Gentlemen, thank you for holding and welcome to the ABN AMRO Q3 2018 analyst presentation. At this moment, all participants are in listen only mode. After the presentation, there will be an opportunity to ask questions. I would like to hand over the conference to Mr. Kees van Dijkhuizen, CEO. Please go ahead, sir.
Thank you very much, operator. Good morning, everybody. Welcome to the investor and analyst call for ABN AMRO's Q3 results. I am joined here by Clifford Abrahams, our CFO, and Tanja Cuppen, our CRO. This update is shorter than our usual quarterly presentation because next week we are hosting our investor day. Today we will focus on the Q3 financial results. If we now turn to slide two, I will highlight the main points of the third quarter. I am pleased with our financial results for the third quarter. They were good. Our net profit was EUR 725 million. Our NII increased, supported by corporate loan growth in our strong domestic market. Costs are well controlled and impairments continue to trend down. Capital position strengthens further to 18.6%.
As a result, we decided to accrue 60% of the year-to-date net result to create flexibility to pay additional dividends over 2018. I am also very pleased with our performance under the 2018 EBA stress test, showing strong capital resilience under adverse circumstances. We also scored well in RobecoSAM's annual sustainability review, and we are one of the best performing banks on sustainability across the world again. We have renewed our purpose in banking for better for generations to come and refreshed our strategy. We will focus on three pillars, supporting our clients transition to sustainability, reinventing the customer experience, and building a future-proof bank. We will discuss these strategic themes in more detail during our investor day next week. Furthermore, the members of the executive committee will give an update on achievements and outlook for their businesses. We now move on to the P&L slide on slide three.
Like I said, we are pleased with the third quarter result. A net profit of EUR 725 million, up 8% on last year. Operating income increased on the back of higher NII and private equity gains. Operating expenses were marginally higher. It is also good to see that impairments are lower compared to previous quarters. Tanja will discuss these in more detail later. I would like to hand over to Clifford to take you through the details on the financials.
Thank you, Kees. I will start with developments in client lending on slide four. The trends we see in the mortgage market are that house prices continue to rise, but with lower transaction volumes due to a housing shortage. We also see that long-dated mortgages remain the most popular choice given the low interest rate environment, and competition from banks and non-banks is still strong. Because we remain disciplined in pricing, we have seen a decrease in our market share to 16% over the last quarter and 18% year-to-date. This is below our natural market share. On the other hand, commercial banking continues to grow, driven by the strong Dutch economy, leading to credit demand across all sectors. CIB's loan book showed a small increase. That's our corporate bank, and this warrants an explanation. We announced in August that CIB would lower its RWAs by EUR 5 billion by 2020.
We also said that the decline would not be linear, and you can see that this quarter. Dollar appreciation was responsible for around $0.1 billion increase, while loans in the Netherlands and natural resources also showed an increase. On the other hand, volumes in commodities and transportation were lower, reflecting our business refocus. We expect the effects of the CIB refocus to be more evident in coming quarters. Finally, we're encouraged by the increase in consumer loans, given our efforts to grow steadily in this market. Turning now to net interest income on slide five. NII was up versus Q3 last year, mainly due to corporate loan growth and higher mortgage penalty fees. Margins remained broadly stable across products compared to Q3 last year. These effects were partly offset by headwinds from low interest rates. Our income related to our equity duration is declining.
Margins on deposits are under pressure as most client rates cannot be lowered further. These headwinds led to marginally lower NII versus Q2. We expect a further marginal decline for Q4. We also updated our model for non-maturing deposits. This led to lower internal compensation for deposits raised by our business lines, lowering NII for business segments with a consumer deposit base and benefiting group functions. From now on, interest income of group functions will be distributed to the business lines in line with our allocated equity. The combined effect of all this has led to some intragroup shifts in NII. The numbers you can see relating to this is in the appendix for this presentation.
I would emphasize that the overall impact for the group is limited to only around EUR 10 million additional hedging cost per quarter from the rebalancing we've made to our interest rate exposure. Moving now to fee income on the next slide. The third quarter fee income was largely unchanged from previous quarters. Trading volumes in the financial markets were relatively low, negatively impacting fee income at clearing. Securities volumes in private banking were also somewhat lower. This was offset by an increase in payment package fees in retail banking. Our other income has remained above trend. EUR 80 million of other income was due to hedge accounting and various other valuation account effects. Private equity showed a strong gain of EUR 107 million in Q3. Currently, we're the sole investor in our private equity funds.
We're in the process of exploring possibilities to enable external parties to participate in existing and new funds, I expect to update you regarding this in coming weeks. Moving on to costs on slide seven. As you can see from the left-hand chart, personnel expenses continue to trend down. FTEs have decreased another 500 since the last quarter and by 1,500 over the year. We took a restructuring provision of EUR 27 million in Q3 and expect to take a further provision in Q4. Other expenses, excluding incidentals and levies, are up. This was due to somewhat higher external staffing and costs related to completed M&A activities within private banking. External staffing is up due to high levels of temporary staffing and some regulatory projects currently underway. On the right-hand chart, you see how we're delivering on our cost-saving programs.
Since year-end 2015, our cost-saving initiatives reduced costs by EUR 640 million. As you know, we're targeting EUR 1 billion cost reduction, including in relation to the corporate bank. We're well on track here. I'll now hand over to Tanja to pick up impairments on Slide eight.
Thank you, Clifford. I will update you on three topics which have your attention: loan impairments, conduct, and the stress test. Starting with impairments, the third quarter showed a further decline. Within CIB, some additional impairments were taken within natural resources on already impaired files, mainly offshore clients. In commercial banking, impairments were largely on existing shipping files. This quarter, we had a release in healthcare, I don't expect substantial impairments here for the remainder of the year. The lower coverage ratio is largely due to a write-off of fully provisioned metal files. I'm still confident with the outlook we gave for full-year impairments and expect to end below the through-the-cycle cost of risk of 25 to 30 basis points. The indicators for the Dutch economy remain strong. The outlook remains positive. The defaulted portfolio continues to decline, though challenges remain in the sectors we have identified.
With regards to conduct, we are transparent with regulators and have an open dialogue. We have made significant investments in our transaction monitoring processes and systems continuously use actual cases to improve. We have also made significant investments in KYC over the last years. Our decision to divest offshore private banking activities was partly related to reduce our exposure to conduct risk. The executive committee is actively engaged on these topics. Moving to the results of the EBA stress test on slide nine. I'm pleased with our recent EBA stress test results, where ABN AMRO performed really well. Under the adverse scenario, our CET1 ratio declines by around 270 basis points, reflecting the resilience of our capital position. This number compares favorably with the 48 banks in scope for this stress test.
At 14.5% in the adverse scenario, the CET1 ratio remains above the 2018 SREP requirement of 10.4%. The same applies to the leverage ratio, which remains above 4% in the adverse scenario. Now handing back to Kees.
Thank you, Tanja. As you can see on slide 10, CET1 is up to 18.6% held by lower RWAs, something we also saw last quarter. I would like to point out that most of the drivers responsible for this decline of RWAs under Basel III do not improve Basel IV RWAs. For example, higher collateral values for residential or commercial mortgages, lower Basel III RWA, but don't impact Basel IV RWA. While Basel III CET1 ratio has improved materially during 2018, Basel IV CET1, excluding mitigations, remains broadly flat around 13%. Nevertheless, we have decided to accrue 60% of the total year-to-date results. It gives us the flexibility to pay an additional dividend over 2018. We prefer an additional dividend over a share buyback.
Our final decision on dividend payout will be made at the full-year results in February of 2019, when we can also reflect on our SREP target for 2019, which we expect by January 2019 at the latest. We want to know the SREP because ECB is currently formulating industry-wide guidance on provisioning backstops for non-performing loans. If these backstops turn out more stringent than accounting standards, this will lead to capital reductions or a higher SREP capital requirement. In addition, the leverage ratio requirement of 4% is, for the time being, also a constraint in the short term we have to deal with. We will update you further on our investor day on capital management, returns, and our Basel IV management response, including mitigations. Now moving on to our targets on slide 11.
As you can see on this slide, we are well on our way to achieving our financial targets for 2020. We have already for some time been consistently meeting three of the four targets, being ROE, capital, and dividend.
Cost-income ratio of the first three quarters also meets our target. However, the full-year number will be impacted by seasonally higher regulatory levies in the fourth quarter. As already mentioned, we also expect some additional restructuring charges in Q4. Here we still have some work to do to bring our CIR ratio structurally within the target range. Before I go to Q&A, I would like to briefly recap the highlights on slide 12. We delivered a good quarter with a strong net profit of EUR 725 million. NII remains resilient, helped by domestic corporate loan growth. Impairment show a further decrease from last quarters. Costs are well controlled. We have focused on the Q3 results so far. As we have an investor day next week, I will most likely refer you to next week for questions on strategic themes and outlook of the various businesses.
Now I would like to ask the operator to open the call for questions.
Thank you. Ladies and gentlemen, we will start the question-and-answer session now. If you have a question, please press star one. May I remind you to limit yourself to two questions. For questions, you can press star one. The first question is from Pawel Dziedzic, Goldman Sachs. Your line is open.
Good morning. Thank you for the presentation. Two questions from me. The first one is quite basic, I guess, and it just goes back to your payout accrual. Can you help us understand how you decided on 60% for this quarter? Is it simply a figure that leaves your Core Tier 1 slightly above upper end of your capital targets? Perhaps there is more to it. I guess related to that, how flexible do you intend to be when you announce your final dividend recommendation? For example, if your guidance on Basel IV, including mitigation, changes a little bit. That would be my first question. The second question is just on your mortgage market shares dropping. You mentioned the competition is ongoing. How should we think about your tactics here over the next couple of quarters?
How long are you willing to see this market share erosion, at what point in time you think you may need to adjust your pricing? Thank you.
Thank you very much. Payout accrual of 60% is a figure we have taken now into the figures, not so much because it is exactly leading to an 186 or something like that. It's just a percentage we feel comfortable with to accrue today. We are flexible in February. With respect to the market share in mortgages, of course, we will look into this carefully, but it's also important that, we've seen it actually 10 years ago, when there was also a lot of competition in the mortgage area. We want to stay disciplined here, especially when you talk about 20, 30 years mortgages. As we swap the interest, you actually lock in a margin for a long period. We don't want to have margins below hurdle. We will be disciplined here in our margin approach.
Of course, we will watch it every quarter, how we exactly are going to maneuver in the quarters.
Thank you. Maybe just one follow-up, this is on leverage. You mentioned you still want to be above four%. When do you expect to realize this 50 basis points uplift under CRR2? Does it impact the way you think about dividend payment when you announce the dividend early next year? Is this one of the things that you consider?
Yeah. Well, the leverage ratio, the one related to clearing, is actually in the figures now for 2021. That's late. There are negotiations at the moment going on in Brussels to open up possibly a possibility for national regulators to earlier adapt, but that's not done yet. At the moment, it's 2021.
Would you be willing for the meantime drop below 4%, or we should see 4% as already a floor?
I think the 4% is seen by regulators as something they see as a kind of floor.
Understood. Thank you very much.
Thank you.
The next question, Farquhar Murray from Autonomous. Your line is open.
Morning, ladies and gentlemen. Just two questions, if I may. Firstly, the impact of Basel IV seems to have increased by 100 basis points versus the indication we got at full-year 2017. Could we just decompose what drove that increase? I clearly understand that some of the risk migration we've seen in the year probably won't carry through to Basel IV, but I don't think it can explain all the change there. Secondly, coming back on the Dutch mortgage margins, we seem to have some commentary towards positivity on margins there. Obviously, you seem to be losing market share to hold things flat. What exactly are you seeing in terms of margin trends in recent quarters by product? Also just what's your appetite with regards to the longer duration mortgages at the moment, particularly in terms of the split of production you're doing? Thanks.
Richard, you take the first one, yeah?
Farquhar, I think you're right to point out the approximate steps. We do have volatility in RWAs under Basel III, in particular, quarter-on-quarter. I'll just explain the reason for the variance. There are a few things. We continue to refine our methodology regarding Basel IV, and that was an element over the course of this year. The rules, as you know, are not enacted yet. We need to make judgments, and we continue to refine that. I think we've highlighted the credit quality improvements as one driver. That flows straight through in Basel III, but Basel IV, we're using the floored standardized approach, and it does not directly impact that. I think our data is also an element that we've been working on improving, what we know about our loan book, and that flows to the benefit of Basel III.
That's another thing I'd highlight. Finally, on business mix, while our overall loan book is roughly flat through the year, our mix has changed a little bit in corporate. That at the margin has an impact because the capital intensity of some of the corporate businesses is really quite high under Basel IV. You put all that together, and that drives that delta. While RWAs have come down under Basel III, they're sort of flattish under Basel IV, and we're calling around 13. It's actually a marginal increase, but it's approximately 13. A number of drivers. I think we're working hard on a few things. One, on business mix. As you know, in August, we announced that we would reduce the size of our corporate bank, and that will flow through.
That will reverse some of the effects we've talked about through mix. We're also working, I call it, on business response. Across the business, we're working very hard on Basel IV, including specific mitigations where we're working through the rules. It's not just the rules. We want to adapt the business to Basel IV. Combined with that effort, we're feeling really quite comfortable with Basel IV. It's around 13. We said we wanted to be 13.5 early in the phasing. We have some years to achieve that. We don't consider Basel IV as a sort of hard constraint in terms of running the business or in thinking about our flexibility around additional distributions currently. Kees talked about some of the other factors that we're reflecting on.
Thank you, Clifford. With respect to Dutch mortgages, I would say the margins across the board are a bit under pressure. For all the maturities, with respect to the longer durations, our market share, of course, is clearly lower there. As banks, I think, in general, it's more for pension funds and insurance companies, not a sweet spot. Especially there, of course, these days, a lot of clients go there in the area of 20, 30 years, because they expect higher interest rates going forward, and they like to take up an interest fixed period of 20, 30 years. I said that's an area where our market share is lower compared to the five and 10 years.
Okay. Just as a quick follow on, coming back on the 3, 4 drivers you've identified for the change on Basel IV, could you give us a sense of which is the most significant? Is it the refinement in methodology? Can you be specific to what might have changed there? In particular, does that pick up any change on the NHG treatment?
Yeah. I think the factors I gave sort of 3 elements, I think I would just highlight they're all meaningful in terms of accounting for that difference. I think on NHG, our current treatment in our estimate of around 13 includes the benefit of NHG. We see that as a sovereign guarantee, our planning is that that would transition into Basel IV. I think you highlight a theme here, which is we're making judgments about Basel IV. Although the rule is 200 pages, sounds like a lot. We have to make judgments about how it applies, our peers are doing the same. We'll continue to refine that. We think the best way of signaling financial flexibility remains through our Basel III target of 17 and a half to 18 and a half, we're a little bit above that today.
Feeling well positioned on Basel III, comfortable on Basel IV, continuing to work hard on this, we'll update on this further at our Investor Day next Friday.
Okay, great. Thanks.
The next question is from Mr. Stefan Nedialkov, Citi. Your line is open.
Hi, guys. Good morning. Stefan from Citi. A couple of questions on my side. Just to continue on the Basel IV versus Basel III. Did your previous methodology include input floors? To what extent did input floors play a role
Yeah
in terms of Basel IV previous estimate, Basel IV today's estimate?
Yeah.
On my second question, well, some banks have told us how much they can mitigate Basel IV. Are you comfortable giving us some guidance out of this 560 basis points or so of Basel IV impact? How much can you mitigate via management actions on day one versus over time? Lastly, you did mention there needs to be industry-wide NPL coverage guidelines that are coming up. Are we talking about the two-year unsecured 100% coverage, seven-year secured NPL coverage type of guideline, or do you have anything else in mind? Any color you can provide us in terms of numbers. Thank you.
Okay. I'll take the first two, Tanja, the third. We're talking about the output floor, the figures that we've provided are based on the output floor. The revised standardized approach times the 72.5%. That's how we're thinking about it. They're the numbers that we quote.
Clearly, other banks are influenced by other things, the output floors are the binding constraint for us. We'll work through the input floors, for our constrained IRB, that's meaningfully lower than our capped revised standardized approach. That's why we're focused on that standardized approach as the constraint. I think in terms of our responses and mitigations, as others are, we're working hard on that. We expect that our mitigations would mitigate some of that RWA inflation, we'll give more color on that next week. We see there's really a few elements around Basel IV, we call it business response. Mitigations are working through the, call it, the rules and the application, thinking about our products. I call that behind-the-scenes work. We think there's scope for that, as others have commented on.
We'd call it business response, which is how we're managing our business in terms of the mix of business. Can we distribute more? We've announced, I think, a material step in that direction in August. That's separate. Finally, pricing. Part of it is mitigations is around can we reduce our Basel IV RWAs? We think we can meaningfully. A lot of our work now is thinking about how do we deliver adequate ROE on all our business going forward. Across that, we'll update, and give you further insight into our thinking next week.
Okay. Yeah. I will respond to your question on the NPL guidance. It's indeed the guidance related to the percentages that you were just mentioning. Actually, we see a few developments in this area. We see, well, ECB has come with NPL guidance. EBA has a guidance sent out as a proposal, also the European Commission is working on regulation for non-performing loans. We see quite some developments. Well, it's still uncertain how this all will pan out. We do see that regulators are developing their regulatory expectations. Of course, the ECB guidance is already in place, that's applicable to new exposure. It's hard to say at this stage what the implications there will be, we are preparing for that, and doing our analysis.
Okay. Thank you.
The next question is from Mr. Nick Davey, Redburn. Your line is open.
Yes. Good morning, everyone. Two questions, please. The first one on the private equity business. First, in terms of its contribution this year. Second, this comment you've made about seeking external funding. I mean, if I look at the first nine months of this year, the private equity business has contributed nearly 10% of earnings. It's almost needing its own division pretty soon. If I go back just a couple of years to 2016, it contributed basically nothing. Could you just help us, A, understand what's going on here, why the really strong results this year? Maybe make some comment about how comfortable you are in terms of this unit introducing, I guess, this P&L volatility. Maybe related to that, just talk about this comment about seeking external funding. Are you trying to beef it up?
Are you trying to reduce it by moving it to third parties? Just so I understand what's going on there, please. Then a second comment, please, on a second question on the replicating portfolio. Sorry, it's a bit of a perennial question from this side. We obviously had the helpful update into the quarter on what you're doing with the non-maturing deposits. Still struggling a little bit to understand the outlook here, because on the one hand, in the NII slide, you're talking about the headwinds from this replicating portfolio. On the other hand, you're talking about now being better positioned into interest rate rises. I'm just trying to understand, A, the sort of attrition from this portfolio, if rates stay low for as long as rates stay where they are, and B, what you hope starts to happen as rates start to rise.
I hope that's clear. Thanks.
Thanks, Nick. With respect to private equity, as you mentioned, good results, very good results this year and less in earlier years. That also is, by the way, one of the reasons it's quite cyclical, that we would like to also have external funding here, third parties. It's, by the way, also market practice, so it's not new. We think indeed it will lower our private equity exposure a bit, when we have third parties in the private equity area. Less cyclical movements as well. Clear.
We appreciate it's a complex area. I'd say two things. We're exposed to low rates around the three themes. One is it comes through in mortgage market, which Kees talked about. The two things that we're talking about here in this question are deposit margins and the money we make on our equity. Two different things. In terms of our deposit margins, as you said, we recognize our margins via the replicating portfolio. That introduces a lag in terms of as interest rates are coming down over time. If rates develop as expected, there'll be a natural feed-through into our replicating portfolio or the way we think about margins, that will reduce margins moderately over time. We know what the forward market is saying about rates. Rates have consistently come down and that works its way through.
Our outlook has been, if you like, for some modest further deposit margin pressure over the next year or so, based on our view of interest rates, we expect those to pick up at the end of next year, short rates. Clearly if rates pick up sooner or later, you'll get variance around that. That's one effect. There's not a lot we can do about that other than lower the rates we pay to clients, we feel that's pretty much run its course. I think the third theme I talked about was positioning ourselves for rate increases. That relates to the money we make on our equity, if you like, our equity duration. There we've shortened somewhat, less than two years as disclosed at the half year.
That means that we're in a position, our money is locked in for a shorter time period, as rates pick up, we should see the benefit of that. We'll report it through group functions then allocate it out to the businesses. I hope that gives a bit further clarity. We're happy to pick this up offline as well, we'll touch on it next week at the investor day.
That's really helpful. Thank you. Could I ask just one follow-up then? Sorry, back on the private equity contributions, which you're obviously trying to reduce. Could you give us a sense of the capital tied up in the private equity operations currently and maybe the capital benefit you get from seeking third party investment?
Yeah. The total assets we have is just under EUR 1 billion. There are different risk weights associated with that portfolio. The RWAs are more than that, somewhat more than that. I think, if we end up engaging with third party money, I think at least in the short term, you should see it as an opportunity to leverage the capability in the business more than a material reduction in RWAs, at least in the short term.
Okay. Thank you. Sorry, I'm going to try my luck on the deposit margin pressure.
Yeah
I can see you're still avoiding giving us numbers, which I sympathize with. If I interpret your language on modest further deposit margin pressure over the next year or so, my suspicion is that you're running something like a five-year swap book then. At the moment, five-year swap rates are in line with the rolling average of the last five years, which means for the next year or so, the swaps you put on five years ago are reinvesting lower. At some point, 12, 18 months from now, you reach net neutral. Am I wide of the mark? Is that a crazy interpretation?
Well-
Bit simple, no doubt.
First you are trying your luck. I agree with that. We've not disclosed deposit margins. I don't think any banks do that. I think the five years, it's a bit less than that. We'll give a bit more color, we don't want to give forecasts for obvious reasons on particular elements.
We've guided the effect of this in our historical remarks around flattish NII, we've indicated earlier today what we see of Q4. We'll give a bit more color on that next week to help folks understand it. It's really so that you're in a position to come up with your view of interest rates because people have different views.
Yeah. Absolutely. Yeah. Sadly, we've got to make the forecast, don't we, if you don't have to.
Yeah.
Okay. Thank you very much. Thanks, guys.
The next question is from Mr. Adrian Cighi, RBC. Your line is open.
Hi there. This is Adrian Cighi from RBC. Just one follow-up question on capital, please. Your average risk-weighted asset for mortgages increased marginally quarter-on-quarter. As you noted earlier, house prices have increased and the LTVs have declined. Is there any impact from TRIM or are there any other drivers? More broadly speaking, do you see any impact from TRIM coming through the numbers? Thank you.
Yes, I'll take that question. Actually, I think what came through in the Q3 numbers is a small move of a portfolio from one to the other that had some impact on RWAs. I think no significant change there. In terms of TRIM, we do see some impact there, but it is also not material. The slight change that you see it can be part of that because, well, we are of course addressing the TRIM findings over time. It is not significant.
Okay. Thank you very much.
The next question is from Mr. Benjamin Goy, Deutsche Bank. Your line is open.
Yes, hi. Good morning. Two questions, please. One on loan growth and the other on fees. Maybe starting with fees, in particular in retail you saw an uplift. Just wondering whether this repricing is basically a turnaround what we have seen in 2017 and how sustainable you think it is, and what your assumptions about behavioral effects here from clients are. The second one is on your commercial banking loan growth. It has slowed down further in the quarter. Do you expect some new trends here? Because in the past you said growth largely in line with
With, GDP-
Yeah
just any thoughts.
I think on fees, I agree with your comment. We did reverse some of the fee reductions we took 18 months or so ago. We follow the market. We want to give our clients competitive products. We feel that's in line and have no plans to change that and no material impact on our client base. That was behind some of our comments earlier about, we think we've rebased fees. There'll continue to be volatility. We're looking to, over time, grow fees from here. I think on the commercial bank, you're right. It was slower growth in Q3. I think there are a few drivers for that. The economy remains strong. We are looking to support our clients into the growing economy, as Kees indicated. In parts of the market, it can be quite competitive.
We are very focused on maintaining our discipline both on pricing and terms. We're looking at leverage finance, real estate, as particular areas of, call it continuing discipline. Finally, the market just is a bit slower in Q3, where you have the lagged effect of the summer. I think going forward, we're looking to continue to grow that book nicely. Looking to remain cautious on particular segments as we get to the later stages of the credit cycle.
Okay. Thank you.
The next question is from Mr. Kiri Sri-Ayuthia, HSBC. Your line is open.
Yes. Thank you. First question, going back to the RWAs in CIB, and the lack of the progress I guess there. I was just wondering, are you having any issues with the originate to distribute model , that you're finding it may be harder to offload assets than you previously thought? Or do you need to build out your originate to distribute platform further to get the volume done? Second question, just very quickly on the private equity, reducing your exposure there is I know you said short term, not much RWA release, but when you look out to your overall RWA targets, am I right in thinking that's additive to what you've earmarked, the EUR 5 billion-
Yeah
reduction, is that additive to your plans from last quarter? Thank you.
Yeah. I'll answer that. In terms of RWAs, we were pleased with initial progress in Q2, that addressed, call it shorter term business. We've made a good start there. Going forward, we've said we want to bring this down over time. We don't want to disrupt our client franchises. And we'll do that through 2020. Some of the more medium-term business, we have a pipeline of business. The business takes a while to run off. There's no particular issue around the performance in Q3. And in fact, in CIB, it's gone up largely as a result of operational risk, which has moved out of group functions, which Tanja referred to earlier. These are quite small movements. We're very much on track. On originate to distribute, we see great opportunity there. This will take place over a number of years, not quarters.
We have distributed in the past, but we're looking to build our capability meaningfully and our activity here, and we'll update further on that next Friday. On private equity, as Kees said, the business is cyclical. We've not committed to anything. Intuitively, we feel it's smart to lighten up what we think is towards perhaps the top of the market in terms of the asset cycle. And we'll look to manage that portfolio in a sort of smart way over time. So we're not going to commit to dramatic reductions in RWAs. But with third-party money, we have much more flexibility to reduce our capital allocated, in what we might think is a sort of riskier environment going forward.
That's a potential that gives us flexibility as we consider meeting our commitment of a EUR 5 billion RWA reduction, on the timescales I referred to earlier.
Great. Thanks, guys.
The next question is from Bruce Hamilton, Morgan Stanley. Your line is open.
Hi. Morning, guys. Thanks for taking my questions. One just on the topic of private equity, you've had quite a few on this. Just on Tanja, you're saying you think you're pretty good at private equity, and therefore it's an area that you will look to grow, but with third-party money, i.e., it's a kind of fee growth driver in the future. You want to keep the capital intensity no more than EUR 1 billion and hopefully a bit less over time. There's no real plan to grow. I'm just trying to make sure I fully understood that. Then on the sort of distribution guidance, just to get clarity. You're saying sort of 60% payout should be the baseline now, but anything above that will be heavily dependent on any progress on the Basel mitigation-
Yes
which we'll learn about next week, or on the leverage ratio, both of which are a constraint for expecting anything more than that in the short term.
First one. That's it.
Yeah. As you say, we're good at private equity, so we're exploring whether we can make that track record available to external parties, as you say, as a fee opportunity. We don't have plans to grow that business on our own balance sheet materially because of the capital issues. I think we like the profits, but we recognize it's cyclical. In order to better leverage that business whilst maintaining reasonable allocation from a balance sheet management perspective, we're exploring third-party money. We don't plan to materially grow the capital allocated to that business in terms of our on-balance sheet allocation.
Okay, thanks, Clifford. Bruce, on your 60% baseline question, I would say the 60% is of course a signal, but it's not a promise. That means that we, in the end, will decide in February, of course it gives a kind of indication, and it's a signal. That's true.
Great. Okay. Thank you.
Ladies and gentlemen, if you have questions, you can still press star one. The next question is from Marcel Halden. Your line is open.
Good morning. Thank you for taking my questions. I have two left, please. Just on the capital discussion again. Could you discuss with us the capital build year to date this year on the Basel IV? It seems to me that on Basel III, you're building quite a significant amount of capital. Just on Basel IV, it seems flattish. That was my first question. The second question is on costs. Can you highlight any variable costs which was driven by the high other income revenues there? Is there any variable compensation or variable costs that are associated with the higher other income? Thank you.
Yeah. I think on those questions, yes, you're right. The Basel IV position was flattish, and that reflects the standardized approach with the floor. It's a very mechanical calculation. Our business hasn't materially changed in three quarters. I think you wouldn't be surprised if the number was roughly the same. I've given the factors behind that delta with Basel III, including some minor methodology changes. What I would emphasize is these are, if you like, pro forma figures based on our view of the rules. We've not applied any mitigations to those numbers. We're very focused on how the business as a whole is responding to Basel IV, and we'll update on that next week. In terms of costs associated with other income, I think there are no specific variable costs.
I think we flagged what they were, sort of hedging benefits, accounting effects, and the private equity. The private equity, we clearly have a cost base associated with it, but it's fairly modest and largely fixed. Those gains reflect the benefit of deals entered into some years ago.
Okay. Thank you.
Yeah.
Sorry, just one follow-up, if I may. On leverage rates, again, if you're accruing roughly, say now 60% of the year to date, the profits, your leverage ratio doesn't seem to grow that much.
Yeah.
Do you think the 60% is sort of a ceiling then regarding the payout ratio?
The leverage ratio, you can see it's a solid 4.1. It's 4+ this year, and it has been less than that. In earlier years, we had the AVA Q&A. That had been a constraint. Leverage ratio, as Kees said, remains an important constraint for us. It's not an economic one, but one that we've managed to, and I think the 60% accrual reflects our target capital and our various constraints. The two primary ones relate to the target capital range, Basel III, that we're well-placed. The leverage ratio, which remains a constraint, 4.1 is better than 4, but it's a modest buffer. We've talked about how we see that progressing in the medium term. Basel IV, despite this volatility, we remain comfortable at around 13 with some years to meet our target early in the phase-in.
Hopefully that gives you a sense of why, as Kees mentioned, we're comfortable accruing at 60% and giving ourselves flexibility for the end of the year.
Thank you. Very helpful.
The next question is from Mr. Le Gouvello du Timat, from Jefferies. Your line is open.
Yeah. Good morning. I have one last question for Tanja on the CIB customer risk. Can you give us a little bit more color of the dynamic into that part? Because this seems to have some additional sides that are deteriorating on some of the sides and some right back. Also, what can we expect going forward? Thank you.
Okay. Well, thank you for that question. Yeah, you see, of course, still somewhat elevated impairments, a lot lower than in the first quarter of this year. It's also more, I would say, evenly divided within the organization, in corporate banking between commercial banking and CIB. In CIB, we mainly see still provisioning in the energy sector related to offshore. We see clients still either struggling with the recovery or missing out on contracts or impacted in another way indirectly from investments not happening in the offshore industry. That's what we see. Well, I think we are very much on top of this sector, as said, I'm also confident with the outlook for the rest of the year to stay below this 25 to 30 basis points, cost of risk.
I also don't see any other developments in other sectors that cause concern right now in CIB.
That means that you feel confident because you have a few files regarding healthcare over the two last quarter. Also regarding the offshore, is it a specific part of the world, or it's the full sector?
I would say it's the full sector. It's not related to a specific region.
Thank you. See you next Friday.
Okay. Thank you.
The next question is from Mr. Jason Kalamboussis. KBC, your line is open.
Yes. Hi there. I got three quick questions. The first one is on the cost side. Looking at the fourth quarter, you mentioned restructuring regulatory charges. Is there anything else, or should we expect just to continue to see the impact of the lower FTEs on the personnel expenses? The second thing is just checking on the diamond. Can you confirm that you basically feel comfortable that there is nothing coming from that end? The third thing is just on the SMEs, mid-corporates . You had a good growth over the last four or five quarters, slowed down a bit in Q3. What's the outlook, and what can you comment also on the market more in general? Thank you very much.
Okay. Should I do the first, and then-
Yeah.
Maybe I'll turn to you. Yeah. On costs, I think the short answer is no, there's nothing else than the two things you talked about. Tanja?
Yeah. On diamonds, we talked about it earlier in the year, seeing some additional provisions there. We continue to monitor this portfolio very closely. We see also the portfolio reducing over the years. That's all I can say at this stage.
With respect to SME Q3, I think indeed, as Clifford already mentioned, a bit of a summer effect and also margin discipline. Going forward, I would say guidance is still in line with Dutch economy.
Thank you.
There are no further questions at this moment. Please continue.
Anybody else, a question? If not, I would like to thank you all for your questions. This concludes our Q3 results update, and hope to see you all in person next week at our Investor Day. Thank you. Goodbye.
Ladies and gentlemen, this concludes the conference call. You may now disconnect your line. Thank you for your participation, and have a very nice day.