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Nationwide B.S. (NAWI)

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Friday 15 November, 2013

Nationwide B.S.

Half Yearly Report

RNS Number : 1023T
Nationwide Building Society
15 November 2013
 



 

 

 

 

  

 

 

Nationwide Building Society

 

 

 

 

 

Interim Results

For the period ended

30 September 2013

 

 


CONTENTS

 

Page

Financial summary

5

Chief Executive's review

6

Business review

10

Risk Management Report

34

Interim financial statements

74

Notes to the interim financial information

80

Responsibility statement

103

Independent review report

104

Other information

105

Contacts

105

 

 

Underlying Profit and Pre Provision Underlying Profit

 

Profit before tax shown on a statutory and underlying basis is set out on page 10. Statutory profit before tax of £270 million has been adjusted for a number of items, consistent with prior years, to derive an underlying profit before tax of £332 million. The purpose of this measure is to reflect management's view of the Group's underlying performance and to assist with like for like comparisons of performance across years. Underlying profit is not designed to measure sustainable levels of profitability as that potentially requires exclusion of non-recurring items even though they are closely related to (or even a direct consequence of) the Group's core business activities.

 

Pre provision underlying profit of £655 million relates to underlying profit before impairment losses and provisions for liabilities and charges. The purpose of this measure is to demonstrate net income generation capacity and the ability of the business to absorb losses in a challenging economic climate.

 

Comparatives have been restated in accordance with IAS 19 (Revised). Refer to note 2 of the interim financial information for further details.

 

Forward Looking Statements

 

Statements in this document are forward lookingwith respect to plans, goals and expectations relating to the future financial position, business performance and results of Nationwide. Although Nationwide believes that the expectations reflected in these forward looking statements are reasonable, we can give no assurance that these expectations will prove to be an accurate reflection of actual results. By their nature, all forward looking statements involve risk and uncertainty because they relate to future events and circumstances that are beyond the control of Nationwide including, amongst other things, UK domestic and global economic and business conditions, market related risks such as fluctuation in interest rates and exchange rates, inflation/deflation, the impact of competition, changes in customer preferences, risks concerning borrower credit quality, delays in implementing proposals, the timing, impact and other uncertainties of future acquisitions or other combinations within relevant industries, the policies and actions of regulatory authorities, the impact of tax or other legislation and other regulations in the jurisdictions in which Nationwide operates. As a result, Nationwide's actual future financial condition, business performance and results may differ materially from the plans, goals and expectations expressed or implied in these forward looking statements. Due to such risks and uncertainties Nationwide cautions readers not to place undue reliance on such forward looking statements.

 

We undertake no obligation to update any forward looking statements whether as a result of new information, future events or otherwise.

 

This document does not constitute or form part of an offer of securities for sale in the United States. Securities may not be offered or sold in the United States absent registration or an exemption from registration. Any public offering to be made in the United States will be made by means of a prospectus that may be obtained from the Society and will contain detailed information about the Society and management as well as financial statements.


 

NATIONWIDE BUILDING SOCIETY

INTERIM RESULTS FOR THE PERIOD ENDED 30 SEPTEMBER 2013

 

 

 

Graham Beale, Nationwide's Chief Executive said:

 

"The first six months of the financial year have seen Nationwide build on the momentum generated in 2012/13, with strong business volumes driving an excellent financial performance.

 

"We have continued to play a leading role in the financing of the housing market, consistent with our role as the UK's largest mutual building society: our gross mortgage lending is up 37% at £14.0 billion, a market share of 15.4%, and our net lending is up 75% at £5.6 billion. This represents our highest six month lending period for five years. We have placed a particular emphasis on supporting first time buyers, helping 30,400 into a home of their own, representing support for more than one in five first time buyers. We have balanced our mortgage growth with an inflow of retail savings and we have increased our deposit balances by £5.4 billion, with a primary focus on rewarding customer loyalty.

 

"We have made further strides towards growing our share of the current account market. Supported by the implementation of our new banking system and the launch of two new current accounts over the past year, we opened over 214,000 new accounts and saw 54,000 customers switching their primary banking relationship to us, proving yet again that while customers may need a bank account, they do not need a bank.

 

"These strong business volumes, coupled with a further significant strengthening in our net interest margin, have contributed to a 25% growth in total income, a reduction in our cost income ratio and a significant increase in profitability. Underlying profit is up 155% at £332 million (H1 2012/13: £130 million), while statutory profit is up 162% at £270 million (H1 2012/13: £103 million).

 

"Our balance sheet continues to be characterised by high quality assets and diversified funding, reflecting our mutual status. Our capital base is strong and is improving further in a manner consistent with the plan agreed with the Prudential Regulation Authority in July this year. Our Common Equity Tier 1 (CET1) ratio has risen by 1.9 percentage points to 11.0% (4 April 2013: 9.1%), and we are confident that the business is on track to meet our 3% leverage target by the end of 2015.

 

"There is no change to our long term strategy - our vision remains to be the first choice for financial services. Over the past six months, we have demonstrated yet again that we remain true to our core principles as a building society: helping people to save, helping them to buy their own homes and helping them to make the most of their money. We have grown our mortgage and savings balances, grown our personal current account base, provided safety and security for our members and have played an active role in lending to the real economy."

 

  

Graham Beale

Chief Executive

KEY HIGHLIGHTS

 

SUPPORT FOR CORE MARKETS

 

·      Gross mortgage lending up 37% to £14.0 billion, a market share of 15.4%

·      Net lending up 75% at £5.6 billion, a market share of 82.8%

·      Over 30,400 first time buyers helped into a home of their own, a market share of 22%

·      16% share of all completed Help to Buy Equity Loan Scheme cases

·      Gross buy to let mortgage lending of £1.7 billion, a market share of 16%

·      £5.4 billion increase in retail savings balances, a market share of 27.5%

·      Loyalty Saver balances increased by £3.5 billion to £11.5 billion

 

GROWTH IN CONSUMER BANKING

 

·      Over 214,000 new current accounts opened, up 16% on last half year

·      Market share of main standard and packaged accounts increased by 0.8 percentage points to 6%

 

MARKET LEADING SERVICE

 

·      Independently ranked number 1 for combined product service satisfaction within our peer group for the six months to September 2013

·      Despite our significant and growing market shares, Nationwide accounts for only 2.2% of all industry complaints

 

STRONG FINANCIAL PERFORMANCE

 

·      Total underlying income up 25% at £1.39 billion

·      Underlying cost income ratio down to 52.8% (H1 2012/13: 59.0%)

·      155% increase in our underlying profit to £332 million

·      162% increase in statutory profit to £270 million

 

SAFE AND SECURE BALANCE SHEET

 

·      Core Tier 1 ratio 14.2% (4 April 2013: 12.3%)

·      Common Equity Tier 1 ratio 11.0% (4 April 2013: 9.1%)

·      Core Liquidity ratio 11.1% (4 April 2013: 11.1%)

·      Loan to deposit ratio 113.8% (4 April 2013: 115.4%)

·      Residential mortgage arrears, at 0.70%, well below CML industry of 1.75%

 

1  For the financial half year 2013. Source: GfK NOP's Financial Research Survey (FRS), 6 months of interviews conducted between April 2013 and September 2013, proportion of extremely/very satisfied customers minus proportion of extremely/very/fairly dissatisfied customers summed across current account, mortgage and savings. Our high street peer group is defined as Barclays, Halifax, HSBC, Lloyds TSB, NatWest and Santander.

 



FINANCIAL SUMMARY


Half Year to

30 September

2013

Half Year to

30 September

2012*

Financial Performance

£m

£m

Total underlying income

1,387

1,113

Pre provision underlying profit

655

456

Underlying profit before tax

332

130

Statutory profit before tax

270

103

Lending and Product Volumes

£bn

%

£bn

%

Group residential - gross/gross market share

14.0

15.4%

10.2

14.4%

Group residential - net/net market share

5.6

82.8%

3.2

81.8%

Commercial - gross

0.4

0.3

Commercial - net

(0.7)

(0.6)

Personal banking product sales (000)

392

437

Retail Savings Volumes (1)

£bn

%

£bn

%

Retail savings balance movement/market share

5.4

27.5

(0.5)

-

Net receipts/(outflows)

4.3

(1.5)

Key Ratios

%

%

Cost income ratio - underlying basis

52.8

59.0

Cost income ratio - statutory basis

56.7

61.5

Net interest margin

1.13

0.91


30 September

2013

4 April

2013

Balance Sheet

£m

£m

Total assets

193,332

190,718

Loans and advances to customers

163,863

159,587

Member savings balances

130,951

125,574

Total shares, deposits and loans (SDLs)

179,067

174,940

Total regulatory capital

8,214

8,496

Asset Quality

%

%

Proportion of residential mortgage accounts 3 months+ in arrears

0.70

0.72

Average indexed loan to value of residential mortgage book

49

51

Average loan to value of new residential lending

69

67

Commercial Property Finance

   Total provision as % of impaired balances

34

35

Key Ratios

%

%

Capital - Basel II

   Core Tier 1 ratio

14.2

12.3

   Tier 1 ratio

16.1

15.5

   Solvency ratio

20.0

19.1

Capital - CRD IV(end point)

   Common Equity Tier 1 ratio

11.0

9.1

   Leverage ratio (2)

2.3

2.2

Other balance sheet ratios

   Wholesale funding ratio

21.6

22.5

   Core liquidity ratio

11.1

11.1

   Loan to deposit ratio (3)

113.8

115.4

   Loan to deposit ratio (including long term wholesale funding) (4)

98.9

99.1

 

* Comparatives have been restated in accordance with IAS 19 (Revised). See note 2 of the interim financial statements for further details.

 

(1)  Savings volumes include current account credit balances.

(2) Comparative restated for change in treatment of certain securitisations to be risk weighted as opposed to capital deducted. See the Capital Structure section in the Business Review for further Information.

(3)  The loan to deposit ratio represents loans and advances to customers divided by (shares + other deposits + amounts due to customers).

(4)  The loan to deposit ratio including long term wholesale funding represents loans and advances to customers divided by (shares + other deposits + amounts due to customers + wholesale funds with a maturity greater than 1 year).

 

CHIEF EXECUTIVE'S REVIEW

Strong trading performance

 

In the six months to the end of September, we have made tangible progress on our strategy by investing in our core franchise to enhance our products, services and processes for our members. As a result, we have driven real momentum across our business reflected in the strongly improving trends both in volumes and profitability.

 

Supporting the housing market

 

Over the six months to 30 September 2013, we have continued to play a leading role in the financing of the housing market, consistent with our role as the UK's largest building society. Our gross lending has increased by 37% to £14.0 billion (H1 2012/13: £10.2 billion), the highest six month lending period for five years, whilst our net lending rose by 75% to £5.6 billion (H1 2012/13: £3.2 billion). Our market shares of gross and net lending were 15.4% and 82.8% respectively (H1 2012/13: 14.4% and 81.8%).

 

In line with our core building society principles we have continued to support first time buyers. Over the past six months we have helped a further 30,400 borrowers take their first steps onto the housing ladder, up 52% on the same period last year, accounting for more than one in five of all first time buyer mortgages in the UK. During the six month period we accounted for 16% of all cases advanced under the first phase of the Government's Help to Buy Equity Loan Scheme.

 

The recent extension of the Help to Buy scheme is intended to make it easier for borrowers to access mortgages of up to 95% loan to value (LTV). We have been active in 95% LTV lending for first time buyers since November 2011, following the launch of our Save to Buy product in May 2011, and for our existing mortgage customers since 2008. We welcome the Government's initiatives in support of first time buyers and hope that more lenders will join us in supporting this segment of the market.

 

Over the past six months we have maintained our Base Mortgage Rate (BMR) at 2% above Bank of England (BoE) base rate. We estimate that the member benefit of our BMR pledge has been in the region of £400 million when compared with the standard variable rate charged by other major lenders.

 

Helping our savers

 

We have maintained a competitive stance in the savings market over the first half of the year, resulting in a strong growth in our savings balances of £5.4 billion (H1 2012/13: outflow of £0.5 billion), a market share of 27.5%. A large proportion of this growth is due to the continuing popularity of our Loyalty Saver product, in which balances grew by £3.5 billion to £11.5 billion. Loyalty Saver provides a perfect example of how we aim to deliver benefit to our existing members, with 533,000 having taken advantage of this exclusive product which pays higher rates of interest according to length of membership.

 

The past six months have seen interest rates paid on savings accounts declining across the whole market. We are concerned that savers in general are increasingly struggling to achieve a fair return on their deposits and, as such, we reiterate our call for the Government, as a minimum, to address a current anomaly and to increase the annual limit on funds that can be deposited into a cash ISA to £11,520.

 

Growing our share of current accounts

 

Our drive to offer a genuine alternative to the banks has stepped up a gear over the past six months, supported by the delivery last year of our new banking infrastructure and the addition of our new FlexDirect and FlexPlus accounts, both of which have proved popular and been well received; indeed, FlexPlus has been rated as the number one packaged account by Which Magazine. 214,000 customers opened a new current account during the period, an increase of 16% on the same period last year (H1 2012/13: 184,200), with a further 54,000 customers switching their main banking relationship to Nationwide. We now have 5.3 million current accounts, increasing our market share of main standard and packaged accounts by 0.8 percentage points to 6.0%.

 

We have continued to grow our personal loan book: over the first six months we issued 68,200 new loans, up 3% on the same period last year (H1 2012/13: 65,900). Our credit card business has grown more slowly in the face of fierce competition in the market, with 109,200 new accounts (H1 2012/13: 186,900) opened in the period.

 

 2 Which? Magazine November 2013

 

Strong financial performance

 

The first six months of 2013/14 have been marked by increased levels of profitability, continuing the momentum evident in our 2012/13 results. Strong business volumes, coupled with a strengthening in our net interest margin, have contributed to a 25% growth in total underlying income to £1,387 million (H1 2012/13: £1,113 million) and a 6.2 percentage point reduction in our cost income ratio to a record low of 52.8% (H1 2012/13: 59.0%).

 

Our financial performance is underpinned by our strong balance sheet which reflects our mutual status and focus on the provision of mortgages and savings to our members: 88% of our business assets are secured on UK residential property and 78% of our funding comes from retail savings balances. Our three month mortgage arrears ratio at 0.70% continues to be significantly below the industry average of 1.75%. We have made further managed divestments of our legacy commercial real estate and non-core treasury portfolios, which have reduced by 18% and 36% respectively over the last 18 months.

 

Our total charge for impairment losses and provisions for liabilities and charges has remained broadly flat at £323 million (H1 2012/13: £326 million). Within this, our retail secured and unsecured portfolios have performed strongly and, although our commercial impairment charge of £225 million is marginally up on the same period last year (H1 2012/13: £193 million), it is £75 million lower than the charge in the second half of 2012/13. Provisions for liabilities and charges have increased to £71 million (H1 2012/13: £45 million) reflecting ongoing costs of customer redress and compliance.

 

Our underlying profit has increased by 155% to £332 million (H1 2012/13: £130 million) and statutory profit is up 162% at £270 million (H1 2012/13: £103 million). Underlying profit includes a gain of £124 million as a result of our cash offer on five tranches of our Permanent Interest Bearing Shares (PIBS) securities. Our offer comprised premia to market values and was well received and supported by investors, with a take up of 68%.

 

Stronger capital ratios

 

We place significant emphasis on preserving the strength of our balance sheet through a conservative approach to lending and prudent management of our business. We believe that this is a key priority for a business focused on providing a secure home for our members' savings. As at 30 September 2013 our Common Equity Tier 1 (CET1) ratio (on an end point Basel III basis) was 11.0% (4 April 2013: 9.1%), one of the strongest ratios amongst major UK institutions. The increase is largely due to reductions in our commercial real estate and non-core treasury portfolios, coupled with strong profitability in the period, which together have reduced our risk weighted assets and improved our reserves. The equivalent leverage ratio as at 30 September 2013 was 2.3% (4 April 2013: 2.2%).

 

In June 2013, the Prudential Regulation Authority (PRA) announced targets for capital ratios for financial institutions, calculated on an adjusted basis. As a result of this exercise Nationwide agreed a plan with the PRA to meet an adjusted Common Equity Tier 1 (CET1) ratio of 7% by 31 December 2013 and an adjusted leverage ratio of 3% by the end of 2015. Our strong financial performance in the first half of 2013/14 gives us confidence that we are on track to meet that plan.

 

Our PRA adjusted CET1 capital ratio has risen by 1.3 percentage points to 8.1% (4 April 2013: 6.8%3) over the past six months. The improvement in our PRA adjusted leverage ratio is naturally expected to take longer, but it has risen by 10 basis points to 2.1%3 over the period and we are confident that the target of 3% will be achieved by the end of 2015.

 

We have previously indicated our intention to issue Core Capital Deferred Shares (CCDS). This new capital instrument is designed for mutual building societies and will enable us to raise common equity tier one capital to supplement retained earnings and to diversify our capital base. It remains our intention to establish and access this form of capital during the current or next financial year. Any such capital issuance remains at the discretion of the Nationwide Board and will have the effect of enhancing the ratios and timetable agreed with the PRA.

 

3 These ratios are after adjustments calculated by the PRA. They therefore differ from our ratios quoted in accordance with CRD IV which excludes such adjustments. For further details of the Group's capital position and ratios see 'Capital Structure' in the Business Review.

Stability of our long term strategy

 

There is no change to our long term strategy - our vision remains to be the first choice for financial services. Over the past six months, we have demonstrated yet again that we remain true to our core principles as a building society: helping people to save, helping them to buy their own homes and helping them to make the most of their money. We have grown our mortgage and savings balances, provided safety and security for our members and have played an active role in supporting the UK economic recovery.

 

Our people are integral to the delivery of our strategy and the vision to be the first choice for financial services. Our strong trading and financial performance has been achieved as a result of having a team of talented people who share a distinct culture with a strong belief in Nationwide and a firm commitment to our members. Our measure of employee engagement has bucked the trend of competitors, rising to 74%, well above the benchmarks for both the financial services sector and high performing companies.

 

As a building society we place a consistent focus on improving our customer service. We are proud both that we continue to be independently ranked number one for combined product service satisfaction amongst our high street peer group4 and that our internal surveys show a continued increase in satisfaction for our branch and telephone channels.

 

Despite our significant market shares in both mortgages and savings and the rapid growth of our current account portfolio, we account for only 2.2% of all industry complaints and deal with all legitimate cases in our usual fair and open manner. Our success in doing so is clearly demonstrated by the fact that of all cases referred to the Financial Ombudsman Service (FOS), only 11% of our decisions are overturned, compared with an industry average of 64%. For Payment Protection (PPI) referrals to FOS the position is even better, with only 7% of our decisions overturned compared with 75% for the industry as a whole. Although complaints about the past sales of Payment Protection Insurance continue to account for a significant proportion of our complaints, we do not believe that any further provision for PPI redress needs to be made at this point.

 

In recent weeks we have seen representations made to the Treasury Select Committee in its investigation into the Co-operative Banking Group, which stated that "it is going to be difficult going forwards for a mutual to be a really serious competitor in the retail banking market". We strongly disagree. Nationwide, by example, is a successful building society with a robust business model and a clear focus on looking after its members. Unlike many of the banks we have remained profitable not just over the past 18 months, but throughout the financial crisis and for decades before. We are making tangible progress in growing our market shares and continue to demonstrate that we offer a real, consistent and viable alternative to the UK banks. In short, we are a "really serious competitor".

 

 

Outlook

 

Over the past six months we have seen encouraging signs that the UK economic recovery is gathering pace. The UK economy grew by 0.8% in the third quarter of 2013, the fastest pace for three years and output was 1.5% higher than in Q3 2012. Recent strength in forward looking indicators gives reason for optimism that the upturn in activity will be maintained.

 

The housing market appears to have turned a corner, with transactions and prices both rising. Whilst the recovery has been particularly strong in London and the South East, the market improvement seems to be spreading to other areas of the UK and we expect these trends to continue for the rest of the year and into 2014. House prices in most UK regions are still below the levels seen in the years before the financial crisis, both in nominal terms and relative to earnings. Mortgage servicing costs as a share of household incomes are in line with long term averages, lending standards are more stringent than in the pre-crisis period and macro-prudential regulators remain vigilant, with a wide range of tools at their disposal if they believe that the risks are beginning to crystallise.

 

We remain confident in our business performance: our margin has continued to strengthen and we expect this to be maintained in the second half of the financial year. Whilst it is too early to predict any meaningful improvement in the short term, there are initial signs that the recovery in the economy will stabilise the outlook for the commercial real estate market. As such, we expect our levels of provisioning to remain elevated but stable, and to begin to improve in 2014/15.

 

4 For the financial half year 2013. Source: GfK NOP's Financial Research Survey (FRS), 6 months of interviews conducted between April 2013 and September 2013, proportion of extremely/very satisfied customers minus proportion of extremely/very/fairly dissatisfied customers summed across current account, mortgage and savings. Our high street peer group is defined as Barclays, Halifax, HSBC, Lloyds TSB, NatWest and Santander.

 

Overall, our performance in the first half of 2013/14 has been very positive and we expect a strong performance for the rest of the financial year.

  

 

Graham Beale

Chief Executive

14 November 2013

 



BUSINESS REVIEW

 

INCOME STATEMENT OVERVIEW

 

Statutory profit before tax of £270 million has been adjusted for a charge of £11 million relating to the bank levy, restructuring costs of £35 million representing the cost of changes to the Group's operations, and losses from derivatives and hedge accounting of £16 million to derive an underlying profit before tax of £332 million as set out below.

 

Half Year to

30 September 2013

Statutory profit

 

£m

FSCS and bank levy

 

£m

Restructuring costs

 

£m

Movements on derivatives and hedge accounting

£m

Underlying profit

 

£m

Net interest income

1,084

-

-

-

1,084

Other income

303

-

-

-

303

Movements on derivatives and hedge accounting

(16)

-

-

16

-

Total income

1,371

-

-

16

1,387

Administrative expenses

(645)

11

31

-

(603)

Depreciation and amortisation

(133)

-

4

-

(129)

Pre provision underlying profit





655

Impairment losses

(252)

-

-

-

(252)

Provisions for liabilities and charges

(71)

-

-

-

(71)

Profit before tax

270

11

35

16

332

 

Half Year to

30 September 2012*

 

Statutory profit

 

£m

FSCS and bank levy

 

£m

Restructuring costs

 

£m

Movements on derivatives and hedge accounting

£m

Underlying profit

 

£m

Net interest income

890

-

-

-

890

Other income

223

-

-

-

223

Movements on derivatives and hedge accounting


(14)

 

-

 

-


14


-

Total income

1,099

-

-

14

1,113

Administrative expenses

(579)

8

11

-

(560)

Depreciation and amortisation

(97)

-

-

-

(97)

Pre provision underlying profit

456

Impairment losses

(281)

-

-

-

(281)

Provisions for liabilities and charges

(39)

(6)

-

-

(45)

Profit before tax

103

2

11

14

130

 

*Comparatives have been restated in accordance with IAS 19 (Revised). Refer to note 2 of the interim financial statements for further details.

 

For the purposes of management reporting, the Group is organised into three business streams: Retail, Commercial and Head office functions, which includes our treasury group operations, capital and other items classified as being non-attributable to our core business areas.

 

Nationwide is predominantly a retail focused operation which trades almost exclusively within the UK, with the exception of wholesale funding and liquidity management activities which are undertaken in both UK and overseas markets. The Group's operations incorporate a commercial property lending business and a treasury non-core portfolio which comprises approximately 26% of our treasury assets and includes loans to banks and asset backed securities. Both the commercial property loan portfolio and the treasury non-core portfolio include non-UK assets; the treasury non-core portfolio and a substantial part of the commercial loan portfolio are in managed run off and do not form part of the Group's future core strategy. This mix of activity is reflected in the business stream performance below.

 

Pre provision underlying profit has increased by 43% to £655 million (H1 2012/13: £456 million) driven by improvements in margin and the liability management gain arising from the buyback of certain tranches of PIBS.

 

Half Year to 30 September 2013

Retail

 

£m

Commercial

 

£m

Head office functions

£m

Total

 

£m

Net interest income/(expense)

1,200

61

(177)

1,084

Other income

170

9

124

303

Total income

1,370

70

(53)

1,387

Expenses

(683)

(27)

(22)

(732)

Pre provision underlying profit/(loss)

687

43

(75)

655

Impairment losses

(24)

(225)

(3)

(252)

Provisions for liabilities and charges

(71)

-

-

(71)

Underlying profit/(loss) before tax  

592

(182)

(78)

332

Restructuring costs

-

-

(35)

(35)

Bank levy

-

-

(11)

(11)

Losses from derivatives and hedge accounting

-

-

(16)

(16)

Profit/(loss) before tax

592

(182)

(140)

270

 

Half Year to 30 September 2012*

 

    Retail

 

£m

Commercial

 

£m

Head office functions

£m

Total

 

£m

Net interest income

773

26

91

890

Other income

205

10

8

223

Total income

978

36

99

1,113

Expenses

(618)

(24)

(15)

(657)

Pre provision underlying profit

360

12

84

456

Impairment losses

(64)

(193)

(24)

(281)

Provisions for liabilities and charges

(45)

-

-

(45)

Underlying profit/(loss) before tax  

251

(181)

60

130

FSCS levies

6

-

-

6

Restructuring costs

(7)

-

(4)

(11)

Bank levy

-

-

(8)

(8)

Losses from derivatives and hedge accounting

-

-

(14)

(14)

Profit/(loss) before tax

250

(181)

34

103

 

*Comparatives have been restated in accordance with IAS 19 (Revised). Refer to note 2 of the interim financial statements for further details.

 

 

PERFORMANCE BY INCOME STATEMENT CATEGORY

 

Net interest income 

 


Half year to

30 September

2013

£m

Half year to

30 September

2012

£m

Net interest income

1,084

            890

Weighted average total assets

192,771

195,652

%

%

Net interest margin (NIM)

1.13

0.91

 

The Group has shown strong results in the six months to 30 September 2013 largely driven by a continued improvement in net interest margin. Net interest income has increased by 22% to £1,084 million.

 

Mortgage margins have remained stable throughout the period and net interest income continues to benefit from the re-pricing of existing assets onto current higher prevailing market rates. The cost of retail deposits has fallen during the 6 months to 30 September 2013 with new business rates significantly lower. This has had the effect of lowering the overall cost of retail funding by 18bps, relative to the position at 30 September 2012.

 

FLS utilisation at 30 September 2013 amounted to £2.5 billion. The direct interest cost saving, relative to the Group's average cost of funding, as a result of this utilisation amounted to an annual net interest reduction of £40 million, an impact of 2 basis points on our net interest margin at the half year for 2013/14.

 

The Group's net interest margin includes a net loss of £36 million arising from the sale of investment securities as part of the management of our liquidity portfolio (H1 2012/13: net gain of £69 million). The margin also includes £37 million net income (H1 2012/13: £22 million net income) from an update of our effective interest rate assumptions with respect to the recognition of mortgage and savings income and £nil (H1 2012/13: income of £48 million) from the release of excess credit fair value adjustments relating to the Regional Brands portfolios.

 

Margin recovery has been supported by the increase in the proportion of mortgages reverting onto the Standard Mortgage Rate (SMR) product rather than the BMR price promise for which balances peaked at £55 billion in May 2013. The BMR promise caps rates at 2 percentage points above the Bank of England base rate and whilst it represents a significant distribution of value to our members in line with our mutual principles, it constitutes a significant opportunity cost and constrains our ability to manage our margin. We estimate the opportunity cost to be approximately £400 million in the period by reference to standard variable rates available elsewhere in the market. All new business written since September 2009 will revert onto our SMR product.

 

 

Underlying other income

 

 

 

 

 

Half year to

30 September

2013

£m

Half year to

30 September

2012

£m

Current account

58

59

Protection and investments

40

62

General insurance

50

55

Mortgage

12

20

Credit card

14

13

Commercial

9

10

Other income and charges

120

4

Total underlying other income

303

223

Movement on derivatives and hedge accounting

(16)

(14)

Total statutory other income

287

209

 

Underlying other income grew by £80 million relative to the first half of 2012/13 as a result of the buy-back of certain tranches of PIBS which generated a net gain of £124 million.

 

Protection and investment income fell £22 million to £40 million as a result of the operational impact of the Retail Distribution Review which came into force on 1 January 2013 and improved customer pricing on protection policies. General insurance income fell £5 million to £50 million as underwriting profit shares reduced. Mortgage income fell to £12 million due to lower mortgage payment protection income and the impact of the introduction of a new policy to carry out regular automated valuations across the residential mortgage portfolio, the cost of which is netted off against mortgage income.

 

Derivatives and hedge accounting

 

Nationwide uses derivative financial instruments to manage various aspects of risk. In doing so it complies with the Building Societies Act 1986, which limits the use of derivatives to the mitigation of consequences predominantly arising from changes in interest rates, exchange rates or other market indices.

 

Even though the Group uses derivatives exclusively for risk management purposes, income statement volatility arises due to accounting ineffectiveness of designated hedges, or because hedge accounting is not achievable. Management believes that this volatility arises from application of the accounting rules, which do not reflect the economic reality, and consequently it is excluded from underlying performance.

 

The £16 million loss (H1 2012/13: £14 million loss) from derivatives and hedge accounting represents the net change in fair value of derivative instruments versus the change in fair value of the underlying asset or liability.

The two main components of this half year's loss were:

 

·      A loss of £47 million relating to ineffectiveness in micro hedge relationships caused by increasing sterling and euro interest rates coupled with bond maturities and disposals;

 

·      A £26 million gain as a result of continued volatility in the currency markets, particularly relating to sterling:euro basis risk which is economically hedged but where hedge accounting treatment is not available.

 

The four main components of the loss for the period ended 30 September 2012  were a  £74 million gain on micro hedge relationships following a large gilt disposal and an £11 million gain on the fair value of mortgage commitments, offset by a £66 million loss arising from the reversal of past ineffectiveness in respect of the maturity of fixed rate mortgages and a £35 million loss as a result of sterling:euro volatility.

 

Underlying expenses 

 

 

 

 

 

Half year to

30 September

2013

£m

Half year to

30 September  

2012

£m

Employee costs:

 Wages and salaries

245

233

 Social security costs

23

23

 Pension costs 

40

38

308

294

Other administrative expenses

295

266

Administrative expenses (underlying)

603

560

Depreciation and amortisation

129

97

Total underlying expenses

732

657

Restructuring costs

35

11

Bank levy

11

8

Total statutory expenses

778

676

 

Total underlying expenses amounted to £732 million, an increase of 11% compared to 30 September 2012, but in line with the £731 million of underlying expenses in the second half of 2012/13. The growth was driven primarily by increased depreciation and running costs of enhancements to the Group's technology infrastructure which became operational in the second half of 2012/13.

 

A significant element of the incremental investment relates to the delivery of industry level regulatory programmes such as the Current Account Switching Service and the Mortgage Market Review Programme. Other key discretionary investment is focused on the broadening of the Group's product range and improved customer service such as the new banking platform, mortgage origination systems and the internet bank. The strategic investment has resulted primarily in increases in technology depreciation (approximately £32 million) and around £8 million of other administrative expenses.

 

The cost of processing invalid PPI claims amounted to approximately £20 million (H1 2012/13: £15 million) and is included in other administrative expenses. This has increased over the comparable period as a result of increased Financial Ombudsmen Service (FOS) fees incurred as a backlog of complaints carried forward from prior periods was processed. Our decision has been upheld in 93% of cases where claims were referred to FOS. In total, 42% of all claims received have been in respect of customers to whom we have never sold a policy.

 

We have continued our progress towards achieving our medium term target of an underlying cost income ratio (CIR) of less than 50%. Our CIR for the period on an underlying basis was 52.8% (H1 2012/13: 59.0%).

 

Restructuring costs

 

These costs relate to the continuing restructuring of our business, largely in relation to the establishment of a more efficient and flexible sourcing model for the Group's technology and business change support and the Regional Brands integration programme.

 

The Regional Brands integration programme will migrate customer balances, products and distribution channels currently branded Dunfermline, Cheshire and Derbyshire into a single branded Nationwide organisation. The total cost of this restructuring is expected to be £77 million, of which a transformation charge of approximately £22 million is included within these results relating to the implementation of the programme, write down of assets, and provisions for onerous leases and severance. The programme will ensure the smooth transition of approximately one million account holders and disposal of redundant infrastructure assets to deliver ongoing cost savings of circa £30 million per annum from 2015/16.

 

Bank levy

 

The £11 million charge in the half year ended 30 September 2013, which is included within administrative expenses, is half of the cost which the Group estimates will arise in respect of chargeable equity and liabilities as at 4 April 2014.

 

Impairment losses

 


Half year to

30 September

2013

£m

Half year to 30 September

2012

£m

Prime residential

(2)

6

Specialist residential

10

20

Residential lending

8

26

Consumer banking

16

38

Retail lending

24

64

Commercial lending

225

193

Other lending

4

1

Impairment losses on loans and advances to customers

253

258

Impairment (gains)/losses on investment securities

(1)

23

Total

252

281

 

Retail impairments have fallen by 63% to £24 million (H1 2012/13: £64 million), driven by a reduction in residential impairments of £18 million and consumer banking of £22 million.

 

Nationwide has maintained a consistent philosophy to retail lending which focuses on prudent underwriting criteria. We ensure high LTV loans are advanced to customers with high credit scores and strong affordability assessments, and a track record of payments or saving. This allows us to offer 95% lending through our Save to Buy scheme and to existing mortgage customers, whilst continuing to manage the overall residential LTV profile of new secured lending.

 

The low residential impairment charge during the period reflects an observed gradual rise in house prices in the six months to 30 September 2013, a low interest rate environment and relatively stable unemployment trends, all of which are offsetting the pressure on household budgets. This is reflected in the arrears performance of our mortgage book which has remained stable over the period and continues to outperform industry averages by a significant margin.

 

The lower consumer banking impairment charge includes a reduction in provisions of £27 million reflecting updated recovery assumptions in respect of defaulted unsecured lending balances in line with recent experience.

 

Commercial loan impairments of £225 million are £32 million (17%) higher than the corresponding first half of 2012/13 but £75 million lower than the charge for the second half of 2012/13 (H2 2012/13: £300 million). After adjusting for a management overlay of £50 million recognised in the second half of last year, the charge for the current period is moderately lower than the previous six months reflecting relatively consistent market conditions and portfolio performance over the last year. This stabilisation in performance is welcome but represents only a first step towards a recovery in valuations over the medium term.

 

The UK economy has now had three consecutive quarters of positive growth and there are some signs of increased liquidity and investor appetite for CRE assets. In addition there is anecdotal evidence of recovery sentiment spreading beyond London and the South East to regional markets. Performance is, however, variable and the established trend of more resilient London and prime property markets performing more strongly than secondary properties in regional locations continues to be a dominant feature of the market.

 

Our strategy remains one of optimising value recovery from the portfolio over the medium term. We expect to make substantial progress towards divestment of underperforming assets and loans which are outside current risk appetite over a 3-5 year timeframe; the reduction in gross balance sheet exposure over the last 18 months of 18% indicates that this is a realistic target.

 

Impairments continue to be driven by a range of factors including weak tenant demand, tenant failure or maturity, withdrawal of equity sponsor support on weaker cases and property obsolescence necessitating capital investment prior to re-letting. Impairment losses in the period are attributable to both new provisions on maturing facilities typically originated in the 2005-2008 period, together with some additional provisions on restructured cases where asset management strategies have proved unsuccessful or collateral values have been eroded further for other reasons. To the extent that property prices have now stabilised we expect to be less exposed to the requirement for additional provisions on impaired cases. We have previously indicated that we expect impairment losses on our CRE portfolio to continue to accrue at levels broadly consistent with our experience in our 2012/13 financial year for a period of 1-2 years before improving thereafter. Our experience in the first half of 2013/14 has been consistent with this expectation.

 

The charge for the period includes a release in the collective provision against unidentified impairment of £10 million driven by a reduction in the management overlay, reflecting our view that the inherent uncertainty relating to market conditions has moderated slightly.

 

The other lending charge of £4 million (H1 2012/13: £1 million) relates to the impairment charge arising on a European commercial loan portfolio.

 

Impairment  writebacks on investment securities of £0.7 million (H1 2012/13: £23 million charge) comprise a loss of £1.5 million mainly on a single US collateralised debt obligation security, offset by impairment write backs of £2.2 million in relation to two assets sold in the period.

 

Underlying provisions for liabilities and charges

 


Half year to

30 September

2013

£m

Half year to

30 September

2012

£m

Underlying provisions for liabilities and charges - customer redress

71

45

FSCS

-

(6)

Statutory provisions for liabilities and charges

71

39

 

In light of a review of compliance with consumer credit legislation being undertaken across the industry, we are undertaking a comprehensive review of our own documentation and processes. A number of areas which require further enquiry have been identified and whilst our investigations are still at a relatively early stage, we have recognised a charge in the current period of £71 million in respect of potential costs in relation to matters which may require remediation. Our findings to date have not revealed any customer detriment.

 

The charge for the half year to 30 September 2012 was in respect of PPI, further details of which are provided in note 9. Based on latest experience in relation to PPI claims volumes and the average level of settlements, the Group is satisfied that no further provision for losses is required at 30 September 2013.

 

Nationwide pays levies to the FSCS based upon its share of protected deposits. There has been no charge raised for FSCS in the period to 30 September 2013 as the levy is applied to firms who are members of the scheme on 31 December in respect of the year commencing on the following 1 April. A charge for the 2014/15 scheme year will therefore be recognised in the second half of our current financial year.

 

The Group also has a potential exposure to future levies resulting from the failure of the Dunfermline Building Society. The quantification and timing of such losses has yet to be determined and hence no provision has been recognised. Further information is provided in note 9.

 

Taxation   

 

The tax charge in the period to 30 September 2013 is £36 million on profits of £270 million (H1 2012/13: credit of £17 million in respect of profits of £103 million), giving a tax rate of 13%. This is below the statutory rate of 23% for two main reasons. Firstly, progress was made during the year on an outstanding tax matter relating to prior periods, resulting in a release of excess provisions of £13 million at the half year. Secondly, following a change in the corporation tax rate which has been substantially enacted, from 23% to 21%, from 1 April 2014, the Group has restated its deferred tax balances to 21%. This has resulted in a credit to the income statement of £14 million. Excluding the effects of these two items, the Group's tax rate is 24%, compared to a statutory rate of 23%.

 

 

BALANCE SHEET 

 

Loans and advances to customers 

 

Lending remains predominantly concentrated on high quality secured products, with residential mortgages accounting for 86.0% of our total loans and advances to customers (2012/13: 85.0%).

 

Loans and advances to customers

30 September 2013

4 April 2013

£bn

%

£bn

%

Prime residential mortgages

115.7

70.4

110.6

69.4

Specialist residential mortgages

25.6

15.6

25.0

15.6

Total residential mortgages

141.3

86.0

135.6

85.0

Commercial lending

19.1

11.6

19.9

12.5

Other lending

0.2

0.1

0.4

0.3

Consumer banking

3.7

2.3

3.5

2.2

Gross balances

164.3

100.0

159.4

100.0

Impairment provisions

(1.4)

(1.2)

Fair value adjustments for micro hedged risk

1.0

1.4

Total

163.9

159.6

 

Residential

 

Prime residential mortgages are primarily Nationwide branded advances made through our branch network and intermediary channels.

 

Specialist residential mortgages are made up of £23.0 billion of advances made through our specialist lending brands, TMW and UCB Home Loans Corporation Limited (UCB), and £2.6 billion arising from the acquisitions of the Derbyshire, Cheshire and Dunfermline portfolios in prior years. Buy to let mortgages make up 82% of total specialist lending, 12% relates to self-certification mortgages, 4% relates to near prime and just 2%, amounting to £0.4 billion, relates to sub prime. New specialist lending is restricted to buy to let mortgages.

 

Arrears as a percentage of the total book have continued to reduce on both Prime and Specialist mortgages as a result of continued reducing arrears volumes and strong book growth. Group arrears performance remains very favourable relative to the Council of Mortgage Lenders (CML) industry average, and specialist lending arrears are below the overall industry measure as seen in the table below.

 

Cases more than 3 months in arrears as % of total book

30 September 2013

%

4 April

2013

%

Prime

0.51

0.53

Specialist

1.73

1.75

Group

0.70

0.72

CML Industry Average

1.75

1.89

 

Total residential balance sheet provisions have reduced to £136 million, compared with £165 million at 4 April 2013, driven primarily by increasing house prices and improving arrears. This combined with a 4% book growth has reduced the coverage ratio against total balances to 0.10% (2012/13: 0.12%) and against balances more than three months in arrears to 10.9% (2012/13: 12.8%).

 

We maintain close relationships with customers experiencing financial difficulties and work with them to agree the most appropriate course of action. In the case of short term difficulty, we will seek to agree revised payment schedules with the customer, which may include a reduction to the contractual monthly payment due. Further information regarding change in terms and forbearance is provided within the retail section of the Risk Management Report.

 

Strong property sales and a continued reduction in the intake of possessions have led to the number of properties in possession continuing to fall significantly to 444 at 30 September 2013 (4 April 2013: 600). This represents 0.03% of our book, which compares well with the industry measure of 0.09%. The table below shows possessions as a percentage of book.

 

 

Possessions as % of total book
(number of properties)

30 September 2013

 

4 April 2013

 

Number of properties

%

%

Prime

186

0.02

0.02

Specialist

258

0.11

0.18

Group

444

0.03

0.04

Industry statistics

0.09*

0.10

* Based on quarterly data as at 30 September 2013

 

Our approach to dealing with customers in financial difficulties combined with our historically cautious approach to lending, means that we only take possession of properties as a last resort. This is illustrated by comparing the number of properties we have taken into possession with the total for the industry. During the period to 30 September 2013 the properties we have taken into possession has reduced to 518 representing 3.5% (2012/13: 4.6%) of properties taken in by the industry as a whole, against our market share of all residential mortgages of 13.2% (2012/13: 12.8%).

 

Commercial

 

Our commercial lending portfolio of £19.1 billion (4 April 2013: £19.9 billion) comprises £9.5 billion secured on commercial property (Property Finance) (4 April 2013: £10.2 billion), £8.1 billion advanced to registered social landlords (RSL) (4 April 2013: £8.2 billion) and £1.5 billion advanced under Project Finance, principally via the Private Finance Initiative (PFI) (4 April 2013: £1.5 billion).

 

Our Property Finance portfolio is diverse both in terms of sectors and geographic spread. The non-UK element of our commercial property portfolio (excluding secured lending to a European commercial loan portfolio classified as Other lending below) amounted to £0.9 billion (4 April 2013: £1.0 billion) and is principally in Germany with only a single exposure to Ireland.

 

The portfolio is actively monitored for evidence of impairment by reference to a range of factors which include significant financial difficulty of the borrower, payment default, granting of a concession in accordance with the Group's forbearance policies or other circumstances indicating the likelihood of a material change in cashflow expectations. Further information on the Group's forbearance policies is provided within the commercial section of the Risk Management Report.

 

Our exposure to Property Finance is 30% lower than its £13.7 billion peak in 2009, with an 18% reduction in our exposure over the last 18 months. This reflects both scheduled repayments and our active management of our Property Finance loans. Nationwide uses a range of options to reduce its exposure including equity injections from sponsors, restructures with increased amortisation, and full redemption where possible for maturing loans. Refinancing and longer term asset management plans are used where necessary and appropriate, for example where loans are supported by better quality properties.

 

The proportion of our Property Finance balances classified as impaired and the provision coverage against these balances are shown below:

 

Property Finance Portfolio

30 September

2013

£m

4 April

2013

£m

Gross balances

9,536

10,192

Impaired balances

3,210

2,715

Impaired balances as % of gross balances

34%

27%

Commercial provisions

  Individual

965

810

  Collective

138

148

Total provisions

1,103

958

Provision coverage ratios

  Individual provisions as % of impaired balances

30%

30%

  Total provisions as % of impaired balances

34%

35%

  Total provisions as % of total gross balances

12%

9%

 

Impaired balances at 30 September 2013 amounted to £3,210 million (4 April 2013: £2,715 million). All provisions are reassessed at least once every six months and will incorporate any change to our exit strategy or expected cashflow, for example from updated valuations, withdrawal of equity sponsor support or tenant maturities/failures. This reassessment process, together with the impairment drivers referred to in the impairment losses section of the Business Review, has driven this increase in impaired balances.

 

Provisions held against the portfolio amounted to £1,103 million (4 April 2013: £958 million) representing a coverage ratio of 34% (4 April 2013: 35%). The stable coverage ratio reflects, in part, the recent stabilisation of commercial property values. In addition, estimated (indexed) collateral values for impaired balances amounted to £2,296 million (72% of impaired balances) at 30 September 2013 and £1,743 million (64% of impaired balances) at 4 April 2013. This further improves the relative strength of our total coverage (collateral and provision) from 99% at 4 April 2013 to 106% at 30 September 2013.

 

Nationwide's strategy is to continue to rebalance its commercial property exposure by exiting non-performing loans and to maintain a lower proportion of the Group's balance sheet in this asset class. Against the backdrop of stabilised market conditions and satisfactory returns available on new assets, we will carry out measured new lending in line with our reduced risk appetite.

 

Our strategic objective to undergo a managed divestment of the book is being achieved by using a variety of approaches including asset sales, refinances and loan sales to take advantage of increased liquidity and any sustained improvement in market sentiment. Since the period end we have seen further repayments and disposals of Property Finance exposures amounting in total to £442 million at prices in line with their carrying values as recorded at 30 September 2013. This has reduced the gross exposure on the Property Finance book at the date of this report to approximately £9.1 billion. This includes the disposal of approximately £200 million of loans classified as weak or in default. We expect to see further significant progress in asset disposals over the remainder of the financial year.

 

Other lending

 

Other lending includes £209 million (4 April 2013: £219 million) of secured lending relating to a European commercial loan portfolio and a loan secured by a senior ABS reference portfolio. These investments were acquired by the Treasury Division and are therefore held within the head office functions business segment.

 

The Group's unsecured lending in relation to a student loan portfolio was sold on 24 April 2013 (4 April 2013: £217 million).

 

Consumer banking

 

During the period to the 30 September 2013, the provisioning assumptions for unsecured products have been updated to reflect expected recoveries on delinquent balances based on recent past experience. As a consequence of this change, the point of full write off of the loan is also being deferred, resulting in higher reported delinquent balances without any deterioration in the quality of the book.

 

30 September 2013

    Delinquent 

balances

30 September 2013

Balances before provisions

30 September 2013

Delinquent to total*  

4 April

2013

Delinquent to total

£m

£m

%

%

FlexAccount (overdraft balances)

 35

 206

17

10

Personal loans

78

1,916

4

3

Credit cards

75

1,520

5

3

 

* Without the change referred to above, delinquent balances as a proportion of total balances would have been reported as 13%, 3% and 3% respectively for current accounts, personal loans and credit cards.



CAPITAL STRUCTURE  

 

Capital is held by the Group to protect its depositors, to cover its inherent risks, to provide a cushion for unexpected losses and to support the development of the business. In assessing the adequacy of its capital resources Nationwide considers its risk appetite, the material risks to which the Group is exposed and the appropriate strategies required to manage those risks.

 

The Group is required to manage its capital in accordance with prudential rules issued by the PRA, and from 1 January 2008 the Group has also complied with the rules which implement the EU Capital Requirements Directive (Basel II). Since 4 April 2009 the Group has predominantly calculated its capital requirement on an Internal Ratings Based (IRB) approach.

 

The table below details the capital position as at 30 September 2013:


30 September 2013

Basel II

£m

 4  April

2013

Basel II

£m

General reserve

6,842

6,765

Regulatory adjustments and deductions (Note 1):

·      Defined benefit pension fund adjustment (Note 2)

416

263

·      Intangible assets (Note 3)

(904)

(878)

·      Goodwill (Note 3)

(12)

(16)

·      Excess of regulatory expected losses over impairment (Note 4)

(381)

(429)

·      Securitisation positions (50%)

(110)

(245)

·      Other (50%)

-

(6)

(991)

(1,311)

Core Tier 1 capital

5,851

5,454

Permanent interest bearing shares (Note 5)

631

1,304

Tax in respect of expected loss excess over impairment

114

136

Total Tier 1 capital

6,596

6,894

Dated subordinated debt (Note 5)

2,125

2,281

Revaluation reserve

68

67

Collectively assessed impairment allowances

29

70

Deductions:

·      Excess of regulatory expected losses over impairment

(494)

(565)

·      Securitisation positions (50%)

(110)

(245)

·      Other (50%)

-

(6)

(604)

(816)

Tier 2 capital

1,618

1,602

Total regulatory capital

8,214

8,496

Risk weighted assets (Note 6):

£m

£m

Credit risk:

·      Retail mortgages

15,571

16,953

·      Retail unsecured lending

6,659

6,485

·      Commercial loans

12,132

13,643

·      Treasury

1,976

2,526

·      Counterparty credit risk

252

276

·      Other

1,101

1,107

Total credit risk

37,691

40,990

Operational risk

3,398

3,398

Market risk

7

52

Total risk weighted assets

41,096

44,440

 


30 September 2013

Basel II

 4  April

2013

Basel II

Key capital ratios (Note 7):

%

%

Core Tier 1

14.2

12.3

Tier 1

16.1

15.5

Total capital

20.0

19.1

 

Notes

(1)  Certain deductions from capital are required to be allocated to Tier 1 and to Tier 2 capital. Deductions are subject to different treatment under IRB in respect of net expected loss over accounting provisions and certain securitisation positions. These are calculated in accordance with PRA guidance.

(2)  The regulatory capital rules allow the pension fund deficit to be added back to regulatory capital and a deduction taken instead for an estimate of the additional contributions to be made in the next five years, less associated deferred tax.

(3)  Intangible assets and goodwill do not qualify as capital for regulatory purposes.

(4)   For capital purposes a deduction is made for future expected losses in addition to incurred losses, calculated using IRB guidelines.

(5)  Permanent interest bearing shares and subordinated debt include fair value adjustments related to changes in market interest rates, adjustments for unamortised premiums and discounts that are included in the consolidated balance sheet, and any amortisation of the capital value of lower Tier 2 instruments required by regulatory rules for instruments with less than five years to maturity.

(6)  The Basel II Pillar 1 capital requirements (risk weights) are calculated using the Retail IRB approach for mortgages (other than those originated by the Derbyshire, Cheshire and Dunfermline societies) and unsecured lending, Foundation IRB for treasury and commercial portfolios (other than sovereign exposures), and the Standardised approach for all other credit risk exposures, including some mortgages and treasury and commercial exposures that are exempt from using the IRB approach.

(7)  Solvency ratios are calculated as relevant capital divided by risk weighted assets.

 

The table below shows movements in capital since 5 April 2013:

 

£m

Core Tier 1 capital at 5 April 2013

5,454

Profit for the period

234

Other comprehensive expenses recognised directly in the general reserve

(157)

Pension deficit adjustment

153

Intangible assets and goodwill

(22)

Excess of expected loss over impairment

48

Securitisation and other positions

141

Core Tier 1 capital at 30 September 2013

5,851

Other Tier 1 capital at 5 April 2013

1,440

Buy back of permanent interest bearing shares

(485)

Fair value adjustments

(188)

Tax on excess of expected loss over impairment

(22)

Other Tier 1 capital at 30 September 2013

745

Total Tier 1 capital at 30 September 2013

6,596

Tier 2 capital at 5 April 2013

1,602

Amortisation

(53)

Fair value adjustments

(103)

Revaluation reserve

1

Collectively assessed impairment allowances

(41)

Excess of regulatory expected loss over impairment

71

Securitisation and other positions

141

Tier 2 capital at 30 September 2013

1,618

Total regulatory capital at 30 September 2013

8,214

 

The growth in Core Tier 1 capital is due to an increase in profits of £234 million and a decrease in capital deductions. Capital deductions have decreased as a result of the sale of securitisation assets, and increased commercial provisions which have reduced the level of expected loss over impairment deduction. The movement in the general reserve primarily relates to an actuarial reassessment of the defined benefit pension fund which is offset in capital terms by the pension deficit adjustment.

 

Total capital decreased by £0.3 billion to £8.2 billion (4 April 2013: £8.5 billion) reflecting the buy back of £485 million of Permanent Interest Bearing Shares in September 2013 which contributes to the decrease in the fair value adjustments of £188 million.

 

Nationwide uses the IRB approach to calculate its capital requirements for most of its exposure classes and the standardised approach for some other classes. The following table shows the Pillar 1 capital requirement for credit risk at 30 September 2013:

 

30 September 2013

4 April

 2013

£m

£m

Internal Ratings Based (IRB) exposure classes

Institutions

42

52

Corporates (commercial lending)

937

1,064

Retail mortgages (Note 1)

963

464

Qualifying revolving retail

311

310

Other retail (unsecured loans)

222

208

Securitisation positions

78

112

Non-credit obligation assets (fixed assets and other)

88

89

Counterparty credit risk (derivatives)

20

22

2,661

2,321

Standardised exposure classes

Central governments & central banks (Note 2)

-

-

Regional governments & local authorities

1

1

Multilateral development banks (Note 2)

-

-

Corporates (Non Commercial)

11

14

Retail mortgages (secured against residential property) (Note 1)

253

830

Other retail (Note 3)

-

-

Commercial lending (secured against property)

16

13

Commercial lending (other)

16

12

Past due

48

81

Other

9

7

354

958

Total

3,015

3,279

 

Notes

(1)  During the period the Specialist residential mortgage portfolio was moved from a Standardised basis to IRB; this has resulted in a switch               from Standardised risk weightings to IRB risk weightings as shown above.
(2)  Nationwide's exposures to central banks and governments and multilateral development banks are zero risk weighted.
(3)  The capital requirement for 'Other' retail is immaterial.


The table below shows movements in credit risk Risk Weighted Assets (RWAs) since 5 April 2013.

 

Credit risk RWA flow statement

 


Residential Mortgages

Unsecured lending

Commercial

Treasury

Other (Note 1)

Counterparty credit risk

(Note 2)

Total

£m

£m

£m

£m

£m

£m

£m

RWAs at

5 April 2013

16,953

6,485

13,643

2,526

1,107

276

40,990

Book size   growth/(reduction)

794

64

(541)

(464)

(6)

(2)

(155)

Book quality (improvement)/

deterioration

(577)

110

(970)

(86)

-

(22)

(1,545)

Model updates

(1,599)

-

-

-

-

-

(1,599)

RWAs at

30 September 2013

15,571

6,659

12,132

1,976

1,101

252

37,691

 

Notes

(1)   'Other' relates to fixed and other assets held on the balance sheet

(2)   'Counterparty credit risk' relates to derivative financial instruments

 

Credit risk RWAs have decreased to £37.7 billion (4 April 2013: £41.0 billion). Nationwide's mortgage and unsecured lending has continued to grow, resulting in increased book sizes. In addition Nationwide's house price index has increased since 4 April 2013, improving 'loan to value' ratios and consequently the quality of the mortgage book.

 

The model update adjustment reflects the fact that since August 2013 the capital requirements for 'Buy to Let' and 'Self Certified' mortgages generated by Nationwide's specialist lending subsidiaries have been calculated using the IRB approach. They were previously measured under the Standardised approach; this has resulted in an overall decrease in RWAs for mortgages. Under the IRB approach there is an offsetting adjustment to capital resources for expected losses.

 

Continued management of the Commercial portfolio has resulted in a reduction of the book size; the movement in book quality is driven by assets moving into default due to the challenging conditions in the commercial property markets which results in a switch from risk weighted assets to expected loss deductions.

 

Active Treasury portfolio management, through the sale and run off of securitisation assets, has resulted in a reduction of RWAs to £2.0 billion (4 April 2013: £2.5 billion).

 

Capital position on a CRD IV basis

 

The final text of the Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR) (known together as 'CRD IV') was published on 27 June 2013, for implementation from 1 January 2014. The European Banking Authority (EBA) is in the process of releasing a number of technical standards to provide further detail on specific parts of CRD IV. In addition, the PRA published a consultation paper on 2 August 2013 outlining their intended approach to implementing CRD IV in the UK.

 

The most significant changes under CRD IV are:

·      Additional deductions will apply to capital resources

·     Most existing Tier 1 and Tier 2 instruments will no longer be eligible as own funds. Their eligibility will be reduced over a phased implementation period

·      Firms will need to hold a higher quantity of Common Equity Tier 1 (CET1) capital than under the existing regulations.

In the UK, the PRA is proposing to:

·      Accelerate the implementation of CET1 deductions to apply in full from 1 January 2014

·      Potentially increase firms' CET1 requirements above the levels in CRD IV, with additional requirements phased in during the period 2014-2018. 

The table below sets out estimated CRD IV ratios as at 30 September 2013, based on our current understanding of the regulation and reconciles the accounting capital to both transitional and full impact capital positions as if 2013/14 is 'year 1' of the transitional period. Accounting capital consists of the general reserve, revaluation reserve and available for sale reserve as shown on the balance sheet. The table shows how these items are represented for regulatory purposes. The transitional measure is based on the PRA consultation paper CP5/13 which states that there will be no transitional provisions for the deductions from capital. Therefore this column is not directly comparable with Table 3 in our 2013 Pillar 3 disclosure which assumed there would be a transitional approach to these items. Our actual ratios under CRD IV may differ as further technical standards and policy statements clarify the detailed requirements.

 

Nationwide's CET1 capital ratio has increased from 9.1% on 4 April 2013 to 11.0% on 30 September 2013. This is due to:

·      An increase in CET1 resources, due to increased reserves from profitability in the period and a reduction in the deduction for expected losses

·      Reduced RWAs, primarily in the specialist lending, commercial and treasury portfolios due to a combination of model changes, asset disposals and the migration of commercial assets moving into the default slotting grade, resulting in a switch from risk weighted assets to expected loss deductions.

·      These were partially offset by a change in the capital treatment of securitised assets rated lower than BB-, where from 1 January 2014 Nationwide intends to risk weight these assets at 1250% as opposed to deducting them from capital resources. This change is applied in the transitional and fully-loaded CET1 capital ratios in the CRD IV table.

 

Common Equity Tier 1 (CET1)

Current rules

Transitional

 

Full

impact

Full

 impact

30 Sept 2013

30 Sept

2013

30 Sept

2013

4 April

2013

£m

£m

£m

£m

General reserve

6,842

6,842

6,842

6,765

Revaluation reserve

-

-

68

67

Available for sale reserve

-

(163)

(163)

(252)

Regulatory adjustments:

  Prudential Valuation Adjustment

-

(9)

(9)

(13)

  Defined benefit pension fund adjustment

416

-

-

-

CET1 deductions:

  Intangible assets and goodwill

(916)

(869)

(869)

(837)

  Securitisation positions

(110)

-

-

-*

  Excess of expected losses over impairments

(381)

(988)

(988)

(1,130)

  Other

-

-

-

(12)

Total Common Equity Tier 1 capital

5,851

4,813

4,881

4,588

Additional Tier 1 (AT1)

Permanent interest bearing shares

631

631

-

-

Tax in respect of expected losses over impairments

114

-

-

-

Total Tier 1 capital

6,596

5,444

4,881

4,588

Tier 2

Revaluation reserves

68

-

-

-

Collectively assessed impairment allowances

29

36

36

92

Dated subordinated debt

2,125

2,125

1,924

1,972

Tier 2 deductions:

  Securitisation deductions

(110)

-

-

-

  Excess of expected losses over impairments

(494)

-

-

-

Total Tier 2 capital

1,618

2,161

1,960

2,064

Total capital

8,214

7,605

6,841

6,652

Current RWAs

41,096

41,096

41,096

44,440

Additional CRD IV RWAs

3,135

3,135

5,845

Total RWAs under CRD IV

44,231

44,231

50,285

Total exposure for Leverage Ratio

212,013

211,449

211,449

207,668

CET 1 Ratio

14.2%

10.9%

11.0%

9.1%

Leverage Ratio

3.1%

2.6%

2.3%

2.2%*

Leverage Ratio with PIBS included

2.6%

2.8%

 

*From 1 January 2014, Nationwide intends to change the treatment of securitisation assets rated lower than BB-, which will be risk-weighted as opposed to deducted from capital. This change is applied in the transitional and fully-loaded CET1 capital ratios above and results in a restatement of the leverage ratio to 2.2% from 2.0% as at 4 April 2013.

 

A reconciliation of total assets as disclosed in the balance sheet to the leverage ratio exposure is given in the table below:


Current rules

Transitional

 

Full

impact

Full

 impact

30 Sept 2013

30 Sept

2013

30 Sept

2013

4 April

2013

£m

£m

£m

£m

Total Assets (Balance sheet )

193,332

193,332

193,332

190,718

Mortgage pipeline

5,740

5,740

5,740

4,735

Other committed facilities (Note 1)

12,641

12,641

12,641

12,807

Repurchase agreements (Note 2)

2,397

2,397

2,397

2,941

Netted derivative adjustment

(804)

(804)

(804)

(1,554)

Common Equity and Tier 1 deductions

(1,293)

(1,857)

(1,857)

(1,979)

Leverage ratio exposure

212,013

211,449

211,449

207,668

 

Notes

(1)  Other committed facilities relates to mortgage overpayments and unsecured, commercial and treasury undrawn lending.
(2)  Repurchase agreements includes exposure in relation to the Bank of England's 'Funding for Lending Scheme'.


PRA 'adjusted' ratios

 

As part of its assessment of capital adequacy of major banks and building societies (performed at the request of the FPC, with results announced on 20 June 2013) the PRA introduced certain adjustments to the measurement of CET1 and leverage ratios. This was for the purposes of measuring firms' positions against a CET1 ratio target of 7% and a leverage ratio target of 3%.

 

For Nationwide the adjustments were:

·      A reduction in capital resources of £0.4 billion in respect of estimated future losses on specific loan assets

·      The imposition of a risk weight floor of 15% for residential mortgages resulting in an increase in Nationwide's total RWA's by £10.6 billion as at 31 December 2012.

 

As a result of this exercise Nationwide agreed a plan with the PRA to meet an adjusted leverage ratio of 3% by the end of 2015. As at 30 September 2013 the Group's PRA adjusted CET1 ratio was 8.1%, well in excess of the 7.0% target and our performance in the first half of the financial year means that we remain confident that we will also meet the adjusted leverage target of 3% by the end of 2015.

 

The 30 September 2013 position is shown in the table below:

PRA adjustments

CRD IV

30 September 2013

£m

Common Equity Tier 1 capital

4,881

PRA adjustment

(427)

Adjusted Common Equity Tier 1 capital

4,454

Risk weighted assets

44,231

PRA adjustment

10,602

Total risk weighted assets

54,833

PRA adjusted CET1 ratio

8.1%

PRA adjusted Leverage ratio

2.1%

 

In calculating the PRA adjusted ratios above, Nationwide has treated the adjustments communicated in the announcement of 20 June 2013 as fixed. Application of the risk weight floor of 15% to the Group's residential mortgage book as at 30 September 2013 would increase the PRA adjustment in respect of risk weight assets, leading to a reduction in the PRA adjusted CET1 ratio to 7.9%.

 

Nationwide is on track to meet the capital expectations that the PRA has set. As at 30 September 2013, Nationwide's adjusted CET1 capital ratio is 8.1%, compared with the PRA's 7% target. The adjusted CET1 leverage ratio is 2.1%. Nationwide's capital plan is founded on organic growth, consistent with the Society's current business model and strategy.

 

On 2 August 2013, the PRA published consultation paper CP5/13 which consults on the changes required to implement CRD IV, including the new capital buffer framework, changes to Pillar 2 requirements, and the decision to not allow transitional provisions for the new deductions from capital required by CRD IV. The changes will be clarified and implemented via a Policy Statement in December 2013. Based on our current understanding and a prudent assessment of the impact of CP5/13, Nationwide will continue to meet all regulatory requirements and maintain a robust capital position.

 

Funding and Liquidity

Funding Strategy

 

The Group has a strong and well diversified funding base, and continues to be predominantly funded by retail savings. We have continued to manage our balance sheet actively during the period by accessing a variety of funding sources in response to conditions in both the retail and wholesale markets.

 

The Group aims to align the sources and uses of funding. As such, retail customer loans and advances are largely funded by customer deposits. Other assets including commercial customer loans, core liquidity and other treasury assets are funded by long term wholesale debt and equity.

 

These funding relationships are summarised below as at the balance sheet date:

 

Liabilities

Assets

30 Sept

4 April

4 April

30 Sept

4 April

4 April

2013

2013

2012

2013

2013

2012

£bn

£bn

£bn

£bn

£bn

£bn

Retail funding

136

132

132

Retail lending

141

137

130

Wholesale funding

42

43

49

Other lending

23

23

24

Capital & reserves

10

10

10

Core liquidity

17

17

25

Other

5

6

5

Non-core treasury portfolio

6

7

9

Other

6

7

8

Total

193

191

196

193

191

196

 

We continue to maintain a high quality liquid asset portfolio consisting primarily of deposits at central banks and government bonds. The PRA notified firms of a relaxation to their stance on the definition of assets that count towards the Liquid Asset Buffer (LAB), which now allows a proportion of a firm's regulatory liquidity requirements to be met by collateral pledged with the Bank of England (BoE).

 

In April 2013 the Bank of England extended availability of the Funding for Lending Scheme (FLS) until January 2015 to boost lending to the economy. Nationwide has both supported and participated in the FLS although in terms of volumes has made relatively limited use of the scheme, having drawn £2.5 billion as at 30 September 2013 (4 April 2013: £2.5 billion.)  Subsequent to the period end a further £2.0 billion was drawn down in line with our continued support of the UK housing market. This brings the total amount of the FLS facility used to £4.5 billion as at the date of this report.

 

The core liquidity ratio at 30 September 2013 was 11.1% (4 April 2013: 11.1%).

 

Liquidity

 

Liquidity represents a significant area of risk for financial institutions and, as such, it is a main area of focus for regulatory authorities. The Group continues to enhance and strengthen its liquidity management systems and approach.

 

In December 2010, the Basel Committee on Banking Supervision (BCBS) announced proposals to introduce two new liquidity metrics as part of the implementation of Basel III. These are a short term liquidity stress metric, the Liquidity Coverage Ratio (LCR), and a longer term funding metric, the Net Stable Funding Ratio (NSFR). In January 2013, the BCBS announced revised guidelines in respect of the LCR and confirmed that work continues on the NSFR. On 27 June 2013, the CRR / CRD IV package, which includes requirements for the LCR, was published in the Official Journal of the European Union. The LCR will become a European standard from January 2015 with firms required to have a ratio in excess of 60%, with progressive increases thereafter to 100% by 1 January 2018.

 

The implementation of the LCR in the UK is likely to include a higher requirement following the FPC recommendation in June 2013 to the PRA that the LCR is introduced in the UK with a minimum requirement of 80% until 2015, rising thereafter to a minimum ratio of 100% by January 2018. The NSFR is expected to be implemented from January 2018. These measures are subject to ongoing development so there remains uncertainty as to their final form. In particular, the European Banking Authority (EBA) is still to opine on a number of areas of the LCR calculation and the PRA is to consult on transition arrangements from the current regulatory regime. Nationwide continues to monitor its position relative to the anticipated requirement of both the LCR and NSFR. Based on current interpretations of the requirements, Nationwide holds sufficient high quality liquid assets and stable funding to meet the new requirements.

 

Nationwide ensures sufficient resources are available for day-to-day cash flow needs whilst enabling the Group to meet internal and regulatory liquidity requirements. These requirements are calibrated to ensure the Group has sufficient liquidity resources, both as to amount and quality, to meet financial obligations as they fall due, even in the event of unexpected outflows that could be seen across a range of stress scenarios. Liquid assets are managed centrally by the Treasury Division. All liquidity is held centrally to meet cash outflows seen in any entity across the Group with the exception of a small portfolio of assets held in our Irish branch, Nationwide UK (Ireland) (NUKI). These assets (£143 million sterling equivalent, 4 April 2013: £131 million) are held at NUKI to ensure compliance with local liquidity regulations.

 

The stock of liquid assets managed by Nationwide's Treasury Division falls into the categories listed below.

 

Core Liquidity

 

The Group maintains a high quality core liquidity portfolio through continued investment in highly liquid securities in line with the Liquid Asset Buffer (LAB) as defined by the PRA in BIPRU 12 which comprises:

·      reserves held at central banks; and

·      highly rated debt securities of varying maturities issued by a restricted range of governments, central banks and multilateral development banks.

 

The amount is net of any core liquidity holdings that are encumbered (through repurchase arrangements or other transactions) but includes assets held under reverse repurchase arrangements. It also excludes contingent liquidity capacity available through central bank funding schemes.

 

Other Central Bank Eligible Assets

 

In addition to the core liquidity portfolio, the Group holds a stock of unencumbered third party securities that are eligible for use in the funding operations of those central banks that we have access to. In terms of their relative liquidity characteristics, these assets may be viewed as the next tier below the core liquidity portfolio.

 

Other Securities

 

Nationwide holds other third party assets (such as fixed rate investments) that are not eligible for central bank operations but may be capable of financing through third party repurchase agreements.

 

Self Issued RMBS and Covered Bonds

 

The Group holds undrawn AAA notes issued under the Group's asset backed funding programmes. These self-issued securities represent eligible collateral for use in repurchase agreements with third parties or in central bank operations.

 

Whole mortgage loan pools pledged with the BoE

 

Nationwide holds a number of unencumbered whole mortgage loan pools at the BoE for use as collateral for contingent funding.

 

The table below sets out the fair value of each of the above liquidity types as at 30 September 2013. The table is not a representation of the accounting balance sheet position as it includes off balance sheet liquidity (including self issued RMBS and covered bonds) but excludes any encumbered assets. The carrying value of the liquidity portfolio as per the accounting balance sheet is shown at the end of this Business Review.

 


30 September 2013

£bn

4 April

2013

£bn

Core liquidity*

19.8

19.2

Other central bank eligible assets

1.2

1.4

Other securities

2.3

2.7

Self issued RMBS and covered bonds

14.0

14.0

Whole mortgage loan pools pledged with the BoE

1.2

1.4

Total

38.5

38.7

 

The table below sets out the sterling equivalent of the liquidity portfolio categorised by issuing currency.

 

At 30 September 2013

GBP

£bn

EUR

£bn

USD

£bn

Total

£bn

Core liquidity*

17.7

1.4

0.7

19.8

Other central bank eligible assets

-

1.2

-

1.2

Other securities

0.5

0.5

1.3

2.3

Self issued RMBS and covered bonds

14.0

-

-

14.0

Whole mortgage loan pools pledged with the BoE

1.2

-

-

1.2

Total

33.4

3.1

2.0

38.5

 

At 4 April 2013

GBP

£bn

EUR

£bn

USD

£bn

Total

£bn

Core liquidity*

16.8

1.6

0.8

19.2

Other central bank eligible assets

0.1

1.3

-

1.4

Other securities

0.6

0.6

1.5

2.7

Self issued RMBS and covered bonds

14.0

-

-

14.0

Whole mortgage loan pools pledged with the BoE

1.4

-

-

1.4

Total

32.9

3.5

2.3

38.7

 

*Core liquidity includes off balance sheet items, primarily treasury bills held through FLS participation.

The average month end balance for core liquidity during the 6 months to 30 September 2013 was £20.0 billion.

 

Wholesale funding

 

An analysis of the Group's wholesale funding (made up of deposits from banks, other deposits and debt securities in issue as disclosed on the balance sheet) is set out in the table below:

 

Wholesale funding mix

30 September 2013

4 April 2013

£bn

%

£bn

%

Repo and other secured arrangements

1.0

2.4

1.2

2.8

Deposits, including PEB balances

9.4

22.2

8.7

20.0

Certificates of deposit

3.3

7.8

3.8

8.8

Commercial paper

4.0

9.5

4.0

9.2

Covered bonds

11.3

26.8

11.4

26.3

Medium term notes

4.3

10.2

4.7

10.8

Securitisations

7.3

17.3

7.6

17.5

Other

1.6

3.8

2.0

4.6

Total

42.2

100.0

43.4

100.0

 

The table below sets out an analysis of the currency composition of the Group's wholesale funding: 

 

30 September 2013

USD

£bn

EUR

£bn

GBP

£bn

Other

£bn

Total

£bn

Repo and other secured arrangements

-

-

1.0

-

1.0

Deposits

0.3

1.1

8.0

-

9.4

Certificate of deposit

0.3

0.2

2.8

-

3.3

Commercial paper

3.5

0.5

-

-

4.0

Covered bonds

-

9.4

1.7

0.2

11.3

Medium term notes

1.0

2.1

1.0

0.2

4.3

Securitisations

3.8

0.9

2.6

-

7.3

Other

0.1

0.8

0.7

-

1.6

Total

9.0

15.0

17.8

0.4

42.2

 

4 April 2013

USD

£bn

EUR

£bn

GBP

£bn

Other

£bn

Total

£bn

Repo and other secured arrangements

-

0.2

1.0

-

1.2

Deposits

0.2

1.1

7.4

-

8.7

Certificate of deposit

0.2

0.1

3.5

-

3.8

Commercial paper

3.4

0.4

0.2

-

4.0

Covered bonds

-

9.4

1.7

0.3

11.4

Medium term notes

1.0

2.3

1.2

0.2

4.7

Securitisations

4.1

0.9

2.6

-

7.6

Other

0.1

1.1

0.8

-

2.0

Total

9.0

15.5

18.4

0.5

43.4

 

During the first half of 2013/14 a combination of strong retail performance, low long term maturities and a reduced liquidity requirement has resulted in a minimal long term funding requirement. As a result we have not been active in the long term markets. Additionally, we did not increase our drawings from the FLS scheme during the period. Subsequent to the period end a further £2.0 billion was drawn down in line with our continued support of the UK housing market. This brings the total amount of the FLS facility used to £4.5 billion.

 

Nationwide tendered £715 million of PIBS in September 2013 as part of the Group's capital optimisation strategy. This resulted in the Group redeeming £485 million of PIBS with the consent of the PRA. The 68% participation rate contributed £124 million to profit in the period with the majority of this attributable to the unwinding of the associated swaps.

 

Short term funding instruments in issue have decreased to £11.3 billion (4 April 2013: £11.5 billion). The average initial term of outstanding short term balances as at 30 September 2013 was 143 days (4 April 2013: 162 days).

 

The residual maturity profile of the Group's wholesale funding portfolio has shown a modest decline from 35 months to 32 months and the proportion of funding that is categorised as long term (>1 year to maturity) has decreased slightly to 60.7% (4 April 2013: 62.2%).

 

The table below sets out the residual maturity of the wholesale funding book:

 

Wholesale funding residual maturity

30 September 2013

4 April 2013

£bn

%

£bn

%

Less than one year

16.6

39.3

16.4

37.8

One to two years

8.3

19.7

7.3

16.8

Two to five years

10.1

23.9

11.8

27.2

More than five years

7.2

17.1

7.9

18.2

Total

42.2

100.0

43.4

100.0

 

The table below sets out a more detailed breakdown of the residual maturity on the wholesale funding book:

 

At 30 September 2013

Maturity of wholesale funding


Not more than one month

Over one month but not more than three months

Over three months but not more than six months

Over six months but not more than one year

Sub-total less than one year

Over one year but not more than two years

Over two years

Total

£bn

£bn

£bn

£bn

£bn

£bn

£bn

£bn

Repo and other secured arrangements

-

-

-

-

-

1.0

-

1.0

Deposits, including PEB balances

3.6

1.4

0.9

0.4

6.3

0.6

2.5

9.4

Certificates of deposit

0.6

1.7

1.0

-

3.3

-

-

3.3

Commercial paper

0.7

2.3

1.0

-

4.0

-

-

4.0

Covered bonds

-

1.7

-

0.1

1.8

1.7

7.8

11.3

Medium term notes

-

0.1

0.1

0.2

0.4

1.6

2.3

4.3

Securitisations

0.3

-

-

-

0.3

3.3

3.7

7.3

Other

0.5

-

-

-

0.5

0.1

1.0

1.6

Total

5.7

7.2

3.0

0.7

16.6

8.3

17.3

42.2

Of which secured

0.3

1.7

-

0.1

2.1

6.0

11.5

19.6

Of which unsecured

5.4

5.5

3.0

0.6

14.5

2.3

5.8

22.6

 

At 4 April 2013

Maturity of wholesale funding


Not more than one month

Over one month but not more than three months

Over three months but not more than six months

Over six months but not more than one year

Sub-total less than one year

Over one year but not more than two years

Over two years

Total

£bn

£bn

£bn

£bn

£bn

£bn

£bn

£bn

Repo and other secured arrangements

-

-

0.2

-

0.2

1.0

-

1.2

Deposits, including PEB balances

3.1

1.3

0.9

0.5

5.8

0.1

2.8

8.7

Certificates of deposit

0.8

1.0

1.6

0.4

3.8

-

-

3.8

Commercial paper

1.0

2.0

1.0

-

4.0

-

-

4.0

Covered bonds

-

-

-

1.7

1.7

0.8

8.9

11.4

Medium term notes

-

0.1

-

0.2

0.3

1.6

2.8

4.7

Securitisations

-

-

-

0.4

0.4

3.4

3.8

7.6

Other

0.2

-

-

-

0.2

0.4

1.4

2.0

Total

5.1

4.4

3.7

3.2

16.4

7.3

19.7

43.4

Of which secured

0.2

-

-

2.1

2.3

5.5

14.1

21.9

Of which unsecured

4.9

4.4

3.7

1.1

14.1

1.8

5.6

21.5

 

External Credit Ratings

 

Our short and long term credit ratings from the major rating agencies as at 14 November 2013 are as follows:

 


Long Term

Short Term

Subordinated

Date of last rating action/confirmation*

Standard & Poor's

A

A-1

BBB

August 2013

Moody's

A2

P-1

Baa1

October 2013

Fitch

A

F1

A-

September 2013

 

* The outlook for Moody's and Fitch is Stable; the outlook for Standard & Poor's is Negative.

 

Treasury asset quality

 

Group treasury assets at 30 September 2013 were £23.5 billion (4 April 2013: £23.8 billion) and are held in two separate portfolios: the core liquidity portfolio and the non-core portfolio. At 30 September 2013, the core liquidity portfolio totalled £17.4 billion (4 April 2013: £16.9 billion), with the non-core portfolio totalling £6.1 billion (4 April 2013: £6.9 billion).

 

The quality and liquidity of treasury assets has been maintained with over 74% of the total portfolio held in core liquidity exposures (4 April 2013: 71%). 98% of the total portfolio is rated A or better, with 86% rated AA or above (4 April 2013: 97% rated A or better, 85% rated AA or above).

 

We retain £0.8 billion of securities within the non-core portfolio domiciled in the "peripheral" Eurozone countries. Of the £0.8 billion, 40% is rated AA or above and 66% is rated A or above. This exposure has reduced by 27% in the 6 months to 30 September 2013 (including the impact of exchange rate movements). Further details can be found in the 'Country exposures' section in the Risk Management Report.

 

A monthly review is undertaken of the current and expected future performance of all treasury assets. A governance structure exists to identify and review under-performing assets and highlight the likelihood of future losses. In accordance with the accounting policy on impairment of AFS assets described on page 145 of the 2013 Annual Report and Accounts, assets are impaired where there is objective evidence that current events and/or performance will result in a loss.

 

Additional information on the treasury asset portfolio is disclosed in the Risk Management Report.

 

Available for sale reserve

 

Out of a total of £23.5 billion of assets held in the core liquidity and non-core portfolios, £11.2 billion are held as available for sale (AFS). Under IFRS they are marked to market through other comprehensive income and fair value movements are accumulated in reserves unless impaired, in which case the impairment is charged through the income statement. The non-AFS assets are loans and advances to banks or deposits with the BoE. Of the £11.2 billion of AFS assets, only £81 million are classified as Level 3 (valuation not based on observable market data) for the purposes of IFRS 7.

 

Impairment write backs on investment securities of £0.7 million (H1 2012/13: £23 million charge) comprise an impairment loss of £1.5 million mainly on a single US collateralised debt obligation security offset by £2.2 million of impairment write back in connection with asset disposals during the period. The fair value movement of AFS assets that are not impaired currently has no effect on the Group's profit or its regulatory capital.

 

As at 30 September 2013, the balance on the AFS reserve had improved to £163 million negative, net of tax (4 April 2013: £252 million negative). The improvement in the AFS reserve reflects general market movements and the disposals of non-core portfolio assets resulting in losses which are recognised in the Group's net interest income as shown in the table below.


The table below sets out the carrying value of the core liquidity and non-core portfolios and, where applicable, the associated cumulative AFS reserve.

 

             30 September 2013

           4 April 2013


Carrying value on balance sheet

Cumulative

AFS reserve

 

 

Carrying value on balance   

 sheet           

Cumulative AFS reserve

     

£bn

£bn

£bn

£bn

Cash

9.7

-

7.9

-

Gilts

4.9

 (0.3)

5.6

(0.7)

Non-domestic government bonds

1.9

-

2.3

(0.1)

Supranational bonds

0.8

-

1.0

(0.1)

US Medium term notes

0.1

-

0.1

-

Core liquidity portfolio total

17.4

(0.3)

16.9

(0.9)

Loans and advances to banks

2.5

-

2.5

-

Residential mortgage backed securities (RMBS)

1.3

0.1

1.6

0.3

Commercial mortgage backed securities (CMBS)

0.3

0.1

0.4

0.1

Covered bonds

0.5

-

0.6

-

Collateralised loan obligations (CLO)

0.6

-

0.7

-

Financial institutions bonds

0.2

-

0.3

-

US student loan

0.4

-

0.5

-

Other investments

0.3

-

0.3

-

Non-core portfolio total

6.1

0.2

6.9

0.4

Positive AFS reserve before hedge accounting and taxation

-

(0.1)

-

(0.5)

Hedge accounting adjustment for interest rate risk

-

0.4

-

0.9

Taxation

-

(0.1)

-

(0.1)

Total

23.5

0.2

23.8

0.3

 

 

Risk Management Report

Contents

 

Pages

Risk overview

35

Enterprise risk management framework

36

Risk culture

36

Risk categorisation

37

Top and emerging risks

37

Lending risk

39

Financial risk

63

Operational risk

71

Customer and compliance risk

72

 


Risk overview

 

Robust management of the risks inherent in running our business is at the heart of safeguarding our members' interests and delivering a sustainable business model. Our day to day business activities, whether they are offering a range of product choices, making sound lending decisions or managing our balance sheet effectively all require effective management of risk.

 

The chart below is designed to provide a high-level guide about how the Group's business activities are reflected in our risk measures. The regulatory capital risk weightings below indicate the relative risks each area carries.

 

 


Nationwide Group

 


Retail

Commercial

Head office (including Treasury)

 

·  Prime residential lending

·  Specialist residential lending

·  Consumer banking

·  Savings products

·  Insurance

·  Investments

 

·  Commercial lending business

·  Savings products

 

·  Treasury including funding, liquidity and market risk management

·  Head office functions

·  Central support functions

 

                             £m

Credit risk          22,230

Operational risk   3,014 

Market risk                  -

 

                             £m

Credit risk          12,132

Operational risk      136

Market risk                  -

                             £m

Credit risk            3,329

Operational risk      248

Market risk                  7

 

 

 

Whilst the Group accepts that all of our business activities involve risk, we seek to protect our membership by managing the risks that arise from our activities appropriately. The principal risks inherent within the business are:

 

·      financial risk (liquidity and funding, solvency, market, pension risks)

·      lending risk (retail, commercial, treasury)

·      operational risk (including transformation risk)

·      customer and compliance risk, and,

·      strategic risk.

 

Enterprise risk management framework

 

The Group manages risks within an enterprise risk management framework (ERMF) and has continued to strengthen its risk management frameworks and controls during the half year. ERMF applies to the Group including all trading divisions and subsidiaries. For further details regarding our ERMF structure please see the Risk Management Report in the 2013 Annual Report and Accounts.

 

In September 2013, the Group appointed Julia Dunn as Chief Compliance Officer (CCO) with responsibility for compliance and oversight of the customer and compliance risks for the Group. The Chief Risk Officer (CRO) has responsibility to oversee all risks for the Group. Both the CCO and CRO report to the Chief Executive Officer.

 

As part of the annual ERMF governance review completed in March 2013, a number of changes to the risk committee structure were agreed and implemented at the start of the current financial year:

·      The creation of a first line Operational Risk Committee under the chairmanship of the Chief Operating Officer. This committee replaced the previous Operational Risk Oversight Committee.

·      The Group Risk Oversight Committee has been renamed the Group Risk and Compliance Committee (GRCC) with enhanced focus on compliance matters. The GRCC continues to be chaired by the CRO, with the CCO as deputy chair and the Group Risk Director and Director of Compliance Oversight as committee members.

·      The composition and chairmanship of the existing risk committees has been revisited.

 

For further details regarding the Group's risk governance structure please see of the Risk Management Report in the 2013 Annual Report and Accounts.  

 

A "risk roadmap" has been developed setting out developments to ERMF for the current financial year and through to 2015/16. The risk roadmap explains the Group's vision for the future of risk management covering key areas of focus and explaining why risk management is a key component of the Group's Corporate Plan.

 

Further development work in customer and compliance risk has resulted in a re-grouping of risk categories. These are detailed in the Customer and Compliance Risk section.

 

Risk culture

 

Within the Group, risk culture continues to be defined as "the values, beliefs, knowledge and understanding about risk and the management of risk, advocated by the Board, shared and adopted by employees within the organisation". This risk-focused 'tone from the top' is supported by appropriate levels of resource with the necessary skills.

 

The risk culture therefore sets out:

·      our approach to maintaining a strong risk culture for the Group

·      the risk culture statements to which all directors and staff are committed

·      required ('do') and prohibited ('don't') behaviours at enterprise level.

 

The risk culture statements are grouped under four headings:

·      shared understanding and attitude

·      clear communication

·      effective risk teams, and

·      highest standards.

 

Through the understanding of these statements, the aim is to ensure that all staff are risk aware, communicate effectively about risk, and work together to recognise, manage and mitigate risk. In the final quarter of the year, a survey is undertaken to assess the effectiveness of the risk culture in the Group, the results of which feed both the Board Risk Committee and the objectives for the Risk Management Division for the next financial year.

 

Training in risk control self-assessment has been rolled out to Risk Governance and Control departments over recent months and a comprehensive, more detailed re-assessment of risk controls is underway for the remainder of the financial year.

 

Risk categorisation

 

As set out in the 2013 Annual Report and Accounts the Group has five principle risk categories namely: Lending; Financial; Operational; Customer and Compliance and Strategic risk. Our updated assessment of these and our top and emerging risks are set out below. It should be noted that there have been no material changes to the Group's strategic risks since year end. As a result, no further discussion of the strategic risks faced by the Group is included below. For further information regarding the Group's strategic risks, please see the Risk Management Report in the 2013 Annual Report and Accounts.

 

In addition to these principal categories of risk, model risk (the risk of an adverse outcome as a direct result of weaknesses or failures in the design or use of a model) is managed under a separate framework. This is applied across all risk categories and business areas where models are used and overseen by a dedicated department. The model risk framework ensures effective governance and oversight of models, and that standards are consistently applied.

 

Top and emerging risks

 

The identification, monitoring and management of top and emerging risks that could affect delivery of the Corporate Plan are integral to the Group's strategy for risk management.

 

The Group's top and emerging risks are identified through its risk measurement process and closely tracked throughout the governance structure, both of which were described in full in the Risk Management Report in the 2013 Annual Report and Accounts. A suite of specific metrics is defined to track each of the top and emerging risks and these are reported to the Board and Board Risk Committee.

 

In the 2013 Annual Report and Accounts, the Group considered its top and emerging risks to be:

 

·      Slow growth in the UK economy

·      Eurozone uncertainty

·      Regulatory developments, and

·      Business transformation.

 

These remain our current top and emerging risks and, in addition, a further item has been added in relation to acceleration in UK House Price Growth. These risks are monitored closely as they have the potential to significantly impact the Group's Corporate Plan. An updated assessment of these risks as at 30 September 2013 is set out below.

 

Slow growth in the UK economy

 

The pace of the UK economic recovery is expected to remain subdued by historic standards, with interest rates expected to match this outlook. There are risks that the pace of economic growth could slow further or stall, adversely impacting the hitherto resilient UK labour market and resulting in interest rates remaining lower for longer. Forward guidance from the Bank of England on interest rates has not removed uncertainty about when a rise in base rate may occur. Our assessment is that the potential impact remains in line with the April 2013 view, namely:

 

·      If interest rates remain low for longer, margin pressure may be more protracted, putting pressure on Group profitability and retained earnings.

·      Worsening economic conditions could lead to increased retail loan losses in the medium term due to increased unemployment and falling house prices, as well as commercial loan losses due to increasing tenant failures and falling commercial property values.

·      Worsening economic conditions could result in a prolonged closure of some or all wholesale markets, limiting our funding options and exerting pressure on liquidity positions.

 

Eurozone uncertainty

 

The risk of a Eurozone debt crisis is abating although some residual risk remains of a full breakup or unilateral exit, and there is a non-negligible risk of a hard default happening over the next few years. Such a development could still have significant knock-on effects on other Eurozone member states and hence the value of treasury assets. Our assessment is that the potential impact remains in line with the April 2013 view, namely:

 

·      While the Group's direct exposure to the peripheral Eurozone countries is limited, a break-up could result in significant treasury losses through redenomination of assets and could impact the cost and availability of wholesale funding. Such an event would be significantly more severe in the event of contagion spreading throughout the Eurozone.

 

Regulatory developments

 

The Regulators' expectations and the requirements they set for financial services providers are continually increasing, particularly in the areas of customer conduct, capital requirements and liquidity management. The regulatory developments during the period are largely in line with those outlined in the Risk Management Report in the 2013 Annual Report and Accounts. Whilst we fully expect to be able to meet these developments, the potential impact on the Group is as follows: 

 

·      The plans agreed with the regulator for capital and leverage have the potential to adversely impact our business model, constraining growth or forcing retrenchment. The development of a capital instrument for building societies goes some way to alleviating this concern; however, ultimately our capacity to issue new capital remains at the discretion of investors.

·      Increasing demands to manage two regulators, the potential for overlap or differing requirements as the new bodies continue to establish themselves and increased demands on scarce resources whilst working to adopt new reporting standards.

 

Business transformation

 

As set out previously, we have made significant investment in transforming our products and delivery channels through the implementation of new systems and organisational structures. Whilst this will enable us to provide improved services, the operational complexity of these activities, especially during transition periods increases the risk of system failures or process errors. For example:

 

·      The Group has worked with the Payments Council to create a new current account switching service to make switching easier, faster and more secure for customers.  The Current Account Switch Service is an industry-wide scheme which launched on 16 September 2013; the Group was able to meet the scheme's launch deadline.

·      The Back Book Migration programme is migrating established customers' current accounts to the new banking system which was launched in 2012.  This programme of work will help reduce the operational risks of running concurrent banking platforms. The process of migrating established customers' current accounts was still ongoing as at 30 September 2013.

 

Our assessment is that the potential impact remains in line with the April 2013 view, namely:

 

·      The implementation of new systems and management structures could result in degraded systems or control effectiveness. Failure of critical systems could restrict the Group's ability to provide services to customers.

·      Transformation projects with mandatory deadlines imposed by regulators may expose the Group to unavoidable investment costs and the potential for regulatory sanctions that are not entirely within our control.

 

Acceleration in UK house price growth

 

While at a national level UK house prices remain below their pre-crisis peaks, the pace of house price growth has picked up significantly in recent quarters while wage growth has remained subdued. Given the tendency of asset prices to overshoot, there is a risk that house prices could become detached from fundamental economic factors, leaving them vulnerable to a subsequent correction. Our assessment is that the potential impact is as follows:

 

·      A rise in house prices would improve LTV and to that extent improve the outlook on retail loan losses. However, there is a risk that house price growth will continue to accelerate whilst incomes stagnate stretching affordability metrics. This would leave households more vulnerable to shocks such as unexpectedly early increases in interest rates which could ultimately lead to higher retail loan losses.

 

Lending risk

 

Lending risk is considered by reference to three sub-categories as follows:

 

Risk category

Definition

Retail (secured and unsecured)

The risk that a borrower or counterparty fails to pay the interest or to repay the principal on a loan or other financial instrument within the prime mortgage, specialist lending or personal loan, credit card and banking portfolios.

Commercial

The risk that a borrower or counterparty fails to pay the interest or to repay the principal on a loan or other financial instrument within the commercial lending portfolio.

Treasury

The risk that a borrower or counterparty fails to pay the interest or to repay the principal on a loan or other financial instrument within the treasury liquidity and non-core portfolios.

 

Lending risk includes all aspects of credit risk including concentration risk and extension risk.

 

There have been no material changes to our policies and practices for the management of credit risk as described in the 2013 Annual Report and Accounts.

 

Maximum exposure to credit risk

 

The following tables present the Group's maximum exposure to credit risk of on balance sheet and off balance sheet financial instruments before taking into account any collateral held or other credit enhancements and after allowance for impairment where appropriate. The maximum exposure to loss for off balance sheet financial instruments is considered to be their contractual nominal amounts.

 

30 September 2013

(Unaudited) 


Carrying value

Commitments

Maximum credit risk exposure

£m

£m

£m

Cash

9,737

-

9,737

Loans and advances to banks

2,537

412

2,949

Investment securities - AFS

11,225

-

11,225

Derivative financial instruments

3,439

-

3,439

FV adjustment for portfolio hedged risk

366

-

366

Loans and advances to customers

163,863

7,582

171,445

Investment in equity shares

28

-

28

191,195

7,994

199,189

 

 

4 April 2013

(Audited) 


Carrying value

Commitments

Maximum credit risk exposure

£m

£m

£m

Cash

7,886

-

7,886

Loans and advances to banks

2,522

423

2,945

Investment securities - AFS

13,421

-

13,421

Derivative financial instruments

4,212

-

4,212

FV adjustment for portfolio hedged risk

872

-

872

Loans and advances to customers

159,587

6,736

166,323

Investment in equity shares

28

-

28

188,528

7,159

195,687

 

In addition to the figures shown above, the Group has, as part of its retail operations, commitments of £7,223 million (4 April 2013: £7,169 million) in respect of credit card and overdraft facilities. These commitments represent agreements to lend in the future, subject to certain conditions. Such commitments are cancellable by the Group, subject to notice requirements, and given their nature are not expected to be drawn down to the full level of exposure.

 

Retail (secured and unsecured) credit risks

 

Significant events/environment

 

The strategy for the Group has been to expand in the mortgage market, based on its well-established risk assessment and control processes for retail secured lending. This includes credit policy, arrears management and underwriting, using both scorecards and an affordability assessment. The success of these controls is demonstrated by the continuing low arrears and impairment performance of the secured portfolios. The Group has been able to expand its lending in a controlled way which can be seen in its support of the first time buyer market and in maintaining its presence in the expanding buy to let market through The Mortgage Works (UK) plc (TMW).

 

Initiatives to support the first time buyer market have included our Save to Buy product enabling customers to access products up to 95% LTV where they have demonstrated a track record of saving prior to applying for the mortgage. The availability of the deposit and being able to demonstrate that the mortgage is affordable are critical factors in the mortgage application. The Group has strongly supported the Government's Help to Buy (shared equity) scheme, offering our full range of mortgage products to this segment. Lending to 30 September 2013 under this scheme has been £137 million, with an approximate market share of 18%.

 

The continued low base rates and Government support through the Funding for Lending Scheme have supported competitive interest rates for secured lending.

 

More recently, UK house prices have increased in the 12 months to 30 September 2013 by 5.0%, with strong growth being observed in southern regions of England, especially London, and with demand being fuelled by policy measures (such as Funding for Lending and Help to Buy schemes). This increase in property values will have a positive impact on the indexed LTV of the existing mortgage portfolios but may create risks on affordability (please see pages 38 and 39 for further details regarding the risks to the Group in respect of an acceleration in UK house price growth). The resulting impact on the affordability profile of new lending will be monitored closely.

  

Retail credit risk profile

 

The Group's loans and advances to customers continue to have a low risk profile when compared to industry benchmarks. By their nature, the Group's retail lending books comprise a large number of smaller loans which are broadly homogenous and have low volatility of credit risk outcomes.

 

Group loans and advances to customers, gross of impairment provisions can be analysed as follows:

 

Loans and advances to customers

30 September 2013

(Unaudited)

4 April 2013

(Audited)

£m

%

£m

%

Prime residential mortgages

115,689

70

110,619

69

Specialist residential mortgages

25,603

16

24,939

16

Total residential mortgages

141,292

86

135,558

85

Consumer banking

3,642

2

3,488

2

Retail loan portfolio

144,934

88

139,046

87

Commercial lending

19,136

12

19,916

13

Other lending operations

209

-

436

-

Total gross balance

164,279

100

159,398

100

 

Geographical concentration

 

Residential mortgages are only secured against UK properties. The geographical split has remained consistent with the position on 4 April 2013:

 

Analysis calculated on a volume basis

30 September 2013

(Unaudited)

4 April 2013

(Audited)

%

%

Greater London

22

22

Central England

22

22

Northern England

20

20

South East England (excluding London)

11

11

South West England

9

9