The Lebanese Eurobonds Saga, hike in price and an eye on buyback?

"The risk of legal action by holders of Eurobonds is increasing. Since Lebanon defaulted, the holders of Eurobonds have a straightforward debt claim against the state for non-payment," Camille Abousleiman (ex-Minister of Labor and the eminent corporate lawyer) writes.

Yet those are witnessing a hike in the secondary market. Just before the crisis started, Lebanese Eurobonds outstanding totaled around $30 billion, with banks holding $14.8 billion, BDL $5 billion, and foreign investors the remaining $20.2 billion. But throughout the crisis, this composition has changed dramatically with considerable losses on the part of Lebanese banks. An interesting question is: how big exactly were these losses?

Lebanon's reliance on Eurobonds has been a key aspect of its financial strategy, especially over the past few decades. Eurobonds are international bonds issued in a currency not native to the country where they are issued. For Lebanon, issuing Eurobonds was a way to tap into global capital markets, raising much-needed funds to finance its budget deficits and support its economy.

Initially, this strategy provided Lebanon with substantial capital inflows, helping to stabilize its economy and fund public services. The Lebanese government issued these bonds with the expectation that economic growth would allow for their repayment. However, this reliance on Eurobonds also increased Lebanon's exposure to foreign currency debt and global market fluctuations.

By early 2020, Lebanon's financial situation had become increasingly precarious. The country's economy was burdened by a high public debt-to-GDP ratio, political instability, and a banking sector in crisis. In March 2020, Lebanon defaulted on a $1.2 billion Eurobond payment, marking its first-ever sovereign default. This default was a significant turning point, highlighting the unsustainable nature of Lebanon's debt strategy.

The default on Eurobonds led to a loss of investor confidence and further economic deterioration. It also resulted in complex negotiations with creditors, as Lebanon sought to restructure its debt. The default and subsequent economic turmoil exacerbated the country's financial crisis, contributing to severe currency devaluation, inflation, and a sharp decline in living standards.

Lebanon's default on Eurobonds underscores the risks associated with heavy reliance on foreign currency debt without adequate economic growth and fiscal management. The country's experience serves as a cautionary tale about the importance of sustainable debt strategies and the need for comprehensive economic reforms to ensure long-term financial stability.

The BLOM Bond Index (BBI) which is BLOMInvest Bank’s market value-weighted index tracking the performance of the Lebanese government Eurobond’s market (excluding coupon payments), slightly increased throughout the course of the week by 0.32%, to reach 6.36 points by May 30th, 2024. Meanwhile, JP Morgan EMBI dropped by 0.26% to stand at 857.30 on May 30th, 2024 compared to 859.51 on May 23rd, 2024.

It is to be noted that BBI increased notably by 8.53% since May 9th, 2024 from 5.86 to reach 6.36 on May 30th, 2024 (with an increase of 4.44% between May 9th, 2024 and May 10th, 2024 from 5.86 to 6.12). The increase in BBI has led to a couple of speculations. First, some foreign investment funds that already own Lebanese Eurobonds totaling around $17 Billion (such as Ashmore and BlackRock to name a few) might be buying more Eurobonds in order to increase its shares and then raising a lawsuit against the Lebanese Republic. As Mr. Camille Abu Sulieman argued, Eurobond holders have till March 2025 to raise a lawsuit against the Lebanese Republic in New York City in order not to lose access to their interest payments under the stipulations of the Eurobond issues. Second, sources of Lebanese Prime Minister Najib Mikati stated that the caretaker government is considering repurchasing the Eurobonds bought by foreign investment funds at a discount. In such action, not only that it mitigate the risk of foreign investment funds raise a lawsuit against the Lebanese Republic, but it decreases the losses of the Central Bank and Lebanese commercial banks that currently hold $5 Billion & $9 Billion respectively if the prices rise due to the increase in demand for these Eurobonds in addition to retiring part of the foreign debt at lower cost. But such operation is not straight forward, since foreign creditors might not have interest to sell their holding of Lebanese Eurobonds anticipating a capital gain if prices increase.

BLOMINVEST research discloses three interesting observations. First, even before the crisis hit in Q4 2019 (specifically on 17 October), the average weighted price of Eurobonds in the previous quarter was quite below par (of 100) at 75.93, a harbinger perhaps of worse things to come

Second, the biggest drop in the weighted price took place in Q1 2020, from 54.44 to 32.25, as the Lebanese government’s default took place during that quarter (early March 2020); also, it continued to drop as no resolution was in sight for the crisis, reaching 6.18 by Q4 2022. Third, Lebanese banks’ holding of Eurobonds fell notably during Q1 2020 by $3 billion, as banks scrambled to unload some of their Eurobond holdings right before and after the default. Additionally, Eurobond holdings fell again by $3.2 billion in Q4 2021, driven by the need to abide by BDL’s regulation that required banks to increase their FX reserves by 3% and by the need to enhance their FX liquidity to meet clients’ demand arising from Circular 158. In fact, the urgent need for FX liquidity drove banks’ Eurobond holdings down to $2.9 billion by Q4 2022! And the end result was that $11.9 billion of Eurobonds changed hands from banks to mostly venture funds who hoped to cash in on huge capital gain profits once the crisis is over and a resolution to foreign debt restructuring is agreed upon.

Of course, these “fire sales” – or the (reasonable) fear of being FX illiquid – on the part of banks implied huge losses as they were forced to sell their Eurobonds at market prices way below par. As we can we see from the table above, total realized losses stood at more than $9.5 billion by Q4 2022, close to 65% of their initial holdings of $14.8 billion and, more importantly, about 50% of banks’ total capital prevalent on the eve of the crisis[4].

These are no doubt huge losses, not counting banks’ losses accruing from NPLs, let alone the losses accruing from deposits at BDL, which potentially could be even bigger. The irony is that the default on Eurobonds was intended to save BDL reserves, but with the government deciding also at the time to subsidize basic (mostly imported) goods, the country ended up hemorrhaging more FX reserves, besides punching a great hole in banks’ capital and losing precious international credibility. That really hurts!