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Headline: Banks face second wave of mergers
Source: Euromoney
Date: June 2000
Author: Jules Stewart
Last year five private-sector banking groups dominated the Portuguese market. The number has now been whittled down to four. And next year? Jules Stewart reports
"All we can say with certainty is that the next round of consolidation will be the one you weren't betting on," says António de Sousa, chairman of state-owned savings bank Caixa Geral do Depósitos (CGD). De Sousa says that in his previous role as governor of the Bank of Portugal he was often asked what he envisaged as the pattern for future bank mergers. "It was assumed that the logical move would be for the family-controlled groups to pool their resources, while the others would get together through the normal merger process of private-sector banks. What we have seen in the last round is just the opposite."
The recently completed second round of consolidation involved Banco Comercial Português acquiring the family-owned Banco Mello and Banco Pinto & Sotto Mayor (BPSM), one of the Champalimaud family banks, as well as insurer Imperio. Meanwhile the family-dominated Banco Espírito Santo (BES) negotiated a merger with Banco Português de Investimento (BPI), a group with no family interests. In the end the BES-BPI deal collapsed, officially because both sides realized the merger lacked the "special chemistry" needed to make it work - a euphemism interpreted by the market to mean that the two management teams failed to agree power-sharing terms. Given the Espírito Santo family's tight control over their bank, BPI is generally viewed as the last takeover target of any significance up for grabs in the Portuguese market.
BPI has three large foreign shareholders. Spain's La Caixa has 12.4%, as does Brazil's Itausa group, and Germany's Allianz holds an 8.9% equity stake. They are strategically important stakes but none of these investors is closely involved in the management of BPI, which remains under the tight control of chairman Artur Santos Silva and his deputy, Fernando Ulrech. Banking sources in Lisbon say Allianz is upset at not being allowed to market its life products through BPI, which uses its own subsidiary. They say that if one of these shareholders were to fall out with BPI the stake could be sold on to a domestic or foreign predator.
António Champalimaud, Portugal's richest man with a personal fortune by all accounts equivalent to 2% of the country's GDP, has been a key figure in the reshaping of the banking sector. In 1995 he was hailed as the saviour of what was at that time the third-largest bank, Banco Totta & Açores (BTA), which he snatched from Spanish hands at a cost of Esc153 billion ($680 million). The controlling stake in BTA was owned by Spain's Banco Español de Crédito (Banesto), the failed group taken over the previous year by Banco Santander, now a partner in the BSCH group. Banesto's move into BTA was a political embarrassment as the Spanish bank had bent the rules by using two Portuguese law firms as proxies to acquire its stake. So anxious was the previous centre-right government of Aníbal Silva to see BTA back in Portuguese hands that it exempted Champalimaud from takeover regulations that would have required him to bid for the bank's entire share capital.
Champalimaud, at that time a tycoon in his seventies, had once more established himself as a kingpin in Portuguese banking. Hounded into exile after the 1974 left-wing revolution, the reclusive billionaire rebuilt his banking empire in Brazil and on his return to Portugal he bought back a bank of his that had been nationalized, Banco Pinto e Sotto Mayor (BPSM), and his old insurance company, Mundial Confiança.
Roughly at the same time BCP pulled off Portugal's biggest-ever bank takeover with the acquisition of Banco Português do Atlántico, the country's largest bank. The driving force behind BCP is Jorge Jardim Gonçalves, another émigré who fled to Spain after the 1974 revolution to work for Banco Popular Español. Back in Portugal, he founded BCP as a bricks and mortar start-up and after the latest round of mergers it has now become Portugal's leading bank.
The first phase of consolidation, the reprivatization and in particular the re-acquisition of banks by families dispossessed by the revolution, was successful. It also entailed the consolidation of small and in some cases highly troubled banks into larger groups. These moves resulted in stronger, more commercially oriented management, and they diluted asset quality problems within larger and stronger groups.
The second round of consolidation started last year with Spain's Banco Santander Central Hispano (BSCH) negotiating to acquire both Champalimaud group banks, Banco Pinto and Banco Totta, a move fiercely opposed by finance minister António de Sousa Franco and a contingent of Portugal's most powerful bankers. In order to avoid an EU court case that could have dragged on for two years or more, BSCH in the end accepted a Solomonic solution for the break-up of the Champalimaud empire. BSCH acquired Banco Totta and Champalimaud's small investment bank, while Banco Pinto went to Caixa, which as expected later sold it on to BCP.
Now the dust has settled on the latest shake-out, Portugal is left with two institutions, BCP and Caixa, which between them account for almost 60% of the market, leaving Banco Espírito Santo, Spain's BSCH and BPI as strong second-tier players. The enlarged BCP group will control around a third of the domestic banking market, and will have a market capitalization of around e10 billion compared with e3 billion for BES and e2 billion for BPI.
"There is limited scope for another round of bank consolidation," says Ian Centis, banking analyst at Chase Manhattan. "What we have now is BCP which, with the acquisition of Banco Mello and Banco Pinto, has pipped Caixa Geral to the top post in terms of assets. They are not in a position to make a major acquisition for the time being as they need to concentrate on consolidating these two acquisitions, which will require some effort."
BCP concedes that there is scope for further consolidation in the Portuguese market, although the bank's director general, Rui Alexandre Lopes, emphasizes that it would be difficult to read the tea leaves. "Given the size of Portugal's financial markets the country might be best served with three large players in the same way that other European banking systems have achieved a similar scale of consolidation," he says. "We are about halfway through digesting the Mello acquisition in terms of integration and it has been made easier by similar IT and systems platforms. We've just got started on Banco Pinto, which is a larger bank than Mello. So this is a process with two different timetables. I would say that 'busy' is a word that can describe our state of affairs today."
Foreign expansion
Lopes says the challenge is not so much one of making a move in the Portuguese market in order to achieve greater scale, but rather to grow the bank's business outside its home market. "Our concern is to expand abroad and Europe seems to us to be the desired target market, where we have focused on assessing and implementing investment opportunities," he says. BCP is launching a joint venture in Greece with a local group, Inter-American Life Insurance Co, to set up a bancassurance operation. In the Netherlands it is teaming up with insurer Achmea to start a joint venture bank aimed primarily at medium- to high-net-worth individuals. "BCP could eventually consider some opportunities in the Portuguese market in a niche-like way," says Lopes. "This could be a small deal with the capacity to increase our franchise in a given financial activity or market. It is not easy to see a
large transaction now in which we would participate."
With BCP on the sidelines the only domestic player in a position to launch a bid would be Banco Espírito Santo. Chase Manhattan's Centis, however, points out that the bank's ownership structure could be an inhibiting factor to making an expensive acquisition, as opposed to a straightforward merger, which is what had been on the cards with BPI. "The other possible bank that could be a consolidator is BES, which is effectively family controlled," he says. "They have stated before that they don't like paying high goodwill charges. They focused on merging with BPI, which would not have incurred goodwill charges, but that deal went awry. BES is a very well managed institution but being controlled by a family they may be reluctant to dilute themselves out, so they would probably find it difficult to raise additional capital to carry out an acquisition without undermining their own control."
Manuel Pinho, a member of the BES executive board, says he believes the Portuguese banking landscape has stabilized for the time being. "The only doubt would centre around BPI now that the merger talks with us were not successful," he says. Pinho insists that the failed merger does not pose a setback for BES, which he says is quite happy to go it alone. "We have absolutely no problems dealing with the current situation," he says. "There are plenty of examples at international level where mergers have not worked out. For a merger to succeed there must be a special chemistry. It's not only about figures. As we looked closely at the structures of the two banks it became clear that the value to be created was not as large as we had initially believed."
Pinho says the bank's strategy has been one of organic growth while remaining open to other possibilities. "Now we are back to square one," he says. "If by chance any acquisition at domestic or international level arises we will look at it in a professional manner, but we
are not obsessive about it. Our return on equity is close to 25% and our costs ratio is below 50%, so we are in good shape to carry as in the past."
Pinho says the bank's international focus will be opportunistic, investing in niche markets when the opportunities arise. It has decided to sell its Brazilian bank, Boa Vista, to Bradesco, one of Brazil's three largest banks, and take an equity stake of about 5% in the latter bank jointly with its partner Crédit Agricole. "Boa Vista represented a problem of size," he says. "It was somewhere in a no-man's-land and the alternatives for us were to go out and buy a larger bank or sell it."
BES is placing its bets on organic growth in the domestic retail market, in areas such as consumer credit, mortgages and asset management. "We are not ignoring capital markets and corporate business, but the priority is really retail banking," says Pinho. "A second priority is to control costs and our cost-to-income ratio is already the best in the market."
Market sources say a "merger of equals" was the only chance BES had of striking a deal with BPI, as it is too expensive for them to consider buying it outright. European banking analyst Carlos Pertejo at JP Morgan estimates that BPI is on a reported price to book value of 2.8 times, compared with 2.3 for Banco Espírito Santo and 2.6 for BCP. "On a price to net asset value basis a buyer would have to make a significant investment plus a premium and a price to NAV of 3 times for BCP, compared with 2.3X for BES or 2.5X for BPI," he says. "Portugal is a small market and there is probably no room for more than three important names. The BCP merger with Banco Mello, Imperio and BPSM, as well as BES with BPI, made sense, although at the end of the day the latter deal fell through due to personal problems among the top management of BES and BPI."
The banking sector may have stabilized for now but the factors that led to a second round of consolidation are still lurking out there. The market has been expanding dramatically, with loan growth of up to 25% in recent years, and local banks have to contend with pressures from abroad and e-banking. "This is creating tremendous pressures on the smaller banks," says João Morais, head of research at Banco Santander de Negócios Portugal. "This will in turn bring pressure to bear on profitability and efficiency, especially on BES and BPI." Morais says he had difficulty seeing the logic of the BES-BPI merger. "BES is a more traditional bank that perceives the business as a network of relationships, while BPI has a more youthful and entrepreneurial outlook. This is a problem in domestic consolidation. When it is a classic takeover of a smaller organization by a bigger one, such as BCI's acquisition of Banco Mello, the dominant partner is clear from the outset. In a so-called merger of equals things tend not to match and eventually someone has to relinquish power."
For now Portugal's banks are still riding a high of consumer spending, with mortgage lending and consumer credit in general averaging 20% annual growth over the past five years. Banco Espírito Santo reported net income growth of 20.6% in the first quarter compared with the same period the previous year, and its 25% return on equity makes it the most profitable of the big banks. BPI showed even stronger growth, with net interest income up 26.7% and a 34% increase in loans, and BCP posted a 20.5% gain in net attributable profit.
The most important task facing the large Portuguese banks is that of digesting what they have recently consumed, says Andrew Cunningham, banking analyst at Moody's Investors Service. "They must show that their management structures can cope with a larger scale of operations and can successfully combine previously distinct management teams."
"My great source of concern for the Portuguese banks is asset growth," says Chase Manhattan's Centis. "It has been sustaining the banks' profitability. Non-interest is still not high enough to take the strain. The average Portuguese customer is keen on spending money on mortgages, and in fact a lot of the commissions stem from lending fees, so a fall in asset growth could also bring a fall in commissions. BCP on a like-for-like basis in the first quarter reported a net interest revenue growth of 2.8% on loan growth of 33% compared with the same period last year."
Caixa Geral plays an important role as power broker, as was seen in the Champalimaud saga, and though it took over the tycoon's insurance business, Mundial Confiança, it is not in the business of acquiring private-sector banks. "Our growth has to be organic," says Caixa chairman De Sousa. Despite its state ownership Caixa has become a serious competitor in market sectors that were until recently the domain of the retail banks. Until the home loan sector was deregulated in 1992 Caixa accounted for about 90% of the mortgage lending market. This has now been trimmed to 36% by competition from the other banks but Caixa has shaken off its stodgy image and is taking on the banks in lending to large corporates, which it grew by 100% last year and new areas such as M&A through Banco Totta Soto Mayor, a small investment bank that ended up in the Caixa group as a result of the break-up of the Champalimaud empire.
Caixa's only direct participation in the last round of bank consolidation was a small stake it acquired in BCP in lieu of part payment for Banco Pinto. It is also developing e-commerce jointly with Espírito Santo and Portugal Telecom. Caixa has also built up an 18% market share in asset management and has also been expanding internationally, in Brazil as well as in Spain where it owns three small banks. De Sousa says discussions are under way for ventures in some east European countries. He says that Portuguese banks could exploit competitive advantages in countries soon expected to join the EU given Portugal's experience in transition politics. "We have a clear limitation in that we cannot participate in certain types of consolidation," says De Sousa. "At this moment in the Portuguese and European consolidation process we are comfortable being a public sector bank, but we shall see what happens in four or five years' time."
A banker who was closely involved with Caixa's deal-making during the Champalimaud affair says: "Caixa is one to keep your eye on."
The foreign predator
If Portuguese banks are seen as temporarily out of the running with regard to the next stage of bank consolidation, the push is logically going to come from abroad. The large British, German and French banks have shown little interest in the Portuguese market apart from taking small stakes in several financial institutions and supporting their investment banking teams on privatization and M&A advisory work. Moody's Cunningham believes it is unlikely that foreign banks will enter the market aggressively and try to displace local players. "The local players are too well entrenched and already provide a reasonable level of service, and the size of the Portuguese market makes it an insufficient prize for a major European player looking for a strategic enhancement to its existing business," he says. Portugal accounts for about 1.6% of the eurozone's combined GDP and 3.4% of its population.
The Spanish, on the other hand, have been pursuing a more aggressive Portuguese strategy, partly to get a foothold in a small but accessible and dynamic retail market and also to provide a service base for their corporate customers doing business in Portugal.
"The key question is what the Spanish banks intend to do next," says JP Morgan's Pertejo. "It is important for Spanish banks to have a presence in the Portuguese market to support their clients in Spain. They can centralize operations such as back office, technology, asset management and capital markets in Spain, while leaving the distribution network in Portugal, thereby significantly reducing their cost base. There is a good chance that BES or BPI could go to a Spanish bank. BSCH would probably look at any opportunity to buy another bank and boost its market share to a level similar to what they have in Spain."
The Champalimaud settlement boosted BSCH's market share from 2% to 11%, a substantial stake for any foreign bank in a European market. This is still only about half of the level it controls in its home market. Meanwhile its chief Spanish rival, Banco Bilbao Vizcaya Argentaria (BBVA), apart from buying broker-dealer Midas and setting up a network of about 115 branches, lags well behind BSCH in Portugal. BSCH also got full control of Banco Totta, which will become a key plank in its international expansion into Latin American markets. BBVA, on the other hand, prefers to acquire minority equity stakes and run its foreign bank subsidiaries through local management. BSCH has decided to keep Totta as a separate franchise rather than amalgamate it into the group. The Spanish bank looked at the experience of BCI, the product of a merger of four small banks in the 1990s. The holding company decided to rebrand its acquisitions under the BPI logo and consequently lost market share from customers who were unhappy about losing their relationship with a familiar name. BSCH is considering the options of setting up a holding company for the group to have a single listing in Portugal or maintain Totta's separate listing, depending on the free float once the IPO is completed. If there is a large overhang, the Spanish bank will probably keep Totta as a separately listed entity, but if BSCH is left with 100% of Totta it is more likely to set up a group holding. BSCH has anyway agreed with the Bank of Portugal that the group will be supervised on a consolidated basis.
Spanish strategy rethink
BBVA is monitoring the situation very closely, according to a Spanish banking source. BSCH and BBVA have about the same number of branches in Portugal but BSCH has placed itself well ahead of its rival through its recent acquisitions. BBVA's European strategy, on the other hand, is viewed as incomplete and has focused until recently on a 10% stake in Italy's BNL. "They have been surprised by the political problems involved with cross-border deals and are rethinking their European strategy," says this banker. "BBVA only wants to invest if it can achieve a dominant role, albeit without taking a majority equity stake. They appointed the chief executive officer at BNL and have many members on the board as well as a key influence in strategy decisions. They are looking at Portugal on the same basis, which is the policy they have deployed in Latin America as well."
BSCH has opted for a European strategy of taking stakes in major foreign institutions, holding on to them to using these shareholdings at a future date for bargaining or to establish some joint ventures so they get to know each other, which is what they're doing with Société Générale. That strategy is predicated on ownership of existing institutions in foreign markets. BBVA's strategy has so far been very different, because all they have in Europe is the 10% stake in BNL. They seem to be focusing much more on internet banking through the merger of their own Uno-e with France's First-e. "The strategy is not to start spending money by taking positions in other European banks, as it is already a bit on the late side and valuations are high," says Centis. "Instead they will try to set up a 'Latin' internet network that will appeal equally to Spaniards, Portuguese, Italians and South Americans. It really depends on the character of the foreign participant that wants to go into Portugal, and whether it thinks that it's necessary to take a stake or instead bet on the development of the internet and virtual banking."
A BBVA link-up would provide BCI or another bank with a badly needed international dimension. Portuguese banks have mainly a domestic focus and where they have ventured abroad the focus has been to be present in countries where there are Portuguese emigrants, or in culturally similar markets such as Brazil and Spain.
"The Portuguese economy has been growing quickly, loan growth has been expanding with interest rates on the decline," says JP Morgan's Pertejo. "This clearly cannot last for ever. We'll see lower loan volume growth and while the Portuguese banks are mostly profitable, well-managed institutions with good franchises, they are small." Even BCP, he says, which has been trying to buy small entities in eastern Europe, will need to spend the next three or four years digesting their recent acquisitions. "But in the longer term their lack of international diversification is a weakness," says Pertejo.
Portuguese and Spanish banks can provide one another synergies in their respective Latin American markets of Brazil and the Spanish-speaking countries. António Guerreiro, chairman of investment bank Banco Finantia, says Spain and Portugal form a natural Iberian corridor to Latin America. "This has been overlooked by the big banks," he says. "This concept has its own cultural identity, while the large houses see it more from the perspective of New York or London." Guerreiro believes the only card left to play is BPI and that if there is an approach the likelihood is it will come from outside Portugal. He doubts that a move by BSCH would be well received by the government after the recent confrontation over the Champalimaud episode.
BBVA's co-chairman, Francisco González, believes European bank mergers are commanding excessively high prices and he says BBVA prefers more "imaginative solutions" along the bricks and clicks approach. Sources close to BBVA say that while Portugal is a natural market for any Spanish bank, given BBVA's size there is no possibility of a merger among equals with any Portuguese bank. They say it would have to be an outright takeover involving high premiums and goodwill charges.
Apart from the Portuguese market itself, if BBVA wants to enhance its presence in Brazil, which accounts for about 50% of Latin America's economy, the most logical step would be to move in on the back of a Portuguese partner. None of the two big Spanish groups now active in Brazil has achieved any success without the help of local or Portuguese partners. Brazil, like Portugal, is a market where BBVA has fallen behind its main Spanish competitor. BBVA's Brazilian market share is below 1% while BSCH, when it completes its $1 billion acquisition of Banco Meriodional de Brasil, will have 3.1% of the market.
"Despite the Latin similarities, Spanish banks find the language and cultural barriers difficult to overcome," says a Portuguese banker.
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