Lebanon Default May Trigger $400 Million Payout to Investors
Lebanon Default May Trigger $400 Million Payout to Investors
(Bloomberg) --
Lebanon’s decision to default on its debt to pay for essential goods will probably hand investors a windfall of as much as $400 million.
Buyers of credit insurance on the heavily indebted nation may be in line for the cash payout after it said it wouldn’t honor a $1.2 billion Eurobond due on Monday.
The investors hold the world’s most expensive credit default swaps -- derivatives used to bet on a borrower failing to keep up with its debts. It costs $792,000 upfront plus fees to insure $1 million of Lebanon’s debt against default for five years. That’s the equivalent of a 18,000 credit-default swap spread, compared with a roughly 290 basis-point average for the Markit CDX Emerging Markets index.
On Saturday the government declared that it will prioritize spending foreign-currency reserves on the import of essential goods over debt payments, putting the country on course for its first default in history.
To unlock a CDS payment, a panel of traders called the Determinations Committee must rule that a credit event has occurred. An auction of Lebanon’s bonds will then be held to determine the exact value of compensation that the banks and funds which sold the swaps must pay their customers. The process can take many weeks.
“The announcement over the weekend that they won’t pay the bonds looks to start the default process which should also trigger CDS eventually,” said Jonny Goulden, an analyst at JPMorgan Chase & Co. in London.
The Middle Eastern country is suffering its worst financial crisis in decades, struggling to cope with dwindling foreign-currency reserves and double-digit inflation. A new government backed by Hezbollah, the Iranian-linked group, is looking to draw up an economic program that cuts debt and overhauls the country’s banking industry.
Lebanon wants to cut its debt to between 60% and 80% of gross domestic product from 170% as part of the efforts, Economy Minister Raoul Nehme told Bloomberg on Monday.
Lebanon’s notes mostly trade below 30 cents on the dollar, suggesting CDS will pay out at a rate of at least 70%.
Debt Swap
Default wasn’t always on the cards. The central bank had proposed a debt swap with local lenders in January as a way to avoid that outcome. But the prospects of a swap faded after local banks sold some of their Eurobond holdings at a discount to overseas funds such as London-based Ashmore Group Plc.
Credit-default swaps, which were blamed for exacerbating the 2008 financial crisis, have come back in vogue over the past year with a number of high-profile corporate failures. Traders received $247 million from debt insurance after the collapse of U.K. travel agent Thomas Cook and $522 million in June after French retailer Rallye SA filed for court protection.
Lebanon joins a series of sovereigns that have defaulted in recent years including Venezuela, Puerto Rico and Ukraine.
To contact the reporter on this story: Katie Linsell in London at klinsell@bloomberg.net
To contact the editors responsible for this story: Vivianne Rodrigues at vrodrigues3@bloomberg.net, Marton Eder, Bruce Douglas
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