Banks are preparing to reshape Portugal’s financial sector over the coming years by reining back lending, increasing deposits, strengthening their capital ratios and cutting costs following the country’s request for an EU-led bailout. In a shrinking domestic market hit by austerity measures, deleveraging and an inevitable recession, bankers also see further consolidation as increasingly likely over the medium term.
“We expect to see an end to the expansion of the past 15 years as lending decreases and banks scale back their commercial networks,” says Nuno Amado, chief executive of Banco Santander Totta, Portugal’s third largest private sector lender. “This could eventually make room for more consolidation,” he adds.
A key target for the next two to three years is to lower the sector’s average loan-to-deposit ratio from the current level of about 150%, to close to the European average of about 120%. Much of this will be achieved by reducing lending to the state and public sector companies, and by targeting credit at the private sector export companies that economists hope will lead the country out of recession.
Loan-to-deposit reductions
State-owned Caixa Geral de Depósitos (CGD), the largest bank in Portugal by deposits, has already made significant headway this year, with a deleveraging programme aimed at cutting its loan-to-deposit ratio from 120%, the lowest in Portugal, to about 115%.
“The first step has been to sell financial securities and international loan portfolios, provided we can do this without any loss in value,” says Jorge Tomé, a CGD board member and chairman of CaixaBI, the group’s investment bank.
“We have also stopped lending to international companies and encouraged big Portuguese groups with international credit ratings to source their funding overseas. This enables us to make the most rational use of our liquidity by focusing lending on small and medium-sized Portuguese enterprises.”
Banco Espírito Santo (BES), the largest listed bank by market value, has announced plans to reduce its loan-to-deposit ratio from about 165% at the end of 2010 to 120% by 2012, partly by reducing its project finance portfolio, especially outside Spain and Portugal. Analysts expect BES to divest between €2bn and €3bn in project finance loans and believe a strong bias towards corporate lending, which accounts for about 70% of its total loan book, will help the group accelerate deleveraging.
Deposit targeting
Bankers are also targeting deposit growth, although higher funding costs and increased competition in a period of economic recession mean that any expansion will be moderate. “This will be partly achieved by transferring other savings products into deposits,” says Banco Santander Totta's Mr Amado. Mr Tomé says that CGD has determined that any increase in the group’s corporate lending must be wholly funded by a matching rise in deposits.
Portuguese banks obtain roughly half their funding from retail deposits. But competition has grown increasingly aggressive as successive downgrades of Portugal’s sovereign credit rating over the past year have virtually shut lenders out of wholesale finding markets, forcing them to rely increasingly on European Central Bank (ECB) financing and short-term debt issues.
Borrowing from the ECB currently totals about €40bn across Portugal’s banking system, with Millennium BCP, the largest listed bank by loans and deposits, relying most heavily on this source of liquidity. This accounted for about 15% of its total balance sheet funding at the end of 2010. However, Banco BPI, the fourth largest listed bank, said recently it had weaned itself off all ECB funding, while BES has significantly reduced its reliance on the facility.
Downgrade, downfall
Unlike Ireland and Spain, Portugal has not suffered a property crash and banks do not face the threat of a bursting asset bubble. Nor are they as extensively exposed to sovereign risk as Greek lenders. António de Sousa, head of the Portuguese Banking Association, estimates the total exposure of Portuguese banks to government debt, state-owned companies and state-guaranteed public-private partnerships at about €40bn.
However, the increase in Portugal’s perceived sovereign risk over the past year triggered successive downgrades in bank credit ratings, with two smaller banks, Montepio and Banco Banif, seeing their ratings cut below investment grade following the resignation of José Sócrates, the country's prime minister, in late March. It was partly the downgrading of bank ratings to what Mr Sócrates called “dangerous levels never seen before” that prompted him to submit a formal request for a bailout to the European Commission.
Before banks can return to issuing medium- and long-term debt, Portugal has to reassert control of its budget deficit. Mr Amado believes wholesale funding markets could begin to reopen to Portuguese banks in 2012, “if Portugal can achieve a clear, consistent and credible reduction in public spending over the coming year with exports growing and domestic consumption falling”. If the country fails to reassure financial markets with an “unquestionable” turnaround in its public finances and a change in its growth model by early 2012, he fears funding markets could remain closed to banks for another two to three years.
State support
In addition to budget consolidation, bankers see the recapitalisation and restructuring of state companies as a vital component of Portugal’s bailout agreement with the EU and the International Monetary Fund. In 2011, the funding needs of these groups, which include the Lisbon and Porto metros and the state railway company, is estimated to be about €3.8bn, the equivalent of 2.2% of gross domestic product.
This support for state companies as well as local and regional governments – a “bailout within the bailout” as one Lisbon banker puts it – will enable banks to reduce the weight of state lending on their balance sheets, improving their overall risk profiles and freeing up liquidity for more economically productive lending to private-sector export companies.
“Alleviating the state’s liquidity problems will automatically improve the liquidity of banks,” says Mr Tomé. CGD, for example, has provided about €5bn in finance for Banco Português de Negócios, a small, troubled bank that the government rescued through nationalisation at the height of the global financial crisis in 2008. The bailout should see these funds return to CGD.
Portugal’s financial rescue package, expected to total about €80bn, is likely to include funds for shoring up bank capital ratios, should the need arise. In April, the central bank set a minimum core Tier 1 solvency ratio of 8%, to be met by the end of 2011. BCP, the only bank significantly below the new minimum, has proposed a €1.2bn rights issue that is expected to lift its core Tier 1 ratio to between 8.5% and 9%, up from 6.7% at the end of 2010.
Solvency strengthening
Overall, Portuguese banks have been strengthening their solvency levels over the past three years and are committed to continuing the process, mainly by retaining dividends and profits. Bankers and analysts are confident they will comfortably meet the requirements of Basel III, especially as minimum capital ratios may be made even more demanding under the terms of Portugal’s financial rescue.
Levels of debt impairment will inevitably increase during the recession forecast for 2011 and 2012. The level of non-performing loans has reached a 10-year peak and is continuing to rise. Corporate and household leverage has also risen dramatically, from about 95% and 75%, respectively, in 2000, to more than 140% and 118%, respectively, last year, making it harder for companies and families to adjust to lower levels of income.
Banks believe this will not significantly affect the quality of their assets as most household lending is through mortgages, which homeowners are strongly committed to paying. Most other loans also have a relatively high level of guarantees, including public-private partnerships with state guarantees. According to Mr Amado, this means “the quality of the assets held by Portuguese banks is better than it is generally perceived to be”.
