Jul 31, 2007
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Executives
Sir Victor Blank - Chairman of the Board Helen Weir - Group Finance Director Eric Daniels - Group Chief Executive Officer G. Truett Tate - Group Executive Director for Wholesale & International Banking Archie Kane - Group Executive Director for Insurance & Investments Terri Dial - Group Executive Director for UK Retail Banking
Analysts
Ian Smillie - ABN Amro Stephen Andrews - UBS Jonathan Pierce - Credit Suisse Bruce Packard - Pali International Alistair Ryan - UBS Carla Antunes - JP Morgan Derek Chambers - Standard & Poor's Antony Broadbent - Sanford Bernstein Simon Willis - NCB John-Paul Crutchley - Merrill Lynch
Sir Victor Blank
Good morning, ladies and gentlemen, and welcome to you. Both those of you here and those on the webcast, welcome to the presentation of our results for the first half of 2007.
I'm delighted to report that the Group has delivered another strong performance, building on the improved earnings momentum that's been achieved over the last few reporting periods. Let me just share something with you.
Since I took over as Chairman just over a year ago, I have seen the scale of change that Lloyds TSB has undergone over the last few years, which, quite frankly, has been massive. The way that Eric Daniels and the management team have transformed the culture of the Group and transformed the dynamics within our business has been underestimated by many people outside the organization.
These results truly demonstrate the progress that has been made, and they point to the opportunity ahead of us over the next few years. I think it's fair to say that 2007 is a year of considerable delivery.
Lloyds TSB now operates to its own focused and balanced business model. It's a business model that generates a higher quality, lower-risk earnings profile, and one where we're now delivering broad-based revenue and earnings growth.
Eric and Helen will take you through the key operating highlights and the numbers shortly. But, perhaps, I could just steal a little bit of their thunder by touching on some of the key issues from the Board's perspective.
Throughout the business, Lloyds TSB is continuing to achieve good levels of business growth. The combination of improved income growth and strong cost management has led to accelerating profit momentum.
And at the same time, it's improved our profitability in many areas of the Group. This is the first time for some while that we're in a position to stand in front of you and talk about double-digit growth in profit before tax, double-digit earnings per share growth, and double-digit economic profit growth.
But what's been particularly pleasing is the fact that the progress has been made throughout the Group in the delivery of strong profit growth in each division. Of course, our customers and our staff remain the keys to our success.
We've continued to invest in the quality of service that we give to our customers and in the quality of the people we employ to serve them. As a result, we have maintained high levels of customer satisfaction and customer advocacy, high employee engagement scores, and a strong sales performance.
The real strength of Lloyds TSB lies in its employees, in its customers, and in its broadly based, well positioned set of businesses. Taking these together, alongside the quality of our management team, I believe that Lloyds TSB is in great shape and well positioned to continue to deliver double-digit economic profit growth.
I mentioned earlier that I believe that 2007 is a year, in which you will -- in which you are starting to see the effect of several years of management effort aimed at transforming the earnings outlook of Lloyds TSB. We've seen the restoration of strong earnings growth momentum and significant recent improvement in capital disciplines throughout the Group.
The Board has confidence in the sustainability of this momentum and has, therefore, decided to increase the interim dividend by 5%. We're delighted with this position.
It's the first time in five years that we've increased the dividend. Going forward, we expect to maintain a progressive dividend policy while continuing to build dividend cover.
Now, let me hand you over to Helen, first, and then Eric, who will take you through the results, and then there'll be an opportunity to ask questions at the end. Thank you.
Helen?
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Helen Weir
Thank you, Victor, and good morning everyone. This morning, I'm very pleased to be presenting a strong set of results, continuing and improving the momentum we've established in the business.
It's clear that this performance is not just a result of the actions we've taken over the last six months but is underpinned by steady improvements that we've been making to the business over the last few years. As you can see, we've delivered an excellent first-half performance.
Profit before tax, excluding volatility, is up by 15%, with strong double-digit growth in earnings per share and an economic profit growth of 31%. Our return on equity has also increased from what was already a high base and now stands at 27%.
As Victor mentioned, we've taken the decision to increase our interim dividend by 5%. We've said frequently in the past that our approach has been to grow into our dividend, and I think that the last few years have proved that this was the correct strategy.
We're now clearly demonstrating strong capital efficient earnings growth. Once again, we've delivered a balanced trading performance, with all three divisions showing double-digit profit growth.
This is a strong and consistent performance in what remains a competitive environment and is driven by our improved rate of revenue growth, excellent cost management and very satisfactory asset quality. Our high quality business model means that we're well positioned to outperform and out-compete in the future.
But growth is only good, if it's profitable. Our focus is very much on capital efficient growth throughout the business and on operating in a more profitable business segments, and this slide demonstrates the results of that focus.
We've managed to deliver strong growth, while at the same time improving our return on equity. Our increased earnings momentum has not come at the expense of returns.
We continue to make good progress in our capital efficiency program throughout the Group, and this is demonstrated by our improving return on risk-weighted assets and return on embedded value. The strong growth in the first half combined with our traditional strengths of good cost management and strong capital disciplines bodes well, as we look to the rest of the year.
Turning now to some of the detail behind the numbers. On a reported basis, overall income growth of 9% reflects an improvement on recent reporting periods and demonstrates the good progress we're making in delivering our divisional strategies of increasing income from both new and existing customers.
Group expenses grew by 6%, giving a robust set of jaws of 3 percentage points. This combined with our strong topline performance means that our trading surplus grew strongly, up 12%.
The reduced growth in our total impairment charge means that we've delivered a strong 15% growth in profit before tax. However, included in these figures are a number of specific and exceptional items, which distort the underlying numbers.
The two main items are the £36 million charge for overdraft claims in the Retail Bank and a £28 million impairment charge in our leasing business as a result of the reduction in the rate of corporation tax in 2007 Finance Act. At the profit after-tax level, the act actually has a positive impact of some £70 million.
And as usual, we've excluded the insurance grossing adjustment. On this basis, the trends are largely unchanged, but you can see a more representative view of our underlying performance, with income up 8%, costs up 4%, and profits up 19%.
We've delivered a strong trading performance and positive jaws across each of the divisions. In the Retail Bank, we've continued the increased income momentum from the second half of last year.
This has been accompanied by good cost management, with costs up 2% and, as you can see, impairments slightly down with the result that underlying profits were up 18%. We've also maintained good momentum in Insurance and Investments, with underlying income up 8% and profits 11% higher.
This is underpinned by a 16% rise in bancassurance sales and a 1% sales increase through IFAs, a good performance against last year's record A-day related sales. Divisional profit was depressed by about 8% as a result of claims amounting to £45 million, following the floods in Yorkshire in June.
In Wholesale, we continue to see good income growth and strong positive jaws, while also investing in the business. Despite the increased charge for impairment losses, the division delivered a 16% increase in profit.
Turning to the drivers of income growth; firstly, balances. In retail, asset growth was 6%, with average mortgage balances up by 8%.
Consistent with the market, unsecured retail lending was down as a result of lower consumer demand and prudent credit criteria. This was particularly apparent in credit cards, where, although we held market share, balances actually declined half-on-half.
We've continued to see good growth on the liability of the side of the balance sheet. Average retail deposits are up by 7%, with the strongest performance coming in bank savings, where balances are up 11% as a result of our continuing focus on building this part of the business.
In the wholesale bank, we saw strong asset growth, particularly in commercial banking and corporate markets, especially in our expanding structured products and debt capital markets businesses. These more than offset a decline in asset finance, following the market slowdown in unsecured lending, as well as a tightening of our own credit criteria.
Liability growth was robust with strong growth in commercial banking as a result of our continuing focus on new start-up and switcher accounts. So, overall, good growth on both sides of the balance sheet.
In terms of margin, we've seen a continuation of recent trends. Almost all of the 16 basis points year-on-year decline is attributable to two key areas: Mortgages and our asset finance business.
In the case of mortgages, we've seen some decline in margins in what remains a very competitive market. At the same time, because our mortgage book has grown at a much faster rate than the unsecured book, there's an adverse mix effect.
In wholesale, there's a similar picture where the move to higher quality lending in asset finance has resulted in lower lending margins. Notwithstanding this, asset finance remains one of our higher margin wholesale businesses but because assets have fallen there, while we've seen good growth in our corporate and commercial businesses, we, again, have an adverse mix effect.
Over the period, we've seen an increase in our savings margins, which has gone some way to offset these effects particularly in bank savings and wealth. The 2 basis point funding movement includes the impact of the five-year rolling swap on the current account credit balances.
The negative funding impact that we've experienced for some years finally reversed in June and we now expect to see an improving trend on the back of recent interest rate increases. Looking specifically at the drivers of growth in the Retail Bank, once again, we see greater income growth on the liability side of the balance sheet.
We continue to make good progress in driving income from both savings and investments, and have also seen good growth in AVA fees as a result of strong sales and higher fee levels. New to bank AVA sales were up 70% year-on-year.
On the asset side, we saw income growth, due to an increase in insurance commissions, reflecting higher new sales levels and an increase in the proportion of our sales through the branch network. Good progress on both sides of the balance sheet means that we've maintained the momentum established in the second half of 2006 with retail revenues up 6%.
I'd now like to spend a couple of minutes highlighting the way in which we think about growth. While clearly our objective is to grow the business, this is not at any cost.
Our focus is on profitable growth. Market share alone is not one of our KPIs.
Looking at savings in more detail we can see this strategy in action. Our focus has been very much on growing bank savings deposits, where we have been encouraging our customers to save regularly.
Similarly, we've been focused on growing our wealth deposit book and have increased the number of customers in our investment portfolio business who also bank with us. As you can see, these are the more profitable areas in terms of our savings book.
In contrast, the C&G savings book, which tends to be more post and Internet-based, is finer margin. So while our overall volume share of the savings market has been stable, we've increased our share of value by focusing on the more profitable business areas.
Our focus is on share of value not volume for volume's sake. Turning now to the wholesale division where income is up 10% half-on-half, most of this income came from our two key businesses, corporate markets and commercial banking, with asset finance income impacted by the unsecured consumer credit market.
Commercial banking income increased by 8% as a result of continued strong lending, particularly larger ticket secured lending and deposit balance growth driven by new-to-bank recruitment. In corporate markets, income was up 26%, supported by continued high levels of cross-selling income.
By building new product revenue streams in areas such as structured products and debt capital markets, and by targeting and developing relationships in selected corporate customer segments, corporate markets has created a broader, more diversified stream of revenues, which will underpin future revenue growth. This chart disaggregates some of the drivers of revenue growth in corporate markets and as you can see while we continue to deliver good growth from our traditional corporate business, a significant proportion of the growth has come from areas in which we've been investing over the last two years or so, for example, sales and risk management.
Our broadened product offering has enabled us to grow cross-sales income across corporate markets by 32%. The development capital growth is worthy of mention as we had a gain on one particular business during the half that meant that LDC income was around £50 million pounds more than its typical run rate.
In insurance and investments we, again, saw good growth. On an EEV basis, Scottish Widows' profits were up 12% or 16% after adjusting for surplus capital repatriation.
We saw good growth in new business profits as a result of new business sales, which were up 8%, and continued robust margins. Bancassurance sales were up 16% building on the success of the simplified product range sold through the Lloyds TSB branch network, commercial banking and wealth management channels.
We saw particularly strong performance in protection sales, including the new product Protection for Life, and payment protection insurance, which was previously sourced from an external provider. Sales through the IFA channel increased by 1% against the record A-day related sales on the first half of last year.
Sales of retirement products, OICs and managed funds were particularly strong and more than offset a reduction in savings and investment sales as a result of the need to limit investment in our property fund following the highly successful launch. Existing business profit remained robust with lapse experience in line with expectations, and the expected return on shareholder funds increased as a result of higher levels of free assets driven by strong equity markets as well as higher expected returns.
What is interesting here is that despite the fact that we have repatriated over £1 billion worth of capital from Scottish Widows in the last year, the strong set of results has meant that the total EEV has remained constant year-on-year at £6.4 billion, and this highlights the value being created by our strategy. To illustrate this point, we need look no further than the IFA and bancassurance channels.
The margin in the bancassurance channel is significantly better, in no small part due to the product mix. So this is why access to branch distribution is so key and why we are focused on growing our bancassurance business with considerable success.
As you can see from the charts, the percentage of bancassurance business has risen from 37% to 40% in just one year. Turning to costs, the Group's cost performance remains strong and, as you would expect, tight cost management continues to be a priority but not at the expense of investing for future growth.
Our philosophy is to continually seek productivity improvements in our existing business, some of which flow through to the bottomline but some of which we reinvest for the future. Costs in the Retail Bank, excluding the cost of overdraft claims, increased by only 2%.
This highlights the ongoing improvements being made in the rationalization of back office operations to improve efficiency. Over the last two years, the amount of branch network staff time spent on back office administration work has reduced from approximately 35% to around 5%.
This has freed-up a huge amount of time to focus on sales and service and has been one of the factors behind the significant increase in branch network product sales over the same period. Cost growth in the wholesale division was slightly higher than the other divisions and this is where we have seen the greatest business investment.
Overall costs rose by 5% but there was significant investment in both corporate markets and commercial banking. In corporate markets, we have made and expect to continue to make, significant investment in people and systems and this is paying off.
Corporate markets' income grew by 26% in the first half. In commercial banking, we're investing in migrating almost 1 million business customers on to a new banking platform which will allow online real time banking access across all channels as well as straight through processing of our core processes.
So, for example, while it can currently take several days to process a business loan, once this investment is finished, a customer will be able to receive new loan funds to their account in less than an hour. I've previously discussed the various elements of our productivity program so I'm not going to dwell on it further today.
Suffice it to say, the program delivered £72 million of net benefits over the first half of 2007. We remain well on track to deliver a benefit of about £125 million this year even after reinvestment and £250 million in 2008.
The value of this program is that it is allowing us to deliver real reductions in our underlying cost base by re-engineering the business without cutting into valuable investment spend, and to deliver further sustainable improvements in our cost income ratio. Not surprisingly, given my comments about our cost disciplines, all our divisions have once again delivered income growth ahead of cost growth.
Half-on-half, the cost/income ratio in retail is down by more than 1.5 percentage points, and notwithstanding the investments in the corporate markets and commercial business units is down by nearly 2.5 percentage points in wholesale. As a result, our Group cost/income ratio continues to improve substantially, now standing at 48.6%, down 2 percentage points on the first half of last year.
Turning now to impairment. For the period, the Group charge for impairment losses grew by 5% or 1% if we exclude the impact of the corporation tax change.
Starting with wholesale, as expected, the underlying wholesale charge for impairment losses increased by 14%, reflecting a lower level of releases and recoveries. But as you can see, the charges as a percentage of lending remain constant.
The trends in asset finance are similar to those in the retail book, but we've not yet seen any deterioration in our SME book, in part as a result of our strategy on focusing on secured lending. Overall asset quality in wholesale remains strong, and the level of new corporate provisions remains low.
In the Retail Bank, we saw impairment decrease by 1%. We indicated earlier in the year that we did not expect the retail impairment charge to be any higher in the first half of this year than last, and our expectations have been realized.
The quality of new secured lending has continued to be strong and impairment in the mortgage book has actually fallen. A significant driver of the retail impairment charge is consumer insolvencies.
As you can see, we're well positioned against the wider market, and in the last quarter, we saw a decrease in insolvencies compared to a slowdown in the rate of growth for the market as a whole. We previously highlighted that our credit scoring models include criteria for propensity as well as ability to pay, and we've continued to maintain tight monitoring and management of IBAs.
Looking forward, the rate of growth in the number of customers filing for insolvency, along with future interest rate trends remain key factors in the outlook for retail impairment. Looking now at some of our own internal data, you'll be familiar from previous presentations with the dynamic delinquency charts, which show arrears trends in our various books of business.
In loans, the overall arrears profile is relatively consistent, with the latest vintages shown in blue here, continuing to perform well. It is this strong performance that has led to a 9% reduction in the impairment charge in our personal loan portfolios.
The picture in cards is slightly more complex, and I've color-coded the chart to try and make it easier to understand. As I've previously discussed, the cards opened in early 2004, colored pink, showed a good arrears experience.
However, we saw deterioration in the performance of cards issued towards the end of 2004 and into 2005, colored red here. We started tightening our scorecards at the end of 2004 and continued through 2005 with the result that the arrears performance of cards opened since the middle of 2005, shown in green, has improved considerably, and is back to the levels of early 2004.
And as you can see from the blue lines, this improved performance continued through 2006 and into the first part of this year. So overall, our new lending continues to perform well.
And this is one of the key reasons why assuming no further deterioration in the external environment, we currently believe there will be no increase in our 2007 retail impairment charge. The overall level of impaired assets is broadly unchanged year-on-year, and impaired assets as a percentage of total lending has reduced slightly from 2.1% to 2%.
So all in all, we continue to have a satisfactory credit position. Moving on to our capital ratios, growth in Group risk-weighted assets was 5%, all of which is accounted for by growth in wholesale, where RWAs grew by 11%.
There was actually a reduction in the retail bank as a result of recent mortgage securitizations. This is a very pleasing position, as we are now beginning to see some tangible benefits from our move over the last few years from a buy-and-hold balance sheet management model to an originate-and-distribute model.
One of the benefits of this change in approach has been a significant increase in the return on risk-weighted assets in both the retail and the wholesale bank. Overall, our capital position remains robust.
Our capital ratios are strong and we continue to have significant capital headroom. We've continued to make substantial progress in our balance sheet management as we embed economic capital disciplines throughout the business.
In corporate markets, we've made significant progress in structuring and distributing risk, with increased loan underwriting and syndication volumes. In addition, in the first half, we repatriated a further £600 million in capital from Scottish Widows, ahead of expectations, making a total of £2.3 billion over the last couple of years.
As part of this program, we are pleased to announce today the sale of our Abbey Life closed book business for just under £1 billion. This represents a premium of 4% over the half-year EEV value, and a profit of almost £300 million over the half-year IFRS net asset value.
Following the sale, we expect to repatriate just over £960 million of capital to the Group, which will increase our Tier 1 ratio by 17 basis points, and our total capital ratio by 67 basis points. And we will continue to examine further opportunities to improve our capital efficiency at Scottish Widows.
Returning to my previous slide, as you are aware, our regulatory capital will move to the Basel II basis from the beginning of 2008. We submitted our credit risk waiver at the end of last year, and our ICAP earlier this year.
The feedback from the FSA has been encouraging, and we're confident of moving to the internal ratings-based approach from January 2008. Our final capital assessment will not be confirmed until the fourth quarter; however, we're confident we will maintain satisfactory capital ratios throughout the transition.
In summary then, we've delivered a strong set of results. We continue to build earnings momentum and a high-quality balanced set of businesses with good sales growth across the Group.
Cost management remains strong, and we've again delivered wide positive jaws. All this has combined to deliver a strong profit performance in each division, which has resulted in accelerating profit momentum.
Our focus on improving efficiency means that we've once again substantially improved our cost-income ratio. Asset quality remains satisfactory, and we continue to demonstrate that we can both grow the business and maintain our high returns.
Finally, we have a robust capital position and are improving our overall capital efficiency. All this has created an increased confidence in the Group's ability to sustain good momentum, a confidence that has been reflected in the Board's decision to increase the dividend and endorse a progressive dividend policy going forward.
With that, I'd like to handover to Eric, who will take you through a further overview of our progress.
Eric Daniels
Good morning, and thank you for coming. I'm very pleased to be reporting a very strong set of results for the first half of the year.
This is the strongest rate of growth that we've had in this decade. In my view, the very good performance is the latest in a series of results that we've been building over the past few years, but in some sense, they also mark a watershed for the Group.
In previous presentations, we told you we had a view for our future, that we could get both growth and returns by better leveraging our franchise. We told you that we needed to put in place the underpinnings to allow us to perform.
With this set of results, we can show you that the fundamental processes which drive the business model, customer acquisition, relationship deepening, managing the cost base effectively, and managing capital efficiently, are firmly in place and are delivering and have led to our strong performance. We've improved our topline growth to the highest level in ten years.
This is our fifth straight year of productivity improvement. We have double-digit economic profit growth, and we're delighted to announce the dividend increase.
Our view is that we've built momentum in the franchise from these very solid foundations. We believe we have much more opportunity and a clear roadmap toward realizing that opportunity.
What makes these results particularly good is that we have momentum across all three divisions, in retail, wholesale, and insurance. We have good income growth in each division.
We have positive jaws in each. Asset quality is being well managed across the piece, and each has delivered double-digit profit growth.
The results are income-led, and it's increasingly better-quality income as it's built on deep relationships with our customers. We're successfully acquiring more customers and cross-selling more products.
We will be able to continue this progress as we expand the franchise and develop a broader set of product capabilities. We've maintained our strong productivity disciplines, reducing our cost/income ratio to 48.6% in this period.
This is the latest step in a series of improvements, as you can see from the chart. We've achieved this through the systematic implementation of our key programs, centralizing operations in Group manufacturing, applying lean and sigma techniques to all of our processes, and we're getting much smarter about leveraging our scale to reduce our procurement costs.
We expect to be able to continue to improve our efficiency as we expand our capabilities across the Group, and move the existing areas to the next level. We've worked every element of the income statement.
We've raised the rate of topline growth. We've consistently improved our efficiency.
Helen talked to you about our impairments, which are well managed due to the strengthening of the credit function and taking the right decisions early on. As a result, we're seeing a 15% growth in profit in the half and a healthy build over the past several periods.
We've delivered the profit growth while maintaining our high returns. We've achieved this as we've focused on managing our costs and capital much more efficiently, and we've redirected our key resources to the greatest opportunities within the core franchise.
Our expectation is that we can continue to drive the cost and capital efficiencies going forward and continue to grow profits, with high returns. Our focus on high quality growth underpins our longer-term commitment to our shareholders to deliver sustainable double-digit economic profit growth.
We've exceeded that goal by some margin in this period, in some small part due to taxes, but it's still a very robust result. This is a clear sign that the business model is delivering.
Our focus on the customer drives our income. Our focus on efficiency drives our expenses.
Our focus on capital and economic profit drives our profitability. The result of working these drivers is strong shareholder returns.
I think it's well understood that we've maintained a high dividend, which we regard as a good operating discipline and the right repositioning vis-à-vis our shareholders. However, as our performance has steadily improved, we've also seen good share price appreciation over the period, and hence we've outperformed our UK peers on a total shareholder return basis.
We've clearly delineated a change in our dividend policy, with this set of results. In prior periods, we maintained our strong dividend, while establishing momentum within the business, managing our capital efficiently to support growth and rebuilding our dividend cover.
With this latest set of results, and the increasing confidence we have in our future delivery, we've decided to increase the dividend for the first time in five years. In the future, we look to grow the dividend and to increase the level of cover.
When we set out our strategy, we said there was a real opportunity within the franchise to leverage our customer base, brand and distribution strengths. We thought we could fund growth by better utilizing our resources.
At that stage, the strategy was unproven. Over the past several periods, we've made considerable progress in realizing the franchise opportunity.
We've put in place a set of capabilities and processes, such as customer acquisition, relationship deepening, efficiency programs and managing risk, and they have served us well in building the business thus far, and they will drive our future growth. In the future, we'll continue to explore extending our franchise, but the core franchise is strong, and represents our greatest opportunity for growth.
We have arguably the best distribution system in the UK, and we're leveraging it to improve our customer acquisition in current accounts, which is the key relationship product. The left-hand chart shows you how we're improving our rate of acquisition, and we're getting better at cross-selling the higher-value current accounts at the start of the relationship.
And as you can see from the right-hand chart, we're deepening relationships and generating better returns, as we're getting better at cross-selling high-value accounts into the existing customer base. We're the largest provider of added-value accounts in the UK with a 35% share.
This shows that we can successfully acquire and deepen relationships and we will continue to do so. I'd like to spend the next few minutes showing how some of these capabilities and processes are delivering today and how they'll drive our growth going forward.
As you know, selling insurance products through the branches has been an elusive goal for many. At Widows and the Retail Bank, they've worked together to redesign products and overhaul our sales processes, and we've seen tremendous results.
The encouraging point is that bancassurance sales have not been achieved at the expense of our savings. We've seen the savings net inflows growing roughly at the market, so we're not cannibalizing them to grow Bancassurance.
As we grow the customer base, we can see further opportunities. In the wholesale business, we've been extending our product range to serve a greater share of our customers' needs.
We've been growing the income stream, which shows a compound annual growth rate of 15% over the period. The focus has been on the customer base, and we're selling products into the franchise customers, and here we've seen a growth of 21% compounded.
And we're building deeper relationships and this is reflected in our cross-sales income, which is up 47% since 2005. Perhaps this is more vividly illustrated by the way that we've grown a successful relationship with a construction company based in the Midlands.
In 2002, we had a pretty simple relationship with one of the subsidiaries. We provided clearing services and working finance.
By 2005, we became the mandated lead arranger for the entire Group and started handling their interest rate management products. In 2006, we picked up the Group clearings and began to service their currency needs.
This year, we expect to provide their international cash management services. A very strong trajectory has been established in the wholesale bank and we expect to continue to build on the same themes to advance our future growth.
Turning now to productivity. We believe that we had opportunities to improve our efficiency, and at the same time, deliver enhanced customer service levels.
We've driven our key programs, which have enabled us to become more efficient. Over this period, we reduced our staffing levels by some 9,500.
We estimate that these programs have taken out between £250 million and £350 million from the cost base. At the same time, we've seen our customer service ratings rising and gaining external recognition, such as this year's Euromoney's Best UK Bank award and the CBI's Bank of the Year for the third time in succession.
We believe we can continue to drive these and new efficiency programs across the Group to further improve our cost/income ratio. In the branches, we've been improving our back office processes.
This has enabled us to reduce our non-sales staff in the branches by 28% since 2005, and this has more than funded the increase in customer-facing staff, which have grown by 41% over the period. We've also been improving our sales processes, and this has helped drive the improvement in seller productivity by 17%.
These elements have driven the growth of 65% in sales since 2005. In the wholesale division, we've delivered strong profit growth, underpinned by a good income performance.
We've improved performance due to the investment in increased levels of customer-facing staff and improved products and processes. In corporate markets, we've increased the number of front office relationship managers and product staff by 26% since 2005.
We've partially funded the increase by making the back office more efficient. We've made the relationship managers more effective, through the use of better account planning tools and a broader product range.
This has increased the income per member of front office staff by some 16% over the period. The overall impact has been a 46% increase in income over the two years.
We've made significant strides in becoming a more efficient and a more effective organization. This is an important discipline, and has allowed us to significantly raise the level of investment for the Group.
The left-hand chart shows you the high growth in investment in capital and revenue expense and above-the-line marketing. But even this understates the total investment for the Group, as much of it is people-related.
We've been both increasing the number of customer-facing people, as well as some of the more specialized positions, such as in products and risk. We're also investing to improve our people's skills.
As I mentioned earlier, we believe that we had a real opportunity to use our capital more efficiently. In the Retail Bank, we focused on the growing demand for savings and investment products and we've seen terrific results.
We have a 48% increase in total UK RB sales of products over the past two years with especially strong growth in the sales of liability products. This less capital-intensive business and combined with the more actively managing the UK RB balance sheet shows that the risk-weighted assets have only grown by 2%.
In the wholesale division, we've seen clear progress in our strategy of directing capital to the higher return business. We've embedded economic profit disciplines at the account level.
This means that relationship managers are looking for more fee-based revenues and higher return products to sell alongside of the traditional banking services. It's easy to get higher returns by simply moving up the risk spectrum where you can see from the right-hand chart we're actually improving our risk profile and hence we are not driving returns with greater risk.
We're growing our income faster than the growth in risk-weighted assets, and hence we're improving our risk-adjusted returns. Scottish Widows has been very successful in improving its efficient use of capital.
By redesigning the products and improving our productivity, we've improved our internal rates of return in both the IFA and the bancassurance channels. We've gone further than that by weighting our selling efforts more heavily toward the higher return channel.
In Bancassurance, we've seen a growth of 87% in sales over the past couple of years. We began regular dividend payments from Scottish Widows in 2005 and since then we've repatriated some £2.3 billion of capital to the Group.
We've build strong franchises as evidenced by our service quality programs and the uplift in acquiring and deepening relationships. We've continuously improved our efficiency and managed our capital better, and these results show our progress.
The building momentum in the business encourage us to think there is a lot more headroom in the franchise and gives us the confidence that we can and will execute against this opportunity. So let me sum up.
The Group has delivered a very strong performance. These results are underpinned by good revenue momentum.
Each of the three divisions is growing. Each is extending and deepening its franchise.
We're improving our efficiency, and we're investing for future growth, and we've delivered strong economic profit growth. As we continue to strengthen the underpinnings of our business model and see the improving results, we're increasingly confident in our ability to deliver sustained growth over time.
Thanks very much.
Unidentified Analyst
Can I ask a couple of questions on recent disposals please? Both the Registrars business and the Abbey Life business have added about 45 basis points, I think, to your Tier 1 capital; can you give us some idea of how that would be invested to offset earnings dilution from those sales?
And secondly, more strategically, as we're in phase two now with double-digit profit growth moving into phase three, should we expect any more portfolio realignment from the Group?
Eric Daniels
Well, I'll ask Helen to answer as well but basically what we have done, as we talked about on the platform, is that we have used our resources more efficiently. So we have had a systematic program over the past two to three years of managing our capital and these latest disposals are part of that where we are allocating our capital toward our best growth opportunities, and that's how we're generating the headroom for future growth.
Very clearly, one of the things that we set out when we started the strategy was to get both growth and returns, and a strong part of that has been due to not only the productivity but the capital management disciplines. So I think that what you'll see in terms of the Registrars and Abbey transactions specifically is more of the same, that we will continue to allocate the capital toward the highest areas of growth.
In terms of where we are in turning phase two, phase three, we're very solidly in phase two, but as I just signaled, we continue to see terrific headroom within the franchises, we continue to see good growth going forward and so that's where we'll stay for a while. Helen?
Helen Weir
I don't think there's anything I can add, Eric.
Eric Daniels
Sorry.
Ian Smillie - ABN Amro
Thank you. It's Ian Smillie from ABN Amro.
Two questions, please, both on the quality of revenue, an angle that you've encouraged us to think about over the last 12 months or so, and it goes back to the charts that you have given us, Helen, on the breakdown of revenue both in retail firstly and then secondly in wholesale. It looks like something like 85 million or so of the increase in retail revenues has come from insurance and other, so I was wondering whether you could talk to us a bit about how much of that is dependent on the flow of new business and how much of that is repeatable going forward?
What I'm thinking about here is the potential volatility or the cyclicality of revenues that we have seen in historic years. That's the first question.
Sir Victor Blank
Helen, do you want to do that?
Helen Weir
Yes, I men, you're right in saying that we're seeing a significant improvement in our lending-related insurance income coming through. I find your question slightly strange though because the nature of the retail business is that there are a number of annual flows and every year you have to start the year and make up those annual flows.
So that's part of our overall business model. Yes, it’s not the annuity in the same way as the savings and investment side, and that's one of the reasons why we've clearly been growing our savings and investments side, but it's part of our overall business model to have some flows that are also annualized flows.
One of the things that Terry and the team sit down at the beginning of every year, they sit down and think, okay, fine, what are we going to do this year to generate those annualized flows? So it's just part of our overall business model.
Ian Smillie - ABN Amro
Can you give us some sense as to what products those insurance relate to? Is that mortgage rather than unsecured?
Helen Weir
It's across the piece. So it's mortgage related, insurance and also it's the creditor insurance.
It's both.
Ian Smillie - ABN Amro
Okay. And on the other number that's in there?
Helen Weir
That includes sort of general insurance, house insurance, and things of that type as well.
Ian Smillie - ABN Amro
Thank you. And the second question, the same thing but for the wholesale bank chart that you gave us and the venture capital gains, which you referred to being above normal, can you give us some sense of the size of the book there and potentially the unrealized gains which should still come through in future periods?
Helen Weir
Okay. I mean the overall book is somewhat less than £1 billion in terms of our venture capital.
We normally have a run rate of earnings, which I think would run at about £50 million, something like that in a half and then we've seen an upside of about £50 million extra in the half that came through. So last year we had about £30 million in the first half, this year we've got about £100 million.
£50 million is what we'd normally expect as an average although you can understand there's a bit of variability. But we do see it as an ongoing part of our business and part of our business flow and it's an area that's served us very well in recent times as well.
Ian Smillie - ABN Amro
Thank you.
Eric Daniels
If I can just add on to that. Ian, it's good to see you.
The venture capital portfolio, as you know, over the past two to three years has been very solid in terms of its performance. Now we'll always have some lumpiness but it's an ongoing feature and it's certainly part of the wholesale bank.
We do that very, very well.
Sir Victor Blank
Okay. Thanks.
Stephen Andrews - UBS
Thank you. It's Stephen Andrews from UBS.
It's a question for Truett really and his appetite for risk in the corporate bank. I'm just interested in the -- his current appetite for property lending because I think, since the beginning of the year, his property book's grown at an annualized rate of 50%.
And I think it's now over the last five years it's gone from 8% of total corporate lending to almost a quarter of the book at a time when other banks are looking to actually reduce their commercial real estate lending and prices anecdotally look like they're now falling. Can you give us an explanation why you have such an appetite for that particular sector at this particular moment in the cycle?
And I've got a second question as well on Widows.
Sir Victor Blank
Can Eric start that one off anyway?
Eric Daniels
Thank you. I'll just top it and then ask Truett to comment, but basically, as you know, we have been under-leveraged in the real estate part of our portfolio.
We are underrepresented, probably a better way to say it, but what Truett and his team have done over the past couple of years is started to grow that book but we're still very much under our natural share. We've been very selective.
It's a very high quality book. Truett, would you care to comment more?
Truett Tate
Sure. First of all, Eric's generalization is absolutely right.
We feel quite good about the book. And probably the best way to give you a little bit of detail, I think in the half draw on balances went from about £13 billion to £16 billion.
That's -- you're right, 25% increase. The fact is you have to look at the way we've focused it, which is very, very much on our traditional focus on our customers that we know well.
Of that £3 billion two names basically accounted for over £1.2 billion of it, two names alone, both of those strong investment grade names. Those are -- that's name property lending versus opposite a given project.
Another £800 million would come out of packs or public sector, half of that to a given name investment grade, almost all of the rest coming from RSLs and Housing Associations, government supported if not guaranteed. £300 million in business banking, of the business banking 64% of that is to existing customers.
So you break the £3 billion down and in very short order you come up with an accounting, which makes you feel very comfortable that it's not about a large exposure to vulnerable properties but rather an extension on our normal focus on our known business, our known customers and it's high quality portfolio.
Sir Victor Blank
Thanks, Truett. Stephen, do you have a second question?
Stephen Andrews - UBS
Yes, sorry. Just a second question.
Just thank you very much for the additional net flow data in Scottish Widows. It's extremely useful in terms of understanding how that business is progressing.
Can I ask and just put you -- obviously you've got the flow numbers now but on the stock, just the split between retail and institutional where the -- how much of the £102 million, £103 million -- £1 billion of stock at the end of the year was at retail versus institutional so we can put the £1 billion of net inflows in retail in the context of the stock you've got there?
Sir Victor Blank
Archie, can you answer that one?
Archie Kane
Most of the growth you can see on the fund management side is coming through in the retail side. The institutional side which includes I think in that schedule that you're talking about, includes the cash flows of the global liquidity fund and that washes around quite a bit.
Institutional relatively flat and the retail side is the one that's contributing mostly to the growth.
Sir Victor Blank
Okay, thanks Archie.
Jonathan Pierce - Credit Suisse
Good morning. It's Jonathan Pierce from Credit Suisse.
Can I ask a question, just going back to Ian's question in the Retail Bank because the other income growth is good versus both the first and the second half of last year, and I just wanted to clarify has there been any assumption changes in terms of the commission payments that are paid out of general insurance into the Retail Bank for the writing of general insurance products?
Sir Victor Blank
Helen.
Helen Weir
No, I don't believe there have. No, there haven't been.
Jonathan Pierce - Credit Suisse
Okay, thank you. The second question is on capital, previously the cover target was 1.4 to 1.6 times, I think this year you're probably going to be around the middle of that.
But you're still talking about increasing the cover from here. Is the 1.4 to 1.6 still the sort of range we should be thinking about?
And as a supplementary to that, can I ask whether you've taken the dividend that has been declared out of the Tier I at the interim stage?
Eric Daniels
In terms of dividend guidance going forward we had basically said that we would hold our dividend position over the past several years until we hit the 1.4 to 1.6 level. And that was what we in fact did.
We grew into our dividend very nicely. We're delighted to be reporting the first increase in dividend in five years.
We've said in terms of future guidance that of course the Board is going to take each decision as it comes and look at the future and the quality of the earnings. You would expect that.
But what we've gone further in saying is that we would expect to grow the dividend and increase the cover and that's the extent of the guidance we've given.
Helen Weir
In terms of the second part of the question, the dividend has not been deducted. So the interim dividend has not been deducted from the capital ratios in the half year.
Sir Victor Blank
Okay, thanks.
Unidentified Analyst
Just on this question of dividend cover, under Basel II I suspect there'll be a very significant reduction in risk-weighted assets. Have you thought about how that might cause you to operate with an even lower level of dividend cover than you might have previously been assuming?
Eric Daniels
We've clearly looked into Basel II. We're comfortable with our capital position.
We're comfortable with the guidance that we've given thus far.
Bruce Packard - Pali International
Yeah. It's Bruce Packard at Pali.
I just wanted to explore a little bit at expanding new business margin in the Insurance and Investment division and, sort of, the capital intensity of that business as well. It's quite unusual to see the new business margin expanding at the same time as writing less capitally intensive business.
So I was just wondering if you could give us some help there?
Sir Victor Blank
Eric?
Eric Daniels
Thank you. Again, I'll give you, sort of, an overview and then ask Archie to comment.
But what I had talked to you about on the platform is we've done really two major -- we've had two major thrusts. The first is that we've rewritten a lot of our products.
We're redesigned an awful lot of the product to be more friendly in terms of its capital usage. Archie and his team have also done an absolutely brilliant job in terms of managing the productivity and efficiency within Widows, which, of course, helps our capital ratios.
So what we've done is basically reworked the whole franchise over the past several years. It's been hard work, but you're starting to see the results of that now.
We've also gone further than that. In addition to improving the overall efficiency and the overall capital efficiency within Widows, we're moving more toward the bancassurance channel, which, of course, has higher margins and higher returns.
So that's, sort of, a broad brush frame of what we've done. Archie?
Archie Kane
As Eric says, we've put a lot of effort into improving the efficiency and the productivity and the margins within our various products. An example of that is the protection for life product, which we launched at the start of this year into the bancassurance channel, which is selling well.
We've had very good growth in that protection product, in excess of 20% year-on-year. And the way the product is structured is it consumes less capital for a shorter period of time.
Also in terms of the pensions market, we've introduced our retirement product, our new pensions product, sit-tight (ph) product, which was launched at the end of the first quarter, and that is much more capital efficient. One of the things we've done is we've looked at the payback periods of all of the products.
And as we redesigned them, we reduced the payback period and, hence, the capital consumption. One other thing that has impacted the overall margins is that we've seen a movement from regular OEICs to single-premium OEICs, and single premium OEICs are -- have a better margin and, therefore, improve the overall margin as well.
Sir Victor Blank
Thanks, Archie.
Alistair Ryan - UBS
Alistair Ryan at UBS. Two questions if I may.
One of them (inaudible). Helen, you mentioned that there's been a change in how you're writing protection business.
You've brought some in-house. That's about 98% of the increase in PVNBP in the first half.
And is that the main driver of that? And subsequent to that, is the flat OEICs sales performance -- I mean, we typically expect strong bancassurance to reflect good OEICs performance.
That's not the case. And then I have a second unrelated question.
Thanks.
Helen Weir
Okay. I mean, on the PVNBP and the protection item, I mean, there were two key things there.
The first one is the protection for life product that Archie has just referred to. And so that accounts -- that increased year-on-year by about 20 to 30%.
So that's the first element. And then the rest of the increase, as you rightly say, is accounted for by the product that we now have brought in-house and we're underwriting ourselves.
So that is the reason for the 340% increase that you see coming through there. The second question was in terms of OEICs.
Basically, what we saw was a slight fall in bancassurance OEICs. I think they were down about 10%.
But don't forget that was up against a 153% or something in that kind of order of magnitude increase last year. So we more than doubled the sales last year.
So the overall level of OEICs, we think, remains -- sales within the branch network remains pretty strong. And we actually think we've maintained our share within that, although the second quarter numbers aren't yet out.
What we have seen is an uplift in OEICs through the IFA network. So that's why the overall PVNBP on OEICs is broadly flat.
Alistair Ryan - UBS
Thanks, again. And the second question was, I mean, you've guided 1.6 billion pounds in disposals, and you increased the divvy by a 100.
I mean, presumably, there is an earnings dilution impact from the sales you've made, particularly as the Registrars business wasn't using any capital at all. I mean, just to re-ask the question, maybe, what are you going to do with the difference?
Eric Daniels
I'm sorry. What are going to do with the dividends?
What are we going to…
Alistair Ryan - UBS
No. The difference.
The 1…
Eric Daniels
The difference.
Alistair Ryan - UBS
… billion you've now got in your pocket.
Eric Daniels
Well, I'll, again, give a summary answer and then ask Helen to comment. But I will simply repeat what we had said before that we are very comfortable in terms of our efficient use of capital.
And what we have done is redirected capital from businesses or from areas where we didn't think we had good growth possibilities to those that we did, and this is part of an ongoing program. Helen?
Helen Weir
I think our capital stance, as Eric says, has been very focused on being capital-efficient, at the same time, as being shareholder-friendly. And if you think about our yields, we're one of the highest yielding stocks in terms of return on capital to shareholders through the dividend.
We've also demonstrated that the capital that we have retained in the business we've used effectively. So as Eric says, that's what we would expect to continue to do with the proceeds from the sales as well.
Carla Antunes - JPMorgan
Thank you. It's Carla Antunes, JP Morgan.
I wonder if I can turn you to the Retail Banking and, in particular, to the mortgage aspect. And you gave the very helpful spreads of the new businesses both through the IFA and the bancassurance.
Could you please give us a similar comment along the lines on the mortgage product, particularly in context of your competitive pressures and comments?
Sir Victor Blank
Eric?
Eric Daniels
We've maintained a very consistent posture over the last several years regarding mortgages. But we really view that there are two different channels, there are two really completely different businesses.
We've been focusing more and more on the branch-delivered business. This is relationship business.
It's not done through the IFAs, but rather directly with our customers. We view this as being key to the relationship.
It also is higher return business. So that we will continue to grow.
You've seen some of the redesigned product that we've launched in the fairly recent months, and that's going very successfully. In the IFA business, what we have is, basically, a good channel.
We like our IFA business. We're strengthening it.
But there will be times when we can't get the credit conditions that we want or the returns that we want, and so our share will tend to fluctuate there. And so what you're seeing is the balance between profitability and share.
And as Helen had said on the platform that we basically will not run for share alone, but we will look for both profitability and share through the IFA channel. We will look to grow the relationship or the branch channel significantly and continue to do that consistently.
Derek Chambers - Standard & Poor's
Derek Chambers from Standard & Poor's Equity Research. Can I ask two questions?
One is on headcount. The headcount overall and division-by-division look very stable in the first half.
I wonder if that is the position you've reached, that there might be changes in mix but it's going to be stable? And I wonder what implication that has for the continued low growth of costs in the retail division in particular?
And could I ask an unrelated question on -- just going back to capital ratios. I note that you said you're comfortable with your guidance.
So you're probably not going to say too much. But when you said that you've expected to maintain satisfactory capital ratios during the transition, that sounded to me somewhat more cautious than I thought you had been before.
So I wonder if you could correct or refine that? And I wonder if you're now taking the -- you're expecting to take out the innovative elements from the Tier 1 in future?
Sir Victor Blank
Eric?
Eric Daniels
Let me start by talking about our staff. We are always careful not to refer to people as headcount.
They're people. They are valued members of staff -- I said, valued members of staff.
We continue to believe that managing efficiency and managing productivity is a necessary discipline for us. We've used it, basically, very successfully to help fund our growth over the past several years.
As you know, when we started the strategy, we said that we think we can get both growth and returns, although I think there were some skeptics in the room when we said that. Clearly, one of the ways in which we've been able to fund the growth is by managing for efficiency.
We will continue to use this as a key discipline, going forward. What you'll see is that it's rare that you see productivity improvements being absolutely linear.
You'll see, as projects come on stream, usually, an increase in staffing before you get new launches and so on -- that's a normal thing. And then you'll see, basically, some step changes further on.
So what I would basically say is, our guidance going forward is that productivity is going to continue to be a watchword. It's a discipline that we have used to build the business.
It's something that we view as critical, going forward. In terms of our capital ratios, I'll ask Helen to answer.
But basically, I think, our guidance has been consistent all the way along. We are not signaling any change.
Helen Weir
Yeah. I think I do try and use the same words I've used before.
Maybe I should say we are very confident we'll maintain satisfactory capital ratios with -- throughout, because that's the tonality of what we're trying to convey here. Clearly, we're still in discussions with the FSA, and we don't expect to hear finally until the fourth quarter.
I think that -- I know that there are some institutions who've probably talked in more detail than we have about the FSA position, but they tend to be the mortgage businesses, which are much simpler. And I think what you'll find is, generally, companies such as ours or banks such as ours, which tend to have a variety of different lines of business.
John-Paul Crutchley - Merrill Lynch
Good morning. It's JP from Merrill Lynch.
I wanted maybe to actually target a question specifically at Terri, if I could. I wanted to really just frame the 6% retail growth in the first half.
There's been a flurry of initiatives, marketing etcetera over the last 6 to 12 months from the Retail Bank. And I just wondered, if you can just comment on your aspirations for Retail Bank revenue growth generally, whether you're happy with that 6% number, or whether we should expect a faster growth in the future, without looking for specific forecasts in the coming period?
And secondly, related to that, a number of your peers have, who've also been very selective in terms of asset quality, like yourselves, have struck distribution arrangements with investment banks to do business which they wouldn't want on their balance sheets, but to get distribution income from that. Is that something you've looked at and/or discounted, and I'm just wondering if you can comment on that strategy too?
Sir Victor Blank
Eric is going to just make a couple of remarks…
Eric Daniels
I'll give Terri an introduction, because to save her blushes. That Terri and her team have just done an outstanding job at getting very good retail growth and frankly, a very -- well, a changing market.
As you know, the business that had powered the U.K. Retail Bank for many years was being really terrific at personal lending.
We continue to be the leader there we continue to have a good share. And that really powered the earnings.
What Terri has done, and the reason why I wanted to just sort of introduce her on this, was that the entire UK. Retail Bank has been refocused.
It works just so much better. If you look at our sales, if you look at our liability sales especially, that has completely transitioned, so we are no longer a one-trick pony.
If you look at the productivity, if you look at the seller effectiveness, there has just been a revolution there. So, I think that it again, in a fairly well, febrile market, let's put it that way, that Terri and her team have just done an outstanding job.
We are very pleased with the progress to-date, and we continue to expect growth. Terri?
Terri Dial
Thank you. I was feeling left out.
I'll answer the easier question, the latter part, have we looked at distribution agreements? Yes, and there probably is some opportunity in the mortgage space.
I would not say there's much opportunity in the unsecured space; from my past life experience it's a lot of work, a lot of effort, a lot of hand-off, and frankly never enough payback for the diversion of attention. So it will probably be, if any opportunity, in the mortgage space, not the unsecured loan space.
Thank you for acknowledging the marketing efforts and the product efforts, but first and foremost retail is a sales business, and yes, we need new product and pricing, and promotion and advertising, but those are all in support of sales, and we never forget that. We meet every week, two hours every week, as a leadership team, and go through excruciatingly granular detail on what's working and not working from a sales perspective, and then go adjust accordingly.
So the credit goes to the front line, it really does, they're the ones that are delivering, and ultimately that's what this business is all about, and that's why we call it retail. Am I happy with 6%?
It's a yes and no answer. No, you're never happy with 6%.
Over the long-term, as a Retail Bank you'd always like to be delivering more than that. Am I happy that we are achieving this in this environment?
Actually, I am pretty happy. I mean, one of the headwinds that we're definitely having to work against is some of what's happening on the balance side.
I mean credit card balance is a very good example. We can hold our market share, but it's in a declining marketplace, and those are balances with very high margins.
Now, admittedly, we give a lot of that margin away in impairment costs in that product, but it's a very high margin business, and when it declines, it has very real and immediate impact on your P&L statement. And at the end of the day, as I said certainly, you can't control the market.
This is a market phenomena in the U.K., and all you can do is control your sales and service efforts, and you have to sell and serve through it, which is why you've seen some of the increases in some of the commission-related products, because we have simply have put as much of our effort and attention as we can behind those.
Sir Victor Blank
Thanks, Terri. Any more questions, or should we call it a day?
Thank you all very much indeed for coming. Thank you.
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