Banks Operating In Lebanon Have Been Weathering The Storm.

It is not the time to listen to Fitch, Moody’s or S&P!

It’s week 9 in the uprising, and year 3 of one of the longest economic slumps in Lebanon’s recent history: drop in output, high unemployment, high inflation, unsustainable public debt, an over-valued exchange rate, and a painful political impasse! Lebanon is falling and it needs help; this is not news today! The banking sector, which is a core component of the economy, holds more than twice the size of Lebanon’s GDP in economic weight, has been feeling the heat more than any of the other domestic productive sectors. The sector has been engaged in daily “fire-fighting” for the last nine weeks! Priority right now is to adequately secure “sector-sustainability”; and yes I don’t mean “institution-sustainability”!

We all are aware of what the problem is. Instead of flooding the news with their gloomy description of the obvious, and pessimistic outlook of the expected (but not inevitable); rating agencies should focus on what is possible and least damaging. It will, indeed help, to give banks in Lebanon a space to focus on “putting out the fire”! Fitch Ratings’ latest episode of downgrading two top Lebanese banks and Lebanon’s Sovereign debt was very “evil” in its timing! At the time when everyone in Lebanon awaits a glimpse of hope, Fitch Ratings dawned on us with triple knock outs!

I spent my weekend digging through Fitch Ratings’ own documents “Rating Definitions”, and what I discovered was that “Fitch’s timing of its downgrade was an utter evil”, and I shall demonstrate.

Let me first let you in on something personal. I was a normal child though I had my evil deeds! My mother had her own way of voicing her rating of my evil conduct: if she calls me once in response to something I did (Mohammad! . . . ), it means I did something wrong; she calls me twice (Mohammad! . . . Mohammad! . . .), immediately I know I did something real bad. And I’m an utter evil if she calls me three times (Mohammad! . . . Mohammad! . . . Mohammad!). 

Fitch! . . . Fitch! . . . Fitch!

In December 2019, Fitch Ratings downgraded Lebanon-based Bank Audi s.a.l. and Byblos Bank s.a.l. Long- and Short-Term Issuer Default Ratings (IDRs) to 'RD' (Restricted Default) from 'CCC-' and 'C' respectively. This is like the doctor saying the patient is dead, but not ready to be buried. The rating downgrade was hard to swallow!

In a journey across the 58 pages of the book of “Rating Definitions”, I found a number of interesting definitions, and as I was reading a voice continued to echo in my head “Fitch! . . . Fitch! . . . Fitch!”.

Fitch defines RD rating to “indicate an entity that has defaulted on one or more of its financial commitments, although it continues to meet other financial obligations.”

However, the fact is none of the banks operating in Lebanon, and more so the banks which are the subject of the latest downgrade, have defaulted on any of their obligations: Claim on deposits are met in full and on the maturity of the time deposit. Bank clients have been demanding that the bank pays them in cash, or transfer the balance to an account outside Lebanon. The intrinsic capacity for timely payment of financial commitments is adequate, but, and according to most clients, the means of payments is not adequate. I DON’T THINK THIS IS A LEGITIMATE REASON TO DOWNGRADE STRONG FINANCIAL INSTITUTIONS like Audi and Byblos Banks TO ‘RD’.

Restricted default ratings indicate, in Fitch’s opinion, that:

·      the issuer has entered into a grace or cure period following non-payment of a material financial obligation;

·      the issuer has entered into a temporary negotiated waiver or standstill agreement following a payment default on a material financial obligation;

A bank’s refusal to settle their obligations (withdrawal of deposit funds upon maturity) in cash cannot be considered a form of default on the part of the banks; especially when clients’ are requesting to be paid in US dollar banknotes! Simply, there has not been a single default on any obligation, to date.

On the other hand, ‘Country Ceilings’ reflect Fitch’s judgment regarding the risk of capital and exchange controls being imposed by the sovereign authorities (the central bank of Lebanon in this case) that would prevent or materially impede (i.e., obstruct) the private sector’s ability to convert local currency into foreign currency, and transfer to non-resident creditors — transfer and convertibility (T&C) risk. Although bank clients have enjoyed for years an unrestricted convertibility and transfer, recent events necessitated some form of controls on these banking services. Convertibility of local currency to foreign currency is no longer available on demand to clients unless the reason is:

·      Humanitarian (it’s unrestricted): to provide living expenses to a child receiving his/her education overseas,

·      To pay for the import of prescription drugs (it’s limited to 50% of invoice),

·      To pay for the import of fuel (It’s limited to 15% of invoice),

·      And others of less significance.

 As I dwelled through the definitions, I concluded that the ratings do not predict a specific percentage of default likelihood or failure likelihood over any given time period. The ratings do not necessarily communicate on:

·      the market value of any issuer‘s securities or stock, or the likelihood that this value may change,

·      the liquidity of the issuer‘s securities or stock, and

·      the possible loss severity on an obligation, should an issuer default. 

So what is the usefulness or the informational content of the downgrade? Nothing! Just to kick them when they’re down!

Fitch! . . . Fitch! . . . Fitch! 

Fitch has also downgraded the banks' Viability Ratings (VR) to 'f' (stands for ‘failing’) from 'ccc’. The rating action, as the report indicates, follows recently adopted measures by the Banque du Liban (BDL; Lebanese central bank), which introduced certain restrictions for banks' operations in foreign currency (FC), including for payments on customer deposits. This is partially true but only when payments on customer deposits in foreign currency are requested in cash. Checks can be, and are written against the FC deposit fund with no restrictions! It is important to note that these measures were initiated by banks, not BDL, in response to elevated funding and currency stress in the country and in order to limit pressure on the country's currency reserves and banking sector.

I agree that, in the absence of these controls, banks would have defaulted given the high appetite for deposit withdrawals and lack of confidence in the banking system. This only means the measures imposed by banks helped banks:

·      avoid the disastrous implications of bank runs,

·      manage with the existing liquidity in FC, and meet customer needs (not wants) without having to borrow FC liquidity from BDL at 20%,

·      not fall under severe liquidity distress to the extent where BDL must step in as ‘Lender of Last Resort’.

All of these are positive signs of banks’ capacity to serve under stressful scenarios.

Fitch! . . . Fitch! . . . Fitch!

I was shocked to read: “The downgrade of both banks' IDRs (Issuer Default Ratings) reflect the regulatory intervention into banking-sector deposits, which impedes the banks' ability to service their contractual obligations in FC in full compliance with their original terms.” If regulatory intervention is perceived as an impediment by Fitch, then where should banks go for guidance, and who should they listen to?

More of the same on the downgrade. “The new regulatory measures, which require banks to pay in local currency (LC) half of the interest due on their FC customer deposits, in Fitch’s view, represent a material reduction in terms compared with the original contractual terms of banks' financial obligations.” Lebanon is in a recession with a painful political stalemate; and there is no chance economic forces will pull interest rates down. The move by the Central Bank is a justified, and much needed, intervention by the monetary authority to bring interest rates down to a reasonable level. These measures:

·      apply to deposits in Foreign Currency,

·      apply on deposits that are benefiting from excessively high interest rates,

·      will not apply on deposits that earn the newly instituted rate of 5%, and

·      are announced to be in place for only six months.

And Fitch’s closure was: “The ratings are unlikely to be upgraded until Fitch believes the banks are no longer defaulting, capital controls are materially eased and confidence is restored in the banking system, as evidenced by a return of strong FC inflows from non-resident depositors and investors, easing pressure on the banks' FC liquidity. In case of any upgrade we expect the ratings to be closely linked to those of Lebanon's sovereign 'CCC' rating, given the banks' large exposure to BDL and the Lebanese sovereign, and also capturing other weaknesses in the credit profiles and performance challenges that domestic banks are facing.”

Don’t we all wish for that!

Fitch! . . . Fitch! . . . Fitch!