Over the past year, Lebanon's defaulted government bonds have nearly tripled in value. While investors are betting on recovery prospects amid signs of economic improvement, vast disparities in estimates for potential bond values following debt restructuring could constrain further gains.

The bonds' "recovery value" will only become clear after lawmakers determine the scale of losses that troubled domestic banks must absorb—a decision that will in turn affect how much the government can allocate to bondholders.

Lebanon previously endured over two years of government paralysis, which further intensified the country's economic crisis. As political developments broke the deadlock, government bond prices have climbed from just 6 cents per dollar of face value a year ago to nearly 24 cents currently.

**Rising Hope, But Significant Recovery Value Estimate Disparities**

The formation of a new government in February drove bond price increases. Following the destructive conflict between Israel and Lebanese militant group Hezbollah, investors expect Lebanese authorities to push the nation closer to securing reconstruction funding.

However, some fixed-income analysts suggest the current rally may have exceeded reasonable bounds given numerous uncertainties, particularly regarding bond "recovery values"—the actual worth of bonds after the long-awaited debt restructuring that is crucial for Lebanon's economic recovery.

Current estimates for bond values span an unusually wide range.

"We can construct multiple scenarios with recovery values estimated between 20 to 40 cents," said Roger Mark, a fixed-income analyst at asset management firm Ninety One, which holds Lebanese government bonds.

"Of course, more pessimistic scenarios exist, such as failing to reach an International Monetary Fund (IMF) assistance agreement within the next year."

In June, the IMF indicated Lebanon had made progress toward securing a loan agreement, subsequently raising hopes for IMF assistance to support reconstruction efforts. IMF staff will visit Beirut this month to advance related negotiations.

A Morgan Stanley client report obtained by Reuters shows Lebanese bond recovery values could reach as high as 40 cents, but under worse scenarios, could "drop significantly to around 23 to 26 cents."

A group representing bondholders declined to comment on the matter.

**Initial Signs of Recovery**

In March 2020, Lebanon defaulted on $31 billion in outstanding international bonds, after which its financial crisis deteriorated sharply: bank balance sheets collapsed and the currency depreciated by as much as 99%.

At that time, hopes for debt restructuring or crucial IMF assistance appeared increasingly remote, with Lebanese government bond prices once falling below 6 cents.

This January, Lebanon's parliament elected a new president; in July, lawmakers passed long-awaited banking restructuring legislation—one of several pieces of legislation needed for financial system reform.

Goldman Sachs economist Farouk Soussa noted that investors seized this "ultra-low price asymmetric" opportunity. However, he indicated that some investors entered the market fearing they might miss explosive gains without fully recognizing that remaining obstacles could be far larger than anticipated.

"Current pricing implies a high probability of positive resolution for remaining obstacles over the next 12 to 18 months, but this pricing doesn't adequately reflect some downside risks," Soussa pointed out, with the key being pending legislation that must clarify the scale of losses banks need to absorb.

Lebanon's central bank also warned last week that elevated global interest rates would complicate its international bond restructuring efforts.

**Focus on the "Funding Gap"**

The scale of losses that insolvent banks must bear is called the "funding gap"—the difference between bank liabilities and assets.

Almost no one expects lawmakers to pass crucial legislation determining this gap before the May 2026 elections.

While estimates for the "funding gap" vary dramatically and its calculation process is complex and politically contentious, this figure is essential for determining bond recovery values.

Two years ago, the IMF estimated that Lebanon's central bank, which accounts for the largest portion of the "funding gap," could ultimately face $60 billion in negative equity.

In March, the Institute of International Finance (IIF) calculated that the central bank's negative equity had decreased from $76.4 billion at the end of 2022 to $48.4 billion.

The scale of debt the government must assume will affect the IMF's assessment of Lebanon's "sustainable" repayment capacity to bondholders and other creditors during restructuring.

Even if core data including the funding gap is clarified, bond recovery values will still be affected by other factors: how JPMorgan's estimated $14.3 billion in overdue interest is accounted for, and the extent of asset write-downs (or "debt haircuts") that bondholders must accept.

Yvette Babb, portfolio manager at asset management firm William Blair (which holds a small amount of Lebanese bonds), stated that current bond pricing above 22 cents is approaching previous recovery value estimates.

"Other (high-yield) bonds have risen significantly, so we believe Lebanese bonds remain relatively attractive," Babb said. Emerging market bond valuations have generally risen, even in war-torn Ukraine and highly indebted Argentina.

Soussa indicated that signs of progress in Lebanon (including forming a new government and passing banking reform legislation) are difficult to ignore, and these developments could further drive up bond prices.

"There aren't many quality distressed asset investment opportunities in the market currently, and given rising U.S. risk premiums, emerging market spreads have generally narrowed," Soussa said.

"This is one reason why investors' increased risk tolerance has generated demand for Lebanese bonds."