Scottish Widows Bank plc 2016 Annual Report and Financial Statements

Transcription

1 2016 Annual Report and Financial Statements Member of Lloyds Banking Group

2 CONTENTS Company Information 2 Strategic Report 3 Directors Report 7 Independent Auditors Report to the Members of Scottish Widows Bank plc 11 Income Statement 14 Balance Sheet 15 Statement of Changes in Equity 16 Statement of Cash Flows 17 Notes to the Financial Statements 18 1

3 COMPANY INFORMATION Board of Directors S J Noakes MA (Non-Executive Chairman) M J P Jones MA, ACIB, FCIBS (Chief Executive Officer) M F Fleming BEng, MBA (Managing Director) I Santos BCom, ACA (Finance Director) C Gowland BSc, MA (Non-Executive Director) Secretary M J C Watson MA, CA Independent Auditors PricewaterhouseCoopers LLP Hay s Galleria 1 Hay s Lane London SE1 2RD Registered Office PO Box Morrison Street Edinburgh EH3 8YJ Tel: Fax: Registered No: SC

4 STRATEGIC REPORT The Directors present their Strategic Report for the year ended 31 December Review of the business Scottish Widows Bank plc ( the Company ) provides banking services and aims to offer a competitive range of banking products and services while maintaining a consistently high level of service and efficiency. Lending activity is largely in the form of residential mortgages, and the Company also accepts deposits from customers. As a member of Lloyds Banking Group plc ( the Group ), the Company places funds with and borrows from Lloyds Bank plc ( Lloyds Bank ) as part of its normal banking operations. The Group accesses funding from the government s Funding for Lending Scheme and Term Funding Scheme, but the Company itself is not a direct participant in these schemes. In 2016 the Company delivered a solid performance in a continued uncertain economic environment. Loans and advances to customers increased by 266m to 6,074m (2015: fall of 41m to 5,808m). In 2015 net new lending of 178m was more than offset by the disposal of a closed book of 219m of equity release mortgages, resulting in a net reduction in customer lending in that year. Deposits from customers fell by 692m to 4,022m (2015: fall of 1,266m to 4,714m). The continued reduction in customer deposits reflects market conditions, particularly the ongoing low interest rate environment, combined with a reduced appetite for external deposits. Profit before tax was 54.3m (2015: 76.1m), with total assets of 7,639m (2015: 7,564m). The reduction in profitability reflects lower total income of 68.2m (2015: 81.5m), higher operating expenses of 14.8m (2015: 7.4m) and a smaller net credit for impairments of 0.9m (2015: 2.0m). The reduction in total income is driven by a 7.4m gain on disposal of the aforementioned closed book of equity release mortgages which was realised in 2015, together with lower margins on customer lending. The increase in operating expenses arises as 2015 costs were reduced by the release of 8.2m from a conduct risk exposure made in 2014 and a 1.4m write-back of pension deficit reduction payments charged in The smaller net credit for impairments in 2016 reflects lower house price inflation. The retained profit after tax was 39.1m (2015: 60.7m) and this has been transferred to reserves. Principal risks and uncertainties As a banking institution, the Company s activities are principally related to the use of financial instruments, although the Company does not trade in financial instruments. These activities expose the Company to a number of risks, principally as set out below. The Company s policy is to effectively manage the risks to which it is exposed in order to obtain competitive advantage, within a defined and approved risk appetite. Responsibility for the day-to-day management and control of the various risks to which the Company is exposed is delegated by the Board to various committees. The Board retains an active role in risk management through regular reporting and oversight. 3

5 STRATEGIC REPORT Principal risks and uncertainties (continued) Further information is provided in note 4 to the financial statements. Principal risk: context and appetite Credit risk As a provider of credit facilities to personal customers any adverse changes in the economic and market environment in which the Company operates or the credit quality and/or behaviour of the Company s borrowers and counterparties could reduce the value of the Company s assets and increase write-downs and allowances for impairment losses, adversely impacting profitability. Conduct risk As a financial services provider the Company faces significant conduct risk including: selling products to customers which do not meet their needs, failing to deal with customers complaints effectively, not meeting customer expectations, and exhibiting behaviours which do not meet market or regulatory standards. Market risk As a financial services provider, the Company faces a number of key market risks. The most significant market risk is interest rate risk. In 2016 market risk has been impacted by the UK vote to leave the European Union and the low interest rate environment. Operational risk The Company faces a number of key operational risks including fraud losses and failings in customer processes. The availability, resilience and security of the Company s core IT systems is the most significant. Capital risk The Company s future capital position is potentially at risk from adverse financial performance and the introduction of buffers or higher capital requirements for specific risks or sectors. Mitigating actions Credit policy incorporating prudent lending criteria aligned with Board approved risk appetite to effectively manage credit risk. Clearly defined levels of authority to ensure the Company lends appropriately and responsibly with a separation of origination and sanctioning activities. Robust credit processes and controls including well established committees to ensure distressed and impaired loans are identified, considered and controlled. Customer focused conduct strategy implemented to ensure customers are at the heart of everything the Company does. Product approval, review process and outcome testing supported by conduct management information. Clear customer accountabilities for employees including rewards with customercentric metrics. Close monitoring of interest rate movements. Exposure associated with fixed rate mortgage products is reduced by maintaining an appropriate level of fixed rate debt. Interest risk associated with fixed rate deposits is managed through equivalent fixed rate placements. The Company continually reviews its IT system architecture to ensure systems are resilient, readily available to our customers and secure from cyber attack. Internal stress testing results indicate sufficient levels of capital adequacy for the Company. Close monitoring of actual capital ratios to ensure they comply with current regulatory capital requirements and are well positioned to meet future requirements. 4

6 STRATEGIC REPORT Principal risks and uncertainties (continued) Principal risk: context and appetite Funding and liquidity risk The Company has a formal borrowing facility in place with Lloyds Bank plc and has a Revolving Credit Facility Agreement with three other Group entities. The Group s funding and liquidity position is supported by a significant and stable customer deposit base. However, deterioration in either the Group s or the UK s credit rating or sudden or significant withdrawal of customer deposits could adversely impact the Company s funding and liquidity position. Regulatory risk Due to the nature of the industry in which the Company operates, it has to comply with a complex regulatory change agenda, otherwise enforcement action may be taken. Regulatory initiatives the Company has been working on in 2016 include the Senior Managers and Certification Regime. Mitigating actions The Group holds a large pool of liquid primary assets to meet cash and collateral outflows. The Group maintains a further large pool of secondary assets which can be used to access Central bank liquidity facilities. Stress testing is carried out on the Company s liquidity position against a range of scenarios. The Company continues to benefit from the investment made by the Group to progress compliance with changing regulatory requirements. The Company also monitors forthcoming regulatory changes and will make continued investment in IT systems to meet regulatory commitments. Future outlook The Company will continue to focus on residential mortgage lending and the Company expects to write an increased level of new mortgage business in Customer deposits are expected to continue to fall in The Company will continue to be reliant on Lloyds Bank for funding, and expects to remain a net borrower of funds during The Group has confirmed its intention to ensure that Lloyds Bank and its subsidiaries, including the Company, will be maintained in a position to meet their financial liabilities as they fall due for a period of at least 12 months from the date of this report. Although the outlook for the UK economy remains uncertain, conditions are expected to remain broadly stable in Development of the business The Company continues to invest in IT systems, technology and people development to optimise the range and quality of products and services available to customers and to ensure compliance with changing regulatory requirements. The Directors regard this investment as integral to the continuing success of the business. 5

7 Key performance indicators Scottish Widows Bank plc STRATEGIC REPORT The Directors use various key performance indicators ( KPIs ), examples of which are given below. In the opinion of the Directors, these KPIs, together with the information presented in the financial statements, provide the management information necessary for the Directors to understand the development, performance and position of the business of the Company. Financial KPIs Note Total income 5 & m 81.5m Profit before tax 54.3m 76.1m Cost income ratio % 9.1% Adjusted cost income ratio % 22.9% Loans and advances to customers 11 6,074m 5,808m Due to customers 16 4,022m 4,714m Other KPIs Total capital ratio % 55.0% Mortgage repayment rate % 16.3% Credit quality % 0.38% Ratio of liquid assets to customer liabilities % 53% 1 Operating expenses as a percentage of total income 2 Operating expenses as a percentage of total income, adjusted to remove the impact of non-recurring items 3 Annual value of principal repaid as a proportion of opening book balance (excludes loans sold) 4 Percentage of accounts 3+ payments in arrears The increase in the cost income ratio reflects higher operating expenses of 14.8m (2015: 7.4m). In 2015 costs were reduced by 8.2m released from a conduct risk exposure and a 1.4m write-back of pension costs. The adjusted cost income ratio has improved in The change in the credit quality measure is driven by a reduction in the number of mortgage accounts, due to a higher average loan size, rather than any significant rise in the number of cases three or more payments in arrears. The modest increase in the mortgage repayment rate reflects a higher level of principal repaid, driven by a larger volume of fixed rate product maturities in 2016 and an increasingly competitive mortgage market. Employees The Company has no direct employees. All staff are employed by other Group companies and the costs of employee benefits are recharged to the Company. Full details of policies relating to disabled persons, together with details of actions taken regarding the provision of information to employees, their consultation and involvement, are shown in the financial statements of Lloyds Banking Group plc. On behalf of the Board M F Fleming Director 3 March

8 DIRECTORS REPORT The Directors present their report and the audited Annual Report and Financial Statements for the year ended 31 December General information The Company is incorporated and domiciled in Scotland. It provides retail banking services to the UK market primarily through intermediary, telephone and internet channels. The Company has no branches that operate within or outside the UK. The immediate parent undertaking is Lloyds Bank plc, which is the parent undertaking of the smallest group to consolidate these financial statements. Copies of the consolidated annual report and financial statements of Lloyds Bank plc may be obtained from Group Secretariat, 25 Gresham Street, London EC2V 7HN. The ultimate parent undertaking and controlling party is Lloyds Banking Group plc, which is the parent undertaking of the largest group to consolidate these financial statements. Copies of the consolidated annual report and financial statements of Lloyds Banking Group plc may be obtained from the Group s head office at 25 Gresham Street, London EC2V 7HN or downloaded via Business review and future developments A review of and the likely future developments in the Company s business are set out in the Strategic Report on pages 3 to 6. Financial instruments Details of financial risk management objectives and policies and the exposure of the Company to credit risk, market risk and liquidity risk are set out in the Strategic Report on pages 3 to 6 and in note 4 to the financial statements. Post balance sheet events There have been no material post balance sheet events. Going concern The Directors recognise their responsibility to make an assessment of the Company's ability to continue as a going concern for a period of at least 12 months from the date the financial statements are approved. The ability of the Company to continue as a going concern is dependent on successfully funding its balance sheet and maintaining adequate levels of capital and liquidity. The Company remained a net borrower of funds from Lloyds Bank during 2016 and it continues to be reliant on Group funding. The Directors are satisfied that it is the intention of the Group to ensure that Lloyds Bank and its subsidiaries, including the Company, will be maintained in a position to meet their financial liabilities as they fall due. In addition, there are no material uncertainties related to events or conditions that may cast significant doubt about the ability of the Company to continue as a going concern and, accordingly, the Directors consider that it is appropriate to adopt the going concern basis in preparing the financial statements. Further information is provided in note 4.4 to the financial statements. 7

9 DIRECTORS REPORT Directors The names of the Directors of the Company are shown on page 2. Mr A R Brindley resigned on 6 March Mr J Burgess was appointed on 3 March 2016 and resigned on 15 August Mr M F Fleming was appointed on 16 March 2016 and Mr I Santos was appointed on 19 October All other directors held office for the whole year and there have been no changes in directors since the end of the year. The Directors will retire at the Annual General Meeting and, being eligible, offer themselves for re-election. No Director has any interest in the share capital of the Company. Directors indemnities The Group has granted to the Directors of the Company a deed of indemnity through deed poll which constitutes third party indemnity provisions and qualifying pension scheme indemnity provisions for the purposes of the Companies Act The deeds were in force during the whole of the financial year, or from the date of appointment in respect of the Directors appointed in 2016, and at the date of signing of the financial statements. Directors no longer in office but who served on the Board at any time during the financial year had the benefit of this contract of indemnity during that period of service. The indemnities remain in force for the duration of a Director s period of office. The deeds indemnify the Directors to the maximum extent permitted by law. Deeds for existing Directors are available for inspection at the Group s registered office. In addition, the Group has in place appropriate Directors and Officers Liability Insurance cover which was in place throughout the financial year. Share capital There were no changes made to share capital during the year. Dividends An interim dividend of 25m was paid during the year (2015: 68m), which represents pence per share (2015: pence per share). The Directors do not recommend the payment of a final dividend in respect of the year ended 31 December 2016 (2015: nil). Research and development During the ordinary course of business the Company develops new products and services. Employees Information on employees is set out in the Strategic Report on pages 3 to 6. 8

10 DIRECTORS REPORT Statement of Directors responsibilities in respect of the financial statements The Directors are responsible for preparing the Annual Report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Company s financial statements in accordance with International Financial Reporting Standards ( IFRSs ) as adopted by the European Union ( EU ). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Company and of the profit or loss of the Company for that period. In preparing these financial statements, the Directors are required to: select suitable accounting policies and then apply them consistently; state whether applicable IFRSs as adopted by the EU have been followed, subject to any material departures disclosed and explained in the financial statements; make judgements and accounting estimates that are reasonable and prudent; and prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Company will continue in business. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company s transactions and disclose with reasonable accuracy at any time the financial position of the Company and enable them to ensure that the financial statements comply with the Companies Act The Directors are also responsible for safeguarding the assets of the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. A copy of the financial statements is placed on our website The Directors are responsible for the maintenance and integrity of the Company s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. In the case of each Director in office at the date the Directors Report is approved: as far as the Director is aware, there is no relevant audit information of which the Company s auditors are unaware; and they have taken all the steps that they ought to have taken as a Director in order to make themselves aware of any relevant audit information and to establish that the Company s auditors are aware of that information. 9

11 Reappointment of independent auditors DIRECTORS REPORT Resolutions concerning the re-appointment of PricewaterhouseCoopers LLP as auditors and authorising the Directors to set their remuneration will be proposed at the Annual General Meeting. On behalf of the Board M F Fleming Director 3 March 2017 Company number SC

12 INDEPENDENT AUDITORS REPORT TO THE MEMBERS OF SCOTTISH WIDOWS BANK plc Report on the financial statements Our opinion In our opinion, Scottish Widows Bank plc s financial statements (the financial statements ): give a true and fair view of the state of the company s affairs as at 31 December 2016 and of its profit and cash flows for the year then ended; have been properly prepared in accordance with International Financial Reporting Standards ( IFRSs ) as adopted by the European Union; and have been prepared in accordance with the requirements of the Companies Act What we have audited The financial statements, included within the Annual Report and Financial Statements (the Annual Report ), comprise: the Balance Sheet as at 31 December 2016; the Income Statement for the year then ended; the Statement of Cash Flows for the year then ended; the Statement of Changes in Equity for the year then ended; and the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. The financial reporting framework that has been applied in the preparation of the financial statements is IFRSs as adopted by the European Union, and applicable law. In applying the financial reporting framework, the directors have made a number of subjective judgements, for example in respect of significant accounting estimates. In making such estimates, they have made assumptions and considered future events. Opinions on other matters prescribed by the Companies Act 2006 In our opinion, based on the work undertaken in the course of the audit: the information given in the Strategic Report and the Directors Report for the financial year for which the financial statements are prepared is consistent with the financial statements; and the Strategic Report and the Directors Report have been prepared in accordance with applicable legal requirements. In addition, in light of the knowledge and understanding of the company and its environment obtained in the course of the audit, we are required to report if we have identified any material misstatements in the Strategic Report and the Directors Report. We have nothing to report in this respect. 11

13 INDEPENDENT AUDITORS REPORT TO THE MEMBERS OF SCOTTISH WIDOWS BANK plc Other matters on which we are required to report by exception Adequacy of accounting records and information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion: we have not received all the information and explanations we require for our audit; or adequate accounting records have not been kept, or returns adequate for our audit have not been received from branches not visited by us; or the financial statements are not in agreement with the accounting records and returns. We have no exceptions to report arising from this responsibility. Directors remuneration Under the Companies Act 2006 we are required to report to you if, in our opinion, certain disclosures of directors remuneration specified by law are not made. We have no exceptions to report arising from this responsibility. Responsibilities for the financial statements and the audit Our responsibilities and those of the Directors As explained more fully in the Statement of Directors responsibilities in respect of the financial statements set out on page 9, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland) ( ISAs (UK & Ireland) ). Those standards require us to comply with the Auditing Practices Board s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the company s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. What an audit of financial statements involves We conducted our audit in accordance with ISAs (UK & Ireland). An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: 12

14 INDEPENDENT AUDITORS REPORT TO THE MEMBERS OF SCOTTISH WIDOWS BANK plc Responsibilities for the financial statements and the audit (continued) What an audit of financial statements involves (continued) whether the accounting policies are appropriate to the company s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. We primarily focus our work in these areas by assessing the directors judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements. We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. With respect to the Strategic Report and Directors Report, we consider whether those reports include the disclosures required by applicable legal requirements. Stuart Scoular (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 3 March

15 INCOME STATEMENT For the year ended 31 December 2016 Note Interest and similar income 5 134, ,982 Interest and similar expense 5 (68,896) (80,905) Net interest income 65,735 71,077 Fee and commission income 6 2,494 2,965 Other operating income 6-7,421 Other income 2,494 10,386 Total income 68,229 81,463 Operating expenses 7 (14,770) (7,433) Trading surplus 53,459 74,030 Impairment ,047 Profit before tax 54,325 76,077 Tax expense 8 (15,272) (15,403) Profit for the year 39,053 60,674 Attributable to: Owners of the Company 39,053 60,674 There are no items of comprehensive income which have not already been presented in arriving at the profit for the year. Accordingly, the profit for the year is the same as the total comprehensive income for the year. The notes on pages 18 to 55 form an integral part of these financial statements. 14

16 BALANCE SHEET As at 31 December 2016 Note ASSETS Balances with central banks 9 3,449 4,045 Loans and advances to banks 10 1,559,406 1,749,821 Loans and advances to customers 11 6,074,164 5,807,639 Intangible assets ,114 Property, plant and equipment Deferred tax assets Other assets ,368 Total assets 7,638,951 7,564,181 LIABILITIES Deposits from banks 15 3,306,549 2,555,329 Due to customers 16 4,022,346 4,714,261 Subordinated liabilities 17 90,036 90,052 Other liabilities 18 9,854 8,345 Current tax liabilities 15,290 15,371 Total liabilities 7,444,075 7,383,358 EQUITY Share capital , ,000 Retained earnings 20 74,876 60,823 Total equity 194, ,823 Total equity and liabilities 7,638,951 7,564,181 The financial statements on pages 14 to 55 were approved by the Board of Directors on 3 March 2017 and signed on its behalf by: M F Fleming, Director 3 March 2017 The notes on pages 18 to 55 form an integral part of these financial statements. 15

17 STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2016 Note Share Retained Total capital earnings equity At 1 January ,000 68, ,149 Profit for the year 20-60,674 60,674 Ordinary dividends paid 22 - (68,000) (68,000) At 31 December ,000 60, ,823 Profit for the year 20-39,053 39,053 Ordinary dividends paid 22 - (25,000) (25,000) At 31 December ,000 74, ,876 The notes on pages 18 to 55 form an integral part of these financial statements. 16

18 STATEMENT OF CASH FLOWS For the year ended 31 December 2016 Note Cash flows from operating activities Interest received 134, ,299 Interest paid (73,198) (89,955) Fees and commissions received 2,493 2,965 Cash payments to employees and suppliers (11,558) (18,987) Tax paid (15,362) (8,852) Cash flows from operating activities before changes in operating assets and liabilities 37,223 39,470 Changes in operating assets and liabilities: Net decrease in balances with central banks Net decrease in loans and advances to banks 68, ,000 Net increase in loans and advances to customers (265,011) (176,303) Net increase in deposits from banks 748, ,372 Net decrease in amounts due to customers (687,485) (1,256,530) Net cash used in operating activities (98,014) (699,628) Cash flows from investing activities Proceeds from sale of financial assets - 226,000 Purchase of intangible assets (209) (516) Purchase of property, plant and equipment - (98) Net cash (used in) / provided by investing activities (209) 225,386 Cash flows from financing activities Interest paid on subordinated liabilities (489) (511) Ordinary dividends paid (25,000) (68,000) Net cash used in financing activities (25,489) (68,511) Change in cash and cash equivalents (123,712) (542,753) Cash and cash equivalents at beginning of year 23 1,057,937 1,600,690 Cash and cash equivalents at end of year ,225 1,057,937 The notes on pages 18 to 55 form an integral part of these financial statements. 17

19 1. General information Scottish Widows Bank plc Scottish Widows Bank plc ( the Company ) provides retail banking services to the UK market and is a public limited company, limited by shares, incorporated and domiciled in Scotland. The Company s immediate parent undertaking is Lloyds Bank plc, which is a public limited company and is incorporated and domiciled in the UK. Its registered office is 25 Gresham Street, London, EC2V 7HN, from which copies of its annual report and financial statements will be able to be obtained. The Company s ultimate parent undertaking is Lloyds Banking Group plc, which is a public limited company and is incorporated and domiciled in the UK. Its registered office is 25 Gresham Street, London, EC2V 7HN. The Group has a primary listing on the London Stock Exchange, with a further listing in New York. 2. Summary of significant accounting policies The principal accounting policies applied in the preparation of these financial statements are set out below. The policies have been consistently applied to all the years presented, unless otherwise stated. 2.1 Basis of preparation The financial statements have been prepared under the historical cost convention and in accordance with IFRSs as adopted by the European Union. IFRSs comprise accounting standards prefixed IFRS issued by the International Accounting Standards Board (IASB) and those prefixed IAS issued by the IASB s predecessor body as well as interpretations issued by the IFRS Interpretations Committee and its predecessor body. The financial statements also comply with those parts of the Companies Act 2006 applicable to companies reporting under IFRSs. As stated on page 7 the Directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements. The preparation of financial statements in conformity with IFRSs requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Company s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the financial statements are disclosed in note Accounting pronouncements effective in 2016 There are no new or amended accounting standards that have required a change to accounting policies for the 2016 financial year. 18

20 2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) Future accounting developments The following pronouncements are not applicable for the year ended 31 December 2016 and have not been applied in preparing these financial statements. Save as disclosed below, the full impact of these accounting changes is still being assessed by the Company and reliable estimates cannot be made at this stage. With the exception of IFRS 9, which was endorsed in November 2016, these pronouncements are awaiting EU endorsement. IFRS 9 Financial Instruments IFRS 9 replaces IAS 39 Financial Instruments: Recognition and Measurement and is effective for annual periods beginning on or after 1 January Classification and Measurement IFRS 9 requires financial assets to be classified into one of three measurement categories, fair value through profit or loss, fair value through other comprehensive income or amortised cost. Financial assets will be measured at amortised cost if they are held within a business model the objective of which is to hold financial assets in order to collect contractual cash flows, and their contractual cash flows represent solely payments of principal and interest. Financial assets will be measured at fair value through other comprehensive income if they are held within a business model the objective of which is achieved by both collecting contractual cash flows and selling financial assets and their contractual cash flows represent solely payments of principal and interest. Financial assets not meeting either of these two business models; and all equity instruments (unless designated at inception to fair value through other comprehensive income); and all derivatives are measured at fair value through profit and loss. An entity may, at initial recognition, designate a financial asset as measured at fair value through profit or loss if doing so eliminates or significantly reduces an accounting mismatch. The Company has undertaken an assessment to determine the potential impact of changes in classification and measurement of financial assets. The adoption of IFRS 9 is unlikely to result in significant changes to existing asset measurement bases, however, the final impact will be dependent on the facts and circumstances that exist on 1 January IFRS 9 retains most of the existing requirements for financial liabilities. However, for financial liabilities designated at fair value through profit or loss, gains or losses attributable to changes in own credit risk may be presented in other comprehensive income. 19

21 2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) Future accounting developments (continued) Impairment Overview The IFRS 9 impairment model will be applicable to all financial assets at amortised cost, debt instruments measured at fair value through other comprehensive income, lease receivables, loan commitments and financial guarantees not measured at fair value through profit or loss. IFRS 9 replaces the existing incurred loss impairment approach with an Expected Credit Loss ( ECL ) model, resulting in earlier recognition of credit losses compared with IAS 39. Expected credit losses are the unbiased probability weighted average credit losses determined by evaluating a range of possible outcomes and future economic conditions. The ECL model has three stages. Entities are required to recognise a 12 month expected loss allowance on initial recognition (stage 1) and a lifetime expected loss allowance when there has been a significant increase in credit risk since initial recognition (stage 2). Stage 3 requires objective evidence that an asset is credit-impaired, which is similar to the guidance on incurred losses in IAS 39. Under IAS 39, provisions are recognised for losses that have been incurred but may have not been separately identified. An assessment is made of the likelihood of assets being impaired at the balance sheet date and being identified subsequently; the length of time taken to identify that an impairment event has occurred is known as the loss emergence period. The Company has a range of emergence periods which are dependent upon the characteristics of the portfolios, but typically range between one month and twelve months based on historical experience. Unsecured portfolios tend to have shorter emergence periods than secured portfolios. Under IFRS 9, all loans in stage 1 will require a loss allowance measured at an amount equal to 12 months ECL and is therefore longer than current emergence periods for certain portfolios. The requirement to recognise lifetime ECL for loans which have experienced a significant increase in credit risk since origination, but which are not credit impaired, does not exist under IAS 39. The assessment of whether an asset is in stage 1 or 2 considers the relative change in the probability of default occurring over the expected life of the instrument, not the change in the amount of expected credit losses. This will involve setting quantitative tests combined with supplementary indicators such as credit risk classification. Reasonable and supportable forward looking information will also be used in determining the stage allocation. Any asset more than 30 days past due, but not credit impaired, will be classed as stage 2. 20

22 2. Summary of significant accounting policies (continued) 2.1 Basis of preparation (continued) Future accounting developments (continued) Impact of IFRS 9 on the Company The adoption of IFRS 9 may result in an increase in the Company s balance sheet provisions for credit losses. The extent of any increase in provisions will depend upon on a number factors including the composition of the Company s lending portfolios and forecast economic conditions at the date of implementation. Whilst the Company is still refining its methodology and completing the development of the models required to calculate the provision, it is not possible to provide a reliable estimate of the impact of adopting IFRS 9. It is also too early to estimate the on-going impact of the IFRS 9 impairment model on the financial results although the requirement to transfer assets between stages and to incorporate forward looking data into the expected credit loss calculation, including multiple economic scenarios, could result in impairment charges being more volatile when compared to the current IAS 39 impairment model. Hedge Accounting The hedge accounting requirements of IFRS 9 are more closely aligned with risk management practices and follow a more principle-based approach than IAS 39. The revised requirements are not expected to have a significant impact on the Company. IFRS 15 Revenue from Contracts with Customers IFRS 15 replaces IAS 18 Revenue and IAS 11 Construction Contracts. Financial instruments, leases and insurance contracts are out of scope. This standard is not expected to have a significant impact on the Company. IFRS 15 is effective for annual periods beginning on or after 1 January IFRS 16 Leases IFRS 16 replaces IAS 17 Leases and requires lessees to recognise a right of use asset and a liability for future payments arising from a lease contract. Lessees will recognise a finance charge on the liability and a depreciation charge on the asset which could affect the timing of the recognition of expenses on leased assets. This standard is not expected to have a significant impact on the Company. IFRS 16 is effective for annual periods beginning on or after 1 January Minor amendments to other accounting standards During 2016, the IASB has issued amendments to IAS 7 Statement of Cash Flows (which require additional disclosure about an entity s financing activities) and IAS 12 Income Taxes (which clarify when a deferred tax asset should be recognised for unrealised losses) together with a number of other minor amendments to IFRSs, which will be effective for annual periods beginning on or after either 1 January 2017 or 1 January These revised requirements are not expected to have a significant impact on the Company. 21

23 2. Summary of significant accounting policies (continued) 2.2 Interest income and expense Interest income and expense are recognised in the statement of comprehensive income for all interest-bearing financial instruments using the effective interest rate method. The effective interest rate method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the future cash flows are estimated after considering all the contractual terms of the instrument, but not the future credit losses. The calculation incorporates all amounts paid or received by the Company that are an integral part of the overall return, direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument and all other premiums or discounts. For mortgages these amounts include mortgage arrangement fees charged to customers and valuation refunds, subsidised legal fees and mortgage procurement fees payable by the Company, and for deposits they include trail fees payable to intermediaries. Once a financial asset has been written down as the result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see note 2.7). 2.3 Fee and commission income and expense Fees and commissions which are not an integral part of the effective interest rate are generally recognised when the service has been provided. Commission income in respect of insurance products is recognised as it becomes receivable. Commission expense is recognised in the income statement as it accrues over the life of the underlying loans. 2.4 Employee benefits The Company has no direct employees. The costs of employee benefits, including pensions (note 7) and share-based compensation (note 27), are recharged from other Group companies. Short-term employee benefits, such as salaries, paid absences, performance-based cash awards and social security costs are recognised over the period in which the employees provide the related services. The costs of pensions and share-based compensation are charged to the income statement as they fall due. 2.5 Ordinary dividends Dividends payable on ordinary shares are recognised in equity when the Company becomes irrevocably committed. 22

24 2. Summary of significant accounting policies (continued) 2.6 Loans and advances to banks and customers The Company classifies all of its financial assets as loans and receivables, which are nonderivative financial assets with fixed or determinable payments and are not quoted in an active market. They arise when the Company provides money directly to a debtor with no intention of trading the receivable. Loans and advances to banks and customers are accounted for at fair value at inception and subsequently measured at amortised cost using the effective interest rate method, less provisions for impairment. 2.7 Impairment of financial assets At each balance sheet date the Company assesses whether, as the result of one or more events occurring after initial recognition, there is objective evidence that a financial asset has become impaired. Evidence of impairment may include indications that the borrower is experiencing significant financial difficulty, default or delinquency in contractual payments of principal and/or interest, restructuring of debt to reduce the burden on the borrower, breach of loan covenants or conditions and initiation of bankruptcy proceedings. If there is objective evidence that an impairment loss has been incurred, an allowance is established and charged to the statement of comprehensive income. The allowance is calculated as the difference between the balance sheet carrying value of the asset and the present value of estimated future cash flows discounted at the asset s original effective interest rate. If an asset has a variable interest rate, the discount rate used for measuring the impairment loss is the current effective interest rate. The calculation of the present value of the estimated future cash flows of a collateralised asset reflects the cash flows that may result from foreclosure, less the costs of obtaining and selling the collateral, whether or not foreclosure is probable. Where there is no objective evidence of individual impairment, the financial asset is included in a group of financial assets with similar credit risk characteristics and collectively assessed for impairment. Segmentation takes into account such factors as the type of asset, geographic location, collateral type, past due status and other relevant factors. These characteristics are relevant to the estimation of future cash flows for groups of such assets as they are indicative of the borrower s ability to pay all amounts due according to the contractual terms of the assets being evaluated. Future cash flows are estimated on the basis of the contractual cash flows of the assets in the group and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted on the basis of current observable data to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period which do not exist currently. The methodology and assumptions for estimating future cash flows are reviewed regularly by the Company to reduce any differences between loss estimates and actual loss experience. 23

25 2. Summary of significant accounting policies (continued) 2.7 Impairment of financial assets (continued) If, in a subsequent period, the amount of the impairment loss decreases and this can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the statement of comprehensive income. When a loan or advance is uncollectable, it is written-off against the related allowance once all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written-off decrease the amount of impairment losses recorded in the statement of comprehensive income. 2.8 Intangible assets Intangible assets comprise purchased software, and costs associated with the development of separable new systems when they are considered likely to generate economic benefits exceeding costs beyond one year, and are stated at historical cost less accumulated amortisation. Amortisation is calculated using the straight-line method to allocate the difference between the cost and the residual value over the assets estimated useful lives of 3-5 years. A full year s amortisation is charged in the year of purchase. The assets residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. In the event that an asset s carrying value is determined to be greater than its recoverable amount it is written down immediately. 2.9 Property, plant and equipment Property, plant and equipment comprises computer and other office equipment, and is stated at historical cost less accumulated depreciation. Depreciation is calculated using the straight-line method to allocate the difference between the cost and the residual value over the assets estimated useful lives of 3-5 years. A full year s depreciation is charged in the year of purchase. The assets residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date. In the event that an asset s carrying value is determined to be greater than its recoverable amount it is written down immediately Deposits from banks Deposits from banks are recognised at fair value at inception and subsequently measured at amortised cost using the effective interest rate method Due to customers Amounts due to customers are recognised at fair value at inception and subsequently measured at amortised cost using the effective interest rate method. 24

26 2. Summary of significant accounting policies (continued) 2.12 Subordinated liabilities Subordinated liabilities are accounted for at amortised cost using the effective interest rate method Taxes, including deferred tax Corporation tax, which is payable on taxable profits, is recognised as an expense in the period in which the profits arise. Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. The amount provided is determined using tax rates that have been enacted or substantially enacted by the balance sheet date, and expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. Deferred tax assets are recognised where it is probable that future taxable profits will be available against which the temporary differences can be utilised. Deferred and current tax assets and liabilities are offset where there is both a legal right of offset and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously Foreign currency translation The financial statements are presented in sterling which is the Company s functional and presentation currency. Foreign currency transactions are translated into sterling using the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses arising from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the statement of comprehensive income Cash and cash equivalents For the purposes of the statement of cash flows, cash and cash equivalents comprise loans and advances to banks and deposits from banks with less than three months to maturity from the date of acquisition. 25