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ABN Amro faces challenges to hit cost, capital goals due to rates, regulations

Low interest rates and regulatory changes will make it harder for ABN Amro Group NV to reach its 2020 cost and capital targets, but the Dutch bank remains focused on them, CFO Clifford Abrahams said May 15.

The environment has become "more demanding" in 2019 and ABN Amro is seeing more earnings pressure, which is likely to extend into 2020, he said during a presentation of first-quarter results. This will challenge the group's ability to achieve a cost-to-income ratio of 56% to 58% by 2020, though it will "work hard" on further cost savings to mitigate that effect, he said.

Disappointing Q1

ABN Amro was not able to achieve a big enough cost reduction over the first quarter to offset the revenue and profit declines over the period. Overall, first-quarter figures were "fairly disappointing" with most key figures missing market consensus, Rabobank Research credit analysts said in a note May 15.

The lender's first-quarter net profit plummeted 20% year over year to €478 million, missing market consensus by 4%, according to Rabobank's analysts. Return on average equity fell to 9.2% from 11.5% a year ago with net interest income sliding 6% year over year to €1.57 billion and operating income dropping 11% to €2.08 billion.

ABN Amro reduced first-quarter operating expenses by 2% year over to some €1.33 billion while its cost-to-income ratio grew to 63.8% from 57.9% a year ago. The bank blamed the inflated cost-to-income ratio and weaker return on average equity on higher regulatory levies, saying that if levies were evenly divided over the year the first-quarter return on equity would stand at 10.2% and cost-to-income at 60.2%.

Cost pressure

Nevertheless, ABN Amro will face further cost headwinds in 2019 as it is focusing on boosting compliance, Abrahams said. "[W]hile we feel well provisioned for our existing cost plans if we come up with extra things, there may well be costs associated with that," the CFO said but declined to give specific guidance for 2019.

The bank launched an accelerated client due diligence program in late 2018 in the wake of the money-laundering scandal that rocked European banking last year. Numerous big European lenders faced fines and regulatory probes a €200 billion money-laundering scheme centered around a Russian investment bank with European ties was uncovered. This led to a strong regulatory push for tougher AML and know-your-client controls.

ABN Amro provided €85 million for client due diligence program costs over the years 2019 and 2020, CEO Kees van Dijkhuizen said. The provision was booked in the fourth quarter when the bank also added 400 new staff to the team working on the program, which currently includes 1,000 employees, he said. The additional staff are mainly necessary for remediation of backlogs in the group's commercial banking and credit card businesses, the CEO said. It is too early to speak about potential additional costs here, he said.

Although the due diligence may result in the exiting of some client relationships, the effect would not be significant enough to affect ABN Amro's financial performance, the CEO said.

So far, ABN Amro has achieved roughly €740 million of its €1 billion cost-saving target by 2020.

Capital headwinds

Apart from the challenges related to costs, ABN Amro is likely to face more pressure on its capital generation in 2019 due to regulatory changes in the EU, including the Targeted Review of Internal Models, or TRIM, and the new rules on nonperforming exposures.

TRIM-related effects inflated ABN Amro's risk-weighted assets by €1.3 billion in the first quarter, after a €5 billion TRIM-related increase in the fourth quarter of 2018, Abrahams said. Higher risk-weighted assets lead to a drop in the common equity Tier 1 ratio, the main gauge of a bank's capital strength.

ABN Amro is already under pressure to keep its CET1 ratio high as it has to mitigate a higher risk-weighted assets inflation in its transition to the new Basel capital rules, to be implemented in 2022 and fully-adopted in 2027. Dutch banks are more exposed to the final Basel rules given their traditionally low risk covers on mortgages and other loans.

ABN Amro's first-quarter CET1 ratio was 18.0%, lower than 18.4% in the fourth quarter of 2018 but higher than the 17.5% booked a year ago. The group aims at a ratio in the range of 17.5% to 18.5% in 2019 but could lower that target if it faces more capital pressure coming from TRIM in the course of the year, the bank said in its earnings report.

Although the TRIM exercise could be finalized in 2020 or even beyond, ABN Amro would prefer to book possible effects earlier rather than later, Abrahams said, adding "it's quite possible" to see more TRIM-related effects on capital in 2019.

The situation is similar with the EU nonperforming exposure regulations, which will likely be finalized in 2020 or later but ABN Amro could see effects as early as 2019, the CFO said.