Global Bank Equity Specialist, Creative Portfolios

Paul Hollingworth

Global Bank Equity Specialist

Creative Portfolios

Equity Bottom-Up

<a href="https://www.smartkarma.com/entities/bank-pekao-sa" target="_blank" data-smartkarma-citation="entities:25195:1" rel="noopener">Bank Pekao SA (PEO PW) </a>strikes us as interesting in the unloved and unfashionable sphere of global bank stocks. While we have been cautious on Polish banks for some time now given structural issues related to “National Policy” and legacy assets as well as decreasing Profitability, recently we have identified the relative progression of specific names in our VFM model. VFM expresses an asset according to its value-quality characteristics (PH Score™), its technical picture, and an additional valuation filter.PEO struck us as particularly interesting a couple of weeks ago as a top decile asset globally in the banking universe. Its share price has outperformed global bank stocks since. We see this as a positive confirmatory signal and would buy on any weakness. The share price trend looks healthy.The shares are not dear. A FV of 8%, a PBV of 0.58x, and an Earnings Yield of 13.7% are not unattractive. They trade below common-sense thresholds of 10%, 1x, and 10%, respectively.  Our PH Score™ shows that the bank is making marked headway on the Efficiency front which is a key variable. This helps the bank offset some margin erosion though NIMs are still above the danger zone of other European and APAC lenders such as Taiwan and Japan. Liquidity trends are also highly benign with Deposits climbing by 23% YoY. The top-line shows moderate growth while “non-core Income” represented just 14% of PT Profit – an indication of benign earnings quality. The bottom-line was impacted lower by higher credit costs which may be partially reversed going forward. Comprehensive Income was well higher than Net Profit – a good sign.

Bank Pekao SA (PEO PW) strikes us as interesting in the unloved and unfashionable sphere of global bank stocks. While we have been cautious on Polish banks for some time now given structural issues related to “National Policy” and legacy assets as well as decreasing Profitability, recently we have identified the relative progression of specific names in our VFM model. VFM expresses an asset according to its value-quality characteristics (PH Score™), its technical picture, and an additional valuation filter.PEO struck us as particularly interesting a couple of weeks ago as a top decile asset globally in the banking universe. Its share price has outperformed global bank stocks since. We see this as a positive confirmatory signal and would buy on any weakness. The share price trend looks healthy.The shares are not dear. A FV of 8%, a PBV of 0.58x, and an Earnings Yield of 13.7% are not unattractive. They trade below common-sense thresholds of 10%, 1x, and 10%, respectively.  Our PH Score™ shows that the bank is making marked headway on the Efficiency front which is a key variable. This helps the bank offset some margin erosion though NIMs are still above the danger zone of other European and APAC lenders such as Taiwan and Japan. Liquidity trends are also highly benign with Deposits climbing by 23% YoY. The top-line shows moderate growth while “non-core Income” represented just 14% of PT Profit – an indication of benign earnings quality. The bottom-line was impacted lower by higher credit costs which may be partially reversed going forward. Comprehensive Income was well higher than Net Profit – a good sign.

Thematic (Sector/Industry)

The financial sector in Poland has had a tailwind from pretty favourable macroeconomic conditions. GDP growth of &gt;3.5% today is underpinned by buoyant private consumption and continued absorption of EU funds. Poland, similar to Australia, has had an enviable record of continuous growth over a quarter of century. Macroeconomic policies have facilitated a further narrowing of fiscal and external imbalances, while also supporting growth. The policy interest rate has been on hold at a historically-low level for more than three years amid persistently low inflation. The current account balance has shifted from a surplus but remains broadly in line with medium-term fundamentals.But all is perhaps not so rosy. For some purists, the "big government" footprint will lower growth over the medium-term. This is particularly the case in the Banking Sector. State ownership and control of domestic systemically-important banks have risen to 14 percent and 42 percent of assets, respectively. The state holds minority-but-controlling stakes in the two-largest commercial banks (which stress test quite well) and the largest insurance-led group (which, in turn, owns shares in banks), giving it control of three SIBs, thus accounting for 42 percent of total Banking System assets.In Poland, sovereign-bank linkages have intensified considerably in recent years due to the double-whammy of increases in bank holdings of domestic sovereign debt, spurred by bank tax exemption, and the aforementioned state-controlled ownership of financial institutions. Such linkages can mutually reinforce fiscal and financial vulnerabilities.    These factors point to an inward-looking sector, averse to openness.The introduction of the financial institutions asset tax (FIAT) prompted banks to shift their asset allocation toward government bonds (which are tax exempt) and to more profitable-but-riskier unsecured consumer credit at the expense of less profitable, but potentially more-productive, corporate lending. Unsecured consumer credit has grown rapidly (NPL ratio of &gt;10%). The FIAT -which has funded in part child benefit and a decrease in the pension age- has generated distortions related to risk and credit allocation.Risks may have been understated in some areas and overstated elsewhere. The legacy portfolio of foreign currency-denominated (FX) mortgages has declined to &lt;6½ percent of GDP. Loan quality is very high here, and these portfolios do not pose a systemic risk. A distressed FX mortgage should be restructured based on a voluntary bilateral agreement between the creditor and the debtor, and mandatory centralized approaches should be avoided. Of course, politics -via an imposition of a statutory conversion of FX-mortgages into zloty- can upset the apple cart.An IMF "Technical Note on Macroprudential Policy Framework for the Republic of Poland"  published on May 9th states "overall, the banking system, which accounts for almost three-quarters of assets of the total financial sector, is in sound condition". We do not disagree. Maybe "relatively sound" is more appropriate. The Fund adds that "capitalisation, liquidity, and asset quality continue to improve, even though profitability has tended to decline over recent years". We agree with the last part. Bank profitability is decreasing on the back of the cumulative effects on profits of rising regulatory capital requirements, the bank tax which was introduced in 2016, and a potential increase in contributions to the Bank Guarantee Fund and Borrower Support Fund. In addition, some parts of the credit market (unsecured consumer, Zloty mortgages) are quite heated which can exert a negative pull on trends. Regarding the other metrics, it depends on the timeframe. Yes: compared with the past, trends are better. However, what we see over the last 12 months at Q119, at least with regards the banks that have just reported, is a deterioration of key metrics such as Capital Adequacy, Asset Quality, Liquidity, Provisioning, Efficiency, NIM, and of course Profitability. This is very different from the picture this time last year.<div class="content-highlight">In fact, Polish banks - based on latest Q119 data- score poorly according to our PH Score™, a fundamental momentum value-quality gauge. <a href="https://www.smartkarma.com/entities/25195" target="_blank" data-smartkarma-citation="entities:25195:1">PEO PW</a>, <a href="https://www.smartkarma.com/entities/27035" target="_blank" data-smartkarma-citation="entities:27035:1">mBank SA (MBK PW)</a>, <a href="https://www.smartkarma.com/entities/27577" target="_blank" data-smartkarma-citation="entities:27577:1">Santander Bank Polska SA (SPL PW)</a> and ING Bank Slaski all score in the bottom quartile globally. Trends are not benign relative to Europe or globally, while valuations are rich vs regional and global peers.</div>Renewed turbulence in global financial markets could abruptly tighten financial conditions in Poland and lead to exchange rate depreciation, more than most analysts foresee, that feeds into inflation.In addition, EU relations remain thorny. An unravelling in the relationship would, arguably, not be constructive for Poland.<div class="content-highlight">All in all, the initial signals from this quarter underpin our view that Polish banks are not adequately priced for risk while valuation and trends are not benign.</div>

The financial sector in Poland has had a tailwind from pretty favourable macroeconomic conditions. GDP growth of &gt;3.5% today is underpinned by buoyant private consumption and continued absorption of EU funds. Poland, similar to Australia, has had an enviable record of continuous growth over a quarter of century. Macroeconomic policies have facilitated a further narrowing of fiscal and external imbalances, while also supporting growth. The policy interest rate has been on hold at a historically-low level for more than three years amid persistently low inflation. The current account balance has shifted from a surplus but remains broadly in line with medium-term fundamentals.But all is perhaps not so rosy. For some purists, the "big government" footprint will lower growth over the medium-term. This is particularly the case in the Banking Sector. State ownership and control of domestic systemically-important banks have risen to 14 percent and 42 percent of assets, respectively. The state holds minority-but-controlling stakes in the two-largest commercial banks (which stress test quite well) and the largest insurance-led group (which, in turn, owns shares in banks), giving it control of three SIBs, thus accounting for 42 percent of total Banking System assets.In Poland, sovereign-bank linkages have intensified considerably in recent years due to the double-whammy of increases in bank holdings of domestic sovereign debt, spurred by bank tax exemption, and the aforementioned state-controlled ownership of financial institutions. Such linkages can mutually reinforce fiscal and financial vulnerabilities.    These factors point to an inward-looking sector, averse to openness.The introduction of the financial institutions asset tax (FIAT) prompted banks to shift their asset allocation toward government bonds (which are tax exempt) and to more profitable-but-riskier unsecured consumer credit at the expense of less profitable, but potentially more-productive, corporate lending. Unsecured consumer credit has grown rapidly (NPL ratio of &gt;10%). The FIAT -which has funded in part child benefit and a decrease in the pension age- has generated distortions related to risk and credit allocation.Risks may have been understated in some areas and overstated elsewhere. The legacy portfolio of foreign currency-denominated (FX) mortgages has declined to &lt;6½ percent of GDP. Loan quality is very high here, and these portfolios do not pose a systemic risk. A distressed FX mortgage should be restructured based on a voluntary bilateral agreement between the creditor and the debtor, and mandatory centralized approaches should be avoided. Of course, politics -via an imposition of a statutory conversion of FX-mortgages into zloty- can upset the apple cart.An IMF "Technical Note on Macroprudential Policy Framework for the Republic of Poland"  published on May 9th states "overall, the banking system, which accounts for almost three-quarters of assets of the total financial sector, is in sound condition". We do not disagree. Maybe "relatively sound" is more appropriate. The Fund adds that "capitalisation, liquidity, and asset quality continue to improve, even though profitability has tended to decline over recent years". We agree with the last part. Bank profitability is decreasing on the back of the cumulative effects on profits of rising regulatory capital requirements, the bank tax which was introduced in 2016, and a potential increase in contributions to the Bank Guarantee Fund and Borrower Support Fund. In addition, some parts of the credit market (unsecured consumer, Zloty mortgages) are quite heated which can exert a negative pull on trends. Regarding the other metrics, it depends on the timeframe. Yes: compared with the past, trends are better. However, what we see over the last 12 months at Q119, at least with regards the banks that have just reported, is a deterioration of key metrics such as Capital Adequacy, Asset Quality, Liquidity, Provisioning, Efficiency, NIM, and of course Profitability. This is very different from the picture this time last year.In fact, Polish banks - based on latest Q119 data- score poorly according to our PH Score™, a fundamental momentum value-quality gauge. PEO PW, mBank SA (MBK PW), Santander Bank Polska SA (SPL PW) and ING Bank Slaski all score in the bottom quartile globally. Trends are not benign relative to Europe or globally, while valuations are rich vs regional and global peers.Renewed turbulence in global financial markets could abruptly tighten financial conditions in Poland and lead to exchange rate depreciation, more than most analysts foresee, that feeds into inflation.In addition, EU relations remain thorny. An unravelling in the relationship would, arguably, not be constructive for Poland.All in all, the initial signals from this quarter underpin our view that Polish banks are not adequately priced for risk while valuation and trends are not benign.

Polish Banks: Latest Fundamental Trends and Valuations Instil Caution

Poland

Bank Pekao S.A. attracts deposits and offers commercial, retail, and investment banking services. The Bank provides mortgages, consumer and business loans, debit and credit cards, custody, factoring, lease financing, private banking, asset management, and securities brokerage services.

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Bank Pekao SA (PEO PW)

Bank Pekao: Top Decile VFM Asset

$BANK POLSKA : Top Decile VFM asset While we have been cautious on Polish banks for some time now given structural issues related to “National...

Paul Hollingworth

Polish Banks: Latest Fundamental Trends and Valuations Instil Caution

The financial sector in Poland has had a tailwind from pretty favourable macroeconomic conditions. GDP growth of >3.5% today is underpinned by...

Paul Hollingworth

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