For the Beirut Stock Exchange (BSE), crises at home and abroad made 2011 a predictably rough year. A five-month government deadlock in Lebanon left the country in a bind, and Lebanese securities priced in this uncertainty. Revolutions in the Arab world and the unresolved European sovereign debt crisis took their toll on the Lebanese stock market as well. Lebanon’s fixed income market, on the other hand, is looking increasingly attractive to investors in comparison to troubled markets on the other shores of the Mediterranean and beyond.
The nascent year
At the beginning of 2011, just weeks before the fall of the previous cabinet, the BSE’s market capitalization stood at $12.6 billion. Six months later, immediately following the formation of the current cabinet, it had fallen to $11.3 billion.
Although Lebanon’s political situation stabilized after the formation of a government in June, the BSE was not immune to regional turmoil, nor the European sovereign debt crisis. The BSE witnessed consistent monthly drops in its market capitalization throughout the year but these accelerated into double digits from June through October as political troubles in Syria and economic woes in Europe escalated.
In addition to the turbulent regional and global markets, the BSE has its own structural problems, such as a lack of liquidity, a deficiency of listed companies, a now two-year void in its presidency and no independent authority to oversee the exchange. The capital markets and insider trading law approved by parliament in August is expected to tackle this last issue by providing Lebanon with an independent authority to oversee the exchange and protect investors.
According to Riad Salameh, governor of Banque du Liban (BDL), Lebanon’s central bank, the law would attract “substantial” investment in Lebanese companies.
Good-looking Lebanese… debt
As Lebanese equities suffered steep losses in 2011, Lebanon’s credit default swaps (CDS) — a proxy for sovereign default risk — performed relatively better. In the third quarter of 2011, Lebanon’s change in CDS spreads was one of the best performers globally, along with Venezuela, Qatar, the United States and Ireland. Lebanon’s CDS spread widened by only 22 percent in the third quarter to 430 basis points. The widening of a CDS spread means it is more expensive to insure a country’s credit and it reflects an increased perception that the country is more likely to default. Relative to the widening of the CDS spreads of 68 countries monitored by CMA Vision, a provider of market pricing data, Lebanon fared well. Italy, Germany, the Netherlands, Denmark and Austria, meanwhile, all saw their CDS spreads widen by more than 150 percent in the third quarter.
Lebanon’s credit is classified as non-investment grade or “junk” by the three rating agencies Moody’s, Standard & Poor’s and Fitch, though all three have a stable outlook on Lebanon.
Lebanon’s gross public debt stood at $54.4 billion as of September 2011; Finance Minister Mohammad Safadi expects this figure to reach $60 billion by the end of 2012. Lebanon’s gross public debt to gross domestic product (GDP) stands at an astounding 134 percent, according to the International Monetary Fund. By comparison, Greece’s ratio, the highest in Europe, stands at 142 percent.
Freddie Baz, chief financial officer at Audi Bank, likes to compare Lebanon’s debt profile to that of Japan and not Portugal, Ireland, Greece or Spain (PIGS), as 95 percent of the debt is held by local investors, as opposed to only 30 to 40 percent in PIGS. Indeed, Jean Riachi, chairman of FFA Private Bank, says, “Although rating agencies classify Lebanon’s debt as low grade, many investors around the world and not only in Lebanon are quite confident because of the technicalities of the Lebanese debt whereby it is 95 percent held by Lebanese.”
There are restrictions imposed by BDL requiring local banks to acquire investment grade bonds only and, according to Khaled Zeidan, general manager at MedSecurities, yields on these bonds are very low and thus government debt becomes attractive for local banks. “Most banks have few options in deploying their liquidity and with all the restrictions that the central bank has put in place, banks generally go back to Lebanese republic paper whether in USD [dollars] or LBP [Lebanese pounds],” he says.
Lebanese bankers are not the only ones recommending Lebanese debt as an investment. International banks are doing so as well. Merrill Lynch upgraded in October its rating on Lebanese Eurobonds to “Overweight” from “Marketweight,” while Barclays, which has kept its “Marketweight” recommendation, raised the allocation of Lebanon’s debt in its emerging markets portfolio.
The 10-year yield on Lebanon’s sovereign debt has dropped by 40 bps this year and stands at around 5.8 percent as of mid-November, which bodes well in comparison to those in floundering countries in Europe like Italy, which has its 10-year yield at over 7 percent, a 2 percent rise from the beginning of the year, and Spain, which stands at 6.3 percent, a 1 percent rise year-to-date.
Alain Wanna, deputy general manager at Byblos Bank, notes changes in the approach to Leban-on’s sovereign debt. “For the last two years, we had a strategy at Byblos of reducing our exposure to the government as a percentage of equity. But today, when we compare the sovereign debt of Lebanon to the sovereign debt of some European countries, we see that Lebanon is still performing extremely well,” he says. “At the end of the day, we need to make a choice on where to place our money.”
The attractiveness of Lebanon’s debt is reflected by the successful refinancing and issuance of Eurobonds this year. In May, Lebanon refinanced $1 billion in Eurobonds: one issue of $650 million maturing in 2019 at a yield of 6 percent, and a second issue of $350 million maturing in 2022 at 6.1 percent. And in July, Lebanon launched a $1.2 billion two-tranche Eurobond composed of a $500 million issue of bonds maturing in 2016 with a 4.75 percent yield, and a $700 million issue of bonds maturing in 2022 with a 6.2 percent yield.
“If you look at rates paid on the Eurobonds and the rate in the latest issued tranche, you can see [it] has dropped and not increased,” says Francois Pascal de Maricourt. “That's really a sign of confidence in Lebanon.”
The rosy picture painted by the attractive rates of Lebanon’s debt will likely be shaken if the government does not take action and implement the reforms necessary to tackle the debt. “A lack of reforms in the budget is very dangerous because they don’t realize the dangers if things go wrong,” says Byblos’ Wanna.
“Today there is excess liquidity in the sector, money is coming into Lebanon. But what if the banks stop investing; what if deposits don't flow?” he added. “The government should start to think about that and take corrective action. And it is time today to initiate reforms because money is available. It is more difficult to initiate reforms under pressure; look at Greece.”