Portuguese banking aristocracy: Time for family planning

Banco Totta & Acores (BTA), one of Portugal’s leading banks, was in turmoil last January. Its shares were in free fall, its chairman had resigned in a huff and investors were on the point of revolt after the announcement of a proposed dividend abysmally below market expectations.

Historically one of Portugal’s most profitable banks, Banco Totta was the first to be returned to the private sector under a government decree that effectively overturned the nationalization policy of Portugal’s 1974 revolution.

The market knew that last year – Banco Totta’s first full year of operation under new ownership – would be a difficult period of adjustment. But the bank’s fall in net profit to Esc15.6 billion ($90.28 million) from Esc17.2 billion in 1995 came as a bitter disappointment. It was generally accepted that sharply higher bad-debt provisions – part of a balance-sheet clean-up – were going to eat into profits. However, shareholders felt they had been let down by a proposed Esc135 a share dividend. The market expectation had been Esc190 (with profits of Esc18 billion forecast by the bank’s management during a roadshow for international investors), a payout that would have been in line with the previous year’s, thus topping the 6.8% T-bill yield by about two basis points instead of what would be a yield of 200bp or so below the 10-year bond.

Selling point

“One of the selling points of bank privatization was the promise to shareholders of better dividend yields than they could expect to earn on T-bills,” says Graca Graca Moura, Banco Portugues de Investimento (BPI) bank analyst.

The day the dividend was announced by Luis Champalimaud – who had just been appointed head of the financial services empire that includes Banco Totta – bank chairman Alipio Dias handed in his resignation. Dias, a long-serving Banco Totta executive, had always been identified with a generous dividend policy.

That was on a Friday. The following Monday Banco Totta’s shares tumbled 10% on the Lisbon stock exchange. The collapse did not slow until they had shed 25% of their value. The market was desperate for some sign of hope from Banco Totta that would halt the blood letting, the most severe a Portuguese bank had experienced since reprivatization.

Enter Antonio Champalimaud, Luis’s father, an almost sightless near-octogenarian, a former exile and the richest man in Portugal, with a personal fortune estimated at $1.5 billion. Two years ago Champalimaud paid Esc153 billion in a controversial deal to acquire a controlling stake in Banco Totta, the country’s third-largest bank, from Banesto (Banco Espanol de Credito), the Spanish bank which was at that time the target of a Pta313.4 billion ($92.4 million) rescue operation undertaken by Banco Santander.

In a dramatic statement that overrode his son’s tight-fisted dividend proposal, Champalimaud said he would ask the bank’s shareholders to consider accepting a “significantly higher dividend”. The market heaved a sigh of relief. This was assurance that the godfather of Portuguese banking was still at the helm, with his shareholders’ best interests at heart.

Once more Champalimaud showed that he was still in the driver’s seat. “No-one takes any major policy decision without consulting Antonio Champalimaud,” says a banker at Banco Totta. “The group has a strategic council that formulates strategy and it is headed by Champalimaud.”

The bank’s shareholders finally accepted a compromise Esc145 per share dividend with the promise of better times to come. “In the end the dividend yield was unchanged from the previous year at 5.7%, below market expectations but still at the higher end of the banking sector,” says BPI’s Moura.

Banco Totta’s dividend episode dispelled any doubts the market might have had about Antonio Champalimaud’s ability and willingness to wield his stick when key strategic matters were at stake.

Champalimaud lost an earlier banking empire when he was hounded into exile in 1974 by Portugal’s left-wing revolutionary leaders. It was the second time in his career he had found himself on the verge of financial ruin. This time, sensing a pending upheaval in the final years of Portuguese dictator Antonio Salazar’s rule, he had taken the precaution of building a base in Brazil, where he set up one of the country’s largest cement businesses.

Champalimaud was the leading figure among a handful of old-guard entrepreneurs whose pre-revolution family businesses accounted for a sizeable chunk of Portugal’s GDP. Others included the Espirito Santo dynasty, which staged a dramatic return by buying back its old firm, Companhia de Seguros Tranquilidade, the country’s leading insurer, as well as the family-owned Banco Espirito Santo, reprivatized in 1991. It has built this into a broad-based financial services group that includes retail banking, a mortgage lender, insurance and a leading stockbroker and investment bank.

Banco Espirito Santo’s rise has been spectacular among the reprivatized family banks. Analyst Inigo Lecubarri, research director at Salomon Brothers in London, says it has the best brand recognition of all Portuguese banks, which represents true franchise value. “The bank holds a leading position in financial services, such as insurance, leasing, asset management and investment banking,” he says.

The intertwined Portuguese banking aristocracy also includes the Mello family, to which Antonio Champalimaud is linked through his first marriage to Jose de Mello’s sister. Mello’s vast holdings in chemicals, tobacco, shipping and insurance were once equivalent to 5% of Portugal’s GDP. After his return from exile in Brazil, Jose de Mello rebuilt his fortunes at a whirlwind pace through investment banking company MDM, set up with former partners Deutsche Morgan Grenfell and Morgan Guaranty.

There followed a complex comeback to banking. In 1992 Mello regained control of his insurance firm, Companhia de Seguros Imperio. In 1995 Imperio acquired the troubled publicly-owned bank Uniao de Bancos Portugueses (UBP). The group’s retail banking activities were transferred to UBP, whose name was changed to Banco Mello Comercial, then Banco Mello. It is now Portugal’s leading medium-sized bank. Through Imperio, the Mello family controls 51% of the bank.

Ambitious target

Banco Mello has completed its integration process; Isabel Botelho of its strategic planning department says the aim is to boost return on equity (ROE) to 15% by next year, an ambitious target since last year’s ROE was below 1%. The bank managed to post net income of Esc503 million last year, a sharp turnround from an Esc1.83 billion loss the previous year.

“We are confident we can achieve that ROE target with a projected Esc9 billion profit,” says Botelho. “We have done a major strategic assessment of the retail and corporate markets and we are exploring alternative channels of distribution. Our priority areas include consumer credit, which is growing at 20% to 30% a year, and mortgage lending.”

After a dizzying round of reprivatizations and takeovers involving several name changes, Portugal’s new banking groups have begun to digest and consolidate the structures springing from their recent acquisitions.

Doubt continues to overshadow the Champalimaud group’s prospects. One concern is the calibre of the man running a financial services conglomerate that includes two large retail banks, a big mortgage lender and, since last year’s takeover of Chemical Bank’s Portuguese operations, an investment bank.

“Luis Champalimaud is an untested commodity,” says a banker in Lisbon. “The market is wary of his lack of experience and questions his ability to pull the group together into a coherent and rational structure.”

Antonio Champalimaud’s family life has twice been marred by tragedy. One of his sons, Miguel, died in a car accident 12 years ago. Last year another son, Joao, was bludgeoned to death by a tenant farmer living on one of the Champalimaud estates. The killer, in a rage over an eviction order, decided to take his revenge on the family. With Joao’s death the Champalimaud business dynasty lost its heir apparent – hence Luis’s rise to prominence.

One of the main problems the group faces is its dispersed structure. Champalimaud’s 50%-owned investment vehicle, insurance group Mundial Confianca, is one of three separately listed companies – the others are the two retail banks, Banco Totta and Banco Pinto & Sotto Mayor (BPSM).

BPSM was owned by Champalimaud before the revolution and he regained 80% control of it in 1994 through Mundial Confianca. Mundial Confianca has a controlling stake in Banco Totta, a much larger bank. Banco Totta owns 43.4% of the group’s mortgage bank, Credito Predial Portugues (CPP).

“It is not a very rational structure and investors who want exposure to the Champalimaud group and to its enormous cost-cutting and cross-selling potential find it difficult to know exactly what the effect of their policies will be,” says Joao Bouca Morais, head of research at stockbroker Banco Finantia.

Management concerns

Among the problems: the group runs non-integrated IT systems, the various dealing rooms are now under one roof on Chemical’s former premises but each bank operates in its own name, and there are concerns over the quality of management at BPSM, which has an Esc40 billion pension shortfall.

Market sources say the lack of a clear corporate structure and strategy in implementing restructuring and rationalization across the BPSM group is the main investment concern for all the group’s stocks, and hence for Banco Totta.

Antonio Champalimaud is now set on enhancing the group’s transparency through his so-called Project Harmony and he has brought in Morgan Stanley to look into the possibility of a capital restructuring and to help devise a rationalization plan.

“Management quality, especially at BPSM, is an issue that needs to be addressed urgently,” says a Lisbon banker. “One of the reasons Champalimaud bought Chemical was to surround himself with younger and more capable professionals.”

But time may not be on the patriarch’s side. Pressure is growing from competitors as well as shareholders to move quickly towards an integrated and transparent structure for the four main group member companies.

“Portugal does not exist in isolation and you cannot run a transparent banking group without it being transparent,” says this banker. “A lot of the Portuguese banking system is owned by foreign institutional investors who want reliable information and transparency.”

Takeover unlikely

The takeover option is deemed unlikely, at least not on a hostile basis. To a certain extent Portuguese banking remains a “family affair”, as witnessed by a gentleman’s agreement recently struck between Champalimaud and the Espirito Santo family to come to one another’s aid in the event of an unwelcome bid by a third party.

This does not rule out the possibility of some sort of business union between the two families. An eventual link-up between Champalimaud and the Espirito Santo family, with whom he shared the post-revolution years of exile, has been mooted as a possibility. There would be mutual benefits – Champalimaud would resolve his management problems through access to Espirito Santo’s top-rated banking team. Banco Espirito Santo would acquire critical mass on a par with Portugal’s largest banking groups and position itself more comfortably to meet growing competition from abroad.

The Portuguese banking sector’s aggregate assets of about $250 billion would make one good-sized bank elsewhere in Europe – in Portugal they are divided among more than 40 domestic players. Portuguese bankers tend to play down the issue of size, but it does enable a bank to build business through expansion and diversification at home and abroad.

Banco Espirito Santo now ranks third among Portugal’s four big private banking group in terms of assets – excluding state savings bank Caixa Geral de Depositos, the country’s largest financial institution – with more than a quarter of the banking system’s total deposits. Unlike its peers, Espirito Santo has eschewed the recent takeover mania and devoted resources to organic growth.

“We do not rule out an acquisition,” says Manuel Pinho, a member of the bank’s executive board. “All we are saying is that, given the market prices of the day, it did not make sense to get involved in the acquisition process and ignore our potential for organic growth. If a good opportunity at the right price were to come along we would consider it our duty to look at it. But through organic growth we have cornered a 12% market share, our 17% return on equity is the sector’s highest and we rank first or second in areas such as new mortgage business, stockbroking, bancassurance and leasing. So for us the policy of organic growth has paid off.”

Champalimaud’s biggest challenge comes from Banco Comercial Portugues (BCP), one of Europe’s most remarkable banking success stories. BCP, a venture started from scratch in 1985, made a record Esc308 billion takeover of Banco Portugues do Atlantico (BPA) last year that catapulted it to a near 19% market share in terms of assets, second only to state-owned Caixa Geral. Its Esc23.3 billion net profit last year rivalled that of sector leader Banco Espirito Santo’s Esc23.6 billion.

Driving force

BCP’s driving force is Jorge Jardim Goncalves. Like Champalimaud, Mello and Espirito Santo, he was an émigré who fled after the revolution. He worked in Spain for Banco Popular Espanol and was imbued with the work ethic and professionalism of the Spanish bank’s guiding influence, the secretive Catholic lay organization Opus Dei. On his return to Portugal, Goncalves rose to the top of BPA but was lured away to start Banco Comercial Portugues and later came back with a takeover bid for his former employer.

“The decision has been not to merge the two banks but rather operate them as two different franchises and produce cost synergies,” says Salomon Brothers’ Lecubarri. These were achieved by creating Servibanca, a unit dedicated to coordinating the integration of systems, operations and property, and providing autonomous support and strategy units to look after head-office strategic implementation. “The result has already been integration, outsourcing and a 20% staff reduction,” says Lecubarri. In short, a model of efficiency for the unwieldy Champalimaud group.

Transition year

As analyst Vasco Moreno at Santander Investment in London points out, 1996 was a transition year for BCP and the bank has already completed its operational and balance sheet restructuring at Atlantico. “The quarterly reduction in personnel expense, the improvement in asset quality, the strong insurance performance and the increase in net interest margin were positive highlights of the year,” he says. “With the relaunch of Atlantico and staff reductions, everything is in place for significant improvement in core earnings from the first half of 1997 onwards.”

Goncalves striking a deal with Champalimaud has also been mooted as a possible move in the restructuring of the banking sector, bearing in mind that as recently as 1993 Goncalves hinted at his interest in acquiring Banco Pinto & Sotto Mayor. Also, Goncalves holds a 20% stake in Champalimaud’s investment vehicle, Mundial Confianca. This is viewed as a potential springboard to a future tie-up with Banco Totta.

A merger with the Champalimaud group would leave the combined BCP-BPA group with more than a third of the banking system’s total assets, a market share unrivalled by any European bank and would surely be a mouth-watering prospect for Goncalves.

“There are prospects for a major alliance involving the Champalimaud group,” says Jose Freire, general manager at stockbroker Espirito Santo Dealer. He points out that size becomes a concern in the light of European economic and monetary union (Emu). “You need economies of scale to be efficient,” he says. “With the elimination of the currency risk and interest rate differential there will be nothing to stop a big German bank, for instance, coming in and deploying its large capital to aggressively market the same range of products it sells at home. There is also a real risk that Portuguese banks could lose a lot of their top clients to much larger foreign competitors.”

Foreign banks have also been turning up the pressure, with varying degrees of success, in retail as well as wholesale operations. Of the four foreign banks competing for retail business, UK bank Barclays and Spain’s Banco Bilbao Vizcaya (BBV) grew their profits significantly last year. Banco Santander’s Banco de Comercio e Industria (BCI) and the local unit of French bank Crédit Lyonnais just managed to scrape by above break-even. Banco Santander, which runs a profitable investment banking operation in Lisbon, is expected to hold on to BCI for reasons of prestige. Crédit Lyonnais, on the other hand, has failed to attract a Portuguese buyer. “The fear is that once Crédit Lyonnais is taken over by a Portuguese bank it will be deserted by its largely French base of corporate clients,” says a Lisbon stockbroker. Finibanco and Banif are two Portuguese banks that have already turned down a Crédit Lyonnais acquisition.

Barclays, with net profits of Esc2.06 billion last year, is the top performer among foreign retail banks. “We have restricted our target market,” says Tom Luke, Barclays deputy general manager in Lisbon. “We are looking at the top end of the market instead of trying to compete across the board. With 61 retail branches we’ve got the network pretty much where we want it.”

Putting Champalimaud’s group together with Banco Espirito Santo or Banco Comercial Portugues would, some bankers say, make sense as a defensive strategy to cushion rapidly growing competition from Banco Portugues de Investimento (BPI). BPI started life in 1986 as an investment bank, run by one of Portugal’s most wealthy and skilled bankers, Arturo Santos Silva. It was the first to gain expertise in privatization and led some of the top deals along with international majors such as Deutsche Morgan Grenfell and Barings.

In the last 10 years BPI has blossomed into the country’s third-largest private financial group. Net profit soared 56% last year to Esc15.1 billion, by far the strongest performance of any Portuguese bank.

BPI’s growth has come through acquisition, spending more than a quarter of the near Esc700 billion that has been shuffled about the Portuguese financial services sector in mostly hostile bids over the past few years. BPI will concentrate this year on digesting its new subsidiaries and is likely to start seeing the benefits of its rapid expansion drive by 1998.

The other big players will certainly want their banks restructured and in shape by then to confront the challenge. The sector will face a tougher environment in the coming months, without the benefit of the spectacular trading profits that bloated last year’s results.

Margins will probably stabilize this year after halving over the last five years at a rate of adjustment unseen elsewhere in Europe. “The sector is at a turning point,” says Salomon Brothers’ Lecubarri. “On the positive front, consolidation has led to fewer domestic players, asset quality is improving and foreign competition should remain subdued.”

However, Lecubarri points out that Emu, if it happens, will take a big toll on the Portuguese banks given their relatively small size and the large European trade that originates in Portugal. Record trading profits cushioned a lot of underlying problems, in particular, heavy cost structures and consolidation costs.

The Portuguese banking system has shown itself remarkably agile and capable of adapting to change swiftly. As late as 1990 banks operated under a quota system whereby the government dictated the location of every fifth new branch. That was followed by a system of financial rationing that imposed an Esc40 million fee for each new branch. Today Portugal’s interbank automated teller machine network is the most sophisticated in Europe and the banks’ electronic payment system allows you to drive through a motorway toll booth and have an optical reader automatically debit the toll charge on your account.

“The banks have gone full speed on a modernization drive and they will not hesitate to make very aggressive moves to protect and grow their market share,” says an American banker in Lisbon. “Survival will depend largely on size in the retail sector so it would not come as a surprise to see further consolidation, and that almost by definition will involve the Champalimaud group.”