RAIFY - BAWAG Group: An Undervalued Highly Profitable Retail Bank With A Low-Risk Profile

2023-03-20 04:34:42 ET

Summary

• BAWAG Group is an Austrian retail/universal bank.
• Along with other banks, shares are down more than 20 percent since the beginning of March.
• This is unwarranted as the bank has a purposefully low-risk profile, solid fundamentals, and is very profitable.
• There is a Buy opportunity for investors.

Thesis

(Note: all amounts in the article are in EUR. At the current exchange rate this is almost equivalent to USD.)

BAWAG Group (BWAGF) is one of the three banks which are in the included in the Austrian ATX index [ATX:IND], the other two being Erste Bank Group (EBKDY) (EBKOF) and Raiffeisen Bank International (RAIFF) (RAIFY).

Together the three banks make up almost 30 percent of the index. So, it is no wonder that the ATX tanked significantly over the past days during the global banking turmoil.

Since end of February, Erste Bank is down 18.6% percent, RBI (which has significant exposure to Russia) 10.3% percent, and BAWAG 21.5%. I think this is unwarranted as BAWAG has strong fundamentals. It carries less risk and is more profitable than the other two banks.

With a cost income ratio of 35.9% BAWAG could possibly be the most efficient retail/universal bank in Europe. The bank is highly profitable with a 2022 RoTCE of 18.6% (adjusted for the City of Linz legal cost, which I will explain later). The NPL ratio in 2022 was at a low 0.9%, showing a low risk profile.

After presenting strong 2022 results in February, the bank announced that it is accelerating its 2025 mid-term targets to 2023, meaning RoTCE for this year should be more than 20% and the C/I ratio below 34%. The target value for profit before tax is more than 825mn (2022: 681mn), which comes to earnings per share of at least 7.50 euros and a dividend per share of at least 4.10 euros. At the current share price of 45.6 euros the forward looking P/E ratio is just 6.5 and the forward looking dividend yield 9%. The bank also has excess capital which it can use for share buybacks or acquisitions.

Company Overview

BAWAG Group goes back a long time but had a turbulent history especially over the last 20 years. The bank is the outcome of a merger between two banks, Bank für Arbeit und Wirtschaft AG (BAWAG) and Österreichische Postsparkasse (Austrian Postal Bank). Technically BAWAG had bought the Austrian Postal Bank in 2005, but both banks were about the same size. Soon after that it turned out that BAWAG was basically bankrupt due to management malversations (which ended up in long legal proceedings), and at the end of 2006 the bank was sold to Cerberus Capital Management , a U.S. private equity fund. Over the following years Cerberus transformed the bank and made it profitable again. BAWAG did an IPO at the Vienna Stock Exchange in October 2017 and today Cerberus does not have a stake anymore.

The IPO share price was 48 euros, so a little higher than where the share price is currently after the turmoil of the last two weeks. Not so great for investors, you will probably say. Additionally, due to share buybacks there are now almost 20 percent less shares than at the time of the IPO. My view is that the IPO price was too high, and Cerberus took the right moment to cash out. Shares reached the IPO level again only in late 2021:

City of Linz lawsuit and settlement

The share price was probably also held back by a legal dispute with the City of Linz (Austria's third largest city and the capital of the Upper Austria province) on swap deals going back to 2006 and 2007. This resulted in a long-running lawsuit, which the bank eventually lost. A final settlement was agreed in 2022. In the lawsuit the City of Linz and the bank were talking about a sum of up to 600mn euros, but the settlement in 2022 resulted only in one-time accounting charge of 245mn (before tax, 190mn after tax) which shows up in the 2022 risk cost.

Why is BAWAG Group a Buy?

The bank is very efficient and highly profitable with a RoTCE of 18.6%. I already mentioned the exceptionally low C/I ratio of 35.9% in 2022. It is even more remarkable that, despite the inflationary environment and increased revenue, the bank managed to continuously reduce operating expenses in absolute numbers over the last year. Personally, I am not aware of any other bank which has achieved this:

With a CET1 ratio of 13.5% (already after the dividend accrual) the bank is well capitalized. The management target for CET1 is 12.25%, so there is excess capital of 261mn which will be either used for share buybacks or acquisitions.

Risk cost is very reasonable, given the low NPL ratio of 0.9%. The bank expects risk cost in 2023 to be only between 20 and 25bps. BAWAG on purpose maintains what they call a fortress, safe and secure balance sheet. 73 percent of the business is in the so called DACH region (Germany, Austria and Switzerland) and the Netherlands, 27 percent in other Western European countries and the United States. The bank has no exposure to Ukraine or Russia.

Across the board, all key performance indicators have continuously improved since the IPO in 2017:

Both assets and liabilities are solid

Silicon Valley Bank was also profitable and did hold quality assets, namely US Treasuries. The problem was that their asset liability management did not recognize or deal with the combination of the duration risk between the short-term deposits and long-term Treasuries, and the interest rate risk on the value of those Treasuries.

This is not a concern for BAWAG, and management has done the opposite of what Silicon Valley Bank did.

At the end of 2022 (the last numbers we have) the bank had a balance sheet of 56.5bn euros. Thereof 13.2bn euros were in cash and cash equivalents (mostly money at central banks). This had increased QoQ by 1bn from Q3 2022 as the bank says it had on purpose under-invested in its securities portfolio to take advantage of future higher credit spreads:

Here is a summary of the balance sheet from the FY 2022 presentation:

Two additional things to note: The 34.2bn customer deposits are spread across more than 2mn customers, so there is very little concentration risk. Deposits up to 100,000 euros are insured as a minimum across the European Union. If you do the math, most customers should have fully insured deposits. And second, of the 35.7bn customer loans, 16bn are housing loans and 6.4bn consumer loans. In contrast to mortgages in the United States, housing and consumer loans in Germany and Austria usually have floating interest rates that automatically adjust, often linked to the 3M Euribor. This obviously reduces duration and interest rate risk on those assets.

Conclusion

BAWAG Group is an exceptionally profitable bank with a very clean balance sheet and a purposefully low risk profile. The current market turbulences should not have a significant impact on the bank.

The reduced share price is therefore a Buy opportunity - in my view. The high dividend yield and a shareholder-friendly distribution policy, with continuously increasing pay-outs, make shares especially suitable for buy-and-hold value investors.

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