Decline in Lebanese banks’ foreign assets is credit negative – Moody’s

Instability weighs on GDP growth

DUBAI, Oct 24: Last Wednesday, Banque du Liban (BdL), Lebanon’s central bank, published data showing that Lebanese banks’ foreign assets, mostly in the form of foreign bank placements, had declined by $1.9 billion between May 2016 to August 2016, and by $1.1 billion in August alone.

As a result, Lebanese banks’ net foreign liabilities increased to $18 billion in August from $15 billion at the beginning of the year, a credit-negative acceleration of a trend that began in 2011, when banks had a net foreign asset position.

The repatriated $1.9 billion of foreign assets were invested in long-term Lebanese government (B2 negative) Eurobonds and BdL certificates of deposits (CDs) that increased the banks’ overall exposure to the sovereign.

Reduction

The large reduction in Lebanese banks’ foreign assets is the result of a BdL financial operation that began in May. Although the BdL has not disclosed details of this operation, we estimate, based on news reports and published figures, that BdL bought $2 billion of Eurobonds from the Lebanese Ministry of Finance in exchange for an equivalent amount of debt denominated in Lebanese pounds.

Additionally, there are reports that BdL bought roughly $6 billion of Lebanese pound- denominated Treasury bills over the summer from commercial banks at a premium and sold them the $2 billion in Eurobonds and an additional $4 billion in CDs. Banks were required to keep the profits generated from these transactions as Lebanese pound-denominated reserves ahead of the implementation of International Financial Reporting Standard No. 9, which takes effect in 2018. Banks will be allowed to recognise any excess as profits once they have taken those provisions.

The transaction grew BdL’s foreign assets to a record $40.6 billion at the end of September 2016 from $34.6 billion in May. Including gold, BdL’s foreign assets now cover a record 26 months of imports. As a result of slowing financial inflows into Lebanon, BdL’s foreign assets had been declining since July 2015.

Domestic political paralysis and ongoing regional instability led to almost flat GDP growth, and deposit growth slowed in the first half of the year to $3.2 billion from $4.2 billion in the yearago period. Lebanon continues run a large budget deficit, which we forecast at 8 percent-9 percent of GDP for 2016-17, and relies on the domestic banking system to finance that deficit.

The transactions have significantly reduced Lebanese banks’ dollar liquidity and have increased banks’ already large exposures to Lebanese government Eurobonds, which we estimate are at 1.2x banks’ Tier 1 capital as of July 2016. We estimate the banking sector’s overall government exposure1 to be more than 5x banks’ Tier 1 capital. As a result, banks raised interest rates on dollar deposits to a weighted average of 3.39 percent in August from 3.26 percent in May to attract additional inflows and shore up liquidity.

Deposits grew by $2 billion in August alone, and we estimate that deposits placed at Lebanese banks now equal 300 percent of GDP, one of the highest ratios globally. Some banks were also able to recover some of their foreign liquidity by selling Eurobonds in the secondary market to foreign banks.