Long-Term Savings: Emerging Markets

Continuing strong single premium growth

Overview

The South African economy grew by 4.6% in the first quarter of 2010 and we expect the growth momentum to be maintained for the rest of the year. Our good sales performance continued in the second quarter, resulting in a 15% rise in APE sales compared to the first half of 2009. However, the trading environment remains tough due to the continued high and rising South African unemployment. In the rest of Emerging Markets, economies achieved positive year-on-year GDP growth, with Chinese GDP growing by 11.1% compared to 30 June 2009, and Mexico and Columbia growing by 4.3% and 4.4% respectively between 31 March 2009 and 31 March 2010.

We continue to make good strides towards our goal of becoming our customers' most trusted partner. In South Africa, we received the Employee Benefit Administrator of the Year at the Annual Imbasa Yegolide Awards (which are designed to recognise and reward those service providers who render excellent service to funds), and we were ranked first in both Group Business Investments and Group Business Risk categories in the 2010 PricewaterhouseCoopers survey.

During the first half of the year, OMIGSA extended its range of investment offerings to the market, with Futuregrowth launching a South African Agricultural Fund in March, and our Long-term Equity boutique launching two African-listed equity funds in May 2010. We expect funds under management and NCCF to benefit from these initiatives in the second half of the year.

IFRS AOP Results

The IFRS AOP (pre-tax) increased by 5% relative to the comparative period, with strong asset management profits (up 147% to R789 million) partially offset by lower long-term investment return (R602 million compared to R833 million in 2009) and lower life profits (R1,708 million compared to R1,800 million in 2009). Whilst our life profits were down 5% from 2009, the 2009 results had benefited from a number of large non-recurring items, namely the value of reductions in benefit assumptions and profits from the Nedbank joint ventures in the first five months of 2009. Excluding the impact of these items in 2009, underlying life profits increased by 50% over the comparative period. This growth is mainly due to the positive impact of higher equity markets on asset-based fees, a significant improvement in Retail persistency and expense experience variances, and a successful turnaround in the adverse experience seen in 2009 in the Group Assurance suite of products. 

Asset management operating profit grew significantly by 147% relative to the comparative period, as a result of higher average asset values in both South Africa and Colombia, stronger performance fees in OMIGSA, a first contribution from ACSIS (which was acquired in the second half of 2009), a higher contribution from Old Mutual Finance as the business grows, and mark-to-market profits in the Old Mutual Specialised Finance (OMSFIN) business. The factors above were partially offset by lower transactional revenue and lower revenue on the term portfolio of OMSFIN.

The LTIR declined by 28% from R833 million to R602 million, after a 390bps reduction in the LTIR rate from 13.3% in 2009 to 9.4% in 2010, reflecting our strategic move to a lower proportion of shareholder assets invested in equities, and lower expected return in the current year. 

Life sales summary

* Institutional sales are Corporate and OMIGSA life sales

** Rest of Africa is Namibia only

*** New Markets is Latin America only

We achieved excellent growth in APE sales of 15% compared to the first half of 2009, driven by continued single premium sales growth of 18%, strong Greenlight and Max sales in Retail Affluent, and outstanding protection sales in Corporate. Retail Mass recovered in the second quarter after a weak first quarter.

OMSA

Recurring premium sales

Protection

Recurring premium protection sales are 16% above the comparative period. In Retail Affluent, protection sales increased by 16% relative to the comparative period, as a result of higher Greenlight sales, reflecting the improved economic environment. Corporate achieved excellent growth in protection sales of 80% relative to the comparative period as a result of some large schemes coming on the books during the second quarter. In the Retail Mass segment, protection sales were marginally down by 3% relative to the comparative period due to a lower number of advisors in the period.

Savings

Recurring premium savings sales are 13% above the comparative period with improvements across all segments. In Retail Affluent and Retail Mass, sales are 13% and 10% above prior year respectively with sales boosted by recovery in the economy. This was supported by the success of specific initiatives to drive sales in the first half, as well as bedding down of the new commission structure introduced at the start of 2009.

Single premium sales

Single premium sales exceeded the comparative period by 20%. This was driven by the Retail Affluent segment which benefited from the Investment Frontiers Fixed Bond product being competitively priced in the first half of the year, and improved retail annuity rates. Institutional single premium sales, which tend to be lumpy, were 7% lower than the first half of 2009.

Rest of Emerging Markets

In Namibia, life sales were down 16% from the comparative period, due to a decline in both recurring and single premium sales in Corporate. In Latin America, life sales increased by 40% in local currency, mainly as a result of enhancements to the savings product in Mexico.

Both India and China achieved double-digit APE sales growth in local currency terms. Old Mutual Kotak Mahindra's APE sales grew by 11% to INR6.6 billion (R1.08 billion) relative to the comparative period and China APE sales increased by 13% to CNY48.7 million (R53.7 million) in the first half of 2010. The increase is mainly due to strong growth in single premium sales, up 72% to CNY41.3 million on an APE basis. The newly-launched telemarketing channel is gaining traction with year to date sales of CNY3.4 million (R3.8 million) from its launch at the start of the year. We are in the process of developing a Group Protection product range for our new Joint Venture partner, Goudian, and we expect to receive about CNY300 million sales from this source before the end of the year. 

A more detailed review by segment is included in the Financial Disclosure Supplement which is available at www.oldmutual.com. 

Unit Trust Sales

Unit Trust sales decreased by 7% relative to the comparative period. In South Africa, unit trust sales decreased 26% mainly as a result of lower flows into money market and lower reinvestments. The 2009 results included a significant inflow from the Remgro distribution to shareholders which was not repeated.  Investment performance is improving for the 12 month period but three-year underperformance continues to affect Unit Trust sales.

In the rest of Emerging Markets, Unit Trust sales performed well, with sales in Namibia up 64% mainly due to the continued strong inflows into the money market funds from corporate clients on the back of competitive returns offered.  In Mexico, Unit Trust sales are up 25% in local currency mainly as a result of a large pension scheme secured in the period. In Colombia, Unit Trust sales were up 16% in local currency as a result of strong money market sales.

Value of new business and margins

The value of new business margin increased from 14% in the first half of 2009 to 17% on an APE basis mainly due to the favourable impact of the higher margin investment products in Retail Affluent and higher recurring protection premium sales in Corporate. However, this was partially offset by lower margins in the Retail Affluent protection product, Greenlight, as well as in Namibia, due to changes in persistency assumptions at the end of 2009.

MCEV Results

Operating MCEV earnings after tax increased by 9% from the 2009 level. There was favourable persistency experience in Retail Affluent and Retail Mass, and higher new business contribution due to improved sales volumes was offset by lower mortality experience in Retail Affluent and lower expected existing business contributions due to the fall in the swap yields at the end of December 2009.

Net Client Cash Flow

NCCF (excluding the PIC flows) was 7% or R0.1 billion better than the comparative period, but was still negative (outflow of R1.4 billion) for the period. NCCF in the Retail segments remained positive, with an improvement in NCCF in the Retail Mass segment. 

In the Corporate segment, NCCF, while still negative as a result of benefit flows being inflated by market levels, showed a 25% improvement over the comparative period, and the pipeline for this segment is strong. OMIGSA flows were similarly negative, but improved relative to the comparative period, with terminations in Symmetry partly offset by inflows from ACSIS.

Persistency has improved across all of OMSA's Retail segments. Persistency over three months in Retail Affluent has significantly improved from last year and premium collections have improved in Retail Mass. Persistency experience variances were positive for the first half of 2010.

Funds under management

Funds under management are up 2% from year-end levels to R529 billion, despite the negative NCCF, as a result of positive market return. Of the total FUM, R472 billion is in South Africa.

Long-Term Savings: Nordic

Margins improve significantly following management actions

*       Return on equity is IFRS AOP (post tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

Overview

Macro-economic trends in the Nordic region continued to be favourable with economic growth returning (Swedish GDP was 3% higher in Q1 2010 compared to Q1 2009), and a 4.5% increase in the Swedish stock market in the six months to 30 June 2010. However, unemployment continues to remain relatively high. The customer behaviour trends seen in the first quarter of 2010 continued, with clients positively allocating towards global equity and investment products and decreasing their exposure to Swedish Fixed Income products.

The operating performance of the business improved strongly in the period driven by management actions taken at the end of 2009 to re-price the healthcare business in Sweden, tighten underwriting terms and close an unprofitable and significant regular premium pension product.

IFRS AOP Results

The IFRS AOP (pre-tax) increased by 142% relative to the comparative period to SEK655 million. The key driver of the AOP improvement is a higher FUM which reflects the market recovery and strong net client cash flows in 2009 due to successful product launches such as Skandia Investment portfolio in that period.  All product lines, with the exception of Skandiabanken which remained under continued pressure from the low interest rate environment, contributed to this strong improvement. In particular, Risk and Lifeline healthcare products have delivered an improvement driven by price increases and tight underwriting. Additionally, a non-recurring divestment of a private equity holding during the first quarter resulted in a profit of SEK126 million.

Life sales summary

APE decreased by 29% relative to the comparative period to SEK1,154 million. The primary driver for this was the closure of the unprofitable regular premium Private product Link regular in the second half of 2009. Occupational pension sales in the Swedish corporate sector continued to be suppressed, reflecting lower salary increases and less labour mobility, and our investment portfolio product, Skandia Depå, lost market share as a result of fierce competitor activity on that type of product. Total market share decreased primarily as a result of our competitors' sales of low margin "tick the box" pensions products that Skandia does not wish to offer. The APE decline in Denmark is due to slow recovery from the recession. Our expectation for the full year is that sales will be down 10-30% compared to 2009 but that we will deliver stronger margins.

By contrast, Nordic had excellent growth in mutual fund sales increasing 130% relative to the comparative period. The drivers behind this success are product innovation, an improved customer offering through the Skandia Global Hedge fund and the launch of the new set of Skala funds. Sales were further boosted by the relatively strong performance in the Swedish stock market.

Value of new business and margins

The value of new business and APE margin have increased substantially relative to the comparative period, with an APE margin for the half year of 25%. The increase in margin is mainly due to a more profitable business mix.  This was positively affected by a higher share of occupational pension sales and top-ups, and a more profitable, lower commission pension product which replaced the withdrawn Link regular product.

Price pressure continues, especially in the Swedish corporate market, and there is uncertainty on the future taxation of Swedish insurance companies. In the medium-term, the margin is expected to be in the high teens rather than at the current elevated levels.

MCEV Results

Operating MCEV earnings after tax increased by 40% relative to the comparative period to SEK712 million. This was mainly due to a more profitable business mix and changed assumptions for the cost of non-hedgeable risks.  These were partially offset by a reduction in risk premiums for the waiver of premium business.

Net client cash flow

NCCF for the first half of the year was SEK4.6 billion, down 21% relative to the comparative period in large part due to the sales action taken in the period, and reflecting higher outflows from single premium products as clients crystallise their investment returns. For mutual fund business, NCCF is higher than prior year through strong inflows as a result of the success of new product launches.

Funds under management

FUM at 30 June 2010 were SEK132 billion, up 4% from 2009 year-end levels.  The increase is mainly due to equity market growth and positive net client cash flows.  FUM has been relatively stable during the first half, moving in line with stock market which increased in the first quarter but fell back in the second quarter.

Long-Term Savings: Retail Europe

Key foundations laid for the future development of the business

Overview

Retail Europe's markets remain challenging, and the stock markets closed flat compared to the end of 2009 (the DAX index increased by less than 1%) though GDP growth improved following government stimulus packages.

Overall sales performance improved in the half year, relative to the first half of 2009, with the second quarter performance in line with first quarter trends. Funds under management rose strongly and retention was good.

Work to transfer Retail Europe IT and client administration functions to South Africa continues. This will begin to take effect in the second half of the year, and will lay the foundations for leaner and more efficient customer service. It will also potentially benefit other business units in the Group. We continue to balance this operational change with pursuing growth opportunities in the markets in which we operate.

IFRS AOP Results

The IFRS AOP increased significantly over the comparative period to €29 million. The main driver of this was lower administration expenses, and non-recurrence of costs incurred in 2009.

Life sales summary

APE sales in the first half of 2010 grew by 9% to €37 million, and mutual fund sales grew by 17% to €14 million. Single premium sales improved in all our markets, with the exception of Switzerland, while recurring premiums saw only modest growth. Overall, APE sales in the first half of 2010 increased by 80% in our Polish business and by 15% in Germany.

Underlying sales productivity in terms of new applications for the first six months of the year increased by 30% compared to 2009. However, in all our markets, there has been a reduction in the average policy size due to changing product mix.

We have carried out intense marketing activity in the period. These have included product events and roadshows, further development of cooperation with banking partners, and the launch of new products. We expect these activities to have a positive impact on sales in the second half.

Value of new business and margins

VNB for the period was €2 million, a significant improvement on the comparative period. This was driven by lower acquisition expense overruns and improved profitability from product mix compared to the prior year. These factors also drove the increased APE margin to 6% from (11%) for the same period last year.

MCEV Results

Operating MCEV earnings (post-tax) improved by €43 million relative to the comparative period, driven by a better new business contribution, modelling changes to fully recognise the value of the disability insurance business in Switzerland and less negative experience variances than in the comparative period.

Net client cash flow

NCCF was €226 million for the first six months of 2010, consistent with the comparative period. This was driven by an increase in premiums offset by higher surrender values, given market movements. Across the Retail Europe markets, maturities formed a larger portion of the total outflows during the first half compared to that of the prior year.

Funds under management

FUM of €5.2 billion at 30 June 2010 reflects the positive NCCF in the period, and continued recovery in the equity markets. In terms of client asset allocation, we continued to see clients defensively positioned in guaranteed and balanced/fixed income funds.

Long-Term Savings: Wealth Management

Strong half-year results, driven by UK platform and Italian markets

*       Return on equity is IFRS AOP (post tax) divided by average shareholders' equity, excluding goodwill, PVIF and other acquired intangibles

Overview

The UK economy grew by 1.4% in the first half of the year, although the FTSE-100 fell 9% in the same period, with particular volatility in the second quarter when it declined by 13%.

Improving investor sentiment during the first half led to strong trading performance and significant year-on-year growth in sales across our markets. Increased volatility of equity markets in the second quarter did not noticeably impact new sales, although a prolonged continuation is likely to dampen customer confidence in equity investments and may lead to reduced sales in later periods.

The APE in the second quarter returned to the levels seen at the end of 2009 following higher than usual volumes on the UK platform and in Italy during the first quarter. Surrender experience has improved and NCCF in the second quarter remains broadly in line with the first quarter at £1.2 billion.

Although we do not target growth in market share as a KPI, Skandia UK's market share increased significantly in Q1 2010, to 7.2% across all industry channels compared to 6.4% in the fourth quarter of 2009. This is a record for Skandia in the UK and compares to a range of 3.5% to 5.5% over 2001-07. Given the scale and investment in our UK platform, we are ideally positioned to lead and benefit from this industry shift and are actively looking at how we will further enhance our platform offering and rationalise our suite of life products over the second half of the year.

IFRS AOP Results

IFRS AOP (pre tax) increased by 121% to £95.1 million. IFRS AOP continues to perform strongly relative to 2009, due to higher FUM and favourable expense levels, and this resulted in a strong boost to return on equity given the operating leverage in the business, even at this stage of the restructuring process. FUM remains strongly positive driven by NCCF and market growth. The main drivers of the increased funds under management are market-related and due to higher sales volumes. In addition, one-off costs in 2009 amounting to £19 million did not re-occur. Profitability for the second half of the year is expected to reduce as spend on the transformation programme and the platform development increases.

Life sales summary

Total APE improved by 54% to £412 million. This is mainly attributable to sales on the UK platform, and in Continental Europe which improved by 145% (increase of £74 million) and 151% (increase of £59 million) respectively compared to the prior period.

UK platform sales volumes continue to grow at rates much higher than prior year, primarily driven by single premium pensions. There were spikes in March and April driven by tax year-end activity and an increase in the new tax year ISA limits. Our charging structure has remained consistent during the period. First half sales also include switches from UK Legacy (which are currently reported gross as inflows and outflows) as well as transfers of in-force books of business as IFAs register onto the platform. While migration from our Legacy products to the platform is likely to continue going forward, we anticipate a reduction in absolute volume terms over the remainder of the year. Switches onto the platform accounted for 12% of total UK APE sales during the first six months of the year.

UK Legacy sales volume is continuing at reasonable levels, despite strong growth in the platform space. We have been evaluating our Legacy product set in light of changing customer requirements and new regulation being driven by the Retail Distribution Review. The combination of these two factors is increasing demand for platform services that are customer-focused and transparent, whilst at the same time reducing demand for older style life products which are complex and rely on high adviser commission to drive sales.

Sales volume across International is 9% up on the prior year. We continue to sell in Finland to maintain a foothold in the market with a tactical product offering, although volumes are relatively modest. Sales in the Middle and Far East strengthened in the first half following the launch of a qualifying recognised overseas pension scheme (QROPS). We also have worked on improving the efficiency of our sales coordination with other parts of the Old Mutual Group, and with South Africa in particular. 

The 2010 Italian fiscal window has now expired, but we continue to sell large volumes due to the strong relationship with one of our distributors, Fideuram. These volumes are expected to return to normal rates in the second half of this year. French volumes remain ahead of prior year but overall, the unit-linked market is proving slower to recover than initially expected.

Value of new business and margins

The value of new business increased by £9 million relative to the comparative period, with an APE margin for the half year of 8%. There was a slight decrease in margin, mainly due to changes in persistency assumptions for the Finnish business and the shift from UK Legacy business to the platform model. This was partially offset by strong higher margin sales in Italy and the tax legislation change in International.

MCEV Results

The operating MCEV profit after tax increased by £51 million relative to the comparative period. This was mainly due to much better persistency and paid-up premiums experience on International and UK Legacy business, with higher VNB offset by lower one-year discount rates on in force book.

Net client cash flow

NCCF is more than triple prior year driven by strong contributions from Italy and the UK platform business. This more than compensated for run-off of the UK Legacy book that did not get recaptured onto the platform.

Funds under management

Funds under management have grown 4% during the first half of 2010 driven by rising bond values and continuing NCCF.

Long-Term Savings: US Life

Steady business performance, improved persistency and credit outlook

*       Calculated as the operating MCEV earnings (post-tax) divided by the absolute value of the opening MCEV

**     Stated on a start manager basis as USAM manages $6bn of the funds on behalf of US Life

Overview

The US economy continued to show signs of recovery in the period, although this has not been even across all sectors. Capital markets continued to be adversely affected by Europe's sovereign debt crisis and fiscal challenges, with the ratings downgrades of peripheral countries weighing on investors' confidence in risk assets.  As a result, investors sought safe-haven assets such as Gilts and US Treasuries, and in June, the ten-year US Treasury yield dipped below 3% for the first time since April 2009 as a result of demand from increasingly risk-averse investors.

US Life sales results are in line with target levels and reflect the reduction in the product set that was undertaken in 2009 as part of the focus on more profitable products with lower new business capital strain. During the first half of 2010, there was an improvement in net client cash flows due to higher sales and lower surrenders; growth in funds under management due to net unrealised gains; impairment reversals exceeded impairments for the period; and expenses continued to trend lower.

IFRS AOP Results

Pre-tax adjusted operating profit (IFRS basis) was $45 million compared to $44 million for the comparative period. While gross margins (prior to DAC amortisation) were $218 million, compared to $261 million for the same period in 2009 (higher net investment spread in 2010 was more than offset by an increase in the LTIR default rate adjustment, an increase in hedge losses and negative mortality experience in 2010), there was a reduction in surrender-related adverse DAC unlocking and other movements which depressed profits in 2009. This meant that  the AOP has remained broadly level. The RoE has declined as a result of the recovery in the IFRS equity position through the significant reduction in unrealised loss position between 30 June 2009 and 30 June 2010.

Life sales summary

APE sales for the first half of 2010 increased by 19% to $68 million relative to the comparative period. This is within the budget set for the business and reflects our approach to capital within the business. APE for annuity products increased by 50% over the comparative period, and within this, FIA sales increased by 29% on an APE basis relative to the comparative period driven by revisions launched in March 2010 to the fixed indexed annuity (FIA) OM Index - Accelerator 10  product, and competitive multi-year guarantee annuity rates in March and April 2010.  The Medicaid single premium immediate annuity (SPIA) sales had a good performance in the first half of the year. In July 2010, the Chairman of the SEC confirmed that the SEC will not be seeking to regulate the distribution of FIA products.

Value of new business and margins

The value of new business decreased by $17 million relative to the comparative period, with an APE margin for the half year of (9%). The decrease in margin was mainly due to extended low yield environment and a lower assumed liquidity premium. Management actions taken during the period included lowering commission rates on certain products in June aiming to achieve the targeted profitability over the balance of the year.

MCEV Results

The operating MCEV earnings after tax decreased by $194 million relative to the comparative period. Despite a much higher opening MCEV position, significantly lower initial credit spreads in 2010 compared to 2009 caused a much lower expected return in 2010. This was partially offset by the improvement in the operating experience variance which was $107 million higher than in the first half of 2009, primarily due to higher than anticipated persistency on profitable Traditional Life contracts and lower than expected persistency in respect of FIA contracts that are unprofitable on an MCEV basis.

Net client cash flow

As expected, net client cash flows for the first half of 2010 reflected the expected evolution of the general account given the active management of sales levels in the last two years. They improved compared to the first half of 2009, primarily due to lower surrender activity and higher sales in the current period.  The pace of surrender activity continued to trend favourably in the first half of 2010, as in the second half of 2009. Index credits on the fixed indexed annuity product, which are credited (if earned) on the policy anniversary date, have been strong in the first half of 2010 and should facilitate management of persistency. We continued to see benefits from a conservation programme initiated in the second quarter of 2009 which focuses on the reduction of full surrender activity.

Funds under management

Funds under management ended the period at $17.0 billion, up $0.3 billion from the opening position, primarily due to a $0.6 billion increase in the market value of the investment portfolio and investment income for the period. This was partially offset by $0.4 billion of negative net client cash flows.

Investment portfolio

The net unrealised position on the fixed income security portfolio improved to a net gain of $138 million at 30 June 2010 ($497 million and $1.6 billion net unrealised loss at 31 December 2009 and 30 June 2009), reflecting lower yields across the credit spectrum, most significantly in corporate bonds, and selective de-risking. Net cash holdings at 30 June 2010 were $268 million. Prices throughout the portfolio continued to improve through the first half of 2010, such that as of 30 June 2010, 85% of the total portfolio had a market to book value ratio greater than 90%. The market to book value ratio of the fixed income portfolio improved from 97% at the beginning of the year to 101% at 30 June. We continue to manage the portfolio closely. Encouragingly, US regional banks have seen increased access to capital and declines in problem loans.  The portfolio's commercial mortgage backed securities are of generally high quality and earlier vintage. 

There were no defaults in the first half of 2010. Realised gains include $39 million of gains on previously impaired securities that had recovered in fair value and $10 million of trading gains primarily through the sale of corporate bonds and structured securities. Expected cash flows on certain previously impaired structured securities improved significantly in the first half of 2010, resulting in $54 million of revaluation gains. These revaluation gains were partially offset by impairments for the first half of 2010 of $23 million, in line with our long-term assumption of $24 million per annum in the AOP, and compared to $199 million of impairments for the same period in 2009. The 2010 impairments on 21 securities related to corporate bonds as well as structured securities, with the losses on the latter due to adverse changes in expected cash flows, or the likelihood of diminished loss coverage from distressed monoline insurers that guaranteed the performance of the security. The impairment losses were primarily in RMBS ($16 million) and corporate holdings ($6 million).

Capital

OM Financial Life Insurance Company's risk based capital ratio increased from 312% as at 31 December 2009 to 347% as at 30 June 2010. Regulatory capital grew $85 million during the first half of 2010 driven by strong statutory operating earnings as well as net positive investment results. OM Financial Life's required capital decreased (at the targeted 300% level) primarily due to a lower risk investment portfolio offset by capital required for new business growth. There were no capital transactions between Group and OM Financial Life in the period.

Nedbank Group (Nedbank)

Headline earnings improve; outlook remains cautious

*       FY 2009

**     As reported by Nedbank in their report to shareholders as at 30 June 2010

The full text of Nedbank's results for the six months ended 30 June 2010, released on 2 August 2010, can be accessed on Nedbank's website http://www.nedbankgroup.co.za. The following is an extract from it.

Banking environment

"The economy continued to recover in the first half of 2010. However, the upswing comes off a low base and remains fragile. Household spending has been slow to recover, with high personal debt levels, tight credit conditions and further employment losses hampering consumption. High wage settlements and lower interest service costs have led to an improvement in disposable income, but the benefits of these have been thinly spread with many households still under credit related pressure. Capital formation benefited from the strong effort to complete infrastructural projects ahead of the 2010 FIFA World Cup, but the underlying trend in the private sector demand for credit remains weak given low capacity utilisation levels and continuing uncertainty over future prospects.

Review of results

Headline earnings increased by 8.3% from R1,988 million for the period to June 2009 to R2,153 million for the six months to June 2010. Diluted headline earnings per share increased by 0.2% from 474 cents to 475 cents, which is lower than the increase in headline earnings as a result of the added dilution from the issue of shares for the Nedbank Wealth joint ventures acquired from Old Mutual in June 2009 and a higher than usual acceptance level of the scrip dividend alternative. Diluted earnings per share decreased by 22.4% from 611 cents in June 2009 to 474 cents. As previously reported, 2009 diluted earnings per share were boosted by a once-off IFRS revaluation gain of R547 million (after taxation) from the consolidation of the Nedbank Wealth joint ventures acquired.

These results reflect an improving operating environment. They also highlight the continued endowment related pressure on margins following an unexpected 50 basis points decrease in the prime lending rate in March 2010 and slower than forecast wholesale credit growth. These factors were partially offset by asset re-pricing over the past 18 months and continued low impairments in Nedbank Corporate and Nedbank Business Banking.

Given Nedbank's strategy to grow non-interest revenue (NIR), it is pleasing to report core commission and fee income growth on a comparable basis of 15.7%. Total comparable NIR grew by 7.8%, with NIR being negatively impacted by a R195 million change in the credit-related fair-value adjustments of the bank's own subordinated debt as Nedbank's credit spreads improved.

Nedbank Retail celebrated a milestone with the total retail client base exceeding five million customers.

Lower interest rates have benefited impairments and the downward trend in early arrears remained intact. However, improvements in retail defaulted advances have taken longer to come through, compared to past cycles, as a result of the comparatively higher levels of debt to disposable income. This delay has been increased by challenges experienced in the debt counselling process. Recent discussions between the South African Reserve Bank, commercial banks and the National Credit Regulator on improving the debt counselling process are expected to have a positive impact with new debt counselling inflows slowing and overall levels of advances in the debt counselling process stabilising. The level of defaulted advances in Nedbank Retail has improved to 11.9% from 12.2% in December 2009.

Nedbank achieved a return on average ordinary shareholders' equity (ROE), excluding goodwill, of 12.2% and an ROE of 10.7% (restated), resulting in an overall economic loss (earnings after deducting the cost of capital employed) of R352 million for the period (June 2009: loss of R24 million).

Nedbank's net asset value per share continued to increase, growing by 6.6% (annualised) from 9,100 cents in December 2009 to 9,397 cents in June 2010.

Financial performance

Net interest income (NII)

NII decreased by 1.3% to R8,082 million (June 2009: R8,185 million), largely as a result of endowment related margin compression. The net interest margin for the period was 3.34%, down from 3.44% for the period to June 2009 and 3.39% for the year ended December 2009. Average interest-earning banking assets increased by 2.8% (annualised) (June 2009 growth: 17.4%). 

Changes in margin were mainly caused by reduced endowment income on capital and current and savings accounts, from the 294 basis point reduction in average interest rates; liability margin compression reflecting a higher cost of funding, including the cost of increased duration; the cost of holding additional liquidity buffers; a relative benefit in interest-earning assets re-pricing more quickly than interest-bearing liabilities as rates did not fall as aggressively nor as quickly as last year; and, the benefit on improved asset pricing on new business.

Impairments charge on loans and advances

Improving conditions have resulted in the credit loss ratio on the banking book decreasing to 1.46% for June 2010, compared with 1.60% (restated) for the same period in 2009. Given the uncertain global economic conditions, we remain cautious on the wholesale sector as this sector tends to lag retail. Wholesale credit loss ratios, with the exception of Nedbank Capital and Commercial Property Finance within Nedbank Corporate, improved. Nedbank Corporate's credit loss ratios remain below expectations for this stage of the cycle.

In the retail sector impairments for unsecured lending reduced as a result of improving arrears, the better quality of advances and recoveries. Stabilising defaulted advances and higher levels of restructured loans of R2.4 billion (December 2009: R1.2 billion) in the secured lending categories have started to reduce impairments in these categories.

During the period, Nedbank aligned impairment methodologies for common clients of Imperial Bank and Nedbank. Nedbank raised an additional R42 million in impairments through this process.

Non-interest revenue (NIR)

NIR increased 14.5% to R6,158 million (June 2009: R5,377 million). On a comparable basis, adjusting for the acquisition in 2009 of the Nedbank Wealth joint ventures, NIR growth was 7.8%. The ratio of NIR to expenses was 78.2% (June 2009: 75.5%).

Commission and fee income grew strongly by 21.9% (on a comparable basis by 15.7%) from growth in transactional volumes and annual inflation-linked fee increases. This strong growth is pleasing to see in the light of Nedbank's strategy to grow NIR. In Nedbank Retail the 8.2% year-on-year increase in primary clients as well as an improved mix contributed to NIR growth. This was further supported by strong growth in electronic banking, cash handling and cash management volumes in Nedbank Business Banking and Nedbank Corporate.

Trading income decreased by 3.9% from R928 million in 2009 to R892 million. The high base was due to outperformance in the Treasury and Global Markets businesses that benefited from trading conditions in the cycle of decreasing interest rates in the first half of 2009. Difficult conditions were experienced in the same period this year, although this was partially offset by equity trading that performed reasonably well.

Expenses

Nedbank maintained a strong cost discipline ensuring that increases in expenses were in line with management's expectations. Expenses grew by 10.5% to R7,872 million (June 2009: R7,121 million), largely as a result of the acquisition of the Nedbank Wealth joint ventures and consolidation of Merchant Bank of Central Africa, and on a comparable  basis, expenses increased by 7.5%.

Taxation

The taxation charge (excluding taxation on non-trading and capital items) decreased by 10.1% from R642 million in June 2009 to R577 million with a decrease in the effective tax rate from 22.2% to 19.9%.

Non-trading income

Income after taxation from non-trading and capital items decreased from a R576 million profit to a R3 million loss at June 2010 following the one-off R547 million revaluation of BoE (Pty) Limited and Nedgroup life in the first six months of 2009 on the acquisition of the remaining shares in the joint ventures.

Capital

Ongoing strong balance sheet management has maintained Nedbank's capital ratios well above Nedbank's internal targets and at levels similar to those of December 2009. As reported at the end of the first quarter, the acquisition of the minority shareholding in Imperial Bank was settled in cash, resulting in an approximate 0.5% decrease in Nedbank's capital adequacy ratios. This was partly offset by a 0.28% increase in capital from higher levels of take up under the scrip dividend alternative in the second quarter.

*       Capital adequacy ratios include unappropriated profit.

Liquidity

Nedbank's liquidity position remains sound. Nedbank remains focused on diversifying its funding base, lengthening the funding profile and maintaining appropriate liquidity buffers.  Nedbank successfully increased its long-term funding ratio from 18.1% in December 2009 to 23.9% in June 2010, mainly from increased capital market issuances under the domestic medium-term note programme (R6.23 billion) and increased duration in the money market book.  Nedbank's liquidity position is further supported by a strong loan-to-deposit ratio of 96.0% and a low reliance on inter-bank funding and foreign markets. Nedbank is able to leverage off its favourable retail, commercial and wholesale deposit mix which compares well with domestic industry averages.

Advances and Deposits

Advances grew by 4.9% (annualised) to R461 billion at June 2010 (December 2009: R450 billion). Deposits increased by 4.8% (annualised) from R469 billion at December 2009 to R480 billion at June 2010 remaining in line with advances growth.

Nedbank continued to focus on improving its funding mix and building on its strong retail and business banking deposit franchise. However, retail deposit growth remains challenging given the low interest rates and a highly competitive market, while in the professional fund management market the cost of funding has increased as a result of the increased demand for higher yielding negotiable certificates of deposit (NCDs).  

Outlook

Conditions during the remainder of the year will be heavily influenced by developments in the global economy. South Africa has benefited from rising commodity prices and improved capital inflows, but international prospects remain uncertain.  Domestic spending is expected to rise although some loss of momentum is probable after the initial boost provided as companies restocked in early 2010 and as 2010 FIFA World Cup-related spend fades. Interest rates are forecast to remain low well into 2011 given low inflation and below-trend economic growth.

Retail banking should fare better as household credit demand improves, house prices edge higher and impairments moderate. Wholesale banking areas are expected to remain under pressure with slow credit growth as fixed investment activity remains subdued, but transactional volumes are expected to gradually improve.

The negative endowment effect on capital and margin compression on current and savings accounts is anticipated to reduce during the second half if rates remain at current levels.  At the same time asset quality improvement and impairment reductions are expected to continue, albeit at a gradual pace given the high levels of consumer indebtedness.

Nedbank remains cautious in its outlook for the remainder of 2010 and performance is now expected to reflect:

·      Advances growth in the mid-single digits.

·      Margin compression, on the 2009 margin, of around 15 to 20 basis points.

·      Ongoing, gradual improvement of the credit loss ratio.

·      NIR growth for the year in early to mid double digits, subject to unforeseen moves in fair value adjustments.

·      Expense growth for the year in early double digits.

·      Maintaining strong capital ratios and funding structure.

Given this outlook for the second half we currently anticipate that it will be challenging to meet Nedbank's medium term growth target for diluted headline earning per share of the average consumer price index plus gross domestic product (GDP) growth plus 5%. As a result improvements in ROE for the balance of the year are expected to be muted.

Given the strength of Nedbank's balance sheet, the development of the strategy to grow NIR and the benefits of the acquisitions made in 2009, Nedbank is well positioned to take advantage of the economic upswing when it emerges more fully."

Mutual & Federal (M & F)

Improved underwriting result drives profitability

*       The ROE is now shown over a one-year average equity base (previously three-year average) to achieve consistency with the rest of the Group.

Overview

During the first half of 2010, growth has proved difficult due to continued high levels of competition within the industry. The overall results for the period were satisfactory and reflect a significant improvement on the comparative period, with a positive net underwriting surplus of 2.6%. This is despite the difficult trading conditions during the first three months, which saw adverse weather conditions and a number of large industrial claims.

Underwriting and IFRS AOP results

We have been successful in implementing pricing increases where necessary and this, together with the underlying quality of the insurance business, has resulted in a general improvement in underwriting results during the period. The level of overall premium decline has been driven by the cancellation of certain unprofitable portfolios.

Claim levels during the first quarter were exceptionally high following record rainfall levels in much of South Africa and a higher-than-expected number of commercial fires. Results improved significantly in the second quarter following a return to more normal claims patterns and reflected the implementation of a number of remedial measures.

Over the course of the first half of 2010, the commercial business benefited from a significant turnaround in our retail industry credit insurance book (CGIC) which reported profits ahead of expectations. However, the personal portfolio remains challenging in terms of both growth and profitability but a number of initiatives have been implemented to reduce cost structures, promote growth and develop premium flows through alternative channels. One example of this is the iWyze initiative, which is a joint venture operation with the Retail Mass segment of Old Mutual Emerging Markets.

The long-term investment return for the period was significantly lower due to a reduction in the rate applied, from 13.3% to 9.4%.

We have completed a comprehensive business review, and are now beginning to prioritise and implement measures which will improve efficiencies, reduce expenses and promote profitability. While this will be a three to five year programme, we expect the first tangible impacts of this exercise to be apparent in 2011.

Solvency margin

There has been a significant improvement in the solvency margin (being the ratio of net assets to net premiums) and this reflects the overall improvement in the investment environment during 2009 and positive underwriting returns in 2010.

US Asset Management

Management actions drive improved margins and AOP

Overview

Our continuing strategic focus areas for 2010 are delivering strong investment performance, enhancing our client service and distribution capabilities to capture assets, and improving operating margins.  Investment performance in many long-term institutional asset classes is improving, particularly for some of the quantitative strategies which were affected by the market more severely than the traditional equity strategies in the past few years.  Institutional investment consultants continue to allocate towards investment strategies for the long-term rather than be heavily influenced by near-term performance. We continue to look at various opportunities to expand the product offerings of our global business, and in July announced the formation of a new international equity portfolio management team, Echo Point Investment Management.  Our diversified investment capabilities will provide the foundation needed for significant long-term growth.

We expect that equity markets will continue to be very volatile in the second half of 2010. While we have a number of accounts at risk at certain affiliates, we are focussed on building our pipeline for the remainder of 2010 to deliver an improvement in net client cash flow.  We believe the trends for customers migrating asset allocation decisions toward international, global and alternative strategies will continue for the rest of 2010. We have demonstrated our ability to reduce our expense base, and this is a competitive advantage as market volatility continues. We are on track to achieve our goal of 25% to 30% margin by 2012.  Our track record of investment performance and global business focus has historically positioned us well relative to our competitors, and our diversified asset/client mix has helped us weather market volatility.

Investment Performance

Long-term investment performance of our affiliates remains competitive and our managers' diversification and bias to style purity continues to protect the business from experiencing more dramatic performance swings across the business in volatile markets.  Market conditions remained difficult during the first half of 2010 for active equity strategies that focus on security selection, particularly domestic equity strategies.   However, relative performance has improved over the shorter term in key strategies at certain of our affiliates, including Acadian Asset Management and Analytic Investors. The majority of assets under management by our affiliates continue to outperform benchmarks over the long-term, though we now trail our peers due to slight underperformance in a few strategies.   Improving investment performance throughout our business remains a key area of focus.

IFRS AOP results

IFRS adjusted operating profit of $61 million increased 33% ($15 million) over the same period last year.  Management fees were 16% higher than the first half of 2009 due to strong year over year asset growth.  Performance and transaction fees remained at cyclical lows. Additionally our performance fees typically are more heavily weighted to the second half of the year.  Operating expenses increased slightly relative to the comparative period, mainly driven by higher average AUM.

Operating margin and cost management

The 200 basis points improvement in our operating margin demonstrates the success of the expense management actions taken over the past year. Restructuring in 2009, primarily in our retail business, has delivered approximately $15 million of expense savings in the first half of 2010. However, these savings were largely offset by $12 million non-recurring expenses related to equity plan implementations.

Net client cash flows

Net client cash flows in the period were negative $8.0 billion, or (3%) of opening funds under management. The net outflows included large Real Estate Investment Trust (REIT) outflows at Heitman, solely driven by short-term profit taking after our REIT product provided significant investment gains to investors over the past six to nine months. Of the outflows from Heitman, a significant amount had been invested for less than one year, and despite the outflow, the total funds under management at Heitman are in excess of the amount at 30 June 2009. Dwight's stable value product, which like other short-term investments generally produces modest returns in low interest rate environments, is experiencing outflows as investor appetite towards higher risk investments has returned. Despite the challenging environment in the second quarter, net client cash flows for the business were positive excluding Heitman and Dwight. Global and domestic fixed income products continued to attract new assets, and we are seeing the outflows in global and international equities begin to stabilise as performance improves.

Funds under management

Funds under management decreased by 7% from the year-end position. This was a result of the net outflows in the period and negative markets in the second quarter.

Growth and diversification through international distribution remains a key element of our strategy, with non-US clients comprising 26% of total funds under management at the end of the period.  Last year we took steps to establish an effective centralised distribution coverage model and asset-gathering sales mechanism by creating a UK-registered entity for global distribution. FSA registration was granted with effect from 30 April 2010 and OMAM International is now operational.  OMAM International is already enjoying some early success in raising assets, and we are hopeful that it will be an important contributor of our long-term asset growth.

Affiliate Developments

We are transferring ownership of Thomson Horstmann & Bryant (THB), a $1.7 billion institutional equity manager, to the firm's management team through a management buy-out.  The transaction is expected to close on or about 27 August 2010 and represents the culmination of discussions which began in early 2009. Both organisations are committed to ensuring a seamless transition for the clients. Equity plans were implemented at two of our major affiliates during 2010, and we will complete the rollout to the one remaining smaller firm during 2010. Alignment of the interests of affiliate management was a key factor in the success of our cost management initiatives during 2009 and remains a vital component of our long-term strategy, critical to talent retention and positioning the business for sustainable long-term growth.

We recently announced the acquisition of an international equity portfolio management team, led by Hans van den Berg, from Invesco. The team will form a new OMAM affiliate, Echo Point Investment Management, based in Pennsylvania. Hans van den Berg and his investment colleagues have delivered strong long-term results and have worked together for many years. The senior portfolio management team has an average of 20 years of international investment experience and is expected to remain intact during the transition. The addition of this experienced and respected international team will expand OMAM's capabilities in the actively-managed international equity area.

Retail Developments

The restructuring of our US retail platform in 2009 has improved overall efficiency in our business during the first half of 2010.  We streamlined our product offerings and are now focused on distributing to Registered Investment Advisors (RIAs), Family Offices, and Bank Trust channels which are among the fastest growing segments of the financial services industry.  A successful retail platform is a key component of our growth, and will also be an important driver of margin improvement. We remain committed to developing this part of the business.