John Mitchell, Chairman
Chairman's Statement
I am pleased to present the Julian Hodge Bank results for the year ended 31st October 2009, a period characterised by a deep recession and continued nervousness within financial markets.
The Bank made a pre-tax profit of £1.2 million (2008: pre-tax loss of £0.9 million) which, in the present economic circumstances, is considered to be a solid performance. Our aim is to ensure that the Bank is well positioned to provide a quality service to all its customers for many years to come and not to seek short-term gains.
The Board considers it prudent to ensure that the Bank remains adequately covered against its latent exposure to the commercial property market. Therefore, in keeping with the approach adopted last year, a further £3 million has been added to the general provision held against the Bank’s commercial lending portfolio.
Highlights
- Tier 1 asset ratio of 19.7%.
- Named 3rd soundest bank in the UK and 17th in the world in The Banker – 2009 Top 1,000 World Banks.
- Customer deposits rose from £503.4 million to £610.5 million – an increase of 21%.
- Liquid assets increased by 28% from £85.5 million to £109.7 million.
- Total assets increased by 17% to £738 million.
Economic Environment
The effects of the “credit crunch” linger on as financial institutions across the globe seek to rebuild their balance sheets and increase capital ratios to satisfy regulators’ demands. In this respect, banks in the U.K. have to address the requirements of the Financial Services Authority’s new liquidity regime which will result in the need to hold greater volumes of liquid assets. Both these elements will have a significant effect on lending capacity and make it very difficult for banks to acquiesce to governmental pressure to increase lending in order to stimulate economic growth; or in the U.K.’s case, improve the prospects for an early recovery from recession.
There does, however, appear to be greater confidence within the financial markets that as far as the “credit crunch” is concerned the “worst is over”. A number of banks throughout the world have reduced or eliminated their dependency on state support and have found investors willing and able to provide additional capital. In the U.K., both Barclays and Lloyds have successfully taken this approach, the former to avoid state support entirely and the latter to avoid the government’s asset protection scheme.
On the other hand, the jury is still out on the success of the measures taken by the U.K. government to create an economic stimulus. A massive programme of quantitative easing has been undertaken with commentators divided as to its success, with some convinced it will create inflationary pressures. In addition, whilst the success or otherwise of the stamp duty holiday for house purchase and the temporary reduction in VAT can be questioned, there can be no doubt that their reversal will not encourage the housing market nor boost consumer spending.
From the Bank’s perspective it has been a difficult year with both its key markets, residential and commercial property, becalmed and activity levels at historic lows. However the Bank has benefited greatly from its considerable property expertise which has protected us from some of the problems that have befallen others less well versed in the vagaries of the property market. It is worth reiterating that our interest in residential property assets is for the long-term and that our equity release portfolio is able to withstand short-term adverse movements in house prices. We continue to believe that residential property remains an attractive asset class with its value underpinned by demographic factors.
Financial Performance
Although the profit represents an improvement on the prior year, the result does reflect the difficult trading environment within which the Bank has had to conduct business during 2009.
Interest and fee income has suffered as new business has fallen short of target and the Bank’s prudent provisioning policy has played its part in depressing the overall result. Furthermore, the cost of maintaining liquidity had an adverse effect on profits as returns available on liquid assets have been substantially below the rates necessary to attract and retain retail deposits.
| 2009 | 2008 | 2007 | 2006 | 2005 | |
|---|---|---|---|---|---|
| £m | £m | £m | £m | £m | |
| (Loss)/profit before tax* | 1.2 | (0.9) | 7.1 | 6.5 | 5.0 |
| Total assets* | 738.0 | 629.2 | 465.9 | 441.8 | 302.7 |
| Loans and advances to customers* | 470.2 | 419.3 | 366.1 | 305.7 | 216.5 |
| Customer deposit balances | 610.5 | 503.4 | 317.5 | 316.5 | 401.0 |
| Shareholder’s funds | 122.1 | 124.2 | 126.5 | 123.0 | 130.5 |
*The figures for the years 2005-2007 have been restated to eliminate dividends receivable from subsidiary companies and to remove the assets relating to the businesses disposed of during 2006.
Commercial Lending
Unsurprisingly, but as predicted last year, 2009 has been extremely challenging for Commercial Lending. Asset values across both the residential and commercial property markets continued to fall in the early part of the year and whilst there has been some recovery in recent months it has in no way compensated for previous falls. Of greater concern has been the lack of transactions generally, which has meant that comparable evidence to support asset valuations has been hard to come by.
Our efforts have been directed towards protecting the Bank’s existing commercial property assets rather than searching for new business opportunities. We identified at an early stage in the year that there was a dearth of quality new lending proposals and that our time would be better served working with existing customers to maximise the returns on their assets. Sadly this approach resulted in a number of redundancies within the Commercial Lending team as we needed to reduce our cost base to take account of lower sales activity.
The outlook for Commercial Lending remains challenging but we believe that our conservative approach to underwriting coupled with our prudent provisioning policy will leave us well placed to take advantage of the opportunities that will present themselves as the recovery gathers pace.
Hodge Lifetime
Hodge Lifetime is the umbrella brand for the Group’s equity release activities which are conducted through the Bank and its subsidiary, Hodge Life Assurance Company Limited (Hodge Life). Under the Hodge Lifetime brand, cash lump-sum equity release products are provided by the Bank (Hodge Life specialises in pension and purchased life annuities and annuity-based equity release products). Hodge Life is separately regulated by the Financial Services Authority.
The market for equity release products saw considerable upheaval during the year with a number of product providers withdrawing from the market, primarily due to the difficulty of funding their assets over the long term.
The Bank is in the fortunate position of not only being able to fund equity release assets on its own balance sheet but, also, Hodge Life has been and continues to be an investor in this asset class. During the year, that Company successfully launched a pension annuity product which will provide an additional source of funding for equity release mortgages. Over time this is expected to become the primary funding mechanism for the Group’s equity release activity and the Bank’s exposure to lifetime mortgages will, therefore, stabilise. The Bank sold £11 million of mortgage assets to Hodge Life in October 2009 and anticipates further sales taking place in 2010. As at 31st October 2009 we had £409 million of equity release mortgage assets under management including £140 million for other financial institutions.
We remain committed to equity release business, having been at the forefront of this market for over 40 years. Our knowledge of this market is unrivalled and we believe that the reduced number of participants will allow product profitability to be enhanced.
Treasury and Funding
The absence of any meaningful wholesale funding availability, particularly securitisation, has resulted in the retail deposit market becoming the prime source of funding for most financial institutions and, as a consequence, highly competitive. The London Inter-Bank Offer Rate (LIBOR), the rate at which banks traditionally lend to each other, has reduced substantially during the year, to a level more in keeping with its long-run average spread over base rate. However this has had no noticeable effect on reducing the cost of raising retail deposits in the U.K. which remains historically high. Nevertheless the Bank has been extremely successful in increasing its retail deposit base despite facing considerable competition. What was noticeable was the aggressive position adopted by institutions either owned in whole or in part by the U.K. government. These institutions have been offering extremely high rates and have not been shy in promoting the fact that their products benefit from a government guarantee, which has not been available to those banks able to survive without assistance.
Our deposit balances rose from £503 million to £611 million, an increase of 21% over the year. I would like to thank those depositors who remained loyal to us during the past year and to welcome the many new customers who have been attracted to the Bank. We now have over 45,000 customers, a 22% increase over the previous year. This is testimony to the continued success of the Bank’s policy of providing simple, straightforward deposit products, utilising our in-house customer service team. We aim to treat our customers fairly and to put the security of our depositors at the heart of everything we do.
The Bank has begun to invest in U.K. treasury bills (gilts) in advance of the new liquidity regime introduced by the Financial Services Authority which takes effect on 1st October 2010. This will further enhance the Bank’s strong liquidity position. Whilst the Bank fully supports the aim of strengthening standards to prevent a recurrence of the liquidity failures of the past two years, the amount of highly liquid assets that will need to be held by banks will inevitably curtail future lending.
During the year the Bank continued to hedge its equity release and deposit portfolios in order to reduce its exposure to interest rate volatility. We have also renewed our committed funding line facility with a major UK bank in order to strengthen our liquidity position further.
Our People
On behalf of the Board I would like to thank all staff members for their endeavour, commitment and loyalty during the past year. During trying times they have demonstrated energy and enthusiasm - their contribution to the Bank’s performance is highly valued.
The Future
Whilst there has been some improvement in the economic climate in recent months, it is too early to say whether it is sustainable and, thus, the outlook for the forthcoming year remains uncertain.
Although the U.K. emerged from recession in the last quarter of 2009, the Bank’s two key markets, housing and commercial property, will remain subdued. Unemployment will be a major factor in determining the direction of house prices but we believe they are unlikely to move far from current levels. There has been improved demand from investors for prime commercial property which has translated to a significant yield reduction in certain sectors of the market. However, the market is suffering generally from low transaction volumes as potential customers are loathe to commit to new premises until there is clear evidence that an economic recovery is underway.
The Bank has navigated through the “credit crunch” and subsequent recession without external assistance. Our capital base remains strong and has been largely undiminished despite the adverse economic environment over the past two years. I have no doubt that our understanding of the markets in which we operate and know best has been a significant contributory factor in this success.
The robust balance sheet of Julian Hodge Bank means we are very well positioned to take the business forward once the UK economy recovers.
John Mitchell
Chairman
28 January 2010