The Dutch banks: turning from catalysts into liabilities for the Dutch economy.

Today, a seemingly strange event took place at the Dutch stock exchange NYSE Euronext Amsterdam. Yesterday, on June 14, 2012,  Moody’s downgraded the ratings of five important Dutch banks. ING Bank, ABN Amro,  Leaseplan Bank and Rabobank lost two notches, while SNS Bank lost one notch. ING Bank was the only bank to remain at negative outlook, in spite of today’s downgrade.

Everybody who felt that this news would have a negative impact on the exchange rates of SNS Reaal and ING Groep NV… was terribly mistaken: the exchange rates of these banks soared with respectively 10,43% and 5.62%!

News like this and the reaction to it at the stock exchanges gives you an impression of how messed-up the situation in the Dutch and European economies is at the moment.

If you look at the 1Y exchange rates of both SNS and ING, you see why such a strange reaction could take place today:

1Y Exchange rates of SNS Bank
Data courtesy of IEX.nl
Click to enlarge

1Y Exchange rates of ING Groep NV
Data courtesy of IEX.nl
Click to enlarge

SNS Reaal has generally been in a steady ride downhill for the last 12 months, turning the €3 stock from June 30, 2011 in a genuine penny stock during the last week. The enduring problems with the (commercial) real estate portfolio of SNS Investment Management and the troubles that the relatively small bank experiences at the capital markets, turn the fund into a bleeder.

Also the owners of ING stock have had a wild ride over the last 12 months. While the bank stock experienced considerable growth during the first three months of 2012, afterwards the bank rate declined to levels not seen since August 31, 2011.

On June 12, the investors had to swallow another bitter pil, as the bank received a €500 mln penalty from the US government, for violating the Cuba boycot in the years before 2008.

The same investors know that the bank still has considerable exposure to the PIIGS-countries: €33 bln, with especially Spain (€20.7) as the most prominent problem zone. The same country that is now in such dire straits.

Another problem zone for ING and - as a matter of fact - all other Dutch banks (except Leaseplan Bank) is the exposure to the Dutch Residential (RRE) and Commercial Real Estate (CRE) markets: 

• many billions of Euro’s are invested in mortgages on presumably overvalued houses;
• presumably billions of Euro’s in loans have been handed out to the ailing building and construction industry; 
• billions of Euro’s are invested in overvalued and (sometimes structurally) vacant CRE.

It is this desperate situation at the Dutch banks that triggers a relief rally, when Dutch banks are only downgraded one or two notches by the official ratings agencies; things could have been much worse, according to the investors.

Looking at the situation of other very large banks in Europe, the awkward situation of the largest Dutch banks is not an exception, but rather the rule of thumb that can be found all over Europe.

Here are the latest ratings and the pertinent snips of the Moody report:

Latest rating changes for  five large Dutch banks
Data courtesy of Moodys.com
Click to enlarge

Summary

Today, we downgraded five Dutch banking groups. The ratings for four groups (ING Bank, N.V., Rabobank Nederland, ABN AMRO Bank N.V. and LeasePlan Corporation N.V.) declined by two notches, while the ratings for one institution (SNS Bank N.V.) were downgraded by one notch.

Today’s actions reflect our view that Dutch banks will face difficult operating conditions throughout 2012 and possibly beyond. Furthermore, the Dutch banks affected by today’s actions have structural features which, while not new, heighten risks for creditors amidst elevated uncertainty and downside risks to the economic outlook and fragile investor confidence in Europe.

Specifically, the main drivers underlying today’s rating actions on Dutch banks are as follows:

• Adverse operating conditions, including the current recession and declining house prices in the Netherlands, will likely persist at least through 2012. Moreover, the Netherlands, as a euro area member deeply integrated within the EU, is affected by the ongoing euro area debt crisis and regional economic weakness. Economic weakness also limits household incomes and business earnings, which will likely adversely affect credit costs and profitability for banks.
  
• The Dutch banks affected by today’s rating actions have characteristics that render them more vulnerable in the current environment. These characteristics include structural reliance on wholesale funds and large mortgage books. Wholesale funding is susceptible to changes in investor confidence, while high real estate exposures leave banks sensitive to potential deterioration in loan performance given declining real estate collateral values. 

The negative rating outlooks for ING Bank and its related entities take into account the bank’s specific funding structure which substantially relies on wholesale funds and which has a significant proportion of non-domestic deposits. Under a stressed scenario, some of these non-domestic deposits could, in Moody’s view, become less fungible as national regulators focus on safeguarding local liquidity.

You could argue that the Moody’s downgrades are almost a question of ‘too little, too late’, as there is nothing in their report that we didn’t know yet one year ago:

• There is huge exposure to the PIIGS countries for almost all Dutch banks (except for Leaseplan Bank)
  
• There is huge exposure too to the Dutch CRE and RRE markets and Dutch mortgages. While Moody’s state that the housing and CRE crisis will last at least until 2013, it is my personal opinion that it might last at least until 2017, taking into consideration the reluctancy of the Dutch government to take decisive action in the crisis in these extremely important industries.
  
• Dutch banks are still extremely reluctant to invest in SME (Small and Medium Enterprises) and say ‘nyet’ to lending requests much more often than in earlier years.
  
• In my opinion, the Vestia case could be the tip of a very nasty iceberg, considering structured finance operations for non-profit, non-commercial body’s like building cooperatives, hospitals and pension funds. If the Dutch Public Prosecution wants to be taken seriously in the future, it should better investigates the very questionable role that the banks have played in the Vestia affair.
  
• The general profitability of banking operations in The Netherlands will further decline under pressure of the strict Basel III rules for solvability and liquidity and the limited access to the capital markets for cheap capital. Summarized, this means less profit on a smaller amount invested capital.
  
• The consequences of the fifth bullet might cause that banks again invest heavily in dangerous structured products, as these are the ones that could yield more than average profits. Banks that are strapped for cash could not have another option to earn money.

In earlier decades, the solid Dutch banks with their limited-risk operations have been catalysts for the Dutch economy, enabling investments for small, medium and large enterprises and supplying loans to people that needed a mortgage for buying a house or a loan for buying a car and other consumption goods. While the bank earnings were relatively low, as a consequence of the limited risk, there was in those days no need for two-digit profit growth per year. Yields were limited, but risk was limited too.

During the last two decades, however, the Dutch adoption of the Anglo-Saxon focus on shareholder value has spurred the banks to present profit growth marks of 15+% per year, in order to shake off the increasingly dissatisfied and spoilt shareholders.

As we know, the consequences were very seriously. Almost all formerly healthy banks turned into ailing institutions that might present small losses or even a decent book profit, but in reality can only be kept upright with billions and billions of tax-payer money as a back-stop.

If you doubt the previous statement, I invite you: take the equity of the four largest Dutch banks (ING, ABN Amro, Rabobank and SNS Reaal) and compare it with their mortgage portfolio’s and/or CRE investments. 


Imagine that these banks have to write off 15% on the value of their mortgages and CRE investments. Looking at the desperate state of the current Dutch RRE and CRE market, this is not a very wild guess.

How many of these banks still look healthy after you deducted the written-off amount from their equity? Well, do you feel lucky??

This is the reason that the Dutch banks could turn from catalysts into liabilities for the Dutch economy: instead of investing money, the banks just swallow taxpayer money up from the Dutch government and the ECB, while giving very little in return for it. Almost like a zombie…