Beirut: Lebanon is about to enter the crucial first phase of talks aimed at renegotiating its $30 billion in Eurobonds after saying at the weekend it won’t pay dollar debt coming due on Monday.
The government’s declaration on Saturday that it won’t repay the $1.2 billion Eurobond puts the country on course for the first default in its history as it copes with dwindling foreign-currency reserves and inflation running in double digits. Talks will be complicated by high foreign ownership of some of the bonds and political divisions that have left the economy on the ropes.
“Sovereign defaults are relatively complicated to begin with, but this is compounded by the rather unique political environment in Lebanon,” said Abdul Kadir Hussain, the head of fixed-income asset management at Arqaam Capital in Dubai. “This will be drawn-out and complicated and will probably have many parties involved.”
Once boasting an unblemished record of bond repayment through war and political strife, Lebanon came undone after months of protests fed its worst financial crisis in decades just as remittances from abroad - the main source of hard-currency revenue - slowed to a trickle. Led by a new government backed by Hezbollah and its allies, one of the world’s most indebted nations will be taking on creditors at a time the global economy is reeling from the coronavirus outbreak and the start of an oil-price war.
Prime Minister Hassan Diab said in a televised address over the weekend that his government would seek to restructure its debt through negotiations with bondholders. Formal talks are expected to start in about two weeks, Reuters reported, citing a person familiar with the matter.
“Creditors have begun the efforts to open the appropriate lines of communication with Lebanon and its advisers,” said Hans Humes, chief executive of New York-based distressed-debt investor Greylock Capital Management, which had formed a group to talk to the government about its options.
IMF, Hezbollah
It isn’t clear if Lebanon will seek an International Monetary Fund bailout. Although IMF experts recently held meetings in Beirut, the issue of securing financing from the fund has become entangled in politics.
Hezbollah, an Iran-backed group that has a major say in government and parliament, has rejected the possibility of seeking a financial aid program from the IMF, fearing it could hurt the poor and be used by the U.S. as a political lever. That deprives Lebanon of a potential lifeline and could undermine the confidence in economic reform that creditors need when forgiving debt.
Iran and the U.S. came to the brink of war earlier this year, with the Trump administration imposing punishing sanctions on the Islamic Republic after abandoning the 2015 nuclear deal.
“The IMF involvement will be tricky given the current U.S. policies,” said Humes at Greylock Capital. “There is no question that the heightened tension between U.S. and Iran has complicated the situation in this and many other ways.”
Locals Versus Foreigners
One question is whether the government will make a distinction between local and foreign bondholders, Fitch Ratings said in a report last month. Local lenders, which hold almost $14 billion of the notes, had lobbied against a disorderly default that would force hefty losses on creditors, warning it could also inflict irreparable harm on the reputation of the country’s banks and their capital.
The central bank, which itself owns about $5.5 billion of the debt, has proposed swapping the March bond for longer-dated instruments.
Bond investors are more skeptical about the prospects for an easy fix. Lebanon’s notes have mostly traded below 30 cents on the dollar, suggesting the market expects losses of roughly 70% in their value. Lebanon’s credit-default swaps - a form of insurance for debt investors - are the most expensive in the world.
There is also concern over litigation risk, including the probability that some foreign investors could file a lawsuit asking the authorities in the U.S. to impound Lebanon’s physical gold assets there, according to Fitch.
Lazard Ltd. and law firm Cleary Gottlieb Steen & Hamilton are advising Lebanon.
Ashmore Factor
Lebanon’s looming default is a blow for Ashmore Group Plc, which was attracted to the bonds’ valuations as they tumbled last year and had bet the government would pay out.
The London-based firm has amassed large positions in the $1.2 billion March bond, as well as $1.3 billion of notes maturing in April and June, that it can reject potential restructuring proposals backed by other creditors.
The wager had sparked a local investigation and condemnation from President Michel Aoun after Lebanese banks offloaded some of their bonds to Ashmore.
A spokesman for Ashmore, Jan Dehn, didn’t immediately respond to a request for comment.
Even if the Eurobonds were restructured with a writedown, any devaluation in the official exchange rate would likely keep the overall burden high. The country’s ratio of debt to gross domestic product has reached 170%.
“Lebanon needs external funding, and the IMF seems to be the most plausible - if not the only viable option that Lebanon can have,” Zeina Rizk, executive director of fixed-income asset management at Arqaam Capital, said in an interview with Bloomberg Television. “But obviously this is a political decision. And it seems that personal agendas are taking priority over a way to navigate the country out of the crisis.”
