While we upgraded our recommendation on Sri Lanka’s eurobonds to Hold from Sell on 8 April, we maintained our Sell recommendation on the SRILAN 5 ⅞ 07/25/2022s due to the large premium to the rest of the eurobond curve (averaging around 15% in the 3 months immediately following Sri Lanka’s decision to default).
More recently, the premium was supported by legal action attempting to accelerate payment of the bonds by a large holder of ‘22s. However, with the 25 July maturity date passing without payment, the bonds have since collapsed and now trade on par with the rest of the eurobond curve, showing that markets have little confidence that the case will yield a favourable outcome for the holders of the ‘22s.
The narrowing premium has also been driven by price appreciation on the rest of Sri Lanka’s eurobonds, with the SRILAN 7.55 03/28/2030s rising by c9pts (c36%) since reaching a low of just above US$24 on 20 April, reaching US$33 at the time of writing (versus US$39 at the time of our upgrade on 8 April).
The rally has been driven by the election of President Wickremesinghe on 20 July, which we said at the time was likely the best outcome for reform continuity but raised the risk of further political unrest. But with protests calming down and the formation of an “all-party government” underway, markets have seemingly turned more upbeat on Sri Lanka’s restructuring prospects.
Still, we think Sri Lanka’s restructuring is likely to be a long and difficult road (see here, here and here for an explanation why) and the risk of political unrest will remain in the months ahead (albeit less so than we previously feared).
With the SRILAN 6.85 03/14/2024s now trading in line with our “worst case” recovery value of US$32-35 at 12-14% exit yields from April (which is now probably closer to the “base case”), we maintain our Hold recommendation on the eurobonds beyond the ‘22s. While risks are skewed to the upside, renewed political uncertainty or a messy restructuring could also lead to further declines.
Meanwhile, with the SRILAN 5 ⅞ 07/25/2022s now trading in line with the rest of the curve, we upgrade our recommendation to Hold from Sell on the ‘22s at US$33.1 at the time of writing on Bloomberg, thus unifying our recommendations across the curve.
Sri Lanka banks: The severe effects of any domestic debt restructuring activity, August 2022 (Shah and Kumar)
Sri Lanka: IMF talks mark beginning of long road, April 2022
Sri Lanka announced external debt restructuring, April 2022
Sri Lanka finally turns to the IMF, March 2022