Retail

Non-Interest income
Our focus on growth in fee income combined with gains from the disposal of certain non-core assets saw non-interest income advance by 24% to £1,029m (2003 £827m). Fees and commissions receivable were £141m higher at £1,410m (2003 £1,269m) reflecting solid growth in each of our principal product lines, notwithstanding a reduction in mortgage redemption penalty fee income compared to 2003. Fees and commissions payable were £17m lower at £434m (2003 £451m). Other operating income was £44m higher at £53m (2003 £9m) mainly reflecting gains on non-core asset disposals in our credit card business.

Operating Expenses
Continued focus on effective cost management coupled with the delivery of merger cost synergy targets enabled us to achieve a cost outturn well within our 3% annual growth target. Annual cost growth was only 0.5% and operating expenses were just £10m higher at £2,093m (2003 £2,083m). The analysis of operating expenses by cost type in 2004 reflects changes to the classification of direct and recharged expenditure. The total costs of the division are unaffected by these changes and comparative figures have not been restated. Plans are already in place to deliver further efficiency gains to enable us to maintain our record of low single digit cost growth, notwithstanding growth in balances and transaction numbers and our commitment to invest in both product development and brand.

Provisions
The total provisions charge as a percentage of average loans and advances was 0.33% compared to 0.30% in 2003. The provisions charge increased by 21% to £653m (2003 £538m) and comprised £631m (2003 £488m) for unsecured lending and £22m (2003 £50m) for secured lending. Closing provisions as a percentage of period end loans and advances increased to 0.75% (2003 0.69%). Total provisions (including interest in suspense) coverage of NPAs fell to 37% (2003 40%), reflecting the benefit of continued house price inflation which means the growth in secured NPAs does not result in a substantially increased provisioning requirement.

Profit on Sale of Fixed Assets
The £23m profit on sale of fixed assets represents the gain arising in the period to 31 December 2004 on the disposal of cash machines situated in locations remote from the Group’s bank branches.

Balance Sheet and Asset Quality Information
	As at 31.12.2004 £bn	As at 31.12.2003 £bn
Loans & advances to customers
Loans and advances to customers	209.4	190.6
Less: non-returnable finance	(28.1)	(15.6)
	181.3	175.0
Bad debt provisions:	£m	£m
Specific	1,162	944
General	414	370
Total	1,576	1,314
Provisions as % of loans and advances	0.75%	0.69%
Classification of loans and advances:	%	%
Home mortgages	91	91
Other personal lending:
Secured	1	1
Unsecured	4	4
Credit cards	3	3
Banking	1	1
Total	100	100
Non-performing assets	£m	£m
Secured	2,758	2,056
Unsecured	1,761	1,386
Total	4,519	3,442
Interest in suspense	£77m	£70m
NPAs as a % of closing advances	2.16%	1.81%
Total risk weighted assets	£105.2bn	£99.5bn
Total customer deposits	£126.1bn	£117.7bn

Total balance sheet provisions increased by £262m to £1,576m analysed as follows:

	As at 31.12.2004 £m	As at 31.12.2003 £m
Closing provisions
Secured	428	407
Unsecured	1,148	907
Total	1,576	1,314

Closing provisions as a percentage of period end loans and advances were 0.75% (December 2003 0.69%) as shown below:

	As at 31.12.2004 %	As at 31.12.2003 %
Secured	0.22	0.23
Unsecured	7.20	6.26
Total	0.75	0.69

Balance sheet provisions coverage of NPAs fell to 37% (December 2003 40%):

	As at 31.12.2004		As at 31.12.2004
	£m	% of NPAs		% of NPAs
Specific	1,162	26	944	27
General	414	9	370	11
Interest in suspense	77	2	70	2
Total	1,653	37	1,384	40

Operational Performance
Mortgages

As previously indicated in our 2004 interim results announcement, we have tightened our lending underwriting criteria and consequently reduced our market share of new mortgage lending. Gross Mortgage lending of £68.1bn (2003 £71.8bn) represented an estimated market share of 23% (2003 26%). We have grown the Retail mortgage book by £18.5bn to £193bn of assets in 2004 (after transferring £1.4bn of balances in respect of the Irish residential mortgage book to the International division), delivering a net lending market share of 17% (2003 25%).

The reduction in the net to gross ratio of our lending performance has been driven by the maturing profile of our portfolio following three years of strong growth, combined with a reduction in new lending, to maintain the risk profile of our portfolio. In the second half of 2004 we introduced a new approach to retention. As a result, our principal repaid market share run rate has fallen in the final quarter of 2004 and we expect to see a reduction in both the absolute amount and market share of principal repaid in 2005.

Throughout 2004 and across all lending segments our pricing strategy was designed to target further improvements in the LTV profile of the mortgage portfolio. Based on house prices at the end of December 2004, the average LTV for the portfolio was 41%, down from 43% at the end of 2003 and the average LTV of our new mortgage lending was 59%, down from 61% for 2003, underlining our commitment to maintaining asset quality. Only 7% of the mortgage portfolio was above 85% LTV, down from 10% a year ago and our average income multiple remains prudent at 2.5 times. Throughout 2004, we have significantly tightened our specialist lending underwriting criteria, with only 4% of new specialist lending with an LTV above 85%, down from 9% last year. Based on end of December 2004 house prices, the LTV of our specialist book was 61%, down from 66% at the end of 2003.

	Cases 000’s		Total Mortgages %		Value of Debt* £m		Total Mortgages %
Arrears	Dec 04	Dec 03	Dec 04	Dec 03	Dec 04	Dec 03	Dec 04	Dec 03
Mainstream	26.9	30.9	1.06	1.19	1,700	1,601	1.2	1.1
Specialist	5.8	2.6	1.57	0.92	952	400	2.1	1.1
Total	32.7	33.5	1.13	1.15	2,652	2,001	1.4	1.1

*Value of debt represents total book value of mortgages in arrears

The total number of cases in arrears fell by 2% to 32,732, representing 1.13% (December 2003 1.15%) of total mortgages. However, the total value of mortgage cases in arrears increased to £2,652m representing 1.4% (December 2003 1.1%) of the value of the total portfolio. This trend has been driven by the controlled growth of higher margin specialist lending. We continue to source around 30% of our lending from the specialist sectors as the higher expected loss associated with this lending is more than compensated for by higher margins. We therefore believe it is appropriate to disclose the split of our arrears analysed as between mainstream and specialist lending.

In our secured lending book arrears closely approximate to NPAs. Mainstream mortgage arrears at the end of 2002, 2003 and 2004 were the lowest in the last 20 years. NPAs continue to be well covered by assets. The average LTV of the secured NPA portfolio is 53%, with the equivalent figures for mainstream and specialist lending being 48% and 67% respectively.

The implementation of FSA Mortgage Regulation on 31 October saw some upheaval in the UK mortgage market but HBOS successfully delivered this significant change programme across all five brands. As a result, HBOS was able to take advantage of a competitive environment in which the key mortgage intermediary channel has relied on lenders who demonstrated their ability to maintain service levels.

In the final quarter of the year, the UK mortgage market weakened significantly with the total market value of mortgage offers falling 24% from the same quarter a year earlier. However, HBOS started 2005 with a very strong pipeline of £11.6bn of mortgage offers, in line with the position a year ago.

The overall success of the five brand strategy was again acknowledged in 2004. Both Personal Finance Magazine and The Daily Mirror recognised the quality and success of our mortgage business by awarding ‘Best Mortgage Provider’. In addition, at the recent ‘Your Mortgage’ awards, the Halifax was acknowledged ‘Lender of the Year’ for the third consecutive year and Birmingham Midshires as ‘Best Specialist Lender’.

Bank Accounts
We have opened over one million new bank accounts for the third successive year since merger. Our market leading current accounts combining attractive interest rates and value added features, backed up by aggressive marketing, have allowed HBOS to sustain its attack on the incumbents in the UK banking market. The strong sales performance delivered since 2001 has been maintained with the estimated HBOS share of the new and switchers market being 25%. In the important full facilities current account market the share of switchers to HBOS is estimated at 23%. We will continue to attack the traditional high street banks’ dominance of the full facilities current account market by developing attractive new full facilities banking products. Our Moneyback current account launched in February 2005 will be the first account in Europe to offer cashback on debit card transactions.