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Liberbank: Begin the beguine

 

The rationale for the capital increase

The €500mn from the capital increase will be used to increase the coverage of NPAs to c. 50%, a figure more aligned with its peers. We consider that this step is a defensive move in other to avoid potential difficulties associated to any worries about its weaker asset quality.

The asset quality theme

Liberbank has done a tremendous job in reducing its NPAs to €6.2bn in June 2017. 64% of NPAs belong to the APS portfolio: should we exclude this portfolio, NPAs ratio would be 14.1%. The group has set ambitious reduction targets for both NPLs and NPAs that we consider achievable if the trend of negative net entries to NPLs witnessed in 1H17 continues due to the benign economic conditions.

The profitability theme

Profitability is the Achilles’ heel of Liberbank. The 8% ROE target set for 2020e does not cover our hypothesis of cost of equity (10%). Furthermore, our estimates point to a 6.5% ROE. Although the management is implementing adequate measures to enhance profitability, the group faces two head winds: First, the negative short term interest rates that penalize banks with a strong low cost deposit franchise and a large mortgage portfolio. Second, the regulatory requirements coupled with the digital challenge are a tougher levy in terms of costs for the smaller banking groups.

Is consolidation a solution?

Consolidation is seen in Spain as a means of reducing the spare capacity still installed in the system. Liberbank has two main strengths: (a) its geographical footprint, with market shares that exceed 25% in its regions of origin, and (b) it is a listed bank. We consider that the group will be probably involved in a consolidation process in the near future, once the concerns regarding its asset quality are removed. Assuming cost synergies equal to 40% of the cost base, we estimate its NPV at €800mn.

Valuing the stock

We reduce our December, 2017e target price to €0.84 from €1.06 (pre–announcement of the capital increase). The bank is trading slightly below its nearest competitor (Unicaja) in terms of P/BV and P/TBV once the impact of the capital increase is considered. The stock offers a +9.1% upside potential, which we consider insufficient due to the forthcoming capital increase and the tightening of the Spanish country risk. Hold unchanged.