Bondholders in Sri Lanka are bracing for significant losses as a result of debt restructuring.

Sri Lanka's creditors face losing a third to half of their investment in the country's dollar bonds after the government announced plans to restructure $11 billion in debt, the first such financial restructuring in the country's modern history.

Although formal debt talks have not yet begun, analysts are already crunching the numbers to estimate what kind of haircuts might be imposed on bondholders.

Sri Lanka, which is mired in an economic crisis, has halted all external debt payments and is prioritizing the use of its remaining hard currency reserves to purchase food and fuel.

The 22-million-person country has been hit by nationwide street protests and shortages of everything from electricity to medicines, and its dollar bonds are trading at deeply distressed levels of around 40 cents on the dollar.

With markets accounting for an International Monetary Fund (IMF) loan program as part of the debt restructuring, a $1 billion bond maturing on July 25 LK080475284= is worth around 45 cents on the dollar, according to Refinitiv data.

According to Citi, Sri Lanka may seek a coupon haircut of around 50%, a face value reduction of at least 20%, and maturity extensions of 10-13 years for bonds maturing between 2022 and 2030.

"We estimate that the recovery value on the dollar bonds in such a scenario could range in the low to mid-40s, assuming an 11 percent exit yield," Citi strategist Donato Guarino said, referring to the interest rate at which the new securities will trade on the day of the debt exchange.

Step-up coupons, which are interest payments that increase over time, could also play a role in "giving the government more time to recover" after the restructuring, according to Guarino, who noted that these were used in Ecuadorean and Argentine debt restructurings.

Tellier analysts assumed a 30% haircut in their base case scenario. They assign the bonds a recovery value of around 60 cents on the dollar, with an exit yield of 8 percent.

They also mentioned a different scenario with a 42-cent recovery value and a 16-percent exit yield.

UNEXPECTED SURPRISES?

Teller senior economist Patrick Curran regards a 50% haircut as a "worst-case" scenario, with a recovery value as low as 30 cents for a 16 percent exit yield.

He raised the possibility that the debt restructuring would take longer than expected.

"While bondholders will receive some downside protection if interest is capitalized if negotiations drag on," Curran added, "prolonged delays will also make for a more onerous starting point and political risk will raise exit yields, potentially eroding recovery values."

According to S&P Global, debt talks could be complicated and take "many months" to complete.

On Wednesday, it downgraded Sri Lanka's foreign currency rating to "CC" from "CCC" - two notches above default - while Fitch downgraded its rating to "C" from "CC."

According to JPMorgan analysts, the debt servicing moratorium will pave the way for an IMF program, but a restructuring may be "more comprehensive" than what has been announced.

Citi calculates that the debt service suspension currently only covers about 55% of the public debt, noting that the latest IMF report suggests a "tough program ahead."

The fund suggests tax reforms, as well as possible limits on public-sector wages and capital expenditure.

BlackRock (BLK.N) and Ashmore (ASHM.L) are two of the largest holders of Sri Lanka's international bonds. They are members of a fledgling creditor group, with White & Case serving as legal counsel.

Bondholders are waiting for the government to select a financial adviser, according to one creditor who spoke on the condition of anonymity.

"The group's current strategy is to be reactive, not proactive," the source explained.