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Western EuropeOctober 2 2005

The bank that changed its spots

Alliance & Leicester is run by a chief executive with retailing in his blood. But he is repositioning it as a niche commercial player, as Michael Imeson reports.A leopard cannot change its spots but a bank can change its make-up. Alliance & Leicester (A&L), Britain’s seventh largest bank and a former building society, is primarily a retail bank but is gradually developing its wholesale banking business.
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In the first half of this year, A&L boosted its commercial lending, won thousands more new small and medium-sized business customers and got involved in Private Finance Initiative (PFI) contracts. It had a small wholesale business even before it became a bank in 1997, but it announced two years ago that it would build this up with a focus on cash sales to banks, commercial lending (especially where asset quality is high), business banking and treasury operations.

It is a diversification strategy that makes sense at a time when UK consumer demand has slowed and retail banking is in the doldrums. Richard Pym, A&L’s chief executive, explains: “With only a minor exception, the banks that grew their profitability in the first half of this year were those that were growing from their overseas or investment banking operations. The profitability of UK retail banking in most of the large institutions was flat or slightly down, and our performance was very much in line with the market.”

A&L’s overall pre-tax profits for the six months to end-June were £256m, down from £314m for the same period last year. Stripping out unusual items, core operating profit rose by only £1m, to £263m. The contribution from wholesale banking to that core profit increased from £56m to £62m, meaning that wholesale banking accounted for 24% of the bank’s profits.

Of particular note was that commercial lending balances rose £500m (11%) to £5bn, and the number of new small business bank accounts increased by 10,500 (35%) to about 60,000.

Where it all started

A&L’s commercial banking business started as a money transmission business. When it was still a building society, it bought Girobank from the Post Office. A large part of Girobank’s business was an esoteric form of commercial banking that involved taking cash from supermarkets and other retailers and supplying it to organisations that needed it – primarily other banks and the Post Office.

Because of changes in the cash market, the profitability of this business has been in slow decline for some years, even though volumes are rising. A&L has therefore moved into other areas of commercial banking, though it is still one of only a handful of “used” cash providers to the banking system – more than 20% of cash taken at shop tills is channelled through A&L.

This cash business has given the bank a wide variety of customers in the corporate and public sector, and it is using these relationships to sell other services and build a broader base.

“Where it will end is that the bulk of commercial banking’s profits will come from business banking and commercial lending,” says Mr Pym. Although he will not readily admit it, the bank’s strategy for small and medium-sized enterprises is to cherry-pick them from other banks. Business start-ups, with their higher failure rates and lower margins, are left to the big banks.

Mr Pym is talking from the bank’s small offices on the southern edge of leafy Regent’s Park in central London. Headquarters are in Leicester, about 100 miles north of the capital, while big-ticket commercial lending is handled from the Regent’s Park office.

The bank has a comparatively high proportion of local authority and other public sector customers, but only this year started doing PFI transactions. It advanced more than £30m to PFI projects in the first six months.

“PFI is a broad field. We did a massive research project on it and identified areas with an acceptable risk profile for us,” says Mr Pym, although he will not reveal what those areas are. “We don’t want to be explicit externally about the commercial decisions we have made there.”

Retail growth

Despite reduced profitability on the retail side, A&L achieved some solid “franchise growth” in that area in the first six months, says Mr Pym. The number of current accounts rose by 112,000 to 1.47m; personal savings rose £1.2bn to £21bn; and unsecured personal loans gross advances rose £200m to £1.5bn. Although gross mortgage lending fell £1.4bn to £4.1bn, market share remained the same at 3.2%.

“It wasn’t growth for growth’s sake,” stresses Mr Pym. “It was where we wanted it to be. One of the most pleasing things was the growth in our internet and direct business.” The bank now has 750,000 current account and savings customers using the internet. “We’re building a customer base which is going to be low cost to service.”

This approach resulted in the closure of 46 branches last year, leaving it with 254.

A&L has four core retail products which it ‘manufactures’ itself: mortgages, savings, personal loans and current accounts. Parallel to those are four partner products that it buys in: credit cards from MBNA, investments and life insurance from Legal & General, and general insurance from Zurich.

Mr Pym, who became chief executive in 2002, has a strong retail background. This comes across when he talks about branch design, delivery channels, customer focus and media advertising. His previous position was as managing director of retail banking, and before he joined the bank in 1993 he worked for high street clothes retailer Burton. He was a non-executive director of department store Selfridges from 1998 to 2003, and in 2004 became a non-executive of Halfords, the car accessory chain store.

Mortgage market

A&L had a 4% share of the mortgage market when it was a mutual building society but that has slipped because it has eschewed the specialised end of the market.

“Since we demutualised, the traditional mortgage market hasn’t grown as much as new segments, which are the sub-prime, self-certified [where the self-employed ‘self-certify’ that their income is high enough to service the loan] and buy-to-let mortgages,” explains Mr Pym.

“We don’t trade in any of those segments, so we have effectively excluded ourselves from areas where we haven’t liked some of the risk characteristics. That’s the major reason why our market share has fallen.”

A change of policy is on the cards: A&L plans to offer buy-to-let mortgages next year. Two things have prompted the move: borrowers have become more sophisticated as the market has matured, and the law is changing to allow residential property to be invested in pension funds.

Awash with capital

Sometime this year A&L expects to undertake a £50m share buy-back, part of a long-standing programme. “When we demutualised, we had very high capital levels and we have brought them down in two ways: by growing the balance sheet and by share buy-backs,” Mr Pym says. When it floated, it had a Tier 1 capital ratio of around 13%. This is now around 7%.

“In reducing our equity Tier 1 capital we obviously have to pay due regard to both the equity shareholders and to the bond investors, and we were very pleased that at the end of last year our credit rating from Moody’s was upgraded from A1 to Aa3. Of all the things we have achieved over the past four or five years, that ranks as one of the ones that I am the most pleased about,” Mr Pym says.

“Getting back a double A credit rating, which is unusual for a bank our size, is quite rare these days. The improved rating gives us a wider range of counterparties and also provides some external evidence of the high quality of our balance sheet.”

John Windeler, the bank’s chairman since 1996, announced in May that he would stand down once a successor had been found. “We are in the middle of that search now, and it is going very well,” is all Mr Pym will say on the matter.

Important as succession is, he does not want to be distracted by it. Foremost in his mind is adhering to the bank’s strategy – namely, expanding the commercial banking business, winning more retail banking customers, protecting mortgage market share, maintaining the return of capital at around its current level of 21% and controlling costs mainly by transferring more customers to the internet.

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