Portuguese Municipal  Woes

It appears Portugal's municipalities have a debt problem that is a spitting image of that plaguing Spain's regional governments. As remittances from the central government decline, many have reached the point where they would normally be considered insolvent. Some € 9 billion in municipal debt are apparently threatening to default unless some aid comes forth from the central government. The problem with this is of course that the government needs to hew to its 'troika'-imposed deficit targets and therefore can not help them.



As Bloomberg reports:


Portugal’s town halls face default amid 9 billion euros ($12 billion) of debt unless the government provides aid soon, said Fernando Ruas, president of the nation’s association of municipalities.

“At a company we call it insolvency,” Ruas said in a telephone interview from Lisbon on March 21. “It could happen that some town halls could have to restructure their debt if the government doesn’t intervene.”

Ruas blamed a decline in money transfers from the government in Lisbon to municipalities for their growing financial woes. Portugal last year became the third euro-area country to request external aid, following Greece and Ireland. Prime Minister Pedro Passos Coelho is cutting spending and raising taxes to meet the terms of the 78 billion-euro rescue.

“A sharp decrease in money transfers has made it harder for many town halls to comply with their ongoing commitments,” said Ruas. His association estimates town halls face about 9 billion euros in liabilities. About 1.5 billion euros of the total is in bills to suppliers overdue by more than 90 days while the remainder is mostly made up of debt  banks, he said.”


(emphasis added)

Readers who have followed or previous missives on Spain's debt predicament will surely recognize this process: the government tries to keep its deficit spending within the prescribed EU target, which in turn means it begins to starve the regions, leaving them to sort out their financial problems on their own. However, it appears nothing has really been sorted out. From the above we deduce that the already troubled Portuguese banks are soon going to have to bid assets worth €7.5 billion adieu unless a deus ex machina can be conjured up somehow.

As it were,  Bloomberg remarks on the similarities with Spain as well:


“The southern European country’s 308 town halls and two semi-autonomous regions face similar issues to those of Spain, whose regions and municipalities have been shut out of capital markets due to the credit squeeze, leaving many bills to suppliers unpaid. Spain’s government is offering them loans to help pay suppliers.

Money-transfers from the central government to town halls are set to decline 4.7 percent this year to 2.28 billion euros from a year earlier, according to Portugal’s 2012 budget. To cut costs, Portugal is encouraging some town halls to merge as part of a plan to re-organize local governments, the government said in a statement on Feb. 2.

“The high level of indebtedness of town halls across the country is nothing new,” said Joao Cesar das Neves, a professor of economics at Lisbon’s Catholic University. “The government had little control over the country’s municipalities, which spent way beyond what is admissible, and now it is faced with a complicated problem.”


(emphasis added)

Contrary to Spain, Portugal can not simply declare the EU's deficit target null and void and come to the aid of overindebted regional governments, as it is already a ward of the EFSF/IMF.  So yes, it is indeed a 'complicated problem'.

It should be noted here though that this problem is not unique to Portugal. All over Europe, provincial and municipal governments have way too much debt. Portugal is merely a decisive step closer to a debt restructuring than the rest. It remains on the top of our list of candidates likely to follow in Greece's footsteps.


“Portugal’s shrinking economy may make further help harder to come by. Gross domestic product declined for a fifth quarter in the three months through December and the jobless rate rose to 14 percent. That may hurt efforts to cut the budget deficit to 4.5 percent of GDP this year and within the European Union’s 3 percent limit in 2013.

Town halls may also find it tougher to get bank funding as Portuguese lenders will probably have to cut back on lending to bolster capital ratios and comply with the terms of the nation’s bailout package, Andre Rodrigues, an analyst at Caixa Banco de Investimento in Lisbon, said last week.

“From a regulatory point of view, it still makes little sense to restart lending growth in the short term,” he said.

The rescue plan assumes Portugal will regain access to medium and long-term sovereign debt markets in 2013, with the program’s last disbursement to be made in June 2014, the International Monetary Fund said in December.

Passos Coelho said in an interview on March 6 that if the country is unable to return to markets next year due to external factors, it would be able to count on the support of the IMF, the European Commission and the European Central Bank.


(emphasis added)

Return to the capital markets in 2013? The boundless optimism informing such forecasts seems more than a tad misguided. The support of the 'troika' will no doubt be called upon again.



The contraction of Portugal's economy is accelerating



Concurrently the government's total public debt-to-GDP ratio keeps growing – it has been above the Maastricht treaty limit since 2006



Lack of CDS Contracts Weighs on Greece's New Bonds 

We now have some evidence for something we have asserted for a long time: should sovereign CDS no longer be regarded as a viable hedging instrument, then peripheral bonds would probably come under additional pressure.

As our readers know, we have been unable to obtain a quote for new CDS on Greece's government debt ever since the post PSI 'credit event' led to a debt auction and the payout of the old contracts. We were not sure for a while why we could not obtain any quotes for CDS on Greece's post PSI debt, but we certainly  were aware that said debt has traded at distressed levels from the day it was issued.

As the WSJ reported last week, these bonds are currently trading at less than one fifth of their face value:


„It was barely two weeks ago that holders of €177 billion in Greek bonds had their securities zapped and replaced by new bonds, the central piece of the country’s historic debt default. Those new bonds have had an unhappy life.

Greek creditors got a package of 20 new bonds for each old bond, with varying maturities between 2023 and 2042. At the time of the exchange last Monday, the collection of bonds was priced by markets at around a quarter of face value. Now it has dipped below 20 cents.


(emphasis added)


Below are Greek bond prices (various maturities ranging from 10 to 20 years) over the past nine trading days:


Prices of new Greek bonds of maturities between 10 and 20 years as a percentage of face value.



So why are investors so down on the new bonds, on which Greece only pays a coupon of 3.5%? As it turns out, it is not only the fact that everybody knows that Greece is just as bankrupt today as it was three weeks ago – in spite of 'losing' € 100 billion in debt between then and now.

It is precisely the fact that no new CDS contracts exist as of yet that holders of the new bonds have begun to sell – right into a vacuum, as there are barely any bids to be had.

As the International Financing Review reports, it is a legal fine point that currently stands in the way of creating new CDS contracts:


„Despite a successful CDS auction on Monday, dealers have been unable to start trading Greek CDS again due to a contractual technicality that could allow clients to trigger their new CDS.

Traders are hopeful the International Swaps and Derivatives Association will soon make an announcement and rule that 60-day look-back clauses in standard CDS contracts cannot be used to reference the credit event ruling of March 9. As ISDA continues to deliberate, though, the market in Greek government bonds remains in turmoil with dealers thought to have suffered some serious mark-to-market pain on their positions.

“After a brutal session yesterday, the market liquidity is certainly reflecting the pain on dealers’ books,” one major dealer wrote in an email to clients this morning, “With no CDS technical to assist with unwanted positions, the market is struggling to find the marginal buyer.”

Greek government bonds have been particularly dislocated towards the back-end of the curve. The longest-dated new 2042 GGB – with an issue size of €2.8bn – had a bid/offer of 17.084/19.16 today and the yield has shot up to 17.83% from 14.34% on March 14. The yield on the shortest-dated new 2023 GGB – with an issue size of €2.7bn – has jumped from 18.21% to 20.15% over the same period, while the current bid/offer is 24.815/27.41. To give an idea of where a liquid bond trades, Italy’s 2023 BTP has a current bid/offer of 96.37/96.62 and a yield of 5.2%.”


Gavan Nolan, director in credit research in Markit, said there have been a few quotes on five-year Greek CDS with the mid-market price in the 70 to 72 points upfront range – only six to eight points tighter than where it was trading prior to the trigger. There is no evidence to suggest that dealers had executed on these prices, though.

Others banks have been reluctant to start making markets before they have received legal certainty.  “If we write a CDS now, our counterparty could try and trigger on us. We’ve raised the question with ISDA and we’re waiting to hear back. Until we do, we’re not going to trade it,” said one head of sovereign CDS trading at a major European bank.

There is nothing explicit in the definition of a credit event that stops holders of new Greek CDS triggering their protection by citing the recent Greek credit event, confirmed Edmund Parker, global co-head of the derivatives and structured products practice at law firm Mayer Brown. Since 60 days have yet to elapse since Greece used the collective action clauses, purchasers of new Greek CDS could take advantage of this apparent loophole.”


(emphasis added)

In other words, contrary to the claims of the eurocrats – often repeated, never proved – that CDS 'allow speculators to attack sovereign debtors', things are working exactly the other way around. The view that it is not the profligacy of governments but 'evil speculators' that have created the sell-offs in euro area debt markets led to a discussion over banning this type of insurance altogether, an idea enthusiastically supported by Michel Barnier, the EU commissioner for internal market and services.

It is only logical that things actually don't work that way, as we have often pointed out.  Anyone holding the debt of a dubious debtor will be more inclined to hold on to it if they can credibly insure themselves against default than when this possibility doesn't exist. Naturally we cannot prove whether Greece's new debt paper would in fact trade any firmer if it were possible to buy CDS on it at this time. As always in questions touching on the markets we are constrained by the impossibility to conduct an experiment that would provide incontrovertible evidence (conversely, even if Greek debt were to weaken further after CDS on it begin to trade again, this would also not necessarily disprove our argument).

However, one only needs to look at things from the point of view of a creditor holding Greek (or Portuguese, Spanish, etc.) bonds: since CDS contracts as a rule tend to gain in value when the bond prices of issuers fall due to growing worries about default, they can effectively offset any 'paper losses' in the underlying bonds. This makes them especially attractive in markets that are not very liquid, a situation that undoubtedly pertains in the euro area's peripheral bond markets.



10 year government bond yields of Spain, Italy, Portugal and Greece late last week. While the biggest relative move was (not surprisingly) in Spain's bonds, the new Greek 10-year bonds ended the week at a yield above 20% – a new post PSI high.





Charts by: Bloomberg, Tradingeconomics, WSJ



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One Response to “Portugal’s Insolvent Town Halls and the Trouble with Greece’s New Bonds”

  • Crysangle:

    I will clarify regional debt workings a little for you for Spain .

    In Spain there is broadly :

    Central debt
    Regional debt
    Municipal debt

    They add up to make total national debt . In Spain regional debt in particular is proving hard for regions to fund and hard for central government to control . It is also a main ingredient of total national debt. Central government is NOT allowed to fund the regions (to maintain impartiality in regional government) . There is a reciprocal arrangement of central redistribution of regionally collected income . What is happening now is that the central government is setting up a structure to nationally guarantee issuance of regional debt , so lowering its cost (but increasing the cost of issuance maybe of national debt due to the liability incurred through the guarantees) . The form , agreements and legal aspects to this are under discussion.

    The municipal (town hall, if you like) income (local taxes and fines etc.) is also partly redistributed amongst the municipalities . Municipal debt tends to be locally acquired via banks or due to non payment (!) of bills . The management of municipal income by the state is complex (as is that of the regions) , suffice to say that recently announced is that the municipalities will have income due forwarded in time , at least for one payment of 50% yearly amount due.

    This leaves us with the topic of unpaid debt in the form of bills to service providers and businesses (possibly some local financial debt too). Effectively the country (central , regional and local) has @ 35 billion (with a b) eu in unpaid debt up to the end of 2011. To deal with this the government has set up and guarantees access to credit (with easy initial payback terms – if I remember, interest only for five years or similar) to pay off these bills . All government offices, town halls and so on are to have presented a complete list of these debts, and individuals , companies and so on have more time to present their own claims to government if they feel they have been missed.

    Where does that leave the debt to GDP figure ? Effectively no change – all the regional and municipal debt, including the unpaid bills, was counted in last years deficit figure. From now on central government may have more control on regional spending levels (which are limited by the market now anyway) .

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