As Portugal recovers from a punishing adjustment programme and a deep recession, the country’s banks are becoming profitable again. But the legacy of the past still weighs heavily on a sector in which lenders are struggling to ease the burden of non-performing loans (NPLs) and cut their costs to take better advantage of a gradually improving economy.
The way forward will inevitably involve a new wave of consolidation, with the ownership and control of leading players set to change hands. This could help drive further synergies as banks have already stripped back, restructured and recapitalised to focus leaner, more solvent operations on the domestic market. But the level of economic, political and business risk remains high.
“The banking system in Portugal has been going through a very rough period,” says António Vieira Monteiro, chief executive of Banco Santander Totta, the country's fifth largest bank by total assets. “The fundamentals of banking are being restructured and I believe a lot still has to be done. Weak banks make weak economies. But I’m confident this crisis will have the effect of making both banks and the economy more sound.”
Moderately optimistic
On the positive side, Portugal's economy is expanding on the back of robust exports, with annual growth expected to reach 2% by 2019. Unemployment has fallen from a record 16.2% in 2013 to just more than 12%. Banks have reduced their credit exposure to companies by 30% over the past five years, and three of the country's top five lenders posted net profits for 2015.
“We’ve already seen reasonable economic growth in 2015 and I expect that trend to continue over the medium term,” says Nuno Amado, chief executive of Millennium BCP, the country's second largest lender by assets. “There are obviously risks to the outlook, but we are moderately optimistic. I believe Millennium is well positioned to maintain its role as a leading, profitable bank going forward.” BCP posted a consolidated net profit of €253.3m in 2015, following four consecutive years of net losses.
Problem credit is the chief negative factor holding the sector back. NPLs continued to increase in 2015, and represent 8.8% of total lending and 15.4% of corporate loans among the country's banks. Solvency levels have improved but remain weaker than in most other eurozone countries. Santander Totta is the only leading bank to have come though the crisis without posting negative results. Political risk has increased following a general election in October. The vote saw the previous centre-right government replaced by a minority socialist administration, which is reliant on support in parliament from the Left Bloc party and Portuguese Communist Party.
A recent Moody’s report reflected the 'glass half full, half empty' outlook for Portuguese banks. The rating agency revised its outlook for the banking system from 'negative' to 'stable', saying lenders were better equipped to absorb potential losses after having “recapitalised, restructured and bolstered loan-loss provisions”. At the same time, however, it warned that “low interest rates, substantial non-earning assets and reduced business volumes” were likely to keep profits low.
Down but not out
The turmoil Portuguese banks have had to deal with since the financial crisis cannot be underestimated. Between 2008 and 2014, they had to recognise about €40bn in impairments. They raised about €26bn in capital, including state aid, over the same period. In 2014, the country's third largest lender, Banco Espírito Santo (BES), had to be rescued with a €4.9bn bailout as the Espírito Santo family business empire crumbled in one of Europe’s largest financial failures. In December, the new government had to rescue Banco Internacional do Funchal, a small Madeira-based bank, setting aside €2.2bn to cover future contingencies and selling its healthy assets to Santander Totta for €150m.
Amid the upheaval, two of the country's largest listed lenders have seen their market value plummet. From a peak of €3.90 in 2007, shares in BCP have fallen to below €0.05. The market value of Banco BPI, the country's fourth largest lender by assets, has dropped from €6.70 a share to about €1.30 over the same period. Average consolidated return on equity for the sector is about 7%, but considerably lower when overseas operations are factored out.
Bankers believe their stock has been excessively devalued in relation to forecast profitability – an average price-to-book ratio of 0.4 times – and see themselves as no exception to overall European trends. “I would say the markets have been undervaluing Portuguese banking stocks for some time now, and, of course, that is true of European banking stocks as a whole,” says Mr Amado. “There have been shocks, and there has been a growing drumbeat of regulation that means there is still uncertainty over future profitability. There is also a general aversion to risk in the market.”
The most critical uncertainty facing the sector is consolidation. Novo Banco, the 'good bank' salvaged from the wreckage of BES in 2014, has to be sold by August 2017, a deadline extended by the EU authorities after an initial attempt to sell off the lender was abandoned last November because the offers that came in from Chinese and US investors were considered too low.
Banco BPI is almost certain to be taken over by Spain’s Caixabank, which already owns 44% of the lender, as part of a deal that is expected to see the bank’s lucrative Angolan operations sold to Isabel dos Santos, the Angolan investor and BPI’s second largest shareholder.
The changes may not end there. Ms dos Santos, daughter of Angola’s president and Africa’s first female billionaire, has previously proposed a merger between BPI and BCP, a bank in which Sonangol, Angola’s state oil company, is already the single largest shareholder with a 17.8% stake. Such a merger, or the acquisition by Ms dos Santos of a significant stake in BCP, is still seen as a possibility as the ownership and control of Portuguese banks continues to shift.
Movers and shakers
The collapse in share prices has left Portuguese banks particularly vulnerable to takeover. Excluding overseas operations in Poland and Africa, BCP’s domestic price-to-book ratio, for example, is about 0.2 times, compared with an average ratio for European banks of about 0.8.
Political attitudes to consolidation and the challenges facing the banking sector have also changed following the election in recent months of a new government and a new president. António Costa, the prime minister, has censured the previous centre-right administration and, indirectly, the 'troika' of the EU, the European Central Bank (ECB) and the International Monetary Fund, for failing to deal with the problems affecting the banking sector during Portugal’s three-year adjustment programme, when only half of the €12bn set aside for banks from the country’s €78bn bailout was channelled into lenders.
“Portugal has to turn the page on the instability of our financial system,” Mr Costa said in March, promising that his government “will not turn its back” on problems in the sector that needed to be resolved. The prime minister’s criticisms of the Bank of Portugal have also sparked controversy.
The change in political stance has triggered suggestions that Portugal should create a 'bad bank' to absorb the system’s problem loans. Looking back, many believe it would have been advisable to follow Ireland’s 'big bang' approach by creating a 'bad bank' at the outset of the bailout programme in 2011, freeing up lenders to focus on strengthening solvency and profitability. “Instead we have followed the gradualist Japanese model, which resulted in 20 years of stagnation,” says a senior Lisbon banker. Others consider, however, that the additional €30bn that the state would have had to inject into a 'bad bank' would have made the cost of Portugal’s bailout too high for a country already grappling with high levels of debt.
Bankers and analysts are sceptical. “It’s a political decision that I cannot rule out and there could be some lobbying for this if the economy were to deteriorate,” says André Rodrigues, a banking analyst with Caixa-Banco de Investimento. “But following the substantial amount of provisions booked since 2008, and after being subjected to the comprehensive assessment exercises from ECB and to other five examinations of their credit portfolios by the Bank of Portugal, we should not expect Portuguese banks to have many skeletons left in their cupboards.”
Such a move would also be liable to run up again EU competition rules. “I don’t see a ‘bad bank’ as necessary,” says Mr Amado of Millennium BCP. “The stock of NPLs was already decreasing in the second half of last year and this trend is expected to accelerate over the coming quarters. It is something we pay close attention to at Millennium and I think that we have been managing this factor very successfully,” he says.
Gaps in the market?
The provisions banks have had to make against problem loans has slowed the pace at which lenders are returning to profitability. However, the level of NPLs is expected to peak in the first half of 2016 after more than a year in which the amounts being reimbursed have exceeded the new inflow. This should lead to a reduction in provisions – which last year averaged about 1.5% of total lending – although not to the pre-crisis level of about 0.7%. Concerns centre on large specific exposures, particularly in the construction and real estate sectors, which have already been identified.
Under pressure from tougher EU regulation, banks have increased their common equity Tier 1 ratios to an average for the sector of 11.1%, below the EU average of 12.5%, but well above the minimum 8% threshold. However, all banks, except Santander Totta, received some form of state aid during the crisis. “We have already repaid €2.25bn of the state support we received in 2012, but we still have to repay €750m,” says Mr Amado at Millennium BCP. “I’m confident that we will be able to generate capital organically and complete that payment ahead of the June 2017 deadline.” State-owned Caixa Geral de Depósitos (CGD), Portugal's largest lender by assets, still has €900m in state aid to pay back and is expected to need a sizeable capital injection to maintain an adequate solvency ratio.
Banks recognise they still have much to do in terms of restructuring and cost cutting, not just in terms of reducing staff and branches as they have been doing in recent years, but also by preparing for increased digital competition.
“Consolidation will create space for newcomers such as Metro Bank, Virgin Money and Funding Circle to enter the market with new technologies,” says Joaquim Souza, chief executive of CaixaBI, the investment banking arm of CGD. “Because Portugal doesn’t have the scale that technology-based business models require, banks need to ready themselves to compete against challenger banks with European-wide operations.” Mr Vieira Monteiro of Santander Totta says: “Customers increasingly prefer smartphones to branches. New technologies are mandatory for competing with the new digital players.”
Pushing forward
Eduardo Stock da Cunha, chief executive of Novo Banco, sees his main task as putting the lender on the right track in operational terms, while the Bank of Portugal prepares the bank for sale, having abandoned a first attempt last year because the bids that came in were too low. The higher the price, the more Portugal can recoup from its €4.9bn rescue of the bank.
The advisors working on the sale, Deutsche Bank for the Bank of Portugal and JPMorgan for Novo Banco, have recommended exploring all avenues. This may include travelling to New York and London for what are known as early meetings with cornerstone and institutional investors. The plan is to test the waters to see if there is any interest for this type of investment, which could take the form of a private placement of a minority stake with a group of perhaps 20 or 30 investors.
This is seen as an alternative to trying to sell the bank only to strategic investors and it is hoped that a combination of the two methods could provide a way forward. The deadline for selling 100% of Novo Banco is August 2017. “The biggest challenge is to get started,” says Mr Stock da Cunha. “Once we have sold a first stake, we expect things to get easier.” The advisors believe there could be an appetite for this type of investment at the right price. But the final decision will be with the seller: the Bank of Portugal.
Novo Banco’s strong franchise, particularly in corporate lending, is seen as its main selling point. It has a market share in Portugal of about 12% in loans, including 20% of the corporate sector, and 13% in deposits. Buyers could also benefit from the resolution of some of the more costly legacies the bank inherited. For example, refinancing €1.6bn in senior debt that matures in April 2019 should on its own produce savings of €12m a month.
Getting sidetracked
Novo Banco is also creating a side bank as a vehicle for assets to be disposed off. These include its operations in France, Macau, Venezuela and Cape Verde. But it is keeping assets in Spain as part of its core franchise. The side bank will also include most of Novo Banco’s problem loan portfolio, as well as sound credits in segments that are outside its commercial strategy. The value of Novo Banco will to a large extent depend on the value buyers give to this side bank.
In 2015, Novo Banco brought costs down by 13% and expects a further 20% reduction in 2016. “In the beginning, liquidity was our first, second and third priority. But we have addressed that and our priorities now are liquidity, capitalisation and profitability,” says Mr Stock da Cunha. The bank's loan portfolio has been reduced from €41.4bn to €35bn.
Novo Banco has recently reduced staff numbers by more than 600 through mutual agreement and hopes soon to reach a settlement on bringing this total to 1000. It has sold Espírito Santo Investment Bank, shut down its New York office as well as one of two banks in Cape Verde. It started with assets of €73bn. They are now down to €57bn. “That’s a 25% reduction in the balance sheet in two years, “ says Mr Stock da Cunha. “We’re working hard on deepening this restructuring.”
