Introduction
I have been keeping an eye on the financial results of some of the banks I follow closely, and I was looking forward if ABN AMRO (OTCPK:ABNRY) (OTCPK:AAVMY) was able to limit the damage after a very bad first quarter where the bank wasn’t just hit by the fallout from the COVID-19 pandemic but also had to deal with two fraud cases.
Source: Yahoo Finance
ABN AMRO’s most liquid listing is on Euronext Amsterdam where the company is trading with ABN as its ticker symbol. With an average daily volume of around 6 million shares, the liquidity in Amsterdam is clearly superior to any of the bank’s secondary listings. As ABN trades and reports in Euro, I will use the EUR as base currency in this article.
The Q2 results were slightly better than anticipated
I can be relatively brief about the Q2 results as what really matters is the soft (implied) guidance provided by the ABN management team.
As generally expected, the net interest income decreased slightly while the net fee and commission income showed the same pattern. What mattered for ABN was to keep the operating expenses low, and the Dutch bank succeeded: The operating expenses decreased to just under 1.2B EUR, down 8% from the 1.31B EUR in Q2 2019 and 1.3B EUR in Q1 2020. This helped to boost the operating result by 162M EUR to 786M EUR (which includes trading gains where the Q1 loss under “other income” was reversed, but the Q2 “other operating income” of 96M EUR was still substantially lower than the 228M EUR in Q2 2019).
Source: financial results
From the operating result of 786M EUR we still need to deduct the provisions on credit losses to the tune of 703M EUR and this caused the pre-tax income to come in at approximately 83M EUR. A fraction of the Q2 2019 result, but the loan loss provisions did increase by almost 600M EUR. The relatively heavy income tax caused ABN’s bottom line to show a net loss and applying a normalized tax rate would have resulted in ABN remaining profitable in Q2 despite the 703M EUR in loan loss provisions.
The outlook for H2 2020 indicates ABN AMRO will be profitable again, and the CET1 ratio will increase
I already mentioned in my previous article which was published in May I wasn’t expecting a meaningful dividend for this year, and the Q2 results haven’t changed my opinion. However, from this moment on, ABN’s financial performance should improve and I expect the bank to be profitable in the current semester.
In its Q2 overview, ABN AMRO mentions it’s now aiming for an impairment charge of 3B EUR in FY 2020, and as the bank already recorded 1.81B EUR in loan loss provisions in the first half of the year, this implies the impairment charges will be “just” 1.19B EUR in the current semester.
Considering the operating result based on the Q2 financial results will be 1.57B EUR in H2 2020, the pre-tax income could very well come in at 380M EUR (1.57B EUR operating income minus 1.19B EUR in additional loan loss provisions). Applying a normal tax rate and the 940M share count, the net income in H2 could be around 30 cents per share.
However, these estimates could still be impacted by ABN also recording an additional 200M EUR provision related to staff expenses and the impairment of deferred tax assets to the tune of 280-320M EUR. A large part of these additional provisions will very likely be recorded in the current quarter. That’s fine with me as I prefer to get everything out of the way this year (and reporting a zero net income) so ABN AMRO can start 2021 with a clean slate.
Additionally, ABN will be winding down its non-core corporate & institutional banking portfolio over the next few years. This will free up capital that could be deployed elsewhere (read: in markets where ABN AMRO enjoys more success). This actually could be a pivotal element to re-position ABN AMRO. Although the details were hidden in a footnote to the financial statements, they contain very valuable information:
Source: half-year report
It looks like ABN AMRO will be gradually winding down a higher risk portfolio of loans (a 14B EUR RWA on a 18B EUR portfolio is very high) which means two things. First of all, ABN’s portfolio will become safer. While ABN also will lose the income on the 18B EUR portfolio, the high RWA to total asset ratio of the non-core assets basically means that ABN could for instance issue 50-60B EUR in mortgages while not seeing the RWA increase from the 14B EUR. While the net interest margin on mortgages would be lower than on these corporate loans, the loan book could expand by a factor of three without having an impact on the RWA.
A second option would be to see ABN AMRO reducing its size and not redeploy the 14B EUR in RWA. In that case, upon winding down the non-core portfolio, the total amount of risk-weighed assets would decrease from 112B EUR to 98B EUR (keeping all other things equal). Assuming the CET1 capital position does not increase (i.e. no earnings will be retained) during the wind-down of the portfolio, the 19.4B EUR CET1 capital would represent a CET1 ratio exceeding 20% indicating ABN AMRO had a serious amount of excess capital.
So either ABN AMRO redeploys its capital and makes up for the loss in income, or it doesn’t redeploy the 14B EUR in Risk-Weighted Assets and will have a multi-billion Euro capital surplus. In any case, something’s gotta give.
Investment thesis
2020 will be a year to forget for ABN AMRO, but I’m already looking to 2021 and beyond. If ABN can indeed keep its loan loss provisions limited to the 3B EUR it’s currently guiding for, we can look forward to the Dutch bank reporting a handsome net income again in 2021 which should result in the reinstatement of the dividend.
As mentioned in the previous article, I’m not expecting a meaningful dividend to be paid out over FY2020 and perhaps a symbolic 10-cent dividend could be all we are hoping for. But in the conference call discussing the Q2 results, the ABN management reaffirmed its intention to reinstate a dividend. I expect there will be some more clean-up work to do which may still have a negative impact on the net income in 2021 but from 2022 on I’m expecting EPS to exceed the 1.25 EUR per share again, making ABN AMRO a cheap bank if you have the patience to wait for 12-18 months while ABN cleans up its mess.
I have a long position but although ABN appears to be cheap based on its future earnings potential, I will only add to my position at bargain prices.
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Disclosure: I am/we are long ABNRY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
