Portuguese banking is in flux. The catastrophic collapse in 2014 of Banco Espírito Santo (BES), one the country’s oldest and best-known lenders, has shifted the tectonic plates of a sector already severely buffeted by the global financial crisis and a three-year international bailout.
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Fifteen potential bidders approved by the Bank of Portugal are now eyeing Novo Banco, the so-called good bank created out of the healthy assets of BES. At the same time, Banco BPI, the smallest of the five banks that account for 80% of the Portuguese market, has been targeted by Spain’s Caixabank, its largest shareholder, for a full takeover.
Caixabank’s bid has in turn sparked BPI’s second largest shareholder, Isabel dos Santos, the daughter of Angola’s president, to propose the alternative of a merger between Millennium bcp, the largest listed lender in Portugal, and BPI. The fact that BPI, whose board rejected Caixabank’s initial bid as too low, is also seen as a frontrunner to buy Novo Banco further complicates the jigsaw of potential mergers and acquisitions that will determine a new landscape for Portuguese banking over the coming year.
Potential for profit
The flurry of investor interest in Portuguese banks is seen as a positive reflection on their potential for returning to profitability after a gruelling period of plummeting earnings, radical restructuring in return for state aid and a toughening in the regulatory environment, especially with regard to capital requirements.
“The fact that people are talking about potential mergers and acquisitions is a good indication that the climate is improving,” says one senior bank economist in the country. “The industry is still saddled with extensive non-performing assets and the idea that investors are now interested in buying or merging banks is a sign that the outlook for the sector is considerably better than it was two years ago.”
Portuguese banks have undergone a punishing transformation. In a sector that enjoyed high levels of profitability before the global crisis, with the top lenders posting annual earnings in the region of €500m to €800m, Banco Santander Totta, the Portuguese subsidiary of the Spanish group, is the only one of the top five lenders to have recorded a profit for its domestic operations over the past two years. Returning to profitability, inevitably at significantly lower levels than in the past, is now the top priority for the country's lenders.
As Nuno Amado, chief executive of Millennium, puts it: “The main challenge for Millennium bcp is to ensure we return to sustainable profitability in our Portuguese operations. Our international operations are performing well and our Portuguese operations recovered dramatically over the past year, but we still need to reach a net profit in Portugal and to continue improving. This means increased lending, increased operating profit, higher net interest income and continued cost control.”
Painful restructuring
Millennium, BPI and state-owned Caixa Geral de Depósitos (CGD), the largest lender in Portugal by assets, have all undergone painful restructuring and recapitalisation programmes in return for state aid, which is now largely repaid. The fact that BES resisted accepting similar state support, which would have obliged it to open its books to outside scrutiny, is widely seen as both a symptom of the mounting difficulties it was facing and a cause of its eventual downfall.
In March, the Bank of Portugal commissioned Deloitte to perform a forensic audit of BES’s activities, which uncovered the “potential practice of illegal acts of ruinous management”. Legal action against former BES executives is expected to follow over what became one of Europe’s largest financial failures and is estimated to have left investors with losses totalling about €10bn.
In the run-up to the rescue of BES last August, the bank lost about €11bn in deposits. But the flight of funds from BES, which had once been one of the country’s most trusted lenders, remained largely in Portugal. Despite the fall of the country’s largest bank by market value, a tough EU/International Monetary Fund bailout and a deep recession, the Portuguese have kept faith with their banks.
“Unlike in Greece, Spain or Ireland, confidence in Portuguese banks has never seriously been undermined,” says Luís Saraiva Martins, a board member at Caixagest, the country’s largest asset manager and a part of the CGD group. “The crisis of confidence caused by the collapse of BES was limited to the bank itself and hasn’t spread to other lenders.”
With recession and internal restructuring now largely behind them, Portugal’s banks are looking towards earnings growth. “The future of each individual group will ultimately depend on several factors,” says Joaquim Souza, chief executive of Caixa-Banco de Investimento, the investment banking arm of CGD. “It will be contingent first on the size of their past liabilities and second on how efficiently they deal with them in terms of appropriate provisioning and restructuring of those credits, paying back state loans and cutting costs.”
Tough regulations
Portugal’s deep recession and the imposition of tougher regulatory controls have obliged banks to build high levels of provisions and register significant impairments. Novo Banco, for example, reported a loss of €468m, reflecting impairments and provisions totalling just under €700m, for its first five months of operation from August to December 2014.
As the country's gradual economic recovery begins to gather pace, levels of non-performing loans (NPLs) are expected to fall, allowing banks to lower their provisions and creating room for a tentative return to profitability.
Three years of recession pushed up the sector’s NPL levels to about 11% of total lending in 2014, when 31% of Portuguese firms had overdue bank loans, up from less than 20% five years earlier. The total debt burden of non-financial companies last year was equivalent to 156% of the country's gross domestic product.
The Organisation for Economic Co-operation and Development says some form of “orderly debt restructuring” by companies could be necessary to reduce this debt burden in the private sector and enable banks to repossess the collateral of bad loans before the assets in question lose their value. As the economic climate gradually brightens, banks are adopting their own individual strategies to clean up their loan books and help companies restructure their debts.
“We have already made very significant provisions in all areas of our operations,” says Mr Amado of Millennium. “Don’t forget that there have been a number of regulatory inspections of our loan portfolio – and we are working closely with our customers to find solutions that help them restructure and develop sustainable business plans. We are also keen on helping companies that need to strengthen their capital, and we have launched a capitalisation fund as part of our state aid agreement that is available for companies looking for this kind of support.”
Corporate lending
New corporate lending began picking up in mid-2014 at levels of about €4bn a month, but tough competition is squeezing margins, says Rui Constantino, chief economist at Santander Totta. At the same time, NPL levels are falling, enabling banks to reduce provisioning. During the crisis, banks engaged in a significant process of repricing loans and the healthiest companies have stepped up their efforts to deleverage.
Tough competition for the business of promising companies is forcing banks to rethink their approach to corporate lending. “It’s a different world in which banks will have to work much harder,” says Mr Souza of Caixa-Banco de Investimento. “They will have to change their credit culture. Lending to a property developer is relatively easy. The buildings are there as collateral. It’s much harder to make the right decision when it comes to lending to service or industrial companies, when you often have to assess a stream of future cash flow, the potential of an idea or the capabilities of the people involved.”
New production of mortgage loans, which account for about 45% of total bank lending to the private sector in Portugal, fell drastically during the crisis, from about €2bn a month to only €200m. But amid the economic upturn, it is now growing at a year-on-year rate of about 20%, with new lending close to €300m a month. Pre-crisis spreads of as little as 25 to 30 basis points above Euribor are now 10 times higher, while the fall in interest rates means that some 70% of customers’ monthly payments may go towards paying down the capital of their loans, leading to a natural reduction in the size of Portugal’s mortgage loan book.
“The banking sector has emerged from the crisis facing lower credit volumes, tighter spreads, higher capital costs and a tougher, more level playing field in terms of solvency ratios and other regulatory issues,” says Mr Constantino of Santander Totta. “They are now engaged in improving efficiency, using lower levels of impairment provisions to restructure and cutting back further on costs.” A critical competitive issue in this new climate, he says, will be cutting deposit rates to lower funding costs.
Banks are also placing a greater emphasis on brand value. “In these complex times, a strong brand and strong brand loyalty are essential for a bank, part of a broader effort to increase contact, business and involvement with existing customers, and to attract new customers,” says Mr Amado.
Cost cutting has focused on reducing branch networks and lowering staff levels. Most of the top five banks have reduced their commercial networks from about 800 to 600 branches. Portugal, nevertheless, remains heavily banked, with 57 branches per 100,000 people, fewer than in Spain, but much higher than in some northern European countries, such as the Netherlands, which has only 13 branches per 100,000 people.
Towards consolidation
Further consolidation within the sector should lead to more efficiency gains. Caixabank projects that its bid to control BPI, which has a cost-to-income ratio of 75%, compared with the Spanish group’s 57%, would produce €130m a year in cost savings. The alternative of a Millennium-BPI merger proposed by Ms dos Santos, Africa’s richest woman, would also be expected to produce significant synergies. Millennium, which has a cost-to-income ratio of 52%, has said it is willing to consider the idea if BPI is also open to the possibility. BPI has not yet commented.
One large-scale merger or acquisition that is almost certain to go ahead this year is the sale of Novo Banco, with BNP Paribas having been contracted by the Bank of Portugal to organise the auction process. BPI and Santander are the only banks to have publicly confirmed they are among the 15 potential bidders. Unconfirmed reports also list Spain’s Banco Popular, Apollo Global Management of the US and Fosun International, China’s largest private sector conglomerate, among the other institutions that have registered an interest.
Novo Banco was created from the healthy assets of BES, including its branch network and workforce. BES’s bad loans and liabilities were left in a bad bank, which is being wound up. As part of the rescue, Novo Banco has received €4.9bn in fresh capital from Portugal’s bank resolution fund, which is owned by all the country’s banks and is Novo Banco’s sole shareholder.
The official deadline for the sale is mid-2016, but the centre-right government of prime minister Pedro Passos Coelho would clearly prefer a deal to be agreed before a general election due in October this year. Novo Banco has been cleared of €7bn in toxic assets and has inherited from BES a corporate loan portfolio and related expertise. The portfolio is considered one of BES’s most attractive assets.
Its purchase by either BPI or Santander would result in a considerable overlapping of branch networks, implying further restructuring by a sector that has already significantly cut back operating costs, making it one of the most efficient in Europe, although it remains one of the least profitable and has some of the weakest credit ratings.
Investment bankers have warned that the sale of Novo Banco is unlikely to raise the €4.9bn book value of its equity capital. Any shortfall would have to be borne proportionately by all Portuguese banks. If the sale raised only €2.5bn, as some analysts speculate, Millennium, for example, would stand to lose about €380m net of taxes, having contributed 24% of the capital injected into Novo Banco by the resolution fund, which was boosted by a €3.9bn state loan. This level of loss would be painful for banks, but is likely to prove manageable, given that repayment is almost certain to be deferred over several years.
