Lebanon’s banks in danger of downgrade after Moody's puts country on notice

The rating agency will review the ratings of Bank Audi, Blom Bank and Byblos Bank

epa07860687 People look at the artwork for the Lebanese sculptor Bassam Kyrillos 'Equinox' made by aluminum and synthetic colors diameter 300 cm during a Beirut Art Week 2019 in downtown Beirut, LebanShow more

Moody's Investors Service put the deposit ratings of Lebanon’s top banks under review for a downgrade after warning the country this week its own rating was in danger of being cut deeper into junk territory.

The rating agency placed the Caa1 deposit ratings of Bank Audi, Blom Bank and Byblos Bank under review, it said in a statement on Thursday.

The rating action on the lenders “reflects the high interlinkages between their balance sheets and sovereign credit risk, and mirrors Moody's review for downgrade of the Lebanese government's Caa1 issuer rating on 1 October 2019 … accordingly, the reviews on the banks' ratings will predominantly focus on the likely deterioration of the sovereign's credit quality,” the agency said.

The primary driver of the review it added is the exposure of the lenders to the Lebanese sovereign, which is their main source of risk, through government securities and placements at the central bank of Lebanon, equivalent to around seven-to-nine times their capital and more than half of the banks' assets, Moody’s said. In addition, despite being geographically diversified, the three banks continue to be exposed to “the challenging Lebanese operating environment … which also indirectly exposes them to sovereign event risk,” the agency said.

Lebanese banks have channelled private sector deposit inflows that have supported the government, which it estimated had a fiscal deficit of 11 per cent in 2018. Banks have also helped shore-up the central bank’s foreign currency reserves in light of large current account deficits estimated at 24 per cent last year and the Lebanese pound's peg to the US dollar.

Moody’s said because of the credit linkage with the sovereign, and “the mismatch between the long-term maturities of banks' sovereign holdings and the shorter maturities of their main liabilities, customer deposits, the review will therefore also look into the rate of growth in customer deposits in Lebanon that would enable the banking sector to continue to fund the sovereign and the central bank's foreign reserves that help maintain the stability of the peg”.

The agency said the banking system deposit growth stalled in the first seven months of this year which lead to “liquidity pressures” that challenged the sector's “ability to fund the country's twin deficits, which is also a key driver for the review on the sovereign's Caa1 rating”.

Private sector deposits at banks in Lebanon declined by $2.2 billion (Dh8.1bn), or 1.3 per cent, in the first seven months of the year whereas during periods of significant political instability from 2001 to 2008, deposits had continued to grow annually, the agency said.

Deposit dollarisation reached 72 per cent in July 2019, a level last-seen in 2008, which Moody’s said illustrates declining confidence in the Lebanese pound's peg to the dollar.

Should the rating of the Lebanese government's Caa1 rating be confirmed upon the completion of the three-month review, the agency is then likely to also confirm the ratings of the three banks.

Moody's said it may also downgrade the banks' ratings because of a sustained slowdown in banking system deposit growth or outright outflows in Lebanon that would “challenge the financial sector's ability to meet its dues and to finance the government, thereby jeopardising financial stability”.

Any official restrictions on transferring foreign currency deposits may lead it to downgrade the banks' relevant ratings, it said.

Lebanon, which has $86bn of public debt as of the end of July, and one the world’s highest debt to GDP ratios, is in a precarious situation as it has traditionally relied on capital flows from its citizen abroad to help finance its deficits and service its debts.

Until Syria’s civil war erupted in 2011, Lebanon had managed to remain resilient in the face of a month-long war with Israel in 2006, internal political differences that led to civil strife in 2008 and political vacuums that left it without a president twice after presidential terms of incumbents expired.

A combination of high interest rates on deposits and relying on economic growth expanding at a pace faster than public debt growth helped the country escape the crisis it faces now in the past.

The country received pledges for $11bn at the CEDRE international donor conference in Paris last year that were tied to the government implementing structural reforms and reining in spending. However, none of those funds have come through due to lack of implementation of the required reforms.

In its review for downgrade of the Lebanese government's Caa1 issuer rating on October 1 Moody’s said a decision to cut Lebanon’s rating would take place if it “were to conclude that Lebanon's fiscal, liquidity, bank deposit and balance of payments dynamics will likely continue to weaken, potentially destabilizing the currency peg and/or increasing the risk of an imminent debt rescheduling or other liability management exercise that may constitute a default”.

The government's inability to comply with the conditions attached to the disbursement of CEDRE funds which included the adoption of the 2020 budget before the end of this year, or failing to secure anticipated bilateral support from other lenders, to ease immediate liquidity pressures would prompt the action, Moody’s said.