ING Groep - Earnings Call - Q3 2011
November 3, 2011
Transcript
Speaker 6
Ladies and gentlemen, thank you for holding. My name is Yvonne, welcoming you to ING Groep N.V.'s Q3 2011 conference call. Before handing this conference over to Mr. Jan Hommen, Chief Executive Officer of ING Groep N.V., let me first say that any forward-looking statements in today's comments are subject to a number of current views, assumptions, and variables, including interest rates, foreign exchange rates, inflation rates, movements in security markets, including equity markets, and underlying economic conditions and changes. These are set out in greater detail in our public filings, which we would urge you to read. The realization of forward-looking statements could be materially altered and unexpected movements in any or all of these and other variables. Good morning, Jan. Over to you.
Speaker 1
Thank you very much, and a warm welcome to everyone on the ING Third Quarter 2011 Results Conference Call. The quarter saw a marked deterioration on debt and equity markets, and a slowdown in the macroeconomic environment, as well as a deepening of the sovereign debt crisis in Europe. In this quite challenging environment, the earnings that ING produced today remained resilient, and our strong funding position enabled us to continue to increase lending to support our customers in these very uncertain times. I will talk you through the presentation, and afterwards, we have Patrick Flynn, our CFO, Wilfred Nagel, our CRO, Matt Ryder, our CEO of Insurance, and as special guests, we have Kosty Mammons, who was still the CRO during the third quarter, helping us with answering the questions. Let me take the first slide, the summary slide.
You see that we reported the profit underlying net of €1.285 billion in Q3. That was up almost 54% from a year ago. The underlying result at the bank before tax declined to €1.063 billion, mainly due to additional impairments on our Greek government bonds and lower financial market results. We maintained a strong capital ratio in the bank with a core Tier 1 ratio of 9.6%. Operating result at ING Insurance was €527 million. That was up 27% from a year ago, an increase that was mainly driven by higher investment margin, higher fees, and premium-based revenues. Underlying result was €561 million, where we could include significant favorable hedging results in the Benelux, which more than offset the impairments we had to take on our Greek government bond exposure.
Income is coming a bit under pressure, so we must renew our efforts to reduce expense across the group, to adapt to a leaner environment, and to make sure that we can maintain a competitive position. In retail banking Netherlands, we are taking now decisive steps to reduce our costs by decreasing our overheads and improving efficiency through operational excellence. In addition, we continue to work towards the separation of our insurance companies so that we can be ready to move ahead with the IPOs when the markets have recovered. Slide three, you can see that the bank's third quarter results were down from both the third quarter last year as well as the second quarter this year.
The decline was caused mainly by a charge of €267 million of impairments on Greek government bonds and a decline in financial markets, reflecting sustained weakness in fixed income and in equity markets. Operating result of insurance improved, driven by an increase in the investment margin and higher fees and premium-based revenues. Operating result was down from the second quarter, which included seasonally high and non-recurring items. The underlying result before tax was €561 million, and I mentioned already that we had favorable hedging results that more than offset the €200 million of impairment charges we took on Greek government bonds. For the group, that resulted in a net profit underlying of €1.285 billion and a net profit of €1.692 billion, but that included a gain of €516 million on divestments, which were mainly the Clarion Real Estate Securities and ING Car Lease.
Special items after tax were also €122 million negative. That had to do with all types of reorganizations and special charges for special programs, also relating to restructuring and the preparation for the separation and the two IPOs. Our exposure to the Southern European countries was significantly reduced. We impaired Greek bonds that had a pre-tax charge of €467 million. That also included new bonds, and also it included bonds that we already had impaired, that were re-impaired, and that all was a result of the outcome of the EC meeting on October 26. We have now impaired, as of September 30, our Greek bond exposure to market value, which represents roughly a 60% write-down of our nominal position.
In addition, we have also reduced the exposure to government bonds in Greece, in Italy, Ireland, Portugal, and Spain by €4.8 billion in the third quarter, and the charges related to that were in the numbers as well. In October, we were able to further reduce the exposure by another €600 million. On page five, you see that our restructuring is on track. We have announced the sale of ING Direct in the U.S. and our Latin American insurance and pension and investment management operations. We expect to close the Latin American transaction in Q4. We're still hoping to do ING Direct U.S. in Q4 as well, but potentially that could also slip into the first quarter next year. We made significant progress on the separation and preparation of the two IPOs.
The bank and the insurance company were already operationally split at the end of 2010, and the operational disentanglement of the U.S. and then the Eurasia insurance IM operations are expected all to be finalized at the end of this year. Separation and IPO preparation costs were $55 million in the quarter, and so far this year, $116 million. These numbers are after tax, and we expect that we will remain within the guidance we have given you of $250 million after tax for this year. Probably will be lower. On page six, you see that we have continued the preparations for the two IPOs and that we have made some important steps to realign the legal structure and the governance of the insurance operations.
We have regulatory approvals outstanding and are nearing completion so that we have a new holding company for Europe and Asia that we then have for managing our activities there. The company will be called ING Insurance Eurasia. U.S. insurance will continue to be part of a separate already existing legal entity that is ING America Insurance Holdings. These are all steps that we have taken that are no regrets, so we have to do them no matter what type of divestment strategy ultimately will result. The change in the legal structure is important because we now can also optimize our capital structure in the separate entities, and then we can complete the disentanglement process in order to be able to move quickly towards an IPO when market conditions are getting better.
At the same time, we have flexibility with respect to timing as well as to the sequence of the IPOs. Let's take a look at the bank. The bank is making good progress on the ambition that we have set out in 2009, the ambition for the year 2013. We have seen a slight decline in income year to date compared with a year ago, but that's entirely due to the $455 million of impairments that we have taken on Greek government bonds. We continue to see moderate growth in the underlying business. Cost-income ratio ticked up, was 58.3% in the first nine months, but if you exclude market impacts, it was 54.7%. As the economic environment and financial markets remain uncertain, we will reinforce our vigilance on costs by focusing on structural improvements in our processes and our organization.
Risk costs were 48 basis points in the first nine months of risk-rated assets. For the full year, we anticipate that risk costs in absolute terms are expected below the level that we saw in 2010, which were 53 basis points. Return on equity year to date was 16.5% when we based that on the original plan we made in 2009, and that started with a core Tier 1 ratio of 7.5%. If we take into account the current IFRS equity, then the ROE was 11.4% in the first nine months of this year. Next slide, you can see the impact of the impairments on Greek government bonds and the lower income by financial markets. Underlying result was €1.063 billion, was lower than the third quarter last year, but primarily because of the €267 million impairments on Greek bonds.
If we exclude that, then the result would have been 5.4% lower, mainly because of lower interest income. Additions to loan loss provisions already mentioned for the period €438 million. The quality of our loan book is not changing significantly, and you can see that non-performing loans and onwards exposures remain stable during the quarter. Interest margin, page 10, interest results were down 3.5% from the third quarter a year ago and 1.5% compared with the second quarter, largely due to the narrowing of the interest margin by 4 basis points to 1.37%, of which 3 basis points came from financial markets. The increase in the average total bank assets also had an impact, and the narrowing net interest margin was partly offset by higher client balances. In the Benelux, the margins for mortgages and current accounts slightly improved, but margins on savings and other lending products came under pressure.
ING Direct total interest margin declined from the previous quarter, and that was mainly due to increases in client saving rates. Margins in the lending book of commercial banking held up well, whereas margins in structured finance showed a very small decline. Slide 11, you see our client balances. Net production was positive, and that's now already for nine quarters in a row. Net production in residential mortgages was €5.4 billion. Overall demand for credit is still quite subdued, we would say, and that's because of the challenging market environment. Shorter tenor lending was reduced when we saw that short-term funding became more expensive. Consequently, total other lending showed a net decrease of €400 million, and there was a decline in commercial banking, but it was not fully offset by net growth in the retail banking.
Net production of funds interested at retail banking was €1 billion, driven mainly by ING Direct, while the commercial bank saw an increase of €5.5 billion, and that was mainly because we took in a lot of deposits from asset managers and corporate treasurers amid the uncertainty on the professional markets in this quarter. Slide 12 shows our expenses. They declined. Cost-income ratio increased to 61.3% or 55.8%, excluding the market impact, and that mainly had to do with declining income levels. As a result, we are taking steps to make sure that we reduce our expense and that we stay abreast of a leaner environment and that we can maintain our competitive position. In retail banking, slide 13, we are taking decisive steps to reduce costs by decreasing overheads while we are maintaining customer focus and improving operational excellence.
It is unfortunate but also inevitable that we have to take these measures that will lead to redundancies of about 200 internal people and 700 externals. We will do our utmost to implement these steps with great care, as we have always done, and we will make sure that people will be very well guided from job to job. In addition, we will make IT investments of about €200 million in the coming two years. That will help to reduce costs and deliver faster and more accurate type of services. In Q4, we have a charge of €235 million that will be booked as a special item, and that includes a €215 million provision for redundancy. The measures, as well as the additional savings, mainly from reduced general expense, are expected to lead to structural cost savings with a run rate of approximately €300 million from 2013 onwards.
In slide 14, you see our risk position. We added €438 million to the loan loss provisions compared with €374 million a year ago and €370 million in Q2, mainly attributable to provisioning for some existing large non-performing files in structured finance and general lending, and a bit to the mortgage position portfolio in ING Direct. Quality of the loan book did not change. Non-performing loans and onwards exposures remained stable. In fact, non-performing loans slightly declined as a percentage of outstanding loans in the quarter. As I said, we expect risk costs for the whole year to be lower than what we saw in 2010. Slide 15. On the right hand, you can see that the NPLs, as a percent of total loans, slightly declined to 2%. Most areas were showing improvement. Dutch mortgages remained stable at a very low level of 1% only.
Real estate finance and leasing and factoring had a little increase in the NPL ratio. The increase in leasing and factoring is mainly driven by the sale of car lease, while the increase in real estate is due to a deterioration of the onwards files. Slide 16. Retail banking underlying result before tax was €811 million. That is down almost 20%. It was a year early, and included in there is €85 million for impairment on Greek bonds. Plus, we had some losses from selective de-risking in ING Direct this quarter and lower margins on most products in the Netherlands. Results were higher compared with the previous quarter due to lower impairments on Greek government bonds and despite margin pressure in ING Direct. Results in the commercial bank were down, and that mainly had to do with the loss in financial markets.
That loss was triggered by €182 million impairments of Greek sovereign bonds, while we had also some adverse market conditions in financial markets. We saw a widening of bid-offer spreads. Country and credit spreads resulted in significant additions to reserves on the existing inventory of trades that we do with clients, and they were partly offset by gains due to fair value of issued structured notes. In addition, funding increased due to the liquid money markets, and interest income was also lower following the sale of European government bonds and actions that we have taken to deleverage specific securities lending and trading positions. Commercial bank had a steady flow of business in the general lending, payment and cash management, structured finance, and they had a stable pre-tax result compared to last year. We saw higher income that was able to offset the provisioning that we had to do.
Real estate was positive in the first quarter, showed a positive result for the first consecutive quarter. An impairment on Greek government bonds amounted here to €9 million in Q2 2011. You also saw that we met the stress test that was done by EBA. We met the target of 9%, and you can see here the build-down. We started with 9.6%. We sold our Rhine business. We had the implementation of Basel 2.5, and that resulted in a 9.4% position. We really made the cuts and don't have to raise additional capital. We benefit also from the funding mix, as you can see on slide 19. Loan-to-deposit was 1 to 1.15, slightly increasing because of ING Direct USA, no longer in the consolidation. Deposits were accounting for 61% of our total funding, customer deposits.
While markets were significantly deteriorating in Q3, we were able to maintain access to short-term and long-term funding for prices that were acceptable and at tenors that were acceptable as well. On the next slide, you see the funding position that we have. We issued €3.5 billion of debts in Q3, including €0.5 billion unsecured, €2.7 billion of covered bonds, and €3.3 billion for RMBSs. We have basically done our funding for 2011; that was done. In fact, we have excess funding, and we are now already looking at 2012. You can see that we have done the issuance at an average spread, which is clearly below the average CDS spread, which is trending below the ITREX bank five-year CDS. The refinancing needs that we have in 2012 amount to €16.5 billion. That concludes the bank. Now, we turn to insurance.
Insurance showed clear progress towards the ambition that we have stated early in 2009 for the objectives 2013. Investment margin continued to improve, and that was following the reinvestments we did last year. Administrative expense remained tightly under control, and the ratio of administrative expense over operating income improved to 39.4% for the first nine months of this year. Partly, this can be explained by non-recurring items in the second quarter, but clearly, the trend is positive here. ROE turned positive, 9.3%. Still some work to be done to get the ROE structurally into the double digits, but clearly, we can see the improvements that we have secured in the last nine months. On page 23, you see the results. Third quarter results were €527 million. That is up 27% from a year ago, mainly driven by investment margin and higher fees and premium-based revenues.
In the previous quarter, operating result was compared with the previous quarter, operating result was 24% lower, but that's mainly due to seasonally higher dividend income, as well as positive non-recurring items we had in Q2 in the Benelux. Underlying result before tax at €561 million. That is a strong number, also impacted by significant favorable hedging results in the Benelux that more than offset the impairments, including €200 million of impairments on Greek bonds. On page 24, you see that the investment spread increased to 104 basis points. That, by the way, does not include normally the basis points that we generate by the LATAM business. That would add another 3 basis points, so you can say we really have met the target we have set in the year 2009, which was 105 basis points. Page 25, you see the premium and the fees.
They increased 5% from the same quarter in 2010. The increase was driven mainly by higher sales in Asia-Pacific. Technical margin was $136 million. That is lower than last year and reflected an increase in the guarantee provisions in the Benelux that we made during this quarter. Compared with the previous quarter, the reduction was mainly due to $70 million of positive impact from a surrender of a contract with a large pension fund in the Netherlands in Q2. Administrative expense already mentioned, good numbers here. The administrative expense was $750 million. That is down 4.5% compared with a year ago, and also 1.2% lower than the second quarter this year. The third quarter ratio of administrative expense to operating income was 40.7%.
It improved compared to the third quarter last year, but it increased compared to Q2 of this year as the positive impact of lower expense was offset by a substantially lower operating income due to the impact of seasonal and incidental items in Q2. Q2 is a bit of an exception. Operating result improved on page 27 was $527 million. The decline compared to the second quarter can be explained by a seasonally higher dividends income, as well as positive non-recurring items in the second quarter that I already mentioned in the Benelux. When you look at non-operating results, they totaled $34 million, but included some very significant positive and negative items. You can see that we had a gain on the equity position in the Benelux. We had changes on the provision for guarantees on separate account pension contracts. They were favorable. We have the Greek impairments.
We had losses on some sale of Italian government bonds and some subprime mortgages we still had, and we had some other non-operating impact. That explains the result between operating result and the underlying pre-tax result. Solvency on page 29 came down a little to 242 from 252 at the end of the second quarter, mainly due because of the deterioration in market conditions, whereby the change in the statutory test of adequacy for certain Dutch entities was not completely offset by higher revaluation reserve on the Dutch securities. The expected net transaction result of approximately $1 billion on the sale of Latin America will increase the IGD ratio by roughly 13% at the closing. If you look at our risk-based capital in the U.S., it remains stable at 492%.
Sales page 30, excluding currency effects, they increased 6.5%, good quarter, mainly driven by strong sales in Asia and also higher sales of our retirement plans in the U.S. Insurance sales, excluding currency, increased 5.2% compared with Q2, and again driven by higher sales in Asia-Pacific. That I think concludes the presentation that we have, and we're very happy now to answer your questions.
Speaker 5
Thank you, sir. If any participants would like to ask a question, please press the star followed by the one on your telephone. If you wish to cancel your request, please press the star followed by the two. Your questions will be pulled in the order they are received. There will be a short pause while participants register for a question. The first question comes from Mr. Farouk Hanif from Morgan Stanley. Please go ahead, sir.
Speaker 2
Good morning, everybody. Three brief questions. Firstly, on your disclosure about the EBA stress test, if we took this forward and we assumed that the ING Direct US disposal and other disposals go ahead, we allow for retained earnings, and if we then assume that you repay the Dutch government with a penalty, it seems to me that you would still just about pass the test. What comment can you make on that? Basically, can you repay the Dutch government and pass the test? Second question is, can you give us an update on the European court hearing, so the court hearing with the European Commission? Thirdly, in the margins in insurance, it seems to me that investment margin is at target, fees and premiums are very strong, and technical margin was affected by some one-offs. Do you think some of these underlying trends here are quite sustainable going forward?
Thank you.
Speaker 1
Okay. First question, can we still do all the things you mentioned, including repaying the Dutch state and maintain the 9% core Tier 1? Yeah, I think that is the test we are looking at. We are not making at this moment. Let me start from this point. Our main interest is to repay the Dutch state as quickly as we can, but at the same time, we need to do it in a way that we are not jeopardizing our capital position because the last thing that we want is to go back. We never, never will go back. That is, I think, a very clear message. We need to make our plan and our strategy based on doing it careful, doing it diligent, and doing it smart. That's all I can say at this point in time. The court hearing, we have no further news to mention.
As you know, we had public hearings in July, and we are waiting anxiously what the court has to say. Matt, would you like to comment on the investment margin?
Speaker 0
Yeah, I think in general, Farquhar, we're obviously pleased by the results so far. As Jan had said, the investment margin has basically improved a little bit ahead of schedule to the 104 basis points. I think that we've done that largely by getting out of some shorter-term investments, getting into a little bit more credit. Difficult to say how that is going to evolve going forward. I mean, the markets are actually in quite a bit of turmoil right now. We've seen interest rates quite a bit lower. I think we're pleased that we've reached it, but we want to be modest a bit on our expectations for that investment margin.
I think where we are seeing some very positive progress is on the, and I think you've seen it on the expense side, very stable expenses, and that's where we put a lot of our emphasis to make sure that we really keep our expenses low in difficult markets. I think we've shown some very positive progress there. Also, on the sales front, it's a little bit masked because we've had some reductions in sales on the pension side in Central Europe, but actually, we've seen quite positive sales in Central Europe on the life insurance side, and we see continuing growth in Asia, and we've seen some good results out of the U.S. In general, we're pretty positive on the results this quarter. Going forward, it's going to depend a little bit on what the financial markets give us going forward.
Speaker 2
Okay, thank you very much.
Speaker 5
Thank you. The next question is from Kirishanthan Vijayarajah from Citigroup. Please go ahead.
Speaker 4
Good morning. I have two questions, please. Firstly, on slide 17, the financial markets business in particular, I'm interested just on a bit more detail there. You talk about underlying pre-tax profit of $14 million versus $223 million a year ago. That's stripping out the impact of the Greece markdown. You mentioned three things specifically. That was the lower NIR and the reduction in the sovereign positions, the extra reserves on the inventory, and then also the cost of a liquid money market. Perhaps, given the size of the swing, the $200 million, could you perhaps quantify between those three things? Also, interested to know, the cost of liquid money markets, is that more specifically on the U.S. dollar funding money market side, or is that across the board? Interested on a bit more detail there.
Second question regards to the Dutch Central Bank announcement yesterday where they talked about a 1% to 3% surcharge above 7% for Dutch systemically important banks. Is that in your mind an additional amount that you now think you'll have to raise in terms of capital requirement? I.E., before, I think you said you're at the low end of the potential CIFI surcharge from the Bar Committee. Interested in if that changes your thoughts on what the right capital level might be going forward. Thank you.
Speaker 1
Okay, I think Patrick will deal with the first question.
Speaker 3
Yeah. Good morning, Andrew. Yeah, the total reduction in revenues Q3, Q2 for financial markets was, I know you mentioned $379 million, big number, but there's a couple of major blocks that happened in there. Impairment of Greece is $182 million, so that's one large element that's referred to already. Another big block is reserve requirements in financial markets, particularly in very turbulent times as we've seen in the third quarter. We've added two reserves. These include credit reserves, bid-offer reserves, CVA, DVA, so the net of that is a little over $100 million. If you add together the impact of the impairments in Greece and the additions to reserves, you're looking at an explanation that covers approximately 85% of the total revenue decline in FM. The other pieces, including the NII, are comparably smaller.
Speaker 1
Okay. With respect to the Dutch Central Bank, yeah, we don't have all details yet. We have had some preliminary information here, but they have not been quite specific who gets what type of additional charge. As I understand it, this is a charge that will be on top of the Basel, on top of the calculation that they have for Basel 3, which is the 7%. It's anywhere between 1% and 3% for ING on top of the 7%. That is all I understand at this moment, but they have not given any particular details for each individual of the institutions here.
Speaker 4
Okay, thank you very much.
Speaker 5
Thank you. The next question is from Jeremy Omahan from Goldman Sachs. Please go ahead, sir.
Speaker 1
Yeah. Good morning. I have a couple of questions. The first one relates to slide four of your presentation, which is on the residual exposures to the peripheral countries in terms of sovereign debt. I just wanted to essentially confirm the Q3 numbers that you showed them here, are they the same numbers that you will be submitting to the EBA for the final run, or you have submitted to the EBA for the final run of the capital shortfall calculations? The second question I wanted to ask on this slide is, what is the remaining maturity profile of the sovereign bonds that you've kept? Do you intend to prolong or reinvest any of these bonds as they mature? Ultimately, what is your targeted exposure to these four countries?
I.E., do you aim to have nothing at all as these things mature, or do you plan to run a residual position? The second question I have relates to slide eight of your presentation where you show the return on equity target for the bank in the range of 13% to 15%, and you point out that this is calculated on a core Tier 1 ratio of 7.5%. I was just wondering, given that the EBA is now asking you to run on a 9% core Tier 1, to what extent should we be thinking about this slide as still being an appropriate guide to the future returns of the bank? To what extent do you think this 7.5% is an adequate capitalization of your banking assets?
The final thing I wanted to ask, and this is maybe a question which is not directly relevant to your results, but more of a longer-term question, the EBA has opened an option for banks to include newly issued contingent capital notes in their core Tier 1 capital calculation. Is that something that ING would contemplate in the future? Thanks a lot. Okay. We'll take them in order. The first question is easy. The answer is yes. We did include the numbers at the end of Q3 as presented here in our filing with the EBA. Second question was the maturity profile cost.
Speaker 0
Yeah, I think what you can say is that it's, of course, spread because we have different countries and we have different bonds. You could say on the bank side, roughly, you have quite some paper maturing before 2018 because they want to have a shorter dated investment profile. You know, there you're talking more roughly 30% that is only after 2018. On the insurance side, it's slightly longer dated given the fact that they have to do some interest rate matching. There you would see a bigger percentage over 2018. In fact, that's more going towards over the 50% is 2018 plus.
Speaker 1
Okay. The targeted exposure, I don't think we have an answer for that. We have internal targets, but I don't think it's appropriate to share them with the outside community. The 7.5%, is that adequate? The 7.5%, we show that because we want to, let's say, be accountable to the forecast that we make. We made a forecast in 2009 that this was the objective for 2013, and that's why we are presenting that. Going forward, I think we will have to adjust to levels that are appropriate for the time that is ahead of us, and it's closer probably to the 9% than it is to the 7.5%. The EBA option newly issued, I think we will evaluate that. We have not made a firm position on whether we will include these new options, yes or no.
Speaker 4
Thank you very much. I appreciate the answers.
Speaker 5
Thank you. The next question is from Michael Van Vegen. Please go ahead, from Bank of America.
Speaker 2
Yeah. Morning, guys. Mike Vega from Bank of America Merrill Lynch. Three questions, actually. Starting with the insurance business, you've done a couple of things with your VA operations this quarter in terms of debt unlocking. You also flagged the reserve strength of your VA reserves if markets fall further. What you haven't talked about much is LAPS assumption updates. I understand that you're now reviewing that for Q4. Is there any sort of sense you can give on the potential impact from that? That's question number one. Secondly, the restructuring of your legal entities within the insurance business, how are we going to look at the debt restructuring now that you know effectively what the legal structure of these entities will be? The final question on loan loss provisioning, the pickup that we've seen in Q3, it's clear what your guidance is for the full year.
How do you feel about those, let's say, the existing case that you still have? Should we expect a little bit extra reserving on those historic cases, or is it going here onwards just a matter of whatever the economy brings us in terms of new cases? Thank you.
Speaker 1
Okay. The first one will be Matt Ryder. Matt.
Speaker 0
Yeah. On the VA, I think you raised sort of two points. The first one is in respect of, let's say, the results for the quarter, which were actually very stable on an underlying profit basis. I think this goes to the effectiveness of the hedging program that we do have in place, together with the implementation of mean reversion that we had done in the first quarter of the year. That's a bit why the sensitivities, if you look at the, as you get into the detail, when you look at the sensitivities of our earnings to equity market moves, they actually go up in the U.S. VA business as a consequence of, you know, if you're mean reverting and you have a more significant drop in the equity markets, we will have to unlock further. I think that's pretty well detailed in the quarterly report.
With respect to the assumption changes, and I would say this goes also for the Japan VA business as well as the U.S. VA business, but over the past couple of years, we've made assumption changes, and sometimes it's the third quarter. We did that in 2009. Sometimes it's in the fourth quarter. We did that in 2010. This quarter, we're going to do it in the fourth quarter, so you can expect to see changes if there are any come through in the fourth quarter results.
Speaker 2
Is there any sort of sense you can give for the magnitudes, or can you help us understand where your assumptions are today?
Speaker 0
No, we don't comment on that. We have to complete the work, and those will come through the results in the fourth quarter.
Speaker 1
Michael, on the legal entities, I missed exactly the question. Can you repeat that again?
Speaker 2
Oh, sorry. Yeah. I mean, up till now, we had little detail about how you see the debt restructuring or the capital restructuring in your insurance unit happening. Now that you have figured out the ideal, let's say, legal structure, what does that mean in terms of capital restructuring? How do you see that happening progressing from here?
Speaker 1
Yeah, that's an item that we are, of course, that's the next step in our process, and we'll come back on that one as soon as we have more information on that. We are planning now to look individually at capital positions and also combine that with, let's say, the overall position that we have in the company, including some of the divestments that are taking place. More to come, but at this moment, I think all we can say is we're getting ready for it. Wilfred, you take the loan losses.
Speaker 0
Yeah. On the loan losses, maybe I should start with the conclusion on the question, which is that we think our guidance is still valid, which was that we will end up below the number that we had last year. Why do we say that? A couple of reasons. If you look at the uptake in Q3 and you break it down a bit, then it's about $68 million, $70 million difference. Almost half of that is model updates, which are essentially one-offs, and the other half are mainly a couple of provisions on existing problem files and not so much a reflection of a big new inflow of problems. If you look at a couple of other indicators, the watchlist in Q3 is pretty much stable in terms of size, i.e., volume of outstandings, as well as number of files.
The weighted average risk rating in the portfolio is stable as well. As Jan mentioned, are the NPLs, so there aren't any strong indicators of a particularly negative trend there. At the same time, being realistic about what's happening in the economy outside, you can't close your eyes for that. The uncertainty around these numbers, of course, is not getting less. If you look at where the potentially somewhat weaker parts are, it would be the real estate finance business and generally the SME mid-corp portfolios. On the mortgage front, we're seeing that that portfolio is holding up very well.
Speaker 2
Thank you very much.
Speaker 5
Thank you. The next question is from Kirishanthan Vijayarajah from Bathvis Capital. Please go ahead.
Speaker 2
Yes. Good morning, guys. I wonder if you could update us on where your liquidity coverage ratio would be once you deconsolidate ING Direct USA and perhaps some of the other disposals you also have in the pipeline. That would be very helpful. Secondly, you've had three, four quarters now of declining net interest margins, and I wonder what your outlook there would be, particularly if we allow for maybe a 50 bps ECB rate cut by the end of the year. Thanks.
Speaker 0
Yeah. If we look at our liquidity coverage ratio, the way how we calculate it right now, we look at transferable liquidity. Since ING Direct was holding a lot of liquid securities, but that was not really transferable out of the country, it also means divesting ING Direct will not have a lot of impact on our liquidity if we look at it for the company as a whole.
Speaker 2
Okay. Yeah, the net interest margin outlook?
Speaker 3
Yeah. Net interest margin, what you saw in the quarter is that it came down from 142 to 137, and three basis points of that was in financial markets. Of that, approximately half of it was offset by trading profits. The net impact that hits the bottom line is 1.5. You're looking at three to four basis points as being the impact that hits the bottom line, not the full five. What are we seeing? We've seen a strong competition for savings in the Netherlands, and we've also seen the impact of the increases in the standard rates for ING Direct countries following the ECB rate increase in the second quarter of 25 bps increase in Germany and France and 20 in Austria, which had a negative impact on interest margin in ING Direct in the third quarter.
On the other hand, in the Netherlands, margins on mortgage production are better, and also we've had a positive effect from lower prepayments and lower swap funding costs. That actually offset the impact of the margin increase on deposits in the Netherlands. Corporate banking, small decrease in margin as some shorter dated financing matured. We're also seeing that the margin on new business, particularly in corporate banking, is increasing quite rapidly. However, the positive impact of that is not particularly visible because volumes and demand are still fairly low. To your direct question, if there's a decrease in ECB, that should have a positive impact, but the timing and quantum is a little bit difficult to predict because the individual entities will be balancing the desire to reduce with where competitors are at.
That could require some lagging in terms of implementation, but clearly, a reduction would be a positive in terms of savings to the extent you can pass it on to customers. What are we saying overall? Our guidance is that we will have a continued gradual decline in interest margin, but it should remain above the levels we saw in the previous crisis. Our guidance stays the same as we've given previously, that it should be around about the 140 bps for the full year.
Speaker 2
Okay, that's very helpful.
Speaker 5
Thank you. The next question is from Francois Bossin from Exane BNP Paribas. Please go ahead.
Speaker 2
Good morning, gentlemen. Three questions, please. You mentioned you further reduced CHIPS exposure by €600 million in October so far. Could you just maybe give us the updated exposures by country, let's say, early November? Second question is with regards to insurance operations. I mean, could you provide a rough overview of what the impact on earnings would be if market conditions remain stable and in particular the interest rate scenario? Finally, do you book own debt at fair value, and if so, what was the impact in Q3? Thank you.
Speaker 1
Yeah, Francois, we prefer at this moment not to make any. We have given you the total number, but we would not prefer to go into details on the $600 million. I think that would be more appropriate when we do that at the end of the quarter. Matt, would you like to do the insurance?
Speaker 0
Yeah. With respect to the impact of a low interest rate portfolio or a low interest rate scenario going forward, we obviously look at this pretty frequently. If you look back at, let's say, the interest rate levels as they existed at September 30, over the long term, and let's say, you know, on or sort of 2015, you'll see a gradual decrease in the investment margin in the insurance business. We would estimate that number again, you know, sort of several years from now to be about 20 basis points of the 104. I think very important in this is that I think 65% or something of our total operating income comes from fees and premium-based revenues. Actually, this is a relatively small percentage of the operating income for the insurance business.
Speaker 2
Okay, with regards to equities?
Speaker 0
With respect to equities, I mean, I think the results for the third quarter are something stable around this level. Just kind of muddling along equity environment, not a lot of volatility if we just see it at the current levels.
Speaker 2
Finally, on your own debts?
Speaker 3
Yeah. The fair value of owned debt is of Tier 2 debt was a $90 million increase in the quarter. There's a modest amount of owned debt which is fair valued, and we report that in the corporate line.
Speaker 2
Thank you very much.
Speaker 5
Thank you. The next question is from Thomas Nathagal from RBC Capital Markets. Please go ahead.
Speaker 2
Good morning, gentlemen. Thomas Nathagal, RBS. I only have one question remaining. Could you disclose if you realized any losses in further reducing your periphery exposure during October? Thanks.
Speaker 3
Sorry, we'll give you an update on Q3, I'm afraid, when we complete Q3.
Speaker 2
Okay, thank you.
Speaker 5
Thank you. The next question is from Benoit Petrarque from Kepler Cheuvreux. Please go ahead.
Speaker 2
Yes. Good morning. Benoit Petrarque from Kepler in Amsterdam. Three questions, please. The first one is basically on the fact that in past presentations, you mentioned your intention to repay the state in May 2012. I see it nowhere in the slide this time. I was wondering if you changed your mind in terms of repaying the state. Are you now trying to eventually postpone it a bit? When are you going to give us an update on the recurrent capital level, I mean, quarter one by three you are aiming for? That's the first question. Number two is on the margin on savings in the Netherlands. Basically, you mentioned that you have not seen anything special this quarter. Obviously, the competition is eating up. I was wondering if you have booked any gains on hedging your interest rate risk in the Netherlands, and if yes, how much?
Could you give us also an update on WestlandUtrecht, which is for sale? You have been quite aggressive this quarter, and I was wondering if you see inflow of savings money actually coming from ING Bank to WestlandUtrecht. The final question is whether you could give us an outlook on the risk-related asset migration expected in the coming quarters. We have seen quite some positive migration in the past 18 months. We started to see actually a bit of more negative migration this quarter, but could you give us a bit more kind of guideline for the coming quarters on that side? Thanks.
Speaker 1
Okay. With respect to repaying the Dutch state, I told earlier we are very dedicated to repay them as quickly as we can. At the same time, you need to take into account the ability to do that and the requirement we have on the new regulation that you just heard. The Dutch Central Bank has come up with some new requirements. We need to know exactly where we stand before we can make any firm commitments here. Our intentions are the same. They have not changed, as quickly as we can. That brings me to the second point, Basel 3. The Dutch Central Bank has yesterday given some idea of what they want to do, but they have not been specific. As soon as we have that, we will communicate that with you as well. Let me do the other one, Westland Utrecht.
I think I can say that we are active with the European Commission to find a solution for that. If we have one, we'll let you know, but at this moment, we're still in the process of divesting Westland Utrecht. Any comment on savings?
Speaker 0
Yeah, maybe the other part because what I understood the question, Benoit, was on the hedging and taking gains on hedging, for instance, for mortgages, so where we are fixed rate payer, we are not doing that. What we are doing normally is we are hedging according to the economics and to expected prepayments, so we are not sort of releasing profits by basically skipping or basically unwinding receivers. That is not something we are doing. What you do see in the Netherlands, if you look at margins, is a bit that savings margin. Yeah, that is the part which is under pressure, but for the rest, there is nothing specific to mention.
If you look at RWA migration, I think in general, where you see that happening, it's mostly in the securities portfolios, and that is why from time to time, you manage that and you de-risk it, so you sell off some of these securities before. Please note that the part where the securities portfolio could bite as well, the U.S., that is something which is available for sale, so we will need less operations on that side.
Speaker 2
All right. No big migration to be expected, no negative migration to be expected in the next quarters?
Speaker 0
No, I think in general, in the securities portfolio, because you have this rating table, if you have migration, then you sell it before you get the migration.
Speaker 2
On the loan lending side?
Speaker 0
I think in general, what you have seen or that my colleague Wilfred already said, you look at the ratings and the current ratings of our portfolio, and you don't see a significant deterioration there. That is not something where you can say, like, you expect a very quick RWA pickup.
Speaker 2
Very good. Thank you very much.
Speaker 5
Thank you. The next question is from Duncan Russell from JPMorgan Chase & Co. Please go ahead.
Speaker 4
Good morning. This one was on the IGD for the insurance business where the IGD adjustments swung from €453 million to €2.7 billion. I guess that's mostly related to the Dutch business. Could you just confirm that in that context? Could you give me an indication of where the Dutch legal entity solvency ratios stand as of the end of the nine-month stage on a Dutch regulatory basis, please? Maybe just for the largest legal entity. The second thing was on the U.S. business. You've previously said that your accounting is you've structured the U.S. to align the accounting with that of U.S. peers on the basis that that's where it's going to be IPO'd. Does that mean you'll be adopting the change in the DAC accounting rules, I guess, like some of the U.S. peers are going to be doing, or will you wait for that?
Thirdly, with respect to the Dutch state and your plans to repay first quarter, second quarter next year, my understanding is that there's an IRR which the Dutch state and the EU or EC have in mind, and that by paying on that date next year, you're basically hitting that IRR. If that were to be delayed, would you expect you would have to put in place additional measures in order to get that IRR back up? Thank you.
Speaker 0
Hi, Duncan. It's Matt. I'll take the IGD ratio first. First of all, yes, I can confirm that number in the strange Dutch test of adequacy test. I see that you've already had a chance to look at the detail in the statistical supplement early in the morning, so well done for that. Obviously, that's a big change in this regulatory line item, but it's compensated a bit by the change in the revaluation reserves given the low interest rates, so we don't have so much of a problem there. I would say we do not talk about the individual local solvency in any of our businesses. We can just say that it's comfortable, it's adequate, it's fine. With respect to the U.S. business, you've called out the accounting change, and this is under U.S. GAAP.
What companies are going to be required to do is effectively decrease the amount of capitalization they can do for certain, let's say, internal expenses that are related to new business production. This is something that we're still looking at for IFRS purposes. We'll have to adopt it, obviously, for U.S. GAAP reporting. We're still looking at it for IFRS, but it looks like many of our peers are not taking that into account for IFRS reporting. We would likely not do the same thing, but still looking at it, but so far, we think probably not.
Speaker 2
Okay.
Speaker 1
Yeah. With respect to the payment to the Dutch state, I said earlier, we would like to do it as quickly as we can, but we need to take into account the ability to do so as well. Now, we have agreements in place with the Dutch state that were sanctioned by the European Commission, and we will look and evaluate all the options we have to make sure that we do the right thing for the company at the end. That's all I can say at this moment, Duncan.
Speaker 2
Okay, thank you very much.
Speaker 5
Thank you. The next question is from William Hawkins from Keefe, Bruyette & Woods. Please go ahead.
Speaker 2
Hi. Thank you. Just briefly, with regards to your banking targets, do you still feel happy with the trend growth of 5% for underlying income given how the world's moved on? Secondly, the headcount changes that you're making in the Netherlands, how does that make you think about your 50% cost income ratio target? I guess I'm assuming that this is just something that improves your comfort level that you may reach it at some point, but do you actually consider it something incremental or something that just helps in achieving your existing targets? Thanks.
Speaker 0
Yeah. I think with regards to the 5%, that is one of the things, income growth, we clearly have to look at the following, and that is that balance sheets are more or less constrained at the moment, so you don't want to see the growth from a bigger balance sheet, and maybe you can change something in the composition of the balance sheet, but that's an area where we will come back to in January if we talk about the investor roadshow.
Speaker 1
With respect to the headcount, this is not something that we can play with in order to make our spreadsheets. That is a very serious topic that we do with very careful consideration. We are seeing that we have completed a very important phase of transformation in the bank, and we're now getting into the next phase, and that is to make sure that we serve our customers in the best possible way, that we have the latest technology in place, that we can do it quick and accurate, and that we can help our customers realize what they need from a bank. That's the next phase we're getting into. We see new technology which requires that we can, let's say, let the old systems we have let go, and that saves people, and that results in that we have some redundancies here.
I must also say we will handle people with care because we are a top employer for all employees, and we'll make sure that we guide our people from job to job as best as we can. The headcount reduction and the 50%—I would see 50% as an objective that we have set for the long run, and it's still an objective that we have.
Speaker 2
Thank you.
Speaker 5
Thank you. The next question is from Matthias De Witt from Petercam. Please go ahead.
Speaker 2
Yes. Thank you. A few questions from my side. First, with regard to the capital generation at the bank, could you comment on what the net negative foreign exchange impact was on the core Tier 1 ratio during the quarter? I'm a bit puzzled that core Tier 1 only increases 20 basis points sequentially despite the hedging of currency movement, so it would be helpful if you could comment on that one. Then, on the impact of lower interest rates, could you provide any insight into the economic impact on your U.S. insurance activities and also highlight to what extent the DAC is still recoverable at the current low rates in equity markets? Follow-up question on the U.S. DAC accounting changes. If you would eventually adopt them retrospectively, what would be the impact then on the U.S. DAC balances? Thank you.
Speaker 1
Okay, we need to make some quick calculations here on the foreign exchange impact, so give us a minute.
Speaker 3
Yeah. I mean, with respect to the quarter one, we do delve to hedge the impact of FX, so we try to keep that neutral. There's a limited impact of FX in the quarter one ratio. That's a longstanding policy.
Speaker 1
Matt, interest rates.
Speaker 0
Yeah, on the U.S. question, first of all, there was a question earlier on the impact of low interest rates on investment margins. I
Speaker 6
Quoted a number of about 20 basis points for insurance overall. It's actually a little bit higher than that for the U.S. It's a little bit lower than that for the Netherlands. It's about the same for Korea. I'm not going to give out any specific numbers on that, but longer term, the U.S. is exposed to low interest rates, but that comes in over time. It's a relatively long liability portfolio. With respect to the DAC recoverability, this is a test, obviously, that we do every quarter in line with our management best expectations. The long-term interest rate assumption that we use for, let's say, reserve adequacy testing and all the DAC and reserving is reviewed regularly. It'll be reviewed again in the fourth quarter, but it is a long-term assumption.
With respect to the U.S., the DAC accounting changes, and this is that the change to the capitalization of internal expenses. I don't have the number in front of me. That'll be something we'll have to get back to in due course.
Speaker 1
Okay, thank you.
Speaker 5
Thank you. The next question is from Tony Silverman from S&P Equity Research. Please go ahead.
Speaker 1
Yes, good morning. Just a couple of questions left. I wonder if you could give an indication of how you see the outlook for risk-weighted assets in the bank, any ex-disposals, and what your plans are for that. The second question was just a bit of detail on the Greek impairments. In the bank, they're stated at €267 million, but in the table on page 27, the amount in the balance sheet over the quarter just seems to go down from €406 million to €280 million. Not in less than the impairment. I don't know if that means you bought Greek debt in the meantime or not. Similarly, for insurance, there's a €200 million impairment, but the amount in the balance sheet just goes down from €323 million to €226 million. Finally, if I may, one question actually left on insurance.
The impact of lower interest rates that you've mentioned, does that include the impact on the cost of VA guarantees as well, or not? Thank you.
Speaker 6
Yeah, I think if you look at risk-weighted assets, of course, what you expect is to move up a little bit because of Basel 2.5. That is, I think, the biggest part in terms of trend what we see going forward. For the rest, given the fact that what I already indicated is RWA migration, you know, it's difficult to look far beyond, but at the same time, I don't have early signals for RWA migration. That means I don't expect a lot there. Since loan growth is quite muted at the moment, that is not something, you don't expect it from a boost of your balance sheet. In that sense, I think the biggest driver for RWA is Basel 2.5.
Speaker 1
If I can just say your strategy basically exposed changes, those influences, is for stable RWA. You're not looking to do anything managerially with the number.
Speaker 6
No, I mean, again, I think Basel 2.5, that's basically the only big one we see early coming up.
Speaker 1
Okay, yeah. Thank you for the other questions.
Speaker 5
In respect of Greece, yes, you'll remember this is the wonderful world of AFS accounting where the bonds are on the balance sheet at market value and the negative mark-to-market was in equity. When you impair, you take it out of equity and through the P&L, but the balance sheet doesn't change. If you look at the slide on page four, you see that it looks relatively stable. The Greece number down 0.4, 0.3 in the bank, but the P&L takes the hit. I'm afraid it's the wonderful world of AFS accounting. You're not going to see the reduction in the balance sheet side as when the equity is reduced because you've taken the impairment out of equity through the P&L.
Speaker 6
Okay. On the insurance side, just maybe two quick things. Patrick just very well described the Greece situation. If you go back to the last quarter and factor in the revaluation reserve that was there, the math actually works out. You'll go and do that. On the VA cost of guarantees, in the U.S. VA business, we hedge for approximately, we've said about 50%. I think currently it's about 53% on interest rate exposure economically. Over time, if interest rates persist at a low level, it can dribble into earnings and capital and so on. For right now, we're pretty much matched off against movements in capital, which is really where we want to put our emphasis. We remain pretty happy with the position right now.
Speaker 1
That is hedging that program against VAs then. The gains on that will be from the fall in interest rates that would protect the value over time of those contracts, will all be in this, the hedging gains that are in this quarter, which have been offset by Greek debt and other things. You would be then left with a negative impact in succeeding quarters. Could you quantify that if conditions remain simply as they are?
Speaker 6
Yeah, I think so. Let's be careful not to mix things up. Let's take the Greek debt out of the situation. In fact, the interest rate hedging in the U.S. for the VA block had very little impact on the overall results for the quarter. The reason is that the interest rate hedges that we have in place are matched off against the reserves that we hold on the liability side, which are based on market rates. It's actually a bit complicated in the balance sheet, but it comes through about as a null.
Speaker 1
Taking the U.S. on its own, I can see that, but yeah, thank you very much.
Speaker 5
Thank you. The next question is from Farquhar Murray from Bernstein Autonomous LLP. Please go ahead.
Speaker 1
Morning, gentlemen. Silverman just took the question I had there, actually. The one remaining one I've got is, what's driving the deterioration in NPLs in the real estate finance sector? In particular, I'm just thinking geographically. Thanks.
Speaker 2
Yeah, the story on real estate is that what you see driving these numbers is mainly the Netherlands and Australia. There's no particularly strong trend in any of the other countries.
Speaker 1
Okay, great. Thanks so much.
Speaker 5
Thank you. The next question is from Lamar Salah from SNS Securities. Please go ahead.
Speaker 0
Good morning, gentlemen. Lamar Salah from SNS Securities. Two questions from my side. First of all, can you give us an update with regard to the ING Direct USA deal with Capital One? Can I presume that this deal will proceed or will be closed in the fourth quarter of 2011? Secondly, with respect to the cost savings, which are mentioned on slide 13, is the $300 million cost saving as of 2014 entirely attributable to the headcount reduction, or is there something else involved? Thank you.
Speaker 4
Sorry. Your first question, ING Direct USA. It's on track. Closing process could happen Q4. There is a possibility that it may slip in Q1 next year. However, so far, we are still working on the assumption it will happen this year. With respect to the cost savings, the number is $300 million. That's correct, starting in 2014 on a run rate basis. That is mainly as a result not only of the package that we have, but also the investments we are doing in IT. We're spending about $200 million in IT, and the benefits of that will also result in additional cost savings.
Speaker 0
Okay, thank you.
Speaker 5
Thank you. The next question is from Jan-Willem Vink from ABN AMRO. Please go ahead, sir.
Speaker 3
Good morning. A few questions. Could you give us the revaluation reserve on the remaining PIX portfolio? Secondly, could you give us what the fair value of your Alt-A portfolio as percentages of nominal value is? Thirdly, on the guarantee provision you mentioned on slide 25, is it correct that it's around $60 million, and if not, how much is it? Finally, on the state support, if the CFIE charge is still unclear in May 2012, what's the most likely scenario that you'll delay the repayment one year to avoid an 8.5% coupon, or would you prefer to repay as soon as the CFIE charge are certain?
Speaker 6
Yeah, I think Jan-Willem, on the revaluation reserve, we give the overall revaluation reserve of the bond portfolio, and that is a slight positive one. Overall, we know that, you know, government bonds overall are positive as well, but I don't want to go through the detail at the moment of giving the revaluation reserve of the PIIGS apart from what we have disclosed still so far.
Speaker 5
Yeah, in our published documents for both bank and insurance, we give a table which shows the reval reserve for Southern European countries split between bank and insurance. It's published minus €442 million on page 27 for the bank, and there's a similar table for insurance.
Speaker 1
Maybe the question on the Alt-A again, the fair value, you said, because we don't own a lot of Alt-A. What was it precisely that you wanted to know?
Speaker 3
The fair value is a % of the nominal value of the product.
Speaker 6
I think the fair values were approximately at the moment 61.3%.
Speaker 1
Thank you.
Speaker 6
On page 25, and I think an insurance one, it's actually split into two pieces. There's one piece that is a provision for separate account guarantees within the Netherlands, and then there is another piece, which is a decline in the technical margin as a result of, and this is a little complicated, but it's a decrease in the amortization of a gain that we had taken on a U.S. group reinsurance transfer. We're going to have to get back to you with the split of those two things later.
Speaker 1
Okay.
Speaker 4
Okay, Jan-Willem, on the state support, again, I can only repeat, we'll do it as quickly as we can, do it as mindful as we can with respect to the quarter one. I hope by that time, by the way, that we will have a very clear picture on what the requirements will be from the Dutch regulator. If they know what their plans are, I think they can quickly say who is getting what type of additional quarter one requirements. I think that will be known. We'll see what happens at that time. I don't want to speculate on what the alternatives could be at this moment.
Speaker 1
Okay, thank you very much.
Speaker 5
Thank you. Once again, if you would like to ask a question, please press the star followed by the one on your telephone. Gentlemen, there appear to be no further questions.
Speaker 4
Okay, I'd like to thank everyone for participating in the call. Thank you for your questions and your encouragement. I wish you all a very good day. Thanks again. Bye-bye.
Speaker 5
Thank you, sir. Thank you, ladies and gentlemen. This does conclude today's presentation. Thank you for participating. You may now disconnect.