Thursday, 10 March 2011 05:47

Moody's Tardily Cuts Spain's Rating After Greece Gets Put In The Trash Bin, All The While Ireland Plainly States That It Will Default!

You know, timing is everything. If you hit brakes after you pass the red light... Bang! If you pucker up after you press your face against that of your sweetheart's.... You bonk her/him on the forehead. If you downgrade a nation after obvious signs of insolvency... From CNBC today: Moody's Cuts Spain's Debt Rating by One Notch

Ratings agency Moody's cut Spain's sovereign debt rating one notch on Thursday and warned of further cuts due to fears that bank restructuring will likely cost more than twice what the government expects. "(Moody's) believes there is a meaningful risk that the eventual cost of the recapitalization effort could considerably exceed the government's current projections," it said in a statement.

Moody's Investors Service still rates Spain — one of the countries now in the firing line in Europe's debt crisis — as a high grade investment proposition.

By way of comparison, the agency rates Portugal two notches lower and Greece far down with junk status.

The ratings agency said the overall cost of recapitalizing struggling banks was likely to be nearer to 40 billion euros, double the government's estimate.

In a more stressed scenario recapitalization needs could even rise to around 110 to 120 billion euros, it said.

... Moody's also noted that nine of the country's 17 autonomous regions breached budget deficit targets.

Exactly 1 year ago tomorrow, I issued the following report to my subscribers - File Icon Spain public finances projections_033010, as excerpted from the first four pages...

To add fuel to the fire, one year before this warning (two years ago) I warned of the real estate based risks of the Spanish banks - starting with BBVA. This is the subscriber report issued last year on the contagion risk to Spain's more vulnerable banks. Nothing much has changed - at least for the positive:

Of course, the cloud over everybody's head is the risk of default/restructuring. If one of the weak or periphery states default, funding costs will skyrocket across the board as will real economic solvency issues due to the levered holding of sovereign bonds that suddenly plummet (even further) in price. The question is not necessarily whether Spain will default or not, but whether Spain, Ireland, Greece, Portugal or Italy will deal with their hiccups via restructuring.

For subscribers, this is a very detailed scenario roadmap of haircuts and NPV of future cash flow reductions upon a wide variety of Spain restructuring options: The Spain Sovereign Debt Haircut Analysis for Professional/Institutional Subscribers. For the hopium smoking, ratings agency following crowd who still believe such an event may not take place, reference the new government over in Ireland. Our friends over in Ireland have issued a new roadmap for the country which is not very different from what they can campaigned on when they were running from office. It's good to know politicians can keep their word for more than a few weeks... Check this out though... "Towards Recovery: Programme for a National Government 2011-2016 - as excerpted and annotated (click, then click the image that opens up in new page again to enlarge):

You better get those clippers ready... The new government is gonna' get to cuttin'! Of course, we anticipated this about this time last year as well - a little more than a year ahead of the ratings agencies - remember that timing thing! Subscribers should see File Icon Ireland public finances projections.

Professional/institutional subscribers can go through the multitude of haircut scenarios and the economic losses to be taken under each scenario by the respective bondholders here: Ireland Default Restructuring Scenario Analysis with Sustainable Debt/GDP Limits and Haircuts.

Any non-subscriber who is wondering about the depth and of the haircut analysis that I have posted can peruse the full Portugal analysis online for free - reference The Anatomy of a Portugal Default: A Graphical Step by Step Guide to the Beginning of the Largest String of Sovereign Defaults in Recent History as a primer than move on to the article with the embedded online spreadsheet - the entire Portuguese default scenario analysis you will find it nowhere else on the Web: or move directly to the embedded model - Portugal’s Debt Ridden Finances: An Analysis of Haircuts, Restructuring and Strategy – Professional Analysis

More reading on Greece: Moody’s Very Late, But Nevertheless Quite Appropriate Greek Downgrade Inches Us Closer To the Rate Volatility Storm

The obvious but rarely reported fact...

Please feel free to peruse the entire Pan-European Sovereign Debt Crisis series and/or catch up with my latest musings, opinions and analysis regarding Europe.

Last modified on Wednesday, 30 March 2011 06:52


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    It strikes me as more likely that the governments will allow the markets to work their magic on bank stocks. If you were Germany, would you rather see Greece default on sovereign debt or see some of its banks fail? As you suggest, if a Euro government restructures, it cuts off the bond pipeline and shrinks the pie for everyone. If the EFSF lends the government money to buy back bonds in an erratic fashion over the next 20 months, then the whole market may calm a little. Remember the Spiegel numbers that I cited: in 2013 the need for liquidity to service sovereign bonds drops off greatly.

    China has a trillion in dollars and is catching up in Euros (both of which make up a supermajority of its exports), but the renmibi looks like it might be fully convertible (not to discuss depth of market under best-case scenarios) in the five- to ten-year horizon. Did Chinese bond holdings scare "helicopter Ben" from tripling the money supply? This all is a dangerous game of chicken, to be sure, but political pressures play a huge part in the calculations. If the junk is concentrated in the banks, it will catch a lot of pensions and wealthier private investors with some sovereign investors. If it restructures debt, it will burn mostly other sovereigns. Merkel said that the private investor will have to shoulder some of the burden come 2013, and bond restructuring looks like an unpalatable way to do that.

  • Comment Link Reggie Middleton Thursday, 10 March 2011 16:21 posted by Reggie Middleton

    The reason why banks haven't had their bond holders suffer is because governments world wide fear that foreign investors (who are mostly other sovereign governments) would not foot future bills. A good example is to look at how was on the hook for the US GSEs (a quasi-governmental financial entity, as can be said of socialize Irish banks) - the Chinese government.

  • Comment Link Jim Thursday, 10 March 2011 16:03 posted by Jim

    Not to get too technical here, but didn't the Irish government socialize those banks? People who purchased sovereign bonds did so with a much lower guaranteed risk and lower potential reward than those who bought the stocks of private banks, now illiquid. The reach of the Irish government presumably is greater than an Irish bank, in terms of setting the playing field. The fact that a private stock was bought, then clipped by its controlling shareholders has different implications for the worldwide financial system than when governments default on their debt to other governments. We'll see if the effects are the same a decade from now, but allowing "nature to take its course" with public stock companies will not inhibit the social security check to grandma or the defense contract for planes and many other parts of citizens' lives. If a big bank is socialized, then restructured; the likely losers are likely to be a different demographic.

  • Comment Link Reggie Middleton Thursday, 10 March 2011 15:15 posted by Reggie Middleton

    Certain Irish banks have already clipped principal. Its too late to assume no haircuts.

  • Comment Link John Ryskamp Thursday, 10 March 2011 14:58 posted by John Ryskamp

    You overlook the word "enabling." Germany will tolerate enabling legislation for bailouts, but won't tolerate enabling legislation for haircuts. No restructuring. Watch the pressure mount on this government.

  • Comment Link Reggie Middleton Thursday, 10 March 2011 13:28 posted by Reggie Middleton

    The fault with the debt buyback idea is that astute (and/or greedy) market participants simply won't cooperate. If you had a bunch of these bonds and you know the government was going to cut the coupon and buy the bonds wouldn't you try to hold them hostage for the highest dollar? Even you wouldn't, trust that their are more than enough market participants that would. The result is the opposite of what was initially proposed, a rise in the bond prices - largely unwanted bonds. In addition, how would the states offer new debt when the older formerly devalued debt would be more valuable to speculators due to the market perversions introduced by those who initiated this scheme.

  • Comment Link Jim Thursday, 10 March 2011 13:07 posted by Jim

    What is becoming clearer by the day is that going back to the markets is what it is all about, or they simply would have defaulted old style a long time ago. The point of your article seemed to be that governments would come out and announce restructuring terms across the board, but that prospect is becoming cloudier until 2013. If they can take borrowed money and buy back their bonds at lower prices, then there certainly will be losses for investors but not necessarily haircuts (that is, a one-time government-imposed reduction in principal). Your statistics with and without various measures show that maturity extension is a non-starter in solving the problems in cash flow. Coupon reduction looks a lot different if a government can buy back a substantial portion of the debt, thus not having to pay the coupon on it or in years to come. Depending on how buybacks take place, it might help dampen the stratospheric costs for issuing more debt too, which is highly desirable. It really is about the future, not about this year or next year.

    Flash forward to 2013 with a mix of EFSF payments and bonds. Greece and Portugal don't have a housing bubble, so the NPA's are a diverse mix of assets concentrated in the hands of the banks. My hunch is that this is where the losses will develop: the banks. The EFSF could help the national governments buy back and pay off their bonds, but you are right that something has to give. As Spain concentrates debts in the new mega-cajas, the housing still will be empty. It is worth considering that the music will stop in 2013 with most of the debt in banks, rather than in government bonds. Far from defaulting, the ECB and EFSF seem to be playing a game like the Fed with Fannie and Freddie. It could be that the banks end up taking bankruptcy, with the government and private investors sharing the losses.

    This isn't really a haircut in the bond market, and such a haircut would be disastrous as you repeatedly warn. That is why it is hard for me to conceive that a currency union representing the other major developed block in the world simply would fall into that ditch on the order of Argentina. Even poor little Iceland negotiated its way through a kind of default without exactly defaulting. It is worth considering that Europe would go down the path that everyone talked about in the US, creating "bad" banks filled with NPAs and then lighting them on fire. Sinking the national banks that have dominated Europe will cause a lot of problems, but it will leave national governments free to return to the bond markets and with their sovereignty.

  • Comment Link Reggie Middleton Thursday, 10 March 2011 12:08 posted by Reggie Middleton

    "One presumes that the governments first would renege on the coupon,"

    You mean default, which is the point of this whole article. If they do that then they get their debt service reprieve, but get hit VERY hard when (not if, but when) they need to go back to the markets because not only has the underlying structural problem not been rectified but they have proven that they will do what they have sworn they wouldn't do - default. In addition, if the markets perceive this is a ploy to cheapen debt for buyback, speculators will simply gather the devalued debt and hold on to it, driving the costs up for the sovereign state. The will have to negotiate a principal reduction no matter which way you look at it.

    "The relatively recent rise in the yen is worth more investigation too. You may want to direct your subscribers to the cheap Nikkei and strong yen, not to mention work on rebuilding its military. There is some action emerging there that could be striking over the coming decade."

    Of interest, worth looking into.

  • Comment Link Jim Thursday, 10 March 2011 10:58 posted by Jim

    Of course, the scenario that German bankers and the ECB are entertaining is quite different. They are saying that the EFSF should simply give European governments the money to buy back the bonds on the open market. How this would work remains to be seen, since buyers then would hold them. One presumes that the governments first would renege on the coupon, since cash flow is a big part of the problem. Bear in mind, though, that all the Europeans want to thaw markets that remain effectively frozen to placing even short-term debt. If the coupon is suspended and the EFSF announces that it will retire or swap bonds in 2013, then it might thaw the market for short-term debt and give the government time to buy back longer debt at reduced prices. This looks nothing like the clean, government-ordered solution of Argentina that you have been proposing for the past year or two, but it is another scenario that might better need European needs and follows a stepped progression announced by Germany over the past year in vague terms. Those terms increasingly look like extend to 2013 and impose discipline; convert to legal terms under semi-autonomous ECB; issue ECB debt selectively.

    Exchange rates and commodity prices likely will become the main mechanisms to relieve pressure under this new regime. In my recent travels to central Europe, I noticed again how close the pricing of daily life in nominal terms has become in euros to dollars. What is even more interesting is how oil, gold and agricultural commodities are rising to par with the dollar in terms of real goods. Governments, like China and Switzerland, are going to have to decide how many Euros they want to hold for trade and how many for "investment." The movement of the euro against commodities would make me nervous as a European, until the EU fundamentally reforms its agricultural and energy policies - which it valiantly has placed on the table. The recent resolution of its infamous banana embargo is a case in point. The relatively recent rise in the yen is worth more investigation too. You may want to direct your subscribers to the cheap Nikkei and strong yen, not to mention work on rebuilding its military. There is some action emerging there that could be striking over the coming decade.

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