Bankinter: An Under-Followed Quality Bank In Europe

| About: Bankinter, S.A. (BKNIY)

Summary

Bankinter is a small Spanish bank that targets mainly affluent clients and has a conservative management.

It has an above-average credit quality due to its small exposure to real estate, leading to good profitability and capitalization.

Bankinter has recently bought Barclays retail operations in Portugal and will test its business model for the first time in a new geography.

It is currently fairly valued but the recent acquisition gives it more upside in the medium-term if the integration is successful.

Bankinter (OTCPK:BKNIY) is an under-followed Spanish bank that operates only in its domestic market, but has recently bought Barclays' (NYSE:BCS) retail operations in Portugal and will test its business model abroad for the first time. If this move is successful, it could represent only the first step to a new growth phase through the internationalization of the bank. Currently, its valuation is quite full reflecting its superior quality, but the new business abroad may unlock further value in the medium-term.

History & Description

Bankinter was created in 1965 as a Spanish industrial bank through a joint venture between Banco Santander (NYSE:SAN) and Bank of America (NYSE:BAC). It was listed in 1972 on the Madrid Stock Exchange and at the same time the bank became fully independent of its founders and transformed itself into a commercial bank. It pioneered the mutual fund industry in Spain and the mortgage segment following its deregulation, which gives it a strong competitive position in these segments. More recently, the bank acquired Barclays' retail business in Portugal and 50% of its insurance business. It has a market capitalization of about $6.5 billion and is traded in the U.S. on the over-the-counter market.

Despite a relatively small network of slightly above 500 branches, Bankinter controls around 4% of the Spanish banking system, mainly through mortgages to individuals. It also fully detains Linea Directa Aseguradora, the market leader in motor insurance through direct channels in Spain, after the acquisition in 2009 of the 50% stake held by Royal Bank of Scotland (NYSE:RBS). Its main competitors are large Spanish banks, like Santander and BBVA (NYSE:BBVA), but also domestic players, such as Caixabank (OTCPK:CAIXY) and Sabadell (OTCPK:BNDSY).

Within the Spanish banking system, Bankinter enjoys a very attractive position given that its business model is biased towards mid-to-high net worth individuals leading to good credit quality and more cross-selling opportunities of different services and products. Reflecting this, beyond banking services Bankinter's asset management and insurance operations are important drivers of group results.

The bank uses traditional banking products, such as mortgages, to grab clients and then tries to upscale its relationship through complementary products, like mutual funds or car insurance. Bankinter is the Spanish bank with higher exposure to Asset Management and brokerage in Spain and has avoided highly dilutive joint-ventures for these businesses during the crisis years like some of its peers have done. Indeed, over the past few years, both asset management and insurance have been important growth drivers for Bankinter showing its strategic nature to the group business profile.

Financial Overview

Regarding its financial performance, Bankinter has a very good track record over the long-term. Even during bad times, like the global financial crisis of 2008-09 and the Euro sovereign debt crisis of 2011-12, its profit declined, but Bankinter had been always profitable throughout the past 9 years, which is a very good track record considering the many challenges that European banks had to face during this period.

Bankinter has achieved good results posting strong results and high growth on most business lines. In 2015, Bankinter has achieved a new record year, boosted by top-line growth, good cost control and better credit quality. This was achieved while the bank has deleveraged its balance sheet and maintained its capital levels, showing that the bank is moving in the right direction.

During the past year, Bankinter gross operating income (GOI) was up by 8.3% to $1.74 billion, with growth coming mainly from net interest income. Contrary to many Spanish and other peripheral European banks, Bankinter's reliance on trading income is low as the bank has not used much the 'carry trade' to boost its earnings. In 2015, trading income accounted for only 5% of GOI while for other Spanish banks, like Bankia (OTCPK:BNKXY) or Banco Sabadell, trading income generates between 30-50% of GOI.

Trading income is by nature more volatile than net interest income because it depends on gains from investments in capital markets and usually the market's valuation for this type of income is rather low. By generating most of GOI from client related business, Bankinter's GOI is highly recurrent and therefore is considered sustainable over the long-term justifying higher valuation multiples based on revenues.

Bankinter has also experienced significant growth in commissions mainly coming from asset management that has also registered good operating momentum, with assets under management (AUM) doubling in two years to more than $12 billion leading to strong growth on commissions' over the past couple of years.

Bankinter is one of the most efficient banks in Europe with a cost-to-income (C/I) ratio of only 44% in 2015. Even though costs have increased over the past years, its growth rate has been lower than revenue growth leading to improved efficiency. Bankinter's C/I ratio has steadily declined since 2011 when reached a peak of 54% to, on average, 45% in the past four years. This compares very well with other Spanish banks and the most efficient banks in Europe that have C/I ratio slightly above 40%.

Another distinctive factor of the bank is its better credit quality than its closest peers, showing better underwriting discipline. Bankinter's non-performing loans (NPL) ratio was, on average, 4.3% in the past five years with an NPL peak ratio of 5%. This compares very well with Spanish NPL ratios that have reached around 13% at peak level and still above 10% right now. This difference is mainly justified by the fact that Bankinter did not have excessive exposure to the Spanish property sector that went bust in 2008. Nevertheless, the bank has negatively affected by the economic contraction in the country and NPLs are higher than compared to other European banks.

Its NPL ratio declined in 2015 to 4.1% showing that credit quality is improving with the economic recovery. This better credit quality is also reflected in its lower cost of risk (COR) ratio of only 52 basis points (bps) in 2015, almost half of its peak 94 bps reached in 2012. This has been a boost to Bankinter's earnings and should continue to be a tailwind over the next couple of years as the bank needs less provisions for bad loans.

This positive operating environment of higher revenues, good cost control and better credit quality has also been reflected in Bankinter's net profit that has recovered from low levels reported during 2010-12. In 2015, it reached a new record with net profit of about $415 million, or $0.47 per share, representing an increase of 36% from the previous year. Its return on equity (ROE), a key profitability measure in banking, was close to 11%, which is the highest level in Spain and among the most profitable banks in Europe.

Acquisition Abroad

Bankinter is a Spanish domestic bank with a different approach targeting a niche market segment of medium and high wealth clients. This business model has been a successful history of the bank, but it was never tested abroad. In September 2015, Bankinter announced the acquisition of Barclays' Portuguese retail operations, changing its profile considerably given that this now represents the start of internationalization for Bankinter.

Portugal has a banking market with a relatively high concentration, making it quite difficult to grow organically or through a new operation. Barclays had its retail business in Portugal reported within its non-core division and was looking to divest it since 2011. The Portuguese banking system has suffered from the European debt crisis of 2011-12 and most foreign banks are divesting in this country, most notably BBVA and Barclays. This has opened an opportunity for other players at depressed valuations.

Bankinter was able to reach an agreement with Barclays at only 0.4x book value, which is a very cheap valuation and gives Bankinter a large safety net to restructure the business and improve its profitability. It also bought half of the insurance business, which is operated under a joint-venture with Mapfre (OTCPK:MPFRY). Based on pro-forma numbers, as of June 2015, Portugal would represent 10% of the combined loan book, 13% of total assets under management, 19% of group branches and 23% of group customers. Therefore, its impact will be significant for Bankinter while for a global bank like Barclays this was almost negligible in a group context.

Barclays' retail operations in Portugal were also targeted for premium clients and its business model has a good overlap with Bankinter. This means Bankinter should be able to replicate its business in Portugal, targeting mainly private banking, personal banking and mid-sized corporates. Additionally, from a financial standpoint the acquisition is also attractive given that, according to Bankinter, it should build shareholder value, as EPS is accretive from day one and sustainable return on invested capital is over 10% in the medium-term. Furthermore, the transaction is expected to be capital neutral something that is particularly good for shareholders.

Barclays' operation is currently on run-off and therefore is not taking advantage of instability within the Portuguese banking system following the BES and Banif collapses that led to the resolution of the banks. Bankinter believes that the performance of the business can be turned around by focusing growth in the areas where it has a clear expertise. This operation has market shares of 5% in private banking and 6% in personal banking and Bankinter can further develop current customer relationships to improve profitability. Bankinter expects to start running the business in the next few weeks and be fully integrated by year-end.

Capitalization & Dividends

Bankinter is a relatively well capitalized bank with a fully loaded core equity tier one (FL CET1) ratio of 11.8% at the end of 2015. Compared to other Spanish and peripheral banks this is among the highest and has been quite stable over the past three years, showing that its capitalization level is adequate and the bank is comfortable at this level.

Moreover, compared to its closest peers that benefit from some special items to boost capital ratios, such as deferred tax assets and the Danish Compromise, which on some cases increase capital ratios by more than 5%, for Bankinter this is not an issue given that its capital ratio practically does not benefit from any add-on. This means its capital is of higher quality and is also less exposed to potential regulatory changes.

This good capitalization enables the bank to pay an attractive dividend to its shareholders even. Historically, its dividend has reflected fluctuations in earnings and Bankinter has slashed its dividend several times during the past few years. Reflecting its better earnings momentum and profitability recently, Bankinter's dividend was increased significantly in 2015 to $0.25 per share.

Its dividend payout ratio was 55% in 2015, an acceptable level that can be slightly increased in the future if the bank decides to be more aggressive towards shareholder remuneration but most growth should come from higher earnings. Even though Bankinter is not a high-dividend yield stock, at its current share price it offers a dividend yield above 3%. Contrary to many European companies that pay only one dividend per year, Bankinter's dividend payment frequency is quarterly making it more attractive for U.S. investors.

Conclusion

Bankinter is an under-followed quality bank in Europe that is showing good operating performance and has a solid balance sheet. Currently, its valuation is high, reflecting its quality status trading at 1.4x book value, well above the European banking average of only 0.85x. Bankinter is now starting the internationalization its successful business model and if the integration of Barclays' Portugal operations performs well, it should have upside taking into account the cheap price paid for these operations. This would lead to a re-rating of Portuguese operations towards its valuation for current operations, something that may happen in the next 12-18 months.

Disclosure: I am/we are long BBVA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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