Caja de Ahorros del Mediterraneo CAM SM S
April 13, 2011 - 12:02pm EST by
value_31
2011 2012
Price: 5.87 EPS $0.00 $0.00
Shares Out. (in M): 50 P/E 0.0x 0.0x
Market Cap (in M): 294 P/FCF 0.0x 0.0x
Net Debt (in M): 0 EBIT 0 0
TEV: 0 TEV/EBIT 0.0x 0.0x
Borrow Cost: NA

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Description

Thesis

Caja de Ahorros del Mediterraneo (CAM) is trading at >2x P/BV (17x P/E).  This is despite (based on CAM's own calculation of its equity capital shortfall) it requiring additional new equity capital equal to approximately 1.4x its current book value.  The systemic importance of CAM and solvency concerns mean that the capital injection must be completed in the near term and the new equity will likely come into the bank at a discount to current book value.  This will be extremely dilutive to current equity holders, which already enjoy a premium valuation to comparables (without any justification based on business fundamentals).  CAM's equity is likely worth >75% less than its current value. 

Cross checks:

  • The Bank of Spain has proactively contacted a number of banks over the past two weeks and has been unable to find a buyer for CAM (it is understood that buyers are unwilling to buy CAM - even for nominal value - without an asset protection scheme to protect them from further losses)
  • Fitch downgraded CAM to sub-investment grade on 1 April 2011
  • CAM's Senior Credit is currently trading at a spread of ~500bps and its Perpetual Subordinated Bonds trade in the high-30s (this is entirely inconsistent with a bank that has equity trading at a material premium to book value)

Summary

  • Valuation: CAM is the only Spanish Savings Bank (Caja) with listed equity. CAM's equity trades at >2x P/BV. The equity is likely worth >75% less than its current value
  • Catalyst: CAM is the 10th largest bank in Spain and systemically important. Solvency concerns mean that new equity must come into the bank in the near term. This is not in dispute as even CAM has acknowledged it has a requirement for €2.8 billion of fresh equity capital (vs. its current book value of €2 billion - i.e. 1.4x its current book value must come in as fresh equity). This equity will very likely come in at a discount to book value
  • Background & Context: Spain's banking issues are well known. The savings banks are more troubled than the listed commercial banks. CAM is no exception to this. As part of an effort to clean up its balance sheet CAM had agreed a merger with three other savings banks. As a result of a material deterioration of its loan book in late 2010 / early 2011 the merger was rejected by the other three savings banks. CAM is now left with a very large capital shortfall (and thus a very large requirement for new equity). The following chronology of events shows how the situation developed:
    • CAM had agreed to merge with three other savings banks. The merged entity would seek an equity infusion from a specially established government fund (FROB) to replenish its equity capital to minimum core capital requirements. The merger was subject to shareholder votes from each of the four institutions. The votes were scheduled to take place in late March 2011
    • 30-Mar-11: CAM shareholders approved the merger. The other three savings banks all voted against the transaction. The other institutions indicated they voted against the transaction because they became increasingly concerned with CAM's solvency as a result of a material deterioration of its loan book. The capital shortfall of the merged entity doubled.  All of this increased capital shortfall was due to CAM's loan book deterioration
    • 30-Mar-11: After the three other banks had voted against the merger the Bank of Spain issued a statement requiring that a new recapitalization plan be presented "immediately"
    • 1-Apr-11: Fitch downgraded CAM to sub-investment grade (downgrade to BB+)
    • 3-Apr-11: CAM announced it had calculated it had a €2.8 billion equity capital shortfall and it required this much fresh equity (vs. a €2 billion book value at 31 December 2010)
    • 8 Apr-11: The other three savings banks that were previously going to merge with CAM approved a merger among themselves. The merged entity (with only these three institutions) has not requested any additional equity (i.e. it does not have a shortfall)
    • 13-Apr-11: Press reports indicate the Bank of Spain was unable to find a buyer for CAM (Note: the BoS had pro-actively contacted a number of banks looking for a buyer for CAM. It is understood that no banks were willing to buy CAM - even for nominal value - without an asset protection scheme from the government to protect the buyer from future losses in CAM's loan book)

Background

I have written a couple of times on Banco De Valencia (BVA):

Approximately 2/3 of CAM's Branch Network is located in the same geographies as BVA and from what I understand there was not a large differentiation in lending standards among the institutions competing in these regions.  The background information provided in these write-ups in relation to the Spanish banking system and its challenges, house prices, lending to developers and sub-economic loan roll-overs as well as the specific issues related to the Valencia/Murcia geographies is also applicable to CAM.  

In May 2010 CAM and three other savings banks (Cajastur, Caja Cantabria and Caja Extremadura) agreed to merge.  As part of the merger the four institutions agreed to:

  1. effectively pool all of their assets and liabilities;
  2. write-down their assets to fair value and/or recognize appropriate levels of provisioning;
  3. apply to the FROB* for fresh capital to allow the merged entity to be adequately capitalized and in compliance with the minimum capitalization requirements as set by the Bank of Spain.  The original capital shortfall identified for the merged entity was calculated at €1.45 billion

Implementation of the merger was subject to shareholder approval from all four savings banks.

In early 2011 press speculation and rumours emerged that the merger was in jeopardy as a result of disagreements between CAM and its potential merger partners.   It has been reported that CAM's merger partners claimed that as a result of a rapid and material deterioration in CAM's loan book, the capital shortfall of the merged institution had increased from €1.45 billion to €2.8 billion.  CAM's merger partners argued that as a result of this more fresh equity would be required which would dilute each institution's economic interest in the merged entity.  They argued that because all of the deterioration was from CAM's loan book CAM should shoulder the burden of the additional dilution.  It is understood that the Bank of Spain exerted pressure on all institutions to proceed with the merger.  Despite this pressure, on 30 March 2011 CAM's merger partners all voted against the merger and the deal fell over.  In the two weeks since the merger fell over CAM has identified that it has a capital shortfall of €2.8 billion (i.e. 100% of the capital shortfall the entire merged entity identified) and the other three institutions have proceeded with their own merger (without CAM) and have identified zero capital shortfall.

More background on the situation available here for those interested:

 

*Note: the FROB is a fund created by the Spanish government to recapitalize troubled banks - see here for more information: http://es.wikipedia.org/wiki/Fondo_de_reestructuraci%C3%B3n_ordenada_bancaria).

 

CAM's Capitalization as a Savings Bank & CAM Listed Equity

CAM is a Caja (a savings bank) and as such (like other savings banks in Spain) is a non-profit social institution.  Essentially, what this means is that the equity in CAM is "owned" by the local municipality and any profits generated by the bank are for the benefit of the community.  In practice the bank makes distributions to a welfare fund which spends money on various projects. 

In 2008 CAM issued 50 million non-voting shares which are traded on the Madrid Stock Exchange (CAM was the first - and to my knowledge the only - savings bank to have issued public shares).  The rights conferred on the shares are summarized in CAM's Annual Report, but simplistically the non-voting shares receive a specified percentage of CAM's after tax profits but have no voting rights.  In a liquidation the non-voting shares rank equal to the welfare fund (and junior to subordinated creditors).  For 2010 the non-voting shares are entitled to 6.935% of CAM's distributable profit (see 2009 Annual Report for the calculation of this percentage). 

Those interested can find CAM's Annual Reports (in English) here: https://www.cam.es/EN/inversores/FinancialInformation/Paginas/pgAnuales.aspx 

 

Valuation

The current market capitalization of CAM's non-voting shares is approximately €294 million.  Applying the non-voting shares percentage entitlement to distributions implies a market value for all of CAM's equity of approximately €4.2 billion (i.e. €290 million / 6.935%).   At 31 December 2010 CAM's book value was €2 billion.  CAM's profit after tax for the year ended 31 December 2010 was €244 million (€277 million in 2009). On this basis the non-voting shares are trading at approximately 2x P/BV and approximately 17x P/E. It is noteworthy that CAM took €1 billion of write-downs through equity (this did not hit the income statement) in 2010 (this is part of the reason that additional equity is now required - more on that below).  Regardless, at its current valuation, (with the exception of BVA - which I have written about before as referenced above - this makes CAM the most expensive bank in Spain and one of the most expensive in Europe.  Importantly, this valuation does not adjust for CAM's capital shortfall and the fresh equity that will be coming into the bank (see below).  

The listed Spanish domestic banks* currently trade at an average P/BV of 0.8x and an average P/E of 13x P/E.  The rationale for valuations that are below book value is because the sector is expected to earn a Return on Equity that is below its Cost of Equity for the short to medium term and overall loan growth in Spain is expected to be negative over this same time period.  CAM is no exception to the sector trends.  

The other very relevant data point was a transaction announced in January 2011, where Criteria Caixa Corp acquired La Caixa (the largest savings bank in Spain).  La Caixa was widely perceived to be one of the healthiest savings banks in Spain with a very valuable retail franchise.  The transaction was completed at a valuation multiple of 0.8x book value.   More information on the transaction can be found here: http://www.criteria.com/deployedfiles/caixaholding/Estaticos/PDFs/InversoresInstitucionales/110128_HR_CRIWebcast_en.pdf

Because of the size and quality of the institution, the La Caixa transaction multiple will likely be the ceiling for acquisitions of savings banks (as well as for fresh equity contributions into savings banks).  The trading multiples of the domestic banks will also be valuation benchmarks and the current P/BV multiples are wrapped around the La Caixa transaction multiple.

* Note: represents Banco Popular, Banco Sabadell, Banesto, Bankinter and Banco Pastor (excludes Banco De Valencia which is a valuation anomaly, albeit one that is correcting)

 

CAM's Capital Shortfall

On 1 April 2010 CAM announced that it had a capital shortfall of €2.8 billion (see here: http://www.cnmv.es/Portal/HR/verDoc.axd?t={a2895af5-6067-483c-a331-0c275d18a4d9}).  While this amount has not yet been formally agreed by the Bank of Spain (it could increase if the BoS believes CAM's methodology was aggressive), it is probably the best case for the bank.   Given the valuations of the domestic banks as well as the valuation for the La Caxia transaction it seems extremely unlikely that this fresh equity capital will enter the bank at book value.   The analysis below assumes the capital is contributed at 0.5x P/BV:  

CAM Current Book Value (at 31-Dec-10): €2 billion

New Capital: €5.6 billion notional (i.e. €2.8 billion capital contribution at 0.5x P/BV)

% Total Capital Post Recap:

New Shareholders: 74% (i.e. €5.6 billion / €7.6 billion)

Current Shareholders: 26% (i.e. €2 billion / €7.6 billion)

of which: CAM non-voting shares: 1.8% (i.e. (€2 billion x 6.935%) /  €7.6 billion)

In this scenario the current market value of the non-voting shares (~€294 million) would result in a valuation of 3.3x P/BV and 66x P/E (versus the new money that has come into the bank at 0.5x P/BV).   This represents ~85% downside from CAM's current valuation to the valuation that new money came into the bank.  

 

If you assume new money comes into the bank at 0.8x (which is probably the ceiling based on the La Caixa transaction as well as where the public comps are currently tradnig, as discussed above) then the resulting percentage ownership of the non-voting shares would be 2.5% (rather than 1.8%).  This would result in a valuation for the non-voting shares of 2.4x P/BV and 48x P/E (i.e. 65% downside to where new money came into the bank).

 

The final point that is worth noting on valuation is that the Bank of Spain has been actively seeking a buyer for CAM since its merger fell over on 30 March 2011.  The press has reported that eight institutions have been approached.  On 13 April 2011 press reports indicated that the Bank of Spain was unable to find a buyer for CAM.  It is understood that no banks were willing to buy CAM (even for nominal value) without an asset protection scheme to protect the buyer from future losses that could emerge from the CAM loan book.  This scenario indicates that strategic buyers value the current equity at effectively zero (i.e. they likely believe that CAM's estimate of a capital shortfall of €2.8 billion is too low and the capital contribution they will need to make is higher and therefore the deal does not make economic sense for them, even if they acquire CAM's current equity at nominal value).  

 

Likely Outcomes

It is not in dispute that CAM requires fresh equity (the bank itself has admitted this).  The question then becomes what are the likely outcomes and how dilutive will this be to current equity holders.  I think there are three potential likely outcomes:

  1. CAM is acquired by a strategic buyer.  Absent an Asset Protection Scheme it appears the value for equity is this scenario is very low.  As an Asset Protection Scheme is a transfer of value from the Spanish taxpayer to current equity owners and there is no impending banking crisis, I would argue the appetite for an APS is low.  As such, it seems likey that current equity holders will be heavily diluted in this scenario (probably even more than the analysis above shows) 
  2. FROB Equity Injection.  This seems like the most likely scenario. If this takes place the FROB would likely replace existing management, try to put CAM's house in order and then probably sell the assets in a public auction.  it is worth noting that any equity injection by the FROB will be done at a value determined by an independent third party. The analysis above indicates this is a very dilutive outcome for existing equity holders but this assumes that the FROB equity comes in at the same level as the existing equity.  It is possible that FROB could put its equity in as preferred (or something simialr).  This could change the calculation for current equity holders and potentially make the outcome even worse
  3. Bank of Spain Intervention. If CAM started to become a systemic concern (e.g. large retail deposit outflows, etc.) then the likelihood of  direct intervention would increase.  In this case it is likely that the equity would be seized for nominal value, some good bank / bad bank separation would take place and the good bank would be on-sold and/or an Asset Protection Scheme is put in place for the buyer (for those interested, you can look at the separate recent cases of CajaSur and Caja Castilla La Mancha for case studies of how this would likely occur in practice)

Catalyst

Fresh equity injection. CAM is systemically important and new equity needs to come into the bank in the near term.   It is worth noting that this situation is developing against the backdrop of the European bank stress tests and Spain trying to prove to investors that it will not be the next Perpherial European country that needs to go to the EU for a bailout.  This backdrop (as well as the systemtic important of CAM) adds urgency to the issue.  

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    Description

    Thesis

    Caja de Ahorros del Mediterraneo (CAM) is trading at >2x P/BV (17x P/E).  This is despite (based on CAM's own calculation of its equity capital shortfall) it requiring additional new equity capital equal to approximately 1.4x its current book value.  The systemic importance of CAM and solvency concerns mean that the capital injection must be completed in the near term and the new equity will likely come into the bank at a discount to current book value.  This will be extremely dilutive to current equity holders, which already enjoy a premium valuation to comparables (without any justification based on business fundamentals).  CAM's equity is likely worth >75% less than its current value. 

    Cross checks:

    • The Bank of Spain has proactively contacted a number of banks over the past two weeks and has been unable to find a buyer for CAM (it is understood that buyers are unwilling to buy CAM - even for nominal value - without an asset protection scheme to protect them from further losses)
    • Fitch downgraded CAM to sub-investment grade on 1 April 2011
    • CAM's Senior Credit is currently trading at a spread of ~500bps and its Perpetual Subordinated Bonds trade in the high-30s (this is entirely inconsistent with a bank that has equity trading at a material premium to book value)

    Summary

    • Valuation: CAM is the only Spanish Savings Bank (Caja) with listed equity. CAM's equity trades at >2x P/BV. The equity is likely worth >75% less than its current value
    • Catalyst: CAM is the 10th largest bank in Spain and systemically important. Solvency concerns mean that new equity must come into the bank in the near term. This is not in dispute as even CAM has acknowledged it has a requirement for €2.8 billion of fresh equity capital (vs. its current book value of €2 billion - i.e. 1.4x its current book value must come in as fresh equity). This equity will very likely come in at a discount to book value
    • Background & Context: Spain's banking issues are well known. The savings banks are more troubled than the listed commercial banks. CAM is no exception to this. As part of an effort to clean up its balance sheet CAM had agreed a merger with three other savings banks. As a result of a material deterioration of its loan book in late 2010 / early 2011 the merger was rejected by the other three savings banks. CAM is now left with a very large capital shortfall (and thus a very large requirement for new equity). The following chronology of events shows how the situation developed:
      • CAM had agreed to merge with three other savings banks. The merged entity would seek an equity infusion from a specially established government fund (FROB) to replenish its equity capital to minimum core capital requirements. The merger was subject to shareholder votes from each of the four institutions. The votes were scheduled to take place in late March 2011
      • 30-Mar-11: CAM shareholders approved the merger. The other three savings banks all voted against the transaction. The other institutions indicated they voted against the transaction because they became increasingly concerned with CAM's solvency as a result of a material deterioration of its loan book. The capital shortfall of the merged entity doubled.  All of this increased capital shortfall was due to CAM's loan book deterioration
      • 30-Mar-11: After the three other banks had voted against the merger the Bank of Spain issued a statement requiring that a new recapitalization plan be presented "immediately"
      • 1-Apr-11: Fitch downgraded CAM to sub-investment grade (downgrade to BB+)
      • 3-Apr-11: CAM announced it had calculated it had a €2.8 billion equity capital shortfall and it required this much fresh equity (vs. a €2 billion book value at 31 December 2010)
      • 8 Apr-11: The other three savings banks that were previously going to merge with CAM approved a merger among themselves. The merged entity (with only these three institutions) has not requested any additional equity (i.e. it does not have a shortfall)
      • 13-Apr-11: Press reports indicate the Bank of Spain was unable to find a buyer for CAM (Note: the BoS had pro-actively contacted a number of banks looking for a buyer for CAM. It is understood that no banks were willing to buy CAM - even for nominal value - without an asset protection scheme from the government to protect the buyer from future losses in CAM's loan book)

    Background

    I have written a couple of times on Banco De Valencia (BVA):

    Approximately 2/3 of CAM's Branch Network is located in the same geographies as BVA and from what I understand there was not a large differentiation in lending standards among the institutions competing in these regions.  The background information provided in these write-ups in relation to the Spanish banking system and its challenges, house prices, lending to developers and sub-economic loan roll-overs as well as the specific issues related to the Valencia/Murcia geographies is also applicable to CAM.  

    In May 2010 CAM and three other savings banks (Cajastur, Caja Cantabria and Caja Extremadura) agreed to merge.  As part of the merger the four institutions agreed to:

    1. effectively pool all of their assets and liabilities;
    2. write-down their assets to fair value and/or recognize appropriate levels of provisioning;
    3. apply to the FROB* for fresh capital to allow the merged entity to be adequately capitalized and in compliance with the minimum capitalization requirements as set by the Bank of Spain.  The original capital shortfall identified for the merged entity was calculated at €1.45 billion

    Implementation of the merger was subject to shareholder approval from all four savings banks.

    In early 2011 press speculation and rumours emerged that the merger was in jeopardy as a result of disagreements between CAM and its potential merger partners.   It has been reported that CAM's merger partners claimed that as a result of a rapid and material deterioration in CAM's loan book, the capital shortfall of the merged institution had increased from €1.45 billion to €2.8 billion.  CAM's merger partners argued that as a result of this more fresh equity would be required which would dilute each institution's economic interest in the merged entity.  They argued that because all of the deterioration was from CAM's loan book CAM should shoulder the burden of the additional dilution.  It is understood that the Bank of Spain exerted pressure on all institutions to proceed with the merger.  Despite this pressure, on 30 March 2011 CAM's merger partners all voted against the merger and the deal fell over.  In the two weeks since the merger fell over CAM has identified that it has a capital shortfall of €2.8 billion (i.e. 100% of the capital shortfall the entire merged entity identified) and the other three institutions have proceeded with their own merger (without CAM) and have identified zero capital shortfall.

    More background on the situation available here for those interested:

     

    *Note: the FROB is a fund created by the Spanish government to recapitalize troubled banks - see here for more information: http://es.wikipedia.org/wiki/Fondo_de_reestructuraci%C3%B3n_ordenada_bancaria).

     

    CAM's Capitalization as a Savings Bank & CAM Listed Equity

    CAM is a Caja (a savings bank) and as such (like other savings banks in Spain) is a non-profit social institution.  Essentially, what this means is that the equity in CAM is "owned" by the local municipality and any profits generated by the bank are for the benefit of the community.  In practice the bank makes distributions to a welfare fund which spends money on various projects. 

    In 2008 CAM issued 50 million non-voting shares which are traded on the Madrid Stock Exchange (CAM was the first - and to my knowledge the only - savings bank to have issued public shares).  The rights conferred on the shares are summarized in CAM's Annual Report, but simplistically the non-voting shares receive a specified percentage of CAM's after tax profits but have no voting rights.  In a liquidation the non-voting shares rank equal to the welfare fund (and junior to subordinated creditors).  For 2010 the non-voting shares are entitled to 6.935% of CAM's distributable profit (see 2009 Annual Report for the calculation of this percentage). 

    Those interested can find CAM's Annual Reports (in English) here: https://www.cam.es/EN/inversores/FinancialInformation/Paginas/pgAnuales.aspx 

     

    Valuation

    The current market capitalization of CAM's non-voting shares is approximately €294 million.  Applying the non-voting shares percentage entitlement to distributions implies a market value for all of CAM's equity of approximately €4.2 billion (i.e. €290 million / 6.935%).   At 31 December 2010 CAM's book value was €2 billion.  CAM's profit after tax for the year ended 31 December 2010 was €244 million (€277 million in 2009). On this basis the non-voting shares are trading at approximately 2x P/BV and approximately 17x P/E. It is noteworthy that CAM took €1 billion of write-downs through equity (this did not hit the income statement) in 2010 (this is part of the reason that additional equity is now required - more on that below).  Regardless, at its current valuation, (with the exception of BVA - which I have written about before as referenced above - this makes CAM the most expensive bank in Spain and one of the most expensive in Europe.  Importantly, this valuation does not adjust for CAM's capital shortfall and the fresh equity that will be coming into the bank (see below).  

    The listed Spanish domestic banks* currently trade at an average P/BV of 0.8x and an average P/E of 13x P/E.  The rationale for valuations that are below book value is because the sector is expected to earn a Return on Equity that is below its Cost of Equity for the short to medium term and overall loan growth in Spain is expected to be negative over this same time period.  CAM is no exception to the sector trends.  

    The other very relevant data point was a transaction announced in January 2011, where Criteria Caixa Corp acquired La Caixa (the largest savings bank in Spain).  La Caixa was widely perceived to be one of the healthiest savings banks in Spain with a very valuable retail franchise.  The transaction was completed at a valuation multiple of 0.8x book value.   More information on the transaction can be found here: http://www.criteria.com/deployedfiles/caixaholding/Estaticos/PDFs/InversoresInstitucionales/110128_HR_CRIWebcast_en.pdf

    Because of the size and quality of the institution, the La Caixa transaction multiple will likely be the ceiling for acquisitions of savings banks (as well as for fresh equity contributions into savings banks).  The trading multiples of the domestic banks will also be valuation benchmarks and the current P/BV multiples are wrapped around the La Caixa transaction multiple.

    * Note: represents Banco Popular, Banco Sabadell, Banesto, Bankinter and Banco Pastor (excludes Banco De Valencia which is a valuation anomaly, albeit one that is correcting)

     

    CAM's Capital Shortfall

    On 1 April 2010 CAM announced that it had a capital shortfall of €2.8 billion (see here: http://www.cnmv.es/Portal/HR/verDoc.axd?t={a2895af5-6067-483c-a331-0c275d18a4d9}).  While this amount has not yet been formally agreed by the Bank of Spain (it could increase if the BoS believes CAM's methodology was aggressive), it is probably the best case for the bank.   Given the valuations of the domestic banks as well as the valuation for the La Caxia transaction it seems extremely unlikely that this fresh equity capital will enter the bank at book value.   The analysis below assumes the capital is contributed at 0.5x P/BV:  

    CAM Current Book Value (at 31-Dec-10): €2 billion

    New Capital: €5.6 billion notional (i.e. €2.8 billion capital contribution at 0.5x P/BV)

    % Total Capital Post Recap:

    New Shareholders: 74% (i.e. €5.6 billion / €7.6 billion)

    Current Shareholders: 26% (i.e. €2 billion / €7.6 billion)

    of which: CAM non-voting shares: 1.8% (i.e. (€2 billion x 6.935%) /  €7.6 billion)

    In this scenario the current market value of the non-voting shares (~€294 million) would result in a valuation of 3.3x P/BV and 66x P/E (versus the new money that has come into the bank at 0.5x P/BV).   This represents ~85% downside from CAM's current valuation to the valuation that new money came into the bank.  

     

    If you assume new money comes into the bank at 0.8x (which is probably the ceiling based on the La Caixa transaction as well as where the public comps are currently tradnig, as discussed above) then the resulting percentage ownership of the non-voting shares would be 2.5% (rather than 1.8%).  This would result in a valuation for the non-voting shares of 2.4x P/BV and 48x P/E (i.e. 65% downside to where new money came into the bank).

     

    The final point that is worth noting on valuation is that the Bank of Spain has been actively seeking a buyer for CAM since its merger fell over on 30 March 2011.  The press has reported that eight institutions have been approached.  On 13 April 2011 press reports indicated that the Bank of Spain was unable to find a buyer for CAM.  It is understood that no banks were willing to buy CAM (even for nominal value) without an asset protection scheme to protect the buyer from future losses that could emerge from the CAM loan book.  This scenario indicates that strategic buyers value the current equity at effectively zero (i.e. they likely believe that CAM's estimate of a capital shortfall of €2.8 billion is too low and the capital contribution they will need to make is higher and therefore the deal does not make economic sense for them, even if they acquire CAM's current equity at nominal value).  

     

    Likely Outcomes

    It is not in dispute that CAM requires fresh equity (the bank itself has admitted this).  The question then becomes what are the likely outcomes and how dilutive will this be to current equity holders.  I think there are three potential likely outcomes:

    1. CAM is acquired by a strategic buyer.  Absent an Asset Protection Scheme it appears the value for equity is this scenario is very low.  As an Asset Protection Scheme is a transfer of value from the Spanish taxpayer to current equity owners and there is no impending banking crisis, I would argue the appetite for an APS is low.  As such, it seems likey that current equity holders will be heavily diluted in this scenario (probably even more than the analysis above shows) 
    2. FROB Equity Injection.  This seems like the most likely scenario. If this takes place the FROB would likely replace existing management, try to put CAM's house in order and then probably sell the assets in a public auction.  it is worth noting that any equity injection by the FROB will be done at a value determined by an independent third party. The analysis above indicates this is a very dilutive outcome for existing equity holders but this assumes that the FROB equity comes in at the same level as the existing equity.  It is possible that FROB could put its equity in as preferred (or something simialr).  This could change the calculation for current equity holders and potentially make the outcome even worse
    3. Bank of Spain Intervention. If CAM started to become a systemic concern (e.g. large retail deposit outflows, etc.) then the likelihood of  direct intervention would increase.  In this case it is likely that the equity would be seized for nominal value, some good bank / bad bank separation would take place and the good bank would be on-sold and/or an Asset Protection Scheme is put in place for the buyer (for those interested, you can look at the separate recent cases of CajaSur and Caja Castilla La Mancha for case studies of how this would likely occur in practice)

    Catalyst

    Fresh equity injection. CAM is systemically important and new equity needs to come into the bank in the near term.   It is worth noting that this situation is developing against the backdrop of the European bank stress tests and Spain trying to prove to investors that it will not be the next Perpherial European country that needs to go to the EU for a bailout.  This backdrop (as well as the systemtic important of CAM) adds urgency to the issue.  

    Messages


    Subject"other" shareholders
    Entry04/13/2011 02:14 PM
    Membermiser861
    who are these other shareholders and why wouldn't the government just sieze their stake.  My worry is that the tradeable equity at only 7% is so small that the government might just let them get a free pass and sieze the other 93% and sell to the chinese.

    SubjectRE: "other" shareholders
    Entry04/13/2011 04:58 PM
    Membervalue_31
    The "other shareholders" are basically the municipality.  I think there are four points to make in relation to your question: 
    1. The most probable scenario is not that the equity gets siezed.  This is an institution that requires a significant amount of additional equity capital.  The question is what value this new equity comes in at and how dilutive it is to existing equity interests.  I think the equity would only be siezed in the event BoS intervention is required (see point 3 under "likely outcomes") which is not the most likely outcome at this point 
    2. Even if the shares remain outstanding (which is probable and is my base case) their entitlement to profits will be significantly diminished.  This is really the whole point.  If you get diluted down from a 7% economic interest to a 2% economic interest then the current valuation must adjust to reflect the new economics => CAM already trades expensive for no real fundamental reason.  There is no reason for it to trade at a 300%+ premium to its domestic peers post recapitalization
    3. Given that the non-voting shares and the other shares are basically pari-passu in respect to economics any actions that are taken will equally dilute all shareholders.  If the non-voting shares were to be given a free pass it would probably require a transaction to buy back the shares somehow.  It is unclear what the justification for this would be given that the policy/systemic issue is recapitalizing the bank.  Giving the non-voting shares a free pass does not further advance the objective of recapitalizing the bank
    4. From a buyers point of view you don't care if these shares remain outstanding because they have no voting rights.  In fact if you dilute them enough they are pretty cheap permanent capital for the bank, so you would probably prefer to keep them outstanding. 

    SubjectBank of Spain Confirms Equity Shortfall
    Entry04/15/2011 03:00 AM
    Membervalue_31
    Last night the bank of Spain confirmed that FROB will assist 4 Cajas (including CAM) with straight equity.   The CAM recap needs to be closed before September although completing the recap before the European Bank stress tests in June is likely a priority.  
     
    This confirms the catalyst for the trade and adds clarity to timing. 

    SubjectMoody's Downgrades CAM to Junk
    Entry04/19/2011 08:43 AM
    Membervalue_31
    Today Moody's downgraded CAM to sub-investment grade.  Moody's assumes that the E2.8bn capital raising (which I describe in the write-up above) is completed and yet despite this,  still questions the adequacy of CAM's overall loss absorption capacity (i.e. because the quality of CAM's loan book is so bad the 10% capital it will have post recapitalization may still not be sufficient to meet potential losses). Despite being down almost 10% since the time of the original write-up CAM still trades at almost 2x P/BV (~3x P/BV adjusted for the recapitalization) when fair value is less than 0.5x P/BV.  
     
    Quoting from the Moody's statement: 
     
    "Despite the clear benefits of the capital injection and the restructuring plan, Moody's believes that CAM continues to face challenges especially in view of its risk-absorption capacity which Moody's considers to remain weak. According to Moody's views, the FROB's funds may not be sufficient to fully cover all the expected losses embedded in CAM's balance sheet, as envisaged under Moody's own scenario analysis. In other words, given Spain's uncertain economic outlook and the uncertainties within the real-estate sector, the rating agency believes that the FROB's recapitalisation may not sufficiently protect CAM against a more conservative loss scenario. Furthermore, Moody's expects that internal capital generation from recurrent sources may be limited by the very challenging domestic operating environment of subdued growth, downward margin pressures - which arise from the high level of non-earning assets and increased funding costs - and ongoing provision requirements."

    SubjectRE: Moody's Downgrades CAM to Junk
    Entry04/19/2011 12:40 PM
    Membersunny118
    This idea seems to be working out just as you predicted.  Nice call and thanks for sharing it.
     
    Given the tone of the Moody's release (i.e., the assumption that the e2.8b has been received) do you have a guess for the timing that the new capital will come in?  And have you heard any talk of the price for the new capital? 
     
    Thanks

    SubjectRE: RE: Moody's Downgrades CAM to Junk
    Entry04/20/2011 02:10 PM
    Membervalue_31

    As I understand it the deadline for the capital to come into the bank is Sep'11, however for a variety of systemic and other reasons I believe there is a desire (by the government and regulator) for it to be completed sooner rather than later.  

     On pricing ... 

    It seems like there is very little desire for a strategic investor to 'pay' anything for the existing equity (I say 'pay' but in reality new equity would need to be injected, so this would be done at a heavy discount to book value effectively dilute existing equity - including the listed shares - to a nominal holding only).

    In the event the FROB injects equity this will be done at the appraisal of an independent 3rd party.  As I describe in the write-up above 0.8x would very likely be the absolute ceiling for valuation.  Having said this it seems very unlikely that CAM would warrant a valuation this high as a result of the poor quality of its loan book and the lower franchise value it has versus La Caixa.  The people I have spoken to think a fair valuation range is 0.3 - 0.5x P/BV.  Personally, I am at the bottom end of the range because I think the loan book quality is poor and there is a likelihood that CAM needs more than E2.8bn of equity when it is all said and done (note: the Moody's statement which I highlighted has not made folks any more bullish). 

    However, if you assume that new money comes into CAM at 0.5x P/BV and then the post-recap entity trades at 0.5x P/BV that equates to a share price of <Euro 1.00/share for the listed shares (i.e. E4.8bn of equity post recapitalization x 0.5 P/BV x 1.8% shareholding that the listed shares will have post recap / 50m shares outstanding). This represents ~80% downside from the last close.  You can adjust these assumptions to your taste to get the output you think is reasonable but it is difficult to come up with a scenario where the stock shouldn't fall by >50% from here.   

    Even though the stock is down 21% since I first posted this idea there is still significant downside from the current share price. 


    SubjectRE: RE: RE: Moody's Downgrades CAM to Junk
    Entry04/20/2011 06:13 PM
    Membersunny118
    Thanks for the response and most importantly, thanks for sharing a great idea.

    SubjectMoody's assigns rating to Caja's covered bonds
    Entry04/26/2011 09:17 PM
    Membersunny118
    I'm sure you saw the Moody's rating today on the banks mortgage covered bonds.  In their release they note their rating takes into account four different factors.  The fourth factor noted: "as of September 2010, the over-collateralisation level consistent with the Baa1 rating is 12.5% and the level of over-collateralisation is 170.4%." 
     
    I took this to mean that the bank was extremley over collateralized indicating that the underlying assets were extremely poor.  Am i interpreting this correctly?  If not, what is the correct way to look at this?

    SubjectGood bank / Bad bank
    Entry05/11/2011 10:26 AM
    Membersunny118
    Thoughts on the good bank / bad bank and implications for the common equity discussed in the WSJ today? 

    SubjectRE: Good bank / Bad bank
    Entry06/03/2011 05:18 AM
    Membervalue_31
    Sunny,
     
    Apologies for the delayed reply.  
     
    In response to your two questions: 
     
    1) Over-Collateralisation: I caveat by saying that I am not an expert on this but my understanding is that Spanish Covered Bonds are revolving colateral pools (unlike static pools of assets more common in US RMBS securitizations).  As such, the collateral can be reduced (e.g. to issue new bonds) as long as it does not fall below the minimum required level  
     
    2) Good Bank / Bad Bank: As CAM is unique in that it is the only Caja with listed (non-voting) equity securities there are no direct precedents to draw upon.  However, there are some precedents that can be used as a guide.  For example, as part of the La Caixa / Criteria transaction, "bad" assets (foreclosed real estate assets, other problematic real estate assets, equity stakes in real estate developers received as part of restructurings, etc.) were left behind and only "good" assets were transferred as part of the transaction.  Importantly, in this transaction subordinated debt & perpetuals were left behind in the "bad" bank.  You can find more information about the CRI transaction & structure
     
    Applying this to CAM, my view is that in the event of a good bank / bad bank the equity securities would remain behind with the bad bank as would junior debt instruments.  This makes intuitive sense as the bad bank will need capital to absorb future losses.  The equity securities are the most junior instuments in the capital structure and they are also carried at book value for regulatory capital purposes.  The risk to this view is that unlike junior debt instruments there are retail holders of the equity securities and there has been some reluctance to zero equity holders in Europe (with the noteable exceptions of Anglo Irish Bank in Ireland and Northern Rock in the UK which were both nationalized).  It is possible therefore that equity holders receive some non-commercial deal, although this would essentially be a value transfer from the FROB to equity holders.  Having said this, it seems unlikely that anything close to current valuations is justified.  For reference, yesterday Cinco Dias (Spanish newspaper) reported that FROB may be preparing to intervene in CAM in July and several investment banks are currently completing valuation reports on CAM.  The indicative price stated is a maximum discount of 75% to book value (i.e. 0.25x P/BV) which would leave the FROB with control of >80% of CAM's capital. 
     
     

    SubjectCAM Fails European Bank Stress Tests
    Entry07/16/2011 10:56 AM
    Membervalue_31

    European Bank Stress Tests released after market close on Friday.  CAM was one of the nine (out of 91) institutions that failed the stress test.  Of the 91 institutions CAM was the second worst performer in the stress test (only ATEBank in Greece was worse).  

    Important points for CAM:

    1. CAM failed the stress test despite being given credit for the E2.8bn capital injection I discuss in the write-up above.  This capital injection has not occurred yet but CAM was given credit for it because it has been committed to by the relevant government authorities.  Including the benefit of the capital injection, CAM's Core Tier 1 ratio under the stress test was 3% (minimum required to pass was 5%)
    2. Without the E2.8bn capital injection CAM's Core Tier 1 ratio under the stress test would have been negative 2.8% (i.e. clearly insolvent)
    3. The Spanish regulator is giving its banks credit for "mitigating factors" even though the European Central Bank does not.  As such, under the ECB definitions five Spanish banks failed the test but under the Bank of Spain definitions zero banks failed the test
    4. Using the Bank of Spain methodology (which includes "mitigating factors") CAM's Core Tier 1 under the stress test was 5.1% (i.e. 0.1% above the minimum to pass).  Importantly, (as I said above) this 5.1% is based on the assumption that E2.8bn of fresh equity capital comes into CAM in the very short term  
    5. At a ratio of 5.1%, CAM is still the worst performer of any of the 25 Spanish institutions that underwent the stress test.  To put CAM's 5.1% ratio in context, only one other Spanish institution has a ratio below 6% and only two more have a ratio below 6.5%.  17 of the 25 Spanish institutions that underwent the stress test had ratios above 7% 

    Implications:

    1. As CAM's losses deplete its enitre current equity capital base (and then more) under the stress test and the regulators are giving them credit for already having completed the recapitalization the E2.8bn equity capital injection must come into the bank in the very short term
    2. Based on valuation comparables (e.g. the price ranges for the Bankia IPO and Civica IPO which are currently being marketed) it is impossible to justify a valuation of more than 0.3-0.4x P/BV for the new capital coming into CAM (this valuation is generous, I think given the poor quality of CAM's loan book, as again evidenced by its performance in the stress test); 
    3. Assuming a 0.3-0.4x P/BV valuation for the new equity coming into CAM, CAM's current equity will get diluted from 100% o/ship to ~20% o/ship.  At a post-money valuation of 0.5x P/BV (which is broadly in line with where CAM should trade) there is >80% downside to CAM's current share price


    Subjecttrading
    Entry07/18/2011 02:35 PM
    Membermiser861
    any thoughts on the manipulation story that is CAM?  Seems as if one of the bank subsidiaries is holding the stock up.  At this point, this manipulation/short squeeze is really the only risk to the trade.  But i worry about it.

    SubjectRE: trading
    Entry07/19/2011 07:34 AM
    Membervalue_31
    The intra-day price action of the stock as well as the suspiciously strong performance into each quarter end for the past 18 months does tell you quite a lot.  There could be technical risks here but the long-game does seems pretty clear (to me anyway).  There was manipulation taking place at Banco De Valencia (BVA SM) too ... until it all fell apart 
     
    There is a theory that CAM is being held up until the Bankia IPO is completed for systemic reasons.  The CAM capital injection won't happen until Bankia is done but personally I think that's when the 'buyers' for the stock could disappear.  New capital is coming into CAM.  Either new capital comes into the bank from FROB or another buyer.  Either way existing equity holders are going to get massively diluted.  At that point the only risk is whether there is a conscious decision made to transfer value from the government/buyer to equity holders and if yes, how much.  

    SubjectShare amortization?
    Entry07/22/2011 07:23 AM
    Membernha855
    There was a very short story on Bloomberg today that said "Caja de Ahorros del Mediterraneo's board voted to amortize the lender's "cuotas participativas," a type of traded security, at a price of 4.7714 euros apiece, the company said in a filing to regulators today." - can you please explain what this means?

    SubjectRE: Share amortization?
    Entry07/23/2011 03:34 AM
    Membervalue_31
    Two very material developments since Thursday Night: 
    1. Thursday Night (after close): CAM announced the amortization (essentially a buyback/cancellation) of all shares for E4.77/share that you mention.  Importantly, this was subject to Bank of Spain approval.  You can find CAM's filing here: http://www.cnmv.es/Portal/hr/verDoc.axd?t={9706bacf-a6d5-4727-8480-8ddb575ccc38}
    2. Friday Night (after close): The Bank of Spain announced it had ceased CAM and will repalce the Board/Management.  FROB is injecting E2.8bn of equity and providing a further E3bn liquidity facility.  You can find the BoS announcement here: http://www.bde.es/webbde/en/secciones/prensa/Notas_Informativ/anoactual/presbe2011_29e.pdf

    As stated many times, it is virtually impossible that new equity comes into this bank at a valution that ascribes much value to the existing equity.  Post this ceasure/recapitalization the existing equity will be significantly diluted and probably worth a small fraction of the last traded price.  What it not clear is what will happen with the buyback/cancellation that has been announced (by CAM's old Board).  I believe the new (BoS controlled) Board will need to sign off on any distribution (note: this is almost 10% of the new BoS capital coming into the bank leaving immediately, so very material).  It is also worth noting that CAM would fail the EU Bank stress test if this capital leaves the bank because the test gave CAM credit for having raised the full E2.8bn and under that scenario it just barely passed the test (passed using BoS's definition.  It actually still failed under the EU definition -  see my previous post for more information).  If this capital leaves the bank CAM will be below the minimum 5% capital ratio (even under the more lenient BoS definition).  

    So in order for the buyback/cancellation to take place you need to believe: (i) that BoS will allow these instruments to be "purchased" for a valuation many multiples above what they are injecting their own capital at; (ii) that an institution that is short of capital can let a material amount of capital leave the bank for no reason; (iii) that BoS will allow CAM to move into a position where it is failing the EU Bank Stress Test through this capital leaving the bank (i.e. they then need more equity again).  However, this issue was not directly referenced in either the BoS release on Friday night or CAM's own release on Friday night, so it is still uncertain.   

    The other complicating factor is CAM is now essentially for sale and so (depending on how quickly a sale is consumated) the new buyer's intentions will also be important. 

    I expect more news on this in the near term (likely before Monday open). 


    SubjectRE: trading
    Entry07/26/2011 05:01 AM
    Membervalue_31
    According to Cinco Dias CAM has turned from a net buyer to a net seller of its stock: 
     
     
    CAM's share price performance since the Bank of Spain intervention on Friday night has been very weak without this apparant support.  

    SubjectCAM Revokes Decision to Repurchase Shares
    Entry08/25/2011 04:29 AM
    Membervalue_31
    The non-voting shares will now be subject to significant dilution.  

    Subjectthnx
    Entry08/25/2011 10:41 AM
    Membermiser861
    great call!

    SubjectCAM Capital Shortfall to Increase to E4bn
    Entry09/02/2011 04:08 AM
    Membervalue_31
    Cinco Dias reported this morning that an audit of CAM's accounts has revealed a larger capital shortfall than the E2.8bn previously identified by the Bank of Spain.  It reported that CAM could require a capital injection of up to E4bn.  As a reference point CAM's Tier 1 Capital at 31-Dec-10 was E1.8bn (per the EU bank stress tests rleased) so an incremental capital shortfall of >E1bn is significant.  As such, existing shareholders will be materially further diluted. 

    SubjectH1'11 Results: -E1.6bn Pre Tax profit
    Entry09/05/2011 02:21 PM
    Membervalue_31
    CAM released summary reults after market close today.  Key Points: 
    • Pre Provision Profit: E60b
    • Provisions & Other Impairments: E1.7b
    • Pre Tax Profit: -E1.6bn
    • NPL Ratio: 19%
    • NPL Coverage: 39% 
    • Total Capital (Tier 1 + Tier 2): 4.8% (increases to 11.8% with E2.8bn FROB injection)
    These extremely poor results support recent press reports that CAM will likely require capital in excess of the E2.8bn currently committed.  The 11.8% Total Capital ratio  is broadly in line with the capital ratios of domestic peers, however CAM's NPLs are significanlty higher than peers and coverage is the lowest in the sector.  Press reports have indicated a E4bn capital shortfall (rather than the E2.8bn committed to date).
     
    It looks increasingly likely that existing equity holders are going to be further materially diluted.  


    SubjectBank of Spain Governor says CAM has zero value
    Entry09/30/2011 10:13 AM
    Membervalue_31
    Today the Bank of Spain (BOS) provided an update on the recapitalization of Spanish Savings Banks.  The Governor of the BOS made some comments in relation to CAM.  The important points are: 
    - CAM is the "worst of the worst" of the Spanish Banks
    - The rescue of CAM will probably end up costing the taxpayer money (i.e. sale proceeds will not allow the government to get back the capital it has injected into CAM)
    - CAM has been valued by BOS/FROB at zero (i.e. the valuation at which FROB injected capital into CAM implied zero value for existing equity) 
     
    As such, the listed shares have zero value.  The sale of CAM is currently underway and will likely be completed in the next 4-6 weeks.   Sometime between now and late October / early November the shares will likely go to zero. 
     
    Here is the link with more detail (in Spanish): 
     
     
     

    SubjectCAM sold. Equity Has Zero Economic Value
    Entry12/09/2011 04:11 AM
    Membervalue_31
    CAM has been sold to Banco Sabadell for EUR1 (not EUR1 per share, EUR1 in total).  
     
    The structure of transaction is as follows: 
    1) Spanish Deposit Guarantee Fund injected EUR5.2bn of fresh capital into CAM and will end up with 100% of the entity (note: this was all primary issuance, nothing was paid to existing shareholders)
    2) Spanish Deposit Guarantee Fund then sold the entity to Banco Sabadell for EUR1 
     
    Given the atrocious state of CAM's balance sheet, in addition to the EUR5.2bn capital gift described above Banco Sabadell is also getting an asset protection scheme to protect it against future losses.  The transaction structure is described here: http://www.bde.es/webbde/en/secciones/prensa/info_interes/frob071211e.pdf
     
    CAM's listed shares have no economic value.  This was confirmed by the Chairman of Banco Sabadell yesterday.  There is a chance that some arbitrary payment is made to equity holders (as the holder base is largely retail, who were customers of the bank) but this is uncertain and has not been stated publicly. 
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