Interest Rates Focus FIM RESEARCH
06 July 2011
Portugal and Moody’s blues – another rater tantrum Summary
Moody’s slashed Portugal’s rating by four notches to Ba2 (neg), precipitating fresh losses in peripheral EGBs.
The reasoning about Portugal’s finances and market access seems unduly skewed, to us.
Portugal has very real issues but there is a decent chance that by H213 they will be better positioned to re-enter the market.
We still do not like the idea of being long core paper at negative real yields on the hope the ‘next chap’ panics even more.
Late yesterday evening, Moody’s rating agency downgraded Portugal’s sovereign rating from Baa1 to Ba2 (negative outlook). The four-notch downgrade is the sharpest move among any of the illiquid periphery sovereigns other than what Moody’s did to Ireland last December after they were bailed out. With both S&P and Fitch giving Portugal a BBB- rating with a negative outlook, this issuer teeters very close to ‘junk’ status. Market reaction has been swift and predictable, with the 10Y Portugal-Germany spread leaping wider by 45-55bp at the time of writing, relative to yesterday’s close. Other periphery spreads have also come under considerable pressure.
Fig. 1: Portugal’s average rating and 10Y spread over Bunds 900 800 700 600 500 bp 400 300 200 100 0 Jul-07
BB+
10Y OT vs. Bund (LHS)
BBB-
PTE avg rating (RHS)
BBB BBB+ AA A+ AAAA
Jul-08
Jul-09
Jul-10
Jul-11
Source: S&P, Moody’s, Fitch, Bloomberg, Crédit Agricole CIB.
Moody’s two main concerns are that Portugal may not be able to meet its deficit-reduction targets and, more importantly, that the spectre of private-sector burden-sharing makes a return by Portugal to the primary market in the second half of 2013 unlikely. In turn, this would require a second round of international loans (à la Grecque) which would suggest some sort of… private-sector burden-sharing. Are these concerns justified, or is it this yet another case of rating agency attention-seeking behaviour?
Luca Jellinek, European Head Interest Rates Strategy +44 20 7214 6244 luca.jellinek@ca-cib.com
catalystresearch.ca-cib.com Crédit Agricole Corporate and Investment Bank is authorised by the Autorité de Contrôle Prudentiel (ACP) and supervised by the ACP and the Autorité des Marchés Financiers (AMF) in France and subject to limited regulation by the Financial Services Authority. Details about the extent of our regulation by the Financial Services Authority are available from us on request.
Interest Rates Focus
Portugal may well deliver on the deficit front Portugal’s general government deficit results for FY10 were somewhat disappointing, coming in around 9% of GDP (the target had been closer to 7.5%) though that was almost entirely due to a change in accounting treatment on the part of Eurostat. The outlook so far this year is distinctly more encouraging:
Over the first five months of the current fiscal year, revenues rose (relative to the comparable FY10 period) by 7.8% and outlays fell by 6.5%. On that basis, the rolling, 12-month deficit/GDP ratio fell, since end-2010, from 8.3% to around 6.9% (just under EUR12bn). Even if this trend slows somewhat through the remainder of the year, the target of a EUR10bn deficit should be roughly achievable.
The incoming PSD/PP coalition government has a 17 MP majority and a mandate to further shrink the inefficient public sector. They have already implemented a one-off tax-hike but, more importantly, are looking to speed up cost reduction and privatisation. They very recently eliminated the “golden share” the government held in some partly publicly-owned companies, with a view towards privatisation. Just as an example, utility provider EDP has a capitalisation of roughly EUR9bn (and Participacoes Publicas holds about 25% of its stock).
The bottom line is that, taking the new austerity impetus into account, it is entirely possible for Portugal to come very close to the near- and medium-term fiscal goals set by the EC/IMF. In this, it differs markedly from Greece’s recent performance, which has led to the need for a second round of loans and, therefore, ‘German’ insistence on private sector burden-sharing. Fig. 2: Portugal’s rolling deficit/GDP balance (cash basis) -6.0% -6.5% -7.0% -7.5% -8.0% -8.5% -9.0% Dec-09
Mar-10
Jun-10
Sep-10
Dec-10
Mar-11
Source: DGO, Eurostat, Crédit Agricole CIB.
Market access should not be assumed away It is understandable that investors are worried about the insistence on burden sharing. It is not just a matter of substance but also of uncertainty, since the parameters of the debate are constantly shifting on the back of political exigency. At any rate, the memorandum of understanding accompanying Portugal’s existing EUR78bn loan package from the EC and IMF already includes a reference to private-sector liquidity support, namely: “…the Portuguese authorities will undertake to encourage private investors to maintain their overall exposures on a voluntary basis”. That phrase was admittedly vague and not comparable to the effort currently underway with regards to private institutional holdings of Greek debt. In any case, Portugal’s return to the private-sector primary debt market is scheduled for the second half of 2013, by which time, according to recent Eurogroup decisions, all Eurozone Government Bonds (EGBs) will carry collective action clauses and
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Interest Rates Focus
other terms that make ‘burden-sharing’ much more likely in the event of a bailout. In that sense, the rating agency’s concept that burden-sharing makes primary market access less likely and therefore requires more loans which make burden-sharing more likely is an exercise in circular logic. Assuming that Portugal delivers on the fiscal and microeconomic reform front – which at this point does not seem a low-probability event – and that other, liquid peripherals (Spain, Italy) also continue to show progress on that front, we see no reason why Portugal should be unable to raise the scheduled EUR10bn of bond issuance in 2013 or why they should necessarily need more EC/IMF money. If those conditions are met, even in very rough terms, the need for a second bail-out is doubtful. Below, we show Portugal’s financing schedule as outlined by the IMF in its Spring report. Fig. 3 Portugal funding programme (Spring 2011 Review) Portugal: General Government Financing Requirements and Resources EUR bn
Gross borrowing need Budget balance Amortization M&LT debt ST debt EU/IMF loans
Other (1) Gross financing sources Privatisation receipts Market access M&LT debt ST debt
Other Financing gap
2010 42.3 15.8 26.5
2011e 56.5 10.0 29.7
2012e 36.0 7.5 24.0
2013e 29.9 5.1 18.7
2014e 29.9 4.2 22.9
2015e 24.6 3.6 21.0
2016e 29.8 3.2 26.6
7.3 19.2 0.0 0.0
9.6 20.1 0.0 16.8
12.7 11.2 0.0 4.5
9.8 8.9 0.0 6.1
14.1 8.9 0.0 2.8
10.6 8.9 1.5 0.0
9.9 8.9 7.8 0.0
42.3 0.9 41.4
18.7 2.0 16.7
10.9 2.0 8.9
19.9 1.0 18.9
24.8 0.0 24.8
24.6 0.0 24.6
29.8 0.0 29.8
21.3 20.1 0.0
5.5 11.2 0.0
0.0 8.9 0.0
10.0 8.9 0.0
16.0 8.9 0.0
15.8 8.9 0.0
20.9 8.9 0.0
0.0
37.8
25.0
10.0
5.1
0.0
0.0
EU loans IMF loans
0.0 0.0
25.2 12.6
16.7 8.3
6.7 3.3
3.4 1.7
0.0 0.0
0.0 0.0
Total public debt
160
182
191
201
208
211
215
(1) Includes the Bank Solvency Support Facility, bank restructuring costs and net financing from retail government securities programmes. Source: IMF June Review (page 28)
Flow effects after the downgrade Whatever our take may be of the rating agencies’ opinions, it is empirically inescapable that the market reacts to them. In mid June we said that: “one ratings-related risk that is specifically connected to Portugal is …the potential loss of ‘investment grade’ status … in the case of Greece … the loss of investment grade status from S&P exacerbated the crisis there”. Although the main factor for illiquid EGBs is whether they are accepted as collateral by the ECB (as Portuguese bonds will continue to be), one cannot rule out that at the margin this downgrade may further reduce international investors’ propensity to hold Portuguese paper. The thing is, foreign investors have been reducing Portuguese exposure for some time (since 2010) and we doubt too many investors that are ratings-conscious still own much Portuguese paper. Does Portugal face a further ratings risk? On a relative basis, its rating/debt relationship is among the ‘cheapest’ in the Euro periphery, suggesting that the risk is greater elsewhere. Figure 4 shows the ratio between the average number of rating notches below AAA and the level of debt expected by end-2012 by the European commission. By that measure, Portugal (and Spain) seem to carry a rating that is rather harsh, relative to debt load. Against that, we have substantial evidence of ‘group-think’ and ‘momentum-trading’ on the part of the agencies, so the risk is not negligible.
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Interest Rates Focus
Fig. 4: Periphery ratings vs. GG debt outlook
ITL
BBB
IEP
BB+ BB-
PTE
GRD
AA A+ A-
ESP
average rating
AA
BEF
B CCC 170
150
130 110 debt/GDP outlook
90
70
Source: European Commission, ratings agencies, Crédit Agricole CIB.
Our overall conclusions, based on the observations above, would be as follow:
06 July 2011
The rationale accompanying Moody’s slashing of Portugal’s rating seems somewhat dubious and circular, though obviously the country faces substantial difficulties.
We think that, on balance, Portugal has a good probability to show considerable, sustained fiscal improvement and return to the market by H213.
While we cannot discount some negative flows and even further rating agency noise, the viciousness of the move in periphery rates this morning should fade. We also do not see distress (real or sentiment-led) in one EMU member as a good reason to buy core paper at negative real yields.
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Interest Rates Focus
FIM Research contact details Hervé Goulletquer Global FX Strategy Mitul Kotecha Daragh Maher Simon Smollett Adam Myers
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