Thank you for holding and welcome to the ABN AMRO second quarter 2008 analyst and investor call. At this moment, our participants are in listen-only mode. Following the presentation, there will be a question and answer session. I would now like to hand the call over to Mr. Kees van Dijkhuizen, CEO. Go ahead please, sir.
Thank you very much, operator. Good morning and welcome to the analyst and investor call for ABN AMRO's Q2 results. I am joined by Clifford Abrahams, our CFO, and Tanja Cuppen, our CRO. Today, I will run through the Q2 results and also update you on the corporate banking as promised. Turning to slide two, I will highlight the main points. I am pleased with our financial results for the second quarter, with solid net profit of EUR 688 million. Our operating income remains strong, and impairments have reduced significantly compared to the previous quarter. Our capital ratio has improved strongly to 18.3%, reflecting balance sheet management and is now well-placed within our target range. We have declared an interim dividend of EUR 0.65 a share in line with last year. We are also progressing with our strategic agenda and are well on track to achieve our 2020 financial targets.
We are taking action on CIB, our corporate bank. I will go through the details later, but will summarize here. We will refocus the global sector of CIB and reduce RWAs by EUR 5 billion by 2020. Together with cost reductions of EUR 80 million, we will deliver an ROE of 10% by 2021. Last week, we announced the acquisition of a private bank in Belgium. This adds EUR 6 billion of assets under management, strengthening our position in this attractive market. I would also like to take this opportunity to announce an investor day on November 16th to be held in London. I will now highlight our sustainability activities and then update you further on CIB. Within private banking, sustainable investments are now the default option for our clients in the Netherlands. I am delighted that over 80% of new Dutch clients are happy with this default.
We will introduce this approach in Germany and France shortly. We are targeting a doubling of sustainable assets under management to EUR 16 billion by 2020 and making good progress. On the corporate side, we are involved in many interesting projects. We launched a EUR 200 million energy transition fund, which will focus on sustainable energy and carbon reduction. During Q2, we financed a 110-megawatt solar project in Chile, shown on this slide. We are committed to building out further our franchise around sustainability. Now turning to our plans for CIB. I want to be clear with you that we have some very good client franchises. Our corporate franchise holds a top three position in the Netherlands. We also leverage our strong sector knowledge and domestic platform to serve selected corporate clients in Northwest Europe. Clearing is a top three global player, predominantly in derivatives contracts.
The global sectors, which we often refer to as ECT, have a strong client base, including many industry leaders. Finally, we have a number of product units which support the client franchises. We have leading capability here as evidenced by our top XL ratings in the Benelux. However, CIB's financial performance has not been good enough. We have steadily grown CIB over the years. I'm on slide five now. Costs have followed top-line growth, which means that we achieved only limited benefits of scale. RWAs have also increased, but to a lesser extent. Consequently, ROE has been disappointing over the years, remaining structurally below our group target of 10%-13%. This conclusion doesn't change if you look through the recent elevated impairments and the cost for SME derivatives. We have Basel IV coming, we will also be faced with high capital requirements in the future.
All this means we need to look hard at where and how we compete in CIB. Turning to the next slide, I want to go into more detail on the individual sectors. Over recent months, we've done that in-depth analysis. You see here on the left, our sectors plotted against the key drivers of cost efficiency and margins. This allows us to view the sector's ROE in relation to these metrics. As you can see, generally, our sectors deliver a return above 10% through the cycle. The two exceptions are TCF, Trade and Commodity Finance, and Global Markets. Global Markets will focus on a limited product offering tailored to our core domestic clients, further reducing its cost and RWAs. We announced this with the Q1 results. We've taken a careful look at our global sectors.
Within TCF, we will address low-return clients, de-risk diamonds portfolio further, and downsize the organization reflecting these changes. Natural resources and transport and logistics sectors meet the return target. We want to reduce our exposure to highly cyclical sectors as well. This will mainly impact energy offshore and shipping. We will continue to develop the business where we have both strong franchises and good returns, which is the corporate Netherlands, clearing, and private equity. Turning to the financial impact of these plans. We will improve the return on CIB through three main levers. Reducing capital, lowering cost, and transforming the business model. We plan to refocus global sectors and Global Markets and reduce RWAs by EUR 5 billion to EUR 34 billion by year-end 2020. This will benefit the group quarter one ratio by 90 basis points. We estimate revenues will be impacted by around EUR 100 million by 2021.
We will rightsize the organization to reflect that we will be servicing fewer clients. We will reduce costs by EUR 80 million through a reduction of CIB staff of 250 FTEs, IT rationalization, and scaling down our international presence. CIB will take a restructuring charge of around EUR 50 million during the second half of the year. Reducing RWA and costs are important, we also need to transform the business model to stay competitive as we transition to Basel IV. We will further optimize capital usage, putting more emphasis on distribution. Our focus will be on core clients spanning multiple products, sustainability franchise will be further expanded. To recap, CIB is core to ABN AMRO, serving an international active client base. Most sectors meet the group return target, CIB overall does not. We will reduce capital, lower costs, and embark on transforming the business model.
Within global sectors, we will reduce capital in TCF and highly cyclical sectors, leading to a net reduction of RWAs of EUR 5 billion. We will bring costs down by EUR 80 million, reflecting a more focused CIB. You can see here, I'm on slide eight, these measures will deliver an acceptable ROE of 10% by 2021 and better position us for Basel IV. The group as a whole, these plans are also capital accretive, benefiting the CET1 ratio by 90 basis points. Now I'd like to hand over to Clifford to take us through our second quarter results.
Thank you. As Kees mentioned, we are pleased with the second quarter result of a net profit of EUR 688 million. Last year, we booked the sale of Private Banking Asia, which explains the movement you see here in operating income. Expenses have trended down on the back of our cost-saving programs, and impairments were down significantly compared to the first quarter of this year. Tanja will discuss these in more detail later. I will describe the individual line items on the next slides, but first I show the trends in our client lending on slide 10. You see here mortgage volumes remain fairly stable over the quarter. We see house prices continuing to rise. However, transaction volumes are lower. Competition remains strong, especially in longer-dated mortgages, and we remain price disciplined and have allowed our market share to decline slightly to 19%.
Commercial banking is growing well at attractive margins. We see growth across most sectors reflecting the strong Dutch economy. Our outlook remains positive for the Dutch SME sector. Kees set out our plans to refocus CIB, and we've already started to reduce the loan book during the second quarter. The rise in loan volumes measured in EUR within CIB that we've delivered during Q2, you see for CIB is in fact wholly driven by USD appreciation. Now to net interest income on the next slide, 11. NII was up compared to Q2 last year, mainly due to higher mortgage penalty fees. Corporate loans showed both volume and margin growth. Mortgage volume and margins remained broadly stable. This was offset partly by headwinds from the low interest rate environment. Our income related to our equity duration declined as a result.
We have lowered our equity duration to position ourselves for future rate increases. This feeds into our NII outlook for the full year. We expect NII to increase compared to 2017, supported by mortgage penalties, but partly offset by the effects of continuing low rates. To fee income on the next slide, 12. I mentioned last quarter that the Q1 2018 fee income is a fair reflection of our current underlying run rate. This quarter's fees are pretty much at the same level as last quarter. While other income remained above trend, this quarter, private banking had a gain on a disposal related to an earlier divestment. This quarter, that is Q2, accounting effects were also modest, and private equity showed a decent result of EUR 29 million following the very large gain in Q1 this year. To costs on slide 13.
As you can see from the left-hand chart, personnel expenses continue to trend down. FTEs have decreased by over 1,500 since Q2 last year and 400 since Q1 this year. During the second quarter, we closed another 28 branches, bringing the total down to 151 branches by the end of Q2. Other expenses are stable, excluding incidentals. The right-hand chart shows how operating costs are declining, reflecting our cost savings program and divestments. The divested activities had an annual cost base of around EUR 100 million, so in this bridge, around only EUR 25 million is due to the lower run rate, and that's because we took EUR 56 million of transaction costs in private banking last year in relation to the disposal of Private Banking Asia.
Underlying cost savings improved by EUR 44 million compared to Q2 last year, and cumulative savings now stand at EUR 570 million versus our target of EUR 900 million, which we announced at the end of 2016. I'm pleased with our cost performance so far, but we have more to do. I now want to say a few words on cost income ratio going forward. Turning to the next slide 14. I'm pleased with the decline in cost income ratio on the left-hand chart. Our cost reduction programs are delivering, as I said earlier, and our run rate for the first half of the year is already in line with our EUR 5.2 billion cost guidance for 2020. Since we announced this guidance, we have divested our Private Banking Asia, and today we have announced the CIB refocus.
Reflecting these developments, the cost guidance can be resharpened to around EUR 5 billion. Despite the impact on revenues from the CIB refocus, we are on track to achieve our target cost income ratio of 56%-58% by 2020. I'll now hand over to Tanja to update on impairments.
Thank you, Clifford. I'm now on slide 15. Second quarter impairments were significantly lower than previous quarter, in line with our guidance. Impairments taken this quarter are in the same industry sectors as Q1. On a number of clients in the onshore and upstream energy sectors, we booked some additional provisions. Healthcare related impairments were concentrated on new files. We see these impairments as sector and file specific and not as indicative of a broader trend. For drilling, offshore service vessels, and crude tankers, the market is challenging, but seems to have bottomed out. I don't expect substantial impairments for healthcare for the remainder of the year. The indicators for the Dutch economy remain strong and the outlook here remains positive. As a result, we expect the overall defaulted portfolio to decline further.
The outlook for full year impairments continue to be below the through-the-cycle cost of risk of 25-30 basis points. Of course, we can never exclude sizable impairments on individual clients. I will now hand back to Clifford.
Thank you, Tanja. We're pleased with the strong increase in our CET1 ratio over the quarter. We've actively managed our RWAs, including the first effects of the CIB refocus. RWAs reduced by EUR 3 billion during the quarter, reflecting credit quality improvements, reduced risk in our investment portfolios, and lower volatility in Global Markets, reducing market risk. Kees set out our ambition to reduce CIB's RWAs by EUR 5 billion or 90 basis points to Group CET1 ratio. We've already achieved around EUR 1.5 billion expect further benefits of around 65 basis points for CET1 ratio. These will materialize over time more gradually through 2021. The leverage ratio improved to 4.1% as we carefully manage our exposures here. As you are aware, CRR II will boost the leverage ratio once implemented. I will now hand back to Kees.
Thank you, Clifford. Looking at our targets, I'm pleased with our ROE. I'm on slide 17. We are committed to all our business units delivering on group target. We are announcing action on CIB today in line with this commitment. We have worked hard to lower our cost income ratio, have more work to do to bring it structurally within the target range, as Clifford said. CIB refocus impacts our top line, we will work even harder on reducing expenses. Our quarter one ratio is 18.3%, well placed within the 2018 capital target range. We expect capital formation to continue. CIB updates strengthens capital generations further in the coming years. We are clearly more comfortable on the prospects of additional distributions this financial year. We maintained our interim dividend of EUR 0.65 a share, reflecting an increase in our interim payment to 50%.
Our final decision on additional distributions will be made towards the end of the year. Following any potential additional distributions, we want to remain within our quarter one target range. We are well on track to deliver what we set out to achieve since the IPO and have made a number of adjustments to our initial plans as there is a new team at helm. Coming November is therefore a good moment for senior management to present ourselves and run through our plans in more detail. I hope to see you all there. Before we go into Q&A, I would just like to briefly recap the highlights on slide 18. We delivered a strong quarter with a solid net profit of EUR 688 million. Impairments decreased significantly from Q1.
We've shown good progress in bringing down the cost base. I've updated you on CIB and how this will benefit the capital position of the group. Now, I'd like to ask the operator to open the call for questions. Thank you.
Thank you, sir. Ladies and gentlemen, we're starting the question and answer session now. If you have a question or remark, please press star one now on your telephone. Star one for questions or remarks. Go ahead, please. May I please remind you to limit yourself to two questions. If you have any remaining questions afterwards, you can press star one again to rejoin the queue. Thank you. Our first question is from Mr. Stefan Nedialkov, Citi. Go ahead, sir. Your line is open.
Yeah. Hi, good morning. Two questions on my side. In terms of the 5 billion of overall CIB reduction, could you let us know what is the associated Basel IV inflation that would have been there if you had not gotten rid of those 5 billion of RWAs? The second question is, in terms of potential capital return, how would you think in terms of buybacks versus dividends and on what timeframe would those be determined, end of year or half yearly going forward?
Thank you very much, Stefan. I think it's a bit too early to say exactly what the effect on the EUR 5 billion would be. We have given a general update on that, but it can drift, of course. With respect to capital return, I would say, as mentioned before, can of course be a pay ratio increase. It can also be buybacks. Although, of course, for both, presumably, we need regulatory approval. We keep all those options open, actually. Can you say something on the Basel IV inflation?
Yeah. As you know, Stefan, we have a Basel III target this year, the 17 after 18.5. We announced in February that we thought Basel IV impact was 35% in terms of RWA inflation at year-end 2017. It's clear that CIB has a higher RWA inflation than average. By targeting a EUR 5 billion RWA reduction on CIB, we should see the benefit of that coming through our numbers for Basel IV. We're managing the business for Basel III, clearly ensuring a good transition through Basel IV as we set out in February this year.
Okay. Thank you very much.
Our next question is from Mr. Farquhar Murray, Autonomous. Go ahead, sir. Your line is open.
Morning, gentlemen. Just two questions from me, if I may. Firstly, on the CIB restructuring, you flagged obviously EUR 50 million of restructuring costs related to cost-cutting. Should we expect any upfront losses from the EUR 5 billion RWA reduction? I'm just wondering if there's element to that, and indeed, obviously was there part of that in the second quarter, given you've made some progress there. Secondly, a little bit of a follow-on from Stefan's question, actually. Given the CIB and the EUR 5 billion probably has more than average Basel IV inflation, equally, you've done this balance sheet clear up, and we've obviously seen a reduction in Basel III RWA in the quarter. Are we still comfortably able to take the 17.5 to 18.5 indication under Basel III as a good indication of where you want to be ultimately under Basel IV?
Should we think of that if you're wanting to drift up within that target range? Can we just take the 17.5%-18.5% pretty cleanly for the end of the year? Thanks.
Thanks very much for your question. No, we don't expect actually, aside the restructuring cost, any losses on portfolios when we take action on the EUR 5 billion.
Slide.
With respect to the EUR 5 billion, I think the question there is we would like, I would say, to stay in that bandwidth. I think it's important perhaps there to stress that in the past, we guided on all the portfolio differently. We said on mortgages flat. On the Dutch corporates, we said more or less Dutch GDP. Well, that's higher these days, by the way. 7% in the first half of the year, 5% last year. We guided around, well, world trade, which is a bit 5%-plus, on this ECT portfolio, actually. It's important to notice that the EUR 5 billion is a nominal reduction actually from the figure we are right now, Q1, EUR 39 billion-EUR 34 billion end of 2020. Presumably, you have taken all in your models an increase of, say, the 5%, what have you, I don't know, EUR 2 billion a year.
The decrease presumably is, in your models, a bit bigger. We do it as a nominal decrease. With respect to the margin, I think we have said that we wanted to update that every year, I think we will do that accordingly at the beginning of next year, the end of this year.
Yeah. Maybe just chipping in a little bit on Basel IV and how we think about it. As Kees said, look, we've got a Basel III target for this year, 17 after 18.5. We think the right way to manage capital this year is Basel III, and we've set that by reference to our Basel IV views. Clearly, the difference between Basel IV and Basel III is going to vary over time. For example, where we see credit improvements in the mortgage portfolio, we get the benefit in Basel III. We don't see the benefit in Basel IV because of the very rigid approach there. You'll see some sort of pluses and minuses around Basel IV. We want to give confidence to the market that we have clear metrics. We're still in the Basel III world, and that's why we have a Basel III target.
We're well-placed in that range, and Kees indicated our appetite, the distributions around that. At the end of the year, we'll have another look at that Basel III target to reflect developments. They could be developments around the regulatory world, the prospects for the systemic risk buffer and so on, how we're thinking about mitigation. There are a number of factors there that will factor into that target range. We want to give clarity that we're focused on the Basel III target range, which underpins the statements we've made this morning.
Okay. Thanks very much indeed.
Next question is from Mr. Bruce Hamilton, Morgan Stanley. Go ahead, please.
Thanks. Morning, guys. In terms of the phasing of the RWA reduction, you're off to quite a fast start in Q2. Do you think it's possible you deliver the RWA reduction quite a lot earlier than 2021? Because you want to try and avoid any sort of losses on roots, that's why it's kind of quite a slow phase. I guess what you're saying is all capital above 18.5% should come back to shareholders, and you'll determine that on an annual basis. I guess the only other constraint would be leverage ratio. I presume you always want to be above 4%, but if you just sort of clarify on that. Second question on the new guidance for 2020, I guess costs are EUR 200 million lower, revenues because of CIB are EUR 100 million lower.
It feels like an embedded upgrade, though your cost income guidance implies revenues sort of EUR 8.6 billion to EUR 8.9 billion. It looks as though in there, is that just a bit of caution around NIM or am I trying to read too much into that? It looks like it should be a slight earnings upgrade, but then your cost income is implying a slight revenue downgrade. Just understanding the dynamics there.
Okay. Thanks, Bruce. I will take your first two questions, Clifford will take your third question. RWAs, as indeed mentioned by Clifford, EUR 1.5 billion in Q2. As already mentioned, it's focused our RWA reduction in TCF and Global Markets, which of course are on average, relatively shorter term transactions that we have there. That's the reason why we started already and have a good reaction already, good effect already in the second quarter. Yeah, we might deliver earlier than 2020, actually, with respect to RWAs end of 2020. We will, of course, look into that, what's possible. Leverage ratio, indeed, I think we want to stay above 4%. That's correct. Can you say something, Clifford, on the last question?
Yeah. I think I broadly agree with you, Bruce. I think in terms of upgrades, you're referring to your and your peers' views. We've remained committed to 56%-58%. I have no consensus how to slightly outside that range ahead of this call. We thought it was helpful to clarify that we are committed to EUR 5.2 billion, that we sold Private Banking Asia. If you factor in today's announcement, we're very much targeting around EUR 5 billion. I think that probably is a little bit more caution around income than recent quarters, partly reflecting sustained low interest rates. You're seeing that in the comments I made regarding NII. Look, we're taking capital out of CIB. We have been growing that strongly recently, don't expect income to power ahead in CIB as we take capital out.
We do expect sustained increase in ROE, which we think is in the interests of the business.
Great. Helpful. Thank you.
Our next question is from Mr. Benoit Petrarque, Kepler Cheuvreux. Go ahead, please.
Yes. Good morning, Benoit Petrarque from Kepler Cheuvreux. Two questions on my side. First one will be on asset quality. You seems to be a little bit more positive than you were last quarter. Just wanted to confirm this view. We know you've commented that healthcare will not be an issue in H2 potentially. Offshore services have been turning the cycle, and I don't see any big impairment on shipping with you, which was also problematic last quarter. Just wanted to understand better what changed your view. Are you happy now with the cleanup process you have actually done in the past two quarters? What is specifically the outlook for H2? I think you are guiding for less than EUR 25-EUR 30 for full year, but specifically for H2, how do you see the loan loss provisions moving? Second one will be on the CIB.
I just wanted to understand how you will actually address the lack of scale benefits you have been seeing at the CIB operation over the past years. You want to reduce costs by EUR 80 million, but top line will also shrink by EUR 100 million. There's limited effect on cost income ratio for the CIB operation. Excluding the EUR 80 million cost reduction, how do you see costs moving at CIB going forward? Just to come back on your growth outlook, is your 5% rebased from the EUR 5 billion still a kind of good proxy for future loan growth for the CIB operation? Thank you very much.
Okay, Tanja, can you take the first one, Clifford the second?
Yeah.
Okay. Well, thank you for your question. Indeed, well, as indicated in the first quarter, we were cautious on the several sectors. I will talk you through the different sectors. You've seen indeed that our impairments in Q2 are significantly lower than in Q2 versus Q1. If I look at the sectors, on energy upstream, we have seen some impaired clients where we had to add some provisioning. If we look at the outlook, we are more optimistic. We still stay cautious on the offshore segment where we see investments not fully coming back. In terms of shipping, I do expect that we stick to the same provisioning levels as we've seen in the first half of the year. Especially, we stay also there cautious with respect to the segment related to offshore. I think TCF is quite stable.
Of course, within TCF we have the diamond sector. That is a segment that we monitor very closely. Well, given the developments in that segment, also given our decision that we close our Dubai portfolio. All in all, our outlook is quite stable for the rest of the year. We do expect that we will continue to be below the 25-30 basis points cost through the cycle. I forgot to mention the healthcare sector, where we did a review of our portfolio, and we don't expect any new substantial impairments in the second half of this year.
If I understand correctly, you are now putting a 22 basis points cost of risk in Q2, but with quite a substantial amount coming from healthcare. Can we expect something lower than 20 basis points for H2?
Yeah. If you listen carefully to my guidance and do the math for the second half, we do expect indeed a lower cost of risk than the first half.
Okay. I'll pick up outlook for CIB. I think it's important to emphasize that we've kind of reset the outlook for CIB. I think the 5% growth that we've seen historically, we don't expect that going forward. We've seen income growing, but we've also seen RWAs growing quite strongly in CIB. The statements that Kees made are in respect of the sort of the current position. We're looking to take EUR 5 billion of RWAs out, sort of in absolute terms from Q1 to the end of 2020. That will have a reduction of income of EUR 100 million. Not a change in growth per se, but we're guiding to EUR 100 million impact of that. We're being realistic, right? If we're reducing the capital base, we need to recognize that will have a adverse impact on income.
Clearly, the teams are going to work hard on that to see if we can mitigate that. Fundamentally, we're planning for a decline in income in CIB, which is why we need to work hard on costs. The EUR 80 million was cost savings, and those are expressed in the same way as our original EUR 900 million. We'll take those costs out, and there may be some residual inflation in terms of wages and so on. We're not expecting a dramatic reduction in the cost income ratio in CIB. This is really about refocus and redeployment of capital rather than, if you like, transformation of the cost income ratio. We're not looking for that. I think it reflects a realistic plan and one that's focused on de-risking, right sizing, and positioning the business in Basel IV rather than a step change in earnings.
Thanks. If you just strip out the kind of EUR 5 billion RWA reduction and also the cost reduction you are planning, what will be the underlying growth of the CIB business going forward? Just stripping out all the restructuring you are planning to do in the next 3 years, what will be the underlying growth of the division going forward?
I think that's not the way we're thinking about it. Kees has indicated that we're targeting EUR 5 billion RWA reduction from 39 billion to around 34, and that's what we expect, 34.
Okay.
The same is in costs. Costs, you do have some underlying inflation around that, we're not going to come back and say, "Look, we've delivered on our restructuring, the business has changed in the interim, it's a different business." That's not what we mean. We're being clear. We're looking for the business to change trajectory, that will release the capital that we've indicated.
Okay. Yeah, thank you.
Our next question is from Mr. Benjamin Goy, Deutsche Bank. Go ahead, your line is open.
Yes. Hi, good morning. Two questions from my side, please, as well. First, on Dutch mortgages. You mentioned you slipped below the 20% market share. Any thoughts on this going forward appreciated or whether you see more potential for off-balance sheet measures in case competition remains intense? Secondly, on the SME derivatives provision. There was another charge in Q2. You only said you have 600 clients that have received compensation, much more to come still. But I assume some of the provisions you already booked are also for the files under review. Any thoughts about potential H2 charges and whether that's something we can basically close this chapter by the end of 2018? Thank you.
Thanks very much, Benjamin. What we've said around Dutch mortgages, indeed, we have been disciplined and have accepted a bit lower market share to keep margins in place, as you can also It's reflected, by the way, in our NIM. We will continue to do that. I think, yeah, off balance sheet is not.
Something we think sometimes about it when perhaps in the 20 years domain, but it's not a main focus point at this moment in time. As said, we will stay disciplined on ROEs, margins, and the likes, and market share is a secondary one. With respect to derivatives, no, we don't expect in the second quarter an extra amount to be taken. Indeed, we have sent to 600 clients, or I think it's now 800 sent letters. We are in the process of sending a lot of letters now of all letters that we actually have sent already to our auditor. We have been able now with the AFM, the conduct regulator in the Netherlands, that we are able to send these also already to our clients, and that's over 1,500 letters.
Hopefully we can do that in the coming weeks so that we are able to send much more letters to clients. We have provisioned actually, for all the 7,000 derivatives. We have enough files.
Okay, great. Thank you.
Next question is from Mr. Kiri Vijayarajah of HSBC. Go ahead, please.
Yes. Good morning, everyone. A couple of questions going back on the CIB refocusing. I was wondering if you could give us the loan losses associated with the 5 billion RWAs to be exited, either the normalized number or the one H number, because you've given us the revenue and the cost for the loan loss number there, it'll be helpful. Going back to the bubble chart on slide six, and the impact of Basel IV. I'm just curious why there's no action or shrinkage planned for corporate NL, because that's right on the cusp of your curve for a 10% ROE, and presumably it slips downwards under Basel IV. Really your thought process there, why there's no sort of action on that quite sizable bubble for corporate NL, please.
Tanja, you take the first one and Clifford the second.
The loan losses related to the CIB refocus. We assume going forward in our projections through the cycle cost of risk of 40 basis points for CIB. While you have seen it has been elevated over the past period. That's what we assume. We don't assume additional provisioning because of the reduction as we take a gradual approach here to minimize losses.
Just picking up your second question, Kiri. Just looking at the chart, we've plotted the various businesses in respect of Basel III. Basel III remains the current regulatory basis for the next few years, and it's important that all our businesses are delivering on Basel III, which is why we're taking this particular action. I think the third element of our strategies, we call it sort of transform the business model, but we recognize that for those businesses that are delivering under Basel III, they will need to do better under Basel IV. We have time to transition those franchises, and the sorts of things we're working through, as you'd expect, is looking very closely at the rules, particularly as they crystallize. For example, shifting our client franchise to more rated issuers and away from collateralized lending if the rules as stated stand.
There's working within the strictures of the new regulation to mitigate the direct impact. Also, as we've said, we really need to do more distribution of risks rather than just us warehousing those risks. I think we're a fairly traditional corporate bank where we maintain very largely on our balance sheet the loans we originate, and we need to work the franchise harder, both here in the Netherlands and overseas, to distribute more of those risks while serving our client franchise as well. I think we can make that transition over time as we see some of our peers further along in that journey.
Okay, great. Thanks.
The next question is from Mr. Pawel Zygier of Goldman Sachs. Go ahead, please.
Hi. Thanks for the presentation. I wanted to ask if you can give us a little bit more clarity on the timing of the reduction in risk-weighted assets and associated loss in income, then reduction in costs, because we know the endpoint, but how should we think about getting there? For instance, you managed to upfront quite sizable cut in your risk-weighted assets already in Q2. Should we expect anything similar for Q3? Should we expect any income loss in Q3 on the back of cut in risk-weighted assets in Q2 and so on? Any details around that would be very helpful. Maybe a follow-up on cost of risk as well.
You mentioned that overall you expect lower impairments in the second half of the year. Obviously they came down in this quarter, but also on the back of the releases in retail segment. Should we expect more of that going forward as well? Thank you.
Thank you, Pawel. No, we don't expect a similar decline in the third quarter as in the second, because of course, one and a half billion was a very significant one, 30% of the EUR 5 billion. That's when we want to have the result anyhow. We will see if we can do things quicker, but that's too early to say. Of course, income losses are related to that timeframe. With respect to your second question, Tanja?
With respect to cost of risk. Indeed, we have seen some releases in retail in the first half of this year. The outlook is good, so we do expect that to continue, but always will be more and more to a lesser extent, given the low levels of provisions that we see. We are reaching the top of the cycle, implicitly in my messages as well, is that we do expect lower additions in the other segments.
That's clear. Thank you. Can I just come back to this risk-weighted assets evolution? You expect some growth and the EUR 5 billion number that you give us is net of growth, if I understand correctly. Should we think about risk-weighted assets reduction as a gradual process from now to 2020? Or is there a possibility that risk-weighted asset reduction related to CIB will be somewhat front-loaded, which means that your risk-weighted assets will dip below EUR 34 billion grow subsequently?
Clifford?
Just picking it up, I can see this is an area of focus. The EUR 5 billion is net. We are withdrawing capital from those particular sectors we've identified, but we are looking to see growth elsewhere. We expect the EUR 5 billion to come out, as Kees said, by the end of 2020. I think it's important to recognize that RWAs can be volatile, and we're pleased with progress in Q2. We definitely don't expect to see that repeated in Q3 and Q4. To some extent, we've managed to act on some of the short-term business. I think we're mindful of the impact on the quality of the book through an accelerated reduction. We want to manage that sensibly over time.
I think if you run the numbers, if the RWAs come out by the end of 2020, the full income benefit you won't see until 2021, as you get the full run rate benefit of that. On costs, we're looking to deliver that through 2021, but very largely by 2020. Hopefully that gives you the guidance you're looking for.
Okay. That's very helpful. Maybe just one small clarification. On your EUR 3 billion risk-weighted assets move just this quarter. We know what's related to CIB, but can you comment, for instance, on group function, what drove the change there, and do you expect any volatility in the second half of the year?
I think in group functions, we've done some de-risking. We've exited certain low-rated sovereign positions. It had jumped up in Q1, we wanted to bring that down, as we're focused on capital, as we should be. I think there's one or two other things going on in global functions. We wrote down the value of an investment which hits your capital but benefits RWAs. There's a few things. I would emphasize that we are very focused on capital and RWAs. Basel III and increasingly Basel IV. We do see volatility quarter on quarter, which can hide the underlying trends.
We'll be keeping a close eye, as you will, on RWAs through the period through 2020.
Okay. That's very clear. Thank you.
Following question is from Mr. Johan Ekblom, UBS. Go ahead, please.
Thank you very much. Can we just talk a little bit about the NII on a divisional basis? I guess I'm trying to understand the trends. We saw quite a meaningful reduction still in retail banking. I was wondering, is this the kind of pace of NIM decline we should be expecting there, given where savings rates are and the competitive position you talked about in the mortgage space? Then maybe if we look, I guess both in CIB and in the commercial, we saw a relatively good performance in terms of both NII and NIM quarter-on-quarter. Are there any timing difference, for example, in the CIB in terms of running off some of these risk-weighted assets? It looks like quite a large sequential improvement in margins.
Finally on sticking with the NII, if we looked at the underlying NII in group functions, I think it's at a sort of multi-year low this quarter. Can you say anything about what we should expect there going forward?
Clifford?
Yeah. I think there are a few things going on quarter-on-quarter. In retail, we've taken a hit, if you like, in relation to our credit card business, ICS, that runs through the NII line. You'd need to strip that out, and if you do that, to me it looks pretty flat in retail, in NII. We do see sort of headwinds over time in retail, and if you look at margins, they're still pretty strong. You can see we're defending margins by taking market share loss. I think you should not expect margin expansion from here in retail banking. I think in terms of the Corporate Bank, we have grown that over recent quarters prior to the refocus we've just announced. That's benefited NII.
In terms of NIM, we've lightened up on some of our leverage ratio heavy areas, and that would have benefited NIM. Finally, on group functions, as you rightly say, looking through some of the incidentals, you see some negatives coming through. That reflects a couple of things which I mentioned on the presentation, which is the effect of low interest rates on the earnings that we make. We call it our equity duration, but it's effectively the earnings on our capital position. We have a duration, so we benefit from an upward-sloping yield curve on the EUR 20 billion of our equity. Now that yield curve has flattened. Earnings are going down. We've also reduced the duration of our equity, because we think we want to be better positioned for higher rates when they come through. That will have reduced it.
It's cost us money to maintain our liquidity buffer, and the costs of that are material, and they come through the group functions line and get hit by low rates. It was those factors that I was thinking when I said headwinds of low rates, and now I've talked it through, you see where it appears in our segment disclosure.
Yeah. I guess if I understand correctly, then we shouldn't be expecting any immediate improvement in the group functions. Maybe if I can come back to both the CIB and the retail. On the CIB, when we start to run off more of these riskier assets, should we expect not only that NII will go down because of volumes, but also because of NIM contraction from the Q2 level? I guess on the retail, you had exactly the same credit card provision in Q1. I guess the reduction of EUR 14 million in NII Q1Q is predominantly margin-driven. The volumes are essentially flat. Am I missing something there?
Yeah. On CIB
Yeah
we've announced the EUR 5 billion RWAs and the EUR 100 million income. That largely reflects net interest income. The loan impact is of that order of magnitude. You get a feel for the revenue margins. We are focusing the contraction in some of the low revenue margin product areas as Kees talked through. That should give you a feel. We're hoping to improve the quality of our book on a risk-adjusted basis by downsizing in areas with low revenue margins, but also downsizing in areas of high volatility, some of which actually have quite good revenue margins. Overall, you need to do that to deliver on the cost of risk improvement that Tanja talked about.
I think in terms of NII, I think I'm going to refer you offline to the IR team to talk through the incidentals, because I can't see the ICS that you referred to. There's a bunch of other things going on quarter-on-quarter. Overall, what we're seeing in retail is quarter-on-quarter through incidentals, kind of flattish, but over time, headwinds relating to the things that we discussed earlier, the continuing low rates.
Perfect. Thank you.
Next question is from Mr. Tarik El Mejjad, Bank of America Merrill Lynch. Go ahead, please.
Hi. Good morning, everybody. Just a couple of questions, please. First of all, on your deleveraging or structural CIB. I think it's a very good initiative to get rid or deleverage some of the low profitability businesses. I was a bit surprised that you couldn't actually point to any area where you could reallocate some of this capital or RWAs that delivers high returns. A lot of discussion today about shrinking, but no really perspective for growth. That leaves two routes, either for M&A. Maybe you can actually discuss a bit what's your idea there and what is the outside private banking, which area you could expand non-organically. The dividend. I understand from the big focus on RWAs deleveraging pattern, it will be more progressive because I guess you had all the low-hanging fruit done already in Q2.
Would that mean that any capital return increase or higher payout or share buyback will be more towards 2020 and beyond, or progressively growing, or that be like a more radical change in dividend policy once you get to 18.5 or so by end of the year? Thank you.
Thank you, Tarik. We did talk mostly about indeed the decline because that I think is centerpiece in our approach at this moment in time. Of course, there are some areas like, especially the ones I would say that are on the left side in the chart, where we feel comfortable to grow. We definitely are going to grow also in part because it's a net figure five, that's clear. We will see where we can do deals where we can make good returns and do that
Now, I think for us, it's important now to focus on the decline of the EUR 5 billion. That's our main target at this moment in time. Indeed, also, by the way, your private bank remark, of course, as you have seen now with Société Générale in Belgium, the EUR 6 billion asset management, we have already, since IPO, mentioned that that could be a possibility in Belgium, France, or Germany. Definitely, if we see areas of growth, we will definitely or also inorganically in private banking, as said before, we will do that. I mentioned already the commercial banking in the Netherlands doing better than the guidance before, 7% in the first half of the year, there's some growth there.
With respect to dividend, I think we have always set, I would say, a gradual approach in the sense that in the end of this year. A yearly approach, of course. At the end of the year, we will look at this year, what can we do with respect to 2018, asset payouts higher than 50% or, and/or buybacks. It will be a gradual approach and not a backloaded 2020 approach.
Yeah.
Okay. The guidance will be like in a year-by-year basis. Just one follow-up question on costs, if I may. I'm a bit surprised by the Private Banking Asia new guidance on EUR 100 million lower cost from that. I mean, that deal was done a year ago. Why is this coming now? I just want to understand basically the rationale for that.
Clifford?
Frankly, we've always been clear on the 5.2, and we've noted consensus. I don't know what you had penciled in for us. I think we've got more comfortable that we can manage down costs, and we think it's important to come up with a new target and new clarity around the 5. Our primary target has always been cost-income ratio.
Yeah.
We think it's helpful to give you guys a sense of how we're going to get there. Given the, call it, the revisions to income that we've talked about, particularly with respect to CIB, we thought it was helpful to be clear on the EUR 5 billion.
Okay. Thank you very much.
Next question is from Miss Alicia Cheung, Miscellaneous. Go ahead, please.
Morning, everyone. Just a couple of very quick questions from me. Firstly, on the EUR 5 billion RWA reduction, can you break down what proportion comes from each of the CIB subsectors? Then for the remainder where you aren't reducing, what is your outlook in terms of loan growth by subsectors, even if it's just very high level. Then on costs, looking at 2018 specifically, what can we expect in terms of investments and cost savings this year? Can you give any guidance on cost growth? Obviously, you've talked about the restructuring costs, but that aside. Thank you.
Can you take those?
Yeah. I think I'll try and be helpful. I'm not going to give numbers in respect to the segments, but the EUR 5 billion is net, as Kees has said. We expect most of that from TCF, which includes diamonds. We do expect some further reduction on the Global Markets side, so they would be the bubbles on the right side. Kees indicated we're looking to de-risk pockets of energy in shipping, where we see the risk-adjusted returns as not what we're looking for. I think in terms of growth within that net figure, we're comfortable with the franchises in the top left, so we'll continue to grow in Northwest Europe. We're pleased with the progress that we're making in Belgium, U.K., and Germany in particular, and you'll see incremental growth there.
We've set out our appetite to grow in new energy, that would be within natural resources. We do see some areas of growth. I think we're committed to the net EUR 5 billion, and the gross reductions will clearly be bigger than that EUR 5 billion, together with some incremental growth takes us down to a net five. Hopefully, that gives you some color. I think in terms of costs, just reflecting on your questions, I think we're pleased with the cost income ratio for the half year at a little over 56. I think there will be some incremental restructuring in the second half of the year. We've announced something in respect to CIB, but there may be further restructuring in respect of the work that other parts of the business are doing. We saw levies up a little bit in Q1.
There's a few things going on, but we're feeling comfortable around our progress on costs and are fully on track to meet our 56%-58% cost income ratio target with the new income outlook as set out on this call.
Okay. Thank you.
Our next question is from Mr. Marcel Huben, Credit Suisse. Go ahead, your line is open.
Yeah, good morning. Thank you for taking my questions. I have two left. On the investor day, can you just tells a little bit about the expectation, what to expect, just because the hard financial targets are already set. Just to gauge the expectations there. The second one is, there was some press coverage on the financial vehicles, some potential benefits from lower funding costs. Is this already in the CIB update or is this incrementally? Thank you.
Thank you, Marcel. Let's manage expectations here upfront. With respect to investor day, it's to after 3 years after IPO, to show you the new team so that we're able to present ourselves, tell you about all the stuff we have done in the last one and a half year. I think that is actually what we're aiming for and not all kind of expectations about new targets and the likes. With respect to the press coverage, indeed, yesterday, those are vehicles we're looking into, as I also mentioned, and we don't expect material effects of them on our figures.
All right. Thank you.
Next question is for Mr. Maxime Le Gouvello du Timat, Jefferies International. Go ahead, please.
Yeah, good morning. Maxime Le Gouvello, Jefferies. I have a question for you regarding the investment banking on the revenues on RWAs. If we look on 2017, you have the margin of 4.85. Taking into account the adjustment that you have announced this morning in term of RWA reduction and the EUR 100 million of revenue loss, we are moving to 5.10, and this quarter you have achieved 5.3. What is your goal in term of revenues on RWAs going forward? As you mentioned that you are going to optimize some portfolio, get rid of some clients that are not really profitable. Any kind of color would be much appreciated. Thank you.
Richard?
Yeah. Look, we are looking for making better use of our capital, improving our income over RWAs. I think you've seen some mixed benefits that you referred to, We expect to see those continue. I mentioned on the previous question that there's a bit of a barbell approach. We're looking to reduce in areas of low income to RWA, where we're just not getting the returns we're looking for. We're also looking to line up on what are quite high income to RWAs, where we don't like the risk profile. You see the two effects going on. Those should net out actually as improving income over RWA or further improvements, modest improvements. I think the challenge for the business and the sector is to build more fee income.
It's not just about mix and moving to high income, which can often be higher risk as well. It's sharing more of the risk we originate so that we are leveraging our own capital, and that's what I'd like to see the business doing over time. I think, frankly, we have the time ahead of Basel IV to deliver on that. That's the third part of our strategy, the transform the business model, and that will help those income margins.
Okay. You want to accelerate in terms of originate to distribute. You are not the first one to think about it. The question on those elements in terms of strategy is distribution capacity.
Yeah.
Have you some pre-agreement with some asset manager or life insurers who are going to give you some abilities to accelerate on that path or not yet?
No, I think you're right, we're not the first to talk about it. I think the good news is we're behind in that area, there's peers that are doing perhaps further ahead so that we can learn from and adopt best practice. There are market templates out there. I think we have a very strong financial institutions franchise in Europe and the Netherlands in particular. We feel we have all the elements to make that transformation. We need to do that over the next few years, and that will help the economics of that business. Frankly, that's the way corporate banking in Europe needs to go, which is, yeah, a little bit more of a U.S. model. Under Basel IV, we clearly believe that's the right business model to succeed and be relevant to our clients going forward.
It's exactly what Natixis did five years ago. They moved from revenues on RWAs below five to well above six. Is it for you something reachable?
Well, I'm not going to comment on the numbers, but I think, yeah. I'm familiar with Natixis. We really do have strong client franchises, both with corporates and financial institutions. We think we have the elements to really succeed in this space if we focus on it.
Okay. I think we can take a few questions in. Operator, you have some questions still?
Yes, sir. We have some more questions. The next question is from Mr. Brajesh Kumar, Societe Generale. Go ahead. Your line is open.
Hi. Thanks for taking my question. Brajesh from SocGen Credit Research. Two questions for me, please, as well. Firstly, on MREL, you mentioned that your MREL target is of 29.3% based on own funds and subordinated instruments. I'm just curious that why you have not included preferred senior as well out there. Are you expecting any changes in SRB stance and you might have to fill the whole MREL bucket using own funds and subordinated only? Next on issuance. I believe no plan for NPS in H2. What about AT1? Any plans out there? Thank you.
Clifford, can you take it?
Yeah. We've adopted a prudent approach, as you say. You have the prospect of RWA inflation around Basel IV, so we think this is the right way to prudently manage the transition. I think we've got no current plans in respect of AT1 this year.
Okay. Fair enough. Just to be very clear on MREL. Going forward, are you going to include preferred seniors or not? That's my question, basically. Because you very clearly said that you intend to fill 29.3% just by own funds and subordinated only. What's your stance out there?
Yeah. I haven't got a lot to add. We're aware of the rules, and we're very comfortable. The fact that we've hit our ambition pretty much already, relying on the more junior instruments, I think demonstrates the strength of our balance sheet.
Okay. Fair enough. Thank you.
Next question from Mr. Nick Davey, Redburn. Go ahead, please.
Good morning, everyone. Two questions, please. The first one, sorry, back on the CIB plan, but it's a simpler question, which is: Is it enough, really? I'm looking at the 10% ROE plus in 2021. It struck off 13.5% CET1 allocated. If you're going to have to run the group at 18%, 18.5%, that's really a plan to get the divisional returns to maybe 7%, 7.5% a few years away. You're taking EUR 5 billion of RWA out, but Basel IV probably puts them back again. I guess the question is: Why not more? Is EUR 80 million of cost reduction really getting you down to the bone? Do you not see this business still being a drag on valuation three, four years from now? Sorry for the direct question, but it's just not evident to me. The second one will be on rate sensitivity.
Thanks for the earlier discussion about the EUR 20 billion of equity and shortening the duration. Could you just help us with a few more bits of information so we understand which point on the yield curve we're watching, at what point things stop being a drag and become a positive? If you can give us any more disclosure on the overall swap position, at what duration, just some ingredient parts so we know what we're watching for. Thank you.
Thanks, Nick, for the candid question. First one. Rather the question is already answered than let people might think only about it. Is it enough? No, it's not enough. I think we clearly stated that this is what we should do, and it's said here as well. We want to repair the roof when the sun is shining. That's what we're doing with respect to getting as quick as possible above 10 in a Basel III environment, which these days for European banks, if you look around corporate banks CIB banks, other banks it's already a serious challenge in Europe. Indeed, as mentioned by Clifford, and I appreciate Clifford as well indeed, we have to take further action as well. Distribution model as mentioned. Think about the rating, rated loans or not. There's much more to do, which we will do. We have some time for that.
It's definitely not the case that for the three years we're now not going to do anything else than what we said today. Does that sound clear? Rate sensitivity?
I think we gave a little bit more color of that on page 34 of our quarterly report. Where we quote the duration of our equity in years of 1.6, down from 2.2 in December. That's the movement I referred to earlier. If you double it to think about the maturity, it's low single digits. Those are the areas of the yield curve to look at. There's obviously more going on in those lines, but that should give you a feel for the income opportunity related to our equity duration.
Sorry, Nick. My mic was not okay. I heard from people. What I said, thanks for the candid question. It's not enough, ROE. Indeed, we have to do more, as we will do, I said already. Do more originate to distribute, look for rated loans instead of unrated. We're definitely going to do more in the coming years than what we just mentioned only here with respect to. Yeah. Thanks.
Thanks. Can I ask just a quick question on the rate sensitivity. Clifford, if I understand well, 1.6 years. You're saying that you're using basically three-year swaps. Is that right on average? As soon as the-
Yeah.
Three-year swaps above the back book, it's-
On that element.
Very positive.
Yeah. On that element of income, yes. I also mentioned cost of liquidity. There's other things going on that are impacted by the low interest rate environment. You'll recognize the way we manage our risk. We lock in rates over time, but as those swaps roll off, we then move into the current low interest rate environment, and that headwind grinds through our P&L.
Mm-hmm. Where do you think the net of all of that is, in terms of at what point can we stop worrying about the low interest rate environment? Do you think you're positively geared to rising rates?
Yeah.
Is that a fair number?
I've given an indication earlier in our NII guidance. We are looking for rates to start moving up in these sorts of durations at the end of next year. To the extent that gets further out, will have an adverse impact on our margins. That's how we think about it.
Okay. Thank you for the answers. Yeah.
Next question is from Mr. Albert Quaranta, ODDO BHF. Go ahead, please. Your line is open.
Yes. Hi. Two follow-up questions from my side. The first one is on your Common Equity Tier 1 ratio. I'm sorry if I missed the answer, but assuming you hit the 18.5% by the end of the year, should I consider that everything above that number should be returned to shareholder or used for the acquisition, meaning that you don't want to build capital above the 18.5%? The second question is on the other revenue line. You're able to beat your target on a quarterly basis. Why don't you update this target going forward? The third question is on the distribution in the CIB. The FTE reduction, is that a net number or you need to hire people to build your distribution platform? Thank you very much.
Thank you very much, Albert. Definitely, we will give Q1 above 18.5 back to investors. With respect to other revenues, I would say the distribution is, well, it's a figure we attach to the operation we are now doing. Of course, if we need other people, if we would need other people for distribution, I think we can do it as we are. If necessary, of course, we will do that. Other revenues, Clifford?
Look, I think that's a fair comment. We like to be prudent here. I think you've probably got that message throughout the call. There are quite some volatile items. I think we're comfortable with that kind of guidance, but we'll reflect on that going forward. I think just one comment, just to build on Kees' comments. Our current target is 17 after 18.5. When we're in that range, we will consider additional distributions. We're not waiting until it's above 18.5 in order to consider that. Obviously, we're well-placed in the range, you've seen we're more comfortable with the prospect of additional distributions. That should give you a feel for our decision-making towards the end of the year.
Yes, at the same time, I can say that whenever you hit the 18.5%, you could be in the position where 100% of your net profit could be returned to the shareholder. Is that something that you may consider?
Yeah. Well, Kees is very clear. As a CFO, I would certainly consider it. If there's a credit crisis looming, we need to be looking out the windscreen, not through the rear view mirror.
Sure. Thank you very much.
That's why I'm happy with my CFO now.
Thank you very much.
Last question.
We have another question from Mr. Benoit Petrarque, Kepler. Go ahead, please. Your line is open.
Yeah, just a final question. Could you disclose the gross risk-weighted assets reduction from CIB? I just want to get a feel about the underlying growth embedded in the figure. I am looking for the gross risk-weighted assets reduction.
Yeah. Look, we have not disclosed that. I think the gross is somewhat bigger than the 5, but we have not disclosed it. We also need to recognize the business needs to trade through. Market conditions, opportunities will change between now and 2020. The business needs flexibility to trade through that. What we are committed to is a net reduction of EUR 5 billion.
Okay, great. Thanks.
Thanks, Benoit. Operator, any further questions?
No, sir. There are no questions. Please continue.
Okay. Thank you very much. I would like to thank you all very much for your questions. This concludes then our Q2 results update, and hope to talk to you again next quarter, and definitely with some of you already a earlier occasion. Thank you very much, and goodbye.
Ladies and gentlemen, this concludes this conference. On behalf of ABN AMRO, thank you for attending. You can disconnect your line now.