Alliance & Leicester: FY05 results

4:05 a.m. Tue 28 Feb 2006

Alliance & Leicester reported statutory pre-tax profits of £547m for the year to December 2005, almost 7% down from the £587m achieved the previous year. Core operating profits (ie excluding a £1m pre-tax loss from fair value accounting volatility in 2005 and a £52m pre-tax profit on the sale of the merchant acquisition business in 2004) improved slightly to £548m from £540m.

Wholesale banking performed slightly better than retail banking with core operating profit growing to £132m (2004: £126m). Commercial Banking core operating profit rose by 23% (to £89m) but this was partly offset a weaker treasury operation where core operating profit dropped 18% to £43m (2004: £53m).

Retail Banking core operating profit was relatively flat at £438m (2004: £436m). Despite aggressive cost cutting (which resulted in operating costs £14m lower than 2004), strong revenue growth from mortgages, personal loans current accounts and savings weak performance elsewhere (particularly credit cards, long term investments, life assurance, and general insurance) kept earnings flat.

Our concerns with this bank are with high costs (the cost:income ratio is 55% compared to 45%-50% for more efficient players) shrinking margins and of late, what appears to be an overly aggressive expansion in the mortgage portfolio, just as the housing market is slowing. Although the cost:income ratio has improved from 57% seen last year, there is some way to go before it reaches the level of the most efficient players – the bank hopes to bring it down below 50% only by 2010. The capital ratios have also weakened slightly; tier 1 is now is 7.6% compared to 8.3% last year and total capital has declined to 10.5% from 11.5% last year. (An issue of £300m in tier 1 capital is expected in the middle of 2006 in order to redress the situation).

The bank’s plans for growth seem to be centred around cost control and growth in new lending products but with a shrinking margins and an increasingly tough environment Alliance & Leicester is less than ideally placed to take on the best in the industry.

The share trades at 1138.5p, on a prospective PE (2006 earnings) of 13.9x, at the upper end of the sector range with a yield of 4.7%.