Lebanon’s Battered Bank Bulwark
Following a year with Middle East stock markets down aside from tiny Tunisia, ratings agencies repeated a gloomy banking sector forecast for 2019, with Lebanon in particular now on a related sovereign debt restructuring precipice as the ratio to gross domestic product tops 150%. S&P Global Ratings in a January report predicts tighter liquidity, falling currencies and geopolitical unrest, while oil importers they should get balance of payments relief. For the region including Turkey annual loan growth will average 7-8%, with Jordan and Lebanon stagnant from a combination of Syrian war refugee and trade spillover and depressed consumption and tourism. Tunisia has upcoming elections and understates bad loans in the absence of international financial reporting standards, as it tries to keep another International Monetary Fund program on track. Banks in Egypt and Morocco depend on expatriate transfers, while Turkey’s must roll over volatile external funding as $40 billion comes due in the next twelve months. Return on assets will fall further to 1.2% despite higher government bond yields, with most countries implementing strict Basel III capital adequacy criteria.
Egypt was removed from the riskiest category on projected medium term 5% GDP growth with rising gas production and tourism. Loan expansion is set at 15%, but double-digit inflation will hurt borrower debt servicing ability. The loan-to-deposit ratio is a conservative 40%, and private sector credit is only 30% of output as banks prefer state company lines and Treasury bill holdings. In Jordan only leader Arab Bank has a cross-border presence for diversification, and amid steady profitability sovereign debt exposure at one-fifth of assets is steep. Morocco’s automotive and phosphate exports will pick up through end-decade, but high unemployment and income inequality stoke social tensions. Banks face increased commercial real estate developer losses to lift bad loans to 7% of the total, and they will turn to domestic capital markets for financing beyond customer deposits, S&P believes. The recent dirham band widening against the currency basket will have negligible balance sheet impact, with the free-float transition timetable extended to 15 years. Tunisia’s economy shows meager 2-3% growth on an uneven reform record to shrink fiscal and current account gaps, with the political cycle likely to again freeze progress. Banks must draw on central bank refinancing, with one-fifth of loans non-performing on glaring asset-liability mismatches, the rater notes.
Lebanon was demoted to the top risk “10” group mainly due to the central bank’s “distorting” stimulus and swap operations. Public debt will hit 155% of GDP at year-end and burdens the sector after an official spate of “financial engineering” deals swapping local for foreign currency obligations. Real estate and construction credit will sour without subsidies, but banks have a solid 70% US dollar and euro- denominated non-resident deposit base and a broader regional footprint. Despite parliamentary elections in 2018 for the first time in a decade, government formation remains in limbo, with billions of dollars in donor pledges suspended as a result. With double-digit budget and current account deficits, and the Finance Minister explicitly raising the restructuring option, Eurobond yields spiked to over 900 basis points over US Treasuries the past month. This year respective totals of $7.5 billion domestic and $3 billion foreign bonds must be rolled over, and the central bank and commercial banks hold 85% of that amount. Gulf allies Qatar and Saudi Arabia are in line to buy paper, as growth is estimated at a meager 2%. Almost $35 billion in reserves supports the 1500 exchange rate peg to the dollar, but the prospect of bond write-downs could unravel the delicate balance and spur severe capital outflows and balance sheet damage.
Debt service will absorb one-quarter of GDP this year, and the central bank will likely have to strike more arrangements such as the “soft leverage” one in place with commercial lenders since 2017, which generated short-term profits on favorable regulatory terms, to preserve buyer appetite. The $11 billion in bilateral and multilateral assistance pledged at last year’s CEDRE conference would almost equal the requirement, but even if accessed with a functioning coalition are soft loans demanding repayment and disbursed with delays. Foreign investors controlling over 10% of Lebanese debt are underweight since early 2018, and default scenarios with 25% haircuts would pare capital positions at leading banks like Blom and Audi to simultaneously tarnish their overseas appeal.
