RNS Number:2803B
HBOS PLC
01 August 2007
1 August 2007
HBOS plc Interim Results 2007
Stock Exchange Announcement
Contents
Highlights 3
Chief Executive's Report 4
Financial Highlights 12
Key Divisional Statistics 15
Summary Consolidated Income Statement 17
Summary Consolidated Balance Sheet 17
Divisional Reviews
Retail 18
Corporate 24
Insurance & Investment 29
International 37
Treasury & Asset Management 51
Financial Review 54
Financial Information 66
Consolidated Income Statement 67
Consolidated Balance Sheet 68
Consolidated Statement of Recognised Income and Expense 69
Consolidated Cash Flow Statement 70
Notes to the Accounts 72
Independent review report to HBOS plc 75
Supplementary Embedded Value Information for the UK Investment Business 76
Expected Timetable 80
Contacts 81
Page 2
HBOS plc 2007 Interim Results
Group Highlights * Profit before tax up 13% to #2,997m.
* Underlying profit before tax up 13% to #2,962m.
* Basic earnings per share up 22%(1) to 55.1p.
* Underlying earnings per share up 16%(1) to 54.6p.
* Interim dividend up 23% to 16.6p, with the expected full year dividend payout ratio
increasing from 41% to around 46%.
* Share buyback totals #394m year to date out of our current #500m programme.
* Group post tax RoE increases to 21.0% (H1 2006 20.5%).
* Group net interest margin at 168bps (H2 2006 171bps, H1 2006 174bps).
* Lending grows at an annualised 10% to #395.2bn; customer deposits grow at an
annualised 14% to #227.1bn.
* Impaired loans flat at 2.19% of advances (end 2006 2.18%); closing provisions
represent 0.79% of advances (end 2006 0.82%).
* Underlying operating income up 11% at #6,427m (H1 2006 #5,797m).
* Underlying net interest income 1% lower at #3,626m (H1 2006 #3,647m). On a
like-for-like basis(2), underlying net interest income is 4% higher.
* Underlying non-interest income 30% higher at #2,801m (H1 2006 #2,150m).
* Group underlying operating expenses up 8% at #2,563m (H1 2006 #2,369m).
* Group cost:income ratio improves to 39.9% (H1 2006 41.3%).
* Tier 1 capital ratio 8.0%, total capital ratio 12.0% (end 2006 8.1% and 12.0%).
Divisional Highlights * Underlying profit before tax in Retail down 8%, Corporate up 54%, Insurance &
Investment up 10%, International up 12% and Treasury & Asset Management up 24%.
* Annualised lending; Retail up 4%, Corporate up 14%, International up 34%.
* Retail estimated market shares; UK gross mortgage lending 19%, UK net mortgage
lending 8%, new Current Accounts 24%, Household Sector Liquid Assets 16%, and new
Credit Card accounts 10%.
* Annualised customer deposit growth; Retail up 9%, Corporate up 12% and International
up 27%.
* General Insurance sales fall 1% (excluding Paymentshield); Household up 8%,
Repayment down 9% and Motor up 9%.
* UK Investment sales rise 11% to #1,004m APE; Bancassurance up 16%, Intermediary down
10% and Wealth Management up 32%.
* Cost:income ratios; Retail 38.8% (H1 2006 38.5%), Corporate 22.8% (H1 2006 27.1%),
International 47.0% (H1 2006 44.1%) and Treasury & Asset Management 47.2% (H1 2006
46.4%).
* Net interest margins; Retail 173bps (H2 2006 176bps, H1 2006 180bps), Corporate
212bps (H2 2006 213bps, H1 2006 237bps), and International 190bps (H2 2006 198bps,
H1 2006 197bps).
* Impaired loans; Retail 2.67% (end 2006 2.72%) of closing advances, Corporate 1.58%
(end 2006 1.30%) and International 1.17% (end 2006 1.19%).
Supplementary EV * Underlying earnings per share on a Full EV basis 5% higher than reported under IFRS.
Information(3)
* Total Group embedded value (net of tax) on a Full EV basis of #7.4bn, #2.7bn higher
than reported under IFRS.
* New Business Contribution from UK Investment Business on a Full EV basis #255m
higher than under IFRS (H1 2006 #235m).
(1) Growth in basic EPS is higher than growth in underlying EPS because we have
excluded from the latter the net favourable items detailed in the reconciliation
on page 14.
(2) Excluding the impact of the sale of Drive, the acquisition of Lex and
non-interest income bearing Treasury investments analysed on page 56.
(3) The Full EV basis shows the Group's results had investment contracts been
accounted for on an Embedded Value basis rather than the IFRS reporting basis.
This is further explained in the supplementary Embedded Value information on
pages 76 to 79.
Page 3
CHIEF EXECUTIVE'S REPORT
Profit momentum In the first half of 2007, HBOS has again delivered another strong set of results,
with further momentum in underlying earnings from the Group's increasingly balanced
range of businesses.
Reported profit before tax increased by 13% to #2,997m (H1 2006 #2,654m) and
underlying profit before tax increased by 13% to #2,962m (H1 2006 #2,612m). Each
division, with the exception of Retail, delivered double digit underlying profit
growth.
This profit performance, together with the positive contribution from recent share
buyback programmes, delivered underlying earnings per share up 16% to 54.6p (H1 2006
47.0p) and an increase in post tax return on equity to 21.0% (H1 2006 20.5%).
These results demonstrate that we are now benefiting from five years of diversifying
our earnings base, allowing us to deliver double digit earnings growth even in
tougher retail markets. We have also yet again delivered on our pledge of achieving
further improvements in our cost:income ratio. This has fed straight through to
improved returns for our shareholders.
The 16% increase in underlying earnings per share at the same time as a further
reduction in the cost:income ratio demonstrates the strength and diversity of the
HBOS UK and International operating model.
Dividends and Capital Since our last step change in capital management in 2005, HBOS has returned #2.4bn
of surplus capital to shareholders via share buybacks and maintained a dividend
payout ratio of around 41%, with dividends increasing closely in line with earnings.
It is clear that HBOS has a strong capital generation capability, as a natural
consequence of returns on equity running above 20%, increased capital generation
from our Investment businesses, and the benefits to be derived from the move to
Basel II. The combination of this strong capital generation and our confidence in
future earnings momentum, has led us to conclude that we should now enhance our
approach to capital management still further.
We intend therefore, without sacrificing any of our current capacity to support
growth, to step up our dividend payout ratio from 41% to around 46% in 2007.
As a result, we have today declared an interim dividend of 16.6p, an increase of 23%
over the first half of 2006, and it is our intention that the full year dividend for
2007 will increase to reflect the enhanced 46% payout ratio. Following this step
change in the level of dividend payout, our policy will be to increase dividends
broadly in line with underlying earnings growth. We will also continue to use share
buybacks as a flexible tool by which we return capital in excess of the amount
required to support growth in any particular year.
Our Tier 1 ratio of 8.0% at 30 June 2007 (end 2006 8.1%) remains at our Basel I
target level and our total capital ratio was 12.0% (end 2006 12.0%). We expect to
brief the market on the benefits to emerge over time from our future Basel II
capital position at our 2007 Preliminary Results in February 2008, after
confirmation from the FSA of our new capital requirements. In the meantime we
remain on track to complete our 2007 share buyback programme of #500m, #394m of
shares having been bought back for cancellation year to date.
Page 4
Growth Advances to customers increased by an annualised 10% to #395.2bn (end 2006
#376.8bn). While Retail advances grew by 4%, Corporate and International both
delivered excellent growth rates with advances increasing by 14% and 34%,
respectively.
Customer deposits have also grown strongly by an annualised 14% to #227.1bn (end
2006 #211.9bn) and investment funds under management have grown by an annualised 10%
to #139.6bn (end 2006 #132.8bn).
Margins The Group net interest margin reduced by 3bps in the first half of 2007 to 168bps
(H2 2006 171bps, H1 2006 174bps).
In Retail, an overall 3bps fall in the margin reflects strong competition in the
mortgage market, offset by increased margins from banking and savings products. In
Corporate, margins fell 1bp as our selective hold appetite continues to focus on
managing overall returns. In International, margins have declined 8bps mainly as a
result of business mix changes as we source a higher proportion of income from
retail markets in Australia and Ireland.
In the UK Investment Business, new business profitability improved to 29% APE (H2
2006 27%, H1 2006 26%).
Efficiency Underlying operating income increased by 11% to #6,427m (H1 2006 #5,797m) whilst
underlying operating expenses increased by 8% to #2,563m (H1 2006 #2,369m).
Underlying net interest income increased by 4% on a like-for-like basis but fell 1%
on the comparative period, primarily reflecting lower growth in Retail and the
impact of the Drive and Lex transactions in 2006. Underlying non-interest income
increased by 30%, reflecting strong realisations in Corporate, partially offset by
lower fee income in Retail.
Positive operating 'jaws' thus delivered a reduction in the Group cost:income ratio
to 39.9% (H1 2006 41.3%). This improvement in our cost:income ratio was achieved
despite expenses incurred in the first stages of our efficiency programme and we are
on track to deliver our goal of a mid-thirties cost:income ratio by 2010.
Allowing for the timing of our investments supporting our International expansion
and our efficiency programme, we continue to expect that cost growth for the year as
a whole will be around 7%.
Credit Quality The credit environment across the Group remains benign by historic standards and in
line with previous trends. Impaired loans as a % of advances were stable at 2.19%
(end 2006 2.18%) whilst impairment losses increased by 11% to #963m (H1 2006 #864m)
representing 0.25% of average customer advances (H1 2006 0.24%).
In Retail, we believe unsecured impairments have now peaked, with the combination of
impaired loans as a % of advances being slightly lower than six months ago and an
increase in provision coverage of impaired loans in the first half of 2007
supporting the view that unsecured impairment losses will be lower in the second
half. Secured impairments and provisioning continue to reflect the strong collateral
in our book.
Page 5
Corporate credit conditions remain robust with impairment losses in the first half
of 2007 lower than in the second half last year. In International, credit
conditions also remain robust.
Taxation and Regulation As a result of the 2007 Finance Act, the main UK corporation tax rate will reduce
from 30% to 28% from April 2008. This has resulted in a net benefit of #97m to
reported attributable profit arising from a reduction in deferred tax net
liabilities of #110m offset by a #13m (#18m pre-tax) reduction to the value of
leasing assets. This one-off net benefit has been excluded from our underlying
results.
Regulatory pressure across the UK retail banking industry is currently tempering the
prospects for more positive momentum in non-interest income. In the middle of 2006,
we reduced Credit Card default fees in response to an OFT ruling and Mortgage exit
fees in response to a FSA determination, the combined impact of which is expected to
be a #65m reduction in fee income throughout 2007.
The publicity generated by the OFT market study into current account charges has
generated an industry wide increase in customer requests for refunds of current
account service fees (in particular, unauthorised overdraft fees). In the first
half of 2007, such refunds, including amounts agreed in principle but not yet paid,
together with the associated administration costs, amounted to #79m, and were
reported outside of our underlying results as they relate predominantly to fees
charged in prior years. On 27 July it was announced that we, along with seven other
major UK current account providers, had reached agreement with the OFT to start
legal proceedings in the High Court of England and Wales for a declaration to
resolve legal uncertainties concerning the level, fairness and lawfulness of
unauthorised overdraft charges. In the meantime, we and the other major UK current
account providers are seeking a stay of all current and potential future Court
proceedings regarding these fees which are brought against us in the UK, prior to
the resolution of the test case. We have also obtained the consent of the Financial
Ombudsman not to proceed with consideration of the merits of any complaints
concerning these charges that are referred to him prior to the resolution of the
test case. The outcome of the test case is unlikely to be known for at least 12
months. Given the very early stage of these proceedings and the uncertainty as to
their outcome, it is not practicable at this time to estimate any potential
financial effect.
The Competition Commission review of Payment Protection Insurance is expected to run
well into next year and in the meantime it is likely that growth in this market will
not only be curbed by the appetite for unsecured credit but also by the uncertainty
of the review's outcome.
Finally, we welcome the Competition Commission's enquiry into the regulatory regime,
including price controls for SME banking services. This is a market in which we are
currently under-represented and thus we intend to press for measures that will also
help stimulate more customer choice.
Page 6
Divisional Performance
Retail Underlying profit before tax decreased by 8% to #1,043m (H1 2006 #1,133m).
Underlying net operating income was unchanged against the first half of 2006, net
interest income growth being held back by lower mortgage net lending and
non-interest income falling as the full year effect of changes to Credit Card fees
in 2006 emerges.
Underlying operating expenses also remained flat compared to the first half of 2006
reflecting further productivity improvements and the cost:income ratio remained
broadly stable at 38.8% (H1 2006 38.5%).
Advances increased by an annualised 4% reflecting our lower net mortgage share and
our continuing caution in unsecured markets, whilst deposits increased by an
annualised 9%. The overall movement in net interest margin to 173bps (H2 2006
176bps, H1 2006 180bps) reflects strong pressure on mortgages largely offset by
better margins on liability products.
In Mortgages, our estimated gross lending market share in the first half of 2007 was
lower at 19% (2006 21%) as a consequence of the pricing strategy introduced in the
second half of 2006 which was designed to trade an element of gross share for
improved margins and lower principal repaid. Our estimated share of principal
repaid, however, remained at 24% (2006 24%), the new pricing strategy proving to be
largely unsuccessful. The combination of these factors saw our estimated share of
net lending reduce to 8% (2006 17%).
Having taken corrective action to our pricing strategy, the strength of the HBOS
franchise has been demonstrated by the speed with which we have returned to our
15-20% net lending range in May and June. We also expect to trade in this range
through the second half of the year.
The mortgage market has gone through a significant structural change over the last
year, which has seen declining margins and shortening average lives. In part, this
is a natural consequence of our continuing preference to take around 30% of our
lending from the specialist sector where the returns are higher but the average life
shorter, owing to the highly intermediated nature of the specialist market. However,
HBOS, with our five brand distribution strengths and our low cost base, is
particularly well placed to emerge from the current changes in the mortgage market
as a clear long term winner.
Elsewhere in Retail, we continue to make good progress with product sales across the
Retail product range. The real strength of the HBOS franchise is best illustrated
by our performance on the liability side of the balance sheet over the past six
months. In Bank Accounts, our high interest current account, backed up with a high
profile TV campaign, has been very successful and we have increased our share of new
current accounts to 24%.
Savings inflow has also been extremely encouraging. We are successfully exploiting
our position as the "clear number one" in Savings and we are seeing growth in
customer numbers and balances ahead of the market. In total we have opened over
900,000 new savings accounts, with around 16% of these by new customers. Savings
balances increased by an annualised 11%.
Retail credit trends are robust and in line with our previous guidance. Retail
impaired loans as a % of closing advances decreased to 2.67% (end 2006 2.72%).
Secured impaired loans as a % of closing advances were slightly higher at 1.86% (end
2006 1.84%) reflecting a modest increase in specialist arrears offset by continuing
improvements in mainstream arrears. Secured impairment losses were again minimal,
reflecting the strong collateral in the book.
Page 7
Retail unsecured impaired loans as a % of advances decreased to 12.9% (end 2006
13.2%) giving us confidence that, when coupled with recent trends in respect of IVAs
and insolvencies, unsecured impairments have now peaked. Unsecured impairment
losses in the first half of 2007 increased by 33%, strengthening unsecured provision
coverage from 71% to 76%, our expectation being that the improving trend of
unsecured impairments will lead to a lower charge in the second half.
Underlying profit before tax increased 54% to #1,243m (H1 2006 #809m) with a
continued excellent performance from the core UK operations now supplemented by
strong growth from our European operations.
Corporate
Underlying net operating income increased by 42%, reflecting good lending fee income
and very strong revenues from the investment portfolio. Underlying net interest
income was broadly stable with the net interest margin at 212bps (H2 2006 213bps, H1
2006 237bps), the corresponding period last year benefiting from the inclusion of
Lex as a joint venture and from higher levels of early redemption premia. The
strength of the Corporate franchise is demonstrated by the achievement of a stable
margin against the second half of 2006, whilst still delivering good growth in
lending.
Underlying operating expenses increased by 19% which included the consolidation of
Lex from 31 May 2006. Excluding Lex, the increase in underlying expenses was 13% as
a result of performance based remuneration and continued investment in enhanced risk
management capabilities.
We continue to approach the UK corporate market from a selective and cautious
standpoint. Despite the strong deal flow in the market, we have not participated in
deals with sub-optimal risk-adjusted returns or weaker covenants. However, the
strength of our franchise and, in particular, our partnership approach with clients,
has supported strong ongoing growth.
Lending originations grew at an annualised 22% but, as in previous years, we
utilised sell down, this time to a hold level of 14% annualised growth. Both the
origination and hold growth rates are ahead of the 2006 outcome, reflecting the
strength of both our origination franchise and our distribution capabilities.
Customer deposits increased by an annualised 12% to #41.9bn (end 2006 #39.5bn) as we
completed the move to focus our deposit gathering on sources suitable for funding
purposes.
The book value of the investment portfolio increased to #2.9bn (end 2006 #2.6bn)
despite strong first half realisations. The stock of unrealised gains is broadly
unchanged from the start of the year and the portfolio continues to be exceptionally
well diversified across more than 600 investments.
Page 8
Corporate credit quality remains robust. While impaired loans as a % of advances
increased to 1.58% (end 2006 1.30%), impairment losses as a % of average advances
improved to 0.25% against the second half of 2006 (H1 2006 0.22%, H2 2006 0.29%).
Forward looking credit indicators remain favourable although we continue to exercise
caution in our underwriting and pricing disciplines at this stage in the credit
cycle. In particular, given the potential for reduced liquidity in the secondary
markets, we continue to underwrite and price our originating activity on the
assumption that we would be comfortable holding the business on our balance sheet if
required to do so.
Insurance & Investment Underlying profit before tax increased by 10% to #316m (H1 2006 #287m).
Underlying profit before tax for the General Insurance business reduced to #107m (H1
2006 #163m) as a result of a significant increase in claims arising directly from
the storms in January and the floods in June, the latter event estimated to have
cost #60m in claims. The recent flooding in south and central England in July will
give rise to further significant claims. Our current expectation is that the claims
arising from this latest event will be modestly higher than that for the June
floods.
General Insurance sales fell 1% to #868m GWP (H1 2006 #874m excluding Paymentshield
of #45m). Household Insurance sales increased by 8%, as strong volume growth in our
branch network and improved cross sales with intermediaries more than offset a
competitive pricing environment. Motor Insurance sales increased 9%, benefiting
from esure's prominent position in the growing internet segment. Repayment
Insurance sales fell by 9% as a consequence of reduced consumer credit volumes and
the uncertainty arising from the Competition Commission enquiry into Payment
Protection Insurance.
Underlying profit before tax for our Investment Business increased by 69% to #209m
(H1 2006 #124m), reflecting the growth in profits from investment business as the
existing book of business grows in relative size.
UK Investment sales increased by 11% to #1,004m APE (H1 2006 #904m). Bancassurance
sales increased by 16% as further productivity gains allowed us to consolidate our
position as the market leader. In the Intermediary market, our more selective value
based approach which saw us withdraw from the Group pensions market in the first
half of 2007, resulted in 10% lower sales. Wealth Management enjoyed an outstanding
first half with sales up 32%. New business profitability improved to 29% of APE (H2
2006 27%, H1 2006 26%), well above our 25% benchmark.
On pages 76 to 79, we have provided supplementary embedded value ('Full EV')
information for our Investment Business. On a Full EV basis, in the six months to
30 June 2007, Group underlying profit before tax was #136m higher than under IFRS
and underlying earnings per share was 2.5p or 5% higher. The total net of tax
embedded value for our UK Investment Business at 30 June 2007 was #6,681m, #2,735m
(end 2006 #2,525m) higher than reported under IFRS.
International Underlying profit before tax in International increased by 12% to #327m (H1 2006
#293m, restated to exclude our European corporate business which transferred to
Corporate in the first half of 2007 and Drive which was sold in December 2006).
This is a particularly strong result given the significant levels of investment we
are making across the division. Profits from our overseas operations (i.e.
International, Corporate Europe and overseas Treasury offices) now account for 13%
of Group underlying profit before tax.
Page 9
In Australia, underlying profit before tax increased 4% to #144m (H1 2006 #139m).
In local currency the increase was 16%. Underlying net operating income increased
by 18% reflecting strong lending and deposit growth (annualised 40% and 35%
respectively) in a buoyant economy, with some margin erosion due to business mix and
a competitive commercial environment. Underlying expenses increased by 29% in line
with the continuing investment in our distribution network and the recently
announced branch expansion on the East Coast, where we plan to open more than 125
retail branches and 35 business banking centres over the next 3 to 4 years.
Impaired loans as a % of closing advances were largely unchanged at 0.99% (end 2006
1.00%). Impairment losses as a % of average advances were also unchanged at 0.13%
(H1 2006 0.13%).
In Ireland, underlying profit before tax increased by 14% to #80m (H1 2006 #70m).
Underlying net operating income increased by 16% reflecting strong lending and
deposit growth (annualised 23% and 10% respectively). Underlying expenses increased
by 24% in line with our investment in the Retail expansion, with a market leading
personal current account launched in May and we are on track to achieve our branch
roll-out target for the remainder of the year.
Impaired loans as a % of advances decreased slightly to 1.82% (end 2006 1.87%) and
impairment losses as a % of average advances decreased to 0.06% (H1 2006 0.09%)
reflecting a generally benign credit environment.
In Europe & North America, underlying profit before tax increased by 23% to #103m
(H1 2006 #84m) driven by growth in European Financial Services ('EFS') and North
America. Underlying net operating income increased by 22% primarily reflecting
annualised 34% lending growth, at broadly stable margins. Underlying operating
expenses increased by 22% due to investment in the expansion of our distribution
capabilities, particularly in North America and Spain.
Impaired loans as a % of advances increased to 0.49% (end 2006 0.47%). Credit
performance remains strong with impairment losses as a % of average advances stable
at 0.04% (H1 2006 0.05%).
Treasury & Asset Management Underlying profit before tax increased by 24% to #194m (H1 2006 #156m). Underlying
net operating income increased by 24% driven by strong sales and trading income.
Underlying operating expenses increased by 26% as we continue to invest in the
expansion of our Treasury operations, particularly in support of International
growth. A notable feature of the first half's performance was the increasing use of
non-interest income bearing investments that have the effect of reducing net
interest income in favour of non-interest income returns.
In the first half of 2007, Treasury arranged 5 capital issues on behalf of HBOS plc
raising approximately #2.0bn in sterling equivalent and supported the raising of
#11.6bn from existing funding programmes, comprising #3.2bn of covered bonds and
#8.4bn of securitisations.
Total funds under management of our Asset Management businesses increased to
#112.3bn (end 2006 #107.8bn). The increase was after the transfer of #4.2bn of
client funds as part of an agreed sale of Equitable Life funds. Excluding this
transfer, funds under management increased by an annualised 16%, driven by strong
support for Insight's Liability Driven Investment and Fixed Income products and
Invista's property funds.
Page 10
Outlook and Strategy The UK economy continues to grow at a rate above its long term trend. This,
together with inflation above the MPC target rate, is fuelling market expectations
of at least one more increase in Base Rates, additionally impacting affordability in
the second half of 2007. House price growth is therefore expected to slow in the
second half. We expect to see a similar controlled slowdown in the commercial
property market over the next 12 months.
On the liability side of the balance sheet, the outlook remains positive and we
expect to see continued strong growth right across the range of our savings and
investment businesses during the rest of 2007.
Our strategy is based around four clear strands: Growing the UK franchise, targeted
international growth, cost leadership and capital discipline.
With annualised growth currently running at around 10% and mortgage lending back on
track, we are seeing good progress across the range of UK growth opportunities, with
a particularly pleasing performance on the liability side of the balance sheet.
In Corporate, the strength and reputation of our franchise, together with our
investment in enhanced risk management capability, has enabled us to continue to be
selective in our hold appetite while still participating in value enhancing
opportunities.
Internationally we are delivering well on our growth agenda and making significant
investments in retail and commercial distribution in Australia and Ireland to
support our long term ambitions.
Cost leadership and improving efficiency are clear hallmarks of value creation at
HBOS. We have made another substantial improvement to our cost:income ratio in the
first half of 2007 and we are on track to achieve the mid-thirties cost:income ratio
by the end of 2010.
Our view on the importance of capital discipline and efficiency at HBOS is
unchanged. We will complete our #500m share buyback programme this year. In
addition, today's 23% interim dividend increase demonstrates how our capital
discipline and efficiency is translated into a higher payout ratio for our
shareholders. Above all, today's dividend increase points to the confidence we have
in our future.
Page 11
FINANCIAL HIGHLIGHTS
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Divisional underlying profit before tax*
Retail 1,043 1,133 1,231 2,364
Corporate 1,243 809 967 1,776
Insurance & Investment 316 287 294 581
International 327 293 324 617
Treasury & Asset Management 194 156 194 350
Group Items (161) (111) (130) (241)
Drive 45 45 90
Group underlying profit before tax 2,962 2,612 2,925 5,537
Profit attributable to ordinary shareholders 2,063 1,729 2,091 3,820
Balance Sheet
Loans and advances to customers ('Advances') 395,210 361,631 376,808 376,808
Total assets 624,090 570,433 591,029 591,029
Customer deposits 227,117 208,137 211,857 211,857
Debt issued(1) 204,190 189,523 203,342 203,342
Shareholders' equity (excluding minority interests) 21,521 19,088 20,685 20,685
Capital Adequacy % % % %
Tier 1 capital ratio 8.0 8.1 8.1 8.1
Total capital ratio 12.0 12.2 12.0 12.0
Performance Ratios % % % %
Post tax return on mean equity(2) (3) 21.0 20.5 21.0 20.8
Cost:income ratio(2) (4) 39.9 41.3 40.7 41.0
Net interest margin(3) (4) 1.68 1.74 1.71 1.72
Per Ordinary Share
Earnings (basic)(5) 55.1p 45.3p 55.3p 100.6p
Earnings (underlying)(5) 54.6p 47.0p 53.5p 100.5p
Dividends 16.6p 13.5p 27.9p 41.4p
Dividend growth 23% 15% 15% 15%
Net asset value 541p 469p 516p 516p
Share Information
Closing number of ordinary shares in issue (millions) 3,745 3,801 3,764 3,764
Average number of ordinary shares in issue for basic 3,746 3,819 3,796
and underlying EPS (millions)
3,773
Value of shares bought back for cancellation (#m) 394 502 480 982
Average price per share of buyback #10.45 #9.57 #10.51 #10.01
* Refer to Definition of Underlying on page 13.
Notes 1 - 5 refer to page 14.
Page 12
Definition of Underlying
References to underlying incorporate the following adjustments:
* Excluding Retail banking fee refunds, the impact of the change in corporation tax rate, the profit on sale of
Drive, mortgage endowment compensation, goodwill impairment, policyholder tax payable, the impact of short term
fluctuations ('STFs') and changes to economic assumptions for Long Term Assurance Business accounted for on an
embedded value basis;
* Netting against income of operating lease depreciation, impairment on investment securities, changes in
insurance and investment contract liabilities, change in unallocated surplus and net claims incurred on
insurance contracts; and
* Including share of profits of associates and jointly controlled entities within underlying non-interest income.
The following table summarises the movements between underlying profit before tax and profit before tax:
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Underlying profit before tax 2,962 2,612 2,925 5,537
Retail banking fee refunds (79)
Impact of the 2008 change in corporation tax (18)
rate on the value of leasing assets (6)
Profit on sale of Drive 180 180
Mortgage endowment compensation (95) (95)
Goodwill impairment (2) (55) (55)
Policyholder tax payable 167 134 86 220
Short term fluctuations (7) (33) (92) 11 (81)
Profit before tax 2,997 2,654 3,052 5,706
Notes 6 - 7 refer to page 14.
Page 13
Notes
(1) The figures for debt issued comprise debt securities in issue and other borrowed funds.
(2) Calculated on an underlying basis.
(3) Annualised.
(4) Excluding the impact of Drive.
(5) Basic earnings per share is based on profit attributable to ordinary shareholders of #2,063m (H1 2006
#1,729m) and weighted average number of ordinary shares in issue of 3,746m (H1 2006 3,819m). Underlying
earnings per share is based on underlying profit attributable to ordinary shareholders of #2,046m (H1
2006 #1,794m).
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Profit attributable to shareholders 2,114 1,759 2,120 3,879
Preference dividends (51) (30) (29) (59)
Profit attributable to ordinary shareholders 2,063 1,729 2,091 3,820
Retail banking fee refunds 55
Impact of the 2008 change in corporation
tax rate on:
the value of leasing assets (6) 13
deferred tax net liabilities(6) (110)
Profit on sale of Drive (180) (180)
Mortgage endowment compensation 67 67
Goodwill impairment 2 55 55
Short term fluctuations 23 65 (8) 57
Profit of disposal group classified as (3) (3)
held for sale attributable to ordinary
shareholders
Underlying profit attributable to ordinary 2,046 1,794 2,022 3,816
shareholders
(6) As a result of the 2007 Finance Act, the main UK corporation tax rate will reduce from 30% to 28% from
April 2008. This has resulted in a net benefit to profit attributable to ordinary shareholders of #97m
in H1 2007, comprising a #110m reduction in deferred tax net liabilities and a #13m (#18m pre-tax)
reduction to the value of leasing assets which contain tax variation clauses that pass on the benefit
of tax changes to customers.
(7) Short term fluctuations represent the impact of fluctuations in investment returns relative to those
based on longer term assumptions and variances in policyholder tax payable from an expected charge for
the period.
Page 14
KEY DIVISIONAL STATISTICS
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
Retail
Underlying profit before tax (#m)(1) 1,043 1,133 1,231 2,364
Gross mortgage lending (#bn) 33.6 35.2 38.4 73.6
Net mortgage lending (#bn) 4.3 10.3 8.5 18.8
Gross mortgage lending market share (estimated) (%) 19 22 21 21
Principal repaid mortgage lending market share (estimated) (%) 24 23 24 24
Net mortgage lending market share (estimated) (%) 8 21 14 17
Stock of mortgages market share (estimated) (%) 20 21 21 21
Customer deposits (#bn) 151.3 135.9 144.6 144.6
Share of UK Household Sector Liquid Assets (estimated) (%) 16 16 16 16
Loans and advances to customers (#bn) 242.1 229.1 237.7 237.7
Risk weighted assets (#bn) 109.6 112.2 112.4 112.4
Impairment losses as a % of average advances (%) 0.28 0.26 0.22 0.48
Impairment provisions as a % of impaired loans (%) 32 32 33 33
Impairment provisions as a % of closing advances (%) 0.86 0.92 0.89 0.89
Impaired loans as a % of closing advances (%) 2.67 2.91 2.72 2.72
Net interest margin (%)(2) 1.73 1.80 1.76 1.78
Cost:income ratio (%)(3) 38.8 38.5 38.2 38.4
Corporate
Underlying profit before tax (#m)(1) 1,243 809 967 1,776
Loans and advances to customers (#bn) 95.8 86.0 89.6 89.6
Customer deposits (#bn) 41.9 41.1 39.5 39.5
Risk weighted assets (#bn) 111.9 100.7 106.5 106.5
Impairment losses as a % of average advances (%) 0.25 0.22 0.29 0.50
Impairment provisions as a % of impaired loans (%) 49 61 63 63
Impairment provisions as a % of closing advances (%) 0.78 0.82 0.82 0.82
Impaired loans as a % of closing advances (%) 1.58 1.35 1.30 1.30
Net interest margin (%)(2) 2.12 2.37 2.13 2.25
Cost:income ratio (%)(3) 22.8 27.1 26.8 26.9
Insurance & Investment
Underlying profit before tax (#m)(1)
Insurance & Investment 316 287 294 581
General Insurance 107 163 141 304
Investment Business 209 124 153 277
General Insurance sales (Gross Written Premiums) (#m) 868 919 975 1,894
Investment sales (Annual Premium Equivalent) (#m)(4) 1,004 904 913 1,817
Page 15
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
International
Underlying profit before tax (#m)(1) 327 293 324 617
Loans and advances to customers (#bn) 56.8 42.7 48.7 48.7
Customer deposits (#bn) 19.8 14.3 17.5 17.5
Risk weighted assets (#bn) 47.7 37.2 41.3 41.3
Impairment losses as a % of average advances (%) 0.09 0.11 0.12 0.22
Impairment provisions as a % of impaired loans (%) 42 43 42 42
Impairment provisions as a % of closing advances (%) 0.49 0.51 0.51 0.51
Impaired loans as a % of closing advances (%) 1.17 1.18 1.19 1.19
Net interest margin (%)(2) 1.90 1.97 1.98 1.97
Cost:income ratio (%)(3) 47.0 44.1 45.0 44.6
Investment sales (Annual Premium Equivalent) (#m)(4) 41 39 64 103
Treasury & Asset Management
Underlying profit before tax (#m)(1) 194 156 194 350
Risk weighted assets (#bn) 15.4 14.5 15.0 15.0
Net interest margin (bps)(2) 5 7 6 7
Cost:income ratio (%)(3) 47.2 46.4 47.7 47.1
Asset Management funds under management (#bn) 112.3 96.6 107.8 107.8
Total Group funds under management (#bn) 139.6 110.1 132.8 132.8
(1) Refer to Definition of Underlying on page 13.
(2) Annualised.
(3) Calculated on an underlying basis.
(4) Annual Premium Equivalent ('APE') is calculated as annual premiums plus 10% of single premiums.
Page 16
SUMMARY CONSOLIDATED INCOME STATEMENT
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Underlying net interest income (1) 3,626 3,647 3,753 7,400
Underlying non-interest income (1) 2,801 2,150 2,567 4,717
Underlying net operating income (1) 6,427 5,797 6,320 12,117
Underlying operating expenses (1) (2,563) (2,369) (2,539) (4,908)
Impairment losses on loans and advances (963) (864) (878) (1,742)
Underlying operating profit (1) 2,901 2,564 2,903 5,467
Non-operating income 61 48 22 70
Underlying profit before taxation (1) 2,962 2,612 2,925 5,537
Retail banking fee refunds (79)
Impact of the change of corporation tax rate on (18)
the value of leasing assets
Profit on sale of Drive 180 180
Mortgage endowment compensation (95) (95)
Goodwill impairment (2) (55) (55)
Policyholder tax payable 167 134 86 220
Short term fluctuations (33) (92) 11 (81)
Profit before taxation 2,997 2,654 3,052 5,706
Tax on profit (858) (865) (907) (1,772)
Profit after taxation 2,139 1,789 2,145 3,934
Profit of disposal group classified as held for 4 5 5
sale
Profit for the year 2,143 1,789 2,150 3,939
Attributable to:
Parent company shareholders 2,114 1,759 2,120 3,879
Minority interests 29 30 30 60
2,143 1,789 2,150 3,939
SUMMARY CONSOLIDATED BALANCE SHEET
As at As at As at
30.06.2007 30.06.2006 31.12.2006
#m #m #m
Assets
Loans and advances to customers 395,210 361,631 376,808
Investment securities 120,864 113,271 117,031
Other assets 108,016 95,531 97,190
Total Assets 624,090 570,433 591,029
Liabilities
Customer accounts 227,117 208,137 211,857
Debt securities in issue 181,477 169,449 183,650
Other borrowed funds 22,713 20,074 19,692
Other liabilities 170,902 153,480 154,659
Total Liabilities 602,209 551,140 569,858
Shareholders' Equity (excluding minority interests) 21,521 19,088 20,685
Minority interests 360 205 486
Shareholders' Equity 21,881 19,293 21,171
Total Liabilities and Shareholders' Equity 624,090 570,433 591,029
(1) Refer to Definition of Underlying on page 13.
Page17
RETAIL
Underlying profit before tax in Retail decreased by 8% to #1,043m (H1 2006
#1,133m). Underlying net operating income remained flat at #2,717m (H1 2006
#2,729m), primarily as a result of lower net lending share in Mortgages and
downward pressure on fee income, in particular in respect of Credit Card default
fees. Lending increased by 4% (annualised) and customer deposits increased by
9% (annualised).
Underlying operating expenses remained flat and, as a consequence, the cost:
income ratio remained stable at 38.8% (H1 2006 38.5%). Impairment losses
increased by 15%, strengthening provision coverage in respect of unsecured
impairments. Impairments in our unsecured portfolio have, we believe, now
reached their peak.
Financial Performance
Income Statement Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Net interest income 2,087 2,047 2,141 4,188
Underlying non-interest income 630 682 670 1,352
Mortgages and Savings 256 241 252 493
Banking 220 217 211 428
Business Banking 20 13 18 31
Personal Loans 66 57 52 109
Credit Cards 116 152 134 286
Other 22 24 25 49
Fees and commission income 700 704 692 1,396
Fees and commission expense (55) (31) (35) (66)
Other operating income 14 8 12 20
Share of profits of associates and jointly (7) 1 1 2
controlled entities
Impairment on investment securities (22)
Underlying net operating income 2,717 2,729 2,811 5,540
Underlying operating expenses (1,053) (1,052) (1,075) (2,127)
Staff (524) (524) (532) (1,056)
Accommodation, repairs and maintenance (4) (5) (5) (10)
Technology (25) (25) (29) (54)
Marketing and communication (87) (94) (85) (179)
Depreciation:
Property and equipment and intangible assets (37) (34) (35) (69)
Other (43) (50) (51) (101)
Sub total (720) (732) (737) (1,469)
Recharges:
Technology (129) (131) (132) (263)
Accommodation (137) (122) (140) (262)
Other shared services (67) (67) (66) (133)
Underlying operating profit before provisions 1,664 1,677 1,736 3,413
Impairment losses on loans and advances (678) (592) (505) (1,097)
Underlying operating profit 986 1,085 1,231 2,316
Non-operating income 57 48 48
Underlying profit before tax 1,043 1,133 1,231 2,364
Net interest margin 1.73% 1.80% 1.76% 1.78%
Impairment losses as a % of average advances 0.28% 0.26% 0.22% 0.48%
Cost:income ratio 38.8% 38.5% 38.2% 38.4%
Page 18
Operating Income and Margins
Total underlying net operating income remained flat at #2,717m (H1 2006
#2,729m). Net interest income grew by 2% to #2,087m (H1 2006 #2,047m) but
underlying non-interest income declined by 8% to #630m (H1 2006 #682m). Fees
and commission income fell by #4m to #700m (H1 2006 #704m) including a #36m
reduction in Credit Card related fees, attributable to the industry wide changes
following the OFT enquiry in the second half of 2006.
The table below summarises the movements in net interest margins and spreads.
Net Interest Margins and Spreads Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Net Interest Income:
Interest receivable 7,914 6,881 7,450 14,331
Interest payable (5,895) (4,908) (5,376) (10,284)
Capital earnings 68 74 67 141
2,087 2,047 2,141 4,188
Average Balances:
Total interest earning assets 242,895 229,840 240,812 235,371
Interest bearing - deposits 158,638 142,367 149,090 145,756
liabilities
- other 84,257 87,473 91,722 89,615
Total interest bearing liabilities 242,895 229,840 240,812 235,371
Average Rates: % % % %
Gross yield on interest earning assets 6.57 6.04 6.14 6.09
Cost of interest bearing liabilities (4.89) (4.31) (4.43) (4.37)
Net Interest Spread 1.68 1.73 1.71 1.72
Capital earnings 0.05 0.07 0.05 0.06
Net Interest Margin 1.73 1.80 1.76 1.78
Movement in margin Basis points
Net interest margin for the half year ended 31 December 2006 176
Mortgages and Savings (8)
Banking 6
Credit Cards (1)
Net interest margin for the half year ended 30 June 2007 173
In aggregate, product spreads fell by 3bps. The highly competitive conditions
in the mortgage market and shorter asset lives on existing business have led to
an 8bps fall in the combined Mortgages and Savings spread. This has been
partially offset by the favourable movement in the Banking spread of 6bps due to
a combination of growth in balances and improved product spreads. There was
also a reduction of 1bp in the contribution from Credit Cards.
Operating Expenses
Cost management remains a core competence in Retail and we continue to maintain
a tight rein on costs which is evident in our first half performance. The
ongoing benefits of cost management programmes initiated in prior years have
enabled us to not only absorb volume related increases in the underlying cost
base but also reinvest an element of the savings in the future development of
the Retail business. Growth in underlying operating expenses has been contained
to just #1m taking total operating expenses to #1,053m (H1 2006 #1,052m).
Consequently, combined with the flat position in income, our cost:income ratio
remained broadly stable at 38.8% (H1 2006 38.5%).
Credit Quality and Provisions
With 92.9% (end 2006 92.7%) of loans secured on residential property, Retail's
overall credit quality remains strong with total impaired loans falling slightly
to 2.67% (end 2006 2.72%) of closing advances.
Page 19
Impairment losses as a % of average advances were 0.28% (H1 2006 0.26%). Total
impairment losses increased by 15% to #678m (H1 2006 #592m) with the unsecured
impairment charge comprising #690m (H1 2006 #520m). Total provisions coverage
of impaired loans was broadly unchanged at 32% (end 2006 33%) with closing
provisions as a % of closing advances decreasing to 0.86% (end 2006 0.89%).
Secured Impairments
Total impaired secured loans increased to #4,183m (end 2006 #4,047m),
representing 1.86% (end 2006 1.84%) of asset balances. Mortgages in arrears but
not in possession increased marginally to 1.73% (end 2006 1.70%) of the debt
value as a result of increased arrears in our Specialist book, in line with
expectations given interest rate increases, partially offset by a further
reduction in Mainstream mortgages.
Arrears Cases 000s Total Mortgages % Value of Debt #m* Total Mortgages %
30.06.2007 31.12.2006 30.06.2007 31.12.2006 30.06.2007 31.12.2006 30.06.2007 31.12.2006
Mainstream 28.0 28.3 1.20 1.17 2,351 2,362 1.42 1.46
Specialist 8.7 7.8 1.93 1.76 1,512 1,366 2.59 2.40
Total 36.7 36.1 1.32 1.26 3,863 3,728 1.73 1.70
* Value of debt represents total book value of mortgages in arrears.
Secured provisions as a % of closing advances decreased to 0.15% (end 2006
0.19%). Improvements in the Loan to Value (LTV) of the impaired portfolio and
roll rates have supported a reduction of provisions coverage to 8% (end 2006
10%). The average LTV of the impaired portfolio has decreased slightly to 55%
(end 2006 57%) with the equivalent figures for the impaired Mainstream and
Specialist portfolios at 49% (end 2006 52%) and 65% (end 2006 68%) respectively.
Unsecured Impairments
Impaired unsecured loans declined to #2,277m (end 2006 #2,411m), representing
12.86% of closing advances (end 2006 13.17%). Provisions as a % of closing
advances increased to 9.83% (end 2006 9.29%), provisions coverage as a % of
impaired loans being strengthened to 76% (end 2006 71%) and impairment losses in
the first half of 2007 increasing to #690m (H1 2006 #520m). Our expectation is
that this marks the peak of unsecured impairments and thus that the
corresponding impairment charge will be lower in the second half.
Personal Loans
Impaired personal loans decreased to 16.2% of closing advances (end 2006 17.0%).
Provisions as a % of closing advances have increased to 12.7% (end 2006
11.5%).
Credit Cards
Impaired loans and provisions have decreased to 15.0% (end 2006 15.4%) and 11.3%
(end 2006 11.4%) of closing advances respectively. We are encouraged by
stability in arrears roll rates, overdrawn limits and utilisation levels.
30.06.2007 30.06.2006 31.12.2006
% % %
Credit utilisation(1) 27.2 27.9 28.1
Overdrawn limits(2) 7.0 6.9 6.9
Arrears roll rates(3) 57.5 56.5 58.1
(1) percentage of total available credit lines that are drawn down (restated
to exclude unutilised expired cards).
(2) percentage of accounts in excess of credit limit.
(3) percentage of credit card balances in arrears that have worsened in the
period.
Bank Accounts
Impaired assets have decreased slightly to 5.2% of closing advances (end 2006
5.3%) and provisions increased to 3.9% (end 2006 3.6%) of closing advances
reflecting our continued focus on the acquisition of good quality new business.
Business Banking
For Business Banking, impaired assets remained at 5.3% (end 2006 5.3%) and
provisions increased slightly to 3.6% (end 2006 3.5%) of closing advances
respectively. This is in line with expectations given the current stage in the
evolution of this business.
Page 20
Non-operating Income
Non-operating income of #57m (H1 2006 #48m) comprises realised gains of #29m (H1
2006 #26m) from the sale of shares in Rightmove, and profit on the sale and
leaseback of premises of #28m (H1 2006 #22m).
As at As at As at
Balance Sheet and Asset Quality Information 30.06.2007 30.06.2006
31.12.2006
Loans & advances to customers #242.1bn #229.1bn #237.7bn
Classification of advances* % % %
Residential mortgages 92.4 92.5 92.1
Other personal lending:
Secured Personal Loans 0.5 0.7 0.6
Unsecured Personal Loans 3.7 3.5 3.7
Credit cards 2.8 2.9 3.0
Banking 0.6 0.4 0.6
Total 100.0 100.0 100.0
* Before impairment provisions.
Impairment provisions on advances #m #m #m
Secured 340 446 408
Unsecured 1,740 1,659 1,700
Total 2,080 2,105 2,108
Impairment provisions as a % of closing advances % % %
Secured 0.15 0.21 0.19
Unsecured 9.83 9.43 9.29
Total 0.86 0.92 0.89
Impairment provisions as a % of impaired loans % % %
Secured 8 10 10
Unsecured 76 73 71
Total 32 32 33
Impaired loans #m #m #m
Secured 4,183 4,380 4,047
Unsecured 2,277 2,288 2,411
Total 6,460 6,668 6,458
Impaired loans as a % of closing advances % % %
Secured 1.86 2.07 1.84
Unsecured 12.86 13.00 13.17
Total 2.67 2.91 2.72
Risk weighted assets #109.6bn #112.2bn #112.4bn
Customer deposits #151.3bn #135.9bn #144.6bn
Operational Performance
Lending and Deposit Growth
Overall Retail lending increased by an annualised 4% to #242.1bn (end 2006
#237.7bn) and deposits increased by an annualised 9% to #151.3bn (end 2006
#144.6bn).
Mortgages
The first half mortgage performance has been heavily influenced by our retention
strategy, which was introduced in the latter part of 2006 and designed to trade
an element of gross share for improved principal repaid. Two initiatives were
introduced to improve retention; paying procuration fees to intermediaries for
mortgage transfers and a change in pricing for transfers and remortgage
business. While the payment of procuration fees to
Page 21
intermediaries has been largely successful, the change in pricing strategy has
not. As anticipated, gross lending fell to #33.6bn (H1 2006 #35.2bn), resulting
in an estimated market gross share of 19% (2006 21%). Principal repaid,
however, did not improve as anticipated, continuing to reflect previous high
levels of gross lending in addition to the current market trend towards shorter
asset lives. Our estimated share of principal repaid was unchanged at 24% (2006
24%).
As a consequence of the above, net lending of #4.3bn (H1 2006 #10.3bn) resulted
in an estimated market share of 8% (2006 17%). However, having taken the
corrective action to change the pricing of our remortgage business, volumes
picked up significantly in the second quarter and we finished the half with a
strong pipeline. In May and June, estimated net lending share was within our
expected 15%-20% range and we anticipate operating within this range in the
second half of 2007.
Our stock of mortgage assets ended the half year at #224bn (end 2006 #219bn),
representing a market share of 20% (end 2006 21%).
The share of our new business which was taken up by specialist lending remained
stable at 29%, slightly ahead of the industry average. Our reduced reliance on
remortgage business has resulted in a marginal increase to our new business LTV
ratio to 65% (end 2006 64%). Our overall book LTV fell slightly to 43% (end 2006
44%).
Unsecured Personal Loans
The personal loan gross lending market has remained flat year-on-year. We
therefore continue to focus on the acquisition of better quality business at
returns that reflect the associated risk, maintaining our estimated share of
gross lending at 9% (H1 2006 9%). Balances have remained unchanged at #6.6bn
(end 2006 #6.6bn), also maintaining our share of stock at 9%.
Credit Cards
In the first half of 2007, in line with our reduced appetite for Credit Card
growth, we acquired 296,000 new accounts (380,000 including those acquired
through our joint venture partners), resulting in an estimated market share of
10% of new credit card accounts. We continue to focus on higher quality
segments of the market. Outstanding balances fell by 4% to #6.7bn (end 2006
#7.0bn) compared with a reduction of 2.7% in the market as a whole, reflecting
the proactive tightening of credit availability to higher risk accounts.
Retail Savings
Savings deposits have grown by an annualised 11% to #131bn (end 2006 #124bn),
slightly ahead of market growth, further consolidating our position as the UK's
largest savings provider with an estimated share of Household Sector Liquid
Assets of 16% (end 2006 16%). Our multi-brand strategy has enabled us to
compete successfully whilst at the same time protecting margins. During the
first half we delivered #1.2bn inflow into ISAs, helping to maintain our
estimated share of stock at 21%. We also achieved an inflow of #1.1bn into
Fixed Rate and #1.1bn into Internet/Telephone based accounts.
Our product range continues to offer value and choice, ensuring we remain
attractive to new and existing customers alike. This has enabled us to increase
the size of our customer base, with over 140,000 new to franchise customers and
over 900,000 new accounts opened in total during the first half. We continue to
innovate with the launch of the Halifax Christmas Saver, and we were the first
savings institution to announce plans to reunite dormant account holders with
around #50m of their deposits in advance of the Government scheme that is
expected to be introduced in 2009.
Bank Accounts
The launch of the Ultimate Reward Current Account, which offers a package of
benefits in return for a monthly fee, coupled with our #100 switching incentive,
has helped continue the sales momentum enjoyed last year. The competitiveness
of our product range has been recognised by Your Money with the award of the
Best Banking Provider 2007, and the Best Student Banking Provider 2007 for the
second year running. We have acquired 516,000 (H1 2006 400,000) new Bank
Accounts of which 77% (H1 2006 77%) were full facilities current accounts. We
have an estimated market share of new current accounts of 24% (H1 2006 20%).
Regulatory Enquiry into Bank Charges
The publicity generated by the OFT market study into current account charges has
generated an industry wide increase in customer requests for refunds of current
account service fees. In the first half of 2007, the cost of such refunds
amounted to #79m, which we have reported outside of our underlying results as
they relate predominantly to fees charged in prior years. The heightened
publicity has also resulted in a growing propensity for customers to
Page 22
challenge current year banking fees more generally, the impact of which has been
included in our underlying results.
Business Banking
We continue to win quality business banking accounts from the competition, with
7,300 switchers in the first half of 2007 (H1 2006 8,450). The focus on higher
value new business has helped underlying income increase by 16% compared to the
first half of 2006.
We continue to see the SME market as an attractive opportunity for growth in
England & Wales. We welcome the Competition Commission's forthcoming review of
SME banking services. This is a market in which we are currently
under-represented and thus we intend to press for measures that will also help
stimulate more customer choice.
Prospects
We expect to build on the strong first half performances of our Savings and
Banking businesses. We will also maintain our focus on growth in good quality
Credit Cards and Unsecured Personal Loans.
In Mortgages, the anticipated slow down in house prices, together with a subdued
unsecured loan market and the anticipated benefits of Basel II in respect of
secured assets, is likely to lead to continued competition and associated
downward pressure on margins. In this environment, we will seek to optimise
shareholder value through the careful management of our business mix in specific
product segments and distribution channels.
As in the recent past, this will see us pursue greater share in higher margin
product segments and less share in lower margin segments. We will also seek to
positively influence retention rates on existing business, but only in so far as
such actions enhance value. As previously guided, we expect to trade within a
15%-20% net lending range for the second half of 2007.
We remain confident in respect of our growth prospects across all of our Retail
businesses despite the current headwinds being experienced in Mortgages and
banking fees. Whilst recognising the need to choose the right time for growth
in markets, our uniquely strong sales and distribution model gives us the
ability to achieve profitable growth and market share.
Page 23
CORPORATE
Underlying profit before tax in Corporate increased by 54% to #1,243m (H1 2006
#809m). This performance demonstrates continued success in growing our
non-interest income revenue streams. It also reflects selective asset growth
under our Asset Class model, combined with continued cost discipline across the
business. With continued competitive pressure on margins prevailing in many
segments of the UK market, we retain an appropriate risk appetite in order to
protect returns, and continue to see good opportunities for growth in both the
UK and in Europe.
As announced in March 2007, the Group's European Corporate business now forms
part of the Corporate Division's results.
Financial Performance
Income Statement Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m
#m #m
Underlying net interest income 992 1,003 961 1,964
Underlying non-interest income 922 348 705 1,053
Commitment fees 29 24 21 45
Guarantee fees 12 14 13 27
International fees 8 23 26 49
Transaction fees 30 33 30 63
Underwriting fees 87 58 35 93
Other 77 45 59 104
Fees and commission income 243 197 184 381
Fees and commission expense (17) (19) (4) (23)
Profit on sale of investment securities 253 69 155 224
Operating lease rental income 646 379 642 1,021
Other operating income 187 48 111 159
Share of profits of associates and jointly 108 19 137 156
controlled entities
Operating lease depreciation (493) (287) (509) (796)
Impairment on investment securities (5) (58) (11) (69)
Underlying net operating income 1,914 1,351 1,666 3,017
Underlying operating expenses (436) (366) (446) (812)
Staff (259) (206) (261) (467)
Accommodation, repairs and maintenance (3) (3) (1) (4)
Technology (8) (10) (6) (16)
Marketing and communication (16) (14) (18) (32)
Depreciation:
Property and equipment and intangible assets (23) (13) (18) (31)
Other (52) (42) (55) (97)
Sub total (361) (288) (359) (647)
Recharges:
Technology (26) (23) (27) (50)
Accommodation (27) (25) (28) (53)
Other shared services (22) (30) (32) (62)
Underlying operating profit before provisions 1,478 985 1,220 2,205
Impairment losses on loans and advances (235) (176) (253) (429)
Underlying profit before tax 1,243 809 967 1,776
Net interest margin 2.12% 2.37% 2.13% 2.25%
Impairment losses as a % of average advances 0.25% 0.22% 0.29% 0.50%
Cost:income ratio 22.8% 27.1% 26.8% 26.9%
Page 24
Operating Income and Margins
Underlying net operating income increased by 42% to #1,914m (H1 2006 #1,351m).
Underlying net interest income fell by 1% to #992m (H1 2006 #1,003m) and
underlying non-interest income increased by 165% to #922m (H1 2006 #348m).
Underlying net interest income growth is distorted by the inclusion of Lex, now
a wholly owned subsidiary but previously reported as a joint venture until 31
May 2006. Adjusting for Lex, underlying net interest income on a like-for-like
basis increased by 2%. A table has been included below setting out the overall
impact of Lex on the Income Statement.
Lending margins have narrowed slightly due to the high level of liquidity
available in the market, but the impact on the net interest margin has been
offset by improvements in deposit margins.
Movement in margin Basis points
Net interest margin for the half year ended 31 December 2006 213
Lending margins (4)
Deposit margins 2
Capital earnings 1
Net interest margin for the half year ended 30 June 2007 212
Net fees and commission income increased by 27% to #226m (H1 2006 #178m) mainly
arising from an increase in underwriting fees. Net operating lease income
increased by 66% to #153m (H1 2006 #92m), primarily as a result of the inclusion
of Lex as a wholly owned subsidiary.
Corporate investment portfolio revenues (i.e. profits on the sale of investment
securities, other operating income, share of profits of associates and jointly
controlled entities, less impairment on investment securities) increased to
#543m (H1 2006 #78m). Against the #392m recorded in the second half of 2006,
the increase was #151m or 39%. Profits on the sale of investment securities
increased to #253m (H1 2006 #69m), mainly reflecting realisations within the
Fund Investment portfolio. Other operating income increased to #187m (H1 2006
#48m), as a result of profitable disposals from our Joint Venture portfolio as
well as revenues across other asset classes. Profits from associates and
jointly controlled entities increased to #108m (H1 2006 #19m), although lower
than recorded in the second half of 2006. As at 30 June 2007, the book value of
the investment portfolio increased by an annualised 23% to #2.9bn (end 2006
#2.6bn) and unrealised gains in the investment portfolio remain broadly
unchanged from the beginning of the period.
Operating Expenses
The cost:income ratio at 22.8% (H1 2006 27.1%) continues to improve as a result
of strong income growth and our focus on cost discipline, whilst ensuring that
an appropriate level of investment is made in the business. Underlying operating
expenses increased by 19% to #436m (H1 2006 #366m), although on a like-for-like
basis excluding Lex, the increase was 13% as a result of performance based
remuneration and continued investment in enhanced risk management capabilities.
Credit Quality and Provisions
Impaired loans as a % of advances increased to 1.58% (end 2006 1.30%), mainly in
our traditional commercial book where our assessment of a number of small
credits has been reviewed in the light of the current interest rate environment.
Impairment losses increased by 34% to #235m (H1 2006 #176m) relative to the
first half last year, although this charge was 7% less than the second half of
2006 (H2 2006 #253m). Impairment losses as a % of average advances moved to
0.25% (H2 2006 0.29%, H1 2006 0.22%) whilst impairment provisions as a % of
impaired loans decreased to 49% (end 2006 63%).
Page 25
Lex Vehicle Finance ('Lex')
On 31 May 2006, Lex became a wholly owned subsidiary, having previously been a
50% owned joint venture. The table below shows the results of Lex which have
been included in the Corporate Income Statement.
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Net interest income (32) (4) (33) (37)
Operating lease rental income 287 39 291 330
Operating lease depreciation (206) (28) (207) (235)
Profits from associates and jointly 8 8
controlled entities
Underlying operating expenses (27) (3) (28) (31)
Underlying profit before tax 22 12 23 35
As at As at As at
30.06.2007 30.06.2006 31.12.2006
Balance Sheet and Asset Quality Information
Loans and advances to customers #95.8bn #86.0bn #89.6bn
Impairment provisions on advances #748m #702m #735m
Impairment provisions as a % of closing advances 0.78% 0.82% 0.82%
Classification of advances*: % % %
Agriculture, forestry and fishing 1 1 1
Energy 2 2 2
Manufacturing industry 5 6 5
Construction and property:
Property investment 19 18 17
Property development 6 6 6
Housing associations 2 3 3
Housebuilders 2 3 2
Other property 6 4 6
Hotels, restaurants and wholesale and retail trade 10 13 11
Transport, storage and communication 8 10 7
Financial 6 4 5
Other services 12 11 15
Individuals 3 3 3
Overseas residents 18 16 17
100 100 100
Impaired loans #1,518m #1,157m #1,163m
Impaired loans as a % of closing advances 1.58% 1.35% 1.30%
Impairment provisions as a % of impaired loans 49% 61% 63%
Risk weighted assets #111.9bn #100.7bn #106.5bn
Customer deposits #41.9bn #41.1bn #39.5bn
* Before impairment provisions.
Page 26
Operational Performance
Our Asset Class model brings focus and specialisation to diverse asset classes
and further reinforces our ability to form deep, lasting customer relationships,
with an overall view to creating competitive advantage. Our strategy allows
clients to benefit from the combination of expertise, versatility and long term
commitment.
In the first half of 2007, pre-sell down lending increased at an annualised rate
of 22%. Our cautious approach at this stage of the cycle complements our focus
on the quality of our lending and returns rather than volume, and has resulted
in lending growth after sell downs of an annualised 14% to #95.8bn (end 2006
#89.6bn). Customer deposits increased by an annualised 12% to #41.9bn (end 2006
#39.5bn).
Real Estate
Real Estate accounts for 31% (end 2006 31%) of our lending book. The real estate
market continues to grow as a result of high liquidity levels and stability of
UK and European property values. New business is well spread, predominantly
across the UK, and margins have been protected through leveraging our strong
reputation which is built on sector expertise and risk understanding.
Commercial
Commercial business accounts for 23% (end 2006 23%) of our lending book. It is
principally focused on relationship banking for UK businesses with an annual
turnover of greater than #1m. It offers a differentiated banking proposition in
the UK market place, challenging the long held dominance of the Big 4. In the
second half of 2007, we plan to extend this differentiation by refining our
operational model to improve our market facing capability, complemented by an
enhancement of our product offering.
Joint Ventures
12% (end 2006 11%) of our lending book supports transactions with associated and
joint venture partners, predominantly in the property, house builder and hotel
sectors. These sectors have seen good growth in the first half of 2007. Our
approach remains very selective, with a focus on partners with good track
records across varying economic environments.
Integrated, Structured, Acquisition Finance ('ISAF')
Some 9% (end 2006 10%) of our lending book supports individual transactions in
the private equity market, which has continued to enjoy strong growth in the
first half of 2007, particularly in Europe. High levels of liquidity have
resulted in some downward pressure on margins and increased leverage levels but
our approach remains very selective and weighted towards the highest quality
private equity houses. We also continue to build in a significant level of
protection through covenants and by selling down to hold levels with which we
are comfortable. The average hold level across the portfolio is below #25m. Our
strategy in Integrated Finance in 2007 has been to seek robust businesses with
significant downside defensibility and well spread earnings, run by excellent
management teams. ISAF continued to benefit in a healthy market for exits with
significant gains and realisations alongside active investment across the equity
businesses and an attractive pipeline of new business opportunities.
Specialised Industry Finance (formerly Infrastructure, Housing and Oil & Gas)
This part of our business accounts for 16% (end 2006 16%) of our lending book.
In the first half of 2007, our Infrastructure and Oil & Gas businesses have
performed well, although the markets experienced high liquidity and pressure on
margins. Expansion of our presence in European markets offers the opportunity
for additional growth and in the second half of 2007 we will fully integrate
parts of our European product into the existing structure together with the
asset finance transport sectors, thus providing an improved product and service
offering to customers.
Asset & Motor Finance
The Asset & Motor Finance asset class accounts for 9% (end 2006 9%) of our
lending book and continues to experience steady growth, consolidating its
position as a leader within its chosen markets. The inclusion of Lex as a wholly
owned subsidiary together with our other asset and motor activities brings a
strong cohesive proposition upon which to build. In the first half of 2007,
margin pressures were evident but the opportunities for additional profitable
growth continue to be available. Further investment in systems and process
engineering present major opportunities.
Page 27
Deposits
Deposits increased by an annualised 12% to #41.9bn (end 2006 #39.5bn). This
strong growth has restored our balances to pre-June 2006 levels when we took the
decision to price away volatile, expensive deposits. As a consequence, our
deposit book is now more stable and the margins have improved. In the second
half of 2007, we have a number of initiatives planned to enhance our position in
England & Wales and to increase our penetration of certain niche markets.
Prospects
Our strategy is one of measured growth, strong returns, and sound credit
quality, with a focus on increasing non-interest income in order to generate
significant and sustainable shareholder value. We will continue to challenge
competitors in our chosen markets by offering an informed and more integrated
approach to customers, through our asset class strategy.
We continue to focus on increasing our market share in the mid value sector
within England & Wales and in Europe. In Scotland we are market leaders across
all our target markets, a position we continue to build on.
Our Integrated, Structured and Acquisition Finance and Joint Venture businesses,
which provide a 'one-stop' for senior debt, mezzanine and equity finance,
continue to generate attractive growth and returns. In our Specialised Industry
Finance business, we continue to work closely with the public sector in the
provision of social and economic infrastructure. Each of these businesses has
good expansion prospects in Europe.
Revenues from our investment portfolio have been exceptionally strong in the
first half of 2007, and may not be repeated in full in the second half.
Nonetheless, we remain confident that overall 2007 will see a substantial
increase in the contribution from our investment portfolio and that the
portfolio is well positioned to sustain its contribution to earnings in future
years.
With the prospect of higher interest rates, our underwriting and pricing
practices are well positioned should there be a turn in the corporate credit
cycle. Given the potential for reduced liquidity in the secondary markets, we
continue to underwrite and price our originating activity on the assumption that
we would be comfortable holding the business on our balance sheet if required to
do so.
Our differentiation from others in our chosen markets emanates from two core
themes: the importance of developing and deepening relationships with both
customers and introducers, and the continual drive to be innovative and
entrepreneurial in our dealings with our target markets. The development of
these core themes gives us confidence that the positive trends evident in the
first half of 2007 will continue for the rest of the year.
Page 28
INSURANCE & INVESTMENT
Underlying profit before tax in Insurance & Investment increased by 10% to #316m
(H1 2006 #287m). General Insurance profits fell to #107m (H1 2006 #163m)
reflecting the January storms and June flooding, which together gave rise to an
estimated claims cost of #80m. Investment profit increased by 69% to #209m (H1
2006 #124m) benefiting from the growth in profits from the in-force book and
increased contributions from new business.
On the Full Embedded Value ('EV') basis, underlying profit before tax in
Insurance & Investment was #452m (H1 2006 #435m), #136m (H1 2006 #148m) higher
than reported under IFRS. This equates to a 2.5p (5%) uplift to Group underlying
earnings per share. Balance sheet embedded value, net of tax for the UK
Investment Business was #6,681m (end 2006 #6,384m) and was #2,735m (end 2006
#2,525m) higher than reported under IFRS.
Investment sales increased by 11% to #1,004m APE (Annual Premium Equivalent),
whilst General Insurance sales (excluding Paymentshield) fell 1% to #868m GWP
(Gross Written Premium).
Financial Performance
Income Statement Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Net interest income (50) (42) (51) (93)
Underlying non-interest income 775 747 747 1,494
Fees and commission income 30 64 27 91
Fees and commission expense (412) (415) (369) (784)
Change in value of in-force assurance business 124 117 62 179
Net income from long term business 549 448 499 947
Investment earnings on surplus assets attributable 54 59 54 113
to shareholders using long term assumptions
Net earned premiums on General Insurance ('GI') 631 630 685 1,315
contracts
Net GI claims incurred and net change in (246) (174) (224) (398)
GI contract liabilities
Investment and other operating income in GI 42 37 31 68
Share of profits/(losses) of associates and 3 (19) (18) (37)
jointly controlled entities
Underlying net operating income 725 705 696 1,401
Underlying operating expenses (409) (418) (402) (820)
Staff (179) (170) (189) (359)
Accommodation, repairs and maintenance (10) (10) (10) (20)
Technology (19) (18) (16) (34)
Marketing and communication (23) (16) (23) (39)
Depreciation:
Property and equipment and intangible assets (29) (27) (24) (51)
Other (95) (131) (88) (219)
Sub total (355) (372) (350) (722)
Recharges:
Technology (23) (22) (23) (45)
Accommodation (18) (17) (18) (35)
Other shared services (13) (7) (11) (18)
Underlying profit before tax 316 287 294 581
Underlying profit before tax (IFRS basis) 316 287 294 581
Additional contribution from new business 255 239 235 474
Lower contribution from existing business (123) (94) (128) (222)
Additional investment earnings on net assets 4 3 7 10
Increase in underlying profit before tax 136 148 114 262
Underlying profit before tax (Full EV basis) 452 435 408 843
Note: The presentation of the income statement has been simplified by combining
a number of predominantly policyholder related items such as investment and
other operating income, the change in investment contract liabilities, net
claims incurred on insurance contracts, net change in insurance contract
liabilities and change in unallocated surplus into a single caption called net
income from long term business.
Page 29
General Insurance Business
Financial Performance
General Insurance profit of #107m is #56m (34%) lower than the first half of
2006 (H1 2006 #163m) reflecting the cost of two major weather events in the
first half of 2007. The January wind storms resulted in #20m of claims costs
whilst the heavy rains and resultant floods in June have cost an estimated #60m.
Underlying non-interest income fell by #47m (22%) to #167m (H1 2006 #214m) with
business growth being more than offset by the costs of the two major weather
events detailed above. Underlying operating expenses increased by 11% to #71m
(H1 2006 #64m) reflecting additional investment in marketing and sales resource
as we seek to capitalise on growth opportunities in household insurance.
Income Statement Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Net interest income 11 13 14 27
Underlying non-interest income 167 214 199 413
Fees and commission income 21 23 (7) 16
Fees and commission expense (288) (288) (258) (546)
Net earned premiums on General 631 630 685 1,315
Insurance contracts
Change in value of in-force assurance business 4 5 10) (5)
Investment and other operating income 42 37 31 68
Net General Insurance claims incurred and (246) (174) (224) (398)
net change in insurance contract liabilities
Share of profits/(losses) of associates and 3 (19) (18) (37)
jointly controlled entities
Underlying net operating income 178 227 213 440
Underlying operating expenses (71) (64) (72) (136)
Underlying profit before tax 107 163 141 304
Operational Performance
General Insurance sales, as measured by GWP, fell by 1% to #868m (H1 2006 #874m
excluding sales through Paymentshield which was sold in November 2006). Both
Motor (up 9%) and Household (up 8%) delivered strong performances offset by
lower sales in Repayment Insurance (down 9%).
General Insurance Sales Gross Written Premiums
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Household 260 241 284 525
Repayment:
1st party 254 272 256 528
3rd party 186 212 193 405
Motor 152 140 158 298
Other 16 9 21 30
Total excluding Paymentshield 868 874 912 1,786
Paymentshield 45 63 108
Total 868 919 975 1,894
Page 30
Household Insurance
After many years of benign claims experience, competition has continued to
intensify during the first half of 2007, putting downward pressure on premium
rates especially in direct channels. Growing our share of the household
insurance market remains an important strategic priority allowing us to leverage
our leading mortgage market position. We have therefore increased our
investment in marketing activity to raise product and brand awareness and are
already seeing the benefits with policy sales increasing by 20% bringing our
total policies in force to 2.7m (end 2006 2.6m excluding Paymentshield).
Despite pricing pressures, sales grew by 8% to #260m GWP (H1 2006 #241m
excluding Paymentshield) reflecting the strength of our branch franchise where
sales grew 31%, representing 37% of total new business in the period. Direct
telephone sales volumes also grew strongly (up 16%).
Claims experience has been significantly affected by the January and June
weather events (currently estimated at a combined cost of #80m). As a result,
the Household Insurance loss ratio increased to 79% (H1 2006 45%) with benign
claims conditions benefiting the prior year result. Excluding the impact of
these weather events the loss ratio would have been in line with the first half
of 2006. The recent flooding in south and central England will give rise to
further significant claims. We are still assessing the full impact but our
current expectation is that the cost will be modestly higher than that for the
June floods.
These weather events again provide examples of the strength of our industry
leading claims management service, which continues to be a source of competitive
advantage, enhancing the customer experience and at the same time, through our
speed of response, driving down claims costs.
Repayment Insurance
Sales of Repayment Insurance fell by 9% to #440m GWP (H1 2006 #484m) primarily
as a result of lower unsecured personal loan and credit card volumes, with sales
to Group customers down by 7% to #254m (H1 2006 #272m).
In February, the OFT announced their decision to refer Payment Protection
Insurance ('PPI') to the Competition Commission ('CC'). The CC has now
commenced its investigation which will be concluded in 2008. We are proactively
engaging with the CC to highlight the extensive improvements in transparency
which the FSA's intervention has brought to the market, and to demonstrate the
value of PPI products to customers.
Motor Insurance
Sales of Motor Insurance, at esure, increased by 9% to #152m GWP (H1 2006
#140m). Sales have increased across our motor brands, with the increased
prominence of web-based business being an important factor. esure's state of
the art technology and internet infrastructure, together with the strength of
its brands, makes us ideally placed to benefit from increasing levels of
internet business. The Sheilas' Wheels brand continues to go from strength to
strength, while sales of esure and Sainsbury's products also increased
significantly. Strong price competition has continued and we have not yet seen
evidence of a sustained rise in premium rates amongst our main competitors.
Page 31
Investment Business
Financial Performance
Underlying profit before tax in the Investment Business increased by 69% to
#209m (H1 2006 #124m). Underlying net operating income increased by 14% to
#547m (H1 2006 #478m) whilst underlying operating expenses decreased by 5% to
#338m (H1 2006 #354m) generating strong positive operating "jaws". Underlying
profit before tax on the Full EV basis increased by 27% to #345m (H1 2006
#272m).
Income Statement Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Net interest income (61) (55) (65) (120)
Debt financing costs (64) (64) (64) (128)
Other net interest income 3 9 (1) 8
Underlying non-interest income 608 533 548 1,081
Fees and commission income 9 41 34 75
Fees and commission expense (124) (127) (111) (238)
Change in value of in-force assurance business 120 112 72 184
Net income from long term business* 549 448 499 947
Investment earnings on surplus assets attributable 54 59 54 113
to shareholders using long term assumptions
Underlying net operating income 547 478 483 961
Underlying operating expenses (338) (354) (330) (684)
Core operating expenses (276) (289) (272) (561)
Overheads associated with development activity (24) (26) (30) (56)
Development expenditure (38) (39) (28) (67)
Underlying profit before tax 209 124 153 277
Underlying profit before tax (IFRS basis) 209 124 153 277
Additional contribution from new business 255 239 235 474
Lower contribution from existing business (123) (94) (128) (222)
Additional investment earnings on net assets 4 3 7 10
Increase in underlying profit before tax 136 148 114 262
Underlying profit before tax (Full EV basis) 345 272 267 539
* "Net income from long term business" is explained in the note on page 29.
This effectively represents the annual management charge on long term assurance
business together with premiums, net of claims and changes in liabilities, in
respect of protection business.
Under IFRS, insurance contracts (i.e. investment business which carries
significant insurance risk as well as 'with-profit' contracts) are accounted for
on an embedded value ('EV') basis, whereas investment contracts (i.e. investment
business which does not carry significant insurance risk) are accounted for
under IAS 39. Consequently, on an IFRS basis the Income Statement incorporates
two very different profit recognition patterns depending on the nature of the
contract. The table below sets out the contribution from each type of contract.
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Contribution from insurance contracts* 306 253 227 480
Contribution from investment contracts* 29 48 48
Development expenditure (38) (39) (28) (67)
Overheads associated with development activity (24) (26) (30) (56)
Debt financing cost (64) (64) (64) (128)
Underlying profit before tax 209 124 153 277
* The other income and costs line item previously disclosed separately (#(7)m
for the full year 2006) has been allocated to the contribution from
insurance contracts and the contribution from investment contracts line items.
Page 32
Insurance Contracts (accounted for on an EV basis)
The contribution from insurance contracts increased by 21% to #306m (H1 2006
#253m). The contribution from new business increased by 35% to #142m (H1 2006
#105m) reflecting continued growth in insurance contract sales (up 14%), and in
particular, strong growth in sales of higher margin bonds sold in our
Bancassurance channel. The expected contribution from existing business
increased by 6% to #76m (H1 2006 #72m) as a result of the growth of the in-force
book. Actual vs expected experience was #34m (H1 2006 #17m) reflecting the
partial recognition of the positive impact of changes to non-unit reserving due
to the FSA Policy Statement PS06/14, partly offset by adverse persistency
experience.
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Contribution from existing business:
Expected contribution 76 72 63 135
Actual vs expected experience 34 17 (1) 16
110 89 62 151
Contribution from new business 142 105 111 216
Investment earnings on surplus assets attributable 54 59 54 113
to shareholders using long term assumptions
Contribution from insurance contracts 306 253 227 480
Investment Contracts (accounted for on an IAS 39 basis)
Under IAS 39, profit recognition on investment contracts is deferred to later
years with a loss typically recorded in the year of sale. The contribution
from investment contracts increased to #29m (H1 2006 #nil) reflecting a 26%
increase in the contribution from existing business to #153m (H1 2006 #121m) and
a modest 2% increase in initial profit strain from new business to (#124m).
Half year Half year Half year Year
ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
#m #m #m #m
Contribution from existing business 153 121 156 277
Contribution from new business (124) (121) (108) (229)
Contribution from investment contracts 29 48 48
Full EV Basis Supplementary Information
To assist in the understanding of the underlying performance and value
generation of the Investment Business, supplementary information is set out on
pages 76 to 79, providing Income Statement and Balance Sheet information for our
UK Investment Business on a consistent EV accounting basis for both insurance
and investment contracts. We refer to this basis as the 'Full EV' basis.
Page 33
New Business Profitability
New business profitability is reported by reference to the Full EV basis. New
business profitability by channel and product type on the Full EV basis is set
out below.
New Business Profitability Half year Half year Half year Year
(Full EV basis) ended ended ended ended
30.06.2007 30.06.2006 31.12.2006 31.12.2006
% APE % APE % APE % APE
Bancassurance 34 33 33 33
Intermediary 10 9 10 10
Wealth Management 38 35 36 36
Total 29 26 27 27
Life & Pensions 29 27 25 26
Mutual Funds 27 23 36 29
Total 29 26 27 27
New business profitability increased to 29% (H2 2006 27%, H1 2006 26%).
Bancassurance margins remain strong, reflecting the efficiency of our model and
the productivity of our sales forces. In Wealth Management, at the same time
that we have delivered a significant increase in business volumes, profitability
has increased to 38%, reflecting reductions in unit costs particularly on
pensions business as volumes have grown. The rise in Intermediary margins to
10% reflects our increasing focus on profitable products and segments in this
channel.
Operational Performance
Investment sales increased by 11% to #1,004m APE (H1 2006 #904m) reflecting
strong growth in Bancassurance, up 16%, and Wealth Management, up 32%, partially
offset by a 10% fall in Intermediary.
Investment Sales* Half year Half year Half year Half year Half year Half year Half year Half year
ended ended ended ended ended ended ended ended
30.06.2007 30.06.2007 30.06.2007 30.06.2007Total 30.06.2006 30.06.2006 30.06.2006 30.06.2006
Single Annual APE Single Annual
Total Total Total APE
#m #m #m #m #m
#m #m #m
Investment Bonds 4,101 4 4,105 414 2,942 9 2,951 303
Individual Pensions 1,393 115 1,508 254 1,020 126 1,146 228
Group Pensions 49 52 101 57 38 66 104 70
Annuities 167 167 17 130 130 13
Protection 2 23 25 23 29 20 49 23
Mutual Funds 945 144 1,089 239 1,023 165 1,188 267
Total 6,657 338 6,995 1,004 5,182 386 5,568 904
Bancassurance 3,460 193 3,653 539 2,459 218 2,677 464
Intermediary 1,528 99 1,627 252 1,540 125 1,665 279
Wealth Management 1,669 46 1,715 213 1,183 43 1,226 161
Total 6,657 338 6,995 1,004 5,182 386 5,568 904
Insurance Contracts** 2,238 31 2,269 255 1,794 45 1,839 224
Investment Contracts 4,419 307 4,726 749 3,388 341 3,729 680
Total 6,657 338 6,995 1,004 5,182 386 5,568 904
* APE is calculated as annual premiums plus 10% of single premiums.
** Accounted for on an EV basis under IFRS reporting.
Page 34
Movement in assets under management
The following table analyses the movement in assets under management.
Half year Half year Half year
ended ended ended
30.06.2007 30.06.2006 31.12.2006
#bn #bn #bn
Opening assets under management 76.1 68.1 71.5
Premiums (new and existing business) 7.2 6.4 5.8
Maturities & claims (0.9) (0.4) (2.0)
Lapses (i.e. surrenders and repurchases) (4.7) (3.9) (3.5)
Net inflow of business 1.6 2.1 0.3
Investment return (net of charges) 2.0 1.3 4.3
Increase in assets under management 3.6 3.4 4.6
Closing assets under management 79.7 71.5 76.1
Lapse rate (i.e. annualised lapses as % of average assets) 12% 11% 9%
Assets under management increased by #3.6bn (an annualised 10%) to #79.7bn (end
2006 #76.1bn). Premiums increased by 13% to #7.2bn (H1 2006 #6.4bn) whilst
lapses also increased, primarily in the Intermediary channel as a result of
higher lapses on with-profit bonds. Improving retention performance in the
Intermediary channel is a key objective and a specialised existing business team
was formed in late 2006 for this purpose.
Bancassurance
Sales through the Bancassurance channel increased by 16% to #539m APE (H1 2006
#464m), a strong performance reinforcing our position as the clear No. 1
bancassurer in the UK with simple value for money 'no load' products provided
alongside full financial advice, offering our customers a compelling
proposition. Leveraging the scale and operational benefits from manufacturing
the majority of our products remains at the heart of our model.
We have seen growth in sales through both of our Bancassurance sales forces.
Sales through our mass market branch based Personal Financial Advisers ('PFA')
increased by 7% to #353m (H1 2006 #331m) with sales in our Bank of Scotland
Investment Service ('BOSIS') high net worth sales force up by 15% to #117m (H1
2006 #102m). We believe that our sales forces remain the most productive in the
market, with productivity again increasing to #710,000 APE per active PFA in our
branches (H1 2006 #700,000) and #880,000 APE (H1 2006 #850,000) per BOSIS client
manager.
Bond sales have been very strong in our Bancassurance channel, increasing by 67%
to #277m (H1 2006 #166m), with the successful re-launch of our inheritance tax
proposition being an important factor. This has more than offset a fall in
sales of mutual funds, which partly reflected lower pre-tax year end sales of
ISAs.
Intermediary
We are refocusing our strategy in the Intermediary channel around individual
pensions and investment business, our core areas of strength. As a result, we
ceased writing new Group Pensions business in April 2007. As expected, these
changes have impacted sales in the short term, which fell by 10% to #252m (H1
2006 #279m). Our primary objective is to focus on increasing profitability and
we have made progress in this regard, with new business margins rising to 10%
APE (H1 2006 9%).
One of our key objectives in the Intermediary channel is to deliver continued
improvements in service quality and to increase utilisation of e-processing so
as to optimise both service standards and efficiency. Excellent progress
continues to be made in this regard with Clerical Medical winning a five-star
award in the Investment Providers and Packagers category of the FT Adviser
Online Service Awards in June 2007.
Page 35
Wealth Management
Sales at St. James's Place ('SJP') have continued to grow strongly, increasing
by 32% to #213m (H1 2006 #161m). This follows two years of exceptional growth,
emphasising the strength of the business model in realising the significant
market opportunities presented by increasing wealth alongside advisory
opportunities following Pensions 'A' Day. Sales of pensions have been
particularly strong, up 45%.
Fund performance and business retention continue to be strong, with funds under
management up an annualised 25% to #17.3bn (end 2006 #15.4bn). Partner numbers
increased to 1,187 (end 2006 1,157).
Prospects
Our objective remains unchanged, namely to become the UK's leading insurance and
investment group. Our long term ambition is to grow market share in all the
sectors in which we operate but in doing so our emphasis will continue to be on
profitable growth. Our strategy is based on the core strengths of our existing
multi-channel, multi-brand operating model, leveraging the strength of the
Group's brands and customer base, but also further extending our presence in 3rd
party channels.
In General Insurance, the medium term prospects for our combined personal lines
businesses remain strong, subject to a degree of regulatory uncertainty until
the Competition Commission enquiry reports. We will continue to leverage our
market leading position in mortgages to target further growth in Household
Insurance, through the development of our product propositions and brand
offerings. In Motor Insurance, we will utilise the strength of the esure,
Sheilas' Wheels and Sainsbury's brands alongside our efficient internet
infrastructure to deliver profitable growth.
In Investment, demographic trends and increasing wealth point to significant
long term growth potential. Our multi-brand, multi-channel operating model and
distribution strength represent a clear source of competitive advantage. In our
mass market Bancassurance channel, our focus is on growing capacity through the
recruitment and retention of high quality advisers whilst developing direct
access to our one million strong existing customer base. We will continue our
focused strategy targeting profitable segments of the Intermediary channel and
aligning our products and broker consultants accordingly. Finally, we will
continue to focus on exploiting the significant growth opportunities in the
wealth sector through both SJP and BOSIS.
Page 36
This information is provided by RNS
The company news service from the London Stock Exchange
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