a look at Portugal and subordination in their coming second bailout

http://ftalphaville.ft.com/blog/2012/04/20/967011/normalising-subordination-in-portugal/

Normalising subordination, in Portugal

Posted by Joseph Cotterill on Apr 20 08:30.

Something you will never ever read in an IMF report on Greece…

But there it was on page 25 of the Third Review for Portugal, out a week or two back.

It’s the kind of thing that makes Portugal just a very interesting call in the crisis – beneath the second bailout? debt restructuring? second bailout then restructuring?stuff flying around at the moment. (Including – as our FT Brussels Blog colleagues note – in comments from the Portuguese PM.)

There’s a still-on-track programme here. The government is doing better than had been expected on (eg.) privatisation proceeds to date and on narrowing its current account deficit.

And so, put yourself in the shoes of a international civil servant who tries to sell a new bailout to northern eurozone creditors when things still do look on track. (Or who tries to sell PSI, asking the creditors to turn Greece from an exception to precedent.)

At the same time, the IMF downgraded growth in 2012 (see the Fund’s chart to right). It also warned ‘partner country demand’ might drag things down further. Which we read as an IMF acknowledgement that Portugal is stuck next door to Spain.

Do you (as civil servant) come back in September 2012 and decide, oops, Portugal probably stays in recession through 2013? The Fund also got it wrong about a rising jobless rate in 2012 (it now reckons 14.5 per cent from below 14 per cent). And which economic metric do you think matters most if the summer is a restive one on the streets, etc?

What’s crucial to note is the ubiquity of this ‘second bailout’ idea.

Nomura said bailout then – maybe – PSI a month ago. Now it’s Morgan Stanley’s analysts’ turn in a Wednesday note (hat-tip to the FT’s Tracy Alloway):

Given that returning to the bond market in September 2013 appears too soon, we believe that a second bailout package is likely. It will have to be decided by September 2012, as the IMF needs a funding plan for the subsequent 12 months before disbursing a loan tranche…

We think that this scenario is similar to Greece around the time of theFrench Proposal at the end of June 2011. By this time, talks were ongoing about a second bailout package and any forms of PSI discussed resembled more of a liability management transaction than a restructuring…

Current PGB’37 prices seem to be priced already broadly in line with GGB’40s at the time of the French Proposal.

(That’s the 30-year bond, trading quoted these days at about 46 cents in the euro.)

‘Although a bail-in is not our central case,’ Morgan Stanley say, they did generate some scenarios for write-downs, which we may as well get out of the way (click to enlarge)…

But! Here is one of those things that make Portugal interesting. It’s not just that it might follow the restructuring model set by Greece, which already involves heavy bond subordination to official lenders and the ECB. You can see that factored in within Morgan Stanley’s scenarios. It’s also that the need for PSI simply isn’t immediate. While we all wait for the issue to become clearer, maybe even into a second bailout, not only senior official loans but other bits of subordination risk quietly rise by (ha) default. Morgan Stanley note a few as it happens.

Such as Portugal’s (more than forecast) issuance of T-bills…

Portugal is likely to increase the use of T-bills as a source of internal funding, but this should be interpreted as a negative by investors. Indeed, extensive use of T-bills would reduce the average maturity of the stock of debt, on one hand, and, would most probably make bond holders junior, on the other hand. In fact, it is worth highlighting that Greek T-bills were not included in the list of bonds eligible for the PSI…

And the fact that it’s not clear what the final debt bill for a write-down will be, if private debts continue to migrate to the public balance sheet…

While the situation within this sector is heterogeneous, and goes beyond the scope of this report, potential difficulties for, say, SMEs, to honour their debts might put the government purse under further pressure.

- This means that corporate balance sheet repair, under certain hypothetical negative scenarios, might well imply a degree of stress on the government balance sheet

- Put differently, the distinction between public and private sector debt is fictional at times. As such, corporate debt is a further contingent liability from the perspective of the public sector and might well add to government indebtedness.

Which is why Portugal’s – genuinely mixed – macro matters so much. That’s very different to Greece this time last year, but the process for deciding how Portugal is doing remains quite similar to things back then. Quarter on quarter of IMF reviews, and everyone relying on the IMF’s forecasts.

As food for thought on that, we’ll close with this slide from the Morgan Stanley note: