We're on a road to nowhere
Come on inside
Takin' that ride to nowhere
We'll take that ride
The Dutch bank/insurer SNS Reaal and especially its banking subsidiary SNS Bank seem to be on a dead end road, due to enduring problems with the vast Commercial Real Estate (CRE) portfolio of the bank.
Last year, the bank/insurer entered the news bulletins with their CRE misery and with the request of CEO Ronald Latenstein to his personnel to ‘voluntarily’ reduce their remuneration by 10%, as ‘their wages were too generous to meet the demands for solid yields on the bank’s services’.
In those days, I expected Latenstein’s request for more austere remuneration of banking personnel to start a new trend in the banking industry, but that didn’t happen until now. However, this doesn’t mean that this won’t happen in the foreseeable future anyway.
Nevertheless, the problems with the CRE portfolio of SNS Bank have not been solved yet and yesterday, this caused Fitch to downgrade their viability rating by one notch to bb from bbb-: a junk status.
Here are the pertinent snips from the Fitch press bulletin:
The downgrade of SNS Bank's VR [Viability Rating – EL] to 'bb' from 'bbb-' and removal from RWN reflects the heightened risks carried by the bank's commercial real estate (CRE) loan book (EUR4.2bn property development and, to a lower extent, the EUR3.6bn property investment - in total around 4x book equity at end-June 2012) in the view of the data published by the bank in its first-half results and the latest commercial property market trends in the Netherlands (around 80% of the total exposures) and across Europe.
Fitch expects that the difficulties in the highly cyclical commercial property markets will protract if not worsen, notably in the Netherlands, as the public and private sectors are undertaking a substantial deleveraging process, given the reducing refinancing opportunities as financial institutions turn away from property lending and as the economic conditions remains weak. Unlike other major Dutch banks, SNS Bank's CRE portfolio is dominated by exposures to property development (Property Finance) which is, by nature, much riskier than property investment. In addition, SNS Bank has property development exposures to countries that have experienced severe real estate shocks (Spain and US), although these have been largely written-down and/or foreclosed.
The quality of the Property Finance loan book in run-off (EUR4.2bn) has further weakened with impaired loans and average loan-to-value ratios deteriorating again during H112 to high levels (39.6% and 105.4% respectively). In addition, the less risky property investment loan book (Property Finance SME) has started to experience some deterioration and the relatively low 4.3% impaired loan ratio reported at end-June 2012 is expected to increase, causing higher loan impairment charges. Along with earnings strains in the bank's retail activities due to continued pressure on net interest margin and higher, but still low, loan impairment charges, the CRE exposures will cause significant further losses for the bank over the foreseeable future and, ultimately, pressure on capital. The bank has so far succeeded in mitigating the negative impact on its capital position through deleveraging (but also through some support from the group's insurance operations) but would not be able to continue doing so if the current adverse conditions on the CRE markets protracts, if not worsen.
In Fitch's opinion, the continued, and potentially increasing, burden of the property lending on SNS Bank's earnings and ultimately capital (ahead of the implementation of tougher regulatory requirements) is not commensurate anymore with an investment grade standalone creditworthiness.
Fitch placed the insurance operating entities' ratings on RWE on 16 July 2012 reflecting SNS REAAL's announcement that it will take capital strengthening initiatives by the end of 2012. All scenarios are still under review by management and no final decision has been made yet. Consequently, Fitch has maintained the RWE on the insurance operating entities. Fitch expects to resolve the RWE once there is greater clarity about the future of the insurance operations in the context of the group's capital strengthening initiatives.
RATING DRIVERS AND SENSITIVITIES - VR
SNS Bank's VR reflects its solid franchise in Dutch retail banking, which has enabled it to maintain a healthy net inflow of customer deposits during H112, improving its funding mix while the bank is reducing its loan book (the loans/deposits ratio improved to 147% at end-June 2012 versus 162% at end-2011). This still high loans/deposits ratio indicates that the bank remains reliant on the capital markets for its funding needs (a structural feature of Dutch banks), but has regained access to secured funding in H212 with a EUR1bn covered bond and EUR960m RMBS placements. This has further strengthened an already solid liquidity position. The VR also incorporates the substantial strains of the property finance exposure on SNS Bank's earnings and the related significant challenges for its capital position.
SNS Bank's VR would be vulnerable to any deterioration in asset quality beyond current expectations causing heightened stress on capital, but also to a weakening of the bank's core retail franchise or to any material set-back in its liquidity profile.
After reading this Fitch report, I couldn’t agree more with the downgrade. The still enormous €7.8 bln CRE portfolio of SNS Bank (when compared to SNS Bank’s approx. €2 bln equity), makes the bank extremely vulnerable for deterioration of their CRE portfolio at especially the domestic market.
In my opinion this deterioration is inevitable, as the current vacancy of CRE at the domestic market is already hitting 17% and insiders even predict 25% vacancy (of which about 80% structural) for the near future.
Existing CRE is vacant in many, many occasions, especially at beneath AAA locations; for instance in commuter-driven cities like Amsterdam Zuid-Oost, Zoetermeer, Almere, Hoofddorp, Den Haag etc. Even at top-notch locations there is (structural) vacancy, albeit much lower. There is no way that this vacancy will be reduced soon. To the contrary, in my opinion the vacancy will only rise during the next 5-10 years. Reduction of CRE vacancy might be a process of many years to come.
Although the impaired loan ratio for the whole property investment loan book is still very low with 4.3%, I expect this number to rise in accordance with the structural vacancy on the Dutch CRE market. Commercial buildings that supply no rental or sales yields, but still have their fixed expenses will inevitably lead to arrears and foreclosures among investment companies and project developers. They will also lead to financial damage for SNS Bank itself. Another side-effect is the depreciation in the value of SNS Bank’s CRE portfolio.
Even more tricky is the property development portfolio of the bank. Many buildings are currently being built for (structural) vacancy, as the potential customers have gone bankrupt, or have simply vanished. On top of that, the supply on the Dutch CRE market is still overwhelming for the next few years, due to reckless investments of banks, local communities and central government. SNS Bank will inevitably suffer from this development as new buildings will fail to find tenants or buyers.
SNS Bank is still very much dependent on the capital markets, but it is also one of the banks that pays a much higher than average interest on saving’s accounts. This is – of course – not a sign of financial strength, but rather weakness. These higher interest rates on savings from private customers also make it more difficult to gain a solid yield on investments and loans.
Although Fitch still believes that the management of SNS Bank will deploy a kind of financial restructuring at the end of this year, I don’t see the problems of SNS to be solved soon:
- You can stop all future investments in the IT infrastructure, fire all excess (?) personnel and run the bank with a skeleton crew, but this will lead to deterioration of service and quality and in the end to mounting losses, due to failed business operations.
- With the current high costs of capital and low yields on investments, the financial situation of the bank will rather deteriorate, instead of improve in the coming years.
- In my opinion, there is no way in hell that the bank can sell its CRE portfolio at a decent price in order to improve the financial situation of the bank. CRE will be a millstone in years to come.
- I also don’t think that the CRE portfolio of the bank can be sold through CMBS (Commercial MBS) securities. It is nice that the bank could successfully issue RMBS (residential mortgage backed securities) in 2012, but I am truly puzzled that people are buying those securities anyway. The outlook for CBMS is far worse, IMHO.
Due to SNS Bank’s vast CRE portfolio and the increasing difficulties to acquire money at a decent price, the bank seems on a road to nowhere.
If you don’t mind, I don’t take that ride!