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Annual Report 2014

Plain-text annual report

A l d e r m o r e G r o u p P L C A n n u a l r e p o r t a n d a c c o u n t s 2 0 1 4 Banking as it should be Aldermore Group PLC Annual report and accounts 2014 Highlights of the year Increased support for UK SMEs and homeowners • Net loans to customers up by 42% to £4.8 billion (2013: £3.4 billion) • Record level of annual organic origination of £2.4 billion (2013: £1.7 billion) • Lending to SMEs up by 32% to £2.2 billion (2013: £1.7 billion) • Residential Mortgages grew by 53% to £2.6 billion (2013: £1.7 billion) Dynamic online savings franchise • Customer deposits up by 29% to £4.5 billion (2013: £3.5 billion) • Excellent growth in SME deposits, up by 97% to £1.0 billion (2013: £0.5 billion) Record levels of profitability • Profit before tax up by 96% to £50.3 million (2013: £25.7 million) • Excluding IPO costs, underlying profit before tax more than doubled to £56.3 million • Return on equity1 increased to 15.1% (2013: 11.6%) Diversified funding and strong capital base • Issued £333 million of RMBS to further diversify funding base • Successfully issued £75 million of Additional Tier 1 capital • Total capital ratio of 14.8% (2013: 14.2%) and leverage ratio of 6.3% (2013: 5.3%) Building a Bank to be proud of • Delivering exceptional service, rated 4.6 out of 5 by our customers • Number of customers up by 23% • Received accreditation as ‘One to Watch’ in The Sunday Times ‘Best Companies to Work For’ annual survey • Investing for the future, number of staff increased by 28% to 876 1 Excluding IPO costs of £6.0 million. Aldermore Group PLC Annual report and accounts 2014Strategic reportIn this report Strategic report Aldermore at a glance Chairman’s statement Chief Executive Officer’s statement Leveraging the business model Our strategy Our Key Performance Indicators Chief Financial Officer’s review Business review Asset Finance Invoice Finance SME Commercial Mortgages Residential Mortgages Savings Principal risks and uncertainties Our customers, people and communities Corporate governance Corporate governance report Biographies of the Board Consolidated Directors’ report Statement of Directors’ responsibilities Financial statements 2 4 6 8 10 11 12 18 22 26 30 34 38 42 45 52 54 57 Independent auditor’s report Consolidated financial statements Notes to the consolidated financial statements The Company financial statements Notes to the Company financial statements 58 59 63 121 124 For more information on our business visit www.aldermore.co.uk Twitter: @AldermoreBank Facebook: AldermoreBank LinkedIn: company/aldermore-bank-plc YouTube: AldermoreBank The consolidated financial statements of Aldermore Group PLC (‘the Group’) comprise of Aldermore Group PLC (‘the Company’) and its subsidiary undertakings, including Aldermore Bank PLC (‘the Bank’). 1 GovernanceFinancial statementsStrategic report Aldermore at a glance Established in 2009, Aldermore is a SME-focused bank with a legacy-free, modern and scalable digital infrastructure. Vision – “Banking as it should be” • To be the strategically important bank for UK SMEs and homeowners • DNA: Reliable, Expert, Dynamic, Straightforward Targeted product offering • Asset-backed lending for underserved customer segments • Large, growing markets with attractive risk-adjusted returns • Dynamic online deposit franchise forms funding core Intermediary-led distribution complemented by direct • 12 regional offices provide operational support Consistent, robust credit risk management • Modern IT systems allows focused use of expert underwriters • Granular loan portfolio with strong credit KPIs Proven track record of growth and profitability • 98% of origination organically generated2 • Profit before tax almost doubled in 2014 to £50.3 million Net loans3 1 Customer deposits4 1 1 Asset Finance 22% 2 Invoice Finance 4% 3 SME Commercial Mortgages 21% 4 Residential Mortgages 53% Total net loans2 £4.8bn 2 3 4 2 Total deposits3 £4.5bn 1 Retail deposits 2 SME deposits 77% 23% 2 From 2012 to 2014. 3 Loans and advances to customers as at 31 December 2014. 4 Customers’ accounts as at 31 December 2014. SME deposits includes corporate deposits. 2 Aldermore Group PLC Annual report and accounts 2014Strategic report Proven track record of delivery Net loans (£bn) Customer deposits (£bn) 4.8 3.4 4.5 3.5 2.1 1.2 2.2 1.4 Compound Annual Growth Rate +61% Compound Annual Growth Rate +49% 2011 2012 2013 2014 2011 2012 2013 2014 Profit before tax (£m) Return on equity5 (%) 50.3 25.7 15.1 11.6 -0.7 0.3 0.7 -0.5 2011 2012 2013 2014 2011 2012 2013 2014 5 Return on equity is calculated as profit after tax (excluding post tax IPO related costs) as a percentage of average shareholders’ funds. 3 GovernanceFinancial statementsStrategic reportChairman’s statement “ Aldermore has the corporate governance, risk management and culture to operate a profitable and sustainable business in public markets over the long term.” Glyn Jones Chairman 2014 highlights • Further strengthening of the Board with the appointment of four new independent Non-Executive Directors • A Corporate Governance Policy Framework in line with best practice standards set out in UK Corporate Governance Code • Continued development of our customer-centric culture founded on a clearly defined approach to risk management 4 Aldermore Group PLC Annual report and accounts 2014Strategic reportAnother record year When appointed to the Board in March 2014, it was evident I was joining an energised business which had a refreshingly different approach to banking. It really is quite remarkable that a bank which started in the midst of the financial crisis has grown so significantly and is now an established business delivering long-term sustainable growth and strong shareholder returns. By offering our customers exceptional service, underpinned by strong values, Aldermore is performing strongly, with excellent organic growth and a proven track record of delivery. The Group generated profit before tax excluding IPO costs of £56.3 million, more than double the amount achieved in 2013. The Group ended 2014 with a fully loaded CRD IV Common Equity Tier 1 capital ratio of 10.4 per cent, underlining our strong capital base and positioning the Group for long-term growth. Our liquidity position is also robust and in excess of regulatory requirements. Governance One of my primary goals since joining has been to further enhance the Group’s corporate governance as we prepare for life as a public entity. In September, we announced Aldermore’s intention to float on the London Stock Exchange, however, the significant deterioration in global equity markets persuaded the Board to postpone the initial public offering (IPO). The number of IPOs that did not proceed during this period reinforces just how difficult the global markets were at the time. It is impossible to call the markets, but I am very proud of the management team for what was achieved, and the positive feedback that we received, against a backdrop of market turmoil. The excitement generated amongst a broad range of investors was clearly evident and so we remain confident that a listing on the London Stock Exchange is the natural next step in Aldermore’s evolution. Further strengthening our Board This year saw a number of changes to our Board composition. When I joined, I began recruiting further Directors to build a Board capable of supporting the Group’s ambitions. During the course of the year four independent Non-Executive Directors joined the Board, Danuta Gray as the Senior Independent Director, John Hitchins as Chair of the Audit Committee, Cathy Turner as Chair of the Remuneration Committee and Peter Shaw, who will now take over as Chair of the Risk Committee with effect from 1 March 2015. Neil Cochrane also joined the Board as a Non-Executive Director representing our principal shareholder. I am delighted that we were able to attract such high calibre and experienced individuals who bring a wealth of business and public company experience. In December, John Callender decided to step down from his position on the Board with effect from 27 February 2015, having served as an independent Non-Executive Director since the Group was established. John has played a critical role at Aldermore, making invaluable contributions both as a member of the Board, as Chairman of the Audit and Risk Committee and latterly the Risk Committee and as Acting Chairman prior to my appointment. I would like to thank John for all of his hard work and wish him the very best for the future. I would also like to thank Mark Stephens, Deputy CEO and Group Commercial Director, Paul Myers, Chief Operating Officer, and Steve Barry, Chief Risk Officer, who in line with best practice for listed entities stepped down from the Board in 2014. Mark, Paul and Steve have been with Aldermore since the beginning and have made an enormous contribution to the effectiveness of the Board. They all remain key members of our Executive team. A clearly defined approach to risk management As well as making changes to the Board composition we restructured our committees by splitting the Audit and Risk Committee into two separate entities. This was done to support the evolution of our Risk Management Framework. The development, implementation and maintenance of this framework is now overseen by the Risk Committee to ensure that its strategy, principles, policies and resources are aligned to the Group’s risk appetite and to regulatory and industry best practices. The Risk Committee also reviews the Group’s performance against risk appetites and the effectiveness of the Group’s risk management processes. Underpinned by our culture We continue to foster a culture centred on the customer which is informed by a keen awareness of risk. We encourage staff to take personal responsibility and ask managers to empower their teams. We have developed a management framework which supports a balanced and fair approach towards risk and reward. What does this mean in practical terms? It means that we clearly communicate our risk appetite to all staff including measurable risk tolerances and the appropriate escalation procedures. It means that our people are assessed not only on what they achieve, but more importantly on how they achieve it. It means that incentives we offer to senior management are aligned with long-term outcomes. Crucially, it means that we deliver products and services to our customers which are transparent and meet their needs. I am confident Aldermore has the corporate governance, risk management and culture to operate a profitable and sustainable business in public markets over the long term. 2015 and beyond 2015 will be an important year for the Group. The challenges facing the global economy look set to continue, particularly in the eurozone. Meanwhile the general election in May looks likely to be one of the most unpredictable in living memory. Yet amid this economic and political uncertainty, SMEs, homeowners and savers will continue to require financial services which meet their needs and we are committed to playing our part. On behalf of the Board, I would like to thank our customers for their continued support and to extend my gratitude to our fantastic team for their hard work, dedication and loyalty to Aldermore. Glyn Jones Chairman 5 GovernanceFinancial statementsStrategic reportChief Executive Officer’s statement “ Our financial results for 2014 demonstrate our approach is working. During the year, we lent more than ever before to UK SMEs and homeowners.” Phillip Monks Chief Executive Officer 2014 highlights • Profit before tax excluding IPO costs more than doubled to £56.3 million • Net loans to customers up by 42% to £4.8 billion • Loans to SMEs up by 32% to £2.2 billion • Loans to homeowners up by 53% to £2.6 billion • Record loan origination of £2.4 billion, up 39% • Customer deposits up by 29% to £4.5 billion Net loans (£bn) 3.4 1.7 1.7 4.8 2.6 2.2 Loans to SMEs Loans to homeowners +42% 2013 2014 6 Aldermore Group PLC Annual report and accounts 2014Strategic reportA different kind of bank From the beginning, nearly six years ago, Aldermore set out to be different to Britain’s traditional high street lenders. Unconstrained by legacy systems and processes, our approach to serving our customers is modern, streamlined and designed to take the hassle out of banking. We understand that people are free to choose who they bank with and that their custom must be earned – not taken for granted. We are transparent about how we operate, our business model is straightforward and we have nothing to hide. We are agile, expert and entrepreneurial in our approach which allows us to empathise with our customers: Britain’s underserved Small and Medium-sized Enterprises (SMEs), homeowners and savers. An approach that works Our financial results for 2014 demonstrate our approach is working. During the year, we lent more than ever before to UK SMEs and homeowners with total loans up by 42 per cent to £4.8 billion. Record levels of organic origination of £2.4 billion, up 39 per cent on the previous year of £1.7 billion, drove this excellent growth in net lending. To support our lending businesses our online retail and SME deposits franchise continues to go from strength to strength. Customer deposits grew by 29 per cent to £4.5 billion with SME deposits up by 97 per cent to £1 billion. We continued to diversify our funding in 2014 with our inaugural Residential Mortgage-Backed Securitisation (RMBS) in April, which was oversubscribed. We maintained our focus on managing costs and leveraging our operating model which saw our cost to income ratio fall by six per cent6 to 60 per cent and we continue on plan towards our target of less than 40 per cent by the end of 2017. The growth we have seen in our business has delivered strong and sustainable returns for our shareholders. Profit before tax excluding IPO costs of £6.0 million more than doubled to £56.3 million driving a return on equity of 15.1 per cent. To support our medium-term growth plans and to adopt a capital structure appropriate for a mature bank, we raised £75.1 million of additional capital through the issuance of Additional Tier 1 (AT1) securities in December 2014. Our customers’ success is our success Every day we see examples of how our support is helping to fuel the success of Britain’s SMEs, whether this is by enabling them to purchase equipment to fulfil new contracts, providing expertise to manage their cash flow or advancing them funds to expand their property portfolios. Our customers like what we are doing. We are one of the only banks to ask customers to rate and review our services online. In 2014, our average score was 4.6 out of 5 and 96 per cent of customers who left us a review said they would recommend us. We often read reviews which describe our service as “banking as it should be”. Building a long-term, sustainable business In May 2015, we will celebrate the Group’s sixth anniversary. We have achieved a great deal since we were founded in 2009. When I think back to those early days, our focus was on building sound and sustainable infrastructure, smart and efficient processes and customer-focused propositions. We simply wanted to lay the foundations of a profitable business while being reliable, expert, dynamic and straightforward in everything we do. That, in essence, is our DNA. Since then we have demonstrated that we have a profitable and straightforward business model that provides great service for our customers. In 2014, we made further significant investment in the Group’s controls and infrastructure, including configuring our digital platform so it is fully scalable to support future growth with moderate ongoing investment. We also have a great team dedicated to executing our strategy, which was further bolstered in June 2014 with the appointment of Vicki Harris who joined as Group Strategy and Marketing Director. Our Board of Directors has been further strengthened in 2014 and I am grateful for their support in ensuring we build a sustainable business for the long term. A year of highlights In 2014, we restructured our mortgages businesses to better serve customers, expanded our customer Ratings & Reviews service, launched the Aldermore Community Team (ACT) and received accreditation as ‘One to Watch’ in the Sunday Times ‘Best Companies to Work For’ annual survey. We also continued to improve the services we provide to customers, with the launch of products including our unique Customised Fixed Rate Account which allows SMEs to decide – to the day – how long they want to deposit their money for. We also introduced ‘APP+’, a mobile application which enables Asset Finance introducers to price a deal or complete an application on the go, wherever they are and whenever is convenient. The Group won more industry awards than ever before – 24 across our business lines and some for the fourth consecutive year. A strong track record set to continue I am very proud of our achievements during 2014. It was another busy year for the Group which saw us achieve record results. I would like to thank all of our employees not only for their dedication but for the shared excitement and pride in what we are building at Aldermore. We measure our success by how we have helped customers grow their business, buy a property and save for the future. This is why people join us and it is what sets us apart from the competition and I am confident this strategy will continue to serve us well in 2015 and beyond. Phillip Monks Chief Executive Officer 6 Excluding IPO related costs of £6.0 million. 7 GovernanceFinancial statementsStrategic reportLeveraging the business model Risk appetite Customers Distribution Strong lending growth drivers Prime credit quality customers Highly secured asset-backed lending with attractive risk-adjusted margins SMEs Intermediated Property investors Homeowners Direct Savers Online direct Interest Income Strong capital base Expert underwriting and risk management Modern, legacy-free systems Scalable operating platform Culture Customer-centric; Risk aware Lending Asset Finance Invoice Finance SME Commercial Mortgages Residential Mortgages Our DNA is to be Reliable, Expert, Dynamic and Straightforward – these values inform everything we do forming the basis of our culture and brand. We focus on prime credit quality customers across four lending lines chosen for their size, attractive risk adjusted returns and tangible asset security. We engage with our customers through intermediaries and directly. We enjoy the advantage of modern, legacy-free systems which we use to support, where appropriate, our expert underwriters in making considered 8 Aldermore Group PLC Annual report and accounts 2014Strategic reportStrong lending growth drivers Strong growth in net interest income Cost base grows more slowly Accelerating profit trajectory Cost of funds Net interest income Costs Profit Funded by Retail deposits SME deposits Wholesale funding decisions rather than a “computer says no” approach. Our operating platform is scalable to allow for future growth. We advance loans on which we earn income; these loans are funded via a mix of deposits and wholesale funding on which we pay interest. The difference is net interest income which grows with our loan book. Having invested upfront in our operating platform, our cost base grows more slowly than our net interest income driving an accelerating profit trajectory. This is what we refer to as “leveraging our business model”. 9 GovernanceFinancial statementsStrategic reportOur strategy To deliver long-term sustainable growth and strong shareholder returns through offering simple financial products and solutions that are within our risk appetite and meet the needs of disenfranchised and underserved SMEs, homeowners and savers across both their business and personal lives. Strategic objectives 1 Build strong market positions with distinctive customer propositions in chosen segments, while maintaining excellent asset quality Aldermore focuses on specialist lending to SMEs and homeowners across four large lending segments which were deliberately targeted for their strong collateral characteristics, attractive risk-adjusted returns and growth potential. 2 Deliver long-term sustainable and efficient growth and generate strong shareholder returns The Group aims to leverage its scalable, efficient and legacy-free operating model to grow revenues more quickly than its cost base and deliver long-term, sustainable profitability. Maintain prudent capital, funding and liquidity positions 3 Our aim is to take a prudent approach towards maintaining a capital base that supports the Group’s growth aspirations and exceeds regulatory requirements. Our funding is expected to remain predominantly deposit-led. However, in addition we utilise wholesale sources such as the Bank of England’s Funding for Lending Scheme, our Residential Mortgage Backed Securitisation and a small amount of Tier II funding. 4 Continue to build an engaged and productive workforce aligned with the Aldermore culture We recognise that for us to be successful in what we do, it is important to attract and retain a talented workforce. The Group aims to hire people who fit culturally and have the right competencies. We then empower managers with the tools and support needed to increase employee engagement. 10 Aldermore Group PLC Annual report and accounts 2014Strategic reportOur Key Performance Indicators Net loans growth (£m) Cost/income ratio (%) Return on equity (%) 1,427 1,317 90 900 66 60 2012 2013 2014 2012 2013 2014 15.1 11.6 0.7 2012 2013 2014 Definition Absolute increase in loans and advances to customers net of impairment provisions. Definition Cost/income ratio is calculated as administrative expenses (excluding IPO related costs), depreciation and amortisation, as a percentage of operating income. Definition Calculated as profit after tax (excluding post tax IPO related costs) as a percentage of average equity. We aim to grow net loans whilst remaining within our clearly defined risk appetite. We aim to maintain net loan growth in line with current run rates. Our return on equity increased from 11.6 per cent in 2013 to 15.1 per cent (excluding costs associated with the IPO) primarily as a result of increased profitability. As a Group, we are successfully leveraging our operating model. Between 2012 and 2014, whilst our loan book grew at a compound annual rate of 53 per cent, the compound rate of increase in our cost base over the same period was only 33 per cent. As a result, cost/income ratio at the end of 2014, excluding IPO related costs, was 60 per cent compared to 90 per cent in 2012 and 66 per cent in 2013. The Group is targeting a cost/income ratio of less than 40 per cent by the end of 2017. Total capital ratio (%) Leverage ratio (%) Ratings and reviews 14.2 2.1 12.1 14.8 1.7 2.7 10.4 CET1 ratio Additional Tier 1 capital ratio Tier 2 capital ratio 128 1,688 1,904 No. of reviews 6.3 5.3 4.4 4.5 4.6 N/A 2012 2013 2014 NA 2012 2013 2014 2012 2013 2014 Definition Fully loaded CRD IV Common Equity Tier 1 (CET1) capital ratio is calculated as risk weighted assets as a percentage of CET1 capital. Fully loaded represents the adoption of all requirements of CRD IV once the transitional phase has elapsed. In Aldermore’s case, there is no difference between current CET1 ratio and fully loaded CET1 ratio. Aldermore has levels of capital which are in excess of the requirements set by the Prudential Regulation Authority (PRA). As at 31 December 2014 Aldermore’s fully loaded CRD IV CET1 Ratio was 10.4 per cent and total capital ratio of 14.8 per cent. Definition A ratio of Tier 1 Capital to total exposures, calculated in accordance with the requirements of CRD IV. Definition Our online Ratings & Reviews service enables customers to provide honest reviews of our products and services. When customers submit a review, we ask them to give us a rating out of 5 based on their experience with us. Aldermore’s leverage ratio as at 31 December 2014 was 6.3 per cent and exceeds the minimum requirement as proposed by the PRA. Our Ratings & Reviews service was launched in 2012 for our personal savings, business savings and Invoice Finance customers. In 2014, we also extended the service to our Residential Mortgage customers. The feedback we receive is published unedited on our website and is used by us to help improve our services to customers. 11 GovernanceFinancial statementsStrategic reportChief Financial Officer’s review Another record year for the Group “ 2014 was another record year for Aldermore. As expected, as the business matures we are seeing our significant balance sheet growth driving an accelerating profit trajectory. We delivered record loan origination of £2.4 billion, net new lending in excess of £1.4 billion and almost doubled profit before tax to £50.3 million.” James Mack Chief Financial Officer 2014 highlights • Net loans to customers up by 42% to £4.8 billion • Customer deposits up by 29% to £4.5 billion • Cost to income ratio7 down 6pts to 60% (2013: 66%) • Excluding IPO costs, profit before tax of £56.3 million is more than double 2013 • Return on equity7 increased to 15.1% (2013: 11.6%) • Issued £333 million of RMBS to further diversify funding base • Successfully issued £75 million of AT1 capital • Strongly capitalised with total capital ratio of 14.8% and leverage ratio of 6.3% Profit before tax (£m) 50.3 25.7 +96% 2013 2014 7 Excludes costs related to IPO of £6.0 million. 12 Aldermore Group PLC Annual report and accounts 2014Strategic reportBalance sheet – key items Loans and advances Cash and near cash equivalents8 Investments Other assets Total assets Customer deposits RMBS FLS Tier 2 capital Other liabilities Total liabilities Total equity Key ratios Net loan growth Loans to deposits ratio Liquid assets/deposits Total capital ratio 2014 £m 2013 £m % change 42 (54) 43 33 32 29 – (21) 3 95 32 43 4,801.1 197.0 509.7 57.5 5,565.2 4,459.0 279.1 304.2 36.8 107.3 5,186.4 378.9 1,427 108% 16% 14.8% 3,373.8 430.4 355.7 43.1 4,203.0 3,464.0 – 383.1 35.6 55.0 3,937.6 265.4 1,317 97% 23% 14.2% Assets exceed £5 billion Diversified funding base In 2014, we increased our support to British SMEs and homeowners with a 42 per cent increase in net loans to £4.8 billion (2013: £3.4 billion). Net new lending of £1.4 billion was above both our guidance of around £1.3 billion and the prior year and was supported by record organic origination of £2.4 billion. We hold a liquid assets buffer in the form of cash and investments to mitigate liquidity risk. As at 31 December 2014, the ratio of liquid assets to deposits was 16 per cent compared to 23 per cent for the prior year when the Group was holding additional liquidity in advance of issuing our inaugural RMBS. Total assets exceeded £5 billion for the first time and were up by 32 per cent on the prior year driven by increased lending volumes. Our lending activity is matched by a diversified funding base which is predominantly deposit-led with wholesale funding from RMBS, the UK Government’s Funding for Lending Scheme (FLS) and a small amount of Tier 2 debt securities. We continued to attract savers with our ‘good returns effortlessly’ proposition and deposits increased by 29 per cent over 2013 to £4.5 billion at the end of 2014. We have driven very strong growth in SME deposits, up 97 per cent in 2014 to over £1 billion. We’ve also recently launched corporate deposits to further diversify our future funding sources. Our loans to deposits ratio has moved from 97 per cent at the end of 2013 to 108 per cent at 31 December 2014 as we have continued to diversify the wholesale element of our funding base. Looking forward, we expect to see this ratio to remain above 100 per cent reflecting the increased proportion of wholesale funding now used. 8 Includes ‘Cash and balances at central banks’ and ‘Loans and advances to banks’. In April 2014, we completed our inaugural RMBS issuing c.£333 million of securities priced at LIBOR +67bps. We were delighted at the level of investor interest in this transaction. We continue to use the FLS and Aldermore was the third biggest lender to UK SMEs under this scheme during the year. As at 31 December 2014, we had drawn £485 million of treasury bills under the FLS creating £304 million of on-balance sheet funding via repurchase transactions. The Tier 2 instrument is a historic instrument with a nominal value of £40 million issued in May 2012 and a first call date in May 2017. As a result of the above, total liabilities grew at 32 per cent to £5.2 billion (2013: £3.9 billion). 13 GovernanceFinancial statementsStrategic reportChief Financial Officer’s review continued 2014 £m 227.8 (87.6) 140.2 18.6 6.2 165.0 (105.1) (6.0) (9.6) 50.3 (11.9) 38.4 3.4% 60% 23bps 15.1% 2013 £m 156.4 (75.8) 80.6 16.0 11.7 108.3 (71.2) – (11.5) 25.7 – 25.7 3.0% 66% 42bps 11.6% % change 46 16 74 16 (47) 52 48 – (17) 96 – 50 0.4% (6)% (19)bps 3.5% Other income includes other operating income and derivative income and was down over prior year at £6.2 million (2013: £11.7 million) due to adverse mark to market movements on hedging derivatives caused by financial markets volatility in the fourth quarter. Record profitability Income statement – key items Interest income Interest expense Net interest income Net fee income Other income Total operating income Operating expenses of which IPO related costs Impairment losses on loans and advances to customers Profit before tax Tax Profit after tax Key ratios Net interest margin Cost/income ratio9 Cost of risk10 Return on equity9 (post tax) Total equity As at 31 December 2014, total equity was £378.9 million an increase of 43 per cent on the prior year due to the issue of £73.7 million of AT1 capital, net of costs, in December 2014 and an increase in retained earnings driven by the profit for the year. Lending growth drives interest income The 42 per cent growth in net lending delivered during the year has driven 46 per cent growth in interest income to £227.8 million (2013: £156.4 million) with the gross interest margin remaining broadly constant at 5.57 per cent (2013: 5.76 per cent). We continued to diversify our funding mix with a higher proportion of SME deposits and the RMBS issuance in April. Both of these funding sources are cheaper than our average cost of funding and helped drive our cost of funding down to 2.14 per cent (2013: 2.79 per cent). As the RMBS 9 Excludes costs related to IPO of £6.0 million. 10 Cost of risk is calculated as impairment losses as a percentage of average net loans. 14 was issued in April 2014, we have only experienced nine months of benefit and expect to accrue further benefits in 2015. As a result, we delivered an increase in net interest income of 74 per cent to £140.2 million (2013: £80.6 million) whilst also driving a 0.4 per cent improvement in the net interest margin from 2.97 per cent in 2013 to 3.43 per cent for 2014. Net fees and other income Net fee income is predominantly driven by the Invoice Finance business which was stable in the year. The growth of 16 per cent during the year to £18.6 million (2013: £16.0 million) predominantly relates to other fee income. Other fee income contains commitment, arrangement, valuation and early redemption fees related to our mortgages business as well as fees associated with the Asset Finance business and the increase during the year was driven by growth in lending in these portfolios. Aldermore Group PLC Annual report and accounts 2014Strategic reportLeveraging our scalable operating platform Operating expenses were £105.1 million, an increase of 48 per cent on 2013 expenses of £71.2 million. Excluding costs related to the IPO of £6.0 million, underlying operating expenses were £99.1 million, an increase of 37 per cent over 2013. Operating expenses Other administrative expenses Provisions IPO related costs Depreciation and amortisation Total operating expenses Operating expenses excluding IPO related costs 2014 £m 91.6 3.6 6.0 3.9 105.1 99.1 2013 £m 65.3 2.1 – 3.8 71.2 71.2 % change 40 71 – 2 48 39 Other administrative expenses have grown by 40 per cent during the year to £91.6 million (2013: £65.3 million). The rise was mainly due to an increase in staff costs, up by 29 per cent to £49.4 million (2013: £38.4 million). The number of employees and contractors increased by 28 per cent to 876 in 2014. The increase in costs represent a ‘step-change’ from the previous year as we invested further to build a sustainable and prudently managed business. We particularly focused on the strengthening of central functions including risk, compliance and finance to ensure we retain the appropriate levels of oversight as the business continues to grow and mature, and to prepare for a potential listing. We have increased investment in information technology systems by 77 per cent to £8.3 million (2013: £4.7 million). Despite the increase, our ongoing investment needs in IT remains moderate. Included within administrative expenses was a charge of £1.6 million as we wrote off the investment in development of systems, related to Asset Finance, following a review of requirements. Provisions predominantly reflect the levy for the UK Government’s Financial Services Compensation Scheme (FSCS) which offers protection to individual deposit holders on amounts up to £85,000. The levy is linked to size of the Group’s savings business and has grown by 57 per cent in 2014 to £2.6 million (2013: £1.7 million). During 2014, the Group undertook significant preparations for a listing on the London Stock Exchange and the related costs charged to the income statement in the year were £6.0 million (2013: £nil). Due to adverse stock market conditions following the announcement of our Intention to Float (ITF), the Group withdrew the offer on 15 October 2014. Depreciation and amortisation remained broadly consistent with the prior year at £3.9 million (2013: £3.8 million). Reduced cost/income ratio We continued to make good progress towards our target cost/income ratio of less than 40 per cent by the end of 2017 with a 6 percentage point reduction over the year to 60 per cent (2013: 66 per cent) excluding IPO costs. Improved cost of risk We continue to rigorously manage the credit portfolio. In addition to the actions taken in Invoice Finance, we also benefitted from a large recovery in the Asset Finance division and two large recoveries in our SME Commercial Mortgages business. As a result, impairment losses in 2014 were reduced to £9.6 million (2013: £11.5 million) equating to a cost of risk of 23bps (2013: 42bps). Excluding these three recoveries, the cost of risk for 2014 was 33bps. Underlying profit doubled In 2014 we have generated profit before tax of £50.3 million, up by 96 per cent over 2013. Excluding IPO related costs, underlying profit before tax of £56.3 million is more than double that achieved in 2013. 15 GovernanceFinancial statementsStrategic reportChief Financial Officer’s review continued Strong performance across all divisions Segmental result11 Asset Finance Invoice Finance SME Commercial Mortgages Residential Mortgages Central Functions Profit before tax Tax Profit after tax During 2014, we delivered improvements in profit before tax in each of our lending divisions. Our Asset Finance division almost doubled its segmental result to £25.5 million, while SME Commercial Mortgages division was up by 82 per cent to £34.0 million (2013: £18.7 million). The segmental result for Residential Mortgages more than doubled to £56.8 million (2013: £26.4 million). I am pleased to see the positive impact of actions that we took in our Invoice Finance division, with the segmental result up by 64 per cent at £5.4 million. Further details on financial performance of each business can be found on page 18 to page 37 of this report. 2014 £m 25.5 5.4 34.0 56.8 (71.3) 50.3 (11.9) 38.4 2013 £m 12.9 3.3 18.7 26.4 (35.6) 25.7 – 25.7 % change 97 64 82 115 100 96 – 50 Driving strong returns The record profit performance of the Group resulted in strongly improved returns with a return on equity, excluding IPO costs, of 15.1 per cent compared with 11.6 per cent for 2013. On a like for like basis, the improvement over 2013 is closer to 6 per cent as, had 2013 not benefitted from brought forward tax losses and been taxed at 2014 rates, the 2013 return would have be closer to 9 per cent. 2014 costs related to central functions were £71.3 million (2013: £35.6 million). These costs are mainly related to staff costs and office costs, as we invested in further strengthening risk, finance and compliance. Central functions include costs associated with our Savings and Treasury divisions which are responsible for raising finance on behalf of lending divisions and are managed centrally. Included within these central functions costs are staff related costs of £26.7 million, information technology related costs of £6.7 million, office costs of £3.8 million, depreciation and amortisation costs of £3.4 million, Financial Services Compensation Scheme costs of £2.6 million as well as £1.6 million relating to the write down of an intangible asset. As previously discussed, we also incurred £6.0 million costs related to the IPO. The tax charge for 2014 was £11.9 million (2013: £nil) as the Group became a taxpayer for the first time during the year and represents an effective tax rate of 23.6 per cent (2013: 0 per cent). Profit after tax was £38.4 million (2013: £25.7 million), an increase of 50 per cent over 2013. 11 Segmental result = Divisional profit before allocation of central costs and tax. Numbers may not exactly sum due to rounding. 16 Aldermore Group PLC Annual report and accounts 2014Strategic report2014 £m 281.2 73.7 45.3 400.2 2013 £m 242.1 – 41.9 284.0 2,702.0 1,993.0 10.4% 14.8% 6.3% 12.1% 14.2% 5.3% % change 16 – 8 41 36 (1.7)% 0.6% 1.0% Outlook We are confident of continuing to build upon these excellent results. In 2015, we expect to again grow net loans in line with current run rates and make further progress towards our target of a cost/ income ratio of less than 40 per cent by the end of 2017. Capital position Capital Common Equity Tier 1 capital Additional Tier 1 capital Tier 2 capital Total capital Risk Weighted Assets (RWA) Key ratios Fully loaded CRD IV CET1 ratio (%) Total capital ratio Leverage ratio12 The Group’s fully loaded CRD IV total capital ratio as at 31 December 2014 was 14.8 per cent up from the prior year of 14.2 per cent driven by retained earnings and AT1 capital. In December 2014, Aldermore issued £73.7 million, net of costs, of AT1 perpetual notes with an associated coupon of 11.875 per cent and a first call date of April 2020. This is an important step in developing a CRD IV compliant capital structure appropriate for a mature bank and strengthens our overall capital position. The Group’s proforma leverage ratio was comfortably above the required minimum of 3 per cent at 6.3 per cent, up from 5.3 per cent at the end of 2013 due to the issuance of AT1 securities. 12 A ratio of Tier 1 Capital to total exposures, as calculated by the Group in accordance with the requirements of Capital Requirements Directive (CRD IV). 17 GovernanceFinancial statementsStrategic reportAsset Finance 2014 highlights • Net lending exceeded £1 billion, up by 45% on 2013 • Advanced over £2 billion in asset finance funding since 2009 • Record origination of £739.5 million, up 21% over 2013 • Net interest income up by 60% to £36.9 million • Cost of risk remains low at 30bps • Segmental result up 97% to £25.5 million • New stocking finance and operating lease products • Launched smartphone and tablet pricing application 13 Source: Finance & Leasing Association (Asset Finance). 18 Aldermore supports capital investment in business-critical assets via hire purchase and lease agreements. Leveraging our depth and breadth of expertise, we finance a wide array of assets encompassing plant and machinery, transportation, printing equipment, digital technologies and specialist large ticket items. This flexibility enables us to meet the needs of customers ranging in size from micro clients to plcs across key industries. In addition, we offer wholesale and block discounting facilities to smaller leasing companies and brokerages enabling them to extend credit directly to SMEs. Market Asset Finance loans originated in the UK were approximately £25 billion13 in 2014. Around 80 per cent of market origination relates to ‘hard’ assets such as vehicles and plant and machinery for which there are strong secondary markets. A significant proportion of the remainder consists of ‘soft’ assets such as telephony, IT and printing equipment, which tend to have low or no secondary values. Our estimated market share based on loan originations for 2014 was 3.0 per cent. There are three distinct distribution channels within the Asset Finance market13: Direct, which is mostly dominated by large banks, accounted for around 50 per cent of the market, Vendor i.e. equipment manufacturers represented around 33 per cent, with the remainder being distributed by specialist commercial finance brokers. Strategy We aim to be our partners’ ‘funder of first choice’ by being easy to do business with, quick to respond and consistent in our credit decisions, giving direct access to our underwriters when required. We employ specialists across key industries including logistics, manufacturing, construction and agriculture with an in-depth understanding of our clients’ businesses and the assets they require. In addition, we have a dedicated structured products team who can consider larger ticket, more complex transactions and receivables financing. Our modern digital technology allows us to use expert human underwriting in a targeted and cost-effective way. Where we are unable to auto-accept a proposal, our credit experts will work with our introducers to better understand the transaction enabling us to consider every transaction on its own merit. Since inception, our focus had been predominantly on hard assets distributed via brokers. During 2014, we expanded the range of assets we finance to include printing equipment, digital technologies, renewables and a wide array of soft assets. Building on our strong track record with our introducers, we also extended our distribution focus to Vendors. Portfolio by sector (%) Portfolio by product type 1 10 9 8 7 6 5 4 1 Logistics (transport) 19% 14% 2 Manufacturing 11% 3 Construction 10% 4 Plant hire 5 Wholesale and retail trade 6 Financial 7% intermediation 7 Community activities 7% 5% 8 Agriculture 2% 9 Utilities 12% 10 Other 13% 2 3 1 6 7 5 4 3 1 Plant & machinery 2 Commercial vehicles 3 Receivables 4 Cars – used 5 Cars – new 6 IT equipment 7 Other 37% 30% 11% 7% 5% 2% 8% 2 Aldermore Group PLC Annual report and accounts 2014Strategic report Recently, we wrote off an investment in development of a system following a review of requirements. The related costs were included within central expenses. Our Asset Finance team increased from 128 at the end of 2013 to 146 with a focus on front end sales-force to support our customers and introducers, and our credit team. We’re pleased to see a lot of interest from people within the industry who are attracted by our approach to improve the customers’ experience via human interaction rather than the credit scoring approach of some competitors. Around 100 of our employees completed our ‘exceptional customer service training programme’ which we implemented during the year. We’ve also extended a new internal technical training programme to our key introducers’ teams – free of charge – as we look to help develop the next generation of Asset Finance professionals across the industry. We received over 100 external applications and excellent feedback for what we believe is a unique initiative within the industry. Outlook As business confidence increases and SMEs look to catch up on investment delayed since the financial crisis, we expect the asset finance market as a whole to grow. We look to build on our strong foundations to continue to diversify the distribution and asset mix of our growing business. Distribution Aldermore currently works with a network of around 600 introducers who are supported by a national network of Aldermore business development managers and our central service team. These introducers accounted for around 75 per cent of loans originated during the year. The remaining 25 per cent of origination was generated via vendors, dealers and, through our wholesale channel. Financial performance 2014 was another excellent year for our Asset Finance business with our portfolio exceeding £1 billion for the first time. Net loans grew by 45 per cent, and at the end of 2014 were £1,044.3 million (2013: £720.2 million) with customer numbers14 up by 60 per cent to around 33,000. Our Asset Finance division has now advanced over £2 billion to UK businesses since its inception in 2009. We grew organic origination to £739.5 million, up 21 per cent over prior year of £609.8 million. In the fourth quarter we launched our stocking finance product, to finance equipment dealers’ inventory, which we expect to support growth of our vendor business in the future. As expected, the enlarged portfolio generated significant growth in gross interest income, up 52 per cent to £56.7 million (2013: £37.4 million). Along with all of our lending lines, Asset Finance benefitted from a reduced cost of funding as we continue to diversify our funding sources. Net interest income grew by 60 per cent to £36.9 million (2013: £23.0 million) while net interest margin remained constant at 4.2 per cent. The cost of risk improved by 17bps to 30bps (2013: 47bps) as it benefitted from a significant recovery. Administrative expenses increased by 25 per cent to £11.9 million (2013: £9.5 million) as we continued to invest in the business. The segmental result almost doubled, growing at 97 per cent to £25.5 million (2013: £12.9 million). Continued investment We continued to invest in our digital capability and in the second half of 2014, launched our Asset Finance application for pricing and proposals, called APP+, making it easier for our introducers to get a quote for their clients anytime, anywhere and speeding up the credit approval process. Using a mobile or tablet, registered introducers can obtain a price, even on complicated quotes, within around 60 seconds. Organic loan origination (£m) Net loans (£m) 739 610 1,044 720 +21% +45% 2013 2014 2013 2014 Growing interest income (£m) Declining cost of risk (bps) 56.7 47 37.4 30 +52% -17bps 2013 2014 2013 2014 14 As measured by customer accounts 19 GovernanceFinancial statementsStrategic reportAsset Finance Case Study “I wanted to make sure I was dealing with people who understood what I was trying to achieve. Aldermore and Matt made my life easy, so I could focus on servicing our clients while they sorted out my financial requirements.” Steve Knee Managing Director Cloudbass Cloudbass – Investing for growth The challenge… With clients including Sky, BT, ITV Sport, the BBC and Manchester United, Cloudbass is one of Britain’s leading suppliers of outside broadcasting facilities and specialist crew. Recently, the company took advantage of the opportunity to expand its business when a key competitor exited the industry. 20 Cloudbass was able to buy out its competitor’s contracts, which included the BBC’s Question Time programmes and Premier League commitments. In order to fulfil these new contracts, the company needed to purchase additional specialist broadcast kit, including outside broadcasting vehicles and cameras. Steve Knee, Managing Director at Cloudbass, required funding for these purchases and called in the help of Matt Vaughan at Asset Finance Solutions. Matt, who is one of our brokers, understood our strong commitment to helping companies like Cloudbass fulfil their potential and knew that we had the expertise and appetite to consider a deal of this complexity and find the right solution. Aldermore Group PLC Annual report and accounts 2014Strategic report“ Because our team of credit experts personally reviews every proposal we receive, we are able to gain an in -depth understanding of specialist businesses like Cloudbass whose specific requirements do not fall into the usual boxes.” David Ray Business Development Manager Aldermore The solution… When we initially reviewed the Cloudbass proposal, the rationale for the purchase was clear. Nevertheless the company required a large advance in relation to the size of the business for what are considered to be specialist assets. Working in collaboration with Matt Vaughan, our underwriters took the time to get to know and fully understand the business along with the wider sector in which Cloudbass operates. We also took comfort in the strong management team and their industry experience. In order to complement the Asset Finance solution provided, a facility through our Invoice Finance team was also included. The fact that Cloudbass needed to secure funding within a matter of weeks from winning the new contracts was not a problem for us. Due to working in close partnership with our introducer, we were able to deliver a solution within the required timescale. 21 GovernanceFinancial statementsStrategic reportInvoice Finance 2014 highlights • Supporting UK SMEs with c.£1.4 billion of financing in 2014 • Segmental result up by 64% to £5.4 million • Driven significant operational and process improvements • Cost of risk improved to 174bps (2013: 290bps) • Specialist Finance team created • Construction Finance proposition launched Awards • Winner – Factor and Invoice Discounter of the Year (National Association of Commercial Finance Brokers (NACFB) Awards 2014) • Winner – Alternative Funder of the Year (South West Dealmakers Awards 2014) • Winner – Alternative Funder of the Year (Central and East of England Dealmakers Awards 2014) Invoice Finance is an important working capital tool for SMEs. Aldermore will usually lend up to 85 per cent of the value of approved outstanding invoices issued by the borrower to its customers. There are two main products, Factoring and Discounting; with the difference being that with the former, Aldermore often takes control of the borrower’s debt collection. Our customers are typically owner- managed SMEs and we focus on key sectors including Manufacturing, Wholesale, Recruitment and Logistics. Market According to the Asset Based Finance Association (ABFA), gross advances for the first nine months of 2014 were around £19 billion and up by 12 per cent over the same period in 2013. However, the majority of this growth in pound terms was generated by companies with turnover greater than £50 million rather than our target customers who are at the smaller end of the turnover scale. We estimate our market share to be around one per cent based on advances at the end of the third quarter of 2014. Strategy Invoice Finance currently represents around four per cent of our total lending portfolio and we expect it to continue to constitute a small part of our loan book. Given the short-term nature of this product, with the underlying invoices translated into cash within 60 days, our average gross lending is equivalent to providing around £1.4 billion of working capital finance to UK SMEs in 2014. We employ specialist service teams in our target sectors that spend time understanding our clients’ business and design appropriate financing solutions. We offer simple and transparent solutions such as our ABC fixed fee Factoring product and look to provide a fast response with around 98 per cent of credit decisions made within 48 hours. Following a small number of fraud cases in 2013, we have improved the controls across risk, operations and sales to build a sustainable platform for the future. We are growing and upskilling our sales force and creating a trainee development plan to build the next generation of talent. From a product perspective, we will continue to innovate to meet our customers’ needs and will expand our Specialist Finance team, who focus on construction, trade and export finance initiatives. To date, we have generated strong growth in direct distribution and we plan ongoing investment in technology to enhance the customer experience and drive further growth from this channel. Distribution Our intermediated and direct distribution channels are supported by local relationship managers based in our 12 regional offices. We work with more than 500 intermediary groups at a local and national level who originated around 71 per cent of loans in 2014. Direct distribution has grown rapidly in recent years and now represents around 29 per cent of origination. Portfolio by product type Portfolio split by sector 1 2 1 Factoring 51% 2 Invoice discounting 49% 6 1 5 4 1 Manufacturing 2 Wholesale 3 Recruitment 4 Logistics 5 Other business activities 2 6 Other 3 36% 17% 15% 14% 12% 6% 22 Aldermore Group PLC Annual report and accounts 2014Strategic report Administration expenses of £14.7 million (2013: £14.0 million) reflect the ongoing investment to improve the operating platform. We were pleased to see the result of our actions with cost of risk declining by 116bps to 174bps (2013: 290bps) in line with management expectations. As a result, the segmental result improved by 64 per cent to £5.4 million. Initiatives In 2014, we set up a Specialist Finance team who launched a new Bad Debt Protection proposition, Construction Finance and Trade Finance solutions. We are also working with the Institute of Recruiters to continue to drive our proposition in this sector forward. As well as working with existing intermediaries, we introduced a scheme to work with accounting firms to distribute Invoice Finance products to SMEs which has been well received. Financial performance Our key focus for 2014 was to build a stable platform for the future. Following a small number of fraud cases, more than would normally be expected in 2013, we have substantially enhanced credit and operational procedures, centralised operations, refocused the portfolio towards customers with smaller turnover and exited a number of accounts. As a result of these actions, we reduced the overall size of the portfolio by £31.4 million or 15 per cent to 1 £180.6 million (2013: £212.0 million). Origination at £45.2 million (2013: £67.9 million) was also impacted by our focus on smaller clients. Gross interest income remained consistent with the prior year at £9.3 million (2013: £9.4 million) and net interest income increased by 18 per cent to £5.9 million (2013: £5.1 million) as we benefitted from the reduced cost of funds associated with our ongoing funding diversification strategy. The mix between Factoring, which attracts higher fees for running a client’s debtor ledger, and Discounting has stabilised, and as a result, fee income is also stable at £17.5 million (2013: £17.9 million). Continued investment During 2014, we upgraded our core systems and are piloting mobile technology via the launch of a pricing app with a quick quote calculator. We have also focused on recruitment and training as a key element of building a sustainable platform for the future. We have appointed new Directors of Risk, Operations and Sales, invested in a Sales Excellence programme targeted at employees with the potential to be a regional sales manager within twelve months and launched an online Career Academy. We were delighted to win ‘Factor and Invoice Discounter of the Year – 2014’ from the National Association of Commercial Finance Brokers (NACFB). Even more pleasing are the unedited comments provided by our customers on our online ratings and review service where our service is rated 4.7 out of 5. Outlook Having stabilised the platform, we look forward to continuing to develop our Invoice Finance business and providing ongoing working capital support to UK SMEs. Net interest income (£m) Net revenue margin (%) 5.9 5.1 11.7 12.0 +18% +0.3% 2013 2014 2013 2014 Segmental result (£m) Declining cost of risk (bps) 5.4 290 3.3 174 +64% -116bps 2013 2014 2013 2014 23 GovernanceFinancial statementsStrategic reportInvoice Finance Case Study “From the beginning Aldermore took the time to learn about my business, and they have been proactive and flexible in supporting us ever since our initial meeting. This has eased our constraints and enabled us to focus on continuing our growth.” Richard Haines Managing Director Mainstream Direct Mainstream Direct – Taking time to understand the business The challenge… Mainstream Direct, a family-run direct mail production business based in Northampton, did not feel that it was getting the support it required from its existing invoice finance provider. Richard Haines, the Managing Director of the company, wanted a funder who would take the time to understand his business and work closely with the company to help it continue its growth. 24 Richard mentioned this to his accountant, Gavin Parsons at Haines Watts, leading Gavin to direct him to Aldermore through our Accountancy Advice Scheme. The scheme, which was launched in 2014, sees us reward customers that come to us via an accountant with a voucher to redeem against further accountancy services. Explaining his decision to refer Mainstream Direct to us, Gavin at Haines Watts said “Aldermore has developed a reputation for making the extra effort to understand their customers’ needs and offer bespoke deals which fulfil their businesses’ requirements. Recommending Aldermore to Mainstream Direct was an easy decision.” “ It’s great that we have been able to support a strong family business which has a real impact on the local community. Mainstream Direct has benefitted from coming to us through our Accountancy Advice Scheme, not only gaining a new Invoice Finance facility, but also enjoying additional accountancy services funded by Aldermore.” Jacques Alard Relationship Manager Aldermore The solution… Early on in the relationship, our Invoice Finance team visited Richard and his team at their premises to discuss their requirements and to walk them through the interfactor transfer process from their existing provider to Aldermore. We also explained the dedicated support that was on offer throughout the term of the facility. Given the company’s experience with its previous provider, it was important that we demonstrated that we would provide consistent support and always be on hand to assist. For instance, we were able to support the company with its credit control when it lost a member of staff responsible for processing invoices by providing guidance on managing the ledger and working through outstanding invoices. As a result of our support, Mainstream Direct has been able to unlock cash to support its ambitious growth plans. The facility we provided has supported the company to expand its current services and diversify into new areas such as packaging for the printing industry. 25 GovernanceFinancial statementsStrategic reportSME Commercial Mortgages 2014 highlights • Net lending up by 33% to £1.0 billion • Organic origination of £421.9 million; up 45% over 2013 • Net interest income up by 64% to £41.6 million • Record segmental result of £34.0 million Awards • Winner – Development Lender of the Year (Bridging & Commercial Awards 2014) • Highly Commended – Commercial Lender of the Year (Bridging & Commercial Awards 2014) Integrated approach Market We offer a full range of mortgage products and whether a customer accesses us directly or via an intermediary, we aim to be easy to do business with and respond quickly. During 2014, we brought our two mortgage businesses together under a single management team, supported by a single IT platform, to provide an integrated approach to our customers. We have a private rental sector proposition across the whole spectrum of property investment, supported by expert teams. SME Commercial Mortgages Aldermore offers mortgages to cover the full lifecycle from property development through to purchase and refinancing as well as bridging loans. Our SME Commercial Mortgages business focuses on mortgages for shops, warehouses, industrial units, offices and professional buy-to-let, where the customer has more than five properties or is a corporate entity. Our maximum loan size is £2 million on a single property or £5 million over multiple properties. The majority of the underlying assets are residential properties. We estimate15 that gross annual commercial mortgage origination is currently around £44 billion. Based on our 2014 origination of £421.9 million we estimate our market share to be around 1.0 per cent. Strategy We look to build on our ability as one of the few lenders who can offer a full spectrum of products from vanilla buy- to-let mortgages to complex Houses of Multiple Occupancy (HMO), commercial investments and commercial owner occupied. Having created a centre of excellence to support the private rental sector, we will continue to leverage our integrated approach to grow this part of the portfolio. We work closely with our brokers to ensure we are easy to do business with and responsive, for more complex cases. We will continue to invest in our online portal technology to support this important channel. Looking forward, we also seek to actively develop our direct business which to date has grown as a result of repeat business and referrals. Distribution The portfolio is very granular, with the average loan size being £320,000. It is well secured with a maximum Loan to Value (LTV) of 75 per cent and an average indexed LTV ratio of 52 per cent. 91 per cent of SME Commercial Mortgages originated during 2014 were distributed through our broker panel of around 1,000 brokers. The remaining 9 per cent were distributed directly. Portfolio by product type Portfolio by asset type 3 1 1 Professional buy-to-let mortgages 50% 2 SME commercial mortgages 43% 3 Property development 7% 6 7 1 5 4 3 15 Estimates based on De Montfort University mid-year 2014 Commercial Property Lending Report. 2 2 26 1 Residential 2 Shop 3 Office 4 Warehouse 5 Property development 6 Industrial unit 7 Other 52% 18% 11% 7% 7% 3% 2% Aldermore Group PLC Annual report and accounts 2014Strategic report We have retained our focus on credit quality as average loan size remains relatively small with a high proportion of tangible asset security. In addition, we benefitted from two large recoveries and this is reflected in the reduced cost of risk which at the end of 2014 was at 25bps (2013: 30bps). The continued investment in the business is reflected in a 43 per cent increase in administrative expenses to £6.9 million (2013: £4.8 million). Finally, the segmental result was £34.0 million (2013: £18.7 million), a record for this business. Continued investment In 2014, we recruited a specialist team to focus on residential property development, developing a new IT platform to support our proposition. We also launched a new Bridging Finance product for brokers. Unlike many bridging lenders we look to offer a long term mortgage at the same time as bridging finance. To support continued growth of the business, we have increased our sales force and also our back office operations. As a result our team has grown from 61 to 84 during 2014. Outlook Improving business confidence and an increasing need for rental properties are expected to boost demand for commercial mortgages in the medium term. We will continue to support our customers’ financing needs, leveraging our modern technology to deliver excellent service. Financial performance We drove significant growth in 2014, with the SME Commercial Mortgages portfolio exceeding £1 billion for the first time. Driven by an increase in customers16 from 2,400 to 3,200, we delivered growth in net lending of 33 per cent to £1,011.3 million (2013: £762.0 million). We saw the success of our private rental sector initiative with professional buy-to-let growing by 24 per cent and now forming 50 per cent of the overall portfolio. Organic origination of £421.9 million, increased by 45 per cent on the prior year (2013: £291.9 million). We have expanded our reach into the broker market with originations in 2014 up by 45 per cent through this channel. Strong growth in net lending positively impacts our gross interest income, which is up by 41 per cent to £56.2 million while we have maintained our gross interest margin at 6.3 per cent (2013: 6.1 per cent). Funding costs across the Group have continued to decline with net interest margin improving to 4.7 per cent (2013: 3.9 per cent). Net interest income has grown by 64 per cent to £41.6 million (2013: £25.3 million). Organic loan origination (£m) Net loans (£m) 422 1,011 292 762 +45% +33% 2013 2014 2013 2014 Growing interest income (£m) Declining cost of risk (bps) 56.2 39.9 30 25 +41% -5bps 2013 2014 2013 2014 16 As measured by customer accounts 27 GovernanceFinancial statementsStrategic reportSME Commercial Mortgages Case Study “ Aldermore are different from many other lenders in the way that they view the client and their circumstances. They use common sense when it matters and are always looking at ways to ensure, where they can, that they get the deal done.” Howard Thomas Director Howard Thomas Ltd Howard Thomas – Getting the deal done at pace The challenge… When Howard Thomas’s clients approached him to find them a commercial mortgage for the purchase of a ground floor retail unit with upstairs residential accommodation in Derby, he knew that Aldermore would be able to help. 28 Mr Thomas’s clients are seasoned property owners with commercial and residential properties as part of their portfolios. The husband of the investment duo already held commercial property under his name, and on this occasion the couple wanted to extend the wife’s residential portfolio to include a commercial property. The property in Derby represented the perfect opportunity. The challenge with this application was the property had already been purchased at auction so needed a very quick completion. In fact, the timeline was so tight that the deal needed to be paid out within 13 working days from the date of the application in order to meet the auction house deadline. Strategic report“ A deal like this would normally take between eight and twelve weeks from application to completion. To turn it around in thirteen days was a remarkable achievement by all involved and is the quickest I’ve ever seen a case go through for a commercial property purchase.” Lisa Baker Commercial Mortgage Manager Aldermore The solution… To meet the purchase deadline, everything about the deal had to be prioritised. As soon as Mr Thomas submitted his clients’ application, we assessed it on the same day and sent back confirmation to Mr Thomas to proceed to valuation. The survey was booked for the following day. We contacted the surveyor as soon as the valuation had taken place to ensure the case could be passed to our underwriters for approval as quickly as possible. Following our call to the surveyor, some reports were required which were needed as a condition of approval. Mr Thomas worked extremely quickly to obtain these reports which were satisfactory to clear the conditions by the time we received the valuation report. Ultimately it was down to the great communication and speed of response from all parties, including Mr Thomas and his client, which enabled us to make an offer within four working days of the valuation instruction. Mr Thomas’s clients were able to complete their purchase a mere eight working days after the initial offer was accepted, meeting their deadline. 29 GovernanceFinancial statementsStrategic reportResidential Mortgages Our Residential Mortgages business provides residential buy-to-let and owner-occupied mortgages with around 62 per cent of the portfolio currently being buy-to-let. In the owner-occupied sector we target underserved prime customers including the self-employed, professionals and first time buyers. Our owner-occupied business targets underserved prime customers who may fall outside the automated decisioning processes of some of our competitors, e.g. self-employed and first time buyers. We were also an early adopter of Government schemes such as the Help to Buy: mortgage guarantee scheme. 2014 Highlights • Net lending up by 53% to £2.6 billion • Organic loan origination exceeds £1.1 billion • Net interest income doubled to £63.5 million • Segmental result more than doubled to £56.8 million • Cost of risk remains low at 6bps Awards • Winner – Best Specialist Lender (Financial Reporter Industry Awards 2014) • Winner – Best Specialist Lender (Legal & General Mortgage Club Awards 2014) • Winner – Best Specialist Lender (Mortgage Strategy Awards 2014) – third consecutive year We offer a full product range with fixed, variable and discounted rates and although our maximum loan size is £1 million, the average loan size is much smaller at around £137,000. Market The UK residential mortgage market is large, with 2014 gross originations including buy-to-let, of £206 billion17, giving Aldermore an estimated market share18 of 0.6 per cent. Market originations are expected to grow17 as the demand for housing continues. Distribution through intermediaries remains a significant market feature19 accounting for in excess of 50 per cent of total originations. • Winner – Best Specialist Lender Strategy (Mortgage Force Awards) • Winner – Best Specialist Lender (Pink Service Awards 2014) • Winner – Best Lender Customer Service (What Mortgage Awards 2014) We aim to get new customers into new homes and support small businesses including first time landlords. Our private rental sector team works across both residential and commercial segments providing a full suite of buy-to-let products and are able to deal with everything from an amateur landlord with one property to a professional investor with hundreds of properties. Within Residential Mortgages we focus on individuals where we can finance up to five properties. As in our other divisions, we aim to be easy to do business with, transparent and quick to respond. We benefit from our modern technology. In Residential Mortgages, our brokers are able to apply via an online portal and obtain a decision in principle within 90 seconds. This portal takes the application and links to external systems automatically completing basic identity, fraud and credit checks and builds an underwriting file highlighting any specific issues to our underwriters. This technology allows us to use targeted human underwriting in a cost-effective manner to make considered and consistent credit decisions. Distribution We enjoy strategic relationships with major UK distributors and in total work with around 12,000 brokers via our paperless bespoke broker portal. Around 88 per cent of 2014 originations were generated by brokers. We have had a tremendous response to our direct to customer proposition and it now accounts for 12 per cent of all originations. Over time, we would expect the distribution mix between intermediated and direct to move towards market average levels. Portfolio split by product type Portfolio by customer type 1 2 1 Buy-to-let 62% 2 Owner-occupied 38% 4 5 1 3 2 1 Employment 2 Self-employed 44% 38% 3 Director/partner 9% 4 Retired 5 Other 4% 5% 17 18 19 Source: Council of Mortgage Lenders (CML) – December 2014. Market share calculation based on loan originations in 2014. Source: FSA – Mortgage Market Review: Distribution and Disclosure. 30 Aldermore Group PLC Annual report and accounts 2014Strategic report Financial performance 2014 was a record year for our Residential Mortgages business with net loans up by 53 per cent to £2.6 billion (2013: £1.7 billion) driven by an increase in number of customers20 to 19,000 (2013: 13,000). The buy-to-let portfolio grew by 45 per cent during the year, while the owner occupied portfolio grew by 106 per cent thereby becoming a larger proportion of the overall portfolio at the end of 2014. Originations exceeded £1.1 billion per annum for the first time, with Help to Buy mortgage guarantee scheme generating £189 million of loans in the year. Origination via brokers grew as we saw increased levels of repeat business from existing brokers. Direct originations were supported by the launch of our direct loyalty and retention programmes. This significant growth resulted in an increase in interest income of 60 per cent to £106.9 million with our gross interest margin remaining stable at 5.0 per cent (2013: 5.1 per cent). Net interest income after funding costs doubled to £63.5 million (2013: £31.8 million) mainly driven by lower cost of funding, a feature across all our lending divisions. We manage the credit quality of the portfolio carefully, with the average loan size remaining small at £139,000 and high asset security with indexed loan to value of 67 per cent. This control is reflected in the low cost of risk of 6bps (2013: 10bps). Administrative expenses at £9.6 million grew at a much lower rate than growth in operating income. The segmental result more than doubled to £56.8 million (2013: £26.4 million). Continued investment We continue to invest in our systems to ensure they allow our customers and brokers to access us easily and support our underwriters. During 2014, we invested in a Bridging portal for intermediary applications which will be fully deployed in 2015. Our team grew from 97 at the end of 2013 to 132 by the end of 2014 as we invested in increasing our operations and risk functions. We’re delighted with the positive feedback we’ve had from customers via our online rating and reviews service where we scored 4.7 out of 5. Outlook There remains a fundamental shortage of new housing in the UK and we look to support efforts to alleviate this issue. We see significant growth opportunities in the underserved market segments we target and buy-to-let, which should continue to drive growth in our Residential Mortgages portfolio in 2015. Organic loan origination (£m) Net loans (£m) 1,165 740 2,565 1,680 +58% +53% 2013 2014 2013 2014 Growing interest income (£m) Declining cost of risk (bps) 106.9 66.7 10 +60% 6 -4bps 2013 2014 2013 2014 20 As measured by customer accounts 31 GovernanceFinancial statementsStrategic reportResidential Mortgages Case Study “From the moment we approached Aldermore, we really felt like they cared about us. They were professional yet friendly and did everything in their power to help us secure the mortgage as promptly and efficiently as possible. Now that we are in our new home, our quality of life has improved greatly and it is perfect for our expanding family.” Malcolm and Julia Wiggins Homeowners The challenge… Mr and Mrs Wiggins, a married couple who are both self-employed, were looking for their ‘forever home’ ahead of the birth of their first grandchild. They wanted somewhere with space for their growing family and soon found the perfect property – a lovely country house surrounded by fields and wildlife in Wales. 32 In order to purchase the property, the couple submitted a joint mortgage application to a major high street lender. Despite having significant equity in their existing property, they were not offered the terms they had requested, a decision that the lender only informed them of after 14 weeks had passed. Mr and Mrs Wiggins then approached their existing mortgage lender who declined their application to port their current mortgage. After their second mortgage application was turned down, Mr and Mrs Wiggins became extremely worried that they were in danger of losing the house. Given the time that had elapsed since their original offer on the property had been accepted, there was extreme pressure on the chain and the vendor was threatening to pull out of the sale. “I’ve spoken to Mr and Mrs Wiggins since they moved and they are extremely happy in their new home – in fact they said moving there is the best thing they’ve ever done. I’m really pleased that we were able to step in at the last minute to help them complete their purchase.” Gemma Donnelly Mortgage Advisor Aldermore The solution… Anxious to find a lender that would support them, Mr and Mrs Wiggins undertook an internet search and came across Aldermore. Fortunately we were able to quickly step in and do all within our power to help them meet their tight and demanding timeframe. To better understand Mr and Mrs Wiggins’s needs, we spoke to them on the phone before they submitted their application. Although they were both self-employed, their requirements seemed straightforward. However, to ensure that we gave the best advice, we needed to discuss their repayment plans as they had applied for an interest only mortgage on a residential property. Due to these initial discussions, we were able to make an offer extremely quickly upon receiving the full application – within less than a week and a half. Throughout the process, we stayed in regular phone contact with the couple, remaining especially conscious of their prior experiences with other lenders. Mr and Mrs Wiggins were able to successfully complete their purchase and have since written to thank us for our support. 33 GovernanceFinancial statementsStrategic reportSavings 2014 highlights • Total deposits grew by 29% to £4.5 billion • SME deposits now exceed £1 billion • SME Customised Fixed Rate Account (CFRA) launched • Rated 4.6 out of 5 by our customers Awards • Four Time Winner – ISA Provider of the Year (Consumer Moneyfacts Awards 2011-14) • Winner – Best Business Fixed Account Provider (Business Moneyfacts Awards 2014) • Winner – Best Bank Savings Provider (Moneyfacts Awards 2014) • Winner – Best Cash NISA (Online Personal Wealth Awards 2014 and 2013) • Winner – Best Business Savings Account Provider (Savings Champion Awards 2014) • Winner – Best Bank Savings Provider (Your Money Awards 2014) • Winner – Best Online Savings Account Provider (Your Money Awards 2014) • Winner – Best Online Cash ISA Provider (Your Money Awards 2014) • Winner – Innovation in the SME Finance Sector (Business Moneyfacts Awards 2014) 21 SME deposits include corporate deposits 22 Source: Bank of England. UK deposit pool comprises outstanding sterling deposits and repos for individuals (retail) and non-financial businesses (SME/Corporate) 23 Based on deposits as at 31 December 2014 24 Based on accounts opened in 2014 34 A key pillar of our brand is total transparency. We publish unedited reviews on our website which allows us to react to customer feedback, improving our offering, and allows potential customers to see what other savers think of our products and services. In this, we believe we are unique in the UK banking sector. We don’t believe in products with gimmicks, teaser rates or introductory offers which the customer then has to keep an eye on. Having identified that SMEs’ savings needs were as underserved as their lending needs, we launched our SME offering in 2012. We see strong opportunities for growth in both the SME and Corporate deposit market which we recently entered. Distribution Our distribution strategy is predominantly online with around 76 per cent of retail and almost all SME accounts opened via our website. Aldermore’s dynamic online savings franchise anchors our funding base enabling us to support the financing needs of UK SMEs and homeowners. We offer a range of award-winning, straightforward saving products to both Retail and SME customers and have recently expanded into the corporate savings market. Products include retail fixed term, notice, easy access and cash ISAs as well as SME fixed term and easy access accounts. Market The UK savings market is large at around £1.7 trillion22 across both retail and SME/Corporate deposits and is steadily expanding. Aldermore has estimated market shares23 of around 0.3 per cent in retail deposits and 0.2 per cent in SME/ Corporate deposits leaving substantial scope for future expansion without the need to target large market shares. Strategy We believe that saving should be as straightforward and as rewarding as possible for our customers. For both retail and SME depositors, we aim to deliver exceptional service. Accounts can be opened and funded online within fifteen minutes as our modern IT systems and processes are able to link to external systems to complete key identity checks. We also offer phone and postal access for retail customers. Deposits by customer type21 Retail deposits – distribution24 1 1 2 1 Retail deposit 2 SME deposits 77% 23% 2 1 Online 2 Telephone/ post 76% 24% Aldermore Group PLC Annual report and accounts 2014Strategic report Growth Product innovation Ratings and reviews Our deposit business delivered another strong year of growth, with total deposits growing by 29 per cent to £4.5 billion (2013: £3.5 billion) and forming around 88 per cent of the Group’s total funding base (2013: 90 per cent). We now have almost 94,000 retail savers holding around 114,000 accounts (2013: 86,000 customers with 100,000 accounts) with total retail deposits growing by 16 per cent to £3.4 billion (2013: £2.9 billion). Within three years, SME deposits have surpassed £1 billion and are nearly double the balance at the end of 2013 (£0.5 billion). SME customers increased to 11,000 (2013: 7,000) while number of accounts more than doubled to 14,500 (2013: 7,000). At the start of 2014, we launched our Customised Fixed Rate Account (CFRA) for SMEs, with our modern, flexible systems enabling us to develop and launch this product within three months. This innovative account allows SMEs to decide the exact term of their deposit ranging from 60 days to five years and a maturity date dial will provide the corresponding interest rate. Alternatively, a customer can select the interest rate they want to earn and our system will calculate the maturity required. We believe this is the only account of its kind in the SME market and in less than a year represents around 11 per cent of our SME deposit base. We believe that reviews are an excellent way of providing a great customer experience for both existing and future customers and we are delighted that our customers currently rate us at 4.6 out of 5. We take feedback seriously and take action to improve our services and products: • during 2014 we changed our 0845 telephone number to a 0345 number so that calls would be free from mobile phones as well as landlines; • we simplified our payments processes to make faster payment options more obvious; and • a customer can now open a subsequent account in two clicks as we link automatically to data from the original account rather than making the customer repeat the full process. Outlook We will continue to provide transparent, straightforward and innovative products which meet the needs of both our Retail and SME depositors supported by exceptional customer service. During 2015, we also look to extend further into the corporate savings market. Customer deposits25 (£bn) 4.5 1.0 3.4 3.5 0.5 2.9 2013 2014 Retail deposits SME deposits +29% Illustration purposes only. For more information on the Customised Fixed Rate Account please visit http://www.aldermore.co.uk 25 SME deposits include corporate deposits. Numbers may not exactly sum due to rounding. 35 GovernanceFinancial statementsStrategic reportSavings Case Study “Dealing with Aldermore was really simple. Their website was easy to use and compared to other banks their account opening process was extremely straightforward. What’s more, when I needed to call them, they answered the phone straight away and didn’t leave me hanging on the line.” Steve Edwards Managing Director Silvertel Silvertel – Allowing customers to choose their own terms The challenge… Silvertel, which is based in Newport in Wales, specialises in developing and supplying electronic components to an extensive customer base including many leading technology, telecoms and security companies around the world. The business was founded by electronics graduate Steve Edwards in 1997. 36 Steve keeps spare cash in reserve in case of an emergency. He cannot lock this money away for long periods of time since he never knows when the company may need to access it at short notice, however there is the flexibility to lock it away for a few months at a time. Steve was disappointed with the rate he was getting from the company’s main high street bank so began looking at other options. Steve had not previously heard of Aldermore and came across us through a search on a price comparison website. He also read a number of independent reviews of Aldermore online which talked positively about us. Intrigued by what he had seen, Steve was persuaded to come to us for his company’s savings needs. “We pride ourselves on our simple, straightforward products and processes and the great value returns that we offer. All of our savings accounts can be set up and funded online in fifteen minutes, meaning that SMEs like Silvertel can open an account with us effortlessly without leaving the office.” Richard Taylor Head of Products, Savings Aldermore The solution… Steve decided that our Customised Fixed Rate Account (CFRA) was right for Silvertel. With the account, customers do not have to adhere to a maturity date chosen by us; instead they can select any date between 60 days to five years, with the interest rate increasing the longer they leave their money with us. We believe it is the only account of its kind for SMEs. The ability to select a maturity date has proved useful for Silvertel. It allows Steve to fix the term for a few months at a time before rolling the funds over for another fixed term – something he has done several times since opening the account. In fact, he was so impressed with his experience of Aldermore that he has since opened a personal savings account with us too. We developed the CFRA after speaking to hundreds of SMEs who told us that, as well as good returns and straightforward processes, they require flexibility from their savings accounts. The account is one example of how we put customers at the heart of what we do. 37 GovernanceFinancial statementsStrategic reportPrincipal risks and uncertainties This section describes the principal risks and uncertainties to which the Group is exposed along with the Group’s approach to mitigating these risks. All of the risks described within this section are classified as principal risks within the Group’s Risk Management Framework and are considered to be important to the future development, performance and position of the Group. However, there is a sub set of these principal risks which are deemed to be more pertinent given the Group’s current circumstances. These particular risks reflect the Group’s development and growth strategy: • credit risk: in particular, given the unseasoned nature of the book, there is a future risk that the underlying credit impairment loss trends differ from the Group’s current expectations; • capital risk: as the Group continues to follow a growth strategy, there is a risk that the Group has insufficient capital to cover regulatory requirements; • operational risk: given the growth strategy, there is a risk that the operational infrastructure is inadequate to support the Group. The Group currently has a significant transformation and change agenda which includes the concurrent running of numerous projects. These projects include IT based projects designed to ensure that the Group’s infrastructure remains modern and scalable, to support the Group’s growth strategy. Therefore the Group is exposed to execution risk on these projects. During 2014, an element of this risk crystallised resulting in a £1.6 million write off of an intangible asset. Each of these risks, along with how the Group mitigates them, is discussed in detail below. The Group’s Risk Management Framework is designed to ensure that risks are identified, assessed, managed and monitored effectively. Group Risk provides oversight of the risk profile. Each risk has a defined risk appetite which is controlled through documented policies and regular reporting, and is monitored and overseen by one or more committees as part of the Group’s governance process. Further detail regarding the Risk Management Framework is provided in Note 40 and specific detail on capital management is provided in Note 41. Further details regarding the management of strategic risk, operational risk and conduct risk are presented below. Current risks Economy The economic environment is relatively stable within the UK, with growth across most sectors and contained inflationary risks. However, international geopolitical risks are increasing in the EU, Russia and China which may adversely affect the UK and these developments are being closely monitored. Deflation and contraction, especially in the EU economies, could act as a drag on the UK, and central London property price softening could broaden out. The Group is not exposed to any direct risks of a possible Greek exit from the eurozone. Recent deflationary pressures, exacerbated by reducing oil prices have reduced and flattened the yield curve and have extended the timing for near-term interest rate increases. The Group has a material proportion of mortgage assets which are sensitive to interest rate rises, therefore the reduced interest rates in the near term will lower the risk on affordability pressures linked to rising interest rates. Oil & gas sector Falling oil prices over a prolonged period are likely to affect property and asset values for companies involved in the oil industry, especially for property values in Aberdeen, Scotland. The Group has a very modest exposure to this risk and there are no immediate signs of stress apparent, but the position is being closely monitored. Cyber risk As the Group continues to grow, with a number of projects running, operational risk will continue to remain an area of focus. Operational risks such as cyber risk and IT security are reviewed at Board level as well as at management level committees. Cyber risk is a high profile issue for banks and cyber risk threats are expected to increase over time for the industry. The Group’s current position in managing cyber risks has been reviewed during 2014 and control enhancements made. Further investment and actions are planned for 2015 to increase protection against IT security and IT resilience risks. The following table details all of the risks classified as principal risks within the Group’s Risk Management Framework. Strategic risk Definition The risk which can affect the Group’s ability to achieve its corporate and strategic objectives. Mitigation of risk Strategic risk is particularly important as the Group continues its growth strategy. The Group seeks to mitigate strategic risk by focusing on a sustainable business model which is aligned to the Group’s business strategy. Strategic risk can arise as a result of both internal and external factors. The Group seeks to identify and mitigate the individual components of strategic risk through the application of the Risk Management Framework. Further details of strategic risk are provided below. 38 Aldermore Group PLC Annual report and accounts 2014Strategic reportCredit risk Definition The risk of financial loss arising from a borrower failing to meet their financial obligations to the Group in accordance with agreed terms. Capital risk Definition The risk that the Group has insufficient capital to cover regulatory requirements and growth plans. Liquidity risk Definition The risk that the Group is not able to meet its financial obligations as they fall due, or can do so only at excessive cost. Interest rate risk Definition The risk of financial loss through un-hedged or mismatched asset and liability positions sensitive to changes in interest rates. Mitigation of risk The Group seeks to mitigate credit risk by focusing on business sectors where it has specific expertise and through limiting concentration of exposures of larger loans and or geographical and business sectors, especially where there are higher levels of risk. The Group also seeks to obtain security cover, and where appropriate, personal guarantees from borrowers. The Group uses detailed lending policies tailored to each business area which outline the approach to lending, underwriting criteria, credit mandates, concentration limits and product terms. The Group maintains a dynamic approach to credit management. Its lending policies and performance against risk appetites are regularly reviewed and the Group will take necessary steps if specific issues are identified or expected to deteriorate, due to economic, sector or borrower specific weaknesses. External rating agency ratings for borrowers are not typically available in the specialist segments in the retail and SME markets in which the Group operates. Credit risk is, instead, assessed through a combination of due diligence, reviewing credit reference agency reports, reviewing financial information, credit scores and the use of underwriting expertise. As a growing business with a relatively unseasoned loan book, there remains a risk that the level of credit risk incurred to date is not reflective of the future credit risk which may be incurred as the loan book matures. The Group actively manages credit risk as described above and is cognisant of the relatively unseasoned nature of the book as it reviews credit performance. See page 104 for further analysis. Mitigation of risk The Group undertakes certain activities to manage and mitigate capital risk. The primary mechanism to ensure that sufficient capital is held is through regulating the volume of asset origination. In addition, capital risk management activities include monthly capital forecasting over a period of 12- 18 months designed to provide a forward view on capital allocation and excess regulatory capital. Furthermore, stress testing and sensitivity analysis is performed to provide information on the Group’s capital position. Capital requirements under stressed conditions are considered as part of the Group’s Internal Capital Adequacy Assessment Process. In December 2014, the Group has raised further capital in the form of Additional Tier 1 securities to enable it to continue its growth strategy. There will continue to be a keen focus on capital management to ensure that the Group has a capital structure which is both compliant with the relevant regulatory requirements and also supports the Group’s growth strategy. See page 119 for further analysis. Mitigation of risk To protect the Group and its depositors, the Group maintains a liquidity buffer, which is based on its liquidity needs under stressed conditions. The liquidity buffer is monitored on a daily basis to ensure there are sufficient liquid assets at all times to cover cash flow movements and fluctuations in funding and to enable the Group to meet all financial obligations and to support anticipated asset growth. Liquidity requirements under stressed conditions are considered as part of the ILAA process. Through the ILAA process, the Group has assessed the level of liquidity necessary to prudently cover systemic and idiosyncratic risks and the ILAA process determines the appropriate liquidity buffer, taking into account the specific nature of the deposit base. See page 115 for further analysis. Mitigation of risk Where possible the Group seeks to match the interest rate structure of assets with liabilities or deposits creating a natural hedge. Where this is not possible the Group will enter into swap agreements to convert fixed interest rate liabilities into variable rate liabilities, which are then matched with variable interest rate assets. See page 117 for further analysis. 39 GovernanceFinancial statementsStrategic reportPrincipal risks and uncertainties continued Market risk Definition The financial impact from movements in market prices on the value of assets and liabilities. Mitigation of risk The Group does not seek to take or expose itself to market risk, and does not carry out proprietary trading, although certain liquid asset investments which form part of the liquid asset buffer may carry a limited amount of mark-to-market risk which is regularly monitored. It is accordingly considered that there is minimal exposure to market risk. See page 117 for further analysis. Operational risk Definition The risk of financial loss and/or reputational damage resulting from inadequate or failed internal processes, people and systems or from external events including financial crime. Conduct risk Definition The risk of detriment to the Group’s customers due to the inappropriate execution of its business activities and processes. Mitigation of risk The Group aims to minimise operational failures through the establishment and subsequent investment in sound systems, controls and audit functions. Further details are provided below. Mitigation of risk The Group has a zero appetite for systemic unfair outcomes that may result in significant detriment to the Group’s customers. However, occasional failures in operational processes may occur, for example administration and processing errors or interruptions to IT systems. These occasional events may have an impact on customers leading to customer detriment. The Group has set a tolerance around the detriment caused through such non-systemic process failings. The Group has reviewed its conduct risk framework and is rolling out further improvements in 2015. The Group mitigates conduct risk by monitoring various operational metrics and by tracking activities which affect customers, monitoring customer complaints, implementing process improvements and adhering to service standards. Further details are provided below. Strategic risk As described above, the Group seeks to mitigate strategic risk through the application of the Risk Management Framework. The section below provides further details of how strategic risk can arise. The Group’s strategic direction and performance is impacted by external factors (that are similar to those impacting other financial institutions) and internal operational factors. External factors External factors include uncertainty around future interest rate movements and increased competition, especially from new entrants to the market, which may challenge product and pricing margins. The Group closely monitors competitor activity, pricing, and customer behaviour and feedback and reflects this in pricing and marketing plans. As with other financial institutions, the Group is also affected by the level of litigation activity environment. However, the Group has not sold any PPI products and only provides advice to retail mortgage customers on a limited basis. The Group does not currently operate in the retail lending space of unsecured personal loans, credit cards or current accounts. As a regulated business, the Group must also comply with the complex and changing regulatory environment. Prudential and conduct regulation continues to evolve and the Group maintains regulatory monitoring activity to understand future requirements and how this may affect the Group. To comply with current prudential regulatory requirements, the Group maintains adequate capital and liquidity resources to satisfy these requirements at all times. Notwithstanding, the Group’s borrowing costs and capital requirements could be affected by future prudential regulatory developments. 40 There remains a keen focus on capital management to ensure that the Group has an appropriate capital structure in place to support the Group’s growth strategy. The Group has a zero risk appetite for material regulatory breaches. To ensure compliance with regulatory requirements, the Group has policies, processes and standards which provide the framework for business activities and staff to operate to which are in accordance with the laws, regulations and voluntary codes which apply to the Group and its activities. Compliance with regulation incurs significant costs which are factored into the operational cost and are considered in relation to the specific products and services that the Group offers. Aldermore Group PLC Annual report and accounts 2014Strategic reportInternal factors Internal factors which impact strategic risk include the adequacy of IT systems, data security, project management, supplier and outsourcing arrangements and from internal and third party fraud and compliance failings. As the Group grows it continues to monitor the adequacy and ability of its third party suppliers to support the Group, now and in the future and where necessary will seek alternative arrangements. The Group distribution strategy involves the use of intermediaries based in the UK. As a result of this strategy, the Group is exposed to the risk inherent in relying on third parties to sell and promote products. There is a risk that intermediaries act inappropriately or fail to adhere to applicable conduct regulations or standards in the sale of the Group’s loan products, which could harm the Group’s brand and/or reputation. Other risks include that the Group may fail to develop products that are attractive to intermediaries or otherwise not succeed in developing relationships with intermediaries and could therefore lose the service of intermediaries. Operational risk A key internal factor is operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This risk includes IT, information security, project, outsourcing, tax, legal, fraud and compliance risks. The Group aims to maintain robust operational systems and controls and seeks to operate within the defined level of operational risk. The operational risk appetite considers risk events, the assessment of internal controls as well as holding additional capital for certain operational risks. As part of the operational risk management process, the Group has an Operational Risk Policy, and undertakes a Risk & Control Self-Assessment process across the Group, and has business continuity plans in place. The Group uses an Enterprise Risk Management system to support the recording of risks and controls as well as monitoring operational risks and risk events. Through the establishment of, and investment in, sound systems, controls and audit functions, the Group aims to minimise’s operational failures. Operational risk is reviewed by the Business Risk Committee, which meets monthly to ensure that a quality and robust IT, operations and compliance service is delivered at all times and is capable of supporting the changing business requirements of the Group. It has responsibility for monitoring all the key operational risks facing the organisation, including compliance and operational risks. The Business Risk Committee provides a monthly report to the Executive Risk Committee on operational risk matters. The Group has placed emphasis on ensuring that the IT infrastructure, performance, resilience, and security meet the on-going needs of the business. In particular significant investment in cyber risk controls to ensure that the Group maintains appropriate levels of controls to counter the increasing threat of cyber-crime across the banking and financial services industries. The Group currently has a significant change agenda which includes the concurrent running of numerous projects. These projects include IT based projects designed to ensure that the Group’s infrastructure remains modern and scalable, to support the Group’s growth strategy. Therefore the Group is exposed to execution risk on these projects. Conduct risk Conduct risk is the risk of detriment caused to the Group’s customers due to the inappropriate execution of its business activities and processes. The Group extends the definition of ‘customer’ to include both retail and SME commercial customers (but excludes intermediaries and/other third parties) across all business segments, including both regulated and non-regulated activities, thereby applying its conduct risk policies to all lending and deposit-taking activities. The Group has a zero appetite for systemic unfair outcomes, which may result in significant detriment to the Group’s customers. Systemic unfair outcomes may arise from poor product design, poor sale processes or unacceptable operational practices which risk repeated or continual outcomes which are detrimental to customers. However, occasional failures in operational processes may occur, for example administration and processing errors or interruptions to IT systems. These occasional events may have an impact on customers, leading to customer detriment. The Group has set a tolerance around the detriment caused through such non-systemic process failings. The risk is that customers can suffer detriment due to actions, processes or products which originate from within the Group. Conduct risk can arise through the design of products that do not meet customers’ needs, mishandling complaints where the Group has behaved inappropriately towards its customers, inappropriate sale processes and exhibiting behaviour that does not meet market or regulatory standards. Customer detriment could affect the Group’s reputation, lead to loss of market share due to damage to Aldermore’s brand, may lead to customer redress payments and could lead to regulatory action and censure. The Group mitigates conduct risk by monitoring various operational metrics and by tracking activities which affect customers, monitoring customer complaints, implementing process improvements and adhering to service standards. The conduct risk metrics (which include among others, staff performance levels, training, customer feedback and complaints, product retention rates and cancellations, arrears levels and customer service standards) vary across the business lines and consist of individual business line conduct risk KPIs, the sum of which is measured against the risk appetite. Conduct risk metrics and KPIs are in place to evidence fair outcomes, identify any emerging issues and document remedial actions. Each customer-facing area is responsible for implementing controls designed to manage and report on conduct risk, which includes understanding how customer detriment may occur, how it is identified and how it is prevented going forward. Conduct risk is monitored by the Business Risk Committee. 41 GovernanceFinancial statementsStrategic reportOur customers, people and communities By acting in a socially beneficial and ethical manner, we are both contributing to the communities where we operate and also supporting our strategy, long-term performance and the sustainability of our business. Our brand pillars – total transparency, exceptional service and community – shape everything we do and inform our approach to our customers, our people and our communities. Businesses that last have a purpose beyond simply making money. This is why we are committed to fulfilling the responsibilities that come with being a British bank supporting SMEs, homeowners and savers. Our customers Our aim is to deliver exceptional service. By exceeding customers’ expectations, we are differentiating Aldermore from its competitors, helping to attract and retain customers. We continue to focus on our digital infrastructure to ensure that our customers can interact with us whenever is most convenient for them. Visits to our website exceeded 1.85 million in 2014, up 19 per cent. Over 76 per cent of retail savings applications and all of our SME savings applications are now taken online. At the end of 2014, we relaunched our website to simplify the customer journey and improve usability. Navigation is now customer-led, meaning visitors can select who they are, to help them find suitable products and services. The website is tablet and mobile friendly to enable visitors to access the information they need wherever they are. We are dedicated to transparency in everything we do. In 2012, we launched unedited ratings and reviews on our website, giving every customer the opportunity to comment on our products and services online. Initially launched for Retail Deposits, SME Deposits and Invoice Finance, we extended the service to Residential Mortgage customers in 2014. We received 1,904 reviews across our Ratings & Reviews service during 2014 and achieved an average rating of 4.6 out of 5, something we are very proud of and an endorsement of our approach. Not all of the feedback we receive is positive and there are times we fall short. If we receive a complaint, it is investigated by the relevant business line and reported to our Executive Team. We actively use feedback from our customers to improve our products and processes. In 2014, improvements included changing our 0845 telephone number to a 0345 number so that calls are free from mobile phones as well as landlines; simplifying our payments processes to make faster payment options more obvious; and streamlining the process for opening multiple accounts by linking automatically to data from the original account instead of making the customer repeat the full process. Ratings & Reviews We read every comment that we receive through our online Ratings & Reviews service. Customers regularly suggest improvements to our products and services and we always consider these suggestions when developing our offering. 42 Aldermore Group PLC Annual report and accounts 2014Strategic reportOur people In 2014, the number of people we employ increased by 28 per cent taking the total number of employees to 876. To support this growth, we focused on our recruitment and induction processes. Recognising the importance of social media for reaching key talent, we have increased our use of channels such as LinkedIn for recruitment. In the second half of 2014, we centralised our induction programme to ensure a consistent introduction to the Group for all new starters. Each new starter is invited to a full day workshop in which they learn about our brand, values, approach to risk management and our products and services. We are committed to employee engagement at Aldermore. To reward and recognise the contribution our people make, we relaunched our REDStar recognition scheme which rewards our people for going above and beyond. The scheme now sees us rewarding weekly nominees and quarterly overall winners. Throughout the year we received 358 REDStar nominations. We also understand that clear career progression has a positive impact on employee motivation. During 2014, 137 of our people were promoted or moved into new roles and 27 per cent of positions were filled internally. To encourage career development, we launched a ‘Building Your Career’ toolkit which is now widely used and accessible to all. Best Companies ‘One to Watch’ accreditation We have been awarded ‘One to Watch’ status by Best Companies to Work For, acknowledging our progress towards making Aldermore a great place to work. The Best Companies Index is recognised as a leading measure of workplace excellence. We place a great deal of importance on ensuring that the lines of communication between our people and the Group’s leaders are two-way and transparent. We have continued our programme of Executive visits to our regional offices during which our people are able to meet and hear from senior members of the Aldermore team. We hold an annual employee roadshow in which we bring our people together to update them on the Group’s vision and strategy. The roadshow also provides a forum for our people to pose questions to the Executive Team and to network with their colleagues. Roadshow events were held in Manchester, Leicester and Reading to enable all of our people to attend regardless of their geographical location. Following the roadshow, 84 per cent of respondents felt they had a good understanding of our vision and strategy. At the end of 2014, we took part in the Sunday Times ‘Best Companies to Work For’ survey and were accredited as ‘One to Watch’. We are very proud of this recognition and our people are clearly proud to work for Aldermore. Our communities We make a real effort to give back to our communities, whether it is supporting the country’s vital SME community, making a positive contribution to the local communities in which we operate or behaving as a responsible member of the UK’s financial services community. Our commitment to Britain’s SME community extends beyond simply providing lending to businesses. In September, we piloted our first ‘Helping You Grow Your Business’ event, inviting our customers and introducers to a topical discussion on industry trends which included representation from the Bank of England. It also provided individuals the opportunity to network with like-minded businesses. We realise the importance of sharing our industry insight as widely as possible, which is why we produce regular industry research. In 2014, this included our quarterly ‘SME Monitor’ report produced in conjunction with the Centre for Economics and Business Research (Cebr) which looked at cost inflation amongst Britain’s SMEs. Our ‘Saving SMEs’ report provided a measure of the business savings market by analysing SMEs’ attitudes towards saving. Executive roadshow We are committed to giving our people regular updates on the Group’s strategic vision and direction. Our annual Executive roadshow ensures that all employees hear directly from our Executives and can ask any questions they may have. 43 GovernanceFinancial statementsStrategic reportStrategic report Our customers, people and communities continued Aldermore Community Team The Aldermore Community Team (ACT) was established in October 2014 to enhance our ‘Community’ brand pillar and is responsible for our community and fundraising initiatives. We have ACT champions based in each of our 12 offices. Our communities continued We also recognise our duty to help our intermediary partners deliver exceptional service to their SME clients. To support the commercial finance broker community, we launched our ‘Next Generation Training Academy’ which sees us provide training to junior staff at our Asset Finance broker partners. This initiative has reinforced our broker relationships and is another way we are helping SMEs to access the expertise they need. Recognising the important contribution made by entrepreneurs to the British economy, we support the SKILL! Programme which promotes business skills and entrepreneurialism amongst young people. This year our staff acted as corporate mentors to budding entrepreneurs at schools in Manchester, Reading and Peterborough. We regularly run community and fundraising activities. In October 2014, we launched the Aldermore Community Team (ACT), a group of volunteers spanning our offices who are responsible for managing these initiatives. The team has already staged several fundraising events coordinated across the Group. Our £ for £ Matching Scheme sees us top up charitable contributions made by our employees. Through the scheme we donated £11,360 to non-profit and community organisations during 2014. Causes supported included the Royal British Legion, Macmillan Cancer Support and Help the Hospices. Through our support for Government schemes encouraging lending to businesses and homeowners, we aim to play our part in Britain’s banking community. Aldermore has been an enthusiastic participant in the Funding for Lending Scheme, providing much-needed credit to Britain’s SMEs, and was an early adopter of the Help to Buy scheme. As a bank supporting over 160,000 customers, it is vital that we contribute our views to industry discussions and respond to Government consultations on the banking needs of SMEs and individuals. The evidence we gave to the Business, Innovation and Skills Select Committee on the Government’s support for SMEs in December is just one instance where we have been able to share our experiences. Our communities are extremely important to us and we are committed to making a positive contribution to them. In this way, we are not only giving something back but also supporting the long-term performance and sustainability of Aldermore. Approved by the Board and signed on its behalf by: Phillip Monks Director 16 February 2015 44 Aldermore Group PLC Annual report and accounts 2014Governance Corporate governance report Introduction This aim of this Corporate governance report is to provide shareholders with a clear view of the Group’s corporate governance approach. The Group is committed to the highest standards of corporate governance. The corporate governance of the Group has evolved during the year in order to strengthen further the robust framework by which the Group is governed. This report represents the position as at 2014 year-end unless stated otherwise. The following sections provide details of the role and composition of the Board, its Committees and other key individuals and committees. Aldermore Bank PLC is owned 100 per cent by Aldermore Group PLC. During the year, changes were made to conform the respective Boards so that the same Directors served on both Boards. This Corporate governance report includes the following sections: 1. Overview of the Corporate Governance Structure 2. The Board a. Board composition b. Roles and responsibilities of the Board c. Role of the Chairman d. The role of the Senior Independent Director e. Changes to the Board f. Director’s induction and ongoing professional development g. Directors’ conflicts of interest 3. Board Committees a. Composition of Board Committees b. Audit Committee c. Risk Committee d. Remuneration Committee e. Nomination Committee 4. Executive Team a. Details of the Executive Team b. The role of the Chief Executive Officer and Executive Committees c. Executive Committees 5. Company Secretary 46 47 49 51 51 45 GovernanceFinancial statementsStrategic reportCorporate governance report continued 1. Overview of the Corporate Governance Structure as at 1 January 2015 Aldermore Group PLC Corporate Governance Framework Aldermore Group PLC Aldermore Bank PLC Board Committees Audit Committee Risk Committee Remuneration Committee Nomination Committee CEO Executive Committees ExCo (CEO) ExCo Risk (CRO) Strategy Board Treasury Management Committee Asset and Liability Committee IT and Transformation Board 3 Divisional Boards* Product Committee Business Risk Committee Management Credit Committee Performance oversight Risk oversight * Divisional Boards comprise of: Mortgages Board, Commercial Finance Board (Asset Finance and Invoice Finance) and Savings Board 46 Aldermore Group PLC Annual report and accounts 2014 Governance2. The Board a. Board composition as at 31 December 2014 The Board Non-Executive Directors: Glyn Jones (Chairman) Peter Cartwright (Non-Executive Director) Neil Cochrane (Non-Executive Director) Danuta Gray (Senior Independent Director) John Callender26 (Independent Non-Executive Director) John Hitchins (Independent Non-Executive Director) Christopher Stamper (Independent Non-Executive Director) Cathy Turner (Independent Non-Executive Director) Peter Shaw (Independent Non-Executive Director) Executive Directors: Phillip Monks (Chief Executive Officer) James Mack (Chief Financial Officer) As at 31 December 2014 the Board consisted of nine Non-Executive Directors (including the Chairman) and two Executive Directors. During 2014 there were a number of changes to the composition of the Board as detailed on page 48. The Board regards all of the Non-Executive Directors, other than Peter Cartwright and Neil Cochrane (appointed as shareholder Directors by the Group’s principal shareholders, AnaCap Financial Partners and AnaCap Financial Partners II (‘AnaCap’)) and Glyn Jones (as Chairman), as ‘independent Non-Executive Directors’ (within the meaning of the UK Corporate Governance Code) and free from any business or other relationship that could materially interfere with the exercise of their independent judgement. The Board regarded Glyn Jones as independent upon his appointment as Chairman (within the meaning of the UK Corporate Governance Code). The Board currently includes two female members, 18 per cent of its total composition. b. Roles and responsibilities of the Board The Board is collectively responsible to the shareholders and its other stakeholders for the long term success of the Group. The Board is committed to implementing and maintaining a well-defined and well-structured corporate governance framework to achieve long term sustainable success. The Board has responsibility for determining the business strategy and related risk appetite of the Group and to monitor performance against the plan, objectives and performance indicators for each area. The Board also has responsibility to maintain a system of internal controls, which provide assurance of effective and efficient operations, internal financial controls and compliance with all applicable laws and regulations. Additionally, the Board is responsible for ensuring that the executive maintain an effective risk management and oversight process across the Group to enable delivery of the strategy and business performance within the approved risk appetite and risk control framework. Fundamentally, the Board is the main decision making forum for the Group. Therefore, all matters of significance because of their strategic, risk, financial, key person, regulatory or reputation implications or consequences are addressed by the Board. However, certain matters are reserved for the Group’s principal shareholders, AnaCap, and the Board actively engages AnaCap on all such matters through the shareholder Directors. In addition, the Board sets annual objectives for each year in addition to setting the Group’s strategic direction. These are implemented through approval and regular assessment of the business plan and strategy process. At each Board meeting the Directors discuss strategic and business matters, financial, operational, risk and governance issues and other relevant business items that arise. Following Board Committee meetings the Board receives oral reports from the Chairs of each Committee at the next Board meeting. 26 John Callender resigned with effect from 27 February 2015. 47 GovernanceFinancial statementsStrategic reportCorporate governance report continued 2. The Board continued c. Role of the Chairman Glyn Jones was appointed as Chairman in March 2014. As Chairman, Glyn’s primary objective is the governance of the Board. He leads the Board and is primarily responsible for setting the Board’s agenda and ensuring that adequate time is available for discussion of all key agenda items, in particular strategic issues. The Chairman promotes a culture of openness and debate by facilitating the effective contribution of Non-Executive Directors and ensuring constructive relations between Executive and Non-Executive Directors. He also ensures Directors receive accurate, timely and clear information and that there is effective communication with shareholders. The Chairman is not responsible for the running of the day-to-day business of the Group, such duty being delegated to the Chief Executive Officer by the Board. Details of Glyn’s other business commitments are included in his biography and the Board is satisfied that these commitments do not interfere with the performance of his duties for the Group. There is a clear division of responsibilities between the Chairman and the Chief Executive Officer. Prior to Glyn’s appointment, John Callender acted as Interim Chairman. d. The role of the Senior Independent Director Danuta Gray joined the Board as the Senior Independent Director in September 2014. The Senior Independent Director is available to shareholders if they have concerns that the normal channels of communication to shareholders via the Chairman, Chief Executive Officer or other Executive Directors have failed to resolve any issues, or for which such channels of communication are inappropriate. The Senior Independent Director will meet with the other Non-Executive Directors without the Chairman present once a year and on other occasions, as appropriate, to appraise the Chairman’s performance. Details of Danuta’s other business commitments are included in her biography on page 52 and the Board is satisfied that these commitments do not interfere with the performance of her duties for the Group. e. Changes to the Board27 Name Position Relevant Date David Soskin Non-Executive Director Resigned from the Board on 02/06/2014 Christopher Stamper Non-Executive Director Appointed to the Board on 06/02/2014 Appointed to the Board on 06/02/2014 Glyn Jones Cathy Turner John Hitchins Peter Shaw Neil Cochrane Danuta Gray Steve Barry Paul Myers Mark Stephens Non-Executive Director Appointed to the Board on 21/03/2014 Non-Executive Director Appointed to the Board on 28/05/2014 Non-Executive Director Appointed to the Board on 28/05/2014 Non-Executive Director Appointed to the Board on 04/09/2014 Non-Executive Director Appointed to the Board on 04/09/2014 Non-Executive Director Appointed to the Board on 29/09/2014 Executive Director Executive Director Executive Director Resigned from the Board on 21/09/2014 Resigned from the Board on 21/09/2014 Resigned from the Board on 21/09/2014 27 The Executive Directors above who resigned from the Board on 21 September 2014 did so in order to ensure the Group could meet UK Corporate Governance Code requirements for the Board to have a majority of independent Non-Executive Directors; all three executives continue to work for the Group in their executive roles. 48 Aldermore Group PLC Annual report and accounts 2014 Governancef. Directors’ induction and ongoing professional development All Directors receive a comprehensive tailored induction programme. The induction programme includes an introduction to the Board and the business, including strategy, key risks and topical issues in order to enhance their understanding and knowledge of the Group’s business and operations. The Board also receives regular training and briefing sessions for on-going professional development both internally and externally in order to update and refresh their skills and knowledge. g. Directors’ conflicts of interest The Companies Act 2006 provides that a Director must avoid situations where he/she can have a direct or indirect interest that conflicts or might conflict with the interests of the Group. The Company’s Articles of Association contain provisions that allow the Board to consider and, if it sees fit, authorise such conflicts in certain situations. The Board confirms that such powers have been operated effectively and that a formal system for Directors to declare their interests and for the non- conflicted Directors to authorise conflicts continues to be in place. 3. Board Committees The Board is supported by four key Committees: • Audit Committee • Risk Committee • Remuneration Committee • Nomination Committee a. Composition of Board Committees at 31 December 2014 Details of the respective responsibilities of each Committee are provided below. Audit Committee Risk Committee Remuneration Committee Nomination Committee John Hitchins (Chair) John Callender (Chair)28 Cathy Turner (Chair) Glyn Jones (Chair) Peter Cartwright Peter Shaw Christopher Stamper John Callender28 Peter Cartwright John Hitchins Christopher Stamper Peter Shaw29 Danuta Gray Peter Shaw Glyn Jones Peter Cartwright Peter Cartwright Danuta Gray John Callender28 Cathy Turner b. Audit Committee The Audit Committee is made up of five members, four of whom are independent Non-Executive Directors. The Audit Committee is chaired by John Hitchins, who is considered by the Board to have recent and relevant financial experience. Further details of John’s experience are provided in his biography on page 53. The Audit Committee30 met eight times in 2014 – three times as the Audit and Risk Committee and five times as the Audit Committee. The Audit Committee’s responsibilities include the monitoring of the integrity of the Group’s financial statements and the involvement of the External Auditors in that process as well as reviewing the Group’s internal control and risk management systems. It focuses in particular on compliance with accounting policies and accounting estimates and ensuring that an effective system of internal financial control is maintained. The ultimate responsibility for reviewing and approving the annual report and accounts and the half-yearly reports, remains with the Board. The Audit Committee also receives regular updates from Internal Audit. The Committee reviews and assesses the annual Internal Audit work plan and receives reports on the results of the Internal Auditors’ work. 28 John Callender resigned from the Board and its committees with effect from 27 February 2015. 29 Peter Shaw has been appointed Chair of the Risk Committee and a member of the Nomination Committee, replacing John Callender with effect from 1 March 2015. 30 Until June 2014 part of a joint Audit and Risk Committee. 49 GovernanceFinancial statementsStrategic reportCorporate governance report continued 3. Board Committees continued The Audit Committee formally reports to the Board on its proceedings after each meeting on matters within its duties and responsibilities, including how these duties and responsibilities have been discharged. In addition, the Audit Committee makes recommendations to the Board on any area within its remit where action is required. c. Risk Committee The Risk Committee is made up of five members, four of whom are independent Non-Executive Directors. During 2014, the Risk Committee was chaired by John Callender31. Further details of John’s experience are provided in his biography on page 53. The Risk Committee32 met six times in 2014 – three times as the Audit and Risk Committee and three times as the Risk Committee. The Risk Committee’s responsibilities include the development and maintenance of the Group’s Risk Management Framework, ensuring that its strategy, principles, policies and resources are aligned to the Group’s risk appetite, as well as to regulatory and industry best practices. The Risk Committee also monitors and reviews the formal arrangements established by the Board in respect of internal controls and the Risk Management Framework and reviews the effectiveness of the Group’s systems for risk management and compliance with financial services legislation and regulatory requirements. The Risk Committee formally reports to the Board on its proceedings after each meeting on matters within its duties and responsibilities, including how these duties and responsibilities have been discharged. In addition, the Risk Committee makes recommendations to the Board on any area within its remit where action is required and makes recommendations to the Remuneration Committee on issues that should be taken into account in remuneration decisions. d. Remuneration Committee The Remuneration Committee is made of five members, three of whom are independent Non-Executive Directors. The Remuneration Committee is chaired by Cathy Turner. Further details of Cathy’s experience are provided in her biography on page 53. Prior to Cathy, the post was held by John Callender. The Remuneration Committee met four times in 2014. The Remuneration Committee’s responsibilities include assisting the Board in relation to the Group’s remuneration framework, including making recommendations to the Board on the Group’s policy on executive remuneration, setting the over-arching principles and parameters of the Group’s remuneration policy and determining the individual remuneration and benefits package of each of the Group’s Executive Directors and certain senior Executives. The remuneration of Non-Executive Directors is a matter for the Chairman and Executive Directors of the Board. No Director or senior manager shall be involved in any decisions as to their own remuneration. The Remuneration Committee is also responsible for recommending and monitoring the structure and level of remuneration for senior management, including pension rights and any compensation payments. The Remuneration Committee formally reports to the Board on its proceedings after each meeting on matters within its duties and responsibilities, including how these duties and responsibilities have been discharged. In addition, the Remuneration Committee makes recommendations to the Board on any area within its remit where action is required. e. Nomination Committee The Nomination Committee is made up of five members, three of whom are independent Non-Executive Directors. The Nomination Committee is chaired by Glyn Jones. Further, details of Glyn’s experience are provided in his biography on page 52. Prior to Glyn’s appointment, the post was held by John Callender. The Nomination Committee met formally once in 2014. On other occasions, the full Board discharged the responsibilities of the Committee. The Nomination Committee’s responsibilities include considering and making recommendations to the Board in respect of appointments to the Board, the Board Committees and the chairmanship of the Board Committees. It is also responsible for keeping the structure, size and composition of the Board under regular review, and for making recommendations to the Board with regard to any changes necessary. This Committee also considers succession planning, taking into account the skills and expertise that will be needed on the Board in the future. The Nomination Committee formally reports to the Board on its proceedings after each meeting on matters within its duties and responsibilities, including how these duties and responsibilities have been discharged. In addition, the Nomination Committee makes recommendations to the Board on any area within its remit where action is required. 31 Peter Shaw has been appointed Chair of the Risk Committee with effect from 1 March 2015. 32 Until June 2014 part of a joint Audit and Risk Committee. In addition, the Board Credit Committee met twice during 2014 before being amalgamated with the Risk Committee. 50 Aldermore Group PLC Annual report and accounts 2014 Governance4. Executive Team a. Details of the Executive Team James Mack Chief Financial Officer Responsible for the Finance and Treasury functions Steve Barry Chief Risk Officer Responsible for Credit, Operational, and Treasury Risk and Compliance Phillip Monks Chief Executive Officer Paul Myers Chief Operating Officer Responsible for the Savings division and the Group’s infrastructure including IT Ali Humphries Group HR Director Responsible for the HR function including reward, performance management and recruitment Vicki Harris Group Strategy and Marketing Director Responsible for Marketing and Group Strategy Mark Stephens Deputy CEO and Group Commercial Director Responsible for the Mortgages division and the Commercial Finance division, comprising Invoice and Asset Finance b. The role of the Chief Executive Officer and Executive Committees Phillip Monks has direct charge of the Group on a day-to-day basis and is accountable to the Board for the financial and operational performance of the Group. Phillip was part of the team that founded the Bank in 2009 and has over 30 year’s industry experience. Further details of Phillip’s experience are provided in his biography on page 52. He is supported by the Executive Team, who make up the two Executive Committees (ExCo) whose responsibility it is to implement the strategic objectives as agreed by the Board. ExCo, under the leadership of the CEO, is responsible for the management of the Group. As set out on page 46, the ExCo is split into two committees: • Executive Committee (Performance) • Executive Risk Committee c. Executive Committees A number of sub-committees report into ExCo and assist with monitoring and oversight of the running of the business. The following sub-committees report to the Executive Committee (Performance): • Strategy Board • Divisional Boards (Mortgages, Commercial Finance, Savings) • IT and Transformation Board • Treasury Management Committee The following sub-committees report to Executive Risk Committee: • Asset and Liability Committee • Business Risk Committee • Management Credit Committee • Product Committee 5. Company Secretary The Company Secretary is responsible for advising the Board through the Chairman on all governance related matters. All Directors have access to the advice and services of the Company Secretary. 51 GovernanceFinancial statementsStrategic report Board of Directors Executive Directors Phillip Monks Chief Executive Officer, Age 54 James Mack Chief Financial Officer, Age 43 Phillip was part of the team which founded Aldermore in 2009 and has over 30 years’ industry experience. Most recently he established, and obtained a banking licence for, Europe Arab Bank where he was CEO until 2008. Prior to this, Phillip held senior roles within Barclays Bank plc, including Branch Director of Barclays Private Bank in Geneva, Director of Business and Corporate Banking in North West England, Managing Director of Barclays Corporate Banking in London, the Midlands and South East and, finally, CEO of Gerrard Investment Management from 2003 upon its acquisition by Barclays from Old Mutual plc. James joined Aldermore in June 2013 and is responsible for the Finance and Treasury functions. From 2010, he held a number of senior finance roles within the Co-operative Banking Group including Acting CFO, Director of Financial Control and Head of Financial Planning and Analysis. Prior to this, James spent six years with the Skipton Building Society and was instrumental in leading the merger with the Scarborough Building Society. James joined KPMG in 1993 and spent 11 years in their financial services practice. Danuta Gray Senior Independent Director, Age 55 Peter Cartwright Non-Executive Director, Age 49 Danuta joined the Board as the Senior Independent Director in September 2014. Danuta has extensive business experience having spent 26 years in the telecommunications sector. Starting her career at BT in 1984, Danuta held numerous senior roles becoming Senior Vice President, BT Europe in 1999. During her time at BT she gained experience in marketing, customer service, communications, technology and sales, and in leading and implementing change. Danuta was Chairman of Telefonica O2 in Ireland until December 2012, having previously been its Chief Executive from 2001 to 2010. Previously Danuta served for seven years on the Board of Irish Life & Permanent PLC as Chairman of the Remuneration Committee and was a Non- Executive Director of Aer Lingus PLC from 2006 – 2013. Danuta is currently also a Non-Executive Director at Old Mutual PLC, Michael Page International PLC and Paddy Power PLC. Peter’s involvement with the Board dates back to the launch of Aldermore in May 2009. He is one of the founding partners of AnaCap Financial Partners LLP where he is also the Co-Managing Principal responsible for developing AnaCap’s portfolio company investments. Prior to AnaCap, Peter was Commercial Director within a speciality insurance services provider backed by a UK-based private equity firm, and between 1999 and 2003 was Sales & Marketing Director and Operations Director for GMAC UK and On:line Finance, respectively, having previously worked for GE Capital. Peter is an experienced business builder and operational specialist and holds various Non-Executive and supervisory Board roles within banks and financial services companies across Europe. Non-Executive Directors Glyn Jones Chairman, Age 62 Glyn joined the Board as Chairman in March 2014. He is currently the Senior Independent Director on the Board of Direct Line Insurance Group plc and, since May 2007, has been the Chairman of Aspen Insurance Holdings Limited, a New York listed specialty lines insurance and re-insurance business. Glyn was formerly the Chairman of Towry Holdings Limited between 2006 and 2011. He also served as Chairman of Hermes Fund Managers from 2008 to 2011 and was Chairman of the sister company BT Pension Scheme Management for a part of this period. Glyn was Chief Executive Officer of the independent investment group, Thames River Capital, from 2005 to 2006. From 2000, he served as Chief Executive Officer of Gartmore Investment Management in the UK for four years. Prior to this, Glyn was Chief Executive Officer of Coutts NatWest Group and Coutts Group, having joined in 1997. In 1991, Glyn joined Standard Chartered in Hong Kong where he became the general manager of Global Private Banking. He was a consulting partner with Coopers & Lybrand/Deloitte Haskins & Sells Management Consultants from 1981 to 1990. Glyn is a graduate of Cambridge University and a Fellow of the Institute of Chartered Accountants in England & Wales. 52 Aldermore Group PLC Annual report and accounts 2014 GovernanceNeil Cochrane Non-Executive Director, Age 30 John Hitchins Independent Non-Executive Director, Age 60 John Callender Independent Non-Executive Director, Age 64 Neil joined the Board in September 2014. Neil’s involvement with Aldermore dates back to May 2010, when he joined AnaCap Financial Partners LLP’s Business Services team. This role saw Neil take responsibility for day-to- day interaction with senior management of the AnaCap’s portfolio companies on strategic and operational development. Neil is currently an Investment Director within the team. Neil brings eight years strategic financial services experience to this role. He started his career as a consultant at Oliver Wyman Financial Services in 2006 where he was involved in a broad range of projects for banking and insurance clients. His assignments covered clients in the UK, Europe and the U.S. and were predominately focused on new business launches, strategy development, M&A and risk management. Neil graduated from the University of Nottingham in 2006 with a BA (Hons) in Economics. John is an independent Non-Executive Director and chairs the Audit Committee. He was appointed to Board in May 2014. He brings 36 years of experience in the audit arena, having spent his whole career at PricewaterhouseCoopers (‘PwC’), including as an audit partner. John was formerly Chairman of the Banking Committee of the Institute of Chartered Accountants in England & Wales and a Board member of the Institute’s Financial Services Faculty. He has also served as a member of the Institute’s Business Law Committee. During his career with PwC, John specialised in bank auditing and financial advisory services and his clients have included institutions such as Euroclear, Lloyds Banking Group, The Bank of England, Bank of Ireland, Britannia Building Society, Barclays, JP Morgan Chase and Nomura. Until recently, John was a member of the UK FCA Practitioner and Markets Practitioner Panels. He is currently a member of the Governing Council of the Centre for the Study of Financial Innovation, a not- for-profit City-based think tank. John is a graduate of Oxford University and a Fellow of the Institute of Chartered Accountants in England & Wales. John joined the Board in May 2009 and chairs the Risk Committee. John resigned from the Board and its committees with effect from 27 February 2015. He is currently Non-Executive chair of ANZ Bank Europe Ltd and holds Non-Executive Directorship at Ford Credit Europe Plc (where he chairs the Risk Committee and is a member of the Audit Committee), and at Motability Operations Plc (Where he chairs the Remuneration Committee and is a member of the Audit Committee). John is also a member of the Financial Conduct Authority Regulatory Decisions Committee which he was invited to join in 2013. Until recently John served for a number of years as Governor of Reading Blue-Coat School in Sonning, Berkshire. Previously he was a senior executive in Barclays plc with considerable experience of operating in Europe, India and the USA, running a number of Businesses including the asset finance, leasing, invoice finance and contract hire operations. He served on the Board of the Finance and Leasing Trade Association for six years and was elected Chair for 1996/1997. Peter Shaw Independent Non-Executive Director, Age 55 Chris Stamper Independent Non-Executive Director, Age 59 Cathy Turner Independent Non-Executive Director, Age 51 Chris is an independent Non-Executive Director and was appointed to the Board in February 2014. He brings 35 years of experience in the asset finance industry, most recently as Director and CEO of ING Lease (UK) Ltd. He is a founding governor of The Leasing Foundation and was a Director of Finance and Leasing Association Ltd. from 2003 to 2012 and a former Chairman of their Asset Finance Division. Previously, Chris was Head of Abbey Business responsible for five business units focused on the SME market. Prior to this, Chris was the Managing Director of Lombard Sales Finance where he spent 21 years. Peter joined the Board as an independent Non-Executive Director in September 2014 and will chair the Risk Committee with effect from 1 March 2015. Peter brings over 30 years financial services experience to his new role, having spent most of his career at RBS NatWest. Joining NatWest as a graduate trainee in 1981, Peter worked across a number of business areas during his career with the group including retail, SME, private banking, corporate banking, HR and risk. Between 1994 and 2002, Peter was Managing Director of various group businesses offshore, based in Jersey. In 2002, Peter returned to the UK to become COO of the Risk Function at Group Head Office and between 2004 and 2010 Peter was Chief Risk Officer for various group businesses including RBS UK Retail, Wealth & Ulster Bank. Between May 2012 and January 2013, Peter acted as interim Chief Risk Officer for the Co-operative Banking Group. Peter is currently also a Non-Executive Director at Bank of Ireland UK PLC, where he is chair of the bank’s Risk Committee and a member of the Audit Committee. Peter graduated from London South Bank University in 1981 with a BA in Modern Languages. Peter holds an ACIB and DipFS. He is also a Fellow of the Chartered Institute of Bankers in Scotland. Cathy is an independent Non-Executive Director and chairs the Remuneration Committee. She was appointed to the Board in May 2014. She is currently Non-Executive Director and Chair of the Remuneration Committee of Countrywide plc. She is also a Vice President of UNICEF UK and a member of the Board of the Royal College of Art. She is also an Associate of the advisory group Manchester Square Partners. Cathy has extensive industry experience working with Deloitte & Touche, Ernst & Young and Watson Wyatt as a compensation and benefits consultant in her early career. She subsequently joined Barclays PLC, where she was a member of the Group Executive Committee with responsibility for Human Resources, Corporate Affairs, Strategy and Brand and Marketing. During her time with Barclays she was also Director, Investor Relations for four years and had extensive experience in remuneration in her many roles. Most recently, she was Chief Administrative Officer of Lloyds Banking Group PLC. Cathy is a graduate of the University of Lancaster. 53 GovernanceFinancial statementsStrategic reportConsolidated Directors’ report The Directors present their consolidated Directors’ Report and the financial statements of the Group for the year ended 31 December 2014. Strategic Report The Group has chosen, in accordance with section 414c(11) of the Companies Act 2006, as noted in this Directors’ Report, to include certain additional matters in its Strategic Report that would otherwise be required to be disclosed in this Directors’ Report. Principal activity The Group is authorised to accept deposits under the Financial Services & Markets Act 2000. The Group’s principal activities during 2014 were the provision of banking and related services in the United Kingdom. See page 10 for a description of the Group’s business model and strategy. Corporate Governance The Corporate Governance section set out on pages 45 to 53 forms part of this Directors’ Report. Results and dividends The results for the year are set out in the Income Statement on page 59. The profit before taxation for the year ended 31 December 2014 was £50.3 million (2013: £25.7 million). A full review of the financial performance of the Group is included within the Strategic report starting on page 6. The Directors do not recommend the payment of a dividend (2013: £nil). Business review and future developments The required information regarding the business review and future developments, key performance indicators and principal risks and uncertainties are contained within the Strategic Report. Business review and future developments Key performance indicators Principal risks and uncertainties Financial instruments Page 6 11 38 The Group uses financial instruments to manage certain types of risk, including liquidity and interest rate risk. Details of the objectives and management of these instruments are contained in the risk management section. Details of exposures to these risks, as well as credit risk are also provided in Note 41 to the consolidated financial statements. Post balance sheet events Details of significant events after 31 December 2014 are included in Note 44 to the consolidated financial statements and form part of this Report. Capital management The Board is required to consider all material risks which the Group faces and determines whether additional capital is required in order to provide further protection to depositors and borrowers and to ensure the Group is sufficiently well capitalised to withstand a severe economic downturn. Full details of the Group’s approach to capital management, including an analysis of the Group’s regulatory capital position, are provided in Note 42 to the consolidated financial statements. On 9 December 2014, Aldermore Group PLC issued £75 million Fixed Rate Reset Additional Tier 1 Perpetual Subordinated Contingent Convertible Securities (the ‘Securities’). The Securities are perpetual and have no fixed redemption date. Redemption of the Securities is at the option of the Company on 30 April 2020 and annually thereafter. The Securities bear interest at an initial rate of 11.875 per cent p.a. until 30 April 2020 and thereafter at the relevant Reset Interest Rate as provided in the terms and conditions governing the securities. Interest is payable on the loan annually in arrears on each interest payment date commencing 30 April 2015 and is non-cumulative. The Borrower has the full discretion to cancel any interest scheduled to be paid on the Securities. The Securities are convertible into ordinary shares of the Company in the event of the Group’s Common Equity Tier 1 ratio falling below 7 per cent. 54 Aldermore Group PLC Annual report and accounts 2014 Governance The issuance of the above securities raised proceeds of £75.1 million, which after deducting issuance costs, resulted in net proceeds of £73.7 million. Further details are provided in Note 36 to the consolidated financial statements. Share capital Details of the Company’s share capital at 31 December 2014 is provided in Note 35 to the consolidated financial statements. Going concern The financial statements are prepared on a going concern basis, as the Directors are satisfied that the Group has the resources to continue in business for the foreseeable future. In making this assessment, the Directors have considered a wide range of information relating to present and future conditions, including the current state of the balance sheet, future projections of profitability, cash flows and capital resources and the longer term strategy of the business. The Group’s capital and liquidity plans, including stress tests, have been reviewed by the Directors. The Group’s forecasts and projections show that it will be able to operate at adequate levels of both liquidity and capital for the foreseeable future, including a range of stressed scenarios, taking management actions into account as appropriate if the additional capital needed to continue the forecast growth strategy is not forthcoming. After making due enquiries, the Directors believe that the Group has sufficient resources to continue its activities for the foreseeable future and to continue its expansion, and the Group has sufficient capital to enable it to continue to meet its regulatory capital requirements as set out by the Prudential Regulation Authority (‘PRA’). Employees Our people are proud of the Bank we are building. All new starters attend a centralised induction programme to ensure a consistent introduction to the Group. Each new starter is invited to a full day workshop in which they learn about our brand, values, approach to risk management, products and services. We run a full communications programme targeted at all of our people, as well as bespoke programmes for managers and our senior leadership team. These programmes are orchestrated by an employee communications manager who reports into the central Corporate Affairs team and has direct access to the Executive Team. Regular central communications are issued to all of our people, covering topics including our financial performance at key points throughout the year, as well as other strategic and HR-related updates. Channels include, although are not limited to, all employee emails, our intranet and Yammer. In 2014, we refreshed our intranet to make it more user-friendly and bring it in line with our brand identity. As part of our commitment to transparency, key information has also been made more visible. For example, the intranet homepage now carries our Twitter feed, so that our people can follow external conversations we are involved in; recent examples of customer reviews from our Ratings & Reviews service, so that we can see what our customers are saying about us; and a feed from Yammer, to keep our people abreast of internal conversations. We place a great deal of importance on ensuring that the lines of communication between our people and the Group’s leaders are two-way and transparent. We have continued our programme of Executive visits to our regional offices during which our people are able to meet and hear from senior members of the Aldermore team. We hold an annual employee roadshow in which we bring our people together to update them on the Group’s vision. The roadshow also provides a forum for our people to pose questions to the Executive Team and to network with their colleagues. Roadshow events were held in Manchester, Leicester and Reading to enable all of our people to attend regardless of their geographical location. Following the roadshow, 88 per cent of people surveyed said that our Executive Team answered all of the questions put to them. In early 2014, we conducted a pulse survey amongst employees which revealed that 84 per cent of respondents agreed that they received regular information from Aldermore that keeps them informed. We continue to make every effort to ensure that all of our people are aware of our strategy and understand the Group’s performance objectives as this drives our success. We are committed to ensuring that disabled people are afforded equality of opportunity in respect to entering and continuing employment within the Group. This includes all stages from recruitment and selection, terms and conditions of employment, access to training and career development. 55 GovernanceFinancial statementsStrategic report Consolidated Directors’ report continued The Group is committed to diversity and we work hard to ensure that all of our people are offered equal opportunities throughout their career with us. We are determined that nobody is discriminated against, directly or indirectly, on the basis of age, ethnic or national origin, religion or beliefs, sexual orientation, gender, marital status or disability. Directors Details of the Directors, including appointments and resignations during the financial year, and changes since the end of the financial year are provided on page 48 of the Corporate Governance section of the report. Directors’ indemnities Certain Directors benefited from qualifying third party indemnity provisions in place during the year ended 31 December 2014 and at the date of this report. The Group also purchased Directors, and officers, liabilities insurance during the year, which provides appropriate cover for legal actions brought against its Directors. Significant contracts Details of related party transactions are set out in Note 39. Corporate responsibility The Group’s corporate responsibilities activities are outlined on page 42. Substantial shareholding Aldermore Group PLC (the Parent Company) is controlled by AnaCap Financial Partners II, LP (52.3 per cent. of voting rights) and AnaCap Financial Partners, L.P. (47.7 per cent. of voting rights). Political contributions The Group made no political donations during the year (2013: £nil). Research and development The Group has a comprehensive product approval process and develops new products and services in each of its business divisions in the ordinary course of business. All new products, campaigns and business initiatives are reviewed and approved by the Group’s Product Committee. Disclosure of information to Auditors The Directors who held office at the date of approval of this Directors’ report confirm that, so far as they are aware, there is no relevant audit information of which the Group’s auditors are unaware; and each Director has taken all steps that he/she ought to have taken as a Director to make himself/herself aware of any relevant audit information and to establish that the Group’s auditor is aware of that information. Auditor KPMG LLP have expressed their willingness to continue in office as auditors. By order of the Board Phillip Monks Director 16 February 2015 56 Aldermore Group PLC Annual report and accounts 2014 GovernanceStatement of Directors’ responsibilities in respect of the Strategic report, the Directors’ report and the financial statements The Directors are responsible for preparing the Strategic report, the Directors’ report and the financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and Parent Company financial statements for each financial year. Under that law they have elected to prepare both the Group and the Parent Company financial statements in accordance with IFRSs as adopted by the EU and applicable law. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and Parent Company and of their profit or loss for that period. In preparing each of the Group and Parent Company financial statements, the Directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • state whether they have been prepared in accordance with IFRSs as adopted by the EU; and • prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the Parent Company will continue in business. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Parent Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Group and Parent Company and enable them to ensure that its financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. 57 GovernanceFinancial statementsStrategic reportIndependent auditor’s report to the members of Aldermore Group PLC We have audited the financial statements of Aldermore Group PLC for the year ended 31 December 2014 set out on pages 59 to 126. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the EU and, as regards the Parent Company financial statements, as applied in accordance with the provisions of the Companies Act 2006. This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of Directors and auditor As explained more fully in the Directors’ Responsibilities Statement set out on page 57, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit, and express an opinion on, the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. Scope of the audit of the financial statements A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate. Opinion on financial statements In our opinion: • the financial statements give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31 December 2014 and of the Group’s profit for the year then ended; the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the EU; • the Parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the EU and as applied in accordance with the provisions of the Companies Act 2006; and • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006. Opinion on other matter prescribed by the Companies Act 2006 In our opinion the information given in the Strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: • adequate accounting records have not been kept by the Parent Company, or returns adequate for our audit have not been received from branches not visited by us; or • the Parent Company financial statements are not in agreement with the accounting records and returns; or • certain disclosures of Directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. Michael Peck (Senior Statutory Auditor) for and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants 15 Canada Square Canary Wharf London E14 5GL 16 February 2015 58 Aldermore Group PLC Annual report and accounts 2014Financial statementsFinancial statements Consolidated income statement For the year ended 31 December 2014 Interest income Interest expense Net interest income Fee and commission income Fee and commission expense Net (expense)/income from derivatives and other financial instruments at fair value through profit or loss Gains on disposal of debt securities Other operating income Total operating income Provisions Costs in preparation for an initial public offering Other administrative expenses Administrative expenses Depreciation and amortisation Operating profit before impairment losses Impairment losses on loans and advances to customers Profit before taxation Taxation (charge)/credit Profit after taxation – attributable to equity holders of the Group Basic earnings per share Diluted earnings per share The notes and information on pages 63 to 120 form part of these financial statements. The result for the year is derived entirely from continuing activities. Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 227,833 156,441 (87,618) 140,215 26,386 (7,819) (4,066) 2,944 7,357 (75,799) 80,642 23,555 (7,529) 3,277 1,869 6,531 165,017 108,345 (3,605) (6,014) (91,622) (101,241) (3,901) 59,875 (9,570) 50,305 (11,871) 38,434 16.4 16.3 (2,111) – (65,252) (67,363) (3,822) 37,160 (11,468) 25,692 14 25,706 12.7 12.6 Note 5 6 7 8 9 10 32 14 15 20 17 18 18 Consolidated statement of comprehensive income For the year ended 31 December 2014 Profit after taxation Other comprehensive income/(expense): Items that may subsequently be transferred to the income statement: Available for sale debt securities: Fair value movements Amounts transferred to the income statement Taxation Total other comprehensive income/(expense) Total comprehensive income attributable to equity holders of the Group Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 38,434 25,706 793 3,456 (2,465) (198) 793 39,227 (2,566) (1,490) (1,869) 793 (2,566) 23,140 59 GovernanceFinancial statementsStrategic report31 December 2014 £’000 31 December 2013 £’000 Note 19 21 22 20 5 26 27 17 25 24 28 29 22 6 30 31 32 33 34 35 35 36 79,567 117,401 509,684 8,168 192,844 237,544 355,653 8,872 4,801,064 3,373,844 7,175 3,344 6,856 6,598 2,815 – 312 5,109 3,299 2,858 22,571 22,657 5,565,243 4,202,992 305,907 385,951 4,458,962 3,464,018 54,198 1,528 18,634 21,107 8,148 2,008 279,143 36,758 17,867 – 14,343 16,236 2,492 1,157 – 35,571 5,186,393 3,937,635 23,737 23,737 – 237,305 73,657 2 2,200 1,375 277,879 – 2 2,200 582 1,531 378,850 265,357 5,565,243 4,202,992 Consolidated statement of financial position As at 31 December 2014 Assets Cash and balances at central banks Loans and advances to banks Debt securities Derivatives held for risk management Loans and advances to customers Fair value adjustment for portfolio hedged risk Other assets Prepayments and accrued income Deferred taxation Property, plant and equipment Intangible assets Total assets Liabilities Amounts due to banks Customers' accounts Derivatives held for risk management Fair value adjustment for portfolio hedged risk Other liabilities Accruals and deferred income Current taxation Provisions Debt securities in issue Subordinated notes Total liabilities Share capital Share premium account Contingent convertible securities Capital contribution reserve Warrant reserve Available for sale reserve Retained earnings Equity Total liabilities and equity These financial statements were approved by the Board and were signed on its behalf by: Phillip Monks Director 16 February 2015 Registered number: 06764335 The notes and information on pages 63 to 120 form part of these financial statements. 60 Aldermore Group PLC Annual report and accounts 2014Financial statementsConsolidated statement of cash flows For the year ended 31 December 2014 Cash flows from operating activities Profit before taxation Adjustments for non-cash items and other adjustments included within the income statement (Increase) in operating assets Increase in operating liabilities Income tax paid Net cash flows (used in)/generated from operating activities Cash flows from investing activities Purchase of debt securities Proceeds from sale and maturity of debt securities Capital repayments of debt securities Interest received on debt securities Purchase of property, plant and equipment and intangible assets Net cash used in investing activities Cash flows from financing activities Proceeds from issue of shares Capital repayments on debt securities issued Debt securities issuance costs Proceeds from issue of debt securities Issuance costs of contingent convertible securities Proceeds from issue of contingent convertible securities Interest paid on debt securities Interest paid on subordinated notes Net cash from financing activities Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at start of the year Movement during the year Cash and cash equivalents at end of the year Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 Note 50,305 25,692 37 37 37 (9,422) 18,002 (1,487,787) (1,320,852) 962,772 1,571,927 (9,712) – (493,844) 294,769 (531,953) 346,183 48,226 11,229 (5,400) (89,071) 41,265 23,893 7,948 (5,298) (131,715) (21,263) – 63,165 (52,840) (2,086) 333,300 (1,454) 75,111 (2,513) (5,150) 344,368 – – – – – – (5,150) 58,015 (281,191) 331,521 415,210 83,689 (281,191) 331,521 134,019 415,210 37 37 61 GovernanceFinancial statementsStrategic report Consolidated statement of changes in equity Share capital £’000 Share premium account £’000 Contingent convertible securities £’000 Capital contribution reserve £’000 Year ended 31 December 2014 As at 1 January Total comprehensive income Transactions with equity holders: – Reduction in share premium (Note 35) – Issuance of contingent convertible securities (Note 36)1 – Issuance costs – Share based payments (Note 35) As at 31 December Year ended 31 December 2013 As at 1 January Total comprehensive income Transactions with equity holders: – Shares issued, net of expenses – Share based payments (Note 35) As at 31 December 23,737 237,305 – – – (237,305) – – – – – – 23,737 – – – – 75,111 (1,454) – 73,657 19,918 177,959 – – 3,819 59,346 – – 23,737 237,305 – – – – – 2 – – – – – 2 2 – – – 2 Warrant reserve £’000 2,200 – – – – – Available for sale reserve £’000 Retained earnings £’000 Total £’000 582 793 1,531 265,357 38,434 39,227 – 237,305 – – – – – – 75,111 (1,454) 609 609 2,200 1,375 277,879 378,850 2,200 3,148 (24,337) 178,890 – – – (2,566) 25,706 23,140 – – – 63,165 162 162 2,200 582 1,531 265,357 1 On 9 December 2014, Aldermore Group PLC (‘the Company’) raised £75.1 million of Fixed Rate Reset Additional Tier 1 Perpetual Subordinated Contingent Convertible Securities. Further detail is provided in Note 36. 62 Aldermore Group PLC Annual report and accounts 2014Financial statementsNotes to the financial statements 1. Basis of preparation (a) Accounting basis The consolidated financial statements of Aldermore Group PLC (the ‘Company’) and its subsidiary undertakings (together, the ‘Group’), including its principal subsidiary, Aldermore Bank PLC (the ‘Bank’). Both the Group consolidated financial statements and the Company financial statements have been prepared and approved by the Directors in accordance with International Financial Reporting Standards (‘IFRSs’) as issued by the International Accounting Standards Board (‘IASB’), and as adopted by the European Union. The Group prepared its annual consolidated financial statements under United Kingdom Generally Accepted Accounting Practice (‘UK GAAP’) until 31 December 2013. UK GAAP differs in certain respects from IFRSs, hence when preparing these financial statements, management has amended certain accounting and valuation methods and accounts disclosures to comply with IFRSs. The significant accounting policies adopted are set out in Note 2. The Group’s first set of IFRS financial statements for the six months ended 30 June 2014 was included in the information memorandum for the contingent convertible securities issued in December 2014 (see Note 36). The Group’s date of transition to IFRSs was 1 January 2011. The Group’s first set of IFRS financial statements, including the reconciliations required by IFRS 1, are available on the Group’s website www.investors.aldermore.co.uk. By including the Company financial statements here together with the Group consolidated financial statements, the Company is taking advantage of the exemption in Section 408 of the Companies Act 2006 not to present its individual income statement and related notes that form a part of these approved financial statements. The principal activity of the Company is that of an investment holding company. (b) Basis of consolidation The consolidated financial statements incorporate the financial statements of the Company and its subsidiaries which are entities controlled by the Company (jointly referred to as the Group) made up to 31 December each year. Control is achieved when the Company: • has power over the investee; • is exposed, or has rights, to variable returns from its involvement with the investee; and • has the ability to use its power to affect its returns. The Company reassesses whether or not it controls an investee if facts and circumstances indicate that there are changes to one or more of the three elements of control listed above. Subsidiaries are consolidated from the date on which control is transferred to the Group and are deconsolidated from the date that control ceases. Uniform accounting policies are applied consistently across the Group. Intercompany transactions and balances are eliminated upon consolidation. Securitisation vehicles The Group has securitised certain loans and advances to customers by the transfer of the beneficial interest in such loans to securitisation vehicles (see Note 20). The securitisation enabled the subsequent issue of debt securities by a securitisation vehicle to investors who have the security of the underlying assets as collateral. The securitisation vehicles are fully consolidated into the Group’s accounts as the Group has control as defined above. The transfer of the beneficial interest in these loans to the securitisation are not treated as sales by the Group. The Group continues to recognise these assets within its own Statement of Financial Position after the transfer as it continues to retain substantially all the risks and rewards from the assets. (c) Going concern The financial statements are prepared on a going concern basis, as the Directors are satisfied that the Group has the resources to continue in business for the foreseeable future (which has been taken as 12 months from the date of approval of the financial statements). In making this assessment, the Directors have considered a wide range of information relating to present and future conditions, including the current state of the balance sheet, future projections of profitability, cash flows and capital resources and the longer term strategy of the business. The Group’s capital and liquidity plans, including stress tests, have been reviewed by the Directors. The Group’s forecasts and projections show that it will be able to operate at adequate levels of both liquidity and capital for the foreseeable future, including a range of stressed scenarios, taking management actions into account as appropriate if the additional capital needed to continue the forecast growth strategy is not forthcoming. After making due enquiries, the Directors believe that the Group has sufficient resources to continue its activities for the foreseeable future and to continue its expansion, and the Group has sufficient capital to enable it to continue to meet its regulatory capital requirements as set out by the Prudential Regulation Authority (‘PRA’). 63 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 1. Basis of preparation continued (d) Basis of measurement The financial statements have been prepared on the historical cost basis except for the following material items in the financial statements: • derivative financial instruments are measured at fair value through profit or loss; • debt securities designated at fair value through profit or loss; • available for sale debt securities are valued at fair value through other comprehensive income; and • fair value adjustments for portfolios of financial assets and financial liabilities designated as hedged items in qualifying fair value hedge relationships, which reflect changes in fair value attributable to the risk being hedged. (e) Use of estimates and judgements The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimates are revised and in any future periods affected. Information about areas of estimation, uncertainty and critical judgements in applying accounting policies that have the most significant effect on the amounts recognised in the financial statements are included in Note 3. (f) Future accounting developments All standards or amendments to existing standards which have been endorsed by the European Union (‘EU’) and which are available for early adoption for annual periods commencing on or after 1 January 2014 have been adopted by the Group. There are also a number of standards, amendments and interpretations which have been issued by the IASB but which have not yet been endorsed by the EU. The most significant of these is IFRS 9: ‘Financial Instruments’, the planned replacement for IAS 39: ‘Financial Instruments: Recognition and Measurement.’ IFRS 9 introduces new requirements for the classification and measurement of financial assets, hedge accounting and the impairment of financial assets. Under IFRS 9 financial assets are classified and measured based on the business model under which they are held and the characteristic of their contractual cash flows. In addition, IFRS 9 is replacing the incurred loss approach to impairment of IAS 39 with one based on expected losses, and is replacing the rules based hedging requirements of IAS 39 with new requirements that align hedge accounting more closely with risk management activities. IFRS 9, including the final version of the requirements in respect of impairment, was issued on 24 July 2014. The IASB has decided to apply IFRS 9 for annual periods beginning on or after 1 January 2018. IFRS 9 is required to be applied retrospectively, but prior periods need not be restated. IFRS 9, including its commencement date, will be subject to endorsement by the EU. In addition, the IASB has commenced a separate project for macro hedging, which is exploring a new way to account for the dynamic risk management of open portfolios and is likely to be of future relevance to the Group. That project is still at the Discussion Paper stage and as yet the likely final form of any amendments to IFRS 9, or their required implementation date, is not clear. The adoption of IFRS 9 is expected to have a material impact on the Group’s financial statements. Work is ongoing to quantify the impact. The changes in the approach to impairment would not be likely to have a significant impact on the Group’s impairment provisions in respect of specifically impaired loans or those loans where there has been a credit deterioration although the loans are not considered to be yet impaired, as the current impairment provisions on such loans are based on estimates of expected losses. In respect of other loans against which collective provisions are raised our current approach as explained in Note 3 is to estimate probabilities of defaults, and hence expected losses, for the next 12 months. This approach is similar to that which will be required under IFRS 9 except that in order to measure incurred losses, as required by IAS 39, we then adjust the calculated 12 month expected loss for an emergence period reflective of the underlying asset so as to reflect only the impairment which is considered to have been incurred at the reporting date. The IASB has also issued IFRS 15: ‘Revenue from contracts with customers.’ The impact for the Group is currently being assessed. The Standard will be effective for annual reporting periods beginning on or after 1 January 2017 with retrospective application subject to EU endorsement. 64 Aldermore Group PLC Annual report and accounts 2014Financial statements2. Significant accounting policies (a) Interest income and expense Interest income and expense are recognised in the income statement on an effective interest rate (‘EIR’) basis. The EIR is the rate that, at the inception of the financial asset or liability, exactly discounts expected future cash payments and receipts over the expected life of the instrument back to the initial carrying amount. When calculating the EIR, the Group estimates cash flows considering all contractual terms of the instrument (for example, prepayment options) but does not consider the assets’ future credit losses. At each reporting date, management makes an assessment of the expected remaining life of its financial assets, including any acquired loan portfolios, and where there is a change in those assessments the remaining amount of any unamortised discount or premiums is adjusted so that the interest income continues to be recognised prospectively on the amortised cost of the financial asset at the original EIR. The adjustment arising is recognised within interest income in the income statement for the current period. The calculation of the EIR includes all transaction costs and fees paid or received that are an integral part of the interest rate, together with the discounts or premium arising on the acquisition of loan portfolios. Transaction costs include incremental costs that are directly attributable to the acquisition or issue of a financial asset or liability. Interest income and expense presented in the income statement include: • interest on financial assets and financial liabilities measured at amortised cost calculated on an EIR basis; • interest on available for sale debt securities calculated on an EIR basis; • interest income recognised on finance leases where the Group acts as the lessor (see Note 2(o)); • the effective portion of fair value changes in qualifying hedging derivatives designated in fair value hedges of interest rate risk, together with changes in the fair value of the hedged item attributable to the hedged risk; and • interest income on financial assets designated at fair value so as to avoid an accounting mismatch with derivatives held as an ‘economic’ hedge and the matching interest component of the derivative. Interest income includes amounts the Group charges its Invoice Finance clients as interest each day on the balance of their outstanding loans. This interest income is recognised in the income statement on an EIR basis. (b) Fee and commissions and other operating income Fee and commission income Fee and commission income includes fees relating to services provided to customers which do not meet the criteria for inclusion within interest income. Within the Invoice Finance division of the Group, customers are charged a factoring fee for managing their sales ledgers. This fee is recognised within fee and commissions income over the period in which the ledger management service is provided. Other fee and commission income includes fees charged for valuations, documentation, mortgage services and arrears, and are recognised as the related services are performed. Arrangement fees and others fees relating to loans and advances to customers are included within interest income as part of the EIR calculation. Fee and commission expense Fee and commission expense predominantly consists of introducer commissions, legal and valuation fees and company search fees. Where these fee and commissions are incremental costs that are directly attributable to the issue of a financial instrument, they are included in interest income as part of the EIR calculation. Where they are not incremental costs that are directly attributable they are recognised within fee and commission expense as the services are received. Other operating income Other operating income predominantly arises from the provision of Invoice Finance services and includes disbursements and collect out income. This income is recognised within other operating income when the service is provided. (c) Net income from derivatives and other financial instruments at fair value through profit or loss Net income from derivatives and other financial instruments at fair value through profit or loss relates to non-trading derivatives held for risk management purposes that do not form part of a qualifying hedging arrangement and financial assets designated at fair value through profit or loss. It includes all realised and unrealised fair value changes, interest and foreign exchange differences, with the exception of interest income on financial assets designated at fair value and the matching interest component of the hedging derivatives. The assets designated at fair value are treated in this manner so as to avoid an accounting mismatch with derivatives held as an ‘economic’ hedge. 65 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 2. Significant accounting policies continued (d) Financial instruments – recognition and derecognition (i) Recognition The Group initially recognises loans and advances, amounts due to banks, customer accounts and subordinated notes issued on the date that they are originated. Regular way purchases and sales of debt securities and derivatives are recognised on the trade date at which the Group commits to purchase or sell the asset. All other financial assets and liabilities are initially recognised on the trade date at which the Group becomes a party to the contractual provisions of the instrument. (ii) Derecognition Financial assets are derecognised when they are qualifying transfers and: • the rights to receive cash flows from the assets have ceased; or • the Group has transferred substantially all the risks and rewards of ownership of the assets. When a financial asset is derecognised in its entirety, the difference between the carrying amount and the sum of the consideration received (including any new asset obtained less any new liability assumed) and any cumulative gain or loss that had been recognised in other comprehensive income is recognised in the income statement. When available for sale financial assets are derecognised, the cumulative gain or loss, including that previously recognised in reserves, is recognised in the income statement. A financial liability is derecognised when the obligation is discharged, cancelled or expires. Any difference between the carrying amount of a financial liability derecognised and the consideration paid is recognised through the income statement. (iii) Funding for Lending Scheme (‘FLS’) Loans and advances over which the Group transfers its rights to the collateral thereon to the Bank of England under the FLS are not derecognised from the statement of financial position, as the Group retains substantially all the risks and rewards of ownership, including all cash flows arising from the loans and advances and exposure to credit risk. The treasury bills that the Group borrows against the transferred assets are not recognised in the statement of financial position, but where they are sold to third parties by the Group under agreements to repurchase, the cash received is recognised as an asset within the statement of financial position together with the corresponding obligation to return it which is recognised as a liability at amortised cost within ‘Due to banks’. Interest is accrued over the life of the agreement on an EIR basis. (e) Financial assets (i) Overview The Group classifies its financial assets (excluding derivatives) as either: • loans and receivables; • available for sale; or • financial assets designated at fair value through profit or loss (ii) Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market and that the Group does not intend to sell immediately or in the near term. These are initially measured at fair value plus transaction costs that are directly attributable to the financial asset. Subsequently, these are measured at amortised cost using the EIR method. The amortised cost is the amount advanced less principal repayments, plus or minus the cumulative amortisation using the EIR method of any difference between the amount advanced and the maturity amount less impairment provisions for incurred losses. Loans and receivables mainly comprise loans and advances to banks and customers. (iii) Available for sale Available for sale financial assets are debt securities that are not held for trading and are intended to be held for an indefinite period of time. These are initially measured at fair value plus transaction costs that are directly attributable to the financial asset. Subsequently, they are measured at fair value based on current quoted bid prices in active markets for identical assets that the Group can access at the reporting date. Where there is no active market or the debt securities are unlisted the fair values are based on valuation techniques including discounted cash flow analysis, with reference to relevant market rates, and other commonly used valuation techniques. Interest income is recognised in the income statement using the EIR method. Impairment losses are recognised in the income statement. Other fair value changes are recognised in other comprehensive income and presented in the available for sale reserve in equity. On disposal, the gain or loss accumulated in equity is reclassified to the income statement. (iv) Fair value assets designated at fair value through profit or loss Financial assets designated at fair value through profit or loss are assets which have been designated as such to eliminate or significantly reduce a measurement and recognition inconsistency or where management specifically manages an asset or liability on that basis. These assets are measured at fair value based on current quoted bid prices in active markets for identical assets that the 66 Aldermore Group PLC Annual report and accounts 2014Financial statementsGroup can access at the reporting date. Gains and losses arising from changes in the fair value are brought into the income statement within ‘Net income/(expense) from derivatives and other financial instruments at fair value through profit or loss’ as they arise. (f) Financial liabilities (i) Overview Financial liabilities are contractual obligations to deliver cash or another financial asset. Financial liabilities are recognised initially at fair value, net of directly attributable transaction costs for financial liabilities other than derivatives. Financial liabilities, other than derivatives, are subsequently measured at amortised cost. (ii) Financial liabilities at amortised cost Financial liabilities at amortised cost are recognised initially at fair value, which equates to issue proceeds net of transaction costs incurred. They are subsequently stated at amortised cost. Any difference between proceeds net of transaction costs and the redemption value is recognised in the income statement over the period of the borrowings using the effective interest method. (iii) Subordinated notes Subordinated notes issued by the Group are assessed as to whether they should be treated as equity or financial liabilities. Where there is a contractual obligation to deliver cash or other financial assets, they are treated as a financial liability and measured at amortised cost using the EIR after taking account of any discount or premium on the issue and directly attributable costs that are an integral part of the EIR. The amount of any discount or premium is amortised over the period to the expected call date of the instrument. All subordinated notes issued by the Group are classified as financial liabilities; however, the warrants attached to the subordinated notes, which give the holders the right to subscribe for shares in Aldermore Group PLC (the ‘Parent Company’), have been included in equity as a warrant reserve at the residual value attributable to the warrants after deducting from the face value of the instrument as a whole the amounts determined separately as the fair value of the subordinated notes at the date of issue. (g) Impairment – financial assets (i) Assessment At each reporting date the Group assesses its financial assets not at fair value through profit or loss as to whether there is objective evidence that the assets are impaired. Objective evidence that financial assets are impaired can include: • significant financial difficulty of the borrower; • a breach of contract such as default or delinquency in interest or principal repayments; • the granting of a concession for economic or legal reasons relating to the borrower’s financial condition that the Group would not otherwise grant; • indications that a borrower or issuer will enter bankruptcy or other financial reorganisation; • the disappearance of an active market for a debt security because of the issuer’s financial difficulties; or • national or local economic conditions that correlate with defaults within groups of financial assets e.g. increases in unemployment rates or decreases in property prices relating to the collateral held. The Group considers evidence for the impairment of loans and advances at both the individual asset and collective level. In certain cases where a borrower is experiencing significant financial distress, the Group may use forbearance measures to assist them and militate against default. Any forbearance measures agreed are assessed on a case by case basis. (ii) Scope The Group considers evidence of impairment of financial assets at both an individual asset and collective level. Individual impairment All individually significant financial assets are assessed for individual impairment using a range of risk criteria. Those found not to be individually impaired are then collectively assessed for any impairment that has been incurred but not yet identified. Assets are considered to be individually impaired where they meet one or more of the following criteria: • a default position equivalent to three or more missed monthly repayments (or a quarterly payment which is over 30 days past due); • litigation proceedings have commenced; • act of insolvency, e.g. bankruptcy, administration or liquidation, or appointment of an LPA Receiver; • invoice finance accounts are classified as in default when there is cessation of additional advances and/or when the facility is in collect out; or • where there is evidence of fraud. 67 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 2. Significant accounting policies continued Collective impairment All financial assets that are not found to be individually impaired are collectively assessed for impairment by grouping together financial assets with similar risk characteristics. (iii) Measurement Impairment provisions on financial assets individually identified as impaired are calculated as the difference between the carrying amount and the present value of estimated future cash flows discounted at the asset’s original EIR. When assessing collective impairment, the Group estimates incurred losses using a statistical model which multiplies the probability of default (‘PD’) for each class of customer (using external credit rating information) by the loss given default (‘LGD’) multiplied by the estimated exposure at default (‘EaD’) to arrive at the projected expected loss. An emergence period is subsequently applied to the projected expected loss to determine the estimated level of incurred losses at each reporting date. In addition an adjustment is made to discount the imputed cash flows from the model at the assets’ original EIR to arrive at the recorded collective provisions. The model’s results are adjusted for management’s judgement as to whether current economic and credit conditions are such that actual losses are likely to differ from those suggested by historical modelling. In assessing the level of collective impairment provisions, the Group uses statistical modelling of historical trends of probability of default, the timing of recoveries and the amount of loss incurred, adjusted for management’s judgement as to whether current economic and credit conditions are such that actual losses are likely to be greater or less than suggested by historical trends. Default rates, loss rates and the expected timing of future recoveries are benchmarked against actual outcomes to ensure they remain appropriate. Impairment losses are recognised immediately in the income statement and a corresponding reduction in the value of the financial asset is recognised through the use of an allowance account. A write-off is made when all or part of a financial asset is deemed uncollectible or forgiven after all collection procedures have been completed and the amount of the loss has been determined. Write-offs are charged against amounts previously reflected in the allowance account or directly to the income statement. Any additional amounts recovered after a financial asset has been previously written off are offset against the write-off charge in the income statement once they are received. Allowances for impairment losses are released at the point when it is deemed that, following a subsequent event, the risk has reduced such that an allowance is no longer required. Interest on impaired financial assets is recognised at the same EIR as applied at the initial recognition of the financial asset but applied to the book value of the financial asset net of any individual impairment allowances that have been raised. (iv) Impairment of financial assets classified as available for sale Impairment losses on available for sale debt securities are recognised by reclassifying the losses accumulated in the available for sale reserve in equity to the income statement. The cumulative loss that is reclassified from equity to the income statement is the difference between the acquisition cost, net of any principal repayment and amortisation, and the current fair value, less any impairment loss recognised previously in the income statement. Changes in impairment provisions attributable to the effective interest method are reflected as a component of interest income. If in a subsequent period the fair value of an impaired available for sale debt security increases and the increase can be related objectively to an event occurring after the impairment loss was recognised, then the impairment loss is reversed. (h) Financial instruments – fair value measurement Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal, or in its absence, the most advantageous market to which the Group has access at that date. The fair value of a liability reflects its non-performance risk. When applicable, the Group measures the fair value of an instrument using the quoted price in an active market for that instrument. A market is regarded as active if transactions for the asset or liability take place with sufficient frequency and volume to provide pricing on an ongoing basis. When there is no quoted price in an active market, the Group uses valuation techniques that maximise the use of relevant observable inputs and minimises the use of unobservable inputs. The chosen valuation techniques incorporate all the factors that market participants would take into account in pricing a transaction. The best evidence of fair value of a financial instrument at initial recognition is normally the transaction price – i.e. the fair value of the consideration received or given. If an asset measured at fair value has a bid and an offer price, the Group measures assets and long positions at a bid price and liabilities at an offer price. 68 Aldermore Group PLC Annual report and accounts 2014Financial statements(i) Derivative financial instruments The Group enters into derivative transactions only for the purpose of reducing exposures to fluctuations in interest rates, exchange rates and market indices; they are not used for proprietary trading purposes. Derivatives are carried at fair value with movements in fair values recorded in the income statement. Derivative financial instruments are principally valued by discounted cash flow models using yield curves that are based on observable market data or are based on valuations obtained from counterparties. As the Group’s derivatives are covered by master netting agreements with the Group’s counterparties, with any net exposures then being further covered by the payment or receipt of periodic cash margins, the Group has used a risk free discount rate for the determination of their fair values. All derivatives are classified as assets where their fair value is positive and liabilities where their fair value is negative. Where there is the current legal ability and intention to settle net, then the derivative is classified as a net asset or liability, as appropriate. Where cash collateral is received, to mitigate the risk inherent in amounts due to the Group, it is included as a liability within ‘Amounts due to banks’. Where cash collateral is given, to mitigate the risk inherent in amounts due from the Group, it is included as an asset in ‘Loans and advances to banks’. (j) Hedge accounting The Group designates certain derivatives held for risk management as hedging instruments in qualifying hedging relationships. On initial designation of the hedge, the Group formally documents the relationship between the hedging instruments and hedged items, including the risk management objective, the strategy in undertaking the hedge and the method that will be used to assess the effectiveness of the hedging relationship. The Group makes an assessment both at the inception of the hedge relationship as well as on an ongoing basis, as to whether the hedging instruments are expected to be highly effective in offsetting the changes in the fair value of the respective hedged items during the period for which the hedge is designated. Fair value hedge accounting for a portfolio hedge of interest rate risk The Group has applied fair value hedge accounting for a portfolio hedge of interest rate risk for the first time, starting on 1 January 2014. As part of its risk management process the Group identifies portfolios whose interest rate risk it wishes to hedge. The portfolios comprise either only assets or only liabilities. The Group analyses each portfolio into repricing time periods based on expected repricing dates, by scheduling cash flows into the periods in which they are expected to occur. Using this analysis, the Group designates as the hedged item an amount of assets or liabilities from each portfolio that it wishes to hedge. The Group measures monthly the change in fair value of the portfolio relating to the interest rate risk that is being hedged. Provided that the hedge has been highly effective, the Group recognises the change in fair value of each hedged item in the income statement with the cumulative movement in their value being shown on the statement of financial position as a separate item, ‘Fair value adjustment for portfolio hedged risk’, either within assets or liabilities as appropriate. This amount is amortised on a straight line basis to the income statement over the remaining average useful life of the original hedge relationship, from the month in which it is first recognised. The Group measures the fair value of each hedging instrument monthly. The value is included in derivative financial instruments in either assets or liabilities as appropriate, with the change in value recorded in the income statement. Any hedge ineffectiveness is recognised in the income statement as the difference between the change in fair value of the hedged item and the change in fair value of the hedging instrument. (k) Embedded derivatives A derivative may be embedded in another instrument, known as the host contract. Where the economic characteristics and risks of an embedded derivative are not closely related to those of the host contract (and the host contract is not carried at fair value through profit or loss), the embedded derivative is separated from the host and held on the statement of financial position with derivatives held for risk management at fair value. Movements in fair value are posted to the income statement, whilst the host contract is accounted for according to the relevant accounting policy for that particular asset or liability. Embedded derivatives contained within equity instruments are considered separately. The embedded derivative on the contingent convertible securities is not separated as the Group has an accounting policy not to separate a feature that has already been considered in determining that the entire issue is a non-derivative equity instrument. 69 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 2. Significant accounting policies continued (l) Property, plant and equipment Items of property, plant and equipment are stated at cost or deemed cost at transition to IFRSs, less accumulated depreciation and any provision for impairment. Cost includes expenditure that is directly attributable to the acquisition of the asset or costs incurred in bringing the asset to use. Depreciation is provided on all property, plant and equipment, at rates calculated to write off the cost of each asset to realisable values on a straight line basis over its expected useful life, as follows: • fixtures, fittings and equipment five years • computer hardware one to five years Purchased software that is integral to the functionality of the related equipment is capitalised as part of that equipment. Equipment held for use in operating leases is written down to its estimated residual value on a straight line basis over the period of the underlying lease agreement. (m) Intangible assets Goodwill Goodwill is stated at cost or deemed cost at transition to IFRSs, less any accumulated impairment losses. Goodwill is not amortised but is tested for impairment on an annual basis. Where impairment is required, the amount is recognised in the income statement and cannot be subsequently reversed. Computer systems Software acquired by the Group is measured at cost less accumulated amortisation and any accumulated impairment losses. Expenditure on internally developed software is recognised as an asset when the Group is able to demonstrate its intention and ability to complete the development and use the software in a manner that will generate future economic benefits, and can reliably measure the costs to complete the development. The capitalised costs of internally developed software include all costs directly attributable to developing the software, and are amortised over its useful life. Internally developed software is stated at capitalised cost less accumulated amortisation and impairment. Software is amortised on a straight line basis in the income statement over its useful life, from the date that it is available for use. The estimated useful life of software is one to five years. (n) Impairment of non-financial assets The carrying amounts of the Group’s non-financial assets are reviewed at least annually to determine whether there is any indication of impairment. If any such indication exists, then the assets recoverable amount is estimated. Goodwill Goodwill is tested for impairment at least annually. For the purpose of impairment testing, goodwill is allocated to divisions. An impairment loss is recognised if the carrying amount of a division exceeds its recoverable amount. The recoverable amount of a division is the greater of its value in use and its fair value less costs to sell. The estimation of recoverable value is based on value in use calculations incorporating forecasts by management of post-tax profits for the subsequent five years, and a residual value, discounted at a risk-adjusted interest rate appropriate to the cash generating unit. Where impairment is required, the amount is recognised in the income statement and cannot be subsequently reversed. Intangible assets If impairment is indicated, the asset’s recoverable amount (being the greater of fair value less costs to sell and value in use) is estimated. Value in use is calculated by discounting the future cash flows from continuing use of the asset. If the carrying value of the asset is less than the greater of the value in use and the fair value less costs to sell, an impairment loss is recognised in the income statement. An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortisation, if no impairment loss had been recognised. (o) Assets leased to customers All leases of assets to customers are finance leases as defined by IAS 17. When assets are leased to customers under finance leases, the present value of the lease payments is recognised as a receivable. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance income. Lease income is recognised, within interest income in the income statement, over the term of the lease using the net investment method (before tax), which reflects a constant periodic rate of return ignoring tax cash flows. (p) Assets leased from third parties Leases where the lessor retains substantially all the risks and rewards of ownership are classified as operating leases. Payments made under operating leases, net of any incentives received from the lessor, are charged to the income statement, within administrative expenses or staff costs (in the case of company cars), on a straight line basis over the period of the lease. The Group holds no assets under finance leases. 70 Aldermore Group PLC Annual report and accounts 2014Financial statements (q) Provisions A provision is recognised if, as a result of a past event, the Group has a present legal or constructive obligation that can be estimated reliably, and it is probable that an outflow of economic benefits will be required to settle the obligation. The Group has an obligation to contribute to the Financial Services Compensation Scheme (‘FSCS’) to enable the FSCS to meet compensation claims from, in particular, retail depositors of failed banks. A provision is recognised to the extent it can be reliably estimated and when the Group has an obligation in accordance with IAS 37. The amount provided is based on information received from the FSCS, forecast future interest rates and the Group’s historic share of industry protected deposits. (r) Foreign currencies Transactions in foreign currencies are recorded using the rate of exchange ruling at the date of the transaction. Monetary assets and liabilities held at the balance sheet date are translated into sterling at the exchange rates ruling at the balance sheet date. Exchange differences are charged or credited to the income statement. (s) Taxation Taxation comprises current and deferred tax, which is recognised in the income statement except to the extent that it relates to items recognised directly in equity or in other comprehensive income. Current tax is the expected tax payable or receivable on taxable income or loss for the period, 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 is recognised in respect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is not recognised for: • temporary differences on the initial recognition of assets or liabilities in a transaction that is not a business combination and that affects neither accounting nor taxable profit or loss; • temporary differences related to investments in subsidiaries to the extent that it is probable that they will not reverse in the foreseeable future; and • taxable temporary differences arising on the initial recognition of goodwill. The measurement of deferred tax reflects the tax consequences that would follow the manner in which the Group expects at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities. Deferred tax is measured using tax rates enacted or substantively enacted at the balance sheet date. A deferred tax asset is recognised only to the extent that it is probable that future taxable profits will be available against which the asset can be utilised. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realised. (t) Pension costs The cost of providing retirement benefits is charged to the income statement at the amount of the defined contributions payable for each year. Differences between contributions payable and those actually paid are shown as accruals or prepayments. The Group has no defined benefit pension scheme. (u) Shareholders’ funds (i) Capital instruments The Company classifies capital instruments as financial liabilities or equity instruments in accordance with the substance of the contractual terms of the instruments. Where an instrument contains no obligation on the Company to deliver cash or other financial assets or to exchange financial assets or financial liabilities with another party under conditions that are potentially unfavourable to the Group, or where the instrument will or may be settled in the Company’s own equity instruments but includes no obligation to deliver a variable number of the Company’s own equity instruments then it is treated as an equity instrument. Accordingly, the Company’s share capital, contingent convertible securities and warrants represented by the warrant reserve are presented as components of equity within shareholders’ funds. Any dividends, interest or other distributions on capital instruments are recognised in equity. Related income tax is accounted for in accordance with IAS 12. (ii) Share premium Share premium is the amount by which the fair value of the consideration received exceeds the nominal value of the shares issued. (v) Capital raising costs Costs directly incremental to the raising of share capital are netted against the share premium account. Costs directly incremental to the raising of convertible securities included in equity are offset against the proceeds from the issue within equity. 71 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 2. Significant accounting policies continued (w) Cash and cash equivalents Cash and cash equivalents comprises cash balances and balances with a maturity of three months or less from the acquisition date, which are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. (x) Investment in Group undertakings Investments in Group undertakings are initially recognised at cost. At each reporting date, an assessment is made as to whether there is any indication that the investment may be impaired. If such an indication exists, the Company estimates the investment’s recoverable amount. The investment is written down to the recoverable amount if this is lower than its carrying value. The impairment loss is recognised in the income statement. (y) Warrants The Company’s subsidiary, Aldermore Bank PLC, has issued subordinated notes with an attached warrant. The warrant gives the holders the right to subscribe for shares in the Company. The value attributable to these warrants has been reflected in an increase in the investment in Group undertakings and has been included in equity as a warrant reserve. (z) Share based payment transactions Employees (including senior Executives) of the Group may receive remuneration in the form of share based payment transactions, whereby employees can purchase equity instruments in Aldermore Group PLC, the Group’s Parent Company (‘equity-settled transactions’). The consideration paid for the equity instruments was in some cases below the fair value at the transaction date. The fair value of these transactions is determined at the transaction date and is recognised, together with a corresponding increase in equity, over the period in which the performance and/or service conditions are fulfilled, ending on the date on which the relevant employees become fully entitled to the award. The expense recognised in the income statement for the period represents the movement in cumulative expense recognised at the beginning and end of that period. Where the Group’s Parent grants equity instruments to the Group’s employees, which are accounted for as equity settled in the consolidated accounts of the parent, the Group accounts for these share based payments as equity settled. Further details of share based payments are provided in Note 35. The share based payment transactions are recognised as an investment in Group undertakings with an associated credit to the share based payment reserve within the Parent Company standalone financial statements. 3. Use of estimates and judgements The preparation of financial information requires management to make judgements, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates. Estimates and assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognised in the period in which the estimate is revised and in any future periods affected. The judgements and assumptions that are considered to be the most important to the portrayal of the Group’s financial condition are those relating to loan impairment provisions, EIRs, contingent liabilities, the classification of contingent convertible securities and intangible assets. (a) Loan impairment provisions Loan portfolios across all divisions of the Group are reviewed on at least a monthly basis to assess for impairment. In determining whether an impairment provision should be recorded, judgements are made as to whether there is objective evidence that a financial asset or portfolio of financial assets is impaired as a result of loss events that occurred after recognition of the asset and by the reporting date. The calculation of impairment loss is management’s best estimate of losses incurred in the portfolio at the balance sheet date and reflects expected future cash flows based on both the likelihood of a loan or advance being written off and the estimated loss on such a write-off. At 31 December 2014 gross loans and advances to customers totalled £4,824 million (31 December 2013: £3,395 million) against which impairment allowances of £23 million (31 December 2013: £21 million) had been made (see Note 20). The Group’s accounting policy for loan impairment provisions on financial assets classified as loans and receivables is described in Note 2(g). Impairment allowances are made up of two components, those determined individually against specific assets and those determined collectively. Of the impairment allowance of £23 million at 31 December 2014, £14 million relates to individual provisions and £9 million relates to collective provisions. The section below provides details of the critical elements of judgement within the loan impairment calculations. Less significant judgements are not disclosed. Individual Individual impairment allowances are established against the Group’s individually significant financial assets that are deemed by management to be impaired. The determination of individual impairment allowances requires the exercise of considerable judgement by management involving matters such as local economic conditions, the financial status of the customer and the realisable value of the security held. 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. 72 Aldermore Group PLC Annual report and accounts 2014Financial statementsCollective The collective impairment allowance is also subject to estimation uncertainty and in particular is sensitive to changes in economic and credit conditions, including the interdependency of house prices, unemployment rates, interest rates, borrowers’ behaviour and consumer bankruptcy trends. All of these factors can influence the key assumptions detailed below. It is, however, inherently difficult to estimate how changes in one or more of these factors might impact the collective impairment allowance. The key assumptions used in the collective model are: probability of default (‘PD’), the loss given default (‘LGD’) and the loss emergence period (‘EP’) (the time between a trigger event occurring and the loans being identified as individually impaired). An additional element is included within the collective provision to reflect fraud losses that are incurred as at the reporting date but are yet to be individually impaired. Further details in respect of assumptions and details of the sensitivity of the estimate of the impairment allowance to changes in significant assumptions are as follows: Probability of default: The PD is based on external individual customer credit rating information updated for each reporting date. This external credit rating information gives a PD in the next 12 months where ‘default’ is defined as loans which are 2 months or more in arrears ‘2 MIA’ and incorporates credit information from a broad range of financial services products for each customer. Management make an estimate so as to adjust the external data to reflect both the individual nature of the Group’s lending and the Group’s policy of classifying loans which are 3 months or more in arrears (‘3 MIA’) as ‘impaired’. This adjustment is achieved by using two management assumptions: firstly a ‘roll rate’ that reflects how many of the loans which fall into 2 MIA will also fall into 3 MIA; and secondly a scalar that adjusts the external PDs to reflect the individual nature of the Group’s lending. • A 10 per cent absolute increase in the ‘roll rate’ assumed by management between 2 MIA and 3 MIA (e.g. a PD increasing from 50 per cent. to 60 per cent.), when the loans are considered to be individually impaired would increase the impairment allowance by £0.4 million. • A 10 per cent relative reduction in the scaling factors applied to external data in order to arise at PDs appropriate to the individual nature of lending being undertaken would increase the impairment allowance by £0.5 million. Loss given default The model calculates the LGD from the point of repossession. Not all cases that are 3 MIA will reach repossession. Management therefore adjust the model by applying an assumption of the percentage of accounts 3 MIA that will reach repossession. • A 10 per cent absolute reduction in this assumption would decrease the impairment allowance by £0.8 million. The LGD is also sensitive to the application of the House Price Index (‘HPI’) and Forced Sale Discount (‘FSD’) which affect the underlying value of the collateral which is expected to be received. • A 10 per cent relative reduction in the HPI would increase the overall impairment allowance by £1.2 million. • A five per cent absolute increase in the FSD would increase the overall impairment provision by £0.9 million. Emergence period Management make a judgement, according to the line of business for the underlying loans, on the length of emergence period to apply to the estimated losses expected to be recognised in the next 12 months in order to determine those which are considered as incurred as at the reporting date. • A three month increase in all emergence periods would increase the overall impairment allowance by £3.3 million. (b) Effective interest rate IAS 39 requires interest earned from mortgages to be measured under the EIR method, as described in Note 2(a). Management must therefore use judgement to estimate the expected life of each type of instrument and hence the expected cash flows relating to it. The accuracy of the EIR would therefore be affected by unexpected market movements resulting in altered customer behaviour, inaccuracies in the models used compared to actual outcomes and incorrect assumptions. A critical estimate in determining EIRs is the expected lives to maturity of the Group’s commercial and residential mortgage portfolios, as a change in the estimates will have an impact on the period over which the directly attributable costs and fees, and any discount received on the acquisition of the mortgage loan portfolios, are recognised. An extension of the estimated expected lives for a period of six months would have the effect of reducing the cumulative profit before tax recognised as at 31 December 2014 by £2.4 million (31 December 2013: £2.4 million). 73 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 3. Use of estimates and judgements continued (c) Contingent liabilities As outlined in Note 32 and 38, the Group has made certain judgements and estimates about the extent of any customer redress for aspects of non-compliance with certain areas of detailed laws and regulations including the Customer Credit Act. The judgements and estimates made represent the best estimate of the Directors based on information available including legal advice. Further details are outlined in Note 32 and 38. (d) Classification of contingent convertible securities The Group issued £75 million of Fixed Rate Reset Additional Tier 1 Perpetual Subordinated Contingent Convertible Securities (‘the Securities’) during the year (see Note 36 for further detail). The Securities (net of the associated issuance costs) have been classified as equity within the statement of financial position. The decision to classify the Securities as equity (as opposed to debt) required management to consider the individual terms attached to the Securities, including the conversion clauses. This involved obtaining external legal and professional advice. The Group is not required to make payments under any circumstances, other than on a winding up. The Securities are convertible into ordinary shares of the Company in the event of the Group’s Common Equity Tier 1 ratio falling below 7 per cent. Subject to circumstances which are within the Company’s control, conversion can only be for a fixed number of the Company’s ordinary shares. The Securities impose no obligation on the Group to deliver cash or other financial benefit to security holders because they are perpetual, with no fixed redemption or maturity date and interest is due and payable only at the sole and absolute discretion of the Company. Furthermore, interest is non-cumulative. After consideration of all of the terms and the external advice received, management concluded that the Securities should be classified as equity in accordance with IAS 32: Financial instruments. (e) Intangible assets The Group assesses its intangible assets at least annually for evidence of impairment. Where the asset is under development, the Group considers whether it is reasonably likely to complete the asset and bring it into use. The Group also considers if the asset will generate sufficient economic benefit over and above the current carrying value of the asset. These considerations have resulted in a write-off of £1.6 million during the year. 4. Segmental information The Group has four reportable operating segments as described below which are based on the Group’s four lending divisions plus Central Functions. Each segment offers groups of similar products and services and are managed separately based on the Group’s internal reporting structure. Residential and SME Commercial Mortgages are operated under a single management team and supported by a single IT platform. However, the characteristics of the two businesses are sufficiently different and accordingly the segments are reported separately to the Board. Therefore, the two businesses represent separate operating segments in accordance with IFRS 8. For each of the reportable segments the Board, which is the Group’s Chief Operating Decision Maker, reviews internal management reports on a monthly basis. The following summary describes the operations in each of the Group’s reportable segments: • Residential Mortgages – Prime residential mortgages targeting underserved segments of creditworthy borrowers that provide attractive and sustainable margins and residential buy-to-let mortgages. • SME Commercial Mortgages – Property finance needs of professional, residential/commercial property investors, and owner- occupier SMEs. Targets prime and specialist prime segments with loan sizes below £5 million. • Asset Finance – Lease and hire purchase financing for SMEs, focusing on sectors with strong returns and liquid secondary asset markets. • Invoice Finance – Simple factoring/discounting facility and credit control for SMEs, targeting owner managed businesses. Central Functions represent the reconciling items between the total of the four reportable operating segments and the consolidated income statement. As well as common costs, Central Functions includes the Group’s Treasury and Savings functions which are responsible for raising finance on behalf of the operating segments. The costs of raising finance are all recharged by Central Functions to operating segments, apart from those costs relating to the subordinated notes (Note 6) and net expense/income from derivatives held at fair value. Common costs are incurred on behalf of the operating segments and typically represent savings administration costs, back office costs and support function costs such as Finance, Risk and Human Resources. The costs are not directly attributable to the operating segments. 74 Aldermore Group PLC Annual report and accounts 2014Financial statementsInformation regarding the results of each reportable segment and their reconciliation to the total results of the Group are included below. Performance is measured based on the segmental result as included in the internal management reports. Segmental information for the year ended 31 December 2014 Residential Mortgages £’000 SME Commercial Mortgages £’000 Interest income – external customers 106,924 56,215 Interest expense – external customers – – Asset Finance1 £’000 56,684 – Invoice Finance £’000 9,276 – (43,427) (14,663) (19,749) (3,327) Central Functions1 £’000 (1,266) (87,618) 81,166 Total £’000 227,833 (87,618) – Interest (expense)/income – internal Net fees and other income – external customers Total operating income Administrative expenses including depreciation and amortisation Impairment losses on loans and advances to customers Segmental result Tax Profit after tax Assets Liabilities 4,109 67,606 1,518 43,070 3,064 39,999 17,543 23,492 (1,432) 24,802 (9,150) 165,017 (9,551) (6,865) (11,878) (14,712) (62,136) (105,142) (1,252) 56,803 (2,246) 33,959 (2,661) 25,460 (3,411) 5,369 – (71,286) (9,570) 50,305 (11,871) 38,434 2,564,899 1,011,291 1,044,298 180,576 764,179 5,565,243 – – – – (5,186,393) (5,186,393) Net assets/(liabilities) 2,564,899 1,011,291 1,044,298 180,576 (4,422,214) 378,850 1 A £1,628,000 write-off in relation to an Asset Finance intangible asset has been recorded within Central Functions as the asset was under construction at the time of write-off. Segmental information for the year ended 31 December 2013 Residential Mortgages £’000 SME Commercial Mortgages £’000 Asset Finance £’000 Interest income – external customers 66,670 39,910 37,375 Interest expense – external customers – – – Invoice Finance £’000 9,379 – (34,920) (14,562) (14,360) (4,318) Central Functions £’000 3,107 (75,799) 68,160 Total £’000 156,441 (75,799) – Interest (expense)/income – internal Net fees and other income – external customers Total operating income Administrative expenses including depreciation and amortisation Impairment losses on loans and advances to customers Segmental result Tax Profit after tax Assets Liabilities 2,875 34,625 89 25,437 1,992 25,007 17,861 22,922 4,886 354 27,703 108,345 (6,944) (4,792) (9,501) (13,993) (35,955) (71,185) (1,261) 26,420 (1,965) 18,680 (2,585) 12,921 (5,657) 3,272 – (35,601) (11,468) 25,692 14 25,706 1,679,686 761,998 720,198 211,962 829,148 4,202,992 – – – – (3,937,635) (3,937,635) Net assets/(liabilities) 1,679,686 761,998 720,198 211,962 (3,108,487) 265,357 75 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 5. Interest income On financial assets not at fair value through profit or loss: On loans and advances to customers On loans and advances to banks On debt securities On financial assets at fair value through profit or loss: Net interest expense on financial instruments hedging assets Net interest income on debt securities designated at fair value 2014 £’000 2013 £’000 227,758 153,676 1,548 5,105 1,206 3,818 234,411 158,700 (12,128) 5,550 (7,970) 5,711 227,833 156,441 Included within interest income on loans and advances to customers for the year ended 31 December 2014 is a total of £2,029,000 (31 December 2013: £957,000) relating to impaired financial advances. Included within net interest income on financial instruments hedging assets are fair value losses of £8,758,000 (31 December 2013: £nil) on derivatives held in qualifying fair value hedging arrangements, together with gains of £7,175,000 (31 December 2013: £nil) representing changes in the fair value of the hedged item attributable to the hedged interest rate risk on loans and advances to customers. 6. Interest expense On financial liabilities not at fair value through profit or loss: On customers’ accounts On amounts due to banks On debt securities in issue On subordinated notes On financial liabilities at fair value through profit or loss: Net interest income on financial instruments hedging liabilities Other 2014 £’000 2013 £’000 80,035 1,522 3,281 6,338 91,176 (4,785) 1,227 87,618 70,411 1,822 – 6,121 78,354 (3,678) 1,123 75,799 Included within net interest expense on financial instruments hedging assets are fair value gains of £1,649,000 (31 December 2013: £nil) on derivatives held in qualifying fair value hedging arrangements together with losses of £1,528,000 (31 December 2013: £nil) representing changes in the fair value of the hedged item attributable to the hedged interest rate risk on customers’ accounts. 7. Fee and commission income Invoice finance fees Insurance commissions receivable Other Details of ‘other’ fee and commission income are provided in Note 2 (b). 2014 £’000 2013 £’000 14,546 14,949 601 11,239 26,386 1,221 7,385 23,555 76 Aldermore Group PLC Annual report and accounts 2014Financial statements8. Fee and commission expense Introducer commissions Legal and valuation fees Company searches and other fees Credit protection and insurance charges Insurance commissions payable 9. Net (expense)/income from derivatives and other financial instruments at fair values through profit or loss Net (losses)/gains on derivatives Net gains/(losses) on assets designated at fair value through profit or loss Net gains on available for sale assets held in fair value hedges Less: realised gains transferred to gains on disposal of debt securities 10. Other operating income Disbursements, collect out and other invoice finance income Other 11. Staff costs Wages and salaries Social security costs Other pension costs 2014 £’000 1,932 2,467 1,815 1,154 451 7,819 2013 £’000 1,962 1,688 2,296 762 821 7,529 2014 £’000 (17,278) 9,537 4,068 (393) 2013 £’000 13,993 (10,716) – – (4,066) 3,277 2014 £’000 7,066 291 7,357 2013 £’000 6,344 187 6,531 2014 £’000 2013 £’000 43,248 33,684 5,009 1,157 3,905 835 49,414 38,424 The average number of persons employed by the Group during the year, including Non-Executive Directors, was 764 (31 December 2013: 621). 12. Remuneration of Directors Directors’ emoluments Compensation for loss of office Contributions to money purchase scheme 2014 £’000 2,797 20 61 2013 £’000 2,747 195 60 2,878 3,002 Compensation for loss of office in 2014 of £20,000 (2013: £195,000) relates to two Directors (2013: two Directors) and includes £nil (2013: £nil) pension plan contribution. In addition, in the prior year, the Group’s controlling party repurchased those Directors’ shares in the Company for an amount which was £94,000 in excess of the initial purchase price. The Group made payments of £24,000 to two Directors’ individual personal pension plans during the year (2013: £25,000, two Directors). 77 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 12. Remuneration of Directors continued During 2014 one Director was given the option to purchase B ordinary shares of £0.10 and two Directors were given the option to purchase C ordinary shares of £0.0001 in the ultimate Parent Company, Aldermore Group PLC, at a discount to market value. 455,021 discounted B ordinary shares were purchased and 17,985,919 discounted C ordinary shares were purchased (2013: one Director, 303,347 B ordinary shares). The shares issued in the year give rise to a benefit of £408,000 (2013: £61,000). A charge of £555,000 has been recognised in the year in relation to the total share based payments amount. Highest paid Director The above amounts include the following in respect of the highest paid Director: Emoluments Contributions to money purchase scheme Share based payments 2014 £’000 703 20 4 727 2013 £’000 653 10 61 724 13. Pension and other post-retirement benefit commitments The Group operates two defined contribution pension schemes. The assets of the schemes are held separately from those of the Group in independently administered funds. Pension contributions of £1,157,000 (31 December 2013: £835,000) were charged to the income statement during the year in respect of these schemes. The Group made payments amounting to £24,000 (31 December 2013: £25,000) in aggregate in respect of certain employees’ individual personal pension plans during the year. There were outstanding contributions of £209,000 at the year end (31 December 2013: £128,000). 14. Administrative expenses Staff costs Legal and professional and other services Information technology costs Office costs Provisions Other Note 11 32 2014 £’000 49,414 23,527 8,289 4,017 3,605 12,389 2013 £’000 38,424 12,095 4,683 3,191 2,111 6,859 101,241 67,363 Included in administrative expenses are £6,014,000 of costs incurred in preparation for an initial public offering. Information technology costs include £1,628,000 (31 December 2013: £nil) in relation to a write-off of intangible assets. Included in other administrative expenses are costs relating to temporary staff of £4,534,000 (31 December 2013: £2,322,000), travel and subsistence of £2,825,000 (31 December 2013: £2,382,000) and staff recruitment of £2,050,000 (31 December 2013: £1,197,000). 15. Depreciation and amortisation Depreciation Amortisation of intangible assets Note 25 24 2014 £’000 950 2,951 3,901 2013 £’000 697 3,125 3,822 78 Aldermore Group PLC Annual report and accounts 2014Financial statements16. Profit on ordinary activities before taxation The profit on ordinary activities is arrived after charging: Operating lease rentals (including service charges) – land and buildings – plant and equipment Foreign exchange loss The remuneration of the Group’s external auditors, KPMG LLP, and their associates is as follows: Fees payable to the Group's auditor for the audit of the annual accounts (excluding VAT) Fees payable to the Group's auditor for the audit of the accounts of subsidiaries (excluding VAT) Audit fees Fees payable to the Group’s auditor and its associates for other services (excluding VAT): Audit related assurance services1 Taxation compliance services Other taxation advisory services2 Corporate finance services3 Other assurance services4 All other services Non-audit fees 2014 £’000 1,898 522 29 50 347 397 568 14 232 827 582 21 2,244 2,641 2013 £’000 1,174 436 33 – 245 245 43 29 94 – 94 58 318 563 1 2 3 Audit related assurance services comprise services provided in relation to the IFRS conversion audit and interim profit verifications during the year. Also included is work in relation to the Group’s issuance of Additional Tier 1 contingent convertible securities. Other taxation advisory services relate to advice provided on a number of specific tax areas arising in the normal course of business. The advice provided also included tax advice relating to the Group’s initial public offering. Fees payable for corporate finance services for year ended 31 December 2014 include £827,000 for the Reporting Accountants’ reports in relation to the Group’s intended initial public offering. 4 Other assurance services relate to services provided in relation to the audit of the Group’s results in preparation for its intended initial public offering. 17. Taxation a) Tax charge/(credit) Current tax on profits for the year Over provision in previous periods Total current tax charge Deferred tax Under provision in previous periods 2014 £’000 15,510 (157) 15,353 (3,731) 249 11,871 2013 £’000 2,492 – 2,492 (2,506) – (14) A current tax charge of £16,000 and a deferred tax charge of £182,000 was recognised in other comprehensive income during the year ended 31 December 2014 (31 December 2013: £793,000 deferred tax credit) in respect of available for sale debt securities. 79 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 17. Taxation continued b) Factors affecting tax charge/(credit) for the year The tax assessed for the year is different to that resulting from applying the standard rate of corporation tax in the UK of 21.5 per cent (31 December 2013: 23.25 per cent). The differences are explained below: Profit before tax Tax at 21.5% (2013: 23.25%) thereon Effects of: Expenses not deductible for tax purposes Prior year deductible temporary differences utilised in the year Recognition/(release) of deferred tax asset Over provision in previous period Deferred tax rate adjustment 2014 £’000 50,305 10,816 689 – – 92 274 11,871 2013 £’000 25,692 5,973 (26) (3,455) (2,506) – – (14) c) Deferred tax asset A net deferred tax asset is regarded as recoverable and therefore recognised only when, on the basis of all available evidence, it can be regarded as probable that there will be suitable future taxable profits against which the unwinding of the asset can be offset. Analysis of recognised deferred tax asset: Year ended 31 December 2014 Capital allowances less than depreciation Gains on available for sale debt securities recognised through other comprehensive income Other temporary differences Year ended 31 December 2013 Tax losses carried forward Capital allowances less than depreciation Gains on available for sale debt securities recognised through other comprehensive income Other temporary differences Balance at start of the year £’000 Recognised in income statement £’000 Recognised in other comprehensive income £’000 Balance at end of the year £’000 3,392 3,163 – 6,555 (148) 55 3,299 – 318 3,481 (182) – (182) (330) 373 6,598 Balance at start of the year £’000 Recognised in income statement £’000 Recognised in other comprehensive income £’000 Balance at end of the year £’000 941 – (941) – – (941) 3,392 – 55 2,506 – – 793 – 793 – 3,392 (148) 55 3,299 Reductions in the UK corporation tax rate from 24 per cent to 23 per cent (effective 1 April 2013) and to 21 per cent (effective from 1 April 2014) were substantively enacted on 3 July 2012 and 2 July 2013 respectively. A further reduction to 20 per cent (effective from 1 April 2015) was also substantively enacted on 2 July 2013. This will reduce the Group’s future current tax charge accordingly. The deferred tax assets at 31 December 2014 and 31 December 2013 have been calculated based on the rate of 20 per cent substantively enacted at those balance sheet dates. There were £nil unrecognised deferred tax balances at 31 December 2014 (31 December 2013: £nil). 80 Aldermore Group PLC Annual report and accounts 2014Financial statements18. Earnings per share Basic earnings per share is calculated by dividing the net profit/(loss) attributable to equity shareholders of the Group by the weighted average number of ordinary shares in issue during the year. Profit attributable to equity shareholders of the Group (£’000) Weighted average number of ordinary shares in issue (thousand) Basic earnings per share (p) 2014 38,434 2013 25,706 233,658 203,019 16.4 12.7 The ordinary shares in issue used in the denominator in the calculation of basic earnings per share are the A1, A2, D and E ordinary shares. The B and C ordinary shares are excluded from the calculation on the basis that prior to any initial public offering they have no entitlement to dividends or other distributions of the Parent Company. The calculation of diluted earnings per share has been based on the same profit attributable to equity shareholders of the Group as for basic earnings and the weighted average number of ordinary shares outstanding after the potential dilutive effect of outstanding share warrants. The share warrants give the holders the right to subscribe for 2,905,779 E ordinary shares at a price of £1.12 per share and a further 1,452,889 E ordinary shares at a price of £1.55 per ordinary share, and are exercisable until 31 May 2022. Weighted average number of ordinary shares in issue (thousand) (basic) Effect of share warrants in issue Weighted average number of ordinary shares in issue (thousand) (diluted) Diluted earnings per share (p) 19. Loans and advances to banks Included in cash and cash equivalents: balances with less than three months to maturity at inception Cash collateral on derivatives placed with banks Other loans and advances to banks 2014 233,658 1,967 235,625 16.3 2014 £’000 60,371 46,162 10,868 2013 203,019 357 203,376 12.6 2013 £’000 226,194 11,350 – 117,401 237,544 There were no individual or collective provisions for impairment held against loans and advances to banks. £10,868,000 is recoverable more than 12 months after the reporting date (2013: £nil) and relates to cash held by the Group’s securitisation vehicle, Oak No.1 PLC. 20. Loans and advances to customers Gross loans and advances less: allowance for impairment losses Amounts include: 2014 £’000 2013 £’000 4,823,638 3,394,872 (22,574) (21,028) 4,801,064 3,373,844 Expected to be recovered more than 12 months after the reporting date 4,205,825 2,880,879 At 31 December 2014, loans and advances to customers of £719.9 million (31 December 2013: £822.9 million) were pre-positioned with the Bank of England and HM Treasury Funding for Lending Scheme. These loans and advances were available for use as collateral with the Scheme, against which £485.0 million of UK Treasury Bills had been drawn as at the reporting date (31 December 2013: £485.0 million). 81 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 20. Loans and advances to customers continued At 31 December 2014, loans and advances to customers include £293.1 million (31 December 2013: £nil) which have been used in secured funding arrangements, resulting in the beneficial interest in these loans being transferred to Oak No. 1 PLC which is a securitisation vehicle consolidated into these financial statements. The carrying value of these loans on 10 April 2014 when the beneficial interest was transferred was £362.3 million. These loans secured £333.3 million (2013: £nil) of funding for the Group (see Note 33). All the assets pledged are retained within the statement of financial position as the Group retains substantially all the risks and rewards relating to the loans. Allowance for impairment losses Year ended 31 December 2014 Balance as at 1 January Impairment loss for the year: Charge to the income statement Unwind of discounting Write-offs net of recoveries Balance as at 31 December Year ended 31 December 2013 Balance as at 1 January Impairment loss for the year Charge to the income statement Unwind of discounting Write-offs net of recoveries Balance as at 31 December Individual £’000 14,714 Collective £’000 Total £’000 6,314 21,028 6,373 (1,025) (6,015) 3,197 (984) – 9,570 (2,009) (6,015) 14,047 8,527 22,574 Individual £’000 9,318 7,689 (361) (1,932) 14,714 Collective £’000 Total £’000 3,131 12,449 3,779 (596) – 6,314 11,468 (957) (1,932) 21,028 The charge to the Group’s income statement shown in the table above is presented net of releases of provisions previously recorded against individual customers. The following table provides a further breakdown of impairment losses: Provisions established Less: Significant provision releases prior to write-off1 Recoveries of amounts previously written off Charge to the income statement 2014 £’000 2013 £’000 12,758 12,262 (2,091) (1,097) 9,570 (793) (1) 11,468 1 Significant provision releases comprise individual cases where a change in circumstances has resulted in a release of an individually assessed impairment provision in excess of £300,000. Finance lease receivables Loans and advances to customers include the following finance leases of equipment where the Group is the lessor: Gross investment in finance leases, receivable: Less than one year Between one and five years More than five years Unearned finance income Net investment in finance leases Net investment in finance leases, receivable: Less than one year Between one and five years More than five years 82 2014 £’000 2013 £’000 469,841 690,359 16,672 279,078 512,398 19,574 1,176,872 811,050 (130,686) (90,852) 1,046,186 720,198 376,079 653,902 16,205 235,781 465,403 19,014 1,046,186 720,198 Aldermore Group PLC Annual report and accounts 2014Financial statementsThe Group enters into finance lease and hire purchase arrangements with customers in a wide range of sectors including plant and machinery, cars and commercial vehicles. The accumulated allowance for uncollectible minimum lease payments receivable is £2,213,000 (31 December 2013: £2,328,000). Due to the nature of the business undertaken, there are no material unguaranteed residual values for any of the finance leases at 31 December 2014 or 31 December 2013. Included in the above disclosure is approximately £70 million in relation to block discounting facilities (31 December 2013: approximately £52 million) and approximately £17 million in relation to unsecured lending at 31 December 2014 (31 December 2013: approximately £17 million). 21. Debt securities Debt securities designated at fair value through profit or loss: UK Government Gilts Supranational Bonds Available for sale debt securities: UK Government Gilts and Treasury Bills Supranational Bonds Corporate Bonds Asset-backed securities 2014 £’000 2013 £’000 116,405 108,399 37,951 54,499 154,356 162,898 21,519 292,965 24,516 16,328 24,647 90,264 – 77,844 355,328 192,755 509,684 355,653 At 31 December 2014, £459.1 million (31 December 2013: £301.6 million) of debt securities are expected to be recovered more than 12 months after the reporting date. There were no impairment losses in respect of available for sale debt securities. 22. Derivatives held for risk management Amounts included in the statement of financial position are analysed as follows: Instrument type Interest rate (not in hedging relationships) Interest rate (fair value hedges) Equity Foreign exchange 2014 2013 Assets £’000 1,075 6,632 408 53 Liabilities £’000 23,218 30,546 408 26 Assets £’000 8,484 – 354 34 Liabilities £’000 17,511 – 354 2 8,168 54,198 8,872 17,867 All derivatives are held either as fair value hedges qualifying for hedge accounting (from January 2014) or are held for the purpose of managing risk exposures arising on the Group’s other financial instruments (all periods). Fair value hedges of interest rate risk From January 2014, the Group has used interest rate swaps within qualifying hedge accounting relationships to manage its exposure to changes in the fair values of certain fixed rate lending and savings products and debt securities held, attributable to changes in market interest rates. Further details regarding the Group’s approach to hedge accounting, including a description of the Group’s exposure to volatility are provided in Note 41. 83 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 22. Derivatives held for risk management continued Other derivatives held for risk management The Group uses other derivatives, not designated in qualifying hedge relationships, to manage its exposure to the following: • Interest rate risk on certain debt securities held which are designated at fair value through profit or loss; • Interest rate basis risk on certain mortgage loans; • Equity market risk on equity linked products offered to depositors; and • Foreign exchange risk on currency loans provided to invoice finance customers. 23. Investment in subsidiaries On 25 September 2014, the 99.9 per cent majority interest in Aldermore Holdings Limited was transferred to Aldermore Group PLC, leaving the Bank as a wholly owned subsidiary of Aldermore Group PLC. Subsidiary undertakings, all of which are registered in England and operate in the UK, are listed below. All subsidiaries are included in the consolidated financial statements. Subsidiary undertakings Aldermore Bank PLC Securitisation vehicles Principal activity Shareholding % Banking and related services 100% Oak No.1 Mortgage Holdings Limited Holding company for securitisation vehicle * Oak No.1 PLC Securitisation vehicle Dormant subsidiary undertakings Aldermore Invoice Finance (Holdings) Limited Aldermore Invoice Finance Limited Aldermore Invoice Finance (Oxford) Limited Subdsidiary undertakings struck-off Aldermore Holdings Limited Aldermore Bank Nominees Limited Base Commercial Mortgages Holdings Limited Base Commercial Mortgages Limited Base Commercial Mortgages Funding Limited Lynchwood Commercial Funding No.1 Limited Lynchwood Commercial Funding No.2 Limited Dormant Dormant Dormant Holding company Dormant Dormant Dormant Dormant Dormant Dormant * 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% * The share capital of these securitisation vehicles is not owned by the Group, but these vehicles are included in the consolidated financial statements as they are controlled by the Group. An application to strike companies from the register of companies was filed with Companies House on 29 September 2014. Formal strike-off was completed on 3 February 2015. 84 Aldermore Group PLC Annual report and accounts 2014Financial statements24. Intangible assets Cost/deemed cost at transition to IFRS 1 January 2014 Additions Write-off 31 December 2014 1 January 2013 Additions 31 December 2013 Amortisation 1 January 2014 Charge for the year 31 December 2014 1 January 2013 Charge for the year 31 December 2013 Net book value 31 December 2014 31 December 2013 Computer systems £’000 Goodwill £’000 Total £’000 16,253 4,493 (1,628) 19,118 12,898 3,355 16,253 6,249 2,951 9,200 3,124 3,125 6,249 12,653 – – 12,653 12,653 – 12,653 – – – – – – 28,906 4,493 (1,628) 31,771 25,551 3,355 28,906 6,249 2,951 9,200 3,124 3,125 6,249 9,918 10,004 12,653 12,653 22,571 22,657 Goodwill arose on the acquisitions of Base Commercial Mortgages Holdings Limited and Absolute Invoice Finance Holdings Limited. For the purpose of impairment testing, goodwill is allocated to the Group’s operating divisions. The aggregate amount allocated to each division is as follows: SME Commercial Mortgages Invoice Finance 2014 £’000 8,547 4,106 2013 £’000 8,547 4,106 12,653 12,653 No impairment losses on goodwill were recognised during the year ended 31 December 2014 (31 December 2013: £nil). The recoverable amounts for SME Commercial Mortgages and Invoice Finance divisions have been calculated based on their value in use, determined by discounting the future cash flows to be generated from the continuing use of the division. Value in use at 31 December 2014 has been determined in a similar manner as at 31 December 2013. • Key assumptions used in the calculation of value in use were the following: Cash flows were projected based on past experience, actual operating results and the five year business plan (31 December 2013: the four year business plan). Cash flows for a further 10 year period were extrapolated using a constant growth rate of 3 per cent (31 December 2013: 3 per cent). The forecast period is based on the Group’s long term perspective with respect to the operation of these divisions. • Pre-tax discount rates of 13 per cent and 15 per cent (31 December 2013: 13 per cent and 15 per cent) respectively were applied in determining the recoverable amounts for the SME Commercial Mortgages and Invoice Finance operating divisions. These discount rates were based on the weighted average cost of funding for the divisions based on the Group’s regulatory capital requirement and expected market returns for debt and equity funding, adjusted for risk premiums to reflect the systemic risk of the individual divisions. The key assumptions described above may change as economic and market conditions change. The Group estimates that reasonably possible changes in these assumptions are not expected to cause the recoverable amount of either division to reduce below the carrying amount. 85 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 25. Property, plant and equipment Cost/deemed cost at transition to IFRS 1 January 2014 Additions 31 December 2014 1 January 2013 Additions 31 December 2013 Depreciation 1 January 2014 Charge for the year 31 December 2014 1 January 2013 Charge for the year 31 December 2013 Net book value 31 December 2014 31 December 2013 Fixtures, fittings and equipment £’000 Computer hardware £’000 2,661 568 3,229 1,888 773 2,661 1,357 396 1,753 1,040 317 1,357 1,476 1,304 3,078 339 3,417 1,908 1,170 3,078 1,524 554 2,078 1,144 380 1,524 1,339 1,554 Total £’000 5,739 907 6,646 3,796 1,943 5,739 2,881 950 3,831 2,184 697 2,881 2,815 2,858 86 Aldermore Group PLC Annual report and accounts 2014Financial statements26. Other assets Amounts recoverable within one year Amounts recoverable after one year 27. Prepayments and accrued income Amounts recoverable within 12 months: Accrued income Other prepayments 28. Amounts due to banks Amounts repayable within 12 months: Due to banks – repurchase agreements Due to banks – deposits Cash collateral received on derivatives 2014 £’000 3,124 220 3,344 2014 £’000 2,683 4,173 6,856 2013 £’000 197 115 312 2013 £’000 1,810 3,299 5,109 2014 £’000 2013 £’000 304,207 383,071 600 1,100 1,205 1,675 305,907 385,951 Collateral given under repurchase agreements The face value of securities sold under agreements to repurchase at 31 December 2014 was £305 million (31 December 2013: £385 million) all of which were drawn down from the Bank of England under the terms of the Funding for Lending Scheme. The Group conducts these repurchase transactions under the terms of applicable General Master Repurchase Agreement guidelines. Consideration received in return for the collateral is recorded as ‘Amounts due to banks’ and is accounted for as a financial liability at amortised cost. 29. Customers’ accounts Amounts repayable within one year Amounts repayable after one year 30. Other liabilities Amounts payable within 12 months: Other taxation and social security costs Amounts payable to Invoice Finance customers Trade creditors Other payables 2014 £’000 2013 £’000 3,438,472 2,728,364 1,020,490 735,654 4,458,962 3,464,018 2014 £’000 3,813 10,091 2,870 1,860 2013 £’000 3,967 7,146 848 2,382 18,634 14,343 87 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 31. Accruals and deferred income Amounts payable within 12 months: Accruals Deferred income Fee accruals 32. Provisions 1 January 2014 Utilised during the year Provided during the year 31 December 2014 1 January 2013 Utilised during the year Provided during the year 31 December 2013 2014 £’000 2013 £’000 18,424 13,787 1,971 712 1,805 644 21,107 16,236 Financial Services Compensation Scheme £’000 Customer redress £’000 707 (2,083) 2,606 1,230 576 (1,530) 1,661 707 450 (671) 999 778 – – 450 450 Total £’000 1,157 (2,754) 3,605 2,008 576 (1,530) 2,111 1,157 Financial Services Compensation Scheme (‘FSCS’) In common with all regulated UK deposit takers, the Group’s principal subsidiary, Aldermore Bank PLC, pays levies to the FSCS to enable the FSCS to meet claims against it. The FSCS levy consists of two parts: a management expenses levy and a compensation levy, which includes capital and interest levies. The management expenses levy covers the costs of running the scheme and the compensation levy covers the amount of compensation the scheme pays, net of any recoveries it makes using the rights that have been assigned to it. During 2008 and 2009 claims were triggered against the FSCS in relation to Bradford & Bingley plc., Kaupthing Singer & Friedlander Ltd, Heritable Bank plc., Landsbanki Islands hf, London Scottish Bank plc. and Dunfermline Building Society. In order to fund the compensation costs of the defaults, the FSCS borrowed £20.4 billion from HM Treasury which is repayable by 31 March 2016. The FSCS provision at 31 December 2014 of £1,230,000 represents interest levies for scheme years 2014/2015. The interest levy provisions represent the interest costs on the loans borrowed for HM Treasury for the 12 months ending 31 March 2015. The funding rate used is the higher of the 12 month LIBOR plus 100 basis points, and the relevant gilt rate published by the Debt Management Office. The capital levy provision of £nil (31 December 2013: £nil) includes the Group’s estimate of its share of the capital shortfalls on loans made to failed institutions by the FSCS. The shortfalls are expected to be recovered by 31 March 2016 when the loans from HM Treasury are due for repayment. The capital levy is paid in the same financial year in which it is levied. Customer redress A provision of £999,000 (31 December 2013: £450,000) in relation to Consumer Credit Act (‘CCA’) non-compliance has been reflected in the financial statements. The Group has a small number of loans which are regulated under the CCA and has identified that, following changes to the CCA in 2008, certain letters and statements have been sent to customers that do not fully comply with the requirements prescribed by the CCA. Accordingly, these customers are entitled to redress for interest and fees charged on the relevant loans as a result of this technical non-compliance, notwithstanding there is unlikely to have been any customer detriment. 88 Aldermore Group PLC Annual report and accounts 2014Financial statements33. Debt securities in issue Debt securities in issue are repayable from the reporting date in the ordinary course of business as follows: In more than one year 2014 £’000 279,143 2013 £’000 – Debt securities in issue with a principal value of £280.5 million are secured on certain portfolios of variable and fixed rate mortgages through the Group’s securitisation vehicle, Oak No. 1 PLC. These notes are redeemable in part from time to time, such redemptions being limited to the net capital received from mortgage customers in respect of the underlying assets. There is no obligation for the Group to make good any shortfall. Further disclosure relating to the underlying assets is contained in Note 20. 34. Subordinated notes Subordinated notes 2014 £’000 2013 £’000 36,758 35,571 During 2012 the Group issued £40 million subordinated 12.875 per cent loan notes, repayable in 2022, with an option for the Group to redeem early after five years. The interest rate is fixed until May 2017. The loan notes were issued at a discount, and are carried in the balance sheet at amortised cost using the EIR of 18.597 per cent. In addition to the loan notes, a warrant was issued by the Group’s Parent Company, Aldermore Group PLC. The warrant was valued at £2,200,000, and this was treated as a warrant reserve within equity in accordance with the accounting policy in Note 2 f(iii). 35. Share capital Type A1 ordinary shares of £0.10 each A2 ordinary shares of £0.10 each B ordinary shares of £0.10 each C ordinary shares of £0.0001 each D ordinary shares of £0.10 each E ordinary shares of £0.10 each Rights of class of share: Type A1 ordinary shares of £0.10 each A2 ordinary shares of £0.10 each B ordinary shares of £0.10 each C ordinary shares of £0.0001 each D ordinary shares of £0.10 each E ordinary shares of £0.10 each 2014 £ 2013 £ 3,569,400 3,569,400 5,870,427 5,870,427 385,463 385,463 13,200 12,845 5,440,522 5,440,522 8,458,428 8,458,428 23,737,440 23,737,085 Full voting rights Dividend rights Distribution rights in the event of a sale or wind-up 3 3 7 7 7 7 3 3 7 7 3 3 3 3 3 3 3 3 During the year ended 31 December 2014, 7,815,867 C ordinary shares with a total nominal value of £781 were issued for £781. During the year ended 31 December 2014, 4,260,960 (31 December 2013: 1,361,031) C ordinary shares with a nominal value of £426 (31 December 2013: £136) were repurchased. These shares were subsequently cancelled creating a capital contribution reserve. During the year ended 31 December 2013, 38,196,551 E ordinary shares with a nominal value of £3,819,656 were issued for £64,138,380. A total of £59,344,711 share premium was recognised on these issues, net of capital raising costs. 89 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 35. Share capital continued Share premium On 21 September 2014 AC Acquisitions Limited reduced its share premium by special resolution from £237,305,000 to £nil. This amount has been transferred to retained earnings. AC Acquisitions Limited was re-registered on 30 September 2014 as Aldermore Group PLC. Share based payments The Employee Share Programme allows employees (including senior executives) of the Group to receive remuneration in the form of share based payment transactions, whereby employees can purchase equity instruments in Aldermore Group PLC. The consideration paid for the equity instruments was in some cases below the fair value at the transaction date. The grant date fair value of share based payment awards granted is recognised as an employee expense in the Group with a corresponding increase in equity over the period in which the performance and/or service conditions are fulfilled, ending on the date on which the employees become fully entitled to the award. The amount recognised as an expense is adjusted to reflect the actual number of awards for which the related service and non- market vesting conditions are expected to be met, such that the amount ultimately recognised as an expense is based on the number of awards that meet the related service and non-market performance conditions at the vesting date. For share based payment awards with non-vesting conditions, the grant date fair value of the share based payment is measured to reflect such conditions and there is no true up for differences between expected and actual outcomes. The consolidated charge reflects that recognised at a subsidiary level with the corresponding credit going to equity. The following classes of shares have been granted to employees and Directors of the Group. For shares issued below fair value, the difference between fair value and price paid is charged to the income statement by the employing entity over the relevant service period over which the benefits of the awards are received. Year ended 31 December 2014 B ordinary shares of £0.10 each C ordinary shares of £0.0001 each Year ended 31 December 2013 B ordinary shares of £0.10 each C ordinary shares of £0.0001 each E ordinary shares of £0.10 each Number of shares granted Weighted average fair value at grant date 455,021 £1.21 36,182,667 £0.0018 Number of shares granted Weighted average fair value at grant date 303,347 £0.52 – – 171,027 £1.31 The value from the shares is expected to be derived on a form of exit. However, the Articles of Association stipulate that in the event of an employee leaving the Group, the shares are immediately transferred back to the Company’s custody with an amount paid back to the leaver depending on the conditions of leaving. The fair value of services received in return for shares granted is measured by reference to the fair value of shares granted. The fair value of the shares granted during 2014 and 2013 was based on contemporaneous transactions between unconnected parties in the same, or similar, shares, with adjustments made to take account of the different rights, including dividend rights. The charge in the Group’s income statement for the year ended 31 December 2014 in relation to all share based payment transactions was £609,000 (31 December 2013: £162,000). 36. Contingent convertible securities On 9 December 2014, the Company issued £75 million Fixed Rate Reset Additional Tier 1 Perpetual Subordinated Contingent Convertible Securities (the ‘Securities’). Net proceeds arising from the issuance, after deducting issuance costs totalled £73,657,000. The Securities are perpetual and have no fixed redemption date. Redemption of the Securities is at the option of the Company on 30 April 2020 and annually thereafter. The Securities bear interest at an initial rate of 11.875 per cent p.a. until 30 April 2020 and thereafter at the relevant Reset Interest Rate as provided in the Information Memorandum. Interest is payable on the securities annually in arrears on each interest payment date commencing 30 April 2015 and is non-cumulative. The Borrower has the full discretion to cancel any interest scheduled to be paid on the Securities. The Securities are convertible into ordinary shares of the Company in the event of the Group’s Common Equity Tier 1 ratio falling below 7 per cent. 90 Aldermore Group PLC Annual report and accounts 2014Financial statementsAs the Securities contain no obligation on the Company to make payments of principal or interest they have been classified as equity instruments as required by IAS 32. Accordingly the Securities have been included in equity at the fair value of the proceeds received less any direct costs attributable to the issue of the Securities. Any interest paid on the Securities will be a distribution to holders of equity instruments and shall be recognised directly in equity on the payment date. Although there are number of additional terms relating to events such as acquisition and wind up, there are no circumstances in which the Group has an unavoidable obligation to issue a variable number of its own shares. The Group has not separated any embedded derivative features because the Group has an accounting policy not to separate a feature that has already been considered in determining that the entire issue is a non-derivative equity instrument. The classification of the Securities is considered a critical judgement. See Note 3 (d). 37. Statement of cash flows a) Adjustments for non-cash items and other adjustments included within the income statement 2014 £’000 Depreciation and amortisation Write-off of intangible assets Amortisation of securitisation issuance cost Discount accretion on subordinated notes Impairment losses on loans and advances Unwind of discounting Write-off net of recoveries Net (gain)/loss on debt securities designated at fair value through profit or loss Gains on hedged available for sale debt securities recognised in profit or loss Net (gain) on disposal of available for sale debt securities Interest expense on subordinated notes Interest income on debt securities Interest expense on debt securities in issue Equity settled share based payment charge b) (Increase)/decrease in operating assets Loans and advances to customers Loans and advances to banks Derivative financial instruments Fair value adjustments for portfolio hedged risk Other operating assets c) Increase in operating liabilities Amounts due to banks Customers' accounts Derivative financial instruments Fair value adjustments for portfolio hedged risk Other operating liabilities 2013 £’000 3,822 – – 971 11,468 (957) (1,932) 10,716 – (1,869) 5,150 (9,529) – 162 3,901 1,628 431 1,158 9,570 (2,009) (6,015) (9,537) (4,068) (2,465) 5,179 (10,655) 2,851 609 (9,422) 18,002 2014 £’000 2013 £’000 (1,428,766) (1,325,863) (45,680) 704 (7,175) (6,870) 10,480 1,390 – (6,859) (1,487,787) (1,320,852) 2014 £’000 2013 £’000 (80,044) 270,872 994,944 1,302,369 36,331 1,528 10,013 (13,745) – 12,431 962,772 1,571,927 91 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 37. Statement of cash flows continued d) Cash and cash equivalents For the purpose of the statement of cash flows, cash and cash equivalents comprise cash on demand and overnight deposits classified as cash and balances at central banks (unless restricted) and balances within loans and advances to banks. The following balances have been identified as being cash and cash equivalents. Excluded balances comprise minimum balances required to be held at the Bank of England as they are not readily convertible to cash in hand or demand deposits. Cash and cash equivalents as at 31 December 2014 exclude £10.9 million held by the securitisation vehicle, Oak No.1 PLC, which is not available to the other members of the Group (31 December 2013: £nil). Cash and balances at central banks Less excluded balances Loans and advances to banks 2014 £’000 79,567 (5,919) 60,371 2013 £’000 192,844 (3,828) 226,194 134,019 415,210 38. Commitments and contingencies At 31 December 2014 the Group had undrawn commitments to lend of £404.6 million (31 December 2013: £343.7 million). These relate mostly to irrevocable lines of credit granted to customers. At the end of the reporting period, the future minimum lease payments under non-cancellable operating leases are payable as follows: Land and buildings In less than one year Between one and five years More than five years Equipment In less than one year Between one and five years 2014 £’000 1,545 2,942 544 5,031 2014 £’000 180 267 447 2013 £’000 1,201 3,319 1,123 5,643 2013 £’000 140 14 154 At 31 December 2014 the majority of operating leases for equipment related to 49 cars that the Group held under lease (31 December 2013: 64). The majority of these leases are due to expire in 2017. Legislation As a financial services Group, Aldermore Group PLC is subject to extensive and comprehensive regulation. The Group must comply with numerous laws and regulations, including the Consumer Credit Act, which significantly affect the way it does business. Whilst the Group believes there are no unidentified areas of failure to comply with these laws and regulations which would have a material impact on the financial statements, there can be no guarantee that all issues have been identified. Working Time Directive A recent ruling by the European Court of Justice indicated that under the European Working Time Directive, ‘normal pay’ for the purposes of calculating statutory holiday pay, includes contractual commission rather than being limited to basic salary. A UK Employment Tribunal is now considering the implications for UK employers under the Working Time Regulations 1998. Meanwhile, the UK Employment Tribunal has ruled that non-guaranteed overtime payments should be included for the purposes of calculating how much holiday pay a worker should receive. It is therefore expected that the UK Employment Tribunal will conclude on a similar basis for certain commissions. Based on information and advice to date, the Group does not expect the impact of either the non-guaranteed overtime payments or commissions to be material; however, in the event that analysis, judgements and/or appeals are determined to ultimately be different, the Group expects the likely impact to be immaterial. 92 Aldermore Group PLC Annual report and accounts 2014Financial statements39. Related parties a) Controlling parties The Group is controlled by AnaCap Financial Partners, II L.P. (52.3 per cent. of voting rights) and AnaCap Financial Partners, L.P. (47.7 per cent. of voting rights) who are the sole voting shareholders of Aldermore Group PLC. The following agreements are in place with a company under their control: • The Group provides £5 million of block discounting facilities to Syscap Limited, a provider of business finance solutions. The facilities are secured by underlying receivables of short term loans, primarily to solicitors’ practices which are funded at a discount to the face value of the loans. The facilities contain appropriate conditions relating to performance, non-performing deal substitution rights and default provisions in line with the Group’s standard commercial policies. Pricing on the facilities is subject to normal commercial terms. • During the year ended 31 December 2014, Syscap Limited introduced business of £21.9 million (31 December 2013: £27.7 million) and received commission of £0.4 million (31 December 2013: £0.3 million) of which £nil is outstanding as at 31 December 2014 (31 December 2013: £nil). • In addition, the Group has been charged investment monitoring fees and capital raising costs by funds related to AnaCap Financial Partners L.P. of £150,000 for the year ended 31 December 2014 (31 December 2013: £150,000). The balance outstanding at 31 December 2014 is £93,000 (31 December 2013: £195,000). b) Key management personnel compensation Until 21 September 2014, key management personnel comprised the Directors of the Group. From 21 September 2014, following changes to the Group’s governance structure, key management personnel also comprise the members of the Executive Committee. Prior year comparatives consist of Directors of the Group. Details of the compensation paid to key management personnel are: Emoluments Compensation for loss of office Group contributions to money purchase scheme 2014 £’000 3,366 20 72 2013 £’000 2,747 195 60 3,458 3,002 Compensation for loss of office for the year ended 31 December 2014 of £20,000 (31 December 2013: £195,000) relates to two key persons (31 December 2013: two key persons) and includes a £nil (31 December 2013: £nil) pension plan contribution. In addition, in the prior year, the Group’s controlling party repurchased key persons shares in the Company for an amount which was £94,000 in excess of the initial purchase price. The Group made payments of £24,000 in aggregate in respect of two key persons personal pension plans during the year ended 31 December 2014 (31 December 2013: £25,000, two key persons). During the year ended 31 December 2014, one key person was given the option to purchase B ordinary shares of £0.10 and three key persons were given the option to purchase C ordinary shares of £0.0001 in Aldermore Group PLC, at a discount to market value. 455,021 discounted B ordinary shares were purchased and 26,250,206 discounted C ordinary shares were purchased (31 December 2013: one key person, 303,347 B ordinary shares). Key persons’ emoluments includes £nil of deferred bonus (31 December 2013: £nil). 93 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 39. Related parties continued c) Transactions with key management personnel The aggregate value of transactions and outstanding balances related to key management personnel (as defined by IAS 24 Related Party Disclosure) were as follows: Loans Deposits Loans Deposits Loans Deposits Transaction values for the year ended 31 December 2014 £’000 31 December 2013 £’000 33 2,015 2 1,570 Maximum balance for the year ended 31 December 2014 £’000 31 December 2013 £’000 162 1,565 115 1,862 Balance outstanding as at 31 December 2014 £’000 31 December 2013 £’000 162 1,565 115 1,067 The table above includes transactions and balances relating to key management personnel in post at the end of the year. Interest rates charged on loan balances outstanding from related parties are lower than the rates that would be charged in arm’s length transactions. During the year ended 31 December 2014 interest was charged on these loans at an annual rate of 0.8 per cent above one month LIBOR. These loan balances are not secured. All deposit arrangements have been operated by the Group on commercial terms and conditions. 40. Financial instruments and fair values The following tables summarise the classification and carrying amounts of the Group’s financial assets and liabilities: 31 December 2014 Cash and balances at central banks Loans and advances to banks Debt securities Derivatives held for risk management Fair value adjustment for portfolio hedged risk Loans and receivables £’000 79,567 117,401 – – – Loans and advances to customers 4,801,064 1,298 Other assets Total financial assets Amounts due to banks Customers’ accounts Derivatives held for risk management Fair value adjustment for portfolio hedged risk Other liabilities Debt securities in issue Subordinated notes Total financial liabilities 94 Designated at fair value through profit or loss £’000 Fair value through profit or loss (required) £’000 Available for sale £’000 Fair value hedges £’000 Liabilities at amortised cost £’000 – – – – 355,328 154,356 – – – – – – – – – – – 8,168 – – – – – – – 7,175 – – Total £’000 79,567 117,401 509,684 8,168 7,175 – – – – – – 4,801,064 – 1,298 – 5,524,357 – – – – – – – – – – – – – – – – – – – – – – – – – – – 305,907 305,907 – 4,458,962 4,458,962 54,198 – 1,528 – – 54,198 1,528 – – – 14,778 14,778 279,143 279,143 36,758 36,758 – – – – 54,198 1,528 5,095,548 5,151,274 4,999,330 355,328 154,356 8,168 7,175 Aldermore Group PLC Annual report and accounts 2014Financial statements31 December 2013 Cash and balances at central banks Loans and advances to banks Debt securities Derivatives held for risk management Loans and receivables £’000 192,844 237,544 – – Loans and advances to customers 3,373,844 Designated at fair value through profit or loss £’000 Fair value through profit or loss (required) £’000 Available for sale £’000 – – – – 192,755 162,898 – – – – – – – – – 8,872 – – Other assets Total financial assets Amounts due to banks Customers’ accounts Derivatives held for risk management Other liabilities Subordinated notes Total financial liabilities 159 3,804,391 192,755 162,898 8,872 – – – – – – – – – – – – – – – – – – – – 17,867 – – Fair value hedges £’000 Liabilities at amortised cost £’000 – – – – – – – – Total £’000 192,844 237,544 355,653 8,872 – – – – – 3,373,844 – 159 – 4,168,916 385,951 385,951 – 3,464,018 3,464,018 – – – – 10,304 35,571 17,867 10,304 35,571 17,867 – 3,895,844 3,913,711 The following table summarises the carrying amounts and fair values of those financial assets and liabilities not presented in the statement of financial position at fair value: Cash and balances at central banks Loans and advances to banks Loans and advances to customers Other assets Total financial assets Amounts due to banks Customers’ accounts Other liabilities Debt securities in issue Subordinated notes Total financial liabilities 2014 2013 Carrying value £’000 Fair value £’000 Carrying value £’000 Fair value £’000 79,567 79,567 192,844 192,844 117,401 117,401 237,544 237,544 4,801,064 4,807,766 3,373,844 3,351,249 1,298 1,298 159 159 4,999,330 5,006,032 3,804,391 3,781,796 305,907 305,907 385,951 385,951 4,458,962 4,469,413 3,464,018 3,473,176 14,778 14,778 10,304 10,304 279,143 281,281 – – 36,758 47,930 35,571 44,219 5,095,548 5,119,309 3,895,844 3,913,650 Key considerations in the calculation of the disclosed fair values for those financial assets carried at amortised cost include the following: Cash and balances at central banks These represent amounts with an initial maturity of less than three months and as such their carrying value is considered a reasonable approximation of their fair value. Loans and advances to banks These represent either amounts with an initial maturity of less than three months or longer term variable rate deposits placed with banks, where adjustments to fair value in respect of the credit risk of the counterparty are not considered necessary. Accordingly the carrying value of the assets is considered to be not materially different from their fair value. Loans and advances to customers For fixed rate lending products the Group has estimated the fair value of the fixed rate interest cash flows by discounting those cash flows by the current appropriate market reference rate used for pricing equivalent product plus the credit spread attributable to the borrower. For standard variable rate lending products, and fixed rate products when they revert to the Group’s standard variable rate, the interest rate on such products is considered equivalent to a current market product rate and as such the Group considers the discounted future cash flows of these mortgages to be equal to their carrying value. The fair value estimations do not incorporate adjustments for future credit risk, however, incurred loss provisions are deducted from the fair value amounts. 95 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 40. Financial instruments and fair values continued Other assets and liabilities These represent short term receivables and payables and as such their carrying value is not considered to be materially different from their fair value. Amounts due to banks These mainly represent securities sold under agreements to repurchase which were drawn down from the Bank of England under the terms of the Funding for Lending Scheme. These transactions are collateralised by UK Government Treasury Bills, which have a low susceptibility to credit risk, so adjustments to fair value in respect of the credit risk of the counterparty are not considered necessary. Accordingly the carrying value of the liabilities are considered to be not materially different from their fair value. Customers’ accounts The fair value of fixed rate customers’ accounts have been determined by discounting estimated future cash flows based on market interest rates on equivalent deposits. Customers’ accounts at variable rates are at current market rates and therefore the Group regards the fair value to be equal to the carrying value. The estimated fair value of deposits with no stated maturity is the amount repayable on demand. Debt securities in issue Where securities are actively traded in a recognised market, with readily available and quoted prices, these have been used to value the securities. These securities are therefore regarded as having Level 1 fair values. Subordinated notes The estimated fair value of the subordinated notes is based on discounted cash flows using interest rates for similar liabilities with the same remaining maturity, credit ranking and rating. The calculated fair value takes no account of the warrants issued separately to the holders of the subordinated notes, which have been separately accounted for as a capital contribution within equity (see Note 34). The following table provides an analysis of financial assets and liabilities held on the consolidated statement of financial position at fair value, grouped into Levels 1 to 3 based on the degree to which the fair value is observable: 31 December 2014 Financial assets: Derivatives held for risk management Debt securities: Asset backed securities UK Gilts and Supranational bonds Corporate bonds Financial liabilities: Derivatives held for risk management Level 1 £’000 Level 2 £’000 Level 3 £’000 Total £’000 – – 468,840 24,516 493,356 8,168 16,328 – – 24,496 – – 54,198 54,198 – – – – – – – 8,168 16,328 468,840 24,516 517,852 54,198 54,198 Level 1: Fair value determined using quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2: Fair value determined using directly or indirectly observable inputs other than unadjusted quoted prices included within Level 1 that are observable. Level 3: Fair value determined using one or more significant inputs that are not based on observable market data. 31 December 2013 Financial assets: Derivatives held for risk management Debt securities: Asset backed securities UK Gilts and Supranational bonds Financial liabilities: Derivatives held for risk management 96 Level 1 £’000 – – 277,809 277,809 Level 2 £’000 8,872 77,844 – 86,716 – – 17,867 17,867 Level 3 £’000 – – – – – – Total £’000 8,872 77,844 277,809 364,525 17,867 17,867 Aldermore Group PLC Annual report and accounts 2014Financial statementsThe fair values of UK Gilts and Supranational bonds are based on quoted bid prices in active markets. The fair values of asset backed securities are based on prices provided by third party pricing services, but before relying on these prices, the Group has obtained an understanding of how the prices were obtained to ensure that each investment is assigned an appropriate classification within the fair value hierarchy. The fair values of derivative assets and liabilities are determined using widely recognised valuation models for determining the fair values of common derivative financial instruments such as interest rate swaps that use only observable market data that require little management judgement and estimation. Credit value and debt value adjustments have not been applied as the derivative assets and liabilities are largely collateralised. Fair value measurement – financial assets and liabilities held at amortised cost All the fair values of financial assets and liabilities carried at amortised cost are considered to be Level 2 valuations which are determined using directly or indirectly observable inputs other than unadjusted quoted prices, except for debt securities in issue which are Level 1 and Loans and advances to customers which are Level 3. Fair value of transferred assets and associated liabilities Securitisation vehicle The beneficial ownership of the loans and advances to customers sold to the securitisation vehicle by the Bank fail the derecognition criteria, and consequently, these loans remain on the balance sheet of the seller. The seller therefore recognises a deemed loan financial liability on its balance sheet and an equivalent deemed loan asset is held on the securitisation vehicle’s balance sheet. The deemed loans are repaid as and when principal repayments are made by customers against these transferred loans and advances. The securitisation vehicle has issued fixed and floating rate notes which are secured on loans and advances to customers. The notes are redeemable in part from time to time, such redemptions being limited to the net capital received from mortgagors in respect of the underlying assets. The Group retains substantially all of the risks and rewards of ownership. The Group benefits to the extent to which surplus income generated by the transferred mortgage portfolios exceeds the administration costs of these mortgages. The Group continues to bear the credit risk of these mortgage assets. The results of the securitisation vehicle listed in Note 23 is consolidated into the results of the Group. The table below shows the carrying value and fair value of the assets transferred to the securitisation vehicle and its associated liabilities. The carrying value presented below is the carrying amount recorded in the books of the subsidiary company, some of these notes are held internally by the Group and as such are not shown in the consolidated statement of financial position of the Group. 31 December 2014 Oak No. 1 PLC Carrying amount of transferred assets not derecognised £’000 Carrying amount of associated liabilities £’000 Fair value of transferred assets not derecognised £’000 Fair value of associated liabilities £’000 Net position £’000 293,110 279,143 295,526 281,281 14,245 In addition to the transferred assets not derecognised, the Group held within Oak No. 1 PLC Loans and advances to banks amounting to £18.4 million. This represents amounts of interest and principal already collected from the transferred mortgage portfolios which will be required to be distributed to the note holders of Oak No. 1 PLC on the next quarterly repayment date in 2015. 41. Risk management A key component of the Group’s business strategy is the effective management of risk in order to ensure that the Group maintains sufficient capital, liquidity and controls at all times, and acts in a reputable way, taking into account the interests of customers, regulators and shareholders. Given the nature of the activities undertaken, the principal risks that the Group faces are strategic risk, credit risk, capital risk, liquidity risk, interest rate risk, market risk, operational risk and conduct risk. The Group has not defined regulatory risk as a single category of risk, owing to the broad nature of regulation. Prudential regulatory risks are covered as part of capital risk, liquidity risk and operational risk. Conduct regulatory risks are covered under conduct risk. The Group’s Risk Management Framework, policies and procedures are subject to ongoing improvement, and are regularly reviewed and updated to ensure that they accurately identify the risks that the Group faces in its business activities. In addition, the Group continues to invest in and develop its risk management systems and resources to ensure that the risk management function, governance and infrastructure are appropriate for the nature, scale and complexity of the business, which has and continues to experience growth. All these risks arise as a result of the Group’s normal operations. The Group does not enter into transactions for speculative purposes. The Group uses derivatives such as interest rate swaps to manage interest rate and other market risks. 97 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued The risk management structure has developed over the current and comparative period presented. In prior periods, the governance structure operated primarily at an Aldermore Bank PLC level. Whilst it has continued to operate at the Aldermore Bank PLC level during the year ended 31 December 2014, the intention is for the structure to operate equally at the Aldermore Group PLC and Aldermore Bank PLC level. The following sections describe the Risk Management Framework and committee structure in operation at 31 December 2014. A review of the governance structure at an Executive Committee level was performed in December 2014. A number of changes were made which became effective from 1 January 2015. Details of the revised structure are provided within the Corporate Governance section on page 45. Further details regarding the Group’s capital management are provided in Note 42. a) Risk Management Framework A core objective for the Group is the effective management of risk. The responsibility for identifying and managing the principal risks ultimately rests with the Group’s Board of Directors. The Board has ultimate responsibility for setting the Group’s strategy, risk appetite and control framework. The Risk Management Framework is outlined below, indicating the relevant governance and control structure for each principal risk. i) Principal risks The principal risks faced by the Group are listed below: • strategic risk – the risks which can affect the Group’s ability to achieve its corporate and strategic objectives; • credit risk – the risk of financial loss arising from a borrower or counterparty failing to meet their financial obligations to the Group in accordance with agreed terms; • capital risk – the risk that the Group has insufficient capital to cover regulatory requirements and growth plans; • liquidity risk – the risk that the Group is not able to meet its financial obligations as they fall due, or can do so only at excessive cost; • interest rate risk – the risk of financial loss through un-hedged or mismatched asset and liability positions sensitive to changes in interest rates; • market risk – the financial impact from movements in market prices on the value of assets and liabilities; • operational risk – the risk of financial loss and/or reputation damage resulting from inadequate or failed internal processes, people and systems or from external events including financial crime; and • conduct risk – the risk of detriment caused to the Groups’ customers due to the inappropriate execution of its business activities and processes. The Risk Management Framework is designed to ensure that each risk is managed, monitored and overseen through a dedicated risk-individual committee. Each risk has a defined risk appetite which is controlled through documented policies and frequent reporting, and is overseen by a governance process. The Group’s Risk Management Framework is outlined below, indicating the relevant governance and control structure for each principal risk. The Risk Management Framework includes the following components: • policy and control documents – the overarching document which sets out the overall appetite and how each principal risk is managed; • risk reporting – the primary reporting document relating to the risk; • stress testing – the primary means to understand how the risk area behaves under stressed conditions, and the implication for capital and liquidity resources; and • monitoring committees – the principal committee responsible for monitoring risk is the Risk Committee. This is supported by further oversight by the Group Risk function, executive committees, other Board level governance committees and internal audit. To support the Risk Management Framework, the Group operates a ‘three lines of defence’ model: • the first line of defence comes through operational management, who manage risk by operating within approved policies and implementing and maintaining appropriate systems and controls that are effective on a daily basis. • the second line of defence comprises governance and oversight. Governance and oversight include the monitoring committees and the Group Risk function. These functions cover all principal risk areas, such as credit risk, interest rate risk, operational risk and liquidity risk. The committee structure is covered in more detail below. • the third line of defence is independent assurance checking. This is provided by the Internal Audit function. Assurance reporting is provided to the Audit Committee. 98 Aldermore Group PLC Annual report and accounts 2014Financial statementsii) Control framework The control framework operates over each principal risk as described below: ‘ALCO’ is the Asset and Liability Committee. Escalation procedures exist which seek to ensure that issues are reported and addressed at the right level. Business model risk Group risk oversight Prudential risks Conduct risks Principal risk Strategic risk Credit risk Capital risk Liquidity risk Market & interest rate risk Operational risk Conduct risk Control documents Risk reporting Business plan (strategic objectives/ financial forecast) Strategic risk register & financial reporting Stress testing Strategic risk stress- testing pack (also ICAAP) Credit policy ICAAP ILAA & liquidity policy Interest rate policy Operational risk policy and key risk registers Conduct risk policy Credit pack ALCO & capital forecast ALCO & treasury forecast ALCO & treasury forecast OPCO & operational risk reporting Conduct risk reporting ICAAP ICAAP ILAA ICAAP ICAAP ICAAP Second line monitoring committee ExCo (report to Board) Management Credit Committee (report to ExCo) ALCO (report to ExCo) ALCO (report to ExCo) ALCO (report to ExCo) Operating Committee (report to ExCo) Product Committees (report to ALCO/ ExCo) Additional oversight Board / ExCo / Internal audit oversight A detailed analysis of all key risks has been considered as part of the capital adequacy assessment and is documented in the Internal Capital Adequacy Assessment Process (‘ICAAP’) report, which is approved by the Board. Liquidity risk is individually assessed through the Individual Liquidity Adequacy Assessment (‘ILAA’), also approved by the Board. Operational risk is managed through the Operational Risk Policy and Key Risks Registers. 99 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued a) Risk Management Framework continued iii) Risk oversight, monitoring and reporting The Group has a Chief Risk Officer (‘CRO’) who is responsible for ensuring each risk is adequately monitored, managed and mitigated. Through the Group Risk function, the CRO is responsible for providing assurance to the Board and the Directors that the principal risks are adequately managed and that the Group is operating within its risk appetites. The below diagram presents the functional focus of the risk department: Chief Risk Officer Prudential risk management Credit risk management Operational risk management Compliance Financial crime Prudential risk management covers liquidity, market and capital risk. Strategic risk is managed collectively by the Board and the Executive Committee. Group Risk is an independent risk management function, and is separate from the operational and sales side of the Group. Group Risk is responsible for ensuring that appropriate risk management processes, techniques and controls are in place, and that they are sufficiently robust. The Group Risk function provides periodic independent reports on risk positions, risk management and performance against the risk appetite statements for all principal risks faced by the Group. Risk reports are provided to the Operating Committee, Executive Committee, Risk Committee, Audit Committee and Board. The reporting and oversight process is designed to ensure the committees which form the governance structure are informed and aware of the principal risks and that there are adequate controls in place for these risks. Reports are produced on each principal risk and the frequency ranges from daily to monthly, according to what is appropriate for the risk. 100 Aldermore Group PLC Annual report and accounts 2014Financial statementsiv) Committee structure The responsibility for managing the principal risks ultimately rests with the Group’s Board of Directors. The Group’s committee structure with regard to risk management is outlined below. This structure was in existence as at 31 December 2014. A review of the governance structure at an Executive Committee level was performed in December 2014. A number of changes were made which became effective from 1 January 2015. Details of the revised structure are provided within the Corporate Governance section on page 45. The Board Risk Committee* Audit Committee* Remuneration Committee* Nomination Committee* Chief Executive Officer Executive Committee** Operating Committee** Management Credit Committee** Asset and Liability Committee** Mortgages Divisional Board*** Commercial Finance Board*** Savings Board*** Asset and Liability Product and Pricing Committee** * Non-Executive oversight ** Executive/Second line oversight *** First Line 101 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued a) Risk Management Framework continued Set out below are the details of the Board and principal committees which enable high level controls to be exercised over the Group’s activities. The frequency of meetings is detailed below, although these committees will meet more frequently as circumstances require. The details provided below represent the operation of each committee as at 31 December 2014. In the prior period, the risk management structure operated primarily at an Aldermore Bank PLC level. Whilst it has continued to operate at the Aldermore Bank PLC level during the year ended 31 December 2014, the intention is for the structure to operate equally at the Aldermore Group PLC and Aldermore Bank PLC level. Committee The Board Audit Committee Risk Committee Risk focus The Board is the primary governing body and has ultimate responsibility for setting the Group’s strategy, corporate objectives and risk appetite. The strategy and risk appetites take into consideration the interests of depositors, borrowers and shareholders. The Board defines and approves the level of risk which the Group is willing to accept and is responsible for maintaining a sufficient control environment to manage the principal risks. The Board is also responsible for ensuring the capital and liquidity resources are adequate to achieve the Group’s objectives without taking undue risk. The Board also maintains a close oversight of current and future activities, through a combination of monthly board reports including financial results, operational reports, budgets and forecasts and reviews of the main risks set out in the ICAAP and ILAA reports. During 2014, the Audit and Risk Committee separated into two separate committees. The Audit Committee is responsible for reviewing the Group’s internal control environment and monitors the financial integrity of the financial statements, and involves internal and external auditors in that process. It focuses in particular on compliance with accounting policies and ensuring that an effective system of internal financial control is maintained. During 2014, the Audit and Risk Committee separated into two separate committees. The Board has delegated responsibility for oversight of the Group’s principal risks to the Risk Committee, which includes reviewing the performance against risk appetites and the effectiveness of the Group’s internal controls and risk management processes. This committee oversees the development, implementation and maintenance of the Group’s Risk Management Framework, ensuring that its strategy, principles, policies and resources are aligned to the Group’s risk appetite, as well as to regulatory and industry best practices. Remuneration Committee The Remuneration Committee reviews remuneration matters, employee benefits and performance related pay structures for the Group. It is also responsible for considering and determining the Group’s remuneration policy and reviewing its adequacy and effectiveness. Nomination Committee The Nomination Committee reviews the structure and composition of the Board, succession planning and material appointments, in particular Board appointments. Executive Committee The Executive Committee takes day-to-day responsibility for the running of the business. The Executive Committee implements the strategy and financial plan which is approved at the Board and ensures the performance of the business is conducted in accordance with the Board’s instructions. The Executive Committee interacts with the Board via the CEO. Management Credit Committee This committee meets monthly and is responsible for monitoring portfolio performance to ensure it remains within the Bank’s credit risk appetite and reviewing and maintaining credit and lending policies. Detailed credit reports are produced covering each specific business line. These reports are reviewed by the Management Credit Committee and Group Risk. The credit packs report on the quality of new lending, credit performance, arrears and non-performing loans and also provides detail on the composition of the credit portfolios. Asset & Liability Committee (‘ALCO’) The Executive Committee has delegated responsibility for managing the Group’s exposure to capital, liquidity, interest rate and market risk to the ALCO. The ALCO meets monthly and ensures that the firm adheres to the market risk, interest rate risk and liquidity policies and objectives set down by the Board. It also has responsibility for ensuring that the policies that are implemented are adequate to meet prudential and regulatory targets. The committee is also responsible for the effective management of the Group’s assets and liabilities and the impact on capital and liquidity of future business activity and management actions. 102 Aldermore Group PLC Annual report and accounts 2014Financial statementsOperating Committee (‘OPCO’) The Operating Committee reviews IT, operational and compliance matters to ensure appropriate systems and controls exist which are able to support the needs of the Group including any projects and change programmes. The committee monitors operational risk, including regulatory, compliance and conduct risk, implements the operational risk management policy and reviews operational performance, including key risk indicator reports. Asset and Liability: Product and Pricing Committee The committee meets monthly to review, approve and set the pricing for new products proposals, and reviews product performance as well as on-going pricing initiatives and strategic directions on product launch. The committee is also responsible for the effective oversight of the Group’s conduct risk processes for new products. Divisional Boards (Mortgages, Commercial Finance and Savings) The Divisional Boards meet on a monthly basis and provide a forum for open discussion and decisions on key issues affecting the relevant business segment. Specific responsibilities include the delivery of strategic objectives, budget formulation and financial delivery, recruitment, training, implementing and maintaining effective controls, product review and performance and management of conduct risk. v) Risk appetite The Risk Management Framework is the means through which risks are identified, assessed, reported and monitored. The Group has set a defined risk appetite for each of the principal risks and performance against the risk appetite statements is monitored and reported on a regular basis. The risk appetites are set by the Board and implemented by the Executive Committee. The Group Risk function is responsible for ensuring the Group operates within the stated risk appetites. The risk appetite framework has the following components: • risk appetite statement: the articulation of the level and types of risk that the Group is willing to accept in order to achieve its business objectives; • risk capacity: the maximum level of risk the Group can assume before breaching constraints determined by regulatory capital and liquidity needs; • risk limits: quantitative measures that allocate the Group’s aggregate risk appetite statement to individual activities. Where possible this includes forward looking measures; and • risk profile: the point in time assessment of the Group’s net risk exposure. The following section provides details of the Group’s risk appetite for each of the principal risks: Strategic risk appetite The strategic risk appetite is measured in terms of the deviation against key performance indicators which form part of the Group’s business plan. Performance against the strategic risk appetite is measured every quarter and reported to the Risk Committee. Credit risk appetite The Group operates a business line individual credit risk appetite, as well as an overall credit risk appetite for its lending activities. Expected losses are factored into the budgeting and forecast process and reflect the Group’s expected view of lending performance, taking into account recent performance data and the prevailing economic environment. The Group recognises that actual losses may differ from forecasted or budgeted values. The credit risk appetites are set as an upper limit on losses from credit and credit related fraud and so this limit is set above the budgeted value for each business. Capital risk appetite Capital Risk is the risk that the Group has insufficient capital to cover regulatory requirements and/or growth plans. The Group maintains sufficient capital to cover regulatory requirements, including any capital planning buffers, and maintains a management capital buffer. Liquidity risk appetite The Board has set a liquidity risk appetite which aims to ensure that a prudent level of liquidity is held to cover an unexpected liquidity outflow such that the Group will be able to meet its financial commitments during an extended period of stress. Additionally, reputational risks are kept low through honouring pipeline commitments expected to complete during a three month period. 103 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued a) Risk Management Framework continued Market and interest rate risk appetite The Group aims to minimise interest rate risk and has a policy of matching fixed or variable rate assets with liabilities of a comparable interest rate basis, supplemented by derivatives such as interest rate swaps. The Group does not seek to take or expose itself to market risk, and does not carry out proprietary trading, although certain liquid asset investments which form part of the liquid asset buffer carry mark to market risk which is regularly monitored. Operational risk appetite The Group aims to maintain operational systems and controls and seeks to operate within a defined level of operational risk. The operational risk appetite considers risk events, the assessment of internal controls, as well as holding additional capital for certain operational risks. Conduct risk appetite The Group has a zero appetite for systemic unfair outcomes, which may result in significant detriment to the Group’s customers. Systemic unfair outcomes may arise from poor product design, poor sales processes or unacceptable operational practices which risk repeated or continual outcomes which are detrimental to customers. b) Credit risk i) Overview Credit risk is the risk of financial loss arising from a borrower or counterparty failing to meet their financial obligations to the Group in accordance with agreed terms. This risk arises from the Group’s lending activities as a result of defaulting mortgage, lease and loan contracts and is the most significant risk faced by the Group. Although credit risk arises from the Group’s loan book it can also arise from off balance sheet activities. The Group does not actively trade in financial instruments, other than for liquidity management purposes. Credit risks associated with lending are managed through the use of detailed lending policies which outline the approach to lending, underwriting criteria, credit mandates, concentration limits and product terms. The Group maintains a dynamic approach to credit management and aims to take necessary steps if individual issues are identified or if credit performance deteriorates, or is expected to deteriorate, due to borrower, economic or sector-specific weaknesses. The Group seeks to mitigate credit risk by focusing on business sectors where it has specific expertise and through limiting concentrated exposures on larger loans, certain sectors and other factors which can represent higher risk. The Group also seeks to obtain security cover, and where appropriate, personal guarantees from borrowers. Due to the retail and SME markets the Group operates in, external rating agency ratings for borrowers are not typically available. However, credit risk is assessed through applying a combination of due diligence, reviewing credit reference agency reports, reviewing financial information, credit scores and the use of underwriters. Group Risk, the Management Credit Committee and Risk Committee have oversight responsibility for credit risk. ii) Credit exposure Maximum exposure to credit risk The following table presents the Group’s maximum exposure to credit risk of financial instruments on the balance sheet and commitments to lend before taking into account any collateral held or other credit. The maximum exposure to credit risk for loans, debt securities, derivatives and other on balance sheet financial instruments is the carrying amount and for loan commitments the full amount of any commitment to lend that is irrevocable or is revocable only in response to material adverse change. Included in the statement of financial position: Cash and balances at central banks Loans and advances to banks Debt securities Derivatives held for risk management Loans and advances to customers Other assets Commitments to lend Gross credit risk exposure Less: allowance for impairment losses Net credit risk exposure 104 Note 38 20 2014 £’000 79,567 117,401 509,684 8,168 2013 £’000 192,844 237,544 355,653 8,872 4,823,638 3,394,872 1,298 159 5,539,756 4,189,944 404,593 343,652 5,944,349 4,533,596 (22,574) (21,028) 5,921,775 4,512,568 Aldermore Group PLC Annual report and accounts 2014Financial statementsiii) Credit risk management Credit risk – lending The Group targets SME and mortgage customers. Credit risk is managed in accordance with lending policies, the risk appetite and the Risk Management Framework. Lending policies and performance against risk appetites are reviewed regularly. This section provides further detail on the specific areas where the Group is exposed to credit risk. Residential Mortgages The Group’s residential mortgage lending focuses on owner occupied residential and buy-to-let mortgage loans. All applications are reviewed by an experienced team of underwriters who assess each application. Applications are underwritten in accordance with a residential mortgage lending policy and each loan has to undergo an affordability assessment, which takes into account the specific circumstances of each borrower. Information is obtained on all loan applications from credit reference agencies which provide a detailed insight on the applicant’s credit history and indebtedness, which is reviewed by the underwriters. The Group aims to take a conservative approach to lending, lending up to a maximum of 85 per cent loan-to-value (‘LTV’) on a single dwelling without further guarantees and undertakes a full valuation on all properties which act as security. Valuation reports are produced by an experienced panel of qualified external valuers. The Group also offers mortgages with a LTV between 85 per cent and 95 per cent via the Help to Buy scheme. This lending has an associated government guarantee which reduces the credit risk to the Group. The Group does offer limited advice to mortgage borrowers but does not sell payment protection insurance policies. SME Commercial Mortgages The Group provides commercial mortgages to businesses who own their own property and to commercial and residential property investors. Loans are typically to SMEs and secured on smaller properties, with limits in place for loans over £1.5 million. A team of experienced underwriters review all applications. Properties are individually valued and a detailed report produced to ensure the property represents suitable security. Consideration is given to whether the property has an alternate use and/or can be disposed of within a reasonable period in the event of default, where the asset acting as security has to be recovered and sold. Valuations are performed by qualified external surveyors. The valuation reports also provide commentary on the tenancy/letting of properties where the commercial mortgages are connected to an investment property transaction. In-house valuation experts approve the panel of qualified external valuers and perform ongoing quality monitoring. Affordability assessments are performed on all loans and other forms of security are often obtained, such as a personal guarantee. Loans to commercial mortgage customers are secured on properties solely located in the UK, although there are various sectors within the UK to which the Group is not currently lending. Concentration risks are monitored and credit exposures are diversified by sector and geography. Regular reviews are performed on loans in the portfolio, with particular attention paid to larger exposures. Property Development The Group has a small portfolio of property development loans, which are predominantly for the purpose of building and developing residential property. Although the UK property sector has shown signs of recovery, the Group continues to be cautious about property development financing. The Group has maintained a conservative approach to development lending and developments are regularly inspected by the Group and external quantity surveyors. Invoice Finance The invoice financing activity provides working capital finance for SME clients. This activity may also include credit control and collection services for clients. The approval process includes a review of the management, financial and operational strength of the client’s business and careful consideration is given to the quality and contractual collectability of the underlying receivables which act as security. Information on the business and the individuals behind the business are reviewed and financial and credit information is obtained from external credit reference agencies. During the term of the facility, in-life monitoring, audits and reconciliations are performed to ensure the risk of fraud and default risks associated with client failure are carefully managed. There is significant diversification at the invoice level which heavily mitigates concentration risk. 105 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued b) Credit risk continued Asset Finance The asset finance business line originates loan and lease contracts to a diversified range of end users and finances a range of assets. Exposures range from public sector organisations to corporates, SMEs and sole traders. Asset finance and leasing to smaller businesses can represent a higher risk, although the majority of contracts will have tangible assets acting as security which can be recovered and sold in the event of default. Expert manual underwriting, supported by data driven by risk management systems and automated decision making is used to underwrite credit proposals. Information on the business and the individuals behind the business are carefully reviewed and financial and credit information is obtained from external credit reference agencies. Assets which act as security are valued and the future resale value of assets is also considered where appropriate. Audits and site visits are used to ensure the Group maintains an awareness of the location, use and condition of assets being financed where considered necessary. At the balance sheet date the Group has nominal direct residual value risk. Impaired and past due loans The table below provides information on the payment due status of loans and advances to customers: Details of the methodologies and estimates used to determine the allowances for loan impairments are provided in Note 3. Residential Mortgages £’000 SME Commercial Mortgages £’000 Asset Finance £’000 Invoice Finance £’000 Total £’000 2014 Neither past due nor individually impaired 2,542,738 994,410 1,039,692 183,324 4,760,164 Past due but not individually impaired Individually impaired 2013 19,405 6,003 16,061 6,292 7,167 2,614 – 5,932 42,633 20,841 2,568,146 1,016,763 1,049,473 189,256 4,823,638 Neither past due nor individually impaired 1,654,324 752,387 715,971 213,749 3,336,431 Past due but not individually impaired Individually impaired 23,715 3,634 4,733 9,979 5,228 3,238 – 7,914 33,676 24,765 1,681,673 767,099 724,437 221,663 3,394,872 Past due but not individually impaired loans are further analysed as follows: Past due but not individually impaired – Up to 2 months past due – 2 to 3 months past due Total Impairment coverage is analysed as follows: Coverage ratio Gross Loans and advances Of which individually impaired Impaired as a % of gross loans and advances Allowance for losses – individual provisions Coverage 106 2014 £’000 29,989 12,644 42,633 2013 £’000 27,318 6,358 33,676 2014 £’000 2013 £’000 4,823,638 3,394,872 20,841 0.43% 14,047 24,765 0.73% 14,714 67.40% 59.41% Aldermore Group PLC Annual report and accounts 2014Financial statementsThe credit quality of assets that are neither past due nor individually impaired are internally analysed as follows: 2014 Low risk Medium risk High risk Total Residential Mortgages SME Commercial Mortgages Residential £’000 Buy-to-Let £’000 Total £’000 Commercial £’000 Buy-to-Let £’000 Total £’000 Asset Finance Total £’000 585,826 1,380,644 1,966,470 257,375 369,693 627,068 59,262 Invoice Finance Total £’000 – 341,771 172,479 514,250 113,865 105,938 219,803 839,553 6,502 38,040 23,978 62,018 103,308 44,231 147,539 140,877 176,822 965,637 1,577,101 2,542,738 474,548 519,862 994,410 1,039,692 183,324 Fair value of collateral held 965,559 1,576,914 2,542,473 474,548 519,862 994,410 738,390 181,752 2013 Low risk Medium risk High risk Total Residential Mortgages SME Commercial Mortgages Residential £’000 Buy-to-Let £’000 Total £’000 Commercial £’000 Buy-to-Let £’000 Total £’000 Asset Finance Total £’000 392,637 965,253 1,357,890 171,859 268,893 440,752 32,160 Invoice Finance Total £’000 – 115,445 151,279 266,724 12,400 17,310 29,710 86,927 80,199 87,856 56,653 174,783 579,290 7,388 136,852 104,521 206,361 520,482 1,133,842 1,654,324 338,985 413,402 752,387 715,971 213,749 Fair value of collateral held 520,127 1,132,891 1,653,018 338,985 413,402 752,387 509,456 206,342 The above categorisation is based on internal grading models. Low medium high grading methodology: The grading models are used to generate a consistent Group-wide approach for the grading of customer credit risk exposures for all lending businesses, and provide a relative internal ranking of risk. Drivers for the grade mapping include external credit reference agency risk scores, property valuations and qualitative factors. The relative measure of risk reflects a combined assessment of the Probability of Default (‘PD’) by the customer and an assessment of the expected loss in the event of default. The probability of default refers to the probability of a customer or counterparty defaulting, which is typically taken as three payments past due, within the next 12 months. A default probability model predicts this probability by using credit scores along with financial, behavioural and qualitative inputs. The main drivers of loss in the event of default i.e. Loss Given Default (‘LGD’) are the propensity to ‘cure’, that is for an account to be restored to a performing status, and the level of security held in relation to the credit exposure. The level of security varies, ranging from a small number of very short term unsecured loans in the Asset Finance business, to highly secured loans on residential property within the Residential Mortgage business. The valuation method for assets is specific to the nature of the collateral and includes indexation for property valuations. The resulting classification of balances between Low, Medium and High is consequently driven by a combination of the probability of default and loss given default grades explained above. A matrix of fifteen PD and ten LGD grades determine the category within which each loan is categorised. Fair value of collateral methodology: For Residential and Commercial Mortgages agreements, the fair value of underlying collateral is calculated based on the indexed valuation of the property on which the mortgage is secured. Where the balance outstanding is greater than the indexed valuation, the fair value of the collateral is capped to the value of the outstanding balance. For Asset Finance agreements, the estimated fair value of the collateral is calculated by applying LGDs on a case by case basis. The LGD against each loan is deducted from the balance outstanding to derive a proxy for fair value. As the fair value is derived using LGDs, the fair value calculated includes an element of prudence as the LGD is based on non-performing loan data. Only a small proportion of neither past due nor impaired assets will ultimately default. 107 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued b) Credit risk continued Individually impaired balances are further analysed as follows: 2014 Impaired status: Past due 3 – 6 months Past due 6 – 12 months Past due over 12 months Of which: Possessions 2013 Impaired status: Past due 3 – 6 months Past due 6 – 12 months Past due over 12 months Of which: Possessions Residential Mortgages SME Commercial Mortgages Residential £’000 Buy-to-Let £’000 Total £’000 Commercial £’000 Buy-to-Let £’000 Total £’000 1,709 186 1,407 3,302 1,376 1,688 737 276 2,701 3,397 923 1,683 6,003 436 2,891 2,543 5,870 – 1,376 – 74 – 348 422 – 510 2,891 2,891 6,292 Residential Mortgages SME Commercial Mortgages Residential £’000 Buy-to-Let £’000 Total £’000 Commercial £’000 Buy-to-Let £’000 Total £’000 2,479 482 – 2,961 – 279 284 110 673 – 2,758 766 110 3,634 122 1,104 3,382 4,608 2,295 153 2,923 5,371 2,417 1,257 6,305 9,979 – 1,363 – Asset Finance Total £’000 1,837 370 407 2,614 Invoice Finance Total £’000 – 3,225 2,707 5,932 Asset Finance Total £’000 1,424 654 1,160 3,238 Invoice Finance Total £’000 – 4,727 3,187 7,914 – 2,176 – 2,176 280 – Residential Mortgages £’000 SME Commercial Mortgages £’000 3,634 4,090 (1,147) (59) (515) 6,003 9,979 1,828 (581) (336) (4,598) 6,292 Residential Mortgages £’000 SME Commercial Mortgages £’000 1,398 3,370 (597) (94) (443) 3,634 9,184 7,098 (2,828) (925) (2,550) 9,979 Asset Finance £’000 3,238 3,517 (630) (2,190) (1,321) 2,614 Asset Finance £’000 3,992 1,226 (441) (767) (772) 3,238 Invoice Finance £’000 7,914 4,171 – (4,246) (1,907) 5,932 Invoice Finance £’000 3,591 4,505 – (65) (117) 7,914 Movement in impaired loans is analysed as follows: 2014 At 1 January Classified as impaired during the year Transferred from impaired to unimpaired Amounts written off Repayments At 31 December 2013 At 1 January Classified as impaired during the year Transferred from impaired to unimpaired Amounts written off Repayments At 31 December 108 Aldermore Group PLC Annual report and accounts 2014Financial statementsCollateral held and other enhancements The principal indicators used to assess the credit security of performing loans are loan-to-value ratios for commercial and retail mortgages. Loan-to-collateral value on indexed origination information on the Group’s residential mortgage portfolio is set out below: Residential Mortgages 100%+ 95 – 100% 90 – 95% 85 – 90% 80 – 85% 75 – 80% 70 – 75% 60 – 70% 50 – 60% 0 – 50% Capital repayment Interest only Average Loan to Value percentage – all residential mortgages Average Loan to Value percentage – buy-to-let residential mortgages 2014 £’000 9,167 82,454 151,447 82,427 117,888 219,839 370,024 770,682 450,194 310,777 2013 £’000 39,122 26,378 23,775 20,103 62,875 225,890 421,991 486,067 211,533 161,952 2,564,899 1,679,686 898,008 425,316 1,666,891 1,254,370 2,564,899 1,679,686 66.84% 64.18% 66.80% 68.19% Residential Mortgages at a Loan to Value of 90% and above have increased as a result of the Group’s participation in the Help to Buy Scheme. SME Commercial Mortgages Loan-to-collateral value on indexed origination information on the Group’s commercial mortgage portfolio is set out below: 100%+ 95 – 100% 90 – 95% 85 – 90% 80 – 85% 75 – 80% 70 – 75% 60 – 70% 50 – 60% 0 – 50% Capital repayment Interest only Average Loan to Value percentage – all commercial mortgages Average Loan to Value percentage – buy-to-let 2013 comparatives have been re-presented with a revised split between the LTV bandings. 2014 £’000 – – – 209 2,113 26,522 73,065 204,627 252,420 452,335 2013 £’000 – – – 566 812 21,515 42,474 215,914 264,764 215,953 1,011,291 761,998 478,760 532,531 380,760 381,238 1,011,291 761,998 52.23% 55.73% 56.82% 60.72% 109 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued b) Credit risk continued Invoice Finance In respect of invoice finance, collateral is provided by the underlying receivables (e.g. trade invoices). As at 31 December 2014, the average advance rate against the fair value of sales ledger balances which have been assigned to the Group, net of amounts considered to be irrecoverable, is 68.04 per cent (31 December 2013: 69.34 per cent). In addition to the value of the underlying sales ledger balances, the Group will, wherever possible, obtain additional security before offering invoice finance facilities to a client. These include limited personal guarantees from major shareholders, charges over personal and other business property, cross guarantees from associated companies and unlimited warranties in the case of frauds. These additional forms of security are impracticable to value given their nature. Asset Finance In respect of asset finance, collateral is provided by the Group’s rights and/or title to the underlying leased assets, which the Group is able to repossess in the event of default. Where appropriate, the Group will also obtain additional security, such as parent company or personal guarantees. Asset finance also undertakes a small volume of unsecured lending where it has obtained an understanding of the ability of the borrower’s business to generate cash flows to service and repay the facilities provided. As at 31 December 2014 the total amount of such unsecured lending was £17.4 million. Concentration of credit risk The Group monitors concentration of credit risk by product type, geographic location and sector. Analyses of concentrations are shown below. Details of the Group’s lending by product type are as follows: Finance lease receivables Invoice financing SME Commercial Mortgage loans Residential Mortgage loans Including: Value of buy-to-let residential mortgages Value of buy-to-let commercial mortgages Credit concentration of assets by size analysed as follows: 2014 £’000 1,044,298 180,576 1,011,291 2013 £’000 720,198 211,962 761,998 2,564,899 1,679,686 4,801,064 3,373,844 1,597,255 1,172,213 401,090 411,262 2013 SME Commercial Mortgages £’000 5,857 46,889 52,634 48,419 83,997 56,632 45,989 156,023 157,566 107,992 Asset Finance £’000 291,794 155,957 72,116 44,609 55,074 32,528 18,112 37,122 10,459 2,427 2014 SME Commercial Mortgages £’000 7,117 64,933 69,861 71,650 114,550 80,233 62,991 190,714 181,727 167,515 Residential Mortgages £’000 32,485 548,053 608,382 424,686 479,799 233,269 93,509 132,502 12,214 – Asset Finance £’000 460,409 224,912 108,361 59,135 73,556 36,274 21,644 39,988 12,208 7,811 Residential Mortgages £’000 24,011 390,316 404,716 271,954 283,193 135,404 66,570 98,180 5,342 – 2,564,899 1,011,291 1,044,298 1,679,686 761,998 720,198 £0 – £50k £50 – £100k £100 – £150k £150 – £200k £200 – £300k £300 – £400k £400 – £500k £500k – £1m £1m – £2m £2m+ Total 110 Aldermore Group PLC Annual report and accounts 2014Financial statementsAn analysis of the Group’s geographical concentration is shown in the table below: East Anglia East Midlands Greater London North East North West Northern Ireland Scotland South East South West Wales West Midlands Yorkshire and Humberside An analysis of the Group’s loans and advances to customers by sector is shown in the table below: Agriculture, hunting and forestry Construction Education Electricity, gas and water supply Financial intermediation Health and social work Hotels and restaurants Manufacturing Mining and quarrying Private households with employed persons Public administration and defence; compulsory social security Real estate, renting and business activities Residential Transport, storage and communication Wholesale and retail trade; repair of motor vehicles, motorcycles and personal household goods 2014 % 9.5 6.3 20.9 1.6 11.9 0.1 4.6 19.5 9.9 3.2 8.2 4.3 2013 % 8.8 6.2 19.2 1.9 13.2 0.1 4.3 18.7 9.9 3.3 8.3 6.1 100.0 100.0 2014 % 1.3 3.2 0.1 0.6 1.4 0.2 0.3 4.8 0.2 0.8 0.1 18.7 61.4 3.9 3.0 2013 % 0.9 3.2 – 0.6 1.2 0.3 0.4 5.9 0.2 1.0 0.2 18.5 59.1 4.4 4.1 100.0 100.0 Forbearance On occasion, borrowers experience financial difficulties which impact their ability to meet mortgage or SME finance obligations. Management seeks to identify borrowers who are experiencing financial difficulties as well as contacting borrowers whose loans have gone into arrears, consulting with them in order to ascertain the reason for the difficulties, and to establish the best course of action that can be taken to bring the account up to date. In certain circumstances where the borrower is experiencing significant financial distress, management may use forbearance measures to assist them. These are all considered on a case-by-case basis and must be in the best interest of the customer. The forbearance measures are undertaken in order to achieve the best outcome for both the customer and the Group by dealing with financial difficulties and arrears at an early stage. 111 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued b) Credit risk continued The most widely used methods of forbearance are reduced monthly payments, loan term extension, deferral of payment and a temporary or permanent transfer to interest only payments to reduce the borrower’s financial pressures. Where the arrangement is temporary, borrowers are expected to resume normal payments within six months. Temporary concessions are counted as forborne for three months following the end of the concession. Permanent concessions are counted as forborne for 24 months following the concession. As at 31 December 2014 and as at 31 December 2013, the Group had undertaken forbearance measures as follows in each of its lending divisions: 2014 £’000 2013 £’000 Asset Finance Capitalisation Reduced monthly payments Loan-term extension Deferred payment Total Asset Finance Total forborne as a percentage of the total divisional gross lending book (%) SME Commercial Mortgages Temporary or permanent switch to interest only Total SME Commercial Mortgages Total forborne as a percentage of the total divisional gross lending book (%) Residential Mortgages Temporary or permanent switch to interest only Reduced monthly payments Loan-term extension Deferred payment Total Residential Mortgages Total forborne as a percentage of the total divisional gross lending book (%) Total forborne Total capitalisation Temporary or permanent switch to interest only Total reduced monthly payments Total loan-term extension Total deferred payment Total forborne Total forborne as a percentage of the total gross lending book (%) 21 68 162 1,152 1,403 0.13% 3,741 3,741 0.37% 1,661 1,076 11 624 3,372 0.13% 21 5,402 1,144 173 1,776 8,516 0.18% 953 – 482 1,601 3,036 0.42% 7,152 7,152 0.93% 1,842 – 11 90 1,943 0.12% 953 8,994 - 493 1,691 12,131 0.36% The Group’s total loan balances in forbearance decreased by 30 per cent from £12.1 million as at 31 December 2013 to £8.5 million as at 31 December 2014. 112 Aldermore Group PLC Annual report and accounts 2014Financial statementsAnalysis of forborne accounts is shown in the tables below: 2014 Neither past due nor impaired Past due but not impaired Impaired 2013 Neither past due nor impaired Past due but not impaired Impaired Residential Mortgages £’000 SME Commercial Mortgages £’000 1,438 1,225 709 3,372 Residential Mortgages £’000 1,481 111 351 1,943 2,259 1,482 – 3,741 SME Commercial Mortgages £’000 7,152 – – Asset Finance £’000 1,152 175 76 1,403 Asset Finance £’000 2,076 960 – Total £’000 4,849 2,882 785 8,516 Total £’000 10,709 1,071 351 12,131 7,152 3,036 Credit risk – treasury Credit risk exists with treasury assets where the Group has acquired securities or placed cash deposits with other financial institutions. The credit risk of treasury assets is considered to be relatively low. No assets are held for speculative purposes or actively traded. Certain liquid assets are held as part of the Group’s liquidity buffer. The table below sets out information about the credit quality of financial assets held by treasury: 2014 £’000 2013 £’000 Cash and balances at central banks and Loans and advances to banks – Rated AAA – Rated AA+ to AA- – Rated A+ to A- – Rated BBB+ Debt securities: UK Government Gilts and Treasury Bills and Supranational Bonds – Rated AAA – Rated AA+ to AA- – Rated A+ to A- – Rated BBB+ Debt securities: Asset backed securities – Rated AAA – Rated AA+ to AA- – Rated A+ to A- – Rated BBB+ Derivatives held for risk management purposes – Rated AAA – Rated AA+ to AA- – Rated A+ to A- – Rated BBB+ As at 31 December 2014 and at 31 December 2013 none of the treasury assets were past due or impaired. – 79,555 100,043 17,370 196,968 334,927 158,429 – – 16,328 – – – 509,684 – 689 4,182 3,297 8,168 714,820 – 192,844 237,544 – 430,388 144,794 133,015 – – 68,837 8,609 398 – 355,653 – 651 8,221 – 8,872 794,913 113 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued b) Credit risk continued Cash placements Credit risk of Group and treasury counterparties is controlled through the counterparty placements policy which limits the maximum exposure by entity where the Group can place cash deposits. All institutions need a sufficiently high long term and short term rating at inception. Gilts and Supranational Bonds As part of the liquidity buffer, the Group holds a portfolio of Gilts and Supranational Bonds. These instruments are AAA or AA+ to AA- rated, and typically carry sovereign risk. Asset backed securities The Group has a portfolio of asset backed securities. The majority of these investments are in AAA or AA+ to AA- rated bonds secured on UK originated assets. All investments are in Sterling; no foreign currency bonds were bought. The portfolio has credit enhancement, providing principal protection against losses. Derivatives Credit risk on derivatives is controlled through a policy of only entering into contracts with a small number of UK credit institutions, with a credit rating of at least AA- at inception. Most derivative contracts are collateralised through the receipt/payment of daily cash margin calls to cover the mark to market asset/liability. iv) Offsetting financial assets and liabilities It is the Group’s policy to enter into master netting and margining agreements with all derivative counterparties. In general, under master netting agreements the amounts owed by each counterparty that are due on a single day in respect of all transactions outstanding in the same currency under the agreement are aggregated into a single net amount being payable by one party to the other. In certain circumstances, for example when a credit event such as a default occurs, all outstanding transactions under the agreement are aggregated into a single net amount being payable by one party to the other. In certain circumstances, for example when a credit event such as a default occurs, all outstanding transactions under the agreement are terminated. Under the margining agreements where the Group has a net asset position valued at current market values, in respect of its derivatives with a counterparty, then that counterparty will place collateral, usually cash, with the Group in order to cover the position. Similarly, the Group will place collateral, usually cash, with the counterparty where it has a net liability position. As the Group’s derivatives are under master netting and margining agreements as described above, they do not meet the criteria for offsetting in the statement of financial position. The following tables detail amounts of financial assets and liabilities subject to offsetting, enforceable master netting agreements and similar arrangements including the Funding for Lending Scheme as detailed in Notes 20 and 28. Gross amount of recognised financial instrument offset in the statement of financial position £’000 Net amount of financial instruments presented in the statement of financial position £’000 Gross amount of recognised financial instruments £’000 Related amounts not offset in the statement of financial position Financial instruments £’000 Cash collateral paid /(received) £’000 Net amount £’000 719,900 8,168 728,068 (304,207) (54,198) (358,405) – – – – – – 719,900 (304,207) – 415,693 8,168 (7,068) 728,068 (311,275) (1,100) (1,100) – 415,693 (304,207) 304,207 (54,198) 7,068 (358,405) 311,275 – 46,162 46,162 – (968) (968) 2014 Type of financial instrument Assets Loans and advances to customers (amounts pre-positioned as collateral under the FLS) Derivatives held for risk management Liabilities Amount due to banks – repurchase agreements Derivatives held for risk management 114 Aldermore Group PLC Annual report and accounts 2014Financial statements2013 Type of financial instrument Assets Loans and advances to customers (amounts pre-positioned as collateral under the FLS) Derivatives held for risk management Liabilities Amounts due to banks – repurchase agreements Derivatives held for risk management Gross amount of recognised financial instrument offset in the statement of financial position £’000 Net amount of financial instruments presented in the statement of financial position £’000 Gross amount of recognised financial instruments £’000 Related amounts not offset in the statement of financial position Financial instruments £’000 Cash collateral paid /(received) £’000 Net amount £’000 822,900 8,872 831,772 (383,071) (17,867) (400,938) – – – – – – 822,900 (383,071) – 439,829 8,872 (6,163) 831,772 (389,234) (1,675) (1,675) 1,034 440,863 (383,071) 383,071 (17,867) 6,163 (400,938) 389,234 – 11,350 11,350 – (354) (354) c) Liquidity risk Liquidity risk is the risk that the Group is not able to meet its financial obligations as they fall due, or can do so only at excessive cost. To protect the Group and its depositors against liquidity risks, the Group maintains a liquidity buffer which is based on the Group’s liquidity needs under stressed conditions. The liquidity buffer is monitored on a weekly basis to ensure there are sufficient liquid assets at all times to cover cash flow movements and fluctuations in funding and to enable the Group to meet all financial obligations and to support anticipated asset growth. Through the ILAA process, the Group has assessed the level of liquidity necessary to prudently cover systemic and idiosyncratic risks and the ILAA process determines the appropriate liquidity buffer, taking into account the specific nature of the deposit base. The ILAA requires the Group to consider all material liquidity risks in detail and the ILAA has documented the Group’s analysis of each key liquidity risk driver and set a liquidity risk appetite against each of these drivers. Liquidity risks are specifically considered by the ALCO each month. Based on the business model of funding primarily via retail and SME deposits, the Board has set a liquidity risk appetite which it considers to be appropriate to provide it with the assurance that the relevant liquidity risk drivers should be considered and appropriately stressed and that the Group is able to meet liabilities beyond the targeted survival period. The components of the Group’s liquidity buffer were as follows: Bank of England reserve account and unencumbered cash and bank balances UK Gilts and Treasury Bills and Supranational Bonds Treasury Bills held under the FLS scheme Covered Bonds Total liquidity buffer As a % of funding liabilities 2014 £’000 104,216 486,225 179,608 4,005 2013 £’000 390,369 275,817 99,784 – 774,054 765,970 14.87% 19.56% 115 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued c) Liquidity risk continued Encumbered assets The Group holds encumbered assets in the form of a reserve bank account with the Bank of England (see Note 37), loans and advances to customers secured within the securitisation vehicle and prepositioned under the FLS scheme (see Note 20) and cash collateral received from derivative transactions. These balances have been disclosed in the relevant note disclosures. Further details of assets encumbered within the Group’s securitisation vehicle are provided in Note 40. An overview of the Group’s key liquidity risk drivers is provided below: Deposit funding risk The deposit funding risk is the primary liquidity risk driver for the Group and this could occur if there was a concern by depositors over the current or future creditworthiness of the Group. Although the Group seeks to operate in such a way as to protect depositors, an extremely high proportion of deposits are also protected by the government’s Financial Services Compensation Scheme (‘FSCS’). The FSCS provides £85,000 of protection to depositors. Wholesale funding The Group mainly finances its operations through retail and SME deposit taking. It does not have long term wholesale funding lines in place with the exception of drawings under the Funding for Lending Scheme, repo facilities to help manage liquid assets, and debt securities issued by the Group securitisation vehicle in April 2014. The Group does have relationship banking facilities in place which are used to hedge against currency and interest rate exposures as well as repo facilities for short term liquidity management. A summary of the Group’s wholesale funding sources is shown below: Repurchase agreements on drawings under FLS Scheme Debt securities in issue Deposits by banks Note 28 33 28 2014 £’000 304,207 279,143 600 2013 £’000 383,071 – 1,205 583,950 384,276 Payments systems The Group does not form part of the UK payment system. However, in the event there are problems with one of the payment systems, the Group has access to other facilities with which to make payments if needed. Pipeline loan commitments The Group needs to maintain liquidity to cover for the outstanding pipeline of loan offers. Although certain pipeline offers may not be legally binding, the failure to adhere to an expression of intent to finance a loan contract brings reputation risk, therefore liquidity is held for such pipeline offers. Cash collateral requirements The swap Credit Support Annex (‘CSA’) agreement requires the Group or a swap counterparty to hold cash in a deposit account, depending on whether the swap is in or out of the money. As the Group is unrated, the swap agreements are not credit rating sensitive in relation to the Group, which removes the impact from a downgrade risk. Contingency funding plan As a regulated firm, the Group is required to maintain a Contingency Funding Plan (‘CFP’). The plan (which is now part of the Group’s Recovery and Resolution Plan (‘RRP’)) involves a two stage process, covering preventative measures and corrective measures to be invoked when there is a potential or actual risk to the Group’s liquidity or capital position. The CFP/RRP provides a plan for managing a liquidity or capital situation or crisis within the Group, caused by internal events, external events or a combination thereof. The plan outlines what actions the Group could take to ensure it complies with the liquidity adequacy rules, maintains sufficient capital and operates within its risk appetite and limits, as set and approved by the Board. 116 Aldermore Group PLC Annual report and accounts 2014Financial statementsThe following is an analysis of gross undiscounted contractual cash flows payable under financial liabilities: Gross contractual cash flows 2014 Non-derivative liabilities Amounts due to banks Customers’ accounts Other liabilities Debt securities in issue Subordinated notes Unrecognised loan commitments Payable on demand £’000 Up to 3 months £’000 3 to 12 months £’000 1 to 5 years £’000 More than 5 years £’000 Total £’000 1,142 1,190,398 4,200 – – 404,593 1,600,333 234,785 809,826 9,479 14,770 – – 1,068,860 69,910 1,434,729 – 40,651 5,150 – 1,550,440 – 1,090,600 – 240,033 47,725 – 1,378,358 – – – – – – – 305,837 4,525,553 13,679 295,454 52,875 404,593 5,597,991 Derivative liabilities Derivatives held for risk management – settled net Derivatives held for risk management settled gross: Amounts received Amounts paid 542 1,200 10,597 25,029 18,022 55,390 (2,349) 2,349 542 (4,544) 4,545 1,201 – – 10,597 – – 25,029 – – 18,022 (6,893) 6,894 55,391 2013 Non-derivative liabilities Amounts due to banks Customers’ accounts Other liabilities Subordinated notes Unrecognised loan commitments 1,685 944,724 3,583 – 343,652 1,293,644 174,938 668,323 6,793 – – 850,054 109,934 1,138,897 – 5,150 – 1,253,981 99,806 775,581 – 52,875 – 928,262 – – – – – – 386,363 3,527,525 10,376 58,025 343,652 4,325,941 Derivative liabilities Derivatives held for risk management – settled net Derivatives held for risk management settled gross: Amounts received Amounts paid – (13,849) 13,849 – 978 – – 978 3,179 11,158 3,118 18,433 – – 3,179 – – 11,158 – – 3,118 (13,849) 13,849 18,433 d) Market and interest rate risk The main market risk faced by the Group is interest rate risk which primarily arises from retail and commercial assets and liabilities, liquidity holdings, funding through FLS, debt securities issued by the Group securitisation vehicle and subordinated notes. Interest rate risk is the risk of loss through mismatched asset and liability positions sensitive to changes in interest rates. Oversight of interest rate risk is covered by ALCO on a monthly basis. Interest rate risk consists of asset-liability gap risk and basis risk. Asset-liability gap risk Where possible the Group seeks to match the interest rate structure of assets with liabilities, creating a natural hedge. Where this is not possible the Group will enter into interest rate swap transactions to convert the fixed rate exposures on loans and advances, customer deposits and available for sale securities into variable three month LIBOR liabilities. Given timing differences and the price of hedging small gaps, it is not cost effective to have an absolute match of variable rate assets and liabilities. The risk exposure of the overall asset-liability interest rate profile is monitored against approved limits using two main measures: • Changes to economic value of the balance sheet as a result of 2 per cent shift in the interest yield curve; and • Simulated Value at Risk (‘VaR’). 117 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 41. Risk management continued d) Market and interest rate risk continued For each period the risk measures reported were as follows (note: potential losses are shown as negative numbers): 2% shift up of the yield curve: As at period ended Average of month end positions reported to ALCO 2% shift down of the yield curve: As at period ended Average of month end positions reported to ALCO Simulated VaR: As at period ended Average of month end positions reported to ALCO 2014 £’000 2013 £’000 (323) (2,274) (1,086) 2,490 (3,687) (1,966) (1,459) (1,463) 3,206 1,722 1,106 1,652 Simulated VaR measures the monthly maximum potential gain or loss in the net fair value of interest bearing assets and liabilities due to market volatility within a statistical confidence level of 99 per cent. The VaR methodology employed is a Monte Carlo simulation based on 30 day average movements in LIBOR. The VaR methodology has inherent limitations in that market volatility in the past may not be a reliable predictor of the future, and may not reflect the time required to hedge or dispose of the position, hence VaR is not used as the sole measure of risk. The risk measures above are based on the Group’s interest bearing assets and liabilities, including the Contingent convertible securities. Basis risk Basis risk is where there is a mismatch in the interest rate reference base for assets and liabilities. When the Group enters into derivative contracts to swap fixed rate assets and liabilities into variable rate liabilities, the reference base is usually three month LIBOR. Certain lending products have interest rates which are based on the prevailing Bank of England Base Rate (‘BBR’) and this different basis reference leads to basis risk. The Group has a basis risk policy in place which places limits on the net mismatch between base rate linked assets and liabilities; and seeks to manage the overall level of basis risk exposure by entering into basis swap agreements. As at 31 December 2014 the amount of the basis risk sensitivity measure, as described above, was £480,000 (31 December 2013: £260,000). Other market risks The Group does not carry out proprietary trading or hold any positions in assets or equity which are actively traded. The Group does, however, hold a portfolio of asset backed securities and a portfolio of liquid assets (primary Gilts, Treasury Bills and Supranational Bonds) which are used for liquidity buffer purposes. The interest rate risk on these liquid assets is considered as part of the asset – liability gap risk described above. The instruments are also exposed to other forms of market risk e.g. credit spread risk. Prices are monitored on a day-to-day basis to ensure that the Group is aware of any material diminution in value. Formal monthly prices are subject to independent review and are reported to ALCO. The Group has repo facilities in place which will be used in the first instance to obtain liquidity when necessary, which will avoid the need to sell the liquidity buffer assets and so crystallise any price gain or loss due to market price movements. Hedge accounting As detailed above, the Group only uses derivative contracts in order to hedge existing exposures on loans and advances to customers, customer deposits and available for sale securities, principally with regard to following the Group’s policies in respect of the management of asset-liability gap and basis rate risks. Wherever possible the Group seeks to include the derivatives used within hedges which meet the qualification requirements of IAS 39 to be accounted for as fair value portfolio hedges (see accounting policy (j) and Note 22). There are however times where, in order to meet IAS 39 requirements for prospective testing of hedge effectiveness for new derivatives to be included in hedging portfolios, there is a time lag before IAS 39 hedge accounting may commence. Similarly, there are also certain derivative contracts, e.g. those hedging basis risk exposures (see above) which do not meet the criteria for hedge accounting under IAS 39. The gains and losses arising on contracts which do not meet the IAS 39 hedge accounting criteria are included within ‘Net (expense)/income from derivatives and other financial instruments at fair value through profit or loss’, but as they are not matched by similar adjustments to the economically hedged hedged assets and liabilities they give rise to volatility in the income statement which will reverse over the life of the instrument. 118 Aldermore Group PLC Annual report and accounts 2014Financial statementsThere is also a portfolio of fixed rate UK Gilts and Supranational Bonds where the pre-existing hedges using interest rate swaps did not meet the requirements for hedge accounting on transition to IFRSs and as a consequence the Group used the option available within IFRS to designate the bonds at fair value through profit and loss in order to reduce the accounting mismatch with the derivatives used to hedge the bonds. Changes in the fair value of the bonds and the hedging derivatives, and any differences between them, which are largely attributable to changes in the fair value of the bonds due to changes in their credit risk, are both reflected within the income statement as part of ‘Net (expense)/income from derivatives and other financial instruments at fair value through profit or loss’. 42. Capital management The European Union Capital Requirements Directive came into effect on 1 January 2007. This introduced consistent capital adequacy standards and an associated supervisory framework in the EU based on the Basel II Accord. This was replaced by Capital Requirements Regulation (‘CRR’) and Capital Requirements Directive (together referred to as CRD IV) which came into force on 1 January 2014 and is enforced in the UK, together with local implementing rules and guidance, by the Prudential Regulation Authority (‘PRA’). The Group operated under CRD III framework for periods up to 31 December 2013 and under the CRD IV framework from 1 January 2014. As part of the Internal Capital Adequacy Assessment Process (‘ICAAP’) applicable to CRD IV firms, the Board is required to consider all material risks which the Group faces and determine whether additional capital is required in order to provide additional protection to depositors and borrowers and to ensure the Group is sufficiently well capitalised to withstand a severe economic downturn. The Board manages its internal capital levels for both current and future activities and documents its risk appetite and capital requirements during stress scenarios as part of the ICAAP. The ICAAP represents the aggregated view on risk for the Group and is used by the Board, management and shareholders to understand the levels of capital required to be held over the near and medium term and to assess the resilience of the Group against failure. The Group submitted its last ICAAP to the PRA in February 2014 and is currently in the process of revising the current year ICAAP. It was subject to a Supervisory Review Evaluation Process (‘SREP’) by the PRA. The Group is required to maintain a certain level of capital to meet several requirements: • to meet minimum regulatory capital requirements; • to ensure the Group can meet its objectives, including growth objectives; • to ensure the Group can withstand future uncertainty, such as a severe economic downturn; and • to provide assurance to depositors, customers, shareholders and other third parties. The Group presents regular reports on the current and forecasted level of capital, as well as the results of stress scenarios, to the ALCO, Board and to the Risk Committee. The key assumptions and risk drivers used to create the ICAAP are regularly monitored and reported and any material deviation from the forecast and risk profile of the Group would mean the ICAAP would need to be reviewed. The Group complied with all externally imposed capital requirements throughout the years ended 31 December 2014 and 2013, when its reporting to regulators was based on its books and records maintained under UK GAAP. As at 31 December 2014, the Group’s capital base was made up of £354.9 million of Tier 1 capital and £45.3 million of Tier 2 capital. Tier 1 capital consisted of fully issued ordinary shares, satisfying all the criteria for a Tier 1 instrument as outlined in the CRR, audited/verified reserves, and qualifying Additional Tier 1 capital issued by the Group in December 2014. Tier 2 capital relates to issued subordinated loan notes and collective impairment allowances. 119 GovernanceFinancial statementsStrategic reportNotes to the financial statements continued 42. Capital management continued The Group’s regulatory capital position as at the period end was as follows: Tier 1 Share capital Share premium account Capital contribution reserve Warrant reserve Retained earnings Less: Intangible assets Total common equity Tier 1 capital (CET1) Additional Tier 1 (AT1) Additional Tier 1 – contingent convertible securities Total Tier 1 capital Tier 2 Subordinated notes Collective impairment allowance Total Tier 2 capital Total regulatory capital 2014 £’000 2013 £’000 23,737 – 2 2,200 277,879 (22,571) 23,737 237,305 2 2,200 1,531 (22,657) 281,247 242,118 73,657 – 354,904 242,118 36,758 8,527 45,285 35,571 6,314 41,885 400,189 284,003 Both years above are presented on an IFRS basis. The 2013 comparatives were previously reported to the Prudential Regulation Authority (‘PRA’) and its predecessor, the Financial Services Authority, based on the Group’s UK GAAP accounts. Regulatory capital has increased during 2014 as a result of the issuance of Additional Tier 1 capital in December 2014 and the inclusion of the profit for the year in retained earnings. The Group has elected to use the standardised approach for credit risk. Under CRD III and CRD IV, the Group must set aside capital equal to 8 per cent of its total risk weighted assets to cover its ‘Pillar 1’ capital requirements. The Group must also set aside additional ‘Pillar 2’ capital to provide for additional risks. This is calculated by multiplying the Pillar 1 capital by the Individual Capital Guidance (‘ICG’) ratio. The ICG ratio is based on the various risks which the Group faces and is agreed by the PRA. The Group’s capital base was in excess of the minimum required under the ICG. Further details of the Group’s management of capital are provided in the Pillar III disclosures which are available on the Group’s investor relations website: www.investors.aldermore.co.uk. Reconciliation of equity per statement of financial position to capital resources Equity per statement of financial position Regulatory adjustments: Add: subordinated notes Add: collective impairment allowance Less: available for sale reserve Less: intangible assets Total regulatory capital 2014 £’000 2013 £’000 378,850 265,357 36,758 8,527 (1,375) 35,571 6,314 (582) (22,571) (22,657) 400,189 284,003 With effect from 1 January 2015, the available for sale reserve will be included in the Group’s Common Equity Tier 1 capital. 43. Controlling party information Aldermore Group PLC (the Parent Company) is controlled by AnaCap Financial Partners II, L.P. (52.3 per cent. of voting rights) and AnaCap Financial Partners, L.P. (47.7 per cent. of voting rights). 44. Post balance sheet events There have been no material post balance sheet events. 120 Aldermore Group PLC Annual report and accounts 2014Financial statementsThe Company statement of financial position As at 31 December 2014 Assets Loans and advances to banks Investment in Group undertakings Other assets Total assets Liabilities Accruals and deferred income Total liabilities Share capital Share premium account Contingent convertible securities Other reserves Warrant reserve Retained earnings Equity Total liabilities and equity As at 31 December 2014 £’000 As at 31 December 2013 £’000 Note As at 1 January 2013 £’000 3 4 6 7 8 8 9 1,368 2,330 102 333,975 259,116 197,394 265 115 2 335,608 261,561 197,498 843 843 744 744 – – 23,737 23,737 19,918 – 237,305 177,960 73,657 914 2,200 234,257 334,765 335,608 – 305 2,200 (2,730) – 141 2,200 (2,721) 260,817 261,561 197,498 197,498 These financial statements were approved by the Board and were signed on its behalf by: Phillip Monks Director 16 February 2015 Registered number: 06764335 The notes and information on pages 124 to 126 form part of these financial statements. 121 GovernanceFinancial statementsStrategic reportThe Company statement of cash flows For the year ended 31 December 2014 Cash flows from operating activities (Loss) before taxation (Increase)/decrease in operating assets Increase/(decrease) in operating liabilities Net cash flows (used in)/generated from operating activities Cash flows from investing activities Investment in Group undertakings Net cash used in investing activities Cash flows from financing activities Proceeds from issue of shares Net cash flows from contingent convertible securities Net cash from financing activities Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at start of the year Movement during the year Cash and cash equivalents at end of the year As at 31 December 2014 £’000 As at 31 December 2013 £’000 Note As at 1 January 2013 £’000 2 6 7 4 8 9 3 3 (318) (150) 99 (369) (9) (113) 744 622 (74,250) (74,250) (61,558) (61,558) – 63,164 73,657 73,657 (962) 2,330 (962) 1,368 – 63,164 2,228 102 2,228 2,330 – 586 (608) (22) (689) (689) 182 – 182 (529) 631 (529) 102 122 Aldermore Group PLC Annual report and accounts 2014Financial statementsThe Company statement of changes in equity For the year ended 31 December 2014 Share capital £’000 Share premium account £’000 Contingent convertible securities £’000 Share based payment reserve £’000 Capital contribution reserve £’000 Warrant reserve £’000 Retained earnings £’000 Total £’000 Year ended 31 December 2014 As at 1 January Loss for the year Transactions with equity holders: – Reduction in share premium – Issue of contingent convertible securities – Issue costs – Share based payments As at 31 December Year ended 31 December 2013 As at 1 January Total comprehensive income Transactions with equity holders: 23,737 237,305 – – – (237,305) – – – – – – 23,737 – – – – 75,111 (1,454) – 73,657 19,918 177,960 – – – – Shares issued during the year 3,819 – Premium on share issued during the year – Issue costs – Share based payments As at 31 December – – – 60,319 (974) – 23,737 237,305 – – – – – – – 303 – – – – 609 912 139 – – – – 164 303 2 – – – – – 2,200 (2,730) 260,817 – – – – – (318) (318) 237,305 – – – – 75,111 (1,454) 609 2 2,200 234,257 334,765 2 – – – – – 2,200 (2,721) 197,498 – – – – – (9) (9) – – – – 3,819 60,319 (974) 164 2 2,200 (2,730) 260,817 In 2014 and in previous years, certain Directors have been given the option to purchase ‘B’ ordinary shares of £0.10 at a discount to market value. This gives rise to a reserve of £912,000 (2013: £303,000; 2012: £139,000) which is distributable. 123 GovernanceFinancial statementsStrategic reportNotes to the Company financial statements 1 Basis of preparation a) Accounting basis These standalone financial statements for Aldermore Group PLC (‘the Company’) are the first to be prepared in accordance with International Financial Reporting Standards as adopted by the European Union (‘IFRSs’). The Company prepared its financial statements under United Kingdom Generally Accepted Accounting Practice (‘UK GAAP’) until 31 December 2013. The date of transition to IFRS is 1 January 2013. No amendments to accounting and valuation methods were required to transition from UK GAAP to IFRS. When preparing these financial statements, management made a number of presentational changes to comply with IFRSs. The significant accounting policies adopted are set out in Note 2 to the consolidated financial statements. b) Going concern The Directors consider that it is appropriate to continue to adopt the going concern basis in preparing the financial statements. c) Income statement Under Section 408 of the Companies Act 2006 the Company is exempt from the requirement to present its own income statement. 2. Net loss attributable to equity shareholders of the Company On including the standalone Company financial statements here together with the Group consolidated financial statements, the Company is taking advantage of the exemption in Section 408 of the Companies Act 2006 not to present its individual income statement and related notes that form a part of these financial statements. Net loss attributable to equity shareholders of the Company 3. Loans and advances to banks Repayable on demand Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 (318) (9) As at 1 January 2013 £’000 – Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 1,368 2,330 As at 1 January 2013 £’000 102 There were no collective or individual provisions for impairment against loans and advances to banks. All amounts are considered to be cash and cash equivalents. 4. Investment in group undertakings As at 1 January Capital injections – share capital Equity warrants issued Capital contributions – share based payments Capital raising costs Additional Tier 1 perpetual loan As at 31 December Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 As at 1 January 2013 £’000 259,116 197,394 194,366 – – 609 – 74,250 61,558 – 164 – – 700 2,200 139 (11) – 333,975 259,116 197,394 As at 31 December 2014, £nil worth of investments (31 December 2013: £nil; 1 January 2013: £nil) were classed as impaired. Investment in subsidiaries The Company owns 100 per cent of the issued share capital of Aldermore Bank PLC, which is a registered bank. Details of subsidiary undertakings of the Bank are provided in Note 23 to the consolidated financial statements. During the year ended 31 December 2012 a non-returnable capital contribution of £2,200,000 was paid on the issue of share warrants. In addition, certain Directors were given the option to purchase ‘B’ ordinary shares of £0.10, at a discount to market value. This gave rise to a movement of £139,000. All the companies listed in Note 23 to the consolidated financial statements are related parties to the Company. See Note 5 for the related party disclosures. 124 Aldermore Group PLC Annual report and accounts 2014Financial statementsAdditional Tier 1 Perpetual Loan On 9 December 2014, the Company issued £75 million Fixed Rate Reset Additional Tier 1 Perpetual Subordinated Contingent Convertible Securities (the ‘Securities’) as described in Note 36 to the consolidated financial statements. Also on 9 December 2014, the Company entered into an agreement with Aldermore Bank PLC (the ‘Bank’) for an Additional Tier 1 Perpetual Loan. The Company agreed a loan to the Bank of £75 million less the sum of £750,000 in respect of certain costs borne by the Company in connection with its issue of the Securities. The loan is perpetual and has an indefinite duration, is repayable at the option of the Bank, and bears interest at an initial rate of 11.875 per cent p.a. until 30 April 2020 and thereafter at the relevant Reset Interest Rate as provided in the loan agreement. Interest is payable on the loan annually in arrears on each interest payment date commencing 30 April 2015 and is non-cumulative. The Borrower has the full discretion to cancel any interest scheduled to be paid on the loan. The loan balance is written down to zero and all accrued but unpaid interest and any other amounts payable on the loan are cancelled in the event of either the Bank’s or the Group’s Common Equity Tier 1 ratios falling below 7 per cent or if the Securities are converted or written down at the request of the Supervisory Authority. Given its nature the loan has been classified as an investment in a subsidiary undertaking and is carried at cost in accordance with IAS 27. Interest on the loan is recognised on payment as that is the point at which the unconditional receipt by the Company is established. 5. Related party transactions The aggregate value of loans and balances relating to Directors of the Company were as follows: Transaction value for the year ended Maximum balance during the period ended Balance outstanding as at year ended Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 33 162 162 2 115 115 As at 1 January 2013 £’000 n/a n/a 113 Interest rates charged on loan balances outstanding from related parties are lower than the rates that would be charged in arm’s length transactions. During the year ended 31 December 2014, interest was charged on these loans at a rate of 0.8 per cent above one month LIBOR. These loan balances are not secured. In addition to the above transactions, the Company entered in to an Additional Tier 1 perpetual loan with Aldermore Bank PLC as described in Note 4. 6. Other assets Amounts recoverable within 1 year: Amounts recoverable after 1 year: Total other assets Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 As at 1 January 2013 £’000 65 200 265 – 115 115 2 – 2 Other assets includes £200,000 (31 December 2013: £115,000; 1 January 2013: £ nil) of loans to Group employees. During the year ended 31 December 2014, Group employees received loans totalling £33,000 (year ended 31 December 2013: £nil). Interest was charged on these loans at an annual rate of 0.8 per cent above 1 month LIBOR. The loans are made for the purpose of enabling the employees to satisfy their personal liabilities in respect of shares issued, and are repayable in 2018. 7. Accruals and deferred income Amounts payable within 12 months: Accruals Year ended 31 December 2014 £’000 Year ended 31 December 2013 £’000 As at 1 January 2013 £’000 843 843 744 744 – – 125 GovernanceFinancial statementsStrategic reportNotes to the Company financial statements continued 8. Share capital Details of share capital of the Company are provided in Note 35 to the consolidated financial statements. 9. Contingent convertible securities Details of the contingent convertible securities issued by the Company are provided in Note 36 to the consolidated financial statements. 10. Risk management Through its Risk Management Framework, the Group is responsible for determining its principal risks, and the level of acceptable risks, as stipulated in the Group’s risk appetite statement, thus ensuring that there is an adequate system of risk management so that the levels of capital and liquidity held are consistent with the risk profile of the business. The risk management disclosures of the Group on pages 97 to 119 apply to the Company where relevant and therefore no additional disclosures are included in this note. 11. Fair values of financial assets and liabilities The Directors consider that the fair value of its financial assets and liabilities are approximately equal to their carrying value. Accordingly no further disclosures in respect of fair values are provided. 12. Controlling party information Aldermore Group PLC is controlled by AnaCap Financial Partners, II L.P. (52.3 per cent. of voting rights) and AnaCap Financial Partners, L.P. (47.7 per cent of voting rights). 13. Post balance sheet events There are no material post balance sheet events. 14. IFRS reconciliations The Company previously prepared its primary financial statements under UK GAAP, which differs in certain significant respects from IFRSs. There were no amendments to accounting and valuation methods required to transition from UK GAAP to IFRS. When preparing these financial statements, management made a number of presentational changes to comply with IFRSs. 126 Aldermore Group PLC Annual report and accounts 2014Financial statementsNotes 127 GovernanceFinancial statementsStrategic reportNotes 128 Aldermore Group PLC Annual report and accounts 2014Financial statementsA l d e r m o r e G r o u p P L C A n n u a l r e p o r t a n d a c c o u n t s 2 0 1 4 Aldermore Group PLC Registered Office: Apex Plaza 4th Floor Block D Forbury Road Reading Berkshire RG1 1AX United Kingdom aldermore.co.uk 

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