Description

Bladex has been written up several times in the past – the writeups are worth revisiting for further background on the name.  The company has provided trade finance since the late 1970’s in a volatile region in the world.  Many have probably been attracted to the simplicity of the bank – it makes short-duration dollar denominated loans, generally has zero credit losses, has lots of capital and, in the last 10+ years, has often paid a generous dividend/traded below book value.    Having owned the shares off and on over this period, I would also have pointed to one/several of previous attributes as a reason to own the stock.   

The past decade has been more than challenging for LATAM -  Lava Jato, Argentina/Venezuela  imploding, weakened currencies across the region, declines in trade flows and (most recently) a severe COVID fallout across the entire region.  On the plus side, BLX’s lower risk/lower duration model has produced minimal credit losses (essentially none during the GFC, but some losses in 2017/2018 including a  ~52mm hit from a single sugar credit that was ultimately sold in Q2 2020)  and a clean book post COVID.  The company has generally returned substantial capital to shareholders.  While the stock is has risen only 10 percent over the past decade, investors have collected nearly the entire stock price in dividends ($14 in payouts).  That said, the loan book is roughly $400 million smaller than at the end of 2012.  On top of this, rating agencies (S&P 500 in particular) have emphasized the headline macro risk of the LATAM area versus the actual makeup of BLX’s portfolio, thereby pressuring the company to hold more capital than is economically justified.  NIM are at record lows and if rates do not rise, BLX likely will be a meandering 5-6% ROE bank and investors will simply collect 6-7 percent yields.  And while BLX would be a prime beneficiary of any interest rate increases, one could argue you get far more juice from other names (especially in Europe).  

So why bother?  At just under 60% tangible book value, a good bit of downside is priced into the name.  A cyclical rebound in the loan portfolio combined with opportunistic share repurchases (first buyback program in 10+ years announced with Q1 results) could provide respectable upside, especially if spreads widen and/or rates actually rise.

  I show BLX’s balance sheet (avg balances) from 03/31/19, 03/31/20, 03/31/21 and then separately a downside 03/31/22 (assumes that the vast majority of the portfolio reprices to currently depressed disbursement levels – see page 4 of Q1 earnings presentation.)  I assume the bank repurchases $60mm of shares at $16 in the 03/31/22 downside scenario.  

BLX should do better than the 03/31/22 scenario above despite its wholesale funding model (which limits liability repricing).  BLX will almost certainly increase the tenor of its loan book (even on 2-year loans, repricings typically occur every six months).  While spreads vary by country, typically they are 80-100 basis points wider for medium term maturities.  When COVID hit, BLX essentially increased its cash position and emphasized <1 year loans.   As (hopefully) an economic recovery takes hold along with increased commodities driven borrowing (30% increase demand from commodity clients…including multiple state-owned entities which are presumably less concerned with ESG considerations) and higher trade flows (now forecast to increase 16% y-y in 2021 following 12% declines in 2020), BLX should be able to increase its loan book back to pre-COVID letters.  While higher interest rates would obviously help, BLX should be able to increase spreads when other banks pull out (as in the case for Colombia right now).  It is not hard to imagine a scenario where fears over Brazil’s fiscal situation/or president Lula causes a capital flight and BLX can demand higher spreads.  All of this can easily be funded with excessive capital (16.7% tangible equity/assets or 26.3% under Basel 3 standards).  

But what happens if rates don’t rise or loan growth beyond $6 billion becomes challenging?  A bank with an indefinite 5-6 percent ROE trajectory does not have much of a future with investors.  The bank really has a couple of options:

1. Drastically slash its footprint/cost base 

2. Liquidate the bank

3. Pay large special dividends/buyback stock  

The new CEO has various management consulting firms working on optimizing fee earnings (essentially letters of credit and fee syndication), better efficiency, new products, etc.  The past 3 BLX CEOs have all spoken about some version of an optimization strategy.  Maybe this one will yield better results.  Based upon historical performance, however, it is harder for the bank to achieve a 10% return unless the loan portfolio/fee earnings are near cyclical highs and spreads are wider than current levels.  That said, the normalized level of earnings is almost certainly higher than current levels.  BLX also believes there is room for operational improvements, and the bank also believes that periods of capital flight will allow BLX to deploy capital at higher spreads – so options 1 and 2 are out.  Based on recent conversations with the company’s management, it does seem the willingness to pursue option 3 has increased, with buybacks the preferred return mechanism at current prices.  At current capital levels, Bladex could triple the size of its current buyback program (at an assumed ~20% premium to current prices), return its loan portfolio to pre-COVID levels and still have capital levels near post GFC levels.  If one were to assume roughly 100 basis points of higher interest rates and/or spreads (still well below 03/31/19 levels), the bank could return to 8 percent ROEs while book value per share would be 15 percent higher than 03/31/21 levels.  At 80 percent of book value or 10x earnings, BLX could offer 15-25 percent IRRs depending on the time required for spread improvement and/or the aggressiveness of capital return.  

LATAM Central banks and commercial banks own ~16% and ~5% of outstanding shares respectively and therefore repurchases of this size would be equal to roughly one third of the freely traded float.  Certainly, there could be pushback on more aggressive buybacks from certain shareholder constituencies.  There also could be pushback from rating agencies whose risk weightings are far harsher than Basel standards.  But, when pushed on these points, BLX reiterated that all options must be considered and that at this price, more aggressive buybacks must be considered.  Even only assuming 50 basis points of spread/and or interest rate expansion off the bear scenario and only $120 million of share repurchases over the next 2 years, one would still be looking at 30-40% price upside plus a nearly 7 percent annual dividend.  If rates don’t move and liquidity continues to slosh around LATAM trade financing, the 6-7 percent dividend is covered but there is little upside in the name.  That said, downside is also likely limited in this scenario given the yield and capital for meaningful share repurchases.  BLX is not a “buy and forget” name – rather it is cyclical financial name that appears to be trading nearer the bottom point in the cycle with a new management team that seems more willing to deploy capital more aggressively towards accretive share repurchases.  

Catalyst

-Larger than anticipated buybacks

-Higher interest rates/spreads

-Growth in trade volumes