ING Groep (NYSE:ING) is one of my favorite banks in Europe and a great income investment.
ING is a Dutch bank with operations in the retail and commercial banking segments, being one of the largest banks in Europe given that, at the end of last March, it had more than €1 trillion in assets and some €660 billion in customer deposits. Its current market value is about $46 billion and trades on the New York Stock Exchange through its ADR program.
While in the past ING had several operations across the financial industry, including insurance or asset management, it has streamlined its operations following the global financial crisis of 2008-09, and has nowadays a business profile focused on banking activities, namely in lending. Beyond that, ING also offers other banking activities, such as trade finance, industry lending, or cash management.
Indeed, its loan book represents more than 63% of the bank’s total assets, of which more than 75% of its loan book is retail loans while the rest comes from its commercial business. In the retail part of the loan book, more than 60% of loans are related to residential mortgages in the Netherlands, Belgium, and Germany, thus ING’s loan book has a relatively low-risk profile.
Geographically, even though ING is present in several countries and is relatively well diversified, its most important markets are the Netherlands, Belgium, and Germany, which together account for around half of the bank’s loan book.
Given this geographical background, ING distinguishes its markets between core countries, where it has leading market shares, challenger markets where it offers a direct offering (such as Germany or Australia), and growth markets. Its strategy is to maintain operations in retail markets where it can have a considerable size and reach good levels of profitability, while disposing operations that lack scale or where it can’t reach a good level of profitability.
This means its business profile is well balanced across markets with good profitability levels and other markets with stronger growth prospects. In its domestic market, ING operates in a relatively concentrated banking market, where the top three banks hold a significant market share (about 80%), which is a key factor for a relatively high and sustainable profitability for established players over the long term. Indeed, this is a strong reason why ING and some of its closest peers, such as KBC (OTCPK:KBCSY) or ABN AMRO (OTCPK:AAVMY), have higher return on equity (ROE) ratios than most European banks.
Regarding growth, like other banks, its prospects aren’t particularly impressive as the banking penetration is high across its main markets and competition is quite intense. Its strategy is focused on organic growth through a better customer service, including digitalization to offer a more convenient customer experience and reduce complexity.
Reflecting its mature business, the bank’s main financial targets are not much different from what the bank has recently achieved, showing that its business is not expected to perform much differently in the near future compared to its recent history, as shown in the next graph.
Regarding its financial performance, ING has reported a relatively stable performance since 2015, when its restructuring program ended following the global financial crisis, while more recently its bottom-line was impacted by higher provisions in 2022 due to the pandemic, but recovered thereafter.
More recently, its operations benefited from rising interest rates in Europe, which have been a strong tailwind for its net interest income as expected for a bank with strong exposure to retail and commercial banking.
Indeed, during 2022, ING’s total revenues increased by 5.5% YoY to €19 billion, boosted by net interest income (NII) that increased to €13.8 billion during the past year (+5.3% YoY). Some 75% of the bank’s revenues were generated by NII, but a large part of its assets are based on fixed rates, thus the positive impact of rising interest rates is lower than compared to banks with a higher weight of floating-rate loans. Its fees were up by 2% YoY to €3.6 billion, impacted negatively by a drop of 15% on investment product fees due to weak capital markets in recent quarters.
Regarding expenses, the bank was able to have a good cost control despite the inflationary environment, and total costs were practically flat compared to the previous year. Its efficiency ratio, measured by its cost-to-income (C/I) ratio was 60% last year, which is an acceptable level, but higher than its own medium-term target and above the most efficient banks in Europe.
Its 2025 target is to have a C/I ratio between 50-52%, which the bank expects to reach by a combination of revenue growth, lower regulatory expenses, and overall cost control. However, in the short term, inflationary pressure is likely to lead to higher expenses, and its C/I ratio is expected to be about 55-56% in 2023.
Regarding credit quality, its provisions increased to more than €1.8 billion in 2022, a significant increase compared to 2021. This is explained by the bank’s decision to increase provisions related to Russian exposures, plus some conservative assumptions related to macroeconomic slowdown across its major markets. This led its cost of risk ratio to increase to 29 basis points (bps) in the year, slightly above its over the cycle average of around 25 bps.
This increase in provisions had a negative impact on the bank’s bottom-line, given that its net profit was €3.7 billion (-25% YoY) mainly explained by higher provisions. Its return on equity ratio, a key measure of profitability within the banking sector, declined to 7.2% last year (vs. 9.2% in 2021) and considerably below its 2025 target of 12%.
During the first three months of 2023, its operating momentum improved significantly due to the rising rates, leading to overall revenue growth of 23% YoY. This was supported by NII growth (+17% YoY), while fees dropped by 4% YoY, and for the full year the bank expects NII to rise by more than 10% compared to 2022.
While revenues had a big jump, its C/I ratio only improved to 58% due to higher expenses, remaining at a higher level than desired. On the other hand, risk costs amounted to only €152 million in Q1 (vs. more than €900 million in Q1 2022 related to Russia), or 9bps of average loans, being positive for its net income and profitability level, with its ROE increasing to 9.7% in Q1.
Going forward, ING’s results should continue to be supported by higher rates in Europe, boding well to achieve a double-digit ROE in the coming quarters. However, to reach its ROE target by 2025, the bank needs to improve its efficiency, which may not be easy to achieve given that its track record is not great in recent years.
Regarding its capital position, ING has a very strong position given that its CET1 ratio was 14.8% at the end of last March, being above the European banking sector average and its own target of 12.5%. This means that ING has an excess capital position, enabling it to offers an attractive shareholder remuneration policy, both through dividends and share buybacks.
The bank’s policy is to distribute about half of its earnings through dividends, plus perform share repurchases to gradually converge to its 12.5% capital ratio by 2025. Given this strategy, ING has recently announced a new €1.5 billion share buyback program, which is expected to be completed in about five months. Regarding its dividend, its last annual dividend, related to 2022 earnings, was €0.97 per share, and further dividend growth is likely in the coming years as earnings are also likely to rise.
At its current share price, based on its main listing in Amsterdam, ING offers a very attractive dividend yield of more than 8% based on its last annual dividend, being one of its key positive factors of its investment case. The bank’s goal is to deliver a progressive dividend over the coming years, which clearly seems sustainable given ING’s strong business fundamentals and excess capital position, which provide a strong backdrop for its dividend.
Together with share buybacks, ING expects to return capital above its annual earnings in the next couple of years, as the bank does not desire to operate with excess capital over the medium to long term.
ING is a bank with strong fundamentals due to its retail-oriented business model and a loan book with a relatively low risk profile. Its operating momentum has been supported by rising rates, supporting its excess capital position. Due to this background, ING wants to return most of its earnings to shareholders, making its high-dividend yield quite attractive for income investors.
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