ABN Amro Bank NV

OTC:AAVMY

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for holding and welcome to the ABN AMRO Q3 2018 analyst presentation. [Operator Instructions]I would like to hand over the conference to Mr. Kees van Dijkhuizen, CEO. Please go ahead, sir.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Thank you very much, operator. Good morning, everybody. Welcome to the investor and analyst call for ABN AMRO's Q3 results. I'm joined here by Clifford Abrahams, our CFO; and Tanja Cuppen, our CRO. This update is shorter than our usual quarterly presentation because next week we are hosting our Investor Day. So today we will focus on the Q3 financial results.If you now to Slide 2, I will highlight the main points of the third quarter. I'm pleased with our financial results for the third quarter. They were good. Our net profit was EUR 725 million. Our NII increased supported by corporate loan growth in our strong domestic market. Costs are well controlled and impairments continue to turn down. Capital position strengthens further to 18.6%. And as a result, we decided to accrue 60% of the year-to-date net result to create flexibility to pay additional dividends over 2018.I'm also very pleased with our performance under the 2018 EBA stress test showing strong capital resilience under adverse circumstances. We also scored well in RobecoSAM's annual sustainability review, and we are one of the best performing banks in sustainability across the board again. We have renewed our purpose in banking for better for generations to come and refreshed our strategy. We will focus on 3 pillars: supporting our client's transition to sustainability, reinventing the customer experience, and building a future-proof bank. We will discuss these strategic teams in more detail during our Investor Day next week. Furthermore, the members of the Executive Committee will give an update on achievements and outlook for their businesses.We now move onto the P&L slide on Slide 3. Like I said, we are pleased with the third quarter result with net profit of EUR 725 million, up 8% on last year. Operating income increased on the back of higher NII and private equity gains. Operating expenses were marginally higher. It's also good to see that impairments are lower compared to previous quarters. Tanja will discuss these in more detail later.Now I would like to hand over to Clifford to take you through the details on the financials.

[Clifford J. Abrahams, CFO & Vice]

Thank you, Kees. I will start with developments in client lending on Slide 4. The trends we see in the mortgage market are that house prices continue to rise, but with a lower transaction volumes due to a housing shortage. We also see that long-dated mortgages remain the most popular choice given the low interest rate environment, and competition from banks and non-banks is still strong. Because we remain disciplined in pricing, we have seen a decrease in our market share to 16% over the last quarter and 18% year-to-date. This is below our natural market share. On the other hand, commercial banking continues to grow driven by the strong Dutch economy leading to credit demand across all sectors.CIB loan book showed a small increase. That's our corporate bank and this warrants an explanation. We now said in August that CIB would lower its RWAs by EUR 5 billion by 2020. We also said that the decline would not be linear and you can see that this quarter. Dollar appreciation was responsible for our EUR 0.1 billion increase, while loans in the Netherlands and natural resources also showed an increase. On the other hand, volumes in commodities and transportation were lower reflecting our business refocus. We expect the effects of the CIB refocus to be more evident in coming quarters. Finally, we are encouraged by the increase in consumer loans, given our efforts to grow steadily in this market.Turning now to net interest income on Slide 5. NII was up versus Q3 last year mainly due to corporate loan growth and higher mortgage penalty fees. Margins remained broadly stable across products compared to Q3 last year. These effects were partly offset by headwinds from low interest rates. Our income related to our equity duration is declining. We also lower duration to better position ourselves for higher rates and margins on deposits were under pressure as most client rate cannot be lowered further. These headwinds leads to a marginally lower NII versus Q2 and we expect a further marginal decline for Q4.We also updated our model for nonmaturing deposits. This led to lower internal compensation for deposits raised by our business lines, lowering NII for business segments with a consumer deposit base and benefiting group functions. From now on, interest income of group functions will be distributed to the business lines in line with our allocated equity. The combined effect of all this has led to some interest -- intergroup shift in NII and the numbers you can see relating to this is in the appendix for this presentation. I would emphasize that the overall impacts of the group is limited to only around EUR 10 million additional hedging cost per quarter from the rebalancing made to our interest rate exposure.Moving now to fee income on the next slide. The third quarter fee income was largely unchanged from previous quarters. Trading volumes in the financial markets were relatively low, negatively impacting fee income at clearing. Securities volumes in private banking were also somewhat lower. This was offset by an increase in payment package fees in retail banking. Our other income has remained above trend. EUR 80 million of other income was due to hedge accounting and various other evaluation account effects. And private equity showed a strong gain of EUR 107 million in Q3. Currently, we are the sole investor in our private equity funds. We're in the process of exploring possibilities to enable external parties to participate in existing and new funds, and I expect to update you regarding this in coming weeks.Now moving on to costs on Slide 7. As you can see from the left-hand chart, personnel expenses continued to trend down. FTEs have decreased another 500 since the last quarter and by 1,500 over the year. We took a restructuring provision of EUR 27 million in Q3 and expected to take a further provision in Q4. Other expenses, excluding incidentals and levies, are up. This was due to somewhat higher external staffing and cost related to completed M&A activities within private banking. External staffing is up due to high levels of temporary staffing and some regulatory projects currently underway.On the right-hand chart, you see how we are delivering on our cost saving programs. Since year-end 2015, our cost saving initiatives reduced costs by EUR 640 million. As you know, we are targeting EUR 1 billion cost reduction including emulations to corporate bank. So we are well on track here.I'll now hand over to Tanja to pick up impairments on Slide 8.

[Tanja J. A. M. Cuppen]

Thank you, Clifford. I will update you on 3 topics which have your attention: loan impairments, conduct and the stress test. Starting with the impairments. The third quarter showed a further decline. Within CIB, some additional impairments were taken within natural resources on already impaired files, mainly offshore clients. In commercial banking, impairments were largely on existing shipping files. This quarter, we had a release in healthcare and I don't expect substantial impairments here for the remainder of the year.The lower coverage ratio is largely due to a write-off of fully provisioned Madoff files. I'm still confident with the outlook we gave for full year impairment and expect to end below the through-the-cycle cost of risk of 25 to 35 -- 30 basis points. The indicators for the Dutch economy remains strong and the outlook remains positive. The defaulted portfolio continues to decline, though challenges remain in the sectors we have identified.With regards to conduct, we are transparent with regulators and have an open dialogue. We have made significant investments in our transaction monitoring processes and systems, and continuously use actual cases to improve. We have also made significant investments in KYC over the last years. Our decision to divest offshore private banking activities was partly related to reduce our exposure to combat risk. The Executive Committee is actively engaged on these topics.Now moving to the results of the EBA stress test on Slide 9. I'm pleased with our recent EBA stress test results where ABN AMRO performed really well. Under the adverse scenario, our CET1 ratio declined by around 270 basis points reflecting the resilience of our capital position. This number compares favorably with the 48 banks in scope for the stress test. At 14.5% in the adverse scenario, the CET1 ratio remains above the 2018 SREP requirement of 10.4%. The same applies to the leverage ratio which remains above 4% in the adverse scenario.Now handing back to Kees.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Thank you, Tanja. As you can see on Slide 10, CET1 is up to 18.6% held by lower RWAs, something we also saw last quarter. I would like to point out that most of the drivers responsible for this decline of RWAs and the Basel III do not improve Basel IV RWAs. For example, higher collateral values for residential and commercial mortgages lower Basel III RWA, but don't impact Basel IV RWA. So our Basel III core Tier 1 ratio has improved materially during 2018. Basel IV core Tier 1, excluding mitigations, remained broadly flat around 13%. Nevertheless, we have decided to accrue 60% of the total year-to-date results. It gives us the flexibility to pay an additional dividend over 2018. We prefer an additional dividend over a share buyback.Our final decision on dividend payout will be made at the full year results in February of 2019 when we could also reflect on our SREP targets for 2019, which we expect by January 2019 at the latest. We want to know the SREP because ECB is currently formulating industry-wide guidance on provisioning backstops for nonperforming loans. If these backstops turn out more stringent than accounting standards, this will lead to capital reductions or a higher SREP capital requirement. In addition, the leverage ratio required of 4% is for the time being also a constraint in the short term we have to deal with. We will update you further on our Investor Day on capital management, returns, and our Basel IV management response including mitigations.Now moving on to our targets on Slide 11. As you can see on this slide, we are well on our way to achieving our financial targets for 2020. We have already for some time been consistently meeting 3 of the 4 targets being ROE, capital and dividend. Cost/income ratio over the first 3 quarters also meets our target. However, the full year number will be impacted by seasonally higher regulatory leverage in the fourth quarter. And as already mentioned, we also expect some additional restructuring charge in Q4. So here we still have some work to do to bring our C/I ratio structurally within the target range.Before I go to Q&A, I would like to briefly recap the highlights on Slide 12. We delivered a good quarter with a strong net profit of EUR 725 million. NII remains resilient held by domestic corporate loan growth. Impairments show a further decrease from last quarters. Costs are well controlled. We are focused on the Q3 results so far. As we have an Investor Day next week, I will most likely refer you to next week for questions on strategic themes and outlook of the various businesses.Now we'd like to ask the operator to open the call for questions.

[Operator]

[Operator Instructions] The first question is from Pawel Dziedzic, Goldman Sachs.

[Pawel Dziedzic, Equity Analyst]

Two questions from me. The first one is quite basic I guess and it just goes back to your payout accrual. Can you help us understand how you decided on 60% for this quarter? Is it simply a figure that leaves your core Tier 1 slightly above upper end of your capital target or perhaps there is more to it? And I guess related to that, how flexible do you intend to be when you announce your final dividend recommendation? For example, if your guidance on Basel IV including mitigation changes a little bit? So that will be my first question. The second question is just on your mortgage market shares dropping. You mentioned the competition is ongoing, but how should we think about your tactics here over the next couple of quarters? How long are you willing to see this market share erosion and at what point in time you think you might need to adjust your pricing?

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Thank you very much. Payout accrual of 60% is a figure we have taken now into the figures, not so much because it is exactly leading to an 18.6% or something like that. It's just a percentage we feel comfortable with to accrue today. And we are flexible in SREP. With respect to the market share in mortgages, of course we will look into this carefully. But it's also important that -- and we've seen it actually in the -- well, actually 10 years ago when there was also a lot of competition in the mortgage area. We want to stay disciplined here, especially when you talk about 20, 30 years mortgages because as we swap the interest, you actually lock in a margin for a long period. And we don't want to have margins below hurdle. So we will be disciplined here in our margin approach. But of course, we will watch it every quarter how we exactly are going to maneuver in the quarters.

[Pawel Dziedzic, Equity Analyst]

Maybe just one follow-up and this is on leverage. So you mentioned you still want to be above 4%. When do you expect to realize this 50 basis points uplift under CRR2? And does it impact the way you think about dividend payment when you announce the dividend early next year? Is this one of the things that you consider?

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Yes, well, the leverage ratio, the one related to clearing is actually in the figures now for 2021. So that's late. There are negotiations at the moment going on in Brussels to open up possibly a possibility for national regulators to early adapt. But that's not done yet. So at the moment, it's 2021.

[Pawel Dziedzic, Equity Analyst]

And would you be willing for the meantime drop below 4% or we should see 4% as already a floor?

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

I think the 4% is just seen by regulators as a kind of something they see as a kind of floor.

[Operator]

The next question Farquhar Murray from Autonomous.

[Farquhar Charles Murray, Partner, Insurance and Banks]

Just 2 questions if I may. Firstly, the impact of Basel IV seems to have increased by 100 basis points versus the indication we got at full year '17. Could we just decompose what drove that increase? And I clearly understand that some of the risk migration we have seen in the year probably won't carry through to Basel IV, but I don't think it can explain all the change there. And then secondly, coming back on the Dutch mortgage margins, I mean we seem to have some commentary towards positivity on margins there. Obviously, you seem to be losing market share as the whole thing is flat. What is -- are you seeing in terms of margin trends in recent quarters by product? And also just what's your kind of appetite with regards to the longer duration mortgages at the moment, particularly in terms of the split to production you're doing?

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Clifford, you take the first one, yes?

[Clifford J. Abrahams, CFO & Vice]

Yes. The -- so Farquhar, I think you're right to point out the approximate steps. So we do have volatility in RWAs under Basel III, in particular quarter-on-quarter, but I'll just explain the reason for the variance. There are few things. We continue to refine our methodology regarding Basel IV and that was an element over the course of this year. I mean the rules we know are not enacted yet. We need to make judgments and we continue to refine that. I think, there is the -- we highlighted the credit quality improvements as 1 driver. So that flows straight through in Basel III, but Basel IV, we're using the floored standardized approach and so it does not directly impact that. I think our data is also an element that we've been working on improving what we know about our loan book and that flows to the benefit of Basel III, [ that's something ] to highlight. And finally on business mix. While our overall loan book is roughly flat through the year, our mix has changed a little bit in corporate. And that the margin has an impact because the capital intensity of some of the corporate businesses is really quite high under Basel IV. And so you put all that together and that drives that delta. So while RWAs have come down on the Basel III, they are sort of flattish on the Basel IV. And we are calling around 13%. So it's actually a marginal increase, but it's approximately 13%. So a number of drivers. I think we're working hard on a few things. So one on business mix. I mean, as you know, in August we announced that we would reduce the size of our corporate bank and that will flow through -- that will reverse some of the effect we've talked about through mix. We're also working, I call it, on business response. So across the business, we are working very hard on Basel IV including specific mitigations where we're working through the rules. So it's not just the rules. We want to adapt the business to Basel IV. But combined with that effort, we are feeling really quite comfortable with Basel IV. It's around 13%. We said we wanted to be 13.5% early in the phasing, we have some years to achieve that. So we don't consider Basel IV as sort of hard constraint in terms of running the business or in thinking about our flexibility around additional distributions currently, in case talked about some of the other factors that we're reflecting on.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Thank you, Clifford. With respect to Dutch mortgages, I would say the margins across the board are a bit under pressure. So for all the maturities, with respect to the longer durations, our market share of course is clearly lower there. As banks I think in general, it's more for pension funds and insurance companies, not a sweet spot. And especially there of course, these days a lot of clients go there in the area of 20, 30 years because they expect higher interest rates going forward and they like to take up an interest fixed period of 20, 30 years. And I said that's an area where our market share is lower compared to the 5 years and 10 years.

[Farquhar Charles Murray, Partner, Insurance and Banks]

Just really quick follow on. Coming back on the kind of 3 or 4 drivers you've identified for the Basel IV. Could you give us a sense of which is the most significant? Is it the refinement in methodology? And can you be specific to what might have changed there, I mean in particular it does not pick up any change on the NHG treatment?

[Clifford J. Abrahams, CFO & Vice]

Yes. So I think the factors, I gave sort of 3 elements and I think they have -- I would just parlor they're all meaningful in terms of accounting for that difference. I think on NHG, our current treatment in our estimate of around 13 includes the benefit of NHG that we see that as a sovereign guarantee and our planning is that that would transition into Basel IV. I think you highlight a theme here, which is we're making judgments about Basel IV although the rules 200 pages sounds like a law. We have to make judgments about how it applies, and I'm sure our peers are doing the same. We'll continue to refine that. We think the best way of signaling sort of financial flexibility remains through our Basel III target of 17.5% to 18.5% and we're a little bit above that today. And so feeling well positioned on Basel III, comfortable on Basel IV, a bit continuing to work hard on this, and will update on this further on our Investor Day next Friday.

[Operator]

The next question is from Mr. Stefan Nedialkov, Citi.

[Stefan Rosenov Nedialkov, Director]

Stefan from Citi. A couple of questions on my side. Just to continue on the Basel IV versus Basel III. A bit -- your previous methodology include input floors and to what extent that input floors play a role in terms of Basel IV previous estimate -- Basel IV today's estimate? On the second -- on my second question, well, some banks have told us how much they can mitigate Basel IV. Are you comfortable giving us some guidance out of this 560 basis points or so of Basel IV impact? How much can you mitigate it by management actions on day 1 versus overtime? And lastly, you did mention there used to be industry-wide NPL coverage guidelines that are coming up. Are we talking about the 2-year unsecured 100% coverage, 7 years secured NPL coverage type of guideline or do you have anything else in mind? And any color you can provide us in terms of numbers?

[Clifford J. Abrahams, CFO & Vice]

Okay. I'll take the first 2 and Tanja the third. In terms of -- we're talking about the output floor. So the figures that we've provided are based on the output floor. So the revised standardized approach times are 72.5%. That's how we're thinking about it and they are the numbers that we quote. Clearly other banks influenced by other things, but the output floors are of a binding constraint for us. We work through the input floors, but for our constrained IRB, that's meaningfully lower than our kept revised standardized approach. So that's why we're focused on that standardized approach as the sort of the constraint. I think in terms of our responses and mitigations, we're working -- as others are, we're working hard on that. We expect that mitigations would mitigate some of that RWA inflation and we'll give more color on that next week. We see there's really a few elements around Basel IV to record a business response. So mitigations are working through the call it the rules and the application, thinking about our products. But it's, I'd call that behind-the-scenes work and we think there's scope for that as others have commented on. We think -- we'd call it business response, which is something -- which is how we're managing our business in terms of the mix of business, can we distribute more. We've announced I think a material step in that direction in August. And so that's separate. And finally, pricing. So part of it is mitigation is around can we reduce our Basel IV RWA? We think we can meaningfully, but a lot of our work now is thinking about how do we deliver adequate ROE on all our business going forward. And across that, we'll update and give you further insight into our thinking next week.

[Tanja J. A. M. Cuppen]

Okay. Then I'll respond to your question on the NPL guidance. And it's indeed other guidance related to the percentages that you were just mentioning. Like you may see a few developments in this area. We see, well, ECB has come with NPL guidance, EBA has guided to a -- as a -- send out as a proposal and also the European Commission is working on regulation for nonperforming loans. We see quite some development. But it's still uncertain how this all will turn out. But we do see that regulators are developing their regulatory expectations. Of course, the ECB guidance is already in place, but that's applicable to new exposure. So it's hard to say at this stage what the implications will be, but we are preparing for that and doing our analysis.

[Operator]

The next question is from Mr. Nick Davey, Redburn.

[Nick Davey, Research Analyst]

Two questions, please. The first one on the private equity business. First, in terms of its contribution this year, but second, this comment you made about seeking external funding. I mean if I look at the first 9 months of this year, the private equity business have contributed nearly 10% of earnings. So I mean it's almost meeting its own division pretty soon. If I go back just a couple of years to 2016, it contributed basically nothing. So could you just help us, a, understand what's going on here, why they're really strong results this year, maybe make some comments about how comfortable you are in terms of this unit introducing I guess this P&L volatility? And maybe related to that, just talk about this comment about seeking external funding? Are you trying to beef it up or you're trying to reduce it by moving it to third parties? Just so I understand what's going on there please. And then the second comment, please, on -- second question on the replicating portfolio. So it's a bit of a perennial question from this side. But yes, we obviously had the helpful update into the quarter on what you're doing with the nonmaturing deposits, but still struggling a little bit to understand the outlook here because on the one hand, in the NII slide, you're talking about the headwinds from this replicating portfolio. On the other hand, you're talking about now being better positioned and interest rate rises. So I'm just trying to understand a specific attrition from this portfolio as if rate -- if rates stay low for as long as rates stay where they are. And b, what you hope starts to happen as rates start to rise? I hope that's clear.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Thank, Nick. With respect to private equity, as you mentioned, good results, very good results this year and less in earlier years. So that also is, by the way, one of the reasons it's quite cyclical that we would like to also have external funding here, third parties. It's, by the way, also market practice, so it's not new. And we think indeed it will lower our private equity exposure a bit when we have in third party -- third parties in the private equity area. And less cyclical movements as well. And Clifford on the...

[Clifford J. Abrahams, CFO & Vice]

Yes, I think on -- we appreciate it's a complex area. I think I'd say 2 things. So we're exposed to low rates around the 3 themes. So one is, it comes through the mortgage market which Kees talked about. But the 2 things that we're talking about here in this question are deposit margins and the money we make on our equity, 2 different things. So in terms of our deposit margins, as you said, we recognize our margins by the replicating portfolio. That introduces a lag in terms of this interest rates are coming down overtime. So if rates develop as expected, there'll be a natural feed-through into our, call it, our replicating portfolio or the way we think about margins that will reduce margins moderately overtime. And so we know what the forward mark is. Saying about rates, rates have consistently come down and that works its way through. And so our outlook has been if you like some modest further deposit margin pressure over the next year or so and based on our view of interest rates, we expect those to pick up at the end of next year short ways. And so that -- and now clearly if the market -- if rates pick up sooner or later, you'll get variance around that. But that's one effect. There's not a lot we can do about that other than lower the rates we pay to clients and we feel we've -- that's pretty much run its course. I think the second -- the third theme I talked about was position ourselves for rate increases. That relates to the money we make on our equity, if you like, equity duration, and there we've shortened somewhat less than 2 years as disclosed at the half year. And that means that we're in a position -- our money is locked in for a shorter time period and as rates pick up, we should see the benefit of that through our -- reported through group functions and then allocated out to the businesses. So I hope that gives a bit further clarity. We're happy to pick this up offline as well and we'll touch on it next week at the Investor Day.

[Nick Davey, Research Analyst]

That's really helpful. So could I ask just one follow-up then? So back on the private equity contributions which you're obviously trying to reduce, could you give us a sense of the capital tied up in the private equity operations currently and maybe the capital benefit you get from seeking third party in...

[Clifford J. Abrahams, CFO & Vice]

Yes. So we have -- the total sort of assets we have is just under EUR 1 billion and there are different risk weights associated with that portfolio. So the RWAs are more than that, somewhat more than that. And I think if we end up engaging with third-party money, I think at least in the short term, you should see it as an opportunity to leverage the capability in the business more than a material reduction in RWAs, at least in the short term.

[Nick Davey, Research Analyst]

And then so I'm going to try my luck on the deposit margin pressure because I mean I can see you're still avoiding giving us numbers which I sympathize with. But if I interpret your language on modest further deposit margin pressure over the next year or so, my suspicion is that you're running something like a 5-year swap book then. So at the moment, 5-year swap rates are in line with the rolling average of the last 5 years, which means for the next year or so, the swaps you put on 5 years ago are reinvesting lower, but at some point 12, 18 months from now, you reach net neutral. Am I wider than mark? Is that a credit computation...

[Clifford J. Abrahams, CFO & Vice]

It's at -- if at where -- I guess you are trying your luck. I agree with that. And we've not disclosed deposit margins. I don't think any banks do that. See, I think the 5 years, it's a bit less than that. And we'll give a bit more color, but we don't want to give full cost for obvious reasons on particular elements. But it should give you -- we've guided the effect of this in our historical remarks around flattish NII and we've indicated earlier today what we see of Q4. We'll give a bit more color on that next week to help folks understand it. But it's really so that you are in a position to come with your view of interest rates because people have different views.

[Nick Davey, Research Analyst]

Yes. Absolutely. Yes, certainly, we've got to make the forecast as soon as [ you don't have to ].

[Operator]

The next question is from Mr. Adrian Cighi, RBC.

[Adrian Cighi, Equity Analyst]

This is Adrian Cighi from RBC. Just one follow-up question on capital, please. Your average risk rate asset for mortgages increased marginally quarter-on-quarter. As you noted earlier, house prices have increased and the LTBs have declined. Is there any impact from TRIM or are there any other drivers? And more broadly speaking, do you see any impact from TRIM coming through the numbers?

[Tanja J. A. M. Cuppen]

Yes, I'll take that question. Actually I think what came through in the Q3 numbers is a small move of portfolio from monthly. Other that had some impacts on RWA. So I think no significant change there. And in terms of TRIM, now we had -- do see some impact there, but it's also not material. So had it flattened, the slight change that you see is -- can be part of the answer because where we are of course addressing the TRIM findings overtime, but it's not significant.

[Operator]

The next question is from Mr. Benjamin Goy, Deutsche Bank.

[Benjamin Goy, Research Analyst]

Two questions please. One on loan growth and the other on the fees. Maybe starting with fees, and particular in retail, you saw an uplift. Just wondering whether this reprising is basically a turnaround what we have seen in 2017 and how sustainable you think it is? Then what's your behavioral or your assumptions about behavioral effects here from clients are? And the second one is on your commercial banking loan growth. It has slowed down further in the quarter. Do you expect some new trends here because in the past you said growth last year in line with GDP? Just give me your thought.

[Clifford J. Abrahams, CFO & Vice]

Yes. Okay. I think on fees, I agree with your comment, I mean we did reverse some of the fee reductions we took 18 months or so ago. We follow the market. We want to give our clients competitive product, so that's -- we feel that's in line and have no plans to change that, and no material impact on our client base. So -- and that was behind some of our comments earlier about -- we think we've rebased fees. There'll continue to be volatility, but we're looking to overtime grow fees from here. I think on the commercial bank, you're right. It will slow our growth in Q3. I think there are few drivers for that. The economy remains strong. So we are looking to support our clients since the growing economy as Kees indicated. In parts of the market, it can be quite competitive. And we are very focused on maintaining our disciplined, both on pricing and terms. And so we're looking at leverage finance, real estate as particular areas of call it continuing discipline. And finally, the market, it just is a bit slower in Q3 where you have the lagged effect of the summer. So I think going forward, we're looking to continue to grow that book nicely, but looking to remain cautious on particular segments as we get to the latter stages of the credit cycle.

[Operator]

The next question is from Mr. Kiri Vijayarajah, HSBC.

[Kirishanthan Vijayarajah, Analyst]

First question is going back to the RWAs in CIB and the lack of the progress I guess there. I'm just wondering, you having any issues with the originate to distribute model but you're finding it may be harder to offload assets than you previously thought or do you need to build out the -- your originate to distribute platform further to get the volume done? And second question just very quickly on the private equity reducing your exposure there. Is -- I know you said short term not much RWA release, but when you look out to your overall RWA targets, is that -- am I right in thinking that's additives to what you've earmarked the EUR 5 billion reduction? Is that additive to your plans from last quarter?

[Clifford J. Abrahams, CFO & Vice]

Yes. So I think the -- in terms of RWAs, I mean we were pleased with the initial progress in Q2 that addressed call it shorter term business or that we made a good start there. Going forward, we've said, look, we wanted to bring this down overtime. We don't want to disrupt our client franchises and we'll do that through 2020. Some of the more medium-term business, we have a pipeline of business. The business takes a while to run off. So we're not -- there's no particular issue around the performance in Q3. And in fact in CIB, it's gone up largely as a result of operational risk which has moved our group functions which Tanja referred to earlier. So these are quite small movements. I think we're very much on track. I think on originated distribute, we see great opportunity there. This will take place over a number of years, not quarters. So we are -- we have distributed in the past, but we're looking to build our capability meaningfully and our activity here, and we'll update further on that next Friday. On private equity, I think the -- I think as Kees said, look, the business is cyclical. I think we've not committed to anything. But intuitively, we feel it's smart to lighten up of what we think is the -- was perhaps the top of the market in terms of the asset cycle. And we'll look to manage that portfolio in a sort of smart way over time. So we're not going to commit to dramatic reductions in RWAs, but with third-party money. We had much more flexibility to reduce our capital allocated in what we might think is sort of riskier environment going forward. And that's a potential -- well, it gives us flexibility as we can see the meeting our commitment of the EUR 5 billion RWA reduction on the timescales I referred to you earlier.

[Operator]

The next question is from Bruce Hamilton, Morgan Stanley.

[Bruce Allan Hamilton, Equity Analyst]

So one, just on the -- the topic of private equity, so you've got quite a feel in this. So I mean just to understand, are you saying you're seeing a pretty good private equity and therefore it's an area that you will love to grow but with third-party money i.e. it's a kind of fee-growth driver in the future or you want to keep the capital intensity no more than EUR 1 billion and hopefully a bit less overtime, so there's no real plan to grow? I'm just trying to make sure I fully understood that. And then on the sort of distribution guidance, it -- just to get clarity, so you're saying sort 60% payout should be the baseline now, but anything above that will be heavily dependent on any progress on above all mitigation which we'll learn about in next week or on the leverage ratio both of which are a constraint, so expecting anything more than that in the short term?

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

You want to take the first one then?

[Clifford J. Abrahams, CFO & Vice]

Yes. So we're good at -- as you say, we're good at private equity, so we wonder -- we're exploring whether we can make that track record available to external parties as you say as a fee opportunity. I think we won't -- we don't have plans to grow that business on our own balance sheet materially, because of the capital issues. I think we liked the profits, but we recognize it's cyclical. So in order to better leverage that business whilst maintaining reasonable allocation from a balance sheet management respective, we're exploring third-party money. So we don't plan to materially grow the capital allocated to that business in terms of our own-balance sheet allocation.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Okay. Thanks, Clifford. Then Bruce, on your 60% baseline question, I would say the 60% is of course a signal, but it's not a promise. So that means that we, in the end, will decide in Feb. But of course it gives a kind of indication and a signal, that's true.

[Operator]

[Operator Instructions] The next question is from Marcell Houben.

[Marcell Houben, Research Analyst]

I have 2 left, please. Just on the capital discussion again, could you discuss with us the capital build year-to-date this year on the Basel IV? It seems to me that on Basel III, you're building quite a significant amount of capital. Just on Basel IV, it seems flattish. That was my first question. And the second question is on costs. Do you -- can you highlight any variable costs which was driven by the other income, the high other income reviews there? Is there any variable compensation or variable cost that are associated with the higher other income?

[Clifford J. Abrahams, CFO & Vice]

Yes, yes. I think on those questions, yes you're right, the Basel IV position was flattish and that reflects the standardized approach with the floor. That's a very mechanical calculation. Our business hadn't materially changed in 3 quarters. So I think you wouldn't be surprised if the number was roughly the same. And I've given the factors behind that dealt with Basel III including some minor methodology changes. So what I would emphasize is these are, if you like, pro forma figures based on our view of the rules. So we've not applied any mitigations to those numbers. And we're very focused on how the business as a whole is responding to Basel IV and we'll update on that next week. In terms of costs associated with other income, I think there are no specific variable costs. I think we flagged what they were sort of hedging benefits, accounting effects, and the private equity. I mean the private equity, we clearly have a cost base associated with it. But it's fairly modest and largely fixed. And those gains reflect the benefit of the deals entered into some years ago.

[Marcell Houben, Research Analyst]

Sorry, just one follow-up, if I may, on leverage ratio. Again if you're accruing roughly say now 60% of the year-to-date, the profits, your leverage ratio doesn't seem to grow that much. Do you think the 60% is sort of a floor or a ceiling then regarding the payout ratio?

[Clifford J. Abrahams, CFO & Vice]

Yes. So I mean the leverage ratio, you can see it's solid 4.1%. It's 4 plus this year and it had to be less than that. In earlier years, we had the EBA Q&A. So that had been a constraint. So leverage ratio, as Kees said, look, remains an important constraint for us. It's not an economic one, but one that we've managed to. And I think the 60% accrual reflects the -- our target capital and our various constraints. And the 2 primary ones relate to the target capital range Basel III that were well placed. The leverage ratio which remains a constraint 4.1% is better than 4%, but it's a modest buffer. And we've talked about how we see that progressing in the medium term. Now Basel IV, despite this volatility, we remain comfortable at around 13% with some years to meet our target early in the phasing. So hopefully that gives you a sense of our -- why, as Kees mentioned, we're comfortable accruing at 60% and giving us the flexibility for the end of the year.

[Operator]

The next question is from Mr. Le Gouvello du Timat from Jefferies.

[Maxence Patrick Patrick Laurent Le Gouvello du Timat, Equity Analyst]

I have one last question for Tanja on the CIB cost of risk. Can you give us little bit more color of the dynamic into that topic because there seems to be have some additional side that are deteriorating on some -- the side, there's some write-back? And also what can we expect going forward?

[Tanja J. A. M. Cuppen]

Okay. Well, thank you for that question. Yes, well, you see of course still -- well, that's somewhat elevated impairments, but a lot lower than in the first quarter of this year. It's also more, I would say, evenly divided within the -- within the organization, so in corporate banking between commercial banking and CIB. In CIB we mainly see still provisioning in the energy sector related to offshore. So we see clients still either struggling with recovery or missing out on contracts or impacts us in another way indirectly from investments not happening in the offshore industry. So that's what we see. But I think we are very much on top of this sector. And as said, I'm also confident with the outlook for the rest of the year to stay below this 25 to 30 basis points cost of risk. And I also don't see any other developments in other sectors that cause concern right now in CIB.

[Maxence Patrick Patrick Laurent Le Gouvello du Timat, Equity Analyst]

So that mean that you feel confident because you have a few files regarding healthcare about the -- over the 2 last quarter? And also regarding the offshore, is it a specific part of the world or is it the full sector?

[Tanja J. A. M. Cuppen]

No. I would say it's the full sector. So it's not related to a specific region.

[Operator]

The next question is from Mr. Jason Kalamboussis, KBC.

[Jason Kalamboussis, Equity Analyst]

I got 3 quick questions. The first one is on the cost side. Looking at the fourth quarter, you mentioned restructuring regulatory charges. Is there anything else or should we expect just to continue to see the impact of the lower FTEs on the personnel expenses? The second thing is on the -- just checking on the diamond, can you confirm that you basically you feel comfortable that there is nothing coming from that end? And the third thing is just on the SMEs and corporates. You had a good growth over the last 4, 5 quarters, slow down a bit in Q3. How -- what's the outlook and what can you comment also on the market more in general?

[Clifford J. Abrahams, CFO & Vice]

Okay. Should I do the first and then maybe ask Tanja.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Yes. We'll divide it. That's good.

[Clifford J. Abrahams, CFO & Vice]

Yes. On costs, I think the short answer is no, there's nothing else than the 2 things you talked about.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Tanja?

[Tanja J. A. M. Cuppen]

Yes. On diamonds sale, we talked about it early in the year. Well, seeing some additional provisions there. We continue to monitor this portfolio very closely. We see also the portfolio reducing over the years. And that's all I can say at this stage.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

With respect to SME Q3, I think indeed, as Clifford already mentioned, bit of a summer effect and also a margin discipline. But going forward, I would say guidance is still in line with Dutch economy.

[Operator]

There are no further questions at this moment. Please continue.

[Kees C. van Dijkhuizen, Chairman of Executive Board & CEO]

Anybody else have question? If not, then I would like to thank you all for your questions. This concludes our Q3 results update and hope to see you all in person next week at our Investor Day. Thank you. Good bye.

[Operator]

Ladies and gentlemen, this concludes the conference call. You may now disconnect your line. Thank you for your participation and have a very nice day.