RNS Number:9787H
Abbey National PLC
26 February 2003
PART 1
2002 Full Year
Financial Results
CHIEF EXECUTIVE'S REVIEW
Overview
Abbey National's reported results for 2002 reflect resilient Personal Financial
Services (PFS) businesses overshadowed by large write-offs and charges relating
to goodwill, credit exposures in Wholesale Banking and Life Assurance embedded
value. These charges reflect the harsh impact on Abbey National of equity and
credit market declines in recent years, impairment of certain assets, and
management action taken to reduce risk in the business. Abbey National was not
well positioned for these market conditions. The resulting loss before tax for
the Abbey National Group of #984 million is extremely unsatisfactory to all our
stakeholders and highlights the real challenges that the business is facing up
to. We are acting fast and decisively to address these challenges.
Following an intensive strategic review initiated in November, the ongoing
businesses will be focused solely on providing the full range of personal
financial services in the UK through direct and intermediary channels. All
businesses outside this remit (other than treasury activities supporting PFS)
are to be managed for value and exit in the Portfolio Business Unit (PBU). These
are detailed below.
In taking these and other actions, we will be removing the majority of the risk
inherent in current operations outside PFS whilst substantially reducing risk in
the ongoing business as well. Abbey National remains well capitalised, offering
stability and security to our 16 million customers in the UK, who will
increasingly be our focus in the future. This is a radical shift in strategy. It
will allow us to channel our energies into our core markets where we have
demonstrable strengths and where we have the greatest opportunity to succeed and
distinguish ourselves. In all we do, we are governed by the goals of rebuilding
and maximising value for our shareholders, and working with all our stakeholders
to deliver enhanced earnings quality.
Financial and Business Highlights
Included in the loss before tax of #984 million (equating to a loss per share of
87.4 pence) are a number of material charges and accounting policy changes,
including:
* embedded value re-basing and other related adjustments, of #632 million
pre-tax in 2002, with total prior year restatements of #480 million;
* goodwill impairments of #1,138 million, (which have not affected
regulatory capital ratios); and
* provisioning, impairments and losses on disposals of credit impaired
assets in the Wholesale Bank totalling #902 million.
The core ongoing personal financial services businesses remain sound and
generated 'trading' profit before tax (defined in Section 1.1) of #1,219 million
and earnings per share of 50.6 pence in 2002. PFS earnings in 2003 will be
adversely affected by a lower expected return on embedded value (prior to any
market movement in 2003) following its re-basing to year-end market values, the
probability of some additional spread decline in the Retail Bank and additional
pension costs as a result of stock market declines.
In terms of new business flows, the PFS business ended the year with reasonable
momentum, with highlights including:
* a 10.6% share of mortgage net lending in the second half, full year 8.9%,
and deposit inflows of #1.9 billion in the year;
* ISA and unit trust sales almost doubling;
* opening of almost half a million bank accounts and issuing over a quarter
of a million new credit cards;
* sales of general insurance up 20%; and
* sustained growth of protection sales, up 38% boosted by the progress of
Scottish Provident.
Abbey National has also made substantial strides in terms of risk management.
Actions taken include:
* a review of the Wholesale Bank with assistance from external market
specialists;
* a 23% reduction in total risk weighted assets in the Wholesale Bank, with
assets allocated to the portfolio business unit further reduced by
#7.7billion in the first seven weeks of 2003. Significant progress in
reducing concentration risk is also being made;
* major steps taken to reduce the risks in our life assurance business from
exposure to downward movements in equity markets, including hedging
programmes for product guarantee risks and substantial reductions in the
effective equity backing ratios of the "with-profits" funds (25% as at
market levels on 19 February 2003);
* ceasing the manufacture of with-profits bonds and subsequently reducing
bonus rates in the light of the third successive year of market falls;
* improved lending quality in the Retail Bank; and
* a range of activities to reduce other risks including addressing interest
rate risk and pension fund risks. This includes the closure of the defined
benefits pension scheme to new starters in 2002 and a reduction in the
scheme's equity exposures in early 2003.
Capital and Dividends
The Board is proposing a final dividend of 7.35 pence, to give a full year
dividend for 2002 of 25 pence per share (2001: 50 pence per share). The 25 pence
level represents an appropriate starting point based on the trading potential of
the ongoing PFS businesses, whilst having regard for the non-cash elements of
Life Assurance reported earnings. It is Abbey National's intention to rebalance
the dividend in 2003 in order to maintain its historical target split of
payments between the interim and final dividend of approximately one-third/two
thirds for future years.
For the future, we are targeting progressive dividend payouts. However, until
the re-structuring is further progressed and underlying business performance
improves, expected future dividend growth rates and payout ratios cannot be
finalised.
We believe that the steps we are taking are consistent with our desire to ensure
a strong capital position to protect against market shocks, and to maintain
stability and offer security to our customers. At the same time our actions are
materially reducing the risks in the business against which capital is held.
At all times we intend to be disciplined in managing for shareholder value. A
net capital release from the PBU is targeted. To the extent that surplus capital
arises from our actions, we favour shareholder distribution unless there is a
compelling strategic and economic case for reinvestment.
Strategy
Abbey National intends to maximise customer and shareholder value. We are
targeting excellence via an intense focus as the largest 'pure-play' provider of
personal financial services in the UK. While not yet in optimal shape, we
nevertheless start with a franchise of around 16 million customers, a top 5
position in many relevant markets, a distinctive, trusted and powerful brand,
and broad distribution network.
Our goal is to deliver a compelling proposition to UK consumers, who do not feel
that they have been well served by the UK banking industry. Through the highest
level of service and advice to all, we will deliver more value to customers - to
earn their trust and commitment. Work is underway to develop and implement this
model.
To support this, we have moved away from a vertical, silo-based organisational
approach, to a flatter, functional structure. This new structure is built around
the customer, and will deliver enhanced performance through a streamlining of
operations and enhanced focus on the economics of distribution and production. A
rigorous consolidation, rationalisation and sourcing review is underway.
We will operate as "one company" based on function, with a single leadership
team, whilst reducing risk and realising capital from non-core activities.
Cost Reduction
We are targeting annualised cost savings exceeding #200 million in our PFS
businesses, deliverable by the end of 2005. In addition, extensive cost savings
will be realised in the Portfolio Business Unit as disposals and rundowns are
executed.
In total, implementation costs are expected to lie in a similar ratio to those
of other cost programmes in the financial services sector in recent years. The
majority of the implementation spend is expected to be incurred in 2003 and
2004. It is the intention that some of the cost savings will be reinvested where
critical to the transformation of the business.
Portfolio Business Unit
As part of the strategic review, all businesses were challenged in terms of
their underlying potential, within the context of the company's need to focus on
its competitive strengths. As a result, all international operations (excluding
certain international funding and deposit taking activities) have been deemed
non-core, as has First National due to the lack of synergy and brand
compatibility. It is important to stress that whilst we will exit the
operations, some of these businesses remain profitable and open for 'business as
usual' - they simply do not fit with the new focus.
The asset-based portfolios (loans, leasing and bonds), representing a majority
of the Wholesale Bank's risk, have also been assigned to the PBU. This reflects
application of the same criteria and also the desire to align risk appetite with
business advantage and stakeholder needs going forward.
In 2003 and thereafter, a material fall in pre-provisions PBU income would be
expected dependent on the pace of wind down of the asset based portfolios. In
addition, dependent on market conditions and the speed and manner of the asset
run-off or disposal process selected, further substantial credit related losses
could arise as risk is reduced and capital released.
All of the PBU portfolios and businesses will be managed to maximise value to
our shareholders, targeting the greatest net capital release. Equally, it is
important that this release of capital and management resource is timely. As a
result, consideration is being given to a range of strategies which would enable
business and asset disposal, or run-off, of the majority of assets in the PBU
within the next three years.
The activities we are exiting are primarily those where we have limited
competitive advantage and therefore, if kept, would tend to produce weak returns
on capital and be especially vulnerable to disproportionate losses in bear
markets.
Progress to date
Abbey National has made considerable progress since the interim stage and
accelerated the transformation process since the strategic review commenced in
November.
The Wholesale Banking asset base and concentrations have been significantly
reduced, with excellent progress also made in the first few weeks of 2003. We
have stepped away from the manufacture of with-profits bonds, replacing them
with a version of Prudential's Prudence Bond in our branch network and a soon to
be launched smoothed investment product for the intermediary channels. We have
taken major steps in mitigating shareholder and customer exposure to further
downward movements in equity markets in relation to the stock of business
previously written. Important risk mitigation has also been accomplished in
pensions and interest-rate exposures.
In 2003, we have already contracted to sell the Consumer and Retail Lending
businesses of First National Bank (excluding Motor Finance and Litigation
Funding) for a premium to net assets before goodwill of #218 million, which will
dispose an estimated #3.9 billion of risk weighted assets on completion.
Since December, a transformation programme led by the Executive team and 50 top
managers has been executed and the new top-level structure, strategy and
implementation plan put in place. This has allowed planned cost savings to be
validated and is a key enabler to future business improvement.
As shown by this release, we have also significantly increased disclosure and
transparency in our reporting - a discipline we intend to maintain.
Key Performance Indicators (KPIs) and immediate goals
A key principle in the new organisation will be to increase accountability and
drive superior performance through greater internal and external transparency.
Over time, we will develop and disclose performance measures that are aligned to
the long-term improvement in company value, and will be used to measure
performance internally.
The high level KPIs are:
* revenue per customer;
* operating costs per customer;
* new customer metrics;
* customers retention metrics; and
* passive customer metrics.
These KPIs are aimed at sales efficiency, profitability and length of
relationships. Market share will be a measure of our success, not a driver of
value per se.
Our priorities for the next six months include :
* implementation of the new company structure, with all roles confirmed and
initial KPIs defined and communicated;
* delivering tangible improvements in terms of sales and service, supported
by the launch of new CRM software 'One on One' and a new advice model in
testing phase;
* 'on track' performance versus cost targets; and
* further substantial progress within the PBU.
Challenges ahead
"On behalf of the whole Board, I would like to express our regret at the results
and dividend cut that we have announced today.
However we have absolute conviction that we are pursuing the right strategy for
Abbey National; for our customers, our employees, and our shareholders. It will
be a long, hard process that we envisage spanning the next three years. We know
that our shareholders will want to see tangible progress along the way, and we
will be reporting regularly, the first opportunity being at the time of the
interim pre-close statement in June. When we have completed our three year
strategy we intend Abbey National to be esteemed by all its stakeholders for its
positive value attributes.
The strategy will focus all our resources on serving the personal financial
services needs of the customer - by delivering greater value to our customers,
we will earn more value for shareholders. Our focus, as a scale institution,
will make us unique and will enhance business performance and execution. The
events of 2002 have also acted to focus minds, and this is already driving an
increased sense of determination and delivery within the business. Our people
are integral to our success and they are responding positively.
We have aligned all our talent, investment and energies on a clear, single and
unifying goal under a suitable organisational structure. We are now wholly
focused on delivering. "
Luqman Arnold
1. GROUP SUMMARY
1.1: Basis of results presentation
2002 financial results have been impacted by a number of significant items and
accounting policy changes including re-basing of embedded value (EV), increased
Wholesale Banking provisioning and losses on asset disposals, and charges for
goodwill impairment. Prior years' numbers have been restated throughout the
document as appropriate.
In addition, other accounting policy changes include the expensing of stock
options, providing for deferred tax on a full provision basis (FRS 19), and the
reclassification of Reserve Capital Instruments (UITF Abstract 33). A summary of
all accounting restatements is included in Section 4, with a detailed
reconciliation included in Appendix 7.
The accounting policy changes are a result of the adoption of new accounting
standards, and in the case of embedded value and stock option expensing, as a
result of a review of industry or emerging accounting practice.
Table 1.2 has been prepared on a statutory consolidated basis. Table 1.3 and
much of the analysis that follows has been prepared on a "Trading Performance"
basis. This presentation excludes:
* the impact of the embedded value re-basing and other adjustments;
* losses on disposal of credit impaired assets;
* other asset disposals;
* the impact of goodwill charges; and
* expenses relating to cost programme implementation and a write-down of
shares held to hedge stock options.
In particular, for the Life businesses, embedded value results are included on a
smoothed basis, which includes investment earnings calculated using long-term
rates of return. The impact of the embedded value re-basing and other
adjustments is disclosed separately.
This approach is being adopted to enable the reader to discern the underlying
performance and trends in the business, with significant items disclosed
separately. In all instances, all differences from the statutory presentation
are identified and reconciled.
1.2: Summarised consolidated profit and loss account
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Net interest income 2,689 2,692 2,680
Non-interest income 876 1,400 1,512
___________ ___________ ___________
Total income 3,565 4,092 4,192
Other administrative expenses (1,889) (1,709) (1,685)
Depreciation of tangible fixed assets (103) (111) (122)
Goodwill impairment and amortisation (1,202) (36) (12)
Depreciation and impairment of operating lease assets (280) (256) (178)
Provisions for bad and doubtful debts (514) (263) (273)
Provisions for contingent liabilities and commitments (50) 9 (21)
Amounts written off fixed asset investments (511) (256) (32)
___________ ___________ ___________
(Loss) / profit on ordinary activities before tax (984) 1,470 1,869
___________ ___________ ___________
(Loss) / earnings per ordinary share (87.4)p 63.2p 89.2p
Dividends per ordinary share 25.0p 50.0p 45.5p
Tier 1 ratio 9.2% 8.4% 8.8%
Equity Tier 1 ratio 6.4% 6.3% 7.4%
___________ ___________ ___________
* Loss before tax of #984 million (2001: profit of #1,470 million) was
largely due to the impact of re-basing embedded value on income, increased
Wholesale Banking capital losses and provisions, and goodwill impairments.
This is reflected in the loss per share of (87.4) pence.
* Full year dividend of 25.0 pence, down 50% on 2001, and including a
proposed final dividend of 7.35 pence (2001: 33.2 pence).
* Tier 1 capital remained strong at 9.2% (2001: 8.4%), whilst the equity
Tier 1 ratio remained broadly flat at 6.4% compared with the restated 2001
level. The negative impact on equity Tier 1of the embedded value re-basing
and Wholesale Banking provisions, was offset by a reduction of risk weighted
assets of #5.8 billion, largely due to asset sales in the Wholesale Bank.
1.3: Consolidated trading profit and loss
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Gross trading income 4,257 4,420 4,229
Less: Depreciation of operating lease assets (242) (256) (178)
___________ ___________ ___________
Trading income 4,015 4,164 4,051
Adjust for:
- Embedded value re-basing and other adjustments (632) (443) (102)
- Wholesale Banking losses on asset disposals (104) (15) -
- Other asset disposals 44 130 65
- IEM impairment (1) (38) - -
___________ ___________ ___________
Total income 3,285 3,836 4,014
Trading expenses (1,911) (1,820) (1,807)
Adjust for:
- Cost programme implementation (44) - -
- Share write-downs (37) - -
- Goodwill charges (1,202) (36) (12)
___________ ___________ ___________
Total expenses (3,194) (1,856) (1,819)
Personal Financial Services provisions (315) (254) (292)
Wholesale Bank provisions (2) (760) (256) (34)
___________ ___________ ___________
(Loss) / profit before tax (984) 1,470 1,869
___________ ___________ ___________
Trading cost: income ratio (3) 47.6% 43.7% 44.6%
___________ ___________ ___________
(1) IEM impairment charge of #38 million reported on a statutory basis as
depreciation of operating lease assets. IEM is the Wholesale Bank's aircraft
leasing subsidiary.
(2) Includes #247 million (2001: # nil) reported on a statutory basis as
provisions for bad and doubtful debts.
(3) Trading cost: income ratio is calculated as trading expenses divided by
trading income as shown in the table above.
* Trading income of #4,015 million was down 4% (2001: #4,164 million). This
reflects a reduced contribution from Wholesale Banking arising from the
planned reduction in risk weighted assets, and increased interest expense
reported in Group Infrastructure partly offset by asset growth in Retail
Banking and a full year contribution from Scottish Provident.
* Total income was down 14% largely due to losses on credit impaired asset
disposals in the Wholesale Bank, and the embedded value re-basing in the
Group's life businesses. The latter was #632 million pre-tax and #480
million post-tax, with prior year restatements included in the table above.
Asset disposal profits of #44 million in 2002 relate to leasing companies
sold in the second half.
* Trading expenses were up 5% to #1,911 million (2001: 1,820 million),
largely driven by increased pension fund costs of #26 million and investment
spend in the Retail Bank.
* Total expenses increased significantly, largely due to goodwill
impairments relating to First National, Scottish Provident and Cater Allen
Offshore. These are non-cash items and do not affect the Group's core
regulatory equity ratios. In addition, expenses relating to the recently
announced cost programme were #44 million (largely redundancy costs), whilst
shares held to hedge stock based compensation programmes, were also written
down.
* The trading cost: income ratio was 47.6% (2001: 43.7%), the decline being
driven by the fall in Wholesale Banking income and the increase in trading
expenses.
* Total provisions outside of the Wholesale Bank, consisting of lending
provisions and provisions for contingent liabilities, of #315 million
increased by #61 million. This was driven by provisions for contingent
liabilities, relating to 2001 write backs of #25 million not repeated, and
additional 2002 provisions to cover potential claims. Retail lending
provisions (including First National) were broadly flat at #268 million
(2001: #263 million).
* Wholesale Bank provisions were #760 million (2001: #256 million). In
total, credit charges and asset impairments were #902 million (2001: #271
million), including #38 million related to aircraft asset impairments in IEM
reported for statutory purposes in depreciation of operating lease assets,
and #104 million (2001: #15 million) which was charged to the income line as
a result of losses on credit impaired asset disposals.
1.4: Analysis of PFS and PBU
Profit before tax
31 December 2002
# m
___________
Personal Financial Services (PFS)
Retail Bank 930
Abbey National Life 205
Retail Insurance 92
Scottish Mutual (excluding International Operations) 126
Scottish Provident (excluding International Operations) 48
Wealth Management (excluding First National and European Operations) 50
cahoot (25)
___________
1,426
Financial products 60
Short-term markets and asset and liability management 88
___________
Group Treasury 148
Group Infrastructure (355)
___________
PFS trading profit before tax 1,219
Adjust for:
- Embedded value re-basing and other adjustments (553)
- Goodwill charges (811)
- Share write-downs (37)
- Cost programme implementation (34)
___________
PFS loss before tax (216)
Portfolio Business Unit (PBU)
Wholesale Banking businesses (after credit charges and impairments) (455)
International Life businesses 5
European Banking 8
First National 110
___________
PBU trading loss before tax (332)
Adjust for:
- Embedded value re-basing and other adjustments (79)
- Goodwill charges (391)
- Other asset disposals 44
- Cost programme implementation (10)
___________
PBU loss before tax (768)
___________
Group loss before tax (984)
___________
The above table is only intended to give broad guidance as to the split of
business going forward and comparatives have not been provided above or in the
remainder of this section.
It is possible that additional businesses may still be allocated to the PBU, but
these will not be significant within the Group context.
Personal Financial Services
Trading profit before tax for the personal financial services businesses was
#1,219 million. The following analysis calculates pro forma trading earnings per
share for the retained PFS business.
Pro forma trading earnings per share 31 December 2002
# m
___________
PFS trading profit before tax (as defined on page 8) 1,219
Estimated tax expense (assuming 30%) (366)
Minority interest and preference shares (124)
___________
Profit attributable to shareholders 729
___________
Average number of shares in issue (m) 1,442
___________
Trading PFS earnings per share (pence) 50.6p
___________
As set out on page 8, PFS 'trading' profit before tax excludes the cost
programme expenses and ongoing goodwill amortisation.
Note that the 2003 results for these businesses may vary materially from 2002.
Amongst other factors and before the impact of the cost programme, embedded
value re-basing in 2002, and the resultant unwind of the discount rate on a
lower embedded value stock figure will impact 2003 PFS earnings. The impact is
estimated at #70 million. In addition, a further decline in the Retail Banking
spread is expected, and additional pension costs of circa #34 million are
possible, subject to market movements and the outcome of the annual review in
March. Certain historic capital raisings by the Group incorporated floors, which
meant a minimum fixed rate interest rate would be paid (in order to reduce the
margin over LIBOR). In the light of a revised approach to risk management and
the current interest rate environment, the Group has decided to convert these to
a fully floating rate, with an anticipated increase in margin cost going forward
of circa #23 million.
Portfolio Business Unit
Of the #332 million trading loss incurred by the Portfolio Business Unit
(reflecting the Wholesale Bank related credit costs), #64 million of trading
profit relates to First National businesses contracted to be sold to GE Consumer
Finance.
In 2003 and thereafter, a material fall in pre-provisions PBU income would be
expected dependent on the pace of wind down of the asset based portfolios. In
addition, dependent on market conditions and the speed and manner of the asset
run-off or disposal process selected, further substantial credit related losses
could arise as risk is reduced and capital released.
Risk weighted assets (RWAs) associated with the PBU as at 31 December 2002 were
as follows:
31 December 2002
Assets RWAs
# bn # bn
___________ ___________
Debt securities 32.3 11.1
Loan portfolio 8.4 7.2
Leasing businesses 5.7 3.7
Private Equity 0.8 1.1
Other 1.4 -
___________ ___________
Wholesale Banking businesses 48.6 23.1
Consumer and Retail Finance 4.8 3.9
Motor and Litigation Finance 3.2 3.9
___________ ___________
First National 8.0 7.8
European Banking and other 3.4 1.8
___________ ___________
60.0 32.7
___________ ___________
Note: International Life businesses do not have RWAs, and are therefore excluded
from the above analysis.
The Chief Executive's Review provides more detail on the strategic review and
direction of the Group, and the resulting split of the existing Group, part of
which is depicted in the table above. Further details relating to the Portfolio
Business Unit are included in Section 5. The remainder of the report is based on
the existing divisional structures as reported at the interim stage. Appendix 7
provides details of divisional restatements made at the interim stage.
1.5: Material charges and accounting policy changes
Note that detailed explanations of all accounting policy changes can be found in
Section 4.
Impact of embedded value re-basing and other adjustments
31 December 31 December 31 December
2002 Restated Restated
2001 2000
# m # m # m
___________ ___________ ___________
Adjustment to period end market values (321) (259) (102)
Guaranteed liability / MVA adjustment (362) (184) -
Change in equity backing assumption (64) - -
One-off benefit of funds under management transfer 115 - -
___________ ___________ ___________
Total pre-tax impact on embedded value earnings (632) (443) (102)
___________ ___________ ___________
Embedded value in the Life businesses has previously been calculated using a
smoothed basis using long-term assumptions relating to investment returns, bonus
rates, mortality and lapse rates. In 2002, following a review of industry
practice, a significant change to the accounting policy has been adopted which
has two effects.
Firstly, the approach to investment returns has now changed and actual period
end market levels are used to calculate embedded value, thereby recognising any
variation from the long-term investment assumptions. The substantial fall in
equity values, with year-end FTSE 100 levels of 3,940 compared to 5,217 at the
start of the year, has produced a significant negative variance in this item.
Secondly, certain investment products sold in prior years contain valuable
options to the customer in the form of investment guarantees at certain dates in
the future. There is #4.7 billion of MVA-free and premium guarantee business
outstanding in Scottish Mutual and Scottish Mutual International and #2.6
billion of guaranteed annuity business written in Scottish Mutual and Scottish
Provident. At the year-end, as the potential cost of these liabilities was
substantially above the current and assumed future value (taking account of
certain surrender and other assumptions) of the assets that support them, this
gave rise to a charge against the embedded value. The new policy also recognises
the value of the option to the customer. Hedging has now been put in place to
substantially address the interest rate and equity option risk of the products.
The additional impact of valuing these options in this manner compared to
recognising losses on embedded value assumptions amount to #233 million in 2002
and #119 million in 2001.
In addition, the percentage of life assurance funds invested in equity markets
has been actively reduced during 2002 and subsequently, to protect both
customers and shareholders from further falls in equity markets. The long-term
equity backing ratio assumption has therefore been reduced from 70% to 30%. At
the year-end, the actual equity backing ratio was 34% compared to 50% at the end
of 2001. Additional derivative based contracts would have produced an effective
equity backing ratio of circa 10% at a FTSE level of 3,000 as at February 2003.
Finally, a gain in embedded value has been recognised reflecting the benefit of
cost savings connected with bringing the fund management associated with
Scottish Provident in house, also giving a small benefit to the costs of the
other Life businesses. This is shown separately, with an offsetting impairment
charge included in goodwill, as this amount was previously recognised as
goodwill on acquisition.
Both the period end values and the change to the equity backing ratio will have
the effect of reducing the expected profits from in-force business in 2003
compared to 2002. The resulting impact on a pre-tax basis of the unwind of the
discount on a lower embedded value stock is estimated at circa #70 million for
2003, prior to any market movements in 2003.
Of note, net capital injections into the Life businesses totalled #866 million
during 2002.
Wholesale Bank provisioning
As flagged at the interim stage, and in the full year pre-close statement, the
2002 results were adversely impacted by a significant increase in the level of
provisioning and losses on asset disposals in the Wholesale Bank. The charges
totalled #902 million (2001: #271 million), broken down as follows:
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Specific provisions 689 226 17
General provisions 71 30 17
IEM impairment 38 - -
Losses on disposals of credit impaired assets 104 15 -
___________ ___________ ___________
Total provisions and losses on asset disposals 902 271 34
___________ ___________ ___________
As highlighted in the Chief Executive's statement, a significant change in
strategy for the Wholesale Bank has been determined. Accompanying the execution
of this change has been substantial work on risk exposures and asset values
within the Wholesale Bank, including in-depth reviews by a range of external
advisors. The result of this work is driving improvements to risk management,
rationalisation of assets, provisioning and related risk disclosures.
The increased provisioning relates primarily to a marked deterioration in credit
quality in certain sectors where Abbey National held risk concentrations.
However, a substantial amount of the remaining asset portfolios have also
experienced credit spread deterioration since their acquisition. More detail on
the makeup of these portfolios is provided in Section 5. The losses on disposal
of credit impaired assets reflect sales of #10.5 billion (#5 billion RWAs)
accomplished during 2002, primarily in the second half.
Of the specific provision charge of #689 million, #164 million relates to high
yield and #123 million to private equity. In addition, #162 million relates to
the power sector and #34 million to the aviation sector.
Taking into account the more illiquid and complex parts of the CBO portfolio,
the 'fair value' deficit relating to the #31.5 billion non-trading bond
portfolios as at 31 December 2002 was estimated to be #664 million (2001: #428
million). This reflects losses that would be realised, largely as a result of
credit spread deterioration, were a decision to be taken to sell portfolios down
rather than hold them to maturity.
In the loan book specific balance sheet provisions of #204 million have been set
against #836 million of exposures, the majority of which are in part secured. In
substantial parts of the remaining portfolio, loan assets would be expected to
realise less than book value were they to be sold in the near term rather than
held to maturity.
Abbey National holds significant leasing portfolios. While the finance lease
portfolio continues to exhibit sound credit quality, the operating lease
portfolios, most notably the IEM aircraft leasing portfolio, would show
meaningful deficits if sold in present market conditions.
Private equity exposures have been provided for in line with the recent fund
manager valuations. However, in current market conditions, even a controlled
disposal process would be expected to realise a lower value for the Group
overall.
The general balance sheet provision is now #146 million (2001: #91 million)
driven by a significantly increased charge in 2002.
Goodwill impairment
Opening Goodwill Amortisation Write-down Closing balance
balance acquired / 31 Dec 2002
1 Jan 2002 disposed
# m # m # m # m # m
___________ ___________ ___________ ___________ ___________
Goodwill asset 1,243 (38) (64) (765) 376
Goodwill previously
written-off to reserves 1,201 (13) - (373) 815
___________ ___________ ___________ ___________ ___________
2,444 (51) (64) (1,138) 1,191
___________ ___________ ___________ ___________ ___________
Scottish Provident (604)
First National (357)
Cater Allen Offshore (149)
Abbey National business (12)
Porterbrook (16)
___________
(1,138)
___________
As a result of the Group strategic reviews, and changing market conditions, a
revised view of the future value of certain assets has been calculated resulting
in a goodwill impairment charge of #1,138 million. These charges do not impact
Group capital ratios.
The write-down with respect to Scottish Provident reflects the proposed exit
from the International business, together with a cautious assessment of the
growth prospects for the UK protection market, despite the good performance in
2002. This impairment is partly offset by the recognition of #115 million
pre-tax benefit in embedded value asset following the transfer of funds to Abbey
National Asset Managers.
The First National impairment is a result of an assessment of the carrying value
of goodwill against the projected financial performance of the businesses. The
amount of the impairment is consistent with the proposed sale of parts of First
National to GE Consumer Finance announced in February 2003.
The goodwill amortisation charge increased to #64 million (2001: #36 million),
reflecting the full year impact of Scottish Provident. The carrying value of the
goodwill asset as at 31 December 2002 was #376 million. Based on this amount,
the goodwill amortisation impact for 2003 is expected to reduce to circa #19
million.
Expensing of stock options
The emerging trend in the accounting industry is to require that the fair value
of all employee options be charged to the profit and loss account. Adopting this
trend through a change in accounting policy results in a pre-tax charge of #7
million in 2002 and cumulative prior year adjustments of #17 million.
A further provision has also been made in relation to Abbey National ordinary
shares acquired in past years through ESOP Trusts and other similar programmes.
These have been held at cost against potential share requirements under various
stock based employee compensation schemes, significant proportions of which may
not vest or be exercised. The decision has been taken to write these down to
market value and has led to a pre-tax charge of #37 million in 2002. The company
is planning to reduce the risk of similar charges in the future through revised
share re-purchase and cancellation arrangements, to the extent allowed by the
schemes.
Cost programme
Implementation expenses relating to the cost review programme initiated in 2002,
totalled #44 million. The cost programme is targeting over #200 million of
annualised cost savings from the PFS businesses by the end of 2005, in addition
to removal, to the extent possible, of costs associated within the Portfolio
Business Unit's activities. The relative cost to achieve these savings is
expected to be similar to other cost programmes in the financial services
sector.
In 2003, the cost of implementation is expected to exceed any cost savings
included in that year. Disclosure will be made on programme progress and its
financial impact in future results announcements.
1.6: Divisional summary
Profit before tax: 31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Retail Bank (1) 930 936 1,002
Abbey National Life 205 202 182
Retail Insurance 92 88 116
___________ ___________ ___________
Retail Banking 1,227 1,226 1,300
Scottish Mutual 133 164 113
Scottish Provident 46 30 -
First National 110 94 130
Wealth Management (incl. Inscape and Europe) 58 50 9
cahoot (25) (63) (63)
___________ ___________ ___________
Wealth Management and Long-Term Savings 322 275 189
Wholesale Banking pre-provisions 595 775 609
Provisions (760) (256) (34)
Losses on disposal of credit impaired assets (104) (15) -
IEM impairment (38) - -
___________ ___________ ___________
Wholesale Banking (307) 504 575
Group Infrastructure (2) (355) (186) (146)
Adjust for:
- Embedded value re-basing and other adjustments (632) (443) (102)
- Other asset disposals 44 130 65
- Cost programme implementation (44) - -
- Share write-downs (37) - -
- Goodwill charges (1,202) (36) (12)
___________ ___________ ___________
Profit before tax (984) 1,470 1,869
___________ ___________ ___________
(1) Restated to exclude the proceeds from the sale of the credit card business
to MBNA in 2001.
(2) Restated to exclude goodwill amortisation and the impact of asset disposals
included in 2001 and 2000.
Retail Banking
In Retail Banking, profit before tax was marginally higher at #1,227 million
(2001: #1,226 million) driven by volume increases in General Insurance. The
Retail Bank benefited from a growth in assets, more than offset by a reduction
in fee income.
Wealth Management and Long-Term Savings
Profit before tax from Wealth Management and Long-Term Savings increased to #322
million (2001: #275 million). This reflected reduced losses in cahoot and the
first full year from Scottish Provident.
Wholesale Banking
A loss before tax of #(307) million was largely due to a significant increase in
provisions. Pre-provision operating performance reflected difficult market
conditions resulting in a reduction in trading income and fees, while the
strategic review of the business led to an active reduction of risk-weighted
assets.
Group Infrastructure
Losses in Group Infrastructure increased significantly to #(355) million (2001:
#(186) million). Of the increased loss, #92 million was in operating income, and
largely reflected additional funding costs relating to Scottish Provident and
the impact of increased subordinated debt borne centrally. Cost growth of #26
million (12%), with additional project costs and the head office move, partly
offset by reduced corporate advisory fees.
In addition, there was a #51 million increase in provisions for contingent
liabilities, partly resulting from releases in 2001 of #25 million not repeated,
with the balance relating to various potential claims.
1.7: Group business flows
31 December 31 December 31 December
2002 2001 2000
___________ ___________ ___________
Mortgages
Gross mortgage lending #22.8bn #17.2bn #12.8bn
Capital repayments #15.8bn #12.0bn #9.6bn
Net mortgage lending #7.0bn #5.2bn #3.2bn
Mortgage stock #80.1bn #73.1bn #67.9bn
Market share - gross mortgage lending 10.4% 10.7% 10.7%
Market share - capital repayments 11.3% 11.3% 12.2%
Market share - net mortgage lending 8.9% 9.5% 7.9%
Market share - mortgage stock 11.9% 12.4% 12.7%
Savings and Investments
Retail deposits: (1)
Total net deposit flows #1.9bn #4.6bn #1.4bn
Outstanding deposits #59.3bn #57.4bn #51.3bn
Cash ISA sales (included in deposit inflows) #1.3bn #2.5bn #1.3bn
Investment ISA sales #0.5bn #0.3bn #0.7bn
Market share - total household deposit flows 2.2% 7.5% 3.6%
Market share - outstanding household deposits 7.6% 8.0% 8.3%
Retail deposit flows by business:
Retail Banking #1,034m #1,344m #427m
cahoot #(78)m #1,699m #177m
Cater Allen and Inscape #558m #857m #364m
Other (including Offshore) #361m #660m #457m
___________ ___________ ___________
#1,875m #4,560m #1,425m
Investment: (2)
New business premiums #3,279m #4,101m #4,267m
Annualised equivalent #427m #534m #524m
Funds under management #29bn #22bn #21bn
Banking
Bank account openings:
Retail Banking 397,000 389,000 294,000
cahoot 46,000 97,000 25,000
Wealth Management 43,000 41,000 12,000
___________ ___________ ___________
486,000 527,000 331,000
Bank account stock:
Retail Banking 2,582,000 2,346,000 2,101,000
cahoot 151,000 112,000 17,000
Wealth Management 296,000 301,000 119,000
___________ ___________ ___________
3,029,000 2,759,000 2,237,000
Total bank account customer base (3) 3.72m 3.52m 3.33m
31 December 31 December 31 December
2002 2001 2000
___________ ___________ ___________
Credit card openings:
Retail Banking 216,000 162,000 23,000
cahoot 48,000 45,000 46,000
___________ ___________ ___________
264,000 207,000 69,000
Credit card stock:
Retail Banking 810,000 610,000 470,000
cahoot 114,000 73,000 35,000
___________ ___________ ___________
924,000 683,000 505,000
Unsecured gross lending:
Retail Banking #1,014m #1,117m #963m
cahoot #507m #134m #-m
___________ ___________ ___________
#1,521m #1,251m #963m
Unsecured lending stock:
Retail Banking #1,662m #1,673m #1,472m
cahoot #464m #116m #-m
___________ ___________ ___________
#2,126m #1,789m #1,472m
SME bank account openings (net) 36,000 19,000 8,000
SME bank account stock 91,000 55,000 35,000
Insurance and Protection
General Insurance:
New policy sales 546,000 456,000 395,000
Policies in force 2,028,000 2,100,000 2,095,000
Protection: (2)
New business premiums #112m #81m #14m
Annualised equivalent #112m #81m #14m
First National - net loan assets
Secured lending (4) #2,780m #2,309m #1,962m
Motor finance (5) #2,823m #2,869m #2,906m
Retail lending #1,995m #2,294m #2,695m
___________ ___________ ___________
#7,598m #7,472m #7,563m
___________ ___________ ___________
(1) Deposit inflows and stock have been redefined to include all (both retail
household and non-household) deposits made through the branch network and remote
channels in the Group's retail orientated businesses, which are predominantly UK
based. For market share purposes only personal deposits have been used to
calculate the share of 'UK Household Deposits', in terms of both stock and flow,
using a market size estimated from Office of National Statistics data.
(2) The acquisition of Scottish Provident was completed on 1 August 2001. 2001
includes a full year for Scottish Provident for comparative purposes. 2000
contains no Scottish Provident values.
(3) Statistic relates to the Retail Bank only.
(4) Balance includes Litigation Funding.
(5) First National Motor Finance balances include the Group's 50% share of
assets held by the PSA joint venture
Mortgages
Gross mortgage lending of #22.8 billion (2001: #17.2 billion) was up 33% which,
combined with capital repayments below our stock share, contributed to growth in
net lending, of 35% on 2001. Total net lending of #7.0 billion (2001: #5.2
billion) represents a 8.9% full year net mortgage lending market share, and a
second half share of 10.6%.
Mortgage lending to housing associations represented 0.6% and 0.4% of the
Group's net lending and stock shares, whilst commercial and sub-prime lending
through First National (included in the assets contracted to be sold to GE
Consumer Finance) accounted for 0.3% and 0.3% on the same basis.
Savings and Investment
Total retail deposit inflows were #1.9 billion (2001: #4.6 billion). Within
these, household inflows represented an estimated share of market household
inflows of approximately 2.2%.
The second half performance was stronger than the first, with total retail
deposit inflow of #1.7 billion, and an estimated household market share of 5.1%.
This was supported by a strong performance in the fixed-rate bond market, with
inflows of #0.6 billion in the second half of the year, and market leading
internet only accounts, with eSaver regularly in best buy tables since launch in
2000.
cahoot suffered a decline in deposits through 2002, reflecting a re-pricing to
move the in-credit account into positive margin.
Investment new business premiums of #3.3 billion were down 20% on 2001, largely
reflecting reduced sales of "with-profits" bonds through both Abbey National
Life and Scottish Mutual.
In Abbey National Life, despite an estimated 19% fall in the Investment ISA
market, sales increased by around 67% on 2001, boosting market share to
approximately 9% during 2002. In total, ISA and unit trust sales almost doubled
year-on-year, largely offsetting the fall in "with-profit" sales through direct
channels. In September, Abbey National signed a deal with Prudential to
distribute a version of its 'Prudence Bond' with sales commencing from 11
December 2002.
Investment funds under management increased by 32% to #29 billion (2001: #22
billion) following the transfer of #10 billion of Scottish Provident funds to
Abbey National Asset Managers in April and inflows of new business, offset by
negative investment returns and market movements.
Banking
The momentum in bank account openings was maintained through 2002, with the
opening of 397,000 bank accounts through the Abbey National brand alone (2001:
389,000). Banking in-credit balances grew accordingly, with steady improvement
in the Abbey National branded primary account base, now at 1.4 million, up 9%.
With cahoot and other Wealth Management businesses including Cater Allen Private
Banking, total account openings were 486,000 (2001: 527,000).
Credit card openings of 264,000 were up 28% on 2001, largely due to a full year
impact of the relationship with MBNA. Total cards in issue are now 924,000.
Gross unsecured lending of #1.5 billion (2001: #1.3 billion) increased by 22%
driven by strong growth in cahoot.
SME Banking account openings were 89% higher than 2001, with 36,000 accounts
opened. The total account base now stands at 91,000, up 65% on last year.
Insurance and Protection
General Insurance new business policy sales were up 20% to 546,000 (2001:
456,000), reflecting strong sales of both household, up 21%, and mortgage
payment protection, up 34%, with sales across all channels contributing to this
growth. This was offset by reduced motor insurance volumes, which should in part
be addressed through new systems delivered through 2002 to support both direct
and Internet channels. In total, active policies reduced due to increased new
business sales being more than offset by net closures (non-renewals) on the
existing book.
Protection new business volumes continued to grow during 2002. In particular,
Scottish Provident UK term assurance new business volumes increased by 47%,
representing a market share of over 20%.
First National
Total net loan assets increased by 2% to #7.6 billion (2001: #7.5 billion), with
growth in secured lending broadly offset by competition-driven decreases in
retail lending.
1.8: Risk Management and post year-end events
Personal and mortgage lending
Throughout 2002, and since the interim stage, the credit quality of the secured
lending book has improved significantly. 3 month plus arrears cases now stand at
13,500, down 30% during the year, and 16% since the interim stage. Repossessions
are also lower than at the interim stage, and down 36% on the same point last
year.
Lending criteria were tightened in 2002, with 86% of all new lending to
customers with a loan to value of less than 90%. This compares to 67% in 2001.
In total, the average loan to value on the overall book is estimated at 46%
gross of securitised assets. General provisions grew by 17% compared to a growth
in the asset of 9%. This is a reflection of the current market conditions and
would not necessarily be adequate in the event of a significant economic
downturn.
Through 2002, bank account general provisions increased by 53% relative to asset
growth of 11%. Excluding First National, Abbey National's exposure to unsecured
lending represents only 2.5% of its total PFS credit exposures.
Life Assurance
Substantial risk management advances have been accomplished with respect to the
Life businesses. A number of actions were taken to significantly reduce the
Group's exposure to "with-profits" policies, including, early in 2002, a
de-emphasis of "with-profits" new business in the UK and an accelerated process
of product migration.
Going forward, the Group's capital exposure in this area will be further reduced
as a result of the Retail Bank's arrangement with Prudential to distribute a
version of its 'Prudence Bond'. Scottish Mutual has withdrawn its own
"with-profits" products from the end of December 2002, prior to the launch of a
new lower risk, less capital intensive investment contract in the first quarter
of 2003.
In seeking to mitigate ongoing exposure to equity markets relating to historical
business written, the actual equity backing ratios (EBR) across the Group's life
assurance operations have been reduced to a level of 34% at 31 December 2002
compared to 50% at the start of the year. In addition the impact of derivative
protection introduced, further reduces the equity exposure in the funds at the
end of 2002 to an effective EBR of 30%.
Since the year-end, the EBR in the Group's closed with-profits funds (including
the impact of derivatives) has been further reduced. Based on various
assumptions, effective EBR at FTSE 100 level of 3,000 would now be approximately
10%. In addition, a variety of hedging strategies have been put in place,
effectively cushioning policyholders and the Group against the impact of the
previously unhedged guarantee exposures for GAOs and MVA-free guarantees. The
cost of this programme was broadly covered by the provision raised and included
in the embedded value re-basing and other adjustments. Nevertheless, given the
range of assumptions necessary to model life exposures and run hedge programmes
against them, particularly those relating to policy surrenders, the risk
management activity must be expected to reduce, but not eliminate, future profit
impacts from these exposures.
Since the year-end, #120 million has been injected into the Life companies as a
result of January's falling markets. A fall in equity values comparable to a
decline in the FTSE 100 index from 3,500 to 3,000 would broadly necessitate a
further #100 million of capital to maintain 100% statutory solvency. In
February, the Group announced that it had cut annual bonus rates to between 0% -
4% on its "with-profits" policies in force. This was again driven by risk and
capital management discipline, striking a fair balance between policyholder and
shareholder interests.
Wholesale Banking
The recently completed strategic review has redefined the scale and role of the
Wholesale Bank within the Group's focus on Personal Financial Services. Core
treasury, risk and product structuring and money market operations will be
retained, with the remainder of the Wholesale Bank placed in the Portfolio
Business Unit. As part of the strategic review, a full assessment of operational
and financial risks was undertaken, drawing upon external market specialists
from a number of institutions.
Since the interim, the business has sought to actively reduce balance sheet
exposures and risk concentrations, and has taken on limited new business. Total
assets at June were #123 billion, which had reduced to #89.5 billion by the
year-end, though close to two-thirds of this reduction was in the short-term
trading portfolio of Cater Allen International Limited (CAIL). Risk weighted
assets have reduced accordingly (relating overwhelmingly to non-CAIL asset
reduction), down 18% since the interim stage to #30.4 billion.
Since the year-end, a further #7.7 billion of assets relating to the Portfolio
Business Unit have been sold, including strong progress in reducing certain
larger single name exposures. This has been achieved at a cost of circa #68
million pre-tax. Further updates on progress will be provided at the interim
stage.
An enhanced disclosure of Wholesale Banking exposures relating to the Portfolio
Business Unit is included in Section 5.
Pension Fund and other corporate exposures
In early 2002, the Group closed its final salary pension schemes to new
entrants. These have been replaced with a defined contribution scheme where the
Group's obligations are limited to its initial contributions. Additionally, a
substantial reduction of the Group's exposure to equity risk in its pension
funds was accomplished early in 2003 reducing the aggregate equity backing ratio
in its pension funds to 50% from 80%.
One of Abbey National's important risk exposures is the potential adverse effect
on net interest margins of falling interest rates. This derives primarily from:
* the gap between interest rates on mortgages and savings; exposure is
dependent on competitive behaviour and has now been particularly mitigated
by hedging, using parts of the fixed rate mortgage book; and
* capital issuance; #1.85 billion of the Group's subordinated debt and
preference share issuance prior to 2002 was not fully swapped to LIBOR-based
floating interest rates, leaving un-hedged long-term risk exposures to lower
interest rates. This exposure has been substantially eliminated in 2003 at
an estimated future margin cost in the region of #23 million per annum.
First National and other disposals
On 4 February 2003, the sale of First National to GE Consumer Finance was
announced. The sale price includes a premium of #218 million to net assets
(subject to regulatory approvals and other conditions), and relates to #4.8
billion of assets comprising First National's secured and retail unsecured
lending. It excludes Motor Finance and Litigation Funding businesses. The sale
covered an estimated #3.9 billion of risk weighted assets.
In January, the Group also disposed of its 5.5% shareholding in Dah Sing at a
book profit of #3.3 million, releasing #35 million in capital.
1.9: New organisational structure and directors' responsibilities
New Structure:
As part of the Group's strategic review, a new functional organisational
structure has been implemented. This has the effect of changing the roles and
responsibilities of a number of full Board members.
The new structure will lead to an increased focus on the customer, and is
expected to deliver enhanced performance through a streamlining of operations,
and much greater emphasis on the economics of distribution and production.
The main components of the new organisation will be:
Customer Sales - responsible for all channel delivery (branches, telephone,
internet banking) to both direct and intermediary customers, with a particular
focus on increasing contact with customers who no longer visit branches or
contact us. This will be headed by Mark Pain, formerly Managing Director,
Wholesale Bank.
Customer Propositions - operating around five competencies: segment management,
economic insights, branding, product strategy and marketing operations. This
will develop detailed and unique customer insights and execute responsive
marketing strategies. This division will be headed by an external appointment
that has yet to be made.
Customer Operations - responsible for all operations activity (including service
centres) built around five product service units including banking and savings,
payment processing, investment, asset management, lending and general insurance.
This will be headed by Mac Millington, formerly Managing Director, Wealth
Management and Long-Term Savings.
Supporting the customer-facing divisions will be a number of business support
functions:
Central Division - consisting of Finance, Communications, Corporate Development,
Programme Management, Risk, Audit, Legal Services and ongoing Treasury business.
This will be headed by Stephen Hester, who will assume the role of Chief
Operating Officer, reflecting his increased responsibilities, which will also
include the PBU.
IT - responsible for providing the organisation with all its IT needs, as well
as procurement, property and security will be headed by Yasmin Jetha, formerly
Group IT and Infrastructure Director.
Human Resources - responsible for all human resources strategy and personnel
support, and will be headed by Jim Smart (not a Board Director), pending an
external appointment.
Portfolio Business Unit - consisting of those businesses earmarked for exit in
coming years. This (together with the ongoing Treasury business) will be headed
by Nathan Bostock (not a Board Director) reporting to Stephen Hester.
The new organisational structure is effective from 26th February 2003.
2. ANALYSIS OF KEY DRIVERS
2.1: Group operating income
2.1.1: Group trading income
31 December 31 December 31 December
2002 2001 2000
Restated Restated
# m # m # m
___________ ___________ ___________
Statutory net interest income 2,689 2,692 2,680
Statutory non-interest income 876 1,400 1,512
Less: Statutory depreciation of operating lease assets (280) (256) (178)
___________ ___________ ___________
Adjusted non-interest income 596 1,144 1,334
___________ ___________ ___________
Total income 3,285 3,836 4,014
Adjust for:
- Embedded value re-basing and other adjustments 632 443 102
- Wholesale Banking losses on asset disposals 104 15 -
- Other asset disposals (44) (130) (65)
- IEM impairment 38 - -
___________ ___________ ___________
Trading income 4,015 4,164 4,051
___________ ___________ ___________
Other asset disposals comprise:
Wholesale Banking leasing companies 44 - -
Credit card business - 49 -
Aitken Campbell - 52 -
London Stock Exchange shares - 17 -
Willis National - 12 -
Sale and leaseback of property portfolio - - 65
___________ ___________ ___________
44 130 65
___________ ___________ ___________
(Refer to Appendix 2 and 3 for detailed statutory disclosures of net interest
income and non-interest income.)
The remainder of Section 2 details the key drivers contributing to the 4%
decline in trading income.
Group trading income by division
31 December 31 December 31 December
2002 2001 2000
Restated Restated
# m # m # m
___________ ___________ ___________
Retail Banking 2,444 2,392 2,462
Wealth Management and Long-Term Savings 831 788 753
Wholesale Banking 809 961 764
Group Infrastructure (69) 23 72
___________ ___________ ___________
Trading income 4,015 4,164 4,051
___________ ___________ ___________
Retail Banking trading income increased 2% to #2,444 million (2001: #2,392
million), reflecting growth in net interest income despite a narrowing of the
spread, and a stronger contribution from general insurance sales.
Trading income from Wealth Management and Long-Term Savings was up 5% to #831
million (2001: #788 million), partly due to the first full year contribution
from Scottish Provident, but also supported by increased cahoot unsecured
lending, the re-pricing of cahoot deposits and growth in Cater Allen Private
Bank.
In Wholesale Banking, trading income was down 16%, reflecting difficult market
conditions, asset reductions and the lack of new business written in the second
half.
In Group Infrastructure, negative trading income of #(69) million (2001: #23
million) reflects the full year impact of the Scottish Provident acquisition,
and the impact of increased gearing levels borne centrally.
2.1.2: Retail Banking net interest income - spread
31 December 31 December 31 December
2002 2001 2000
% % %
___________ ___________ ___________
Net interest income (# m) 1,666 1,586 1,615
Average spread (1) 1.79 1.86 2.01
Average asset spread 0.93 0.81 0.83
Average liability spread 0.86 1.05 1.18
Average margin (2) 2.03 2.11 2.27
Year end free to go SVR asset (% of total) 23 26 28
Year end SVR free to go asset spread (%) 1.99 1.67 1.43
Year end branch-based deposits (% of total) 33 34 37
Year-end branch-based deposit spread (%) 2.73 3.26 3.28
___________ ___________ ___________
Note: Retail Banking spreads and margins calculated exclude general insurance,
unsecured personal loans and Abbey National Life. In addition, the half one
asset and liability spreads have been restated to: Asset spread 0.93%; Liability
spread 0.89%.
(1) Average spread is defined as interest received (less suspended interest)
over average interest earnings assets, less interest payable over interest
bearing liabilities (including an element of Wholesale Lending).
(2) Average margin is defined as net interest income (less suspended interest
but after a recapitalisation adjustment) divided by the average interest earning
assets.
The full year Retail Banking average spread was 179 basis points, down from 186
basis points for 2001. The second half spread was 175 basis points.
Despite a reduction in the spread, and a dual pricing liability charge of #9
million, net interest income of #1,666 million was up 5% (2001: #1,586 million).
This reflected growth in asset balances, largely resulting from high levels of
new mortgage business. In addition, the low interest rate environment and
competitive marketplace have resulted in higher levels of redemptions, with
associated fees up #67 million, totalling #198 million in 2002.
The stock of 'free to go' standard variable rate (SVR) asset declined marginally
through 2002, and as at the end of 2002 represented 23% of the total. The tied
SVR asset halved through 2002 to around #2 billion.
The majority of the mortgage book is currently in an incentive or fixed rate
period, after which it reverts to standard variable rate. Over #3 billion asset
are now in various flexible mortgages; simple products allowing customers to
reduce their mortgage quickly by over-paying whenever they want, while keeping
their banking and savings accounts separately.
In addition, #19 billion of the mortgage asset is now in products where rates
are linked directly to base rates.
Mortgage new business margins have tightened through 2002, and in the second
half there has been a shift towards fixed rate lending.
The percentage of branch-based deposits was held broadly constant through 2002,
following sharper reductions in previous years. The spread on branch-based
accounts compressed during 2002 reflecting more competitive product offerings
and the impact of lower base rates. Growth in current account balances during
the year helped to support overall spreads.
2.1.3: Retail Banking trading non-interest income by product
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Mortgage 149 154 161
Savings 67 69 65
Life Assurance 208 204 189
Banking 163 170 206
Business Banking (including depreciation of operating
lease assets) 9 48 37
Insurance and Protection 149 134 163
Unsecured personal lending 33 27 26
___________ ___________ ___________
Trading non-interest income 778 806 847
___________ ___________ ___________
Net mortgage related fee income of #149 million was down marginally (2001: #154
million). Within this decline is a #37 million one-off benefit relating to the
amortisation of introducer fees over 6 years (the average life of a mortgage),
previously charged in the year incurred. In addition, a #24 million benefit
associated with mortgage indemnity guarantee (MIG) fees, resulting from
amortisation over 6 years compared to 7 years previously assumed. This has been
offset by increased mortgage new business volumes, and a one-off adjustment in
2001 of #32 million reflecting treatment of MIG moving from an actuarial to
straight line amortisation basis.
Savings related fee income was marginally down at #67 million (2001: #69
million). This was due to a fall in commissions receivable on sales of Abbey
National Life policies, arising from lower sales of "with-profits bonds".
The trading income of the life businesses is described in detail in Section
2.1.4.
Banking fee income of #163 million is down marginally on last year's levels
(2001: #170 million). This is primarily as a result of reduced interchange fees
received from Link, offset by a net increase in bank account income following
the introduction of revised tariffs and increased volumes. Fees relating to the
distribution of credit cards supplied by MBNA also had a positive impact.
The fall in fee income relating to business banking was largely due to the
disposal of First National Vehicle Holdings in April. Net of depreciation on
operating lease assets, this accounted for #30 million of the #39 million
year-on-year decline.
Growth in retail insurance commissions, up 11% to #149 million (2001: #134
million) reflected improvements across most product lines, supported by improved
systems and on-line functionality, in addition to strong growth in the 'Peace of
Mind' product.
Unsecured personal lending non-interest income increased by 22% to #33 million
(2001: #27 million), driven by increased fee income resulting from payment
protection on higher average loan sizes.
2.1.4: Life Assurance income
31 December 2002
AN Scottish Scottish Total
Life Mutual Provident
# m # m # m # m
___________ ___________ ___________ ___________
New business contribution to EV 31 32 20 83
Contribution from existing business to EV:
- expected return 50 108 30 188
- experience variances 15 19 (6) 28
- changes in assumptions and other items 35 - 3 38
- integration costs - - (16) (16)
___________ ___________ ___________ ___________
Increase in value of long-term assurance businesses 131 159 31 321
Non-EV earnings:
ANUTM and ANPIM contribution 63 - - 63
Other income and operating expenses 11 (26) 15 -
___________ ___________ ___________ ___________
Trading profit from long-term assurance 205 133 46 384
Less: Embedded value re-basing and other adjustments (32) (549) (51) (632)
___________ ___________ ___________ ___________
Statutory profit / (loss) from long-term assurance
businesses 173 (416) (5) (248)
___________ ___________ ___________ ___________
New business margin (%) (1) 41% 16% 16% 21%
31 December 2001
AN Scottish Scottish Total
Life Mutual Provident
# m # m # m # m
___________ ___________ ___________ ___________
New business contribution to EV 52 82 9 143
Contribution from existing business to EV:
- expected return 52 104 14 170
- experience variances 11 (6) 11 16
- changes in assumptions and other items 25 4 - 29
- integration costs - - (13) (13)
___________ ___________ ___________ ___________
Increase in value of long-term assurance businesses 140 184 21 345
Non-EV earnings:
ANUTM and ANPIM contribution 53 - - 53
Other income and operating expenses 9 (20) 9 (2)
___________ ___________ ___________ ___________
Trading profit from long-term assurance 202 164 30 396
Less: Embedded value re-basing and other adjustments (34) (351) (58) (443)
___________ ___________ ___________ ___________
Statutory profit / (loss) from long-term assurance
businesses 168 (187) (28) (47)
New business margin (%) (1) 40% 29% 23% 32%
Note: Abbey National Life is included within the Retail Banking division, while
Scottish Mutual and Scottish Provident are part of the Wealth Management and
Long-Term Savings division.
(1) New business margin is calculated as new business contribution to EV,
divided by related annualised equivalent premiums for Life contracts.
New business contribution to embedded value, representing the profit earned from
sales of new business after allowing for acquisition costs including commission,
fell for Abbey National Life and Scottish Mutual mainly due to the decrease in
sales of "with-profit" bonds, reflected in the decline of overall margins.
The expected return is the profit expected from in-force policies at the start
of the period, and in Scottish Provident a full year contribution has driven the
increase.
Experience variances capture the difference between actual experiences in the
period compared to the assumptions, except for investment returns, which are
handled separately, contained within the opening embedded value. In Abbey
National Life the experience variances in 2002 include mortality and critical
illness benefits and expense underruns. In Scottish Mutual a one-off benefit
from tax settlements is offset by pension lapse losses in the UK and expense
overruns in the international businesses. In Scottish Provident the principal
item relates to expense overruns during the integration phase.
The main component of the changes in assumptions and other items represents
improvements in Abbey National Life mortality experience. At the half year 2002,
#25 million was included for Scottish Provident as trading income from long-term
assurance as partial credit for the funds under management transfer. This is now
included within embedded value re-basing and other adjustments.
In Scottish Provident, integration expenses of #16 million were incurred in
order to achieve annualised savings which reached 86% of the targeted #55
million by end 2003 (after allowing for the impact of the increase in new
business volumes).
The contribution from Abbey National Unit Trust Management and Abbey National
PEPs and ISAs Managers has increased largely due to the increase in single ISA
and unit trust volumes, which almost doubled in 2002.
Other income and operating expenses represent net earnings on capital offset by
the Group's internal charge for capital (that impacts non-interest income).
Where capital injections are made to the shareholder fund, the earnings on these
are recorded as interest income, whereas injections into the long-term funds
impact embedded value (non-interest income).
The new business margin percentage is influenced by the relative proportions of
life, pension and protections products as well as being impacted by the split
between single and regular premium contracts. The main reason for the
year-on-year decline is due to reduced sales of "with-profits" products. In
Scottish Provident the margin narrowing reflects market pressures.
The table below shows the Abbey National Asset Managers funds under management
by company, and split by type of business:
31 December 2002
AN Scottish Scottish Total
Life Mutual Provident
# bn # bn # bn # bn
___________ ___________ ___________ ___________
With-profit fund - 9.3 5.1 14.4
Non-profit fund 4.9 7.6 2.4 14.9
___________ ___________ ___________ ___________
Total 4.9 16.9 7.5 29.3
___________ ___________ ___________ ___________
The with-profit Scottish Provident fund has been closed since acquisition.
With-profits business previously written through Abbey National Life is
reassured to Scottish Mutual.
Life Assurance - new business premiums
31 December 2002
AN Scottish Scottish Total
Life Mutual Provident
# m # m # m # m
___________ ___________ ___________ ___________
Single
Pension 29 623 159 811
Life and investments:
- ISA and unit trusts 1,031 50 - 1,081
- Life and other bonds 111 222 155 488
- With-profits 101 688 - 789
___________ ___________ ___________ ___________
1,272 1,583 314 3,169
Annual
Pension 18 42 9 69
Life and investments:
- ISA and unit trusts 19 - - 19
- Life and other bonds 5 2 15 22
- Term assurance and protection 27 15 70 112
___________ ___________ ___________ ___________
69 59 94 222
___________ ___________ ___________ ___________
Total new business premiums 1,341 1,642 408 3,391
___________ ___________ ___________ ___________
Annualised equivalent (1) 196 217 125 539
___________ ___________ ___________ ___________
31 December 2001
# m # m # m # m
___________ ___________ ___________ ___________
Single
Pension 22 717 34 773
Life and investments:
- ISA and unit trusts 542 8 - 550
- Life and other bonds 104 173 153 430
- With-profits 705 1,505 - 2,210
___________ ___________ ___________ ___________
1,373 2,403 187 3,963
Annual
Pension 18 47 8 73
Life and investments:
- ISA and unit trusts 41 - - 41
- Life and other bonds - 4 20 24
- Term assurance and protection 20 13 48 81
___________ ___________ ___________ ___________
79 64 76 219
___________ ___________ ___________ ___________
Total new business premiums 1,452 2,467 263 4,182
___________ ___________ ___________ ___________
Annualised equivalent (1) 216 304 95 615
___________ ___________ ___________ ___________
(1) Calculated as the sum of 10% of single premium new business premiums, plus
annual new business premiums.
Note: 2001 has been adjusted to include a full year of Scottish Provident
(acquired 1 August 2001).
Single premium pension sales increased by 5%, largely due to the reinvestment in
the first half of 2002 of pension scheme compensation payments made to Scottish
Provident policyholders on demutualisation.
Single ISA and unit trust sales almost doubled in 2002 to #1.1 billion (2001:
#0.6 billion). The rise was largely due to the increased number of structured
ISA tranches sold through Abbey National Life during 2002.
Total life and other bonds were 12% ahead of 2001 mainly due to sales of the
flexible investment bond in Scottish Mutual.
As expected, Scottish Mutual and Abbey National Life have suffered in 2002 due
to the decline in "with-profit" bond sales. Scottish Mutual plans to launch a
new smoothed investment product in early 2003. Whilst Abbey National Life signed
a deal with Prudential to distribute a version of its 'Prudence Bond' with sales
commencing from December 2002.
2002 protection sales were 38% ahead of 2001, largely due to increased sales of
term assurance contracts through Scottish Provident, but also boosted by Pegasus
"Whole of Life" and Abbey National Life protection sales.
2.1.5: Wholesale Banking trading income
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Net interest income 459 508 441
Dealing profits 103 174 107
Fee income 24 73 52
Operating lease income (net of depreciation and
impairment) 152 151 91
Private equity realisations 34 29 28
Other 37 26 45
___________ ___________ ___________
Trading income 809 961 764
___________ ___________ ___________
Net interest income fell by 10% to #459 million (2001: #508 million) due
predominantly to the restructuring of the investment portfolio. In total, assets
were down 12%, and risk weighted assets by 23%.
Dealing profits and net fee income were lower due to poor global trading
conditions and lower new business activities. Operating lease rental income
reflects the full year impact of IEM, offset by increased charges for
maintenance relating to Porterbrook. Private equity realisations remain in line
with prior years. Other income principally relates to gains on other asset
disposals and foreign currency exposures.
2.1.6: Group Infrastructure trading income
Trading loss in 2002 was #(69) million, compared to #23 million in 2001. This is
largely due to the impact of funding Life businesses, including the Scottish
Provident acquisition and capital injections through 2002.
Group Infrastructure operating income should reflect earnings on the equity
(i.e. interest free) element of the Group's surplus capital. To achieve this,
the business unit statutory results are adjusted to reflect the impact of the
regulatory capital they absorb, assuming a historical 70:30 equity: debt ratio,
rather than the statutory capital they hold.
Over the last two years the Group has raised a significant amount of Tier 2 and
interest bearing Tier 1 innovative capital, which now totals 62% of Group
capital. The increased interest cost before tax, associated with the Tier 2
capital, has been reported in Group Infrastructure, and resulted in a net loss
in 2002.
The balance of the year-on-year movement related to other funding arrangements
with the Retail Bank.
2.2: Group operating expenses
2.2.1: Group trading expenses
31 December 31 December 31 December
2002 2001 2000
Restated Restated
# m # m # m
___________ ___________ ___________
Statutory operating expenses (excluding depreciation
of operating lease assets) 3,194 1,856 1,819
Adjust for:
- Cost programme implementation (44) - -
- Share write-downs (37) - -
- Goodwill amortisation (64) (36) (12)
- Goodwill impairment (1,138) - -
___________ ___________ ___________
Trading expenses 1,911 1,820 1,807
___________ ___________ ___________
Of which:
Stock option expensing 7 6 4
Pension costs 100 74 71
___________ ___________ ___________
Refer to Appendix 4 for a detailed statutory disclosure of operating expenses.
Group trading expenses increased 5% to #1,911 million (2001: #1,820 million).
2.2.2: Group trading expenses by division
31 December 31 December 31 December
2002 2001 2000
Restated Restated
# m # m # m
___________ ___________ ___________
Retail Banking 1,067 1,016 995
Wealth Management and Long-Term Savings 378 392 452
Wholesale Banking 214 186 155
Group Infrastructure 252 226 205
___________ ___________ ___________
Trading expenses 1,911 1,820 1,807
___________ ___________ ___________
Operating expenses in the Retail Bank increased by 5% to #1,067 million (2001:
#1,016 million) as a result of investment in general insurance and customer
relationship management platforms, an increase in customer-facing staff, pension
cost increases and increased marketing spend in attacking the 'big 4' in
personal and SME banking. Life assurance related expenses reported in embedded
value were #28 million (2001: #25 million).
In Wealth Management and Long-Term Savings, trading operating expenses fell by
4% to #378 million (2001: #392 million) driven by the non-repetition of First
National related integration costs. In addition, expenses in cahoot fell as
investment spend reduced. Most of life assurance related expenses are reported
on a net basis in embedded value earnings. These totalled #209 million in 2002
(2001: #161 million).
Wholesale Banking trading expenses of #214 million (2001: #186 million) were
higher as a result of a full year impact of 2001 growth, which has subsequently
been curtailed, and costs associated with the move to new premises incurred in
the second half of the year.
Trading expenses in Group Infrastructure increased by #26 million to #252
million (2001: #226 million) driven by increased (internal audit and risk
management) headcount, property costs relating to the relocation of head office,
and increased pension costs. This has been partly offset by reduced corporate
advisory fees.
2.3: Personal Financial Services provision charge
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Secured 32 42 43
Unsecured 107 100 113
___________ ___________ ___________
Retail Banking 139 142 156
First National 115 113 112
cahoot 12 7 2
Other 2 1 3
___________ ___________ ___________
Wealth Management and Long-Term Savings 129 121 117
___________ ___________ ___________
Total lending provisions 268 263 273
___________ ___________ ___________
Provisions for contingent liabilities and commitments,
and other 47 (9) 19
___________ ___________ ___________
Personal Financial Services provisions 315 254 292
___________ ___________ ___________
Refer to Appendix 5 for detailed statutory disclosures of provisions. Note that
the statutory definition of provisions for bad and doubtful debts includes #247
million of cost relating to Wholesale Banking exposures, not included in the
above table.
Lending related provisions remained broadly flat in total, with a decrease in
the Retail Bank of #3 million to #139 million (2001: #142 million), more than
offset by the charge in Wealth Management and Long-Term Savings, increasing to
#129 million (2001: #121 million) as a result of asset growth in cahoot.
Secured lending provisions of #32 million, were lower compared to 2001, with
improvements in arrears, properties in possession and losses per case partly
offset by an increased general provision driven by asset growth.
In total, provisions increased by 24% to #315 million, almost entirely due to an
increase in provisions for contingent liabilities and commitments to #47 million
(2001: #(9) million). The year-on-year increase was partly the result of #25
million write-backs in 2001 not repeated, and additional provisions raised in
2002 in relation to potential claims.
2.3.1: Total Personal Financial Services non-performing loans (NPLs) (1)
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Loans provided for 669 848 915
Arrears greater than 90 days not provided 550 798 885
Non-accruing lending 22 28 160
___________ ___________ ___________
Total non-performing loans 1,241 1,674 1,960
___________ ___________ ___________
Total loans and advances to customers 76,571 69,657 71,127
Total provisions 487 498 527
___________ ___________ ___________
NPLs as a % of loans and advances 1.62% 2.40% 2.76%
___________ ___________ ___________
Provisions as a % of NPL's 39.24% 29.75% 26.89%
___________ ___________ ___________
(1) Table excludes Wholesale Banking
The number of non-performing loans decreased in each of the major product
categories, despite strong asset growth over the period. The number of
non-performing secured loans (excluding Abbey National business) decreased by
around 30%, to the lowest level for a decade.
In total, the value of non-performing loans as a percentage of loans and
advances continued to improve, ending the year at 1.62% (2001: 2.40%). The level
of provisions coverage also increased, closing at 39.24% (2001: 29.75%).
2.3.2: Retail Banking arrears and properties in possession
31 December 2002 30 June 2002 31 December 2001
No. cases % of total CML No. % of total CML No. % of total CML
(000) industry industry industry
average % cases average % cases average %
(000) (000)
______ ______ ______ ______ ______ ______ ______ ______ ______
1 - 2 months arrears 24.8 1.78 n/a 28.0 2.01 n/a 30.2 2.15 n/a
3 - 5 months arrears 8.7 0.63 0.59 9.8 0.71 0.66 11.3 0.81 0.72
6 - 11 months 4.8
arrears 3.8 0.27 0.30 0.35 0.37 6.2 0.44 0.38
12 months + arrears 1.0 0.07 0.15 1.4 0.10 0.16 1.9 0.13 0.18
______ ______ ______ ______ ______ ______ ______ ______ ______
Mortgage properties in possession
31 December 2002 30 June 2002 31 December 2001
Nos % of loans CML Nos % of loans CML Nos % of loans CML
industry industry industry
average % average % average %
______ ______ ______ ______ ______ ______ ______ ______ ______
No. of repossessions 1,110 0.08 0.05 1,518 0.11 0.06 1,727 0.12 0.07
No. of sales 1,414 0.10 0.06 1,614 0.12 0.07 2,042 0.15 0.08
Stock 419 0.03 0.02 723 0.05 0.04 819 0.06 0.05
______ ______ ______ ______ ______ ______ ______ ______ ______
Notes: The above tables exclude First National and Abbey National business.
The provision charge on secured advances were lower at #32 million (2001: #42
million) with lower non-performing assets, lower losses per case and fewer
repossessed properties incurring a loss on disposal. The higher asset base
offset this.
Mortgage arrears continued to improve throughout 2002, with the key highlights
being a 30% reduction in the level of 3 month plus arrears cases to 13,500
(2001: 19,400). In the second half, arrears have continued to reduce falling by
16% compared to the first half.
In addition, the number of possessions reduced by 36% to 1,110 cases (2001:
1,727 cases) and the stock of properties in possession fell by 49% to 419
properties (2001: 819 properties).
2.3.3: Retail Banking - banking and UPL arrears
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Banking arrears (1) 54 56 63
Unsecured personal loans arrears (2) 59 100 103
___________ ___________ ___________
113 156 166
___________ ___________ ___________
Total banking asset 316 285 234
Total unsecured personal loan asset 1,986 2,023 1,814
___________ ___________ ___________
2,302 2,308 2,048
___________ ___________ ___________
Banking arrears as a % of asset 17.1% 19.6% 26.9%
UPL arrears as a % of asset 3.0% 4.9% 5.7%
___________ ___________ ___________
(1) Banking arrears are defined as customers whose balances exceed their credit
limit by over #100.
(2) UPL arrears are defined as accounts that are two monthly instalments in
arrears.
Growth in customer lending balances resulted in the provision charge relating to
personal banking increasing 63% to #65 million (2001: #40 million). However the
banking portfolio experienced a further improvement in arrears as a percentage
of the asset, due to enhancements to front end underwriting and middle office
operational controls.
The provision charge relating to the unsecured personal loan book decreased
significantly, down 29% from #58 million to #41 million. The reduced charge was
due to a combination of improvements in new lending criteria, and the sale of
assets previously written-off releasing #12 million in the current year. UPL
arrears as a percentage of asset fell from 4.9% to 3.0%
2.3.4: Provisions - other businesses
In First National, the lending provisions charge increased by #2 million to #115
million, driven by a 7% increase in lending assets, offset by an improvement in
arrears across all lending portfolios.
The provisions charge relating to cahoot increased to #12 million (2001: #7
million), reflecting unsecured loan and credit card growth of 300% and 62%
respectively.
2.4: Wholesale Bank provisions and losses on asset disposals - key drivers
Profit and loss provisions
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Project finance 178 18 -
High yield 164 115 10
Private equity 123 10 -
Corporates (investment grade on acquisition) 106 67 7
Asset backed securities 52 9 -
Aviation 34 - -
Other 32 7 -
___________ ___________ ___________
Specific provisions 689 226 17
___________ ___________ ___________
General provisions 71 30 17
___________ ___________ ___________
Wholesale Bank provisions 760 256 34
IEM impairment 38 - -
Losses on credit impaired asset disposals 104 15 -
___________ ___________ ___________
Total credit charges and asset impairments (1) 902 271 34
___________ ___________ ___________
(1) #247 million of the total of #902 million is classified as provision for bad
and doubtful debts for statutory reporting purposes, while #38 million is
included within depreciation of operating lease assets, and #104 million
included within non-interest income.
The increased charge largely reflects specific provisions raised against
exposures in the debt investment securities and loan portfolios.
The specific provision charge for 2002, and particularly the increase since June
2002, was a reflection of the further deterioration of the high yield sector as
well as certain UK and US power exposures (included in Project Finance), in
addition to stressed airplane and collateralised bond obligation (CBO) exposures
(included in Asset backed securities above). Corporates (investment grade on
acquisition) and other provisions relate to exposures to the telecoms and cable
sector.
The operating lease impairment of #38 million related to the IEM subsidiary and
reflected the general uncertainties existing in the aviation sector. Losses on
credit impaired asset disposals increased significantly to #104 million. In the
first half the losses were predominantly high yield related, whilst in the
second half of the year they relate to losses on general corporate exposures
from asset sell-downs and risk reduction.
Further analysis of the credit exposures and provisioning levels in relation to
the Wholesale Bank PBU can be found in Section 5.
2.5: Group capital - key issues
2.5.1: Group capital
31 December 31 December 31 December
2002 2001 2000
Restated Restated
# m # m # m
___________ ___________ ___________
Balance Sheet:
Distributable reserves and shareholders' funds 6,196 7,456 6,954
Life assurance reserves - non distributable 153 416 555
Less goodwill recognised (1,277) (2,505) (1,475)
___________ ___________ ___________
Equity Tier 1 5,072 5,367 6,034
Tier 1 capital instruments 2,174 1,717 1,123
___________ ___________ ___________
Total Tier 1 capital 7,246 7,084 7,157
Undated subordinated debt 3,065 3,181 2,699
Dated subordinated debt 2,745 2,719 2,963
General provisions and other 394 335 240
___________ ___________ ___________
Total Tier 2 capital 6,204 6,235 5,902
Less:
Investments in Life assurance businesses (3,782) (3,201) (1,831)
General insurance and other (575) (301) (251)
___________ ___________ ___________
Total supervisory deductions (4,357) (3,502) (2,082)
___________ ___________ ___________
Total regulatory capital 9,093 9,817 10,977
___________ ___________ ___________
Risk Weighted Assets:
Retail Banking 37,572 33,380 33,803
Wealth Management and Long-Term Savings 10,452 11,160 11,225
Wholesale Banking 30,410 39,634 35,889
Group Infrastructure 271 284 284
___________ ___________ ___________
Total group risk weighted assets 78,705 84,458 81,201
___________ ___________ ___________
Banking book 72,900 76,341 74,756
Trading book 5,805 8,117 6,445
___________ ___________ ___________
Total group risk weighted assets 78,705 84,458 81,201
___________ ___________ ___________
Capital ratios:
Risk asset ratio (%) 11.6% 11.6% 13.5%
Tier 1 ratio (%) 9.2% 8.4% 8.8%
Equity Tier 1 ratio (%) 6.4% 6.3% 7.4%
___________ ___________ ___________
(1) Goodwill recognised in the table above differs to that quoted in Section 4.2
due to the differing regulatory treatment of goodwill amortisation and other
adjustments.
Balance Sheet
As at 31 December 2002, the equity Tier 1 ratio was 6.4% (2001 6.6% before prior
year accounting adjustments; 6.3% post), and the Group's risk asset ratio was
11.6%. The Group risk asset ratio was above the minimum standard set by the
Financial Services Authority. The slight increase in the Equity Tier 1 ratio
over the previous year resulted from the reduction in risk weighted assets more
than offsetting the negative Equity Tier 1 impacts of the material charges to
the P&L. Goodwill impairments are Equity Tier 1 neutral. The Group's strategy is
to rebuild its effective capital position through retained earnings and asset
disposals, while also reducing the risk against which the capital is held.
Abbey National manages capital at a Group level to optimise capital efficiency.
The core Tier 1 position gives the Group the flexibility to issue further
structured Tier 1 and 2 instruments if appropriate and subject to market
conditions.
Abbey National's Tier 1 capital increased by #162 million to #7,246 million, as
the reduction in retained earnings (pre-goodwill charges) was more than offset
by the issuance of Tier 1 capital instruments. The Group's Tier 1 capital
includes a #153 million non-distributable reserve, representing the unrealised
organic embedded value post-tax profits generated by the life assurance
businesses. This reduced in 2002 reflecting the post-tax impact of embedded
value re-basing. Tier 1 capital also includes the cash profits generated by the
life assurance operations.
The #31 million decrease in Tier 2 capital to #6,204 million was principally due
to the amortisation of existing subordinated issues offset by the issue of dated
subordinated debt and a circa #60 million increase in general provisions.
Supervisory deductions primarily represents capital utilised in non-banking
businesses, and mainly represents the equity investment and retained earnings in
life assurance and insurance companies. Of the #3,782 million deduction relating
to Life businesses, #2,935 million represents the value of the long-term
assurance business, and the balance relates primarily to the net assets of the
shareholders funds, which includes a #500 million contingent loan and #200
million of capital lending. The increase in these deductions over the year
relates to a net increase in the exposure to the Group's life businesses,
arising from the level of capital injections into the subsidiaries outweighing
the fall in embedded value of these businesses. Remaining deductions largely
relate to investments in various special purpose vehicles, which have grown
primarily as a result of increased utilisation of wholesale credit protection
vehicles, which has now been curtailed.
Risk weighted assets
Retail Banking risk weighted assets have increased by #4.2 billion, principally
as a result of movements in the mortgage assets which carry a 50% risk
weighting. These include #3.1 billion of RWAs relating to net lending and the
transfer of social housing assets equating to #1.7 billion RWAs from Wholesale
Banking partially offset by the net impact of mortgage asset securitisations.
Wholesale Banking risk weighted assets have decreased by #9.2 billion due to
asset portfolio disposals and the transfer of Social Housing to Retail Banking,
offset by the transfer in of #1.1 billion of bond related risk weighted assets
previously reported in Wealth Management and Long-Term Savings.
The corresponding decline in Wealth Management and Long-Term Savings risk
weighted assets was partially offset by lending growth in cahoot.
Risk weighted assets in the trading book have fallen by #2.3 billion reflecting
sales and the reduction in the regulatory capital charge for fixed income and
equity derivatives following approval by the FSA of the use of Abbey National
Financial Products' risk models.
Capital ratios
Reconciliation of Equity Tier 1 # m %
___________ ___________
Equity Tier 1 as at 1 January 2002 (restated) 6.3
Capital impacts:
- Trading profit after tax (before EV re-basing and goodwill) 546 +0.7
- Embedded value re-basing after tax (480) -0.6
- Dividends (ordinary, preference & minorities) (486) -0.6
- Scrip dividends and other 125 +0.2
___________ ___________
(295) -0.3
Risk weighted asset impacts:
- Personal Financial Services lending growth 4,192 -0.3
- Wholesale Banking risk weighted asset reduction (9,224) +0.6
- Wealth Management asset transfer, and other (721) +0.1
___________ ___________
(5,753) +0.4
___________
Equity Tier 1 as at 31 December 2002 6.4
___________
Note: The goodwill impairment and amortisation after tax of #1,202 million does
not impact Equity Tier 1.
The Group's equity Tier 1 ratio was stable at 6.4% at 31 December 2002, compared
to the restated 2001 ratio, with the impact of the embedded value re-basing and
other adjustments more than offset by the lower dividend payout and the
reduction in risk weighted assets, particularly in the Wholesale Banking
business.
Potential impact of Life Assurance on Equity Tier 1
The following analysis illustrates the impact on the Group's equity Tier 1 ratio
should the assets of the long-term assurance business (per supervisory
deductions) be supported by Group capital in the same proportion as its banking
businesses (circa 38% equity) - rather than being treated as a deduction from
total capital as required by current FSA regulations.
Balance Sheet Equity Tier 1
# m %
___________ ___________
Equity Tier 1 as reported 5,072 6.4
Less:
Illustrative equity funded element of Life investment (1,426) -1.8
___________ ___________
Banking Equity Tier 1 Ratio 3,646 4.6
___________ ___________
There are a number of potential medium term accounting and regulatory
developments, which may impact the calculation of banking and insurance capital
in coming years. Inter alia, these relate to a variety of insurance, regulatory
initiatives, Basel II banking reforms and other issues such as IAS. Some of
these developments may be adverse to existing capital ratio calculations (such
as the one illustrated above), while others are likely to be positive, notably
in the mortgage book.
2.5.2: Analysis of life assurance capital
Value of long-term assurance business
31 December 31 December
2002 2001
Restated
# m # m
___________ ___________
Net present value of future profits 1,209 1,202
Net assets held by long-term assurance funds 1,107 460
___________ ___________
Embedded value of the long-term assurance business 2,316 1,662
Contingent loan to Scottish Provident's with-profits sub fund (1) 619 628
___________ ___________
Total value of long-term assurance business 2,935 2,290
___________ ___________
(1) The Scottish Provident with-profits fund has a liability to repay a debt to
the Group in respect of a contingent loan established as part of the
de-mutualisation scheme. A condition of the arrangement is that the surplus
emerging on the non-participating fund accrues to the benefit of the
with-profits fund until such time as the obligations under the loan are fully
discharged; and that recourse for repayments on the loan is restricted to the
surplus emerging on the Scottish Provident non-participating fund. The carrying
value of the debt is covered by the current value of the future earnings on the
non-participating fund.
(2) In addition, during 2001 Scottish Mutual received capital support from the
Group in the form of a contingent loan of #500 million, not included in the
table, that forms part of the net assets of the shareholders funds and therefore
total supervisory deductions. This was used to support the new business strain,
and was structured as a contingent loan to ease repayment at a later date.
The shareholders' interest in the long-term business operations is represented
by the embedded value. The embedded value is the total of the net assets of the
long-term operations and the present value of the projected releases to
shareholders arising from the business in force. During 2002 the present value
of the in-force business was broadly flat. Although the underlying business
in-force has increased, the impact of the stock market falls coming through the
embedded value re-basing offsets this rise. The increase in net assets is
largely attributable to the capital injections made during 2002 offset by the
guaranteed liability/MVA adjustments and capital required to support new
business.
Movements in embedded value of the long-term assurance business # m
___________
Opening value as at 1 January - as previously stated 2,015
Restatement resulting from accounting policy change (including impact on all prior years) (353)
___________
1,662
Transfers to shareholders' funds (16)
Increase in value of long-term assurance businesses after tax 252
Embedded value re-basing and other adjustments after tax (480)
Capital injections 913
Dividends paid to Abbey National Group (15)
___________
Closing value as at 31 December 2002 2,316
___________
Part of the movement in embedded value relates to prior years impact of moving
to an unsmoothed position. This reduces the opening value by #353 million. The
increase in the value of long-term business is achieved through ongoing
management of the business and writing new business and represents the value
added before consideration of market movements. The re-basing adjustment
reflects 2002 changes related to the move to an unsmoothed basis together with
the other items discussed in Section 4.1.
During 2002, injections into the long-term funds included #825 million to
Scottish Mutual, in six separate tranches and #88 million to Scottish Mutual
International. Abbey National Life repaid #15 million from the long-term fund.
In total, including the shareholder fund, injections totalled #917 million, with
#51 million dividends paid back to the Abbey national Group in April 2002. This
equates with net injections of #866 million. Since the year-end Scottish
Provident received a capital injection of #120 million.
Life assurance ratios (1)
As at 31 Dec 2002 As at 31 December 2001
SMA (2) ANL SP SMA ANL SP
% % % % % %
_______ _______ _______ _______ _______ _______
Free asset ratio 1.8 3.7 0.8 3.4 3.8 5.9
Solvency ratio 157 192 129 204 197 259
_______ _______ _______ _______ _______ _______
(1) The Life Assurance ratios are an estimate as at the time of signing the
accounts. They will be finalised upon completion of the Group's regulatory
returns, in March 2003.
(2) Scottish Mutual International is included as part of Scottish Mutual (SMA)
in the above table.
The Abbey National Group manages its capital requirements on a consolidated
basis. Capital is held centrally and allocated to business segments as required.
The ratios have been calculated according to the FSA guidelines in force at that
time. The ratios include the negative impact of reducing the implicit item by
#50 million to #250 million for solvency purposes as granted by the FSA in the
regulatory returns of Scottish Mutual.
3. DIVISIONAL P&L ANALYSIS
The term "Trading profit" in this section refers to statutory profit before tax
excluding the impact of the embedded value re-basing, profits on asset
disposals, the impact of goodwill charges, expense items relating to the
implementation of the cost programme and the write-down of shares held to meet
potential employee option exercise. Please refer to reconciliations contained in
Section 7.
3.1: Retail Banking
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Net interest income 1,666 1,586 1,615
Non-interest income 801 903 916
Less: Depreciation of operating lease assets (23) (97) (69)
___________ ___________ ___________
Total trading income 2,444 2,392 2,462
Operating expenses (1,067) (1,016) (995)
Provisions for bad and doubtful debts (139) (142) (156)
Contingent liabilities and commitments (11) (8) (11)
___________ ___________ ___________
Trading profit before tax 1,227 1,226 1,300
___________ ___________ ___________
Adjust for:
- Embedded value re-basing (32) (34) (13)
- Cost programme implementation (16) - -
- Profit on sale of credit card business - 49 -
___________ ___________ ___________
Statutory profit before tax 1,179 1,241 1,287
___________ ___________ ___________
Trading profit by business:
Mortgage and Savings 904 911 934
Banking and Unsecured Lending 26 25 68
___________ ___________ ___________
Retail Bank 930 936 1,002
Abbey National Life 205 202 182
General Insurance 92 88 116
___________ ___________ ___________
1,227 1,226 1,300
___________ ___________ ___________
Cost: income ratio (%) 43.7 42.5 40.4
Cost: income ratio (excl. AN Life) % 47.4 46.2 43.6
Average spread (%) (1) 1.79 1.86 2.01
Average margin (%) (1) 2.03 2.11 2.27
Average risk weighted assets (# bn) (2) 41.6 38.4 36.1
Post-tax return on regulatory equity (%) (2) 24.5 26.3 31.7
___________ ___________ ___________
(1) Spread and margin calculations exclude Unsecured Lending, Business Banking,
General Insurance and Abbey National Life.
(2) RWA and RoE analysis excludes Abbey National Life. The RoE is before the
allocation of Group Central costs.
Commentary by P&L
Trading profit before tax remained flat at #1,227 million (2001: #1,226
million).
Net interest income of #1,666 million was up 5% (2001: #1,586 million). This
reflected asset growth, partially offset by the expected spread compression and
a charge in respect of dual pricing of #9 million. The Retail Banking spread was
179 basis points (2001: 186 basis points), and 175 basis points for the second
half.
Trading non-interest income (net of operating lease depreciation) fell by 3% to
#778 million (2001: #806 million), due primarily to reduced income as a result
of the sale of First National Vehicle Holdings (FNVH). On a like-for-like basis,
non-interest income was broadly in line with last year reflecting increased
general insurance commission income offset by reduced ATM fee income and
commission on sales of Abbey National Life policies.
Trading operating expenses of #1,067 million were up 5% (2001: #1,016 million).
The increase relates primarily to investment in general insurance and customer
relationship management platforms. In addition, there was an increase in
headcount related spend in attacking the 'big 4' in current accounts and SME
banking, and increased pension fund costs also had an impact. This was in part
offset by the removal of costs associated with FNVH, the net impact of which was
a #15 million reduction.
The provision charge for bad and doubtful debts reduced for the third
consecutive year to #139 million (2001: #142 million). This reflects both the
favourable economic conditions through 2002, as well as improvements to the
overall quality of the lending portfolio as a result of effective risk and debt
management operations.
The business has also taken a cautious approach to higher multiple secured
lending to certain market segments, coupled with a reduction in the proportion
of mortgage lending to customers with a loan to value of above 90%. Arrears
levels and properties in possession continued to improve throughout the year.
Contingent liabilities of #11 million (2001: #8 million) relate to additional
misselling provisions.
Commentary by business
Trading profit before tax in Mortgages and Savings was slightly down to #904
million (2001: #911 million) due to the managed spread decline partly offset by
growth in the mortgage asset.
Trading profit before tax in Banking and Unsecured Lending of #26 million
increased 4%. This reflected improved contributions from the new credit card
arrangements and the benefit of risk based pricing in unsecured personal
lending, partly offset by increased investment in the current account and SME
business offering.
Abbey National Life trading profit before tax of #205 million was up 1% (2001:
#202 million) despite the fall in sales of the "with-profits" bond. This
reflects a one-off adjustment of #35 million to reflect positive mortality
experiences in recent years, and the fall in new business profit being partially
offset by a 80% increase in investment ISA and unit trust sales, and a 35%
increase in protection new business. Income is calculated on an embedded value
basis, with #28 million (2001: #25 million) of expenses incurred in the year
offset within non-interest income.
In General Insurance, profit before tax increased by 5% to #92 million (2001:
#88 million), driven by a strong growth in new business sales of 20%.
3.2: Wealth Management and Long-Term Savings
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Net interest income 739 641 632
Non-interest income 97 154 130
Less: Depreciation of operating lease assets (5) (7) (9)
___________ ___________ ___________
Total trading income 831 788 753
Operating expenses (378) (392) (452)
Lending provisions (129) (121) (117)
Other provisions (2) - 5
___________ ___________ ___________
Trading profit before tax 322 275 189
___________ ___________ ___________
Adjust for:
- Embedded value re-basing (600) (409) (89)
- Cost programme implementation (14) - -
___________ ___________ ___________
Statutory (loss) / profit before tax (292) (134) 100
___________ ___________ ___________
Trading profit by business:
Scottish Mutual 133 164 113
Scottish Provident 46 30 -
First National 110 94 130
Wealth Management (incl. European Operations) 58 50 9
cahoot (25) (63) (63)
___________ ___________ ___________
322 275 189
___________ ___________ ___________
Commentary by P&L
Growth in net interest income of #98 million to #739 million (2001: #641
million) reflected an improved contribution from cahoot and the European
Operations. In addition, there was a full year impact of earnings on the
contingent loan to Scottish Provident that is reported as part of net interest
income.
Trading non-interest income (net of depreciation of operating lease assets) fell
to #92 million (2001: #147 million) as a result of a lower contribution to
profit from new business in Scottish Mutual, and the non-recurrence of one-off
items included in the 2001 First National results.
Trading operating expenses were down 4% at #378 million (2001: #392 million),
largely due to reduced costs in cahoot and reduced investment spend in First
National. Income from the Life Assurance businesses is calculated on an embedded
value basis, with #209 million (2001: #161 million) of expenses incurred in the
year offset within non-interest income. The 2001 expenses include only five
months of Scottish Provident.
Growth in provisions to #131 million (2001: #121 million) was largely due to
asset growth in cahoot.
Commentary by business
Trading profit before tax in Scottish Mutual (excluding the impact of Scottish
Provident) was down by 19% at #133 million, largely due to reduced sales of UK
based "with-profits" bonds partly offset by the benefit of positive experience
variances.
Scottish Provident contributed #46 million in trading profit before tax, up from
#30 million in 2001, reflecting the full year effect, improved new business
contribution and the realisation of synergy benefits of which 86% (after
allowing for the increase in new business volumes) are now in place. Integration
costs of #16 million were incurred in this period, offset by the inclusion of
part of the related cost saving.
Trading profit before tax in First National was up 17% to #110 million (2001:
#94 million), driven by growth in secured lending, a recovery of profits in
Motor Finance, a significant reduction in the cost base following completion of
certain investment projects, and further cost savings put in place through 2002.
This more than offset a fall in income reflecting the poor market conditions in
Retail Finance, and the non-repetition of one-off profits included in 2001.
Credit quality across this business remains sound.
Wealth Management profits increased to #58 million (2001: #50 million). This
reflects strong growth in deposit balances in Cater Allen Private Bank, and the
return to profitability of operations in Continental Europe, partly offset by
spread narrowing in Abbey National Offshore driven by low interest rates, and
increased investment spend across the businesses including the integration and
re-branding of Fleming Premier Banking into Cater Allen Private Bank.
cahoot made good progress through 2002 in moving towards profitability, with
losses more than halving to #(25) million. Losses in the second half reduced to
#8 million, largely due to successful re-pricing of the in-credit liability and
growth in unsecured lending combined with reduced costs as the business matures
from launch phase.
3.3: Wholesale Banking
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Net interest income 459 508 441
Non-interest income 564 605 423
Less: Depreciation of operating lease assets (214) (152) (100)
___________ ___________ ___________
Total income 809 961 764
Operating expenses (214) (186) (155)
Provisions (760) (256) (34)
Losses on disposal of credit impaired assets (104) (15) -
IEM impairment (38) - -
___________ ___________ ___________
Trading (loss)/profit before tax (307) 504 575
___________ ___________ ___________
Adjust for:
- Profit on sale of leasing companies 44 - -
- Goodwill impairment (16) - -
- Cost programme implementation (3) - -
___________ ___________ ___________
Statutory (loss) / profit before tax (282) 504 575
___________ ___________ ___________
Commentary by P&L
Trading loss before tax of #307 million (2001: profit of #504 million) was down
#811 million, largely resulting from increased provisions, losses on disposal of
credit impaired assets and IEM impairment.
Total trading income of #809 million was 16% lower than last year (2001: #961
million). Net interest income fell by #49 million due predominantly to the
reduction of the investment portfolio. Trading non-interest income (net of
depreciation) decreased by #103 million due to #71 million lower dealing profits
and lower fees.
Trading operating expenses increased by 15% to #214 million (2001: #186
million), primarily as a result of 2001 expansion which, whilst now curtailed,
had a significant full period impact in 2002. Operating expenses in the second
half were adversely impacted by the costs associated with the move to new
premises.
Wholesale Banking provisions increased to #760 million (2001: #256 million). In
total, the cost of credit and impairments was #902 million (2001: #271 million)
including #104 million of credit impaired asset disposal losses taken through
the non-interest income line, and a #38 million IEM impairment charge in
depreciation of operating lease assets. In total, the charges related to
exposure to high yield securities, private equity, operating leases and
corporate securities/loans in light of the difficult global credit conditions.
3.4: Group Infrastructure
31 December 31 December 31 December
2002 2001 2000
# m # m # m
___________ ___________ ___________
Net interest income (175) (43) (8)
Non-interest income 106 66 80
Less: Depreciation of operating lease assets - - -
___________ ___________ ___________
Total trading income (69) 23 72
Operating expenses (252) (226) (205)
Provisions (34) 17 (13)
___________ ___________ ___________
Trading loss before tax (355) (186) (146)
___________ ___________ ___________
Adjust for:
- Goodwill impairment (1,122) - -
- Goodwill amortisation (64) (36) (12)
- Share write-downs (37) - -
- Cost programme implementation (11) - -
- Other asset disposals - 81 65
___________ ___________ ___________
Statutory loss before tax (1,589) (141) (93)
___________ ___________ ___________
Commentary by P&L
Trading loss before tax in Group Infrastructure increased from #186 million to
#355 million.
Movements between net interest income and non-interest income largely reflect
the impact of the recapitalisation adjustments for the Life businesses.
Effectively the cost of additional subordinated debt and injections into the
Life businesses is adversely impacting net interest income, whilst non-interest
income has improved due to the charge for additional capital being used by the
Life companies.
Trading income of #(69) million was #92 million lower than 2001. This is largely
due to the full year funding impact of the Scottish Provident acquisition, and
the impact of increased gearing levels being borne centrally.
Trading expenses in Group Infrastructure increased by #26 million to #252
million (2001: #226 million) driven by increased headcount (particularly in
internal audit and risk), costs relating to the relocation of head office (#21
million - an element of which is non-recurring), and increased pension costs (#7
million). This has been partly offset by reduced corporate advisory fees.
Provisions increased by #51 million to #34 million in part due to 2001 provision
write backs not repeated of #25 million. In addition, further provisions have
been raised in 2002 against potential claims.
Outlook for 2003
The net trading loss before tax is expected to reduce in 2003, as the benefits
of the cost programme start to impact and certain one-off expenses incurred in
2002 are not repeated,
This information is provided by RNS
The company news service from the London Stock Exchange
MORE TO FOLLOW
FR UVUUROBRUUUR