BANK OF AMERICA EUROPE CARD SERVICES (MBNA Europe Bank Limited) Pillar 3 Market Disclosures As at 31 st December 2010
Contents 1 Background 5 1.1 Business of MBNA Europe Bank Limited 7 1.2 Purpose of report 7 1.3 Scope of application of directive requirements 7 1.4 Approval of these disclosures 7 2 Capital resources 9 2.1 Capital resources 11 3 Compliance with Pillar 1 and the overall Pillar 2 rule 13 3.1 Risk management and capital adequacy 15 3.2 Credit risk minimum capital requirement 15 3.2.1 Strategies and processes to manage credit risk 16 3.2.2 The structure and organisation of credit risk management 16 3.2.3 The scope and nature of credit risk reporting and measurement systems 16 3.2.4 The policies for hedging and mitigating credit risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants 16 3.2.5 Credit risk capital component 16 3.2.6 Counterparty risk capital component 17 3.2.7 Past due and impaired definition 17 3.2.8 Approaches and methods adopted for determining value adjustments and provisions 17 3.2.9 Residual maturity breakdown by exposure class 18 3.2.10 Impaired and past due exposures by geographical area including provisions related to each geographical area 18 3.2.11 Provision for loan loss 18 3.3 Market risk minimum capital requirement 18 3.3.1 Strategies and processes to manage market risk 19 3.3.2 The structure and organisation of market risk management 19 3.3.3 The scope and nature of market risk reporting and measurement systems 19 3.4 Operational risk minimum capital requirement 19 3.4.1 Strategies and processes to manage operational risk 19 3.4.2 The structure and organisation of operational risk management 19 3.4.3 The scope and nature of operational risk reporting and measurement systems 19 3.4.4 The policies for hedging and mitigating operational risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants 20 4 Exposures to interest rate risk in the non-trading book 21 4.1 Strategies and processes to manage interest rate risk in the non-trading book 23 4.2 The structure and organisation of interest rate risk management 23 4.3 The scope and nature of interest rate risk reporting and measurement systems 23 4.4 The policies for hedging and mitigating interest rate risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants 23 A Consolidation status of group entities 25 3
Tables Table 1 Capital resources 11 Table 2 Credit risk capital component 17 Table 3 Provision for loan loss 18 Figures Figure 1 Group company status 27 4
Section 1 1 Background
Background 1.1 Business of MBNA Europe Bank Limited MBNA Europe Bank Limited ( EBL ) provides personal finance and ancillary services in Europe. 1.2 Purpose of report This report presents the required Market Disclosures for EBL and its UK Consolidation Group in accordance with the rules and guidance of Chapter 11 of the Prudential Sourcebook for Banks, Building Societies and Investment Firms ( BIPRU ). 1.3 Scope of application of directive requirements EBL and its UK Consolidation Group is the subject of the disclosures made in this document. Europe Card Services Partners (Scotland) Limited Partnership is the ultimate European Economic Area ( EEA ) parent of EBL. EBL s UK Consolidation Group includes all subsidiaries of Europe Card Services Partners (Scotland) Limited Partnership in accordance with Chapter 8 of the BIPRU sourcebook. A table of all group entities is included in Appendix A. There is no current or foreseen material practical or legal impediment to the prompt transfer of capital resources or repayment of liabilities among Europe Card Services Partners (Scotland) Limited Partnership and its subsidiary undertakings. A solo consolidation waiver has been granted by the FSA in relation to most of EBL s subsidiaries. EBL has made disclosures with respect to remuneration as part of the Bank of America/Merrill Lynch disclosures. These consolidated disclosures can be found on the investor relations pages at the following website: www.bankofamerica.com 1.4 Approval of these disclosures These disclosures were approved for publication by the Capital Adequacy and Liquidity Committee ( CALC ) of EBL on 20 th December 2011. They have not been the subject of an external audit. 7
Section 2 2 Capital resources
Capital resources 2.1 Capital resources The capital resources of EBL s UK Consolidation Group as at 31 st December 2010 are shown in the table below: 31st December 2010 MM Tier 1 capital Permanent share capital 1,403 Profit and loss account and other reserves 968 Total tier 1 capital before deductions 2,371 Intangible assets (213) Total tier 1 capital after deductions 2,158 Tier 2 capital General/collective provisions 171 Total tier 2 capital after deductions 171 Total capital after deductions 2,329 Table 1 Capital resources There are no restrictive legal or regulatory terms or conditions attached to any of the items in EBL s UK Consolidation Group s capital resources. EBL has adopted The Standardised Approach to credit risk and therefore no expected loss amounts are applicable as deductions to capital resources. 11
Section 3 3 Compliance with Pillar 1 and the overall Pillar 2 rule
Compliance with Pillar 1 and the overall Pillar 2 rule 3.1 Risk management and capital adequacy Overview EBL maintains a strong and comprehensive risk framework. The objective is to understand and manage risk to minimise volatility and create sustainable earnings for EBL. EBL has disciplined and deliberate governance that allows management to identify and oversee the risks and rewards inherent in each business unit. Risk management is fully integrated with strategic, financial and business planning so that goals and responsibilities are aligned across EBL. EBL uses the Bank of America ( BAC ) Economic Capital model as a capital adequacy assessment tool in addition to stress testing and scenario analysis. Integrated Business Planning The Integrated Business Planning ( IBP ) process is the cornerstone of managing risk and reward in the company. Starting with an assessment of the strategic risks facing the business, this process integrates customer, financial, risk and associate planning. It ensures that goals and objectives are well defined and aligned throughout the company and that risks are identified and anticipated during the planning process. It ensures that associates at all levels work toward the same goals and that resources are properly allocated to these goals. Governance structure and process EBL maintains a governance structure that delineates the responsibilities for risk management activities, as well as governance and oversight of those activities, by management and the Board. The structure ensures governance processes are explicit, with clear lines of authority and defined escalation paths to manage significant risks and processes. The governance structure is derived from Board committees, management committees and individuals, where specific responsibilities have been apportioned by either the Board or the Chief Executive Officer in line with the FSA Approved Person Framework. Board members are provided with regular management updates, including, but not limited to, reports from finance, compliance risk management, operational risk management, credit risk management, and corporate audit. They are also given reports that set out EBL's risk appetite and the performance against that risk appetite. Management committees have broad authority to manage and monitor the risks assigned to them, including the approval of policies and limits. Risk Governance Framework EBL's risk governance framework ensures that risk and reward are appropriately identified, measured and managed across all business activities. The risk governance framework requires effective integration across all business areas, combined with individual accountability within defined roles. Line of business managers are accountable for identifying and managing all existing and emerging risks in their units. Governance and Control managers provide an independent and objective view on line of business risk management. Corporate Audit is responsible for providing independent assessments and validation of the company s risk management activities through testing of key processes and controls. 3.2 Credit risk minimum capital requirement EBL has adopted The Standardised Approach to credit risk. The Pillar 1 credit risk capital requirement, as at 31 st December 2010, was 876MM. EBL assesses the adequacy of its credit risk capital requirement by conducting stress tests and scenario analysis. The stress test methodology and assumptions are reviewed and approved by the CALC. The results of the stress tests and scenario analysis are compared to the Pillar 1 capital requirement to determine the adequacy of its current capital requirement. 15
Compliance with Pillar 1 and the overall Pillar 2 rule 3.2.1 Strategies and processes to manage credit risk EBL manages credit risk using both automated and judgmental decisioning processes. A series of policies have been designed to articulate the supporting controls and monitoring processes around these key decisions. As part of the approval process for any new strategy, the expected performance of the strategy is measured against EBL s risk appetite. These assessments are performed to ensure that the intended outcome of the strategy change is in line with the overall credit risk appetite for EBL. Credit risk appetite The management of risk and reward in EBL is a continuous process that must be proactive to be effective. This is supported through the application of the credit risk governance structure that seeks to ensure continuous review of the business performance for each portfolio and consideration of whether the business is operating within the stated risk appetite. If the business is not operating within the stated risk appetite, actions are taken to move the portfolio s performance back within the risk appetite. EBL risk management has established clear tolerances and guardrails for the business to operate within, which are embedded into the regular business routines and governance framework. These tolerances and guardrails are designed to express the expected performance of both existing and new business, in terms of revenue and losses and are designed to promote early identification of variance to expected performance thereby enabling prompt action to address issues where appropriate. EBL reviews these tolerances on at least an annual basis. As EBL provides personal finance and ancillary services in Europe its exposure to concentration risk is considered minimal. Concentration risk is managed through the credit risk management function. 3.2.2 The structure and organisation of credit risk management EBL s Board of Directors oversees the management of Credit Risk through a number of Board and executive management committees. These committees are staffed by a cross-section of executive and senior management from relevant EBL business units. 3.2.3 The scope and nature of credit risk reporting and measurement systems The Credit Risk Committee reviews the performance of the portfolio on a monthly basis. Credit risk is measured, using a number of Key Performance Indicators, against EBL s risk appetite and tolerance levels. 3.2.4 The policies for hedging and mitigating credit risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants In order to maintain the level of credit risk, within agreed tolerances, action is taken through a number of risk mitigating strategies. These strategies are all approved and monitored through the Strategy Governance Process. 3.2.5 Credit risk capital component The table below details the exposure, the risk weighted exposure amount and 8% of the risk weighted exposure amount for each of the standardised credit risk exposure classes: 16
Compliance with Pillar 1 and the overall Pillar 2 rule 31st December 2010 Exposure Risk-weighted 8% of Riskexposure weighted exposure MM MM MM Standardised credit risk exposure class Claims or contingent claims on central governments or central banks 296 0 0 Claims or contingent claims on institutions 590 142 11 Retail claims or contingent retail claims 13,114 9,835 787 Past due items 304 456 36 Other items 513 513 41 14,817 10,946 876 Table 2 Credit risk capital component EBL operates in one geographic area, Europe. Accordingly geographic segmental analysis is not provided. EBL s claims or contingent claims on central governments or central banks are all on European central banks. EBL s claims or contingent claims on institutions are all on European banks. EBL s retail claims or contingent retail claims are materially on individuals as are EBL s past due items. 3.2.5.1 External Credit Assessment Institutions (ECAIs) EBL has nominated the following ECAIs: 1. Standard and Poor s; and 2. Moody s Standard and Poor s are used for claims or contingent claims on central governments or central banks and both the nominated ECAIs are used for claims or contingent claims on institutions. All claims or contingent claims on central governments or central banks ( 296MM as at 31 st December 2010) and all claims or contingent claims on institutions ( 590MM as at 31 st December 2010) are associated with credit quality step 1 or 2 as prescribed in BIPRU 3 of the FSA Handbook. 3.2.6 Counterparty risk capital component EBL has no trading book but does have foreign currency and interest rate contracts in its non-trading book. EBL has adopted the counterparty credit risk mark to market methodology for calculating the minimum capital requirement in respect of these exposures. As at 31 st December 2010 EBL has a capital requirement of 2MM in respect of contracts concerning foreign currency and interest rate risk of 21MM, which is included within the figure for claims or contingent claims on institutions in Table 2 Credit risk capital component. 3.2.7 Past due and impaired definition For the purposes of Pillar 1, EBL classifies accounts that are 90 days or more past due as past due exposures. 3.2.8 Approaches and methods adopted for determining value adjustments and provisions EBL maintains a provision for bad and doubtful debts at an amount sufficient to absorb losses in the group s loan receivables. To estimate these losses EBL regularly performs a migration analysis of current and delinquent accounts. Migration analysis is a technique used to estimate the likelihood that a loan receivable will progress through the various delinquency stages and ultimately charge off. On a quarterly basis EBL reviews and adjusts these estimates as appropriate. EBL s estimate of probable net credit losses considers the impact of economic conditions on the borrower s ability to repay, past collection experience, the risk characteristics and composition of the portfolio, and other factors. EBL then provides for the probable net credit losses based on its estimation of these amounts. 17
Compliance with Pillar 1 and the overall Pillar 2 rule EBL also provides for its estimate of interest and fee income that it does not expect to collect in subsequent periods through adjustments to the profit and loss account and provisions against loans and advances to customers. The estimate of uncollectible interest and fees is based on a migration analysis of delinquent and current loan receivables that will progress through the various delinquency stages and will ultimately charge off. EBL incurs loan receivable fraud losses from the unauthorised use of customer accounts and counterfeiting. These fraudulent transactions, when identified, are reclassified from loans and advances to customers to other assets. Loans and advances to customers are reduced to estimated net recoverable values through a charge to the profit and loss account. 3.2.9 Residual maturity breakdown by exposure class Due to the revolving nature of the credit card product the majority of the exposures and in particular the retail exposures do not have a contractual maturity date and therefore no residual maturity breakdown is disclosed. 3.2.10 Impaired and past due exposures by geographical area including provisions related to each geographical area As noted in 3.2.5 Credit risk capital component EBL operates in one geographic area, Europe. Accordingly geographic segmental analysis is not provided. 3.2.11 Provision for loan loss EBL provides for expected future loan loss. The table below shows the movement in the loan loss provision over the year. 31-Dec-09 31-Dec-10 MM MM Opening balance 541 801 New Provisions 979 1,214 Exchange rate movements (11) (5) Amounts written off (768) (1,304) Recoveries 60 129 Closing balance 801 835 Table 3 Provision for loan loss Note that the provision for loan loss as at 31 st December 2009 is against held assets and does not include any provision for loan loss against securitised assets, however the provision as at 31 st December 2010 includes a provision for loan loss against securitised assets. 3.3 Market risk minimum capital requirement EBL has no trading-book business and as such has no minimum capital requirement in respect of interest rate position risk requirement ( PRR ), equity PRR, option PRR, collective investment schemes PRR, counterparty risk capital component, or concentration risk capital component. EBL holds no commodities and as such has no minimum capital requirement in respect of commodity PRR. EBL does have assets and liabilities denominated in currencies other than Sterling. EBL s foreign currency PRR as at 31 st December 2010 is 149k. Due to the size of EBL s foreign currency PRR it is not deemed to be a material risk. 18
Compliance with Pillar 1 and the overall Pillar 2 rule 3.3.1 Strategies and processes to manage market risk EBL s Finance Committee is responsible for monitoring foreign currency PRR. Monthly monitoring of foreign currency PRR is performed by the Accounting team with hedging activity performed by Treasury. EBL has foreign currency PRR in Euros, US Dollars and Indian Rupees. 3.3.2 The structure and organisation of market risk management The EBL Board of Directors is responsible for the governance of market risk. The Finance Committee oversees the measuring, monitoring and reporting of market risk. The Finance Committee is a sub-committee of the EBL Board. The day to day processes and procedures relating to the measuring, monitoring and reporting of market risk are undertaken by the Treasury and Accounting departments. 3.3.3 The scope and nature of market risk reporting and measurement systems The only market risk that EBL is exposed to is foreign currency PRR. As noted above the size of this risk is considered immaterial. 3.4 Operational risk minimum capital requirement EBL has adopted The Standardised Approach to operational risk. The operational risk capital requirement ( ORCR ) is calculated as a percentage of the average of the last three financial years gross revenues and as at 31 st December 2010 was 216MM. EBL assesses the adequacy of its ORCR by conducting stress tests and scenario analysis across key operational risk areas, identified using a variety of risk management routines. The stress test methodology and assumptions are reviewed and approved by the CALC. The results of EBL s stress tests and scenario analysis, after taking into consideration any correlation benefit, are compared to the Pillar 1 ORCR to determine the adequacy of its current capital. 3.4.1 Strategies and processes to manage operational risk EBL manages operational risk in accordance with the Operational Risk policy, which sets out its commitment to effective risk management, outlines roles and responsibilities, and details the structure of the risk management framework. Operational Risk appetite is managed through EBL governance committees, with the Compliance and Risk Committee providing oversight of the risk management framework and the CALC establishing tolerance levels and monitoring routines for operational losses identified through risk management processes. EBL has an executive level Internal Controls Committee ( ICC ) which oversees the operational risk framework as well as performance of controls within the business. For selected risks, EBL uses specialised support groups, such as Information Security, Human Resources, Fraud and Business Continuity to develop risk management practices. 3.4.2 The structure and organisation of operational risk management A formal governance structure provides oversight to the management of operational risk across EBL s operations. The ICC, which reports to the Compliance and Risk Committee and meets monthly, discusses key risk issues and reviews the adequacy and effectiveness of the operational risk management framework. 3.4.3 The scope and nature of operational risk reporting and measurement systems EBL has policies which explain the approach to identifying, measuring, mitigating and monitoring operational risk which could prevent EBL from achieving its business objectives, and employs a variety of reporting and measurement systems, overseen by Operational Risk Management ( ORM ). 19
Compliance with Pillar 1 and the overall Pillar 2 rule Corporate Audit also plays an important role in the risk reporting and evaluation process by providing executive management and the EBL Compliance and Risk Committee with thorough and independent assessments of the company s risk management systems and internal controls. 3.4.4 The policies for hedging and mitigating operational risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants The objective of risk mitigation is to ensure risk levels stay within tolerance limits as well as achieving an appropriate balance between risk and reward. Risk response can take the form of: Risk acceptance: intentionally retain current level of risk or adjust upwards to take on more risk; Risk reduction: entails taking steps that decrease the total amount of risk by reducing the likelihood and / or impact, or increasing the ability to detect and correct; Risk transfer: any actions taken to move ownership, in full or in part, of the risk to an outside entity, such as through the purchase of insurance; or Risk transformation: the result of business activities, which intentionally change the characteristics of the risk. Operational risk is mitigated through a broad based approach to process management and improvement. ORM liaises with the business management to ensure the appropriate risk mitigation strategy is considered sustainable and is monitored on a timely basis. 20
Section 4 4 Exposures to interest rate risk in the non-trading book
Exposures to interest rate risk in the non-trading book 4.1 Strategies and processes to manage interest rate risk in the non-trading book Interest Rate Risk ( IRR ) is managed in accordance with EBL s IRR Policy. This policy establishes the risk management procedures and hedging strategies EBL may adopt in relation to the management of IRR. EBL assesses the adequacy of its capital position in relation to IRR by conducting stress tests and scenario analysis. The stress test methodology and assumptions are reviewed and approved by the CALC. The results of the stress tests and scenario analysis are then reviewed to determine the adequacy of EBL s current capital position. 4.2 The structure and organisation of interest rate risk management The EBL Board of Directors is responsible for the governance of IRR in the non-trading book. The Finance Committee oversees the measuring, monitoring and reporting of IRR in the non-trading book. The Finance Committee is a sub-committee of the EBL Board. The day to day processes and procedures relating to the measuring, monitoring and reporting of IRR in the non-trading book are undertaken by the Treasury department. 4.3 The scope and nature of interest rate risk reporting and measurement systems EBL acknowledges that volatile rate movements, competitive markets and shifting economic conditions require active management of IRR. One of the key measures of IRR is the impact of an interest rate shock on Net Interest Income ( NII ). Accordingly, when fluctuations in interest rates affect or are forecast to affect the earnings stream, outside of EBL established tolerance levels, management will act to protect its ability to raise funds and capital while stabilising earnings. The existence of this tolerance level ensures management gives appropriate consideration to options to close potential IRR gaps in a timely manner. In addition, there is also a tolerance level for the contractual static balance sheet gap. The contractual static balance sheet gap is reviewed on a monthly basis. IRR is stressed monthly through a number of scenarios including a 200 basis point shock. 4.4 The policies for hedging and mitigating interest rate risk, and the strategies and processes for monitoring the continuing effectiveness of hedges and mitigants In order to maintain the level of IRR within the established limits, management may, with the Finance Committee's agreement, use a variety of financial instruments and strategies, which may include altering the rate structure and term of EBL s funding. In the event exposures outside of the established guidelines are reported, the EBL Board must be satisfied that a responsible plan to reduce exposure is developed. 23
Appendix A A Consolidation status of group entities
Consolidation status of group entities Main Group Securitisation vehicles 1 Europe Card Services Partners (Scotland) Limited Partnership 30 Deva One Limited 2 MBNA Funding Company Limited 31 Deva Two Limited 3 MBNA Europe Bank Limited 32 Deva Three Limited 4 MBNA Property Services Limited 33 Chester Asset Securitisations Holdings Limited 5 MBNA Direct Limited 34 Chester Asset Receivables Dealings Issuer Limited 6 MBNA Europe Funding Plc 35 Chester Asset Receivables Dealings No.5 Limited 7 MBNA International Properties Limited 36 Chester Asset Receivables Dealings No.10 Limited 8 Paneldeluxe Company Limited 37 Chester Asset Receivables Dealings No.11 Plc 9 Mainsearch Company Limited 38 Chester Asset Receivables Dealings No.12 Plc 10 Windeluxe Company Limited 39 Chester Asset Securitisation Holdings No.2 Limited 11 Chester Property & Services Limited 40 Chester Asset Receivables Dealings 2001-A Plc 12 MBNA Europe Holdings Limited 41 Chester Asset Receivables Dealings 2001-B Plc 13 MBNA Receivables Limited 42 Chester Asset Receivables Dealings 2002-A Plc 14 MBNA Europe Finance Limited 43 Chester Asset Receivables Dealings 2002-B Plc 15 MBNA R&L Sarl 44 Chester Asset Receivables Dealings 2003-A Plc 16 MBNA Luxembourg Holdings Sarl 45 Chester Asset Receivables Dealings 2003-B Plc 17 MBNA Global Services Limited 46 Chester Asset Receivables Dealings 2003-C Plc 18 MBNA Scotland Limited Partnership 47 Chester Asset Receivables Dealings 2004-1 Plc 19 MBNA Indian Services Private Limited 48 Chester Asset Receivables Dealings 2009-1 Limited 20 Vendcrown Limited 49 Chester Asset Receivables Dealings 2009-A Limited 21 Premium Credit Limited 50 Chester Asset Securitisations Holdings VFN Limited 22 Marlin House Holdings 51 Chester Asset Receivables Dealings VFN Limited 23 Loans.co.uk 52 Chester Asset Receivables Dealings VFN2 Limited 24 MBNA Ireland Limited 53 Chester Asset Receivables Dealings VFN3 Limited 25 Trifesol S.L. 54 Credit Card Securitisation International Limited 26 MBNA Investment & Securities Limited 55 Credit Card Securitisation Europe Limited 27 Direct Debit Management Services Limited 56 Chester Asset Options Limited 28 Debt Clear Recoveries & Investigations Limited 57 Chester Asset Options No.2 Limited 29 Aarco 106 Limited 58 Chester Asset Options No.3 Limited Figure 1 Group company status 27