Banca Sistema — Q2 shows further strength in factoring turnover

Banca Sistema’s main activity is providing financing (factoring) of trade receivables for companies supplying a range of Italian public sector entities including central and local bodies and state-owned companies (collectively labelled Public Administrations or PAs). These counterparties represent a low credit risk, comparable to the sovereign credit risk on an Italian government bond. The bank also undertakes factoring of receivables relating to VAT and other tax receivables and from private sector companies in Italy.

The bank seeks opportunities for attractive diversification and this led to the expansion of salary and pension backed loans and, recently, a pilot investment in institutional pawnbroking, currently comprising two branches. The group has also made loans to small and medium enterprises that benefit from a state guarantee. The announcement of a reduction in the level of guarantee prompted Banca Sistema to withdraw from this business and the book is in the process of being run down.

Exhibits 1 and 2 show the predominance of factoring within customer loans and net interest income.

Exhibits 3 and 4 show the medium-term progression of customer loans, net banking income and profit after tax. Customer loan growth paused in FY16 reflecting the temporary impact of the cancellation of a factoring receivables purchase in the final quarter. The resumption of factoring turnover growth of over 20% in both the first and second quarters of the current year is reflected in the resumption of loan growth in H117. We discuss the H1/Q217 results in the next section.

For further discussion of the factoring industry and description of Banca Sistema’s business see our initiation note published in May 2018.

Banca Sistema’s first half results showed net income down by nearly €6m to €10m but this primarily reflected the absence of a late payment interest accrual of €5m relating to prior periods and a €2.3m profit on the sale of a stake in CS Union which bolstered the H116 result.

From a fundamental, forward-looking perspective the increase in factoring turnover and receivables outstanding is more important and is an encouraging indicator (Exhibit 5). Growth in the level of salary and pension-backed loans outstanding has also continued and at present the bank is not actively considering a sale of a securitisation of these assets, instead initiating a tap issue of Tier II subordinated loans. This means there has been no profit on disposal but the higher level of assets outstanding is set to increase prospective interest income.

Reflecting in part a second half bias in the level of expected late payment interest accrual and collection the group has confirmed its target remains a return on average equity of over 20%.

We have set out a comparison of the H1 and Q2 income statements with the prior year periods in Exhibit 6 and highlight key features below with % changes against the same period in 2016 unless otherwise indicated.

Looking more closely at the increase in factoring turnover, Banca Sistema highlights a rising number of new clients (26% of H1 turnover) and a larger contribution from its 14 partner banks (30% of turnover) during the period. The company hopes to expand this network of partners by adding a further two banks during the current quarter. With-recourse factoring (where Banca Sistema has recourse to the seller of receivables) has become a more significant part of factoring outstanding at 19% (versus 9% FY16) while public authority clients remain the dominant part of the book at 79%.

As a reminder, the group adopted a change in accounting for late payment interest in June 2016. Previously, Banca Sistema only recognised this on a cash basis but it now recognises a portion of late payment interest accrued (in common with competitors). The policy reflects the adoption of a statistical model based on collection experience and is only applied where legal proceedings have begun. For receivables from the national healthcare system, 65% of qualifying late payment interest is accrued and for other public sector receivables, 15%. Banca Sistema typically does not pursue a legal route to collect amounts owing and related interest although it will do in some cases (c 10%, accumulating to 27% of outstanding in H117); it therefore differs from some competitors whose model is to focus on legal collection. In the next exhibit we show an analysis of interest income including the contribution of late payment interest based partly on the group’s commentary and partly our own estimates of the different components.

There are limited changes in our overall estimates (see Exhibit 8) with the main adjustments within the numbers flowing from the assumption that Banca Sistema does not now carry out sales of securitisations of salary and pension based loans during FY17 and FY18. We have modestly tempered our previous assumed level of asset acquisition in this area but retention of the loans should at least compensate for the absence of profits on disposal. For the moment we have maintained the assumption of a securitisation sale in FY19 although Banca Sistema reports that regulatory discussions are continuing which may lead to a reduction in the level of risk weighting applied to these assets from 75%, potentially to 30%. At this level pressure on capital ratios would ease and the bank is unlikely to find a sale of these assets attractive.

In the next two exhibits we have updated charts showing our assumptions for customer loans outstanding and the yield on customer loans. The first shows continued growth in the main factoring activity while salary and pension backed loan growth is held back in FY19e by the assumed securitisation disposal. The overall yield on average customer loans is broadly stable on our estimates.

Turning to capital ratios, the end H117 CET1 ratio stood at 12.6% compared with 13.3% at the year end, while the total capital ratio was 16.3% versus 15.8%. In response to institutional investor interest a tap issue of a €1.5m Tier II bond is to be offered (10 years, Euribor +450bps) and further issues up to €13.5m may follow. On our estimates this should allow the total capital ratio to remain above 16% while the CET1 ratio is likely to remain at a similar level to the half year at the end of FY17, potentially increasing thereafter subject to the rate of asset growth.

As a starting point we have updated our comparative table showing valuation metrics for Banca Sistema and selected peers involved in factoring, debt purchase, debt management and collection. Given Banca Sistema’s focus on public sector receivables, the closest peer in the group is Banca Farmafactoring. Banca Sistema trades on the lowest prospective P/E and trades on a below-average price to book and above average yield.

Our next chart compares returns on equity (ROE) and price to book (P/B) ratios for the same peer group. Here, Banca Sistema appears broadly in line with its peers but we have used the H117 return on equity of 17% and if we were to apply our FY17 forecast of 22.7% (or the company’s own indication of over 20%) then the shares would appear distinctly cautiously rated.

Reflecting the limited change in our estimates our ROE/COE valuation gives an unchanged central valuation of €3.15 (assumptions include 22% ROE, long-term growth of 4% and cost of equity of 12.4%). Alternatively, the model indicates that the current share price implies a cost of equity of over 16% again implying cautious assumptions being made by the market and suggesting scope for a rerating as the bank delivers its target returns.