Lloyds Banking Group PLC (LYG) 2012 Q2 法說會逐字稿

Good morning, everyone, and welcome to our first-half presentation. I am joined here by our Chairman and our Executive team which is now complete. As you know, George Culmer joined us as Group Finance Director in May, and you will hear from him later. And Cathy Turner joined in June as our new Chief Administrative Officer in charge of HR, legal, brands and audits. And Andrew Bester joined as a new CEO of wholesale just this month.

In the first part of my presentation I will describe our strategic progress in the half year, our continued risk reduction reflected in our ratings update, and the resilient operational performance we have delivered in a challenging environment.

George will then give you more detail on our financial performance. And Mark Fisher, our Group Operations Director, will update you on the progress we are making on the simplification cost programs.

Finally, we will summarize our first half and talk you through our expectations for the remainder of the year, and the outlook for the medium term.

So, turning first to the first half highlights. We made further substantial progress in strengthening our balance sheet and reducing risk. We have further reduced GBP23b of non-core assets ahead of expectations. Our core Tier 1 capital ratio has now increased to 11.3%. We have completed our term wholesale funding program for the year by the end of April, and as you will hear from George, our liquidity position improved further.

And, we have continued to deliver above-market customer deposit growth, further reducing our wholesale funding needs by around GBP40b and allowing us to further improve our Group loan to deposit ratio.

There is no doubt that this is a challenging environment for the banking sector, with subdued loan demands, high funding costs, very low interest rates and a stringent regulatory environment. Nevertheless, the actions we have taken to reduce balance sheet risks, non-core assets, costs and impairments, when combined with the delivery of improved management profitability at a Group level and stable core returns, should give you a clear idea of the potential of Lloyds' core bank going forward.

I am, of course, disappointed to report a statutory loss for the period, driven entirely by our decision to increase the PPI provision by a further GBP700m to address this disappointing legacy issue. More on that later.

We have continued to implement our strategic initiatives, building for the future, with an additional GBP600m investment behind the growth initiatives in the first 12 months of the program. And elsewhere we have seen encouraging developments.

Last week we signed high level terms of agreement with the Co-operative Group and the disposal of Verde as you know. And we remain on track to complete this disposal, as required, by the end of November '13.

In June, the substantial progress we are making in delivering our strategy was also reflected in the outcome of the Moody's rating review, which reaffirmed Lloyds' short term P1 rating, while the longer term rating was lowered by only one notch to A2, a good outcome relative to others in the sector, and as good as we had hoped for.

And we have now completed two-thirds of our international divestments, having announced the exit of 10 international locations. Also, the changes we are seeing in external environments endorse that a strategy focused on traditional retail and commercial banking in the UK is the right one for Lloyds.

Our business model is fully aligned with the White Paper's proposed banking reforms. And the recent regulatory authority focus on supporting the UK's economic recovery is most welcome.

So it is clear that the strategy we set out a year ago remains entirely appropriate, even more, given the deterioration in the external environment. And the progress we have made against it means, in my opinion that the Group's prospects are getting stronger in spite of this deterioration.

I will now look in more detail at the key achievements in the first half against the strategy. A cornerstone of the strengthened balance sheet has been the substantial growth of customer deposits we have achieved over the past 18 months. In the first half, we delivered a further increase of 3% and 6% year on year, broadly consistent with the growth rate we achieved in 2011. This solid performance reflected in particular our compelling multi-brands and multi-channel customer proposition.

As a result of the strong deposit growth and the substantial non-core asset reduction, the Group loan to deposit ratio reduced further, to 126%, 28 percentage points down since January last year, with the core loan to deposit ratio down to 103%. As you can see we are well on track to achieve our target of a long-term loan to deposit ratio of 120% by early 2013, approximately two years ahead of target, which will lead to a 100% core loan to deposit ratio.

We also continue to strengthen our balance sheet by reducing the non-core portfolio. And we made strong progress again in the period, in spite of challenging market conditions. We achieved a substantial reduction in non-core assets of GBP23b with GBP11b in Q2 ahead of expectations and again, in a capital accretive way, as we have committed. This included reductions of GBP11b in treasury assets, GBP3b in UK commercial real estate and GBP5b in international assets of which GBP2b was in Ireland. George will give you additional disclosure on our core assets -- non-core assets later on.

We remain confident that we will reduce non-core assets by at least GBP30b this year and to GBP90b by 2013, one year ahead of target. We now expect our non-core assets to reduce further to GBP70b, or less, by the end of 2014, 50% of which will be retail assets. So, non-retail assets being around 5% of total funded assets. As a consequence of this, from 2015 onwards we will cease to report on the non-core business separately.

Moving on to capital. Our core tier 1 capital ratio increased to 11.3% at the end of June, up from just over 10% a year ago. This was mostly driven by our management profits and the reduction in risk-weighted assets, with one-off legacy items offsetting progress which would otherwise been even more significant.

Our Basel 3 fully loaded core tier 1 capital ratio stands at 7.7%, up from 7.1% at the year end. And I expect it to continue to trend towards our core tier 1 ratio throughout a transition period, well ahead of regulatory requirements.

The total capital ratio increased to 16.6% from 15% a year ago, positioning us very well relative to the ICB's recommendations for loss absorbent capital in excess of 17%.

Now turning to the income statement. Our income performance continues to be affected by the subdued economic environment, very low interest rates and higher funding costs. However, the actions we have taken to accelerate our cost management program and reduce impairments meant that we improved Group profitability and returns, and continued to deliver stable returns above our cost of capital in our core business.

Even though we delivered a resilient underlying performance in this first half, we are disappointed that we had to make further provisions in both the first and second quarter for PPI contact and redress, which impacted our statutory results, as a consequence of the current claim experience, which did not decline as quickly as anticipated in quarter one.

Notwithstanding pressures on the top line, we have continued to invest a proportion of the simplification cost savings, around GBP600m so far, to grow our core cost in the businesses through the launch of new products and services. We are continuing to do what we said we would do and a bit more. We have made good progress, but it is clear that some of our businesses need some additional attention to operate more effectively in their particular environments.

However, it is also clear that our initiatives are delivering the sort of returns we want in the next three to five years, in the restructuring journey that we started last year.

Some highlights are, in retail we are investing in new channels for customers, ensuring that our products and services remain convenient and accessible, and thereby increasing usage and engagement. We are pleased with the very strong increase we have seen in our internet banking user base by 650,000, which takes us to over 9m users. We now have 2.5m mobile banking users, accounting for almost 25% of all customer logins onto our banking systems.

In Commercial, we are on track to exceed the SME Charter commitment of GBP12b of gross lending in 2012, while we have now increased our target by a further GBP1b. And we are proud to have supported 64,000 start-up businesses so far this year. And net lending to SMEs is also positive and accelerating, despite a falling market.

Let me move on now to the performance of each of our divisions. In Retail, we have delivered further reductions in costs and in impairments, more than offsetting the fall in income. As a consequence, underlying profit increased by 12%, with return on risk-weighted assets improving to over 3%, well above our cost of capital.

Customer deposits increased by 3% since the year end, significantly above the market as a whole. This success of deposit growth is a result of retail's ongoing commitment to its multi-brand, multi-channel strategy, the investment in our relationship brands, Lloyds, Bank of Scotland and Halifax, and a strong focus on holistic and continuous fine tuning in the pricing of both our loans and our deposits together.

In mortgages, we have continued to supply one out of four loans to first time buyers, having supported 25,000 people in H1 to get their first home. And we have achieved an overall gross lending market share of 18% in the period.

In Wholesale, underlying profit before tax in the first half declined modestly year on year, although we delivered a slight increase in returns. While continued customer deleveraging and higher wholesale funding costs drove a decreasing underlying income, the continued improvement in asset quality drove a substantial decrease in impairments. These returns are still not acceptable. And, we have reviewed the strategy and asset allocation to improve this going forward in the context of the ICB recommendations.

Total costs rose modestly, as cost savings and continuing cost management focus were offset by ongoing investments in core customer facing resource and systems in line with the priorities we set out in the Group strategic review a year ago.

I am looking forward to Andrew Bester leading the next phase of the reshaping of this business as we also advance in our plans to become a ring-fenced bank, ahead of the regulatory deadline and we will let you know more on these plans at the Q3 IMS.

Moving onto commercial. Commercial delivered a strong result with underlying profit before tax increasing by 24%. It has continued to focus on strengthening its customer relationships and on supporting SMEs through the difficult trading conditions by further developing its understanding and support of individual businesses business requirements.

This is demonstrated by, amongst other things, the growth in our net lending to SMEs, with core loans and advances increasing by 4% against a contracting market, as I mentioned. Customer deposits grew by 3% ahead of the market, and reflecting our ongoing success in attracting new SME customers, particularly through current accounts.

In Insurance, we continued to generate strong returns with IRRs on new life pensions and the investment business of over 16%, and the combined operating ratio on our general insurance business of 80%. Sales through the bank insurance channel have nevertheless been impacted by subdued demand for investment products, and by the preparations for the RDR.

In terms of results, core underlying income is down 19% with the changes to economic assumptions and adverse weather accounting for most of this reduction. The remainder has been partly offset by further action on expenses which decreased by 8%. These are decent performances in challenging markets, particularly given the impacts referred to above although, we will have to do better, and get it right in the context of RDR.

As I said before, the retail distribution review will materially change the landscape of bank insurance and wealth from January 2013. And, we will update you at the Q3 AMS on our latest plans.

Wealth, Asset Finance and International profits were stable, with a continued reduction in impairments and expenses, offsetting a decrease in income of 3%. The focused deposit-gathering strategy delivered 29% growth, primarily due to the continued strong in-flows in both the wealth and international deposit businesses, which have strongly supported our overall deposit growth.

Our European online business is expanding quickly, bringing a stable, diversified retail euro deposit base to the Group. And, the international wealth deposits are also progressing strongly, following a more targeted approach in the business, and the perceived safety of the Lloyds brands in the current European turmoil.

Our Asset Finance unit continued to deliver strong profits and returns, and this continued to gain market share in the segments where we already have significant leadership positions.

As I have said before, only by focusing on customers' needs and addressing those needs in a cost effective way can we expect to deliver strong and sustainable benefits to our shareholders. Throughout the Group we have focused on implementing a number of service initiatives to drive improved customer experience. These are already showing significant progress, as Mark will detail later on.

Internally we measure customer satisfaction through the net promoter scores, which indicate the likelihood of customers recommending us to others, and is based on a comprehensive set of over 45,000 customer interviews every month. On this basis, all of our major brands made significant headway in the first six months of the year. There was good improve in the Halifax and the Bank of Scotland, reflecting the investment in their re-launch as stand-alone brands. And also on Lloyds that has the highest scores, and ranks highly among high street brands.

At the channel level we also saw improvements across branch, telephony and the internet. And, as a result, our overall Group wide score has seen significant progress with an 11% increase in the first half. We will continue to build on this strong start to improving our customer advocacy across all brands and all channels.

As part of our Best Bank for Customers strategy we have also committed to reducing banking complaints per 1,000 accounts to 1.3 by the end of 2012, a 40% reduction from 2010. We are making good progress towards to our target, having already achieved 1.4 at the half year. This reduction was driven by initiatives to remove the causes of complaints, for example, by ensuring that our telephone banking teams now have the ability to see details of earmarked transactions on a customer's accounts, which enables our customers to get the right [outcome] faster, as we ensure that complaints are resolved at first touch whenever possible.

These improvements we are making to the customer experience have also been evidenced by the continued significant decline in our FOS overturn rates, where we now have the best outcome of the five major banks. Only one out of four customer complaints going to the Ombudsman is decided in the customer's favor from one out of two 18 months ago, which clearly proves the appropriateness of our customer redress policies.

Retail deposits increased by 3% in H1 and by 5% year on year, once again outperforming market growth. This solid performance across all our brands reflected the compelling customer proposition, Retail has developed, and has again been achieved in a cost effective manner, as you can see from the headline ISA rates in the first half of this year.

This strong evidence of customer preference and trust in Lloyds is a sign of appropriate segmentation and illustrates the value of the core bank we are building, to the benefit of our customers and shareholders; a stronger, simpler and more efficient retail and commercial bank, which will create strong and sustainable returns over time.

This concludes the first part of my presentation. I would now like to pass over to George for more detail on the financial performance in the first half.

Thank you, Antonio, and good morning, everyone. I'm delighted to be here to present the results for the first time. This morning I'll update you on our performance in the first half, and then cover our balance sheet, funding, liquidity and capital positions.

As you heard from Antonio, in the first half we delivered a resilient underlying performance, with improvements in costs and impairments offsetting the expected decrease in income with NNI impacted by the smaller balance sheet and higher funding costs and OOI by subdued demand and adverse economic assumptions and weather in insurance.

Underlying profit for the half year is GBP1.1b for the Group and GBP3b for the core business. Management profit for the Group was GBP1.2b. However, this was after a number of offsetting items.

Volatility of our own debt was a charge of GBP357m as the mark-to-market movement in our ENTNs and ECNs and reflects the improvement in credit spreads towards the end of the half.

Asset and bond sales of GBP585m comprised a loss on asset disposals, associated fair value unwind and gains on bond sales.

Other volatile items of a charge of GBP452m is mostly timing and accounting and economic mismatches as we hedge out the Group's interest rate and FX exposures. Liability management of GBP168m is the gain on our own debt purchases, while the fair value unwind of GBP157m is significantly down on prior year, which included a much higher level of impairments. That brings us to the management profit of GBP1.2b for the Group and GBP2.7b for the core.

Looking now more closely at underlying profit, and starting with income. Underlying income of GBP9.2b is GBP1.9b down on prior year. GBP648m of this movement comes from subdued lending demand and customer deleveraging in the core business, and accelerated non-core asset reduction.

Increased wholesale funding costs contributes a further GBP254m while insurance saw an adverse impact of GBP266m, primarily from the changes to economic assumptions and adverse weather. Non-recurring items of GBP257m mostly comprise recoveries in the prior year.

Looking next to the net interest margin, in the first half of 2012 we delivered a robust margin performance. The core net interest margin was broadly stable at 2.32% with asset repricing offsetting deposit spread pressures. The non-core margin has fallen 25 basis points since year end, largely due to wholesale funding costs, although the impact on the Group is mitigated by the decrease in proportion of non-core.

For the total Group the margin stands at 1.93% for the year to date and 1.91% in the second quarter. For the full year we expect the net interest margin to be in line with existing guidance, of around 1.93%.

Moving on to asset quality, our asset quality ratios continue to show favorable trends with the Group AQR of 1.1% reflecting the improved quality of the core book, an improvement in experience in non-core, and again the decreasing size of that book. And going forward, we remain confident that we can achieve the Group AQR target of 50 to 60 basis points in 2014.

In terms of impairments, the first half charge of GBP3.2b was 42% lower than the first half of 2011, and continues to benefit from our prudent risk appetite and strong management controls while external benefits of low interest rates and stable UK retail property prices are partly offset by subdued UK growth, rise in unemployment and the weak commercial real estate market.

Within the divisions, Retail's total impairment charge decreased by 35% to GBP0.8b with continued reductions in both secured and unsecured portfolios.

In Wholesale the 31% reduction to GBP1b largely reflects a GBP0.3b in improvement in the core book, where we've seen reduced levels of large defaults, and a benefit from the improvement in overall quality through a collective impairment release.

In Wealth, International and Asset Finance the impairment charge fell by 51% to GBP1.3b, with lower charges in the wholesale Irish and Australasian businesses. In Ireland we have seen a significant reduction in the rate of increase in newly impaired loans while in Australia the net wholesale book now stands at GBP6.8b following the recent successful disposals.

This improvement in portfolio quality is consistent with what we are seeing in new to arrears and newly impaired data. In Retail new to arrears in secured is down 14% on last year and in unsecured by 31%. In Wholesale and Commercial we're also seeing a reduction in newly impaired assets. These trends support our confidence in the sustainability of the improvement in impairments. And for the full year we now expect to come inside our previous guidance of an impairment charge of around GBP7.2b.

Looking at the statutory result, here we show the movement from the management profit to the statutory loss after tax of GBP641m. Simplification and Verde costs total GBP513m. Simplification comprised GBP274m of this while Verde costs were GBP239m.

On PPI, as you heard from Antonio, claims continue to run ahead of previous estimates. The additional GBP700m we have provided in Q2 reflects our assessment of the expected total, based on current complaint levels, projected future trends and our own separate analysis. The provision does however remain sensitive to future claim levels.

As described at Q1, the past service pension credit of GBP250m relates to the move to CPI for discretionary pension increases within the Group's main defined benefit schemes.

And finally, the tax charge at the half year of GBP202m includes GBP120m from the lower carrying value of future losses following the reduction in UK corporation tax rate, and a further GBP258m of insurance policyholder tax that has no net impact on the P&L.

Turning to the balance sheet, as you already know, we continue to take action to strengthen the balance sheet, and have made significant progress over the last 18 months. For the first half of 2012 we have kept up the pace. In the last six months we have grown deposits by GBP13b and reduced non-core assets by GBP23b. We've also seen a reduction in core lending of GBP8b, although it was pleasing to see this stabilize in the second quarter.

These movements have helped us drive a GBP37b reduction in wholesale funding and build our liquidity buffer by GBP10b, mainly in the first quarter. These actions have improved the Group's loan to deposit ratio from 135% to 126%, while our primary liquidity portfolio now stands at GBP105b, providing a substantial buffer and giving us optionality.

Looking in more detail at non-core, the non-core portfolio now stands at GBP118b with a decrease in the first half including GBP11b of treasury assets, UK commercial real estate, and GBP5b in international assets. Non-core RWAs stand at GBP93b and are down 14% since year end, and broadly in line with the reduction in non-core assets.

As Antonio has said, we now expect the non-core portfolio to be below GBP70b in 2014. And, with more than 50% of that be in retail assets, we will cease separate reporting of non-core after 2014.

On wholesale funding we continue to reduce our requirements and improve the profile. At the half year, only GBP73b or 34% of wholesale funding had a maturity of less than one year, compared with 45% at December 2011 and 50% a year before that. And less-than-one-year money market funding now accounts for only 21% of total wholesale funding, again, down from 27% at the end of 2011 and 34% in 2010.

On liquidity the Group has built up a strong position and considerably in excess of our ILG requirement. As mentioned our primary liquidity at the half year was GBP105b and this represents approximately 240% of our money market funding and around 140% of all wholesale funding with maturity of less than one year. We also have significant secondary liquidity holdings of GBP110b, which provide access to the open market operations at a number of central banks.

Liquidity requirements is an area of evolving regulatory guidance. However, this level gives the Group significant flexibility, and one of the first examples of which was the successful recent tender for GBP4.6b of senior unsecured funding.

Finally, coming to capital, in the first half our core tier 1 capital ratio increased by 50 basis points to 11.3%, while fully loaded Basel 3 ratio increased from 7.1% to 7.7%. Both measures benefited from management profits and RWA reductions, offset by statutory profit items and other adjustments, including, of course, PPI.

Going forward, we will continue with our strategy to maximize capital generation. While the successful resolution of open items, such as the treatment of insurance, recognition of defaults, CVAs and SMEs could represent significant upside potential to our pro forma numbers.

I am comfortable with our current capital position and outlook, and confident of meeting our guidance to be both prudently excess of transitional requirements and, of course, to comply fully with Basel 3.

That completes my review of the financials. And I would now like to hand over to Mark.

Thank you, George. Good morning, everybody. I'd like to spend a few minutes updating you on progress on costs and the simplification program that I talked about when we were here last in February.

Starting with total costs. We've seen a reduction of 6% compared to the first half of 2011. The key driver in the lower costs has been the simplification program, where run rate savings have now reached GBP512m, up from GBP242m at the end of 2011. Simplification investment costs, GBP274m in the first half.

The savings from the program that we're reporting today are ahead of our original plan, and are completely consistent with the increased target of GBP1.7b of savings in 2014 and an exit run rate of GBP1.9b.

To put some context on these results it's worth looking at the longer term trend. Costs have reduced significantly since the acquisition of HBOS, but the key point is that last five half-years of costs have progressively reduced half year and half year. Firstly, through the integration program and now through simplification, this is after reinvestment in our strategic programs and is a pattern we very much like, and we're working hard to continue.

I'm sure you'll note that typically the second half-year reductions are not as strong as the first. This is largely due to the UK bank levy which accrues in the second half. For example, the levy costs last year were GBP189m.

Moving to the half-on-half comparison, here's some more detail on how the 6% reduction came about. There were final synergies of GBP168m from the integration program and then very material benefits from simplification amounting to GBP298m in the first six months. These savings are partly offset by the GBP135m investment we made in our strategic initiatives such as the ongoing development of our digital capabilities. Then there is an inflationary wage increase of GBP46m, representing about 2.5% increase for the majority of our staff.

The range of other cost movements unusually sums to a net positive variance of GBP22m. Within this there are a number of increases, inflation on non-labor costs, energy prices, higher regulatory costs, but these are more than offset by the impact of one-off items.

Now, for a closer look at how simplification is going. I'm very pleased that within a year of announcing the program we have already achieved more than GBP0.5b of sustainable run rate savings. In fact, we're ahead of where we expected to be at this stage. We've seen a strong flow of early deliverables, whilst the more heavy lifting projects have been mobilized and moved into build.

In 2012 to date we've announced over 4,000 job reductions, bringing the total since the start of the program to over 6,000. And, I'm pleased that we continue to achieve over half of our job reductions through natural attrition, management of vacancies and redeployment.

We remain focused on reducing the supplier base. Over the past 12 months we've moved from over 18,000 suppliers to less than 14,000. You may remember I said a year ago the target was a supplier base of less than 10,000, but that I thought that was still a large number. With the progress we're making now, I'm confident we're going to achieve the target earlier than expected and beat it by the end of 2014.

We continue to make very good progress in flattening the organization, reducing management layers and increasing spans of control. Crucially we've also started to simplify the organization in other ways. We're consolidating our back office operations into 15 scale efficient centers, down from our existing 27 centers. Having worked through all the details of our property plans, we now forecast reducing our non-branch office locations by nearly a half, from 112 to 68.

As you've heard from Antonio, we're also making a difference for our customers. Our account transfer, or switchers process, is the first significant re-engineering of a core process, and is going extremely well, averaging over 2,000 transfers a day since we launched the new process in April. We're seeing areas reduce, colleagues are spending 75% less time on the process, as a result of automation, and the removal of 23 manual process steps, and customer feedback has been extremely positively. Customers like the fact that they typically receive a text message confirming that the transfer process is underway, before they leave the branch.

In February, I mentioned the improvements we were making to the cash ISA process for this year. Through the tax year end we successfully managed significantly for increased volumes, followed by a rate of -- by delivering a range of changes, including auto validation of data entry and enabling customers to reinvest their funds online. By the end of the next tax year I expect the ISA process to be fully automated.

In commercial, we're rolling out a more effective loans process with greater automation and reduced hand-offs. Across the regions where this has gone live we're already seeing a 45% reduction in the time that it takes for customers to draw their loans. Our relationship managers now have more time to spend with their customers. In fact in Birmingham and South London regions, where we have rolled this out first, they are now ranked second and third in terms of volume of new term lending, whereas previously they were 13th and 14th.

In general insurance we have completely redesigned the process for handling home insurance claims. Customers now have a dedicated advisor through the process. We've rolled this out in dealing with the largest type of claim, escape of water, and we're already seeing a 40% reduction in the follow-up calls between ourselves and customers, with settlement times reduced by 30%. Of course, we're rolling this out now across other claims types.

We continue to see a rapid increase in the usage of our internet channel as we improve our digital service. This includes a strong growth in the mobile banking user base. Our latest peak of customer log-ons was 4.2m on the day of April 30. And we're well on the way to seeing more than 1b log-ons to our banking systems during 2012. As Antonio has mentioned, our improved service is reflected in lower levels of complaints across the board, and a strong improving trend in all quality measures.

Finally, this slide shows the trajectory of our cost savings target. The savings are split by the four core work streams that I've described in previous presentations. By using a balance of initiatives we're aiming to deliver a reasonably linear increase towards our target. So far we are one year into a three and a half year program. Approximately 28% of the way through and we've delivered 27% of the benefits. Overall, we're strongly on track with a good line of sight to our benefits delivery for 2013 and 2014 and the program is now well into its stride.

Thank you. I'd now like to hand back to Antonio.

Thank you, Mark. I would now like to sum up the highlights of the first half, our expectations for the rest of the year and our outlook for the medium term.

We have a clear strategy which is being consistently implemented. Overall the first six months represent further good progress on implementing our strategy to strengthen the Group's balance sheets and liquidity position; to reshape the business portfolio to fit our capabilities and its risk appetite, focusing on UK retail and commercial banking; to simplify the Group, improving agility and efficiency, and simultaneously to invest for the future.

We are, as you have seen, on track to meet our 2012 financial guidance despite the subdued economic and the adverse external environments. Simplification is already bringing annual run rate cost savings of over GBP400m as you heard.

We confirm our loan to deposit ratio targets of 120% should be reached in the first quarter of 2013, well ahead of target. We now expect the 2012 impairment charge to be less than previous guidance. And, non-core assets are now targeted to be below GBP70b by the end of 2014, when we will cease separate reporting. We also remain confident that our other medium-term financial targets are achievable over time.

Looking ahead, the operating environment will remain challenging as the outlook for the UK economy remains uncertain and exposed to continued vulnerability in the euro zone. It is clear that corporate and consumer deleveraging will continue to impact demands, and interest rates will remain lower for longer. As I have said many times now, this will be a long and difficult recovery.

Also, the sector as a whole continues to face a number of challenges and uncertainties, some of them arising from past industry behaviors, which have attracted much comment in recent weeks. This will make rebuilding trust even harder for the industry and addressing these issues head on a top priority for management. This is what we intend to do at Lloyds.

As far as the Banking Reform White Paper is concerned, we are already close to loss absorbency requirements. And given that our business model is aligned with a ring fencing goal, we plan to discuss with our regulators the advantages of becoming a ring-fenced bank ahead of regulatory requirements.

And turning to recent policy and regulatory changes aimed at encouraging UK growth, again this supports our chosen operating model and we will therefore play our part in making it happen.

In concluding, I believe we are building a very powerful, yet simple, core bank, totally aligned with our customers' interests and the external environment. We have, unfortunately, to do this at the same time as we deal with legacy issues, accelerate a shrinking of non-core assets that 15 months ago still represented one-third of our funded assets, and execute the EU mandated sales of Verde and other assets.

In this three- to five-year journey, now two to four, we are doing what we said, and a bit more. We are delivering on our operating guidance for 2012 while delivering the balance sheet guidance faster than planned, in spite of the deterioration of the external environments, and, in response to what we perceive to be an increase in the external risks.

Simultaneously, we are relentlessly pursuing the creation of a leading cost efficiency competitive advantage, and a portfolio characterized by a lower risk premium through the cycle, which will differentiate Lloyds from its competitors. These measures will, I believe, create a sustainable return on equity above our cost of equity and, therefore, deliver strong and sustainable returns for you, our shareholders.

Thank you, we will now be happy to take your questions.

Okay. I would very much appreciate if you could say -- start by saying your name and the company you come from.

So, good morning, everyone, it's Chris Manners from Morgan Stanley here. Just two questions if I may. The first one was, you've had six plus quarters of sequential falling net interest margin on a Group basis, and you're guiding that the second half is going to be 193 basis points. And so, the margin should actually start to tick up from here. Would it be possible to run us through what the biggest moving parts are? Is it repricing, funding mix, funding for lending scheme etc?

And the second one was just on the core loan book. Obviously it shrank by GBP8b in the first half, stabilization in the second quarter. How do you see the outlook here? The way that I look at it is that if you've got 7.7% Basel 3 core tier 1 ratio, the financial policy committee is indicating UK banks need to raise capital levels, that capital will still be a constraint on your thinking about growing that core loan book. Thanks.

Yes. Okay, Chris, and good morning. Look, starting by the NIM, as I said at year end results, we expected NIM to go down this year by the same amount as last year. And, I said it should be concentrated on the first half and then flattening out. So, we have exactly the same guidance, both in terms of intensity and shape as we had and as you are seeing.

How do I see things going further? Well, as I have said then, as our core loan to deposit ratio reaches 100% our funding -- our wholesale funding costs will progressively decrease. And, given that we are offsetting the repricing of liabilities with the repricing of the loans, I believe we will see the NIM progressively ticking up. And, in my -- my expectation is this should happen by the end of Q1, so around March. So, you will see a flat NIM approximately through H2, as we had said at the beginning of the year.

And, given that we are now with the ratings outcome of Moody's and also with the different schemes to support growth and we now have excess liquidity, that as we told you we were hoarding because of the Moody's review as an insurance, that was costing us money, that we were expecting not to use, like an insurance. We will now deploy that excess liquidity. The first of which employments was, as George told you, the buyback of senior unsecured bonds by GBP4.6b. And, therefore, all these factors together leave me to expect that our NIM will turn up, tick up by around March next year. Given I'm not an economist maybe I get it right.

On our core loan book, and following what I just told you, I expect -- first I expect the UK economy, as I have told you many times, to continue deleveraging, because we have as a country more credits versus GDP than we should. But, while I expect our mortgage book to continue ticking down a bit, because we want, as I told you before to rebalance our market share from 26.5% in mortgages and 23.5% in savings to 25%, which is our natural market share post Verde. And, which will bring, as I told you, the core loan to deposit ratio to 100%. So I don't expect significant different behavior in the mortgage book over the second half, although I think we will reach what we want by H1 next year.

I do expect SME gross lending -- net lending, to continue to increase. We are now at 4%, up from 3% last year, and given the funding for lending scheme and the good dynamics that we have inside the bank, I think we will continue increasing net lending positively in spite of a falling market of 4%. And, by the way, we have 20% of that market. So it means the market's falling 6% while we are increasing 4%. So it's a 10 percentage points difference, which is very significant.

We now want to do two things. First, we want to increase our mid corps net lending, building on the best practices we've got in SMEs. And I think we will achieve that through the second half of the year. So by year end you should see our mid-corps segment to also turn net positive in terms of lending.

And given the funding for lending scheme, which we welcomed immediately as it came out, and we thought it was the proper thing to do when I told you about the holistic solution of financial stability where we were better in capital supervision and ring-fencing increasing the credibility of recovery and resolution. And therefore liquidity was not, in my opinion -- should not, in my opinion be super-equivalent as well.

We are going to use the funding-for-lending scheme specially to offset the disadvantage that we have in larger corporations where our funding costs, as I told you many times, did not allow us to be competitive, not for credit standards, but because of funding costs. And therefore we expect those efforts to reverse quickly, because you know in larger corporations these things are more -- are quicker. And therefore I think that all these impacts combined, so continued positive SME lending, mid-corps turning positive by December, larger corporations stop shrinking, given the elimination of the cost disadvantage, and mortgages still decreasing until H1 next year, I think again with the risk -- with a risk of not being an economist, I think our core book will start increasing by June next year.

Thank you.

Okay.

(technical difficulty) Just on the FLS, if I can follow up to your comments from the previous question. The Bank of England clearly expects that the UK banks will grow lending to the economy. From what I'm hearing from you, that's probably not going to happen at least until June next year. What kind of pressures would you expect from the regulator if being a large participant you are not able to deliver some stability in your UK lending as an aggregate number? And whether you'd need to react based on what regulatory pressures you may get on the back of that.

And my second question would be on asset quality. You have stated that you expect lower impairments than before. Given the macro political outlook, I would think that's quite a brave guidance. Where -- you must be seeing something in your operations that gives you that confidence. If you could just elaborate on where some of the quarter-on-quarter or half-on-half spends are coming from. Thank you.

Yes. Well, on your first question, I strongly disagree with what you said because the purpose of the Bank of England scheme and the objective overall of the regulators in this shift towards growth is exactly to support two segments; first, small businesses which do not have access to other funding sources, and second, first-time buyers in the mortgage market.

We are keeping a very strong focus on first-time buyers. And although our market share in gross lending in mortgages is 18%, we kept a 25% market share in first-time buyers, whereas I said we are giving one out of four new mortgage loans in the half. So we will continue the first-time buyer efforts. And the reason why our mortgage book is decreasing is because people are repaying their loans, which is up to the customers to decide.

On the small businesses, we are probably the only large bank that is increasing SME on a net basis. And as I just answered to Chris, we are 10% above the market. So that is absolutely in line with what the economy needs. We are the largest bank in this country, and therefore, as I said many times, our future and of the UK economy are inextricably linked.

On mid-corps, irrespective of the funding-for-lending scheme we are going, as I said, to replicate the best practices of SMEs and make it grow on net terms by December. So in terms of pre-scheme and after-scheme, we will continue to contribute to SME net worth. We will turn positive in mid-corps. And the only reason why our core book as a whole will not increase is because customers are repaying their mortgages, which is their wishes.

And large corporations is less relevant to the economy, because as you know, they have multiple funding sources.

So I think we are absolutely in line with authority's objectives. We do not do it because of regulatory pressure. But we do it because we think, number one, it's the right thing for our shareholders. And secondly, it is the right thing for the economy. And again, being the largest bank in this country what is right for the economy is right for Lloyds.

In terms of the asset quality question, which you are absolutely right in asking, I strongly believe, with the caveats I said before about economists, that the number yesterday is incorrect. And the reason is because everything we see in the bank, all trends in NPLs, in all segments, continue to trend better than we expected and falling, as you saw in George's presentation. And I will ask Juan to comment and give you more color in a moment. And therefore I am very confident that the economy will be around flat this year, as I said many times, and will start recovering next year as CPI comes down, given energy prices and some appreciation of the pound, which will increase people's disposable income and will allow them to spend a bit more.

Nevertheless, I think as I always thought, this is going to be a long and difficult recovery as all debts, recessions are -- recovery from debts, recessions are always long. And when I was probably being accused of being too cautious 12 months ago, you are accusing me of being too optimistic. And I am basically saying the same thing. And I think the facts absolutely substantiate what I'm telling you. Also unemployment is lower than people would have thought and is not compatible to yesterday's numbers. So I think we can be a bit more optimistic than the move of yesterday's number.

Juan, can you give some more color on these numbers.

Yes, two comments on Antonio's point. To give you some more color, I think if you look at the different portfolios, all of them are performing much better. So it's not a -- I think a portfolio that is improving. The second thing I would say, I think it's very important in our bank to separate the core from non-core. I would recommend you to look at the numbers separating both portfolios. And you will see that our position has always been that our core book is a good book, and our non-core book is well-provisioned. This is how we see the picture in Lloyds in terms of provisioning.

The encouraging thing is that the core book -- you have seen the new [impaired] trends across the whole bank. And all of them are improving as well, which is a very good indicator, leading indicator what impairments could be in the coming months. And a good thing is that in the core book the level of impairments that we are having in the different portfolios are really good. So look at the quality of this book. And we are very confident that the core book that we are building for Lloyds in the future is a very good one.

Other questions?

Yes, good morning. It's Ian Gordon from Investec. Just one question, please. George, you referenced in your remarks the evolving regulatory guidance as the Bank of England and FSA seek to reverse some of their policy mistakes of the last five years. Specifically in relation to emerging FSA guidance in relation to liquidity buffers, can you help us with some quantification of the latitude this may give you? Obviously the tender offer, which you referenced earlier, gives us an indication of the direction of travel. I'm assuming that some of the benefit is wrapped into your margin guidance. But what we can't yet see from the outside is what level of dispensation the FSA may be giving you.

And I'm sorry, I'm going to frustrate you today by not giving you a precise number. Part of that is because, precisely as you say, this is actually evolving regulation. So there was a meeting this week which didn't shed too much light on what precisely that meant. So I can't give you that precise number.

Obviously we do have flexibility in terms of the balance sheet structure, in terms of how we might deploy it, to support some of our core lending activities. So I won't be precise. But the big message is that that optionality is there through all the hard work and endeavor of the last 18 months, and puts us in a very good position. But sorry, I will not -- and I cannot give you what a precise pound, shilling, pence number that that equates to.

Hi.

Go ahead.

Okay, it's Sandy Chen from Cenkos Securities. I just have one question, and it's going back to impairments, and related to the mortgage book. The -- looking at the UK mortgage book, 40% on a loan-to-value basis is still 80% LTV or above, 23% is still 90% LTV or above. Is -- are your improved impairment assumptions based on a relatively flat set of house prices over the next 12 months? Or are you factoring in, say, the 5% to 10%, 15% house price declines that some economists, as you say, are looking for?

And if that is, is there -- what's going on in terms of that underlying dynamic in terms of the impairment assumptions?

Well, I have my chief economist on the first row, so I cannot comment anything else about economists. But our forecast in the Group is for reasonably flat house prices, which we had -- last year we had forecast minus 2%, which actually happened. This year we forecast reasonably flat house prices which are happening. And therefore we forecast accordingly.

So as you saw, and as Juan mentioned, the non-performing loans are trending downwards. We thought in the beginning of the year they would trend slightly upwards, as I think I said at the time. So they're trending better than we thought. And the house prices are behaving according to flat house prices in spite of some predictions they might fall a lot. I really don't share that view, because I think that in the UK, as long as interest rates are very low, as you know there is no over-supply because of housing permits. And therefore it is reasonable to consider reasonably flat prices. And that's what we consider. We have to provision according to an expected view and not according to an extreme scenario.

Of course we know what would happen in extreme scenarios. And we do not think that that would be as we said sometimes in previous questions in other presentations, very, very significant impact. But what we think is, house prices are going to be flat this year, should continue to be flat for the next foreseeable future, and we have been reasonably good in terms of our chief economist's predications in predicting house prices. So I'm quite confident about that.

You want to add something?

I'll add to the weight on the mortgage book. So in the mortgage book, I think you have to analyze it by vintages. So we -- it's a combination of couple of years or three years of bad vintages. The important thing of the book is that these bad vintages ended in the middle of 2008. So they have been on our books for four years now. And our expectation is that they are seasoning. So at some point -- the rest of the vintages are a very good quality. And you know that the average life of a mortgage for seasoning is four, five years. So what we should expect, if the rest of the conditions remain stable, that we should start to see an improvement in the portfolio. Thank you.

Okay? Please.

Hi, it's Cormac Leech here from Liberum Capital. I'm not sure if this is on. I just had two questions. One on the NIM. I think you guided that from first quarter of next year, maybe we see the NIM for the Group start to tick up slightly. Just wondered, are you making any assumptions about Bank of England base rate changes in that forecast? In other words, if we, for example, saw a 25 basis point cut in the Bank of England base rate, would that change the guidance for the Group?

And I just had a question on other operating income.

I am assuming flat interest rates for the rest of our three-year plan, which is the reason why we said in November last year that our guidance in terms of income-orientated target would be delayed beyond '14, but achievable over time, because 12 months ago, the structure of the yield curve was positive, as you know. Market was expecting interest rates to start increasing, six months ago. Now we are assuming interest rates get 0.05% for -- throughout '14. And it is on that basis that I gave you my assumptions.

So of course, if there was a cut in interest rates, there would be an impact on NIM.

Okay. And then, sorry, could I just ask one follow-on, just to invite you to possibly provide a little bit more transparency on how much of your mortgage book is available to reprice over the next couple of years? Because I'm conscious of the old legacy Lloyds TSB book. I'm not sure if you're willing to comment on that or not.

We have never commented on that, to be honest. I don't know those numbers by heart. There is a proportion of the book that we can't reprice, on an individual basis, as you know, and another one that we can, like we did in the Halifax book in May. And the -- we can do that in that part of the book if we want going forward. But what I just told you does not take into consideration any unilateral repricement in the same way that when I said that NIM guidance for this year was in like -- in line with previous year. We had, as I said at the time, incorporated the repricing of May in the estimate.

So this new estimate has interest rates flat throughout '14, number one. Number two, no unilateral increase in mortgage prices included.

Great, and then just briefly. On other operating income, if I'm modeling that forward, is it fair to assume that it should track average interest-earning assets? Or would you expect the growth in other operating income to be higher or lower than average interest-earning assets going forward?

That's a good question as well. As we said in the strategy review, we expect OOI to trend towards 50% of total income. So it should grow over time, as it is slightly growing. This quarter, second quarter, was not good because the markets were very, very bad. And although we have very little exposure to markets obviously, our corporate clients were more standing still, as you know, given what happened.

And on the other hand, also given the markets, all our investment products through the insurance business and into affluence and private customers were not sold, given they prefer deposits where we are performing above expectations and go through NII instead of investment products.

I expect this percentage to increase over time, as I said at the strategy review. And all the investments we are doing on the growth initiatives are mainly orientated exactly at OOI initiatives, because we have substantial segments and products in the market which are OOI driven, where we have subscale market shares, for example, in FX products to our medium-sized corporations or SMEs. As I said last year, interest rates, money markets, in terms of retail, we are subscale in terms of asset management, and the affluent in the private space. So most of the 20 growth initiatives where we have already invested, as I said, GBP600m, are mostly orientated at generating OOI. And therefore the percentage should increase towards 50% over time.

Okay, thanks.

Mike, please. Do you want to give the microphone here to Michael as well?

I've got it, can I keep it?

I have.

It's Tom Rayner at Exane.

Yes, Tom?

You don't want Mr. Helsby asking you questions. Could I just --

It's called first mover advantage.

Sorry, Mike. Just a couple of follow-ups on what you've just said, actually. The insurance revenue did look a little bit weak in the first half. Sales margins and returns on policy-holder funds all seemed to contribute. I'm just wondering if the retail distribution review can make a big enough difference to offset this fairly difficult environment. And I've just for a second follow-up question on the margin, if that's okay.

Tom, that first question, George is going to give you more color on it.

Okay. Well, on insurance, as I think we said in the presentation, there are a number of factors that impacted the results. First, it was obviously just the economic assumptions. So the lowering of the assumptions at the start of the year basically means that the value of in force is going to unwind at a lower rate. And that accounted for about GBP100m of the movement in insurance result from first half last year to first half this year.

And obviously we had the God-awful weather over the summer, which again I think was a GBP50m, GBP60m swing factor in terms of half-year on half-year.

Then in sales of products, yes, going back to part of the earlier comment, it's been a difficult quarter for sales of particular products. Although there's things like the retail branch prepares for RDR. What we have seen compensating that, though, again I think as we said in the presentation and the release, we've seen very strong sales through the IFA market of corporate pensions, where we very much lead the market. Corp pensions hit our required returns, they make our required returns. But they are at the lower end. And when you see that slight drop in the EV from new business it's just the increasing proportion of corporate pensions that's pulled that slightly back from the equivalent number last year.

And you had a question on margin growth?

Yes, just could you comment on everything you've said about the margin, how material the issue of structural and product hedging is to the current margin and the sort of guidance that you're offering us.

Right, well, we don't comment on our hedging in detail. But as we said before, we have some hedges. What we are doing, and I'll tell you what that direction so you understand our reasoning.

As a bank we are basically a hedged bank, i.e. we are a retail commercial bank. We have a basic ALCO position which is basically hedged. And we may open small positions according to what's happening in the markets.

So relating to your question on the hedge, what we are seeing is that given the very low interest rate levels in the long ends on gilts, we have growingly thought and decided among ourselves that it makes less and less sense to have hedges connected to the gilts portfolio, given that it doesn't make a lot of sense to put our capital into sub-CPI gilts for 10 years.

And so we have progressively stopped additional hedging. And then we have sold some of the gilts on those hedges, as you saw, or when George explained the volatile items, because we think that as interest rates trend lower and lower, it makes sense for us at minimal accrual costs to increase the duration of our liabilities. So that's as far as I'm going to go on this one.

Michael. Thank you.

Thanks, this is Michael Helsby from Merrill Lynch. Just two questions. Firstly, at the Strategy Day you talked about Verde having a GBP500m PBT contribution. Clearly it didn't turn out that way. So I was wondering if you'd give us a best guess on what the PBT will be transferring over? Because I think most of us have got GBP500m to GBP600m still in the models.

That's a very good point. Well, what can I say on Verde? I'll ask George then to add some color.

It is true that we had absolutely forecast that. But that was in line with the big balance sheet. And there was the option, at the request of the buyers, we discussed many times, to go to a lower balance sheet. And the final outcome we reach with the Co-Op, at their request, was for an even lower balance sheet. And therefore the impact on results of the sale is much lower in terms of the net income we forgo than originally forecast.

You want to add some follow-on?

Yes, just to add to what Antonio said. Yes, we've looked at this in a variety of ways, and it's a bit of a -- which assumptions you plug in and the timing. But to endorse what you said. We said we don't expect it to have a -- the disposal to have a material impact on the BAU trends, PB -- the PBT level within our business, okay?

And as you can expect, given it is not a good moment to sell assets, is as we said all along. And we had to do this. We'd like these assets, as we said. But it was a mandated [new] sale given the rescue of HBoS. This was clearly the best proposal the Lloyds' Board was faced with. And given it was a sale below book value, our strategy was, as you just said, to minimize what we were selling, and therefore to have as least capital as possible and results included on the sale, which is what we basically did. And I think that apart from being the best offer the Lloyds' Board was faced with, it is clearly the best owner for our customers and for our employees.

Okay. And just separately, your funding position is beginning to evolve now quite rapidly, clearly to your benefit. But it does mean that the mix between short-term and long-term has now started to change quite rapidly as well.

Yes.

You've always talked in the past about 50/50. It doesn't feel like that (multiple speakers) --

I never talked about 50/50.

Maybe -- okay. So maybe George predecessor talked about 50/50.

Like I never talked about big NIMs.

Okay. My NIM's bigger than yours. It's -- yes, no, sorry, I couldn't help that. Yes -- no, so I just wandered, give us an update on how you see, George, the funding position evolving now you're in charge of the ship.

Well, I'm not going to give you any categoric percentages. One of the discussions that we've had internally a lot is in terms of things like the short-term wholesale, what is the right number. How far, how low do you need -- how low can you go in terms of keeping access to markets open, in thinking of the world ahead where you're going to have entities that in the years to come are going to sit outside of things, like ring-fenced bank and are going to need to leave their own access to markets. So I won't be precise, because it will depend upon the pricing at the time. But as the FD, I sure as hell like the percentage of the more than one year going up.

Michael, thank you.

I think it's very important, relating to your question, to really understand. And now I can speak about it, because we have had a very favorable ratings outcome, and the progress is done, as you said. So this is the type of things you can only speak when you have solved the problem, not before you've solved the problem.

When you have 18 months ago GBP300b of wholesale funding out of which GBP150b short-term, I really think, as I said at the time, that was not the proper balance. And imagine what would have happened should the ratings review have been done. Now we have GBP73b of short-term funding, so less than half, a year and a half ago, and less than half means more than GBP75b, those cost LIBOR, now they cost us at least 200 basis points. So it means GBP1.5b less in NII.

But that was not a free lunch. That was something, in my opinion, that should have never been there in the first place, because we were basically funding a mortgage portfolio with a five-year duration, with short-term wholesale funding.

Thank you.

Hi, it's Rohith Chandra-Rajan from Barclays. A couple if I can, please. One on the wholesale bank. On your numbers pre-tax return on risk-weighted is about half at wholesale as it is at retail. And if we look I guess at the pre-provision level, it's more like a third. And it consumes more capital. And all of those metrics I guess get worse under Basel 3. I appreciate you're going to give us more detail at Q3, but I was just wondering if you could give us some early hints as towards your thinking in terms of the scale and the focus for that business going forward?

And then I have a second one on non-core.

Okay. It's very easy. As I said in my speech, either the income will go up, or the capital will go down, to the division. And I think it will be a combination of the two. So we have to absolutely increase the returns. The strategy last year was absolutely correct in the sense let's maximize the share of wallet of customer instead of being a wholesale bank just focus on lending.

We have been doing good progress on those items, as you can see from the market shares in sterling capital markets issues, in terms of the Arena platform, number of customers, money market transactions. But still the environment was (inaudible), number one. Secondly, the ICB is very clear. And if further returns, as you say, are not acceptable, as I said. And they will have to increase either through increasing income or decreasing capital allocated to the division. And I think it will be a combination of the two. And we'll give you more detail at Q3 IMS.

And any indication just in terms of the scale of the capital reduction?

We'll give you more details in the Q3 IMS.

Okay. It was worth --

Your second question is -- ?

Yes, sure. No, very briefly, non-core -- so less than GBP70b by the end of 2014, at which you'll drop reporting. Just wondering -- wanted to clarify whether that's a very straightforwardly you're reporting and you'll continue to look to reduce those assets? Or whether what's left you would consider core, or it takes just a long time to work them out?

No, I think that's a very fair point. Basically what we think is the following. So in '14, instead of GBP90b we will get to GBP70b. And I know there is -- I hope a decreasing concern that we have time bombs left in what we don't sell, because we consider to sell ahead of target in a capital-accretive way and across the board. But the only thing we can do to increase your degree of confidence is continuing to sell, which we'll continue to do, so it's a matter of time.

But relating to the center of your question. When we reach GBP70b in '14, half will be the retail assets, like the self-certified mortgages in the UK and the retail mortgages in Ireland, which as you know we cannot sell in terms of they are in SVR, it's the option of the client. They are quite sticky. And the UK ones perform well. It's just a closed book, because we don't do self-certified any more. And the Irish ones do not perform well, and therefore we are provisioning them much quicker than others where we have already, as you know, declared impaired assets above the 90 days over. We have 22% impaired ratio, which is more than the 90 days over ratio. And we have covered those at the 72% coverage level.

So the ones that are not good we are covering, provisioning as much as possible as quickly as possible. The self-certified book, which is most of it, it's GBP29b as you know, it's a good book, but it is not core. So by '14, those GBP35b of assets will come into the core book and we will run them off. And you can very well extrapolate the behavior because they are known, they are retail, they are sticky, they are predictable.

The other GBP35b or less non-retail, non-core assets, we will cease reporting because given they will be less than 5% of our funded assets, they will become in our view non-material, and therefore we will bring them back and report as a single bank. But, as you correctly ask, we will continue to run them down to zero.

(technical difficulty) it's Raul Sinha from JP Morgan. If I can just ask about PPI, would you be able to clarify some of your assumptions behind the GBP700m provisioning? And the reason I ask is from the outside, it appears that if you take the FSA data, for example, which was about GBP730m for the industry in May, if you analyze that, if you take that for the quarter even, that means GBP2b plus for the industry, and with 50% market share for -- between Lloyds and HBoS, that means GBP1b a quarter for the Group as an ongoing run rate. And then when I look at the remaining charge on your balance sheet, it looks like you've probably got GBP1.3b left.

So would you probably -- quantify what assumptions you've put behind the provisioning? Do you expect claim rates to tick down from here? Or have you assumed it to stay at the same levels?

Okay, I think the Company's approach to PPI provision has been entirely the right one, going back to the early mover and the original GBP3.2 and then at Q1 going for the [375], which basically costed what we'd seen as a -- the Company had seen as a spike in PPI claims at that particular time. And that was costed based on an assumption that it would revert back to previous assessments in terms of claims levels.

As you know, what's actually happened since is that claims actually stayed at a higher level. We have in the last few weeks seen a decline, a slight decline, in those claims numbers coming through, which is cause for encouragement without getting carried away with it.

The GBP700m that we've provided this time has been based upon both an assessment obviously of claims that we're receiving, but studies into populations in terms of ones we've received from, expectations from future mailings, etc., and the propensity of those peoples to complain. So we have applied as much high science as one can to this particular number.

Yes, the run rate remains significant. I think we've got about GBP4.3b, as you say, as the aggregate provision, I think we talk about GBP2.9b in terms of spend to date within the RNS. So you can work out run rates, etc.

I'm not going to give you the precise components of how it's built up, because it doesn't mean anything. We have based our assessment on what we think the cost will be. And we've done it in the most appropriate way that we can. That all said, future claims levels are uncertain. And much as I would love to tell you that that is it, and there's a line under that, there is still uncertainty.

Thanks very much. And just a quick follow-up on the capital treatment of the sub-debt that you would be underwriting for the Co-Op Group. Whenever that comes in, would you -- you obviously don't know the amount? Would that -- should we assume that to be deduction against capital?

May have to get back to you. It's not going to be a material amount, but I can get back to you on the treatment of that.

Thanks.

Yes? Can you give the microphone there as well?

Who has the -- ? Manus. Yes, please?

Hi. Thank you, it's Manus Costello from Autonomous. You talked a lot about the improvements in impairment trends. But if I look in core, Q2 versus Q1, there was quite a big step-up in fact in impairment in Q2. I wonder if you could give us an indication of which divisions drove that step up quarter on quarter? And I have a follow-on on that, please.

Yes. Juan can give you color on that. Just to introduce the point, we have said specifically in Q1 that the dip in the AQR of the core book 2.35 or 2.36 was [too small] and normal. So we are basically recovering the trend. But the overall number, as Juan said, is very positive, is below our guidance for the future, 50 to 60 basis points, but Juan will tell you exactly what happened and when.

There is some seasonality in some of our portfolios between -- so the Q1 is normally the strange quarter. So you close the accounts in the previous quarter, and there's normally happens many things and so some of the variances between the Q1 and Q2 are due to this different treatment between quarters. It is not a change in trend. As you can see it from the different quarters' information that we have provided you.

Indeed. So just to follow on from that, on the basis therefore that Q2 is normalized in terms of your pre-tax return on risk-weighted assets, that means we see a continual decline in the return on risk-weighted assets in the core bank. And I wondered -- this looks like it's the lowest return for the last seven quarters at least. I wondered if you could give us an indication of when you would improve core return on risk-weighted assets if 1Q was just an aberration.

Well, I thought I had already answered that question, but I will tell you again. So if costs are going to continue to go down, impairments, all trends are in direction of going down. And our NIM is going to improve by margin the volumes by June. I think you have all the ingredients you need. Right?

Robert?

Thanks. Robert Moore, Nomura. I've got two questions, please. Firstly on the ICB issue. I'm interested that you're looking at accelerating creating a ring-fenced bank. Could you give us some idea of what you think as a result of this, the cost to the org will be of the ring-fencing?

Well, what I said exactly -- and I think that's a very fair point, by the way. But what I said exactly is the following. We do not have the strategic question to answer, like most of our peers. We said last year we are going to be a UK-centered retail and commercial bank, with our wholesale bank focused on creating value around the retail and the commercial bank. So we do not have a strategic existential question. And therefore we are able, as we have already 90% of our assets inside the ring-fence; we are able to move very quickly into being a ring-fenced bank.

As I said in my speech, therefore we think the uncertainty for investors and for customers may be advantageous for us in going to a ring-fenced bank sooner. But if it is advantageous to us, because as you say correctly, there are costs in terms of setting up the ring-fenced bank, those costs for us are not very high. If in the discussions with the regulators, we see it is favorable for our shareholders and customers to move ahead, we will. And we think it will be, and therefore it is likely that we will be a ring-fenced bank well ahead of regulatory requirements. As we evolve in our discussions with the regulator that we are now going to start, we will report you more on that straight off.

But I think strategically it is very clear where we are going. And I think that should take away a lot of uncertainty in terms of direction of this bank for the future, which I think we are the only one that can really do that.

If I paraphrase that, does that imply you think the bulk of your costs would be one-off in nature? And any ongoing costs thereafter would be pretty immaterial to the Group? Is that a fair statement?

Excuse me, I didn't understand?

The bulk of your costs would be one-off in nature --

Yes.

-- and ongoing costs would be immaterial?

That is absolutely correct. That's exactly what is behind this thinking.

All right. The second area is in terms of the non-core business. Now that you're planning to discontinue reporting it for 2015, could you give us some idea of what the financial performance is at the moment of the assets that you will be retaining, so we can get some idea of where we think your underlying sustainable --

Okay. Well, that is a very fair point as well, Robert. But we are not seeing it that way, i.e. we will retain the GBP35b of retail assets which you can -- it is -- the disclosure we are now giving is much bigger than before. So you can assess the behavior of the UK self-certified book, and of the Irish retail mortgages. You have that information. The other, at most, GBP35b, which we will then bring back into the core book, we are going to do that because it becomes immaterial. But it is not because it will be ramp full of problems. As I said many times, we are selling the non-core assets across the board, based on risk concerns. And we will continue to do so, and in a capital-accretive way.

We have on the table every 15 days at maximum level in the bank all the non-core assets, all in process of being sold, and as markets evolve, as buyers come up, as prices change, we are going to sell them all. So our estimate at the moment is that instead of GBP90b by '14, we will have only GBP70b. Given that the retail ones are stable and sticky, we will bring them in the bank, and you can model them. And the other GBP35b at most we will bring in the core bank, but we'll continue to exit. They will not be there forever.

And I cannot tell you at this moment, because I don't know exactly which ones they will be, because we have everything on the table that we can sell. It may happen that we get to '14, and instead of GBP70b we have less because we said GBP70b or less. So let's discuss that as we go. I think the main take here is instead of GBP90b we are going to go to GBP70b. Second, it will become immaterial because it's 5% of non-retail, non-core. So we don't think it is worth reporting separately.

And third, we are doing this in a capital-accretive way, and by the way, in a very different -- difficult quarter. Because quarter two was very difficult. And we sold, for example, our main exposure in Australia, which was terrible. And it was sold and everything together was again sold in a capital-accretive way.

Difficult to have so -- such bad portfolio in Australia. That's why you're laughing, I guess. Such a good country, such a bad portfolio. Things happen.

Hi, there. It's Claire Kane from RBC. Can I follow up on your other operating income trends, please? In the core business I believe in Q2 it's down 4% quarter on quarter 15% year on year, and you did mention that there's more of a push towards deposits rather than savings products.

It was not a push, a client preference.

Client preference. Can you then --

We don't push things.

Can you then maybe give us an indication of the marginal cost of these deposits, if you're seeing these come down?

Yes.

And also how that ties up with your aim to get the 25% market share?

Yes. The marginal cost of deposits has been around for us 200 basis points. We measure, as I told you many times -- sorry, not to you, but in these presentations -- we absolutely measure the cost of deposits versus wholesale funding. And the reason why we have been growing deposits at twice the market rate is twofold.

Firstly, because the customers have been having a natural preference for the products we have given to them, for example, in the ISA season with the same value as of the request of the customer, which was very important, given the queues that happened last year, for example, or in October last year, when we set out for the first time a drawing lottery process in Halifax, which we now have close to 1m customers enrolled.

So first is the customer's preference. But second, we are only growing the deposits, as I said many times, as long as the marginal cost of deposits, as you ask, was lower than our marginal wholesale funding cost. And given that the wholesale funding cost was much more expensive, we have continued to increase deposits and those marginal deposits were probably around 200, 200-and-something basis points.

Given that now our rating has relatively improved, and that we have additional schemes, as we have discussed previously, it is likely that on the margin we skew our portfolio a little bit less towards deposits and a bit more towards lending given the funding-for-lending scheme. But overall this is a marginal thing. And the main take you can -- I think you should take is customers given the financial market's conditions in the first half, have preferred deposits to investment products, that has an impact in OOI and benefits NII, because our wholesale funding costs were higher.

So we just accepted what the clients want. And as times move, depending on customers' preference, probably they will go back to OOI, which we also think will be enhanced by the fact that the retail distribution review is putting the market a bit on hold because there is uncertainty. And therefore when it is implemented in January '13, you should see a more natural behavior, depending on the clients' response to the distribution review.

More questions?

Peter Toeman from HSBC.

Yes?

I want to come on to your statement about dividend. Are you signaling here that FSA or other regulators might preclude you from making a dividend payment until your Basel 3 fully loaded number gets to, say, 10%? Or is there some other thinking here?

No, and I haven't yet commented the difference. It was difficult to have hint of anything.

No, what I said in Q1 was, I told you in Q1 that when we knew the white paper content in terms of the SEB, and the draft Basel 3 paper on CR deferrals, we would give you what we thought was the likely path to dividends. We now have the white paper of the SEB, which does not present any significant differences to what we thought. But unfortunately, as you know, the CRD consultation paper was delayed to September. So we think we'll only be able to give you that path in quarter three, at the Q3 IMS.

In any case, as I said in Q1 IMS, we are following a capital maximization strategy which is based on lower non-core in a capital-accretive way, and lower costs and lower impairments on the core book. So whatever will be the content of the CRD4 paper, we would not change our strategic direction, because we are maximizing capital as much as we can, and despite of the one-off hits that we have, we have been generating between 20 and 30 basis points of core Tier 1 capital per quarter.

In January '11 this bank was at 10.2%. Now it's 11.3%. So we're 110 basis points higher, with a PPI hit of GBP4.3b, you see? So we are maximizing capital generation. We think the core book is very powerful, as we told you. Key leading retail brands, leaders in their markets, totally segmented, we are achieving a leading position in costs where we will achieve a key competitive advantage, which, as I said, and now for many years, is what retail in the UK should do.

UK retail banks have never been very focused on costs, specially now in a low interest rate environment, in a high regulatory cost environment, and difficult economic circumstances, I think costs are even more key. As we get to a cost leadership position we will growingly be offering our customers more value for money. And as we offer them more value for money, those segments I mentioned before where we are subscale, we'll increase, as they bank more with us, especially in OOI. And this will become a virtuous circle whereby we will then in the future have flat costs and start increasing.

So I think we are absolutely in the right strategy. And the only reason why I don't tell you more about the path is because we do not know the content of the CRD 4 paper. But the capital maximization part of the strategy is absolutely clear.

More questions? No? Well, if we don't have more questions, thanks for the very lively debate. Thank you very much for coming in spite of the Torch relay, and speak to you soon. Thank you.