DBRS Comments on the Potential Rating Implications of the Fortis-RBS-Santander Consortium Offer for ABN AMRO
DBRS has commented today on the potential rating implications arising from the offer of the consortium formed by Fortis SA/NV (Fortis), the Royal Bank of Scotland Group plc (RBS) and Banco Santander Central Hispano S.A. (Santander) for ABN AMRO Holding N.V. (ABN AMRO), highlighting the opportunities and challenges that such a transaction, if completed, might entail for its participants, as well as several of the uncertainties which remain at this stage in the process. The proposed offer was published yesterday.
DBRS’s comment starts by noting that the consortium offer is unsolicited, which creates uncertainty regarding its realization as well as inherent execution risk. The offer is competing with the merger agreement announced by ABN AMRO and Barclays plc (Barclays) on 23 April 2007, which has been backed by the board of ABN AMRO. This said, ABN AMRO has announced today that it has created a management team to review the relative merits of the consortium offer. The key pre-conditions to the proposed consortium offer are predicated on both the preliminary ruling from the Dutch Enterprise Chamber not being overturned and ABN AMRO shareholders not approving the April 23 Bank of America agreement. In that regard, ABN AMRO’s management has highlighted that breaching the sale agreement with Bank of America might entail significant potential liabilities which would weigh ultimately on the consortium members. To offset this financial risk, the consortium plans to retain up to EUR1.8 billion from the ABN AMRO acquisition price to cover potential legal liabilities.
The offer entails the allocation of ABN AMRO’s businesses and geographies among the consortium members. As a result, if completed, the proposed transaction could have material ramifications on the business mix, earnings and risk profile of all participants, as summarized below.
Overall, DBRS reiterates that the end result of the transaction fits with the strategies of each consortium member and creates significant revenue-diversification opportunities and synergy opportunities as well. It allows the three banking groups to fast-forward their international expansion in geographic areas in which they are already present or aim to be: Santander in Italy and Brazil, Fortis in the Netherlands and RBS in the United States and Asia. That said, the inherent execution risks of a transaction of such magnitude and complexity – the first of its sort in the modern history of banking – include key employee buy-in, especially for the wholesale and investment banking parts.
The proposed total consideration of EUR71.1 billion, which incorporates a significant goodwill and a large cash component, will require the potential acquirers to implement substantial capital management exercises – including raising significant amounts of regulatory capital.
DBRS adds that, given the early stage and high degree of uncertainty of the proposed transaction – which is likely to meet several hurdles – expressing a final opinion on the existing ratings would be premature. That said, if future developments match its current analysis, DBRS says that the current ratings of the three consortium banks – RBS, Santander and Fortis – appear well positioned. This could also be true in the case of ABN AMRO’s ratings, although further clarification is needed regarding the future structure of the Dutch bank’s liabilities and assets.
With regard to RBS – rated AA (high)/R-1 (high) with a Stable trend:
Geographically, the acquisition of the ABN AMRO businesses (mainly the wholesale banking, U.S. retail and Asian banking businesses) will mean that a lower proportion of RBS group profitability will stem from the United Kingdom (around 46%, compared with 58% at year-end 2006) and a higher proportion from the United States (34%, compared with 26%), thus increasing the proportion of RBS’s operating profit coming from outside the United Kingdom from 42% to around 54%, and enhancing the group’s global footprint and earnings diversification.
DBRS also notes that the enlarged RBS’s business profile will be further skewed towards wholesale and investment banking, incrementally raising the bank’s overall risk profile. Other key challenges include risks associated with managing a transaction of this size and complexity, in particular those of client and key employee retention. RBS has stated that it intends to minimize the destabilising effect on the enlarged franchise through the use of well-tested integration principles. In this context, DBRS recognizes the U.K. banking group’s solid track record so far in integrating large acquisitions.
A strain on capital should be short-lived, with the group targeting a 7.2% Tier 1 ratio (on a fully consolidated basis) at the end of 2007 (7.1% on a pro forma proportional consolidated basis) versus 7.5% at year-end 2006. The hybrid component of Tier 1 capital will be raised temporarily to 36% (on a fully consolidated basis, 40% on a pro forma proportional consolidated basis), but going forward it should revert to the 25%-30% band.
DBRS aims to review in more detail the financing of the transaction and the plans to integrate ABN AMRO’s activities. At this stage, however, it expects the transaction’s potentially negative connotations to be mitigated by the revenue-diversification opportunities – especially in the U.S. market – and by RBS’s overall strong credit fundamentals and management expertise.
With regard to Fortis – rated R-1 (middle) with a Stable trend:
Fortis aims to secure from the proposed transaction ABN AMRO’s Dutch universal banking activities (excluding wholesale clients and some consumer finance subsidiaries), as well as its global private banking and asset management businesses.
The combination of ABN AMRO’s well entrenched domestic franchise with Fortis Bank Nederland’s activities should bolster Fortis’ market position in the Benelux area. While the challenges of managing a smooth integration and extracting the ambitious EUR1 billion cost and revenue synergies should not be underestimated – especially given the magnitude of the transaction and the manner in which it has been initially proposed by the consortium – DBRS also points to the management team’s experience in dealing with complex mergers.
Fortis intends to fund the transaction rather conservatively, through a combination of rights and hybrid debt instruments issues, asset sales and more efficient capital management, to minimize the dilution of its solvency and maintain the group’s leverage at tolerable levels, although DBRS said that the amounts required remain significant relative to Fortis’ current capital base.
As a result, DBRS estimates that, subject to the ongoing review of the transaction, this should not have adverse ramifications on Fortis’s current R-1 (middle) short-term rating. (At this time DBRS does not rate Fortis’ long-term debt.)
With regard to Santander – rated AA/R-1 (high) with a Stable trend:
Santander aims to acquire ABN AMRO’s business unit in Latin America (mainly Banco Real’s operations in Brazil), Antonveneta in Italy and some Dutch consumer finance activities in the Netherlands. All these additions would fit well with Santander’s retail financial services focus and the geographic areas where it is or wishes to be present. Synergy and market-enhancement opportunities also exist, for example in Brazil, where it would own one of the largest and geographically well-diversified banks.
Santander’s well-tested capacity to integrate acquisitions gives credibility to the bank’s planned EUR1 billion cost and revenue synergies, by aligning the operating efficiency of the acquired entities to the group’s high standards. The Spanish group intends to minimize the dilution of its Tier 1 by issuing a mix of equity and mandatory convertible debt for around EUR9.4 billion. Also, a very large share of the financing of the proposed transaction will come from “balance sheet optimization”, of which EUR8.7 billion from increased leverage and securitization and EUR1.9 billion from asset sales.
With respect to the group’s business and geographic mix, DBRS adds that the planned transaction would increase exposure to Latin America and would make it more vulnerable to the potentially volatile and less seasoned Brazilian market. Pre-provision income from the whole Latin American region would reach close to 45%, compared to 35% currently, and Brazil would account for around 25%, versus 14% currently. That said, asset-quality challenges should remain manageable, given that lending to Latin America in general and to Brazil in particular would remain limited to 13% and 5%, respectively, of the consolidated book.
DBRS adds that it will consider further development of the proposed transaction, but at this stage Santander’s current ratings and Stable trend appear well positioned, especially given that progress in Abbey’s U.K. activities is a powerful mitigant to any negative connotations arising from Santander’s increased exposure to riskier markets.
With regard to ABN AMRO – rated AA/R-1 (high) with a Stable trend:
According to the consortium plans, the Dutch banking group should become a subsidiary of RBS, upon the completion of the proposed offer, with Santander and Fortis having minority interests, but various businesses will ultimately be transferred to the respective consortium members as summarized above. In DBRS’s opinion, the transfer of some of the bank’s most valuable assets (e.g., domestic and international retail banking, or wealth management) will materially alter the business franchise and earnings level and diversification of ABN AMRO. In addition, the wholesale banking activities that are planned to be retained within the legal entity display higher earnings volatility and risk profile, which would also significantly affect ABN AMRO’s credit fundamentals. As a consequence, once the probability of the proposed transaction under its current terms becomes higher, DBRS will be reassessing ABN AMRO’s AA (low) Intrinsic Assessment (which is a component of the bank’s AA rating), with the likely outcome being a material downgrade.
DBRS adds that there remain significant uncertainties with regard to the future situation of the outstanding rated debt securities of ABN AMRO. If transferred with the matching assets to the consortium members, their rating might have to be re-examined in light of the rating of the new parent. If they remain on the balance sheet of ABN AMRO, however, their rating will be pegged on the rating of RBS, as the securities will ultimately be supported by the parent, reflecting a Support Assessment of SA1. In such a scenario, ABN AMRO’s current ratings are consistent with RBS’s current ratings
DBRS's rating definitions and the terms of use of such ratings are available at www.dbrs.com.