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Financial review

Positioning for the future

Delivering strong results during a time of unprecedented turbulence.
Continued focus on the fundamentals of banking will assure the
future for our customers and our business.

Our highlights and achievements in 2008

Our priorities in 2009

Group summary

The Group has delivered another strong performance for the year ended 31 December 2008. Operating profit rose 13 per cent to $4,568 million, with operating income increasing 26 per cent to $13,968 million.

The normalised cost to income ratio was 56 per cent, flat to 2007. Normalised earnings per share increased by one per cent to 174.9 cents. Further details of basic and diluted earnings per share are provided in note 14 on page 116.

In what has been a difficult year for the financial sector, the Group has focused on balance sheet management as a key priority. There has been a focus on maintaining a liquid balance sheet and the efforts of both Wholesale Banking and Consumer Banking to raise deposits have driven an improvement in the asset to deposit ratio of the Group to 75 per cent at the end of 2008, from 86 per cent at the end of 2007. The Group remains a net lender into the interbank market.

The capital position of the Group was further strengthened by a rights issue completed in December 2008 and the Core Tier 1 ratio of 7.6 per cent is up from 6.6 per cent at the end of 2007.

The quality of the asset portfolios positions the Group well for 2009. The Group has tightened underwriting criteria, invested in collections capacity and tightened control processes. Whilst some deterioration in asset quality was seen in the latter months of the year, the quality of the customer assets is good.

Expenses remain under control. In the face of difficult trading conditions, Consumer Banking has been restructuring, reducing headcount while investing in distribution and product capabilities. Wholesale Banking, even though it has had a very strong year, has also shown a disciplined approach to expenses, reducing its costs in the second half of the year.

The Group’s balance sheet, capital resources and expense base have been positioned to face what is a challenging outlook. The Group remains resilient and open for business.

Operating income and profit

  2008 2007
  AEB
$million
Underlying*
$million
As reported
$million
As reported
$million
Net interest income 240 7,147 7,387 6,265
Fees and commissions income, net 252 2,689 2,941 2,661
Net trading income 62 2,343 2,405 1,261
Other operating income (2) 1,237 1,235 880
  312 6,269 6,581 4,802
Operating income 552 13,416 13,968 11,067
Operating expenses (603) (7,008) (7,611) (6,215)
Operating profit before impairment losses and taxation** (51) (6,408) 6,357 4,852
Impairment losses on loans and advances and other credit risk provisions (74) (1,247) (1,321) (761)
Other impairment - (469) (469) (57)
Profit from associates 1 - 1 1
Operating (loss)/profit (124) 4,692 4,568 4,035

The early part of 2008 was characterised by strong economic growth across the Group’s key markets, driven by strong regional trade flows, with the Middle East benefiting from high oil prices. In the middle of the year, increasing fuel and food prices heightened concerns over rising inflation, with a number of countries taking pre-emptive action to raise interest rates and moderate inflationary pressures. The last few months of 2008 witnessed severe disruption in financial markets including a significant deterioration in international trade flows and a fall in confidence across much of the world. This has already prompted significant policy stimulus measures in a number of countries.

The Group maintained a liquid and well-capitalised balance sheet throughout 2008, which was further bolstered by a rights issue launched in November 2008. As at 31 December 2008, the Group was a net lender into the interbank markets and had strong capital ratios. The failure of some financial institutions and stock market falls have, however, significantly reduced the appetite of retail and corporate customers for structured equity, commodity and exchange rate linked products, and this affected performance, particularly in the fourth quarter. The Group saw an increase in loan impairment in the latter months of 2008 and this contributed to a slowing performance in the second half of 2008.

The only significant acquisition was that of AEB. Its only material impact on performance was in the Americas, UK and Europe geographic segment. A description of the overall performance of AEB is included below. References to ‘underlying’ exclude the post-acquisition results of AEB.

Operating income grew by $2,901 million, or 26 per cent, to $13,968 million. Consumer Banking income grew three per cent but, on an underlying basis, fell two per cent. Income growth was constrained by a sharp decline in Wealth Management and Deposits (Wealth Management) revenues across the franchise in the latter half of the year. Wholesale Banking income grew 43 per cent, reflecting another strong year as it continued to execute its customer-focused strategy, delivering income growth in all geographies and most products.

Seven of the nine geographic segments now deliver over a billion dollars of income, reducing the Group’s exposure to any single territory. All of the Group’s key markets were affected to some extent by the adverse economic conditions in the last quarter of the year. However, for the full year, with the exception of Korea, all geographies delivered strong double-digit income growth.

Net interest income grew $1,122 million or 18 per cent. Interest rates across most markets have been on a downwards trend. Against a deteriorating credit environment, Consumer Banking has moved its focus to secured products, de-emphasising relatively higher-yielding unsecured loans. Underwriting standards have also been tightened and additional resources have been allocated to recovery management. Interest expense reduced as interest paid on customer current accounts and time deposits reduced even though customer deposits grew 31 per cent. Net interest margin was 2.5 per cent, in line with last year.

Non-interest income grew $1,779 million, or 37 per cent, to $6,581 million.

Net fees and commissions income increased by $280 million, or 11 per cent, to $2,941 million. The volatility seen across stock markets and exchanges dampened investor sentiment and significantly affected Wealth Management offerings such as unit trusts, insurance and structured investment products. Custody income in Wholesale Banking was also adversely impacted as assets under management (AUM) fell and the benefit of cash deposits fell in a lower rate environment. Trade finance commission income benefited from higher transaction volumes, and in Transaction Banking, payments and cash management services delivered strong performances, driven by the growth in commercial balances.

Net trading income increased $1,144 million, or 91 per cent, to $2,405 million. A significant proportion of this growth was client driven, with particularly high growth in foreign exchange income. The high volatility seen in key markets such as Korea and India drove increased client demand and the Group was well positioned in terms of product capabilities to meet customer needs. Own account trading performance was strong with significant gains in foreign exchange, debt securities trading and asset and liability management (ALM).

Other operating income increased $355 million, or 40 per cent, to $1,235 million. Other operating income benefited from a $146 million gain on the disposal of the asset management business in India, and $384 million of gains on the buy back of Upper Tier 2 floating rate notes. These gains were offset, in part, by lower dividend income. Other operating income also benefited from $80 million of recoveries in respect of assets that had been fair valued at acquisition in Taiwan, Korea and Pakistan, down $18 million, or 18 per cent, from 2007.

Operating expenses increased $1,396 million, or 22 per cent, to $7,611 million. Almost 60 per cent of this increase was driven by staff costs which increased 20 per cent, or $788 million, to $4,737 million. Consumer Banking made organisational changes to improve efficiency and to generate headroom for investment. Wholesale Banking took advantage of the market dislocation to recruit staff with specialist market and product knowledge to augment its existing technical skill base. Variable compensation also increased in line with the strong business performance. Other investments were directed at enhancing the product suite and extending and upgrading branch networks in China, Hong Kong, Pakistan, Taiwan and Korea. Expenditure was also incurred to upgrade and expand office premises and to strengthen regulatory compliance and control systems.

The normalised cost to income ratio was 56 per cent, flat to 2007.

Operating profit before impairment losses and taxation increased $1,505 million, or 31 per cent, to $6,357 million.

The charge for loan impairment increased by $560 million, or 74 per cent, to $1,321 million. In the second half of the year, the credit environment became increasingly challenging for corporate and retail customers alike, with an increase in delinquencies. There was higher specific provisioning and also an increase in the portfolio impairment provision as flow rates deteriorated.

Other impairment charges increased significantly to $469 million, from $57 million in 2007, driven primarily by write downs in asset backed securities of $41 million, impairment of private equity investments of $171 million and impairment of the strategic investment portfolio of $186 million.

Operating profit was up $533 million, or 13 per cent, to $4,568 million. As explained in note 11 on page 114, the Group was required to recognise a gain of $233 million on the rights issue option. Profit before taxation was up $766 million, or 19 per cent, to $4,801 million.

Consumer Banking

The following tables provide an analysis of operating profit by geographic segment for Consumer Banking:

2008
Asia Pacific
Hong Kong
$million
Singapore
$million
Malaysia
$million
Korea
$million
Other Asia Pacific
$million
India
$million
Middle East & Other S Asia
$million
Africa
$million
Americas, UK & Europe
$million
Consumer
Banking
Total
$million
Underlying
$million
Operating income 1,163 618 265 1,017 1,128 484 700 344 233 5,952 5,682
Operating expenses (587) (289) (128) (726) (879) (317) (410) (250) (257) (3,843) (3,492)
Loan impairment (106) (20) (48) (161) (263) (89) (178) (19) (53) (937) (869)
Other impairment (25) - - - (2) (7) - - (22) (56) (56)
Operating profit/(loss) 445 309 89 130 (16) 71 112 75 (99) 1,116 1,265
2007
Asia Pacific
Hong Kong
$million
Singapore
$million
Malaysia
$million
Korea
$million
Other Asia Pacific
$million
India
$million
Middle East & Other S Asia
$million
Africa
$million
Americas' UK & Europe
$million
Consumer
Banking
Total
$million
Operating income 1,188 471 274 1,142 1,167 408 751 310 95 5,806
Operating expenses (478) (191) (116) (907) (760) (268) (395) (224) (54) (3,393)
Loan impairment (53) (15) (41) (96) (308) (77) (129) (17) - (736)
Operating profit 657 265 117 139 99 63 227 69 41 1,677

An analysis of Consumer Banking income by product is set out below:

Operating income by product 2008
$million
2007
$million
Cards, Personal Loans and Unsecured Lending 2,106 2,089
Wealth Management and Deposits 2,789 2,621
Mortgages and Auto Finance 928 906
Other 129 190
Total operating income 5,952 5,806

The early part of the year saw steady income growth, although with some emerging signs of softness in unit trust sales. As the year progressed, the earlier signs of weakness in Wealth Management product sales turned into a sharp slowdown in the second half. The operating income growth of 15 per cent in the first half was not sustained and income fell 13 per cent in the second half when compared to the first half of the year. In the face of challenging liquidity conditions, Consumer Banking raised significant additional deposits supporting the strength of the Group balance sheet.

For the full year, Consumer Banking’s operating income increased by $146 million, or three per cent, to $5,952 million. Net interest income grew $30 million, or one per cent, to $4,224 million, with an increase in asset and liabilities volumes offsetting lower margins. Other income grew $117 million, or seven per cent, to $1,806 million.

Across the geographic segments, Singapore, India, Africa and Americas, UK and Europe all delivered strong double-digit income growth. Hong Kong, Malaysia, Korea, Middle East and Other South Asia (MESA) and Other Asia Pacific delivered reduced income year on year reflecting the difficult trading conditions, and to some extent adverse exchange translation effects.

Operating expenses increased by $450 million, or 13 per cent, to $3,843 million. Against a backdrop of slowing revenue growth the Group has been rigorous in reducing the cost base. Headcount has been reduced which has created capacity in the expense base for investment in infrastructure such as branch renovations in Korea, China and Taiwan, a continuation of the Private Bank roll out in China, Hong Kong and Singapore and product roll outs across the franchise.

Loan impairment increased by $201 million, or 27 per cent, to $937 million. Worsening credit conditions have driven up impairment charges across the franchise in the latter part of the year, most notably in the unsecured and SME portfolios in Hong Kong, Korea, UAE and India. Individual impairment provision accounts for $121 million of the increase, and $80 million from portfolio impairment provision. AEB accounts for $68 million of the total increase in loan impairment. The impact of the deteriorating markets on the Consumer Banking portfolio has been mitigated with over three quarters of the asset portfolio secured, and the average loan to value in the mortgage books being under 52 per cent. The Group has also taken early action to tighten lending criteria, adjust pricing to reflect the higher risk environment and to increase collections resources.

Operating profit fell $561 million, or 33 per cent, to $1,116 million.

Product performance

Cards, Personal Loans and Unsecured Lending grew operating income by $17 million, or one per cent, to $2,106 million. Excluding the revenue from the partial sale of Visa shares of $17 million, $107 million in 2007, income growth was five per cent. Income was reduced by actions taken to move into lower risk and more secured portfolios, notably in Korea, Thailand, India and Pakistan. This fall was partially mitigated by strong volume growth in Personal Loans driven by Hong Kong, Taiwan, Singapore, China and Malaysia. Actions were taken early in the year to reduce the risk of the SME portfolio and this has had some initial adverse impact on income.

Wealth Management grew operating income by $168 million, or six per cent, to $2,789 million. Falling equity markets and retail customer risk aversion following the collapse of Lehman Brothers adversely affected fee income, primarily in funds and structured notes sales, where income in the second half of the year was down over 50 and 67 per cent respectively, with Hong Kong and Taiwan being particularly affected. This reduction in fee income was partly offset by customers switching into ‘all weather’ products such as treasury, capital protected and deposit products. Wealth Management liabilities grew by 19 per cent, driven by deposit product innovation such as Marathon Savings in Hong Kong, E$aver Kids in Singapore, Do-Dream accounts in Korea and E$aver in Malaysia. Although the average liability margin was constant throughout the year, there were significant underlying fluctuations with margins reducing in the last quarter of the year.

Mortgages and Auto Finance income grew by $22 million, or two per cent, to $928 million. Net interest margins were under pressure in the latter half of the year particularly in Hong Kong, due to narrowing of the Prime-HIBOR spread, in Korea due to increased funding costs and in Taiwan due to intense competition. This has been compensated to some extent by an increase in volumes in Hong Kong, Singapore and Taiwan driven by new products such as tracker rate mortgages in Singapore and Hong Kong.

Geographic segment performance
Hong Kong

In Hong Kong, income was down $25 million, or two per cent, to $1,163 million. The second half of 2008 was particularly challenging. Falling equity markets and the failure of Lehman Brothers in mid-September led to widespread public concern over wealth management products in general. Sales of unit trusts, structured notes and other investment products slowed sharply in the second half of the year with a fall in fee income. Mortgage volumes grew $1.1 billion, but spread compression reduced interest income, although this was offset to some extent by increased fees on home insurance products, amongst others. Income from deposits increased, supported by new products and savings rate offer campaigns driving up liabilities by 23 per cent, which more than compensated for reduced margins. Operating expenses grew $109 million, or 23 per cent, to $587 million. Expenses increased, largely due to incremental staff and premises costs as a result of the expansion in the branch network. Incremental expenses relating to the impact of financial dislocation were incurred in the Wealth Management business. Working profit was down $134 million, or 19 per cent, to $576 million. Loan impairment grew $53 million, or 100 per cent, to $106 million. The rise in loan impairment was driven primarily by the SME segment which deteriorated in the latter part of the year as economic conditions worsened. Other impairment of $25 million reflects impairment on strategic investments. Operating profit was down $212 million, or 32 per cent, to $445 million.

Singapore

In Singapore, income grew $147 million, or 31 per cent, to $618 million. Income from mortgages rose, supported by lower customer attrition, and stronger sales which resulted in a doubling of share of new market sales to 20 per cent. Margins improved in the early part of the year, then compressed as a result of increased funding costs and intense competition. Wealth Management income grew 52 per cent, mainly from the acquisition of AEB as noted below. Income was driven up by customer deposits which grew by 60 per cent as deposit gathering campaigns were launched, coupled with Wealth Management customers retaining funds largely in deposits. Excluding AEB, Wealth Management was adversely impacted by the global downturn, as customers switched away from unit trusts into lower fee earning treasury and deposit products. Operating expenses grew $98 million, or 51 per cent, to $289 million. Flow through costs from 2007 investments in Private Bank and other products contributed $31 million of this increase. Working profit grew $49 million, or 18 per cent, to $329 million. Loan impairment was up $5 million, or  33 per cent, to $20 million. An increase in the unsecured loan impairment as a result of the deteriorating economic conditions was offset by a lower charge in mortgages and SME, which benefited from proactive risk management. Operating profit was up $44 million, or 17 per cent, to $309 million.

Malaysia

In Malaysia, income was down $9 million, or three per cent, to $265 million. Mortgage income was lower as margins fell in the face of competition. A decrease in Wealth Management income reflected a lack of consumer confidence in the equities markets. There was, however, an improvement in unsecured lending income, which benefited from the implementation of a revised sales and incentives scheme. Operating expenses grew $12 million, or ten per cent, to $128 million. Expenses were driven higher by projects, reorganisation expenses and also costs related to product development. Working profit was down $21 million, or 13 per cent, to $137 million. Loan impairment was up $7 million, or 17 per cent, to $48 million. The second half of the year saw an increase in delinquencies across unsecured products driving up the impairment charge. Reduced income, increased costs and loan impairment drove operating profit down $28  million, or 24 per cent, to $89 million.

Korea

In Korea, income was down $125 million, or 11 per cent, to $1,017 million. On a constant currency basis income rose four per cent. Income was adversely affected by the sharp downturn in the investment services market, where in the second half of 2008 income fell 52 per cent from the first half, and by a decision to reduce new sales in SME unsecured lending; a product set with higher margins but also higher risk. Margins on mortgages also reduced in the latter part of the year. Income benefited from recoveries of $14 million on assets that had been fair valued at acquisition, although this was down $53 million from 2007. Income also included a credit of $24 million from the economic hedges of the mortgage portfolio, which had an adverse impact on income of $102 million in 2007. Operating expenses were down $181 million, or 20 per cent, to $726 million. On a constant currency basis expenses fell five per cent. Expenses were tightly controlled with the extension of an early retirement programme helping reduce headcount and salary costs. Approximately 200 staff were redeployed to sales areas, with a similar number taking early retirement. Expenses also benefited from the release of certain provisions related to staff costs. This was offset by costs relating to repositioning and upgrading the branch footprint as part of the strategic reorganisation of the business, with 109 branches upgraded during the year. Marketing and brand expenditure also drove expenses higher. Working profit was up $56 million, or 24 per cent, to $291 million. On a constant currency basis working profit was up 39 per cent. Loan impairment was up $65 million, or 68 per cent, to $161 million. Impairment was driven higher by a number of factors. Increased debt restructuring applications increased impairment on unsecured lending products as the number of applicants increased through 2008. There was also deterioration in the SME sector, and in particular, the performance of the Business Instalment Loan portfolio in the second half of the year. Operating profit was down $9 million, or six per cent, to $130 million, though on a constant currency basis operating profit increased two per cent.

Other Asia Pacific

In Other Asia Pacific, income was down $39 million, or three per cent, to $1,128 million. In China, income was up 20 per cent to $143 million driven by deposit growth of 53 per cent and strong volume growth in Personal Loans, Mortgages and Business Instalment Loans, although Wealth Management sales fell in the second half of the year. In Thailand, income reduced as secured lending volumes fell and margins compressed. Taiwan saw a sharp decrease in Wealth Management income as consumer confidence fell sharply in the light of volatile equity markets. Income in Taiwan benefited from recoveries of $37 million on assets that had been fair valued at acquisition, up $36 million from 2007. Operating expenses in Other Asia Pacific were up $119 million, or 16 per cent, to $879 million. Expenses were up $103 million in China to $238 million, driven higher by the rapid expansion of the workforce as the number of outlets grew to 54 from 38 at the end of the previous year. China and Taiwan also both saw expenses increase from flow-through depreciation from branch premises investment in previous years. Working profit in Other Asia Pacific was down $158 million, or 39 per cent, to $249 million, with loan impairment down $45 million, or 15 per cent, to $263 million. Thailand saw a reduction in impairment as actions taken to de-risk the portfolios took effect. In Taiwan, impairment was down as collections efforts were enhanced in the face of a weakening credit environment and the introduction of new bankruptcy laws. In China loan impairment was up $5 million to $14 million and other impairment was $2 million. Overall, the operating loss of $16 million in Other Asia Pacific was down $115 million on 2007. Losses in China increased from $25 million to $111 million.

India

In India, income was up $76 million, or 19 per cent, to $484 million. Income was driven up by increased product volumes in SME and mortgages, with strong momentum in the second half. This strong volume growth more than offset a reduction in margins due to an increased cost of funding. Wealth Management was impacted by the global downturn with unit trust sales down sharply in the last quarter. Cards income fell as margins were squeezed and volumes were also reduced to de-risk the portfolio. Operating expenses were up $49 million, or 18 per cent, to $317 million. Expenses were driven higher by flow-through investment costs from 2007 and incremental premises and technology costs. Working profit was up $27 million, or 19 per cent, to $167 million. Loan impairment was up $12 million, or 16 per cent, to $89  million. Impairment was driven higher by increased delinquencies on personal lending products. There has, however, been no equivalent deterioration on cards or mortgages products. Other impairment was $7 million, reflecting impairment on strategic investments. Operating profit was up $8 million, or 13 per cent, to $71 million.

MESA

In MESA, income was down $51 million, or seven per cent, to $700 million. In UAE, income fell three per cent, as deposit spreads fell in a low interest rate environment, and a weaker performance in the Wealth Management business was only partially compensated by liability growth of 11 per cent. The mortgage portfolio grew throughout the year, although this growth stalled in the last quarter of the year as levels of activity in the market fell. In Wealth Management, whilst customer AUM remained flat over the whole year, the second half of the year saw a steady decline in bancassurance product sales in the light of global equity market falls. In Pakistan, economic factors contributed to a difficult trading environment with income down 25 per cent year on year. Operating expenses in MESA were up $15 million, or four per cent, to $410 million. In UAE, management has taken strong action on expenses and the cost run rate reduced in the second half of the year. In Pakistan, expenses were down as the workforce reduced by nine per cent, partly offset by expenditure on the branch network. Working profit in MESA was down $66 million, or 19 per cent, to $290 million, and loan impairment was up $49 million, or 38 per cent, to $178 million. The principal increase was in UAE where loan impairment was up over 90 per cent, driven by unsecured lending, and in the SME sector, with some early signs of stress in the mortgage book as property prices fell and loan to value amounts increased. As a result of falling income, increased expenses and loan impairment, operating profit for the MESA region fell $115 million, or 51 per cent, to $112 million.

Africa

In Africa, income was up $34 million, or 11 per cent, to $344 million. In Nigeria, recent investments in branches helped drive performance with income up $15 million, or 58 per cent, with liability growth of 41 per cent. In Uganda and Zambia, income growth was strong, increasing by 36 per cent and 33 per cent respectively, compensating for the flat growth in Kenya where momentum slipped after the elections. New product launches and targeted deposit campaigns served to drive a double-digit percentage increase in liability balances in all markets though this growth was offset by currency translation effects. Operating expenses in Africa increased $26 million, or 12 per cent, to $250 million. Staff costs were driven higher across the region primarily driven by wage inflation. Zambia and Ghana both incurred redundancy costs as the organisations were restructured. Working profit in Africa was up $8 million, or nine per cent, to $94 million. Loan impairment was up $2 million, or 12 per cent, to $19 million. Operating profit in Africa was up $6 million, or nine per cent, to $75 million.

Americas, UK and Europe

In Americas, UK and Europe, the impact of the AEB acquisition was material and is covered below. Underlying income increased $13 million, or 14 per cent to $108 million. Income growth was achieved despite falling interest rates and market volatility by realigning the relationship management sales teams, and by driving higher fee income, primarily from foreign exchange products and premium currency investments. Underlying operating expenses were up $1 million, or two per cent, to $55 million. Underlying working profit was up $12 million, or 29 per cent, to $53 million. Underlying other impairment was up $22 million representing provisions on strategic investments, which eliminated the improvements made at the working profit level. Underlying operating profit was down $10 million, or 24 per cent, to $31 million.

Wholesale Banking

The following tables provide an analysis of operating profit by geographic segment for Wholesale Banking:

2008
Asia Pacific
Hong Kong
$million
Singapore
$million
Malaysia
$million
Korea
$million
Other Asia Pacific
$million
India
$million
Middle East & Other S Asia
$million
Africa
$million
Americas UK & Europe
$million
Wholesale
Banking
Total
$million
Underlying
$million
Operating income 1,104 808 250 559 1,310 1,116 1,034 565 743 7,489 7,207
Operating expenses (430) (348) (84) (229) (630) (329) (403) (314) (1,001) (3,768) (3,516)
Loan impairment (77) 5 1 (102) (126) (44) (7) (14) (20) (384) (378)
Other impairment (27) (30) (21) - (79) (17) - - (162) (336) (336)
Operating profit/(loss) 570 435 146 228 475 726 624 237 (440) 3,001 2,977
2007
Asia Pacific
Hong Kong
$million
Singapore
$million
Malaysia
$million
Korea
$million
Other Asia Pacific
$million
India
$million
Middle East & Other S Asia
$million
Africa
$million
Americas, UK & Europe
$million
Wholesale
Banking
Total
$million
Operating income 870 421 184 418 933 899 676 485 357 5,243
Operating expenses (347) (239) (69) (239) (445) (260) (299) (244) (672) (2,814)
Loan impairment 3 (1) 3 2 (10) (13) (14) (10) 15 (25)
Other impairment - - - - - - - (2) (55) (57)
Operating profit/(loss) 526 181 118 181 478 626 363 229 (355) 2,347

During the year Wholesale Banking has realigned its financial disclosures to provide greater transparency. As a result, the Trade and Lending businesses have been split; the ‘Trade’ business, with income of $1,023 million in 2008 and $699 million in 2007, is now reported together with ‘Cash Management and Custody’ which are part of ‘Transaction Banking’. The ‘Lending’ business, with income of $551 million in 2008 and $537 million in 2007, is now reported with ‘Lending and Portfolio Management’. ‘Global Markets’ remains unchanged. An analysis of Wholesale Banking income by product is set out below:

Operating income by product 2008
$million
2007
$million
Lending and Portfolio Management 551 537
Transaction Banking 2,663 2,033
Global Markets*
Financial Markets 2,365 1,323
Asset and Liability Management (ALM) 912 496
Corporate Finance 745 454
Principal Finance 253 400
Total Global Markets 4,275 2,673
Total operating income 7,489 5,243
Financial Markets operating income by desk 2008
$million
2007
$million
Foreign Exchange 1,194 1,017
Rates 748 158
Commodities and Equities 141 49
Capital Markets 234 259
Credit and Other 48 (160)
Total Financial Markets operating income 2,365 1,323

Wholesale Banking had another strong year, with broad based income growth driven by continued client revenue momentum, which remains the cornerstone of a consistent and well executed strategy. Own account income also reported a significant increase reflecting strong ALM income growth, and the benefits from the recent investment in the capabilities of the Financial Markets teams who were well positioned to take advantage of the opportunities provided by high market volatility. Targeted investments in core strategic markets and products strengthened and broadened capabilities into the large geographies. This, together with the further acquisition of talent, has provided product depth and breadth to better meet customer needs.

Operating income grew $2,246 million, or 43 per cent, to $7,489 million. Net interest income was up $1,092 million, or 53 per cent, to $3,163 million while non-interest income was up $1,153 million, or 37 per cent, to $4,248 million. Client revenues represented 75 per cent of total income and were up 31 per cent on the previous year.

Operating expenses grew $954 million, or 34 per cent, to $3,768 million. Approximately one third of this increase was driven by staff expenses. The business continued to invest in skills and expertise, building in areas such as sales, trading and financial institutions teams. Flow through expenses from projects and new investments also drove up expenses together with increased property costs. In the light of market uncertainty Wholesale Banking reduced its expense run rate in the latter part of the year and second half expenses were some six per cent lower than the first half.

Working profit increased $1,292 million, or 53 per cent, to $3,721 million.

Loan impairment increased $359 million to $384 million reflecting the deteriorating economic environment. Most of the increased impairment came in the last quarter of the year notably in Korea, Hong Kong and Other Asia Pacific. The portfolio remains well diversified and is increasingly well collateralised.

Other impairment increased reflecting impairment on private equity investments of $171 million, and on asset backed securities of $41 million, and impairment provisions being taken against bonds of $60 million and other strategic investments of $55 million.

Operating profit increased $654 million, or 28 per cent, to $3,001 million.

Product performance

Lending and Portfolio Management income increased by $14 million, or three per cent, to $551 million. Gross lending was up 47 per cent year on year but was impacted by higher portfolio management costs in line with higher distribution activity.

Transaction Banking income increased by $630 million, or 31 per cent, to $2,663 million. The increase in income was driven by Trade, where income increased by 46 per cent, with strong growth in trade origination and improved margins as the business repriced to reflect the higher risk environment and tighter market liquidity. Cash Management and Custody income was up 23 per cent year on year, driven by a 24 per cent increase in volumes, more than offsetting the effects of reduced margins.

Global Markets income increased by $1,602 million, or 60 per cent, to $4,275 million.

The Financial Markets business is primarily driven by client income. Financial Markets grew income $1,042 million, or 79 per cent, to $2,365 million with strong growth across most products. Foreign exchange income increased 17 per cent with growth being adversely impacted by provisions raised in relation to model and counterparty risk. Rates had an exceptional year in both sales and trading. Sales were driven higher by an increasing number of large transactions with corporates, notably in India, Korea and UAE. Enhanced risk management practices, correct positioning on rate reductions, and gains from government bonds all helped drive income higher.

ALM income grew 84 per cent from $496 million to $912 million, benefiting from strategic positioning in late 2007 coupled with timely re-investment in 2008 to maximise accruals from steepening yield curves.

Corporate Finance income was up 64 per cent with strong revenue growth across all products. Much of the growth was fuelled by Corporate Advisory with income more than doubling, driven by a number of landmark deals in South Asia.

Principal Finance income was down 37 per cent year on year due to adverse mark-to-market valuations as a result of distressed global equity markets.

Geographic segment performance
Hong Kong

In Hong Kong, income was up $234 million, or 27 per cent, to $1,104 million. Client revenue was up 23 per cent and comprised over 85 per cent of total income. Transaction Banking grew $45 million, or 11 per cent, as strong volume growth more than offset the impact of reduced margins in a lower rate environment. Operating expenses grew $83 million, or 24 per cent, to $430 million. Expenses were driven higher by increased variable compensation for Global Markets staff and also by an increase in headcount. Investment expenditure also increased along with premises and infrastructure expenses. Working profit was up $151 million, or 29 per cent, to $674 million. Loan impairment grew $80 million, from a net recovery of $3 million in 2007. This was primarily due to deterioration in the local corporate and middle market segments. Other impairment of $27 million reflects provisions for strategic investments. Operating profit was up $44 million, or eight per cent, to $570 million.

Singapore

In Singapore, income grew $387 million, or 92 per cent, to $808 million. Own account had a very strong year delivering exceptional income growth as ALM and fixed income trading were able to take advantage of volatile market conditions. Client income increased 50 per cent with interest rate derivative sales, foreign exchange and debt capital markets all performing well. Operating expenses grew $109 million, or 46 per cent, to $348 million. The main driver of the increase was staff expenses and investment in specialist teams in areas such as commodities, options and interest rate derivatives, as well as variable compensation and investment expenses. Working profit grew $278 million, or 153 per cent, to $460 million. Loan impairment was down $6 million, to a net recovery of $5 million and was reflective of strong risk management processes. Other impairment of $30 million represents provisions made against private equity investments. Operating profit was up $254 million, or 140 per cent, to $435 million.

Malaysia

In Malaysia, income was up $66 million, or 36 per cent, to $250 million. Income growth was driven by structured finance, foreign exchange and derivative sales. Interest rate derivatives also performed strongly particularly in the first half of the year, bolstered by good volumes. Own account was also higher with ALM and foreign currency trading making strong contributions. Operating expenses grew $15 million, or 22 per cent, to $84 million. Expenses were driven up by higher staff costs from variable compensation and from investment costs. Working profit was up $51 million, or 44 per cent, to $166 million. The continued net recovery position reflects strong risk management and collections efforts. Other impairment was up $21 million as provisions were made against private equity investments. Operating profit was up $28 million, or 24 per cent, to $146 million.

Korea

In Korea, the business had a good year. Income was up $141 million, or 34 per cent, to $559 million. On a constant currency basis income rose 55 per cent. The weakening of the won drove significant income gains on foreign exchange and derivatives sales. In the latter half of the year interest rate derivative sales also made strong advances as prevailing interest rates moved favourably. Income benefited from recoveries of $4 million on assets that had been fair valued at acquisition, though this was down $28 million from 2007. Income also benefited from a $32 million credit to income from the economic hedges of the mortgage portfolio, as compared to an adverse charge in 2007 of $53 million. Income was also adversely impacted by a $118 million reversal of income relating to foreign exchange option contracts. Operating expenses were down $10 million, or four per cent, to $229 million. On a constant currency basis, expenses rose 13 per cent. Expenses were driven higher by staff and premises costs, though these were significantly offset by a retirement plan release arising from a curtailment. Working profit was up $151 million, or 84 per cent, to $330 million. On a constant currency basis, working profit rose 109 per cent. Loan impairment was up $104 million, from a net recovery of $2 million in 2007. This was driven up $79 million by provisions raised in respect of corporate customers who are disputing the terms of certain foreign exchange related transactions. Operating profit was up $47 million, or 26 per cent, to $228 million. On a constant currency basis, operating profit rose 43 per cent.

Other Asia Pacific

In Other Asia Pacific, income was up $377 million, or 40 per cent, to $1,310 million. Strong Transaction Banking income growth was driven off deposit growth, improved margins and fee income. In Thailand, the loosening of capital control measures allowed increases in currency and interest rate product sales to grow income. Income in Taiwan benefited from recoveries of $21 million on assets that had been fair valued at acquisition, up $18 million from 2007. China, Indonesia and Vietnam all saw an increase in foreign exchange and derivative sales. In China, income was up 29 per cent to $489 million. Operating expenses in Other Asia Pacific were up $185 million, or 42 per cent, to $630 million. Expenses across all countries were driven higher by staff and premises costs and investments. In China operating expenses were up 40 per cent to $229 million. Working profit across the region was up $192 million, or 39 per cent, to $680 million. Loan impairment was up $116 million from $10 million in 2007. Loan impairment increased in Indonesia from exposure to the steel sector and in Taiwan against electronic and computer manufacturers. Loan impairment in China was up $12 million to $13 million. Other impairment in Other Asia Pacific was up $79 million as provisions were made against private equity investments; $70 million of this increase related to China. Operating profit was down $3 million, or one per cent, to $475 million, of which $177 million came from China.

India

In India, income was up $217 million, or 24 per cent, to $1,116 million. Client revenues drove income growth. Corporate Finance and advisory transactions performed very strongly and higher foreign exchange and derivatives sales also contributed. Cash Management benefited from higher balances. There was strong growth in all customer segments led by local corporates where income grew 91 per cent. Own account performed well driven by Trading and ALM offset by lower Principal Finance. Operating expenses were up $69 million, or 27 per cent, to $329 million. Staff and premises related costs contributed to an increase in expenses. Working profit was up $148 million, or 23 per cent, to $787 million. Loan impairment was up $31 million, or 238 per cent, to $44 million. This increase in impairment reflects a general worsening in economic conditions, with the greatest impact in the middle market customer segment. Other impairment was up $17 million as provisions were made against private equity and strategic investments. Operating profit was up $100 million, or 16 per cent, to $726 million.

MESA

In MESA, income was up $358 million, or 53 per cent, to $1,034 million. Client revenues increased by 33 per cent and own account revenues also grew strongly. Islamic Banking income grew by over 60 per cent. UAE led income growth in MESA with an overall increase of 84 per cent, driven by Lending, Corporate Finance and Trade. Pakistan delivered income growth of eight per cent. This was driven by good growth in both the customer and own account areas. Operating expenses in MESA were up $104 million, or 35 per cent, to $403 million driven by staff and investment expenditure. Working profit was up $254 million, or 67 per cent, to $631 million. Loan impairment was down $7 million, or 50 per cent, to $7 million. Operating profit in MESA was up $261 million, or 72 per cent, to $624 million.

Africa

In Africa, income was up $80 million, or 16 per cent, to $565 million. Operating income growth was client led, up 29 per cent, and now forms 78 per cent of total income. This growth was driven by treasury products and in particular Financial Market sales and Corporate Finance, where combined revenue grew $71 million, or 40 per cent, to $250 million. Nigeria saw good income growth of 23 per cent, driven by Financial Market sales and Corporate Finance. In Ghana, Botswana, Uganda and Zambia, the combined income grew 19 per cent. Transaction Banking revenue across the region grew by 17 per cent with trade finance up over 40 per cent. Operating expenses in Africa were up $70 million, or 29 per cent, to $314 million. Working profit was up $10 million, or four per cent, to $251 million. Loan impairment was up $4 million, or 40 per cent, to $14 million. Operating profit was up $8 million, or three per cent, to $237 million.

Americas, UK and Europe

In Americas, UK and Europe, the impact of the AEB acquisition was material and is covered below. Income on an underlying basis increased by $116 million, or 32 per cent, to $473 million. Growth in client revenues in fixed income sales was strong, up 23 per cent, and Corporate Advisory and Structured Finance up 75 per cent. ALM also performed well taking advantage of declining interest rates. The income growth was, however, offset by higher credit loss provisions. Underlying expenses grew $123 million, or 18 per cent, to $795 million, reflecting continued investment in the region, amortisation of intangibles relating to the acquisitions of Harrison Lovegrove and Pembroke, and increased depreciation on aircraft leases in respect of the Pembroke business. Loan impairment charges increased $28 million from a net recovery position of $15 million in 2007. Other impairment charges increased by $107 million to $162 million. This was due to provisions taken for impairment on debt securities, private equity and strategic investments. Impairment on asset backed securities was up $6 million to $41 million. The underlying operating loss increased from $355 million to $497 million.

Acquisitions

The Group made a number of acquisitions in 2007 and 2008. The only acquisition to materially impact the results of the Group was on 29 February 2008, when the Group completed the purchase of AEB from American Express Company. In relation to the acquisition of AEB, the Group and American Express Company also entered into a put and call option, exercisable after 18 months from the acquisition of AEB, under which American Express Company can sell and the Group can purchase 100 per cent of American Express International Deposit Company at its net asset value at the time that option is exercised.

The Group made good progress in integrating AEB and, rebranding work is finished as is the majority of the technology migration work. Approximately 70 per cent of AEB’s income and expenses is shown in the Americas, UK and Europe geographic segment, 13 per cent of income and expenses in Singapore and approximately ten per cent of income and expenses in Hong Kong. AEB total income was $552 million, of which $270 million, or 49 per cent, was in Consumer Banking, predominantly in the Private Bank. There was some downwards pressure on income in the latter part of the year as both fund values and AUM reduced, adversely impacting client income. This was partially offset by an increase in liability balances as, against a backdrop of falling equity markets, customers moved a higher proportion of their assets into cash. Wholesale Banking derived $282 million of income from AEB, 82 per cent of which was in Transaction Banking products. In the second half, Transaction Banking income reduced as trade volumes fell and margins compressed. ALM income was also down in the latter part of the year as, in increasingly uncertain market conditions, the risk profile was reduced.

Operating expenses were $603 million, and included integration, amalgamation and restructuring expenses of $157 million. Expense synergies delivered were approximately $60 million.

Impairment of $74 million is predominantly against impaired collateral provided by the Private Bank’s clients where sharp falls in collateral values have resulted in a shortfall against lending assets. The operating loss of $124 million was slightly more than our expectations.

The effects of the following acquisitions were not material to the 2008 results of the Group.

The acquisitions of Pembroke Group Limited (Pembroke), Harrison Lovegrove & Co. Limited (Harrison Lovegrove) and A Brain Co. Limited (A Brain) were completed on 5 October 2007, 3 December 2007 and 5 December 2007 respectively. The Group acquired the remaining share of A Brain Co. Limited (A Brain) on 21 January 2008.

On 11 January 2008, the Group completed the acquisition of a 49 per cent joint venture interest in UTI Securities Limited (UTI), an equity brokerage firm in India. On 12 December, the Group exercised its option to acquire a further 25.9 per cent, which increased the Group’s investment to 74.9 per cent. This is currently accounted as a joint venture and the Group has the option to obtain full control by acquiring the balance of 25.1 per cent in 2010.

On 25 February 2008, the Group completed the acquisition of a mutual savings bank, Yeahreum Mutual Savings Bank (Yeahreum), in Korea.

On 27 December 2008, the Group completed the acquisition of the ‘good bank’ portion of Asia Trust and Investment Corporation (ATIC) in Taiwan.

In September 2008, the Group received regulatory approval to exercise its nil cost option to convert the $4 million of convertible preference shares it holds into equity of First Africa, which, when exercised, would give the Group an equity shareholding of 65 per cent. Following such conversion, the Group will also exercise its call option over the remaining 35 per cent of the company. Both these transactions are expected to complete in the first quarter of 2009. As the conversion options are currently exercisable, the Group has consolidated First Africa from September 2008 in line with the requirements of IAS 27.

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