Fitch Ratings-Dubai/London: The main risk to Lebanese banks' solvency following Lebanon's USD1.2 billion Eurobond default is their exposure to the central bank, Banque du Liban (BdL), Fitch Ratings says.
Deposits and certificates of deposit at BdL were 54% of commercial banks' total assets and 6x their core capital at end-2019. BdL's ability to meet its foreign-currency (FC) obligations to banks was already weak due to increasing pressure on its FC reserves. Its FC assets, excluding USD5.7 billion Eurobond holdings (and gold) at end-2019, were USD32 billion, less than half of its FC liabilities to banks, estimated by Fitch at USD70 billion. BdL faces particular pressure in 2022-2023 when significant amounts of FC certificates of deposit, bought by banks during financial engineering operations in 2016, reach maturity. If BdL is unable to meet its FC obligations to domestic banks, this could lead to depositor bail in.
Direct exposure to the Eurobond default represented 6% of domestic banks' balance sheets and about two thirds of their equity at end-2019. Domestic banks sold USD1.1 billion of this exposure in January 2020, in need of FC liquidity and fearing a default. This was traded at less than half of the face value. The restructuring scenarios are not clear but could involve nominal haircuts, coupon omissions or maturity extension.
Link to Infogram: Lebanese Domestic Banks - Exposure to BdL and Government
We see an increasing risk that banks' access to assets at BdL becomes restricted, especially as most deposits are long term. BdL's circular in December 2019 stating that interest on banks' US dollar deposits and certificates of deposit with the BdL would be paid 50% in local currency highlights the intensifying pressure on BdL's FC assets. A 20% haircut on BdL's liabilities to the banking sector would wipe out the sector's equity.
Banks' ability to meet their outstanding FC liabilities is in serious doubt given their highly stretched FC access. FC liabilities were USD129 billion at end-2019, of which USD120 billion were FC deposits. The sector's FC placements with foreign banks halved in 2019 to only USD7 billion, with banks having to meet FC deposit outflows despite Lebanon's capital controls.
Link to Infogram: Lebanese Banks - Deposit Dollarisation
The requirement for banks to pay half of the interest on FC customer deposits in local currency meets Fitch's definition of a restricted default. We view it as a reduction in terms compared with the original contractual terms, given the weaker parallel market exchange rate. We believe there is an increasing risk of depositor bail-in if external financial support for the banking sector is not secured, as BdL continues to run a negative net FC position and banks continue to draw on their off-shore FC assets.
Fitch withdrew its ratings of Lebanese banks in January 2020. See "Fitch Affirms 2 Lebanese Banks at 'RD'; Withdraws Ratings".
Media Contacts: Louisa Williams, London, Tel: +44 20 3530 2452 Email: louisa.williams@thefitchgroup.com
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Additional information is available on www.fitchratings.com
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