Interim Results 2015 - Part 1

Reorganisations can be distracting but, from what I have heard as I have travelled across the Group, this is what we need, and it has been welcomed. There is a strong desire to follow through and make lasting improvements in how we serve our clients and manage our processes. 

Following the organisation changes we have announced, we have a new leadership; more streamlined regional groupings; a structure that reinforces the highest standards of risk management, compliance and conduct; more accountability for issues that matter for our clients and other stakeholders in our markets; and business leaders, including me, who can be held accountable for performance through to the bottom line. This is only the first step we will be taking in reshaping the Group. 

Asset quality

One clear area of focus for investors and the Board as I joined the Group was for me to review the quality of the Group's lending decisions and credit portfolio, the quantum of certain exposures and the trends in impairment, particularly in our corporate client base. I have not completed my review of the entire book. However, I have spent time getting to understand our people and processes, and have looked more closely at some of our larger exposures, both to large corporates and in areas such as our Retail unsecured portfolio. The loan impairment outcome for the first half and the increase in non-performing loans is a continuation of adverse trends, and there are no signs of these reversing. The sources of impairment have been the same that the Group identified previously: commodities, China and India. My initial observations on the loan book are:

First, the small number of concentrated exposures we have already flagged are not representative of our wider loan book. We have reduced exposures to the top 20 corporate groups, both in absolute terms and as a proportion of the Group's Capital resources, consecutively since 2013.  We will focus on further reducing these exposures over time.

Second, the on-the-ground credit culture of the organisation is generally sound. We have the right people in place now, and I am particularly pleased to have announced that Mark Smith will be joining as the new Chief Risk Officer at the start of next year.

Third, some elements of our risk management framework were not what they should have been. Mistakes have clearly been made where decisions were taken which would now be outside of our risk framework. We grew aggressively in certain markets, we accepted high concentrations by industry, by geography and by individual borrower, and we have found some weak operational controls which exposed the Group to losses and fraud. 

Finally, pricing discipline has been lacking. In my experience, a strong focus on return discipline is the first and most important contributor to a sound risk management framework. As we focus on achieving our return targets, we will shift the balance of our business decidedly towards assets which generate an acceptable return through the credit cycle.

We will fix the issues relating to our prior risk mistakes, and indeed we have already started: we are reducing the unsecured portfolio in Korea; originating personal loans through full-time staff members rather than sales agents; reducing exposures to commodity clients, given the adverse trends in commodity markets; and continuing to manage down the Group's small number of concentrated exposures. 

We are also adjusting our approach, recognising the lessons learned from these mistakes, and formalising revised risk appetite policies and limits along industry, geography and borrower dimensions; upgrading management information systems to clearly present return expectations and tracking; and streamlining approval processes to speed up decision making and, most importantly, improve accountability.

Overall, I am sure we can fix the systems and processes, in large part because we have good people throughout the Risk team who understand our markets and are ready to go.

Capital and dividends

The Board has decided to rebase the dividend to better reflect our current earnings expectation and outlook and to set a payout ratio consistent with our desire to continue to strengthen our capital position. The decision to rebase the dividend reflects our current profile and not the outcome of the ongoing strategic and structural changes that we are considering. 

The Group outlined its plans to achieve a Core Equity Tier 1 ratio of between 11 and 12 per cent. We have reached this level six months before the end of the year. The uplift of 80 basis points in the period is testament to the Group's ability to accrete capital and generate momentum. As part of our strategic review, we will look at both our capital targets and our ability to continue to generate capital, which will also be informed by the upcoming Bank of England stress test. 

No decisions have yet been taken on whether or not we will seek additional capital, but we are taking a long-term view, ensuring that we can remain absolutely and relatively strong through economic cycles and the inevitable macro shocks, either from our markets or arising globally, and absorb the impacts from increases in conduct costs. If we decide we need capital for the long-term benefit of the Group, we will raise capital. If we decide we don't need it, we won't.

Conduct

The Management Team is focused on meeting our obligations to our communities and regulators in all matters related to compliance and prevention of financial crime. 

We have previously disclosed that we are in ongoing discussions with the relevant authorities regarding our sanctions and anti-money laundering (AML) controls. We continue to co-operate fully with US authorities on this work, and it remains that we cannot predict the nature or timing of its outcome. We exited the small and medium-sized enterprise client segment in the UAE at the end of last year, and are taking other measures across the globe to de-risk our client portfolios and enhance our transaction screening and monitoring in order to avoid any repeat of earlier shortcomings.

We continue to work closely with our home regulators on financial crime compliance. This has likewise prompted changes to the way we do things in a number of our markets and client segments. As a result, we have tightened client on-boarding procedures to reduce inherent risk while we focus on improving our controls.

As noted in our disclosures, the outcome of these enquiries is impossible to predict accurately, but we will provide updates as appropriate.

It is imperative that we always learn from any past shortcomings, and apply these lessons as we continue to reinforce our controls and processes.

We have hired some of the best and brightest people in the industry over the past year, and have increased our financial crime compliance headcount nearly five-fold in the past three years. We have ensured local compliance managers are guided to take direct action as appropriate. Our new structure gives local and regional management authority and accountability for their control environments but also access to resources needed to discharge this responsibility, including the strategic oversight from our Board Financial Crime Risk Committee. In May we were also invited to join the Wolfsberg Group, an association of global banks that set the industry standards for know-your-customer, AML and anti terrorist financing.

The goal of all this activity and investment is not merely to ensure robust compliance, but to make a meaningful and leading contribution to the global fight against financial crime.

Conclusion

I intend to announce a clear plan of action by the year end. Many of the areas we are considering are complex; the Board and I want to get to the right answers and are taking the time to complete our work. In my conversations with shareholders, they have made it clear they want a thorough review of the areas I have outlined, and prefer a thoughtful response to a rushed one. I am listening to, and acting upon, those views.

In the meantime, we are not standing still: our focus on returns is clear in our client and investment decisions; our new Management Team is in place and focused on driving the organisation; and our regional CEOs are forming plans to run integrated local banks, leveraging our global strengths. Finally, we continue to innovate and transform our underlying businesses along the lines we have previously set out, building on the strengths of our underlying franchise: our network, our brand and our solid core businesses.

Beyond the current execution areas of focus, we will continue to ask ourselves questions, including:

·    How do we benchmark against our evolving competitors, and where are we advantaged?

·    How should we reshape our portfolios, business mix and geographic presence, given the linkages between them?

·    How can we make more of our investment in technology to extend our pockets of outstanding innovation across the Group?

·    How can we continue to evolve and simplify our structure to improve processes and controls and ensure that our corporate structure is fit for purpose and an enabler of strategy?

·    How can we think more strategically about our cost base, taking out costs where we can and investing in the areas of the business that will drive future performance?

As we work through these questions, we are assessing ourselves and the outcomes through the dual financial priorities of strengthening our capital position and re-building returns on equity. We are making good progress, and have a clear view of what the Group should look like at the end of the process.

In my day one letter as Group Chief Executive I wrote that I had reached the clear conclusion that this is a great bank. That is still my view.

As we address performance challenges and think about the shape of the Group over the next few months, the Management Team and I are focused on ensuring this institution is: well capitalised and able to manage and navigate any future shocks; delivering returns above its cost of capital; more efficiently structured, with a lower cost base; at the leading edge of risk management, regulatory compliance and the fight against financial crime; and more clearly focused on what we can do well,  making better use of our key competitive advantages: our global network and deep client relationships.

We are determined that this great bank regains its sense of self belief and self confidence so that we can again lead in our chosen businesses and deliver strong performance.

Bill Winters

Group Chief Executive

5 August 2015