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Don't Forget Portugal: MS Sees A Second Bail-Out By September With A Bail-In To Follow

Tyler Durden's picture




 

With all eyes firmly planted on Spain, the little-Escudo-that-could has quietly slipped off the heading-into-the-abyss list of the mainstream media. Little was made this week of the fact that 10Y Portuguese bond yields dropped to seven-month lows - except by us of course where we explained that this is almost entirely due to the CDS-Bond basis trade 'arb-du-jour' that has placed a technical bid under Portuguese bonds. Between the help from LTRO and the fact that ISDA is under-pressure to improve/amend CDS rules to 'honor the spirit of the CDS contract to the fullest extent' which implicitly reduces the massive 'event' premium uncertainty between CDS and Bond risks for distressed-names (thanks to the ECB's actions in Greece), every bond in the short- to mid-term maturity of Portugal appears notably rich - with only the longest-dated bonds reflecting the crisis that remains. As we described in detail here, the real Debt/GDP of Portugal is around 140% (notably higher than the EC estimates of 111% once contingent liabilities are take account of) and the issues that face this small nation are entirely unresolved with bank recapitalization needs of at least EUR12bn and a highly indebted private sector. The bottom-line is that optically-pleasing bond improvements recently have been entirely due to synthetic credit arbitrage and, as Morgan Stanley notes, the nation remains mired in the three risks of contingent liabilities, bank recap needs, and a grossly indebted private sector; leaving a second bailout very likely by September 2012 and the challenging debt dynamics likely to mean a restructuring.


The rally in Portuguese bonds has been impressive (though interestingly un-covered by bullish leaning media who are always looking for a good-news story). However, given the illiquidity of Portuguese bonds in general and the massive premium difference between the bonds and CDS (as seen below), the emergence of hope that ISDA will make more 'honorable' decisions with regard to CDS triggers and with some help from LTRO, the basis (the spread between bonds and CDS) has begun to normalize though we note 5Y CDS still trade around 1000bps...

This chart shows the spread between CDS and Bond spreads (in fact it is CDS spread - Bond spread both adjusted for systemic 'German' risk) - a negative point on the chart means bonds are trading 'cheap' to CDS. A rising trend in the chart means bonds are outperforming CDS.

Morgan Stanley; Portugal: Bail-Out Now, Bail-In Later

1. Further Rescue Package Likely – Risk of Debt Restructuring Later on

Risk One: Contingent Liabilities
Up to €21bn from SOEs
Up to €12bn from PPPs
Up to €6bn from local government arrears

Risk Two: Banks’ Recapitalisation Needs
At least €12bn

Risk Three: Highly Indebted Private Sector 


 

2. What’s Priced in? Putting the Bond Curve in Context

The Portuguese credit story is at a crossroads, when compared to Ireland and Greece

LTROs Have Caused a Significant Curve Steepening

  • The front end is pricing in some sort of normalisation...
  • ...but this seems to be mostly the result of recent LTRO operations and expectations of the second bailout package

  • The long end is still pricing in caution

 

Morgan Stanley sees the front-end and the belly looking rich while the long-end appears more fairly priced. We tend to agree - especially with the debt dynamics in the CDS curve and think their recommendation of a curve flattener (with the belly to underperform the long-end as the curve inverts into distress and restructuring) is a worthwhile trade...

What is most notable is the 'richness' of the belly of the curve (over the short- and long-end) which likely reflects this odd technical that we have discussed from the CDS-Bond basis traders. As that basis normalizes, this technical demand for bonds will drop (i.e. at a 200bps carry - with all the uncertainty around restructuring triggers - the 'easy carry' trade is a lot less attractive than at 600-700bps). In fact, we would not be surprised to see profit-taking on Portuguese basis-trades sooner rather than later as opposed to letting them run into the actual event - also likely to put pressure on Portuguese bonds.

All-in-all, Portugal remains totally unresolved as a nation mired in unsustainable debt, is likely to need a second bailout very soon and probably a restructuring and while bonds may appear to have rallied, this is entirely due to LTRO and Basis-trade effects and only the long-end (less affected by these technicals) reflects the considerably less sanguine state of this nation's future.

 

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Sun, 04/29/2012 - 12:31 | 2383651 Cultural Capital
Cultural Capital's picture

This extend and pretend will last another 15 years.. No catalyst, no change. 

 

Sun, 04/29/2012 - 12:38 | 2383663 Timmay
Timmay's picture

I disagree. Morpheus has been busy lately......

Thu, 07/12/2012 - 13:13 | 2610352 Nagelstudio
Sun, 04/29/2012 - 12:44 | 2383674 smb12321
smb12321's picture

Maybe we can get Spain and Portugal to go on the same day - a twofer!

Sun, 04/29/2012 - 14:41 | 2383786 butchee
butchee's picture

I think it is called a Dos-fer over there!

Sun, 04/29/2012 - 12:45 | 2383676 TooBearish
TooBearish's picture

Tyler - OT please comment or start a thread on the SWIFT sanctions on IRAN possible causing gold for oil trade between Iran/China -- thanks

Sun, 04/29/2012 - 13:06 | 2383688 dick cheneys ghost
dick cheneys ghost's picture
How bout this......From Voice of Russia "Russia and China have started making mutual payments in trade in their national currencies, Chinese Deputy Commerce Minister told reporters in Moscow on Saturday. “The Chinese yuan is now a hard currency in Russia,” Chong Shan said, adding that the two countries were mulling a joint investment fund. In the past 12 months the bilateral trade figure has reached almost $80 billion, and the volume of direct investment now stands at $4 billion.'' http://english.ruvr.ru/2012_04_29/73285173/
Sun, 04/29/2012 - 13:23 | 2383709 El
El's picture

Also OT, but while you're at it, can someone comment on JPM increasing their registered silver inventories by 500% this past Thursday and whether there is any  significance to it?

Sun, 04/29/2012 - 14:15 | 2383757 Amish Hacker
Amish Hacker's picture

I'm guessing they're expecting a lot of longs to stand for delivery next month.

Sun, 04/29/2012 - 13:41 | 2383727 Zero Debt
Zero Debt's picture

Jim Sinclair has been all over this issue for weeks now. http://www.jsmineset.com/. Target date: June 28th 2012.

Did some back-of-the envelope calculations on this to get an idea of the magnitude -

1) Iran exports 2.6m barrels of oil per day, http://www.reuters.com/article/2012/03/22/us-china-iran-idUSBRE82L05L201...

2) Approx value in USD of Iran's oil exports = 2,600,000 x 105 usd/barrel = 273,000,000 usd per day

3) Iran's oil exports in ounces of gold = 273,000,000 / 1,663 = 164,161 oz per day

4) Total number of oz of gold per year needed = 365 x 164,161 = 59,918,821 oz

5) 1 metric ton = 35,374 oz, so they need to obtain 59,918,821/35,374 tonnes of gold = 1,693 metric tonnes of gold per year

Since annual mining production is around 2,500 tonnes, that would mean that other countries would need to purchase 68% of total world mining output only to buy gold from Iran at today's prices, which is an extraordinary amount. As for the geopolitics, Japan, China and India consumes half of Iran's oil output. One would imagine that energy-poor Japan and China and India are more interested in sourcing energy for their economies rather than appeasing the U.S. Something will have to give here: either Japan, China and India will stop importing Iranian oil, which is not appealing to them, the oil price would have to fall which is rather unlikely, Iran would have to play ball with U.S. which they will not do, or, gold buyers would have to bid up gold significantly in relation to the dollar and the oil price to obtain the gold to settle the transaction.

Sun, 04/29/2012 - 13:17 | 2383703 Conman
Conman's picture

No prob, all news is good news so bailout means more liquidity. Buy buy buy.

puke.

Sun, 04/29/2012 - 13:32 | 2383717 q99x2
q99x2's picture

Extend and pretend. Fine for fishing and playing in a band and writing stories and lots of real life fun. When the banksters blow up Chicago or Long Beach we can worry about it then. Don't eat corn based products in the meantime.

Sun, 04/29/2012 - 13:40 | 2383724 Caviar Emptor
Caviar Emptor's picture

Shocked? Don't be. Portugal's main export partner is Spain! 

 

Portugal - UN Comtrade

Sun, 04/29/2012 - 14:10 | 2383753 Manthong
Manthong's picture

Don’t forget Portugal

Don’t forget Greece

Don’t forget Ireland

Don’t forget Italy

Don’t forget Spain

Don’t forget Japan

Don’t forget France

Don’t forget the Netherlands

Don’t forget the downgraded, 16 going on 17 trillion indebted, unbudgeted US.

We are in a swarm of the walking dead.

Remember to have a nice day.

Sun, 04/29/2012 - 14:29 | 2383772 I am Jobe
I am Jobe's picture

Don;t forget

UK

USSA.

 

Sun, 04/29/2012 - 14:37 | 2383782 Manthong
Manthong's picture

oops., yes.

Sun, 04/29/2012 - 15:30 | 2383825 CryingBear
CryingBear's picture

NOBODY CARES ABOUT PORTUGAL OR THEIR BANKS. LIKE HOW NOBODY CARED WHEN GREECE DEFAULTED. THE ONLY ONE THAT MATTERS IS THE USA AND THEIR BANKS. REMEMBER WHEN JUST 1 BANK FAILED? REMEMBER THE DOWNGRADE BY JUST 1-NOTCH FROM JUST ONE RATINGS AGENCY THAT GAVE WARNINGS MONTHS AHEAD OF TIME?

DO YOU GUYS KNOW WHY THIS IS?

REMEMBER WWI? REMEMBER WWII?

THOSE euroPEONS THOUGHT THE US WOULD JUST SIT BY WHEN THEY WERE TOLD WHAT TO DO AND DISOBEYED.

THIS IS WHY IRAN WILL OBEY JUST LIKE HOW CHINA, JAPAN, EU, CANADA, AUSTRALIA AND RUSSIA OBEYS ALONG WITH THE REST OF THE OTHER SMALL COUNTRIES THAT ARE JUST USED BY US SPECIAL FORCES FOR COMBAT EXERCISE.

NOTHING GOOD EVER HAPPENED TO ENEMIES OF THE US.

WE ARE THE SUPREME WORLD POWER.

Sun, 04/29/2012 - 15:36 | 2383832 CryingBear
CryingBear's picture

EVERY EZ COUNTRY SHOULD HAVE THEIR BUDGET APPROVED BY THE USA.

Sun, 04/29/2012 - 15:33 | 2383830 CryingBear
CryingBear's picture

ITS BEEN A LONG LONG TIME SINCE A GREAT WAR HAS OCCURED. IT IS TIME FOR ONE SOON AND I WILL BE HAPPY TO KILL ALL ENEMIES OF THE USA. I WILL THEN COME HOME TO A BEAUTIFUL WIFE AND HAVE CHILDREN AND MAKE HER RAISE THEM BECAUSE I MAKE ENOUGH FOR THE FAMILY. THEN I WILL PUT ALL MY EARNINGS INTO THE STOCK MARKET AND BUY A HOUSE THAT WILL BE WORTH 50 TIMES MORE IN 50 YEARS.

Sun, 04/29/2012 - 21:03 | 2384133 Errol
Errol's picture

CryingBear,

1. Why are you yelling?

2. Nice fantasy, dude.  The US did pull that off once, when US oil production was still rising.  In fact, at the time the US was a net exporter of oil.  Our position is much more precarious now, that's why the ruling elite has a short-term outlook and is grabbing all they can while they can: the present arrangement has no long-term future.

Mon, 04/30/2012 - 01:48 | 2384399 DutchR
DutchR's picture

He is a little deaf from firing his colt 45 without earplugs, hence the shouting....

Mon, 04/30/2012 - 13:07 | 2385400 ovigia
ovigia's picture

hmmm those graphs at least for Portugal must have some problem, because the prices are not falling as they say!

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