- BNP Paribas can take the blow from the fine without raising capital.
- 30% upside based on peer valuations.
- With the uncertainty about the magnitude of the fine behind it, the undervaluation should not persist.
French BNP Paribas (OTC:BNPZY) is one of the biggest banks in the world, having total assets of 1.8 trillion euros. At the end of June, the bank pleaded guilty to criminal charges. Charges were related to breaking U.S. sanctions against Sudan, Iran and Cuba. The imposed fine was just a bit under $9 billion, being the biggest in history. What the market hates the most is uncertainty, and now after the court case is over, the low valuation should gradually improve closer to its peers.
I think that the fine will not affect the company in any major way. Maybe the dividend could be suspended in a worst case scenario. But the major point is that it is unlikely the bank would have to raise more capital. Operating income in 2013 was 7.8 billion euros or about $10.5 billion. Net income was 4.8 billion euros ($6.5 billion). (Source: BNP Paribas: Key Figures)
The bank is also well capitalized, having 11% tier 1 capital ratio and they have set aside $1.1 billion for the fines. (Source: BNP Paribas Financials) The effect of the fine would therefore be about $8 billion. This would bring the capital to $84 billion, which would still amount to about 10% tier 1 capital. (Source: Dealbook, The New York Times)
The bank could take the blow and still be within all the regulatory requirements. If the dividend is cancelled and the company has the same net profit this year than in 2013, the tier 1 capital would be actually good in the year end (over 11%), at least for an European bank. I think that the dividend would not even have to be cancelled. It is quite conservative, the payout ratio being about 40%. This amounts to about $2.6 billion from 2013 numbers. (Source: BNP Paribas: Key Figures)
Comparison to peers and valuation
Here is a comparison to some other huge banks, which I chose to be about the same quality and size.
Tier 1 capital ratio
JPMorgan Chase (NYSE:JPM)
Banco Santander (NYSE:SAN)
Based on the numbers above, BNP Paribas seems to be cheap. It has about 6% ROE, but is selling well below book value - about the same valuation as BAC, which has considerably lower profitability. I think that the best way to come to some fair value is P/B ratio, because it is a quite stable and liquid metric. The forward looking PE ratios for example are actually very different for the above numbers, so there is a lot of variation and in the past few years all the banks have faced issues, so the past values are not very comparable either. The average PB of the three comparable companies is 0.99. This gives about 30% upside for BNP Paribas if it were to reach the average valuation. Based on above numbers, I see no reason why the company should trade lower in the medium term.
I think that the imposed fines do not affect the company in any major way. The bank is unlikely to need more funds from investors. The fine could maybe dampen the growth prospects lowering the capital ratio, but still the undervaluation seems to be too wide considering that the uncertainty is largely behind. I think that in a year or two the company should appreciate about 30% to reach comp valuations.
Lastly I must say that this investment is somewhat morally questionable and I personally do not have interest in it. The huge fine actually was not that huge when compared to the dollar volume of the fraud. It seems that the company was very much aware that they were breaking the law and profited from it handsomely. Here is a good critical piece about the bank's actions.
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