MARKET COMMENT
Abbey National Goes Back To Basics

By Cliff D'Arcy
February 26, 2003

Troubled ex-building society Abbey National (LSE: ANL) revealed its 2002 figures today and, as widely predicted, they weren't pretty.

Last year was wretched for the mortgage lender, as it turned a tidy profit of £1.47b in 2001 into an enormous first-ever full-year loss of £984m in 2002.

The problem with Abbey is that, under its previous management team, it diversified away from its traditional mortgage and savings businesses and into life assurance and corporate lending. Thanks to three years of falling stock markets, things have turned sour at the life assurance division. Meanwhile, the worsening worldwide economy has hit companies hard, massively increasing bad debts at Abbey's wholesale banking wing.

Luqman Arnold, Abbey's replacement chief executive, has decided to reverse Abbey's diversification strategy by focusing on the bank's core retail financial services business. Over the next three years, businesses that lie outside of this sector will be closed or sold. Arnold has had a distinguished career in investment banking; this experience must have helped him when debating whether to close Abbey's sickly corporate lending business.

It's clear that some hard times are coming for the company. Corporate change is always painful and distracts both management and staff from the job in hand – managing products and customers. What is also clear is that short-term sentiment will depend on the prices that the UK's sixth-largest bank gets from selling off its non-core assets. A successful series of auctions will boost sentiment; conversely, write downs from a fire sale will damage profits in future years.

Sadly, Abbey's millions of small shareholders will share the pain, with the final dividend slashed to 7.35p. This means that the full-year dividend has been halved to 25p from 50p. Despite this reduction, at 6.7%, Abbey yields far more than both the market as a whole and the base rate.

Nevertheless, for the next two to three years, Abbey's growth is going to be held back while the business transforms itself. It remains to be seen if its new focused approach is the right one. It's interesting to note that, despite rising sales, profits at the group's core UK business were flat at £1.23b.

Also, based on comments we received following a recent article on Abbey's mortgages, the company is letting itself down with poor customer service and retention in a cut-throat lending market. Furthermore, planned job cuts at the sharp end will inevitably worsen this situation.

Other risks include: further capital injections into its life assurance businesses if markets fall further; goodwill impairments on disposals; further provisions and losses in wholesale banking.

Given the large number of risks it faces, future earnings and dividend growth rates at Abbey are uncertain and the group may be forced to cut its dividend again in 2003 and beyond. Alternatively, good prices for its superfluous businesses could trigger special dividend payments to shareholders.

Nevertheless, Abbey could possibly attract a bidder once it emerges in its streamlined form, so the shares are worth hanging on to now all the bad news has been factored into the price.

The author owns shares in Abbey National.