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ISBs at historically low prices

14 May 2022

  • Upside depends on trajectory of restructuring process 
Following the further collapse of Sri Lanka’s International Sovereign Bonds (ISBs) across all maturities in the face of continued political instability in the country, Sri Lankan ISBs are currently trading at historically low prices. This has been described as an attractive investment opportunity with a significant upside by certain daring speculative traders. During last week, prices compiled by Bloomberg showed that the Sri Lankan ISB with a 5.875% coupon rate due on 25 July was trading at around 45 cents on the dollar and the March 2030 ISB was trading at around 37 cents on the dollar.   Speaking to The Sunday Morning Business, First Capital Holdings Head of Research for Investments, Fixed Income, and Equity Dimantha Mathew stated that considering that Sri Lanka’s ISBs were currently at around 40 cents on the dollar, it represented a high risk and high upside investment for speculative traders even with potential of a haircut. He explained that from a speculative point of view, since Sri Lanka was restructuring its foreign debt, there was hope that economic recovery would commence, whereupon this would be the lowest prices levels these ISBs would fall to. He pointed out that even when a country was defaulting, there were people who would take a speculative risk and invest. However, he expected such interest to be reflected in the market once Sri Lanka gives a clear indication of the direction of the restructuring process by appointing financial and legal advisors. Speaking to The Sunday Morning Business, JB Securities Chief Executive Officer (CEO) Murtaza Jafferjee stated: “The upside of the Sri Lankan ISBs depends upon the trajectory of the restructuring process. There will always be traders who will say that the real value of these bonds will be higher.” He noted that in the debt restructuring process, Sri Lanka would seek to restructure the cash flows and the timing of the cash flows. The restructuring of cash flows may involve a haircut on the principal as well as coupons. He further explained that the restructuring process involved the exchange of the old bond with a new bond with less favourable terms. Speculative traders will try to estimate the restructured value of these new bonds, and if they believe that it will be higher than the current secondary market prices, they will buy it from the secondary market.   Jafferjee stated that the secondary market prices of the ISBs would move based on the expectation of what the exit yield would be. “About four months ago they used 8% as the exit yield, but because of increasing interest rates and the deteriorating situation in Sri Lanka, the exit yield is now 11%. That’s why the price is decreasing to this extent.” Exit yield is the interest rate at which new bonds are issued and traded in the secondary market the day of the debt exchange. Jafferjee pointed out that the secondary market prices of the ISBs would also be affected by the expectation that the haircut on the cash flows would be significant since it was delayed and also that we would push back the cash flow maturity for a significant period. “For the next three to four years Sri Lanka’s ability to repay will be highly impaired. We need time to recover and grow the economy. I believe it will take us around six years to get back to where we were, because we have had a very steep fall. Then we will have to grow again thereafter, and our capacity to repay will improve,” stated Jafferjee. According to Reuters, Citi projected that across the bonds maturing between 2022 and 2030, Sri Lanka may seek a coupon haircut of around 50%, a reduction of at least 20% in face value and maturity extensions between 10-13 years. “Assuming an 11% exit yield, we estimate that the recovery value on the dollar bonds in such a scenario could range in the low to mid 40s,” Citi strategist Donato Guarino said, referring to the interest rate at which the new securities would trade on the day of the debt exchange. Moreover, Tellimer analysts assumed a 30% haircut in their base case scenario. They assign a recovery value near 60 cents on the dollar for the bonds, with a 8% exit yield. They also flagged an alternative scenario with a 42 cent recovery value and a 16% exit yield.    – By Shenal Fernando

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