HBOS IFRS Restatement Conference Call - 1 June 2005

Transcription

1 HBOS IFRS Restatement Conference Call - 1 June 2005 Phil Hodkinson Group Finance Director This morning we published the restatement of our 2004 Results onto an IFRS basis, alongside a pre-close trading statement covering the first four months of In the next twenty minutes or so, I plan to cover the main highlights of the restatement, and after that I'll take any high level questions that you may have. Also, over the next few days, our Investor Relations team will be available to respond to any detailed queries you may have once you've had a chance to absorb all 120 pages or so! On the question of length, I make no apologies for the size of the document. We've provided both full year and half year restatements for We've also provided both statutory and pro-forma accounts, the latter covering the impact of IFRS 4, IAS 32 and IAS 39, so in essence an "all in" comparison of IFRS with UK GAAP. And we've also given you guidance on how we see IFRS affecting 2005 as well. And finally, we've provided an analysis of the main changes for each of our divisions. So even though it's a long document, we've tried as far as we can, to make the restatement as helpful as possible. As you know, we held a seminar in December describing the main changes from UK GAAP to IFRS, giving you estimates of the likely impact on our P&L and on Shareholders' Equity. 1

2 I don't intend to cover all of the same ground again, at least not in as much detail by and large our estimates from December have proven to be remarkably robust. I will, however, comment on the key areas of change since December and, in particular, I'll cover those areas where there have been significant developments in the standards themselves. Finally, for ease, I'll restrict all of my comments this morning to the Pro-forma figures for the full year. These figures are certainly the most useful basis for comparison. The only IFRS change that we've not been able to reflect in the Pro-forma figures is hedge accounting for derivatives, where because the relevant standard was only agreed late in 2004 we don't have the necessary retrospective documentation for the year as a whole to support a full restatement. I will, however, give you guidance on how we expect hedge accounting to affect results in Let's get into the detail and let me cover each item in the order that we've suggested in this morning's . You can follow the figures from Table 2 in today's , this compares our pro-forma restatement with our guidance from December. If you don't have the to hand, you can access both Table 1 and Table 2 by clicking on IFRS "Key Impacts". One thing to bear in mind throughout is that in December, we rounded all our estimates to the nearest 100m and hence, not surprisingly, many of the differences between now and December are simply due to this rounding. 2

3 The first and biggest change to Shareholders' Equity is in respect of employee benefits, and in particular in respect of pension scheme deficits. Our net pensions liability at the end of 2004 was 1,138m and under IFRS this is charged directly to capital and reserves. In December, we'd estimated the deficit would be of the order of 1bn or so and hence this item accounts for 138m of the total 301m difference between our restatement and our December estimate. In contrast, the P&L impact of employee benefits came in more or less as expected, this of course being the cost of employee share schemes. As we said in December, due to the IFRS transition rules, we expect the cost of employee share schemes to rise modestly in 2005 as the cumulative value of shares being charged to the P&L increases. Changes to the way in which we account for Long Term Assurance business accounts for the second largest negative impact to Shareholders' Equity. The reclassification of certain Long Term Assurance contracts, from an Embedded Value basis to a Deferred Acquisition Cost or DAC basis, and also changes to the level of acquisition expenses that can be deferred on investment contracts, results in a 714m reduction in Shareholders' Equity. This was slightly higher than we'd anticipated in December, mainly as a result of a better than expected outcome for the Investment Business for 2004 as a whole. It accounts for roughly 20m or so of the 69m total P&L difference between the Restatement and our original December estimate. 3

4 Roughly 30% or so of our Long Term Assurance business, previously accounted for on an Embedded Value basis, has now been moved to a DAC basis. In total, allowing for the investment business that was already on a DAC basis under UK GAAP, roughly half of our Investment Business is now Embedded Value and half is DAC. Another significant change for Long Term Assurance business is the line-by-line classification of income and expenses. Previously, net Embedded Value profit was shown under the non-interest income caption of the P&L, expenses being netted off within the calculation of the Embedded Value. Now income, expenses and tax are shown separately and this has significantly changed the look of both the P&L and the Balance Sheet, though of course it doesn't change the net position. In addition to the line-by-line approach to Long Term Assurance business, movements in benefits attributable on investment contracts now go through the P&L. This has also changed the look of both the P&L and the balance sheet, though again it doesn't change the net position. As a result of these classification changes in the Insurance & Investment Division, the trend in the Group's cost:income ratio as a measure of efficiency has been significantly disrupted. As a consequence, we now intend to show the Banking Divisions' cost:income ratio separately and to use this as our primary reporting measure of efficiency. The Banking Division cost:income ratio is not significantly different between IFRS and UK GAAP. Finally, perhaps the most difficult aspect of the new standards to interpret within the Long Term Assurance business, has 4

5 been in respect of the grossing-up of EV profits for tax. Under UK GAAP, profits calculated net of tax via movements in Embedded Value, were grossed up for shareholder tax. Under IFRS, the standard is open to interpretation the choice being either that post tax EV profit should be grossed up at the aggregate rate of shareholder and policyholder tax or that EV profit should not be grossed up at all. In our restatement, we've adopted the former approach grossing up for both shareholder and policyholder tax. Discussion on this topic will no doubt run until an industry consensus emerges, and hence it is possible that this aspect of our restatement may change. The third and final major negative change to Shareholders' Equity is in respect of leasing, where operating leases have moved on to a straight line depreciation basis and finance leases are now accounted for on a pre-tax basis the effect of both being to defer profit recognition on leasing contracts. The impact of this change on Shareholders' Equity was 190m, more or less in line with our December estimate. The biggest positive item in terms of Shareholders' Equity is the deferred recognition of dividends that remain unpaid as at the balance sheet date. This resulted in a 870m credit, higher than the 800m estimate in December. For obvious reasons, in December we were unable to flag our plans to increase the final dividend growth for In contrast, the introduction of Effective Interest Rates has produced a lower IFRS adjustment than forecast in December, 5

6 the main reason being down to the finalisation of the EIR model and underlying assumptions. Rounding of the December figures was also a significant factor. These changes also resulted in a lower benefit to the P&L of some 50m. The classification of financial instruments, principally unlisted equity investments marked to market under IFRS rather than held at book value, has resulted in a 169m benefit to Shareholders' Equity, some 69m higher than estimated in December. This has no impact on profit, as movements in the value of "available for sale assets" are taken directly to capital & reserves and not through the P&L. The change to the treatment of Goodwill, which under IFRS is no longer amortised but is subject to an annual impairment test, resulted in a 102m improvement to both Shareholders' Equity and P&L, as predicted in December. We now come to two changes, hedge accounting and loan impairment, which have had no significant impact on either Shareholders' Equity or P&L in 2004, but nonetheless deserve mention. As mentioned earlier, because of the late finalisation of the standard affecting hedge accounting, we didn't have the necessary retrospect documentation in place in 2004 to enable us to restate our results for this aspect of IFRS. We have, therefore, used the exemption that allows the accounts to be prepared without restating for hedge accounting. 6

7 Our policy is to use derivatives to hedge interest rate and currency risks within our banking book, and to offer similar facilities to corporate customers. Our aim continues to be to make all our hedging as effective as possible, thus reducing the potential volatility that can now arise under IFRS as a result of a mis-match. In practice, we expect that it will be impossible to entirely eliminate volatility, but we'd expect to manage this volatility to within ±1% of Group profits each year. Under IFRS, profits relating to some of our hedging activities will now be accrual accounted and will no longer be recognised up front. The result of this is that in the transition to IFRS in 2005, profit on these hedges will be deferred and hence have a modest impact on our P&L. Turning to provisioning, IFRS introduces more stringent rules for the recognition and calculation of provisions, including the use of discounting. Specific and general provisions are now replaced with Individual and Collective assessments of impairment. The net effect of these changes on Shareholders' Equity and P&L is negligible, as predicted in December. However, it does make a difference to our total capital ratio. Following the FSA policy statement in April, if the amount impaired on an individual loan is calculated using a portfolio approach, the FSA has confirmed that from a regulatory perspective all such collectively assessed impairment provisions can be counted towards total regulatory capital. As a result, under IFRS, our total regulatory capital as at 31 December 2004 has increased to 12.3%. 7

8 This benefit will, of course, disappear under Basle II, but we expect the overall benefit of Basle II to HBOS to more than compensate for the loss of this item. For this reason, we feel comfortable in taking credit for it now in line with our peer group. Had we not adopted this approach, our total capital ratio would have been 11.9%. Whilst on the topic of capital ratios, it is worth noting that under IFRS, our Tier 1 capital ratio at 31 December 2004 has reduced by 0.2% to 7.9%, largely as a result of the FSA's final policy statement in April that confirmed that software development, now treated as intangible assets under IFRS, would be disallowed from Tier 1. Despite this change, we will continue to manage Tier 1 towards a central target of 8%. From time to time, it may be slightly higher or lower but not by much, and not for long. The change to preference shares, now accounted for in the P&L as interest paid on debt rather than treated as dividends, results in a reduction in profit of 211m, more or less as predicted. There is no effect on Shareholders' Equity or Earnings Per Share. Finally, there are a whole host of smaller movements which have been collected together under the heading of "others". Apart from roundings, the biggest change here is that since December it's been clarified that the appropriate accounting treatment for own shares held within our OEICS, when bringing them on to the Balance Sheet as required by IFRS, is to exclude them from the asset side of the balance sheet, even though they remain as a liability to policyholders. 8

9 So let me summarise: In Shareholders' Equity terms, since our initial guidance in December, the additional impact of IFRS on a pro-forma basis, is a reduction in capital and reserves of 301m with the largest differences being down to a higher year end pensions deficit, and the finalisation of our Effective Interest Rate model and assumptions. In P&L terms, the impact of IFRS is 69m higher than predicted, with the biggest differences between now and December being Effective Interest Rates again, and a better than anticipated performance from our Investment businesses in As a result, on a pro-forma basis, basic Earnings Per Share in 2004 were diluted by 4.1% and underlying Earnings Per Share by 7.1%. On a statutory basis, underlying Earnings were diluted by just 1.4%. Looking to 2005, I've already highlighted two effects that will be more significant in 2005 than in 2004 these being the cost of employee share benefits and the introduction of derivative hedge accounting for the first time our estimate is that the combined effect of these two items will be that Earnings Per Share in 2005 will be diluted by approximately 1% more than in Whilst this will, undoubtedly, make the achievement of 19-20% ROE slightly more challenging in 2005 than otherwise would have been the case, there's nothing we see in IFRS as a whole that would change our view that 19-20% should be our benchmark for sustainable returns going forward. 9

10 In passing, whilst talking about EPS, I'd bring your attention to our comments on the likely number of shares in issue in We remain as committed as ever to the share buyback programme announced in December, nothing in IFRS has changed that view, and indeed to date we've already bought back some 230m shares for cancellation since March. Allowing for this and the removal of our SCRIP dividend, we expect the total number of shares in issue to fall during 2005 by approximately 2% and hence the average number of shares in the year will be roughly 1% lower than at the start of the year. To end, I'd like to re-iterate the view we expressed in December that IFRS does not change the profitability of our business, simply the timing of profit recognition. Once it's settled down, it should provide a better basis for comparison but no doubt in the short-term IFRS is going to take some getting used to. Importantly, IFRS does not change our views about sustainable returns, or capital management, or cost efficiency, or the value being created by each of our businesses. 10