Financial Review

Group underlying profit before tax increased by £695m (14%) to £5,537m (2005 £4,842m). Net interest income, led by lending growth, increased by 8%, and underlying non-interest income increased by 10%. Costs rose by just 6% and impairment losses by 9%.

Basic earnings per share increased by 22% to 100.6p (2005 82.2p). Underlying earnings per share rose 16% to 100.5p (2005 86.4p) and the proposed final dividend is 27.9p, an increase of 15% over the previous year. The basic dividend cover is 2.4 times (2005 2.3 times) and 2.4 times on an underlying basis (2005 2.4 times). The final dividend will be paid on 14 May 2007 to ordinary shareholders on the register at the close of business on 16 March 2007.

The table below reconciles reported and underlying profit before tax.

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Profit before tax	5,706	4,808
Adjusted for:
Profit on sale of Drive	(180)
Mortgage endowment compensation	95	260
Goodwill impairment	55
Retail rationalisation costs		84
Policyholder tax payable	(220)	(200)
Short term fluctuations	81	(110)
Underlying profit before tax	5,537	4,842

The disposal of our shareholding in Drive was completed in early December and gave rise to a gain on sale of £180m. 2006 saw a significant reduction in the volume of endowment complaints and has given us a better view on the level of remaining complaints. As a result, barring an unexpected change in the current trend, we have set aside a final provision of £95m to cover the cost of all outstanding and future complaints. The goodwill impairment principally relates to the full write-down of the goodwill held in respect of a specialist leasing company following an impairment review.

Divisional financial performance can be summarised as follows:

Year ended 31 December 2006	Retail	Corporate	Insurance & Investment	Inter- national	Treasury & Asset Mgmt	Group Items	Year ended 31.12. 2006	Year ended 31.12. 2005
	£m	£m	£m	£m	£m	£m	£m	£m
Net interest income	4,188	1,861	(93)	1,239	205		7,400	6,829
Underlying non-interest income	1,350	852	1,531	444	414		4,591	4,169
Underlying net operating income	5,538	2,713	1,438	1,683	619		11,991	10,998
Underlying operating expenses	(2,127)	(783)	(820)	(645)	(292)	(241)	(4,908)	(4,642)
Impairment losses on loans and advances	(1,097)	(424)		(221)			(1,742)	(1,599)
Underlying operating profit	2,314	1,506	618	817	327	(241)	5,341	4,757
Share of profits/(losses) of associates and jointly controlled entities	2	157	(37)	3	1		126	39
Non-operating income	48				22		70	46
Underlying profit before tax	2,364	1,663	581	820	350	(241)	5,537	4,842
Year ended 31 December 2005
Underlying profit before tax	2,283	1,420	489	610	263	(223)	4,842
Increase/(decrease) in underlying profit before tax	4%	17%	19%	34%	33%	(8%)	14%

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Post Tax Return on Mean Equity

Group post tax return on mean equity (‘ROE’) increased to 20.8% in 2006 (2005 19.6%). This increase was driven by a 14% increase in the underlying post tax profit attributable to ordinary shareholders compared to just a 7% increase in mean equity, the latter benefiting from the cumulative impact of the share buyback programme.

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Underlying profit attributable to ordinary shareholders	3,816	3,358
Mean Equity	18,375	17,139
	%	%
Group post tax return on mean equity	20.8	19.6

Note: ROE is calculated by dividing underlying profit attributable to ordinary shareholders by the monthly average of ordinary shareholders’ funds.

Net Interest Income

Net interest income increased by 8% in 2006 to £7,400m reflecting asset growth of 10% and a slightly lower Group net interest margin compared to last year. The Group net interest margin fell 2bps, mainly reflecting a reduction in the Retail net interest margin of 6bps.

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Interest receivable	26,742	24,134
Interest payable	(19,342)	(17,305)
Net interest income	7,400	6,829
Average balances
Interest earning assets:
- Loans and advances	372,938	335,584
- Securities and other liquid assets	42,741	42,910
	415,679	378,494
Group net interest margin	1.78%	1.80%
Divisional net interest margins:
Retail	1.78%	1.84%
Corporate	2.22%	2.15%
International	2.49%	2.65%
Treasury & Asset Management	0.07%	0.08%

Non-interest Income

Underlying non-interest income increased by 10% in 2006 to £4,591m (2005 £4,169m).

Net fees and commissions have increased by 12%, driven in part by Corporate where we continue to generate strong fee income from our diversified portfolio and also in International where net fee and commission income has grown strongly in Australia and Ireland. Strong investment sales and the inclusion of Heidelberger Leben, which was consolidated from July 2005, contributed to a 21% increase in net earned premiums on insurance contracts. Net operating lease income has increased by 50% following the part year consolidation of Lex which became a wholly owned subsidiary on 31 May 2006. Net trading income increased by 28% to £279m due to strong performances from the UK Trading and Sales businesses in Treasury.

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Fees and commission income	2,175	2,212
Fees and commission expense	(1,012)	(1,178)
Net earned premiums on insurance contracts	5,648	4,654
Net trading income	279	218
Change in value of in-force Long Term Assurance Business	282	394
Other operating income:
Profit on sale of investment securities	307	172
Operating lease rental income	1,042	714
Net investment income related to insurance and investment business	6,306	9,032
Other income	148	260
Non-interest income	15,175	16,478
Impairment on investment securities	(71)	(51)
Operating lease depreciation	(812)	(561)
Change in investment contract liabilities	(2,910)	(5,089)
Net claims incurred on insurance contracts	(2,328)	(2,019)
Net change in insurance contract liabilities	(3,894)	(4,220)
Change in unallocated surplus	(569)	(369)
Underlying non-interest income	4,591	4,169

 

Underlying non-interest income analysed by division:

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Retail	1,350	1,315
Corporate	852	805
Insurance & Investment	1,531	1,420
International	444	303
Treasury & Asset Management	414	326
	4,591	4,169

Operating Expenses

Underlying operating expenses increased by 6% in 2006 to £4,908m (2005 £4,642m).

The increase of £266m over 2005 included planned investments in International and Treasury & Asset Management, the impact of full year consolidation of Heidelberger Leben, which was included from July 2005, and part year consolidation of Lex which became a wholly owned subsidiary on 31 May 2006.

The East Coast expansion programme in Australia, the roll-out of the Retail branches in the UK and Ireland, and the impact of Heidelberger Leben have contributed to staff costs which increased by 10% against the corresponding period in 2005.

Excluding International and Treasury & Asset Management, underlying operating expenses increased by 2.7%.

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Staff	2,674	2,432
Accommodation, repairs and maintenance	421	399
Technology	238	220
Marketing and communication	367	343
Depreciation:
Property and equipment and intangible assets	380	375
Other	828	873
Underlying operating expenses	4,908	4,642
Operating lease depreciation	812	561
Change in investment contract liabilities	2,910	5,089
Net claims incurred on insurance contracts	2,328	2,019
Net change in insurance contract liabilities	3,894	4,220
Change in unallocated surplus	569	369
Total	15,421	16,900

Underlying operating expenses analysed by division:

	Year ended 31.12.2006 £m	Year ended 31.12.2005 £m
Retail	2,127	2,124
Corporate	783	717
Insurance & Investment	820	802
Group Items	241	223
	3,971	3,866
International	645	529
Treasury & Asset Management	292	247
	4,908	4,642

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