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Western EuropeMay 1 2006

Competition heightens

Millennium BCP’s bid for Banco BPI will make competition in the banking sector even more fierce, even if it fails. Peter Wise reports.
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Portuguese banking is about to undergo a seismic shift. The decision by Millennium Banco Comercial Portugues (BCP), the country’s largest listed bank, to launch a €4.3bn takeover bid for Banco BPI, the smallest of the top five banks, is already altering the landscape of the sector several months before the final outcome is decided.

“Nothing can go back to where it was before,” says Bruno Duarte, a London-based analyst at Fox-Pitt, Kelton. “Whether it succeeds or fails, the bid will have an important impact on a sector where the pressure to reduce costs to enhance revenue growth is already strong. Competition, which has been fierce, will become even more aggressive.”

The highly competitive climate of Portuguese banking was reflected in BPI’s robust rejection of BCP’s cash offer as “wholly unacceptable”. In a strongly worded defence document, BPI chairman Artur Santos Silva said: “Given BCP’s record on governance, value destruction and its industrial plan, BPI shareholders should reject this option out of hand.”

Mark of sophistication

The battle over BPI is a measure of the level of sophistication of Portuguese banking, which is considered the most advanced and competitive sector of the country’s economy. “Portuguese banks are competing at the same level of efficiency as banks in the UK and Spain,” says Luís Bento dos Santos, a board member of Santander Totta, Portugal’s third largest private sector bank.

Freed from state controls in the 1980s, liberalisation, privatisation and the opening of the market to foreign competition have obliged banks to sharpen their competitive edge much more than other, more protected sectors of the Portuguese economy. “Competitive demands have resulted in levels of efficiency that have been highly beneficial to customers, employees and shareholders,” says Mr Bento dos Santos.

Profitability, solvency, return on equity and efficiency levels in the Portuguese banking sector are all significantly above average European levels, says Eduardo Stock da Cunha, also a member of the Santander Totta board.

Cost margin remains

BCP’s bid for BPI is an indication of the margin that remains for some banks to tighten costs still further. BCP calculates that it could reduce the costs of a combined BCP-BPI group by 11%, a saving of €232m a year that would result in a cost/income ratio of 50%, down from the current 63% for BCP and 58% for BPI.

Despite economic growth of less than 1% a year, Portuguese banks have been producing strong earnings. However, the introduction of new international accounting standards – BCP prides itself on being the first European bank to report consolidated results using the new rules – has made comparisons between 2004 and 2005 more difficult.

Several Portuguese banks invested heavily in early retirement programmes in 2004 but these are not expressed as non-recurring costs using the new rules. In reality, the net profits of several of the biggest banks showed little real growth in monetary terms between December 2000 and December 2004, despite year-on-year percentage gains.

The Bank of Portugal also permitted banks to write off goodwill against reserves in a way that is not possible under the new accounting standards. This has tended to inflate the return on equity levels of several Portuguese banks that made large-scale acquisitions in recent years.

In this context, BCP’s bid, announced in mid-March, is aimed at creating “a genuine Portuguese champion” that would take its place among the top five banks in the Iberian peninsular. Success would lift the group’s market share from 25% to 35% of deposits and from 22% to 31% of lending. Market capitalisation would grow from €9.1bn to €12.7bn.

This would place BCP definitively ahead of Caixa Geral de Depósitos, Portugal’s wholly state-owned bank, which leads the market in terms of deposits and mortgage lending with market shares of 27.8% and 28.7% respectively.

But Paulo Teixeira Pinto, BCP’s chief executive, says it is not leadership in Portugal that is his chief concern. “We have no ambition to become a ‘national champion’ because the championship we’re playing in is in Europe, not Portugal,” he says.

Bid for critical mass

The offer for BPI was not a reversal of the group’s strategy of international growth, as some analysts have claimed, but a bid to gain critical mass to expand more aggressively overseas. “The stronger we are in Portugal, the faster and more effectively we can grow abroad,” says Mr Teixeira Pinto. BCP plans to gain one-third of its income from outside Portugal by 2008. Operations in Poland and Greece currently account for almost 10% of its total earnings.

After losing a contest in December to buy Banca Comerciala Romana, Romania’s biggest bank, BCP may opt to create a Romanian bank from scratch, says Mr Teixeira Pinto. And Turkey is another market where the bank may expand. “We think in terms of markets, not geopolitical regions, and Turkey could prove to be Europe’s biggest emerging market. We have a small operation there already and if an opportunity arises that fits our strategy we could expand,” he adds.

“BCP is not a Portuguese bank with international operations,” he stresses. “We are a multi-domestic bank with our headquarters in Portugal. We aspire to be the most important bank not only in Portugal, but also in Poland and Greece. We may be far from that today. But how many people thought we would be number one in Portugal when we started out 20 years ago?”

Long-term plan

The merger of BCP and BPI has made sense for a long time, he says. But after taking over as chief executive from Jorge Jardim Gonçalves, BCP’s founder, in March 2005, Mr Teixeira Pinto wanted a proven track record before advancing. In the event, BCP reported record net income of €753.5m in 2005, up 24.2% on 2004 and the biggest annual profit for a Portuguese bank to date.

BCP has sought to woo BPI’s management and core shareholders, expressing admiration for Fernando Ulrich, its chief executive, and describing the unsolicited offer as a “unilateral merger proposal” that would increase the value of both banks. BCP has also offered to welcome BPI’s core shareholders as leading investors in the merged group. Brazil’s Itaú group and La Caixa, the Spanish savings bank, each own 16% of BPI. Allianz of Germany holds 9%.

Stern rebuff

The overture has been met with a stern rebuff from BPI. Its board has urged shareholders to reject BCP’s offer of €5.70 a share, saying it substantially undervalues the group and its potential for growth. “BPI has a significantly superior governance model in terms of costs and accountability of management,” the board said, adding that acquisition by BCP would “destroy a significant number of skilled jobs” and prove prejudicial to BPI customers.

Comparing track records, BPI says that it has provided shareholders with an average return of 18.4% a year over the past decade, compared with BCP’s 7.9%. In response to the BCP bid, BPI has put forward a five-year business plan in which net profit is forecast to grow at an average of 15.6% a year until 2008. The plan envisages cutting the cost/income ratio from 58% in 2005 to 48% by 2010.

BPI’s defence rests partly on an ‘armour plating’ clause in its statutes that limits the voting rights of any shareholder to 12.5%, regardless of how many shares they own. BPI is proposing to raise this limit to 17.5%, which would increase the voting rights of Itaú and La Caixa. BCP’s offer is conditional on the abolition of these limits, which it sees as restrictive of minority shareholders’ rights and damaging to share value.

BCP and BPI are both confident of success but the outcome of the bid, which is not expected for several months, will ultimately depend on BPI’s core shareholders. “The only way never to fail in operations like this is not to launch them at all,” says Mr Teixeira Pinto. Whatever the result, winners and losers will both emerge from the battle into a more aggressively competitive market

Complex challenges

Caixa Geral de Depósitos (CGD), Portugal’s biggest bank in terms of total assets, is protected from the cut and thrust of stock market takeovers by virtue of state ownership. The group faces equally complex challenges, however, as it seeks to consolidate its position as Portugal’s biggest mortgage lender and compete more effectively in other market segments.

“At four million, we have considerably more customers than any other bank,” says José Ramalho, a CGD executive director and board member. “The challenge is to cross-sell more products and gain a greater share of the wallet of this extensive customer base.” CGD estimates its cross-selling to be about three products per customer, less than that of the big private sector retail banks.

The bank’s cross-selling focus is on structured savings products and investment funds, providing alternatives to the rolling six-month term deposits that have long been its mainstay. It is also seeking to expand in areas where it believes it has not yet reached its natural market share, says Mr Ramalho. This includes corporate lending, for which the group has opened a dedicated network of more than 40 branches.

CGD also leads the market in automation, with about 75% of banking operations being made through automatic teller machines, telephone banking and the internet. The group’s strong investment in this area led to exponential growth in 2005, with monthly use of electronic banking growing 100% year-on-year in some months. Automation is seen as an important means of lowering the group’s cost/income ratio, which decreased from 66.3% in 2004 to 59.7% last year.

CGD is also segmenting its traditional network of about 770 branches, with special sections for more affluent customers requiring more sophisticated products. Unlike most Portuguese banks, which are closing branches to cut costs, CGD plans to open several new branches in Lisbon and some other large cities.

Network expansion

Santander Totta is the only other big Portuguese bank that is expanding its network, with 30 new branches planned for 2006 in addition to 46 new openings last year. Totta, which was acquired by Spain’s Santander group in 2000, has the lowest cost/income ratio in Portuguese banking at 43.4% in 2005, and is using this low-cost basis to market competitive products in targeted segments.

This strategy has enabled the bank to grow above its natural market share of 11% in areas such as mortgage lending, where it has a market share of 14.5%, investment funds (18%), life insurance (13%) and credit cards where its share has grown from 5% to 10% since 2000.

Banco Espírito Santo, Portugal’s second largest listed bank, plans a €1.5bn capital increase to help fund an expansion programme aimed at increasing its overall market share from 18% to 20%. Its approach to investors is based on a track record of increasing the group’s market capitalisation from €786m in 1991 to more than €4bn last year. Allowing for dividends and previous capital increases totalling €1.8bn, this represents an average annual return for shareholders of 13% over the past 14 years.

BES will use €450m of the capital raised to acquire 50% of Tranquilidade Vida, the group’s life insurance operation.

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