value and opportunity

As this is going to be a pretty long post, the “executive summary” upfront:

– For a specialized private bank without PIIGS exposure, Van Lanschot looks extremely cheap (P/B 0,5 vs. 2.0 for other private banks)
– negative 2012 result is very likely „kitchen sink“ result in order to give new CEO a head start
– turn around story. Strategy change under way, goals look achievable
– Van Lanschot has no controlling shareholder, a potential M&A transaction likely if turn-around is sustainable
– potential secular tail wind because of crack down on Swiss Private Banks and regulation for large international banks
– negative overall sentiment vs. Dutch real estate market could explain very low valuation

Introduction:

Van Lanschot is one of the oldest names in Dutch Banking and celebrated ist 275th anniversary in 2012.

Until 2008 The Bank showed healthy profits, EPS increased from around 3,30 EUR per share in 2001 to around 5,20 EUR in 2007. Since then, Van Lanschot has struggled. After a smaller loss in 2009 (-0.78 EUR per share) during the first leg of the financial crisis, the company showed a big loss in 2012 (almost -4 EUR per share).

The stock chart mirrors this developement. After a peak of around 85 EUR in 2006, the stock traded at around 80 EUR until 2008, but then lost more than 80% and did not really recover until now:

The old CEO Floris Decker resigned by the end of 2012 and was replaced by Karl Guha effectively on January 1st 2013. There is a good story about the old CEO to be found in a Dutch financial publication here.

Guha came from Unicredit but worked most of his professional life at ABN Amro. interestingly, at Unicredit he was responsible for Risk Management.

Business model Van Lanschot / Private banking

The core business of Van Lanschot is Private banking, merchant banking and Asset Management. In the years before the financial crisis, they made the mistake to increase their balance sheet and start lending to corporates without private bank relationship, moving to become a „universal bank“. According to somereports, the CEO even started to speculate in financial stocks with the money of the bank.

Private Banking per se is maybe the most lucrative part of the whole banking segment. Besides Wealth Management, it also includes loans to owners and advisory to wealthy clients and the companies they might own. The typical client would be for instance the owner of a medium-sized company, where the Private bank manages his wealth and the merchant also extends loans or even M&A advice to the company if necessary. This kind of business however requires more equity capital than traditional banking. It is not uncommon for private banks to have equity ratios of 10-20% compared to 2-3% for large banks like Deutsche Bank or Barclays.

Private banks usually also don’t have liquidity problems as their (rich) clients usually provide quite some “float”. Under the old CEO, Van Lanschot seemed to have used part of this “float” to extend loans to companies which were not private banking clients. This is much more risky. If you extend for instance loans to the company of a client, the bank usually has collateral in some or the other form outside the company, which, in the case of problems, will usually mitigate the majority of the losses.

This is also one of the major strategy changes they have announced: No more loans to companies without private banking relationship. In the short-term, this will lead to a shrinking balance sheet, but in the long-term this should clearly improve profitability.

Depending on what report you read, Van Lanschot is either number 2 or 3 in the Dutch private banking market, with a market share of around 10-15% which is not bad. There is of course competition but the market itself is growingwhich cannot be said of many areas in banking these days.

As a funny reality check, find some pictures of Van Lanschot branches in Netherlands:

Breda

Utrecht

Rotterdam

This really looks like Private Banking….

Potential secular tail wind due to Swiss tax changes and Bank regulation

The absolute no brainer for private banking in the past was: Just move your money to Switzerland, giving Swiss private banks a huge “natural” competitive advantage with regard to “after tax returns”. Now however, this seems to change. Not only seems the Swiss tax secrecy regime falling, on top of that some Swiss private banks already closed doors in 2013 due to issues with US tax authorities, Bank Wegelin in March 2013 and Bank Frey a few days ago.

This might not be a big impact in the short term, but long term I think that this is a big plus for many non-Swiss Private Banks.

Another potential tail wind might be more and more regulation for big banks. In the mid to long term, this could improve the relative position for smaller, focused niche banks. I think part of the whole regulation is actually aimed at the big banks in order to prevent them from grwoing even more. Smaller players liek Van Lanschot might have an advantage in this environment.

Dutch banking and housing markets

The Netherlands are in a kind of housing crisis as well. The property market is going down, residential homes lost alone around -10% over the last 12 months.

The big Dutch financial institutions have a lot of problems. ING is still struggling and had to get aid from the Government, ABN had to be nationalised as well as most recently SNS Reaal, another Dutch financial institution.

SNS Reaal is a pretty interesting case in itself. In the latest report, they showed a percentage of non-performing loans of 39% and LTVs far above 100%. SNS Reaal seems to be a very special case, with everything from fraud, kick backs, fleeing CEO’s etc. ().

The only bank „still standing“ of the large ones is Rabobank, the cooperative bank, which by the way, owns 11% of Van Lanschot

LTVs in Dutch mortgages are very high. But there is one caveat: The high LTVs in the Netherlands are a result of the Dutch Tax code. Even very rich people take out loans as high as possible as the full interest is tax-deductible. As the loans in the Netherlands are made on a “full recourse” basis and loans to poorer people are usually guaranteed by the Government, actual loss rates for Dutch Retail mortgages are very small despite the fall in market prices. A good reporton Dutch mortgage debt camn be found here at Rabobank.

Van Lanschot loan portfolio

Equity capital ist he main „resource“ of any banking activity. The problem of this „resource“ ist he fact, that it is a simple residual of assets minus liabilities. So in order to estimate the value, one should have at least an idea about the asset quality of a bank.

Van Lanschot shows impaired assets of 597 mn EUR, against that they have set up 312 mn EUR loan loss reserves. They have no significant exposure to PIIGS. According to this detailed Fitch report, the quality of the loan book doesn’t seem too bad and reserveing even before the 2012 “kitchen sink” is considered conservative. That does not guarantee that there are no surprises, but I consider the risk as managable.

Interestingly, S&P downgraded Van Lanschot last year but mostly because of their general sceptical outlook towards the Dutch market.

Shareholders:

The shareholder structure is quite interesting. Only 14% are free float, the Van Lanschot family owns 11%. Largest owner is Delta Lloyd, the Dutch Life Insurer with 30%.

Van Lanschot Shareholders	%
Delta Lloyd	30%
Free Float	14%
ABP	13%
Rabobank	12%
Friesland Stichtung	11%
Van Lanschot Family	11%
SNS	5%
Management	4%

Delta Lloyd as an insurer, will not be happy with the 30% stake if Solvency II gets implemented in 2016. So I guess at some point in time tehy want out. There were even rumours that the family wanted out. So it is not unlikely that at some point in time one will see some “action” in the shareholder structure.

Valuation:

A simple, “Berkowitz style” valuation would be: Book value

With ~0.51 times book value, Van Lanschot is one of the cheapest banks in Europe. Even Greek Banks like Piraeus Bank trade higher. The current valuation is on a level with „quality banks“ like Unicredit, Espirito Santo and Credito Bergamesco.

Interestingly, the P/B multiple for listed Private banks is a lot higher. Swiss competitors Julius Baer, EFG and Banq Privee de Rothschild for instance trade on multiples between 1.1-2.0 times book, a clear premium to „normal“ banks.

So with a “normal” result, one could argue for a valuation somewhere at 1.5 x book value. Clearly, this will be a long way, one should not expect exploding profits in the next quarters. But in a time period of 3-5 years, I could imagine that the stock can triple if the turn-around is succesful. Also, when people finally realize that not every Dutch homeowner will go broke, there might be a rerating of Dutch financial stocks in general. But this might also take time.

It would be easy to comeup with a much more complicated valuation method, but I like to keep it simple. If there are no big holes in the balamce sheet and costs are kept under control, equity is at a safe level, then book value should be achievable for any bank.

Why ist he stock cheap ?

As always one should be aware that there are clearly issues:

– House prices are dropping in the Netherlands, fear of more defaults, esp. Property loans
– „kitchen sink“ losses in 2012
– shrinking balance sheet & top line interest income to be expected for the next quarters
– pension deficit (IAS 19 let to -50 mn in equity), overall DBO with 855 mn EUR quite high. Assumptions have been changed and look conservative
– reporting could be better (Goodwill impairments etc.)
– Van Lanschot took 750 mn from the ECB LTRO program. They did this to earn a spread but it might have been interpreted as a sign of weakness
– Cost ratio is far to high. That had problems with IT projects and outsourcing in the past. Costs have to come down significantly
– as every bank, they are suffering from low interest rates in general

Timing aspects and other considerations

Some people might argue that the timing is not great. The stock market is making new highs on the one hand and the Dutch market is clearly suffering on the other. I did also ask myself: Would I buy this stock, if I had no cash and we would be in 2012 ? “Secretly” I have been looking at Van Lanschot since early 2011, when we did an analysis of Delta Lloyd. Van Lanschot was always relatively cheap but at that time i didn’t see the turnaround.

But now, with the individual factors (new CEO, new strategy, 2012 kitchen sink) and bad headline news, I feel much more confident.

As I have already another Dutch Bank in my portfolio (KAS Bank), concentration is also an issue. In this case it is not a big issue, as KAS Bank is much more a service provider than a “real” bank and has only limited exposure to Dutch real estate. My overall exposure to banks is also something to consider, but still at an OK level.

Finally a few words on Banks in general: Many Value investors do not invest in banks as they consider it too risky or too difficult. Clearly, a bank as a leveraged institution is always risky but so is any company with debt. Personally, i think the business model of a “Normal” bank is rather simple, much more simple than many other companies I have been looking at. So for mee, banks are part of the “normal” menu, if they are cheap and attractive, I will buy them.

Summary:

Van Lanschot is for me a stock with an attractive risk/return ratio. Despite the bad 2012 result and bad headline news, I think the risk/return ratio is pretty good at 0.5x book value for a business which could trade at a potential 1.5-2.0 times book value.

It is clearly a bet that the Dutch real estate sector does not implode and that there are no big black holes in the balance sheet.

As usual, I will start with a “half” position at 2.5 of the portfolio. If the turn around is confirmed over the next 2-3 quarters, I will scale up to a full position.

Disclaimer:
The author will most likely own the shares prior posting. Please do your own researchg. This is not an investment recommendation or advice. Never follow any tips blindly. The shares discussed are usually reltively illiquid.