Description

Bladex was originally established by the central banks of Latin America in 1979 to promote trade finance in the region. In 1992, the Company became the first Latin American bank to list its shares on the New York Stock Exchange, and today its public shareholders include 23 Latin American central and state-owned banks that own the Class A (17%) and Class B (7%) supermajority shares while the Class E shares (77%) are owned by private investors. As a trade bank, Bladex specializes in short-term loans (avg duration ~1.5 yrs) and letters of credit that finance international trade transactions for Latin American private corporations, commercial banks and financial institutions, state-owned banks and other public entities. Bladex does not have a retail branch network, and instead relies on funding primarily from time deposits and wholesale funds. BLX also houses a Latin American focused, global macro hedge fund with ~$163 million in assets under management, 90+% of which is from the bank itself, and the balance is from external investors that are charged a fee structure of 2% management fees and a 20% promote. The bank is exempt from income tax in Panama under a special exemption granted during the founding of the bank.  

As a trade finance bank, Bladex's loan portfolio is considerably less risky than the typical bank asset profile. Total write-off's since inception have been just 0.2% of all loans, net charge-offs over the past five years have been non-existent, and total reserves equate to a very conservative 16% of tangible book value (~$3.00/share).  Given the Company's conservative loan portfolio and meaningful discount to tangible book value (0.90x), we believe BLX offers a sizeable margin of safety.  Moreover, we see room for significant earnings improvement (and dividend increases) as the Company reaches a more optimal leverage target and resolves issues in its non-core Asset Management segment.  While extremely cheap on an absolute basis, BLX also compares favorably to other publicly traded Latin American banks, which on average trade for nearly 3x tangible book value and 15x earnings. As Bladex reestablishes scale and reaches its target leverage ratio of 10x to 13x over the course of the next few years, we expect the bank's return on equity to approach 15% and estimate its true earnings power to be over $2.50/share.

Below are some of the attributes that we believe make Bladex a particularly attractive business:

• 1) Favorable competitive dynamics: The alignment of interest between Bladex and the 23 Latin American central and state-owned banks that own 24% significantly enhances the Company's competitive position through superior access to information, funding, institutional support, product distribution channels and access to multilaterals.
• 2) High-quality loan portfolio: The trade finance business has a particularly low risk profile with strong asset coverage and extraordinarily low default rates, as referenced above.
• 3) Diverse nature of its commercial loan book: Assets are well diversified both by geography and end market / industry. BLX has exposure to 19 countries in Latin America and the Caribbean with Brazil, Colombia and Mexico representing 33%, 12% and 11% of outstanding loans, respectively. Loans to banks represent 41% of total loans, but this percentage is expected to decline as the Company expands its corporate lending, where they are very well diversified, with oil and gas as the highest weighting at 12% of total loans. Also worth noting, the Company has recently expanded its efforts to lend to the middle market, which now comprises over 5% of total loans.
• 4) Compelling growth prospects in regional trade flow: Latin American export volume is expected to grow at a healthy 12% compounded annual growth rate over the next 3 years, with the Panama Canal expansion as a major impetus, doubling cargo capacity by 2014. Bladex is poised to capitalize on this growth as a leader in Latin American trade finance.

As for risks, the market's biggest concerns stem from the Company's internal global macro hedge fund.  Despite compounding at +8.4% net of fees since its inception in May of 2006, including a particularly impressive 2008 in which it returned +12.2% net, recent underperformance at the hedge fund caused the Company to miss earnings estimates over the past few quarters.  While we understand management's desire to diversify away from its core banking business, the synergies between the hedge fund and core banking model are somewhat dubious, and they haven't had much success in raising outside capital, which has declined from a peak of $43 million earlier this year to less than $15 million today. Bladex has already stated that they are going to lower their investment in the fund back to their original $100 million (and take out the $50+ million in profit) by the end of 2011, and longer term we think they are likely to exit this business completely. Additionally, since the second quarter of 2010, management has put much tighter risk controls on the hedge fund, and volatility has come down materially.  Should BLX decide to liquidate or spin-off their hedge fund (which equates to ~3% of BLX's total assets), we believe the market would react favorably, and actually consider this to be a meaningful potential catalyst to further appreciation in the stock.    

On the positive side, the Company is redirecting its diversification efforts toward an acquisition of a factoring business, a much better complement to its core banking business in our opinion. For those of you that aren't familiar, factoring businesses buy accounts receivables from companies at a slight discount to face value in exchange for immediate liquidity for the seller. While very common in most of the developed world, factoring is a nascent industry in South America, and Bladex is looking to acquire a small factoring business in Brazil and then expand this business into other parts of Latin America. Factoring businesses can have very attractive returns on equity, upwards of 30% in most cases, which would help the Company's long term plan to attain a mid-teens return on equity. Moreover, with more overall scale in their business through this potential acquisition as well as more leverage in the core banking business, Bladex should be able to realize significant cost efficiencies. The Company's efficiency ratio is currently 40%, and in the coming years they are targeting an efficiency ratio that is at least 10 percentage points lower.  Over the long term, as Bladex continues to execute on its growth plans and exploits its significantly higher earnings power, we believe the stock will get rerated to a healthy premium to tangible book value.

Other points of interest:

• Though we believe it is unlikely and it is not core to our thesis, Bladex has been rumored to be a buyout candidate over the years by buyers looking for a strong foothold in the entire region of Latin America, a factor that differentiates Bladex from most Latin American banks, which have much more individual country concentration. Given the share ownership of Latin American central banks and complicated share structure, we believe that it is unlikely that this will occur. It is worth noting though that in 2009, the Company created a class F share class (but did not raise capital), designed for government agencies of non-Latin American countries as well as regional and international multilateral financial institutions. In our discussions with the Company, it seems like this is also unlikely in the nearer term unless a value added strategic partner presents itself and is willing to buy in at a premium to book value.
• BLX just released 1Q 2011 EPS of $0.44 per share, comping up nicely yoy through high quality, incremental leverage, with an improved net interest margin and efficiency ratio. Moreover, the Asset Management segment returned to profitability through decent operating performance in their hedge fund (implied +2.5-3.0% return in the fund). Nothing appears to have materially changed in the story overall, and our long term thesis remains in tact. The Company is hosting a conference call tomorrow 10 AM eastern to discuss its results.

Catalyst

• Greater earnings power through more optimal leverage ratios
• Increased institutional awareness
• Spin-out or liquidation of internal hedge fund
• Acquisition of higher ROE factoring business