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Lebanon downgraded to Selective Default on suspended Eurobond payments

Authorities also said they are suspending coupon and principal payments on all Eurobonds until a comprehensive debt restructuring agreement can be reached with creditors

We are lowering our foreign currency ratings on Lebanon to 'SD/SD' (selective default) from 'CC/C' The negative outlook on the local currency rating reflects the risk to commercial debt repayment Printing Lebanese pounds for upcoming local debt payments to domestic banks, could result in sharp inflationary pressures

By: S&P Global Ratings

Rating Action On March 11, 2020, S&P Global Ratings lowered its foreign currency sovereign ratings on Lebanon to ‘SD/SD’ from ‘CC/C’. We affirmed our local currency long- and short-term ratings at ‘CC/C’ and maintained the negative outlook on the long-term rating. The transfer and convertibility assessment on Lebanon remains at ‘CC’. 

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Outlook

The negative outlook on the local currency rating reflects the risk to commercial debt repayment in the context of ongoing political, financial, and monetary pressures. We could lower the rating to ‘SD’ if the government signals that it will restructure local currency debt in addition to the Eurobonds. We could raise the rating if we perceived that the likelihood of a distressed exchange of Lebanon’s local currency commercial debt had decreased. This could be the case if, for example, significant donor funding support were to materialize, allowing the government a small window to implement immediate and transformative reforms, or if significant reforms led to sustained strong economic growth. 

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Rationale 

Following rising funding pressures, alongside widespread social and political protests and opposition to debt repayment, the Lebanese government has decided to stop paying its commercial foreign currency debt obligations, including a $1.2 billion Eurobond that matured on March 9, 2020. We understand that there is a grace period of seven days on the maturing bond, but the government has announced its intention to restructure the debt. Lebanon has total outstanding Eurobonds of about $31 billion, with other short-term maturities of $700 million in April and $600 million in June. 

The Lebanese government under Prime Minister Hasan Diab will engage in debt re-profiling negotiations with creditors over the coming months. Potential options include haircuts on principal and coupon payments, as well as an extension of maturities. The government has hired Lazard and Cleary Gottlieb as financial and legal advisors on the debt restructuring. 

We would likely remove the foreign currency ratings from ‘SD’ once any debt exchange or restructuring agreement between Lebanon and its creditors became effective. We could also raise the sovereign credit rating from ‘SD’ if, over time, we expect no further resolution to occur and we believe a revised rating better reflects our forward-looking opinion on the creditworthiness of Lebanon. 

The restructuring negotiations could be complicated and drawn out due to three reasons. First, as per official statements, we do not expect a funded program from the IMF that could provide a policy anchor and encourage other international donor financial support. Second, one investment fund holds more than 25% of the Eurobonds maturing in 2020, which gives it the ability to block restructuring terms it may consider unfavorable. Third, domestic banks and the central bank (Banque du Liban) hold more than 60% of the outstanding Eurobonds. Depending on the severity of the restructuring terms, haircuts on nominal payments could have ripple effects across the domestic financial system, including depositors, and the economy. Transforming the economy will be an even more challenging task in the context of Lebanon’s fragmented political environment, organized along confessional lines, and high regional security risks. 

We understand the government intends to continue paying its local currency debt obligations for now. Our ‘CC/C’ ratings on Lebanon’s local currency debt reflect ongoing severe economic and monetary pressures. Although the central bank can technically print Lebanese pounds for upcoming local debt payments to domestic banks, this could result in sharp inflationary pressures and further diminish the value of the local currency vis-à-vis the U.S. dollar, threatening to end the official currency peg. 

Read: Thinking the unthinkable: Lebanon’s sovereign debt default?

Key Statistics Table 1 

Lebanon Selected Indicators