WHEN BANCO ESPÍRITO Santo (BES), the banking unit of Portugal’s Espírito Santo Financial Group (ESFG), announced on May 18 that it expected compound annual growth of 20% a year until 2010, investors saluted its confidence and sent the shares higher – BES’s by 2.23% and ESFG’s by 1.8% – feeling justified in their valuation of the bank at a higher multiple than rivals such as Millennium BCP and Banco BPI.
Yet BES and ESFG – the latter also controls non-life insurance company Tranquilidade and other businesses – have hardly been an overnight success. "We have grown fairly consistently over the past 15 years but because of where we operate and our size, we are only rediscovered by analysts and investors on an intermittent basis," says Manuel Villas-Boas, director and president of the executive committee of ESFG based in London.
BES and ESFG are finding favour because the Portuguese economy, which accounts for the vast majority of their revenues, is showing signs of recovery, having been moribund for much of this decade: it grew just 0.3% in 2005 and 1.3% in 2006 and was widely expected to perform poorly in 2007. However, in the first quarter of 2007, GDP grew 2.1% year on year, according to Instituto Nacional de Estatística, the Portuguese government statistics organization.
"The big question is whether the recovery in Portugal is sustainable," says Daragh Quinn, analyst at Lehman Brothers in London. Most forecasters believe it is. In early May, the European Commission revised Portugal’s GDP growth estimates upwards: it now expects growth of 1.8% in 2007 compared with the 1.5% it had predicted earlier, and 2% in 2008 from 1.7% previously forecast. The Bank of Portugal, the central bank, is even more bullish: it expects GDP growth to hit 2.4% in 2008 – compared with its earlier prediction of 2.1% – and believes it will reach 3% in 2009.
Moreover, on May 1, Fitch Ratings revised Portugal’s outlook to stable from negative, noting that the economy was growing more rapidly than expected and – most important – that the government was making efforts to tackle its large budget deficit. Portugal is rated AA for foreign currency and local currency debt, with a short-term foreign currency rating of F1+ and a country ceiling of AAA, which is the level for eurozone members.
"Portugal’s public debt ratio now looks set to stabilize sooner and at a significantly lower level than previously expected, improving the credit outlook," says Chris Pryce, director in the Fitch sovereigns team in London. Portugal cut its fiscal deficit in 2006 to 3.9% of GDP from 6% in 2005 and is expected to get it below 3% – the level set by the European Union as the maximum permissible – in 2008.
BES’s chief economist, Carlos Almeida Andrade, notes that the reduction in the deficit is improving confidence in sustained economic growth in the near future. At the same time, structural reforms such as those being applied to public administration, and new investments, such as a high-speed train network and a new international airport, indicate that the outlook for Portugal will improve.
Andrade expects GDP growth of 1.7% in 2007, 2% in 2008 and 2.5% by 2010, driven by "stronger net external demand" while "increased exposure to fast-growing economies [both inside and outside the eurozone], structural reform efforts and fiscal consolidation are expected to improve Portugal’s growth potential over the medium and long term".
However, as Villas-Boas points out, the recovery in Portugal is still nascent and therefore not the main driver of the group’s recent impressive performance. "From a holding company perspective, the recent performance of our banking and insurance subsidiaries is all the more interesting because it was achieved during a period of economic stagnation in Portugal," he says.
A banking odyssey
When considering the current state of the Portuguese financial sector, it is important to remember that the country’s politics, society and economics have changed beyond recognition in living memory. Portugal spent four decades under a dictatorship that ended following a bloodless coup in 1974. The left-wing government that followed placed much of Portugal’s industry in state hands: indeed, the alleged actions of the Espírito Santo family in backing a counter-coup in 1975 hastened, according to some observers, the nationalization of the financial sector.
The Espírito Santo family was forced to flee to Spain and, although active in international banking in the 1980s – founding various banks and fund management operations – it was unable to re-establish the group in Portugal until the government changed in the mid-1980s and privatization of a wide variety of industries began, following amendments to the Marxist-style constitution of the 1970s.
In 1986 – as Portugal joined the European Union – ESFG regained its foothold in the Portuguese market by establishing Banco Internacional de Crédito with Crédit Agricole; by 1990 it had bought back its Tranquilidade insurance operation from the government; and finally, in 1991, it bought back 40% of BES from the government – again with Crédit Agricole’s support – before taking full control in 1992.
"The legacy of privatization was remarkable," says Villas-Boas. "During the period when banking and insurance was nationalized there was a huge pent-up demand for financial products that only came to be realized when the banking and insurance sector was set free – prompting significant growth."
At the same time as financial companies gained the freedom to determine their own future, they were forced to compete with international operations because privatization had been accompanied by liberalization of the market when Portugal entered the EU. Consequently, financial services companies in Portugal needed to reform themselves extremely rapidly.
"Fortunately, ESFG – and some other financial companies in Portugal – were able to harness the demand for financial services and the efficiencies gained through technology and new banking practices to be able to compete head on with foreign competition," says Villas-Boas. "The Portuguese banking sector worked quickly enough to prevent any foreign competitor gaining an opportunity to grow organically." Indeed, Santander Totta, which was purchased by Spain’s Grupo Santander in 2000, is the only sizeable international banking operation in the country.