Retail Division

The new segmentation of Austrian customer business in line with the divisional structure of UniCredit Group no longer reflects the traditional distinction between private customers and corporate customers but is based on specific customer needs. In 2006 we combined those sub-segments within the new Retail Division which are characterised by large numbers of low-volume transactions and can therefore be served through a similar cost-efficient approach, using a product range that is geared to the needs of customers at different stages in their lives. Therefore we transferred the high-net-worth segment of private customers, to which the bank applies a different service approach, and the asset management product competence to the Private Banking & Asset Management (PB&AM) Division. Business with private customers was combined with the business customer sub-segment, which has so far shown below-average profitability and was previously included in the SMEs Austria segment. SMEs Austria had been created with a view to restoring business with this customer group to profitability.

The new segment presentation shows an inacceptably high cost intensity of the Retail business segment, especially for the 2005 base year (over 90 %). Moreover, given the large proportion of lending business in the newly added lower SME sub-segment, the risk/earnings ratio was far above average (about 30 %, adjusted for one-off effects). These were the main factors responsible for the large loss. We are currently implementing a comprehensive package of measures, for which we made restructuring provisions in 2005 and 2006, in order to eliminate this structural weakness in profitability with our new business model. In 2006, we made significant progress in this respect.

The income statement for 2006 therefore reflects substantial provisions while also showing distinct improvements in operating performance – a sign that the measures that have been taken are effective.

In 2006, despite the difficult competitive environment, total revenues from current business increased slightly compared with the previous year (by 2 %) to € 1,283 m, accounting for 27 % of the bank’s total revenues.

Net interest income (€ 768 m) matched the previous year’s level. However, this reflects significant changes which partly offset each other: in lending business, annual average volume increased by 7 % as a result of successful advertising campaigns; growth in the private customers sub-segment was 8 %, while loans to business customers rose by only 1 %. Overdraft loans and short-term commercial loans declined, while medium-term and long-term loans expanded strongly, especially in the area of residential construction finance (+11 %). Average risk-weighted assets (RWA) in the Retail business segment rose by 2 %. Significantly higher market interest rates, and thus funding costs, led to stronger pressure on margins as the year progressed. As credit margins recently fell to the lowest level for many years, the revenue contribution from lending business declined. This effect was more than offset by business on the liabilities side. Average volumes of savings deposits and especially time deposits grew strongly across all customer segments; despite rising customer interest rates, margins on deposits business developed favourably, supported by factors related to the interest rate cycle.

Net fee and commission income made a substantial contribution to profits, rising by € 56 m or 12 % to € 535 m. Securities business accounted for a large part of the increase. This reflects primarily the successful placement of our structured investment products, which meet specific customer needs, and cross-selling initiatives launched in the business customer sub-segment. Fee income from account maintenance for private customers improved slightly. Within the range of services for business customers, the focus on electronic banking services, lively international business and the market success of derivatives – also in this low-volume sub-segment – resulted in a favourable trend.

Operating expenses in the Retail Division were reduced by € 170 m or 15 % compared with the previous year; at € 978 m, they still accounted for 35 % of the total figure for the bank, while the share of revenues was 27 %. The cost/income ratio, though falling sharply from 91.5 % in 2005 to 76.2 % in 2006, is still too high, as can be seen from a comparison within UniCredit Group. The cost reduction demonstrates, however, that we are moving in the right direction. Contributions to this favourable development came from the spin-off of settlement and back-office activities to Administration Services, which enhanced efficiency in this area, and from cost/performance transparency and improvements in process efficiency in past years. As a result, non-staff expenses declined (not only in the Retail business segment but also in the bank as a whole).

As revenues remained stable, operating profit started to improve mainly on the cost side: at € 305 m for 2006, it was significantly higher than in 2005 (€ 107 m).

In the income statement items between operating profit and the loss before tax, the addition to loan loss provisions explained above in connection with improvements in credit risk management methodologies was a major factor; the additional charge in the Retail business segment was € 186 m. In 2006, net writedowns of loans totalled € 414 m; the comparative figure for 2005 was € 302 m, which also included a one-off effect of € 70 m. Adjusted for one-effects resulting from the switch to the new provisioning principle and the introduction of higher risk standards, net writedowns of loans declined slightly, by 2 % to € 228 m. The adjusted figure for net writedowns of loans still absorbs almost 30 % of net interest income. In 2006, the Retail Division recorded a loss before tax of € 119 m, compared with a loss before tax of € 283 m in the previous year. The 2005 figure also reflects the allocation of € 92 m to restructuring provisions (shown in the item Integration costs), which were attributable to the Retail business segment. Restructuring provisions made in 2006 relate to the adjustment of staffing levels and are therefore included in the figures for the Corporate Center. Adjusted for one-off effects in 2006 and 2005, the Retail Division achieved a profit before tax of € 67 m, after a loss before tax of € 118 m in 2005.

Outlook: In the current year we are working to further differentiate our service approach to customer groups with different needs and adjust it to the requested level of service intensity. Another focus of sales activities is on cross selling, especially in the business customer sub-segment. These efforts are supported by the product policy, with a standardised and/or discretionary approach to lending and investment business in response to customers’ specific needs. We are also reviewing our internal processes, in close cooperation with Group Banking Services, on an end-to-end basis covering the whole range of payment transactions to the entire credit process chain. One of the results of this work is the introduction of automated monitoring systems. Last but not least, we will adjust our incentives and compensation system to give more weight to performance. Overall, our objective is to achieve a significant and sustainable improvement in results to restore the Retail Division to profitability through revenue growth and strict cost management.