Legal & General’s half-time profit was almost wiped out by £351 million of “negative investment variances” in a £20 billion bond portfolio, which supports annuities whereby it has to pay life-time incomes to pensioners.
Headline profits fell to £31 million from £391 million last time in a half year when L&G concentrated on generating cash – to the tune of £302 million – and a £50 million-a-year cost-cutting drive.
But by the alternative measure of European embedded value, where investment factors were favourable, higher margins on sales helped push the profit 12 per cent higher to £657 million.
Even so, the interim dividend is cut by 45 per cent to 1.11p.
L&G had halved its final pay-out for last year, so presented this reduction as a “ten per cent progression from the re-based 2008 dividend, indicating growing confidence in sustainable cash flow generation combined with our commitment to a strong balance sheet”.
Chief executive Tim Breedon said: “Subject to satisfaction with the strength and resilience of our capital position, we will be looking to grow the dividend in line with expected medium-term growth in operational cash.
“Confidence has started to return to markets, but we expect some continued uncertainty for the remainder of 2009,” he added.
“As a result of the actions we have taken in the first half of this year and will continue to take in the second half of the year, Legal & General is better positioned to take advantage of new opportunities to grow profitably when the economy recovers.”
The stock market reacted cautiously, with shares finishing 3p lower at 61.25p.
More than half the “variances” that undermined the six-month profit arose from successful currency and interest- rate hedging against L&G’s holdings of overseas bonds.
Cash payments by counter-parties to the hedging deals were so big that L&G took some time to reinvest them. When it did, it had to accept lower yields in an adverse market.
“It was not an error,” a spokesman insisted. “These are very large sums and you cannot invest them instantly.” The cost, though, came to £206 million.
Another loss arose from the sale of some £1 billion of bonds issued by banks, which L&G replaced with lower yielding, but less risky, corporate bonds. That lowered the expected return over the eight-to-ten-year life of the portfolio by £75 million.
A final £55 million write-down occurred because L&G opted not to release any of the £650 million it had set aside last year against possible defaults in its bond portfolio.
Losses so far have come to just £1 million. But L&G has rolled the entire provision forward rather than assume that future experience will remain equally benign.