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Nationwide B.S. (NAWI)

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Wednesday 28 May, 2014

Nationwide B.S.

Preliminary Results Announcement

RNS Number : 1718I
Nationwide Building Society
28 May 2014
 



   

Nationwide Building Society

 

 

 

 

Preliminary Results Announcement

For the year ended

4 April 2014

 

  

Underlying Profit and Pre Provision Underlying Profit

Profit before tax shown on a statutory and underlying basis is set out on page 11. Statutory profit before tax of £677 million has been adjusted for a number of items, consistent with prior years, to derive an underlying profit before tax of £924 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 £1,376 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 Employee Benefits (Revised).

 

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

RESULTS FOR THE YEAR ENDED 4 APRIL 2014

 

 

Graham Beale, Nationwide's Chief Executive said:

"Over the past year Nationwide has lived up to the building society tradition of looking after both savers and borrowers.  As a modern mutual we also recognise the need to offer a broader set of financial services and products. In particular, we have had another successful year in developing our personal current account proposition.

 

"We played a leading role in the housing market; during the year our gross mortgage lending was £28.1 billion, an increase of 31% on 2012/13, whilst our net lending was up 52% at £9.9 billion. Our market shares of gross and net lending were 14.9% and 70.8% respectively.  We actively supported first time buyers and accounted for over one in five such mortgages.

 

"Our savings products have been competitive throughout the year and, as a result, we have increased our member deposit balances by £4.9 billion, a market share of 12.1%. We have sought to reward our existing members by offering our Loyalty Saver account, which now has balances of £17.1 billion and delivered value to our members of around £130 million during the year.

 

"Recognising the broader financial needs of our membership, we have expanded our presence in the current account market in order to diversify our business and share the benefits of mutuality with more members. Our expansion has accelerated and over the past year we opened over 430,000 new current accounts, up 18% on last year. In addition, over 98,000 existing current account members upgraded to our new FlexPlus packaged account, which has attracted a number of industry awards.

 

"Over the past year there has been significant debate around the standards and reputation of the financial services sector. I am therefore delighted that we have been recognised as the strongest financial brand in the UK across a number of metrics. We have been voted the most reputable bank or building society1; the best bank or building society to work for2; first for customer satisfaction, trust and fairness in financial services3 and one of the top ten most 'Human Brands'4 in the UK.

 

"Our successes highlighted above have resulted in our excellent financial performance, which has seen underlying profits increase by 113% to £924 million and statutory profit increase by 303% to £677 million.  Our financial performance, coupled with our landmark issuance of 'mutual friendly' core capital, has further strengthened our balance sheet. Our Common Equity Tier 1 ratio has risen to 14.5%, the strongest ratio amongst our peer group of UK banking competitors5, and we have achieved the PRA target leverage ratio of 3%.

 

"Taken together with our continued focus on providing exceptional service, our performance demonstrates yet again that Nationwide has remained true to its core purpose and heritage. Looking ahead, we will maintain the strength of our business while investing to support growth and changing customer behaviours in an increasingly digital age. We will continue to provide our members with innovative and market leading products and services, which together will reinforce Nationwide's position as a clear and compelling alternative to the established banks."

 

 

 

Graham Beale

Chief Executive 

 

[1] Reputation Institute's RepTrak survey 2014

[2] Sunday Times Top 25 Best Big Companies to Work For 2014

[3] GFK NOP and Nationwide Brand and Advertising tracker

[4] Human Era Index 2013

[5] Peer group consists of Santander UK, HSBC, Lloyds Banking Group, Barclays and Royal Bank of Scotland.

KEY HIGHLIGHTS

 

 

Support for the housing market

·      Gross mortgage lending up 31% to £28.1 billion, a market share of 14.9%

·      Net lending up 52% at £9.9 billion, a market share of 70.8%

·      Helped support 58,100 first time buyers, a market share of 20.3%

 

Delivering value to our savers

·      £4.9 billion increase in member deposit balances, a market share of 12.1%

·      Balances in our Loyalty Saver account, which pays higher rates according to length of membership, have increased by £9.2 billion to £17.1 billion, benefiting over 810,000 members

 

Providing a meaningful alternative to the established banks

·      Over 430,000 new current accounts opened, up 18% on previous year

·      Market share of main standard and packaged accounts increased to 6.2%

 

Focus on customer service

·      Independently ranked number 1 for customer satisfaction amongst our high street peer group1

·      Despite our significant and growing market shares, Nationwide accounts for only 3.55% of all industry complaints

 

Our people

·      Record employee engagement and enablement scores, exceeding industry norms3

 

Strong financial performance

·      Total underlying income up 16% at £2.9 billion

·      Underlying cost income ratio down to 52.5% (2013: 55.9%)

·      113% increase in underlying profit to £924 million

·      303% increase in statutory profit to £677 million

 

Safe and secure balance sheet

·      Primary liquidity ratio 11.9% (4 April 2013: 11.1%)

·      Wholesale funding ratio 19.6% (4 April 2013: 22.5%)

·      Loan to deposit ratio 115.8% (4 April 2013: 115.4%)

·      Residential mortgage arrears, at 0.63%, well below CML2 industry of 1.59%

·      24% reduction in commercial real estate (CRE) balances, from £10.2 billion to £7.8 billion

 

Increased capital strength, securing the future of mutuality

·      Successful issuance of £550 million 'mutual friendly' core capital deferred shares (CCDS) in December 2013 and £1 billion of Additional Tier 1 capital in March 2014

·      Common Equity Tier 1 ratio 14.5% (4 April 2013: proforma CRD IV of 9.1%), reflecting increased capital and reduction in risk weighted assets, primarily through deleveraging of CRE portfolio

·      Leverage ratio 3.3% (4 April 2013: 2.2%),

·      PRA adjusted CET1 and leverage ratio targets met.

  

[1] For the financial year 2013/14. Source: GfK NOP's Financial Research Survey (FRS), 12 months of interviews conducted between April 2013 and March 2014, 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.

[2] Council of Mortgage Lending (CML) average as at March 2014

[3] The Hay Group Financial Services industry benchmark is based on data collected from approximately 55 companies around the world within the financial services industry. It includes data from over 850,000 employees who work in these companies and is updated annually.

 

FINANCIAL SUMMARY

 

 

2014

2013*

Financial Performance

£m

£m

Total underlying income

2,895

2,485

Pre provision underlying profit

1,376

1,097

Underlying profit before tax

924

433

Statutory profit before tax

677

168

Lending and Product Volumes

£bn

£bn

Group residential - gross/gross market share

28.1

14.9%

21.5

15.1%

Group residential - net/net market share

9.9

70.8%

6.5

108.3%

Personal banking product sales (000)

826

848

Member deposits (1)

£bn

£bn

Member deposit balance movement/market share

4.9

12.1%

-

-

Net receipts/(outflows)

2.9

(2.2)

Key Ratios

%

%

Cost income ratio - underlying basis

52.5

55.9

Cost income ratio - statutory basis

56.6

61.2

Net interest margin

1.25

1.02

Balance Sheet

£m

£m

Total assets

189,926

190,718

Loans and advances to customers

166,574

159,587

Member deposits (shares)

130,468

125,574

Total shares and deposit liabilities (SDLs)

174,352

174,940

Asset Quality

%

%

Proportion of residential mortgage accounts 3 months+ in arrears

0.63

0.72

Average indexed loan to value of residential mortgage book

48

51

Average loan to value of new residential lending

69

67

Total provision as % of impaired balances on commercial real estate lending

33

35

Key Ratios

%

%

%

CRD IV

CRD IV

Basel II

Capital - CRD IV (end point) unadjusted (2)

Proforma

   Common Equity Tier 1 ratio

14.5

9.1

12.3

   Leverage ratio (3)

3.3

2.2

PRA adjusted ratios

  PRA adjusted CET1 ratio

11.2

  

  

  PRA adjusted leverage ratio

3.2

Other balance sheet ratios

   Primary liquidity ratio

11.9

11.1

   Wholesale funding ratio

19.6

22.5

   Loan to deposit ratio (4)

115.8

115.4

   Loan to deposit ratio (including long term wholesale funding) (5)

104.5

99.1

* Comparatives have been restated in accordance with IAS 19 Employee Benefits (Revised).

 

(1) Member deposits include current account credit balances.

(2) Basel III was implemented through the Capital Requirements Regulation and Directive, ('CRD IV'), and became effective on 1 January 2014. The table above includes prior year amounts on the previously reported Basel II basis and under CRD IV on a pro-forma basis to aid comparability. The concept of leverage was not captured under Basel II and so was not reported in the prior year. PRA adjusted measures, which are explained further in the Capital Management Report, were not established until 20 June 2013, and so are also not relevant to prior reporting periods.

(3)  Comparative restated for change in treatment of certain securitisations to be risk weighted as opposed to capital deducted. See the Capital Management Report for further Information.

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

(5)  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

 

Staying true to our mutual heritage

 

Our performance over the past year is in line with our strategy of being a modern mutual: looking after the needs of savers, home owners and providing a whole range of financial services and products. Our mortgage lending was up 31% on last year, we have increased our member deposit balances by £4.9 billion and we have opened over 430,000 new current accounts. We have achieved this level of performance by concentrating on the needs of our existing and new members, aiming to provide ongoing good value and exceptional service at all times. Our financial results reflect this success, with an increase in underlying profit of 113% to £924 million. Statutory profit has increased by 303% to £677 million. In addition to stronger retained earnings, we have strengthened our balance sheet further with a new form of capital: core capital deferred shares (CCDS), and disposed of a number of non-core assets.  As a result, we have a top of peer group Common Equity Tier 1 (CET1) ratio of 14.5% and a leverage ratio of 3.3%.

 

Supporting our members in the housing market

 

Over the past twelve months we have played a major role in providing finance to the UK housing market, with gross and net lending both increased year on year and in excess of our par market share. Total gross mortgage lending was up 31% at £28.1 billion (2013: £21.5 billion), accounting for 14.9% of all mortgage lending, whilst our net lending for the year was £9.9 billion, up 52% year on year (2013: £6.5 billion) and representing a market share of 70.8%. We have 1.5 million mortgage accounts and our residential lending portfolio now stands at £145.7 billion (2013: £135.6 billion).

 

Consistent with our mutual heritage we have continued to support first time buyers; during the year we have helped 58,100 people take their first steps into home ownership, an increase of 37% on last year (2013: 42,500), and representing over one in five of all first time buyer mortgages in the UK.  Throughout the year we have supported the Government's Help to Buy shared equity scheme, accounting for over 31% of all cases advanced, and our Save to Buy1proposition offers access to 95% LTV mortgages, our equivalent of the Government's second phase of Help to Buy. Our lending at above 90% LTV remains low, representing only 2.4% of the total value of our lending during the year.

 

In addition to our support for first time buyers, we have continued with our policy of rewarding our members by providing a loyalty discount to our mortgage rates to existing mortgage customers wishing to move, switch product or take a further advance. We have also maintained our Base Mortgage Rate (BMR) at 2% above the Bank of England (BoE) base rate. We estimate that this has delivered member benefit in the region of £800 million per annum when compared with the standard variable rate charged by other major lenders, equivalent to a saving of around £1,100 for our average BMR borrower.

 

As patterns of housing tenure continue to evolve, with greater numbers of people choosing to rent rather than buy, our subsidiary, The Mortgage Works (TMW), has continued to be a leading provider of high quality loans to the buy to let sector. Over the past year TMW gross advances accounted for £3.7 billion (2013: £3.3 billion) of our total mortgage lending, representing a market share of 16%, with net lending of £1.7 billion. Our total specialist mortgage book now stands at £26.3 billion (2013: £24.9 billion), representing 18.1% of our total residential lending portfolio (2013: 18.4%).

 

Delivering value to our savers

 

We have offered a choice of competitive savings products throughout the year and we have seen our member deposit balances grow by £4.9 billion to £130.5 billion. In line with our core purpose of looking after our members we have focused our efforts on rewarding the loyalty of our existing members. Our Loyalty Saver product, which pays higher rates of interest according to length of membership, has been particularly popular and has attracted balances of £9.2 billion during the year, taking the total balances held in this account to £17.1 billion. We estimate that the member value from Loyalty Saver was in the region of £130 million during the year.

 

[1] Through Nationwide's Save to Buy scheme customers have access to a dedicated savings account to help save for a deposit towards their home and a competitive interest rate on their mortgage when ready to buy. The Save To Buy mortgage is only available for a loan to value of 85% to 95%.

 

For many years we have campaigned for changes to the structure of tax-free savings in the UK. We are delighted that in the recent Budget the Chancellor reacted to our calls by increasing both the amount that can be saved into an ISA and allowing people to switch freely between stocks and shares and cash ISAs. In a market where interest rates paid on retail savings have declined, this will provide a timely boost for savers and remove structural anomalies.

 

We believe that savers should be presented with simple, transparent products. To that end, we have continued our policy of simplifying our savings range for both existing and new accounts, removing notice and complicated bonus arrangements, while making all accounts accessible online. To date over 1.5 million customers have benefited from this change and we have done this without reducing interest rates as a consequence. During the year we also launched our "2 clicks" service, which allows our online bank members to open most of our savings accounts with only two clicks of a mouse. Our overall approach and the quality of our products and service were recently recognised with Nationwide being named as the Moneyfacts High Street Savings Provider of the year.

 

A meaningful alternative to the established banks

 

The past year has seen an acceleration in our drive to diversify our business through the provision of personal banking services to new and existing members. We have opened over 430,000 new current accounts, an 18% increase on last year (2013: 365,000), with the latest additions to our product range, FlexDirect and FlexPlus, proving popular. In addition, over 98,000 existing current account members upgraded their account to FlexPlus, thereby gaining access to a comprehensive range of benefits including interest on credit balances, worldwide travel insurance, breakdown cover and extended appliance warranties. The quality of our current account offering is demonstrated by the number of awards we have won:

·       each of our full service current accounts was rated as 5 star by Defaqto;

·       Nationwide was named as the Consumer Moneyfacts 'Current Account Provider of the Year'; and

·       FlexPlus has been rated as the number one packaged account by Which? Magazine and as the Best Packaged Current Account in the Moneynet Personal Finance Awards.

 

We now have 5.5 million current accounts, and our market share of main standard and packaged accounts as at February 2014 had risen over the year to 6.2% (2013: 5.7%).

 

As a challenger to the established banks, we welcome the drive to facilitate easier current account switching for customers. The industry-wide seven day account switcher initiative launched in September, and Payments Council data indicates that our monthly share of switching had reached 10.8% in March.

 

Our total gross lending of personal loans was £1.2 billion (2013: £1.2 billion), representing a market share for the year of 4.8%. Our total outstanding balances have reached £1.9 billion (2013: £1.8 billion), taking our market share to 3.8% (2013: 3.6%).

 

The credit card market over the past year was very competitive, with aggressive pricing and increasingly long interest free periods being used to attract customers. Against this backdrop, we have grown our credit card business more slowly than in previous years, with 272,000 new accounts opened over the past twelve months (2013: 350,000). Our credit card outstanding balances have increased by 12.9% to £1.7 billion. Moneynet named our Select card as the Best All Round Credit Card, and we were named as the organisation with the Most Responsible Credit Card Lending Practices in the Card and Payment Awards for the seventh successive year.

 

This was the first year following the implementation of the Retail Distribution Review (RDR) and also the introduction of a new reward structure for regulated sales advisers. We have experienced a reduction in the volume of our protection and investment sales, which were down 40% at 104,000 (2013: 174,000). We have refined our processes as we have adapted to RDR, and by the year end investment sales per adviser had recovered back towards pre RDR levels.

 

Continued focus on member service

 

The provision of excellent member service is central to our values. Getting the basics right is critical to ensuring that our members trust us with their money, and our success in this area is evidenced by the fact that despite accounting for over 10% of the mortgages and savings market and 6% of the current account market, we accounted for only 3.6% of total industry complaints. Of all complaints about Nationwide referred to the Financial Ombudsman Service 10% are upheld, compared with the industry as a whole where 51% are upheld.

 

True success in delighting customers means having a culture that is focused entirely on delivering the right customer outcomes every time. This requires a mindset that puts our members, who are also our owners, at the centre of our thinking at all times. A number of recent surveys have suggested that we are leading the way in this area:

·       the Reputation Institute's annual RepTrak survey ranked us as having the best reputation of UK banks and building societies;

 

·       the Human Era Index ranked us as the top financial services provider and in the top ten brands in the UK.

 

These findings are backed up by Nationwide being ranked number one for customer satisfaction amongst our high street peer group for two and a half years2,and our internal surveys show a continued improvement in satisfaction for our branch and telephone channels. We publish our track record on member service on our website on a quarterly basis; your.nationwide.co.uk/stats.

 

People

 

At Nationwide we are proud of our people and the manner in which they bring our brand to life for our members. It is vital that our people are fully engaged in the aims of the Society and are provided with the tools to allow them to provide exceptional customer service. I am therefore delighted that Nationwide has been recognised as the eleventh best big company to work for by the Sunday Times, ahead of all other banks and building societies, and has been ranked as one of the top 50 places for women to work in the UK. This external recognition reinforces what our own people are telling us through our internal "ViewPoint" survey, which shows levels of employee engagement and enablement that are well above the benchmarks set for high performing companies.

 

Strong financial performance

 

Our business continues to be supported by the strength of our balance sheet. In line with our mutual status and focus on the provision of mortgages and savings to our members, over 90% of our lending is secured on UK residential property and approximately 80% of our funding is raised from retail sources.

 

Our financial performance builds on our success in growing the Society and delivering great service.  Strong business volumes, combined with a strengthening in our net interest margin, have contributed to a 16% increase in income to £2,895 million (2013: £2,485 million). Our underlying profit for the year was £924 million (2013: £433 million), an increase of 113%, and statutory profit before tax was £677 million (2013: £168 million), an increase of 303%. Costs have increased by 9% reflecting the significant growth of our business and continued investment. However, this has been more than offset by the growth in our income, resulting in our underlying cost income ratio falling to a record low of 52.5% (2013: 55.9%).

 

This level of financial performance underpins our promise to be safe and secure. As a mutual we aim to optimise, rather than maximise, profit, retaining sufficient earnings to support future growth, sustain strong capital ratios and to allow us to invest in the business to provide the services that our members demand. Our performance this year is in line with this aim and helps us to deliver a long term, sustainable business that operates purely in the interests of our members.

 

Our prudent approach to mortgage lending is evident in our three month mortgage arrears ratio of 0.63%, which compares favourably with the industry average of 1.59%. We have made significant progress in reducing our exposure to non-core commercial real estate by reducing our balances by 24% over the past year; our total exposure now stands at £7.8 billion (2013: £10.2 billion) and since the year end we have reduced our exposure by a further £0.7 billion through the sale of non UK CRE assets. Alongside this deleveraging, we have seen a modest improvement in the outlook for the commercial real estate sector and, as a consequence, our commercial impairment charge has reduced to £309 million (2013: £493 million). Total provision charges for all impairments have fallen by 35% to £383 million (2013: £591 million).

 

[2] Source: GfK NOP's Financial Research Survey (FRS), 30 months of interviews conducted between October 2011 and March 2014, 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.

 

 

Capital strength, securing the future of mutuality

 

We have continued to place emphasis on preserving the strength of our balance sheet through our conservative approach to lending and prudent management of our business. Since the financial crisis of 2008 banks and building societies have been required to increase both the quality and quantity of capital to support their businesses, and over the past twelve months we have made great strides in both these areas.

 

In December we issued £550 million of core capital deferred shares (CCDS), a new capital instrument that qualifies as Common Equity, the highest quality of capital, and which does not compromise our mutual business model and contains "mutual friendly" features, namely: one member one vote, capped distributions and capped participation in residual assets. Our successful launch of CCDS supports our mutual status, demonstrating our ability to access capital in the market and providing greater flexibility over the long term management of our business. In addition, this instrument may be suitable for other building societies, thereby supporting the long term health of the mutual sector in the UK and across Europe. In March we made a further improvement to our capital position through an inaugural £1 billion issue of Additional Tier 1 capital, the first Sterling issue of this form of capital by any institution. Both issues were oversubscribed, demonstrating widespread investor support for Nationwide and the strength of our mutual business model.

 

As a result of our strong financial performance and capital issuance, our Common Equity Tier 1 ratio has grown by 5.4 percentage points to 14.5% (2013 proforma: 9.1%), the strongest ratio amongst our peer group of UK banking competitors9. As a result of the reduction in our non UK CRE exposures since the year end, this figure will improve by a further 0.5%. Our leverage ratio has now exceeded 3% on both unadjusted and PRA adjusted bases (3.3% and 3.2% respectively), meaning we have achieved our agreed PRA target ratio.

 

Whilst our progress in strengthening our capital ratios through business performance and capital issuances provides evidence of our ability to manage our capital resources, we remain alert to the ongoing regulatory debate on leverage ratios which may result in higher leverage ratio requirements in future, even for low risk institutions such as Nationwide. In this context it will be important that we monitor developments and plan our business in order to be able to accommodate any new requirements that may emerge.

 

Progress of our strategy and future plans

 

We remain committed to mutuality, providing outstanding retail financial services to a growing member base and expanding our presence in the personal current account market to establish a market share in proportion to our shares in mortgages and savings.

 

Member behaviours and expectations are changing, with an increasing use of internet and mobile channels, and we will ensure that we respond accordingly. We have already seen a significant uptake of our digital services: we have over 2.6 million active users of our digital services, with over 620,000 log-ons each day to our internet bank, almost half of which are made through our mobile banking app, and products bought through our internet bank are up 60% year on year. In November 2013 we became, in conjunction with Visa, the first organisation in the UK to offer V.me, a new digital wallet designed to make online shopping more convenient and secure. We are developing a number of future enhancements to our digital payment services, including a mobile person to business payments service in partnership with Zapp and a person to person payments facility through Paym. These new services are due to become available during the course of 2015.

 

[9] Peer group consists of Santander UK, HSBC, Lloyds Banking Group, Barclays and Royal Bank of Scotland.

 

Even in an increasingly digital world our branches will be a key element of our service, although their role is likely to develop with more time spent on the provision of advice and sales support and less on transactional activity. We have recently taken an important step with the launch of Nationwide Now, a service which will boost our branch capacity by delivering help and advice to our customers via a real time video link to an adviser based at a central location. Early indications are that this is breathing new life into some of our more marginal branches.

 

Over the past five years we have renewed our infrastructure through the delivery of a new banking platform, new data centre, new payments platform, new website and a mobile banking service. Whilst these programmes have improved customer service and increased technical resilience, it is likely that over the next few years the pace of change will speed up, with an increasing number of smaller initiatives to enable Nationwide to operate in an evolving digital society.

 

At the same time we will not lose sight of the fact that some members prefer branches and telephone channels to digital services, and we will continue to operate and maintain these channels to ensure that we meet the needs of all of our members.

 

Outlook

 

We expect the UK economy to continue to improve over the coming year. Despite this improvement, we do not expect the Bank of England base rate to rise imminently given the low rate of inflation, and future rises when they occur will be gradual in nature. The health of the UK housing market has been the subject of much commentary in recent months, with the annual growth of house prices now above 10% and at its highest since 2007. All regions are now experiencing some growth, but the big increases are mainly centred on London and the South East and there are few signs of affordability being stretched in other UK regions.

 

In the recent Budget the Chancellor made substantial revisions to ISAs and announced proposals for National Savings and Investments (NS&I) to issue pensioner bonds in 2015. We believe that the changes to ISAs will result in more savings into cash ISAs, but that we may see some deposit outflows to NS&I if rates on the pension bonds are above the normal market range and we are therefore unable to compete.

 

Our business performance is strong, and we believe it will improve further over the coming year, with a further increase in margins and a continued growth in our banking products. The future is not without challenges; the whole industry needs to evolve its approach to delivering compliant solutions in a fast moving digital world, and the demand for further increases in capital requirements cannot be ruled out. However, we are very confident that we are in an excellent position to deliver more value to more members in the coming years, sharing the benefits of mutuality more widely and presenting the only truly national alternative to the established banks.

 

 

  

 

Graham Beale

Chief Executive

 

27 May 2014

 

 

FINANCIAL REVIEW

 

INCOME STATEMENT OVERVIEW

 

Profit after tax on a statutory basis is set out below. In addition, certain aspects of the results are presented to reflect management's view of our underlying profit performance.

 

Underlying profit equates to statutory profit before tax adjusted for charges in respect of the Financial Services Compensation Scheme (FSCS), bank levy, transformation costs and fair value losses from derivatives and hedge accounting as set out below.

 

Year to 4 April 2014

Statutory profit

FSCS and

bank

levy

Transformation

costs

Losses from derivatives and hedge accounting

Underlying profit

£m

£m

£m

£m

£m 

Net interest income

2,403

-

-

-

2,403

Other income

492

-

-

-

492

Movements on derivatives and hedge accounting

(51)

-

-

51

-

Total income

2,844

-

-

51

2,895

Administrative expenses

(1,611)

17

75

-

(1,519)

Pre provision underlying profit

1,233

17

75

51

1,376

Impairment losses

(383)

-

-

-

(383)

Provisions for liabilities and charges

(173)

104

-

-

(69)

Profit before tax

677

121

75

51

924

Tax

(128)

Profit after tax

549

 

Year to 4 April 2013*

 

Statutory profit

FSCS and

bank

levy

Transformation

costs

Losses from derivatives and hedge accounting

Underlying profit

£m

£m

£m

£m

£m 

Net interest income

1,981

-

-

-

1,981

Other income

504

-

-

-

504

Movements on derivatives and hedge accounting

(165)

 

-

 

-


165


-

Total income

2,320

-

-

165

2,485

Administrative expenses

(1,420)

16

16

-

(1,388)

Pre provision underlying profit

900

16

16

165

1,097

Impairment losses

(591)

-

-

-

(591)

Provisions for liabilities and charges

(141)

68

-

-

(73)

Profit before tax

168

84

16

165

433

Tax

10

Profit after tax

178

 

*Comparatives have been restated in accordance with IAS 19 Employee Benefits (Revised). Refer to note 2 for further details.

 

Statutory profit before tax for the year ended 4 April 2014 was £677 million, up 303% compared with the prior year (2013: £168 million). Underlying profit, which reflects management's view of performance on a like for like basis across years, was £924 million, up 113% compared with the prior year (2013: £433 million). Increased profitability was driven mainly by the continued improvement in net interest income and reduced impairment charges, offset in part by increased administrative expenses.

 

Net interest income


Year to

4 April

2014

£m

Year to

4 April

2013*

£m

Net interest income

2,403

1,981

Weighted average total assets

191,604

193,832

%

%

Net interest margin (NIM)

1.25

1.02

 

*Comparatives have been restated in accordance with IAS 19 Employee Benefits (Revised). Refer to note 2 for further details.

 

Net interest income for the year was £2,403 million, £422 million higher than the prior year, driven largely by retail asset growth and reduced costs of retail funding. Weighted average total assets are 1.1% lower, as planned reductions of non-core treasury and commercial assets have more than offset the growth in retail lending balances. Net interest margin improved by 23 basis points on an annualised basis to 1.25%. Margin recovery has continued throughout the year and our point-in-time NIM at the end of 2013/14 was approximately 1.40%.

 

Mortgage balances have grown by around £10 billion during the year and the margin performance has continued to benefit from re-pricing of maturing longer term fixed rate balances onto higher current market rates. Base Mortgage Rate balances (BMR) peaked in May 2013 and now constitute a decreasing proportion of our mortgage book, whilst continuing to represent a significant distribution of value to members with a headline pay rate of 2.5%. Total BMR balances at 4 April 2014 amounted to £52 billion (2013: £54 billion).

 

The most significant drivers of our higher margin were maturing fixed mortgage deals re-pricing onto higher margin products and lower retail funding costs which reflect reduced demand across the market for retail savings, in part as a consequence of the availability of the Funding for Lending Scheme (FLS), and growth in our personal current account credit balances by approximately £1.5 billion over the course of the year. The section of the FLS which provides funding linked to net residential mortgage lending has now been withdrawn and we do not expect to make any further drawings under FLS; our total drawings to date are £8.5 billion and we estimate our utilisation of the scheme contributed approximately 2 basis points (2013: less than 1 basis point) to our net interest margin for the year. We estimate that the marginal cost of retail funding has fallen by around 80 basis points since FLS was launched.

 

Net interest income for the year includes £45 million of losses (2013: £139 million gain) primarily arising from the sale of around £1.1 billion of treasury assets in line with our ongoing strategy to reduce non-core exposures, a charge for fair value adjustments of £23 million (2013: £48 million gain), and a £30 million gain (2013: £44 million) from updated effective interest rate assumptions relating to recognition of mortgage and savings interest.

 

During the year we raised approximately £1.5 billion through issuance of CET1 (CCDS - core capital deferred shares) and AT1 capital securities. The returns paid to investors on these securities will be treated as an appropriation of profit after tax, reflecting their categorisation as capital instruments, and hence are not reflected in our interest margin. The first distributions for CCDS, in respect of 2013/14, and AT1 capital securities in respect of the period from issue to the payment date, totalling £49 million, will become payable in June 2014 and will be reflected in the 2014/15 financial statements.

 


Other income

 

 

Year to

4 April

2014

£m

Year to

4 April

2013

£m 

Current account and savings

111

114

Protection and investments

82

122

General insurance

101

126

Mortgage

30

41

Credit card

29

28

Commercial

17

18

Gain on redemption of subscribed capital

125

43

Other

(3)

12

Total underlying other income

492

504

Losses from derivatives and hedge accounting

(51)

(165)

Total statutory other income

441

339

 

Total underlying other income of £492 million is 2% down overall year on year and includes gains from the redemption of subscribed capital of £125 million (2013: £43 million). Excluding this non-recurring item, other income has reduced by £94 million, including a £40 million reduction in net protection and investment income as a result of a change to customer pricing on protection policies and the impact of the Retail Distribution Review which came into force on 1 January 2013. The £25 million reduction in general insurance is driven by a one-off commission benefit of around £20 million relating to general insurance which was taken in the prior year. The 'Other' category for 2013 includes a £7 million profit on the sale of equity investments relating to participation in an industry wide credit card service operation.

 

Administrative expenses


Year to

4 April

2014

Year to

 4 April

2013*

£m

£m

Employee costs

636

604

Other administrative expenses

601

568

Administrative expenses (underlying)

1,237

1,172

Depreciation, amortisation and impairment

282

216

Total underlying administrative expenses

1,519

1,388

Transformation costs

75

16

Bank levy

17

16

Total statutory administrative expenses

1,611

1,420

Cost income ratio - underlying basis

52.5

55.9

Cost income ratio - statutory basis

56.6

61.2

 

*Comparatives have been restated in accordance with IAS 19 Employee Benefits (Revised). Refer to note 2 for further details

 

Underlying administrative expenses have increased by 9% to £1,519 million, largely driven by ongoing investment in the business, general inflation and increased levels of business activity. At a statutory level administrative expenses have increased by 13% to £1,611 million.

 

Investment spend during the year has included revenue costs of £23 million associated with the implementation of the Mortgage Market Review and the Current Account Switching Service. In addition, depreciation and amortisation for the year includes the first full year's charge of £50 million (2013: £11 million) relating to our new banking platform which became operational in October 2012.

 

The year on year increase in employee costs reflects the impact of annual pay awards averaging 2.4% and 2.5% respectively in each of the last two years, combined with a 1.5% increase in employee numbers year on year.  

 

Increased levels of business activity are evident across many aspects of our operations, including financial transactions (up 14%), mortgage lending (up 31%) and current account sales (up 18%).

 

Transformation costs include £39 million relating to our ongoing programme to integrate distribution and account administration relating to our Dunfermline, Derbyshire and Cheshire brands. Under the programme the branch network will be rationalised and re-branded "Nationwide" to eliminate unnecessary duplication whilst preserving levels of physical access for members as a whole. Account administration will be migrated onto Nationwide core systems. Costs relate to asset write downs, provision for ongoing onerous lease contracts and headcount reductions. The programme is expected to deliver annualised cost savings in excess of £25 million and additional income of £10 million on completion. 

 

The other significant transformation programme is the execution of our strategic programme to source IT application and support activities through strategic delivery partners and to transform the way these activities are performed. Costs charged in the year for this programme were £30 million and relate to the commercial processes, transition activity, provision of technical infrastructure and headcount reductions. The programme is expected to deliver annualised cost savings in the region of £50 million.

 

Underlying income growth of 16% continues to run well ahead of cost growth, resulting in a reduction in both our statutory and underlying cost income ratios to 56.6% (2013: 61.2%) and 52.5% (2013: 55.9%) respectively. Cost growth is expected to moderate in 2014/15.

 

Impairment losses


Year to
4 April

2014

£m

Year to
4 April

2013

£m 

Residential lending

-

16

Consumer banking

60

79

Retail lending

60

95

Commercial lending

309

493

Other lending

11

1

Impairment losses on loans and advances to customers

380

589

Impairment losses on investment securities

3

2

Total

383

591

 

Impairment losses for the year of £383 million are £208 million (35%) lower than 2013 primarily as a result of a significant improvement in the level of impairment suffered on our commercial lending portfolio.

 

Residential mortgage impairments have benefited from house price growth of 9.5% over the course of the financial year and continuing low levels of arrears reflecting relatively benign, and now improving, levels of unemployment and our prudent underwriting approach. In addition the continuation of the low interest rate environment is supporting stability of repayment obligations at unusually low levels by historic standards. These factors have contributed to a zero charge for residential impairments (2013: £16 million). In calculating mortgage loss provisions house price inflation based on movements in the Nationwide House Price Index (HPI) to the balance sheet date are factored in, but no recognition for anticipated future house price inflation is included.

 

Nationwide has maintained a consistent philosophy to retail lending over many years with a focus on prudent underwriting criteria. We place a heavy emphasis on managing the LTV profile of new secured lending, including restricting the volume of higher LTV lending and ensuring such loans are only advanced to customers with a high credit score and strong affordability assessments. As a result of our approach, our mortgage arrears have outperformed industry averages by a significant margin and this continues to be the case.

 

Consumer banking impairments are down 24% at £60 million (2013: £79 million) including a credit of £27 million (2013: £nil) relating to an update to model assumptions for late stage recoveries on defaulted balances to reflect recent experience. Excluding this adjustment, the implied underlying increase in consumer banking impairment of around 10% is attributable to balance growth with no significant change in portfolio performance.

 

Commercial lending impairments relate exclusively to commercial real estate (CRE) lending, with no arrears in our social housing and Project Finance portfolios. The decrease in the impairment charge to £309 million reflects a £2.4 billion reduction in CRE exposures and stabilisation of CRE market conditions with a consequent improvement in investor sentiment towards the sector, allowing a wider range of exit options at improved valuations on all but the most severely distressed exposures.   

 

Other lending relates to loans historically originated by our Treasury Division and includes a portfolio of £176 million (2013: £219 million) which primarily comprises secured lending relating to a European commercial loan portfolio and a revolving loan facility secured by a portfolio of asset backed securities. The charge of £11 million (2013: £1 million) relates to the impairment of individual under-performing exposures.

 

 

Provisions for liabilities and charges

 

Year to

4 April

2014

£m

Year to

4 April

2013

£m 

Underlying provisions for liabilities and charges - customer redress

69

73

FSCS levies

104

68

Total provisions for liabilities and charges

173

141

 

The charge for customer redress provisions of £69 million (2013: £73 million) relates to estimated costs of remediation and redress in relation to past sales of financial products and post sales administration, including compliance with consumer credit legislation and other regulatory matters.

 

More information, including details of the increase in the FSCS charge, is included in note 9.

 

Taxation

 

The statutory reported tax charge for the year of £128 million (2013: £10 million credit) represents an effective tax rate of 18.9%, which is lower than the statutory rate in the UK of 23%. The lower rate is due principally to adjustments with respect to prior periods and the effect of the change in the UK corporation tax rate. Further information is provided in note 10.

 

During the year our income statement bore taxes of £345 million (2013: £258 million) including irrecoverable VAT, bank levy, employment and property taxes, all of which are charged to profit before tax as part of administrative expenses and depreciation. With the exception of the bank levy, all of these amounts are recognised in arriving at underlying profit.



BALANCE SHEET

 

ASSETS

4 April 2014

£m            %

4 April 2013

£m         %

Change

%

Residential mortgages

145,660

87

135,558

85

7

Commercial lending

18,164

11

21,329

13

(15)

Consumer banking and other lending

4,038

2

3,924

2

3

167,862

100

160,811

100

4

Impairment provision

(1,288)

(1,224)

5

Loans and advances to customers

166,574

159,587

4

Other financial assets

21,285

28,941

(26)

Other non-financial assets

2,067

2,190

(5)

Total assets

189,926

190,718

-

Key ratios

%

%

Asset quality

Residential Mortgages

  Proportion of residential mortgage accounts 3 months+ in arrears

 

0.63

 

0.72

 

(0.09)pp

  Average indexed loan to value (LTV) of residential mortgage book

48


51


(3)pp

  Average loan to value of new residential lending

69

67

2pp

Commercial Property Finance

  Total CRE gross balances (£m)

7,764

10,192

(24)

   Impaired balances (£m)

3,065

2,715

13

  Total provision as % of impaired balances

33

35

(2)pp

 

Residential mortgages

 

Residential mortgages include prime and specialist loans, with the specialist portfolio primarily comprising buy to let (BTL) lending. We delivered gross mortgage lending during the year of £28.1 billion (2013: £21.5 billion), representing a market share of 14.9% (2013: 15.1%). Mortgage balances grew by £10.1 billion of which £8.7 billion (86%) was prime lending and £1.4 billion (14%) related to BTL. This mix of lending is consistent with prior years and maintains our stock of residential lending at 82% prime, 18% specialist (2013: 82% prime, 18% specialist). The loan to value (LTV) profile of new lending, weighted by a volume basis, was broadly consistent with the prior year at 69% (2013: 67%), and the average LTV of the portfolio at 4 April 2014 was 48% (2013: 51%). Our residential mortgage arrears fell from 0.72% at the end of last year to 0.63% at 4 April 2014 and continue to be significantly lower than the Council of Mortgage Lenders (CML) industry averages. Full details of our lending risks are provided in the Business and Risk Report.

 

Commercial lending

 

Commercial lending includes commercial real estate (CRE) loans of £7.8 billion (2013: £10.2 billion), loans to housing associations of £8.1 billion (2013: £8.2 billion) and a portfolio of loans made under the Government's Project Finance initiative amounting to £1.4 billion (2013: £1.5 billion). The balance sheet total for commercial lending quoted above includes £0.9 billion (2013: £1.4 billion) of fair value adjustments relating to loans where the Group has hedged associated financial risks, typically interest rate risk.

 

We have undertaken limited amounts of new lending with total gross advances during the year of £65 million. Activity has been concentrated on ongoing management of the existing portfolio with particular focus on managed work out of weak and distressed CRE exposures. This has resulted in a reduction of £2.4 billion of CRE balances during the year, bringing our gross exposure down from £10.2 billion at the end of last year to £7.8 billion at 4 April 2014. In addition, since the year end, we have sold over 90% of our non-UK CRE portfolio representing gross loans of £694 million as at 4 April 2014, with net sales proceeds in line with their  carrying value; the sale will be recognised in the first quarter of 2014/15 and will increase our CET 1 ratio by an estimated 0.5%.

 

The level of impaired balances as a proportion of our total CRE exposure has risen from 26% to 39%, reflecting a reduction in the portfolio size and new impairment cases. Whilst we are seeing continued credit risk migration, the rate of deterioration within the portfolio, including the volume of new problem cases emerging, has slowed, reflecting stabilisation in market conditions and the increased proportion of the book which has now been subjected to detailed scrutiny and challenge. Whilst provision coverage is lower at 33% (2013: 35%), the aggregate coverage across the impaired portfolio including collateral valuations has improved from 94% at the end of last year to 102% at 4 April 2014.  

 

Consumer banking and other lending

 

This comprises retail balances relating to personal loans of £1.9 billion (2013: £1.8 billion), credit cards of £1.7 billion (2013: £1.5 billion) and current account overdrafts of £0.3 billion (2013: £0.2 billion), together with £0.2 billion relating to two portfolios of European business loans originated and managed by our Treasury Division (2013: £0.4 billion including £0.2 billion of student loan exposure sold on 24 April 2013).  We have seen steady growth in unsecured retail lending across all three products reflecting our strategy to increase current account market share and serve members across a full range of retail financial services. Delinquency within unsecured portfolios remains stable with full details provided in the Business and Risk Report.

 

Other financial assets

 

Other financial assets total £21.3 billion (2013: £28.9 billion) and comprise liquidity and investment assets held by our Treasury Division amounting to £18.0 billion (2013: £23.8 billion), derivatives with positive fair values of £3.0 billion (2013: £4.2 billion) and fair value adjustments and other assets of £0.3 billion (2013: £0.9 billion).

 

Treasury assets include our on balance sheet primary liquidity amounting to £12.3 billion (2013: £16.9 billion), substantially comprising UK gilts and cash held at the Bank of England, which is held to meet regulatory requirements, and other investment securities and loans to banks of £5.7 billion (2013: £6.9 billion), some of which are eligible as security with central banks to support our broader ongoing management of liquidity. The reduction in treasury liquidity and investment assets totalling £5.8 billion reflects the replacement of on balance sheet primary liquidity with equivalent off balance sheet liquidity in the form of FLS, together with divestment of approximately £1.1 billion of legacy investment assets in line with our ongoing strategy of deleverage of assets which no longer meet risk appetite or regulatory benchmarks. During the financial year an additional £6 billion was drawn down from the FLS scheme and this underpinned our primary liquidity ratio which was 11.9% at 4 April 2014 (2013: 11.1%). Full details of our treasury portfolios are included in the sections of the Business and Risk Report which discuss treasury assets, liquidity and financial risks.

 

Derivative instruments relate to interest rate and other swaps we use to hedge financial risks inherent in our core business. The fall in value is driven by a combination of interest rate movements and an overall reduction of derivatives with an outstanding maturity of less than one year.

LIABILITIES

4 April 2014

£m      

 

    

4 April 2013

£m

Change

% 

Member deposits

130,468

125,574

4

Debt securities in issue

28,557

33,429

(15)

Other financial liabilities

20,621

23,816

(13)

Other liabilities

1,374

1,319

4

Total liabilities

181,020

184,138

(2)

Members' interests and equity

8,906

6,580

35

Total members' interests, equity and liabilities

189,926

190,718

-

Key ratios

%

%

Primary liquidity ratio

11.9

11.1

0.8pp

Wholesale funding ratio

19.6

22.5

(2.9)pp

 


Member deposits

 

Member deposits increased by £4.9 billion to £130.5 billion (2013: £125.6 billion) due to retail inflows and capitalised interest on members' accounts of £1.7 billion (2013: £2.3 billion).  We attracted total retail inflows, including non-member balances (categorised within other financial liabilities above), of £2.9 billion (2013: £2.2 billion - outflow). We estimate our share of the balance growth in the UK savings market for the year to be 12.1%.

 

Debt securities in issue

 

Debt securities in issue of £28.6 billion (2013: £33.4 billion) are used to raise funding in wholesale markets to finance our core activities. The reduction in outstanding amounts at 4 April 2014 reflects re-financing of natural maturities with drawings under FLS in preference to funding with market counterparties. In the context of our overall funding position, we have made moderate use of FLS, drawing a total of £8.5 billion to date, and the benefits of this cheaper form of funding have been passed on to members through lower mortgage rates in line with the purpose of the scheme. FLS drawings have a contractual maturity of four years but are fully flexible, allowing early repayment without penalty at any time.   

 

The reduction in our wholesale funding ratio to 19.6% (2013: 22.5%) reflects this re-financing of wholesale maturities with off balance sheet FLS drawings which are excluded from the calculation but which we view as flexible wholesale term funding.   

 

Other financial liabilities

 

Other financial liabilities include customer and bank deposits of £15.3 billion (2013: £16.0 billion), permanent interest bearing shares (PIBS) of £0.6 billion (2013: £1.3 billion), subordinated debt of £2.3 billion (2013 £2.5 billion) and derivatives and fair value adjustments of £2.4 billion (2013: £4.0 billion).

 

The reduction in PIBS reflects the repurchase in September and October 2013 of £506 million of these capital securities which will become ineligible for regulatory capital purposes on a phased basis under CRD IV, generating a gain of £125 million which is included in other income. This transaction was undertaken as part of the ongoing management of our capital position as we transition to new regulatory capital requirements. We also redeemed $225 million (£138 million sterling equivalent) of subordinated notes in January 2014 at contractual maturity which accounts for the majority of the movement in outstanding subordinated debt during the year. The reported values of PIBS and subordinated debt include adjustments to fair value these liabilities as prevailing interest rates change and these valuation adjustments, which are disclosed in the relevant notes, have also contributed to overall movements in our financial liabilities. 

 

Derivatives and fair value adjustments of £2.4 billion (2013: £4.0 billion) included in financial liabilities largely comprise interest rate and other derivatives taken out to hedge our core lending and funding activities. The negative value of these positions has reduced significantly over the course of the year as the upward trend in market interest rates has improved valuations of derivatives used to hedge fixed rate assets.



CAPITAL STRUCTURE

4 April 2014

£m / %

CRD IV1 

4 April 2013

£m / %

CRD IV

Proforma

4 April 2013

£m / %

Basel II

Capital resources

Common Equity Tier 1 capital

5,849

4,551

5,454

Total Tier 1 capital (transitional)

7,433

5,488

6,894

Total regulatory capital (transitional)

9,704

7,746

8,496

Risk weighted assets (RWAs)

 40,455

 50,285

 44,440

CRD IV capital ratios (unadjusted)

Common Equity Tier 1  (CET1) ratio

Leverage ratio

14.5%

3.3%

9.1%

2.2%

12.3%  

PRA adjusted ratios

PRA adjusted CET1 ratio

PRA adjusted leverage ratio

 

11.2%

3.2%

1. Capital resources, RWAs and ratios above are reported under CRD IV on an 'end point' basis with the exception of total Tier 1 capital and total regulatory capital, which include grandfathered legacy Tier 1 and 2 instruments under transitional rules.

 

We reported our capital position under the Basel II framework last year. Basel III was implemented through the Capital Requirements Regulation and Directive, together "CRD IV", and became effective on 1 January 2014. The table above includes prior year amounts on the previously reported Basel II basis and under CRD IV on a proforma basis to aid comparability. The concept of leverage was not captured under Basel II and so was not reported in the prior year. PRA adjusted measures, which are explained further in the Capital Management Report, were not established until 20 June 2013, and so are also not relevant to prior reporting periods.

 

The impact of CRD IV is complex but in summary tends to reduce capital resources by imposing risk based deductions which were not recognised under Basel II and restricting eligibility of non-core capital instruments either entirely or on a phased basis under transitional rules which extend to 31 December 2021. CRD IV also increases risk weighted assets through a variety of adjustments designed to capture risks associated with the valuation or ultimate realisation of assets which were deemed not to be recognised sufficiently under Basel II. Given these differences in the basis of measurement of our capital position, and the fact that only Basel III is relevant to the regulatory assessment today, the analysis below focuses on the movement in CRD IV measures only.

 

Our CET1 capital resources have increased over the financial year by approximately £1.3 billion. This increase includes £531 million of net proceeds from our inaugural issue of CCDS in December 2013 and retained earnings of £549 million. The remainder of the increase relates primarily to a £201 million reduction in the adjustment for unrealised fair value deficits on our "available for sale" portfolio held in Treasury, as a proportion of the assets have been sold during the year, and the fair value of the remainder has increased as market prices have improved.

 

Our total capital resources have increased over the financial year by approximately £2.2 billion. The balance of the increase in capital resources relates to our issue of £1 billion of Additional Tier 1 capital securities in March 2014 net of other more minor adjustments, including a reduced level of outstanding permanent interest bearing shares (PIBS) following our redemption of PIBS in September and October 2013.

 

The issue of CCDS represented a strategically important landmark for Nationwide and is discussed in the Chief Executive's Report. CCDS are fully qualifying common equity capital instruments under Basel III, but importantly incorporate features which are consistent with a mutual ownership structure. In particular, CCDS holders are members of the Society and the Board acknowledges a fiduciary responsibility towards them; they are subject to the "one member, one vote" principle in line with other membership interests (although for other reasons in practice their votes are unlikely ever to be exercised in general meetings); the investment returns available to CCDS holders are subject to an inflation linked cap thus mitigating the risk of over distribution; and finally the distribution available to CCDS investors in the event the Society is wound up is restricted to their original investment thus avoiding any incentive to lobby for demutualisation.

 

Risk weighted assets reduced significantly over the year due to the deleverage of legacy treasury and CRE assets; the total deleverage across these two asset classes during the year amounted to approximately £3.5 billion in gross terms and £5.2 billion in risk weighted terms.  In addition ongoing credit risk migration within the CRE portfolio tends to reduce RWAs as exposures are treated as deductions from capital, and hence carry a zero risk weight, when they are classified as in default.

 

The movements described above have resulted in an increase in our CET1 ratio from 9.1% to 14.5%, and in our leverage ratio from 2.2% to 3.3%, on a like for like basis over the course of the year. On a PRA adjusted basis our CET1 and leverage ratios were 11.2% and 3.2% compared with regulatory targets of 7% and 3% respectively. The regulatory adjustment to our leverage ratio is modest and relates to an asset valuation adjustment of £127 million. The adjustment to our CET1 ratio is more significant due to the fact that for this measure the regulator also introduces a risk weight floor of 15% for residential mortgages, leading to an increase in our RWAs of £10.6 billion (26%).

 

More details of the capital position are included in the Capital Management Report.

 

  

 

 

BUSINESS AND RISK REPORT

                 

Introduction and key risks

 

Overview

 

This Business and Risk Report explains in greater detail the Group's business, the risks it is exposed to and how it manages those risks.

 

The Group is organised into three business streams: Retail, Commercial and Head Office functions. The Group is predominantly a retail focused operation which trades almost exclusively within the UK, with the exception of wholesale funding and liquidity management activities. Wholesale funding is accessed by the Group from both UK and overseas markets. The Group's liquidity position is actively managed from the UK.

 

The Group's operations incorporate a commercial property lending business and a treasury portfolio which includes loans to banks, cash, investment securities and derivatives.

 

The chart below shows the Group's business model and how these activities are reflected in its risk measures. The regulatory capital risk weightings below indicate the relative risks each area carries as at 4 April 2014. Please see the Capital Management section of this report for further details regarding the Group's capital position.

 

  

Nationwide Group

 

Operating

Segment

 

Retail

 

Commercial

 

Head office (including Treasury)

 

Activities

 

·  Prime residential lending

·  Specialist residential lending

·  Consumer banking

·  Savings products

·  Insurance

·  Investments

 

·  Commercial lending business

·  Commercial real estate

·  Social housing

Project Finance

·  Treasury including funding, liquidity and market risk management

·  Head office functions

·  Central support functions

 

Regulatory Risk Weighted Assets as at 4 April 2014

 

                              £m

Credit risk           22,004

Operational risk     3,542         

Market risk                  -        

 

                             £m

Credit risk            9,061

Operational risk       111

Market risk                  -

 

                             £m

Credit risk            5,599

Operational risk       109         Market risk               29

 

 

  

Principal risks

 

Whilst the Group accepts that all of its business activities involve risk, it seeks to protect its members by managing the risks that arise from its activities appropriately. The principal risks inherent within the business aredescribed in the table below:

 

Risk category

Definition

Lending

The risk that a borrower or counterparty fails to pay interest or to repay principal on a loan or other financial instrument (e.g. a bond) on time. Lending risk also encompasses extension risk and concentration risk.

Financial

The risk of the Group having inadequate earnings, cash flow or capital to meet current or future requirements and expectations. It includes loss or damage to the earnings capacity, market value or liquidity of the Group, arising from mismatches between the Group's assets, funding and other commitments, which may be exposed by changes in market rates, market conditions or the Group's own credit profile.

Operational

The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.

Customer and compliance

The risk that the organisation fails to design and implement operational arrangements, systems and controls such that it can maintain legal and regulatory compliance, deliver fair customer outcomes and achieve a positive experience for customers.

Strategic

The risk of significant loss or damage arising from business decisions that impact the long-term interests of the membership, or from an inability to adapt to external developments.

 

In addition to these principal categories of risk, model risk, which the Group is exposed to, is managed under a separate framework across all risk categories and business areas where risk models are used.

 

Risk category

Definition

Model risk

The risk that an adverse outcome occurs as a direct result of weaknesses or failures in the design or use of a model.  The adverse consequences include financial loss, poor business or strategic decision making, or damage to the Group's reputation.

 

The frameworks for the above risks (including associated risk appetite, limits, supporting policies and other documents) are reviewed annually or more frequently as appropriate. They are also subject to continuous monitoring by the relevant governance committees and by the Chief Risk Officer.

 

In addition to these principal risks that are inherent in the Group's business it identifies, monitors and manages the top and emerging risks that could affect delivery of the Corporate Plan as an integral element of its risk and management strategy.

 

Top and emerging risks

 

The Group's top and emerging risks are identified through the process outlined in the Risk Governance section, and are closely tracked throughout the governance structure. The Group continues to keep these risks under close observation through risk reporting and metrics where appropriate.

 

The Group sees three themes to its top and emerging risks: continuing to contain financial and lending risks, evolving with the new regulatory environment and managing the operational risks driven by digital transformation.

  

Continuing to contain financial and lending risks

 

Managing financial and lending risks is a fundamental part of what Nationwide does. Over the past few years, the Group's exposure to financial risk has decreased as its profitability has improved. The Group has successfully issued new capital and has been deleveraging its highest risk lending books. The current economic environment poses three main risks to the Group's continuing ability to manage financial and lending risks:

 

·      The housing price bubble bursting, accompanied by a reversal in the UK economy, could increase credit losses significantly

Government policies, the low interest rate environment, and a significant flow of overseas buyers stimulate the housing market. There is a risk that these conditions may reverse, increasing credit losses in the Group's mortgage portfolios and depressing the wider economy.

 

·      Resurgent competition could squeeze core margins below sustainable levels

The margin earned on the Group's core products may be squeezed through increased competition. Several of the Group's competitors have announced strategic changes, reducing their international and investment banking activities to refocus on the UK retail banking market where they have set ambitious growth objectives.

 

·      Wider global financial developments, for example the re-emergence of tensions within the Eurozone, might increase the Group's funding costs

The global economy has strengthened in the past 12 months. However, uncertainties remain over the sustainability of this recovery. The risk of Eurozone break up has broadly receded. However, it remains a possibility. Whilst the Eurozone has emerged from recession, risks to economic growth persist and could affect the outlook. In addition, the political issues arising on the edge of Europe pose risks to the wider economic outlook and investor sentiment.

 

Evolving with the new regulatory environment

 

Dealing with regulation is an unavoidable part of running a modern financial institution. Nationwide's business model and member focus puts it in a good position to meet the regulator's expectations of conduct and the Group has seen proportionately less enforcement action and customer redress than its competitors. There are two key areas in the regulatory environment that pose a risk to achievement of the Group's goals:

 

·      Increasing standards for conduct could restrict the Group's channels, services or proposition

The FCA is still evolving its approach to conduct risk but is already significantly more assertive than its predecessor. The digitisation of the Group's proposition provides further challenges where legislation and processes are carried forward into the digital age. The Group will design and implement appropriate controls and process in order to continue to provide the services that its members value against the changing regulatory backdrop.

 

·      Regulatory standards, for example the minimum leverage ratio, could increase

The regulatory expectations and requirements set for financial services providers are still undergoing change as national and international regulatory initiatives develop. There is a risk that further increases in capital and leverage requirements have the potential to adversely impact the building society model, constraining growth or forcing retrenchment.

  

Managing the operational risks driven by digital transformation

 

The pace of technological development is creating a period of significant change in financial services. The Group's aim is to make the most of new technology to achieve its goal of being number one for customer service. The Group has already successfully delivered a new banking system, mortgage system and mobile banking alongside a number of other technology changes. As the Group continues to invest in new technology there are three areas that pose a risk to achieving its goals:

 

·      Rising customer expectations could exceed the Group's ability to provide highly reliable, widely available  services

The rise of digital banking is changing customer expectations of the availability of banking services. As digital changes make transactions easier and more convenient the Group expects customers to transact more, and in many different ways. The Group needs to ensure it manages service provision ahead of rising customer expectations to maintain its goal of being number 1 for customer service.  The Group has a programme in place to ensure that while developing its digital proposition it also increases IT resilience and round-the-clock service availability.

 

·      Executing changes to business processes to adapt to the new environment could disrupt the Group's business or its customers

The Group will make significant investment in transforming its products and delivery channels to meet evolving consumer and regulatory expectations. The complexity of these transformation activities may increase the inherent risk of system failures or errors and the Group will need to ensure controls to manage this remain effective in order to underpin its services to members.

 

·      Building a new digital proposition that appeals to new members could compromise the services that are valued by longer established members

The Group faces a challenge to strengthen its appeal to customers who have affinity to new, digital technologies whilst still providing market leading service to those members who value traditional services, such as its branch network and contact centres.

 

The Group's business and managing risks in it

 

The following sections contain detailed analysis of the Group's business, principally its balance sheet, and provide further analysis in the context of the principal risks and top and emerging risks identified above. Information is given regarding management and mitigation of risks. This review covers:

 

·      Loans and advances and lending risks

·      Treasury assets and treasury credit risks

·      Financial risk management

·      Operational risks

·      Customer and compliance risks

·      Strategic risks

 

Details relating to market risk management, pension obligation risks and the Group's risk governance framework are provided in the Group's Annual Report and Accounts 2014.

 

 Loans and advances and lending risks

 

Loans and advances to customers

 

Loans and advances to customers account for 87.7% (2013: 87.0%) of the Group's total assets. Lending remains concentrated on high quality secured products with residential mortgages accounting for 87.3% of the Group's gross loans and advances to customers. This is an increase from 2013 (85.0%) reflecting the Group's strategy of exiting non-core commercial lending.

Loans and advances to customers

 

4 April 2014 

 

4 April 2013 

 

£m

%

£m

%

Prime residential mortgages

119,319

71.5

110,619

69.4

Specialist residential mortgages

26,341

15.8

24,939

15.6

Total residential mortgages

145,660

87.3

135,558

85.0

Commercial lending

17,284

10.3

19,916

12.5

Other lending

176

0.1

436

0.3

Consumer banking

3,862

2.3

3,488

2.2

Gross balances

166,982

100.0

159,398

100.0

Impairment provisions

(1,288)

(1,224)

Fair value adjustment  for micro hedged risk

880

1,413

Total

166,574

159,587

 

Lending risk

 

Lending risk is considered by reference to the four main types of lending the Group provides and relates to the risk that a borrower or counterparty fails to pay interest or to repay principal on a loan or other financial instrument. Lending risk includes all aspects of credit risk including concentration risk and extension risk.

 

Risk category

Portfolio

Retail (secured)

Residential mortgages including prime mortgage and specialist lending.

Retail (unsecured)

Consumer banking including personal loans, credit card and banking portfolios.

Commercial

Commercial lending portfolio.

Treasury

Treasury liquidity and discretionary portfolios.

 

Comprehensive credit risk management methods and processes are established as part of the Group's overall governance framework to measure, mitigate and manage credit risk within its risk appetite. As a mutual, the Group maintains a conservative approach to risk as shown by the quality of its balance sheet. Lending risk portfolios are managed within concentration limits and are subjected to stress testing and scenario analysis to simulate potential outcomes and calculate their associated impact.

 

Each of the above portfolios is considered in turn below.

 

 

Residential mortgage lending and credit risks

 

Overview

 

The makeup of prime and specialist mortgage lending is as follows:

 

2014

2013

£m

%

£m

%

Buy to let

21,932

83

20,081

80

Self-certified

2,960

11

3,297

13

Near prime

1,037

4

1,162

5

Sub prime

412

2

399

2

Specialist lending

26,341

100

24,939

100

Prime lending

119,319

110,619

Total residential mortgages

145,660

135,558

 

The Group's residential mortgages include both prime and specialist loans. Prime residential mortgages are mainly Nationwide branded advances made through the Group's branch network and intermediary channels.

 

All new specialist lending is originated through The Mortgage Works (UK) plc (TMW), exclusively in the buy to let market. Self-certified lending was originated historically by TMW, UCB Home Loans Corporation Limited (UCB) and Derbyshire Home Loans Limited, but this type of lending was discontinued in 2009. The majority of near prime and subprime balances were acquired from the Derbyshire and Cheshire building societies.

 

Prime mortgage assets purchased from the Bank of Ireland in December 2011, although acquired by TMW, are categorised as prime business. New specialist lending is restricted to buy to let.

 

The major risk on retail mortgages is credit risk. The Group's prudent approach to new business means that impairments are low and rising house prices have further improved the position. The impairment position is summarised below:

 

2014

2013

£m

%

£m

%

Prime book:

Impaired balances / % of book

504

0.42

564

0.51

Impairment provisions / coverage

18

3.6

32

5.7

Impairment credit for the year

-

(6)

Specialist lending:

Impaired balances / % of book

651

2.47

726

2.91

Impairment provisions / coverage

84

12.9

133

18.3

Impairment charge for the year

-

22

 

Impairment charges and provisions have reduced in both prime and specialist lending books reflecting increases in the House Prices Index (HPI), the Group's prudent underwriting discipline and its approach to managing cases individually. The sections below provide greater detail on credit concentrations and performance on the book.

 

Significant events/environment

 

Over the past year UK house prices have increased by 9.5% with growth in most geographical areas albeit that biggest rises have been in London and the South East. This growth has eased credit risk pressures to date but is being kept under close review.

 

The Group is committed to supporting the housing market and first time buyers in particular. As a result, the average loan to value (LTV) of new residential mortgage lending has increased to 69% (2013: 67%) calculated on a volume basis. The Group's strategy is supported by a robust affordability assessment and credit scoring process that ensures that asset quality remains within the Group's risk appetite. The success of these controls is demonstrated by the continuing low arrears and impairment performance of the secured portfolios.

 

The Group has supported government initiatives in the housing market, accepting applications under the Help to Buy shared equity scheme. In doing so, the proportion of the Group's new lending which is on new build property has increased. The Group is closely monitoring the volume of lending within both the Help to Buy scheme and on new build properties to ensure unreasonable concentrations of lending are not introduced into the portfolio.

 

Initiatives to support the first time buyer market continue to include the Save to Buy product, which enables 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.

 

TMW has strategically adjusted its product range in order to attract larger loans.  This has resulted in the average specialist loan size increasing by approximately £15,000 in the last 12 months and an increased proportion of lending in the South East where property prices are higher. Industry leading controls to reduce the potential misuse of buy to let mortgages  for residential lending have proven to be effective. Despite increased competition TMW has maintained a strong market presence with around 17% market share in 2013/14.

 

Geographical concentration

 

Residential mortgages are only secured against UK properties. The geographical split of the book for the year ended 4 April 2014 is shown below:

 

Analysis calculated on a value basis

 

2014

%

2013

           %

Greater London

        32

22

Central England

        19

22

Northern England

           16

20

South East England (excluding London)

        12

11

South West England

             9

9

Scotland

          7

9

Wales and Northern Ireland

          5

7

Total

100

100

 

Loan to value (LTV)

 

All borrowing applications are subject to appropriate credit risk underwriting processes, including an affordability assessment. For secured loans, pricing will typically vary by LTV. Higher LTV products are typically subject to higher interest rates commensurate with the associated risk.

 

LTV of loan stock and new business

2014

%

2013

%

Average loan to value of stock (indexed) by volume

48

51

Average loan to value of new business by volume

69

67

Average loan to value of stock (indexed) by value

58

62

Average loan to value of new business by value

73

71

 

Note: The average value of new business above excludes further advances.

  

LTV is measured both on a volume basis (i.e. number of loans) and by value (based on mortgage balance at balance sheet date for stock and at inception for new business). The average LTV on the overall stock (indexed) has reduced by 3% to 48% (2013: 51%), and average LTV of new business has increased by 2% to 69% (2013: 67%) on a volume basis with similar movements in value based LTV.

 

The details in the remainder of this section use value based calculations to allow analysis of the balance sheet.

 

New business by borrower type

2014

%

2013

%

Home movers

32

36

First time buyers

31

26

Remortgagers

22

22

Other

1

0

Buy to let

14

16

100

100

 

Note: The new business profile of new business above excludes further advances.

 

The proportion of first time buyers has increased over the year, as the Group has actively supported this segment of the market as part of the wider Nationwide Citizenship agenda. Competitive pricing to this segment, predominantly within a higher LTV range (80%-90%) has been used in conjunction with other initiatives such as the running of first time buyer clinics to support first time buyers through their journey of buying their first home. This focus on first time buyers at higher LTVs has driven the increase in LTV on new lending.

 

The table below sets out the LTV profile for new business:

New residential lending - distribution of loans by original LTV band

2014

%

2013

%

Loan to value analysis:

0% - 60%

19

21

60% - 75%

38

38

75% - 80%

10

12

80% - 85%

15

18

85% - 90%

16

9

90% - 95%

2

2

>95%

-

-

100

100

 

  

The table below shows LTVs for the Group's residential mortgage portfolio split between performing and non-performing loans and by geographical segment. Average LTVs are calculated on a weighted value basis. Non-performing accounts include all impaired loans and also loans which are past due but not yet impaired; performing loans are neither past due nor impaired.

 

Residential mortgage balances by LTV and region

 

Greater London

Central England

Northern England

South East England (excluding London)

South West England

Scotland

Wales & Northern Ireland

Total


      £m

£m

£m

£m

£m

£m

£m

£m

%

At 4 April 2014

Performing loans

Fully collateralised

LTV ratio:

<50%

16,771

7,405

5,587

5,916

4,165

2,664

1,899

44,407

50-60%

8,889

3,576

2,758

2,764

1,839

1,305

832

21,963

60-70%

10,703

5,097

4,240

3,712

2,615

1,915

1,155

29,437

70-80%

6,418

6,196

5,860

3,721

2,917

2,456

1,492

29,060

80-90%

1,972

3,213

3,401

1,488

1,359

1,352

915

13,700

90-100%

38

424

1,102

72

108

244

331

2,319

44,791

25,911

22,948

17,673

13,003

9,936

6,624

140,886

96

Partially collateralised

- >100% LTV (A)

7

31

188

4

8

56

510

804

1

- collateral value on A

5

29

177

3

6

53

414

687

Total performing loans

44,798

25,942

23,136

17,677

13,011

9,992

7,134

141,690

97

Non-performing loans

Fully collateralised

LTV ratio:

<50%

366

149

110

104

62

50

50

891

50-60%

229

85

69

59

34

26

25

527

60-70%

292

139

114

87

58

40

37

767

70-80%

187

162

157

95

70

61

42

774

80-90%

55

134

146

63

53

38

37

526

90-100%

5

67

127

14

16

20

38

287

1,134

736

723

422

293

235

229

3,772

2

Partially collateralised

- >100% LTV (B)

2

14

52

3

3

10

114

198

1

- collateral value on B

2

13

47

2

2

10

86

162

Total non-performing loans

 

1,136

750

775

425

296

245

343

3,970

3

Total residential mortgages

45,934

26,692

23,911

18,102

13,307

10,237

7,477

145,660

100

 

 

 

Residential mortgage balances by LTV and region

 

 

Greater London

Central England

Northern England

South East England (excluding London)

South

West England

Scotland

Wales & Northern Ireland

Total


       £m

£m

£m

£m

£m

£m

£m

£m

%

At 4 April 2013

Performing loans

Fully collateralised

LTV ratio:

<50%

13,083

6,609

5,034

5,121

3,756

2,348

1,738

37,689

50-60%

5,593

2,778

2,177

1,992

1,447

1,028

701

15,716

60-70%

8,002

3,929

3,103

2,787

2,005

1,353

927

22,106

70-80%

8,627

5,118

4,535

3,308

2,496

1,802

1,160

27,046

80-90%

4,399

4,140

4,151

2,506

1,853

1,908

1,064

20,021

90-100%

448

1,587

2,110

674

550

688

524

6,581

40,152

24,161

21,110

16,388

12,107

9,127

6,114

129,159

95

Partially collateralised

- >100% LTV (A)

19

222

823

47

52

225

733

2,121

2

- collateral value on A

17

213

782

45

50

212

594

1,913

Total performing loans

40,171

24,383

21,933

16,435

12,159

9,352

6,847

131,280

97

Non-performing loans

Fully collateralised

LTV ratio:

<50%

290

140

105

90

60

43

47

775

50-60%

157

70

57

46

29

20

23

402

60-70%

239

105

86

66

45

29

28

598

70-80%

303

147

126

76

64

46

40

802

80-90%

195

162

151

92

62

52

42

756

90-100%

53

133

160

55

49

32

38

520

1,237

757

685

425

309

222

218

3,853

2

Partially collateralised

- >100% LTV (B)

10

58

143

16

11

33

154

425

1

- collateral value on B

9

54

133

14

10

31

114

365

Total non-performing loans

1,247

815

828

441

320

255

372

4,278

3