Description

Summary

With the global economy recovering and investors increasingly looking for “reflation trades”, many U.S. bank stocks have staged sharp recoveries and now trade on average at a significant premium to book value. While a few months behind U.S. peers, many European bank stocks have also begun to show some signs of life, reaching an average valuation of around 85% of book value.

By contrast, shares in ABN Amro (ABN NA) have continued to languish, remaining well below pre-pandemic levels and trading at a valuation of just 50% of tangible book value despite having almost 50% of the current market cap in excess capital.  Over the next year, we think the stock has the potential to double as:

(1) a new CEO restructures the company (including winding down its unprofitable investment banking arm);

(2) the business turns the corner (particularly as the pace of European vaccinations and economic recovery begins to catch-up with the U.S. and U.K.);

(3) the company begins returning its significant levels of excess capital to shareholders starting later this year or early 2022 (including a significant 2019 dividend that has been deducted from its capital ratios despite not yet being paid out); and

(4) investors begin to focus on the stock’s extreme absolute and relative undervaluation.

Overview

As background, the current ABN Amro is largely a Netherlands-focused bank with retail (~44% of profits), private banking (~18% of profits), commercial banking (~20% of profits), and corporate & investment banking operations (~18% of profits).  The bank was taken over by the Dutch government during the financial crisis and brought back to the public markets through a 2015 IPO at a share price of €17.75.  The Dutch government subsequently completed three follow-on offerings in 2016 and 2017 at prices ranging from €20.40 to €23.50.  These transactions have left the government owning just over 56% of the bank.

For much of ABN’s first four years as a public company, it was viewed as a solid, well-capitalized bank that could earn a respectable ROE (double digits with old targets of 10-13%), while paying out sizable dividends to shareholders.  Consequently, ABN’s stock traded at an average of 1.1x book from its IPO through late 2019, reaching a high of 1.4x book in early 2018.

However, starting in late 2019 and into 2020 (and COVID), multiple headwinds plagued the company, culminating in the current severely dislocated valuation:

(1) Anti-Money Laundering (AML) investigation headlines starting in September 2019, which created severe uncertainties on the heels of a number of similar investigations at other European financial institutions;

(2) several disappointing corporate and investment banking (CIB) losses during 2020 ($200 million loss from a U.S. clearing client during March 2020 turmoil, roughly $300 million loss from Singapore-based Hin Leong Trading collapse in April 2020 and sizable losses from the June 2020 Wirecard collapse);

(3) credit concerns due to COVID, particularly in CIB’s energy-heavy loan book; and

(4) the suspension of capital return due to ECB restriction with the €639 million accrued 2019 dividend that was set to be paid out is still being held in reserve by the bank (and is already deducted from capital despite still being owed to shareholders).

At this point we believe these concerns are largely in the past.  First, the AML investigation was just settled last month with a €480 million total settlement (in-line with expectations, representing a €300 million fine and €180 million in disgorgement).

Second, while the sizable 2020 credit losses were clearly disappointing, it is important to note that (1) the core retail/commercial bank was not the problem during 2020 but instead the non-core, sub-scale operations in CIB that ABN never should have been involved in and (2) the new management team has aggressively wound down the “non-core” portion of CIB where gross exposures have fallen from €17 billion one year ago to below €7 billion currently, aided by a rebound in corporate credit (particularly in the energy sector).

Finally, the company’s strong capital position should pave the way for aggressive capital return by early 2022 at the latest and will create a very compelling story for investors given the sheer extent of the bank’s excess capital. 

Path Forward

One year ago, ABN Amro appointed a new CEO, Robert Swaak, who had previously been a senior executive at PwC Netherlands.  We have had several interactions with Robert and have come away impressed.  Amid a chaotic year with the focus on daily COVID headlines, we think the market is missing the turnaround story that Swaak has already started to execute.   While there were originally concerns the Dutch government would push for a caretaker CEO, Swaak has proven to be the opposite. In his first year, he has moved aggressively to settle the AML overhang, divested the problem areas within ABN’s CIB business, begun to right-size operations and reduce costs, and outlined a new framework for aggressively returning capital through dividends and buybacks.

Management’s current target is for a medium-term ROE of 8% or 10% as rates normalize.  Given they outlined these targets last November as Dutch COVID cases were spiking (and no vaccines had been approved yet) and without any certainty around the timing to normalize its capital levels, we think the 8% target will prove conservative and management will likely be able to manage capital levels lower and achieve ROEs of  nearly 10% by late 2023.

Capital Return / What We Think It’s Worth

As of the latest quarter, ABN has fully loaded Basel IV capital ratios of “over 15%” (we estimate ~15.5%) which already includes a reserve of ~60bps for the accrued 2019 dividend (6.4% of the current market capitalization), compared to a regulatory minimum of 11.1% and a management target of 13.0%.  With the remaining net income expected to be generated during the rest of 2021 (including a large expected gain on sale from the sale/leaseback of their headquarters), we believe ABN will end 2021 with ~€4.8 billion of excess capital (including the accrued 2019 dividend) above management’s target, which represents roughly 50% of the current market cap.  Further, with the additional capital generation expected as the bank improves its operations and generates solid profitability, we estimate that if ABN is successful in bringing capital ratios to their 13% target, it will be able to return almost €9 billion of capital to shareholders through dividends and buybacks through the end of 2024.  For perspective, the current market capitalization of the entire bank is just €10 billion and the public float is just €4.4 billion.  Importantly, we believe from our interactions with management that they want to start share repurchases soon (likely early 2022).

We believe ABN can be on its way to generating a nearly 10% ROE by 2023 and trade at closer to book value next year (just 10-11x forward earnings despite a continued large excess capital position), resulting in a total value (including future dividends) of nearly €23 per share or over 110% above the current share price.

Catalyst

• Europe economic recovery in H2 2021 following vaccine ramp
• Resumption of capital return and buyback announcement