|Shares Out. (in M):||130||P/E||6x||0|
|Market Cap (in $M):||240||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
All figures in €
Summary quantitative information and investment thesis
Investing in a depressed Italian bank stock with a 100% upside. Context characterized by: illiquidity, no sell-side analyst, no significant institutional investors’ stake and with a majority shareholder (family) retaining control (very low profile attitude). Situation favorable for a value investor because of still adverse market mood for Italian bank stocks. Limited downside thanks to i) the recent securitization of a large portfolio of NPLs aimed at fixing balance sheet and ii) very low entry multiples. Upside visible thanks to Earnings Power value highlighting 16% yield and surplus assets for free.
The Company and the business
Banco di Desio e della Brianza (hereinafter “BDB” or the “Company”) is an Italian commercial bank listed on the Italian stock exchange and headquartered in Desio (Province of Lombardy), a town close to Milan. Gavazzi family owns the majority stake while nearly 30% of the shares is free float. Minority shareholders are mostly retail investors. The bank runs nearly 265 branches across northern and central Italy. Most of branches are in two key areas: in Lombardy - the richest region of Italy - and in two regions of central Italy (Lazio and Umbria). BDB offers commercial banking services to its customers: current accounts, deposits, mortgage and corporate loans, securities’ services and asset management.
Quality of assets
Bank’s assets are mostly loans to customers (€9.7bn) and investments in securities (€2.2bn). Common equity of the group was €0.9bn by the end of FY17. Leverage (total assets/net equity) is at market average (14x) and expanded in the last 3 years following investment in securities funded with ECB’s facilities and abundant liquidity.The Company funds its operations through deposits from customers, bonds and interbank facilities. The largest part of interbank liabilities is toward ECB (long-term refinancing operations carried out by the central bank). BDB benefits of a significant stock of indirect funding (assets under management and assets under custody). Actually, the ratio of indirect funding and direct funding is 1.3x, significantly higher than the Italian market average close to 1x.
Loans’ portfolio can be broken down as follows (data as of December 2017): medium-long term loans 70%, current accounts 17%, other bank facilities 13%. More than 60% of loans’ portfolio is fully guaranteed (where real guarantees represent nearly 78% of total outstanding amount). Similarly to other Italian banks, the Company reported a huge increase in non-performing exposures (“NPEs”) in the last years, which are the sum of non-performing loans ("NPLs"), unlikely-to-pays ("UTPs") and past-dues ("PDs"). The surge was the outcome of the prolonged (double-dip) macroeconomic recession that hit the country (2009 and then 2012-13). As of the end of FY17, BDB's gross NPEs’ reached 15% of total gross loans while net NPEs were nearly 7.6%, down from 9.6% in FY15 as a result of a considerable provision policy carried out over the last 3 years. The Bank has recently done a further step to tackle the stock of NPLs through a sale of nearly €1bn occurred by the beginning of July. The sale was prepared with a further increase in the general level of provisions in Q1 to align carrying value with projected sale prices. The financial effects of such transaction are not fully disclosed (will be in the coming reports) but, according to the Q1 figures, could be simulated as below:
As a result of the transaction, Gross NPEs ratio is expected to decline below 7% while net NPEs ratio is projected to go below 4.5%, a safe level, consistent with the best performers in the industry. Moreover, Texas ratio (calculated as NPEs/tangible equity), that was nearly 85% as of 31 December 2017, would decline to ca. 40%.
BDB funds most of its invested capital through direct funding from customers (deposits and bonds). In the last 3 years, the outstanding amount of bonds declined sharply because of: i) a progressive fall in market returns which made increasingly less attractive to customers this investment option; ii) an unfavorable tax treatment, according to Italian law, than an investment in government bonds; iii) the effects of European legislation on banking resolution that extended burden sharing to bonds in case of resolution (no more bail-out from the government); iv) commercial efforts of the whole banking sector toward asset management’ products in order to collect higher commissions in the current ultra-low interest rates environment. BDB successfully offset the lower outstanding amount of bonds with “demand” and “time” deposits. Prudently, net loans were nearly 78% of total funding by the end of FY17. Excluding interbank funding, net loans totaled 90% of funding from customers, still prudent.
Quality of earnings
Company’s net revenue peaked at €469m in FY15 following the acquisition of a small competitor occurred in FY14 (BDB completed acquisition of a small regional competitor, Banca Popolare di Spoleto, through a right issue; beginning with FY15, the income statement fully factors the effects of the deal while comparability with previous years is limited).
The largest share of revenue comes from Net Interest Income and Fees while the impact of trading profits is negligible.
In FY16 revenue declined because of the low-interest-rate-policy implemented by ECB and a general context of sluggish growth in Europe while unusual items related to provision for redundancies.
The Bank remained profitable and EBT excluding unusual items set, on average, in a range around €45m in the last 4 years.
Normalized Net Income
I estimated the Normalized Net Income starting from the revenue level of the last years (low interest rates environment) and factoring i) provision for loan losses (or cost of risk normalized at 70 bps following the recent disposal of NPLs and some benefits on personnel cost coming from the recent agreement with employees and unions for headcount reduction in FY17 and FY18 (economic benefits will be fully effective starting from FY19).
Normalized earnings before taxes resulted equal to €72m. With a 33% tax rate, Normalized Net Income is projected to be €48m.
The balance sheet exhibits a huge amount of prepaid taxes arising from loan loss provisions posted in the last years. According to the tax rules, BDB will benefit, in the coming years, of significant reduction of taxable income because of losses utilization. The utilization of tax benefits has no time limitation and, according to the Italian tax law, they have been transformed in tax receivables. I consider the DTAs (nearly €150m) a pure surplus asset that I prudently valued assuming a certain haircut (50%) to factor time value and some degree of risk (tax savings upon achievement of profitability).
The valuation exercise, according to the income approach, is based on the following key assumptions:
Cost of equity 10%;
No growth, capitalization of the estimated Normalized Net Income in order to get the Earnings Power value in the current rates environment (potential forthcoming rises in interest rates are not factored).
Furthermore, the equity value calculation factors: i) the discounted (50%) value of tax benefits (refer to the surplus assets above), ii) the book value of certain equity securities valued at €90m, iii) the actuarial/present value of leaving employees indemnity (“TFR”, according to the Italian law) and the book value of other provisions for risks.
The estimated Intrinsic Value (€4,37 per share) highlights a potential 100% upside for the common and a 50% margin of safety. At that level, the stock would trade at 0.6x the tangible book value, consistent with ROTE. Based on the current market price for the common, an investor would pay the Earnings Power value with a 40% discount and get the surplus assets (DTAs and securities), netted of any potential liability in the books, for free.
Reasons for mispricing
Market prices of Italian bank stocks are particularly depressed:
The prolonged recession and the zero-interest-rate era have severely affected the business of commercial banking in terms of both declining revenues and large provision for loan losses. That rose general concern about the overall stability of the Italian banking system. The reputation and perceived opinion on bank stocks’ profitability and perspectives, among investors, is still bad.
Concern about the actual possibility to fix the governance issues of the Euro area and the related fears about medium-term sustainability of the European single currency has a strong direct impact on the most vulnerable countries’ standing (Southern Europe’s countries) and the risk perceived by investors. The mentioned uncertainties hit largely the bank stocks because of strict connections among public budget of the states, risk sharing and banking system.
In particular, this is an out-of-favor sector in Italy for i) (still) relative large size of NPEs in the balance sheets (ii) the perceived strict connection with domestic sovereign debt and (iii) the concomitant absence of an European cross-border deposit insurance.
Moreover, BDB’s common are depressed because, as a low-capitalization and illiquid stock, most analysts and institutional investors ignore BDB, no sell-side analyst covers the stock and trading volumes are extremely low. The stock price lags behind the other Italian bank stocks, with a multiple to tangible of 0.3x and on earnings of 6x that I consider unreasonably penalizing (at the same time it offers limited risk for downside) for a bank and a management exhibiting a consistent low-risk profile over time.
Motives to invest
A clear and straightforward traditional business model of commercial banking in rich regions. It has consistently avoided exotic ideas and continued to focus on lending to SMEs. Still profitable in the ultra-low-rate environment.
Full alignment of interest among management and shareholders (Gavazzi family retains control over the business). Historically, there were no operations to the detriment of minority shareholders’ interest.
NPEs are no longer an issue for the bank thanks to the recent securitization of a €1bn portfolio. Safe Texas ratio.
Capital ratios stably in a safe range.
Uncertainties surrounding the banking sector
With the recently-formed government in Italy by populist parties, there is some degree of concern among investors regarding fiscal policies, effects on public budget and, at the end of the day, on sovereign debt outlook. Following the establishment of the new government, yields curve shift by 100bp and bank stocks collapsed on average by 30%. The market rapidly discounted uncertainties with lower stocks’ prices.
About the consequences of the mentioned potential risks on this investment case and whether the risks actually compromise the investment thesis: of course, I cannot have a perfect view on the coming economic policy of this government and I think it does not make sense spending pages from an investment standpoint (I am for sure available to discuss and consider views on that). In my view, there is no actual rational interest/incentive for the governing parties to create serious instability in Europe proposing to sharply exceed the target deficit (to boost the growth) and engaging a tough negotiation with the European Commission. Deficit limit are actually set by the market and not by European Commission. For a country with structural high sovereign debt, should a government pursue a large public deficit, that results in perceived higher risks for sovereign bonds. Actually, the final outcome would probably be higher yields in the market for families/firms, weakening economy, more deteriorating public budget and, at the end of the day, loss of support among the voters (the experience in Greece some years ago proved that Euro is irreversible).
Current Earnings power for BDB, calculated in an environment of very low market rates and narrowed spreads, highlights the potential for substantial appreciation of the stock.
Thanks to extremely low entry multiples, I think potential for appreciation greatly exceeds the risk of capital loss and potential risks are addressed by the attractive market price.
I would be happy to interact for anyone might be interested in approaching this investment case. Please comment.
The key catalyst is the increase in earnings for BDB that I expect in the coming quarters as a result of a sharp decline in the cost of risk.
A second short-term catalyst is at industry level: the forthcoming NPLs’ disposals. Most Italian banks completed securitizations in the last 12 months (nearly €100bn out of a total of €200bn for the whole system) and there is strong interest among specialized investors for these assets. The increasing coverage ratios of NPLs pushed by the regulators, coupled with the possibility to use the government guarantee for senior notes secured by NPLs, should contribute to narrow the bid/ask prices gap and furtherly speed up market transactions (a number of industry reports forecasts several disposals in the coming months).
|Subject||Re: Playing Politics|
|Entry||07/15/2018 01:26 AM|
Thank you for your message. Your interpretation is very very careful and interesting.
So, I try to summarize some points:
1) Actually, Lega (Salvini’s party) and its leader are navigated politicians and they proved to be very effective in the last weeks from a communication standpoint. They raised the voice against Europe mostly about immigration and actually Salvini appears to be the premier (instead of Conte) and, anyway, the most influential person in the government. He is also perceived to be fully consistent with his electoral promises/mandate. So, in the polls, he is now very high. And the bet to form a government with M5S revealed winning, Lega is now probably the first party, at least in the polls. I would add also that Salvini’s promises do not bear any cost, so they are easy to be carried forward and he can leverage on the fact that actually European Union, on immigration, has not a common sustainable framework.
2) M5S (Di Maio) took the leadership in some critical ministries (for example Economic Development) and the party is totally unexperienced. Moreover, it is very difficult, as you pointed out, to deliver on that, cause Italy needs supply-side reforms and not public deficit to boost the growth.
3) But bear also in mind that the most critical seat is the Ministry of Finance where the coalition put a full-time economics professor (Giovanni Tria). He is in charge of public deficit and debt. He deals and negotiates with European Commission the budget law. He is a very prudent person, low profile, and is continuously reassuring the markets and Europe that Italy will respect the common rules and keep up with its own commitments in terms of deficit and debt reduction. He is credible and respectable.
So, I cannot do predictions in the political sense. Too uncertain. And this is a game, political game, you know, but what I can reasonably say to answer your question?
- I agree with you that Salvini and its party can benefit over the mid term from the government, thanks to the low-risk position they took and visibility they have.
- But I see also a situation where both the parties (and not just Lega) could say, at the end of the day, that they could not deliver properly because Europe does not allow to exceed the limits and Tria risks to become the scapegoat.
- I cannot know if in an 1-year time from now, Italy will see other elections with Salvini taking the government along with other right parties. I can for sure agree with you that Salvini is actually the strong leader of far-right and could have the incentive, at a certain time, “to monetize” this advantage. But, again, following this coalition with M5S, is Lega still a party that can build a coalition with former Belusconi’s party or alone as right populist party? And can they win alone?
- It is also possible that PD moves close to M5S positions, but for the time being they have not disclosed a clear position and they do not enjoy a leader. This would be safer for Italy cause PD is pro-Europe but, to me, that would mean the end of PD, becoming ancillary to M5S.
- We could also predict that a new movement, liberal, different from PD, trying to collect the votes of many Italians (30%?) looking for normal politics in the interest of the economy and will be launched by some people (hope so).
Volatility? Yes, possible, and we experienced that in the last weeks. But this is what we need. Bank stocks decline by 30% but next quarter results (early August) will prove very good, with cost of risk particularly low and stock of NPL still declining. I think we can benefit from volatility if, at the end of the day, we can buy at lower prices (lower risk). And that is the case: to buy at 0.3 Tangible Book Value.
Generally, investing in Italy is not safe as investing in Germany. It will never be. But, I am interested in taking a position where the prices are so low that risks can be borne with a great potential for upside and limited room for downside.
In addition to that, the thesis is based on the fact (not predictions) that looking at ROTE, NPLs ratio, Texas ratio, regulatory capital ratios, this stock is depressed compared to stocks of larger banks with similar figures, for the reasons I wrote in the note and Earnings Power confirms the thesis. And this makes, to me, the investment case favorable.
You are welcome should you have more comments.
|Subject||Re: Re: Re: Playing Politics|
|Entry||07/16/2018 10:25 AM|
Thanks again for interest in this case. I appreciate.
I want to clarify that I have not built the case on a specific prediction in terms of political outcome. It would not make me serious cause it is very difficult to do such a prediction, would be pure betting.
Politics is part of the risk but it is also the reason why we are in a position to pay 0.3x TBV multiples. Do you agree?
But I would like to elaborate on your analysis and comments. Assuming that in a 1-year time or more the Far-Right+Forza Italia takes the lead of the government thorugh new elections, I do not believe that such a coalition would push the country to leave the Euro. I try to make myself clearer:
2) Lega supported by Forza Italia (Berlusconi's party) would be a coaltion with a strong anti establishment party (Lega) + an old party supportive of business and voted by businessmen. Such a coalition would be a minor threat compared to the current coalition where there is a party (M5S) led by guys who never worked and totally unexperienced. The current one is the worst possible coalition.
3) Incentives: what are the incentives for leaving the Euro? I don't know. Perhaps ignorance of people/voters/politicians. You are right. It is a possibility. My sense is that majority of people can understand that printing money alone does not solve an issue. Secondly, exiting the Euro mean uncertainty/chaos. Chaos means recession, unemployment, people suffering. So, the likely outcome of this action would mean worsening Italians' condition and losing votes/support quickly.
4) Technicality: Euro Area is not just a currency, it is an integrated banking system and single structured payment system. I do not think it is realistic to quit in just a weekend surprising the whole market. I see a situation characterized by weeks of interrupted payments, block of any capital flow, deferred expenses and investments. That would cause a very deep recession and again back to the point "3" above. Germany can leave the Euro alone, with limited effects, not Italy.
5) For your last point, Italy suffered many currency crisis because historically it has always been an inflationary country. And the market will continue to perceive Italy as that, should the governement decide to quit the Euro Area. There is no hope for country perceived as inflationary; simply the money flees away. Argentina and Turkey, you know. Outcome?
6) Lastly, negotiating hard with Europe because Italy is the third economy by size, would be a non-credible threat. First of all yields would jump immediately with likely recession. Secondly, Italy is the country that has the most to lose. Actually, treasuries are for nearly 70% held by Italians (Bank of Italy because of QE, Banks, Insurances, Retail). Cutting off 30-50% of debt through unexpected inflation would make Italians poorer -> Loss of savings and the need to recapitalize banks and insurance companies. Default. ---> would need ask help from FMI or Europe (again).
I just tried to find a rational way of brainstorming about the Euro and future of Italy in the single currency. I do not make predictions, as I said.
Other facts support my investment case.
|Subject||Re: Re: Re: Re: Re: Playing Politics|
|Entry||07/17/2018 08:44 AM|
Got your point.
1) Political uncertainties will continue - likely - and this could dampen catalyst's effects but - as I said - I like the idea to stay invested in assets with such a large discount and I cannot do any bet on political development. I feel protected on the downside and, at the same time, I can benefit of earnings growth(my expectation), NPL collapsing (this event - in particular - has not yet recognized by the market, I am sure, considering the volumes and low interest on the stock). Perceptions may change rapidly.
2) If you are worried abut a potential quitaly or higher risk because of potential deteriorating macroeconomics in Europe in the future, but you like the stock, you may manage through an ETF short (1x o 2x) on 10y Italian treasuries which, in case of higher risk, will see increasing yields and higher returns for you. This is a play that you can do without setting any specific deadline which is embedded with an option.
You're welcome, let's see what happens, thank you.
|Entry||07/19/2018 02:12 AM|
Thanks very much for the write-up Trajan. How does the valuation compare to other similar, small-cap banks in Italy? Is 0.3x to 0.5x type of tangible book value common or BDB is a big outlier?
|Entry||07/19/2018 12:45 PM|
Average P/e (NTM) is 10.5x for Italian commercial banks (11 peers). Average P/TBV (last annual) is 0.6x with ROTE at 5.8%.
However, I could consider core peers (as per the size/market cap and the fact that they are regional banks with focus in certain areas and not at national/European level as the giants Unicredit/Intesa for example) just 4 banks which are:
- Banca Popolare di Sondrio (BPSO)
- Credito Emiliano (CE)
- Carige (CRG)
- Credito Valtellinese (CVAL)
This is a very limited sample but the data are:
Average P/e (NTM) is 15.3x for core peers Italian commercial banks (3 peers cause CRG is deeply distressed with still negative profitability). Average P/TBV (last annual) is 0.6x with ROTE at 5.0%. BPSO and CVAL are exiting a turnaround so eps are expected growing in the comig years. This is the reason for seeing such a high P/e (NTM) multiple.
Hopefully this is helpful. Happy to enter more in details should you be interested in.