Lloyds Banking Group's (LYG) CEO Antonio Horta-Osorio on Q2 2016 Results - Earnings Call Transcript

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Lloyds Banking Group Plc (NYSE:LYG) Q2 2016 Earnings Conference Call July 28, 2016 4:30 AM ET


Antonio Horta-Osorio - Group Chief Executive

George Culmer - CFO

Juan Colombas - Chief Risk Officer


Chris Manners - Morgan Stanley

Raul Sinha - JPMorgan

Michael Helsby - Bank of America Merrill Lynch

Martin Leitgeb - Goldman Sachs

Chris Can't - Autonomous Research

Manus Costello - Autonomous Research

Rohith Chandra-Rajan - Barclays

Andrew Coombs - Citigroup

Tom Rayner - Exane BNP Paribas

David Lock - Deutsche Bank Research

Ed Firth - Macquarie Research

Robert Noble - RBC Capital Markets

Vivek Raja - Mediobanca

James Invine - Societe Generale

Antonio Horta-Osorio

Good morning, everyone and thank you for joining us for our 2016 half-year results presentation. We have seen another period of good financial and strategic performance. I will outline the progress made and how our transformation and differentiated business model positioned us well to withstand the uncertainty facing our sector and the broader economy. George will then cover the financial results and guidance and Juan will highlight some of the key elements of our prudent risk capital. After this we will take your questions.

Turning then to the highlights for the first six months, in the first half of 2016 our differentiated business model has continued to deliver with robust underlying profits, a doubling of statutory profits and strong capital generation along with further progress against our strategic initiatives. Following the vote to leave the European Union, the outlook for the UK economy is uncertain. While the precise impact is dependent on a number of political and economic factors, a deceleration of growth is anticipated. Given the sustainable recovery in recent years, the UK enters this period of uncertainty from a position of strength.

As a simple UK focused Bank we have also benefited from this recovery and from the simplification of our business in the past five years. This, along with our prudent approach to risk and the lowest cost structure of the major UK banks, position us well to continue to serve our customers and to deliver strong returns to shareholders. Our strategy therefore remains unchanged. We're committed to supporting the UK economy and helping Britain prosper. We're not, however, immune to the recent market volatility and our capital generation guidance for 2016 has been updated to reflect the impact of the referendum results.

Our remaining 2016 guidance is unchanged, except for our AQR guidance which we're upgrading. George will cover these points in more detail shortly. Considering the updated guidance and the fact that our underlying capital generation remains strong, the Board has approved an increased interim dividend of 0.85p per share in line with our progressive and sustainable ordinary dividend policy. Before looking more at the transformation of the business and our strategic progress, let me first cover the financial highlights. We have delivered another good financial performance in the first half. Underlying profit was robust at £4.2 billion with a slight fall in income and higher impairments offset by lower costs, whilst statutory profits more than doubled to £2.5 billion.

Our market-leading cost to income ratio improved by an additional 50 basis points to 47.8% on the back of additional cost reductions. And given our accelerated progress on costs ,we're today announcing a £400 million enhancement to the simplification target we outlined in the 2014 strategy update. On the balance sheet we have once again demonstrated the capital generative nature of the business, generating 50 basis points of Common Equity Tier 1 in the quarter. Our balance sheet remains strong with our CET1 ratio of 13.0% or 13.5% pre-dividend and leveraged ratio of 4.7% amongst the strongest of our major banking peers worldwide.

As I have already mentioned, following the EU referendum the outlook for the UK economy is uncertain and we expect a deceleration of economic growth. However, the UK is well positioned as it enters this period of uncertainty, given the strength of the recovery in recent years. Since the 2008/2009 recession, both households and corporates have been deleveraging which is reflected in the reducing ratios of debt to GDP. Mortgage market activity and growth are also low by historic standards and transactions are well below the level seen in the build up to 2008. House prices have also improved which has led to much healthier LTVs on the balance sheets of the banks and our customers now have mortgage debt which is less than half the value of their homes on average.

Mortgage affordability has also improved and is significantly better than the long-term average. In addition, unemployment now below 5%, is at its lowest level in over 11 years. Therefore, although a deceleration is likely, the nature of the recovery over the past few years puts the UK in a strong starting position. In terms of the Group we're also in a strong position. Over the past five years we have substantially strengthened the balance sheet and de-risking the business through the successful execution of our strategy. In de-risking our lending portfolio and simplifying the business, since 2010 we have reduced runoff assets by over 90% in a capital accretive manner and have reduced risk-weighted assets by over 45%, one of the largest reductions amongst the top 25 banks in the world, during this period.

This progress, coupled with the improvement in the UK economy in recent years, has also led to a significant reduction in impaired loans which now represent only 2% of lending balances and we remain prudently provisioned. At the same time we have significantly improved our funding position, having reduced our wholesale funding requirements by almost £170 billion, while fully repaying almost £100 billion of emergency government funding. And we have also increased our pool of liquid assets by over £40 billion. As a result, our liquid asset portfolio now exceeds our wholesale trading requirements.

Cost leadership has also been an important element of our transformation. We have reduced our cost base by over £2 billion and have improved our already market-leading cost to income ratio to less than 48%, significant ahead of our major UK peers. Over this period our prudent approach to risk has resulted in a substantial improvement in the quality of our portfolios. The average loan to value of our mortgage book has improved significantly to just over 43% and more than 90% of the book now has a loan to value of less than 80%. We have also restricted our share of new mortgages in London and as I have mentioned before, we have been growing below the market in buy to lets.

On commercial real estate our exposure is now less than one-third of what it was in 2010 and represents less than 5% of total lending. Elsewhere in commercial banking we have reduced our exposure to higher-risk segments through selective participation, while in our higher-growth motor finance business we have maintained tight underwriting criteria with over half the growth in this area coming from our Jaguar Land Rover partnership which we initiated in January 2014. And our resilience to severe stresses in all of these portfolios has also been seen in the PRA stress test results in both 2014 and 2015.

Turning now to our strategic priorities, our strategy remains unchanged. We're a simple, low-risk, customer-focused UK retail and commercial Bank. This differentiated business model continues to provide competitive advantage and we're making good progress against each of our three strategic priorities. Starting with creating the best customer experience; we continue to invest to ensure we meet the evolving preferences of our customers through our multichannel approach.

We operate the UK's largest digital Bank with a 21% market share, with over 12 million online users and more than 7 million mobile users accessing our top-rated mobile banking app, we now meet 60% of our customer needs digitally. And this progress is reflected in the Group's customer satisfaction metrics. Our net promoter score is over 50% higher than at the end of 2011 and has improved across all brands and channels. Also, our Group reportable banking complaints remain significantly lower than our major peer group average.

Turning to becoming simpler and more efficient; we announced in February with the 2015 results that we have been accelerating the delivery of cost initiatives in response to changing customer preferences and a lower for longer rate environment. We also previously said that we would complete our existing branch closure and role reduction plans ahead of schedule. As a result of this progress and evolving customer behavior, we're today announcing additional initiatives including further branch closures and role reductions to be completed by the end of 2017.

These initiatives will generate significant additional cost savings taking our run rate target for the end of 2017 from £1 billion to £1.4 billion. We will also be undertaking a rationalization of our non-branch property portfolio. George will detail these points shortly. Turning to delivering sustainable growth; we have continued to deliver growth in our key customer segments within our prudent risk appetite. In retail we have maintained our leading market shares of key product lines including personal current accounts. In mortgages we remain committed to supporting first-time buyers and continue to be the largest lender to this customer segment, although we continue to balance margin and risk considerations with volume growth and have therefore continued to grow below the market, especially in the buy-to-let segment. In SME we have once again outperformed the market, growing lending by 4% in the last 12 months, although slightly less than in previous periods.

The SME and mid-markets net lending growth was £2.2 billion in the period, in line with our £2 billion commitment for the year. In insurance we have continued to support our corporate clients in de-risking their balance sheets with the successful completion of a further three bulk annuity deals in this period, following our entering the market last year. In addition, we have further strengthened our general insurance proposition through the launch of our flexible online home insurance offering.

And finally, in UK consumer finance, we have continued to exceed our £2 billion annual growth commitment, delivering year-on-year customer assets growth of £2.6 billion, predominant across our motor finance and credit card businesses.

I will now hand over to George who will cover the financials.

George Culmer

Thank you, Antonio and good morning, everyone. Starting with the underlying results, first half saw a robust underlying profit of £4.2 billion and a strong underlying return on acquired equity for 14%.Underlying profit was 5% lower than a year ago and down 2%, excluding TSB, with a slight reduction in income and increase in impairments, partly offset by 3% lower operating costs as we continue to simplify the business.Positive operating jaws of 1% demonstrates our continued ability to manage the cost base in a challenging environment and it's driven further improvement in our cost to income ratio to 47.8%.

Looking at net interest income, NII was up 1% at £5.8 billion reflecting the continued improvements in the net interest margin which at 2.74% was up 12 basis points on a year ago. Lower deposit and funding costs, including the benefits of the ECN redemption continued to more than offset lower asset pricing and as mentioned at Q1, the first-half margin also includes a small one-off benefit from credit cards.

In terms of divisional performance, commercial saw a 3% increase, largely due to higher deposit balances while retail, a 2% decline due to lower mortgage lending as we continue to focus on protecting margins and risk profile in a highly competitive pricing environment. Looking forward, we expect the full-year NIM to be in line with our existing guidance of around 2.70%. Other income was £3.1 billion which reflects the 9% improvement in Q2 over Q1 and the year-to-date run rate is in line with full-year expectations. Year-over-year, other income is down 5% with retail in line with prior year and consumer finance down marginally due to continued drag of reduced credit card interchange fees. Commercial banking delivered a resilient performance in tough market conditions while insurance, we completed a further three new bulk annuity transactions but this was more than offset by adverse economic impacts and weather-related claims.

On costs, operating costs of £4 billion were down 3% with efficiency savings from our current simplification program more than offsetting the increased investment in the business. Simplification has now delivered £640 million of run-rate savings and we're ahead of our original schedule to deliver £1 billion savings by the end of 2017. At Q1 we said that, given our customers' evolving behaviors and the expected lower for longer rate environment, we will be looking again at our efficiency program. We're now extending the scope of the current program by targeting an additional 200 branch closures and a further 3,000 role reductions by the end of 2017.

These actions will increase our run-rate savings by £0.4 billion to £1.4 billion for a total cost of £2.2 billion, compared with the original £1.6 billion. Total spend to date is half of this at £1.1 billion with a further £1.1 billion to be incurred by the end of 2017 of which around £350 million is for role reductions which will be taken below the line. In addition, in our continued drive to reduce costs and improve efficiencies, we're now targeting a 30% footprint reduction in our non-branch property portfolio over the next two-and-a-half years. This initiative will cost around £300 million over this period which will also be taken below the line will deliver one-off savings around £100 million and annual run rate savings of around £100 million by the end of 2018.

On credit, our asset quality remains strong. Charge for the half-year was £245 million which represents an AQR of just 11 basis points with the increase on prior year reflecting lower releases and write-backs and a stable gross AQR of 26 basis points, compared with 25 basis points a year ago. The quality of the Group's loan portfolio also continues to improve and non-performing loans, as a percentage of closing advances, now stands at 2.0% compared with 2.1% at the end of 2015 and over 10% in 2010. In terms of guidance, while we expect slightly lower releases and write-backs in the second half, we now anticipate the AQR for the full year to be less than 20 basis points.

Moving on to statutory profits, statutory profit before tax was more than double to £2.5 billion in the first half, boosted by the robust underlying profit and a low level of below the line items in the second quarter. Looking at individual line items, firstly as previously reported, the Group took a £790 million charge in Q1 for the redemption of the ECNs. The Supreme Court has since found in favor of the Group which supports the decision taken to redeem these notes and means there are no further charges in respect of this item.

Market volatility and other items, total a charge of £150 million. This includes a £484 million gain on sale from the Group's stake in Visa Europe and this offset the fair value unwind charge of £110 million, the amortization of intangibles of £168 million as well as negative insurance volatility of £372 million, primarily driven by low interest rates and widening in credit spreads. On restructuring, the £307 million charge mostly reflects the simplification program severance costs related to the accelerated role reductions and also includes around £60 million for the implementation of the Group's non ring-fenced spend. Other conduct was £460 million with £345 million recognized in the second quarter. Charge for the half includes a range of conduct issues including arrears, handling activities, packaged bank accounts and legacy German insurance products.

On PPI no further provision has been taken, with complaints in the first six months averaging around 8,500 per week, although this has dropped to around 7,500 over the last six weeks. We're currently still awaiting the final outcome of the FCA's consultation on a potential time-bar and treatment of complaints relating to the Plevin case. Finally our tax charge was £597 million, representing an effective rate of 24%, reflects the impact of tax-exempt gains and capital losses not previously recognized. We continue to expect a medium-term effective rate of around 27%.

Very briefly, on the balance sheet; average interest earning assets, excluding run off, were broadly flat in the first half at £426 billion, with growth in consumer finance and SME lending offset by lower mortgage lendings as we focus on risk profile and margin preservation. Risk-weighted assets were also flat in the six months at £222 billion, reductions from monetization and disposals were offset by around £3 billion of increases due to adverse FX movements following the outcome of the EU referendum.

Finishing then with capital, the business remains well capitalized and it continues to be strongly capital generative. In the second quarter the Group delivered 50 basis points of capital, after 30 basis points adverse impact from the EU referendum, primarily relating to the FX movements on RWAs. Given this referendum impact, we now expect to generate around 160 basis points of capital pre-dividend for 2016. Given the current uncertainty, it is too early to determine the impact on our formal longer-term guidance at this stage. However, while the business will remain highly capital generative, it's possible the capital generation may be somewhat lower in future years from previously guided. We will formally update guidance when we have a clearer view of the likely outcome.

Finally, on net tangible assets, TNAV has increased by 2.7p since the 2015 year-end, so 55p per share, driven by statutory profit and positive reserve movements, partly offset by the cash payment of the 2015 full-year dividend of 2p per share.

I'll now hand over to Juan who will cover some of the credit portfolios in more detail.

Juan Colombas

Thanks, George and good morning, everyone. Given the current market concerns we thought it would be useful for me to talk through some of our key portfolios and demonstrate how our low-risk business model and prudent risk appetite have ensured that the Group is well positioned.

Starting with the mortgage book, the risk profile of the mortgage book has improved significantly over the last five years. We have current LTV of 43% which is down from 56% in 2010. In addition, the proportion of the portfolio with an LTV greater than 100% is now less than 1%, while only 9% of the book has an LTV greater than 80%. Impaired loans are also significantly lower and are down 43% compared to 2010 with improvements across all portfolios. Our new business quality is strong due to our prudent lending criteria, for instance we do not lend to owner-occupied borrowers at an LTV above 90% without reasonable notification. We do not participate in buy-to-let lending over 75% LTV. We do no subprime nor self-certified new lending. And we have a loan to income multiple cap of 4 times for loans over £500,000 which we voluntarily introduced ahead of the FPC recommendation for the sector.

This prudent criteria means that in London, for instance, our share of flow has been significantly below our market share at just 14% over the last 12 months. Over half of our out of tenancy £100 billion mortgage portfolio has been written since the last recession and at this low risk criteria and pre-2009 lending is now well seasoned with an average LTV of less than 50%. In addition, in buy-to-let we have taken the conscious risk appetite decision to grow significantly below the market in recent years with growth of just 1% over the last 12 months compared to a market of 12%. Finally, it is important to note that our provision approach is prudent and we have taken a conservative view of recent house prices increases in our provisions.

Turning to commercial banking, since the financial crisis much of the Group restructuring has focused on de-risking the corporate lending and commercial real estate exposures. The risk profile of the commercial book has benefited from a significant decline in corporate gearing since 2008 which has eased debt burden and reduced debt servicing costs for the sector. Our commercial banking business model is now focused in delivering sustainable returns through a client-led, low risk, selective participation strategy and this approach means that we have limited exposure to higher risk segments. For instance, oil and gas, mining and commodities in total account for less than 1% of the booked loans and advances and around 75% of this exposure is investment grade.

In commercial real estate our exposure is now less than one-third of the level of 2010, down at £20 billion and accounts for less than 5% of the Group loans and advances. This figure of £20 billion includes around £5 billion of residential property lending. This reduction has been achieved through exiting higher risk commercial real estate business and focusing on our core UK clients. Indeed, overseas CRE has reduced from £20 billion in 2010 to de minimis levels in 2016. As in other sectors, we also have prudent lending criteria in place for CRE, for instance, we do not hold junior debt and only lend at senior level. We do not lend for speculative commercial development and we have restrictions of the maximum single hold positions.

This approach results in a high quality CRE portfolio where around 90% of the book is investment lending supported by rental cash flows. In addition, the book has a strong LTV profile with over 95% of CRE, secure lending over £5 million, having an LTV of 70% or less.

Finally looking at UK consumer finance, back in 2014 when the Group announced the strategic plan, we identified consumer finance as an area for targeted growth as it was a segment in which we were underrepresented. The Group has been delivering on our growth ambitions, however the focus has been on doing this with our prudent risk appetite. And the 73% decline in impaired loans since 2011 is testament to this approach. The quality of the consumer finance new business is strong, we do not participate in subprime, we do not credit repair cards and we operate robust affordability and indebtedness checks to ensure the lending is sustainable for our customers.

Finally, as you can see, the majority of the book growth over the last few years has come from motor finance and of this over 60% has come from our relationship with Jaguar Land Rover that sources high prime quality lending. So in summary we have de-risked the books significantly over the past five years and at the same time ensured that the new lending written since the crisis has been of the strongest quality.

We're now a simple low-risk UK focused retail and commercial Bank and the Group's low risk culture and prudent risk appetite means that our portfolios are well positioned in the face of our current uncertainty.

I will now hand back to Antonio for his closing remarks.

Antonio Horta-Osorio

Thank you, Juan. So to conclude, we have delivered a robust financial performance and have been successfully executing against our strategic priorities. Our simple UK-focused business model remains the right one. Our cost discipline and low-risk approach continues to provide competitive advantage. Whilst the outlook for the UK economy is uncertain and the deceleration of growth is expected, the UK is well positioned to face it. Regarding Lloyds, the successful transformation simplification of the business, together with our low-risk appetite, also position us well to weather this deceleration and continue to deliver for our customers and our shareholders.

Looking ahead, we will not be immune to the consequences of the EU referendum results and regarding 2016 specifically we expect to generate 160 basis points of capital, reaffirming our NIM and cost to income guidance and are improving our AQR guidance. On strategy and our strategy of becoming the best Bank for customers and shareholders hasn't changed. We're open for business, have a strong financial position and remain committed to doing the right thing for customers and to helping Britain prosper.

Thank you, we will now take your questions and I would appreciate if you said your name and institution for the benefit of everybody in the room.

Question-and-Answer Session

Q - Chris Manners

It's Chris Manners from Morgan Stanley here. Two questions, if I may. The first one was on the dividend and payout potential. I guess it looks like a conservative stance the Board's taken with the 0.85p dividend for the interim. But you've printed a 13% CET1 ratio. The countercyclical buffer has been cut.

And as I look at your guidance of 160 basis points of generation for the full year, that means we might get another 110 basis points capital formation in the second half. How do we think about that 13% for the base line? And are we still going to be comfortable paying out everything above the 13%?

George Culmer

In a world that is changing, some things haven't changed. So our dividend policy very much hasn't changed. And I think how the Board goes about considering that and when the Board considers that hasn't changed as well. So as of last year, the Board will make full consideration at the end of the year, in terms of both the final dividend and should there be any surplus capital, what to do with that surplus capital at that particular point. As regards requirements as well, yes, the impact has changed on things like countercyclical. But our view that 12% is the requirement, plus the management buffer on top of that, coming to about 13%, remains the right requirement.

Chris Manners

And a second question, if I may. Just on the net interest margin. I guess 2.74% at the first half, pretty good, I guess, versus what we were looking for. If you're now saying 2.70% for the full year, that gets us to about 2.66% for the second half. Maybe you could talk us through a few of the moving pieces there and how you get to that number. And maybe I could ask for a few views into 2017. I know you've shied away from it, but anything you can offer would be very helpful. Thanks.

Antonio Horta-Osorio

Chris, you have been very precise in your arithmetic. I think I have given the same guidance in Q1 which was reaffirming around 2.70% for the year. We came out at 2.74%. It's correct it's a little better than we expected. But I don't think, I told that, the 2.74% means 2.66% for the second half. It means around 2.70%, we keep the same guidance. We think 2.74% is around 2.70%. And, of course, there's small volatility that can happen. But we're reaffirming our guidance. Quarter 2 was a little bit better than we expected. I think we see the repetitive comment over the last few years. We manage margin, we believe, in a different way which provides competitive advantage.

As you know, we're the only Bank in the UK that has a multibrand, multichannel strategy which as I have said many times now, is very relevant on managing deposit costs in a low-rate environment, given different brand customers' preferences. We manage the difference between asset margin and the deposit margin together. And we do this on a quite firmly basis every week on all prices of retail. And over time, I told you this should provide competitive advantage. It is showing a different behavior than at other peers.

And I do not see with what happened with Brexit, any difference in outlook for the current year. I also told you several times that I would never give guidance for more than one or two quarters because that's what we can see.

And if there is anything, as we were very open with you, about Brexit's uncertainty, we're only five weeks after the vote. It's very uncertain what will happen. It's very important to see the government's economic plan, the government's social plan, apart from the negotiation with the EU. It's very important to see how other banks will react. And therefore it's quite uncertain, we don't know. But we're very, very firm that our NIM guidance will be the same for the full year.

Raul Sinha

Raul Sinha from JPMorgan. If I could focus on the impact of lower rates going forward, just to get an understanding of how you're looking at the business. Firstly, if you could tell us what proportion of the SVR mortgages would need to be priced lower if there was a Bank of England base rate cut in the second half? And secondly, if you could talk a little bit about what mitigating actions you can take within the business, in terms of hedging or in terms of repricing. You've previously talked about a £60 billion book of deposits which you're paying about 2%. Any update on that which you could use as a mitigate for lower rates, that would be really helpful. And the second question was just, if you're planning to change your strategy of growth towards consumer credit going forward at all? Thank you.

George Culmer

So it's simple numbers in terms of SVR, there's about £70 billion which is on an automatic reprice. So that's number one. Fact two though would be that we would and I think Antonio was just talking about and as we've demonstrated, in terms of mitigating that, to taking action on the other side of the balance sheet, we've got a good track record of that and we would certainly be looking to offset that, in terms of action taken.

And to your question in terms of what's been happening on those cost of funds over the last few years; on the retail blended savings rate, it's about 96 basis points. I think it was about 100 basis points Q1 and I think it was about 106 basis points at the start of the year. So we've continued to manage that down and would basically back ourselves to be able to mitigate.

In terms of impacts of rate cuts and people always want hard numbers but there are variables and then how that flows through into swap rates, what the competition decide to, what we're able to do and all those sorts of things. I also count these comments in with that sort of guidance around - all morning around them.

But we disposed at - I think year end in the annual full accounts, we talked about 100 basis points, being £600 million or something like that. As it stands today, a 25 basis point cut, we estimate will be something like £100 million over the next 12 months. Now, as you go out the numbers change, etc. But a bit like our NIM guidance, I'm not going to speculate on what happens for that. But in terms of 25 basis points, that's the sort of number. If you go beyond that, it's not quite linear but it doesn't change dramatically. But that's how we look at them. We would, again, look to carry on in terms of what we've achieved over the last few years, in terms of managing the spread between the two.

So lower rate of run makes things tougher; the longer it persists, the tougher it gets. We would look to respond - that's the reason why some of our - some of the comments that we give. But I think, as I say, we've demonstrated over the last few years that we're well-placed to respond. And that's both through the margin management, that's through in terms of continued high quality in the credit portfolio and through being proactive and never being complacent in terms of the cost position. Again, there are a number of things - additional items, as we've said.

Now those had their source back in Q1 at the start of the year, where we assumed it was going to be lower for longer. We saw the changes in consumer behavior and decided we had to act. And you're seeing the consequence of that now. But lower for longer makes things tougher but we think we're in a good position to be able to respond to that.

Antonio Horta-Osorio

Yes. Indeed before I go into the second question, just to give two more points of call to what George said which are relevant. I don't think this is going to be like it was before, i.e., before you had slightly lower asset prices, where you don't expect lower AQRs which the banks were, some better, some worse, matching with lower deposit prices. And the fact that deposits were more and more being close to zero made it more difficult. I don't think this will be repeated. First, we saw with the referendum. For example, in our case we saw ourselves as a refugee in terms of deposits - a refuge in terms of deposits. If you look at our loan to deposit ratio, it has spiked down to 107% because we had an influx of deposits which was more than we expected with the vote.

So we will be able to recycle these deposits going forward, in terms of margin and drawings, to go back to our loan to deposit ratio target which we told you would be closer to 110% than 105% in a low interest rate context. So I think this is the first point. How people perceive banks in terms of risk has changed. In our case, the loan to deposit ratio shows that. And secondly, I think that on the asset site, banks are going to take stock, to think about the price and asset spreads because the lower AQR in the future will no longer be there. So as people decide how to price for mortgages, they will have to decide what will be the AQR in the future. And the AQR will be higher, intensity to be known. So I expect a change in behavior than given the vote. And, therefore, it is not clear to me that asset mortgage prices will come down.

You have to differentiate here, what is fixed rate because of the swap rates and floating rates. Some banks have commented on things, but it depends where swap rates are. But I do expect a different behavior on the markets, given the AQR expectations. And we obviously, as the leader in the market will continue as they have done for more than 12 months, to privileged low risk and margin versus volumes which was already the right thing to do in a low growth environment, it's even more right to do in an uncertain environment.

To your second question on growth in consumer finance, I think it was clear, that's why we're going to be more open - to tell you more things about risk which I know you were not so interested before. Because our prudent risk approach, it was not that important in a high growth economy, our prudent risk approach has been a reality over time. We told you three years ago, look, we're going to be emphasizing less large corporate loans because margins are lower, because covenants are being more lax and our corporate loan book has decreased. And we said two years ago, London is booming in terms of prices. Bank of England is worried. Again, we're the largest lender, we should be prudent. We reduced loan to income multiples.

And then more than a year ago, we heard, buy to let, the regulator is worried again. The largest lender, we're going to de-emphasize buy to let. So our strategy has been a strategy in a very robust economy but always with a view this will one day turn. And I think I told you last time, the longer we go, the closer the turning will be. I never thought it would be immediately, but it was the decision of the vote. And, therefore, the reason why I am saying this is we're not going to do - and I think it was clear from Juan's slide, we're not going to change our credit policy. We have been doing adjustments as we thought was appropriate. We might do small tweaks. We're completely open for business. And we're not going to change it.

But do we expect a slight deceleration of loan demand? Yes, in the same way that we expect some deceleration in growth, we expect some deceleration in loan demand. So our core book was growing 1%, 2% a year; it will grow slightly less because there'll be less demand. But our credit policy has always been prudent and therefore with hindsight after the vote, it was even more appropriate for the times when we're not going to change our credit policy. And we'll continue to grow in consumer finance.

The quality of the Jaguar Land Rover joint venture is very high, until four years elapsed and it took some time to grow. All gross business is new business but there is no redemptions. That's why [indiscernible] so much in that area. We're very comfortable with that and will continue to do so and the same in SMEs.

Michael Helsby

It's Michael Helsby from BAML. I've got two questions if I can. Just on the incremental cost reduction. George, you highlighted, I think it was on slide 12, that there's going to be an incremental CTA to that. Previously you - or you used to put all of that below the line and now obviously there's some goes above the line and there's £350 million now below the line. I was wondering if you could help us understand how much of that incremental £400 million would fall into profit, if you like, in 2017 and maybe 2018, i.e., how much is the offset that's above the line, if there is any?

George Culmer

Okay. My answer is a slightly different way. As I said in the presentation there's about a sort of £1.1 billion of spend to come, in terms of the simplification and about £350 million of that relates to redundancy. And we take redundancy below the line. The reason for that is slightly clunky, I know, in terms of above and below the line. But for us, managing that cost to income ratio and sticking to that cost to income ratio reducing each year is very much core to how we run the business. And from a purely practical sense, that gets messed up if I've got those large one-offs. So that's how we run it internally.

Now that focus on reducing the cost to income ratio, very much remains at the core of what we do. And we've reiterated that that's - we're seeking to achieve this year and that's our existing guidance that's on the table, our desire and target to continue reducing that each year. That very much remains in place. So that continues the sort of bedrock of what we do. As I say, in terms of additional costs to come, there's about - the £350 million that will go below. Quite separate to that, I know we've got the non-branch copy that we talked as well. And I know we're taking some of that below the line, but again it's for the similar reason.

This is how we manage internally in terms of giving that extreme focus on the cost to income. And again, this is going to be lumpy-type costs, so I put that below the line which gives you that pure line of sight in terms of what the ongoing are and how we run the business internally, but as I said, we've got this commitment in terms of reducing cost to income ratio each year. That remains in place. That's how we focus and that's how we run the business.

Michael Helsby

Maybe I wasn't clear. So I appreciate that - I guess that that £1.1 billion that's left, the £350 million, so all of that is in the P&L in other words. So none of it's being capitalized. There's no CapEx, it's all RevEx.

George Culmer

No, there'll be a proportion. I don't know what the number is, but there'll be a proportion of that that'll be capitalized because within that, a lot of the simplification is around automation processes, invested in digital, all those sorts of things that you wouldn't expect to be expensed through that. So there's a proportion of that. But within that £1.1 billion, that £1.1 billion, the bit that isn't below the line, we're going to absorb that above the line and do that and whilst keep to commitments in terms of cost to income ratio.

Michael Helsby

Second question, I think all the stuff on the risk was very helpful, so thank you for that. I think the flip side of having an LTV position in the mortgage book that's dramatically changed, if you like, from where it was, is that obviously a lot more people can refinance now.

So, George, I was wondering if you could help us - or give us an update on what's happening in the SVR book, by brand and rate and the redemption pace that you've been seeing and if you'd expect that to change, going forward? Thank you.

George Culmer

Okay. Yes, regards the SVR book, that continues to be probably more sticky than we assumed in our plans. And there's a dramatic change in terms of some of the attrition ratio. So overall, I think it was about 9% at Q1 and it's about 8%, 7.9% at Q2 and that's the annual attrition rate. And actually within that, the Halifax book which is now at about £50 billion/£50.7 billion, was about 5% in the quarter. So that's its annual rate. So it's actually dropped. Now, it may pick up a bit, in terms of going back to some of the other questions, in terms of an offset, in terms of when you look at base rate cuts or all those sorts of things, how it might develop, should there be a base rate, cut I would expect that book to be significantly more sticky.

And in terms of, again at the offset, in terms of, if I've got lower returns on cash on deposit, lower returns on structural hedge, etc., one of the offsets going the other way, so I would expect that book to be significantly more sticky. So we've actually seen, as I say, a sort of slowing-down of attrition in Q2. And we'll see what happens going forward, but it may be pretty closely linked to what happens on base rate, I would have thought.

Martin Leitgeb

Martin Leitgeb from Goldman Sachs, two questions, please. The first one is to follow up on your NIM guidance or comments on NIM, how you expect the market to behave going forward. Just to confirm, so your expectation is, if there would be a base rate cut next week, you would assume that given that the Bank's factoring higher risk cost, you would assume the base rate cuts not to be fully passed on in terms of asset spreads going forward? How could the Bank of England help alleviate some of the pressure on P&L from lower-rate environment on banks with an extension of funding for lending or an activation of the --?

I'm sorry. I was just trying to think what the Bank of England could do in order to help offset some of the pressure from a lower-rate environment. Would an extension of funding for lending or an activation of the contingent repo facility, be of help going forward? And then the second question is more on consumer behavior and new business, post-referendum.

And I appreciate it's an extremely short period of time; but equally, you probably have one of the best visibilities, given your leading market share in a number of products. Could you shed a bit of light in what you have seen in terms of consumer behavior, new lending volumes, appetite, demand for new lending? And also in terms of property valuations or if you have seen some of the valuers marking-down, whether it's residential real estate or commercial real estate?

George Culmer

Yes, the first one; the extent to which things get passed through, will depend upon actions at the time. So it's a slightly tough to answer your question, but to be no doubt, if there is a base rate cut next week, a 25 basis cut or whatever, for us we would be sticking to our guidance. And within that, going back to some of the effects that would - that implies, it's only the [indiscernible] the liability side to offset some of the automatic elements in terms of the asset. But we would be sticking with our guidance on that.

In terms of other things that the Bank might do, the countercyclical was nice but actually I think the sentiment was more important than the actuality of it. And I do think that - whatever, whether it's extensions of Help to Buy, it's FLS, announcement of infrastructure or whatever, irrespective of time periods and pounds, shillings and pence, I actually think the symbolism of action and of being prepared to step in and being able to talk in a competent fashion and about standing behind the economy, is it kind of - matters more, it's - morale it's three-to-one for physical-type things.

So I actually think that those indications support willingness to do it, is what will in turn drive confidence which will in turn drive investment which will in turn drive [indiscernible], etcetera. So I should - I think the symbolism and the communication is what matters most.

Antonio Horta-Osorio

Okay. And Martin, for your second point, on consumer behavior and client behavior in general. It's very early days, so five weeks from the vote. Trying to give you some color, because as you said, we have 25% of the retail customers and 18%/19% on the SME's new market. On the retail side we basically see no change, post-vote. So debit card transactions, credit card transactions, the current accounts. The only movement that we saw which we think is Lloyds-specific, is we saw an abnormally high influx of deposits on us, as reflected in our loan-to-deposit ratio going down to 107%. But in the market in general in retail, we think it's very early days and we see no change in behavior.

In terms of prices of homes that you mentioned, we see London is going down. So the latest numbers from June are quite symmetric regionally throughout the UK; and London has gone down in June. We haven't yet seen the numbers, post-vote, but I would expect that to continue. And on the corporate sector we had seen already, pre-vote, some holding of some investments waiting for the vote. And we have continued to see some holding of investments in SME mid-markets post-vote which is logical. But again, it's very early days.

Chris Cant

It's Chris Cant from Autonomous. I just want to say thank you for giving us the notional value of the hedge on page 7 of your report. That's, I think, the first time you've given us it. But I was just trying to solve the riddle of how you have £120 billion invested with a three-year average duration, at a gross yield of 1.8% at the end of 2Q. I'm not sure whether you have some kind of very aggressive barbell strategy. I know you used to have -

Antonio Horta-Osorio

Can you speak a bit louder--?

Chris Cant

Sorry. I'm not using the mic properly there. I know you used to say you'd reloaded in 2013 with 10-year gilts, the hedge around 2.2%. But I don't see how you get to a three-year duration with 10-year gilts at 2.2% and an average of 1.8%. So if you could give some color on that? And as a second question, if I may, your non-banking NII was quite negative again in the second quarter; very negative overall for the first half. I'm just wondering if you can give us some guidance on how that is likely to look going into next year? It feels like we're becoming structurally more negative in your non-banking NII when arriving at your reported margin. Thanks.

George Culmer

I think I'm going to frustrate on both questions. So no, I don't really want to go into detail of how the hedge is constructed. There's no mystery there. We have the - I think we have the benefit of - and you're right, we've sort of come in and gone out, at various times, this is a strategy we've pursued for some time, so we were able to buy-in at significantly greater yields at the time.

So we've got the benefit of history. But I'm - I don't think I'm going to - can dissect it further for you in terms of duration and tenures, etc. So those are the numbers. As I said, we've been asked a numerous times to get them out and we have done and hopefully you do find them useful. But I don't think we'll be dissecting the thing further.

Antonio Horta-Osorio

I think, Chris, what you have, I think, if I understand correctly, what you ask, is we have done a few years ago some 10-year deals and why you did three years' average duration, that's what you asked right?

Chris Cant

How do you get to a gross yield of 1.8%, you say it's 1.3% over LIBOR, return, how do you get to an average 1.8% with a three-year duration? What have you invested in to arrive at 1.8%?

Antonio Horta-Osorio

Yes. So the answer is, exactly what George said, we have invested over time. And if your question is, if we have in the hedge anything which is not gilt, we don't. So it's three years' average duration. It's all government securities and this is just the weighted average of whenever we did the hedge. The only additional information we might tell you which you might find useful, is that we have not been reinvesting the hedge since the end of the year because we don't think that at present interest rates, that would be worth it. So that's probably the only additional information which might be useful for you.

But as George said, we gave you more information because [indiscernible] and there is nothing but gilts on that portfolio and we have not done any reinvestments since the end of the year.

George Culmer

Yes. And the non-banking NII trend in 2017, no I'd have to go back and have a look at a more considered view in terms of what the trends might be. I've got to fees and arrangement-type business, but I don't know if there's anything particular to call out in that trend.

Manus Costello

Manus Costello from Autonomous. I was a bit surprised by the RWA move due to FX this quarter. What proportion of your RWAs are not in sterling and why don't you hedge them?

George Culmer

Okay. In in terms of raw data, there's about $20 billion, about €12 billion, €15 billion - sorry, yes, $20 billion and €12 billion, of that order. And to hedge or not to hedge? The reality is, you can't do a hedge on these so to speak, in the sense that these are off balance sheet. If you think about it, I've got my balance sheet, in my balance sheet I've got my assets, I've got my liabilities, etc. which I look to hedge and from a balance sheet perspective. But from an RWA calculation, I just take the assets over here and calculate what the RWAs is and therefore, I have to put my capital against that. So it's just taking the asset side of things.

Now, if I did decide to cover that, it's not a hedge per se. I won't be able to get hedge accounting treatment, so I'd have to take the volatility on that currency exposure through the P&L. So that's how it will work from an accounting perspective. So you could take a deliberate view to, inverted comma, over hedge and you just take the P&L volatility on the FX. So that's why you can't do a hedge because it exists outside of my balance sheet.

So what happened, obviously, following the referendum in terms of the big movement in sterling, particularly against the dollar, is you have to revalue the RWA and the only thing I'm sticking against that is capital which is all sterling-denominated. You could over hedge. You take the P&L volatilities as you go through it but that's a - so you can't do a hedge.

Manus Costello

And just related, therefore, that's low teens of your total RWAs, is that going to be inside or outside the ring-fence sector?

Antonio Horta-Osorio

But, Manus, your doubt is because when you say, why we don't hedge. As George explained, we completely hedge in terms of assets and liabilities. But given that we're domiciled in the UK, that dollar exposure and euro exposure is from the UK. You cannot hedge at the equity level. If we have, if you imagine, a subsidiary out of which those are done, you have the equity as well and that has a different accounting treatment.

So it's because we're UK-domiciled. It's a massive tariff in currencies when the sterling depreciates there's no P&L impact but you have higher RWAs because our equity is in pounds. That's why it produced this small impact of around 30 basis points because it was a massive depreciation of sterling, 11% versus the dollar and close to that the euro exchange.

Rohith Chandra-Rajan

Rohith Chandra-Rajan from Barclays. A couple as well, if I could, please? The first one is just on the motor finance business in the UK, on credit quality. The NPL ratio and actually, if you take the balance of NPLs, have been improving in the first half but the coverage has moved up from 67% to 92%.

I'm just wondering, in a more uncertain environment, how we should think about that coverage ratio going forward for that particular business and what the reason for the move in the first half was? That was the first question. And secondly, you've been very helpful in giving some indication in terms of your London mortgage exposure, in terms of 14% of the flow. I just wondered if you could give us a bit more detail in terms of how that sits, in terms of the overall stock and any segmentation you might be able to provide on LTV or LTIs? Thanks.

Juan Colombas

On the coverage, we haven't changed at all our policy to cope with provisions and the way we do it. So there have been some one-offs in the unsecured lending related with that sale. But there is nothing to call out as a change or the fact that we may have seen a change in the trends at all. The trends continue to be the same and so there is no reason for thinking that this is due to a potential deterioration of the portfolio at all. So there is continuity on that. On the profiling of our presence in London, I don't have it at the top of my head now, so I will need to go to see this, Rohith.

Rohith Chandra-Rajan

Can I just come back on the UK motor. So how should we think about, what's the appropriate coverage for that book going forward? I appreciate there might have been - and it's a small balance of NPLs, so I appreciate that small changes can have a big impact on the coverage ratio, but what is - at the moment it's higher than you've got on consumer - on credit cards and NPLs. And so what's the right level of coverage? So, the European book is covered at just over 50%

Juan Colombas

There's no right or wrong answer, so we do our provision, as always, based on the flows that we see in arrears and in recovery. And over that you apply a judgment, based on judgment and we tend to be in the conservative side. As soon as we see any reason to overlay provision and you have seen it in the past, we do it. But there is not a single version of the truth on this.

George Culmer

And you've got to remember the scale as well. We talk about impaired loans as up 0.1% and provisions about 0.1%. That's a good question to answer but you have to remember the proportionality here.

Rohith Chandra-Rajan

No, I appreciate it's small at the moment. It's just wondering about, if things do deteriorate, what it would be. But thank you.

Juan Colombas

I would answer this more broadly because in unsecured we haven't seen, as Antonio has said, any change at all. So, other than this continuous improvement in all the portfolios in the asset [indiscernible].

Andrew Coombs

Andrew Coombs from Citi. Three questions from me, please. The first, perhaps I'm being slightly pedantic here, so I apologize. But given you changed your capital generation guidance from 200 basis points to 160 basis points, 30 basis points of that we see in this quarter on the FX translation impact but that's arguably one-off in nature and what you assume for the drift in FX rates from here. So perhaps if you could just elaborate on what's the extra 10 basis points? Is that a lower profit outlook for the second half or is it another assumption?

The second question would just be on July mortgage application rates. I know you don't like talking about the next quarter, but given the extraordinary events we've had, could you comment on what you're seeing in terms of applications in July? And then finally, I noticed you've put through quite an aggressive cap on your first-time buyer mortgage rate in June. How is that - it's moved you back into the pack, so just what the rationale for doing that was? I know it's a space you've been very active in beforehand.

George Culmer

Shall I do the first bit. You're right, it is pedantic. Look, yes, the guidance is 200 basis points. I think we've said, some years it's going to be tougher than others. This was - this is a pretty tough year to achieve that. We came in, we had the ECNs in Q1 which we had to work around. We had then change in the utilization of brought forward tax offers that we had to work around as well. We had the imposition of PVAs that came in as well which we had to work around.

So despite all those sort of headwinds, we still thought actually, as we move through the year, we'll be able to hold to that guidance, that's based upon what we saw as underlying profit generation and what we're doing in terms of RWA optimization. So in terms of this year's issues, it's quite an active management of the 200 basis points, because there were some things that we had to work to, to overcome.

In terms of what's happened - yes, this 200 basis points, most of those, yes, there's RWAs as previously discussed. There's a bit there in terms of PVA volatility as well. You've got to drop the numbers into a machine and it works against you as well. When I look at the numbers - underlying profit will remain strong. I'm not trying to signal any deterioration. When I look at the first half numbers, I'm pleased with income, I'm pleased with costs, I'm pleased with credit.

Other conduct was a disappointment, so that worked against me. I don't expect that level in the next - second half of the year. But certainly it was a disappointment in the first half of the year, again, that made it slightly harder. So those things are just things that we strive to overcome and 10 basis points, in the size of the capital base. We thought we were close enough.

Antonio Horta-Osorio

You could see it the other way around right? We generated 50 so far, we're giving 160 for the year which is more than 50 for each of the following two quarters, right. It depends how you look at it. To your second and third questions; we have seen a slight acceleration of mortgage applications [indiscernible], but I don't think that is related to the vote. As I have said before, we think that is related to the fact of the tax changes in April which led people to anticipate mortgage applications and therefore, you move forward [indiscernible] to pre April. So we think it's absolutely too soon, as I said, to call any material change on the retail space. Please Tom?

Andrew Coombs

Just on the FTB capped mortgages. The first-time buyer mortgage rate caps in June.

Antonio Horta-Osorio

Yes, you should take in the context of what George said. We - depending on what the market does, we act in the market, but as I said before, our strategy has always been to privilege margin and low risk versus volume. And given the [indiscernible], as I said before, even more so, going forward which I think is absolutely the right thing to do, in a low growth market and which now will have a higher risk [indiscernible].

Tom Rayner

Tom Rayner from Exane BNP Paribas. Can I have two questions please? The first really on your core franchise, because obviously you describe yourself as the leading UK retail commercial Bank. And first half of the year, your mortgage book shrunk, your commercial loan book didn't grow and the only real growth we saw was coming through your UK motor and to a lesser extent, your European consumer business.

I just wonder if you could comment on how you're feeling about the franchise, in terms of that performance in the first half. And, I have a second question, if I can, just to come back on, on the structural hedge, please. Thank you.

Antonio Horta-Osorio

So on that first question, I would disagree with that comment, to be fair.

Tom Rayner

It's a question, not a comment.

Antonio Horta-Osorio

No, it was a comment, you said, we did not grow in commercial portfolio. And we did. We have a commitment of growing around £2 billion, every year, until the end of 2017, on both SMEs and mid-markets. And as I said on my speech, we actually grew £2.2 billion. So we met that target.

We don't have loan growth targets, for large corporates, because large corporates can tap the capital markets, can do strategic, can do whatever they want. So they - no logic in targeting as we said many times, loan growth in large corporates. So we met our targets, slightly exceeded in mid-markets. Plus SMEs, we continue to gain market share in both segments. We have, as you said, continued to grow very well in consumer finance, where our target was also £2 billion per year. And we did £2.6 billion in the last 12 months, so significantly ahead of the target.

So we feel very well above the growth in our key segments. And the only additional segment where we have not grown our additional key segments, where we have not grown for the reasons that we have been discussing. Over the past 18 months is mortgages what is written. The only segment growing in mortgages is buy to let. We thought it was prudent not to grow as the market in that segment. The second we thought as the largest lender we should set the right standards and the regulator is worried about the segment. And as you know, buy to let is growing 12%, year on year and we're only growing 2% in that segment which again, with the hindsight of the vote, is even more appropriate in our opinion, to do. But we will continue to balance risk and margin, in mortgages, versus volumes, because of those reasons.

So our core loan book was growing around 1%, 2%; is it going to grow slightly less, going forward? Probably yes. As I said previously, because I expect a slight deceleration of loan demand following an expected deceleration in growth. But our risk policies are not changing as one should and as I told you, because we were already managing in a very prudent way and we continue completely open for business. But I have to remind you, Tom, it is very easy to grow in credit, just have to give money to people that is not the point. The point is to get it back in a profitable way and we're always very mindful of our debt.

Tom Rayner

Just going back to the structural hedge, maybe one of the surprising things was the size of the hedge, at £120 billion. If I look at your equity and add on your interest-free balances, you don't get to as big as that. So I was just wondering if you could explain the size of the hedge and also given that that's now in place, does that not represent a fairly severe headwind to margin, in the next two to three years? Or does that depend on the term structure and how it unfolds?

Antonio Horta-Osorio

I would say the positive. You think the hedge is too big or too small?

Tom Rayner

Well, it just seems bigger, bigger than if it was purely hedging your equity and fee balances, that's the point really.

George Culmer

Okay. You've got current accounts, you've got the rate intensive element, so variable account balances, that's sitting there as well. So you've got amalgam of things. And in terms of headwinds, I don't know. We think what we've done has served us well, in terms of income generation, so shareholders’ value in terms of income generation.

As Antonio says, we've not been investing in the first six months. There's a predictability value trade-off in terms of deployment, in terms of downside protection. We will see where rates go. We remain very flexible, we remain able to respond. And it goes back to part of the questions around, give me a number for rate cuts and what happens. Well, actually it depends what happens to flow through to swap rates and my ability to respond as and when they move.

Antonio Horta-Osorio

By the way, I think RBS also gives similar information on hedge. And we have seen ours versus theirs and we think it's very much in line in terms of size. If anything, ours is a bit smaller now. Because as I was telling previously, we haven't reinvested any of the hedge in the first six months of the year because we felt that the risk trade-off was not appropriate at the current level of rate.

But if you would look at the RBS and we have [indiscernible] as of the end of the year, we were very much equivalent, because you have to have the right insensitive deposits to equally measure.

David Lock

David Lock from Deutsche. Two quick questions, please. Firstly on PPI, I think it was about a year ago, George, that you gave the guidance that every six month delay would be about £1 billion. I just wondered if you still stood by that guidance, given where claim volumes have gone. And then secondly, one of the things that was highlighted from the stress test last year, was that you had a higher than average mortgage loss impairment driven by your self-serve book.

And I noticed in the specialist book, this half the arrears have actually ticked up a little bit, both in terms of balances, in terms of borrowing. So I just wondered if you could give a little bit of color on what's going on in that book in particular and if you see any concerns there? Thank you.

George Culmer

I'll do probably the PPI. Yes, you're right. 12 months, 15 months ago, whatever it was, 6 months - now that was pre time-barring and at that point that was sort of the conversion factor because pre time-barring, what happens is you always have the extrapolation whichever the adverse experience now, I've got to extrapolate forward. So actually if you have a time-bar in place, that run rate drops away and you don't have 6 months equals £1 billion because you don't do the forward extrapolation. So you have a cut-off point.

Now what we've assumed in terms of our provisions, the back end of last year, when obviously the consultation paper was out, we assumed a 2-year period through to time-barring. So with effect the time-bar would come into place mid-2018. We're obviously past the start point of that, because we await the FCA's response. We know no more than yourselves, probably, in terms of what they might say and when they might say it.

In terms of what it means for - let's just assume it is delayed or start point's delayed or whatever - extended back, we will make that decision at that point. And whilst that may sound a bit rubbish, that will depend upon what I'm seeing in terms of run rate at the time.

So it was quite clear in the presentation, we talked about where reactives come in and how they've been pretty - as we went into this year, in terms of time-barring in place, also the CMC regulation coming in place, etc., there were many scenarios that we talked about including big spikes, etc. So claims have stayed pretty stable but actually, as I said, the last 6 weeks or so now, let's wait and see, but we've actually been seeing a decline.

So answering to your question, if I get to the end of the year and, whatever, the FCA has been delayed, let's wait and see at that point because the reference points are not just what the FCA has said or hasn't said at that point, but also what's my trend of reactives look like at that point. And that's quite important. And as I said and we - what we've been seeing of late is quite encouraging just from those reactives.

David Lock

Just as a follow-up to that, is it fair to assume then that the 160 bps of Core Tier 1 capital this year, given that you don't know what the FCA will or when it will say, that there isn't any further PPI number in that you've penciled in for the second half of the year?

Antonio Horta-Osorio

Yes, with respect to the mortgage portfolio, it's true that we have had an increase in loans, a number of them in this portfolio in the last 6 months. It is - you will recall that we mentioned there was a judgment in Northern Ireland called [indiscernible] and as a consequence of that, we have done some changes in operations in the litigation of mortgages. And what you are seeing is just - we're thinking it was longer for - in the litigation process for mortgages. These operations have been implemented so we think this will be absorbed, so to say or normalized in the coming quarter.

If you look at the new arrears and some early arrears of any portfolio in the mortgage book, it is improving as we were expecting. So it is just this complication on the litigation process.

Ed Firth

Ed Firth from Macquarie. Again, just two very quick questions. I hear what you say about not passing on base rate cuts to customers but I just wondered how the Bank of England -

Antonio Horta-Osorio

We have not said that, I'm sorry. We have said that the automatic pass would be off and the rest we would decide in the context of what decision the Bank of England takes and what competitors do. That's what we said.

Ed Firth

Okay. I guess there's a question about the whole - I guess the logic of a base rate cut, if banks don't pass it on, then the economic benefits are obviously not there. So I see there was some imperative on you to pass those on.

Antonio Horta-Osorio

Well, we will see what happens.

Ed Firth

And then my second question was just on - going back to your NPL cover, I notice it's down quite a lot from the full year. It was over 46% at the full year and it's now down to, what, 43.5%. Is there some sort of disposals that are driving that and how would we expect to see that as we go through the rest of the year?

George Culmer

The answer is yes, there's been some disposals of heavily-impaired assets. So that's what's caused the move in the period. In terms of future coverage trends--

Antonio Horta-Osorio

I think you should look at the retail coverage as quite steady and the commercial coverage has therefore been a given which assets we disposed. And normally if you dispose of [indiscernible] higher coverages, so when you sell them the remaining coverage comes down because on commercial you do asset by asset, while in retail it's statistical, I think. If you look two years back, it was 43% as well and we gave you that series.

So the series is a bit lumpy because of commercial but we do a provision asset by asset on the commercial side as Juan showed you. It is prudent. The proof that it is prudent is that we normally have write-backs in the future. As you see, we always have write-backs and you should expect some steadiness on retail, but some lumpiness on commercial. We don't see any trends at the moment, as Juan said, of any deterioration in any of our portfolios.

Ed Firth

But we shouldn't be expecting any increasing cover into the second half?

Antonio Horta-Osorio

No, you should just expect the coverage name by name on commercial and steady on retail.

Juan Colombas

The only thing I would add is that in commercial, you should expect a BAU flow of write-backs in the future. The more prudent you are, the sooner your provision and if the case is [indiscernible] you will have the write-backs. So that is a - in the write-backs there is a continuous in and out. There is a BAU flow of write-backs in the future.

Robert Noble

Robert Noble from RBC. Just on your capital generation guidance going forward, not for this year, you say there's a risk that it might be lower. I was just wondering what you see as the biggest risks, is it higher RWAs, lower house prices, lower growth, lower margin, higher cost of risk? What's the pecking order of the risks there? And do you see any risk on your pension surplus from the lower rate environment as well? Thanks.

George Culmer

Look, the comments regards - certainly going forward, it's not a higher RWA, it's more, going back to what we talked a bit about in terms of a general deceleration and the expectations that there will be a rate cut out there and to Tom's point, in terms of impact through on structural hedge earnings and reinvestment. So it's predominantly a deceleration in terms of lower growth, lower commensurate activity that hangs off the back of that and allied with some rate cut which would then feature through into, as I say, things like structural hedge earnings, cash earnings, as I move further out.

So that's the context that we think about, as opposed to specifically any big RWA hike, be it through the HBI or through imposition of Basel or whatever. It's more a deceleration, interest rate, that's how we view that. Pension, as you've seen, our [indiscernible] pensions are absent. Going back to hedging, all those sort of things, we've taken some action over the last few years to hedge the pension out completely which has really come into its own this year and the numbers - we have about a £43 billion in terms of pension liabilities. But our hedging strategy has benefited us by about £10 billion. It's no less than about £6 billion in 2016 as a whole. So we're still in surplus as a scheme.

You're dead right in terms of discount rates, all those sorts of things. And our sensitivity is around about £600 million or so for every 10 basis points. But we still think we would work to offset some of that. So it's a risk that's out there but I think we've managed the pension, I shouldn't really say this, but pretty well so far and we'll continue to do so.

Antonio Horta-Osorio

We have completely revamped the way we were managing the pension funds to three years ago, going into much more fixed income to match with the discount rates. That's why George has said it is quite matched; with hindsight quite good results. Let's take two or three final questions.

Vivek Raja

Vivek Raja from Mediobanca. A couple of questions, please. The first one was, I think you previously said - guided £6.1 billion for OOI for this year; just wondered how you felt about that? Obviously that was more productive in Q2. And just as you think about, yes, I guess the lumpy items within that, if you could give us any color on how that could pan out as you see it for the rest of the year? And the second question was on the margin and I just wanted to understand what the impact of deposit savings has been on the margin in the first half and how that's worked; so how much of that was commercial, how much of that was change within the retail mix? Just if you could give some words on that, please? Thank you.

George Culmer

Okay, so on the OOI, you're right, we said that - last year's OOI was about £6.1 billion and we would hope this year to try and get ahead of that, at £3.1 billion or whatever we're for the half year, this is why we said we think we're on line for that. There are risks out there, so there are things like the obvious ones in terms of things like bulk annuity timing, they're quite volatile.

But at the moment, that remains - we'd look to try and beat the £6.1 billion. But to your question, we appreciate there are risks out there, some of it's around bulk annuity - bulk annuity, some it's what levels of activity we do actually see in terms of the second half. There's been a slowing over summer, let's see how that comes back. So there are risks to delivery, I would say that. And then in terms of margin, we do the various walks etc., there are sort of two things going on. As we said earlier, in terms of the retail blended savings, we talked about it dropping from 107, 106 to 100 to 94 or 96 so that's year end, Q1, Q2, so we've managed that down.

But what we've also done at the same time, we managed the blend across the book as well. So while retail savings have been on a downward track, actually we've been growing commercial, so commercial cash is up, I think, about 10% in the six months. And with that we pay, on an average, of 40 basis points or 50 basis points.

So there are complications you've got to manage in terms of LCRs, all those sorts of things. But as long as you're managing that correctly which we think we're, then in terms of being able to manage the totality of the balance sheet and being able to use the reputation that we're building up within the commercial business and our rating and as Lloyds is a bank to do business with, we're were able to play into that and build up a cheaper source of funding. And we're able to utilize that as well.

So I managed each book unto itself, but then I can manage the totality and flex between the two and that's how I seek to optimize. And that's how the business is run. So we'll sit down with a single balance sheet and we'll sit down, in terms of what's the best - what's the most marginal cost effective net source for funding from everything, from wholesale, going through my retail brands and my relationship and my tactical, through my commercial options and what's the liquidity costs and what's the marginal costs of adding this on, that's how we look at managing the funding part of the Bank.

Vivek Raja

If I could put that question a bit more simply then; so in the deposit funding, the benefits you've taken recently, how much of that has been about the mix shift towards commercial and how much of that has been about lowering retail?

George Culmer

Well, it's both. I don't have a sort of pounds, shillings and pence to tell you; both factors contribute to the basis points improvements which you see. So it's a simpler question but I'm afraid it's a meaty empty answer for you, but I haven't got the pounds. But that's what it is, that's how we manage the rates.

Antonio Horta-Osorio

And, as I was mentioning in the beginning, we have some additional leeway, because following the vote, as I told you, we have had a nominally high influx of deposits, so our loan to deposit ratio which was close to 109%, it's close to 107%. And we, in terms of managing the loan to deposit ratio, we're thinking this low interest rate environment should be closer to 110%.

So we have some leeway in terms of managing the mix and the prices to go back to where we were which was close to 109% and that, obviously, we will have an additional lever, if you want, in terms of our margin management because the way we do, is we first decide which asset growth we want to do in all segments, that determines the assets' growth rate, that's determined through the loan to income ratio, how many deposits we need and therefore the pricing and the mix. And we do this centrally as a whole. So the fact that we're at 107% which was a bit unexpected, gives us additional room to go back to the 109% and have an additional lever for the margin.

James Invine

It's James Invine from Societe Generale. I've got two questions, please. First of all, George, you talked about retail deposit pricing coming down to the 94, 96, I was just wondering could you split out the fixed rate book like you usually do within that please and ISAs as well?

And then the second question, I guess, is for Juan, this is about the motor finance book which obviously has been growing pretty well. But if I look at your website, I can see that I can borrow up to £250,000 and I don't need a deposit. So I just wondering how many people don't put down any deposit and what is the average size of the deposit when you lend somebody money on your motor finance? Thanks.

George Culmer

Fixed ISAs is about 186 and that compares to sort of 201 at Q1, 207 at the yearend. And in terms of just the fixed book itself, it's about 208 and that was 210 at Q1 and about 213 at the end of last year. So that's the progression in those books. And those, there's about £29 billion in the ISAs and about £23 billion in the fixed book.

Juan Colombas

And on the second question, I don't think we fund any car for £250,000, so I don't know which is the website that you're looking to?

James Invine

The Black Horse [ph] website.

Juan Colombas

I will have to look at it; I don't think it is - it's a normal loan [indiscernible].

James Invine

No, I mean, that's a pretty nice car but--

Antonio Horta-Osorio

Because we will get the client as a whole.

James Invine

But on the second part of it, what is the average deposit that people put down as a percentage of the car value?

Juan Colombas

I don't know the answer, so I cannot answer that.

George Culmer

Any final questions? Nobody else wants to ask anything? Okay. We'll take your final question.

Unidentified Analyst

Sorry, just take this risk of asking another question but this is an insurance question? So just on page 22, George, I was wondering if you could talk a little bit about the performance of the life and pensions experience and obviously there there's a net benefit of £124 million as a result of experience.

I'm just trying to understand, it's not something that we would usually focus on, but within that you talk about £184 million benefit of the addition of new debt benefit to like the pension schemes. And previously when we look at this line, obviously it's been a little bit volatile with a number the different lines. So what can we think about the run rate; is there - are you flagging that this is a specific development in this half which we shouldn't really expect to repeat going forward? Or the numbers here generally reflect the level of business?

George Culmer

Okay. One of its issues, obviously as you know, with insurance accounting, assumption changes of some degree will always be a feature. And in the current period, for example, we were suffering in terms of revision to assumption changes around persistency, around corporate pensions. We've benefited here, in terms of the extension of death benefits within some of our legacy pension business which essentially turns these things into life insurance business, so you can - you change the accounting of these. So assumption changes will remain a constant, the impact, the size impact will be volatile, bulks will be volatile within that, so they're sort of two elements that will remain volatile.

Other parts though, the general insurance business where we have an absolute jewel in the crown, in terms of our own business, will and does continue to generate strong stable profitability. I think the base - corporate pensions and new business coming from that, in the underlying, should be stable. My in-force book, most of that should be stable. So, I think the level of profitability that you're seeing, despite all the moving parts, it's not a bad guide. Insurance has had a much better Q2 than Q1. But in terms of run rate, it's not a bad guide in terms of the move forward.

Antonio Horta-Osorio

Okay, thank you very much, everyone, for joining us today.

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