BATH BUILDING SOCIETY

Transcription

1 BATH BUILDING SOCIETY Pillar 3 Disclosure Document

2 Index Page 1. Introduction 3 2. Risk management policies and objectives 5 3. Main Board and committee structure Capital resources and capital ratios Capital resources integrated into business strategy Risk weighted exposure amounts and operational risk capital Past due exposures Provisions Breakdown of treasury assets under the standardised approach Conclusion 23

3 1. Introduction The legislative framework governing how much capital banks and building societies must hold to protect their members, depositors and shareholders is the Capital Requirements Directive (CRD). The Capital Requirements Directive 4 (CRD4) was introduced by the European Union from the beginning of In the UK, the requirements of CRD4 are implemented by the Prudential Regulation Authority (PRA). Bath Building Society s aim is to ensure that it protects its members savings by having sufficient reserves of capital to withstand a significant economic downturn. The Basel 3 framework is not just about capital provisioning, it also requires disclosure of key pieces of information, such as risk exposures and risk assessment processes. Below are the 3 main Pillars that make up the Capital Requirements Directive: Pillar 1 Pillar 2 Pillar 3 Minimum capital requirements, Additional capital requirements as assessed by firms and by the PRA, Disclosure. The Pillar 1 assessment is based on a formulaic risk based capital calculation that focuses particularly on credit and operational risks. This determines the Society s basic Capital Resources Requirement (CRR). The Board of Bath Building Society has undertaken a bottom up assessment of all the specific risks facing the Society and its subsidiary companies, and has established extra capital provisions under Pillar 2. As part of this Pillar 2 assessment, the Society has applied stress tests to determine whether it could maintain capital adequacy in a severe economic downturn.

4 This document deals with the requirements laid down for Pillar 3 (disclosure) and the information provided here is in accordance with the rules laid out in the PRA Handbook, BIPRU Chapter 11. This disclosure document applies to the following trading entities on an unconsolidated basis: Bath Investment & Building Society, Bath Property Letting Limited, which collectively are referred to together as the Society. Bath Property Letting Limited (BPL) is a wholly owned subsidiary company of Bath Investment & Building Society (BIBS). The company is registered in England and Wales. The principal business activity of BPL is that of residential property management operating wholly in the United Kingdom. There are no current or foreseen material, practical, or legal impediments to the prompt transfer of capital resources or repayment of liabilities when due between BIBS and its subsidiary company. All figures and statements within this document were correct as at 31 December 2014 unless stated otherwise.

5 2. Risk management policies and objectives The Society is primarily a producer and retailer of financial services products, mainly in the form of mortgages and savings. These products give rise to financial assets and liabilities and are termed financial instruments. As well as mortgages and retail savings, the Society also invests liquid asset balances, or borrows wholesale funding, using money market financial instruments. The Society looks to manage all the risks that arise from its operations, the main risks within its business being credit risk, market risk (including interest rate risk), liquidity risk and operational risk. The Society manages risk using a number of techniques. It employs financial forecasting and stress test modelling to help guide the business strategy. The Society structures its Board committees on a risk basis so that each key committee monitors and controls a key risk area. Quarterly risk reviews of those areas and changes/additions are reported to the Risk Committee. Credit risk Credit risk is the risk of customers (or treasury counterparties) failing to meet their obligations to the Society as they fall due. Credit risk arises primarily from mortgage loans to private customers and commercial organisations, and from liquid asset investments placed with the treasury departments of other financial institutions. The Board s Risk Committee approves the Society s Lending Policy but delegates the ongoing monitoring of the Society s mortgage exposures against that policy to a Credit Committee. The Board s Risk Committee also approves the Society s Financial Risk Management Policy. This includes establishing assessment criteria for treasury counterparties, setting maximum exposure limits for countries and counterparties, and for authorising the types of treasury investments that can be purchased. The Risk Committee delegates the ongoing monitoring of financial risks to an Assets and Liabilities Committee (ALCO).

6 Market risk Market risk is the risk that the value of, or income arising from, assets and liabilities will vary as a result of changes in interest rates or exchange rates. For the Society, the contributors to market risk are interest rate risk and basis risk. Interest rate risk arises from imperfect matching of different interest rate features, re-pricing dates, and maturities relating to mortgages, savings products and treasury investments. The Society manages its exposure to interest rate risk on a continuing basis, within limits set by the Risk Committee. The following activities are sensitive to changes in interest rates: 1. The use of fixed rate mortgage products, 2. The use of fixed rate retail savings products and wholesale funding, 3. The management of fixed rate treasury investments. The Society uses off balance sheet, interest rate swap contracts to manage its interest rate risk. On occasion, it also employs natural hedges to match fixed rate assets with fixed rate liabilities. The Society models a parallel shift in interest rates of 2% to ascertain a likely interest rate shock and this stress test guides the Society s creation of a suitable capital provision under Pillar 2. The Society s assets and liabilities are priced against different interest rate bases such as the Society s own Standard Variable Rate, the Bank of England s base rate or the 3 month London inter-bank offer rate (libor). Basis risk occurs when an interest rate base moves independently from a general move in market rates and independently from the bases on which other assets and liabilities are priced. The Society controls and monitors the total level of its assets and liabilities that can be priced against an interest rate base other than on an

7 administered rate basis. This reduces the Society s susceptibility to basis risk. The Society also estimates the net impact on profitability from a 2% change in all non administered bases. This net impact is compared with an internal policy limit and a suitable capital provision is made under Pillar 2. Liquidity risk The PRA s rules for liquidity risk management are set out in the PRA s Handbook, section BIPRU 12. The Society qualifies as a Simplified ILAS firm which requires it to hold a portfolio of highly liquid assets in line with the size and features of its funding base and its current lending commitments. The rules stipulate the types of treasury assets that can be considered as qualifying assets for the required liquidity buffer and the rules for calculating the minimum buffer that must be maintained at all times. The Society operates an internal policy limit which requires a liquidity buffer to be held in excess of the PRA s minimum. The Society s liquidity policy requires the maintenance of a total liquid asset portfolio of sufficient quantity and quality to enable the Society to meet its obligations as they arise, and to fund strategic investment. The policy always requires the Society to stay within the Risk Committee s policy limit for Total Liquidity. The Society has a relatively diverse funding base that enables it to maintain net retail inflows under normal market conditions. Wholesale funding sourced from the central money markets is only used on a short-term, tactical basis to smooth out the peaks and troughs that occur between the Society s funding and mortgage activities. The Society does not use funding sourced via the money markets as a long-term, strategic funding tool. The Society has accessed the Bank of England s (BOE) Funding for Lending Scheme (FLS). Its total drawings from FLS are under 7% of its funding base. The Society has access to the BOE s standard liquidity support mechanisms but use of these facilities is not foreseen within the Society s core plans. Operational risk

8 Operational risk is the risk of losses arising from failed or inadequate internal processes or systems, human error or external factors. Operational risk is managed on a day to day basis by the Society s departmental managers who have responsibility for putting in place appropriate controls for their departments. The Society s Conduct and Operations Committee has overall responsibility for monitoring the performance of the Society s control systems and for directing internal audit effort towards key operational risk areas. The committee is guided by a quarterly risk review process which is approved by the Risk Committee This considers the materiality of individual operational risks crystallising, the probability of risks crystallising, and the ability of the Society to manage each risk area. The Society maintains a range of insurance policies to cover eventualities such as business interruption, loss of computer systems, crime etc. Business risk Business risk is the exposure of the Society s business to uncertainty in the macroeconomic environment, with specific consideration of earnings volatility and cost overruns in severely adverse conditions. An assessment of business risk is undertaken during the risk review process. Concentration risk Concentration risk is the risk of losses being incurred due solely to certain concentrations existing within the Society s asset base or its activities. For the Society the main areas of consideration are geographic concentrations, sectoral concentrations and industry concentrations. The Board recognises that the Society s loan book is predominantly located in the South West of England with the single biggest geographic concentrations being in the post code areas surrounding the City of Bath. However, as a small lender, the Society s share of the mortgaged housing stock in all post code areas where it has a presence is estimated to be below 1%. Within its terms of reference, the Credit Committee monitors

9 the Society s loan book on a regular basis to review the level of geographic concentration that exists. For many years, the Society has engaged in lending to the buy-to-let and commercial sectors. As a result it has built up a significant level of expertise with these sectors where lending constitutes approximately 40% of the Society s current loan portfolio. The Credit Committee monitors the different types of property assets and business sectors where the Society has buy-to-let and commercial lending exposures. The Board believes that the Society has a relatively diversified portfolio of residential mortgage assets and that the Society s commercial loan book is not at risk from any business sector concentration.

10 3. Main Board and Committee Structures Board of Directors Audit Committee Risk Committee Nominations and Remuneration Committee Credit Committee Assets and Liabilities Committee Conduct and Operations Committee Main Board of Directors Composition: 6 non-executive directors plus the Chief Executive and the Deputy Chief Executive. The Chairman of the Board is always a nonexecutive director. The Deputy Chief Executive acts as the Society s Finance Director. The Board has terms of reference that include approving overall business strategy, reviewing financial performance and monitoring the management of the Society s assets. Key reports include Executive Reports, Finance Reports and minutes from all sub committees and the Society s subsidiary company. The Board of Directors meet not less than 10 times per annum.on a monthly basis. Audit Committee Composition: 3 non-executive directors selected from a pool of 6. Certain senior managerial staff attend by invitation to report to the Committee and

11 usually representatives from Deloitte LLP and Baker Tilly (the Society s external and internal auditors) also attend to report. The Audit Committee has terms of reference that include all aspects of audit, compliance, rissystemsk and control. The Committee approves the monitoring plans and assesses the adequacy of the audit and compliance functions. It also formally recommends approval of the Financial Report and Accounts to the Board. Key reports that are reviewed by the Committee include audit reports from internal and external auditors, reports from the Money Laundering Reporting Officer and the Society s register of customer complaints. The Committee meets at least four times per annum. Risk Committee Composition: 6 non-executive directors plus the Chief Executive, Deputy Chief Executive and the Head of Compliance & Society Secretary. The Risk Committee has terms of reference that include providing strategies for managing risk across the Society s operations and for setting an appropriate risk appetite. The committee oversees the Society s current risk exposures in totality, reviews specific risk management information and makes suggestions as to how the Society s risk management framework can be improved. The Committee approves the Society s Lending Policy and Financial Risk Management Policy. It also reviews the Society s Recovery and Resolution Plan on an annual basis. The Committee meets at least four times per annum. Nomination and Remuneration Committee

12 Composition: 3 non-executive directors. The Chief Executive attends meetings by invitation but none that relate to his own remuneration. The Nomination and Remuneration Committee has terms of reference that include senior management appointments, remuneration, directors contractual terms and review of Board performance both collectively and individually. Credit Committee Composition: 1 non-executive director plus the Chief Executive, Deputy Chief Executive, Head of Mortgages, Senior Underwriter and the Head of Compliance & Society Secretary. The Credit Committee has terms of reference that include maintaining the quality of the Society s mortgage book and monitoring the Society s lending positions against Risk Committee policies for lending and underwriting. The Committee also recommends new underwriting mandates to the Risk Committee and gives approval for certain loans as specified in the Society s lending policy. Key reports that are reviewed by the Committee include reports from the Senior Underwriter covering mortgage arrears and the volume and nature of exceptions to the lending policy. Details of the composition of the mortgage book are also reviewed. The Committee meets on a quarterly basis and more frequently if required. Assets and Liabilities Committee Composition: 1 non-executive director plus the Chief Executive, Deputy Chief Executive, Head of Mortgages, Head of Compliance & Society Secretary, Head of Savings and Investments, Head of Accounts and the Treasury and Reporting Accountant.

13 The Assets and Liabilities Committee has terms of reference that include financial risk management and liquidity management. The Committee recommends changes to the Society s Financial Risk Management Policy to the Risk Committee. Key reports that are reviewed by the Committee include reports from the Treasury and Reporting Accountant covering the ongoing management of interest rates, liquidity positions, funding requirements and hedging. The Committee meets on a quarterly basis and more frequently if required. Conduct and Operations Committee Composition: 1 non-executive director plus the Chief Executive, Deputy Chief Executive, Head of Mortgages, Head of Compliance & Society Secretary, Head of Savings and Investments. The Conduct and Operations Committee has terms of reference that include providing an overview to the Board Risk Committee on current risks, reviewing s, conduct issues and providinge details on the Society s current risk exposures. of the Society. The Committee ensures that the Society s culture and conduct underpins the operation of the business to ensure delivery in a clear, transparent and fair manner. Key reports that are reviewed by the Committee include the Conduct and TCF Policy which incorporates complaints procedures and the product governance framework. The Committee meets on a quarterly basis and more frequently if required.

14 4. Capital Resources and capital ratios The capital resources of the Society are calculated under Pillar 1 of the Capital Requirements Directive. Total Society assets as at 31 st December 2014 were 279 million. Of this, 252,000 related to the investment in, and intercompany balance with Bath Property Letting Limited. The Society s capital resources are comprised of: Core Equity Tier 1/Tier 1 capital - Profit and loss account reserve accumulated by the Society and revaluation reserve, Tier 2 capital - General mortgage loss provisions. Core Equity Tier 1/Tier 1 and Tier2 capital resources are broken down as follows: Core Equity Tier 1 capital - retained earnings 23,264,000 Core Equity Tier 1 capital - revaluation reserve* 428,000 Less deductions investments in subsidiaries - 252,000 Total Core Equity Tier 1 and total Tier 1 capital 23,440,000 Tier 2 - general provisions 274,000 Total Tier 2 capital 274,000 Total capital resources 23,714,000 *Under the CRD transitional arrangements, revaluation reserves do not strictly form part of Core Equity Tier 1 capital until 1 st January The capital resources and ratio calculations within this document include revaluation reserve within Core Equity Tier 1 as though the final requirements of CRD 4 were in place.

15 The Society s Core Equity Tier 1capital ratio and Tier 1 capital ratio are calculated by dividing Core Equity Tier 1/Tier 1 capital resources ( 23,440k) by the total risk exposure amount ( 112,632k see section 6). Ratios of 20.81% are obtained. The Society s leverage ratio is calculated by dividing Tier 1 capital resources ( 23,440k) by the sum of total assets ( 279,035k), less investments in subsidiary holdings ( 252k), plus off balance sheet swap exposures ( 25k) plus 10% of the Society s pipeline of offered mortgages ( 947k). A ratio of 8.38% is obtained.

16 5. Capital resources integrated into business strategy Over the next 5 year strategic time frame, the Society aims to maintain sufficient capital to allow it to grow its core mortgages business and also to increase investment in its subsidiary businesses. At all times, it plans to retain a material capital buffer in excess of the CRD4 requirements. The Society s only source of new capital is retained profits and so the Society needs to generate new profits in order to grow. Strategy and planning The Society s 5 year Business Plan has established the Board s appetite for asset growth and investment. The Society prepares an annual Operating Plan and budgets to aid the management of the delivery of the strategic objectives. Close monitoring of actual performance against the Operating Plan and budgets, and an annual review of strategic progress, all focus the Board s attention towards ensuring that the Society has sufficient financial and nonfinancial resources to meet the strategic objectives. Internal Capital Adequacy Assessment Process The Society has an Internal Capital Adequacy Assessment Process (ICAAP) which assesses the capital required to support the planned strategy in normal and stressed economic circumstances. This process involves reviewing all business areas with estimates for capital allocation across the Business Plan period. The Board establishes the core economic assumptions to be used in the ICAAP process, and also the stress test models to be applied to the core assumptions. The Board approves the Society s capital provisioning taking into account any areas where they may feel that models and assessments do not

17 adequately capture the full risk exposures, and where they deem that holding extra capital is appropriate. Lending and business decisions The Society s annual Operating Plan and budgets state annual targets for the volume of mortgage lending by main types of mortgage lending. The Society s actual performance against budgetary targets is monitored on a monthly basis by the Board. Through this process the Society controls actual book positions against planned book positions and can make the appropriate calculations as to whether further capital provisions are required or not. A quarterly assessment is undertaken of the Pillar 1 capital required against current credit risk in the Society s mortgage book. The results from this exercise are monitored by the Executive and by the Board. Pricing The Society assesses the rates that need to be charged on new and current mortgage loans in order for the Society to generate the profits, and hence new capital, that its has modelled into its Business Plan. The Society has also developed a basic model for assessing whether new mortgage product proposals achieve a satisfactory return on regulatory capital.

18 6. Risk weighted exposures The assets of the Society are allocated risk based exposure amounts in line with the Standardised Approach under Pillar 1 of the CRD4. In addition and evaluation of capital required to cover Operational Risk is calculated under the Basic Indicator Approach and determined by reference to the net income of the Society averaged over the previous 3 years. Asset value Risk weighted exposure value Capital required Treasury exposures on balance sheet Investments with central governments 15,510 nil nil or central banks Investments with financial institutions 41,320 8, Treasury exposures off balance sheet Interest rate swap contracts Total treasury 56,855 8, Loans and advances to customers Commercial mortgages 18,964 14,449 1,156 Retail mortgages 197,364 69,393 5,551 All mortgages >3 months in arrears 4,150 4, Total loans 220,478 88,510 7,081 Total credit risk exposures 277,333 97,081 7,767 Operational risk exposures 12, In addition to the above capital provisions, the Society holds a further capital provision of 254,000 against 3,101,000 of other balance sheet

19 assets (with a risk weighted exposure of 3,176,000). Total risk weighted exposure is 112,632,000. Counterparty credit risk The purpose of the Society s treasury counterparty credit risk management policy is to ensure that the Society can obtain the best possible return on its treasury assets whilst operating within prudent limits in respect of counterparties. The methodology for establishing counterparty limits normally involves consideration of third party professional advice taken by the Society and rating agency information. When credit ratings are used to assess a counterparty, the Society normally requires the following minimum (Fitch) ratings: Short term - F1+ Long term - A On occasion, the Society will place deposits with the major UK banks even if they fail to meet the Society s credit rating criteria. In such circumstances, treasury deposits will always be restricted to 12 months duration or less. The Society does not use agency rating information to assess the creditworthiness of other UK building societies. It uses its own knowledge of the sector and an assessment of audited balance sheet data to establish its investment policy. New limits are approved and existing limits removed only on the recommendation of the Assets & Liabilities Committee (ALCO) to the Risk Committee. All limits are reviewed at least annually by ALCO, any changes being recommended to the Risk Committee as appropriate. The Deputy Chief Executive prepares submissions to Risk Committee for the approval of new counterparties. Limits may be suspended by the Chief Executive pending Risk Committee approval in the event of adverse market conditions. No dealing takes place with any counterparty that does not have a pre-approved limit established by Risk Committee. Where

20 appropriate, exposures to counterparties are monitored on a group consolidated basis. 7. Past due loans As at 31 st December 2014, the Society had only 13 loans out of its portfolio of 1,489 loans where arrears existed of greater than 3 months. These loans are classified as Past due loans. Past due loans Performing loans Total loans South West 1,294 note 1 103, ,378 London 485 note 2 15,711 16,196 Elsewhere 1,958 note 3 97,946 99,904 Totals 3, , ,478 Notes: 1. This figure comprises 7 loans, 2 being residential cases totalling 180,000, 2 being buy-to-let cases totalling 451,000 and 3 being holiday let cases totalling 663, This figure comprises 2 loans, 1 being a residential case of 226,000 and 1 being a buy-to-let case of 259, This figure represents 4 loans, 1 being a buy-to-let loan of 995,000, 2 being self-build loans totalling 697,000 and the remaining 1 being a commercial case of 266,000.

21 8. Provisions The mortgage portfolio is assessed at each year end to determine the Society s level of general and specific loss provisions. A general loss provision of 0.25% is made against the proportion of the Society s loans that are under 80% loan-to-value that are fully secured on residential properties. A general loss provision of 0.5% is made against the proportion of loans that are over 80% loan-to-value that are fully secured on residential properties. A general loss provision of 0.5% is also made against the proportion of loans that are under 80% loan-to-value that are fully secured on land. A general loss provision of 0.75% is made against the proportion of loans that are over 80% loan to value that are also fully secured on land. As at 31 st December 2014, the Society had a general loss provision of 274,000. These general provisions represent the Board s assessment of the potential losses which, although not yet specifically attachable to individual loans, are known from experience to exist in the Society s loan portfolio. All loans that are 3 or more months in arrears are then individually assessed to determine whether the Society would likely make a loss in the event that the specific mortgaged properties were repossessed and subsequently sold. A current realisable value for each property is determined by indexing the last recorded system valuation to balance sheet date. However, if the last recorded valuation is over 24 months old, then an up to date external valuation is obtained as at balance sheet date. Estimated sale costs are then applied to the gross realisable values to estimate net realisable values. Each net realisable value is compared against its corresponding outstanding loan balance. When a loss on disposal is likely on a particular loan, the Society will establish a specific provision against that loan. As at 31 st December 2014, the Society had established specific loss provisions of 1,334,000 against 9 loans. The total level of provisions has been deducted from the declared mortgage asset value shown in the Society s 31 st December 2014 Annual Report.

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23 9. Breakdown of treasury assets under the Standardised Approach Maturity of treasury investments Fitch ratings < 3 months 3 months > 1 year Total to 1 year Cash in hand 118 Nil Nil 118 AAA 13,500 Nil 2,010 15,510 AA- to AA+ Nil Nil Nil Nil A- to A+ 36,702 Nil Nil 36,702 BBB+ Nil Nil Nil Nil Building Societies 3,500 1,000 Nil 4,500 Totals 53,820 1,000 2,010 56,830

24 10. Conclusion This disclosure document is intended to provide background information on the Society s approach to risk management as related to maintaining and preserving the capital position of the Society. It also provides asset information and capital calculations under Pillar 1. In the event that a user of this document has comments or requires further information then they are requested to contact Kevin Gray, Deputy Chief Executive at kagray@bibs.co.uk. In the absence of the Deputy Chief Executive, please contact Dick Jenkins, Chief Executive at djenkins@bibs.co.uk.