We think policy options include (1) status quo – pay 9 March maturity and muddle through, but this doesn’t look viable; (2) a homegrown adjustment plan – pay 9 March maturity but use the time to come up with a credible and coherent economic adjustment plan, one which does not include debt restructuring; this may not be viable either; (3) adjustment plan plus domestic debt exchange; (4) comprehensive restructuring including domestic debt and foreign bonds within an IMF programme. Given the IMF’s view that Lebanon’s debt is unsustainable, we think the Fund could only approve a programme under its new lending framework if there is a debt restructuring (PSI), although how much they would seek is unclear.
Lebanon’s gross public debt is high, at 158% of GDP in 2019, and unsustainable. That is, Lebanon is unlikely to grow out of its debt problem, especially in the context of a fixed exchange rate, and we see little scope for asset sales (privatisation) to pay off the debt. And there are limits to the size of fiscal consolidation on its own that would be needed to reduce the debt. We think it requires a primary surplus well in double digits which is not feasible or desirable. If, instead, we assume as reasonable a 4-5% primary surplus (as per the IMF’s adjustment scenario in the 2019 Article IV), compared with an expected small primary deficit last year (-0.3%), implying a 5ppt adjustment, we think this will mean that a significant contribution is still needed from domestic creditors and foreign bondholders. The majority of Lebanon’s public debt is domestic debt (63% of total gross public debt) while eurobonds amount to only 35% of the total (gross), albeit 94% of the public sector’s foreign debt and 54% of GDP. Moreover, total interest payments are a whopping 10% of GDP, although the average nominal interest rate is only about 6.7%.
Bond restructuring is, therefore, inevitable in our view. Our DSA suggests that a 50% nominal haircut would be needed on the bonds, in conjunction with a primary fiscal adjustment and domestic restructuring. However, domestic holdings of local government bonds and eurobonds mean that a domestic restructuring will need to balance the impact on domestic financial stability. While the eurobonds contain CACs, they lack aggregation which could frustrate the restructuring process. Upside risks include stronger-than-expected growth or lower interest rates, while downsides include political risks, implementation risks, the impact on the banking system and currency devaluation.
We calculate a 50% principal haircut produces a PV (recovery value) of 35 cents per unit of existing notional (ie US$35 per US$100) at a benchmark 12% exit yield based on the 6.65% 2030 bond, with unchanged coupons and maturity date. At a more optimistic 8% exit yield, the PV increases to 45.5 cents per unit of existing notional.
We assign a Hold to medium/long-term US$ bonds, with a current price of c29.5 (mid basis) for the 6.65% 2030, as of cob 24 February on Bloomberg.
We assign a Hold to front end US$ bonds, with the 9 March maturity priced at c53 (mid-basis) as of cob 24 February on Bloomberg.
Read the full report here.
Recap of the week’s key credit developments
Nigeria (NGERIA): GDP figures released on Monday came in higher than expected. According to the National Bureau of Statistics (NBS), Nigeria’s Q4 19 real GDP growth rate was 2.55% yoy, bringing annual 2019 real GDP growth to 2.27%, up from 1.91% in 2018 and the fastest annual growth rate since 2015.
Ratings update from 21 February:
- Lebanon (LEBAN): Moody’s and S&P both downgraded Lebanon’s long term foreign currency rating by two notches to Ca and CC, respectively, in line with Fitch’s comparable CC rating, in place since 12 December. Moody’s changed its outlook to stable, while S&P retains its negative outlook. Both agencies cite the high likelihood of debt restructuring.
- Turkey (TURKEY): Fitch affirmed its long term foreign currency rating on Turkey at BB-, with a continued stable outlook. Fitch said that the rating reflects the weak external finances and the record of economic volatility, high inflation and political risks.
- Kazakhstan (KAZAKS): Fitch affirmed its long term foreign currency rating on Kazakhstan at BBB, with stable outlook. Fitch said that the BBB rating balanced the positives of accumulated oil revenues, and the resulting fiscal and external buffers, against the negatives of high commodity dependence, a weaker banking sector than peers and lower governance scores than BBB medians.
- Zambia (ZAMBIN): S&P downgraded its long term foreign currency rating on Zambia to CCC from the CCC+ rating (in place since the last downgrade six months ago). The outlook was also changed to negative from stable.
- Tajikistan (TAJIKI): S&P affirmed the long term foreign currency rating on Tajikistan at B-, with stable outlook.
IHS Netherlands (IHSHLD) outperforms on IPO plans despite rating downgrade. An eventful week for IHS Netherlands with the news of an IPO supporting the bonds amid the coronavirus driven sell-off. The structure of the potential IPO, specifically the proportion of new and existing shares to be offered and valuation of the company, which according to Bloomberg is aimed at US$7bn, could become the key variables for bondholders.
Initiate VF Ukraine (VODUKR) US$500mn 6.20% notes due 2025 with a Hold. VF Ukraine, the second-largest mobile operator in Ukraine, has recently issued its maiden bonds with strong investor demand. The issue came to the market before the coronavirus-driven sell-off in EM debt, and VODUKR 25s are still indicated yielding above c6.00%.
Metinvest (METINV) is looking to buy a steel mill in Poland. Metinvest is looking to participate in a tender to acquire ISD Huta Cztochowa, an idled Polish plate producer undergoing bankruptcy proceedings. Given the circumstances, the price is unlikely to be high. According to S&P Global Platts, the banks were looking to get US$56mn for the plant in August 2019. METINV underperformed in the last three weeks after releasing the monthly production and headline financials for November 2019 when the company’s EBITDA was barely positive. We warned that the company’s profitability and cash flows were declining, however, optically low leverage amid a search for yield in December 2019–January 2020 must have supported bond valuations.
DTEK hit hard by risk-off. DTEKUA 24s recorded the worst performance among Ukrainian corporates since January. Weak preliminary FY 19 results released on 5 February 2020 had some negative effect on bond prices, but the big leap down has taken place this week, with DTEKUA down 3ppts in price and 150bps in z-spread, which approached 1,000bps, according to Bloomberg. At the same time sovereign bonds of a similar tenor widened 30-40bps, while the corporate sector showed mixed performance, but none of the bonds maturing before 2024 widened more than 60bps in z-spread terms.
ShaMaran Petroleum (SNMCN) published upbeat 2020 guidance. The company expects Atrush field gross daily production to be in the range of 44,000-50,000bopd in 2020, which corresponds to net 12,144-13,800bopd to ShaMaran. Management estimates average lifting costs to decrease to US$5.5-6.7/bbl and capex guidance on the filed level is guided at US$131mn, of which SamMaran’s share is US$36mn.
Nostrum Oil (NOGLN) downgraded to Caa3 by Moody’s. The outlook on the rating is Negative. The rating agency highlighted declining production and a lack of clear path for materially increasing cash flows as reasons for the downgrade. In our view, Nostrum could muddle through 2020 in a cost-saving mode. However, with current level of production, the company’s debt is not sustainable in the long-term.