Summary

This week's main developments relate to two heavily-indebted emerging market countries moving in opposing directions:

• Barbados appears to have reached agreement with its international creditors on debt restructuring and relief, including a 26.3% haircut.
• Lebanon is facing political instability which threatens to undermine its currency peg and is pushing its debt to yield levels that appear to discount write-downs.

Barbados restructuring

On 18 October, Barbados announced that it had reached a deal with its international market creditors, some 18 months after defaulting. Under the announced arrangements, Barbados will issue at least USD500 million of new 6.5% debt with a 2029 final maturity, making the new issue index-eligible. The new bonds will amortize in equal instalments semi-annually from April 2025. Outstanding debt, including deals due in 2019, 2021, 2022 and 2035 will be exchanged for the new instrument with a 26.3% haircut.

Unpaid interest will be subject to a similar haircut and covered by a USD7.5 million cash payment on closing, along with USD32.5 million of Past Due Interest bonds largely payable in October 2020, with final maturity due in February 2021.

The restructuring also makes provision for natural disasters, allowing Barbados to capitalize interest and defer principal payments for two years in the event of such events. Overall, the arrangements are similar to those already accepted by domestic creditors.

According to Barbados's statement, the deal is an in-principle arrangement subject to the completion of mutually acceptable documentation. It notes that the bondholder committee that agreed to the new arrangements represents "more than half" the government's eligible debt.

Lebanon

Lebanon's economic fundamentals have been weak for an extended period. It has long-standing deep economic imbalances, including a last-reported debt-to-GDP ratio of 152%, a budget deficit of 11%, and a current-account deficit of 23%. It needs continued access to external funding to support these severe imbalances and repay maturing debt, with near-term refinancing needs reportedly of USD2 billion.

Efforts to restrict its fiscal imbalances have triggered widespread recent protests, with widespread calls for the government to resign. In the event this occurs, which our Country Risk team views as likely (if not an immediate prospect) the country faces an extended interval before elections could be held and a new administration formed. There is also risk that Hizbullah would use its strong parliamentary position to seek greater involvement in government, potentially steering the country's political orientation towards Iran and increasing the risk of US sanctions.

In prior analysis, IHS Markit has flagged that Lebanon's foreign exchange reserve position is considerably weaker on a net basis than the headline data. This reduces its resilience to the current political uncertainty, posing challenges to the continued viability of the country's currency peg, and its access to international bond markets. Bond market reactions to recent developments indicate growing concern over Lebanon's debt sustainability. The return on Lebanon's 2021 debt rose three percentage points on 21 October to a 24% yield, implying the likelihood of debt-restructuring and potential haircuts for bondholders.

Emerging markets

Saudi Arabia gained USD14 billion of demand for a USD2.5 billion 10-year sukuk issue, priced at 127 basis points over mid-swaps versus initial guidance of 145 b.p.

Indonesia launched a 12-year Euro-denominated benchmark deal on 23 October, with initial price guidance of mid-swaps plus 160 basis points.

On 21 October, Norilsk Nickel launched a USD500 million five-year deal. The offering had initial price guidance of 3.625%. The deal was increased to USD750 million and priced at 3.375%: peak demand reached USD2 billion from over 110 investors according to Tass, citing a lead manager.

Majid Al Futtaim, a shopping mall firm based in UAE, is preparing its second issue of Green sukuk bonds. The deal will be dollar denominated with a 10-year term. On 23 October, demand reached over USD2.1 billion.

High-yield debt

There has been adverse focus on a buy-out debt package funding Blackstone's USD7.5 billion buy-out of the UK's Merlin Entertainments, operator of Madame Tussauds and Legoland. On 17 October, Merlin raised two eight-year bonds, comprising EUR350 million at 4.5% and USD410 million at 6.625%. Analysts have highlighted the modest returns for the deal along with the weakness of its financial covenants, which allow the firm to issue up to EUR1.2 billion of additional debt (2.4 times its equity), despite having 5.9 times leverage after the buyout.

Conversely, on 21 October, International Financing Review claimed that investors had gained "the upper hand" in negotiations over covenants in Bain Capital's USD4 billion buyout of Kantar, a "data, insight and consultancy" company previously owned by advertising group WPP.

Other debt

Landesbank Baden-Wuerttenberg is planning a debut AT1 issue, seeking a perpetual deal callable in 2025 or 2027, and is meeting investors this week. It has established a program to arrange up to EUR1.5 billion of such instruments by end-2020.

Implications and outlook

Barbados's deal with its creditors - if approved, which seems likely - is a further positive indicator for the re-establishment of its debt sustainability. At its default in 2018, public debt had increased to 157% percent of GDP, with a minimal reserve cushion of just 5-6 weeks of import coverage. In a September 2019 statement, the IMF - which agreed a support package with Barbados in late 2018 - noted that it now "continues to make good progress in implementing its ambitious and comprehensive economic reform program". It flagged that the government achieved a primary surplus of 2.5% of GDP in Q1 2019, which "bodes well" for achievement of its 6% primary surplus target for 2019 while reserves also stood above IMF program targets.

According to Professor Avinash Persaud, Special Envoy on Investment and Financial Services to the Prime Minister, quoted in Barbados Today newspaper, the new deal implies debt service savings of around USD1 billion over a four to five-year time span. He flagged that "the reduction in the amount of external debt outstanding is around 25 per cent or USD422 million", with the country also benefitting from a reduced interest coupon of 6.5% (versus 8% average on prior outstanding debt), longer maturities and a smoother amortization schedule.

Lebanon's position looks far less encouraging. During 2019, there has been ongoing discussion that its domestic banks would subscribe new government debt at below-market rates to enable Lebanon to repay maturing debt. For some time, the narrow investor base for its debt - largely comprising local banks with a few speculative international investors - has been a source of concern. This is growing as market participants place increased focus on its political risks, the potentially-modest nature of its foreign exchange reserves and heavy reliance on local banks to fund its debt requirements.

The fall of the current government, and the resulting likelihood of limited scope to progress planned fiscal austerity, along with a possible swing towards Iran, would leave Lebanon facing severe risks, including the possible collapse of its currency peg. Default is not yet inevitable: one particular "bail-out" source could be a rescue package from other regional governments, with Lebanon having sought help from the UAE recently. Overall, however, its financial position looks bleak: we would not be surprised to see local banks undertaking "voluntary" debt exchanges within the coming year to relieve near-term debt service obligations, as an alternative to facing further bank levies and the threat of asset confiscation.

Lastly, the focus on covenant quality in the high-yield market is becoming increasingly important. With renewed central bank easing, both banks and asset managers face additional constriction of available returns. If this translates into increased willingness to invest in highly-risky assets with weak covenant protection, this would represent a clear indicator of the potential for financial sector misallocation of assets, raising future systemic risks for banks and asset managers.

Posted 25 October 2019 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence