NatWest Group plc

Stephen A. M.

Hester - Group Chief Executive Officer and Executive Director Bruce W. Van Saun - Group Finance Director and Executive Director

Rohith Chandra-Rajan - Barclays Capital, Research Division Chirantan Barua - Sanford C. Bernstein & Co., LLC., Research Division Chintan Joshi - Nomura Securities Co.

Ltd., Research Division Raul Sinha - JP Morgan Chase & Co, Research Division Peter Toeman - HSBC, Research Division Gary Greenwood - Shore Capital Group Ltd., Research Division Chris Manners - Morgan Stanley, Research Division Jason Napier - Deutsche Bank AG, Research Division Michael Helsby - BofA Merrill Lynch, Research Division Thomas Rayner - Exane BNP Paribas, Research Division Andrew P. Coombs - Citigroup Inc, Research Division

Good morning, everyone. Thank you very much for joining us for our third quarter results call this morning.

Bruce Van Saun is with me as usual. And I'm sure most of you know, there are reams of disclosure and other materials available on our website to support and amplify on what we're saying this morning.

The period we are reporting on today, I think and hope you will acknowledge is one with some really important and positive milestones passed in RBS' restructuring. It was also one where our ongoing businesses showed solid performance and resilience, and it was one when like other banks, we were reminded that the going is still tough, that there's plenty left to do to make the bank as good as we target, and of course, especially so in reputational terms.

But nevertheless, I think that we are increasingly coming to the point of clarity that we can complete the restructuring in the 5 years that we said it would take us, that the cleaner, slimmer and smaller and fitter bank that 2014 should see the future RBS should be one where we can generate significant broad-based investor appeal of a much less complex start. There is heavy lifting to do between now and then, but I think what we've done so far gives us confidence we can do that.

Obviously, what happened thereafter in terms of economic pressures, regulatory pressures, pace of growth and so on, we all have to wait and see. But we believe that we're establishing increasingly the platform from which to do good business in the future.

So with that, let me ask Bruce to take you through the results.

Okay, thanks, Stephen. The third quarter showed continuing solid progress, as we strive to recover and reposition RBS.

We made excellent progress against all the key balance sheet targets in our safety and soundness agenda. Our core bank generated solid profitability, delivering a 10% year-to-date ROE, while Non-Core maintained its excellent pace of asset production.

We also continue to hit our major milestones, including the Direct Line IPO and the exit from the APS scheme. And while Santander's decision to withdraw from the branch sale was disappointing, we have relaunched the divestment process, and we remain optimistic.

Let me turn to the financial highlights of the quarter. The group's third quarter operating profit of just over GBP 1 billion was up GBP 400 million on the prior quarter and up more than GBP 1 billion on a year ago.

Core's Q3 operating profit was GBP 1.6 billion, which is up 8% from prior quarter, 67% on a year ago. Most of our R&C businesses were broadly flat given the sluggish environment, except for U.K.

Corporate, which suffered from some single-name impairments. Markets saw a sequential quarter improvement in operating profit as revenues were stable, and we continue to lower costs.

Non-core's operating losses were nearly GBP 300 million lower in the quarter, given favorable market conditions and avoidance of significant impairments. At the attributable profit level, the group showed a loss of GBP 1.4 billion, driven largely by GBP 1.5 billion pretax own credit adjustments.

Our credit spreads on 5-year maturities have come in from 450 basis points to about 100 basis points year-to-date, reflecting the improving strength of the group. However, under the current accounting rules, this good news is reflected as a charge in our income statement.

Our capital position remains robust with a Core Tier 1 ratio of 11.1%, if you include APS; 10.4%, excluding APS. Our TNAV was down 2.7% to 476p per share, reflecting the large own credit adjustment charge.

Excluding this OCA charge, TNAV is broadly flat on the prior quarter. Next, let me turn to the major group P&L categories.

Group income was flat on Q2 at GBP 6.5 billion, but it was up 6% or GBP 400 million on a year ago. Core's revenues were also stable sequentially.

R&C income was down by 3%, broadly reflecting the impact of sluggish economies and low rates. Markets' income was steady versus Q2, as credit spreads tightened moderately.

Flows were stable, and new issue Markets were active. We also realized some incremental bond gains in the group center as we rebalanced and downsized our liquidity portfolio.

This allowed us to offset several charges in the quarter, protecting our capital ratios. Group NIM was stable at 194 basis points, while R&C NIM declined slightly by 2 basis points, reflecting downward pressure on deposit margins.

Expenses remain tightly controlled, down 6% on prior quarter and 5% on a year ago. Our Core cost to income ratio year-to-date is 60%, which is stable versus a year ago.

Group impairments were down 12% or GBP 160 million sequentially. The decline was driven by a fall in Non-Core due to the non-repeat of Q2 project finance charges and a decline in Non-Core's Ulster impairments.

Ulster's impairments overall, Core plus Non-Core, were down around 4% on the prior quarter. That represents 42% of the group's total in Q3.

While we see a few early signs of stabilization in the housing markets, we're still fairly cautious and don't see an imminent turn at this point. Group NPLs are broadly flat versus Q2.

They're down GBP 3 billion on last year. Our group provision coverage of NPLs is 51%, which is up 2% from the beginning of the year.

The so-called below-the-line items were a negative GBP 2.3 billion in the quarter, driven primarily by a GBP 1.5 billion charge for own credit adjustment. Other major items include a GBP 400 million top-up to our PPI provision, as claim volumes continue ahead of expectations and ongoing restructuring costs, which will peak this year.

Several divisions had noteworthy performance in the quarter. In Q3, we were pleased by the performance of U.K.

Retail, where operating profit increased by 6% on prior quarter. As income was up modestly, costs were tightly managed down 2% and impairments were flat.

Q3 ROE improved to 24%. Markets was another solid performer as operating profit was up 18% on Q2, driven by good cost control; while rates, asset-backed products and credit businesses continued their strong performance as spreads have tightened given investors' search for yield.

Markets year-to-date ROE of 12% compares favorably versus peers. The U.S.

R&C International Bank and Wealth businesses all saw stable performance in the quarter, while U.K. Corporate had a soft quarter due to several factors.

Revenues were lower due to non-repeat of the first half one-offs. There was a collapse of the LIBOR base rate spread, deposit margin pressure and weak loan demand.

Impairments also increased materially in U.K. at large corporate, driven by a small number of individual cases.

The pattern of impairment charges in U.K. large corporate can be lumpy given the size of the credits.

Non-Core had another terrific result in Q3. We made good progress on asset run-down, dropping GBP 7 billion to GBP 65 billion, while RWAs fell even more by GBP 11 billion in the quarter, as we continue to emphasize derisking the Markets portfolio.

Year-to-date, asset run-down is GBP 29 billion. We now expect to hit the GBP 60 billion in TPAs at year end, and we remain confident of hitting GBP 40 billion by the end of 2013.

Non-Core's operating loss declined versus prior quarter despite increased trading losses from the further reduction and derisking of the structured credit portfolio. The quarter's P&L benefited from an improved market environment, lower costs and the absence of significant impairments.

Next, let me turn to the balance sheet. In the third quarter, we reduced our balance sheet by GBP 20 billion to GBP 909 billion.

Group RWAs, excluding APS cover, fell to GBP 481 billion. Our funding, liquidity and capital metrics improved further.

The loan-to-deposit ratio is now 102%, with Core at 91%. Deposits constitute 70% of the group's funding base.

The group's short-term wholesale funding declined by GBP 13 billion to GBP 49 billion. We're now down GBP 53 billion year-to-date.

This now represents only 5% of our funded balance sheet, well below our peer group. We were able to reduce our liquidity buffer, given the shrinkage in short-term borrowings, down to GBP 147 billion.

That said, the liquidity buffer cover of short-term wholesale funding rose to 3x from 2.5x at the half year. We remain comfortable with our capital base post the APS exit, with a 10.4% Core Tier 1 ratio.

Now this is up 70 basis points from the beginning of the year. Our target remains to maintain the group's reported Core Tier 1 ratio above 10% at the 2012 and 2013 year ends, incorporating various regulatory changes.

So to sum up, the group's balance sheet strengthened further in the quarter, while Core continues to deliver solid returns. We are pleased with the progress on our 2012 milestones and our route back to normality, including the exit of the APS and the IPO of Direct Line.

We see the next 15 months as important to finishing the recovery effort, as we position RBS to be a cleaner and more profitable bank thereafter. With that, let me turn it back to Stephen.

Bruce, thank you very much. And let's go straight into questions.

A couple if I could, please. One on the U.K.

Corporate trends that you highlighted, which I guess, in terms of the Retail & Commercial businesses were sort of the sort of soft area. You talked about margin and the impairments.

So I guess on the margin, just in terms of how you see that progressing from here, we're now back, I guess, at a level we saw this time last year. You highlighted LIBOR-based spread and deposit pressure, so just interested in your comments on that going forward.

And then also just on the provision line, looks particularly due to a pickup in the property sector impairments and just any sort of further comments about credit quality generally in the Corporate book and going forward.

Yes, sure. Well, first off, again, I think the first half NIM in U.K.

Corporate was a bit turbocharged from some one-offs, which we had flagged. So part of that reduction was just not having those occur again in Q3.

I think there are further things that exacerbated the decline. Clearly, that collapse in LIBOR, relative to base rate, had an anticipated impact.

And then we continue to be in a competitive marketplace for the Corporate deposits. So I think again, where we are now is around a 3% level.

And I think that's probably a reasonable run rate absent kind of the good news that we had in the first half of the year. On the impairment side of the coin, again, we've run 2 years in a row, we had U.K.

Corporate impairments of around 800. The first half of this year, we were at about 350.

And I think we were cautious to say, "Look, there's some lumpiness in this," and we weren't calling out that we were going to be at a reduced run rate. And in fact, we've seen -- I don't know if there's any seasonal pattern to it, but we've seen second half impairments bigger than first half impairments for each of the last 2 years.

And so we saw that emerge again this quarter, and I think it's fairly contained. So when we look at where is that, you're right in commercial real estate, there were some top-ups on some credits that were already in our workout group.

We have an eye on the shipping portfolio that we have in U.K. Corporate as well.

I think on a broad basis, outside of those areas, we're not seeing anything troubling or alarming. And in the smaller business in commercial space, we actually see things have been very stable, and they're actually starting to trend slightly favorable.

So again, we look out at Q4. We don't have a crystal ball, but I think you might see again, something maybe more akin to Q3 than to the first half as we kind of balance things out.

But I wouldn't really call out a adverse trend when you think about 2013. I think that kind of number of 800 or a little over 800 is probably still a reasonable expectation.

Okay. And you mentioned sort of CRE there.

Just in terms of the capital base, is there now some CRE slotting impact in the RWAs?

Yes, absolutely. So on a year-to-date basis, we've actually had, through CRE and through other model changes that we've agreed with the FSA, we've had about 70 basis points of headwind in the overall group capital ratio.

And so that's something that will affect U.K. Corporate.

It's also affecting Non-Core to some extent, but Non-Core has a lot going on. So there's a lot of asset reductions and trying to offset that.

But the places where you'll see the impacts from some of these changes in local regulation even pre-BIII, U.K. Corporate would be one, Non-Core would be another.

And then some of the international bank with some of the changes to the large corporate model would also have a bit of headwind there as well.

And I think you previously estimated the CRE slotting impact was about GBP 20 billion, so I was just wondering if that was still your expectation, and how much of that is in the current numbers?

Yes, probably year-to-date, we've had about half of that in the numbers.

I have 2 questions. The first one is on the Irish commercial real estate book.

I've just seen that it's probably the first time you've dropped coverage on that from 56% to 55%. So given what we are seeing in Dublin commercial real estate, do you see the turnaround in that portfolio right now and further write backs in 2013?

That's number 1. And number 2 is more to Stephen.

This is around Citizens. There's been lots of noise around Citizens being asked to be sold and for capital reasons.

It'd be great if you can highlight the strategy going forward.

Bruce, do you want to do the first one?

Sure. On the first one, I think the overall coverage on commercial real estate, I wouldn't call out anything from that reduction from the 56% to 55%.

There's continued increasing provision coverage on the Non-Core development lending book, which is probably where we have our greatest risk. So at this point, on the commercial side, I wouldn't say there's anything that says we're seeing a massive deterioration or any kind of early signs of green shoots that would lead to recovery.

So I think we pretty much have the coverage where we want it. If you -- if I extend that over to the resi side, there's been maybe a few green shoots just in terms of asset values have started to stabilize.

So for the last 3 months there, you've had either flat or slight rises in housing. But again, I would only call them green shoots.

We're not changing our view at this point. We're keeping a cautious view.

But the things that have driven the Core impairments have been falling asset values and rising delinquencies. If we can start to see asset values solidify here, that would start to presage some falling impairment numbers, maybe in 2013.

Obviously on the delinquencies, that's going to depend on whether the economy gets a little more vigor. It's grown at about 0.5% GDP growth in Ireland this year.

Analysts are projecting 1.5% next year. And unemployment, which has been stubbornly high at 14.5% might start to come down a bit next year.

But again, I think people have called the turn before, and we'll just have to see how it plays out. So generally, I think we're cautious still.

Thanks, Bruce. On your second question, Citizens.

I mean I think the short answer is nothing has changed in the way we think about this. But to reiterate that, the reason that Citizens has always been a part of, if you like, our base case, plan a, for the ongoing Core of RBS is no different than it was a few years ago.

And that is to say that we think it's a good business, that it can be variable to our shareholders, that it will pass both customer safety and soundness and shareholder value test. And that's happened that not having -- not being a second-best Lloyds, i.e.

every single egg in one economy, but where we don't have the dominant market shares that Lloyds have that it's to our shareholders' interest for us to have a slightly better business balance. But the U.S.

economy, as we know, tends to grow faster than U.K. It's more fragmented than the banking industry, so you have better growth opportunities organically and in other ways.

And it gives us a business balance with 80% Retail & Commercial, only 20% investment banking that a number of our larger competitors would much prefer than the balance they've got. Now I think that our base case is that over the long haul, RBS shareholders will be better off from a strategic and balanced standpoint of RBS with this as part of the base case.

However, all of that said, we're pragmatists, and we quite completely appreciate in the course of our journey, events may change, and we may have to look at things through different pressures in different ways. And so we test every bit of our base case every year, at least, against alternatives.

Now, and clearly in common with a number of other assets we have, we just did one, which was DLG and we sold one. And I think we -- our credentials in selling things are pretty good.

And we could sell Citizens. I think selling Citizens today would be a little bit like selling RBS shares for the government.

We'd be selling an asset before it maximizes value and before the market is properly valuing financial assets. And so it wouldn't help shareholder value whether it would give us, obviously a nominally higher capital ratio.

I don't think there would be any prospect of that finding its way to shareholders, so it'd in the bank and make nothing. But these are the things that we consider.

Clearly, our plan a is to help Citizens develop into the really good bank that we want it to be and to improve its performance. As you know, its performance is way up on last year, which was up on the year before and so on and so forth, but there's still important things to go.

And the U.S. economy is sluggish as the U.K.

one is even though it's been growing faster. So we remain open minded, but with clarity of thinking both as to the base case and why it's the base case in strategic terms and is the need to compare the base case to alternatives now and in the future.

And if I may just add, this whole debate came out of capital. So where do you stand in terms of your interaction with the regulator on capital, because there's been lots of pressure on you being asked to sold Citizen for mostly capital reasons, nonstrategic?

Well, I'm not sure I know the answer to that question. I mean clearly, the U.K.

authorities, you can see from the FPC announcements, remain at the hawkish end of global authorities on bank regulation and capital. And so you can see there's public pressures from U.K.

authorities there, actually sort of open parens, it was kind of interesting yesterday with the new global SIFI list published, which shows RBS, as a result of our restructuring and strengthening measures and shrinkage pressures, moving from the highest level of global SIFI down into the middle category, such that if we were held by international standards as opposed to U.K. standards, we could be 1% of capital ratio below the biggest banks and 0.5% of capital ratio below, let's say, Barclays.

But obviously, the U.K. authorities are applying different rules.

So I think we and all banks are under pressure from regulators to be conservative in capital. Obviously, our capital journey has been outstanding so far at every single moment in the last 4 years.

Despite headwinds of different sorts, we've beaten where the regulatory fears where. I'm not complacent about that because obviously, things can go wrong in the outside world that will reverse that.

We want our capital ratios to climb still further. We want to be on the good track to Basel III.

We think we can be, but I can't hide from you that there are regulatory pressures on us on and all banks to be more conservative still faster. And these are the discussions that we have all the time.

Can I just follow up on the capital? I mean we get different shades of messages on how comfortable the regulators are with the capital position from different banks.

I'm just wondering why this difference exists? Because your -- I mean, Lloyds, for instance, is highlighting that the regulator's comfortable with their capital position.

And as soon as CRD IV is fixed, we can talk about the dividends, whereas you are taking bit more cautionary tone. I'm just wondering why this difference.

Well, obviously, I don't know if the regulators are giving Lloyds an easier ride or not, and if so, why they would be. You must ask Lloyds about that, I can't answer for Lloyds.

But what I know is that so far in the last 4 years, I think we have operated cooperatively with the regulator. They've seen that our actions have been leading to a much stronger RBS.

They want that, we want that. And I very much hope that, that process of cooperation in search of a common goal continues.

Clearly, of their nature, the regulators are more concerned about capital and don't have any responsibility to balance it with shareholder value and so on. So we have to balance things that some of the people who comment on us from different angles don't have to balance.

But that's part of normal life. I never know whether things are just -- the word someone chooses on a day and what mood they're in or whether there's anything underlying.

It's very hard for us to make that comparison. But what I do know is that RBS' path has been consistently positive in terms of becoming safer and sounder at a pace faster than other people have expected us to do.

By the way, but it's just -- Bruce mentioned it, but I think we should also refer to it. The market appreciation of how much safer and sounder we are is clearly greater than either rating agencies or some other commentators.

Our spread's coming in from 450 to 100 over the last year is not just a stunning narrowing in absolute terms and a real change in the creditworthiness perceived by investors in us in the wholesale markets, but it's also a big narrowing relative to other banks. So we're far from complacent.

We want to keep going on safety and soundness, but I do feel that the dynamics of RBS have been recovering in an extremely satisfactory way, whether you're looking at us as a regulator or from any other angle.

Yes, and I think just to add to that, we're at the time of the year where we work on our budgets for next year, and we have a capital plan associated with that. We feel good about our capital position and our plan to get through 2013.

And we'll be sharing that with the regulator, and hopefully, we align our views around a common plan there.

But there's a reason bank share prices are low, and it's because investors, generally, still don't have enough visibility, both on growth through economies growing and the outcome of regulatory pressures. And those 2 things, those 2 headwinds on bank share prices and the solidity of their returns are not going to disappear overnight.

Fair enough. My next question is on mortgages.

If I look at FSA industry data then mortgages that are yielding more than 4.5%, used to be 46% of the total in 2009. That's steadily come down to 24% currently.

And that's kind of bringing down bank book mortgage rates for the industry. I'm just wondering if this is a similar trend that you see in your mortgage book.

Is the differential between the mortgages that roll off versus the new mortgages that you take on, is that negative?

It depends on which books. The mortgages, the bank book mortgages that are on FCR, we haven't changed our rate on that for some time.

The bank book mortgages that were fixed rate deal swapped, obviously as they roll off, then by and large, the margins increase from that roll-off when they're replaced rather than decrease from the bank book. So the retail bank, overall, has had some margin squeeze coming from the deposit side, but I think the asset margins are broadly stable.

Yes. And finally, just on the similar topic.

We've seen, as you highlighted, funding pressures have eased considerably. I just wanted to take your thoughts on where you think deposit costs go on the back of that?

There's already been an improvement there. And more importantly, what do you think lending rates will do on the back of that?

Can that be steady, or do you think lending rates will have to go lower if deposit rates go lower, generally?

No, I think, look, for the last couple of years, the U.K. banks were focused on improving their loans-to-deposit ratio.

And so there was quite a bit of heated competition to secure deposits and to improve those metrics. Now what you're seeing is that across the whole U.K.

bank universe, a lot of progress has been made. And the marginal value of a new deposit isn't as great as it was when we were going through that recovery phase.

There's not the kind of loan demand that you'd like to see. So you're not really fueling significant asset growth by taking in those deposits.

So I do think, as you've seen in the U.S., been a wash in deposits and liquidity, there's been an effort to start to reprice interest-bearing deposits a bit. I think you potentially could start to see that happen through 2013.

The flip side to that is on the noninterest-bearing deposits in the low-rate environment, as the hedges continue to tractor through into this lower-rate environment, you've still had a headwind there. And so there's that dynamic where I think you can make some of that up on not being as aggressive in the interest-bearing deposit pricing side.

I'm not sure in the end if lending rates would have to come down and be linked to that. So I'm not sure the moves will be so noticeable that you'd have to drag along your lending rates at the same time.

Can I have 2 questions, please? Very quick ones.

Firstly, could you talk to us about your fully loaded Basel III ratio as it was at Q3? And secondly, on the NIM in U.K.

Retail, it looks like it's gone back to 353 from 357 sequentially. Wondering if you could give us some comments there?

Do you see stabilization going forward? Do you think the pressure continues to stay high on that?

Okay. On B III, we didn't put anything out publicly on that ratio at this point, but I think we did, in response to a question on the half year call, say that we were in the mid-7s, and I think that would be the same situation today.

We also said that our target would be to arrive at a 9% to 9.5% target range with a bias to the low end of that range at December of 2013. And again, that continues to be our view today.

On the NIM in U.K. Retail, again, we have those different dynamics of compression on noninterest-bearing deposits.

And the possibility of backing off on interest-bearing deposits, I think, in general, that could wash. We are changing the business mix to have more mortgages on -- as a percentage of our total assets in U.K.

Retail, which again mortgages have lower yield than some of the personal unsecured credit that's been another factor. So I think we are maybe plateauing to slightly negative in U.K.

Retail. But I do think there's other good dynamics going on in that business on the cost side, on the impairment side, that I think the profitability is -- will stay robust and potentially continue to improve.

Just back on the capital ratio, and again for the sake of clarity, we clearly are aiming to get to above 10% fully loaded Basel. We think that we can transition well ahead of the full Basel transition period, and obviously, all efforts to date have done that.

And our goal is to be 10% or better or around 10% at each stage of that process, as Basel comes in, that will improve our capital ratio. So hopefully, on transitional Basel, whenever that comes in, we'll have got to 10% and so on as we go through.

And you can see the underlying capital ratios have been improving very nicely in the last year despite regulatory headwinds. So we're very clear, we're on journey.

We're progressing very well on that journey. We know the dimensions of the endpoint and believe that we can get there.

Obviously, we're helped in that process by having a much lower investment bank weighting than some of our competitors through the next phase, and the prospect of no insurance company weighting, which is different than some other competitors in the next phase. So we have those things helping us in our transition, but we're clear that transition is important, and that we will need to make it.

Back on the subject of capital. I remember that I think in 2009, you issued some contingent capital to HM Treasury.

I think it was about GBP 8 billion and noting the FSA seems quite keen on contingent capital, and you want to normalize RBS' relations. Have you considered the prospect of issuing contingent capital to the private sector and canceling out the contingent capital with HM Treasury?

Well, I guess our fundamental view is that the contingent capital arrangements in the public domain are still evolving. And given the fact that we have the current arrangement in place, we don't need to be on the bleeding edge of that.

I personally view LT2 as a preferable security to augment the total capital base if we were contemplating that. Clearly, it's much cheaper.

So it's generally 250 basis points lower cost than a contingent capital instrument. And banks, in times of mild stress, have been able to go into the market and execute liability management exercises around that and turn that into real Core Tier 1 capital.

And you've never really seen a contingent capital instrument. And no one's hit a trigger and actually delivered any Core Tier 1 capital benefit from that.

So I think because of the cost of contingent capital and because of those dynamics around the trigger, I think LT2 made the preferable way to go, to augment a total capital position. But again, we'll watch how things evolve, and if the whole market moves in that direction, then certainly, we wouldn't rule it out.

I've got 2 questions. The first is just on the branch network sale and in terms of the deadline on the regulatory requirement.

I'm just wondering if you fear that there might be any penalties if you missed the regulatory deadline? That's the first question.

And then the second question is just on Slide 14. On the REIL trends, I noticed that the REILs have increased in Q3 versus Q2, following a downward trend.

I'm just wondering if that's an inflection point, or are you expecting then to resume a downward trend going forwards?

Yes, sure. So on the first question, look, we were disappointed at Santander's decision, but certainly, we have worked very, very hard to comply with the divestiture timeline.

And in everything else that was part of the agreement with the EC, we've met or exceeded expectations. So certainly, the divestiture around WorldPay, around the Sempra Commodities joint venture, in terms of DLG and being on track to deliver that, we've got all ticks there.

In terms of reducing the balance sheet size, we're well below, I think, the year 5 target was GBP 1 billion -- GBP 1.060 trillion in terms of assets. We currently just printed in the low-900s.

So I think all that would be taken into account if we have to extend the timeline. We've started a new process around that.

We are engaged in an active sales process now. We have interest in the business.

It's a small business, but it's quite attractive, so it delivers a high-teens ROE. It's self-funded.

It's got a 5% SME market share. So I mean it's not surprising that it would be of interest to potential buyers.

I think we also have to look again, given our success at the floatation of DLG, that might be a route we could go as well to make sure that we keep the buyer universe honest on the pricing. So once we figure out which route we're going, if there's a need to extend the timeline, we would bring that to the EC.

And I think they'd take the broader considerations into account, and hopefully, there wouldn't be anything but a clean approval on that. With respect to the REILs, I think it was really just a blip here in terms of the bump up in Q3.

If you look at the trend for the last 5 quarters, we're down GBP 2.5 billion, and we really think that, that's the broader trend and the bigger picture. There were a few pockets, we had some uplifts in a couple of areas in Q3.

But I think we will be continuing to move down from here.

I just had a couple of questions for you. The first one was on the net interest margin.

I saw core net interest margin was down about 5% in the quarter, but you're guiding flat group NIM for second half. I was just trying to work out what the prospects are for next year, given that you have had a good reduction there in the short-term wholesale funding, some of the senior unsecured tenders.

And also, you've been able to bring down liquid-asset buffer after the rule changes. The second one was on the Funding for Lending Scheme and just how you've been able to take that opportunity and what impact do you think that's going to have sort of on the business?

Okay. Well, on the first one, again, it's a little early to give guidance on the NIM.

Certainly at the annual results meeting, we'll have completed our budget, and we'll give you, I think, some tram lines on that. But our gut feel is that I think we'll continue to have that slightly up bias that we referenced at the half year.

So I think, again, it's looking stable at this point, second half versus first half. But I think the bias is to move ahead based on some of the features that you mentioned.

In terms of FLS, Stephen, I don't know if you want to comment on that.

Well, I think that at the moment, FLS is unlikely to result in an explosion of net lending for the industry until the economy is growing more sharply. And so I think total loan outstandings probably won't change a lot.

Obviously, what we are doing, I don't know about other banks, but what we are doing is passing on the interest rate benefit of FLS to our customers, so the customers are getting a benefit. We will not get a P&L benefit out of it.

If we get some volume benefit, that'll be terrific but at the moment, I'm cautious on that.

Two or three pretty mundane ones. Actually, it was just testament to really good work on the restructuring side by yourselves.

The first was International Banking's risk-weighted assets to customer loans is up from 70% to over 100% now, in a little over a year. And I just wanted to explore sort of with 40% of revenues being in cash management, I'm just wondering why the capital efficiency of that division isn't sort of better than, perhaps, I would have expected it to be?

That'd be the first one. Second, the balance of the loan book and U.K.

Retail now nearly 90% mortgages and cards and personal loans continue to ebb as a share of the total. I just wondered whether that was sort of driven by strategy, customer demand or conduct risk and the like?

And then lastly, and this isn't material at a group level, but it's certainly interesting. In U.S.

Retail & Commercial, we're seeing net write backs in resi, corporate commercial, especially for the last 2 or 3 quarters. And I just wondered whether that was something that might be sustained for the near term?

And how you think about sort of overall bad debt charges for that division next year?

Yes, sure. So first off on International Banking, I think it's really just a function of some of the model changes that we've made under the auspices of the FSA.

So we flagged that not only do we have to deal with the Basel inflation of RWAs, we've had other things locally, CRE slotting, being most prominent, but also in some of our other models like large corporate credit where the dial is turning to the right, i.e. more conservative.

So the places that has most impact on the capital base of U.K. Corporate, certainly CRE slotting is a big impact there.

In International Bank, it's on the kind of large Corporate credit model and then Non-Core would get an impact from both of those changes. So that's really what's behind that one.

In U.K. Retail, in terms of the shift towards mortgages, I think we've just had a tighter risk appetite for the business as a policy change that we've made.

So we had a, kind of below, punching below our weight mortgage market share relative to our share of current accounts. And we've tried to organize ourselves to gain share there.

So our stock was about 8% in mortgages. We've been kind of delivering around an 11% share of flow.

Our current account share is 20%, so there's still quite a differential. And I think what we found through the last crisis was, if you look over a long period of time, some of that personal unsecured really was not delivering a proper through-the-cycle return, so we've tightened the risk appetite in terms of where we want to play on personal unsecured.

We don't want to go too far. We do think there's valid customer needs, and we can service a segment of our population in a good -- with a good risk-adjusted return coming from that.

And so I don't think you'll see this trend continue. I think we're probably about where we want to be.

And then lastly on the U.S., we've certainly been benefiting from very good credit conditions on the ground. And I think that should continue, whether we can actually see net recoveries, I would question that.

But I still think that we can probably run a very favorable level of impairments to loans and advances for some time forward.

So just to follow-up on the large Corporate credit model changes and so on. Is there more of that to come or is that pretty much all done?

Yes, I mean, that's going to continue to flow into Q4 on -- and then I think that one's pretty much behind us. But we're probably slightly ahead of 50% of the way through that one.

On the CRE slotting, we're probably also about 50% of the way through that one. So again, we're just managing through.

Our capital plans, obviously, have a glide path for how these models are affecting us. They have the Basel uplifts and all the mitigation and the deleveraging that's happening in Non-Core.

And so we're just managing that composite picture, as Stephen said, to try to deliver above 10% Core Tier 1 at the end of this year and above 10% at the end of 2013.

Just a couple of questions from me. Firstly, I'm just wondering if I could get your comments on things the Bank of England have been saying recently on asset prices and the carrying value of those at U.K.

banks seems quite bizarre. But I was just wondering if you could give us your take from Royal Bank's perspective?

And Bruce, I saw on Bloomberg before on the press conference that you were talking about dividends in 2014. I don't remember you saying that before.

I was wondering if you'd just give me a bit more color on that.

We all know that Bruce is way too cheerful, so we'll [indiscernible]. On -- I mean I didn't closely look at the Bank of England comments, but I think there were sort of 3 buckets of assertion that some people are making.

I think the first is that bank share prices are low, because somehow accounting hasn't marked the books properly. Now you guys are professionals in this, so you will know what you think.

As far as what I can observe, bank share prices are low because banks aren't making enough profit. Nothing to do with their book value, it's to do with what kind of profit they're making and how quickly you guys think that, that situation will be correct in the light of economic and regulatory pressures.

So it seems to me the solution for bank share prices can only be growth in profit, and it's not an accounting issue. I think the second concern is, is somehow the back book on lending, holding banks back from new lending to the economy.

Obviously, I can't speak for other banks, but I can be absolutely unambiguous that the answer to that at RBS is no. We have more funding and more capital than we need to satisfy commercial loan demand.

And we are not constrained by our back book in lending to the real economy. And so I think those are, if you like, 2 of the key arguments I've made.

I think there's a third argument, which is very important from a social standpoint, and that is there are some who believe -- who seem to believe that forgiveness or working -- put it another way, working with customers to avoid making them bankrupt is a bad thing. I think it's absolutely the other way around.

I think if we went around merrily putting people into bankruptcy, throwing people out of jobs, it would have a negative social and economic effect. And also mean that we get less loans back at the end of it financially ourselves, so we go to enormous efforts to work with borrowers not to put them into bankruptcy and to help them restructure their business and help them emerge as positive, healthy businesses, both to maximize our recoveries and to help the economy.

So and by the way, I think that's our social requirement, as well as the right business thing to do.

Yes, let me step in and talk about my views on the future. So I think what we've been very clear about is that this is a big fix-it job of RBS, and it's going to take us the full 5 years that we set out in our recovery plan, and we still have 15 months to go.

So while we've made very good progress, and we're pleased with the progress made, we still have some hard yards here to get to the end of 2013. Having said that, we do think we will deliver the key elements of our recovery plan, and we'll have the bank in good shape as we look out into 2014.

At that point, you would expect that we would have the kind of drags from the cleanup reduce fairly significantly, so there'd be no need to incur the big Non-Core losses from disposals. Most of the restructuring costs would be behind us.

And so our Core attributable profit, which has held up well through a choppy environment, we've been delivering GBP 6 billion of stable Core profit here, will start to radiate through, which should give us some flexibility on capital management. Obviously, we don't know what the regulator will require in terms of top-ups to the capital position that we think is adequate, but my hunch is that we should have enough free cash flow in that period to start to put a dividend in place.

I think just from creating the fertile ground, so that the government has an ability to consider selling stock, it's really their choice, but putting a dividend in place increases the appeal of the stock to broader constituency. So that's what we're working towards, and certainly, what we'd like to try to achieve.

But obviously, we're very conscious that you pay dividends out of earnings. You don't pay dividends out of capital.

And so we need ongoing earnings, and we need them to be optical [ph], we need the deductions against them to be down, which is why we've spent a lot of time trying to accomplish that.

Yes. Can I just come back, Stephen, on your point about the new lending.

I think consumer credit's been slowly picking up, and last month there was a notable increase in consumer credit at an industry level. I think you referred earlier about your appetite, and you've been changing the mix.

Your bad debts and retail from consumer are now extremely low, as probably as low as they've been, probably for a decade actually. So I was wondering if you could talk about your risk appetite/consumer credit and whether you're seeing any change in utilization?

We would like to increase our lending, both in Retail and in Commercial. We're resolved to do it, we'd like to do it.

And we'll be -- we'll serve our customers better and make more money if that's what happens. However, we can't force people to borrow if they don't want it, and we shouldn't be thrusting money at people who may not pay us back.

And so the macro lessons of the past are that lending growth does not front-run economic recovery; economic recovery front-runs lending growth. And so unless somehow lessons from the past don't repeat themselves at a macro level, it seems likely that both individuals and businesses will want to gather confidence from economic growth resuming before they stick their necks out in financial terms by borrowing more.

So all we can do is stand ready and try and offer the money responsibly. And then obviously, it's up to our customers whether they want to take it down and whether their confidence levels in their own futures allow that.

Actually, Stephen, my question, I mean it does sort of relate back to just the last point you made about economic recovery coming before lending growth. Because just looking at the funding for lending scheme and on paper, if there was good loan demand out there to be done, I think the FLS scheme would make it reasonably attractive for banks, such as yourselves, to actually go out there and meet that demand.

And my sort of question really was can the FLS, by lowering funding costs which you then pass on to the end customers, actually create any loan demand? It sounds as if you don't think that's the case from your last answer.

But just wanted to sort of check on that. And when I look at your sort of GBP 215 billion of qualifying loans under the scheme, are you saying that sort of by the end of next year, you'd expect that sort of number to be broadly similar to what it was at the end of June?

Well, as I said, the FLS, as I said earlier on, does a few different things. As it relates to, if you like encouraging loan demand as opposed to loan supply, if borrowing is price sensitive at low interest rates, then it might.

Obviously, there is some room to doubt as to how price sensitive. In other words, if you're a business and you have a target return on new project of, let's say, 10%, 15%, 20%, does your interest rate moving from 4% to 3% or 5% to 4% or whatever make you build a new factory?

There's room for doubt about that. But if there is price elasticity of loans, then FLS will encourage it.

I suspect there may be a bit more in the mortgage market than in business where people are a bit more sensitive to outgoings as a percent of their salary. But obviously, FLS is partly an experiment in the price elasticity of loans at low interest rates.

The second is if there's a confidence effect, which is sort of non-direct, but nevertheless, helps along with other measures in the economy, and they may work there. What FLS doesn't do is turn a non-creditworthy borrower into a creditworthy borrower.

And so obviously, if the shortage of lending is people who are not creditworthy, it won't change that. So those are, if you like, observation with FLS.

Now FLS is an imperfect measurement because Non-Core is included and asset finance is excluded. And so we, and no doubt, Lloyds, at least, will have some strange-looking headline numbers under FLS, which is why we give, I think, the best level of disclosure so far about FLS trends and other trends in our IMS today, which you can read for yourselves.

As to whether taking all that together, lending goes up in the next year or not, your guess is as good as mine. We'd love it to do.

We have the money to support it, but it needs some help from the economy. And I think, and as I say, I think the past pattern would suggest that economic growth needs to be extent for a while before loan growth follows.

But obviously, we'll see, and we're certainly ready to encourage support and applaud if we can grow our business on the back of our customers growing theirs.

Okay. And just on that point, I mean do you think it will be a sensible policy move to tweak the FLS, so that it kind of adjusted for Non-Core type assets, which clearly the regulators are happy to see you dispose of for transparency reasons and focus it on to the Core business?

Because that's really the aim, I guess, of the scheme or was that just too complicated in...

Well, we certainly pointed out to the Bank of England that FLS discriminates against risk management at Lloyds and RBS, because it incentivizes not to run down Non-Core. As it happens, we are going to run down Non-Core anyway.

That aside, that sort of carping at the margins, I think FLS is a good experiment for the economy. We were the first, loudest and biggest supporters in terms of actually putting actions into place for our customers, and whether or not it benefits us, we want to be seen and to actually support our customers in the economy.

If I could be cheeky, I'd like to ask 3 actually, 2 on the financials and 1 on strategy. With regard to 2 financial questions, the first one is on the central items.

There's a large profit on bond disposals in there of GBP 225 million. I'm just interested to know your thoughts on whether that is seen as a one-off item or whether you think there's further liquidity repositioning there in the future?

Second is on PPI. Your redress increased from plus GBP 200 million in the second quarter to plus GBP 300 million in the third.

So interested to know if you could share with us the experience in October to see if that has slowed at all? And then finally, on strategy, thank you for the comments on Citizens.

But could you also comment on your other remarks made by your largest shareholder about the possible consideration of scaling back the Investment Bank?

Yes, sure. Maybe I'll take the first 2 and then, Stephen, you can comment on the third.

But yes, in terms of the bond gains, we have been clipping a moderate level of gains throughout the year. But we stepped that up in Q3, partly in response to seeing a clear ability to lower the overall amount of liquidity that we had to hold.

So we brought liquidity buffer down by GBP 9 billion in the quarter, and some of that was released from the bond portfolio that we were holding, which was in very, very safe securities, largely gilts, treasuries and bonds. And as you know, those have been safe haven assets, and certainly, we're bid up, and so we were able to sell some of that.

We were largely replenished, by the way, in the quarter as other movements in the portfolio were positive. And so we still have a fairly sizable number of unrealized gains available to harvest down the road if we choose to do that.

But again, I think I would look at the number as being probably higher than you would see on a going-forward basis. I think Richard and I tried to kind of work out what the net impact is on the quarter from that.

And I think if you look at some of the reserves that we took net of the gains, there might be GBP 200 million to GBP 225 million of above run rate benefit in central items before the quarter. But again, we'll continue to have a certain level of gains each quarter for the foreseeable future.

On PPI, again, we have made our best estimate as to where we think response rates are going. That's been challenging, I think, for the whole industry that response rates have stayed up higher than we anticipated.

We would have expected to see those flatten out. I think in October, so far, I don't have the full data, but anecdotally, I think they're tracking about to where we expected.

We've just had to go out with a positive outreach to our customers and sending a letter notifying them that they should contact us, because they might be in a position to claim. And I think the response rate on those letters are about where we thought they'd be.

So all of the big banks really stepped on the accruals this quarter, hoping to hopefully, nail it here, given past experience. So I can't say for sure that, that'll be the case, but we'll just have to wait and see.

Third one, Stephen on IB?

Yes, I guess here's the way we think about it. From a strategic standpoint, as you know, one of the fundamental observations of our strategic plan was that the banking industry itself had got over-expanded and too risky and the area within it that had got the most over-expanded and the most too risky was investment banking activity at RBS and generally.

And so a major strategic thrust we have is to recalibrate the balance of Retail & Commercial and Investment Banking within RBS and the scale of the scope of the investment banking activities with RBS. So that's 1 major strategic thrust of thinking, which hasn't changed.

On the other side, we have been equally clear that the world needs market. The world needs international trade.

The world needs more than just checkbooks from banks. And there will be other points in the cycle when world economic growth depends on those more international aspects of financial markets.

And certainly, any bank with aspirations to seriously serve companies to less [ph] insurance companies pension funds and so on. And obviously, one of RBS's distinctive strengths is our corporate business, must be present in a meaningful way in markets in order to provide those services and to participate properly in financial markets.

So we know that we must be there to reflect the future of financial services and our customer base in particular strengths. We know we must be there in much smaller and more narrow way than we were in the past.

And those are the 2 strategic threads, which moves us then from principle to pragmatism in terms of how to give expression to that. So we have cut the size of our investment banking activities to 1/3 of where they were, pre-crisis.

I think no other bank in the world has managed that. Roughly, we think we will -- we're aspiring to sort of an 80-20, 80% Retail & Commercial, 20% Investment Banking.

I think even post implementation of their dramatic actions announced in the last week, I don't think UBS gets to 20% in its Investment Bank. So I think if we stopped at 20%, we'd still be at the low end of global banks in market participation.

Do I feel dug in about 20% versus 23%, or 15% or any number? No, I don't.

That's an issue of pragmatism. We announced in January exit from equities and advisory, which was our equivalent of UBS exiting from fixed income in a sense that it was our big weak suit.

We've got, probably, another 1.5 years of shrinkage to implement what we announced this -- early this January. And whether we go for -- go further or not and to what extent, I view it as just a pragmatic response.

I think it's very -- it's not obviously healthy for the employees, but it's very healthy for the industry that at long last, people who manage investment banks are taking capacity out in a very serious way. That's what the industry needed.

I think it gives hope that it can provide a sensible part of the business makeup of financial services going forward. And so in a sense that gives support to, broadly, to our strategy, both of shrinkage and of believing that market activities have a place in a balanced portfolio, especially if you want to service corporates.

And I would just add that, so far, year-to-date, we've executed that revised strategy quite well. So we're on target in terms of the business exits, the balance sheet shrinkage, the headcount reductions in the sustaining businesses.

And our year-to-date ROE end markets is 12%.

But we do -- we have some more shrinkage to do to for carrying out what's announced. Whether there is more shrinkage on top of that, I think depends on the outlook, how we cope with it and making sure that we retain an RBS, which is characterized by dominant Retail & Commercial solidity, the Markets businesses that support our franchise and are attractive in their own right in terms of ability to compete, and that's the pragmatic balance beneath the strategy.

That's very clear.

Good. I think we are coming to an end.

Obviously, you know where to find us if any of you have follow-up questions. Thank you very much for listening.

And as I said at the beginning, it's only 1 quarter, but I think the patterns with RBS are reasonably established. We are making excellent restructuring progress.

That should give confidence we can deliver a clean-ish bank by 2014. There's hard work to do in the meantime, of course.

The shift of the hard work is moving probably more to reputational issues from safety and soundness issues. But nevertheless, they're equally important in wrenching and dealing with them.

Our ongoing businesses, I think, are proving their value, but they're also mimicking their customers. We're running hard to stand still in our Core businesses.

And until the economy changes, we'll -- that's what we'll be doing. And so clearly, that has implications for the path of share prices.

That's it. We're trudging on, cognizant of the challenges and confident by the progress we've made.

Thank you for listening.