(Bloomberg) — Emerging-market money managers say it’s too early to sell Lebanon’s defaulted bonds even after they nearly tripled in value in recent months, as the appointment of a new president potentially opens the door for dollar flows, reforms and debt restructuring.
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The sovereign bonds traded little changed on Friday after notching the best gains in the developing world, surging to above 16 cents on the dollar from about 6 cents in September. Danske Bank AS, Pictet Asset Management and Bank of America are now penciling a price of 20 cents, though they say the outlook beyond that will depend on success in implementing hoped-for reforms.
Lebanese bonds became popular last year among emerging-market investors who were buying up distressed debt for its high yields and idiosyncratic turnaround stories. Though the country hasn’t serviced its debt since 2020 and remains in economic paralysis, the risky trades are paying off. A ceasefire between Israel and Hezbollah in November and Thursday’s presidential election have emboldened traders to bet on a path that ultimately leads to restructuring the defaulted bonds.
“Twenty cents is a potential target if we move closer to a restructuring, so profit-taking before that level might be limited,” said Guido Chamorro, a senior EM portfolio manager at Pictet. “As long as the ceasefire holds and the president is able to appoint a prime minister quickly, bond prices still have upward potential, and investors will continue to look toward an eventual debt restructuring.”
Lebanon has faced an economic crisis since 2019 arising from years of corruption and mismanagement, pushing it to default on $30 billion of international bonds. With poverty deepening and the costs of war mounting, the country’s politicians have remained divided on the way ahead, leaving it without a president for 26 months. They also failed to carry out reforms required by the International Monetary Fund, depriving the nation of a $3 billion rescue agreed in 2022.
The appointment of army commander Joseph Aoun as president is a first step toward resolving the complex matrix of Lebanon’s problems. He’s now tasked with naming a prime minister, finance minister and central bank governor who can navigate Lebanese politics while reassuring investors and multilateral lenders.
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The daunting agenda includes “creating a functional government, getting institutions up and running, the central bank being able to govern, and rebuilding the country,” said Soeren Moerch, portfolio manager at Danske Bank, who bought the bonds last year at an average cost of 6.5 cents. But “Lebanese people now might have this thing hope, a thing they did not have for a long time.”
International Support
Investors say the current situation offers the best chance of success in years. Aoun not only has the support of the US, but also of Saudi Arabia, which can help bring Lebanon back into the Arab and international fold. Wagers are on for what kind of immediate assistance Riyadh can bring.
“Saudi Arabia can do marvelous things,” said Fouad Makhzoumi, a member of the Lebanese parliament and a contender for prime minister, who said he met Saudi officials during the run-up to the presidential vote.
Investors are also debating whether the new political leadership will mean a weakening of Hezbollah, the Iran-backed paramilitary group, which is designated as a terrorist group by the US but also wields significant political power in Lebanon. The group has seen much of its leadership killed and its capabilities degraded in an Israeli military offensive.
“Hezbollah, for years, has been refocusing on two things: prosaic domestic concerns and its regional standing,” said Peter Harling, founder and director of Synaps Network, a Beirut-based research firm. “It has lost the latter and will invest all the more in defending its interests within the Lebanese political and economic system.”
Multi-Billion Dollar Hole
One of the biggest obstacles to reforms comes from Lebanon’s banking system. As a result of a complex spiral of high-interest deposit plans, excessive borrowing and default by the government, the central bank — also known as Banque Du Liban — as well as local commercial lenders are stuck with an estimated $80 billion deficit. Bankers have repeatedly said that the state should solely bear the losses and have urged the government to sell assets to repay depositors.
The hole at BDL “can only be closed by bailing in the banks, their owners and deposits,” said Timothy Ash, senior EM sovereign strategist at RBC BlueBay Asset Management. “But the bank owners are typically the same politicians” who caused the problem in the first place, he said. The world-beating bond rally may quickly reverse if the stalemate returns, he said.
“The market is still in rose-tinted spectacles mode,” Ash said. “Now hard decisions need to be taken.”
–With assistance from Dana Khraiche.
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