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Lloyds Banking Group (LLOY)

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Friday 25 February, 2011

Lloyds Banking Group

2010 Results

RNS Number : 8448B
Lloyds Banking Group PLC
25 February 2011
 

 

 

2010 Results

News Release

 

Lloyds Banking Group plc

 

 

 

25 February 2011

 

 

 

 

 

 

 



 


BASIS OF PRESENTATION


This report covers the results of Lloyds Banking Group plc (the Company) together with its subsidiaries (the Group) for the year ended 31 December 2010.


Statutory basis

Statutory results are set out on pages 106 to 144.  However, a number of factors have had a significant effect on the comparability of the Group's financial position and results.  As a result, comparison on a statutory basis of the 2010 results with 2009 is of limited benefit.


Combined businesses basis

In order to provide more meaningful and relevant comparatives, the results of the Group and divisions are presented on a 'combined businesses' basis.  The key principles adopted in the preparation of the combined businesses basis of reporting are described below.


·   

In order to reflect the impact of the acquisition of HBOS, the following adjustments have been made:


-

the 2009 results assume HBOS had been owned throughout the year;


-

the gain on acquisition of HBOS (in 2009) and amortisation of purchased intangible assets have been excluded; and


-

the unwind of acquisition-related fair value adjustments is shown as one line in the combined businesses income statement.

·   

In order to better present the business performance the following items, not related to acquisition accounting, have also been excluded:


-

integration costs;


-

insurance and policyholder interests volatility;


-

the Government Asset Protection Scheme (GAPS) fee paid in 2009;


-

goodwill impairment;


-

the curtailment gain in respect of the Group's defined benefit pension schemes;


-

the customer goodwill payments provision; and


-

loss on disposal of businesses.


Further, to enable a better understanding of the Group's core business trends and outlook, certain income statement and balance sheet information is analysed between core and non-core portfolios.  Non-core portfolios consist of non-relationship assets and liabilities, together with assets and liabilities which are outside the Group's current appetite.  The EU mandated retail business disposal is not included in non-core portfolios.

 

Unless otherwise stated income statement commentaries throughout this document compare the year ended 31 December 2010 to the year ended 31 December 2009, and the balance sheet analysis compares the Group balance sheet as at 31 December 2010 to the Group balance sheet as at 31 December 2009.


 

FORWARD LOOKING STATEMENTS

This announcement contains forward looking statements with respect to the business, strategy and plans of the Lloyds Banking Group, its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about the Group or the Group's management's beliefs and expectations, are forward looking statements.  By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future.  The Group's actual future business, strategy, plans and/or results may differ materially from those expressed or implied in these forward looking statements as a result of a variety of risks, uncertainties and other factors, including, without limitation, UK domestic and global economic and business conditions; the ability to derive cost savings and other benefits, as well as the ability to integrate successfully the acquisition of HBOS; the ability to access sufficient funding to meet the Group's liquidity needs; changes to the Group's credit ratings; risks concerning borrower or counterparty credit quality; market related trends and developments; changing demographic trends; changes in customer preferences; changes to regulation, accounting standards or taxation, including changes to regulatory capital or liquidity requirements; the policies and actions of governmental or regulatory authorities in the UK, the European Union, or jurisdictions outside the UK, including other European countries and the US; the ability to attract and retain senior management and other employees; requirements or limitations imposed on the Group as a result of HM Treasury's investment in the Group; the ability to complete satisfactorily the disposal of certain assets as part of the Group's EU state aid obligations; the extent of any future impairment charges or write-downs caused by depressed asset valuations; exposure to regulatory scrutiny, legal proceedings or complaints, actions of competitors and other factors.  Please refer to the latest Annual Report on Form 20-F filed with the US Securities and Exchange Commission for a discussion of such factors together with examples of forward looking statements.  The forward looking statements contained in this announcement are made as at the date of this announcement, and the Group undertakes no obligation to update any of its forward looking statements.



CONTENTS


Page 

Key highlights

Summary of results

2 

Group Chief Executive's statement

3 



Combined businesses information

8 

Combined businesses consolidated income statement

9 

Reconciliation of combined businesses profit (loss) before tax to statutory profit before tax for the year

9 

Combined businesses results by half-year

10 

Combined businesses profit (loss) analysis by division

11 

Half-year profit (loss) analysis by division

11 

Summary consolidated balance sheet

12 

Group Finance Director's review of financial performance and outlook

13 

Combined businesses segmental analysis

29 

Divisional performance


Retail

31 

Wholesale

37 

Wealth and International

45 

Insurance

53 

Group Operations

61 

Central items

62 



Additional information on a combined businesses basis

63 

Basis of preparation of combined businesses information

63 

Banking net interest margin

66 

Integration costs and benefits

67 

Impairment charge

68 

Core and non-core business

69 

Volatility arising in insurance businesses

70 

Number of employees (full-time equivalent)

72 



Risk management

73 

Risk management approach

74 

Principal risks and uncertainties

75 



Statutory information

106 

Primary statements


Consolidated income statement

107 

Consolidated statement of comprehensive income

108 

Consolidated balance sheet

109 

Consolidated statement of changes in equity

111 

Consolidated cash flow statement

113 

Notes

114 



Supplementary information


Supplementary European Embedded Value (EEV) disclosures

145 

Contacts

149 

 


Key highlights

 

'2010 was an important year for Lloyds Banking Group, marking our return to profitability, and a further reduction in risk in our business.  Our significant progress in the year has positioned the Group well to become the best bank in the UK for all our stakeholders, including our customers, shareholders and employees.'

J Eric Daniels

Group Chief Executive

 

RETURN TO PROFITABILITY

·    The Group returned to profitability on a combined businesses basis with profit before tax of £2,212 million (2009: £6,300 million loss).

·    Statutory profit before tax was £281 million (2009: £1,042 million, including an £11,173 million gain on the acquisition of HBOS); after charging integration costs of £1,653 million and other adjusting net charges of £278 million including a loss on disposal of businesses of £365 million.

·    Loss attributable to equity shareholders was £320 million (2009: profit of £2,827 million); equivalent to a loss per share of 0.5 pence (2009: earnings per share of 7.5 pence), after a charge for taxation of £539 million (2009: credit of £1,911 million) and a charge for profit attributable to non-controlling interests of £62 million (2009: £126 million).

 

GOOD FRANCHISE MOMENTUM

·    Good trading performance against the backdrop of modest growth in UK economy.

·    Continued active support for the UK's economic recovery by providing £30 billion of gross mortgage lending (including remortgages) and £49 billion of committed gross lending to businesses, of which £11 billion for SMEs.

·    Underlying total income increased by 3 per centto £23,641 million, including core business income growth of 7 per cent.

·    Banking net interest margin improved to 2.10 per cent (2009: 1.77 per cent) with the majority of the gain achieved in the first half of the year.

·    Significant reduction in the impairment charge. Impairment charge was 45 per cent lower at £13,181 million (2009: £23,988 million).

·    Strong cost performance with a 6 per cent reduction in operating expenses to £10,928 million.  Further improvement in the underlying cost:income ratio to 46.2 per cent (2009: 50.7 per cent).

·    Continued strong progress with the integration programme delivering annual run-rate savings of £1,379 million.  Confident of delivering a run-rate of £2 billion per annum by the end of 2011.

 

BALANCE SHEET STRENGTHENED; RISK REDUCED

·    Good progress on balance sheet reduction with cumulative non-core asset reduction of £105 billion.  On track to meet target of £200 billion over the next three years.

·    Capital position significantly improved with core tier 1 ratio increased to 10.2 per cent, primarily reflecting a reduction in risk weighted assets by 18 per cent to £406.4 billion.

·    Excellent progress against term funding objectives with £50 billion of wholesale term issuance in the year.

·    Customer relationship deposits increased by 3 per cent reflecting good growth in Retail and in Wealth and International.

·    Reduction in liquidity support from government and central bank facilities of £61 billion to £97 billion.

 

STRONG MEDIUM-TERM PROSPECTS

·    Given the flexibility and capacity we have for core business growth, we continue to believe that the Group has strong medium-term prospects, notwithstanding the economic and regulatory headwinds that we face in 2011.



SUMMARY OF RESULTS

 





2010 


2009 


Change 

Results




£m 


£m 











Statutory









Total income, net of insurance claims




24,956 


23,278 


Total operating expenses




(13,270)


(15,984)


17 

Trading surplus




11,686 


7,294 


60 

Impairment




(10,952)


(16,673)


34 

Gain on acquisition





11,173 



Profit before tax




281 


1,042 


(73)

Profit (loss) attributable to equity shareholders




(320)


2,827 



Earnings per share




(0.5)p


7.5p 












Combined businesses basis (note 1, page 63)









Total income, net of insurance claims




23,444 


23,964 


(2)

Underlying total income, net of insurance claims1




23,641 


22,893 


Operating expenses2




(10,928)


(11,609)


Trading surplus




12,366 


12,355 



Impairment




(13,181)


(23,988)


45 

Profit (loss) before tax




2,212 


(6,300)












Banking net interest margin




2.10% 


1.77% 



Banking asset margin




1.56% 


1.11% 



Banking liability margin




0.97% 


1.28% 



Cost:income ratio3




46.6% 


48.4% 



Underlying cost:income ratio1, 2, 3




46.2% 


50.7% 



Impairment as a % of average advances




2.01% 


3.25% 












Capital and balance sheet




As at 

31 Dec 

2010 


As at 

31 Dec  2009 



Statutory









Loans and advances to customers4




£592.6bn 


£627.0bn 


(5)

Customer deposits5




£393.6bn 


£406.7bn 


(3)

Wholesale funding




£298.0bn 


£325.5bn 


(8)

Loan to deposit ratio6




154% 


169% 



Net assets per ordinary share




68p 


68p 


Risk-weighted assets




£406.4bn 


£493.3bn 


(18)

Core tier 1 capital ratio




10.2% 


8.1% 



Tier 1 capital ratio




11.6% 


9.6% 



Total capital ratio




15.2% 


12.4% 



Leverage ratio




17 times 


18 times 












 

1

Excluding liability management gains of £423 million (2009: £1,498 million) and a £620 million (2009: £427 million) reduction in the fair value of the equity conversion feature of the Group's Enhanced Capital Notes.

2

Excluding impairment of tangible fixed assets of £150 million (2009: Nil).

3

Operating expenses divided by total income, net of insurance claims.

4

Includes reverse repurchase agreements of £3.1 billion (31 December 2009: £1.1 billion).

5

Includes repurchase agreements of £11.1 billion (31 December 2009: £35.5 billion).

6

Excludes repurchase agreements of £11.1 billion (31 December 2009: £35.5 billion) and reverse repurchase agreements of £3.1 billion (31 December 2009: £1.1 billion).



GROUP CHIEF EXECUTIVE'S STATEMENT

 

Summary

2010 was a good year for the Group, in which we made significant progress, delivering a strong operating performance, while strengthening the business for the future.

 

We achieved a step change in our financial performance despite modest economic growth, returning the Group to profitability while absorbing the substantial costs of reducing risk in the business.  While the significant decrease in impairments was a key driver in our return to profitability, we also saw a good performance in the core business where underlying income grew 7 per cent.

 

We delivered good momentum across our core businesses through the continued development of our customer relationship strategy, attracting new customers to the Group and broadening and deepening our relationships with existing customers.

 

We also realised substantial cost savings, and we are on track to deliver our target of £2 billion of run-rate cost synergies from the integration of HBOS by the end of 2011.

 

We made considerable progress during the year in reducing the Group's risk.  The application of our prudent approach to restructuring of the existing book and our risk standards to all new business is being reflected in the more predictable performance of these portfolios.  We also made good progress in reducing the size of our balance sheet and substantially strengthened both our capital and funding positions.

 

As a result of the significant progress we have made in 2010, Lloyds Banking Group is now a much stronger business and is well positioned to realise the potential within its franchise.

 

Results overview

On a combined businesses basis, the Group reported a £2.2 billion profit in 2010, compared to a £6.3 billion loss before tax in 2009.  Underlying income grew by 3 per cent to £23.6 billion, reflecting good underlying income growth of 7 per cent in our core business, partially offset by a reduction of 9 per cent in our non-core business as a result of planned asset reductions.  Operating expenses fell by 6 per cent, resulting in an improvement in our underlying cost:income ratio of 4.5 percentage points to 46.2 per cent.

 

On a statutory basis, the Group delivered a profit before tax of £0.3 billion in 2010.  This compared to a profit of £1 billion in 2009, which benefited from an £11.2 billion negative goodwill gain associated with the purchase of HBOS.

 

A significant reduction in the impairment charge

We achieved a significant reduction in the impairment charge, which fell 45 per cent, with the deterioration in some of our International businesses more than offset by a substantial improvement in the rest of the Group, notably in the Wholesale division. 

 

The considerable reductions in the Retail and Wholesale impairment charges reflect the benefit of the actions we have taken over the past two years and our ongoing effective risk management, as well as the slowly improving economic environment.  While we were disappointed by the increases in the International portfolios, these reflect specific economic challenges facing Ireland, and to some degree Australia, which we are managing closely.

 



GROUP CHIEF EXECUTIVE'S STATEMENT (continued)

 

Good franchise momentum in 2010

We have seen good momentum across our core business franchise in 2010, supported by the extension of our relationship strategy across the Group, in what remain highly competitive markets.

 

In Retail, our strategy is to develop deep and enduring customer relationships through offering a broad range of products addressing customers' needs, alongside superior service and advice.  We opened 1.9 million current accounts, and over 5 million new savings accounts, and increased customer deposits by 5 per cent in the year.

 

In Wholesale, our commitment to supporting our customers through the cycle was equally successful, and we attracted over 100,000 new start-up customers.  Our achievements were recognised in the marketplace by the receipt of a number of awards.

 

We see strong growth opportunities in Wealth, through deepening relationships with existing Group customers and through the targeted acquisition of new customers.  In 2010, we saw encouraging early results from the development of our customer offerings, and we grew our UK relationship customer base by 12 per cent.

 

In Insurance our focus on sustainable and profitable growth led to a 13 per cent increase in profit before tax.  While this strategy led to a reduction in overall sales volumes in our UK Life, Pensions and Investments business as we stopped selling a number of low return heritage HBOS products, this resulted in a substantial increase in new business margin.

 

Supporting the UK's economic recovery

During 2010 the Group continued to support the UK's economic recovery through new lending to our mortgage and business customers.  The Group extended £30 billion of gross mortgage lending (including remortgages) to UK homeowners and supported over 50,000 first time buyers. 

 

We also provided £49 billion of committed gross lending to UK businesses in 2010, of which £11 billion was for SMEs.  As part of our SME Charter, the Group has committed to helping 300,000 new start-up businesses by the end of 2012, and has already helped in excess of 100,000 such enterprises during 2010.  We continue to approve over 80 per cent of lending applications from SME customers.  Despite the uncertain economic environment, the Group has successfully grown net lending to its core SME customers by 2.1 per cent, which compares favourably with the industry-wide reduction in SME lending reported in the latest available market statistics.

 

As a result of our focus, we will exceed the mortgage and business lending commitments made by the Group to the UK government for the year ended 28 February 2011.

 

We have recently announced, along with four other major UK banks and in the context of an agreement with the UK Government, our intent to help support the UK economic recovery by jointly providing the capacity to support gross new lending of £190 billion to creditworthy UK businesses (including £76 billion to small and medium sized businesses).  We are determined to play a full role in supporting investment by UK businesses and households.

 



GROUP CHIEF EXECUTIVE'S STATEMENT (continued)

 

Integration programme on track

We continued to make good progress on the integration of Lloyds TSB and HBOS, one of the largest and most complex programmes undertaken in the UK, exiting the year with run-rate cost synergies of £1.4 billion, as expected.  We achieved savings across a wide range of Group activities, including implementing improved processes which are now being used on a harmonised basis across the Group, and driving savings in property and procurement.  As part of the integration, we have also commenced the implementation of a number of major systems changes, which will complete in 2011.

 

Our progress in 2010 underpins our confidence that we will deliver our target of £2 billion of annual run-rate cost synergies by the end of 2011.

 

Further progress in balance sheet reductions

We are pleased with the progress we have made in reducing the size of the Group's balance sheet, with over half of our five year reduction plan achieved in the first two years.  Although this has had an adverse effect on income, it has resulted in a material reduction in the Group's risk profile, and a smaller balance sheet which brings associated funding benefits.

 

We have now achieved asset reductions totalling £105 billion in the two years since the inception of the programme, against our target of a £200 billion reduction.

 

Excellent progress on funding and liquidity

We made excellent progress in enhancing our funding and liquidity position in 2010, thereby further reducing the Group's risk, albeit at some incremental cost. 

 

We increased our deposit base by 3 per cent, which, together with the reduction in the size of our balance sheet, resulted in an improvement in our loan to deposit ratio to 154 per cent at the end of 2010 from 169 per cent at the 2009 year end.

 

In addition, we substantially exceeded our guidance for term wholesale funding issuance, achieving £50 billion of issuance in the year.  We also continued to broaden the range of our funding sources, and maintained the proportion of our wholesale funding with a maturity of more than one year at 50 per cent.

 

Term issuance during the year enabled us to materially reduce the liquidity we receive from government and central bank sources, by £61 billion to £97 billion at the year end and we have made further progress since then.

 

Capital position further strengthened

We considerably strengthened our capital position in the year, positioning us well ahead of the implementation of the Basel Committee on Banking Supervision's so called 'Basel III' capital reforms, and changes expected to a number of accounting practices.

 

Our core tier 1 ratio increased to 10.2 per cent, from 8.1 per cent at the end of 2009, substantially in excess of regulatory requirements.  We also restructured the capital within our insurance subsidiaries, which will deliver substantial benefits under the Basel III reforms.  At the year end, our tier 1 ratio was 11.6 per cent, and our total capital ratio was 15.2 per cent.

 



GROUP CHIEF EXECUTIVE'S STATEMENT (continued)

 

Regulatory environment

We operate in a demanding and evolving regulatory environment, and have continued to engage actively with our regulators during the year on a number of proposed reforms, ensuring we have a strong and stable banking system, which will also be able to support and serve its customers and the wider economy.  

 

Following extensive scrutiny of the Payment Protection Insurance (PPI) market in recent years, the Financial Services Authority issued its final policy statement on PPI complaints handling in August 2010.  The application of this policy, which has been challenged by the British Bankers' Association in a judicial review, could in extremis have a material effect on the Group's financial position.

 

Our people

I am proud of the high levels of support and service our staff have continued to deliver to our customers over the past year, in what remains a challenging environment, and in the context of the considerable changes to the Group arising from the integration.  Their dedication is reflected in our significant achievements in 2010, and the Board and I are very appreciative of their contribution.

 

Well positioned for future success

It has been a tremendous honour and a privilege to lead our many talented and dedicated people over the last eight years, and I would like to thank my colleagues and the Board for their support over this time.  I am grateful to have been given the opportunity to create the new Group.  The significant progress we have made in 2010 positions the Group well for the future to meet our objective of becoming the best bank for all our stakeholders, including our customers, shareholders and employees.

 

 

 

J Eric Daniels

Group Chief Executive

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

THIS PAGE IS INTENTIONALLY LEFT BLANK



COMBINED BUSINESSES INFORMATION

 

The analysis and commentary that is set out on pages 8 to 72 is presented on a combined businesses basis.  The basis of preparation of the combined businesses results is set out on page 63.

 


Page 

Combined businesses consolidated income statement

9 

Reconciliation of combined businesses profit (loss) before tax to statutory profit before tax for the year

9 

Combined businesses results by half-year

10 

Combined businesses profit (loss) analysis by division

11 

Half-year profit (loss) analysis by division

11 

Summary consolidated balance sheet

12 

Group Finance Director's review of financial performance and outlook

13 

Combined businesses segmental analysis

29 

Divisional performance


Retail

31 

Wholesale

37 

Wealth and International

45 

Insurance

53 

Group Operations

61 

Central items

62 

Additional information on a combined businesses basis

63 

Basis of preparation of combined businesses information

63 

Banking net interest margin

66 

Integration costs and benefits

67 

Impairment charge

68 

Core and non-core business

69 

Volatility arising in insurance businesses

70 

Number of employees (full-time equivalent)

72 

 



COMBINED BUSINESSES CONSOLIDATED INCOME STATEMENT

 







2010 


2009 







£ million 


£ million 










Net interest income






13,822 


12,726 

Other income






10,164 


11,875 

Total income






23,986 


24,601 

Insurance claims






(542)


(637)

Total income, net of insurance claims






23,444 


23,964 

Costs:









Operating expenses






(10,928)


(11,609)

Impairment of tangible fixed assets






(150)








(11,078)


(11,609)

Trading surplus






12,366 


12,355 

Impairment 






(13,181)


(23,988)

Share of results of joint ventures and associates






(91)


(767)

Loss before tax and fair value unwind






(906)


(12,400)

Fair value unwind






3,118 


6,100 

Profit (loss) before tax - combined businesses





2,212 


(6,300)

 

The basis of preparation of the combined businesses income statement is set out on page 63.

 

 

RECONCILIATION OF COMBINED BUSINESSES PROFIT (Loss) BEFORE TAX TO

STATUTORY PROFIT BEFORE TAX FOR THE YEAR

 







2010 


2009 







£ million 


£ million 










Profit (loss) before tax - combined businesses




2,212 


(6,300)

Integration costs






(1,653)


(1,096)

Volatility arising in insurance businesses (note 6, page 70)




306 


478 

Amortisation of purchased intangibles and goodwill impairment




(629)


(993)

Pension curtailment gain (note 4, page 122)






910 


Customer goodwill payments provision






(500)


Loss on disposal of businesses






(365)


Government Asset Protection Scheme fee







(2,500)

Negative goodwill credit







11,173 

Pre-acquisition results of HBOS plc







280 

Profit before tax - statutory






281 


1,042 

 



COMBINED BUSINESSES RESULTS BY HALF-YEAR

 







2010 


2010 







First 
half-year 


Second 
half-year 







£ million 


£ million 










Net interest income






6,911 


6,911 

Other income






5,831 


4,333 

Total income






12,742 


11,244 

Insurance claims






(261)


(281)

Total income, net of insurance claims






12,481 


10,963 

Costs:









Operating expenses






(5,435)


(5,493)

Impairment of tangible fixed assets






(150)








(5,585)


(5,493)

Trading surplus






6,896 


5,470 

Impairment 






(6,554)


(6,627)

Share of results of joint ventures and associates






(62)


(29)

Profit (loss) before tax and fair value unwind






280 


(1,186)

Fair value unwind






1,323 


1,795 

Profit before tax - combined businesses






1,603 


609 

 



COMBINED BUSINESSES PROFIT (LOSS) ANALYSIS BY DIVISION

 







2010 


2009 







£ million 


£ million 










Retail






4,716 


1,382 










Wholesale






3,257 


(4,703)










Wealth and International






(4,824)


(2,356)










Insurance






1,102 


975 










Group Operations and Central items:









Group Operations






(63)


(149)

Central items






(1,976)


(1,449)







(2,039)


(1,598)

Profit (loss) before tax






2,212 


(6,300)

 

 

HALF-YEAR PROFIT (LOSS) ANALYSIS BY DIVISION

 







2010 


2010 







First 
half-year 


Second 
half-year 







£ million 


£ million 










Retail






2,495 


2,221 










Wholesale






742 


2,515 










Wealth and International






(1,609)


(3,215)










Insurance






469 


633 










Group Operations and Central items:









Group Operations






(56)


(7)

Central items






(438)


(1,538)







(494)


(1,545)

Profit before tax






1,603 


609 










Banking net interest margin






2.08% 


2.12% 

Banking asset margin






1.55% 


1.57% 

Banking liability margin






0.98% 


0.97% 

Impairment as a % of average advances






2.01% 


2.02% 

 



SUMMARY CONSOLIDATED BALANCE SHEET

 


As at
31 December
2010

As at 
31 December 
2009 

Assets


£ million 


£ million 






Cash and balances at central banks


38,115 


38,994 

Trading and other financial assets at fair value through profit or loss


156,191 


150,011 

Derivative financial instruments


50,777 


49,928 

Loans and receivables:





     Loans and advances to customers


592,597 


626,969 

     Loans and advances to banks


30,272 


35,361 

     Debt securities


25,735 


32,652 



648,604 


694,982 

Available-for-sale financial assets


42,955 


46,602 

Held-to-maturity investments


7,905 


Other assets


47,027 


46,738 

Total assets


991,574 


1,027,255 

 

Liabilities





Deposits from banks


50,363 


82,452 

Customer deposits


393,633 


406,741 

Trading and other financial liabilities at fair value through profit or loss


26,762 


28,271 

Derivative financial instruments


42,158 


40,485 

Debt securities in issue


228,866 


233,502 

Liabilities arising from insurance and investment contracts


132,735 


123,609 

Subordinated liabilities


36,232 


34,727 

Other liabilities


33,923 


33,361 

Total liabilities


944,672 


983,148 






Total equity


46,902 


44,107 

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK

 

2010 performance - a return to profitability and a further reduction in risk

The Group delivered a good operating performance in 2010 against the backdrop of modest growth in the UK economy, with good revenue growth in the core business, an improved net interest margin, a further reduction in costs, and continued strong progress on the integration of HBOS.  The impairment charge reduced significantly, with deterioration in impairments in Ireland more than offset by substantial improvements elsewhere in the Group, particularly in the Wholesale division.  As a result the Group returned to profitability in 2010 on a combined businesses basis, reporting a profit before tax of £2,212 million in 2010, compared to a loss before tax of £6,300 million in 2009. 

 

The increase in profit before tax was primarily generated by Wholesale and Retail.  Wholesale returned to profitability in 2010 delivering profit before tax of  £3,257 million compared to a loss before tax of £4,703 million in 2009 reflecting a significant reduction in the impairment charge.  Retail profit before tax also increased significantly to £4,716 million from £1,382 million in 2009 driven by good income growth and a significantly lower impairment charge.  Insurance delivered a 13 per cent increase in profit before tax to £1,102 million as our focus on improved profitability of the product set delivered higher new business profits, despite lower sales.  However, these increases were partially offset by a significant increase in loss before tax in Wealth and International to £4,824 million from £2,356 million in 2009, driven by a higher impairment charge, predominantly due to the material deterioration of the economic environment in Ireland in the last quarter of 2010.

 

While the majority of the Group's 2010 profit was earned in the first half, when liability management gains in the first half and losses in the second half arising from the equity conversion feature of the Enhanced Capital Notes (ECNs) are excluded, the second half saw a significant improvement in profitability when compared to the first half, driven by a significant increase in Wholesale profit, partially offset by an increased loss in Wealth and International.

 

Statutory profit before tax was £281 million in 2010.  While this was a reduction from £1,042 million in 2009, the 2009 result had benefited from an £11,173 million credit from the gain arising on the HBOS acquisition (negative goodwill).  In 2010, statutory profit included a charge for integration costs of £1,653 million (2009: £1,096 million), a provision of £500 million for customer goodwill payments, and a loss on disposal of businesses (acquired from a previous lending relationship) of £365 million; these items were partially offset by a £910 million pension curtailment gain and positive insurance volatility of £306 million.  After a taxation charge of £539 million (see page 26) and a charge for profit attributable to non-controlling interests of £62 million, loss attributable to equity shareholders was £320 million and loss per share amounted to 0.5 pence.

 

We further reduced risk in the business, through the reduction in the size of the Group's balance sheet in line with our strategy and through the significant improvements in our capital, funding and liquidity achieved during the year.  Our core tier 1 ratio now stands at 10.2 per cent (2009: 8.1 per cent), and our loan to deposit ratio, excluding repos, improved to 154 per cent, and to 119 per cent in our core business.  Through strong term wholesale funding issuance during the year, which totalled £50 billion, we maintained the maturity profile of the Group's wholesale funding, with 50 per cent having a maturity of more than one year.  We also made excellent progress in reducing liquidity support from government and central bank facilities, which reduced by £60.6 billion to £96.6 billion.

 

Outlook - strong medium-term prospects

Given the flexibility and capacity we have for core business growth, we continue to believe that the Group has strong medium-term prospects, notwithstanding the headwinds that we face in 2011.  We give detailed comments on our prospects in the following sections.

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Our medium-term targets remain unchanged.  However, having joined the Group in January, António Horta-Osório will be appointed Group Chief Executive on 1 March, and will be reviewing the business to further develop the strategy and actions needed to realise its full potential.  He expects to report to the board and subsequently to shareholders on the outcome of his strategic review and his plans at the end of the first half of 2011.

 

With the Group having returned to profitability in 2010, the risk in the business further reduced, and our improved capital, funding and liquidity positions, we now have a stronger business, which is well positioned for the future.

 

Note on presentation of results

To enable meaningful comparisons to be made with prior periods, and in line with previous results announcements, the income statement commentaries below are on a combined businesses basis (see 'basis of presentation').  Certain commentaries also exclude the unwind of fair value adjustments.

 

Further, to enable a better understanding of the Group's core business trends and outlook, certain income statement and balance sheet information is analysed between core and non-core portfolios.  Non-core portfolios consist of non-relationship assets and liabilities, and assets and liabilities which are outside the Group's current appetite.  The EU mandated retail business disposal is not included in non-core portfolios.

 

Combined businesses results summary - income




2010 


2009 


Change




£m 


£m 


%









Net interest income



13,822 


12,726 


Other income:








    Underlying other income



10,361 


10,804 


(4)

    Liability management gains



423 


1,498 



    Reduction in fair value of equity conversion feature of ECNs



(620)


(427)






10,164 


11,875 


(14)

Total income



23,986 


24,601 


(2)

Insurance claims



(542)


(637)



Total income, net of insurance claims



23,444 


23,964 


(2)

 

Underlying income

Net interest income



13,822 


12,726 


Underlying other income



10,361 


10,804 


(4)

Insurance claims



(542)


(637)



Underlying income



23,641 


22,893 


 

Core and non-core income

Core




19,371 


18,188 


Non-core




4,270 


4,705 


(9)

Underlying income




23,641 


22,893 


 

A good revenue performance

Total income, net of insurance claims, decreased by 2 per cent to £23,444 million, which included a reduction of £1,075 million in gains from the Group's liability management exercises and a £193 million increase in the mark-to-market losses arising from the equity conversion feature of the Group's Enhanced Capital Notes.  The total mark-to-market loss relating to the ECNs in 2010 was £620 million, and comprised a gain of £192 million in the first half of the year and a loss of £812 million in the second half.



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Underlying income, excluding these items, increased by 3 per cent.  The Group delivered a good revenue performance in its core business in 2010 despite subdued growth in lending markets.  Core business underlying income growth of 7 per cent was, however, partially offset by a reduction in non-core income of 9 per cent, in line with progress against the Group's strategy to reduce the size of its balance sheet.

 

Group net interest income increased by £1,096 million, or 9 per cent, to £13,822 million.  The net interest margin from our banking businesses was 33 basis points higher at 2.10 per cent, as higher asset pricing and reductions in the average spread between base rate and LIBOR more than offset lower deposit margins in Retail and increasing wholesale funding spreads.  The incremental costs of wholesale funding have been recorded within Central items.  The banking asset margin increased by 45 basis points to 1.56 per cent, and the banking liability margin decreased by 31 basis points to 0.97 per cent.

 

The majority of the net interest margin increase was achieved in the first half of the year, with only modest improvement in the second half, as previously guided, given rising wholesale market funding costs, a slowing migration of mortgages to standard variable rates, continued liability margin pressures, and modest additional costs reflecting the successful increase in term issuance compared to our initial expectations. 

 

In 2011, we see limited scope to increase asset pricing, with any gains likely to be offset by elevated wholesale funding costs, while liability margins will remain under pressure as a result of competitive markets and low base rates.  Given these factors and the margin expansion since 2009, which we have achieved earlier than expected, we do not expect further progression in our net interest margin in 2011 compared to 2010 as a whole.

 

Other income decreased by 14 per cent to £10,164 million.  Excluding liability management gains and movements in the fair value of the ECNs, underlying other income decreased 4 per cent.  This reflected lower payment protection insurance (PPI) income as a result of the Group's decision to withdraw from writing PPI business during the year, lower overdraft charges following changes to fee structures, and loss on sale of assets arising from targeted balance sheet reductions, as well as other elements principally related to changes in financial market conditions during the year.

 

Divisional underlying income performance







2010 






2009 


Change 



Core 

£m 


Non-core 

£m 


Total 

£m 


Core 

£m 


Non-core 

£m 


Total 

£m 


Core 
















Retail


10,394 


591 


10,985 


9,386 


388 


9,774 


11 

Wholesale


5,540 


3,022 


8,562 


5,336 


3,573 


8,909 


Wealth & International


1,679 


657 


2,336 


1,601 


744 


2,345 


Insurance


2,009 



2,009 


1,990 



1,990 


Group Operations and Central items


(251)



(251)


(125)


 


(125)



Underlying income


19,371 


4,270 


23,641 


18,188 


4,705 


22,893 


 

Core business income growth was primarily driven by a strong performance in Retail, where net interest income benefited from an increase in asset margins, the majority of which occurred in the first half of the year.  This increase was partially offset however by lower savings margins.  Mortgage margins reflected a continued increase in the proportion of mortgages on standard variable rates (now representing 48 per cent of outstanding balances), lower LIBOR to base rate spreads, and higher new business margins as assets were priced to appropriately reflect



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

risk and changes in funding costs.  The Group achieved a 22.1 per cent share of gross mortgage lending (2009: 24.1 per cent), in markets which remained generally subdued.  Unsecured lending balances were lower, continuing the recent trend and reflecting lower customer demand and continuing customer deleveraging.  During the year, we continued to build our current account and savings customer franchises in what remains a competitive market for customer deposits, and reduced the proportion of more expensive term deposits while maintaining good overall deposit growth of 5 per cent.

 

In Wholesale, core income grew by 4 per cent, driven by an increase in the banking net interest margin, principally from asset margin growth, which largely reflected the repricing of lending business.  This was partially offset by lower net interest income in Treasury and Trading, reflecting the more stable interest rate environment.  Non-core income decreased by 15 per cent, given lower interest earning asset balances resulting from the excellent progress in targeted balance sheet reductions. 

 

In Wealth and International, core income increased by 5 per cent, driven by the positive effect of foreign exchange movements in the International business and of higher global stock markets in the Wealth businesses, partially offset by a decline in the banking net interest margin.

 

The present value of new business premiums in our life, pensions and investments businesses decreased by 20 per cent, largely reflecting the focus on improving the profitability of the product set and the withdrawal of certain HBOS legacy products with lower returns.  However, as a result of the repositioning of the product set, the benefits of cost savings and a reduction in initial commission on OEICs in 2010, UK new business profit increased by £135 million to £267 million.  This improved performance shows through the Insurance division's UK margins on an EEV basis increasing to 3.7 per cent in 2010, compared to 2.6 per cent in 2009.  General Insurance delivered a robust performance after taking account of the impact of the 2010 freeze events and the Group's decision to cease writing new payment protection business during the year.

 

Within Group Operations and Central Items, underlying income decreased by £126 million primarily due to a reduction in the fair value of derivatives not mitigated through hedge accounting.  Net interest expense was broadly unchanged at £823 million, but included capital and wholesale liquidity funding costs of £601 million (2009: £260 million) not recovered from the divisions, with the increase primarily due to higher wholesale market funding spreads and the Group's decision to accelerate its wholesale funding in 2010.  These increased costs were offset by improved net interest from interest rate risk management activities.

 

Outlook - income

Core assets accounted for approximately 82 per cent of income in 2010 (2009: 79 per cent), with core income growing 7 per cent.  In 2011, however, we expect income trends will reflect continued customer deleveraging and subdued new lending demand which, with further non-core asset reductions, will result in a continued reduction in the overall size of the Group's balance sheet.  As already stated, we do not expect to see further net interest margin progression in 2011.

 

Over time, however, we continue to target core businesses income growth of between 6 and 7 per cent per year and believe that our margin is likely to return to more than 2.5 per cent in the medium-term (approximately 2014) reflecting the effect of modest further improvements in asset pricing, higher liability margins facilitated by higher base rates, and greater stability in wholesale funding markets.  We also anticipate reducing our wholesale funding requirements over this period.  This margin outlook reflects, inter alia, our core economic assumptions for the medium-term, including base rates increasing to 3.75 per cent by the end of this period and no deterioration in consumer spending, the Group's asset reduction programme, the assumed costs of refinancing as wholesale funding matures, and a narrowing of wholesale market credit spreads over the medium-term.  At the same time however, it is not possible to predict what effect current regulatory discussions could have on funding costs and therefore margin.



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Combined businesses results summary - expenses

 





2010 


2009 


Change 





£m 


£m 











Operating expenses




(10,928)


(11,609)


Impairment of tangible fixed assets1




(150)








(11,078)


(11,609)











Integration synergies run rate at 31 December




1,379 


766 



Underlying cost:income ratio




46.2% 


50.7% 



 

1

Further detail is given in note 6, page 123.

 

Strong cost management delivering benefits

The Group has an excellent track record in managing its cost base, and has delivered a strong cost performance in 2010.  During 2010, operating expenses decreased by 6 per cent to £10,928 million, as substantial integration related savings were captured, together with lower levels of operating lease depreciation.  After investment, ongoing business as usual expenses were held within inflationary levels.  Our underlying cost:income ratio also saw further improvement to 46.2 per cent.

 

We have already made significant progress in capturing savings from the integration programme with annual run-rate savings totalling £1,379 million achieved as at 31 December 2010.  The Group is on track to deliver a run-rate of £2 billion per annum of cost synergies and other operating efficiencies by the end of 2011.

 

To date, costs of preparing for the EU mandated disposal of at least 600 UK branches, associated customer assets and liabilities and a proportion of our mortgage assets, have been modest.  However with integration nearing completion, activity preparing for this divestment will accelerate significantly.  The final cost will depend on the buyer and the extent to which substantial IT system and infrastructure development will be necessary.  Therefore the total cost is hard to predict but is likely to be substantial.  These costs will be excluded from combined businesses profits.

 

With income growth in the short term dependent, inter alia, upon economic conditions, strong cost management will continue to be an important focus for management.

 

Outlook - expenses

We expect that our costs will be broadly flat in 2011, with further absolute cost savings likely to be partially offset by increased investment proposed to support the growth of the core business, increasing regulatory costs, costs resulting from the introduction of the Bank Levy (which is expected to cost around £260 million in 2011), and the combined cost in the region of £100 million of the recent rise in VAT and employers' National Insurance contributions.  Excluding the cost of the Bank Levy, the Group continues to target a cost:income ratio of approximately 40 per cent in the medium term.

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Combined businesses results summary - impairment charge

 







2010 






2009 


Change 



Core 

£m 


Non-core 

£m 


Total 

£m 


Core 

£m 


Non-core 

£m 


Total 

£m 


Core 

Retail















     Secured


251 


41 


292 


656 


133 


789 


62 

     Unsecured


2,372 


83 


2,455 


3,318 


120 


3,438 


29 



2,623 


124 


2,747 


3,974 


253 


4,227 


34 

Wholesale


1,276 


3,170 


4,446 


2,187 


13,496 


15,683 


42 

Wealth and International













     Ireland



4,264 


4,264 



2,949 


2,949 


     Other


221 


1,503 


1,724 


189 


940 


1,129 


(17)



221 


5,767 


5,988 


189 


3,889 


4,078 


(17)

Impairment charge


4,120 


9,061 


13,181 


6,350 


17,638 


23,988 


35 

 

Impairment charge significantly lower

The Group achieved a significant reduction in the impairment charge in 2010, in both the core and non-core businesses.  The impairment charge of £13,181 million was 45 per cent lower than the £23,988 million charge in 2009, with deterioration in Ireland more than offset by substantial improvements elsewhere in the Group, particularly in the Wholesale division. 

 

Impaired loans increased by 10 per cent to £64,606 million, representing 10.3 per cent of closing advances, driven by an increase in impaired loans in International, partially offset by decreases in Retail and Wholesale facilitated by improving economic conditions and, in Wholesale, also as a result of write-offs of irrecoverable assets and the sale of previously impaired assets.  The Group's coverage ratio increased by 1.7 per cent to 45.9 per cent, primarily as a result of an increase in provisions in International, predominantly in Ireland.  Non-core loans and advances to customers generated approximately 70 per cent of the Group's impaired loans reflecting their higher risk profile, with a coverage ratio of around 50 per cent at 31 December 2010.  The coverage ratio of the Group's impaired core loans and advances to customers was approximately 37 per cent.

 

In Retail, the improvement in credit performance was faster than expected a year ago, with the impairment charge as a percentage of average loans and advances to customers decreasing to 0.74 per cent in 2010, significantly lower than 1.11 per cent in 2009.  The core business impairment charge decreased by 34 per cent, reflecting the improved quality of new business and effective portfolio management and the continuing slow recovery of the economy.

 

The lower secured impairment charge reflected reduced impaired loan levels and improved arrears in the first half of 2010, although in the second half, and particularly in the last quarter, we saw some signs of strain, with fewer customers returning their accounts to order than was the case six months ago.  House prices fell slightly in the year and the proportion of the mortgage portfolio with an indexed loan-to-value of greater than 100 per cent was broadly stable at 13 per cent.  The value of the portfolio with an indexed loan-to-value greater than 100 per cent and more than three months in arrears has increased slightly by £0.2 billion and is now £3.2 billion, representing 0.9 per cent of the portfolio.  The number of mortgage customers new to arrears has also remained relatively stable in the last twelve months, and is now well below the peak experienced in the second half of 2008.  However, as a result of the early signs of strain we saw in the second half of the year and the subdued economic environment, we expect to see an increase in the secured impairment charge in 2011.

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

The unsecured impairment charge decreased by 29 per cent, reflecting continued improving portfolio trends resulting from the Group's prudent risk appetite, management actions taken over the past two years, and stable unemployment.  Unsecured impaired loans decreased by £0.8 billion to £3.0 billion as a result of fewer cases going into arrears, improved quality of new business and increased write off of impaired loans.  Impairment provisions as a percentage of impaired loans decreased to 50.6 per cent from 55.3 per cent, driven largely by relatively highly provided assets being written off combined with more stringent criteria for unsecured collections repayment plans.

 

The Wholesale impairment charge fell significantly from £15,683 million in 2009 to £4,446 million in 2010.  There was a significant reduction in both the core and non-core businesses impairment charge.  The impairment charge as a percentage of average loans and advances to customers improved significantly to 2.08 per cent in 2010 compared to 5.92 per cent in 2009. 

 

The decrease in this period generally reflects the significant actions which were taken in the first half of 2009 on the heritage HBOS portfolios (including the identification of large impairments post the HBOS acquisition, especially in corporate real estate, real estate related and Corporate (UK and US) portfolios), together with the stabilising UK and US economic environment in 2010, a low interest rate environment helping to maintain defaults at a lower level and a number of write backs due to asset disposals.

 

In Wealth and International, impairment charges totalled £5,988 million, up 47 per cent on £4,078 million in 2009, reflecting increasing impairment charges in corporate and real estate in Ireland and Australia.  The majority of the increase was in the non-core portfolio.  The level of losses continues to be dominated by the economic environment in Ireland, and to a lesser extent has also been influenced by the performance of specific areas of the Australian economy.

 

After the release of the Interim Management Statement on 2 November 2010, the Group saw a further significant deterioration in market conditions in Ireland, with concerns over the country's fiscal position leading ultimately to the approval of its application for EU-IMF financial support on 21 November 2010.  Market sentiment continued to be negatively affected by uncertainty about the political situation and about the economic effect of the austerity measures introduced in the Irish Budget of 7 December 2010.  As a result, in a statement dated 17 December 2010, we noted that any economic recovery in Ireland may take longer to achieve, that asset prices will remain depressed for longer than previously anticipated and therefore that we believed that the significant deterioration in the Irish market would affect the timing and level of value realisation from this portfolio. 

 

At the year end, compared to 30 June 2010, given the deterioration in market conditions noted above, a further approximately 10 per cent of the £27 billion Irish portfolio had become impaired, and we have increased the level of provisions against the portfolio, increasing the impairment charge relating to Irish exposures for the full year 2010 to £4.3 billion on a combined businesses basis.  This has resulted in an increase in provisions as a percentage of impaired Irish loans to 53.7 per cent at the 2010 year end, in line with our expectations in our statement of 17 December 2010.

 

In Australia, although economic performance has been robust overall, there are significant geographical and sector variations, and property assets situated outside the principal metropolitan areas have been particularly weak.  Our exposure to these areas within our Australian portfolio drove increased impairments in 2010. 

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Outlook - impairment

Overall, and based on our current economic assumptions for the UK and Ireland, including unemployment and property valuations, we expect to see further reductions in impairment losses in 2011 and beyond.  We continue to target an improvement in the overall Group impairment charge as a percentage of average loans and advances to customers towards an expected 50-60 basis points by around 2014, as economic conditions improve.

 

In Retail, given our expectations for a modest improvement in the UK economic environment, and a further 2 per cent reduction in house prices in 2011, we currently expect that there will be a modest reduction in the overall Retail impairment charge in 2011.  The rate of improvement is, however, expected to be significantly slower than in 2010, with the improving performance of the unsecured book more than offsetting additional secured charges.

 

In Wholesale, depending upon UK economic conditions, notably consumer spending, future commercial real estate price stability, the continuation of low interest rates, and the performance of individually large exposures, we would expect to see a further modest reduction in 2011 as a whole, although the timing of the trend is inherently hard to predict.  As previously guided, we expect the overall net impairment charge in our traditional lending businesses (especially in the trading and manufacturing sectors) to increase in 2011, driven in part by lower write backs on asset disposals compared to 2010 and the effect of the UK government austerity measures on the wider economy.  However, we also expect our impairment charges in corporate real estate and real estate related sectors to be lower than 2010 as a result of a continuing stabilisation of the existing portfolio.  We remain vigilant in monitoring changes in economic conditions and to individual lending positions and we continue to invest heavily in expert resource to work with customers to restructure their businesses on to sustainable bases, thus protecting employment where possible.

 

Despite the worsening trend during 2010, we expect to see a reduction in the Wealth and International impairment charge in 2011, although we anticipate that conditions will remain difficult, and we will therefore continue to monitor international markets closely.

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Capital resources 

 



2010 


2009 






Risk-weighted assets


£406.4bn 


£493.3bn 

Core tier 1 ratio


10.2% 


8.1% 

Tier 1 capital ratio


11.6% 


9.6% 

Total capital ratio


15.2% 


12.4% 

 

Strong capital ratios

Our capital ratios improved significantly during the year, primarily reflecting a reduction in risk weighted assets, and balance sheet liability management transactions.  Total capital also increased through further subordinated debt issuance and through a repatriation of capital held within our insurance subsidiaries, although this increase was partially reduced by a revised approach to private equity investments which have now been deducted from total capital.

 

Risk weighted assets reduced by 18 per cent to £406.4 billion, driven by strong management of risk, reduced asset levels and tighter risk criteria for new business.  Reductions were also achieved through changes to our credit risk measurement methodology in certain portfolios, including migrating a number of our Wholesale portfolios, which had previously been modelled on an Advanced Internal Ratings Based Approach, to the Foundation Internal Ratings Based Approach (FIRB), which will facilitate integration work.

 

Effects of Basel III on capital

During 2010 the Basel Committee on Banking Supervision has substantially refined the details of the so called 'Basel III' reforms for an enhanced global capital accord.  These include increased minimum levels of, and quality standards for, capital, increased risk weighting of assets, and the introduction of a minimum leverage ratio, as well as the timing and transitional arrangements for implementation.  The final details are still to be clarified, particularly as the reforms are implemented within the European and UK regulations, which may include a countercyclical buffer, requiring higher levels of capital to be held at certain points of the economic cycle, and higher capital requirements for systemically important financial institutions.

 

One of the key reforms impacting the Group arises from a revised treatment of the capital held within our insurance subsidiaries. During 2010, following a strategic review of our capital structure, £0.8 billion of equity was exchanged for subordinated debt within the insurance group and £1.5 billion was repatriated from the insurance group.  Whilst this has no overall effect on the Group's core tier 1 capital under current Basel regulations, it does deliver a material core tier 1 capital benefit under the proposed Basel III reforms.

 

Outlook - capital resources

The effect of the Basel III reforms is uncertain as much will depend on business performance and mitigating actions that can be completed, even before the transition period comes in to effect.  Analysis suggests that with no mitigating actions the reforms will reduce the Group's core tier 1 ratio by approximately 1.2 per cent in 2013, although lower risk weighted assets are expected from the planned reduction in the non-core balance sheet.  The additional impact in 2014 of deducting the equity investment in insurance in excess of 10 per cent, transitioning in at 20 per cent per annum from 1 January 2014, would be around 0.3 per cent were the Group to take no further action to mitigate this.  The Group is confident that it is well positioned to maintain a strong capital position, meeting all regulatory requirements as currently formulated.

 

Based on our economic outlook, we continue to target returns on equity of more than 15 per cent over the medium to longer term.  However, there continue to be material uncertainties as to future capital requirements and therefore we cannot be more specific at this stage.



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Balance sheet

 



As at 

31 Dec 

2010 


As at 

31 Dec 

2009 



£bn 


£bn 






Funded assets1


655.0 


715.1 

Non-core assets2


194.7 


236.1 

 

1

Further analysis is set out on page 79.

2

Further analysis is set out on page 70.

 

Rightsizing the balance sheet

Total Group funded assets decreased to £655.0 billion from £715.1 billion at 31 December 2009, substantially driven by reductions in non-core lending portfolios across the three banking divisions, continued customer deleveraging and de-risking and subdued demand in lending markets.  We are pleased with the progress made on our balance sheet reduction plans in the period, given challenging market conditions, particularly in the latter part of 2010.

 

Previously, we set out our strategy to reduce non-core assets, including non-relationship assets and businesses which are outside our current appetite, by some £200 billion from a non-relationship pool of £300 billion.  It continues to be our intention to manage these assets for value and, given the current economic climate, our primary focus remains on running these assets down over time.  This strategy has been very effective and so far reductions of £105 billion have been achieved.

 

Outlook - balance sheet

We are confident of achieving our targeted further reductions in non-core assets of approximately £100 billion over the next three years.  In addition, we continue to progress plans to execute the divestment of retail assets and liabilities in line with our state aid obligations. 

 

The balance sheet reduction over time is providing the Group with increased optionality and flexibility from the resultant releases in both funding and capital.  Together with initiatives to increase customer deposits in line with market growth, we expect to reduce the proportion of the Group's funding that is derived from wholesale markets and eliminate our use of government and central bank facilities by the end of 2012.  This will provide capacity for core business growth in line with our relationship strategy. In 2011, however, we expect to see a continuation in the trend of customer deleveraging and generally subdued demand for new lending.

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Liquidity and funding

 



As at 

31 Dec 

2010 


As at 

31 Dec 

2009 






Wholesale funding


£298.0bn 


£325.5bn 

Loan to deposit ratio1


154% 


169% 

Core business loan to deposit ratio1


119% 


128% 

Government and central bank funding


£96.6bn 


£157.2bn 

Proportion of wholesale funding with maturity of greater than one year


50% 


50% 

 

1

Excluding repos and reverse repos.

 

A strengthened liquidity and funding position

The Group made excellent progress against its funding objectives in 2010 and further enhanced its liquidity position which is supported by a robust and stable customer deposit base.  While total customer deposits fell 3 per cent, deposits excluding repurchase agreements increased by 3 per cent, reflecting good growth in relationship deposits in Retail and in Wealth and International.

 

The Group has continued to reduce its reliance on short-term wholesale funding.  During the year the absolute level of Group wholesale funding fell to £298.0 billion, from £325.5 billion at the end of 2009, reflecting a reduction in balance sheet assets.  By the end of 2010, our loan to deposit ratio, excluding repos and reverse repos, had improved to 154 per cent.  Strong term issuance in 2010 also allowed the Group to maintain its maturity profile of wholesale funding with 50 per cent of wholesale funding having a maturity date greater than one year at 31 December 2010. 

 

As previously guided, over the next couple of years the Group expects its public capital and senior funding issuance to be £20 billion to £25 billion per annum.  We made excellent progress in 2010 on our term funding issuance plans, achieving £30 billion of publicly placed term issuance in the year.  In addition, the Group issued a further £20 billion of term funding during the year via a series of privately placed funding transactions, a level which we do not expect to repeat in 2011.  The Group continues to benefit from a diversity of funding sources.  For example, during the year, we established a new funding programme in the US with our SEC Registered Shelf, issued inaugural Japanese Yen Samurai, Swiss Franc and Canadian Dollar bonds, and publicly launched the Lloyds TSB Bank plc Covered Bond Programme.  We continue to look for opportunities to diversify our funding sources.

 

We welcome the proposals on minimum standards for funding and liquidity published by the Basel Committee on Banking Supervision in December 2010.  The introduction of the Liquidity Coverage Ratio and Net Stable Funding Ratio will raise the resilience of banks to potential liquidity shocks and provide the basis for a harmonised approach to liquidity risk management.  These proposals are subject to ongoing refinement and have not yet been enacted into UK and European law.  However, the Group monitors compliance against these internal metrics, and as at 31 December 2010, the Group's Liquidity Coverage Ratio was estimated at 71 per cent and the Net Stable Funding Ratio at 88 per cent.  The actions already in place to reduce the size of the balance sheet are expected to ensure compliance with the future minimum standards, which are expected to be 100 per cent for both ratios, by their respective effective dates.

 



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

The Group made excellent progress on reducing its liquidity support from governmental and central bank sources, achieving reductions of £60.6 billion in 2010 leaving £96.6 billion outstanding at the year end.  The Group currently receives no liquidity support from either the US Federal Reserve or the European Central Bank.  The drawings from the UK Special Liquidity Scheme facilities and the issuance under the UK Credit Guarantee Scheme have various maturity dates, the last of which is in the fourth quarter of 2012.  The Group is confident that all maturities can be met, and a further £13 billion of government and central bank facilities have been repaid since the year end.

 

Outlook - liquidity and funding

We expect the combination of continued increases in customer deposits and reductions in assets (primarily from non-core asset reduction plans) over the next three years to deliver further improvements in the Group's liquidity and funding position.  As a consequence, we expect steady improvement in the overall loan to deposit ratio (which is expected to fall to below 140 per cent within three years), a reduction in wholesale funding requirements and therefore levels of ongoing term issuance, and liquidity levels to be maintained in excess of regulatory requirements.



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Reconciliation of combined businesses results to statutory results

 







2010 


2009 







£ million 


£ million 










Profit (loss) before tax - combined businesses




2,212 


(6,300)

Integration costs






(1,653)


(1,096)

Volatility arising in insurance businesses




306 


478 

Amortisation of purchased intangibles and goodwill impairment




(629)


(993)

Pension curtailment gain






910 


Customer goodwill payments provision






(500)


Loss on disposal of businesses






(365)


Government Asset Protection Scheme fee







(2,500)

Negative goodwill credit







11,173 

Pre-acquisition results of HBOS plc







280 

Profit before tax - statutory






281 


1,042 

Taxation






(539)


1,911 

Profit (loss) for the year






(258)


2,953 

Earnings per share






(0.5)p


7.5p 

 

Integration costs

One-off integration costs of £1,653 million were incurred in 2010, bringing the total integration costs since the HBOS acquisition to £2,749 million.  The integration costs relate to severance, IT and business costs of implementation.

 

Volatility arising in insurance businesses

A large proportion of the funds held by the Group's insurance businesses are invested in assets which are expected to be held on a long-term basis and which are inherently subject to short-term investment market fluctuations.  Whilst it is expected that these investments will provide enhanced returns over the longer term, the short-term effect of investment market volatility can be significant.  In 2010, higher equity market returns compared to our long-term assumptions have contributed to positive insurance and policyholder volatility totalling £306 million.

 

Pension curtailment gain

A net curtailment gain of £910 million was recognised in 2010 following changes to the Group's UK defined benefit pension schemes.  In the first half of 2010 the Group implemented changes to the terms of its UK defined benefit pension schemes.  As a result of these changes, the amount of any future salary increases that will be deemed pensionable will be capped each year at the lower of Retail Price Index inflation; each employee's actual percentage increase in pay; and 2 per cent of pensionable pay.  This resulted in a curtailment gain of £1,019 million, but was partially offset in the second half of 2010 from a change in the commutation factors in certain defined benefit schemes.



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Customer goodwill payments provision

On 21 February, 2011, we announced that we had reached a voluntary agreement with the Financial Services Authority (FSA) to initiate a customer review and contact programme regarding outstanding concerns relating to the variation of limits on some Retail mortgage contracts.  These specifically related to some Halifax standard variable rate mortgage customers, where the wording in the mortgage offer documents received by these customers had the potential to cause confusion.  Under the contact programme, goodwill payments will be made to affected customers.

 

We have made a customer goodwill payments provision in 2010 of £500 million in relation to the contact programme.  This provision, which has been excluded from combined businesses profits, is expected to fully cover the costs of the programme. Further detail is given in note 26 on page 144.

 

Loss on disposal of businesses

During 2010, the Group recorded a loss of £365 million on the disposal of two wholly-owned subsidiary companies, acquired from a previous lending relationship, each of which owned an oil drilling rig under construction.  Consistent with the Group's previous treatment, this loss has been reported outside of the Group's combined businesses results.

 

Taxation

The tax charge for the year to 31 December 2010 was £539 million.  This reflects a higher effective tax rate than the UK statutory rate primarily due to the effect of partially unrelieved losses in Ireland and Australia, policyholder tax, and the effect on deferred tax of the reduction in the UK corporation tax rate from 28 per cent to 27 per cent with effect from 1 April 2011.

 

Acquisition related balance sheet adjustments

Profit before tax includes the unwind of £3,118 million of acquisition related fair value adjustments, of which £2,229 million relates to impairments.  This is ahead of our previous expectation of approximately £2,500 million due to the acceleration of amounts held against the Group's securities portfolios as expectations of future credit losses have improved.  In 2011, we expect a further benefit of some £2 billion broadly in line with previous guidance.  Thereafter, over the medium term, declining annual benefits are expected to accrue.

 

Legal and regulatory

There has been extensive scrutiny of the Payment Protection Insurance market in recent years, and the Financial Services Authority issued its final Policy Statement on PPI complaints handling in August 2010.  The application of this Policy Statement could in extremis have a material impact on the Group's financial position.  In October 2010, an application for judicial review was issued by the British Bankers' Association challenging the FSA's new standards for PPI complaints handling and the Financial Ombudsman Service's approach to such complaints.  The hearing was held in late January 2011, and the judgement (which may be subject to appeal) is expected shortly.  Further detail is given in note 23 on page 137.

 

The UK Government has appointed an Independent Commission on Banking (ICB) to review structural measures to reform the banking system and promote stability and competition.  The ICB is not expected to publish its final report until September 2011 and it is too early to quantify any possible effect on the Group.

 

Financial Services Compensation Scheme (FSCS) costs in respect of certain investment company failures have now started to emerge and, although relevant costs cannot be predicted, we expect that during the course of 2011 the Group will be required to make contributions towards such costs as required by the FSCS.



GROUP FINANCE DIRECTOR'S REVIEW OF FINANCIAL PERFORMANCE AND OUTLOOK (continued)

 

Lending to homeowners and businesses

The Group continues to actively support the UK economy by lending to UK households and businesses.  In 2010, we have extended £30 billion of gross mortgage lending (including remortgages) and £49 billion of committed gross lending to businesses, of which £11 billion was for SMEs.

 

Under the terms of our lending commitments to the UK Government, we agreed to make available gross new lending of £67 billion in the 12 months to 28 February 2011, of which £23 billion would be extended to homeowners and £44 billion to UK businesses.  In the ten months from 1 March to 31 December 2010, we have extended lending that qualifies under the programme totalling over £20 billion to UK homeowners and over £42 billion to UK businesses, of which £10 billion has been extended to SMEs and we are on track to meet our lending commitments in full.

 

Bank of Scotland (Ireland) Limited

In February 2010, we announced that we would close our retail and intermediary business in the Republic of Ireland, and in August 2010 we announced that we would transfer, subject to the necessary approvals, the Bank of Scotland (Ireland) Limited (BOSI) business to Bank of Scotland plc.  The business was transferred to Bank of Scotland plc on 31 December 2010, including all of the strategic management and decision making activities, at which point BOSI ceased to exist.  As a result the Group no longer has any regulated banking business in the Republic of Ireland.  Bank of Scotland plc will utilise its extensive operational and management capability, including general and credit management, oversight and control, within the UK in relation to the Irish portfolio, aiding the efficient run-down of the existing lending portfolio.

 

UK economic outlook

We continue to believe that a slow recovery over the next couple of years remains the most likely outcome for the UK economy.  Our central planning scenario reflects a number of economic assumptions including that GDP growth will recover to approximately 1.9 per cent in 2011 with a further increase to 2.4 per cent in 2012.  We expect a decrease of 2 per cent in UK house prices in 2011, with a 2 per cent increase in 2012.  We also expect a decrease of 2 per cent in commercial property prices in 2011 and a recovery of 3 per cent in 2012.  Finally, we believe that unemployment will peak at 8.1 per cent in 2011.

 

Outlook - strong medium-term prospects

Given the flexibility and capacity we have for core business growth, we continue to believe that the Group has strong medium-term prospects, notwithstanding the headwinds that we face in 2011.

 

Our medium-term targets remain unchanged.  However, having joined the Group in January, António Horta-Osório will be appointed Group Chief Executive on 1 March, and will be reviewing the business to further develop the strategy and actions needed to realise its full potential.  He expects to report to the board and subsequently to shareholders on the outcome of his strategic review and his plans at the end of the first half of 2011.

 

With the Group having returned to profitability in 2010, the risk in the business further reduced, and our improved capital, funding and liquidity positions, we now have a stronger business, which is well positioned for the future.

 

 

 

Tim Tookey

Group Finance Director

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

THIS PAGE IS INTENTIONALLY LEFT BLANK



COMBINED BUSINESSES SEGMENTAL ANALYSIS

 


Retail 


Wholesale 


Wealth 

and Int'l 


Insurance 

Group 

Operations 

and 

Central  items 

Group 

2010

£m 


£m 


£m 


£m 


£m 


£m 













Net interest income

9,378 


4,426 


1,176 


(263)


(895)


13,822 

Other income

1,607 


4,136 


1,160 


2,814 


447 


10,164 

Total income

10,985 


8,562 


2,336 


2,551 


(448)


23,986 

Insurance claims




(542)



(542)

Total income, net of insurance claims

10,985 


8,562 


2,336 


2,009 


(448)


23,444 

Costs:












Operating expenses

(4,644)


(3,744)


(1,536)


(854)


(150)


(10,928)

Impairment of tangible fixed assets


(150)





(150)


(4,644)


(3,894)


(1,536)


(854)


(150)


(11,078)

Trading surplus

6,341 


4,668 


800 


1,155 


(598)


12,366 

Impairment

(2,747)


(4,446)


(5,988)




(13,181)

Share of results of joint ventures and associates

17 


(95)


(8)


(10)



(91)

Profit (loss) before tax and fair value unwind

3,611 


127 


(5,196)


1,145 


(593)


(906)

Fair value unwind1

1,105 


3,130 


372 


(43)


(1,446)


3,118 

Profit (loss) before tax

4,716 


3,257 


(4,824)


1,102 


(2,039)


2,212 

























Banking net interest margin2 

2.46% 


1.88% 


1.63% 






2.10% 

Cost:income ratio3

42.3% 


43.7% 


65.8% 


42.5% 



46.6% 

Impairment as a % of
average advances4

0.74% 


2.08% 


8.90% 






2.01% 













Key balance sheet and other items as at 31 December 2010

£bn 


£bn 


£bn 


£bn 


£bn 


£bn 













Loans and advances to customers

363.7 


173.2 


55.3 




0.4 


592.6 

Customer deposits

235.6 


124.3 


32.8 




0.9 


393.6 

Risk-weighted assets

109.3 


222.7 


58.7 




15.7 


406.4 

 

1

The net credit in 2010 of £3,118 million is mainly attributable to a reduction in the impairment charge of £2,229 million as losses reflected in the acquisition balance sheet valuations of the lending and securities portfolios have been incurred.  There has also been a credit to other income of £1,263 million mainly reflecting the sale of debt securities from the heritage HBOS portfolios during the year.  This has been partly offset by a charge to net interest income of £301 million.  The impact of the fair value unwind on net interest income is lower than in 2009 because the liability management exercises undertaken by the Group have had the effect of crystallising a proportion of the gains reflected in the opening balance sheet valuation of HBOS's own debt; there has also been a benefit from revised expectations of future impairment losses.

2

The calculation basis for banking net interest margins is set out in note 2 on page 66.

3

Operating expenses divided by total income net of insurance claims.

4

Impairment on loans and advances to customers divided by average loans and advances to customers, excluding reverse repo transactions, gross of allowance for impairment losses.



COMBINED BUSINESSES SEGMENTAL ANALYSIS (continued)


Retail 


Wholesale 


Wealth 
and Int'l 


Insurance 

Group  Operations  and 

Central 
items 


Group 

2009

£m 


£m 


£m 


£m 


£m 


£m 













Net interest income

7,970 


4,710 


1,217 


(287)


(884)


12,726 

Other income

1,804 


4,199 


1,128 


2,944 


1,800 


11,875 

Total income

9,774 


8,909 


2,345 


2,657 


916 


24,601 

Insurance claims




(637)



(637)

Total income, net of insurance claims

9,774 


8,909 


2,345 


2,020 


916 


23,964 

Operating expenses

(4,566)


(4,106)


(1,544)


(974)


(419)


(11,609)

Trading surplus

5,208 


4,803 


801 


1,046 


497 


12,355 

Impairment

(4,227)


(15,683)


(4,078)




(23,988)

Share of results of joint ventures and associates

(6)


(720)


(21)


(22)



(767)

Profit (loss) before tax and fair value unwind

975 


(11,600)


(3,298)


1,024 


499 


(12,400)

Fair value unwind

407 


6,897 


942 


(49)


(2,097)


6,100 

Profit (loss) before tax

1,382 


(4,703)


(2,356)


975 


(1,598)


(6,300)

























Banking net interest margin

1.97% 


1.52% 


1.71% 






1.77% 

Cost:income ratio

46.7% 


46.1% 


65.8% 


48.2% 


48.4% 

Impairment as a % of
average advances

1.11% 


5.92% 


6.04% 






3.25% 

























Key balance sheet and
other items
As at 31 December 2009

£bn 


£bn 


£bn 


£bn 


£bn 


£bn 













Loans and advances to customers

371.1 


191.8 


63.5 




0.6 


627.0 

Customer deposits

224.1 


153.4 


29.0 



0.2 


406.7 

Risk-weighted assets

128.6 


286.0 


63.2 




15.5 


493.3 

 



DIVISIONAL PERFORMANCE

 

RETAIL

 



2010 


2009 


Change 



£m 


£m 









Net interest income 


9,378 


7,970 


18 

Other income 


1,607 


1,804 


(11)

Total income


10,985 


9,774 


12 

Operating expenses


(4,644)


(4,566)


(2)

Trading surplus


6,341 


5,208 


22 

Impairment


(2,747)


(4,227)


35 

Share of results of joint ventures and associates


17 


(6)



Profit before tax and fair value unwind


3,611 


975 



Fair value unwind


1,105 


407 



Profit before tax


4,716 


1,382 










Banking net interest margin


2.46% 


1.97% 



Banking asset margin


1.93% 


1.18% 



Banking liability margin


0.87% 


1.41% 



Cost:income ratio


42.3% 


46.7% 



Impairment as a % of average advances


0.74% 


1.11% 












As at  31 Dec 
2010 

 

 

As at  31 Dec 
2009 


Change 



£bn 


£bn 









Loans and advances to customers







Secured


337.3 


341.1 


(1)

Unsecured


26.4 


30.0 


(12)



363.7 


371.1 


(2)

Customer deposits







Savings


195.3 


185.6 


Current accounts


40.3 


38.5 




235.6 


224.1 


Risk-weighted assets


109.3 


128.6 


(15)

 



RETAIL (continued)

 

Key highlights

·    Profit before tax increased to £4,716 million, compared to £1,382 million in 2009.

·    Profit before tax and fair value unwind increased to £3,611 million, a strong increase of £2,636 million compared to 2009, driven by good income growth, tight cost control and a significantly lower impairment charge.

·    Net interest income increased by £1,408 million or 18 per cent to £9,378 million, largely as a result of the continuing re-pricing of risk, mortgage customers moving onto standard variable rates and a decrease in the LIBOR to Base Rate spread.

·    Other income decreased by £197 million or 11 per cent to £1,607 million, relating particularly to changes to current account overdraft structures.

·    Operating expenses remain tightly controlled, increasing by only 2 per cent to £4,644 million, which combined with strong income growth led to a significant reduction in the cost:income ratio to 42.3 per cent.  Operating expenses benefited from continuing cost control as well as cost synergies.

·    The impairment charge reduced significantly to £2,747 million, down by 35 per cent, supported by prudent risk management, a stabilising economy, broadly stable house prices and low interest rates.  The improvement in credit performance was faster than expected a year ago.

·    Loans and advances to customers decreased by £7.4 billion, or 2 per cent to £363.7 billion, as customers continued to reduce their personal indebtedness, particularly unsecured debt.  While mortgage balances declined by £3.8 billion, Retail continued to support first time buyers and home movers with gross mortgage lending of £30 billion.

·    Customer deposits increased by £11.5 billion, or 5 per cent, to £235.6 billion, predominantly from instant access and tax free ISA accounts rather than more expensive term deposits.



RETAIL (continued)

 

Strategic vision

Retail's goal is to be recognised by customers as the UK's best bank.  This will be achieved by building deep and enduring customer relationships which deliver real value to customers.  Retail believes this strategy will drive sustainable long term value for all stakeholders.  A deep understanding of customers and their needs combined with highly efficient and effective processes will allow more investment in products and services that customers really value.  Retail is increasing its capabilities through the integration of Lloyds TSB and HBOS which presents a great opportunity to use the best from each heritage and significantly improve systems and processes.  This includes extending Lloyds TSB's strong customer insight capabilities to Halifax and Bank of Scotland.  Success for Retail will be reflected in enhanced customer service resulting in strong customer advocacy which in turn leads to lower customer acquisition costs, increased share of wallet and improved customer retention.

 

Progress against strategic initiatives

 

Deep and enduring customer relationships

The Retail strategy is to build deep and enduring relationships so that customers choose Retail's relationship brands (Lloyds TSB, Halifax and Bank of Scotland) for more of their financial needs.  This is being achieved through offering a broad range of products that address customer needs, alongside superior customer service and advice.  Retail also continues to work to ensure customers are the focus of business development including instituting a number of programmes to ensure key customer needs underpin ongoing product and service development.

 

During 2010, Retail successfully delivered a number of elements of the strategy, with a focus on rebuilding trust with customers.  A primary focus was the development of products that are simple, transparent and easy for customers to understand.  Customer demand for these products has been very positive.  For example, the customer response to the Halifax's Clarity card has been strong with 145,000 new cards issued since its launch in July 2010.  This card leads the market in terms of transparency and simplicity with a single customer interest rate and no usage fees for balance transfers, cash withdrawals and international usage.

 

Retail has also continued to develop its current account switching facility, which plays a key role in building a strong relationship with new customers, by making it easy for customers to switch.  Experience has shown that after customers use the current account switching facility, they are over 70 per cent more likely to transfer their primary current account.

 

Creating products and services that customers value

A focus on customers, including active use of Retail's strong customer insight capability, ensures that products and services are customer-led in a highly competitive market.  Retail has a strong record of award-winning products and services.

 

Retail is committed to supporting the housing market and working with customers to find solutions to their changing situations.  An example of this is the recently launched Equity Support Scheme that enables customers with low or negative equity to move home.  This scheme recognises that there are significant numbers of customers who are making payments on their mortgage and have a desire to move but due to lack of equity have been unable to do so.  Retail has also extended its popular first time buyer 'Lend a Hand' mortgage to all home movers.  This product helps customers through allowing friends and family to contribute to a savings account supporting a mortgage.

 



RETAIL (continued)

 

Retail continues to work to deliver products and services that address customer needs.  An example of this is the recently launched Halifax Cash ISA Promise.  In the month following the launch in October 2010 the ISA business performed significantly ahead of expectations with 44,000 accounts transferred, despite the launch being outside of the traditional ISA season.  This industry leading promise addresses the poor transfer times between ISA providers, by promising to pay interest on new cash ISAs from the completed application date rather than when funds are transferred into the account, often weeks later.  The other parts of the promise are increased information on cash ISA interest rates and an assurance that all cash ISAs are open to both new and existing customers.

 

Continually improving customer service

Retail continues to benefit from the opportunities afforded by its heritage businesses and is taking the best from the Lloyds TSB and HBOS franchises to create 'one best way' of doing things.  Integration, together with changes in working practices, will deliver significant increases in efficiency which will allow further investment in the products and services that customers really value and will deliver a better customer experience.

 

Internet banking continues to grow in popularity amongst Retail's customers.  To support the development and broaden the potential of this format Retail has introduced a new internet platform which was rolled out to Lloyds TSB customers during 2010.  One example of the new services being delivered on this platform is Money Manager which provides an innovative tool for customers to better manage their finances.

 

Retail has been implementing new sales and customer service technology for mortgages and bancassurance across the network.  These are being delivered to improve the quality of customer advice and increase the speed of decision making.  The Mortgage Sales Platform offers customers a more comprehensive interview experience, a faster mortgage decision and 'one best way' of selling mortgages across its brands.  In the bancassurance business a new platform has been rolled out to advisors, with tools which better identify customer's needs.  This innovative platform also brings portfolio modelling tools to the Retail market. 

 

Mobile banking is another key growth area and Retail is investing to make financial services more accessible and to increase the range of options available to customers.  Lloyds TSB has launched a mobile banking application that allows customers to manage their money on the move, including transferring funds between accounts via their mobiles.  Lloyds TSB now also offers a range of free text alerts, including balance updates and near limit alerts, thereby helping customers to better control their finances.

 

Integration

Retail has made good progress with integration, delivering significant cost savings and increased productivity as well as optimising performance across the business.  The division has delivered run-rate synergies of £529 million at the end of 2010 and is on track to achieve run-rate synergies of £867 million by the end of 2011.

 

In 2010, Retail commenced the roll-out of a single counter system across all its branches providing a strong and efficient platform with increased functionality to further improve customer service.  This is being supported by a 'one best way' programme that ensures there is a single efficient and effective approach to all major processes.

 

As part of the integration Lloyds TSB's Protection for Life bancassurance product range was extended into Halifax and Bank of Scotland.  The impact of these changes has already been significant with close to 50 per cent uplift in protection new business premiums in Halifax and Bank of Scotland.

 



RETAIL (continued)

 

Financial performance

Profit before tax increased to £4,716 million compared to £1,382 million in 2009, an increase of £3,334 million.  This included an increase of £698 million in respect of the fair value unwind.

 

Profit before tax and fair value unwind increased to £3,611 million, a significant improvement compared to £975 million in 2009.  This increase in profit was driven by strong income growth, tight cost control and a significant reduction in the impairment charge in the context of a stabilising economy.

 

Total income increased by £1,211 million, or 12 per cent, to £10,985 million.  This was driven by a strong increase in net interest income of £1,408 million, partially offset by a reduction in other income of £197 million.

 

Net interest income increased by 18 per cent, with a significant increase in the net interest margin to 2.46 per cent, from 1.97 per cent in 2009.  The asset margins expanded significantly during 2010 from 1.18 per cent to 1.93 per cent as a result of decreases in LIBOR to base rate spread and stable customer interest rates.  The asset margin also widened partly as a result of mortgage customers continuing to move onto, and staying on, standard variable rates and assets being priced to more appropriately reflect risk and rising funding costs.  The liability margin, on the other hand, has reduced from 1.41 per cent to 0.87 per cent as the effect of lower LIBOR to base rate spreads was partially offset by the reduction of expensive deposit balances.

 

Other income decreased by 11 per cent in 2010 to £1,607 million from £1,804 million largely as a result of changes to current account overdraft charges.  Retail continues to focus on having fees and rates that customers understand.  It is believed that this will result in stronger customer relationships as well as supporting the deepening of these relationships.  An example of this focus is the changes to the overdraft charging structure for Halifax and Bank of Scotland personal current accounts at the end of 2009, which delivers a more suitable product proposition and an improved customer experience and resulted in a reduction in other income of approximately £90 million.  Similarly, the changes to the Lloyds TSB current account pricing model, which became effective at the end of 2010, provide a simpler, more sustainable proposition for customers, resulting in an overall reduction in the cost of overdraft usage.

 

Total income is analysed as follows and reflects the trends discussed above:





2010 


2009 


Change 





£m 


£m 











Mortgages and Savings




4,739 


3,667 


29 

Consumer Banking




6,246 


6,107 


Total income




10,985 


9,774 


12 

 

Operating expenses remained well controlled and increased by 2 per cent, against an increase in total income of 12 per cent, reflecting ongoing cost control and synergies from the integration.  The cost:income ratio for the year improved to 42.3 per cent compared to 46.7 per cent in 2009.

 

The impairment charge on loans and advances decreased by £1,480 million, or 35 per cent, to £2,747 million reflecting the stabilising economy, more stable house prices, low interest rates and prudent lending criteria.  As a percentage of average advances, the impairment charge decreased to 0.74 per cent, significantly lower than 1.11 per cent in 2009.  The secured impairment charge reduced to £292 million from £789 million in 2009 while the unsecured impairment charge reduced to £2,455 million from £3,438 million in 2009.

 



RETAIL (continued)

 

The fair value unwind net credit of £1,105 million compares with £407 million in 2009.  The net fair value unwind credit was larger than in 2009 which reflected a smaller charge related to the fixed rate mortgage portfolios as mortgages reached the end of their fixed term and borrowers moved to standard variable products.  This was partially offset by a reduction in the credit attributed to the fixed rate savings portfolio as fixed rate term deposits, existing prior to acquisition, matured.

 

Balance sheet progress

Total loans and advances to customers decreased by £7.4 billion, or 2 per cent, to £363.7 billion, compared to 31 December 2009.  This resulted from reduced customer demand for credit and customers continuing to reduce their personal indebtedness.  The reduction in lending to customers was partly the result of the repayment of unsecured debt where balances reduced by £3.6 billion, or 12 per cent.

 

Secured balances were broadly stable as Retail maintained its strong commitment to the housing market and first time buyers.  The proportion of mortgages on standard variable rate or equivalent products now stands at 48 per cent and is expected to rise only modestly during 2011.

 

The UK mortgage market for both house purchase and re-mortgaging was slightly lower in 2010, with gross market lending of £136.1 billion compared to £143.3 billion in 2009.  Retail's gross new mortgage lending was £30 billion in 2010.  This lending included full delivery on agreed lending commitments.  New mortgage lending continued to be focused on supporting the housing market with 70 per cent of the lending being for house purchase rather than re-mortgaging.  Retail remains the largest lender to first time buyers in the market helping over 50,000 customers buy their first home.  It also continues to be an industry leader in its support for shared equity and shared ownership schemes.

 

Risk-weighted assets decreased by £19.3 billion, or 15 per cent, to £109.3 billion in 2010.  This reduction was driven by lower lending balances, recalibrated downturn loss given default rates and the lower risk mix of the loan portfolio with reduced exposure to unsecured lending.

 

Total customer deposits increased by £11.5 billion, or 5 per cent, to £235.6 billion in the year.  The growth was predominantly from instant access and tax free cash ISA accounts, rather than more expensive term deposits.  This approach has helped support the net interest margin.  Retail continues to perform well in the savings market, with a strong stable of savings brands which can be tailored to customer demands.

 

Non-core operations

Non-core operations consist of specialist mortgages (self-certified and sub-prime), selected third-party branded loans and selected third-party branded credit cards.  As at 31 December 2010, these operations included loans and advances to customers of £30.6 billion (31 December 2009: £33.5 billion) and risk weighted assets of £11.2 billion (31 December 2009: £13.2 billion).  In 2010 they also contributed income of £591 million (compared to £388 million in 2009) and an impairment charge of £124 million (compared to £253 million in 2009).  In addition to the non-core assets, Retail continues to progress plans to divest other retail assets and liabilities in line with the state aid obligations.

 



WHOLESALE

 



2010 


2009 


Change 



£m 


£m 









Net interest income


4,426 


4,710 


(6)

Other income


4,136 


4,199 


(2)

Total income


8,562 


8,909 


(4)

Costs:







     Operating expenses


(3,744)


(4,106)


     Impairment of tangible fixed assets


(150)






(3,894)


(4,106)


Trading surplus


4,668 


4,803 


(3)

Impairment


(4,446)


(15,683)


72 

Share of results of joint ventures and associates


(95)


(720)


87 

Profit (loss) before tax and fair value unwind


127 


(11,600)



 

Fair value unwind


3,130 


6,897 


(55)

Profit (loss) before tax


3,257 


(4,703)










Corporate Markets


(697)


(11,736)


94 

Treasury and Trading


428 


595 


(28)

Asset Finance


396 


(459)



Profit (loss) before tax and fair value unwind


127 


(11,600)










Banking net interest margin


1.88% 


1.52% 



Banking asset margin


1.28% 


1.02% 



Banking liability margin


1.29% 


1.16% 



Cost:income ratio (excl. impairment of tangible fixed assets)


43.7% 


46.1% 



Impairment as a % of average advances


2.08% 


5.92% 



















As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 
















Loans and advances to customers


173.2 


191.8 


(10)

Loans and advances to banks


12.4 


18.9 


(34)

Debt securities


25.8 


31.7 


(19)

Available-for-sale financial assets


29.5 


36.9 


(20)



240.9 


279.3 


(14)

Customer deposits







Customer deposits excluding repos


114.1 


117.9 


(3)

Repos


10.2 


35.5 


(71)



124.3 


153.4 


(19)

Risk-weighted assets


222.7 


286.0 


(22)

 



WHOLESALE (continued)

 

Key highlights

·    Profit before tax was £3,257 million compared to a loss before tax of £4,703 million in 2009.

·  Profit before tax and fair value unwind was £127 million, a £11,727 million improvement on the loss of £11,600 million in 2009, primarily reflecting the significant decrease in the level of impairment charge.

·    Net interest income decreased by 6 per cent to £4,426 million.  This decrease reflected the lower interest earning asset balances, in-line with targeted balance sheet reductions and lower net interest income in Treasury and Trading, partially offset by a 36 basis point increase in the banking net interest margin.

·    Other income decreased marginally to £4,136 million, primarily reflecting a reduction from the higher market volatility in 2009 in Wholesale Markets and lower operating lease income in Asset Finance, partially offset by investment gains in Wholesale Equity.

·    Operating expenses decreased 9 per cent, reflecting reduced levels of operating lease depreciation and further cost savings achieved from the integration programme, partially offset by additional staff related costs in the Business Support Unit and continued investment in customer facing resource and systems.

·    Impairment charges on financial assets decreased significantly to £4,446 million, compared to £15,683 million in the previous year.  The total impairment charge is 72 per cent lower than last year and continues to be primarily driven by the HBOS heritage corporate real estate and real estate related asset portfolios.  

·    Assets decreased by 14 per cent to £240.9 billion continuing on from a 28 per cent reduction in 2009.  This reflects the targeted reduction in the balance sheet, mainly in loans and advances to customers and banks in non-core business and through reductions in debt securities and available-for-sale positions.

·    Customer deposits excluding repos decreased 3 per cent to £114.1 billion, due to a reduction in short-term deposits in Treasury and Trading partially offset by higher deposits in Corporate Markets in line with the Group's funding strategy.

·    Continued progress in deepening customer relationships.  Cross-selling has increased by 9 per cent, reflecting increased product capabilities and opportunities arising from applying a single sales force model on the combined customer base.



WHOLESALE (continued)

 

Strategic vision

Wholesale's strategic goal is to be recognised as the UK's leading, through-the-cycle, relationship-focused wholesale bank.  The mission is to retain and deepen recurring, multi-product customer relationships building on deep insight into customer needs to provide a broad range of banking, risk management and capital market products.

 

Progress against strategic initiatives

 

Supporting customers through the cycle

Wholesale's through-the-cycle commitment to businesses is evidenced by key initiatives such as the SME Business Charter which was awarded the prize for innovation in SME finance by Business Moneyfacts in March 2010.  In 2010, over 100,000 new Commercial start-up customers were attracted and over 200 regional customer events were held across the country, demonstrating our commitment to this segment.  Wholesale's focus on deepening customer relationships and continued commitment to businesses was again recognised by Finance Directors of commercial and corporate companies who voted Lloyds TSB as Bank of the Year in the CBI/Real FD awards for the sixth year running in May 2010.  In September 2010, our Commercial Finance business was voted as winner in the InterContinental Finance Magazine's global awards for Alternative Finance Provider of the year - United Kingdom.

 

Continued investment in Wholesale Markets capabilities has helped customers to diversify their funding sources and manage their interest rate and currency risks.  This successful investment provides the foundations for deeper customer relationships and is earning external recognition which includes the Group being named 'The most improved European Debt Capital Markets and Syndicate team' by Euroweek in May 2010 and awarded 'Best Arranger of UK Loans' and 'Best Arranger of Mid-Corporate Loans' at the 2010 Euroweek Syndicated Loan & Leveraged Finance Awards.

 

Integrating the businesses

Progress towards creating a single Wholesale Bank by the end of 2011 continues on track, with several notable milestones passed in 2010.  Internal business structures are in place across Wholesale, and around 30 customer and data migrations successfully took place in 2010, representing assets of approximately £50 billion.  The new Lloyds Bank Corporate Markets brand was launched in December, providing a single, comprehensive and consistent corporate banking and financial markets service for our customers.  In the Asset Finance business, the successful integration of Lex and Autolease brands has created one of the UK's leading car leasing firms.

 

The focus for 2011 remains on the planning and execution of the remaining 40 migrations and strengthening risk systems, whilst ensuring that we continue to deliver our high levels of customer service.  The division achieved run-rate synergies of £359 million at the end of 2010 and is on track to deliver run-rate synergies of £532 million by the end of 2011.

 

Prioritising businesses

In 2009, Wholesale systematically reviewed its assets, portfolios and businesses to identify those that would add most value to its relationship-focused strategic vision.  In 2010, Wholesale ensured that investment in product and service capability was directed towards these core growth areas, and explored divestment opportunities for the remaining non-core assets.

 

Investment and change in the core growth areas continues to be embedded, with new talent joining the Group and new processes introduced to our client facing businesses.  Cross-selling from deepening relationships increased by 9 per cent reflecting these enhanced product capabilities.



WHOLESALE (continued)

 

A number of disposals of non-core assets were completed during 2010 in line with the planned reduction of Wholesale's total assets, which includes part of the Group's commitment under the state aid restructuring plan.  Wholesale continues to operate under an oversight and governance framework with the intention always of maximising long-term shareholder value from any asset sale.

 

Financial performance

Profit before tax was £3,257 million compared to a loss before tax of £4,703 million in 2009.  The improvement of £7,960 million is after taking into account fair value unwind of £3,130 million, which decreased by £3,767 million compared to 2009.

 

Profit before tax and fair value unwind of £127 million was an £11,727 million improvement on the loss of £11,600 million in 2009, driven by a significant decrease in the impairment charge reflecting the stabilising economic climate, continuing to support previous guidance that the impairment charge peaked in the first half of 2009.

 

Total income decreased by £347 million, or 4 per cent to £8,562 million mainly driven by a 6 per cent decrease in net interest income.

 

The decline in net interest income primarily reflects lower interest earning asset balances across loans and receivables in line with the Group's targeted balance sheet reduction, mainly in loans and advances to customers, debt securities and available for-sale-positions.  Income was affected by higher funding costs and lower lending volumes, although this was partly offset by higher customer margins on new business and from re-pricing on renewals.  

 

Banking net interest income, which excludes trading activity, increased by £330 million, to £3,683 million as lending business continued to be re-priced to reflect customer risk profiles, with lending margins increasing by 26 basis points.  Deposit margins increased moderately, by 13 basis points, reflecting favourable internal liquidity rates, which was partially offset by the impact of lower LIBOR to base rate spreads.  As a result, the banking net interest margin increased by 36 basis points to 1.88 per cent in 2010.  The impact of re-pricing was only partially offset by a decrease in average interest earning assets and liability balances. 

 

Other income decreased by £63 million, or 2 per cent, to £4,136 million, primarily reflecting higher levels of market volatility in 2009 which resulted in mark to market gains in Wholesale Markets, whilst 2010 experienced losses on sale of assets in targeted balance sheet reductions and lower operating lease income.  Other income in 2010 benefited from investment gains in Wholesale Equity as a result of stabilisation in market conditions and improved fund investment performance, strong fee income across structuring and capital markets and more favourable performance in Treasury and Trading.

 

Operating expenses decreased by £362 million, or 9 per cent, to £3,744 million primarily from a further reduction in the level of operating lease depreciation in Asset Finance and a continued focus on cost management including savings attributable to the integration programme.  This was partially offset by additional costs in the Business Support Unit and continued investment in customer facing resource and systems.

 

The impairment charge decreased by £11,237 million to £4,446 million in December 2010.  As a percentage of average loans and advances to customers, impairment charge improved to 2.08 per cent in 2010 compared to 5.92 per cent in 2009.  The decrease reflects reductions, notably in the heritage HBOS corporate real estate and real estate related portfolios and heritage HBOS Corporate (UK and US) portfolios and write backs from asset disposals, due to the stabilising economic environment, low interest rates which helped to maintain defaults at reduced levels, the stabilisation of UK real estate prices and prudent provisioning against base case assumptions undertaken on the acquired heritage HBOS portfolios in the first half of 2009.  The decrease further confirms the Group's belief that the impairment charge peaked in the first half of 2009 under base case assumptions.



WHOLESALE (continued)

 

The share of losses from joint ventures and associates comprises a small loss of £95 million, a decrease of £625 million.  This represents a net reduction in both the value and size of the portfolio compared to the prior year.  The majority of the portfolio is now valued at nil with a remaining portfolio carrying value of approximately £128 million.

 

Fair value unwind decreased £3,767 million to £3,130 million, mainly due to lower impairments in 2010 relating to the HBOS assets that were fair valued on acquisition.  The decrease was partially offset by charges relating to the expected losses on acquired debt securities and by fair value releases on sales.

 

Balance sheet progress

The division's asset balances (comprising loans and advances to customers and banks, debt securities and available-for-sale financial assets) reduced by £38.4 billion, or 14 per cent to £240.9 billion, primarily reflecting deleveraging by customers and continuing active de-risking of the balance sheet by either selling down or reducing holdings in debt securities and available-for-sale positions.

 

Loans and advances to customers decreased £18.6 billion, or 10 per cent to £173.2 billion.  In Corporate Markets, balances decreased by £17.5 billion or 10 per cent, as demand for new corporate lending and refinancing of existing facilities were more than offset by the level of maturities, reflecting a continued trend of subdued corporate lending, customer deleveraging and asset sales in non-core sectors.  Despite this overall reduction, net lending to core customers in the SME sector increased by 2.1 per cent.  In Asset Finance, the decrease of £2.7 billion, or 23 per cent, reflected the targeted reduction in this asset class.  Available for sale financial assets balances reduced by £7.4 billion, or 20 per cent, to £29.5 billion and debt securities decreased by £5.9 billion, or 19 per cent, to £25.8 billion, as Corporate Markets reduced the non-core balance sheet by either selling down or not replenishing total holdings after amortisations or maturities.  Loans and advances to banks decreased £6.5 billion, or 34 per cent as the division refocused the balance sheet.

 

Customer deposits excluding repos decreased by £3.8 billion, or 3 per cent to £114.1 billion, due to a reduction in short-term deposits in Treasury and Trading, which was partially offset by higher deposits in Corporate Markets in line with the Group's funding strategy.

 

Risk-weighted assets decreased by £63.3 billion, or 22 per cent to £222.7 billion, primarily reflecting the balance sheet reductions and the move to Foundation IRB from Advanced IRB for all HBOS non-retail portfolios.

 

Non-core operations

Non-core consists of businesses and/or business lines that are inconsistent with Wholesale's relationship-focused strategic vision of capital and liquidity efficient growth, driven by broad and deep customer relationships and within a prudent risk framework.

 

As at 31 December 2010, operations and portfolios considered to be non-core included assets of £126.9 billion (2009: £158.3 billion) which included £71.2 billion (2009: £83.1 billion) of loans and advances to customers, £25.4 billion (2009: £31.5 billion) of debt securities, £22.2 billion (2009: £32.0 billion) of available-for-sale financial assets and other assets of £8.1 billion (2009: £11.7 billion).  Non-core risk-weighted assets were £94.8 billion (2009: £135.4 billion).  Non-core portfolios and businesses include £4.9 billion (2009: £4.9 billion) of customer deposits.  

 

In 2010, non-core businesses generated income of £3,022 million and impairment of £3,170 million, compared to 2009 income of £3,573 million and impairment of £13,496 million.

 



WHOLESALE (continued)

 

Corporate Markets



2010 


2009 


Change 


£m 


£m 









Net interest income


3,669 


3,756 


(2)

Other income


2,471 


2,541 


(3)

Total income


6,140 


6,297 


(2)

Costs:







     Operating expenses


(2,410)


(2,461)


     Impairment of tangible fixed assets


(150)






(2,560)


(2,461)


(4)

Trading surplus


3,580 


3,836 


(7)

Impairment


(4,182)


(14,855)


72 

Share of results of joint ventures and associates


(95)


(717)


87 

Loss before tax and fair value unwind


(697)


(11,736)


94 








Cost:income ratio (excl. impairment of tangible fixed assets)


39.3% 


39.1% 



Impairment as a % of average advances


2.08% 


6.09% 










As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 









Loans and advances to customers


160.2 


177.7 


(10)

Risk-weighted assets


202.1 


263.8 


(23)

 

Loss before tax and fair value unwind decreased by £11,039 million to £697 million, due to a significant decrease in the impairment charge.  Net interest income decreased by £87 million or 2 per cent.  This reflected lower interest earning asset balances as a result of the ongoing focus on reducing the balance sheet.  Despite increased funding costs net interest income benefited from improved margins from customer re-pricing.

 

Other income was £70 million or 3 per cent lower, primarily due to increased market volatility in 2009 which resulted in mark to market gains in Wholesale Markets which did not reoccur in 2010.  Additionally other income benefited from investment gains in Wholesale Equity as a result of stabilising market conditions, and strong fee income across structuring and capital markets.

 

Operating expenses decreased by £51 million to £2,410 million due to continued synergy benefits, partially offset by investment in the Business Support Unit as well as customer facing resource and systems.

 

The impairment charge decreased by £10,673 million to £4,182 million reflecting a sustained decrease since the peak in first half 2009.  As well as reflecting stabilising economic conditions, a significant amount of the decrease was also due to the application in 2009 of Lloyds Banking Group provisioning policy and risk review processes which were applied to the heritage HBOS corporate real estate and real estate related portfolios and heritage HBOS Corporate (UK & US) portfolio.

 

Impairment of tangible fixed assets of £150 million was incurred on assets held on the balance sheet as a result of the consolidation of certain entities over which the Group exercised control.  A £365 million loss was recorded in 2010 on the disposal of these entities which is excluded from the Group's combined businesses profit before tax.

 



WHOLESALE (continued)

 

Treasury and Trading



2010 


2009 


Change 



£m 


£m 









Net interest income


324 


544 


(40)

Other income


322 


238 


35 

Total income


646 


782 


(17)

Operating expenses


(218)


(187)


(17)

Profit before tax and fair value unwind


428 


595 


(28)








Cost:income ratio


33.7% 


23.9% 



















As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 









Loans and advances to customers


4.1 


2.5 


64 

Risk-weighted assets


8.6 


8.4 


 

Profit before tax and fair value unwind decreased by £167 million to £428 million due to lower net interest income.

 

Total income decreased by £136 million, or 17 per cent.  Interest income reduced as the highly volatile interest rate market evident in early 2009 was not repeated in 2010.  Other income performance benefited from strong customer demand for interest rate, foreign exchange and risk management products in 2010.  Trading flows are managed with the overriding aim of providing a service to customers, whilst maintaining Treasury and Trading's conservative risk appetite.

 

Operating expenses increased by £31 million to £218 million reflecting the investment in people and systems, in particular back office infrastructure, to support internal risk management and the customer franchise.

 



WHOLESALE (continued)

 

Asset Finance



2010 


2009 


Change 



£m 


£m 









Net interest income


433 


410 


Other income


1,343 


1,420 


(5)

Total income


1,776 


1,830 


(3)

Operating expenses


(1,116)


(1,458)


23 

Trading surplus


660 


372 


77 

Impairment


(264)


(828)


68 

Share of results of joint ventures and associates



(3)



Profit (loss) before tax and fair value unwind


396 


(459)










Cost:income ratio


62.8% 


79.7% 



Impairment as a % of average advances


2.34% 


5.86% 



















As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 









Loans and advances to customers


8.9 


11.6 


(23)

Operating lease assets


3.0 


3.4 


(12)

Risk-weighted assets


12.0 


13.8 


(13)

 

Profit before tax and fair value unwind was £396 million compared to a loss before tax and fair value unwind of £459 million in December 2009.  The £855 million improvement was due to a lower impairment charge and lower operating expenses.

 

Total income decreased by £54 million, or 3 per cent, to £1,776 million as a result of lower business volumes on assets held under operating leases.  The lower business volumes are in-line with a targeted reduction in this asset class and were partly offset by stronger margins.

 

Operating expenses decreased by £342 million, or 23 per cent, to £1,116 million, reflecting reduced depreciation charges on assets held under operating leases due to lower fleet size and a year on year improvement in used car values, and strong cost management and savings achieved from integration.

 

The impairment charge decreased by £564 million to £264 million, reflecting a stabilising economic environment and an improvement in market conditions for both the retail and non-retail consumer finance businesses.  The lower impairment charge has been driven by a reduction in new cases entering arrears, the reduced book size and a better mix in the credit quality of new business being written over the last two years.

 



WEALTH AND INTERNATIONAL

 



2010 


2009 


Change 



£m 


£m 









Net interest income


1,176 


1,217 


(3)

Other income


1,160 


1,128 


Total Income


2,336 


2,345 



Operating expenses


(1,536)


(1,544)


Trading surplus


800 


801 



Impairment


(5,988)


(4,078)


(47)

Share of results of joint ventures and associates


(8)


(21)


62 

Loss before tax and fair value unwind


(5,196)


(3,298)


(58)

Fair value unwind


372 


942 


(61)

Loss before tax


(4,824)


(2,356)










Wealth


269 


198 


36 

International


(5,465)


(3,496)


(56)

Loss before tax and fair value unwind


(5,196)


(3,298)


(58)








Banking net interest margin


1.63% 


1.71% 



Banking asset margin


1.22% 


1.26% 



Banking liability margin


0.83% 


0.82% 



Cost:income ratio


65.8% 


65.8% 



Impairment as a % of average advances


8.90% 


6.04% 



















As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 









Loans and advances to customers


55.3 


63.5 


(13)

Customer deposits


32.8 


29.0 


13 

Risk-weighted assets


58.7 


63.2 


(7)

 



WEALTH AND INTERNATIONAL (continued)

 

Key highlights

·    Loss before tax increased to £4,824 million compared to £2,356 million in 2009.

·    Loss before tax and fair value unwind increased by £1,898 million to £5,196 million, compared to £3,298 million in 2009, due to a higher impairment charge, predominantly in Ireland.

·    In Wealth, profit before tax increased by 36 per cent to £269 million.  However, this was more than offset by the International loss before tax which increased by 56 per cent to £5,465 million.

·    Net interest income decreased by 3 per cent to £1,176 million, as an 8 basis points decline in the banking net interest margin more than offset the favourable impact of foreign currency movements, particularly the Australian dollar, and the income on the £7 billion European loan portfolio transferred in from the Wholesale division in the second half of 2009. 

·    Operating expenses decreased by 1 per cent to £1,536 million, with cost savings achieved from integration, particularly in the asset management businesses in Wealth, partly offset by investment in International's German deposit taking operation, increased resources in business support functions and the effect of stronger foreign currency rates.

·    The impairment charge amounted to £5,988 million, compared to £4,078 million in 2009, reflecting the material deterioration in the economic environment in Ireland in the last quarter of 2010 that resulted in EU-IMF financial support in late November 2010 and the tightening of liquidity in the second half of 2010 in regional Australian property markets to which the Group is exposed.

·    Loans and advances to customers decreased by £8.2 billion, or 13 per cent, to £55.3 billion, reflecting net repayments of £4.1 billion, and additional impairment provisions in the International businesses, partly offset by foreign exchange movements of £1.1 billion.

·    Customer deposits increased by £3.8 billion, or 13 per cent, to £32.8 billion, due to strong inflows in UK Private Banking and Bank of Scotland Germany, partly offset by outflows in Ireland following the closure of the Irish retail branch network.

·    Against its strategic objectives, Wealth has demonstrated continuing strength in client acquisition through the UK franchise with a 12 per cent increase in customer numbers.  In International, resources have been deployed to manage arrears, and the balance sheet reduction strategy resulted in underlying local currency advances decreasing by £4.1 billion, or 7 per cent.

 



WEALTH AND INTERNATIONAL (continued)

 

Strategic vision

Wealth provides strong growth opportunities for the Group and, through deepening the relationships with existing Group clients alongside targeted external customer acquisition, Wealth's goal is to be recognised as the trusted adviser to expatriate and private banking clients both in the UK and selected international markets.  Wealth's initial focus in the UK is to increase the penetration of its offering into the Group's existing customer base by the referral of wealthier customers to its private banking businesses where their wider financial needs can be more effectively met. Outside the UK, Wealth will be building on the strengths of its brand portfolio and existing expatriate, wealth management and private banking propositions.

 

In the International businesses, the priority is to maximise value in the medium term.  International's immediate focus is on close management of the lending portfolio, particularly in the Irish business, and re-pricing assets where appropriate.  At the same time International is delivering operational efficiencies, reshaping its business models and rightsizing the balance sheet to reflect the ongoing environment.

 

Progress against strategic initiatives

 

Deep and enduring customer relationships

In Wealth, the focus has been on driving additional income growth from the Group's affluent and high net worth client base through more effective use of the opportunities afforded by the Retail and Wholesale franchises to cross sell Wealth products to these customers.  During 2010, customer segmentation across the Wealth businesses has been implemented and businesses transferred as appropriate to align to this segmentation, the customer referrals model has been formalised, and a new UK investment proposition launched.  Continuing progress was demonstrated through a 7 per cent increase in Wealth relationship customers in 2010, including a 12 per cent increase in UK Wealth, and a 16 per cent increase in Wealth's customer deposits.

 

Maximising value in the short to medium term

In International, the focus remains on managing the impaired asset portfolio and continued strengthening of the control environment.  Redeployment of resource from front line activity and the wider Group to manage arrears and collections is now complete and business support units are fully operational.  The business aims to de-risk and reduce the balance sheet where possible, with net repayments in the International portfolio contributing £4.1 billion to the reduction in underlying local currency customer advances.

 

As previously announced, the Group completed a strategic review of Bank of Scotland (Ireland) Limited (BOSI) during the year, concluding that there was little opportunity for scalable growth in the future and that the business currently carried on by BOSI would merge, pursuant to a court process, into Bank of Scotland plc.  This announcement followed the closure earlier in the year of BOSI's retail and intermediary business in Ireland, including all 44 Halifax retail branches.

 

The merger completed on 31 December 2010 at which point BOSI ceased to exist and its banking licence was relinquished.  Bank of Scotland plc will utilise its extensive operational and management capability, including general and credit management, oversight and control, within the UK in relation to the Irish portfolio.  This will support the efficient rundown of the remaining Irish lending portfolio.

 

In order to retain local administrative capability, historic knowledge and continuity of customer relationships, Bank of Scotland plc has entered into an agreement with an independent service company which will perform various administrative functions relating to the Irish business.  Under this proposal the majority of BOSI employees have transferred to the service company.



WEALTH AND INTERNATIONAL (continued)

 

Integration

Wealth and International is making excellent progress with the integration of its businesses with an annual synergies run-rate as at 31 December 2010 of £240 million, substantially achieving the end of 2011 run rate target of £242 million.  The transfer of £50 billion of funds under management from Insight Investment to Scottish Widows Investment Partnership was successfully completed in the first half of 2010 along with the sale of Employee Equity Solutions and Bank of Scotland Portfolio Management Service.  In the second half of 2010 the division successfully completed the integration of its Spanish businesses, while the UK Private Banking, Channel Islands and Wholesale Europe integration programmes are progressing well ensuring Wealth and International is on track to deliver targeted cost savings by the end of 2011.

 

Financial performance by business unit

 

Wealth


2010 


2009 


Change 



£m 


£m 









Net interest income


345 


383 


(10)

Other income


1,018 


1,003 


Total income


1,363 


1,386 


(2)

Operating expenses


(1,047)


(1,119)


Trading surplus


316 


267 


18 

Impairment


(46)


(71)


35 

Share of results of joint ventures and associates


(1)




Profit before tax and fair value unwind


269 


198 


36 








Cost:income ratio


76.8% 


80.7% 



Impairment as a % of average advances


0.48% 


0.70% 












As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 









Loans and advances to customers


9.1 


9.2 


(1)

Customer deposits


26.8 


23.2 


16 

Risk-weighted assets


10.4 


10.0 


 

Profit before tax and fair value unwind increased by 36 per cent to £269 million due to lower costs and lower impairment charges.

 

Total income decreased by 2 per cent to £1,363 million.  Net interest income decreased by 10 per cent, reflecting continued margin pressure driven by low base rates and a competitive deposit market.  Other income increased by 1 per cent, as growth was constrained by lower asset management fee income following the sale of the external fund management business of Insight Investment in November 2009.

 

Operating expenses decreased by 6 per cent, driven by cost savings from integration, particularly in the Asset Management business and also include the effect of the sale of Insight Investment.  On a like for like basis, excluding the costs of Insight Investment operating expenses decreased by 1 per cent.

 

The impairment charge decreased by 35 per cent reflecting strong credit management and improved collections and recoveries processes in 2010.

 

Customer deposits have increased by £3.6 billion, or 16 per cent, reflecting strong growth in the UK Private Banking business driven by the success of the Reserve savings account.



WEALTH AND INTERNATIONAL (continued)

 

Funds under management



As at 
31 Dec 

2010 


As at 
31 Dec 
2009 



£bn 


£bn 






SWIP:





Internal


118.2 


111.7 

External


28.0 


30.0 



146.2 


141.7 

Other Wealth:





St James's Place


27.0 


21.4 

Invista Real Estate


5.3 


5.4 

Private and International Banking


13.5 


15.6 

Closing funds under management


192.0 


184.1 








Year ended 
31 Dec
2010


Year ended 
31 Dec 
2009 



£bn 


£bn 

Opening funds under management


184.1 


244.9 

Inflows:





SWIP and Insight

- internal


2.0 


7.1 


- external


8.9 


33.1 

Other


6.7 


4.1 



17.6 


44.3 

Outflows:





SWIP and Insight

- internal


(5.6)


(6.8)


- external


(13.3)


(26.4)

Other


(5.1)


(4.0)



(24.0)


(37.2)

Investment return, expenses and commission


15.1 


16.4 

Net operating increase (decrease) in funds1


8.7 


23.5 

Sale of Insight and Bank of Scotland Portfolio Management Service2


(0.8)


(84.3)

Closing funds under management


192.0 


184.1 

 

1

Includes Insight Investment's external fund management business up to disposal on 2 November 2009. 

2

Insight Investments was sold on 2 November 2009.  The Bank of Scotland Portfolio Management Service business was transferred to Rathbone Brothers Plc over the course of 2010.

 

Funds under management of £192.0 billion increased by £7.9 billion.  Net outflows of £6.4 billion reflect an exceptional withdrawal from a single institutional investor in SWIP, partially offset by strong net inflows in St. James's Place plc.  Increases in global equity values, particularly in the second half of 2010, increased funds under management by a further £15.1 billion.

 

In October 2010, Invista Real Estate announced that its contracts to manage the Group's funds had been terminated on 12 months notice and that these contracts, representing £2.4 billion of Invista's total funds under management, will be managed in future by SWIP.  Invista Real Estate has commenced an orderly realisation of its assets, including the remaining investment management business, and plans to return the proceeds of these realisations to shareholders.



WEALTH AND INTERNATIONAL (continued)

 

International


2010 


2009 


Change 



£m 


£m 









Net interest income


831 


834 



Other income


142 


125 


14 

Total income


973 


959 


Operating expenses


(489)


(425)


(15)

Trading surplus


484 


534 


(9)

Impairment


(5,942)


(4,007)


(48)

Share of results of joint ventures and associates


(7)


(23)


70 

Loss before tax and fair value unwind


(5,465)


(3,496)


(56)








Cost:income ratio


50.3% 


44.3% 



Impairment as a % of average advances


10.30% 


6.99% 



 








 








 


 

 

As at 
31 Dec 
2010 


As at 
31 Dec 
2009 


Change 

Key balance sheet and other items


£bn 


£bn 









Loans and advances to customers


46.2 


54.3 


(15)

Customer deposits


6.0 


5.8 


Risk-weighted assets


48.3 


53.2 


(9)

 

Loss before tax and fair value unwind increased by £1,969 million to £5,465 million due to a higher impairment charge, reflecting an increase of £1,315 million in Ireland and £513 million in Australia.

 

Total income increased by 1 per cent, but was 7 per cent lower in constant currency. This reflects lower interest earning assets and the increased strain of higher impaired assets, partly offset by additional income on the £7 billion European loan portfolio transferred from Wholesale division in the second half of 2009.

 

Operating expenses increased by 15 per cent, partially due to foreign exchange movements.  In constant currency, operating expenses increased by 12 per cent reflecting the development of International's deposit taking operation in Germany, increased risk management resources to manage impaired asset portfolios in Ireland and Australia and costs associated with the closure of the Irish business.

 



WEALTH AND INTERNATIONAL (continued)

 

The impairment charge and loans and advances to customers are summarised by key geography in the following table.



Impairment charge


Loans and advances
to customers












2010 


2009 


As at 
31 Dec 
2010 


As at 
31 Dec 
2009 



£m 


£m 


£bn 


£bn 










Ireland


4,264 


2,949 


19.6 


25.0 

Australia


1,362 


849 


12.3 


13.0 

Wholesale Europe


210 


129 


6.9 


8.5 

Latin America/Middle East


97 


69 


0.6 


0.6 

Netherlands



11 


6.8 


7.2 



5,942 


4,007 


46.2 


54.3 

 

The impairment charge increased by £1,935 million, or 48 per cent, to £5,942 million due to increased impairment charges in Ireland, particularly in the last quarter of 2010 as a result of downward revisions in the Group's Irish economic assumptions, and increased impairment charges in Australia as a result of significant contractions in liquidity in regional property markets to which the Group has exposure in the second half of 2010.

 

The lower credit in respect of the fair value unwind reflects the unwind profile of the original fair value adjustment which anticipated a peak in the impairment charge in 2009 based on a faster economic recovery in Ireland than is now being experienced.

 

Balance sheet progress

Loans and advances to customers decreased by £8.1 billion or 15 per cent, to £46.2 billion due to net repayments of £4.1 billion across all businesses and higher impairment provisions, partly offset by an increase due to foreign exchange movements of £1.1 billion.  The division is focused on de-risking and right-sizing the balance sheet, focusing on key Group relationships, as well as reducing concentrations in Commercial Real Estate.  In the International businesses, drawn exposures in local currency have decreased with limited new business written within a tightened risk appetite that has been applied across the division since early 2009. 

 

Customer deposits increased by £0.2 billion, or 3 per cent, to £6 billion with a strong performance in Bank of Scotland Germany, which has now raised over €4 billion of deposits since its launch in January 2009, offset by a fall in customer deposits in Ireland following the closure of the division's Irish retail business.

 

Non-core operations

Consistent with the division's strategic approach to maximising value in the medium term, a number of businesses are considered to be non-core, predominately the remaining Irish lending portfolio.  As at 31 December 2010,
non-core businesses included loans and advances to customers of £37.2 billion (2009: £44.3 billion), risk weighted assets of £35.0 billion (2009: £40.1 billion) and customer deposits of £0.3 billion (2009: £3.7 billion).  In 2010, these non-core operations contributed income of £657 million (2009: £744 million) and an impairment charge of £5,767 million (2009: £3,889 million).



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

THIS PAGE IS INTENTIONALLY LEFT BLANK



INSURANCE

 



2010 


2009 


Change 



£m 


£m 









Net interest income


(263)


(287)


Other income


2,814 


2,944 


(4)

Total income


2,551 


2,657 


(4)

Insurance claims


(542)


(637)


15 

Total income, net of insurance claims


2,009 


2,020 


(1)

Operating expenses


(854)


(974)


12 

Share of results of joint ventures and associates


(10)


(22)


55 

Profit before tax and fair value unwind


1,145 


1,024 


12 

Fair value unwind


(43)


(49)


12 

Profit before tax


1,102 


975 


13 








Profit before tax and fair value unwind - before
impact of PPI new business closure


1,215 


1,024 


19 

Other income - impact of PPI new business closure


(70)




Profit before tax and fair value unwind


1,145 


1,024 


12 








Profit before tax and fair value unwind
by business unit







Life, Pensions and Investments:







Before impact of PPI new business closure


753 


617 


22 

PPI new business closure


(70)




UK business


683 


617 


11 

European business


110 


75 


47 

General Insurance


372 


367 


Other1


(20)


(35)


43 

Profit before tax and fair value unwind


1,145 


1,024 


12 

 







EEV new business margin2


3.5% 


2.5% 



Life, Pensions and Investments sales (PVNBP)


10,828 


13,519 


(20)

 

1

Includes certain Group and divisional costs and income not allocated to business units, as well as the division's share of results of joint ventures and associates.  2010 includes a gain on disposal of £13 million from the sale of the Group's joint venture investment in esure.

2

Further detail of the EEV results is shown on pages 145 to 148.

 



INSURANCE (continued)

 

Key highlights

·    Profit before tax increased by 13 per cent to £1,102 million, compared to £975 million in 2009.

·    Profit before tax and fair value unwind increased by 19 per cent, to £1,215 million, before a non-recurring charge of £70 million in respect of the Group's decision to cease writing new payment protection insurance (PPI) business. 

·    Other income decreased 4 per cent to £2,814 million largely resulting from the decrease in PPI income as a result of the Group's decision to cease writing payment protection business, partially off-set by improved new business income and the higher than expected return from improved investment markets.

·    Total income, net of insurance claims decreased by £11 million to £2,009 million, primarily reflecting lower PPI income and claims arising from the freeze events in 2010, which are offset by reduced payment protection insurance claims and improved investment markets.

·    Operating expenses decreased by 12 per cent or £120 million to £854 million due to a continued focus on cost management and delivery of integration synergies.

·    Good progress continues to be made on integration, including the launch of a single bancassurance proposition in June 2010.

·    LP&I UK sales of £10,316 million (PVNBP) reduced by 20 per cent.  The reduction in sales is largely due to the withdrawal of certain lower return HBOS legacy products in the second half of 2009 as the business continued to focus on value over volume and a change in mix towards protection products which, although more profitable, result in relatively lower PVNBP.  An improvement in investment market conditions resulted in a reduction in sales of capital protected products.

·    LP&I UK margins increased to 3.7 per cent from 2.6 per cent in 2009.  The improved margin reflects strategic choices made in respect of product and channel propositions as the legacy businesses are integrated in order to focus on value.  The IRR on new business continues to improve and was in excess of 15 per cent in the year.

·    General Insurance profits increased by 1 per cent to £372 million primarily due to improved unemployment claims experience and integration synergies after taking account of continuing lower income resulting from ceasing to write new PPI business and claims related to the freeze events in 2010.

·    Capital management initiatives resulted in £2.3 billion mitigation of the potential impact of Basel III. 

 



INSURANCE (continued)

 

Strategic vision

The insurance division's strategic vision is to be recognised as the leading insurance business by its customers, the Group's shareholders and staff.  The division has four strategic objectives to achieve its vision:

·    complete the integration of the businesses;

·    continue to strengthen its leading brands and grow sales profitably in its targeted markets;

·    enhance the capital management and operational efficiency of existing and future business; and

·    utilise the Group's strengths in distribution and asset management.

 

Progress against strategic initiatives

 

Integrating the business

The integrations of the legacy Life, Pensions and Investments businesses and the legacy General Insurance businesses have continued to progress well.  The division achieved run-rate synergies of £197 million by the end of 2010 and is on track to deliver run-rate synergies of £239 million by the end of 2011.

 

In the Life, Pensions and Investments UK business good progress was made in integrating the legacy distribution functions in both the Intermediary and Bancassurance channels.  Following the integration of the Scottish Widows and Clerical Medical intermediary sales forces in July 2009, a single Bancassurance proposition was launched in June 2010.

 

In the General Insurance business an integrated supply chain model was implemented and includes the introduction of personal claims consultants, across all brands, since July 2010.

 

Sustainable growth

The UK Life, Pensions and Investments business continues to make excellent progress in improving the profitability of the combined product set.  Certain low returning products sold through the HBOS heritage channels have been discontinued and replaced with products providing an improved customer proposition, and enhanced shareholder value.  The decision to change the mix of business from investment to protection products, while resulting in higher margins has contributed relatively lower PVNBP due to the premium size, with PVNBP in the UK business decreasing by 20 per cent.  However the focus on value has resulted in strong increases in new business profits, new business margins and internal rates of return.

 

This focus on value over volume will continue, establishing a realistic base from which to continue to grow a business that is both profitable and focused on meeting customer needs.

 

In General Insurance, the combined ratio improved from 83 per cent to 79 per cent. Home insurance delivered a resilient underwriting performance in the year.  Adverse weather conditions at the beginning and end of the year impacted the performance of the home book, however this was partially mitigated by improvements made to the efficiency of the claims processes.

 

Capital management and operational efficiency

Managing the use of the Group's capital remains a key objective of the business.  Significant work has been undertaken to optimise the Insurance division's contribution to Group capital and in 2010 this resulted in £2.3 billion mitigation of the potential impact of Basel III.  The Insurance division remains well capitalised as assessed via the Insurance Groups Directive (IGD) regulatory measure of surplus capital.  The division is progressing its plans to achieve Solvency II compliance.

 

The Insurance division continues to focus on cost reduction with costs decreasing by 12 per cent in 2010.  Efficiencies have been achieved without compromising the quality of customer service and customer satisfaction scores have remained robust across the division.

 



INSURANCE (continued)

 

Leveraging distribution and asset management

An integrated Life, Pensions and Investments UK Bancassurance proposition was launched in June 2010.  The proposition draws on product design and customer service expertise from the two heritages in order to establish a consistent base from which to further leverage the scale of the Group's Bancassurance operation.

 

Life, Pensions and Investments

 

UK Business



2010 


2009 


Change 



£m 


£m 









Net interest income


(227)


(273)


17 

Other income


1,408 


1,474 


(4)

Total income


1,181 


1,201 


(2)

Operating expenses


(498)


(584)


15 

Profit before tax and fair value unwind


683 


617 


11 








Profit before tax and fair value unwind - before impact of PPI new business closure


753 


617 


22 

Other income - impact of PPI new business closure


(70)



Profit before tax and fair value unwind


683 


617 


11 








Profit before tax and fair value unwind by business unit







New business profit:

Insurance business1


332 


328 



Investment business1


(65)


(196)


67 

Total new business profit


267 


132 


102 

Existing business profit


464 


431 


Experience and assumption changes


22 


54 


(59)

Profit before tax and fair value unwind - before impact of PPI new business closure


753 


617 


22 

Other income - PPI new business closure


(70)




Profit before tax and fair value unwind


683 


617 


11 








EEV new business margin (UK)


3.7% 


2.6% 



Life, Pensions and Investments sales (PVNBP)


10,316 


12,973 


(20)

 

1

As required under IFRS, products are split between insurance and investment contracts depending on the level of insurance risk contained. For insurance contracts, the new business profit includes the net present value of profits expected to emerge over the lifetime of the contract, including profits anticipated in periods after the year of sale; for investment contracts the figure reflects the profit in the year of sale only, after allowing for the deferral of income and expenses.  Consequently the recognition of profit from investment contracts is deferred relative to insurance contracts.

 



INSURANCE (continued)

 

Life, Pensions and Investments UK (LP&I UK) delivered profit growth, before tax and fair value unwind, of £136 million, or 22 per cent, before taking into account the non-recurring £70 million charge from the Group's decision to cease writing new payment protection business.  After this charge, profit before tax and fair value unwind was £683 million, an increase of 11 per cent compared to 2009.

 

Total new business profit increased by £135 million, or 102 per cent, to £267 million.  The increase primarily reflects a reduction in initial commission on OEICs sold through the branch network and cost reductions through integration across our sales channels in addition to progress made on product participation choices.

 

LP&I UK margins on an EEV basis increased to 3.7 per cent in 2010 from 2.6 per cent in 2009.  The improved margin reflects the strategic choices made in respect of product and channel propositions as the legacy businesses have been integrated in order to focus on value.  The IRR on new business was in excess of 15 per cent in the year.

 

Existing business profit increased by £33 million, or 8 per cent, to £464 million.  This predominantly reflects higher asset values and a higher assumed rate of return following improved market conditions in the second half of 2009.

 

Profits arising from experience and assumption changes decreased by £32 million to £22 million mainly reflecting the non-recurrence of benefits recognised in 2009, including a liability management gain of £30 million.  During 2010 a review was undertaken into the charging between the funds of Clerical Medical prior to the acquisition of HBOS, giving rise to a charge of £132 million.  Additionally assumptions regarding future maintenance expenses within the Clerical Medical business were aligned to reflect the heritage Lloyds TSB approach, giving rise to a charge of £119 million.  These charges relate to pre-acquisition matters and were largely offset by the release of fair value provisions.

 

The capital positions of the UK life insurance companies within the Insurance division remain robust.  The estimated Insurance Groups Directive (IGD) capital surplus for both the Scottish Widows and HBOS Insurance groups remained consistent with last year at £1.3 billion and £1.6 billion, respectively.

 

European business

Profit before tax increased by 47 per cent to £110 million driven largely by experience and assumption changes.  New business sales reflect difficult economic and market conditions in Germany, our main European market.



INSURANCE (continued)

 

New business

An analysis of the present value of new business premiums for business written by the Insurance division, split between the UK and European Life, Pensions and Investments Businesses is given below:

 

Analysis by product


UK 


Europe 


2010 
Total 


UK 


Europe 


2009 
Total 


Change 



£m 


£m 


£m 


£m 


£m 


£m 

















Protection


574 


56 


630 


519 


49 


568 


11 

Payment protection


70 



70 


153 



153 


(54)

Savings and investments


1,617 


315 


1,932 


2,689 


312 


3,001 


(36)

Individual pensions


1,606 


141 


1,747 


2,275 


185 


2,460 


(29)

Corporate and other pensions


2,750 



2,750 


2,600 



2,600 


Retirement income


889 



889 


887 



887 


Managed fund business


177 



177 


146 



146 


21 

Life and pensions


7,683 


512 


8,195 


9,269 


546 


9,815 


(17)

OEICs


2,633 



2,633 


3,704 



3,704 


(29)

Total


10,316