DBRS Confirms ABN AMRO at AA/R-1 (high) and Barclays Bank at R-1 (high)

DBRS has today confirmed the long- and short-term ratings of ABN AMRO Bank N.V. (ABN AMRO) and its affiliates at AA/R-1 (high) and the short-term rating of Barclays Bank PLC (Barclays) at R-1 (high); the trends are Stable. The rating action follows the announcement this morning of an agreement on the terms of a merger of the two institutions and reflects the current credit strength of the banks, which both enjoy solid franchises and sound financial conditions. The ratings take into account both the potential benefits afforded in terms of enlarged business and earnings diversification and a broader international footprint, as well as the significant execution challenges entailed by the combination.

In confirming the ratings of both Barclays and ABN AMRO, DBRS underlines that the merger envisions the combination of two healthy institutions, as reflected in their current high ratings, while it affords significant opportunities, not only in terms of cost synergies, but also in allowing the combined entity to boast one of the strongest and most diversified business franchises among European banks, in retail banking, wholesale activities and asset and wealth management.

The current ratings of Barclays reflect the strong market position of the group in the U.K. market as well as its financial strength and highly diversified earnings profile. The rating is also supported by the bank’s strong product and geographical diversification both within the United Kingdom and internationally. All the bank’s business units have been growing successfully over the past several years and enjoy strong franchises and high levels of profitability. The bank’s high short-term rating reflects the group’s solid liquidity and sound practice in managing its overall liquidity.

According to DBRS, the current ratings of ABN AMRO reflect the strength of its domestic and internationally diversified franchise as well as the initial benefits from the bank’s strategic overhaul initiated in recent years, which has crystallised in significant improvement in cost-efficiency measures, asset sales and a more focused capital management. Despite the sale of its U.S. subsidiary, LaSalle Bank Corporation (LaSalle), ABN AMRO retains a strong international footprint, notably in Asia and Latin America, further enhanced by the recent acquisition of Italy’s Antonveneta. Although improvement in the bank’s profitability may have somewhat trailed progress made by similar peers in recent years, DBRS believes that ABN AMRO is on course to deliver enhanced revenue and profit growth, notably by managing costs more aggressively and by dealing with underperforming wholesale banking activities, as highlighted by the bank’s first quarter 2007 earnings.

DBRS also notes that both institutions have a strong track record in managing risks, and that rising credit expenses associated with unsecured lending in both the domestic market of Barclays, particularly Barclaycard, and the Brazilian operations of ABN AMRO remain manageable and are offset by solid lending margins and credit protections.

DBRS adds that the transaction will maintain the capital strength of the two institutions. The merger proposed by Barclays is to be consummated through an exchange of shares at a parity of 3.225 new Barclays shares for every ABN AMRO share. On this basis, ABN AMRO’s valuation is around EUR 67 billion. Given the Barclays market capitalization of approximately EUR 71 billion, the combined entity will be owned by the current shareholders at a rate of 48% ABN AMRO and 52% Barclays. Based on the transaction’s all-share financing, the acquisition goodwill that will arise will be offset by a corresponding increase in regulatory capital, allowing the combined group to retain satisfactory solvency levels. The two institutions both report their accounts under International Financial Reporting Standards (IFRS); therefore, the impact of changes required to ensure a full alignment of accounting principles should remain minimal. However, more material adjustments are likely to be made with regard to the costs associated with the restructuring ensuing from the merger, which the two banks currently estimate at EUR 3.6 billion.

The enlarged group will be committed to maintaining a strict approach to capital management, as well as sound regulatory solvency. The new group is expected to display a Tier 1 ratio of around 7.75%, with an equity ratio of around 5.75%. The proportion of innovative Tier 1 should remain unchanged, at less than 15%. The regulatory capital released by the sale of LaSalle, of approximately USD 12 billion, will be returned to the shareholders of the combined group after completion of the merger, which is fully in line with the group’s strategy for managing excess capital.

One of the key attractions of the combination is the high level of cost savings implied. DBRS views them as significant and challenging, believing that they must include extensive usage of ABN AMRO’s offshoring initiatives. The banks estimate that there will be total synergies of around EUR 3.5 billion by 2010 – composed of EUR 2.8 billion of cost savings and EUR 700 million of revenue synergies. Given complementary rather than overlapping geographical franchises, DBRS views these forecasted cost savings as rather challenging. However, the complementarity of the two groups may also provide them with the opportunity to adopt best practice wherever possible. One area of cost savings could be ABN AMRO’s wholesale banking operations. DBRS remains of the opinion that other contenders for a transaction with ABN AMRO may be able to extract higher potential synergies than Barclays, although the process in that case could be more controversial and more painful.

There continue to be a number of hurdles the two banks must overcome to see the transaction through. However, the fact that ABN AMRO has also announced the sale of LaSalle to Bank of America for USD 21 billion in cash diminishes to some extent the possibility that a consortium of banks (The Royal Bank of Scotland plc (RBS), Banco Santander Central Hispano S.A. (Santander) and Fortis Bank SA/NV (Fortis)) will come forward with a counter bid (given that RBS was primarily interested in the U.S. operation). We view this sale as an integral and key part of the deal. It is, of course, possible that other suitors will show their hand in the short term, so there is no certainty that this planned combination (1) will materialize and (2) will proceed on the current terms and conditions. However, given the friendly nature of the discussions, it is more unlikely that the board of ABN AMRO would recommend a competing bid unless Barclays were given the opportunity to revise its offer. It is indeed precluded from doing so through the deal agreement.

While viewing the proposed combination as positive, DBRS anticipates significant management challenges for the process, particularly given the diverse cultures of the two groups. For example, the more centralised and integrating strategy of Barclays appears different from ABN AMRO’s more federal and decentralised structure. Looking back on the recent history of cross-border bank mega-mergers, DBRS believes that cultural integration will remain a significant challenge for some time. Without ultimate success in this area, such a large combination would always raise questions regarding the wisdom of the transaction and its accretive value. That said, DBRS adds that it has high regard for the quality of the management team that will steer this transaction forward and believes that it will be successful if the planned combination goes forward.

In time, meaningful integration between the groups and their cultures should lead to the same level of ratings, according to DBRS. Going forward, DBRS concludes that any rating upside potential will be predicated on managing a seamless integration of the two banks’ wholesale banking units; delivering on the expected synergies, notably the cross-fertilisation of the two groups’ strong mid-market franchises; and leveraging the development of their international business units.

DBRS adds that, at their current level, the ratings of both Barclays and ABN AMRO also incorporate DBRS’s expectation of some form of timely systemic support for the merged bank and its core subsidiaries, in the highly unlikely event of a stress scenario.

ABN AMRO has its headquarters in Amsterdam and reported total assets of EUR 987 billion at year-end 2006. With its headquarters in London, Barclays had total assets of GBP 996.8 billion at 31 December 2006.

DBRS's rating definitions and the terms of use of such ratings are available at www.dbrs.com.

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