Keith Mullin, IFR Editor-at-Large
Am I having one of my mad Mullin moments in suggesting five and 10-year Portuguese government debt is a screaming buy at these levels? Maybe. But I’m recommending it anyway. I’m not looking deeply at the technicals here; it’s more of a fundamental-cum-emotional play. And to be fair, there’s a lot of potential downside and you’ll have to take a lot on trust.
First of all, the general market is talking Portugal into an early second bailout in that dangerous self-fulfilling prophecy sort of way. Ten-year government bond yields are pushing back up towards 15%, partly because of general malaise, partly because the Portuguese banks aren’t there to engage in the Sarkozy carry trade of using the ECB’s LTRO funds to pile into government bonds. The banks are dealing with issues closer to home.
The ratings agencies have cut the sovereign’s credit rating to sub-investment grade, and the country has lost a lot of its investor base through forced selling as a result – which also caused yields to balloon. These days, the ECB is the only real buyer of Portuguese debt in any size. And of course, the fact that the Bank demanded preferred credit status on the Greek PSI deal is a big turn-off for private buyers of Portuguese bonds, who are loathe to be legged over twice if things turn bad.
Angela Merkel reportedly told German lawmakers Tuesday that she was concerned about the rise in Portuguese bond yields. While eurozone politicians and officials continue to be adamant that Greece is a one-off situation, Merkel’s comments won’t have done anything to improve sentiment. Net result: widely reported gloom around Portugal.
The IMF has given its thumbs-up to Portugal on the issue of debt sustainability. The government debt-to-GDP ratio came in ahead of target in 2011, and Portugal’s numbers stack up very favourably against Greece
Hence the opportunity. On the plus side, Prime Minister Pedro Passos Coelho is equally adamant that his government won’t need to restructure the country’s debt. (OK he would say that, wouldn’t he, so maybe that’s not a particularly big plus point). But the IMF has given its thumbs-up to Portugal on the issue of debt sustainability. The government debt-to-GDP ratio came in ahead of target in 2011, and Portugal’s numbers stack up very favourably against Greece. On the basis of the numbers, including forecasts that the debt burden will peak at 115% of GDP, you’ve got to wonder: why all the comparisons with Greece?
The third round of the Troika’s Special Inspections Programme basically ended up with ticks in all the boxes relating to the solvency of the country’s eight largest banking groups (albeit with some remedial work required here and there). There’s a lot of scare-mongering out there from people who don’t know what they’re talking about. With the country’s debt levels where they are, there shouldn’t really be any grave concerns about private investors being forced to take haircuts etc. People bandy around notions of contagion without really evaluating its triggers, force or direction.
The more international of Portugal’s banks – Banco Espirito Santo (BES) and Millennium BCP – were early adopters of deleveraging and have been fairly successful in offloading assets. I watched a TV interview with BES chief executive Ricardo Espirito Santo Salgado a day or so ago in which he gave a fairly robust account of what’s happening on the ground.
He pointed to the successful deleveraging of project finance and corporate loan assets booked out of London and New York, as well as the sale of the bank’s stake in Brazil’s Banco Bradesco for around US$1.3bn. He said the bank was redeploying some of the cash to finance Portuguese SMEs, particularly exporters. (It’s worth pointing out that, incidentally, Credit Suisse increased its stake in BES to 2.53% in January.)
Salgado also said the bank was engaged in a government bond curve play, taking advantage of the big price discount to increase the duration of its exposure to two-thirds short end, one-third five-year.
The banks have also been active on the liability management side to tidy up their capital structures and improve their capital ratios. BES’s debt-equity swap pushed up its Core Tier One ratio by 93bp (targeting two Upper Tier 2 and a Tier 1 deal for buyback and issuing 294m new shares at €1.80), while Banco Comercial Portugues got a high hit-rate on its discounted exchange offer (senior or subordinated notes for Tier 1 securities). Alas, Banco BPI’s discounted covered bond buyback was a bit of a dog because the pick-up was way too small. Despite the setbacks, the general point here is clear.
Attracting foreign investment
On a more general level, Portugal sits at the epicentre of the Lusophone commodity and natural resource flow that links Brazil with Angola and Mozambique. That’s already seeing positive results. The Portuguese export sector, which saw tremendous performance in the fourth quarter of 2011, is being especially targeted as a driver of economic growth.The newly-formed Conselho Estratégico de Internacionalização da Economia (Strategic Council for the Internationalisation of the Economy), a mixed government/private sector body, met for the first time a couple of weeks back to kick-start the country’s mission to attract foreign investment and to target specific export markets.
I’ll be honest; I do have some doubts about Portugal’s ability to resume voluntary bond sales in 18 months’ time, given the weight of negativity around its economic prospects and the number of naysayers willing to do the country down.
But austerity takes time to produce results. Portugal is going to suffer some real pain to achieve the desired – and required – results. The severe drought and multiple forest fires that the country is experiencing at the moment will make reaching its goals ever more difficult. But the expectation is still that the government will hit its deficit targets in 2012.
What’s that old saying? You’ve got to speculate to accumulate. I’m a receiver of 5s and 10s and am happy to buy with anything that’s got a 50 handle on it.