Institutional Investor 2006-05-01 18:32:34Mahmoud Abdel Latif knew he faced a struggle in trying to rebuild Egypt's state-owned Bank of Alexandria when legislators railed at him about his draconian standards and called him "Mr. Basel." It was November 2002, and nationalist lawmakers were leery of foreign meddling in Egypt's domestic affairs and fearful that the tighter risk controls promulgated by the Basel II capital adequacy rules would put an end to the politically influenced lending practices of the bank.
"We were discussing the need to lift provisions," recalls Abdel Latif of testimony he was giving in the legislature on his plans for the bank, "and members of the general assembly were standing up and yelling, 'Why do we have to listen to this Mr. Basel?' They were attacking everything and everybody."
It was a reminder--if the 52-year-old, Egyptian-born, Citibank-trained banker needed one--of how long his country had been languishing on the dark side of the global economy. Abdel Latif held his ground, however, and introduced a series of landmark reforms that have made the bank a prime asset for privatization and helped revitalize Egyptian banking.
In a whirlwind series of moves, he and his handpicked team of senior managers have cleaned up the bank's balance sheet by establishing a new in-house credit evaluation system that complies with the Basel II accord and are publishing financial results under International Accounting Standards. The efforts have made the bank the first in Egypt to comply with those key international codes.
Abdel Latif has renovated the bank's once-dilapidated branch offices, cut staff and retrained the remaining 7,000 employees. He has also rapidly expanded lending to small businesses and consumers, an untapped sector with enormous potential. The restructuring has paid off in a nearly fivefold increase in operating income since 2002.
Having turned Bank of Alexandria from a financial backwater into arguably the strongest bank in Egypt's increasingly robust financial sector, Abdel Latif is getting ready to harvest the fruits of his efforts. The government of President Hosni Mubarak plans to auction its 76 percent stake in Alexandria later this year, making it the first of Egypt's four state-owned banks to be privatized. Analysts believe that the sale, expected to be held in the middle of this year, will fetch anywhere from 6 billion to 9 billion Egyptian pounds ($1.1 billion to $1.6 billion). Likely bidders include France's BNP Paribas, Saudi American Bank, the National Bank of Kuwait, the National Bank of Greece and Commercial International Bank, a subsidiary of the National Bank of Egypt, the country's largest lender.
"Abdel Latif is running Bank of Alexandria like a real bank," says Amr Abaza, the treasury director for Egyptian telecommunications giant Orascom Telecom, a Bank of Alexandria client. "It's a message to the rest of the banking community that they have to clean up their balance sheets, and they're doing it."
The big four state-owned banks--National Bank of Egypt, Bank Misr, Banque du Caire and Bank of Alexandria--have dominated Egyptian banking for decades, providing almost half of all loans. A handful of foreign institutions, such as Chase Manhattan Bank, American Express Bank and Citibank, established joint ventures with local players in the 1970s under the open-door policy of then-president Anwar Sadat. Most of the country's 60-odd banks, however, are small and inefficient.
Since being appointed in July 2004 by President Hosni Mubarak with a mandate to unleash long-delayed economic reforms, Prime Minister Ahmed Mahmoud Nazif has made bank restructuring a key plank of his economic program. Last year the government sold its stakes in two small joint venture banks, enabling Greece's Piraeus Bank to acquire Egyptian Commercial Bank and Lebanon's BLOM Bank to take control of Misr Romanian Bank, formerly a joint venture between Bank Misr and Bucharest-based Commerciali Bank Romania.
The privatization of Bank of Alexandria is the latest and most dramatic evidence of the government's liberalizing zeal. Over the past two years, Nazif and his team have broken with decades of protectionism and bureaucratic controls and invigorated the economy with market-oriented policies. They have let the pound float freely, slashed customs duties and privatized a raft of companies ranging from steel and cement producers to textile makers (see box). They have also facilitated foreign investment, which, although officially permitted since the 1970s, has been held back by red tape and political opposition.
The results have been impressive: Privatizations and asset sales have raised more than E£16.5 billion, foreign direct investment has surged to $3.9 billion in 2005 from $3.0 billion in 2004 and a measly $237 million in 2003, and exports have expanded rapidly, rising 31 percent, to $13.8 billion, in the fiscal year ended June 2005. The pound has also been firm, gaining 6.4 percent against a strengthening dollar in calendar 2005 and holding steady so far this year, a performance that reflects increasing investor confidence in the government's commitment to reform. Egyptian stock prices have soared--the CMA general index rose 225 percent between January 2004 and early February but has since fallen by 18 percent as part of a regional setback--boosting market capitalization to 80 percent of Egypt's $90 billion gross domestic product.
The work is far from complete, however. Cairo now is preparing to remove billions of pounds' worth of subsidies on everything from energy to housing. The government plans to spend E£38 billion on subsidies--nearly a third of its total budget--in the current fiscal year, contributing to a projected deficit of E£59 billion, or 9.4 percent of GDP. But efforts to reduce the deficit are potentially explosive in a country where 20 percent of the population lives below the poverty line. Previous attempts to dismantle subsidies have led to social unrest, most notably riots in 1977 that forced then-president Sadat to restore subsidies on bread.
Still, even onetime skeptics are impressed with the achievements of the past two years. "Back in the 1990s there was nothing but fluff" from government ministers, says Philip Khoury, head of research at EFG-Hermes Holdings in Cairo, one of the Middle East's biggest investment banks. "Now they're not only making promises, they're delivering in short order. What's going on is very real."
The reformist measures have certainly boosted the economy. EFG-Hermes is forecasting that growth will accelerate to 5.7 percent in the current fiscal year, from 5.1 percent last year. But Nazif's government can't afford to stand still. Egypt has a serious unemployment problem and needs a growth rate of at least 7 percent a year to absorb new entrants into the job market. The jobless rate officially stands at 9.5 percent, and private economists estimate the real rate to be twice as high. The Muslim Brotherhood, Egypt's oldest and most potent Islamic movement, played on discontent over unemployment to win 20 percent of the seats in the People's Assembly in elections last December, making it the largest opposition group.
"Unemployment was a huge issue in the elections," says Hanaa Ramzy, an economics specialist at the British Embassy in Cairo. She notes that even Mubarak's ruling National Democratic Party acknowledges it lost many seats because people hadn't seen the benefits of reform.
The imminent sale of Bank of Alexandria is crucial to the government's broader economic reform agenda. Despite improvements, the country's banking sector remains sprawling and inefficient. Most banks offer only basic products, like checking and savings accounts, and impose onerous collateral requirements that restrict lending, particularly to small and medium-size borrowers who could serve as important engines of growth. Modernizing the banks and giving them the capital and technical strength to increase lending is vital to raising the economy's growth potential.
A successful sale should also help discredit the widespread opposition to privatization, which many Egyptians regard as a plundering of the nation's prized assets by greedy financiers, both foreign and domestic. Consider, for example, the popular resistance to Bank of Alexandria's sale in January of its 33.8 percent stake in Egyptian American Bank to Calyon, the investment banking subsidiary of France's Crédit Agricole. Unions and some shareholders criticized the sale because, at E£50 a share, it was done at a 15 percent discount to the prevailing market price. Abdel Latif countered that the rise in EAB's share price had been purely speculative and that Alexandria and its adviser, Credit Suisse, had determined a minimum fair value of E£45 a share. The transaction was approved by a government committee charged with appraising state holdings.
"This is a society very much against selling the crown jewels," says Mahmoud Mohieldin, the Investment minister who is leading Egypt's privatization program. "If there's nothing wrong to be found in the transaction, some people will object on the grounds of ideology or race. But Bank of Alexandria will be sold by the end of the fiscal year as a key part of the privatization process."
Following the mid-1990s, when the Egyptian economy stagnated after the collapse of a real estate bubble, the government seemed content with reformist tinkering. The temporizing came to an end in 2002, however, after currency speculation provoked a drop in the pound and riots in the streets. Cairo, like many capitals across the region, began looking to economic and political reform as an antidote to Islamic fundamentalism in the post¬9/11 world.
After taking office, Nazif retained reformists like Mohieldin, Finance Minister Youssef Boutros Ghali and Central Bank of Egypt governor Farouk el-Okdah, a former Bank of New York executive; he then buttressed the cabinet with businessmen such as Trade Minister Rachid Mohamed Rachid, an ex-regional head for Unilever, and Transport Minister Mohamed Lutfi Mansour, a former banker and auto dealer.
Abdel Latif first entered public service in 2001 when Prime Minister Atef Obeid, Nazif's predecessor, tapped him as vice chairman of Banque du Caire and gave him the task of making the bank commercially viable. It was an inspired choice.
One year after graduating from Cairo's Ain Shams University in 1976, Abdel Latif joined Citibank's local branch as a clerk. Two years later he was transferred to Athens for a year's training before being posted to Citibank's Saudi Arabian venture at the time, Samba. In 1991 he was sent to Bahrain to run the bank's corporate finance division for the Gulf region. Over the next decade, he arranged financing for deals worth billions of dollars, ranging from new petrochemical projects to energy grids and auto dealerships, and advised clients including General Electric Co., Siemens and the bin-Laden Group.
"What I know about proper procedures, risk management, and debt classification I learned from Citibank," Abdel Latif explains, "and that informs what we're doing here."
Chase Manhattan Bank wooed Abdel Latif back to Cairo in 1998 to run its North African operations. By then he had developed a reputation as a blunt speaker with little time for Levantine subtlety--a by-product, he says, of his upbringing by his father, a corporate lawyer who represented a host of international businesses.
"I grew up around my father's clients, most of whom were very plain-speaking American businessmen," Abdel Latif says. "I guess it rubbed off."
But it would take more than straight talk to salvage Banque du Caire, where Abdel Latif got an intimate view of a musty, subterranean banking culture that only an archeologist could love. The bank had Egypt's largest corporate exposure and a pile of nonperforming loans to real estate developers. Many of the loans were sweetheart deals to favored clients--15 borrowers accounted for 40 percent of outstanding loans--and the institution was called on to finance wasteful public projects like the housing developments in suburban Cairo known as El Fil el-Abyad, or the white elephants. For such lending the national banks became known as sabeel, or public drinking fountains.
Abdel Latif personally took control of Banque du Caire's credit division, writing off some loans, rescheduling payment terms on others and ignoring or rejecting demands for policy loans. To dilute his loan portfolio's concentration, he launched a pilot scheme offering small businesses loans of E£5,000 to E£25,000 at a time when most Egyptian banks wouldn't touch the sector. Abdel Latif also started marketing loans to the country's 15 million state employees, believing that would diversify risk and allocate much-needed credit to workers in low income brackets, a segment of the population where commercial activity is limited and Islamist influence is significant.
"It's not a stretch to suggest this is a tool in the fight against extremism," Abdel Latif said at the time.
In September 2002, Obeid asked Abdel Latif to do a similar makeover at Bank of Alexandria, this time as chairman. It was a clear mandate with no strings attached, the banker explains.
"This government did us the biggest favor by simply staying out of the way," Abdel Latif says from his office in downtown Cairo, where modernity in the form of a state-of-the-art video-conference system contrasts with Victorian-period drapes, leather-bound chairs and cherry-wood molding.
Bank of Alexandria was saddled with less corporate debt than the other state banks, but it was the most backward in procedures and technology. Most bank clerks were using typewriters and calculators. Financial statements were written by hand, and it could take hours, if not days, to cash a check.
Abdel Latif pulled together a management team of Egyptian bankers with extensive experience at home and abroad. He hired Fatma Ibrahim Lotfy, a veteran of Chase Manhattan and American Express Bank in Cairo, as his first deputy chairman, and tapped Mehdat Zakaria, a former credit analyst at Citibank in Jeddah, Saudi Arabia, and at Chase Manhattan in Cairo, to oversee credit and marketing.
Hesham Hamdy, another American Express Bank alumnus, remembers going to Bank of Alexandria headquarters intending to politely decline Abdel Latif's offer to run the bank's risk management division. An hour later he had succumbed to the chairman's bold talk of revitalizing Egyptian banking. "They convinced me to do something for the country," he says.
Hamdy immediately set out to adopt Basel II standards, a bold step considering that Egypt requires its lenders to adhere only to the first Basel accord. He broke down the bank's loan portfolio into three categories based on size; risk managers were assigned to each client, and credit committees were formed to evaluate new loan requests, a process that has shortened the time for approving loan applications to two to three days from two weeks. "We exceed central bank requirements, and our clients are very happy with that," Hamdy says.
Once in place, Abdel Latif led his team on a tour of all 192 Bank of Alexandria branches, most of which were as isolated as they were decrepit. Staff morale was low and procedures were primitive. A bank employee with a college degree and ten years' experience could earn as little as E£400 per month, or slightly more than half of Egypt's per capita income.
At each stop Abdel Latif delivered his gospel of reform. Sohair Gaafar Appadi, a 34-year veteran at the bank's former headquarters in the seaside city of Alexandria, remembers the chairman visiting the branch three years ago and winning over anxious staff with his talk of change.
"People responded," says Appadi, who was recently named branch manager. "They felt as if he really was looking out for us."
To drive the message home, Abdel Latif immediately doubled salaries. He and his managers also launched a series of training programs for everyone from credit analysts to the bank's human relations staff. To pay for the salary hikes and boost efficiency, the bank offered an early retirement package to trim head count from 8,500 to 7,000. The plan slashed the number of clerks in the main hall of the Cairo headquarters from 700 to 250, but even so the bank managed to extend opening hours, thanks to automation.
The new management team overhauled the bank's treasury department and built a dealing room staffed by 15 traders that handle foreign exchange, money market and fixed-income products, including government securities. Once little more than a place for bookkeepers, according to Abdel Latif, the treasury averaged monthly net interest income of E£75.7 million in the six months to December 2005, up from a monthly average of E£18 million in the fiscal year ended June 2005.
With staff numbers stabilized, salaries were doubled for the second time and a system of bonuses and incentives was introduced. "Prior to that, salaries were raised no matter what," says Appadi, who was awarded a bonus after persuading clients, by appealing to their patriotism, to sell their dollars at the official exchange rate rather than unload them at more lucrative black-market rates. The tactic was particularly helpful because the branch needed hard currency to pay for new equipment at the time.
Abdel Latif and his crew then turned to the bank's mountain of bad debts--half of its E£8 billion in private sector loans were nonperforming. They foreclosed on some but renegotiated as many as possible, going so far as to finance raw materials purchases for some stretched companies in return for a share of future profits. "Whenever possible, we'd give people an opportunity to keep going," says Zakaria.
Today the bank still has E£3.5 billion in nonperforming loans, out of a total portfolio of E£7.5 billion, but it has built up provisions equal to 100 percent of those NPLs.
Abdel Latif expects the real growth to come from the retail side. He projects total retail lending, now E£1.5 billion, to grow by 50 percent annually for the next three years, driven in large part by recently adopted laws designed to encourage land registration and make it easier for banks to make mortgage loans, a revolution in a country where most property buyers pay cash.
The bank set up a pilot mortgage program in 2005 that has already extended some E£500 million in home loans. "It's virgin territory for everything from home loans to credit cards," says Abdel Latif. "This is a market of 78 million people where only a fraction of the population actually banks."
Bank of Alexandria's nonperforming public sector debt was settled by the government in January with the delivery of E£7 billion in cash to a vault in the basement of the bank's headquarters. Abdel Latif wouldn't comment on the terms but insists the payment provided a "nearly total" redemption of outstanding credits. The bank is investing the money in short-term government bills. "We're going in a lot of directions at once, and this will allow us to keep our eyes open for midterm opportunities," he says.
The bank has also developed a strong capital markets capability in a bid to generate fee income. In January 2005, Bank of Alexandria was co-underwriter, along with National Bank of Egypt and Bank Misr, on a $270 million domestic bond issue for Orascom Telecom Holdings, a member of Egypt's powerful Orascom Group. (Abdel Latif had a relationship with Orascom Telecom that went back to the chairman's days at Chase, when he syndicated an $800 million loan for Mobinil, the company's cell phone unit.) The bond issue, which Orascom used to refinance outstanding debt, followed a E£2 billion bond that Bank of Alexandria helped underwrite in 2004 for Telecom Egypt, the state-owned giant that listed on the local stock exchange in November. In March 2005, Bank of Alexandria teamed with National Bank of Egypt and Misr to underwrite a $320 million syndicated loan to finance Orascom's buyout of its minority partners in a cell phone company in Algeria.
The bond deal was new for Orascom, says treasury director Abaza. The company had considered borrowing against a margined allotment of its own shares as collateral. After conferring with Bank of Alexandria's senior managers, however, it agreed to tap the capital markets for unsecured credit.
Abdel Latif was characteristically blunt, says Abaza. "He speaks his mind, and he was very direct about how we should structure the transaction. We're used to national banks that know only collateralized lending, but Abdel Latif understands what a company our size needs." Bank of Alexandria's epic makeover has transformed its bottom line and made the bank attractive to potential bidders. Its assets, including holdings of government securities and equity stakes in Egyptian companies, have increased by more than 60 percent over the past three years, from E£26 billion to E£42 billion, while operating profits before provisions during the same period rose from E£432 million to E£2 billion.
Having overhauled Bank of Alexandria, Abdel Latif fully expects to be out of a job by the end of this year, after a foreign owner takes control of the bank. He won't be idle for long, however. He and his wife are having a villa built that overlooks Cairo and will have a view of the pyramids on the horizon. And after the privatization, the banker says he will be ready to tackle another turnaround job.
"I love what I did, and I proved I can do it," he says, adding, "The country needs more reform in other areas."
Breathing new life into old industries
The Egyptian Iron & Steel Co., on the outskirts of Cairo, is almost as much a relic of a bygone era as the nearby pyramids of Giza. The mill looks much like it did when it was opened in 1958 by then- president Gamal Abdel-Nasser, who nationalized everything from banks and power grids to the country's Arabian horse farms. Aging trucks with running boards pass through the compound's gates, and a thick layer of dust covers the narrow-gauge tram that takes workers to the mills from their on-site dormitories.
One thing is new, however. Last year the company was in the black for the first time, posting a modest profit of 100 million Egyptian pounds ($17.5 million) on E£2.5 billion in sales. Rising world steel prices undoubtedly helped, but the turnaround also reflects an aggressive restructuring effort spearheaded by Mahmoud Mohieldin, Egypt's Investment minister.
"We started the renovation a year ago with Mahmoud," says Abdel-Aziz Hafez Gharib, a 32-year veteran who became chairman of the company in October. "For years we approached previous governments for help, but this is the first time they've responded. Now we're optimistic. We feel we can do better."
In the late '90s and the early part of this decade, when Egypt's government was stalling on much-needed economic reforms, Mohieldin--then an adviser to the minister of Economy and Foreign Trade--was a lonely voice for privatization. He got his chance in July 2004, when President Hosni Mubarak tapped him to run the new Ministry of Investment and gave him a mandate to unload a mass of state assets. Since then he has sold E£16.5 billion in government-owned properties. The privatizations include the E£5.1 billion initial public offering of 20 percent of Telecom Egypt and the E£2 billion IPO of 46 percent of Egyptian Fertilizers Co. last year.
"There will be no turning back," says Mohieldin, who has a Ph.D. in economics from the U.K.'s University of Warwick. "I'm not leaving any company behind."
At Egyptian Iron & Steel, Mohieldin has combined steep cost cuts--the company laid off 4,000 workers, or 23 percent of its labor force, offering severance packages worth up to two years' salary--with a E£100 million investment in a new hot-rolling mill to increase capacity. The company is negotiating with the government for a reduction of its E£6 billion debt. "If we can ease the interest on the payment burden," says Gharib, "we can lower prices."
Thanks to such restructurings, Mohieldin's portfolio of state-owned companies earned E£600 million last year, up from E£80 million in 2004. Hot demand for shares in privatized companies has made Egypt's stock market one of the world's top performers for two years running, with foreign investors now accounting for 40 percent of daily turnover. Direct foreign investment surged to $3.9 billion in 2005 from $3 billion in 2004 and hit $2.5 billion in the first quarter of this year alone, two thirds of it in non-energy sectors such as tourism, manufacturing and textiles.
The government plans to sell another 45 companies this year, up from 28 in 2005. Its targets include retail chains and chemical manufacturers. "People have seen that economic reforms are working, and they want more," says Kenneth Ellis, director of the U.S. Agency for International Development in Cairo. "That's as close to a mandate as you'll get in Egypt."