Moody's Investors Service has maintained its negative outlook on Lebanon's banking system, reflecting the rating agency's expectation of a continued weak operating environment that will slow credit expansion and raise asset quality pressures for banks, as well as their high and growing exposure to sovereign debt. The Moody's report, entitled "Banking System Outlook — Lebanon: Weak operating environment and exposure to sovereign drive negative outlook," expresses Moody's expectation of how bank creditworthiness will evolve in Lebanon over the next 12-18 months. "We consider high and increasing exposure to Lebanese sovereign debt to be the main credit risk for Lebanese banks over the outlook horizon," says Alexios Philippides, an assistant vice president at Moody's. "Lebanese banks will also continue to face significant headwinds from a challenging operating environment." Lebanese banks' rising sovereign debt holdings link their creditworthiness to that of the government (B2 negative), which Moody's estimates will run an average fiscal deficit of 8 percent of GDP in 2016 and 2017, and which relies primarily on local banks to cover its funding gap and roll over existing debt. "As of March 2016, banks' aggregate sovereign-related exposures — incorporating both Lebanese sovereign debt and exposures to Banque du Liban — were an estimated 129 trillion Lebanese pounds ($86 billion), or 46 percent of total assets," explains Philippides. "This constitutes the largest component of the banking sector's combined balance sheet and equals over 5x their Tier 1 capital." Furthermore, the rating agency forecasts real GDP growth of 1.7 percent in 2016 (2015: 1.3 percent), well below the 2007-10 average (9 percent), while political instability and regional conflict will continue to weigh on private investment, consumer confidence, trade and the construction sector. In turn, this will raise asset quality pressures for banks, with Moody's estimating loan-loss provisions to remain high at 1-1.5 percent of gross loans for the year and nonperforming loans (NPLs) to increase above 5 percent of gross loans, up from 4 percent at year-end 2015. "Asset-quality pressure for banks in Lebanon will likely rise across all economic sectors in Lebanon especially in the banks' construction and real estate sectors — which accounted for 24 percent of system loans at the end of December 2015 — and in retail credit," explains Philippides. Despite these pressures, Moody's notes that capital levels will remain broadly stable — supported by Basel III implementation, profit retention and limited asset growth — although will remain vulnerable to downside risk. The rating agency expects equity-to-total assets to remain stable at 9 percent for 2016, a modest level considering the difficult operating environment and banks' aforementioned very high sovereign exposures. In addition, Moody's expects profitability to remain stable, though muted, posting net income to tangible assets of between 0.9 percent and 1.1 percent in 2016 (2014-15: 1.0 percent) supported by their overseas operations and broadly stable interest spreads. Furthermore, solid liquidity buffers and depositor-based funding will continue to support system stability in Lebanon, according to Moody's. Deposits will continue to grow, but at a slower rate reflecting subdued domestic economic growth and lower inflows from Gulf Cooperation Council countries. Lebanese banks have low reliance on market funding, as deposits fund more than 80 percent of system assets. source: Arab news
