António Horta-Osório - Group Chief Executive, Executive Director, Chairman of Group Asset & Liability Committee, Chairman of Group Risk Committee and Member of Chairmans Committee
Tim J. W. Tookey - Former Group Finance Director and Executive Director
Mark Fisher - Director of Group Operations
Kate O'Neill - Managing Director of Investor Relations
Juan Colombás - Chief Risk Officer
Andrew Geczy - Chief Executive Officer of Wholesale Banking & Markets
Chris Manners - Morgan Stanley, Research Division
Robert Law - Nomura Securities Co. Ltd., Research Division
Jason Napier - Deutsche Bank AG, Research Division
Thomas Rayner - Barclays Capital, Research Division
Rohith Chandra-Rajan - Barclays Capital, Research Division
Manus Costello - Autonomous Research LLP
Michael Helsby - BofA Merrill Lynch, Research Division
Arturo de Frias Marques - Grupo Santander, Research Division
Peter Toeman - HSBC, Research Division
Michael Trippitt - Oriel Securities Ltd., Research Division
Raul Sinha - JP Morgan Chase & Co, Research Division
Gary Greenwood - Shore Capital Group Ltd., Research Division
Lloyds Banking Group (LYG) 2011 Earnings Call February 24, 2012 4:30 AM ET
I am very pleased to be here to present our 2011 results and talk about our journey to become the best bank for customers. After the first part of my presentation, Tim will give you the detail behind our 2011 financial performance, and Mark Fisher, our Group Ops Director, will then cover integration and simplification. I will return to briefly cover the economic and regulatory environments and future guidance.
As you know, Tim took ill yesterday, so you will hear a little bit more of me than I would normally expect. After that, for the question-and-answer session, I'll be joined by a number of our senior executives: Alison Brittain, our Group Director of Retail; Andrew Géczy, our CEO of Wholesale Banking and Markets; John Maltby, who leads Commercial; Antonio Lorenzo, Director of Strategy, Wealth and International; Toby Strauss, Director of Insurance; and Juan Colombás, our Chief Risk Officer. This team brings together many years of experience, and we are fully committed to executing on the strategic initiatives we set out in June last year.
Today, I would like to present some key points to start with, then 2011 in context for Lloyds, then discuss the progress we have made against our strategy, provide you with an overview of our financial performance, where Tim will provide more detail later on, Mark will then cover costs and simplification, and I will do the close with some remarks on the economic and regulatory environments and our guidance for the year ahead.
Let me take you through the key points. We have achieved a significant reduction in balance sheets and delivered a resilient performance given the challenging economic environment. And we have made good progress against our strategic initiatives, achieved strong market shares in our core segments and strengthened our franchise through investment behind the brands, distribution, customer relationships and our people. We are building a bank which has the balance sheet strength, efficiency and customer franchise to continue to deliver a resilient performance in challenging market conditions.
Before I go into detail on our performance during 2011, I think it is important to set the context around what has been a very challenging year. From an economic perspective, you will recall that at the time we announced the outcome of our strategic review and our first half results in 2011, I emphasized the contagion risks from a sovereign debt crisis and the impact of a double dip. The risk has partly materialized and impacted on the propensity of consumers to spend and invest, interest rates remaining long for longer, continued high levels of impairments and ongoing challenge in the wholesale funding markets and related costs for the industry.
As we set out on our journey to become the best bank for customers, 2011 was focused on establishing the right foundations from which to rebuild the business. We have had to tackle many internal challenges such as: reshaping the organizational design to make us more agile and bring us closer to the customer, developing a new culture on simpler values and increased urgency to tackle problems and enhancing operational controls to manage the business more effectively.
And in terms of meeting customers' expectations, we took the responsible position in tackling PPI, which has required a significant mobilization to process claims and has come at a significant cost. This was the right thing to do. It provided clarity for customers and shareholders, whilst also going some way to rebuild our customers' trust.
The ICB outcome was uncertain for large parts of the year and, like many of our peers, we are being scrutinized much more by our regulators. We are at the beginning of this journey, and although 2011 showed good progress in building the right foundations to take us forward, we remain aware of the many challenges we continue to face. The turnaround at Lloyds will take 3 to 5 years to complete.
Turning now to the progress we have made this year. To deliver on our strategy to be the best bank for customers, we are focusing on 4 key pillars: strengthening our balance sheet, reshaping the business, simplifying the group and investing to grow our core business. We have made strong progress on each of these areas, and I will now provide you more detail on what we have achieved and why it has been so important to do this in the context of my earlier remarks.
During 2011, we prioritized strengthening our balance sheet by focusing on four key areas in order to reduce our exposure to wholesale funding markets and improve the quality of our assets. First, the total balance sheet for the group reduced 2% year-on-year, but the decline in our banking-funded assets was 10%, primarily driven by noncore assets, which we managed down by 27%.
It is important to note that from a funding perspective, our banking-funded assets are now less than GBP 600 million -- GBP 600 billion. Second, we delivered above market growth of 6% in customer deposits, and this now provides 62% of the group's total funding requirements.
Third, we improved the overall credit quality of our portfolio, with a 13% reduction in RWAs when compared to the decline in funded assets. These measures led to a reduction in our wholesale and government funding of 16% and an improvement in its maturity profile. Finally, we also increased the amount of liquid assets we hold, providing an additional buffer to our funding position and increasing our resilience to market shocks.
This has resulted in a significant strengthening of the balance sheet in 2011 and was clearly demonstrated in the substantial decrease in our group loan-to-deposit ratio, down 19 percentage points and now only 5% above our medium-term target of 130%. And in our core business, we are now well below our target of 120%. Given the decrease we have achieved in RWAs, which, in relation to our noncore assets, has been achieved without significant hits to capital, we have been able to increase our core Tier 1 ratio by 60 basis points to 10.8% despite the PPI charge, equivalent to approximately 60 basis points of core Tier 1 capital as well.
So in summary, we have a smaller balance sheet underpinned by a stronger capital base, with less reliance on wholesale funding markets and greater liquidity buffers.
Now I would like to focus on the core business, where we saw good underlying profit growth across all divisions, apart from Wholesale, where the impact of customer deleveraging and challenging conditions more than offset the successful enhancement of product capability. At the same time, we have significantly reduced risk by a number of management actions, including an accelerated reduction of non-core assets by GBP 53 billion, which was more than half the amount we committed to delivering in the 4-year period to 2014.
A particular area of focus for the management team has been our Retail deposit growth, where, despite the market slowing, we have maintained our momentum. This has been particularly noticeable in the successful relaunch of Halifax as a challenger brand. Our ISA Promise in the first half of the year and our savings prize draw in the second half result in deposits growing 8% year-on-year, 3x the market growth. This is strong evidence of the success of our multi-brand strategy. It provides flexibility to use our different channels to attract deposits and grow share whatever opportunities exist.
In this slide, I want to emphasize we have found ways to reward our customers through product innovation rather than our success being led through aggressive pricing strategies. We were not leaders in price, yet our growth was more than double that of the market.
Supporting our customers and the U.K. economy is at the heart of our strategy. In 2011, we provided GBP 45 billion of committed gross lending to U.K. businesses, of which over GBP 12 billion was to SMEs. We outperformed the market, growing net loans and advances to customers of our core commercial business by 3% versus a market decline of 6% according to Bank of England data. In 2012, we will extend this support further to help stimulate growth and improve confidence through making at least GBP 12 billion of gross new lending available and deliver positive net lending growth again and reducing the time it takes to get money to our customers through simpler end-to-end processes for loan approvals.
And that brings me neatly to the third pillar of our strategy, simplification. Simplifying the group is a key part of our strategy. We have an enviable foundation of knowledge and expertise based on the success of our integration program, which is now delivering annual run rate savings of over GBP 2 billion as we promised. This foundation gives us great confidence in delivering cost savings from simplification. We've made a strong start and achieved run rate cost savings of over GBP 240 million last year. And underlying operating expenses have reduced by 6% in 2011. Given the progress we have made, we are today announcing that we will increase our 2014 in-year cost-saving target by a further GBP 200 million to GBP 1.7 billion and our run rate target to GBP 1.9 billion by the end of 2014.
While we are reducing costs, we are committed to improving the quality of our service for our customers, and I am very pleased that we have outperformed against the stretching targets we set ourselves. As you can see, we have achieved substantial reductions in reportable FSA complaints. This puts us ahead of our major banking competitors.
In 2012, we aim to improve further by reducing complaints to only 1.3 per 1,000 current accounts, and by 2014, we aim to reduce this to 1 per 1,000 accounts. But it's not just about complaints. Less time spent on complaints means greater time for our colleagues to devote to broadening our relationships, enhancing the customer experience and increasing the share of wallet of our customers.
Now I will turn to the investment we are making in our core business and highlight a few examples of progress with the growth initiatives I announced at our strategic review. In Halifax, we promised to relaunch the brand as part of our multi-brand strategy, open all branches on Saturday and deliver new challenger products. We are making good progress, as I showed you earlier, regarding deposits growth. We have also seen growth in main banking customers at 4% and direct mortgage lending at 8%.
Turning now to SMEs. Here, our targeted customer propositions and advice model are having a positive effect, as I described earlier on. Importantly, as this is a key part of our strategy, Commercial has been active in supporting the wider group results with good growth in cross-selling of insurance, wealth and financial markets products.
In bancassurance, our wider distribution initiatives are beginning to gain momentum as we prepare our business model for RDR. In Retail, our bancassurance initiative was a key driver behind a 6% growth in other operating income, and our value-over-volume strategy resulted in a 23% increase in U.K. new business profit.
With regard to Wholesale, we have been refocusing the business and working on improving the range of products for our existing corporate customers. For example, in debt capital markets, our sterling market share has increased from 8% to 9% as we develop this capital-light franchise, supporting U.K. companies' access to capital markets.
And finally, on Wealth, we see good opportunities. We are making enhanced use of the group's Insight program to identify customers most likely to benefit from Wealth services. This has resulted in 80% of our customers within our newly developed Wealth proposition coming from our existing group customer base. We have initiated IT development to provide an enhanced service for our execution-only customers and are building simpler processes for customers to move from other parts of our group into Wealth.
Turning now to our financial performance. Our combined business profit was broadly in line with expectations, with a profit before tax of GBP 2.7 billion. Our statutory result was impacted by the GBP 3.2 billion PPI provision we took in the first half of the year. Underlying income in our core business was down 5%, reflecting subdued customer demand and lower interest rates. This was partly offset by a reduction in our core costs, where operating expenses fell, and we also benefited from a fall in impairments. As a result, core underlying profit before tax and fair value unwinds fell by 2%, but return on risk-weighted assets increased to 2.5%.
Turning to the core business performance. Thanks to the improvement in our funding mix, margin performance was resilient, declining by only 6 basis points. This was despite lower interest rates and the refinancing of a significant amount of government and central bank facilities at a higher wholesale funding cost.
The decline in noncore income and margin reflected the asset reductions we achieved in the year, higher funding costs on what is a predominantly Wholesale-funded business and a higher proportion of impaired assets. As a consequence of some of the risk-mitigation actions I talked about earlier, we saw declines in both core and noncore AQRs. Core performance continued to trend closer to our target of 50 to 60 basis points for the group as a whole.
Now looking at margin drivers in the core business in more detail. This slide first shows the progression of group asset and liability margins in the year. The point I want to make here is that you can see that by improving our pricing and mix on the asset side, we haven't been able to broadly offset the negative impact of more costly deposits. The real funding cost for Lloyds is therefore being driven by wholesale funding markets.
And when you look at our core business, although we have been able to fully offset the decline in deposit spread and mix through repricing of our assets, we still have some wholesale funding cost impact. But in the core business, where we are focusing for the future, we have been able to fully offset the impact of liability cost and mix with the repricing and mix of our assets.
Turning now to impairments. Improving asset quality resulted in a continued decline in impairments in both core and noncore across all divisions. This reflected our prudent provisioning and the conservative approach to risk, which we have fully embedded across the business. This is driving tangible benefits to the overall quality of loans being added to our book.
Looking now at the performance of each division's underlying core business in more detail, starting with Retail. Retail made good progress in executing against its strategy. Despite subdued markets, Retail delivered a 9% increase in underlying core business profit before tax and fair value unwinds, and the return on risk-weighted assets increased by 40 basis points to 2.8%.
As a result of our investment in multichannel, we saw a 9% increase in active online customers and successfully launched mobile applications from October 2011. We now have 1.5 million customers using this technology.
The core Wholesale business saw a fall in profitability, largely driven by a decline in income as a result of a reduced balance sheet as customers deleveraged and challenging market conditions. We did see growth in some of the capital-light businesses we are developing such as our rates and foreign exchange businesses. Continued success in our growth initiatives such as this will lead to an increase in revenue per customer, a key KPI for this business. The rise in impairment was caused by the impact of a few specific large cases, reflecting the lumpier nature of Wholesale impairments.
Looking now at Commercial. Commercial delivered a strong operation and financial performance despite a challenging environment, thanks to its robust relationship model. Core profit before tax and fair value unwinds more than doubled due to higher income combined with reduction in both impairments and costs. As a result, return on risk-weighted assets grew by 110 basis points to 1.8%.
Turning now to insurance. Here, profit before tax and fair value unwinds increased by 11%, driven by a reduction in operating expenses and insurance claims. Insurance remains a consistent contributor to the group's overall performance, and the success of our value-over-volume strategy has delivered a 50-basis-point increase in EEV new business margin and increased Life, Pensions and Investments U.K. new business profit by 24%, despite sales being broadly flat.
In Wealth and International, core total income increased by 6% and net interest margin by 85 basis points. This mainly reflected improved margins and strong volume growth in deposits. We saw strong progress in other parts of the franchise, with an 8% growth in affluent customers and 22% growth in customer balances, for example. This concludes the first part of my presentation. I would now like to pass over to Tim.
Tim J. W. Tookey
Thank you, António, and good morning, everybody. This morning, I'm going to review the group's full year results for 2011, look at how the noncore rundown has been managed and then review the further strengthening of our capital funding and liquidity positions.
Despite the challenging external environment, we delivered a combined businesses performance broadly in line with our expectations. On this basis, and excluding all of the volatile items, good or bad, underlying income declined by about 10%. This reduction reflects a smaller balance sheet, principally driven by the substantial runoff of noncore assets, the subdued demand in our core business and the expected reduction in our net interest margin. Costs reduced by 4%, mainly as a result of further integration synergies as well as the initial cost savings delivered by the simplification program. More from Mark on that later.
The impairment charge reduced by 26%, with reductions of over 20% from each division. As a result of these factors, we delivered a 21% increase in profit before tax, and the picture isn't very different if we strip out all of the volatile items, liability management gains and asset sales, which I will set out on the next slide. Stripping those out, group profits are up by 22%.
The core business also performed well, with strong margin performance and lower impairments delivering a 3% profit growth. I'll look at core results again in a moment.
But that's profit on a combined businesses basis. But as I said, this measure of performance is somewhat obscured by the volatility effects. Filtering out this noise down the page and filtering out this noise created by volatile items as well as liability management and asset sales, we get a clearer view of the underlying performance and see that underlying or clean profit for the year increased by that 22%.
If we now take the profit numbers on a combined business basis from the top of the slide, then we need to include the other statutory items to get to the bottom line result. As expected, the biggest effect came from the PPI provision, which we reported in the first quarter. In addition, this year, we have seen negative volatility from the Insurance businesses, in contrast to a positive impact last year. The statutory result also includes charges for both integration and simplification delivery costs, as well as the costs of Project Verde.
If we now move from performance at the group level to performance in the core business for a moment. Well, as I said, I'm pleased to report that our core business delivered a really good performance considering the challenging economic environment. We saw subdued demand for new lending and continued customer deleveraging in the core business, and average interest earning assets are down 5%, and of course, that contributed to the 2% decline in core income.
Now you've heard me talk before of higher wholesale funding costs in our business, but this is much less of an issue in the core book, which benefited from an improved funding mix as a result of increased customer deposits. So our core net interest margin was down just 2% or 6 basis points to 2.42%. Even with lower operating expenses and given the small reduction in income, the 3% increase in profit before tax was mainly driven by a substantial reduction in the core impairment charge, but this also includes the liability management gains and those volatile items. So to be fair, if we strip out the one-off and volatile items, core business profit before tax and fair value unwind decreased by just 2%. And this principally reflects the lower income arising from higher funding costs and the smaller balance sheet.
These same trends are prevalent if we look at group income where the reduction is mainly as a result of the smaller balance sheet with shrinkage, of course, in both core and noncore assets in 2011. Even though we have exceeded our Merlin lending targets, we continue to see subdued lending demand as well as customer deleveraging continuing. At the same time, as we've said, we continue to reduce noncore assets in order to strengthen and derisk the balance sheet.
This shrinkage, obviously, had a negative effect on income. However, it also creates a benefit from the reduced volume of costly wholesale funding required. In addition to this volume effect, we've also seen a funding cost effect, with the biggest movement coming from the increase in the wholesale funding cost. Now this has had a large effect on our group margin, as António showed, but this was partly offset by the funding mix benefit we realized from increasing customer deposits.
Then the same analysis just for the core business, well, we have a similar pattern, although here, I have drawn out separately the benefits of the deliberate and continued asset margin widening activities, which have fully offset the pressures on liability margins. So the core income story can be simplified to a simple perspective of subdued demand and higher wholesale funding cost. So it's just as well that we're bringing down wholesale funding as fast as we can through our deliberate and focused risk management programs.
I always give you a helicopter view of the margin drivers. Well, here it is. The net interest margin on our banking business was 2.07%, as we have seen. The decline from 2010 is in line with our guidance, but we have yet to see the full annualized impact of refinancing ourselves away from central bank facilities. In addition, on-balance sheet liquid assets, are up 44% to GBP 97 billion, and that's expensive. In 2011, we also saw a continued impact from lower returns on invested assets, and this will be somewhat of a feature of the next few periods as well. On the upside, however, we continue to reprice assets wherever appropriate, and we have seen the margin benefit from a stronger deposit funding mix in the core business.
Turning briefly now to costs. Well, total cost are down 4%, but actually, the costs that we can directly control are down 6%, and this is great delivery of integration savings and the first deliveries of cost savings from the simplification program. The bank levy shown here was accrued in the final quarter and was lower than initially expected due, of course, to the improvements in our funding profile.
I'd now like to spend some time on impairments. Well, I'm very pleased with the continued reductions in the impairment charge in 2011, which is 26% lower, and we have seen lower charges across all divisions. Especially pleasing is that we have delivered another strong year of noncore asset reduction, and we have achieved that without taking additional impairments out with our guidance. So let's have a closer look at divisional performance using the usual charts.
We saw a 29% reduction in the Wholesale impairment charge in 2011. This reduction was mostly driven by lower impairment from the corporate real estate portfolios, but this was partially offset by the higher impairment on leveraged acquisition finance exposures. You will remember that we discussed those in the context of Q2.
In Wealth and International, impairment charges decreased by 23%, but the division's charge is still dominated by Ireland, as you can see, and it is the slowing rate of impaired loan migration in Ireland that drives the lower divisional charge this year.
Of the Irish wholesale portfolio, 86% is now impaired, a bit like my voice, and we have a coverage ratio of 61%. We've made terrific progress on reducing Australia and New Zealand exposures where impaired assets are down 1/3 through well-executed disposal programs.
Retail's impairment charge reduced by 28%, with the reduction in the unsecured charge more than offsetting the predicted increase in the secured charge. The decrease in unsecured was largely a result of the improved quality of new business. The secured impairment charge increased exactly in line with expectations and mainly reflects a less favorable medium-term outlook for house prices compared to the outlook that we had at the end of 2010.
In Commercial, well, the numbers are tiny, but we still saw an -- the impairment charge fall by 21%, reflecting the benefits of the lower interest rate environment and our continued prudent credit risk appetite. Portfolio metrics, including delinquencies and assets under close monitoring, however, remain above normal levels. So the charges are down as expected, but perhaps more importantly, there are good, solid trends of improving asset quality across the board.
In Retail, the trends which I have shown you before have continued throughout the year, with fewer cases entering arrears compared to 2010 in both the secured and the unsecured portfolios. This shows that our prudent risk appetite and the higher quality of new business is delivering exactly what we expected it would.
In Wholesale and Commercial, we've also seen a reduction in newly impaired assets. Even more importantly, though, the really troubled assets have been dealt with in prior periods, and this shows through with the average provision needed on these newly impaired loans being materially lower than in 2010.
On Ireland. Well, although many economists reported improving conditions in Ireland, we have seen a modest increase in impaired loans in 2011, and coverage ratios have been increased to ensure that we stay well provided due to continuing market weakness risks. In the slide appendix in your pack, there is the usual detailed slide showing the impairment trends by book within the Irish business.
And so to summarize the group's performance. Well, it's not always easy to summarize a full year's performance into a single sentence, but despite the volatile items, I see 2011 as a good year of delivery, broadly in line with expectations, whilst achieving an above-expectation reduction in the risk profile of our business.
Let me now update you on the profile and management of noncore business. Despite challenging market conditions, you've heard us say that we achieved a substantial reduction in the noncore portfolios of GBP 53 billion, achieving, in 12 months, 50% of a 4-year reduction target. Within this, we reduced the U.K. commercial real estate portfolio by GBP 4.8 billion. What is important to point out here is that about 80% of these CRE disposals were outside of London and of a value of GBP 5 million or less each, which clearly shows that there is reasonable liquidity in that market and that we have been prudently provisioned.
In International, we saw some liquidity return in Ireland, where cash sales and capital repayments were over EUR 2 billion. In Australia and New Zealand, we reduced our remaining exposures by about GBP 4.3 billion, disposing of about 1/3 of the impaired assets in the whole region, including a GBP 1 billion portfolio of loans in our 2 most challenging markets, which, as you know, are the Gold Coast and New Zealand. We now have no assets in the Gold Coast, and our exposures in New Zealand have reduced to less than GBP 200 million.
The noncore income statement shown here shows both the impact of the smaller asset base as well as the impact of higher wholesale funding costs, which have taken 45 basis points off the margin. Losses on asset sales are modest in the context of the reductions achieved, but the main driver of the overall performance is the 28% reduction in impairments. Noncore loss before tax was better by 7%, with the improvement principally driven by those reductions in impairments and partly by costs, partly offset by lower income and lower fair value unwind.
But the income statement result is just one aspect of the noncore asset management and reduction process. So let's look at the impact on capital of our noncore portfolios.
Despite the continuing impairments and the reduced margin in noncore, the rundown of noncore portfolios in 2011 has been capital-generative. The capital consumed by the loss after tax in the noncore business has been more than offset by capital released by the reduction in risk-weighted assets from their disposal. But of course, the full benefits of the rundown are greater than this because not only did we achieve significant funding benefits but we have also avoided future impairments on sold assets, which could have been several hundred million pounds in 2012 alone.
In the news release, we have provided extensive disclosure on our exposures to a number of Eurozone countries, but let me give you a brief overview of some of those portfolios other than the Irish book, which we've just looked at.
We reduced our overall exposure to these countries by 26%, with substantial reductions achieved pretty much across-the-board. As previously reported, our largest exposures in these countries are retail and corporate assets and exposures to banking groups.
At interims last year, I gave quite a lot of commentary on the Spanish corporate real -- retail -- excuse me, I gave quite a lot of commentary last summer on the Spanish corporate and retail exposures, which I'm not going to repeat here, but we feel that we are well provided and we are not unduly concerned.
Exposures to local banking groups are mainly short-term money market and trading exposures or money market lines and repo facilities. Such exposures are down 36% on last year, and half of the residual exposures are actually backed by covered bonds.
Moving on now to capital liquidity and funding. Well, as you've heard, our core Tier 1 capital ratio improved significantly to 10.8% at the year end. We saw a 13% reduction in risk-weighted assets, predominantly, of course, from disposals of higher-risk noncore assets, but also benefiting from improvements in the risk profile of our assets and better-quality new business, which is clearly reducing, as intended, the capital intensity of our balance sheet.
The implementation of CRD III was exactly as predicted a year ago, reducing our core Tier 1 capital ratio by about 20 basis points. The direct benefit of this risk reduction is that despite the effect of the statutory loss, including, of course, the PPI provision, our core Tier 1 capital ratio improved by 60 basis points, and our total capital ratio improved to 15.6%, clearly a nice and strong position.
Let me now give you an update on the impacts that we anticipate from the implementation of CRD IV. Well, the top bar here shows that we expect that January 2013 impacts of CRD IV if modeled onto our December 2011 balance sheet would reduce our current core Tier 1 ratio by about 0.8% to 10%.
Looking further into the future, the transitional rules which phase in the new core Tier 1 deductions will start in January 2014 and will take 5 years to come in. If we apply these future rules to a static balance sheet, then these would reduce our core Tier 1 ratio by about 0.25% per annum, due mainly to the insurance deduction and other transitional adjustments, including excess expected loss. These are akin to permanent capital reductions but, of course, will take 7 years to be implemented.
Any residual deferred tax assets relating to trading losses that may still be on our balance sheet in 2014 would reduce the core Tier 1 ratio in stages over that same 5-year transition period, but the full value of these today on our static balance sheet is about 1.6%. So if we did a fully-loaded CRD IV assessment on our core Tier 1 today, the chart tells us that we get to about 7.1%, and of course, this excludes the implied 2.2% benefit from our CoCos.
But this isn't the real story for a number of reasons. The transitional rules are there for a purpose, including to deal with what are, in effect, timing differences, and I see the value of our tax losses purely as a timing difference, with the value of these losses being there for the benefit of the bank and shareholders over the next few years. These impact illustrations assume a static balance sheet, but as you know, our business is not static. We will see further RWA reductions from noncore asset disposals, and we are confident of improving earnings, so the overall result will be a very manageable transition to the new world, one in which we will always maintain modest but prudent levels of capital in excess of regulatory requirements.
Turning now to funding. As António mentioned earlier, we have seen good growth in relationship deposits. This, together with lower loan balances, has improved the loans-deposit ratio to 135% at the year end, and we expect this will continue to improve in the future.
Moving on to wholesale funding. Well, the combination of rightsizing the balance sheet and continued growth in customer deposits has seen the group's wholesale funding requirement reduce materially in the past few years. Total wholesale funding reduced 16% last year to GBP 251 billion, with the volume with a residual maturity less than one year falling GBP 36 billion to GBP 113 billion.
Additionally, the group term funding ratio improved to a very prudent 55%. Last year, we exceeded our 2011 issuance target with over GBP 35 billion achieved, which included some prefunding for 2012. We've already achieved GBP 15 billion of 2012 funding against our plans for GBP 20 billion to GBP 25 billion across all of the public and private issuance programs. In addition, our reduced requirements now falls in line with our public term issuance plans of GBP 10 billion to GBP 15 billion per annum going forward. So this is a very good position to be in.
But we also continue to maintain a strong liquidity position, and our primary liquidity portfolio at the year end was GBP 95 billion. This is 84% of all wholesale funding with a maturity of less than one year and provides us with a very substantial buffer. In addition to this primary liquidity, the group continues to hold more than GBP 100 billion of secondary liquidity, giving us, in overall, 179% coverage of all less than one year maturities.
And so in summary. The group delivered a combined businesses performance in 2011 broadly in line with expectations despite the challenging external environment. The core business delivered a resilient performance with strong funding improvements resulting in a very good margin performance.
Noncore asset reductions were fantastic, releasing capital to support core business growth in the future. Our actions in 2011 have materially reduced the risks in our balance sheet, strengthened our core Tier 1 ratio and further improved our funding position. Well, that's enough from me. I now hand you over to Mark.
Thank you, Tim. Good morning, everybody. I'd like to spend about 10 minutes talking to you about our progress on costs and simplification that I introduced to you when we here in June of last year.
So let's start with costs. As Tim said, total costs reduced by 4% absolutely. At the operating expense level, excluding major increases in the U.K. bank levy and FSCS charges, costs reduced by 6%. This excellent result reflects the delivery of planned integration synergies, with in-year integration cost savings in 2011 rising to GBP 1,851 million compared to GBP 1,361 million in 2010. Our tighter approach to cost management, which I'll describe later, and lower operating lease depreciation also helped to offset inflationary pressures.
We announced in the final quarter of last year that we'd achieved our integration goal of GBP 2 billion of run rate synergies well before the 3-year target period. I'm pleased to report that over and above competing integration in the second half of last year, we've also begun to deliver simplification. You'll note the program's already generated savings of GBP 242 million run rate at December 2011. Now I regard that as a strong start.
Rather than look at our performance on cost just for 1 year, it's worth looking at the longer-term trend. This slide shows the progression of costs for the Lloyds Banking Group from the acquisition of HBOS in January 2009 to the present day. The pro forma cost base of the newly combined group was just over GBP 12.2 billion. It is now GBP 10.6 billion, down just over GBP 1.6 billion. This represents an absolute 13% reduction.
The principal driver is integration savings, which are passed through to the bottom line. That number of GBP 1,851 million savings is the in-year benefit in 2011, which translates to the run rate in excess of GBP 2 billion that we've reported. And in line with our strategy of reducing noncore assets in the Asset Finance business, operating lease depreciation has also reduced substantially over the period by GBP 663 million.
Now these reductions have been partly offset by cost increases reflected in bank levy, wage inflation, national insurance, energy costs and VAT, together with some early investment in the strategic initiatives that António has described earlier.
And last but not least, the early mobilization of simplification has now delivered GBP 178 million in the year. This is particularly pleasing as it overlaps with the key closing stages of integration and once again demonstrates the maturity of our change management capability to deal with both complexity and scale. All in all, I hope you agree this shows a strong downward momentum in costs and evidences our determination to deliver benefits and savings through to the bottom line.
Now for a close look at how the simplification program is going. Simplification is central to our strategy of becoming the best bank for customers. Customers will experience processes with fewer steps, more automation and more transparent outcomes. Fewer errors will mean fewer complaints and increased brand consideration. António has already detailed the progress we're making on reducing complaints. We're determined that simplification will enable us to reduce those FSA-reportable complaints to less than 1 per 1,000 in 2014.
Simplification will also generate significant financial benefits. I've previously described to you the iceberg effect, where simpler processes and fewer errors and complaints leads to a virtuous circle of lower cost primary processes generating fewer demands for secondary processes of error correction and rework, complaint handling and so on.
And whilst the majority of simplification benefits will flow to the bottom line, approximately 1/3 of the benefits over the life of the program will be used to fund investment in our strategic growth initiatives. For colleagues, simplification will eliminate low-value tasks, increase cross-skilling and free up time to spend with customers to deepen relationships and drive income growth.
Now hopefully, you recognize this slide from last year. Simplification is organized into 4 key streams: operations and processes, sourcing, organization, and channels and products. You'll see that at the outset of the program last year, we'd identified 111 initiatives. Now that number's grown to 183. This reflects the addition of new ideas as well as the deletion of some ideas that didn't provide the right financial payback. And this also reflects the added granularity of our plans as we move into delivery mode.
With the core technical aspects of integration now complete, we've been able to move substantial and highly skilled resources onto our program of transforming the business and technology, harnessing automation and workflow tools, simplifying and driving out cost.
I reported last time on the cost management approach that we had implemented. This is now maturing into a very effective process, bringing both detail and control to all aspects of our cost base. 14 dedicated cost management units, each responsible for a single type of cost, now review and control all costs and budgets on an end-to-end basis across all divisions and businesses reporting to a group cost board chaired by me. We've extended this process now to look at costs which are treated as netting off income, for example, insurance claims.
It's the success we've had in 2011 in reducing the operating expenses, the good early mobilization of the program, the increase in detail and definition of our plans and the growing maturity of our cost management approach that, as António has already outlined, leads us to increase our cost target to GBP 1.7 billion of in-year cost savings in 2014.
So let me talk a bit more about that early mobilization. I've already highlighted the benefits in 2011. These run rate benefits were delivered primarily through our sourcing and organization work streams. By the year end, we'd announced 2,098 role reductions and achieved 1,665 job savings. I'm pleased to say we continue to achieve over half of our role reductions through natural attrition and redeployment. We've centralized our corporate functions such as HR, finance and risk, removing duplication of activity and strengthening control.
In the Wholesale and Retail banks, we've increased leadership spans of control and reduced management roles. All these restructures demonstrate what I talked to you about last time in terms of flattening the organization to a 7-by-10 structure. That is 7 layers from top to bottom with average spans of control of 10 or more. This gives increased personal accountability and promotes a high performance culture. And we've made good progress in our plans to reduce the number of suppliers we have, rationalizing contracts and removing 2,351 suppliers since the 1st of July.
Now in terms of the heavy lifting part of the program aimed at reengineering our processes, we've completed a mapping of all our processes, and this is it. So don't worry, you're not meant to be able to read it, but it does show you the core processes of the bank.
Now behind each of those boxes, we've mapped how many times a day we do the process, where it's done, who does it, the time they take, the costs involved, the error rates involved, the complaints we get. Now the data is not 100% complete, but it is good enough to help us identify the target areas for our improvement.
Now we've actually mapped 910 processes, and that covers the day-to-day activity of over 85,000 of our employees. Now not surprisingly for a bank, around 16,000 employees are in the top 5 processes, which, surprise, surprise, are paying money in, taking it out, opening accounts, answering queries and sales prospecting. Now clearly, we can't fix all 900-plus processes, simultaneously. That's like trying to boil the ocean. But the top 125 processes account for the work of around 68,000 of our colleagues, so that's where we're directing our focus. Because we believe this will do the most to simplify customer service and enable us to maximize cost-savings potential.
We'll take 1 of 3 approaches to simplifying those processes. Where possible, we're going to automate, so that once the button is pressed, technology and systems will execute the request with no further human intervention. We estimate that around 30% of processes could be handled in this way. Now if full automation is not appropriate, we'll harness technology, like imaging workflow, so the work is sent to the right place first time for fulfillment.
And finally, there are times when automation just isn't appropriate, for example, dealing with bereavement. So we'll have centers of excellence, where trained and highly skilled colleagues can provide the right support for customers.
We're in the process of finalizing our design choices for key processes and will shortly mobilize the first of 30 work streams, making changes on the ground. We've already begun to build the technical infrastructure and architecture to support these programs.
Now I mentioned earlier, we're in delivery mode. Since the end of the year, we've announced a further 1,690 role reductions, bringing the total for the program to date to 3,700. And let me give you a few examples of things that are coming in the next few months. António's referred to our very successful cash ISA campaign, but our underlying cash ISA process is extremely manual.
This month, we have launched an improved process, supported by elements of automation that will significantly improve this year's customer experience and our efficiency for the tax year end coming soon. In quarter 4 of this year, we intend to further reduce the ISA switching time frames and to have a fully automated process by 2013.
In account transfer or switches, that's accounts transferring into the group from competitors, which I'm very pleased to say is a high-volume activity. In April, we will introduce a new transfer process. This will reduce the time to transfer by up to 30%, reduce our data entry by up to 65% and we think will eliminate errors by 50%.
Now as António has mentioned, the online channels really continue to grow rapidly, with over 1.5 million downloads of the mobile app. At one point in December last year, LBG brands were #1, 2 and 3 most popular free financial downloads in the Apple App Store, and this is leading to increased usage. So on the first business day of 2012, we saw a record 3.7 million customer log-ons through the Internet and mobile. Now that's a staggering number and far more than any daily volume of branch or telephone traffic.
And there's a lot more to come from simplification. It ranges from improvements to the functionality of our telephone service right through to reengineering the way we clean our major offices. This latter improvement, for example, should give us a reduction of 15% in cleaning costs.
So to summarize, I believe we've made a good start to simplification. Integration delivered its synergies of GBP 2 billion. It was a fantastic achievement and, most importantly, shows what we can do. We've taken the integration savings through to the bottom line, so our total cost base has reduced by 13% since 2008 and our operating costs by 6% in 2011 alone. All of this supported by a tighter and more disciplined approach to the management of costs.
Our early deliverables from simplification have already generated GBP 178 million of benefits, we're well through detailed analysis, and we're mobilizing at scale to deliver. And finally, with the strong momentum, we're now targeting an additional GBP 200 million of cost savings, that's GBP 1.7 billion of in-year cost savings in 2014. Thank you. I'd now like to hand back to António.
Thank you, Mark. I will now turn to the economic and regulatory environment, summarize our 2011 performance and comment on our guidance and outlook before concluding.
Turning first to the economic environment. The outlook for the U.K. economy remains uncertain and, to some extent, contingent on developments on the Eurozone. We believe the most likely scenario is for the weakness we saw in the second half of 2011 to continue in the first half of this year, followed by a relatively shallow recovery in the second half and into 2013. As a result, we expect U.K. base rates to remain at current levels through 2013 and unemployment to rise from current levels to peak at around 9% next year. However, we expect CPI inflation to fall from current high levels to below 3% this year and possibly below 2% next year.
U.K. property prices are likely to reflect this weak economic environment with house prices remaining broadly flat in 2012 and 2013 and commercial property prices likely to be marginally weaker in 2012 before recovering in 2013.
In terms of the regulatory environment, the publication of the ICB's final report and the government's response to it have represented significant steps in providing greater clarity. On capital, the proposals are consistent with the targets we set in the strategic review, and although much work remains to be done on the details of the implementation, we are on track to achieve the recommended capital levels, as well as to comply with the requirements of CRD IV. We also welcome the government's endorsement of the ICB proposals to ring-fence retail banking operations as part of a wider regulatory framework.
As a predominant retail and commercial bank, we would expect to be less affected by the implementation of a ring fence than other market participants. However, we believe it is important for any transition period to be flexible in order to minimize any impact on economic growth and to enable banks to implement the required structural changes.
Finally, the Retail Distribution Review is expected to have a significant impact on the way in which financial services are delivered in the U.K., especially to U.K. retail customers. As we stated at the time of the strategic review, we see a substantial opportunity arising from this change given our franchise, brands and product capability.
Now moving on to guidance. In 2012, given the economic outlook and noncore asset reductions, subdued demand in the core book, higher wholesale funding costs, and interest rates remaining low, we expect our banking net interest margin to decrease in 2012 by around the same amount as we experienced in 2011.
In terms of the 2012 margin shape, we would expect significant reductions during the first half of 2012 and then flattening in the second half. We expect our total income to be lower than in 2011, and we would continue to expect subdued demands in the core loan book.
In terms of costs, we expect to reduce nominal costs further, driven by simplification. We also expect to see a further decline in the group impairment charge in similar percentage terms to the reduction we saw in 2011 as a result of further asset quality improvements across all divisions, with the largest improvement coming from International.
We also expect the benefit from fair value unwinds to reduce to around GBP 500 million. We expect to continue to strengthen our balance sheet in 2012 by a further reduction in noncore assets of around GBP 25 billion and by improving our funding position through further deposit growth, at least in line with the market.
For the medium term, we remain confident that the targets we set out in the strategic review in June 2011 are achievable over time. However, as we indicated in our Q3 IMS, we now expect the attainment of our income related targets to be delayed as a result of the weaker-than-expected economic outlook. This will also delay the attainment of our return on equity target to beyond 2014. We continue to expect to deliver our balance sheet, costs and impairment targets by the end of 2014 and, in some cases, sooner.
As you have heard, we have increased our cost savings target by a further GBP 200 million by 2014, and we now expect to deliver our group loan-to-deposit ratio target in 2012, 2 years ahead of target.
So to summarize. We are building a bank which has the balance sheet strength, efficiency and customer franchise to continue to deliver resilient performance in challenging market conditions. Given we are likely to have lower interest rates for longer and higher regulatory costs, along with deleveraging in credit markets, it will be those banks who can create competitive advantage through a lower-risk premium, combined with best-in-class efficiency, who will achieve superior returns and will capture the opportunities as economic conditions will improve. Thank you very much for listening, and let me now turn to questions and answers, which Kate will facilitate.
Good morning, everyone. [Operator Instructions] Chris, do you want to start us off over there?
Chris Manners - Morgan Stanley, Research Division
It's Chris Manners from Morgan Stanley here. So I had 2 questions, if I may. The first one was on the core average interest-earning assets development. Obviously, you'd commented that there was subdued demand for new loans in the core division. Average interest-earning assets were down about GBP 20 billion last year. Would we be expecting the average interest-earning assets in core to continue to fall into 2012? And the second question was on CRE slotting. And obviously, Royal Bank is saying it's going to add around GBP 20 billion to their RWAs. Do you have a figure for that?
Okay. Thank you very much, Chris. Well, about our core book, it's very interesting, the question you make, because we are absolutely investing in the core book. And the fact is that the economy is deleveraging as a whole and, therefore, customers, in general, are having less credit in relation to either GDP or to their disposable income. But we are targeting and have improved significantly our positioning in our core segments. For example, in savings, as I showed you, we got probably a 50% market share of net savings flows. In terms of mortgages, we have had 20% market share of gross mortgage lending and in the core segments of first-time buyers, 24%. Nevertheless, as you said, given that customers are repaying on accelerated rate mortgages, the total mortgage book goes on. And in SMEs, which is our other core segment, we have increased net lending by 3% while the market has gone down by 6%. So here, we have significant market share improvement. Our objective, always subject to market conditions and competitive conditions, is to keep very strong market shares in our core segments such as that when those markets recover, we will recover and grow with them. So in this context, how do I see 2012, which is the core of your question? I think that the mortgage market is going to behave very much in line with this year, more or less flat, as you were asking. I can see SMEs’ net lending to continue to be negative, but we have publicly committed, and I'm very confident about it, that we will again provide at least GBP 12 billion of gross lending to SMEs and that we will achieve again positive SME net lending. And on the corporate space, we have been prioritizing according to the segments, where we have been focusing more on medium corporates and the ones which are more attractive and less focused on the ones where we have less margins versus our cost of funding, and on the higher segments, which I think will be a similar picture next year, but less pronounced because, as you know, the market, overall, in corporates, is also going down 5%. So that's why I said that in 2012, I continue to foresee subdued demand in our core book but keeping very good market shares in our key segments, and in some of them, as SME for example, continue to have positive net lending in spite of a negative market growth as a whole. Relating to your second question of CRE slotting, the impact in ourselves is not as high as Royal Bank has stated yesterday, but I will ask Juan Colombás, our Chief Risk Officer, to give you some more color into it.
The impact of slotting in our portfolio, if we do it today, we think it would be of the order of less than GBP 10 billion, and it will depend on the pace of implementing it and the rundown of our portfolio. Just to give you an idea, in 2011, our CRE portfolio went down by 15%. You can make this number from the pages in the appendixes. So it will depend on -- also on the pace of its implementation. This is not exactly at the base. We are incorporating this number also what will be the impact on the excess of expected loss through implementation. But what we think -- I mean, to summarize, the number in our single one, the impact would be equivalent to RWAs less than GBP 10 billion.
Rob, over there?
Robert Law - Nomura Securities Co. Ltd., Research Division
Robert Law of Nomura. Could I explore 2 areas, please? First of all, thanks for the guidance on the margin and the factors behind it, and I was wondering if I could invite you to comment about how long those factors are sustained for. So if one looks into not so much 2012 but beyond, what does it take for these factors to start to moderate? On the -- so if you look at the slide that you gave, I think on Page 19 of the slide pack, have we seen the end of the wholesale funding pressures this year? What happens if rates stay low? What are the hedging impacts that you have? And how do they run off? So I'm looking for some kind of indications of what it takes for this progressive decline in the margin to ameliorate in subsequent years.
Okay. Robert, thank you very much. Look, I think the way we should look at it is exactly as you said, in terms of the factors, the underlying factors, and each one can make its expectations on how those factors will evolve. In terms of '12 versus '11, to position this first, the fact that we think that the margin will decrease more significantly in the first half and then flatten in the second half is mainly due to the fact that in the comparison with '11, we have, in the first 6 months of '11, the cost of the SLS, which was extremely low, as you know. So it was like a kind of subsidy, which, in the comparison, makes the comparison negative. And on the other hand, we had the wholesale cost of funding increasing, especially in the second half of the year when the crisis started in the summer, and we have also increased the amount of liquid assets we hold on the balance sheet in the second half of the year as well, and those assets have costs because, as you know, funding them has a negative cost for us. As we go further, what is our strategy in terms of what we control, and how do we see the factors that we do not control? So from the second half of '12 onwards, we do -- we will no longer have the distortion on the comparison, both from the liquid assets and from the SLS effects of '11. Still, the wholesale cost of funding, we think it will continue to be high, although with all the improvements we made in terms of capital liquidity, we would expect it on a relative basis to start trending lower because we'll need less and less wholesale funding, and our position is improving sustainably. But we are thinking, as I told you, that it will remain high, and therefore, that's a negative effect in terms of margin, but progressively lower because we will need less and less wholesale funding. And in terms of our core book, which, as I showed you in one of my slides, we have a deliberate policy of offsetting the higher cost of deposits and mix on the liability side, with the asset repricing and the mix on the asset side. And we expect that equation to continue to hold, and the more the core represents of the total bank, the more important that picture is versus the picture of the noncore where, basically, all the noncore is wholesale-funded.
Can we go to Jason over here in the corner and then Tom?
Jason Napier - Deutsche Bank AG, Research Division
It's Jason Napier from Deutsche. Two questions. Firstly, on the simplification cost savings. I appreciate the program hasn't been running all that long, and results so far are, indeed, impressive. But if I look at the run rate at the end of the period at about GBP 242 million, GBP 178 million for the overall period, I just wonder how steep a hockey stick we're looking at, particularly as it relates to 2012, given that you're obviously aiming for a colossal saving as recent -- or as near as 2014. And then the second question is sort of a follow-on from Robert's question on net interest margin. I wonder whether you'd comment on whether the shape of NIM compression in the next 6 months is similar to what you've seen in the last 12 as far as the split between core and noncore is concerned. Obviously, the NII in noncore is a very small number, and NIM's already down 45, 46 bps in the last 12 months. If you could just talk about how you see core margin evolving over the next 12, that would be great.
Okay, relating to the first question, which is a great question, I will let Mark go into detail in this question. Mark, please?
Okay. Well, we're not disclosing a specific year-by-year forecast for simplification, but we have clearly set the end point, and GBP 1.7 billion, we've got 3 full years, so '12, '13 and '14, to get there. As you say, we start effectively on a GBP 242 million start point. Let me put it like this. It is definitely not a flat line with a hockey stick at the end. It is a much more linear increase, but nevertheless, the heavy lifting parts I referred to, they do take time to build and mature. So there's a sort of a reasonable linear increase with some acceleration towards the back end as the IT development, which takes, sometimes, a year or more, you do it, you implement it, you then have to really exploit those things, so it is going to gather pace through there, but it's definitely not a hockey stick.
Look, Jason, we don't -- we only give guidance for the group as a whole, and we don't split between core and noncore book. But to give you a bit more insight on the flavor of 2011, as you saw on my presentation, on Tim's as well, our core margin has only decreased by 6 basis points because, as I showed in my slide, we were able to fully offset the higher cost of deposits with the mix on the deposits and with the repricing of the assets, and we expect that to continue. Therefore, on the core book, the only impact that makes the margin go down is the wholesale cost of funding. So depending on your expectation on wholesale cost of funding and the amount that we will need, which will go down, you can make your own expectation. On the non-core NIM, which, as you say, we don't find very relevant, the important thing is to look at the noncore assets as a whole, and as long as we do it as we have been doing it, holistically, and we shared noncore assets in a way that is accretive to capital as we have committed at the strategy review last year and, at the same time, has minimal hits to the balance sheet and, therefore, increases core Tier 1 as they are liberated and do not originate provisions for the future and, finally, also release liquidity, that's the holistic equation that we should look at the noncore books. So very different, as you were saying, from how we look at the core book.
Thanks. Tom? And then you can play nicely and pass it down the row.
Thomas Rayner - Barclays Capital, Research Division
It's Tom Rayner from Exane BNP. Could I have a couple, please, one on costs and the other on noncore. I wouldn't mind a third, but maybe I shouldn't try that. Okay. Just on the costs. The last 2 years, the statutory costs have been above GBP 13 billion, and obviously, there's a lot of focus on the underlying measures. I mean, I'm just trying to get a feel, as we get to 2014 and we reach full achievement, I mean, restructuring can become a bit of a habit or an ongoing process. I'm just trying to get a sense that we will have seen a convergence in the statutory expenses number and the underlying number by the time we get to the end of the program. And as I say, I have a second question. Do you want me to do it now or wait?
Yes, put it in.
Thomas Rayner - Barclays Capital, Research Division
It's really just a sort of update on the noncore assets. Again, 2014, assuming we are at about GBP 90 billion, can you give us any sort of flavor of what the plan then is? I mean, are we going to see this reduce to 0? If so, what's the capital implications, or may we see some of these assets sort of drift back into part of a sort of core Lloyds business? I'm just trying to get a sense for what happens post-2014.
Okay. Relating to the first question on costs, I'll ask Mark to give you some more color as well on what you asked.
Okay. Thank you. As you say, there are some quite heavy underlying costs, and clearly, the integration was, by far, the biggest factor of that over the period. Quite obviously, that's done. Verde is a different feature. Obviously, that's growing, but again, in the period we're looking at, obviously, that will be finished in the middle of the period. So it's definitely also going to go away. And as we've discussed, simplification, we've outlined the cost there, which, when we declared last summer, the target cost for the simplification of GBP 2.254 billion, the vast majority of which will go below the line. But as you say, we don't intend that to become a habit. The simplification is transformational in the sense that it really will move our systems and processes and customer service to a completely different base. So clearly, I would expect to be able to continue to improve after that, but I'm not expecting maybe at quite such a heavy pace, or at least if we do, we'll be having to generate the equivalent benefits.
Okay. Tom, relating to your second question. I mean, the fact that we were able to do GBP 53 billion of noncore asset reduction without any significant hits to capital as we discussed was a very good achievement in difficult market conditions from the team and from the committee that we've put in place that sees this, as I said, on a holistic way. So given that we have another GBP 50 billion to go in terms of our target for 2014, what we said is within the same principles, we will do at least GBP 25 billion, which is, again, more than half of what we have to do in the next 3 years, and that is our base case to start with. So I think the implication of what you're asking is that most likely, we will be ahead of target for '14 if this continues at the current pace, but we are going to absolutely privilege the criteria that I told you, which is capital release, which is less provisions for the future, therefore, risk and liquidity liberation, very important for the wholesale, for the whole liquidity position of the bank. In the present market conditions, and last year was very difficult as we have commented, we are very comfortable we can do at least GBP 25 billion within those criteria for the current year and, therefore, as you say, we will have only, like, GBP 15 billion, GBP 20 billion to do.
You can pass it over here.
Rohith Chandra-Rajan - Barclays Capital, Research Division
Rohith Chandra-Rajan from Barclays Capital. Could I have 2 as well, please? First one, just on the sort of near-term guidance, on impairments where you're talking to reduced impairments across all of the divisions, but particularly, in the international businesses. Given your cautious outlook on the U.K. economy, I just wonder if you could talk a bit more about your expectations, particularly in the U.K. corporate book and the degree of confidence that you have around that in terms of impairments for 2012 and onwards. And then the second question was a sort of medium-term question just in terms of your income aspirations. You talked quite a bit today about net interest income, the lower rate environment, deleveraging in the economy, et cetera. I just wondered, in terms of the noninterest income drivers, given that there was a lot of focus placed on those within the new strategy, how you expect those to proceed versus sort of original expectations back in June.
Okay. Look, Rohith, that's a very good question because it is absolutely true, as you say, and it might work given everything consistent. We are cautious about the outlook. I think we all share that the economy is going to be probably flattish this year and then slow recovery this -- next year. So it will be, again, a long and difficult recovery, more difficult than everybody would have anticipated a year ago. But it is as true that we see across all divisions very good performance in terms of impairments across the board, and all the leading indicators that we have point in the same direction, and that's why we are very comfortable when we are guiding you to a same percentage reduction in terms of our group provisions for 2012, the same as we have in 2011, with especially important contribution from the International division. So that is something, which, in terms of the underlying performance of the portfolios, makes us very comfortable. What are the main reasons behind that comfort, going a bit deeper, and how can they be contrasted to, what you say, our cautious outlook on the economy? Well, I think we have to split core and noncore. And when you look at noncore, we start from a base where we have less GBP 53 billion of noncore assets on the book. And those GBP 53 billion of noncore assets that no longer exist in the book, as Tim mentioned, do not generate more provisions in the future. And those include almost GBP 5 billion in CRE, those include GBP 2 billion of cash from Ireland, to give you a few examples, significant cash receivables from Australia and New Zealand, apart from noncore treasury securities, so as Tim showed, very much across the board. So in terms of the noncore, the fact that we reduced 27% our noncore assets and especially based on risk criteria is one of the major reasons why there is a significant improvement going forward, those risky portfolios disappear. When we go into the core book, you can see as well from all my slides in all divisions that although we have been going up, for example, SMEs loans going up 3%, risk-weighted assets go down by 3%. In Retail, assets go down 3%, risk-weighted assets go down 6%. In all divisions, you have the same behavior, which means, as Tim also showed, that the new loans that we are getting into the books are less risk and more in line with our more prudent approach to risk which is the Lloyds heritage type of risk management that's used to -- Lloyds used to have, and therefore, the new business has a lower risk premium for the future. And this will translate as well into lower impairments in spite -- and I fully agree, and I was the first to tell it -- that we are going to face a very challenging economic environment. Would you like to add something to this in terms of '11, in terms of what we saw in '11, Tim?
Tim J. W. Tookey
I agree with what you said. I think if you wanted to see the trends, I'd take you back, Rohith, to my slide, which showed the reducing level of capital intensity required by the business. I'd also look at the arrears trends, which are down steadily half-on-half-on-half-on-half -- the trend's getting a bit boring, actually -- just showing the steady improvement in the quality of the book. But I was really pleased to see the reduction in new to impaired in Wholesale, in Commercial, and the slowing migration to impaired in Ireland. Those are all good signs of the improving quality in the book.
Juan, you also add some color about the 2012 impairments and NPLs perspectives?
Yes. Our outlook for '12, as António was saying, is to improve the level of impairments in the Wholesale book as well. We are monitoring the entries into the -- what we call the business support unit, where we treat all the bad assets, and the trends in terms of entries are encouraging. So -- and we see it -- I mean, when you compare the second half with the first half of 2011, you'll see significant, I mean, kind of a fat reduction in the second half against the first half. So we think this, together with what Tim is saying, and it is that the level of impairment that we'll have to charge for the new entries into BSU is lower, that's what is making the equation work.
And just through the second part of your question, as we said, we think that our income-related targets for '14 will be delayed beyond '14, given the weaker economic environment, but we still expect to achieve them over time, and that includes sort of what you asked about LOI where we had some improvement last year already. We are working on the growth initiatives that all base on the capital-light projects, which will increase LOI further as we go, and we are continuing to be committed to achieving around 50% of LOI of our total income over time.
We'll go to Manus over here.
Manus Costello - Autonomous Research LLP
It's Manus Costello from Autonomous. I've got a couple of questions for Tim, or perhaps, Andre, actually. I noticed that you have decided to issue some equity to settle the coupon payments in some of your hybrid instruments. I wondered what's going on there, and if that's something we should see going forward or if that's a one-off. And my second question is that, like RBS, you're on review for a downgrade to your P1 rating, and I wondered what impact that would have on your business, and in particular, what we should expect to see in terms of mitigating measures. Would we expect to see the liquidity pool fall? Would we expect to see significant outflows of corporate deposits and short-term wholesale funding, if you could give some color around that, please?
Tim J. W. Tookey
Thanks very much, Manus. On the equity piece, the answer to your questions, we haven't done yet, but we have set out in the notes an intention this year, now that we are finally free of the coupon blocker from the EU, which is a terrific position to be in now, that it's our intention to issue what will be a very modest level of new equity to satisfy the coupons on the instruments that are due for benefiting from the EU blocker coming off. This is a small amount. I mean, we're talking less than 1% in terms of dilution here. But the benefit, obviously, is that it does it in a capital-neutral way. And I think in the current environment, it's my view, it's our view that, that's probably the right thing to do at this time. You ask whether that's something you should expect into the future. I think we'll probably do that for this year and then we'll take a raincheck and see how we feel about the future next time. On the second part of your question, yes, there's an awful lot of banks in this situation right now, but we've set out in one of the notes deep in the news release today, some quite extensive disclosures on what the impact might be. It's very difficult to predict how this is going to be, so we've illustrated what might happen. I mean, we saw virtually no change in patterns from either from corporates, or pricing or accessibility to the debt markets in the autumn and the downgrades that happened then. And I think it's one of the things that makes me feel very comfortable about it, because we're sitting on GBP 200 billion of primary and secondary liquid assets, which is a very strong position to be in. It's over 170%, as I said in my chart, of all maturities that are due in the next 12 months, which is a very good position to be on. Put on top of that the fact that we continue to outperform the market in growing retail deposits, add on to that the fact that we've done GBP 15 billion of term funding for this year against a target of GBP 20 billion to GBP 25 billion, and there's a degree of skepticism whether we can grow the core book in the room, so I might not even need GBP 20 billion to GBP 25 million, so you can't have it both ways, guys. I look at it and I say, where there’s so much uncertainty out there, we're in a very good overall position.
Let's go over here to Mike Helsby.
Michael Helsby - BofA Merrill Lynch, Research Division
It's Michael Helsby from Merrill Lynch. Just a couple-ish questions, please. Just on costs, I see we've -- you've exited the fourth quarter on OpEx at GBP 2.4 billion, and that's been progressively trending down in every quarter. Is that the base that we should be looking at for 2012? If you could give us any guide if there's any particular investment that you're going to be doing in 2012. On bad debt, Irish NPL cover is now at 62%, which is -- it's clearly very high. I was wondering if you could talk about the outlook as you see it for NPL formation in Ireland. Appreciate asset values are still depressed and there's no liquidity but just how you see NPL formation given NPLs are very, very high as well. And just finally, I was wondering if you could give us a comment on how you see the LTRO. You've clearly got a big funding requirement in noncore. A lot of that's European. It just begs the question why you don't spread the pain of that and use the LTRO while it's there. And then just attached to that but maybe a little bit different, it's just that GBP 25 billion of assets that you're running off in noncore, can you tell us if that's all now interest-earning assets or if that's -- if any of that is maybe in trading or something like that?
Mark, maybe you can take the cost one, then Juan will take the Ireland NPLs one, and I'll take the LTRO one, and we think whether we answer the fourth.
Okay. So I mean, essentially, the question is, do you take Q4 and extrapolate it. I think I'd rather you didn't. The costs are quite lumpy, so things like the bank levy, FSCS compensation, bonus accruals, impact of pay rises, do make the quarterly trend a little bit more volatile, so it's far easier to think of it, I think, in terms of the long-term rate of cost decline on an annual basis and, really, to think about it much more as an annual trend rather than trying to extrapolate a quarter by 4, could lead you to wrong answers.
Basically, the idea that I think you should keep is, we are going in an accelerated way, nominal costs start to reduce quickly this year, they're going to continue to reduce, we are increasing our targets for the end of '14, and you can extrapolate how we are going to do until then. But we are going quicker than we expected at a sustainable pace is the way I would put it.
Ireland, we have 2 books in Ireland. One is the Wholesale and the other one is Retail. I think the picture is different in both. So in Wholesale, we have GBP 17 billion net, and if you look at the numbers at the end, we have an impaired asset ratio of 84%. So you cannot impair more, right? So we have impaired everything. And in spite of this level of impairment, we have a coverage ratio of 61%, which is extremely high. So the more you impair, the new assets that you impair normally have a lower coverage ratio. And in spite of that, in spite of having built almost the whole book, our coverage ratio is 61%. So for Wholesale, we are comfortable with our current provisional levels in a very bad book, right? So -- but we feel that we have done the right thing in terms of provision coverage. In Retail, the picture is different. So you have seen increased level of impaired assets in 2011. We think the overhang on Ireland on the property market will continue, so we are not very optimistic on -- in spite of the economy growing in '11. And the latest outlook that came up yesterday was for growth also in 2012, we think this is not going to impact positively in the property market. So we continue being very cautious on Ireland. What we think is that the level of coverage that we have in our impaired assets is very good, so we are in 70% in the mortgage book in Ireland. It's a GBP 7 billion portfolio, it’s a small one, and we have a very high level of coverage. And on top of that, we are keeping a very conservative policy in terms of recognition of impaired assets. So you compare NPLs for 90-plus arrears in the mortgage book in Ireland with your impaired assets, we have today, 18 90-plus and 20% impaired. If you do the same with the competitors, the picture is totally different, so they reduced from kind of 10 to kind of 5. So we are impairing more because we have seen that the level of impairment we have to take is more than 90-plus. So we think that 70% in our case is, again, as it happens in the Wholesale, it is a higher level even when you compare like for like. And the coverage ratio of the competitors is -- are at levels of 50. So we think we have taken a big hit. For the next year, as for 2012, we think that the situation will continue to do it. But our impairment charge in Ireland, we think we have taken one-offs in '11 and, therefore, we could see in '12 compared with '11 some improvement.
Mike, relating to the LTRO, we have not yet taken a decision and, as we just discussed, I mean, we are improving our funding position substantially. We have already done more than half our funding plan for the year. We don't really need to access the LTRO. But -- and we are going to take a definite decision on this next Monday when we have our group outlook. But as you said, we are thinking about our European noncore assets, which are euro-based and where we have more assets than liabilities, and given those are noncore assets, which will run down, most of them, over the next 3 years, it might make sense from a risk management and liquidity perspective to match those assets with -- using the LTRO in moderate amounts and have them ring-fenced and, therefore, having a much better risk management in terms of our noncore euro assets. So we are thinking about that.
Michael Helsby - BofA Merrill Lynch, Research Division
I take it that's not in your margin guidance?
Michael Helsby - BofA Merrill Lynch, Research Division
I take it that's not in your margin guidance?
It's correct. It's not in our margin guidance.
There was one on the noncore.
Tim J. W. Tookey
I'll deal with the fifth part of section 1 of question 2. You asked if all disposals contributed to average interest-earning assets. The answer’s no, Mike, they don't because our treasury assets don't count into that total. And I might just say, you will find Pages 106 to 110 of the appendices particularly fascinating, if you want to understand Ireland, dissect it every which way. So that may help you understand the Irish book.
It's down here, Arturo. Nice to see you back.
Arturo de Frias Marques - Grupo Santander, Research Division
Arturo de Frias from Santander. Two questions as well, one on strategy and one on capital, please. The one on strategy is related to the Wholesale unit. The Wholesale unit is the only one that has seen the returns coming down this year. The return on risk-weighted assets pre-tax is 1.4%. That equals an ROE of around 10%, which is not the end of the world, but it's clearly diluting the ROE of Retail, Commercial and Wealth, which are all above 15%. So my question is, probably you are not very happy with a 10% ROE in Wholesale. What are you going to do about that? Are you -- and the other problem is that Wholesale is the biggest division still in RWA terms. So are you going to decrease Wholesale in terms of RWAs, or are you going to substantially increase the returns on that division? Or you are just happy with the other divisions doing the heavy lifting and Wholesale diluting every -- and the second question is on capital. The CRD IV guidance, I think, if I add the DTAs and the insurance, is now 285 bps. And if I remember correctly, the last time we talked about this, it was going to be in the region of 200 bps. So am I right? Is the impact now a bit worse? And if yes, where are we with your guidance of being prudently in excess of 10% core Tier 1 by 2013?
Okay, Arturo. Thank you very much. Welcome back, as Kate said. I will take the first question, and I'll ask Tim to ask about the insurance one about the difference that you mentioned. Well, obviously, we are not happy with the return on the year of the Wholesale division, obviously not. On the other hand, we recognize that it was especially difficult year. The decrease on the profitability of the unit is a result of both deleveraging on our core corporate customers on one hand, and second and especially, very difficult market conditions, which made customers transact less, and therefore, our growth initiatives and our plans of enhancing the share of wallet of fee-based capital-light products was less successful in the year, which we would hope to change. So in terms of the future, I would separate this in 2 parts. On the noncore, because there are substantial assets on the noncore division which are Wholesale, we want, as in the other noncore divisions, to share them as soon as possible within the holistic view of balancing liquidity, capital and results on the sale. We have been successful as well on the Wholesale division this year, and we plan to do the same and reduce noncore wholesale as quickly as possible within this criteria. In terms of the noncore -- of the core part of the business, we have significant growth initiatives in Wholesale, such as the Arena platform launched last year for many markets and foreign exchange transactions, where we have had a substantial increase in terms of volumes, and I can ask Andrew to give you some flavor on that. And we have other initiatives, which take longer, like transaction banking, that require investments in order to generate income. But the strategy for Wholesale in terms of principles is very clear. We do not want, as I said in the strategy review, to build a big investment bank. We do not want to have an equities business. We do not want to have an advisory business. We do not want to have trading. We want to have our Wholesale business focused on mid-corporates, focused on our extremely strong positions in SMEs, on the Retail business and help those areas get the biggest share of wallet of those customers, especially products-orientated to LOI, because they will be capital-light products. So that is -- those are the principles of the strategy that we have set out in June, and those principles, I would say, are even more valid today. In any case, Andrew, I would really like that you say something about the success we've had with the first initiatives with the Arena, foreign exchange, and the rates business.
Certainly. I mean, I think there's been a couple of things that we've been investing in pretty on in the business itself. The foreign exchange business is a great example. Through Arena, we've been changing the way or responding the way customers want to do business. The corporate customers have said to us that they want to transact over an e-channel. We've built the e-channel. They've responded to that. We've also expanded our foreign exchange business in the financial institution, and our volumes are up significantly there inside our foreign exchange business. I think the other piece that happens not just in foreign exchange but our debt capital markets business, António mentioned earlier that the sterling investment grade bond business, we've had an increased market share there, we have an increased market share in our lending business aspect as well. So we've seen growth in our key initiatives in each of them. The last point to highlight, though, is that these product initiatives are only linked to what our customers want. We're building a platform, we're building capability to serve our customers, and the customers are responding to that.
Thank you, Andrew. Tim, can you answer the second part of the question?
Tim J. W. Tookey
Yes, I will. I'll take the CRD IV bit, Arturo, for you. The 285 you're getting to is the 5 lots of 25 and then the 160 for tax. I do see those as very differently, and I do see that the 25 bps is akin to a permanent change in the capital rules, whereas the tax deduction or the losses point, I do see that very differently. Comparing that to the 2%, which is 5 lots of 0.4% that was flagged last summer, of course, that 5 lots of 0.4% didn't include any aspect of the deferred tax at all. The 0.4% in each year was made up of 2 parts. There was 0.2% to do with the insurance deduction and a further 0.2% to do with the other changes, which was principally excess expected loss. So that 0.4% has now translated into the 0.25% that we have today, which is you're doing 5x to get to 1.25%. So it's actually come down. How's it come down? Well, part of the answer is on Page 197 of the news release, where we've actually, this year, taken a GBP 720 million approximately charge against core Tier 1 for the increase in excess expected losses. That brings down the amount, therefore, that we have to absorb into the future, and that's about 20 bps worth, so that's the lion's share of it. The rest of the benefit would come from the capital restructuring that we did in the insurance businesses, which we completed in July of last year. The reason this time I've being specific on the tax point, although I do regard it as very different, is because we had a number of people reading our tax note in the statutory accounts and coming up with different answers. So I thought I'd just put the number on the slide and make it easy for everybody to understand what it is, and that's why you get the 1 6 that you get today. So actually, we've got an improvement in our implied CRD IV position, partly through the mitigation actions that we've undertaken, and also the fact that the excess expected loss has swung against us during the year.
Arturo, can you pass it over to Peter? Thanks.
Peter Toeman - HSBC, Research Division
Peter Toeman from HSBC. Tim, can I -- from your comments, assume that there's no P&L impact in 2012 from the end of the coupon blocker on regulatory capital, that there's no sort of adverse P&L consequence. And how does the ability now to pay coupons on regulatory capital make you feel about paying dividends on equity capital?
Tim J. W. Tookey
I'll answer the first question. The second question's probably a question for when I'm gone. The first question is yes. The answer is yes, there is no impact on the P&L from what we're doing. Shall I stretch it out? It's approximately nil. Ordinary dividends. I think the other part is on when how do we feel about [indiscernible].
Well, about the dividends. What I would say about the dividends is, I mean, we have made a lot of progress since last year, but the answer is very similar, i.e., we do not -- we want to have our regulatory requirements clearly defined and then we want to prudently meet them. We know that the dividend policy is very important for our shareholders. We are absolutely mindful of that, and I think that when you look at the core book and you see that we have a core book that generates more than GBP 6 billion of pretax profit in a difficult year and with a return on risk-weighted assets of 2.5%, you can have an idea on the future of what that book will look like and what dividends it can generate. Nevertheless, we are waiting for full clarity on the ICB discussion with the treasury in offer implementation, and we are waiting for the CRD clarification as well in order to implement those rules as well. I have to add that versus what we said in June, and we said at the time we wanted to have a capital ratio, core Tier 1 capital ratio prudently above 10% when the CRD implementation would start so in '13, I think all the numbers moved in the direction of what we said a year ago. And if you apply, as you saw in Tim's slides, current CRD rules to the present position, we are already at the core Tier 1 level of 10% for January '13 without any management mitigating actions and without any profit reduction.
Michael Trippitt - Oriel Securities Ltd., Research Division
Mike Trippitt at Oriel. Two questions. I'm still trying to understand, within the Retail division, you talk about impairment's up because of your outlook on house prices, yet the risk-weighting on that book is down. And I'm just trying to sort of square that with now, as you just pointed out, Tim, the expected additional losses in the core Tier 1, you've taken a charge in '11. So I'm just trying to sort of square that circle on impairment versus risk weighting. And the second question is on noncore. As you sort of progress through that runoff, I'm just trying to understand, what -- how the loss -- what I'm trying to understand is what the capital released would be in '12. Because if your funding costs are going up presumably, your opportunity cost is higher on that book, so I'm just trying -- if you could throw a bit of light on that one in terms of capital release.
Well, I can start from the second one and tell you, that is exactly one of the reasons why we have accelerated the noncore reduction during the year, as wholesale funding costs were going up, as you correctly say, the opportunity cost is higher, so it is an additional incentive, everything else constant, for you to accelerate the noncore reduction once it is totally wholesale funded, as you just said. So for 2012, our expectation, as I just said, is to do again at least half of what we have committed to do after '14, which will have a benefit, obviously, in terms of the wholesale funding position, but we want, Mike, to keep the other criteria, which is not only to release liquidity but to be capital accretive as we have committed for the period '12, '14, and we want to have into consideration the hits to the book, which then increase our core Tier 1. I would -- I think you should think along the same lines that we have followed in '11 for 2012, and given that we have still GBP 110 billion of risk-weighted assets on the noncore book, which is like 1/3 of our total risk-weighted assets, as you correctly say, there is a lot of capital still tied in that portion of the book. Relating to the first part in RWAs, I would ask -- RWAs on Retail, I'd ask Juan to make a few comments about how do you evolve and how you square the circle that you mention.
Yes, the RWAs in Retail are reducing because the quality of our Retail book is improving. In terms of how this fits with the increase of impairments in 2011 in the mortgage book, in -- what we have done in '11 is to change our outlook for house prices for the future, and that was the reason of increase. That was the reason we have increased the coverage in the mortgage book from 23% to 25%, 26%. So for '12, so what does it mean in terms of the performance of the portfolio for the future? What you can see in the appendix is information that we have provided that the mainstream and the RWA book are performing very well, and the specialist book in the first half of '11 increased arrears; in the second half, it has flattened, and then -- and it is a book that at some point, it will have 2 season, because it is a closed book since 2009. It has happened 3 years since we closed it. So at some point, we should start to see a decrease in the level of new arrears in this book and -- but at the same time, as António was mentioning, the outlook for the economy is not positive, unemployment could rise in '12 and '13, and therefore, we're keeping a cautious view of the Retail book for 2012.
We are expecting, as we said in the beginning, that overall, in terms of the Retail book, nonperforming loans will continue to decrease in 2012.
The biggest improvement in Retail is coming from the unsecured book where, in '11, we have seen significant improvement in the level of impairment charge. For '12, our expectation is to continue with this improvement.
Tim J. W. Tookey
Can I answer the last part of your question, Mike? How does that interact with the GBP 720 million, the excess expected loss. This is an interplay between the assets that have run off during the year and fair value. So at the start of the year, we didn't have an overall excess expected loss, and all those expected losses were more than fully provided by the impairments on the balance sheet and the fair value provisions, so the excess was 0. There wasn't one. One of the benefits of running off -- well, I suppose it’s not a benefit, is it? One of the effects of running off noncore assets that are very well provided, we had the huge benefit of turning them into cash and liberating capital, of course, but we've actually had exactly the predicted uncovering, if you like, of an excess expected loss on the rest of the book, and that's the GBP 720 million that appears on, I think it's page -- it's on the left-hand side, Page 197, which is a capital note. That's what I was predicting would happen when we were giving the guidance on CRD IV, to come back to Arturo's first question, when we were looking at Basel III impact last summer and in February of last year. And that's coming through now as we expected, so the future uncovered is reduced.
Thanks. If we can go here to Raul.
Raul Sinha - JP Morgan Chase & Co, Research Division
It's Raul Sinha from JPMorgan here. If I can have 2, please. Firstly on -- if you could give us an update on Verde, how is the sale going and maybe if you could give us the P&L contribution for the year? And secondly, I was wondering if you might be able to talk about your restructuring policy around loans in the Wholesale division or in the corporate division. I mean, yesterday, we saw at RBS roughly GBP 23 billion of corporate restructured loans. I was wondering if you might be able to give us some indication of what that number might be for you.
Okay. I will answer your question about Verde, and then Juan will tell you about the restructuring policies on the Wholesale division. In terms of Verde, as you know, we are in exclusive talks with a cooperative group, where we are progressing well, and we have said we would update the market by the end of Q1, and I don't want to add more into it. We are progressing well together with the cooperative group, with the regulator, and we keep at the same time, as we have said, the IPO route in parallel as a contingent plan, and we are progressing well and expect to update by the end of Q1. Relating to the restructuring policies on the Wholesale division, can you comment, Juan?
Yes. What I can tell you about how we manage the restructure of the loans in the corporate book, everything is done through the business support unit entirely, so -- and the policies that we are following in the business support unit are, I think, very prudent, not only in the way we do it, also in the way we recognize it and we keep it until we are totally sure that it is sorted.
Gary Greenwood - Shore Capital Group Ltd., Research Division
It's Gary Greenwood from Shore Capital. I've got 2 questions. The first, something that I'm struggling with a bit, it’s the return on equity in the Retail banking division, which I think is around 25%. And that's not dissimilar to what we're seeing from Barclays or from Royal Bank of Scotland, but clearly, it's a very healthy return on equity. And given the commentary that we hear from politicians, from the ICB, from consumer watchdogs about U.K. retail banking not being competitive enough, I mean, just wondering how sustainable you think the returns are in that business over the medium term. And then the second question is just on Verde. And it's just in terms of your preliminary assessment when you came to the view of choosing the co-op as your preferred option. I'm just interested in how you think that they might be able to fund the bid on the basis that they're a mutual organization with a core Tier 1 ratio of sub 10%, which lags other mutuals. So I'm just interested in how you've gained comfort that they can back it up with the money.
Okay. Relating to Verde. I'm sorry, but you'll have to understand, given we are in exclusive conversations with both the cooperative and our advisors, with their advisor, I mean, we are obviously considering everything both from their capital raising perspective, the business, as you know, will be more or less funded, because there were -- there was the option of having the smaller business, but we are in exclusive conversations, and I would not like to go into detail. But we'll update at the end of the quarter. Everything that you asked is obviously being taken into consideration on the negotiations we are having. Relating to Retail, as I showed in my slide, the return on risk-weighted assets in Retail increased 2.4% to 2.8%. That is a pretax return on risk-weighted assets. So if you look on an after-tax basis, it will come to about 20%, 21%, which we think that for a Retail business in the present market conditions is absolutely fine. We have to go, if you put now the political question or the social question into the future, what I would answer to you is the following: As I said in my closing remarks, I strongly believe that we are going to go through a period of lower interest rates for longer, which normally affects retail negatively. At the same time, you are going to go through a period of higher regulatory costs and scrutiny and off a deleveraging customer base, because debt versus GDP or income is too high. So in this context, what will be critical, in my perspective, is to offer transparent products to customers, well priced, that offer superior value for money, and where the winners will be, as I said in my concluding remarks, is on building a competitive cost advantage in terms of costs, by being able to deliver the same value for money for customers with a more efficient machine or factory, which is what Mark showed you, and secondly, building a lower risk premium going forward, getting lower risk assets into the book in a sustainable way, which are the points that Juan has been asking. And I think we have made major progress on those, and I think when you combine both those 2, if you assume the same environment I'm telling you, that's what will make the difference, and those 2 criteria will differentiate the banks that will have superior returns from the ones who don't. It will not be an income equation from my point of view. It will be a costs and risk premium equation for the foreseeable future.
Okay. In the interest of time, I think that's all we've got for questions today, so thanks for that. And I see you, Tom, but thank you again and I'll pass over to António to end the session. Thank you.
Thank you very much.