Lebanon – running out of time
A plan: Debt restructuring, FX devaluation, bail-in of bank capital and of large deposits
• Draft bold reform plan leaked last week represents a step in the right direction; debt restructuring, a 5-year payment holiday on Eurobonds, swapping old for new debt at 3% pa, a devaluation of the LBP of 2x. It would wipe out all capital of shareholders of the banks and assume a 45% bail-in of all deposits (> USD 100k), smaller deposits are protected.
• The plan relies of funding from CEDRE (USD 11bn) and IMF (10-15bn), and support of the domestic banks, who hold 34% of government debt. However, it is unlikely to pass in its current form as it has been met with staunch pushback from banks and politicians.
• We reiterate our Sell ratings on Bank Audi and BLOM.
Draft reform plan represents a bold step, but opposition from banks is strong. The draft plan presents the government’s current thinking on bringing the country’s debt/GDP ratio to more sustainable levels, details the country’s external funding needs over the next five years, and presents an array of fiscal reforms. However, the plan also appears to require the banks (and the large deposit holders) to shoulder the cost of restructuring the government’s debt including the losses of the central bank, in a move that has already garnered staunch opposition from the banking sectors, the political parties, and the general population. The banks prefer bolder fiscal austerity and accountability and smaller haircuts.
Lebanon’s economy expected to collapse in FY 20e. We forecast a contraction of real GDP to the tune of 16% in 2020, above the Ministry of Finance’s 12% after accounting for the impact of COVID-19 on the economy. The economy has already come to a stop following the outbreak of the virus with a formal lockdown starting on the 15th of March (schools since the 29th of February), significantly hurting Lebanon’s predominantly service-based industry and tourism sector. This has been amplified by the recent liquidity crunch that has put pressure on the banking sector. Harsh restrictions on FX withdrawals and transfers have already pushed many businesses to either close their doors or slash salaries, while rising inflation to > 25% is likely to put pressure on disposable incomes.
Recent BdL circular officially creates a secondary FX window. The BdL circular aims to protect very small deposit holders (60% of total accounts) by allowing anyone with less than USD 3k (and no debt) to fully withdraw their money in LBP at a secondary rate that will be set by the CB/banks following the 40-50% depreciation on the parallel market. It also allows small LBP account holders to have their money adjusted for the new secondary rate. This creates a secondary FX window that should help make it easier to do business.
Shareholders of banks are wiped out under the plan. The draft reform proposes that bank capital is fully bailed in, while deposit holders will need to shoulder USD 62bn. Even though some banks shied away from directly lending to the government, they would have to shoulder the losses created by financial engineering by the central bank, which only delayed the inevitable. This means that banks will need to raise additional capital to avoid nationalization, in our view, or alternatively large deposit holders will have to swap their deposits into equity. While interest income on sovereign debt and central bank exposure should fall to c.3%, we expect banks to lower the deposit remuneration. As a result, we continue to expect capital controls (for deposits > 3k) to remain in place until the system has been put on a more sustainable footing, which will take at least 3 years. We reiterate our Sell ratings on BLOM and Bank Audi. We estimate a fair value loss of c.65% for 10 YR Eurobonds.