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Monday, 28 January 2013

Endgame for SNS Reaal: whatever happens with this bank-insurer, somebody has to pay dearly for it. And it will probably be the Dutch taxpayer again.

The Dutch bank-insurer SNS Reaal has been a regular visitor of these lines. The bank/insurance conglomerate, formed by SNS Bank and the insurance companies Reaal and ZwitserLeven (i.e. Dutch Swiss Life) has had four difficult years, since the credit crisis broke out.

Together with ING Groep NV, the combination Fortis/ABN Amro (now ABN Amro bank) and a number of insurance companies, the bank received state support in order to survive the 2008 banking crisis. As SNS Bank is a relatively small bank, the amount was “only” €750 million, which is peanuts compared to the many billions of Euro’s that Fortis/ABN Amro and the ING Groep received.

Still, it seems that it is precisely the state support that is currently giving SNS Bank the last push down the drain.  The bank had already returned €185 mln of this state-support in 2009, but the €565 million in remaining debt, plus a penalty interest of 50% makes that the amount to be returned is still €848 million.

Normally, this amount would not have been a problem for a bank of the size of SNS Reaal, but the situation is far from normal. SNS has a subsidiary called SNS Property Finance, which had been called Bouwfonds Property Finance in an earlier life. Unfortunately, the name Bouwfonds is synonymous for ‘trouble’ in The Netherlands.

People from Bouwfonds had been the protagonists in the enormous Dutch Commercial Real Estate fraud case that shook The Netherlands to its foundations a few years ago. Through this fraud case, the large Dutch banks, like ABN Amro and Rabobank, who both had bought their share of Bouwfonds subsidiaries, came to know that Bouwfonds meant bad news.

SNS Bank was unfortunately no exception to this. In the years before SNS took over Bouwfonds Property Finance, Bouwfonds had invested heavily in North-American and Spanish Commercial Real Estate. The former had to deal with the consequences of the United States debt crisis, while the latter suffered from the implosion of the massive Spanish Real Estate bubble. But there was more bad news.

By purchasing Bouwfonds Property Finance, SNS PF had become the ‘happy’ owner of a shopping mall to-be-built in Luxemburg. While everything looked hunky dory on paper, reality was very much different, according to a story in Het Financieele Dagblad.

The real estate branch of SNS, earlier Bouwfonds Property Finance, financed the construction of two shopping malls, Belval Plaza 1 and 2. Construction? What construction?! The SNS experts are shocked by what they see. Offices, houses and shops are half finished, but there is no visible activity. 

The 110 subcontractors stopped working two months ago. Their bills were not paid by the Dutch project developer Multiplan, with whom SNS has a joint venture for Belval. Multiplan and SNS own each 50% of Belval. SNS pays all bills for the project, but doesn’t have it in legal control.

This was a common construction within the old Bouwfonds, but it bore the risk that in a bad market SNS would have to finance a money pit, without having anything to say about it legally.

The rest of this story is an absolute must-read on how not to do business in Commercial Real Estate financing (unfortunately only available in Dutch). 

Also the daily newspaper NRC wrote a story on bad investments of SNS Property Finance. These investments could happen, because bank executives didn’t listen at all to warning signals of their own risk management department.

Circumstances, like the aforementioned failed investments and others, were the main reasons that SNS Reaal is now struggling with a real estate portfolio that is worth €4.8 bln on paper, but in reality has no more value than €2.8 - €3.3 bln. The inevitable write-offs on this portfolio will be too much to bear for the bank. On top of that, the remaining €848 mln in state support must be paid back as late as 2013.

Already in the first part of 2012, it became clear that the refunding of the state support would be a mission impossible for SNS Reaal. Since 2012HY2, the bank hoped to be taken over (i.e. rescued) by a consortium, existing of the three largest banks in The Netherlands: ING Groep, Rabobank and current state-bank ABN Amro.

Not unexpectedly, however, this was forbidden by the EU for the following reason:

Both the ING Groep and ABN Amro had received large amounts of state support in 2008/2009. As a consequence, both were subject to an acquisition ban, which specifically forbid these banks to make large acquisitions, due to their 'competitive advantage' as a consequence of the state support.

Another reason could have been that the ‘three sisters’ in The Netherlands, with yet another bank in their portfolio, could have had a near-monopoly, which is bad for the negotiating position of consumers and businesses.

At this moment, SNS Reaal is in a very awkward position, with large financial problems and very little time to solve them. A position that could also cost the Dutch state a possible €750 mln in state support that won’t be returned anymore.

Last week, the Dutch newspaper Volkskrant came with the following story: in 2008, when the government paid the €750 mln in state-support to SNS Reaal, it received 142 million SNS share-certificates as a collateral. In those days, those certificates had a value of about €750 mln (one certificate = one share).

The agreement between SNS and the government stated that, if the bank would not be able to return the state support in cash, the certificates would be exchanged with normal shares; this would be considered a payment in full.

Unfortunately for the Dutch government, the value of those 142 mln certificates is currently not more than €98 mln, as SNS has turned into a penny stock. Deducted from the current SNS state-debt of €848 mln, this leaves €750 mln in state-support that possibly won’t be paid back: a considerable loss for the Dutch taxpayers. This is the reason that the Dutch government is also pushing a quick solution for SNS Reaal.

Here are three possible scenario’s for a rescue plan that are widely discussed nowadays: 
  • SNS Reaal puts (parts of) SNS Property Finance and other bleeders in a so-called ‘bad bank’ and sells this in combination with a state guarantee;
  • SNS Reaal as a whole is nationalized by the Dutch government and the bank and insurer are split up and divided over the current state-companies ABN Amro (banking) and ASR (insurances);
  • SNS Reaal is rescued by letting the shareholders and holders of normal bonds and subordinated bonds bleed for the losses that the bank suffered. The bank will probably be either partly nationalized, or it will receive additional state-support. This would be a novelty in the Dutch banking industry; 
The Bad Bank-solution

When the bleeding elements of SNS (Property Finance) would be put in a so-called bad bank, the remainder of this bank/insurer would be quite healthy, with good opportunities for survival in the future. Reaal and ZwitserLeven are common insurers: Reaal sells common (personal) indemnity insurances, while Zwitserleven sells life-insurances. Both companies are doing fine in their own right.

Also SNS Bank, without the property finance branch, would be a small, but viable full-service bank with a fixed array of customers, that probably don’t like to go to the other large banks.

In this solution, the bad bank is the true problem: while the Volkskrant spoke of a real estate portfolio of €4.8 bln, Het Financieele Dagblad spoke even of €8.8 bln in property to be possibly stashed in the bad bank.

No group of investors in their right minds would invest a few billion in a bubble without a state-guarantee or another kind of financial parachute. Everybody knows that the property that SNS owns, is probably worth less than 50% of its balance value. On top of that, the Dutch and European markets for Commercial Real Estate (CRE) are still a disaster, with structural vacancy everywhere.

If the SNS CRE is not top-notch, which it probably isn’t, it will be very hard to sell. This makes the risk for losses a very large one, unless the bad bank property is sold to investors with an enormous discount AND a state-guarantee.

The freshman Finance minister and Eurogroup-chairman Jeroen Dijsselbloem does probably not want to have another open-end(?) state warranty to keep him from sleeping. This circumstance makes this scenario possible, but not very plausible.

The nationalization solution

With ABN Amro / Fortis-bank and ASR (formerly Fortis insurance, now also in hands of the state), the Dutch government has ample experience with a nationalization proces in the financial world. Probably, the Finance Ministry has – in combination with the Dutch national bank DNB - the scenarios already written down and ready for action.

In this case, SNS Reaal will probably be split up into a banking part and an insurance part. Although I don’t know if the EU will allow a merger between SNS Bank and ABN Amro at one hand and Reaal, Zwitser-leven and ASR at the other hand, I consider this a very plausible possibility.

The difference is that in this case the Dutch government takes the initiative and not ABN Amro itself. The same will be true for ASR.

When the EU still would not allow the Dutch government to merge SNS Reaal into the other state bank and insurer soon, the government might keep the SNS Reaal shops open, until both ABN Amro and ASR are private companies again (planned somewhere in 2014/15) and there would be no obstacles for the merger anymore.

SNS Bank would be assimilated within the ABN Amro group and most bank shops would actually disappear; SNS shops at A-locations would be renamed to ABN Amro, the others would simply be closed. 

The insurance-label Reaal would probably disappear, while ZwitserLeven IMHO would survive as a label under the ASR umbrella.

Whatever happens, this will be a costly solution for the Dutch taxpayer. In this case, the taxpayer is on the hook for all the losses at SNS Property Finance. 

In the process he might lose at least €2-€4 billion in real estate write-offs, plus the €750 mln in state support. To keep the bank and insurer running, an additional €2-€3 billion might be necessary, bringing the total bill for the taxpayers to €5-€6 bln. 

In exchange, the Dutch taxpayer receives a bank/insurer with a few healthy parts and a lot of dead bodies. This solution seems possible and very plausible.

The shared burden solution

Finance Minister Jeroen Dijsselbloem likes the idea of letting the share- and bondholders share in the burden of rescuing SNS Bank. With bondholders, he does not only mean the holders of subordinated bonds, but also normal bondholders.

This possibility send shockwaves through the financial world. Not only the holders of normal and subordinated debt where shocked that their “safe investments” were on the line suddenly, also Fitch reacted like it was stung by a wasp and warned that this could have grave consequences.

One of these consequences could be that the ratings of all European banks would be lowered, as the bondholders could not reckon anymore that the European banks would always be protected by the national governments of the Eurozone eventually.

At this moment it seems that Dijsselbloem is still resisting the pressure of Fitch (and probably the other rating agencies), so lets have a look at this possibility.

According to the annual report for 2011, SNS Reaal had equity to the tune of about €4.350 bln, in combination with €650 mln in subordinated debt and €1.9 bln in other liabilities (which I presume to be bonds). 

This brings the total value of SNS Reaal’s paper officially to €7 bln, although I am certain that the current value of the equity is probably not more than €1.5 - €2 bln, making it a total of €5 bln.

When the losses on SNS PF (for the equasion, I will set these to €3 bln) would be written off from the share- and bondholders, the shareholder capital would be totally wiped out and the bondholders would be in for a costly X-mas present of minus €1 - €1.5 billion. In my opinion, this would wipe out the subordinated debt holders and leave the normal bondholders with a write-off of about 15% - 50% of their bond value.

In this case the Dutch government would probably warrant €2 - €3 bln in additional state support to keep the bank up and running, making a total possible loss of €2.75 - €3.75 bln, due to the €750 mln in SNS share-certificates that would go up in smoke when this solution is chosen.

I consider this solution also possible, but not plausible.

I am certain that Dijsselbloem will pull the chicken-switch under the pressure of the rating agencies and financial markets on one hand and the bondholders (often private citizens, who bought these bonds under advice of SNS Reaal as a ‘safe’ investment), who would suffer a huge loss.

Conclusion: the probable path to go for SNS Reaal is being nationalized, making the Dutch taxpayers the ‘happy’ owner of yet another bank with executive management  who thought that ‘risk’ was just a theoretical concept, invented by misanthropes. Congratulations.


Breaking news: Tomorrow, on Monday, 28 January, I will again visit BNR Newsroom, the live discussion program on BNR Business Radio, hosted by Paul van Liempt. The topic of the evening is the rescue of… SNS Reaal. If I will hear radically different insights, I will write a follow-up on this story!   

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