Description

Bladex is a multinational bank headquartered in Panama. The bank was created in the late 1970s by several Central Banks of Latin American. The purpose behind creating Bladex was to help finance trade in the region. Bladex is still a bank primarily focused on trade with most of the business being short-term trade loans, letters of credit, etc. The bank also does credit syndication for regional clients and structured funding for LatAm financial institutions.

The crux of the thesis is that basically Bladex is a bank with significant competitive advantages including funding, cost and tax efficiencies, which should translate into a decent ROE. If the bank goes back to earning close to 10% on its capital, shareholders should do well.

During 2018, the bank took large and significant provisions that erased the earnings for the fiscal year. Also, there was a change in the management team. This caused the stock to decline significantly (as expected) and opened the opportunity to invest in a good business with a prudent banking culture.

Why is it attractive?

1)      Overcapitalized

a.       The bank has a very high quality, short-term loan book and also operates with very low leverage. The bank has a tier 1 equity ratio of 20.1%, assets of $6.5bn and equity of $1.0bn. 5 years ago, the bank had roughly $8.0bn in assets with equity of just $900mm. It is fair to expect growth in assets or Bladex will keep returning capital via dividends as it has done for years. It is also important to note that Bladex has historically been very prudent with provisions. During the Argentina crisis of 2001, they took massive reserves. Eventually, many of these credits were over-provisioned and the bank ended up in a position of overcapitalization.

2)      Funding Advantage & Efficiency

a.       Currently, Central Banks and other financial institutions own roughly 20% of the shares through the A & B class shares. The importance of having this group of shareholders is that they provide two competitive advantages: preferred creditor status and wholesale funding (2/3 of funding comes from this source). The bank is funded primarily through deposits from the regional Central Banks (which are also shareholders). This is an advantage because the bank has a stable and cheap funding source. Also, the bank does not need to invest in branches. This has helped the bank keep costs very low compared to peers. Efficiency is close to 30%, that is one of the best efficiency ratios in the industry.

3)      Taxation

a.       The bank has a tax-free status, meaning it does not have to pay any corporate taxes on profits. This is a significant competitive advantage over peers that would send close to 25% of profits to the Government.

4)      Conservative Culture

a.       This is an intangible asset and difficult to explain, but very valuable in banking. The bank operates in Latin America, which means there is always a crisis. As explained above, the bank already went through a significant crisis in Argentina, and Bladex took the provisions and raised capital. Eventually, these measures proved to be too conservative. The company is focused on its trade finance business which is very safe by nature given the security and duration of these loans. Default rates have been very low and the bank has consistently overprovisioned. A negative aspect of this safe business is that spreads are quite low, but the bank has mitigated this by keeping costs low. Another way to look at how prudent the bank operates is by looking at the low leverage ratios and the securities portfolio. Even though the bank has the capital to grow its asset base through loans or securities, the bank has opted to only lend where they think it makes sense. This was very important during the crisis that hit Latin American in 2015. During this period, the bank was able to navigate a rocky environment with decent results.

5)      Valuation

a.       The bank trades at 0.8x book value and over the past 10 years the bank has on average earned a ~10% ROE. The problem is that last year, the bank took a massive provision on a sugar producer loan. For this reason, the bank was barely profitable in 2018 and figures have been distorted. I expect the bank will once again deliver high single digit ROEs this year and should get to double digits in the near term. Since the bank is overcapitalized, it should continue paying its dividend of $1.54/share (7.6% yield) and also be able to grow.

Risks?

The biggest risk here is that an investment in Bladex is an investment in Latin America. The portfolio is spread through Latin America, with the two largest exposures being Brazil and Mexico. There is always a reason to be worried or pessimistic about this group of countries. The eternal hope comes with sudden periods of volatility, crisis, etc. The bank was tested in 2015 and 2016 when the region went through a rough few years (Dilma Impeachment, Oil Crisis, Odebrecht, Lava Jato, etc) and Bladex earned decent returns and the loan book remained healthy. Here, the positive aspects on Bladex´s loan book came to light, due to the short duration and type, the Bank is able to move away from borrowers that start deteriorating. Losses were quite low during these years, which is a testament to their strength. Last year, the bank did took large provisions in a specific credit. They have mentioned that the legal system in Brazil impeded them from being able to execute on their collateral while the credit was deteriorating. Due to their conservative nature, they have decided to write it off entirely but it is possible these losses can be reversed.

Another risk is that the board is controlled by the central banks and their figures. This means that there is not a large appetite to push hard for growth, efficiencies and big bets. There is a risk that culture can be too conservative and not particularly focused on shareholder returns. The good thing is that Bladex has a large dividend and payout ratio, which means that they have a “compromise” to return that amount every year. I believe management and the board are very committed to maintaining the dividend, which puts pressure on the team to improve efficiencies, profitability, etc.

Conclusion

I believe Bladex is a good bet. The bank has a conservative nature, underleveraged balance sheet and ability to return its excess capital to shareholders. Valuation is undemanding trading at 0.8x book, with a “clean” and well provisioned book of loans. Also, there is no reason why this business can´t return to earning at least 10% ROE. I believe that there is a path for Bladex to trade at a premium to book value, as it has in the past, once results stabilize and investors once again feel comfortable with the business and the region.

Catalyst

2019 results show progress and decent profitability

Latin America returns to growth