Argentina Banks Are An Opportunity, But Patience Is Needed

by: Jaime Campo

Argentina's new pro business government has taken decisive action to reinsert the country in the financial world.

Argentina's banking sector accounts for 15% of GDP compared to 40% in other LatAm countries and 160% in developed economies.

The sector needs to grow only 4x to catch up with neighboring developing economies. The new government has already signaled it wants credit to grow.

With a small number of medium and large banks accounting for most of the credit business and limited new competition, incumbents stand to gain the most.

Slowly but surely Argentina's road to "economic normality" seems to be on track. A fifteen-year long sovereign bond default and financial isolation have left plenty of potential opportunities for the enterprising (and shrewd) investor. The banking sector stands to gain the most if the new government achieves its goal of macroeconomic stability, with only 4x credit growth needed to catch up with neighboring Brazil and 7x to catch up with Chile. This makes for an incredible long-term growth opportunity in a country that ranks 24th in the world in GDP terms. The potential is overwhelming, but growth will not come overnight. For those investors gifted with the virtue of patience, we introduce the four Argentinean banks trading in the US markets.

As we expected in a February article, Argentina's new pro business government has taken several decisive measures to bring back the country into world financial markets and regain international investor trust. So far, it has been successful. After settling a 15-year-long judicial battle with hedge funds led by Paul Singer's Elliot Management in a New York court, the country returned to global debt markets with an oversubscribed record $16.5B bond sale. Measures have been taken to tackle the country's decade long struggle with double-digit inflation and its 7% fiscal deficit. Overall, progress has been made, but the road to normality is a long one for Argentina.

Argentina's financial system is comprised of only 78 financial institutions of which 62 are banks and 16 are non-bank entities. Among the banking institutions, 13 are federal or state owned and 49 are private, of which 32 are domestically owned and 17 are foreign owned banks. As in other markets, the system has seen consolidation during the last three decades, reducing the number of institutions from 214 in 1991 to the 78 operating at year-end 2015. The top 10 banks in the system hold 76% of deposit market share and 71% of loans.

Banco Macro (NYSE:BMA), BBVA Banco Francs (NYSE:BFR), Grupo Financiero Galicia (NASDAQ:GGAL) and Grupo Supervielle (SUPV) trade both in the domestic market and in US markets via ADR programs. The first three larger banks have been trading in the US markets for over a decade. Grupo Supervielle, a century old bank, IPO'd last week in both markets.

US Traded Argentinean Banks (in billions of AR$)

Bank Country Ranking (Assets) Assets Share (%) Loans Share (%) Deposits Share (%)
GGAL 2 138.7 12.9 75 13.7 99.7 13.4
BFR 3 109.4 10.2 55 10.0 76.8 10.3
BMA 4 103.7 9.7 62.3 11.4 74.3 10.0
SUPV 11 30.1 2.8 17.9 3.3 23.1 3.1

The big three publicly traded banks account for 35% of the domestic credit market. This is pretty impressive, but let's take a look at where they stand on valuation.

Net Income FY2015 (AR$ B) 4.34 3.79 5.01 0.67
Market Cap (AR$ B) 51.81 47.76 51.44 11.59
P/E 11.93 12.6 10.26 17.29
Book Value 12.31.2015 (AR$ B) 14.48 13.72 15.88 2.37
P/BV 3.57 3.48 3.24 4.89
ROE 29.97% 27.62% 31.55% 28.2%
ROA 3.13% 3.46% 4.83% 2.22%

Source: Company Filings. 20F forms.

Valuation figures regarding Argentinean banks need to be handled with care. Double-digit inflation and interest rates result in apparently impressive ROEs that are not that impressive when adjusted by domestic inflation. The bad news is that there are no trustworthy domestic inflation figures to use in the adjustment calculation, as the former administration manipulated national statistics to the point where they became useless (the new government plans to launch new figures shortly).

We expect ROEs to fall in 2016 as inflation and interest rates fall towards the end of FY2016. Price to book value is also a misleading indicator in this analysis as some assets held by banks are carried on books at historical Argentinean peso denominated values. Overall, valuation analysis for Argentinean banks makes little sense at this point, and investors should be cautious.

We therefore find ourselves in a situation where the medium- and long-term potential for Argentina's banking sector appears to be brilliant from a macroeconomic standpoint, but find it difficult to formally assess their value merit in the short term.

Grupo Financiero Galicia

GFG is holding entity that owns, through its subsidiaries, operations in the retail and corporate banking, consumer financing, non-bank personal loan, insurance, mutual fund and asset management markets. All in accordance with Argentine central bank regulations that allow for financial institutions to provide a wide array of financial services.

Galicia's focus over the last decade has been on consumer lending and it has paid off, as the surge in consumption in Argentina, especially in low and middle income classes, has significantly impacted the bank's top and bottom line. Galicia, through its subsidiary Tarjetas Regionales, is the largest issuer of property brand consumer cards in the country. Consumer financing in Argentina is a competitive market that has seen signs of saturation over the last years. Competition is fierce, not only from other financial institutions but from retailers that have started offering financial products. We are not that enthusiastic about this segment providing organic long-term growth for Galicia.

Galicia also has a significant competitive advantage in agricultural sector financing, where it has become the leading private bank. Through its Galicia Rural credit card, Galicia controls 37% of the agricultural sector financing market share. This is pretty impressive, and the bank should be able to leverage this platform to capture a significant amount of the explosive growth in farm related credit we expect for the next few years in Argentina. We are very confident that this farm exposure will contribute nicely to both top and bottom lines for Galicia, since Argentina is fundamentally a farm export oriented economy and the new government has set up incentives to increase production and investment in the sector.

BBVA Banco Francs SA

BBVA Banco Francs is the Argentine subsidiary of Spanish banking giant Banco Bilbao Vizcaya Argentaria SA (NYSE:BBVA), with operations across the Americas and Europe. In Argentina, BBVA operates in the retail and corporate banking, asset management, mutual funds, insurance and consumer financing segments.

Like Galicia, BBVA has focused on consumer retail banking and consumer financing for much of the last decade. Specifically, BBVA has developed a strong presence in the auto financing segment. Through its subsidiaries, PSA Finance Argentina (where it owns a 50% stake and partners with the Peugeot Citroen Group (OTCPK:PEUGF)) and Rombo Compañia Financiera (where it partners with Renault SA (OTC:RNSDF)), BBVA is the leading player in auto financing. As in other developing economies, auto sales have grown sharply during the last decade and BBVA has been an active participant in financing these purchases. Combined, Peugeot Citroen and Renault account for almost 27% of the auto market in Argentina. Almost all of the financing business for these brands goes through BBVA. This a significant competitive advantage for the bank, as no other bank in the system has such a strong platform in auto sales. We believe auto financing has a lot of room to grow in the country but will probably be outgrown by other, more relegated, segments.

Being part of the BBVA group and having strong ties with Spanish multinational companies with significant investments in Argentina, BBVA also has corporate banking and export services divisions oriented to large corporations. We would expect management to further the bank's reach into small and medium enterprises, as we believe much of the corporate credit growth over the medium and long term will be derived from this sector.

Banco Macro SA

Macro ranks fourth in the system by assets but has the most branches, 439. The result of a smart strategy of consolidation of small banking operations in smaller provinces of Argentina, Macro has unparalleled geographical reach and this is its most interesting competitive advantage. More specifically, Macro has a dominant market share in the main export oriented Argentine provinces, which are set to boom if the new government succeeds in its export incentive plans.

As all of the other large Argentinean banks, Macro has operations in retail and corporate banking, credit cards, insurance, mutual funds and asset management. A relevant player in the retail banking segment, what we really like about Macro is its focus on small and medium enterprises, especially outside of the main city of Buenos Aires. We are really bullish on this sector's growth potential and Macro should be able to leverage its formidable platform to enhance top and bottom lines in the medium and long term.

Ceteris paribus, Banco Macro's business model is the one we like the most amongst US publicly traded banks in the new economic scenario.

Grupo Supervielle SA

Supervielle is the most recent addition to the group of US traded Argentina banks. A relatively much smaller bank than the other three, Supervielle is a centenarian institution in the country's financial system. Domestically owned, it has been run by the same family for most of its history.

Supervielle's operations span across the retail and corporate banking, consumer financing, asset management and insurance sectors. Its main focus is in retail banking for individuals and consumer financing. This strategy has paid off over the last years but management will need new growth platforms to boost loan volumes in the medium term.

What we like about Supervielle is that it is a market leader in the Cuyo region of Argentina. Cuyo, comprising the provinces of Mendoza, San Juan and San Luis, is the main wine producing region of the country and a significant export originator. We like the prospects of the region as a whole if the new government's policies succeed, and believe Supervielle can leverage this exposure significantly.

What's Next for Banks

2016 will undoubtedly by a transition year for the Argentine economy as a whole and for the financial system in particular, as government measures to curb inflation and reduce fiscal deficit are causing a slowdown in economic activity that may stretch into 2017. If the government is successful in reducing inflation, the net interest spreads banks have enjoyed for the last few years will be forced down in nominal terms and margins will be under pressure. Double-digit net spreads in a zero interest rate world are not sustainable if the country returns to "economic normality". Banks' bottom lines may suffer this transition in 2016.

As the new government stimulus measures start to kick-in in late 2016 and economic activity picks up, we believe volume growth will begin to compensate the loss of nominal margins. We expect FY2017 to be the start of a new period of growth for the Argentine financial sector with focus in underdeveloped segments such as long-term project financing, investment banking and mortgage lending, among others.

If you managed to read through here, you may have noticed that we are extremely bullish on the long-term prospects of the Argentine banking sector. Our advice to those interested in this long-term potential: add these banks to your watchlist, wait for new economic policies to kick-in in the next 6 to 12 months and quarterly reassess valuation metrics as they become increasingly trustworthy. We will monitor and update on each of these banks' situation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.