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Patrick Brennan Portfolio Manager, Brennan Asset Management
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JEF & TSB
Patrick Brennan, CFABest Ideas 2019
Hosted by MOI GlobalJanuary 2019
Opportunities in “Risk Off” Financial Names
BAM Disclosures
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In BAM’s investment decision making process involves a number of different factors, not just those discussed in this document. The views expressed in this material are subject to ongoing evaluation and could change at any time. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. It shall not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities mentioned here. While BAM seeks to design a portfolio which reflects appropriaterisk and return features, portfolio characteristics may deviate from those of the benchmark. Although BAM follows the same investment strategy for each advisory client with similar investment objectives and financial condition, differences in client holdings are dictated by variations in clients’ investment guidelines and risk tolerances. BAMmay continue to hold a certain security in one client account while selling it for another client account when client guidelines or risk tolerances mandate a sale for a particular client. In some cases, consistent with client objectives and risk, BAM may purchase a security for one client while selling it for another. Consistent with specific client objectives and risk tolerance,clients’ trades may be executed at different times and at different prices. Each of these factors influences the overall performance of the investment strategies followed by the Firm. Nothing herein should be construed as a solicitation or offer, or recommendation to buy or sell any security, or as an offer to provide advisory services in any jurisdiction in which such solicitation or offer would be unlawful under the securities laws ofsuch jurisdiction. The material provided herein is for informational purposes only. Before engaging BAM, prospective clients are strongly urged to perform additional due diligence, to ask additional questions of BAM as they deem appropriate, and to discuss any prospective investment with their legal and tax advisers.Contact information
Patrick Brennan, CFABrennan Asset Management, LLCpatrick@brennanvalue.com
BAMStrategy
• All-cap strategy: 12-20 total names• Top 10 names: 70-80% of portfolio• 3-5+ year holding period
• Eat our own cooking
• Media/telecom, specialty financials and consumer discretionary focus
• Own under-followed or under-owned because of complexity issues
• Investments include documented areas of inefficiency including:
• Spinoffs/Thrift Conversions • Liberty Media Complex• Owner/Operator Businesses
• Generally looking for 15-20%+ IRRs on base case scenarios over 3-5 year time period
BAM is a registered investment advisor based in Napa, CA. BAM manages money through: • Separate accounts • Subadvisor to Oceancross
Capital Partners Fund
Brennan Asset Management, LLC (BAM)
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Cheap gets cheaper Value underperformed for most of past decade Beaten up stocks get crushed in Q4 2019
What screens well for beaten-up “risk off” names? Financials/Leveraged Names Exposure to slowing growth/lower interest rates Exposure to Europe Complicated stories
Jefferies (JEF) and Permanent TSB (TSB) check nearly every box for what investors DO NOT want to own… Statistically cheap stocks sold off in Q4 2018
…But beaten up valuations, capital return and partial/total sale can unlock substantial value Downside cases likely above current price Aggressive share repurchases (JEF)/capital return(TSB) Partial (JEF/TSB) or Total (TSB) sales possible
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Overview
“Simplified” JEF: Still a Mouthful…but Easier
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Estimated % of Total Value
Jefferies Non-bank holding company investment bank$4.5 billion tangible equity 51
HomeFed Historical LUK investment; public real-estate development company 70% owned by JEF 6
National BeefHistorical LUK investment…4th largest beef processor $600mm+ EBITDA LTM 09/30/1848% sold - ~$900mm gain
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Linkem Wireless Broadband Italy…540,000+ subs – spectrum >$1.5B 6
Oil and Gas (Vitesse and JETX)
Non-Operating owner in Bakken acreage$500MM+ 2014….$190mm 2018 6
Spectrum Brands Bought HRG stake (Phil Falcone) bought additional shares, simplified, sold Fidelity…SPB hit wall 2018 4
Idaho Timber Manufacturer/distributor wood products~$40mm EBITDA 1
Other FXCM, Golden Queen, M Science, Foursight and other 9
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*Source: Jefferies
Book Value per Share Growth
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*Source: Jefferies
Total Shareholder Return
Despite strong historical returns, historicalLUK shareholders want nothing to do withNYC investment bank.
Historical Jefferies Group Performance: Then Versus Now
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Historical (and current) returns not achieved with crazy leverage
Business is much larger…but not more profitable
12/31/200611/30/2017Net Revenue $1,458 $3,198Equity $1,581 $5,759Tangible Equity $1,454 $3,916
Total Assets $17,900 $39,706Assets/Equity 11.3x 6.9xAssets/Tangible Equity 12.3x 10.1xPre-Tax Income $349 $505Net Income $211 $358Net Income (post Minority Interest) $204 $357Tax Rate 39% 29%Adjusted Pre-Tax Profit $337 $505
ROE 14% 6%ROTE 15% 10%Comp Ratio 54% 57%
12/31/2006 1/4/2019Price Book 2.6x 0.6xPrice/Tangible Book 2.8x 0.7x
Is this pessimism warranted?
US rises again…Europe falls
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Jefferies has clearly taken share since the financial crisis…and could continue to do so as European banks further retreat
Historical Jefferies Group Performance
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12 months ended 11/30 9 Months 11/30/13 12 months ended 11/30 12 months ended 12/31
2017 2016 2015 2014 2013 2012 2011 2010 2009 2008 2007
Revenue $3,198 $2,415 $2,475 $2,990 $2,137 $3,019 $2,549 $2,192 $2,163 $1,014 $1,568
Comp and Benefits($1,829
) ($1,569) ($1,467) ($1,699) ($1,214) $1,771 ($1,483) ($1,283) ($1,196) ($1,522) ($946)
Pre-Tax Income $505 $30 $114 $303 $264 $492 $419 $397 $508 ($888) $241
Net Income $358 $15 $95 $161 $170 $323 $286 $240 $312 ($595) $148
Shareholders Equity $5,759 $5,371 $5,509 $5,463 $5,422 $3,783 $3,537 $2,811 $2,309 $2,121 $1,762
Goodwill $1,843 $1,847 $1,882 $1,904 $1,986 $381 $386 $368 $365 $359 $344
Tangible Equity $3,916 $3,523 $3,627 $3,559 $3,435 $3,402 $3,151 $2,443 $1,944 $1,762 $1,417
Comp Ratio 57% 65% 59% 57% 57% -59% 58% 59% 55% 150% 60%
Pre-Tax Avg ROE 9% 1% 2% 6% 13% 13% 15% 23% -46% 14%
Post-Tax Avg ROE 6% 0% 2% 3% 9% 9% 9% 14% -31% 8%
Pre-Tax Avg ROE (Tan) 14% 1% 3% 9% 15% 15% 18% 27% -56% 17%
Post-Tax Avg ROE (Tan) 10% 0% 3% 5% 10% 10% 11% 17% -37% 10%
Inconsistent results since merger closing…last seven quarters, ROTE=10% average
“Float” for merchant bank not as valuable as combined ratios<100%, but still more consistent stream than that available to Joe/Ian
2014/2015 results negatively impacted by losses at Prudential Bache (exited in 2015)
Black Box Investment Bank?
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Jefferies continues to maintain reasonable leverage ratios…
Black Box Investment Bank?
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2% Level 3 Assets - Never been a big player in “mark to model” products (CDO, non-exchange traded derivatives, etc).
Markdowns from hung leveraged loan/block trade possible but…leverage discipline/lack of exotic products provide comfort.
Significant ownership by insiders Richard Handler: 3% outstanding shares Brian Friedman: 1% Joe Steinberg: 6%
Outside of taxes/charities, Handler has never sold shares despite huge JEF gains over past 2 decades
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Other Risk Management: Inside ownership
Jefferies Investments
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Bankers paid in cash…not JEF stock Takes time for new team to show production –
costs upfront, revenues over time
Investment Banking Fee Market Share LTM 08/31/18
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JEF: Global non-bank investment banks… Scarcity value: Asia enters Tier 1 US banking?
Sold 48% National Beef (~$870mm gain)
Sold Garcadia ($220mm gain)
Combine Berkadia/Leucadia Investment Management with Jefferies
$190mm acquisition by Vitesse
Increases buyback program
November 30 fiscal year for Jefferies AND Merchant Bank – few blackout days
Name change from Leucadia to Jefferies
Stock jumps 12% single day…now 24% lower
If waging activist campaign…what else would you ask them to do?!
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April 2018 announcements
Berkadia
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50/50 Joint Venture with Berkshire Hathaway Originates/sells/services commercial loans (multi-family) for Fannie Mae/Freddie
Mac Steady, high return earner…reported with Jefferies Nov 2010 Little valuation credit as part of merchant bank…will smooth investment bank
results
Berkadia Growth Opportunity
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Leucadia Asset Management: Added to Jefferies
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~$17 billion AUM.
Organic build vs. acquisition.
Not significant to NAV but lots of optionality.
The Goldman Issue
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Source: Sentieo Data
Goldman Sachs declined ~25% over the past 3 months and currently at 0.9x tangible book.
If I can buy Goldman<Book value, why mess around with JEF?
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GS Historical ROE vs. Price/Tan Book
ROE Price/Tangible Book
…But many smaller banks>Price/Tangible Book versus GS
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Market Cap LTM Revenue Price/TBV
Goldman Sachs $65,248 $50.899 0.9x
Morgan Stanley $71,042 $49,614 1.1x
Raymond James $10,666 $7,476 1.9x
Stifel $3,029 $3,168 1.6x
Evercore $3,493 $1,852 5.2x
Moelis $2,905 $817 4.5x
PJT $1,478 $595 NM
Greenhill $529 $330 NM
Smaller banks historically carried larger multiples.
EF M&A margins (~$825mm LTM revenue) not meaningful different than advisor boutiques.
Source: Sentieo Data
“Simplified” JEF: Still a mouthful…but easier
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Estimated % of Total Value
Jefferies Non-bank holding company investment bank$4.5 billion tangible equity 51
HomeFed Historical LUK investment; public real-estate development company 70% owned by JEF 6
National BeefHistorical LUK investment…4th largest beef processor $600mm+ EBITDA LTM 09/30/1848% sold - ~$900mm gain
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Linkem Wireless Broadband Italy…540,000+ subs – spectrum >$1.5B 6
Oil and Gas (Vitesse and JETX)
Non-Operating owner in Bakken acreage$500MM+ 2014….$190mm 2018 6
Spectrum Brands Bought HRG stake (Phil Falcone) bought additional shares, simplified, sold Fidelity…SPB hit wall 2018 4
Idaho Timber Manufacturer/distributor wood products~$40mm EBITDA 1
Other FXCM, Golden Queen, M Science, Foursight and other 9
National Beef: Supply Build
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• National Beef 2015 EBITDA: ~($35)mm• LTM EBITDA 06/30/18: $640mm• Supply constrained: “Not in my backyard”• High visibility on future supply
Linkem: Spectrum Upside to Italian Wireless Broadband
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Italy: Hilly country/expensive roll-out broadband Wireless broadband using mid-band spectrum… 58% sub-growth since original 2011 investment…100% LTE enabled/Population
reach 66% country October 2018 3.6 GHz auction implies value >$1.5 billion for Linkem frequency (ex-
high frequency assets)
Merchant Bank Value
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Book Value Fair Value Method
Spectrum Brands $610 $610 Mark-to-marketHomeFed $346 $599 Mark-to-marketOther $238 $238 Mark-to-marketPublic Investments $1,194 $1,447
National Beef $604 $604 Transaction ValueLinkem $178 $485 Market TransactionOil and Gas (Vitesse and JETX) $594 $750 VariousIdaho Timber $77 $145 VariousOther $882 $934 VariousTotal Private Companies $2,335 $2,918
Total Merchant Bank $3,529 $4,365
Merchant Bank Value
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Bear Base Bull Bear Base BullSpectrum Brands $281 $440 $703 80% 125% 200%HomeFed $281 $599 $599 80% 0% 0%Other $281 $238 $238 80% 0% 0%Public Investments $844 $1,277 $1,540
National Beef $483 $604 $725 80% 100% 120%Linkem $388 $631 $606 80% 130% 125%Oil and Gas (Vitesse and JETX) $450 $638 $900 60% 85% 120%Idaho Timber $116 $145 $174 80% 100% 120%Other $747 $934 $1,121 80% 100% 120%Total Private Companies $2,184 $2,951 $3,526
Total Merchant Bank $3,028 $4,228 $5,066
Jefferies $3,375 $5,175 $6,750 75% 115% 150%
Liquidity & Corporate $800 $800 $800 100% 100% 100%
Total Value $7,203 $10,203 $12,616
Shares Outstanding $350 $350 $350
Value Per Share $20.56 $29.12 $36.01
Debate on Jefferies multiple…but difficult to show downside from current levels
Stock has been statistically cheap last several years – what changes? More consistent results from Jefferies Additional “wins” on capital allocation decisions (National Beef, Linkem, Vitesse,
FXCM, Spectrum Brands, HomeFed, etc) - when does market decide Handler is actually good capital allocator?
And… Large share repurchases
JEF complicated/susceptible to “risk off” selling In 2015, weakness at National Beef AND Jefferies prevented larger share
repurchases First nine months 2019: 26 million shares (7%) purchased at $24.16 Fiscal year Jefferies/Merchant Bank=November 30 – reduces share blackout periods Handler: October 2018 analyst day: stock cheap/repurchases continue (20% lower
today) Sale of minority stake Jefferies
Scarcity value Premium to book
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JEF: Aggressive buybacks
Key person risk (Handler/Friedman)
Further inconsistency at Jefferies
Bad deal
Dead money
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JEF Risks
Europe: Struggling…Financials among weakest sectors in underperforming continent
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Lots of negative headlines/sentiment in Europe Greece, Italy, Brexit Weaker economic growth
Euro Stoxx Banks Index (SX7GT) 1 Year performance: -30% 9.5x earnings ~60% Book Value Value trap for Years
Irish Housing Crisis: Traumatic Experience Spectacular housing price rise (192% 1997-2005…30% more 2005-2006)…then
fall (50%+)
Government guarantees all liabilities (including subordinated debt) in September 2008
Government nationalizes multiple banks, including TSB (2015 IPO)
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Ireland Housing Crisis
…But Now Ireland a Standout Economy
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Source: AIB Economic Forecast January 2019
Stock economic growth, low inflation, low/declining unemployment levels and declining debt
Irish Residential Prices: Boom to Bust to Boom
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Irish Residential Property Prices: 2005-2018
Source: Irish Central Statistics Office
• Prices begin rebounding in 2013• Prices now 108% 2005 levels
Housing Supply/Demand Imbalance: Could Take Years to Fix
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Housing output needs to double from current levels to meet pent-up demand and rising migration… 2020+
Strong economy, migration lead to housing shortage
Bank Concentration/Foreclosure Difficulty=Relatively Expensive Mortgages
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Irish mortgages ~140bp above euro area Reasons? Concentrated banking system, high number of lower yielding
tracking mortgages, messy foreclosure process
Yield pickup as lower yielding
tracking loans are replaced with higher yielding
mortgages
TSB Overview ~€724mm market capitalization (75% government owned) 37% of tangible book value…Declined ~60% since 2015 €4.50 IPO €15.2 performing loan book…14-15% market share residential mortgages
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Permanent TSB Summary
Lots of ways to win…bombed out valuation provides downside support
TSB: 37% of tangible book value…Declined ~60% since 2015 €4.50 IPO
Sale – attractive asset in strong economy…establish number 3/fastest government payback
Capital Return (16% vs. 12% target…50%+ capital return possible)
Interest rates rise
Combination of above leads to multiple expansion
“Heads I win, Tails…dead money”
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Permanent TSB Summary
TSB History
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NPL Ratios Look Awful…but Rapidly Declining
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Huge NPL balance reflection of historic problems, slow foreclosure process and rigid accounting rules on modifications…
Two recent securitizations will take NPL <10%
Cognitive Dissonance?
EU Bank Regulators: Lower NPLs
Irish Government: No vultures (you greedy bastards)
Capital Ratios Rising…Large Dividends Possible
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Pro-forma CET 1 Tier 1: 13%+ vs. 12% target
Expect build over 2019 and potential for large capital return
Ireland Has Most Conservative Risk Weightings in Europe
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Mortgage Risk Weightings SME Risk Weightings
Source: EBA
Continued Reduction in Loan Losses
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6/30/18 9/30/18 12/31/18 3/31/19 6/30/19 9/30/19 12/31/19
Stage 3 NPL € 5,050 € 4,860 € 3,420 € 1,180 € 1,090 € 1,000Glas -€ 2,100Treated Securitization -€ 1,300NPL Next 12 -€ 100 -€ 50 -€ 50MTR -€ 17 -€ 17 -€ 17 -€ 17 -€ 17 -€ 17Others -€ 73 -€ 73 -€ 73 -€ 73 -€ 73 -€ 73AdditionsStage 3 NPL € 5,050 € 4,860 € 3,420 € 1,180 € 1,090 € 1,000 € 910
NPL/Total Loans 25% 24% 18% 7% 7% 6.1% 6%
Stage 1 € 46 € 46 € 46 € 46 € 46 € 47 € 47Stage 2 € 379 € 379 € 379 € 381 € 383 € 385 € 387Stage 3 € 1,824 € 1,752 € 1,299 € 446 € 412 € 378 € 344Stage 3 Change -€ 72 -€ 453 -€ 853 -€ 34 -€ 34 -€ 34Total Allowance € 2,249 € 2,177 € 1,724 € 873 € 841 € 810 € 778
Risk Weighting -Performing 54% 54% 54% 54% 54% 54% 54%NPL Risk Weighting 100% 100% 100% 100% 100% 100% 100%
Rising housing prices could allow markups on existing provisions -we assume none
Assuming NPLs continue to decline, then TSB should have a significant release of Stage 2 (non-specific) reserves.
Loan Growth Assumption
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9/30/2018 12/31/2018 3/31/2019 6/30/2019 9/30/2019 12/31/2019
Loan Growth -0.10% -0.10% 0.50% 0.50% 0.50% 0.50%Growth in Other 0.50% 0.50% 0.50% 0.50% 0.50% 0.50%Performing NII (stock) 2.34% 2.35% 2.37% 2.40% 2.43% 2.46%Performing NII (flow) 3.21% 3.21% 3.10% 3.10% 3.10% 3.10%Non-Performing NII 1.50% 1.50% 1.50% 1.50% 1.50% 1.50%
NII € 99 € 97 € 91 € 89 € 91 € 92Core Fee Income € 10 € 10 € 10 € 10 € 10 € 10Total Income € 109 € 106 € 101 € 99 € 100 € 102
Operating Income € 109 € 106 € 101 € 99 € 100 € 102Operating Expenses € 82 € 79 € 75 € 73 € 74 € 74Pre-Tax Income € 27 € 27 € 26 € 26 € 27 € 28Tax -€ 1 -€ 1 -€ 1 -€ 1 -€ 1 -€ 1Net Income € 27 € 26 € 26 € 1 € 26 € 27Equity € 2,060 € 2,086 € 2,112 € 2,112 € 2,139 € 2,166Adjusted Equity (Cap Return) € 2,032 € 1,910 € 1,746 € 1,809 € 1,805 € 1,800
Efficiency Ratio 75% 75% 74% 74% 73% 73%
Equity/Assets 9.0% 9.5% 10.3% 10.2% 10.3% 10.4%Stated ROE 5.2% 5.1% 4.9% 0.1% 5.0% 5.1%ROE (Cap Return) 5.3% 5.4% 5.6% 0.1% 5.8% 6.0%
Loan growth/operating expense cuts partially offset by lost NPL NII.
Net loan balance grows in 2019 as new loans (flow) offsets maturities on existing book.
Significant Opportunity for Capital Return
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6/30/18 9/30/18 12/31/18 3/31/19 6/30/19 9/30/19 12/31/19RWA Performing € 8,200 € 8,192 € 8,184 € 8,225 € 8,829 € 8,870 € 8,911RWA NPL € 2,801 € 2,683 € 1,696 € 307 € 249 € 190 € 132Assumed Total RWA € 11,001 € 10,875 € 9,880 € 8,532 € 9,077 € 9,060 € 9,044Actual RWA € 11,211TRIM Adjustment € 1,700 € 1,698 € 1,697 € 1,705 € 1,714 € 1,722 € 1,731Pro-Forma TRIM RWA € 12,911 € 12,573 € 11,576 € 10,237 € 10,791 € 10,783 € 10,775
Total Equity € 2,033 € 2,060 € 2,086 € 2,112 € 2,112 € 2,139 € 2,166Less AT1 Capital -€ 122 -€ 122 -€ 122 -€ 122 -€ 122 -€ 122 -€ 122Captive Insurance Equity -€ 9 -€ 9 -€ 9 -€ 9 -€ 9 -€ 9 -€ 9Adjusted Capital € 1,902 € 1,929 € 1,955 € 1,981 € 1,981 € 2,008 € 2,035Intangibles -€ 36 -€ 36 -€ 36 -€ 36 -€ 36 -€ 36 -€ 36Deferred Tax -€ 354 -€ 351 -€ 347 -€ 344 -€ 341 -€ 338 -€ 334Others -€ 6 -€ 6 -€ 6 -€ 6 -€ 6 -€ 6 -€ 6Common Tier 1 (Fully Loaded) € 1,506 € 1,536 € 1,566 € 1,594 € 1,598 € 1,628 € 1,659CET Tier 1/Equity (Fully Loaded) 74% 75% 75% 76% 76% 76% 77%
CET Tier 1/RWA 13.4% 14.1% 15.8% 18.7% 17.6% 18.0% 18.3%CET Tier 1/RWA (Trim Adjusted) 11.7% 12.2% 13.5% 15.6% 14.8% 15.1% 15.4%CET Tier 1 Target 12.0% 12.0% 12.0% 12.0% 12.0% 12.0% 12.0%
Capital Return>12% Tier 1 Target € 0 € 27 € 177 € 366 € 303 € 334 € 366
Shares 454.69 454.69 454.69 454.69 454.69 454.69 454.69Capital Return Per Share € 0.06 € 0.06 € 0.39 € 0.81 € 0.67 € 0.73 € 0.80Book Value Per Share € 4.47 € 4.53 € 4.59 € 4.64 € 4.65 € 4.70 € 4.76
It is true that TSB will struggle to earn its cost of capital but large capital returns and small valuation improvements can drive meaningful returns.
Sale In 2018, Chairwomen of ECB Bank Supervision Arm suggested merger of TSB
and Ulster Bank CSFB estimated that a combined TSB/Ulster would generate €150 million in
synergies Starting in 2019, Irish government no longer restricted in only selling 25
percent of bank stake Attractive asset in strong economy…establish number 3/fastest government
payback Easily reduce 20% of operating expenses – potentially much more (CSFB: 50%) Likely the highest returning scenario for investors
44
Other Ways to Win
Interest rate increase 50bp increase=40mm increase in NII (8.5% ROE on Q4 2019 annualized at 12%
CET 1) Odds of rate increase lower than 1-2 months ago but huge rerate if rates
surprise
45
Other Ways to Win
75% government stake – unexpected policy decision (dividends/sale/regulation)
No Deal Brexit hurts Irish economic momentum
New competition Irish mortgage market
Interest rates never rise (Waiting for Godot)
46
TSB Risks
CONTACT INFORMATION
Patrick Brennan, CFABrennan Asset Management, LLC
patrick@brennanvalue.com
W W W. B R E N N A N V A L U E . C O M
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APPENDIX
US Rises Again…Europe Falls
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SPB Overview
50
Vitesse Overview
51
Non-operating owner of Bakken acreage
2% average interest in 4,300+ wells – 12 different operators
$439 million invested
HomeFed Property Locations
52
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