Lebanese Banks resist political deadlock and pursue overseas expansion

The main impediment for Lebanese banks remains their high direct exposure to the risks inherent in operating in the Republic of Lebanon, Standard & Poor’s Ratings Services noted in a report titled “Lebanese Banks Plant Cedars Abroad While Resisting The Political Impasse,” published today on RatingsDirect.
The ratings on Lebanon were lowered to ‘CCC+/Stable/C’ on Jan. 31, 2008, to reflect the current political impasse there. “The Lebanese government’s high indebtedness, fiscal deficit, and fragile political stability pose a serious threat to any bank in the system,” said Standard & Poor’s credit analyst Paul-Henri Pruvost.
Although Lebanon has never defaulted, the banking system, which has proven highly resilient thus far, would suffer dramatically from an unwinding of public finances. Consequently, the three rated Lebanese banks’ (Bank Audi SAL – Audi Saradar Group, Bankmed, s.a.l., and Blom Bank sal) exposure to sovereign risk is paramount and impinges significantly on the ratings on the banks. These ratings are supported, however, by steady growth in business and profits, improvements in loan quality, and good management.
“In the longer term, the ratings on both the sovereign and the banks could be raised if the pressure on both the political and economic front is alleviated through the combination of a consensual political decision leading to the appointment of a president and the formation of a cabinet, as well as a demonstrated capacity to advance on the program of economic reforms pledged at the Paris III conference,” said Mr. Pruvost. “Conversely, the ratings could be lowered should civil unrest break out or the political impasse cause protracted policy inertia,” he added.
Several specific features make Lebanese banks unique in the Middle East:
— First, the banking sector’s assets represent about 3.5x the country’s GDP. Deposits made by both residents and nonresidents (the latter attracted by the high returns available and drawn by longstanding family and community ties) are driving banking activities, leaving the whole sector vulnerable to a deterioration in confidence.
— Second, Lebanese banks are heavily dollarized (usually about 65%), and even more in times of crisis (about 70% since year-end 2006).
— Third, Lebanon is overbanked. Since competition is tense, and the Basel II implementation does not favor excessive holding of non-investment-grade government debt, consolidation may be under way as small banking institutions struggle to keep up.
Aware that using their balance sheets to fund the government’s financing needs is unsustainable, larger banks are favoring geographic expansion to deploy their liquidity having little use for it locally. “If the drive for geographic expansion proves successful in dramatically reducing Lebanese banks’ dependency on government debt, the ratings on the banks may improve in the long term,” said Mr. Pruvost.
Asset quality is strengthening at a sustained pace, driven by the authorities’ proactive attitude. Banks have also been attempting to clean up their loan books through write-offs and more active recovery. Nonperforming loan ratios are still relatively high, however, at 8.5% at year-end 2007, when interests in suspense are excluded. At about 68%, coverage by provisions is satisfactory.