Abbey National yesterday became the second high-profile casualty of the Financial Services Authority's new regulations for life insurance, revealing that it has had to make a £373m provision to bolster its reserves.
The provision helped to drag Abbey to a pre-tax loss of £686m for 2003, which disappointed the City, sending its shares tumbling nearly 12 per cent to 485p.
The Financial Services Authority wants all financial institutions with life businesses to move during the course of this year to a new, "realistic", basis for calculating solvency. Standard Life, Britain's biggest mutual, became the first insurer to be affected by the initiative last month, and has been forced to sell £7.5bn of equities and slash bonuses in order to boost its own reserves.
Stephen Hester, the chief operating officer of Abbey, said the extra £373m was the best estimate the bank could make as to how much it needed under the new rules. But he added that the picture was still "pretty foggy" because the FSA was still consulting on the detail of the regulatory change.
As a consequence of the uncertainty, Mr Hester said he had become more cautious about a possible pay-out to shareholders following the sale of its corporate loans book and other businesses which fall outside Abbey's new strategy of being a pure retail bank. The move disappointed analysts, who had pencilled in a special dividend next year.
Abbey's loss for the 12 months to 31 December was an improvement on 2002, when it went £947m into the red. Last year it discovered a massive black hole in its wholesale banking business and also realised that its provisions in its life arm, which included a substantial number of policies with guaranteed pay-outs, were too weak.
Luqman Arnold, appointed as chief executive in 2002, has embarked on a three-year turnaround programme, hoping to reinvigorate the bank by focusing entirely on core personal financial services.
Last year saw Abbey, which has dropped the word National from its trading title, sell £48bn of non-core assets, slash costs and begin to retrain staff to offer what Mr Arnold described as "open and honest" advice to customers.
"We are entering an awkward phase. We have laid a huge amount of foundations, but none are visible above the ground. This year we are trying to deliver some visible evidence that it is all coming together," Mr Arnold said yesterday.
He added that the second half of 2004 would be "crucial" because that was when he and Mr Hester had briefed the City that Abbey's "supertanker" of problems of the past would begin to turn around and there would be a pick up in revenues. The duo have said real momentum will not be in evidence until 2005.
Analysts said Abbey had a long way to climb. Its trading profit from personal financial services fell 16 per cent to £1.02bn. Its margins shrank - and Abbey warned they would continue to shrink - as it sliced the price of its mortgages to try to gain ground on its competitors.
Mr Arnold, an investment banker by training who used to work at UBS, is widely thought to be trying to get Abbey into as good shape as possible so that a larger competitor might buy the business.
But that would be difficult under the UK's current competition regulations. Lloyds TSB has been blocked from buying its smaller rival and it is likely that other members of the Big Four would meet a similar fate at the hands of the Competition Commission.
Mr Arnold said: "If Fred [Goodwin, the chief executive of Royal Bank of Scotland] could, he would. But he hasn't."
He added that he thought his three-year programme was the best way to maximise shareholder returns.
"The strategy of just sitting on the shelf and tarting yourself up does not guarantee shareholder value because there might not be a buyer," he said.