Dubai: Lebanese banks’ high and growing exposure to Lebanese sovereign debt and the uncertainty over sovereign credit strength will remain a major source of credit risk according to rating agencies and analysts.
Credit rating agency Moody’s has recently assigned negative B1 rating for the banking system with a negative outlook while the sovereign is rates at B1 negative. In November last year, Standard & Poor’s (S & P) had assigned negative outlook for the banking sector linked to a downgrade of Lebanon’s sovereign rating to B minus (B-) in November 2013.
“The outlook on Lebanon’s banking system remains negative, reflecting our expectations of high and growing exposure to B- rated Lebanese government securities, which leaves the banks’ modest capital buffers susceptible to sovereign event risk; asset-quality pressures, owing to weak economic growth and high provisioning needs and limited new business generation,” said Alexios Philippides, an analyst with Moody’s.
Analysts see the banks’ high exposure to the sovereign as the key credit risk, leaving the banking system’s credit profile susceptible to any sovereign downgrade. As the government continues to run high budget deficits, it relies primarily on the local banks to fill the funding gap and roll over existing debt. Banks’ aggregate sovereign exposure increased by LBP10 trillion ($7 billion, Dh25.71 billion) during 2013 to LBP106 trillion ($70 billion). These holdings constitute the largest component of the banking sector’s combined balance sheet, at 43 per cent of total assets and it is more than 5 times the tier 1 capital.
The capacity of the Lebanese authorities to provide systemic support to banks is under pressure because of the government’s weakening fiscal position. In May 2013, Moody’s affirmed Lebanon’s B1 government bond rating but changed the outlook to negative from stable. And in November Standard & Poor’s changed Lebanon’s rating to B- with a negative outlook.
Despite, the lowered ratings, the central bank insists that the Finance Ministry and the Central Bank had no difficulty swapping all the maturing bonds in 2013 at reasonable rates and yields. “The last declaration of the rating agencies was an indication that they now have a negative outlook of the country. The market did not react to the news and we are still seeing stability in the interest rates on our bonds,” Central Bank Governor Riad Salameh told Lebanon’s The Daily Star newspaper last week.
Lebanon’s Finance Ministry is expected to soon swap some $1.6 billion in maturing Eurobonds before April at attractive rates that are comparable to countries with B+ or even BBB ratings.
Moody’s expects that the operating environment will remain challenging for Lebanese banks, with real GDP forecasted to grow by 2 per cent in 2014, well below the 8 per cent average for 2007-10. The ongoing conflict in Syria and domestic sectarian tensions escalating into sporadic violence within Lebanon will continue to weigh on key sectors of the economy, including tourism, real estate and construction. Political uncertainty will also lead to reduced private investment and impair the government’s ability to enact structural reforms.
“The challenging operating domestic environment, together with Lebanese banks’ operations in high-risk countries, primarily Egypt and Syria, will drive further loan quality deterioration,” Elena Panayiotou, assistant vice president and analyst at Moody’s.
Analysts expect loan-loss provision expenses to remain high at around 1.5 per cent of gross loans and non-performing loans to rise above 6 per cent of gross loans.
