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Finding value in a European Banking Storm

May 22, 2012 | About:
Tarn

Tarn

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The events in Europe have punished the ADR shares of the Netherlands-based ING Group (ING) which traded for US$5.94 a share as of May 21, 2012, down 52% from their 52-week high of US$12.68.


There is no doubt that the European banking system will need to strengthen its capital position and the issue of whether the Euro will survive is an open question. However, what we do know is that in times of distress often the best investment opportunities present themselves.


ING Bank NV is systemically important bank to a strong sovereign


When looking to invest in banks in Europe, I would approach it from this point of view. If the European Union was to dissolve, which bank and in what post Euro currency and country would I want to own? The Netherlands has AAA rating and ING Bank is systemically important to the Dutch economy. In a post Euro world, the Netherlands would remain one of the strongest sovereigns in Europe along with Germany, Finland and Switzerland to name a few.


Recently Moodys has indicated that it may reduce the ratings of the Netherlands and the ratings of ING, however, even with a ratings downgrade, I expect the the Netherlands & ING Bank to retain strong credit issuer ratings.


Strengthened capital position


ING Bank NV is one of just a few banks in Europe that has not participated in the LTRO operation offered by the ECB, including the second round in February 2012. Further, ING Bank has been methodically boosting its capital position and recently sold ING Direct USA for US$9 billion (€6.3 billion) to Capital One. This has helped raised its Core Tier 1 Capital position to 10.9%, well above the 9% level required under Basel III.


ING Group has repaid €$7 billion of the €10 billion of aid provided by the Dutch Government and with the eventual sale of ING Insurance Asia, which has received several offers as of the 18th May 2012 , they will be able to repay the remaining €3 billion.


ING shares fell recently as the EU re-opened the issue of whether ING received favourable treatment on its bailout. I think the ramifications of this investigation are manageable.


The catalysts for ING Group


· Sale of ING Insurance Asia for around US$7billion will boost the capital position of ING Group , allows ING to repay the remaining Dutch aid and also raise its dividend paying capacity.


· ING Group carries a cheap valuation as it trades at adjusted PE ratio (excluding interest on Dutch aid) of 3.5 based on its 2011 earnings and a price to book of 0.34. Further it is trading close to its 52 week low.


· ING management have said they will reinstate dividend payments once the Dutch Government is repaid & Basel III requirements are met.


· Slow economic improvement in the European and global economy will boost ING’s business and the market price of ING’s shares.


· The IPO of ING’s US insurance business, which is their preferred divestment option as required under their EU bailout, at an attractive valuation will further boost ING Group’s financial position.


The risks


· A severe further deterioration in the Netherlands economy , the European and global economy due to ongoing austerity measures and low economic growth. The Dutch unemployment rate has risen to 4.9% which could lead to higher NPLs on its loan book in the Netherlands as well as other European markets.


· A severe disruption in the wholesale bank funding market. ING has already raised €9.2 billion or over 50% of its wholesale funding needs for 2012 and has not needed to tap the LTRO financing. The Dutch Government would ultimately support ING Bank in a severe funding squeeze.


· There is political uncertainty over the whether tax deductions for interest payments on Dutch mortgages will gradually be reduced which could raise the real cost of mortgage debt , however, mitigating this factor are the high level of Dutch private savings, benefits for unemployed workers, Government guarantees on mortgage debt and low unemployment rate.


· ING Group’s loan exposures in Spain, Italy & Greece are potentially a problem, however, they appear manageable and ING has been reducing its exposure over the last few quarters.


· ING Group is unable to divest its insurance businesses at attractive valuations. So far, ING Group has been achieving good prices for its divestments.




Conclusion


I would recommend ING Group at its current price as a buy based on its cheap valuation, solid capital position and the strength of its franchise. ING Group will be a survivor in Europe among its financial peers.


Note: I own shares of ING Group. The author’s views expressed in this article are for journalistic purposes only and should be construed as investment advice or relied upon as investment advice.


Rating: 3.9/5 (21 votes)

Comments

Cornelius Chan
Cornelius Chan - 2 years ago
"ING Bank NV is systemically important bank to a strong sovereign"

How does the other Netherlands TBTF, AEGON, fit into your worst-case-scenario case?
trotta
Trotta - 2 years ago
I would not say the Dutch economy is that strong, since their ratio of private debt to GDP is among the highest in Europe, most of the debt in mortgages, most of them for strongly overvalued houses (median house price to median household income ratio is above 8, against a stable long-term natural ratio of 3), and to add the icing to the cake, these mortgages are extremely often interest-only. There is no reasonable scenario where this debt is duly serviced.

When this shoe drops, which admittedly I am not forecasting will happen tomorrow, I wonder how many people will find it obvious, in retrospect. I wonder what batbeer thinks of this situation though.
ajaydesai
Ajaydesai - 2 years ago
TEF is a good value every week from last couple months. Its down 25% from your value analysis. I would wait till it gets to $8 or so.

If very tempted to buy in Euro telecom look for FTE. Stronger country and company than TEF.
tarn
Tarn - 2 years ago
CWR , I haven't analysed AEGON from a financials viewpoint. They arguably are of systemic importance to Netherlands as they were provided with a 3 bil euro loan by the Dutch govt in Oct 2008 to assist their capital position & which Aegon subsequently repaid. So you could say there is a precedent there.
tarn
Tarn - 2 years ago


Trotta, I think looking at the level of mortgage debt to disposable income in the Netherlands you need to factor that it is tax efficient for a mortgagee to put all their savings into a special savings account & earn interest which is tax exempt & maximise your interest tax deduction on your mortgage repayment by not repaying your mortgage other than making the minimum repayment - you could then eventually use your savings account to repay the principal on the mortgage. The mortgage debt to GDP in the Netherlands is high but so to are the private savings levels at around 340 bil. There are other factors to consider too - the Dutch government guarantees mortgages issued by the banks up to a certain limit, there are strict underwriting codes that all lenders must abide by with emphasis on the borrowers capacity to repay rather than emphasising the LTV ratio, unemployed workers receive 3-36 months of unemployment benefits to help them continue to make repayments, unemployment rate in the Netherlands is substantially below the EU average, the Netherlands runs a current account surplus, most of the mortgages written are fixed interest rates and the level of consumer credit debt in the Netherlands is low.

tarn
Tarn - 2 years ago


Trotta I just wanted to add that I am not talking up the Dutch economy or housing market which remains weak and all the evidence is that housing prices will continue to fall. I was more focusing on the issue of ING's mortgage and real estate book and the mitigating factors to those risks of higher NPLs as we go forward.

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