In general, debt restructuring means that new Eurobonds are issued with longer maturity dates, reduced interest rates and often reduced principals. The existing issues are then exchanged for new ones. The restructuring proposals may differ depending on the issues and creditors. If applied, a reduction in the debt’s principal will therefore amount to a haircut on Eurobonds.
The fact that local banks are the main Eurobond holders means that such a decision will affect them first, and that they’ll have to bear the losses resulting from the elimination of part of the government’s dollar-denominated debt. The extent of this debt elimination (haircut on Eurobonds) remains largely unknown; one of the main missions of Lazard (the financial adviser mandated by the government to advice it in the debt restructuring process) is to determine this extent based on a series of simulations and impact studies in accordance with the scenarios envisaged.
Banks' capital Not Sufficient
But there is a problem: irrespective of the the extent of the haircut, “banks' capital won’t be sufficient and must be increased,” Finance Minister Ghazi Wazni last week told "Vision 2030," a talk show aired on LBCI and hosted by Albert Kostanian. Wazni, moreover, noted that "70% of their (banks) dollar investments were made in Eurobonds or in Central Bank deposit certificates, and 20% of their loans granted to the private sector are bad debts"; meaning that these loans will probably not be repaid.
The capital of Alpha banks (the country’s first top 16 banks, with deposits exceeding $2 billion) was $22 billion at the end of December 2018, according to Bankdata Financial Services. In a circular in November 2019, the Bank of Lebanon (BOL) requested the banks to increase their capital by 20%, or $4.4 billion, by the end of June, and to not redistribute their 2019 profits to their shareholders. The short-term goal was to respond to the dollar liquidity crisis, but the circular was also meant to strengthen the banks' solvency in the face of rising bad debts and to expand their “security cushion” in the event of haircut. For the time being, most of the country’s major banks have announced their intention to respond favorably to BOL’s request.
But even such an increase won’t be sufficient for bank recapitalization.“The banking sector needs an external cash injection of $20-$25 billion for it to recover,” Wazni said. According to Nassib Ghobril, head of the Economic Research and Analysis Department at Byblos Bank, the banking sector will need much more if we take into account the restructuring of the government’s debt altogether (Eurobonds, Treasury Bills and BOL’s balance sheet). That necessitates the injection of about $40 billion.
It is this reality that is leading the government and sector professionals to advocate a restructuring of the banking sector. Prime Minister Hassan Diab had said that the sector “will no longer be able to continue to have a volume that is four times greater than the country’s economy.” Wazni, on his part, explained: “We will have to look at the situation of each bank on a case-by- case basis; some banks are doing well, unlike others. Banks mergers will be necessary.” Some will do better than others – because they have comfortable capital and have little or no exposure to sovereign debt – and will therefore be called upon to absorb the weak banks.
The question of banks’ capital is crucial because it will determine how much losses, incurred (in particular) after a reduction in dollar-denominated debt, banks will have to pass on to their depositors. If this reduction is greater than their capital, banks will be forced to weigh the recorded loss on depositors, by chopping some of their deposits. Then a haircut on deposits will be the issue.
But not all depositors will be affected. Diab has emphasized that the government will seek to protect bank depositors, particularly small ones who account for more than 90% of all deposits. Wazni clarified that “91.5% of depositors, or 1,600,000 accounts, are less than $100,000 each, and thus represent only $12 billion. They are a priority for the government.” In total, bank deposits amounted to $158.8 billion (all currencies combined) at the end of 2019, with a dollarization rate of around 75%.
Wazni’s Three Alternatives
But what about the remaining 10% of depositors? Knowing that a haircut on deposits will require legislation, the government is considering protecting them, but to a lesser extent. During his interview on LBC, the finance minister said there were three potential alternatives to impose a haircut on deposits. He has discussed them with many of his domestic and international interlocutors, reflecting a serious approach towards this matter. Lazard should assess their feasibility.
Wazni’s first alternative is to offer major depositors the option of converting some of their deposits into equity (shares) in the banks where they had originally placed these deposits. This is what is commonly referred to as a “bail-in.” “It’s the most plausible alternative, and it has become the absolute rule in EU countries. This principle was adopted in Cyprus, for example,” Jean Riachi, CEO of the Lebanese FFA Private Bank, told L’Orient-Le Jour. Nassib Ghobril does not approve such an approach. “Depositors can’t be forced to convert their deposits into shares. We are in this situation because the government has decided to default on Eurobonds; it should bear the consequences, and certainly not the depositors who have chosen to trust the banking sector.” Ghobril explained that "most of the large or big deposits belong to big corporations, Lebanese expatriates who have succeeded abroad or even Arab nationals: Why should they bear the cost of such a decision?”.
The second alternative is to propose to the big depositors to freeze part of their deposits for a fixed period of five to six years. To Ghobril, it is the "most acceptable” alternative for depositors, but Riachi argued that it won’t solve the problem of the banks and their recapitalization. "From an accounting point of view, to obtain adequacy in the balance sheets of banks, one can’t envisage that vis-à-vis assets lowered by 40% (the value of a Eurobond), for example, a liability (the value of a deposit) is sustained, even frozen, at the initial value,” Riachi said.“We can’t rebuild this sector and the country’s economy with such imbalances; we’ll have to do so on a sound basis.”
The third alternative is to offer these depositors an equity stake in a fund, which will be created later to include all state assets (revenue-generating public or semi-public enterprises). “Good luck,” said Ghobril, arguing that it’s an unlikely alternative; “escaping forward” to avoid “real reforms,” which should lead to a reduction in the size of the public sector. For Riachi, however, the alternative is feasible, but it poses “an ethical problem.”“The depositors are the creditors of their bank, while state assets belong to all Lebanese nationals,” he said. He thus argued that this option could be offered to government creditors during negotiations for debt restructuring.
(This article was originally published in French in L'Orient-Le Jour on the17th of March)
After the government defaulted on a Eurobonds issue which matured on March 9, it must in principle formally begin negotiations with all its creditors over restructuring its dollar-denominated debts. But it seems that the executive authority is considering without any doubt to immediately reduce this debt; by imposing a haircut on the Eurobonds. In other words, this means that the government will...