ING Groep N.V. (NYSE:ING) Q2 2017 Earnings Conference Call August 2, 2017 3:00 AM ET
Koos Timmermans - CFO
Ralph Hamers - Chairman and CEO
Steven van Rijswijk - Chief Risk Officer
Sofie Peterzens - JP Morgan
Benjamin Goy - Deutsche Bank
Alicia Chung - Exane BNP
Marcell Houben - Credit Suisse
Stefan Nedialkov - Citigroup
Benoit Petrarque - Kepler Cheuvreux
Anke Reingen - Royal Bank of Canada
Bruce Hamilton - Morgan Stanley
Matthew Clark - Mainfirst
Pawel Dziedzic - Goldman Sachs
Natacha Blackman - Société Générale.
Martina Matouskova - Jefferies
Bart Jooris - Degroof Petercam
Vardhman Jain - Macquarie
Alex Koagne - Natixis
Good morning. This is Peter, welcoming you to ING's Q2 2017 Conference Call. Before handing this conference call over to Ralph Hamers, Chief Executive Officer of ING Group, let me first say that today's comments may include forward-looking statements such as statements regarding future developments in our business, expectations for our future financial performance and any statement not evolving a historical fact. Actual results may differ materially from those projected in any forward-looking statement.
A discussion of factors that may cause actual results to differ from those in any forward-looking statement is contained in our public filings, including our most recent Annual Report on Form 20-F filed with the United States Securities and Exchange Commission, and our earnings press release as posted on our website today. Furthermore, nothing in today's comments constitutes an offer to sell or a solicitation of an offer to buy any securities.
Good morning, Ralph, over to you.
Well, thank you. Good morning, everyone. Welcome to this quarter's results conference call. As always, I will talk you through some of the highlights and the presentation that we've prepared for you. With me are CFO, Koos Timmermans, as well as our new Chief Risk Officer, Steven van Rijswijk.
On the key points, Slide #2 for you there. We posted a net profit of nearly EUR 1.4 billion for the quarter. That's a 6% year-on-year increase. We continue to record a good lending growth, resilient margins, basically which you say this quarter is that our well diversified geographical and product footprint provide for a strong foundation for this growth.
I'd like to specifically highlight the strong growth in commission income, which was up 17% versus last year and that's the sign of our Think Forward strategy paying off in terms of improving the customer experience, the growth in the primary customers that we have been talking about with you all the time and the increase of the cross-buy.
Now on the retail side, we welcomed our 10 millionth primary customer this quarter and added up another 250,000 primary customers in the quarter alone. And this all contributed to a half-year fourth quarter rolling average return on equity of 10.8% and our group CET1 capital position remains stable at 14.5%, just like last year we declared an interim cash dividend of EUR 0.24 per share.
Now turning to Slide #3 just to give you where we are on the commercial development. Also in the second quarter, we maintained the strong commercial momentum there. We continued to focus on customer acquisition. We managed to reach the interim target of 10 million primary customers six months ahead of schedule. And as you can see, many of our countries are contributing to this growth. So it's not a single country that is delivering this growth. It's truly all over. It's very well diversified with more engines of growth in number of customers and primary customers there, as you can see.
Our core lending and deposits moved in sync. If you take it on a first half of 2017 basis, both growing at EUR 12.1 billion and these results you can't have if you don't have highly satisfied customers. And that's why, for us, the net promoter score is such an important KPI for all of our businesses. And I'm happy to see that from that perspective we were ranked number one in seven of our 13 retail markets, where we are active but also on the wholesale banking side we measure net promoter score and take customer feedback all the time in order to ensure that we keep improving for our customers.
If we then turn to the update on the transformation program, just quickly some of the important steps. During the quarter, we made good progress in the market leaders that we started to introduce the agile way working in Belgium now as well. At the same time, we are going through the different product designs and we have found more than a 1,000 differences in product offerings between the numbers in Belgium. We have now reduced up to 65 accepted ones. So we are truly, truly making progress in making sure that we come to shared customer propositions, which is a condition to further integrate the way we work between the two countries and build one platform across.
Now I'm going to drift on the model bank. We have further expanded the central development capabilities for that model bank and we have started to internally test a digital platform for the Czech Republic with four key banking products. So also there, we are making progress. Then in Germany, we continue to further digitize the business through Project Welcome. We have a couple of new features for our clients that are well received, so that's working well as well.
And then on the wholesale banking side, our cash management dashboard, an integrated tool inside business, that we have talked to you about in the past as well, that's now being rolled out to and available to 4,600 clients in all of the 20 European countries at this moment. So also making true progress on our commercial offering in the wholesale bank on the back of the digitalization of our business there.
Now in order to support creation of the go-to platform that we've talked about with you during our Investor Day nine months ago, you see couple of examples of how we are making steps into that direction. We keep developing our app, Yolt in the U.K. Yolt has now been released in Open Beta, which basically means that it is now available to thousands of new users out there and there is no limit there and we are running our first steps with these new users and see how we can further improve.
Now we clearly see Yolt as a step towards backing to future and improving the customer's experience through, what we call, open platforms, which basically means that what you offer to your clients is not necessarily limited to your own product or your own service but you open yourself up to third-party providers as well.
And as you know, we don't just develop these things ourselves. We also partner with external fin-techs on these kind of things. And since we are a strong believer in open banking, we've made an investment in Fintonic in Spain. And that's a platform that aggregates transactions across banks with a single app. The app also provides financial advice.
But then again innovation is not just about apps, it's about culture as well. And I think structurally that's a differentiating factor or a distinguishing factor that we, as ING have. So we run another boot camp, innovation boot camp. We've got almost 800 new ideas from employees in 22 countries and in end we have three winners that we will invest in further develop. You can see that there is - we have the innovation in our DNA and we keep coming up with new approaches.
Also I'd like to remind you once again on how sustainability is embedded throughout our organization. Some of the main sustainability themes that we have within the firm are around energy transition, the circular economy, water, and for instance, through our participation in the important industry forms, we tried to play a meaningful role in facilitating society shift to sustainability. You see a couple of examples here.
One way to contribute to this shift is our financing of sustainable projects and clients that are environmental and social outperformers in their sectors. We talk to you about the deal with the syndicate loan the date for Philips last quarter. That was the first ever signed syndicated loan with interest rate linked to the company's sustainability ratings but now we made similar loans to more companies as you can see with EDF and Barry Callebaut. During the quarter, we also acted as a book-runner on the first Austrian social covered bond for Kommunalkredit. So you see that we are acting in many dimensions here in order to support the sustainability and the progress, environmental progress.
Now on keeping with tradition, which is Slide #7, I'd like to focus on a few minutes on Challengers and Growth Markets, where you can clearly see that the Think Forward strategy is delivering results. Primary customers are up strongly. Headcount remains flattish. Commission income up 21% there as well. So you see strategy at work here. We've been optimizing the use of our balance sheet by growing the customer lending, both in retail banking as well as in wholesale banking.
And we do that faster than the deposit growth and that has a positive effect on the loan to deposit ratios. Good part of the lending growth aside from the wholesale banking growth in these markets is also now in higher yielding consumer and SME lending, which together showed 10% increase in the first half.
Another point to make here showing the success of our approach here is the growth of the investment products business. You see this is accelerating with assets under management now up 10% year-to-date and this is an important anchor for commission income, which recorded as early said to 21% increase year-on-year in these markets.
Now here you see the strategy of the disruptor at work. This is how fast growth can be, how diversified lending can be and how diversify the income can be also as a digital bank.
Turning to the half-year results from a return on equity perspective and the net underlying result perspective. Net underlying result was nearly EUR 2.6 billion for the first half-year, which is a 14% improvement for the same period last year, which actually included, as you may remember, a EUR 200 million one-off gain on the sale of Visa shares in the same period a year ago. So that would make the comparison even better.
Now even though the group common equity tier-1 ratio has increased to 14.5% from year-end 2016, we managed to achieve a healthy return on equity of 10.8%. And that is supported by the, on the next slide, the net interest income, which showed, excluding FM, a 3.8% increase year-on-year, very much a result of a continued lending growth supported by relative stability in margins.
Our growth in fee income, you see here as well, for the total bank of nearly 15% year-on-year. That's broad-based, reflects improvement in almost all segments and our products. So all geographies, all segments are contributing to both the interest growth as well as the commission growth.
Now let's turn to the second quarter results and let's start with the growth of our lending franchise on Slide 12. In the second quarter, we grew core lending by EUR 6.4 billion, which is at the higher end of our loan growth guidance of 3% to 4% of the year. This quarter, we again saw the strongest contribution from retail Other Challengers and Growth Markets. However the growth was again broad-based. Also saw strong performance by Retail Belgium, Retail Germany, industry lending in wholesale banking as well. So a good well diversified picture here as well.
So that's the growth of the core lending but one element for you to get a good understanding of the growth is the effect that the foreign exchange has brought to the growth of our lending portfolio because the 6.4%, if we exclude the FX impact, the FX impact in itself and particularly as a result of the weakening dollar is EUR 7.3 billion. So the EUR 7.7 billion that you see in the slide on slide - on Page 12, EUR 7.3 billion of that, so basically almost everything is foreign exchange on the dollar book, the weaker dollar.
The underlying results. Turning to the next - let me see where are we? I'm skipping a page, I'm sorry. I skipped the Page 11 here, which is on net income. So that was the growth - the net income on the back of that, net interest income has grown 3.2%. We see some modest pressure on lending margins in certain areas. Savings margins were supported by further core savings rate in adjustments as well.
You see that the net interest margin on Slide 11 remains in line with our guided range. It's at 151 basis points for the quarter, which is a slight drop of 1 basis points versus the last quarter, that can be fully explained by lower net interest income in financial markets. So that's the growth of the result - the core lending growth on 12 we have done.
Then we turn to Slide 13 on the commission income. Commission income rose by an impressive 17% year-on-year in the quarter to EUR 714 million and that increase was visible in all segments and nearly all products with 40% growth in the retail Challengers and Growth Markets.
Now in these Challengers and Growth Markets, commission income is driven by increasing numbers of primary customers buying more products as we diversify our product range available through digital channels. Also banking fees although were also up, this can be more volatile quarter-on-quarter but a very good result for wholesale banking on the fees side as well.
Financial markets income was down compared to the very strong quarter of last year, particularly lower market volatility led to a less client activity and sequentially financial markets revenues helped up, which you think is a good result, certainly in view of the softer markets that we see.
Turning to Slide 14 now. As you know, the expense base remains impacted by regulatory costs, which is why we prefer to look at the four quarter-rolling average if it comes to cost income ratio. Now that four quarter-rolling average cost/income ratio ticked up slightly to 53.6%. And on the regulatory cost side, this was broadly unchanged and we benefited somewhat from a downward adjustment of the DGS contributions in Belgium. And the underlining expenses were up by around EUR 100 million quarter-on-quarter, but this is going to be largely explained by a legal provision in Luxembourg, as well as higher expenses related to our digital transformation to support business growth. Now these higher investments are partly offset by ongoing cost savings initiatives.
Turning to the risk cost. The risk environment remains benign with the overall NPL ratio for the bank at 2.1% for the quarter with the risk costs remained well below or through the cycle average of 40 basis points to 45 basis points. No loan loss provisioning in retail banking is an important factor in this. Risk costs were substantially lower again due to the improved macroeconomic environment, housing market conditions are really improving as well in most, if not, all of the countries in which we are active. So that is really helping us there.
The risk cost for the wholesale bank, which is a 36 basis points of average risk weighted assets increased in the second quarter and that is because the impact from releases was smaller compared to prior quarters but also we booked a few larger files in Structured Finance in the quarter. But overall we remain at a level below through the cycle average also in the wholesale bank.
Turning to Slide 16. The group CET-1 ratio stable on 14.5%. The capital position benefited from the inclusion of EUR 0.5 billion profit for the quarter, as well as the overall positive FX impact but that was broadly neutralized due to an increase in risk-weighted assets, reflecting the lending growth itself and also some model updates. As we explained last quarter, we decided to reserve an amount equal to one-third of the 2016 total dividend in each of the first three quarters in 2017, and this treatment of interim profits is in line with our aim to pay a progressive dividend over time.
Also as far as policy, like we did last year, we aim to pay an interim dividend after half-year results and the cash interim dividend has been set now at EUR 0.24 per share and will be paid out later this month.
Now if you then turn to our Ambition 2020 and how we are performing versus our own ambition there. We continue to perform well, making real progress on the financial targets with both the CET-1 and as well as the leverage ratio ahead of the regulatory requirements. Also happy with the progress we're making on the cost/income side. We'll keep doing more in order to reach our target range here. We have again reached important milestones with respect to the transformation programs, which help us in that regard, maybe not on a quarter-by-quarter basis but certainly as a trend you can expect that the cost/income ratio over time should move closer and closer to the ambition level.
And finally the four quarter-rolling average return on equity was at a strong 10.8%.
To wrap up, and before we open for questions, I think the conclusion is that we performed well against our Ambition 2020 targets. We see strong commercial momentum continuing in both retail and wholesale. We see more and more customers putting their trust in us, value our services, value our offering. We increased the primary customers and on the back of that, we create true value for this franchise and we'll be able to maintain our profitable growth in general going forward.
So let's open the call for questions.
Ladies and gentlemen, as said, we will start the question-and-answer session now. [Operator Instructions]. In the interest of time, we kindly ask each analyst to limit yourself to two questions. Thank you. The first question is coming from Ms. Sofie Peterzens, JP Morgan. Go ahead please.
Hi. Here is Sofie Peterzens from JP Morgan. I have two questions. So my first question is on your hedging program. Could you just remind us how much of the FX risk and interest rate risk is hedged and the sensitivity to movements in currency, and also rates both on the P&L and capital? And my second question is on your Challenger and Growth Markets. Given that you have a truly online banking platform, how are you gaining all these new customers and could you just talk a little bit about how you plan to expand your revenue base in these markets going forward even further? Thank you.
Sofie, I'll start with your second question, and then Koos will answer your first question there. Yes, on what we see in the Challenger and Growth Markets and you really have to go back to the origin of how we build these banks and with the introduction of internet, many banks basically saw internet as an additional channel and they started to deliver their offers and their services through internet as well and the same with mobile. But what we do is exactly the other way around. We take these channels as the prime channel for dealing with our customers and then you come to a completely different service delivery and it's completely different experience, which is differentiating in itself.
Now all of these customers increasingly so expect from a bank the same experience that you can expect from a tech company, which has to be personal, instant, relevant and seamless. And that's the level of expectations they have. And we invest in that heavily in order to make sure that we get there.
Now on the back of that, you see that the net promoter score is improving and the net promoter score itself will tell you that the way customer sees is far beyond the experience they get from other banks and that itself causes client advocacy through which we get more and more clients. And with these more and more clients that come in buying one product from us, will see that overtime we are able to make them real primary bank customers. And the primary bank customer also has their salary account with us.
And somebody who has a salary account with us also in the digital bank thinks of us as their main bank and therefore are likely to buy more products from us. So the way we can continue to grow is by: first, growing the number of customers; secondly, turning more customers into primary customer; thirdly, making sure that these primary customers take more products from us, so it's a cross-buy not a cross-sell. This is a digital bank, so we are not selling products but the client is actually buying products. And for that we have to make sure that we make more products available as well.
So you now see the growth in assets under management, so we expect some growth there to continue. We are thinking about releasing more insurance-like products on it as well that could help commission income as well. But it's basically how you grow your client base, how you grow your primary client base and how do you grow your product offering. It's all of those three through which we feel confident that this growth can continue.
With that I'll give it over to Koos for your first question.
Yes, Sofie, on the hedging part, maybe indeed we have had an exceptional quarter because the dollar had a significant move. What you normally see is what we do is we try to adjust our capital for our composition of risk-weighted assets. So what you've seen this quarter is a decline of our risk-weighted assets because the dollar weakened, but at the same time, then you lose some money on your centralized hedges because your long dollars and your capital against it. And the two of them, you see them roughly netting off. So you see EUR 4.5 billion less risk-weighted assets and you see EUR 0.4 billion lower FX reserve in your capital, then it means like the hedges in general worked.
On your interest rate risk, let me make a distinction of three points. Our capital what we do is we reinvested normally long from an interest rate perspective, so seven years. If you look at your savings mortgages but also wholesale banking loans, in general we try to hedge. So our purpose is not to take a burnt [ph] on the rates but we hedge according to how these behave. So the risk we take there is more a residual customer behavior risk.
Then you could say do we have any deliberate open interest rate positions, may be opportunistic on the back of client business in financial markets. If you look at the Treasury over the last years, the answer is not really because we have had a period of prolonged low and flat yield curve, so that was not worth it. So that's in general the short version of our hedging program.
Thank you very much. That's very clear.
The next question is coming from Mr. Benjamin Goy, Deutsche Bank. Go ahead please.
Yes, good morning. Two questions from my side, please. First, you mentioned you had a few larger cases in the industry lending on the loan loss side. I was wondering whether we are talking about one or two larger cases that mainly drove the loan losses potentially in offshore or is it broader base, let's say, 5% to 10% cases. And then secondly, Ralph, you just highlighted again the Challenger strategy and the digital first approach, but is there country where you feel you could grow faster or your market position would be better and you can gain more customers if you would have a more significant branch network in any of your Challenger markets? Thank you.
Okay, I'll start with that, and Steven will come back to your first question. Well, in the Challenger markets, we have - we generally have a concept which doesn't need branches and we try to have an offering that is fully digital in every respect, whether it's a client onboarding or whether it's taking out a product, a normal savings product or even a mortgage product. Now clearly in order to generate some of these businesses, for example in the mortgage business, we are dependent on some brokerage distribution in some countries.
In Germany, for example, we have next to ING-DiBa, we have the largest German mortgage broker called InterHyp, and that distribute not only for us by the way. So they take the interest of the client as a starting point. And they advise on what is the best mortgage for them, and sometimes that's an ING mortgage and sometimes it's mortgage of one of our colleague banks in Germany.
In Spain, we have our around 26 branches, which basically means that in larger cities, we have two to five branches. And through that we cover 80% of the economy. And again if you do all your transactional business digitally but you do some advice business through phase, you don't need that many branches because people don't need a daily advice or a weekly advice or even a monthly advice on their mortgage. If they take out mortgages, they may do this three times in their lifetime.
If they take out investment-wise, they may take that once a year, maybe once every two years. So proximity of branches if you only limit the activities to advise is less important than proximity of branches if you still do transactional activities in branches and we don't do that. So transactional activities are fully digital for us, and therefore we can either work without a branch network, or in some cases, with a very limited branch network. And that's the way we continue to grow. Steven?
Steven van Rijswijk
Yes. Thanks, Benjamin. So in industry lending versus finance, this is one larger case, which partially is in the oil and gas space and partially in the metals and mining space and hence why we also see the NPL ratio increasing on both sides but that is just one case.
Great. Thank you.
The next question comes from Ms. Alicia Chung, Exane. Go ahead please.
Good morning, everyone. Just a couple of questions from me. Firstly on IFRS 9. Do you have any update on what the day one impact would be? And also is there any color that you can give on how we should think about the ongoing P&L volatility from IFRS 9? What does that mean for ING's normalized provision levels and how should we think about potential management buffers to cope with that volatility? And also any thoughts about loan pricing going forward? And then secondly, PSD2 is coming into effect next year. Are there any immediate effects that we should consider in the first year as you and other third-parties adapt? Thanks.
Okay, I'll take your first question, and Koos will take your - I will take your second question and Koos will take your first question.
On PSD2, actually PSD2 may bring quite a change to the banking market in Europe. It is - the idea behind PSD2 that will bring a major change and much more competition to Europe. So what we are doing in order to prepare for that is that we have a large program to make sure that we can live up to the expectations and the requirements that banks need to have in place at that moment and try when PSD2 is enacted. So that's more from a technical perspective.
From a commercial perspective, we are actually quite happy with PSD2 because it plays very well for us in our strategy as a challenger, as a disruptor. So it will help us in growing our customer base. It will help us in building open platforms in which third-parties or other banks may offer their products as well and it will be - through that we will they be able to give a complete dashboard for our customers across different banks.
And in order to ensure that we know already what can be done. That's why we are building platforms ourselves at this moment is why we are doing Yolt, if it comes to the aggregation approach through open banking because in the U.K. we can do this already. That's why we purchased Fintonic in Spain, because in Spain you can also do that already. And that's also why in the inside business portal, the offering that we have for our wholesale banking customers, we already now give them the option to also upload information from third-party banks in order to get a full picture there.
So I think it really helps us in our strategy. We are making sure that internally we are prepared to fulfill the requirements on one side. Strategically it helps us. And on the payment side specifically, as you know, we have the initiative of bitconic [ph] in some major countries through which we feel that already we are ahead of the PSD2 in opening up that payments market through the direct debiting by onboarding other banks, so that customers have a flawless and seamless experience across banks not having to wait for PSD2.
Yes, Alicia, maybe on the IFRS 9. If you look at day one impact, our estimation currently is that that is relatively modest or it's up to 35 basis points fully loaded. The point is that the numbers are still draft and preliminary. The reason is our portfolio composition can still change, market circumstances can change so that clients move to a different transition phase.
You also have the issue that all the models, they still need to be validated or most of the models. So it's a bit in that sense a rough estimate but we feel comfortable with the day one impact. If you look at the volatility over time, that is a bit more uncertain. So it's a good question but we don't have all the answer yet. If you - so we will further elaborate on that once we are there but we don't have a good handle on that on this moment. If you look at what does it mean for P&L and for loan pricing? Well, the first observation is that IFRS 9 does not change the characteristics of the loan itself. It changes the timing of when you take the provision.
So it will only have an impact in as far as we need to hold higher capital buffers to buffer our provisions and to be able to pay you a predictable dividend. So if capital buffers are slightly higher because we want to have something in reserve, then that could have an impact on loan pricing but it's - we see that as a very indirect effect.
Got it. Thank you.
The next question comes from Mr. Marcell Houben, Credit Suisse. Go ahead please.
Good morning. Thank you for taking my questions. Two as well. First on the loan loss provisions. Previously you guided for EUR 1 billion for the full-year. If I take a look at the first half, it's around EUR 360 million. Do you still feel comfortable with the EUR 1 billion for the full-year? The second one is the legal case in Luxembourg. Could you just elaborate a little bit more and explain a bit more what it exactly is, as well as can you give us a little update on the AML updates, please? Thank you.
Steven van Rijswijk
Yes, thanks Marcell. Yes, we do still feel comfortable with the EUR 1 billion. Indeed the loan loss provisions for the first half year have been a bit below the 50%, but as you can see in the second quarter - and I mean that goes for every quarter, that is a composition between releases and new loan losses. Retail banking in that sense as shown at least in the first few quarter to be a bit more predictable. What you see typically in wholesale banking headed is more lumpy, so couple of cases it can certainly increase or decrease the loan loss provisions for the next quarter, in that sense we remain at the EUR 1 billion provision level for 2017.
Yes. And if you - Marcel, if you look at both legal cases, both cases are ongoing. So in that sense we are a bit restricted in what we say. But if we assume [ph] Luxembourg, what we can say is it is discontinued business. It is a business which actually was already discontinued in the year 2000, so it's really an older case.
If you look at the AML part, as you know, we are being investigated by the Dutch authorities relating to the onboarding of clients, the money-laundering and the corrupt practices. There we have not yet taken a provision on this as we are not able to estimate reliably what the size or timing or the fine on the penalty might be. So that matter is still under investigation and we are still cooperating with the authorities on that. So that is all we can say about it at this moment.
Okay. Thank you.
The next question comes from Mr. Stefan Nedialkov of Citigroup. Go ahead, please.
Hi, guys. Good morning. It's Stefan from Citi. I just downloaded the Yolt app actually. It looks pretty cool, so congratulations on that. And I had two questions beyond the fintech that are mentioned here. In terms of the Dutch risk-weighted assets, I notice that the risk density went up by, call it, 200 basis points in the quarter. Can you just give us some color on what is causing that? And secondly, on Belgium fees. Those came in again quite strong this quarter, almost on par with the first quarter, which is seasonally tends to be quite strong. Can you just give us some color on what type of products on the insurance side or asset management side exactly your customers to buy and what are the economics on those products for you? Thank you.
Yes, thank you, Stefan. Thanks for the complimenting Yolt. So on the second question, so what is the driving the Belgium fees? It's really the assets under management and the fees that we make on that, not only selling them but also managing these portfolios. As you know, the Belgium market is a market with a higher appetite for investments, for equity investments for - because now there is no central pension system as much developed as it is, for example, in the Netherlands, so people really take care of their own savings. Therefore as the savings surplus market. Now the savings - the yields on savings in Belgium for almost all banks is at the legal minimum. So therefore consumers and customers are looking for alternatives, and that's why you see a continuous inflow in our investment products and that is basically driving those fees in Belgium.
On the Dutch risk-weighted assets, I will give that to Steven.
Steven van Rijswijk
Yes. Thanks, Stefan. And if you look at the press release, you see a composition in terms of the RWA that there was an increase in terms of RWA EUR 0.5 billion. That is a composition of a number of factors, but one of the largest factors in the plus is a EUR 5.3 billion in mortgages [ph]. A large part of that is attributable to Netherlands regarding more updates for digital mortgages.
Okay, great. Thank you.
The next question comes from Mr. Benoit Petrarque, Kepler. Go ahead please.
Yes, good morning. Two questions on my side. First one will be on the net interest margin. Good loan growth at stable margin this quarter. What type of kind of NIM guidance you are putting to market now after the slight increase of market rates we have seen in the quarter? I think you have been talking about high 40s but you have been running in relatively low 50s for several quarters now. So what type of NIM guidance are you giving us now? And could you also come back to the margin pressure in Germany? NIM is a bit under pressure despite the savings cut in Q2? And then the second question will be on the cost base. It is a small miss. I've got an underlying cost growth at between 1.5% to 2% this quarter year-on-year. I think you have been getting for flattish cost growth in the past. So what type of gross level we are going to see? Is that the cost growth we should expect, given you are growing the business clearly on premier accounts and loan growth? Thank you.
Yes, Stefan. On the NIM guidance, as Koos already indicated, we basically hedge our commercial balance sheet, so basically the fact that the interest rates they move up per se does not necessarily change our NIM because we manage this through how we price. The NIM guidance going forward for the year we had indicated high 140s, low 150s. That's exactly where we're coming out. In some lending categories we see some pressure. In some others we don't see margin pressure. We still have room to maneuver on the same size over the two few quarters 2017.
We are still guiding around this level, high 140s and low 150s. Specifically in Germany, the margins there, we announced a rate cut at the end of the first quarter. Improved margin came in through that, however, that was offset by a lower investment income in the German book, some bank Treasury, more technical effects as well, continuous inflow of savings at a lower replicating rate as well and a mortgage market which is a bit competitive at this moment and we basically are very disciplined the way we price our mortgages in Germany, like everywhere, on a return on equity basis. So that more or less explains what's going on in Germany.
On the cost growth, if you take the one-off in Luxembourg, where you see the cost growth, we have never guided flat cost. Maybe that's what you were expecting but we've never guided that. We've always guided cost income trends because we are investing in our franchise. We are investing in digitalization of all of our franchises. And therefore on a quarter-on-quarter basis, you may see some movements on the cost side but what you should really take into account is the trend of cost income because in the end we are investing to grow, we are investing to get more clients to get more business and that is where you can expect basically to return on the investments.
Now we have indicated how we think this will develop across the three different businesses that we have, to market lead this business. These investments are truly to decrease cost because we don't expect too much growth on revenue side.
In the Challenger and Growth, we actually expect cost to continue to increase but we also expect revenues to increase faster, and with that, to cost/income ratio.
And for the wholesale banking side, the investments, we'll make sure that we become more and more efficient in a more operational areas of the wholesale bank but given the fact that we are growing our franchise successfully, we also need more people in the front office and that's where you see cost increase versus the cost decrease in the operational part of it. So for the wholesale banking side, given the current strategy, we expect flattish cost maybe a bit increasing but again decreasing cost/income ratio if you take it over a longer period of time.
Great. Thank you very much.
The next question comes from Mr. Anke Reingen, Royal Bank of Canada. Go ahead please.
Yes, Anke Reingen from RBC. Just on IFRS 9 a follow-up. Would you still - I mean, I understand there is still some uncertainty on the P&L, but would you still think you can reiterate your previous guidance of the normalized loan loss charge of 40 basis points to 45 basis points across the cycle? And then on the risk-weighted assets, I read in your report that you said there were some model updates, which increased the risk weightings on Dutch mortgages. And I just wondered if you can say what the risk-weighting is on the Dutch mortgages and should we expect more fees to come? Is this anything like a light-up potential regulatory changes or is this nothing to read too much into it? Thank you very much.
Steven van Rijswijk
Okay. Thanks Anke. In terms of your first question on IFRS 9, like Koors already said, IFRS 9 in and of itself does not change the risk of our loans or our portfolio. What it could have - the impact IFRS 9 could have in terms of volatility, sometimes the timing of our loan loss provisions need to be different than they were in the past but we still are investigating that, when do loans move to a different stage and therefore how much do you need to provide? And that sounds - and that is a capital impact that Koors was talking about in terms of well that if we want to get a certain dividend policy there, does that mean that we need to build an additional difference of capital or not.
But when you purely look at the loans and the risk appetite framework that we have, the 40 basis points to 45 basis points in terms of our risk process through the cycle, this still stand. Then we come to the increase in the Dutch mortgages, indeed there are always regular mortgage but in this case it was about the - largely about the Dutch mortgages. I believe the risk weight until now was about 11% so that will grow to approximately 13% to 14%.
And should we expect more of this model updates to come through potentially in preparation of the loan loss changes or is that nothing to do?
Steven van Rijswijk
Yes, I mean, typically we have hundreds of models and every year models being reviewed and what we call, these are backed-assets based on actual performance. As the reviews, they will go to the ECB to actually validate them, and based on their ARPU we will update these models. So that's an ongoing normal course of business for us as a bank.
Okay. Thank you very much.
The next question comes from Mr. Bruce Hamilton, Morgan Stanley. Go ahead, please.
Hi, good morning, guys. Two questions. One just sort of returning to this debate on IFRS 9. I know there are still some moving pieces. But can you at least give us a bit more thinking behind your current thinking on sort of capital and buffers, and how much that might move depending on the outcome, given what you know today? And then secondly, just again looking at the impressive growth in assets under management, which is driving fees, both in the Challenger markets and in Belgium, can you talk a bit more about the economics? So is this - are these assets managed by third-parties, where there is a sort of fee share or you are actually managing portfolios yourself using passive investments or other? I'm just trying to understand how the economics of that works. Thanks.
Yes, really on the capital side, what I said, so the initial part when we adopted, it's not going to have any implications on us on the capital. It's a modest effect what you have there but it doesn't do anything. But really to test this volatility, like if you go into a more downward cycle and the effects that has that your clients move to a different stage where you have to provision more, that's a more difficult one to say. At the same time, what you do know right now is that if you look at our total provisioning per quarter and as a percentage of profit, it is not at your profit so totally fall off a cliff. I mean that is what we don't expect. But yes, you do see something different in the cycle.
If we look at it over the longer period of time, then always what you see is that at the end of the credit when we rework we had releases, so we had never under provision but the recognition and the balancing over time, how that will exactly come out, we don't know yet but you'll be the second one to know.
So in terms of assets under management, it's a mix of everything a little bit. So in Germany, we have a big online broker and the more traffic, the more money you make. In some markets, we actually have some asset management, some structured product business as well. So these are partially ongoing fees in the Netherlands as well as in Belgium. But at this moment, the boost is really on the back of the further distribution of new product literally growth underlying and that is generally third-party products.
We generally have open architecture. So it's the sale of ETFs and funds [ph] to our clients, and you can expect more of this because more and more we are building, what we call, digital financial coaches. In Spain, we have built one, where we basically take a situation of a client and digitally we come to a certain advise for the client to decide whether to move from savings to assets under management and we are replicating that model into Italy at this moment in time. We are collaborating with some robo-algorithms as well and testing that in Germany, so it's an underlying trend.
It is becoming more and more digital also the investment business there and we are an attractive partner for many asset managers for the distribution. We have EUR 36.5 million customers. And so you can expect some growth there through our primary relationships, through our digital financial coaches that we are building. So that's basically how you can expect how to develop - how the business will develop.
Okay, that's helpful. Thank you.
The next question comes from Mr. Matthew Clark, Mainfirst. Go ahead please.
Good morning, a couple of questions please. Firstly on the Dutch mortgages. Can you just talk a bit more about reentering the 20-year fixed-rate market and what that means for volumes, the end margins there going forward? Is it reasonable to think we can see flat volumes in the Netherlands from here onwards now you're writing business in that sub-segment again? And then second question is on the Treasury drag in the corporate center. There was quite a big delta from the first quarter to the second quarter there? I think it was EUR 110 million negative in the first quarter and EUR 90 million negative in the second quarter. Just wanted to check whether that was due to the kind of lower funding drag or whether that's - and so you can expect it to run at that rate going forward or whether there was some other lumpiness that was driving that EUR 20 million or so improvement in the Treasury line second quarter versus first quarter? Thank you.
Yes, thank you, Matthew. So we didn't actually have a product beyond 10 years in the mortgage market in Netherlands because we were very cautious to enter into that market on the back of - and clarity around the mortgage credit directive and the - basically the guidance around breakage cost that would come in potentially in the future on the back of these products, as well as clarity around Basel IV in terms of the risk weight. So you don't want to create a huge legacy. You don't want to build currently huge legacy just because there is a market demand for our mortgages that have an interest rate tenor beyond 10 years.
Now on the guidance around mortgage credit directive through the markets, authorities and now there is much more clarity there. So on the back of that we are now cautiously entering into this market but we are also distributing that in that market for third parties. So we don't keep everything on our book there either.
For the corporate line, I refer to Koos.
Yes, so on the corporate line, may be the first thing, Matthew, is that what we decided and that's already straight after the crisis is to fund our loan portfolio longer and the cost of funding that longer, took it central at that time because we felt like we don't want to retroactively change the margin of our business. So that is the first part and we called it the legacy.
Now actually what you saw is same period last year that was partially offset because we had TLTRO. We picked up money. But we also reduced the old former TLTRO and that meant we had to clean up some swaps and on that we made an incidental profit. So in fact you had Q2 2016 was a bit more beneficial and now we are back to our normal EUR 100 million run rate, which over the longer period of time and then I think we are looking at around 2020, you will start to see that decline.
Okay. Just coming back to the mortgages, what's the practical impact on volume growth then from you reentering into this market?
That's going to be limited. It's going to be limited. It's just that we want to service our clients. It was demand for this product. We had this product now, so we don't want to lose on that opportunity to build that relationship with our client but we'll stay cautious on it.
Okay. And just to be clear, you weren't distributing third-party product in the 20-year space before either?
No, we weren't.
No, okay. Thank you very much.
[Operator Instructions]. The next question comes from Mr. Pawel Dziedzic, Goldman Sachs. Go ahead please.
Good morning. I have two more questions. The first one is a follow-up on fees and I know you made already a few remarks on the call today. But when you look at the growth rate overall for the bank, which is in the mid-teen range, does it strike you as high and is it sustainable going forward? And in particular in the retail, because the remarks you made today, for instance on the fees in place like Belgium seems that you would be able to at least defend the level of fees where they are now? And also on Growth and Challenger Markets, in particularly Other Growth and Challenger Markets, again comments throughout the call suggest that the growth there is very much underlying. So it would be helpful to understand how you think about overall growth rates and outlook for the fees going forward? And then the second question is on Basel IV. Again your peer earlier this summer warned that the outcome of Basel IV might be very harsh. How do you see the process currently? Do you expect to see any clarity over the coming months or perhaps not and how do you adjust thinking about your dividends based on the outcome? Thank you.
Thank you, Pawel. Yes, on the fees, I remember the discussion that we had like a year, year-and-a-half ago when basically many people were discussing with us our business model that we were too dependent on interest income. And basically we said, well, that's the strength of our franchise because we have upside on the fees, whereas what we see in many markets is that where - that our colleagues are under pressure in being able to charge fees because there is more and more consumer, agencies and protection coming up as a consequence of which you can't just charge fees with things that don't add value.
In our model, our business model has always been very, very clear. You can't charge fees for things that don't add value, and we won't. Now having said that, given the fact that we're trying - we're moving - certainly in the Challenger and Growth Markets, we're moving away from a savings versus mortgage business but much more toward primary relationship business. You see that that relationship will generate interest in products that we can distribute digitally on the back of which we can make fees. So, on the back of that you can expect that we do expect fees to continue to increase. That's one thing.
Second element there is a bit of pricing what are the optimal fees, also on products that we already charge fees, like payments accounts in some markets, like in the Netherlands and other markets where we are basically looking at how can you optimize vis-à-vis client behavior to get them the right package that belongs to their behavior. You can work on that.
So in markets in which there is generally - it's a higher fee markets, it maybe - even be a bit more pressure coming but given the fact that our business model has never been high on fees, we actually expect this to be a strength of our model because we see quite some upside if we can really continue to move through a primary digital bank.
That's on fees. On Basel, I give the word to Koos.
Yes, on Basel, well, we are still living with the uncertainty there. So yes, we know the industry studies of the McKinsey's. We had a look at more than like 25%. We have also seen Morgan Stanley studies. And even there are some higher outliers in there. What I know on the process part is that, yes, there will be a meeting in September in Basel, and of course there is the IMF in October, so those are key dates where we will currently look at. Does that mean that we can tell anything on implications on dividend? The answer is no. I think it is too early for that part.
I think what is more important for us what we can do as the bank if you look at your loan pricing and what we have done and what we already indicated in the past. We have always said like we work with higher capital requirements for more than five year tenure loans simply because we think that that has to do with the phase-in and we felt like we want to make sure that we adequately priced for that. So that's the only precautionary measure. All the other thing would basically be running ahead all the facts which we cannot do yet.
That's very clear. And could I come back just one follow-up on fees. So you mentioned basically that fees were strong among markets and products but Other Challenger Markets are more different in different regions. Would you be able to give us a sense if all - how does your fee growth there split across different geographies? Does the implementation and phasing of model bank help to accelerate the growth and are there pockets of potential growth ahead of you?
On the exact geographic split, I refer to the Investor Relations department, so if you want to get more insight on that. Coming back to then your question on the model bank, yes, it will help us. Why will it helps us? Because through the model bank, we are actually building a cross-border platform, and given the cross-border platform, we will be able to introduce new products much quicker in specific countries than we are doing currently. And the incremental cost of introducing new product in a country will be much lower given the fact that we will have a standardized front-end, the way we interact with our clients as well as a standardized back-end.
So yes, it will help us build primary relationships across the different geographies that otherwise would be much more expensive to build and will help us to ensure the cross-buy across different products, and the product offering will be much broader in all of the different geographies that are subject to the model bank because the incremental cost of introducing products will be much lower. So that's certainly the idea.
All right. Thank you very much.
The next question comes from Ms. Natacha Blackman, Société Générale. Go ahead please.
Thank you. Please could you talk about your funding plans for the rest of the year, particularly holding company senior and subordinated debt? You've done a reasonable amount already so far but obviously the spread environment is quite favorable right now. So interested to you hear your thoughts on that?
Yes, overall, Natacha, we are in a phase that in fact we are relatively fully funded. So if you ask like do we need additional funding to fund assets? The answer is no. So normally what we do is we look at our runoff in our portfolio of senior debt, in particularly the operating company, and then we try to replenish that with a bit of TLAC paper in the holding. So that is the normal way how we try to do it. So anything that runs off we replace.
Now there might be times that we throw and run that a little bit because we think that credit spreads are good or an opportunity is there, but normally speaking, I would say funding requirements are quite modest and if you look at the runoff portfolio, you see a bit like what we would continue to issue.
Thanks very much.
The next question comes from Ms. Martina Matouskova, Jefferies. Go ahead please.
Good morning. I just want to go back to Slide 3, where you have 400,000 new primary customers, which I think is impressive and you're six months ahead of your target. Can you just maybe comment a bit more maybe where the growth is coming from in Q2 and provide expectation for the rest of the year? And also you had the intent to release [ph] in the Czech Republic. Can you give details in the new four products introduced and what is your view on the primary customer growth in that country? Thank you.
Well, as you see in the presentation, you see that the growth of primary customer is, it's truly across the different geographies. So Germany, clearly because we already have a high customer base of more than 8 million customers, you can expect the primary customer growth to continue there. And Australia is doing very well as well. Poland and Romania doing very well. It's truly across the board and we don't see a reason why the growth that we have seen, not only this year - in the first half year or this year, but also over the last couple of years why that would decrease going forward. So we expect the primary customer growth to continue across all of these geographies. Specifically in the Czech Republic, this is something that we are working on. It's not live, so it's still something internally. So I will let you know when we open up for clients beyond what we currently already offer in the Czech Republic.
Okay. Thank you.
The next question comes from Mr. Bart Jooris, Degroof Petercam. Go ahead please.
Yes, good morning. Big lines of my questions have been answered already, so some small follow-ups. First of all on Basel IV. We did get some questions from your side, how we view it if it would be like a long implementation phase should you go directly for fully loaded or for phase 10. So I'd like to return the question and ask if you have already established a view or on evolution on your view on that, if there is a loan implementation period, would you more go for a phase 10 directly at the fully loaded impact regarding the buildup of your capital? And then second question on the fees and commissions once more. In which way are they related to a more positive financial markets? I appreciate you were saying you're also introducing new products on which you can get fees and stuff, but we did saw a strong growth in your assets under management also. So could you give us a flavor on is there a part of the growth that is influenced by the beneficial financial markets and how big is that part?
Yes. So on the Basel IV, well, first of all, of course we have the uncertainty like how much capital do we need to build up and let's set that aside. The question is should we go immediately for a fully loaded or a phased-in? First thing to note is this is not 2007, so that means like it's not that the expectations should be there that will be there as of tomorrow. So in that sense, some leniency is there.
On the other hand, suppose there is a ten-year phased-in, we would become in such a case, call it, a category two bank, so you need to show linear progression towards your new capital requirement.
Now normally you want to be ahead of that because you want to be certain to pay dividend, so expect that even although we might not be there on day one, we are not going to wait exactly 10 years if that is you're phase in to do it. So normally speaking, it will be somewhere between five and seven years that you want to get there. That's the current rough way of thinking. But then again we haven't seen any proposals yet. But that is as far as we can say.
That's very clear.
Now then again on the fees, it's clearly something of interest. We are very happy with that. So basically you see the fees growing both in retail banking as well as wholesale banking. And the retail banking is truly on the back of growth across different products, including the assets under management. I'll come back to that. And the wholesale banking, it is partially it's financial markets. It is partially a couple of deals that are being closed but it's always a little bit more lumpy in the wholesale bank but certainly the EUR 297 million of fees in the wholesale bank is - at least 50% of that is what you could say is structural or sustainable.
Now on the retail banking fees specifically is related to the market performance of our asset under management. Honestly if you look at the last three quarters, the market has not really moved up - have moved down a little bit. So it's truly on the back of inflow. And that inflow is increasing for two reasons. First, it's clearly for consumer the alternative between a low savings rate, which is everywhere in Europe at this moment and the potential upside of investing, and secondly as I said, it is on the back of our offering of digital financial advice and showing the alternatives for customers, and therefore it's - the increase is largely driven on the back of inflow.
Okay. Thank you very much.
The next question comes from Mr. Vardhman Jain, Macquarie. Go ahead please.
Firstly, do you have any sort of update on the TRIM review process? Any sort of any initial colors, thought on that, because some of the banks in Europe have started giving some guidance on that? And secondly, on the cost side. If you could give more details on where exactly are you seeing the cost savings, some of the cost savings that you mentioned in the first quarter and second quarter? If you could give a bit more color on that, that would be helpful? Thank you.
Now on the cost savings, the cost savings that you currently see, Vardhman, are the savings that are coming from the programs that we have started years ago. So just to remind you, the programs that we still have running are the Forward and Now program, so it's basically program in further efficiency in the Netherlands. It's the Power IT program, which should deliver further efficiencies on the IT side that we have heavily invested in. It's the Wholesale Banking TOM. It's the continuous investment for further efficiency of the operational side of the wholesale bank and it is the Belgian transformation program that is still also throwing off benefits. So the savings in the first and second quarter are truly coming from those programs that we have reported to you on that will lead to savings in FTEs and headcount and savings in efficiency of IT as well.
So that's where the savings are coming from. Against that, now in the first two quarters, are the first steps in our investments in the transformation program that we announced in October and that's how you should see the balance of the cost growth.
For an update on the TRIM, I'll give the word to Steven?
Steven van Rijswijk
Yes, thanks, Vardhman. On TRIM, a number of quarters ago already the TRIM exercise started. So the past number of months the teams have been very busy with providing datasets to the ECB. The focus currently is on the mortgage portfolios in the Netherlands and Belgium, the SME portfolio in the Netherlands, as well as all of our trading models, so that will be the first phase but the real onsite inspections of the ECB will only start after the summer in September. And then the second phase, that is 2018, there will be a focus on the lower PD [ph] portfolios including the number of the portfolios and models in wholesale banking.
Okay. Thank you.
And the final question will come from Mr. Alex Koagne, Natixis. Go ahead please.
Yes, hi. Alex Koagne from Natixis. One very quick question from me again on fees. Thank you very much for all the details. But in term of dynamic, should we expect fees to grow at the pace higher than 5% or should we expect it to be in that region which is the level we saw last year? So that's my question. Thank you.
So Alex, who else can ask questions like this?
You know how I've been very focused to that in terms of [ph].
So, well, for the wholesale banking side, as I said already, it's much more chunky and lumpy, and therefore it's really difficult to predict. But you can expect that on the back of other larger deals that we do on the wholesale bank that across the year, if we grow our book, our lending book, the way we have been growing, that you can expect the lending asset growth of like 3% to 4% also to be the growth on the fee side because there is some kind of a linear relationship year which is on the wholesale bank.
And then clearly, so here and there you will have some more opportunistic businesses on the back of which we make fees as well. The real engine clearly is the lending engines and with that comes fees as well. Now on the retail banking side, it is really a structural change in the business model as a primary bank offering more and more products. So the more products that we onboard in the retail bank that come from third-parties, the more fees you can expect. And whether fees will grow higher than the 5%? We would hope so and we would certainly work on it. But again, we don't charge fees for charging fees. That's not how we deal with our clients.
So it has to be on the back of a true added value, a new product that we introduced that a client is then buying. Again we are not selling. And so we see opportunity for further growth in distributing insurance products in terms of growth markets that we're working on with a couple of partners and further growth in the asset management with a couple of partners that are very interested in our digital distribution power. So if we can get those new products going in a digital way, then fees can grow higher than the 5%.
Okay. Thank you. If I may, last question please. Just to understand, at with stage of the discussion regarding other litigation would you start to take provisions? I mean, what is the trigger? Is that when you still - you start to have discussion about around the [indiscernible] what is the trigger to start to book provision for litigation?
Good question. Koos, will comment to that.
I think there is always three points of the importance. The one is, is there a penalty or something more likely than not? The second part is, is that penalty going to be a financial obligation? And the third part is, can you assess reasonably anything of the height of that? And that - so all these three criteria need to be met and then you can book a provision. So that is what we have always done and that is what we will continue to do. But clearly if we don't provide, then the criteria have not been met.
Okay. Thank you very much.
Okay. Well, that ends our analyst call for today. Again thanks for calling. Thanks for your questions. I really appreciate that. It slows the interest that you have in our franchise and the way we are developing. The quick summary of the second quarter is a continuous commercial growth in the number of clients and the primary relationships in the lending book, in the savings book.
It's across the different sectors. It's across the different geographies. We are not dependent on one or two main geographies. It's very well diversified, both from a lending growth perspective, as well as from a fee growth perspective across products. You see that the strategy that we started a couple of years ago on focusing on primary relationships and the cross-buy through that, it's really working out in order to diversify the income away from interest income also into fees income. And with that, we, for the quarter, realize the return on equity of 10.8% with still strong capital buffers at 14.5%.
Thanks a lot for the attention. For the ones who haven't gone on a holiday, I wish you a great vacation. Thank you. Bye.
Ladies and gentlemen, this will conclude the ING's Q2 2017 conference call. You may now disconnect your lines. Have a nice day.