Good morning,
We have recently added a few new bonds like two new EDF hybrid bonds in USD and EUR, the Electricity of Portugal 2021 in USD, and the Banco BMG 2018 bond to our Conviction list. We have distributed comments about why we believe that the first three bonds offer value in the past (let us know if you are missing these).
One that we have never wrote about is the Brazilian Banco BMG which we have been following closely since 2012 when the whole mid-sized banking sector struggled. After a few successful quarters we now believe that the bank delivered a successful turnaround. While most of the positives might already be priced into the issuer’s bonds we still consider them as attractive for dedicated “HIGH” risk takers and thus added one of them to our conviction list.
Bond:
· Banco BMG 8% 15.04.2018, yield 7.45%, ISIN USP07785AF85.
The issuer will repay 1/3 of the nominal in 2016, another 1/3 in 2017 and the remainder at final maturity.
The average maturity is 2017 and at 102.50 the yield to this date is 7.1%.
Banco BMG:
· The mid-size Banco BMG, founded in 1930, is better known to investors as being one of the pioneers in granting loans to civil servants with repayments taken from monthly paychecks - a business which per definition implies lower risk than pure unsecured lending since public sector employees usually keep their jobs until retirement. In addition the bank also grants car loans, leasing and other kind of financing services. The bank is privately-owned by the Guimaraes family.
· Loans to civil servants: While all the major banks have been active in this business in the past, especially the smaller banks were attracted by the low risk, high potential and aggressively grew their “sales force” in order to reach as many clients as possible. The growth strategy went well until the Brazilian regulator eventually changed several accounting rules in 2012 in order to slow down consumer credit growth. The changes had severe negative impacts and led to high industry write-downs, followed by an increase in bond yields of the smaller lenders and ultimately led to bailouts of Banco Schahin (by BMG), Banco Panamericano (by BTG Pactual) and even to one default in the case of Banco Cruzeiro do Sul. The investor base suddenly realized about the very intransparent accounting methods and the high dependency on the monoline business and wholesale funding. That initiated the start of a consolidation in this sector.
· Banco BMG also ran into troubles but managed to survive also thanks to Itau Unibanco with whom it created a BRL 1 billion joint-venture (JV) called BMG Consignado which belongs 30% to Banco BMG and 70% to Banco Itau. Itau Unibanco (rated Opportunistic HOLD at JB Research) is Brazil’s largest non-government-owned bank. In terms of market capitalization (USD 62 billion) it ranks something in between of Credit Suisse and UBS. So there is no doubt about potential positive impact that a collaboration with such a big bank can have.
· Banco BMG continues to operate under its sole brand but will also be the sole operator for acquiring clients and granting new loans to BMG Consignado. New loans will be randomly allocated 70% to BMG Consignado (the JV) while the remaining 30% of new loans will be booked onto Banco BMG’s own balance sheet. Since funding remains expensive for Banco BMG and this would threaten the plan of the JV to reach a loan book of BRL 20 billion by 2017, Itau Unibanco decided to provide up to BRL 300 million of funding per month to BMG at favourable funding rates until 2018. This cheap funding is the main advantage that BMG now has compared to its mid-sized peers and this will reduce costs and increase profitability going forward.
· After a brutal shrinkage of its loan book, loan restructurings and losses in 2012, Banco BMG has started to deliver profits again in 2013. During the first 9 months of 2013 it generated a net income of BRL 415 million and received about BRL 20 million in the form of dividends out of the JV, whose loan book increased from zero to BRL 5.6 billion already. Currently BMG’s capital adequacy ratio is 14%, the net interest margin 9.9%, return on equity was 17.3% and non-performing loans stood at 3.8% while its interest earning loan book was BRL 20 billion. Apart from Itau Unibanco related funding Banco BMG today also has BRL 6.9 billion in term deposits with roughly 50% being guaranteed by the depositor insurance fund. So its funding base is more diversified than before.
Investment rationale:
· The JV created good potential for BMG on a standalone basis due to access to cheap funding and the benefit from increasing dividend income from the joint-venture going forward. After outlook revisions from both S&P (positive) and Moody’s (stable), which acknowledged the favourable trend in the bank’s credit profile and the fact that the business will benefit from lower operating costs and growing business due to the leverage with Itau Unibanco, an upgrade could be in the cards which is also expected by the bank’s CEO. There is no kind of guarantee from Itau Unibanco or the JV company for any of Banco BMG's debt and after the strong rally of the bonds since mid-2012 further spread tightening in the same way as before can no longer be expected.
We nevertheless would consider the 7.1% yield to the average 3 years maturity as interesting for “HIGH RISK TAKERS” on a buy-and-hold basis and, as the bond’s credit spread might still not fully reflect potential positive impacts of the joint-venture, there could still be some price appreciation driven by further spread tightening.
· The comparison with bonds from other EM consumer loan companies (like Tinkoff Credit Systems, Russian Standard Bank, African Bank, Tanner Servicios Financieros, Credito Real, etc.) show that BMG’s bonds indeed trade at a juicy yield especially when taking into consideration that its business is less risky and it has access to cheap funding for as long as Itau Unibanco remains solvent (which is our base case). Last but not least the yields are also above the average of bonds included in the JPMorgan Corporate EM Brazil and EM HY Index and above the BofAML’s 3-5 year B US HY index.
