Lloyds Banking Group PLC (LYG) 2009 Q2 法說會逐字稿

Ladies and gentlemen, good morning, and welcome to the Lloyds Banking Group results presentation for the first half of 2009. With me on the platform are Eric Daniels, our Group Chief Executive, and Tim Tookey, the Group Finance Director. And they will join me in making some prepared remarks, following which we will, as usual, open the floor to questions.

But first, let me make a few comments. In examining these results, and in conjunction with the comments from Eric and Tim, you will see that they demonstrate that we have made excellent progress with the integration of the HBOS businesses, clearly one of the largest such integration projects ever undertaken. And we're well ahead of our plans. And we've achieved this progress whilst, at the same time, ensuring that our key businesses have continued to perform well against what remains an extremely challenging economic backdrop.

During the first half, I was particularly pleased to see the successful completion of a GBP4b fund raising to replace an open offer, which also raised a considerable sum from equity markets, both from the initial open offer and from the subsequent institutional placing. I think I'm right in saying that this is the first repayment of government capital injected into a bank in Europe.

The subsequent preference share redemption, then the block on payment of ordinary dividends was removed. However, it remains the case that the Board does not expect to pay a dividend of ordinary shares in respect to 2009.

In the last six months, we have been able to review fully and to take actions on our more problematic loans, particularly the larger HBOS exposures. We've taken a prudent view of the impairment losses. And as a result, we expect the impairment charge taken this half to be at the highest level we will see. We anticipate that this charge will decline from here on.

The UK economy, where we have the vast bulk of our exposure, is stabilizing. The risk of a more pronounced downturn is less than it was even a few months ago. Nevertheless, we remain cautious about the short-term outcome of the economy and all our plans are based on this cautious view.

Before I hand over to Eric and Tim, as many of you know, this will be my last results presentation as Chairman of this Group before I hand over the reins to Sir Win Bischoff who succeeds me as Chairman in the middle of September. And I wish Win every success. He inherits the Chair of a great financial institution.

Lloyds Banking Group has a fantastic customer franchise in the UK, with a wide range of key product lines, current accounts, savings, mortgages, insurance and long-term savings. We're a leading player in the SME markets and the corporate banking sectors. We have a very significant insurance presence, Scottish Widows, Clerical Medical, our general insurance business and our bancassurance businesses.

The Group has an exceptional footprint, with approximately 3,000 branches, and is able to support our customers in more UK locations than any other financial institution. I have immense belief in the exciting prospects for this Group going forward, particularly as the economic backdrop improves and we continue to develop and improve our businesses. We are very strongly positioned for long term success. Whilst, in common with other banks, we are addressing short term challenges, we have plans and actions in place to deal with each of them.

One of the most important ways in which leading businesses differentiate themselves from their peers is through the quality of their people and the high quality of service they provide to customers. At Lloyds Banking Group we are very fortunate in having many of the best people in our industry working for us. The job that all our colleagues do for our customers is incredibly valuable and has been highly valued by me during my time at Lloyds. And I'd like to take this opportunity to thank them once again for their outstanding contribution to our business.

With that, let me hand you over to Eric. Thank you.

Thanks very much, Victor. Thank you all for coming.

The first half of the year was clearly a difficult period for banks. It's against this backdrop that the new Lloyds Banking Group is reporting a substantial loss for the half year, before the benefit of negative goodwill. The loss is mainly due to the high level of impairments in the large HBOS property book. Although the economic environment remains difficult, we're successfully addressing the near-term challenges and believe the Group is strongly positioned for long term growth.

The messages I'd like to leave you with today are our core of relationship business is performing well. The integration is ahead of schedule. Our capital and funding plans are in place and showing good progress. We have a realistic view of the economy. And we expect to outperform over the medium term, delivering value to both customers and shareholders.

I'll start by reviewing our performance for the first half of 2009. I'll then outline how we're positioning the Group to outperform. Tim will take you through the results and provide texture behind our near-term outlook and longer term goals. I'll then come back and summarize before we move to the questions and answers.

Our statutory results came in with a profit of some GBP6b, but these were boosted by the one-off benefit of negative goodwill associated with the acquisition of HBOS. However, the way that Tim and I look at the numbers and what we'll be talking about today is the way the business is really performing without the non-recurring items.

Income was up 7% on the year -- over the prior year, helped by lower write-downs on treasury assets and profits from debt swaps. These gains more than offset the decline in margins which suffered from very low base rates and increased funding costs. While the income line was flattered by one-offs, I'm really pleased that despite the weakness in the economy, the core business performed strongly.

Costs were down 3% as we continued to manage the expenses of the Group and we began to deliver against the integration benefits. As a result, the trading surplus was up 17%. Clearly the most significant number on the slide is impairments, which were up significantly, at GBP13.4b. This was the primary driver behind the GBP4b pre-tax loss that we reported. And I'll get back to impairments in a second.

Looking beneath the headlines, the core business is performing well. In Retail, our sales performance was only slightly off the very high levels of last year, despite the economy. We opened 1m new current accounts and 2.3m savings accounts. We continued to support our customers looking for mortgages, advancing GBP18b of gross new lending, and achieving a market share of 27% of gross lending and 37% of the net.

In our Commercial business, we opened 60,000 new accounts, which includes a 24% share of startups. In the first six months of the year, we approved 180,000 overdraft requests and opened nearly 19,000 loans, worth GBP1.8b, to SMEs.

We have an equally strong story in the Corporate Bank. And as a result of the acquisition, Bank of Scotland is lending again. We continued to work on deepening customer relationships. And across our Wholesale customers, we saw a 40% improvement in cross-sales income. We're very cognizant of the importance of supporting households and businesses through the recession, and we are absolutely continuing to lend.

We set up the Wealth & International division, and they made an encouraging start. And I'm really pleased that bancassurance remains resilient, despite the difficult market for investment products and pensions.

In February, we said we were undertaking a detailed review of the acquired portfolios, with emphasis on the most stressed parts of the book. We also informed you that we were rolling out the Lloyds risk and sanctioning processes across the enlarged Group. These processes are now in place, and all new lending is being made within the Lloyds risk criteria.

We have completed a detailed credit review of the HBOS book and this is reflected in our first half impairment charge. Of the GBP13b in impairments, around 80% of the charge is accounted for by the legacy HBOS portfolio, with the majority of the loss coming from property-related assets. Normally we expect impairments to peak one to two years after the trough of the recession. But we anticipate our loss profile will be different this time given the nature and concentration of the property assets within the HBOS portfolios.

In this recession, we've seen an early and sharp fall in asset prices. And this has driven the prudent view that we have taken on the valuation of these assets. We expect the rest of the portfolio to behave more in line with past recessions. Therefore, while impairments on these portfolios will rise, the very high property-related impairments will be lower. So we expect the Group's total impairment charge to decline from here on in.

This is one of the largest banking integrations ever undertaken. It would have been a significant challenge at any time, but even more so in the current environment. I am therefore pleased that the integration is proceeding well and we are, in fact, ahead of schedule.

The new organization was up and running very quickly and we have already made major decisions on the IT platforms. We are on track with our cost targets and generated over GBP100m of savings during the half. Combined with the programs that we're putting in place in the second half, we expect to exit the year with a run rate of some GBP700m. And we remain confident that we will deliver more than the GBP1.5b run rate target by the end of 2011.

Despite the level of write-downs, we ended the half with a robust capital tier -- core tier 1 capital ratio of 6.3%, in line with the pro-forma opening position. We took a number of management actions to mitigate the impacts of write-downs and pro-cyclicality. These include the successful placing in open offer and liability management initiatives. Over the next several years, we expect to run off around GBP200b of higher-risk assets. This will allow us to further strengthen our balance sheet and to reinvest in our relationship businesses.

We have strong and diversified sources of funding, anchored by our large retail and corporate deposit base. In the half, we took a number of steps to extend our maturities of the wholesale funding and to further improve our liquidity profile. At the end of June, 47%, nearly half of our wholesale funding, had maturities over one year. This ratio compares very favorably to any other banks.

We have great access to short-term funding, but we've chosen to extend our maturity profile despite the higher cost. We believe that this is the prudent and appropriate way to manage our balance sheet, especially given the current environment. We raised GBP4b of un-guaranteed public debt in the half. Our seven-year un-guaranteed EUR2b euro bond issue was very well received by the market. It was twice oversubscribed and priced well within our expectations.

Let me now turn to the future and look to -- and start with the economic outlook. The performance of the economy this year has been worse than most expected, including ourselves. Although we remain highly cautious, our view is that the risk of a severe further downturn in 2010 is significantly lower than a few short months ago.

Our customer data shows that consumers and corporates took early action to cut spending and have been helped by the very low interest rates. This has led to increased savings and, in some cases, early repayment of debt. Corporates acted early during the downturn, aggressively shrinking stocks and cutting costs. In the first quarter, inventories were down 5% and investment fell by 10%.

Our corporate customers' financial positions are showing signs of improving. Our surveys of business customers show that they are becoming more confident about an upturn in sales. Despite this, we remain cautious. We model a number of scenarios for the economy. Our central scenario projects a slow below-trend recovery. This is in line with the more recent external forecasts which reflect a deeper trough this year and a more -- and a moderate upturn next year.

We project the recent moderating trends in property prices to continue. We now expect residential property prices to fall by 7% or less this year, and to rise modestly next year. We have previously been forecasting a 15% drop. But the year-to-date fall, that is as of July, was only less than 1%, 0.8%, according to the Halifax measure that we released today.

On commercial property prices, we're expecting a fall of 15% in 2009. But we expect that they will stay flat in 2010.

We expect company failures to continue to rise, peaking in 2010, but not to reach the heights seen in the last recession due to much lower corporate debt servicing costs. We also expect unemployment to continue to rise, peaking in 2010, at a rate similar to that seen in the last recession.

Against this forecast, let me now turn to how we see the business developing over the next several years. We expect revenue growth to build to a high single-digit level over the next two years. In the short term, the primary driver will be the modest economic recovery combined with an improvement in margins, backed by good volume growth. We expect margins to better reflect the real cost of funding and risk as the book gradually reprices. Deposit margins will improve but will remain below the long-term trend, given the outlook for base rates.

In the longer term, revenue growth will benefit as we redirect capital from the lower-returning businesses and deliver the potential within our franchise. We remain focused on cost management. We're targeting a 2% per annum reduction in the cost/income ratio, although in the early years it should be better as we deliver against the synergies.

As I've mentioned, we believe we are already past the peak in impairments. Turning to the balance sheet, we will run off around GBP200b of higher-risk assets. But with redeployment, we expect our balance sheet to reduce by around GBP100b.

Reflecting our increased distribution scale, we expect our customer deposits to grow. And when combined with a reduction in higher-risk assets, we would expect our loan to deposit ratio to return to legacy Lloyds levels.

I'd now like to turn to why we believe we can deliver a level of sustained growth that we have set out here. We're well positioned to grow and outperform. First, this is a large and attractive market. While it's been impacted by the recession, it will grow as the economy recovers and we will benefit from that growth.

Second, our business is focused on the higher growth areas of the market, areas such as savings, life and pensions and wealth management, which will grow as consumers look to save more and provide more for retirement. In addition, small and mid-cap companies are looking for increasingly sophisticated banking products which will enable them to better manage their businesses.

The new Lloyds Group is well positioned for these trends. We have an unparalleled distribution network which serves 30m retail customers and around 1m business customers. We have powerful information systems and product capabilities to help us better serve our customers. And finally, scale, which allows us to better deliver value for customers and shareholders.

We have a strong track record of delivering profitable growth by focusing on acquiring, deepening and broadening the relationships we have with our customers. This will continue to drive our growth.

We begin the customer relationship with a sale of a product. We're good at this, as evidenced by our sales figures for the half, especially in the key relationship products, such as current accounts. We also have the opportunity to further broaden the franchise, with the creation of the Wealth division and the development of new corporate products.

We have started up the Wealth division as we think that we have substantial opportunity to refer wealth customers from our wholesale and retail franchises into the private bank. There we can better serve their needs, with a richer product offer and more personalized attention.

While there are opportunities for us to acquire new customers, the real value is the opportunity to build deeper relationships and broaden our reach and offerings. I'd like to briefly illustrate the opportunities that we see with a couple of examples.

The value of our relationship model is illustrated by this chart, which shows the distribution of the Lloyds TSB retail customers by number of products they buy from us and their relative profitability. Today, even with the success that we've had in relationship building over many years, nearly half of our customers still only have one of our products. A further 20% have just two. Clearly there's a great deal of potential left within the Lloyds TSB franchise.

We see even bigger opportunity to increase our relationship depth within the legacy HBOS customer franchise as their cross sale levels are lower, over 60% holding just one product. And as we integrate the two banks, our scale will enable us to deliver better value for our customers and win more of their business.

The benefit of deepening relationships is just as evident in our corporate business. We've been very successful in deepening relationships by expanding into capital rights and fee-based products. Sales of these products through Lloyds TSB doubled between 2006 and 2008. The left-hand chart shows the significant income differentials between single product corporate customers and those who buy more products and services. Those customers with whom we have a trusted advisor status contribute nine times more income than a customer with just a single lending product.

We still have considerable scope to build deeper, more valuable relationships with Lloyds customers. But, as the right-hand chart shows, the upside is even greater in the Bank of Scotland franchise, where revenues per corporate customer are roughly half that of Lloyds.

Before handing over to Tim, let me summarize. Our aim remains to become recognized as the UK's best financial services provider and to deliver sustainable value to our customers and shareholders. The principal elements of our strategy will be very familiar to you, our customer relationship focus, our cost management skills, our capital management disciplines and our prudent risk management framework. What's different is the breadth of the revenue opportunity with the enlarged franchise, the size of the cost opportunity from the merger between Lloyds and HBOS, and the opportunity for capital redeployment as we build the quality of our earnings.

Within the next two years, if the economic environment plays out as we forecast, we expect to be delivering high -- sustainable, high single-digit income growth. We will deliver an annual 2 percentage point reduction in the cost/income ratio, with a faster reduction in the early years as we realize the cost synergies.

Finally, we will run off around GBP200b of assets as we restructure our balance sheet. We have a successful track record of creating value by executing against this model. This gives me the confidence that we, in fact, can deliver.

Now let me turn over to Tim who will walk you through the results and the financial framework in more detail.

Thank you, Eric, and good morning, everyone. This morning I'm pleased to be presenting the financial results for Lloyds Banking Group for the first half of this year. And in the following slides I will take you through some of the key elements of Eric's presentation in greater detail and further reinforce our confidence in the strength of our business, its strategy and its expected performance over the next few years.

In the first half, we have demonstrated that our core business is in good shape, with resilient revenues in a difficult economic environment, notwithstanding significant margin pressure. And the integration of the new Group is ahead of schedule, with cost synergies well on track.

We've completed detailed credit reviews of the HBOS high-risk portfolios and applied Lloyds' prudent provisioning methodology and taken the pain of very substantial first-half impairment provisions required in the current economic environment on the higher-risk HBOS books. Following this analysis, we can say with a high level of confidence that, based on our current economic assumptions, Group impairment charges have peaked.

As you know, we have a track record of deepening customer relationships, and it is from this relationship model that we see opportunities for growth across the enlarged franchise. For the first half of 2009, we can report a resilient trading performance in very challenging markets, with our trading surplus up 17% despite significant margin pressure.

On a pro-forma basis, total income is up 7%. At the same time, we have continued to maintain excellent cost control, with operating expenses down 3%. And I will break out some of the components of our revenue and cost performance shortly.

In line with previous guidance, we have experienced a significant increase in impairment levels in the Group's lending portfolios. This largely reflects the impact of the further economic deterioration, including falls in the value of commercial real estate, the effects of rising unemployment, reduced corporate cash flows, and the continuing impact, thus far, of lower house prices. However, we believe that overall impairments have now peaked. And I'm going to go through this more specifically later.

With the positive effect of the fair value unwind, we reported a loss before tax of some GBP4b for the half. Our statutory result in the first half was a substantial profit, reflecting the impact of the credit to the income statement from the negative goodwill arising from the HBOS acquisition.

Now let's look briefly at divisional performance. Retail has delivered a good underlying performance against a background of slowing economic activity. Income, however, fell 14%, driven by the erosion in the net interest margin, reflecting higher wholesale funding costs and lower deposit margins in the falling base rate environment. However, the quality of retail lending remains good, reflecting continued strong credit criteria. An example of this is the average LTV on new mortgage lending which, in the half, was 58% compared to 63% last year. And this demonstrates our focus on avoiding higher LTV lending.

Wholesale Banking reported a loss of GBP3.2b, primarily due to the expected increased levels of impairment. But Wholesale trading surplus grew strongly, driven by income being up 37%, principally as a result of the lower impact of investment write-downs and reflected continued strength in cross sales in the Wholesale market and continued good trading.

The Insurance reduction in profit reflects the extremely challenging market conditions. Income was affected by the market-wide slowdown in life, pension and investment sales across both the UK and Europe. But operating expenses were very well managed and reduced by 14%.

In Wealth and International, a sound underlying performance has been turned into a significant loss before tax due to increased impairment losses driven by the economic downturns in both Ireland and Australia.

Group Operations and central items is a loss this time, reflecting the impact of fair value adjustments which more than offset the benefit of liability management gains made during the half.

Now I want to walk through some of this in more detail, and firstly revenue. As I said, first half revenue was supported by the good performance in Wholesale as a result of the absence of last year's market dislocation impact and good underlying growth from traditional corporate customers.

I also want to draw out here the overall resilience of revenues against both the backdrop of the significant margin pressures we experienced, which I will talk about shortly, and the impact of moving to a monthly premium PPI product in January which was also a drag on revenues this time around. In addition, you will see that we've executed a number of liability management transactions in the half. These have generated strong gains, over and above the fair value unwind that crystallizes as a result of these transactions.

Turning now to margins. The net interest margin from our Banking business was 28 basis points lower, at 1.72%, as higher asset pricing was more than offset by the impact of lower deposit margins, reflecting the impact of falling base rates, and higher funding costs as the Group consciously extended its wholesale funding maturity profile. Before I expand on our expectations for margins going forward, I would like to discuss the key forces that are currently influencing our margins.

Starting top left, new lending is generally being done at prices that reflect the appropriate cost of funds and, of course, proper pricing for risk. However, in many sectors, notably within Wholesale, we are seeing considerable reductions in demand as companies refocus their own businesses and look carefully at their financial requirements.

Within existing lending we're seeing quite different trends from those that have prevailed in recent periods. This is perhaps most noticeable in our mortgage portfolios, where redemptions and re-mortgaging have dropped significantly. In fact, this is underpinned by totally logical customer behavior, as whether you are coming off a fixed-rate period or your tracker product is coming to an end, reverting to the current contractual SBR is probably getting you the best rate around. Of course, for us, customers moving to SBR from trackers is helping interest income. But with customers moving from fixed rate products to SBR, it's reducing our income.

Corporate lending products, however, are naturally repricing much more quickly, which is helping us avoid further net interest income reductions. To understand the overall impact of these forces on our margins, we must look at funding costs. As far as wholesale funding is concerned, costs generally have increased and, of course, as I said, we have consciously extended our maturity profile. On customer deposits, the rates we pay have not borne the full impact of base rate reductions as we seek to secure and grow such balances.

So what does all this mean going forward? We do not expect these trends in our net interest margin to continue throughout the rest of the year. And during the second half we expect a significant slowdown in the rate of margin decline, as the impact of lower base rates and higher funding cost eases. You will see from our news release issued this morning that we've given some future guidance. We expect the margin to start to increase next year, although not to the 2008 levels of 2%. Thereafter we expect the impact of rising base rates, further portfolio repricing and greater stability in wholesale funding markets to lead to further margin increases.

Now let's look at costs. The Group has an excellent track record in managing its cost base and has continued to deliver a strong cost performance. During the first half of 2009, operating expenses decreased by 3%. Over the last six months, staff numbers have reduced by over 2,500, to 118,000, as the Group has started to achieve integration savings from bringing together the combined businesses.

We anticipate further significant cost savings from integration over the next three years. More in just a second. And as a result of this, we expect to exceed our recent cost/income ratio improvement of approximately 200 basis points per annum. After three years of integration delivery, we will still be targeting further improvements in the cost/income ratio of that same 200 basis points per annum.

So now let's look at progress on integration. Less than six months after the date of acquisition, and with the planning of many of the key integration activities largely complete, the execution of a broad range of programs is well underway. We are very pleased with progress made so far. And this reaffirms our confidence that we will meet our commitment to deliver cost synergies of greater than GBP1.5b per annum by the end of 2011.

In the first half of this year, we've already captured savings of over GBP100m. Early synergies have come mainly from non-IT dependent programs, such as procurement benefits, streamlining our non-branch property portfolio, and the obvious de-layering and de-duplication of roles. We're aiming for over GBP400m of savings this year, which would equate to a run rate equivalent of some GBP700m. All in all, I see this as excellent progress.

This being one of the largest bank integrations ever, we have over 70 integration programs planned. The initial planning phase is done. And we have the program management team and structure in place to support and drive the integration process. And a considerable amount of time is being spent dedicated to achieving a smooth integration.

This is one of the most important issues currently on the management agenda. And as you would expect, the Group Executive Committee reviews status and progress on a weekly basis, dealing with any potential issues before they can become problems. As I've said, program delivery is gaining momentum and a number are already delivering benefits. But, of course, some projects are more complex, including product migration and full systems integration. Whilst initial scoping work and the main platform choices have already been made, many of these programs will take until 2011 to see full delivery.

I'd now like to spend some time on impairments and the outlook for the second half of 2009 and beyond. Firstly, Retail. In the first half of 2009, we've started to see a change in the mix of retail impairments between secured and unsecured, towards a more normal pattern. What we've seen is the combined impact of a number of factors, a stabilizing outlook for house prices, increasing level of unemployment, primarily affecting the unsecured portfolio, and lower than previously expected repossessions as customers benefit from the low interest rate environment.

Compared to the first half of 2009, we expect to see a moderate increase in the retail impairment charge in the second half of the year which we believe will represent the peak in retail impairments, with an improving trend expected in 2010.

Looking specifically at our secured portfolio for a moment, we are reasonably pleased with the performance of the different mortgage books. Over the past six months, our secured portfolio has performed better than our expectations. As I said in February, we were swift in identifying those parts of the mortgage books which are our areas of focus as a relationship lender and we immediately put certain books into runoff. We have stopped writing specialist, self-certified and subprime mortgages, and have continued to write only a modest amount of new lending in buy-to-let. And this is being written to Lloyds TSB lending criteria.

The values of our book that are both more than 100% loan to value and in arrears are very modest indeed. In fact, they total around 1.1% of the total mortgage portfolio. It's worth noting that all of the assets with an LTV greater than 100% and more than three months in arrears within the specialist and HBOS buy-to-let portfolios are intended to be covered by GAPS.

Forgive me if I dive into detail here, but I think it's just worth drawing out another really good nugget of mortgage book performance, repossessions. Our repossessions actually peaked in Q3 2008. And since then the trend has been marginally downward, against the clear industry trend, reflecting the benefits of quickly identifying and working closely with customers who get into financial difficulty. And there's a lot more data on the mortgage portfolio in the back of your packs this morning.

Now to Wholesale. As expected, the charge for our wholesale impairment losses increased significantly in the first half of 2008, although this was only moderately higher than the second half of last year. The increase primarily reflects continuing declines in commercial property prices and reducing levels of corporate cash flows. In addition, what we saw in the first half, we found in particular the real estate related exposures in the legacy HBOS portfolios were more sensitive to a downturn in the economic environment. We've spent considerable time analyzing and addressing the issues in these portfolios, with the greatest attention paid to the over-concentration in real estate and those portfolios that fell outside the Lloyds risk appetite.

As a result of our portfolio review, and with the further deterioration in the economy in the first half translating into lower commercial real estate valuations, we took a prudent but significant impairment charge during the first half of this year. It's worth drawing out at this stage that approximately 80% of the first half impairment charge for Wholesale relates to assets intended to be covered by our participation in GAPS.

As we've said, we believe that wholesale impairments have now peaked. And we expect a significant overall reduction in the wholesale impairment charge in the second half, and a further reduction in 2010. As with retail, we expect the mix of wholesale impairment charge will change. Against our base economic assumptions, we expect to see lower charges from commercial real estate related portfolios. This will be partially offset by higher charges from corporate and commercial businesses as a result of what you might call more normal impairment levels against the backdrop of deteriorating economic conditions and higher corporate failures.

Turning now to International. In our International businesses, the impairment charge rose to GBP1.5b, reflecting significant deterioration in real estate related exposures. And we've booked significant provisions against these portfolios. Again, these portfolios are predominantly expected to be included in GAPS, with some 85% of the first half impairment charge related to assets intended to be included. Looking forward, we expect a reduction in the charge in the second half of 2009, with further reductions next year, although we do continue to have ongoing concerns with regard to the outlook for the Irish economy.

I've given you a lot of impairment guidance here, so let me just recap for a second. We believe the overall Group impairment charge peaked in the first half. We believe Wholesale and International impairments have peaked, and we expect retail impairments to peak in the second half of 2009. Though we would normally expect impairments to peak one to two years after the low point in a recession, given the prudent approach we have taken, resulting in a very substantial Wholesale charge in the first half of the year and, based on our current economic outlook, we believe that the Group's overall impairment charge in the second half of 2009 will be significantly lower than in the first half. Thereafter, the 2010 charge will be significantly lower again.

We expect to put into the asset protection scheme virtually all of those assets that we deem to be higher risk or overly concentrated following the acquisition of HBOS. And the portfolio will of course evolve as we complete GAPS documentation.

Looking at the initially announced GAPS portfolio, approximately three quarters of the Group impairment charge in the first half of the year relates to assets intended for GAPS. The residual charge relates to non-GAPS assets, such as our credit card and prime mortgages portfolios, where impairment trends are pretty much as expected given the economic environment. But approximately GBP1b of this residual charge relates to impairments on legacy HBOS asset-backed securities, where there is a largely offsetting credit in the income statement fair value unwind. So that leaves just over GBP2b of the remaining charge as what you might consider our non-GAPS lending portfolio impairment.

Now turning to fair value adjustments. We spent some time on this topic back in February, so I don't intend to go over the full technical details again now. However, as a reminder, there was a reduction in the net assets acquired from HBOS following the fair value exercise. We reduced the value of the assets required, principally the loans acquired, to their fair value. And this was partly offset by reduction in the value of own debt on the HBOS balance sheet.

The former reduced net assets acquired and results in an increase in profits going forward as it unwinds, whilst the latter increased net assets acquired and will reduce profits as it unwinds. We also had to take adjustments for HBOS's available for sale and cash flow hedging reserves.

These adjustments have now started to unwind. A credit of some GBP3.7b in the first half is principally the unwind relating to credit losses coming through from the HBOS loan portfolios which were a component of the fair value acquisition adjustment and have now been incurred. Quite simply, with the level and speed of impairments increasing as it did in the first half, so the unwind gets accelerated.

The patterns of unwind, of course, are tied to the underlying assets and liabilities. So for predictable maturities on HBOS debt, for example, the unwind is straight line to maturity. But on loans and advances, the faster the impairments come through, the faster the unwind of credit adjustments comes through to mitigate.

I've shown here the unwind I currently expect in the second half and beyond. And I'll -- excuse me. I should stress, however, that these numbers are likely to change somewhat, especially on the credit side, as, as I've just set out, part of the unwind is determined by the profile of expected losses being incurred. And I will update you on an ongoing basis with regard to the evolution of this profile. Between 2010 and 2013, the unwinds are modestly favorable overall as further credit adjustments are greater than the unwind on the own debt revaluations, also taken on acquisition. The tail after 2013 is not expected to be significant.

Let's move on to net tangible assets. In the first half of the year, the key changes to our net tangible assets were, of course, the GBP4b increase from the placing on open offer and the impact on our earnings. As a result of these, the overall impact was to increase net tangible assets to GBP25b. In per share terms, and allowing for these adjustments, net tangible assets per share reduced from 140p to 92p. Adjusting further for our intended participation in GAPS, we expect the initial net tangible assets per share, fully diluted by the issue and subsequent conversion of these shares, to increase to GBP1.

At the end of June 2009, the Group's capital ratios, prior to the implantation of GAPS, remained robust, with a total capital ratio of 10.6%, a tier 1 ratio of 8.6%, and perhaps most importantly these days, a core tier 1 ratio of 6.3%. In addition, the Group's intended participation in GAPS is expected to substantially derisk the Group's balance sheets, reduce risk-weighted assets and very significantly further strengthen our capital position.

When we look at the evolution of our core tier 1 ratio in the first half, we can see the impact of the placing on open offer, the balance sheet management initiatives, and lower risk-weighted assets, have more than mitigated the impact of the losses incurred in the first six months, bringing our core tier 1 capital ratio for the first half back up to 6.3%.

In an economy which we believe will continue to be difficult, but one which is showing some early signs of stabilization, the capital management actions we have taken continue to give us a robust capital position and one which leaves the Group well positioned. And while we maintain and strengthen our capital base, it is crucial to consider the size of our balance sheet going forward.

As part of our review of the business, we have identified over GBP300b of assets, associated principally with non-relationship lending and investments and a business which is outside our current risk appetite. This equates to just under 30% of the Group's total balance sheet assets. It is our intention to manage these assets for value. And given the current economic climate, our primary focus will be on running these assets down over time.

Over the next five years, we expect to achieve a reduction in such assets of approximately GBP200b, split of that GBP140b from customer lending, and GBP60b in treasury assets, and with the profile of runoff weighted towards the latter years. The rest are likely to take more time to run off.

The expected RWA reduction of some GBP100b is, of course, heavily overlapped with the RWA reduction that would arise on completion of GAPS. But the right-sizing and funding benefits from this asset reduction over time will give the Group greater optionality. And I want to set out our current thinking on this now.

With most of the assets targeted to run off currently generating lower returns, our optionality is many-fold. We can look at this as the opportunity to increase returns by reinvesting in our core relationship businesses, or to reduce our overall wholesale funding requirements, further supporting our desire to reduce the loans-to-deposit ratio and maintain a prudent wholesale funding profile. Whilst we will clearly have a range of options and outcomes, it is our current view that up to half of the released funding and capital will be redeployed into our core relationship businesses, principally in the UK. The remaining funding and capital benefit will be absorbed within the Group's overall plans.

As far as these portfolios are concerned then, in summary, we're seeking an asset reduction of about GBP200b, of which up to half will be reinvested in the businesses. As a result, our balance sheet size is currently expected to reduce by some GBP100b over the next five years. But the impact of this on income and therefore earnings will be minimal, reflecting the higher returns on reinvested assets.

Now let's look at funding. Our high customer deposit base is a key part of our funding model. And we currently have some GBP370b of retail and corporate customer deposits, the majority of which are sticky relationship balances. As you can see, however, we do have a significant wholesale funding requirement, but that is satisfied from a wide variety of sources.

We have a well-spread funding profile. And the enlarged Group now has a longer-term maturity profile than Lloyds had previously. Our broad aim is to ensure that we maintain our more than one-year funding balances above 40% of the Group's wholesale funding requirements.

Over the last six months, and as many of you will already be aware, we have been consistently and consciously working to reduce our reliance on short-term funding. And it is pleasing to report that the percentage of our funding, with a maturity of more than one year, has increased from 44% to 47%. And this compares very favorably with many of our competitors.

As I mentioned earlier, this has not come without cost. But at a time when wholesale funding markets have not been easy, I believe that the additional cost is a price worth paying for the extended maturity profile. And this extension achieved has, of course, further derisked what was already a prudent maturity profile.

During the first six months of the year, our retail customer deposits grew by 1%, despite subdued retail deposit markets in general. Our corporate deposits, however, reduced during the half as we chose not to renew a number of historic high interest paying Bank of Scotland corporate deposits.

Whilst looking at a funding slide, I should briefly comment on our loans deposit ratio which, excluding repo activity, improved slightly to 176%. As you know and for those of you who know me, the Group does not set a target for this ratio, which does not reflect either the quality of lending or the term of deposits held. But I would expect to see a slow and steady reduction in the ratio and thus for it to return to legacy Lloyds TSB levels of around 140% over the next five years.

So, in concluding, our business is in good shape, with resilient revenues in a difficult economic environment, notwithstanding margin pressures. I've outlined as well how we expect to see improved margins over the next few years. The integration of the Group is well underway. In fact it's operating ahead of schedule in many areas, with cost synergies firmly on track. We believe that overall Group impairment levels have peaked. We have a robust capital and funding position and expect this to improve significantly as a result of our intended participation in GAPS.

Overall, therefore, we expect the second half of the year to be tough but manageable, with strong medium term upside. And with that, I'd like to hand you back to Eric.

Thanks very much, Tim. Before concluding the formal remarks today, I wanted to take a moment to say a few words of thanks to Victor, as this is his last results meeting. He's been our Chairman since 2006 and during that time he's made a significant contribution to the Group and its development. On behalf of the Group I'd like to offer him our sincere thanks for the important role that he has played and to wish him every success in the future, Victor.

This last year has been difficult for our industry. We've all been reminded of the overriding importance of strong risk disciplines and a prudent through the cycle approach. It now seems that the UK economy is stabilizing but the growth will be below trend as the credit excesses of the boom years are unwound. For many years, Lloyds bank has aimed to deliver sustained growth and value for its customers and shareholders. We have focused our business model on customer value and deep relationships within a highly disciplined risk framework. We've stuck to what we're good at and we have not expanded into the higher risk product led businesses which drove much of the unsustainable growth in banking profits in recent years.

You've heard today that we will continue to pursue our business model across the enlarged franchise. Although the economic environment remains difficult, we are successfully addressing our near term challenges. We believe that our new Group can consistently outperform and create value for its customers and shareholders, as we deliver against the significant opportunities within our business franchise. Thanks very much for listening. Now let me hand you back to Victor for the Q&A.

Thanks, Eric and Tim. Let's go straight into questions and answers. If you can just wave your hands and I'll try and get around to everyone. Let's just start at the front here, thank you. Microphone's coming.

Hi, this is John-Paul Crutchley from UBS. Can I ask a question about longer term? You've not really said anything about longer term returns and earnings. I guess clearly the environment is still highly uncertain and the regulating environment is still very uncertain. But if you sort of put together what you've been saying in terms of revenues looking to be sort of stable to up over longer term, clearly taking costs out and thinking about a more normalized impairment. It's hard not to get to the conclusion which is a mid to high teens ROA business the other side of the cycle. I'm just wondering if you could just make some comments on whether that analysis is sound, or whether there's anything missing in that, in terms of the equity part of the equation?

Thanks for the question, JP. I think that you've read all the [terms] I think exactly right. That's as we see it. It's of course dependant on how the economy eventually pans out but if you take that forecast, that would say that our guidance would look an awful lot like the old Lloyds Bank and you know what the returns were in the old Lloyds. So I think that that would be about how we would view the future.

Thanks, Eric.

The gentlemen immediately behind, thanks.

Peter Toeman from HSBC. I wondered what your attitude is towards the asset protection scheme because it seems to me the benefit of the scheme was the elimination of uncertainty in back in March, April where no one had any idea how impairments could be. Now you're sufficiently confident to tell us that the peak of impairments has passed. So do you really need to spend GBP15b on an insurance policy to remove a risk that might now look less likely to materialize? I suspect reduction in WRAs that the asset protection scheme will give you. But I wondered if you'd considered asking shareholders directly to recapitalize the bank, rather than relying on the APS scheme?

Thank you. I'll give you a couple of very quick thoughts and then ask Tim whether he has any other considerations. The way we think about the APS program is that it is insurance. And as with any insurance you would hope like hell that your house doesn't burn down but if it does you're protected. And that's sort of the way that we think about it. Very clearly we do believe that the peak of impairments has passed but we also believe that it remains an uncertain environment. Tim?

(Inaudible - microphone inaccessible).

Thanks.

Thanks. Ian Smillie from RBS. Two questions please. The first one is thanks very much for the -- for all the forward looking guidance. To make sure that we all take it away correctly, are you suggesting that there will be a profit or a loss in the second half of this year? On a pro forma basis?

We're not changing our guidance that we gave previously on the overall result for the year.

Clearly we've seen the first half numbers and I'm trying to work out what you're pointing us to for the second half of the year?

We've given guidance on the full year results and we've given in this statement today indicators on some of the trends that we see, but I'm not changing my guidance for the overall half of the overall year. Sorry.

The second question is on book value progress. Could you give us the updated fair value adjustments on both sides of the balance sheet as they stand at the period end? Because I'm just trying to work out why you're guiding us to a net positive contribution from that net unwind over the coming years, given that the starting point was slightly bigger benefit to liability reduction than asset reduction.

Now I know it's distorted by the debt buyback that you did in the first half of the year, so it would be very helpful if we could see what the end of period numbers are, so that we can work through that amortization process for ourselves. And therefore take a view on where book value will be in a couple of years' time.

Yes, the guidance we've set out here shows what's -- and all of these things will unwind through the income statement. So there's nothing else that you will see that isn't in the profile that I have set out on the slide there. In terms of why you're seeing that overall positive trend and you're looking and saying, well where's the negative? Remember that those numbers are actually net of the fair value on HBOS own debt that unwinds.

With the liability management actions that we've taken in the first half, we've of course captured, is the word I use, Ian, some of that unwind but now cannot unwind (inaudible) because the gain that we show on the liability transactions of about GBP0.75b already reflects the capturing of that unwind. So that's dealt with, it can't come back. And therefore reduce profits and capital going forward. That's a very smart tool for managing capital and managing profits going forward.

The overall profile going forward, you've seen we've guided on what we'll see in the second half and as the years to come. Of course what you're seeing there is what's going to happen on the income statement. There are two sources of that. You get the pure fair value for the fixed net assets but you also get the available for sales reserves unwind that comes through. And that's why you don't see an overall negative coming through in any of the years going forward. If you want, I'll take you through some of the individual math after. I'll run a master class after we break.

Yes, pass it along, right, thanks. No, the gentleman next to Ian Smillie.

Cheers. Thanks very much. It's Sandy Chen from Panmure Gordon. Just two related questions actually. Probably the same question actually. I'm trying to put the guidance that you've given in terms of balance sheet shrinkage together with a goal of maintaining top line growth or increasing cross selling in the customer base. Because the way I kind of think about it, if you're looking at a, let's say, net GBP100b reduction in your balance sheet assets, or GBP200b reduction on let's say a GBP650b customer loan book, would you be in effect giving maybe 10%, 20% of your customers that are behind those loans the heave ho? And would that -- or am I thinking about that the wrong way in terms of cross selling?

And related to that, the government -- participation in the government assets protection scheme, obviously it's been widely reported that the EU may require both non-core or core disposals related to that. Do you see that having an impact on that top line growth?

(Inaudible - microphone inaccessible).

Okay, I'll meander a bit and then -- but the real answer to you can ask Tim. In terms of answering the second question first. You're asking a state aid question and whether that's going to be a meaningful consideration. I think that it would be safe to say that we would expect to -- we're in conversations with Europe and we would expect to have a satisfactory conclusion.

In terms of how we are managing the business going forward, very clearly we have a large percentage of our portfolio, some GBP300b as Tim pointed out, of assets that are reasonably high risk. And if you look at a real risk adjusted return, we talked about these during the February presentation where they occupy a very large part of our risk weighted assets but don't really contribute an awful lot to our returns. And so what we will do is run those down over time.

We will use part of that run down to help support our relationship businesses and as you know, we have been very successful in growing in a risk efficient fashion, if you will. So if there's a disproportionate impact by switching it over to the relationship business, I know we would expect to use part of it to shrink the balance sheet. Tim?

I agree with all of that. I'll just add that of course we've got a market leading business support unit, which is really a turnaround unit. It's not a unit that says let's go in and get as much as we can out and create significant pain for customers. This is a unit that specializes in supporting customers through their difficulties which, at the end of the day, will minimize the losses, or any losses that we would take on that portfolio.

So to the very first part of your question, no, we've no intention of leaving customers in the lurch as we look to manage down over time and for value assets that we would regard as outside of our risk appetite, or non-relationship based.

Sandy, can you just pass it to your left? I think the gentleman next to you, no, you didn't want to ask a question? Sorry. Behind. Thanks.

Hi there, it's Aaron Ibbotson here from Goldman Sachs. Just a quick question on wholesale funding, maybe to you, Tim. You seem to be reasonably happy with the profile at the moment. I was just hoping that you could clarify, do you expect to push the funding profile out further, i.e. increase the sort of term funding part of it? Are you all in all reasonably happy with the current structure? Thank you.

Thanks very much for the question. I've certainly -- what we would like to do is over time, maintain it at more than 40%. I said that from the podium. At the moment it's 47%. I'm comfortable with that 47%. I think that is a prudent place to be and we have deliberately and consciously pushed it out this year from 44% to 47% notwithstanding the margin pressure that's put us under. That reflects a prudent profile, given the state of the funding markets generally. But over time I want to keep it above 40%.

Thanks. And so the next question on the -- in the third row. Thanks.

Thank you. It's Michael Helsby from Morgan Stanley. I've just got four -- sorry, two questions and -- but there's four very brief ones on something that I think are quite important and just one on bad debt. Firstly, I was wondering if you could tell us what the deposit spread is at the half year? And what's the marginal cost of your deposits at the moment? And that's part one of funding.

Then what -- within your margin guidance, what's the average mortgage duration that you're assuming? There's been a very sharp change clearly in durations, so that's key.

In the move in the wholesale funding greater than one year, I was just wondering if you could clarify how much of that has been government led because clearly all the government funding is sort of greater than one year? And also if you can tell us to what extent that the total reliance on government funding is at the balance sheet at the period end?

And then just lastly on funding, I'm very, very surprised that you're making the comment that you can move back towards a 40% greater than one year wholesale funding duration. If we just take the pro forma as you did at 44%, clearly that's even lower than where HBOS were at the end of December. We were all here, we all watched the concerns about the funding position of HBOS. So the fact that you, in the new world, think that you can move to a level that's substantially below that, I just find very, very surprising. So if you could explain why you feel so comfortable in making that statement? So that's the funding out of the way.

[Let's do that] and then come back?

Yes, that's question one, yes.

Okay, Eric can start it off and then Tim.

Thank you. Michael I fully appreciate your concern and I'll ask Tim to talk to you about the margins but let me address the wider issue of wholesale funding and what this 40% guidance means. I think the first thing you have to look at is what is the quality of your lending and what is the quality of your deposits on the overall book. And what is going to happen with those?

What we have basically said is that we are going to grow our deposit base. Now there's a couple of different ways you can grow it. If you put in a very high rate you'll attract in hot money, this is clearly what HBOS did. And then you're on a grub, you have to keep on paying very, very high rates. If you build them an account at a time and when we opened in the first half for example, the 1m current accounts and the 2.3m savings accounts, that's building it a brick at a time. And so over time, what we will do is increase our rich consumer deposit base and our wholesale deposit base and have less reliance on wholesale funding.

When you're a smaller player in the marketplace, which we already are, we are -- have a much different wholesale funding requirement than many other banks. But if you're a smaller player in the marketplace, then your maturity is less of concern because you have the big part of the nut already solved. And so that's really the context. This is not an HBOS strategy. This is a proven Lloyds strategy. Now let me turn you over to Tim.

Thank you, Eric. Michael, I'm not going to get into individual deposit spreads or marginal costs. What you do know, because we set it out right from the very first presentation we gave around the new Group back in September, is that one of the key strengths of having multiple brands and multiple distribution channels, is that we can use different pricing techniques to manage our liability gathering particularly in the retail space and that's something that we continue to do very successfully.

You asked about mortgage duration. I've already commented that we've seen a significant reduction in redemption activity but we are seeing an encouraging proportion of those customers who are on tracker mortgages actually using some of the benefit that they're seeing in their own pockets from the rates coming down to actually make some capital repayments. But mortgage durations are going out, they're extending a bit because of the lack of redemption activity. As I said from the podium, the SVR that people are migrating onto is probably the best rate around that people will get. How that pattern will change going forward, I don't know. I think that's when we'll have to sort of wait and see.

On the next part of your question you asked about sort of more than one year government funding, etc. Clearly an element of our extension has been using government guaranteed debt. We make no bones about that. We've also done some very successful unguaranteed issuance and we're particularly pleased with the way our seven year euro bond issue which received. It priced inside competitors and inside our own expectations. And there was a significant over-demand and we're very pleased with how that got away.

In terms of where the overall profile goes forward, I think you can sense from the table here today and from the numbers we've given you that we will maintain a prudent funding position for the bank. Notwithstanding how we would see that happening over time, the decision to move that out during the first half of this year was taken very carefully in a very considered way.

I think a 47% funding in more than one year stands us in exceptionally good stead against peer banks. You then have to look at the diversity of funding sources and what we will be looking to do over the next few years is diversify the kind of writing that some of that term funding that is coming into place. And as one diversifies away, then we can consider the overall risk profile of the balance sheet. So at the moment I would look to maintain that above 40%. But don't think that I'm going to come back from 47% to 40% by Christmas, because that won't be happening either.

Second question, please.

Part of that question was the total amount of government sponsored funding, SLS, etc. If you could share that number that would be useful.

We don't disclose that I'm afraid.

On the bad debt. I think if we look to the US banking system as a guide to how they've approached the credit cycle and clearly they've been building provisions very aggressively for the last couple of years. So on page 67 of your press release I'm very surprised to see that actually you've not just reduced your cover from your provisioning but you've also released about GBP1.3b, or you've shrank the actual provision by GBP1.3b. I can see that you've done some write-offs with the unsecured. So but it still looks more than I would expect. So that's an explanation for that.

And also what recovery rate you're assuming on your unsecured bad debt? And that's me done. Thanks.

Okay, thanks, Michael. Yes, I'll take that. You're right, we've done some writing off. What we've done is simply netted off principle against provisions where we've got close to or exactly 100% provision against it. What that gives you is actually a greater line of sight to the impairment provision coverage that we have across the three different books. And I might get the numbers wrong, but you've got 40%, 46% and 40% across the three different banking divisions that we have, which gives us a very, very substantial level of provision coverage against impaired loans.

I think at those -- at that type of coverage, where it's not being in any way distorted by what might be there for things that are 100% provided, you really are getting a line of sight to a very comfortable level of provisions. And we're certainly very happy at that level. You've got here, you know, good old fashioned Lloyds TSB proven methodology now sitting in our June 30 balance sheet and I'm very comfortable with the levels of provision.

Thank you.

Just behind you. Gentleman on the aisle.

Thanks very much. It's Mike Trippitt at Oriel Securities. I want to come back to Peter Toeman's question actually. What I don't understand is the relationship between the GBP200b runoff of assets and the GBP260b that goes in for the GAPS scheme. To what extent is there an overlap? And if there is an overlap then I begin to understand less the merits of GAPS because you're still going to get the capital relief by the GBP200b runoff and I guess you'll also move towards your funding targets as well. And I guess at the same time you'll also reduce the concentration risk that the EU is worried about. So I think just to understand the relationship between the GBP200b and the GAPS portfolio is crucial.

Thanks. Do you want me to start?

Yes.

Yes, thanks for your question, Mike. There's a number of numbers in play here. GBP260b is the intended asset portfolio that we announced back on March 7. That included about GBP30b of undrawn commitments. So in terms of items on balance sheet, you had about GBP230b. What we've identified is now, is probably just over GBP300b of total assets and investments that we would consider either outside risk appetite or of an investment nature that we would look to run off over time.

In terms of the capital benefit, the capital benefit as I've said from the podium, there'll be significant overlap between the runoff of GBP200b out of the GBP300b and what we're going to get a very significant runoff. But what you get by running these assets off is you get a funding benefit. And we want to use that funding benefit as we set out to further derisk what's going on in the balance sheet. Further derisk the profile of funding and also create capacity for reinvestment. Because what this business is, the bank is open for business. The bank is not in runoff and we are here to work with our core relationship strategies in our main divisions, banking and insurance, to build the business going forward. And we want to create the capacity to do that.

So GAPS doesn't give you any kind of a funding benefit. So by being careful and measured in how we manage this portfolio of assets over time, we can create capacity to both invest in the business going forward and further derisk the balance sheet. And that's what we're going to achieve.

I thought by definition, the GAPS assets are in runoff anyway. I mean they're clearly not core. So I'm still not clear, is the GBP200b is that part of the GBP260b GAPS or is it --

There's a very significant overlap between the two.

Thank you, good morning. It's Leigh Goodwin from Fox-Pitt Kelton. Just another question on the APS first and I've got a second one on margins if I may. I wonder if you could just confirm for us where we are in relation to the first loss piece now? I mean clearly we can see GBP13.4b of impairments. 75% of those are on APS assets, so that gives us about GBP10b. But I mean the complicated bit is the -- of the GBP25b there was then an adjustment, part of the capital adjustment on acquisition could effectively come from that GBP25b as I understood it. Now the capital adjustment you guided us back in February has changed, it looks to be more severe, hence the more positive unwind shall we say, over the next few years. So how should we think about where we are in relation to moving through that first loss piece?

The capital adjustment you get with GAPS has a number of legs. You have the increase in capital from the B shares. You have the reduction in the IWAs and then you have an adjustment, as you rightly say, around first loss which has an overlap with fair value accounting. The impairment charge that we've taken in the current year, about three quarters of that relates to assets that are intended to go into GAPS.

There's not a direct correlation -- a complete direct correlation between that and the first loss consumption because you need to understand what's happening around the first losses and other pieces. We can't go into -- we're not going to go into any more detail on that at the moment. We're in the middle of a process working to conclude that, so we're confident we're going to conclude that process.

Okay, well, let me put it a different way then. When we do our models looking forward for you, should we assume that there is another GBP15b left, so to speak, in the first loss piece, or is it less than that?

I think I'm going to just go back to my previous answer. We're in the middle of a process. The detailed terms and conditions on GAPS and how it's going to work are still being discussed and documented. It's an incredibly complex beast.

Okay, thanks. Just then on margins, I just -- I mean I appreciate we can all see the trends that are going on and those things that have been negative this year and which hopefully provide positive momentum through next year. I suppose my question is more thinking through the longer term and where you think margins are going to go to. You're saying next year you don't expect them to go back to 2008 levels. I wonder whether you think by 2011, 2012 you will have done. And, in that context, one has to think that this is going to be a fairly visible change in pricing that will be taking place perhaps, as interest rates rise. And whether you think that there might not be some external scrutiny of any margin widening?

What I've done is set out today quite a lot of detail on what I see as the forces that are influencing our margins and I've given near term guidance on how that is going to play out. My intention is to provide the analyst community with enough guidance on what the inputs will be that they can watch and observe those inputs and come out with their view and interpret that into how the margin will perform going forward. So we're not actually giving specific guidance beyond 2010, except around those inputs. So I think we've given a significant amount of guidance on the inputs for how that will happen going forward.

The second part of your question was around pricing. Let's be careful how we look at this here. You're suggesting that the only way we achieve it is by putting up prices. I'm suggesting that actually by focusing on relationship businesses and relationship customers, they're another way of earning income. And if you look particularly at some of our activities through our corporate businesses, we are looking to achieve far more non-interest based income from customers. We're looking to have a greater share of transaction business, providing interest rate and currency management activities. That's been a key driver of some growth in the wholesale business in the first half of this year and we look to continue that momentum going forward.

I see. Now just a third question if I may, sorry to be greedy but just on impairments on the unsecured book, because you don't split it up by credit cards and unsecured loans I see. And I think credit cards are outside of the asset protection scheme. But in any case, with quite a rise in the unsecured charge on the first half of the year, we're at over 9% of the book and quite a big increase. And we know unemployment is going up through to next year as you pointed out. So I wonder why you feel so confident that the retail impairment charge will improve a lot -- will improve next year, considering those trends?

Yes, okay. Leigh, what I tried to do and I apologize if I didn't do it clearly enough, was talk about the change in mix that we see in the retail impairment charge. And you've got here the different dynamics of rising unemployment, which as you quite rightly flag is a key driver of unsecured impairments. But also the improving outlook for house prices. And our current view for this year is to be 7% or better in terms of house price performances and then to see a marginal increase, going forward. So you have to look -- we're looking here at the balance of overall retail impairments and that's what's underpinned our guidance on how charges will peak and then improve.

Eric (inaudible).

Thank you, Chairman. I just wanted to follow up on one question which was government pressure and what would happen with pricing. I think there are two things that I would point out. The first is that risk has not been appropriately priced for a good long time. And if you recall, we talked about this in the first half of 2007, where Lloyds had basically withdrawn from the mortgage market because we thought pricing was nuts. It was about 10 basis points. You can't cover your liquidity risk for 10 basis points never mind credit risk. So what we believe is that the market will in fact have reasonable risk adjusted pricing for both credit as well as liquidity risk. And that means that prices will, in fact, go up on lending.

But I think the other thing we have to look at is where we are in the cycle. That if you have traditionally very high interest rates, what happens is that you have very good liability spreads and asset spreads tend to compress. And likewise if you have a very low interest rate environment, asset spreads tend to go up, liability spreads go to hell. So what I think we're going to see is, as base rates adjust, we are going to see some adjustment in that asset and liability mix. And hopefully what we will see is that the market has at least learned something from the more recent troubles and price risk appropriately.

Thanks, Eric. Can we go right to the back? Thanks.

(Inaudible - microphone inaccessible) question please. Firstly, just on the asset protection scheme, I am a little surprised that you aren't prepared to update us on some of the financials there. Can I check that the initial broad financial guidelines you gave when announcing the scheme are still appropriate? I.e. the GBP25b first loss piece and the GBP250b of assets that you're putting into the scheme. And that essentially, those -- makeup of those assets has not materially altered since the announcement?

Tim, can you?

(Inaudible), hi, good to see you. Yes, broadly speaking that's absolutely right. Those are the numbers that were there with the intended portfolio to go into GAPS. As I said in my prepared words, there may be some minor adjustments to the construct of the portfolio as due diligence and everything goes through. We're in the middle of that process and when we have something formal to update, then we'll update.

Secondly, also related to that, in terms of the page 67 of your release where you look at impaired assets. Could you comment on a split of impaired assets between GAPS and non-GAPS assets?

No, we haven't given that information.

And the final one was in the revenue line there's been, I think there's likely to have been some negative revenue effect on the private equity portfolio of a principle finance portfolio of HBOS. Could you quantify that and any other negative revenue items that I may have missed?

The total value of all write-downs on investments is less than GBP200m.

In revenue?

That's where those write-downs are taken, yes.

Thank you.

Did I see another hand go there? Yes.

Yes, Pilkington Simon from Cazenove. Just a couple of questions on the margins. Your point of clarification on slide A, where you referred to base rate movements. Are you assuming base rates could go up next year and really if base rates stay flat, does that have any impact on your guidance for the net interest margin?

You want to take that?

Simon, hi. We would expect there to be a -- probably one small increase in rates -- in base rates next year. Nothing particularly material. The benefit of that to us will be marginal but would be positive, hence why you get a small arrow on there. In terms of if the economic scenario was different and therefore you had different base rates, then that little favorable arrow on my margin chart will disappear.

Then what's been the benefit in the first half from hedging on your net interest margin?

Not very -- not significant.

Because you've given it up, or what?

There were some hedges that were in place that in the second half of last year, principally in the HBOS side, many of those were closed out and the benefit was spread over the second half of last year. Small benefit in the first half of this year.

Thanks. Take this one there.

Hi, it's Ian Gordon from Exane. Could I have three quick ones, please? Firstly on APS, can you remind me, when you first announced your proposed participation you explained that there would be a non-linear amortization of the premium. For 2009, should I assume a -- will be at non-linear full year's worth, notwithstanding the fact that the scheme won't formally be signed off until maybe Q4? That's the first one.

If you want to model it in that way, that would be perfectly acceptable, yes.

Thanks. Second point, the main positive as far as I can see it in the results was the non-interest income component within Wholesale. I hope it's not disingenuous to suggest that elements of that out-performance seemed to be products with a level of complexity and sophistication, which was outside the Lloyds appetite prior to (inaudible) survival of the Group. So I wondered if you could provide a little bit more color on your future aspirations for developing those particular product lines? I.e. they appear to go beyond improving cross sales, existing corporate relationships.

And on a sort of similar vein, the third question is the old favorite of PPI and I guess PPI was an element which, let's say, went to the opposite category, i.e. a non-sophisticated product force fed to customers. I think you did explain that the main driver of the reduction in the recognized income from the source in 2009 isn't lower penetration, but it's attention accounting recognition. I.e. you lose the upfront recognition. Can you give us any feeling for the current pace of deterioration in cross sales of PPI, albeit off a lower base of gross personal [end] sales? Thanks.

Okay. Good morning, Ian, how are you? In terms of the non-interest income, I'm going to ask Truett to comment as well. But the quick answer is, no, we're not becoming an investment bank. No, we never will. We are a relationship bank. To the extent that we develop a product it is to help to serve our customers' needs. We are not a product shop that basically goes out and tries to find -- invents a better mousetrap, goes out and tries to find customers that will buy it. We have a group of customers, they have a set of needs, we develop against those needs. That's the way we operate. So we are also gratified to see the non-interest income. We think that's an important revenue stream, but this is not something where we are going to change colors.

As far as PPI and again, then I'll turn it over to Truett to give you a little more color. Our penetration rates are very good on PPI. No, we did not force feed customers. This is a very valuable product and I think that an awful lot of customers, especially with higher unemployment, are very happy that they in fact took the product.

In terms of our product change, you know that we now have a monthly charging product as opposed to a single premium product and yes, we do have a difference in accounting recognition and that is accounting for the difference in income. The penetration rates are very, very good. Truett?

Right, thanks. (Inaudible). Okay thanks. Yes, there's not much to add because the core response is 100% correct. I'll give you a little color in the sense that debt capital markets, in particular in terms of our hedging derivatives, Clare Francis's area which you know we brought in about three years ago. We invested a lot in terms of people, in terms of infrastructure and platform has proven really very, very profitable for the last two years.

And if you go back to both Tim and Eric's slides, we could give you a fistful of live examples of names that we had an exposure in Lloyds TSB. We had a Lloyds -- an HBOS exposure. We did nothing more than combine the two exposures. We went from having a third and fourth position to then being the leading position in terms of the balance sheet and we have doubled and tripled our profitability with no change in balance sheet.

How did that happen? One of the two had not leveraged the balance sheet position to cross sell into what we have in debt capital markets and what we have in terms of Clare Francis's area, derivatives, hedging. Cameron [Knowles's] area in terms of other creative things. But it's with the product set that we defined for you a couple of years ago we continue to invest people and platforms and then the key is leveraging the cross sell. And we're doing it already this year in a matter of months across a broad number of names.

Any more questions on this side? Yes. Can you just give it to the gentleman at the end?

Good morning, thank you. It's Steve Hayne from Morgan Stanley. I just want to make sure I've understood the guidance clearly in relation to the next two years. You've made it clear that it's peaked in the first half of this year and then we're getting better from here. For the non-APS portfolios, if I add up your guidance and just make sure I understand this correctly. So house prices going nowhere, sort of 2% in 2010. Company failures peaking in 2010. Unemployment peaking in 2010. The vast majority of your bad debt comes in the wholesale and not in the retail area. So if I put all those pieces together am I clear in saying that the non-APS book impairment is peaking in 2010, not in the first half of this year? That's my first question.

We've given pretty comprehensive guidance and tried to break it out as far as we can for you, how the different books are going to perform. I think we've also been very clear that the majority of the impairments that we've seen in the first half of this year on assets that are going into GAPS is about three quarters. What we've also tried to convey is the fact that you would expect more normal patterns in traditional lending books to see a peak as a bank goes through the economy. We're not calling a profile of that pattern going forward, but the kind of analysis that you're doing is the kind of analysis that I'm also looking at.

As part of that, I'm wondering if you could just give me a bit more flavor on the GBP9.7b in wholesale bad debt? As you say the vast majority of that is APS but it leaves about GBP4b or so that comes through in non-APS. Can you just give me a flavor of where that's coming through? Which bits in wholesale are we seeing lots and lots of bad debt coming through?

Okay, Steven, in part what I said, I hope I read the words out right, is actually on the wholesale side about 80% of the impairment actually relates to assets going into GAPS. And you've got about 20% of GBP10b, or GBP1.8b to spare. Where that's coming through is in the more traditional areas where the wholesale bank operates around traditional corporate and commercial customers and some of the lending in the asset finance business for example.

Okay.

Thank you. Good morning, it's Jonathan Pierce from Credit Suisse. I've got three quick questions. Can I come back on the APS fee? Obviously the APS covers assets and terms of deterioration from the start of 2009. On day one when this thing gets introduced, why won't there be quite a big retrospective accrual? Because in the same way that a fair value unwind is accelerated because the deterioration has been more rapid, I'd have thought the accrual of the APS fee would be more rapid as well. And clearly there's no accrual yet because it's not been introduced.

What we said about this in March, and I still have the same position at the moment, Jonathan, is that you would typically amortize an insurance premium over the profile of the time over which you expect to receive benefits. So at the moment, whilst you're earning through a first loss piece for example, then you have one type of benefit from the fee which is the B share element, so you have a benefit in your capital side but you're not getting any benefit in earnings.

As you go through and that changes, so the level of amortization would increase. And that's why we've always said that the amortization in the early years would be lower than they would then become.

Okay, so that should be in line with the payout?

It will be in line with our expectations of the benefit of the APS scheme. Quite clearly, if you take out an insurance policy on your house, you still have some expenses, even if you don't claim. So there comes a point when that changes.

Okay, thanks. The second one is on margins, particularly the wholesale funding cost elements in margin guidance. If you hold your term funding of one year plus funding of 47% of total, I'd have still thought there would be an increase in wholesale funding costs next year as some of the term funding, the old stuff gets refinanced at LIBOR plus 150 to 300 as is happening at the moment. Why not?

I think we're looking at the overall profile of it and how that's going to come through in looking at the diverse sources, where we get it from. Because not all of it's coming on purely sort of money market stuff. All that is being fed into our guidance on how we expect to see that going forward and I'm comfortable with the profile.

Third and final question. I was slightly surprised to hear you say that the repricing of some of the fixed rate mortgages onto SVR was hitting you because ordinarily I'd have expected you to have swapped out the fixed rate element of those mortgages on day one as origination. And hence when you go from, I don't know 10, 20 basis points as Eric was saying onto an SVR of 200, I'd have thought that would benefit your margin. Were you not hedged against a chunk of this book?

What I was describing, you'd have to see the [transfer]. I was describing the impact on our income. Clearly the customer is moving from a fixed rate product to an SVR, the amount of income that we're receiving from the customer is reduced. And that's the element that I'm feeding into. Where we have fixed rate products that were put in place, we do absolutely hedge the interest rate exposure on that for the period of the fixed rate. The hedging in place on a fixed rate mortgage covers the period on the fixed rate.

When you come off that, you're then into a situation where you're funding that mortgage, assuming the mortgage stays with you, from whatever your various funding supplies and different costs [levels] providing you with the input, which is the big box across the bottom of my margin forces chart. But the actual level of income that the bank will get from the customer would reduce when they come onto an SVR. That's what I was trying to describe. I was talking about the impact on income rather than net income.

Thanks.

Question here?

Thanks, it's Michael Helsby, from Morgan Stanley again. Just on the income, I was wondering if you could tell us, looking at the GBP49b of impaired loans at the end of June, what level of income is in the P&L account for the first half of the year, please? Thanks.

I'm not -- I don't have that figure to hand. What you have to consider though is of course you don't earn income. When you impair a loan you're bringing the value of that loan in your balance sheet down to the original effective interest rate that you had put on the loan balance. And we're currently carrying -- I haven't got the good number in my head, but as I said it's between 42% and 46% across the three divisions. And then provision coverage against that GBP49b, you'd have to take that into account in determining it. But I haven't broken it out, sorry.

Any more questions? We'll leave it there? Thank you all very much indeed for coming. Thanks. Bye bye.