Moody's reports: Negative outlook for Lebanese Banking system reflects fragile political environment combined with high sovereign exposure

Although it may be argued that the political setting has improved following the withdrawal of Syrian troops from Lebanon, it still remains precarious and not conducive for the time being to pushing through badly needed economic reforms, and with upcoming presidential elections likely to bring further complications.

Lebanese Banks exhibit structurally weak profitability and earnings profiles, mainly driven by interest income stemming from their investments in sovereign-related debt.

Around 28% of the banking system's interest income originates form Lebanese treasury bills. Moody's estimates that around 45% of the banks' total interest income derives from sovereign-related investments and placements with the central bank (Banque du Liban -- BdL).

'Such a high level of dependence of core income on a poorly-rated (B3) sovereign is a worrying factor as any disruption in the latter's payment capacity is likely to significantly jeopardise the banks' revenues,' says Nondas Nicolaides, a Moody's AVP/Analyst and author of the new report.

'At the same time, the banks' strong retail deposit base provides them with a good funding profile and shows resilience to political shocks,' the analyst comments.

The banking system remains the most prosperous industry driving the Lebanese economy. The level of total deposits at the end of December 2006 was higher by 7.1% compared to the prior year, indicating some level of restoration of depositors' confidence towards the banking system following the end of adverse events during 2005 and 2006.

This is even more important considering that May 2007 data indicate a 4.6% year-on-year growth in private-sector deposits amid a fragile political situation in the country, with a government that is not fully functional.

Moody's also notes the rated banks' high core liquidity levels which mitigate systemic risks. Core liquidity in foreign currency assets
excluding any sovereign Eurobonds represented 21.6% of total assets and 35.5% of foreign currency deposits at the end of 2006, while these indicators increase significantly if we were to include foreign currency placements with BdL.

'Most of the liquid foreign currency assets are placed short-term with foreign banks in Europe and the US,' says Nicolaides. Moody's believes that Lebanese banks would on average be able to withstand a confidence crisis that might result in a run on US$ deposits or other capital outflows from the banking sector.

'This is a fundamental positive rating driver for the rated Lebanese banks that is likely to remain in the foreseeable future and as long as the banking system is highly reliant on the sovereign' the analyst adds.

However, despite the Lebanese banks' sophistication and good management as well as a regulatory environment and supervision of good standard, their ratings remain constrained at the lower end of the scale mainly due to their high overall sovereign exposure through government securities and placements with BdL.

According to Moody's, this exposure usually amounts to multiple times their equity base (more than 450%), to a certain degree compromising the banks' true economic capital. Efforts to grow their asset base regionally, which will take time to start contributing significantly to their core revenues, could gradually lessen the Lebanese banks' interdependent relationship with the local sovereign going forward.