Financial Review
continued
Capital Structure
Tier 1 and Total regulatory capital ratios remain strong at 8.1% (2005 8.1%) and 12.0% (2005 12.4%) respectively. This position has been achieved notwithstanding a share buyback of £982m (including costs) in 2006.
As already reported, £1bn was put aside for contributions to reduce the deficit in the Group’s defined benefit pension scheme over the next five years, of which £800m has been paid into the scheme as at 31 December 2006. The IAS19 deficit as at 31 December 2006 was £0.9bn (2005 £1.8bn) despite a £348m strengthening of longevity assumptions. Our Tier 1 capital ratio of 8.1% makes full allowance for the remaining planned contributions.
Total regulatory capital increased during the year to £33,154m from £31,726m.
Risk weighted assets increased in 2006 by 8% to £276.0bn (2005 £255.1bn). The increase is after taking account of a £7.4bn reduction due to loan securitisations and £1.9bn of unfunded ‘synthetic’ securitisation undertaken in the year, and redemptions of existing loan securitisations of £3.2bn.
In addition to retained earnings, Tier 1 capital was strengthened by £843m by the issuance of innovative Tier 1 securities of €750m in May 2006 and non-innovative preference shares of £350m in June 2006. These increases were offset by £982m of ordinary shares bought back in the year. Tier 1 gearing at the end of the year was 25% (2005 24%) in line with our benchmark of 25% ± 2%.
Tier 2 capital was increased during the period by a dated subordinated debt issue of €500m in March 2006 and US$750m in September 2006. In Sterling equivalent terms at 31 December 2006, this new issuance totalled £717m. Growth in Tier 2 capital balances was reduced due to exchange rate fluctuations, amortisation and the repayment of existing dated subordinated debt.
Supervisory deductions mainly reflect investments in subsidiary undertakings that are not within the banking group for regulatory purposes together with deductions relating to the securitisation of loans. These unconsolidated investments are primarily Clerical Medical, St. James’s Place (‘SJP’), St. Andrew’s Group and Heidelberger Leben. Total supervisory deductions increased to £5,666m from £5,229m mainly as a result of increases in the embedded value of life policies held and increased securitisations outlined above.
| As at 31.12.2006 £m |
As at 31.12.2005 £m |
|
|---|---|---|
| Risk Weighted Assets | ||
| Banking book – on balance sheet | 253,839 | 236,202 |
| Banking book – off balance sheet | 14,272 | 12,353 |
| Trading book | 7,901 | 6,510 |
| Total Risk Weighted Assets | 276,012 | 255,065 |
| Tier 1 | ||
| Ordinary share capital | 941 | 959 |
| Preference share capital | 2,422 | 2,187 |
| Eligible reserves | 18,496 | 16,826 |
| Minority interests (equity) | 1,058 | 806 |
| Preferred securities | 3,189 | 2,821 |
| Less: goodwill & other intangible assets | (3,677) | (2,932) |
| Total Tier 1 capital | 22,429 | 20,667 |
| Tier 2 | ||
| Available for sale reserve | 168 | 104 |
| Undated subordinated debt | 5,598 | 5,941 |
| Dated subordinated debt | 7,914 | 7,884 |
| Collectively assessed impairment provisions | 2,711 | 2,359 |
| Total Tier 2 capital | 16,391 | 16,288 |
| Supervisory deductions: | ||
| Unconsolidated investments – Life |
(4,260) | (4,067) |
| Unconsolidated investments – Other | (510) | (546) |
| Investments in other banks and other deductions | (896) | (616) |
| Total supervisory deductions | (5,666) | (5,229) |
| Total regulatory capital | 33,154 | 31,726 |
| Tier 1 capital ratio (%) | 8.1 | 8.1 |
| Total capital ratio (%) | 12.0 | 12.4 |
Supplementary Embedded Value Information for the UK Investment Business
Introduction
The introduction of IFRS in 2005 resulted in a change to the timing of reported profit recognition in respect of Investment Business. Under IFRS, insurance contracts (i.e. investment business which carries significant insurance risk and with-profit business) continue to be accounted for on an Embedded Value (‘EV’) basis but investment contracts (i.e. investment business which does not carry significant insurance risk) are now all accounted for under IAS 39. Relative to UK GAAP, this had the effect of delaying the recognition of profit in respect of some investment contracts and, in particular, has resulted in the reporting of losses in the year of their sale.
To assist in the understanding of the underlying performance and value generation of our UK Investment Business, the supplementary information set out below in respect of 2006 and 2005 provides the financial results for our UK Investment Business as if both insurance and investment contracts (including funds) were accounted for on an EV basis. We refer to this as the ‘Full EV’ basis.
The Full EV basis uses the same methodology as that which is applied to the calculation of EV on insurance contract business under IFRS and also that which was applied to the calculation of life and pensions EV under UK GAAP until 2004. The economic assumptions used for the Full EV basis are the same as used under the reported IFRS basis set out on page 18.
Applying the Full EV basis results in the earlier recognition of profit on new investment contract business, but subsequently a lower contribution from existing business, when compared to the recognition of profits on investment contracts under IAS 39. Differences between actual and expected experience on existing business often have a greater impact on a Full EV basis, as changes in experience can result in significant adjustments to modelled future cashflows. In contrast, under IAS 39, variations in experience compared to expectations are recognised in the income statement in the year in which they arise.
No additional information has been provided in relation to General Insurance or European Financial Services as the investment business not already accounted for on an EV basis under IFRS on these businesses is immaterial.
Key Financial Highlights
The key highlights of the Full EV basis are as follows:
- Group embedded value on a Full EV basis was £7,086m as at 31 December 2006 (2005 £6,540m), £2,525m higher than reported under IFRS.
- Underlying earnings per share on the Full EV basis increased 18% to 105.5p (2005 89.6p), 5.0p higher than reported under IFRS.
- Overall, underlying profit before tax for the UK Investment Business increased 30% to £539m (2005 £414m), £262m higher than reported under IFRS.
- Contribution from new business in the UK Investment Business increased by 38% to £461m (2005 £333m), £474m higher than reported under IFRS.
| Year ended
31.12.2006 Full EV Basis |
Year ended
31.12.2006 IFRS Basis |
Year ended
31.12.2005 Full EV Basis |
Year ended
31.12.2005 IFRS Basis |
|
|---|---|---|---|---|
| Underlying profit before tax | £5,799m | £5,537m | £5,021m | £4,842m |
| Underlying EPS | 105.5p | 100.5p | 89.6p | 86.4p |
| Post tax return on equity | 20.2% | 20.8% | 18.8% | 19.6% |
| Group embedded value (net of tax)* | £7,086m | £4,561m | £6,540m | £4,534m |
| Net asset value | 561p | 516p | 485p | 452p |
* Includes Europe of £488m (2005 £499m) and UK General Insurance of £214m (2005 £217m).
UK Investment Business
Full EV Information
| Year ended 31.12.2006 | Year ended 31.12.2005 | |||||||
|---|---|---|---|---|---|---|---|---|
| Life & Pensions Insurance Contracts £m | Life & Pensions Investment Contracts £m | Mutual Funds Investment Contracts £m | Total £m |
Life & Pensions Insurance Contracts £m | Life & Pensions Investment Contracts £m | Mutual Funds Investment Contracts £m | Total £m |
|
| Contribution from existing business |
||||||||
| Expected contribution | 140 | 98 | 50 | 288 | 133 | 84 | 41 | 258 |
| Actual vs expected experience |
16 | (62) | (29) | (75) | 77 | (77) | (33) | (33) |
| 156 | 36 | 21 | 213 | 210 | 7 | 8 | 225 | |
| Contribution from new business |
216 | 121 | 124 | 461 | 176 | 82 | 75 | 333 |
| Investment earnings on net assets |
113 | 6 | 4 | 123 | 105 | 4 | 1 | 110 |
| Contribution from Investment Business |
485 | 163 | 149 | 797 | 491 | 93 | 84 | 668 |
| Development expenditure | (67) | (67) | (80) | (80) | ||||
| Overheads associated with development activity |
(56) | (56) | (45) | (45) | ||||
| Other income and costs | (7) | (7) | (11) | (11) | ||||
| Debt financing cost | (128) | (128) | (118) | (118) | ||||
| Underlying profit before tax |
227* | 163 | 149 | 539 | 237 | 93 | 84 | 414 |
* Development costs, overheads, other income and costs and financing costs have been attributed to Life & Pensions Insurance Contracts business for presentational purposes only.
