International rating agency Moody’s downgraded Lebanon’s banking sector outlook from stable to negative, citing the unfolding events in neighboring Syria as one of the main reasons behind this step.
“The key drivers of credit risk within this system are (i) slower economic growth, following a sharp GDP deceleration in H1 2011; (ii) downside economic risks due to regional political uncertainty, particularly in Syria; and (iii) the banks’ asset and loan exposures to other regional countries experiencing political unrest and/or economic slowdown, such as Egypt and Jordan,” Moody’s said in its report. The report added that although nonperforming loans improved during 2006-10, it is now more likely that this trend will reverse.
“In addition to the weakened domestic operating environment conditions, the banks (predominantly the larger ones) have material exposures to countries undergoing political transition or experiencing political unrest (particularly Syria and Egypt). Moody’s therefore expects that the political unrest and the broader economic slowdown in other neighboring countries (e.g., Jordan), will exert upward pressure on problem-loan trends, at least into H1 2012,” the report added.
Some large Lebanese banks have an important presence in Syria and Egypt, which have both seen political upheaval this year. Lebanese banks operating in Syria for example have seen their assets and deposits shrink in the first nine months of this year.
The rating agency expects the banks’ profitability to come under pressure over the outlook horizon, as subdued business activity will likely cause a slowdown in credit growth and fee-generating income. Combined with historically low interest rates and potential upward pressure on funding costs, Moody’s expects the slowdown to exert pressure on banks’ pre-provision income. At the same time, provisioning charges are likely to rise at least into H1 2012, further suppressing net income.
The Lebanese banking system is highly exposed to Lebanon’s sovereign debt (rated B1, stable). Government debt on banks’ balance sheets stood at a very high 3.4 times the system’s aggregate Tier 1 capital at year-end 2010, while the wider exposure to the Lebanese government is estimated to have been even higher, at over 6.1 times Tier 1 capital.
Lebanese banks are the main subscribers to government treasury bills and Eurobonds which makes these banks more vulnerable to default risk in the future, especially if the state fails to seriously tackle the debt and budget deficit problem.
Moody’s does not expect a material shift in the composition of the banking sector’s balance sheet over the outlook horizon; therefore, the banks’ credit risk profile will continue to be closely linked to that of the Lebanese government. But Moody’s emphasized that the banking system’s liquidity buffers and resilient depositor base will likely be maintained over the outlook horizon, thereby mitigating some of the downside risks.
Highly liquid assets and placements with predominantly international banks account for approximately 25 percent of total assets. In addition, the sector retains a relatively stable funding structure driven by customer deposits, which account for approximately 90 percent of total liabilities. “Supporting these deposits is the resilient influx of remittances (22 percent of GDP at year-end 2010), which have historically proven to be resilient even though the risk of capital flight increases during periods of political unrest,” Moody’s said.
As of year-end 2010, the sector’s reported capitalization was around 13 percent, which Moody’s views as moderate given high operating environment risks.
In addition, risk-weighted assets in the system are understated in Moody’s view, as low-rated (B1) local currency denominated government securities carry a 0 percent risk weighting. The banks’ capitalization levels are likely to fluctuate around their current levels over Moody’s outlook period, although there are growing downside risks on the banks’ capital levels.