Banking on Value
The Case for Value in Raiffeisen Bank International AG (XWBO: RBI AV)
### Disclaimer: Nothing in this post is investing advice; do your own research! ###
Caught in the headlights of the Russia-Ukraine conflict, Raiffeisen Bank is an Autrian headquartered bank with large operations in the region
Fears about the lost income as a result of the war, and the potential for severe balance sheet stress, sent the market price of the company tumbling ~60% in short order, from a high of €28.42 in February 2022 to a (closing) low of €10.98 in March
Amory believes that the market has drastically overreacted to the risks brought on by the war, and has failed to take into account esoteric group structures that will ensure liquidity across the business. At an average purchase price of €11.55, Amory is long
Overview
Raiffeisen Bank (henceforth, RBI) is an Austrian bank, headquartered in Vienna, with operations across central and Eastern Europe. I’d been tinkering over it for a while, mainly because it was just cheap (at around €24), but I didn’t feel that it was really at the right level for me, and there wasn’t the margin of safety I wanted. I left it up on the watchlist, and thought I would keep an eye on it, and potentially have another look at ~€20. Then, Russia invaded Ukraine.
On the morning of Thursday, February 24th, Russian forces invaded Ukraine, and RBI finished the day down 23%; it closed at €16.31, from €21.22 the previous day. As the conflict intensified, the price continued to dive, hitting a (closing) low of €10.98 on March 7th. This, needless to say, got my attention.
I see you: looking confused, wondering why RBI took such a pronounced hit over the invasion. Let me take a step back and explain. The reason for the precipitous decline is that RBI had the largest foreign bank (i.e. not a sanctioned Russian bank) loan book exposure to the combined Russia / Ukraine region, with SocGen and UniCredit behind. At the end of FY21 (to 31st December), RBI had total assets of €192.1bn, of which €20.8bn was in Russia and Belarus, and €4.1bn in Ukraine, a total exposure to the region of 12.9%. More important, though, was the contribution of those regions to profitability at the group: €600m out of €1.5bn of net income attributable to common shareholders, or a whopping 40.5%, the single largest contributing region. The after-tax RoE for the region, as calculated by RBI (using the end of year numbers, not the beginning of the year as I like to calculate it), is 27.3%, compared with 13.2% for Southeastern Europe, the banks’ second most profitable region by RoE. The potential loss of that income would thus drastically change the earnings profile of the bank; so, sell, right?
Hopefully, my (carefully curated?) audience will all be yelling at the screen: “it depends on what’s priced in!!”. And that, dear friends, is the key question.
Are They Going Bankrupt?
First, let’s start to think about the realistic worst-case outcome for the firm, from a first-principles balance sheet perspective. Yes, on a consolidated basis they are carrying €24.6bn in assets from the region: however, consider the fact that, in reality, the regional entities are separate legal corporations, and are bankruptcy remote. They are funded locally, by Russian retail and corporate deposits, meaning that inter-company balances are effectively nil. In fact, as local Russians are so worried about sanctions on local Russian-owned banks, RBI management has reported significant deposit inflows, as depositors look to protect their capital under the umbrella of an unsanctioned foreign bank. This means that the real exposure we need to think about for RBI is the equity value in the Russian, Belarusian and Ukrainian entities that the parent company – whose shares we are buying – actually owns. At FY21, RBI marked this at €2.9bn, out of a total of €12.8bn. Inclusive of this Eastern European region, book value per diluted share is €39.0; without, it is €30.1. So, assuming that RBI management completely strand the businesses – all of the businesses, with no value left from the carcasses, and no sale proceeds – the write off is roughly €9 per share of equity capital. This is not nothing, but, at €11.55, I am still paying in the region of 1/3 of book value, having wiped away the entirety of the Eastern European businesses with the stroke of a pen. My margin of safety bell is ringing, but let’s dig deeper.
The corporate structure of RBI now becomes relevant. RBI is part of the Raiffeisen Banking Group (RBG), Austria’s largest banking group, which has its interesting historical origins in the cooperative banking movement in Central Europe. RBG itself is comprised of three parts: 341 independent local Raiffeisen banks (1st tier), eight regional, independent Raiffeisen banks (2nd Tier), and RBI (the listed entity that we are discussing, and the 3rd Tier). The local branches are independent, and collectively own the eight regional branches, with each regional branch (Raiffeisen Landesbanken and Raiffeisenverband) being owned by the independent local branches native to the region it serves. The regional branches essentially work as mini-Central Banks for the local branches, offering liquidity balancing and central services to the local branches. The local branches also own 58.8% of RBI, with the remaining 41.2% as free float available to you and me. RBG has in place a statutory deposit protection scheme, the Austrian Raiffeisen-Sicherungseinrichtung eGen (ÖRS) (try say that with a mouthful of cornflakes…), which is basically a deposit protection scheme for retail customers. More importantly, at an institutional level, the group has in place an Institutional Protection Scheme (Raiffeisen IPS) that “commits member institutions to ensure one another’s security and in particular, join forces to ensure liquidity and solvency when required”. This last bit is important. Although we have hopefully shown that the Eastern European businesses will have de minimis impact on book equity (and we’ll touch on solvency later), another key consideration here is that RBI is part of a very large Austrian banking group, and can draw on plentiful resources for liquidity purposes if needed, which sit outside of the reported balance sheet that appears in RBI’s accounts. This is a respectable backstop to an already large margin-of-safety opportunity: buying shares for 1/3 of book value, with a binding group agreement with a large banking organisation that stands behind the balance sheet in times of crisis. Per Moody’s:
“Moody's considers the increased risks for creditors to be substantially mitigated because of RBI's status as the central institution of the Austrian Raiffeisen Banking Group (RGB) and it being a member bank in RBG's institutional protection scheme (IPS), which ensures financial support for RBI, in case of need”
It seems quite hard to lose (famous last words, especially with a structurally leveraged business…)
For those of you who still need some help falling asleep to the sound of solvency, I’ll briefly touch on solvency ratios, too.
At FY21, RBI reported a CET1 ratio of 13.1%, meaning that €11.8bn of Tier-1 Common Equity stands behind the €89.9bn of Risk-Weighted Assets (“RWA”), itself a risk-adjusted version of the total €192bn of assets (the €51.7bn of cash is not going to default on its obligations, we presume). That is a healthy number, and well above the 7% mandated by Basel III (4.5% minimum + 2.5% conservation buffer). RBI’s total capital ratio stood at 17.6% at year-end FY21, again well ahead of the 10.5% minimum (8% minimum + 2.5% conservation buffer). These are good numbers to begin with, I hear you say, but where does getting rid of the Eastern European business leave us? Well, to assess that, we could try to piece it together theoretically by region – or we could just look at the Q1 22 report, which, well, just tells us what it now is. The first piece to note is that RWA have increased, due to a (sensibly) higher risk weighting for Russian, Belarussian and Ukrainian assets; RWA now stands at €104.0bn, an increase of €14.1bn, of which €8.2bn was directly due to risk weight changes for the Eastern European region. Remember, increasing RWA means that the value of the equity of the company (ultimately shareholders capital) counts for less, as it now needs to stand as a buffer against a larger asset base. At the same time, however, management responded quickly, cancelling the €1.15 / share declared dividend to conserve cash, bringing the CET1 ratio to 11.7%, before the incorporation of Q1 22 results. With the positive performance in the quarter, the CET1 ratio stood at 12.3%, by no means a distressed level. By the end of the year, RBI should be back at its ~13% CET1 target, per management’s guidance (and some not very complicated maths).
So, the balance sheet is strong, and solvency and liquidity are clearly not going to be an issue. This was reiterated by both Moody’s and S&P, who left RBI’s ratings unchanged (A2 and A-, respectively), although S&P has a ‘Negative’ outlook, compared to Moody’s ‘Stable’ view. So, from a balance sheet, liquidity and solvency perspective, I am confident in not losing my money in the business at this price.
Do They Make Any Money?
Next, let us explore the opportunity at an earnings level, and I will wrap up my argument that, even with the hypothetical complete and enormous loss of the Eastern European business, RBI is still worth a lot more than the €11.55 I paid for it.
In FY21, RBI earned €3.89 per diluted share, roughly in line with its pre-COVID earnings level post the merger with Raiffeisen Zentralbank Österreich (RZB) in 2017. Over the past ten years, diluted EPS has averaged €2.48 per year, or €3.33 from the RZB merger (including a rubbish year in FY20). This represents something in the region of 10% - 11% return on equity each year, averaging 8.1% (on a per-share basis) over the past decade, inclusive of the 6.2% RoE in pandemic year FY20. This isn’t spectacular, or special, but it’s not bad for a well-capitalised European bank. So, let’s do some boring, no-growth earnings forecasting. Let’s assume that the entire of the Eastern European business disappears from RBI’s net income stream, and think about a ball-park long-term earnings capability for the company. Using a normalised average of per share earnings (ex-COVID, and post-merger), €3.33 x 0.595 = €1.98 per share. This is a bank, so let’s be safe (we’d do it anyway, whatever the business) and bake in 0% growth for the next ten years, and 0% terminal growth thereafter (who says I’m not an optimist?).
There a then couple of ways to approach discounting these cash flows, either thinking about them as a remote shareholder (i.e. dividend cashflows based on management policies, and the residual balance of retained equity capital per share at the terminal end) or looking at it as a private owner (my preferred method) and discounting diluted EPS (making sure to confirm that net cashflow to equity reasonably sits in line with net income). The latter is my preferred method, because its purer and I think a fairer reflection of intrinsic business value, but I tend to use both, and then input the lower of the two to think about scenario analysis. (Educate me in the comments if I am missing something else to think about). Here, the dividend / cashflow number is lower, so I will use that. At 0% earnings growth, and 0% terminal growth, the present value per share is €13.09 at a 15% discount rate, a 17.1% premium to the price I paid (€11.55). At a discount rate of 10%, it is €21.23, an 89.9% premium to my purchase price. This is, to reiterate, with (i) 40.5% EPS being effectively deleted from the business, the worst-case scenario that I can see for the Russia/Ukraine problem; and (ii) a 0% EPS growth rate, and terminal growth rate. At 2.5% for each of those rates, the present value per share is €16.10 (at 15% discount rate) or €28.59 (at a 10% discount rate); for context, RBI has managed to grow diluted EPS at 3.94% since the RBZ merger. Obviously, none of the figures I have presented are precise and correct. However, they give us confidence in the range of the value of the business, allowing us to feel “vaguely right” about the opportunity, in the words of John Maynard Keynes.
In sum, I think that even with a tremendously gloomy view for the business’ earnings power going forward, the diluted EPS that RBI may likely produce demands a far higher intrinsic value than the market capitalisation currently offers. Hence, opportunity. Coupled with the balance sheet strength - both as an independent business and as a key component of a wider, highly solvent banking group - I am confident that RBI has an intrinsic worth in the order of ~2x what I paid for it, looking at the low end of a conservative range of valuations.
It is worth briefly mentioning that, since I bought my own small slice of RBI, they updated with positive Q1 22 results. However, these are choppy, marred by excessive trading P&L from their Ruble hedge and currency trading opportunities, and, in any case, are a relatively short-term view of the business. Feel free to read it if you like, but it wasn’t part of my original thinking, and hasn’t done anything to change it, either, so it would be unfair of me to wave their positive quarter around as if that is somehow proof that I was right. For that, let’s wait a few years; for now, Amory is long.