By Libby George
LONDON (Reuters) – Lebanon’s defaulted government bonds have nearly quadrupled in price over the past year as investors bet on signs of economic recovery but a wild variance in estimates of their likely worth after a restructuring could restrain any further rally.
A “recovery value” for the bonds will not become clearer until lawmakers decide what level of losses struggling local banks must take, which in turn will inform how much money the government can funnel to bondholders.
The bonds have rallied from just 6 cents on the dollar a year ago to close to 24 cents, following a political shake-up which ended more than two years of government paralysis that had exacerbated Lebanon’s economic crisis.
RISING HOPE – BUT WIDE RANGE OF ‘RECOVERY VALUE’
The formation of a new government in February spurred the gains, with investors hoping authorities would bring the country closer to accessing reconstruction funds after a devastating war between Israel and the Lebanese armed group Hezbollah.
Some fixed income analysts, however, say the rally may be getting ahead of itself given myriad uncertainties, notably on the bonds’ “recovery value”. This figure is what the bonds will be worth after a long-awaited debt restructuring that is essential to revive the economy.
The range of estimated value is disproportionately large.
“One can construct scenarios of recovery in a broad range (of) 20-40 cents,” said Roger Mark, an analyst in the fixed income team at asset manager Ninety One, which holds the bonds.
“Of course, there are also more negative scenarios whereby we don’t get an IMF deal in the coming year at all.”
Hopes that Lebanon can secure an International Monetary Fund bailout to help rebuild rose after the IMF said in June that the country had made progress toward a lending deal. Its staff will visit Beirut this month to advance discussions.
Morgan Stanley, in a note to clients seen by Reuters, said recovery on Lebanon’s bonds could be as much as 40 cents – but also could “fall materially, to around 23-26 cents” in a worse scenario.
A group representing bondholders declined to comment.
GREEN SHOOTS OF PROGRESS
After defaulting on its $31 billion of outstanding international bonds in March 2020, Lebanon’s financial crisis spiralled, wiping out banks’ balance sheets and costing the currency 99% of its value.
The bonds fell below 6 cents as hopes dwindled for a debt restructuring or crucial IMF bailout.
Following parliament’s election of a new president in January, lawmakers passed in July a long-awaited banking sector restructuring law, one of several pieces of legislation needed for financial system reform.
Investors pounced on what Goldman Sachs economist Farouk Soussa described as an “asymmetry” of ultra-cheap bonds. But the remaining obstacles are potentially larger than some investors, driven by fear of missing out on meteoric returns, acknowledge, he said.
“Current pricing implies a significant likelihood of a positive resolution to remaining hurdles in the next 12-18 months or so and doesn’t fully reflect some of the downside risks,” he said, citing awaited legislation that must set the level of bank losses.
Lebanon’s central bank itself also warned last week that elevated global interest rates would complicate its efforts to restructure its international bonds.
MIND THE ‘FINANCIAL GAP’
The level of losses insolvent banks must take, known as the “financial gap”, is the difference between banks’ liabilities and their assets.
Few expect lawmakers to pass crucial legislation setting this before elections in May 2026.
Estimates vary widely and calculating it is complex and politically fraught – but key to determining the bonds’ recovery value.
Two years ago, the IMF estimated that the central bank – accounting by far for the biggest chunk of the gap – could end up with negative equity of $60 billion.
In March, the Institute of International Finance calculated central bank negative equity had shrunk to $48.4 billion from $76.4 billion end-2022.
How much the government needs to shoulder will inform what the IMF determines is “sustainable” for Beirut to pay bondholders and others in a restructuring.
Even once the core figures, including the financing gap, are clear, the recovery value will also vary depending on how past due interest – estimated at $14.3 billion by JPMorgan – is included, and what level of writedowns – or “haircuts” – bondholders will have to take.
Yvette Babb, portfolio manager at William Blair, which holds a small amount of the bonds, said the debt pricing above 22 cents is getting close to previous estimates of recovery values.
“Other (high-yield) names have rallied considerably, so we see Lebanon is left looking comparatively attractive,” Babb said; valuations across emerging market bonds have increased, even in war-torn Ukraine and debt-laden Argentina.
Soussa said signs of progress in Lebanon, including forming a government and passing banking reform laws, will be difficult to ignore, and could boost bonds further.
“There are few good distressed opportunities out there and spreads are generally quite tight across EM (emerging markets) given the rise in U.S. risk premia,” Soussa said.
“This is a factor behind the higher risk tolerance and subsequent demand for Lebanese bonds.”
(Additional reporting by Marc Jones in London and Rodrigo Campos in New York; Editing by Karin Strohecker and Emelia Sithole-Matarise)
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