Hitt og þetta 26. júlí 2006


26 July 2006

Northern Rock plc today issued its Interim Results for the six months ended 30 June 2006.

HIGHLIGHTS Operating Performance

* Total underlying assets of £88.0 billion - an increase of 23.6% from June 2005 underlying assets of £71.2 billion * Record H1 gross lending of £14.8 billion - an increase of 28.3%, with record H1 net lending of £7.3 billion - an increase of 22.0% * Share of UK net mortgage lending of 14.3% - similar to levels achieved in 2005 * Number of mortgage accounts 3 months or more in arrears at 0.45% (31 December 2005 - 0.39%) remain under half of industry average * Retail savings intake of £1.7 billion - continuing to grow our retail funding franchise


* Statutory pre tax profits of £293.9 million, up by 13.3% * Underlying pre tax profits of £273.7 million, up by 14.4% * Underlying attributable profits of £173.5 million, up by 16.1%


* Cost to underlying asset ratio improved to 0.32% (2005 full year - 0.34%) * Cost to underlying income ratio improved to 28.9% (2005 full year - 29.8%)

Shareholder Value

* Underlying return on equity increased to 21.5% and 23.3% on a statutory basis (2005 first half - 20.7% and 21.6%) * Underlying EPS of 41.6p (2005 first half - 36.1p) - an increase of 15.2%. * Interim dividend per share of 10.9p (2005 first half - 9.4p) - an increase of 16.0%

Social Responsibility

* The Northern Rock Foundation - supporting charitable causes - to receive £14.7 million

Adam J Applegarth, Chief Executive, said:

"Northern Rock has had a good first half in 2006. We achieved all of our strategic targets, with our performance very much in line with the guidance we gave at the beginning of the year. In addition, we have put in place some key building blocks for the longer term, including a preference share issue, a second Whinstone transaction as well as bringing on-stream major new IT systems.

Another strong lending performance has contributed to an increase in underlying profits attributable to shareholders of 16.1%, generating a return on equity of 21.5%. These results are in line with our objective of seeing our rate of asset growth trending towards the centre of the 20% + / - 5% range over the next two to three years.

Given the proven robustness of our business model, we also announce today that we are changing our strategic target range for annual growth in underlying profits attributable to shareholders upwards to 20% + / - 5%, on a like for like basis (from 15% + / -5%) recognising that it is likely to take a couple of years to achieve the centre of this range."

The full set of financial results is available at the following link: http://companyinfo.northernrock.co.uk/investorRelations/results/


Following the introduction of IFRS, the balance sheet and income statement are subject to a certain amount of volatility. This particularly arises from accounting for hedges which although economically effective are deemed under IFRS rules to be ineffective. In addition, volatility arises from fair value movements on derivatives taken out to minimise risk in respect of certain financial liabilities and instruments included in non shareholders' equity which themselves are not subject to fair value treatment. Where appropriate, such volatility is separately identified in the review of financial and operating results to enable underlying performance to be separately identified. Underlying total assets also exclude the fair value of derivative instruments due to volatility in such values.

As explained in note 2, the 2005 statutory Interim Results have been restated to reflect changes to the treatment of certain hedge accounting adjustments. There is no impact on the 2005 underlying Interim Results nor on any aspect of the 2005 full year results.


Strong lending volumes continued in the first half of 2006 resulting in underlying total assets of £88.0 billion, an increase of 23.6% compared with 30 June 2005. Residential net lending market share at 14.3% to the end of May 2006, is similar to the 14.5% share achieved in 2005 and ahead of the 13.5% achieved in the first half of 2005. Our lending portfolios continue to be dominated by residential mortgage lending representing 89.3% of all outstanding loans (31 December 2005 - 89.5%).

The strong performance of our retail funding in the last few years continued in the first half of 2006 resulting in net inflows of £1.7 billion. Two successful securitisation issues raised £9.0 billion with a further £1.4 billion from our covered bond programme. Capital ratios have been enhanced by a second Whinstone transaction resulting in the transfer of a further £169 million of our securitisation vehicles' retained first loss risk and by the issue of £400 million of preference shares.

Profit before tax (underlying) grew by 14.4% and profit attributable to shareholders (underlying) of £173.5 million grew by 16.1% compared with the first half of last year. Underlying return on equity at 21.5% (30 June 2005 - 20.7%) remained within the top half of our strategic target range.


During the first half of 2006 Northern Rock again achieved record levels of total lending. Total gross lending was £14,807 million, an increase of 28.3% (2005 first half - £11,543 million), with total net lending of £7,276 million, an increase of 22.0% (2005 first half - £5,965 million). Prospects for the remainder of 2006 are good, with a pipeline of £5,482 million (31 December 2005 - £5,300 million) including a residential lending pipeline of £4,955 million (31 December 2005 - £4,779 million). Improvements in processing efficiency and continued attention to customer retention means that our 2006 lending and asset growth targets are consistent with the level of pipeline at the end of the half year.

The composition of our lending portfolios has continued to be low risk. At 30 June 2006, 89.3% of our loans to customers were residential secured loans (31 December 2005 - 89.5%), 2.1% commercial secured loans (31 December 2005 - 2.2%) and 8.6% within our personal unsecured portfolios (31 December 2005 - 8.3%). This mix is not expected to change significantly going forward.

An analysis of lending by portfolio is set out in the following table:

£ millions Residential Commercial Unsecured Total 2006 1st Half Gross 12,711 259 1,837 14,807 Net 6,351 72 853 7,276

2005 Full Year Gross 23,618 408 2,853 26,879 Net 13,350 5 1,200 14,555

2005 2nd Half Gross 13,394 190 1,752 15,336 Net 7,740 (26) 876 8,590

2005 1st Half Gross 10,224 218 1,101 11,543 Net 5,610 31 324 5,965

Residential - UK market

The UK residential lending market was stronger in the first half of 2006 compared with the equivalent period in 2005, continuing the improvement in activity levels seen in the second half of 2005. Increased levels of housing transactions together with above anticipated levels of house price increases, skewed by central London, contributed to increases in gross residential lending of 27% and net residential lending of 25% in the first five months of the year. Whilst we do not expect this rate of growth to continue for the full year, we expect both gross and net lending to be ahead of levels seen in 2005 of £288 billion and £91 billion respectively. We also expect to see house price inflation slow in the second half of 2006 and over the medium term be in line with increases in earnings. Housing transactions are expected to be higher than 2005 partly reflecting the gradual return of first time buyers to the market. Gross lending also continues to be supported by remortgage activity which accounted for approximately 40% of gross lending by value so far this year. The gross market remains key to Northern Rock achieving its growth targets, and economic conditions remain supportive with low inflation, relatively low unemployment, low interest rates and consequently good affordability.

Residential - Northern Rock performance

Against this background we achieved gross residential lending of £12,711 million (2005 first half - £10,224 million) and net residential lending of £6,351 million (2005 first half - £5,610 million), representing increases of 24.3% and 13.2% respectively. Our share of UK gross residential lending for the first five months of 2006 was 8.1% and our market share of net residential lending for the same period was 14.3%. This compares with 8.0% and 13.5% respectively for the first half of 2005, and 8.1% and 14.5% for 2005 in total. Our share of redemptions in the first five months of the year was 5.3%, identical to the first half of 2005 and again lower than our closing share of mortgage stock of around 6.7%. This continues to reflect the success of our pro-active customer retention process and our fair and transparent policy of allowing existing customers, subject to contractual terms, to transfer their loan to any product available to new borrowers.

In the first half of 2006, 89% of our gross residential lending was originated via the indirect market (2005 full year - 90%) reflecting the importance of mortgage clubs and networks to our distribution strategy. Of our awards, the proportion of indirect business was 88% and has fallen further since the half year. By the end of the first half around 80% of indirect applications were being processed via our

on-line trading platform, resulting in improvements in service levels as well as our own operational efficiency. We currently operate 80 loan originating branches and aim to broaden this distribution network to around 100 by 2010 via a programme of opening new branches in major urban areas.

The profile of our new lending has remained low risk despite the strong growth in volumes. In line with market activity in the first half, lending to first time buyers increased to 27% (2005 full year - 24%). 73% (2005 full year - 76%) of new customers have a proven payment track record. The impact of this trend has been to slightly increase the average Loan to Value ratio ("LTV") of lending in the first half of 2006 to 79% (2005 full year - 78%) although we have increased the proportion of new lending at or below 90% LTV to 76% (2005 full year - 70%). The average indexed LTV of our mortgage book is now 60% (31 December 2005 - 58%) which continues to provide strong cover in the event of default. We continue to have a good spread of geographic risk and minimal exposure to large loans with only 3.9% of new loans over £500,000 (2005 full year - 3.4%).

We offer customers a wide range of innovative and attractive products including lifestyle products and traditional price-led products. Our lifestyle products comprise our "together" family of products, Lifetime and residential Buy to Let mortgages. The "together" products combine a secured and unsecured loan at one interest rate and one monthly payment. Gross lending of "together" products amounted to £4.7 billion of which £4.1 billion were advances secured on residential property representing 35.4% (2005 full year - 28.7%) of new residential lending, excluding further advances. Outstanding balances of "together" mortgages increased to 22.7% of our mortgage portfolio (31 December 2005 - 20.6%).

Our Lifetime range is aimed at homeowners aged 60 and over, who wish to utilise equity in their homes to enhance their lifestyle. Such lending accounted for 1.2% of gross new residential lending (2005 full year - 1.4%), with outstanding Lifetime balances representing 2.9% (31 December 2005 - 3.0%) of our mortgage balances.

Residential Buy to Let lending is focussed on lending to private investors secured on good quality residential properties. Such lending accounted for 5.6% of our mortgage portfolio at 30 June 2006 (31 December 2005 - 4.9%) and for 8.8% (2005 full year - 7.1%) of gross new residential lending.

In total our lifestyle products, which are margin enhancing, represented 45.4% (2005 full year - 37.2%) of our gross new residential lending and 31.2% of mortgage balances at 30 June 2006 (31 December 2005 - 28.5%).

Of our traditional price-led mortgage products, fixed rate mortgages remained the most popular with 25.2% (2005 full year - 25.3%) of total new lending accounted for by short term fixed products up to two years, and 23.5% (2005 full year - 28.8%) by longer term fixes normally up to a maximum of seven years. The demand for longer term fixed rates eased as pricing increased in response to higher swap rates.

Our residential lending remains focussed on prime mortgage customers. There is a market for near or sub-prime and self certified lending, but we have avoided this market due to concerns over the risk reward relationship and we have no need to move down the credit curve to achieve our lending volumes. This on-balance sheet appetite has not changed. However, we recognise that offering such products would add to the portfolio available through our sales distribution network and so we intend to work in partnership with Lehman Brothers to introduce directly such loans to them. In return, we will earn fee income but will not take any credit risk, nor will we administer the loans post completion. We anticipate the venture will be on-stream by the end of the current year, benefiting earnings next year.


Our personal unsecured credit portfolios comprise the unsecured element of "together" lending and standalone unsecured loans not linked to a residential mortgage. An analysis of lending volumes on the separate elements of our unsecured portfolios is shown in the following table:

£ millions Standalone Together Total Unsecured Unsecured 2006 1st Half Gross 1,182 655 1,837 Net 458 395 853

2005 Full Year Gross 1,970 883 2,853 Net 744 456 1,200

2005 2nd Half Gross 1,209 543 1,752 Net 570 306 876

2005 1st Half Gross 761 340 1,101 Net 174 150 324

Standalone gross lending was at a similar level to that achieved in the second half of 2005 with net lending lower as the portfolio matures and redemptions and repayments increase.

Volumes of "together" unsecured lending have increased in conjunction with the increase in volume of "together" secured lending. At 30 June 2006 our unsecured lending balances were £6,638 million (31 December 2005 - £5,789 million) of which 41.1% (31 December 2005 - 40.0%) represented "together" unsecured advances.


Competition in the commercial secured lending market has remained strong in the first half of 2006 with certain lenders remaining aggressive on price and LTV levels at which they are prepared to lend. We have continued to grow our commercial lending portfolio gradually, maintaining our emphasis on quality rather than volume of lending. Gross lending in the first half amounted to £259 million (2005 first half - £218 million) with net lending of £72 million (2005 first half - £31 million).

Arrears and Possessions

The arrears position of each of our personal lending portfolios based upon accounts three months or more in arrears is set out in the following table:

Residential Standalone "Together" CML Residential Unsecured Unsecured Average

30 June 2006 0.45% 1.08% 0.97% n/a

31 December 0.39% 0.98% 0.84% 0.97% 2005

30 June 2005 0.35% 1.02% 0.82% 0.87%

Note: CML Residential Average Arrears shown at 31 December 2005 and 30 June 2005. Data at 30 June 2006 not yet available. Source: Council of Mortgage Lenders.

Our residential arrears continue to be below half the industry average as reported at 31 December 2005, the latest available data. Northern Rock's arrears data is calculated more conservatively than the CML data, for example we include all loans three months and over in the three month category whereas the CML definition is only above three months in arrears. There has been an increase in arrears in line with default levels across the sector with Northern Rock's arrears returning to levels seen in 2004, which at the time were historic lows. One reason for the increase since the beginning of the year reflects the increased proportion of "together" lending within the residential portfolio. The "together" secured three months plus arrears increased to 0.95% (31 December 2005 - 0.84%) but remain below the industry average for secured residential loans. The three months plus arrears figure for our standard loan portfolio has increased to 0.29% (31 December 2005 - 0.26%).

At 30 June 2006, properties in possession had increased to 628, representing 0.09% of all accounts compared with 576 (0.09%) at the end of 2005. New possession cases in the first half of 2006 amounted to 838; broadly stable compared with 804 cases in the second half of 2005.

Standalone personal unsecured loan arrears remain significantly better than industry average and only marginally ahead of the position 12 months ago, reflecting our policy of attracting high quality lending and use of our bespoke scorecard to avoid lower quality lending. We continue to monitor and adjust our scorecard ratings in response to tighter conditions in the unsecured market ensuring a balanced approach to price, volume and risk. Unsecured loans within the "together" brand continued to perform in line with the "together" secured advances and similar to traditional residential secured loans.

At 30 June 2006, only 3 of our commercial loans (0.26% of accounts) with balances outstanding of £3.2 million were three months or more in arrears compared with 10 accounts (0.42%) with outstanding balances of £5.8 million at 31 December 2005.


Northern Rock has established four distinct funding arms enabling it to attract funds from a wide range of customers and counterparties on a global basis. Flows of new funding and closing balances are shown in the following table:

£ millions Retail Non-Retail Securitisation Covered Bonds 2006 1st Half Net flow 1,666 (2,329) 5,834 1,382 Closing balances 21,773 19,570 36,334 4,965

2005 Full Year Net flow 2,809 2,317 8,831 2,378 Closing balances 20,104 22,253 31,156 3,830

2005 2nd Half Net flow 1,093 4,562 2,693 1,353 Closing balances 20,104 22,253 31,156 3,830

2005 1st Half Net flow 1,716 (2,245) 6,138 1,025 Closing balances 19,008 17,520 27,706 2,430

Note: Net flows represent net cashflows excluding fair value adjustments. Closing balances are stated including fair value adjustments.


Retail funding comprised a net inflow of funds of £1,666 million including interest credited of £314 million and builds on the successful funding in 2005, again demonstrating the strength and diversity of our retail franchise.

Funding during the six months was largely into our 30 day Silver Savings notice account. Balances in our Ireland based operation rose to £1,341 million (31 December 2005 - £1,026 million), with £2,218 million (31 December 2005 - £1,940 million) in our Guernsey based off-shore vehicle. We intend to supplement our retail offshore activities by opening a new retail funding operation in Denmark early in 2007.


Our non-retail funding provides a balanced mixture of short and medium term funding with increasing diversification of our global investor base. As in 2005, demands on our non-retail funding programmes were restrained during the first half due to the volumes taken from our other funding arms, resulting in a net outflow of £2.3 billion of non-retail funding.

During the first half we raised £2.0 billion medium term wholesale funds from the US, Europe, the Far East and Australia. This included US$2.0 billion Extendible Quarterly Securities sold to domestic US investors and A$1.2 billion raised under a newly established Australian debt programme, targeted at both domestic Australian investors and the Far East. This transaction was the largest debut deal in this market for a single A rated financial institution and demonstrates our strategy for diversification of Northern Rock's investor base.


Funding through securitisation remains an integral part of Northern Rock's funding strategy. During the first half of 2006 two residential mortgage issues were completed raising £9.0 billion through our Granite vehicles. The January deal at £6.0 billion was our largest to date. Diversification of our investor base continued with 75% of the securitised bonds being issued in US dollars or euros. The characteristics of the mortgages securitised, in terms of product type, LTV and geographic distribution remain similar to those of our non-securitised mortgages.

We have continued to see the spreads on our securitisation deals improve, with the May transaction achieving our cheapest pricing to date, over 10bps cheaper than the maturing deals in part being replaced.

At 30 June 2006 advances to customers subject to securitisation, including the Whinstone transactions, amounted to £36.6 billion (31 December 2005 - £39.1 billion).

Covered Bond

In the first half of 2006 we raised ¤2.0 billion (£1.4 billion) from a fourth issue from our ¤10 billion programme established in 2004. This provided further diversification of the investor base as around a third of the participants were new to Northern Rock. The covered bond is secured by a pool of ring-fenced residential mortgages.


Total assets on a statutory and underlying basis (excluding fair value adjustments) are set out in the following table:

£ millions 30 June 2006 30 June 2005 31 December 2005 Statutory 88,821 72,435 82,709 Underlying 88,035 71,211 81,057

On a statutory basis, total assets are 7.4% higher than at the previous year end and 22.6% higher than 12 months ago. On an underlying basis, growth in total assets was 8.6% and 23.6% respectively.


Our Treasury operation continues to raise wholesale funds, manage interest rate and currency risks, and manage a portfolio of investments primarily for liquidity purposes. It is not a separate profit centre and does not operate trading portfolios. At 30 June 2006, 96% (31 December 2005 - 97%) of our Treasury investment portfolios comprised assets which are rated single A or better, continuing our strategy of seeking security and not increasing credit risk. We continue to have no exposure to emerging markets or non-investment grade debt.

Total Income and Net Interest Income

The following tables show net interest income and total income on a statutory and underlying basis (see notes 5 and 6). The underlying basis excludes volatile hedge ineffectiveness as management considers that our hedging is economically effective and that movements in fair value on individual hedges and underlying instruments will offset over time and do not form part of operational performance.

Statutory basis 6 months ended Year ended £ millions 30 June 2006 30 June 2005 31 December 2005 Net interest income 401.9 369.3 752.3 Other income 77.7 50.5 129.0 Hedge ineffectiveness 8.5 (1.3) (56.4) Total income 488.1 418.5 824.9

Underlying basis 6 months ended Year ended £ millions 30 June 2006 30 June 2005 31 December 2005 Net interest income 389.2 345.0 706.8 Other income 77.7 50.5 129.0 Total income 466.9 395.5 835.8

On a statutory basis total income in the first half of 2006 amounted to £488.1 million representing an increase of 16.6% over total income in the first half of 2005. On this basis the ratio of total income to mean total assets at 1.14% in the first half compares with the 2005 full year and half year ratios of 1.12% and 1.22%. Total income as a proportion of mean risk weighted assets at 3.65% compares with the 2005 full year and half year ratios of 3.34% and 3.58%.

On an underlying basis total income in the first half of 2006 amounted to £466.9 million representing an increase of 18.1% over underlying total income in the first half of 2005. On this basis the ratio of total income to underlying mean total assets at 1.10% in the first half compares with the 2005 full year and half year ratios of 1.15% and 1.16%. Total underlying income as a proportion of underlying mean risk weighted assets at 3.49% compares with the 2005 full year and half year ratios of 3.41% and 3.41%.

Underlying interest spread at 0.75% in the first half compares with the 2005 full year and half year ratios of 0.81% and 0.80% on an underlying basis. On this basis, interest spread is 6bps lower than the full year in 2005 and 7bps lower than in the second half of last year. This reduction is primarily attributable to the costs of the Whinstone transactions and the effect of the Libor Bank Base Rate differential. The interest costs in respect of Whinstone are offset by containing the growth in the appropriation line by not having to raise additional Tier 2 capital resulting in the impact on profit attributable to shareholders being minimal. During the first half of 2006, 3 month Libor remained on average 14bps higher than Bank Base Rate compared with 7bps in the second half of 2005 and so has continued to adversely affect the price of our securitisation and non-retail funding. Mortgage spreads have remained the same as throughout all of 2005. Total spreads on all loans to customers were lower by 3bps compared with 2005, due to tighter pricing on commercial and unsecured lending.

At 30 June 2006 the net value of fees deferred to future periods amounts to £324.2 million, compared with £292.0 million at 31 December 2005 and £268.7 million at 30 June 2005. This deferred income returns to the income statement over the life of loans, reducing the future dependence of income growth on volume growth.

Other income primarily comprises insurance commission generated on sales of third party products such as building and contents and payment protection insurance together with administration fees not

Total Income and Net Interest Income (continued)

included within interest margin. Other income at £77.7 million was similar to the £78.5 million achieved in the second half of 2005.


Total operating expenses amounted to £135.0 million representing an increase of 13.5% over the £118.9 million in the first half of 2005. The increase of 13.5% compares with an increase in underlying assets of 23.6% over the twelve months and a rise in underlying total income of 18.1%, resulting in a cost to underlying asset ratio of 0.32% (30 June 2005 - 0.35%) and cost to underlying income ratio of 28.9% (30 June 2005 - 30.1%).

Our cost performance is in line with achieving for the full year the bottom of our strategic target of cost growth being 1/2 to 2/3rds the rate of growth of assets. We also expect cost growth to be noticeably lower than either income or profit growth leading to falling cost to underlying income and cost to underlying asset ratios. This is despite substantial expenditure on new IT systems (particularly for self-service processing for new and retained customers) and spend on our central administration sites.

Social Responsibility - The Northern Rock Foundation

Northern Rock donates 5% of pre tax profit to The Northern Rock Foundation under a deed of covenant. Such donations are used to support community and charitable causes mainly in the North East of England and Cumbria. The covenant from 2006 first half profits amounts to £14.7 million (2005 first half - £14.7 million), resulting in donations of approximately £160 million since its inception in 1997 as an integral part of Northern Rock's conversion to a plc.

Loan Loss Impairment

The charge for loan loss impairment amounted to £44.5 million for the first half (2005 first half - £25.5 million) representing 0.12% of mean advances to customers (2005 first half - 0.09%). The impairment allowance coverage of total loans and advances to customers at 17bps remains similar to the 18bps coverage at 31 December 2005.

The combination of high quality lending, low interest rates, low arrears and continued strong average LTV of the portfolio have continued to contain the levels of loan loss impairment provisions required for residential mortgages. Loan losses have increased in line with higher levels of possessions and a slowdown in house price inflation. This impact is reflected in an increased impairment charge maintaining the impairment allowance coverage at 5bps.

The growth in loan loss impairment provision balances against our personal credit portfolios reflects the combined effects of the growth in balances, the maturing nature of the portfolios and the impact of better quality newer standalone unsecured lending following revisions to credit acceptance criteria. As a result, total loan loss impairment provision balances for these portfolios have increased to £92.6 million (31 December 2005 - £87.1 million) with total cover of 1.38% (31 December 2005 - 1.48%), well below industry average in line with lower than industry average arrears.

We expect to see a lower impairment charge in the second half than in the first half of 2006, although the extent of the reduction is likely to be affected by the levels of personal bankruptcies and individual voluntary arrangements. Whilst we have seen an increase in such arrangements in the last 12 months, the impact continues to be mitigated by improved collection activity and underwriting policies.

Hedge Ineffectiveness

Following the introduction of IFRS all derivatives entered into by Northern Rock are recorded on the balance sheet with any fair value movements being taken to the income statement. Where effective hedge relationships can be established, the movement in the fair value of the derivative instrument is offset in full or in part by opposite movements in fair value of the underlying instrument being hedged. Any ineffectiveness arising from different movements in fair value will offset over time and so any recorded ineffectiveness in any accounting period is excluded from underlying results in that accounting period.

In addition, Northern Rock enters into certain derivative contracts, which although efficient economically, cannot be included in effective hedge accounting relationships. Consequently, although the implicit interest cost of the underlying instrument and associated derivative are included in net interest income in the income statement, future fair value movements on such derivatives are recorded in "Net hedge ineffectiveness and other fair value gains and losses" on the face of the income statement and are excluded from underlying results. The same treatment also applies to the revaluation at each balance sheet date of economically hedged foreign currency liabilities.

The over-riding objective of the presentation of underlying results is to show a more appropriate net interest /cost of hedged instruments and to exclude future fair value adjustments from current performance measurement.

In the first half of 2006 the income statement shows "Net hedge ineffectiveness and other fair value gains and losses" as a gain of £8.5 million (2005 first half - £1.3 million loss (restated - see note 2)). This increases to £21.2 million gain (2005 first half - £23.0 million gain (restated - see note 2)) after the cost of interest implicit in forward exchange contracts is transferred to underlying net interest income.


The effective tax rate for the first half was 29.2% (30 June 2005 - 29.3%). We continue to anticipate, with a corporation tax rate of 30%, that the ongoing effective tax rate will trend towards 30.0% in the medium term.

Profits and EPS

Details of profit before tax, profit attributable to shareholders and earnings per share on statutory and underlying bases are set out in the following tables:

Statutory basis 6 months ended Year ended 30 June 2006 30 June 2005 31 December 2005 PBT £m 293.9 259.4 494.2 Attributable profit £m 187.8 163.7 300.7 EPS p/share 45.1 39.6 72.5

Underlying basis 6 months ended Year ended 30 June 2006 30 June 2005 31 December 2005 PBT £m 273.7 239.2 504.6 Attributable profit £m 173.5 149.4 308.1 EPS p/share 41.6 36.1 74.3

The reconciliation of underlying results is set out in note 3 of the Interim Results (page 27).

Profits and EPS (continued)

Statutory profit before tax of £293.9 million for the six months ended 30 June 2006 represents an increase of 13.3% over the equivalent statutory figure for 2005. Statutory profit attributable to shareholders for the first half of 2006 was £187.8 million, an increase of 14.7% over the 2005 statutory result for the same period.

Compared with the 2005 first half underlying results, the underlying 2006 profit before tax of £273.7 million represents an increase of 14.4%, with underlying attributable profit rising by 16.1% to £173.5 million.

Return on equity for the first half of 2006 was 23.3% on a statutory basis and 21.5% on an underlying basis compared with 21.6% in the first half of 2005 on a statutory basis and 20.7% on an underlying basis.


Maintaining our policy of increasing dividends in line with sustainable growth in profit attributable to shareholders, the proposed interim dividend is 10.9p per share payable on 27 October 2006 to shareholders on the register on 29 September 2006, a 16.0% increase over the 2005 interim dividend of 9.4p.


At 30 June 2006 total capital amounted to £3,656 million resulting in a total capital ratio of 13.4%, comfortably above regulatory and internal requirements. Tier 1 capital was £2,490 million and the Tier 1 ratio 9.2%. The equivalent ratios at 31 December 2005 were 12.3% and 7.7% respectively.

Tier 1 capital and total capital have been enhanced by the issue on 29 June 2006 of £400 million (£397 million net of issue costs) of perpetual non-cumulative callable preference shares. Dividends on these shares are discretionary and subject to Board approval will be first paid on 4 July 2007 and then annually thereafter at a rate of 6.8509%. The issue supports the future growth of lending as well as improving the mix of our capital base.

In the first half we also completed a second Whinstone transaction transferring £169 million of the reserve funding risk relating to the 2005 and the first 2006 Granite residential mortgage securitisations to third party investors. The Whinstone transactions reduce the level of core capital required under credit rating assessments of required capital as well as the regulatory capital deduction in respect of the reserve funds, thereby enhancing capital efficiency and more closely aligning regulatory and credit rating capital.

Following the submission in December 2005 of our application to use the Retail Internal Ratings Based approach to Basle II we have continued to assess our Basle II systems in response to the FSA's CP06/3 and emerging interpretation of requirements. We continue to aim for adoption of Basle II with effect from 1 January 2007 which if achieved will be ahead of the majority of the sector, which is not expected to adopt Basle II until 1 January 2008. As a low risk lender we continue to anticipate significant savings in regulatory credit risk capital under Pillar I which will be partly offset by Pillar II requirements. Realisation of the benefits will be phased in over the three year transition period in conjunction with our internal and rating agency assessments of our capital requirements.


The first half of 2006 saw strong mortgage lending on the back of higher levels of housing transactions and house price inflation. Although we expect growth in lending to moderate in the second half we remain comfortable with our forecast of a £300 billion gross UK residential lending market for both 2006 and 2007.

Our view of the economy is that with rising worldwide interest rates, higher energy costs and higher European unemployment, the UK will experience a slowing economy over the next few years. This is likely to result in a moderate deterioration in credit risk across the retail banking sector. Our low risk appetite to such risk means that we expect our residential arrears to remain below half the industry average.

We confirm our strategic asset growth target of 20% + / - 5%. We are performing towards the top of this range but expect to move towards the centre over the next couple of years. In addition, as we see our underlying profits attributable to shareholders move through the centre of the existing 15% + / - 5% range we are lifting this target on a like for like basis to 20% + / - 5%, aiming to move towards the centre of this new range over the medium term.

The range of underlying attributable profit expectations for 2006, excluding any fair value and hedge accounting gains or losses, as provided by 18 of the major bank research analysts, is £339 million to £363 million, with a mean of £355 million, growth of 15.2% compared to the 2005 underlying figure. Northern Rock remains comfortable with this consensus mean.