Banque du Liban had proposed a debt swap with local lenders in January 2020 as a way to avoid that outcome/Bloombergby 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 pay-out after it said it would not honour a $1.2 billion Eurobond.
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 is 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.
The Lebanese government declared that it would prioritise 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 credit default swaps 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.
Jonny Goulden, an analyst at JPMorgan Chase & Co in London, said, “The announcement over the weekend that they will not pay the bonds looks to start the default process which should also trigger CDS eventually.”
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 is considering drawing up an economic programme that cuts debt and overhauls the country’s banking industry.
Raoul Nehme, the Lebanese economy minister, said that Lebanon wants to cut its debt to between 60 and 80 per cent of GDP from 170 per cent as part of the efforts. Lebanon’s notes mostly trade below 30 cents on the dollar, suggesting CDS will pay out at a rate of at least 70% per cent
Default was not always on the cards. Banque du Liban had proposed a debt swap with local lenders in January 2020 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.
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 UK travel agent Thomas Cook and $522 million in June 2019 after French retailer Rallye filed for court protection.