DISCLOSURES AND DISCLAIMER AT THE END OF THE DOCUMENT PAGE 1/26 SEE MORE INFORMATION AT WWW.FE.UNL.PT
We initiate our coverage of Millennium BCP with a “Hold” recommendation and a 12-month target price of €0,90. We believe that recent market performance of BCP shares, with an average price of €0,88 in the last two months, fairly reflect the uncertainties and challenges that the Bank will face in the near future.
Bank’s profitability has been pressured by the rapid increase in spreads of its financing instruments that a tenacious repricing effort in loans portfolio has not yet been able to compensate. Moreover, the fragile condition of Portuguese economy boosts the incidence of non-performing loans, inhibits the growth of revenues, and inflates the cost of debt. The fragile situation in terms of capital rations weakens the confidence of creditors and investors, thus contributing to a higher cost of funds.
On the bright side, good prospects for international activity, namely for operations in Poland and Africa, and expected improved operational efficiency along with higher commissions income will enhance Bank’s profitability in the future.
Company description
Millennium BCP is the largest private bank in Portugal in terms of total assets (nearly €95.000 Million). The activity of the Bank is centred on mass-market commercial banking, though the range of services offered comprises almost all banking activity, from asset management to investment banking.
Internationally, the Bank has significant operations in Poland, Greece, Mozambique and Angola, all of them operating under the same Millennium brand. International activity accounts for approximately 20% of Bank’s activity in terms of total assets, customers’ funds and loans. Presently, the Bank holds nearly €66.500 million in total customers’ funds and about €75,500 Million in net loans to customers. In 2008, net earnings to shareholders of the Bank totalled €201 Million.
Sonangol is the main shareholder of the Bank with nearly 10% of shares, followed by Teixeira Duarte Group with 7%, and Berardo Group with 6,2%. The Bank is headed by the Chairman Carlos dos Santos Ferreira.
05JANUARY 2010
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ANKINGANALYST: LUIS FERREIRA
mst16000084@fe.unl.pt
Let the dust settle…
Future business context may be even more challenging, and the Bank is not in the best shape to deal with it…
Recommendation: HOLD
Vs Previous Recommendation HOLD
Price Target FY10: 0,90 €
Vs Previous Price Target 0,95 €
Price (as of 4-Jan-10) 0,88 €
Reuters: BCP.LS, Bloomberg: BCP PL
52-week range (€) 0,58-1,07
Market Cap (€m) 4.112,5
Outstanding Shares (m) 4.694,6
Market Return in 2009 2,8% (PSI-20: 31,7%) Volatility of daily returns in 2009 2,30% (PSI-20:1,17%) Beta of daily returns in 2009 (vs PSI-20) 1,32 Source: Euronext
Source: Euronext
2008 2009E 2010E NII (€ million) 1.721,0 1.234,8 1.532,6 Net Income (€ million) 201,2 226,3 301,9
EPS (€) 0,043 0,048 0,064
P/E (Multiple) 19,0 17,5 14,0
ROA (%) 0,2 0,2 0,3
ROE (%) 3,4 3,4 4,5
Total Assets (€ million) 94.423,7 95.193,5 98.629,6 Net Loans (€ million) 75.165,0 75.869,2 79.003,4 Source: Bank’s public reports, Analyst’s Estimates
50 75 100 125 150 Ja n-09 Feb -09 M ar -09 Ap r-09 M ay -09 Ju n-09 Ju l-09 Au g-09 Se p-09 O ct -09 N ov -09 D ec -09 BCP vs PSI-20 - (2009) PSI-20 BCP
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Our analysis is divided in two steps. Firstly, we analyse the core activity of the Bank which comprises loaning activity and banking services provided by the Bank. Secondly, we analyse non-core activity, which includes mainly investing and trading activity of the Bank that are not directly linked with core activity. After analysing in detail the major components of each activity, we assess their individual profitability and perform a comprehensive valuation of the Bank. Subsequently, we performed a risk analysis of our valuation starting with a sensitivity analysis for key variables followed by a scenario analysis in order to capture the correlation among them. Succinctly, the major highlights of our analysis are:
Currently, rising funding costs is one of the major hindrances to Bank’s profitability. Deposits spreads for BCP went an average of -120 b.p. before 2009, to more than 100 b.p. in 2009. Likewise, spreads on Bank’s debt securities have increased nearly 150 b.p.. Besides general increase of cost of risk, deteriorating credit quality of the Bank contributes significantly for the sharp increase in spreads. The high level of indebtedness and bleak prospects for Portuguese economy that makes international funds more expensive and deteriorates the quality of Bank’s assets, namely its vast loans portfolio, and the weak capital ratios of the Bank, are two of the main causes for the expensiveness of Bank’s debt funds.
Non-performing loans (NPL) in loans portfolio is another serious problem for the Bank, having increased more than €1.300 Million since 2007. Shrinking coverage margins have kept this problem from showing up in net earnings. However, with coverage ratios below 100%, and the expected poor performance of Portuguese economy with skyward unemployment rates, we expect loans impairment losses to surpass €900 Million, within 3 years. The likely increase in market reference interest rates along with significant spreads increases in loans may escalate the problem drastically, especially if Portuguese economy fails to recover considerably from current crisis.
Problems mentioned above would be less worrying to shareholders if the Bank was able to transfer, entirely and rapidly, these extra costs to customers. However, a great part of loans portfolio is composed by long-term mortgage loans whose contract terms are fairly fixed, thus retarding significantly the repricing of portfolio. Yet, the major problem is the limited capacity of Portuguese families and small and medium companies to absorb this new extra cost of their loans, with little or none increase of their income. Indeed, in many cases, the Bank will have to manage a delicate balance between spread increases and increased probability of default and occurrence of significant capital losses.
In response to these adversities, we expect that the Bank will continue to improve its operational efficiency that has had a considerable development in last years. In domestic activity, the Bank still stands below its peers in this topic, but we believe that current management team is seriously committed to enhance Bank’s overall operational efficiency in the near future. Similarly, we anticipate an increase in commission income, in great part due to an overall increase in commission charges to final customers in an attempt to capture more revenue from steadier sources of income.
In contrast, international activity is expected to perform well in the foreseeable futures. In Poland, we expect credit activity to grow vigorously, sustained by a dynamic economy. Expected growth in Bank’s mortgage loans and higher commission income shall increase significantly earnings coming from Polish operations. In Africa, a strong market position in Mozambique will provide the Bank with an increasing stream on income, while budding Angolan operations promise a great upside value for shareholders of the Bank. Yet, some problems in domestic activity may also affect the expansion in international activity, namely by making debt funds more expensive and consequently undermining competitiveness in international markets, along with the potential difficulty to obtain sufficient equity capital to sustain international growth.
In conclusion, the activity of the Bank in the near future is full of important uncertainties highly correlated among them, suchas the evolution of Portuguese economy, the success of repricing effort in loans portfolio, the levels of NPL and the magnitude of spread increases in financing funds. Under this scenario, we found no strong evidence to believe that BCP shares are currently mispriced for which our recommendation is “Hold”, with a final target price of €0,90 for 2010. However, if mentioned uncertainties unfold favourably to the Bank, there is an important upside in the value of the Bank.
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Page [A.A.1.] - Net Loans By Category - BCP (€ Million) 4 [A.A.2.] - Net Loans by Geography - BCP (€ Million) 4 [A.A.3.] - Loans as % of Nominal GDP - 2008 4 [A.A.4.] - Net Loans by maturity - BCP (2008) 5 [A.A.5.] - Impairment incidence by type of loan - BCP (2008) 5 [A.A.6.] - Mortgage Loans - Market Annual Growth Rate 5
[A.B.1.] - Spreads on new operations – Market - Portugal - (12 month moving average) 6
[A.B.2.] - Spreads on new operations - Market - Poland - (12 month moving average) 6
[A.B.3.] - Interest Income from Loaning Activity - BCP - Forecasts 6
[A.C.1.] - NPL Coverage Ratio - (A2007 to 1H2009) 7 [A.C.2.] - NPL to Net Loans Ratio - (A2007 to 1H2009) 7 [A.C.3.] - Impairment Charges to NII Ratio - (A2007 to 1H2009) 7 [A.C.4.] - NPL in Portugal (% Total Loans) - Total Market 7 [A.C.5.] - Estimated Coverage Ratio Impact on Impairment Charges - BCP - (€ Million) 7
[A.D.1.] - Deposits-to-Loans Ratio (2008) 8
[A.D.2.] - Debt Ratings 8
[A.D.3.] - Financing cost yields - BCP 8
[A.E.1.] - Net Commissions - Breakdown by Geography - BCP 9 [A.E.2.] - Net Commissions - Breakdown by category - BCP - (€ Million) 9 [A.E.3.] - Net Commissions - ( as % of Total Assets) - (2008) 9
[A.E.4.] - Income Breakdown - (2008) 9
[A.F.1.] - Cost-to-income* - (2007-2008) 10
[A.F.2.] - Staff costs per employee - (€) - (2007-2008) 10
[A.F.3.] - Employees per branch - (2007-2008) 10
[A.F.4.] - Cost* per branch - (€ thousand) - (2007-2008) 10
[A.F.5.] - Business Volume* per Branch - (€ Million) - (2007-2008) 10
[B.A.1.] - Investment Portfolio Breakdown 1 - BCP - (€ Million) 11 [B.A.2.] - Investment Portfolio Breakdown 2 - BCP - (€ Million) 11
[B.B.1.] - Financial Assets yield - BCP 11
[B.B.2.] - Trading and Hedging Net Gain - BCP - (€ Million) 12
[B.B.3.] -Trading and Hedging Gains Breakdown - BCP - (€ Million) 12
[B.B.4.] - Other non-core income - BCP - (€ Million) 12
[B.C.1.] - Yield differential of financial assets above debt securities cost - BCP 13 [B.C.2.] - Estimated Financing Structure of Investment Portfolio - BCP - (€ Million) 13 [B.C.3.] - [B.C.3.] - Differential between interest income from financial assets and
investment portfolio financing costs - BCP - (€ Million) 13
[C.A.1.] - Earnings by activity. 14
[C.A.2.] - Cash-Flow Valuation. 15
[C.B.1.] - Sensitivity analysis A. 16
[C.B.2.] - Sensitivity analysis B. 16
[C.B.3.] - Sensitivity analysis C. 16
[C.B.4.] - Sensitivity analysis D. 16
[C.C.1.] - Scenario Analysis. 17
[D.A.1.] - Total Bank Loans (as % of GDP) - Portugal 18 [D.A.2.] - Yearly external financing needs (€ Million) Portugal 18
[D.A.3.] - General government debt (% of GDP) 18
[D.A.4.] - External Trade Deficit (€ Million) - Portugal 18
[D.A.5.] - Labour productivity Index (EU-27 = 100) 19
[D.A.6.] - Unit Labour Cost Index (2000 = 100) 19
[D.A.7.] - Total factor productivity Index (2000 = 100) 19
[D.A.8.] - Industrial production: construction excluded (2000=100) 19 [D.A.9.] - GDP annual growth rate (constant prices) 20 [D.A.10.] - Loans NII response to Market interest rates 20 [D.A.11.] - Harmonised consumer price index (2005=100) 20
[D.B.1.] - Capital Ratios – BCP and Peers 21
[D.B.2.] - RWA and Tier I Capital – BCP and Peers 21
[D.B.3.] - Pension Fund Responsibilities and Market Cap - (1H2009) 21
[D.C.1.] - Cost-to-income* - Poland vs Greece 22 [D.C.2.] - Total customers' funds/Gross loans - Poland vs Greece 22 [D.C.3.] - Operations as % of Total International Activity (2008) 22 [D.C.4.] - Millennium bim operations - (€ Million) 23 [D.C.5.] - Gross domestic product, constant prices - (Annual percent change) 23 [D.C.6.] - Domestic Loans - Total Market - Angola - Index (Dec-06=100) 23
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Executive Summary 2
A. Core Activity Analysis
A. Loans Portfolio 4
B. Interest Income. 6
C. Impairment Charges 7
D. Loans Portfolio Funding Costs 8
E. Commissions Income 9
F. Operational Costs 10
B. Non-Core Activity Analysis
A. Investment Portfolio 11
B. Investment Income 11
C. Investment Portfolio Financing Costs 13
C. Valuation
A. Business analysis and Valuation 14
B. Risk Analysis 16
D. Other Important Topics
A. Macroeconomic Insights 18
B. Capital Adequacy and Pension Fund 21
C. International Activity 22
E. Annex - Forecasts 24
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As Portuguese largest private commercial bank in Portugal in terms of total assets and market share, loaning activity is undoubtedly central for BCP. The decisions of the Bank in this area, namely to whom the Bank lends money and at which price, are not only vital for value creation to shareholders as they also shape the structure of Portuguese economy to a great extent.
In order to generate value to its shareholders in loaning activity, BCP must be able to accurately access risk and price it accordingly. Thus, one expects the Bank’s funds to flow primarily to investments with safe and fairly high returns. Hence, it is straightforward why mortgage credit represents such a large part of loans portfolio (A.A.1.). Historically, there has been a great demand for mortgage credit in Portugal, which is a predictable consequence of three main factors: the natural housing demand of an expanding economy with an initial housing shortage, especially near the major urban areas; a favourable institutional framework, where mortgage loans were endorsed by the State (for example, through fiscal benefits and subsidized interest rates for young families); an economy structure, with a substantial construction sector that employed a major part of the working population and a residential rental market practically inexistent; finally, an additional cultural factor as Portuguese have always been fond of owning their own homes instead of renting them, and are prone to invest in real estate as well. Correspondingly, Portuguese banking system has granted funds to cope with this demand, as mortgage credit has traditionally been deemed safe (jobs were stable and unemployment low, and collateral was valuable given the increasing price of houses and its importance for families, which also deters defaulting). As a result, currently mortgage credit represents nearly 45% of total credit outstanding in Portugal, with BCP holding a significant share of almost 20%.
The impact of such a large position in mortgage loans in the future performance of the Bank is, at best, dubious. In general, mortgage credit has one major drawback: being a long-term loan, the portfolio renewal rate is very low, and most terms of the contracts are fixed. This constitutes a serious problem when market conditions change fast and unpredictably, as adapting the portfolio to a new market context is a difficult and slow process. With current market changing adversely to mortgage credit, such a large exposure is expected to cause serious trouble to the Bank, as updating spreads and other contract terms to reflect the new market reality may not be enough to mitigate the devastating effect of fast decreasing credit quality of mortgage loans.
Notwithstanding these bleak prospects for mortgage credit in Portugal, BCP continues to build up a significant position in mortgage credit in Poland, taking advantage of a fast-growing market and Bank’s expertise in retail banking. Mortgage credit in Poland has been growing at an impressive average annual rate of nearly 50% over the last 5 years and Millennium Bank holds an important market share of 11,5%. In spite of this prominent recent performance, mortgage credit in Poland has plenty of room to growth given the vitality of Polish economy (with an expected
35.862 42.164 41.628 42.663 43.707 45.559 25.286 28.329 29.503 31.479 33.613 36.108 0 20.000 40.000 60.000 80.000 100.000
2007 2008 2009E 2010E 2011E 2012E [A.A.1.] -Net Loans By Category - BCP (€ Million)
Consumer Loans Credit to Companies Mortgage Loans
11.007 11.637 11.337 11.925 12.642 13.329 48.832 55.673 55.332 55.903 56.093 57.263 5.811 7.855 9.200 11.176 13.595 16.255 0 20.000 40.000 60.000 80.000 100.000
2007 2008 2009E 2010E 2011E 2012E [A.A.2.] -Net Loans by Geography - BCP (€ Million)
Rest of the world Portugal Poland
72% 63% 9% 59% 48% 8% 18% 15% 8% 0% 10% 20% 30% 40% 50% 60% 70% 80% Credit to
Companies Mortgage Loans Consumer Loans [A.A.3.] -Loans as % of Nominal GDP - 2008
Portugal Europe Poland Source: Bank’s public reports; analyst’s estimates.
Source: Bank’s public reports; analyst’s estimates.
Source: International Monetary Fund; European Central Bank; National Bank of Poland.
PAGE 5/26 average annual growth above 6%, over next 5 years) and the low levels of indebtedness (mortgage credit represents at 15% of GDP, in contrast with an average level of 48% in central-western Europe). Hence, Group’s mortgage credit in Poland is expected to continue growing significantly, doubling its weight on Group’s whole mortgage portfolio by 2015 (nearly 36% versus 18% presently).
Aside from mortgage credit, retail loaning to families also includes consumer credit. In spite of market growth in recent years, BCP’s position keeps shrinking every year (from nearly 26% in 2005 to less than 20% in 2008), mainly due to the tough competition in this segment. However, this loss in market share of consumer credit may end up being beneficial to shareholders, given high level of non-performing loans in this segment and its consequent unattractiveness in current market context. In Poland, consumer credit is growing vigorously but bank’s low market share makes its weight on loans Portfolio relatively insignificant (less than 1%).
In terms of loans to companies, BCP holds a strong position, being a market leader (with a market share of nearly 30%) and one of the main financers of back spine of Portuguese economy, that is, medium and small businesses. The overall market of credit to companies has been growing at a dramatic rate (40% in last 5 years), reflecting, on one hand, the widespread availability of debt financing in last decade, and on the other hand, the scarcity of own funds and equity financing to fund growth in Portuguese companies.
However high current level of indebtedness of Portuguese companies may be (presently, loans to companies represent more than 70% of GDP), it is not expected to decrease in the near future as, presently, debt funds are the lifeblood of Portuguese economy. Banks, and especially BCP given the size and kind of its exposure to credit to companies, cannot stop financing these companies and let them fall, as non-performing loans losses would be unsustainable. Therefore, BCP is “hostage” of its own portfolio of credit to companies, though this problem is being minored by an intense effort to reprice the portfolio and ensure more collateral to the loans. Although higher revenue is being collected, it is, at best, just reflecting the higher risk of loaning to these companies and the higher cost of funds for the Bank, in an attempt to minor losses in this segment. Moreover, under a scenario where the Portuguese economy takes longer recovery, this precarious situation may become unsustainable and non-performing loans may start to increase sharply.
In conclusion, loans portfolio in Portugal is expected to grow at a very modest rate in the near future (less than 10% in the next 5 years), mainly due a poor performance economy that reduces demand and increases risk, along with the natural reduction in demand due to the increasing cost of credit. In opposition, credit in Poland is expected to grow significantly in the next decade, boosted by a strong economy with a relatively low level of indebtedness, and we anticipate that it accounts for a very significant part of the value created by the loaning activity of the Group within the next five years. 52% 58% 49% 34% 0% 29% 20% 22% 28% 25% 98% 55% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
[A.A.4.] -Net Loans by maturity - BCP (2008)
% Less than 1 year % More than 5 years
7% 4% 20% 6% 37% 11% 8% 22% 14% 14% 0% 5% 10% 15% 20% 25% 30% 35% 40% Companies
-ConstructionCompanies -Wholesale business
Companies
-Services Consumer credit Mortgage credit [A.A.5.] -Impairment incidence by type of loan
- BCP (2008)
% of Total Loans % of Total Loans Impairment
48% 21% 41% 54% 50% 65% 2% 7% 12% 16% 10% 4% 0% 10% 20% 30% 40% 50% 60% 70% 2003 2004 2005 2006 2007 2008 [A.A.6.] - Mortgage Loans
Market Annual Growth Rate
Poland Portugal Source: Bank’s public reports.
Source: Bank’s public reports.
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Generally, interest rates charged to customers have one fixed component, the spread rate, and a flexible one, the rate indexed to a market reference rate. While indexation to a market reference rate (usually Euribor) tries to capture variations in time value of money, that is, to put a floor on the opportunity cost of the money lent, the spread is meant to cover the extra cost of the Bank’s funds above market reference cost, the credit risk and losses incurred, the operational costs and still provide a fair remuneration to shareholder investment. For this reason, accurately defining the spread for each loan is the single most important decision of the Bank in its pursuit to generate value to its shareholders. While the minimum interest rate charged is (or should be) determined to cover all costs, including capital costs, the maximum rate is determined by competition forces.
This serves as a starting point to explain what happened to BCP and other Portuguese retail banks, in recent years, in terms of interest income. As we can observe in A.B.1., spreads in Portugal decreased significantly during 2005, 2006, and 2007. Ideally, this decrease should have been a consequence of not only of increased competition, but also of a structural decrease in cost of capital, given that most loans are medium-long term loans. However, and quite worryingly to shareholders, that was not the case.
Since far ago, and especially after adopting the Euro, Portuguese economy is going through serious structural problems (see Section D.A.), that, all together, have been worsening the credit risk of all sectors in the economy, from families to companies. During this period (2005-2007), this was completely overlooked. A rare combination of excessive availability of funds, short-term focus and herd behaviour in the industry created a pressure towards more credit concession, which led to a clearly excessive amount of credit granted at spreads below their risk level. When the illusion was finally shattered, banks, among which BCP, were stuck with a credit portfolio clearly underpriced under normal circumstances, leave aside under a widespread severe recession in the real economy. To mend this problem, BCP is expending a tremendous effort to reprice its loans portfolio, charging higher spreads in new operations, and renegotiating those which can be renegotiated.
The present context is not unfavourable to this task. Low reference interest rates and the dependence on bank funds leave margin to charge higher spreads. However, to compensate for the undepricing of outstanding portfolio and cover current real risk of loaning and the increased cost of funds requires a magnitude of spread increases (a very minimum of 300 b.p., roughly, at least 100 b.p. and 120 b.p., respectively, for the increase in deposits and debt securities spreads, and 80 b.p., nearly €600 Million, for increased impairment losses), that simply may not be feasible without serious volume effects and customer dissatisfaction. Moreover, when reference rates rise and if this is not matched by a noticeable recovery of Portuguese economy, a very difficult situation will arise in terms of non-performing loans.
0,0% 0,5% 1,0% 1,5% 2,0% 2,5% 3,0% 3,5% N ov -04 Ap r-05 Se p-05 Feb -06 Ju l-06 D ec -06 M ay -07 O ct -07 M ar -08 Au g-08 Ja n-09 Ju n-09
[A.B.1.] - Spreads on new operations - Market - Portugal - (12 month moving average)
Mortgage Credit Credit to Companies
0,0% 0,5% 1,0% 1,5% 2,0% 2,5% 3,0% 3,5% 4,0% D ec -05 M ay -06 Se p-06 Ja n-07 M ay -07 Se p-07 Ja n-08 M ay -08 Se p-08 Ja n-09 M ay -09 Se p-09
[A.B.2.] -Spreads on new operations - Market - Poland - (12 month moving average)
Mortgage Credit in PLN Credit to Companies
786,5 864,1 933,5 990,0 478,7 580,3 801,7 1122,2 2153,8 2496,7 2744,5 2970,5 0 1.000 2.000 3.000 4.000 5.000 6.000 2009 2010 2011 2012
[A.B.3.] -Interest Income from Loaning Activity - BCP - Forecasts
ROW Poland Portugal
Source: Bank’s public reports; Analyst’s Estimates. Source: National Bank of Poland.
PAGE 7/26 In Poland, spreads were far more stable from 2005 to 2007 (A.B.2.), yet they also have been rising recently to reflect the higher amount and cost of risk, and cost of funds. Traditionally, mortgage loans were granted in Swiss francs to take advantage of lower reference rates but this is no longer the predominant trend due to devaluation of zloty that caused problems both to families and banks. The expected growth in Polish loan activity will help to reprice the overall Group’s portfolio due to the increasing weight of newly hopefully correctly priced loans.
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Presently, non-performing loans is one of the major problems of banking industry, and BCP is no exception. A substantial amount of non-performing loans was an expected outcome of a loans portfolio grounded on an economy with excessive levels of indebtedness and in deep recession. Non-performing loans in Portugal climbed sharply since the beginning of 2008, with special incidence in loans to corporations. BCP, as its peers, have been trying to handle this problem narrowing down coverage margins in order to avoid recognizing colossal impairment losses. However, from a shareholders perspective, the benefits of exchanging the security of prudent broad coverage margins for short-term higher net results are, at least, questionable. In fact, as presented in A.C.5., the difference between current strategy of narrowing coverage rates (from 85% in 2009 to 75% in 2012) and a back-to-average strategy (to 120% in 2012), for the same expected evolution of NPL, would have a tremendous estimated impact of profitability (nearly €700 Million in 2012).
The expected evolution of NPL in Portugal is fairly discouraging. There are already pervasive signs of recovery of the major European economies which indicates that ECB will start to raise reference interest rates soon. Conversely, Portuguese economy is expected to perform poorly in the next following years (see Section A.D.), and therefore Portuguese families and companies will have to deal with significantly higher interest payments, aggravated by current spread increases, with little improvement in their income. Thus, NPL in Portugal are expected to continue to grow significantly in the foreseeable future, and NPL to Total Loans ratios above 6% within two to three years would not be surprising. In addition, the value of collateral, mainly composed of real estate, is falling steeply, making not only the probability of default higher but also increasing the losses in case of default.
To counteract this sharp deterioration in credit quality, BCP is trying to update loan spreads. An overall increase of 100 b.p. in loans spreads represents an approximate extra interest income between €750 to 800€ Million per year, in the next 3 years, which would allow to cover the expected increase in NPL along with a slight improvement in coverage margin. However, we must be aware that, as mentioned in next section, bank as also has to update spreads to account for the higher cost of funding, which, together with rising reference interest rates, may create an unsustainable pressure on customers, triggering a vicious cycle of increasing NPL and loans spreads.
A special note on Polish operations should be made to mention that the bulk of loans portfolios, mortgage credit, still has a good credit quality, which is reassuring given the importance of this segment for Bank’s growth in Poland. On the other side, consumer credit and credit to companies
100% 134% 89% 0% 50% 100% 150% 200% 250% BCP BES BPI
[A.C.1.] -NPL Coverage Ratio - (A2007 to 1H2009)
2,6% 2,3% 1,8% 0,0% 0,5% 1,0% 1,5% 2,0% 2,5% 3,0% BCP BES BPI
[A.C.2.] -NPL to Net Loans Ratio - (A2007 to 1H2009)
670 713 783 356 517 700 0 500 1.000 1.500 2010 2011 2012
[A.C.5.] -Estimated Coverage Ratio Impact on Impairment Charges - BCP - (€ Million)
Descending Coverage Ratio (Minimum Charge) Back-to-average Coverage Ratio Impact 1,0% 1,5% 2,0% 2,5% 3,0% 3,5% 4,0% 4,5%
Dec-99 Nov-01 Oct-03 Sep-05 Aug-07 Jul-09 [A.C.4.] -NPL in Portugal (% Total Loans)
Total Market
Companies Families Total
41% 42% 16% 0% 10% 20% 30% 40% 50% BCP BES BPI
[A.C.3.] -Impairment Charges to NII Ratio - (A2007 to 1H2009)
Source: Banks’ public reports.
Source: Bank of Portugal.
Source: Banks’ public reports.
Source: Analyst’s Estimates. Source: Banks’ public reports.
PAGE 8/26 were responsible for significant impairment charges in the last 12 months. Nevertheless, this impairment charges should be deemed a natural impact of current crisis, without much impact on future performance of the Bank.
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The most basic and primary function of a retail bank is to receive deposits that, in return for safety, ease of transactions and a prime claim on the Bank, provides the Bank with funds at a cost significantly below market cost of similar funds. The extent of this benefit is mainly determined by competition for these funds, but other factors, such as the perceived creditworthiness of the Bank, are also important. In Portugal, deposits had been growing slowly until mid-2007 when the subprime crisis burst. Running away from dubious risky investments, and attracted by appealing interest rates paid, deposits grown 35% in just two years. Nevertheless, BCP still has a significant deficit of deposits financing of its loans portfolios in domestic activity, comparatively to its pears. This fact implies that the Bank has to finance its loans with debt, which is more expensive. Recently, deposits spreads have increased significantly, partially because of low reference rates but mainly as consequence of scarcity and rising costs of debt funds, that make deposits funds more attractive and therefore driving spreads up through competition. As a result, spreads in Portugal increased nearly 100 b.p. in less than 1 year.
In Poland, the situation is very similar, though a little more severe. Spreads on households deposits went up nearly 150 b.p. since reference interest rates start to fall abruptly. This increase in deposits spread causes a serious problem to the Bank, as the cost of its main source of funds is rose steeply, and the Bank is not able to pass this cost to its customers with the same speed. This increase in deposits spreads since October 2008 has cost the Bank approximately an extra €350 million, thus it has had a significant impact on Bank’s profitability.
Unfortunately, it is not only deposits funds that are more expensive, debt financing is also substantially more costly to BCP. Many factors led to this situation. Firstly, risk is inherently more expensive due to a higher degree of risk aversion from investors. Secondly, the bad image of banking industry, the epicentre of current financial crisis, makes scarce funds even more scarce and expensive for banks, which even led Portuguese State to back some debt issues.
Finally, the desolate prospects for the Portuguese economy with its fast growing external debt, makes the cost of financing for the whole economy more expensive. Credit Ratings for Portuguese banks have been deteriorating, and BCP stands slightly below its peers in terms of creditworthiness. In addition, gloomy outlooks from credit agencies indicate a negative evolution in this topic. We can see in A.D.3. that average cost of debt, that has traditionally followed interbank reference rates, presently stands above it by nearly 1%.
It is also important that part of the loans portfolio has to be financed by equity due to a regulatory demand to protect depositors and system stability against credit losses. This creates a pressure to increase share capital and the Bank has had difficulty to bear with it. Additionally, part of portfolio has to be financed by liquid sources of funds such as interbank funds, for liquidity reasons. Recent crisis showed that this short-term liquid
S&P BCP BES BPI
Long-Term A- A A
Short-term A-2 A-1 A-1
Outlook Stable Negative Negative
Moody's BCP BES BPI
Long-Term A1 A1 A1
Bank Financial Strength D+ C- C-Outlook Negative Stable Negative
Fitch BCP BES BPI
Long-Term A+ A+ A+
Short-term F1 F1 F1
Outlook Stable Stable Negative [A.D.2] - Debt Ratings
53,9% 65,6% 70,3% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% BCP PT BES PT BPI PT
[A.D.1.] -Deposits-to-Loans Ratio (2008)
0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 1Q 06 2Q0 6 3Q 06 4Q 06 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q0 9
[A.D.3.] -Financing cost yields - BCP
Interbank Deposits
Debt Securities Interbank Reference Source: Banks’ public reports.
Source: Credit Agencies’ Websites.
PAGE 9/26 markets may dry up suddenly, driving the cost of funds to extremely high levels.
In conclusion, the bulk of loans financing funds has become more expensive. In the near future, spreads on deposits and debt securities are expected to be, at least, 100 b.p. above last year’s levels. It is probable that it continues to grow, especially if creditworthiness continues to deteriorate, as we expect.
A
A..EE..))CCoommmmiissssiioonnIInnccoommee
Commission income is a very important of part of BCP core activity as it represents a significant and steady source of income that the Bank charge to its customers for the Banking services it provides, from credit concession to asset management. Over the last five years, net commission income provided more than €500 Million per year, on average, in Portugal alone, and international activity almost doubled its contribution from nearly €112 Million in 2004 to €205 Million in 2008.
We foresee that net commission income shall present an overall upward trend in the near future supported by Bank’s necessity of developing stable, more traditional sources of revenues, which is common throughout the industry, thus more likely to withstand competition, though slightly offset by increasing regulatory restraints and public awareness.
Card net commissions represented 25% of total net commissions and have grown significantly last year (+14%).They are expected to keep growing in following years mainly taking advantage of expanding business in international activity. Credit commissions have been quite stable over the last 5 years growing between 1% and 4%, and this growth is expected to speed up in the following years due to the necessity of increasing revenues and the prominence of credit activity in Bank’s total activity and its international growth. Commissions charged on securities transactions and asset management are much more volatile and dependent on the levels of activity and performance of financial markets. They are expected to represent less than 20% of net commissions in 2009 against more than 40% in 2007, which corresponds to less €135 millions. Thus, financials markets have a significant impact in bank’s core income too, in addition to non-core direct trading and investment activities. As investors recover their confidence and financial markets start to improve their performance, these asset management and securities commission income shall start to improve as well.
In Poland, the expected expansion of retail banking activity will increase the net commissions income generated mainly by accounts services, payments and credit cards, credit activity, saving products, that last year represented, respectively, €21,7 Million, €21,9 Million, €9,2 Million and €23,9 Million. Hence, we expect that Polish operations account for nearly one quarter of net commissions income within 3 years.
Comparatively to its peers, BCP Group net commission income, proportionately to total income and total assets, is notoriously below BES Group, which indicates that the Bank favours more volatile sources of revenues, which is translated inevitably into more volatile results. On average, net commissions represented nearly 30% of total income of Portuguese banks in 2008, thus it is undoubtedly a major source of income on which banks will rely to sustain results during the turbulent times ahead.
80% 79% 69% 72% 72% 70% 69% 67% 9% 12% 20% 20% 20% 21% 23% 24% 11% 10% 11% 8% 9% 9% 9% 9% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
2005 2006 2007 2008 2009E 2010E 2011E 2012E [A.E.1.] -Net Commissions
- Breakdown by Geography - BCP
Portugal Poland Rest of the World
153 161 166 190 195 205 216 226 103 97 128 95 69 74 78 84 82 102 138 83 60 63 66 70 133 138 139 143 147 151 158 166 188 216 197 230 239 252 264 274 0 100 200 300 400 500 600 700 800 900
2005 2006 2007 2008 2009E 2010E 2011E 2012E [A.E.2.] -Net Commissions Breakdown by category
-BCP - (€ Million)
Cards Securities
Asset management Credit Operations
Other Commissions 0,72% 0,94% 0,65% 0,0% 0,2% 0,4% 0,6% 0,8% 1,0% BCP PT BES PT BPI PT
[A.E.3.] -Net Commissions - ( as % of Total Assets) - (2008) 60,2% 53,4% 52,2% 28,7% 32,9% 28,0% 11,1% 13,7% 19,8% 0% 20% 40% 60% 80% 100% BCP BES BPI
[A.E.4.] -Income Breakdown - (2008)
NII Net Commissions Other income Source: Bank’s public reports.
Source: Banks’ public reports. Source: Banks’ public reports. Source: Banks’ public reports.
PAGE 10/26
A
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Presently, given the austerity of banking business, operational efficiency is of crucial importance for Bank’s profitability. Although Bank’s performance in this matter is not yet outstanding, in all fairness, it has improved very much in recent years.
From 2005 to 2008, the number of employees in domestic activity decreased from 12.400 to nearly 10.800, while the average staff cost per employee decreased bout 30%, from almost €79.000 to less than €56.000. Even though it the number of employees and staff costs still seem excessive comparatively to its peers, the Bank is certainly moving in the right direction. The Bank has the largest network of branches in Portugal, more than 900, which is not yet particularly efficient, with a higher cost per branch though with a significant improvement in 2008. The business volume and revenues generated by this larger network is not compensating for the poor cost efficiency, and consequently the Bank presents higher cost-to-income indicators than competition.
Internationally, efficiency indicators are significantly worse, which is understandable given that the priority in these markets (Poland, Mozambique, Angola) is to growth and establish a strong competitive presence. Nonetheless, current thigh margins and low profitability compelled a new strategy more rigid in terms of cost efficiency, which may have long-lasting benefits in terms of profitability of these operations.
To conclude, it must be emphasized the focus on efficiency in domestic operations that the Bank has had in the last three years that generated great value to shareholders. Comparatively to 2005, from 2006 to 2009, cost savings in domestic operations represented an estimated cumulative gain of more than €1.400 Million, which is nearly 80% of Group’s cumulative net profit to shareholders in the same period, nearly €1750 Million. Though the starting position of the Bank in terms of operational efficiency was very weak, attaining such results in cost cutting while keep growing, is at all levels impressive. We expect this focus efficiency to persist in the future, given that the Bank is still performing worse than its peers, and austere times ahead require such cost efficiency to improve results. Indeed, current management team and business strategy seems committed to reducing costs and improve operational efficiency as a safe way to generate more value to shareholders.
We also expect the cost of financing related to the operational structure to grow in the following years, mainly driven by a higher cost of debt and the growth of international activity. Additionally, it must be mentioned that the operational structure is financed mainly by debt, as equity is barely sufficient to comply with the minimum regulatory levels of equity financing for loans and investments. Even though this situation increases risk and cost of debt significantly, we do not foresee any improvement in this topic, as raising equity funds in the future is likely to be even more difficult than it has been until now.
57% 56% 80% 79% 0% 20% 40% 60% 80% 100%
BCP PT BES PT BPI PT BCP INT [A.F.1.] -Cost-to-income* - (2007-2008) 55.984 52.594 48.987 60.759 27.550 0 10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000
BCP PT BES PT BPI PT CGD PT BCP INT [A.F.2.] -Staff costs per employee - (€) - (2007-2008)
11,8 10,7 11,3 11,7 12,8 0 2 4 6 8 10 12 14
BCP PT BES PT BPI PT CGD PT BCP INT [A.F.3.] -Employees per branch - (2007-2008)
121,1 112,0 84,7 32,7 0 20 40 60 80 100 120
BCP PT BES PT BPI PT BCP INT [A.F.5.] -Business Volume* per Branch - (€ Million)
- (2007-2008) 1.069 1.012 833 1.183 652 0 200 400 600 800 1.000 1.200 1.400
BCP PT BES PT BPI PT CGD PT BCP INT [A.F.4.] -Cost* per branch - (€ thousand) - (2007-2008) Source: Banks’ public reports.
Source: Banks’ public reports.
Notes: *Cost-to-income equals staff costs plus administrative costs over net interest income plus net commissions. Net commissions from BCP in 2007 adjusted to include BPI takeover bid costs.
Source: Banks’ public reports.
Notes: *Business Volume equals total customer’s funds plus gross loans to customers.
Source: Banks’ public reports.
Notes: *Cost per branch equals total staff costs plus total administrative costs over total number of branches.
PAGE 11/26
B
B
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NO
N
O
N
N
-C
-
C
O
O
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R
E
E
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B..AA..))IInnvveessttmmeennttPPoorrttffoolliioo
Recently, the investment portfolio of the Bank has presented three main trends. Firstly, since 2006, the size of equity portfolio has been reduced significantly. On one hand, this is a natural consequence of mark-to-market of available-for-sale equity instruments during equity markets crash due to current financial crisis. On the other hand, a few important equity investments have been sold, for example, the Bank sold its qualified position in Banco BPI in 2008 (€164 Million), and its shares in EDP and Banco Sabadell, in 2007.
We do not expect investment in equity instruments to grow in the near future (besides the usual slight increase of investment in associated companies), due to the current volatility of financial markets and gloomy performance of most companies. Therefore low earnings and volatile capital gains may inhibit the Bank to take further risks in this area. Nonetheless, equity portfolio may increase in value if equity markets recover, but it is always difficult to forecast the moment and magnitude of this plausible recovery.
Secondly, fixed-income instruments, namely government bonds and treasury bills, are expected to gain weight in the overall portfolio. Pos-crisis increased yields and the relative safety of these investments make them attractive for the Bank, as they allow a considerable and stable stream of income to shareholders. In 2008, a set of bonds and commercial paper valued at €2.713 Million, due to its nature, was reclassified as Customers’ Loans, thus explaining the sudden drop in investment portfolio in general, and in fixed-income instruments portfolio in particular. Nonetheless, growth in fixed-income instruments hold will be moderate and gradual, tempered by capital requirements and increasing expensiveness of debt funds.
Finally, the Bank has been accumulating a net derivative liability that in the end of 2008 stood at nearly €570 Million, divided into €337 Million from trading derivatives and €233 Million from hedging derivatives. While losses in hedging derivatives are hopefully offset by correspondent gains in operational activity, net negative fair value in trading derivatives is either an indicator of poor performance or an alternative source of financing. Moreover, the magnitude of derivatives trading has increased significantly in the last 4 years, from an average volume of €926 Million in 2005 to more than €1.970 Million in 2008.
B
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Interest income from financial assets has been an important source of revenue for the Bank. As presented in B.B.1., interest spreads on financial assets have been fairly stable over the last 4 years. We expect spreads to increase slightly in the future, though mainly due to the deterioration of public debt of most advanced economies. Thus, increasing spreads come with higher risk that the Bank will have to manage with rigour to avoid undesirable exposures and extraordinary impairment charges. Therefore,
1.102 1.300 1.500 4.631 4.411 4.419 1.714 2.350 2.700 2.346 2.733 3.085 3.903 4.150 4.150 0 2.000 4.000 6.000 8.000 10.000 2005 2006 2007 2008 2009E 2010E [B.A.1.] -Investment Portfolio Breakdown 1
- BCP - (€ Million)
Other Hedging Derivatives Investments in associated companies Financial assets held to maturity Financial assets available for sale Financial assets held for trading
1.115 927 1.043 1.919 2.210 2.210 1.496 1.711 1.653 1.200 1.089 1.184 4.831 5.015 5.268 4.082 5.120 5.470 0 1.000 2.000 3.000 4.000 5.000 6.000 7.000 8.000 9.000 10.000 2005 2006 2007 2008 2009E 2010E [B.A.2.] -Investment Portfolio Breakdown 2
- BCP - (€ Million)
Derivatives Equity Portfolio Fixed Income Portfolio
5,2% 6,1% 6,4% 3,7% 3,8% 4,5% 5,0% 0% 1% 2% 3% 4% 5% 6% 7%
2006 2007 2008 2009E 2010E 2011E 2012E [B.B.1.] -Financial Assets yield - BCP
Interbank Reference Interest Rate Financial Assets Yield
Source: Bank’s public reports.
Source: Bank of Portugal; Bank’s public report. Source: Bank’s public reports.
PAGE 12/26 the magnitude of future earnings in this topic will be mainly dependent on future evolution of reference rates.
In terms of equity proceeds, namely dividends, future earnings will be significantly below past values. On one hand, equity portfolio (excluding associated companies) is considerably smaller due to important sales in previous years. On the other hand, companies’ future earnings are expected to be smaller than in the past, but more importantly payout ratios are expected to be reduced as capital is required to face a scenario of scarce and expensive debt.
Trading and hedging income represents a major source of income for the Bank. Foreign exchange activity and trading financial instruments are the two main contributors to total income while hedging activity income is very unstable. Regarding this topic, it is important to highlight the impressive volume of transactions that last year reached more than €13.000 Million where only €278 Million were net gains. This average volume of losses and gains in this area (see B.B.2.) represents more than 3 times the balance sheet value and more than 45 times the net gains. This may be especially relevant to shareholders, as most of the transactions in this rubric involve derivatives, which embodied complexity and volatility implies significant risks, and that may lead to major impairment losses if all risks are not accounted properly, which, as current financial crises has confirmed, is a very difficult task. We expect trading and hedging income to lay between €250 to 300 million, in consonance with past performance in this area.
In terms of gains from available-for-sale financial instruments, though it has had an important impact in profitability in recent years, it is significantly influenced by one-off items. From 2005 to 2007, major sales, along with the good performance of equity markets, allowed for record gains in these years. In 2006 and 2007, sale of EDP shares and Banco Sabadell shares represented, respectively, €243 Million and €157 Million, while in 2007 and 2008, the position in Banco BPI stood for nearly €348 Million in losses. We expect a neutral evolution of net gains in this topic, in future. The small portfolio of equity instruments available-for-sale, (the more volatile component of the portfolio), and the unpredictability of equity markets, make it difficult to foresee major gains in this area, while major impairment losses are expected to have already been recognized. Yet if equity markets do recover soon, we may expect a few sales in order to boost reported earnings.
Regarding other provisions and impairments we expect that devaluation in real estate and a business environment full of uncertainties may pressure results in this rubric.
Finally, the rubric other income may present abnormal positive values in 2009 and 2010, as extraordinary sources of revenues, namely the sale of patrimony, may be used to increase bottom line earnings, especially in the next two years.
4.733 6.259 4.621 13.051 285 192 199 278 0 2.000 4.000 6.000 8.000 10.000 12.000 14.000 2005 2006 2007 2008
[B.B.2.] -Trading and Hedging Net Gain - BCP - (€ Million)
Traiding & Hedging Losses Traiding & Hedging Net Gain
2.087 3.895 2.227 8.268 1.055 1.167 1.033 2.184 1.656 1.256 1.422 2.702 0 2.000 4.000 6.000 8.000 10.000 12.000 14.000 2005 2006 2007 2008
[B.B.3.] Trading and Hedging Gains Breakdown -BCP - (€ Million)
Foreign Exchange Activity Hedging Activity
Financial instruments associated to financial instruments through profit and loss account Other 193 -260 35 50 50 111 75 75 100 100 8 -8 125 70 30 79 56 58 70 75 -300,0 -250,0 -200,0 -150,0 -100,0 -50,0 0,0 50,0 100,0 150,0 200,0
2007 2008 2009E 2010E 2011E
[B.B.4.] - Other non-core income - BCP - (€ Million)
Net gains from Investments Other operating Income Other Income Equity Proceeds Source: Bank’s public reports; analyst’s estimates. Source: Bank’s public reports.
PAGE 13/26
B
B..CC..))IInnvveessttmmeennttPPoorrttffoolliiooFFiinnaanncciinnggCCoossttss
Regarding the core activity of BCP, value creation to customers, to the economy, and ultimately to shareholders, through the channelling of savings to investment, the eased payment system and the safeguard of values, to mention just a few, is easily understandable. Conversely, value creation to shareholders in non-core activity is much more unclear. As most of the financial assets in BCP portfolio are traded in organized markets, in order to add value, BCP has to generate higher returns than those investors would obtain if they invested directly in those markets. Sources of value such as economies of scale in transactions, a higher degree of diversification, access to more markets, better management, are easily attainable through investment funds. Thus, value generation is likely to come from a cheaper source of funds.
As we can see in B.C.2., Bank’s portfolio is highly leveraged, in the sense that only a small fraction of it is financed through equity. This high level of leverage in investment allows for better returns, as investment yields are higher than the cost of additional debt, though margins tend to become tighter as debt costs increase more than the yield on financial assets, as presented in B.C.1.. More importantly, Bank’s cost of debt is lower than the cost of debt for most shareholders individually, and this would be the main reason for shareholders to support the investment activity of the Bank.
However, high leverage brings significant added risks, as equity responds first to investment losses and therefore even relatively small losses may easily absorb all the equity invested. Moreover, and here lies the heart of the problem, not only equity affected to investment responds to investment losses but also equity affected to core activity, and therefore this is the main drawback of highly leveraged investment through a retail bank like BCP. In fact, this is the main reason why debt funds invested are cheaper to the Bank, that is, because all Bank’s equity and patrimony answers to any investment losses. Still, this risk is hard to measure, and many times, goes unnoticed to shareholders, as major investment losses are not common (due to the composition of portfolio). Nonetheless, current financial crises proved that retail banks investments, however safe they may be deemed, can generate colossal losses and cause serious distress to banks. Indeed, presently, supervisory authorities are considering limiting dramatically commercial banks investments and exposure to certain financial instruments, some of them considered perfectly safe before current crisis.
In conclusion, BCP shareholders should be aware of this risk, especially given the fragile situation of the Bank in terms of capital adequacy (see Section D.B.), and some recent alarming cases related to debt investments in Greece and Dubai. Furthermore, we anticipate a sharp deterioration of margins due to increasing cost of debt (assuming that the Bank will not bear more risk to increase income yields), thus making non-core investing activity even less appealing.
0,0% 0,5% 1,0% 1,5% 2,0% 2,5% 3,0% 1Q 05 2Q 05 3Q 05 4Q 05 1Q06 2Q06 3Q06 4Q06 1Q07 2Q07 3Q07 074Q 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09
[B.C.1.] -Yield differential of financial assets above debt securities cost - BCP
768,4 734,3 739,2 811,1 1.054,8 6.454,5 6.168,3 6.209,0 5.758,8 0 1.000 2.000 3.000 4.000 5.000 6.000 7.000 8.000 9.000 2007 2008 2009E 2010E
[B.C.2.] -Estimated Financing Structure of Investment Portfolio - BCP - (€ Million)
Equity Interbank
Subordinated Debt Debt Securities
-62,2 56,8 122,9 -18,6 -43,3 -82,9 -102,5 -150,0 -100,0 -50,0 0,0 50,0 100,0 150,0 2006 2007 2008 2009 2010 2011 2012 [B.C.3.] - Differencial between interest income from
financial assets and investment portfolio financing costs - BCP - (€ Million)
Source: Bank’s public reports. Analyst’s Estimates.
Source: Bank’s public reports. Analyst’s Estimates. Source: Bank’s public reports. Analyst’s Estimates.
PAGE 14/26
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C
C..AA..))BBuussiinneessssAAnnaallyyssiissaannddVVaalluuaattiioonn
The profitability of the core activity of the Bank is going through a period of serious distress that will extend to 2011, at least. The profitability of the bulk of core activity, that is, loaning activity, suffered a strong hit in 2009, with a loss of over €500 Million comparatively to the average of previous 3 years. The main cause for this underperformance was the sudden increase of spreads on funds used in this activity that was not accompanied by a corresponding increase in loans spreads. This difference in the speed of adjustment between loans spreads and funds spreads (especially deposits, which adapt in just a few months) is creating serious problems in profitability and demanding an extra effort to reprice loans portfolio as quickly as possible, which becomes even harder when more than 40% of loans portfolio consists of long-term mortgage loans.
In terms of impairment losses in loans, the situation is equally difficult, with skyward NPL rates. During 2009, the Bank managed to veil the problem cutting down on coverage ratios, but with coverage ratios at minimum levels, we anticipate that impairment losses start to increase significantly, already during 2010. Therefore, success in repricing loans portfolio is critical as quickly as possible is crucial to compensate increasing cost of funds and impairment losses, and, in this way, to improve profitability of loaning activity.
Expected higher net commissions income and improved operational efficiency will enhance core activity profitability, thus, providing an important contribution to offset the bad performance of loaning activity and increasing structure financing cost. Nonetheless, net income from core activity is expected to be negative in 2009 and 2010, and shall recover after 2011, though crucially dependent on the success of repricing effort and the evolution of NPL rates.
€ Million 2006 2007 2008 2009E 2010E 2011E 2012E
Interest Income From Loans 2.905,7 3.701,1 4.433,7 3.419,0 3.941,1 4.479,6 5.082,6
Interest Expense From Loans 1.291,9 1.972,9 2.594,6 2.002,9 2.210,8 2.463,5 2.705,9
Loans Impairment 128,4 257,7 538,5 526,5 741,2 843,9 927,1
Loaning Activity Net Income 1.485,4 1.470,6 1.300,5 889,6 989,1 1.172,2 1.449,6
Net commissions 713,5 664,6 740,4 709,9 745,6 782,1 820,0
Net Income from Core Activity Before Structure Costs 2.198,9 2.135,2 2.040,9 1.599,5 1.734,7 1.954,2 2.269,6
Operating Costs 1.725,5 1.748,6 1.670,8 1.575,0 1.565,2 1.578,2 1.641,0
Structure Debt Financing Costs 117,0 215,2 241,3 162,6 154,4 203,2 231,6
Net Income from Core Activity After Structure Costs 356,4 171,3 128,9 -138,1 15,1 172,8 397,0
Interest from Financial Assets 186,4 374,1 453,2 170,2 201,2 253,4 302,3
Dividends from equity instruments 32,5 27,9 36,8 8,0 20,0 25,0 30,0
Share of Profit of Subsidiaries 42,0 51,2 19,1 50,0 50,0 50,0 50,0
Net gains From Trading and Hedging 192,0 199,1 277,6 260,0 260,0 260,0 270,0
Net gains from Investments 203,0 193,2 -259,5 35,0 50,0 50,0 50,0
Other operating Income 130,3 110,8 75,0 75,0 100,0 100,0 100,0
Income from Investments before Financing Costs 786,2 956,4 602,2 598,2 681,2 738,4 802,3
Investment Debt Financing Costs -248,6 -317,3 -330,3 -188,9 -244,5 -336,3 -404,8
Other assets impairment and Provisions -35,4 -94,8 -44,5 -85,0 -100,0 -100,0 -100,0
Other Income 130,6 7,7 -8,4 125,0 70,0 30,0 0,0
Net Income from Non-Core activity 632,8 551,9 218,9 449,4 406,7 332,1 297,5
Total Net Before Taxes and Minority Interests 989,2 723,2 347,8 311,3 421,9 505,0 694,5
Taxes -154,8 -76,5 -84,0 -60,0 -60,0 -60,0 -65,0
Minority Interests -51,9 -55,3 -56,8 -25,0 -60,0 -70,0 -80,0
Net Profit attributable to Shareholdersof the Bank 782,5 591,4 207,0 226,3 301,9 375,0 549,5
[C.A.1.] – Earnings by activity.
