Lebanon’s banks add insult to injury

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Lebanese banks hold some $120 billion in foreign currency deposits, with concerns on whether these will ever see the light of day mounting.

by Georgi Azar -Source: Annahar

A damaged ATM screen has been spray painted during one of the anti-corruption protests. (AP Photo/Bilal Hussein)

BEIRUT: Lebanese banks are increasingly morphing into ‘shadow banks’ as broad deregulation coupled with a lack of oversight risk further harming unsuspecting depositors.

A shortfall of dollars has forced banks to limit domestic depositors’ ability to access foreign currency amid unofficial capital controls. This has put their ability to “defy financial gravity” in jeopardy, as experts have continuously warned.

The overwhelming majority of Lebanon’s alpha banks are in turn resorting to untraditional dealings, offering complicated financial instruments to credulous clients in an attempt to slash their liabilities and raise their capital. Lebanese banks hold some $120 billion in foreign currency deposits, with concerns on whether these will ever see the light of day mounting.

Taking a page out of Bernie Madoff’s playbook, banks are marketing the latest cash contribution to capital (CCC) as a measure for some clients to shield themselves from an inevitable haircut. These contributions, taken from deposits, can then be converted into shares. In some cases, banks have implemented a mandatory conversion clause, requiring all clients to convert their CCCs into shares in order “for the losses to be borne by all the shareholders of the bank,” according to copies obtained by Annahar.

Little does the average client know, is that when a bank is liquidated or its debt restructured, creditors are paid in a particular order.

Depositors get first priority, while shareholders are last in line.

“Whenever a restructuring happens, the first to get hit by a haircut is the bank’s equity,” a senior banker who spoke on condition of anonymity told Annahar.

Lebanese banks also hold around $15 billion in dollar-denominated Eurobonds and $22 billion in Certificates of Deposits issued by the Central Bank, with the default and subsequent restructuring of the government’s debt looming. The government is currently debating on whether to pay a maturing $1.2 billion Eurobond due in March and held mostly by foreign investors.

Signaling an imminent default, the newly formed Cabinet appointed last week legal and financial council moving forward.

As rating agency Fitch noted last week, banks are so intertwined with the government and the central bank that they also will need to be restructured.

“If a bank is holding 1 billion dollars in Eurobonds and the state can only pay $500 million, it will incur a $500 million loss that should be provisioned for in the bank’s shareholders equity,” the source said.

To then make up for these losses and attain capital ratios required by Lebanon’s central bank, banks would normally resort to recapitalization through existing shareholders, new shareholders or a bail-in.

A bail-in scenario would force depositors to once again foot the bill for banks that bought these bonds to finance the government’s twin deficit.

For years on end, the government financed itself by selling bonds to the Central Bank and commercial banks. Meanwhile, banks raised money from abroad by offering very high deposit rates for dollars as part of the so-called financial engineering scheme by the Central Bank.

By purchasing Eurobonds and subscribing to Certificates of Deposits from the Central Bank, the yearly profits of Lebanon’s four largest banks almost doubled within a decade, from $678 million in 2008 to $1.39 billion in 2018. Estimates indicate that Lebanese banks made nearly $19 billion in profits in the past decade.

As cracks began to show and foreign currency liquidity dropped sharply, matched by nationwide protests, Lebanon’s central bank instructed commercial banks in November to raise their Common Equity Tier 1 capital, a key measure of financial strength, by 10% through cash injections by the end of the year and a further 10% by June 30 this year.

Instead of raising capital by repatriating profits held by shareholders abroad, some banks have pounced on depositors and attempted to convince them to flip their deposits into cash injections and then shares, the source said.

“The more new shareholders are brought in, the less the existing shareholders have to contribute themselves and risk their own capital,” the banker said. “At the very least, it’s irresponsible to be offering such complex instruments to none professional investors.”

A contractual agreement from one of these banks obtained by Annahar shows a “conversion rate” of $2 per share, with a depositor who’s holding $50,000, for instance, being entitled to 25,000 shares.

Yet these complicated financial instruments were only made available after Lebanon’s Capital Market Authority slashed regulations which “exempted Lebanese banks from adhering to the CMA’s Financial Instruments Directives to secure cash injections intended for the capital increase” stipulated by the Central Bank.

“This allowed banks to sell these very complicated capital products to unprofessional depositors and investors who might not fully understand their inherent risks,” leading emerging markets specialist Saeb El-Zein told Annahar.

By international standards, “such products should be regulated and offered strictly by authorized bankers”, El-Zein said.

What’s even more egregious, is that these share prices do not properly represent their true value, another banker, who also spoke on condition of anonymity, told Annahar.

As things currently stand, “the majority of Lebanese banks are simply insolvent,” the banker added.

Banks have yet to take into account the tumbling Lebanese bonds despite the market already pricing in a major restructuring. Long-dated bonds are trading at 40 cents on the dollar or less.

“Before offering any kind of equity or Tier 1 capital products, banks should revalue their equity based on IFRS9 accounting standards,” El-Zein said, adding that some banks have yet to make provisions for the awfully low bond prices.

“Any offerings should wait until after Lebanon begins to restructure its debt as the equity value will be materially different then,” he said.

Non-performing loans are also on the rise, with Lebanon’s portion of problematic loans expected to jump above 20 percent of all loans in 2020, according to AME Info.

To add insult to injury, Lebanese banks last month dropped the International Financial Reporting Standard or IFRS9, which establishes principles for the financial reporting of financial assets and financial liabilities. It is used by almost all international financial institutions to present relevant and useful information to users of financial statements for their assessment of the amounts, timing, and uncertainty of the entity’s future cash flows.

With a classification of international default looming, Lebanese banks lobbied the central bank to scrap IFRS9 reporting.

“This was a mistake because what this document does is asses the quality of a bank’s asset and consolidates its financial standing,” Mohammad Fheili, a risk and capacity building expert told Annahar. As things currently stand, banks are holding sizeable distressed assets, including commercial, housing and personal loans that are none performing.

“The IFRS9 reporting puts in place provisions for banks to guard against possible losses and improve their chances of sustainability which at this moment is more important that increasing capital,” he said.

 

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