1. Purpose Frequency and Basis of Disclosures Overview Risk Management Objectives and Policies 5

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1 PILLAR 3 DISCLOSURE DOCUMENT June 2013

2 CONTENTS PAGE 1. Purpose Frequency and Basis of Disclosures 3 2. Overview 4 3. Risk Management Objectives and Policies 5 4. Risk Management Framework Structure and Organisation of Risk Management 7 5. Credit Risk 5.1 Mortgages Past Due items Provisions Treasury Summary Liquidity and Funding Risk Market Risk Interest Rate Risk Operational Risk Concentration Risk Conduct Risk Business Risk Remuneration Code Capital Resources Capital Adequacy Assessment 23 2

3 1. Purpose The purpose of this document is to assess the appropriateness and whether the Society s risk profile is disclosed comprehensively to members and to the market. This policy documents the Pillar III public disclosure requirements of the Capital Adequacy Directive and complies with BIPRU and Frequency and Basis of Disclosures The policy is prepared on an annual basis in light of the size, scale and complexity of the Society. As a solo entity, wholly UK based, which transacts with UK counterparties only and in sterling currency. If the Society materially diversifies away from this model or if the risk profile materially changes, the Audit Risk and Compliance Committee will consider publishing an update to this disclosure document more frequently. Unless otherwise stated, all figures are as at the financial year end, 4 February The Society s business model comprises making loans that are secured primarily on residential property that are funded substantially by its members. The primary business objective of the Society is to promote savings and home ownership particularly within the North West of England through an attractive range of products and services, combined with the provision of a high standard of customer service whilst maintaining a competitive position within the business areas in which it operates. The Society is based in the United Kingdom and has no branches or subsidiaries outside the UK. The Society is a single entity firm with no subsidiaries and is not part of a group structure. The Pillar III disclosure is published as soon as practicably possible after the Society has held its Annual General Meeting (AGM) whereby the Annual Report and Accounts are accepted by the Society members. The disclosure document can be found on the website. The policy is prepared by the Finance Director on an annual basis and reviewed by the Audit Risk and Compliance Committee and the Board of Directors. Should the reader of this disclosure document require further explanation, application should be made in writing to the Society Secretary at The Chorley and District Building Society, Key House, Foxhole Road, Chorley, Lancashire PR7 1NZ. 3

4 2. Overview Background The Basel Accords refer to recommendations on banking regulations known as Basel I, Basel II and Basel III issued by the Basel Committee on Banking Supervision (BCBS). They are called the Basel Accords as the BCBS normally meet in Basel, Switzerland. Basel I was enforced by law in the G-10 countries in It mainly focussed on credit risk, with banks and building societies required to hold capital equal to 8% of risk weighted assets but Basel I was superseded by a more comprehensive set of guidelines known as Basel II. Basel II was intended to create an international standard for regulators to control how much capital banks and building societies needed to put aside to safeguard against the types of financial and operational risks banks, building societies and the whole economy face. The Basel II framework introduced the concept of three 'pillars'. Pillar I which sets out the minimum capital requirements firms are required to meet for credit, market and operational risk. Pillar II (a) and (b) whereby firms and supervisors take a view on whether a firm should hold additional capital against risks not covered in Pillar I. Pillar III aims to improve market discipline by requiring firms to publish certain details of their risks, capital and risk management The Capital Requirements Directive (CRD) introduced a supervisory framework in the EU which reflects the Basel II rules on capital measurement and capital standards. Firms in the financial services industry had to apply the CRD from 1 st January A third Basel accord, Basel III has been developed to address the deficiencies in financial regulation highlighted by the most recent financial crises in Basel III is a global standard aimed at strengthening banks and building societies capital adequacy, stress testing and liquidity risk. Basel III requires firms to hold high quality capital together with higher levels of capital broadened by enhanced definitions of liquid assets and liquidity requirements. Basel III will be introduced later in 2013 with extended implementation until Under Pillar I, The Chorley and District Building Society (CDBS) has adopted the Standardised Approach permitted by the CRD when calculating the minimum capital requirement. Under Pillar II, the Society is required to develop and maintain an Internal Capital Adequacy Assessment Process (ICAAP). The firm must regularly assess the amount of internal capital it considers adequate to cover all the risks it is exposed to, within the context of its overall risk management framework. The Society s regulatory supervisors review the ICAAP and assess whether a firm should hold additional capital against risks not covered under Pillar I. The aim of Pillar III is to improve market discipline by requiring firms to publish certain details of their risks, risk management, capital and liquidity. It is the intention of the Board of Directors that the Society remains an independent Building Society acting in the interests of present and future members, maintaining its financial strength and security, and continuing to prosper as a viable mutual institution. 4

5 3. Risk Management Objectives and Policies The ICAAP (Internal Capital Adequacy Assessment Process) is one of the tools that forms part of the risk management framework from which the Society can assess risk and ensure capital resources are of appropriate quantity and quality to cover those risks. The risk framework exists to promote financial soundness and stability and is forward-looking in its capital planning. The ICAAP should be considered in conjunction with the regulatory back-drop, policy statements and internal documents detailed as follows:- The Building Societies Act 1986 (as amended from time to time) The Financial Services Act 2012 (the Act ) The Financial Services and Markets Act 2000 (the FSMA ) The Prudential Regulation Authority (the PRA) and the Financial Conduct Authority (the FCA ) Handbooks specifically:- GENPRU General Prudential Sourcebook BIPRU Prudential Sourcebook for Banks and Building Societies and Investment Firms BSOCS the Building Societies Sourcebook SYSC Senior Management Arrangements, Systems and Controls CAD the Capital Adequacy Directive GAAP the Generally Accepted Accounting Principles in the UK Guidance provided by the Joint Money Laundering Steering Group The Society s Corporate Plan The Society s Risk Management Framework Policy Statement The Society s Risk Appetite Policy Statement The Society s Treasury Policy Statement The Society s Individual Systems Assessment (the ILSA ) The Society s Lending Policy Statement The Society s Contingency Funding Plan The Society s Recovery and Resolution Plan The Society s Risk Register The Society s Risk Dashboard Prevailing market conditions As a mutual organisation which is run for the benefit of its Members, the Board is prudent when deciding upon its appetite for risk. The Board of Directors has approved the following overall high level risk appetite:- we will not knowingly take risk positions that threaten our ability to remain an independent mutual building society that is able to continue to provide long term value to our members. In addition, we will conduct our activities in a manner that safeguards the Society s investing members balances whilst maintaining at all times the minimum amount of capital required to meet the Individual Capital Guidance (ICG) and an additional capital planning buffer (CPB) determined by the appropriate regulator. Implicit within this risk appetite statement are the assumptions that we will not make decisions which might: Result in a financial loss being reported, which would weaken the capital position Damage the business model or threaten market position Adversely affect reputation or reduce confidence in the Society amongst key stakeholders such as members, staff, the community in which we operate, business partners and the appropriate regulators Strain liquidity ratio or adversely impact funding capabilities Endanger compliance with legislation, regulations, guidance and relevant codes of conduct. 5

6 A third Basel accord, Basel III has been developed to address the deficiencies in financial regulation highlighted by the most recent financial crises in Basel III is a global standard aimed at strengthening banks and building societies capital adequacy, stress testing and liquidity risk. Basel III requires firms to hold high quality capital together with higher levels of capital broadened by enhanced definitions of liquid assets and liquidity requirements. Basel III will be introduced from 2013 with extended implementation until 2019, subject to issuance of the final statutory text expected later in Risk Management Framework The Board has implemented a clearly defined risk management framework that contains the following features:- A risk focused governance structure Risk policy statements and risk limits Risk identification, assessment, monitoring and reporting, and An effective internal control framework The Society operates a Three Lines of Defence model to manage its risks. First line of defence: business operations - risk and control in the business Primary responsibility for the identification, control, monitoring and mitigation of risks lies with the appropriate operational areas. It is the responsibility of the risk owner to correctly assess each risk. There is a standardised approach to how risks recorded and assessed. Second line of defence: risk management and compliance functions The risk management function facilitates and monitors the implementation of effective risk management practices by operational management. It also assists the risk owners in reporting adequate risk-related information. This provides oversight over business process and risks. Oversight and governance is provided through Audit Risk & Compliance Committee via the Management Risk & Compliance Committee. Third line of defence: internal audit Internal audit undertakes a programme of risk-based audits covering all aspects of both first and second lines of defence. Independent assurance is provided by the Internal Auditors and the Audit Risk and Compliance Committee. 6

7 4.1 Structure and Organisation of Risk Management The Board is ultimately responsible for Risk Management Framework which is supported through a series of sub-committees, or by Management operating under delegated mandates outlined as follows:- Key Risks First Line Second Line Credit Risk Risk Management Risk Oversight Risk Governance Retail Credit Risk Branches and Relevant Department Managers General Manager Customer Services Credit Committee and the Management Risk & Compliance Committee Audit Risk and Compliance Committee and the Board of Directors Commercial Credit Risk Head of Mortgages, Senior Underwriters and Society Treasurer General Manager Customer Services, Credit Committee, ALCO and Management Risk & Compliance Committee Audit Risk and Compliance Committee and the Board of Directors Liquidity & Funding Risk Society Treasurer and Finance Manager CEO, Finance Director, ALCO and Management Risk & Compliance Committee Audit Risk and Compliance Committee and the Board of Directors Interest Rate Risk Society Treasurer CEO, ALCO and Management Risk & Compliance Committee Audit Risk and Compliance Committee and the Board of Directors Operational Risk Branches and Relevant Key House Department Managers CEO and Management Risk & Compliance Committee Audit Risk and Compliance Committee and the Board of Directors Concentration Risk Head of Mortgages and Society Treasurer CEO, Credit Committee, Product Committee and Management Risk & Compliance Committee Audit Risk and Compliance Committee and the Board of Directors Conduct Risk Branches and Relevant Department Managers General Manager Customer Services, Head of Conduct, Compliance Department & Conduct Risk Committee Board of Directors Business Risk Relevant Department Managers CEO, DCEO, Finance Director, General Manager Customer Services, ALCO, Product Committee, Credit Committee Board of Directors 7

8 First Line of Defence: Senior Management responsibilities All departmental managers are responsible for managing business performance within the Society s overall Risk Management Framework. Business areas identify, assess, monitor and report risks through departmental Risk Registers. Second Line of Defence: Board Committee responsibilities The Society s Board Audit Risk and Compliance Committee has Board delegated responsibility to monitor business performance against Risk Appetite and to set, monitor and report on risk policy and methodology and to challenge the risk management approach undertaken for specific risks. The Society s Risk Committee structure is as follows: Audit Risk & Compliance Committee Board Nominations & Remuneration Committee Oversight Management Risk & Compliance Committee (monthly) Chair = Deputy Chief Executive, Secretary and Treasurer ALCO (monthly) Chair = Chief Executive Credit Committee (as required) Chair = Chief Executive Operational Management Product Committee (Quarterly) Chair = Chief Executive The full terms of reference for the Board and appointed Committee are available on the Society s website in the About Us section. 8

9 Board of Directors As at 4 February 2013 the Society s Board of Directors comprise three Executive Directors and six Non- Executive Directors. From a risk management perspective there are two Board appointed committees that report directly to the Board. These are the Audit Risk and Compliance Committee, and the Nominations and Remuneration Committee. The Board meet monthly. Responsibilities include:- Strategy and Planning approval of the long term strategy of the Society approval of the Corporate Plan, ICAAP, ILSA and all other Policy Statements and budgets put forward by the Society the overall approval and review of the major risks facing the Society and the establishment of appropriate controls to mitigate those risks oversight of the Society s operations setting the risk appetite, reviewing and approving the Risk Appetite Policy Statement Regulatory Matters high level monitoring and responsibility for the legal and regulatory governance of the Society annual review of compliance with the appropriate regulator for Threshold Condition 4 (adequate resources) and Threshold Condition 5 (suitability) annual review of compliance with the High Level Standard requirements of the appropriate regulator as set out in the handbook, including the Principles for Business (PRIN) and Senior Management Arrangements Systems and Controls (SYSC) approval of the Internal Capital Adequacy Assessment Framework (ICAAP) Audit Risk and Compliance Committee This Committee comprises three non-executive directors. The Chairman, Chief Executive, Deputy Chief Executive Secretary and Treasurer, Finance Director, Compliance Manager and representatives from the Society s internal and external auditors, KPMG and PricewaterhouseCooper and compliance consultants Mutual One, are invited to attend. The Committee meets quarterly and the minutes of each meeting are provided to the Board of Directors. Responsibilities include:- Annual Report and Accounts to review, agree and recommend for approval to the Board, the Society s Annual Report and Accounts, Summary Financial Statement, and Going Concern Paper and Pillar 3 Disclosure Internal Controls and Risk Management to review, agree and recommend for approval to the Board, the Corporate Governance Policy Statement, Risk Appetite Policy Statement, Risk Management Policy Statement, Risk Management Framework and Conduct Risk Policy Statement to review, approve and monitor the Risk Register to review the ICAAP to review the Treasury Policy Statement and ILSA to apportion capital in line with risk appetite and the Corporate Plan to review the impact of business proposals on risk appetite and capital to monitor via the Risk Dashboard the risk appetite against policy limits and assess the effectiveness of policies, processes and controls 9

10 to receive and review the quarterly risk report provided by the Deputy Chief Executive Secretary & Treasurer to review the Remuneration Policy Statement to ensure that the overall and individual remuneration and reward structure is compatible with the Society s Risk Appetite Policy Statement Board Nominations and Remuneration Committee This Committee comprise three Non-Executive Directors. The Chief Executive, Deputy Chief Executive Secretary and Treasurer and Head of HR attend each meeting. The Committee meets on an ad-hoc basis but at least three times a year. The minutes of each meeting are provided to the Board of Directors. The Chief Executive has overall responsibility for the operations of the Society. Responsibilities include:- to agree the level and structure of remuneration for Remuneration Code staff in determining remuneration policy and packages, the Committee shall have regard to the UK Corporate Governance Code, the appropriate regulator s Remuneration Code and Policy Statement PS 09/15 Reforming Remuneration Practices in Financial Services and all other relevant codes, laws and regulations to oversee directly the remuneration of senior officers in the Society s Risk and Compliance function(s) to consider a report from the Deputy Chief Executive Secretary and Treasurer on the overall setting of remuneration for the different business areas of the Society in relation to risk The committee sets remuneration policy in conjunction with the Society s risk framework. The policy is based on the principles of the Remuneration Code 2011 issued by the appropriate regulator. These principles are considered against levels of remuneration and levels of risk. Assets and Liabilities Committee This Committee comprise three Executive Directors, one Non-Executive Director. Members of the Senior Management team are invited to attend. The Committee meets on a monthly basis and the minutes of each meeting are provided to the Board of Directors Responsibilities include:- to review, agree and recommend for approval by the Board, the Treasury Policy Statement and Individual Liquidity Systems Assessment on at least an annual basis to consider the Recovery and Resolution Plan to assess the liquidity levels of the society and the adequacy of liquid funds in relation to both expected and unexpected events to ensure the liquid buffer assets held are always in excess of (at least 5% above) the regulatory requirement to review the requirements for wholesale funding to review compliance with agreed treasury limits to review treasury activity and performance to review and approve the treasury strategy to monitor the mismatch position and ensure the society adheres to the requirements of the matched approach to monitor the gap analysis and ensure the society keeps within the limits agreed by the Board of Directors to review liquidity stress testing results and assumptions to assess implications, monitor and agree developments / changes in treasury activity especially with regard to regulatory requirements and guidelines 10

11 to review and recommend for approval by the Board treasury counterparties at least annually and associated credit lines to review and approve committed facility lines where considered appropriate to receive and agree the society s interest rate expectations to monitor and agree the use of interest rate derivatives used in the management of interest rate risk to monitor the impact of basis risk on the net interest margin to ensure that the Society s liquidity risk tolerance is documented in the Risk Appetite Policy Statement and is appropriate for its business strategy (BIPRU ) to ensure the society conducts its treasury operations within the parameters of the Risk Appetite Policy Statement to review the capital position on a six-monthly basis and make recommendations to the Board as appropriate to review the balance sheet, income and expenditure account and margin analysis to assess current and forward-looking economic and market conditions to ensure management information provided to the Board of Directors and the appropriate regulator is both timely and accurate Management Risk & Compliance Committee Responsibilities include:- to review, agree and recommend for approval by the Board the Recovery & Resolution Plan on at least an annual basis to review, agree and recommend for approval by the Audit Risk & Compliance Committee and the Board, the Risk Management Policy Statement on at least an annual basis to review, agree and recommend for approval by the Audit Risk & Compliance Committee and the Board, the Risk Appetite Policy Statement on at least an annual basis to review, agree and recommend for approval by the Board, the Stress Testing and Reverse Stress Testing Policy Statement on at least an annual basis to review, agree and recommend for approval by the Audit Risk & Compliance Committee and the Board, the Conduct Risk Policy Statement at least on an annual basis to review, agree and recommend for approval by the Audit Risk & Compliance Committee and the Board, the Financial Crime Policy Statement at least on an annual basis to review, agree and recommend for approval by the Board the Mortgage Loss Provision Policy Statement on at least an annual basis to review, agree and recommend for approval by the Board the Information Security Policy Statement on at least an annual basis to review, agree and recommend for approval by the Board the IT Communications Policy Statement on at least an annual basis to review, agree and approve the Document Retention Policy Statement on at least an annual basis to review, agree and approve the Financial Promotions Policy Statement on at least an annual basis to develop the risk management framework of the Society to review and challenge the Society s risk register to develop the risk response processes, including the business continuity plan to co-ordinate and monitor the implementation of risk management within the Society, by working with risk owners to ensure that risk management processes are implemented as agreed per policy and plan to receive all appropriate Society risk management information including the risk register and risk dashboard to prepare regular and relevant reports for the Board and Audit Risk and Compliance Committee to ensure that members of the Management Risk & Compliance Committee attend each meeting of the Audit Risk & Compliance Committee to provide the training necessary to ensure a risk aware culture 11

12 Credit Committee Responsibilities include:- to review, agree and recommend for approval by the Board, the Lending Policy Statement on at least an annual basis to assess and approve the recommendations made by the Advisors and/or Mortgage Underwriters regarding an application, which is either outside the Society s normal remit and/or above the lending mandate up to a maximum of 1 million to review the credit quality and risk profile of the Society s mortgage book to review the performance of the Society s mortgage book in terms of profitability, arrears and loss performance and the settling of provisions to ensure compliance with the limits set out in the Lending Policy Statement Product Committee Responsibilities include:- Branches to agree product terms and conditions to agree rates of interest generally and for specific classes of savings and mortgage products and manage the interest margin to agree product distribution channels to agree marketing campaigns to review the product pricing model on a regular basis at least annually to review all product back-testing results to create products in response to the ever changing market conditions to ensure all products are compliant with the Society s TCF policies, governing legislation and regulations and any prevailing Codes of Conduct to agree the Society s Fees and Charges tariff Main focal point for customer transactions and interaction Ensure all customers are treated fairly Ensure Society AML, TCF and health and safety rules are adhered to at all times Underwriters Assess all mortgage applications in line with the Society s Lending Policy to ensure that mortgages and further advances are suitable and affordable and responsible lending rules are adhered to at all times Review and recommend new mortgage products to the Product Committee for consideration Review market trends and recommend changes to the lending criteria to the Credit Committee Operational Risk Relevant Head Office Departments Follow approved and updated procedure and operational manuals to reduce the Society s risk exposure Review internal controls to ensure up to date and relevant Test procedures to ensure up to date and relevant to the Society s Risk Appetite Undertake appropriate stress testing, reverse stress testing and business continuity planning Maintain the departmental risk register 12

13 Delegated committees and areas of the business are responsible for satisfying themselves that no material changes in risk levels and profiles have occurred or are planned. Where appropriate, they will prepare policy and strategy papers for agreement by the relevant management committee and/or the Board of Directors. These papers will propose the appropriate scale and/or desired return to fit with the Society s overall Risk Appetite. All of the above functions are mandated by the Board to carry out their responsibilities. Third Line of Defence: Internal Audit Responsibilities The Society s internal auditors KPMG are responsible for carrying out a risk-based programme of audit work to provide assurance that assets are being safeguarded. This involves ensuring that controls are in place and working effectively in accordance with Society policy and procedures as well as with laws and regulations, and that Society records and reports are accurate and reliable. The work carried out by KPMG includes providing assurance on the effectiveness of the second line of defence functions as well as that of controls operated by the Senior Team and the Board. The Audit Risk and Compliance Committee approve the annual Audit Plan and receive regular reports detailing the results of audit visits. 13

14 5. Credit Risk 5.1 Mortgages The Society is exposed to credit risk in respect of either mortgage customers or treasury counterparties being unable to meet their obligations as and when they fall due. In relation to mortgage borrowers credit risk is managed by maintaining a prudent lending policy. The policy includes comprehensive lending criteria such as, full status checks, affordability and stressed affordability assessments and a full valuation of the security by a suitably qualified professional. The risk framework is inherent within the Board approved:- a) Lending Policy Statement. This is prepared by the Head of Mortgages, reviewed and recommended to the Board for approval by Credit Committee and ultimately approved by the Board. Limits and risk appetites are monitored monthly through the Risk Dashboard and Credit Risk report submitted to the Board Product Committee and the Management Risk & Compliance Committee on a monthly basis. Under the Capital Requirements Directive, the Society has adopted the Standardised approach to credit risk. The Society undertakes regular stress tests on credit risk from varying firm-specific, market-wide and idiosyncratic events. Stress tests are discussed in the ICAAP. A summary of credit risk within mortgages is as follows:- Mortgages (net of specific provisions) Risk weighting Value net of % of total mortgages specific provisions Fully secured on residential property: <80% LTV 35% 135, % Unsecured on residential property: >80% LTV 75% 7, % Past due and fully secured: <80% LTV or 100% 1, % unsecured with a provision of >20% Past due and unsecured: >80% LTV 150% 0 0% Secured on real estate 100% 1, % Lifetime mortgages Appx % 2, % Total 147, % Past Due items The Society regards as past due any mortgage or loan account where contractual repayments have not been met for three months or more. The Society monitors all cases of arrears individually, and operates an open dialogue of communication with the borrowers. The Society regards impaired exposures as those not performing contractually, or exposures that do not reflect their market value. There is no concentration exposure to any specific large scale employers, so whilst rising unemployment which in turn can lead to rising arrears is a concern to the industry, the Society is well equipped with the arrears management team who strictly monitor and report timely on all cases of arrears. All arrears cases are subject to a case by case review on a monthly basis where it is deemed necessary, either specifically provided for or are covered by our general provisioning policy. Whilst arrears are expected to increase in the industry the Society has relatively low levels of arrears in comparison. The number of cases three months arrears or more as a percentage of the total number of loans held is 0.82% as at 4 February 2013 (2012: 1.22%) representing 16 14

15 cases (2012: 23 cases) with arrears balances of 110,140 (2012: 163,828) and redemption balances of 1,305,007 (2012: 1,825,664). We have 10 (2012: 16) borrowers in 12 months arrears or more, who represent 0.51% (2012: 0.85%) of the total number of loans outstanding. Their collective arrears balances total 82,633 (2012: 137,911) with redemption balances of 561, 454 (2012: 1,005,098) Provisions Provisions are recognised when a borrower has an obligation to the Society as result of falling into arrears and a reliable estimate is made to reflect the amounts due to the Society. The Society adopts a robust risk-based methodology in applying provisions as documented in the Mortgage Loss Provisioning Policy Statement. The Mortgage Loss Provisioning Policy Statement is reviewed and recommended for approval by the Management Risk and Compliance Committee and the Board. The Society has fully provided for all known arrears cases in excess of 75 % LTV where we can predict an expected shortfall upon the sale of the property calculated as per the Mortgage Loss Provision Policy Statement. In addition, during the year the Society has reviewed hardship cases that are currently on interest only and have an LTV ratio in excess of 75% whether they are in arrears or not. Where a shortfall could be predicted, a specific provision has been created. The calculation uses the same methodology as applied to the arrears cases. The Society also maintains a general mortgage loss provision which is calculated on a risk-based approach to the mortgage book. The calculation is laid out in the Board approved Mortgage Loss Provision Policy Statement. Each category of lending is risk assessed based on banding of LTV; for example prime owner occupied loans with LTV s between 50% and 75% have a 0.05% general provision as it is perceived of inherently less risk compared to prime owner occupied loans with LTV s between 75% and 90%, which would attract a higher 0.125% general provision. The general provisions range from 0.05% to 1% dependent on the risk category. The general provision represents possible impairments to the remainder of the loan book which are not extracted following the specific provisioning process. Loans Fully Secured on Residential Property ( ) Provisions for Bad and Doubtful Debts Specific General Total Brought Forward 6 February , ,000 Utilised during the year Charge for the year (55,600) 58,500 2,900 Carried Forward 4 February , , ,900 15

16 The table below shows a geographical analysis of mortgage exposure and non-performing accounts as at 4 February Geographical Area Redemption balance of all mortgages Redemption balance of all nonperforming accounts Amount of arrears on nonperforming accounts Specific provisions on cases in arrears North West 81,467, ,188 70,828 13,798 Outer South East 9,807,821 Outer Metropolitan Area 9,304, ,873 8,770 Yorkshire & Humberside 9,252,436 61,640 13,714 Greater London 7,574,453 South West 7,268,778 West Midlands 5,284,676 East Midlands 5,280,680 East Anglia 4,344,815 North 3,794,160 Wales 3,410,043 Scotland 737,473 57,508 16,828 Mortgage assets (excl specific provisions) 147,527,793 1,291, ,140 13,798 The table below provides a Society analysis, for capital adequacy purposes, of loans and advances exposures at 4 February 2013: Society Performing Past Due Total Net Redemption Balances Fully Secured on Other Land (FSOL) 1,327, ,327,576 Fully Secured on Residential Property (FSRP) 145,125,613 1,305, ,430,617 General Mortgage Loss Provision (221,500) 0 (221,500) Specific Mortgage Loss Provision (216,605) (13,795) (230,400) Total net commercial assets 146,015,084 1,291, ,306, Treasury The risk framework is inherent within the Board approved Individual Liquidity Systems Assessment (ILSA) and Treasury Policy Statement. These documents are prepared by the Society s Deputy Chief Executive Secretary and Treasurer, reviewed and recommended for approval to the Audit Risk and Compliance Committee and Board by ALCO and annually approved by the Board of Directors. 16

17 The credit risk associated with treasury counterparties is addressed by the Society s ALCO which ensure that deposits are restricted to UK government debt instruments, the Bank of England, UK banks with high quality credit ratings awarded by Fitch and/or Moody s external credit rating agencies, UK building societies which are regulated by the PRA and FCA and local authorities. Credit ratings are updated immediately after any changes have been announced, whether it is a suspension, removal or reduced counterparty limit. The criterion for suitable counterparties is detailed in the Treasury Policy Statement. In addition, ALCO set and review counterparty limits based on a robust methodology for exposures with counterparties on a pre-approved basis. The Society has no exposure to any counterparty outside of the UK. Under the Capital Requirements Directive, the Society has adopted the Standardised approach to credit risk. The Society undertakes regular stress tests on credit risk from varying firm-specific, market-wide and idiosyncratic events. Stress tests are discussed in the ICAAP. As at 4 February 2013 the Society s liquid assets by credit rating are as follows: _ Liquid Assets by rating Risk weighting Value % of total liquid assets AAA 0% 14, % A 20% 3, % A- 20% 18, % A- 50% 2, % BBB 20% 2, % Non Rated 20% 2, % Non-rated 50% 3, % Total 45, % 5.3 Summary of credit risk by maturity The table below provides an analysis of credit risk exposure by residual maturity as at 4 February 2013 Society FSRP Mortgages FSOL Mortgages Loans and Advances to Credit Institutions Cash in hand n/a n/a 222,399 Repayable on demand 177, ,919,642 Repayable in not more than 3 months 887,127 20,980 18,988,930 Repayable in more than 3 months but not more than 1 year 3,411,273 62,938 10,990,923 Repayable in more than 1 year but not more than 5 years 16,694, ,984 0 Repayable in more than 5 years 125,205, ,454 0 Accrued Interest 81,573 Sub-total 146,376,347 1,327,356 45,203,467 Provisions for bad and doubtful debts (445,533) (6,367) 0 Total 145,930,814 1,320,989 48,907,367 17

18 6. Liquidity and Funding Risk The Society s liquidity policy has been developed to ensure that we maintain sufficient liquid resources to meet known and also any unforeseen financial obligations as they fall due. This is achieved by maintaining an appropriate, prudent level of liquid assets by quality and maturity, by an appropriate combination of savings and funding balances and by having access to additional sources of funds through the wholesale market. Liquidity is maintained at a level that ensures public confidence in the solvency of the Society supported by stress testing. The Society s policy is to comply fully with the appropriate regulators liquidity rules prescribing a sufficient level of high quality, unencumbered liquid resources that can be realised under certain stresses both marketwide and firm-specific liquidity shocks to ensure that it remains a going concern. A significant proportion of liquidity is held in high quality liquid buffer assets comprising UK government treasury bills. As at 4 February 2013, the Society held buffer assets of 61.14% (2012: 49.80%) against a minimum 50% requirement. The Society s ALCO is responsible for setting limits for the level, composition and maturity of liquidity and funding balances. Such limits are quantified in the Society s Treasury Policy Statement. Reviews and compliance checks against some of these limits are monitored daily by the Finance department and other limits are monitored via the month Risk Dashboard report. In addition, the Society carries out stress testing each month of varying firm-specific, market-wide and idiosyncratic events, to ensure its level of liquidity remains sufficient. These results are presented to ALCO and subsequently the Board on a monthly basis. Under the Standardised approach, if the Society places a deposit for a period less than three months, dependent on the credit rating (minimum Fitch F1 or Moody s equivalent P1) this is usually risk weighted at 20%, or 50% if the investment has a residual maturity of more than three months. The Society restricts investments with unrated entities to other building societies which are regulated by the PRA and FCS and to local authorities which are considered to be quasi-government bodies and to banks where the bank is guaranteed by its parent and the parent is on the Society s approved counterparty list. We have stress tested the application of a 2 notch downgrade to the credit ratings of all counterparties and can confirm no extra capital would be required should a downgrade materialise. 7. Market Risk This is the risk that the value of a portfolio, either an investment portfolio or a trading portfolio, will decrease due to the change in value of the market risk factors. The four standard market risk factors are stock prices, interest rates, foreign exchange rates, and commodity prices. The associated market risks are: * Equity risk - the risk that stock prices and/or the implied volatility will change. * Interest rate risk - the risk that interest rates and/or the implied volatility will change. * Currency risk - the risk that foreign exchange rates and/or the implied volatility will change. * Commodity risk - the risk that commodity prices (e.g. corn, copper, crude oil) and/or implied volatility will change. 18

19 The Society is exposed to interest rate risk, arising from changes in the prices and interest rates of our financial instruments. The Society does not take speculative views on future interest rate movements when investing our surplus funds nor do we hold a trading book. Market risk is monitored by ALCO which ensures that any interest rate risk the Society is exposed to is matched adequately under the Building Societies Matched financial risk management approach. The Society has no exposure to equity risk, currency risk or commodity risk and the Society has no trading book, and thus no Pillar 1 requirement for this risk. 8. Interest Rate Risk This is the impact on capital and net interest income arising from timing differences due to mismatches between the dates on which interest is receivable on assets and payable on liabilities when they are reset to market rates. Further interest rate risk is present within the interest basis (basis risk) of assets and liabilities whereby the proportion of assets are not equally matched with the same proportion of liabilities of the same interest basis e.g. fixed rate. The Society s Basis risk appetites are quantified in the Society s Treasury Policy Statement. The Society s operates on the appropriate regulators Matched approach for financial risk management. Internal hedges against fixed rate mortgage and savers profiles are matched off against each other on a month by month basis based on their maturity in the first instance. Due to intense competition and current economic conditions the squeeze on the Society s interest margin is a key interest rate risk. This is fully recognised by the Board of Directors and our current strategy in such difficult times is to ensure that the Society s interest rate structure balances equitably the competing needs of our saving and borrowing members whilst ensuring the continued financial strength of the business for the benefit of all our members. The Society manages interest rate risk in the following ways:- overall management of interest rate risk is controlled by the Board of Directors through the Assets & Liabilities Committee (ALCO). fixed rate mortgages and fixed rate savers are matched off against each other month by month of their maturity in the first instance risk appetite limits are set for monthly mismatches in any one month, in any one quarter in any one year and an overall mismatch position regulatory reporting (gap reports) are produced monthly for monitoring purposes Gap limits are set to allow for flexibility in the timing differences on interest re-pricing of assets and liabilities. Gap re-pricing is subject to an interest rate shock of 2%. These risks are quantified within our risk appetite policy statement. products are priced with due consideration given to the effects of interest rate risk demonstrated in the product proposal the offer of long term fixed rate shares with an equivalent long term fixed rate mortgage and/or to set limits on the extent of any mismatch arising using a maturity ladder to match off maturing treasury assets and liabilities setting maximum limits for maturity mismatches permitted for treasury instruments limiting base rate linked tracker mortgages, each of which is subject to a floor rate are considered against base rate linked shares basis risk (interest basis) within assets and liabilities is monitored monthly risk appetite limits are set against the exposure to basis risk utilisation of a Mismatch Report to assess the level of any mismatch overall and in any time period stress test performed to assess the impact of a 2% interest rate shock on the Society s balance sheet risk appetite limits are set against the impact of a 2% interest rate shock on the balance sheet 19

20 The Society tests on a monthly basis, the cost/benefit to us if interest rates were to change via the Gap report. This report demonstrates the impact of an interest rate shock of 2%. In addition the Society has an expressed risk appetite for 2% exposures which are monitored each month at ALCO. 9. Operational Risk This is the risk of loss/negative impact to the Society resulting from inadequate or failed internal process, people and systems or from external events including regulation, legal and financial crime risks. The Society maintains a Board approved Risk Register, Risk Dashboard and Risk Appetite Policy Statement to identify these risks and mitigating controls. The Society has adopted the Basic Indicator Approach (BIA) under Pillar 1, whereby capital is charged at 15% of income as described in BIPRU 6.3. Operational risk is calculated using average net interest income over a 3 year period. A 15% risk weighting is then applied to the 3 year average. There is no plan to move from this approach. The Society mitigates operational risk by implementing a strong control environment and via risk transfer. The Society is long-standing and has no history of any significant operational loss with the Board and staff mindful of their responsibility to safeguarding members interests. 10. Concentration Risk Concentration risk is the risk arising from lack of diversification in the Society s business. The Society is a traditional regional building society with business being made up of predominantly loans that are fully secured on residential property (FSRP) funded by retail savings. The Society addresses concentration risk through setting risk appetites for each concentration. Each risk appetite is set in conjunction with a trigger limit used as an early warning mechanism. The limits are measured against actual exposures in the balance sheet and monitored on a monthly basis via the Risk Dashboard report. The Risk Dashboard report is presented to the Board of Directors each month to allow further challenge and review of risks. Amendments are fed back into product design and relevant policy statements. The Society faces the following concentration risks in its balance sheet:- geographical regions mortgage products mortgage types large exposures intermediary business The Society manages concentration risk in a variety of ways:- the Treasury Policy Statement sets out both investment and funding limits by counterparty the Lending Policy Statement restricts the amount of loans to individuals and connected counterparties and details risk appetite in relation to geographial region, product type or market segment risk appetite limits set for maximum funding limits with counterparties (1.5% of SDL) risk appetite limits set for maximum retail funding balances ( 350k) risk appetite limits set for maximum mortgage balances ( 1m) risk appetite limits set for maximum connected counterparty balances (10% of capital) 20

21 11. Conduct Risk Conduct Risk is the risk that actual or potential customer detriment arises from the way in which the Society conducts its business. The Society ensures independent assessment of conduct risk through a dedicated Conduct Risk Committee chaired by the Head of Conduct The Society restricts its activities to areas where appropriate expertise is in place. Areas of Conduct Risk in the Society s business are as follows:- Governance, culture and internal behaviours Product Governance including unfair terms and conditions Member engagement activities Arrears and Forbearance Interest Only Mortgages Sales, marketing and distribution channels Post sale standards, Complaints and TCF I.T. Resilience Financial Crime 12. Business Risk This is the risk that the Society is no longer able to continue in business or that we may not be able to carry out our business plans and/or strategy. Business risk is the exposure of the Society s business caused by adverse conditions in the macroeconomic environment, with consideration for earning volatility and cost overruns in severe adverse conditions. Annually the Society presents a Going Concern Paper to the Audit Risk and Compliance Committee held in March and once approved is presented to the Board meeting in March. In addition the Society reviews and revises its strategy, corporate plan and financial projections on a six-monthly basis, monitoring the sustainability through profitability, efficiency, liquidity and capital strength. As the Society continues to suffer from the imposition of FSCS levies that are affecting the entire banking and building society sector the Society s profitability is adversely affected, however remains sufficiently strong. In addition, the industry is expected to contribute to a new pre-funding levy from The new scheme is a result of changes being made to the Deposit Guarantee Scheme Directive, requiring the pre-funding of potential future liabilities. Whilst this also affects profitability adversely, it does not affect our future ability to make acceptable levels of profitability. The Society acknowledges certain firm-specific, market-wide and idiosyncratic scenarios whereby business vulnerabilities can be identified by considering these scenarios and assessing the likelihood and impacts we can identify triggers which if pulled would alert the Board and Senior Management to take necessary actions. The Society also considers Reverse Stress Testing which detail scenarios that could potentially threaten the Building Society s business model. 21

22 13. Remuneration code The Society encourages enhanced performance and will fairly and responsibly reward individuals for their contribution to the success of the Society, bearing in mind at all times the parameters of the Society s risk framework. The design features of the remuneration system comprise basic salary, holiday entitlement, company car (subject to individual contract arrangements), benefits-in-kind and pension benefits. The Society also awards bonuses based on performance measured against our Corporate Plan objectives such as; Financial performance Internal audit grades Issues raised by Regulators Capital strength Member satisfaction rates Member growth rates Balance business scorecard objectives Individual performance The Society does not operate share option schemes and does not offer any guaranteed variable remuneration. The following table is a breakdown of the remuneration awarded to members of staff whose actions have a material impact on the risk profiles of the Society during the financial year ending 4 February 2013; Staff Number of staff Non-Executive Directors 6 77,544 Executive Staff 2 217,266 Senior Management 9 288,828 Total ,638 The following table is a breakdown of remuneration awarded to senior management split into fixed and variable remuneration during the financial year ending 4 February The business areas it relates to are; Chief Executive Deputy Chief Executive Secretary and Treasurer Finance Director Chief Risk Officer (until 30 April 2012) General Manager Customer Services Head of Conduct Head of Finance Head of IT Head of HR Head of Savings Head of Mortgages Fixed Variable Total Number of staff ,475 36, ,094 22