Earnings Call Transcript - ING Q1 2022

Operator, Operator

Welcome to ING First Quarter 2022 Conference Call regarding future developments in our business, expectations for our future financial performance and any statements not involving a historical fact. Actual results may differ materially from those projected in any forward-looking statements. A discussion of factors that may cause actual results to differ from those in any forward-looking statements 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, Steven, over to you.

Steven van Rijswijk, CEO

Thank you very much, operator. Good morning, and welcome to our first quarter 2022 results call. I hope you're all well. I'm joined by our CFO, Tanate Phutrakul, and our CRO, Liliana Cortan. I’m pleased to take you through today’s presentation and we will take your questions afterward. For the first time in two years, I can say that from a coverage perspective, circumstances appear to be normalizing, which is positive. However, challenges persist due to the invasion of Ukraine, which is negatively affecting people, including our colleagues, along with already high energy prices and disruptive supply chains. In these circumstances, we are assisting colleagues with safe relocations and managing our risk exposure. Simultaneously, we are focusing on our strategic priorities by financing the green transition and enhancing our digital channels, while continuing to provide value. This was demonstrated by the increase in pre-provision profits, driven by our efforts to finance the green transition and improve our mobile channel. Operating profit rose 14% year-on-year and 9% quarter-on-quarter, marking a strong start to 2022. I am particularly pleased that all key P&L lines contributed positively. Net interest income, excluding TLTRO, increased in both comparable quarters, which is a significant indicator given the liability pressures of previous years. With yield growth normalizing, we are able to reinvest in our replicating portfolio and see more favorable yields. As we have previously indicated, the effects will materialize over time. However, in 2021, we faced about €600 million in drag from negative rates, which has now ceased. Excluding TLTRO, we anticipate net interest income to rise in 2022. Meanwhile, the ECB has yet to increase rates, so currently, negative interest rate charges remain in place, contributing €300 million for the entire year. With inflation expected to remain elevated for an extended period, the ECB appears poised to begin normalizing monetary policy this summer. While the timing is uncertain, we expect the ECB to conclude net asset purchases and negative deposit rates by year-end. In non-Eurozone countries, central bank rates have already increased, with Poland being a notable example. We are seeing the advantages of geographical diversification. The rapid rise in rates has affected lending margins this quarter as client rates generally lag behind higher funding rates. Additionally, with low rates, net interest income benefited from a high level of prepayment penalty income, which tends to return to more typical levels when interest rates increase. Moving forward, the development of the yield curve should support net interest income growth. We also experienced strong growth in fees, with a 9% year-on-year increase. Furthermore, we expect annual growth at the current higher fee levels. Overall, despite inflationary pressures, particularly in salaries in some regions, we have visible portfolio growth, which has doubled over the past five years, while fossil fuel investment has nearly halved. Looking ahead, we aim to accelerate the growth of new renewable energy loans to a 50% higher level by 2025. At the same time, we will not finance new dedicated oil and gas fields. In Retail, we have taken steps to help customers become greener with the launch of a green mortgage in the Netherlands. I am proud that our expertise is recognized by clients such as Vodafone Ziggo, which we supported in their debut sustainability-linked bond, as well as by external organizations, with two green transactions receiving awards in their respective categories. On Slide 5, we focus on another strategic priority, which is our digital journey. The importance of the mobile channel continues to increase, and it is positive as expanding our mobile offering, both improved customer experience and reduces cost to serve. And this slide demonstrates that approach to digitalization with a focus on more incremental projects with higher execution certainty rather than large multi-year projects. The examples show expanded digital capabilities for our customers, which help the top line as our customers take up more services. And at the same time, we invest in digitalizing processes to both improve efficiency and customer experience by a higher first-time right and shorter time to yes. As a proven example, 2 quarters ago, I mentioned digitalizing the Dutch mortgage process, where we reduce our time to yes. And as the process became more efficient, it also allows us to handle higher volumes when needed. A similar story we have in our investment offering in Germany started some years ago when we launched a fully digital process to open investment accounts. This resulted in continued high growth with the number of new investment accounts opened in the first quarter at 121,000, of which one-third of customers are new to ING. And I'm happy we also received recognition from our customers with good NPS scores and this quarter named being named Best of Preferred Bank in Germany and Poland. As part of our digitalization strategy, we selected 60 main processes for which we will maximize the end-to-end digitalization. And we will elaborate on this during our Investor Day on June 13. We hope you will join in person here in Amsterdam or otherwise virtually. Let me now take you through our first quarter results, starting with our year-on-year net interest income, excluding the TLTRO benefit, which increased by 1.6%, driven by improved results in Treasury and Financial Markets and increased lending volumes. We experienced some pressure on lending margins due to a delay in tracking higher funding rates. Net interest income rose by 1.3% quarter-on-quarter, again supported by Treasury and Financial Markets, although we began to see liability pressure shift from a headwind to a tailwind, which was partially offset by a decrease in prepayment penalty income from mortgages. Our net interest margin remained stable at 130 basis points as the increase in net interest income was balanced by a higher average balance sheet. Turning to core lending growth, in Retail, mortgages continued to be the primary growth driver, with some growth also in business lending. Demand for mortgage lending was strong in Germany, as well as in Australia and Spain. In Wholesale Banking, loan growth was impacted by TLTRO repayments, specifically for short-term facilities in Financial Markets. Looking at the pipeline, we see ample opportunities, so we are optimistic about loan growth in Wholesale Banking. However, considering the higher level of macroeconomic uncertainty, we anticipate growth in 2022 to be below our target of 3% to 4%. Net customer deposit growth decreased by €700 million. In Retail, deposits fell by €7 billion, primarily due to an outflow in Germany following the introduction of negative rates in November 2021. Wholesale Banking, on the other hand, saw a seasonal inflow of €6.3 billion. Regarding fee income, year-on-year growth reached 9% with positive contributions from both retail and wholesale sectors. Retail fees rose by 6%, featuring a notable 26% increase in daily banking fees, reflecting a growth in primary customers, increased payment package fees, and a rebound in domestic payment transaction levels to pre-COVID figures, although international payment transactions still have potential for further growth. Fees from investment products were slightly lower, though they remained at a consistently high level compared to a record quarter from the previous year in terms of brokerage rates. Wholesale Banking fees grew by 17% thanks to syndication deals. On a quarter-on-quarter basis, retail fees saw a 1% increase, although this was offset by a decline in Financial Markets. Total costs were 4.2% lower quarter-on-quarter, influenced by reduced marketing and performance-related expenses, with the fourth quarter usually seeing higher costs seasonally. Year-on-year regulatory costs increased, primarily due to a higher contribution to the European Single Resolution Fund. The quarter-on-quarter increase stems from the full payment of the annual contributions to the SRF and the Belgian Deposit Guarantee Scheme this first quarter, which also applies to the annual Belgian Bank tax, while the fourth quarter included the annual Deutsche Bank tax. There were no incidental costs during this quarter, and I am satisfied with the progress in operating costs, as we start to see the impact of measures implemented. However, we must also look to the future and will invest in areas that offer the best returns. Then on to risk costs, which were €987 million or 62 basis points of average customer lending. This level is mainly driven by €834 million or 52 basis points of provisioning in Wholesale Banking related to Russia. This was predominantly in Stage 2 for rating migration following the sovereign rates for stage migration as we have transferred clients to the watch list and for our management overlay. In Stage 3, the Russia-related inflow was limited to €71 million as the book generally remains performing. Furthermore, we booked €178 million, reflecting updated macroeconomic indicators and released €124 million in sector overlays, which were taken in previous quarters for vulnerable sectors during the pandemic. Aside from these movements, risk costs were limited. And Retail Benelux risk costs include a release following the expiration of payment holidays. While in challenging and growth countries, risk costs reflected collective provisioning, mainly in Germany, Poland, and Spain. In Wholesale Banking, Stage 3 risk costs included limited additions to both new and existing files. Finally, Stage 2 ratio was up, reflecting the aforementioned additions, while the Stage 3 ratio went down to 1.4%. And regarding potential spillover of the situation in Ukraine, we see eurozone economic growth impacted and expect inflationary effects to stay longer. While we don't expect a recession, a stagflation scenario is a possibility. We're closely monitoring our loan book and engaged with our clients. However, so far, we have not observed a meaningful impact on credit risk. Slide 12 provides details on our ratio-related exposure as of April 30. Since the end of February, we have reduced our Russian exposure by €900 million and continue to lower this amount. Of this total, €1.3 billion is onshore, with €200 million covered by European parent guarantees, and the remaining partial exposure consists of Central Bank deposits. Our local capital stands at €100 million, and we have no outstanding internal guarantees. We have €4.5 billion offshore, with €200 million covered and €1.2 billion secured by ECA and CPRI, which is the outstanding amount. Undrawn committed facilities total €700 million, and notional hedge exposure is €600 million, related to client business. Our Financial Markets team has performed well over the past two months by decreasing this figure, and we aim to reduce it further. Additionally, we have taken €800 million in loan loss provisions, reflecting capital impact from expected losses, while the risk-weighted asset impact reflects unexpected losses. Return on assets on our Russian exposure has tripled in the first quarter, reaching €13.3 billion. Thus, at 12.5%, this corresponds to a €1.7 billion capital impact. When combined with risk costs, the total potential impact amounts to €2.5 billion already incorporated in CET1 capital. Our priority remains reducing Russian exposure, and we do not engage in new business with Russian companies. A significant portion of our Russian exposure is short-term. Concerning sanctioned entities, please note that repayments to ING are permitted and are being received. The next slide shows that our CET1 ratio came in lower at 14.9%. The decline was driven by higher RWA, which were up by €21.8 billion, including €1 billion FX. This was primarily due to €19 billion of higher credit RWA, excluding FX, which included €7.3 billion for the risk weight for the other 50% that was reserved for future distribution in line with our policy. On distribution plans, the final '21 dividend was approved at our AGM '22 and will be paid out on the 9th of May. In line with converging our CET1 ratio ambition, we will distribute an additional €1.25 billion. And this amount has been rightsized to reflect increased macroeconomic uncertainties. This additional distribution consists of a cash component and a share buyback, with the split derived from Dutch withholding tax requirements. Based on this, €0.232 per share will be paid out on May 18, and the share buyback for the remaining amount will start on the 12th of May. The additional distribution will bring our CET1 ratio pro forma to 14.5%. And I'm pleased we take this additional step in returning capital to our shareholders and to optimize our capital. As you can see on Slide 14, CET1 ratio remains well ahead of our ambition. On ROE, we saw some impact this quarter from the elevated risk cost. However, with the continued growth of customers, loans, and fees, as well as focus on cost and capital optimization, we maintain our ambition to provide an attractive total return. Cost income remains an important input for ROE, and we continue to work on our ambition of 50% to 52%. Then to wrap it up with the highlights of the quarter. This quarter represents a new challenge with the invasion of Ukraine. And I'm actually very proud of how we deal with this. We're focused on our people. And we manage the risk of Russian exposure while we keep the focus on our strategic priorities, including financing the green transition and improving the digital channel. And last but not least, we continue to deliver strong performance financially. This was reflected in a higher pre-provision profit, driven by resilient NII, higher fees, and lower costs, as well as a healthy return for our shareholders. Risk costs were elevated at €987 million, mainly in Stage 2. The Stage 3 ratio was lower at 1.4%. And we remain confident of the quality of our loan book. The CET1 ratio declined to 14.9%, with 50% of the first quarter resilient net profit reserved for future distribution. The main driver was RWA growth, primarily for the Russia exposure and these mortgages. And finally, on capital distribution, we will pay a €0.41 final cash dividend and a €1.25 billion additional distribution as announced today. With that, we will go to questions.

Operator, Operator

Our first question is from Mr. Robin van den Broek of Mediobanca.

Robin van den Broek, Analyst

The first topic concerns your exposure to Russia and the actions you've taken this quarter. In your introductory comments and slides, you mentioned that you cover within the CET1 ratio of €2.5 billion. You also highlighted your confidence in your track record regarding the risk framework. I'm curious about how well this €2.5 billion will cover future risks. Is this amount what you consider the best or worst-case scenario? Can you elaborate on your thinking regarding this? Is this situation resolved for you, or do you anticipate further increases? Additionally, could you provide some guidance on the potential tailwinds we might expect, as I believe this could lead to significant quarterly benefits for your net interest income trajectory.

Steven van Rijswijk, CEO

Thank you very much, Robin. And I will give the first question to Liliana and the second question to Tanate.

Ljiljana Cortan, CRO

Thank you for your question. Yes, correctly, we have had the elevated risk costs with respect to the Russian situation of €834 million, as you noted. In trying to show you how much we feel confident and adequate with current provisioning and impact on capital, we have summed this impact of the LLPs of €834 million with the additional impact that we have experienced through inflated RWAs, which have resulted in an additional €1.7 billion capital set aside for this cost. So these two are summing up to the €2.5 billion that you are saying. So first on the risk cost, as you've seen, only €70 million out of these risk costs refer to really defaulted exposure. The rest, Stage 2, which is following our very prudent risk management framework, governance, and processes in place, is actually reflecting the downgrade of the Russian-related exposure and as well a certain watch listing of the clients taking a prudent approach. On top of that, you have seen that we have in 60 days been able to manage down our exposure by an additional €1 billion. So all actions are showing that currently, we feel that our best estimate is adequately provisioned and adequately capital impacted.

Steven van Rijswijk, CEO

Okay. Tanate?

Tanate Phutrakul, CFO

And then, Robin, regarding our net interest income. If you review our fourth-quarter disclosure, you'll see that we experienced a reduction of approximately €600 million in 2021. This decline halted in the first quarter, and as you noted, the continued rise in long-term rates makes the replication benefit larger. However, a significant factor influencing net interest income is the anticipated move by the ECB to increase rates in July, which would enhance the positive momentum we are currently experiencing.

Robin van den Broek, Analyst

So just to come back on the second part. I think in the past, there was the market at least had the perception that a rate hike from the ECB would initially be a headwind for NII. But I think now you're saying you basically shortened your duration and that's no longer the case?

Tanate Phutrakul, CFO

Well, I don't think we ever said that rising rates is bad for banks. In fact, it's the opposite. We think rising rates coming out of negative rates is actually positive for financial companies and positive for ING, in particular, given our big retail deposit base. And I think rising rates from the ECB will be indeed more beneficial to us.

Robin van den Broek, Analyst

But also the part from negative to 0 basically, I think that's the more doubtful part of the sensitivity. Can you quantify that by any chance?

Tanate Phutrakul, CFO

Well, we'll give you a bit more detail on Investor Day. But what we can say now is that, as we mentioned, the €600 million compression we saw last year has disappeared. And that we expect, actually this year, that excluding the TLTRO impact, our NII will be positive this year.

Operator, Operator

Our next question is from Mr. Stefan Nedialkov from Citi.

Stefan Nedialkov, Analyst

It's Stefan from Citi. I have a couple of questions. Including two rate rises, is that lending margins are under pressure at the moment because yields are not tracking the increase in funding costs. Are you basically saying that you expect repricing to become stronger for the rest of the year? So that's my first question on NII, what rate assumptions and what lending margin assumptions do you have? The second question is on Russia. It seems that you're effectively silently writing down the exposure to Russia, both onshore and offshore. You have around €2.5 billion of combined P&L and impact capital. So you're not exiting Russia, unlike some of your other peers. What's the strategic thinking here? You're appeasing shareholders by taking a large provision, but you're keeping the optionality for the future? Is that the thinking? And if I may, a super quick third one on fees. Can you quantify the contribution of partnerships to fees at the moment from partners like AXA, Scalable Capital, etc.?

Steven van Rijswijk, CEO

Thank you, Stefan. I'll address the question regarding net interest income fees and also touch on Russia. To start, concerning net interest income, the question was whether this already accounts for the ECB's rate hikes. The answer is no. We indicate that, given the current improved yield curves, the negative impact has been completely eliminated. Net interest income, excluding TLTRO, is expected to be higher this year compared to last year. In terms of lending margins, we've observed that prices are up across many countries, but our cost of funding has also risen. Generally, it takes time for the market to reflect these funding costs fully. Consequently, we don't expect significant increases in margins for the time being, particularly regarding lending margins to our clients. However, we have turned a corner in liability income, which will positively impact net interest income moving forward. Regarding Russia, our priority is to ensure the safety of our personnel while complying with sanctions. In terms of our book, we aim to secure repayments and have stated that we will not engage in new business with Russian clients. This means we are gradually reducing our exposure, having already seen a €1 billion decline in the first two months. Our remaining exposure consists of short-term facilities and project financing backed by ECA and CPRI insurance, allowing us to wind down our book responsibly and decrease exposure in the interest of all stakeholders, including shareholders and savers. As for fees, we have numerous strategies to grow our fee income, including partnerships, though we haven't detailed them separately. Partnerships, like those with AXA and Scalable, contribute relatively small amounts, but they enhance the overall client experience, improving net promoter scores and bolstering the quality and quantity of client interactions and business with us. So, while the fee business from partnerships is still modest, it plays a role in enriching the overall experience for our clients, which in turn supports our fee income.

Operator, Operator

Our next question is from Mr. Kiri Vijayarajan, HSBC.

Kirishanthan Vijayarajah, Analyst

A couple of questions from my side. When I look at the RWA and the ratings migration there, it looks like you've actually had positive ratings migration if you exclude what you've done for the Russia exposure. So I wonder if you could talk a little bit about which portfolios outside of Russia have driven that kind of positive rating migration. And really, what's the risk that reverses in the next few quarters, just given what we're seeing in the macro? And then just coming back to the fees. The growth this quarter is obviously heavily skewed towards the wholesale bank. But focusing on just the retail fees, do you think you can replicate the same kind of double-digit momentum you posted last year? And in your mind, which are the retail markets where you think you're still sort of punching below your weight in terms of particularly kind of investment product penetration? Just sort of more forward-looking commentary there on retail fee would be helpful.

Steven van Rijswijk, CEO

I will take the question on fees, and Ljiljana will take the question on RWA. With regards to fees, like we said, I'm confident that we can continue to grow also this year our fees by 5% to 10% per annum. And why am I confident about that is different things. First of all, we continue to grow our primary clients and the level of interaction with them. That's point one. Point two is that in many of the markets, we are competing with, let's say, local champions or local banks who increasingly feel pressure to increase fees on the back of difficult market circumstances. We have seen it, by the way, lately in the Netherlands where ABN AMRO increased their payment package fees with 50%. And we see that in other markets as well. And three, in a number of markets, we're still actually relatively low in terms of our fee potential also in terms of the interaction we have with our clients. And even though, and I proudly always say every quarter okay, and now we have 2 million brokerage accounts in Germany, and this quarter, we have 2.1 million brokerage accounts in Germany, and that's all fantastic. But if I look at the total number of clients we have, let's take Germany. We have 9 million customers in Germany with only €2 million we have brokerage accounts, and that ratio for some markets is even worse. So it also means that we have still quite some way to go to deal with this leaving alone what we do charge for payments, what we do with insurance. We come from an environment where ING, as a business model, whereby fees as the old ING direct model were relatively benign compared to the activities that we did. And we're gradually catching up, but we're not there yet at all of where we are supposed to be to, let's say, our fair market share, if you will, compared to the size that we have as an organization.

Ljiljana Cortan, CRO

And on the RWA, yes, you're correct. In total, we do see an increase in inflation of RWA based primarily, as we say, on the credit risk side due to the introduction of the risk weight for the Dutch residential mortgages. And on the other side, €9 billion, as Stephen mentioned, for the increased density for the Russian portfolio. If we would actually neglect these 2 points, we would see on the rest of the portfolio and specifically on the Wholesale Banking side, a decrease. This comes from 2 sources. One is definitely on the volume side. We have seen in certain industries, for example, RF some small increases in the portfolio, which absolutely contributed to the decrease of RWA. But as well in the other parts of the Wholesale Banking, we do see reduced RWA based on improved structure, both in terms of the rating of clients but as well in terms of the products and maturities. So in total on the Wholesale Banking side, when isolating Russia, the improvements are positive.

Operator, Operator

Following question is from Mr. Benoit Petrarque of Kepler Cheuvreu.

Benoit Petrarque, Analyst

I have a few questions. First, regarding the special distribution, I would like to understand more about the €1.25 billion amount. It seems to have an impact of roughly 35 to 40 basis points. Is this amount a natural level for you considering the macroeconomic uncertainties? Can you sustain this level in the current environment and for the coming years? I want to clarify the appropriate size of the special distribution. Secondly, on costs, I noticed a strong decrease of 2%. How should we think about costs moving forward and the cost trajectory for the rest of the year? Given the ongoing inflationary pressures, will you be able to keep costs stable, or can we anticipate further restructuring? Lastly, I would like an update on the front book margins in the Netherlands concerning mortgages, which appear to be moving in a positive direction. You mentioned some pressure in Q1, but that seemed to be a timing issue. We are currently witnessing strong repricing on mortgages, indicating that the funding costs are reaching the clients. Can you provide an update on the front book versus the back book?

Steven van Rijswijk, CEO

Thank you, Benoit. I will address the question regarding the front book and costs, and then Tanate will cover distribution. Regarding the front book, it's common to see a delay when pricing and offering in the market, and this usually follows the previous quarter where full funding costs are reflected. As funding costs persist, margins will be affected. While this remains a comparative dynamic we've observed in the past, it's important to note that prepayments contribute to our income as customers pay penalties for partially paying off their mortgages. However, when interest rates rise, this source of income will likely decline. Consequently, while margins may recover, this will exclude the prepayment income which could reduce as margins increase, which makes sense. On the cost front, we are stringent and focused on maintaining operational efficiency with the necessary staffing levels. Over the past year and a half, we've implemented several decisions that are gradually showing results. Despite inflation impacting all markets, we are confident we can keep our operational costs at least on par with 2021 levels in 2022. Looking ahead, we will assess any additional measures we might need to take. We also recognize the importance of investing, and if inflation remains at its current levels, it presents a challenge for everyone. In the meantime, we are digitizing processes that benefit both our customers and our service costs, and we will continue to focus on this path as we have over the last nearly two years.

Tanate Phutrakul, CFO

And Benoit, on capital, clearly, we go through the normal capital management analysis to come with the €1.25 billion. We look at the outlook on earnings and how we can generate capital. And clearly, the tailwind on NII helps support that. We look, of course, at the Russian exposure, what the worst case could be, a stress test scenario. And based on a combination of that as well as any potential regulatory capital coming our way, and that's how we derived the €1.25 billion, which is rightsized from where our thinking was at the end of February prior to the war. That's how we have done that. And of course, we have been having constructive discussions with the ECB to arrive at this number, which they approved for us.

Operator, Operator

Our next question is from Mr. Raul Sinha of JPMorgan.

Raul Sinha, Analyst

I have a couple of follow-up questions. First, I'm interested in your perspective on the distribution strategy between dividends and share buybacks moving forward. I'm also curious about how speculation might impact the bank. I assume you are evaluating different internal scenarios, especially in terms of stress testing. How do you anticipate ING will perform in a challenging environment within your main markets?

Steven van Rijswijk, CEO

Thank you, Raul. First, Tanate, I will address share buybacks, and then Ljiljana will follow.

Tanate Phutrakul, CFO

Raul, regarding the share buyback, the Dutch tax requirements necessitate a minimum cash payment for the share buyback to be exempt from withholding tax. This is why we mentioned the split of 70 against the 380 payment this quarter. Our policy states that the majority of our capital distribution will be in cash, and we plan to adhere to that guidance. However, if the share price is significantly below book value, we may prioritize share buybacks. This is the guidance we can provide for now.

Ljiljana Cortan, CRO

On stagflation, we believe that the threat, if not already a reality, is present in our economies. This indicates that lower growth than expected is now part of our base case, along with higher inflation for an extended period. Because of this, we have adjusted our assumptions for loan growth to the lower range of 3% to 4% annually. However, we are equipped with our resources and coverage to manage this moving forward. It is undoubtedly a challenge for all of us, and we are closely monitoring the situation and evaluating scenarios to ensure we are sufficiently provisioned.

Raul Sinha, Analyst

If I could just start on that. What do you think is the impact on the cost of risk relative through-the-cycle guidance that you've given scenario?

Ljiljana Cortan, CRO

Well, it's difficult to say. We definitely keep our, I would say, through-the-cycle look for the years to come. It might be different from year to year, but through the cycle, I believe we're going to be there. We have significantly, as I said already, provisioned part of the portfolio through Stage 2 provisions and also through still some existing overlays from COVID time and also from the mortgage book, you will remember from the last quarter. So we do believe there are plenty of opportunities in our book to manage this with no significant volatility in cost of risk other than 25 bps.

Operator, Operator

Next question is from Mr. Jon Peace of Credit Suisse.

Karl Peace, Analyst

If I could follow up on Raul's question. Some of your peers have indicated that low Stage 3 losses suggest that 2022 may remain below the through-the-cycle rates. Do you share that perspective excluding Russia, as you see it today? Additionally, regarding capital return, if visibility regarding Russia improves, would you consider any extra returns later this year, or is everything settled until next year's results? Also, you mentioned that the €1.25 billion figure was adjusted from your expectations at the end of February before the situation with Russia. Did that imply that under normal circumstances...

Steven van Rijswijk, CEO

What Ljiljana also said, and what we typically do is that what you have seen through the cycle is that our cost of risk of all the European banks in the eurozone have been the lowest throughout the last 12 years on average. And what we have done also in the last quarter on the wake of higher inflation, on the back of disrupted supply chains is already taken overlays for mortgages and part of the Wholesale Banking book in risk cost. Now that, of course, is helping us now that inflation is really coming or persisting. So it also means that, yes, we still have a buffer based on corona. We built up buffers based on inflation. That's helping the rest of the book and, indeed, when looking at the first quarter. If you look at the remaining risk cost outside of Russia, the total risk costs were €987 million, Russia also about 85% of that. So it basically shows that for this quarter, we do not see current big problems looming. Otherwise, we would have taken the cost.

Tanate Phutrakul, CFO

Then on capital, it's not a simple mathematics that because Russia cost us €2.5 billion, we would have paid more from that perspective in capital returns. I think we just take a comprehensive view of what our earnings ability looks going forward. We look at stress testing. We look at issues like stagflation and what the economies will bring. And then we'll form our view at any given point in time about that convergence to the 12.5%. As for are we going to announce any future plans on capital return this year? Well, the future is the future. We don't comment on any actions we may take in the coming period.

Operator, Operator

Following question is from Giulia Miotto of Morgan Stanley.

Giulia Miotto, Analyst

I had a question about the decline in the Russian book. It decreased by €1 billion in two months. Is that a typical decline, or can you provide insight on the maturities of this book? Was there any proactive action taken, or is this just the usual rate of decline? That's my first question. Secondly, regarding the earlier question about negative rate charging, is the €300 million figure only related to the Retail bank, or does it reflect the group-level net interest income from charging negative rates? Is there also something occurring in the wholesale bank?

Mark Milders, Corporate Representative

Okay. So I give the floor due to Tanate. And Russia, I give the floor to Ljiljana.

Ljiljana Cortan, CRO

So maybe starting with Russia and the rundown question. Yes, this is the normal, I would say, rundown of our portfolio based on the maturities. As you might know, our exposure is partially short term, partially long term. On the long-term side, we are involved in several projects and asset-based financing, where we are also credit insured for the good part of the portfolio. So what we are currently running down is the short part of the book, and we will continue to do that. Clearly, the good relationship with the clients and long-standing relationship the clients helps out in that respect, which was obvious in the last 60 days when we were able to, in a regular way, manage down the portfolio by almost €1 billion.

Tanate Phutrakul, CFO

Then the question on negative rates charging, the €300 million that Steven referred to is mostly retail-related benefits. And from the wholesale bank, we are neutrally geared towards negative rates. As negative rates disappear, we don't expect to lose revenue. In fact, we should benefit from that actually in terms of PCM business.

Giulia Miotto, Analyst

Okay. Sorry to return to the topic of the rate of decline. Is half of the portfolio expected to be completed, or more, by year-end? Given that you have a significant shorter position, can you provide any comments on this?

Steven van Rijswijk, CEO

Yes. Thanks, Giulia. So look, this is an emerging market. So what do you do with the emerging market? The lion's share would runoff this year. Next quarter, Giulia.

Operator, Operator

Next question is from Mr. Omar Fall of Barclays.

Omar Fall, Analyst

Could you discuss loan growth specifically in wholesale? Even outside of FM, there hasn't been any, and presumably, that's not just related to Russia. What is the outlook in this area? Previously, you mentioned that the resumption of corporate lending would be a key driver for you over the next couple of years. Additionally, thank you for the helpful guidance this year on NII. However, the only significant sequential increase in NII has been in Poland, due to the rising policy rates there. It would be beneficial to get some actual sensitivities similar to what your peers are providing over a longer time frame, as the effects of higher rates tend to be exponential in future years. Is it possible to obtain this information at some point, even at your Investor Day? Lastly, could you provide some insight into the impact of lower prepayment fees in the Netherlands, given that the drop there significantly affects NII?

Steven van Rijswijk, CEO

Thank you very much. Omar, regarding loan growth in Wholesale Banking, the growth is primarily driven by the resurgence of syndicated markets post-pandemic. We are seeing an increase in larger underwriting syndicated deals with attractive fees for banks. The pipelines look promising and should remain strong for this quarter and beyond. Additionally, in real estate finance, there has been a slight decline due to reduced demand for certain building uses following the pandemic. We are currently assessing which buildings can be multi-used. These are two factors impacting us in the first quarter. For 2022, we anticipate that repayments related to TLTRO facilities will continue but at a lower rate. Consequently, while we expect loan growth for Wholesale Banking, it will be at a slower rate than the previously estimated 3% to 4%. On the NII sensitivity, it's worth noting markets outside the Eurozone, such as Poland, Romania, and Australia, have already seen rate increases from their central banks, which is favorable for us. We are eagerly awaiting announcements from the ECB, but even without an immediate rate change, the positive movement in short-term rates is beneficial. The negative drag of €600 million from last year has diminished, indicating a positive shift in NII this year. We will provide more details on NII sensitivity during Investor Day, where Tanate will discuss it further. Regarding lower prepayment penalties, we don't disclose specific predictions, but we expect margins—excluding these penalties—to normalize as funding rates are fully reflected in market rates, based on historical trends. This situation may exert some pressure on total NII in the Netherlands, as prepayment penalties have previously been a significant factor for several quarters.

Omar Fall, Analyst

That's very helpful, especially that we'll hear more on the sensitivities at the Investor Day.

Unidentified Corporate Representative, Corporate Representative

That was the most important part? I should have said it in the first place.

Operator, Operator

Next question is from Benjamin Goy of Deutsche Bank. Mr. Goy, are you there?

Benjamin Goy, Analyst

Just one major one left. I mean you gave guidance on your Wholesale Banking loan growth. But just wondering about the mortgage book from here with higher mortgage rates. I mean in some markets, they moved up a lot year-to-date, Germany, 2.5 times. So how do you expect this to impact your origination ultimately loan growth in mortgages?

Steven van Rijswijk, CEO

The loan growth in the first quarter was strong, influenced by several factors. In the Netherlands, we have observed a sustained demand, and we recently recorded significant mortgage growth in Germany as well. We do not anticipate a decrease in this demand in the short term, which makes us optimistic about continued loan growth in retail.

Operator, Operator

Our next question is from Mr. Farquhar Murray, Autonomous.

Farquhar Murray, Analyst

Just two questions, if I may. Firstly, just coming back to the capital update and specifically the kind of question around how the €1.25 billion was arrived at. Should we think of a pro forma 14.5% CET1 level as a kind of near-term threshold perhaps to year-end? And then secondly, just coming back to Russia. In answer to Giulia's question, you give a bit of a sense of how the exposures will develop. Can I ask if the RWA would develop in a similar manner? And on a subsidiary point, the €4.5 billion of market RWA we saw in the quarter, how would that have developed given the markets we've had since? And could we expect some of that to reverse?

Steven van Rijswijk, CEO

Good questions. However, I’m not the best person to provide answers. Regarding capital, should we consider a pro forma 14.5% as our target for the end of the year? No, we have indicated that we aim to gradually reach 12.5% over the next few years. Concerning Russia, did the market risk-weighted assets increase due to high volatility? Yes. If the royalty decreases, will that situation reverse? Yes, that’s correct. Did I overlook any questions?

Farquhar Murray, Analyst

And the actual credit component as well in Russia, will it develop in line with the exposure?

Steven van Rijswijk, CEO

Yes. I mean, look, we have seen currently a decrease of our exposure with approximately €1 billion. I've just said to Giulia, I believe, that we have a sort of a barbell in our exposure, has short-term unsecured, long-term secured. And the short-term exposure, if that gets repaid back, we also see some write-backs or term banks in RWA because that happens when we reduce the exposure.

Operator, Operator

Our next question is from Mr. Tarik El Mejjad of Bank of America.

Tarik El Mejjad, Analyst

I have a quick question about the dividend. To clarify the 50% payout related to resilient earnings, should we include or adjust for the Russian Stage 2 provisions? Regarding capital return, you mentioned that you would like to target 1.5% within the next two years. We understand that this is crucial for your return on equity. This indicates a significant cash flow over the next two years. Do you believe the 14.5% already accounts for developments in the coming quarters? Someone raised this question earlier, and I want to comprehend the ongoing discussions. Are you limited by the ECB guidelines, or is this a decision made internally?

Steven van Rijswijk, CEO

On the dividend, I didn't specify two years; I mentioned a couple of years. I'll pass it over to Tanate for further details.

Tanate Phutrakul, CFO

Yes. A couple of years means that we will converge over time. And I think in the capital return, our conversations with the ECB have been very constructive. And it's really very much based on our own capital management, looking at the geopolitical situation, looking at capital generation that will determine ultimately the pace at which we get to 12.5. So you can imagine that given where we are today, the clarity of the future, it's a little bit more foggy than it was in February. That's why we rightsized the capital returns based on what we see now. But suddenly not being constrained by the ECB, it's more how we see the geopolitical and credit risk as we stand today.

Operator, Operator

Our next question is from Anke Reingen of RBC.

Anke Reingen, Analyst

The first is just coming back to Russia. The €800 million of provisions, can they sort of be used against onshore as well as offshore? Or is there some accounting so it's partly just onshore? And just on the sanctions exposure, the €3.3 billion, and your comment imply no additional exposure, I guess, would suggest that the €2.5 billion capital is largely against that exposure. And I mean how confident are you that, I mean, that the amount could go up with more repayments are received? Is that short term as well? Was it more long term? And just in terms of how fast this number can be coming down. And then sorry, one last question. You briefly mentioned potential regulatory headwinds in your capital path consideration. Is there something on the horizon other than Basel IV in the rest of the year we should be aware of?

Steven van Rijswijk, CEO

Sure. I’ll address the question regarding regulatory challenges and repayments, while Ljiljana will cover the provisions for onshore and offshore activities. Concerning regulatory challenges, we don't anticipate any significant issues. As I've mentioned previously, Basel IV encompasses all necessary adjustments, and the overarching direction from the ECB remains consistent. While we may observe occasional volatility or fluctuations due to model updates, this is expected, and there's nothing notable to report on that front. Now, regarding repayments, we remain optimistic. Although sanctions may increase, they do not prevent sanctioned individuals from making repayments. We continue to receive payments from sanctioned entities as long as they are operational. Aside from a €71 million exception, our Russian clients have been performing well, and we anticipate they will continue to make repayments in the upcoming quarters. Ljiljana?

Ljiljana Cortan, CRO

Yes. On the total risk cost for Russia, €834 million, approximately a bit less, around €200 million refers to the onshore exposure. The rest refers to the offshore exposure.

Operator, Operator

And our next question comes from Guillaume Tiberghien of BNP Paribas Exane.

Guillaume Tiberghien, Analyst

My question relates to the subsidiary in Russia. It has €1.3 billion of exposure incurring losses in that subsidiary, in which case we would worry to lose up to €1.3 billion or when the capital is gone, it's gone and the subsidiary goes away, including the RWA? And what are the RWA in that subsidiary, please?

Steven van Rijswijk, CEO

We are currently assessing our going concern situation and are seeking repayment both onshore and offshore. Our Bank in Russia has a capitalization of €100 million. We don't provide guidance on potential future capitalization. If the situation deteriorates and we lose our subsidiary in Russia, we would consequently lose the equity, amounting to €100 million.

Guillaume Tiberghien, Analyst

So you would not recapitalize it?

Steven van Rijswijk, CEO

I've said that we're not going to make comments on the future. But if you say if you would lose your subsidiary at this point in time, what would that mean? It would mean we would lose our equity, that would be €100 million.

Guillaume Tiberghien, Analyst

Okay. What are the RWA in the subsidiary?

Steven van Rijswijk, CEO

We don't disclose that. That will be released.

Operator, Operator

And we have a follow-up question from Mr. Stefan Nedialkov of Citi.

Stefan Nedialkov, Analyst

A quick follow-up for me. A lot of numbers on NII flying around, and you did mention you will provide some more details with the Investor Day. But obviously, that's more than a month away, and people need to think about their NII numbers in the meantime. So I would really appreciate it if you can give us some sensitivity to the potential ECB rate rises? I'm assuming one happens in the summer and one towards the end of the year. What would that mean for your NII? You obviously mentioned the €600 million headwind from the liability margin is going away this year. And the €300 million benefit from negative charging, which is partly offsetting that. So when you put all that together, with essentially rate rises, what does that mean in terms of extra NII over and above your guidance for '22?

Steven van Rijswijk, CEO

Yes. I believe the expected rate increases will occur on or after Investor Day, and I acknowledge your request for more guidance on Net Interest Income (NII). We have mentioned several points previously. Firstly, despite some market opinions suggesting there would be no benefits from rate increases, we have stated that there are indeed benefits. The €600 million drag is already behind us, and this year, we expect a positive impact on NII. We anticipate that NII will be higher this year as we see advantages in various markets. We will provide more guidance on NII sensitivity on June 13, which is in 5.5 weeks, at that time we can discuss it further.

Operator, Operator

And we have a follow-up question from Benoit Petrarque of Kepler.

Benoit Petrarque, Analyst

Just a short one on Basel IV, given the risk assets have been moving quite substantially this quarter. What is your forma Basel IV CET1, please, at the end of Q1?

Steven van Rijswijk, CEO

We did not have any further impact on Basel IV in the first quarter.

Benoit Petrarque, Analyst

Okay. So I think the difference was less than 30 bps, right?

Steven van Rijswijk, CEO

I will hand this over to Ljiljana. But I assume you are referring to the remaining impact from Basel IV being 30 basis points, is that what you mean?

Benoit Petrarque, Analyst

Yes. Yes.

Steven van Rijswijk, CEO

Less. It's almost zero.

Operator, Operator

And we have a question from Esther Castro of Banco Sabadell.

Esther Castro, Analyst

Can you hear me?

Steven van Rijswijk, CEO

We can.

Benoit Petrarque, Analyst

Yes. Can you hear me?

Steven van Rijswijk, CEO

Yes, Esther, we can hear you very well. Thank you.

Esther Castro, Analyst

Sorry. Just only a follow-up concerning the GDP growth, I mean, the sensitivity. Could you share with us, gentlemen, please any kind of sensitivity scenario concerning the new macro like, for example, for every 1% drop in GDP, which will be the implication of the cost of risk if, of course, you can share with us? And which are the moving parts in this GDP, well, factor to provision?

Steven van Rijswijk, CEO

Thank you very much, Esther. And look, I mean, GDP is only one of the elements that doesn't impact as GDP. But then the question is what does it do to inflation? What does it do to unemployment? What does it do to energy prices? So there are heaps of elements that link that are not necessarily that you then also would need to know, but because GDP stand-alone is a much too simple metric to base the cost of risk on. Otherwise, we wouldn't have needed Ljiljana for this because it's actually quite complicated. So there are more layers behind this and that we do not disclose.

Operator, Operator

We have a follow-up question from Robin van den Broek of Mediobanca.

Robin van den Broek, Analyst

Sorry to come back into the queue. Could you maybe give us a bit more explanation about the tax implications to do buybacks in the Netherlands I guess it has to do with how much cash dividends you pay, but I'm just trying to understand how this will affect future decisions on capital return, cash versus buybacks. And secondly, I was wondering if you could give any disclosure about how much revenue P&L would be lost on the back of your unwind of the Russian activities?

Steven van Rijswijk, CEO

Thank you, Robin. We do not disclose the demand in Russia, but you can see the size of the book and typically know the net interest margin, allowing you to estimate annual revenue from Russian clients. This situation is gradually winding down, so it’s partly short-term and partly long-term. In the meantime, as I mentioned in the past, if you consider our total exposure, it is decreasing. Therefore, the impact is limited, which means we can’t grow there. I'll speak soon.

Operator, Operator

Thank you for joining First Quarter 2022 ING Analyst Call. Thank you for your attention. You may now disconnect your lines.