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StockBeat: Covid-19 and Things That Go Bump in the Night

·3-min read

By Geoffrey Smith -- For most of this week, the sound of Europe’s equity markets has been a high-pitched screech of brakes, as companies do their best to stop any spending that isn’t essential to survival.

Buybacks, capital spending, even dividends have been sacrificed at a giddy pace to preserve fortress balance sheet, along with events, marketing and – to judge by the latest updates from Twitter, Facebook (NASDAQ:FB) and U.K. broadcaster ITV (LON:ITV) – advertising.

But a feature of crises like the current one is that, while you can stop the steady drip of outflows,you don't banish tail risks - those potentially catastrophic low-probability, high-impact events.

Take for example the humdrum business of clearing financial transactions, a business that generates mere pennies on the billions of notional deals that it processes for banks who like earning from markets but don't like betting on their direction.

This is the kind of low-risk, low-return life to which Dutch bank ABN Amro pledged itself (under government stewardship) after its high-profile blow-up in 2008, which wrought havoc in the banking systems of north-west Europe.

At the depths of the Covid-19 rout earlier this month, ABN’s equity was trading at barely 30% of its book value, a seemingly exaggerated sell-off in the light of its low risk-profile and decent profitability: it's one of few European banks with a return on equity of 10% or more, and over half its loan book is dull, low-risk Dutch mortgages – exactly the kind of loans that you would expect to be backstopped by a fiscally strong government in a general economic emergency.

Any doubts about the bank's public standing, after a year in which historic money-laundering issues came to light, also receded after it moved quickly in the crisis to restore its public image, giving 55,000 small business customers a six-month holiday on loans up to 2.5 million euros.

But then, something went bump in the night. The bank announced on Thursday that it had made a pretax $250 million loss on a single clearing client whose futures and options strategy appears, in retrospect, to have been sub-optimal.

The client “failed to meet the minimum risk and margin requirements following extreme stress and dislocations in U.S. markets. To prevent further losses, ABN AMRO Clearing decided to close-out the positions of this client,” the bank said in a statement.

The resulting net loss of 183 million euros is nearly 60% of what the bank earned in the fourth quarter.

With a common equity ratio of over 18% at the end of last year, ABN can stomach worse losses than that without too much trouble, but even so, it’s a salutary reminder of how much can – and will – go wrong before the current crisis can be declared over.

ABN AMRO (AS:ABNd) shares fell 5.3% by 6:15 AM ET (1015 GMT), making it the worst performer among continental European banks. The Dutch AEX was down 2.3% and the benchmark STOXX 600 was down 1.7%.

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