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ING Group (NYSE:ING)

Q3 2007 Earnings Call

November 7, 2007, 3:00 AM ET

Executives

Michel Tilmant - Chairman and CEO

John C.R. Hele - CFO

Dick Harryvan - Member of the Executive Board

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

Tom McInerney - Member of the Executive Board

Bernard Kuiper - IR Manager

Analysts

Nick Holmes - Lehman Brothers

Farooq Hanif - Morgan Stanley

Zenon Voyiatzis - Merrill Lynch

Marc Thiele - UBS

Chris Hitchings - Keefe, Bruyette & Woods

Mark Cathcart - Deutsche Bank

William Elderkin - Citigroup

Ton Gietman - Petercam

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the ING Third Quarter 2007 Results Conference Call on the 7th of November 2007. Throughout today's recorded presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]. I would now like to hand the conference over to Mr. Thomas Werheim [ph]. Please go ahead sir.

Unidentified Company Representative

Good morning, this is Thomas Werheim welcoming you to ING's third quarter 2007 conference call.

Before handing this conference call over to Michel Tilmant, Chief Executive Officer of ING Group and John Hele, Chief Financial Officer, let me first say that any forward-looking statements in today's comments are subject to a number of variables including interest rates, foreign exchange rates, inflation rates, movements in securities markets including equity markets and the underlying economic conditions and changes. The realization of forward-looking statements could be materially altered by unexpected movements in any or all of these and other variables.

Good morning, Michel and John. Michel, over to you

Michel Tilmant - Chairman and Chief Executive Officer

Yes, good morning to all of you and thank you for joining us this morning. Let me first say that the key issue this morning is that our results demonstrates a structural resilience in a very challenging environment as our risk management or risk policies and strong balance sheet has protected us against the market turmoil.

Second, our commercial performance has remained robust as witnessed both in the insurance by our value of new business and sales growth or volume growth in retail balances in banking.

We recognize that we have a more challenging environment and you can here and there that specific businesses and product areas were affected by the environment, and we'll come back on that. Nevertheless, we have continued investment to support growth and optimize our competitive position. We have made some organic growth initiative. We have made some acquisitions, but also we have made investment in restructuration.

And finally, we continue our capital reallocation and it's important as we are selling some business that we feel are not in the core of our strategy or don't provide sufficient growth to reinvest in growth markets.

And very quickly the summary on the financial highlights, and underlining this profit, we are up 19.2% to about €1.95 billion supported by investment gains. Underlying net profit includes a €455 million net gain on the sell of part of ING stake in ABN Amro. Profit declined 8.6% excluding ABN Amro gain.

Let me analyze a few areas. First of all, reevaluations on real estate and private equity investment in Insurance Europe particularly in the Dutch market are less favorable this quarter than in recent quarter. This is not surprising, but has an immediate effect to the numbers. Second, we have lower strategic trading results in wholesale bank and slower deal flow in leveraged finance, which is not surprising. And third, we have seen outflows and loss on ING Direct UK and we will come back on that issue later.

Net profits are up 46.8% to €2.3 billion after divestment again and restructuring expenses and EPS is up 48% to €1.08. Our commercial performance remained robust. That's very important to us. We have experienced strong life sales with value of new business up 47% to about €300 million. We have seen strong performance in Central Europe, particularly in Romania where we have acquired more than 600,000 clients and we have experienced strong growth in all markets including U.S., VAs and GIC sales. Asia Pacific was also very strong everywhere. We have also experienced solid volume growth in mortgages, terms deposits and current accounts. Average outstanding retail balance in the Benelux are up 7.5% year-to-year and ING Direct had a record mortgage quarter and total retail balance are up €6 billion. We have also added 660,000 clients at ING Direct overall, which is a very good performance.

As I mentioned at the start, our risk policies and our risk management and our strong balance sheet protected ING from the direct impact of market turmoil. We have been rather conservative in the past, some say prudent in the past, to the point that we got some criticism to be too conservative. But no, I think this policy is paying off because we have first of all an amount of assets in those assets we require question, which is very limited. We have seen negligible impact from the liquidity crisis on the long-term funding cost. We have experienced no material impairments on the €3.1 billion portfolio of investment backed by subprime assets and we have seen no material revaluation of debt securities held in third quarter as credit spreads increased and we were able to also confirm that between the end of the quarter and October 31st we have experienced the same thing. But of course market turbulence has made business enrolments more challenging.

Let me also say a few words on capital reallocation. You know that we have divested our Belgium brokerage business with very nice capital gains. We divested that business because we felt that it was not strategic anymore in relation to the more strategic sale of insurance product by our branch network in Belgium. And at the same time we have seen two IPOs, one of Bank of Beijing. As you know, we brought Bank of Beijing about 2.5 years ago 19.9% for about €165 million. The value of our participation now is about 2 billion, which shows that redirecting capital to the developing market is a good thing for shareholders. And by the way, this reevaluation is on our balance sheet in the equity account and didn't go to P&L. And second, we have also in agreement with the management of Sul America in Brazil. We have accepted the public offerings, the IPO of Sul America in Brazil, and this also has shown a quite nice value of our investments in Brazil.

Now if you look on page 5, you see the evolution of quarterly profit. I think after a absolute record quarter in the second quarter, the third quarter is slower. But given the circumstances and compare to our competitors and peers, I think we should be pleased with this performance.

I think you have some, on page 6, you have some insurance and highlights in Europe, and our earnings have been impacted by lower evaluation of real estate, private equity and lower dividend income. As you remember, we had a specific one-time dividend income the last quarter last year, the third quarter last year. So this is of course an immediate impact on our profits which are down about 29%. We are also to say that what explained the difference is also the prior year expense, which were reduced by a provision release of 79 million at the time. But against that backdrop, we have sharp increase in value of new business plus 40% driven by strong sales in Central Europe and partly in Romania. In the United States... in Americas, sorry, underlying profits are down 6.2% but flat excluding currency effects. Again, there insignificant earnings impact from subprime in the U.S. Profit of Canada are down €27 million quarter-to-quarter, but we experienced also a strong increase in value of new business plus 70%, and particularly in the wealth accumulation business in the United States.

Turning to Asia/Pacific, underlying profit are down 10% but excluding the volatility of hedge result in Japan plus 16%. So good result, continuing good result. And our single-premium sales doubled and value of new business is up 43%. Assets under management are up 3.8% to about €99.4 billion. The corporate line includes €473 million higher capital gains on equity, driven by ABN Amro.

And you can see on page 7, and I will not comment that in detail, but you can see on page 7 a very strong performance of our value of new business. This was an area of concern a few quarters ago and we have told you that we were going to... first of all that we were optimistic of reversing this and that we were taking some steps. And I think that you can see that this has materialized in a pretty nice value of new business growth this quarter.

On the banking side, on the wholesale side, we have seen a profit decline as market turbulences impacted financial market and structured finance. But growth continued in real estate leasing and general lending and loan loss provisions are still very low, although in a positive of €17 million provision against a €9 million release in prior year.

Coming to retail, I would like to say that retail performed extremely well this quarter. We can see a solid performance underpinned by strong growth in mortgage, term deposits and current accounts which offset the margin pressure from the flat yield curves. Risk weighted assets are up 12.9% from a year ago and income increased 5.4%, the cost/income ratio improving to 64.2%. ING Direct, profit declined mainly due to challenge in the UK market. Excluding the UK and growth investments, profit rose 7.8%, which I think is an exceptional performance given the yield curve and the rate environment. Further, we have continued to invest to expand our product offering and will detail that later and the retail balances are up €6 billion excluding currency effects to more than €300 billion.

On page 9, you can see that we continue to manage our capital in line with our strategy and you can see here that most of the activities that we have entertained in that area since the beginning of the year are really spot on or strategic priorities. Let me say also that we announced yesterday the acquisition of ShareBuilder in the U.S., which is going to expand ING Direct capabilities in the distribution of securities into the retail market.

If we go to organic growth investments, I think you can see that we have done a number of them in the last periods, and I would like to insist also that we are working at enlarging of bank distribution of asset management and wealth accumulation products and we therefore signed a bank insurance agreement with Piraeus Bank in Greece and a very important agreement with Public Bank Malaysia recently, and I think this is certainly going to enhance our distribution going forward.

I think that not only to invest capital in acquisitions, but we also are managing capital by investing to make our business more efficient. And this year we had three major initiatives: One, to combine Postbank and IBN; second, we have announced today the transformation of our retail banking in Belgium where we are going to concentrate more on internal distribution and restructure our branch network; and finally wholesale banking, we are making some restructuring to reduce costs and improve our product development capacity.

Now on page 12, just a few words on the combination of Postbank and ING Bank. It is on track, it is on track. We have received a very, very rapidly, to say, a positive advice from our Works Council, which I think is a good sign that the entire company believes this is the right thing to do. The second thing is we have new top management structure in place since 1st of November. We are transferring the new management to a combined head office on January 1st and we have already €16 million in provision and operating costs taken in the third quarter '07. In Belgium, essentially, we are going to restructure our branch network and in short, in the past, Internet was supporting the branch distribution and now the branch distribution is going to support Internet. So we are into basically transform a number of our branch to make them proximity branch and concentrate most of the services in a limited number of branch. So this should reduce our cost and this should make our distribution more efficient and at the same time we invest in our internal channels where we see the most traction from the customer's standpoint. And we expect from this a positive contribution as quickly as 2009, and as usual we are relatively] conservative in those numbers, particularly on the additional revenues. But this is at least the minimum financial impact this side.

On the wholesale banking, we have taken initiatives to reduce about 300 staff in the next few months and at the sale time to upgrade our IT systems in financial markets and product support and product development. So we believe that we booked a provision of €45 million in the third quarter. We expect another provision of €55 million to come in the fourth quarter, but we expect a €30 million annual cost savings and about €100 million additional revenue benefits by 2009.

I think that also we are announcing today that we are transferring the mid-corporate client business from wholesale to retail bank in the Netherlands and in Europe in general. You have to remind in most banks in the world, mid-corporate clients and SMIs are part of the retail franchise. We moved it to wholesale banking in 2004 for three reasons. First of all, we wanted to manage that business differently, we want to manage for value and not for volumes. We wanted to upgrade the product skills of the sales people and we want to improve the cross sell. So we have the focused approach from wholesale banking in 2004. However, I think that as are moving to reorganize our retail network and not only the branch network but also Internet distribution. And as we are focusing more on wealth management opportunities for the owners of those businesses, we felt that it was the right time to retransfer this business to a retail network. It's about 12% of the wholesale banking profit and we think why the timing now is because as we are reorganizing our network, we feel that we better just do it right to make sure that we align our networks to not only to retail but also to SMI business segments. The target for the transfer is the 1st of January 2008.

So if had to summarize, first of all, we have shown structural resilience in the challenging environment. Our risk policies and management have helped us protect ourselves against the market turmoil. Commercial performance remained robust. Yes, challenging environment in some business and we continue despite the fact we invest to support growth and optimize the competitive position. We have no issue on liquidity, we have no issue of capital and therefore it is probably an optimal time for us to look for opportunities and to reallocate our capital in the right place. John?

John C.R. Hele - Chief Financial Officer

Good morning everyone and I will just give you some insight into a few key areas of our numbers, if you look at the growth in net profit, there is a few things I would like to highlight. The first is our tax rate, which was 15% in the third quarter and you that number is circled on the page. We had given guidance that we think this year our tax rate for the year will be between 15% to 20%. And you can see it's 15% here in Q3 with the upcoming gains we expect in the fourth quarter from our equity stakes. We expect to be at the lower end of that range for the full year of 15% to 20%.

You can see the gains and losses on divestments, that's both the Belgium, our life brokerage business and RegioBank 444. We also have special items after tax. We have taken some of these provisions that Michel has outlined.

If you look at our share buyback program to early this week on Monday, we completed 43% of the program, that's... almost €2.2 billion. We also reached an agreement to buy back our preference shares from ABN and those have a voting of 5 times the preferred share and that will be done in two tranches for a total of €105 million.

We give for you down here the details of what we have in the treasury and the free float of our ordinary share is now about €2.1 billion. I would like to highlight that at the end of September, we still had 9 million of the warrants outstanding. Those expire in January 2008, so expect those to be exercised and those are exercised 2 for 1. So you'd want to put those into your projections.

On the insurance side in Insurance Europe, Michel's already spoken about some of the earnings. I think what's important to note here is we had a 15% increase in the life results of Central Europe and with a sharp increase in the value of new business driven by the Central Europe area. In particular, we had the Romania pension fund was off to a very strong start, 360,000 clients in just the first two weeks, and we are hoping to set a goal of reaching 1 million clients there. And we had a change in expenses year-on-year higher investments in greenfields.

In Insurance Americas, you can see strong VNB growth continues. We had life premium was up 6% if you take out currencies. Life profits was up 11% excluding currency, particularly driven by Latin America but also by the U.S. business. The non-life results countered this a bit, down 24% as we've seen a swing in the P&C cycle in both Canada and Mexico. I think the real story here is a strong increase in the value of new business. The variable annuity sales are up 30% and individual life is positively contributing in terms of value of new business now, an area that we have been working on now that we have the reinsurance structures in place.

In Insurance Asia/Pacific, we had the volatility of the Japan SPVA business, I'll show you in just a minute. But if you take that volatility out quarter-on-quarter, the underlying profit was up 16%, new sales are up 37%, the value of new business up 43%. These are super headline numbers and the investments we are making, we see in our operating expenses are paying off in terms of sales.

Turning to the next page, and just to explain what's going on in Japan, the long-term profitability of this business is driven by gathering assets. We now have almost €12 billion of assets under management in that SPVA business from nothing a few years ago. And we expect that this business will earn about 30 basis points on average. However, the accounting for this is volatile due to the volatility of the hedging as well an accounting match between the hedges and how the liabilities are shown. So on the bottom of this slide, we show you how third quarter a year ago we had a very high gain from the accounting side. And this quarter was a €9 million negative compared to the long-term profitability. So each quarter you have to kind of average this out over time. These contracts by the way are selling extremely well and are 10 years in nature. So you can see how this averages out over time.

On the corporate line in life insurance, the basic items have been the same like interest on core debt and the hybrids. You can see the gains have driven through from the equities here and we have the swing every quarter of the fair value changes of derivatives from accounting. That's 1 point [ph] negative. But this will... we have some core elements that are always the same in the corporate line and then the equity gains and fair value changes change from quarter-to-quarter.

We have been asked for sometime to have more insight in assets under management and how these change from quarter-to-quarter. We have given for some time in our U.S. statistical supplement quite detailed flow, and it shows the gain. We have now expanded this for our major product lines around the world in Insurance Europe, Insurance Americas and Insurance Asia/Pacific. This is detailed in our Group statistical supplement and you'll be able to follow this along for the quarter.

To show you the highlights on page 28, we had solid net flows in Insurance Europe. We did have the sale of course with Belgium that had a negative impact on the assets under management in Europe. But nevertheless, the net flows are positive along with positive market appreciation. You can see the impact in of course Insurance Americas and Asia/Pacific of both the positive net flows as well as the market appreciation. So we'll be communicating this to you as the core focus for us because we are focusing on wealth management, and wealth management is driven by assets under management.

In banking, wholesale banking, our income has been resilient despite the market turmoil in a couple of lines of business, both our strategic trading in financial markets and our leveraged finance business within our structured finance business. But we had many positives in wholesale banking. We have 20% on our general lending businesses and strong growth at real estate and leasing. So these offset the income as well as the earnings, and we're taking initiatives to invest in IT and restructure the business to have continued growth.

Retail banking grew 12%. Solid performance across the board with business volumes that help offset the margin pressure from flatter yield curves and increasing competition. We had strong growth in mortgages, term deposits, and in particular not only we had growth in the Netherlands but Poland doubled year-on-year and the rest of the world, private banking in Asia in particular.

ING Direct reflects continued investment to support our growth, and Dick Harryvan will talk about this in a minute. The underlying profit did decline year-on-year, affected mainly from the challenges in our UK market. But excluding the UK and the growth initiatives of almost €100 million we spent in the quarter, profit was up 8%, which is a good showing in a flat yield curve. We continue to invest for growth in this business and expand our product line. That will help in the future. The corporate line banking has a swing in the quarter from the prior quarter, mainly due to derivatives that do not qualify for hedge accounting.

In terms of the interest margin in the quarter, we saw a flattening of the yield curve and saw 4 basis points mainly driven by retail banking. But we compensated for a good group of this by having larger volumes.

I am going to turn over now to Dick Harryvan to speak about ING Direct.

Dick Harryvan - Member of the Executive Board

Good morning. ING Direct continues to be a growth engine for the Group, setting out to fulfill our mission to become the world's most preferred consumer bank. As of today, we are active in 9 countries, representing together with Japan, which we hope to have on line shortly, 70% of the world economy.

We focus on four simple products: savings, mortgages, investment products and payment accounts. And we envision creating this most preferred bank by continuing to create value for our customers by making banking simple. The new expanded product categories are developing very well. Mortgages are now 46% of our total retail balances and we see improved stickiness and better cross-sell potential for our payment account customers, which today total already 670,000.

The profitability by product line, which I know is of interest to many, is at this point 83% is still contributed by savings; the remainder by mortgages and consumer lending. We are still investing substantially, as you are aware, in these other product lines. But as they gain scale and efficiencies, the profitability will become evident there as well.

As John already mentioned, excluding the UK and these growth investments of €100 million in the third quarter, profit was up 7.8% in a very challenging environment.

If we flip to page 37, you see the total retail client balances. Here also the increasing diversification improved €6 billion in production in the third quarter. If I reduce currency exchange effects, €4 billion of that eliminated. In total, we grew €7.2 billion in mortgages. We had a net outflow of €1.4 billion in savings, primarily due to the UK and we see on the right hand side the distribution, Germany will be our largest country with one-third of our business in the UK... sorry the USA, right behind that and that is growing very well, expanding geographically.

On page 38, I would like to stand still with you for a few minutes on the UK to really shows that this country and the behavior of consumers, our track clients there are different from the other countries. This graph here, if you bear with me for a minute, on the vertical scale, you see the basis points, the pricing of our savings products in basis points relative to the central bank rate. And here you see that in the UK, we were not more aggressive compared to our other countries with... at the start being just slightly 40 basis points higher than the Bank of England. Then the size of the bar indicates for every euro or pound spent on marketing, the amount of savings funds that came in. So in the UK for every pound, we spent £325 of savings came in. This compares to, for instance, Australia, where for every dollar spent AUS$116 came in. So in the UK, for every dollar or euro of marketing spent, we got in three to five times as much savings balances. We also achieved, if you look at the horizontal scale, more than a 3% market share within three years. So in effect what happened is that we grew extremely fast, but we attracted a large segment of highly rate sensitive customers.

On page 39, you see that our average balance in the UK at the outset was three times as high as the other ING Direct countries. And that situation has corrected itself more recently. As of September, the average balance is €25,000. You see that the balances in the other countries have been... the average balance has been a very stable number, still averaging €14,000 at the end of September. €25,000, if we compare that for instance to France where we have €22,000 or Italy which almost €20,000. It's a, let's say, unreasonable number.

We continue to add clients, 32,000 in the UK, net growth in clients. Actually in the third quarter we had 22,000 new clients joining ING Direct. So we still have many people attracted to our straightforward simple way of doing business.

Page 40, in viewing let's say the developments and the savings of our operation in the UK, we set about in the third quarter to take a number of measures. So we are investing further in the UK because we are positive on the outlook. We increased pricing in September and the 1st of October in two steps, increased 5% to 5.4% on base savings account interest rates. Marketing has been intensified, direct marketing, above the line marketing to retain balances and to win back clients and also our new clients. In the meantime, we have also shortened our duration, which will allow us to track more closely to the Bank of England as it moves in the future, which is a key ingredient for success in the UK.

We are very encouraged by the first results of these actions. In the course of October in the second half, the outflows have stopped and as mentioned, we are confident going forward. We expect in the fourth quarter that the profit and loss will get a little bit worse and then gradually into the course of 2008 we expect it to wind down.

So now on the UK. If we look at the overall development of ING Direct then in terms of creating value in this difficult yield curve environment, this was the fourth quarter of record mortgage production, €7.2 billion. And payment accounts which are now actively marketed in Spain, USA and Germany grew by 163,000 accounts in the third quarter, a very encouraging result. So we now have 670,000 payment account customers. And the behavior there in terms of increasing share of wallet and retention is much better than or quite a bit better than the customers without a payment account. We expect to launch in three more countries in the coming year.

On geographic expansion, in the U.S. we launched in Seattle and Houston the third quarter and preparations for launch in Japan are nearing completion. The autonomous growth in London augmented by acquisitions at the third quarter, NetBank in the U.S. where we acquired 104,000 customers at $1.4 billion of savings, then a mortgage portfolio in Germany of 4.3 billion that we bought from Hypo Real Estate including the clients which we will be able to cross-sell to in the future. And these investments together represent €99 million in the third quarter compared to €65 million in the third quarter of last year, so a €34 million increase. As you see, €72 million in mortgages, the majority at this point, €20 million in payment and €7 million in savings, which is the Japan start-up investment.

Thank you.

Michel Tilmant - Chairman and Chief Executive Officer

Okay. Now we turn to Koos. Koos Timmermans was in charge of our risk management.

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

Good morning. Before going through the numbers, just a few words there. We realized the issues in the subprime market as well as with the securitizations. But just to understand the context of our numbers, our insurance company is more a selective buyer subprime mortgages rather than a manufacturer. Also, if you look at our bank, we are a selective buyer of CDOs or securitization products, but we are not a large manufacturer. And that means the portfolio which we have in our books is not something like a market average, and that is also why our numbers look relatively good. If we then go to the numbers here, first on the P&L side, yes, we have €7 million of impairment in our total €83 billion ABS portfolio. We have a small markdown in our leveraged finance pipeline and we have in trading books, we have some P&L items. We had that in both subprime and CDOs in the order of €25 million. And I'll zoom in on the fair values changes later during the presentation.

Also important point is our liquidity part is doing well and we are going to unwind two conduits. And last point is I don't -- we don't think that our funding costs, our balance sheet repair job is anything serial in terms of funding future costs.

If we go through the ABS portfolio, first thing is it's an €83 billion portfolio and there is 41% [indiscernible] agencies. So let's leave that part aside. We have a 32% Alt-A portfolio, we have our subprime portfolio 3.6% and then we have a small CDO/CLO portfolio.

Looking at in the total, our fixed income portfolio overall including ABS and everything else, the fair value has not changed between 2Q and 3Q. So interest... credit spread widening was offset by interest rate declines. If we look at the fixed income impairment in total, so for the whole portfolio including ABS is everything else, €21 million, and again €7 million on the ABS portfolio.

If we then move on towards our subprime mortgages, we are still owning the €3.1 billion portfolio of subprime mortgages with a high quality in terms of ratings. What we have seen is a revaluation from minus €58 million to minus €122 million. So, in total, you see something in the order of a 4% decline in value of that portfolio not going through P&L. We are intending to hold that portfolio. Also, if you look at impairments, €2 million in the third quarter and if we look at the recent route of changes in ratings which happen often in the October month in Moody's and S&P, that affected some securities; it's in the order of €20 million between €20 million and €30 million of euros, what was covered subprime mortgages downgraded.

If we move to our Alt-A portfolio, our total Alt-A portfolio is at €26.9 billion, and again, the largest part of that portfolio is in ING Direct and we had a revaluation there of both Direct and the insurance company of €460 million negative revaluation at the end of Q3 and no impairments, no trading losses and no downgrades, also not after Q3. In order to understand the ING Direct Alt-A portfolio, one thing to say, when we constructed ING Direct in the U.S., we always said we don't want to run a €50 billion balance sheet with only government sponsored mortgage-backed securities. We said we don't want to have large wholesale credit. So find us a well diversified granular portfolio which is not only comprising of any major in there [ph], and this is the context in which we started constructing this Alt-A portfolio and it also means we were looking for high quality. And high quality is what we have in that portfolio. If you look at it, we are sitting on the AAA tranches and we have cover in terms of excess spread, in terms of over collateralization and in terms of the different tranches. And where does that show up? It shows up in the fact that our credit support in that portfolio is 11.6%. And what does that mean? It means that if we look at the total pipeline of the underlying mortgage tool, so that is the RevPar in the graph, that pipeline basically shows where we have delinquencies, late payments. If we take the expected loss out of that, that it something like 0.8%. And that bar starts only to affect us at the time when it hits the 11.6%. So we still have a way to go. If you look at the actual losses right now, it's 0.02% in the portfolio. So that is our Alt-A portfolio.

Quality of the Alt-A portfolio is also reflected I both the high FICO scores as well as the low loan-to-values in the portfolio. If you look at the definition, it's important to understand what we took as a definition is very conservative. We said like if it meets any of the criteria, so loan-to-value 70% to 100% or FICO 647-730 or a low documentation bigger than 50%, then it qualifies. You could also say like if it meets all three criteria, it is Alt-A. So, but the difference between the two is it's either €24 billion or it's something in order of below €10 billion. So we are talking about €9 billion or north, something like it. We have taken a conservative criterion, but it's a high quality portfolio what we are owning there. 99.8% is AAA rated and we do a structural monitoring of that portfolio. So the difference between our credit enhancement and the expected losses is something which is monitored on a monthly basis.

If we move over to the next part, our leveraged finance portfolio. We are still owning our hold book at €5.2 billion of sponsor driven leveraged finance, which is very granular. If we look at our pipeline, the €2.4 billion, not a lot of changes in pipeline. What we did do is we did a mark down, and let me explain that.

Those transactions in the pipeline which were offered to clients but not accepted or funded yet, at the time when the client accepted it, we had a chance to restate the cost price. And that is this €29 million. So the pipeline itself stays at cost. We are still owning the fees ourselves. So they are not realized, but this €29 million is a form of mark down which followed IFRS rules.

If I look at the CDOs and the CLO portfolio, it's a €1.1 billion portfolio where we have €5 million of impairment and a negative revaluation of €45 million in total. There again the majority of the CLOs is rated AAA and AA.

If we then move to the part on the liquidity side, we are owning... we have a balance sheet which basically comprises of customer deposits both on the retail, the corporate side. We have an active repo business because we have a lot of liquid security. We do interbank public debt. We have quite a few funding sources. So not reliant on one source of funding which helped us. Also, I think what is noteworthy is if I look at credit swap spreads, it shows that the market is not expecting from us to be a major issue or in terms of medium term now over the next years or alternatively, it shows it has confidence in our balance sheet structure.

What we did is we announced that we are going to unwind two of our conduits, the conduit Simba and the conduit Mane. We purposely... we set enough for regulatory capital arbitrage and as you all know, we are moving very close towards the 1st of January 2008 when we move to our Basel II models. So we don't need these conduits any more for regulatory purposes and as an alternative source of funding, ABCP for us is not so much interesting because our own commercial paper is trading a lot better. That's the reason why we are winding down the two programs. The only program which we would leave open is our client -- client sponsored conduit Mont Blanc.

If we then go to the key messages for the third quarter, basically negative P&L impact small, so the €7 million impairment, the €29 million and something in our trading books. I can also tell you that if you look at the revaluations of those pressurized asset classes over the month of October, we don't see major material changes there either. That's all for now.

Michel Tilmant - Chairman and Chief Executive Officer

Thank you very much, Koos. Well let me conclude by saying a few things. First of all, we are looking for creating value for shareholders, and we are actively managing our business portfolio. We are not afraid to sell the company if we see that it doesn't fit or strategic long-term growth or because it's not growing fast enough. So we are not afraid with that as evidenced by selling our insurance brokerage business in Belgium.

At the same time, we have a very focused strategy around customer needs, retail customer needs and we have made various acquisitions in the last few months which are focused on retail customer needs in banking, in wealth management and also, as we want to do, is to move this capital to our growth markets. So we actively manage our business portfolios.

Second, we are concentrating also on organic growth. We have made new investment in banking, in pensions in Central and Eastern Europe, think about Romania. We have made new investment in bank distribution agreements in Asia, most recently in Malaysia. We have launched new VA products in Japan, the U.S. and Europe, think about Spain and Hungary. We are in the process of launching ING Direct in Japan. We have shown strong commercial traction in our insurance business worldwide with strong value of new business. And we have seen also volume growth in banking, not only in ING Direct but also in more traditional business. So organic growth is on.

Third, we are permanently looking at how can we more efficiently allocate our capital and manage our capital base. Not only did we really provide capital to growth market, but as you have seen, we are continuing our share buyback program. We are nearly halfway and this shows that we have a capacity to do that, and we are optimistic we will do that under the planning that we have announced.

Fourth, we are investing in business efficiency programs. We are... we don't stand still; we want to improve our mature business and traditional business positioning, think about the Postbank and ING Bank in the Netherlands, think about our retail banking transformation in Belgium and think about the initiatives taken this quarter by our wholesale banking. We continue our disciplined risk management. At the risk of being criticized in the past, and I hope now that most of you will recognize that when we claim that we were restructuring our risk management and you will say well we'll see the next crisis, but here we are in the next crisis. So I think you see what you see. And I hope this will convince you now that the steps we have taken in the last few years were are not only words but real action. And we know as our [ph] such risk management function, it's integrated in our business and you are seeing that we have negligible impairments, revaluations and increase in funding cost. And finally we are investing in brand awareness. We have completed our first year of Formula One sponsorship. We see strong results in terms of brand visibility, and this was the first ever global branding campaign and we intend to do it again next year.

So conclusion is, first of all, we are operating very well in a very difficult environment on the risk side. We have commercial traction with commercial performance remains very strong. Yes, there is a little bit more of a challenging business out there in some specific businesses and product areas. Yes, we continue to invest to support growth and optimize our competitive position and yes, we've got a new a capital reallocation and our share buyback. And we believe very much that as we concentrate on our client needs in the area of wealth accumulation, wealth management into the area of savings accounts, payments accounts, mortgage and mutual funds, asset management, private banking, life insurance, pensions and variable annuities and as we continue to develop more in our banking distribution as we go more into growth markets we believe that we are creating value for shareholders and that our business has a strong potential to grow.

Thank you very much and now I am taking questions.

Question And Answer

Operator

Thank you, sir. Ladies and gentlemen, at this time we will begin the question and answer session. [[Operator Instructions]. Thank you. The first question comes from Mr. Nick Holmes. Please state your name and company name followed by your question.

Nick Holmes - Lehman Brothers

Yes, hi, it's Nick Holmes at Lehman. I have three questions. First one is BVC from Insurance Europe seems to below a normal run rate of, I don't know what you say, but perhaps around €500 million. And the question is should we see the Q3 results as an ongoing reduction or a one-off depressed result? Perhaps you might want to answer that question before I move on to the others?

Michel Tilmant - Chairman and Chief Executive Officer

Yes, first of all, as you know, our insurance business, particularly in the Netherlands, we have a portfolio of investments to match our liability in the Netherlands, and this portfolio is well diversified in a number of categories including equities, real estate and private equity. And I think that if you look to the performance including the capital gains of ABN Amro, you can say that our equity portfolio has performed very well. So I think that we should not be ashamed of this capital gains of ABN Amro; it's a fantastic capital gains. We have decided proactively to keep those shares because we thought it was a good investment for us. It's just paying off this year. So this is very good. And to some extent, it was at the right time because it compensated the fact that the real estate portfolio, we are revaluating our portfolio every quarter and we have been experiencing exceptional improvement increase in the real estate portfolio over the last few quarters. And I think that what you see is a significant slowdown this quarter above the revaluation of our real estate portfolio. That means that the revaluation... the positive revaluation this quarter was much smaller than it used to be in the previous quarter. And I think looking into the future, I think we don't know exactly how the real estate market is going to perform in the next year. There are a number of uncertainties. I think on one end, we see very positive factors because we see that there is a great demand for real estate, particularly at some asset class are under pressure, investors are looking to invest more in real estate. So that's a very positive factor. On the other hand, what we see also that and that we see is that for some real estate investors, it's getting more difficult to get some financing to buy a resi. So you have those two competing factors. But so far, the portfolio has performed exceptionally well and I think that we have to accept that in a market situation like this, it slows down.

Second, in private equity, I think private equity also has performed exceptionally well in last few quarters, and I think that it is not a surprise to you. I assume that the revaluation of those private equity assets has also been lower this quarter than it used to be. So on the other end, equities market has kept very well in our portfolio in equities has performed very well. But as you know, equities revaluation don't go to P&L. Unlike real estate and private equity, they go to capital. So this is not a very parallel accounting treatment, but this is the way IFRS requires.

So I think that all in all, our overall investment portfolio has performed exceptionally well in the recent past and we expect some slowdown this quarter. I think that it is too early to say how this will perform during the course of the next quarter of next year.

Nick Holmes - Lehman Brothers

Great, thank you for that Michel. Michel, another question to you. This is my second question, which is do you have any update for us on the earnings growth targets that I think you mentioned at the last symposium you were considering?

Michel Tilmant - Chairman and Chief Executive Officer

Yes, Nick, I don't think that the current circumstances are favorable of me making a definite choice on this, if I might say.

Nick Holmes - Lehman Brothers

So nothing that you can share with us on that one.

Michel Tilmant - Chairman and Chief Executive Officer

Not at this point, no.

Nick Holmes - Lehman Brothers

Okay, thank you. And then third and final question is for Dick, with ING Direct, why do you want to stay in the UK when it seems to be such a competitive market?

Dick Harryvan - Member of the Executive Board

Well, Nick, of course, it's a big market. It is indeed a competitive market. But with our current pricing and already seeing the results as far as savings balances development based on repricing. We are adequately priced to make a margin that will allow us to make hurdle rates going forward. And of course we'll be diversifying into other product categories going forward as well so that will, let's say, decrease our dependency on just one product right now. We have more reduced, but they are still in a very early stage. So I think basically in UK we grew faster than anywhere else, too fast. Some client balances on these very high balance customers actually didn't belong to us. That has now been largely, let's say, restructured and I think we are on a sound footing to go forward. And we look at the market very positively, Nick, and actually are increasing the investment in marketing at this point to attract customers that are suitable to our market, to our direct strategy.

Nick Holmes - Lehman Brothers

Okay, that's great. That's all of my questions. Thank you very much.

Operator

Thank you. The next question comes from Mr. Farooq Hanif. Please state your name and company mane followed by your question.

Farooq Hanif - Morgan Stanley

Good morning, this is Farooq Hanif from Morgan Stanley. I too have three questions, if I may. Firstly, you say in your subprime portfolio that it doesn't really reflect the market average. But I recall that you have a big exposure to the 2006 and 2007 vintages where others have seen much more material revaluation. I was wondering if you'd comment on that and also maybe give us some information on your Alt-A vintages. That's question one. Maybe, like Nick, if you answer that first and I can give the other two.

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

Okay. I know maybe something on the performance of our subprime portfolio. Indeed what we do have is we do have 2006 and 2007, but there we are more talking about the AAA. If we talk about lower rated, that is more in the 2005 and 2004 tranche. So you see that our portfolio moved more ahead like the 2007, 2006 that is predominantly almost only AAA and AA. If I then look at value in these portfolios, just a few remarks. I know that if I look at our portfolio first, we have good collateral in these portfolios. If I look also at nuances like our trades, they differ from an average ABS if that is where you're referring to also in terms of sequentiality.

I mean we get repaid earlier than an average ABS. So both vintage as well as the sequentialty as well as specific technical factors that an ABS is used to quickly off load and hedge, those three factors make a difference in terms of movement of prices of subprime versus the generalization which you can see in the ABS. We are using basically external data metrics pricing from both Lehman as well IDC on this portfolio.

If I move to the Alt-A portfolio, there you see relatively a lot of 2006 and 2007 and that has to do with our business model. Because remember that interest rates went down over 2005 and 2006, so you get prepayment in the portfolio; that means like you refinance. Our sweet spot in ING Direct is more the hybrid ARM, so they are relatively short term. But it does prepay, so you do refinancing. And again, there we are looking for the highest form of AAA, so that explains that we have a relatively big amount in the fresher vintages but high quality.

Farooq Hanif - Morgan Stanley

Okay, before I go into that two questions, I mean I am reliably informed that even AAA 2007 and 2006 vintages on subprime are sort of being marked down below 90%. So that's really the only reason I kind of ask the question. But maybe we can discuss this offline. But just the other two questions quickly. There seemed to be mixed message in your real estate. So in the Netherlands, you've not been able to take as high sort of fair value revaluations. You also say that real estate securities are under pressure yet your valuations of your real estate and other areas seem to be sort of holding up or going up. That seems to sort of be slightly contradictory. Do you agree?

Michel Tilmant - Chairman and Chief Executive Officer

Well, I think that you have to be a bit careful. If you look into our real estate business, there is a good part which is related to asset management where the fees basically are pretty stable and growing because our business portfolio is growing. Our real estate finance business has done very well and our business development has basically performed normally. So I think that from the real estate business itself, I think that the business itself has done pretty well. I think what... and also on that, we continue to see a lot of flows in the real estate market and basically investors, I would say, institutional investors looking for investments in real estate around the world. And therefore there is a market for that. So that's one thing, which is very important. Our business is still doing very well.

On the other end, what we see is that if you look at the portfolio of assets under management, particularly the one which is in the insurance business, which is partly in the Netherlands area, what we have seen is that the revaluation of that portfolio this quarter has been very low compared to the last quarter because in the last quarter the revaluation had been very strong. That doesn't mean the market is a problem; that means just that the value of the properties you have has not rerated during the last quarter after having a fantastic boost in the last few quarters. So I mean that's all it says, and... but I would say unfortunately given the accounting treatment that we have to use for this that means a mark-to-mark revaluation of those building every quarter, you see an immediate impact because we have taken revaluation in the last few quarters and slower revaluation this quarter. So you see immediately the difference, and we are pretty transparent of the amount.

Farooq Hanif - Morgan Stanley

Okay. That's great. Just a last question. I noticed in certain areas in your banking business, you are obviously having to give up margins; you mentioned ING Direct. Even in general lending, you've been able to grow a lot, and I guess you'd probably have to give up some margin there. But overall, your RAROC has gone up, and I noticed that despite increase in risk weighted assets, your economic capital has gone down, and it seems that your economic capital as a percentage has sort of gone down even within line like general lending. I want to understand where that's coming from. Given the current circumstances, it just seems at odds with what's going on.

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

Okay. What I can tell you is a few things. First, indeed, our portfolio is growing. I think if you look at our economic capital numbers, we have been refining models there over the, year and I must say this has been confirmed also with what we will see with Basel II in the future where you will see a more significant uplift in our capital structure. So we are continuing refining the way how we are using our models. Also if you look at our portfolio and if you look at the statistics and if you look at the defaults and the parameters, you see no changes at this moment in terms of credit quality. So our models really don't show a deterioration there. Now I know that this is working on data in the past, but that still is reflected in the economic capital numbers which we see right now.

Farooq Hanif - Morgan Stanley

Will we see it continuing?

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

So from a technical side -- I'm sorry?

Farooq Hanif - Morgan Stanley

Sorry.

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

Yes, so the economic capital side is one part of the equation of the RAROC, and then of course if you look at the P&L side, yes, there is... partially there is the margin compression which is there. But the EC number, yes, [indiscernible] which we have is lower tax rates which work as a compensating effect as well. So two positive factors there.

Michel Tilmant - Chairman and Chief Executive Officer

I think I would like to add also is that since 2004 the wholesale bank basically concentrates at managing for value and not only managing for volume. And I think that means that when they look at the portfolio don't through the account of which the people in charge of the client, when they go out, that's what they have in mind. So they also structured the deals in such a way that to reduce the economic capital, number one. Number two, I think that we have improved also in the wholesale band the recording for instance of guarantees or of collaterals which has also improved the economic capital. So I think that it is the result of a global effort both on the risk management side, on the modeling side, on those people who are working on Basel II and on the commercial side and managing of the business which basically has shown constant improvements in 2004. So I think we are pretty proud of that.

Farooq Hanif - Morgan Stanley

Okay, that's very, very clear. Thank you very much.

Operator

Thank you. The next question comes from Mr. Zenon Voyiatzis. Please state your name and your company name followed by your question.

Zenon Voyiatzis - Merrill Lynch

Hi, it's Zenon from Merrill Lynch. Hi everyone. Three quick questions, hopefully. The first one is on Romanian sales. The value of new business and also net flows have been very impressive there. You've got somewhere between €30 million and €40 million of VNB year-on-year. I just wonder how to look at it going forward. I mean you are talking about a sales window open in mid September. How much of that increase in VNB comes form Romanian pensions? And I mean if it's just two weeks in September; that's a fairly significant increase. How should we look at it going forward? Maybe I can come back to the other two questions in a minute.

Michel Tilmant - Chairman and Chief Executive Officer

Let me first say that when the pension market opens in a country like Romania, basically what happens is that a number of pensions funds are set up. And you basically... the government basically requests that most people who have a job basically enroll into a pension fund. Then you have a few pension funds going in the market, and the game is to enroll as many people as quickly as possible on your pension fund. And the fact that we have a brand there which is longstanding brand in Romania since years, both in insurance and banking, the fact that we were able to mobilize very, very quickly to our existing networks a number of agents, and basically each agent themselves mobilizing about 10 people around them just to go and basically go after clients to get those forms filled. Very quickly we have been able to build some very significant business by the number of clients we have acquired in a few weeks like 600,000 I mentioned to you.

I think that we now have more than 30% market share as we talk now. I think that we expect... but what you have is because of that, it's a real one-shot deal. The question is to get as many clients as possible as quickly as possible on board. So what you have is you have an instant increase of the value of new business. Over time, we expect that this process will continue until the end of the year. Overall, we expect probably to have the number to be at least double and we intend to keep our market share and move. And this of course is a value of new business which represents earnings, which is going to filter through the P&L over the long period, which is the period at which those people think their contract. But if you look back to Poland, for instance where we started a business like this 10 years ago and if you look, we had exactly the same phenomenon; as a matter of fact, not as quick as this one. But you can see that it has long lasting effect on the P&L and the profit of the company. So I think that our people did a fantastic job there to capture the business, and I think we stand ready if other countries open their market, we stand ready to do the same thing.

Zenon Voyiatzis - Merrill Lynch

Sorry. Can you please isolate how much of the €74 million relates to Romania?

Michel Tilmant - Chairman and Chief Executive Officer

About €30 million.

Zenon Voyiatzis - Merrill Lynch

€30 million. Question number two.

Michel Tilmant - Chairman and Chief Executive Officer

€30 million to €40 million.

Zenon Voyiatzis - Merrill Lynch

Sorry, €30 million to €40 million. Question number two, you've launched a new... we saw a benefit rider in the U.S. Just wanted to understand what features have you got in there either in terms of product features or hedging to protect yourselves from potential adverse selection if there is a U.S. economic slowdown scenario.

John C.R. Hele - Chief Financial Officer

The new rider we call the product LifePay or LifePay Plus, it is a withdrawal benefit rider that stipulates that the benefit base will grow at a minimum of 7% and we delta hedge that by basically taking short positions in the equity market. And we charge depending on the type of product between 60 basis points and 75 basis points for the cost of that hedging.

Zenon Voyiatzis - Merrill Lynch

Right. And the third question, just moving to ING Direct, you talked about the cost of the investment into mortgages, the €72 million. That presumably corresponds to your 140 basis points of upfront costs that you talk about writing new mortgages. Is that correct?

Dick Harryvan - Member of the Executive Board

Well, if you do the calculation, €72 million versus €7.2 billion of production, it's 1%. But that's the accounting, let's say, reflection of those costs. If you look at them more on a cash flow basis, then you're talking about the 140 basis points that you're mentioning.

Zenon Voyiatzis - Merrill Lynch

Right. So my question was really a follow up on that. If you were to I mean you also have now an €80 billion portfolio and you also talked about a 40 basis point run rate from that portfolio back in Q1 results. I just wondered what is the... on the income side, what is the run rate now and how quickly would you expect to get to that 40 basis points excluding the upfront costs?

Dick Harryvan - Member of the Executive Board

The margin development on the mortgage is still basically the same as what I mentioned to you earlier on in the first quarter. So it varies by market, but 80 to 90 basis points gross margin. Our total operational cost to the balances today is for the acquisitions is something like 45 basis points. That number will come down, as the percentage growth decreases, will come down significantly so in the order of 20 to 25 basis points.

Zenon Voyiatzis - Merrill Lynch

Right. But even if you are, say, 20 to 25 points, you should be getting a run rate, a quarterly run rate maybe about €30 million to €40 million for the mortgage portfolio. How much are you getting at the moment?

Dick Harryvan - Member of the Executive Board

That's correct. We expect a profit on the mortgage this year in the order of €70 million to €80 million.

Zenon Voyiatzis - Merrill Lynch

So that's annual, so I guess that's 20. Okay, perfect. Thanks.

Dick Harryvan - Member of the Executive Board

And it's tending up very much because, as we communicated only in the last... the third quarter of last year did we actually go into the black on the mortgage line of business.

Zenon Voyiatzis - Merrill Lynch

Great, thanks.

Operator

Thank you. The next question comes from Mr. Marc Thiele. Please state your name and company name followed by your question.

Marc Thiele - UBS

Good morning. Marc Thiele from UBS. I have two questions; one is on the investment side, subprime CDOs and Alt-A. Have you run stress test to sort of look at that portfolio? Have you run stress test, for example, based on a 20% decline in U.S. house price market and can you share some results with us? And then the second question is can you give us an update on the mark to market of the Alt-A? On one of the slides, I think it says €460 million declined in the third quarter. What will be the number at this moment?

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

First, on the stress testing side, yes, we do perform stress tests. I alluded to that for instance with ING Direct. If we take the Alt-A portfolio, we look at the credit enhancement and we compare that to the portfolio and we compare that to the pipeline losses which are there in the portfolio. And if it reaches a certain level, so if it goes more... the relationship is not one in ten, but is more one in five, then we start to scratch our head and think by ourselves like do we still want to keep this or is there anything else what we will do. So that's first example of stress testing. If I look at other types of stress tests, if I take the CDO portfolio in the bank, we both perform tests in terms of when [ph] to default of the underlying portfolio without wanting to get too technical and also we look at stressing the correlations between the different tranches which we are short and long. So there are tests done over these ones as well. You could say with stress testing we are getting served by the market as well, because that is one bigger stress as a whole, and it's holding up relatively well. So, yes, stress tests on the subprime, on the Alt-A portfolio as well as on the portfolio of CDOs are performed at a business unit level. The other element, if we go back to the Alt-A revaluation, what you said indeed is we have the €460 million. That is the negative revaluation which is there at this moment, the total. So that moved from a certain amount in the previous quarter to €460 million right now. If you ask like what does that do to October? We've seen no material changes in that portfolio. So we had the first few days in October we are positive and then we have a slight negative with credit spread widening, but that's still an offset in rates.

John C.R. Hele - Chief Financial Officer

Yes, Marc, this is John. I think you said it went down by €400 million, but really, that's the balance of the pre-tax revaluation reserve. It was minus 233 in July, the end of July, it's now minus €460 million. And it's pre-tax, and that's on a portfolio of €26.9 billion. We checked these balance recently of course with all the excitement going on in the marketplaces and it materially has not changed to the end of October.

Marc Thiele - UBS

Excellent. Do you have any sort of indication what would happen with the 20% decline in U.S. house prices?

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

No, I would really have to recalculate and run that through my model with an LGD, and that is what I don't have ahead over here.

John C.R. Hele - Chief Financial Officer

As you can see, our loan to values are very good in these portfolios of the Alt-A and also the FICO scores, I mean the ability of people to pay, it's not just the house price, because house prices may go down, but can the people keeping paying? I think there are really two factors here that you have to think about a risk profile and we're good in both of these versus missing on our being --

Michel Tilmant - Chairman and Chief Executive Officer

I mean let's remember also that the first line of defense when you make a loan and the first principle of a loan is that you assume to be repaid and that you look at the quality of the borrower. And I think that we have always put a lot of emphasis at ING to make sure that if we buy a portfolio of this kind of instruments, the quality of the borrower is pretty high. And I think if we look to the FICO scores of our portfolio, it's extremely high, 722, it's close to the market prime average of 734. So I think from that standpoint, we are... and then the second issue is what is the second line of defense is the value of the portfolio and what is the loan to value. And if we look to the loan to value, we have also been very conservative with an average of less than 70%.

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

And maybe I can add something there, Marc. If I take the Alt-A portfolio, we have at the moment an average loan to value of 70%. Suppose that this becomes 50%, then if you move back to page 46 of the presentation, you see our estimated pipeline mortgage pool 3.4, then it means the losses in this case will not became estimated 1.2, but that would become 1.7 because that is basically the part which is uncovered, so. And then we have a 1.7% losses versus the credit enhancement of 11.2. That covers basically the Alt-A portfolio. On the subprime, I just want to reiterate the front-end part that we get repaid relatively early in the process given our higher ratings of it, so. But we can have a look at the specifics of that portfolio and run a simulation of the LGD there, but the big portfolio of Alt-A is what you have basically off the shelf here.

Michel Tilmant - Chairman and Chief Executive Officer

But I think that the good news here, I mean the fundamental good news here if you look to our asset base is that the part of subprime and the part of CDO/CLOs is extremely limited on our balance sheet. I think that's the first overwhelming conclusion that you should take, all right, and I think not only in relative term but in absolute terms and that within those portfolio I think that they are behaving properly. I think that, lets to some extent, realize the performance here.

Marc Thiele - UBS

That's excellent. Thank you very much.

Operator

Thank you. The next question comes from Mr. Christopher Hitchings. Please state your name and company name followed by your question.

Chris Hitchings - Keefe, Bruyette & Woods

Hi, it's Chris Hitchings from KBW. Just a couple of issues. Firstly, a comment on, really, please ING Direct UK is no longer targeting large balances. Can you tell your marketing department to actually stop bombarding me with emails? First question, Asia, Japan, clearly, your SPVA product has done very well. I noted that Hartford [ph] happen to have a similar product had done less well in the third quarter and they complained about aggressive competition. And can you give us some update on that? You clearly haven't suffered from it. Perhaps you are the aggressive competition. Can you tell us something about that? Secondly, fund flows in the U.S. I believe, and I maybe wrong, that under the new disclosure you didn't get the product by product fund flows that you used to get in the U.S. stat supplement. But looking at your wealth management, there is a slight uptick in the third quarter from negative in Q1, Q2 net funds. Is that down to the variable in the U.S. including that because, clearly, one of the issues was on actual retirement services product. What are the net fund flows in that in the third quarter? Has there been any improvement on previous few quarters of rather week trends? Thank you.

John C.R. Hele - Chief Financial Officer

Sure, Chris. In terms of Asia and Japan, well, yes, I'm sure we are the aggressive competitor, of course. We are head to head with Hartford generally in Japan. They are very good competitors. We had 18% of the market share in the third quarter, but you also have to realize that in the third quarter we had extensive advertising and marketing with our Formula One campaign. In Japan, we had our car in the train station and really had strong TV coverage and everything else. I think all these things help out in maintaining in addition to a good product. We have solid distribution. We added Nomura distribution again in late August and that started to kick in. So I think the team there has been executing well and continues to execute well in that marketplace.

Tom McInerney - Member of the Executive Board

And Chris, this is Tom. On the fund flows, we actually did upgrade our disclosers since so many of you have been asking for more details. So we now disclose fund flows by within retirement services, we split it between corporate 401(k), education and our IRA rollovers versus our healthcare, government and other. And I think we have been saying for, and you know this for a long time that the focus in retirement services, the corporate 401(k), education and rollover markets. And then in addition, the other important part of the wealth management is variable annuities because in many cases, as people retire they roll money out of a 401(k), it goes into a variable annuity. So the way I look at it is if you have a chance today to study pages 18 and 9 of the U.S. supplement, our focus... our goal has really been to grow assets under management. I mean that's the key driver of the wealth management business because it's a fee business. And if you look historically, we've been targeting asset under management growth of 15%. But let me break that out because I think you all tend to focus more on net cash flow, market appreciation. I sort of understand that. But of the 15%, one-third of that we would expect to come from that cash flow and two-thirds from market appreciation. So the 15 is 5% positive net cash flow and 10% from market appreciation. That's the long-term equity market growth in the U.S.

And if you actually look at on page 18 the seven quarters that we show, the average net cash flow combing the corporate 401(k), education and IRA with variable annuity is the average of those seven quarters is a billion, that cash flow for those businesses, and that's around 5%.Aand then in addition to that, clearly, we have had market appreciation. So if you look at where assets under management were for, again, the 401(k), education and variable annuity business, at the end of the third quarter of 2006, it was 73... about 73.5 million... these are all in dollars in the supplement... 73.5 million of assets under management in those core segments. And at the end of the third quarter, it was 87.1%, and that's about 18.5%. So we are actually on our target. And if you look at the balance of how we got to that 18% growth, about a third is positive net cash flow and two-thirds is market depreciation. And over the long run, while you will have variances from quarter-to-quarter, that's what we would expect and ultimately that's what drives this business and I think gives it a good... makes it a good growth engine for the U.S.

Chris Hitchings - Keefe, Bruyette & Woods

Okay. Thank you.

Operator

Thank you. The next question comes from Mr. Mark Cathcart. Please state your name and company name followed by your question.

Mark Cathcart - Deutsche Bank

Yes, hello. It's Mark Cathcart from Deutsche Bank. I want to make an observation and ask a question. The observation is if I get into a Formula One racing car with ING logo on it, I want to know two things. One is how fast it can go and also the direction in which it's actually going to travel? And I think the market is confused on both in relation to ING. For instance, in relation to how fast you can grow, we don't seem to get any earnings targets because I guess we have got all of these moving parts on gains. Also, we don't seem to know what would happen to ABS if you get a 20% decline in the housing market. We have got an uncertain outlook for risk costs. And also with ING Direct specifically, it seems to grow where you don't want it to grow and then not grow where you want it to grow. So I guess against the backdrop of Asian and U.S. growth which goes up and down, what do you think you can do as a company to really get rid of this confusion on the earnings trajectory? Because I thought the point of ING as a conglomerate was to have so many parts, you would have smooth earnings growth. And the second part to this is where is ING moving forward? Because I'm not really clear what the game is now if you want to be more a bank or more a sort of diversified player. I keep getting unclear messages on what ING actually wants to be. I guess it comes down to the conglomerate discount. And obviously it's frustrating for investors to see a relatively low rating attached to the stock. So what do you think you can do to really clear up the confusion and all of the noise that we seem to hear on this stock?

Michel Tilmant - Chairman and Chief Executive Officer

Okay. Well thank you very much Mark for those very proactive questions as usual. I mean you have... let me first respond to the overall direction of the car. I don't know if you have been to my presentation or you have listened to my presentation that I did in London recently. But I think that I was there extremely clear about the direction. And what I have said is that when we look to our customer needs and when you look to the customer needs about what they need through their life cycle, which is current account, savings accounts, payment accounts and then move to mortgage, which is the second step generally that customers do and then to buy mutual funds, then to go into private banking, then to buy annuities, then a pension contract. We believe that's... when we look at our customer worldwide, this is the area in which we want to grow, okay, and that is very clear. So we are readjusting our portfolio to grow in those areas.

On top of that, we have said very clearly, we see that there are more and more of those customers sitting in emerging markets and in developing markets which are getting richer and go through this cycle also. And that's why we have... we are rebalancing our portfolio to make sure that we capture also most of those customers in emerging markets. And we have also said that we believe that as investment products and as insurance product are getting more and more close to investment products, that basically the banking distribution is more and more important, and you see us buying retail banking distribution like in Turkey and you see us making a bank distribution contract. So I think the direction is extremely clear. So, and I'm more than happy to spend more time with you to explain to you the direction, but I think that as far I'm concerned, we are very clear. And I have also said very clearly that as we move our portfolio or rebalance our capital base, we are not afraid to sell some companies. I made... at the start when I took my job, I sold 15 companies at once, because I think... we've missed a serious cure at the time. But I am not... all of is going to sleep and not looking at that again. I think that the clear evidence is that we have concluded, for instance, that a business which was the core of a traditional business which was acquired by ING many years ago, probably one of their first acquisition the Netherlands [ph] which was the insurance brokerage business in Belgium, we have decided to sell it. And because we felt that it was not exactly right at the target and we didn't feel the strategic target and we didn't feel that the growth was sufficient, so we sold it. And I think there is no reason that I... to believe that I'm not going to continue to do that. So for me, it's very clear, the direction and it's very clear that we are ready to rebalance our portfolio and it's very clear also that we are doing I think the shareholders in our minds by rebalancing the capital in the right place. So I think from the direction of the car, it's very clear. Any comment on that, Mark?

Mark Cathcart - Deutsche Bank

I think you said in the past that you see insurance companies as tanks that get stuck on landmines and banks as jeeps that are quite nimble. So I guess --

Michel Tilmant - Chairman and Chief Executive Officer

I won't comment on that.

Mark Cathcart - Deutsche Bank

Yes. But I just wondered if you still felt that was the case, and so therefore you are happy buying banks and banking distribution and moving more towards being a bank than an insurance company.

Michel Tilmant - Chairman and Chief Executive Officer

Well I am saying that we are happy to buy banking distribution for the retail market. And by the way also, Mark, I think that when you buy a distribution and when you want to collect savings, you need to know what you are going to do with those savings, and that's why asset management and asset gathering is important. And it's important for us and remains very important for us in the future, so that's very clear.

Mark Cathcart - Deutsche Bank

Right. So what about the speed with all of this diversified asset base you have?

Michel Tilmant - Chairman and Chief Executive Officer

Well, I think that the speed... I mean you have two ways to look at it. The first, if you look to a commercial activity and a commercial development, I think the speed is pretty fantastic. Again, look at the evolution of the value of new business and our investments, look at the number of clients we acquire both in insurance and banking, look at the retail balance that we increase. I think that the commercial development of our business and the speed there is pretty fast. So I think that's pretty encouraging, and I think that we intend to continue to be fast because we invest a lot in fast moving market. No, I think that we are a financial institution, and there are factors that we cannot necessarily control and that we have to accept to basically deal as much as we can with the elements. And I think what you have seen first of all is when you look at those elements, I think that you have seen the success this quarter of a risk management. I think that it's... for us, I think this is evidencing that the prudent approach we took in the last few years is paying off. And I did that... most of you have a lot of questions about it and want to know more and more and more and more. I understand it. But the fact of the matter is that the amount of total assets which we have on our balance sheet and which are now questioned by the market is relatively small. As a matter of fact, in the grand scheme of things, you think... you could say that it's extremely small because it could have been much bigger if we had been more adventures, which we did not proactively did.

So I think we have done our job there. But there are of course things that we cannot 100% manage. For instance, the yield curve, I mean this is something we have to react to and we cannot manage the yield curve itself. We can manage the consequence, but we cannot... we are not forming the yield curve. And I think that like any other financial institution, we are relatively independent of the cycles in private equity, in real estate and in equity market. And by the way, we had some negatives numbers or at least less positive numbers in real estate and private equity. But you seem to forget the fantastic capital gains we make in equities. So I mean it's easy to forget €500 million, but I don't, because I think it's completely part of our business.

Mark Cathcart - Deutsche Bank

I guess --

Michel Tilmant - Chairman and Chief Executive Officer

I think that if you always look at the bad side as volatile and the good side non-existent, then of course we have a problem. I think that --

Mark Cathcart - Deutsche Bank

It's really just trying to work out what your earnings base is and how fast you can grow the earnings base.

Michel Tilmant - Chairman and Chief Executive Officer

Yes, but the earnings base depends very much of also of all those factors. And I think that we tried to give you as much transparency as you have required. I think we had never given you more transparent than today to be able to make your own judgment about the underlying earning without those investment income and make a judgment on the investment income. And I have said also at the conference recently when I was asked are you ready to make earnings projections. And I said that philosophically, and I think we had a conversation about that a few years ago. I think philosophically, I am not very much in favor of doing this and as a matter of fact at the time when I decide to do that, I was one of the first not to publish cash flow projections. People applauded that, and by the way today... when I ask the question in a room of 200 people, 100 people said you should do it and 100 people say you should never do it. So I am still not decided about the benefits of giving very strong earning guidance from myself.

Now I have to say also that going forward, we are going to see growth because of... because we basically are transforming our platform like you see in Postbank/IBN and Belgium. So we are improving our existing platform, number one. We are going to see growth because we are investing in organic growth and you have seen multi evidence of that and we are going to see growth because we have the capacity to acquire. I have to say that the current situation probably put us in a good situation to look at opportunities. We have good earnings and cash flow, we have good capital base and we feel that there might be opportunities. And if there are opportunities in the direction we want, well, I think we will look at it seriously.

Mark Cathcart - Deutsche Bank

If I could just ask one final question --

Michel Tilmant - Chairman and Chief Executive Officer

And by the way --

Mark Cathcart - Deutsche Bank

What's your RAROC ex-ING Direct if you strip out the German business?

Michel Tilmant - Chairman and Chief Executive Officer

Sorry.

Mark Cathcart - Deutsche Bank

What's your RAROC at ING Direct if you strip out the German business?

Dick Harryvan - Member of the Executive Board

We strip out the German business.

Michel Tilmant - Chairman and Chief Executive Officer

So if you strip out what works extremely well, you want to call the numbers and keep the UK, right? Okay, we'll take a look at that.

Mark Cathcart - Deutsche Bank

Yes. Thanks.

Michel Tilmant - Chairman and Chief Executive Officer

Just a SEC, we are looking at that.

Mark Cathcart - Deutsche Bank

Okay. Thank you very much. That's really good. Thank you.

Michel Tilmant - Chairman and Chief Executive Officer

We are looking at that Mark.

John C.R. Hele - Chief Financial Officer

Mark, this is John. We have got an after-tax RAROC around... DBA's [ph] 20 but all the other units are in that ballpark.

Dick Harryvan - Member of the Executive Board

16, 15.8, total.

John C.R. Hele - Chief Financial Officer

U.S. has been down a bit because historically they have been tighter spreads, but that's opened up in the last month or so as the Fed's change. So they should be back up to around the 20. But that's really around the target that group has had. Some have been as high as 30 like Australia and it varies depending on how the yield curves move around. Spain is 19. So I think it's a very solid business and a very efficient business in terms of return on the economic capital. This is driven a lot because the asset portfolio and how ING Direct uses the asset side as a very smart risk manager. And that drives... that keeps the economic capital lower.

Bernard Kuiper - Investor Relations Manager

And Mark just in response to your comment made about growth, I don't know if it's more on ING as a whole or ING Direct, sometimes being in places we don't want and not a place we want. I would say ING Direct, we are in a very fortune position that we are in nine countries and that we have multiple products right now. So we adjust the pressure in growth depending on market circumstances. So right now in Europe, our focus on growth is less so on savings and much more on the other product lines and developing those other product lines. In the U.S. on the other hand, if you look at the savings growth, this last quarter was a very good quarter of $5 billion. Because of the currency exchange effect, is not wiped out largely, but a very conscious decision with the market moving in our direction there that we are going to speed up growth in that area. And mortgages, this year we will end up with something in the order of €27 billion, €28 billion net growth that's even more a force in gross production. So a very solid number spread out across the various business units because mortgages is a market where we... that has a stable flow where we can really make a difference right now.

Mark Cathcart - Deutsche Bank

Okay, thanks a lot Bernard. That's excellent. Thank you.

Bernard Kuiper - Investor Relations Manager

Thanks Mark.

Mark Cathcart - Deutsche Bank

Thanks.

Operator

Thank you. The next question comes from Mr. William Elderkin. Please state your name and company name followed by your question.

William Elderkin - Citigroup

Good morning everyone. It's William Elderkin from Citi. First question, if I back on the subprime and other pressurized asset causes, part A, can you confirm that you are using the same accounting standards, reporting standards of other global financial institutions? And secondly, related to that, given we have seen enormous write-downs from some of the U.S investment banks, again, possibly repeating ground you've already covered, but in layman's terms, why is ING different from those people? Second question on the Dutch life business. Perhaps it would be helpful if you could just give us an idea of what the normalized IFRS earnings rate is that back operation and assuming say that the investment markets perform consistently with your embedded value assumptions. And thirdly, can you just walk us through exactly how you got to the €37 million loss I think in ING Direct UK?

John C.R. Hele - Chief Financial Officer

Why don't I talk to the accounting standards. Of course, we are in IFRS and some of the U.S. banks are fully under U.S. GAAP. But the standards for how you value these instruments, particularly instruments in terms of fair value sense is essentially the same. There are three categories, level 1, level 2 and level 3. We have very few in level 3, which is a model-base approach. Level 1 is a pure totally market value level 2 is in between. But there is no fundamental accounting difference in how the fair values are created. There is a difference, though. Some banks record a lot of these CDOs/CLOs at fair values to the P&L, and so they have great write up in the past as these fair values were going up and they have now seen to their P&L fair values going down. Many of ours are held available for sale, so you see it. The fair values are in the equity, they are in our balance sheet, but it's an amortized cost through the P&L. But if you look to our balance sheet, you're on an apples-to-apples basis really across all IFRS and U.S. GAAP reporters. Koos?

Koos Timmermans - Member of the Executive Board and Chief Risk Officer

Yes, maybe I can add a few things on this with the valuations. Apart from the explanation which I gave that, yes, we do deviate from the ABS. There is another thing and that is first, if I look at the amount of level 1, level 2, level 3 type of valuation, our level 3 valuations, it is something in the order of less than €4 billion in total. So that means of the total amount of over €600 billion of investments, it shows that we have a relatively decomplicated asset profile. So there is the first thing to say. That does mean we do have our level 2 type of valuations where we do observe market prices, and those market prices are prices of securities based on metrics which has both weighted average life which is taking into consideration collaterals, and that is the ones which we are using to value our subprime and Alt-A portfolio. But it's a relatively uncomplicated portfolio. Does it mean that we don't see every now and then something more significant? Yes, if I give you the example in our trading portfolio in New York, that is where we had a portfolio with some CDOs which had underlying subprime. It was very small. But there we took a write-down in total of something like half if you look at it overall from June to now. So where we did see some more exotic asset classes we had a similar in-line type of write-down. But then again we don't have a lot of these.

Michel Tilmant - Chairman and Chief Executive Officer

Okay. Coming to your question as what are the normalized earnings of life insurance in Netherlands and what is basically in your embedded value assumption, well, I can tell you that the results of the third quarter are basically in line with the embedded value assumptions. So what you see today is basically what has been normalized. Now if you look back, and you can see that in the appendix that you receive, but if you... and you have to realize also that this is not basically the base, but you have realize that every year on the second quarter we have about €250 million minimum of additional dividend because it's the dividend season. So you could see that this quarter is basically on line with embedded value expect that normally the second quarter is about €250 million minimum higher than that. Okay, that's globally speaking. I would like also to remind you that in the last few quarters if you read the press release and go back those press releases and if you go back to my statement, in all those quarters I have repeatedly said that we had exceptional returns of private equity and real estate gains. So this has been clearly said by us in the last few quarters. We'll take one more question because I have to go to the press conference right now.

Operator

Thank you. The final question comes from Mr. Ton Gietman. Please state your name and company name followed by your question.

Ton Gietman - Petercam

Good morning. Ton Gietman, Petercam, Amsterdam. I am lucky one to have last question. I will stick to one question then. I always learned that strategic has something to do with long term and trading is what you do for tomorrows profit or the day after. So what exactly does it mean strategic trading and could give us some feel for what numbers we are talking about change in profits here?

Michel Tilmant - Chairman and Chief Executive Officer

The strategic trading is basically it's market trading. This is a sophisticated word to say trading; it is prop trading, if you want to say.

Ton Gietman - Petercam

Okay. But could you give us some idea of changes in profits in this area?

Michel Tilmant - Chairman and Chief Executive Officer

Well, I think that what I said first of all is that the month of August was pretty bad. And if you see the difference in performance, it's essentially to the trading losses that we had in August, which were not exceptionally large, but high enough to be seen. So I have to say that this situation should not be considered as recurrent; let's put it that very clear. So I have the numbers here. Basically, if you look to the quarter... to the few quarters, they were basically about €75 million loss in strategic trading in the third quarter of '07 essentially due to August. Hello, are you there?

Ton Gietman - Petercam

Yes. Somebody else is ringing?

Michel Tilmant - Chairman and Chief Executive Officer

Hello. Are you there?

Ton Gietman - Petercam

If you are asking me, I'm still there.

Michel Tilmant - Chairman and Chief Executive Officer

Okay. No, because we had kind of a technical problem here. And if you look to what we call strategic trading or trading and if you look to over the first quarter, the first quarter income was about €66 million, the second quarter €22 million and the third minus €74 million. But I think you should not take this as a recurrent situation because we are performing well right now, and I think that this certainly should not be considered as recurrent.

Ton Gietman - Petercam

Okay, thank you.

Michel Tilmant - Chairman and Chief Executive Officer

Yes. Okay, before I close, I would like just to... seems to me that we have a technical problem again. Okay, are you there? Okay, let me conclude this call by saying that the first message is that our risk policy, our risk management and our risk profile has performed very well in this time of turmoil. And I think that we should look at that in the grand scheme of things, this is important for us. The second thing is commercial performance has been robust both in banking and insurance. Third, we recognize that there was a challenging business environment which had affected some businesses but on a very limited basis and not necessarily on a recurrent basis. We are continuing to allocate our capital and to make the right investments to support growth and optimize our competitive position. And looking forward, I think that the fundamentals of our business, the fundamentals of what we try to achieve are positive and strong and will support growth in the future. And on this, I would like to thank you very much for joining us and we might have other chance to meet. Thank you very much. Bye bye.

Operator

Ladies and gentlemen, this concludes the ING third quarter 2007 results conference call. Thank you for participating. You may now disconnect.

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Source: ING Group Q3 2007 Earnings Call Transcript