European financials have struggled since the start of the year, with banks in the region dragging the sector down following the Russian invasion of Ukraine in February. The Dutch multinational ING (NYSE:ING) was one of the names captured in sales. He only has very modest direct exposure to the region, but that hasn’t stopped his shares from collapsing significantly.
While ING’s direct exposure to the region may not be that significant, it is the second-order effects that may be weighing on investors’ minds at the moment. Inflation and its impact on the financial health of customers and the bank’s cost base were already being discussed before the recent events, and this has intensified given the negative developments since.
As the macro picture begins to darken, particularly in Europe, these stocks have sold off considerably. In truth, I didn’t think they were that bad as a deal earlier in the year, with a pre-war quote of around 1x tangible book value (“TBV”) at the low end. richer for a eurozone bank, but also supported by higher quality earnings and a stronger balance sheet. After a 30% drop, the stock now offers a substantial discount to TBV as well as a dividend yield of over 6.4%. For one of the few banks in the region capable of achieving double-digit returns on tangible equity, this looks like a decent opportunity for value investors. To buy.
A multinational player
ING has retail banking operations in a dozen countries as well as an international wholesale banking operation. Regarding its loan portfolio, around 40% is in residential mortgages, and around 15% in Dutch mortgages in particular.
The jewel in ING’s crown is its Dutch retail segment. The bank is the country’s largest deposit taker and the wider banking market in the Netherlands is highly concentrated. Along with ABN AMRO and Rabobank, ING has pretty much a lock on the country’s retail deposits. This allows for cheap financing costs, while efficiency and low cost of risk further contributed to a very profitable business, ultimately leading to a segmented ROE in the 25% area according to its supplemental data tables.
It’s more of a mixed bag elsewhere. ING’s other retail business in the Benelux generates around 12% of revenue, but is fairly average in terms of profitability. Same story with its Wholesale Banking division (a third of revenues but with a lackluster ROE).
Its Challengers & Growth Markets segment, which encompasses non-Benelux retail business, is also mixed, with the German digital business extremely profitable, but the rest average overall. ING has shed some of these businesses – exiting France, Austria and the Czech Republic recently – although I wish it would go further and exit other difficult banking markets like Italy as well.
Ultimately, ING remains one of the most profitable listed banks in the Eurozone. Its funding mix is attractive (more than 50% retail deposits with less than 30% wholesale funding), and it has generally benefited from one of the lowest cost of risk in Europe.
A difficult environment
ING’s macro environment has been very challenging in recent years. Interest rates are ultra-low, even negative, and most of its income comes from net interest income (“NII”). Negative interest rates are particularly pernicious, with the bank having to absorb the negative impact on returns but, to a large extent, unable to pass it on to depositors.
Unsurprisingly, net interest margins collapsed, ultimately leading to flat RNI despite modest growth in customer loans and interest-earning assets. Like many of its peers, the bank has done what one would expect in such an environment – trying to bolster non-NII revenue streams and contain operating costs.
Considering the above, 2021 has been another poor year (ING does not publish Q1 2022 results for a few weeks yet). NII was virtually flat at €13.62 billion, even if that includes the benefits of TLTRO-III, the loss of which will be a short-term headwind. Net income from fees and commissions was much brighter, increasing by 17% to more than 3.5 billion euros, while lower provisions helped optimize net income, which was 4.78 billion euros for FY21 compared to 2.49 billion euros for FY20.
Credit quality remains strong. The bank recorded higher provisions in the fourth quarter in response to the changing macro environment, although asset quality did not appear to show signs of deteriorating, with Stage 3 global loans stable sequentially at around 1 .5% of total loans. Higher provisioning resulted in a ~30% sequential decline in quarterly net income, although pre-tax pre-provision earnings were more stable (down ~1% excluding regulatory costs).
Stocks look cheap at 0.7x TBV
Recent events have taken a large chunk out of ING’s share price. Direct exposure to Russia and Ukraine is not that significant – only around 1% of loans, which would still leave its balance sheet in good shape even negating said exposure by 100% (and that’s unrealistic) .
Second-order effects are more uncertain. Energy and commodity prices have exploded, and although inflation is a global problem, Europe is currently in a much more difficult situation than, say, the United States. Supply chain issues are also causing a huge headache right now, contributing to the larger inflation problem. This could harm ING via weakening asset quality and lower demand. In addition, inflation could affect its cost base, as Belgium, for example, has an automatic indexation of wages to prices.
On the other hand, these stocks have sold off considerably, losing around 30% of their value since February. They are changing hands for €9.63 each in Amsterdam at the time of writing, or around 0.7x TBV per share and 7.8x FY21 EPS of €1.23. The dividend yield is slightly higher at 6.4% based on the FY21 payout of €0.62 per share.
ING’s balance sheet is in very good shape, with the CET1 ratio ending the year at 15.9%. With risk-weighted assets at €312.6 billion, this implies excess capital of around €10 billion (equivalent to around 25% of its current market cap) given the CET1 target of management by 12.5%.
Thus, shareholders could consider significant levels of redemptions and/or special dividends in addition to a decent ordinary dividend. Management has so far been a little coy on the timing and nature of its capital return plans, but it aims to achieve its target over the next two years and should be able to reveal more with the first quarter results in a few weeks. weather.
Admittedly, the environment is now a bit more uncertain, but these stocks offer upside potential of 0.9 to 1x TBV and an attractive ordinary dividend yielding over 6%. With the prospect of significant additional capital returns on the cards as well, ING stock could generate very attractive total returns over the next few years. To buy.