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Western EuropeMay 4 2008

Shoring up the defences

Just as the dust was settling on the chaotic attempted takeover of Banco BPI by Millennium BCP, the global credit crunch came along. Peter Wise reports on a tumultuous 18 months for Portugal’s banking sector.
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By the traditionally prudent standards of Portuguese banking, 2007 was a tumultuous year. After the collapse of a hostile €5.32bn- takeover bid for smaller rival Banco BPI, Millennium BCP, the country’s largest listed bank, was shaken by a series of bitter boardroom wrangles and central bank investigations into alleged malpractices.

The fallout was felt across the sector. As the management impasse at Millennium BCP dragged on through four agitated shareholder meetings, Carlos Santos Ferreira moved from his post as chief executive of state-owned Caixa Geral de Depósitos, the country’s largest bank by deposits, to take over as CEO at BCP, with a clear mandate to restore calm.

The dust from these domestic battles is only just beginning to settle. But any prospect of Portuguese banks experiencing a more tranquil 2008 after the upheavals of last year has been rudely shattered by the global credit crunch.

“This year will be much tougher than 2007,” says BPI’s chief executive Fernando Ulrich, who led the bank’s successful defence against the BCP bid. “We now face challenges that affect the whole international financial system. This is much more serious and much more challenging than a merger plan or something domestic of that nature.”

Merger proposal

 

After the failure of the BCP offer, BPI, the smallest of Portugal’s big five banks, responded with a friendly merger proposal, which Mr Ulrich describes as much more favourable to BCP shareholders. BCP’s then management rejected the deal as “inadequate and unacceptable”.

The possibility of a BCP/BPI merger is now “part of history”, says Mr Ulrich. Mr Santos Ferreira, the discreet 58-year-old who has taken over at BCP, has also ruled out any merger or acquisition (M&A) activity. “I’m not opposed to consolidation moves,” he said at a recent conference, “but I think banks will be much busier dealing with liquidity problems and other difficulties arising from the international situation”.

Aggressive expansion is not what is expected of Mr Santos Ferreira, a respected manager who prefers to keep out of the media spotlight. Lisbon bankers see his appointment as a move encouraged by the Socialist government to restore peace at one of Portugal’s top corporate flag carriers.

His candidacy was criticised by opposition parties as a veiled form of government intervention in BCP’s affairs but he was elected in January by an overwhelming majority of 71% of shareholders.

Coping with the crisis

Rather than domestic consolidation, Portuguese banks are now focused on individual strategies for weathering the global credit squeeze. As lending decelerates, most are targeting deposit growth, with BPI and BCP leading the expansion of branch networks to extend their customer base. Credit and price risk controls are being strengthened and capital management discipline tightened. Banks with overseas operations, particularly BCP, BES and BPI, are channelling investment into the markets with the strongest growth potential.

Lisbon bankers say that shareholders are currently bearing the brunt of the crisis through share price depreciation and the cost of capital increases. Commercial banking customers, they say, are benefiting from better deposit remuneration on the same borrowing terms. “Financial margins are tightening because banks cannot increase charges on the lending side at the same pace as the cost of funding is rising,” says BPS’s Mr Ulrich.

The slow pace of economic growth in recent years means that Portugal may be more resilient than some other European economies to the impact of the credit crunch. Portugal’s finance minister Fernando Teixeira dos Santos told The Banker: “Despite increased oil and commodity prices, the appreciation of the euro against the dollar and a restrictive fiscal policy, Portuguese companies have succeeded in diversifying their export markets, increasing the technological content of their exports and gaining market share in some regions. The economy has grown more robust and is now in a better condition to face the uncertainties and challenges of the international situation.”

In Portugal, at least, the credit squeeze is not being aggravated by inflated house prices. Real estate prices have been virtually flat since 2001, falling well below the average EU growth rate.

“Property values in Portugal are one-third to half the level they have reached in Spain,” says Ricardo Espírito Santo Salgado, chief executive of Banco Espírito Santo, the country’s third largest bank, with a market share of about 20%. “The level of mortgage risk here is much lower.”

The direct or indirect exposure of Portuguese banks to the US subprime market is also virtually zero. He adds: “Here on the western coast of Europe, we saw subprime products passing over our heads and landing in countries such as Germany and France.”

Withstanding shocks

After consulting banks in September, Vitor Constâncio, governor of the Bank of Portugal, said he was satisfied that no special initiatives by the central bank were required. The “robustness and ability to withstand shocks” of Portuguese banks, he said, was reflected in their share prices, which had closely tracked the average evolution of the European banking sector since the crisis began.

However, there has been no escape from the consequences of the global credit squeeze in terms of a sharp increase in funding costs, a fall in trading revenue and fees from capital market, asset management and related activities, and the pressure on solvency ratios caused by the falling value of equity holdings and bond portfolios.

Because most Portuguese banks lend considerably more than they can fund from their own deposits, analysts say that their margins are particularly vulnerable to fluctuations in the cost of funding on international markets.

Radical change

To illustrate how radically the funding market has changed, Mr Ulrich cites two recent three-year bond issues by big Spanish banks at spreads of 90 basis points (bps) to 100-plus bps over Euribor. A year ago, the spreads would have been 10bps to 15bps. He says: “The difference is astronomical, but that is now the benchmark for three-year money.”

In this starkly different climate, both BCP and BPI, the two protagonists of last year’s takeover battles, are preparing rights issues to shore up their capital ratios. BCP aims to raise €1.3bn in a capital increase fully underwritten by Merrill Lynch and Morgan Stanley. Its core Tier 1 ratio fell to 4.3% at the end of 2007, down 1.2 percentage points from the previous year and below the 5% minimum recommended by the Bank of Portugal.

By 2010, BCP plans to push the ratio up to 6%, which it sees as “the right level for the bank’s risks”. The new shares, due to be listed in May, are being offered at €1.2 each, a discount of about 45% on the share price when terms were announced in early April.

BPI plans to raise €350m in a rights issue, expected to be completed by June. The bank aims to improve its Tier 1 ratio by 150bps, lifting it back above the group’s long-standing threshold of 7% after it slipped to 6.2% last year. It intends to keep its core equity ratio at about 5.5%, increasing from a 2007 level of 5%.

BCP executives describe 2007 as a “lost year” that has forced the group into a downwards revision of its growth targets for 2010 after suffering a 28.4% slide in consolidated net income last year to €563.3m. Costs related to the BPI bid totalled €183m. BCP has also recorded a €300m equity adjustment dated from January 1, 2006 as a prudential measure relating to central bank enquires into alleged purchases of its own shares by offshore companies set up by the bank. It says that the measure does not represent any admission of wrongdoing.

On a brighter note, the 37.3% fall in BCP’s net income in Portugal to €450.9m last year contrasted with a sharp gain in net earnings from overseas operations, mainly in Poland, Greece and Africa, which rose 64.7% to €112.4m.

Earnings and profit

Despite the combat with BCP, BPI lifted net earnings by 15% in 2007 to €355.1m. Operating profit grew by 27%. During the past two years, it has also achieved stronger loan and deposit growth than any other big Portuguese bank, a total increase of 32%, compared with 29% for its nearest rival, BES.

By the end of 2008, an investment programme will have expanded BPI’s domestic network to 740 branches, on a par with the other top four banks except BCP, which had 872 Portuguese branches at the end of 2007.

BPI is committed to maintaining a long-term policy of paying out 40% of annual profits in dividends. But BCP has postponed the distribution of about €90m in unpaid 2007 dividends, saying that it would resume dividend payouts on 2008 earnings.

Both BCP and BPI have disposed of almost all their equity holdings, with the exception of mutual stakes in each other’s shares, mainly arising from last year’s M&A manoeuvres. In March, BPI posted potential capital losses of €111m for its BCP holding and a further €161m for its bond portfolio.

BES, which has large equity stakes in Brazil’s Banco Bradesco, Portugal Telecom and Energias de Portugal, the dominant power utility, has continued to post strong growth in unrealised capital gains, despite the turbulence that has seen Portuguese stock market indices drop back to 2001 levels. But these gains fell to €423m in March, from €839m at the end of 2007.

Since a failed attempt at a friendly merger with BPI in 2000, BES has focused successfully on organic growth in Portugal and what Mr Salgado calls a “virtuous triangle” of overseas markets – Spain, Brazil and Angola. Spared the takeover battles that absorbed BCP and BPI in 2007, BES achieved net profit growth of 44.3%, placing it almost a year ahead of schedule in its medium-term business plan to achieve a net profit of €850m by 2010 and lift its market share by two percentage points to 22%.

Cost of funding

Mr Salgado estimates that the cost of funding for Portuguese banks is now about 14 times higher –145bp – than before the subprime crisis began in August. Greater risk aversion has led to a marked reduction in the issuing of credit-backed bonds and causing a significant increase in the number of emissions retained or used as collateral with the European Central Bank. BES, Mr Salgado says, is well positioned in this difficult climate because of a €2.4bn short-term liquidity surplus and a €6bn portfolio of rediscountable securities.

Given today’s market difficulties, the timing of BES’s €1.3bn capital increases in 2006 has also proved opportune. The group’s core Tier 1 ratio fell from 7% in 2006 to 6.6% at the end of last year, but remains the highest for a listed bank in Spain and Portugal.

“Our strong capital base places the bank in a better position to grow and to weather difficulties,” says Mr Salgado. “We have always been able to raise capital when it was needed and we have never destroyed capital by making acquisitions that involve paying excessive prices for goodwill.”

Organic growth

Emílio Botín, chairman of Spain’s Santander, has also made clear that the group’s Portuguese bank, Santander Totta, is focusing solely on organic growth. “We want to continue growing in Portugal in the same way as we have done up to now,” he told reporters on a recent visit to the northern city of Porto. Totta was “the most efficient bank” in Portugal, he said, and would post strong results for 2007.

Totta, acquired by the Spanish group in 2000, is now Portugal’s fourth- largest bank with a market share of about 12%. In 2006 it achieved the highest return on equity (25.1%) as well as the lowest cost-to-income ratio (46.2%) of the top five banks. Net income rose 25% in that year to €425.2m. Operating income increased by 13.2%, one of the best performances in the sector.

Led by its new CEO, António Faria de Oliveira, state-owned CGD, the country’s biggest bank by total assets and deposits, is seeking to expand its foothold in Spain. Mr Faria de Oliveira, who headed the group’s Spanish operations before succeeding Mr Santos Ferreira, is understood to have targeted a 2% share of the Spanish market, increasing from about 0.5% today.

In 2007, the group lifted consolidated net income by 16.7% to €856.3m. CGD, which is Portugal’s biggest insurer, has also been given a green light from the government to float some of its insurance assets on the stock market.

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