Portugal: Bigger should be even better

Armour-plated against approaches

The cover of a recent edition of Portuguese magazine Exame announced the failure of Iberianization. Portugal and Spain, it suggested, remain stubbornly apart, and attempts to forge closer links between the two countries have amounted to little. As if on cue, the latest opportunity to build a meaningful relationship between leading Spanish and Portuguese banks disappeared.

On May 17 it was announced that an agreement and cross-shareholding between Spain’s new banking superpower, Banco Santander Central Hispano (BSCH), and Portugal’s largest private bank, Banco Comercial Português (BCP), was to be dissolved. The following day each bank repurchased its shares from the other. Iberianization, it seems, failed again.

Portugal’s largest listed companies Market cap (€bn) 1 Portugal Telecom 5.9 2 Banco Comercial Português 5.5 3 EDP (Electricidade de Portugal) 5.1 4 TELECEL – Comunicações Pessoais 3.2 5 Banco Espírito Santo Comercial Lisboa 2.9 6 Jerónimo Martins, SGPS 2.3 7 BPI-SGPS. 2.2 8 Banco Pinto & Sotto Mayor 2.1 9 Banco Português do Atlântico 2.0 10 Cimpor-Cimentos Portugal-SGPS 1.9 Total 48.9 Source: Bolsa de Valores de Lisboa It was an outcome that found favour with local investors. The prospect of a joint venture between BCP and BSCH had stalled all other merger speculation in the Portuguese banking sector, helping send banking shares into a prolonged decline. With the failure of the link-up the rumour mills are once again up and running. “It’s even more positive now that BSCH has the potential to be involved separately,” says Vasco Moreno, banking analyst at Banco Santander de Negocios in London.

The end to the agreement was unexpected, given that both banks had publicly stressed their commitment to the deal. “I was surprised and also a little disappointed,” says Iñigo Lecuberri, banking analyst at Salomon Smith Barney. “That deal looked a good one, and I hoped it would evolve into something deeper.”

In its existing form, the deal between BCP and BSCH did not exactly constitute a major step on the road to a pan-Iberian bank. The agreement was originally struck between BCP and Banco Central Hispanoamericano (BCH) in 1993. In setting up the cross-shareholding, in which BCP took a 9.6% stake in BCH (or 2.7% of BSCH) and the Spanish bank 13.7% of BCP, the two banks agreed not to compete for business in each other’s domestic markets.

Following the merger of BCH and Banco Santander earlier this year it was inevitable that the terms of the deal would be reviewed. Under the leadership of chairman Emilio Botín, Santander has always followed a policy of seeking outright control of foreign banks rather than minority interests. Unlike BCH, Santander also has its own successful banking operation in Portugal, Banco Santander Portugal, which would have complicated the non-competitiveness accord.

But there were also clear incentives to make the link with BCP stronger. “There were very interesting things about the situation they were both in,” suggests a Portuguese banker. “BCP is a market leader, with a technological edge. Santander has always tried to have a presence in Portugal, but with little success. I’m sure BCP would also like more of a presence in Spain. So looked at coldly, it appears it would have made sense.”

Barbara Fernandes, banking analyst at Banco Finantia in Lisbon, agrees: “There was great potential for cross-selling. BCP really understands the Portuguese retail banking market, whereas Santander is very strong on the investment-banking side, making their businesses here very complimentary.”

For BSCH it certainly seemed the perfect chance to gain a real market presence in Portugal. “I personally thought that BSCH, without really wanting it, had got a fabulous opportunity to get a large stake in the most profitable and best-managed bank in Portugal,” says Moreno. For BCP, in turn, it seemed to offer an ideal opportunity to raise its profile outside Portugal.

Independence

What seems clear is that BCP’s management had no intention of ceding any control in decision-making to BSCH. “I think things broke down when it became clear that decision making wouldn’t stay in Lisbon,” suggests a local banker. Portuguese banks have a dogged determination to remain independent, none more so than BCP. Faced with BSCH’s own preference for outright control it was clear that any agreement between the two banks would satisfy the ambitions of neither.

The erstwhile partners now look set to play very different roles in Portugal’s banking sector. Although BCP is expected to be the prime mover in consolidation, BSCH seems destined to be an onlooker.

Santander’s years of struggle

One reason the Spanish bank may have rejected a deal with BCP is that in 1998 its retail operation, Santander Portugal, finally made headway in the local market after a troubled history. “On the commercial-banking side we’re coming from years of struggle,” agrees Luis Bento dos Santos, a member of the board at Grupo Santander Portugal. “It’s an area where foreign banks have been trying very hard for years.”

Until last year Santander had had little success in the Portuguese retail market. But at the end of 1997 it decided to put its retail-banking operation under the management control of Santander de Negocios, its successful Portuguese investment banking operation.

It was decided to rebrand its branch network, formerly Banco de Comercio e Industria, in the image of Santander’s Spanish operations, something the bank had previously been wary of doing. “There was a lot of fear about putting the Santander name into Portugal, because it’s Spanish,” admits Bento dos Santos. “But we saw an enormous opportunity of building an image of the bank from point zero.” Building that image extended to producing the bank’s logo in special luminous materials that are visible at night from a kilometre away.

At the start of 1998 Santander set out a three-year target for the combined banking operation: to achieve a return on equity of 18% to 20% and a cost-to-income ratio of 50%. In the first quarter of this year it came within a whisker of achieving them: ROE was 21% and cost-to-income ratio 53%. Its net profit of €13.2 million ($12.6 million) made it the fifth most profitable bank in Portugal over the quarter.

But as Bento dos Santos observes: “We may be fifth in terms of results, but not in terms of branches.” Santander has only 110 outlets, less than a quarter the number of the big local banks, and at less than 2%, its market share of the core deposit and credit markets is meagre. The bank expects to be able to double that share through organic growth, but no more. Without an acquisition, its horizons in Portugal are limited.

Bento dos Santos remains tight-lipped on the subject of a possible acquisition strategy, pointing out that it is a matter for the bank’s shareholders rather than its Portuguese management board. He does, however, suggest that for the moment the top tier of Portuguese banking remains off-limits to foreigners. Moreno at Santander de Negocios agrees: “If you’re talking about one of the largest banks [a Spanish takeover] wouldn’t be viewed as positive by the government or the Bank of Portugal.”

As if to reinforce that point, the Portuguese government has been busy promoting the country’s largest bank, state-owned Caixa Geral de Depositos, as the guardian angel of the nation’s banks. Against many people’s expectations the government has emphasized that it has no plans to privatize it, but the finance minister has suggested that should any of Portugal’s leading banks be subject to a hostile takeover bid from abroad, Caixa Geral would be in a position to make a counter-bid. The state bank already owns a stake in Banco Português de Investimento, and there are suggestions it may buy part of the shareholding BCP repurchased from BSCH. BCP has also hinted that it is looking at ways to develop further business links with Caixa Geral.

Marginalization

The failure of the BCP-BSCH deal brings into focus the dilemma facing Portugal’s banks. Independent and profitable they may be, but in the context of euroland they appear insignificant. If they don’t move swiftly they face becoming increasingly marginalized.

It would be unthinkable, suggests a local banker, for a major French bank to relinquish a 14% stake in the largest bank in Spain, and instead announce that it wanted to grow its own minor presence in the Spanish market. And yet in Portugal BSCH felt quite able to follow this route. Such is the standing of the Portuguese market, suggests the banker: “If BSCH feels it’s better to expand its own network rather than having a stake in the best bank in the country then it indicates a weakness in Portuguese banking.”

But according to Lecuberri at Salomon Smith Barney, the failure of the BCP-BSCH link could yet galvanize market participants into action. “I’ve not believed M&A was going to happen over the past year, when everyone else was thinking differently,” he says. “But now there is extra pressure on the regulators and the banks to assess what they have, and question whether what they really need is size.”

Although the market has been brimming with merger rumours for the past 18 months, to date they have amounted to nothing, despite discussions between a number of leading banks. “Portuguese banking is already quite consolidated when you compare it to other European countries, so perhaps the urgency isn’t there,” suggests Alexander van Tienhoven, president and chief operating officer at Citibank Portugal.

The banks are also enjoying remarkable organic growth as Portuguese consumers take advantage of the low interest rates and high economic growth which have resulted from the country’s participation in the European single currency. Credit to individuals grew by over 30% during the first quarter, and should top 20% growth for the year compared with 7.5% in the rest of euroland. Gross domestic product is widely expected to be double that of the wider eurozone.

Portugal’s banks are reaping the reward. The growth in volume of core retail businesses such as insurance and mortgages is more than compensating for the lower interest-rate margins and disappearance of commissions from currency trading that have followed in the wake of the euro.

All the top six banks returned impressive results for 1998. Four boasted ROEs in excess of 20%, and profits were up by more than 100% in two cases. The strong performance has continued into 1999. “Results have come in at or above consensus forecasts, and the consensus was not pessimistic,” says Sofia Raposo, banking analyst at Mello Valores brokerage in Lisbon.

Yet despite their stellar performance, many banks’ share prices have been struggling for the past six months. In terms of P/E ratios, many of the Portuguese banks are trading at levels at least 20% lower than their peers in Spain.

Perhaps the most telling explanation for this sorry performance is that the banking sector is an acute example of the Portuguese market coming to terms with its new status inside euroland, or rather, at its edge.

Portugal has rapidly gone from being an emerging market to part of the second economic power in the world. Although its economy is experiencing the positive sides of the transformation, the stock market has fared less well. Portuguese stocks accounted for around 5% of emerging-market benchmark indices, but they will be unlikely to make up more than 1% of euroland portfolios.

Only the very largest companies will interest most European fund managers, and as the state-owned Caixa Geral de Depósitos is the only Portuguese bank to make it into the top 100 in Europe in terms of shareholders’ equity, banking shares are seeing little interest from abroad. At the same time, Portuguese investors are themselves diversifying out of the local market. It’s causing a slump on the Bolsa de Valores as well as a decline in brokerage commissions for the banks.

Onto the radar screen

It is this less palatable side of the euro coin that may ultimately force the banks together. “They need to increase their market capitalization to appear on the radar screens of European fund managers,” says Moreno. “A big driver of consolidation will be banks vying for investors’ attention.” And in today’s European market, if you’re not involved in some sort of merger speculation investors are going to look elsewhere: “Without interesting consolidation news these are just boring, plain run-of-the-mill, small market caps,” says a banking analyst.

Hence the rejoicing when the proposed link-up between BCP and BSCH foundered. “BCP is seen as the key driver for future consolidation,” says Raposo. “The BSCH agreement was hampering any move. Now it has the freedom to pursue its initial strategy of domestic consolidation.” In the week following the failure of the BSCH agreement, the local press was awash with rumours of talks between BCP and virtually every other bank in the market.

There is no doubt that BCP has the capital to finance a merger or acquisition in the domestic market. Before the unwinding of the BSCH agreement it had already amassed a war chest of around Esc220 billion ($1.2 billion), thanks to a capital increase and the public offering of 32% of Banco Português do Atlantico, the domestic retail bank it owned. With the sale of its 2.7% stake in BSCH it has a capital gain of E229 million to add to its coffers. “BCP has a huge, strong capital base, and most of its tier-one funds can be easily leveraged,” says Fernandes at Finantia.

BCP’s management has said it remains interested in forging links with Spanish partners, with Argentaria, which has only a minor presence in Portugal, believed to be at the top of the list. Raposo at Mello Valores suggests that if BCP does attempt to forge another Iberian link, it would have to be more meaningful than the last: “I don’t think they’re looking specifically for something in Spain, but if they do make another agreement with a Spanish bank it would be a real partnership this time,” she says.

In the domestic market, two banks in particular are the focus of investors’ attention: Banco Português de Investimento (BPI), and Banco Pinto & Sotto Mayor (BPSM). Both are thought to be possible acquisition targets for BCP, and their shares saw healthy price gains in the wake of the collapse of BCP’s agreement with BSCH.

According to analysts, BCP and BPI would be a natural link-up. Both are young banks, set up in the mid-1980s. BCP has specialized in retail banking and BPI has traditionally been a stronger investment-banking operation but over the past year BPI has shifted focus more towards its retail operations. It plans to open 100 new branches in 1999 and has set an ambitious target of growing its credit book by 20% to 25% during the year. It would be unlikely to cede control of operations to BCP at such a point in its development.

BPSM is, as Raposo puts it, “one of the incognitos” of Portuguese banking, thanks in no small part to its unpredictable and ageing chairman, Antonio Champalimaud. The group of companies headed by the octogenarian businessman is widely perceived to have fallen behind the times. As a local banker says: “If you look at the performance of the Champalimaud group compared with the other banks you can see it’s been losing market share, and has been a slow mover in the market.”

Champalimaud has already rebuffed overtures from BCP, but many believe BCP will now redouble its efforts to reach an agreement over BPSM. “BPSM has traditionally been viewed by the market as one of the most likely targets in the consolidation process,” says Fernandes. “It has the largest number of branches following CGD and significant potential for improvement.”

Even though it is perceived as the laggard of the sector, BPSM has still produced impressive results. Net income was up an impressive 136% in 1998, with ROE virtually doubling to 25.1% from 12.8%. It serves as a reminder that Portugal’s banks are likely to be enjoying something of a honeymoon period. “They do have very high ROEs but they’re coming from a very rapid development phase,” suggests van Tienhoven at Citibank Portugal. “They still carry very large returns based on their traditional retail presence, and there’s a question mark over how sustainable that is.”

In the short term, analysts see little cause for concern. They point out that in terms of growth, Portugal is still catching up with the rest of Europe. The rapid expansion of individual credit is expected to continue well into 2000, and Portuguese banks also seem to have discovered the secret of cross-selling.

BCP, among others, has been particularly successful in selling insurance products through its retail-banking network. It’s something that hasn’t escaped the attention of van Tienhoven, who agrees: “In that sense, I think Portugal is quite advanced.” He’s been studying the banks’ cross-selling strategies to see if there are lessons to be learnt for Citicorp.

Although few expect the ROEs in excess of 20% of last year to be sustainable, targets for 2000 of at least 15% from BPI and 20% from BCP look realistic. But what is likely to be more important in the long run is how Portugal’s banks go about carving out a niche for themselves in euroland. Unless they act soon, the biggest risk is being forgotten.