Good morning. This is Yvonne welcoming you to ING's Q3 2013 conference call. Before handing this conference over to Ralph Hamers, Chief Executive Officer of ING Groep, let me first say that today's comments may include forward-looking statements, such as statements regarding future developments 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 our 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 filing, including our most recent annual report on Form 20-F filed with the United States Securities and Exchange Commission and our own news press release as posted on our website today. Furthermore, 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.
Welcome everyone to ING's third quarter 2013 results conference call. I'm Ralph Hamers, CEO of ING Groep. I'll take you through today's presentation, and here with me are Patrick Flynn, our CFO, and Wilfred Nagel, our CRO in the executive board. We also have Delfin Rueda, the CFO of the insurance company, and Dagmar Valcárcel , the CRO of the insurance company, to answer questions about the insurance side. Let's go to page two. We had a very strong third quarter. ING continued to make strong progress on the restructuring, advancing further into the end phase of our transformation. At the same time, what is good is that our businesses have delivered a good set of quarterly results. ING Groep posted an underlying net profit of EUR 891 million, driven by another solid quarter on the bank side and improved operating performance on the insurance side.
If we then go to slide three, I'd like to start by giving you an update on the major events that have happened over the last few weeks on the restructuring side, because we have greatly advanced in our restructuring story. Mid-October, we sold another 15% of ING U.S., and the remaining stake now is 57%. With that, we're almost reaching the deadline of 2014 of reaching 15% stake in that. We're close to that already, whereas we have more than a year to go. As you also can see on the graph, the original double leverage of the group remains effectively covered by the current value of the remaining stakes in both the U.S. as well as South America.
Last week, we announced the agreement with the Dutch state on unwinding the IABF, and today we will pay another EUR 1.1 billion as part of the Core Tier 1 security support that we received in the past. This means that we have only two more payments left under that state support program. Last but not least, we have taken another big step in the EC restructuring, reaching a new agreement with the European Commission as a result of which ING Life Japan will be divested as part of ING Insurance. I will go a little bit more detail in all of these events. First on the state support arrangements, page four. We have recently announced and achieved two major milestones with the Dutch state.
Last week, we reached an agreement on the IABF, basically unwinding the transaction that we have established in 2009, reducing ING's risk on Alt-A. The unwinding will free up EUR 2 billion of risk-weighted assets related to the counter-guarantee that we currently have in place. That release of risk-weighted assets will add another 10 basis points to ING Bank's Core Tier 1 ratio. Following the repayment of the Core Tier 1 securities today, including premium, we have paid more than EUR 11 billion now to the Dutch state, and the remaining EUR 2.2 billion will be paid in two tranches. The first one scheduled in March 2014, and the final one in May 2015. Much on state support. We move over to the other milestone that we reached with the European Commission, basically including Japan as part of the IPO, the base case IPO of ING Insurance.
Under that new agreement, the total restructuring of ING Group will now have to be completed two years earlier by the end of 2016. However, the agreement to divest more than 50% of ING Insurance by end of 2015 remains unchanged. We continue our preparations for base case IPO, and those preparations are on track. With the sale of ING Life Korea, as announced a couple of months ago, these changes mean that we have effectively completed all the restructuring requirements for our Asian insurance businesses. To go a little bit deeper into the Japan Life business, basically, ING Life Japan has two businesses. Now on slide six. One business is Japan Life, and the other one is the closed block VA business.
On Japan Life, that's a COLI business, a company-owned life insurance business in which we are market leader with a 20% market share of the Japanese life markets. It's a focused business model, catering to SMEs and affluent customers through independent agencies and bank as partners. As can be seen in this graph, the operating result of ING Life has continued to increase over the last couple of years. This will be a very significant contributor to ING Insurance earnings and cash flows. That is a very positive signal. Beyond that, you also see here that our life business in Japan is well capitalized. If we then dive deeper into the closed block characteristics, that is the next slide. This closed block is expected to release significant amounts of capital over time.
The vast majority of this portfolio consists of accumulation benefit products, and they will run off quickly and free up capital over the next four years. The Japan VA guarantees are already reinsured to ING Re internally, and we manage them and hedge them on a market-consistent basis. In order to further improve transparency around this VA portfolio, in the new reporting segmentation, as announced today, Japan VA will be reported as a separate segment. That will trigger a P&L charge of approximately EUR 600 million in Q4 of this year. With that, we will restore the reserve adequacy in the Japan VA business to the 50% confidence level, and that will be reflected in a full write-down of the DAC. In addition, ING Insurance is considering and studying a move towards fair value accounting on the reserves for the death benefits.
This would be a further improvement in the alignment of the book value of the reserves with their market value and the accounting for the related hedges that we have in place. If this move towards fair value is implemented, then this would result in a pre-tax charge through equity of approximately EUR 0.4 billion to be taken in the first quarter next year. What is important to note is that these changes will not impact the regulatory capital of ING Life Japan, nor the economic capital of ING Re.
If we look at the pro forma debt on the insurance side, we see that if we adjust the pro forma balance sheet for the announced sales of China Merchants, the ING-BOB Life Insurance Co Ltd, IM in Korea, and the sale of ING Life Korea, you see this clear picture appearing, and this also reflects the negative EUR 1 billion pre-tax impact of the Japan VA measures, as I just explained. The pro forma IFRS equity on ING Insurance will then be EUR 13.7 billion, and the debt net of the cash will fall to EUR 3 billion. As a result of all of this, the pro forma financial leverage ratio of ING Insurance is 22.5%. If we take a closer look at the capital ratios, the solvency ratios on the insurance side, we see that they are impacted by several one-offs. On solvency.
The solvency of NN Life is decreasing from 230% to 183% in the third quarter, and this is mainly due to the move to the DNB swap curve, which we decided to following the downgrade of France by Fitch. NN Life solvency would have been stable in the third quarter of 2013 versus the second quarter if the second quarter of 2013 would also have been based on DNB swap. On the IGD ratio. The IGD ratio for ING Insurance is down versus last quarter, and that reflects the impact on the NN Life solvency ratio, as well as the recognized loss on the sale of ING Life Korea. The pro forma IGD ratio, including the impact of the announced Insurance Asia sales and the EUR 1 billion pre-tax impact of the VA accounting measures for Japan, would be 216%.
The final targets of ING Insurance will have to be finalized, and we aim to provide you with more clarity on these capital targets in the first quarter of 2014. Much on restructuring and all the progress we are making there. Let's take a look at the results. Now, ING Group posted a net result of EUR 891 million. That's up 5%-6% year-on-year, and slightly down on the first quarter or from the second quarter this year. The net profit came in lower at EUR 100 million, EUR 101 million to be exact, and that is a result of the EUR 950 million loss taken on the sale of ING Life Korea. The important thing is that the underlying net results are holding up and actually improving year-on-year. If we take a look at the bank, the bank posted another solid quarter.
The gross result of the bank was stable versus last year, but it's down from the last quarter, and that is mainly caused by lower results on the bank treasury side and financial markets, partly caused by the decline in CVA/DVA impacts. Risk costs were down both year-on-year as well as from the second quarter this year, but they remained elevated amid the weak economic environment in Europe. Looking at the net interest margin, the net interest result remained relatively stable despite lower lending volumes. The margin improved to 144 basis points, but that's mainly driven by a lower average balance sheet. The savings margins increased further in the third quarter of this year, reflecting the lowering of the client savings rates in several countries that we put.
The lending margins, however, were also slightly down from last quarter, and that is due to increased competition and actually low demand in the market. The NIM is expected to remain at around these levels in the coming quarters. The lending assets, as mentioned already, they were significantly down in the third quarter, and that is mainly due to the sales and the transfers of assets as well as some currency impacts. We have particularly reduced our Dutch mortgage exposure on the bank side, but that is mainly due to a transfer of a part of the portfolio, EUR 4.9 billion to NN Bank, which we did as part also of the restructuring. In addition to that, we placed an RMBS for EUR 2.2 billion. Also, we reduced our real estate finance exposures through selling certain files in the U.S. and the U.K.
I think what's important to note for you is that we saw an increase in lending assets in the areas where we can realize growth, very much so in Germany, the rest of the world, and structured finance. Going to the operating expenses, they were roughly stable year-on-year. That basically shows you the impact of the cost-savings initiatives, but also the partial transfer of the staff of WestlandUtrecht, which we transferred to ING Insurance, and to NN Bank, as we call it, and lower impairments on the real estate development portfolio. Those who are decreasing the cost, the increases in cost were very much related to higher pension cost. We took some additional restructuring costs above the line this time. We see in certain of these cost-savings initiatives, we see an acceleration, and therefore, we take some additional restructuring costs there, but above the line.
Versus the second quarter of this year, expenses rose 1.4%, that is caused mainly by the restructuring costs that I just referred to in those cost-savings initiatives. The status of these restructuring program in general is on track. They're a little bit ahead of the plan, and the cost savings reached so far are at EUR 352 million, with the savings of EUR 488 million still to be achieved by 2015. I don't think it needs mentioning that we follow these programs closely because we ensure to deliver these results. They're important for a continuing efficient bank going forward. On the risk costs, they decreased year-on-year as well as vis-à-vis last quarter. They decreased EUR 64 million to EUR 552 million. These reductions are generally in general lending, retail, international, and real estate finance.
I mentioned to you the files that we have sold in that portfolio, some of this was offset by higher additions in structured finance, basically one specific file. We go over to the NPL ratio. There we see a slight decrease to 2.7%, down from 2.8% last quarter. Basically down to a lower number of non-performing loans, decreasing by EUR 0.5 billion in total. Lower NPLs in real estate and lower NPLs in structured finance. If we turn to the Netherlands and focus a little bit on the Netherlands, because I know you're interested in that as well. The risk costs in retail banking Netherlands were up year-on-year and slightly down from last quarter, they remained at an elevated level, that basically reflects the weak economic environment that we still see in the Netherlands.
The NPL ratio for business lending has increased from 6.4% to 7% in this quarter, that was primarily due to an increase in the sectors of transportation, business services, and retail non-food. On the other side, the NPL ratio for Dutch mortgages rose from 1.6% to 1.8%, that was mainly due to a decrease in the mortgages outstanding as a result of the transfers I mentioned earlier. The portfolio that we moved from ING to NN Bank, as well as the RMBS that we placed. Risk costs for business lending and mortgage portfolio are expected to remain elevated, basically at this level. Certainly not improve for the next couple of quarters given the continued weakness in the broader Dutch economy. Although we do see early signs of a bottoming out in the housing market.
We see some positive signals in consumer confidence, we want to be very cautious on this one. On real estate finance specifically, the risk costs for real estate finance were EUR 83 million. They were down both year-on-year and also on last quarter, that was driven by higher releases as a result of the asset sales that I already mentioned in the U.S. and the U.K. The additions, however, remained elevated and were concentrated in the Netherlands and Spain. The NPL ratio declined to 9.9%, the risk costs are also in this segment expected to remain elevated. We take a look at the capital position of the bank. We are now on slide 21. The bank's Core Tier 1 ratio increased from 11.8% to 12.4% in the last quarter, that is driven by continued solid profitability and the decrease in risk-weighted assets.
If we correct for the payment to the Dutch state today, as well as the unwinding of the IABF, you see that the payment that we're making today will decrease the Core Tier 1 by 0.4%. The unwinding will increase it by 0.1%, so the net effect is a decrease of 0.3%, but that will still get us to a pro forma healthy 12.1% Core Tier 1 ratio on a Basel 2.5 basis. If we then correct for the first tranche of the phased-in effect, we would get to a pro forma CRD IV Core Tier 1 of 11%. If we would correct for the full Basel III on a fully loaded basis, the Core Tier 1 would get to 10.4%, still higher than our ambition that we have communicated to you to remain at around and above 10%.
We see that the bank is already meeting the CRD IV requirements, and that we are delivering on the priorities that we have communicated to you at the investor day two years ago. We're accelerating transition to Basel III. We're limiting the balance sheet and risk-weighted asset growth, and we are successfully executing the balance sheet optimization. We are simplifying our business portfolio, and we take a very prudent approach to capital and funding, given the unstable market conditions that we still see. Core Tier 1, as said, stands at 10.4% fully loaded. LCR is above 100%, and the Basel III leverage ratio is well above the 3% of the minimum, which is the minimum CRD IV target. The conclusion is ING is simpler, stronger, and well-positioned to service our customers and improve the business going forward. We move to the insurance side.
The operating result improved strongly year-on-year, supported by higher investment margins, tight cost control, and improved non-life results. The decrease versus last quarter was mainly due to seasonally high dividend income in the second quarter. We see that every second quarter. We see an increased investment income there. ING Insurance is considering to refine the market interest rate assumption for the separate account pension business. If this would be implemented, this would result in a one-off P&L charge of EUR 160 million, one six zero, pre-tax in the fourth quarter of 2013. If we then look more specifically to income and costs on the insurance side, we see that the income was up year-on-year, slightly down from last quarter. Again, that was driven by the investment margin coming in a little bit lower given the high seasonal effect of the dividend income in the second quarter.
You see income stabilizing there. On slide 26, you see that the administrative expenses are down, and I think this is an important one to note for all of you, is that the impact of the transformation program as announced last year is really shown here. We see the administrative expenses declining by 3.8% year-on-year. This transformation program is eating up basically the cost increases from the transfer of people from WestlandUtrecht Bank to NN Bank, as well as also on the insurance side, higher pension cost. Excluding the transfer from WestlandUtrecht Bank to NN Bank and excluding some currency effects, the administrative expenses would be down 6.3% versus last year and 4% versus the second quarter. That's a clear evidence that the transformation plan is paying off. I come to basically a wrap-up.
I think around this table, we are all extremely proud of the financial and strategic progress that we are making and that we have achieved this quarter. We have delivered solid underlying results for both the bank and the insurance. Over the last two, three weeks, we have been able to announce strong progress on our restructuring targets. With that conclusion, I would like to open the call for questions.
Thank you, sir. In the interest of time, we ask each analyst to limit your questions to two. If you would like to ask a question, please press the star followed by the one on your telephone. To cancel your request, please press the star followed by the two. Once again, we would ask that you limit your questions to two. The first question is from Andrew Coombs from Citi. Please go ahead.
Good morning. I'll ask my two questions, please. One on Japan, and then one on the loan loss provisions. Firstly, on Japan. Looking at the EUR 0.6 billion and EUR 0.4 billion charge, that's on an IFRS basis. I just wanted to double-check what the change, or any impact, if any, would be on the local GAAP accounts. If you could please provide an update on the latest equity figure under the local GAAP accounts for Japan. I think it was EUR 500 million, as I recall, last time I checked. Secondly, on the loan loss provisions, I'm just trying to reconcile the points you make on both page 20 and page 29. With regards to the NPLs, you've continued to see an increase, particularly in business lending in the Netherlands.
At the same time, if I look at your outlook commentary on loan loss provisions, you do talk about signs of stabilization and positive signals in terms of consumer confidence. You talk about elevated provisions in the near term, but perhaps you could give us a bit more visibility on when you think loan loss provisions might start to recover in that segment. Thank you.
I will give the question on Japan to Patrick Flynn, the CFO.
The two adjustments are in IFRS only. They have no impact on regulatory capital locally or local GAAP results. I don't have the local GAAP number to hand, but we can get it for you later.
Thank you.
We turn to Wilfred on the risk cost on the loan loss provisions.
Yeah. Provisioning is always a bit of a lumpy business. If you look at the provisions in this quarter, they are down somewhat, but that is driven by a couple of relatively significant individual releases. Indeed, in terms of the guidance, what we have said for a while is we expect provisions to stay at these elevated levels. You do see a slight drop in NPLs across the global book. There are individual portfolios including, for example, the one that you mentioned in the Netherlands, where we're still seeing upticks, and we think that trend is not about to end. In answer to your question on that particular book, when do we expect loan loss provisions to come down? That's hard to predict, but I would say that won't be until well into 2014.
Right, sir. Thank you.
Next question.
The next question is from Farquhar Murray from Autonomous Research. Please go ahead.
Morning, gentlemen. Just two questions, if I may. Firstly, on net interest income, the core retail businesses were actually very strong this quarter, but there would seem to be a step down quarter-on-quarter in retail rest of the world, which went to about EUR 412 million, from memory, versus a kind of EUR 460 million average over the previous quarters. I just wondered if you'd give us some color on what happened there and how we should think about that going forward. Secondly, on ING Insurance, you've provided the pro forma IGD ratio. I just wondered whether you'd come around to having a think about what the interest coverage is on that business as yet. Obviously, that partly depends on how you allocate debt, et cetera, but I just wondered if you might have that number now. Thanks.
On the net interest margin piece, there's a number of pieces in there that are, some of them, non-recurring. Part of it is due to the volatility we saw in the interest rates in Turkey. Another piece is FX as well. It's difficult to isolate it to one individual point.
In net, should we think that the interest rate move from Turkey was a negative and was probably predominant within that mix, or as a one-off?
I'm sorry?
Should we think that the Turkish interest rate move was a negative and was probably the predominant effect there and probably is non-recurring? Is that a fair way of looking at it, or
I think the FX is probably the biggest single impact.
Okay. Thanks very much.
Delfin? Delfin Rueda is here with us.
Yes, on the IGD, your question was about the interest cover. The interest cover is around six times at this point of time. With the inclusion of ING Life Japan, that will improve slightly.
Okay, great. Thanks very much.
Thank you. The next question is from David Andric from Morgan Stanley. Please go ahead.
Hi. Good morning. Two quick questions on my side. First of all, I was just wondering in terms of the Benelux investment portfolio, if you've started to take any action in terms of re-risking it. Second on the non-life insurance business, just wondering, how do you think of the result this quarter? Do we see this being a fairly stable result? Or is there room for further improvement as further price increases come through on the individual disability side? Thanks. Okay, Delfin.
On the question on reinvestment, as we have indicated in the past, we are gradually but very prudently analyzing the different possibilities of doing some risk weighting. That is, of course, linked to our overall total target capital discussions. As we have mentioned in the past, the effect of increased interest margin will only be perceived later on in 2014.
Okay, thank you.
Thank you. The next question is from Kirishanthan Vijayarajah from Barclays. Please go ahead.
Morning, guys. Just a couple of questions on slide 15. If I exclude the various sales and transfers, I wonder what's the underlying picture in terms of your market share development in the Netherlands, and I guess more importantly, looking forward out to 2014, what's your appetite to start regrowing your loan book there, please?
Okay. I think the market share in the Netherlands is relatively stable overall. On the mortgage side, we tend to be up from last year and growing into it, stable at around 15%-16% currently. On the company side, on the lending side for our two companies, it is around 23% in total, 23.5% up from 22 last year. On the savings side, if we take the total, both consumers as well as corporates, so basically on the funding side of things, we have a market share of around 28.6%. Appetite to grow into it, I think that clearly we are a large bank in this country. We have to service our clients, but we will be very cautious as to the risk that we take on the books vis-a-vis the current economic situation and as well as the outlook there.
We do see positive signs of consumer confidence. We see the house prices basically bottoming. We see more volume coming back into that market. We expect basically a modest recovery, and also we will play along with that modesty and see where we can initiate and support further growth, but cautiously.
Okay. Thanks very much. Understood.
Thank you. The next question is from Ashik Musaddi from J.P. Morgan. Please go ahead.
Thanks a lot. A couple of questions. One on your cost savings for the banking. Can you give us some color around how much will be the cost saving on a look-through basis, i.e., net of pensions and restructuring cost? Is this restructuring cost just a one-off or are there more restructuring costs to come in your underlying numbers in the future? That's the first one. There's a lot of things going on real estate finance and structured finance portfolio on loan loss provisions. Can you give us some color on what's one-off and what's recurring, i.e., it looks like on real estate finance, the one-off is some releases, whereas on structured finance, there's one-off additions. Can you give us some color on that? Would be great. Thanks.
May we first move to Patrick?
In terms of costs, the approach is very similar to what we've had in the past. What we're aiming to do is make structural reductions in our cost base. Unfortunately, there are additional regulatory costs that are coming at us. We're trying to make sure that at a minimum, we keep our cost base flat, so absorbing these regulatory changes. What you see is that the program is announced, and like we said before, we will do more. There is more we can do, and there is an additional charge of EUR 56 million that's shown in the slides for improvements that are above, or at least half of which are above and beyond the programs we currently announced. We are looking to do more than the programs we previously announced.
On the loan loss provision in real estate finance, Wilfred.
You're right. There is lumpiness both in the releases that we're seeing in REF as well as in what we see in additions in structured finance. Comparing to earlier quarters, there always have been releases on the REF portfolio as well as growth additions. Difference is that this quarter we have probably around EUR 30 million more in terms of release than normally. If you look at structured finance, then I'd say we've got between EUR 50 million and EUR 60 million additional provision that is slightly more than we would normally expect. If you correct for that lumpiness, you get an idea of where this is, and you'll see that we're roughly trending at the same levels as in the past quarters.
Hello. Thanks.
Thank you. The next question is from William Hawkins from KBW. Please go ahead.
Hello. It's William Hawkins still at KBW. Two questions, please. The insurance investment margin, the EUR 175 million, that seems quite resilient on a quarterly sequential basis because you were about EUR 190 million in the second quarter, and that included well over EUR 50 million of dividends. I appreciate there's the benefit from WestlandUtrecht Bank, but to the extent that sequentially that's still a good EUR 20 million or EUR 30 million increase on the second quarter. Is all of this just quarterly noise or is it the benefit of rising rates, or to what extent should I say it's something sustainable rather than something just kind of volatile?
Secondly, I'm just interested to understand a little bit on your understanding of the outlook for the operating profits for the Japan VA business after you've made these VA changes, and also the emergence of capital. Any kind of guidance you can give on that. I appreciate the announcement today has only just come. Presumably you've already done a lot of work in the background on that. Thank you.
Okay. Delfin?
Yes. Thank you, William. Two questions on the insurance investment margin. Indeed, there is the impact of the increased interest margin coming from the net interest margin coming from NN Bank. Following today's announcement, when we present the new segmentation for the next quarter, that's going to be taken out. In addition to that, there is, in comparison to the previous quarter of last year, there was a lower allocation to profit sharing with our policy holders. In addition to that, of course, there is a gradual, small improvement in terms of the amount of investment rebates to our customers as the guarantees in our pension funds gradually and slowly decrease. That are the three elements that are impacting the interest margin this quarter.
In relationship to your second question on operating profit at the outlook, I will not provide any view in terms of the outlook at this point. I think that the slide in the presentation show that Japan Life business is providing a good, sustainable, and a strong operating result. In addition to that, for the closed book VA, this is something that obviously as the book runs off will generate some capital releases.
Okay, thanks.
Thank you. The next question is from Omar Fall from Jefferies. Please go ahead.
Hi. Good morning. You're remaining very cautious on the outlook for Dutch loan losses, which is certainly understandable. Again, the macro trends in the last two months have shown a fairly sharp improvement across a pretty broad range of measures, like the PMI increasing at a record, lower bankruptcies, more stable house prices, et cetera. You're saying that despite that, you haven't seen any of that reflected in the rate of NPL adds or any other asset quality metrics since the end of Q3? That's the first question. Secondly, just a small one on the net interest margin, please. What was the contribution of financial markets to the NIM? Would it be possible in the future just to get that number a bit more consistently as you used to do in the past? Thanks a lot.
Okay. For the first question, we turn to Wilfred.
Yes. On economic developments in the Netherlands, it is indeed, and Ralph has also highlighted that the case that we are seeing some early signs of a coming recovery. PMI index improvement doesn't directly translate into GDP. What we are seeing at this point is more a slowing down of the deterioration than a real improvement. That's one observation. It's good news, it doesn't translate at all into the NPL rates at this point. That's also because typically, these movements come later in this cycle. Certainly, some of the bigger asset classes are late cycle anyway. As we said before, we do note these potential improvements, and we do expect them to gradually trickle through into the numbers. Again, not until we're well into 2014.
Understood. I guess I would have just been surprised not to see some improvement on the SME lending side, given that is a shorter duration that can much more geared to the immediate economic cycle. I understand your caution.
Yes. Well, maybe to specifically comment on that. What we are seeing is that at least in the SME books in the Netherlands, the NPL rates don't go up anymore. At least they didn't in this particular quarter, which may again, be just quarterly noise, if you like. Where we do see an uptick still in NPLs is in the mid-corporate segment that is also part of business lending. If you combine the two, then we're still seeing an increase in both NPLs and risk cost.
Understood.
On the NIM, the impact of FM was zero. That's why we didn't give it. We can look to include it going forward.
Thank you.
Thank you. The next question is from Francesca Tondi from Morgan Stanley. Please go ahead.
Good morning. Thanks very much for the presentation details so far. I am following up on a couple of points. Looking at the net interest margin, if you could tell us a little bit more, on one hand, how do you see commercial margin trending, especially in Benelux? Also, how are you looking at your still large liquidity buffers? Are you looking at taking them down, especially if you are looking out to potentially either another rate cut or rates going into negative territory? If you could just discuss a little bit around that would be very helpful. The second question is on asset quality. You have really given us a lot of details. Just a couple of points quickly. Do you see potential for further sales, especially real estate finance? I know you have done U.K. and U.S. Still large portfolio. What about elsewhere in Europe?
Do you feel comfortable with the valuation? Also, looking at the AQR, how comfortable you are that the details we have so far, for example, on NPLs definition, how close are they to what you have in your NPLs? Thank you very much.
Okay. Let me take the first question on the commercial margins. Basically, in the part of the year where we are active, clearly we have sufficient liquidity buffers and we're ready to lend, but we don't see a lot of demand. On the corporate side, we see corporates moving into markets directly, often through bond issues. Where we can support them, we will do so. Given the fact that there's not a lot of demand and there is sufficient liquidity in the market, you can expect a bit of pressure on margins from that perspective. Having said that, we have always managed our pricing in a very strict way. We have our specific hurdles on the basis of which we price, and therefore for the coming quarters, we expect the total net interest margin to stay around this level.
Thank you. You still had relatively large liquidity buffers at the treasury level. You've taken somewhat them down. Do you have a further reduction to do, or you are where you were hoping to be?
Maybe in terms of impact on interest margins, yes, we have a comfortable liquidity position. Yes, we're meeting the CRD-
Yeah
requirements. Obviously, we look to try and optimize in that space as well. In terms of interest margin in the Benelux, it did improve, notwithstanding the fact that we moved mortgages across to NN Bank as we were required to do, which obviously is a drag because you take-
Yeah
interest payments out. That was sort of compensated a bit by a further reduction in interest saving accounts in the Netherlands and Holland of 20 basis points. In terms of margin, we managed to compensate in the Netherlands from the negative effect of the asset transfer and the weak-ish loan demand by reducing deposit levels. Yeah, we are looking to optimize in terms of our financing costs. We have a very strong loan deposit ratio. We've seen good inflow of retail funding, which puts us in a stronger position in terms of the outlook for future long-term debt issuance needs.
Yeah. On that, how will you look at the further reduction in interest rates by the ECB, even just taking the ECB negative rates into negative territory, real rates, what would you think of that?
Obviously, we look at this in the round. We look at our position relative to our peers. We look at our position with respect to our customers.
Yeah.
You take a blended and a rounded view of how the market is developing. I think one of the positive points is our deposit rates on average in Holland are still healthy. They're 150 basis points, 1.5%. There's plenty of room there.
Let's move to the questions on NPL. Wiebe.
I think we're now at question number 7. I have noted three things that you wanted to talk about, NPL definition, AQR and valuations, and real estate finance sales. Let me take it in that order. The NPL definition that's come out from EBA, obviously we have noted. We struggle a bit with the fact that it doesn't completely gel with the Basel definitions, which doesn't make it easier. In any case, this definition is substantially less conservative than our own. I can give you two examples. One is, in our situation, we do not only take everything that is more than 90 days overdue, but also everything that has been over 90 days is on the way back to normal or even is normal. We don't take those out of the NPL bucket until they're six-month performing.
Secondly, the EBA definition in a situation where we lend to a group states that we need to take the whole group into NPL once we cross 20% of the total exposure being in default, whereas under our own metrics, that is at the first euro of default of anything outstanding to the group. Just to give you an indication of what the differences roughly are, if you take our own NPL definition on the Dutch mortgages, we look at 1.8%. If you were to take the EBA definition, that would be more like 1.1%. You asked about valuations in AQR. There's obviously a number of things going on. There is a DNB AQR on commercial real estate here in the Netherlands. There's also the ECB AQR coming later in the year and into next year.
Our view is that with regard in particular to commercial real estate finance, which I guess is the background to your question, what we have done over the past few years is first of all, managed to book down substantially by about EUR 10 billion from EUR 36 billion to about EUR 26 billion at the moment. Secondly, we have increased our risk weights quite substantially over that period from about 20% to currently about 53%. Against that smaller book, the stock of provisions has also gone up over that period. On the whole, we feel fairly comfortable with the buffer of capital and provisions that we hold against this book, and we don't expect any major issues there. Then on real estate finance sales, there's obviously a lot more activity in the markets in general than there was a year ago.
We have taken advantage of that in the U.S. and in the U.K. to some extent. There's also a bit more activity in the markets closer to home, not yet at price levels that we and our clients find exciting. I would point out that we're not holding large portfolios of distressed real estate as owners here. Most of our clients are still performing. Most of the assets that we hold are still producing income. In fact, all of them are. It's not something that we do without the consent of our clients and usually the initiative of our clients. Again, where we see opportunities and our clients want to benefit from those, we support them.
Thank you, sir. The next question is from Michael van Wegen from Bank of America, Merrill Lynch. Please go ahead.
Hi, good morning. It's Mike Van Wegen, Bank of America, Merrill Lynch. Two things. First of all, on your net interest income, can you indicate for the treasury unit, you saw a big negative impact in Q3. To what extent that recovers when you start essentially use the funding that we've seen strong growth in Q3, and to what extent does the liability management give you a benefit going forward as well in your NII, by having lower funding costs? That's question number one. Question number two is on the European or Euro-Asia IPO. Now that you've announced that Japan will be part of this entity, I guess you've taken a big hurdle, and the consultation on Solvency I and a half is also out there.
That to me suggests that you, by now, should probably have a fairly good idea of what this business will look like and where you want to get it to. When can we expect an update on targets in terms of solvency, leverage ratios, and I guess, returns? Thank you.
In terms of the outlook for treasury, couple of answers to this one. First is, this is something we probably do owe you an update on, and for more granular analysis. We're looking at it in the context of our current planning process. We're aiming to give a more fuller analysis of this after we've completed that. You're going to have to bear with us a bit. I think the full story on this, or the projections for the future at least, we will give you next quarter when we've completed our MTP process. In terms of your specific question, yes, the liability management exercise, particularly the hybrid, the 8.5%, $2 billion hybrid call is positive. Although that's a relatively small part of the overall total. The deterioration quarter-on-quarter, is more to do with one-off effects.
The treasury is where we have or hold the cost of the tier 2 debt, or sorry, the long-term debt that we've issued as well. The deterioration is more to do with one-off effects, lower mark-to-market gains, and a lower positive and effectiveness result. Like I said, I think we will aim to give more color on this once we've completed our planning round.
Thank you. On the Euro-Asia IPO, sort of targets.
Yes, Michael, I think you're absolutely right. We have now clarity about the scope of the entity to be listed. We have clarity about the earnings potential and the actions that we're taking in order to manage expenses and manage the company going forward. Solvency I and a half is more clear now. There is a proposal that has been put forward in order for consultation. We know what impact that will have. As already mentioned by Ralph before, we will provide more clarity here with the year-end results or in Q1 next year.
Thank you.
Thank you. The next question is from Martin Leitgeb from Goldman Sachs. Please go ahead.
Yes, good morning. My two questions are as follows. The first one is, I realize you guys had quite a significant step up in mortgage production in retail Germany, coming after two quarters of relatively slow production. I was just wondering whether you could provide a bit of color to that. How did you achieve this growth, and what kind of figure or size do we need to think as a run rate going forward? This is particularly in context that previously had very strong deposit growth in Germany, which was not matched by a stronger pickup on the mortgage growth there. I was just trying to see where that is going forward.
The second question is really just to confirm, for the European Commission restructuring, does the announcement today with regards to Japan, does that change anything with regards to the timeline on price leadership ban, on acquisition ban, and with regards to calling hybrids, or do the deadlines there on November 14 and November 15 respectively remain in place as they are? Thank you.
Yeah. On the German mortgages, yes, we did see a bit of an uptick this quarter, I think by about EUR 1 billion or so. At the moment, the demand in Germany is frankly more driving our production than anything else. The capacity to do more is there, but obviously we want to grow this book in a sensible and very risk-aware way. If you look at our plans longer term for the book, what is very important to us is that we build a balance sheet that is, in more than one respect, balanced, and that we differentiate also into more asset categories than just mortgages. We are looking at a more broader-based franchise in Germany over the long run. Therefore, mortgage production will continue to be important, but it's not going to be the only driver of balance sheet growth.
The deal that we have now on basically moving the deadline from 2018 to 2016 does not change anything on the other aspects, as you mentioned, if it comes to M&A ban and price leadership ban.
Okay, thank you very much.
Thank you. The next question is from Anton Kryachok from UBS. Please go ahead.
Good morning. Thank you for taking the questions. Two questions on bank balance sheet, please. Firstly, on capital. You had a very nice capital build in this quarter, up 60 basis points. In that context, I was wondering whether you have heard from your local regulator on the targeted Basel III fully loaded Core Tier 1 ratio that you will be required to have going forward. If this strong capital generation continues, would you look at earlier repayment of state aid? The second question, please, on the balance sheet size of ING Bank. Obviously, apart from meeting the demand from your key markets in terms of lending, what else can you do to actually start growing the total size of the balance sheet of ING Bank to support the NII? Thank you.
In terms of the ratio, we've said for some time that our target is 10%. The regulator is not going to publish his views. You can see from what we've done in terms of paying dividends. We paid dividends at the beginning of the year. We just paid one now, and obviously that requires regulatory approval. There's an implicit message in there on how the regulator views us. We stick to our stance that, as Ralph mentioned in the presentation, that we're looking to be at around 10% Basel III fully loaded. We meet that today. In terms of balance sheet size and growth, yes, we did give a target for 2015, which would imply a significantly higher balance sheet than we currently have today.
Remember, that was in the context of leading to achieving an ROE of 10%-13%. We're currently just below 10%. One thing was certain, certainly in my mind that A, we would reach it, but B, it would not be the way we originally planned two years ago. We'll have to compensate. We're currently seeing limited loan demand. There's excess cash in the market at the moment. We do have some growth, but it's moderate. A pickup in global growth would help. We're still delivering just under 10% notwithstanding that tough environment, with loan losses significantly elevated. We're going to focus on NIM and a very stringent focus on costs, and we will aim to achieve our target ROE.
Thank you. Sorry, just as a follow-up on capital. If the capital generation in the next few quarters surprises positively on the back of RWA contraction, let's say, would you look at accelerating the repayments to the Dutch state, or is it something that you haven't thought about yet?
Yeah, we have two more payments to make. There's a schedule which we set out because the cash flow is fixed. We don't get a discount for paying early, so we have to balance acceleration costs more. Obviously we want to get the state aid repaid as quickly as possible, but we have to balance the accelerated cost with that, and we have to balance the potential uncertainties that are coming next year with the AQR, for example, and seeing how the economy evolves. I'd like to look at it after we've repaid the next tranche and see what the world is like. We have an ambition to exit state aid as fast as is possible, but we will only do that in the context of maintaining strong capital ratios.
Understood. Thank you.
Thank you. The next question is from Benoît Pétrarque from Kepler. Please go ahead.
Yes, couple of questions. First of all, on the Benelux insurance operating earnings, just to come back on the question of the kind of why nots, just to check the improvement year-over-year. As you mentioned, lower profit sharing assumptions and lower interest rate rebates. Could you quantify that, please, for the third quarter? Linked to that, could you also update us on the kind of operating cash flows you've generated from your Eurasia businesses, and the split per distributors will be useful, obviously. Obviously, this is a key question, and you're not talking about cash here. Just wondering if you could clarify that. Then could you talk a bit on solvency for Nationale-Nederlanden, it's 183%. First of all, could you give us the sensitivity to higher or lower interest rates, given it has been moving again this quarter?
Could you update us on Solvency I and a half? What is the kind of likely outcome for the Dutch Life business there? Just quickly on Japan operating earnings, what will that be for the closed block, roughly? Thanks.
Ralph and
Okay, a lot of questions. I'm going to ask Dag to help me with the impact on interest rates, I will try to cover all the remaining. Starting with the operating cash flows generated by the different business. I start with this one because it's the shortest answer. Dag will start providing some information about this once we start reporting with our new segmentation. I think that during the quarter, the main impact on our cash flows, understood as cash capital, have been mainly the change in the discount rate for our business in NN Life To the move to swap. That has been the main drag in terms of capital that compensate some of the generation of capital coming from the different units, investment management, Europe and certainly Japan.
If we look at the impact on the Benelux for the operating results in terms of the profit sharing and rebates together will be approximately EUR 16 million. Looking at the update on Solvency I and a half, as I mentioned before, there is a proposal that has been put forward for consultation. Still, the intention is to have it implemented as of 1st of January 2014. Just to make clear, the Solvency I and a half does not change the base of our solvency capital, the so-called Solvency I. It just establish another threshold for the Dutch regulator to determine or have more limitation on the possibility of distributing dividends. At this stage, and subject to the results, I can basically tell you that the impact of this Solvency I and a half is not limiting our capacity to distribute dividends.
In relationship to Japan earnings for the VA, I'll try to find an answer for that while I allow my colleague, Dag, to reply on the sensitive to interest rates.
Sure. On the NN Life, we effectively try to match fairly closely on an economic basis. As you know, there's a UFR on the Dutch curve requirements, this ultimate forward rate. That basically means is that we're modestly impacted by rising rates. In a rising rate environment, we lose a little bit of solvency. In a falling rate environment, we gain a little bit. It's fairly modest. On an economic basis, we stay quite reasonably protected for up or down rates.
In respect of Japan, the effects of what we're doing in moving to market can be summarized in 3 main things. One, currently 75% of the book is mark to market, and a quarter of it isn't. It follows SOP 03-1. You can get counterintuitive results because we do hedge at a full economic capital basis, and you get catch-up P&L effects from the SOP 03-1 reserves movements. We're going to take that out because we're going to move the full P&L to mark to market. That should make the results more intuitive. Also, there is DAC hung up on that balance sheet that at some point would have to be written off and amortized. We're taking that up front, that will be gone. That overhang will not be there anymore.
Also, we will move the reserve adequacy to a very comfortable position, so there will be no more questions regarding reserve adequacy. Those 3 measures, I think, will help stabilize the operating earnings. They will not fully stabilize them because you're still exposed to some gamma risk, but it takes out 3 of the factors that can lead to volatility in results. It will also mean that, and I really want to emphasize this, that our Japan VA business, I think almost uniquely, is managed on an economic capital basis, on a market consistent economic capital basis. It's hedged on the same. It's capitalized on that basis. We have EUR 900 million of capital there, which is comfortably in excess of the economic capital requirement. We will, in addition, then move the accounting to full mark to market. More transparent than that, I don't think you can get.
Yeah. Thank you.
Thank you once again. If you would like to ask a question, please press the star followed by the one on your telephone. In the interest of time, could we ask that you do limit your questions to two? The next question is from David Lock from Deutsche Bank. Please go ahead.
Hi, everyone. I'll be well-behaved and just ask two. First one on cost reductions, just circling back on an earlier question. I wondered if you could give a little bit more color on how future cost reductions could come through. Ralph, I know in the past you've mentioned that branch footfall has fallen significantly. I just wondered how long we could expect perhaps some of the fixed costs of the branch businesses in Europe to come out. The second question is more around capital again. I know there's been a question previously on how the regulatory level will turn out, but if we compare where we are today versus where you were when you set that 10% level, it's clear that the European environment is a lot harsher in terms of capital requirements. How do you expect that to evolve over the next year?
Please, if you could give any color.
Okay, I'll take the first one because this is specifically related then to one of the business models that we have, which is the branch model. Clearly, we see that customer trends are to do more and more direct and more and more themselves. We're a leader in internet banking. We're a leader in mobile banking. Therefore, you see that a lot of the actual transactions being done, they move to a mobile environment, and they move outside of the branch. That is basically what decreases the traffic to branches in general. Clearly, that has been the underlying factor for some of the restructuring programs that we have. As a consequence of that, we do decrease the number of branches. We have to do that in those areas in a very well-planned way because we also still have a lot of customers who like that.
Basically, you do that in a phased
Approach, and you adapt towards basically the adaptation rate of the consumers taking more products and doing more transactions through mobile and internet. Advice will still be an important role, will still be important in our model going forward. Basically what you can expect is that the plans that are out there right now, we continue to implement them as we speak. Clearly, if there is signals that the adoption of direct channels is even further accelerating, as a consequence of which, the footprint of branches could decrease, now I'm talking about the Benelux more than anywhere else. On the other side, we also see countries, the more emerging countries, where in order to complete our business model going forward, we would even consider opening some branches, for example, in Turkey. The one that you asked for is we will play it by ear.
We check on customer behavior, clearly we move in line with that. On the second one, I'll give the word to Patrick.
Yeah. In terms of capital, we think that 10% is a good number, particularly 10% fully loaded. I think we look well relative to peers in that outlook. The other thing you need to realize is that we operate a Basel III advanced model. The ground on which that is based is moving, and in a downturn environment, a weak economic environment, RWAs are going up. As we constantly update our models for the current economic data, it generally leads to increasing RWA requirements. We're maintaining a 10% RWA target on the back of a stronger RWA. Our mortgage RWAs have gone up, our real estate finance RWAs have gone up significantly, as they should do, and as the Basel III models would expect you to do. In that context, I think 10% is still a good number.
Just to be clear, the model change that you referenced there in terms of Basel III, is that completely separate from the other model refinement that you referenced on page 22 of your quarterly report?
Well, I wouldn't call it model change. This is regular model updates. We do this all the time. That's what Basel III requires, and we regularly update the models around economic data. That has led to significant increase in RWA requirements for real estate finance over the years, and modest increases for mortgages as well. This is just normal practice. Basel III is operating as it should.
Thank you.
Thank you. The next question is from Anke Reingen from Royal Bank of Canada. Please go ahead.
Yeah, thank you very much. Two questions, please. The first is on net interest income and the absolute level. Should we consider Q3 as sort of a trough, or would you believe that the absolute level would continue to come down as you continue to deleverage cheap despite relatively good net interest margins? The second is on costs. You mentioned before that best case costs would stay flat. Is that post the additional steps you mentioned for which you took the EUR 59 million restructuring charge? Also, does the restructuring charge mean that your cost savings target of EUR 840 million effectively has gone up? Thank you very much.
On cost savings, the EUR 840 million target remains. The additional provision of EUR 56 million, approximately half of that will give incremental additional savings, about EUR 15 million. It's not huge, but the point is, we are aiming to do more, and this isn't the end of it. Remind me, what was your first question?
It was just the absolute level of net interest income.
Yeah. We have a strong capital ratio. We're open for business. We have capacity to lend. We're looking to grow, as Wilfred said, in selected areas. Continuing to grow at the healthy margins we currently have gives us capacity to grow absolute level of interest margin.
Q3 could be a trough level in absolute terms?
Well, you look at the overall net interest margin, Q3 versus Q2, I think it's the same number effectively.
Okay, thanks.
Thank you. The next question comes from François Boussin from BNP Paribas. Please go ahead.
Yes, good morning. Actually, my question relates to Japan. I just wondered if you could give a bit more detail about how, or let's say why, a separate sale was not possible. A bit of element from the rationale here would be useful. Going forward, what is your base case? Do you still plan to sell the business in the coming quarters, or do you plan to manage this in runoff? In particular, I'd like to understand what the risks are to the emergence of capital going forward within the back book. Is this equity risk? How is this managed? In what scenario would capital emergence be significantly different to what you expect? Thank you.
First of all, I have to say, I'm very pleased that we have included Japan, COLI, and VA in the European IPO. I think this is an excellent outcome for shareholders. Why? Because it brings two businesses with combined capital of over $2 billion post the accounting changes into the IPO. It brings a COLI business with over $200 million of operating profit and extremely well capitalized, as you can see in the DAC, into the IPO. It also brings a VA block, which is very conservatively managed. As I mentioned earlier, it's hedged and managed from a capital perspective on a market consistent basis. I think, again, almost uniquely so with a surplus of capital over the required economic capital today. We hedge all the main risks, interest rate, equity, and FX. We also have some vega and gamma hedging, but a moderate amount.
The customer behavior has been very stable. We have updated that three years ago and have not needed to make any material changes to that. Significantly, 80% of the block runs off. Its accumulation benefit will run off. There's no extension risk. It simply runs off. That happens by about 2019. It's gone. The remaining part, which is death benefit, has a limited risk in terms of customer extension, but we think quite small in terms of the capital impact. EUR 900 million capital should emerge over time. The risks primarily are to gamma. If you have major shocks, as we saw a bit in Q2, you can get some dislocation. I think that's the major outstanding risk. The other ones are pretty well hedged.
Okay. It sounds like it's a nice asset. Why couldn't you find a buyer for that?
The issue there a bit was we had buyers for the two different parts. We have a COLI business and a VA business in the same legal entity, and part of it reinsured to another legal entity. The complexity of the legal entity structure inhibited the conclusion of a sale.
Thank you very much.
Thank you. The next question is from David Andric from Morgan Stanley. Please go ahead.
Hi. Good morning. Sorry, I just really didn't have my second question answered, so I just wanted to follow up on it. In terms of the non-life business in the Benelux region, particularly in the Netherlands, I'm just wondering if we should think of this result this quarter as kind of a fairly stable result, or if we could expect further improvement coming through from price increases and underwriting, particularly on the individual disability side. Just a quick question on the capital restructuring. Can you quantify what the potential improvement is in terms of cost of capital coming from that? Thank you.
Okay. Delfin. Non-life, gentlemen.
Yeah. On non-life in the third quarter, the operating result was EUR 24 million. That was EUR 18 million better than in the same quarter last year. This was mainly due to the improvement in the disability and accident business. Also, the property and casualty business, compared with the same period of last year, stayed more or less flat. The improvement in the results is due to the recovery plan that was already discussed and commented upon in the last quarter on the group income protection. There were many management actions taken there. There was also more favorable claims experience in the illness protection business, and better results also for individual disability, and that was offset partially by lower results from personal accident and travel. Overall, I think your question is in terms of if the improvements in non-life are sustainable, and we do believe so.
Of course, maybe for the fourth quarter, there's been some strong storms in the Netherlands, and that might have an impact seasonally on the quarter. Overall, the improvements, particularly in D&A, are going through.
Sorry, just to follow up on that, the rate increases are still coming through? I think there's probably still an ongoing process there.
Yes. There has been a repricing in D&A, and that has been done. Normally, the majority of our business has a one year duration. We tend to wait for renewals in order to do these price increases, this has already been happening as we move along. A significant part of the recovery in the claims ratio is both in improvements in claims handling, but also in pricing increases.
Okay, thank you.
Thank you. The final question today is from Jan-Willem Knol from ABN AMRO. Please go ahead.
Yes. Good morning, gentlemen. One last question from my side. It seems that your tone on lending margins has changed a bit vis-à-vis previous quarters and a bit to the negative side, I would say. Can you shed a bit more light on where you see currently most pressure on lending margins, and what is the outlook there? Thank you.
I don't think we intended to give it a change in tone on lending margins. We maintain pricing discipline on lending. That's been a constant theme and remains so. I think what we're saying is that, with a lot of liquidity in the market, that the ability to grow significantly is being constrained. It's more about the ability to grow volume whilst maintaining these margins is where the headwind is a bit.
No, fair enough. I refer to slide 14, where you say lending margins were slightly down due to low demand for credit and increased competition. Low demand for credit is point taken. Thing is, I'm interested in is the increased competition. Where do you see increased competition, in which segments, in which business lines? That would be helpful. Thanks.
We're trying to read too much into very small changes. Our lending margin is up significantly on the prior this year-
Down slightly on the previous quarter. The message is we continue to believe or look to sustain healthy margins consistent with generating a 10% return on equity on new business. The headwind a bit is in volume.
Okay, fair. Lending margins are expected to remain stable going forward.
Overall interest margin, we are aiming to keep it stable going forward.
Okay. Thank you.
Okay. I think that with that as the last question, we can round off this call. Thank you for the interest that you take in having this session with us and all the questions that you have raised. Clearly, if there is more questions, our team is available the whole day, in the coming period as well to further explain. I think to summarize today and the announcements today, the first one, we have made a lot of progress and in such a way, with getting the IABF out of the way, as well as getting a clear decision on Japan. We know the future restructuring is still to be done, and there is much more clarity there, and we have made a lot of progress there, so that is good.
The second core message here is that we have strong underlying businesses, both on the bank and the insurance, both doing very well on underlying performance and both being well capitalized. With that, thanks very much. I wish you a good day.
Thank you, sir. Thank you, ladies and gentlemen. This does conclude today's presentation. Thank you for participating.