Banco Santander SA (SAN) 2007 Q2 法說會逐字稿

Alliance & Leicester has produced a good set of results. Operating profit was up 10% at GBP295 million with good revenue growth and excellent cost control. The strategy is demonstrably working and we're delivering well against our strategic objectives. Our franchise continues to grow, revenues were up 5%. Our core operating expenses fell by GBP1 million, our asset quality remains strong with arrears in both mortgages and unsecured personal loans, lower than at December. And our return on equity Tier 1 capital was 20.4% up on the 19.8% reported last year. Our interim dividend is up 7% reflecting good underlying growth and, as you know, we've been successfully operating on Basel II since January and our GBP300 million share buyback continues.

Our strategy is building banking relationships with personal and corporate customers and delivering franchise and profit growth on a range of markets. We are not an monoline mortgage bank, that's not the way we see ourselves nor the way we've developed our strategy over the past few years. Mortgages are important to us and we aim to trade well in that market. But as this slide shows, mortgages and savings together provide 26% of Group total income. And we see personal current accounts, business banking and commercial lending as engines of growth over the medium term.

When we set out our strategy a few years ago we based it around fundamental trends in consumer behavior. We recognize that in an Internet based age consumers would increasingly be looking for value and for convenience and as a trusted brand delivering that value and convenience could successfully out-punch its weight. That's what Alliance & Leicester has been doing in recent years and our good business results in this half year continue to show firm evidence of our success. The Internet has leveled the playing field; no longer does your share of retail banking high street location dictate the size of your business. By designing products which encourage direct sales and self-service transactions we are able to offer great value and the convenience of self-service for our customers. By linking that with a well known trusted brand, Alliance & Leicester, we're able to gain customers profitably.

In retail banking in the first half of the year our market share of new business was again higher than our market share of stock for each Core 4 product, as it was in '96 and as it was again in 2006, 2005 and 2006; our franchise is growing. Current account sales were 170,000, that's up 12%, driven principally by our premier product range. Net mortgage lending was GBP2.2 billion, a market share of 4.2% reflecting a particularly strong retention performance and our entry into new sectors of the mortgage market. Gross unsecured personal lending was GBP1.4 billion with our direct model continuing to deliver good quality growth. And personal customer deposit balances grew by GBP600 million driven by a strong performance from telephone an Internet based products.

Indeed the Internet is fundamental to our strategy. A recent independent study of UK Internet banking services ranked ours best in class in many categories and joint second overall for usability. And in the first half of this year 41% of our Core 4 sales were over the Internet. We've also been proving that customers will buy current accounts through direct channels with a 67% increase in new current account openings over the Internet.

And our network of sales and service stores on the high street is also an important part of our strategy. Already in those stores which have deployed the new deposit-taking ATMs, over 34% of card based transactions now use the machines rather than the counter, and that proportion will grow. And the extra staff time freed up is increasing sales performance and enabling us to provide more advice for customers. We also have a clear strategy for commercial banking, and momentum is building very well here too. Our commercial lending book grew from GBP6.5 billion to GBP7.3 billion in the first half year.

Alliance & Leicester's had some form of commercial lending since we acquired Girobank back in 1990, but we only developed the current strategy for this area four years ago . And that strategy is based on growth in relationship banking and on growing our lending to a range of commercial sectors based on delivering good products and service from specialist lending teams, who have a thorough understanding of their sector.

We showed the breakdown of our commercial lending book by sector in February and we thought we'd give you a little more flavor about that book today. The book is well diversified, for example we have more than 335 loans of over GBP5 million. For comparison the equivalent figure at the end of 2003 was 158. The GBP1.8 billion of new lending facilities agreed in the first half of this year included a wide variety of fields and I'll give you a few examples. We used our specialist aviation and shipping expertise to take a lead role in the financing of ten aircraft for a major airline, selling down a proportion of the loan to other lenders. We also financed our 150th ship, I don't know whether it's the one on the left or the right, but one of them is our 150th. And in the US bus and coach and commercial vehicle market we completed a number of transactions including agreements to finance 39 coaches for a major transport company and over 100 trailer units for a major hauler.

Our public sector and PFI balances are now around GBP500 million including our first public private partnership lending involving an equity stake. We took a 15% share of a company with interest in six NHS LIFT companies. We continue to manage our commercial lending book proactively buying and selling loans and leases including taking a 51% stake in Mitre Capital Partners, a new joint venture between Alliance & Leicester, Rothschild and Lanebridge Investment Management. Mitre has acquired the property lending portfolio of Ansbacher & Co together with the existing management team. There are many other examples. Our commercial lending business is growing well and we plan for that growth to continue into the future.

Our business banking operations are growing too. Revenues and customer numbers increased with over 16,000 new accounts opened in the first half of the year, up 29%. The success of our business venture network has led to us accelerating its planned growth. The number of business banking centers will now double over the next 18 months, with the number of business banking managers, the relationship bankers the centers, increasing by more than that as we put extra staff into our existing centers as well.

And elsewhere in the Group we are making other additional investments, and in particular we're making very good progress on the major project to implement Alnova as the Group's core banking platform for both retail and commercial banking. Alnova is already loaded onto hardware at our Leicester datacenter and a joint team from Alliance & Leicester and Accenture is progressing well with the task of migrating from numerous legacy systems onto one single modern system. Live implementation will begin from 2008 and the program will be a major enabler for further change and growth at Alliance & Leicester, making it even easier for customers to do business with us and for us to deliver products and services even more quickly and efficiently in an Internet age. Alnova forms a key part of delivering our long term objective of above 50% Group cost income ratio.

Today's results show that Alliance & Leicester is progressing well. We're on track to deliver our strategic objectives and we have a strategy designed to provide sustainable returns to our shareholders over the long term. Indeed over the past five years we delivered total shareholder returns of over 70% without compromising on asset quality.

Any results presentation such as this one naturally includes a blend of the past and of the future and as you all know I'm about to become part of the past at Alliance & Leicester. The Group is now in great shape, delivering good results and with a strong platform in place to grow and to achieve even bigger and better things in the future. Our strategy is delivering real momentum so this is a good time to hand over. Today I will formally handover the role of Chief Executive of Alliance & Leicester to David Bennett who'll be ably supported by Chris Rhodes and Richard Banks. I've worked with David for eight years he's been with the Group; I hired him initially. He has played a crucial role in the development and implementation of the Group strategy. He has wide ranging baking experience, he's been a first rate Finance Director for over five years, he'll make a first rate Chief Executive. So now, over to David who just for a few minutes more is Finance Director, he's going to keep focused on the numbers and he'll take us through those numbers and give us his views on the future direction of the business.

Thank you, Richard. Good morning, everyone. In the first half of 2007 Alliance & Leicester delivered a core operating profit of GBP295 million, up 10%. Underlying basic earnings per share rose 2% to 42.7p reflecting the impact of the 18.7 million coupon paid on preference shares in the first half of this year. The interim dividend will be 18.8p per share, up 7%. Our underlying return on equity was 20.4% and we have continued to improve the cost efficiency of the Group reducing the cost income ratio from 54.8% in the first half of 2006 to 51.8% in 2007.

Core operating profits increased by GBP27 million compared to the first half of last year, looking at how this is broken down, strong asset growth slightly offset by a reduction in margin led to net interest income increasing by GBP39 million. Lower non-interest income and a higher impairment loss charge were partially offset by lower total costs. I'll now go through each of these areas in more detail, starting with core operating profit by sector.

Retail banking profits increased to GBP219 million, up 4% primarily due to an increase in net interest income arising from asset growth. Commercial banking profits increased by 39% to GBP96 million, the key drivers being an increase in the interest income arising from asset growth and high margins together with lower costs from the new Post Office contract. Group Items increased by GBP8 million because of the write-down of the Bootle premises which are due to be redeveloped. In terms of revenues total Group revenues were up GBP32 million compared to the first half of last year.

Net interest income rose GBP39 million to GBP412 million. Retail banking net interest is up GBP10 million and commercial banking up GBP29 million. Group non-interest income excluding fair value accounting volatility was GBP316 million, GBP7 million lower than the first half of 2006. Retail banking non-interest income reduced by GBP5 million to GBP138 million. High revenues from personal loans and Partner 4 products were offset by lower current accounts and mortgage revenues. Current account revenues were impacted by the industry-wide increase in customer complaints relating to fees.

Commercial banking non-interest income fell by GBP3 million. Higher income from the active management of our commercial lending book was more than offset by lower money transmission income, as a result of the one-off fees in the first half of 2006 relating to merchant acquiring not being repeated this year. The increase in Group net interest income, this reflects the 14% growth in average interest earning assets, partially offset by a small reduction in the Group net interest margin over the period.

And looking at margins by sector, the retail banking margin fell by 11 basis points compared to the second half of last year, mainly due to a lower mortgage and savings margin. I expect the retail banking margin in the second half of this year to be relatively stable. The commercial banking margin rose by 10 basis points compared to the second half of 2006, primarily as a result of growth and change in the mix of commercial lending. I expect the overall group net interest margin in the second half of the year to be broadly similar to the first.

Costs. Group core operating expenses were GBP1 million lower than last year. Retail banking costs of GBP180 million were GBP5 million lower than in 2006, the increased costs of servicing higher business volumes and implementing a number of new developments were more than offset by lower customer acquisition costs, increased usage of the lower cost direct channel and productivity improvements. Commercial banking costs, excluding operating lease depreciation, fell by GBP5 million to GBP139 million. This reflects the benefits from the new cash contract with the Post Office, partially offset by the growth in our business centre network and commercial lending operations.

The widening of the income cost jaws with total revenues up 5% and core operating expenses flat, helped drive a reduction in the Group cost income ratio from 54.8% to 51.8%. Within retail banking the cost to income ratio fell from 41.8% to 39.9%.

Turning now to impairment, the retail banking impairment loss charge for the first six months was GBP50 million, GBP2 million higher than last year. The GBP2 million credit on mortgages in the first half of last year was not repeated. Improvement in the credit quality of the personal loan book lead to a reduction in the charge from GBP45 million in the first half of 2006 to GBP42 million in 2007 in line with the guidance given in February. This reduction was offset by an increase in the current account charge due to the growth in our current account base. The commercial banking charge rose by GBP7 million reflecting the growth in commercial lending balances over the last few years and one new specific impairment provision of GBP3 million.

The balance sheet. Total assets grew by GBP2.6 billion in the first half. Lending to customers increased by GBP3.1 billion. The main reasons for this were GBP2.2 billion of net mortgage lending and an GBP800 million growth in commercial lending balances. Of the GBP51.7 billion of total lending to customers, 90% was secured.

Cash and treasury assets fell by GBP700 million primarily due to the utilization of funds from the securitization last November. Overall, asset quality remains strong. I'll take you through the main areas of the balance sheet in more detail, starting with mortgages.

The proportion of mortgage accounts more than three months in arrears continues to fall and stood at 0.46% at June 2007, significantly below the industry average. Although our stock of repossessions increased in the first half of the year, they still remain at historically low levels at just 65 cases at the end of June representing just 0.01% of our total mortgage accounts. Mortgage asset quality remains excellent.

In unsecured lending our asset quality remains strong. The proportion of balances in arrears has fallen from 5.6% at the end of last year to 5.5% at the end of June and is over 40% better than the industry average.

Our new lending in 2006/7 continues to be of significantly better quality than in 2005 due to the tightening of our scorecard in 2005 and early 2006. This can be seen in the dynamic delinquency graph; the 2006 line in blue is tracking below the 2005 line in orange and is close to the 2004 line shown in green.

Commercial lending continues to grow with balances standing at GBP7.3 billion at the end of June, an increase of GBP800 million since the end of last year. The majority of the increase was in secured loans. Non-performing assets, loans over 30 days in arrears represented just 0.2% of the book. Asset quality remains good.

Turning to the liabilities side of the balance sheet, the Group has a well diversified funding mix by geography, maturity and investor type. Customer deposits represent just over 50% of the Group's funding. Treasury funding, includes GBP2.4 billion from our securitization of prime residential mortgages and we will shortly complete our second securitization of around GBP2.5 billion early next month.

Turning to capital, Basel II risk weighted assets grew by GBP1.6 billion in the first half of the year and remain 37% lower than if calculated on a Basel I basis. This reflects the high quality of our assets. Total capital resources at the end of June were GBP2.8 billion. They have fallen GBP200 million since the start of the year due to the final 2006 dividend and the 2007 interim dividend deducted following new FSA guidance. Together with share buybacks, they more than offset retained profits.

The transitional floor of GBP2.5 billion at June 30 is based on 8% of Basel I risk weighted assets of GBP34.8 billion less collective provisions of GBP167 million multiplied by 95% for 2007. Total capital resources are above this floor. As for the GBP2.8 billion of total capital resources, GBP1.7 billion is required for Pillar 1. The Group's assessment of the Pillar 2 requirement is currently around 25% above Pillar 1 requirement and that is prior to any additional FSA capital guidance.

We announced the share buy-back program of GBP300 million in 2007 and have bought back 9.6 million shares at a cost of GBP109 million in the first half of the year. We're currently working on our Pillar 3 disclosures and the intention is to publish these on our website shortly after the 2007 report and accounts are issued.

In terms of the financial outlook for the remainder of the year. The Group plans to build on its performance in the first half. Total revenues in the second half of 2007 are expected to be higher than in the same period in 2006, even taking into account the GBP32 million gain on the lease sale in the second half of last year.

We expect the net interest margin in the second half to be broadly in line with the first half, with changes in business mix offsetting any reductions in back book and new business margins. The Group continues to maintain its focus on costs with the rate of growth of core operating expenses in 2007 expected to be less than the rate of growth in revenues. The Group's cost base in the second half of 2007 is expected to be higher than in the second half of last year, reflecting a significant investment being undertaken and the growth in our franchise.

The Group is continuing to implement its transformation program and this is likely to result in some redundancy costs in the second half of 2007. These are expected to be less than the GBP10 million incurred in the second half of 2006. We expect the Group's impairment charge in the second half of the year to be lower than in the same period last year, primarily as a result of a lower unsecured lending charge.

Finally, we remain committed to our share buyback program with up to GBP300 million in 2007.

Looking to the future more generally, as I take over as Group Chief Executive, please do not anticipate a Gordon Brown style makeover our senior management team, nor a sudden raft of new strategy or policy initiatives. We already have a great team and a strategy that is delivering. Our future plans are based on continued competition from UK banking, there is some regulatory uncertainty about industry issues such as current account fees and payment protection insurance, and arguably some potential for the economic backdrop to be less positive. But we're in a good position, our strategy is currently delivering good growth and our diversified revenues and funding sources, together with our strong credit quality, mean we are also well positioned if the environment should deteriorate.

Our results over recent periods show positive momentum at Alliance & Leicester. We are already for example expanding our coverage of the mortgage market, offering buy to let mortgages and our plus mortgage products. We continue to grow our current account business successfully, we are expanding our commercial lending expertise and broadening the range of lending transitions we undertake, and we are growing our business banking well. Development such as these will all be kickers to growth.

Our business model continues to migrate toward low cost direct banking and the Alnova platform will become a major part of the future of Alliance & Leicester, providing a modern banking infrastructure and further opportunities. We generally have around a 5% market share in each of our four markets, there is plenty to go for as we continue to grow our franchise, and our capital position is strong, with Basel II enabling us to demonstrate clearly the high quality of our balance sheet. We are very well positioned, we are traveling well and we will continue to manage Alliance & Leicester to provide great value for our customers and sustainable returns for our shareholders. Now back to Richard to oversee the question and answer session.

Thank you David. And we're joined by Chris Rhodes, the Managing Director of Retail Banking who will become Group Finance Director later today, and Richard Banks, Managing Director of Commercial Banking. So let's -- who would like the first question? Robert, I think I saw your hand first, Robert.

Yes, thank you, it's Robert Sage from Bear Stearns, a couple of questions if I can? I was very struck by the strength of the commercial banking division in particular, and I was wondering whether I could ask a couple of questions about it? First of all, you had flagged previously that the margin was going to be rising, but I was slightly surprised at the extent of the rise, and I was wondering whether you could sort of comment directionally in terms of whether this stabilizes from this stage onwards? I assume it's stable in half two '07, but in terms of moving into '08 and '09 possibly, should we be looking for further sort of increases there? And a sort of connected question I guess, is that looking at the still fairly low level of impairment charges, is there an expected seasoning impact as you go for slightly higher margin and therefore slightly higher risk loans looking forwards?

Okay, let me just start the answer more generally on the strategy and then perhaps David you can give some margin guidance and impairment guidance? I think the key issue on our commercial lending business is this is very traditional commercial lending business, and I wouldn't want anyone to think for one moment that the higher margin is at the expense of asset quality. Because the quality of this book is absolutely superb, and these are very traditional markets that we're operating in, not the covenant light stuff that were popular until a week ago.

So David, in terms of margin guidance and impairment guidance going forward?

Yes, I mean in terms of where we see margins going, I mean we say, Robert, the Group net interest margin in half two is going to be broadly the same as half one and we also say that the retail banking margin will be broadly stable in the second half. So the commercial banking similarly, will be broadly stable. We have seen a 10 basis point rise in the first half of this year as you correctly say, but we're expecting -- we're not expecting another significant increase in the second half of the year.

In terms of impairment, again we say that we expect the second half Group charge to fall, mainly driven by what's going on in lending. I mean, looking further forward, I mean I think you could see from the arrears numbers, the asset quality was very, very strong in terms of our mortgage asset quality 0.46, our commercial lending 0.2% and the unsecured NPL is also 5.5%. So we do have a very strong asset -- very strong asset position. So we feel quite comfortable in terms of the quality of the book. I don't know, Richard, if you want to add anything in terms of commercial banking.

Part of the movement in the margin is driven by the fact that bank guaranteed loans are a lower proportion of the overall book, but we're very comfortable with the asset quality we have, 80% of our lending is secured by assets or bank guaranteed. We specialize in particular sectors and the portfolio is generally well diversified, so you know we expect that asset quality to continue as it has.

Okay and if you pass the microphone now to the row behind. Thank you Linda.

Thank you, it's Stephen Andrews from UBS. I just wanted to explore the retail revenue growth in a bit more detail because I think the 1% year-on-year you've reported probably, or certainly reading the text, seems to understate the sort of momentum you have on that business at the moment. Two specific issues I was just trying to get a bit more flavor on, I think in the non-interest income line you've taken a provision for current account overdraft charging. I was just wondering how much that was and whether we should be viewing it as a one offer item?

And then a second, just the margin in the retail bank came down a bit faster than we were expecting, and I think it's -- in the text you say it's due to a, at least in part, due to a duration estimate change on the loan book. I was wondering should we view that as a one off, and if so how much of the margin decline did it contribute?

And then coupling those two together, what would you advise us to think in terms of about how much revenue momentum you actually have on that business relative to what's reported? Thank you.

Well let me deal with the non-interest income -- non-interest income piece first, and then David can you and Chris pick up the margin bit? You're right that in terms of our accounts for the first half we have provided for refunds on current accounts. The provision is based upon our current treatment of customer complaints, and it isn't significant in the context of the Group's results, so we haven't disclosed the number. Now we will review the basis of that provision in the event we say in the announcement of any legal or regulatory review. And since we wrote that we now hear that there will be a test case in the courts agreed by both the Financial Services Authority and the Office of Fair Trading.

We are not one of the seven companies in the test case, but we do welcome it because it will provide important legal clarity, because customers are very confused, and it is difficult to deal with their complaints. Now it's unclear how long the test case will take to complete, it could be some while. So in the meantime, along with other financial services providers we are, with immediate effect, suspending the handling of customer complaints or requests for refunds until the court case is resolved, and we have applied for the FSA waiver. So we will review that provision at the year end in the light of the progress or otherwise of the legal case.

So it has been an overhang on the first half income numbers in the retail bank, and I think that's all we can say on current accounts non-interest income, but then the wider issue on the margin, David and Chris.

Let me talk a little bit about the retail banking and then I'll handover to Chris just to talk about average lives point. In terms of, if we go through the retail banking, I mean in terms of the net interest line what we've seen is a fall in the margin of 11 basis points in the first half of this year compared to the second half of last, and that is all lower mortgage and savings margins. And the big reason is that the shortening of these mortgage average lives, which I'll get Chris to comment on in a little bit.

But we do expect that second half margin to be broadly stable and we will see a lower unsecured lending margin, but that will be offset we believe by mortgage and savings margin stability. We're obviously continuing to grow high margin plus in buy to let products. They haven't had a lot of impact in the first half because they only started lending in April, so have only completed May onwards really.

Just looking at non-interest for a moment. Non-interest fell GBP5 million; Richard's covered off the current account point. We also saw lower mortgage fees because our gross spending was slightly down. But on the other side of it we have seen very good growth in the Partner 4 products. We tell you that Partner 4 and non-interest income is GBP60 million, we also tell you that credit card excess was GBP10 million in the first half down from GBP13 million in the first half of last year. So of the remainder that GBP50 million is the non-credit card, non-interest income and that really reflects a good performance in life assurance and investments. So there is some good growth- because the Partner 4 performance that's going very well, but there have been a couple of headwinds and Chris, do you want to talk about the average lives point.?

Yes as David said there's a one off adjustment on average mortgage lives. In the context of customer behavior it relates to the average life of the product not the average life of the customer. And as you've seen from the retention statistics we're doing very on customer retention, but of course, if you retain a customer by moving them from one product to another you actually shorten the average life of the original mortgage. Just to put it into context the adjustment is about, shortening out of the average life across the portfolio as a whole of about one month. So it's not a material change in product or customer behavior, but it does impact as a one-off in the first half of this year.

So can I just come back on -- just on the customer chargings. I know it's probably not material at the Group, or the yearly basis, but it's clearly had a big impact on the non-interest income growth in the first half. Can we just at least say that ex that the non-adjust income would have actually been up year-on-year rather than down 3% or 4%. So we're looking at about GBP15 million odd.

Well if you look at the fees and commissions line the non-interest income you will see it's fallen GBP13 million, it's fallen from GBP257 million to GBP244 million and you'll also see that our mortgage and current account non-interest numbers in the Retail Bank, the implied mortgage and current account non-interest income has fallen from GBP52 million to GBP36 which is a fall of GBP16 million. Now there are other things going on in both those lines, but to give you some broad ballpark that should then give you as much guidance as we can, I think?

Okay. And why don't you move the microphone on to your right, my left.

Good morning it's Ian Smillie from ABN. A question for David please on the outlook for the balance between franchise growth and capital distribution. Obviously there's a share buyback this year and I notice in the comments for capital looking forward, you talk to growing the business and the progressive dividend policy. So could you just contextualize for us the spirit in which this year's share buyback has happened? Is that a one off on the back of the shift to Basel II or are you still thinking about future benefits to come there? Also the potential for gearing up the non-equity component within total regulatory capital, and how that squares away with the faster growing Commercial Bank in one book which we've started to see coming through?

Thanks Ian, we are a growing franchise, you can see there and we are growing commercial lending well. In terms of our capital plans, as you are aware, we announce them annually, we announced the share buyback in February on the back of the Basel II waiver and we haven't -- we're not announcing or signaling anything for 2008 this morning. We have announced a 7% growth in dividends, we do have a progressive dividend policy, meaning we want to grow it faster than RPI, and we also look obviously, towards medium term earnings. That's the sort of thing the Board will take into account. So we're not signaling anything for capital planning beyond this year.

Okay thank you. If you move the microphone back over to this side and then (inaudible) could you bring your microphone over, over there, thank you. Sir, it's you sir.

Yes thank you very much. It's Tom Rayner from Citigroup here. I've got a couple of questions. Could I just though, just go back to the current account provisions? I know you can't quantify the amounts, but do I understand it correctly that the provision you took was your best estimate at the time of what you might have to refund on fees charged to date? And if the test case rules that the banking sector was perfectly legitimate in making these charges, could there actually be a write-back of that provision, is that -- am I understanding that correctly?

Let's just go through this, the provisions were made on the basis of our customer experience to date looking forward. And at the time the accounts were signed and the RNS approved the test case information had not been released, so that was the basis. It was based prior to the test case. We do make comment in the RNS that -- and we will review the provision looking at how the regulatory and legal position develops. I can't really give specific comments on whether there is potential for write-back, what we're saying is we are providing it on our customer experience to date rolling forward over the next few months.

So there was an element of forward looking as well, that people who haven't yet claimed were going to claim.

Absolutely.

And that was your best guess to the total cost to Alliance & Leicester.

Correct, correct.

Okay thanks a lot.

Can I just make the point though, that whilst there is the waiver on refunds, in the case of customer hardship we will be refunding. Okay, so this doesn't mean there'll be no refunds from now on. In the case of genuine customer hardship and distress we will obviously put aside money for that to those customers.

Okay thank you. Can I just ask you now on costs, your guidance at the trading statement was that costs in the first half of this year, I think will be slightly below the second half of last year. It looks like it'll come in 5% below, which it maybe consistent with slightly. The guidance going forward is that the costs in the second half will be higher, not slightly higher, but higher. What should I read into that comment?

Let's deal with the forward looking piece there, what we're signaling is, going back to the revenues to start with, we are saying that we expect second half revenues to be higher than -- second half revenues in '07 to be higher than second half revenues last year. We're recognizing there's a strong comparator obviously for the second half of last year with the lease gain. And that we're signaling also that we expect cost growth to be less than revenue growth for the full year. We're also saying that we expect costs to grow in the second half of the year. In terms of trying to give you a bit more precision, what we're doing is we're obviously investing in the Alnova system, we're rolling it across business centers in the Commercial Bank, there is a lot of investment going on in the business. But we cant really be any more precise, and I think we've given quite a good guidance as it is to be honest. I can't really give you any closer information.

Okay thank you. Can I just have one last one.

Three?

I'm sorry, I didn't advertise it because I know you wouldn't let me. Suppose Northern Rock and Bradford & Bingley say that in a rising rate environment it's inevitable that arrears trend is going to go up and yours is still going down in your mortgage books. Do you agree with their basic view?

At an overall market level that has to be true that the rising rate environment will put pressure on some customers. As to each individual mortgage lender you have got to look at the quality of the assets that have been lent on particularly the average loan to value and what those customers might do if they got themselves into stress. And the lower loan to value of the customer the more likely they are to sell their property or refinance and get themselves out of any short term strain.

You have to see the quite different lending characteristics of our book compared to some of the banks who have reported recently. I would particularly draw your attention, that our stock of properties in possession is 65 at the end of June that's on page ten of our announcement. And that 65 compares to almost half a million mortgages. So we do have a quite different type of lending to some of our competitors and it's being prudent and we have reduced in this first half the amount of lending over 90% loan to value. So we continue to take a prudent stance and we would expect in any credit downturn to have to outperform the industry significantly. Tom, I'm not going to let you have another .

Thanks very much.

Can you grab the microphone from him and move it to the row behind and three seats in.

Thanks a lot, it's Jonathan Pierce from Credit Suisse. Can I ask two questions? The first is on capital and the appetite to increase the gearing on the balance, because the Tier 2 level is clearly very low in comparison to some of the piers. So what's your appetite to gear up the balance sheet a bit to allow, perhaps a further release of equity in the future?

And as a supplementary to that, does this dividend change following the FSA guidance apply across the industry?

Let me deal with the second one first if I may. In terms of the dividend change, what you -- the new -- the bit that's new is you have to recognize a foreseeable interim dividend. You have to recognize that in your capital. And that is what we've done, and that is industry wide, and we regard our interim dividends foreseeable and that's how we've shown in terms of the capital treatment.

In terms of appetite to gear up, we've got no current plans to issue Tier 2; I said earlier, I think we're well set. In terms of this year we've made it very clear what we're up to, a GBP300 million share buyback and we've done GBP109 million the first half and we plan to complete it in the second half. So as we sit at the moment there are no plans to gear up, but there's clearly the potential Jonathan, you're absolutely right, there is that potential but we don't have any current plans.

Okay thanks. The second is on product duration, sorry to come back to this. When you talk about the impact on the first half being a one off are you talking about the size of the fall in the margin being a one off and then it holds this level because you're assuming on new mortgages written that the product duration is shorter than it would have been in the past? Or is an element of this relating to what I would call experience variance? So you've taken earnings over the last year or two on a mortgage in anticipation of having a bigger SVR overhang and that now isn't coming through to the extent that you had assumed, so there's a sterling million one-off if you like, within the first half, which will allow the margin to bounce back up a little bit in the second half?

Yes there is a sterling one-off because you've recognized in the EIR calculation that you expected the mortgage to last longer, therefore there will be SVR earnings that are not going to be there, so there's a one-off catch up associated with the SVR that you're no longer going to receive. And that is a much bigger impact than the impact of the ongoing average life being very slightly shorter. And as I said, it's about a month, so the impact on new business is minimal, very much more a one off catch up.

And is that one off sterling million number broadly equivalent to the estimate you gave us in the critical accounting estimates in the report on accounts? I can't remember the number off the top of my head.

On the basis the accounts were --

It was several million of pounds.

Yes.

Okay thank you.

You're probably wondering what that bit of paper handed to me was, it's not just the cricket score, no just on that interim dividend, this definition depends on when the Board have approved interim dividends, so our interim dividend has been approved and that's why we have included it. But I'm not aware how other people have accounted for it.

And if you pass the microphone over your shoulder to the gentleman behind you, thank you.

Hi it's Manus Costello from Merrill Lynch. I just had a question trying to get to the underlying cost base in the commercial banking division. You had a one-off benefit from the Post Office contract which I think you said was broadly offset in the Group centre by the Bootle admin write down. So is it fair to assume that the underlying cost base we should be achieving for commercial is about GBP9 million or GBP10 million higher?

And then does your guidance show that costs will grow more slowly than revenues hold for that division as well?

Just coming onto -- I mean you can see on our notes on admin expenses, the Post Office is on page 22. The Post Office costs fell from GBP61 million in the first half of last year to GBP45 million in the first half of this year. We actually said in our pre-close that the release from the -- relating to the Post Office contract more than offset the write down of -- the property write down. So having said that I think your underlying premise is broadly right.

In terms of looking forward we will see some growth in costs in the second half of the year, but there are some ongoing savings from the Post Office. There was a one-off element and then there is some ongoing elements, so they will continue, but we are growing the business centre network. I don't know Richard if you want to talk at all a little bit more about the commercial bank investment?

It will be a relatively small increase as a result of growing the business centre portfolio, but David is quite right that the Post Office cash contract provides a lower cost base going forward for over a five year contract period, so you will see lower figures than previous years.

Okay and the next question is along that row there. Thank you.

Thank you, Robert Law at Lehmans. Can I ask two questions please on the commercial bank?

I'll let you.

Firstly the non-interest income line; it's obviously come down and you refer to some non-recurring items in the comparable period last year. Would we take the first half number as a base which can be sustained into the future, and obviously this line has been volatile for a while? Would you expect it to continue to be volatile or is this a representative number? That's the first question.

And the second question is in terms of projecting the margins in the corporate bank in the future, can you give us some feel for the kind of lending spreads you're getting on the new commercial lending businesses you're putting on in that division?

Just -- I'll deal with the first question and then maybe hand over to Richard on the second. I mean in terms of the non-interest income line, I mean what we've seen in that line in the first half is there has been some lower income from money transmission and we did mention this time last year that we'd had some one-off benefits, and they related to the merchant acquiring deal we did. These have been offset to some extent by active management of the commercial lending book. I mean we do -- we are managing that book actively now; well we've been managing it actively for some time and that has continued.

In terms of the second half clearly we got a tough comparator with the commercial lending -- the lease sale last year, the GBP32 million. In terms of can we give any further guidance on this line particularly, I mean that's -- I don't think we want to be any more precise than we're being. We have seen some one-off elements in the first half of the year as I've mentioned, and in the second half we've obviously got that GBP32 million from last year as a comparator. But overall that -- what goes into that line is fees driven off lending, the money transmission income which is very much volume dependent on what we're seeing coming through the Department of Works and Pensions. And then obviously all the cash handling businesses which -- and those in particular are sort of reasonably stable ish.

Yes I would add to that, that over the last few years we've seen a steady decline in the non-interest income from the money transmission products which were in decline, such as the income from the Department of Works and Pensions, and paper bill payment. That decline has significantly tailed off now, so I wouldn't expect a huge reduction there going forward.

In terms of interest margins it's very difficult to give you a detailed steer on that. As I said before, we are no longer writing big ticket leasing which is bank guaranteed which gives you margins of around 35/40 basis points because of the risk weighting of such deals. We are now much more writing vanilla type transactions which are secured by assets and the range of margin really depends on the type of asset, the type of sector that it's in and it's very difficult to do more than say there's quite a wide spread depending on the sector.

Okay and the gentleman with his hand up in the middle, next to Robert. Yes please?

Thank you. It's Leigh Goodwin, HSBC. Can I just follow up the issue of margins and the guidance? I mean I'm -- it seems to me that your guidance for the full year is slightly better than it was previously. I mean I seem to remember you talking about the decline in the Group margin being slightly less than the 16 basis points we saw last year, and now we're talking about 4 basis points. And now we can account for much of that in terms of mix, and I suppose what I'd like to know is whether there's actually any -- there's two elements to this. One should we extrapolate the change in mix into future years, so perhaps we're seeing a change -- a slight change in direction of Alliance & Leicester? And secondly, whether there's maybe anything going on in terms of an improvement in the margin outlook within each of the different product areas? So that's the first question.

I've got a second question if you want to.

Okay well let's deal with the first one. David when it comes to margin guidance I always look to you.

Sure. In terms of the steer we gave in February, I mean we were relating it back to what happened in the previous year where we saw a 16 basis point decline, and we said we would expect to see less than that in 2007. First half as you correctly say, we've seen a 4 basis decline on the first half of last year, then going forward we are signaling that we expect margins to be broadly stable, so that is our guidance and we are -- we will be less than 16 basis points. We're going to be broadly stable as I said on the first half in our view, as we get the benefits of -- we are growing the commercial banking margin, we're see broad stability in the retail margin as well, so I think we're set well there.

In terms of -- sorry what was the second part of the margin question?

Well I was just looking forward to 2008. I mean I'm just sort of asking really whether this change in mix is something we should expect to continue in the future, whether it indicates any change in direction under yourself David?

I mean we do see opportunities in the commercial banking, there is no question and we have set up this transaction with Mitre which Richard talked about in his speech, and there are areas -- there are opportunities in the public and PFI sectors, there's opportunities for us in business banking where our business is growing very well. So there's no question there's opportunities in the commercial lending area.

But in terms of retail though we want to -- we're still growing above our share of stock, we're putting our market share of net lending as well as our share of stock and we've grown very well in the unsecured lending business as well, so they will also continue to grow. So we're not signaling a massive change in mix here. I mean one of the reasons we talked a lot about commercial lending this morning was really just to explain more on -- disclose more about that book and what's going on there, but it is growing well. I don't know Richard if you want to comment at all about future plans on commercial beyond what I've said?

What we're trying to do in commercial lending is continue to specialize in those asset classes and sectors we think that we've got an expertise in. We're growing the teams which means that we can write more business per capita; it doesn't mean we're taking bigger risks. And where we enter new business areas we try and share risks, so the Mitre Capital transaction is a good example where we've entered a slightly different part of the property sector and we're taking that with partners who understand that business.

Thanks. Maybe I could just probe a little bit further on the retail margin though and guidance. You've had the decline in the first half of the year, most of which is accounted for by the -- essentially the write down of the value of the existing book through the change in the average life assumption. And I'm just wondering whether there's been any improvement if you like in the outlook for retail margins going forward?

In terms of -- I mean obviously the biggest driver of the retail margin is mortgages. The new business pricing for what I call prime mortgages hasn't really changed in the last 12 months, but what's changing in our book is we launched on balance sheet buy to let and plus mortgage in April this year in terms of applications. They've just started to feed through in terms of completion. I think we did GBP50 million of plus and just over GBP120 million of buy to let. The margin on those two products is significantly higher than prime, and therefore that will help the mortgage margin going forward as we lend into those segments.

Okay thanks. And if I could just ask an additional question, sorry to test your patience, but just moving onto the capital guidance on Basel II and just specifically in relation to Pillar II. It seems to me that your statement this morning is showing -- indicating rather a lower Pillar II charge, albeit subject to final FSA guidelines and so on. Than you were talking about in February when you essentially were saying that the Pillar II charge could account for up to 30% of the total capital requirements. And this morning's statement suggests up to maybe 20%, as it being 25% of Pillar I. So I wonder whether that really is just a semantic issue or whether there has been any significant improvement in the outlook there?

Just to explain that. I mean you're absolutely right, in February we talked about Pillar II requirement being less than 30% of total capital. This morning we've described it as Pillar II being 25% Pillar I prior to any FSA capital guidance. And what we also said in February actually was there is things we can do on Pillar II, in terms of hedging our pension fund for example is a big driver of Pillar II risks. But the key point is the way we've described it this morning is prior to any FSA capital guidance, that is the key point and that is a number we're not able to disclose.

Okay thank you.

Thank you. If you pass the microphone back. Thank you. Are there any other questions? Are we finished? I can't see any other hands up. Well okay, thank you very much indeed.

It's been a great privilege to lead Alliance & Leicester and it's also been great fun meeting with you over the years. I have enjoyed these meetings. So now for some concluding remarks and I'd like to hand over to Alliance & Leicester's new Group Chief Executive, David Bennett.

Thank you Richard. Alliance & Leicester has progressed hugely over the five years you have been at the helm. You leave behind the legacy of a significantly improved business performance, you will be a tough act to follow. You've also built a strong cohesive management team including Chris Rhodes, someone who I'm sure will make a first class Finance Director and Richard Banks who is doing a first class job running the commercial bank.

It's not Alliance & Leicester's custom to over promise, we try to say it as it is, that's certainly my style. So in summary I would say that we have delivered a good set of results today, we have delivered strong franchise growth, we've delivered improved cost efficiency, we are delivering a good return on capital from a strong balance sheet, our strategy is working.

Looking to the future there is no fundamental change to that strategy, merely a natural and continuing evolution. We're very confident about the Group's plans for the future and we look forward to seeing you again in February for our 2007 annual results. Thanks very much.