source: CBE, Global Research ROAA and ROAE Moving Positively Profitability of the banking sector, measured by Return on Average Equity (ROAE) and Return on Average Assets (ROAA), have been positively affected by the reforms in the sector and the economy as a whole. ROAE and ROAA moved in an upward trend since 2003/04, reaching 14.3% and 0.8% in 2006/07, up from 9.8% and 0.5%, respectively. Chart 12: Profitability Indicators (2003/04-2006/07) % % 15.0 0.9 14.0 0.8 0.7 13.0 0.6 12.0 0.5 11.0 0.4 0.3 10.0 0.2 9.0 0.1 8.0 0 2003/04 2004/05 2005/06 2006/07 ROAE ROAA (right scale) Source: CBE, Global Research A Significantly Unleveraged Sector… Total loans witnessed a modest CAGR of 5.6% over the period from 2003/04 to 2006/07, compared to a CAGR of 14.6% in total deposits. As a result, the loans/deposits ratio declined from 64.2% to 54.4%. This implies that banks are still reluctant to use great portions of deposits in providing loans and having to bear the risk of default. Alternatively, banks prefer to invest more of their funds in less risky assets like treasury bills and other investments, while they have to abide by the minimum required liquidity ratio. They have to keep a minimum of 20% in liquid assets denominated in local currency and 25% in foreign currency. Meanwhile, the tax exemption previously exerted on treasury bills pushed banks to augment their investments in these instruments and put a break on their lending activity. This was another reason leading to the decline of the loans/deposits ratio. September 2008 Egypt Banking Sector 21
  25. 25. Global Research - Egypt Global Investment House As these practices were far away from the core banking activities, the government decided in May 2008 to remove the tax exemption shield on treasury bills’ gains, in an attempt to push banks to expand their lending facilities and restrain from investing their funds in a way that deviates from their core business. The tax exemption on treasury bonds was also cancelled afterwards. In the meantime, the relatively low loans/deposits ratio indicates that banks have enough room if they decide to direct more of their funds to lending opportunities. Chart 13: Loans/Deposits Ratio Development % 66.0 64.0 62.0 60.0 58.0 56.0 54.0 52.0 2003/04 2004/05 2005/06 2006/07 Source: CBE, Global Research CBE and Regulatory Intervention Inflation on the Rise… As described earlier, the growth in the Egyptian economy since 2004 led to an enhanced investment climate and increased money supply. This in turn led to a rise in aggregate demand and consumption, uncoupled with local production, resulting in soaring commodity prices. Simultaneously, the improvements achieved in many sectors resulted in increased raw material prices. Meanwhile, economic growth decreased the rate of unemployment and raised demand for labor, shifting wages upward. In addition, the increase in food and energy prices internationally was reflected on domestic prices. All these factors combined attributed to hiking prices and inflation reaching 23.6% in August 2008, compared to 6.9% in December 2007. Tight Monetary Policy Targeting Inflation… The Unified Banking Law of 2003, which identified the various functions of the CBE, gave it a free-hand to implement the appropriate monetary policy. The policy adopted by the CBE is a tight one aiming at decreasing inflation, which if not adjusted would harm the economy. Counteracting Inflation through the Corridor Range… In 2005, the CBE decided that its main tool to adjust inflation would be the overnight deposit and lending rates at the CBE, which is the “corridor range” that is adjusted every six weeks according to the MPC meeting. In 2005, deposit and lending rates at the CBE were set at 9.5% and 11.5%, respectively. In June 2006, rates were readjusted to be 8% and 10%. The MPC continuously amended the corridor range, in response to the accelerating inflation. Of late, precisely in September 2008, the deposit and lending rates stood at 11.5% and 13.5%, respectively, as the inflation reached 23.6% in August 2008. 22 Egypt Banking Sector September 2008
  26. 26. Global Research - Egypt Global Investment House Chart 14: Development of the Inflation and Corridor Range % 29 23.6 24 22.1 19.7 20.2 19 16.4 14.4 14 12.1 10.5 8.6 9 7.2 6.9 4.7 4 June-05 June-06 June-07 December-07 January-08 February-08 March-08 April-08 May-08 June-08 July-08 August-08 September-08 Deposit Rate at the CBE Lending Rate at the CBE Inflation Rate Source: CBE, Global Research Will the Tight Monetary Policy Succeed in Targeting Inflation? It is not certain whether the restrictive monetary policy will succeed to decrease the inflation rate, especially in the short run, as the government plans to expand the growth of the economy could alternatively lead to higher levels of inflation. Besides, the fiscal policy is contradicting with the monetary policy, where the government’s plan to decrease its expenditures through cutting subsidies, especially those concerning the energy intensive industries, in addition to removing some tax exemptions, could have a significant impact on rising prices and thus increasing inflation. Nevertheless, if inflation continues to rise, which will mostly be the case, the CBE is expected to further raise interest rates gradually. Combined Effect on Interest Rate Spread Not surprisingly, many banks have raised the interest rates on their deposits, following the consecutive climbs of the corridor range. This is expected to be followed by a similar or greater increase in rates posed on the banks’ loans. Albeit the banks will be able to widen their spread in 2008 and 2009, as a result of these practices, it is plausible that spreads will contract thereafter, as a result of the intensifying competition in the sector. This competition will push banks to decrease the rates on loans, while posing higher rates on deposits to be able to maintain their market shares, which will be negatively reflected on the bank’s interest rate spread. The same goes for treasury bills yields, as they are expected to grow higher till 2009, compensating for the removed tax shield, then to decline afterwards, as banks will probably be less relying on these instruments in their investment portfolios. September 2008 Egypt Banking Sector 23
  27. 27. Global Research - Egypt Global Investment House Chart 15: Lending Rates vs. Treasury Bills Rates % 14 13.4 13.1 12.5 12.7 12.5 13 12.0 12 11 10 9 9.4 9.0 8 8.7 8.5 8.5 7 6.9 6 2007 2008 E 2009 E 2010 E 2011 E 2012 E Commercial banks lending rate (average) 3-month Treasury-bill rate (year-end) Source: Economic Intelligence Unit, Global Research Other CBE Tools of Regulatory Intervention The most important regulations of the CBE governing the banking sector are those related to liquidity, reserves, extended credit, capital adequacy and provisions. These are presented in more details below. Capital Adequacy The Unified Banking Law of 2003 requires banks in Egypt to raise the ratio of capital adequacy from 8% to 10%. Minimum Paid-In Capital The Unified Banking Law of 2003 also obligated banks to raise their minimum paid-in capital from LE100mn to LE500mn, which was the main motive for small local banks and poor performers to opt for the mergers and acquisitions in the last few years. Reserve Requirement Banks are required to keep 14% of their deposits denominated in local currency as reserves with the CBE to provide enough liquidity in case deposits are withdrawn by customers. It is worthy to note that these reserves are not interest earning. This explains why banks seek to invest their excess liquidity in interest earning instruments like treasury bills and other government securities to decrease their cost of unused funds. Though banks should focus on exerting more lending activity and orienting fewer funds to investments in treasury bills, this has not been the case for several years, due to the banks’ unwillingness to get exposed to the risk of default. It is worth mentioning that banks should also keep 10% of their deposits denominated in foreign currency as reserves with the CBE, but these reserves earn interest related to LIBOR. Liquidity Ratio Banks must keep at least 20% liquid assets denominated in local currency and 25% of assets denominated in foreign currency. 24 Egypt Banking Sector September 2008
  28. 28. Global Research - Egypt Global Investment House Extending Credit Banks must not extend credit to a single borrower in excess of 20% of the bank’s book value. In addition, banks are not allowed to extend credit to one particular borrower and his affiliates in excess of 25% of the bank’s total equity. Provisions Banks are required to keep provisions according to the credit risk level associated with each loan. Loans are classified into two categories related to regular and irregular settlements. For regular settlements, loans are categorized under many risk levels ranging from low to watch list risk, where each level has a corresponding provision required rate ranging from 0% to 5%. For irregular loans, they are classified into three types, substandard debt, for which a 20% provision must be kept, doubtful debt, with a required 50% provision. Finally, loss debt must have a 100% provision. More conservative banks usually keep higher provision rates than required. Untapped Segments as Key Prospects … Retail Segment The retail banking activities in Egypt are considered an unexploited segment, promising high potentials for the banking sector. There is a great unfulfilled demand for banking activities in this sector. This comes from the fact that large percent of the population, which amounted to 75mn in 2006/07, after a 2% y-o-y increase, still does not participate in banking activities or even have a slight participation, which could be a result of low income levels or not enough understanding of the importance of banking activities. Moreover, 61.1% of the population is in the working age, which implies further increase of demand of the retail segment in the future. From the banks’ side, they have always been reluctant to direct great portions of their loans to individuals fearing of the risk of default, but this is expected to change in the future, especially after the establishment of the credit bureau that should facilitate the flow of necessary information to banks concerning clients’ history and would therefore minimize the risk of default. Lending to individuals is only provided according to salaries and usually not exceeding 20% of the monthly salary. Currently, a large number of banks are expanding their branch networks to fulfill unsatisfied needs from the retail segment. As of March 2008, there were 3,252 branches in Egypt with each branch serving an average of 23.1 thousand people. As for branch network, it is important to note that around 65% of the existing branches in Egypt are owned by the public banks. Some of the private banks that announced their intention to expand their branches were Commercial International Bank, National Societe Generale Bank, BoA, Audi, HSBC, Piraeus, Blom, Barclays, Export Development Bank of Egypt, BNP Paribas and Credit Agricole. SMEs Segment Small and Medium Enterprises “SMEs” are defined as companies whose revenues do not exceed LE1mn. Banks are usually hesitant to lend to SMEs due to the high risk associated with these companies, in terms of lack of adequate capital and assets, in addition to the fact that they are usually not registered. As for the SMEs, interest rates could be high, making the cost of finance through banks higher. These factors explain the low banking penetration of this segment. September 2008 Egypt Banking Sector 25
  29. 29. Global Research - Egypt Global Investment House Recently, the government encouraged the registration of SMEs, which could reduce the reluctance of banks to SMEs lending, through the provision of collateral. If this happens, along with the presence of the credit bureau and its role in minimizing default risk, growth potential in this segment is expected to be high, as banks will be able to expand their banking activities for this sector and hence increase their client base, enabling them to realize higher margins. Mortgage Segment The Mortgage Financing Law was launched in Egypt in 2001. Mortgage loans represent a small fraction of banks’ loans due to many factors. The fact that most properties were not registered due to high registration fees, made banks hesitant to extend mortgage loans, fearing of loans default, especially that unregistered properties could not be used as collateral. Another factor can be attributed to the high rates on mortgage loans reaching 14%, coupled with low purchasing power and low wages. In 2005, the government reduced the registration fees on properties to 3% down from 12% of the property’s price or a maximum fee of LE2,000. Also, property taxes were cut from 46% to 10% of the annual rental value. Such regulations should facilitate property registration and thereby would give more confidence to banks or mortgage finance companies to extend mortgage loans now that they can rely on registered properties as collateral. Moreover, developers are now targeting middle and upper-middle class level, which may facilitate mortgage lending in the coming few years. Mortgage lending opportunities are expected to boost, after the establishment of the governmental institution “the Egyptian Company for Mortgage Refinancing”, along with the emergence of new lending mortgage companies, in addition to the newly established credit bureau. The potential growth expected in the mortgage segment induced the CBE to allow banks increasing the share of loans allocated to the real estate sector from 5% to 15% of their total loan books, to be equally distributed among real estate developers, mortgage borrowers and touristic development companies. An Additional Key Prospect The restructuring that occurred following the banking sector reform program, resulted in a reduction of the number of banks from 61 banks in 2004 to 41 banks in 2007 and raising the number of branches from 2,783 branches to a current number of 3,252 branches. The major influence on the sector was the heating competition among lenders, which accelerated substantially in the last few years, especially with the emergence of foreign expertise. To boost competency, most banks currently provide a wide range of products and services including house and car loans, credit and ATM cards services, automated machines and 24-hour services, capital markets and investment banking activities, along with the traditional banking activities. This intense competition is expected to enhance the banks’ profitability by attracting greater client base through providing better quality of products and services to the public. 26 Egypt Banking Sector September 2008
  30. 30. Global Research - Egypt Global Investment House Issues to be Considered… As the Egyptian banking sector was ruled by the public sector banks for decades, the service was never an issue. These banks were serving the government in financing mainly public enterprises. Now that most of the banks became private, ameliorating the service became a must in order to boost, or at least maintain their market shares. Another important issue is the dissemination of information to the public. As most of the banks are publicly traded now, there is a need for a minimum of disclosure for shareholders about the banks’ operations and performance in any given period. Still the fear of fierce competition stops banks from operating liberally. The sector is shaping and these issues will improve with competition, which pours at the end in the clients’ interests. September 2008 Egypt Banking Sector 27
  31. 31. Global Research - Egypt Global Investment House Peer Group Comparison Banks’ Current Market Shares of The Total Branching Network As of March 2008. The banking system branch network encompassed 3,252 branches. It is worthy to note that public banks and other private banks outside our coverage universe, account for 90% of the branching network, approximately. As for our covered banks, Commercial International Bank “CIB” captures the highest market share, represented by 4.2%, which is explained by the long presence of the Bank in the market, relative to the other banks. National Societe Generale Bank “NSGB” followed, with a market share of 3.6%. Chart 16: Banks’ Branches Market Shares CIB 4.2% NSGB 3.6% CAE 1.6% EGBE 0.3% EDBE 0.3% Public & other Private Banks 89.9% Source: Global Research Balance Sheet Performance Major Source of Funds In terms of deposits market share, also CIB was able to make the highest contribution to the total deposits of the banking system, 6.0%, followed by NSGB, contributing to 4.8% of total deposits. On the other hand, the highest growth realized in deposits over 2007, was performed by Credit Agricole Egypt “CAE”, which witnessed a 36.5% increase. This stems from the bank’s intention to increase its market share, as it stood at 2.6% in H1 2008, lagging far behind the two major players, CIB and NSGB. 28 Egypt Banking Sector September 2008
  32. 32. Global Research - Egypt Global Investment House Chart 17: Deposits market shares-H1 2008 Chart 18: Deposits Growth (2006-2007) CIB 6.0% LEmn NSGB 4.8% 45,000 36.5% 40% CAE 2.6% EGBE 1.1% 40,000 35% EDBE 0.5% 35,000 30% 25.1% 30,000 21.4% 25% 25,000 18.0% 20% 20,000 13.0% 15% 15,000 10,000 10% 5,000 5% Public & other Private - 0% Banks 85.0% CIB NSGB CAE EDBE EGBE Deposits-2006 Deposits-2007 % change y-o-y (right scale) Source: Banks’ financials, Global Research Comparative Growth in Balance Sheet Not surprisingly, the major contribution to total assets came from the two largest banks, CIB and NSGB, contributing to 5.2% and 4.1% of the total assets of the banking system, respectively. This was attributed to the large funding base of these banks, which was founded on the relatively immense deposits balances. In the mean time, the highest y-o-y growth in deposits that CAE was able to realize in 2007, was translated into the highest growth realized in total assets in the same year, as well. That said, total assets of CAE swelled by the same growth of deposits realized in 2007. Chart 19: Total Assets Market Shares-H1 2008 Chart 20: Total Assets Growth (2006-2007) CIB 5.2% NSGB 4.1% CAE 2.1% LEmn EDBE 1.2% 60,000 36.5% 40% EGBE 0.5% 35% 50,000 27.2% 30% 40,000 25% 19.8% 19.7% 30,000 20% ` 11.9% 15% 20,000 10% 10,000 5% - 0% Public & other Private CIB NSGB CAE EDBE EGBE Banks 87.0% Total assets-2006 Total assets-2007 % change y-o-y (right scale) Source: Banks’ financials, Global Research Resulting Acceleration in Lending Activity As for loans, major share went to the two large players, as well. CIB and NSGB contributed to 6.4% and 6.1% of the total loans in the banking system, respectively. The major growth in loans over the year was realized by NSGB and CAE, realizing 22.8% and 22.5%, respectively. This illustrates the two banks’ target of expanding their market shares, relative to their peers. September 2008 Egypt Banking Sector 29
  33. 33. Global Research - Egypt Global Investment House Chart 21: Loans Market Shares-H1 2008 Chart 22: Loans Growth (2006-2007) CIB 6.4% NSGB 6.1% LEmn CAE 1.8% 25,000 45% 39.3% EDBE 1.9% 40% EGBE 0.7% 20,000 35% 30% 15,000 22.8% 22.5% 25% 20.8% 16.7% 20% 10,000 15% 5,000 10% 5% Public & other Private 0% Banks 83.1% - CIB NSGB CAE EDBE EGBE Loans-2006 Loans-2007 % change y-o-y (right scale) Source: Banks’ financials, Global Research Most Conservative While Having Lowest NPLs Ratio Although CIB has the lowest NPLs ratio, 3%, it adopts the most conservative provisioning policy, as its coverage ratio stood at 166% in 2007. It is worth mentioning that the NPLs ratios of NSGB and CAE are magnified, as they inherited bad debts from the acquisitions of MIBank and EAB, respectively. Nevertheless, they are performing well, as their coverage ratios are close to 100%. Chart 23: Provisioning Policies Adopted-2007 180% 160% 140% 120% 100% 80% 60% 40% 24.2% 19.6% 9.0% 20% 9.6% 3.0% 0% CIB NSGB CAE EDBE EGBE Coverge Ratio NPLs/Gross Loans Source: Banks’ financials, Global Research Income Statement Performance Spreads were suppressed over the year… Net spread, representing the core income of banking activity, has narrowed for almost all banks under coverage in 2007, except for CAE and Export Development Bank of Egypt (EDBE), as it inclined from 2.7% to 2.8% and from 1.5% to 1.6%, respectively. The decline in spreads could be a result of the intensifying competition. Nevertheless, we expect spreads to rise until 2009, as a response to the successive jumps in the corridor range. Beyond 2009, the spreads are projected to decline, as a result of the foreseen competition. 30 Egypt Banking Sector September 2008

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