Good morning, ladies and gentlemen. Thank you for holding. This is Yvonne welcoming you to ING's Q2 2012 conference call. Before handing this conference over to Jan Hommen, 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 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, filed with United States Securities and Exchange Commission, and our earnings press release as posted on our website today. Furthermore, nothing in today's comments constitutes an offer to sell or a solicitation of any offer to buy any securities.
Good morning, Jan, and over to you.
Thank you, and welcome everyone to ING's second quarter 2012 results conference call. ING posted solid second quarter results, particularly when we look at the weakening economic environment we are currently in. I will talk you through the presentation, and then Patrick Flynn, Wilfred Nagel, and Matt Rider are here with me, and we are all available to answer your questions. Page two. ING is maintaining strong momentum on restructuring, including the sales process we have for Insurance Asia and the preparations we are having for a U.S. and European insurance and IM organization. The bank is making good progress on balance sheet integration, and we accelerated de-risking efforts, given the deterioration we were seeing in the Eurozone in Q2. The group posted an underlying net profit of EUR 1,045 million in Q2.
That excludes the results from Insurance Asia, which is now reflected in results from discontinued operations. The bank posted robust results despite losses from proactive de-risking. We saw pressure on the net interest margin, and we also saw that risk costs were elevated. We had an underlying profit in the bank before tax of EUR 995 million. Then insurance operating results compared to Q1 went up to EUR 304 million. Underlying results before tax were EUR 229 million, and that include the hedging gains we made in the U.S. for hedging interest and equity exposure on our VA block. Also including the negative change that we saw in the provision for a separate account pension contract that we have in the Benelux.
We go to page three, and you see that we have made good progress and continue to make good progress on our restructuring program as required by the European Commission. The sales process for Insurance Asia and investment management in Asia is on track. In the U.S., I said earlier, good progress on the preparations for our IPO and for Insurance Europe, we have stepped up our efforts to now prepare for the best case of an IPO. We had discussions with the European Commission on adjustments to the restructuring plan. We held them together with the Dutch state, and we will resume these discussions after the summer recess. In the meantime, in order to safeguard the legal rights, ING has filed an appeal with the European General Court against the European decision of May 11, which reinstated the 2009 restructuring plan.
I said earlier, many times, we remain committed to repay the Dutch state as soon as possible, including paying another tranche this year, but at the same time, we need to maintain strong capital ratios given the uncertain economic outlook that we are facing. Page four, you see the divestment process of Insurance Asia that is really on track. The businesses are now classified as held for sale and discontinued operations in our accounts. Insurance Asia had another good quarter. Performance was driven by strong sales in Japan and better mortality results in Korea, while expenses were kept flat. That excludes EUR 180 million goodwill write-off in our investment management activities in Korea. The increase in the book value compared with December 2011 is mainly due to bond revaluations, foreign exchange changes, and also the net results that were added to the equity value.
We have received interest for all units, and the divestment may take place probably through multiple transactions. Negotiations are ongoing, and we cannot predict at this moment the outcome with respect to the divestments of the operations that we have for sale. Page five. The U.S. is making good progress towards a planned IPO. In June, the U.S. completed a key milestone by publishing consolidated U.S. GAAP financials for the first time. In addition, through July, the U.S. has replaced EUR 1.85 billion of internal funding and commercial paper that was guaranteed by ING V with external debt, that way improving its standalone funding and its liquidity. The ultimate timing of an IPO has yet to be determined and of course will depend on market circumstances as well. Announced on August 2nd, that is slide six, ING is reviewing strategic options for ING Direct Canada and ING Direct U.K.
It is important to note that the other ING Direct units are not affected by this. We see ING Direct as a key pillar of our strategy, with strong deposit gathering ability, with innovation and distribution, excellent operational performance, and customer centricity. So key for our operations going forward. ING is integrating its balance sheet of ING Direct with the rest of the ING Bank to improve efficiency and to optimize the returns under Basel III. Slide seven. ING Bank has made real good progress, further progress, on balance sheet optimization in the second quarter. The size of the balance sheet was reduced to EUR 900 billion, in line with our target for 2015.
We also cut our CD and CP issuance after a strong inflow of short-term funding in the first quarter, and consequently reduced cash and balances with central banks by about EUR 30 billion, which anyway are low returning assets anyway. Retail client deposits were up by EUR 4 billion, and customer lending increased without growing the total balance sheet. I think our balance sheet reduction has a favorable impact on future taxes we will have to pay in the Netherlands. Slide eight, you see the balance sheet integration initiatives. They have delivered EUR 31 billion since the beginning of 2011. Another EUR 3 billion is still in the pipeline for the remainder of this year, and further potential now is being investigated.
You see some examples on the right side of things we have done, moving assets to where the deposits and the funding capabilities were in good shape and where we had excess funding capability. On slide nine, you see our Spanish exposure. Given the weakening macroeconomic climate in Europe, we have taken proactive steps to de-risk, in particular, reducing its exposure to Spain by about EUR 6.2 billion in the four months that ended in July. That includes a reduction of EUR 2.6 billion in the lending book and a decrease of EUR 4.1 billion in debt securities, mainly as a result of sales of covered bonds and RMBS. The Spanish funding mismatch, defined as having Spanish assets outstanding minus local funding, has been reduced from EUR 27.5 billion at the end of 2010 to EUR 12.3 billion by the end of July 2012. Go to slide 11.
On slide 11, you can see that ING Bank reported robust second quarter results despite losses from de-risking, pressure we saw on the net interest margin and elevated risk cost, and had an underlying profit before tax of EUR 995 million. Insurance operating results were better and improved to EUR 304 million. Underlying results before tax were EUR 229 million, and they included a gain, a hedging gain on our U.S. VA block and a negative change in the provision for separate account pension contracts in the Benelux. ING Group posted an underlying net profit of EUR 1.045 billion in the challenging environments. Let's go to the bank. Slide 13. Gross results before risk costs were up by 5.9% compared to a year ago, and declined by only 2% from the first quarter, supported by strong cost control. Underlying result before tax was EUR 995 million.
That is down about 13.1% year-over-year and 11% lower than the first quarter of this year. They reflect mainly higher risk costs. Risk costs increased mainly in commercial banking, in particular in real estate finance, due to the further deterioration in the commercial property market. When you look at page 14, during the second quarter, de-risking efforts were accelerated amid the ongoing Euro crisis. Total bond sales amounted to EUR 2.1 billion at a loss of EUR 178 million. The sales were largely related to Spain. If we clean up the numbers for these and other market impacts to make them more comparable, the gross result went down by 7.3% compared to the second quarter and 10.7% from the first quarter. The latter can largely be attributed to seasonally lower financial market income. Page 15.
Underlying interest result held up well, declining 3.3% from a year-over-year and almost the same from the previous quarter. Net interest margin had a sharper decline, down 226 basis points, but mainly due to balance sheet extension. Although the balance sheet was reduced again to EUR 900 billion at quarter end, the average balance sheet, which is the basis for the calculation of NIM, was up slightly compared to Q1 due to higher commercial paper and CD and cash to be maintained with central banks. Margins on lending have been solid despite higher funding costs. You can see that on the right top of the slide. Margins on savings are under some pressure despite reduction of client rates in many countries, and they reflect the impact of low interest rates and de-risking. Slide 16.
You saw that cost control across the bank has supported the decline in underlying operating expense, both sequentially and year-over-year, for the second quarter consecutive. Compared to the first quarter 2012, expenses declined by 3.6%. Decrease was mainly due to lower performance-related personnel expense, also stemming from the new Dutch collective labor agreement that was announced in June of this year. Also we had a reimbursement in the Belgian Deposit Guarantee Scheme. Page 17, risk cost. Further deterioration in the macro environment had a clear impact on the risk costs, which have increased by 22% from the first quarter and almost 78% from the second quarter last year. The increase was driven by industry lending and commercial banking, primarily within the commercial real estate and higher addition to Dutch mortgages, reflecting lower house prices in the Netherlands.
We expect going forward that risk costs will remain elevated, reflecting the weakening of the economic climate. Page 18. Non-performing loans expressed as a percentage of total loans and amounts due from banks increased slightly to 2.3% from 2.1% at the end of March. The increase was mainly driven, as I mentioned earlier, by real estate finance, also the lease run-off portfolio and the mid corporate SME segment in the Netherlands. Page 19. Increase in risk cost, largely due to real estate finance, which was up by EUR 75 million, mainly in the Netherlands, U.K. and Australia. The NPL ratio for real estate finance increased from 5.7% to 7.3%, and NPL ratio in Spain remained flat, but at a relatively high level of 18%. As we said, we expect, given the deteriorating commercial real estate market, that risk cost will remain elevated.
Nevertheless, the overall quality of the ref portfolio remains relatively good. The real estate financing policy is based on cash flow generating prime real estate. As an example, construction is only 2% of the total portfolio, and at least 70% is pre-sold and/or pre-rented. The non-performing loan ratio for Dutch mortgages remains stable at a low 1.2%, despite decline in house prices of 12% since 2008. The main reason for the low NPL ratio is the relatively low unemployment rate in the Netherlands, which is the second lowest rate in Europe. Risk cost increased in the second quarter, mainly as a result of the lower house prices. As a result, we expect unemployment to go up and house prices continue to decline, and we expect some increase in our risk cost on Dutch mortgages this year, but no dramatic changes.
On September 12, there will be elections here in the Netherlands. Most political parties would like to change the tax deductibility for both new and existing mortgages. We are supporting that, but it is important that it is being done in conjunction with a broader tax reform and liberalization of the rental markets. Page 21. Overall quality of the loan book in Spain has remained relatively good despite the weak economic environment. Total risk cost on the Spanish lending book declined from EUR 33 million in Q1 to EUR 33 million in Q2. NPL ratio increased slightly to 6.4%. NPL ratio on Spanish mortgages was stable at a very low 0.7%. The corporate portfolio of EUR 6.5 billion is very well diversified and relatively well-provisioned. Within the corporate portfolio, the real estate finance portfolio of EUR 2.7 billion has a relatively high NPL ratio of 18%.
However, risk costs have been manageable so far. It is important to note that construction accounts for only EUR 42 million or 1.6% of our ref portfolio. Again, here we expect that risk cost will continue to remain elevated. The Core Tier 1 ratio in the bank increased to 11.1%. Risk-weighted assets increased by EUR 3.8 billion, basically driven by foreign exchange. Impact of credit migration was limited to EUR 1 billion, and especially you see here the effect of the de-risking measures that we have taken. That is why the numbers are low. Market risk-weighted assets rose reflecting volatility in financial markets. Let us look at the impact of Basel III on the Core Tier 1 ratio. We think it is quite manageable, and we are maintaining a pro forma ratio of a Core Tier 1 of 10%.
On a like-for-like basis, the impact on risk-weighted assets is little change from what we have disclosed during our Investor Day in January. However, when you express it in basis points, the higher impact, which is 115 basis points in 2013, reflects the lower base of risk-weighted assets following the sale of ING Direct in the U.S. We expect that our actions will reduce Basel III risk-weighted assets by about EUR 15 billion, of which EUR 3 billion so far has already been achieved. The approval of IAS 19R will change the timing of the Basel III impact that is related to pension assets. Under this accounting provision, the pension corridor, which has served as a buffer for unrealized actuarial gains and losses, will disappear as of the 1st of January 2013. Any difference will be taken through equity as of that date.
That will bring forward part of the Basel III impact related to pensions, and the remaining pension assets will be deducted from capital gradually from 2014 through 2018. So the fully loaded Basel III impact, there is no change as a result of all this. Last slide for the bank is the funding position. We have a favorable funding mix, with more than 60% coming from retail and corporate deposits. Retail franchise consistently attracts retail deposits. Inflow again was strong, EUR 4.2 billion this quarter. Liquidity reserves of EUR 191 billion, actually total wholesale funding. So we are able to withstand significant retail stress on top of full wholesale liability run-off. Our Basel III Liquidity Coverage Ratio was above 100%, which is the required minimum. That altogether, I think, shows that paying attention to our balance sheet, our funding, our capital, and liquidity and leverage has really paid off.
Now let's go to the insurance company at page 26. You see that results have improved from Q1 on both underlying and operating basis, reflecting the fact that seasonally we had higher investment margin and a positive result on regulatory capital hedges in our U.S. Closed Block VA business. Compared to the second quarter of 2011, results were lower, in part because of non-recurring items in the prior year, as well as also continuing pressure on our non-life results. The investment spread remains resilient. The margin was EUR 475 million. That was up 9.5% from Q1. It is down compared to Q2 by 2.1%, but that included last year, EUR 28 million of favorable non-recurring items. Increase from the previous quarter was driven by seasonally higher dividends in the Benelux. We saw a growth in the general account assets and also lower average crediting rates in the United States.
Investment spread improved to 133 basis points from 119 in the second quarter last year, and declined slightly from the 134 basis points in Q1 this year. Investment spread is expected to decline gradually in 2012, and that will mainly reflect the ongoing de-risking of our investment portfolio in the Benelux. Fees and premium-based revenues fell slightly compared to last year, reflecting lower results in our U.S. Closed Block VA business and on higher hedging and reserve costs and lower assets under management. Technical margin declined from the second quarter as the prior year included a EUR 70 million non-recurring gain, while this quarter we had some problems in the U.S. with poor mortality results. Page 29. The administrative expense were flat compared to prior year if we exclude the foreign exchange effects. That reflects, again, also here in insurance, strong cost control throughout the organization.
The ratio of administrative expense to operating income compared to last year has deteriorated, That reflected strong operating income. If we take a closer look at our business areas, we see that the operating results in life in Europe improved from the first quarter. That was mainly due to seasonally higher investment income in the Benelux. Operating results declined from the second quarter last year, That included a very large EUR 98 million gain on non-recurring items. While this quarter, we continued to see lower non-life results in the Netherlands. Underlying results reflect a EUR 241 million change in the provision, a negative change in the provision for separate account pension contracts in the Benelux, and also includes losses from further de-risking and equity impairments.
Despite the macroeconomic challenges and regulatory changes in Hungary and Poland, our insurance business in Central and Eastern Europe showed an increase in new sales compared to the second quarter, mainly in the Czech Republic and in Turkey. In the U.S., we benefited from positive net flows and a strong investment margin in retirement, while insurance results reflected lower technical margin in individual life. Underlying result was dampened by a EUR 73 million loss on the sale of alternative assets, which was done to reduce capital requirements and to lower the volatility in our earnings. Sales were up 1.1 as higher sales in full-service retirement, individual life, and employee benefits were offset by intentionally lower sales in the fixed annuities and stable value reflecting disciplined pricing in the current low rate environment. Last slide on the insurance is the closed block.
The U.S. Closed Block VA hedge program is designed to make sure that we protect our regulatory capital across a broad range of equity market scenarios, the top table shows that the hedges are quite effective. Unfortunately, there is a difference between accounting and the accounting for IFRS and regulatory accounting that leads to IFRS P&L volatility. Earning sensitivities have changed somewhat over the quarter, primarily reflecting a slight decrease in the reserve adequacy. That is now at the 59% confidence level, we have updated sensitivities for Q3, as you can see in the slides. Let me wrap up. We are maintaining strong momentum on restructuring, including our sales process in Asia that is on track, good preparation for IPO in the U.S. and in Europe. The bank is making good progress on balance sheet integration, we have accelerated our de-risking efforts.
The group has posted underlying profits of EUR 1.045 billion, excluding the results from Insurance Asia, which is reflected in results from discontinued operations. The bank had pre-tax results of EUR 995 million and Insurance had pre-tax operating results of EUR 304 million. With that, we are ready for taking your questions.
Thank you, sir. If any participant would like to ask a question, please press the star followed by the 1 on your telephone. If you wish to cancel your request, please press the star followed by the 2. Your questions will be polled in the order they are received. There will be a short pause while participants register for a question. Once again, to ask a question, please press the star followed by the 1 on your telephone. The first question is from Spencer Horgan from Deutsche Bank. Please go ahead.
Thank you very much. Good morning. Two questions on the insurance side, please. The first one is, you have sort of suggested quite strongly early on that Asia could come in multiple transactions and often, obviously nothing certain at this point, but I was wondering if you could give us your feeling at least for how confident you would be that you can achieve 100% exit of Asia on that basis. Then the second question is, on slide five, you talk about this transfer of $500 million into SLDI. Could you firstly just expand a little bit on why that has happened and what has gone on there? Secondly, more broadly, is there a risk that further transfers may be needed as Bermuda heads towards equivalence under the Solvency II regime? Thank you very much.
Okay. The first question, Spencer, good morning. Asia. Yeah, I think we are tracking our process quite well. We're very pleased so far with what we have seen, also on bids. As I said, it's most likely that we will have to do multiple transactions to complete the sale, and they will have timing consequences, so not all the transactions will, let's say, take place at the same time. I believe ultimately we will sell 100% of all the assets in Asia. With respect to the SLDI, Patrick?
Yeah. Good morning, Spencer. Yeah, the reallocation simply follows the update on reserve adequacy we took last year. We're basically upstreaming capital from the operating companies to the holding company and pushing some down to SLDI. This was planned, and I think we even flagged it following the reserve adequacy update at the end of last year.
Okay. Do you think there's any possible further need to put more money into SLDI as Bermuda moves towards a Solvency II basis, or do you think it's adequately capitalized?
I believe Bermuda is doing Solvency II.
Sorry?
At the moment, we think this is the adequate level of capital in SOVI. We don't envisage any further changes.
Okay, great. Thanks.
Thank you. The next question is from Farooq Hanif from Morgan Stanley. Please go ahead with your question.
Good morning, everybody. I just had a few questions, again, on the insurance side. Firstly, could you tell us if you're seeing any further deterioration in policyholder behavior in variable annuities? One of your peers in the U.S. has seen additional problems with its GMIB book relating to partial withdrawal experience. Just, when will you update us on that, and what are you seeing? Related to that, do you have any data on the living benefit reserving to net amount at risk? I believe that was about 70% last time you updated us. Has that changed? Has net amount at risk gone up or down? If you could tell us that. Next question is the EUR 1 billion of book value that you have in internal reinsurance out of the Japanese VA book. What happens to that book value in the sales process?
Is that sort of included in addition to the EUR 6.4 billion of tangible equity that somebody will have to pay for? How will that work in the transaction? Lastly, could you make a quick comment on investment margins elsewhere outside of Benelux, just the pressure from low yields? Thank you.
Okay. In terms of the last assumption update, that's something we do annually. We typically do that in Q3. We will conduct that study and communicate on that once it's done. There's not really much I can say about that at this point, or give updates before then. In terms of net amount at risk, we haven't given them this quarter. There were some in the U.S. filing Q1. They were on a U.S. GAAP basis. I suggest if you want to look at those, perhaps you might talk to our investor relations team who can take you through that. In terms of ING Re, yeah, it's difficult to say how this will pan out. It depends on how the transaction works, what type of transaction. It's premature to really comment.
Yeah, if there's a total sale, this could be in part of the overall equity involved. We can't be specific until we know the details of that transaction.
On that point, could there be a situation where you sell Japan, but you continue to reinsure it from ING?
I can't comment yet on how the transaction Jan has already mentioned it could be in a number of blocks, but I really can't comment further as to how that might be structured.
Okay. Any comment on investment margins? Just, I would have thought we'd expect pressure elsewhere, not just in the Benelux, given the value of the environment. What are you doing to offset that, and what do you see as guidance?
I'd say, well, this is Matt. At least for the Benelux, we saw the investment margin at about 111 basis points. I think we had given prior guidance that we would expect to see that come down for the full year, something like 10-15 basis points from the 114 that we had for the full year 2011. We would still expect to see that, in fact, likely at the upper end of that range as we've continued to de-risk. In the U.S. businesses, clearly, reinvestment at lower rates is going to put pressure on margins. What we've seen is more action on the crediting rate side, being able to reduce crediting rates. You see that at about 169 basis points for the quarter.
You think you can continue to maintain decent margins in the U.S. because you've got more ability to reduce crediting rates?
Sorry, we didn't quite hear your question. Yes, I think this is going to come down to a certain extent given the low interest rate environment. We're doing what we can, again, on the credited rate side to be able to maintain those margins.
Okay. Thank you very much.
Thank you. The next question is from Farquhar Murray from Autonomous. Please go ahead.
Morning, gentlemen. Just two questions, if I may. Firstly, on asset quality and commercial real estate, I just wondered if you could give a breakdown of the EUR 120 million of loan losses there, and also actually a breakdown of the NPL rate of 7.3% by the key geographies, if possible. Also, could you just give a bit of color around that in terms of what your expectations are there and what specifically is driving the uptick in loan losses in that business? Is it coming from refinancing limits or businesses hitting refinancing? Secondly, in terms of the Spanish funding mismatch, you've made quite substantial progress there, reducing it by about EUR 7.3 billion since 1Q. Presumably, that included some quick wins. I just wondered what is a realistic ability to work that down in the coming quarters, and what might be an aspirational target there. Thanks.
Yeah. On the asset quality and the breakdown of the risk cost, obviously, if you look at the book and you look at where the biggest chunks are, that sort of is also reflected in the risk cost that we're taking. Just to give you a quick rundown, there's about EUR 50 million in the Netherlands, there's about EUR 27 million in the U.K.
There's EUR 36 million in Australia and about EUR 18 million in Spain. That gives you pretty much what's there. The dynamics of these markets are not all the same, but indeed, you see in quite a few markets that the ability of companies to refinance debt that comes due is limited, and that puts pressure on the asset values as well. There are also some specific issues in each of these files that are not really market-driven. The mismatch in Spain, well, that is a combination of a number of actions. One is bringing down the overall asset exposure that we have in Spain. Two is increasing the local funding that we attract. Both are actions that we believe we can continue, and certainly in terms of reducing our asset exposure, there is a natural runoff in the book there that is quite substantial.
For example, if you take the securities portfolio, the average maturity there is about 2.8 years. The lending book also has a natural runoff. We have, as you've seen, taken specific opportunities to further the risk by selling securities. As and when opportunities arise, we will continue to do that, but at the right prices, obviously, because we do believe that this book is of good quality.
Just as a follow-up on that, what was the par mark on the covered bond book and the RMBS book in Spain?
Sorry, I didn't quite get.
Just as a quick follow-up, if you could. Do you have the par mark, i.e., how much the pricing was on the covered bond book? I think you'd indicated about 96% of par at 1Q. I just wondered if you have more data around that, please.
I think we sold on average at about 97% or so in the securities book. The average market prices that we're seeing at the moment are around 94% or so.
Okay, brilliant. Thanks, Matt.
Thank you. The next question comes from Michael Huebner from J.P. Morgan. Please go ahead.
Good morning. Thanks a lot. A couple of questions. The net inflows, the EUR 4.1 billion in deposits, I just wondered where you could say where exactly they came from. As a follow-up to the de-risking in Spain. You've reduced the assets in Spain by EUR 4.7 billion in Q1. That cost EUR 156 million in terms of de-risking costs, that's 3.3%. In July, you de-risked another EUR 1.5 billion, which cost EUR 78 million, that's 5.2%. Is this accelerating? Obviously you would have done the low-hanging fruit first, and it gets a bit harder and a bit more expensive. Can you get a feel for how much more expensive it could get? Are we going to be looking at a 7% ratio for the rest of the book or something like that? This is a little bit of a funny question.
In Asia, if I remember, a year and a half ago, I guess, or something, you were going to sell the whole of Asia, sorry, the whole of Insurance, I think, it becomes the whole of Asia, now it's country by country or even business by business, I don't know. Is there a chance in Europe that you could adopt the same approach? Is preparing for an IPO a first step to clearing the books effectively inviting everybody to have a look, and then you can start the process of piecemeal as well. Thank you.
I think the calculation you make on Spain is a calculation that I don't think you can make because this is impacted by what's available at what point in time, not necessarily, I think, is this reflecting a trend. I think we need to see going forward, what the price levels are. As Rolf had indicated earlier, we're not going to do it at any price. We will do it at the appropriate price, when we think that the risk elimination that we get relative to the price we pay is a reasonable one. With respect to Asia, yeah, we like to do a full sale, we were not against doing a partial sale or let's say a sale of pieces, in the end, that can create also attractive value. That doesn't mean that we will do exactly that in Europe.
In fact, in Asia, we had not considered an IPO. In Asia, it was either a sale to a strategic partner in full or in parts. In Europe, we are saying we are doing an IPO, that means we have IPO as the base case. We will have, of course, to work with the company to make sure we have the performance that can stand the IPO, but at the same time, we need to watch how markets will develop. That's the work that we are doing. It is certainly not a representation that in Europe we will do what is happening in Asia. Our plan is to do an IPO.
Thank you. The next question is from Michael van Wegen from Bank of America Merrill Lynch. Please go ahead.
Yeah, morning. Mike van Wegen, Bank of America Merrill Lynch. Just wanted to get back to the point that you made earlier about selling ING Direct Canada, potentially, and the U.K., actually. Can you talk us through the impact from such a potential deal for the restructuring of your insurance businesses? Strategically, I can understand why you want to get rid of these two banking operations, but the proceeds, together with potential proceeds from your Capital One stake must have an impact on repaying holding company debt and therefore the flexibility that you get on the restructuring from your insurance assets. Any insight there would be grateful. Thanks.
Yeah, Michael, we are doing this for, I think, strategic reasons. At the same time, we have, of course, an eye on our balance sheets and the flexibility that we create by doing this. We have not determined exactly what will happen. First of all, we need to do the sale. That is not done yet. After that, I think we can discuss what will happen with the proceeds. Clearly flexibility is an important element in this.
Okay. Would you be willing to use those proceeds to reduce the holding company debt? In the past you've always stated that the bank effectively repays the State and holding company debt would be funded through insurance disposals. Are you willing to potentially change that mix a little bit?
Well, I think as you know, money is fungible at the end, so you can use it for multiple purposes, and I think that's still the case. It creates flexibility in our planning going forward, and I think that's not unimportant to us.
Okay. Thank you very much.
Thank you. The next question is from Francesca Tondi from Morgan Stanley. Please go ahead.
A few questions from the bank, again, if I may. Margins. How would you see net interest margin developing over the next few quarters, also in light of the further reduction on EURIBOR, possible rate cut by the ECB? If you could possibly comment, you clearly are one of the banks with the biggest liquidity pool at the ECB. There've been a lot of talks of potentially even looking at excess reserve, negative rates. If those were to happen, what impact would they have? How would you react in terms of your liquidity management? That'll be helpful. Back on asset quality and provisions. Again, I know you've been asked about the commercial real estate, especially in the Netherlands. If you could just give us a bit more color of what is happening there. You continue to talk of elevated provisions.
Should we take that actually provisions will likely continue to increase in the following quarters? I think if you could comment on that it would be helpful. Thank you.
In respect of interest margins, the overall interest margin in EUR terms did come down in Q2 by about 3%. In basis points terms it looks higher from 132 to 126. That's due to, as Jan mentioned, the continued growth in the balance sheet, something we corrected at the end of the quarter. You'll see the benefit of that lower balance sheet in subsequent quarters. Going more closely to your question, what we've seen in terms of under the hood a bit is that our commercial margin, excluding volatile elements like financial markets and corporate line, was stable, actually slightly up. Under the hood there a bit, you see that the loan margins improved a bit, and deposit margins dropped a little bit. We are reducing deposit margins. Sorry, deposits rates paid. We've reduced them in the Netherlands by 20 basis points.
They've come down in Italy and France, they continue to come down. Germany reduced by 25 basis points in Q3. The dynamic though is that, whilst we are reducing the amount paid, which is positive for margin on deposits, you're also seeing a decline in interest rates. An element too, is de-risking, which reduces the value of funds or the earnings you have, which you attribute to your deposits. That sort of mutes a bit the impact of the reduced deposit prices. Going forward, provided interest rates stabilize a bit, we would expect that on the interest margin side, particularly on deposits, there should be some stabilization because the cuts in deposits rates to customers, we think can offset the lower market rates and de-risking impact. The positive bit overall for margins though is that on our loan side, we're holding margins.
In fact, slightly increasing them against a much higher cost of funding, which is a real positive. It's something that is core to our achieving our longer term ambition of 140 to 145 basis points we talked about in the investor day. The ability to reprice on the loan side, and we're seeing evidence that we're able to do that, albeit low demand is a little bit muted. What does that all mean? I think it means outlook for the core business is stable in EUR terms. In basis point terms, it should improve a bit because the balance sheet reduction will reverse the impact, the four basis points in Q1 and one basis point in Q2 of negative impact on the margin due to balance sheet expansion. In basis point terms, it should improve.
In the EUR terms, stable is the best we can judge it at for now.
In a lower EURIBOR from here would put a little bit more pressure on margins?
Yeah. As I said, if interest rates lower, that may reduce the earnings we get on over time in terms of-
Yeah
applicable reporting, but also could stimulate further deposits reduction. We'll have to see.
If the ECB were moved to negative rates on the reserves, how would you think about your excess liquidity?
Well, as you saw what we did in the balance sheet, we reduced the balance sheet significantly in the quarter, and we reduced the amounts placed with the ECB. We are, as you say, a provider of funding to the ECB. They've cut the rate to 0, you get nothing for it.
That's part of the reason we reduced our overall placements. We've got our balance sheet now at the EUR 900 billion level, which is where we targeted it at the investor day. We will actively manage it going forward.
If you were to keep rebalancing your liquidity away from the ECB, where would you rebalance it to, and what kind of assets, if I may ask?
Well, obviously, if you're earning nothing on deposits with ECB, you try to minimize that.
Yeah. Is it other CP papers, other securities, or?
I think we constantly evaluate. The best thing that we can do is make sure that we keep a balance sheet as healthy as we can. If you don't get anything for putting your money someplace, you may as well put it in your own company and use it to your own benefit. At the same time, as you can see, we have significantly improved our own liquidity by having done what we did. I think, we'll manage this quite carefully. If it gets to negative, there's no incentive to put a lot of money with the ECB. You see that in our balance sheet today.
Yeah. Thank you. I have a last point on asset quality and provisions.
Going back to your question on commercial real estate in the Netherlands. Your question was, "What's going on there?" Well, in the first quarter, we saw a bit of turmoil, effectively caused by what was basically a CMBS structure being unwound and a portfolio being sold without creating a lot of coverage of developments in the real estate market in the Netherlands. What we saw subsequently was frankly not a lot of activity. We're seeing vacancies in the Netherlands creeping up. We continue to see very difficult refinancings. A lot of banks have withdrawn from that market. That's not a new development. We've signaled that before. We also gradually see the weighted average lease expiry terms coming down a bit. Having said that, our de-risking of that portfolio continues. You can see the exposure slowly coming down. We didn't have any write-offs in the second quarter.
There's other than a number of things that we already have on the books and have identified as problems and that we're working our way through. There are no big new developments there. Your question on provisions and whether what you're seeing now is a trend. As we've said, and as both Jan and Patrick have said, we expect provisions to stay at elevated levels. They're very closely connected to the macroeconomic trends in the main markets that we're in, and those are not positive. We can definitely count on seeing levels like these, and we're not expecting a reduction anytime soon.
Thank you.
Thank you. The next question is from François-Xavier Bousset, from BNP Paribas. Please go ahead.
Yes. Good morning, gentlemen. Two remaining questions, please. The first one is on ING Direct. Could you maybe just specify what's the main rationale behind putting the UK and Canada for sale? Is it that you would be able to achieve a high price, or do you feel that you need more flexibility to deleverage? Why basically didn't you include Australia within the process? Second question regards the disposal of Insurance Asia. Could you just comment on the evolution of the process for investment management businesses? Is it basically following the same calendar as insurance operations, or is this completely separate? Thank you.
The reason for selling ING Direct in the UK and Canada is these are good businesses. We always do an evaluation from time to time on our portfolio. You need to be looking at not just what is nice, but also can you strategically do with your business what needs to be done going forward, not only this year, but let's say three to five years ahead. Then you need to make choices. Are you putting your capital here, or are you putting it someplace else? We only have so much capital available, so we need to make choices where we are investing that limited capital that we have. I think when you do a rational analysis, this came out. We have also divested our ING Direct business in North America.
Fully, I think it's a result from North America that we are accomplishing now. Then what we will do with the proceeds, I think will depend at the time when we get that. We will include that in our overall picture, and we'll look at it from a corporate perspective, where we can best make the proceeds work. I think the same applies to our Asian operations. When the proceeds will be used, where we see the best fit on a corporate basis, and where we may have to do certain things related to making sure that the business going forward has the capital structure and has the capability to do what needs to be done.
Okay. The rationale for keeping Australia in terms of what you see attractive in terms of underlying business there?
I think our Australian business is doing well. We like our Australian business. As I said earlier, we cannot maintain them all, so we have made some choices, some rational choices, where we can continue to invest and where not. We think our exposure to Australia is also a reflection of an indirect exposure to the Asian market. That, I think, is important in evaluating the reason to maintain our position in Australia.
Okay. Regarding the Asian disposal processes?
Yeah. The timing for Asia's sale is quite I think what you will see is that some units will go quicker than others because they are more complex, and they will need more time. Joint ventures take more time. There will be a number of announcements being made if we go the route of multiple sales. I would expect that certain things will go relatively quick.
Okay. May I just ask in terms of investment management, do you plan to sell the investment management business as a whole, or do you plan to sell it by geography as well?
We're looking at both options. I cannot say which way it will go. It depends on the appetite that bidders will have.
Okay. Thank you very much.
Thank you. The next question is from Hans Zwijgers from Cheuvreux. Please go ahead with your question.
Yes. Good morning. Hans Zwijgers. Three questions if I may. First of all, you talked through real estate loan loss provision going forward. Could you also, let's say, discuss more on the corporate loan book? There you saw that the non-performing loans increased from 2.6%-3.6% quarter-over-quarter. What do you see there? I understand that the increase in loan provisions mainly has to do with one bigger file. What's the, let's say, underlying trend there? Could you give some color there? Secondly, on the Korean goodwill write-down, could give some feeling why they did write-down? Give some color there. Secondly, with respect to the impact from reduction in the balance sheet on the tax position in the Netherlands, could be positive for tax in the long run.
Could you give some feeling what you mean there or what you see, let's say, more in numbers going forward?
Yeah. I'll answer the technical one. In respect of the IAM Korea impairment, this is technical. It's a consequence of IFRS 5 requirements. As it's quite clear, we're quite at an advanced stage in the process. As a consequence of that, we're required to report these businesses' discontinued operations under IFRS, so they don't appear underlying, separate line in the balance sheet and P&L. A follow-on consequence for that, is that you have to ensure where the estimated proceeds are less than book, then you are required to review and impair goodwill. This occurred in IAM Korea only. As a consequence, as I say, the goodwill in IAM Korea only was impaired. It's a technical IFRS requirement.
Yeah, I think your question was, we've talked about the real estate risk cost. You wanted to know a bit more about the general corporate portfolio. If you look at commercial lending overall, the NPLs were up from 3.9%-4.3%. That again reflects just the macroeconomic situation. If you look at the various components, the corporate lending book indeed was up from 2.6%-3.6%. That includes SME and mid-corporates, which indeed is a segment that is having a tough time also in our core market here in the Netherlands. You may have seen from the press that bankruptcies in the Netherlands went up quite sharply in the first half. Of course, we're seeing that reflected in our loan books as well.
The other part of commercial lending where we see upticks apart from real estate finance is mainly in leasing, where also the NPLs are up from about 6.3% to 6.8%. On the other hand, the structured finance and our industry lending businesses, the NPL levels are relatively stable. Generally speaking, what we see, the larger corporate performance is doing well, and it is really in the mid-corp and SME books where we see the pressure.
The question on tax had to do with there will be a new bank tax in the Netherlands, and it will be levied on your total lending. I'm sorry, on the borrowing that you have done. There is an incentive to make sure that where you can, that you reduce your borrowings.
Thank you.
Thank you. The next question is from Federico Sellini from MainFirst. Please go ahead.
Good morning. A couple of questions on my side. The first one on ING Direct UK, do you expect a positive contribution to operating earnings for 2012? If you can give out a number for the first half. That's the first question. On your Tier 1, it's already at 10%, which I think is a bit higher than what you were expecting at Investor Day. Is it conceivable that you might repay the state sooner rather than later based on this? What's going to be the trigger here?
Thanks.
Okay. On ING Direct UK, I don't think we give forecasts what will happen in the quarters to come. On quarter one, yeah, I think we have a good quarter one, 11.1%, but as you can see, when you comply with Basel III, you need to have a good quarter one, because the requirement, if you want to maintain a 10% quarter one, there will be some additional requirements related to pension adjustments that are being made effective January 1. A good quarter one is also important for us to be able to repay the Dutch state. As I said, we like to do that as quickly as possible. We are discussing with the Dutch state and with the European Commission on a program that will be resumed after the vacation time. If possible, we like to repay at least a portion certainly this year.
Okay. Thank you.
Thank you. The next question is from Anke Reingen from Royal Bank of Canada. Please go ahead with your question.
Good morning. It's Anke from RBC. I had two questions on the bank, please. Firstly, on asset quality, I was wondering on the commercial real estate, if you can give us some data on the coverage of NPLs and how this has changed versus Q1. You keep on saying you expect loan loss charges to remain at elevated levels, but given the trends in NPLs, should they not actually increase in the coming quarters? On the capital slide, thanks for the update. I just wondered what would the 9.4% be if you take the DTA and the pension into account as well. Thank you.
Can you repeat the last question because we didn't get that?
On your capital slide, the 9.4% Q1 ratio pro forma, you say this basically assumes the DTA will be assumed, and also I would assume it's pre the pension coming in from 1st of January 2013, while a number of other banks have basically included this in their pro forma guidance as well. I just wonder what the 9.4% would be pro forma for the DTA and the pension.
On the real estate finance book, where we talked about the asset quality and the NPL levels, maybe just a quick rundown on those. In the Netherlands, we're looking at 5.9%. In U.S., we're looking at 8%. Spain, as we've discussed, is around 18%. U.K. is also at that level, and Australia is slightly above 20%. You asked about coverage levels. Overall, they're stable quarter-on-quarter at 27%. We have a slight increase in cover rate in the Netherlands, 26%-27%. We have an increase in Spain from 33%-36%, and an increase in Australia to 41% from 25%. A gradual increase in coverage levels and an uptick overall in the NPL levels on the portfolio, as we said, from 5.7%-7.3%. Well, I think the provisioning levels, we talked about that. Projecting provisions is of course always difficult.
It's a bit of a lumpy thing. Overall in the medium term, this is very much linked to the macroeconomic development, which, as we said, is not positive. We're therefore expecting to continue to see elevated levels.
In respect to the DTAs, we didn't include them because we believe we'll use them up with profits. At the IR day, I think it was 25. Now it's come down as we're using the profits up. It's down to approximately 18-20 basis points. In terms of pensions, it is included, the impact, in the phasing to 14-18. I think the point we're making is this can be volatile going forward, depending on how market interest rates perform. It could be that in the future you have some of it being accelerated into a spot impact. We can't predict the future, so we don't know. The last time we had formal results published on the pension, this would be the number. We'll update it at the end of the year when we know more.
Thank you.
Thank you. The next question is from Lemer Salah from SNS Securities. Please go ahead.
Thank you very much. Good morning, gentlemen. Three questions from my side. First of all, could you elaborate on the NPL definitions in Spain, whether that has changed? Secondly, on the liquidity of covered bonds in Spain, can you say whether the liquidity has improved or deteriorated in the course of the second quarter? My final question is with regard to the pension scheme. You have shifted from a DB to DC. I presume that the IAS 19 impact will be not significant going forward since it's only applicable for DB pension schemes. Am I right?
Yes. On the NPL definitions, there's no change. You asked about liquidity of the covered bonds in Spain. A lot of that has come from buybacks by the issuers, which has helped us quite a bit in the second quarter. There are no programs or restructurings or anything going on at this moment in the mortgage portfolios underlying them. Of course, liquidity of this paper comes and goes a bit with the macroeconomic developments and the developments politically also around the support for Spain. It's moving, but we have taken advantage of quite a bit of liquidity in the second quarter, and we're pleased with that.
Yeah. In respect to the pensions, we announced that for new contributions after January 2014 that we'll move to DC. However, the existing block will remain as a DB. That is why we're including it in the impact for Basel III.
Just two follow-up questions. First of all, on the covered bonds. If Spain is downgraded by Moody's, I presume that the liquidity will further deteriorate. How would you react to that? Secondly, on the pensions, can you quantify what the total size of the book is, which is still on a DB scheme?
On the first question, I don't think necessarily that a downgrade will have a big impact on liquidity. That's also not what we have really seen in the first two quarters of the year.
Yeah, I think the size of the DB assets is about EUR 18 billion.
Thank you.
Thank you. The next question is from William Hawkins from KBW. Please go ahead.
Hello, thank you very much. Back on bank asset quality, can you help me understand why the total coverage ratio has fallen very slightly in the second quarter from 39% to 38%? Everything I've heard from you guys has been about coverage ratios going up. I don't know if there's a mix effect or if there's something else going on. Can you tell us specifically what's happened to the coverage ratio for Dutch mortgages? Again, apologies if it's disclosed somewhere and I've missed it.
Okay. On the first question, indeed, it's mainly a mix matter. There is not a general reduction or change in our provisioning policy. The coverage ratio of Dutch mortgages, off the top of my head, that is about 11%. We're digging up the exact number. No, it's 11 I'm getting here.
Mix effect? Because again, it sounds to me like the areas that are going up in terms of the contribution to NPLs are the areas where the coverage should be higher. I would have thought the mix effect would be driving up the coverage ratio.
Well, I think in the end, the coverage ratios that you're seeing are heavily influenced by the fact, particularly on the retail books, that there is a lot of IBNR there, which is influenced by model LGDs. If you look at the write-offs, that's ultimately what counts, then we're still seeing levels below what we reserve. We have an experience of a very long period where, in the end, our write-offs are always less than what we reserve in terms of provisions. I think the mix of model-based IBNR reserves and the underlying realities makes it very difficult to compare the two.
Thank you.
Thank you. For today's final question is from Tarik El Mejjad from Nomura. Please go ahead.
Hi. Morning, everybody. I have two quick questions. First one, in terms of the divestment of the non-core business, if I can call that like that. I mentioned by that the Asian banking entities, and also your stake on Capital One. What is your strategy on that? Are you thinking to divest that in case you are short in terms of capital? Secondly, in terms of repayment of state aid, I just wanted to know, are you envisioning to do this to exercise your conversion option? You still can do it. Is it one of the topics that you're discussing now with the EC and the Dutch State? Thank you.
Okay. Selling stakes in Asia and our position in Capital One, I don't think we are at liberty to discuss that. We'll look at them from time to time. We will evaluate our position. I must say, certainly with Capital One, we're pretty happy with the position we have taken. When the time is right and things fall into place, then I think we'll make a decision on them. State aid, we are looking at all the options that we have as repaying the Dutch State, and that's why we have discussions with the State itself as well as the European Commission. All that hangs together, and we'll know more after the holidays, after the vacation time, when we hopefully will resume our discussions again.
How these discussions advance, obviously, I know that I'm looking for details here, but is it something advanced or you are still just at the beginning?
No, I cannot give you any details because we are still in negotiation and discussion, so I think it's better to hold off until we can give you the details, but not at this point in time.
Okay. Thank you.
Sir, there are no further questions.
I would like to thank you all for participating in the call, and wishing you a great day. Thanks. Bye-bye.
Thank you, sir. Thank you, ladies and gentlemen. This does conclude today's presentation. Thank you for participating. You may now disconnect.