REG - CYBG PLCClydesdale Bank PLC - Final Results <Origin Href="QuoteRef">CYBGC.L</Origin> - Part 3
21/11/2017 07:06
- Part 3: For the preceding part double click ID:nRSU0461Xb
2017 £m 2016 £m
Interest income and similar income
Loans and advances to other banks 11 22
Financial assets available for sale 11 11
Loans and advances to customers 1,030 1,037
Financial assets at fair value through profit or loss 18 27
Due from related entities - 1
Other interest income 5 3
Total interest income and similar income 1,075 1,101
Less: interest expense and similar charges
Due to other banks 15 8
Financial liabilities at fair value through profit or loss - 1
Due to customers 126 188
Debt securities in issue 90 87
Due to related entities - 11
Total interest expense and similar charges 231 295
Net interest income 844 806
Financial statements
Notes to the consolidated financial statements
Section 2: Results for the year continued
2.3 Non-interest income
Accounting policyGains less losses on financial instruments at fair valueThis includes fair value gains and losses from three distinct activities:· derivatives classified as held for trading - the full change in fair value of trading derivatives is recognised inclusive of interest income and expense arising on those derivatives except when economically hedging other assets and liabilities at fair value outlined in note 2.2;· other financial assets and liabilities designated at fair value through
profit or loss - these relate to the Group's fixed interest rate loan portfolio and related term deposits (note 3.3), which were designated at inception as fair value through profit or loss. The fair value of these loans is derived from the future loan cash flows using appropriate discount rates and includes adjustments for credit risk and credit losses. The valuation technique used is reflective of current market practice; and· hedged assets, liabilities and derivatives designated in hedge
relationships - fair value movements are recognised on both the hedged item and hedging derivative in a fair value hedge relationship (the net of which represents hedge ineffectiveness), and hedge ineffectiveness on cash flow hedge relationships (note 3.4).Fees and commissionsWhere not integral to the effective interest rate, these are recognised on an accruals basis as the services are provided or on completion of the underlying transaction.
2017 £m 2016 £m
Gains less losses on financial instruments at fair value
Interest rate derivatives 45 3
Other assets and liabilities at fair value(1) (35) 7
Ineffectiveness arising from fair value hedges (note 3.4) (4) -
Ineffectiveness arising from cash flow hedges (note 3.4) - (1)
6 9
Other operating income
Fees and commissions 146 151
Margin on foreign exchange derivative brokerage 18 19
Gains on disposal of available for sale financial assets 20 8
Net fair value movement on investment properties (1) (1)
Other income 3 5
186 182
Total non-interest income 192 191
(1) A credit risk gain on other assets and liabilities at fair value of £6m, offset by a fair value loss of £41m, has been
recognised in the current year (2016: £11m gain and £4m loss, respectively).
On 28 April 2017, MasterCard completed its acquisition of 94.2% of VocaLink. By virtue of its 3.24% shareholding in
VocaLink, the Group received cash consideration of £25m. The resulting gain of £20m, which was recognised in the available
for sale reserve following the acquisition announcement in 2016, was recycled to the income statement and is included
within 'Gains on disposal of available for sale financial assets' in the current year.
Financial statements
Notes to the consolidated financial statements
Section 2: Results for the year continued
2.4 Operating and administrative expenses
Accounting policyPersonnel expenses primarily consist of wages and salaries, accrued bonus and social security costs, arising from services rendered by employees during the financial year.The Group recognises bonus costs where it has a present obligation that can be reliably measured. Bonus costs are recognised over the relevant service period required to entitle the employee to the reward.The Group's accounting policies on pension expenses and equity based compensation are included in notes 3.16 and 4.2
respectively.
2017 £m 2016 £m
Personnel expenses 166 280
Restructuring expenses (note 3.14) 67 45
Depreciation and amortisation expense (notes 3.8, 3.10) 87 88
Other operating and administrative expenses 400 468
Total operating and administrative expenses 720 881
Personnel expenses comprise the following items:
2017 £m 2016 £m
Salaries, wages and non-cash benefits and social security costs 171 211
Defined contribution pension expense 19 20
Defined benefit pension (income)/expense (note 3.16) (54) 28
Equity based compensation (note 4.2) 6 5
Other personnel expenses 24 16
Personnel expenses 166 280
The Group recognised gains in relation to its defined benefit pension scheme in the year. A past service credit of £88m is
included in personnel expenses as a result of the closure of the Scheme to future accrual for the majority of members. In
addition, a curtailment gain of £13m was recognised in respect of redundancies which did not attract an enhancement
entitlement and offsets against the related restructuring costs.
The average number of FTE employees of the Group during the year was made up as follows:
2017 Number 2016 Number
Managers 2,234 2,460
Clerical staff 3,806 4,258
6,040 6,718
The average monthly number of employees was 6,818 (2016: 7,567).
All staff are contracted employees of the Group and its subsidiary undertakings. The average figures above do not include
contractors.
Other items of significance to the Group which are included within other operating and administrative expenses are:
2017 £m 2016 £m
Operating lease charges 29 30
Impairment losses on software (note 3.10) - 45
PPI redress expense (note 3.14) 48 44
Other conduct expenses (note 3.14) 10 7
Separation costs 8 11
Auditor's remuneration 2 2
Financial statements
Notes to the consolidated financial statements
Section 2: Results for the year continued
Auditor's remuneration included within other operating and administrative expenses:
2017 £'000 2016 £'000
Fees payable to the Company's auditor for the audit of the Company's financial statements 20 20
Fees payable to the Company's auditor for the audit of the Company's subsidiaries 1,251 1,387
Total audit fees 1,271 1,407
Audit related assurance services 124 180
Other assurance services 308 35
Total non-audit fees 432 215
Fees payable to the Company's auditor in respect of associated pension schemes 63 75
Total fees payable to the Company's auditor 1,766 1,697
Non-audit services performed by the auditor during the year included agreed upon procedures under the Conduct Indemnity
arrangement with NAB; regular profit attestations; preparation of a comfort letter for the global medium term note
programme issuance; and a client asset regulatory review.
In addition to the above, out of pocket expenses of £48k (2016: £58k) were borne by the Group, principally related to
reimbursement of travel expenses incurred by staff when performing the above services.
2.5 Taxation
Accounting policyIncome tax on the profit or loss for the year comprises current and deferred tax. Income tax is recognised in the income statement except to the extent that it is related to items recognised directly in equity, in which case the tax is also recognised in equity.Current tax is the expected tax payable or receivable on the taxable profit or loss for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous
years. Deferred tax assets and liabilities are recognised on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. Deferred tax is determined using tax rates and laws that have been enacted or substantively enacted by the balance sheet date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.
2017 £m 2016 £m
Current tax
UK corporation tax
Current year 17 12
Adjustment in respect of prior years - (3)
17 9
Deferred tax (note 3.11)
Current year 64 236
Adjustment in respect of prior years 5 (4)
69 232
Tax expense for the year 86 241
The tax assessed for the year differs from that arising from applying the standard rate of corporation tax in the UK. A
reconciliation from the expense implied by the standard rate to the actual tax expense is as follows:
2017 £m 2016 £m
Profit on ordinary activities before tax 268 77
Tax expense based on the standard rate of corporation tax in the UK of 19.5% (2016: 20%) 52 15
Effects of:
Disallowable expenses 9 8
Conduct indemnity adjustment 7 (1)
Deferred tax assets (recognised)/written off (21) 237
Impact of rate changes 34 (11)
Adjustments in respect of prior years 5 (7)
Tax expense for the year 86 241
Financial statements
Notes to the consolidated financial statements
Section 2: Results for the year continued
2.5 Taxation continued
The total amount of tax, current and deferred, recognised directly in equity during the year was a credit of £1m (2016:
£21m).
Disallowable expenses represent, in the main, the Group's share of incremental conduct charges that are not deductible in
computing taxable profits.
The Conduct indemnity adjustment represents the receipt from/payment to the Group's former parent less refunds attributable
in accordance with the indemnity agreement (note 3.14).
The rate at which deferred tax is recognised in respect of the defined benefit pension scheme has changed due to the
closure of the Scheme. The surplus is accounted for as a potential refund to the employer, not a reduction in future
contributions. In accordance with tax legislation this 'authorised surplus payment' is recognised as a deferred tax
liability at 35%. There is an overall rate change in respect of the pension of £37m with £30m taken to the income statement
and £7m to the statement of other comprehensive income.
2.6 Earnings per share (EPS)
Accounting policyBasic earnings per shareBasic earnings per share is calculated by taking the profit attributable to ordinary shareholders of the parent company and dividing this by the weighted-average number of ordinary shares outstanding during the period.Diluted earnings per shareThis requires the weighted average number of ordinary shares in issue to be adjusted to assume conversion of all dilutive potential ordinary shares. These arise from awards made under equity based compensation schemes. Share
awards with performance conditions attaching to them are not considered to be dilutive unless these conditions have been met at the reporting date.
The Group presents basic and diluted earnings/(loss) per share data in relation to the ordinary shares of CYBG PLC.
2017 £m 2016 £m
Profit/(loss) attributable to ordinary shareholders 146 (206)
Tax relief on AT1 distribution attributable to ordinary equity holders 7 7
Tax relief on loss on repurchase of CYB Investments Limited (CYBI) AT1 issued to NAB - 1
Profit/(loss) attributable to ordinary equity holders for the purposes of basic and diluted EPS 153 (198)
2017Number ofshares(million) 2016Number ofshares(million)
Weighted-average number of ordinary shares in issue
- Basic 883 880
- Diluted 884 880
Basic earnings/(loss) per share (pence) 17.3 (22.5)
Diluted earnings/(loss) per share (pence) (1) 17.2 (22.5)
(1) The comparative has been restated so that the dilutive effect of the potentially dilutive share based payment awards
has been excluded from the calculation on the basis that it would have reduced the loss per share.
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities
3.1 Cash and balances with central banks
2017 £m 2016 £m
Cash assets 1,507 1,313
Balances with central banks (including EU payment systems) 5,430 4,642
6,937 5,955
Less mandatory deposits with central banks(1) (44) (43)
Included in cash and cash equivalents (note 5.2) 6,893 5,912
(1) Mandatory deposits are not available for use in the Group's day to day business and are non-interest bearing.
3.2 Financial assets available for sale
Accounting policyAvailable for sale financial assets are recognised on trade date and comprise listed and unlisted non-derivative financial assets not classified into any other financial asset category. They are initially recognised at fair value including direct and incremental transaction costs, and subsequently measured at fair value. Gains and losses arising from changes in fair value are included as a separate component of equity until sale or impairment, at which point the cumulative gain or loss is
transferred to the income statement.All available for sale financial assets are continually monitored for evidence of any impairment, which would typically be deemed to have arisen where there is evidence of a significant or prolonged reduction in the fair value of the security below its cost. Where such evidence of impairment exists, the cumulative net loss previously recognised directly in equity is transferred to the income statement.In situations where evidence suggests a subsequent increase in value,
reversals of impairment of previously impaired equity instruments are recognised directly in equity; reversals of impairment of debt instruments are recognised in the income statement.Interest income, determined using the effective interest method, is recognised in the income statement. Impairment losses and translation differences on monetary items are recognised in the income statement within the year in which they arise.
2017 £m 2016 £m
Listed securities 2,066 1,695
Unlisted securities 4 29
Other financial assets 6 7
2,076 1,731
Refer to note 3.18 for further information on the valuation methodology applied to available for sale assets and their
classification within the fair value hierarchy.
Credit quality of investments
2017 £m 2016 £m
Available for sale
Senior investment grade 2,066 1,695
Other 10 36
2,076 1,731
Senior investment grade securities
These include £1,221m (2016: £1,286m) of UK Government Gilts. The remainder relates to highly liquid, AAA-rated corporate
bonds.
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.3 Financial assets and liabilities at fair value through profit or loss
Accounting policyFinancial assets and liabilities are designated at fair value through profit or loss, with gains and losses recognised in the income statement as they arise (note 2.3), when this reduces an accounting mismatch or where the performance is evaluated on a fair value basis. In such cases, transaction costs are recognised immediately in the income statement upon initial recognition of the financial asset and liability.The derivatives related to the assets and liabilities at fair value through
profit or loss do not meet the requirements for hedge accounting and are accounted for as held for trading derivative financial instruments (note 3.4).Critical accounting estimates and judgementsWhere the fair values of financial assets and financial liabilities recorded on the balance sheet cannot be derived from active markets, they are determined using a variety of valuation techniques that include the use of mathematical models. The inputs to these models are derived from observable market data where
possible, but where such data is not available, judgement is required to establish fair values. The judgements include considerations of liquidity and model inputs. The most significant judgement is in relation to the Group's fair value loan portfolio. The most significant input impacting the carrying value of the loans other than interest rates is the future expectation of credit losses. Sensitivity analysis indicating the impact of reasonably possible changes in this input on the fair value is provided in
note 3.18.
2017 £m 2016 £m
Financial assets at fair value through profit or loss
Loans and advances 477 750
Financial liabilities at fair value through profit or loss
Due to customers - term deposits 26 48
Loans and advances
Included in financial assets at fair value through profit or loss is a historical portfolio of loans (sales ceased in
2012). Interest rate risk associated with these loans is managed using interest rate derivative contracts and the loans are
recorded at fair value to avoid an accounting mismatch. The maximum credit exposure of the loans is £477m (2016: £750m)
including accrued interest receivable of £2m (2016: £4m). The cumulative loss in the fair value of the loans attributable
to changes in credit risk amounts to £11m (2016: £24m) and the change for the current year is a decrease of £13m (2016:
decrease of £14m), of which £6m (2016: £11m) has been recognised in the income statement.
The loans are classified as Level 3 in the fair value hierarchy (note 3.18).
Due to customers - term deposits
Included in other financial liabilities at fair value are fixed rate deposits, the interest rate risk on which is hedged
using interest rate derivative contracts. The deposits are recorded at fair value to avoid an accounting mismatch.
The change in fair value attributable to changes in the Group's credit risk is £Nil (2016: £Nil). The Group is
contractually obligated to pay £1m (2016: £3m) less than the carrying amount at maturity to the deposit holder.
The term deposits are classified as Level 3 in the fair value hierarchy (note 3.18).
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.4 Derivative financial instruments
Accounting policyAll derivative instruments manage exposures to interest rates and foreign currency and are recognised on the balance sheet at fair value on trade date. The carrying value of a derivative is measured at fair value throughout the life of the contract. Derivatives are carried as assets when the fair value is positive and as liabilities when the fair value is negative. The notional amount of a derivative contract is not recorded on the balance sheet but disclosed as part of this note.The method
of recognising the resulting fair value gain or loss on a derivative depends on whether it is designated as a hedging instrument and, if so, the nature of the item being hedged. Certain derivatives are designated as either hedges of highly probable future cash flows attributable to a recognised asset or liability, or a highly probable forecast transaction (a cash flow hedge); or hedges of the fair value of recognised assets or liabilities or firm commitments (a fair value hedge). Cash flow hedgeThe
effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in equity. Specifically, the separate component of equity (note 4.1) is adjusted to the lesser of the cumulative gain or loss on the hedging instrument, and the cumulative change in fair value of the expected future cash flows on the hedged item from the inception of the hedge. Any remaining gain or loss on the hedging instrument is recognised in the income statement. The carrying
value of the hedged item is not adjusted. Amounts accumulated in equity are transferred to the income statement in the period in which the hedged item affects profit or loss.When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected
to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement.Fair value hedgeThe carrying value of the hedged item on initial designation is adjusted for the fair value attributable to the hedged risk. Subsequently, changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the
hedged risk. The movement in the fair value of the hedged item attributable to the hedged risk is made as an adjustment to the carrying value of the hedged asset or liability. Where the hedged item is derecognised from the balance sheet, the adjustment to the carrying amount of the asset or liability is immediately transferred to the income statement.When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, the adjustment to the carrying amount of a
hedged item is amortised to the income statement on an effective interest basis over the remaining life of the asset or liability.Hedge effectiveness The Group documents, at the inception of a transaction, the relationship between hedging instruments and the hedged items, and the Group's risk management objective and strategy for undertaking these hedge transactions. The documentation covers how effectiveness will be measured throughout the life of the hedge relationship and its assessment, both at hedge
inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. A hedge is expected to be highly effective if the changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is designated are expected to offset in a range of 80% to 125%. Derivatives held for trading The Group uses derivatives for risk management purposes and does not have
a trading book. However, derivatives that do not meet the hedging criteria within IAS 39, or for which hedge accounting is not applied, are classified as held for trading. Changes in value of held for trading derivatives are immediately recognised in the income statement (note 2.3).
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.4 Derivative financial instruments continued
The tables below analyse derivatives between those designated as hedging instruments and those classified as held for
trading.
Fair value of derivative financial assets
Designated as hedging instruments 202 351
Designated as held for trading 80 234
282 585
Fair value of derivative financial liabilities
Designated as hedging instruments 229 257
Designated as held for trading 147 341
376 598
376
598
Cash collateral on derivatives placed with banks totalled £338m (2016: £337m). Cash collateral received on derivatives
totalled £31m (2016: £57m). These amounts are included within due from other banks and due to other banks respectively.
The derivative financial instruments held by the Group are further analysed below. The notional contract amount is the
amount from which the cash flows are derived and is not an indication of the amounts at risk relating to these contracts.
Total derivative contracts as at 30 September 2017
Derivatives designated as hedging instruments
Cash flow hedges
Interest rate swaps 17,952 56 104
Cross currency swaps 527 89 -
Forward foreign exchange 6 - -
18,485 145 104
Fair value hedges
Interest rate swaps 1,452 57 125
Derivatives designated as held for trading
Foreign exchange rate related contracts
Spot and forward foreign exchange 2,689 45 47
Cross currency swaps 150 9 9
Options 103 2 2
2,942 56 58
Interest rate related contracts
Swaps 983 18 82
Swaptions 33 - -
Options 477 2 3
1,493 20 85
Commodity related contracts 93 4 4
Total derivative contracts 24,465 282 376
Total derivative contracts
24,465
282
376
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
Total derivative contracts as at 30 September 2016
Notionalcontractamount £m Fair valueof assets £m Fair valueof liabilities £m
Derivatives designated as hedging instruments
Cash flow hedges
Interest rate swaps 15,526 154 79
Cross currency swaps 760 88 -
Forward foreign exchange 5 - -
16,291 242 79
Fair value hedges
Interest rate swaps 1,452 109 178
Derivatives designated as held for trading
Foreign exchange rate related contracts
Spot and forward foreign exchange 2,202 84 78
Cross currency swaps 150 11 11
Options 216 5 5
2,568 100 94
Interest rate related contracts
Swaps 1,512 123 233
Swaptions 47 - 1
Options 569 2 4
2,128 125 238
Commodity related contracts 127 9 9
Total derivative contracts 22,566 585 598
Derivatives traded to manage the Group's interest rate exposure on a net portfolio basis are accounted for as cash flow
hedges. Derivatives traded to manage interest rate risk on certain fixed rate assets, such as UK Government Gilts, are
accounted for as fair value hedges. The Group also cash flow hedges its foreign currency exposure on material, highly
probable non-GBP denominated transactions.
The Group hedging positions also include those designated as foreign currency and interest rate hedges of debt issued from
the Group's securitisation and covered bond programmes respectively. As such, certain derivative financial assets and
liabilities have been booked in structured entities and consolidated within these financial statements.
Cash flow hedged derivatives include vanilla interest rate swaps within macro hedges and cross currency swaps within a
structured entity. The Group has notional commitments in the following periods:
Nominal values per time period 2017 £m 2016 £m
Within 0 to 3 months 92 1,452
Between 3 and 12 months 2,986 6,710
1 to 5 years 14,817 8,063
Greater than 5 years 590 66
18,485 16,291
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.4 Derivative financial instruments continued
The Group has hedged forecast future cash flows, which vary primarily with interest or foreign exchange rates. These cash
flows are expected to impact the income statement in the following periods:
Forecastreceivablecash flows 2017 £m Forecastpayablecash flows 2017 £m Forecastreceivablecash flows 2016 £m Forecastpayablecash flows 2016 £m
Within 1 year 52 399 29 261
Between 1 and 2 years 70 86 16 368
Between 2 and 3 years 70 86 15 59
Between 3 and 4 years 44 122 14 77
Between 4 and 5 years 19 6 8 112
Greater than 5 years 26 18 - 6
281 717 82 883
2017 £m 2016 £m
Gain/(loss) arising from fair value hedges (note 2.3)
Hedging instrument 1 15
Hedged item attributable to the hedged risk (5) (15)
(4) -
2017 £m 2016 £m
Loss from cash flow hedges due to hedge ineffectiveness (note 2.3) - (1)
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.5 Loans and advances to customers
Accounting policyLoans and advances to customers arise when the Group provides money directly to a customer and include overdrafts, credit card lending, lease finance, mortgages, invoice financing and term lending. Loans and advances to customers are initially recognised at fair value including direct and incremental transaction costs. They are subsequently measured at amortised cost, using the effective interest method, adjusted for impairment losses. They are derecognised when the rights to receive cash
flows have expired or the Group has transferred substantially all the risks and rewards of ownership. Leases entered into by the Group as lessor, where the Group transfers substantially all the risks and rewards of ownership to the lessee, are classified as finance leases. The leased asset is not held on the Group balance sheet; instead, a finance lease is recognised representing the minimum lease payments receivable under the terms of the lease, discounted at the rate of interest implicit in the lease.
Interest income is recognised in interest receivable, allocated to accounting periods to reflect a constant periodic rate of return.
2017 £m 2016 £m
Overdrafts 1,524 1,536
Credit cards 396 400
Lease finance 594 515
Mortgages 23,480 21,836
Other term lending - SME 4,762 4,393
Other term lending - Retail 709 690
Trade finance 23 26
Gross loans and advances to customers 31,488 29,396
Accrued interest receivable 75 76
Unearned income (28) (26)
Deferred and unamortised fee income (32) (29)
Impairment provisions on credit exposures (note 3.6) (210) (215)
31,293 29,202
The Group has transferred a proportion of mortgages to the securitisation and covered bond programmes (note 3.7).
The Group also has a portfolio of fair valued business loans of £477m (2016: £750m) which are held separately as Other
financial assets at fair value on the balance sheet (note 3.3). Combined with the above this is equivalent to total loans
and advances of £31,770m (2016: £29,952m).
Lease finance
The Group leases a variety of assets to third parties under finance lease arrangements, including vehicles and general
plant and machinery. The cost of assets acquired by the Group during the year for the purpose of letting under finance
leases and hire purchase contracts amounted to £13m (2016: £5m) and £408m (2016: £381m) respectively. The total receivables
from finance leases and hire purchase contracts were £17m (2016: £8m) and £550m (2016: £482m) respectively.
Finance lease and hire purchase receivables
2017 £m 2016 £m
Gross investment in finance lease and hire purchase receivables
Due within 1 year 241 224
Due within 1 to 5 years 346 288
Due after more than 5 years 7 3
594 515
Unearned income (27) (25)
Net investment in finance lease and hire purchase receivables 567 490
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.6 Impairment provisions on credit exposures
Accounting policyAssets carried at amortised costAt each reporting date the Group assesses if there is objective evidence of impairment on a financial asset or group of financial assets due to one or more loss events that occurred after initial recognition but prior to the balance sheet date. Examples of loss events are (i) where there has been an actual breach of contract by the borrower such as a default or delinquency in payment of interest or principal; or (ii) the granting of a concession to the
borrower that the Group would not otherwise consider.The Group first assesses whether objective evidence of impairment exists either individually for assets that are separately significant; or collectively for assets that are not separately significant. If it is determined that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, the asset is included in a group of financial assets with similar credit risk characteristics and collectively
assessed for impairment ('collective provisions').Collective provisionsCollective provisions are generally established for homogenous portfolios such as the Retail portfolios and the small business portfolio within the SME franchise. Within the Group's Retail environment, past loss experience is a key factor in determining an appropriate collective provision level and takes into account a number of different elements including:· the number of days past due; · the realisable value of any security
held; and · the timing of any such security sale. These and other factors will influence the probability that the customer defaults on the loan (the PD). In the event of a default occurrence, the Retail collective provision calculator provides the amount the Group expects to be irrecoverable from that customer (the LGD). The level and impact of LGD varies significantly between the Group's secured and unsecured lending portfolios.Collective provisioning for the Group's SME portfolio is also based on
the use of PD and LGD. The assets are included in a group of financial assets with similar risk characteristics and collectively assessed for impairment. The modelled collective assessment considers factors such as:· credit quality;· levels of arrears;· credit utilisation; · loan to collateral ratios; and · other factors including the Group's internal customer rating system (eCRS).These characteristics are relevant to the estimation of future cash flows for groups of such assets as
they are indicative of the borrower's ability to pay all amounts due according to the contractual terms of the assets being evaluated.Reliance is placed on the eCRS rating when assessing PD as these are directly mapped within the model. Manual interventions to the eCRS rating, such as the placement on a watch list, will directly lead to an increase in PD and consequently the level of collective provision required. LGD assumptions are driven by the level of security assigned to the customer within the
collective provisioning model. These are regularly monitored to ensure comparability with recent actual loss experience.In addition, for both the Group's Retail and SME portfolios, experienced judgement is used to estimate the amount of an impairment loss. This reflects a limited number of refinements that have been assessed as necessary to reflect specific and evolving circumstances that, by their nature, cannot be adequately captured in the models. The use of judgements and supportable estimates is
considered by management to be an essential part of the credit impairment process. The methodology and assumptions used for estimating future cash flows are reviewed regularly to identify and reduce any significant differences between loss estimates and actual loss experience.Specific provisionIf there is objective evidence that an impairment loss has been incurred on a loan, the amount of the loss is measured as the difference between the asset's carrying amount and the present value of the estimated
future cash flows (including the estimated realisable value of any security) discounted at the asset's original effective interest rate (a 'specific provision'). Specific provision allowances are primarily established against the Group's commercial business within the SME franchise. Assets are reviewed on a regular basis and those showing potential or actual vulnerability are placed onto a watch list where enhanced monitoring is undertaken.
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.6 Impairment provisions on credit exposures continued
ImpairmentWhen first recognised, the impairment allowance, which is a combination of both the collective and specific provision, is recognised in the income statement.Following impairment, interest income is recognised using the original effective rate of interest which was used to discount the future cash flows for the purpose of measuring the impairment loss. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the
impairment was recognised, the previously recognised impairment loss is reversed. The amount of the reversal is recognised in the income statement.When a loan is uncollectible, and all necessary internal procedures have been completed, it is written off against the related impairment loss. Subsequent recoveries of amounts previously written off reduce the expense in the income statement.The Group's impairment policy for available for sale financial assets is included in note 3.2Critical accounting estimates
and judgementsIn determining the required level of collective impairment provisions, the Group uses the output from various statistical models, with management judgement required to assess the modelled outputs and, where necessary, make appropriate adjustments. The key assumptions within the Group's collective provisioning models which give rise to significant estimation uncertainty are the PD and the LGD. Both measures are predicated on expectations of customer behaviour and performance, which requires
management to form a judgement based on a wide range of historic and current evidence. The actual amount of the future cash flows and their timing may differ significantly from the assumptions made for the purposes of determining the impairment allowances and consequently these allowances can be subject to variation as time progresses and the circumstances of the customer become clearer.From an SME perspective, changes made to eCRS will have a direct impact as these are mapped to PDs. Assumption changes on
retail customer behaviour will also have an impact on the PDs used. Within the Retail portfolio, the Group's collective provision is reflective of the fact that the majority of lending is concentrated on customer mortgages, where the available security is generally sufficient to cover the exposure. This differs from the SME portfolio where the availability and strength of the security will have less of an impact on overall recoveries, leading to a potentially higher collective provision charge relative to
the overall exposure.Sensitivities within the collective provisionThere are interactions between the various assumptions within the provisioning models which mean that no single factor is likely to move independent of others; however, the sensitivities disclosed below assume all other assumptions remain unchanged.If the PDs were to move by +/- 5% from those presently used within the Group's provisioning models, the impairment provision would increase/decrease accordingly by £5m.An important element to the
PD is the loss emergence period (LEP) which represents the Group's assessment of the period from when a loss event occurs to eventual default. The impact of the LEP differs between the Group's Retail and SME portfolios. A two-month increase in the LEP would result in a further £2m impairment provision within the SME portfolio; and a further £1m being added to the Retail impairment provision.To the extent that recovery rates improve from those presently used within each of the Group's provisioning models by
5%, the impairment provision on loans and advances would decrease by £14m. Alternatively, if recovery rates deteriorate by 5%, the impairment provision on loans and advances would increase by £24m. Provision in the SME portfolio is sensitive not only to default rates and severity of losses, but also to the assessment of risk and security. If 10% of the SME portfolio were to fall by one notch, the impairment provision would increase by £2m. In addition to modelled outputs, the impairment provision is further
impacted by management judgements. These include judgements that reflect elements which are not sufficiently sensitive to the current economic conditions, model risk reserves that are held to cover against a range of potential model limitations, and judgements made in respect of potential recoveries for specific provisions which also involve customer and economic specific conditions. These management judgements do not allow for any meaningful sensitivity comparison.
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
3.6 Impairment provisions on credit exposures continued
2017 £m 2016 £m
Opening balance 215 230
Charge for the year 48 39
Amounts written off (75) (68)
Recoveries of amounts written off in previous years 18 18
Other(1) 4 (4)
Closing balance 210 215
Specific 56 64
Collective 154 151
210 215
(1) Other includes the unwind of net present value elements of specific provisions and other minor movements.
3.7 Securitisation and covered bond programmes
Accounting policyThe Group sponsors the formation of structured entities, primarily for the purpose of facilitation of asset securitisation and covered bond transactions to accomplish certain narrow and well-defined objectives. Although the Group has no shareholding in these entities, where it is exposed, or has rights, to variable returns from its involvement with the entities and it has the ability to affect those returns through its power over the entity, they are regarded as controlled entities as
described in note 1.4 and are consolidated in the Group's financial statements.Securitisation The Group has securitised a proportion of its retail mortgage loan portfolio under the Group's master trust securitisation programmes. The securitised mortgage loans have been assigned at principal value to bankruptcy remote structured entities. These structured entities have been funded through the issue of residential mortgage backed debt to third-party institutional debt investors. The Group is entitled to any
residual income from the vehicles after the debt obligations and senior expenses of the programmes have been met. The securitised debt holders have no recourse to the Group other than the principal and interest (including fees) generated from the securitised mortgage loan portfolio. The Group continues servicing these mortgage loans in return for an administration fee.The mortgage loans do not qualify for derecognition because the Group remains exposed to the majority of the risks and rewards of the
mortgage loan portfolio, principally the associated credit risk. The securitisation structured entities are consolidated and the securitised mortgage loans retained on the Group's balance sheet. A liability is recognised for the proceeds of the funding transaction. The externally held securitised notes in issue are included within debt securities in issue (note 3.15). There are a number of notes held internally by the Group, not recognised on the balance sheet, which are used as collateral for repurchases
and similar transactions or for credit enhancement purposes.Covered bondA subset of the Group's retail mortgage loan portfolio has been ring fenced and assigned to a bankruptcy remote limited liability partnership, Clydesdale Covered Bond 2 LLP, associated with the covered bond programme, to provide a guarantee for the obligations payable on the covered bonds issued by the Group. Similar to the securitisation programmes, the Group is entitled to any residual income after all payment obligations due under
the terms of the covered bonds and senior programme expenses have been met. The Group continues servicing these mortgage loans in return for an administration fee.The mortgage loans do not qualify for derecognition because the Group retains all of the risks and rewards of the mortgage loan portfolio. The covered bond partnership is consolidated with the mortgage loans retained on the consolidated balance sheet and the covered bonds issued included within debt securities in issue. The covered bond holders
have dual recourse: firstly, to Clydesdale Bank PLC on an unsecured basis; and secondly, to the LLP under the Covered Bond Guarantee secured against the mortgage loans. Significant restrictionsWhere the Group uses its financial assets to raise finance through securitisations and the sale of securities subject to repurchase agreements, this leads to the assets becoming encumbered. Once encumbered, the assets are not available for transfer around the Group.
Financial statements
Notes to the consolidated financial statements
Section 3: Assets and liabilities continued
The assets and liabilities in relation to securitisation and covered bonds in issue at 30 September are as follows:
2017
Liabilities Securitisation £m Covered bonds £m Total £m
At 1 October 2016 3,208 797 4,005
Issuance of debt 750 - 750
Repayments (740) - (740)
Other movements 24 (49) (25)
At 30 September 2017 3,242 748 3,990
Assets
Securitised mortgage loans 6,182 1,344 7,526
2016
Liabilities Securitisation £m Covered bonds £m Total £m
At 1 October 2015 3,031 721 3,752
Issuance of debt 750 - 750
Reclassification of notes previously held internally 380 - 380
Repayments (1,029) - (1,029)
Other movements 76 76 152
At 30 September 2016 3,208 797 4,005
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