Good morning. This is Cecilia welcoming you to ING's two quarter 2015 conference call. Before handing this conference call over to Ralph Hamers, Chief Executive Officer of ING Groep, let me first say that today's comments may include forward-looking statements. Such statements regarding future development in our business, expectations for our future financial performance, and any statement not involving a historical fact. Actual results may differ materially from those projected in any forward-looking statement. A discussion of factors that may cause actual results to differ from those in any forward-looking statement is contained in our public filings, including our most recent annual report on Form 20-F, files with the United States Securities and Exchange Commission, and our earnings press release as posted on our website today. Nothing in today's comments constitutes an offer to sell or a solicitation of an offer to buy any securities. Good morning, Ralph.
Over to you.
Good morning. Thank you. Welcome everyone to ING's second quarter 2015 results. I will take you through the presentation first. For questions, I have Patrick Flynn, our CFO, with Wilfred Nagel, our CRO here with me from the Executive Board. Turning to the key points. Slide two, ING posted strong set results in the second quarter of 2015, supported by strong volume growth and lower risk cost. Our underlying return on equity rose to 11.8% in the first half of 2015, that's exactly in line with our Ambition 2017, as you may recall. The bank capital generation remained also strong at 30 basis points, that's offset by 40 basis points upstream to the group. The fully loaded group Core Tier 1 ratio increased 70 basis points to 12.3%, that's principally on the back of the NN deconsolidation, which, from a restructuring perspective, is certainly another milestone.
I think I'm, specifically for our shareholders, pleased to announce an interim cash dividend of EUR 0.24 per ordinary share, which is equivalent to EUR 922 million, or as we had indicated before, 40% of the underlying net profit for the first half of 2015. Before we go into the quarterly figures, I just want to recap a picture on the first half of the year, starting with the progress we're making on strategic initiatives. In March 2014, we launched our Think Forward strategy with one clear purpose, that's to empower people to stay a step ahead in life and in business. The core of our strategy is to create a differentiating customer experience. It's truly all about the customer.
In the second quarter 2015, we continued to expand our digital offerings for our customers. We also identified new ways to facilitate the financing needs of small companies. If you look at the progress we're making again in the first half year, I'm very happy to say that we welcomed another 600,000 new customers in the first half, and established approximately 250,000 new primary banking relationships. We see particularly strong growth in the challenges in growth countries, in line with our strategy. Another part of the strategy that we had indicated is, how can we build more sustainable balance sheets going forward? The next slide four, you actually see that we've also made steady progress on building more sustainable balance sheets in our challenges and growth markets.
You remember that diversification of our assets across different segments was part in order to improve the concentration risk, but also in order to improve our return. Now you see that the lending book is more diversified, with the proportion of mortgages declining and the proportion of commercial banking, consumer lending, and SME and mid corporate lending increasing. Now moving to the P&L, we post a strong result in the first half of 2015. The underlying net result banking increased 31.4% from the first half in 2014, and the return on equity was 11.8%. If we exclude CVA/DVA, which was positive for the first half, the underlying result increased by 17% on a like-for-like basis due to continued volume growth and lower risk cost. These results were supported by higher income, strong lending growth, an improved cost-income ratio, and lower risk cost.
Basically, we have the trend moving in the right direction in all of our key metrics. That's what you can see on slide six. Now, on top of a very strong profit contribution from the bank in the first half and the net gain resulting from the merger between ING Vysya and Kotak Mahindra Bank, we've also booked contributions from both NN Group and Voya in the first half of this year, which have taken us to a net result of around EUR 3.1 billion for the group. With that, we're pleased to announce an interim cash dividend of EUR 0.24 per ordinary share. Which is equivalent to EUR 922 million, or as indicated before, 40% of the underlying net profit for the first half 2014.
We remain committed to returning value to shareholders and reiterate our intention to pay a full-year dividend of at least 40% of ING Group's total net annual profits. We will evaluate the potential for any supplement returns, dependent on financial and strategic considerations and regulatory developments. If we then look at the capital position, slide eight, we see that the bank capital generation remains strong at 30 basis points, but that was offset by 40 basis points capital upstream to the group. We're paying dividends from the bank to the group. As we have indicated before, we decided to manage surplus capital at ING Group, and that's why we upstreamed their dividend. The Core Tier 1 ratio of the bank with that is 11.3%, which is slightly down due to the upstream, but still comfortably above 11%.
The Core Tier 1 ratio of the group increased 70 basis points to 12.3%, and that's principally as a result of the deconsolidation of NN. I want to emphasize here that we have not included any of the second quarter profits in capital. Reason for this is that this actually will give us increased flexibility to decide on our dividend payout ratios for 2015 without requiring regulatory approval. We believe this is more important than showing a slightly higher group Core Tier 1 ratio for the quarter. The buffer surplus, including the EUR 2.1 billion not allocated to the group capital, the group now amounts to EUR 7.9 billion at the end of the second quarter of 2015. If you sum this up in a comparison between the ambitions that we had indicated 18 months ago when we launched the strategy and where we are right now.
I'm now at slide nine, you see that in the first half 2015, we already reached most of our ambitions 2017 targets. I'm very pleased with the progress that we're making on all of these metrics. The focus on the first half year and the strategic progress, let's now zoom into the second quarter results. ING's second quarter underlying pretax result was strong at EUR 1.6 billion. That was positively impacted by CVA/DVA, which was partly offset by the negative impact from mortgage refinancings. Excluding the volatile items as shown in the table in this graph, the pretax result increased by 19.2% from the second quarter of 2014. It was stable if you compare it to the first quarter of 2015, that in itself reflects a positive momentum in our business.
If you correct for all the volatile items, you look through what is really happening operationally, you see that we have real momentum in the business with an increased pretax result of 19.2%. I just mentioned that our results have been negatively impacted by mortgage refinancings. That's because our customers have moved to lock in low rates. I want to give you a little bit more information on this development, slide 12, I'm now on. The prepayment risk and the subsequent impact on our results basically varies from one country to the other, because it's really linked to whether we can actually charge early repayment fees at the point of refinancings.
With the increased rate of mortgage refinancings that we have experienced, we needed to take a closer look at our policies and our hedging models, this has given rise to two changes that we have reported in this quarter. One affects the other income, specifically in Italy and Belgium, that's in the amount of a negative EUR 127 million of non-recurring charges. That mainly has to do with the adjustment of the underlying hedges. The second impact is the one on net interest income, that's basically a change in the recognition of early prepayment fees in the Netherlands, which resulted in a EUR 19 million reversal of net interest income in this quarter. That actually will be spread out over the future.
That is a correction on income, but that is something we will then see coming in in the future as part of our net interest income line. Looking at the net interest income line, turning to slide 13. The result rose 4% from the second quarter 2014, was slightly down from the previous quarter, but it was principally due to a lower interest result for financial markets and a one-off adjustment that I just mentioned in the booking of prepayment fees in the Netherlands. If you correct for the two, we actually see that the. If you correct for financial markets and the impact from mortgage refinancings, we actually see that the net interest income has increased 5.8% from the second quarter of 2014 and was flat from the previous quarter, with Retail Germany and industry lending particularly strong in this quarter.
Zooming into the financial markets side maybe for a second. Where we see a two basis points drop in NIM from financial markets or a lower interest income on the financial market side, we actually see still a good performance on the financial markets. It's just a difference in composition in income and the division between the other income within financial markets and the interest income. Income is good. Net interest income, if you correct it for both, it's stable quarter-on-quarter, and it's 5.8% up if you compare it to the same quarter last year. Good development. If we then zoom into the NIM. The NIM, as I said, decreased by four basis points to 143 basis points. But as I indicated already, it's two basis points on the account of how we recognize income in financial markets.
There is a different division between other income and interest income. The income line is still good, but a different division between interest income and other income, and the other two basis points caused by the different recognition in prepayment fees of the Netherlands. If you correct for those two, which are not really negative, you actually see a stable NIM for the quarter. The underlying there, what is causing this stable NIM for the quarter, we actually see that savings margins are a little bit up in the quarter, and that's because of the adjustments on the savings rates to where the market is going. And the lending margins, if we correct for this impact, in the Netherlands, on prepayment fees, were flat. And we expect that the commercial margins will be roughly stable.
If we then look at the underlying growth of the core lending franchise, turning to slide 15, you can see that in this slide that our core lending business increased by EUR 8.7 billion, with a healthy growth across all different franchises in both retail and commercial banking. And that basically shows that we maintain the momentum that we have built across the network. Retail banking increased EUR 4.3 billion, driven by growth in Belgium, Germany, the other challenges in growth markets. The Netherlands remains a bit weak on this. Commercial banking was EUR 4.7 billion, and that's driven by industry lending and in particular within industry lending, structured finance loans with a longer tenor. Positive development there as well, and this basically shows you how you can reconcile it in the balance sheet as well.
It's also notable that we're booking more and more of our commercial banking assets in the challenger and growth markets, which is exactly in line with our strategy to develop sustainable balance sheets in each of these countries. Specifically, if you look at Germany has demonstrated strong growth in its lending capabilities with funded commercial banking assets hitting the EUR 10 billion mark already. Also, if you look at the underlying development of the consumer lending franchise in Germany, it continues to grow at more than 10% per annum and now exceeding the EUR 5 billion threshold. Also a check mark on where we are in delivering on our strategy. Moving to expenses. Our expense base is more and more impacted by regulatory costs. We had already indicated that regulatory costs were going to increase. We see it happening every quarter.
It is a very volatile component of the cost side because we book them at different moments in time. If you correct for the regulatory cost and if you correct for the foreign exchange influence on our cost base with the weaker EUR and the stronger USD, then expenses increased by 3.6% from the second quarter of last year and 4% from the first quarter. If you really dive into this, then you see that the expenses in Retail Netherlands and Retail Belgium, excluding the regulatory costs, have remained flat, that we continue to invest in business growth in industry lending and Retail Germany and other retail challenges in growth markets, as we have indicated.
We don't mind that because if you now turn to slide 18, we show that in Retail Germany, where we do see cost growth, and in industry lending, where we see the cost growth, that these are two examples of areas where basically we see the cost-income ratio itself either already at best in class, industry lending, and further decreasing, for example, in Retail Germany. Cost growth in an area where income growth is higher and as a result, you actually improve the cost-income ratio and your efficiency, or you actually continue at a best-in-class level in industry lending. I think that is nothing to worry about. Also, as I indicated before, the customer base in Germany and the number of primary accounts is continuing to increase. We see the improvement of the cost-income ratio on the industry lending side.
The cost increase is mainly driven by the number of FTEs that has increased 6%. That's because you need the professionals to actually work with your clients to do the business. The lending book is increasing quickly in that area without changing our risk appetite. These are positive developments, as said before, we don't mind seeing cost increases in these areas where we see either an improvement on efficiency, income growth, or franchises that are already at best in class in the market in terms of efficiency. Turning to risk cost. Risk costs were EUR 353 million in the second quarter, down from the second quarter last year, down from the first quarter this year, reflecting lower risk costs in both retail banking and commercial banking. The total risk costs were 46 basis points of the average risk-weighted assets.
Most of the business are now close to the longer-term average, where we expect them to be across the cycle, except for the Netherlands. If we take a close look at the Netherlands, which is the final page for my introductory presentation before we get to the Q&A, we see that the risk costs in the Netherlands are decreasing, but still relatively high. On the mortgage side, we see it stabilizing from one quarter to the other quarter. On the business lending side, we see it decreasing, but specifically on the business lending side, we feel that this is still an an elevated level, and we expect this to continue around this elevated level for the foreseeable quarters. Clearly, risk costs in the Netherlands are still higher than we would like them to be, but we feel comfortable that the worst is behind us.
We see that in economic growth in the Netherlands, the improvement on the mortgage side, in the housing market, the domestic demand. The worst is behind us. From that perspective risk costs overall will show a downward trend, but they're still at an elevated level. To sum up, I think we have another quarter of strong results. EUR 1.1 billion for the bank, up 21.1% from the same quarter last year. Our strategy implementation is on track. We can see it in different areas. We can see it with different drivers. It's on track across the whole network. It's to the benefit of all of our customers, with the customer growth of 600,000 this half year and 250,000 primary relationships. It's to the benefit of our shareholders, for which we declare an interim dividend, and that basically sums up the presentation. I'd like to open the call for questions.
Thank you. In the interest of time, we kindly ask each analyst to limit yourself to two questions only. If you would like to ask a question over audio, please press star one on your telephone keypad. We will now take our first question. Andrew Coombs from Citi, your line is open. Please go ahead.
Good morning. My first question would be on slide eight and the second question on slide 14. First with respect to slide eight, you specified in your group Core Tier 1 ratio, you've elected not to include retained earnings in order to maintain flexibility on the dividend payout ratio. Could you please just explain the rationale behind that? Secondly, could you confirm that the group Core Tier 1 ratio would actually have been about 50 basis points higher, i.e., 12.8%, if you had included the retained earnings? Just wanted to check my understanding was right there. Secondly, on slide 14, I noticed that the interest margin in the commercial bank, excluding financial market, has actually moved positively. That's slightly surprising given the competitive pressures you've flagged there previously. Perhaps you could elaborate on what's driving the NIM improvement within the commercial bank. Thank you.
Good morning, Andrew. In respect of dividend and the reserving process, what we've seen is that the regulator allows you to pay a dividend out of your accounting profits without recourse to specific approval, provided your fully loaded ratios are in the top bucket, as actually set out in early January, and where we are. To avoid a scenario where we need to ask the regulator for regulatory approval, we need to reserve each quarter, and that's the new bit. Initially, we thought this over the full course of the year, in discussions with the ECB, it seems to be a quarterly process. We need to reserve from our accounting profits, an estimate of what we want to have available to pay out in dividends.
If we were not to do this, not to reserve profits quarterly, and not include them in capital, but reserve them for dividends, because you can't basically do both. I think it's pretty logical. If they think you're going to pay it out in dividend, then you can't include it in your capital. Can't fault the logic in that. To give us flexibility to pay out above 40%, we've decided not to reserve profits in our capital, but keep them to one side and earmark them for potential dividends at the year-end. We more than likely will do something similar in subsequent quarters. This is designed to give us
Complete flexibility or as much flexibility as we can in terms of deciding how much dividend we want to pay and avoid any scenario where we would need to revert to the regulator for permission. You're right, that had we included those profits in our Core Tier 1 ratio, it would actually be closer to 13%.
Right.
We will now take our next question. David Lock from Deutsche Bank, your line is open. Please go ahead.
Hi. Good morning, everyone. I've got two questions. First one's on loan growth. It looks like you get a real strong performance really in your core lending businesses in the second quarter. I just wondered if this is a trend that you're seeing going forward, whether we should expect the 4% ambition to actually be a little bit higher over the rest of this year as some of your lending platforms come online. We've seen a kind of steady step up, I think, in a number of quarters over the last sort of 18 months. The second question is on net interest margin. Just trying to understand the outlook really for the rest of this year, in terms of what you're seeing around deposit repricing potential or loan pricing potential going forward.
Do you think the margin can still expand over the course of this year from the new lower base? Do you think it's really a more of a stable outlook? Thank you.
Well, thank you. I will take the first question on loan growth. Patrick will then come back to your NIM question, but also come back to the NIM question that Andrew asked. Loan growth, strong performance. Clearly, as set, certainly in the commercial banking area, the loan growth is related also to the fact that you build up the number of professionals who know the business, who develop the relationships, and get the business in. It's a good quarter. Also on the consumer lending side and the mortgage lending side and the SME lending side in some of the challenging growth markets, we see good loan growth. Clearly, some quarters were not on the 3% to 4% per annum. Some quarters were above, like this one.
I think, if you look at the model that we're running, the way we reserve capital in order to support loan growth, that works with the 4% ambition. Let's, as we have indicated in previous quarters when we were a little bit short of it, we said, well, you have to look at it from a year-on-year basis. Also on this one, I think let's not draw conclusions on the quarter. We see strong growth this quarter. We have the people, we have the capital, we have the capacity and the resources. We see the demand out there. We're gaining market share in all of these fields. We're very positive on it, but we would like to stick around the 4% ambition for the moment. On NIM, I'll give the word to Patrick.
Sorry, cut Andrew off there a bit too quick. The improvement in commercial banking is due to mix. A lot of the commercial banking lending is in structured finance, which has got good margins, as said before. That mix change from more structured finance as opposed to general lending is positive for the CB margin excluding FM. In terms of NIM, if you look at both NIM and interest income, and I think Ralph's slide 13 pointed it out. Over the past 12 months, past year, we've increased interest income by nearly 6%, 5.8%, and that's due to the mix change and growth, the lending growth, whereas the NIM in basis points has been flat. We do have the negative impact of low rates, which we can mitigate by trimming deposit rates and also improving the asset mix. That's the strategy we've been following.
It has been successful in that we've had, as I say, increased interest income close to 6%, just under, but held NIM stable. Kind of looking forward, I suspect something similar, a similar pattern, provided we're able to continue the lending growth that Ralph just alluded to, I would likely see that pattern continue.
Thank you. We will now take our next question. Martin Rechtin from Goldman Sachs, your line is open, please.
Good morning. My first question is on risk costs and on your comments made earlier that risk costs have now approached the over the cycle average you have been guiding for some time. I was just wondering whether you could provide us with some guidance. Obviously, your guidance is implying that risk costs are likely to undershoot over the next couple of years, given they have overshot it over the last couple of years. I was just wondering if you can provide us any guidance, what level of risk costs we should be looking at in terms of 2016 and 2017, if that is not too far out. The second question is on excess capital.
You state that the pro forma for NN Group, the number is now EUR 7.9 billion, and I was just wondering if you could give us an update in how you're thinking of potential regulatory headwinds, RWA inflation here, and also how you think with regards to potential acquisitions, whether you would use part of that capital for potential acquisitions and whether such acquisitions would be predominantly within the Euro area or also could be elsewhere. Thank you.
Okay. Risk costs, Wilfred.
Thanks. Conceptually, of course, you're right. If we're now coming close to the average through the cycle risk cost, then to maintain that average, there will have to be a period where we're going to be below. The question is, when will that happen? Our guidance for the remainder of the year is unchanged. We still think we're going to end up around the 2014 level. There's a bit of potential, I think, for coming in slightly below that. What we're looking at right now is a slow gradual recovery in most of the core markets. We do see a general, as you've also seen in this quarter, trend in quite a few of the markets for declining risk cost.
The two things that I think for the remainder of this year will impact that positive trend negatively is, first of all, the fact that the Netherlands, as Ralph already pointed out, is still very sluggish in terms of recovery. The second one is there are significant uncertainties out there, which you're all aware of around Russia, Ukraine, China, a lot of macro developments that will have an impact. At the same time, we do see in a number of portfolios where we have taken significant provisions during and after the crisis. We're now seeing significant releases, and that is obviously what's going to be driving the further reduction in net risk cost that we indeed reasonably should expect going deeper into that part of the cycle. That is hopefully going to materialize in 2016 and 2017.
Capital regulatory headwinds.
There's a number of developments on that front, right? The ones that probably everybody is aware of are the major ones. There are four from our perspective. One is the revised standardized approach plus floors. There is the interest rate risk in the banking books. There is the revised SREP methodology, and there is TLAC. On all of those, we have a rough idea of what the framework is, what the methodology is, but we don't really have the actual numbers. If you take the revised standardized approach, it really depends in terms of its impact on where the floors are going to come in, and we don't know that yet.
If you look at interest rate risk in the banking book, we have an idea of the scenarios that are going to be applied, but we don't know exactly what the actual numbers are going to be in those scenarios. It's quite hard to quantify that. Same with the SREP methodology. We know roughly what the new components are, but again, we don't know exactly where they're going to land. On TLAC, partly because TLAC itself is still a discussion, partly because the level is to some extent dependent on Core Tier 1, which again, we don't know exactly what it's going to be. It's hard to quantify. Clearly, individually, each of them could have a significant impact, and collectively they certainly could. All we can say at this point is we participate in all the QIS and consultation processes. We're in constant dialogue with the regulators.
It's clear that all European banks will be impacted, and depending on which floors and which methodologies land where, it could be some more than others. We've talked in the previous quarterly call a bit about the Dutch mortgage book that might, in some scenarios, be impacted more than others. Equally, there are scenarios in which portfolios that do not directly affect us so much would be more impacted. There is, last but not least, all of this analysis would be based on as is balance sheet. Obviously, we have various management actions available to us to mitigate the impact of each of these, and that means that some of this might translate not into capital, but into P&L impact, and some of it would simply be capital. Again, too early to tell.
The second part to that second question on acquisitions. I just go back to the Think Forward strategy. You know that our strategy is based on organic growth. The organic growth is actually happening. We see it in the number of clients. We have real momentum in gaining new clients. We have real momentum in the businesses that we had indicated in which we wanted to grow. From that perspective, growth really needs to come from an organic way. That's why we're principally not really looking at acquisitions from that perspective. If we were to think about acquisitions, as I indicated before, we'll have to be very disciplined around it, but it will be, if it is a team or skill set or assets for balance sheet management or skills, those are things that may be interesting.
Again, we feel that we can do also from the bank's capital generation.
Thank you very much.
We will now take our next question, Benoit Pétrarque from Kepler. Please go ahead, sir.
Yes, good morning, Benoit Pétrarque from Kepler Cheuvreux. Two questions on my side. The first one will be on the mortgage refinancing trend, which seems to accelerate. Could you tell us a bit what do you see in your book? What type of actual refinancing trend you see? Usually, there's also some next to non-recurring impact, there could be some more recurring negative on NII. We've seen one peer in Belgium, which have been mentioning negative impact on recurring NII. Do you expect some negatives on NII going forward and maybe net interest margin as well? Second question will be on the cost side. I think if you look at H1, less regulatory costs, you probably are around EUR 4.2 billion. You mentioned EUR 640 million of regulatory costs in H2.
It looks like you are heading for a nine billion+ on the cost side for full year 2015. Is that something you have also in mind, or you still think you will be lower than that? Just maybe last one, could you update us on your oil and gas/commodity exposure going into Q3? Obviously, prices are going down there. Are you more worried on that? Is that part of your more cautious guidance on risk cost? Could you expand a bit there what you see? Thanks.
Patrick.
Okay. Your question was specifically on the trend, I think on refinancing. Where it is refinancing, I think as Ralph mentioned, happens most where the charges are the lowest, which is in Belgium and to a lesser extent, Italy. Italy is a very small book, so it's not that relevant, particularly for the second part of your question in terms of NIM impact, in terms of the group is just too small. In terms of Belgium, we watch this very closely, and we've seen a significant trail off of mortgage refinancings. It's dropping and has been most quarters now for some time. It's clearly trailing off. Close to half the book has refinanced, so it's largely done, I think. Not everybody will be able to refinance. As I say, it's trailing off significantly. In terms of NIM impact, the non-recurring charges are into other income.
The NIM impacts that could be prospective and continue, well, we do include, as you see in the slide, EUR 20 million-EUR 25 million of the charges that we can charge in Belgium. That will drop off, obviously. You can see it's a relatively small number. There is maybe a little bit lower margin as compared to the hedges on the new refinanced mortgages. That's a small number. That's less than one basis point impact for the overall group. The impact on NIM going forward, there is a little bit, as you can see, but it's not something that would derail us or not derail our views in terms of growing interest income or maintaining NIM. In fact, some of these headwinds you just get, and we have to compensate for. We have.
The Belgian team have looked at this and working hard to mitigate it. We also cut deposit rates. This year, we don't expect to see any net impact at all by virtue of cutting deposit rates in Belgium to offset it. On costs, we had an ambition to try and keep costs flat. It's increasingly difficult with EUR 230 million-EUR 240 million of regulatory costs. FX is going to hit us for maybe another EUR 100 million. That said, that's positive for the cost income ratio, given a lot of this comes in markets like structured finance, where we've an excellent cost income ratio. You get the benefit of that in the overall cost income ratio. Also, there's EUR 100 million adverse from the costs we announced respect to the Dutch Forward NL project, omni-channel project last quarter. We're working very hard to mitigate these cost increases.
We're also trying to keep a very strong eye on the cost income, which you see is at the 53% level.
Oil and gas, Wilfried.
I would refer to page 32 of Ralph's presentation, where we show the breakdown of our oil and gas-related exposure as we did last quarter. It hasn't changed. The exposure is about flat at EUR 30 billion. A couple of characteristics beyond what you see here on the page. Three quarters of this book is very short. It's shorter than a year. We can manage this quite easily if and when required in terms of overall quantum. Secondly, what I would point out before diving in a little bit deeper is that we've got, as you see on this chart, about EUR 5 billion of exposure. That would be negatively impacted by a further decline or prolonged low oil prices. Against that, we have about EUR 550 billion in lending that benefits from low oil prices.
Indeed, part of what we see in terms of economic recovery and write backs of provisions is indirectly related to that. I wouldn't necessarily call it all bad news that oil prices are low. What are we seeing in this portfolio? The watchlist is up a bit. Obviously, we have a number of names that we're watching more closely than we were doing a while ago. NPLs are stable, though we're not seeing an increase in defaults or anything near that. Obviously, you can't rule out that that would start happening at some point. The question is, what is the longer-term oil price scenario? And obviously, a lot of people have views on that. Our house view is that at the moment, the actually quite strong underlying demand for oil is overshadowed by quite a significant oversupply.
We've seen a pretty strong cutback in investments in the oil industry over the past, well, particularly the past nine to 12 months. It started a bit earlier than that. That will, at some point, impact the supply and cut back on the oversupply. Currently, our view is that we expect a stabilization towards the first half of next year and probably a gradual increase in oil prices later next year, which would mitigate some of the things that we're looking at the moment. Obviously, we're watching this space very closely, but given the type of portfolio we have, the tenants in there, and the overall macro impact of the low oil prices, we're not quite as concerned as you might think.
Thank you.
We will now take our next question. Aashish Mohati from JPMorgan, your line is open.
Hi. Good morning. Just a couple of questions. First of all, just to get it correct, can you give us some thoughts on what are the hurdles for any M&A that you're planning in terms of ROE or any other sort of metrics that you're looking for in M&A? Secondly, with respect to your NIM guidance, I remember if your NIM guidance is around 150 to 155 basis points for 2017. Are you still sticking with that? Do you still see possibility of reaching towards those sort of guidance, especially in the mid-range, not at the bottom end of the range? Third question is just a clarification on your previous point on why are you retaining the second quarter profits and not putting in the group capital.
Are you assuming 100% dividend payout ratio at the end of the year, and that's why you're retaining the entire thing? Is it just like creating buffers at the moment? Thank you.
Okay. Thanks for the questions. Well, on M&A, and hurdles, as I said already, we're not planning on M&A like in the sense that you probably would think about M&A. The Think Forward strategy is an organic growth strategy. We have gone through what we call a sustainable share framework. We have organic improvement plans for each and every franchise. Clearly, if there were, what I indicated before, asset books or skills or if technology was available in the market, that sort of M&A is something that we would be looking at. Yes, if in a market in which we are active, in market, in country, consolidation is happening, we'll have to take a look as to how that will influence our own position and how we feel it will affect our own strategy. That would be then more reactive because there's something happening in that market.
Certainly, we would not be thinking about new geographies from that perspective. That's what I can say about that. On the NIM guidance, we have seen flat NIM over the last couple of quarter, if you go back to when we started the strategy, the NIM was around 135-ish, mid-130s. We have improved that to where we are right now, to 147-ish. If you correct it for the two factors that I indicated. There is an improvement there. That improvement is on the back of a change in composition on the asset side. What we've indicated that, first, it's a 2017 indication as to where we want to be in order to improve returns. It's not a target in itself. It's a means to see how we manage returns.
We see that the actual asset diversification into areas in which we have higher NIMs is actually happening. It is not 2017 yet, basically, we feel still comfortable with the 151 and 155 by 2017. Capital clarification, I'll give to Patrick.
Thank you for the question on the reserving. I should have mentioned it when it was asked initially. Given that we reserve 40% in the first quarter, if we were to do 100% for the subsequent quarters, we'd come out probably somewhere near 80%, less than 100. I think the 80% will give us ample flexibility, in terms of what we're thinking of now. That said, the final dividend payout ratio is something we will determine at the year-end. Okay, repeat again. The way we're looking at it, we look at the profits we've made, what we think we'll make in the future, and also what the regulatory world is looking like as well.
Yep, that's very clear. Thanks a lot for this.
We will now take our next question. Guillaume Chéron from AXA. Please go ahead.
Good morning. I've got two questions. The first one is on the cost base. I think someone asked earlier whether you think you can reach a target of EUR 9 billion for this year or whether you will go above that level. The second question is, again, on the dividend. Obviously, payout by consensus has now, I think, increased to about 80%, which is well above your minimum guidance. Presumably, regulatory constraints won't be known fully as we enter 2016. Is there a possibility that you might change the guidance to a more realistic level, even if regulatory uncertainties are not fully clarified, so that consensus can have a better feel as to where your dividend are going? Thank you.
Well, in terms of costs, as I said already, we're going to work very hard to try and mitigate the impact. They are very big, the three things I mentioned, EUR 400 million in aggregate. That said, there's some uncertainty around them. We never give up on this. This is something we will strive to achieve. As I said, it's not easy. We'll see at the end of the year where we end up on costs. Plenty of work to do in the interim.
Dividend. We'll have to read your question again to make sure I hear it. In terms of guidance, yeah, what we're doing now will give us capacity without the necessity to revert to the regulator in a region of somewhere around 80%, mechanically. That doesn't imply that that's the payout ratio we're intending. It simply provides us flexibility up to that level without recourse to the regulator. We're not, at this juncture, disposed to want to go to the regulator. We have to assess what the appropriate number is. The minimum is 40%. It's somewhere above that, provided we are comfortable with how our profits have developed and how we see them developing and the regulatory environment. I'm afraid that's not something that we will decide on or give a more precise view on, probably until the fourth quarter.
Okay.
We will now take our next question. Bruce Hamilton from Morgan Stanley, please go ahead.
Thanks. Yeah, morning, guys. Firstly, again, looking at NIM and your ability to further manage down the deposit side of the equation. How much room do you have there, and which markets in particular do you have the biggest gap relative to peers, just to give us a sense? Secondly, just on the regulatory front, clearly, depending on outcome, mitigating action will be taken. Can we explore that a little bit? If we think about the floors being introduced and impacts on mortgage books, what mitigating action outside of simply de-leveraging the balance sheet or changing your growth dynamics, how should we think about what's within your control to manage for those potential regulatory changes?
I will take the question on the repricing of the liabilities. I refer to slide 28, where you basically see where we're on our savings rates in the different markets in which we're active. Clearly, there's difference per market, per client category. In the end, if it is about savings rate, just like mortgage rates, it's a combination of where the market is and how you run your relationship with your client and the client interest here as well, that you have to take into account. This gives you a little bit of an idea where we are in the different markets. Our position towards peers, in comparison to peers is, if we get 9 billion EUR of savings in the quarter, actually, it's probably interesting and competitive in itself.
I think, at this rate, we're quite happy on one side to get the funding in, build the number of clients. If you gain 600,000 clients in a half year, you must be doing something well and building client relationships going forward. On the regulatory impact, I will give that to Wilfred.
Yeah. In terms of mitigating actions, it really, of course, depends on the product and the client group. Your question, I think, was targeting Dutch mortgages. Number of things to be said there. First of all, again, it really depends on where these floors land and whether or not the ultimate capital impact really makes the product unattractive from an ROE perspective. It's a bit early to tell. Just hypothetically, obviously the treatment of that particular product in the balance sheet of various financial institutions, and in particular, insurance companies and non-regulated investors, is obviously very different from what it is for us. You already see a lot of appetite from institutional investors for mortgages, also in the Dutch market.
I think potentially, one of the mitigating actions could be that we strengthen the ties that we already have with a number of these investors on that particular product in order to move more to an originate-to-distribute model for this particular product. Again, it's quite early to speculate.
Okay, thanks.
We will now take our next question. Anton Kryachok from UBS, your line is open. Please go ahead.
Good morning. Thank you very much for taking my questions. Just two follow-ups, please. Firstly, on net interest margin. Earlier in the call, you have mentioned that you expect net interest margin to sort of broadly stay at similar levels for the rest of the year. I just wanted to make sure which level were you referring to. Is it 143 basis points that you have reported on a stated basis, or should we look at the underlying picture, which is closer to 147 basis points? Then the second question, please, on Dutch asset quality. The improvement in the NPL ratio in the quarter was quite strong. I think you've reported a fall in NPLs to 3.4%. Can you please give us a little bit more color on whether such a strong improvement in the underlying asset quality can actually warrant some write-backs of your existing provisions?
Is it just you working through the files and taking down the provisions accumulated and writing down exposures which were impaired? Thank you.
Okay, thanks. Patrick will give an answer on the NIM and Wilfred on the NPLs.
I think it's very important, again, to go back to slide 13 that showed the EUR 5.8 million growth. This isolates the movement in financial markets, and it's really important to understand that. If you go back to, say, Q2, Q3 last quarter, where we were in the EUR 150 range, we had a very strong contribution from financial markets. It has dropped significantly, the contribution from financial markets this year. Financial markets revenues have increased. Both Q1 and Q2 are sequentially higher. We're very happy with the contribution of financial markets in total. The element, the proportion of financial markets revenues that are attributable to NII or other income is arbitrary. If you isolate the financial markets impact, we're broadly at the same level. Income is up. Commercial results excluding financial markets NIM is holding up well and is comparable to the same quarter last year.
Also, we've had a little bit of negative headwind from the increase in the balance sheet with low rates as it inflates the derivative holdings that we have to gross up in both sides of the balance sheet. If interest rates increase, that could also come down, and we would hope that would happen before 2017. If you take into account what's happened to financial markets, there's not that significant a change in NIM. Hence, we believe that continuing to pursue our strategy of changing the mix means, and with some help from interest rates, by 2017 you could well see us in the target range, our ambition range again. Wilfred?
Bit more color on the Dutch NPL situation. If we look at overall lending for the whole of the country, all the business lines, NPLs were down to 3.6% from 4.1%. The 3.4% that you were mentioning is on the retail banking side, all the lending there, so mortgages, business lending. The only area where we see a slight uptick is in business lending in the Netherlands from 8.1% to 8.3%. I would point out that that is not because the NPL stock is rising, rather because the total book there is dropping faster than the NPL stock. That is a trend that I don't think will continue for long. We do see demand now beginning to pick up in the Netherlands.
Loan demand is beginning to stabilize, so I wouldn't expect this to be a permanent feature, and we will see the NPLs also on that book coming down. By extension, what's going to happen in the next two or three years, in all likelihood, is that we will begin to see some write backs of earlier provisions in that book as well, leading to the below the average of the cycle numbers that we were talking about earlier on. I would reiterate, if you look at the book overall in the Netherlands, the NPLs are down across the board, and that does reflect a real underlying trend, because also when we look at the shorter arrears before NPL, those numbers are also coming down in all segments.
That's very clear. Thank you very much.
Thank you. We will now take our next question, Kirishanthan Vijayarajah, from Barclays. Please go ahead.
Yes, good morning, guys. A couple of questions, one on cost, one on the leverage ratio. Your regulatory cost slide, EUR 640 million for this year, do you think of that as kind of steady state and a sensible number to think about for 2016, 2017? Or is there potentially a bit more inflation to come there? On your leverage ratio, you show 3.8% and a target of 4%, but we're also seeing other Eurozone banks now targeting 4%-4.5%. How are you thinking about leverage ratio right now? Is it becoming maybe a bit more of a constraint? I guess related to that, are there any kind of easier levers you can pull to maybe improve that ratio closer to the 4% in the shorter term? Thanks.
In terms of leverage ratio, we set the target out. When we did it was based on IFRS, and we're comfortably above the 4% on the IFRS basis. The Delegated Act approach is still being finalized. There's quite a bit of detail in how it's computed that is important to work our way through. I think I said in the last call, I believe we'll be able to, whichever the metric is, I think the IFRS number is a good estimation of where we'll end up. We have capacity to manage our leverage, and I think the IFRS number is a good indication of where we'll end up, whatever the base of the computation is. What was the other question?
Regulatory.
Yeah, regulatory costs. Yeah. I hate to say it. It's hard to say that I wish EUR 650 million was the max because it's a very big number, but we think it actually could be closer, a little bit over EUR 700 million in the following year. That's due to-
Oh, yeah
the full impact of the Dutch DGS coming in, because as we expect it to be enacted in July. It hasn't yet been, it could well be done, enacted in legislation retrospectively. Our estimate of EUR 640 includes a half year for the Dutch DGS, and a full year next year, hence the increase.
Okay, great. Thank you.
As a reminder, to ask a question, please press star 1 on your telephone keypad. We will now take our next question, Anke Reingen from Royal Bank of Canada. Your line is open.
Good morning. I just had 2 follow-up questions, please. Firstly, on the dividend, I was just wondering if you accrued at an underlying level or at the first half, you're talking about as a percentage of stated profit. In how far is dividend growth in absolute terms important for you, or is it more you focus on the payout ratio? Obviously there will be different results depending on underlying or stated profit. Secondly, just on potential regulatory changes. Are you aware of any change in how AFS gains are treated in your capital ratio? Thank you.
Okay. In terms of dividend, our ambition is, maybe just to clarify, with the half year we said what we're paying is 40% of the underlying net of the bank, but the dividend for the full year will be based on the net profits. That's what the regulatory, that's what you include in your profits. It's net. After NN Group being deconsolidated, Voya gone, divestitures one-time, we would expect the underlying and the net to be very close. Hence it is our net. In terms of dividend the minimum is 40%. As I said already, we'll have to see at the year end how much more, if we can pay more than 40%. As I said already, that we'll evaluate the full year results and look at economic commercial and regulatory developments. In terms of AFS, it's included in the numbers. It's come down a little bit.
We don't think it's particularly worried about it, in terms of a number given the strength of our capital ratio. Half it's attributed to the Bank of Beijing, where you have a mitigating effect because it's an equity and then you have to hold an RWA against it.
Is also you're not concerned that there might be a change in regulation under which you can't include all the unrealized gains?
Yeah, we can add that to the list of the regulatory things, frankly, it's probably one of the smaller ones.
Okay.
We will now take our next question. Matthew Clark from Nomura. Your line is open. Please go ahead.
Good morning. two questions. one on the cost side. Are there any positive items we should think of going into the second half that might offset the negative regulatory costs and seasonality, et cetera, that would present a headwind? Any reason why we shouldn't expect the second half costs to be higher than the first half? Second question is on the dividend accrual and the decision not to recognize the second quarter profits. Was that a management decision or was that a board decision? Thank you.
I think the latter is one and the same because we're sitting the board. That was our decision. I proposed it and the other members agreed with me. It's simply to create flexibility. These rules on what you include in regulatory capital what you intend or pay out or what you want to keep as a flexibility to pay out a pie to ING, and they apply to all other European banks. There's an ECB framework, and it's been evolved over the second half, and that they want to apply it on a quarterly basis. We proposed it. The ECB don't enforce it.
They ask you, they tell you, "Okay, if you want to include regulatory profits in your regulatory capital, you have to jump through a whole lot of hoops and fill a whole lot of forms and lots of people sign bits of paper." It's quite burdensome and they have to approve that. If you choose not to, the administrative purpose is a lot easier. Their only challenge to this is, "Guys, we hear you talking externally about paying more than 40%. Please be realistic on the amount you want to include in capital." We've decided to ourselves to reserve that profit earmarked for dividends to give us flexibility at the year-end to meet what we said is an ambition, which is to pay more than 40%.
I repeat again, that ambition, we will have to evaluate in the context of the environment that pertains at the year-end, including regulatory developments. We are doing our bit. We don't control those regulatory developments. We don't have them landed, but we're doing our bit in putting the profit aside so that we have the flexibility to pay more than 40%.
On the cost side, clearly, as we've indicated, the regulatory costs are coming in the EUR 240. The second half, the Dutch DGS will come in at a certain moment in time. That is part of that EUR 240. It's EUR 100 million that was kind of coming in as part of the Dutch restructuring program, the actual investment in the omni-channel, but that's basically spread out over the year as well. Depending on where the euro goes, some of the cost increases that we see are basically as a consequence of the weaker euro. It's good for our cost income ratio on the USD side of the business, but it's bad for the cost line itself. For us, on the cost side, clearly it's important to manage our costs. We are very disciplined about it, but we're investing in franchises that are actually growing.
The cost income is a much better indication for us. Now, in the second half specifically, we will see more benefits of the restructuring programs that we're working on in the Netherlands and Belgium and the commercial bank still coming in. That will continue as well. As Patrick has said, will the second half be higher or lower? We're working very hard on it, very disciplined. We will only allow cost growth where we feel it in the end will improve the cost income. That's basically the way we go about it.
Okay. Thank you.
We will now take our next question. Farquhar Murray from Autonomous, please go ahead. Your line is open.
Morning, gentlemen. Just one question, if I may. Really just coming back on the comment you made on China and the potential possibly for further loan losses coming through from there at all. Can you just recap the exposure to China that you have? I think it's in the region of about EUR 15 billion. Within this, I presume you have very limited direct exposure to the recent turbulence that we've seen. I presume what you're thinking about is more indirect consequences. Thanks.
Go ahead, Patrick.
The exposure is a little over EUR 13 billion, indeed. Out of that, EUR 2.7 billion is the Bank of Beijing stake and around EUR 10 is lending. Plus, there is obviously a little bit of pre-settlement exposure. Out of the EUR 10, five is short-term trade finance, and the rest is multinationals, major state-owned companies, and some banks. We don't do mid-market or retail lending in China. If you look at the tenors, 70% of this book is shorter than one year. Currently, the NPLs, and they have been doing that for a number of years, stand at 0%. Doesn't mean we're not watching this. What we've seen is the state taking a number of measures to stabilize the equity markets, blocking shareholders with more than 5% of any company from selling at all.
Interestingly, also telling margin finance houses not to liquidate anything before the index hits 4,500 in Shanghai. A lot of stocks were suspended. We've seen the PBOC pumping a lot of funding into brokers to buy shares. Of course, out there is still EUR 3.7 trillion in forex reserves that the government has at its disposal to do things. We're watching this. I'm sure we're going to see volatility. I'm sure we're going to see some pain at some point. We're not given the quality and the type of our portfolio overly concerned at this point. We don't think that this is something that will lead to a full-blown crisis. Clearly, you'll see contagion, and we're already seeing that from a macro perspective, particularly in the rest of Asia and Australia, but potentially also in the rest of the world.
The commodity markets are a clear indicator of that.
Just as a follow on, where then do you think you might get the knock-on through? Is it just literally just general economic conditions, or is there any kind of marginal exposure to the margin houses that you mentioned?
Sorry, I didn't quite understand your question. Could you repeat it?
I think the question in brief is just trying to ask whether you have any exposure or indirect exposure to those margin financing houses. Just to understand where exactly you're expecting losses possibly to come through. I imagine it's just literally just generally something difficult.
No, we don't have any margin financing based on assets that are directly related to this. I think what we're going to see is simply the macro fallout in terms of weaker demand for a lot of services and goods going into China. We're seeing currency volatility in Asia stemming from this. It is more that macro pattern than anything specific to our portfolio that we worry about.
Okay, great. Thanks very much.
We will now take our next question. Tarik El Mejjad from Bank of America. Your line is open.
Hi, good morning, everyone. I'll just come back on the NIMs, please. You reiterated your guidance of 150-155 basis points, but the asset size, sorry, the balance sheet's growth has been higher than what you targeted in your Investor Day. Does that mean you are scaling back your balance sheet in the next few years, or you're expecting better shift in your business mix towards higher margin products? My second question is on your long road and industry lending. Can you please give us more detail on what sectors are working well and how you manage still to grow although oil and gas is not doing well. I know that you are diversified, but if you can explain us what the other sectors are. Last question, very quickly on Russia. It looks like it's not a concern anymore, but what's your strategy in there?
Are you keen to start to grow your balance sheet again there, or you are leaving it under control at this level? Thank you very much.
Okay. On NIM. No, whenever the lending growth comes in, the lending growth comes in. For us, lending growth, the way it happens here is that we are very prudent. We're not changing our risk appetite to get lending growth in. That's not the way we work. We have the same risk appetite. The machine is running. We go after the categories that we like and the clients that we understand and the business that we understand. There is no change there. When the growth comes in, the growth comes in, and we're not necessarily working on scaling it back from that perspective. Clearly, as we have indicated in the launch of the strategy, a move from the mid-130s to the 150s in NIM was generally because of a change in asset composition. That's what we exactly see happening at this moment in time.
We have seen the NIM increase on that back. It may increase further. In the end, we're managing client relationships, and when we can do deals, we will do so. On the structured finance side and more in particular, we actually see growth across the board in all the different industries and different sectors. Basically, it's a global business for us. We work from Latin America all the way to Asia in it, because these are sector specialists that we work with, and where we can support the business, our clients, we do so. It's really across the board geographically, and it's across the board in terms of sectors. Now, in Russia, I'll give that to Wilfred.
If you look at page 30 of Ralph's presentation, you will see the current breakdown of the Russia exposure and also the delta compared to last quarter, which shows you that we are again down a few hundred million in total exposure. The strategy is unchanged. What we did in 2014 was focus on the quantum, the total outstandings, and we did that by taking out all the exposures that were not core to our core clients and taking out all the clients that were not core to our franchise. Once we had that done, as we said before, we started focusing on the quality of the exposure and managing the event risk that really Russia represents.
What we are doing there is shifting as much as we can to ECA business, to pre-export facilities, to offshore collateralized business, shorter tenors where we can, funding for our clients, where that works for them, their non-Russian activities, and also shifting as much of the onshore exposure really to our own onshore entity and funding it locally as much as we can, which we have been quite successful at. Are we growing the balance sheet? No, that is not the plan. We think that the current exposure levels represent the core of our franchise and what our clients need from us to support them, and we intend, barring any unforeseen new developments, to keep it roughly where it is.
Thank you.
We will now take our final question from Jean-Pierre Lambert from KBW. Please go ahead.
Yes, good morning to you. I would like to come back. It's a single question, but various elements on the calculations of the buffer you will build up at the end of the year. The first question is: are you going to take into account the profit generation you may have next year? Second question is: I would like to understand a bit better the mechanics, how you will build up a buffer and how you will calculate it. If we take a practical example, you have specialized lending, which are EUR 81 billion. It's currently risk-weighted at 37%. The proposal on the BIS is 120%. You have a gap. How you will consider this in practice to build up your buffer? This is a simple example, but can be expanded to the various business lines. Thank you.
Sorry, which buffer are you referring to?
I'm referring to the portfolio of specialized lending, which is well-structured finance and others, which are going to be weighted based on the proposal at 120%. My impression from disclosure on the EBA is it's risk-weighted, I think at 37% in your book.
Well, maybe I'll start. Wilfred, if you're talking about how much profit we will earmark that was available for potential dividends, that's simply the accounting results we have each quarter. If you're asking prospective regulatory changes, well, we'll have to assess at the end of the year what they actually are. Wilfred alluded to that there's quite a lot of uncertainty, makes it very difficult to compute precisely what the impact may arise from them. We'll hope at the year-end we will have more clarity on that. We can actually compute what you're asking.
Yes.
To come back. Going back to how we generally go about capital distribution between three components. We've indicated that 30% of the capital generation of the bank is there to support growth. 30% is there to support improvement in Core Tier 1 or any other risk-weighted changes that you may see. It was the minimum 40% that was earmarked to be paid out as a dividend. In the end, it's about managing debt. If regulatory changes come to us, whether it is this one in structured finance or whether it is floors or whether it is anything else that comes from regulators, in the end, from a bank's perspective, this is the way we manage it. If we have to dedicate more to capital, it may impact growth. That's the way we will go about it.
Clearly, we have a surplus at group as well. That's why we've indicated that if we go about thinking about paying more than 40%, that in the end, that is dependent on strategic considerations, financial considerations, and also regulatory changes that at that moment we expect or not. That's the way we'll go about managing it going forward. James?
To come back maybe to understand better, assume that you need a buffer of 100 at the end of the year, 100 whatever unit, and you have a net profit generation of X next year. Will you deduct some of the buffer you build up, taking the net profit generation of next year into account? The second point is, when you look at the regulatory environment, will you take a conservative view, or you will take a view on the trajectory of the regulation?
I'm happy to go into more details on this in a separate call, but not for this call.
Thank you very much.
Yeah. Okay. Thank you. Operator, I thought this was the final question. With that, I'm very grateful that you took the time to call in and discuss the results with us. Just recapping. Second quarter, strong results. The bank net underlying at EUR 1.1 billion, up 21% from the same quarter last year. Underlying development, strong lending growth, strong savings growth. Over the last half year, 600,000 new clients coming in. Basically, we see that if you look at the strategy and the way we are implementing it, we see that on all accounts, we are progressing and doing well. The results are good. Basically, we're rounding off a good quarter. Thanks very much and stay in touch.
Thank you. That will conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.