On Portugal, PSI and a national salvation pact

Agora Contributor: Jorge Nascimento Rodrigues

Founded in October 2011, Tortus Capital pursues an opportunistic investment strategy across the capital structure, focusing on sovereign credit, corporate credit, equities, and special situations.

Based in New York Midtown, on Madison Avenue, the hedge fund decided in the week that Portugal returned to capital markets with a bond syndicated tap to create a specific website http://rehabilitatingportugal.com/ explaining its bearish position on Portuguese bonds.

The site became viral among Portuguese specialists after Tyler Durden from Zero Hedge website referred the 64 page slideshow “Rehabilitating Portugal” precisely the day of the market operation (9 January). Also on the Alphaville blog of the Financial Times, Dan McCrum, the same day, announced that “those rascal short sellers are at it again” referring to the Tortus presentation proposing a PSI for Portuguese sovereign.

This is a conversation with David Salanic, Chief Executive Officer and Founder of Tortus Capital.

Going directly to your proposal of an urgent PSI as the way for a “Rehabilitation Plan” for the Portuguese debt, you mean after the end of the bail out in May 17 and after the European Parliament Elections of end of May?
From a timing standpoint, the longer Portugal waits to restructure its debt, the higher the debt levels and the lower the debt servicing capacity. Postponing a PSI by a year or two would result in higher haircuts to bondholders but lower debt relief to the country – or a lose/lose situation. As a result, we believe that addressing the overleverage problem earlier is better. Notably, €4.6 billion of bonds mature on June 16, 2014 and another €6.2 billion of bonds mature on October 15, 2014. A PSI should aim to restructure these bonds. Working backwards, sovereigns generally need three months to restructure their debts through an exchange offer. Portugal should therefore start working on a PSI in the next month or two for it to be effective by the middle of June.

You mean a PSI plus a one-year/two-year precautionary line? Or a PSI included in a framework of a second bailout like in Greece in 2012?
A PSI would drastically reduce the financing needs of the country and we believe that a second bailout would not be needed if a PSI takes place. A precautionary credit line would provide the necessary financing backstop while not requiring the harsh conditionality of a full bailout. It is therefore a better way forward.

Troika reviews, and particularly the IMF DSA (debt sustainability analysis), although considering that the debt overhang is highly vulnerable, concluded for its sustainability. You refer that the main arguments for that conclusion are misconceptions. Can you summarize the main reasons why the Portuguese debt is not sustainable?
A sovereign, just like a corporation or an individual, needs to be able to service its debt at some point in the future. Today, servicing Portugal’s debt costs €7.2 billion in interest payments a year and this number will grow every year. In order to service its debt, Portugal would need to be able to generate cash flow before interest expense (called a primary budget surplus) of €7.2 billion a year or whatever amount the interest will have grown to in the future.

Will it be possible?
That will never happen. This would imply a primary budget surplus of 4.3% of GDP. Portugal has had a negative primary budget balance for over 15 consecutive years. The highest primary budget surplus ever realized over the past 36 years for which we have data is 3% of GDP. Portugal’s current primary budget balance is negative 1.6% of GDP. In order to get to a 4.3% primary budget surplus, Portugal would need to improve its annual primary budget balance by €10 billion. Any attempt by the Portuguese government to extract an additional €10 billion annually from the economy, would destroy the economy and the social fabric of the country.

Portugal does qualify for an OMT from ECB, or is that also a myth?
Mr. Draghi and the ECB have clearly indicated that OMTs do not apply to countries that are under a full adjustment program until full and complete market access has been restored, including an issuance calendar, high issuance volume, and a widespread investor base. So right now, I don’t believe that anyone can argue that Portugal qualifies for OMTs.

Could Portugal qualify in the future?
Perhaps. But our impression is that the ECB is already satiated with Portuguese paper. It already owns 23% of Portugal’s bonded debt, via €21.8 billions still outstanding in SMP Bond purchases from Jean-Claude Trichet, former ECB chairman. The ECB has been incredibly accommodative already with Portugal, whether one looks at Portugal’s Target2 balance (€70 billion) or Portuguese banks’ reliance on LTRO (€44 billion).

The European partners are politically sensitive to a PSI for Portugal after considering that the PSI for Greece was “unique”. Do you think the new European Parliament after May and the new European Commission could be more sensitive to a proposal like that?
At the time of the Greek PSI, there was no mechanism to avoid contagion to Italy and Spain such as the OMT program. Things are different today. Contagion risks are better contained. Banks are stronger. Markets have recovered. This is the right time for political leaders to address the problems that are still weighing on the European recovery. We believe that the European Parliament and the European Commission are increasingly against the idea of using taxpayer money to bailout private investors.

The IMF recognized the error of delaying the Greek PSI for almost two years. But regarding Portugal it never mentioned a PSI scenario. Do you think the IMF can change its position after May?
In Ernest Hemingway’s novel “The Sun Also Rises,” Bill asks Mike “how did you go bankrupt?” to which Mike answers: “Two ways: gradually and then suddenly.” This reminds us of the IMF and Greece. In the third quarterly review, Greek sovereign debt was found to be “sustainable.” A few months later, in the fifth quarterly review, the IMF stated that Greek sovereign debt was “clearly unsustainable” due to “more conservative assumptions.” In Portugal, through the third review, Portuguese sovereign debt was found to be “sustainable…assuming full and timely program implementation.” Since the fourth review, the IMF has added the statement that “debt sustainability cannot be asserted with high probability.”

Read the rest of the interview here.

*Jorge Nascimento Rodrigues is editor of Janelanaweb.com and a contributor to Expresso weekly newspaper in Portugal

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