All right. Good morning, ladies and gentlemen. Welcome to RBS's Half Year Results at the end of another quiet week for bank stocks. And our results once more are quite a mixed bag. We've got continued good progress on the balance sheet. Again, capital funding the non-Core rundown all going very well. And our businesses are, generally speaking, performing much better. Certainly, our customer -- our retail-focused business is doing a lot better. GBM obviously suffering from the general market weakness in that area.
But, once again, we've got some big charges coming through, which are effectively the continuing aftershocks of the financial crisis. In our case, Greek sovereign bonds, Ulster Bank and, of course, the PPI charge for redress. I think we're all looking forward probably on both sides of this divide to the day when our results can be simply dominated by the operating performance of our businesses rather than these materializings, which seem to be a recurring feature of our results.
We're also looking forward to the publication of the ICB's final report, especially the recommendations on ring fencing. We at RBS were obviously the biggest casualty of the crisis in banking. And, of course, we did make a big ill-judged acquisition. But our losses that we've been recording since the financial crisis got going, have generally speaking, been plain vanilla credit problems rather than losses resulting from trading activities. And so, for example, in this half, we have GBP 2.5 billion of provisions in Ulster Bank, and that's a relatively simple focused Retail & Commercial bank along the lines of the ring fence activities described in the ICB report. So it will be interesting to see how an efficient, enduring ring fence structure can be identified that deals with the dynamic changes, customer needs and market conditions that are really a feature of our world.
What we will never get away from is the need for effective internal risk controls, external supervision and an appropriate management culture and team. We've made great progress, I think, on our internal risk controls. We have plenty now of external supervision, and I think we've got a fine management team in place at RBS. And I'll hand you over to the top 2 of those -- of that team to talk to you more fully about the results. Thank you. Stephen?
Thank you very much, Philip. We'll go through the normal format introduction for me. Bruce will go through the numbers and then obviously Q&A afterwards, and we'll try and make it brisk because I know you all want to get back to your screens and be uplifted after what I hope will be a characteristically cautious presentation from us.
So in terms of running through the headlines of the business achievements, and, obviously, most of you will have seen this in our press release, I think we feel that RBS has delivered a solid performance in the challenging market positions. You've seen the operating profit up year-on-year whether measured in the first half year or the second quarter on second quarter. Clearly, the Retail & Commercial businesses are the stronger performers, as you would expect in this kind of market, with U.K. Retail our strongest contributor. But we are seeing turnarounds in the areas we needed to see, and I'll talk about that more lately.
And even in GBM, which is going through the most difficult time, a first half return on equity of 15% is really not too terrible. We'd like it to be better and may not be for a while, but I think we feel that there are many good things in that business line as well.
You've seen some of the key business metrics. Our net asset value per share confusingly went up when there was a bottom line loss, which has really to do with the movement on available-for-sale securities. Bruce will take you through that.
Our Core Tier 1 I think, again, is standing us in very good stead, and, of course, we still have the remainder of Non-Core to come down and to further support our capital ratios. We've been increasing our provision coverage in the quarter, becoming more conservative in that area, and despite that and for the half, core impairments continue to go down, and that's the underlying trend. Our business derisking continues to be on or ahead of schedule, whether that be measured by non-core or whether that be measured by the structure of the balance sheet and its liquidity and its loan-to-deposit ratio and so on.
As Philip referenced it, we still have plenty of issues from the past. We're working through most of those line in the Non-Core line. Some of them lie at the lowest and the 2 big ones, again, Bruce will take you through them, PPI and Greece. Greece, where I think we've taken the most conservative view of any bank so far, but that's another story. And as it relates to supporting the U.K. economy, you'll notice that our lending, which we believe we're doing sensibly, nevertheless is something like double that of any of our competitors to the U.K. economy.
And in financial highlights, again, this is picking the Q-on-Q measure of Q2 this year against Q2 last. Operating profit up a bit, driven by U.K. Retail. Return on equity hovering around or above, depending how you calculate it. The return on capital in -- sorry, the cost of equity in our core businesses. Our net interest margin actually up year-on-year, stable in Retail & Commercial. Bruce will take you through that in more detail. Cost income ratio not where we need it to be. That will require more work, both on the cost front and on the revenue front. Impairments gently coming down, and the businesses are pretty well funded. We have more deposits than we have loans in our core businesses. And that's, I think, an important place to be in the Non-Core progress we've talked about.
And simply to remind you and update you on this, not to talk you through it, we think that there are merits to the balance to our bank that you see across different times and different market positions. You'll see that we continue to be pleased that we are weighted as a majority in Retail & Commercial, but with a strong investment banking presence. The geography, clearly, we have a U.K. dominance which will change quarter-on-quarter depending on how businesses change, but good presence in the U.S. and less in Europe and less in Asia. And then we've set out at the bottom some comparisons of our positioning, if you like, dominance of home market versus international, investment banking versus Retail & Commercial against the market which you might find interesting to reflect on.
We also clearly have, since the beginning of the RBS, recovery and turnaround plan set our stall out I hope with great clarity, not just in disclosure and frequency of reporting, but set our stall out in what we're trying to accomplish or what we think we can accomplish. And, again, we report here on this slide where we're trying to get to, where we come from and the progress which you'll see in the majority of measures year-on-year is going in the right direction, in some measures has already arrived where we want to arrive.
We have on this slide presented unchanged 2013 targets from those that were adopted 5 years ago -- 2.5 years ago, over a 4- to 5-year period. Our view is that those targets should be refreshed. We don't see the point in doing it before the regulation position is clear, and so my guess is early next year or something would be the time that we would revisit it. By way of a preview, my guess is that all of what I'll call the risk balance sheet structure type targets, we will keep the same. And capital, we will make that more conservative. Obviously, the GCP number is 9.5, so greater than 8, it's covered by that, but, clearly, we're going to be 9.5-plus, and how much plus is a little bit depends on regulation as well.
And my view is that the cost income ratio, I think, we are likely to think that 50% is still the broad territory that a bank like us should be aiming for, although whether we get there in exactly the year we wanted to might be impacted by the pace of economic recovery slowing. And that leaves, of course, return on equity. I think we believe strongly that we are in business to create a business that returns more than its cost of capital, and I think we believe that we need to keep working our businesses until we get to that position, whether that ends up being precisely 15% or whether that number softens a bit, I do think is open for debate and open to be impacted by whatever regulation comes out.
And so a couple of slides on our business performance during the recent period, and starting with our Retail & Commercial businesses and, obviously, Bruce will go through some of these in more detail. And there are a few 3 -- key things that we're trying to do. What's not on this slide and underlies everything is to do a great job for our customers. And I would say, in our Retail & Commercial businesses, we are seeing some positive signs. In that respect, we are seeing, if you like, brand awareness, customer satisfaction, improving dropping of complaints, some nudging upwards and some cross-sell levels. So all the programs that we've talked about in the deep dives in our businesses that many of you have seen, at the moment, seem to be pointing in the right direction, though it's early days for businesses of this kind.
And you'll see that in profitability terms, it is already the case that the majority of our RNC businesses hurdle higher than the cost of equity. There are a couple that don't at the moment in the U.S. and Ireland about which more in a second. It's also true though that those businesses, while being, I think -- most of our businesses while being in good shape, in profitability terms, we have business improvement programs that have still got more to deliver. The credit outlook, we believe, on balance is still in improving, and there's more to come there. But, clearly, slow economic growth and low interest rates soften the speed with which income can advance, and Bruce will also talk about that more.
Despite that soft picture in terms of being able to get money out of the door in a profitable way, there are a couple of bright spots. In the U.K. mortgage market, we still are one of the few players because we've got more deposits overall than we have loans that can fund itself and compete and gain share. And in the U.S., which hopefully is a lead indicator for the U.K., we have begun to see the ability to grow our commercial loan balances, which is an encouraging early sign which I hope continues.
You'll see the slope of impairments up here, which is another key aspect of what we're doing in Core. In terms of risk and balance sheet structure remains an enduring focus for us, and you'll see again this quarter against the period a year ago that the funding surplus from our Retail & Commercial businesses continues to improve, again, a very important thing given wholesale market turmoil. But we'll also make the point, which is important to understand, that a chunk of our Retail & Commercial deposits, about 1/2 of the deposits, a bit more, that are in our GTS division, actually relate to GBM clients, and so in a sense, the retail bank is not funding the investment bank, but the clients of the investment bank are funding the investment bank through deposits as well as on the wholesale operations.
We have obviously been focused, in addition to strengthening all of our businesses, specifically on some turnaround situations in Retail & Commercial. The 2 underperformers relative to cost of capital have been the U.S. and Ireland. And you'll see that, at the moment, despite a slow and tough U.S. economy, and despite significant regulatory headwinds on fee lines in particular in the U.S., we believe that we are making progress in the U.S., which gives us encouragement that we can get that business back to the point where it's pulling its weight within our overall portfolio.
We stripped out -- just to be clear, there was a one-time pension gain in the second quarter last year. For ease of comparison, we stripped that out, and you can see, I think, a reasonably consistent upward trajectory in profitability, which is driven mainly by continuing increase in net interest margin, including in the last quarter in the U.S. business and, as I say now, just beginning to be some expansion of the asset line as well. And along with that, you'll see, which you see on the right, impairments have been coming down.
On Ulster Bank, and, again, Bruce will go through that in rather more detail as it relates to the impairment line which clearly is the main story still in Ireland, we are hopeful that the corner has turned. At the moment, there are the first signs in economic statistic terms that our provisioning has gone down for the first quarter. Of course, we hope that what's going on in markets around us doesn't set that back, so we're not doing any victory marches at this juncture. But anyway, there's some hopeful signs there. And given the turmoil in Ireland over the last year, I think it is to the credit of our business that we actually had been able to fund improve slightly, the funding profile of the Irish business by holding our loans steady and slightly increasing deposits. We obviously need to keep going with that.
The Investment Bank, clearly, particularly all our banks that have investments banks, are particularly in the spotlight given that, that's where the market turmoil is hitting the most. And, clearly, we have subdued revenues, as you would expect, in this market to set the market conditions, and our revenue performance and therefore our profit performance also reflects a relative weighting towards Europe in our business and a relative weighting towards fixed income in our business. These things will come and go according to market patterns over quarters, but that's where we are.
Clearly, we are working very hard to keep the ROE as high as we can, to keep the cost income ratio in a position where not too much of it is given away, of the revenue is given away. And, priority number one in our business is actually just not to make any stupid mistakes. You'll notice our VAR came down something like 44% Q-on-Q. That's a bit of an exaggeration as to how much risk them down because there's some time series of all that came out of it, but, nevertheless, it's showing you that we are picking safety over high octane revenue bets in this business. I think that will mean that we'll run on lower revenues for a while, but I think that's the only responsible thing to do in these kind of market positions. And, obviously, whilst we do that, we've got a huge amount of change inside the business in any event, which is expensive, but I think retooling us for the future, and we need to keep looking at costs and we will.
And then the final one of the ongoing business is insurance. Clearly, the turnaround in insurance is important in any event and particularly important given the EU requirement to sell this business. We believe that we are on course for a sale process in the second half of next year. We continue to think that an IPO is the most likely method, and we believe that this business will stand up well to scrutiny when we get there, and, in fact, we plan an investor teach-in on the business and a teach-in for you later in the autumn.
But in the meantime, clearly, as you know, the make up of the business is: number one, motor insurer in the U.K., number one; home insurer U.K., prominent in a number of other personal lines. We've held those market positions. We've done major surgery to the risk profile of the motor book, as well as to the competencies that will govern us in the future, and that's showing through nicely in profit recovery and recovery of the key operating risk lines.
Turning to Non-Core. I mentioned in my introduction things going according to plan. So another GBP 12 billion off the asset total in the last quarter, heading for under GBP 100 billion this year. The P&L, Bruce will explain a bit more, but there were some loan write-offs that appear in income which otherwise should net across the impairments, but the P&L behaving itself relative to our expectations and managing to get down risk across the portfolio. We've always been clear that the real estate, that would be stickier than some others so that the percent of real estate is increasing. But nevertheless, we have reduced our real estate exposed by 41% in the last 2.5 years, and so I think that should give encouragement that this division as a whole is on track, not immune from what's going in outside markets, but on track to do the things we needed to do.
And so my final slide, just in terms of outlook. Clearly, no one needs telling that there are external uncertainties, whether that relates to the economic and interest rate outlook, sovereign debt issues, the path of the Irish economy, which at the moment tentatively is in the positive; Basel III, which is becoming clearer in the ways that we expected, and support and the IBC, which we have talked about.
And in terms of the outside world which we can't affect, the contrast with the inside world which we can effect, we do see the ability to continue to progress in Retail & Commercial. We do see the ability to continue the performance improvements in the turnarounds that we had on our docket. We are cautious about the outlook for GBM in the next quarter or two, because I think anyone would responsibly be, and Non-Core tentatively we think is on track. We would expect impairments to fall, but a fair chunk of the, if you like, the room made by that to use -- that we would use in disposal of losses to make sure that some of the stickier assets get gone as well.
And so with that introduction in terms of what's going on in the businesses, I'd ask Bruce to take you through the figures. Thank you.
Bruce Van Saun
Thank you, Stephen, and good morning, everyone. Let me start off with a brief review of the second quarter financial performance.
Looking at the consolidated group financial highlights for the quarter, our group income was down slightly versus the prior quarter, as GBM's income declined in a tough market environment after a seasonally strong first quarter. On the other hand, the Retail & Commercial business maintained its strong performance, with underlying income of 2%. Expenses were down versus Q1 and versus a year ago, reflecting both the lower GBM income and strong cost discipline. Our claims cost continued their improvement, both on a prior-quarter and a year-on-year basis, as the insurance division's derisking strategy is paying off.
The profit before impairment losses, or PBIL, was up about GBP 100 million versus the first quarter and GBP 350 million versus the year-ago quarter. Impairments ticked up in the quarter in Non-Core, which reflected a targeted provision to Irish land values and a few single-name corporate impairments.
The so-called "below-the-line" items increased in the quarter to GBP 1.5 billion. That included a PPI provision of GBP 850 million and a GBP 733 million provision against our Greek sovereign exposure, which resulted in a bottom line loss of GBP 897 million in the quarter.
Nonetheless, the Core Tier 1 ratio held steady at 11.1%, and our TNAV strengthened to 50.3p.
Looking at the detail of our P&L categories. The net interest income was down 2% versus the prior quarter, with Retail & Commercial flat. Note that 87% of our net interest income comes from Retail & Commercial. The group average interest earning assets were up by about GBP 3 billion. That was driven by GTS in Retail & Commercial, as well as group treasury's expansion of the liquidity portfolio.
On the right side of the slide, group NIM was off by 6 basis points on a headline basis, but it's 3 basis points if you adjust for the U.K. Corporate one-timer in the first quarter. Now in R&C, the underlying NIM expanded slightly versus Q1, up 1 bp, and it's 11 basis points higher than a year-ago quarter. We've now moderated our expansion assumptions at this point, given the persistence of low rate and the flattening yield curve, but we clearly expect R&C's NIM to remain stable.
GBM's NIM decline largely reflects Q2 subdued money market income. And GBM and Non-Core also bear the brunt of the costs of strengthening our liquidity and funding profile given their funding gaps, and that hurt the group NIM by about 2 basis points in the quarter.
Our operating expenses fell 6% relative to the prior quarter, and that's down 5% versus a year ago, a good performance in light of increased investment spending in the quarter. Against the prior quarter, second quarter staff costs were down 10%, driven by lower incentive accruals in GBM. And the cost reduction program that we've undertaken delivered a further GBP 100 million of savings in the quarter. The program continues to deliver against its target, and we're actively working on further initiatives. We anticipate GBP 3.3 billion rate of annualized savings by 2013. The group cost-to-income ratio improved by 200 basis points in the quarter to 56%.
At the headline level, Q2 group impairments rose over GBP 300 million versus the last quarter, as core impairments declined modestly and Non-Core impairments increased by about GBP 350 million. The Non-Core increase reflects a provision against land values in the Irish portfolio, as well as some large individual corporate cases.
Note that the recoveries on equity positions from workouts that we recorded in Non-Core largely offset this increase in Non-Core. So there's a little bit of income statement geography going on here. Those gains from equity positions are reported in other income, which is why you saw income pop in Non-Core. So we managed to a total budgeted loss in Non-Core that reduced GBP 200 million relative to the first quarter.
Turning to provisions. The loan impairment provisions increased further by GBP 1.5 billion, so the balance sheet sits at GBP 21 billion at the end of the quarter. This gives us REIL coverage of 49%. We continue to see a gently positive trend for impairments, and we expect Irish impairments the decline in the second half.
Now turning to the so-called below-the-line items. Q2 saw a total charge of GBP 1.5 billion, which is up about GBP 300 million on the previous quarter. Q2's items include the previously announced GBP 850 million PPI charge, as well as GBP 733 million impairment charge against the Greek AFS bond portfolio. So you're aware of the GBP 850 million PPI charge. It's worth commenting probably a little more on the Greek impairment.
We've written our entire position to market values after deeming it impaired. If the current planned restructuring of the pre-2020 maturing Greek debt is approved in the second half, we would stand to recover about GBP 275 million of that charge in the second half.
At fair value of own debt swung positive in the quarter. That remains volatile given significant moves in our credit spreads. And the APS charge declined versus Q1 to GBP 168 million. Now today, we recognized GBP 2.2 million -- GBP 2.2 billion cumulatively versus the minimum fee of GBP 2.5 billion.
The quarterly tax charge also continues to be a drag. It's driven by the ongoing Irish losses, and in this quarter, also by the lack of tax relief on the Greek impairment, which is housed in the our Dutch entity. We continue to look forward to seeing these drags from the so-called sins of the past diminish with time.
Focusing on our Core performance. The operating profit declined versus prior quarter, given the fall in GBM revenues, which reflected a more difficult environment and a decision to dial back on risk. Our average trading for GBM was down 44% relative to the first quarter. Stephen indicated some of that is a statistical anomaly from time series data, but also indicates directionally that GBM was really crunching back on risk.
R&C saw underlying income and NIM rise and impairments fall which led to a 13% sequential improvement in underlying operating profit. ROE improved to 12% in the quarter in spite of the drag from the Irish loss. Compared with prior quarter, Core delivered a 6% increase in operating profit as declining claims and impairments boosted the bottom line. Within Retail & Commercial, net interest income was up 3%, with declining costs and impairments driving an underlying 24% bottom line growth.
Walking through each of the divisions with a few comments. U.K. Retail continued its strong performance. Income was up 3% on the first quarter. It's driven by good fee growth related to transactional and investment sales income. Good cost discipline continues, while driving down direct costs, and that boosted the bottom line by 3% relative to Q1.
U.K. Corporate's underlying income was broadly flat on the prior quarter. Costs were down 5% versus Q1. Impairments, headline impairments were up Q1 due to a handful of single-name impairments and lower releases. I think there's some lumpiness there between the releases and the timing of taking impairments, nothing that we're concerned about. You have to look at this on a half-year-on-half-year basis. The impairments were down by 16%.
Wealth move forward with the execution of its strategy in the second quarter, adjusting its footprint, refining products to better meet client needs and rolling out its technology program. The quarter's highlights include strong income growth which was up 6% versus Q1, and that was boosted by improving asset margins and good growth in lending volumes.
GTS continued to gather momentum. Its PBIL was up 5% versus the first quarter. Again, that was driven by strong net interest income performance. Loans and advances were up 12% on the prior quarter, reflecting good levels of activity in trade lending in Asia. Impairments though, were impacted by a large single-name charge in the quarter, which is really highly unusual for that division and one that we would've hoped to avoid but, anyway, we're working through it.
Continuing on, Ulster Bank. We were pleased to see better performance in the Core part of Ulster Bank, although there is clearly still a long way to go. The profit before impairment loss was steady in the quarter. Impairments fell by 42%, mainly in residential mortgages. Again, there's a bit of timing in that, but we think we're at a better run rate now. Customer deposits were up slightly by about GBP 0.5 billion during the quarter, which is a strong performance relative to our peers.
The U.S. R&C business had a strong quarter as the franchise continues to improve. Our income was up strongly in the quarter due to lower funding costs and recovery in fee performance, lower impairments further boosted operating profit for the quarter, and our ROE improved to 7%. So we're confident that we think at least that level for ROE is sustainable, and we're looking forward to getting back to double digits.
GBM performance was in line with peers. Adjusting for the business mix, GBM saw a subdued income performance in rates. That reflects receding expectations for rate rises in the U.K. and in the U.S., as well as a reduction in our clients' risk appetite. But the bottom line here though is that GBM's first half performance of GBP 3.9 billion of revenues and a 15% ROE is quite respectable, all things considered. Management tightly managed our risk, and the balance sheet position that we will continue to maintain, as Stephen said, until the market settle down.
Insurance saw the second straight quarter of improving profit as the turnaround plan continues to deliver results. Expenses were down 7% due to our reengineering program, and our underwriting and process improvements resulted in a 10% fall in claims. Q2's ROE was 15%. The first half ROE was at 11%, and we continue to work towards an IPO in the second half of 2012.
Turning our attention to Non-Core. The bottom loss declined further this quarter, down by nearly GBP 200 million. The strong income performance in the quarter reflects some sizable securities gains from our recovering workout portfolio, including the IPO of Samsonite.
Impairment losses were higher in the quarter, as I previously mentioned. Our coverage ratio is probably worth pointing out. Our coverage ratio of REILs in Non-Core improved further to 48%.
Non-Core's rundown continues to make excellent progress. You can see the glide path here during the quarter. Of the GBP 12 billion reduction to GBP 113 billion, GBP 7 billion of that was disposals and GBP 4 billion was runoff. At the end of the second quarter, we had pending transaction backlog of about GBP 2.5 billion, and we have a fairly strong pipeline considering the environment, and we are hopeful that it hangs in there reasonably well. We believe we're on track to meet the GBP 96 billion year-end target at this point.
So let's turn to the last section. I'll give you an update on the excellent progress that we've been making on risk reduction, as well as on our funding and liquidity position. Improving our risk profile remains key underpinning to achievement of group turnaround. Group progress has been continuing in the first half, and some of the highlights we've noted here on the slide. First off, very topical, is the peripheral European sovereign exposure in the banking book. We've listed here the countries of greatest interest, and you'll see that our exposures is quite modest, very limited in the case of Ireland, Spain and Portugal. And then the bigger one is Italy. But, again, that's quite modest relative to our capital and our balance sheet position. We have very fulsome disclosures of all of our other exposures in these countries. I think, again, though, if you look at what happened in Greece, with respect to banking book sovereign exposure, it's an outsized position, and it was a legacy of ABN AMRO being a European Eurozone bank and investing in those types of sovereign bonds and their liquidity portfolio.
In the overall sectors, we continue to work on taking down concentrations. Property is a big one that we've been focused on. That's reduced 7% over the past 12 months and reduced by 3% in the first half. We're also very focused on right there in continuing to make headway with our single name concentrations or tall trees. That's down 33% versus a year ago. So clearly, there's more work to do here at the halfway stage of the 5-year plan, but we can see, certainly see, signs of tangible progress.
Digging in a little bit further on Ireland. We continue to provide quite fulsome disclosure here as well. In the Non-Core portfolio, the REILs have continued to rise. The CRE development book has now got 87% of its loan book in nonperforming, so it's quite impaired. And we've improved the coverage ratio at this point to 56% versus 46% in the first quarter. So we feel good about that level of provisioning.
On the rest of the Non-Core book, provisioning is also up quite a bit. It's 53% as of the end of the half, which is up from 47% at the end of the first quarter. Provisioning levels in Ulster Bank Core book have also continued to strengthen.
We're actively managing these impaired assets, but, of course, Ireland will continue to be a long-term workout and is heavily dependent on the path of the economy from here. The Q2 Irish impairments across Core and Non-Core were down 4% relative to the first quarter. Our view at this point, again, is that the second half impairments will fall particularly in Non-Core.
We continue to make good progress with our funding and liquidity position. The group loan-to-deposit ratio has improved further to 114%, while the Core loan-to-deposit ratio remains at 96%, which is below our 2013 target. We remain focused on bringing down the level of wholesale funding to actively term it out and to continue with our deposit growth initiatives. A standout in the first half was the GTS business where deposits increased by 6% to GBP 73 billion. At June 30, the wholesale funding greater than one year was stable at 56%, and deposits represented 58% of our funding structure, a number that compares favorably with our European and our U.K. peers.
The improvement of our funding position continues to be driven by the rundown of Non-Core and our ability to issue term debt across the spectrum of markets, currencies and term structures. We targeted GBP 23 billion of issuance in 2011 and we've made good progress. In the first half, we issued GBP 18 billion, GBP 8 billion of private, GBP 5 billion of secured and GBP 5 billion of unsecured. And looking forward into the second half, we have a relatively limited term funding requirement of GBP 5 billion remaining.
Our gross RWAs were down by GBP 9 billion due to a reduction in GBM market risk, as well as the net impact of Non-Core derisking. Our Core Tier 1 ratio remains strong at 11.1%, despite the GBP 1.6 billion of one-offs that we took during the quarter. Looking forward, our guidance on Basel III remains unchanged. However, we'll continue to work to mitigate the CRD impacts on our capital base.
So to sum up, our Core franchises have shown resilience in a challenging environment, as well as the benefit of having a diversified business mix. The Non-Core rundown, the overall derisking and balance sheet strengthening continued to progress and are either on or ahead of target, and our capital base remains robust.
Thanks, and let me turn it back to Philip to lead the Q&A.
Thanks, Bruce. Usual basis, which is you put your hand up, we'll identify targets, and if you can announce your name, rank and serial number, that will help everybody.
It's Tom Rayner at Exane BNP Paribas. I wonder if it's possible to get Slide 4 up because it's quite hard to read in the back here. But my question was just going to be looking at your liquidity portfolio versus your short-term wholesale funding. And if the market is worrying about possibility of another sort of short-term funding squeeze in the market, I'm just wondering how significant is that, the fact your liquidity portfolio is now actually greater than your total short-term wholesale funding? I mean, can you run that portfolio down materially if you needed to?
The answer to that is yes. Obviously, we hope not too, but we built it out for a reason, for the same reason that we did more term funding than the pro rata amount earlier in the year. And that's standing us in good stead at the moment. Clearly, these are difficult markets, but for the moment, so far, so good.
Bruce Van Saun
Actually, Tom, the number is slightly incorrect. The short-term wholesale funding, excluding derivatives collateral, is GBP 148 billion. The liquidity portfolio's GBP 155 billion. Those derivative positions are netting. They're shown broad, so we've excluded that in the calculation, so we actually do have more liquidity than we do short-term wholesale funding.
Thomas Rayner - Exane BNP Paribas
That's what I thought the slide showed actually. Okay. Just one other quick question. The GBP 7 billion of disposals in Non-Core, what were the losses, if any, associated with that disposal?
Bruce Van Saun
They were quite modest because we've taken -- remember in the fourth quarter, we had a very big pipeline and we've been pulling through that pipeline, so a bunch of that disposal loss was already incurred previously and recognized in prior periods.
Michael Helsby - BofA Merrill Lynch
It's Michael Helsby from Merrill Lynch. I've just got a question on the stress test, actually. You guys came out relatively quite bad, so I'd just invite you to comment on that. And also just hypothetically, clearly, everyone's extremely worried at the moment. If that scenario came to pass as a group, would you be -- I wouldn't use toward happy, but would you be comfortable to see your Core Tier 1 run down to that level? Or is that a level which would require additional capital?
Bruce Van Saun
The first part of that, I think it's been well chronicled that there was a real straitjacket that the EDA applied in terms of the rules around that stress test, which one of the ones that was particularly, I think, inappropriate for a bank like ourselves was the limitation of trading income to the average in the past 5 years, given the sizable loss that we took earlier in the crisis and then putting a stress loss on top of that, which basically moved us to a negative income position in trading. So that alone was worth 80 basis points. Adjusting for that would put us much more back in the pack. Now there's quite a few other things which have also been well chronicled, which I think the way insurance was treated, for example, the way some of the Non-Core rundown was not permitted even though we have a pipeline but it wasn't a mandate like with the EU. So there's some other adjustments that we would make which would say, I think, our performance was somewhat misleading in terms of the bottom line. Having said that, we do still have a big balance sheet, and we do have exposures, and so we're very mindful and careful of how we're managing the risk, and we're trying to obviously derisk and delever as quickly as we can. Stephen, you want to take the broader one?
I think that on the broader one, obviously, it's hard to second-guess circumstances. We are certainly working towards a point that when we're done, and we're not done now, we would want to be able to keep our Core Tier 1 over 7% in the future, even in extreme stress, but we're not at that point yet, and that would be on the Basel III. But I think as Bruce has indicated, our Core Tier 1 is higher today than it was in December for the European stress test. The European stress tests were very idiosyncratic and hit us in a disproportionate way in a way that we didn't think will happen in real life, so at the moment we're feeling fine on this front.
Rohith Chandra-Rajan - Barclays Capital
Rohith Chandra-Rajan from Barclays Capital. A couple of questions on GBM, if I could. First, just on cost flexibility. Given your outlook for a tough, understandably tough, revenue environment, comp ratio picked up to 39% in the quarter despite some reduction in those costs. Just wondering how we should think about that going forward? And secondly on GBM, GBP 7.5 billion RWA reduction in the quarter. What degree is that one-off or part of an ongoing program?
Bruce Van Saun
Okay. Sure. On the comp, there is a fixed element to the comp pool, so there's clearly salaries and then there's deferred compensation from prior periods. So just mathematically, as revenues go down, you're going to see a ticking up of the comp ratio, but we did certainly lower our current projections for the annual award to GBM in line with the lower revenues. So I think what you have to look out from here obviously is that you're in a protracted period where you think revenue is going to be lighter, you probably have more capacity in the plant that you need and so you have to look hard at your headcount and see if there's opportunities to reduce heads. So that would be the first one. The second one, on the VAR decrease, we did get a benefit, as Stephen indicated. Some of this is related to time series data, so when markets were highly volatile, you go back in historical reference point and you pick that up. That's been rolling off. We might be replacing it in the current environment with new volatile data points. And so that might net out. But at this point, a portion of that reduction looks like it will just flow through, provided the markets stay reasonable here. And then the other part of it was discretionary on the part of GBM to take down risk. And then assuming the markets got firmer, we would dial off the risk a little bit and capture the revenues that we'd see in terms of the increased flows in the business. I can't give you the exact split, John. I don't know if you have a -- if it's 50-50 or what the split is, but there's clearly -- some of that is the time series data, and some of that is the risk dialed down.
Rohith Chandra-Rajan - Barclays Capital
Just briefly on Non-Core. Are you slightly paring back your asset disposal aspiration for the year? You previously guided to GBP 96 billion. It's now a little bit softer, less than GBP 100 billion.
Bruce Van Saun
No. We're still targeting GBP 96 billion.
Robert Law - Nomura Securities Co. Ltd.
Robert Law of Nomura. Could I explore a couple of areas, please? Firstly, on the capital side, I mean, I know you're looking at the risk-weighted assets, gross of the EPS amount. Could I ask you to comment on the capital on a stressed position, assuming you were to exit the APS. And I know the FSA is obviously looking at capital in a stressed position rather than on a regulatory side. And assuming you exit the APS, can you advance us on your thoughts on where you progress in terms of capital distribution at a later point, obviously, given where the stock price is now in relation to the conversion of these shares? That's the first area.
Sorry. Could you be a bit clearer on what you mean by distribution? So effectively, we will be working with the FSA through the stress test process at the later part of this year. They run 2 scenarios a year, and they'll have a fall scenario that we need to run probably off of the third quarter data, and then we'll have to roll that forward to the year-end data. So I would anticipate that no decision by the FSA will be made on the exit until we get through that process, which given the amount of crunching that takes place around those numbers, you're probably looking at sometime in the first quarter. I don't know if it'll be by results. I'd like it to be by results, but it's hard to say if it will be at that point. And so, clearly, one of the views is the stress scenario that they develop based on how the world looks then and then where our capital position is, which we've been trying to maintain a very robust position clearly given the current situation. So we're still stating that it's our public desire to exit APS in October of 2012. We don't want to put any new money up beyond the GBP 2.5 billion minimum, and we're working very hard to accomplish that. Clearly, beyond that, how much additional capital we have to turn on the coupons and then ultimately do something on the DAS and then ultimately put the dividend back in place will depend on how we do financially. We believe we'll have some of the capacity to do that in a reasonable time frame, although that could elongate, and that obviously will impact the timing of the privatization.
Robert Law - Nomura Securities Co. Ltd.
And the second area was on Non-Core. Could I ask you to comment on the trends in the margin in Non-Core, given what's happening in funding markets at the moment? And, overall, given the -- with the RWAs, I think you still have there GBP 125 billion, the shrinkage in the quarter and losses were bigger than the capital release. Could you comment on whether you think Non-Core rundown will be capital accretive over the period?
Bruce Van Saun
Okay. So in the margin, with respect to the margin, we are seeing a bit of an eroding margin. I think it went from 90 basis points to 87 basis points in the quarter. And so we're a, selling off loans that have high yield in some instances; and b, as we've improved the term structure of the wholesale funding, they have a big funding gap. They're largely a wholesale funding so that gets passed through to them. So we could continue to see erosion in that net interest income. I wouldn't worry about that so much frankly, because we run Non-Core overall on a budget, if you will, or if necessary, will. And so that also expands or contracts based on everything in the P&L. And so if we have a little bit less net interest income, we try and make it up elsewhere as we go down through the P&L. So what I'm trying to get people to focus on here now is the Retail & Commercial NIM, ultimately the NII that's associated with Non-Core goes away and disappears, and the key number to stay focused on is retail NII, which at this point seems rock solid, was GBP 322 million versus GBP 321 million in the first quarter. The second question was, just refresh me.
Robert Law - Nomura Securities Co. Ltd.
Capital accretion over the runoff of Non-Core.
Bruce Van Saun
Yes. We are doing this to very much focus on getting a bang for our buck in terms of delivering capital and having the losses. We look at the size and shape of the losses going forward relative to the capital that's generated, and it most definitely will be capital accretive. One of the reasons for the little blip in the second quarter is we are also doing some derisking in our market risk positions, which doesn't have a TPA impact. It will have on RWA impact as we work through the trades to do that which are somewhat complex. We can see and actually encounter RWA move for a period of time before all of those trades novate off, which is what you saw in the second quarter.
Leigh Goodwin - Citigroup Inc
Leigh Goodwin from Citigroup. 2 questions, please. One on insurance, which was a good performance quarter. The combined ratio is now below 100%. I wonder if you could give us an idea whether you expect that, whether that's -- you see continued improvement in that, I mean, not withstanding volatile weather-related type of issues. And my second question is just really if you could give us a comment please on July trading, particularly in relation to GBM. Also, on the sovereign exposures.
Paul, do you want to pick up the insurance?
Yes. The second quarter is always a good quarter for insurers. Homes tend not to get flooded by snow and the drivers aren't hit on the roads. So it's a great quarter, and it was a particularly good quarter for us. So whilst our longer-term ambitions are to have a double-digit or even triple-digit Core, 99% is a good performance, and we wouldn't expect that to necessarily be maintained through this year, but that's more in line with our longer-term expectation.
On GBM trading and sovereign exposures. As you can see, our sovereign exposures on the chart that Bruce put up are not material, so they're not the ones, if you like, that are particularly worrying us. July trading was poor in GBM, not big losses but just the revenue rate was poor. I suspect it would have been everywhere else.
Peter Toeman - HSBC
Peter Toeman from HSBC. Your 15% ROE target that you've had for the last 2.5 years is now sort of under threat from regulatory intervention. Obviously, there's a sort of a minimum ROE below what you can fall and have to pay sort of realistic dividend to shareholders and organically finance balance sheet growth. So I was wondering if you might be able to steer us towards what you feel this sort of minimum ROE might be?
Well, I'll just have to repeat what I said earlier on that I think any business needs to exceed its cost of capital. And if it can't, it needs to keep restructuring and keep changing things until it does so that will be what we do.
Right in the middle.
Chris Manners - Morgan Stanley
It's Chris Manners from Morgan Stanley here. I just have a couple of questions on the Retail & Commercial division. Firstly, just on the net interest margin. Obviously, you managed to increase it by one basis point in the quarter. Given what we're seeing in wholesale funding markets and presumably deposit competition is likely to heat up, should we be expecting a sort of flat progression? Or do you think it should actually just sort of nibble down a little bit as we go through the rest of the year? And secondly, just on Core loan growth in the Retail & Commercial division, it seems to be only growing 1% also on a year-on-year basis. U.K. Corporate loans fell in the quarter. That's below normal GDP. I mean, is there a potential that we could actually some more meaningful growth in this division or...
Okay. As I said, I think the Retail & Commercial NIM, we would expect that to be stable. So what are the kind of cross currents? We still have a modest amount of asset repricing although we're largely through that. That's somewhat offset by a business mix kind of tightening, if you will. So for example, in retail, we're doing more mortgage origination and less personal unsecured origination so that tends to work against the margin and negate that asset kind of repricing benefit. And then on the liability side, we've been, I think, reasonably stable. We are not out competing aggressively for deposits but we are seeing some growth in pockets like GTS and wealth in terms of deposits so I think we'll continue to see stability there in the second half. The volumes is really a hard call, particularly if the economy is on the cusp of a double-dip or a recession -- a recessionary environment. The hard part has been demand is to stimulate demand is to certainly open and hoping to land. And I think we've been out aggressively on the corporate side and on the retail side trying to hit our lending targets. In the U.S., we're actually seeing a pickup. We indicated in the prepared remarks, in the U.S. on the commercial C&I side of the business, and that's been helpful so the pipeline is pretty strong there. But I think it's going to be spotty, and it's going to be challenged to see any kind of loan volume growth until the economy gets stronger.
Manus Costello - Autonomous Research LLP
It's Manus Costello from Autonomous. I noticed that you've had to delay the closing of the Santander transaction to the end of 2012. Should we assume that you just keep profits for the second half of 2012? Or will there be a change in the terms of that transaction? And is there any risk if conditions deteriorate in the market further that, that transaction doesn't happen at all?
Bruce Van Saun
No. I think the likelihood is this transaction gets done, probably closes sometime in Q4 at this point, and so we retain the incidence of ownership up until that point. So we own the RWAs and we get the profit in the business until it closes. Now clearly, there'll be some to-ing and fro-ing contractually actually on -- there's going to be, I think, a bigger separation effort and transition effort over to Santander and how those costs are absorbed are things that we're working through Santander. But I think we're in a pretty good space with them in terms of having that sorted out at this point.
Michael Helsby - BofA Merrill Lynch
It's Michael Helsby again from Merrill Lynch. Just a couple of follow on questions. Firstly in GBM, I guess there's been a couple of banks now that have said that they're going to sort of scale back on risk and not necessarily focus on just the driving top line revenue in that business. If you think back 3 years ago, what categorized that period was you saw quite a big expansion in margins as banks sort of looked to widen a bit of the office spread. I guess the question is, do you think that can happen again? And at what point do you start putting your prices up to your customers to try and capture the more volatile environment? And second question is just, I guess looking for a bit of perspective from you guys. Clearly, your share prices are as low now today as it was sort of not quite as low but it's not being as low since the depth of the crisis. I was wondering if you could maybe just wrap up by giving us a perspective of how you see things at the moment? Bruce, you just said we're on the cusp of a recession potentially. It doesn't look when I look at your numbers like you've seen at the moment, clearly, everyone's worried about the future. I was just wondering if you could give us a bit of perspective today versus where we were maybe in 2008. And maybe just by again clearly, we're seeing on the screens but using this opportunity to reiterate where you are today versus where the bank was in 2008?
Quite an arousing speech. Let's see if I can hold down on the job. Look, my own view is that it is always important to be able to be calm when people around you aren't being calm. And normally, that's the right thing to do. And I think that the transmission mechanisms between market upset and real economies are normally less strong than markets fear. And so my end view is that the greater probability is that economies do continue to on balance recover, that doesn't mean say they do every single quarter, but we have always thought and planned and that's one of the reasons I've always struck a cautious note. We've always expected the process of the world working through it's imbalances to be a slow and difficult one even if it's one with a generally an uphill slope to it, and that would still my view and I think that's becoming more apparent. Within that, our expectation is that the derisking and balance sheet recovery that we have already accomplished will stand us in very good stead, and that most of our businesses can create solid returns, even if they're not the returns that we would ultimately like but can do a solid job in this kind of environment. So I think that's the mainstream for me as it relates to RBS is that the RBS story goes forward a bit slower than we wanted with a bit of a flatter trajectory than we wanted, but nonetheless, noticeably goes forward. Now we're not blind and stupid, and of course, there are scenarios where some of those debts will be off the table. I think they are low probability scenarios but they require a lot of concentration. And obviously, one of the things that we're seeing now is that instead of people talking about a banking crisis, which is what they talked about before, I think we're now realizing that actually from the very beginning, what we've had was yes, a banking crisis but that was a subcomponent of a bigger set of world issues in terms of macroeconomic management, and that's becoming back in view and both the macroeconomic management of individual countries in the instances where it's weak and now, it's going to be under huge pressure to improve whether the U.S. or some countries in the Eurozone and similarly the mechanism is strictly in the Eurozone for dealing with liquidity for countries rather than for banks and the framework. We're going to be in the hands of the democratic process to try and come up with some good response and hopefully they will. It won't be a perfect process. And so it would be stupid not to be cautious. It would be stupid not to be alert to those significant risks out there that can turn bad. But I think the probabilities are that the world doesn't turn overnight from a place that's slowly recovering to a place that's a disaster area. That's my view.
Bruce Van Saun
And just a follow-up on that. I know -- I said the markets are indicating we could be on the cusp of recovery if you look at some of the yield curves and things. But again, our view is that we'll find a way to try to power, maybe not power but muddle through and get back and stay in growth, and then it'll just be a kind of an elongated timeframe before we get back to stronger growth than we had originally envisioned. If you look at the company though, 2.5 years into the plan versus where it was, there's been a huge amount of progress, and I think we have certainly very good people on the board and in the management leading the company. We have a very strong vision of what -- where we need to get to and we're making progress in all dimensions in terms of investing the Core franchises, making the business more efficient, more customer-friendly, increasing the risk awareness and in terms of the decisions that we make in how we run the business, that's come -- it's really night and day from where it was 2.5 years ago. So a lot of progress in the Core, the Non-Core's less than 1/2 the size of when it started, and we've done it in a way that's been friendly to preserving shareholder funds. And so again, I feel quite good now the stock markets going to move around based on fear, and there's not a lot we can do about that. What we need to do is just stay focused on executing the plan and doing the best we can. And ultimately, I think that will be manifest in the stock price once people have some conviction that some of these macroeconomic difficulties have been sorted.
The stock price clearly assumes that we are not right and we'll see.
Michael Helsby - BofA Merrill Lynch
And just on the GBM margins, any comment on that will be really helpful.
Bruce Van Saun
Well, I think this is a really hard one because clearly to some extent, what you were able to have in 2008 was interest rate falls, which helped and straight compressions and so on and so forth so you're not in quite that position now. And so I think we would err on the side of cautiousness. My end view would be you're likely have single-digit ROEs for a while in investment banking as you work through these kind of market conditions. That would be my own view. But even if it's just, there's no point torturing yourself. I've said this many times here on a quarter-by-quarter predictions for these business lines.
I think the combination of our transparency and the end of the long week is perhaps reducing the number of questions. We have got room for some more.
Leigh Goodwin - Citigroup Inc
It's Leigh Goodwin again from Citi. Actually, I just wanted to follow-up on Mike's question about in the context of the current crisis. And I wondered if you wanted to comment on the ICB process and the headlines we saw this morning suggesting a rather tough ring fence might be imposed. I mean, it feels as if the ICB are making up proposals or recommendations in a different world to the rest of us. But I mean, I wonder whether the extent to which the potential risks of a, if you like, suboptimal policy outcome from this have increased as a result of what's going on in the world? And whether that's a factor you think will be taken into consideration by those who finally make a decision?
Well, I couldn't possibly comment on your views on the world the ICB live in and so you must have your own views to that. But what I do think is that we and I think many other people have been engaging intensively, not just with the ICB but with the regulators with the government. And I do believe that people are genuinely trying to be thoughtful, they're genuinely listening, they're genuinely trying to consider the different issues. They're also, of course, in a tough political spot in terms of coalition parties, not the least. And so unfortunately, I believe that there must be a possibility of an outcome that is the wrong form at the wrong time. But it won't be for want of thought if that's the way it comes out. And obviously, however it comes out, we'll deal with it but I think the market is right to apply some discount factors to bank prospects in the U.K. until that's becomes clear.
Leigh Goodwin - Citigroup Inc
And would you be able to quantify that in terms of your ROE target? I mean, in terms of the.
It's such a difficult thing because there are -- first of all, there are so many flavors of ring fencing and the devil does lie in the detail. And secondarily, even if you knew the flavor that you're assuming, you then have to understand what the impact of that flavor will be in the eyes of your creditors and rating agencies and then what response you need to take to that and then the long-term impact in the eyes of your customers of the competitiveness that you have as a result. And so this could be something that plays out over quite a few years before you really know whether it ends up being just a negative but one that you can deal with or bigger or worse than that. It's really a tough thing and it's not that we've got a secret dossier that has the answer that we're refusing to tell you. It's just -- it's the second and third-order effects that concern us. The first-order effect's fine. We'll be able to adjust the structure and do what we have to do but the second and third-order effects will be a bit unclear for one.
There are some forms of ring fencing which are completely uncontroversial, either financially and from the other point of view. We spent the last year really in an intensive dialogue with U.S. regulators about structuring the RBS Americas, which is both retail and wholesale investment banking operations. The American regulators, just want to know what our ring fence activities in America are so that they can control it and understand it, understand the risk, understand the government's processes and so on. That is completely uncontroversial to us. Ring fencing activities create a whole host of extra challenges and problems and costs.
Edward Firth - Macquarie Research
Ed Firth from Macquarie. Sorry. Being out here on the right wing. And that also poses a detailed question but in Ulster Bank, you mentioned that one of the reasons for your provisions improving was recalibration to do with the mortgages, I think. Could you just be clear, is that like a one-off in this period? Or is that a new lower base that we should see going forward?
Bruce Van Saun
No, the one-off was really referring to the first quarter, which is where we did the recalibration, and so the second quarter was more a truer number than the first quarter was. Similarly, in Non-Core, in the quarter, we looked very hard at the land values we were carrying in the development book, and so we did a very detailed analysis region by region, looking at concentric circles from major cities and trying to estimate what that land was really worth. So again, you had a bit of a one-time nature to the entry in the second quarter there in Non-Core. And so given the significance of the non-performing loans in Ireland, we will, on a regular basis, be reviewing this with intensity so I'm not going to say there won't be more adjustments down the road but I think we're pretty much now on the front foot, both on the residential side and on the development book side at this point.
If there any would-be any palmists in the room, we've got some development land for you going cheap.
Bruce Van Saun
Don't seem to be any takers, Steve.
Okay. Any other questions or is that it? Okay. Well, thank you all very much, and I hope the end of August is better than the start.
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