ING GROEP (ING) Q4 2011 Earnings Call Transcript

Transcript

Speaker 4

Thank you for holding, ladies and gentlemen. Good morning. This is Carol, welcoming you to ING's Q4 2011 conference call. Before handing this conference call over to Jan Hommen, Chief Executive Officer of ING Groep N.V., 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-S filed with the 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 an offer to buy any securities. Good morning, Jan. Over to you, sir.

Speaker 3

Good morning. Thank you. Welcome, everyone, to the ING Groep N.V. 2011 Results Conference. The first quarter was a challenging period. We had very volatile markets. We saw a deepening of the crisis in Europe. In this uncertain environment, our first priorities were to protect our capital and to make sure that we furthered the rest of the organization. The impact of hedging and de-risking and further impairments on our Greek government bonds took a toll on the results of Q4. Nonetheless, we were able to end the year with an underlying profit of $3.675 billion, which was up 15% compared to 2010. I plan to talk you through the presentation. At the end, we have Mike Smith, our CEO of the US Annuity business here. He will give you some more detail on the assumption update that we pre-announced in December.

Afterwards, Patrick Flynn, our CFO, Wilfred Nagel, our CRO, and Matt Ryder, the CFO of the Insurance Eurasia business, are here together with us, and we are available to answer your questions. Let's begin with slide number two. The underlying profit is up 15% from a year earlier. Q4, we had a loss of $516 million, which reflected the lower results at the bank and the loss at insurance. As I said earlier, in the uncertain environment, we felt our first priority had to be to protect capital and to further the risk, reduce the risk of the organization. I think that's where we have given our highest priority to. The result of the bank in Q4, underlying pre-tax, came in at $793 million, and that included impairment charges of $300 million and $109 million losses related to de-risking our positions.

Insurance had a loss of $1.348 billion in Q4, mainly driven by the charge of $1.1 billion that we took in US closed block variable annuity business. We also had losses on hedges, hedges that were there to protect our capital position, in particular regulatory capital. Plus, we had impairments as well as some gains as a result of de-risking exercises. When I take it all together, then I see that operating results in insurance increased by 20.4% from a year earlier to $478 million, and it was also supported by a higher investment spread and very strong cost control. On slide number three, you see that the 2011 pre-tax result in the bank was down from last year, but it was entirely due to impairments on Greek government bonds and losses related to de-risking. By the way, 2010 included some gains on the sale of two Asian equity stakes.

Excluding these items, the full-year pre-tax result was slightly higher even than last year. The pre-tax result of insurance improved this year compared to last year, and that was despite the impairments we took on Greek government bonds and the charge of the U.S. closed block VA assumption changes. Operating results improved by 41.5%, showing the results of the plans that we initiated in 2009 to further improve our performance. As a group, we had an underlying net profit of $3.675 billion, and on a net basis, we even had a net basis of $5.700666 billion, which was double what it was last year. Slide number four, we have specifically put in to help you with your analysis of the numbers because there was a lot of noise in the numbers.

I think this makes it easier for you to compare, and you can see quickly here the actions that we have taken to de-risk the balance sheets, the priority we have given to protecting our capital with hedging, and the impairments we have taken on the Greek government bonds. There were a number of other one-offs, of course, notably the VA block that we were announcing. If you compare all this, then you see that the group underlying result before tax declined by 8% compared with the previous quarter, with the quarter in 2010. Slide number five, we took the charges of $199 million on impairments of Greek government bonds. We have written them now down by almost 80%. You can see that we further reduced our exposure to countries like Greece, Italy, Ireland, Portugal, and Spain by $1.8 billion in Q4.

Slide number six, capital ratio to quarter Q1 remains stable at 9.6%, even though we had an increase in risk-rated assets of about $10 billion as a result of the introduction of Basel II. Solvency I ratio for insurance and RBC ratio for the U.S. remains stable as well in Q4, despite the decline that we saw in interest rates and the market volatility that we witnessed in Q4. That shows that the capital protection hedges that we put on in order to protect our regulatory capital really were effective. On page seven, you see the summary of the progress we have made on the restructuring with the European Commission. We had hoped that we could have known today the result of the decision by the Fed on ING Direct US, but we understand it will be coming now on Monday, February 13. We completed the letter.

We have done a lot of work in legal separation and capital planning. We paid the state another $3 billion in 2011. We have made now the total payment, $9 billion, including $2 billion of interest and premium. We have done additional divestments in the bank, in our real estate investment management and car lease. As we announced in January, the market conditions for doing an IPO at this moment are not that supportive. We have decided to explore different options for our Asian business and our ING investment management businesses in Asia as well. We will continue to work on preparing for a standalone future of our European insurance and IM business, including possibly an IPO. We continue to prepare our U.S. insurance business for an IPO.

On slide number eight, the divestments that we announced last year together with the liability management transaction that we completed in December have also strengthened our capital position in the bank and helped reduce the leverage in the insurance organization. Our next priority is to reduce the leverage in the group and to repay the Dutch state. We want to repay the state as quickly as we can. We will certainly try to repay at least part of that in May of this year. That depends on market circumstances, of course, and we need to get approval by the DNB. I hope that that's possible. Ideally, we would like to complete the repayment of the state this year. With ongoing volatility in the Eurozone and with increasing requirements on regulatory capital, I think we need to be careful that we are not jumping further than we can.

We will take a cautious approach, as I've said earlier, to our capital position. We remain highly committed to repay them as quickly as possible. On page number nine, you see that the liability management action, along with the closing of the sale of our Latin American insurance business, has helped to reduce the debt at both the group and the insurance business. The core debt decreased by $0.5 billion. The majority of the proceeds of liability management have been realized within the group. The financial debt in ING Insurance declined, and we applied basically the proceeds of the sale of Latin America to do that, partially offset by some injections, predominantly in our Dutch insurance entities of capital, to offset some negative impacts of volatility. Now going to the bank, page 11, return in the bank came in at 10% return on equity.

It's a bit at the bottom of the range of our ambitions for 2015, but still within the range. There was, despite lower income, which was impacted by the impairments we took in Greece and the losses from de-risking our balance sheet positions. It also included, in 2010 for the comparison, $275 million of capital gains. When you eliminate that, you see that our numbers this quarter were basically aligned with last year. The decline in income has led us to increase our cost-income ratio to 59.6%. If you exclude the market impacts, it was down to 55.4%. Our ambition, to repeat it again, is to be at 53% to 50% by 2015. Loan losses were flat for the year at 52 basis points, but elevated compared to the normalized level of 40 to 45 basis points. On page 12, again, you see the comparison to make it easy.

You know what happened when you compare Q4 this year with last year with all the noise that was there. You see that the underlying decline in income was only 5.8% compared with last year. Page number 13, the main element here is the addition to loan loss provisions that increased to $530 million. It was mainly due to Asimia Midcorp portfolio in the Benelux. The underlying result for the bank came at $793 million for Q4. Page 14, the net interest margin increased by five basis points, basically as a result of financial markets. You may remember that in Q3, it was because of financial markets that it declined. It came back up by five basis points. We see a bit of pressure in the Benelux, in particular, on the savings margins. Also, in ING Direct, we see some pressure.

We also see that especially the commercial bank was able to make some adjustments in pricing. I must say, in general, our pricing discipline, I think, is pretty solid here. That reflects the net interest margin. Page 15, we collected a lot of funds in Q4, $8.1 billion, spread in $5.6 billion in retail and $2.6 billion in commercial bank. That is very, very positive. Net production in residential mortgages was $3.9 billion in Q4. The net production to Asimia Midcorp was about $0.8 billion or $800 million. I must say that demand for credits remains subdued in the economic uncertainty that we see in the markets in which we operate. Page 16, expenses were up 1.2% compared with a year ago, which is what we had indicated in our guidance, low single-digit increase. Again, here, I think our cost control is pretty solid.

Operating expenses declined 2.8% in Q4 compared with the same period a year ago. Compared with the third quarter, there was an increase of 2.4%, but that basically had to do with higher marketing expense and some goodwill impairments we took on some software. Cost-income ratio increased to 58.2% if I eliminate the market impacts. Also, I think as a result of the lower income that we noticed. Page 17, here you see that the weakening economic environment and with the crisis shifting to the real economy, it is becoming evident that we will have higher risk costs. In the quarter, there were $530 million. That is equal to 65 basis points on the average risk-rated assets. If we exclude ING Direct US, then the net addition would have been only 61 basis points in Q4.

We expect that going forward, they will be at an elevated level, basically at around these levels in the next quarters. Page 18, non-performing loans remain stable at 2%. We saw an increase in risk cost in the SME and mid-markets in the Benelux. We had some specific files in general lending and some in the Dutch mortgage portfolio, but very minor. You can see that the bank non-performing loans as a percentage were stable at 2%. Our real estate showed a relatively strong decline, but that was offset by slightly higher NPL ratios for SME, structured finance, and general lending. Our watch exposure was a little bit elevated compared to the third quarter, but not alarmingly so. Page 19, you see here that de-risking our balance sheet has really taken hold. We have reduced our investments to $114 billion at the end of the year.

That was $126 billion last year. You also see that the decline was mainly due to the reduction of ABS securities, some financial institution bonds, and we were selling the Southern European government bonds. Real estate in the bank declined to $2.9 billion, which used to be $4 billion at the end of last year. The quality of the balance sheet, page 20, has improved. You see that, which was part of the objectives that we had, and that was explained during the Investor Relations Day that we had in January. This will be a gradual evolution, but we saw a slight reduction in the overall balance sheet due to lower trading assets and the amount due to banks. The change of the banking external reporting, that's page 21. A few comments here. We have made some adjustments in our reporting lines.

Going forward, we will report separately our retail business, our commercial banking business, and the corporate line. We will add Germany as a country in our reporting because that is becoming more important in our strategic thinking. The commercial bank will be more aligned with the management structure that we have today. We will make, of course, historical numbers available before we announce the quarterly results. Now let's go to insurance. Good progress, I must say, towards the ambition 2013 objectives. Underlying result clearly impacted by the U.S. VA charge, but the operating trend is quite positive. Investment margin improved, and the administrative expenses were tightly controlled and came in at 39.8% in 2011. Return on equity is positive, but as you can see, we still have some work to do in order to get it to double-digit levels.

Operating result in page 24 of insurance improved year on year, rising by 20.4% to $478 million. Higher investment margin, lower interest cost in the corporate line, and lower expense. A decline from the third quarter mainly reflects that we had lower fees and premium-based revenues and modestly higher administrative expense. Looking at page 25, you see that the investment margin increased 15.5% to $440 million compared with Q4 last year. The rolling four-quarter average investment spread is now at 106. You may remember that the target was 105, so we have beaten the target. However, standalone, you see that there was a decline to 102 basis points, and that was the impact of de-risking measures that we took basically in the Benelux. We continue to expect that the investment spread will gradually decline in 2012.

On page 26, you see the fees and the revenues slightly down compared to the same quarter last year. You see that we had higher hedging and reserve costs in the U.S. closed block. The impact of the pension fund regulatory changes in Poland and Hungary came through. Technical margin was better by $35 million, and that mainly had to do with morbidity and mortality results in Japan and Korea. On page 27, expenses were 4.9% lower than a year earlier. Again here, very good cost control. Compared to the previous quarter, they were up by 2.5%, but that was mainly due to foreign exchange rates. The ratio came in at 41.8%. That's an improvement versus the first quarter of last year when it was 43.4%. We expect a little bit of upward pressure in 2012 because we are working on many, many different projects.

One of them is Solvency II. Some of the synergies of the separation may come through, but we will be very tight on our cost control, as you can expect from us. On slide 28 and some explanation of the results, starting with the operating result, you see the charges we have taken for the closed block, the losses on the hedges for protecting regulatory capital, gain from the de-risking, the change in provision for the guarantees on the separate accounts pension contract that was net of hedging. We had some non-operating items due to market volatility, all leaving us with an underlying pre-tax result of a negative $1.3 billion. With that, I would say let me hand it over to Mike Smith, who will have a few comments on the remaining slides. We will take it back, and we will deal with your questions. Mike.

Speaker 11

Thank you, Jan. Given the significant impact of the U.S. VA assumption changes in 4Q, we wanted to recap the actions that have been taken in the closed block. On slide 30, just a brief recap of what we did in the fourth quarter with the assumption change. We conducted a comprehensive review of the assumptions, LAPS, annuitization, utilization, withdrawal benefits, and mortality. That resulted in a charge of €1.1 billion, excuse me. The experience that we used to evaluate our assumptions included both pre- and post-crisis experience, and we've set our assumptions to be reflective of that experience. We think that this puts us in line and largely reflects the great volatility that we've seen over the last four or five years. Now, going forward, policyholder behavior is influenced by a lot of factors, and that makes it very difficult to predict, ultimately, whether the assumptions will prove accurate.

In any event, we think that the changes we've made indicate that ING has made a big step forward. While this charge was unfortunately necessary as part of our normal assumption review, I'd emphasize, and we'll talk on the next slide about all the actions we have taken to strengthen the closed block VA balance sheet. On slide 31, as you can see on this slide, after we stopped writing this business effective with the decision in 2009, we've set out and completed a number of measures over the past two years to address this block. We've increased the transparency by reporting this block as a separate line of business. We adopted fair value accounting for the guaranteed minimum withdrawal benefits, and we significantly increased the hedging for interest rates.

Most recently, as I just mentioned on the previous slide, we updated assumptions in the fourth quarter as another large step. Largely, as the result of these numerous measures, reserves have more than tripled since 2009, as you can see on the slide, and the DAC balance has been fully written down, overall significantly strengthening the U.S. VA closed block balance sheet. On slide 32, two things to talk about here on this slide. The first is a disclosure we've added to give you greater detail on the nature of the U.S. VA block. We've split out account value and IFRS reserves by benefit type, and we've provided the net amount at risk, €4.5 billion, for living benefits. The definition of NAR is shown in some detail on the bottom of the slide.

An easy way to think about this is that it's the present value of the income streams that would be paid to policyholders if they all immediately utilize their benefits, less the account values. You can think of the account values as the funds that would first be used to offset the payment of those benefits. In other words, it's a simplistic way to look at exposure. The second point is to give a little more detail on the goals of our hedging program. As you can see from the slide, interest rate hedging is aligned with the sensitivity of the base IFRS reserves. We don't hedge interest risk for GMIB or GMDB, as reserves are insensitive to interest rate movements. We do fully hedge on the GMWB withdrawal benefits and on some of the small block of other living benefits.

Equity market risk is hedged for all benefits, although the hedging is not aligned with base IFRS reserves for the IBs and death benefits. This is because IFRS reserves use SOP 03-1, and they are relatively insensitive to equity market changes. We focus our hedging instead on protecting against changes in the economic value of claims. We also place an overriding priority on the protection of regulatory capital, which does not use IFRS accounting rules. This means that on occasion, as is the case now, we will put additional hedge positions in place to ensure regulatory capital is protected from changes in markets. That priority on capital on slide 33 has an impact on our IFRS earning sensitivities. The table illustrates estimated earning sensitivities to market movements during the first quarter of 2012.

Equity hedge results will cause IFRS earnings volatility as the primary focus is, as I mentioned, on protecting capital. In addition, there may be charges to restore reserves to the 50% confidence level in down equity market scenarios or if interest rates rise. Reserve adequacy will improve in rising equity scenarios, but this will generally not result in an immediate earnings impact. Earnings sensitivities may change significantly in future quarters based on changes in equity markets and interest rate levels over time. This will occur if a significant reserve adequacy buffer is developed in future quarters as a result of increasing equity markets or decreasing interest rates. We will update these sensitivities as market conditions evolve. Now I'll turn it back to Jan for some closing comments.

Speaker 3

Thank you, Mike. Okay, let's wrap it up. Q4 was challenging. We saw very volatile markets, and we saw a deepening of the Southern Europe crisis. The environment being uncertain, our first priority was to protect our capital and to further reduce our risk positions. The impact of hedging, de-risking, and further impairments on Greek bonds took a toll on Q4 results. Nonetheless, we ended the year with an underlying profit of €3.675 billion, which was up 15% compared with 2010. Let's now deal with your questions.

Speaker 12

Thank you. If anybody 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. The first question comes from Mr. Tarik El Mejjad. Please go ahead, sir.

Speaker 8

Hi. Good morning. Thank you for the call. I have two questions. The first one is regarding the asset quality weakening. I mean, first of all, I would like to understand where is that coming from exactly? You mentioned SME's mid-corp, but that differs a lot from the guidance you gave recently in the Investor Day. If I understand well, mid-term, that means 2012, guidance more 60 bps loan loss charge, and goes to 40, 45 later on. Is that correct? When you say coming quarters, how many quarters of that? The second question, can you give us, please, an update on the disposals? You reiterated that it's ongoing, and you're still looking at different options. There were a lot of press reports about Asia, but we haven't heard anything about Europe, U.S. Can you update us, please, on that?

Finally, on Westland Interest as well, if there is any progress on that. Thank you very much.

Speaker 2

Wilfred, do you take the first one?

Speaker 11

Yes. On asset quality in the areas where we see weakness, I believe that what we're seeing is in line with what we said during the Investor Day, which is indeed that mid-corp and Asimia in the Benelux is one area. To give you a bit more flavor of where that's happening, in terms of product types, we see some weakness in leasing and real estate finance. If you were to look at sectors, the main ones where we see it are transportation and logistics and construction. On the other hand, we did see some declines in risk cost in structured finance and also, for example, in ING Direct in Germany. On your question with regard to where we see this going, it is very early in the year. It is a very uncertain, as Jan said earlier, economic environment.

It is very hard to give any concrete guidance at this point. I think the best we can say is we expect elevated levels for some time to come.

Speaker 12

Thank you, sir. Your next question comes in.

Speaker 3

Okay. No, no. Let me deal with question number two and question number three. Disposal program. Yes, you may not have heard much, but we made an announcement only a few weeks ago that we were going to deal with our Asian insurance and investment management businesses in a separate way. We were reviewing new options and different options. We are in the midst of doing that. We have formed teams to look at all the various things that need to be done when you do this. We will make sure that we can separate the business completely. That's a team working on. Not very difficult, I must say. That's relatively simple. In the meantime, we continue to work on redeveloping our plans for Europe. We're very busy with that one. That is a very important exercise in the next few months.

We continue to work on our IPO program for our U.S. business. In the meantime, we did sell ING Direct US. We're waiting for final approval by the Federal Reserve. We had expected that yesterday, but it will come in hopefully sometime next week. The plan is that they have a meeting on Monday, February 13. We have sold our Latin America business. We have sold car lease. We have sold real estate investment management. I think we have been quite busy in our disposal program. Lots of things going on there. Westland Interest, we are in discussion with the European Commission. We expect, we have discussions there. I cannot say what we can expect. They are ongoing. We have presented some alternatives, but it wasn't possible to sell it to a third party. There are discussions going on with the Commission, but I don't have a final answer yet.

Speaker 12

Your next question comes from Mr. Andrew John Milton Bester from Citigroup. Please go ahead.

Speaker 8

Good morning. I've got two questions. One's just a follow-up there on the previous. With regard to the loan loss provisions on the banking book, if I look at page 18, I mean, roughly speaking, about $70 million of the increase is due to general lending, another $70 million due to the SMEs, another $30 million due to the retail mortgages. With all of those, you've mentioned that the NPLs have also ticked up on that chart on the right-hand side. I'm just interested to know, is the increase in provisions purely a reflection of the increase in NPLs and your coverage ratio has remained stable, or has there been a big shift or adjustment in the coverage ratio on those NPLs as well, please? My second question is with regards to your outlook statement on the insurance investment margin.

Sure. The question was, how do you compare net amount of risk and reserves? I think it's a reasonable approach to look at the comparison of the two to try to get an estimate of additional exposure. However, there's a number of important caveats. First, the income benefit is a present value. They are not available as a lump sum to policyholders. Second, utilization is assumed to be instantaneous. There are reasons for both contractual and otherwise to think that that will actually be delayed. I think you can look at net amount at risk versus reserves as one measure. You do want to be careful in comparing us to other companies because the methodologies for income benefit net amount at risks are unclear, and they're certainly not specifically laid out in accounting literature.

You need to look carefully at what disclosure other companies make as to how they do calculate that.

Speaker 8

I mean, just to be clear, you're assuming the most conservative, you're assuming that when people can utilize, if they're in the money, they will, and they're in their assets. You're assuming that where contractually possible, it's going to be the bad outcome for you.

Speaker 7

Actually, that's a good question. Let me clarify. We're actually even a little bit more conservative than that. Even if a policyholder can't utilize it right now, we're assuming that they do. For instance, on the income benefit that we've sold over the early part of the last decade, there's a 10-year waiting period. There's a significant amount of those policyholders that are not eligible to elect at this time. However, we assume that they could right now today in order to give a sense of exposure. It's a simplifying assumption to give a reasonable view. Really, in terms of what the exposure is, the reserves are what we focus on as a management tool. Perhaps the last one on the investment margin.

Speaker 4

Okay. Thank you.

Speaker 12

Thank you. Next question comes from Francesca Tondi. Please state your company followed by your question.

Speaker 8

Good morning. Francesca Tondi from Morgan Stanley. Question on my side as well. On the financial markets, if you don't mind, can you explain a little bit the volatility we have seen in the net interest income, especially the recovery in the fourth quarter, and what we should consider that line being going forward? In terms of looking forward, do you see provisions with the understandable deterioration in economics in Europe then trending up further from the fourth quarter level? Do you think there's a point that actually they could be going up at the 70-bps level that you showed in 2009 or not as bad? If they do trend up, what other lines do you have you can work on to make sure that you at least keep in the bank with a profitability of 10%, which is the minimum target that you are giving out?

I think that will be quite useful to understand the moving parts. Lastly, any intention on using the ECB three-year LTRO at the end of February, even if it's just for some opportunistic cheap money to take in ALM, if you could update us on your thinking there. Thank you.

Speaker 11

In terms of financial markets and net interest income, yes, a big part, but not all of the increase was attributed to FM and that line. In financial markets, it is inherently volatile, and the client-driven structures there typically involve one leg, which has got net interest income in it, and another, which is a dealing line, which you see in other income. They do tend to net out to some extent. If you look at the two, it's much less volatile. It depends on the quarter whether there's a positive in net interest income or negative in other income or vice versa. The point is when you net the two, you're seeing that the revenue is held up fairly well in the fourth quarter, as I mentioned already, albeit you don't see the full impact on net interest income.

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 the 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 an offer to buy any securities. Good morning, Jan. Over to you, sir.

Speaker 7

Good morning. Thank you. Welcome everyone to the ING 2011 results conference. The fourth quarter was a challenging period. We had very volatile markets. We saw a deepening of the crisis in Europe. In this uncertain environment, our first priorities were to protect our capital and to make sure that we furthered the rest of the organization. The impact of hedging and de-risking and further impairments on our Greek government bonds took a toll on the results of Q4. Nonetheless, we were able to end the year with an underlying profit of €3.675 billion, which was up 15% compared to 2010. I plan to talk you through the presentation. At the end, we have Mike Smith, our CEO of the US Annuity business here. He will give you some more detail on the assumption update that we pre-announced in December.

Afterwards, Patrick Flynn, our CFO, Wilfred Nagel, our CRO, and Matt Ryder, the CFO of the Insurance Eurasia business, are here together with us, and we are available to answer your questions. Let's begin with slide number two. The underlying profits, up 15% from a year earlier. Q4, we had a loss of €516 million, which reflected the lower results at the bank and the loss at insurance. As I said earlier, in the uncertain environment, we felt our first priority had to be to protect capital and to reduce the risk of the organization. I think that's where we have given our highest priority. The result of the bank in Q4, underlying pre-tax, came in at €793 million. That included impairment charges of €300 million and €109 million losses related to de-risking our positions.

Insurance had a loss of €1.348 billion in Q4, mainly driven by the charge of €1.1 billion that we took in US closed block variable annuity business. We also had losses on hedges that were there to protect our capital position, in particular regulatory capital. Plus, we had impairments as well as some gains as a result of de-risking exercises. When I take it all together, then I see that operating results in insurance increased by 20.4% from a year earlier to €478 million. It was also supported by higher investment spreads and very strong cost control. On slide number three, you see that the 2011 pre-tax result in the bank was down from last year, but it was entirely due to impairments on Greek government bonds and losses related to de-risking. By the way, 2010 included some gains on the sale of two Asian equity stakes.

Excluding these items, the full-year pre-tax result was slightly higher even than last year. The pre-tax result of insurance improved this year compared to last year, and that was despite the impairments we took on Greek government bonds and the charge of the U.S. closed block VA assumption changes. Operating results improved by 41.5%, showing the results of the plans that we initiated in 2009 to further improve our performance. As a group, we had an underlying net profit of €3,675 million. On a net basis, we even had a net profit of €5,666 million, which was double what it was last year. Slide number four, we have specifically put in to help you with your analysis of the numbers because there was a lot of noise in the numbers. I think this makes it easier for you to compare.

You can see quickly here the actions that we have taken to de-risk the balance sheets, the priority we have given to protecting our capital with hedging, and the impairments we have taken on the Greek government bonds. There were a number of other one-offs, of course, notably the VA block that we were announcing. If you compare all this, then you see that the group underlying result before tax declined by 8% compared with the previous quarter, or with the quarter in 2010. Slide number five. We took charges of €199 million on impairments of Greek government bonds. We have written them now down by almost 80%. You can see that we further reduced our exposure to countries like Greece, Italy, Ireland, Portugal, and Spain by €1.8 billion in Q4. Slide number six.

Capital ratio, the core Tier 1, remains stable at 9.6%, even though we had an increase in risk-weighted assets of about €10 billion as a result of the introduction of Basel 2.5. Solvency I ratio for insurance and RBC ratio for the U.S. remains stable as well in Q4, despite the decline that we saw in interest rates and the market volatility that we witnessed in Q4. That shows that the capital protection hedges that we put on in order to protect our regulatory capital really were effective. On page seven, you see the summary of the progress we have made on the restructuring with the European Commission. We had hoped that we could have known today the result of the decision by the Fed on ING Direct US, but we understand it will be coming now on Monday, February 13. We completed the letter.

We have done a lot of work in legal separation and capital planning. We paid the state another €3 billion in 2011. We have made now the total payment €9 billion, including €2 billion of interest and premium. We have done additional divestments in the bank, in our real estate investment management and car lease. As we announced in January, the market conditions for doing an IPO at this moment are not that supportive. We have decided to explore different options for our Asian business and our ING Investment Management businesses in Asia as well. We will continue to work on preparing for a standalone future of our European insurance and IM business, including possibly an IPO. We continue to prepare our U.S. insurance business for an IPO. Slide number eight.

The divestments that we announced last year, together with the liability management transaction that we completed in December, have also strengthened our capital position in the bank and helped reduce the leverage in the insurance organization. Our next priority is to reduce the leverage in the group and to repay the Dutch state. We want to repay the state as quickly as we can, and we will certainly try to repay at least part of that in May of this year. That depends on market circumstances, of course, and we need to get approval by the DNB. I hope that that's possible. Ideally, we would like to complete the repayment of the state this year. With ongoing volatility in the eurozone and with increasing requirements on regulatory capital, I think we need to be careful that we are not jumping further than we can.

We will take a cautious approach, as I've said earlier, to our capital position. We remain highly committed to repay them as quickly as possible. On page number nine, you see that the liability management action, along with the closing of the sale of our Latin American insurance business, has helped to reduce the debt at both the group and the insurance business. Core debt decreased by €0.5 billion, and the majority of the proceeds of liability management have been realized within the group. The financial debt in ING Insurance declined, and we applied basically the proceeds of the sale of Latin America to do that, partially offset by some injections, predominantly in our Dutch insurance entities, of capital to offset some negative impacts of volatility. Now, going to the bank, page 11. Return in the bank came in at 10% return on equity.

It's a bit at the bottom of the range of our ambitions for 2015, but still within the range. That was despite lower income, which was impacted by the impairments we took in Greece and the losses from de-risking our balance sheet positions. It also included, in 2010 for the comparison, €275 million of capital gains. When you eliminate that, you see that our numbers this quarter were basically in line with last year. Decline in income has led us to increase our cost income ratio to 59.6%, but if you exclude the market impacts, it was down to 55.4%. Our ambition, to repeat it again, is to be at 53% to 50% by 2015. Loan losses were flat for the year at 52 basis points, but elevated compared to the normalized level of 40 to 45 basis points.

On page 12, again, you see the comparison to make it easy. You know what happened when you compare Q4 this year with last year with all the noise that was there. Then you see that the underlying decline in income was only 5.8% compared with last year. Page number 13. The main element here is the addition to loan loss provisions that increased to €530 million. It was mainly due to SME and mid-core portfolio in the Benelux. Underlying result for the bank came at €793 million for Q4. Page 14. The net interest margin increased by 5 basis points, basically as a result of financial markets. You may remember that in Q3, it was because of financial markets that it declined. It came back up by 5 basis points. We see a bit of pressure in the Benelux in particular on the savings margins.

Also in ING Direct, we see some pressure. We also see that especially the commercial bank was able to make some adjustments in pricing. I must say, in general, our pricing discipline, I think, is pretty solid here. That reflects the net interest margin. Page 15. We collected a lot of funds in Q4, €8.1 billion, spread in €5.6 billion in retail and €2.6 billion in commercial bank. That's very, very positive. Net production in residential mortgages was €3.9 billion in Q4. The net production to SME and mid-corporates was about €0.8 billion or €800 million. I must say that demand for credits remains subdued in the economic uncertainty that we see in the markets in which we operate. Page 16. Expenses were up 1.2% compared with a year ago, which is what we had indicated in our guidance, low single-digit increase.

Again, here, I think our cost control is pretty solid. Operating expenses declined 2.8% in Q4 compared with the same period a year ago. Compared with the third quarter, there was an increase of 2.4%, but that basically had to do with higher marketing expense and some goodwill impairments we took on some software. Cost income ratio increased to 58.2% if I eliminate the market impacts. Also, I think as a result of the lower income that we noticed. Page 17. Here you see that the weakening economic environment, with the crisis shifting to the real economy, is becoming evident that we will have higher risk costs. In the quarter, there were $530 million. That is equal to 65 basis points on the average risk-weighted assets. If we exclude ING Direct US, then the net addition would have been only 61 basis points in Q4.

We expect that going forward, they will be at an elevated level, basically at around these levels in the next quarters. Page 18. Non-performing loans remain stable at 2%. We saw an increase in risk costs in the SME and mid-markets in the Benelux. We had some specific files in general lending and some in the Dutch mortgage portfolio, but very minor. You can see that the bank non-performing loans as a percentage were stable at 2%. Our real estate showed a relatively strong decline, but that was offset by slightly higher NPL ratios for SME, structured finance, and general lending. Our watch exposure was a little bit elevated compared to the third quarter, but not alarmingly so. Page 19. You see here that de-risking our balance sheet has really taken hold. We have reduced our investments to $114 million at the end of the year.

That was $126 million last year. You also see that the decline was mainly due to the reduction of ABS securities, some financial institution bonds, and we were selling European government bonds. Real estate in the bank declined to $2.9 billion, which used to be $4 billion at the end of last year. The quality of the balance sheet, page 20, has improved. You see that, which was part of the objectives that we had, and that was explained during the investor relations day that we had in January. This will be a gradual evolution, but we saw a slight reduction in the overall balance sheet due to lower trading assets and the amount due to banks. The change of the banking external reporting, that's page 21. A few comments here. We have made some adjustments in our reporting lines.

Going forward, we will report separately our retail business, our commercial banking business, and the corporate line. We will add Germany as a country in our reporting because that is becoming more important in our strategic thinking. The commercial bank will be more aligned with the management structure that we have today. We will make, of course, historical numbers available before we announce the quarterly results. Now, let's go to insurance. Good progress, I must say, towards the ambition 2013 objectives. Underlying result clearly impacted by the U.S. VA charge, but the operating trend is quite positive. Investment margin improved, and the administrative expenses were tightly controlled and came in at 39.8% in 2011. Return on equity is positive, but as you can see, we still have some work to do in order to get it to double-digit levels.

Operating results in page 24 of insurance improved year on year, rising by 20.4% to €478 million. Higher investment margin, lower interest cost in the corporate line, and lower expense. A decline from the third quarter mainly reflects that we had lower fees and premium-based revenues and modestly higher administrative expense. Look at page 25. You see that the investment margin increased 15.5% to €440 million, compared with Q4 last year. The rolling four-quarter average investment spread is now at 106. You may remember that the target was 105, so we have beaten the target. However, standalone, you see that there was a decline to 102 basis points, and that was the impact of the de-risking measures that we took basically in the Benelux. We continue to expect that the investment spread will gradually decline in 2012.

On page 26, you see the fees and the revenues slightly down compared to the same quarter last year. You see that we had higher hedging and reserve costs in the U.S. closed block. The impact of the pension fund regulatory changes in Poland and Hungary came through. Technical margin was better by €35 million, and that mainly had to do with morbidity and mortality results in Japan and Korea. Page 27. Expenses were 4.9% lower than a year earlier. Again here, very good cost control. Compared to the previous quarter, they were up by 2.5%, but that was mainly due to foreign exchange rates. The ratio came in at 41.8%. That's an improvement from the first quarter of last year when it was 43.4%. We expect a little bit of upward pressure in 2012 because we are working on many, many different projects.

One of them is Solvency II, and some of the synergies of the separation may come through, but we will be very tight on our cost control, as you can expect from us. A slide, 28, and some explanation of the results. Starting with the operating results, you see the charges we have taken for the closed block, the losses on the hedges for protecting regulatory capital, gain from the de-risking, the change in provision for the guarantees on the separate account pension contract that was net of hedging. We had some non-operating items due to market volatility, all leaving us with an underlying pre-tax result of a negative €1.3 billion. With that, I would say let me hand it over to Mike Smith, who will have a few comments on the remaining slides. We will take it back and we will deal with your questions. Mike.

Speaker 9

Thank you, Jan. Given the significant impact of the U.S. VA assumption changes in 4Q, we wanted to recap the actions that have been taken in the closed block. On slide 30, just a brief recap of what we did in the fourth quarter with the assumption change. We conducted a comprehensive review of the assumptions: lapses, annuitization, utilization, withdrawal benefits, and mortality. That resulted in a charge of $1.1 billion, or €1 billion, excuse me. The experience that we used to evaluate our assumptions included both pre- and post-crisis experience, and we've set our assumptions to be reflective of that experience. We think that this puts us in line and largely reflects the great volatility that we've seen over the last four years, four or five years.

Now, going forward, policyholder behavior is influenced by a lot of factors, and that makes it very difficult to predict ultimately whether the assumptions will prove accurate. In any event, we think that the changes we've made indicate that ING has made a big step forward. While this charge was unfortunately necessary as part of our normal assumption review, I'd emphasize, and we'll talk on the next slide about all the actions we have taken to strengthen the closed block VA balance sheet. On slide 31, as you can see on this slide, after we stopped writing this business, effective with the decision in 2009, we've set out and completed a number of measures over the past two years to address this block. We've increased the transparency by reporting this block as a separate line of business.

We adopted fair value accounting for the guaranteed minimum withdrawal benefits, and we significantly increased the hedging for interest rates. Most recently, or as I just mentioned on the previous slide, we updated assumptions in the fourth quarter as another large step. Largely as the result of these numerous measures, reserves have more than tripled since 2009, as you can see on the slide, and the DAC balance has been fully written down, overall significantly strengthening the U.S. VA closed block balance sheet. On slide 32, two things to talk about here on this slide. The first is a disclosure we've added to give you greater detail on the nature of the U.S. VA block. We've split out account value and IFRS reserves by benefit type, and we've provided the net amount at risk, €4.5 billion, for living benefits.

The definition of NAR is shown in some detail on the bottom of the slide. An easy way to think about this is that it's the present value of the income streams that would be paid to policyholders if they all immediately utilize their benefits, less the account values. You can think of the account values as the funds that would first be used to offset the payment of those benefits. In other words, it's a simplistic way to look at exposure. The second point is to give a little more detail on the goals of our hedging program. As you can see from the slide, interest rate hedging is aligned with the sensitivity of the base IFRS reserves. We don't hedge interest risk for GMIB or GMDB, as reserves are insensitive to interest rate movements.

We do fully hedge on the GMWB withdrawal benefits and on some of the small block of other living benefits. Equity market risk is hedged for all benefits, although the hedging is not aligned with base IFRS reserves for the IBs and death benefits. This is because IFRS reserves use SOP 03-1, and they are relatively insensitive to equity market changes. We focus our hedging instead on protecting against changes in the economic value of claims. We also place an overriding priority on the protection of regulatory capital, which does not use IFRS accounting rules. This means that on occasion, and as is the case now, we will put additional hedge positions in place to ensure regulatory capital is protected from changes in markets. That priority on capital on slide 33 has an impact on our IFRS earnings sensitivities.

The table illustrates estimated earnings sensitivities to market movements during the first quarter of 2012. Equity hedge results will cause IFRS earnings volatility as the primary focus is, as I mentioned, on protecting capital. In addition, there will be charges, there may be charges to restore reserves to the 50% confidence level in down equity market scenarios or if interest rates rise. Reserve adequacy will improve in rising equity scenarios, but this will generally not result in an immediate earnings impact. Earnings sensitivities may change significantly in future quarters based on changes in equity markets and interest rate levels over time. This will occur if a significant reserve adequacy buffer is developed in future quarters as a result of increasing equity markets or decreasing interest rates. We will update these sensitivities as market conditions evolve. I'll turn it back to Jan for some closing comments.

Speaker 7

Thank you, Mike. Okay. Let's wrap it up. Q4 was challenging. We saw very volatile markets, and we saw a deepening of the sovereign crisis in Europe. The environment being uncertain, our first priority was to protect our capital and to further reduce our risk positions. The impact of hedging, de-risking, and further impairments on Greek bonds took a toll on Q4 results. Nonetheless, we ended the year with an underlying profit of €3.675 billion, which was up 15% compared with 2010. Let's now deal with your questions.

Speaker 6

Speaker 10

Hi, good morning. Thank you for the call. I have two questions. The first one is regarding the asset quality weakening. I mean, first of all, I would like to understand where is that coming from exactly? I mean, you mentioned SMEs, mid-corp, but that differs a lot from the guidance you gave recently in the investor day. If I understand well, midterm, that means 2012 guidance more 60 bps loan loss charge, and goes to 40, 45 later on. Is that correct? When you say coming quarters, how many quarters of that? My second question, can you give us, please, an update on the disposals? You reiterated that it's going, it's ongoing, and you're still looking at different options. There were lots of press reports about Asia, but we haven't heard anything about Europe, U.S. Can you update us, please, on that?

Finally, on Westland Interest as well, if there is any progress on that. Thank you very much.

Speaker 7

Wilfred, do you take the first one?

Speaker 9

Yes, on asset quality in the areas where we see weakness, I believe that what we're seeing is in line with what we said during the investor day, which is indeed that mid-corp and SME in the Benelux is one area. To give you a bit more flavor of where that's happening, in terms of product types, we see some weakness in leasing and real estate finance. If you were to look at sectors, the main ones where we see it are transportation and logistics and construction. On the other hand, we did see some declines in risk costs in structured finance and also, for example, in ING Direct in Germany. On your question with regard to where we see this going, it's very early in the year. It's a very uncertain, as Jan said earlier, economic environment. It's very hard to give any concrete guidance at this point.

I think the best we can say is we expect elevated levels for some time to come.

Speaker 6

Thank you, sir. Your next question comes in.

Speaker 7

We continue to work on our IPO program for our U.S. business. In the meantime, we did sell ING Direct US. We're waiting for final approval by the Federal Reserve. We had expected that yesterday, but hopefully sometime next week. The plan is that they have a meeting on Monday, February 13, 2012. We have sold our Latin America business. We have sold car lease. We have sold real estate investment management. I think we have been quite busy in our disposal program. Lots of things going on there. Westland Interest, we are in discussion with the European Commission. We have discussions there. I cannot say what we can expect. They are ongoing. We have presented some alternatives, but it wasn't possible to sell it to a third party. There are discussions going on with the Commission, but I don't have a final answer yet.

Speaker 6

Your next question comes from Mr. Andrew John Milton Bester from Citigroup. Please go ahead.

Speaker 10

Good morning. I've got two questions. One's just a follow-up on the previous, with regards to the loan loss provisions on the banking book. If I look at page 18, roughly speaking, about $70 million of the increase is due to general lending, another $70 million due to the SMEs, another $30 million due to the retail mortgages. With all of those, you've mentioned that the NPLs have also ticked up on that chart on the right-hand side. Just interested to know, is the increase in provisions purely a reflection of the increase in NPLs, and your coverage ratio has remained stable, or has there been a big shift or adjustment in the coverage ratio on those NPLs as well, please? My second question is with regards to your outlook statement on the insurance investment margin.

You've said that your rolling average is at 106 bps, but you expect that to continue to decline as you continue to de-risk. Given that your target's 105 bps, should we actually be thinking about a lower target going forward, or is it a case of you see that margin perhaps dipping below 100 bps, but then improving again in the long term?

Speaker 9

Yes. On the loan loss provisioning, there is a bit of seasonality there, but generally speaking, indeed, the provisioning follows the general NPL experience. In terms of coverage ratios, the provisions as a % of the total defaulted outstandings have gone up a little bit. There is a bit of improvement in coverage as well.

Speaker 3

With respect to the investment margin, you'll see later on as you go into the detail, we are telegraphing a reduction in the investment spread of something between 10% and 15% for the Benelux going forward. That's on a general account asset balance of about €64 billion, so we'll see that come in over the course of 2012. As far as setting a new ambition level for all of insurance, I think as we go on, we'll be setting separate ambition levels for the U.S. and the various businesses. A big consequence of the de-risking, particularly in the Benelux, is going to be reflected in the investment spread in 2012. That's in the detail in the quarterly report.

Speaker 7

Speaker 7

Okay. The first question, we have no covenants, and we plan at this moment to use the proceeds to reduce the double leverage of the group. We cannot use full because once you sell the asset in Asia, you also lose some diversification benefits. You will have to also use some of that to reduce the leverage in the holding company and insurance. The main part of that will be used for reducing the double leverage of the group. Mike, you do the second one.

Speaker 9

Sure. The question was, you know, how do you compare net amount of risk and reserves? I think it's a reasonable approach to use, to look at the comparison of the two to try to get an estimate of additional exposure. However, there's a number of important caveats. First, the income benefit is a present value. They are not available as a lump sum to policyholders. Second, utilization is assumed to be instantaneous. There are reasons for, you know, both contractual and otherwise to think that that will actually be delayed. I think you can look at net amount at risk versus reserves as one measure. I think you do want to be careful in comparing us to other companies, because the methodologies for income benefit net amount at risks are, you know, unclear, and they're certainly not specifically laid out in accounting literature.

That's B Capital. I'm Tony Silverman here. I just had two questions. One on the hedging, I think in the insurance division, where I think it's a $300 million or so loss. It's been explained as to do with, if you like, the difference between regulatory and IFRS. I was just, so it's an IFRS charge. I was just wondering if there's any sense in which that loss might be earned back in subsequent years, if things just remain as they are, or is it in fact an economic loss as well? The second question was just on the financial markets part of the bank, which was sort of important to the progression of net interest margin on slide 14. The underlying profits of that division have gone up very substantially.

I was wondering if you could talk a bit more about what is in that division, and whether, you know, what sort of performance you might expect from it going forward. Thank you.

Speaker 8

Yeah, I take the first one. The hedging number that you mentioned, $300 million, it's about, I think it's about $348 million is what we had disclosed. Just to give you an example, $182 million of that is sitting in the Benelux that is hedging an equity portfolio. What that represented is a true loss on the hedges, but what we see is an increase of the value of the securities that we're hedging through equity. You can't really say that it is an economic loss, but there is a positive offset within equity. That's already kind of back, if you will, within the solvency. For the other bits, yes, depending on what interest rates do, those can come back. Similarly, reductions in credit spreads, those can come back as well.

Speaker 12

If things remain just as they are, eventually the equity would be disposed and you would get that back. The rest you wouldn't. Is that a fair comment?

Speaker 8

Speaker 12

Okay. What's in the financial markets division now?

Speaker 2

Yeah, the financial markets results improved significantly in Q4, $280 million increase. What you're seeing there is, if you recall, last quarter it was down significantly. That was impacted by a big chunk of impairments on Greece. They're $150 million lower. We also commented last quarter on reserve adjustments, CVA, which we also talked about at the Investor Day. They were a little bit lower. What you're seeing is lower provisioning requirements. What happens then is the underlying client revenues are coming through and flowing into the bottom line. The client's business had a pretty good quarter, even given its fourth quarter seasonally low. You're seeing lower impairments and the underlying customer revenues flowing into the bottom line.

Speaker 12

Okay. Okay.

Speaker 11

Thank you. Next question comes from Francesca Tondi. Please state your company, followed by your question.

Speaker 10

Good morning. Francesca Tondi from Morgan Stanley. Question on my side as well. On the financial markets, if you don't mind, can you explain a little bit the volatility we have seen in the net interest income, especially the recovery in the fourth quarter, and what we should consider that line being going forward? In terms of looking forward, do you see then provisions with the understandable deterioration economics in Europe then trending up further from the fourth quarter level? Do you think there's a point that actually they could be going up at the 70 bps level that you showed in 2009 or not as bad? If they do trend up, what other lines do you have you can work on to make sure that you at least keep in the bank with a profitability of 10%, which is the minimum target that you are giving out?

I think that will be quite useful to understand the moving parts. Lastly, any intention on using the ECB three years and LTRO at the end of February, even if it's just for some opportunistic cheap money to take in ALM, if you could update us on your thinking there. Thank you.

Speaker 2

In terms of financial markets, the net interest income, yes, a big part, but not all of the increase was attributed to FM and that line. In financial markets, it is inherently volatile and the client-driven structures there typically involve one leg, which has got net interest income in it, and another, which is a dealing line, which you see in other income. They do tend to net out to some extent. If you look at the two, it's much less volatile. It depends on the quarter whether there's a positive in net interest income and a negative in other income or vice versa. The point is when you net the two, you're seeing that the revenue is held up fairly well in the fourth quarter, as I mentioned already, albeit you don't see the full impact on net interest income.

Okay, I really appreciate you being on the call. Thanks for your questions. I hope that we answered your questions. If you still need anything else, you know how to find Dorothy and her staff. In the meantime, I would say have a good day. Again, thanks for being on the call.

Speaker 11

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-S filed with the 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 an offer to buy any securities. Good morning, Jan. Over to you, sir.

Speaker 4

Good morning. Thank you. Welcome everyone to the ING 2011 Results Conference. The fourth quarter was a challenging period. We had very volatile markets. We saw a deepening of the crisis in Europe. In this uncertain environment, our first priorities were to protect our capital and to make sure that we furthered the rest of the organization. The impact of hedging and de-risking and further impairments on our Greek government bonds took a toll on the results of Q4. Nonetheless, we were able to end the year with an underlying profit of €3.675 billion, which was up 15% compared to 2010. I plan to talk you through the presentation. At the end, we have Mike Smith, our CEO of the US Annuity business here. He will give you some more detail on the assumption update that we pre-announced in December.

Afterwards, Patrick Flynn, our CFO, Wilfred Nagel, our CRO, and Matt Ryder, the CFO of the Insurance Eurasia business, are here together with us, and we are available to answer your questions. Let's begin with slide number two. The underlying profit is up 15% from a year earlier. Q4, we had a loss of €516 million, which reflected the lower results at the bank and the loss at insurance. As I said earlier, in the uncertain environment, we felt our first priority had to be to protect capital and to further the risk, reduce the risk of the organization. I think that's where we have given our highest priority too. The result of the bank in Q4, underlying pre-tax, came in at €793 million, and that included impairment charges of €300 million and €109 million losses related to de-risking our positions.

Insurance had a loss of €1.348 billion in Q4, mainly driven by the charge of €1.1 billion that we took in US closed block variable annuity business. We also had losses on hedges, hedges that were there to protect our capital position, in particular regulatory capital. We had impairments as well as some gains as a result of de-risking exercises. When I take it all together, then I see that operating results in insurance increased by 20.4% from a year earlier to €478 million. It was also supported by higher investment spreads and very strong cost control. On slide number three, you see that the 2011 pre-tax result in the bank was down from last year, but it was entirely due to impairments on Greek government bonds and losses related to de-risking. By the way, 2010 included some gains on the sale of two Asian equity stakes.

Excluding these items, the full year pre-tax result was slightly higher even than last year. The pre-tax result of insurance improved this year compared to last year, and that was despite the impairments we took on Greek government bonds and the charge of the U.S. closed block VA assumption changes. Operating results improved by 41.5%, showing the results of the plans that we initiated in 2009 to further improve our performance. As a group, we had an underlying net profit of €3,675 million. On a net basis, we even had a net profit of €5,666 million, which was double what it was last year. Slide number four, we have specifically put in to help you with your analysis of the numbers because there was a lot of noise in the numbers.

I think this makes it easier for you to compare, and you can see quickly here the actions that we have taken to de-risk the balance sheets, the priority we have given to protecting our capital with hedging, and the impairments we have taken on the Greek government bonds. There were a number of other one-offs, of course, notably the VA block that we were announcing. If you compare all this, then you see that the group underlying result before tax declined by 8% compared with the previous quarter, obviously the quarter in 2010. Slide number five, we took the charges of €199 million on impairments of Greek government bonds. We have written them now down by almost 80%. You can see that we further reduced our exposure to countries like Greece, Italy, Ireland, Portugal, and Spain by €1.8 billion in Q4.

Slide number six, capital ratio, the core Tier 1 remains stable at 9.6%, even though we had an increase in risk-weighted assets of about €10 billion as a result of the introduction of Basel 2.5. Solvency I ratio for insurance and IBC ratio for the U.S. remains stable as well in Q4, despite the decline that we saw in interest rates and the market volatility that we witnessed in Q4. That shows that the capital protection hedges that we put on in order to protect our regulatory capital really were effective. On page seven, you see the summary of the progress we have made on the restructuring with the European Commission. We had hoped that we could have known today the result of the decision by the Fed on ING Direct US, but we understand it will be coming now on Monday, February 13. We completed the letter.

Slide number eight, the divestments that we announced last year together with the liability management transaction that we completed in December have also strengthened our capital position in the bank and helped reduce the leverage in the insurance organization. Our next priority is to reduce the leverage in the group and to repay the Dutch state. We want to repay the state as quickly as we can. We will certainly try to repay at least part of that in May of this year. That depends on market circumstances, of course, and we need to get approval by the DNB. I hope that that's possible. Ideally, we like to complete the repayment of the state this year. With ongoing volatility in the Eurozone and with increasing requirements on regulatory capital, I think we need to be careful that we are not jumping further than we can.

We will take a cautious approach, as I've said earlier, to our capital position. We remain highly committed to repay them as quickly as possible. On page number nine, you see that the liability management action, along with the closing of the sale of our Latin American insurance business, has helped to reduce the debt at both the group and the insurance business. The core debt decreased by €0.5 billion. The majority of the proceeds of liability management have been realized within the group. The financial debt in ING Insurance declined, and we applied basically the proceeds of the sale of Latin America to do that, partially offset by some injections, predominantly in our Dutch insurance entities of capital, to offset some negative impacts of volatility. Now going to the bank, page 11, return in the bank came in at 10% return on equity.

It's a bit at the bottom of the range of our ambitions for 2015, but still within the range. There was, despite lower income, which was impacted by the impairments we took in Greece and the losses from de-risking our balance sheet positions. It also included, in 2010 for the comparison, €275 million of capital gains. When you eliminate that, you see that our numbers this quarter were basically in line with last year. A decline in income has led us to increase our cost-income ratio to 59.6%, but if you exclude the market impacts, it was down to 55.4%. Our ambition, to repeat it again, is to be at 53% to 50% by 2015. Loan losses were flat for the year at 52 basis points, but elevated compared to the normalized level of 40 to 45 basis points.

On page 12, again, you see the comparison to make it easy. You know what happened when you compare Q4 this year with last year, with all the noise that was there. You see that the underlying decline in income was only 5.8% compared with last year. Page number 13, the main element here is the addition to loan loss provisions that increased to €530 million. It was mainly due to a mid-corporate portfolio in the Benelux. The underlying result for the bank came at €793 million for Q4. Page 14, the net interest margin increased by five basis points, basically as a result of financial markets. You may remember that in Q3, it was because of financial markets that it had declined. It came back up by five basis points. We see a bit of pressure in the Benelux, in particular, on the savings margins.

Also, in ING Direct, we see some pressure. We also see that especially the commercial bank was able to make some adjustments in pricing. I must say, in general, our pricing discipline is pretty solid here. That reflects the net interest margin. Page 15, we collected a lot of funds in Q4, €8.1 billion, spread in €5.6 billion in retail and €2.6 billion in commercial bank. That is very, very positive. Net production in residential mortgages was €3.9 billion in Q4. The net production to SME and mid-corporates was about €0.8 billion or €800 million. I must say that demand for credits remains subdued in the economic uncertainty that we see in the markets in which we operate. Page 16, expenses were up 1.2% compared with a year ago, which is what we had indicated in our guidance, low single-digit increase.

Again, here, I think our cost control is pretty solid. Operating expenses declined 2.8% in Q4 compared with the same period a year ago. Compared with the third quarter, there was an increase of 2.4%, but that basically had to do with higher marketing expense and some goodwill impairments we took on some software. Cost-income rates should increase to 58.2% if I eliminate the market impacts. Also, I think as a result of the lower income that we noticed. Page 17, here you see that the weakening economic environment and with the crisis shifting to the real economy, it is becoming evident that we will have higher risk costs. In the quarter, there were €530 million, that is equal to 65 basis points on the average risk-weighted assets. If we exclude ING Direct US, then the net addition would have been only 61 basis points in Q4.

We expect that going forward, they will be at an elevated level, basically at around these levels in the next quarters. Page 18, non-performing loans remain stable at 2%. We saw an increase in risk cost in the SME and mid-markets in the Benelux. We had some specific files in general lending and some in the Dutch mortgage portfolio, but very minor. You can see that the bank non-performing loans as a percentage were stable at 2%. Our real estate showed a relative strong decline, but that was offset by slightly higher NPL ratios for SME, structured finance, and general lending. Our watch exposure was a little bit elevated compared to the third quarter, but not alarmingly so. Page 19, you see here that de-risking our balance sheet has really taken hold. We have reduced our investments to €114 million at the end of the year.

That was €126 million last year. You also see that the decline was mainly due to the reduction of ABS securities, some financial institution bonds, and we were selling the Southern European government bonds. Real estate in the bank declined to €2.9 billion, which used to be €4 billion at the end of last year. The quality of the balance sheet, page 20, has improved. You see that, which was part of the objectives that we had, and that was explained during the Investor Relations Day that we had in January. This will be a gradual evolution, but we saw a slight reduction in the overall balance sheet due to lower trading assets and the amount due to banks. The change of the banking external reporting, that's page 21. A few comments here. We have made some adjustments in our reporting lines.

Operating result in page 24 of insurance improved year on year, rising by 20.4% to €478 million. Higher investment margin, lower interest cost in the corporate line, and lower expense. A decline from the third quarter mainly reflects that we had lower fees and premium-based revenues and modestly higher administrative expense. Looking at page 25, you see that the investment margin increased 15.5% to €440 million compared with Q4 last year. The rolling four-quarter average investment spread is now at 106. You may remember that the target was 105, so we have beaten the target. However, standalone, you see that there was a decline to 102 basis points, and that was the impact of the de-risking measures that we took basically in the Benelux. We continue to expect that the investment spread will gradually decline in 2012.

On page 26, you see the fees and the revenues slightly down compared to the same quarter last year. You see that we had higher hedging and reserve costs in the U.S. closed block. The impact of the pension fund regulatory changes in Poland and Hungary came through. Technical margin was better by €35 million, and that mainly had to do with morbidity and mortality results in Japan and Korea. On page 27, expenses were 4.9% lower than a year earlier. Again here, very good cost control. Compared to the previous quarter, they were up by 2.5%, but it was mainly due to foreign exchange rates. The ratio came in at 41.8%. That's an improvement for the fourth quarter of last year when it was 43.4%. We expect a little bit of upward pressure in 2012 because we are working on many, many different projects.

One of them is Solvency II. Some of the synergies of the separation may come through, but we will be very tight on our cost control, as you can expect from us. On slide 28 and some explanation of the results. Starting with the operating results, you see the charges we have taken for the closed block, the losses on the hedges for protecting regulatory capital, gain from the de-risking, the change in provision for the guarantees on the separate accounts, pension contract that was net of hedging. We had some non-operating items due to market volatility, all leaving us with an underlying pre-tax result of a negative $1.3 billion. With that, I would say let me hand it over to Mike Smith, who will have a few comments on the remaining slides, and then we will take it back and we will deal with your questions. Mike.

Speaker 13

Thank you, Jan. Given the significant impact of the U.S. VA assumption changes in Q4, we wanted to recap the actions that have been taken in the closed block. On slide 30, just a brief recap of what we did in the fourth quarter with the assumption change. We conducted a comprehensive review of the assumptions, LAPS, annuitization, utilization, withdrawal benefits, and mortality. That resulted in a charge of €1.1 billion, excuse me. The experience that we used to evaluate our assumptions included both pre- and post-crisis experience, and we've set our assumptions to be reflective of that experience. We think that this puts us in line and largely reflects the great volatility that we've seen over the last four or five years. Going forward, policyholder behavior is influenced by a lot of factors, and that makes it very difficult to predict, ultimately, whether the assumptions will prove accurate.

Most recently, as I just mentioned on the previous slide, we updated assumptions in the fourth quarter as another large step. Largely, as the result of these numerous measures, reserves have more than tripled since 2009, as you can see on the slide, and the DAC balance has been fully written down, overall significantly strengthening the U.S. VA closed block balance sheet. On slide 32, two things to talk about here on this slide. The first is a disclosure we've added to give you greater detail on the nature of the U.S. VA block. We've split out account value and IFRS reserves by benefit type, and we've provided the net amount at risk, €4.5 billion for living benefits. The definition of NAR is shown in some detail on the bottom of the slide.

Equity market risk is hedged for all benefits, although the hedging is not aligned with base IFRS reserves for the IBs and death benefits. This is because IFRS reserves use SOP 03-1, and they are relatively insensitive to equity market changes. We focus our hedging instead on protecting against changes in the economic value of claims. We also place an overriding priority on the protection of regulatory capital, which does not use IFRS accounting rules. This means that on occasion, and as is the case now, we will put additional hedge positions in place to ensure regulatory capital is protected from changes in markets. That priority on capital on slide 33 has an impact on our IFRS earning sensitivities. The table illustrates estimated earning sensitivities to market movements during the first quarter of 2012.

Equity hedge results will cause IFRS earnings volatility as the primary focus is, as I mentioned, on protecting capital. In addition, there will be charges, there may be charges to restore reserves to the 50% confidence level in down equity market scenarios or if interest rates rise. Reserve adequacy will improve in rising equity scenarios, but this will generally not result in an immediate earnings impact. Earnings sensitivities may change significantly in future quarters based on changes in equity markets and interest rate levels over time. This will occur if a significant reserve adequacy buffer is developed in future quarters as a result of increasing equity markets or decreasing interest rates. We will update these sensitivities as market conditions evolve. Now I'll turn it back to Jan for some closing comments.

Speaker 4

Thank you, Mike. Okay, so let's wrap it up. Q4 was challenging. We saw very volatile markets, and we saw a deepening of the sovereign crisis in Europe. The environment being uncertain, our first priority was to protect our capital and to further reduce our risk positions. The impact of hedging, de-risking, and further impairments on Greek bonds took a toll on Q4 results. Nonetheless, we ended the year with an underlying profit of €3.675 billion, which was up 15% compared with 2010. Let's now deal with your questions.

Thank you. Your next question comes from Mr. Andrew Coombes from Citi. Please go ahead.

Speaker 12

Good morning. I've got two questions. One's just a follow-up there on the previous. With regards to the loan loss provisions on the banking book, if I look at page 18, I mean, roughly speaking, about $70 million of the increase is due to general lending, another $70 million due to the SMEs, another $30 million due to the retail mortgages. With all of those, you've mentioned that the NPLs have also ticked up on that chart on the right-hand side. I'm just interested to know, is the increase in provisions purely a reflection of the increase in NPLs and your coverage ratio has remained stable, or has there been a big shift or adjustment in the coverage ratio on those NPLs as well, please? My second question is with regards to your outlook statement on the insurance investment margin.

Speaker 9

Yes, on the loan loss provisioning, there is a bit of seasonality there, but generally speaking, indeed, the provisioning follows the general NPL experience. In terms of coverage ratios, the provisions as a % of the total defaulted outstandings have gone up a little bit. There's a bit of improvement in coverage as well.

Speaker 8

Speaker 4

Speaker 12

Great. Thank you.

Speaker 11

Thank you. Next question comes from Farquhar Murray. Please state your company followed by your question.

Speaker 12

Hi, morning gentlemen. It's Farquhar from Bernstein Autonomous LLP here. Just two questions, if I may. Firstly, with regards to the European Commission court case, I just wondered whether you had any indications on when we might see a decision there. Secondly, you have very helpfully given us some extra disclosure on the closed block variable annuity book, including the SOP 03-01 reserve on the GMIB book of $1 billion. Could I just ask what the interest rate assumptions are behind that $1 billion reserve? Thanks.

Speaker 4

Okay, the first one is pretty easy. We have been notified that the courts will decide and make its decision known on March 2. We know that for a fact. We don't know the outcome yet. Mike, you want to give the second question?

Speaker 8

Speaker 4

Okay, thanks very much.

Speaker 11

Thank you. Your next question comes from Farquhar Murray. Please state your company followed by your question.

Speaker 12

Good morning. This is Farouk Hanif from Morgan Stanley. I've got some questions on the insurance business, if that's okay. Also, one request. The request is, I mean, you've been very helpful in giving us sensitivities on equity markets for the VA business. I was wondering if you'd be able to provide interest rate sensitivities for VAs, but also the group, and also equities for the group, because obviously a lot of your hedging loss this quarter was from the Benelux as well. I would just be interested if we could get that information as a request. On my questions, firstly, if you sell, if you dispose of bits of the insurance business now. Say

Speaker 4

In Asia, for example, do you have to use the proceeds of that to delever at the insurance level, or can you actually take the proceeds and pay them up to the holding? Are there any covenants that stop you? What would your intentions be anyway in terms of where you would use leverage? That's question number one. Question number two is, when you look at slide 32 where you show living benefits IFS reserve against living benefits net amount at risk, is it useful to actually compare those two numbers? For example, if you added another $1.5 billion to your reserving, would that be the same as saying that you're assuming that everybody basically almost immediately takes up their option? Could you please comment on that, please? Just on the investment margin, going back to that, you've given the guidance on Benelux.

Is that what we should be assuming for the time being? Should we be just saying, "Look, there's a 10 to 15 bps impact, and that's sort of it"? What's kind of the more overall guidance that you would give on that? Thank you very much.

Speaker 3

Speaker 11

Sure. The question was, you know, how do you compare net amount at risk and reserves? I think it's a reasonable approach to use to look at the comparison of the two to try to get an estimate of additional exposure. However, there's a number of important caveats. First, the income benefit is a present value. They are not available as a lump sum to policyholders. Second, utilization is assumed to be instantaneous. There are reasons for both contractual and otherwise to think that that will actually be delayed. I think you can look at net amount at risk versus reserves as one measure. I think you do want to be careful in comparing us to other companies because the methodologies for income benefit net amount at risks are unclear, and they're certainly not specifically laid out in accounting literature.

You need to look carefully at what disclosure other companies make as to how they do calculate that.

Speaker 4

Just to be clear, you're assuming the most conservative, you're assuming that when people can utilize, if there is no money, they will, and there are two answers. You're assuming that where contractually possible, it's going to be the bad outcome for you.

Speaker 11

Speaker 6

Good morning. Jan-Willem Wijnhoven, ABN AMRO. A few questions on real estate finance. Could you comment on what you've done there to reduce the NPLs? Secondly, you still have a $1.7 or $1.8 billion development portfolio. Could you indicate how much of that is offices? Finally, could you give some sort of an expected run rate for the loan losses and the other impairments there as you also are looking to sell your seed capital, which apparently comes at a loss? Those were my questions.

Yes, exactly.

Speaker 10

Maybe I can rephrase it. Is there any chance that Westland Utrecht Bank will be merged with insurance activities in Europe, in particular in Benelux, and sold as a bancassurance model?

Yes. Good morning. Francois Bossin from Exane BNP Paribas. Three questions, please. The first one really is on your target ROE of 10% in insurance. Can you give maybe the underlying assumptions in terms of interest rates, long-term interest rates, and annual return in equity markets underlying those assumptions? I mean, those targets of 10%. The second question relates to ING Direct. Just wanted to understand the €18 million impact in Q4. What does it relate to? In your new reporting, basically, I don't see any ING Direct business. Does it mean that it will be included in other banking business? Lastly, on the European Commission appeal on 2nd March, do you expect a decision on all topics, or is it limited to a number of items? Thank you.

I mean, the terms of those would be the same as you'd apply in the market. It's not a capital support. This would be freely entered into. These are normal commercial terms.

Speaker 4

Okay. Okay.

Speaker 8

Thank you. Next question comes from Francesca Tondi. Please state your company followed by your question.

Speaker 1

Good morning. Francesca Tondi from Morgan Stanley. Question on my side as well. On the financial markets, if you don't mind, can you explain a little bit the volatility we have seen in the net interest income, and especially the year recovery in the fourth quarter, and what we should consider that line being going forward? In terms of looking forward, do you see then provisions with the understandable deterioration economics in Europe then trending up further from the fourth quarter level? Do you think there's a point that actually they could be going up at the 70-bps level that you showed in 2009 or not as bad? If they do trend up, what other lines do you have you can work on to make sure that you at least keep in the bank with a profitability of 10%, which is the minimum target that you are giving out?

Speaker 12

In terms of financial markets and net interest income, yes, the big part, but not all of the increase was attributable to FM in that line. In financial markets, it is inherently volatile, and the client-driven structures there typically involve one leg, which has got net interest income in it, and another, which is a dealing line, which you see in other income. They do tend to net out to some extent. If you look at the two, it's much less volatile. It depends on the quarter whether there's a positive in net interest income or negative in other income or vice versa. The point is when you net the two, you're seeing that the revenue is held up fairly well in the fourth quarter, as I mentioned already, albeit you don't see the full impact in net interest income.

We have further opportunities to reduce our costs. We have programs to become more efficient. We are investing in technology to make sure that our systems that we need to have are state-of-the-art and at the same time that they are highly efficient and that we can deal with a low-cost provider of services to our customer base. Further opportunities in purchasing. We have not had a corporate purchasing function. We have installed that just recently. Opportunities like $300 million, $400 million are possible. IT gives us further opportunities. I think on the efficiency side, we're very careful on repricing and then, of course, on making sure that we stay in the markets where we can add value and where we have a strong market position and a strong brand.

That altogether should give us the ability to, even in an environment where you have more capital, you can still make a return of about 10% to 13% on your capital here.

Speaker 1

Perfect. Thank you. Any comment on the LTRO for the next step?

Speaker 3

Speaker 1

That's fine. Thank you.

Okay. I really appreciate you being on the call. Thanks for your questions. I hope that we answered your questions. If you still need anything else, you know how to find Dorothy and her staff. In the meantime, I would say have a good day. Again, thanks for being on the call.

Speaker 8

That concludes the ING Analyst Call Q4 Results 2011. Thank you for participating. You may now disconnect.

ING Groep - Earnings Call - Q4 2011

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