Corporate and Treasury

Prospects
Our reputation for working closely with our customers and introducers to provide tailored, innovative and added value solutions for their financing needs continues to grow and is supported by highly talented, experienced and committed colleagues.The outlook for the corporate sector looks encouraging with sustained economic growth and a favourable interest rate climate creating a positive background for corporate lending. Our work in progress levels remain strong and our share of our core markets continues to increase. With credit quality improving we are confident in the outlook for 2005.

Treasury
Profit before tax and exceptional items increased by 8% to £262m (2003 £242m). Asset quality remains high, and no credit provisions were required in the period.

Interest Income
Net interest income decreased 8% to £165m (2003 £179m). The reduction in net interest income is due to the extensive lengthening of the maturity profile of wholesale funding liabilities which has occurred over the last year, in line with our funding plans. The reduction in net interest income was mitigated by increased contribution from our Structured Investment Portfolio, which invests in high credit quality liquid securities.

Non-interest Income
Non-interest income increased 32% to £206m (2003 £156m). Our sales function contributed strongly to the growth in revenues as a result of increased sales of treasury products to the Group and its customers. The enhancement of the Division’s customer flow income remains a key strategic priority and progress continues to extend the product range, improve our customer information and develop closer links with our Group colleagues and their customers. Other income includes income from derivative structuring transactions, which also increased in the period.

Financial Performance

	Year ended 31.12.2004 £m	Year ended 31.12.2003 £m
Net interest income	165	179
Non-interest income	206	156
Dealing profits	194	161
Fees receivable	4	-
Fees payable	(16)	(19)
Other income	24	14
Operating income	371	335
Operating expenses*	(112)	(93)
Staff	(63)	(53)
Technology	(6)	(8)
Marketing and communication	(1)	-
Depreciation - tangible fixed assets	-	(1)
Other	(32)	(20)
Subtotal	(102)	(82)
Recharges:
Technology	(3)	(3)
Accommodation	(6)	(7)
Other shared services	(1)	(1)
Amounts written off fixed asset investments	3	-
Profit before tax and exceptional items	262	242
Net interest margin (bps)**	9	13
Cost:income ratio***	29.9%	27.8%
Total risk weighted assets	£14.8bn	£14.0bn

* Excluding exceptional items.

** Net interest margin has been calculated as net interest income divided by average interest earning assets excluding securities classified as trading assets but including lending to other members of the Group.

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

Costs
Costs for the period were £112m, up 20% on 2003 (2003 £93m), reflecting investment in the business and its infrastructure. The rise in staff and other costs is due to increased resources required to support new business initiatives, including the initial phases of the implementation of a new Treasury branch office in Australia, the full year effect of our investment in the New York office and establishing the Securitisation team. The cost increase also includes project spend to meet the requirements of the changing regulatory environment, in particular, the implementation of International Financial Reporting Standards and Basel II.

Asset Quality
Treasury maintains a cautious policy to avoid sub-investment grade investments, reflected by the continued high quality of our interbank and Structured Investment Portfolios with 99.0% of total assets rated A or above. During the period no credit provisions were required. In addition, £3m was recovered in relation to a fixed asset investment previously written off.

Operational Performance
Business Overview
Treasury provides and manages prudential and regulatory liquidity and wholesale multi-currency funding for the HBOS Group. Treasury is also responsible for arranging the Group’s debt capital issuance and asset securitisation programmes. In addition, a range of treasury services is provided to SMEs and large corporate customers of Corporate. The Sales function within Treasury works with customers to develop risk management solutions tailored to meet their specific needs. Sales revenues of Treasury products to the HBOS Group and its customers continue to grow strongly. We remain focused on delivering high quality business which is principally derived from both internal and external customer flow business. During the first half of the year Treasury established a branch of HBOS Treasury Services plc in New York. This is part of our strategy to diversify our sources of funding and seek new pools of investors, by utilising the US market as a long term and reliable source of funding for the HBOS Group.

We have also expanded our capital markets business to manage the origination of own asset backed and third party transactions, where some form of securitisation is required, as well as working closely with our Corporate colleagues and their customers to provide capital market solutions.

Funding
In addition to arranging securitisation issues and co-ordinating and executing HBOS plc subordinated debt issues, a key Treasury responsibility is to provide wholesale funding and liquidity for the Group. In support of this role Treasury continued to diversify the range and sources of funding during 2004.

The Group maintains a number of programmes in order to meet the continuing growth in wholesale funding. In April the US and Euro Medium Term Note (‘MTN’) programmes were increased in size to US$85bn. The Group also operates the following programmes; US$15bn US Commercial Paper (‘CP’), €15bn Euro CP, €5bn French Domestic CP and C$4bn Canadian Certificate of Deposit (‘CD’).All operate in the name of HBOS Treasury Services plc. Elsewhere in the Group BOS International (Australia) Limited operates A$10bn domestic and US$10bn programmes. BankWest continues to source funding in the domestic CD market.

Further to these programmes, HBOS launched two additional initiatives to build and diversify its investor base. In March we commenced trading in the name of HBOS Treasury Services New York branch to improve access to US investors and in June we widened the range of products available in MTNs to open up a new investor base.

HBOS continues to achieve its aims of investor diversification and the lengthening of its liabilities through the use of securitisation and covered bonds. The mortgage backed covered bond programme established in July 2003 was supplemented in December 2004 with a new covered bond programme backed by social housing loans. The issuance from these programmes in 2004 were €5.25bn and £1bn with average lives of 9 and 15 years respectively. There were also a further three securitisation transactions from the Permanent Master Trust mortgage programme raising approximately £14bn.

Other notable bond issues in 2004 include €2bn Floating Rate Notes due 2007, JPY60bn 0.25% Fixed Rate Notes due 2006, US$2.5bn Extendible Floating Rate Notes due 2009 and US$750m 4% Fixed Rate Notes due 2009.

Prospects
In 2005 we intend to consolidate the treasury operations of BankWest and BOS International (Australia) Limited into a single branch of HBOS Treasury Services, based in Sydney, which will support the Group’s Australian activities.

The strategy for 2005 aims to develop even further our product services and the provision of treasury related advice to the Group and its customers, to secure and improve on the current year’s performance whilst maintaining asset quality. Our position within the Group and increased sales penetration means that we can continue to benefit from the growth potential of Group businesses.