Interim Report - 12 of 28

Economic background

Growth in Latin America slowed in the first half of 2013 as a result of two sets of factors: externally, the slowdown in mainland China and its negative impact on commodities; and domestically, country-specific weakness in domestic demand and rising political uncertainty.

Brazil's economic performance was below expectations in the period. In the first quarter of 2013, in particular, GDP was weighed down by weak consumption as Brazilian consumers appeared to be cutting back in response to inflation, high levels of indebtedness and weaker confidence.

In Mexico, growth remained weak during the first half of 2013, as a result of mild growth in the US and moderate government spending during the first months of the new administration. Core inflation remained under control and headline inflation began to converge towards the mid-point of the inflation target (3%) after a temporary rise related to agricultural and administered prices.

In Argentina, activity rebounded in the first half of 2013 due to a very good harvest and a buoyant car sector, partially due to stronger exports to Brazil. This is far from what could be considered a broad-based recovery, as most sectors show only a very modest rate of expansion. The inflation situation remains uncertain, while reserves have declined on the back of net external debt payments.

Review of performance

In Latin America, reported profit before tax of US$466m was US$679m lower than in the first half of 2012, and US$607m lower on a constant currency basis.

On an underlying basis, pre-tax profits decreased by US$487m, driven by a rise in both individually assessed and collective loan impairment charges, the latter relating in part to impairment model changes and assumption revisions for restructured loan portfolios in Brazil. In addition, revenue declined, notably in Brazil as GB&M benefited from a more favourable interest rate environment in the comparable period and lower spreads and average lending balances in Business Banking led to a decline in CMB. Revenue in RBWM and CMB was also adversely affected by a significant reduction in the PVIF asset.

Profit/(loss) before tax by country within global businesses

We have made progress in reducing the fragmentation in our Latin American businesses through disposals in non-strategic markets. In February 2013, we announced the sale of our business in Panama, which is expected to be completed later this year. In addition, we completed the sale of a portfolio of our non-life insurance assets and liabilities in Mexico in April 2013. In line with the Group's strategy, we initiated a comprehensive programme to reposition our portfolios to manage the potential risk of financial crime in accordance with the Group's Global Standards. As a result, certain businesses and activities are being exited across the region.

In RBWM, we have grown revenue in our Premier and Advance segments by actively targeting mass affluent customers. In Mexico, we launched a residential mortgage offer which has been positively received by the market. Customer penetration of digital channels also increased, supported by the launch of enhanced digital banking technologies, such as a mobile banking solution in Mexico and an upgrade to the internet banking platform in Brazil. In Argentina, we retained our position as a market leader in mobile banking, as the number of customers using, and transactions through, this channel increased compared with the first half of 2012.

In CMB, as part of our strategy, we concentrated on capturing international trade flows between Latin America and the US and Asia. As part of this initiative, we launched an MXN13bn (US$1bn) fund for Business Banking in Mexico focused on import and export financing, and recently introduced trade financing in RMB across the region.

In GB&M, we extended dedicated investment banking coverage to priority large local corporate accounts. This strengthened coverage has already allowed us to win a number of advisory mandates in event-driven transactions. We also increased collaboration and connectivity through a US into Latin America business development initiative, which connects US-based RMs with Latin American multi-national teams and product partners. We won several awards in the Euromoney Awards for Excellence 2013 including 'Best Debt House', 'Best Project Finance House' and 'Best Risk Advisor' in Latin America.

The following commentary is on a constant currency basis.

Net interest income decreased by US$93m, driven by the effect of non-strategic business disposals. Excluding the disposals, net interest income increased marginally. This was due to the lower cost of funding assets held for trading in

Brazil, reflecting both a reduction in the trading book and a fall in average interest rates, partly offset by lower net interest income in CMB and in Balance Sheet Management in GB&M. The decrease in CMB was driven by Business Banking in Brazil, as a result of lower spreads, and a reduction in average lending balances. The latter was the result of more restrictive origination criteria which included reducing credit limits where appropriate. Net interest income in GB&M also fell as the proceeds from maturing investments were reinvested by Balance Sheet Management at lower prevailing rates.

Net fee incomeincreased by 10%, due in part to higher current account fees in Brazil. The sale of the non-life insurance business in Argentina also contributed to the rise, as sales commissions payable to third party distribution channels were no longer incurred.

Net trading income decreased by US$159m, primarily in Brazil due to a decline in net interest income on trading activities as average trading assets fell. In addition, the comparable period in 2012 benefited from higher Rates trading revenue as a result of downward yield curve movements.

Net income from financial instruments designated at fair value decreased by US$176m, notably in Brazil, mainly in the unit-linked pensions business as a result of significantly lower net investment income due to market movements. To the extent that this was attributed to policyholders there was a corresponding movement in Net insurance claims incurred and movement in liabilities to policyholders.

Gains less losses from financial investments fell by 42% due to lower gains on disposals of available-for-sale government debt securities in Balance Sheet Management.

Net earned insurance premiums decreased by 26%, driven by lower sales of unit-linked pension products in Brazil. Premiums also fell in Argentina as a consequence of the sale of the non-life insurance business in the first half of 2012. The reductionof net earned insurance premiums resulted in a corresponding decrease of Net insurance claims incurred and movement in liabilities to policyholders.

Other operating income decreased by US$22m, driven by a significant reduction in the PVIF asset due to an increase in lapse rates and interest rates movements. This was partly offset by net gains in the current period and the non-recurrence of net losses in the first half of 2012 on the sale or reclassification to 'held for sale' of non-strategic businesses.

LICs increased by US$365m, driven by higher collective provisions in RBWM and CMB and higher individually assessed provisions. This included charges mainly relating to impairment model changes and assumption revisions in Brazil for restructured loans in portfolios in RBWM and Business Banking in CMB (see page 114), although this was offset in part by an improvement in the quality of the portfolio following the modification of credit strategies in previous periods to mitigate rising delinquency rates. Collective impairments also rose in RBWM in Mexico, reflecting the non-recurrence of a provision release in the first half of 2012, higher lending balances and a revision to the assumptions used in our collective assessment models in the first half of 2013. In addition, individually assessed provisions increased, in particular on exposures to homebuilders in CMB due to a change in the public housing policy together with a specific exposure in GB&M, both in Mexico.

Operating expenses decreased by US$62m as a consequence of business disposals, coupled with continued efforts to exercise strict cost control and progress our organisational effectiveness programmes. This was partly offset by the effect of inflationary pressures, union-agreed salary increases in Brazil and Argentina, and higher compliance and risk costs from the implementation of Global Standards and portfolio repositioning, notably in Mexico.

Profit/(loss) before tax and balance sheet data - Latin America

Profit/(loss) before tax and balance sheet data - Latin America (continued)

For footnotes, see page 100.