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The US treasury market reaches breaking point

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June 2001

Problems loom as loan growth slows


After a hectic period of consolidation, Portuguese banks have fed heartily off rapid economic growth, building substantial loan books, particularly in the retail sector. The boom is continuing but credit quality worries are beginning to emerge and a slowdown in growth could seriously hurt banks’ profits.




Portugal's banks have grown rapidly in recent years through consolidation and asset growth, but the warning lights have already begun flashing, signalling a much-feared slowdown in the lending business that accounts for some 60% of their profits.
The customer loan book skyrocketed by an annual 22% across the sector in the 1995-2000 period and growth is still in the high double-digit range. Now a slowdown in the growth of Portugal's economy to 2.5% in the first quarter from 3.3% on average over the past three years has raised doubts about the sustainability of this lending boom.
The danger is that loan volume growth is rolling along at 10 times the underlying GDP growth rate and up to five times the rate for most EU member countries.
       
Caixa: may emerge from its fortress
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So in the context of a slowing eurozone economy, the outcome is obvious: lending has to come down, casting a shadow over Portuguese banks' primary profit source. After consumer lending, Portugal's largest banks derive the remaining 40% of their profits from investment banking, proprietary trading, asset management and life business, none of which alone is capable of generating more than 10% of total revenues.
"In recent years the main driver of lending growth for the Portuguese banks has been residential mortgages," says banking analyst Carlos Pertejo at JP Morgan. "Portuguese families have been borrowing significantly owing to low interest rates and low unemployment. Their indebtedness was equivalent on average to above 80% of disposable income at the end of 2000, compared with less than 20% at the beginning of the 1990s. This could be a problem for the banks if unemployment or interest rates start rising quickly."
Portugal's three-month rates plummeted from an average 20% to 3% in the 1995-99 period. At the same time, unemployment has fallen to historical lows. The country is desperately seeking to fill 100,000 IT jobs, construction workers from as far afield as Ukraine are being brought in to rebuild infrastructure and the health service is hiring Spanish doctors and nurses.
Rising provisions, falling profits
On the face of things, it would require a prodigious stretch of the imagination to envisage doom and gloom. But credit quality concerns have begun to surface. Portuguese banks apply ultra-conservative provisioning policies. They account for all loans 30 days overdue as non-performing and have NPL coverage of 100% to 180%.
The banks' current NPL ratio to total loan book is between 1% and 1.5%, far lower than for most European peers. Yet as one Portuguese banker acknowledged: "If we get a sharper than expected slowdown in GDP, with higher unemployment or interest rates, this 1.5% NPL ratio could easily become 4% or 5% in a very short period of time." Most analysts believe that increased provisioning levels, now at their lowest point in the cycle, are on the cards for this year and that this will lead to a deterioration in earnings. Each of the banks claims to have an effective strategy to deal with the approaching crunch.
The dust has now settled on last year's frantic round of consolidation, leaving four main players in the field. The market does not expect to see any further significant M&A activity in the short term. For Banco Espirito Santo (BES) and Banco Português de Investimento (BPI), which each control 10% to 12% of the market, it has now become a question of how to chip away at the near 30% share controlled by Banco Comercial Português (BCP), now by far the country's largest private-sector bank.
The horse-trading that went on in the wake of the break-up of the vast banking empire owned by Antônio Champalimaud involved Banco Comercial Português acquiring Banco Pinto&Sotto Mayor (BPSM), as well as the smaller family-owned bank Banco Mello and its sister insurance company Cia de Seguros Imperio.
Banco Espirito Santo attempted to negotiate a merger with Banco Português de Investimento in order to achieve a scale that would allow it to compete with BCP. After weeks of wrangling the deal collapsed, officially because the two banks lacked the special chemistry needed to make it work - a euphemism widely interpreted to mean that the two management teams failed to agree on power-sharing.
BPI had serious corporate governance misgivings about merging with another publicly-quoted bank that is effectively a family business. BES is more than 50% controlled by the Espirito Santo family, with another 20% tied up in the friendly hands of France's Crédit Agricole. Spain's Banco Santander Central Hispano (BSCH) also entered the fray to hoover up Champalimaud's Banco Totta e Acores (BTA) and its mortgage lending subsidiary Crédito Predial Português (CPP). BTA is now the controlling shareholder of all BSCH's operations in Portugal. The Spanish group has become the country's fourth-largest private sector bank but it faces an uphill battle to achieve brand recognition.
Before the Champalimaud group break-up, BTA and Banco Pinto were moving closer together and integrating some of their back-office functions. This process must now be undone and BTA also needs to recover market share at a time when consolidation is making competition more intense. Hence the bank's new Spanish owner has its work cut out.
BSCH's Spanish rival, Banco Bilbao Vizcaya Argentaria (BBVA), operates on a much smaller scale in Portugal, with a 1% to 2% market share, and for the moment seems happy to motor on with a moderate retail branch network.
The fourth player - and the largest financial group in Portugal - is Caixa Geral de Depositos, the big public-sector bank whose core franchise is the mortgage lending business. Caixa Geral is something of an anomaly for a state-owned enterprise: it boasts a healthy cost/income ratio of 55.7% as of end-December 2000, comfortably below the 58.6% average for the three big private-sector banks.
In fact, Caixa's efficiency ratio showed a dramatic improvement to 49.5% in the first quarter. At the same time its return on equity (ROE) stood at 23.8%, in line with the top tier of Europe's most shareholder friendly banks. "Caixa used to be viewed as a sleepy competitor," says Sam Theodore, managing director for European banks at Moody's Investors Service. "It is now modernizing and streamlining its operations and it is expected to be a solid player."
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