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IFRS Analyst & Investor Meeting Introduction Tom de Swaan CFO & Member of the Managing Board London, 18 November 2004 Schedule and presenters 14.00 hrs Introduction 14.15 hrs IFRS impact on Balance Sheet Maurice Oostendorp and Income Statement Head of Group Finance 15.00 hrs IFRS impact on BU NA Tom Goldstein CFO BU NA 15.20 hrs IFRS impact on Group ALM Rolf Smit Head of Group ALM 15.40 hrs Concluding remarks Maurice Oostendorp 15.45 hrs Q&A Tom de Swaan Other delegates present: Gerhard Zeilmaker (Head of Group Financial & Management Accounting), Tijmen Bout (Head of Group Accounting Policy), Sarah Russell (CFO WCS) & Richard Bruens (Head of Investor Relations) 2 Introduction Tom de Swaan Main goal is to provide clarity w.r.t. IFRS impact on ABN AMRO We will discuss many things that will change as a result of the introduction of IFRS, but: IFRS will not change the underlying performance of our business. Accounting should continue to reflect business decisions and not drive business decisions Underlying income streams unchanged as differences are mainly due to transition impact and timing differences (especially IER, Pensions and Hedge ineffectiveness) IFRS transition will not have an impact on dividend Transparency and disclosure remain at a high level Our choice w.r.t. Pensions leads to a lower Tier 1 ratio now and higher net profit in the future, which simply reflects a timing difference (taking pension costs now, instead of future). 4 IFRS and ABN AMRO - Background December 2000, the European Commission announced that all EU listed companies must prepare consolidated accounts in accordance with IFRS ABN AMRO adopted IFRS as of 1 January 2004 for comparison purposes. Dutch GAAP and IFRS accounting have run in parallel through 2004 Opening 2004 Balance Sheet prepared on IFRS basis Dutch GAAP leading external reporting in 2004. Dual internal reporting 5 IFRS and ABN AMRO – Looking Forward IASB’s version of IAS 39 fully adopted, except fair value option for liabilities which is not allowed by EU 18 November 2004 indicative HY 2004 IFRS figures are presented FY 2004 IFRS figures will be published by 31 March 2005 Q1 2005 results on IFRS basis (and Q1 2004 IFRS figures) will be published on 27 April 2005 All IFRS figures in this presentation are indicative only and should be treated as such 6 Impact of IFRS on Performance Management Management, hedging strategies, etc in 2004 are still based on Dutch GAAP Full commitment to an IFRS Performance Contract Cycle (PFC) will take place as of 2005 PFC cycle Milestones PFC 2003 and 2004 for IFRS related Implementation Initiative include: - adjust systems and processes - meet the monthly dual reporting requirements - fulfil the disclosure reporting requirements Hedge effectiveness the responsibility of management of the (S)BU 7 IFRS impact on ABN AMRO Volatility – Will increased P&L volatility lead to different business decisions? Hedging – Is hedging ineffectiveness avoidable? Provisioning – Will loan provisioning methodology change significantly? Disclosure – Will disclosure and transparency increase? US GAAP – Can US GAAP be used as a proxy for IFRS? 8 IFRS impact on ABN AMRO Volatility – Will increased P&L volatility lead to different business decisions? IER Fair value adjustments (AFS, MSR’s, Other) Derivatives Private Equity Share based payments Conclusion: Increased volatility will not lead to different business decisions 9 IFRS impact on ABN AMRO Hedging – Is hedging ineffectiveness avoidable? Causes of ineffectiveness: Operational processes around externalisation, documentation and testing Mortgage Servicing Rights characteristics Mortgage Backed Securities characteristics Conclusion: Hedging ineffectiveness is not avoidable 10 IFRS impact on ABN AMRO Provisioning – Will loan provisioning methodology change significantly? Under Dutch GAAP, nominal value of expected cash flows on impaired loans Under IFRS, discounting of expected cash flows on impaired loans Under IFRS a loan loss provision is only permitted for incurred loan losses Conclusion: Loan provisioning methodology will not change significantly (excluding one-off impact) 11 IFRS impact on ABN AMRO Disclosure – Will disclosure and transparency increase? IFRS has increased level of footnote disclosure New exposure draft 7 (risk disclosure of financial instruments) will further increase level of disclosure IFRS increases complexity of financial statements, which requires more in depth accounting knowledge of the reader Conclusion: Disclosure will increase and transparency might increase 12 IFRS impact on ABN AMRO US GAAP – Can US GAAP be used as a proxy for IFRS? In many respects IFRS is similar to US GAAP There are, however, some major differences, like macro cash flow hedging and consolidation of Private Equity Also transition impact causes ongoing different results under IFRS and US GAAP (Goodwill, Pensions and hedge accounting) Conclusion: US GAAP can not be used as a proxy for IFRS 13 Conclusions IASB’s version of IAS 39 fully adopted, except fair value option for liabilities which is not allowed by EU IFRS will not change the underlying performance of our business. Accounting should continue to reflect business decisions and not drive business decisions Underlying income streams unchanged as differences are mainly due to transition impact and timing differences Volatility of results could increase IFRS transition will not have an impact on dividend Most impact on BU NA and Group ALM. WCS modestly impacted. Other (S)BU’s are hardly impacted 14 IFRS impact on Balance Sheet and Income Statement Maurice Oostendorp SEVP & Head of Group Finance London, 18 November 2004 Presentation agenda IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 16 IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 17 IFRS versus Dutch GAAP Hedging Philosophy Share Based Payments Debt/Equity Loan loss provisioning Goodwill Pensions Mortgage Banking activities Investment Portfolio/IER Hedge Accounting Fair Value IAS 39 18 IFRS versus Dutch GAAP: Main differences for ABN AMRO Hedging Philosophy - Dutch GAAP: Accounting of the hedge follows the accounting of the hedged item - IFRS: Accounting of hedged item follows the accounting of the hedge – strict conditions apply Share Based Payments - Dutch GAAP: Stock options not expensed - IFRS: Stock options expensed at fair value Debt/Equity - A more strict definition of Equity is applicable under IFRS. An instrument only qualifies as equity if the payment of a dividend is at the discretion of the issuer 19 IFRS versus Dutch GAAP: Main differences for ABN AMRO (2) Loan loss provisioning - Dutch GAAP: value based on nominal cash flows - IFRS: value based on discounted cash flows. Only specific loan losses are allowed Goodwill - Dutch GAAP: Goodwill immediately charged to Equity - IFRS: goodwill has to be capitalised including an annual impairment test Pensions - ABN AMRO has decided to charge all cumulative actuarial differences against Shareholders’ Equity at transition date (Fresh Start approach). IFRS method as such does not differ significantly from US GAAP, which we used before 20 IFRS versus Dutch GAAP: Main differences for ABN AMRO (3) Mortgage banking activities - Dutch GAAP: only the realised results of terminated hedges are accounted for in the book value of the MSRs - IFRS: Hedge accounting requires unrealised fair value changes to be accounted for in the book value of the MSRs. In addition ineffectiveness is booked through the income statement immediately Investment portfolio/Interest Equalisation Reserve (IER) - Dutch GAAP: the portfolio is stated at amortised cost, results on sales are booked in the IER and amortised over the average life of the investment portfolio - IFRS: the AFS-part of the portfolio has to be fair valued through Equity. Realised results on sales have to be booked immediately through the income statement 21 IFRS versus Dutch GAAP : IAS 39 Hedge Accounting - Effectiveness: in practice many hedges are less than 100% perfect Every difference in the change of the fair value of the hedge and the hedged item has to be booked immediately in the Income Statement. If ineffectiveness exceeds a certain level (80% - 125%) only the fair value change of the hedge can be booked in the Income Statement - Externalisation: clear demonstration of external hedge relationship Every internal hedged risk has to be laid off through an external transaction - Documentation: required by IAS 39 rules To qualify as a hedge, the relation between a hedge and a hedged item has to be documented thoroughly 22 IFRS versus Dutch GAAP : IAS 39 Fair Value - Broader scope: IFRS forces more instruments to be fair valued, for example all derivatives and the AFS portfolio - Deeper impact: the fair value should be based on objective (market) data - Bifurcation: if an instrument includes an embedded derivative with a nature that differs from the host instrument, that derivative has to be separated from the host instrument and marked-to-market through the Income Statement 23 IFRS versus Dutch GAAP : IAS 39 Endorsement of IAS 39 by EU: a) Macro fair value hedging: Removes obstacles for macro fair value hedging of core deposits - will not be utilised by ABN AMRO b) Fair value options will only be used for Assets as it is prohibited for Liabilities – Impact largely quantified – Operational burden of increased use of bifurcation – IASB and EU may yet resolve this ‘disagreement’ arising from ECB concerns prior to our issuance of IFRS data 24 IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 25 IFRS impact on Balance Sheet Time Table Reclassification issues – Equity Presentation impacts Transition impact on Equity Other impacts on Equity (SCE) Impact on Shareholders’ Equity (estimates) Transition impact on Shareholders’ Equity 26 IFRS impact on Balance Sheet: Time Table Opening IFRS balance sheet prepared at January 1, 2004 Dual reporting through 2004 External IFRS developments tracked and included in dual reporting data Review by management and audit is an ongoing process 27 IFRS impact on Balance Sheet: Reclassification issues - Equity IAS 32: a number of items reclassified from equity to debt – Preferred securities issued by ABN AMRO Holding – Trust preferred reclassified from minority interest to liabilities. Cost of servicing these funds will be classified as interest expense under IFRS Fund for General Banking Risks (FAR). This reserve is not permitted under IFRS and will be reclassified to Shareholders’ Equity As such, reclassification issues have no impact on Tier 1 Capital 28 IFRS impact on Balance Sheet: Presentation impacts Offsetting derivative contracts is more difficult under IFRS - estimated grossing up of balance sheet EUR 60 bln (No impact on RWA) Consolidation of Private Equity investments in which the Bank has a controlling stake - impact on gross asset and gross liabilities - estimated at EUR 1 bln No increase of securitised assets because of new consolidation criteria. ABN AMRO does already consolidate these Special Purpose Vehicles since 2001. For synthetic securitisations there is no impact at all 29 IFRS impact on Balance Sheet: Transition impact on Equity Impact arises from choices made by ABN AMRO under IFRS: ABN AMRO has decided, w.r.t. pensions, to charge all cumulative actuarial differences against Shareholders’ Equity at transition date. It should be noted that IFRS would have had a positive impact on Shareholders’ Equity if we had not chosen to use this fresh start approach for pensions Goodwill will be capitalised prospectively and therefore no impact at 1 January 2004 Property in own use will be restated at cost less depreciation 30 IFRS impact on Balance Sheet: Other impacts on Equity (SCE) The Bank will utilise a number of cash flow hedging programs/strategies The fair value of swaps in an effective cash flow program will be recorded in equity, until the hedged cash flow occurs The majority of the bank’s investment portfolio will be classified as Available For Sale (‘AFS’) IFRS requires AFS assets to be held at fair value – Unrealised gains and losses are recorded through equity in the special component of Equity – A limited portion (10%-20%) of the investment portfolio will be classified as held to maturity, which will continue to be booked at cost 31 IFRS impact on Balance Sheet: Impact on Shareholders’ Equity (estimates) Dutch GAAP equity (In EUR mln) 13.050 Impact on equity (net of tax) Release of FAR +1.150 Reclassification of preference shares -800 Reversal of property revaluation -150 Transition items impacting Tier 1 (excluding pensions) -100 Impact on special components of equity Impact of AFS reserve +300 Impact of cash flow hedging -100 Total impact on IFRS equity +300 Pensions -1.000 Total equity 12.350 32 IFRS impact on Balance Sheet: Transition impact on Shareholders’ Equity Transition items impacting Tier 1 Capital (in EUR mln) Impact of derivatives and hedging Release of IER -250 +1.550 Loan impairment -600 Private Equity impact -100 Fair value adjustments -200 Property -50 LeasePlan -150 Bouwfonds -100 Other -200 Equity accounted investees -100 IFRS Impact before tax -200 Pensions -1.500 Taxation +600 Total net of taxation -1.100 33 IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 34 IFRS impact on Income Statement Fair Value adjustments; derivatives, inefficiencies, AFS Private Equity IER MSR Hedge ineffectiveness Pension costs and impact of fresh start approach Reconciliation net profit under IFRS 35 IFRS impact on Income Statement Impacts arising from greater use of fair values – Fair value effects on derivatives are limited as most items involved are covered by hedge accounting – Ineffectiveness in IFRS hedge relationships, for example Mortgage Servicing Rights – Realised gains and losses on AFS assets are booked directly to income (not via IER) – Fair value changes in Private Equity portfolio 36 IFRS impact on Income Statement (2) As a consequence of the consolidation of controlled Private Equity entities, both gross revenues and gross costs of these entities have to be included in the consolidated income statement of ABN AMRO. To improve transparency we have decided to present Private Equity separately, with its own P&L Impact of IFRS on Income Statement basically due to two transition items which will run off within a limited number of years and one item which has been our own choice (Pensions): – Interest Equalisation Reserve (IER) – MSR Hedge ineffectiveness – Pension costs 37 IFRS impact on Income Statement: Impact of Pension fresh start approach DUTCH GAAP IFRS 1500 400 Pension costs 200 0 -200 Interest equalisation reserve -400 -600 2003 2004 2005 2006 2007 2008 600 400 200 0 -200 -400 -600 2003 2004 2005 2006 2007 2008 The negative impact of the loss of the IER contribution in the coming years will be more than offset by the lower pension costs (EUR 120 mln) as from 2007 *please note that IER under IFRS goes directly to Equity 38 IFRS impact on Income Statement: Reconciliation net profit under IFRS Net profit under Dutch GAAP (per 30/6/2004 in EUR mln) 1.921 Reconciling items: IER amortisation investment portfolio -175 MSR’s -450 AFS other +175 Fair value adjustments -75 Derivatives (including unwinding of Trust Preferred swap) +25 Private equity -75 Pension costs +60 Employee stock based compensation -25 Other IFRS impacts +20 Impacts before taxation -525 Tax effect +200 Net profit under IFRS 1.600 39 IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 40 IFRS impact on Tier 1 Capital Ratio Tier 1 capital under Dutch GAAP (in EUR mln) 20.050 Transition items impacting Tier 1 -100 YTD result (per 30/6/2004, Dutch GAAP vs IFRS) -325 Total impact on Tier 1 Capital -425 Pensions -1.000 Tier 1 capital under IFRS 18.625 8,33% 8.15% 7,74% *Tier 1 ratio at 30 June 2004 41 IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 42 IFRS versus US GAAP In principle ongoing difference between IFRS and US GAAP should be less than between Dutch GAAP and US GAAP. However in the short term this may not be achieved, for the following reasons – Standard setters are still not in agreement on a number of key issues: - IFRS requires consolidation of controlled PE investments - IFRS permits additional macro cash flow hedging possibilities - IFRS is less stringent in the forming of restructuring/onerous lease provisions Difference in transition ‘moment’ - ‘transition’ to US GAAP took place in 2001. This impacts: – Held to maturity/AFS designation – Hedge accounting – Capitalisation of goodwill 43 IFRS versus Dutch GAAP IFRS impact on Balance Sheet IFRS impact on Income Statement IFRS impact on Tier 1 Capital IFRS versus US GAAP IFRS impact on (S)BU’s 44 IFRS impact on (S)BU’s Greatest impact on BU North America and Corporate Centre/Group ALM Modest impact on WCS Other (S)BU’s relatively little impacted 45 IFRS impact on BU NA Thomas Goldstein EVP & CFO BU NA London, 18 November 2004 BU North America: IFRS Impacts IFRS Hedge Accounting Hedging mortgage assets result in ineffectiveness – Dutch GAAP smoothes hedge results over time – IFRS requires immediate recognition of hedge results Economics of hedging unchanged IFRS adds complexity to MSR accounting Transition Effects An accounting “catch-up” of past hedge economics Going Forward 47 Hedge Accounting: A Simplified Example Perfectly Matched Hedge Effect –a “perfect” hedge 6% locks in value over 5 5% periods Asset 4% 3% 2% Income impact for a “perfect hedge” is the same Hedge 1% under both accounting methods regardless of 0% Period 1 Period 2 Period 3 Period 4 Period 5 interest rates P1 P2 P3 P4 P5 Total Dutch GAAP $20 $20 $20 $20 $20 $100 IFRS $20 $20 $20 $20 $20 $100 48 Hedge Accounting: Mortgage Assets With mortgage assets: “perfect” hedging nearly impossible due to convexity Result: Economic ineffectiveness Accounting for economic ineffectiveness? Dutch GAAP – smoothed over the life of the asset IFRS – recognized immediately in earnings 49 Hedge Accounting: Ineffectiveness Interest Rates Rise 6% borrowers less likely to Asset 5% 100 bps 4% Mortgage assets lengthen – prepay New Hedge 200 bps Ineffectiveness New hedge required to protect lengthened asset 3% Old Hedge 2% Net hedged value creates ineffectiveness in period 1 of 1% $20 (economic loss) 0% Period 1 Period 2 Period 3 Period 4 Period 5 Dutch GAAP spreads hedge loss; IFRS accelerates P1 P2 P3 P4 P5 Total Dutch GAAP $20 $20 $20 $10 $10 $80 IFRS $0 $25 $25 $15 $15 $80 Dutch & IFRS totals equal over hedge life 50 Hedge Accounting: Ineffectiveness (2) Interest Rates Decline borrowers more likely to 6% Asset 5% 4% Mortgage assets shorten – prepay 200 bps 2% asset – close part of hedge 100 bps 3% Overhedged for shortened Ineffectiveness Old Hedge Closed Hedge Net hedged value creates ineffectiveness in period 1 of 1% $10 (economic loss) 0% Period 1 Period 2 Period 3 Period 4 Dutch GAAP spreads hedge loss; IFRS accelerates P1 P2 P3 Total Dutch GAAP $20 $20 ($10) $30 IFRS $10 $30 ($10) $30 Dutch & IFRS totals equal over hedge life 51 Hedge Accounting: Ineffectiveness (3) Summary When hedging mortgage assets, convexity is inevitable Dutch GAAP smoothes earnings – Economic ineffectiveness spread over the asset’s life IFRS increases volatility in earnings – IFRS accelerates economic ineffectiveness into P&L immediately 52 MSR Accounting Differences Dutch GAAP to IFRS differences for MSR Assets: Timing related hedge accounting differences Both Dutch GAAP and IFRS require: Capitalisation of the Mortgage Servicing Right asset at the time the underlying loan is sold Amortisation of the MSR asset in proportion to and over the life of the expected servicing income Periodic assessments of the MSR asset for impairment Recognition of MSR impairment, if any, immediately in earnings Recovery of temporary MSR impairment charges in earnings Recognition of servicing fee income as earned 53 Accounting: MSR Hedge Accounting Declining interest rates shorten mortgage assets, Simplified Example Rates fall and the MSR asset declines in value while the derivatives gain in value because borrowers exercise their right Beginning Ending MSR book value: 1,000 1,000 mortgage asset MSR fair value: 1,000 500 declines in value in MSR “hedged risk” 0 (450) a non-linear (90%): 0 400 to prepay The shortened manner (e.g., convexity) Derivative fair value: All illustrations are hypothetical and do not consider other hedge accounting requirements such as proof of effectiveness, adequate documentation, etc. 54 Accounting: MSR Hedge Accounting (2) Dutch GAAP Under Dutch GAAP IFRS (& US GAAP) Derivatives are closed resulting in Accounting: hedge performance the receipt of cash Balance Sheet is deferred as a Accounting: MSR reduction of the Balance Sheet IFRS basis adjust mortgage asset MSR resulting in a Derivative gain smooth earnings Adjusted MSR Basis MSR Fair Value impact. Under IFRS income is recognised immediately on the Impairment, if any Net MSR Basis 1,000 (450) Adjusted MSR Basis 550 MSR Fair Value 500 600 Impairment, if any (50) 500 Net MSR Basis 500 (400) (100) 500 hedge and the offsetting 1,000 Net Earnings Effect 0 Net Earnings Effect Derivative Gain 400 MSR Basis Loss (450) Impairment is Derivative Gain (deferred) recognised on the MSR Impairment (100) Impairment asset. Net Earnings Impact (100) Net Earnings Impact Net Ineffectiveness (50) (50) (100) 55 Transition Effects: Initial Impact and Ongoing IFRS Transition Date Impacts: IFRS vs. Dutch GAAP differences are timing differences Transition to IFRS required “catch up” of timing differences Hedge gains occurred in prior years – deferred reflected in Dutch GAAP – Hedges significantly outperformed in 2002 and 2003 Result of transition: Mortgage assets increased in value – Economic and accounting increase 56 Transition Effects: Initial Impact and Ongoing (2) IFRS Ongoing Transition Effects: Increased asset values must be amortised to earnings – Mortgage assets are convex = higher amortisation in earlier years – Amortisation causes decline in P&L – Reversal of transition impact weighted to first 4 years Increased asset values diminish gains on sale in future periods 57 Expectations for the Future When hedging mortgage assets, convexity is inevitable Economic hedge ineffectiveness always has existed – Dutch GAAP smoothed the effect – IFRS accounting accelerates the effect and is more volatile Over time, both economics and P&L are the same Hedge outperformance of 2002 and 2003 not indicative of expected performance 58 IFRS impact on Group ALM Rolf Smit EVP & Head of Group ALM London, 18 November 2004 Guiding principles for Group ALM Objectives of Group ALM: – Preserve long term value – Protect interest margin Risk / reward is driver, risks are hedged whenever economically sensible Accounting standard should not change economic behaviour Either align accounting impact with economic impact or explain in a transparent way 60 IFRS issues for Group ALM Capital Classification and hedge accounting (Net investments) FX Risk Hedging of Profits Liquidity Risk Hedge accounting of hedged debt Interest Rate Risk Classification of Investment Portfolio (Hedge accounting IRS) Discretionary portfolios, No IFRS issues 61 Capital Management Dutch GAAP IFRS Trust Preferred Capital Minority interest Debt Interest Hedging Capital Abroad All value change of hedge in equity Changes in spot rate in Equity Changes in fwd points via P/L 62 Capital Management (2) Applicable hedge accounting: – Capital investments: IAS 39 on Net Investments Revaluation of effective hedge is stored in Equity until disposal of investment Due to chosen separation of interest component of the FX forwards, hedges are fully effective Consequently, change in fair value of forwards due to interest rate changes is directly booked in P&L Minority interest related to Trust preferred disappears, no impact on regulatory capital IFRS has no major impact 63 FX Risk Management Corporate FX risk: Large international business exposes the bank to currency translation risk. Bank’s strategy is to hedge capital abroad and hedge future profit (USD & BRL) Dutch GAAP IFRS Hedged Item Profit Hedged Item Interest Revenue Off-balance SCE Financial Transaction Interest Income Economic hedging of profits qualifies for Hedge Accounting due to appropriate documentation 64 FX Risk Management (2) FX risk of profits: Cash Flow Hedge of a forecast transaction Designated hedging relationship: FX risk from USD denominated Future Cash Flows Hedge Item: Expected Future Interest Revenue of BU NA Assets Hedged amounts are small compared to gross interest revenue High probability of Cash Flows Effective part of hedge stored in Special Component of Equity, recycled in Interest Income upon realisation of Cash Flow FX Forwards: no difference with Dutch GAAP FX options: change in intrinsic value stored in SCE, change in time value directly via P&L. Cumulative effect equal to premium/discount at inception of FX forwards Change to IFRS has no major P&L impact. 65 Liquidity Risk Management Liquidity is the economic driver for issuing Debt securities and Structured notes Swapping Fixed to Floating Rate prevents change of our interest rate risk position/ embedded derivative is hedged Both types of hedges qualify for (Micro) Fair Value hedging Dutch GAAP IFRS Hedged item Amortised Costs Carrying amount adjusted Derivative Off-balance Fair value Change to IFRS has no impact on P&L, change in value of hedge is equal to change in value of the hedged item attributable to the hedged risk. IFRS does have impact on Balance sheet 66 Interest Rate Risk Management Interest rate risk from 3 sources: – Investment Portfolio – Banking Book – Discretionary Portfolio Group ALM manages on behalf of Group ALCO the residual interest rate risk Main goal is to protect Interest Margin of Banking Book (accrual) which includes the investment portfolio Main instrument used to hedge is an Interest Rate Swap As IFRS Financial reporting has to be aligned with Economic impact. How to classify the Investment portfolio? Hedge Accounting is required for swaps in this book. How does it work under IFRS? 67 Interest Rate Risk Management (2) Dutch GAAP Amortised Costs Results of sale amortised (IER) IFRS HTM: Amortised Costs AFS: Fair Value, changes in value stored in SCE HTM: Not applicable AFS: Sale direct in P/L Structural part of investment portfolio in Held to Maturity Consequence IFRS : even a duration neutral switch of Bonds will have direct P&L effects 68 Interest Rate Risk Management (3) Swaps hedge the net interest rate risk position in the banking book. Swaps are Hedge accounted as Cash flow hedge: Dutch GAAP IFRS Off-balance Fair Value Not applicable Effective part of hedge stored in SCE Designated hedging relationship: Risk of repricing cash flows Hedged item: Future interest cash-flow from repricing Assets (or Liabilities). Floating leg of swap hedges repricing risk of hedged item Highly effective program leading to limited volatility in earnings due to minimal basis risk Allows hedging of repricing risk of demand deposits and saving accounts 69 Interest rate risk management: How to interpret SCE ? Special Component of Equity of Cash Flow hedges It is the accounting bridge for Cash Flow hedges to connect the inconsistent approach of valuation of the Hedge (Swap at Fair Value) and the Hedged Item (loan at Amortised Costs) In economic terms the SCE measures the opportunity loss/gains Example: Floating rate liabilities are hedged with pay fix swaps. Rates go down, SCE becomes negative Bank could have done better by not hedging the risk with swaps, however as ALCO did not like the risk / reward profile, it decided to stabilise income (lock-in of margin) by entering into a swap Interest rate risk is managed at the cost of upward potential (there is no free lunch) 70 Summary of differences IFRS Dutch GAAP Debt Value change hedge via SCE Interest Income Equity Not applicable Financial Transaction Carrying amount adjusted for value change of hedged risk Amortised costs Cash flow hedging AFS: Value change via SCE AFS: Sale directly via P/L Value change hedge via SCE Not applicable Sale amortised Not Applicable Discretionary portfolio Marked to Market Marked to Market Capital Trust Preferred Profit Hedges Liquidity risk Fair value hedge of Structured debt Interest rate risk Investment Port. 71 Conclusions It takes discipline to ensure that – the economic risks continue to drive the hedging – the accounting & economic impact are aligned as much as possible – the explanation is transparent Hedging is operationally feasible, at the cost of additional systems and staffing. Scale of ABN AMRO warrants these investments IFRS consequences should not lead banks to avoid hedging economic risks The challenge for the market is to understand that hedging of economic risks is desirable, even if it leads to accounting volatility 72 Conclusions Maurice Oostendorp SEVP & Head of Group Finance London, 18 November 2004 Conclusions IASB’s version of IAS 39 fully adopted, except fair value option for liabilities which is not allowed by EU IFRS will not change the underlying performance of our business. Accounting should continue to reflect business decisions and not drive business decisions Underlying income streams unchanged as differences are mainly due to transition impact and timing differences Volatility of results could increase IFRS transition will not have an impact on dividend Most impact on BU NA and Group ALM. WCS modestly impacted. Other (S)BU’s are hardly impacted 74