Lloyds Banking Group PLC (LYG) 2008 Q2 法說會逐字稿

Good morning, everyone, and a very warm welcome to our broad stream.

The last six months have seen exceptionally tough market conditions for the UK banking sector. In particular, the continued dislocation of the global financial markets has meant that long-term wholesale funding has remained severely constricted in the UK banking markets. Furthermore, the knock-on impact into the mainstream economy is now becoming far more prevalent.

Mike is going to take you through all the detail of the results. At headline level, our profit has been impacted by fair value adjustments in our treasury book and the first sign of increasing impairments in both our retail and corporate businesses, largely as a result of asset price deflation in both residential and commercial property. However, the underlying performance of the business remains extremely robust.

We have quickly reshaped our business in the light of the economic downturn. Most importantly, post the rights issue we now have strong rebased capital ratios. We're making significant progress in repricing new and existing assets to improve margins. We've begun the long but important journey to improving our deposit to loan ratio.

Away from our banking businesses, we're looking for particularly strong growth in our insurance and investment operations. We've refocused our treasury operations, with a significant proportion of our investment portfolio now in run-off mode. And we're turning up the pace even further in terms of tight cost management.

In short, we're reshaping the business to be appropriate for the vastly changed economic circumstances. It's been a tough six months but we're making good progress in delivering all of these initiatives.

When Mike has taken you through the numbers, I'll come back to discuss each of these initiatives in turn. Over to Mike.

Thanks, Andy. Good morning, ladies and gentlemen.

I'm going to start with an overview of the key financials, with and without negative fair value adjustments, FVAs, to the treasury trading book, which do tend to distort comparisons. I'll go on to look at the Group income statement, before commenting on the financial and operational performance and outlook for each of our main businesses. I'll then look at the balance sheet, specifically funding and capital. Now, there's a lot to get through in 40 minutes or so, so let's start with the key financials.

Excluding negative fair value adjustments in the treasury trading book, underlying profit before tax, UPBT, declined by 14% to GBP2,546m. Including FVAs, UPBT fell by 51% to GBP1,451m. Underlying earnings per share, excluding FVAs, declined by 13% to GBP0.474.

Please note that the number of shares in issue has to be adjusted for the rights issue, and later for the capitalization issue in lieu of the interim dividend. It is the average number of shares in issue that is used for the EPS calculations, as opposed to the actual number of shares when calculating dividend per share.

We are proposing a capitalization issue of GBP320m, which is currently equivalent to an interim dividend of GBP0.061. We intend that the final dividend be paid in cash, based on 40% of underlying profits attributable to ordinary shareholders, after deducting the amount of the capitalization issue. For the future, we have adopted a 40% payout ratio and intend to grow dividends in line with underlying earnings.

The cost/income ratio increased to 41.2% and the Group return on equity, ROE, reduced to 16.6%, excluding FVAs. ROE will be suppressed by the new equity that we have raised, but over the cycle we consider an ROE around the mid-teens to be sustainable, accepting that there will be years of performance either side of mid-teens, according to the prevailing economic climate.

We show the Basel II ratios on a pro forma basis to reflect the rights issue and are operating at around the mid-point of our new target ranges, which are 8% to 9% for Tier 1 and 6% for Core Tier 1. We expect to operate comfortably within these ranges.

Taking a brief look at the Group income statement, underlying net interest income shows good growth, of 6%, with the Group net interest margin down slightly, by 3 basis points, from the second half of '07. In overall terms, we expect more stability in margins with a potential for improvement next year, something that we've not been able to say for quite some time.

Non-interest income was down by 7% excluding FVAs, shown at the bottom of the slide, mainly due to lower revenues from our corporate investment portfolio. So, in overall terms, there wasn't much change in underlying operating income, excluding treasury FVAs.

Costs increased by 4% and for the year as a whole we would expect mid-single-digit growth and probably lower growth next year, back to a rate of cost growth you can count on one hand.

Impairments show a sizeable increase that is most marked in residential mortgages and corporate lending. We remain cautious regarding the credit outlook.

The treasury negative FVAs clearly impact on the first half performance this year. We're not expecting further significant negative FVAs and therefore look forward to a stronger second half-year, accepting that there are always market risks.

Let us now look at the results in more detail, and at a divisional level, to understand the trends better. In retail, net interest income was down slightly from the first half '07, reflecting a decline in margins that has now been arrested. In fact, retail margins increased by 3 basis points compared to the second half of '07, despite pressures on funding costs.

We look forward to relatively stable and potentially improving margins, which with approximately one-third of the mortgage book repricing each year bodes well for the net interest income line.

Non-interest income showed a modest increase on the same period last year. So, in overall terms, underlying net operating income was stable year on year, as was underlying operating profit before provisions, because retail held costs flat year on year. The cost/income ratio was unchanged at a very competitive 38.9%.

The strength of pre-provisioning profit that is already evident and will become more so, given the margin trend, is very relevant when you consider the pressure on profit caused by rising impairments.

Underlying PBT for retail was done 5% due to impairment losses, which increased by 6% compared to the same period '07. You have to look at secured and unsecured impairments separately to understand the retail trend. Unsecured impairment losses were lower. The secured impairment losses were GBP213m first half '08, compared to a credit of GBP12m in the same period last year.

Looking at impairments in a little more detail, we continue to be extremely selective in credit cards and unsecured personal lending, and balances have reduced since the year end to a total of GBP13.1b. At this point, early warning indicators on the book performance are stable, but we remain cautious on the credit outlook.

Unsecured impairment loans represented 12.3% of closing advances, down from 13% end '07. Coverage of unsecured impaired loans was broadly stable at 82%. With regard to secured impairments, these increased from 1.8% to 2.16% of the book and coverage increased from 8% to 10%, partly a reflection of falling house prices. But the strength of collateral continues to mitigate provisioning requirements.

The secure book ended '07 in a robust position, with strong collateral levels and a low proportion of ILTV exposures. At June 30, the average indexed LTV was 48%, and some 12% of the book now has an indexed LTV above 90%. This is a quality book and we aim to keep it this way, balancing the profile of the book between mainstream and specialist lending.

Mortgage arrears are increasing in line with our expectations and are likely to continue to do so, given the worsening economic outlook, squeezes on household budgets and modest rises in unemployment. Arrears as a percentage of total mortgage balances increased from 1.67%, the very low level end '07, to 1.95% at June 30, '08, similar to the level two years ago and lower than the level two and a half years ago.

The rate of increase is higher for specialist mortgages, which is what you would expect and why such mortgages are priced more expensively, to ensure an appropriate risk/reward ratio. We're not complacent and expect further increases in arrears, but you would have to see something like a fourfold increase to approach the worst levels of the early '90s, which we do not see happening. You also need to bear in mind retail's pre-provisioning profitability and the more favorable outlook for interest margins in terms of capacity to absorb impairments.

Retail selective and modest asset growth remains retail's objective for the near term, with an emphasis on secured lending where we have already tightened lending criteria, including LTVs. We expect to write roughly one in five new mortgages, but in a much smaller market. And with principal repaid broadly reflecting market share, we would expect low levels of net lending. Quite simply, we will maintain our focus on margin and profitable growth, not market share.

We will continue to develop our savings and banking franchise. The savings market is highly competitive and while recent growth has been encouraging, we will balance market share aspirations against our determination to manage margins.

The acquisition of full facilities current accounts remains a key priority, as these provide the basis to develop, longer term, more profitable relationships with customers. We opened 478,000 bank current accounts. That's an estimated 21% share of the new current account market. And of those, 77% were full facilities accounts.

In summary, in retail, we have taken appropriate action to prepare for the slower economy and impact on housing. We have good growth opportunities in savings and banking. Margin stability and tight cost control will continue to underpin pre-provisioning profitability. And we're confident that we have a strong value-adding franchise for the future.

Turning to corporate. Underlying net interest income increased by 15% over the same period '07. On the back of a strong pipeline of business coming into the year and the slowdown in syndication market, loans and advances increased by an annualized 14%, which drove the increase in net interest income. Asset growth has now slowed and we would expect mid-single-digit growth for the full year.

The net interest margin declined by 5 basis points from the second half of '07, mainly due to slower churn of the back book impacting on fee recognition within net interest income. Pricing for new lending has improved and approximately 20% of the corporate book reprices each year.

As expected, non-interest income showed a significant reduction from the GBP922m reported for the first half '07, due to lower revenues from our investment portfolio. In the current economic climate, there were fewer opportunities to realize investments, and weaker trading from associates and joint ventures resulted in losses of GBP34m compared to profits of GBP108m for the same period last year. There was also a significant increase in impairment losses on investment securities, which totaled GBP145m in the first half '08.

We expect returns from our investment portfolio to remain subdued, but remain confident in the longer-term prospects for the portfolio, which I will comment on shortly.

As you would expect, costs have come down, the biggest single factor being a reduction in remuneration costs. In addition, there are numerous cost initiatives underway within corporate, to adjust to an operating base more appropriate for business in the future.

We have seen a significant increase in impairment losses, to GBP469m for the first half '08, compared to GBP235m and GBP367m respectively in the first and second halves of '07. Impairment losses are now running at an annualized 0.83% of average advances.

Generally, the credit assessment process for corporate lending focuses on the strength and resilience of underlying cash flows rather than placing undue reliance on any collateral, although 40% of corporate's loans and advances are secured on UK property.

For commercial property investment we focus on rental streams, the strength of the tenant covenant and length of lease. We've limited evidence of any material deterioration in tenant defaults, which isn't to say we are complacent, bearing in mind that commercial property prices have probably fallen nearly 20% from their peak in early '07 and could fall further. There will be breaches of lending covenants, particularly those relating to LTVs, but we have experience of working through difficult periods with borrowers to minimize impairments and losses.

The house building sector is under stress and has resulted in a write-down of our equity exposure of nearly GBP0.1b in the first half. Our exposure to house builders totals GBP4.1b, or 3% of total corporate advances, or less than 1% of the Group's loans and advances. Exposure is to more niche house builders and secured on collateral, including land banks. While property prices have been and will continue to be under pressure, in a generally deteriorating economic climate we still prefer bricks and mortar than being unsecured.

Moving on to the investment portfolio, this increased from GBP4.2b end '07 to GBP4.9b June 30, mainly due to the pipeline of business coming into the year. The portfolio has been built up over a number of years and includes vintage from as early as '01. Our expectation is to hold investments for five to seven years, although this shortened during the period '05/'07, which saw peak levels of activity. Private equity funds account for 38% of the portfolio and the average investment is just under GBP2m, spread over around 1,000 individual investments.

In the future, we will seek to partner with others in developing our integrated, structured and acquisition finance, ISAF, JV and specialized industry finance, SIF businesses, rather than grow the business entirely on our own balance sheet.

We have slowed corporate asset growth and will be very selective in targeting growth in areas that add most value and running down assets in lower return areas. We will also be expanding our deposit base through the further development of commercial banking and its expansion into England and Wales, where we are currently underrepresented. With regard to ISAF, JV and SIF businesses, we aim to partner with third parties and continue to provide complete solutions for our clients.

In current market conditions, there are clearly opportunities to improve pricing and take margin opportunities, both on new business and the existing book as it comes up for renewal. It is not sufficient to be prepared for the difficult economic climate. We are positioning corporate to generate revenue growth in future years that is less dependent on balance sheet growth.

Let me now turn to international, where underlying PBT at GBP323m was broadly in line with the first half of '07. I should say that most of the international comparisons here are distorted by sterling weakness.

Net interest income increased by 33% to GBP670m, reflecting strong asset growth, although margins were impacted negatively by higher funding costs and changes to asset mix. Non-interest income showed a modest increase of 4%.

Underlying operating expenses increased by 33%, as we expanded our international business, particularly in Australia and Ireland. The net impact was an increase in underlying profit before provisions of 17%. However, this was offset by increased impairment losses from a very low base.

In Australia, underlying PBT was down by 6% to GBP135m, due to additional investment in expanding the retail and commercial banking network and higher impairment losses associated with some corporate lending. Lending increased by an annualized 39%, although in local currency terms that was closer to 17%. But growth is expected to moderate, as we selectively target those areas which generate higher risk-adjusted returns.

There will also be a greater focus on deposits, as we expand our network in Eastern Australia and as part of our strong franchise in Western Australia.

The net interest margin has been stable, with increased asset pricing offsetting additional funding costs. This trend is expected to continue.

Credit quality is considered to be sound, but we're not immune to the global economic downturn and there are signs of softening in the Australian economy. Consistent with targeting higher returns, asset growth will be more moderate and selective as we continue to build long-term value.

Turning to Ireland, underlying PBT increased by 6% to GBP85m, reflecting strong asset growth. Net interest income increased by 30%, despite a reduction in the net interest margin due to additional funding costs. Margins are likely to remain under pressure but will, to an extent, be offset by higher pricing for new business lending.

Underlying operating expenses increased by 26%, reflecting our continuing investment in both people and infrastructure. In local currency terms, cost growth is closer to 9%.

Impaired loans increased to GBP375m or 1.46% of closing advances at June 30. Credit exposures are underpinned by good cash flows and collateral. Approximately 28% of loans and advances relate to construction and property in Ireland and another 28% to Irish residential mortgages, broadly the same as at the end of last year.

Both commercial and residential property prices in Ireland have fallen and probably have further to fall, but we remain comfortable with the quality of our property portfolios. Economic conditions are unlikely to improve in the near future and, again, we are adopting a selective approach to asset growth, targeting business with higher risk-adjusted returns and increasing the focus on deposits.

In Europe and North America, underlying PBT was unchanged at GBP103m compared to the same period last year. Net interest income increased by 41% on the back of strong asset growth and stable margins. Non-interest income increased by 8%.

Underlying operating expenses increased by 19% at GBP87m, reflecting the expansion of our activities in Germany, Canada and the US. The net result was a 20% increase in pre-provisioning profit, but due to an increase in impairments the underlying PBT result was flat. We will adopt a cautious and highly selective approach to asset growth in Europe and North America.

With regard to European Financial Services, EFS, where the vast majority of investment business is accounted for on an embedded value, EV, basis, underlying PBT was 25% lower at GBP42m, reflecting adverse actual versus expected experience compared to the same period last year. Sales were impacted by difficult market conditions, but we have made significant investment in products and systems and are well positioned to take advantage of future growth opportunities.

Moving on to our insurance and investment business. Underlying PBT increased by 27% to GBP402m, partly reflecting the absence of significant flood claims that were a feature of the first half results in '07, but also improvements in household claims, lower lapses in investment and more favorable actual versus expected experience in our investment business.

We continue to expect surplus capital from both our insurance and investment businesses, with GBP365m paid in dividends in the first half of '08. This reflects the benefits of our capital efficient business mix and the emergence of profits from our growing in-force book of business.

Underlying net operating income increased by 18% over the same period last year. Costs increased by 11%, due to additional marketing expense in our motor business, Esure, without which costs would have been fairly similar to the first half '07.

Looking at the business in more detail, general insurance PBT increased by 64%. Good sales growth coupled with robust claims management and lower weather-related claims drove the strong profit performance.

Overall sales increased by 3%, with gross written premiums at GBP892m. Household sales were up 7%, with continued strong growth of 17% through our branch network. And motor sales, supported by additional marketing, were up by 43%. Strong growth in these areas offset lower sales in repayment insurance, which fell by 13%, largely reflecting lower unsecured lending volumes.

In both household and motor, we are growing market share on the back of strong brands and innovative product propositions that are also expected to increase renewal rates.

Underlying PBT for our investment business increased by 8% to GBP226m, despite very challenging market conditions. Investment sales, measured by the present value of new business premiums, PVNBP, on a comparable basis fell by 5% to GBP7,201m compared to the first half '07.

This overall sales performance reflects the benefits of our multi-channel model, with intermediary sales up 13% and wealth management up 1%, in part offsetting the 18% decline in bancassurance sales, where tax policy changes, IHT thresholds and volatile market conditions had most impacted what are often first time investors. However, compared to the second half of '07, bancassurance sales are down by just 3%.

Net fund flows, which as we've said before are a better indicator of real growth in the business, increased strongly, up 33% to GBP1.2b, as a result of lower lapses.

The core strengths of our insurance and investment division are our multi-channel distribution model, low-cost access to the Group's customer base and strong brands. Taken together, we're the UK's leading savings and mortgages franchisers. It is a powerful combination. We intend to capitalize on these advantages in driving forward the development of these businesses, which are not dependent on the balance sheet for growth.

In the household market, for example, good growth in branch sales combined with the strength of our claims management approach drives strong returns on capital. Future investments in retention, claims and pricing capability will support further profitable growth. The strength of our savings franchise has helped us make us the UK's leading bancassurer with, we believe, advisor productivity around double the level of our nearest competitor.

Putting aside current volatility, the fundamental demographics and increasing need for self-provision in retirement points to significant long-term potential in investment, particularly in the wealth management space where in addition to our 60% share in the award winning St. James's Place we are growing our in-house wealth management operation, Bank of Scotland Investment Service.

Let me now complete the divisional review with a brief look at treasury and asset management and a review of the treasury portfolio. Underlying profit before tax, excluding FVAs, was GBP224m in the first half '08, a 15% increase over the same period last year. Net interest income was down due to higher funding costs, but non-interest income showed good growth driven by sales to HBOS clients.

Underlying operating expenses were down GBP10m, as you would expect in treasury, but there were also a number of cost initiatives within asset management. Of course, the overall result was overshadowed by negative FVAs of GBP1.1b, resulting in an underlying loss before tax of GBP871m for the first half '08.

Before I go through the treasury portfolio, I would like to recognize the strong performance of Insight, our asset management business, which saw net inflows of GBP8.7b, as its leading position in liability-driven investment continued to attract strong levels of new business. Asset management can get lost in the overall treasury and asset management numbers, which is something that we'll look at for future reporting, but it offers good opportunities for profitable growth, notwithstanding the current market difficulties.

Moving on to the treasury portfolio. Debt securities totaled GBP75.6b net of FVAs, compared to GBP81.2b at the end of last year. There's been little activity in the treasury portfolio other than the certificates of deposit, although since the year end there have been some GBP2b pay-downs on the ABS book, offset by GBP1b FX movements that increased the size of the book. Negative FVAs to the treasury portfolio since the end of the first quarter '08 have not been significant.

Let me delve into more detail on asset-backed securities, the ABS portfolio. The overall size of the ABS portfolio has reduced by GBP4.5b since the year end, due to negative FVAs and pay-downs. 93% of the ABS book is rated AAA, compared to nearly 100% at the end of '07. Today, only 1.3% of the book is below investment grade.

As is now becoming usual, I'll go into ABS in a little more detail, starting with US RMBS. 93.5% of the US RMBS portfolio is AAA rated and only 0.6% is below investment grade. As previously noted, we have marked the Alt-A exposure at GBP0.80 in the pound, despite 97.4% of that book still being AAA rated at June 30. And despite many thousands of rating actions over the last few months, we have only suffered downgrades on GBP0.2b in our Alt-A book, out of a total of GBP6.6b, primarily on those with monoline wraps. Remember also that the current weighted average level of credit enhancement for our Alt-A book is 30%.

Looking at CDOs, there's been no change to the composition of this portfolio and it remains strongly rated, with 93% of the portfolio being AAA. The underlying assets are predominantly corporate credit, but the book does include some GBP0.3b of ABS CDOs. Some of those have suffered downgrades and have been marked down accordingly.

Our overall exposure to ABS CDOs is limited. We have GBP0.3b in this portfolio plus GBP0.7b in the negative basis book with investment grade monoline cover. One of the negative basis ABS CDOs has also seen a significant downgrade and although the bond is covered by an investment grade monoline we've taken an appropriate haircut on the value of the CDS protection.

Just to complete the picture, the remainder of the bonds in the negative basis books are predominantly corporate CDOs and CLOs, that's around GBP2b, and some GBP0.4b of non-US RMBS.

We have revised our calculation of monoline exposure relating to the negative basis book and wrapped bonds, to provide a more meaningful measure of exposure and bring it into line with the practice we believe is adopted by others. Our exposure to monolines at June 30 was GBP0.7b, compared to a restated GBP0.4b end '07. Exposure to monolines of GBP0.4b arises from the negative basis book. It represents the mark to market of the CDS protection purchased from the monolines, net of write-downs.

With regard to wrapped bonds, we calculate the exposure as the difference between the value of the bond, with and without the wrapper provided by the monoline. On this basis, our exposure is GBP0.3b. It should also be noted that where coverage is currently provided by sub-investment grade monolines, we have assumed no benefit from such cover in valuing the relevant bonds and have taken any necessary write-downs.

There has been a good deal of external comment and speculation about our treasury portfolio, and in particular ABS. What we know is the portfolio, as a whole, continues to be highly rated. Our Alt-A portfolio is performing satisfactorily. Our exposure to sub-prime borrowers is not significant. Our exposure to ABS CDOs is only 2.5% of our ABS book. 74% of our ABS CDO exposure is mitigated by investment grade monoline cover, and we've taken appropriate write-downs. We've not currently assumed any benefit on monoline cover where the insurer is rated sub-investment grade. This remains overwhelmingly a high-quality portfolio.

However, Treasury's raison d'etre is to manage funding and liquidity, and meet the requirements of HBOS clients and other parts of the Group. The Grampian can't do it. It's being managed down, according to its funding capacity. And we will rebalance the liquidity portfolio away from ABS as bonds mature. Indeed, if markets improve, we wouldn't rule out some sales, but only if realistic value can be obtained. Treasury is focused on delivering for the Group.

Let me now move on to the balance sheet and start with a brief review of funding. We continue to fund successfully in the money markets and have also raised GBP8.7b in the term market, including non-equity capital issuance. We're planning on the basis that securitization markets are unlikely to be open to any meaningful issuance for at least 12 months, but we would expect MTN issuance, both public and private transactions, on a reasonably regular basis, albeit at a higher cost.

The cost of funding in the deposit markets and term markets has risen, but these are factored into our guidance on margins. Furthermore, we have taken account of the significant differential between LIBOR and base rates and similar differentials in other currencies when pricing for business and guiding on margins.

We have also made it clear that we wish to improve the customer deposit/loan ratio, working on both aspects of the calculation, that is, improving the proportion of deposits within the overall funding mix and constraining the overall funding requirement through more selective and modest asset growth.

Let me now turn to capital. We have shown the capital ratios as at June 30 on an actual and pro forma basis, taking into account the GBP4b raised through the rights issue. Previously, the actual ratios would have been regarded as reasonably strong at this stage of the economic cycle, that we have rebased our capital ratios. On a pro forma basis, we have a strong Tier 1 ratio of 8.6% and a core Tier 1 ratio of 6.5%, both around the midpoints of our new target ranges. We expect to stay comfortably within these ranges, despite the worsening economic climate.

There has been an awful lot said and a little bit written about the pro-cyclicality of Basel II, although it has been well known about for quite some time and factored into our capital planning. Basel II has resulted in significant changes to the composition of RWAs. HBOS benefits substantially from a reduction in retail RWAs, due to the very sizeable mortgage portfolio, but this is offset to a large extent by an increase in corporate RWAs, reflecting the nature of our corporate banking business.

Since the year end, we have seen a GBP3.6b increase in retail RWAs, compared to a GBP2.4b increase in loans and advances. And the difference is largely attributable to changes in the arrears profile and, more importantly, decline in house prices. You would therefore expect to see retail RWAs rising at a faster rate than loans and advances, but it will not be a linear progression.

With regard to corporate, RWAs increased in the first half of '08 by less than the rate of growth in customer loans and advances, due to further refinements to models. The worsening economic environment did not impact materially on corporate RWAs in the first half '08. In the second half, deteriorating credit trends are expected to have more of an impact, but over time we expect further benefits from model development and recalibration. Furthermore, we have made it clear that corporate asset growth will be very selective from a funding and capital viewpoint.

While RWAs are clearly more sensitive to change in economic conditions under Basel II, our selective and cautious approach to asset growth and further improvements to models means that we are confident of operating within our target capital ranges.

To summarize, we have strong capital ratios capable of sustaining activity in even more depressed economic conditions. We will be selective in asset growth, focusing single-mindedly on activities with the highest risk-adjusted returns and running down assets that do not offer sufficient return. We will improve the customer deposit/loan ratio by increasing the proportion of deposits in our funding base, which itself will be constrained by lower asset growth.

Clearly, we will need to adjust our cost base to reflect the new business environment; investing for return, driving up productivity gains and extracting costs where activity does not generate sufficient return.

Our insurance and investment businesses offer good prospects for long-term income growth, with strong brands leveraging off our undoubted retail distribution franchise. And the margin outlook has not been as favorable for quite some time. We see relative stability with potentially improving margins. All of this underpins pre-provisioning profitability levels, providing the resilience that will serve us well through an undoubtedly more difficult credit environment.

Thank you for your attention and let me hand back to Andy.

Thanks very much, Mike. Before I return to our strategy, just a brief word on the economic outlook.

GDP growth is slowing and we expect it to remain subdued throughout 2009. The MPC now has limited flexibility on interest rates to counterbalance the slowing level of economic growth, given the inflationary pressures evident in both fuel and food prices.

The consensus view of the decline in house prices over 2008 and 2009 combined is now 15% to 20%. And commercial property prices, which are already down around 19%, and the consensus view here is for a total fall of approximately 25%.

We're assuming that the covered bond and securitization markets will remain largely closed throughout the next 12 months.

Finally, we expect some deterioration in the levels of unemployment. We're still at relative lows, with around 850,000 unemployed. We certainly don't see unemployment levels getting close to early '90s levels, but headline unemployment levels will inevitably show a gradual increase for the next 18 months.

In short, I see little reason to adjust our cautious view of the economy that we've held for the last 12 months and we'll continue to adapt our business to the changing economic environment.

Now, let me return to our core theme of reshaping the business. I'll take each point in turn, beginning with capital. The rights issue was not an easy process, given the extraordinary dislocation in banking stocks on both sides of the Atlantic. However, post the rights issue, we now have the strong capital ratios that are appropriate for tough times. And I intend to take all appropriate actions to keep capital ratios at the very strong end of the spectrum.

We've rebased the dividend payout ratio at around 40%, to retain more capital going forward. And as you know, the interim will be paid in shares. We've also significantly moderated our asset growth and we're prepared to consider selective disposals or business run-offs, as appropriate.

I'm pleased by the progress we're making on our journey to better margins. We're adjusting our risk-based pricing to reflect the increased cost of funding and achieving better margins in repricing both new and existing books of business. In 2008, retail will reprice around one-third of their book and corporate around one-fifth. We expect stable margins in the second half of 2008 and we're targeting stable or improving margins in 2009. This achievement is absolutely key to underpinning the pre-provisions profit line.

Mike's already talked you through our funding position in detail. In short, HBOS is funding extremely well in tough markets. Liquidity remains very strong at the short end, in bank deposits, commercial paper and CDs, and we continue to access MTN markets on a regular basis, through both public and private placements. Across all of our divisions we're slowing asset growth. You should expect to see deposit growth outstrip asset growth over the course of the next two years.

As Mike's already covered, it's particularly in corporate banking that you should expect to see a very significant switch in our deposit to loan ratio, as we move to a far less asset-intensive corporate banking model. In conjunction with selective disposals or run-downs of asset long businesses, all these measures will improve the deposit to loan ratio significantly over the next few years.

In our insurance and investment business, there are clear opportunities for us to capture growth. The success we're achieving in both sales and retention points to strong growth potential that we have in household and motor. The fundamental demographic support for our investment businesses is set to continue and will transcend the current more difficult environment for selling long-term savings and pension products.

Our strong franchise and multi-branded distribution is and will be a source of competitive advantage, allied to the excellent productivity of our sales force. As we grow these investment businesses, the continued emergence of profits from the in-force book will continue to underpin profit growth going forward. In short, these are business areas with real potential.

In our treasury operation, our conduit Grampian is now being managed down in accordance with its funding capacity, and we won't be adding further investments to that portfolio. Whilst the majority of our treasury portfolio is AAA, we've set about changing the profile of this portfolio to one that has more acceptable liquidity regardless of market conditions. Whilst we're perfectly prepared to hold our investment and liquidity assets to maturity, we're also prepared to consider selective sales, not at any price but only at an appropriate value for our shareholders.

Tight cost management is just an accepted part of the way we do business at HBOS. We've limited our first half cost growth to just 4%. Indeed, costs in the UK have fallen in the first half, whilst we have continued to invest in our international businesses. And as Mike's already covered, we will keep a very careful control of costs in the second half and through 2009.

We recently announced the decision to combine the business banking elements in retail and corporate. A smaller number -- a number of smaller operations within our portfolio will be gradually run down and there'll be further opportunities to reduce the cost base within both our front and back offices.

In summary, we've taken the tough actions quickly to ensure that HBOS is well prepared for the downturn. Capital strength is non-negotiable, and having completed our capital raising we've re-based the Group to stronger ratios. We're making significant progress in repricing new and existing assets to improve margins. We will improve the deposit to loan ratio consistently over the next few years.

The combination of a powerful franchise and supportive demographics gives us real growth opportunities in our insurance and investment business. We've refocused our treasury operation and, as you all know, tight cost control is a given.

The actions we've taken give me confidence that we're well placed, not just for the downturn but also to capture the long-term growth opportunities for our shareholders.

Thank you very much for listening. And let's go straight to questions. Mike's going to come and join me on the stage and we'll bring in members of the executive team as appropriate, according to the questions. Start over here on the left and move round the room. Normal rules, please. If you could give us your name and house and move straight to the question, that'd be terrific. Thank you very much.

Thanks. Good morning. It's Jon Kirk of Redburn Partners. A couple of questions, please, the first on the treasury portfolio, I'm just trying to gauge how much of a priority it is for you to reduce that portfolio. Because if I look in the first half, and I accept that market conditions are very difficult, clearly, but it looks like a good 50% or so of the reduction has actually come through write-downs rather than through sales or run-off. So, first of all, just some indication of how big a priority it is.

And then, perhaps some guidance or some indication of where you think that portfolio will be in a year's time, for example, just to give us an idea of the rate of rundown. And then I've got a second question.

I'll take the first point and then -- and pass to Mike for the second half of your question. We will only do it at the right price. The portfolio is performing well. It is proving resilient. Mike covered a lot of the detail today and we covered a huge amount of detail when we did the presentation to you all in the trading update in May. We have no reason to do any for-sales of this portfolio and we will not do it unless the pricing is right. If the pricing is right, we will obviously consider it very, very seriously and take any selective opportunities. We will only do it at the right pricing.

Okay. Thanks. And I suppose it's too much to ask for some kind of forecast on that. When you're looking at your capital planning and that sort of thing, what are you assuming?

Yes, it is too much to ask, Jon. What I'd say on the capital planning generally is I was very clear right across our business that we will consider selective asset disposals and asset run-offs. There are many parts of our business which we're not going to be growing in the next three to four years, within our retail business, within our corporate business, within our international operations, and treasury is no different to that. So if we've got businesses that, frankly, we don't think we should be investing in, they will be allowed to run down and that will release capital.

Okay. Thanks. And a quicker one, just on have you noticed any change in your cost of wholesale funding since you had raised the new equity, or just in general as market conditions have changed in the last few months?

Mike.

Not in the last few months. The cost of funding short term has always been very competitive and we're pleased with that. In the term markets, bear in mind we have done the rights issues and then the interims. We've not been that active. But you're right in surmising over time it ought to have an impact.

Okay. Thanks.

Thanks, Jon. Tom.

Thanks very much. Tom Rayner from Citigroup. Can I have two questions, please? The first is on the margin guidance, because you say it's absolutely critical to the outlook for profits. I'm just trying to get a sense of how you really can be so confident of the margin outlook when you look at the sort of requirement on wholesale funding still. The funding gap in retail alone, I think, is GBP96b. At the Group level it's GBP198b. And you tell us certain parts of the markets are just closed. I imagine there's an element of borrowing from the Bank of England. I'd be quite interested to know your thoughts on the likely extent of the SLS in your funding plans going forward.

But I'm just trying to get a sense that with so -- such a large requirement from markets where at least the pricing has got to be uncertain, how you can be so confident that you're going to have stable to improving margins. And I have a second question, please, as well.

Okay. Let me take --- I think it's actually very simple, Tom. If you look at what we've delivered in the last 12 months, since the dislocation started, LIBOR mismatch has been pretty consistent at around 80 to 85 basis points at three months and around 50 to 50-ish at one month. Term funding we're assuming is not reopening for us in the next 12 months. I think that has to be the prudent assumption.

It is the speed at which we've been able to reprice our -- both for -- not only for new business, but also for existing business which is rolling off. And it is actually quite a simple equation that if you are repricing a third of your retail book every year, we will reprice a third of our book this year, it's not a question of might we reprice it, with a combination of new business written and customers that are rolling off current deals onto new deals, it will be repriced. Likewise, Peter will get a fifth of the corporate book repriced. It's slower in corporate because obviously there's more four to five-year term lending, but every year we will get 20% of it repriced.

When we build that in with what we think is continuing prudent assumptions that we are not going to see any major change in either the cost of deposits or the cost of wholesale funding, then we think our guidance of stabilizing this year and moving to stable or potentially improving margins next year is highly realistic.

Do you want to take the second question?

Yes, please. But just before I move on, I imagine a large part of that wholesale requirement is also repricing. And at the moment there may be funds available at LIBOR from the Bank of England, but may -- that may not always be the case, certainly as we go through the next 12, 18 months. I'm just trying to get a sense of how the planning you're --- what assumptions on the breakdown of that wholesale is feeding through into the [line]?

I think if you look at the wholesale funding, the short-term funding is -- there's lots of liquidity in the short end of the market and it's pricing as aggressively and cheaply as ever. So there's not funding pressures there. The element of pressure on that is arguably the LIBOR base rates, which Andy's just commented on. And it's factored into our thinking, continuing around the current levels.

The term funding, when it matures, where you get some of the pricing pressures that you're talking of, very roughly, we've got around 5% or GBP25b of that would mature in any year, so it's GBP2b a month that would be maturing. And if we replace that from other term funding, that would be subject to increased cost. That's factored into our own planning.

But bear in mind that you are constraining asset growth, so the funding demand itself is more constrained, bearing in mind you intend to grow the proportion of deposits and you're funding very successfully in the money market, it doesn't necessarily mean that all of it will be replaced at an expensive -- more expensive way.

Your second question.

Okay. I can't do part three of my first. (Multiple speakers) are these disposals part of the margin guidance? Just on the monoline, the notional you show on, I've forgotten which slide it is, but I think it's sort of GBP5b notional and it boils down to sort of GBP700m of exposure.

Yes.

Am I understanding rightly that GBP5b is the total amount of assets which have some sort of protection?

Yes, GBP2.8b is the separate insurance cover for the negative basis book and GBP2.2b is wrapped bonds.

And the underlying value of those would currently be about GBP4.3b, giving you the GBP700m of exposure?

Well, we'll have taken, depending on the nature of the bond, we'll have taken appropriate write-downs on the bond. And in the negative basis book, for instance, we will have also taken a haircut on the monoline protection. The wrapped bonds are [valued all] together.

Tom, do you want to pass to your right? We'll come to you next time. Don't worry, we'll get to everyone.

Thanks. It's Ian Smillie from ABN. Two separate questions, please, the first one on deposits. I think GBP15b deposit increase in the half. Divisionally, about GBP11b of that looks like it's come through the treasury division. So could you give us some color as to what type of deposits those are and how sticky they are, and perhaps why the deposit performance in the other divisions hasn't been quite as robust as at the Group level and what you're planning to do to improve that performance going forward?

Shall I take that? I think that a 12% total deposit growth is a really good performance across the Group. We've deliberately not chased price in any of our divisions.

On treasury, we have a tiny percentage compared to our competitors, not trying to (inaudible) a tiny percentage of our deposits through treasury and indeed top end of corporate lending generally. And we will certainly look to increase it over the next two to three years. It's a very, very small percentage of our mix [of money]. And you only have to look at our deposit mix, an exceptionally high percentage is in the very sticky end of the retail end, which is why we're very confident of the quality generally.

The only other thing I'd say, Ian, is that when we are looking forward at our guidance of improving deposits, we are not going to chase deposits at any cost. And it is the guidance we're being very clear on. It's the very moderate nature of the asset growth that we're going to be targeting over the next 18 months to two years which will be driving the consistent improvement in the ratio.

But we should expect the driver of deposits to becoming the same as we've seen in the first half, with the bias to the treasury division. Is that right?

I think there'll be some in treasury. But, no, I think retail finished the first half very strongly. We should expect to see growth there. We shall certainly be looking to drive our international businesses strongly on deposits in the second half. No, I think it'll be consistent.

Thank you. The second question is on the credit loss reserves as a proportion of the impaired loans. Given the pretty cautious outlook that you've given for all your divisions in terms of asset quality, somewhat surprised to see the coverage ratios decline particularly sharply in the corporate division and in the international retail division. So the question is really what has to happen for you to move to rebuild those coverage ratios and over what time period should we expect that to happen?

I think, when you look at the coverage ratios, you really do have to look at it business by business and look at the composition of the assets. There's no better example of that than the retail in the UK, where you've got a coverage ratio of 82% on unsecured but only 10% on the mortgage book because of the quality of the collateral.

And that's the story when you look in international and corporate as well. You look at the quality of the collateral and you look at your likely recoveries on these and establish appropriate provisions. So I wouldn't accept the premise is rebuilding them. It is making sure that you've forecast the net recovery values and made appropriate provisions, and we believe that's what we've done.

I guess it's fair that in UK retail the ratios are low but they've been rising, whereas in the international and corporate book they've been falling. So what's the difference there, because the asset values, I guess, in the corporate book are also falling and in the international and retail books they are as well? So where's the point of difference and when does that delta change for us?

The -- if you look at the -- either international or corporate, it depends on the specific credits that have become impaired and your assessment of the likely recovery value. So it will move about. It can go down or it can equally go back up, if the collateral proves not to be as robust.

So the overall trend over a long period may be relatively stable and we made it clear it's on -- they're on a rising trend there. But you do, I repeat, have to look at the underlying collateral. In international, there's a few large corporate credits where clearly we've got a very positive view as to how much we can recover, which is why the ratio would be there.

Could I request, for the full year, that maybe we could have some more disclosure on that collateral, just to give us some comfort on it, to quantify the point?

Yes. There's a lot of disclosure, actually, on the classification of advances, which should give you a good idea how much collateral it is.

Thanks.

Simon.

Yes, thanks. It's Simon Samuels from Citigroup. A couple of questions, actually. They're kind of leading to the same issue, really, which is the loan to values in the mortgage portfolio, and my suspicion is they're for Mike, actually.

First of all, am I right in saying -- it's difficult to actually get the net lending figure that you've done between mainstream and specialist, because you give lots of percentages but you can't actually get the actual number. It looks roughly as though your mainstream book shrank by about GBP1b in the half-year, net lending was minus GBP1b and your specialist book rose by about GBP3b, to give the net number of plus GBP2b. Is that broadly correct? Unless I've missed a disclosure, which I don't think I have.

Directionally, you're right. There was slightly more in specialist than in mainstream. But it wasn't GBP1b down in mainstream. It was broadly flat, I think, in mainstream and one and a bit up in specialist.

Right, okay.

So, directionally, there was a --

And, Simon, I think the key point is we're not expecting a major mix move at the full year [until] next year.

No, I was just going to say that.

(Multiple speakers) some short-term trends, but you're not [going to expect that] indicative of change across the (multiple speakers).

Okay. Because I tell you what this is all leading to, really, which is page 17 of the announcement, which I thought was in a way one of the most interesting pieces of analysis. It's your loan to value by bands.

Yes.

And what it clearly shows is that just since the end of December, so in the last six months, the proportion of your mortgage portfolio that exceeds 80% LTV has almost doubled, from 17% to just under 30%. And I guess there's two things that will move that around. One, obviously, is house price declines. And secondly will be whether you've got some adverse selection going on here. So, essentially, a lot of your outbound redemption activity is below LTV customers and you've won in higher LTV customers and that's moved it around.

So the questions I've got, really, are twofold. First of all, can you talk about the dynamics surrounding that and in particular, if the consensus house price decline 15% to 20% is correct, what you think that number moves to? I'm talking the excess of 80% range. So that's the first question.

And the second -- no, but I think this is a key issue which is why I'm going on about it. The second is what did that look like in, let's say, 1989, 1990? So what comfort, if any, should we be taking from that?

Yes.

Mike.

Well, let me kick off and Dan might want to chip in as well. The new lending, the LTV for new lending, was around 68% on average rather than 65%, so [there's modest] there. But the main movement between the ladders is to do with house price, is to do with house price declines. You do have to look at them on a regional basis as well, but we'll not necessarily go into that in more detail.

If you actually look further forward, whilst at the very highest levels, at 80 to -- 80 and above, you could see that further house declines you would move pro rata up. If you wanted to then look at the, I think it would be probably '93 or something like that, which would be the sort of '93, some -- '92, I think the highest LTV there, above 90%, would have been something like 34.

34.5% at the end of '92 into '93.

Right. That's the end of the cycle, though?

Yes.

What was that looking like going into that housing cycle?

It rose quite steeply because it started, what you'd had is, late 80s, you'd had a tremendous burst of activity going into this, unlike this particular cycle, by the way. That's one of the differences. And you also had 15% base rates, which itself was increasing debt in arrears. So it rose quite quickly. From memory, I think it would have been something like, what, do we have the figures?

Yes. Well, in 1990 I think it was about 35% of lending was at 100% LTV, which is one of the indicators. That was sort of the beginning of the cycle. So you've got around a third of the lending was done at 100% LTV, whereas last year in the market I think it was about 5% was 100% LTV.

So, going into the cycle, you had a completely different mix of LTV business. And also, the amount of deposits that first-time buyers, for example, were putting down was quite different. I think the average deposit for a first-time buyer in 1989/90 was around 12%. Last year it was around 20%. So the actual collateral values going into the cycle were very different and I think that's why, as Mike said, you ended up with 34% of it was over 100% in '92 or '93. (Multiple speakers).

(Multiple speakers) can't spend more time on that, but --

Can't give you the figures.

But, yes, I think the core point -- I think what you're getting to is that it's certainly true that, going into the early 90s, house prices were still rising very sharply, until it turned. The acceleration into the amount over 90% LTV has been very strong and very quick, peaking at around 35%, largely because of so much more first-time buyer activity.

Just for our spreadsheets, that's all I want is -- so you're telling me the majority of the move in the first six months of this year is house price declines and prices, I guess, are down, I don't know what, 5%, 6% in the half?

(Multiple speakers).

So, basically, does this tie -- if you're right, the consensus decline is 20%, do we kind of do this times four? Are we basically a quarter or a third of the way through the dynamics on this table?

I think the consensus, which isn't our figure but a consensus figure of 15% to 20%, it is not quite so simple as you suggest because the lower down it's not quite the same relativity. For example, if you're around over 90 it is pretty much direct, how they will move by reference to house price declines, but that becomes proportionately less the further down you go. And I think the more year on year, on house price, would be more like about 6.5 right now. That would be the more year on year, I think, we were doing.

You've got to look at it, remember, as well by regional house prices. (Multiple speakers).

Thanks. Alastair Ryan at UBS. Probably coming in at completely the other way to Simon, no change there. It feels like you're pretty well positioned in the UK, strongly secured book and a decent credit performance. It's international where the issues would be for me. It feels like your deposits have gone down in Ireland, they're flat in Australia. Those are between 2 and 400% loan to deposit businesses. They're consuming as much LWAs as your UK book, your UK retail book, which is extraordinary. And there's probably a ready market for them. They'd boost your capital ratios. They -- you'd achieve all of your goals in terms of funding and capital and stability by knocking them out. Is that something we should be considering is a possibility?

Alastair, I'll answer the question very carefully, but very directly. As we said in our script and in the RNS, we will and are prepared to consider asset disposals at the right price and only if it's worth more to other people than to us. But that is equally prevalent across our UK businesses as our international businesses. What would drive the logic for us is two things which have been prevalent in every part of our presentation today.

Firstly, to improve the loan to deposit ratio, so that any disposals we'd look at would need to be in businesses that were long on assets, short on deposits. And secondly, if they're worth more to other people than to us. We've got very strong capital ratios. We're not going to be a forced seller of assets under any circumstances. But we absolutely would consider disposals under that criteria.

Yes, let's go to the back.

Hi. It's Manus Costello from Merrill Lynch. Can I ask a couple of definitional questions, please? Within the treasury portfolio, have you reclassified some of your level three assets from the trading book into the available for sale book? Because looking at the disclosures you give on page 51, it looks like versus the year end some of it might have shifted out of trading and into available for sale.

No. I think we'd happily go through it with you, but we wouldn't, and you don't, under IFRS. No.

So --

Happy to go it with you, but we haven't reclassified any assets between the trading book and the banking book.

Okay. I'll follow up afterwards, maybe. And secondly, I wonder if you could give us a bit more color within corporate on this GBP1.9b of impaired loans, which you say there will be no loss on, which I think might also inform some of the coverage ratio questions which Ian was asking.

Basically, these are loans where there is evidence of impairment, but because fund -- normally, because of the underlying collateral, you don't think there's really any prospects of loss. And therefore, there would be no requirement to make a provision. We actually show the figure, but there was no requirement to make a provision for that.

Okay? Let's move on. Robert.

Could I have a number of questions, please, firstly on --

Two. We've got so many hands up and we are already running behind time, so two.

Okay. Maybe point -- parts one and two, then. On the mortgage side, Lloyds has given a number of charges in the second half on certain house price assumptions, and essentially that's trebled their interim number. Your GBP213m for secured charges in the first half of this year, how do we think about charges for the second half on certain house price assumptions?

Mike.

I think if you looked at the first half and you allowed for the fact that the arrears trends as well, because it's not just the house price issue, you'd be looking at something in the second half on a more gradually rising trend. If you just looked at the house price dimension of it, probably less than -- just less than half would have been down to house prices, if you like, in the first half. The rest would have been trending arrears. And as we have said, that trend is likely to continue for the near future. So, I would say something, broadly, but somewhat higher but not a multiple or anything like that.

And on the impaired assets, there's a schedule on page 65 which gives the growth in impaired assets. I don't want to go through that. You don't have to turn to it. My question is do you think this is a reflection of one quarter's rise in impaired assets or is it a half? So how much of these impaired assets have really arisen in, obviously, the downturn that's been gathering pace now?

You mean right across the Group?

I'm particularly thinking about the corporate and international area, but --

I think, in terms of corporate and international -- corporate first. They are now running at, I think, impairment loss of about 0.83, something like that, of advances, which is a relatively high level. But if you look at the overall economic climate, you would expect to see something around that range. And there is a -- something of a deteriorating trend in both international and corporate, and retail, for that matter.

Yes. I was really talking about the rise in the level of impaired assets. We can make our own assumptions about the charges you're taking out and the coverage of it.

Sorry.

But I'm trying to see the pace that this is rising. So the numbers that we see here, are they really six-month trends or are they more like one-quarter trends?

Dan, do you want to comment on the retail mortgage?

Certainly, on the retail side, it's certainly been a pretty steady -- and within the volatility you get on any sort of month-on-month number, it's been a steady increase through the period. And that's pretty much what we see. We don't see a marked change in trend. There's always monthly volatility, but generally -- so it's very much a six-month increase rather than a quarter increase, I would say would be the answer.

Corporate and international?

Let's move on. Let's move on. Let's move to the right.

Thanks, Andy. Hello?

Is it on? Yes, that's fine.

Yes. Thanks, Andy. It's Tim Sykes from Execution. Just two points really. One is a technical question. The other's a point of clarification. The first is, in terms of the deterioration in the margin in corporate, to what extent is that impacted by the rise in NPLs, in terms of interest potentially foregone?

No, it's -- the main factor, and there is a little analysis on it in the corporate, is the fact that in previous years you've been able to take quite a lot in through the net interest income line, through the timely recognition of fee income, because basically deals have been refinancing much more quickly. So you've basically not been spreading them, as originally assumed, and they've come in for the particular year in question because of more activity. That has slown down, so that's one of the reasons why it's -- that's the main reason why it's lower.

Tim, I --

NPLs (inaudible) they're not the main reason.

It's the same old story for corporate, under International Accounting rules, obviously now a slowdown in churn, and the slowdown in churn has been very considerable, has an immediate impact on the margin.

Yes, I understand that. [There's one that] reassesses the effect of interest rate the margin will decline, but equally that will be true of interest foregone. So --

That's not a major (inaudible).

Okay. The second is just to test your logic. I hear what you say, you're well capitalized, you don't need to dispose of things for capital, but in the statement this morning the allusion is that securitization markets are closed, it's a significant proportion of your funding and you would look to make disposals to improve your ratios from a funding perspective rather than from a capital perspective. And that's not quite what you said just earlier. Should we, from that, take that we should be looking for disposals to replace the quantum which would have been funded through securitization?

No, not all. No, no, no. We've been really clear. We're very comfortable in our core plan, which is for very moderate asset growth and stronger deposit growth. Our funding profile is very comfortable for the next two years. My point is we would consider disposals to make a stepped change, but only at the right price. And that would be a clear criteria for us to consider a disposal.

And it's not just headline that people tend to think of disposals as selling businesses. It can be that, but it's much more around us being very, very tough on saying there's a part of our operations that we are going to allow to run down and we will see assets roll off. And we will continue to do that analysis across the whole book over the course of the next year to 18 months. And that will all drive an improvement profile every time.

Okay. Thank you.

Come to the front here.

Thanks. Mike Trippitt at Oriel. Just a couple of questions on corporate, actually. You talked about asset slowdown, you talked about repricing, but also you're talking about a syndication or a distribution market that's closed. So I'm just trying to understand, net/net, what the size of the balance sheet would be in corporate, say, in a year's time and whether it's a bigger or lower user of capital.

And also, in connection with that, just for the size of the cost base, we've seen a GBP30m-odd reduction half on half. Does that continue or is that revenue related?

Both good questions, Mike. I'm not going to give you a forecast and I'm not going to forecast the size of one element of the balance sheet. But I would say it would not bother me or Peter if the corporate balance sheet is static or even declines over the course of the next year to 18 months. We're going to be very, very tight in terms of asset control. It is possible there'll be some minor disposals in that portfolio, depending on pricing, and we are not going to be going for growth. So we will be very, very relaxed if the corporate balance sheet was static or actually declined.

On the cost base, we're just going to keep going. We saw a good decline in the cost numbers in the first half. Some of that - always show the quick things -- some of that's performance-based remuneration. So just factor that in. We're very happy to give you more detail afterwards, but some of it will be the fact we're clearly going to have significantly lower bonus elements in corporate banking this year than in the -- in previous three years. But some of it is also structural change that Peter and his team are putting through the business and we'll continue to search for opportunities.

Thanks.

Let's go right to the back here. And we'll come to the left. We are getting very tight on time now, so I'll take a couple more over this side.

Thanks very much. Sandy Chen, Panmure Gordon. Just two quick questions. One on the treasury book. Looking at page 49, footnote three, and looking at the write-downs on a per-asset basis, it looks like you've taken 10% write-downs to date on the RMBS, 12% write-downs on the CDO book and 18% write-down on your monoline exposures. Now, given what peers have taken in terms of those write-downs, do you consider those enough, especially given your guidance that, if I heard correctly, that you don't expect further negative fair value adjustments?

We consider them very prudent but, Mike.

Yes, we do consider them prudent. I think we've probably given more disclosure on the book than just about anyone. And I don't think I've seen a book yet that would compare in quality with our book, and that's why we do believe we've put appropriate values on them.

Okay. And then, the second question was just looking at the specialist mortgage book and the arrears performance. There's the continuing trend that the arrears measured on balances for specialist mortgages are bigger than the arrears measured on number of cases. It seems like the bigger mortgages in the specialist book are going bad more quickly. And given the pace of the decline in house prices and the relative size of the arrears cases that are coming up, what effect do you see that will have on, say, second half expectations on PD, LGD, etc., both on provisioning and risk-weighted?

Sandy, let me -- we'll talk in more detail afterwards, but I'd say two, three things about our core expectations for arrears levels that will [fleet] through. We do expect the specialist book to continue to deteriorate marginally quicker than the mainstream book. It will be -- we've always planned for it to do so. It is in our pricing. And we'll expect it to do so going forward. My personal view is the self-certified book will deteriorate quicker than the buy-to-let book. That's certainly been borne out by the first half of this year and we continue to do so.

If you look, though, at the pricing assumptions that we've been able to make around both elements of specialist book, if anything, there is even more of a potential arbitrage opportunity at the moment because pricing in the specialist sector is particularly attractive. But, but, that is not going to allow us to change our mix. You should expect us to stay approximately in our 70 to 30 mix. We're not just going to grab the opportunity to take the higher margin, higher risk business. You should expect us to stay roughly in a 70/30 mix. And that would have inevitable consequences for the arrears trends coming through, the balance. There shouldn't be much of a denominator change in the balances. It's just a question of the flow-through of the top half of the equation, in terms of (inaudible).

Thank you. Let's come over to the left-hand side, which we've slightly ignored for the last -- just a couple more questions and then we'll wrap up.

Hi. Good morning. It's James Hamilton at Numis.

Hi, James.

Coming to the corporate book and your property lending, you say that ultimately you're looking at the income profile of the tenants. Can you give us some sort of breakdown as to what the credit rating of the underlying tenants you have within this book is? How many ultimately are the government, how many ultimately are very highly rated corporates, how many are James Hamilton Traders Limited with no credit rating at all?

James, we're not going to sit here and give you a massive breakdown by tenant, but I think Peter (multiple speakers).

Just a general feel of the quality.

Well, we'll get Peter to come and give you a feel for the general quality of our tenants and the way we look at their ability to carry on servicing the debt.

Thanks, James. I think what I would say to you is that we have a fairly high quality investment portfolio in commercial lending. And the type of organization that we deal with is such that what we have is government, mix of government, mix of institutional leases. I cannot say that we don't have James Hamilton Traders. I'm sure we do and I'd be delighted if we had. But I think it's a very balanced portfolio and we have in it some extremely high quality covenants and well spread. And that's -- the real safety, if you like, is the spread as well as the, at the higher end, the quality of the underlying investment portfolio.

James, what I will say, to show we are not in any way being complacent in this area, is given the falls in commercial property prices and every spot measures slightly differently, I think 19% is a pretty accurate figure in our view from where the markets were when they peaked the first half of last year to where we are now. We have been pleasantly surprised about how very, very low levels of tenant defaults there still are at this stage in the cycle.

There will -- there's bound to be more pressure there at some stage over the next 12 months, as a number of smaller retailers particularly start to feel the pain more. But it is -- I think partly because of the good spread and the high quality nature of [corner store] tenants that, to date, the tenant default levels have been surprisingly low, given the general economic environment.

Thanks. And the second one is would you consider a dramatic shift in your policy towards your general insurance business, to draw in cash for insurance to improve the liquidity profile of the business? I note that there's a very significant uplift in gross written premiums relative to the way the market would have moved, with the exception of pay and protection. Is this a deliberate policy? Are you changing the structure of this product and the strategy of this product to help fund liquidity?

No.

Or would you consider doing so going forward?

No. Quite the reverse. Insurance business is a business we want to grow and will grow. We're not -- the change in the mix of sales is a very national consequence of the change in the market, in that we've deliberately not been chasing volume in unsecured lending. You saw that in Dan's numbers, in that overall balances in unsecured lending has actually fallen. We've done that very deliberately over the course of the last two years. And that's why PPI as a percentage of overall sales have come down.

But our desire to grow household particularly, it's highly capital generative. It's been paying very good dividends up to the parent company at the moment. We've driven a lot more household growth now through branches and standalone sales, rather than just our traditional route through selling through -- selling as a cross-sell to mortgages, and we will carry on doing so. So you should expect strong growth from our insurance business going forward.

Jonathan, let's go right to the back now.

Thanks a lot. I have two quick questions to finish off on, hopefully. It's Jonathan Pierce from Credit Suisse. The first is just on the retail margin again. In the same way that slower churn in the corporate book is pulling margins down, is that having any impact yet through the effective interest rate rules on the retail margin, because presumably you're already taking into account some of the eventual repricing benefits through the EIR rules in the retail bank? Is that right?

It hasn't had any material impact or significant impact thus far. Potentially, you could argue that if the maturities extend that could have a positive benefit. But it hasn't had any material benefit thus far within our own net interest calculations.

Okay. But presumably, the thesis that the margin will lead that [130] repricing is correct?

I'm sorry, I didn't quite catch --

Margin benefits will come through more quickly than the actual repricing of the book.

No. The repricing of the book, which is roughly a third reprices each year, is the main driving force behind that and all our assumptions that we're making. There may be some EIR benefit but that isn't necessarily factored into our thinking.

Okay. Thanks. And then the second one, just coming back to this corporate coverage question. Can I just ask it, perhaps, in a very simple way, which is has the fall in the coverage in the first half of the year been predominantly due to more assets that are perhaps property backed, and therefore with much lower potential losses, contributing to that increase in impairment -- increase in impaired loans, rather?

It will reflect the strength of the collateral, so it's a reasonable assumption that more property-based exposures would give rise to a lower coverage requirement.

Can you give us a feel as to what proportion of that GBP1b increase in impaired loans with loss have come from property-based exposures?

We'll chat to you afterwards, Jonathan. But it wouldn't be an unreasonable assumption, given the fact that 40% -- we gave you a very clear split of the percentage of the book that's corporate, with 40% of our book in commercial property, that that has a major impact on the overall coverage movement.

There are a number of asset classes as well that also have good collateral cover, besides construction and property.

We've had a lot of questions. We've actually over-run. So I assure you that we will stay here and take as many other questions as you'd like to ask. But thank you very much.