Thursday, 31 March 2011 14:06

Portugal Is On The Verge Of Tapping Out, UFC Style - You Knew It Was Coming, Here's The Analysis!

The ING real estate valuation seminar in Amsterdam that I have been invited to as the key note speaker (see  www.seminar.ingref.com) with a capacity of several hundred seats, is now sold out. This is, of course, no surprise being that we're in a global real estate depression and I've been declaring a rate storm emanating from insolvencies and potential haircuts in Europe that will spike CRE cap rates. It is not these bombastic declarations which make the seminar interesting. It's probably not even that I have been correct about each and every past declaration. It's most likely that my proclamations of European insolvencies are coming to fore in lockstep fashion in the here and now, and right before everybody's eyes. No, I am not that smart, I don't have a crystal ball, nor do I employ tarot cards. My secret is that I'm realistic as hell and tend to look at things for what they are  - no the way I want them to be, nor they way they use to be, but the way they are. With that being said, there is significant risk to those who are exposed to rate sensitive assets, with bonds, real assets and the debt behind them standing at the forefront.

What I plan on doing at the seminar is not only outlining the specific issues in REALISTIC detail, as I routinely do on my blog. I will introduce real world solutions to the risks swallowed by those who are exposed to the European (not so) slow train wreck. Yes, that's right. Not just bitching about the problems, but proffering real, actionable solutions. Till then, though...

I made specific warnings of insolvency: Portugal, Ireland and Greece - complete with hundreds of pages of analysis for my site's subscribers. Thus far, two of the three have been bailed out and the third (Portugal) is about to tap out as its yields go vertical after revealing what BoomBustBloggers already knew...

Fromm the WSJ - Portugal Fails to Meet Deficit Goal

LISBON—Portugal said Thursday it missed its 2010 budget-deficit goal and has been forced to revise previous-year figures, hitting market confidence in the country's fiscal management. Portugal's official statistics agency said the deficit stood at 8.6% of gross domestic product in 2010, up from a target of 7.3%.

The recalculation came after the European Union's statistics agency, Eurostat, said Lisbon needed to include a €2 billion ($2.83 billion) cash injection into nationalized Banco Portugues de Negocios and to recast loans to unprofitable mass-transport companies. Those loans are threatened with default and shouldn't be regarded as assets, Eurostat said. Without the changes, the deficit would have been 6.8% of GDP, a figure the government has backed for months.

Portugal faces increased pressure to request a bailout, with some market watchers wondering if the country can reduce big budget gaps in time to avoid having to restructure its debts. After Ireland and Greece sought aid last year, investors have been focusing on Portugal in the belief it will become the next casualty of the euro zone's government-debt crisis. In European credit markets Thursday, the cost of insuring Portuguese government debt shot up to a new record. Yields on Portuguese sovereign bonds, the interest the government has to pay on borrowing, hit fresh euro-era highs with 10-year maturities shooting up to 8.4%, nearly 5.1 percentage points above Germany's equivalent and way above levels deemed sustainable. Late Thursday, Portugal surprised markets by announcing that it would hold an extraordinary debt auction Friday to raise up to €1.5 billion.

...  After Thursday's deficit revision, the country's finance ministry said it would meet its debt repayments but conceded that the situation has become worse than a week ago, adding it doesn't have the capacity to either ask for, or negotiate, a bailout.

Finance Minister Fernando Teixeira dos Santos said "the government will guarantee" that it will cover its upcoming debt repayments but said "we're in a worse situation than a week ago."

The country has to make around €9 billion in bond repayments between April and June, but market participants are worried the government won't be able to cover all of those payments given a surge in borrowing costs to unsustainable levels. Market participants expect the government may have to request a bailout in the near term to deal with unsustainably high borrowing costs.

...  S&P struck again on Thursday, downgrading a series of Portuguese banks and giving their ratings a negative outlook. The ratings agency said the decision reflected the possibility of a further downgrade in the government's credit rating.

"Portugal faces a weak macroeconomic outlook, the government has limited policy flexibility and the economy is exposed to significant external vulnerability," S&P said.

If you recall Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! from last year, you know that the numbers of the PIIGS group of European states, and most likely many of the others, simply cannot be trusted. Neither can the forecasts of those who over see them. Check out these pretty little charts...

Let's take a visual perusal of what I am talking about, focusing on those sovereign nations that I have covered thus far.

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Notice how dramatically off the market the IMF has been, skewered HEAVILY to the optimistic side. Now, notice how aggressively the IMF has downwardly revsied their forecasts to still end up widlly optimistic.

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Ever since the beginning of this crisis, IMF estimates of government balance have been just as bad...

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The EU/EC has proven to be no better, and if anything is arguably worse!

 

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Revisions-R-US!

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and the EU on goverment balance??? Way, way, way off.

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If the IMF was wrong, what in the world does that make the EC/EU?

The EC forecasts have been just as bad, if not much, much worse in nearly all of the forecasting scenarios we presented. Hey, if you think tha's bad, try taking a look at what the govenment of Greece has done with these fairy tale forecasts, as excerpted from the blog post "Greek Crisis Is Over, Region Safe", Prodi Says - I say Liar, Liar, Pants on Fire!...

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Think about it! With a .5% revisions, the EC was still 3 full points to the optimistic side on GDP, that puts the possibility of Greek  government forecasts, which are much more optimistic than both the EU and the slightly more stringent but still mostly erroneous IMF numbers, being anywhere near realistic somewhere between zero and no way in hell (tartarus, hades, purgatory...).

I also made it very clear that haircuts and restructurings were on the table for Portugal.

Speaking of loading up on Portuguese bonds, these Bloomberg screen shots provided by Zerohedge tell the story in an instant:

Same thing for Ireland:

And below are the three horsemen of the Eurocalypse. Ironically the bond market is offering a far higher yield for ultra short-term Portuguese than Irish.

To put these charts in perspective, let's dig up the post I made exactly one year ago in April titled, "How Greece Killed Its Own Banks!":

Well, the answer is.... Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)...

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The same hypothetical leveraged positions expressed as a percentage gain or loss...

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When I first started writing this post this morning, the only other bond markets getting hit were Portugal's. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:

And from the post 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 Tuesday, December 7th, 2010

Re-Introducing the Not So Stylish Portuguese Haircut Analysis

Note: this is a repost of the information initially made available to subscribers in the summer of 2010

For those who feel that the simple application of arithmetic and math amounts to “Doomsday Scenarios”, Fear-mongering, and vultures in the market place, I present to you BoomBustBlog’s scenario analysis of the Portuguese Haircut.

You think those are ugly? You ain’t seen nothing yet!

The Mathematical Truth Concerning Portugal’s Debt Situation

Before I start, any individual or entity that disagrees with the information below is quite welcome to dispute it. I simply ask that you com with facts and analysis and have them grounded in reality so I cannot right another “Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse!“. In other words, come with the truth, or at lease your closest simulacrum of it.

In preparing Portugal’s sovereign debt restructuring model through maturity extension, we followed the same methodology as the Greece’s sovereign debt maturity extension model and we have built three scenarios in which the restructuring can be done without taking a haircut on the principal amount.

  • Restructuring by Maturity Extension – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having same coupon rate but double the maturity. Under this type of restructuring, the decline in present value of cash flows to creditors is 3.3% while the cumulated funding requirements and cumulated new debt between 2010 and 2025 are not reduced substantially. The cumulated funding requirement between 2010 and 2025 reduces to 120.0% of GDP against 135.4% of GDP if there is no restructuring. The cumulated new debt raised is reduced marginally to 70.6% of GDP from 72.2% of GDP if there is no restructuring. Debt at the end of 2025 will be 104.8% of GDP against 106.1% if there is no restructuring
  • Restructuring by Maturity Extension & Coupon Reduction – Under this scenario, we assumed that the creditors with debt maturing between 2010 and 2020 will exchange their existing debt securities with new debt securities having half the coupon rate but double the maturity. The decline in the present value of the cash flows is 18.6%. The cumulated funding requirement between 2010 and 2025 reduces to a potentially sustainable 99.5% of GDP and the cumulated new debt raised will decline to 50.1% of GDP. Debt at the end of 2025 will be 88.6% of GDP (a potentially sustainable).
  • Restructuring by Zero Coupon Rollup – Under this scenario, the debt maturing between 2010 and 2020 will be rolled up into one bundle and exchanged against a single, self-amortizing 20-year bond with coupon equal to 50% of the average coupon rate of the converted bonds. The decline in the present value of the cash flows is 17.6%. The cumulated funding requirement between 2010 and 2025 reduces to 100.1% of GDP and the cumulated new debt raised will decline to 52.8% of GDP. Debt at the end of 2025 will be 90.9% of GDP (a potentially sustainable).

The scenarios above were also calculated using the haircuts necessary to bring debt to GDP below a pre-selected level (user selectable in the model, 80%, 85% or 90% - please keep in mind that a ceiling of 60% was necessary in order to gain admission into the Euro construct). We have also built in the impact of IMF/EU aid on the funding requirements and new debt raised from the market between 2010 and 2025 under all the scenarios.

A more realistic method of modeling for restructuring and haircuts

In the previously released Greece and Portugal models, we have built relatively moderate scenarios of maturity extension and coupon reduction which would be acceptable to a large proportion of creditors. However, these restructurings address the liquidity side of the problem rather than solvency issues which can be resolved only when the government debt ratios are restored to sustainable levels. The previous haircut estimation model was also based on the logic that the restructuring of debt should aim at bringing down the debt ratios and addition to debt ratios to more sustainable levels. In the earlier Greece maturity extension model, the government debt at the end of 2025 under restructuring 1, 2 and 3 is expected to stand at 154.4%, 123.7% and 147.0% of GDP which is unsustainably high.

Thus, the following additional spreadsheet scenarios have been built for more severe maturity extension and coupon reduction, or which will have the maturity extension and coupon reduction combined with the haircut on the principal amount. The following is professional level subscscription content only, but I would like to share with all readers the facts, as they play out mathematically, for Portugal. In all of the scenarios below, Portugal will need both EU/IMF funding packages (yes, in addition to the $1 trillion package fantasized for Greece), and will still have funding deficits by 2014, save one scenario. That scenario will punish bondholders severely, for they will have to stand behind the IMF in terms of seniority and liquidation (see How the US Has Perfected the Use of Economic Imperialism Through the European Union!) as well as take in excess of a 20% haircut in principal while suffering the added risk/duration/illiquidity of a substantive and very material increase in maturity. Of course, we can model this without the IMF/EU package (which I am sure will be a political nightmare after Greece), but we will be recasting the “The Great Global Macro Experiment, Revisited” in and attempt to forge a New Argentina (see A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina).

Here is  graphical representation of exactly how deep one must dig Portugal out of the Doo Doo in order to achieve a sustainable fiscal situation. The following chart is a depiction of Portugal’s funding requirements from the market before restructuring…

This is the same country’s funding requirements after a restructuring using the "Restructuring by Maturity Extension″ scenario described above…

And this is the depiction of new debt to be raised from the market before restructuring…

And after using the scenario “Restructuring by Maturity Extension″ described above… For all of you Americans who remember that government sponsored TV commercial, “This is your brain on drugs. Any Questions?

The full spreadsheet behind all of the calculations, scenarios, bond holdings and calculations can be viewed online here (click this link and scroll to the bottom until you see the live spreadsheet) by anyone with the wherewithal to click the link. This product was formally available only to our professional subscribers, but I have decided to distribute it much more widely. Our Ireland, Greece and Spain (to be published within 72 hours) haircut models are available solely to professional and institutional subscribers. Click here to subscribe or upgrade.

Please be sure to read up on our full Pan European Sovereign Debt Crisis analysis, which is freely available to everyone.

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Last modified on Monday, 04 April 2011 11:50