Introducing the Not So Stylish Portuguese Haircut

Reggie Middleton's picture

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 1 – 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 2 – 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 3 – 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).

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 same scenario “4″ described above…

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

And after using the scenario “4″ 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) by professional level 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. Coming up next are a more
realistic recast of Greece’s restructuring scenarios (with the goal of
attaining GDP/Debt ratios below 100%, as well as similar research for
Spain, Italy and Ireland.