UNCRY - Raiffeisen Bank International: Recent Developments Support The Bear Case

2023-09-01 19:00:09 ET

Summary

• Raiffeisen Bank International AG is one of the largest lenders of Signa Group, which faces challenges in its real estate and retail divisions, including write-offs, bankruptcies, and financial liabilities adjustments.
• The ECB has conducted inspections on financial institutions with business relationships with Signa and is reportedly putting pressure on lenders to write off or make additional risk provisions.
• Raiffeisen Bank's continued and growing Russian business poses significant risks due to potential sanctions.
• Deteriorating economic conditions and the introduction of a windfall tax may negatively affect the Russian business from an economic point of view, too.
• I reaffirm my bearish view on Raiffeisen Bank International AG.

In a previous article discussing Raiffeisen Bank International AG ( OTCPK:RAIFF ; OTCPK:RAIFY ), I identified two main risks: the bank’s significant reliance on its Russian subsidiary and its exposure to Signa Group. There have been further negative developments both at Signa (kindly note, that following, unless otherwise stated, “Signa” refers to the group’s parent company, Signa Holding) and in the Russian business. Below, I will give an overview of recent developments and explain why and how I believe they support my previously presented thesis. Kindly note, that, following, I will refer to the company as “RBI.”

Signa

Signa mainly operates in two fields through various subsidiaries: (mainly commercial) real estate and retail (both stationary and e-commerce). Across divisions, it faces severe challenges.

Signa Prime Selection – which holds various objects valued at € 20.4 billion - had to write around €1.16 billion off the value of its portfolio. Of course, Signa is by no means alone in this. The macro environment for commercial real estate is, mildly spoken, challenging. Covid-induced work-from-home tendencies persist stubbornly, while interest rates have risen to heights not seen in over a decade (and are on track to climb further). What is more unusual is, that the company reports interest rate differences between market rates and its existing fixed interest loans as silent reserves of slightly above €1 billion according to documents obtained by “ Handelsblatt ”, thus leading to a net profit regardless. To be clear, this kind of accounting is not illegal (at least this is my assessment), if admittedly somewhat aggressive. Yet it is not exactly standard practice either.

Signa’s retail division, meanwhile, has been a collection of disasters lately. Galeria Karstadt Kaufhof – notably also an important tenant of Signa’s real estate division - comes fresh off its second bankruptcy proceedings within three years, with Signa on the hook for contributions of at least €200 million as part of the bankruptcy plan.

The Austrian furniture retailer Kika/Leiner was sold for a symbolic Euro plus financial contributions in excess of €100 million. Notably, Kika/Leiner declared bankruptcy within days of the sale (to be fair: all in all, Signa probably still made a healthy profit due to prior asset stripping, real estate in particular).

NYSE-listed sports goods subsidiary Signa Sports United NV ( SSU ), too, has been a money pit for Signa so far. The parent provided €200 million through convertible notes in 2022 , another €130 million in convertible notes plus a €50 million credit, in Q1 and injected a further €150 million in Q2. I previously discussed Signa Sports United more in-depth .

Recently, the ECB has reportedly conducted on-site inspections at all financial institutions that have business relationships with Signa. These inspections may or may not be connected to retroactive balance sheet corrections that Signa undertook. All in all, across various subsidiaries financial liabilities were retroactively adjusted upwards by more than €1.4 billion of (€161 million Signa Development and a total of €1,259 million at Signa Prime Selection).

It should be noted, that auditor KPMG attests that no covenants have been broken. According to sources quoted by Bloomberg , the ECB now puts pressure on Signa lenders to write off and/or make additional risk provisions. While apparently not all the group’s lenders face such action, I believe it to be highly likely that RBI is one of those who do. According to sources quoted by “ profil, ” RBI has been identified as among the top three domestic Signa creditors by Austrian regulators. In addition, closely affiliated Raiffeisenlandesbank NIederösterreich-Wien, which is RBI’s largest shareholder ( 22.63 percent stake) as well as a member of the same cash pool (on overview of the somewhat complicated Raiffeisen Banking Group model can be found here ), is also among the top three, with Unicredit SpA ‘s ( UNCFF ; UNCRY ) Austrian subsidiary being the third.

The fact that Signa and its creditors have been singled out by regulators poses the risk of stigmatization and, in consequence, cutting off or materially reduce the group’s access to credit. Some commentators have even drawn parallels to Kirch Group (which went belly-up after lenders were no longer willing to provide additional funds following comments made by then Deutsche Bank CEO Rolf Breuer).

Another possible sign of trouble is that rating agency Creditreform cancelled its rating for Signa Prime Selection and affiliated entities (the previous A- with a negative outlook rating is “no longer up to date”). Creditreform references an ongoing review of “objections and comments of Signa Prime Selection AG in the course of a rating action”. The development subsidiary Signa Development retains a separate Fitch rating of B- with a negative outlook .

Signa has recently raised € 400 million in new equity from existing shareholders. But to put that in perspective: in the first half of this year, Signa spend more than three quarters of that sum (€330 million) on cash injections into Signa Sports United alone. So, I think it is not unlikely that Signa will have to come up with significantly more cash going forward. One possibility would be asset sales. But keep in mind, that the commercial real estate market is relatively weak at the moment (although, to be fair, Signa’s properties are of exceptional quality which, I believe, will definitely help). The bad news from RBI’s perspective as a creditor is that (partial) disposal of assets mean lower income from these properties going forward. That, in turn, means diminished cash flows from which to pay future principal and interest installments.

All in all, recent developments at Signa have been rather negative. For RBI as one of its largest (if not the largest) creditor, this, naturally, is bad news.

Russia

By far the riskiest part of RBI is its Russian business. So far, despite some general statements regarding an ongoing search for solutions, there has been little tangible progress with regard to an exit from the country. Instead, it appears to me as if the bank is stalling for time. A spin-off or sale is planned “by the end of 2023,” so probably not before Q4. The fact that there have not been any communication so far (as of mid-Q3) makes me wonder whether even this extended target will be met. Especially considering that the issue has been known for more than a year now and RBI continues to pursue new business in Russia. While the total credit exposure in Russia was reduced, the overall number of individual customers increased. The bank also increased its local staff. Personnel expenses, meanwhile, grew significantly.

The weakening Russian ruble as well as deteriorating economic conditions (especially when adjusting for war related spending) translate to economic downside potential, despite RBI profiting off other Western banks’ exit from the market and its resulting importance for cross border payments from and to Russia. At the same time, the Russian state is beginning to skim-off a share of businesses’ profits in order to serve its own interests. RBI expects to pay a windfall-tax of around €100 million in Russia (the corresponding Russian law is expected to come into effect in January). While announced as a one-off item to balance Russia’s fiscal deficit, it is not entirely unlikely that further such measures may be taken in the future, And, of course, the optics of (albeit somewhat involuntarily) contributing €100 million to Russia’s government to be used in funding its wars are far from ideal.

At some point, governments might decide that the time has come to forcefully end RBI’s (voluntary or involuntary) support for the Russian government through sanctions. Ukraine’s NAZK (National Agency on Corruption Prevention) put RBI on its list of “ International Sponsors of War .” As I discussed previously , RBI is on the radar of regulators and enforcement agencies regarding its sanctions compliance, already. According to RBI’s CEO, Johann Strobl , the bank answered questions by OFAC. This may be referring to the request for information received in January , but it is also possible that there have been further inquiries since.

Other Negative Developments

The semi-annual report also reveals some other negative developments. Another headwind for the bank is the need for additional risk provisions of € 429 million in connection with foreign currency denominated mortgage loans in Poland, following a recent ECJ ruling . Windfall taxes introduced in Hungary and the Czech Republic, while certainly not helpful, are negligible in the big picture.

Thesis Risk

First of all, Signa could be in danger of a default than I assume. Its Founder and largest shareholder (though no longer formally holding an executive position), Rene Benko, has historically been very successful in recruiting (equity) investors with particularly deep pockets. Also, as mentioned above, its portfolio comprises objects of superior quality. While arguably valued fairly aggressively, these objects may justify premium valuations and premium rents, even in challenging overall market conditions.

Regarding the threat of sanctions, one should also consider that RBI’s status as too big to fail in Austria (especially as part of the wider Raiffeisen Banking Group) might somewhat shield it from aggressive enforcement to a certain degree due to political cost/benefit considerations. In theory, there is also the possibility of the war in Ukraine ending sooner than expected. I believe such a scenario to be unlikely, but it is not impossible, for example in the case of the unexpected death or incapacitation of president Vladimir Putin.

Conclusion

I considered Raiffeisen Bank International AG stock virtually uninvestable before , absent more transparency regarding the total extent of the Signa exposure and a clear path to a solution for the Russian business. The situation of Signa has deteriorated if anything, and regarding the Russian business, management seems to be stalling. Even when taking into account reduced credit volumes, personnel and customer growth does not exactly paint a picture of footprint reduction. Additional headwinds from Poland, albeit relatively minor compared to other issues plaguing the bank, do not help, either.

While I continue to believe that there is a fair value of more than zero, but (presumably) below the price at the time of my initial coverage (the stock currently trades a little above), I believe that recent developments support a bearish view. Unsurprisingly, I remain of the opinion that one has to assume a value of potentially (close to) zero, to be on the safe side. Consequently, I still consider Raiffeisen bank a strong sell.

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