Britannia Building Society Report and Cessation Accounts For the period ended 31 July 2009

Transcription

1 Britannia Building Society Report and Cessation Accounts For the period 31 July of 120

2 2 of 120 Directors report Business review The period covered by this review is 1 January 2009 to 31 July On 1 August 2009, the Society transferred its engagements to The Co-operative Financial Services ( CFS ), following approval by its members and confirmation by the Financial Services Authority ( FSA ). This report has been prepared by the Cessation Accounts Committee ( the Committee ), a Committee comprising six former directors of the Society, namely Rodney Baker-Bates, Neville Richardson, Phil Lee, Tim Franklin, Chris Jones and Stephen Kingsley. A statement of the responsibilities of the directors and the Committee in respect of the preparation of the Report, Cessation Accounts and the Annual Business Statement is set out on pages 6 and 7. During the period, the Society remained focused on its mission to become known as Britain s best mutual whilst undertaking the extensive planning and integration activity required to ensure the successful completion of the merger with CFS the first ever merger between two different types of mutually-owned businesses. Basis of preparation The accounts have been prepared on a going concern basis as the entire business of the Group and the Society has continued to operate within the CFS business from 1 August Results for the period Challenging market conditions and the low interest rate environment, with base rates at an all time low of 0.5%, have had a significant impact on the Group s interest margins. Despite this, the Group delivered strong profits with pre-tax operating profit, before charging costs of 26.9 million relating to the merger with CFS, for the period of 70.7 million (2008 full year : 23.2 million). During the period the Society purchased 99.5 million of its own subordinated debt and 99.1 million of structured debt issued by its Leek securitisation vehicles. These transactions resulted in a profit of 57.9 million recognised through gains less losses from other financial instruments. Consistent with its previous practice, and in line with its risk management policies, the Group continued to close out swap positions during the period generating significant profits. These are included within gains less losses from derivative financial instruments for the period of 45.0 million (2008 full year : 25.3 million). At 31 July 2009, total assets stood at 34.0 billion, a decrease of 3.2 billion from the year end position. Mortgage balances had fallen to 23.8 billion (2008 : 24.2 billion) due to constrained market conditions and management actions to retain the organisation s focus on balance sheet strength rather than growth. Net lending in the period totalled (480) million (2008 : (1,462) million). Since the end of 2008 total share balances fell slightly by 0.5 billion, to 18.2 billion.

3 3 of 120 Liquid assets, in the form of cash and authorised investments were 8.2 billion, representing 29.2% of share and deposit liabilities (2008 : 33.5%). In 2008, the Bank of England launched its Special Liquidity Scheme which allows banks to swap their high quality mortgage-backed and other securities for UK treasury bills for a defined period. In common with many banks and building societies, the Group has used this facility as an efficient way of maintaining a high level of liquidity. In 2009 the Society issued a 1.4 billion covered bond to enable it to access this scheme. The Group recognised net increases in the fair value of investment securities carried at fair value of 12.0 million (2008 : reduction of 40.8 million) during the period through the available-for-sale reserve. These increases in fair value will only be realised if the Group chooses to sell the investment securities before they reach maturity, at which point they are expected to be redeemed at face value. Total Group capital remained at a healthy level, standing at 14.1% (2008 : 13.8%) under the Financial Services Authority s new capital adequacy requirements. Key performance indicators The Group managed its performance using a balanced scorecard approach and Key Performance Indicators (KPIs). KPIs of the Group (other than profit) include three financial indicators and two non-financial indicators. The financial indicators were: Member Business net interest margin. The Society continued to demonstrate high value to members through competitive rates for both mortgagors and savers and kept the net interest margin at below 1%; Management expenses as a percentage of mean total assets under management. The Group maintained a strong focus on managing ongoing expenses but the reduction in assets resulted in the ratio of management expenses as a percentage of mean total assets under management increasing slightly to 0.64% (2008 : 0.62%). This ratio has been calculated on an annualised basis and excludes impairment losses for counterparties, merger costs and compensation levies.. Exceptional costs of 26.9 million relating to the merger and integration with CFS were charged in the period; and Britannia Membership Reward (BMR) - a BMR payment of 20.0 million has been accrued for the period to 31 July The final amount to be paid out will be dependent on profits of the Britannia business over the full calendar year and will be approved by the CFS Board in The non-financial indicators were: Customer satisfaction. The Group has maintained its impressive record of customer advocacy with some 88% of members saying that they would recommend Britannia; and Employee satisfaction. Our independent surveys show that 95% of our people were proud to work for Britannia.

4 4 of 120 Principal risks and uncertainties and financial risk-management objectives and policies The Group as a whole had a low appetite for risk and actively sought to mitigate its exposure to risks and uncertainties, particularly so in the ongoing challenging market conditions during the period. The Group s objective was to minimise the impact of financial risks upon its performance. The key risks faced by the business were credit risk, liquidity risk, market risk and operational risk. A high-level summary of these risks and uncertainties is included below and more detail is included in Notes to the accounts: Credit risk is the risk that customers or treasury counterparties cannot meet their obligations to us as they become due. Credit risk for the Group arose from loans to retail and commercial customers, the liquid and investment assets held and from derivative contracts with other banks. The economic circumstances made identification and management of credit risk more challenging due to the heightened risk of customer and counterparty default and the difficulty in estimating the expected cash flows where loans were identified as impaired. The Group s processes for identifying, evaluating and managing this risk are set out in Note 52 to the accounts; Liquidity risk is the risk of having insufficient liquid assets to fulfil obligations or liabilities as they become due, or the risk that the cost of raising liquid funds is too expensive or sufficient wholesale funds are not available. The Group s processes for identifying, evaluating and managing this risk are set out in Note 53 to the accounts; Market risk is the risk that the value of, or income or costs arising from, the Group s assets and liabilities change as a result of changes in interest rates, exchange rates or FTSE indices. The Group used derivative financial instruments to manage, or hedge, these risks. The Group s processes for identifying, evaluating and managing this risk are set out in Note 54 and the approach to hedging is set out in Note 55 to the accounts; and Operational risk is the risk of loss arising from poor or failed processes or systems, human error or external events. The Group s processes for identifying, evaluating and managing this risk are set out in Note 57 to the accounts. The Group managed these risks through a risk-management framework, Board policies and its Treasury and Credit Risk departments. A number of committees, including the Audit Committee, Asset and Liability Committee and the Group Credit Committee supported the Board in the measurement and management of these risks. Disclosure of information to the auditors The Committee confirms that, so far as it is aware, there is no relevant audit information of which the Society s auditors are unaware and that it has taken all steps that it ought to have taken to make itself aware of any relevant audit information and to establish that the Society s auditors are aware of that information.

5 5 of 120 Directors The Directors of the Society during the period to 31 July 2009 were: Rodney Baker-Bates * Keith Cameron * Tim Franklin Bill Gordon (retired 21 April 2009)* Francis Gugen * Peter Harvey * Chris Jones * Stephen Kingsley * Phil Lee David McCarthy Neville Richardson Bridget Rosewell * Tom Sawyer * * Non-executive director Francis Gugen ceased to hold office as a director on 19 September 2008 in accordance with Rule 24(1)b of the Society s rules as a result of ceasing to hold in his own right a shareholding of not less than 1,000. This was due to a personal oversight on the part of Mr Gugen and, upon becoming aware of it, Mr Gugen promptly informed the Board, opened a new investment account and was re-appointed by the Board as a non-executive director of the society on 24 February The Board has satisfied itself that no decisions of the Board or any committees of the Board on which Mr Gugen served would have been affected by these facts but has nevertheless ratified all such decisions taken during the period that Mr Gugen had ceased to hold office. On 1 August, the Society transferred its engagements to CFS. Tim Franklin, Phil Lee and Neville Richardson were appointed as Directors and Rodney Baker-Bates, Peter Harvey, Chris Jones and Stephen Kingsley as Non-executive Directors of CFS following the merger. None of the Directors had any interest in the share capital of the Society s connected undertakings at any time during the financial period. Employees The Society was an equal opportunity employer and it gave full consideration to all applications for employment from disabled people. All applicants for roles within the Group were assessed solely on their ability to carry out the role. If existing staff members became disabled then every effort was made to maintain their position or, if this was not possible, to provide appropriate training to enable them to take on a role elsewhere in the Group.

6 6 of 120 'Being a great place to work, grow and develop' was one of the Society s givens. The Britannia Management Academy (BMA) training programme continued to run through the period to ensure that our managers had the necessary understanding, tools and support to manage and develop our people. The Society also recognised the importance of effective communication with its people. Such communication included an active intranet site, in-house publications and regular team briefings. The Society s internal staff satisfaction survey, Viewpoint, continued to show industry-leading levels of staff satisfaction. Overall employee satisfaction stood at 94% (2008 : 95%). Fixed assets The directors consider the estimated market value of the Group s interest in land and buildings to be not less than its net book value at 31 July Creditor payment policy The Group paid supplier invoices for the complete provision of goods and services (unless there was an express provision for stage payments) in full conformity with the terms and conditions of the purchase and within agreed payment terms. The Group s policy was to agree the terms of payment at the start of trading with the supplier, ensure that suppliers are aware of the terms of payment and pay in accordance with its contractual and other legal obligations. Creditor days at 31 July 2009 were 12 days (2008 : 13 days). Charitable and political donations During the period, the Society and its subsidiaries made donations to charities and other deserving causes totalling 244,000. Some 214,000 of this total was allocated through the Britannia Building Society Foundation. No contributions were made for political purposes. Statement of directors responsibilities In respect of the preparation of the Report, Cessation Accounts and the Annual Business Statement The Cessation Accounts Committee ( the Committee ) comprising certain former Directors of the Society, is responsible for preparing the Directors Report, the Corporate Governance Report, the Cessation Accounts and the Annual Business Statement in accordance with applicable law and regulations. The Building Societies Act 1986 requires the Committee to prepare Group and Society accounts for the financial period to 31 July Under that law it is required to prepare the Group Cessation Accounts in accordance with International Financial Reporting Standards (IFRS) as adopted by the EU and applicable law and has elected to prepare the Society Cessation Accounts on the same basis.

7 7 of 120 The Group and Society Cessation Accounts are required by law and IFRS, as adopted by the EU, to present fairly the financial position and the performance of the Group and the Society at the end of the financial period. In preparing the Group and Society Cessation Accounts the Committee is required to: choose appropriate accounting policies and apply them consistently; make reasonable and prudent judgments and estimates; state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the Cessation Accounts; and prepare the Cessation Accounts on the going-concern basis, unless it is inappropriate to presume that the Group and Society would have been able to continue in business had it so chosen. In addition to the Cessation Accounts, the Act requires the Committee to prepare an Annual Business Statement and a Directors Report, each containing prescribed information relating to the business of the Group. In respect of accounting records and internal control The former Directors were responsible for ensuring that the Society and its connected undertakings: kept accounting records in accordance with the Building Societies Act 1986; and took reasonable care to establish, maintain, document and review such systems and controls as are appropriate to its business in accordance with the rules made by the Financial Services Authority under the Financial Services and Markets Act The former Directors had general responsibility for taking such steps as were reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. The former Directors were responsible for the maintenance and integrity of the corporate and financial information included on the Society s website. Legislation in the UK, governing the preparation and dissemination of cessation accounts may differ from legislation in other jurisdictions. Appointment of auditors Following the transfer of engagements to CFS, PriceWaterhouseCoopers LLP will retire as auditors. Rodney Baker-Bates Committee Chairman On behalf of the Cessation Accounts Committee 22 October 2009

8 8 of 120 Corporate governance report The Board directed and supervised the Group, providing leadership within a framework of prudent and effective controls, which enabled risk to be assessed and managed. During the period under review, the Board met on 12 occasions. The Board set strategic aims to ensure that the necessary financial, human and other resources were in place for Britannia to meet its objectives, and reviewed management performance. Throughout the period, the Group complied with the Interim Prudential Sourcebook for Building Societies and the Integrated Prudential Sourcebook as applicable. These are issued by the Financial Services Authority and include guidance for boards and management. The Group complied with all relevant aspects of the Combined Code of Best Practice on Corporate Governance. The Board assessed all of its non-executive directors as being independent in accordance with the criteria set out in the Code. All Board members had access to the director of corporate governance for any further information they required. Independent professional advice was available to directors in appropriate circumstances at the Society s expense, and Britannia had arranged insurance cover in respect of legal action against the directors and officers. The directors maintained a schedule of reserved matters, which were solely for the decision of the Board, for example the maintenance of the corporate plan and the approval of annual budgets and treasury policy. Other matters were delegated to the group executive board and senior management as appropriate, for example product and services development, staffing and marketing. All directors received regular information about the Group so that they could play a full part in Board meetings. Directors submitted themselves for re-election every three years and new directors were historically appointed to the Board on the recommendation of the nominations committee. No new Board appointments were made in the period under review. Since April 2001, non-executive directors tenure could not exceed seven years. Prior to this the maximum was ten years. The normal retirement age was 60 for executive directors and 70 for non-executive directors. In view of the merger with CFS the annual review of the effectiveness of the Board was not carried out. The Board was ultimately responsible for the Group s system of internal control (including ongoing reviews of effectiveness). Through the audit committee, the Board conducted a continuous rigorous review of the Group s systems of internal control, which were considered to have been satisfactory through the period. The review encompassed all material controls, including financial, operational and compliance controls and risk management systems. The Board determined the overall risk appetite strategy and owned the Individual Capital Adequacy Assessment Process, the business s own review of how well its capital resources met its expected needs, as required by the Financial Services Authority. The Group had a formal structure for managing risk, including

9 9 of 120 established risk limits, reporting lines, mandates and other controls. The Board reviewed this structure regularly in line with new requirements from regulators. Day-to-day management of the Group was devolved by the Board to the group executive board. Several sub-committees acted for the Board to ensure that non-executive directors had a direct role in Britannia s corporate governance. The assets and liabilities committee managed and controlled the balance sheet exposures of the Group. The committee developed, reviewed and maintained the long-term funding policy, agreed, implemented and reviewed short-term funding plans, formulated long- and short-term views on interest rate movements and decided on appropriate courses of action and set and reviewed treasury policy exposure limits within parameters agreed by the Board. The committee also approved and monitored the Basel treasury rating systems. The nominations committee consisted of all members of the Board and met to review the composition of the Board and its sub-committees, to review the Group approach to the management of high potential talent and to ensure that Britannia had robust succession plans in place to cover key roles within the business. The remuneration committee comprised four non-executive directors. The committee met twice in the period and ensured that Britannia could attract and retain the right people to manage the business by offering appropriate rewards and incentives. The audit committee comprised three non-executive directors. The committee oversaw the Group s internal controls, accounting policies and financial reports, and monitored compliance with legal and regulatory requirements. It also liaised with the Group s external auditors. The committee met five times in the period and maintained regular contact with key personnel including the head of group risk, the group compliance officer, the group money laundering reporting officer, the group chief internal auditor, the business leaders for financial control and financial management, and the internal auditors. The Group s external auditors undertook non-audit services, including the provision of advice on taxation matters. Audit and non-audit fees of external auditors were approved by the audit committee and auditor objectivity and independence were safeguarded by competitive tendering and regular appraisal. The Britannia Treasury Services (BTS) sub-committee dealt primarily with initial approval of asset purchases and sales, and approval of significant changes in BTS policy or strategy. The group credit committee ensured that lending policies and exposure limits supported the Group strategy, taking due account of external influences on the markets in which we operated together with the associated risks and actual performance. The committee approved and monitored the ongoing performance of Basel rating systems for retail and commercial credit risk. The committee helped the Board to define the Group s risk appetite for lending by monitoring the quality of new and existing lending to ensure appropriate action was taken to mitigate risk.

10 10 of 120 The number of Board and committee meetings att by each director during the period to 31 July is shown in the table below: Britannia Board (12 in period) Audit (5 in period) Rodney 11 Baker-Bates (chair) Assets and Liabilities (8 in period) Remuneration (2 in period) Nominations (2 in period) Treasury Services (6 in period) Group Credit (7 in period) (chair) Keith Cameron 11 1 Tim Franklin 10 8 (chair) 7 Bill Gordon (retired ) 8 (member until ) 2 2 (member until ) Francis Gugen (see note in directors report on page 5) 11 5 Peter Harvey Chris Jones 12 2 (chair) 6 Stephen Kingsley (member 3 Phil Lee 12 5 until ) David McCarthy Neville Richardson (chair) 6 Bridget 5 11 Rosewell (chair) Tom Sawyer 7 2 Rodney Baker-Bates Committee Chairman On behalf of the Cessation Accounts Committee 22 October 2009

11 11 of 120

12 12 of 120

13 13 of 120 Consolidated income and expenditure account 7 months 12 months 31 July 31 December m m Interest receivable and similar income ,107.2 Interest expense and similar charges 2 (400.6) (1,799.7) Net interest income Fee and commission income Fee and commission expense 4 (18.9) (16.0) Net fee and commission income Gains less losses from derivative financial instruments Gains less losses from investment securities Gains less losses from other financial instruments Other operating income Total other operating income Total income Administrative expenses 9 (122.5) (209.9) Merger costs 9 (26.9) - Depreciation and amortisation 13 (16.3) (31.1) Impairment losses on loans and advances to customers 23 (45.3) (57.8) Impairment losses on counterparties (57.4) Provision for additional compensation schemes levies (19.8) Operating profit Share of post-tax (losses)/profits from joint ventures 28 (0.1) 0.6 Profit before tax and Britannia Membership Reward Britannia Membership Reward 14 (18.9) (18.4) Profit before tax Taxation 15 (6.6) (0.2) Net profit Notes Consolidated statement of other comprehensive income Notes 7 months 12 months 31 July 31 December m m Net profit for the period Movement in fair value of available-for-sale assets (40.8) Cashflow hedging gain/(loss) (47.7) Actuarial gain on pension plan Amount of pension surplus not recognised under IAS (4.7) (99.8) Tax on items through equity other than the income and expenditure account (10.8) 46.6 Total comprehensive income 45.6 (114.7) The accounting policies and notes on pages 18 to 111 form part of these accounts.

14 14 of 120 Society income and expenditure account Notes 7 months 12 months 31 July 31 December m m Interest receivable and similar income ,795.8 Interest expense and similar charges 2 (369.5) (1,578.7) Net interest income Fee and commission income Fee and commission expense 4 (5.4) (3.7) Net fee and commission income Income from investments Gains less losses from derivative financial instruments Gains less losses from investment securities Gains less losses from other financial instruments Other operating income Total other operating income Total income Administrative expenses 9 (99.5) (169.8) Merger costs 9 (26.9) - Depreciation and amortisation 13 (13.8) (27.4) Impairment losses on loans and advances to customers (9.7) Impairment losses on counterparties (57.4) Provision for additional compensation schemes levies (19.8) Operating profit before tax and Britannia Membership Reward Britannia Membership Reward 14 (18.9) (18.4) Profit before tax Taxation 15 (12.3) 7.5 Net profit Society statement of other comprehensive income 7 months 12 months 31 July 31 December Notes m m Net profit for the period Movement in fair value of available-for-sale assets (42.7) Cashflow hedging gain/(loss) (45.0) Actuarial gain on pension plan Amount of pension surplus not recognised under IAS (4.7) (99.8) Tax on items through equity other than the income and expenditure account (10.5) 46.3 Total comprehensive income 77.0 (109.5) The accounting policies and notes on pages 18 to 111 form part of these accounts.

15 15 of 120 Group statement of financial position Assets Cash and balances with the Bank of England Loans and advances to banks Loans and advances to customers Fair-value adjustments for hedged risk Investment securities - loans and receivables Investment securities - available-for-sale Derivative financial instruments Investments in joint ventures Goodwill Intangible assets Investment properties Property, plant and equipment Deferred tax assets Other assets Prepayments and accrued income Retirement benefit asset Total assets At 31 July At 31 December Notes m m , , , , , , , , , , ,216.7 Liabilities Shares Guaranteed equity bonds Deposits from banks Other deposits Derivative financial instruments Debt securities in issue Fair-value adjustments for hedged risk Other liabilities Provisions for liabilities and charges Accruals and deferred income Current taxes Subordinated liabilities Subscribed capital Total liabilities 36 16, , , , , , , , , , , , ,144.2 General reserve Available-for-sale reserve Cashflow hedging reserve Total equity and liabilities The accounting policies and notes on pages 18 to 111 form part of these accounts. 48 1, , (88.8) (97.4) 50 (12.7) (33.6) 33, ,216.7 These financial statements have been approved for issue by the Cessation Accounts Committee on 22 October Rodney Baker-Bates (On behalf of the Cessation Accounts Committee) Neville Richardson (On behalf of the Cessation Accounts Committee)

16 16 of 120 Society statement of financial position Assets Cash and balances with the Bank of England Loans and advances to banks Loans and advances to customers Fair-value adjustments for hedged risk Investment securities - loans and receivables Investment securities - available-for-sale Derivative financial instruments Investments Goodwill Intangible assets Property, plant and equipment Deferred tax assets Other assets Prepayments and accrued income Retirement benefit asset Total assets At 31 July At 31 December Notes m m , , , , , , , , , , ,153.1 Liabilities Shares Shares - guaranteed equity bonds Deposits from banks Other deposits Derivative financial instruments Debt securities in issue Fair-value adjustments for hedged risk Other liabilities Provisions for liabilities and charges Accruals and deferred income Current taxes Subordinated liabilities Subscribed capital Total liabilities 36 16, , , , , , , , , , , ,271.4 General reserve Available-for-sale reserve Cashflow hedging reserve Total equity and liabilities The accounting policies and notes on pages 18 to 111 form part of these accounts. 48 1, , (88.8) (98.5) 50 (11.4) (30.7) 32, ,153.1 These financial statements have been approved for issue by the Cessation Accounts Committee on 22 October Rodney Baker-Bates (On behalf of the Cessation Accounts Committee) Neville Richardson (On behalf of the Cessation Accounts Committee)

17 17 of 120 Statement of cash flows Notes Group Group Society Society 7 months 12 months 7 months 12 months 31 July 31 December 31 July 31 December m m m m Cash flows from operating activities 59 (1,632.8) (666.6) (1,569.3) (774.5) Cash flows from investing activities Purchase of investment securities (6,774.5) (23,838.7) (6,744.8) (23,823.6) Proceeds from sale and maturity of investment securities 6, , , ,223.7 Purchase of investment property (26.7) (105.6) - - Proceeds from sale of investment property Investment in share capital of subsidiaries - - (4.9) (15.0) Purchase of property, plant and equipment (1.6) (8.7) (1.5) (7.9) Proceeds from sale of property, plant and equipment Intangible asset additions (5.2) (13.3) (4.9) (11.3) Income from investments Net cash flows from investing activities 23.6 (716.9) (24.8) (601.7) Cash flows from financing activities Repayment of subordinated liabilities (62.5) - (62.5) - Interest paid on subordinated liabilities (12.0) (35.5) (12.0) (35.5) Interest paid on subscribed capital (13.1) (28.9) (13.1) (28.9) Net cash flows from financing activities (87.6) (64.4) (87.6) (64.4) Net decrease in cash (1,696.8) (1,447.9) (1,681.7) (1,440.6) Cash and cash equivalents at start of period 59 3, , , ,421.4 Cash and cash equivalents at end of period 59 1, , , ,980.8

18 18 of 120 Statement of accounting policies On 1 August 2009, the engagements of the Group were transferred to The Co-operative Financial Services ( CFS ). Accordingly, the Cessation Accounts of the Group and Society have been prepared immediately prior to this transfer and represent a period shorter than one year. Therefore, comparative amounts for the income and expenditure accounts, statements of comprehensive income, statements of cash flows and related notes are not entirely comparable. The accounts have been prepared on a going-concern basis as the entire business of the Group and Society has continued to operate within the CFS business from 1 August Basis of presentation The Group s consolidated financial statements have been prepared under the historical cost convention as modified by the revaluation of available-for-sale financial assets and all derivative contracts. The Group is required to prepare its consolidated financial statements in accordance with International Financial Reporting Standards (IFRSs) adopted by the European Union, interpretations issued by the International Financial Reporting Interpretations Committee (IFRIC) and with those parts of the Building Societies (Accounts and Related Provisions) Regulations 1998 applicable to organisations reporting under IFRS. The Group has adopted the following pronouncements in these accounts: IFRS 8 Operating Segments, which requires that information on operating segments is reported based on how it is reported and evaluated internally (see Note 16); IAS 1 Presentation of Financial Statements (revised) which fundamentally revises the format of the financial statements; and IAS 23 Borrowing Costs (revised) which requires that borrowing costs on assets that take a substantial time to prepare for int use or sale must be capitalised. Other pronouncements include: IAS 32 Financial Instruments: Presentation and IAS 1 Presentation of Financial Statements portable financial instruments and obligations arising on liquidations (am); IFRS 3 Business Combinations (revised); IAS 27 Consolidated and Separate Financial Statements (am); and IFRICs 13,15,16,17 and 18. The above pronouncements, while mandatory for the period 31 July 2009, are not relevant to the Britannia Group.

19 19 of 120 Consolidation The financial information of the Group incorporates the assets, liabilities and results of Britannia Building Society and its subsidiaries. Subsidiaries include special purpose entities (SPEs) as defined below. Subsidiaries Subsidiaries are entities over which the Group can exercise control, particularly of their financial affairs and operating policies. In the Group accounts, subsidiaries are fully consolidated from the date on which control is transferred to the Group. Identifiable assets acquired, including intangible assets and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date. The excess of the cost of acquisition over the fair value of the Group s share of the identifiable net assets acquired is recorded as goodwill. Intercompany transactions, balances and unrealised gains on transactions between Group companies are eliminated. In the Society accounts, investments in subsidiary undertakings are stated at cost less provisions for any impairment in value. Special purpose entities The Group s SPEs, entities created to accomplish a narrow and well defined objective, include various securitisation transactions in which it sold mortgages to SPEs. The equity of these SPEs is not owned by the Group; and a covered bond transaction, in which a limited liability partnership was established to act as guarantor for the covered bond issue. In accordance with the Standing Interpretations Committee (SIC) Interpretation 12, the Group is deemed to have control over the SPEs and therefore they are included as subsidiaries in the consolidated financial statements. The Group continues to recognise the securitised assets as loans and advances to customers on the balance sheet and income from the securitised assets continues to be recognised as Group income. Interests in joint ventures The Group s interests in joint ventures are accounted for using the equity method. Under this method the Group s share of profits or losses is recognised in the income and expenditure account and the Group s share of net assets is shown on the balance sheet. Foreign currency translation Functional and presentation currencies The consolidated financial statements are presented in sterling, which is the Group s functional currency (ie the primary currency in which it transacts business) and presentation currency.

20 20 of 120 Transactions and balances Foreign currency transactions are converted into sterling using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the conversion and settlement of currency transactions and from the translation at period-end exchange rates of monetary assets and liabilities denominated in foreign currencies (for example, certain investments and Euro- and US dollardenominated debt securities) are recognised in the income and expenditure account. Interest income and expense This comprises: interest income and expense for financial assets and financial liabilities at amortised cost, calculated using the effective-interest-rate method. This includes accrued interest income on financial assets written down as a result of an impairment; and interest income and expense on available-for-sale investments and derivatives, which are measured at fair value. All derivative financial instruments are entered into for the purpose of hedging exposures. Interest income or expense on derivative financial instruments that are hedging assets is included in interest receivable and similar income. Interest income or expense on derivative financial instruments that are hedging liabilities is included in interest expense and similar charges. Effective interest rate The effective interest rate (EIR) is calculated at initial recognition by discounting the asset s or liability s estimated future cash flows back to its net carrying amount over its expected life. The main impact for the Group is in relation to income from loans and advances to customers. The EIR calculation includes application fees charged to customers, broker fees payable, mortgage discounts and incentives, and estimates of future early repayment fees. The calculation makes no allowance for losses arising from non-payment by customers. The calculation requires assumptions to be made, particularly regarding the expected lives of future cash flows relating to the asset or liability, using both historical data and management judgments. These assumptions are monitored, regularly reviewed and am when necessary. The carrying amounts of assets and liabilities are am to reflect actual and revised estimated cash flows. The entity recalculates the carrying amount by computing the present value of estimated future cash flows at the financial instruments original effective interest rate. Fee and commission income Fee and commission income other than that directly related to loans is recognised over the period for which the service has been provided, or on completion of an act to which the fee relates.

21 21 of 120 Britannia Membership Reward A liability for the Britannia Membership Reward is recognised when a payment has been approved by the Board. It is disclosed separately in the income and expenditure account in view of its size and importance. The liability is included within other liabilities in the balance sheet. Tax Tax on the profit for the period comprises current tax and deferred tax. Current tax The expected tax payable on the results for the period is called current tax. It is calculated using the tax rates in force at the balance sheet date. The current tax charge includes adjustments to tax payable in prior periods. Deferred tax Deferred tax is provided in full using the liability method where there are temporary differences between the carrying value of assets and liabilities for accounting and for tax purposes. Deferred tax is calculated using the tax rates that are expected to apply when the related deferred tax asset is realised or deferred tax liability is settled. The principal temporary differences arise due to: differences in the accounting and tax treatment of payments made into the pension scheme; provisions for loan impairment in the accounts not immediately deductible for tax purposes; differences in depreciation and capital allowance rates used for taxation; differences in tax rules for securitisation companies; and tax losses carried forward. Tax losses available to carry forward and other deferred tax assets are only recognised as assets where it is probable that there will be future taxable profits against which to offset them. Movements in deferred tax are recognised in the income and expenditure account except when they relate to items such as unrealised profits or losses on available-for-sale investments taken directly to reserves. In such cases the tax is also recognised directly in reserves and is subsequently recognised in the income and expenditure account at the same time as the related profit or loss is realised.

22 22 of 120 Financial assets Classification The Group s financial assets are categorised as follows: a. Loans and receivables Loans and receivables are assets with fixed or determinable payments that are not quoted in an active market. They include: cash and balances with the Bank of England; loans and advances to banks; loans and advances to customers; and investment securities reclassified from available-for-sale, or acquired, during an inactive market. b. Available for sale Investment securities available for sale are assets held principally to manage the Group s liquidity. They are generally debt instruments that are held until they mature, although they may be sold in response to needs for liquidity or changes in interest rates. Where the market in such assets became inactive in 2008, the Group reclassified such assets as loans and receivables in accordance with the amendments to IAS 39 Financial Instruments : Recognition and Measurement and IFRS7 Financial Instruments : Disclosures. c. Financial assets at fair value through income or expense This category covers assets acquired principally for the purpose of selling in the short term or those designated at initial recognition by management. It includes: pledged assets; and derivative financial instruments (unless they are designated as effective hedges). The Group s derivatives can be split into three categories: derivatives that meet the conditions for applying hedge accounting; derivatives that provide economic hedges against underlying items but do not meet conditions for applying hedge accounting; and derivatives that were acquired to hedge other financial instruments, but that no longer meet the conditions for applying hedge accounting.

23 23 of 120 Recognition and derecognition Financial assets at fair value through income and expense are initially recognised at fair value on the date that the Group commits to purchase the asset. The fair values of quoted instruments in active markets are based on current bid prices. The fair values of investments where there is no active market or the securities are unlisted are based on valuation techniques including discounted-cashflow analysis, with reference to relevant market rates, and other commonly used valuation techniques. Associated transaction costs are taken directly to the income and expenditure account. Gains and losses arising from changes in fair values are included in the income and expenditure account in the period in which they arise. Loans and receivables are recognised at fair value when the cash is advanced. They are carried at amortised cost using the EIR method, with all movements being recognised in the income and expenditure account. Available-for-sale assets are initially recognised at fair value on the date that the Group commits to purchase the assets. Subsequent movements in fair values are recognised directly in reserves. The fair values of quoted investments in active markets are based on current bid prices. The fair values of investments where there is no active market or the securities are unlisted are based on valuation techniques including discounted-cashflow analysis and other commonly used valuation techniques. Financial assets are derecognised when: the rights to receive cash flows from the assets have ceased; or the Group has transferred substantially all the risks and rewards of ownership of the assets. When available-for-sale financial assets are derecognised (or impaired) the cumulative gain or loss, including that previously recognised in reserves, is recognised in the income and expenditure account. Mortgage commitments The Group enters into derivative contracts to reduce the exposure to risk on mortgage commitments made (for example, where the Group has made an irrevocable offer of a loan to a customer). Mortgage commitments and the corresponding derivative contract are recorded at fair value with movements recognised in the income and expenditure account. Impairment of financial assets An asset is impaired if the recoverable amount of the asset (ie the discounted expected future cash flows from the asset) is less than the carrying value of the asset on the balance sheet. Assets carried at amortised cost At each balance sheet date the Group assesses whether there is objective evidence that any of its assets carried at amortised cost are impaired. The Group assesses assets individually and collectively where a group of assets has similar risk characteristics.

24 24 of 120 Objective evidence that an asset (or group of assets) may be impaired includes observable data that loss events, such as: late or missed repayments of principal or interest; other evidence that borrowers are experiencing financial difficulties; or national or local economic conditions that indicate an increased likelihood that borrowers will default, have occurred subsequent to initial recognition and their impact on the estimated future cash flows of the asset (or group of assets) can be reliably estimated. The Group first assesses whether evidence of impairment exists for individual financial assets. Where the Group concludes that there is no evidence of impairment for individually assessed assets, it includes those assets in groups of assets with similar credit characteristics and collectively assesses these groups for impairment. Where the Group identifies evidence that an individual asset or group of assets is impaired, it reduces the carrying amount of the asset on the balance sheet through the use of an impairment provision and charges the provision to the income and expenditure account. The amount of the provision made is calculated as the difference between the carrying value of the asset and the present value of future cash flows (excluding future credit losses that have not been incurred), discounted at the asset s original effective interest rate. In estimating these future cash flows, the Group takes into account such factors as the expected proceeds from the sale of repossessed properties, the time taken to repossess and any further payments expected from the borrower or counterparty. When an asset is considered uncollectible, it is written off against the impairment provision on the balance sheet. Such assets are written off after all the possible collection procedures have been completed and the amount of loss has been determined. Any additional recoveries from borrowers, counterparties or other third parties made in future periods are offset against the impairment charge in the income and expenditure account, once they are virtually certain to be received. Assets carried at fair value The Group invests in debt instruments, including gilts, certificates of deposit and floating-rate notes, secured against loan assets and issued by third parties. These investments, including those categorised as available for sale, are assessed at each balance sheet date to see whether there is objective evidence of impairment (for example, if there is evidence of significant financial difficulty of the issuer of an instrument). Changes in value from impairment are recognised in the income and expenditure account. If, in a subsequent period, the fair value of a debt security classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in the income and expenditure account, the impairment loss is reversed through the income and expenditure account.

25 25 of 120 Offsetting financial instruments Financial assets and liabilities are offset and the net amount reported in the balance sheet only when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or to realise the asset and settle the liability simultaneously. Sale and repurchase agreements Securities sold subject to repurchase agreements (repos) are reclassified on the balance sheet as pledged assets when the transferee has the right by contract or custom to sell or repledge the assets. The liability to the transferee is also included on the balance sheet, in deposits from banks, other deposits or shares, as appropriate. The difference between sale and repurchase price is accrued over the life of the agreements using the EIR method. Securities purchased under agreements to re-sell (reverse repos) are classified as loans and advances to banks on the balance sheet, as appropriate. Securities lent to counterparties are retained on the balance sheet. Securities borrowed are not recognised on the balance sheet, unless they are sold to third parties, in which case the purchase and sale are recorded with the gain or loss included in gains less losses from investment securities in the income and expenditure account. The obligation to return them is recorded at fair value as a trading liability. Derivative financial instruments and hedge accounting Derivatives Derivatives are financial instruments such as interest rate and currency swaps used by the Group to manage its interest rate and foreign exchange risks arising from the normal course of business. The Group also uses equity derivatives to hedge the equity risks within its guaranteed equity bonds (GEBs). Derivatives are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently remeasured at their fair value. Fair values are obtained from quoted market prices in active markets, or calculated using valuation techniques such as discounted-cashflow models where no active market exists. All derivatives are carried as assets when the fair value is positive and as liabilities when the fair value is negative. Financial guarantee contracts The Society is the holder of a credit-default swap with another Group company which is treated as a financial guarantee contract. In the absence of any available market price for an identical or similar contract, the Society uses a probability-adjusted discounted-cashflow analysis to value the contract. Hedge accounting Hedge accounting is the matching or elimination of risks arising from potential fluctuations in interest rates, exchange rates and market indices, typically through the use of derivative hedging instruments.