Author: Jules Stewart
Portugal’s banks are small compared to many in Europe, but they are both driving and benefiting from the country’s improving economic fortunes.

Abanking system is usually a good barometer of a country’s financial health, and in the case of Portugal the financial services industry plays a key role as a microcosm of the general economy. Albeit a pygmy in comparison with the mighty financial giants of countries like Britain and Germany, Portugal’s banking system is one of the European Union’s most efficient and profitable.

“Private sector discipline has contributed to the development of a dynamic, modern and competitive financial system,” says Elena Iparraguirre, credit analyst at Standard & Poor’s in Madrid. “Portuguese banks are well managed, have strong internal management systems and good credit risk management, and resemble their European counterparts in terms of product range, innovation and sophistication.”

By the time it joined the European Community 18 years ago, this tiny country of 10 million inhabitants sitting on the western extremity of mainland Europe had managed to throw off the shackles of state interventionism and nationalization that followed in the wake of the 1974 “red carnation” revolution. Nowhere was the resurgence of free enterprise expressed with more vigor and innovation than in the banking industry.

A case in point is Banco Comercial Português (BCP), a greenfield operation started in 1985 by exiled banker Jorge Jardim Gonçalves that in the space of five years built up what is today Portugal’s leading financial services group, with a _6.68 billion market capitalization. “BCP has established a multi-channel and multi-product delivery platform and holds leading market shares in almost every financial product category domestically,” says analyst Pedro Furtado Reis at UBS in London. “International ambitions were set in 2000 and are now focused on a 50% stake in Bank Millennium in Poland and the launch of NovaBank, a start-up bank in Greece.” A Portuguese bank going into Poland seemed an improbable venture at the time. BCP’s rationale was that coming from the opposite extreme of Europe was in fact an advantage, as the Polish authorities took a more positive attitude than had it been a large German bank moving in on its neighbor and threatening to transfer all decision-making to its foreign headquarters.

BCP, together with its four rivals—Banco Português de Investimento (BPI), Banco Espírito Santo (BES), Spanish-owned Grupo Totta, and Caixa Geral de Depósitos, the public sector behemoth whose core franchise is the mortgage lending business—account for more than 80% of Portugal’s banking assets.

“A key strength of the Portuguese banking system is its strong resilience to the significant challenges posed by a constantly changing operating environment,” says Standard & Poor’s Iparraguirre, who points to last year’s 0.8% contraction in Portugal’s GDP, as well as the impact of deregulation, the 1993-1994 recession and the rapid convergence of the Portuguese economy with the EU in the late 1990s.

The market heaved a sigh of relief when the banks began reporting their 2003 results earlier this year. The top three banks, led by BCP, posted increases in net income ranging from 14% to 60% last year, in most cases beating market forecasts. Analysts are looking for a repeat performance this year against a consensus forecast of 1% GDP growth.

Signs of an economic turnaround bode well for Portuguese banks in general, although it may still be too early to pronounce them out of the woods. Analysts agree, however, that while last year’s contraction had a negative impact on the country as a whole, the banks did not suffer excessively in terms of asset quality, with no material deterioration in asset quality despite a slowdown in consumer demand for credit.

Scope for Consolidation

Portugal’s banking industry has already undergone considerable consolidation, but there may be more to come. BCP itself was recently rumored to be the subject of a takeover bid by a large European player. The bank was quick to deny the speculation, but there is no doubt that it remains the most attractive target in Portugal. BCP achieved its dominant position through Portugal’s biggest-ever bank takeover when it acquired Banco Português do Atlántico, at that time the country’s largest bank.

Spain’s banks have been active in the Portuguese market, too. Grupo Santander, Spain’s biggest bank, led the way with the takeover of Banco Totta in the late 1990s, a move that was at the time fiercely opposed by the government. Banco Popular Español moved in to the Portuguese market with a _520 million acquisition of BNC, a second-tier retail bank specializing in lending to the property sector. Now all eyes are on BBVA, Spain’s number-two bank, which has been coasting along for about a decade with a small branch network. “BBVA has perhaps a 4% to 5% market share in Portugal, about half that of its rival Santander,” says Paul Fenner-Leitão at Barclays Capital. “Critical mass is defined by a 10% market share.” The other Portuguese bank that the market sees as vulnerable is BPI, as Espírito Santo is protected by a majority family holding. BBVA, however, declines to comment on its Portuguese ambitions.

Whoever makes the next move into the Portuguese banking market will be tapping into a relatively small but increasingly product-hungry customer base. Analysts forecast a steady reduction in income discrepancies with Portugal’s more affluent peers and EMU partners, underpinned by a program of structural reforms being implemented by prime minister José Manuel Durão Barroso’s conservative government. Since it signed the Maastricht Treaty, Portugal has adhered to a policy of economic transparency and fiscal restraint. The government has also embarked on badly needed structural reforms and wage moderation.

As analyst Sara Bertin-Levecq at Moody’s Investors Service points out, when the current government came to power in 2002, it took emergency measures to limit high public deficits. “On the revenue side, those measures included a VAT increase from 17% to 19% and the postponement of the corporate tax reform to 2004. Portugal also continued the fight against tax evasion. For this purpose, bank secrecy has been withdrawn, and the use of tax privileges and benefits has been restricted,” she notes.

The banks to a large extent have set the example for making Portugal’s economy more efficient and cost-aware. The rapid expansion of mortgage lending and bancassurance is a reflection of a growing sophistication on the part of the Portuguese consumer. There is confidence in the system, as evidenced by the average 21.3% growth rate in credit expansion in the five-year period to 2000. Even today, in the context of subdued economic recovery, consumer credit demand continues to grow at a strong, albeit single-digit, level.

Jules Stewart