Directors' report
Business review - Our 2007 performance
Summary and underlying performance
Underlying profit increased by 5% to £351.6m (2006: £335.9m). Group statutory profit was lower at £126.0m (2006: £246.7m). The increase in underlying profit reflects the resilience of our business and our clear strategic focus in a particularly turbulent year. The liquidity squeeze that affected all banks in 2007 had a marked impact on our statutory results. However, Bradford & Bingley has delivered good underlying results in these very difficult conditions.
The underlying business performed very well, despite the distractions of the wider market. We grew our residential lending balances by 27% to £39.4bn (2006: £31.1bn), without increasing our risk appetite, and increased savings balances by 7% to £21.0bn (2006: £19.7bn), continuing our strong focus on retail savings deposits.
A reconciliation betweeen underlying and statutory profit is shown in the following table.
| For the year ended 31 December | 2007 £m |
2006 £m |
|---|---|---|
| Net interest income | 547.7 | 510.2 |
| Non-interest income | 106.6 | 104.7 |
| Underlying net income | 654.3 | 614.9 |
| Fair value movements | (49.7) | (0.1) |
| Hedge ineffectiveness | (23.5) | 0.3 |
| Net income | 581.1 | 615.1 |
| Administrative expenses | ||
 - Underlying |
(280.2) | (271.6) |
| - Compensation |
- | (89.4) |
| Loan impairment | (22.5) | (7.4) |
| Investment impairment | (94.4) | - |
| Loss on sale of assets | (58.0) | - |
| Profit before taxation | 126.0 | 246.7 |
| Fair value movements | 49.7 | 0.1 |
| Hedge ineffectiveness | 23.5 | (0.3) |
| Compensation | - | 89.4 |
| Investment impairment | 94.4 | - |
| Loss on sale of assets | 58.0 | - |
| Underlying profit before taxation | 351.6 | 335.9 |
Underlying performance
Throughout the year, our balance sheet remained strong with funding in place to support lending balance growth. As a result, the Group's underlying net income increased by 6% to £654.3m (2006: £614.9m). The major component of our income is the net interest derived from our assets after accounting for the cost of financing. In 2007, this amounted to £547.7m, an increase of 7% over the previous year (2006: £510.2m). Non-interest income increased to £106.6m (2006: £104.7m); underlying costs increased by 3% to £280.2m (2006: £271.6m); and the impairment charge for loans was £22.5m (2006: £7.4m).
The total tax charge in 2007 was £32.8m (2006: £69.0m) representing an underlying effective tax rate of 28.6% (2006: 28.5%). As a result statutory profit after tax for the year was £93.2m (2006: £177.7m).
On an underlying basis, earnings per share increased by 6% to 40.2 pence (2006: 38.1 pence) and return on equity increased to 19.1% (2006: 17.4%). The basic earnings per share for 2007 was 14.9 pence (2006: 28.2 pence).
On 29 November 2007, the Group issued a trading statement stating, "we expect underlying profit before tax for the full year 2007 to be in line with the current market consensus", and that, "the range of analysts forecast is from £305.0m to £374.8m". The comparable reported profit figure is the Group's underlying profit of £351.6m, and falls within this range.
Net interest income
The Group's net interest income increased by 7% to £547.7m (2006: £510.2m) driven by an increase in interest bearing assets of 16% to £49.7bn (2006: £42.7bn). Underpinning this increase in interest bearing assets is strong growth in our mortgage lending activities, delivering a 27% increase in mortgage balances, offset by the impact of asset sales.
Full year net interest margin declined by 9 basis points to 1.10% (2006: 1.19%) in line with our expectations and previous guidance. We have increased the pricing on new mortgages originated in the second half of the year, compensating for the higher base rate and relevant swap costs and margins have been preserved. The main reason for the decline in net interest margin continues to be increased funding costs due to new funds being more expensive than existing retail deposits and wholesale funds. We expect the trend of a growing balance sheet and higher marginal funding costs to continue, albeit at a slower rate, given the more constrained environment. We have adopted a policy of holding a larger proportion of our liquidity in higher quality, but lower yielding instruments, which also had a small negative impact on net interest margin in 2007 and this will continue in 2008. The 39 basis point increase in the gross yield on average interest earning assets to 5.96% (2006: 5.57%) was lower than the increase in base rate, which averaged 5.51% (2006: 4.64%). These do not move in line because two thirds of our residential balances are fixed rate and our policy is to only invest in higher quality wholesale assets at lower yields.
Average interest-bearing liabilities increased by 17% to £47.9bn (2006: £41.1bn). The average cost of liabilities was up 50 basis points to 5.05% (2006: 4.55%). This increase primarily reflects the changing mix of funding.
| For the year ended 31 December | 2007 £m |
2006 £m |
|---|---|---|
| Net interest income | 547.7 | 510.2 |
| Average balances | ||
| Interest-earning assets ('IEA') | 49,743 | 42,692 |
| Financed by: | ||
| Interest-bearing liabilities | 47,904 | 41,122 |
| Interest-free liabilities | 1,839 | 1,570 |
| % | % | |
| Average rates | ||
| Gross yield on average IEA | 5.96 | 5.57 |
| Cost of interest-bearing liabilities |
(5.05) | (4.55) |
| Interest spread | 0.91 | 1.02 |
| Interest-free liabilities | 0.19 | 0.17 |
| Net interest margin onaverage IEA |
1.10 | 1.19 |
| Average bank base rate | 5.51 | 4.64 |
| Average 3 month LIBOR | 6.00 | 4.84 |
| Average 3 year swap rate | 5.81 | 5.07 |
Non-interest income
Non-interest income increased to £106.6m (2006: £104.7m). During 2006, the Group switched focus to its specialist mortgage lending business and, in November of that year, we ended mortgage broking services. Therefore, in 2007, broking fees derived from mortgage sales in prior years ceased as a revenue stream and were replaced by interest income on loans sold through our branches. Consequently, the net fee income earned from our mortgage book reduced by £5.9m to £5.0m (2006: £10.9m).
We have maintained our relationship, established in 2004, with Legal & General to provide financial advice and product investment within our branches. Sales volumes have been in line with our plans and income from this area of the business remained stable at £30.8m (2006: £31.5m) despite a reduced performance in the last quarter of the year due to market uncertainty. Income from general insurance continues to make progress, increasing to £19.9m (2006: £19.4m).
Income derived from administration of loans fell to £26.2m (2006: £28.9m) following reductions in the level of mortgage administration fees charged, in line with general market price movements.
| For the year ended 31 December | 2007 £m |
2006 £m |
|---|---|---|
| Fee and commission income | 81.7 | 91.7 |
| Realised gains less losseson financial instruments |
6.5 | 2.1 |
| Other operating income | 9.6 | 5.2 |
| Non-operating income | 8.8 | 5.7 |
| Underlying income | 106.6 | 104.7 |
| Analysed as: | ||
| Mortgage broking | 5.0 | 10.9 |
| Investment | 30.8 | 31.5 |
| General insurance | 19.9 | 19.4 |
| Other financial services | 2.0 | 2.4 |
| Total financial services | 57.7 | 64.2 |
| Lending related income | 26.2 | 28.9 |
| Income from sale andleaseback transactions |
8.8 | 5.7 |
| Other | 7.4 | 3.8 |
| Realised gains less losseson financial instruments |
6.5 | 2.1 |
| Underlying income | 106.6 | 106.6 |
The Group transferred ownership of a number of our branches under sale and leaseback transactions. The net income from these transactions was £8.8m compared to £5.7m in 2006.
Net income from the sale of financial investments was £6.5m (2006: £2.1m). Gains are made or losses are incurred if debt securities are sold or funding repaid, prior to their contractual maturity. A number of such transactions were completed in the second half of the year realising gains.
Administrative expenses
We continue to manage the rate of our cost growth carefully, whilst investing in key areas to support growth and productivity. Underlying costs increased by 3% to £280.2m (2006: £271.6m), improving the cost:income ratio to 42.8% (2006: 44.2%).
| For the year ended 31 December | 2007 £m |
2006 £m |
|---|---|---|
| Staff related | 121.0 | 118.2 |
| Premises | 20.5 | 21.9 |
| Marketing | 19.7 | 15.3 |
| Other administrativeexpenses |
95.3 | 98.0 |
| Depreciation andamortisation |
23.7 | 18.2 |
| Underlying costs | 280.2 | 271.6 |
| Compensation costs | - | 89.4 |
| Total | 280.2 | 361.0 |
We have increased investment in our people during 2007, spending more on development and training reflected by higher staff costs of £121.0m (2006: £118.2m). We have also further improved the efficiency of our operating process, increasing new mortgage volumes by 27% whilst reducing the total number of people employed by the Group to 3,035 (2006: 3,154).
We invested in the Bradford & Bingley brand with a new television campaign running throughout the year promoting our mortgages. Marketing expenditure was raised to £19.7m (2006: £15.3m). Additional investment in our IT infrastructure, to improve capacity and efficiency led to an increased depreciation charge of £23.7m (2006: £18.2m).
The provision of £89.4m, made in June 2006 to cover the cost of claims for historic endowment and investment product mis-selling, currently stands at £50.7m. The volume of claims received, the proportion of claims upheld and the average compensation per upheld case are all within the assumptions made in estimating the provision. No further provision is required in 2007.
Arrears and loan impairment
During 2007, arrears levels increased. The total number of cases, three months or more in arrears and in possession, has increased to 6,170 (2006: 4,337) amounting to 1.63% (2006: 1.30%) of the total book. This was expected and reflects the increase in the cost of borrowing, as the Bank of England constrained monetary policy in 2006 and 2007 with a series of 25bp rises to the base rate (from 4.5% to 5.75%). We expect some easing in policy in 2008 helping the affordability of mortgage repayments. Reflecting increased arrears and possessions, we have provided £54.8m (2006: £47.8m) for loan impairment.
Our lending policies and underwriting approach continue to be improved to provide the right balance between risk and return. We have made improvements to our analytical capabilities, developing new approaches estimating losses that are consistent with risk measures under the Basel II regime.
As a proportion of balances, the residential impairment allowance was 0.14% (2006: 0.15%). The charge to the Income Statement to account for impairment was £22.5m Non-interest income (2006: £7.4m).
| For the year ended 31 December | 2007 | 2006 |
|---|---|---|
| Arrears over 3 months | ||
| - number of cases |
5,610 | 4,015 |
| - % of total cases |
1.48 | 1.20 |
| - value (£m) |
731.2 | 498.9 |
| - % of book |
1.85 | 1.60 |
| Possessions | ||
| - number of cases |
560 | 322 |
| - % of total cases |
0.15 | 0.10 |
| - value (£m) |
97.0 | 52.7 |
| - % of book |
0.25 | 0.17 |
| Total | ||
| -number of cases |
6,170 | 4,337 |
| - % of total cases |
1.63 | 1.30 |
| - value (£m) |
828.2 | 551.6 |
| - % of book |
2.10 | 1.77 |
| Residential loan impairment allowance | ||
| - Impairment allowance |
54.8 | 47.8 |
| - % of residential assets |
0.14 | 0.15 |
| -% of arrears andpossessions |
6.62 | 8.56 |
Taxation
The total tax charge for the year was £32.8m (2006: £69.0m). Based on a statutory profit of £126.0m (2006: £246.7m) this equates to an effective tax rate of 26.0% (2006: 28.0%).
