Investors seem more confident that Lebanon's fragile, fledgling government can make the necessary reforms that will unlock vital funding to rebuild the country's infrastructure and ease its swelling debt burden that had heightened worries of a state default and a run on its banks.
Lebanon's state debts, which equate to more than 150% of GDP and totaled 108.9 trillion Lebanese pounds, or roughly $72 billion, as of June 2018, have steadily increased this decade due to its twin fiscal and current account deficits. Banks have been the major buyers of government debt issued to bridge the annual shortfall.
"Until now it was coming from the commercial banks, but now banks are running out of cash and foreign currency," said Sami Nader, an economist and director of Beirut's Levant Institute for Strategic Affairs.
Central bank data shows that Lebanese commercial banks held more than 50 trillion pounds worth of Lebanese treasury bills and sovereign eurobonds in January.
Lebanese banks fund their debt purchases through deposits, so they must expand their deposits to continue buying, while to help attract investors the central bank has hiked interest rates, with the reference rate reaching 12.39% in March, its highest since inception in 2011.
Deposits hit a peak of 282.4 trillion pounds in June 2018, although deposit growth has slowed markedly to around 3% to 4%, "which may indicate some outflows once adjusted for interest payments," said Elena Sanchez-Cabezudo, head of Middle East and North Africa financials equity research at EFG Hermes in Dubai.
"The potential for a large outflow of deposits is the main risk facing the banking system, but in the past, even after political shocks, deposit outflows have been very contained."
Debt restructuring fears
In January, Lebanon policymakers sought to assuage fears that the government may default, or try to restructure, its debts that include $35.1 billion owed in foreign currencies.
"Eurobond restructuring would erode bank capital, endanger the dollar peg and affect depositor confidence," Bank of America Merrill Lynch wrote in a note. "Eurobonds are only a small part of external financing needs while Lebanon's ability to muddle through remains partly a function of depositor confidence, alongside reforms and donor support."
Were Lebanon to restructure its debt, Merrill predicts that large banking sector recapitalization requirements would have to be financed through external sources such as the International Monetary Fund. Merrill also predicts a surge in nonperforming loans should Lebanon falter debt-wise and also devalue the dollar-pegged Lebanese pound.
The impact on banks from a state debt restructuring would depend on its purpose, nature and extent, said Rahul Shah, an analyst at investment analytics firm Exotix in Dubai.
"Most banks have significant exposure to sovereign/central bank instruments," said Shah. "Given the importance of the banking system to the economy, we believe significant efforts would be made to protect banks' capital and profitability."
Lebanon's precarious finances led it to host the CEDRE conference in Paris in April 2018. The 50 countries and institutions participating pledged nearly $11 billion in soft loans and grants for a Lebanon infrastructure spending program that is dependent on Lebanon undertaking widespread reforms to reduce its deficits and debt burden. These include reducing its fiscal deficit by 1 percentage point each year for five years.
Lebanon formed a new government on Jan. 31, nine months after the May 2018 general election. The end to the political impasse seems to have reassured investors; the BLOM Bond Index surged from Jan. 14's all-time low of 81.77 to 90.17 as of March 11, while credit default swaps have fallen from a high in January.
The government has completely adopted the CEDRE conference recommendations, but there are questions about whether it will succeed, Nader said.
"Will this government be able to achieve what all the previous governments failed to do? It's the same political parties," he said. "Little has changed. CEDRE is the last chance and if Lebanon fails to get this funding we're heading for a collapse. It would be an unprecedented economic crisis for Lebanon."
Parallels with Greece
Nader also drew parallels between Lebanon and Greece.
"We've a lot of similarities — Greece didn't have a huge budget deficit but had twin current account deficits. The only difference is that our banks were liquid but now this liquidity is under big stress," he said. "The liquidity crisis could lead to a run on the banks."
The banking sector's combined profits from their Lebanon operations fell 16% in 2018, Saad Azhari, chairman and general manager of BLOM BANK SAL, Lebanon's largest bank by market capitalization, told a Feb. 20 conference call to discuss the company's financial results, a decline he blamed largely on tax increases.
The performance of the big four banks was mixed in 2018. BLOM Bank and Bank of Beirut SAL both saw net income increase year over year, while Bank Audi SAL and Byblos Bank SAL saw income fall. BLOM and Audi have expanded to other Middle East markets to try to offset domestic difficulties.
"There's major pressure on profitability," said Azhari.
Banks are now "double taxed," with the interest earned on Treasury bills and deposits held at the central bank no longer deductible from corporation tax. The banking sector provides 70% of Lebanon's corporate tax revenues despite only generating around 6% to 7% of the country's GDP, Azhari estimates.
"While banks may be viewed as an easy target for tax collection, their key role in the economy and their importance as recipients of capital inflows and purchasers of sovereign debt should prevent the sector from being squeezed too tightly," said Exotix's Shah.
"Banking sector challenges include rising dollar interest rates, which could lift funding costs, persistently weak credit demand and borrower confidence. Given the low-growth environment, we may see sector consolidation activity, probably involving smaller or weaker institutions."
The cost of deposits have risen sharply over the past few months, Azhari noted.
"For all Lebanese banks, growth is slow and there is some upward pressure on funding costs, although BLOM has been able to compensate this with higher asset yields," said Sanchez-Cabezudo.
"BLOM is one of the most conservative banks and has among the lowest [nonperforming loan] ratios. While the rising funding costs has impacted all banks, it may have impacted the smaller banks more."
As of March 20, US$1 was equivalent to 1,508.30 Lebanese pounds.
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