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Western EuropeOctober 5 2008

An uphill climb for credit in Portugal

Global jitters and the escalating cost of financing have forced Portuguese banks to drastically alter their credit model. Writer Peter Wise.
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Millennium BCP’s three covered bond issues highlight how the cost of bank funding has soared since August 2007. In June last year, Portugal’s biggest listed bank paid a premium on the swap rate of 3.5 basis points (bps) for a 10-year transaction. In October 2007, the spread had risen to 11bps for a seven-year issue. In April this year, the premium BCP paid on a two-year transaction had climbed to 40bps.

Other Portuguese banks have recently issued covered bonds at even higher spreads: Banco Espírito Santo at 45bps and Banco BPI at 50bps.

“We have seen a dramatic change in the way banks fund themselves over the past year,” says Diogo Lacerda, head of fixed income at Millennium Investment Banking. “The difference is being felt not only in the cost of financing, but also in terms of execution risk, whether transactions are successful in the market or not.”

Before August 2007, banks could fund themselves in the international wholesale market at much lower rates than companies. But this position has been radically altered by the subprime crisis and the global collapse of confidence in financial institutions.

“The spreads at which banks finance themselves are now very similar to those paid by companies and in some cases even higher,” says Manuel Preto, head of finance at Santander Totta, Portugal’s fourth largest bank.

Portuguese banks may take some comfort from the fact that financial institutions in Spain, which, like the UK and Ireland, is suffering the consequences of a sharp downturn in real estate prices, have to pay even higher spreads for funds. This has led for the first time to a degree of decoupling between the two Iberian economies in the eyes of international credit investors.

“Spanish banks are facing much bigger increases in spreads than their Portuguese counterparts,” says one Lisbon banker. “This is particularly evident in the covered bond market.”

Windows of opportunity

The problem is not just the soaring cost of funds, but often a total lack of availability. “There are occasional windows of opportunities when markets open for two or three days, but there are long periods when they are simply closed,” says Paulo Gray, Citigroup’s country officer in Portugal. In April, for example, BCP said it had taken advantage of a market opportunity to raise an orderbook that significantly exceeded the size of an issue it had been preparing to make, which was a €1bn covered bond issue with a two-year maturity at 40bps above the swap rate.

All Portugal’s big financial groups are universal banks dominated by commercial banking and depend on deposits from corporate, private and retail clients as their main source of funding. Banks have been aggressively targeting deposit growth with a considerable degree of success. But bankers also acknowledge a high degree of ‘cannibalisation’ of investment funds as customers seek to minimise risk exposure.

Portuguese banks have also been successful in shoring up their solvency ratios through substantial capital increases. Earlier this year, BCP raised €1.3bn in a rights issue fully underwritten by Merrill Lynch and Morgan Stanley. Banco BPI raised €350m from a rights issue in June. In July, the government injected €400m of new capital into state-owned Caixa Geral de Depósitos, the country’s largest bank by deposits. BES, Portugal’s second-biggest listed bank, increased its capital by €1.3bn in 2006, a move that has proved particularly timely in today’s challenging market conditions.

In this climate of ‘credit rationing’, Portuguese banks see creativity, flexibility and the agility to respond quickly to market opportunities as essential qualities for meeting their funding requirements at the best possible terms. In January, BES raised $1bn through an issue of exchangeable bonds with a three-year maturity. At the end of this period, the bonds, which are issued at below the market rate, can be exchanged, financially or physically, for shares of Brazil’s Banco Bradesco, in which BES is a shareholder.

“There is a big pool of investors who are attracted by the combination of the credit rating of a bank like BES with the potential appreciation, at risk, of the equity component,” says Luís Luna Vaz, managing director of Espírito Santo Investment. “I believe the use of this kind of transaction will increase significantly in the future as a credit facility that provides investors with an opportunity to reap rewards above the market rate.”

No Portuguese banks were exposed direct or indirectly to the US subprime market and the central bank determined shortly after the onset of the global crisis that no special support initiatives were required in ­Portugal. However, in addition to sharp increases in funding costs, falling trading revenues and the impact of the economic downturn, Portuguese banks have been hit hard by the falling value of their equity holdings.

CGD reported a 27.7% fall in first-half net income to €354.2m, due largely to the recognition of a €130m impairment on its shareholding in BCP and a €243.2m fall in income from financial operations.

“Only the positive performance of net operating income from commercial activities prevented the turbulence in financial markets from having a more negative impact on results,” the bank said.

“Despite the less favourable climate, the CGD group has participated in the financing of projects totalling more than €3.6bn since the beginning of the year with a direct participation of more than €800m,” says Luís Laranjo, chief executive of Caixa – Banco de Investimento, the group’s investment banking arm.

BCP saw first-half net profits fall 67% to €101m. The drop reflected a loss of €176.9m from the group’s 10% shareholding in BPI, which it had tried unsuccessfully to take over last year. Excluding the provision for the depreciation of its BPI holding and other specific items, BCP’s net earnings totalled €265m. Total loans to customers rose 13% to €73.7bn.

BES posted a 28% fall in first-half net profit to €264.1m. Consolidated operating costs rose 11% to almost €500m as the bank expanded its network and increased sal­aries. International operating costs rose 19% to €94.3m. In Portugal, costs increased 9.4% to €405.5m. Net interest income was up 11.3% to €511m.

Winners and losers

Santander Totta registered a first-half consolidated net profit of €273.3m, up 0.7% on the same period last year. Discounting the capital gain the bank made from selling its 10% stake in BPI to BCP last year, net profit rose 7%. Deposits were up 17.8%. Chief executive Nuno Amado says the bank had benefited from a robust balance sheet and the best rating in the Portuguese financial system.

BPI suffered a 95% slide in first-half net profits to €9.1m, down from €193m for the same period in 2007. Profits were hit by a €157.4m loss on its shareholding in BCP. The brightest news for BPI was an 18% increase in customer funds and 10% lending growth. Total deposits reached €29.8bn and the bank’s credit portfolio grew to €28.5bn.

“BPI currently enjoys a strong position in terms of funds and liquidity with a net credit position in the interbank market for the first time in many years,” said chief executive Fernando Ulrich.

In addition to the challenges of the credit crunch, Portuguese banks also have to contend with the impact of the global downturn on the Portuguese economy.

“The great success of the Portuguese economy over the past two years has been the correction of the budget deficit,” says Miguel Athayde Marques, head of Euronext Lisbon, the Portuguese stock market. “Unfortunately, just as the country was poised for recovery, progress has been set back by the international environment.”

GDP growth slows

The Bank of Portugal has revised its forecast for gross domestic product growth downwards to 1.2% in 2008, down from 1.9% in 2007, and to 1.3% in 2009, the country’s biggest slowdown since 2003. The downturn in international trade and the rise in fuel prices has also pushed Portugal’s external deficit up to its highest level since the early 1980s. It is expected to reach 11% of GDP at the end of this year.

Portugal’s socialist government is hoping that an extensive infrastructure programme involving an estimated investment of more than 16bn in the coming decade will help lift economic growth. The programme, to be funded largely through public-private partnerships, involves investing about €8.5bn on a high-speed train network, €3bn on a new Lisbon airport, €3.5bn on new motorway concessions and €1.4bn on building new hospitals.

“These projects will be more difficult to finance than previous infrastructure programmes in Portugal,” says a Lisbon banker. “We can expect banks to allocate smaller amounts to transactions than they have previously done. That means bigger syndicates, smaller operations and bigger equity contributions from promoters.”

Banks are also seeking to compensate for the slow growth of the Portuguese economy by channelling investment into overseas markets with stronger growth potential, particularly eastern Europe, Brazil and Africa. In September, for example, BPI sold 49.9% of Banco de Fomento Angola, the southern African country’s largest private sector bank, for $475m to Unitel, Angola’s leading mobile phone operator. The banking system in Angola, where Portuguese banks have a strong presence, is forecast to experience robust growth in the coming years, given that only about 10% of the population currently has access to banking services.

“For Portugal, the acronym ‘BRIC’ – used for the fast-growing economies of Brazil, Russia, India and China – should have an extra letter,” says Mr Athayde Marques. “An A for Angola.”

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