ING Direct’s ALM and investment policy:
Supporting business growth while limiting market risk
Paul Zelissen, CRO ING Direct
John Mason, CIO and Treasurer ING Direct USA
Madrid – 19 September 2008
www.ing.com
ALM and investment policy: supporting business
growth while limiting market risk
1. ALM and risk management support the business
2. Robust and profitable business model:
Managing through adverse yield curve environments
3. Low-risk investment portfolio:
High-quality fixed income securities
4. Key points
ING Investor Day, 19 September 2008
2
ING Direct’s ALM and Risk Management are
aligned with overall business strategy and growth
Business Leads
Deposit and loan
growth are leading
Treasury Follows
• Clear preference to generate own mortgages
reflecting retail character of the business
• Treasury compliments the duration gaps
Low risk model
• Low risk appetite to optimize net interest margin
• No interest rate bets; durations are
economically matched
• Model based on mass market volumes; limited
credit risk appetite
• High levels of core liquidity
Operational
excellence
ING Investor Day, 19 September 2008
• Superior modelling of client behaviour
• Active balance sheet management to reflect
changes in the competitive environment
3
Business leads, Treasury follows
Example: ING Direct USA
ING Direct USA Earning Assets
$50B
Retail Loans
$44.2B
• Successfully developed the core deposit
base by building strong franchise and brand
Investment Portfolio
$40B
89% CAGR
(2000 – 2008)
$30B
$30.2B
• Prudently developed mortgage generation
capability
• Balanced mortgage growth with credit quality
$20B
Æ We originate for own balance sheet
not to sell to the market
Æ Historically large buyer of securities,
now migrating to mortgage origination
$10B
2000
2001
2002
2003
2004
2005
2006
2007
Q2 2008
Retail Balance Sheet Growth
$18B
$16.2
• Retail mortgage origination capabilities
becoming more aligned with deposit
gathering activities: less dependent on
investment portfolio
$15B
$13.5
$12.6
$12B
$11.2
$10.3
$9B
$7.3
$7.2
$6B
$4.4
$3B
$1.9
Æ Deposits and retail mortgages are
growing more in sync
$4.2
$2.1
$2.0
$2003
2004
2005
Deposit Growth
ING Investor Day, 19 September 2008
2006
2007
2008 YTD
Retail Mortgage Growth
4
Desired asset mix: balance between securities
and loans
ING DIRECT USA Retail Share of Earning Assets
ING Direct
(Q2 2003)
ING Direct
(Q2 2008)
25%
Securities
0%
41%
Maturing Retail Franchise
Securities
U.S. Savings Banks
(Q2 2008)
79%
Retail Loans
100%
Preferred through
the cycle range
Right-sizing the Balance Sheet requires trade-offs
+
Excess Liquidity
+
Ability to Manage
Interest Rate Risk
on Balance Sheet
-
Lower Yielding
Asset
+
Lower Risk-weighted
Assets
ING Investor Day, 19 September 2008
• Strengthening franchise through
higher share of retail balances
• Prudent risk management
• Managing the balance sheet
through interest rate / credit cycles
5
Retail loans
Limits Liquidity
-
Ability to Manage
Interest Rate Risk
on Balance Sheet
-
Higher Yielding
Assets
+
Higher Risk-weighted
Assets
-
ING Direct is highly liquid
ING Direct’s liquidity position is favourable
• Loan to Deposit ratio is 57%
• High-rated liquid investment portfolio EUR 140 billion:
To a large degree repo-able and/or discountable when needed
• Own-originated retail mortgages EUR 104 billion:
Potential source of contingency liquidity and funding
ING Investor Day, 19 September 2008
6
ALM and investment policy: supporting business
growth while limiting market risk
1. ALM and risk management support the business
2. Robust and profitable business model:
Managing through adverse yield curve environments
3. Low-risk investment portfolio:
High-quality fixed income securities
4. Key points
ING Investor Day, 19 September 2008
7
Pro-active ALM addresses client behaviour and
competitive pressures
Market drivers
ALM tools
• Duration: asset
duration needs to
match liability duration
Client behaviour
Competitive
environment
Yield curve
ING Investor Day, 19 September 2008
• Tracking speed of
client rate: percentage
of market rate changes
we need to follow in a
certain time frame
Results
Profitability
Earnings sensitivity:
Earnings-at-Risk (1)
Value sensitivity:
NPV-at-Risk (2)
Growth
• Re-pricing speed of
assets:
percentage of assets
that reprice within a
certain time frame
• Reinvestments:
reinvestment volume to
pick up new credit
spread
8
(1) impact on IFRS
earnings (1-yr) of yield
curve shock or gradual
change (ramp)
(2) impact on the Net
Asset Value of a yield
curve shock
ING Direct maintained its profitability despite a
prolonged flat yield curve environment
Profit before tax in EUR million (RHS)
200
Yield curve steepness in bps (LHS)
200
150
100
50
0
-50
-100
1Q 06
2Q 06
3Q 06
EUR (3-yr -/- 1-month)
150
100
50
0
4Q 06
1Q 07
2Q 07
3Q 07
USD (3-yr -/- 1-month)
4Q 07
1Q 08
2Q 08
Underlying profit before tax
ING Direct maintained attractive profit levels in flat yield curve environment:
• Decline in 2H 2007 mainly due to the specific UK situation
• Yield curve steepening and wide credit spreads beneficial to profitability
ING Investor Day, 19 September 2008
9
Robust net interest income
Sensitivity of net interest income in various yield curve scenarios (3-yr projections)
Interest income (base = 100%)
120%
100%
80%
60%
40%
20%
0%
• Capped by
earnings-atrisk and NPVat-risk
appetite
Base
100%
Ramp
Shock
Tilt
Volumes
Volume
& Tilt
Various yield curve scenarios:
Base
Ramp
Shock
Tilt
=
=
=
=
Volume
=
projected interest income over the next 3 years
interest rate changes develop over a 12 month period
interest rate changes happen instantaneously
interest rate changes that lead to flattening/steepening of
curves
changes in volume funds entrusted
ING Investor Day, 19 September 2008
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• Not that
sensitive to
yield curve
shifts,
steepening or
flattening
• Benefits from
diversification
over different
yield curves
Volatility in net interest income limited by
diversification over currency zones and products
• Pro-active management of changing client behaviour and competitive savings
environment
• Asset yields currently benefit from higher liquidity premiums and credit
spreads
• Multiple currency zones: US yield environment more favourable than in
Europe
• Diversifying income by extending the product range: mortgages doubled share
in total income
2004: income per product (% of total)
1H 2008: income per product (% of total)
Other
15
Other
18
Mortgages
12
Mortgages
23
Savings
71
Source: ING Direct
ING Investor Day, 19 September 2008
11
Savings
62
Managing asset re-pricing speed to safeguard
margins and client rates
Eurozone rates and ING Direct’s repricing speed
50%
5.0%
4.5%
40%
4.0%
3.5%
30%
3.0%
20%
2.5%
2.0%
10%
1.5%
1.0%
Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08
client rate
ING Investor Day, 19 September 2008
ECB
1yr re-pricing
12
0%
• 40% of assets
re-price within 1
year
• Increasing
repricing speed
improves asset
yield pick-up,
enabling tracking
of ECB rates on
the liability side
ALM and investment policy: supporting business
growth while limiting market risk
1. ALM and risk management support the business
2. Robust and profitable business model:
Managing through adverse yield curve environments
3. Low-risk investment portfolio:
High-quality fixed income securities
4. Key points
ING Investor Day, 19 September 2008
13
ING Direct is risk averse in its investment
portfolio
1. Investment portfolio guidelines:
•
•
•
•
•
•
•
No equities
No CDOs
No CDS
No credit trading
Limited credit risk
Highly liquid assets
Limited # of standardised
products
• Derivatives only for hedging
purposes
2. Historically, a RWA constraint
under Basel I
Investment Portfolio: EUR 140 billion (30 June 2008)1
9bn 4bn 12bn
21bn
0.3bn
7bn
3bn
24bn
19bn
Government bonds 12 bn
Covered bonds 34 bn
Agency RMBS 6 bn
Alt-A RMBS 19 bn
34bn Other RMBS 24 bn
CMBS 3 bn
ABS 7 bn
Corporate bonds 0.3 bn
Financials bonds 21 bn
6bn
Intercompany 9 bn
Interbank 4 bn
• Preference for highly rated, liquid, asset backed
fixed income securities
• Other RMBS is primarily European AAA RMBS
• ING Direct is net liquidity provider within ING
Bank’s liquidity framework
Sacrificing yield to maintain low risk fixed income portfolio
1. Includes securities that are included in “loans and advances” and intercompany and interbank assets
ING Investor Day, 19 September 2008
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Extensive pre-purchase securities analysis
Credit Risk
Interest rate risk
Relative value
Liquidity
Credit Enhancement
Short average life
Yield
Deep liquid market
• AAA securities
mostly at the top of
the capital waterfall
structure
Structures with
relatively limited
extension risk
Option Adjusted
Spread
Since August
2007, markets
have become
less liquid
• Scenario Analysis model worst case
default scenarios to
stress test bond
structure
Floating vs. fixed rate
Prepayment
expectations
Collateral Analysis
• Loan to value %
• Credit Score
• Occupancy type
Assessment of the incremental spread risk / reward trade-off
ING Investor Day, 19 September 2008
15
Option ARM RMBS fulfill desired interest rate and
credit risk profile: short duration, high credit quality
Why floating rate securities?
Manage the interest rate risk profile: floating rate assets reduce liability sensitivity
Why non-agency vs. agency paper?
Manage interest rate sensitivity: agency floating rate RMBS have coupon caps
while non-agency RMBS have no caps
Why option ARMs?
Higher credit enhancement than other non-agency RMBS products, protecting
the RMBS from losses in the underlying mortgage pools. Weighted average
credit enhancement is 27% (30 June 2008), more than 2.5 times the level for
other non-agency RMBS
However non-agency options ARM spreads substantially
widened in 2008
ING Investor Day, 19 September 2008
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ING Direct’s US RMBS are not a credit spread play,
but spreads widened substantially since August ‘07
• Historically limited interest rate differential over agency paper;
substantial spread widening since credit crisis emerged (August 2007)
• Prior to credit crisis, non-agency Option ARM RMBS were trading at a
lower yield compared to agency floating rate RMBS
• Spreads on non-agency Option ARM RMBS substantially widened in
2008 in increasingly illiquid markets. This trend intensified in 3Q 2008
Option Arm
ING Investor Day, 19 September 2008
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Agency Floater
Aug-08
Jul-08
Jun-08
May-08
Apr-08
Mar-08
Feb-08
Jan-08
Dec-07
Nov-07
Oct-07
3Q 2008: credit
spread widening in
illiquid markets
Sep-07
Aug-07
Jul-07
August
2007:
start
credit
crisis
Jun-07
May-07
Apr-07
Mar-07
Feb-07
Jan-07
Dec-06
Nov-06
Oct-06
Floating rate RMBS spreads (in bps)
1,200
1,000
800
600
400
200
0
Current RMBS market prices do not fully reflect
the securities’ quality as markets are illiquid
Illustration: US
RMBS structure
Collections paid to
bondholders from
‘AAA’ down
Mortgage pool
Losses allocated
from bottom up
Example: 2007 Option ARM Alt-A RMBS
• Credit enhancement: 48%
AAA Tranche
=
52%
• Today’s market price: 65%
CE1
=
48%
In order to reach these loss levels
AA Tranche
A Tranche
BBB Tranche
Overcollateralisation
• The entire credit enhancement of 48%
has to be wiped out
Excess spread
• Then 35% of the remaining 52% (=18%)
of the underlying mortgage pool would
need to be lost
Underlying losses
• Hence, losses in the underlying
mortgage pool would have to approach
66% (= 48% + 18%) in order to trigger a
35% loss on this specific AAA RMBS
1. Credit Enhancement (attachment point) =
buffer for absorbing losses in the underlying
mortgage pool before the AAA tranche is
affected in terms of principal loss
ING Investor Day, 19 September 2008
• This implies the market expects a 35%
loss on this RMBS
• This implies 100% defaults and a 66%
loss severity or any other combination
triggering a 66% loss
18
Robust monitoring process for US RMBS
• Portfolio modelled weekly for price sensitivity to interest rate changes
• Monthly assessment of current credit support against pipeline losses
• Daily monitoring for rating actions by the rating agencies
US non-agency RMBS surveillance process: Alt-A example 2Q 2008
Current credit support divided by pipeline loss1 = coverage multiple
< 5 x coverage: 28%
>5x
coverage:
72%
Polypaths cash-flow simulation test to
determine point at which bond suffers first
principal loss given severe prepayment and
Fail test
loss severity assumptions
2-5x
coverage:
26%
< 2 x coverage: 2%
Under additional scrutiny
2%
0%
No credit impairment
Credit impairment
1. Pipeline loss = sum of 60+ day delinquencies, foreclosure %, bankruptcy % and
Real Estate Owned, multiplied by a loss severity
ING Investor Day, 19 September 2008
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Key points: ALM and investments continue to
support business growth while limiting market risk
1. Growth of retail deposits and mortgage production leads ING Direct’s
ALM decisions: assets and liabilities are duration matched
2. ING Direct is highly liquid
3. ING Direct’s net interest income is not overly sensitive to changes in
the yield curve environment
4. ING Direct maintains a conservative fixed-income investment portfolio
of high credit quality securities
5. Current US RMBS market prices are increasingly depressed due to
illiquid markets, without fully reflecting the securities’ credit quality
ING Investor Day, 19 September 2008
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Certain of the statements contained in this release are statements of
future expectations and other forward-looking statements. These
expectations are based on management’s current views and assumptions
and involve known and unknown risks and uncertainties. Actual results,
performance or events may differ materially from those in such statements
due to, among other things, (i) general economic conditions, in particular
economic conditions in ING’s core markets, (ii) changes in the availability
of, and costs associated with, sources of liquidity such as interbank
funding, as well as conditions in the credit markets generally, including
changes in borrower and counterparty creditworthiness, (iii) the frequency
and severity of insured loss events, (iv) mortality and morbidity levels and
trends, (v) persistency levels, (vi) interest rate levels, (vii) currency
exchange rates, (viii) general competitive factors, (ix) changes in laws and
regulations, and (x) changes in the policies of governments and/or
regulatory authorities. ING assumes no obligation to update any forwardlooking information contained in this document.
www.ing.com
ING Investor Day, 19 September 2008
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