Overview

BFF Bank is one of the most unique banks you will every come across. Not only does it operate in a very unique niche market, but it also has phenomenal returns on capital, zero credit risk, and is run by a former private equity partner that fully understands capital allocation and returns the maximum allowed by regulators to shareholders. BFF trades at 7.6x earnings and has the potential to double over the next few years.

Business

BFF Bank is headquartered in Italy and has operations in twelve countries with Italy, Spain, and Poland being the largest three. We will mostly talk about Italy as that is their largest market (60% of the business), but the business model is remarkably similar across all the geographies they operate in.

BFF is a leader in Italian factoring and specializes in the non-recourse sale of trade receivables from the National Healthcare System and the public administration. BFF has 35% market share in this market. The Italian market has four main specialists that represent ~80% of the market.

BFF’s factoring business generates revenue from two sources. First, BFF buys the receivables at a discount from suppliers as is typical in factoring. Second, BFF is entitled to the ECB rate + 8% interest on late payments by EU law that has been in place since 2000. Late payment interest (“LPI”) requires going to court or the threat of court in order to collect and this process takes about 5 years. This activity creates a conflict of interest for general banks and therefore general banks are typically absent from this market as they do a lot of business for the state and do not want to be suing their own clients. The public administration and National Healthcare System is legally incapable of default and therefore BFF’s credit costs are minimal. BFF’s cost of risk has averaged 10bps.

An example client might be Pfizer. Pfizer sells a variety of drugs, vaccines, etc. to different regions of Italy and then would use BFF for factoring services to improve their cash conversion cycle.

This unique niche business generates 35% returns on tangible equity and has a strong balance sheet with a CET1 ratio of ~18%.

We believe BFF earns such strong returns as it is a niche market and a few features make it difficult to for new entrants. First, banks need proprietary data to underwrite payments and LPI collection periods for the variety of local administrations they will deal with. Second, company must show years of success and consistency before they are allowed to use accrual accounting for uncollected future late payment interest. Late payment interest takes 5 years on average to collect and therefore a new entrants would need to wait five years before they can recognize this income and even longer before they have sufficient data to show they can accurately accrual account for it. Third, their clients do not just want to factor their receivables to the highest bidder. Given the court processes that are going to follow, they need to sell to a company with a certain reputation and finesse about the process. Otherwise, the Italian government can become angered with Pfizer for selling its receivables to an aggressive and unfriendly party. Fourth, a unique aspect to BFF is its credit management business. This business completely outsources a supplier’s collections department. This is a very sticky business and provides BFF with a stable base of clients. BFF’s top 10 customers have been with them for 17 years on average.

Excess Capital/Capital Allocation

BBF was previously owned by private equity before coming public in 2017. BFF’s CEO came from the private equity sponsor and clearly understands capital allocation. BFF’s capital allocation policy is to return all capital above a 15% total capital ratio. The extremely good return on equity meant BFF could fund its ~7% annual growth and still payout a 90% payout ratio to shareholders historically. The situation improved in 2020, when there was a change in risk-weightings for public exposures which created 107m in additional equity/capital. Unfortunately, the regulator does not allow them to return this to shareholders. Due to this, that 107m in capital can be used to support growth and then BFF can payout 100% of earnings as dividends as the earnings would be a redundant source of growth. We estimate it will take until 2026, before this 107m is used up for supporting growth and BFF will need to start retaining earnings again to support growth.

Management has been very shareholder friendly, and we believe this was shown when the regulator banning dividend during COVID. When the regulator lifted this restriction BFF promptly returned all the retained earnings from before COVID that had been paused and all the earnings during COVID that had since accrued. In addition, BFF recently switched from an annual dividend to an interim and annual dividend based on shareholder suggestions.

Given the low valuation, this dividend policy creates a current dividend yield of 11.7%.

Valuation

We believe BFF’s low price to earnings multiple is largely due to it classification as a European bank. Unfortunately, we do not think that is likely to change and that label will continue to weigh on the valuation. However, given the bank's double digit dividend yield and high earnings growth, with no revaluation, BFF’s stock will still generate ~20% IRRs. We think a modest exit multiple of 11x is not only conservative but a valuation that the stock has traded at on multiple occasions since its IPO in 2017. At an 11x exit in a few years, we believe BFF will generate a 30% IRR and will more than double your money over four years.

Risks

Changes in Regulation – The EU law that dictates late payment regulation by the government has been in place since 2000 and has changed in a positive way for BFF in the past (moved from ECB rate + 7% to + 8% in 2011). Changes to this regulation could impact the business. This law is in place to protect businesses in dealings with the government.

Bureaucratic Delays – A large reason for many of the late payments and slow processing times that necessitate the factoring market is government bureaucracy and disorganization. If these were ever to improve, that is a headwind for the business. Payment times have improved over time in Italy but this headwind was more than offset by more companies adopting factoring solutions. BFF believes the business is only 10% penetrated today.

Sovereign Risk – BFF’s balance sheet has significant holdings of government bonds. So while the public administration and National Healthcare System can not legally default, should Italy as a country default, then that would have a significant impact because they have a large portfolio of government bonds.