|Shares Out. (in M):||473||P/E||23.5x||30.0x|
|Market Cap (in M):||3,830||P/FCF||0.0x||0.0x|
|Net Debt (in M):||0||EBIT||0||0|
Banco De Valencia ("BVA") is Spanish retail and commercial bank with a geographic concentration in the Valencia region of Spain. In summary, I believe BVA is an excellent short candidate because:
BVA is a medium sized Spanish retail and commercial bank which has its origins in the Valencia region of Spain. Over time it has grown into surrounding regions but it is still exclusively based in Spain and highly concentrated in the costal regions of Valencia and Murica (approximately 70% of BVA's branch network is located in these two coastal regions of Spain). BVA's retail orientation means it earns the majority of its income from net interest and fees and commissions, with only approximately 5% of its total income coming from trading activities.
Over the past decade Spain experienced one of the largest real estate bubbles in the world, fuelled by negative real interest rates and significant speculative activity. Between 2000 and 2007 property prices in Spain increased by approximately 250% and residential housing completions increased by over 200%. To put this in perspective Spain is roughly 10% of the EU GDP, yet it accounted for 30% of all new homes built since 2000 in the EU. Spanish banks funded and thus are exposed to the unwind of this bubble. Outstanding loans to developers and construction companies in Spain increased from €33.5 billion in 2000 to €318 billion in 2008, an increase of 850% in just 8 years.
Since mid-2008, the economic situation in Spain has deteriorated rapidly. For the year ended 30 September 2009 GDP contracted 4% and unemployment has increased from a low of 8% at 30 June 2007 to 17.9% at 30 September 2009. To date house prices have fallen approximately 14% from the peak in Dec'07.
The economic situation in Spain is expected to further deteriorate in the medium term as many of the excesses of the last decade are reversed. GDP will likely contract further in 2010 and unemployment is expected to peak above 20%. Currently Spain has over 1 million unsold homes, which equates to approximately 4-5 years of demand. This in addition to the high unemployment rate, difficult macro economic backdrop and continued level of overvaluation will likely continue to put pressure on Spanish house prices. The costal areas of Spain experienced the most excess (both overbuilding and overvaluation) during the boom and are currently suffering the most dramatic correction.
High unemployment, a contracting economy and continued declines in house prices will result in increasing impairments in bank's loan books in the coming years. Banks with exposure to Spanish coastal regions will likely be impacted more significantly.
BVA is heavily exposed to these general trends and issues and, I believe, is an excellent short candidate for the specific reasons outlined below.
(1) BVA is one of the most expensive banks in Europe
BVA is currently trading at a 23x and 30x 2009E and 2010E P/E (consensus earnings) and 1.9x P/BV. At its current valuation BVA is trading at 17x 2008A P/E (2008 represented the peak earnings year for BVA). These valuation levels are despite BVA achieving a modest ROE of 12.8% in 2008 and an average ROE of 14.7% for the past 5 years (2004-2008).
This valuation makes BVA expensive relative to its Spanish peer group (the domestic Spanish peer group trades at 8-10x 2009E P/E and 0.9-1.1x P/BV despite the peers being larger and more diversified) and makes BVA one of the most expensive banks in Europe. Given the highly problematic nature of its loan book, the likelihood it will need to raise equity, its reliance on wholesale funding and potential issues with its largest shareholder (all discussed in more detail below) BVA's valuation seems extremely aggressive.
(2) BVA's loan book is concentrated, highly problematic and rapidly deteriorating
Currently over 3/4 of BVA's loan book is property / construction related (including residential mortgages). Approximately 40% of BVA's loan book is comprised of loans to real estate and construction companies, of which approximately 8% of total loans relate to land financing (including unpermitted land). BVA grew its loan book very aggressively during the bubble, registering a 27% CAGR in gross loans outstanding for the 4 years ended 31 December 2007. A large portion of this incremental lending was construction, development and real estate related and geographically concentrated in BVA's home (coastal) regions of Valencia and Murica. Additionally, BVA's loan book is highly concentrated among borrowers, with the largest 20 exposures accounting for approximately 9% of the total risks (or approximately 140% of core equity capital). Noteably, the majority of the largest 20 exposures relate to regional or large construction companies and real estate developers.
The sharp adjustment of Spain's economy and housing sector has resulted in a large number of real estate companies entering into financial difficulties. This has had a direct impact on the performance of BVA's loan book. BVA's non performing loans have increased from 0.6% of gross loans outstanding at 31 December 2007 to 4.1% of gross loans outstanding at 30 September 2009. Over the same period NPL coverage (Provisions / NPLs) has declined from 316% to 77%. It is worth noting that BVA's reported NPL ratio is understated because BVA has been swapping credit exposures for assets, mainly in the form of real estate projects, land and properties. This practice allows BVA to avoid characterizing these loans as non performing and also has an impact on the provisioning BVA is required to take through its income statement. As at 31 March 2009 BVA had swapped loans equivalent to 1.2% of gross loans outstanding (note: the number of swapped assets has increased over the past 6 months but I have not seen a precise number disclosed in the public domain). Additionally, BVA has been "restructuring" loans before they become non-performing to avoid recognizing these loans as NPLs (note: in Spain changing a loan from cash pay to PIK is sufficient for it to continue to be recognized as a performing loan). Loan "Restructuring" for construction companies and real estate developers has been common practice since the property bubble burst in Spain, resulting in large exposures by the Spanish banking sector to zombie developers.
For the 12 months ended 30 September 2009 BVA recognised net loan losses (impairments) equivalent to 70% of pre provision profits. Please note over this period BVA released E125 million of generic balance sheet loan loss provisions which offset the impairment expense recognized in the income statement. If these provision releases are added back - i.e. to calculate gross impairment expense - gross impairments for the 12 months ended 30 September 2009 equated to 103% of pre provision profit over this period (i.e. Pre Tax Profit would have been negative). The expected continuing deterioration in both the Spanish economy and Spanish real estate prices as well as the required provisioning for BVA's current non performing loans (and the "hidden" non performing loans) will likely result in increasing impairments in coming years.
(3) BVA will likely need to raise more equity
At 30 September 2009 BVA had a core equity ratio of 5.99% and a Tier 1 equity ratio of 6.92%. These ratios are lower than other Spanish domestic banks (peer group Core and Tier 1 Ratio range is 7-8% and 8-9% respectively) and lower than the minimum the Spanish regulator is expected to deem acceptable in the medium term. Additionally, as described above, impairments on BVA's loan book could deplete capital in the coming years. As such, it is likely BVA will require additional equity capital.
(4) BVA relies on wholesale funding
The significant growth in BVA's loan book (described above) was largely financed through wholesale funding as BVA was unable to attract deposits at the same pace as it was growing its loan book. At 30 September 2009 BVA has a Loan / Deposit ratio of 150%. Within its wholesale funding portfolio BVA has a large exposure to short term funding sources (including interbank lending and central bank repo lending). This funding structure exposes BVA to higher liquidity risk than many other European banks (although this is a somewhat systemic issue Spain as most of the Spanish domestic banks have similar finding structures / liquidity risks --- a legacy of the rapid loan growth experienced by the sector).
(5) BVA's largest shareholder is a Spanish savings bank with its own problems
BVA's largest shareholder (38% shareholding) is Bancaja, a large Spanish savings bank with a geographic concentration in the Valencia and surrounding coastal regions in Spain. In similar fashion to BVA, Bancaja aggressively expanded its loan book during the property bubble and significantly increased its exposure to real estate developers during this period. In addition to its retail banking operations, Bancaja has direct equity investments in real estate and real estate developers as well as several other Spanish listed and unlisted equity investments. The performance of many of these investments is believed to be poor and the valuations the investments are carried for on Bancaja's books is not transparent.
Bancaja's loan book has also deteriorated rapidly. NPLs have increased from 0.85% at 31 December 2007 to 5.01% at 30 September 2009 and NPL coverage is only 56% at 30 September 2009. Additionally, Bancaja's capital position is weaker than peers (Core Equity: 6.6% Tier 1: 7.6%). Given its high exposure to developers and geographic concentration to coastal regions, Bancaja's loan book is expected to continue to deteriorate, which when combined with its investment portfolio could put pressure on its solvency.
As such, Bancaja's ability to support BVA (including any capital raising required by BVA) is questionable. Additionally, Bancaja could become a forced seller of its BVA holding if its operations continue to deteriorate.
BVA has a low quality loan book which is rapidly deteriorating. It will likely need to raise additional equity and its largest shareholder is also facing a difficult outlook and may become a seller of its BVA shareholding. Additionally, BVA struggled to earn an stellar Return on Equity during the best part of the cycle. Despite this, BVA's current valuation makes it one of the most expensive banks in Europe. BVA has underperformed its peer group YTD and this should continue for the foreseeable future.