Portugal's banks have undergone a radical transformation in the past few years, emerging from the country's economic crisis better capitalised, leaner and more efficient than ever. Profitability, however, is yet to recover.

After the global financial crisis and a three-year bail-out programme, the new-look banking sector that emerges in Portugal will have undergone a considerable transformation: fewer branches, fewer staff, fewer non-core operations, a tighter focus on domestic lending and possibly, following potential consolidation, fewer big groups.

“There will be big differences,” says Nuno Amado, chief executive of Millennium BCP, the largest listed lender. “The market for financial products and services has shrunk. Core income is down 40% from just a few years ago. There is less appetite for risk, less demand for credit and a sharp decrease in mortgage lending. This means banks have to adjust.”

Banks are entering a new era marked by regulatory and legislative changes, according to António Vieira Monteiro, chief executive of Banco Santander Totta, Portugal’s fifth largest bank by assets. “Banking will change completely in the next decade,” he says. "Relationships with customers will be reinvented and retail banks such as ours will have to focus much more on transparency and intelligibility.”

José Maria Ricciardi, chief executive of Espirito Santo Investment Bank (ESIB), sees 2014 as “a year of transition” for both the Portuguese economy and the banking industry. He is confident that “important turnarounds” made by lenders in response to the adjustment programme will have a “positive effect on their strength” creating an “optimistic framework” for growth.

Trimming the fat

Portugal’s post-bail-out banking sector will inevitably be smaller and leaner. But bankers believe it will also be more efficient. In the decade to June 2013, for example, BCP reduced staff numbers by 36%, or almost 5000 jobs, to 8700 employees. It cut its branch network back by 26%, or 280 branches, to 797 branches over the same period.

Restructuring on this scale has been partly driven by state support provided to several leading banks as part of the rescue programme agreed with the 'troika' of the European Commission, International Monetary Fund and European Central Bank. Overall, funds totalling more than €7bn have been injected into Caixa Geral Depósitos (CGD), BCP, Banco BPI and the smaller Banco Internacional do Funchal (Banif) on the condition of extensive restructuring.

State-owned CGD and BPI, the largest and fourth largest lenders by assets, respectively, have also made commitments to reduce staff numbers and trim branch networks to comply with rules for companies receiving state aid. The restructuring plan that BCP agreed with the EU’s competition authorities is “very demanding”, says Mr Amado. In October, the bank sold its stake in Greece’s Piraeus Bank for €494m as part its agreement to divest non-core assets.

BCP is already ahead of the plan, however. Mr Amado says: “I think the result will be a bank that is leaner and more focused on delivering better products and services to our customers, in line with their specific needs.” As part of its commitment to reduce staff costs, the bank also reached an agreement with its workers in December on temporary salary cuts of between 3% and 11% for a maximum of three years as an alternative to eliminating more jobs. The cuts are to be repaid from future profits.

“Profitability is the big issue for the banking sector,” says Joaquim Souza, chief executive of Caixa-Banco de Investimentos (CaixaBI), CGD’s investment bank. However, like most Portuguese bankers, he is confident that profitability will not fall again as low as it did in 2013, an annus horribilis for Portuguese bank earnings.

Profit squeeze

Among Portugal's banks, only Santander Totta achieved a net profit (€88.6m) for its domestic operations last year. BPI posted a consolidated net profit of €66.8m, but recorded a €28.3m loss in Portugal. BCP’s losses improved 40% on 2012, but were the biggest in the sector at €740.5m. CGD saw it losses fall to €576m and Banco Espírito Santo (BES), the third largest bank in Portugal by assets, to €517.6m.

Since the beginning of the crisis, banks' profits have been under pressure from impairment costs and higher provisioning requirements. At the same time, domestic operating income has been hit by low interest rates, lower business volumes and increased non-performing assets that have to be funded even though they generate no revenue.

According to a recent report by credit rating agency Moody’s, Portuguese banks rank among the least profitable in Europe, but are also some of the most efficient, having significantly reduced operating costs. “The cuts,” says Moody’s, “achieved partly by closing unprofitable branches and reducing staff, have resulted in efficiency indicators that compare well with western European peers.”  At the end of 2013, the average cost-to-income ratio for the top five Portuguese lenders was approximately 64%.

A heavyweight of mortgage loans – which represent more than 45% of total lending to the private sector – is among the biggest constraints on Portuguese banks'  profitability. Manuel Preto, chief financial officer at Santander Totta, says most mortgage loans were negotiated at 100 to 150 basis points above Euribor, the European interbank interest rate, when the cost of deposits for Portuguese lenders was close to Euribor or even lower. Now banks have to compete with deposit rates at much higher spreads, significantly increasing their funding costs and adding to the pressure on profits. 

The rise of the deposits

Deposits have become the predominant source of funding for the sector as the crisis restricted alternative sources of finance. BES says that deposits accounted for 46% of its total financing in 2013 (53% including life insurance products) compared with 16% for debt, noting that this was a “significant contrast to 2009”. BPI and Santander Totta posted similar percentages, while CGD and BCP were dependent on deposits for 68% and 67% of their funding, respectively.

Bank deposits have remained considerably more resilient in Portugal than in some of the eurozone's other crisis economies, such as Greece, Ireland or Spain, suggesting, says BES, that “confidence in the banking sector has remained strong” and reflecting a rising trend in savings in Portugal. According to the National Statistics Institute, household savings have risen by almost 8 percentage points since 2008 to 13.5% of disposable income. Competition for this increasingly important source of funding has grown steadily more intense, straining efforts to reduce cost-to-income ratios. “It is important to diversify our deposits base and strengthen customer relationships,” says Mr Amado of BCP. “We also need to ensure that our cost structure is appropriate for the new environment.”

Mr Vieira Monteiro of Santander Totta says: “The emphasis has to be on customers and market segmentation. This is a consequence of the huge transformation we have seen in the banking market in recent years when the focus has moved from selling mortgage loans and other products to tailoring services to customers’ specific needs and lifecycles.”

Right direction

The bail-out years have seen a significant improvement in solvency levels. The average core Tier 1 capital ratio of Portuguese banks has risen from 8.1% in 2010 to 11.7%, well above the 10% minimum set by the Bank of Portugal in 2012. This increase has been mainly driven by state support. From Portugal’s €78bn bail-out, €12bn was set aside for bank recapitalisation, of which about half has been used by the BCP, BPI and Banif, while state-owned CGD received €1.6bn directly from the state. 

Injections of state capital were administered to BCP and BPI by means of contingent convertible bonds, or CoCos, which convert into state-owned equity if a trigger, such as a bank’s core capital ratio, breaches a predetermined limit. BCP has outlined plans to repay €400m this year, when it expects to return to profit, and the remaining €2.6bn by mid-2017. BPI has already repaid €580m and was expected to pay back a further €500m by the end of March. Banif has repaid €150m of the €400m it received.

Access to private sector finance has been steadily improving for banks and corporates, however, with some lenders tapping the capital markets with senior and covered bond issues. BES, for example, has issued €3bn in debt since it led the way in reopening wholesale debt markets for Portuguese banks in November 2012. In December 2013, it became the first Portuguese lender to issue subordinated debt since the global financial crisis with a €750m Tier 2 issue that attracted some 300 mainly foreign investors. In January this year, it issued €750m in senior unsecured debt at a yield of 4%, compared with 6% in late 2102. 

“The markets are now open,” says Mr Souza at CaixaBI. “As there’s no longer any question of a euro break-up, investors are showing more appetite for Portuguese risk. It’s now a management decision for banks whether they want to use ECB funding, which is cheaper, or to issue an unsecured senior bond, which helps them diversify their funding, create a yield curve and set a benchmark for their risk.”

Natural selection

One area of investment that has rallied rather than closed down during the bail-out has been privatisation. Since 2011, Lisbon has raised an impressive €8.1bn from a series of successful sell-offs, comfortable outstripping the €5bn target set by the troika.

The sales include stakes in Energias de Portugal (EdP), the dominant power utility, Redes Energéticas Nacionais (REN), the national power and gas grid operator, and Correios de Portugal (CTT), the national postal service. CGD sold 80% of its insurance business, the market leader in Portugal, for €1bn and France’s Vinci bought 100% of Aeroportos de Portugal, the national airports operator, in a deal worth €3.1bn.

More than half the privatisation revenue raised so far during the adjustment programme has come from Chinese state-owned and private sector companies. “All the privatisations were decided on the basis of price, not political influence,” says Pedro Siza Vieira, a Lisbon-based managing partner of the law firm Linklaters. “That is very comforting – you pay the price, you get the deal.”

Despite being privatised during the depths of the crisis, companies were not sold at knockdown prices. The EdP stake, for example, was sold at premium of almost 54% per share and REN at a premium of 33.6%. The sale of CTT in November marked Portugal’s first initial public offering (IPO) in five years, raising €579m for a 70% stake. The highest proposal for a direct sale had previously valued the whole company at €600m. Since the IPO, the company’s market value has risen by about 20% to approximately €1bn. CaixaBI and JPMorgan Chase were global coordinators and bookrunners for the IPO. Spain’s BBVA and ESIB were co-lead managers.

The privatisation programme is now drawing to a close with only waste management company Empresa Geral do Fomento (EGF), CP Carga, a railway logistics company, and a number of management concessions to run ports and urban transport systems remaining on the list of planned sell-offs. TAP-Air Portugal, the national airline, may also be put on the market, but bankers say the government will have to resolve complex labour and tax issues with its Brazil-based maintenance operation before TAP is likely to attract investors. In 2012, Lisbon rejected an offer for the airline from a Brazilian investor, citing a lack of financial guarantees.

As the privatisation programme dwindles, investment bankers see their main sources of revenue shifting more towards mergers and acquisitions, IPOs and private placements. “You have to reinvent yourself,” says Mr Souza. “The loss of business from privatisations should be compensated for by capital markets operations."

ESIB has responded to shrinking domestic demand by expanding in overseas markets where the bank believes it has “natural competitive advantages”. The bank is already active in Brazil and Spain, says Mr Ricciardi, and plans to expand in Angola and Mozambique. “In 2015, ESIB will be a very different bank to the one that went into the crisis,” he says. The same will almost certainly be true for every other Portuguese lender.

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