Belgians break for the border

Belgium’s plucky banks are breaking out of their country’s borders to challenge global competitors in the emerging markets of central Europe and beyond. The top three players, who account for about 80% of Belgium’s banking system, are feeling the pinch from a relatively small and highly competitive market with some of Europe’s lowest net interest margins.

“This is one of the most competitive systems in Europe, especially on net interest margins, which are among the lowest in Europe,” says Elisabeth Grandin, a director at Standard & Poor’s. “In addition to fierce competition on loans granted to clients, net interest margins are low because, on average, a significant proportion of the banks’ balance sheet is made up of low-yield assets, government bonds and so on.”

This means that the Belgian banks suffer from an overall low yield on their portfolios. Margins on new mortgage loans, for instance, are estimated to range between zero and 50 basis points (bp), about half the average of most other European countries.

Merger efficiencies

Ms Grandin points out that the three top Belgian banks are the result of mergers, and adds that they have succeeded in extracting efficiencies from these merger processes. “They have now reached a relatively satisfactory cost:income level,” she says. “Five years ago, domestic ratios were in the 80% bracket, while today they are lower than 70%, and even in the 60% range for some players in the retail business.”

Given the constraints of the domestic market, Fortis, Dexia and KBC, the top three players, have been aggressively building up a presence in the new EU accession countries, and they are also taking a serious look at the promising giants of Asia, mainly India and China.

Fortis made 10 acquisitions in 2005 and another 15 last year in countries across the globe, from Turkey to Canada. Dexia has reinforced its international network, notably in central and eastern Europe with the creation of Dexia Kommunalkredit Bank, while KBC has announced plans for possible further minority buy-outs and acquisitions in the same region.

New geographies

“We embarked on a strategic plan in January 2005, explaining how we would grow this company at a faster pace,” says Jean-Paul Votron, CEO of Fortis. “We set a number of strategic objectives, one of which was to grow the bottom line at double digit CAGR [compound annual growth rate] in 2004-09. We said we would like to build the company further in new geographies and opportunities so that Benelux would represent 70% of profit and 30% for the rest of the world by 2009. The percentage now is about 80% versus 20%, although a third of our staff are now based in Benelux and 10% in Turkey.”

Fortis has made several critical acquisitions in the past two years to develop its footprint and buy the competencies that it was lacking on a global basis. It bought leasing, factoring and private bank businesses, and in retail it acquired Disbank in Turkey and distribution networks in Poland and Germany. From this starting point, the bank expanded, opening many branches.

“In insurance, we developed joint ventures in new countries, such as India, where we bring our expertise in selling insurance products through the bank network to our joint venture partners,” says Mr Votron. “In China, we also have a joint venture and a large distribution network. Our strategy is to take our skills to geographies with high potential, such as Malaysia, India and Thailand, as well as some smaller ones like Portugal, where we have a joint venture with BCP.”

While it embarked on the acquisition trail, Fortis also kept a focus on its business in Benelux, where it has gained market share in banking and insurance. “I’ve always been convinced that you can do well internationally if you are strong in your home market,” says Mr Votron. “I don’t know of many companies that are strong on the international expansion side without holding a dominant position in their home market.

“Another critical factor is that you don’t grow a company by focusing solely on the bottom line. You’ve got to motivate people, work on the brand and pay attention to the environment, which has led to a major initiative in corporate sustainability. However, to generate 70% of your profit in Benelux is a privilege. Fortis has a dominance in this part of Europe and this means we use the Benelux model to conquer other parts of the world.”

Segment export

The bank recently embarked on a plan to define the business segments based on what Benelux core competencies it would export to other markets and build market shares. It elected to do that along several simple lines, says Mr Votron. “Starting with merchant banking, we decided to develop a number of key competency areas, such as the ECT sector, which is energy, commodities and transportation. We also wanted to develop our worldwide funds business. We would do this for merchant and also commercial banking, which is more closely linked to the SME [small and medium-size enterprise] sector, making sure we would have a full distribution capacity in the major European cities,” he says.

The bank’s third business segment is retail, where it defines its core competencies as selling through the branch network and remote channels. “We selected consumer finance activities and started exporting that to other markets,” says Mr Votron. “In insurance, we said we would develop more joint ventures to capture the opportunities of very large markets, mainly for life assurance products through big distribution channels for countries such as India and China with large emerging middle classes. All of this would be supported by strong internal discipline. In practice, this means Fortis has completely changed its way of looking at the world.”

Acquisition trail

KBC is another of the top three league players, one that has traditionally been strong in asset management and the SME market. It is also a market leader in insurance and unit-linked products, particularly in its Flemish-speaking home base.

Danny De Raymaeker, the bank’s general manager for retail and private bancassurance, believes that KBC’s future expansion lies beyond Belgium. “We are actively buying banks and insurers in central Europe, in countries such as Hungary, the Czech Republic and Slovakia, which have in effect become our second home market,” he says.

Danny De Raymaeker: ‘We plan to expand in a focused way in central Europe’

KBC’s most recent expansion in the region was the €185m acquisition of the leading Bulgarian insurer DZI Insurance. As part of the deal, KBC will also acquire DZI Invest, a securities broker active on the Bulgarian Stock Exchange. As a result of the bank’s expansion strategy, more than 50% of KBC’s profit is currently generated outside Belgium.

KBC was an early entrant in those markets and the benefit of that is that it did not have to pay current multiples. Banks are now paying 6x or 7x book, whereas KBC rarely paid 2x book on its acquisitions. “In most places, we started out with minority shareholder positions, and that did not always allow us to have access to some critical information,” says Mr De Raymaeker. “We have now acquired majority shareholdings in all of those banks and insurance companies, except for NLB Bank in Slovenia.

“We recently announced plans to continue to expand in a focused way in central Europe. We have been looking at opportunities in countries such as Serbia, Romania and Bulgaria, but prices in the new accession countries are higher than we are prepared to pay. So the original strategy had to be tweaked a bit and we had to look beyond those areas. We have made some additional investments in Serbia and Hungary, and we are looking at opportunities in Russia and possibly further east.”

Business pillars

Dexia is also cashing in on the economic growth opportunities of central and eastern Europe, most recently with the opening of representative offices in Poland and Romania. The bank’s strategy for growth is to expand abroad on its two basic business pillars, which are public finance and universal banking.

“We are worldwide leaders in public financing of local entities with a strong presence in Europe and the US, but we want to further develop this activity in selected countries outside central and eastern Europe,” says Xavier de Walque, Dexia’s chief financial officer.

“The one major developed country where our presence is limited is Japan, the world’s biggest public finance market, with more than $1400bn in public finance assets. We received a Japanese banking licence at the end of last year and we feel that it is crucial to capture market share in that country.

“We have also opened representative offices in tomorrow’s markets, such as China and India. We need to understand the way these markets work and be prepared for if and when they become accessible to us,” he says.

The second pillar of Dexia’s business is universal banking, comprising retail, private banking and all related activities. In this area, Dexia’s strategy is to achieve a balance between pure public finance and universal banking activities. “This brings diversification, which is well regarded by the rating agencies and allows us to do our business with less equity,” says Mr de Walque. “Also, the second pillar of Basel II recognises the benefit of this diversification, therefore access to retail or private banking funding is a plus.

“Last, we believe that universal banking is a good business to be in within Europe, where there is still room for growth. The penetration of consumer credit in Belgium is on the low side compared with the UK or the US. In Italy, for instance, the mortgage business has potential for growth. We’ve just acquired Denizbank in Turkey, and this is a limited part of our activities, or 11% of our net income in personal financial services, which itself represents about 28% of Dexia’s net income. We expect this to grow to 20% by 2009.”

As for public finance activity, this represents almost 50% of Dexia’s group net earnings, of which 46% comes from Belgium and France, where the bank has market shares of 80% and 42% respectively. “It is difficult to grow dramatically in these two countries,” says Mr de Walque. “The growth will come from countries where we are starting out, such as Japan, Canada and Poland, and from others where our market share is still limited, such as Germany, Switzerland, Spain and Italy. The historical markets of Belgium and France should only represent a third of our business in five years’ time.”

No reason to hurry

The Belgian banks will move cautiously into foreign markets. For one thing, they can count on a very comfortable risk profile at home, with asset quality at an all-time high and the mortgage business starting to show positive trends. They have achieved some significant cost-cutting gains in recent years, and this has made them more relaxed about the impact of interest rates on net interest income and bank profits in 2007. The banking system is one of the strongest in the world.

The banks operate in a rich, diversified and highly open economy. Belgian household indebtedness is low, with a high savings rate of 12% to 14%. Despite the fierce level of competition, Belgian bankers are still relying on cross-selling opportunities to boost the bottom line. Fortis, for instance, has an average cross-selling ratio of about 5.8 products per customer, one of the highest in Europe. Thus the big Belgian players benefit from a high level of commissions.

The downside is that the banks are more dependent on the equity markets, and when the markets are down, customers stay clear of mutual fund investments and this translates into lost commissions.