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Executives

António Horta-Osório - Group Chief Executive, Executive Director, Chairman of Group Asset & Liability Committee, Chairman of Group Risk Committee and Member of Chairmans Committee

M. George Culmer - Group Finance Director and Executive Director

Mark Fisher - Director of Group Operations

Juan Colombás - Chief Risk Officer

Analysts

Chris Manners - Morgan Stanley, Research Division

Ian Gordon - Investec Securities (UK), Research Division

Sandy Chen - Cenkos Securities plc., Research Division

Cormac Leech - Liberum Capital Limited, Research Division

Thomas Rayner - Exane BNP Paribas, Research Division

Michael Helsby - BofA Merrill Lynch, Research Division

Rohith Chandra-Rajan - Barclays Capital, Research Division

Manus Costello - Autonomous Research LLP

Robert Law - Nomura Securities Co. Ltd., Research Division

Claire Kane - RBC Capital Markets, LLC, Research Division

Peter Toeman - HSBC, Research Division

Lloyds Banking Group (LYG) H1 2012 Earnings Call July 26, 2012 4:30 AM ET

António Horta-Osório

Good morning, everyone, and welcome to our First Half Presentation. I am joined here by our Chairman and our executive team, which is now complete. As you know, George Culmer joined us as Group Finance Director in May, and you will hear from him later and Cathy Turner joined in June as our new Chief Administrative Officer in charge of HR, Legal, Brands and audits and Andrew Benson joins us as new CEO of Wholesale just this month.

In the first part of my presentation, I will describe our strategic progress in the half year. Our continued risk reduction reflected in our ratings updates and the resilient operational performance we have delivered in a challenging environment. George will then give you more detail on our financial performance and Mark Fisher, our Group Operations Director will update you on the progress we are making on the simplification and cost programs. Finally, we'll summarize our first half and talk you through our expectations for the remainder of the year and the outlook for the medium term.

So turning first to the first half highlights. We made further substantial progress in strengthening our balance sheet and reducing risk. We have further reduced GBP 23 billion of noncore assets, ahead of expectations. Our core Tier 1 capital ratio has now increased to 11.3%. We have completed our term wholesale funding program for the year by the end of April, and as you will hear from George, our liquidity position improved further. And we have continue to deliver above market customer deposit growth, further reducing our wholesale funding needs by around GBP 40 billion and allowing us to further improve our group loan-to-deposit ratio. There is no doubt that this is a challenging environment for the banking sector, with subdued loan demands, high funding costs, very low interest rates and a stringent regulatory environment. Nevertheless, the actions we have taken to reduce balance sheet risks, noncore assets, costs and impairments, when combined with the delivery of improved management profitability at the group level and stable core returns, should give you a clear idea of the potential of Lloyds core bank going forward. I am, of course, disappointed to report a statutory loss for the period, driven entirely by our decision to increase the PPI provision by a further GBP 700 million to address this disappointing legacy issue. More on that later.

We have continued to implement our strategic initiatives, building for the future, we added an additional GBP 600 million investments behind the growth initiatives in the first 12 months of the program. And elsewhere, we have seen encouraging developments. Last week, we signed high level terms of agreement with the cooperative group for the disposal Verde as you know, and we remain on track to complete this disposal as required by the end of November 13. In June, the substantial progress we are making in delivering our strategy was also reflected in the outcome of the Moody's rating review, which reaffirms Lloyds's short-term P1 rating while the longer-term rating was lowered by only 1 notch to A2, a good outcome relative to others in the sector and as good as we have hoped for. And we have now completed 2/3 of our international divestments, having announced the exit of 10 international locations. Also, the changes we are seeing in the external environments endorse that the strategy focus on traditional retail and Commercial Banking in the U.K. is the right one for Lloyds. Our business model is fully aligned with the White Paper's proposed banking reforms, and the recent regulatory authority focus on supporting the UK's economic recovery is most welcome. So it is clear that the strategy we set out a year ago remains entirely appropriate, even more given the deterioration in the external environments and the progress we have made against it means, in my opinion, that the group's prospects are getting stronger in spite of this deterioration.

I will now look in more detail at the key achievements in the first half against this strategy. A cornerstone of the strength in balance sheet has been the substantial growth of customer deposits we have achieved over the past 18 months. In the first half, we delivered a further increase of 3% and 6% year-on-year broadly consistent with the growth rate we achieved in 2011. This solid performance reflected, in particular, our compelling multibrands and multichannel customer proposition. As a result of this strong deposit growth and the substantial noncore asset reduction, the group loan to deposit ratio reduced further to 126%, 28 percentage points down since January last year with the core loan-to-deposit ratio down to 103%. As you can see, we are well on track to achieve our targets of a long-term loan to deposit ratio of 120% by early 2013, approximately 2 years ahead of targets, which will leave to an 100% core loan-to-deposit ratio.

We also continued to strengthen our balance sheet by reducing the noncore portfolio, and we made strong progress again in the period in spite of challenging market positions. We achieved a substantial reduction in noncore assets of GBP 23 billion, with GBP 11 billion in Q2, ahead of expectations, and again in a capital accretive way, as we had committed. This included reductions of GBP 11 billion in treasury assets, GBP 3 billion in U.K. commercial real estates and GBP 5 billion in international assets, of which GBP 2 billion was in Ireland. George will give you additional disclosure on our core assets -- noncore assets later on. We remain confident that we will reduce noncore assets by at least GBP 30 billion this year and to GBP 90 billion by 2013, 1 year ahead of target. We now expect our noncore assets to reduce further to GBP 70 billion or less by the end of 2014, 50% of which will be retail assets so nonretail assets being around 5% of total funded assets. As a consequence of this, from 2015 onwards, we will cease to report on the noncore business separately.

Moving on to capital. Our core Tier 1 capital ratio increased to 11.3% at the end of June, at from just over 10% a year ago. This was mostly driven by our management profits and a reduction in risk weighted assets, with one-off legacy items offsetting progress, which would have otherwise been even more significant. Our Basel III fully loaded core Tier 1 capital ratio stands at 7.7%, up from 7.1% at the year end and I expect it to continue to trend towards our core Tier 1 ratio throughout the transition period, well ahead of regulatory requirements. The total capital ratio increased to 16.6% from 15% a year ago, positioning us very well relative to the ICB's recommendations for loss of servant capital in excess of 17%.

Now turning to the income statement. Our income performance continues to be affected by the subdued economic environment, very low interest rates and higher funding costs. However, the actions we have taken to accelerate our cost management program and reduce impairments meant that we improved group profitability and returns and continued to deliver stable returns above our cost of capital in our core business. Even though we delivered a resilient underlying performance in this first half, we are disappointed that we had to make further provisions in both the first and second quarter for PPI contact and redress, which impacted our statutory results, as a consequence of the current claim experience, which did not decline as quickly as anticipated in quarter 1.

Notwithstanding pressures on the top line, we have continued to invest a proportion of the simplification cost savings, around GBP 600 million so far, to grow our core customer businesses through the launch of new products and services. We are continuing to do what we said we would do and a bit more. We have made good progress but it is clear that some of our businesses need some additional attention to operate more effectively in their particular environments. However, it is also clear that our initiatives are delivering the sort of returns we want in the next 3 to 5 years in the restructuring journey that we started last year.

Some highlights are: In retail, we are investing in new channels for customers, ensuring that our products and services remain convenient and accessible and thereby increasing usage and engagements. We are pleased with the very strong increase we have seen in our Internet banking user base by 650,000, which takes us to over 9 million users. We now have 2.5 million mobile banking users accounting for almost 25% of all customer logins onto our banking systems.

In commercial, we are on track to exceed the SME chart of commitments of GBP 12 billion of gross lending in 2012, while we have now increased our target by a further GBP 1 billion and we are proud to have supported 64,000 start up businesses so far this year, and net lending to SMEs is also positive and accelerating despite a falling market.

Let me move on now to the performance of each of our divisions. In retail, we have delivered further reductions in costs and in impairments, more than offsetting the falling income. As a consequence, underlying profit increased by 12% with return on risk weighted assets improving to over 3%, well above our cost of capital. Customer deposits increased by 3% since the year end, significantly above the market as a whole. This successful deposit growth is a result of retail's ongoing commitment to its multibrand, multichannel strategy; the investment in our relationship brand: Lloyds, Bank of Scotland and Halifax; and a strong focus on holistic and continuous fine-tuning in the pricing of both our loans and our deposits together. In mortgages, we have continued to supply 1 out 4 loans to first-time buyers, having supported 25,000 people in H1 to get their first home, and we have achieved an overall gross lending market share of 18% in the period. In wholesale, underlying profit before tax in the fist half declined modestly year-on-year, although we delivered a slight increase in returns. While continued customer deleveraging and higher wholesale funding costs drove a decrease in underlying income, the continued improvement in asset quality drove a substantial decrease in impairments. These returns are still not acceptable, as we have reviewed the strategy and asset allocation to improve this going forward in the context of the ICB recommendations. Total cost rose modestly as cost savings and continuing cost management focus were offset by ongoing investments in core customer facing resource and systems, in line with the priorities we set out in the group strategic review a year ago. I am looking forward to Andrew better leading the next phase of the reshaping of this business as we also advance in our plans to become ringfenced bank, ahead of the regulatory deadline and we will let you know more on these plans at the Q3 IMS.

Moving on to commercial. Commercial delivered the strong results with underlying profit before tax increasing by 24%. It has continued to focus on strengthening its customer relationships and on supporting SMEs through the difficult trading conditions by further developing its understanding and support of individual businesses' business requirements. This is demonstrated by, amongst other things, the growth in our net lending to SMEs, with core loans and advances increasing by 4% against the contracting markets as I mentioned. Customer deposits grew by 3% ahead of the market and reflecting our ongoing success in attracting new SME customers, particularly through current accounts.

In insurance, we continue to generate strong returns with IRRs or new life pensions and the investment business of over 16% and the combined operating ratio on our general insurance business of 80%. Sales through the bancassurance channel have nevertheless been impacted by subdued demand for investment products and by the preparations for the RDR. In terms of results, core underlying income is down 19% with the changes to economic assumptions and adverse weather accounting for most of this reduction. The remainder has been partly offset by further action on expenses, which decreased by 8%. These are decent performances in challenging markets, particularly given the impacts referred to above, although we will have to do better and get it right in the context of RDR. As I said before, the Retail Distribution Review will materially change the landscape of bancassurance and wealth from January 2013 and we will update you with the Q3 IMS on our latest plans.

Wealth, asset finance and international profits were stable with a continued reduction in impairments and expenses offsetting a decrease in income of 3%. The focused deposit gathering strategy delivered 29% growth, primarily due to the continued strong inflows in both the wealth and international deposit businesses, which have strongly supported our overall deposit growth. Our European online business is expanding quickly, bringing a stable, diversified retail euro deposit base to the group and the international wealth deposits are also progressing strongly, following a more targeted approach in the business and the perceived safety of the Lloyds brands in the current European turmoil. Our asset finance unit continued to deliver strong profits and returns and this continued to gain market share in the segments where we already have significant leadership positions.

As I have said before only by focusing on customers' needs and addressing those needs in a cost-effective way can we expect to deliver strong and sustainable benefits to our shareholders. Throughout the group, we are focused on implementing a number of service initiatives to drive improved customer experience. These are already showing significant progress as Mark will detail later on. Internally, we measure customer satisfaction through the Net Promoter Scores, which indicate the likelihood of customers recommending us to others and is based on the comprehensive set of over 45,000 customer interviews every month. On this basis, all of our major brands made significant headway in the first 6 months of the year. There was good improvement in the Halifax and the Bank of Scotland, reflecting the investment in their relaunch as stand-alone brands and also on Lloyds that has the highest scores and ranks highly among high street brands.

At the channel level, we also saw improvements across branch, telephony and the Internet, and as a result, our overall group-wide score has seen significant progress with an 11% increase in the first half. We will continue to build on this strong start to improving our customer advocacy across all brands and all channels.

As part of our Best Bank for Customer strategy, we have also committed to reducing banking complaints per 1,000 accounts to 1.3 by the end of 2012, a 40% reduction from 2010. We're making good progress towards our targets, having already achieved 1.4 at the half year. This reduction was driven by initiatives to remove the causes of complaints, for example, by ensuring that our telephone banking teams now have the ability to see details of earmarked transactions on a customer's accounts, which enables our customers to get the right item [ph] faster as we ensure that complaints are resolved at first touch whenever possible. These improvements we are making to the customer experience have also been evidenced by the continued significant decline in our fast overturn rates, where we now have the best outcome of the 5 major banks. Only 1 out of 4 customer complaints going to the ombudsman is decided in the customer's favor from 1 out of 2, 18 months ago, which clearly proves the appropriateness of our customer redress policies.

Retail deposits increased by 3% in H1 and by 5% year-on-year, once again outperforming market growth. This solid performance across all our brands reflected the compelling customer proposition retail has developed and has again been achieved in a cost-effective manner as you can see from the headline ISA rates in the first half of this year. This strong evidence of customer preference and trust in Lloyds is a sign of appropriate segmentation and illustrates the value of the core bank we are building to the benefit of our customers and shareholders. A stronger, simpler and more efficient retail and commercial bank, which will create strong and sustainable returns over time.

This concludes the first part of my presentation. I would now like to pass over to George for more detail on the financial performance in the first half.

M. George Culmer

Thank you, Antonio, and good morning, everyone. I'm delighted to be here to present the results for the first time. This morning, I'll update you on our performance in the first half. I'll then cover our balance sheet, funding, liquidity and capital positions. As you heard from Antonio, in the first half, we delivered a resilient underlying performance, with improvements in costs and impairments offsetting the expected decrease in income with an NI impacted by the smaller balance sheet and higher funding costs and ROI by subdued demand and adverse economic assumptions and weather in insurance. Underlying profit for the half year is GBP 1.1 billion for the group and GBP 3 billion for the core business. Management profit for the group was GBP 1.2 billion, but this was after a number of offsetting items. Volatility of our own debt was a charge of GBP 357 million. There's a mark-to-market movement in our EMTNs and ECNs and reflects improvement in credit spreads towards the end of the half. Assets and bond sales of GBP 585 million comprised the loss on asset disposals associated fair value unwind and gains on bond sales. Other volatile items have a charge of GBP 452 million, it's mostly timing and accounts and economic mismatches as we hedge out the group's interest rates and FX exposures. Liability management of GBP 168 million is a gain on our own debt purchases while the fair value unwind of GBP 157 million is significantly down on prior year, which included a much higher level of impairments. That brings us to the management profit of GBP 1.2 billion for the group and GBP 2.7 billion for the core.

Looking now more closely at underlying profit and starting with income. Underlying income of GBP 9.2 billion is GBP 1.9 billion down on prior year, GBP 648 million of this movement comes from subdued lending demand and customer deleveraging in the core business and accelerated noncore asset reduction. Increased wholesale funding costs contributes to further GBP 254 million, while insurance saw an adverse impact of GBP 266 million, primarily from the changes to economic assumptions and adverse weather. Nonrecurring items of GBP 257 million mostly comprised recoveries in the prior year.

Looking next to the net interest margin. In the first half of 2012, we delivered a robust margin performance. The core net interest margin was broadly stable at 2.32% with asset repricing offsetting deposit spread pressures. The noncore margin has fallen 25 basis points since year end, largely due to wholesale funding costs although the impact on the group is mitigated by the decrease in proportion of noncore. For the total group, the margin stands at 1.93% for the year-to-date and 1.91% in the second quarter. For the full year, we expect the net interest margin to be in line with existing guidance of around 1.93%.

Moving on to asset quality. Our asset quality ratios continue to show favorable trends with the group AQR of 1.1% reflecting the improved quality of the core book, an improvement in experience in noncore and again, the decrease in size of that book. And going forward, we remain confident that we could achieve the group AQR target of 50 to 60 basis points in 2014. In terms of impairments, the first half charge of GBP 3.2 billion was 42% lower than the first half of 2011 and continues to benefit from our prudent risk appetite and strong management controls, while the external benefits of low interest rates and stable U.K. retail property prices are partly offset by subdued U.K. growth, rising unemployment and the weak commercial real estate market. Within the divisions, retails total impairment charge decreased by 35% an GBP 0.8 billion with continued reductions in both secured and unsecured portfolios. In wholesale, the 31% reduction to GBP 1 billion largely reflects an GBP 0.3 billion improvement in the core book where we've seen reduced levels of large defaults and a benefit from the improvement in overall quality through a collective impairment release. In wealth, international and asset finance, the impairment charge fell by 51% to GBP 1.3 billion, with lower charges in the wholesale Irish and Australasian businesses. In Ireland, we have seen a significant reduction in the rate of increase in newly impaired loans, while in Australia the net wholesale book now stands at GBP 6.8 billion, following recent successful disposals. This improvement in portfolio quality is consistent with what we have seen in mutual arrears and newly impaired data. In retail, mutual arrears and secured is down 14% on last year and an unsecured by 31%. In wholesale and commercial, we are also seeing a reduction in newly impaired assets. These trends support our confidence in the sustainability of the improvement in impairments, and for the full year, we now expect to come inside our previous guidance of an impairment charge around GBP 7.2 billion.

Looking at the statutory result. Here we show the movement from the management profit to the statutory loss after tax of GBP 641 million. Simplification and Verde costs totaled GBP 513 million. Simplification comprise GBP 274 million of this, while Verde costs were GBP 239 million. On PPI, as you heard from Antonio, claims continue to run ahead of previous estimates. The additional GBP 700 million we have provided in Q2 reflects our assessment of the expected total, based on current complaint levels, projected future trends and our own separate analysis. The provision does however remain sensitive to future claim levels. As described at Q1, the past service pension credit of GBP 250 million relates the move to CPI for discretionary pension increases within the group's main defined benefit schemes. And finally, the tax charge for the half year of GBP 202 million, includes GBP 120 million from the lower carrying value of future losses following the reduction in the U.K. corporation tax rate and a further GBP 258 million of insurance policy holder tax that has no net impact on the P&L.

Turning to the balance sheet. As you already know, we continue to take action to strengthen the balance sheet and have made significant progress over the last 18 months. For the first half of 2012, we have kept up the pace. In the last 6 months, we have grown deposits by GBP 13 billion and reduced noncore assets by GBP 23 billion. We've also seen a reduction in core lending of GBP 8 billion although it is pleasing to see this stabilize in the second quarter. These movements have helped us drive a GBP 37 billion reduction in wholesale funding and build our liquidity buffer by GBP 10 billion, mainly in the first quarter. These actions have improved the group's loan-to-deposit ratio from 135% to 126%, while our primary liquidity portfolio now stands at GBP 105 million, providing a substantial buffer and giving us optionality. Looking more detailed at noncore, the noncore portfolio now stands at GBP 118 billion, with a decrease in the first half including GBP 11 billion of treasury assets, U.K. commercial real estate and GBP 5 million in international assets. Noncore RWA stand at GBP 93 billion and are down 14% since year end and broadly in line with the reduction in noncore assets. As Antonio has said, we now expect the noncore portfolio to be below GBP 70 billion in 2014, and with more than 50% of that being return on [ph] assets, we will see separate reporting of noncore after 2014.

On wholesale funding, we continue to reduce our requirements and improve the profile. At the half year, only GBP 73 billion or 34% of wholesale funding had a maturity of less than 1 year compared with 45% at December 2011 and 50% a year before that. And less than 1 year money market funding now accounts for only 21% of total wholesale funding, again, down from 27% at the end of 2011 and 34% in 2010.

On liquidity, the group has built up a strong position and considerably in excess of our ILG requirements. As mentioned, our primary liquidity at the half year was GBP 105 billion, and this represents approximately 240% of our money market funding and around 140% of all wholesale funding with maturity of less than 1 year. We also have significant secondary liquidity holdings of GBP 110 billion which provide access to the open market operations at a number of central banks. Liquidity requirements is an area of evolving regulatory guidance, however, this level gives a group significant flexibility, one of the first examples of which was the successful recent tender for GBP 4.6 billion of senior unsecured funding.

Finally, coming to capital. In the first half, our core Tier 1 capital ratio increased by 50 basis points to 11.3%, while fully loaded Basel III ratio increased from 7.1% to 7.7%. Both measures benefited from management profits and RWA reductions, offset by statutory profit items and other adjustments, including, of course, PPI. Going forward, we will continue with our strategy to maximize capital generation, while the successful resolution of open items such as the treatment of insurance, recognition of defaults, CVAs and SMEs could represent significant upside potential to our pro forma numbers.

I'm comfortable with our current capital position and outlook and confident of meeting our guidance to be both prudently excess of transitional requirements and, of course, to comply fully with Basel III.

That completes my review of the financials, and I would now like to hand over to Mark.

Mark Fisher

Thank you, George. Good morning, everybody. I'd like spend a few minutes updating you on the progress on costs and the simplification program that I talked about when we were here last in February.

Starting with total costs. We've seen a reduction of 6% compared to the first half of 2011. The key driver in the lower cost has been the simplification program, where run rate savings have now reached GBP 512 million, up from GBP 242 million at the end of 2011. Simplification investment cost GBP 274 million in the first half. The savings from the program that we're reporting today are ahead of our original plan and are completely consistent with the increased target to GBP 1.7 billion of savings in 2014 and an exit run rate of GBP 1.9 billion.

To put some context on these results, it's worth looking longer-term trend. Cost have reduced significantly since the acquisition for HBOS, but the key point here is the last 5 half years of cost have progressively reduced half year on half year: Firstly, through the integration program and, now, through simplification. This is after reinvestment in our strategic programs and it's a pattern we very much like and we're working hard to continue. I'm sure you'll note that, typically, the second half year reductions are not as strong as the first. This is largely due to the U.K. bank levy, which accrues in the second half. For example, the levy cost last year were GBP 189 million.

Moving to the half and half comparison. Here's some more detail on how the 6% reduction came about. There were final synergies of GBP 168 million from the integration program and then very material benefits from simplification amounting to GBP 298 million in the first 6 months. These savings are partly offset by the GBP 135 million investment we've made in our strategic initiatives, such as the ongoing development of our digital capabilities, then there's an inflationary wage increase of GBP 46 million, representing about 2.5% increase in the majority of our staff. The range of other cost movements unusually sums to a net positive variance of GBP 22 million. Within this, there are a number of increases; inflation on nonlabor cost, energy price, high regulatory costs, but these are more than offset by the impact of one-off items.

Now, for a close look at how simplification is going. I'm very pleased that within a year of announcing the program, we have already achieved more than GBP 0.5 billion of sustainable run rate savings. In fact, we are ahead of where we expected to be at this stage. We've seen a strong flow of early deliverables, whilst the more heavy lifting projects have been mobilized and moved into build. In 2012 today, we've announced over 4,000 job reductions, bringing the total since the start of the program to over 6,000. And I'm pleased that we continue to achieve over half of our job reductions through natural attrition, management of vacancies and redeployment.

We remain focused on reducing the supplier base. Over the past 12 months, we have moved from over 18,000 suppliers to less than 14,000. You may remember I said a year ago the target was a supply base of less than 10,000, but then I thought that was still a large number. With the progress we're making now, I'm confident we're going to achieve the target earlier than expected and beat it by the end of 2014. We continue to make very good progress in flattening the organization, reducing management layers and increasing spans of control.

Crucially, we've also started to simplify the organization in other ways. We're consolidating our back office operations into 15 scale-efficient centers, down from our existing 27 centers. Having worked through all the details of our property plans, we now forecast reducing our nonbranch office locations by nearly 1/2, from 112 to 68.

As you've heard from Antonio, we're also making a difference for our customers. Our account transfer or switches processes is the first significant reengineering of a core process and is going extremely well. Averaging over 2,000 transfers a day since we launched the new process in April. We're seeing errors reduced, colleagues are spending 75% less time on the process as a result of automation and they removed the 23 manual process steps and customer feedback has been extremely positive. Customers like the fact that they typically receive a text message confirming that the transfer process is underway before they leave the branch.

In February, I mentioned the improvements we were making to the Cash ISA process this year. Through the tax year end, we successfully managed significant lease for increase volumes, followed by delivering a range of changes including auto validation of data entry and enabling customers to reinvest their funds online. By the end of the next tax year, I expect the ISA process to be fully automated.

In commercial, we're rolling out a more effective loans process with greater automation and reduced handoffs. Across the regions where this has gone live, we are already seeing a 45% reduction in the time that it takes for customers to draw their loans. Our relationship managers now have more time to spend with our customers. In fact, in Birmingham and South London regions where we have rolled this out first, they're now ranked second and third in terms of volume with new term lending, whereas previously they were 13th and 14th.

In general insurance, we have completely redesigned the process for handling home insurance claims. Customers now have a dedicated adviser through the process. We've rolled this out in dealing with the largest type of claim, escape of water, and we're already seeing a 40% reduction in the follow-up calls between ourselves and customers with settlement times reduced by 30%. Of course, we're rolling this out now across other claims types. We continue to see a rapid increase in the usage of our Internet channel as we improve our digital service. This includes a strong growth in the mobile banking user base. Our latest peak of customer log-ons was 4.2 million on the day of the 30th of April, and we are well underway to seeing more than 1 billion log-ons to our banking systems during 2012. As Antonio has mentioned, our improved services reflect lower levels of complaints across the board and a strong improving trend in all quality measures.

Finally, this slide shows a trajectory of our cost savings targets. The savings are split by the 4 core work streams that I described in previous presentations. By using a balance of initiatives, we are aiming to deliver a reasonable linear increase towards our target. So far, we are 1 year into a 3.5-year program, approximately 28% of the way through and we've delivered 27% of the benefits. Overall, we're strongly on track with a good line of sight to our benefits delivered for 2013 and 2014, and the program is now well into its stride.

Thank you. I'd now like to hand back to Antonio.

António Horta-Osório

Thank you, Mark. I would now like to sum up the highlights of the first half, our expectations for the rest of the year and our outlook for the medium term. We have a clear strategy, which is being consistently implemented. Overall, the first 6 months represents further good progress on implementing our strategy to strengthen the group's balance sheets and liquidity position; to reshape the business portfolio to fit our capabilities and risk appetites, focusing on U.K. retail and commercial banking; to simplify the group, improving agility and efficiency; and simultaneously, to invest for the future.

We are, as you have seen, on track to meet our 2012 financial guidance despite the subdued economic and the adverse external environments. Simplification is already bringing annual run rate cost savings of over GBP 400 million as you heard. We confirm our loan-to-deposit ratio targets of 120% should be reached in the first quarter of 2013, well ahead of targets. We now expect 2012 impairment charge to be less than previous guidance, and noncore assets are now targeted to be below GBP 70 billion by the end of 2014 when we will cease separate reporting. We also remain confident that our other medium-term financial targets are achievable over time.

Looking ahead, the operating environment will remain challenging as the outlook for the U.K. economy remains uncertain and exposed to continued vulnerability in the Euro zone. It is clear that corporate and consumer deleveraging will continue to impact demands and interest rates will remain lower for longer. As I have said many times now, this will be a long and difficult recovery. Also, the sector as a whole continues to face a number of challenges and uncertainties, some of them arising from past industry behaviors, which have attracted much comments in recent weeks. This will make rebuilding trust even harder for the industry and addressing these issues head on a top priority for management. This is what we intend to do at Lloyds.

As far as the banking reform White Paper is concerned, we are already close to loss servicing requirements and given that our business model is aligned with the ringfencing goal, we plan to discuss with our regulators the advantages of becoming a ringfenced bank ahead of regulatory requirements. And turning to recent policy and regulatory changes aimed at encouraging U.K. growth, again, this supports our chosen operating model and we will, therefore, play our parts in making it happen.

In concluding, I believe we are building a very powerful, yet simple core bank, totally aligned with our customers' interests and the external environment. We have, unfortunately, to do this at the same time as we deal with legacy issues, accelerate the shrinking of noncore assets, that 15 months ago still represented 1/3 of our funded assets, and execute the EU mandated sales of Verde and other assets. In this 3- to 5-year journey, now 2- to 4-, we are doing what we said and a bit more. We are delivering on our operating guidance for 2012, while delivering the balance sheet guidance faster than planned in spite of the deterioration of the external environments and in response to what we perceived to be an increase in the external risks. Simultaneously, we are relentlessly pursuing the creation of a leading cost efficiency competitive advantage and a portfolio characterized by a lower risk premium through the cycle, which will differentiate Lloyds from its competitors. These measures will, I believe, create a sustainable return on equity, above our cost of equity and therefore deliver strong and sustainable returns for you, our shareholders.

Thank you. We would now be happy to take your questions.

Question-and-Answer Session

António Horta-Osório

Okay. I would very much appreciate if you could start by saying your name and the company you come from.

Chris Manners - Morgan Stanley, Research Division

It's Chris Manners from Morgan Stanley here. Just 2 questions if I may. The first one was you've had sort of 6-plus quarters of sequential falling net interest margin on a group basis and you're guiding that the second half is going to be sort of 193 basis points and so, the margin should actually start to tick up from here, would it be possible to run us through what the biggest moving parts are? Is it repricing, funding mix, funding the lending scheme, et cetera? And the second one was just on the core loan book. Obviously it shrank by GBP 8 billion in the first half, stabilization in the second quarter, how do you see the outlook here, I mean, the way that I look that it is that if you've got 7.7% Basel III core Tier 1 Ratio, the financial policy committee is indicating that you can actually [ph] raise capital levels, that capital will still be a constraint on your thinking about growing that core loan book?

António Horta-Osório

Look, starting by the NIM, as I said at year end results, we expected NIM to go down this year by the same amount as last year and I said it should be concentrated on the first half and then flattening out. So we have exactly the same guidance both in terms of intensity and shape as we have and as you are seeing. How do I see things going further? Well, as I have said then, as our core loan-to-deposit ratio reaches 100%, our funding -- our wholesale funding costs will progressively decrease and given that we are offsetting the repricing of liabilities with the repricing of the loans, I believe we will see the NIM progressively ticking up and in my -- my expectation is this should happens by the end of Q1, so around March. So you will see a flat NIM approximately through H2, as we had said at the beginning of the year. And given that we are now with the ratings outcome of Moody's and also with different schemes to support growth and we now have excess liquidity that, as we told you we were hoarding, because of the Moody's review with an insurance that was costing us money but we were expecting not to use like an insurance, we will now deploy that excess liquidity the first of which employment was, as George told you, the buy back of senior unsecured bonds by GBP 4.6 billion. And therefore, all these factors together leave me to expect that our NIM will turn up -- tick up by around March next year, given I'm not an economist, maybe I get it right. On our core loan book and following what I just told you, I expect -- first, I expect the U.K. economy, as I have told you many times, to continue deleveraging because we have, as a country, more credits versus GDP than we should. But while I expect our mortgage book to continue ticking down a bit because we want, as I told you before, to rebalance our market share from 26.5% in mortgages and 23.5% in savings to 25%, which is our natural market share post Verde and which will bring, as I told you, the core loan-to-deposit ratio to 100%. So I don't expect significant different behavior in the mortgage book over the second half, although I think we will reach what we want by H1 next year. I do expect SME growth lending, net lending, to continue to increase. We are now at 4%, up from 3% last year. And given the funding for lending scheme and the good dynamics that we have inside the bank, I think we will continue increasing net lending positively in spite of a falling market of 4%. And by the way, we are 20% of that market, so it means the market is falling 6% while we increasing 4%. So it's a 10 percentage points difference, which is very significant. We now want to do 2 things, first we want to increase our mid corp's net lending, building on the best practices we got in SMEs and I think we will achieve that through the second half of the year. So by year end, you should see our mid corp segments to also turn net positive in terms of lending and given the funding for lending scheme, which we welcomed immediately as it came out and we thought it was the proper thing to do when I told you about the holistic solution of financial stability where we were better in capital supervision and ringfencing increasing the credibility of recovering resolution and, therefore, liquidity was not, in my opinion, it should not [ph] super equivalent as well. We are going to use the funding for lending schemes especially to offset the disadvantage that we have in larger corporations where our funding costs, as I told you many times, did not allow us to be competitive, not to our credit standards but because of funding costs and, therefore, we expect those efforts to reverse quickly, because in larger corporations these things are quicker. And, therefore, I think that all of these impacts combined, so continued positive SME lending. Mid corps turning positive by December, larger corporations stop shrinking given the illumination of the cost as advantage and mortgages still decreasing until H1 next year, I think, again, with the risk of not being an economist, I think our core book will start increasing by June next year.

Unknown Analyst

[indiscernible] Just on the [indiscernible] if I can followup on your comments from the previous question. The bank of England clearly expects that the U.K. banks will grow lending to the economy. From what I'm hearing from you, that's probably not going to happen at least until June next year. What kind of pressures would you expect from the regulator if being a large participant, you're not able to deliver some stability in your U.K. lending as an aggregate number and whether you need to, I mean, react based on what regulatory pressures you may get on the back of that? And my second question would be on asset quality. You have stated that you expect lower impairments that before. Given the macro political outlook, I would think that's quite a brave guidance where you must be seeing something in your operations that gives you that confidence, if you could just elaborate on where some of the quarter-on-quarter, half-on-half strengths are coming from.

António Horta-Osório

Well, on your first question, I strongly disagree with what you said because the purpose of the Bank of England scheme and the objective overall of the regulators in this shift towards growth is exactly to support 2 segments: First, small businesses, which do not have access to other funding sources; and second, first time buyers in the mortgage markets. We are keeping a very strong focus on first time buyers and although our market share in gross lending in mortgages is 18%, we kept a 25% market share in first-time buyers, where as I said we are giving 1 out of 4 new mortgage loans in the half. So we will continue the first time buyer efforts, and the reason why our mortgage book is decreasing is because people are repaying their loans, which is up to the customers to decide. On the small businesses, we are probably the only large bank that is increasing SME on a net basis, and as I just answered to Chris, we are 10% above the market. So that is absolutely in line with what the economy needs. We are the largest bank in this country and, therefore, as I said many times, our future and of the U.K. economy are inextricably linked. On mid corps, you expect as though the funding falling in scheme, we are going, as I said, to replicate the best practices of SMEs and make it grow on net terms by December. So in terms of pre-scheme and after scheme, we will continue to contribute to SME net worth, we will turn positive in mid corps and the only reason why our core book as a whole will not increase is because customers are repaying their mortgages, which is their wishes. And large corporations is less relevant to the economy because as you know, they have multiple funding sources. So I think we are absolutely in line with the authorities' objectives. We do not do it because of regulatory pressure but we do it because we think: Number one, it's right thing for our shareholders; and secondly, it is the right thing for the economy and, again, being the largest bank in this country, what is right for the economy is right for Lloyds. In terms of asset quality question, which you are absolutely right in asking, I strongly believe, with the caveat I said before about economists, that number yesterday is incorrect and the reason is because everything we see in the bank, all trends in NPLs, in all segments continue to trend better than the expected and falling as you in George's presentation, and I will ask Juan to comment and give you color in moment, and therefore, I am very confident that the economy will be around flat this year, as I said many times, and will start recovering next year as CPI comes down, given energy prices and some appreciation of the pound, which will increase people's disposable income and will allow them to spend a bit more. Nevertheless, I think, as I always thought, this is going to be a long and difficult recovery as all debt recessions are -- recovery from debt recessions are always long and when I was probably being accused of being too cautious 12 months ago, and you are accusing me of being too optimistic and I'm basically saying the same thing. And I think the facts absolutely substantiate what I'm telling you. Also unemployment is lower than people would've thought and is not compatible to yesterday's numbers. So I think we can be a bit more optimistic than the move of yesterday's number. Juan, can you give some more color of these numbers.

Juan Colombás

Just to comment on Antonio's points. To give you some more color, I think if you look at the different portfolios, all of them are performing much better. So it's not [indiscernible] this is growing. The second thing I would say, I think it's very important in our bank to separate the core from noncore. I will recommend you to look at the numbers separating both portfolios and you will see that our position has always been that our core book is a good book and our noncore book is well provisioned. It is how we see the picture in Lloyds in terms of operations. The encouraging thing is that the core book, I mean, you have seen the [indiscernible] trend across the whole bank and all of them are improving as well, which is a very good indicator. A leading indicator on what the impairments could be in the coming months. And the good thing is that in the core book, the level of impairments that we are having in the different portfolios are really good. So look at the quality of this book and we are very confident that the core book that we are building for LLoyds in the future is a very good one.

António Horta-Osório

Other questions?

Ian Gordon - Investec Securities (UK), Research Division

It's Ian Gordon from Investec. Just one question please. George, you referenced in your remarks the evolving regulatory guidance as the Bank of England, the FSA, seek to reverse if their policy inflates since the last 5 years. Specifically in relation to emerging FSA guidance in relation to liquidity buffers, can you help us with some quantification of the latitude this may give you. Obviously, the tender offer which you referenced earlier gives us the indication of the direction of travel. I'm assuming that some of the benefits is wrapped into your margin guidance, but what we can't yet see from the outside is what level of dispensation FSA may be giving you.

M. George Culmer

I'm going to frustrate you today by not giving a precise number. Part of that is because precisely as you said, this is actually evolving regulations. There was a meeting this week, which didn't shed too much light on what precisely that meant. So I can't give you that precise number. Obviously, we do have flexibility in terms of the balance sheet structure, in terms of how we might deploy it to support some of our core lending activities. So I won't be precise. But the big message is that optionality is there, through all the hard work and endeavor of the last 18 months and puts us in a very good position, but sorry, I will not and I cannot give you what a precise pound, shilling, pence number that equates to.

Sandy Chen - Cenkos Securities plc., Research Division

Sandy Chen from Cenkos Securities. I just have one question and it's going back to impairments and related to the mortgage book. Looking at the U.K. mortgage book, 40% on a loan-to-value basis is still 80% LTV or above, 23% is still 90% LTV or above. Are your improved impairment assumptions based on a relatively flat set of house prices over the next 12 months? Or are you factoring in, say, the 5% to 10%, 15% house price declines that some economists, as you say, are looking for and if that is, is there -- what's going on in terms of that underlying dynamic and to the impairment assumptions?

António Horta-Osório

Well, I have my chief economist on the first row. So I cannot comment anything else about the economists. Our forecast in the group is for reasonably flat house prices, which we had -- last year, we had forecast minus 2%, which actually happened. This year we forecast reasonably flat house prices, which are happening and therefore we forecast accordingly. So as you saw and this one mentioned, the non-performing loans are trending downwards. we thought in the beginning of the year they would trend slightly upwards as I think I said it's time. So they're trending better than we thought and the house prices are behaving according to flat house prices in spite of some predictions they might follow. I really don't share that to you because I think that in the U.K. as long as interest rates are very low, as you know, there is no oversupply because of housing permits and, therefore, it is reasonable to consider reasonably flat prices and that's what we consider, I mean, we have to provision according to an expected view and not according to the extreme scenario. Of course, we know what would happen in extreme scenarios and we do not think that, that would be, as we said sometimes in previous questions in other presentations, very, very significant impacts. But what we think is house price are going to be flat this year, should continue to be flat for the next foreseeable future and we have been reasonably good in terms of our chief economist's predictions in predicting house prices. So I'm quite confident about that. You want to add something.

Juan Colombás

On the mortgage book, so in the mortgage book I think you have to analyze it by vintages. So it is a combination of a couple of years, so 3 years of bad vintages. The important thing of the book is that these bad vintages ended in the middle of 2008. So they have been in our books for 4 years now and our expectation is that they are ceasing [ph] in. So at some point, the rest of the vintages are of very good quality and you know that the average life of a mortgage for a season is 4, 5 years. So what we should expect if the rest of the conditions remain stable, that we should start to see an improvement in the portfolio.

Cormac Leech - Liberum Capital Limited, Research Division

It's Cormac Leech here from Liberum Capital -- I'm not sure if this is on -- I just had 2 questions, one on the NIM, I think you guided that from first quarter of next year, maybe we see the NIM for the group start to tick up slightly. Just wondering, are you making any assumptions about Bank of England base rate changes in that forecast? In other words, if we, for example, saw a 25 basis point cut in the Bank of England base rate, would that change the guidance for the group? And I just had a question on the operating income.

António Horta-Osório

I am assuming flat interest rates for the rest of our 3-year plan, which is the reason why we said in November last year that our guidance in terms of income-orientated targets would be delayed beyond '14, but achievable over time. Because 12 months ago, the structure of the yield curve was positive, as you know, market was expecting interest rates to start increasing 6 months ago. Now we are assuming interest rates at 0.5% throughout '14 and it is on debt basis that I gave you my assumptions. So, of course, if there was a cut in interest rates there would be an impact on NIM.

Cormac Leech - Liberum Capital Limited, Research Division

Can I just ask one follow-on just to invite you possibly provide a little bit more transparency on how much of your mortgage book is available to reprice over the next couple of years. Because I'm conscious of the old legacy Lloyds TSB book, I'm not sure if you're willing to comment on that or not.

António Horta-Osório

We have never commented on that. And then to be honest, I mean, I don't know those numbers by heart. There is a proportion of the book that we can't reprise on an individual basis, as you know, and another one that we can, like we did in the Halifax book in May. And we can do that in that part of the book if we want going forward but what I just told you does not take into consideration any unilateral repricement in the same way that when I said that NIM guidance for this year was in line with previous year. We had, as I said at that time, incorporated the reprising of May in the estimate. So this new estimate has interest rates flat throughout '14, number one; number two, no unilateral increase in mortgage price included.

Cormac Leech - Liberum Capital Limited, Research Division

And just briefly, on other operating income, if I'm modeling that forward, is it fair to assume that it should track average interest earning assets or would you expect the growth in other operating income to be higher or lower than average interest earning assets going forward?

António Horta-Osório

That's a good question as well, as we said in the strategy review, we expect OOI to trend towards 50% of total income so it should grow over time, as it is slightly growing. This quarter, second quarter was not good because the markets were very, very bad. And although we have very little exposure to markets, obviously, our corporate lines were more standing still, as you know, given what happened. And on the other hand, also given the markets, all our investment products through the insurance business and into affluence and private customers were not sold, given they prefer deposits where we are performing above expectations and go through NII instead of investment products. I expect this percentage to increase over time, as I said at the strategy review, and all the investments we are doing on the growth initiatives are mainly orientated exactly at OOI initiatives because we have substantial segments and products in the market, which are OOI driven, where we have subscale market shares, for example, in FX products to our medium-sized corporations or SMEs, as I said last year, interest rates, money markets, in terms of retail, we are subscale in terms of asset management and the affluence of the private space. So most of the 20 growth initiatives where we have already invested, as I said, GBP 600 million, are mostly orientated at generating OOI and therefore, the percentage should increase towards 50% over time. Mike, please. Can we give the microphone here to Mike.

Thomas Rayner - Exane BNP Paribas, Research Division

It's Tom Rayner. Could I just -- just a couple of follow-ups on what you've just said actually. I mean, the insurance revenue did look a little bit weak in the first half, sales margins and returns on policy holder funds all seem to contribute. I'm just wondering if the retail distribution review can make a big enough difference to sort of offset this fairly difficult environment and then I just got a second follow-up question on the margin, if that's okay.

António Horta-Osório

So that first question, George is going to give you more color on it.

M. George Culmer

Okay. I mean on -- well, on the insurance, I think we said in the presentation, there are a number of factors that impacted the results. First, it was obviously just the economic assumptions, so the lowering the assumptions at the start of the year basically means that the value of enforced is going to unwind at a lower rate and that accounted for about GBP 100 million of the movement in insurance result from first half last year to first half this year. And, obviously, we had the God-awful weather over the summer, which again I think was in sort of GBP 50 million, GBP 60 million swing factor in terms of half year on half year. Then in sales of products, yes, I mean, going back to part of the earlier comment, it's been a difficult quarter for sales of particular products. Also, there's things like the retail branch prepares for RDR. What we have seen compensating that, though, again, I think as we said in the presentation and the release, we've seen very strong sales to the IFA market of corporate pensions, where we very much lead the market. Core pensions hit our required returns. They make our required returns, but they are at the lower end, and when you see that slight drop in the EV from new business, it's just increasing proportion of corporate pensions that's pulled that slightly back from the equivalent number last year.

António Horta-Osório

And you had a question on the margin, Tom?

Thomas Rayner - Exane BNP Paribas, Research Division

Yes, just -- could you comment on, I don't know what you've said about the margin, how material the issue of structural product hedging is to account margin and the sort of guidance that you're offering us?

António Horta-Osório

We don't comment on our hedging in detail but as we said before we have some hedges, what we are doing, I mean, and I'll tell you about that direction so you understand our reasoning. As a bank -- as a bank, we are basically a hedged bank. We are a retail and commercial Bank. We have a basic [indiscernible] position, which is basically hedged, and we may open small positions according to what's happening in the market. So relating to your question on the hedge, what we are seeing is that given the very low interest rate levels in the long end on gilts, we have growingly thought and decided among ourselves that it makes less and less sense to have hedges connected to the gilts' portfolio given that it doesn't make a lot of sense to put our capital into sub-CPI yields for 10 years. And so we have progressively stopped additional hedging and then we have sold some of the gilts on those hedges as you saw when George explained the volatile items, because we think that those interest rates trend lower and lower, it makes sense for us at the minimum accrual costs to increase the duration of our liabilities. So that's as far as I'm going to go on this one. Michael?

Michael Helsby - BofA Merrill Lynch, Research Division

Michael Helsby from Merrill Lynch. Just 2 questions: Firstly, at the strategy day, your talks about Verde having a GBP 500 million PBT contribution. Clearly, it didn't turn out that way. So, I was wondering if you could give us a best guess on what the PBT and we'll be transferring over. Because, I think most of us have got GBP 500 million to GBP 600 million still in the models.

António Horta-Osório

That's a very good point. Well, what can I say on Verde [indiscernible] color. It is true that we had absolutely forecasted that but that was in line with the big balance sheet and there was the option, at the request of the buyers, we discussed many times, to go to a lower balance sheet and the final outcome will reach with the corp, at their request was for an even lower balance sheet and, therefore, the impact on results of the sale is much lower in terms of the net income we forgo than originally forecasted.

M. George Culmer

[indiscernible] We've looked at this a variety ways. And it's a bit of which assumptions you plug in and the timing but to endorse what you said, we certainly don't expect it to have a -- the disposal to have a material impact on the sort of BAU trends at the PBT level within our business.

António Horta-Osório

And I mean as you can expect, given it is not a good moment to sell assets as we said all along, and we had to do this, I mean, we like these assets, as we said, but it was a mandated new sale given the rescue of HBOS. This was clearly the best proposal that Lloyds board was faced with and given it was a sale below book value, our strategy was, as you just said, to minimize what we were selling and, therefore, to have as least capital as possible and results included on the sale, which is what we basically did. And I think that apart from being the best offer Lloyds board was faced with, it is clearly the best earner for our customers and for our employees.

Michael Helsby - BofA Merrill Lynch, Research Division

And just separately, your funding position is beginning to evolve now quite rapidly, clearly to your benefit but it does mean that the mix between short-term and long-term has now started to change quite rapidly as well. You've always talked in the past about 50-50, it doesn't feel like that's the right...

M. George Culmer

I mean, I never talked about 50-50.

Michael Helsby - BofA Merrill Lynch, Research Division

Maybe, okay. So, maybe George's predecessor talked about 50-50.

António Horta-Osório

Like I never talk about big NIMs.

Michael Helsby - BofA Merrill Lynch, Research Division

My NIM's bigger than yours. So I just wonder if you can give us an update on how you see, George, the funding position evolving now you're in charge of the ship.

M. George Culmer

Well, I'm not going to give you any categoric percentages. In one of discussions that we've had internal losses in terms of things like the short-term or the wholesale. So, what is the right number? How low can you go in terms of keeping access to markets open and thinking of the world ahead where you're going to have entities that, in the years to come, are going to sit outside of things like ringfenced bank, who needs to leave their own access to markets. So I won't be precise because it will depend upon the price at the time but as the FD, I sure as hell like the percentage of the more than 1 year going up.

António Horta-Osório

Michael, I think, it's very important, relative to your question, to really understand -- and now I can speak about it because we have had a very favorable ratings outcome and the progress is done, as you said, so this is the type of things you can only speak when you have solved the problem, not before you solve the problem. When you had 18 months ago, GBP 300 billion of wholesale funding, out of which GBP 150 million short-term, I really think, as I said at the time, that was not the proper balance and imagine what would have happened should the ratings review have been done. Now, we have GBP 73 million of short-term funding. So less than half -- 1.5 years and less than half means more than GBP 75 billion. Those costs of LIBOR, now the cost is at least 200 basis points. So it means GBP 1.5 billion less in NII but that was a free lunch. That was something, in my opinion, that should have never been there in the first place because we were basically funding a mortgage portfolio with a 5-year duration with short-term wholesale funding.

Rohith Chandra-Rajan - Barclays Capital, Research Division

Rohith Chandra-Rajan from Barclays. A couple if I could please. One, on the wholesale bank. On your numbers, pretax return on risk weighted is about half at wholesale as it is at retail and if we look I guess with the pre-provision level it's more like 1/3 and it consumes more capital and all of those metrics, I guess, get worse under Basel III. I appreciate you're going to give us more detail at Q3. But I was just wondering if you could give us some early hints towards your thinking in terms of the scale and the focus of that business going forward. And then I have second one on noncore.

António Horta-Osório

It's very easy. I mean, as I said in my speech, either the income will go up or the capital will go down to the division and I think it will be a combination of the 2. So we have absolutely increase the returns. The strategy last year was absolutely correct in the sense, let's maximizes share of wallet of customer instead of being a wholesale bank just focused on lending. We have been doing good progress on those items as you can see from the market shares, installing capital markets issues, in terms of the arena platform, number of customers, money market transactions. But still the environment worries a lot [ph], number one; second, the ICB is very clear and the further returns, as you say, are not acceptable, as I said, and they will have to increase either through increasing income or decreasing capital allocation to the division and I think it will be a combination of the [indiscernible] and we'll give you more detail as Q3 IMS.

Rohith Chandra-Rajan - Barclays Capital, Research Division

And any indication just in terms of the scale of the capital reduction.

António Horta-Osório

I'll give you more details in the Q3 IMS. Second question is?

Rohith Chandra-Rajan - Barclays Capital, Research Division

Very briefly, noncore, so less than GBP 70 billion by the end of 2014, at which you will drop reporting, just wondering -- wanted to clarify whether that's a very straightforwardly reporting and you'll continue to look to reduce those assets or whether what's left you would consider core or it takes just a long time to work them out.

António Horta-Osório

No. I think that's a very fair point. Basically what we think is the following: So in '14, instead of GBP 90 billion, we will get to GBP 70 billion. And I know that is -- I hope the decreasing concern that we have time bombs left in what we don't sell, because we continue to sell ahead of target in a capital accretive way and across the board. But the only thing we can do to increase your degree of confidence is continuing to sell, which we'll continue to do. So it's a matter of time. But relating to the center of your question, when we reach GBP 70 billion in '14, half will be the retail assets like the self-certified mortgages in the U.K. and the retail mortgages in Ireland, which as you know, we cannot sell in terms of they are in SVR, it's the option of the client. They are quite sticky. And the U.K. ones perform well. It's just a closed book because we don't do self-certified anymore. And the Irish ones do not perform well and therefore, we are provisioning them much quicker than others where we have already, as you know, declared impaired assets above the 90 days over. We have 22% impaired ratio, which is more than the 90 days operation and we have covered those at the 72% coverage level. So the ones that are not good, we are covering, provisioning as much as possible, as quickly as possible. The self-certified book, which is most of it is GBP 29 billion, as you know. It's a good book but it's not core. So by '14, those GBP 35 billion of assets will come into the core book and we will run them off and you can very well extrapolate the behavior because they are known, they are retail, they are sticky, they are predictable. The other GBP 35 billion or less nonretail, noncore assets, we will cease reporting because given they will be less than 5% of our funded assets. They will become, in our view, nonmaterial and, therefore, we will bring them back and report as a single bank. But as you correctly ask, we will continue to run them down to 0.

Unknown Analyst

[indiscernible] from JPMorgan. If I can just ask about PPI. Would you be able to clarify some of the assumptions behind the GBP 700 million provisioning. And the reason I ask is from the outside, it appears that if you take the FSA [ph] data, for example, which was about GBP 730 million for the industry in May. If you annualize that, if you take that for a quarter even, that means GBP 2 billion plus for the industry with 50% market share for Lloyds and HBOS. That means GBP 1 billion a quarter for the group as an ongoing run rate. And then when I look at the remaining charge in your balance sheet, it looks like you've probably got GBP 1.3 billion left. So would you probably quantify what assumptions you put behind the provisioning. Do you expect claim rates to tick down from here or have you sort of assumed it to stay at the same levels?

M. George Culmer

The company's approach to PPI provision has been entirely the right one, going back to the early mover on the original GBP 3.2 billion and then at Q1 going for the GBP 375 million, which basically costed what we've seen as a -- the company had seen it as a spike in PPI claims at that particular time and that was costed and that was costed based on the assumption that it would revert back to previous assessments in terms of claim levels. As you know, what has actually happened since is that claims actually stay at a higher level. We have in the last few weeks seen a decline, slight decline in those claims numbers coming through which is caused for encouragement without getting carried away with it. The GBP 700 million that we have provided this time has been based upon both an assessment, obviously, of the claims that we're receiving. But studies into populations in terms of ones we receive from expectations for future mailings, et cetera and the propensity of those peoples to complain. So we have applied as much high science as one can to this particular number. Yes, the run rate remains significant, I think we've got about GBP 4.3 billion I should say as the aggregate provision. I think we talk about GBP 2.9 billion in terms of spent to date within the RNS, so you can work out sort of run rates, et cetera. I'm not going to give you the precise components of how it's built up because it doesn't mean anything. We have based our assessment on what we think the cost will be and we've done it in the most appropriate way that we can. That all said, future claims levels are uncertain and much as I would love to tell you that, that is -- there's a line under that, there is still uncertainty.

Unknown Analyst

And just a quick follow-up on the capital treatment of the subdebt that you will be underwriting for the core group, whenever that comes in, we obviously don't know the amount, should we assume that to be deduction against capital?

M. George Culmer

I may have to get back to you. I mean there sort of a material amount but I will get back to you on the treatment to that.

Manus Costello - Autonomous Research LLP

It's Manus Costello from Autonomous. You talked a lot about the improvements in impairment trends. If I look in core Q2 versus Q1, there was quite a big step up in fact in impairment in Q2, I wonder if you could give us an indication of which divisions drove that step up quarter-on-quarter. And then I have a follow-on, on that please.

António Horta-Osório

Juan, can give you color on that. But just to introduce your point. We have said specifically in Q1 that the dip in the AQR of the core book, 2.35% or 2.36%, was too small and abnormal. So we are basically recovering the trend but the overall number, as Juan said, is very positive. It's below our guidance for the future 50 to 60 basis points. But Juan will tell you exactly what happened anyway.

Juan Colombás

There is some seasonality in some of the portfolios between sort of the Q1 is normally the strange quarter. Let's say you close the accounts in the previous quarter and there's normally [indiscernible] many things. And so some of the variances between the Q1 and Q2 are due to these different treatment between quarters. It is not a change in trends. You can see it from the different quarters' information that we have provided to you.

Manus Costello - Autonomous Research LLP

Indeed. So just to follow on that, on the basis, therefore, that Q2 is normalized in terms of your pretax return on risk weighted assets, that means we see a continual decline in the return on risk weighted assets in the core bank and I wondered, I mean, this looks like it's the lowest return for the last 7 quarters, at least. I wondered if you could give us an indication of when you would improve core return on risk weighted assets if 1Q was just an aberration?

António Horta-Osório

I thought I had already answered that question, but I will tell you again. So if costs are going to continue to go down, impairments, all trends are in the direction of going down and our NIM is going to improve by March and the volumes by June. I think you have all the ingredients you need. Right? Robert?

Robert Law - Nomura Securities Co. Ltd., Research Division

Robert Law, Nomura. I've got 2 questions, please. Firstly on the ICB issue, I'm interested that you're looking at accelerating, creating a ringfenced bank. Could you give us some idea of what you think, as a result of this, the cost to the organization will be of the ringfencing?

António Horta-Osório

Well, what I said exactly and I think that's a very fair point, by the way. But what I said exactly is the following: We do not have a strategic question to answer. Like most of our peers, we said last year, we are going to be a U.K.-centered retail and commercial bank with our wholesale bank focused on creating value around the retail and the commercial bank. So we do not have a strategic existential question and therefore, we are able, as we have already 90% of our assets inside the ring fence, we are able to move very quickly into being a ringfenced bank. As I said in my speech, therefore, we think the uncertainty for investors and for customers may be advantageous for us in going to a ringfenced bank sooner. But if it is advantageous for us, because as you said correctly, there are costs in terms of setting up the ringfenced bank. Those costs for us are not very high. If in the discussions with the regulators we see it is favorable for our shareholders and customers to move ahead, we will. And we think it'll be and therefore, it is likely that we will be a ringfenced bank well ahead of regulatory requirements. As we evolve in our discussions with the regulator that we are now going to start, we will report to you more on that straight off. But I think, strategically, it is very clear where we are going and I think that should take away a lot of uncertainty in terms of direction of this bank for the future, which I think we are the only one that can really do this.

Robert Law - Nomura Securities Co. Ltd., Research Division

So if I paraphrase that, does that imply you think the bulk of your cost would be one-off in nature and any ongoing cost thereafter would be pretty immaterial to the group, is that a fair statement?

António Horta-Osório

Excuse me. I didn't understand.

Robert Law - Nomura Securities Co. Ltd., Research Division

The bulk of your costs would be one-off in nature.

António Horta-Osório

Yes.

Robert Law - Nomura Securities Co. Ltd., Research Division

And ongoing cost will be immaterial?

António Horta-Osório

That is absolutely correct, that's exactly what is behind this thinking.

Robert Law - Nomura Securities Co. Ltd., Research Division

The second area is in terms of the noncore business. Now that your planning to discontinue reporting it for 2015, could you give us some idea of what financial performance is at the moment of the assets that your will be retaining, so we can get some idea of where we think your underlying sustainable...

António Horta-Osório

Well, that is a very fair point as well, Robert, but we are seeing it that the way. We will retain the GBP 35 billion of retail assets, which you can -- the disclosure we are now giving is much bigger than before so you can assess the behavior of the U.K. self-certified book and of the Irish retail mortgages, you have that information. The other, at most, GBP 35 billion, which we'll then bring back into the core book. We aren't going to do that because it becomes immaterial, but it is not because it will be a rump full of problems. As I said many times, we are selling the noncore assets across the board based on risk concerns and we will continue to do so and in a capital accretive way. We have on the table, every 15 days, at maximum level in the bank, all the noncore assets, all in process of being sold, and as markets evolve, as buyers comes up, as prices change, we are going to sell them all. So our estimate at the moment is that instead of GBP 90 billion by '14, we will have only GBP 70 billion, given that the retail ones are stable and sticky. We will bring them in the bank and you can model them and the other GBP 35 million at most, we will bring in the core bank, which will continue to exit. They will not be there forever and I cannot tell you at this moment, because I don't know exactly which ones they will be because we have everything on the table that we can sell. It may happen that we get to '14 and instead of a GBP 70 billion, we have less because we said GBP 70 billion or less. So let's discuss that as we go. I think the main take here is instead of GBP 90 billion we are going to go to GBP 70 billion. Second, it'll become immaterial because it's 5% of non-return on core. So we don't think it is worth reporting separately. And, third, we are doing this in a capital accretive way. And by the way, in a very different, difficult quarter, because quarter 2 was very difficult and we sold, for example, our remaining exposure in Australia, which was terrible and it was sold and everything together was again sold in a capital accretive way. Difficult to have such a bad portfolio in Australia. That's why you were laughing, I guess. Such a good country, such a bad portfolio. Things happen.

Claire Kane - RBC Capital Markets, LLC, Research Division

It's Claire Kane from RBC. Can I have a follow-up on your other operating income trends, please. In the core business, I believe in Q2, it's down 4% quarter-on-quarter, 15% year-on-year and you did mention that there's more of a push towards deposits rather than savings products.

António Horta-Osório

It was not a push. It's client preference. We usually don't push things.

Claire Kane - RBC Capital Markets, LLC, Research Division

Can you then maybe give us an indication of the marginal cost of these deposits, if you're seeing these come down. And, also, how that ties up will you aim to get the 25% market share?

António Horta-Osório

Yes, that marginal cost of deposits has been around for us 200 basis points, we measure, as I told you many times, we absolutely measure the cost of deposits versus wholesale funding. And the reason why we have been growing deposits at twice the market rate is twofold. First, because the customers have been having a natural preference for the products we have given to them, for example, in the ISA season with the same value date as of the request of the customer, which was very important given the cues that happened last year, for example, or in October last year when we set out, for the first time, at drawing lottery process in Halifax, which we now have close to 1 million customers enrolled. So first is the customers' preference. But second, we are only growing the deposit, as I said many times, as long as the marginal cost of deposits as you asked was lower than our marginal wholesale funding costs. And given that the wholesale funding costs was much more expensive, we have continued to increase deposits and those marginal deposits were probably around 200, 200-something basis points. Given that now our rating has relatively improved and that we have additional schemes as we have discussed previously, it is likely that on the margin, we skew our portfolio a little bit less towards deposits and a bit more towards lending, given the funding for lending scheme. But overall, this is a marginal thing and the main thing you can, I think you should take is customers, given the financial markets conditions in the first half, have preferred deposits to investment products that has an impact in LOI and benefits NII because our wholesale funding costs were higher. So we just accepted what the clients want and as times move depending on customers' preference, probably we will go back to OOI, which we also think will be enhanced by the fact that the retail distribution review is putting the market a bit on hold because there is uncertainty and therefore, when it is implemented in January '13, you should see a more natural behavior depending on the client's response to the distribution review. More questions?

Peter Toeman - HSBC, Research Division

Peter Toeman from HSBC. Coming to your statement about dividend, are you sort of signaling here that FSA or other regulators might preclude you from making a dividend payment until your Basel III [ph] fully loaded number gets to, say, 10% or is there some other thinking here?

António Horta-Osório

No, and I haven't yet commented if it was difficult to have painted [ph] anything. No, what I said in Q1 was -- I told you in Q1 that when we knew the White Paper content, in terms of the ICB and the draft Basel III paper on CRD 4, we would give you what we thought was the likely path to dividends. We now have the White Paper of the ICB, which does not present any significant differences to what we thought, but unfortunately as you know, the CRD consultation paper was delayed to September. So we think we will only be give you that path in quarter 3 at the Q3 IMS. In any case, as I said in Q1 IMS, we are following a capital maximization strategy, which is based on lower noncore in a capital accretive way and lower costs and lower impairments on the core book. So whatever will be the content of the CRD 4 paper, we would not change our strategic direction because we are maximizing capital as much as we can and in spite of the one-off hits that we have, we have been generating between 20 and 30 basis points of core Tier 1 capital per quarter. In January '11, this bank was 10.2%, now it's 11.3%. So 110 basis points higher with a PPI rate of GBP 4.3 billion. So we are maximizing capital generation, we think the core book is very powerful, as we told you. Key leading retail brands leaders in the markets, totally segmented, we are achieving a leading position in costs where we will achieve a key competitive advantage, which as I said and now for many years is what retail in the U.K. should do. U.K. retail banks have never been very focused on costs, especially now in a low interest-rate environment, in a high regulatory cost environment and difficult economic circumstances, I think costs are even more key. As we get to a cost leadership position, we will growingly be offering our customers more value for money, and as we offer them more value for money, those segments I mentioned before, where we are subscale, will increase as they bank more with us especially in OOI and this will become a virtuous circle, whereby we will move them in the future, have flat costs and start to increasing. So I think we're absolutely in the right strategy and the only reason why I don't tell you more about the path is because we do not know the content of the CRD 4 paper, but the capital maximization part of the strategy is absolutely clear. More questions? No?

Well, if we don't have more questions, I think, it was a very lively debate. Thank you very much coming in spite of the torch relay and speak to you soon. Thank you.

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