Monday 26 August 2013 by Legacy

Dutch banks 1H13 results – solid earnings but deteriorating asset quality

While Rabobank and ING Group remain strong and posting solid profits, asset quality in the Netherlands is under stress from weak economic conditions and rising unemployment.  However asset quality measures are still stronger than European peers

Rabobank – poor operating conditions starting to have an impact

Provisions for bad loans and settlements resulted in a 14% drop in profit in the first half to €1.1bn. While Rabo is weathering the housing bust in the Netherlands well, it is starting to take its toll.   At group level, value adjustments amounted to €1.1bn which equates to bad debt costs of 49bps on an annualised basis – which is the same level as last year but well above the 10 year moving average of 28bps. Rabobank's ROE of 5.8% is roughly in line with the average for major European banks in 1H13.

Asset quality in the Netherlands is under stress from weak economic conditions and rising unemployment, although impaired loans (2.8% of total loans) and the impairment charge are still lower than for banks in many other Eurozone countries. There has been much talk about problems in the Dutch housing market, although with impairments at 6bps of average mortgage loans in 1H13, they remain very low. The commercial real estate sector is a different story, and in line with other Dutch banks, Rabobank has seen a clear deterioration in asset quality that continued in 1H13, with the impaired loans ratio rising from 7.9% at end 2012 to 10.5% at 30 June 2013. It has real estate exposure of €29.3bn, 6% of total loans.

The bottom line was also hit by a provision for settlements with US and UK authorities over an investigation into the alleged manipulation of LIBOR. Rabobank said it made "an aggregated provision" for these settlements, but did not give actual figures as “such disclosures could seriously prejudice its position”. 'Other income' fell around €300m from 1H12, but it is not clear how much of this decrease was caused by the provision.  It has been estimated that the total cost of such settlements may be ‘more than’ US$440m – which for Rabo, is manageable.

Measures of capitalisation weakened 1H13 with CET1 down 3bps to 12.9%. The sale of Robeco on 1 July will add around €1.5bn to Rabobank's 2H13 net profit, boosting its Core Tier 1 ratio by around 70bps.

Securities:  We continue to believe Rabobank will call its AUD Tier 1 hybrid securities in December 2014 (subject to regulatory approval and market conditions at the time of call).

ING – restructuring continues

Second quarter earnings were broadly similar to its first quarter, as it continues to make progress in its restructuring against a backdrop of solid earnings performance but gently deteriorating asset quality in challenging operating conditions.

Group underlying net profit of €942m was well up QoQ, although it was a little lower YoY. ING Bank reported an underlying pre-tax profit of €1.15bn, flat on the first quarter, as higher income reflecting an improved net interest margin was offset by an increase in loan impairments (€616m, compared with €561m in 1Q13 and €540m in 2Q12). Underlying operating profit in ING's European insurance business increased on the back of reduced costs, while US insurance benefited from higher fee income.

At 89bps of average RWAs, loan impairments remain well above ING's through-the-cycle target of 40-45bps, but at 44bps of average customer loans, they compare favourably with the current average for European banks. Impaired loans rose from 2.6% at 31 March to 2.8% at 30 June, attributed mainly to one real estate exposure in Spain that has now been sold. Impairments on mortgage lending and commercial real estate, which together accounted for 31% of the 2Q13 impairment charge, were flat on 1Q13 but much higher than 2012 levels.

ING Group has used the initial IPO of its US insurance business and a €1.8bn dividend from ING Bank to pay down debt and thereby significantly reduce double leverage at the holding company, to €4.4bn. The upstreaming of the dividend reflects ING's confidence in the bank's capital position, which reported Common Equity Tier 1 ratio of 10.2%, which compares well with peers. It also disclosed a leverage ratio of 3.9%.

ING has now repaid €7.75bn of the €10bn state aid it received in 2009 (plus a premium of €2.4bn) and is still scheduled to pay off the balance in three equal instalments of €1.05bn (€750m plus a premium of €375m), in November 2013, March 2014 and May 2015. ING also continues to prepare for an initial IPO of its European insurance business in 2014, while negotiations regarding the sale of its Asian insurance businesses are ongoing.

Securities:  ING Bank has a number of AUD senior bonds in the market which compare favourably from a relative value point of view with bonds from domestic issuers with similar credit and rating profiles.

All prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities.