Banco Santander SA (SAN) 2004 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to our interim results presentation.

Before I hand over to Richard and David, I should like to highlight the main numbers and make a few other comments.

We are on track to achieve our primary target of delivering double digit growth in earnings per share and we will increase our interim dividend by 10% to 15.7 pence per share.

Four years ago, we embarked upon our strategy. And rather than trying to preserve the outdated business models of the past, we developed an innovative one, which is designed to meet the needs of customers, now and into the future. We characterize this business model as the bank with the High Street presence. And we have delivered significant improvements in many ways, with stronger franchise performance in our core 4 retail products and in our wholesale banking business.

We have also focused on strengthening our management team and our Board in recent years, and last month, we continued that process with the appointment of a new non-executive director, Margaret Salmon.

Once again, several of our Board members are here this morning and are available to speak to you after the presentation if you wish.

Looking forward, Alliance & Leicester will deliver further long-term shareholder value from our innovative business model and toward the end of this year we will announce our target to deliver that value.

Turning to the economic background, there are now tentative signs that the housing market is cooling, albeit somewhat later than we originally expected. But as you know, we have been cautious on the UK housing market for a number of years. And as a responsible lender, our conservative credit stance means that we are well positioned. In addition to our conservative choice of market and loan to value segments, a key component of our underwriting process means that the lending we do is affordable to borrowers, even if rates rise.

So we are doing well, as you will now hear from Richard and David, who will take you through the results in detail. Richard?

Thank you John. Good morning everyone.

In the first half, Alliance & Leicester has delivered another good set of results. Total pre-tax profit was up 22% to £320m. Operating profit, excluding the proceeds from the sale of our merchant acquiring business, rose by 2% to £268m, after charging all the £10m of one-off branch closure costs in the first half. We have seen good franchise growth in each of our core markets, and our asset quality remains very strong.

We have continued the implementation of our direct bank with a High Street presence business model, with the launch of new internet-based savings and current account products, as well as completing a review of our branch network, which resulted in the announcement in June of our decision to close 46 branches.

We are on track to achieve our full year primary strategic objective of double digit growth in basic underlying earnings per share, as well as each of our supporting targets of accelerating revenue growth, cost management and improving capital efficiency. And although not an explicit target, it is pleasing that in the first half, we delivered a return on equity of over 22%.

Our revenue target is the hardest of our supporting objectives to hit, with revenue growth in the first half of the year having been significantly impacted by the new business strain, associated with very strong mortgage lending in the past twelve months. And we will talk later about the actions we have taken to mitigate this.

All our core 4 retail banking products performed well. Our mortgage lending continued to build on the momentum seen in the second half of last year, and our estimated net lending market share in the first half exceeds our share of outstanding balances. Unsecured personal loans have seen a further increase in new lending, and asset quality remains very strong.

Current account openings have risen significantly in the first half of the year. Personal customer deposit balances have increased slightly and we anticipate further increases in the second half, arising from our recent product launches.

So, looking at the performance of each of the core 4 products in detail, and starting with mortgages. Our mortgage business has had an excellent six months, with gross lending increasing by 74% to £5.5b, with net lending of £2.5b. Both our gross and net market shares of 3.8% and 4.5% are higher than our 3.5% share of mortgage balances. Redemptions were also pleasing, with a market share of 3.3%.

The growth in lending is a result of both a competitive product portfolio, and improvements in the efficiency of our processing operations. We continue to avoid lending in the buy to let sub-prime and income non-verified sectors of the market, and we continue to take a responsible approach to lending in the high loan to value segments. Just 3% of new loans in the first half had an LTV of over 90%.

Throughout the first half, the lifetime profitability of each new mortgage product portfolio that we have introduced has been higher than the last. However, the upfront cost of our strong mortgage lending had a significant impact on the net interest margin. As I said earlier, we have taken steps to mitigate this effect for the second half of the year.

In May, we launched a new product range, which offers customers a choice of products with or without up-front fees and with differing early repayment fees. And these products are expected to reduce the up-front cost of new lending and benefit the margin in the second half, and David will talk more about this in detail later.

You may also have seen that we increased our standard variable mortgage rate by 30 basis points at the last base rate increase, reflecting the fact that wholesale funding costs have increased more than simple rise in base rate. Several other lenders have also adopted a similar approach over the past two base rate changes.

Some commentators have stated a wide range of estimates as to the proportion of our mortgage balances paying standard variable rate, and we wish to correct some of the erroneous estimates. At the end of June, the proportion of our mortgage balances, paying the full standard variable rate, was 20%. Lower than the industry average of 21% quoted in the Miles report.

Asset quality in our mortgage business remains excellent, with the increase in the reported loss charge being solely a result of changes in our internal insurance arrangements.

We expect house price increases to slow, but we do not believe there will be a general price crash, although some hot-spots might fall. Unemployment remains low, there continues to be a shortfall of housing supply and construction levels are not yet increasing to fill the gap. Thus a period of price stagnation could be the outcome. Our credit policies have always been conservative and we do not require house price inflation to justify our lending decisions.

Our unsecured personal loans business has performed strongly, with gross advances up 20% to £1.3b and balances increasing to £2.9b. There has been no relaxation in our lending criteria and asset quality remains very strong.

The personal loans market has remained very competitive in the first half, with price changes by competitors lagging increases in swap rates. In May and June, we were offering the most competitive personal loans in the market. This drove strong business volumes and with the highest credit quality of applications received this year.

Over 50% of our new loans are now to existing group customers and 74% of the remainder are for home owners. The average new personal loan is around £8,500, with the largest individual reason for borrowing being a car purchase. The proportion of loans over 30 days in arrears fell again from 4.4% at the end of 2003, to 4% at the end of June.

Over the past three years we have turned our unsecured loans business around and we believe it is the largest direct vendor of loans in the UK. The business has developed increasingly sophisticated channel, customer and risk-based pricing strategies, together with enhanced credit assessment techniques.

Following the sale of our credit card business, our overall exposure to unsecured personal lending is lower than it was in mid 2002 and the proportion of our lending to retail customers, which is unsecured, has fallen from around 12% in mid 2002, to less than 10% at the end of June 2004. And this is much lower than the 18% of total UK household debt, which is unsecured.

Moving on to current accounts. Sales of new current accounts have seen strong growth in the first half, with 120,000 new accounts opened. The majority of these are premier accounts. These are typically more valuable customers for the group. We have doubled the average product holding compared to our average retail banking customer. And these are also customers who regularly fund the account and would consider Alliance & Leicester now as their main banking relationship.

We now have a valuable current account base of 2m accounts. We expect further growth in the second half, following the recent launch of our market leading premier plus product, targeted at the internet customer, and there it is there.

And in the last of the core 4 product savings, whilst our personal customer deposit balances have only increased slightly to over £18.9b, we are planning for further growth in balances in the second half, following the recent launch of our online saver account. This savings account is opened and serviced by the internet and fills a gap in our range. Customers are now able to apply for all of our core 4 products online.

We have also seen good results in sales of each of our partner 4 products, of credit cards, life assurance, long-term investments and general insurance. Our partnerships with Legal & General, MBNA and Zurich are all working well. We sold over 94,000 new credit cards in the first half. Slightly higher than the number sold in the first half of 2003, which itself was 50% higher than the same period in 2002.

Sales through the higher revenue producing branch channel have seen significant growth, increasing by over 30% on the first half of last year. Sales of long-term investment products have increased, with a value of new investments 11% higher than in the same period of 2003, whilst life assurance sales are level. General insurance sales in the first six months of the year have benefited from the significant growth in new mortgage lending, with new policy sales increasing by a third.

In our wholesale banking business, we have made good progress in implementing our more focused strategy. We sold our non-core merchant acquisition business to Nova in April, for a pre-tax profit of £52m. We continue to grow cash sales to financial institutions and these increased by 21%, to over £23b. Our partnership with Securicor is working well and is a key factor in our ability to win new cash sales business.

Cash handling deposits totaled £29b in the first half, slightly lower than in the same period last year, but this reflects our revised strategy, with cash sales now being the main driver of this part of the business, not cash deposits.

Looking at commercial lending, our balances continue to increase and now total £4.3b. Asset quality remains good, with a proportion of non-performing loans reducing from 0.68% to 0.49%. And the loss charge in commercial lending has fallen from £5m to £3m.

Business banking had a good start to 2004, with new current account openings increasing by over 70%. We won the Business Money Facts award for the best business current account for the second year in succession. The initial results from the pilot of our new customer proposition in the central region of England are encouraging, with business banking account openings in the regions ahead of expectations and with improved sales conversion rates. The pilot is providing valuable lessons for the future of our operations.

Finally, Treasury profits were broadly similar to the same period in 2003. There has been a narrowing of margin on Treasury assets, which has resulted in Treasury's income remaining flat, compared to the same period in 2003. We are, however, determined not to reduce credit quality in this business so we will not chase margin by moving down the credit spectrum.

So, we've had a good start to 2004, with strong growth in our franchise. We are also on track to achieve our full year strategic targets. We need the international accounting standards to be finalized before we can complete the production of our corporate targets, which will take the Group through 2005 and beyond. The main outstanding issue is, of course, the complete muddle around IAS39, so we will announce these targets during quarter four of this year.

We have clear long-term strategies in place across the group, aligned with the changing requirement of our customers. And we are clear on how this will deliver long-term shareholder value and franchise growth, and I will talk more about this point later. But firstly, I would like to hand you over to David for more details on the numbers.

Thank you Richard. Good morning.

Alliance & Leicester have made a good start to 2004. The Group's total profit before tax was £320m, a 22% increase on 2003. This total profit figure includes £52m profit from the sale of our merchant acquiring business in April, which has been accounted for as a non-operating, FRS3 exceptional item.

Operating profit before tax increased by 2% to £268m. This excludes the benefit from the merchant acquiring sale, but includes £10m of one-off branch rationalization costs, which have been accounted for as an operating FRS3 exceptional item.

Underlying basic EPS was up 7% to 42 pence. This includes the £10m of branch rationalization costs, which will not recur in the second half of the year. If these were excluded, then basic earnings per share would have increased by 12%.

We are on track to achieve our full year primary strategic target of double digit percentage growth and underlying basic earnings per share in 2004. The interim dividend is increased by 10% to 15.7 pence and our underlying post-tax return on equity, excluding the benefits of the merchant acquiring sale, was up to 22.3% compared with 21.7% in the first half of last year.

Looking at the analysis of profit before tax by sector, comparing the first half of this year with the same period in 2003, retail banking profits decreased by £9m to £213m, primarily reflecting the £10m of costs associated with the branch network rationalization.

Commercial banking profits increased by £10m to £48m, mainly as a result of lower processing costs, one-off cost savings relating to the conclusion of our contract negotiations with the Post Office and lower merchant acquiring costs. Treasury and Group profits of £11m was in line with the first half of 2003. Strategic investment costs were £5m lower, at £4m.

Turning to income by sector, Group total income increased by 1.3% to £693m. Total retail banking revenues were £14m higher in the first half of 2004, [of that], £465m, with higher non-interest income partially offset by lower net interest income.

Commercial banking total income was marginally lower than the same period in 2003, reflecting the sale of the merchant acquiring business. Treasury and Group income was slightly lower than last year.

Turning to income by category, Group net interest income was £30m lower than the first half of 2003. The primary cause being the upfront costs associated with the growth in new mortgage lending. This was partially offset by higher net interest from unsecured personal loans and current accounts, together with the benefit from the termination of our offshore captive insurance arrangements.

The launch of our new product mortgage product range in May will reduce the impact of new business strain on net interest income in the second half of the year. Non-interest income grew by £39m, compared to the first half of 2003. The key factors for this increase were higher mortgage related fees, increased income from long term investment products, higher insurance commissions relating to unsecured personal lending, higher current account income, a £4m one-off profit from the sale of a branch and higher fees from our cash businesses. And as you can see from the slide, net and non-interest income each represent around 50% of the total.

Our 2004 full year revenue target is for accelerated growth in Group revenues on a like for like basis. That is excluding merchant acquisition revenues and any distortion from significant property disposals. Using this definition, income grew by 2.5% in 2003. Income on this basis in the first half of 2004, was £682m, compared with £675m in the first half of 2003. This represents a 1% increase. This means the first half income was approximately £10m below the minimum level required to achieve accelerating income growth.

We anticipate second half revenue growth increasing more rapidly, because of the recent changes in our mortgage portfolio, which will reduce the level of upfront costs of new mortgage lending in the second half of the year, and improve margins. Greater income resulting from a full six month benefit of higher lending balances at the start of the second half, compared with the beginning of the year, and sustainable high levels of income from our growing current account base. The result will remain on track to achieve our full year 2004 revenue target.

Looking at margins, the Group margin declined by 19 basis points in the second half of last year, and then by 17 basis points in the first of half of this. The primary driver to the decline in the margin in the first half are the upfront costs associated with the growth in new mortgage lending, affording the proportion of mortgages paying standard variable rates, and the growth in higher quality, but lower margin commercial lending. The mortgage margin is the key driver of the Group's net interest margin.

Our new range of mortgage products is expected to result in lower upfront costs being charged to the P&L for the remainder of the year. And where customers choose our no fee option, the costs incurred relating to valuation and legal fees will be amortized over the early repayment period. This will be beneficial for the MLI margin in the second half of the year.

Overall, we expect the Group margins for the whole of 2004, as we indicated at the pre-close, not to be significantly lower than the 1.56% achieved in the first quarter.

Now our retail banking sector spreads. The net interest spread declined from 1.61% in the first half of 2003 to 1.46% in the second half, and then to 1.23% in the first half of 2004. The decline in the asset spread was primarily driven by the upfront costs of higher mortgage lending in the second half of 2003 and the first half of 2004, and the fall in the proportion of mortgages paying standard variable rate. The increase in the liability spread was mainly due to our current account rates being maintained, despite recent rises in bank base rates.

Turning now to costs. In February, we said we were targeting our 2004 operating expenses to be broadly similar to 2003. These expenses exclude operating lease depreciation and strategic investment expenditure. When we announced our branch closures in June, we said we were targeting our operating costs, which include the additional £10m of one-off closure costs, to be broadly similar to 2003 operating expenses.

In the six months to June 30 2004, Group operating costs, including these non-recurring branch closure costs, of £357m compared to £353m in the first half of 2003. We are still on track to achieve our target.

We are also on track to reflect the achievements of a £100m reduction in our core costs, from £650m announced in 2000 and based on 2000 business volumes and prices. In the first half of this year, the Group core cost base was £274m, including the £10m of additional cash market related costs, as the graph shows.

Moving on, loss charges. The total charge for losses in the first half of the year was £33m. The increase in the residential mortgage loss charge reflects the termination of the arrangements with our captive insurance subsidiary, which I referred to earlier. This resulted in an increase in both revenues and losses of £8m in the first half of 2004, compared to £3m in the first half of 2003. The charge for unsecured personal loans and current accounts remains in line with the first half of last year. The commercial banking and Treasury loss charges are below the first half of last year.

Although not shown here, the closing balance sheet provisions for the Group were £12m lower than at the end of December 2003. This reflects the sale of the small remaining and fully provided non-performing elements of the credit card book during the first half of this year.

The balance sheet. Lending to customers increased by £3.2b to £35.4b in the first six months of the year. The main reasons for this are the £2.5b of net mortgage lending, a £400m growth in unsecured personal loan balances and net commercial lending of £200m. Of the £35.4b of total lending to customers, 90% is secured. Cash Treasury assets and loans and advances to banks decreased by £1.6b to £13.7b. As we indicated in February, in December 2003, there was a strong inflow of short term money market funds, which were invested in short term assets. In the first half of the year a significant proportion of these assets matured.

Asset quality remains strong across all categories. I'll take you through each, starting with Group Treasury assets. These remain strong, with 96% of our exposures having a long term credit rating at or above single A, in line with December 31 2003. And we do continue our policy of not investing directly in corporate bonds, emerging markets, venture capital funds or hedge funds.

Moving on to mortgages. Mortgage arrears are at very low levels and are bound across all categories. The number of cases in arrears is now under 3,000, compared to over 4,000 18 months ago. The actual value of the arrears fell from £7.3m at the end of 2003 to £6.7m at the end of June. The significant growth in our mortgage lending has been achieved while still maintaining a prudent approach. 79% of our new lending had an LTV of less than 75% in the first six months of 2004. This is higher than 71% for the same period in 2003. And as Richard said, only 3% have an LTV of over 90%.

Mortgage asset quality remains excellent and we expect to be well placed for any downturn there may be in the housing market.

Non-performing loans, as a percentage of the unsecured personal lending book, continue to decline. They stood at 4.6% on June 30 2003, falling to 4.4% by the end of that year and now stand at 4%. The value of loans over 30 days in arrears, as a percentage of total loans, is almost 40% lower than the average for the finance and leasing association members. As I said earlier, asset quality has improved and remains very strong.

Commercial lending. The loan book stood at £4.3b at the end of June, up £200m. This increase was primarily in secured loans. Of the total leasing book of £2.4b, comprising finance and operating leases, over half are bank guaranteed. Non-performing assets, loans over 30 days in arrears, represent just 0.49% of the book, this compares with 0.68% at the end of 2003.

Moving to capstock. In the first half of 2004, we bought back 6.9 million shares at a cost of £58m. Further buy-backs are planned during for the second half of the year. Our target is to achieve an equity tier 1 ratio towards the lower end of a 7% to 7.5% range by the end of this year, which is £200m of non-equity tier 1 in the first half of 2004. Prior to this, all of our tier 1 capital was pure equity.

The total tier 1 ratio was 8.6%, including this non-equity issue. The level of share buy-back beyond 2004 will be dependent, amongst other things, on the impact of IAS.

Looking briefly at BAAL, we continue to make good progress and given the high quality of our balance sheet, we continue to expect to be a beneficiary under the new rules.

I would now like to provide an update on IAS. As you are all well aware, from January 2005, accounts will have to be prepared on an IAS basis. There is still some considerable debate taking place about IAS39. At this stage it is uncertain whether this standard will be fully or partially endorsed by the European Commission. Despite this, good progress is being made towards the production of our results under the new standards, although our hedging solutions will ultimately depend upon whatever is finalized in respect of IAS39.

You can see here the key areas where the introduction of IAS will impact upon our opening reserves, which will need to be restated by January 1 2004, excluding the impact of IAS39, and then again as at January 1 2005, including IAS39. An increased reserve will result from the impacts of accounting for mortgages on an amortized cost basis. Particularly the impact of amortizing mortgage discounts, fees and incentives. As you are aware, the majority of our discounts, fees and incentives are currently taken to profit as incurred.

Our pension fund deficits will have to be recognized. The final proposed dividend for a year will not be able to be reflected in that year's results, giving rise to a one-off beneficial timing difference. Implementation of our hedging solution is still being progressed, however fair valuing our derivatives as of January 1 2005 will have an impact on our reserves. The other key item is a negative impact from changes in accounting for leases.

Turning now to the profit and loss account. At this stage, we expect the Group's profit and loss account to be affected by two key items. Firstly, the ongoing effect of amortizing mortgage discount fees and incentives. This is initially expected to be favorable but will be influenced by the level of future mortgage business. Secondly, the change in fair value of derivatives will introduce volatility into the profit and loss account. Use of permitted hedge accounting techniques will reduce, but not eliminate volatility. We will announce a more detailed explanation of the likely impact of IAS towards the end of the year.

I think that's enough on IAS. Back to our half year results.

To sum up, we are on track to achieve our full year primary targets of double digit percentage growth in underlying basic earnings per share. We are on track to achieve our full year supporting objectives of accelerated revenue growth, delivering our cost base target and improving capital efficiency. We have delivered strong franchise growth and driven our internal equity higher.

Thank you, that concludes my presentation. Back to Richard.

Thank you David.

As I said earlier, I'd like to spend a few minutes explaining the strength of our retail banking business model and how it positions us for future growth.

As you know, we are building what we call a direct bank with a high street presence. This recognizes that the traditional banking business model, which concentrated on large branch networks, of customer acquisition and servicing, is no longer aligned with current customer preferences. I would like to clarify what we mean when we talk about this direct bank with a high street presence.

What would a bank need to look like to satisfy this description? Well, looking at the first part of the phrase, the direct bank element, we would expect to see a direct bank having the infrastructure to allow customers to buy and transact all the bank's main products by the direct channels.

Secondly, we would expect to see growing sales and customer transactions through direct channels, reflecting the changes now evident in customer behavior. And a direct bank would offer customers better value products, recognizing the lower costs of acquiring and servicing customers directly, and the reasonable expectations of customers that their self-service gets them a better deal.

There are some very good direct-only banks in the UK, but they remain largely a niche offering. Whilst mainstream customers are increasingly comfortable to use direct channels, many of them like to know that there is a branch they can visit if they choose to, for complex issues or if anything should go wrong. And that is why the high street presence is a vital part of our strategy.

So, what's our image of a direct bank but with a high street presence? Well it requires each of the attributes of a direct bank but it also requires a strong network of branches, which give a good coverage of the UK and help support brand awareness. The role of branches is changing and our branches are increasingly focused on sales and on educating customers in the convenience of self-service.

The direct bank with a high street presence also recognizes the different costs associated with different channels and offers customers prices which reflect that difference, for example, channel pricing. And it's a bank, which focuses an increasing proportion of its investment on the channels which are growing in importance.

So how then does Alliance & Leicester stack up against these requirements? Well, our core infrastructure now allows customers to buy and transact via the direct channels. Customers can apply for each of our core 4 products online, by phone, by post or in branches.

Our direct sales and transactions are growing, with the number of retail banking product sales via our own internet site, increasing by more than 150% in the first six months of 2004. And the number of customers registered for our internet banking service was up around 100,000 to now over 300,000.

Offering customers better value products is one of our core brand values and in the first half of 2004 our products have gained more than 900 mentions in national newspaper best buy tables, significantly more than any of our competitors. And as regards the high street presence, our network strategy locates branches in major customer centers. The focus on sales can be seen with 2003 being a record year and in the first half of this year, branch sales were once again higher than in the same period last year.

And as you can see from our marketing material, we proactively price products to reflect the cost of servicing customers. The lower cost of acquiring and servicing customers directly enables us to offer our customers better value products. For example, our recently launched internet only online saver and our directly serviced premier plus current account both offer best buy rates of interest. Pricing through our branch channel will generally not be as keen as through our direct channels, but still offers customers better value than our major high street competitors.

And finally, the announcement of branch closures provides a good demonstration of how our strategy is to invest in the channels offering the greatest long term growth. The gross annual cost savings from the closed branches will be around £8m and we will be using around £3m of this saving to spend on direct marketing, which will replace the value of the business loss as a result of the closures. That leaves a net benefit of £5m per year through focusing on the channels that are growing and putting our acquisition spend where there is the lowest unit cost of customer acquisition.

As I have mentioned in previous presentations, our approach to marketing is very much that of a direct bank. And as an example so far this year, we believe we have invested more in E-commerce marketing than any other UK bank, and we expect this trend to continue.

Now so far most of what I have referred to looks at the business model from a customer's perspective. Now let's look at how our shareholders benefit from this business model. Our direct bank with a high street presence model will, over time, deliver lower unit costs. This will not dramatically happen overnight as we will avoid getting ahead of customer expectations and alienating valuable customer segments and thus destroying shareholder value.

But we are already making real progress in reducing costs and take, for example, current account servicing. I said we had 300,000 plus customers now registered to use our internet banking service and they are serviced by a team of around 20 staff. That's a ratio of over 10,000 customers per staff member. And this compares with one staff member per 2,000 accounts for the remainder of our telephone service account base. As you can see, the potential unit cost savings are very great. This is one reason why we are not going down the offshore call centre route. Why take that risk on customer satisfaction and security when greater adoption of self-service and automation will reduce labor costs anyway?

In summary, the change in customer behavior, in favor of direct channels supports our strategy. It levels the playing field in banking. The traditional players with large physical networks no longer have the advantage that they once had. And the beauty of the direct banking model is that it is easily scalable.

As we increasingly build and refine our direct bank with the high street presence model, the lower acquisition and lower servicing costs will allow us to continue to offer better value products for our customers. The combination of competitive products and lower unit cost will be key to delivering franchise growth and long term shareholder value. That's potential growth, together with our responsible lending and solid financial performance makes me very confident about the future of Alliance & Leicester.

Thank you for listening. I would now like to open the meeting to questions.

I should say that the question session is going to be broadcast over the Bloomberg Network today, so if you've told your office you're somewhere else, don't ask a question. If you can put your hand up and then the microphones will come to you. If you could say, give your name and the name of your house and the first hand up was there. The microphone is coming towards you Mike.

Thanks. Good morning, it's Mike Trippitt, HSBC.

Richard in a statement-- in the actual press statement you talk about the upfront cost of mortgages therefore makes your revenue target the most challenging that you've got amongst the targets. But the thing that struck me about this is that the trend you're talking about, the half year, in terms of mortgages are broadly similar to those you reflected on in the trading statement, where there seems to be a bit of a divergence on the non-interest income line. I don't know if this is just one-offs, but I think in the first quarter you were talking about 14.5% growth, it looks like we're looking now at underlying about 11%.

I just wondered, you give quite a bit of a breakdown in the retail bank of £40m gross, but can you- the bit that's missing is what's happening with fee income on the fixed rate mortgages. We get the partner 4 numbers, we get the MBNA numbers etc. etc., but what I'm just trying to understand is the relationship between the gross mortgage lending and the fee income and whether there is a reduction in the underlying growth in non-interest income going forward.

Well talking in general terms, and the David can perhaps add anything on the quarter by quarter split.

The overall shape of what we're doing is that obviously we are working in a narrowing interest rate, a narrowing margin environment which we've commented on before. And the huge rise in our mortgage lending in the first half obviously put pressure on the margin because we charge the cost of free valuation and free legal fees we give to customers to the margin - bank accounting policy.

Now, one of the factors we have seen over the last few years is a very strong growth of non-interest income, because how we price our products to customers is we're looking for total income and we don't really, we're agnostic or whatever it is, we're just agnostic as to whether it comes in the interest line or the fee income line, we're looking at total income. So that difference between interest income and non-interest income is not something we are particularly sensitive to. We're looking at it as a total income from that customer over the life of the mortgage. And that's why there has been customers more sensitive to margin and they are less sensitive to some types of fees. That's how we've been pricing our product.

Now the trends quarter by quarter, David is there anything? This is very difficult to add.

There's nothing underlying there, I mean, we give a lot of information in terms of the retail banking non-interest income. I mean, just going through it we tell you that the income we have got from the personal loans business was £41m. You can deduce the credit card number. There was a £31m in total credit card income and we tell you that the net interest is £4m, so the credit card non-interest income is £27m.

You can see that the personal banking number was £109m, so if you take the personal loans and the current accounts off that, you can see that the current account and ATM income is the rest.

There is obviously the £4m branch, that was, you know, the only one-off really, that was in the second quarter. And then in terms if you--we give you a number for the partner 4, this £71m and if you take the credit cards off that of £27m you get £44m and that is the numbers for the life company, the life business sorry, the general insurance and other insurance incomes. And then the mortgage, the non-interest income in our mortgage business and the investments business is the remainder.

So I mean the short answer to your question, there is nothing particularly quarter on quarter going on. The only real one-off was the branch, which happened in the second quarter.

Now while the microphone's there, do you just want to pass this to [inaudible] shortly.

[inaudible] You state that the lifetime profitability has increased. Could you tell us first of all what the lifetime profitability is and secondly what has changed to make it increase?

The answer to your first question is no. The second part of your question, is the mortgage market did become less competitive in the first half, [moved on]. You heard statements from Halifax talking about elements of the market, that they were pricing up, and obviously Halifax are the main price setter in the mortgage market. So, the whole industry priced up a little bit successively during the first half. I'm afraid I can't really tell you the internal model on profitability.

I think the pricing observation that you're making and it's not an average duration or a cost or capital variable that is changing?

The statement refers to the calculation that we make on the lifetime profitability of that mortgage.

So is that a variable changing as well with the pricing?

There are always other variables changing. We're not working in a static world. There is no doubt that there is a shortening of the life of certain types of mortgages and that, I think, is a function of a rising interest rate scenario. People are more sensitive.

Thank you.

Now I did see a hand. Simon, I'm not going to miss you again, I'm never going to do it again. Simon.

Thanks very much. Simon Samuels from Citigroup Smith Barney.

I wanted to just-- explore the margin issue a bit further actually. It goes back to what it's, page ten on your slide show, it's the bottom chart showing the retail banking sector spreads going from 1.61 to 1.46 to 1.23.

Now, when that same chart was presented at the full year stage the comment at the time was that you are planning for a narrowing spread, but not at the same rate of narrowing seen in the second half of 03. And obviously today you're reporting that that rate of narrowing has accelerated in the first half of 04.

Now the reason I mention that is not to sort of, you know, score points about you know, your forecast wasn't right, but much more to get a sense of, an understanding of kind of what turned out differently in the first half of 04 from your expectations in February. And the reason I'm asking that is to then get a sense going forward of your degree of confidence on, you know, one looks quite an ambitious drawing the line in the sand on the margin story, essentially saying your margins are now stable at the current rate.

So I'm only trying to test what went wrong against expectation and therefore how confident you are for the next six months.

Well, the key things that happened were that the mortgage business, new lending grew by 74%. That had an impact on the margin and we were not expecting our mortgage lending to grow by 74% and we are delighted that it did. And we have taken actions to ameliorate the effect on the margin for the full year to ensure that the statement we made in February was entirely correct. And David, do you want to take it over from there? What we said and what we are planning to do next?

Just to clarify one point, it doesn't change your question really. But in February it was about the margin rather than the spread and what we said was that we were planning for narrower margins but we expected the rate of decline to slow. And between 2002 and 2003, we saw 22 basis point decline and we were indicating we expected that to narrow. And you are absolutely right Simon, you know, we indicated at the pre-close that we were expecting margins to actually decline quicker than that.

The main reason for that, as Richard has already said, was the very high growth of mortgage lending, in particular. When we see high levels of growth, way beyond what we were expecting it does hit our margin because of the accounting upfront costs.

In terms of going forward, what we're saying is that we don't expect the margin to be significantly lower than the 1.56 we saw at the end of the first quarter. Obviously from the first half, we have seen a 1.53(ph), so that implies a second quarter margin of [may include] 1.50. We are obviously, you know, we expect margins to increase slightly from that level.

The reasons why we are confident is because of the change in the mortgage portfolio we have talked about-- I mean that really is the key driver.

If I just come back on that, I mean you know, looking at your gross, I mean I guess your biggest driver of the margin from a sort of volume perspective is going to be gross mortgage lending.

In the first half of this year you did £5.5b of gross lending, which is the up 74% you refer to. But at the second half of last year you did £4.9b more of gross mortgage lending, so your gross lending wasn't dramatically out of kilter with the second half of last year.

I mean it just strikes me that you must be pretty heavily reliant on that margin comment about quite a big change in your customer's behavior towards the fee versus no fee split within the lending areas. Is that a fair assessment?

Simon, we say in the announcement that the revenue target is the hardest of the targets to achieve. We are confident of achieving it. I think one of the issues in these meetings is obviously we are, we look at margins because that's what drives your spreadsheet. But (indiscernible) will take it up a level.

If you look at Alliance & Leicester's performance in the first half, mortgage lending was up 74%. The personal loan lending was up 20%. The current accounts were up 40%. We have now got more than 2m current accounts and we expect our savings balances to increase, they were stable in the first half. Compared to some results recently I think that's a good performance and we expect them to increase in the second half. And the achievement of those targets, which we originally set in 2000, we expect to achieve them in 2004. It will represent, I think, we think, quite a major confirmation in the Alliance & Leicester business. For something that is growing, has a very clear strategy and delivers long term shareholder value.

Now, very valid questions on the margins and everyone's entitled to ask them and challenge us on it, but the bigger picture is we are building a bank that is a much more valuable bank than the one that we saw in the year 2000. And I hope people can see those results evident in the publication today.

And to move back to the first hand was in the second, third row in the back. There we are.

Robert Law of Lehman. I've got two questions.

First of all could I follow on the margin issue please? Can you give us some indication as to what the better margin indications you are giving in the second half of the year have in terms of implication for business volumes? Are you expecting those to flatten off in the improved margin that you want to see as a result of the pricing initiatives you have made? So I'm looking for the impact of that.

And, do you see any effects on non-interest income from improving the net interest income that that implies?

Yes, I think it's very difficult to predict business volumes. All our products are competitive. We can't predict the volume of mortgages in the UK economy in the second half and the mortgage product range that we launched in May, very competitive still, even though it had the difference on the [help with] fees product. And with, it's still a very competitive range and we've repriced it I think once since, it is still very competitive in the market place.

Our current account pricing has gone up. But a 6.4% rate is still a very attractive one from a customer's point of view, so we are still poised very competitively. And what we've talked about in terms of improving our margin is not having a material effect on our potential for franchised growth. What we can't predict is the strength of the markets or other competitor activity which happens after this date.

Is there anything else more helpful we can say?

Just the second part of you question, Robert, in terms of impact on non-interest income, I mean, clearly volumes do have an impact on non-interest income, so if volumes fall then non-interest income will fall. But I mean, I think Richard has answered the volume point, (inaudible) fairly obvious.

What I'm trying to explore is obviously you have had a margin impact and a pick-up in business volumes in the first half and you're inviting us to suggest there's a remuneration in the margin impact. And I'm just trying to see whether basically that's because you widened the pricing, and your market share's going to fall in the second.

We can't predict our market share. You can't manage a business by market share in these sort of markets. I think the very clear signal today we're giving is that we are on track to achieve our targets and those were targets which, when we gave them four or five years ago, people thought were very challenging and we believe we are going to achieve them.

As a supplementary, where do you expect the SPR proportion to settle? Or do you expect further declines from here?

Oh I think one must anticipate that it will continue to fall.

Secondly, I just wonder if you will briefly.

It’s your [inaudible] not your second.

I know, I hoped you wouldn't stop that. Could you comment on whether you still see potential to accelerate revenue growth from here, looking into next year?

I don't think we can talk about 2005. All we can talk about is growing a more valuable business and growing shareholder value. That's all we can talk about.

There was a hand up behind. You can pass it over your shoulder. Thanks Robert.

It's Jonathan Pierce from Credit Suisse. I just come back to volume actually.

I think if you look at your discounted rate products, the rate on those has gone from about 10 below, sorry 10 basis points below base in February, to about 60 or 70 basis points above base. I know the price of SVR, but you know, if I’m base I’m off base right, then that's, we've seen a significant spread expansion there.

So I was wondering, a lot of competitors, of your competitors, tell us where the pipeline stood at the start of July. Are you able to give us any feel for that?

We have never talked about pipeline information and I think, thanks that I have done that perhaps more, mortgage business. I mean we project ourselves, we are not just a mortgage bank so we have never put out the mortgage pipeline.

We had a good mortgage pipeline at the end of June, that's all we can say.

Would it be fair to say though that the some of the margin improvement, if we see any in the second half, will not just be through [writing] any more of these products with redemption penalties that come with a discount, but also because of this, well potential, well potential massive widening in the sort of spreads you are getting on new business.

I don't, to be honest with you, recognize the numbers that you are talking about there. I mean, there has not been a spread widening of 80 basis points on our mortgage, on the average price that the customer pays at all. That's not what we're doing. The man who does the pricing is in the front row and he's saying that's not what we've done.

Perhaps you can talk to Graham at the end. Graham is our pricing expert. Over all our competitors as well, so he's the man to help you. And then Chris over here, who's looking very smug [indiscernible], because he can help you as well.

Can I give a second quick question then on the hedge against your free funds, because the free fund benefit has gone up for the first time in, you know, several consecutive periods by about 3 basis points in the first half, the first and the second half of last year. And I wonder whether that's a signal that perhaps the hedge has past neutrality and will see further increases moving forwards.

I don't think you can include that Jonathan, I mean you've asked us, you've asked me a lot about this.

We haven't indicated the duration of our [net post] hedging. I don't think you should conclude from this that this is, you know, we've reached some sort of inflection point. No.

Okay, we'll-- Oh sorry, I missed that, sorry.

It's John-Paul Crutchley from Merrill Lynch. Two quick questions.

Firstly, the 20% of your book on SVR. I was just wondering if you could give us any sense of how that's tracked over time as to how we got to this point. And secondly, on the credit card income, which you have now given us sufficient detail we can make a good guesstimate about what the underlying is, that's obviously showing reasonable growth coming though. I was just wondering if there's anything that we should be aware about, can we assume that sort of trajectory going forwards in term so the MBNA partner for underlying income as opposed to the amortization of the sale?

The trend of the SVR is in the announcement. It was 35% as we disclosed in June 02, and then it went to 23% December 03, and 20% June 04.

And in terms of the amortization of the original gain, the excess on the credit cards was disclosed in 2002 and we are tracking very close to that aren't we?

I mean you can get a reasonable figure excluding that in terms of what is coming through on the partnership arrangement and it has been growing. I'm just wondering, you know, is there anything that is, have we seen accelerated growth or is that sort of trajectory the sort of areas of business you'd expect to continue?

Well, it's very difficult to predict. I mean the strategy is, whilst we have core 4 products, the strategy is very much then to cross-sell once we have got customers on our books. So if you take this Premier Plus current account, offering 5.5% fixed for over a year, you know, isn't making a big margin. So it's a very cheap way to recruit customers to the brand and then to sell a credit card. And once you've opened that account and once you've moved your main banking relationship to Alliance & Leicester, it's entirely logical that you will then have a credit card linked to that account.

And there are business processes, which integrate the selling. So everything we are doing to build the current account base is building a credit card business as well, so the more we build current accounts, the more we build credit cards. We then have good sales processes, which recruit new credit card customers anyway. So the whole strategy is to continue growing the franchise of the Group and by deepening that banking relationship.

Just to make an additional comment, I mean we sold 94,000 cards in the first half. That's only slightly higher than this time, in the first half last year. But what was significant was that we were selling I think from that 32% more through our branches and that is a more profitable sale for us. So I mean, it's accepted branches selling credit cards that has been probably the key change rather than the actual overall volume.

Okay, there's a hand up over here. Obviously I'm looking more to the right than left, so I must look to the left more. There's one over here on the left wing. Your right sir.

Thank you very much. Sandy Tern with Williams de Broe. Good morning.

I wanted to get another question on the margins again, unfortunately.

On page 35, looking at the mortgage lending volumes, I was comparing the second half gross yield and cost of interest bearing liabilities versus the first half of this year. And it looks like, first of all, interestingly, the gross yield on interest earning assets has gone up by 22 basis points during a time when you actually gained a significant amount of net mortgage lending, in the net mortgage lending market.

But the place where it looks like it's hurt is in interest bearing liabilities where it appears that your cost of interest bearing liabilities has gone up by 46 basis points from 3.2% to 3.66%.

What you're looking at is a gross rate number. Now the key driver there is obviously the interest rates have moved. What I suggest you look at is the asset spread and liability spread numbers, and what you will see in terms of the MLIs is that the assets spread will have declined 25 basis points on comparing first half of 04 with first half 2003. And that is driven by the new mortgage lending.

The liability spread actually improved slightly by 1 basis point, so those gross numbers are driven by the underlying changes in interest rates.

Yes, I understand that. I think one of my questions was how much of that is in the increase in wholesale funding was wholesale market driven versus driven by the average increase in the customer deposits?

There is no question, we have been impacted, as other lenders have by the way that wholesale rates have trapped the head of bank base rates, and it's quite difficult for us to change mortgage and savings rates when-- until bank base rates change. So we have been impacted.

I think it's also fair to say we're probably not impacted as much others because we do have a significant proportion of funding from retail sources, so we are less sensitive, but it still impacts us.

Which leads me to my next question, which was the 46 branches that are closing. Do you have an estimate of, or can you tell how much, what percentage of customer deposits are actually connected with those 46 branches?

We haven't disclosed that number separately because we have strategies in place that will enable those deposits to, hopefully, remain with the Group. We have a big communication program with those customers.

They, the customers, have the ability to still continue the relationship with us by telephone, by post, but very importantly, the key advantage we have over the other banks is via the Post Office. And with all the branches that we have closed I think there was a Post Office within 800 yards, [indiscernible] yes within 800 yards of every branch that we closed and we've got treatment strategies for those customers too, as much as we can, guarantee that their business will remain with Alliance & Leicester.

We don't want to lose those customers, but they are very low transaction branches, although they represented 15% of our network, only 1% of our customers use those branches on a regular basis.

Thank you.

There's somebody over here now.

Thank you. It's Stephen Rhine here from Kleinworts. I've got a question on the mortgage lending.

You talk about avoiding self-cert, sub-prime and so on, you also said previously that you would like to avoid London, at least at the moment. Have you got an estimate for just how much of the mortgage market you are avoiding in total?

The statement on London and the South East was a couple of years ago where we thought that the relative house pricing in London was moving ahead faster than in the rest of the country. We took a different view towards the end of last year, as you have seen the numbers, and over, for the last decade now we are in equilibrium, for London and the South East and the rest of the United Kingdom. So we haven't got a more pessimistic view on London than in the rest of the United Kingdom. Our lending policies are consistent now in London to elsewhere. And that position changed nine months ago.

Do you have a number for how much of it you are still avoiding?

We're not avoiding anything. In terms of geographic -

Sorry, not in terms of geographic, but just, I mean now, you're still avoiding buy to let and--

Yes, well, the buy, you can see the numbers on buy to let. We think that buy to let is a very dangerous market for customers.

The -- if you look at -- for the achieved rental yields, often below borrowing yields. The whole gain depends on capital appreciation, and once house price increases stall in any way, the buy to let investor is in trouble. And to keep a rental property prime, you have to regularly refurbish it and in a rising house price scenario, people can progressively remortgage the property to take cash out to pay for the new kitchen and the new bathroom, and if house prices stagnate, you can't do that any more. And that leaves the buy to let investor with a slow selling property and a rental yield possibly below the cost of funding. Now, that is where we are today in the buy to let market, once house prices stall. So we think that's bad for the customer and so we haven't been chasing that market. There are a number of good and professional lenders who do, but we have chosen to avoid that.

The other market we have chosen to avoid is the self-certified, also disguised as fast track lending, which I think is, according to the latest CML survey, is 28% of the UK mortgage market. Now for lending below 75% loan to value, we just ask a customer for one pay slip. I don't think that's a very great imposition, but I think asking someone to write down their own income when they're trying to buy the house of their dreams is asking them to be honest beyond what you can reasonably expect.

And we would-- this is one of the great games in banking is adverse selection, and if someone can't prove their income we'd rather they went somewhere else, to be honest with you. Because I think most people who are honest will be able to produce a pay slip or a set of accounts if they are self-employed. So we think it is very good traditional banking to ask, when you are lending someone a couple of hundred thousand pounds or a hundred thousand pounds, just to produce one pay slip. And if they can't produce a pay slip, we will send you to a bank that will give you a loan no matter what you earn. So we avoid that market.

So there are large sections of the market that we do avoid, but we think that in the long term, that is good for shareholders and good for customers because it ain't good for customers giving them the ability to tell a porky on their income.

Thanks very much.

Question here.

It's Tom Rayner with Citigroup Smith Barney.

Can I just ask you on cost because I guess 2004 will see the end of your core cost analysis adjusted for inflation and volumes.

Are there any aspirations going beyond 2004 now? Obviously you are focusing on being a direct bank with a high street presence must be some cost advantage vis a vis the peer group. Do you have an aspirations on either cost income, cost to assets, anything that you can tell us on that issue please?

Well that is one of the issues that we will be talking about later this year. But the overall strategy that we've outline is of reducing unit costs. The cost/income ratio improved in the first half, but it is the unit cost of servicing a customer in a narrowing margin environment that we are aiming for. And all our strategies are increasing customer self-service, increasing automation.

And the lows next year, when chip and pin was introduced for retail transactions, if you go to buy anything in a shop, you have to put in your pin number will convert a lot of the current refuseniks to using their pin numbers and that will lead to another uptake in the percentage of customers who are happy to use automated techniques to identify themselves.

Everything we're doing is to drive a low cost bank, but when someone does want to speak to an operator when they need to speak to an operator when they choose to speak to an operator, that person will be in the United Kingdom or be able to relate to the customer very directly.

I just had a couple of points. There are sort of three costs that we've mentioned which won't recur next year. One is the [screening] investment spend. We've had the £8m full year expectation will be the last of that program.

Branch closures, we've said that, and Richard mentioned in his speech that that will produce a net saving of £5m a year, and obviously the branch closure costs we have experienced is £10m, that is a non-recurring item as well. So, I mean, we haven't not laid out any new cost targets, but I mean those three items you can see won't be around next year.

Okay, thanks.

Thanks Tom. Is there a last question? The last question is in the back row. Right at the back, there we are, thank you.

Good morning. It's Mike Lieber at CSFB. I apologize in advance for this question, because nobody's asked if I will.

Northern Rock have been talking about consolidation of players in the mortgage market, I'm sure you don't really want to be considered a mortgage bank or comparable with Northern Rock. Abbey National is clearly underbid at the moment from Santander.

I wonder what your views are of the sort of changing landscape and where do you see yourself as being one of the major players independently in the market in the coming years?

I am relieved that this is last question where this has come in. It normally is, so thank you very much Michael for that.

Our strategy is, we believe, entirely coherent aligned with customer needs. What goes on around us in the market is something that we can't influence. Our whole focus is on delivering the strategy, delivering better value for the customers, it's driving down the cost of dealing with customers and increasing the overall value of the bank for our shareholders. And that's what we will focus on. Now there will be all the stuff going on around us of speculation, but what we're driving on is delivering a better bank for our customers and our shareholders.

But you would accept that in principle achieving maximum value for shareholders could also result in you entertaining an offer, provided that offer was at a satisfactory level?

The board is always obliged to consider what is in the best interest of shareholders. Our focus is on delivering our strategy.

Thank you.

Thank you Michael. That draws our meeting to a close. Thank you very much.