CA - Laurentian Bank: For Sale Sign Pulled CEO Ousted (Rating Downgrade)

2023-10-04 07:32:29 ET

Summary

• Laurentian Bank of Canada's strategy review concluded without a deal, causing the stock price to plummet.
• The bank has seen an exodus of top management, including the resignation of its CEO.
• Although the failure to sell may raise questions about the bank's financials, current holders should hold on for now due to cheap valuations and relatively safe dividend yield.

A few months ago, I wrote a bullish article on Laurentian Bank of Canada ( LB:CA ) stock, after news broke that the company was putting itself up for sale. Laurentian Bank is a Quebec-focused personal and commercial lender that was trading at a steep discount to peers' valuations on both a P/E basis and P/B basis.

I thought Laurentian shares were worth a speculative buy. If a transaction was consummated, I saw the potential for 10-50% upside to Laurentian Bank's share price, which was hovering around $43 / share after the M&A news came out. (Author's note, all financial figures in this article is in Canadian dollars)

Strategy Review Concluded Without A Deal

However, I also noted the biggest risk to the stock was if the strategy review were to conclude without a deal, then the stock price could fall back to pre-M&A levels or worse:

The biggest risk to Laurentian's stock is if the strategic review were to conclude without a transaction, then Laurentian's stock price may fall back to pre-rumour valuations (sub-$35) or worse, since every other potential suitor would have been invited into Laurentian's data room by now.

Unfortunately, my downside scenario is exactly what had happened , as Laurentian's strategy review process concluded without a deal. The company noted that the Board and the Executive Management Team had "unanimously concluded that the best path forward to drive shareholder value is to embark on an accelerated evolution of its current strategic plan with an increased focus on efficiency and simplification." Of course, for observers knowledgeable in corporate-speak, that is simply code for 'we could not find a suitor at the price we believe we are worth' .

Investors promptly punished the stock, pushing the stock price to a low of $31 on the day of the announcement and basically back to year-to-date lows (Figure 1).

Exodus Of Top Management

Furthermore, problems at Laurentian appears to be snowballing, as the bank saw an exodus of its top management team. First, as part of the conclusion of the strategic review, the bank announced the departure of Karine Abgrall-Teslyk, who headed Personal Banking, and Yves Denommé, who led the bank's operations function.

More importantly, the bank announced on October 2nd the resignation of its Chairman and that Rania Llewellyn, Laurentian's high profile CEO that was hired less than 3 years ago, would be leaving effective immediately. So in the span of a few weeks, Laurentian has seen the departure or resignation of many of its top business executives, throwing the bank's leadership into disarray (Figure 2).

Ms. Llewellyn's replacement, Mr. Eric Provost, is a long-serving Laurentian executive who was most recently Group Head of Personal and Commercial banking.

Are There Skeletons In The Closet? Too Early To Speculate

The sudden departure of Laurentian's CEO and the inability to strike a deal raises the question, are there skeletons in Laurentian's closet? Recall, the prior CEO, Mr. Francois Desjardins, left the bank in 2020 after a scandal-plagued tenure including a mortgage documentation scandal in 2018 and a dividend cut. Ms. Llewellyn, a high achieving executive from Scotiabank, was installed to much fanfare in 2020.

Under Ms. Llewellyn's watch, Laurentian Bank quickly became a poster child of progressive change in the banking industry, as Laurentian was the only Canadian lender to cut ties with Canada's oil and gas industry and the bank changed its hiring policies, removing Canadian experience as one of the requirements. However, Ms. Llewellyn also oversaw enormous employee turnover at the bank, with over 1,000 workers or 1-in-3 leaving Laurentian during her first 18 months on the job.

As an outside observer, Laurentian's financials appears sound, albeit it has been under-earning its peers. In the latest third quarter results , Laurentian showed a 9.8% CET1 capital ratio, low compared to its Canadian peers but not outrageously so (Figure 3).

Credit quality was also fair, with a 0.55% gross impaired loan ratio and a 0.14% provision for credit losses ("PCL"). Laurentian's 0.14% PCL is actually better than peers , which recently saw their PCLs normalize to pre-pandemic levels of ~0.35%.

Finally, by accounting metrics, the bank has $59.30 in 'book value' per share, meaning at a recent $28 / share, Laurentian is trading at less than 0.5x P/BV.

The challenge is that banks are very opaque entities that are difficult for outsiders to analyze. What we do know is that likely all of the Schedule 1 lenders (RBC, TD, BMO, Scotia, CIBC, National) were invited into Laurentian's data room and an M&A deal did not appear. So either the banks saw issues with Laurentian's books, or they were not willing to pay a price that Laurentian's Board of Directors thought the bank was worth.

Valuation Remains Cheap, But No Catalyst On The Horizon

While there are questions abound, current holders should also not panic sell their shares just yet, since most of the downside has already occurred. Trading at just 0.44x P/BV, Laurentian is 1/2 to 1/3 the valuation of its Canadian peers (Figure 4).

At the same time, it is not like the bank is going out of business. Although diluted EPS was down 7% YoY in the latest quarter, Laurentian still earned a respectable $1.02 / share in Q3 and $3.22 in the first 9 months of 2023.

Furthermore, Laurentian still has more than sufficient earnings to fund its $0.47 quarterly dividend, or a 6.6% yield.

The only issue is that with the strategic review concluded without a transaction, there are no short-term catalysts for the stock to re-rate higher.

Risks To Laurentian

With the bank's leadership team in flux, there is a risk that the rank-and-file employees lose focus and operating results slip. For example, as part of the new CEO press release, Laurentian also disclosed that it had suffered a significant mainframe outage in recent days during a planned IT maintenance update. In order to appease aggrieved customers, Laurentian will be reversing all monthly service fees for September.

Laurentian also said it would provide more information when it reports fourth quarter results on December 7th and will unveil a new strategic plan at an investor day early next year.

Until then, investors may be sitting on 'dead money' that pays a 6.6% yield.

Conclusion

In my last article, I said Laurentian Bank shares may be worth a speculative buy for investors with a high risk tolerance as I could see 10-50% upside if the bank was able to find a suitor. However, I could also see significant downside if no deal was announced. Unfortunately, the latter case occurred and Laurentian recently completed its strategic review without a deal to sell the bank. The bank's CEO and other top executives have also recently resigned or left the bank, leaving a leadership vacuum.

Investors punished Laurentian Bank heavily, with shares recently trading at ~$28 / share, far below the pre-M&A rumor price. At this point, investors currently invested in Laurentian may be better served holding their shares until the company reports fourth quarter results in December and unveil a new strategic plan in early 2024.

With a 6.6% dividend yield and a 43% payout ratio, there should be no immediate urgency to sell shares at depressed valuations. I am downgrading Laurentian Bank to a hold .

For further details see: