Banco Santander SA (SAN) 2005 Q2 法說會逐字稿

Good morning ladies and gentlemen, and a very warm welcome to our results presentation.

This morning we announced the results which show continued progress at Alliance & Leicester, and we increased our interim dividend by 7% to 16.8 pence per share. Richard and David will shortly take you through the details of these results, but first I would like to say a few words.

As anticipated the first half year has seen a slowing economy, and a cooling housing market. What has changed in the past six months is that the next interest rate move is expected to be downwards rather than upwards. With credit conditions remaining sound we now have opportunities to grow carefully into new areas of business.

Against this backdrop the overall progress we have made so far this year and the opportunities we have available to us, leave us facing the future with confidence. All of us on the Board believe that our strategy and our effective senior management team, ably led by Richard Pym, will take us forward in a very competitive market.

As I announced at our AGM in May I will be stepping down from the Board of Alliance & Leicester when my successor is appointed. I have been on the Board of A&L for ten years, and chairman for two thirds of that time. During that period the Group has made substantial progress and I will leave with the knowledge that we are well positioned for the current environment, with a high quality balance sheet, strong direct distribution skills and cost effective operations. These qualities allow us to approach the future with growing confidence.

And now over to Richard.

Thank you John. Good morning everyone.

In the first half we produced a satisfactory set of financial results against a backdrop of slowing market growth. We delivered growth in our core franchises, excellent unit cost improvement and maintained strong asset quality. And we continue to develop opportunity for future revenue growth and cost improvement.

In the first six months we delivered core operating profit of 263 million, up 1 million on the pro forma results for last year, underlying basic earnings per share of 43.2 pence and an underlying return on equity tier 1 capital of 21.8% within our target range.

As we anticipated revenue growth in UK banking is slowing. Our revenues have increased slightly from the first half of 2005, with growth from our Core 4 retail banking products and commercial banking being offset by a decline in the Partner 4 product. We have achieved good volume growth in our core franchises which provides a very good platform for revenue growth in future years.

Our cost control has been excellent, delivered to a wide variety of improvements, all driven by a business model based upon implementing low cost ways of delivering good quality sales and service. Useage of our low cost direct channels is growing strongly; more than 35% of our Core 4 product sales are now made via the internet, and the number of customers registered to use our internet banking service is now over 750,000. Online transactions continued to increase, in fact they doubled in the first half, and more than 200,000 customers now use our internet banking each month.

Our excellent cost performance reflects these trends and will continue into the future. Indeed the progress we have made makes us confident in now setting a tighter cost target for this year. We intend total cost excluding operating lease depreciation, to be lower in 2005 than the 714 million in 2004. And in the future our plan is to be the most direct of all the main banks, eliminating most of the paper processing and sharing the reduced cost with customers in better pricing.

Asset quality remains above industry averages across our system, and non-performing loans have remained stable with impairment exactly in line with our expectations.

As we said earlier this year, it seems likely that the first half of 2004 was the best in the personal credit cycle in the UK, but nothing in our book is causing us concern and you will be entertained later by David's delightful dynamic delinquency diagram.

Looking now at progress in each of our core markets beginning with retail banking; our profits were 211 million in the half year, compared with a pro forma of 214 million for last year. We are very pleased with the turnaround in our mortgage performance this year, our growth spending so far is in line with our plans, but customer retention is performing better than expected. We've introduced more refined mortgage retention strategies, we are now more active in our contact with customers prior to them coming to the end of an incentive period. We've also structured our new mortgage products so that at the end of incentive periods most customers will in future roll off onto base rate trackers rather than standard variable rate.

It's too early to conclude on the full effectiveness of these strategies, but certainly the early signs are encouraging. We delivered 1.6 billion of net lending for the first six months, representing a market share of 3.8%.

We maintained a broadly stable retail banking margin whilst achieving a sizeable reduction in the proportion of our mortgage book on standard variable rates, now down to 17% .

Moving on to current accounts. Growing a high quality salary funded current account base is essential to our strategy. We opened 112,000 new accounts in the first half and we now have over 1 million current accounts which are regularly funded. These customers hold more Alliance & Leicester products than our average customer and our internet banking customers have an even deeper relationship holding around four products each. Our current accounts are already profitable and future trends are encouraging, for example around 40% of our new accounts are now open via direct channels and increasing numbers of customers are servicing their accounts through the internet. Taken together these trends are creating an increasingly valuable customer base for us.

In February Chris Rhodes took you through our business model for personal loans and this business continues to demonstrate its value in the first half with balances increasing by 500 million to 3.6 billion. Almost 90% of lending was generated through the telephone or the internet with asset quality at least on a par with branch generated generated business.

Our personal loan asset policy is behaving exactly as we anticipated and pleasingly new business margins are currently slightly higher than they were a year ago. As expected lower levels of payment protection insurance sales were achieved as a result of our best buy pricing condition for much of the half.

Our fourth core product, savings, has also shown good growth with balances up over 1 billion in six months reflecting in particular growing internet balances following our entry into that market in mid 2004. So in our core four products we've had a very encouraging start to the year.

Within the Partner 4 products there was a good sales performance from long term investment with the value of new investment up 10%. The mortgage market as a whole has seen less gross lending this year and as other banks have commented we have seen an increase in the proportion of business through mortgage intermediaries since the introduction of mortgage regulation. Together this has led to fewer opportunities to sell life and general insurance products.

Credit card sales have also fallen so they now represent only a small proportion of Partner 4 revenue.

Moving on, our wholesale banking business made up of commercial banking and treasury is growing well. Profits were 62 million up from 56 million and last year's first half profit included 4 million from thenow sold merchant acquiring business.

Our lending business is a key driver for future profit growth in commercial banking. Commercial lending balances were up 400 million to 5 billion with strong asset policy being maintained.

A further key driver for growth in commercial banking is business banking. We have long thought this a valuable opportunity for us and are taking a segmented approach to the market. We offered direct banking products to businesses with lower turnovers whilst for businesses with turnovers above £1 million we are beginning to deliver a more tailored approach supported by local bankers and business centers. We piloted this approach last year and it worked well. We now have five centers open with plans for more. The results are encouraging with business banking account opening up around 35% and the average turnover through each account is increasing, reflecting the fact that we're now attracting primary relationships not secondary accounts. As a result profits from business banking are increasing.

Historically our commercial banking business is based around money transmission. Recognizing that some of our old markets are in long term decline, we are radically restructuring the business. We have programs to significantly reduce back office paper processing and fixed costs. By restructuring and by focusing on growing our newer cash sales business we can continue to deliver strong returns for our shareholders from these operations. And this restructuring process started with our partnership with Securicor a few years ago which has enabled us to reduce our reliance on the Post Office network; a reliance we plan to reduce further still. Our emphasis on growing cash sales is working well with volumes up more than 25% on the same period in 2004.

So in the first six months of 2005 we've grown our franchise in our core markets, improved our operating efficiency and maintained strong asset quality whilst continuing to develop a firm platform for future growth.

I'll now hand over to David to take you through the financial results and then I'll say a few more words about how we see the future. David.

Thank you Richard, good morning everyone.

I'll now take you through our results for the first six months of 2005. This is the Group's first set of interim results under IFRS. Comparative figures for 2004 are on a pro forma basis which includes IAS 39 except for the impact of fair value accounting volatility.

Core operating profits were 263 million compared to 262 million for the same period last year. This excludes the impact of fair value accounting volatility and the profit from the sale of our merchant acquiring business in 2004. Underlying basic EPS is up 4% to 43.2 pence. Interim dividend has increased by 7% to 16.8 pence and our underlying post-tax return on equity tier 1 capital is at 21.8% which is in line with our target of 20% plus or minus 3%.

Looking at the analysis of core operating PBT by sector comparing the first half of this year with the same period in 2004. Retail banking profits fell slightly to 211 million, wholesale banking profits increased by 6 million to 62 million and group items were 2 million higher than the first half of 2004.

Turning to income by sector, group total income was 679 million compared with 677 million in the first half of last year. Retail banking revenues were 7 million lower in the first half of 2005 at 431 million. Income from the Core 4 products was 16 million higher in the same period last year but was offset by lower income in the Partner 4 products.

Wholesale banking total income increased by 16 million reflecting higher income from commercial lending and cash sales. These were partially offset by the loss of income from merchant acquiring. Group items represent income not allocated to business units including income arising from any residual factor.

The split of income between interest and non-interest income has changed with the introduction of IFRS. Some items that would have been shown as non-interest income under UK GAAP are now part of interest income under IFRS such as mortgage administration and [inaudible] fees. Group net interest income was 11 million higher than the first half of 2004 and average interest earning assets increased by 6%. Non-interest income was 9 million lower and is mainly due to lower income in the Partner 4 products, in particular life assurance and credit cards, which was partially offset by higher income in wholesale banking.

Looking at margins, the Group net interest margin fell by 2 basis points in the first half of 2005 compared to the second half of 2004. The main factor [was a plus] 2 basis point reduction with a continued decline in the wholesale banking margin as a result of growth in lower margin, higher quality assets.

The Group net interest margin fell by 4 basis points compared to the first half of 2004. We expect the Group net interest margin for the second half of this year to fall at a faster rate reflecting a growth of our lower margin with top efficient internet savings balances and the continued run off of older personal and commercial loans, these being replaced by new business at lower margins.

The best guidance we can give you is that we currently anticipate the net interest margin for the whole of 2005 to be around 10 basis points lower than for 2004 when it was 1.51%.

The retail banking margin of 1.85% was 10 basis points lower in the first half of 2005 compared to the first half of last year. The main reasons for this are the continued decline in the personal loan margin as the higher margin older business runs off and is replaced by lower margin new business. A small reduction in the mortgage and savings margin which was mainly due to the growth in internet savings balances and the run off of older mortgage balances. These reductions are partially offset by favorable change in the balance sheet mix. Compared to the second half of last year the margin in the first of this year was stable at 1.85%; the reduction in the personal loan margin being offset by a favorable change in the balance sheet mix.

Turning now to costs by sector. Group operating costs were 347 million, 15 million lower than the 362 million in the first half of 2004. This reflects a 10 million of exceptional costs for the rationalization of the branch network incurred in the first half of 2004. Retail banking costs fell a further 6 million due to savings from the branch rationalization and the growth in business via direct channels.

There has been a small increase in costs in wholesale banking as a result of the growth in business volume. We now anticipate that total Group costs for the whole of 2005, excluding operating lease depreciation should be lower than the 714 million in 2004. Total costs in the second half of 2005 are expected to be slightly higher than in the first half of this year.

Moving on, impairment loss charges. The total impairment loss charge in the first half of the year is 30 million, 8 million higher than the same period last year and in line with the guidance given at the [inaudible].

The retail banking charge of 30 million was 12 million higher than the same period last year, and mainly relates to unsecured personal loans. They're the three main drivers of this increase.

Firstly balances increased by 24%.

Secondly under IFRS there is a one off favorable impact on the level of 2004 impairment provision. This reflected the impact of some older poorer quality pre-2000 lending being replaced with more recent better quality lending in calculating the level of 2004 provisions. The best way of illustrating this is to look at the dynamic delinquency graph. If graphs were boxers then this one would be George Foreman , however hard I try to retire it, it always makes a comeback ]. But under IFRS loss provisioning methodology the 2004 impairment loss charge benefited from the reduced importance of the poorer quality 1998 and 1999 years of lending being replaced by the increased impact of the better quality 2001/2002 years. I've simplified the graph by removing many of the lines, but you can clearly see the 2001 and 2002 lines are of better quality than the 1998 and 1999 lines. This does illustrate illustrate the increased volatility, that can result from IFRS provisioning methodology.

So back to the impairment loss charges table, its one off benefits in 2004 together with the growth in balances accounted for 9 million of the 12 million increase in the unsecured personal loan [loss charge]. The remaining 3 million was due to a slight deterioration in asset quality compared to the first half of 2004 which we considered to be the best period of the UK credit cycle.

Moving on from unsecured loans the charge for mortgages and current accounts remain similar for the same period in 2004, the reduction in the wholesale banking charge was due to a writeback and the good quality of the book.

And finally, before moving onto the balance sheet, the Group incurred an accounting loss of 7 million on fair value accounting volatility. This largely represents fair value losses on derivatives that are economically effective hedges of underlying assets and liability, but where hedge accounting has not been adopted. Because hedge accounting has not been adopted for all the Group derivatives there is a timing difference between income recognition from the derivatives and the hedge assets and liabilities. This will trend to zero over time.

Okay the balance sheet. Lending to customers increased by 2.2 million to 38.4 billion in the first six months of the year. The main reasons for this was the 1.6 billion of net mortgage lending, 500 million growth in unsecured personal loan balances and net commercial lending of 400 million. Of the 38.4 billion total lending to customers 89% was secured, broadly similar to the percentage at the end of 2004.

Asset quality remains strong across all categories, and I'll take you through each starting with mortgage assets.

Mortgage arrears are at very low levels; the number of cases in arrears is just over 3,000 compared to over 3,800 two years ago. The proportion of mortgage accounts in arrears at the end of June 2005 was 0.68%, the same as at the end of December 2004. The actual value of the arrears, 7.3 million at the end of June 2005, compared to 7 million at the end of last year.

There have been some recent press comments about an upturn in repossessions. Just to give you a flavor of the high quality of our book, at the end of June 2005 our stocks of repossessions was 34 cases, compared to 36 cases at the end of 2004.

The average loan to value of new mortgage lending in the first half of 2005 was 59% with 75% of our new lending made with an LTV of less than 75%. Mortgage asset quality remained excellent.

Looking at unsecured personal lending. Non-performing loans as a percentage of the unsecured personal lending book was up 4.2% at the end of June. This is the same level as at the end of December 2004. The value of loans over 30 days in arrears as a percentage of total loans is almost 40% lower than the average in the Finance and Leasing Association members. Asset quality remains very strong with no relaxation in our credit quality standards.

Commercial lending. The loan book stood at 5 billion at the end of June, up 400 million; of the total leasing book of 2.4 billion comprising finance and operating leases over half are Bank guaranteed.

Non-performing assets, loans over 30 days in arrears, represents just 0.26% of the book which compares with 0.33% at the end of 2004. The majority of the 0.4 billion increase in assets is from secured loans.

Moving to capital. We have indicated that our equity Tier 1 ratio will continue to be around 7% by the end of this year. We're planning share buybacks of up 50 million during the remainder of the year. At June 30, 2005, the total Tier 1 ratio was 7.9% and the equity Tier 1 ratio was 6.8%. Looking briefly at f Basel II, 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. Our aim is to submit our waiver application later this year.

Credit risk. We are planning to adopt the IRV approach for most classes of assets. Operational risk; we are planning to adopt the standardized approach.

We maintain our progressive dividend policy with an interim dividend up 7% at 16.8 pence per share.

So, to sum up. We have made good progress against our strategic objectives. We are on track to achieve each of them in 2005 to deliver a satisfactory set of financial results. Thank you.

Thank you David. And Chris and Richard, do you want to come up as well?

Well, we are now looking at the team who are implementing a major change program at Alliance & Leicester, continuing the strategies we have followed in recent years. As we say in our announcement, the pace of change over the next five years will be more intense than in the last five. Chris is building a retail bank that will be more direct than any of our competitors. His task is quite simply to build Britain's leading direct retail bank, supported by national network branches. Richard is continuing to transform commercial banking from its traditional money transmission business based around the Post Office, to a modern commercial bank focused on lending and business banking.

The economic background is changing too. Even six months ago the markets were predicting interest rate rises, whereas the consensus is now with downwards movement. With credit conditions remaining sound, we now have opportunities to grow carefully, and I stress carefully, into new areas of business.

Looking over the next five years, we see opportunities for future revenue growth and further efficiency improvements. These opportunities will take advantage of the current misalignment between UK banking distribution and customer channel preferences. These will show that if distribution was aligned with preferences there would be 58% more online users and 83% more telephone users. And our business model is ideally suited to meet these changing customer needs.

Let me give you a few examples of some of the initiatives we have in hand to meet these changes in customer behavior. In retail banking we've just launched the internet only Moneyback Bank proposition, offering a market leading personal loan product on the internet, and providing us the ability to use more refined channel pricing strategies. We anticipate adding further new product developments in the future, providing compelling propositions to customers who are confident in dealing direct. And our branches remain a core channel for new sales. We recently improved their product range with additional products such as the direct ISA which once opened in the branch can only by serviced via a direct channel.

We continue to see opportunities to evolve our approach to credit risk in the medium term providing new revenue streams. For example, should current trends continue we will probably [enter by] internet mortgage lending, particularly to high net worth customers and professional landlords within the next year or so, if market conditions are right. We will however continue to avoid the amateur landlord market.

Chris and his team are also implementing changes for the current account back office, ensuring this is in line with the requirements of the direct banking world.

In commercial banking, Richard and his team are entering a broader range of commercial lending areas in a prudent way. For example, we're taking a more coordinated approach to offering our services to the public sector where we have strong relationships through our traditional cash and bill payments business. And we have recently completed our first PFI lending deals.

Our business banking model is going well with further opportunities to grow our business center network. During the second half of 2005 we will be launching a new internet banking service which will deliver a significantly improved service to customers, and we are confident of further profitable growth in business banking in the future.

In addition, Richard is transforming -- has a program which will transform the infrastructure supporting our money transmission business, taking it from a high cost paper based operation to being eventually a near paperless process.

So together the bank we are developing gives us great confidence in the future for Alliance & Leicester. Looking over the five years beyond 2005, we see opportunities for both future revenue growth and for further efficiency improvement. Indeed, we expect to see the Group with a sub-50% cost income ratio by the end of that period. But this is more than a cost reduction strategy. It is a strategy designed to meet customer needs and enable some of the cost savings we make to be invested into better product pricing for the benefit of customers. And as David has already mentioned, the strength of our balance sheet will also lead to significant benefits once Basel II is implemented.

We are continuing to develop Alliance & Leicester into the UK's leading direct bank. This transformation has already started, and as it progresses we will continue to deliver a high return on equity for our shareholders from a good quality asset base. We believe it is a very attractive differentiated proposition for both shareholders and indeed for customers as well.

We are now happy to take your questions. If you could give your name and firm please, that would be helpful. There are four ladies who will have the microphones. Now we have a bet on and Jonathan there, if you go into that row. David, how much do you owe me ? £10 a month . Jonathan, over to you.

Good, can I have half of that? Unsurprisingly it's actually a question on the margins. The full year guidance obviously suggests there'll be pretty severe attrition in the second half with 1.48 in the first half and around 1.34 in the second half. And despite what you said, I'm not quite sure still why you are expecting that level of attrition relative to obviously very minimal amount of attrition in the first half. Could you give us a bit more detail therefore on what exactly is happening with the Post Office and how that affects the numbers, how long you expect the run-off of old personal loans to drag on that margin? And I suppose the most important question, if 1.34 is indeed the second half number, is that a sensible base for 2006, and would you expect further attrition from that level?

Let me start and then David will come in with more. We've said that we planned our business for a narrowing margin environment, and we've done that's consistently for a couple of years. We felt it was very important we gave some margin guidance for the second half of the year, but we have to recognize that under IFRS, there is much greater volatility in margins, so to give margin guidance is quite brave I think. And we do say around. So that's the background for the comments and it's only around 10 basis points. So David, the changes that are causing that?

As I said in my presentation, the main factors are -- we're expecting to grow our internet savings balances, and these are cost efficient but obviously, but they tend to be at lower margin. And as I talked about, the run-off of the old commercial and personal loans -- in terms of commercial loans we talked about the small ticket leasing book, we mentioned the RNS which fell by a further 85 million or so from the end of last year. That will continue and also some of the old big-ticket deals written at high margins is going to run off and be replaced by lower margin business, that’s a function of]the market.

Similarly in personal loans, we mentioned, we see some signs of improvement in terms of new business margin, and we've still got the high margins loans from a few years ago, and they're obviously running off. The other factor I mentioned, the RNS, is the change --the settlement change . And what I'll do is I'll hand over the Richard Banks who is responsibl;e for this area.

Remember last year we signed new contracts with the Post Office on cash and bill payment, and the cash contract in particular reflects the changes to the way the Post Office receives its payment from the Department of Works and Pensions or benefits which are paid over the Post Office counter. Before last year they received the cash they were prefunded and no-one could prefund because it changed the way benefits are paid now direct to bank accounts, with the consequences that we receive payments a day later than we used to.

The effect of the run-off of the old small ticket leasing book is of course a very big effect on that. And the benefit of that is the lower risk weighting, much lower risk profile. If you wanted some guidance into 2006. I think actually that'sa bit much

David, can we help or not?

Well I think we're being, as you said Richard, quite brave in giving the guidance we've given in terms of 2005. Your question I think Jonathan is is whether this a good base for 2006; I'm not going to comment on this at this stage. I think we've given you fairly clear steers in terms of the trends; we've seen new business pricing for personal loans ticking up. In terms of mortgages, I think if anything pricing is stabilizing. But underneath that we have got the run-off of the personal and commercial loans. So, I think that's all I can say.

We move on. And James I saw your hand in the row in front of Jonathan in the middle, James Eden, the next question. We'll come down to this row in the front, the gentleman in the very smart blue shirt. James? Without a tie.

Good morning. I'm pleased to see you taking a move into some of the specialist mortgage areas like buy-to-let. You said that you were going to tread very carefully and focus on the lowest risk specialist lending. Does your risk reward analysis suggest that the economics of low risk specialist lending is more attractive than the economics of the high risk specialist lending, and how they both compare with other mortgages?

The margin on a good quality buy-to-let mortgage is perhaps higher than a standard retail residential mortgage. This is our first move into this market, and we are very concerned by the type of customer who is investing in buy-to-let mortgages believing that they were reliant on future house price increases to justify their investment.. If your rental yield is below your borrowing yield, you must be relying on an increase in house prices in perpetuity to justify your investment or big increase in the price of rents. And we consider that those customers are not really well-informed, and I think the Financial Times has been running a very good series of articles on the buy-to-let lending market, which we think justifies all the reasons why we chose not to have a stake in that market.

When we come to April, the end of March next year, the pension regime changes and the higher net worth those result in, investors will be able to invest in buy-to-let properties. And we see that as a very sensible first move into the buy-to-let market which will be very low risk for shareholders and will be good for customers. So our plan is to start there. Chris, what would you add about the risk profiles on our risk appetite.?

What we're talking about is relatively low loan to value buy-to-let; it's around the 75% mark. I don't think you'd find a significant difference in the price that is charged for 75% buy-to-let versus an 85% buy-to-let. And I think the risk profile of that higher LTV outweighs the benefit.

Do you still regard some of your competitors as too brave ?

I don't think I'm going to comment on that. You tempt me James but I won'trise. Can we go to the row in front. ,

Tom Rayner, Citigroup. Just two questions. The first is quite a quick one on why don't you adjust your underlying first half '04 numbers for the 10 million exceptional costs?

We haven't adjusted them for the sale of merchant acquiring either. David?

The number of exceptional differences if you define it like that. There is ranch sale in H1 04 and the the merchant acquiring as Richard has just said, but as I said in the highlights in terms of cost reduction, we accept that there was 10 million of one off costs last year, but even allowing for that, our costs fell by a further 6 million in retail banking..

Brilliant. I might be mistaken. I've just seen Appendix 4 and the earnings per share on page 36. It looks like it was adjusted for the merchant acquisition sale to get to the core post-tax profit which the EPS is based on.

I'm sorry.

We have adjusted the profit on sales; we haven't adjusted for the profit the business made in the first half before the sale. That was what my point referred to. We adjusted for the property profit; that was in the first half of last year, not this year. But we have all the numbers there so people can make their own adjustments. We sometimes find if we adjust for it, you will see that's an underlying item. So we'll put all the numbers out there and you can play with them as much as you want, and we have adjusted the underlying figures as little as possible.

But you have adjusted for some.

The second question's on unsecured credit quality. I'd really like a bit more help actually on this first half '04 effect, because just looking at it very simply, the balances are up 24%, the provision charges up 63%. You're telling me the first half '04 was helped by the favorable changes, but then you've had an increase significantly ahead of balance sheet growth in the first half of this year. I'm just trying to reconcile what exactly is going on there?

In terms of the unsecured loss charging, it went up for unsecured loans,and current accounts togetherits up from 19 to 31, but the 12 million increase is all down to the unsecured personal loans as I said. And there are three elements. The first element is the growth as you rightly stated, the 24% growth in balances , that will give you a few million pounds. And then maybe -- could we have the dynamic delinquency chart up please? While that's happening I'll maybe just explain that change. They're working hard to get it. Right, okay I'm going to stand up here. Under IFRS when you calculate the loss of charge for 2004, you have to take the preceding years into -- the relative importance of changes obviously. And the big change in 2004 was that in 1988, 1999 lending became much less important, and was really replaced by the lending -- the importance of 2002 and 2003 lending was much lower. These are proxies for defaults - so these two lines stop there/ these two lines became less important. These two lines(02/03) became a lot more important. And as a result of that there was a favorable impacwhich isn’t repeated in 2005.

So that together with the growth accounted for 9 million as I said of the 12 million], but the remaining 3 million was due to a slight deteriation in the quality as I said.

One further comments then we've got to move on.

Should I now assume the provision charge will grow more in line with the balance sheet growth going forward?

Broadly speaking absolutely because you can see the lines, the 2004 lines are tracking much more closely together.

So let's move on and the section on the end of that row just by the pillar. Thank you very much. And then we'll go just four seats further along in that row.

Morning it's Ian Smillie from ABN. Another question on the impairment charge please. You’ve explained the increase in the unsecured charge of 30 million and you said that it was a very small asset quality deterioration from H1 '04 which was, I think you said, the best part of the cycle. Doesn’t that suggest that actually as the cycle continues to deteriorate that actually we should expect the charge to go back [further than] assets outstanding for, let's say, another 6 to 12 months? That’s the first part of the question.

Well as I've said, the NPLss at the end of June were the same as at the end of December last year.. We have seen some deterioration as we mentioned that, but you need to strip out the volume and theIFRS changes I outlined. I don’t know Chris, if you want to comment on it.

It should pretty much grow in line with balances both going forward from now. We forecast everything on a loss given default basis now and respectively the adverse to say is just, the services at 3 million is reflected in the numbers and that underlying [inaudible] to take forward now in line with the balance sheet.

Thank you, and the second part of the question is for the rest of the impairment charge which is pretty much zero. How long can that stay at zero or when should we expect that to start to grow again?

I think, well just in the wholesale banking we did get a recovery, so we wouldn’t expect zero in the future, there was a recovery there. The same with the mortgage book. We talked about the policy we've got very low arrears levels, we've got repossessions at 34, that’s the quality. That remains excellent. So we are very, very comfortable there and the wholesale banking we are not trying to say zero is normal . Hhaving said the arrears are very low, just 0.6%] but there will be impairment charges in the future.

How big was the recovery?

I'm not going to give the detail on that, but it basically explained why in the first half of last year we had a 4 million charge and it explained most of that.

Ian can you surrender the microphone and pass it four seats to the left to John. And then we go in front in a few moments.

Good morning it's John Sheridan of Deutsche Bank. Just a very quick question on the dividend policy. You signaled that at the trading statement stage that you were [non-committed] to a progressive dividend policy. Could you please give an indication of whether 7% dividend growth is actually indicative of this, or whether the 10% growth in the past has been a better indication?

I think, we think that most people understand a progressive dividend policy as the dividend is growing in real terms. That is I think the very general guidance we would give. We can't be anymore precise than that, and we're happy, and I hope shareholders are happy, with an increase in the dividend of 7%. That’s all we can say on the dividend. I don't think we can ever predict a dividend a year a head. We have a progressive dividend policy and it's been rising by more than the rate of inflation growing in real terms for shareholders. David? Okay? I'll just pass it forward to Simon.

Thanks guys, it's Simon Samuels of Citigroup Smith Barney. I've actually got two follow up questions from the previous questions that follow on to those. Very quickly to David, just on the effect of tax rates in the [inaudible] book [on the trade they did will be similar to previous bids]. Unusually you didn’t know in the first half of this year is it, could you give a better indication as to the remainder of this year, is 28% for a full year more normal?

I'd looked towards the underlying tax rate which was 26.5% and that compared with 27.2% in the last period . It has dipped slightly, but we're not seeing that changing significantly in the short term.

Thanks. Just to return to the margin question] The first half [inaudible] to margins actually. [inaudible] is a big step down [inaudible] by you guys in H2 , sort of a 10 percentage point move from 148 to 134 would give you your 10 basis points down for the full year. Surely you must be able to give us some help as to the outlook from that level, and maybe I echo what you said Richard, you were saying that you'd been planning this business on the assumption of margin compression going forward; you don’t [just] six months time, having obviously assuming that [inaudible] is right reports a margin at 134 in the second half of this year, would you still be saying on that basis that the planning assumption would be margin compression from there?

We will leave commenting on the 2006 margin until we get there. One of the major reasons why we see the margins compacting in the second half is the growth in internet savings balances. There'll be very large, very low margins or indeed negative margins, and that’s part of growing our franchise as a direct package and you have to expect and re-plan for Alliance & Leicester to be very competitive on pricing, very low on costs and to rebate that low cost back to customer in better pricing. That is our business model. You can look at all sorts of industries, those people that hold] out with high pricing customers and try and maintain a high margin, end up normally without a business at all. We are adding customers. That is causing a loss of revenue, but that is building a very valuable franchise for the future, and we see Alliance & Leicester very much as built for the future of [British] banking. It will be a lower margin environment, but we think we can continue to generate returns of 20% post tax return on equity which can be very high on any basis in Europe. We think we're building a very solid bank as regards margins in 2006. We're going to have to give you guidance on that either later in the year or in February next year.

Okay and just a last quick one. Can you give us an insight in to the Boards thoughts regarding the falls in terms of the big slow down in dividend growth? I hear what you say, it's progressive ie above inflation, but can you explain why you were growing dividends at 10% and better over previously [inaudible] now? What figure are you trying to give to the equity market [inaudible] up to 7% for the half year?

Banking markets are slowing in the UK; the returns you’ve seen or the results you’ve seen from Alliance & Leicester today are very much in line with the core UK retail bank or other more diversified bank who have reported in the last week. We thought that this was a very responsible dividend to pay, and we had hiked the dividend by 10% over the last 4/6 periods. And that was lower than the EPS growth at the time. A 7% hike is above the underlying EPS growth during the period. We thought it was a very comfortable dividend to pay. Obviously it provides some sort of guidance, or as far as we can for 2005, as a whole as regards 2006. I think we'll have to wait for better guidance on that later, but obviously we are taking some sort of guidance for 2005 as a whole.

Let's go behind you Simon, and then I'll come to this gentlemen here in the front row in a few moments.

Good morning it's Ian Gordon from Dresdner Kleinwort Wasserstein. Two questions on PPI if I may. Firstly you refer to a reduced rate of penetration in the first quarter obviously due to the higher class quality of the customer profile in that period. What extent if any do you attribute the reduction in penetration to [inaudible] migration towards the [inaudible] direct channels? The second linked question is, you refer to an increase in penetration in the second quarter. To what extent if any is there a price impact? I ask the question because we've heard one of your competitors refer to reduced PPI pricing as a driver of increased PPI penetration, and another competitor has alluded to price increases in PPI as a driver of higher PPI earnings with no discernable impact on inflation rates.

Chris can come in, in a second and Chris, if you can deal with the characteristic of the channel and the customer behavior. As regards pricing, in all the tables of comparison that we look at, Alliance & Leicester remains very competitive PPI pricing. Obviously pricing trends change in any period, but we have always maintained a very competitive position compared to the mainstream lenders within that market. Chris do you want to go through the characteristics of the channels and how people buy PPI?

There's a simple answer to in the first quarter]is it was clearly the best buy strategy. The best buy strategy does effectively three things. One it brings them back high quality customers which in round buy less PPI, but it also drives new business over the internet as well, and internet customers do buy slightly less PPI than people who walk into a branch or phone us. So the best buy stuff drives lower PPI sales, but also much better quality and lower marketing costs. In the second quarter we've not been out there with the best buy strategy quite as strongly because there's less buyer pressure on the market and we've seen the PPI rates rise as a consequence.

Okay thank you, next question. [inaudible] it's in the front there [inaudible]

Hi it's James Invine from Merrill Lynch; just wanted to ask whether you think you can carry on increasing your gross lending in the unskilled personal market? You've said previously that your target market is the big banks and the BVA has shown the gross lending for the first half was actually down 5%. You're already taking around 8.5% of that number, so the market's going down, there's a general deterioration in credit quality; I know you guys are focusing on that as well, so do you think you can carry on showing an increase?

We target the prime markets for loans so that is really the clearing banks customer base. The clearing banks, , the traditional British clearing banks charge very high pricing for personal loans, and you see on our television advertising, if you watch the channels we advertise on, that we compare ourselves every day, every advert break with the pricing offered by those traditional banks, and they're all 3 and 4% above where we are. And the more we ram that message home, the more they will lose business and the more we will win, but we are only trying to get the really high quality customers, and honestly if they respond and some do that does have an impact, but the fact is they can't match us on price because the cost of their infrastructure is much higher. Chris is there anything you'd add to that?

Just remember the market's cyclical, so H1/H2, the H2 market is slightly slower than H1, but generally there's no reason why good customers are going to disappear from the market and at the end you’ve got the big four and the quality business comes through our doors.

And yet the 5% there is actually H1 this year versus H1 last year. Just moving on actually another question I've got; there have been a few stories in the press that you are looking to sell other bits of the Group. Is that, is there any truth in that, are you have with the shape of the Group as it is at the moment?

I saw those stories as well and there's absolutely no comment on speculation. Want to pass one along?

It's John-Paul Crutchley from Merrill Lynch. Three questions about franchise development actually. The first on business banking, the second actually on cards. If I look at what you showed on the franchise business, commercial banking business, you're showing good progress in relation to new accounts opened, but the number of active accounts --

Hold on a second the microphone's gone off. Okay yes.

The rate of growth of new accounts being opened is quite strong, but if I look at the number of active accounts coming through, the actual rate of those seems to be sort of slowing up. I'm just wondering about the sustainability of customers once you bring them in, what's happening there, whether you are losing customers the back end as well. and [inaudible] and I've got a second question.

Richard do you want to answer the first question [inaudible]?

There's a definite lag between opening and activation of the account of about three months generally before an account becomes fully active. So that --we expect most of the those accounts to become active. The second point is of course that, on average, something like half small business startups fail in the first three years, so you’ve got a natural drop off at the back end. But we are actually quite happy with the progress because this year it's 35% up on last year. Last year was 50% up on the previous year, so the trend is very, very good and compares well with others

And we are moving from secondary accounts to primary relationships which is very exciting. And you had a second one; are you going to have a third one?

No [I surrender] the third one; just actually going back on the [part] before and the [inaudible] bank parts. I think when that was an issue [inaudible] the hope if not the expectation at that point is you would see revenues coming through from selling [card products] is offset and the amortization of the sales coming through [inaudible]. That's not happened to some extent during the first [inaudible] business. If you look back at that process was there a fault in the way that was set up, or the way it's been managed, or can there be more opportunity to re-visit that in the future? I just trying to understand why it hasn’t come through as expected.

I think we would regard that as one of the smartest things we've done over the last few years, to exit the credit card business and where we sub-scale.. We sold that business for I think what was the highest premium ever in the European market for a credit card business, and we effectively swapped from our balance sheet credit card debt where the repayment profile is in the hands of the customer with personal loans. We got roughly -- at the end of last year we had roughly the same amount of unsecured debt on our balance sheet as we had in 2002. We effectively swapped credit card debt for personal loan debt which is fixed term, fixed rate, fixed repayment direct debit. And I think given the credit conditions in the UK, swapping credit card debt for fixed repayment, personal unsecured loan debt was a good thing to do. And I think the issues with credit cards is becoming a very, very specialized market in which the sub-scale players do not have a place andd there's no doubt A&L was never going to be world scale in credit cards. MBNA are now with Bank of America, it is a very big credit card operation. This is moving to the world market . I think we've got a model which we think maximizes our returns in that market with an acceptable risk profile for our shareholders. That’s the strategy I think we will continue to think is exactly the right thing to do. Chris would you add anything to that?

In broad terms there are two types of credit cards that we're selling. Those that are sold via our branch network largely into new bank account customers, and those volumes are very much the same. There's also those accounts where effectively MBNA pay the marketing and direct mail costs to get new stand alone cardholders through the doors of Alliance & Leicester. In essence because of the slow down and the difficulties in the credit card business, they are pushing that far less than they have done over the past few years and I think it's a reflection of where the credit card market is at the moment. So we're very happy that with dealing with card sales to cement out e current account relationships.

Thank you.

There's a question at the very back and then we'll go to three rows in front of that.

Good morning it's Rob Down from HSBC. I've got a couple of questions; the first one is a real sort of train spotter one. I don’t often look at cash flows, but on page 32 I couldn’t help but notice that there's a line item within your cash flow for disposal of subsidiaries in the first half of this year of 57 million. Have I missed something? Have you actually disposed of something, or is this just a technicality?

Well what it relates to, Rob, is within our wholesale banks we frequently sell leases past their maturity, these leases are often set up in different companies, so it relates to the sale of a lease.

Thanks. The second question is really just trying to probe a bit more on how you see the Group shaping up over the next two or three years. Depending on how you cut the numbers in the first half profits were flat to down, can you just give us some quite good guidance on margins in costs and bad debt for the second half which suggests that profits again will probably be flat to down?

The strategy that you're outlining appears to be more one of evolution perhaps rather than revolution within the business. I'm just trying to get a feel for how soon you think that might actually give the payback in terms of profit numbers. I can see some [inaudible] franchise growth coming through, but are we looking at the J curve here, where '06 and '07 should also be flat to down before we start to see some acceleration in profit growth?

We are planning over a five year horizon. The market for British banks is --there is a possibility in British banks, the whole British banking system sector is going to have fairly low profitability growth over the next year or so. That’s coming out in all the numbers. We are running this bank to achieve our target return on equity of 20% plus or minus 3%. I'm not signaling a drop to 17%] but that is our strategic framework that we are working within. It's too maintain the asset quality reduce the costs, and that will deliver a very long term sustainable future for Alliance & Leicester.

We are seeing some new product pricing improve in the first half of this year. Repricing for personal loans and repricing for mortgages much better than it was a year ago, and that is encouraging. If other banks begin to take hits on impairment losses, impairment charges, then that will produce an environment where margins will improve but it's too early to see any changes in the market yet.

But we are managing our business around the strategic framework that we have communicated. Obviously some of the cost program in terms of reducing paper and the fixed cost around the Post Office, will come later in the five year period . In terms of the cost so far you should expect to see very strong cost control over the next couple of years and a migration to direct banking. And you should then expect an improvement from the reduction in paper in the business, and then beyond that, three to four years out, you should expect to see a reduction in fixed costs around the infrastructure supporting the process.

So that would be the sort of profile of costs; this would be more of a J curve as you mention Rob], as regards the shape of the curve on revenue I think that is quite hard to call. David how can you describe that? Is there anything you'd add on to that?

No.

Okay.

Can I be really cheeky and have a quick follow up?

Of course you can Rob.

Just in terms of second half/first half seasonality; typically we see the wholesale bank doing structured transactions in H2 which gives us a bit of a good [swap], certainly last year it gave us a bit of a revenue kicker. And the flip side is personal lending you normally shut up shop, if that’s the right way of putting it, in November/December. Are those the sort of trends we should expect for this year?

David?

Just on the personal lending, in the second half of last year as you know we did half a billion in each quarter. We don't shut up shop as such, but I think as Chris pointed out earlier there is a seasonality in the market generally there seems to be more personal lending done in the first half of the year. So the market you would expect to be slightly slower and that will impact.

In terms of the wholesale banking point you made, the structural transactions we talked about last year; we said regularly do them; I wouldn't like to predict on those. We do have opportunities from time to time, but I'm not going to make a statement or comment on whether we will or won’t in the second half.

I think there's probably time for one more question. Actually I see two hands up; I will take both of those; they're on that side, just along on the top row please.

Robert Law at Lehman. As I've got the mic, can I ask two questions please? Just following on the answer you kindly gave to Robin; you've given here some pretty clear cost income ratio guidance over the next five years. I'm just trying to get a sense of how you see the key relative drivers on that, and are we looking at basically a cost reduction for [inaudible] or do you see this as something where you can change what is potentially a pretty flat revenue pattern over the next few years? Could you just comment on that without obviously getting too close to the line?

And secondly on capital; your risk asset growth I think is into the double digits, certainly on an annualized basis, but you do have a pretty strong ordinary equity Tier 1. You've mentioned Basel II, can you update us on when you might change the capital position of the Group? Do we have to wait for that or could we see changes in the capital position before that?

In terms of the cost income ratio guidance we've given for the five year horizon, that is very much a story of both revenue and cost. I wouldn’t want to over-emphasize the cost side over the revenue side because we do see the opportunity to move into areas of new business. I don't think we can map some of those out today. But the cost income ratio guidance is both improved revenue and improved cost performance over that five year period.

As regards capital I think that’s quite hard to give guidance on, therefore I'll pass it over to David as it's so difficult

I'll just start on Basel II; as you're probably aware there is an initial wave of applications and as I said we hope to be part of that. That may be implemented on January 1, 2007, but I should stress that those dates are provisional . In terms of our current plans for our actual position, they're as we outlined today. We haven't really got anything to add to what we said in the RNS. We're going to continue to manage our equity on around 7%; we've got a share buyback of 50 million in the second half of the year. They are our current plans.

Can we move the microphone forward three rows; I saw a hand up there. I've got a spotlight in my eyes, so I can't see very well.

Hi sorry, it's Ed Firth from SG Securities. It's just a very quick question actually, on mortgage share aspirations in the second half. I think Q2 looks like you've been quite a lot better than Q1, is that something we should expect to continue or -- historically it tends to be a bit light in the second half?

You're absolutely right the second quarter was very strong, and obviously we were affected in the first quarter by the slow down in the last quarter of the previous year. We don't run our business on market share, we're very pleased with 3.8% there being slightly above our shares and stocks. I think you have to see that first half performance as a whole being a reasonable guidance for the second half, but I wouldn't really want to go any further than that at this stage. I'd take the half as a whole as reasonable guidance.

Unless there's any other really urgent questions people have got, we've been going now for an hour and ten minutes; I think we'll bring the meeting to a close. Thank you very much and you'll see on the announcement that the current provisional date for our preliminary results is February 24, next year. Thank you.