Corporate and Treasury

Corporate
Corporate has delivered another set of excellent results with profit before tax and exceptional items increasing by 25% to £1,376m. Our focus on controlled asset growth, improved returns and credit quality, combined with our ability to develop and sustain strong relationships with our ever-widening customer base continues to create significant and sustainable shareholder value. During the year the integration of our Corporate Division and most of our Business Banking Division was successfully completed and has delivered considerable cross-selling and efficiency benefits.

The strong rise in non-interest income resulted from a sustained focus on fees and commissions across all areas of the business and from a number of investment gains from our integrated product portfolio. These investment gains and profits from our numerous joint ventures are a core part of our business and notwithstanding the equity realisations achieved in 2004, the embedded profit in our investment book was higher at the end of the year than it was at the beginning. An increase in redemptions during the year saw a commensurate rise in related fees and the 12% increase in operating lease rental income reflected the continued success of our asset finance operation.

Cost efficiency continues to be a cornerstone of our philosophy. Operational improvements arising from the integration of our previous Corporate and Business Banking Divisions have limited expenses growth, excluding operating lease depreciation, to 6% compared to our underlying income growth of 16%. This has delivered positive “jaws” of 10% and further reduced our cost:income ratio which fell from 29.8% to 27.2%.

Financial Performance

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Net interest income	1,520	1,377
Non-interest income	1,396	1,133
Arrangement fees	326	310
Commitment fees	75	69
Guarantee fees	28	37
Redemption fees	90	33
International services	28	23
Transaction fees	102	72
Other	117	105
Fees and commissions receivable	766	649
Fees and commissions payable	(131)	(127)
Profit on sale of investment securities	91	47
Operating lease rental income	598	535
Other operating income	72	29
Operating income	2,916	2,510
Operating expenses*	(1,071)	(979)
Staff	(367)	(334)
Accommodation, repairs and maintenance	(8)	(30)
Technology	(21)	(37)
Marketing and communication	(28)	(23)
Depreciation:
Tangible fixed assets	(21)	(19)
Operating lease assets	(391)	(340)
Other	(86)	(71)
Subtotal	(922)	(854)
Recharges:
Technology	(47)	(65)
Accommodation	(41)	(15)
Other shared services	(61)	(45)
Amounts written off fixed asset investments	(27)	(26)
Operating profit before provisions*	1,818	1,505
Provisions for bad & doubtful debts:
Specific	(518)	(428)
General	-	(15)
Share of profits of associates and joint ventures	76	39
Profit before tax and exceptional items	1,376	1,101
Net interest margin**	1.98%	1.96%
Net interest spread**	1.72%	1.70%
Bad debt charge as a % of average advances**	0.69%	0.66%
Cost:income ratio***	27.2%	29.8%

* Excluding exceptional items.

** Certain loans and advances to customers have been securitised. Where a “linked presentation” format is used in the statutory balance sheet presentation of these assets and the associated non-returnable finance, these ratios are calculated before deduction of average loans and advances subject to non-returnable finance.

*** Cost:income ratio has been calculated excluding exceptional items and after netting operating lease depreciation and amounts written off fixed asset investments against operating income.

	As at 31.12.2004 £bn	As at 31.12.2003 £bn
Loans and advances to customers
Loans and advances to customers	78.8	72.2
Less: non-returnable finance	(0.7)	(1.4)
	78.1	70.8
Bad debt provisions:	£m	£m
Specific	424	449
General	335	335
Total	759	784
Provisions as a % of loans and advances	0.96%	1.09%
Classification of loans and advances*:	%	%
Agriculture, forestry and fishing	1	1
Energy	1	2
Manufacturing industry	6	7
Construction and property:
Property investment	21	20
Property development	5	5
Housing associations	3	4
Housebuilders	3	3
Other property	2	1
Hotels, restaurants and wholesale and retail trade	9	9
Transport, storage and communication	6	5
Financial	10	9
Other services	18	18
Individuals	3	2
Overseas residents	12	14
Total	100	100
Non performing assets (NPAs)	£1,144m	£1,309m
Interest in suspense	£49m	£62m
NPAs as a % of closing advances	1.45%	1.81%
Provisions including interest in suspense as a % of NPAs	71%	65%
Total risk weighted assets	£92.9bn	£83.5bn
Total customer deposits	£38.6bn	£31.2bn

* Before provisions and after deducting non-returnable finance.

A 10% increase in net interest income and an even stronger 23% increase in non-interest income saw our total operating income increasing by 16% to £2,916m. Our net interest spread and our net interest margin both improved by 2 basis points.

Movement in Margin	Basis Points
Net interest margin for the year ended 31 December 2003	196
Drive Financial Services lending margin	3*
Wholesale funding	(1)
Net interest margin for the year ended 31 December 2004	198

* Fully consolidated with effect from 1.11.2004

Our overall provisioning experience was satisfactory. The total charge for bad and doubtful debts was £518m, equivalent to 0.69% of average advances. Excluding the impact of the change in status of Drive Financial Services from an associate to a subsidiary, this was in line with the previous year’s figure of 0.66%. We are continuing to see an improving trend in credit quality with NPAs as a percentage of closing advances falling from 1.81% to 1.45%. Our provisions including interest in suspense as a percentage of NPAs increased from 65% to 71%.

We continued to attract a strong flow of new business which saw our loans and advances grow by 9% to £78.8bn. This net growth was slower than in recent years, partly as a result of redemptions and partly because we continued to actively sell-down underwritten positions in order to deliver better returns and to ensure we are self financing in terms of capital generation.

The largest overall concentration in our lending book continues to be in property. This consists of property investment 21%, property development 5%, housing associations 3%, housebuilders 3% and other property 2%. Our property investment facilities are backed by rental streams from a wide range of covenants and our property development exposure is largely supported by pre-lets, pre-sales or additional security.

Customer deposits continued to grow strongly, increasing by 24% to £38.6bn and further improving our self-funding ratio to 48%.

Risk Management
We have a conservative approach to credit risk management and are constantly driving for improved credit quality. We continuously review our credit risk strategies and policies, levels of portfolio exposure and lending parameters by industry sector. During the year we successfully launched a new risk rating system which provides comprehensive information on our overall risk exposure and credit quality as well as better management information for lending decisions. We operate a robust sanctioning process, which includes a vertically delegated approach to lending authorities, separation between the originating and sanctioning functions, use of scorecards and other approval mechanisms. The strength of these risk management procedures is key to our objective of continuously improving credit quality.

Operational Performance
The markets in which Corporate operates are large and diverse and have the potential to deliver sustainable profitable growth for many years to come. We provide a comprehensive and ever growing range of products and services, principally in the United Kingdom, but we are increasingly extending our core competencies and expertise to the European and North American markets.

We continue to lead the market in many areas. Our integrated, joint venture, structured and acquisition finance businesses, often providing a “one-stop” mix of mezzanine and equity in addition to traditional senior debt and working capital, continue to attract large volumes of business whilst at the same time optimising our return on capital. In the public/private partnership arena, we continue to work closely with the public sector in the provision of social and economic infrastructure.

Our asset finance business covers the whole range of secured debt and leasing from high value aircraft, rail and marine financing to high volume office equipment financing. We also have a strong performing motor business, including our highly successful joint ventures with Renault and the RAC.

Our presence in the England and Wales market place continues to grow. We are enhancing our local infrastructure in 2005, including the introduction of Bank of Scotland branding to all our Halifax branches, so that our Corporate customers can access cash and counter services at a far greater number of locations.

We target carefully selected opportunities in Europe and North America from our 11 overseas offices. Our recently restructured European network consists of offices in Paris, Frankfurt, Madrid and Amsterdam where we operate in sectors such as acquisition finance, corporate finance, commercial real estate, project finance, Public Private Partnership (PPP) and deposit gathering. Our North American network of 7 offices is primarily focused on continuing to deliver profitable growth through emphasis on lending to niche sectors such as oil & gas and across the regional banking and other financial sectors. Additionally, in November we increased to 64.5% our shareholding in Drive Financial Services, a highly successful motor finance business based in Dallas.

The geographic business mix shows 90% of our country risk exposure is in the United Kingdom, 4% in the USA, 5% in mainland Europe and 1% elsewhere. Our key focus remains on areas of the world that enjoy a stable political, economic and legal environment. We do not enter unfamiliar geographic areas with untested products.

Customer Service
The bringing together of the Corporate Division and most of the former Business Banking Division to create an enlarged Corporate Division has given us a structure that is more closely aligned with our customers and this has already delivered significant cross-selling benefits.

We continue to challenge, consolidate and redesign our back office operations to improve customer service and drive down costs. Systems improvements are key to these initiatives and 2004 saw the successful migration of accounts to “Core Banking”, our real time relationship banking system.

The year also saw the roll-out of Corporate Internet Banking, our enhanced and market-leading on-line banking platform. Our Strategic Motor Solution which has dramatically increased the speed of the decision making process in our Motor business is currently being adapted for our other asset finance businesses. We have also begun a 3 year systems integration programme which will deliver significant business benefits.