JP Morgan Proposes Restructuring Scenario for Lebanon's Sovereign Bonds
Global financial services firm JPMorgan said the recent positive developments in Lebanon raise hopes for the normalization of the political dynamics in the country, but cautioned they remain insufficient without reforms.
The report, published shortly before the announcement of a new government in Lebanon, noted that the value of Eurobonds - dollar-denominated bonds issued by the state - have recently improved, to exceed the average price recorded in 2020.
It noted that this increase was influenced by positive political events after the parliament successfully elected former army commander Joseph Aoun as president, followed by the appointment of Judge Nawaf Salam as prime minister in January.
JP Morgan said the recent recovery in Lebanon's $3.1 billion face value stock of Eurobonds has been strong, as Lebanon was the best performer of the EMBI Global Diversified Index last year due to the positive developments and the supportive global risk environment.
However, it expressed caution about future performance given the risks to political stability in the country and the hurdles that need to be overcome before restructuring negotiations can begin.
It also noted that the country's economic downturn, especially after Israel's war on Hezbollah, will take some time to reach a state of stability in the medium term.
JP Morgan said the Eurobonds' restructuring will require a comprehensive debt sustainability analysis, but it estimated that based on current levels, the market pricing is pointing towards a 70% haircut with a 10-year maturity extension.
The average price of Lebanese Eurobonds rose to 18 cents on the dollar Monday following the formation of Salam's government on Saturday.
The report also said that Lebanon's economy is highly dollarized with dollar-denominated banknotes accounting for about 95% of the volume of cash in circulation and deposits outside banks.
It noted that following the reconstruction efforts, the Lebanese authorities should start rebuilding the economy with significant support from external partners, which in turn will depend on the ongoing developments and the eventual reforms plan.
Political stability would also shift the focus towards addressing the sovereign-banking crisis, it added.
JP Morgan stated that the authorities will need to develop reforms plan in conjunction with the International Monetary Fund (IMF) in order to pave the way for external financing and to get relief from creditors.
It considered that the authorities will prioritize restoring the financial sector's stability, recapitalization and a depositor bail-in over the restructuring of the sovereign Eurobonds, given the respective relative size of liabilities.
It noted that the IMF's 2022 scenario suggests that debt sustainability could be achieved by calibrating the restructuring to deliver an 80% debt to GDP ratio by 2027, and gross financing needs averaging no more than 9% per year in the 2024–27 period.
Such targets would, however, need to be tightened to the extent that the government's balance sheet is used to support the bank restructuring.
While determining the exact magnitude of the overall losses in the financial system requires a comprehensive bank-by-bank asset quality review and the completion of the debt restructuring, IMF said staff and the authorities estimate them at about $70 billion, suggesting that the Central Bank will end up with negative equity of some $60 billion.
JP Morgan noted that about 80% of commercial bank assets are deposited with the Central Bank of Lebanon.
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