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The reckoning

If you were expecting any surprises from the flurry of banks’ annual reports released in the past few weeks you’ll have been disappointed. For the majority of lenders, the most dismal predictions were realised with total losses from the banking sector in 2008 reaching staggering levels. And if anyone had any doubts about the severity of the decay the financial services industry is experiencing, they must surely have been dispelled.

The past 12 months have been some of the toughest the mortgage industry has seen. 2008 saw the nationalisation of Northern Rock, the resigning-before-they-were-sacked of some of the industry’s biggest players, the demise of well-known brokerages and the economy shaken to its core.

Not surprising then that lenders’ profits for 2008 were strikingly lower than in 2007 and for some, losses were inexplicably higher. Indeed, it is unlikely that many bookies would have been offering favourable odds on the possibility of bad news. And when it comes to the Royal Bank of Scotland, it’s likely they stopped taking bets altogether.

The partially nationalised bank announced losses of £24.1bn – the biggest in corporate history – after a disastrous year which saw former chief executive Sir Fred Goodwin resign before becoming embroiled in what can only be described as a hate campaign waged by the public and a battle of wills with the government.

Following the announcement, RBS pledged to boost mortgage lending by £9bn in 2009 in exchange for its participation in the Treasury’s Asset Protection Scheme. The bank claimed it would siphon £325bn of toxic assets into the scheme and receive an extra £13bn from the government to boost its core Tier 1 capital.

In return RBS has committed to £25bn of new lending, with £9bn for mortgage lending and the remaining £16bn for business loans. A further £25bn has been promised for 2010.

While 2008’s results were never going to be anything other than catastrophic for RBS there was always a bit more hope for Lloyds Banking Group. Of course, it was the supposed saviour of the industry that, with a little help from the government, rescued HBOS last autumn. But even the industry’s new Goliath was not strong enough to battle the crunch. It reported that profits before tax fell some 80% from £4bn in 2007 to £807m in 2008 leading Eric Daniels, chief executive at Lloyds Banking Group, to call 2008 “the most difficult operating environment in many years”.

HBOS announced losses of £9.9bn – £1.9bn more than anticipated. On announcing the results Daniels stood by the merger claiming it had enabled Lloyds to acquire a franchise that “brings extensive distribution, a large customer base, good people and excellent brands” – but no money, unfortunately.

For Northern Rock, things went from bad to worse with pre-tax losses of £1.4bn and write-downs on retail customer loans of £894.4m. Losses have more than doubled since the first half of last year when the lender reported a loss of £585.4m. In 2007, before the government took the helm, the bank made a loss of £167.6m.2008 saw the bank’s gross mortgage lending figure seriously reduced as it battled to pay back its government loan of £26.9bn in super-quick time. The figure fell from £29.5bn in 2007 to just £2.9bn in 2008, with residential mortgage balances reduced from £90.8bn at the end of 2007 to £66.7bn.

The stringent strategy paid off, with Northern Rock reportedly reducing its government loan by £18bn to £8.9bn on a net basis. It has now pledged to return to the mortgage market, committing £14bn to fund new mortgage lending in the next two years.

“We have made good progress against the business plan ob-jectives laid out in March 2008,” says Gary Hoffman, chief executive of Northern Rock. “The government loan has been reduced signi-ficantly and the deposit base of the company has grown as cus-tomers have returned to it. We can now return to what we do well – mortgage lending.

“Our return to the mortgage market will be governed by focussing on responsible lending, understanding our customers’ needs and offering them great products and service.

“We have an exciting opportunity to help consumers in the mortgage and savings markets and to secure the long-term future of the company, while protecting the interests of taxpayers,” he adds. “I am confident we will deliver on that opportunity.”

HSBC, long considered one of the strongest banks, reported a fall in pre-tax profits of 62% from £17bn in 2007 to £6.5bn. Soon after, the bank launched a £12.5bn rights issue and announced it is to close its US consumer lending operations HFC and Beneficial as soon as is practical. It claims it will continue to service its existing portfolio while running it down, but has pledged to continue to help home owners with their loan payments and to keep their homes.

“HSBC remains committed to the US financial services market, including the remaining businesses in HSBC Finance as well as its US banking operations under HSBC Bank,” says a statement from the bank.

Stephen Green, chairman of HSBC Group, says the rights issue will further strengthen the banks capital base and so enhance its ability to deal with the impact of an uncertain economic en-vironment and respond to unforeseen events. Following the announcement, HSBC shares fell by 10%.

There was some positive news in the form of Spanish banking giant Santander, which announced an annual UK profit of £991m for 2008 – an increase of 21% compared with 2007. The leviathan’s loan book grew 43% to £179.74bn thanks in no small part to its acquisition of Alliance & Leicester, which accounted for £51.6m.

Combined with its purchase of Bradford & Bingley’s deposit business and branches, Santander says its acquisitions give it a market share of 10% in deposits and 13% in mortgages in the UK.

Abbey has become the second largest bank by mortgages and the third largest by deposits, with 1,300 branches and 25 million customers.

In a statement, Santander says the results were obtained against a “difficult economic and financial backdrop during which a large number of global financial institutions in Santander’s peer group registered losses and required public support”.

On the whole, building societies fared better than banks – the Spanish colossus aside – although their profits took a battering due to the Financial Services Compensation Scheme levy they are forced to pay for the failures of their peers.

Norwich & Peterborough reported pre-tax profits of £5.9m. This figure would have been almost double but £5.5m was subtracted for the levy. Last year N&P saw profits of £24.3m.

Although societies are forced to cough up for the FSCS none have ever had to use its facilities. Indeed, N&P maintains it is in a healthy position. Its annual results show its assets were up by more than 15% to £4.98bn compared with £4.3bn in 2007, and its total mortgage assets increased to £3.52bn from £3.2bn.

“Our challenge in 2008 was to ensure the society remained safe and profitable during the financial crisis while maintaining the momentum to create a mutual alternative to high street banks,” says Matthew Bullock, chief executive of N&P.

“We have sought to build an organisation with enduring values that provides a personal financial service members can trust in these difficult times.”

And things were looking rosy up north, with Leeds reporting a strong pre-tax profit of £20.3m even after paying its FSCS levy. Its pre-tax profit before the levy was £30m although the crunch still had an effect as in 2007 this figure was £63.2m. Operating profit before impairment provisions was £68.6m – in 2007 this was £69.4m. For the third successive year its lending growth was entirely funded by retail investments.

Ian Ward, chief executive of Leeds, says the society has delivered another set of good financial results for its members “in the context of a market that has been characterised by uncertainty and de-clining confidence”.

Britannia’s pre-tax profits took a massive hit, falling from £114.6m in 2007 to £23.8m. It claimed the reason for this was its exposure to Lehman Brothers and Kaupthing, both A-rated institutions that collapsed last year. Britannia had short-term deposits in both banks and as such had to include a provision of £57.4m in its accounts to cover possible losses.

The society also had to pay a £19.8m provision for the FSCS levy. It claims that had it not been for these exceptional circumstances its profits would have been £100.4m. Business at the group’s broker-facing lender Platform fell by 73% in 2008 compared with 2007, from £2.6bn to £700m.

Last month Britannia announced plans to create a supermutual by merging with Co-operative Financial Services. Chief executive Neville Richardson says this will help build a stronger business.

“The world economy is in disarray and no bank or building society is immune to what is going on,” he says. “2009 will be another difficult year as the global recession affects both employment and customer confidence.

“In creating the first supermutual we will preserve all that our customers hold dear about Britannia – being mutually owned, giving them a say in how the business is run, sharing profits with them and maintaining an extensive branch network while building a stronger combined business with more branches, a better internet service, a wider product range and the chance to earn even greater member rewards. There’s a bright and exciting future in store for Britannia’s members.”

Skipton also suffered due to exposure, this time to the Icelandic banking system. It revealed pre-tax profits of £22.5m for 2008 – a fall from £163.9m in 2007. The society also had to pay £16.3m for the FSCS levy and claims its 2008 profits are almost half what they would have been had this not been required. Group assets were up 8.9% to £13.6bn while mortgage assets were up 1.7%, compared with a 15.9% increase in 2007.

The Yorkshire’s profits were down at £8.3m, compared with £54.6m in 2007. It too put this down to the FSCS levy for the failures of B&B, the Icelandic banks and London Scottish Bank.

The society’s growth in savings balances was more than four times its growth in mortgage balances. It also saw mortgage loan growth of 3.7% and an increase in member savings balances of £1.2bn – including the Barnsley merger – compared with an increase in net lending of £300m. Total retail savings balances fund some 88% of its total mortgage assets.

“We reacted early to a crisis which began in the middle of 2007 and intensified in 2008,” says Iain Cornish, chief executive of the Yorkshire.

“Our capital and funding positions are among the strongest in the UK financial sector, we have increased our already substantial holdings of high quality liquid assets and we have never been active in the buy-to-let, commercial lending or mortgage portfolio acquisition sectors – the parts of the market which appear to be suffering most in the recession.

“During a time when competition for retail funds has been particularly aggressive we have grown our retail member savings balances by £1.2bn – more than enough to fund all our mortgage growth in 2008,” he adds. “And we have not had to resort to un-sustainable savings rates.”

Cornish says the lender’s commitment to savers is shown by the fact that it has not passed on the full extent of the Bank of England’s base rate cuts. He also criticises the FSCS levy which he says has adversely impacted the lender and is disproportionate. As Mortgage Strategy revealed last week, the Yorkshire is lobbying against the size of the levy and more than 150 MPs recently signed an early day motion on the subject, tabled by MP Ann Cryer.

Overall, banks’ dismal results may not have been surprising but that doesn’t make them any less depressing. They show that despite government initiatives in the past year the market has been brought to its knees, although one could speculate that without government intervention things might have been a hell of a lot worse.

Still, onwards and upwards. The figures are out in the open, there’s no glossing over the cracks and the only thing we can do is battle on and hope any rescue missions prove to be as useful as Prime Minister Gordon Brown and chancellor Alistair Darling – and indeed US President Barack Obama – hope they will be. If not, banks’ 2009 results don’t bear thinking about. n

Most banks are still profitable

Richard Monahan

Director of Asset Management


Bank reporting season has always been a busy time for news flow. Historically, the sheer number of banks meant a busy fortnight of results that was traditionally kicked off by Northern Rock in mid-February.

As a result of nationalisations and mergers the landscape has changed, leaving fewer players but no less news as there is more detail than ever to pick over – the Royal Bank of Scotland results announcement alone ran to 129 pages.

With losses grabbing so much attention it’s easy to forget that most banks are profitable businesses. Banking results are notoriously difficult to untangle, especially given the impact of international accounting standards which make results volatile.

Traditionally, analysts ignore one-off or volatile items to present their clients with underlying profit figures. This gives investors a better idea of the profitability of banks, stripping out unusual gains and losses. Underlying profit could be higher or lower than the headline figure, or statutory profit, depending on whether a bank had made more one-off gains or losses during the year.

Corporate PR agencies would then encourage their banking clients to highlight favourable figures. This year there are no prizes for guessing which figure banks would prefer you to look at but the financial press has focussed on the statutory figures as one-off items have been so big they have threatened the solvency of banks.

Using underlying profit figures calculated by UBS banking analysts, Lloyds Banking Group made an underlying profit of £1.7bn rather than the £807m widely quoted. Barclays made £8.3bn rather than £6.1bn and HSBC made an underlying $5.7bn, lower than the reported $9.3bn. The only exception to this flattery method is RBS which lost £8bn on an underlying basis. Taking into account one-off write-downs, mainly as a result of the ABN acquisition, it lost £24bn – a UK corporate record.

HBOS has avoided too much analysis given that it has been swallowed up by Lloyds Banking Group but on the surface its £10.8bn loss reflects poor lending in its corporate division and resultant bad loans. As a result of the merger, Lloyds Banking Group is expected to make a loss this year due to consolidating further HBOS losses.

Turning to the public sector, Northern Rock is a comparatively simple bank and was always first to report its results. This year it was last and reported a loss of £1.4bn due to its inefficient funding arrangements and impairment charges on loans gone bad.

Meanwhile, Bradford & Bingley and Alliance & Leicester no longer exist in a form in which reporting is a useful measure of success. It will be interesting to see how many private sector banks report results this time next year.

Worst fears were confirmed

Nick Raynor

investment adviser

The Share Centre

Anyone doubting the extent of the banking crisis must have had their worse fears confirmed in the past few weeks, as many banks published damning annual reports. Even Lloyds TSB, a bank that has traditionally enjoyed a reputation as a trusted institution and a sound investment opportunity, has suffered.

Shares in Lloyds Banking Group fell 32% to 61.4p after it reported losses of more than £10bn in HBOS. This news triggered speculation that the group might have to ask the government for more capital.

Then there was the Royal Bank of Scotland. Having warned investors to expect a full-year loss of £28bn, RBS in fact announced better-than-expected results in its annual report.

Unfortunately, that’s where the good news ended. Its losses for 2008 were £24.1bn – the biggest in UK corporate history.

Indeed, investors need look no further than RBS’ share price to appreciate just how tough times are in the banking sector. Its share price plummeted as low as 8p although it subsequently recovered to around 23p. As a comparison, at the same time last year RBS shares were valued at 300p. Following a big bailout by taxpayers, the government now owns 84% of the bank – a short step from nationalisation.

Despite some banks declaring unprecedented losses it wasn’t all doom and gloom. For example, Barclays and HSBC reported significant profits.

Barclays announced a full-year profit of £6.1bn – well above the £5.3bn predicted. This result was attributed to its takeover of the US operations of Lehman Brothers and the success of its retail arm. But it remains to be seen whether the bank’s apparent financial muscle is enough to reinstate the dividend payments it had planned for the second half of 2009.

Having a £6.5bn profit, HSBC also appears to be in a relatively good position. It recently confirmed it was seeking to raise £12.5bn from shareholders to boost its balance sheet – the biggest rights issue in banking history.

But these profits were the exceptions to the rule and for most savers and investors in the banking sector, the results provided little comfort.

The banking crisis has thrown up few winners but there have been some. Home owners with tracker mortgages are enjoying low interest rates, those looking to remortgage should benefit from attractive rates and first-time buyers should shortly be able to get mortgages.

The government is investing heavily in the banking sector and £23bn has been made available to the mortgage market. It is hoped this will kick-start the housing market, eventually benefiting the economy.

Outsourcing can offer solutions

Neil Warman

finance and commercial director


The recent flurry of bank results saw media coverage spill over from newspapers’ business sections to the news pages, and focussed minds on how bosses can steer their institutions through the most violent economic storm in a generation.

Inevitably, interest focussed on RBS, Lloyds Banking Group – including HBOS – and Northern Rock, given the government involvement in these institutions, but banks such as HSBC and Barclays were also affected by market conditions, although Standard Chartered bucked the trend by announcing record profits.

Multiple challenges face the bosses of financial institutions. These include finding adequate funds to lend, integrating businesses, staff and operations, managing credit quality and streamlining cost bases to reflect lower business volumes not just in mortgages but also in savings, investments, corporate lending and trading.

No bank or building society is immune so optimising everyday operations is vital. Some managers are having to integrate two or more businesses while all must ensure their business platforms deliver high quality, cost-effective service. Cost-cutting, IT integration and strengthening regulatory compliance are rising up the management agenda as companies try to enhance their profitability and position themselves for growth when conditions improve.

Faced with serious strategic decisions, managers must consider all the options. Business volumes are down and will remain so for some time so maintaining expensive internal operations centres which are not fully occupied doesn’t make sense. The need to integrate IT platforms could provide the impetus for firms to review their approach, especially given the costs of regulatory compliance and managing loan books effectively in a Treating Customers Fairly environment.

Specialist outsourcers can offer solutions that ensure quality outcomes, good service and TCF compliance on a variable cost basis. In fact, one recent development in the industry is so-called ‘payment by results pricing’. This is pricing based not on the number of accounts in arrears but rather on success in curing them. It provides a financial incentive to deliver the clean loan books that lenders and their investors want to see.

Operational efficiency – including arrears and repossessions management and compliance with TCF – will grow in importance for financial institutions. Specialist third party providers can provide either fully outsourced solutions or value-adding products such as special servicing.

Meanwhile, several banks say 2009 has begun positively and as the year progresses, let’s hope the financial services market will gradually return to normal.


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