滙豐控股 (HSBC) 2003 Q2 法說會逐字稿

Thank you for holding, ladies and gentlemen. This presentation and subsequent discussion may contain certain forward-looking statements with respect to the final conditions, results of the operations, and business of the Group. These forward-looking statements present the Group’s expectations or beliefs concerning future events, and involve known and unknown risks and uncertainty, that could cause actual results, performance or events to differ materially from these expressed or implied in such statements. Additional details and information concerning important factors that could cause actual results to differ materially is available in are Annual Report. Once again, thank you for holding, ladies and gentlemen, and your conference will begin shortly.

Good morning, ladies and gentlemen, and welcome to this briefing on the 2003 Interim Results of HSBC Holdings. I would like, also, to welcome those investors who are joining us via the internet.

Although we have not met, my name is Stephen Green. This is my first time on this podium. Next to me is Douglas Flint, Group Finance Director, and in the front row Alan (ph) Jebson, our Chief Operating Officer; Bill Dalton, Chief Executive of the UK Bank; and a number of our senior HSBC colleagues. We are also joined by one of our Non-Executive Directors, Sharon (ph) Hintze. Welcome, Sharon.

Before we start the presentation, I would like to draw your attention to the cautionary words on forward-looking statements, which are now showing on the screen. This is, of course, to comply with the regulatory environment. Again, can I please ask that you turn off mobile phones during the briefing. Can I also remind you that at hsbc.com you can find the newsroom release, the slide presentation, and our interim report, which includes the information which will be filed on Form 6K.

Our performance in 2003 demonstrated once again the remarkable resilience of HSBC against a background of uneven economic activity in most of the world’s major economies. Let me start with the headline figures on a cash basis, excluding good will amortization.

Operating profit before provisions was up 51% to US$9.017b; pre-tax profit was up 26% to $6.879b; and profit attributable to shareholders was up 32% to $4.873b. Cash earnings per share increased 20% to 48 US cents.

The Board has declared a first interim dividend of 24 US cents, representing an increase of 17%, in part reflecting the different payment pattern as we move to quarterly dividends. This will be paid on 7th October. The Board has also announced its intention to pay a second interim dividend of 12 US cents on 20th January, the first of those quarterly dividends. Our capital ratios remain strong, with a tier one ratio at 8.5%.

This slide illustrates the movement in pre-tax profits compared with the first half of 2002. Pre-tax profit increased by US$1.4b. Household contributed $651m, Bital contributed $272m, and our existing businesses, expressed in terms of constant currency, added $255m.

The key achievements for the period can be summaries as follows. We have seen continued progress in our core businesses; Secondly, continued investment in our operational infrastructure; we maintained stable credit quality; integration of our acquisitions is well on track; Grupo Financiero Bital in Mexico is already meeting our cost and capital targets, and we shall be giving you some detail in this presentation on the encouraging progress with Household International.

The HSBC brand is increasingly well recognized. We were delighted to be included, for the first time, amongst the top 50 in a ranking of the world’s 100 most valuable brands, prepared by Interbrand.

Now let me show you our progress by our major lines of business. As you can see, there has been progress across all of the lines of business, and the acquisition of Household has given us a new earnings stream in the consumer finance area. I would like to take you briefly through each of the businesses.

Starting with personal financial services, on a cash basis pre-tax profits were up 18% to $2.082b. In constant currency terms the increase was 14%. Our personal financial services business in Mexico added $151m, accounting for 46% of this growth.

Other highlights included the continuing strong growth in mortgage balances in the UK. We also became the first bank in this country to launch an Islamic mortgage product, drawing on the experience of Islamic finance in the group, and following last year’s successful launch of such a mortgage in New York.

In Hong Kong, in the face of a difficult operating environment, we have managed to maintain the level of revenue in our personal financial services business, despite the pressure on the mortgage and savings business, by generating growth in fees and commissions. In Asia Pacific as a whole, we now have 5.9m credit cards in issue.

Against a backdrop of volatile equity markets discouraging retail investors, we also grew sales of capital protective products in Asia, to $3.5b, up 25% over the first half of last year.

We continue to invest in the delivery channels that our customers want. In three years since we launched our personal internet banking product, we have registered 10.9m customers, of which 5.8m came from Household. This channel is becoming increasingly sales directed and, including Household, we sold over 800,000 products through the internet in the half-year period.

In consumer finance, Household’s contribution in the first three months as a member of the HSBC Group, was an encouraging start, and broadly in line with our expectations. Household’s consumer finance business has contributed $649m to cash basis pre-tax profit since becoming a member of HSBC on 28th March 2003.

With modest growth across all consumer portfolios during this period, growth in the real estate secured portfolio was mainly in the correspondent business; MasterCard and Visa growth was mainly in the General Motors portfolio; and the private label and auto-finance portfolios benefited from acquisitions during the quarter.

Household is committed to taking a leadership role in the consumer finance industry, by establishing a benchmark for quality. As a result, Household will significantly increase its [inaudible] investment in compliance, monitoring and training, to approximately $150m during 2003, which is more than double the amount that they invested in 2002.

More importantly, stability returned to Household’s funding base, with its debt spread falling below historical levels. New benchmark issuance during the period demonstrated the increased breadth and depth of the funding support available to Household’s business. The addition of Household takes our personal customer base to just shy of 100m.

Moving on to commercial banking, on a cash basis pre-tax profit was $1.647b, an increase of 11%. In constant currency terms the increase was 5%. We continue to grow this business as a result of broadening relationships with customers, and concentrating on service quality. Overall, credit costs remain low.

In the UK, our net interest margin was reduced by $52m, arising from implementing the requirements of the Competition Commission. In response, we committed more resource to advertising and marketing the broad advantages of our small business product, and in this first half year we helped over 50,000 businesses start up in the UK, and increased the volume of deposits gathered from this sector.

In Hong Kong, we worked hard to look after those customers affected by the economic impact of SARS. It is too early to predict the longer term effects of the outbreak, but we are making every effort to help our customers.

Our commercial banking operations in France made increasing use of the Group’s trade finance capabilities. We now have business internet banking available to 20 countries, with 15% - that is some 300,000 – of our business customers now banking with us on-line.

On a cash basis, our pre-tax profits for corporate investment banking in markets were $2.237b, an increase of 8%, and in constant currency terms, an increase of 5%. We are a top-tier player in this sector, and our success reflects the logic of building a relationship-focused investment bank, and broadening the range of products and services that we are able to bring to our Group client base.

Our global markets business, which is a part of CIBM, produced record results in debt origination, foreign exchange trading, and structured finance and hedging solutions. In corporate and institutional banking, revenue growth was achieved from re-financing activities, and modest credit expansion.

Credit costs rose, mainly due to increased provisioning for a small number of relationships in the energy and telecoms sectors. Finally on that slide, our asset management business attracted net inflows of $10b, and broadly maintained profitability in a difficult environment for the asset management industry.

On a cash basis, pre-tax profit in the private banking line of business grew to $268m, an increase of 8%. On a constant currency basis, that increase was 4%. This reflected an improved revenue mix, and growth in brokerage fees and commissions, structured products, trust services, and safe keepings. We saw a significant increase in asset management mandates, and in client forex and other dealing activity.

We continue the process of restructuring the Group’s private banking operations, to improve productivity, and during the period we started the process of combining our four different private banking entities in France into one single vehicle.

Private banking grew funds under management by $11b, and the total funds under management for the Group, including asset management and private banking, grew 15% to $352b. Cost growth in constant currency reflected the establishment of the wealth tax and advisory service group in the US in July 2002, together with a growth in profit-related compensation in certain areas.

This slide demonstrates the changing shape of the Group. We believe now that we have a unique geographic balance, with North America increasing from 11.3% of pre-tax profit in the H1 2002, to 26.6% in H1 2003. If we look at where the increase in profits has come from over the six-year period from 1997, we can see clearly how HSBC has changed its geographic footprint.

Let me now hand over to Douglas, who will take you through some of the financial details.

Thank you, Stephen. Clearly, in this period, the impact of acquisitions and of currency translation has had an impact, and that is why we have highlighted them.

On this slide, reading the columns from the left, we start with the Group figures, then subtract the effects of Household, then of Bital, giving a comparison for the Group as it was in H1 last year. If we then restate H1 of last year on a constant currency basis, you can see that pre-tax profit grew by around 4%, and cost growth was 3% in constant currency terms.

We grew other operating income by 9%, while maintaining net interest income at the same level, which we believe is a satisfactory achievement in light of margin pressures from low interest rates. Turning to operating margin on a risk-adjusted basis, the Group’s profitability improved from 2.53% in 2002, to 2.74% for H1 2003.

This slide illustrates the change in our loan mix, as a result of the acquisition of Household. Personal lending is now 53% of total customer loans, against 42% at the end of 2002. Within this total, other personal lending grew from 13% of the Group, to 23.5%. During H1 2003, at constant exchange rates, loans and advances to customers, excluding the financial sector and settlement accounts, grew by $121b, or 36%, of which $108b, or 32%, was related to the acquisition of Household. Excluding the impact of Household, again at constant exchange rates, personal lending grew by 4%, and commercial lending by less than 2%.

Dealing profits continue to account for an acceptable proportion of our total income, at just under 7%. Foreign exchange profits continue to account for over half of all our dealing profits.

This familiar slide shows the daily distribution of our market risk revenues, and shows that these revenues are, essentially, concentrated in the same range as previous half years, albeit with a small reduction in the negative outliers.

This slide is, perhaps, a helpful summary of our business performance by line of business in different regions. It is one to take away, I think, rather than look at on the screen. Everything above the white line grew revenues faster than costs; everything above the yellow line grew revenue at least twice as fast as costs. You can see that virtually all of our businesses grew revenue by more than cost and, excluding acquisitions, on a constant currency basis, for every dollar we took on in costs, we grew revenue by more than $2.

The Group’s charge for bad and doubtful debts was 153 basis points, up from 43 basis points. Household bad debts charge of $1.539b was in line with expectations. If we exclude the impact of Household, Bital, and of Argentina, the charge was 45 basis points, which was very much, as you will, in line with H1 2002.

We turn to bad and doubtful debts by line of business, we can see that there was a modest increase in the PFS bad debt charge, which, largely, reflected higher provisioning on mortgages in Hong Kong. Consumer finance – that is Household – with a charge of 550 basis points, while commercial banking remained very low, with a decline from 33 basis points to 20 basis points.

In corporate investment banking in markets, as Stephen mentioned earlier, there were increased charges for a small number of relationships in the energy and telecommunications sector, which led to the charge rising from 23 to 37 basis points.

Turning to credit quality in Household, the rising charge off ratio reflects the seasoning of the portfolio, the weakened economy, and higher bankruptcy filings, which has resulted in the decline in the risk-adjusted revenue margin over the last year. However, the trend in delinquency rates indicate that credit quality is stabilizing.

This slide demonstrates the spread in Household’s funding costs which, as you can see, have narrowed to below historical levels. We are now, therefore, confident that improvements in funding costs will exceed $1bn on an annualized basis, based on spread improvement achieved today, and other related anticipated funding cost savings. In addition we expect to see synergy benefits in card processing, IT contingency rationalization, purchasing, call-center cooperation, and the use of the Group’s service centers. These, together with Group-wide application of Household’s credit scoring and data mining technologies, and the consolidation of some essential administrative functions, should produce total synergy benefits in costs exceeding $200m per year within two years.

We further believe that there will be synergies to come from extending the Household model into new markets alongside established HSBC operations, and there is also potential to cross-refer potential customers from both Household and HSBC to the most appropriate channel. These are both being worked on.

By illustration, an early success came in June, when HSC Bank in the UK, Household’s subsidiary, was awarded a long-term contract with the John Lewis Partnership’s store group for the joint management and operation of their store card.

Let me give you quickly an update on progress with the Group’s service centers. At the end of June we had 6,000 staff employed in these centers, which is up from 4,500 at the end of 2002. We remain on track to have a targeted staff complement of just over 8,000 by the end of this year.

Let me now hand you back to Stephen.

Many thanks, Douglas.

Turning to future prospects, there are mixed signals in current economic data. The significant easing of monetary policy around the world is aimed at bolstering consumer sentiment, in part through a positive effect on the housing market. Fiscal deficits are being recognized as an inevitable consequence of policies aimed at avoiding deflation. Significant debt restructuring and refinancing at lower rates has been achieved in corporate balance sheets, and there has been good progress in corporate refinancing, particularly in restructuring, particularly in the elimination of excess capacity. Sentiment is improving, and there are signs that, in some industries, the worst may be behind us.

Overall, HSBC’s ability to generate capital remains strong. We are in an excellent position to benefit from any upturn in the world economy when it occurs, and to pursue opportunities for growth where they arise. Within our industry, HSBC’s business is uniquely diversified, both geographically and by line of business.

We are positioning HSBC for a modest, but uneven, economic recovery. Prospects for the rest of 2003 look reasonably globally, but we remain cautious about the longer term outlook, because of structural imbalances in the world’s major economies.

In most developed markets we expect revenue growth to remain subdued. We are concentrating on improving our productivity, to respond to the growing costs of new regulations and additional taxes several jurisdictions. Strategically, therefore, we are building our business in those markets where the demographic profile indicates growing consumer demand.

We are particularly excited by the opportunities over the next few years in the emerging economies of Asia, including India and China, and in the Middle East, Mexico, and Brazil.

Finally, perhaps an additional and overlooked new market opportunity will be provided by the immigrant population of the US, to which, through Household, we now have significant access.

HSBC is in good shape, and on course. We are very pleased to have our brand recognized as one of the world’s most valuable, and we will continue to work hard to create brand value.

Now we would be happy to take questions. Can I ask you to wait until the roaming microphone reaches you, so that we can hear the question. If time permits, we will take some questions by e-mail.

Good morning, it’s Simon Samuels (ph) of Citigroup. I have a couple of questions on Household, and I apologize if the answers to these are in the release somewhere where I have not yet found them. The first is for Douglas. The quantification of the fair value adjustments that have boosted net interest income – if I understand your comments on page 48 correctly, referring to the fact that there will be funding benefits, that these have already been recognized through the fair value adjustments, and that as those unwind, if you like, the real funding benefits come through. Am I right in interpreting these results as including essentially three months worth of funding benefits and, if so, could you quantify those?

Do you want to do your second question—

The second question, and again apologies if you have disclosed it. I know you have spoken in past about transferring cost of Household credit card portfolios on the HSBC platform, and changing the provisioning policy to the HSBC provisioning policy on credit cards, where you have a fewer number of delinquent days before you provide. I wanted to see whether that has come through in these numbers yet.

Happy to—

I take the easy ones and [inaudible] the difficult ones.

I was prepared for that one, Simon, so that’s not too bad a one. The statement on page 48 is as you interpreted. The results for the half, including the quarter, for Household incorporate the amortization of fair value adjustments on both their assets and their liabilities, which brings with it a benefit to net interest income of between $250-300m. This is, effectively, bringing the funding of Household onto a current cost basis.

I think the way to think about this, or at least the way I think about it, is it is analogous on the other side of the balance sheet to buying a mortgage book with a back book of mortgages that have not yet re-priced. The margin on those mortgages is excessive and you would adjust it, you would pay for it in the fair value, and you would adjust the yield to current yield.

Is the yield recurring? – taking the analogy with the mortgage book – absolutely, because you are not going to replace those mortgages on a back book widespread basis, neither are we going to replace Household’s funding on a spread basis that was seen historically. So yes, the benefit is in the quarter’s results, based on that.

Applications have been made in the US to transfer the private label card business, which is what you are referring to, and that may move more of the credit card business as well. When we did the circulars on the acquisition we indicated that moving the private label card business would bring it into the FFIEC basis of provisioning, which would mean that we would be called to charge off faster and, therefore, our management of delinquency and default would be different, and it would cost a bit more. We put a figure at the time of around $200m. I do not have a better figure than that. That is not reflected in these results.

Indeed, when we do move the book across and, to the extent that the collection routines change, and the cost of credit goes up, we will take that charge, which will be a charge to earnings in whatever period we do it.

James Hamilton (ph), WestLB. You mentioned that provisions were a little higher on the Hong Kong mortgage book. There has been, if I understand correctly, quite a significant increase in negative equity in the Hong Kong market in H1 this year. Can you comment as to the propensity of people moving to negative equity to file for bankruptcy, and what impact you expect through H2 of the year.

Bankruptcy rates have slightly tailed off in the last month or so, and delinquency rates on mortgages remain very low. In terms of expectations for Hong Kong, I think it is difficult to tell. The remained subdued; the SARS effect is surprisingly little so far, and not noticeably varying the numbers. We would be cautious on whether that continued to be the case.

You are right – negative equity is rising – but in actual quantum terms we have seen quite significant reductions through 1998 through to now, as people have been making payments. The actual amount of negative equity debt is not significantly more than it was some years ago. Apart from that, there is no evidence yet of people filing for bankruptcy to relieve themselves of their mortgage debt. There has been in credit cards, but not in mortgaging. There has not been a change in credit cards, but clearly people have filed for bankruptcy and got rid of credit cards—

--position is actually looking a bit better now.

Robert Norwood (ph) of Lehman. One of the features of these figures is the markets area. I wondered if I could ask about the sustainability of that. I am looking at the data you give on page 84, I think, of the last press release, and also 86, where you show the increase in the markets risk-related revenues this half at something like $300m YoY, maybe more than that. Also the sensitivity to interest-rate movements, you show there too, has gone up dramatically. In H2 last year you did see something of a downturn in this contribution, and I wondered if you could help us with a view on how that goes.

There is no doubt that predicting market revenues is a notoriously difficult thing to do, and we do not do it. The dealing profits are an important component in the increase of performance, and the first half has been a good one in terms of trading performance. I think the main thing to say in terms of contextualizing that is that it is off the back of an increased flow of client business. We are very clearly focused, in our corporate investment banking in markets strategy, on building up client focused business. We have seen the volumes of derivatives grow substantially, and that is, by the way, not reflecting market risk, but simply an increase of client business. That is the way we want to take the business. You will not see us angling our markets business towards potentially a proprietary trading one.

I can not tell you what H2 will be like compared to H1. I think it would be an important component of a profit project and you know that we do not like doing that. Secondly, in any case, it is intrinsically difficult to do. There are, of course, if you take the Group as a whole, swings and roundabouts anyway.

Your own colleagues at Lehman will have a view if any of their performance is sustainable. The conditions are very favorable—

That is why I am asking—

The conditions are very favorable, there is no question. Can I come back to the second point you made. You note something that is quite interesting, but I am not sure that I get the same interpretation. On page 86 of the big release, you can see that the impact on the interest rates sensitivity table is quite marked. Our exposure to rising rates has increased because of our acquisition of Household, but our exposure to falling rates has reduced really very, very markedly, because their interest rate position is at the exact opposite of ours.

They benefit from foreign rates, but we can not any longer, because deposit costs have gone about as low as they can and we bear the further burden of accelerated mortgage pre-payment if rates fall further. Their risk is to rising risks. Our ability to manage a rising rate environment is, actually, much better than in a falling rate environment, because most of the falling rate risk is actually in the structural balance sheet, whereas most of the rising rate is managed within treasury.

You are right that interest rate sensitivity has risen for rising rates, but it has actually significantly reduced for falling rates. You could see that the combination of Household and HSBC has had quite an important impact on that.

Robert Norwood; Can I just have a supplementary briefly on that? What I was really after, particularly, in not just the dealing lines, is the structural positions—

This is the structural—

If interest rates remain as they are, do you see the contribution you are receiving here changing, and also there obviously has been a change of 100 basis points in the wrong yield, and I rather wondered if there was any impact from that on you since the balance sheet date?

Since the balance sheet date, not materially, no. The treasury moves the positions about, of course. The treasury is as aware as anybody else is about what has happened to the bond market. There is nothing to fear or to report.

One of the positives, which will come through slowly, of the rise at the long end is that it is curtailing mortgage pre-payments (inaudible)—

The other point to make is, of course, that our accrual books are much shorter than the 10-year life which is wear the curb was really badly cut.

Alex Brent (ph) from Goldman Sachs. I will try and squeeze three questions into two if I may. The first two questions are on revenues, and the third question is related. Looking at the fair value adjustments on Household, in a rising interest-rate scenario, you have just discussed the increase in the negative impact. How would that fair value adjustment change in a rising interest-rate environment, and a knock-on effect on the P&L? Secondly, looking at net income and [inaudible] profit, which are up ex-Household and ex-Bital by about 4% of your total revenues, is it fair to combine NII with [inaudible] and look at it that way, or would you still look at zero growth in net interest income on a reported basis?

The fair value adjustment will not be impacted by rising interest rates. The fair value adjustment in quantum is set and amortizes over the residual maturity of that debt. Essentially, it represents spread rather than absolute interest rate. The sustainability of the benefit that we forecast has everything to do with the spread and not interest rates. As long as the spread is maintained, the rate they were at 28th March, and they have actually improved since then, that benefit will maintain. It is not impacted by rates.

Household [business], obviously, is impacted by rates, but they offset to rising rates, which reduces margins, assuming the rising rates are reflective of a growing economy, is more employment and, therefore, less debt. There is another scenario as well, of course.

On the treasury books, if rates at the shorter end of the curve back up, you would expect that to flow through to better interest income in the treasury accrual books, over time, as existing assets run off and are replaced at higher rates.

In terms of looking at the net interest income and dealing profits together, I think that would be a reasonable thing to do for the corporate investment banking in markets line of business, which is separated out, but not for the others, because they are transferring their interest rate into the treasury. But for the treasury – yes, that would be a reasonable thing to do.

Finally, just looking at the 17% increase in the dividend, could you relate that to the fairly modest growth in the underlying core business, and your thinking on the dividend at the moment in terms of payout ratios and the growth rate.

As we have said, the increase is partly a re-balancing, as we move to what we plan to be three stable quarterly dividends and a variable final. The dividend growth is projected against a pair ratio, between 60-70%. If you look at the achievement in H1 of this year, you will see that, all other things being equal, the pair will last than last year, making reasonable assumptions. We are happy with a 60-70% range. The benchmark is the amount of capital we need to continue to grow our business. Based on projected asset growth, we think the dividend that we have planned for this year, which we can not really extrapolate from the interim one, is fine.

Your question related it to the 4% growth in constant currency pre-acquisition business, and that is a slightly unrealistic ratio to use. You would expect Household to contribute to the P&L and, therefore, to contribute to the dividend.

Mark Thomas (ph), Fox-Pitt. You are bit more optimistic in the short term, but remain reasonably cautious in the longer term on the economic outlook. I just wanted to explore a little bit whether that has any impact on the P&L. An obvious one is that your pension assumption for salaries is less than the peer group, even though your investment returns are pretty much in line with the peer group. Are there any other economic assumptions or economic impacts from that medium-term caution.

If you go around the world, we look at Hong Kong and say that we expect slightly stronger growth next year. This year our forecast is 0.5% for [inaudible] in Hong Kong, and we see that going up at something like 1.5%, so it is all pretty subdued, but nonetheless an improvement. China is remaining pretty robust, and India is remaining quite strong. There are some quite good conditions in Asia as a whole.

If you look at Europe, I think the picture is more difficult. There are some shoots of economic growth just beginning, and early signs of more confidence and renewed optimism, even in Germany, but still the overall position for the Euro zone is pretty unexciting. The UK is tailing off a little bit.

The US is recovering, undoubtedly, in H2 this year, and may be into next year. Japan, of course, had a very strong Q1, and Q2 results are not out yet, but the signs from export growth in Japan are that they will have fallen back.

That is the sort of background to our view that the medium term is not exactly improving conditions. That is allied to the fact that there are substantial structural imbalances around, notably in the US, with the fiscal position and the current account position, and to some extent in this country too.

What does all that mean for us? It means that we think that there are opportunities for doing business but, as ever, it pays to be diversified and strong in capital. That is our continuing formula.

Mark, on your point on the pension assumptions, and I do not have in my head what everyone else has done, but I do know that what we looked at carefully was the spread, because it is the spread between salary assumptions and investment yield assumptions that matters for the valuation. The spread we got, I think, is cautious in the range. You are looking at one side of it, not both, and we looked at the spread and the two obviously went together.

John Kirkpatrick (ph) of Merrill Lynch. Two questions – one on strategy percieved and one on margins for the debit. The strategy question, I guess, relates to slide 12, where you showed the Group’s balance, and the conclusion from that, if we look from last year to this year, is the lessening of dependence on Hong Kong. Clearly, that is struck at the pre-tax profit line, and what actually matters more to shareholders is earnings. With the US on a higher tax rate and Hong Kong on a lower one, Hong Kong is still a pretty large contributor to the Group in terms of around a third or just over the level. As you look forward, do you see that balance changing further significantly in terms of less incomes from Hong Kong, and are there any mature moves to make that happen?

I would say two things. First of all, I would not want to put in terms of lessening dependence on Hong Kong. Hong Kong remains a very attractive business for us. It is a great position to have. The fact that we are unquestionably broadening the geographic spread, we would expect North America to increase in importance in the Group, not least because we have had one quarter of Household’s results in this, and we are going to end up with something like a one-third/one-third/one-third balance between Asia, Europe, and the Americas. That feels like a good position to be in.

Your implied question about the tax rate is well taken. The Hong Kong environment is a particularly attractive environment on a post-tax basis. There is not a question of running that down at all, and on the contrary we continue to develop that. It continues to be strategically important for us, not only in its own right, but is also the basis and support for our developing mainland China business. We are absolutely not ignoring or treating it as a cash cow in any way at all. Hong Kong remains a very important business for us. When I joined the bank, Hong Kong was something between 90%, if not 100%, of the then Hong Kong Shanghai Banking Group’s P&L, but clearly it is not going to look like that in the future. 25% of the Group’s business is a very material business.

The second question was just some detail on margins, for Douglas. I just want to clarify. In terms of the feeling you talked about on Household’s synergies, is that in what you have got in the fair value adjustment, i.e. it is coming through in profit? Or is there an additional increment of synergies you expect from funding which is not caught in the fair value assessment? Secondly, about the Hong Kong margin. The Hong Kong bank ex-Hang Seng margin seems to be down sharply while the Hang Seng margin is quite slack. Could you explain the sharp divergence there?

The current amortization of the fair value adjustment is on an annualized around about $1b a year – between 250-300. The extent to which we do better or worse than that depends upon whether spreads contract or go out from there, and the extent to which we change the mix of funding between longer and shorter term. The [inaudible] synergies may be different, but the amortization of fair value adjustments are on a roughly $1b a year basis.

I do not recognize that number so I will have to see where you are getting that number from and get back.

Alistair Ryan (ph) from UBS. Firstly, on Bital, you hit your target after six months rather than 30, by the looks of it. Is that a sustainable number? Secondly, on Argentina, there has been a pretty dramatic turnaround, although negotiations I understand are still being concluded between the IMF and the Argentine Government. Is the operating number there sustainable?

As far as Mexico is concerned, we have done clearly rather well in H1 and expected our expectations. We are there for strategic reasons. We believe that there is growth potential in all of the lines of business there. It is an interesting business for us. Outside of Household, it is the one of all of our Group business worldwide that has the highest proportion of consumer finance business in it now. It is a market which is under banked.

It is a young market, and not much more than 30% of Household income is taken up by bank debt. There is an opportunity to grow our business, both with the consumer, and also with the commercial [inaudible] market. Lending in the Mexican economy has been very slow for the last two or three years, and is clearly beginning to pick up.

Whilst I would not cavalierly multiply anything by two and assume that we have a good forecast for the year, if you take a strategic perspective, everything that we have hoped for with Bital is looking really good at the moment. We are confident that this was a good, strategic purchase. The value of Mexico as a member of NAFTA, in a sense, does not need explaining. The flow of business across the border, both in terms of individuals and in terms of US corporates and their involvement in the Mexican economy, gives us opportunities that we are, frankly, only just in the foothills and beginning to exploit.

In Argentina, the performance is looking better. The bank is making money. The Argentine economy is doing better, with 4.8% growth forecast this year, and a not dissimilar number for next year. Is it out of the woods yet? I think it is probably too early to say. As you imply, the negotiations with the IMF on the rescheduling of their debt are at early stages, and I think that it would be complacent to assume that all the difficulties have now passed or that the future is going to be rosy there. It is looking more promising now than would have been six or twelve months ago.

Rob Murphy (ph), Gartmore. A quick thing on the fair value accounting. Is that accounting method one of many options, or is that the one you had to do?

Absolutely standard under both US and UK GAAP.

Secondly, on strategy, given what you have said about your long-term caution on imbalances, how do you reconcile your enthusiasm for your consumer finance where we do see quite large imbalances in terms of debt levels?

My comments are largely directed at the next 18 months or so. Long term I am very confident in the strategic significance of consumer finance as the major area, both in emerging markets and in G7 markets. One of the important reasons for bringing Household into the Group is that it gives us a platform that we can take to a number of our most important franchises in both kinds.

In the near term, I think it is fair to say that nobody expects the increase of consumer borrowing that is taking place in this country to be able to continue at its present rate. We seek to run our business in a way which is responsible vis-a-vis the consumer. It is not in our interest to make loans which do not get repaid. You have to make an awful lot of new lending and get the profit from new lending to account for only one bad debt. We run our business in a way that is targeted at keeping the business on a profitable basis. The number of operational aspects.

We set up a money management service, which is in effect a debt counseling operation, in this country, which has been very helpful in talking to customers who do get themselves overextended. I think that the prospects for consumer finance in this country are almost bound to slow up, compared with the hectic pace of the last couple of months. That does not mean to say it is going to go into free-fall, and it does not mean that the strategic rationale for consumer finance as an important part of financial services has in any way gone away. On the contrary, all the analysis of market conditions, demographic trends, tells us this is a space where we want to be.

Michael Lever, CSFB. I have a couple of questions. You referred in your comments when we started the meeting about further investment in training compliance at Household, and I wondered if it was incremental to, or reflective of, the Attorney General’s settlement.

Not incremental to; a response to the settlement, and also to our determination as a Group, Household’s determination to be a high-quality provider in this area and to be the benchmark of performance. I think that there is a lot of working going on, and we are well on track to complete it.

Just trying to be a bit more specific, as part of the Attorney General’s settlement, in the documentation that was an estimate of the impact on Household’s business over the next couple of years. I am just wondering if this is part of that estimate, or whether this is on top of that estimate.

It is not on top of.

It is part of?

It is broader than that. Household are doing a bunch of things, and a lot of those were encapsulated in the addendum to the Attorney General’s settlement. All the changes in business models, some of which were mandated and some of which they were already implementing on their own back, come to this number, which is double last year’s. It is not on top of what was agreed with the Attorney General.

A third question on Household. I just wanted to clarify your response to Simon’s question earlier about the movement of the private label card book onto the North American book. As you indicated, there will be a $200m possible charge for that. Is that a one off charge in the period, the P&L item–

When it comes, it will be a one off item, subject to growth and changing characteristics of the portfolio. There will be a one time bringing it up to a different basis of faster charge off. In the UK GAAP numbers that will flow to earnings. We will highlight it when and if it happens.

My final question is on dealing profits. I note the comments about favorable conditions and customer-driven business, and the two are inter-related. In a rising interest rate environment, customers may want to do less business, and you may have less opportunities to make money. I am trying to get a sense of what the dealing profits would be in an environment of rising interest rates, or directioning how you feel about the H1 dealing profits, given the obviously easy way of making money in the first half of the year.

That is a hard question to answer.

We feel good about them, Michael.

Dealing profits were good in the first half, but you are a better man than I am, Michael, if you can predict market conditions and the opportunities that will present themselves in that in H2.

I clearly can not, because my dealing profit line was miles down. Thank you.

If you are going to assume profit from acquisitions, then you can report them. In Europe we have made a couple of big acquisitions over the past few years, part of Republic and CCF, a 10% fall in profits on a constant currency basis, excluding dealing profits. It does not sound like a very good results. 4% is stated in constant currency, but if you strip out the doubling of dealing profits, it is a pretty disappointing performance out of Europe. Could you tell us what is going wrong there? Is it something to do with acquisitions in the past?

I am not sure I would accept that something is going wrong there, nor do I think it is reasonable to strip out dealing profits. They are, after all, a reasonable, legitimate and acceptable part of the business. To the extent that businesses are dependent on investment products, and as a course have had a relatively more difficult time, our overall business in Europe in corporate investment banking in markets, in which Paris has played an important part, is going really quite well. The retail business in France is also going well. I do not think there is any reason to believe that there is any significant difficulty there.

There is £100m of additional costs in H1 this year for amortization of pension deficit, property costs, and more depreciation on coming to this building as old equipment being thrown away and replaced with new. The cost of the competition authority’s interest rates on commercial customers. There is £100m in the hold to start the year for things that the Competition Commission can do nothing about, and the others are necessary for our business. I would not characterize the performance as disappointing. The personal and commercial businesses in France and the UK have done extremely well in growing in mortgages and personal lending in asset management products. If we look at the market, clearly asset management products are down against history, and that was part of CCF. CCF’s business in the retail business has done extremely well. It is up double digits again this year.

I think it is fair to say that in private banking in France there is scope to do better. I referred earlier to the fact that we have four different units for essentially historical reasons there. That is not the best structure for an effective on-shore private banking business. We are working on that, and it will be one of the significant objectives of the management there in H2 to get that done, so that we have a platform for private banking in France.

Richard State from SG. Can I ask two separate questions? Firstly, on operating costs. I remember six months ago you gave us some guidance as to what underlying operating costs should be growing by over the next year, because I think there was some disappointment in H2 last year. Is there anything we should look for in H2 this year, and has your guidance changed?

We talked about it, and I remember it, because it keeps being repeated back, around about 2%. If you take out the two big acquisitions it is 3%. If you take out all acquisitions it comes down to about 2.4% HoH underlying cost growth constant currency. That gives us quite a lot of scope to increase costs if we chose to do so in H2 and still be within the 2-3% growth. We are 2% down in constant currency like for like against H2 of last year. I think, all other things being equal, that is a reasonable basis to look at it as that. The cost growth is not a lack of productivity. We are still growing $2 of revenue for $1 of cost. We are growing our business in personal banking in Asia. We are growing in America. The costs are generating revenue. It is not cost of existing business, but the cost of expansion.

A second question, on acquisitions. If you look back at the ones you have done in the last few years, it appears that the synergy benefits you are getting out of Household are considerably larger, mainly due to the funding benefits, if you compare that against CCF and Safra Republic, does that encourage you to do more of this kind of acquisition where you can bring down funding costs?

It is a question that leads, effectively, to our general strategy on acquisition. I would say that we have a very full plate now. We have an extraordinary geographic footprint, and an extraordinary breadth of product capability. The introduction of Household into the Group is a major change for the Group. We are going to be focusing very strongly on getting the integration done, getting the benefits of Household in terms of the North American division, we have referred to the $200m of synergy benefits there, looking at ways of taking the model overseas.

There are 33 different working groups beavering away at the moment to find ways of making sure we get the best out of that. Similarly with Bital, which is not a small acquisition in terms of significance for us, there is a lot of work going on of that kind. I frankly think that that is our priority. I am not going to say that we will never make an acquisition – that would be nonsense. You should never say never. We never comment on rumors on particular things. If you ask me what is the main task over the next one to four years, it is clearly making sure that what we have got functions as seamlessly and connectedly as possible for our clients and, therefore, for our shareholders.

Hugh Pye (ph) from BNP Paribas. On one of your slides – Household credit quality trends – you mentioned that you felt the trend in the delinquency services was suggesting some sort of stabilization in credit quality and the charge off rates. Could you just go into a little bit more detail on why you feel those levels of comfort, and what sort of feelings you have for the slope of the charge off curve, and when it is going to peak? As a small supplementary, those data are in US GAAP. Can you fill us in a bit on what the numbers look like in terms of charge to loans in UK GAAP going forward?

Against a year ago, delinquencies are up about 30% but the rate of increase has declined significantly in the last quarter. The increase has slowed. They are all early indicators of portfolio quality, which comes from within their own portfolio, and indeed from economic statistics, so that if we take the consensus economic view which they hold too of an improving US economy in H2, then by the end of this year and Q1 next year we should have begun to see rising employment, which would drive credit statistics. That is the basis of that.

The bad debt charge in UK GAAP in the quarter is 1.5b. The provisions are roughly around 10 months of provisioning which, for a consumer business, seems to us about right. We would expect to see somewhere between six and 12 months, depending on the product set. The reason we did it in US GAAP is that we do not have a history in UK GAAP. We are going to build one up, and talk about it for the next umpteen years. The only way we can meaningfully give you the statistics is to look at the time series on a US GAAP basis. But on a US GAAP basis, looking at managed receivables, there is a prox sales, although managed receivables includes provisions against accursage receivables on an overall life basis, not in terms of what is impaired, but in terms of what is impaired plus what can be foreseen as impaired in the future, so it is a larger figure.

Those are the trends and the indicators, and their own 10Q and 8K should be published this afternoon, which will give you even more figures to look at. There is in fact a question on the internet as to whether trends in Household’s own base’s charge offs in terms of delinquencies are different from managed bases, and the answer is yes, but only because of mix. The difference is the securitas portfolios, and the securitas portfolios are heavily in credit cards and also finance, which have different delinquency and charge off statistics. It is a mix, rather than different qualities.

Could I come back on Household again please? The contribution in Q2 is something like $650m on a cash basis. If you back out the funding benefits that you have taken, that would equate to something like [inaudible] multiples 15 times, I think. Could you comment on whether you see the Q2 number that Household has reported under UK GAAP as reflective of future performance, or are there things in there that have held back the performance?

Household’s Q2 is typically a weaker quarter for a number of reasons, the biggest one being that their refund loan business on taxes is a Q1 business, and that is a big difference. There are two other things. There are $50m of charges in the quarter in relation to a portion of the expense of the costs of compensating the senior executives in Household, which gets expensed on US GAAP in the opening balance sheet, but a portion of it relates to future incentivization in the UK gets charged as an expense. In Q2, yes. One-time.

H2 in Household is always a larger half. The other thing to note, which is the most significant, is that, for all the obvious reasons of funding strain and the fact that they were in negotiation to sell the business, the origination channels were heavily dampened down in Q4 last year and continuing into Q1 this year, because if the deal was to go ahead there would be funding benefits, and if it did not go ahead we did not want to have extended debt. It takes a certain amount of time to ramp up the channels, and the time it takes from originating the leads through originating the launch to booking the launch. We had a dampened Q2 as things were wound up again. By the end of Q2 the business was back to more like it was in H1 last year. The origination volumes in H2 are planned to be stronger than in the second quarter or first quarter we consolidated for them, because frankly the branch channel was muted as it wound itself up again.

This is clearly getting into profit forecasting and difficult to do anyway. At this stage one of the unknowns about the US economy is if the back up in the bond market that we referred to this morning continues the effect on mortgage financing and mortgage refinancing it will be a dampening one quite quickly. There are some swings and roundabouts in the profile of the business, but it makes it difficult to forecast it meaningfully.

You talked about funding synergies to Household of being within the HSBC Group, and you assumed them in the results, with this amortization item, but in the Group as a whole there is a danger that the new shape of HSBC leads to higher funding costs for the Group as a whole, ex-Household, as a result of owning Household. I haven’t seen a chart on what your funding has gone like over the last few quarters, but it is possible that that could worsen over time from where you were before Household. It seems a slight mismatch, that you are assuming on one side all the positives, but potential negatives on the other side are not being—

That is because we are a bit more sanguine than that. The advance to debt ratio will have risen from 42% to 52%, so that is a move upwards as a result of buying what is an asset book, and is the other side of the coin of the question you asked a little while ago. If you buy a business which has an asset liability match, in the sense of being the opposite way around a core business was before, you would expect the advance to deposit ratio to rise. That is still pretty conservative by the standards of the banking community at large. I do not think we have seen, or have any good reason to fear, that. Our costs of funding in the pre-Household bank would be adversely affected.

In the subordinated debt issues that we have done, including tier one issues, our spreads have been improved. There is no evidence of our spreads widening as a result of Household being part of the Group. You say assumed. What we are doing is accruing the current cost of Household debt in our P&L account, just as we accrue the current earning rate of assets that we buy. There is no difference. The cost of that is reflected in the current terms in which you can buy it in the market place.

Are there any other questions? It looks like we exhausted you on the subject of Household. There are none on the internet either. Thank you very much for coming to hear about the business. We look forward to seeing you next time in January. Thank you.