ARBUTHNOT BANKING GROUP PLC Annual Report & Accounts 2018 Arbuthnot Banking Group PLC Report & Accounts 2018 The importance of history and Sun Tzu The importance of previous experience cannot be overstated. “Those who are not willing to learn from history are doomed to repeat the mistakes of previous generations.” A good place to start, therefore, is with the famous Chinese General, Sun Tzu and his writings in “The Art of War” c. 2500 years ago. He established some basic truths such as: “He whose ranks are united in purpose will be victorious.” “The commander will surely choose those who are most fortunate.” “The traits of a true commander are: courage, wisdom, humanity and integrity.” Origins of Arbuthnot Latham George Arbuthnot (1772 – 1843) was a son of the Edinburgh banker Robert Arbuthnot. He started in 1803 as a partner in Latour & Co. in Madras (today Chennai), Southern India. Latour & Co. had been set up in 1780 by Count Francis Joseph Louis Latour de Quercy, who died in 1808. In 1807 Latour & Co. became Arbuthnot & Co. and George Arbuthnot became the leading partner until he retired in 1824. In his farewell letter to the partners he said: “…not only give the constituent (client) the assurance that his money is safe, but also give him the feeling that he is benefitting himself by dealing with the House.” In 1826 John Alves Arbuthnot started as a clerk at Arbuthnot & Co. and in 1831 became a partner. He married the daughter of George Arbuthnot. Upon his return to London he established, together with Alfred Latham, the trading house Arbuthnot & Latham on 13 March 1833. (For more details, read the book: Arbuthnot Latham 1833 – 2013 by David Lascelles) Strategic Report – Business Review Strategic Report – Financial Review Business Overview Financial Highlights Chairman’s Statement Corporate Philosophy 1 2 3 4 8 12 20 Board of Directors 22 Group Directors’ Report 25 Corporate Governance 31 Remuneration Report 33 Independent Auditor’s Report 44 Consolidated Statement of Comprehensive Income 45 Consolidated Statement of Financial Position 46 Company Statement of Financial Position 47 Consolidated Statement of Changes in Equity 49 Company Statement of Changes in Equity 50 Consolidated Statement of Cash Flows 51 Company Statement of Cash Flows 52 Notes to the Consolidated Financial Statements 128 Five Year Summary 129 Notice of Annual General Meeting 132 Corporate Contacts & Advisers 1 Arbuthnot Banking Group PLC The Seven Principles Ever since George Arbuthnot first gave guidance about corporate behaviour, it has been the culture of Arbuthnot to follow his advice. The Seven Principles summarise Arbuthnot’s corporate philosophy and ethics. During the 186 year history of serving its customers, Arbuthnot has proven its ability to adopt and grow by applying such principles with pragmatism and common sense. 1. Arbuthnot serves its shareholders, 3. Arbuthnot is independent, and its customers and its employees with integrity and high ethical standards. This is demonstrated in a progressive dividend policy, in fair pricing and in pay for performance. 2. Arbuthnot attaches great importance to good relations with customers and business partners, and treating them fairly and promptly. Arbuthnot believes in reciprocity. profit and growth oriented while maintaining a controlled risk profile. 4. Arbuthnot’s business is conducted in an innovative, flexible and entrepreneurial manner, with an opportunistic and counter-cyclical attitude. 5. Arbuthnot’s approach is based on diversification to spread the risk, a long-term view to further growth, empowerment of management and a culture of rewards for achievements to engender loyalty. 6. Arbuthnot does not sacrifice long term prospects for short term gains – nor sacrifice stability for quick profits, and it will never put the whole company at risk. 7. Ultimately, the success of Arbuthnot depends on the teamwork, commitment, and performance of its employees, combined with the determination to win. The continued application of these principles will allow the business to pursue growth in a controlled manner, providing a high quality service to its customers, whilst delivering good returns to shareholders and securing the well-being of its employees. To this end, an inclusive and balanced work environment will provide a rewarding as well as challenging multiformity. Sir Henry Angest Chairman & CEO 27 March 2019 Arbuthnot Banking Group PLCReport & Accounts 2018 2 Business Overview Private Banking Commercial Banking Arbuthnot Latham provides a high quality private banking and wealth management service, consisting of three core elements: Arbuthnot Latham provides a bespoke commercial banking service which includes: Private Banking Comprises current accounts, deposit accounts, loans, overdrafts and foreign exchange. Each client deals with a dedicated Private Banker who is key to providing an individual service. Financial Planning Built on long-term relationships and bespoke financial strategies. The service is independent and fee, not commission based. Investment Management Comprises asset management, developing tailored investment strategies to ensure that each client’s specific investment objectives are met. Banking Property Finance Other finance Comprising current accounts, deposits, overdrafts, guarantees and charge cards. Clients have a dedicated Banker who is key to managing the relationship. Comprises tailored lending to enable funding of both property investments and developments. Comprises individual secured lending which is designed around the needs of each commercial client. Asset Finance Provides asset finance funding in particular for high value and classic cars but also business assets. Asset Based Lending Provides finance secured on either invoices, assets or stock of the borrower. Specialist Finance Provides short term secured lending solutions to professional and entrepreneurial property investors. Deposits Provides deposit products directly to the retail market via a newly created internet platform, with rates advertised on the best buy tables. Arbuthnot Banking Group PLCReport & Accounts 2018 Financial Highlights 2018 £68.8m 2017 £54.6m 2016 £41.5m 3 2018 £7.4m 2017 £3.2m 2016 £1.9m 2018 £6.8m 2017 £2.5m 2016 (£2.0m) Operating income from continuing operations Underlying profit before tax from continuing operations Profit before tax from continuing operations 2018 35.0p 2017 33.0p 2016 31.0p 2018 £2.18bn 2017 £1.85bn 2016 £1.27bn 2018 £178.6m 2017 £171.7m 2016 £179.1m Total ordinary dividend per share Total assets Regulatory capital £1.2bn loan book at December 2018 £1.7bn of deposit funding at December 2018 £985.1m assets under management at December 2018 Arbuthnot Banking Group PLCReport & Accounts 2018 4 Chairman’s Statement I am pleased to report that Arbuthnot Banking Group (“ABG” or “the Group”) has achieved a profit before tax for 2018 of £6.8m (2017: £2.5m). It reflects our continued deployment of capital and investment in our principal banking subsidiary, Arbuthnot Latham and Co., Limited (“AL” or the “Bank”). We have focused on diversifying our revenue streams and invested in developing new businesses Arbuthnot Banking Group PLCReport & Accounts 2018 5 To that end, to allow us to focus solely on managing this investment, Andrew Salmon and I resigned from the Board of Secure Trust Bank PLC in August 2018. While this was the right decision for the Group, it did result in us falling foul of the accounting rules once again. The fact that we no longer had significant influence in our associated company, meant we were required to classify our shareholding as a financial investment and recognise the resultant mark to market loss. This we have shown as discontinued operations. I always felt it was inappropriate that we were required to recognise this unrealised gain in 2016 and now feel justified as we write off a previous profit that we never should have been required to take. As I reflect on the progress that the Group has made, I am encouraged that our strategy of diversification is gathering momentum. It must be noted that two significant market events took place in 2018. Firstly, the large systemic UK banks concluded their ring fencing process and secondly, the final requirement of the phasing in of the capital buffers was completed. Thus, almost ten years since the worst of the financial crisis, the largest banks are able to focus on growth strategies rather than internal projects or capital raising. It is not clear how they will build out their business, but already we have seen an increase in liquidity in the mortgage sector, as the ring fenced banks work to deploy this “trapped funding”. However, we remain steadfast in our philosophy of not chasing lending volumes by lowering our returns or taking excessive credit risk. I am confident that clients will still want to receive a personalised service and specialist banks will therefore continue to play a significant role in providing bespoke funding, services and advice to a market that can’t be mass processed through automated credit models and algorithms. What is clear to me, is that not relying on generating income from a single market sector, will be important. This is why we have focused on diversifying our revenue streams and invested in developing new businesses. Accordingly, I am pleased to see the progress that our new ventures have made in 2018. Renaissance Asset Finance (“RAF”) has grown its lending balances by 21%. Arbuthnot Asset Based Lending (“ABL”) commenced trading in May 2018 ahead of plan and has already issued facilities to the value of £43m and has drawn balances of £25m. This business has also carried its momentum into the new year. In January ABL issued a further £29m of facilities, being an increase of more than 50% on the December balance. The Specialist Finance team joined us in August 2018 and began setting up the infrastructure and operations required to commence trading. This is largely completed now and they have begun a soft launch. Their first loan received Credit Committee approval in February 2019. Given our philosophy of caution when it comes to funding our lending, I have taken a keen interest in the development of our new Arbuthnot Direct deposit platform. This enables us to provide deposit products directly to the retail market via our newly created internet platform, with rates advertised on the best buy tables. Although we do not need to raise deposits via this channel, it is good to have it available, should an attractive opportunity arise, and it is helpful in raising funds of longer duration. Finally, I am satisfied with the progress that our core business has made. The Private Bank has struggled to maintain its momentum, but I hope by refocussing its strategies to concentrate on sourcing and nurturing new relationships with criteria clients, this should bring good future growth. The Commercial Bank has continued to build out both sides of the balance sheet, increasing its loan balances by 45%, while at the same time remaining self-funding, increasing deposits by £258m. RBS Remedies Application As we have previously announced, the Commercial Bank plans to take part in the RBS remedies process. We have already been selected as one of eleven banks accepted into the Incentivised Switching Scheme (“ISS”), where RBS customers are incentivised to join another bank. Additionally, AL will be submitting its application for a grant from the Capabilities and Innovation Fund. We are confident that as a well- established bank with a 186 year history of serving our clients, with high quality products and a tailored relationship- led service, we are a strong candidate for the grant we are seeking. We have a proven track record of building successful businesses which meet customer needs in the sectors in which they operate. Our Commercial Bank launched in 2016 and already has customer loan balances of £443m at the year end. Success with our application for a grant from the Capability and Innovation Fund would enable us to bring our differentiated, private banking style relationship banking offer to a wider range of sectors than we are currently able to service, and to offer a more complete banking service to our clients across the country. Arbuthnot Banking Group PLCReport & Accounts 2018 6 Chairman’s Statement continued We are also delighted to be working closely with Oracle as part of the application process, as we recognise that to service our clients to the highest standards, complementary digital solutions are a prerequisite if we are to provide real competition to this under-served market. We have forged a strong and efficient working partnership with Oracle, who are the providers of our core banking technology. They have been helpful in identifying innovations in the global Commercial Banking industry and plan to deliver them to the UK Market via our bid. except they will not have the right to vote in shareholder meetings. As a Board and Company we believe that the current control structure, has enabled the business to take long term investment decisions and sometimes develop contrarian strategies, like ceasing to lend in the height of the financial boom of the mid 2000s. This strategy paid off when we were able to take full advantage of the opportunities that came our way following the financial crisis, in particular, being able to buy Everyday Loans for £1 in 2012 and then selling it for a profit of £117m in 2016. If we are successful in this bid process, we will bring forward our plans for further developing our Commercial Banking platform, with the grant money accelerating our transformation of the Bank. Non-voting Shares In 2016 we asked shareholders to approve, at the AGM, a number of resolutions to enable us to start the process of creating and issuing a new class of shares in Arbuthnot Banking Group. These new shares will rank pari passu with the existing ordinary shares in every way, including their right to receive the same dividends as ordinary shares, These new non-voting shares will enable us to maintain the control structure, but will provide us with the means to raise further capital, to continue to develop the business and to fund suitable inorganic deals should the opportunities arise. Thus, I am delighted to announce that we will establish these new shares following the AGM in May. To allow all of our shareholders to benefit from the new class of shares, we intend to offer them to existing shareholders by way of a bonus share issue of one new non-voting share for every 100 ordinary shares held. Offering a personalised Offering a personalised service in both Private and service in both Private and Commercial Banking Commercial Banking Arbuthnot Banking Group PLCReport & Accounts 2018 7 Outlook The macro economic outlook has grown increasingly uncertain. Major economies have seen industrial output slow, with Germany narrowly avoiding a technical recession. At the same time trade conflicts may develop further and the impact of Brexit has yet to be reflected fully in the UK economy. However, given our cautious approach to banking, I feel confident that our balance sheet should withstand any likely downturn in the economy. I am also optimistic that our new ventures can continue to make good progress and establish themselves as significant contributors to the future success of Arbuthnot Banking Group PLC. Looking further ahead, the UK economy might surprise us. It has proved to be very resilient, despite all the doom and gloom, and with a strong government introducing the right economic policies to promote business, Brexit could well deliver a bright future. Sir Henry Angest Chairman & CEO 27 March 2019 Since this is an exploratory exercise, your Board is keen to keep central expenses to a minimum and therefore these new shares will be listed on the NEX Growth Market following the issue and at the same time the ordinary shares will be dual listed on the NEX exchange and also AIM. The NEX Exchange is a fully regulated Recognised Investment Exchange for shares in growth companies and its costs are significantly lower than either the main market of the London Stock Exchange or AIM. Further details are set out in the circular to shareholders enclosed with the Annual Report. Board Changes and Personnel Ian Henderson departed from the Board on 31 August and I would like to thank him for the valuable contributions he has made to AL. Jeremy Kaye our Company Secretary, decided to retire after having given 46 years of dedicated service to Arbuthnot. He was succeeded by Nick Jennings. We will miss his attention to detail that only a classical education can develop. I wish him well for a long and happy retirement. Furthermore on 8 August Paul Lynam left the Board. I thank him for the significant contribution he made in developing both Secure Trust Bank and Arbuthnot Banking Group. Most importantly, I should mention that as part of our continued integration of the Group and the Bank, I was pleased to be able to appoint Andrew Salmon as CEO of Arbuthnot Latham in June 2018. Andrew has worked with me in various capacities for over 20 years. He will retain his Group responsibilities. He is supported by two deputies, James Cobb, our Group Finance Director and Stephen Fletcher, previously the Head of our Commercial Bank. Finally, the performance of the Group also reflects the hard work and commitment of all the members of staff. On behalf of the Board I extend our thanks to all of them for their dedicated efforts in 2018. Dividend The Board is proposing a final dividend of 20p, an increase of 1p on last year. Together with the interim dividend of 15p it gives a total dividend of 35p (2017:33p), which represents an increase of 2p on the ordinary dividend. If approved, the dividend will be paid and the bonus share issue will be made on 17 May 2019 to shareholders on the register at close of business on 26 April 2019. Arbuthnot Banking Group PLCReport & Accounts 2018 8 Strategic Report Business Review Arbuthnot Latham & Co., Ltd Arbuthnot Latham & Co., Limited has reported a profit before tax of £14.6m (2017: £11m), which is an increase of 33%. However, the underlying profit increased by 25%, when the impact of the one off adjustment to the management earn out liability for Renaissance Asset Finance and the investment made in our new business ventures are excluded. At the time when the acquisition of RAF was completed, the future liability for the management earn out was estimated to be the maximum permitted under the sale and purchase agreement. This liability has now been reassessed and £2.6m taken back to profit. However, RAF continues to perform well and has increased its customer loan balances by 21% in 2018, even though this is below the level the management team had anticipated at the time of agreeing the earn out contract. Overall the Bank’s leading indicators, namely customer balances, showed good growth during the year. Customer loan balances increased by 17% and deposits grew by 23%. Assets under management declined by 6%, largely as a result of the market volatility experienced in the final quarter of the year, as the global markets declined by in excess of 10%. The other important item in the profit of the Bank is the investment made in the new business ventures. This totalled £1.6m in the year and mainly represents the set up costs incurred by ABL and the Arbuthnot Specialist Finance (“ASF”) business. The ABL team commenced in January 2018 and made good progress in establishing its operational processes. As a result of this and also of growing customer demand, the business was able to start writing business in May, two months earlier than planned. At the end of the year the business had issued customer facilities of £43m and had drawn balances of £25m. This business will continue to be a drag on earnings of the bank in 2019, but is expected to break even toward the end of 2019. ASF was established in August 2018 and has grown to be a team of seven. This team has now also set up its operating systems and has entered a soft launch in 2019, with its first customer loan being approved by Credit Committee in February 2019. It will remain in build out phase during 2019 and expects to break even in 2020. Credit losses in the year increased to £2.7m (2017: £0.4m), which equates to 22 basis points of the year end customer loan balances. This loss rate remains within our accepted range. However, the increase in reported losses is due to Private Banking Provides full service banking and dedicated Wealth Management to criteria clients Arbuthnot Banking Group PLCReport & Accounts 2018 9 several underlying factors. Firstly, the increased size of the loan book will lead to increased credit losses, even if the loss rate remains constant. Secondly, the introduction of IFRS 9 has played a significant role in the higher impairments. The standard requires losses to be attributed to loans at the time of origination as a 12 month Expected Credit Loss (“ECL”) in Stage one, so a growing front book requires higher provision balances. Also, the definition of when loans are considered to be in default is clearly identified, where previously some element of judgement was exercised. It is therefore expected that, in some of the Stage three lending cases where provisions have been required, we will recover a large proportion of the amount outstanding. Private Banking (including Dubai) The Private Bank customer loan balances reduced by 1% as the competitive forces within the prime lending market increased during the year. It is clear that the ring fenced banks have been active in the mortgage markets as lending metrics have taken on an all too familiar picture, namely, lowering margins and increasing loan to value ratios. As a result, the Private Bank has refused to be drawn into this competition. Instead, we prefer to extend loans that we believe meet our return criteria, with volumes of loans being the resultant output rather than an input requirement. This can be seen from the loan origination volumes of the Private Bank which fell by 9% during 2018. Throughout 2018 customer deposits in the Private Bank increased by 9% to close the year at £1,041m (2017: £955m). The Investment Management business started the year with funds under management of £1,044m and closed at £985m. The significant movements in this business saw £90m of gross inflows of new money, which was largely offset by transfers out. The market turbulence of the final quarter saw the funds being marked down by £79m, offsetting the gains made in the early part of the year to leave the net performance a fall of £25m. During the year the management structure in the Private Bank was reorganised. Given the competition in the lending markets the Private Bank has been realigned to focus on growing the Wealth Management sector of the Bank. This will re-emphasise the need to identify and establish banking relationships with criteria clients. Over time, this should increase the flow of customer balances into deposits, investment management and also provide wealth planning opportunities. 2018 £68.4m 2017 £54.9m 2018 £6.8m 2017 £3.9m 2018 £57.8m 2017 £47.4m 2018 £14.6m 2017 £11.0m 2018 £1,224.7m 2017 £1,049.3m Operating income Other income Operating expenses Profit before tax (before Group recharges) Customer loans 2018 £1,714.3m 2017 £1,390.8m 2018 £2,172.5m 2017 £1,783.7m 2018 £985.1m 2017 £1,044.3m 2018 4.7% 2017 4.5% 2018 71. 4% 2017 75.4% Customer deposits Total assets Assets under management Average net margin Loan to deposit ratio Arbuthnot Banking Group PLCReport & Accounts 2018 10 Strategic Report Business Review continued Commercial Bank Renaissance Asset Finance RAF continued to perform well during the year. Customer balances increased by 21% to close the year at £86m and written volumes saw growth of 59% to reach £56m. The salesforce of the business was reinforced during the year and spent time re-engaging in some of the specialist broker markets. In particular the business wrote deals to finance drainage tankers; these are larger and long term finance deals which should help to extend the term duration of the lending book. The business also had some success in cross selling its products to the Private Bank network. In particular, the higher value and vintage car finance has proved popular. The Commercial Bank continued to trade well during the year. Customer loan balances increased by £138m to close the year at £443m, a growth rate of 45%. Additionally, the Commercial Bank remained self-funding and was able to increase its customer deposits by £258m, an increase of 84%, to reach a year end balance of £567m. However, as noted in the 2017 Annual Report and Accounts, the Commercial Bank has targeted a higher return on its lending performance and has therefore accepted a lower flow of business, which resulted in lower volumes of business being completed. Lending volumes fell by 12% to £190m as compared to 2017, which generated volumes of £217m. The Commercial Bank has continued to develop its transactional proposition and to that effect has been accepted into the RBS remedies Incentivised Switching Scheme and will be submitting a bid to the Capabilities and Innovation fund for a mid-tier grant. If successful, the Commercial Bank will continue to develop its SME offering while maintaining a personalised service. This along with technology powered by our partner Oracle, should prove to be successful in the SME banking market. Commercial Banking The bank continues to develop its highly focussed SME offering whilst maintaining a personalised service Arbuthnot Banking Group PLCReport & Accounts 2018 11 Finally, the Arbuthnot Real Estate Fund which was established in 2017, continued its exploratory work of identifying the sector of the investment market that will be the most suitable to receive the marketing of the funds products. Progress has been slow and a decision on the future viability of this fund will be concluded in the first half of 2019. Regardless of the outcome of this review, the ongoing net cost of the fund was neutral in 2018. New Ventures During the year the Bank began developing four new lines of business. Firstly, we launched the Asset Based Lending business which provides finance secured on either invoices, assets or stock of the borrower. This business is performing ahead of expectations with issued facilities of £43m at the year end and drawn loan balances of £25m. The investment made in this business totalled £0.9m net of revenues earned in the year. Secondly, the Specialist Finance business, which provides short term secured lending solutions to professional and entrepreneurial property investors, commenced in August 2018, and after having set up the business platform has now entered a soft launch phase. The business cost £0.3m during 2018. Thirdly, the Arbuthnot Direct deposits platform was developed during the year at a cost of £0.2m. This business will enable us to provide deposit products directly to the retail market via a newly created internet platform, with rates advertised on the best buy tables. Arbuthnot Banking Group PLCReport & Accounts 2018 12 Strategic Report Financial Review Arbuthnot Banking Group adopts a pragmatic approach to risk taking and seeks to maximise long term revenues and returns. Given its relative size, it is nimble and able to remain entrepreneurial and capable to taking advantage of favourable market opportunities when they arise. The Group provides a range of financial services to clients and customers in its chosen markets of Private and Commercial Banking and Specialist Lending. The Group’s revenues are derived from a combination of net interest income from lending, deposit taking and treasury activities, fees for services provided and commission earned on the sale of financial instruments and products. The Group also earns rental income on its investment property and receive dividends from financial investments. The Group has reported a profit before tax on continuing operations of £6.8m (2017: £2.5m). This is an increase on the prior year of 172%. The underlying profit before tax was £7.4m (2017: £3.2m), an increase of 131%. This reflects the progress being made in the core banking business as the surplus capital held by the Group continues to be deployed. However, once again the reported results contain certain one off items that need explanation. Firstly, the results contain an adjustment to the predicted future liability for the amount payable to the RAF management team. At the time of the acquisition, we anticipated that the business performance of RAF would be such that the maximum amount payable of £6.5m would be achieved in the earn out period which ends in 2020. While the business continues to perform robustly, increasing its customer loan balances by 21% in the year, this will not be sufficient to attain the levels forecast in the earn out agreement. Accordingly, the liability has been reduced by £2.6m and the corresponding amount recorded as a one off profit in the Income Statement. Highlights Summarised Income Statement Net interest income Net fee and commission income Operating income Other income Operating expenses Impairment losses - loans and advances to customers Profit before tax from continuing operations Income tax expense Profit after tax from continuing operations (Loss)/Profit from discontinued operations after tax (Loss)/Profit for the year Basic earnings per share (pence) - Continuing operations Basic earnings per share (pence) - Discontinued operations 2018 £000 2017 £000 55,183 12,722 67,905 6,588 (64,982) (2,731) 41,093 13,523 54,616 3,033 (54,721) (394) 6,780 2,534 (1,121) 5,659 (25,692) (20,033) 38.0 (448) 2,086 4,437 6,523 14.0 (172.5) 29.9 Basic earnings per share (pence) (134.5) 43.9 Underlying profit reconciliation 31 December 2018 Profit before tax from continuing operations AL cost of establishing new ventures STB dividend income full year at current shareholding RAF deferred consideration adjustment Arbuthnot Latham & Co. £000 Group Centre £000 Arbuthnot Banking Group £000 14,574 (7,794) 6,780 1,579 – 1,000 641 1,579 1,641 (2,584) – (2,584) Underlying profit 14,569 (7,153) Underlying basic earnings per share (pence) - Continuing operations Underlying basic earnings per share (pence) 7,416 40.3 (132.3) Arbuthnot Banking Group PLCReport & Accounts 2018 13 Secondly, during the year Sir Henry Angest and Andrew Salmon resigned their positions on the board of Secure Trust Bank PLC (“STB”) and the Group has no right to appoint any directors to the STB board in the future. As a result of this the Group was deemed to no longer have significant influence over the associated company and thus the shareholding is now recognised as a financial investment. This required the investment to be marked to market. Given the decline in the share price of STB over the previous years, this assessment resulted in a mark to market loss of £28.7m. The loss was reflected as a discontinued activity, partly offset by the year to date income earned from the associate. Given this accounting requirement, the dividend paid on this investment in the first half of the year, prior to the change in treatment, was not recorded in the profit and loss account, but will be going forward. Finally, the Group continued its policy of diversification and further developed new businesses that have now started trading. The investment in Asset Based Lending, Specialist Finance and Arbuthnot Direct lowered the reported profits by £1.6m as the start-up costs of new staff and operating systems was absorbed by the profit of the Group. These businesses should move toward a breakeven point in 2019 or early 2020 and then reach profitability in 2021. The Group has negative total Basic Earnings per share (“EPS”) of 134.5p (2017: positive 43.9p), including the mark to market loss arising on the de-recognition of the associated company. Adjusting for this, the continuing EPS is 38.0p (2017: 14.0p), an increase of 171% or on an underlying basis the continuing EPS is 40.3p (2017: 17.6p), an increase of 129%. Total operating income earned by the Group increased by 26%, largely due to the increased levels of customer loan balances as the capital deployment continued. The net margin of this lending was 4.7% (2017: 4.5%) as declines in the core bank margins of 4.1% (2017: 4.4%) were offset by the higher margins earned by the new lending businesses, which has become proportionally more significant to the overall results. Fees and commissions declined due to the lower levels of Assets Under Management resulting from the global market volatility, particularly in the second half of 2018. Also, wealth planning advisory fees were lower as the wealth management proposition was realigned. Underlying profit reconciliation Balance Sheet Strength Summarised Balance Sheet 31 December 2017 Profit before tax from continuing operations AL investment in operating systems AL acquisition costs RAF - full year equivalent income* Underlying profit Arbuthnot Latham & Co. £000 Group Centre £000 Arbuthnot Banking Group £000 10,959 (8,425) 2,534 78 108 466 – – – 11,611 (8,425) Assets Loans and advances to customers Liquid assets Other assets Total assets Liabilities Customer deposits Other liabilities Total liabilities Equity 78 108 466 3,186 17.6 Underlying basic earnings per share (pence) - Continuing operations Underlying basic earnings per share (pence) 47.5 Total equity and liabilities * RAF profit contribution adjustment as if received from 1 January 2017 and not as currently included from 28 April 2017 (pro forma basis). 2018 £000 2017 £000 1,224,656 802,189 148,328 1,049,269 610,799 193,164 2,175,173 1,853,232 1,714,286 264,931 1,979,217 195,956 1,390,781 226,076 1,616,857 236,375 2,175,173 1,853,232 Arbuthnot Banking Group PLCReport & Accounts 2018 14 Strategic Report Financial Review continued The Group’s expense base increased by 20% as the cost of the new businesses were absorbed along with natural inflationary increases and further growth in the core banking proposition. The net increase in growth of income and expenses resulted in positive operating leverage or “Jaws” of 6%. Impairment losses increased to £2.7m (2017: £0.4m), with the previous loss rate of 4 basis points increasing to 22 basis points. The increase in the loss rate was largely as a result of the introduction of the IFRS 9 accounting standard during the year. This has three changes, which will affect the results on an ongoing basis. Firstly, the growth of the front book (Stage 1) requires provisions to be made on newly originated loans regardless of their performance, hence a growing loan book will require higher provisions. Secondly, the standard requires future economic scenarios to be modelled and the result of these “stress tests” need to be factored into the resultant provisions. Finally, the old accounting rules allowed for loans to be deemed “non accrual” whereby interest ceased to be accounted for on underperforming loans. Now we are required to gross up the accounting by continuing to record interest on these loans and at the same time increasing the offsetting provisions. This will result in higher impairment losses but no overall change to net income. Overall the return on equity on a continuing basis for the Group was 3.0% (2017: 1.1%), which continues to be distorted by the surplus capital. This return when calculated on the capital required is 5.6 (2017: 4.2%). This remains below target levels as the Group continues to develop operational scale. However, given the final increase in the capital conservation buffer on 1 January 2019, the total capital requirements (including the countercyclical buffer) now stand at levels 44% higher than 3 years ago. Thus, the ROE percentage target is now accordingly lower in the mid-teen range. During the year total assets increased to £2.2bn (2017: £1.9bn), which was as a result of our ongoing growth of customer loan balances, while at the same time maintaining our conservative funding policy of relying only on retail deposits and targeting a loan to deposit ratio of between 65-75%. Included in other assets are the Groups investment properties which total £67m and are held at fair value. The most significant of these properties is 20 King Street which is valued at £53.3m. The valuation methodology is based on a discounted cash flow model, with the most important inputs being expected rentals for prime west end office space and yield values for similar properties. These inputs were reviewed and verified by leading surveyors. The methodology has used 4% as the yield, which is in the range of observed yields of 3.75% to 4.15%. The yield gave the property value of £53.9m which was in fact £0.6m higher than the previous fair value of £53.3m. Given the subjective nature of the model, we have taken the conservative view that the valuation should remain unchanged. Further analysis of the methodologies and sensitivities that the inputs may have on the valuation can be found in Note 4 of the Report and Accounts. Thus, net assets of the Group now stand at £12.83 per share (2017: £15.47). The decrease is attributable to the accounting adjustments made to derecognise the associated company during the year. Private Banking Summarised Income Statement Commercial Banking Summarised Income Statement Net interest income Net fee and commission income Operating income Other income Operating expenses - direct costs Operating expenses - indirect costs Impairment losses - loans and advances to customers 2018 £000 2017 £000 33,763 11,494 45,257 2 (15,601) (21,891) (1,966) 31,528 12,977 44,505 – (14,420) (21,848) (308) Net interest income Net fee and commission income Operating income Operating expenses - direct costs Operating expenses - indirect costs Impairment losses - loans and advances to customers 2018 £000 2017 £000 16,384 914 17,298 (5,636) (8,898) (278) 6,720 471 7,191 (4,584) (4,670) – Profit/(loss) before tax 2,486 (2,063) Profit before tax 5,801 7,929 Arbuthnot Banking Group PLCReport & Accounts 2018 15 Segmental Analysis Private Banking The segmental analysis is shown in more detail in Note 44. The Group is organised into six operating segments as disclosed below: 1. Private Banking – Provides traditional private banking services as well as offering financial planning and investment management services. This segment includes Dubai and the Tay mortgage portfolio. 2. Commercial Banking – Provides bespoke commercial banking services and tailored secured lending against property investments and other assets. 3. RAF – Specialist asset finance lender mainly in high value cars but also business assets. 4. All Other Divisions – All other smaller divisions and central costs in Arbuthnot Latham & Co., Ltd (Arbuthnot Commercial Asset-Based Lending, Arbuthnot Direct, Arbuthnot Specialist Finance, Investment properties and Central unallocated items). 5. Group Centre – ABG Group Centre management. The analysis presented below, and in the business review, is before any consolidation adjustments to reverse the impact of the intergroup operating activities and also intergroup recharges and is a fair reflection of the way the Directors manage the Group. Private Banking reported a profit before tax of £5.8m (2017: £7.9m). This is a decrease of £2.1m or 27%. This decrease is largely attributable to increased credit provisions, which rose by £1.7m, partially due to the introduction of IFRS 9. Operating Income increased by 2% as increased competition in the prime loan markets caused margin compression. Also, volatility in the global markets resulted in reduced fee income from the wealth management division. Direct costs rose by nearly 10%, while allocated indirect costs were largely unchanged. The average customer yield was 4.9% (2017: 5.2%). The customer loan balances of the Private Bank increased by £20m or 3% during the year, as the competitive forces in the markets left the bank unwilling to give up returns on lending and thus not chase loan volumes at any price. The deposits increased to £1,041m (2017: £955m). The average loan to value of the private banking loans was 52% (2017: 53%). Commercial Banking The Commercial Bank generated a profit before tax of £2.5m (2017: loss of £2.1m), an increase of £4.5m. This is due to the increase in operating income as the business benefited from a full year of income from loans that were mainly generated in the second half of 2017. The increase in income was partially offset by a higher level of allocated or indirect costs. This is a result of the increased significance of the business, but also a higher level of central costs to oversee and control the division. The average customer loan yield was 4.0% (2017: 3.2%). RAF Summarised Income Statement Other Divisions Summarised Income Statement Net interest income Net fee and commission income Operating income Other income Operating expenses - direct costs Impairment losses - loans and advances Profit before tax 2018 £000 2017 £000 5,344 137 5,481 73 (3,169) (437) 3,154 75 3,229 – (1,690) (86) 1,948 1,453 Net interest income Net fee and commission income Operating income Other income Operating expenses - direct costs Impairment losses - loans and advances to customers 2018 £000 163 177 340 6,683 (2,634) (50) 2017 £000 – – – 3,870 (230) – Profit before tax 4,339 3,640 Arbuthnot Banking Group PLCReport & Accounts 2018 16 Strategic Report Financial Review continued The customer loan book closed at £443m (2017: £305m), an increase of 45%, with deposits increasing by 84% to £567m. The average loan to value of the Commercial Bank loan portfolio was 50% (2017: 63%). Group & Other Costs The Group costs reduced to £7.8m (2017: £8.4m), mainly due to £0.7m receipt of the interim dividend paid by STB in September. RAF IFRS 9 Renaissance Asset Finance recorded a profit before tax of £1.9m (2017: £1.5m). This represents an increase of £0.5m or 34%. The purchase of RAF was completed on 28 April 2017. The 2018 results therefore include a full year for both operating income and direct costs. The annualised 2017 numbers result in the comparatives being in line. An increase in customer loans were offset by a fall in customer yields, which on average for 2018 were 9.6% compared to 9.9% in 2017. The customer loan balances increased by 21% to close the year at £86m (£71m). Other Divisions The aggregated profit before tax of other divisions was £4.3m (2017: £3.6m). Reported within the other divisions were Investment Properties £1.8m (2017: £1.9m), New Ventures cost of £1.6m (2017: £nil) and central items, which this year contains the £2.6m adjustment to the RAF management earn out liability and rental income earned on space in our Wilson Street offices. The provisions of IFRS 9 – Financial Instruments have been applied by the Group for the year ended 31 December 2018. As a result of the implementation of IFRS 9, accounting for credit losses has fundamentally changed, moving from an “incurred” to an “expected” basis. This has required the development of credit loss models, which are used to estimate credit impairments by taking into account the composition of individual loan portfolios and the macro economic outlook at each reporting date. Also, the future economic environment has been “stressed” in varying scenarios to ensure the provisions are appropriate. The introduction of IFRS 9 has resulted in an initial increase in impairment provisions and may increase volatility in the Group’s Income Statement in the future (see Note 2(f)). Under new capital regulations, the impact of IFRS 9 on regulatory capital is being phased in over a period of five years. The Group has a strong capital position and the fully loaded impact of IFRS 9 is not considered significant. Group Centre Summarised Income Statement Capital ratios Net interest income Subordinated loan stock interest Operating income Other income Operating expenses Loss before tax 2018 £000 2017 £000 (105) (366) (471) 760 (8,083) 51 (360) (309) 160 (8,276) (7,794) (8,425) Core Tier 1 capital Deductions Tier 1 capital after deductions Tier 2 capital Total capital Core Tier 1 capital ratio (Net Core Tier 1 capital/Basel III Total Risk Exposure) Total Capital Ratio (Capital/Basel III Total Risk Exposure) 2018 £000 2017 £000 197,942 (32,658) 165,284 13,283 236,375 (77,761) 158,614 13,104 178,567 171,718 15.9% 17.3% 17.2% 18.8% Arbuthnot Banking Group PLCReport & Accounts 2018 17 Capital The Group’s capital management policy is focused on optimising shareholder value over the long term. There is a clear focus on delivering organic growth and ensuring capital resources are sufficient to support planned levels of growth. The Board regularly reviews the capital position. The Group’s lead regulator, the Prudential Regulation Authority (“PRA”), sets and monitors capital requirements for the Group as a whole and for the individual banking operations. The lead regulator adopted the Basel III capital requirements with effect from 1 January 2014. As a result, the Group’s regulatory capital requirements have been based on Basel III since 2014. In accordance with the EU’s Capital Requirements Directive (“CRD”) and the required parameters set out in the PRA Handbook, the Individual Capital Adequacy Assessment Process (“ICAAP”) is embedded in the risk management framework of the Group and is subject to ongoing updates and revisions when necessary. However, as a minimum, the ICAAP is updated annually as part of the business planning process. The ICAAP is a process that brings together the management framework (i.e. the policies, procedures, strategies, and systems that the Group has implemented to identify, manage and mitigate its risks) and the financial disciplines of business planning and capital management. The Group’s regulated entity is also the principal trading subsidiary as detailed in Note 43. Not all material risks can be mitigated by capital, but where capital is appropriate the Board has adopted a “Pillar I plus” approach to determine the level of capital the Group needs to hold. This method takes the Pillar I capital formula calculations (standardised approach for credit, market and operational risk) as a starting point, and then considers whether each of the calculations deliver a sufficient capital sum adequate to cover management’s anticipated risks. Where the Board considers that the Pillar I capital does not reflect the risk, an additional capital add-on in Pillar II is applied, as per the Total Capital Requirement (“TCR”) issued by the PRA. The Group’s regulatory capital is divided into two tiers: • Tier 1 comprises mainly shareholders’ funds and revaluation reserves, after deducting goodwill, other intangible assets and a significant investment in a financial institution (STB). The portion of the investment representing up to 10% of ABG’s Tier 1 is added back to capital resources and then risk weighted at 250%, while anything above this 10% is deducted. • Lower Tier 2 comprises qualifying subordinated loan capital. Lower Tier 2 capital cannot exceed 50% of Tier 1 capital. The ICAAP includes a summary of the capital required to mitigate the identified risks from the Group’s regulated activities and the amount of capital that the Group has available. All regulated trading entities have complied with all of the externally imposed capital requirements to which they are subject. Risks and Uncertainties The Group regards the monitoring and controlling of risks and uncertainties as a fundamental part of the management process. Consequently, senior management are involved in the development of risk management policies and in monitoring their application. A detailed description of the risk management framework and associated policies is set out in Note 6. The principal risks inherent in the Group’s business are strategic, credit, market, liquidity, operational, cyber, conduct, regulatory and macroeconomic. Strategic risk Strategic risk is the risk that may affect the Group’s ability to achieve its corporate and strategic objectives. This risk is important to the Group as it continues its growth strategy. However, the Group seeks to mitigate strategic risk by focusing on a sustainable business model which is aligned to the Group’s business strategy. Also, the Board of Directors meets once a year to hold a two day board meeting to ensure that the Group’s strategy is appropriate for the market and economy. Credit risk Credit risk is the risk that a counterparty will be unable to pay amounts in full when due. This risk exists in Arbuthnot Latham, which currently has a loan book of £1,225m. The lending portfolio in AL is extended to clients, the majority of which is secured against cash, property or other assets. Credit risk is managed through the Credit Committee of AL. Market risk Market risk arises in relation to movements in interest rates, currencies and equity markets. The Group’s treasury function operates mainly to provide a service to clients and does not take significant unmatched positions in any market for its own account. As a result, the Group’s exposure to adverse movements in interest rates and currencies is limited to interest earnings on its free cash and interest rate re-pricing mismatches. The Group actively monitors its exposure to future interest rate rises. Arbuthnot Banking Group PLCReport & Accounts 2018 18 Strategic Report Financial Review continued The Group is exposed to changes in the market value of properties. The current carrying value of Investment Property is £67.1m. Any changes in the market value of the property will be accounted for in the Income Statement and as a result could have a significant impact on the profit or loss of the Group. The Group has a 15.5% interest in STB. This is currently recorded in the Group’s balance sheet as a Financial Investment. The carrying value is adjusted to market value at each balance sheet date, according to the share price of STB. Any gains or losses that arise are recorded in Other Comprehensive Income. Liquidity risk Liquidity risk is the risk that the Group cannot meet its obligations as they fall due. The Group takes a conservative approach to managing its liquidity profile. Retail client deposits and drawings from the Bank of England Term Funding Scheme fund the Group. The loan to deposit ratio is maintained at a prudent level, and consequently the Group maintains a high level of liquidity. The AL Board annually approves the Individual Liquidity Adequacy Assessment Process (“ILAAP”). The Directors model various stress scenarios and assess the resultant cash flows in order to evaluate the Group’s potential liquidity requirements. The Directors firmly believe that sufficient liquid assets are held to enable the Group to meet its liabilities in a stressed environment. Operational risk Operational risk is the risk that the Group may be exposed to financial losses from conducting its business. The Group is exposed to operational risks from its Information Technology and Operations platforms. There are additional internal controls in these processes that are designed to protect the Group from these risks. The Group’s overall approach to managing internal control and financial reporting is described in the Corporate Governance section of the Annual Report. Cyber risk Cyber risk is an increasing risk that the Group is subject to within its operational processes. This is the risk that the Group is subject to some form of disruption arising from an interruption to its IT and data infrastructure. The Group regularly test the infrastructure to ensure that it remains robust to a range of threats, and has continuity of business plans in place including a disaster recovery plan. Conduct risk As a financial services provider we face conduct risk, including selling products to customers which do not meet their needs, failing to deal with customers’ complaints effectively, not meeting customers’ expectations, and exhibiting behaviours which do not meet market or regulatory standards. The Group adopts a zero risk appetite for any unfair customer outcomes. It maintains clear compliance guidelines and provides ongoing training to all staff. Periodic spot checks and internal audits are performed to ensure these guidelines are being followed. The Group also has insurance policies in place to provide some cover for any claims that may arise. Regulatory risk Regulatory risk is the risk that the Group will have insufficient capital resources to support the business or does not comply with regulatory requirements. The Group adopts a conservative approach to managing its capital. The Board approves an ICAAP annually, which includes the performance of stringent stress tests to ensure that capital resources are adequate over a three year horizon. Capital and liquidity ratios are regularly monitored against the Board’s approved risk appetite as part of the risk management framework. Regulatory change also exists as a risk to the Group’s business. Notwithstanding the assessments carried out by the Group to manage the regulatory risk, it is not possible to predict how regulatory and legislative changes may alter and impact the business. Significant and unforeseen regulatory changes may reduce the Group’s competitive situation and lower its profitability. Macroeconomic and competitive environment The Group is also exposed to indirect risks that may arise from the macroeconomic and competitive environment. The economic environment is relatively stable in the UK. However, the international landscape is increasingly uncertain. The uncertain performance of the economies in the EU and the increasingly protectionist stance being taken by other major economies may have an adverse affect on the UK. In particular, this may cause a further softening of central London property prices, which may spread out further to the South East. The Group monitors its exposure to future interest rate rises and currently has minimal lending to customers in products that would be directly sensitive to interest rate rises. However, at the current levels of interest rates, the affordability enjoyed by the Group’s customers is beneficial. Arbuthnot Banking Group PLCReport & Accounts 2018 19 Brexit Given the uncertainty that exists over Brexit with the UK due to exit from the EU, the Group has tried to anticipate the risks that it may face if an economic shock arises as a result. It has also examined how business activities may be affected if free provision of services cross borders is prohibited. The Group’s only overseas operation is in Dubai, so the vast majority of the Group’s income and expenditure is based in the UK. However, after leaving the EU we may no longer be able to provide financial advisory services to EU citizens in the EU. This amounts to an insignificant value of fees within the Income Statement. We have however made plans to be able to generate uninterrupted EU payments via the SEPA network. Analysis is ongoing with our card service providers to ensure that data transfers made from the UK to EU and vice versa are compliant with the appropriate Data Protection Rules. Finally, there are two significant business risks that may arise in an economic shock. Firstly, increased credit risk as borrowers are unable to continue to meet their interest obligations as they fall due. This would be alongside a significant fall in the collateral values of our security held against the loans. The average loan to value of our lending book is 53.9%, so to have any material impact this fall in collateral values would have to be severe and prolonged. In our ICAAP stress test scenarios, we are able to withstand a property value fall of 40% over an 18 month period alongside a doubling of our loss rates. The second significant asset class that would be at risk in a down turn would be the Investment Properties, in particular 20 King Street. The sensitivity analysis of how a change in yields may affect the property values is shown in Note 4. Any potential reduction in confidence in the West End prime office market would manifest itself in a lower valuation. James Cobb Group Finance Director 27 March 2019 Arbuthnot Banking Group PLCReport & Accounts 2018 20 Board of Directors Sir Henry Angest James Cobb Andrew Salmon Ian Dewar Sir Christopher Meyer Sir Alan Yarrow Nicholas Jennings Arbuthnot Banking Group PLCReport & Accounts 2018 21 Sir Henry Angest Sir Christopher Meyer Appointed to the Board in December 1985. Sir Henry is the Chairman and Chief Executive and is also Chairman of Arbuthnot Latham & Co., Limited. He gained extensive national and international experience as an executive of The Dow Chemical Company and Dow Banking Corporation. He was previously Chairman of Secure Trust Bank PLC and a Director until August 2018, Chairman of the Banking Committee of the London Investment Banking Association and a Director of the Institute of Directors. He is a Past Master of the Worshipful Company of International Bankers. James Cobb FCA Joined the Board in November 2008 as Group Finance Director. He was also appointed Deputy Chief Executive of Arbuthnot Latham & Co., Limited in May 2018. He was previously Deputy Chief Financial Officer and Controller of Citigroup’s Global Consumer Group in Europe, Middle East and Africa and qualified as a Chartered Accountant with Price Waterhouse. Andrew Salmon FCA Appointed a Director in March 2004. He joined the Company in 1997 as Head of Business Development and is also Chief Operating Officer and since July 2018 Chief Executive of Arbuthnot Latham & Co., Limited. He was a director of Secure Trust Bank PLC until August 2018. He was previously a director of Hambros Bank Limited and qualified as a Chartered Accountant with KPMG. Ian Dewar FCA Appointed a Non-Executive Director in August 2015. He is Chairman of the Audit Committee. He was a Partner for 19 years in the Financial Services Practice of KPMG from which he retired in 2012 after 32 years at the firm. He is a non-executive director of Brewin Dolphin Holdings PLC. Appointed a Non-Executive Director in October 2007. He had a distinguished diplomatic career, culminating in 1997 as Ambassador to the USA. He was previously Ambassador to Germany, Press Secretary to Prime Minister John Major and from 2003 to 2009 Chairman of the Press Complaints Commission. He is also on the International Advisory Board of British American Business Inc., Distinguished Fellow of the Royal United Services Institute and Honorary Fellow of Peterhouse, Cambridge. Sir Alan Yarrow FCSI (Hon) Appointed a Non-Executive Director in June 2016. Sir Alan spent 37 years with Dresdner Kleinwort until 2009, latterly as Group Vice Chairman and Chairman of the UK Bank and then served as Chairman of the Chartered Institute for Securities & Investment until October 2018. He is Chairman of Turquoise Global Holdings Ltd and a director of Institutional Protection Services Ltd. He is also Vice President of the Royal Mencap Society, Independent Partnership Advisor to James Hambro & Partners and an advisor to Zeamo. Sir Alan is an Alderman, Magistrate and HM Lieutenant of the City of London, a member of the Court of the Fishmongers’ Company, and Liveryman of several other Livery Companies. He is a member of the Takeover Appeal Board, the Advisory Board of the Commonwealth Investment & Advisory Council. Sir Alan was Lord Mayor of the City of London for the year 2014-15. Nicholas Jennings FCA Appointed Group Company Secretary in July 2018. He was previously Company Secretary of Daily Mail and General Trust plc and of Close Brothers Group plc. He is a Chartered Accountant. Arbuthnot Banking Group PLCReport & Accounts 2018 22 Group Directors’ Report The Directors present their report for the year ended 31 December 2018. Business Activities The principal activities of the Group are banking and financial services. The business review and information about future developments, key performance indicators and principal risks are contained in the Strategic Report on pages 8 to 19. Corporate Governance The Corporate Governance report on pages 25 to 30 contains information about the Group’s corporate governance arrangements, including in relation to the Board’s decision to apply the UK Corporate Governance Code, published by the Financial Reporting Council (“FRC”) in July 2018, in response to a change in the AIM Rules. Results and Dividends The results for the year are shown on page 44 of the financial statements. The Directors recommend the payment of a final dividend of 20p (2017: 19p) on the ordinary shares which, together with the interim dividend of 15p paid (2017: 14p) on 28 September 2018, represents total dividends for the year of 35p (2017: 33p). The final dividend, if approved by members at the 2019 Annual General Meeting (“AGM”), will be paid on 17 May 2019 to shareholders on the register at close of business on 26 April 2019. Directors The names of the Directors of the Company at the date of this report, together with biographical details, are given on page 21 of this Annual Report. All the Directors listed on those pages were directors of the Company throughout the year. Mr. P. A. Lynam and Mr. I.A. Henderson retired from the Board on 8 August and 31 August 2018 respectively. Under Article 78 of the Articles of Association, Sir Henry Angest and Sir Christopher Meyer retire at the AGM and, being eligible, offer themselves for re-election. Sir Henry Angest has a service agreement terminable on twelve months’ notice. Sir Christopher Meyer, an independent non-executive director, has a letter of appointment terminable on three months’ notice. Company Secretary Viability Statement In accordance with the UK Corporate Governance Code, the Directors confirm that there is a reasonable expectation that the Group will continue to operate and meet its liabilities, as they fall due, for the three-year period up to 31 December 2021. A period of three years has been chosen because it is the period covered by the Group’s strategic planning cycle and also incorporated in the ICAAP, which forecasts key capital requirements, expected changes in capital resources and applies stress testing over that period. The Directors’ assessment has been made with reference to: • the Group’s current position and prospects – please see the Financial Review on pages 12 to 19; • the Group’s key principles – please see Corporate Philosophy on page 1; and • the Group’s risk management framework and associated policies, as explained in Note 6. The Group’s strategy and three-year plan are evaluated and approved by the Directors annually. The plan considers the Group’s future projections of profitability, cash flows, capital requirements and resources, and other key financial and regulatory ratios over the period. The ICAAP is updated at least annually as part of the business planning process. Going Concern After making appropriate enquiries which assessed strategy, profitability, funding, risk management (see Note 6 to the financial statements) and capital resources (see Note 7), the directors are satisfied that the Company and the Group have adequate resources to continue in operation for the foreseeable future. The financial statements are therefore prepared on the going concern basis. Authority to Purchase Shares Shareholders will also be asked to approve a Special Resolution renewing the authority of the Directors to make market purchases of shares not exceeding 10% of the issued share capital. The Directors will keep the position under review in order to maximise the Company’s resources in the best interests of shareholders. Details of the Resolutions renewing this authority are included in the Notice of Meeting on page 130. On 17 July 2018, Nicholas Jennings was appointed Secretary on the retirement of Jeremy Kaye. He can be contacted at the Company’s registered office. Financial Risk Management Details of how the Group manages risk are set out in the Strategic Report and in Note 6 to the financial statements. Arbuthnot Banking Group PLCReport & Accounts 2018 23 Directors’ Interests Employees The Company gives due consideration to the employment of disabled persons and is an equal opportunities employer. It also regularly provides employees with information on matters of concern to them, consults on decisions likely to affect their interests and encourages their involvement in the performance of the Company through regular communications and in other ways. Political Donations The Company made political donations of £6,000 to the Conservative Party during the year (2017: £32,000). Branches outside of the UK During the year Arbuthnot Latham operated a branch in Dubai which is regulated by the Dubai Financial Services Authority. Events after the Balance Sheet Date There were no material post balance sheet events to report. Annual General Meeting The Company’s AGM will be held on Thursday 9 May 2019. At the AGM, Shareholders will be asked to vote on a number of resolutions including the creation and bonus issue of a new class of ordinary non-voting shares and the re-appointment of KPMG LLP as the Company’s auditor. Disclosure of Information to the Auditor Each of the persons who are Directors at the date of approval of this Annual Report confirm that: • so far as each director is aware, there is no relevant audit information of which the Company’s auditor is unaware; and • they have taken all the steps they ought to have taken as a director to make themselves aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 418 of the Companies Act 2006. The interests of current Directors and their families in the ordinary shares of the Company at the dates shown, together with the percentage of the current issued share capital held, were as follows: Beneficial Interests 2018 2018 2019 % 1 January 31 December 26 March Sir Henry Angest 8,351,401 8,351,401 8,351,401 56.1 J.R. Cobb A.A. Salmon 6,000 51,699 6,000 51,699 6,000 51,699 – 0.3 Substantial Shareholders The Company was aware at 11 March 2019 of the following substantial holdings in the ordinary shares of the Company, other than those held by one director shown above: Holder Liontrust Asset Management Miton Asset Management Slater Investments Mr. R Paston M&G Investment Management Ordinary Shares 961,028 662,086 595,638 529,130 527,268 % 6.5 4.4 4.0 3.6 3.5 Significant Contracts No Director, either during or at the end of the financial year, was materially interested in any contract with the Company or any of its subsidiaries or associated companies, which was significant in relation to the Group’s business. At 31 December 2018, one Director had loans from Arbuthnot Latham & Co., Limited amounting to £515,000 and four directors had deposits with Arbuthnot Latham amounting to £1,884,000 all on normal commercial terms as disclosed in Note 42 to the financial statements. At 1 January 2018, one Director had a loan from Secure Trust Bank PLC, which ceased to be an associated company on 8 August 2018, amounting to £409,000 and two Directors had deposits amounting to £403,000, all on normal commercial terms as disclosed in Note 42 to the financial statements. Directors’ Indemnities The Company’s Articles of Association provide that, subject to the provisions of the Companies Act 2006, the Company may indemnify any Director or former Director against any liability and may purchase and maintain insurance against any liability. The Company maintained directors and officers liability insurance throughout the year. Arbuthnot Banking Group PLCReport & Accounts 2018 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. The Directors confirm the Annual Report and financial statements, taken as a whole, are fair, balanced and understandable and provide the information necessary for shareholders to assess the Group and Parent Company’s position, performance, business model and strategy. By order of the Board N D Jennings Secretary 27 March 2019 24 Group Directors’ Report continued Statement of Directors’ Responsibilities in Respect of the Strategic Report and 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. As required by the AIM Rules of the London Stock Exchange they are required to prepare the Group Financial Statements in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the EU and applicable law and have elected to prepare the Parent Company Financial Statements on the same basis. Financial Statements 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 the Company and of the Group 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, relevant and reliable; • state whether they have been prepared in accordance with IFRSs as adopted by the EU; • assess the Group and Parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and • use the going concern basis of accounting unless they intend either to liquidate the Group or the Parent Company or to cease operations, or have no realistic alternative but to do so. 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 Parent Company and enable them to ensure that its Financial Statements comply with the Companies Act 2006. They are responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error, and 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. Arbuthnot Banking Group PLCReport & Accounts 2018 Corporate Governance 25 Introduction and Overview Arbuthnot Banking Group has a strong and effective corporate governance framework. The Board endorses the principles of openness, integrity and accountability which underlie good governance and takes into account the provisions of the UK Corporate Governance Code in so far as they are considered applicable to and appropriate for it, given its size and circumstances, and the role and overall shareholding of its majority shareholder. Moreover, the Group contains two subsidiaries authorised to undertake regulated business under the Financial Services and Markets Act 2000, one of which (Arbuthnot Latham & Co., Ltd) is regulated by the Prudential Regulatory Authority and the Financial Conduct Authority and is an authorised deposit- taking business. It in turn has a subsidiary, Renaissance Asset Finance Limited, which is regulated by the Financial Conduct Authority. Arbuthnot Latham & Co., Ltd also operates a branch in Dubai, which is regulated by the Dubai Financial Services Authority. Accordingly, the Group operates to the high standards of corporate accountability and regulatory compliance appropriate for such a business. In March 2018, the AIM Rules were amended to require AIM companies to state which corporate governance code they had decided to apply, how the AIM company complies with that code, and where it departs from its chosen code an explanation of the reasons for doing so. This information was published, as required, on the Company’s website by 28 September 2018 and the Company plans to review it each year as part of its annual reporting cycle. The Board decided to report against the UK Corporate Governance Code, published by the Financial Reporting Council (“FRC”) in July 2018 (“the Code”) with effect from 28 September 2018. This section of the Annual Report summarises how the Company applies the Code and in broad terms how it has complied with its provisions since that date, giving explanations where it has chosen not to do so. The Company is led by the Board which, following changes in August 2018, comprises six members: the executive Chairman, two other executive directors, Andrew Salmon and James Cobb, and three independent non-executive directors who thereby constitute half of the Board in line with the Code. The Board sets the long term focus and customer oriented culture of the Group. The responsibilities of Sir Henry Angest as Chairman include leading the Board, ensuring its effectiveness in all aspects of its role, ensuring effective communication with shareholders, setting the Board’s agenda and ensuring that all Directors are encouraged to participate fully in the activities and decision-making process of the Board. In 2016 an independent Board Effectiveness Review was carried out by an external consultant. In October 2018 it was determined to carry out the annual Board Effectiveness Review internally. The evaluation took the form of a confidential questionnaire which assessed the performance of the Board and its Committees. The questions were set to explore the themes developed the previous year, including Board effectiveness, Board composition, Board dynamics, alignment of the Board and executive team, interaction with major shareholders, induction, performance and training, Board Committees and the Secretariat. The feedback was collated by the Company Secretary and discussed by the Board in November 2018. The responses were positive, confirming that the Board was of the view that it receives the correct level of insight into and oversight of the Company, both directly to it and in terms of management information and oral updates provided during meetings. Directors also agreed that the Arbuthnot culture set out in the Arbuthnot Principles and Values manifests itself at Board level and in the external view of the Group as a whole. The Board The Board met regularly throughout the year, holding six scheduled meetings as well as a two-day off-site strategy meeting. Substantive agenda items have briefing papers, which are circulated in a timely manner before each meeting. The Board ensures that it is supplied with all the information that it requires and requests in a form and of a quality to fulfil its duties. In addition to overseeing the management of the Group, the Board has determined certain items which are reserved for decision by itself. These matters include approval of the Group’s long-term objectives and commercial strategy, ensuring a sound system of internal control, risk management strategy, approval of major investments, acquisitions and disposals, any changes to capital structure and the overall review of corporate governance. The Company Secretary is responsible for ensuring that the Board processes and procedures are appropriately followed and support effective decision making. All directors have access to the Company Secretary’s advice and services. There is an agreed procedure for directors to obtain independent professional advice in the course of their duties, if necessary, at the Company’s expense. All directors receive induction training upon joining the Board, with individual AIM training provided by the Company’s Nominated Adviser, regulatory and compliance training provided by the Group Head of Compliance or an external firm of lawyers, risk management training (including Arbuthnot Banking Group PLCReport & Accounts 2018 26 Corporate Governance continued that in relation to the ICAAP and ILAAP) with an overview of credit and its associated risks and mitigation by the Head of Credit Risk in Arbuthnot Latham. Overview of Compliance with the FRC Code, together with Exceptions The Board focuses not only on the provisions of the Code but its principles, ensuring as follows: • The Company’s purpose, values and strategy as a prudently managed organisation align with its culture, with a focus on fairness and long-term shareholder returns. • The Board has an appropriate combination of executive and non-executive directors, who have both requisite knowledge and understanding of the business and the time to commit to their specific roles. • The Board comprises directors with the necessary combination of skills to ensure the effective discharge of its obligations, with an annual evaluation of the capability and effectiveness of each director as well as the Board as a composite whole; appropriate succession plans are also in place and reviewed annually, or more frequently if appropriate. • The Board and Audit Committee monitor the procedures in place to ensure the independence and effectiveness of both external and internal auditors, and the risk governance framework of the Company, with all material matters highlighted to the relevant forum (Board/Committee). • Remuneration policies and practices are designed to support strategy and promote long-term sustainable success, with a Remuneration Committee in place to oversee director and senior management pay. In respect of the Code’s specific provisions, an annual review is carried out, comparing the Company’s governance arrangements and practices against them. Any divergences are noted, with relevant rationale considered carefully to determine whether it is appropriate. Consideration is also given to guidance issued, which may require a review of the relevant reasoning intra-year. In line with the FRC’s Guidance on Board Effectiveness, the Board additionally takes into account its suggestions of good practice when applying the Code focusing on the five key principles specified in the Code. Where the Company’s governance does not completely align with Code, it is generally as a result of the role of its overall majority shareholder, itself adding a level of protection to long-term shareholder interests, and it has had no negative impact on the Company. All divergences from the Code, with an explanation of the reasons for doing so are set out as follows: Provision 3 – The majority shareholder is Chairman and Chief Executive of ABG. Engagement with other major shareholders is carried out as appropriate by the Chairman, the Group Chief Operating Officer or the Group Finance Director. There has been no requirement to date to consult with them on matters delegated to Board committees, but if appropriate/when requested, this would be arranged. Provision 5 – The Board has regard to the interests of all its key stakeholders in its decision making. The Company has fewer than 20 employees, all of whom have direct access to Board members. As such, it has not been deemed necessary to appoint an employee representative to the Board, nor a formal workforce advisory panel, nor a designated non- executive Director. Provision 9 – Sir Henry Angest carries out the role of Chairman and Chief Executive, given his long-term interest as majority shareholder, itself aligning with the interests of other shareholders. The Group Chief Operating Officer and the Group Finance Director provide a strong, independent counterbalance, ensuring challenge and independence from a business perspective, against the stakeholder focus of the Chairman carrying out his Chairman’s role. The Company follows the US model that is very successful in ensuring commercial success with strong corporate governance and stakeholder awareness, having a shared Chairman and CEO, with a separate, empowered, Chief Operating Officer. Provision 10 – The Board considers Sir Christopher Meyer to be independent, notwithstanding his serving more than nine years, since his views and any challenge to executive management remain firmly independent. Provision 12 – The Board has not appointed a Senior Independent Director, as major shareholders talk openly with the Chairman, the Group Chief Operating Officer and the Group Finance Director on request. Provision 14 – Attendance at meetings is not reported as, should a Director be unable to attend a meeting, that Director receives relevant papers in the normal manner and relays any comments in advance of the meeting to the Chairman. The same process applies in respect of the Board Committees. Provision 18 – For the purposes of stability and continuity, the Company continues to offer Directors for re-election on a three-year rolling basis in accordance with the Company’s Articles of Association and company law. The Directors seeking re-election at the AGM are Sir Henry Angest and Sir Christopher Meyer, who have served on the Board for 33 years and 11 years respectively. The contribution of Sir Henry Angest, who beneficially owns more than 50% of the issued Arbuthnot Banking Group PLCReport & Accounts 2018 27 share capital, has been invaluable in the successful development of the Company. Sir Christopher Meyer’s wide-ranging experience including as a diplomat at the most senior level has provided an important independent measure of challenge to executive management. Accordingly, the Board fully supports the resolutions for their reappointment. Provision 19 – Sir Henry Angest’s role as Chairman has extended over nine years and is expected to continue indefinitely, given his key role as majority shareholder both in protecting the stability of his and other shareholder interests and in overseeing a balanced and risk-managed approach to growing the business with a view to the longer-term. Provision 32 – Sir Henry Angest is Chairman of the Remuneration Committee, as is appropriate in the context of his majority shareholding. Internal Control and Financial Reporting The Board of directors has overall responsibility for the Group’s system of internal control and for reviewing its effectiveness. Such a system is designed to manage rather than eliminate risk of failure to achieve business objectives and can only provide reasonable but not absolute assurance against the risk of material misstatement or loss. The Directors and senior management of the Group review and approve the Group’s Risk Appetite Statement and Risk Management Policy. Risk appetite sets out the Board’s attitude to risk and internal control and includes qualitative and quantitative measures which are reported to every Board meeting; the Risk Management Policy details how risks are monitored and controlled within the Bank. Key business risks and emerging risks are continuously identified, evaluated and managed by means of limits and controls set by and managed at an operational level by AL management and governed through Arbuthnot Latham Committees. Significant risks identified in connection with the development of new activities are subject to consideration by the Board. There are well-established budgeting procedures in place and reports are presented regularly to the Board detailing the results, in relation to Arbuthnot Latham, of each principal business unit, variances against budget and prior year, and other performance data. The Board receives regular reports on any risk matters that need to be brought to its attention, enabling it to assess the Group’s emerging and principal risks. Shareholder Communications The Company maintains communications via one to one meetings as appropriate with its major shareholders and makes full use of the AGM to communicate with shareholders. The Company aims to present a balanced and understandable assessment in all its reports to shareholders, its regulators, other stakeholders and the wider public. Key announcements and other information can be found at www.arbuthnotgroup.com. Board Committees The Board has established Audit, Nomination, Remuneration and Donations Committees, each with formally delegated duties and responsibilities and with written terms of reference, which require consideration of the committee’s effectiveness. The Board keeps the governance arrangements under review. Further information in relation to these committees is set out below. The Board maintains direct responsibility for issues of Risk without the need for its own Risk Committee, since responsibility for large lending proposals is a direct responsibility of its subsidiary, Arbuthnot Latham. Audit Committee Membership and meetings Membership of the Audit Committee is restricted to non- executive Directors and comprises Ian Dewar (as Chairman), Sir Christopher Meyer and Sir Alan Yarrow. The Company Secretary acts as its Secretary. The Committee met four times during the year. The Audit Committee oversees, on behalf of the Board, financial reporting, the appropriateness and effectiveness of systems and controls, the work of Internal Audit and the arrangements for and effectiveness of the external audit. The ultimate responsibility for reviewing and approving the Annual Report and Accounts and the Interim Report lies with the Board. The Audit Committee also reviews whistleblowing arrangements for employees to raise concerns in confidence. External Audit The Senior Statutory Auditor of the external auditors, KPMG LLP, changed in April 2018, following a five-year association with the Company. The Committee assesses the independence and objectivity, qualifications and effectiveness of the external auditors on an annual basis as well as making a recommendation on their reappointment to the Board. The Committee received a report showing the level of non-audit services provided by the external auditors during the year and members were satisfied that the extent and nature of these did not compromise auditor independence. Arbuthnot Banking Group PLCReport & Accounts 2018 28 Corporate Governance continued The Committee has concluded that KPMG remain independent and that their audit is effective. KPMG has held office since August 2009. Consequently, the Committee is required by the EU Audit Regulation 2014 to conduct a competitive audit tender in 2019. The Committee will oversee the tender process and is committed to ensure a fair and transparent process is put in place including a clearly articulated set of selection criteria agreed by the Committee in advance. The tender is not expected to occur before the AGM to be held on 9 May 2019 at which a resolution to re-appoint KPMG LLP as the Company’s auditor will be proposed. Activity in 2018 Internal Audit On behalf of the Board, the Audit Committee monitors the effectiveness of systems and controls. To this end, Internal Audit provides the Audit Committee and the Board with detailed independent and objective assurance on the effectiveness of governance, risk management and internal controls. Since Arbuthnot Latham established its own Audit Committee, the role of the Group Audit Committee has been mainly supervisory in relation to internal audit matters, though it receives items of material note deriving from Arbuthnot Latham’s internal audits, including an assessment of culture which forms part of every internal audit. The Audit Committee approves the Internal Audit risk based programme of work and monitors progress against the annual plan. The Committee reviews Internal Audit resources and the arrangements that: ensure Internal Audit faces no restrictions or limitations to conducting its work; that it continues to have unrestricted access to all personnel and information; and that Internal Audit remains objective and independent from business management. The Head of Internal Audit provides reports on the outcomes of Internal Audit work directly to the Committee and the Committee monitors progress against actions identified in these reports. The Committee received a Self-Assessment report on Internal Audit in September 2018 and it is satisfied with Internal Audit arrangements during 2018. Integrity of Financial Statements and oversight of external audit The Committee: • Received and agreed the Audit Plan prepared by the external auditors; • Considered and formed a conclusion on the critical judgements underpinning the Financial Statements, as presented in papers prepared by management. In respect of all of these critical judgements, the Committee concluded that the treatment in the Financial Statements was appropriate; • Received reports from the external auditors on the matters arising from their work, the key issues and conclusions they had reached; • The Chairman of the Committee attended, as an observer, Audit Committee meetings of Arbuthnot Latham, the Company’s operating subsidiary; • The Committee monitored the changes to financial reporting requirements which came in effect on 1 January 2018, principally IFRS 9; • In addition, it considered changes to financial reporting requirements that are not yet effective but that are likely to affect the reported results or financial position of the Group and Company in future. The most notable change is IFRS 16, Leases, where the Committee has reviewed Management’s methodology, and is satisfied with the disclosures as set out in Note 3.26. The reports from the external auditors include details of internal control matters that they have identified as part of the annual statutory financial statements audit. Certain aspects of the system of internal control are also subject to regulatory supervision, the results of which are monitored closely by the Committee and the Board. In addition, the Committee receives by exception reports on the ICAAP and ILAAP which are key control documents that receive detailed consideration by the board of Arbuthnot Latham. The Committee approved the terms of engagement and made a recommendation to the Board on the remuneration to be paid to the external auditors in respect of their audit services. Significant areas of judgement The Audit Committee considered the following significant issues and accounting judgements in relation to the Financial Statements: Arbuthnot Banking Group PLCReport & Accounts 2018 29 Impairment of loans and advances to customers The Committee reviewed presentations from management detailing the provisioning methodology across the Group as part of the full year results process. The Committee considered and challenged the provisioning methodology applied by management, including timing of cash flows, valuation and recoverability of supporting collateral on impaired assets. The Committee concluded that the impairment provisions, including management’s judgements, were appropriate. The charge for impaired loans and advances totalled £2.7m for the year ended 31 December 2018. The disclosures relating to impairment provisions are set out in Note 4.1(a) to the financial statements. Other Committee activities In November 2018, Committee members contributed to the review of the Committee’s effectiveness as part of its evaluation by the Board. The review did not highlight any material concerns. On behalf of the Board, the Committee reviewed the financial statements as a whole in order to assess whether they were fair, balanced and understandable. The Committee discussed and challenged the balance and fairness of the overall report with the executive directors and also considered the views of the external auditor. The Committee was satisfied that the Annual Report could be regarded as fair, balanced and understandable and proposed that the Board approve the Annual Report in that respect. Valuation of Investment Properties The three investment properties are held at fair value. The Committee reviewed and challenged the key assumptions used in the valuation of the properties including yields, rental income and refurbishment costs. In March 2019 the Committee met separately with each of the Head of Internal Audit and the Senior Statutory Auditor without any other executives present. There were no issues or concerns raised by them in regard to discharging their responsibilities. Nomination Committee Membership and meetings The Nomination Committee is chaired by Sir Henry Angest and its other members are Sir Christopher Meyer and Sir Alan Yarrow. The Head of Corporate Governance acts as its Secretary. The Committee met once during the year. It is required to meet formally at least once per year and otherwise as required. The Nomination Committee assists the Board in discharging its responsibilities relating to the composition of the Board. The Nomination Committee is responsible for and evaluates on a regular basis the balance of skills, experience, independence and knowledge on the Board, its size, structure and composition, retirements and appointments of additional and replacement directors and will make appropriate recommendations to the Board on such matters. The Nomination Committee also considers succession planning, taking into account the skills and expertise that will be needed on and beneficial to the Board in the future. As at 31 December 2018, the Group’s property investment portfolio totalled £67.1m, as detailed in Note 31. The disclosures relating to the fair value of investment properties are set out in Note 4.1(c) to the financial statements. Effective Interest rate Interest earned on loans and receivables is recognised using the Effective Interest Rate (“EIR”) method. The EIR is calculated on the initial recognition of a loan through a discounted cash flow model that incorporates fees, costs and other premiums or discounts. There have been no changes to the EIR accounting policies during the year. The Committee considered and challenged the EIR methodology applied by management and specifically in relation to acquired loan portfolios. The Committee considered management assumptions including expected future customer behaviours and concluded that the EIR methodology was appropriate as at 31 December 2018. The disclosures relating to EIR are set out in Note 4.1(b) to the financial statements. Going Concern and Viability Statement The financial statements are prepared on the basis that the Group and Company are each a going concern. The Audit Committee reviewed management’s assessment and is satisfied that the going concern basis and assessment of the Group’s longer-term viability is appropriate. Arbuthnot Banking Group PLCReport & Accounts 2018 30 Corporate Governance continued Activity in 2018 The Committee reviewed policies on Board Diversity, Board Suitability and Board Training and Development. It also assessed and confirmed the collective and individual suitability of Board members. The contribution of Sir Henry Angest remains invaluable in the successful development of the Company. As regards the non-executive Directors’ skill sets, Ian Dewar, with a wealth of experience as a partner in a major accounting firm, has successfully chaired the Audit Committee. Sir Christopher Meyer’s wide-ranging experience including as a diplomat at the highest level has provided an important independent measure of challenge to executive management. The Board has benefitted from Sir Alan Yarrow’s wise counsel, challenge to management and many years’ experience in the City of London. In November 2018, the Committee confirmed that the Board’s current composition provides the Company with a balanced, knowledgeable, diverse and informed group of directors, bringing strategic acumen, foresight and challenge to the executive, commensurate with the size of the business. The Committee reviewed succession planning and agreed that there was a sensible and strong plan in place. In terms of any new hires, it noted that account would be taken of provisions in the Board Diversity Policy. The Committee also agreed that it continued to operate effectively and, as such, no changes to its membership, composition or activities were proposed to the Board. Remuneration Committee Membership and meetings Membership is detailed in the Remuneration Report on page 31. The Committee met twice during the year. It is required to meet formally at least once per year and otherwise as required. The Remuneration Committee assists the Board in determining its responsibilities in relation to remuneration including, inter alia, in relation to the Company’s policy on executive remuneration determining, the individual remuneration and benefits package of each of the Executive Directors and the fees for Non-Executive Directors. The Committee also deals with remuneration-related issues under the Prudential Regulation Authority’s Remuneration Code applicable to the Company. The Remuneration Report on pages 31 and 32 gives further information and details of each Director’s remuneration. Donations Committee Membership and meetings The Donations Committee is chaired by Sir Henry Angest and its other members are Sir Christopher Meyer and Sir Alan Yarrow. The Committee met once during the year. The Committee considers any political donation or expenditure as defined within sections 366 and 367 of the Companies Act 2006. By order of the Board N D Jennings Secretary 27 March 2019 Arbuthnot Banking Group PLCReport & Accounts 2018 31 Remuneration Report Remuneration Committee Directors’ Service Contracts Sir Henry Angest, Mr. Salmon and Mr. Cobb each have service contracts terminable at any time on 12 months’ notice in writing by either party. Long Term Incentive Schemes Grants were made to three Directors on 14 June 2016 under Phantom Option Scheme introduced on that date, to acquire ordinary 1p shares in the Company at 1591p exercisable in respect of 50% on or after 15 June 2019 and in respect of the remaining 50% on or after 15 June 2021 when a cash payment would be made equal to any increase in market value. Under this Scheme, Mr. Salmon was granted a phantom option to acquire 200,000 ordinary 1p shares in the Company, which remained outstanding at 31 December 2018. Mr. Cobb was granted a phantom option to acquire 100,000 ordinary 1p shares in the Company, which remained outstanding at 31 December 2018. The phantom option granted to Mr. Henderson to acquire 100,000 ordinary 1p shares in the Company lapsed on 31 August 2018 when he left the Company. The fair value of the remaining options at the grant date was £1m. Membership of the Remuneration Committee is limited to non-executive directors together with Sir Henry Angest as Chairman. The present members of the Committee are Sir Henry Angest, Sir Christopher Meyer and Sir Alan Yarrow. The Head of Corporate Governance acts as its Secretary. The Committee met twice during the year. The Committee has responsibility for producing recommendations on the overall remuneration policy for directors for review by the Board and for setting the remuneration of individual directors. Members of the Committee do not vote on their own remuneration. Remuneration Policy The Remuneration Committee determines the remuneration of individual directors having regard to the size and nature of the business; the importance of attracting, retaining and motivating management of the appropriate calibre without paying more than is necessary for this purpose; remuneration data for comparable positions, in particular the rising remuneration packages at challenger banks; the need to align the interests of executives with those of shareholders; and an appropriate balance between current remuneration and longer-term performance-related rewards. The remuneration package can comprise a combination of basic annual salary and benefits (including pension), a discretionary annual bonus award related to the Committee’s assessment of the contribution made by the executive during the year and longer-term incentives, including executive share options. Pension benefits take the form of annual contributions paid by the Company to individual money purchase schemes. The Remuneration Committee reviews salary levels each year based on the performance of the Group during the preceding financial period. This review does not necessarily lead to increases in salary levels. For the purposes of the FCA Remuneration Code, all the provisions of which have been implemented, the Group and its subsidiaries are all considered to be Tier 3 institutions. Activity in 2018 The Remuneration Committee undertook its regular activities during the year including reviewing the operation of the Remuneration Policy, having regard to the performance of the Company during the year, with particular regard to the level of discretionary bonus awarded and the level of inflation impacting on salaries. Arbuthnot Banking Group PLCReport & Accounts 2018 32 Remuneration Report continued Directors’ Emoluments Fees (including benefits in kind) Salary payments (including benefits in kind) Pension contributions 2018 £000 205 4,387 93 2017 £000 205 4,533 105 4,685 4,843 Sir Henry Angest JR Cobb IA Dewar IA Henderson (to 31/08/2018) Sir Christopher Meyer AA Salmon Sir Alan Yarrow Salary £000 1,200 625 – 333 – 1,200 – 3,358 Bonus £000 Benefits £000 Pension £000 Fees £000 – 300 – – – 600 – 900 79 17 – 11 – 22 – 129 – 35 – 23 – 35 – 93 Total 2018 £000 1,279 977 75 367 60 Total 2017 £000 1,289 852 75 840 60 1,857 1,657 70 70 – – 75 – 60 – 70 205 4,685 4,843 Details of any shares or options held by directors are presented on page 31 and 119. The emoluments of the Chairman were £1,279,000 (2017: £1,289,000). The emoluments of the highest paid director were £1,857,000 (2017: £1,657,000) including pension contributions of £35,000 (2017: £35,000). Secure Trust Bank was paid a fee of £36,000 up to 8 August 2018 (2017: £60,000) for the services of Mr. Lynam rendered as a non-executive director. Retirement benefits are accruing under money purchase schemes for three directors who served during 2018 (2017: four directors). Sir Henry Angest Chairman of the Remuneration Committee 27 March 2019 Arbuthnot Banking Group PLCReport & Accounts 2018 33 Independent Auditor’s Report to the members of Arbuthnot Banking Group PLC 1. Our opinion is unmodified We have audited the financial statements of Arbuthnot Banking Group PLC (“the Company”) for the year ended 31 December 2018 which comprise the consolidated statement of comprehensive income, consolidated statement of financial position, company statement of financial position, consolidated statement of changes in equity, company statement of changes in equity, consolidated statement of cashflows, company statement of cashflows, and the related notes, including the accounting policies in Notes 2 & 3. Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (“ISAs (UK)”) and applicable law. Our responsibilities are described below. We have fulfilled our ethical responsibilities under, and are independent of the Group in accordance with, UK ethical requirements including the FRC Ethical Standard as applied to listed entities. We believe that the audit evidence we have obtained is a sufficient and appropriate basis for our opinion. In our opinion: • the financial statements give a true and fair view of the Overview state of the Group’s and of the Parent Company’s affairs as at 31 December 2018 and of the Group’s loss for the year then ended; Materiality: group financial statements as a whole • the Group financial statements have been properly prepared Coverage in accordance with International Financial Reporting Standards as adopted by the European Union (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. Risks of material misstatement Event driven New: Brexit uncertainty Recurring risks Loan loss provisioning Revenue recognition: effective interest rate Investment property Recoverability of Parent Company’s investment in subsidiaries £600,000 (2017: £570,000) 8.8% (2017: 8%) of Group profit before tax 100% (2017:100%) of Group profit before tax vs 2017 New Matter 2. Key audit matters: including our assessment of risks of material misstatement Key audit matters are those matters that, in our professional judgment, were of most significance in the audit of the financial statements and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by us, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. The key audit matters in arriving at our audit opinion above were addressed in the context of, and solely for the purpose of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. Arbuthnot Banking Group PLCReport & Accounts 2018 34 Independent Auditor’s Report to the members of Arbuthnot Banking Group PLC continued Brexit Uncertainty Refer to Strategic Report (page 16). The risk Group and Parent Unprecedented levels of uncertainty All audits assess and challenge the reasonableness of estimates, in particular as described in loan loss provisioning, revenue recognition: effective interest rate and investment properties below and related disclosures and the appropriateness of the going concern basis of preparation of the annual accounts. All of these depend on assessments of the future economic environment and the Group’s future prospects and performance. In addition, we are required to consider the other information presented in the Annual Report including the principal risks disclosure and to consider the directors’ statement that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy. Brexit is one of the most significant economic events for the UK and at the date of this report its effects are subject to unprecedented levels of uncertainty of outcomes, with the full range of possible effects unknown. Our response We have developed a standardised firm-wide approach to the consideration of the uncertainties arising from Brexit in planning and performing our audits. Our procedures included: • Our Brexit knowledge: We considered the directors’ assessment of Brexit-related sources of risk for the Group’s business and financial resources compared with our own understanding of the risks. We considered the directors’ plans to take action to mitigate the risks. • Sensitivity analysis: When addressing loan impairment, recognition of revenue: effective interest rate, investment properties and other areas that depend on forecasts, we compared the directors’ sensitivity analysis to our assessment of the full range of reasonably possible scenarios resulting from Brexit uncertainty. • Assessing transparency: As well as assessing individual disclosures as part of our procedures on loan loss provisioning, revenue recognition: effective interest rate and investment properties we considered all the Brexit related disclosures together, including those in the strategic report, comparing the overall picture against our understanding of the risks. No audit should be expected to predict the unknowable factors or all possible future implications for a Group and this is particularly the case in relation to Brexit. Arbuthnot Banking Group PLCReport & Accounts 2018 35 Refer to page 29 (Audit Committee Report), Note 3.10 (accounting policy) and Note 23 (financial disclosures). The effect of these matters is that, as part of our risk assessment, we determined that the impairment of loans and advances to customers has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole. Note 4 of the financial statements discloses the sensitivities estimated by the Group. Disclosure quality The disclosures regarding the Group’s application of IFRS 9 are key to understanding the change from IAS 39 as well as explaining the key judgments and material inputs to the IFRS 9 ECL results. Loan Loss Provisioning Group: £6.6 million; (2017: £1.4 million) The risk Group Subjective estimate IFRS 9 was implemented by the Group on 1 January 2018. This new standard requires the Group to recognise expected credit losses (ECL) on financial instruments which involves significant judgement and estimates to be made by the Group. The most significant areas where we identified greater levels of management judgement are: • Significant increase in credit risk (SICR) and the Group’s definition of default: the criteria selected to identify a SICR and the Group’s definition of default are judgemental and can materially impact the ECL by determining whether a 12 month (stage 1) or lifetime (stage 2 or 3) provision is recorded. • Economic scenarios: IFRS 9 requires the Group to measure ECL on a forward-looking basis, incorporating future macro-economic variables reflecting a range of future conditions. • Complex ECL model: inherently judgemental modelling techniques are used to estimate stage1 ECLs which involves determining Probabilities of Default (PD) and Loss Given Default (LGD). • Data capture: the ECL model uses a combination of static (e.g. original collateral valuation) and dynamic data (e.g. current balance/interest rates) about the Group’s loans. Owing to the risk of associated with transferring system data to the impairment model (e.g. due to manual process) there is a risk that the data used in the ECL model is inaccurate. • For loans classified as stage 2 or 3, these are individually assessed, an impairment assessment is required at an individual loan level, based on the probability of default and the estimated future cash flows discounted to present value at the loans effective interest rate (‘EIR’). There are a number of data inputs and assumptions including the cost of obtaining and selling collateral and, probable sale proceeds. Arbuthnot Banking Group PLCReport & Accounts 2018 36 Independent Auditor’s Report to the members of Arbuthnot Banking Group PLC continued Assessing transparency We evaluated whether the disclosures appropriately reflect and address the uncertainty which exists when determining the expected credit losses. As a part of this, we assessed the sensitivity analysis that is disclosed. In addition, we challenged whether the disclosure of the key judgments and assumptions made was sufficiently clear. Loan Loss Provisioning continued Our response Our audit procedures over SICR and the Group’s definition of default included: • Methodology implementation: We compared the Group’s SICR thresholds and definition of default with the relevant accounting standard. • Benchmarking assumptions: We compared the Group’s SICR thresholds and definition of default with other lenders. Our audit procedures over the Group’s economic scenarios included: • Sensitivity analysis: We performed sensitivity analysis over the probability weightings attached to each economic scenario. • Benchmarking assumptions: We compared the Group’s probability weightings attached to each economic scenario to other lenders. Our audit procedures over the Group’s ECL model included: • Data comparison: We checked a sample of the internal data used in the model back to the Group’s and Bank’s underlying source. We also checked the external inputs of collateral valuations to supporting documentation. • Methodology implementation: We assessed whether the model, if applied as designed, would perform the impairment calculation as intended. Our audit procedures over the Group’s stage 2 and 3 loans where impairment indicators had been identified included: • Test of detail: We tested the completeness of the Group’s listing of loans classified as stage 2 or 3 by assessing the accuracy of arrears reporting. • Assessing valuers credential: We evaluated the competence of the valuers engaged by the directors to support the valuation of collateral. This included consideration of their qualifications and expertise. • Sensitivity analysis: We performed sensitivity analysis over the collateral valuation, time to sell and probability of default assumptions. Arbuthnot Banking Group PLCReport & Accounts 2018 37 Revenue Recognition: Effective Interest Rate Group: £65.3 million; (2017: £47.4 million) The risk Group Subjective estimate Using models, interest and fees earned and incurred on loans are recognised using the effective interest rate (‘EIR’) method that spreads directly attributable expected cash flows over the expected lives of the loans. The expected lives of loans are uncertain. The most significant areas where we identified greater levels of management judgement are: • Accounting implications: for originated loans, transaction costs are required to be spread over the EIR period. Given that transaction costs are often one-off costs, usually occurring either at the start or at the end of the contract, it is not uncommon for these to be overlooked when constructing EIR models. • Calculation error: the EIR model is complex and so open to the possibility of arithmetical errors and that modelling principles are not in accordance with accounting requirements. • Data capture: the EIR model uses data about the Group’s loans that are sourced in other systems. The transfer of data from the underlying system to the EIR model is a manual process. There is a risk that the data used in the model is inaccurate. The effect of these matters is that, as part of our risk assessment, we determined that revenue recognition; effective interest rate has a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount. Note 4 discloses the sensitivities estimated by the Group. Refer to page 29 (Audit Committee Report), Note 3.4 (accounting policy) and Note 8 (financial disclosures). Our response Our procedures included: • Methodology implementation: We compared the application of the EIR methodology and the cash flows included in the models with the relevant accounting standard, checking that the model included the appropriate transaction costs. • Tests of detail: Through sample testing we assessed whether the model performs the EIR calculation as designed. • Control operations: We visited the servicer for the loan book not administered by the Group to test the relevant controls over the recording of loan balances and interest at these entities. • Data capture: We performed sample testing to assess the accuracy and consistency of the information provided by the servicer company to the Group; and that this is appropriately captured in the models. • Sensitivity analysis: We assessed the models for their sensitivity to changes in the key assumptions by considering different profiles to help us assess the reasonableness of the assumptions used and identify areas of potential additional focus. • Historical comparison: We critically assessed the Group’s cash flow forecasts by comparing them to current and past performance of the Group’s portfolios, including recent cash collections. • Assessing transparency: We evaluated whether the disclosures appropriately reflect and address the level of subjective estimation that exists when determining revenue recognition on the Group’s loan portfolios. In addition, we challenged whether the disclosure of the key estimates and assumptions made was sufficiently clear. Arbuthnot Banking Group PLCReport & Accounts 2018 38 Independent Auditor’s Report to the members of Arbuthnot Banking Group PLC continued Investment Properties Group: £67.1 million; (2017: £59.4 million) The risk Group Subjective valuation Investment property requires the directors to apply significant judgments and estimates to its fair value assessment. The directors have prepared models with input from professional advisors to calculate the fair value of the investment properties. As a result there is an inherent risk that the assumptions used in the calculations are not complete, accurate or appropriate. The effect of these matters is that, as part of our risk assessment, we determined that investment properties have a high degree of estimation uncertainty, with a potential range of reasonable outcomes greater than our materiality for the financial statements as a whole, and possibly many times that amount. Note 4 discloses the sensitivities estimated by the Group. Refer to page 29 (Audit Committee Report), Note 3.17 (accounting policy) and Note 31 (financial disclosures). Our response Our procedures included: • Assessing valuers’ credentials: We evaluated the competence of the experts engaged by the Group to support the valuation methodologies and key assumptions. This included consideration of their qualifications and expertise. • Our property valuation expertise: With the assistance of our property valuation specialists, we challenged the valuation approaches and assumptions determined by the directors. • Benchmarking assumptions: We compared the Group’s key assumptions on yields taking into account market data and asset-specific considerations. We also considered whether other key assumptions applied by the Group (i.e. estimated future rental value) were supported by available data. • Sensitivity analysis: We have undertaken sensitivity analysis over the key valuation assumptions (i.e. yields, renovation costs and future rental value). • Assessing transparency: We assessed the adequacy of the investment property disclosures by reference to the requirements in IAS 40. Arbuthnot Banking Group PLCReport & Accounts 2018 39 Recoverability of Parent Company’s investment in subsidiaries Parent: £134.6 million; (2017: £97.8 million) The risk Parent Recoverability of investment The carrying value of the Parent Company’s investment in subsidiaries represents 79% (2017: 70%) of the Company’s total assets. Recoverability of the investment is not considered a high risk of significant misstatement or subject to significant judgement. However, due to the materiality of the investment in the context of the Parent Company financial statements, this is considered to be the area that had the greatest focus of our overall Parent Company audit. Refer to Note 3.1a (accounting policy) and Note 43 (financial disclosures). Our response Our procedures included: • Tests of detail: Compared the carrying amount of a sample of the highest value investments, representing 98% (2017: 98%) of the total investment balance with the relevant subsidiaries’ balance sheet to identify whether their net assets, being an approximation of their minimum recoverable amount, were in excess of their carrying amount and assessing whether those subsidiaries have historically been profit-making. • Assessing subsidiary audits: Assessing the work performed during the subsidiary audits on that sample of those subsidiaries and considering the results of that work, on those subsidiaries’ profits and net assets. Arbuthnot Banking Group PLCReport & Accounts 2018 40 Independent Auditor’s Report to the members of Arbuthnot Banking Group PLC continued 3. Our application of materiality and an overview of the scope of our audit Materiality for the Group financial statements as a whole was set at £600,000 (2017: £570,000). This was determined with reference to the performance of the individual components within the Group, representing 8.8% (2017: 8%) of Group profit before tax. Materiality for the Parent Company financial statements as a whole was set at £386,000(2017: £406,000), determined with reference to a benchmark of Parent Company profit before tax, of which it represents 4.5% (2017: 4.5% of Parent Company profit before tax). We reported to the Audit Committee any corrected or uncorrected identified misstatements exceeding £30,000 (2017: £28,500), in addition to other identified misstatements that warranted reporting on qualitative grounds. How we scoped our audit: Of the Group’s 6 (2017: 3) components, we subjected 6 (2017: 3) to full scope audits for group purposes. The components within the scope of our work accounted for the 100% (2017: 100%) of Group revenue, 100% (2017: 100%) of Group profit before tax and 100% of Group total assets (2017: 100%). The Group team approved the component materialities which ranged from £40,000 to £530,000 (2017: £130,000 to £515,000), having regard to the mix of size and risk profile of the Group and components. The audit of one (2017: one) component was performed by a UK component audit team. The audit of the remainder of the Group was performed by the Group audit team. The Group team instructed the component auditor as to the significant areas to be covered, including the relevant risks detailed above and the information to be reported back. Telephone conference meetings were held with the component auditor. At these meetings, the findings reported to the Group team were discussed in more detail, and any further work required by the Group team was then performed by the component auditor. Group profit before tax £6,780,000 (2017: £6,971,000) Group materiality £600,000 (2017: £570,000) £600,000 Whole financial statements materiality(cid:31) (2017: £570,000) £530,000 Range of materiality at 6 components £40,000 - £530,000 (cid:31) (2017: £130,000 – £515,000) £30,000 Misstatements reported to the audit committee (2017: £28,500) Group profit before tax Group materiality 0 0 100% (2017: 100%) 100 100 0 0 100% (2017: 100%) 100 100 Group revenue Group profit before tax 0 0 100% (2017: 100%) 100 100 Group total assets Full scope for group audit purposes 2018 Full scope for group audit purposes 2017 Arbuthnot Banking Group PLCReport & Accounts 2018 41 4. We have nothing to report on going concern Based on this work, we are required to report to you if: The Directors have prepared the financial statements on the going concern basis as they do not intend to liquidate the Company or the Group or to cease their operations, and as they have concluded that the Company’s and the Group’s financial position means that this is realistic. They have also concluded that there are no material uncertainties that could have cast significant doubt over their ability to continue as a going concern for at least a year from the date of approval of the financial statements (“the going concern period”). Our responsibility is to conclude on the appropriateness of the Directors’ conclusions and, had there been a material uncertainty related to going concern, to make reference to that in this audit report. However, as we cannot predict all future events or conditions and as subsequent events may result in outcomes that are inconsistent with judgments that were reasonable at the time they were made, the absence of reference to a material uncertainty in this auditor’s report is not a guarantee that the group or the company will continue in operation. In our evaluation of the Directors’ conclusions, we considered the inherent risks to the Group’s and Company’s business model and analysed how those risks might affect the Group’s and Company’s financial resources or ability to continue operations over the going concern period. The risks that we considered most likely to adversely affect the Group’s and Company’s available financial resources over this period was the impact of Brexit on the Group and Company’s liquidity and capital resources, in particular: • availability of funding and liquidity in the event of a market wide stress scenario including the impact of Brexit, and • impact on regulatory capital requirements and resources in the event of an economic slowdown or recession. As these were risks that could potentially cast significant doubt on the Group’s and the Company’s ability to continue as a going concern, we considered sensitivities over the level of available financial resources indicated by the Group’s financial forecasts taking account of reasonably possible (but not unrealistic) adverse effects that could arise from these risks individually and collectively and evaluated the achievability of the actions the Directors consider they would take to improve the position should the risks materialise. • we have anything material to add or draw attention to in relation to the directors’ statement in Note 2e to the financial statements on the use of the going concern basis of accounting with no material uncertainties that may cast significant doubt over the Group and Company’s use of that basis for a period of at least a year from the date of approval of the financial statements. We have nothing to report in these respects, and we did not identify going concern as a key audit matter. 5. We have nothing to report on the other information in the Annual Report The directors are responsible for the other information presented in the Annual Report together with the financial statements. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except as explicitly stated below, any form of assurance conclusion thereon. Our responsibility is to read the other information and, in doing so, consider whether, based on our financial statements audit work, the information therein is materially misstated or inconsistent with the financial statements or our audit knowledge. Based solely on that work we have not identified material misstatements in the other information. Strategic report and directors’ report Based solely on our work on the other information: • we have not identified material misstatements in the strategic report and the directors’ report; • in our opinion the information given in those reports for the financial year is consistent with the financial statements; and • in our opinion those reports have been prepared in accordance with the Companies Act 2006. Disclosures of principal risks and longer-term viability Based on the knowledge we acquired during our financial statements audit, we have nothing material to add or draw attention to in relation to: • the directors’ confirmation within the director’s report on page 22 that they have carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency and liquidity; • the Risks and Uncertainties disclosures describing these risks and explaining how they are being managed and mitigated; and Arbuthnot Banking Group PLCReport & Accounts 2018 42 Independent Auditor’s Report to the members of Arbuthnot Banking Group PLC continued • the directors’ explanation in the Group Directors’ Report - 7. Respective responsibilities Viability Statement of how they have assessed the prospects of the Group, over what period they have done so and why they considered that period to be appropriate, and their statement as to whether they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions. Our work is limited to assessing these matters in the context of only the knowledge acquired during our financial statements audit. As we cannot predict all future events or conditions and as subsequent events may result in outcomes that are inconsistent with judgments that were reasonable at the time they were made, the absence of anything to report on these statements is not a guarantee as to the Group’s and Company’s longer-term viability. Corporate governance disclosures We are required to report to you if: • we have identified material inconsistencies between the knowledge we acquired during our financial statements audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy; or • the section of the annual report describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee. We have nothing to report in these respects. 6. We have nothing to report on the other matters on which we are required to report by exception Under the Companies Act 2006, we are required 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. We have nothing to report in these respects. Directors’ responsibilities As explained more fully in their statement set out on page 24, the directors are responsible for: the preparation of the financial statements including being satisfied that they give a true and fair view; such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; assessing the Group and Parent Company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern; and using the going concern basis of accounting unless they either intend to liquidate the Group or the Parent Company or to cease operations, or have no realistic alternative but to do so. Auditor’s responsibilities Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue our opinion in an auditor’s report. Reasonable assurance is a high level of assurance, but does not guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. A fuller description of our responsibilities is provided on the FRC’s website at www.frc.org.uk/auditorsresponsibilities. Irregularities – ability to detect We identified areas of laws and regulations that could reasonably be expected to have a material effect on the annual accounts from our general commercial and sector experience, through discussion with the directors (as required by auditing standards), and from inspection of the Group’s regulatory correspondence and discussed with the directors the policies and procedures regarding compliance with laws and regulations. We communicated identified laws and regulations throughout our team and remained alert to any indications of non-compliance throughout the audit. The potential effect of these laws and regulations on the annual accounts varies considerably. Arbuthnot Banking Group PLCReport & Accounts 2018 43 8. The purpose of our audit work and to whom we owe our responsibilities 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. Pamela McIntyre (Senior Statutory Auditor) for and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants 15 Canada Square London E14 5GL 27 March 2019 Firstly, the Group is subject to laws and regulations that directly affect the annual accounts including financial reporting legislation (including related companies legislation, distributable profits legislation and taxation legislation), and we assessed the extent of compliance with these laws and regulations as part of our procedures on the related financial statement items. Secondly, the Group is subject to many other laws and regulations where the consequences of non-compliance could have a material effect on amounts or disclosures in the annual accounts, for instance through the imposition of fines or litigation or the loss of the Group’s licence to operate. We identified the following areas as those most likely to have such an effect: regulatory capital and liquidity, conduct, financial crime including money laundering and certain aspects of company legislation recognising the financial and regulated nature of the Group’s activities. Through these procedures we became aware of actual or suspected non-compliance and considered the effect as part of our procedures on the related financial statement items The actual or suspected non-compliance was not sufficiently significant to our audit to result in our response being identified as a key audit matter. Owing to the inherent limitations of an audit, there is an unavoidable risk that we may not have detected some material misstatements in the annual accounts, even though we have properly planned and performed our audit in accordance with auditing standards. For example, the further removed non-compliance with laws and regulations (irregularities) is from the events and transactions reflected in the financial statement , the less likely the inherently limited procedures required by auditing standards would identify it. In addition, as with any audit, there remained a higher risk of non-detection of irregularities, as these may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal controls. We are not responsible for preventing non-compliance and cannot be expected to detect non-compliance with all laws and regulations. Arbuthnot Banking Group PLCReport & Accounts 2018 44 Consolidated Statement of Comprehensive Income Note 8 9 10 11 12 13 14 Interest income Interest expense Net interest income Fee and commission income Fee and commission expense Net fee and commission income Operating income Net impairment loss on financial assets Other income Operating expenses Profit before tax from continuing operations Income tax expense Profit after tax from continuing operations Profit from discontinued operations after tax (Loss)/profit for the year Other comprehensive income Items that are or may be reclassified to profit or loss Available-for-sale reserve Available-for-sale reserve – Associate Tax on other comprehensive income Items that will not be reclassified to profit or loss Changes in fair value of equity investments at fair value through other comprehensive income Tax on other comprehensive income Other comprehensive (loss)/income for the period, net of tax Total comprehensive (loss)/income for the period Profit attributable to: Equity holders of the Company (Loss)/profit for the year Total comprehensive income attributable to: Equity holders of the Company Total comprehensive (loss)/income for the period Year ended 31 December 2018 £000 Year ended 31 December 2017 £000 65,290 (10,107) 55,183 12,956 (234) 12,722 67,905 (2,731) 6,588 (64,982) 6,780 (1,121) 5,659 (25,692) (20,033) – – – (13,893) (26) (13,919) (33,952) (20,033) (20,033) (33,952) (33,952) 47,427 (6,334) 41,093 13,805 (282) 13,523 54,616 (394) 3,033 (54,721) 2,534 (448) 2,086 4,437 6,523 128 389 (104) – – 413 6,936 6,523 6,523 6,936 6,936 14.0 29.9 43.9 14.0 29.9 43.9 Earnings per share for profit attributable to the equity holders of the Company during the year (expressed in pence per share): Basic earnings per share – Continuing operations 16 38.0 Basic earnings per share – Discontinued operations Basic earnings per share Diluted earnings per share – Continuing operations Diluted earnings per share – Discontinued operations Diluted earnings per share 16 16 16 16 16 (172.5) (134.5) 38.0 (172.5) (134.5) The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 Consolidated Statement of Financial Position 45 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost/held-to-maturity Assets classified as held for sale Derivative financial instruments Loans and advances to customers Other assets Financial investments Deferred tax asset Interests in associates Intangible assets Property, plant and equipment Investment property Total assets EQUITY AND LIABILITIES Equity attributable to owners of the parent Share capital Retained earnings Other reserves Total equity LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Current tax liability Other liabilities Debt securities in issue Total liabilities Total equity and liabilities Note At 31 December 2018 £000 At 31 December 2017 £000 17 18 19 20 21 22 24 25 26 27 28 30 31 37 38 38 32 21 33 34 35 405,325 54,173 342,691 8,002 1,846 1,224,656 12,716 35,351 1,490 – 16,538 5,304 67,081 2,175,173 153 209,083 (13,280) 195,956 232,675 188 1,714,286 236 18,549 13,283 1,979,217 2,175,173 313,101 70,679 227,019 2,915 2,551 1,049,269 20,624 2,347 1,527 83,804 15,995 3,962 59,439 1,853,232 153 237,171 (949) 236,375 195,097 931 1,390,781 705 16,239 13,104 1,616,857 1,853,232 The financial statements on pages 44 to 127 were approved and authorised for issue by the Board of directors on 27 March 2019 and were signed on its behalf by: Sir Henry Angest Director J.R. Cobb Director Registered Number: 1954085 The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 46 Company Statement of Financial Position ASSETS Loans and advances to banks Financial investments Current tax asset Deferred tax asset Intangible assets Property, plant and equipment Other assets Interests in associates Interests in subsidiaries Total assets EQUITY AND LIABILITIES Equity Share capital Other reserves Retained earnings Total equity LIABILITIES Current tax liability Other liabilities Debt securities in issue Total liabilities Total equity and liabilities Note At 31 December 2018 £000 At 31 December 2017 £000 18 25 26 28 30 24 27 43 37 38 38 34 35 17,008 19,313 52 113 6 208 42 – 134,614 171,356 153 (8,133) 162,729 154,749 – 3,324 13,283 16,607 171,356 36,103 140 – 641 – 157 199 5,056 97,802 140,098 153 (1,111) 124,659 123,701 152 3,141 13,104 16,397 140,098 The Company has elected to take the exemption under section 408 of the Companies Act 2006 not to present the Parent Company profit and loss account. The profit for the Parent Company for the year is presented in the Statement of Changes in Equity. The financial statements on pages 44 to 127 were approved and authorised for issue by the Board of directors on 27 March 2019 and were signed on its behalf by: Sir Henry Angest Director J.R. Cobb Director Registered Number: 1954085 The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 47 Retained earnings £000 237,171 (2,090) Total £000 236,375 (2,090) Consolidated Statement of Changes in Equity Attributable to equity holders of the Group Share capital £000 Capital redemption reserve £000 Fair value reserve* £000 Treasury shares £000 Balance at 31 December 2017 IFRS 9 adjustment net of tax Balance at 1 January 2018 Total comprehensive income for the period Loss for 2018 Other comprehensive income, net of tax Changes in fair value of equity investments at fair value through other comprehensive income** Tax on other comprehensive income Total other comprehensive income Total comprehensive income for the period Transactions with owners, recorded directly in equity Contributions by and distributions to owners Unwind Employee Trust Sale of Secure Trust Bank shares Final dividend relating to 2017 Interim dividend relating to 2018 Total contributions by and distributions to owners 153 – 153 – – – – – – – – – – 20 – 20 – – – – – – – – – – (1,131) – 162 – 162 (1,131) 235,081 234,285 – – (20,033) (20,033) (13,893) (26) (13,919) (13,919) – 1,588 – – 1,588 – – – – – – – – – – – – (13,893) (26) (13,919) (20,033) (33,952) 685 (1,588) (2,829) (2,233) 685 – (2,829) (2,233) (5,965) (4,377) Balance at 31 December 2018 153 20 (12,169) (1,131) 209,083 195,956 * The Available-for-sale reserve in 2017 was reclassified to the Fair value reserve as from 1 January 2018 with the introduction of IFRS 9. ** Mainly relate to movement in STB share price. There is currently no tax implications to the movement as the shareholding still qualifies for significant shareholding exemption. The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 48 Consolidated Statement of Changes in Equity continued Balance at 1 January 2017 Total comprehensive income for the period Profit for 2017 Other comprehensive income, net of tax Available-for-sale reserve – net change in fair value Available-for-sale reserve – Associate – net change in fair value Tax on other comprehensive income Total other comprehensive income Total comprehensive income for the period Transactions with owners, recorded directly in equity Contributions by and distributions to owners Equity settled share based payment transactions Final dividend relating to 2016 Interim dividend relating to 2017 Total contributions by and distributions to owners Balance at 31 December 2017 Attributable to equity holders of the Group Capital redemption reserve £000 Available- for-sale reserve £000 Treasury shares £000 Retained earnings £000 Total £000 20 (251) (1,131) 235,567 234,358 – – – – – – – – – – 20 – 128 389 (104) 413 413 – – – – – – – – – – – – – – 6,523 6,523 – – – – 128 389 (104) 413 6,523 6,936 (155) (2,680) (2,084) (155) (2,680) (2,084) (4,919) (4,919) 162 (1,131) 237,171 236,375 Share capital £000 153 – – – – – – – – – – 153 The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 Company Statement of Changes in Equity Balance at 1 January 2017 Total comprehensive income for the period Loss for 2017 Other comprehensive income, net of income tax Total comprehensive income for the period Transactions with owners, recorded directly in equity Contributions by and distributions to owners Equity settled share based payment transactions Final dividend relating to 2016 Interim dividend relating to 2017 Total contributions by and distributions to owners Balance at 31 December 2017 Total comprehensive income for the period Profit for 2018 Other comprehensive income, net of income tax Changes in fair value of equity investments at fair value through other comprehensive income** Total other comprehensive income Total comprehensive income for the period Transactions with owners, recorded directly in equity Contributions by and distributions to owners Unwind Employee Trust Sale of Secure Trust Bank shares Transfer of Secure Trust Bank shares to AL Final dividend relating to 2017 Interim dividend relating to 2018 Total contributions by and distributions to owners Balance at 31 December 2018 49 Attributable to equity holders of the Company Share capital £000 Capital redemption reserve £000 153 20 – – – – – – – 153 – – – – – – – – – – – 153 – – – – – – – 20 – – – – – – – – – – – 20 Fair value/ available- for-sale reserve* £000 – – – – – – – – – – – (10,624) (10,624) (10,624) – 1,588 2,014 – – 3,602 Treasury shares £000 Retained earnings £000 Total £000 (1,131) 133,847 132,889 – – – – – – – (4,269) (4,269) – – (4,269) (4,269) (155) (2,680) (2,084) (155) (2,680) (2,084) (4,919) (4,919) (1,131) 124,659 123,701 – – – – – – – – – – – 46,049 46,049 – – – – (10,624) (10,624) 46,049 35,425 685 (1,588) (2,014) (2,829) (2,233) 685 – – (2,829) (2,233) (7,979) (4,377) (7,022) (1,131) 162,729 154,749 * The Available-for-sale reserve in 2017 was reclassified to the Fair value reserve as from 1 January 2018 with the introduction of IFRS 9. ** Mainly relate to movement in STB share price. There is currently no tax implications to the movement as the shareholding still qualifies for significant shareholding exemption. The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 50 Consolidated Statement of Cash Flows Note Year ended 31 December 2018 £000 Year ended 31 December 2017 £000 Cash flows from operating activities Interest received Interest paid Fees and commissions received Other income Cash payments to employees and suppliers Taxation paid Cash flows from operating profits before changes in operating assets and liabilities Changes in operating assets and liabilities: – net increase in derivative financial instruments – net increase in loans and advances to customers – net decrease/(increase) in other assets – net increase in amounts due to customers – net increase/(decrease) in other liabilities Net cash inflow from operating activities Cash flows from investing activities Disposal of financial investments Purchase of computer software Purchase of property, plant and equipment Proceeds from sale of property, plant and equipment Purchase of investment property Disposal of Tarn Crag (Holdings) Limited Purchase of Renaissance Asset Finance Limited Cash balance acquired through Renaissance Asset Finance Limited acquisition Purchase of debt securities Proceeds from redemption of debt securities Net cash outflow from investing activities Cash flows from financing activities Increase/(decrease) in borrowings Dividends paid Net cash inflow/(outflow) from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at 1 January Cash and cash equivalents at 31 December 28 30 30 31 27 29 29 41 73,879 (8,290) 13,669 6,588 (84,216) (1,217) 413 (38) (180,600) 4,758 323,505 2,310 150,348 9,301 (2,294) (2,482) 97 (879) – – – (467,772) 356,883 (107,146) 37,578 (5,062) 32,516 75,718 383,780 459,498 43,389 (6,093) 8,682 3,033 (47,600) (379) 1,032 (331) (233,175) (7,952) 392,937 (843) 151,668 – (2,641) (666) – (6,421) 900 (2,072) 2,815 (211,080) 90,410 (128,755) 132,928 (4,764) 128,164 151,077 232,703 383,780 The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 Company Statement of Cash Flows 51 Note Year ended 31 December 2018 £000 Year ended 31 December 2017 £000 Cash flows from operating activities Dividends received from subsidiaries Interest received Interest paid Other income Cash payments to employees and suppliers Taxation paid Cash flows from operating profit/(loss) before changes in operating assets and liabilities Changes in operating assets and liabilities: – net decrease/(increase) in group company balances – net (increase)/decrease in other assets – net increase in other liabilities Net cash inflow/(outflow) from operating activities Cash flows from investing activities Increase investment in subsidiary Disposal of property, plant and equipment Purchase of property, plant and equipment Net cash (outflow)/inflow from investing activities Cash flows from financing activities Dividends paid Net cash used in financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at 1 January Cash and cash equivalents at 31 December 43 30 41 3,056 84 (559) 52,260 (50,316) (402) 4,123 155 (1) 187 4,464 (18,500) 97 (94) (18,497) (5,062) (5,062) (19,095) 36,103 17,008 2,618 202 (513) 1,643 (7,977) – (4,027) (1,788) 690 120 (5,005) (43,200) – – (43,200) (4,764) (4,764) (52,969) 89,072 36,103 The notes on pages 52 to 127 are an integral part of these consolidated financial statements Arbuthnot Banking Group PLCReport & Accounts 2018 52 Notes to the Consolidated Financial Statements 1. Reporting entity Arbuthnot Banking Group PLC is a company domiciled in the United Kingdom. The registered address of Arbuthnot Banking Group PLC is 7 Wilson Street, London, EC2M 2SN. The consolidated financial statements of Arbuthnot Banking Group PLC as at and for the year ended 31 December 2018 comprise Arbuthnot Banking Group PLC and its subsidiaries (together referred to as the “Group” and individually as “subsidiaries”). The Company is the holding company of a group primarily involved in banking and financial services. 2. Basis of preparation (a) Statement of compliance The Group’s consolidated financial statements and the Company’s financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs as adopted and endorsed by the EU) and the Companies Act 2006 applicable to companies reporting under IFRS. The consolidated financial statements were authorised for issue by the Board of Directors on 27 March 2019. (b) Basis of measurement The consolidated and company financial statements have been prepared under the historical cost convention, as modified by investment property and derivatives, financial assets and financial liabilities at fair value through profit or loss or other comprehensive income. (c) Functional and presentational currency Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (“the functional currency”). The consolidated financial statements are presented in Pounds Sterling, which is the Company’s functional and the Group’s presentational currency. (d) Use of estimates and judgements The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group’s accounting policies. The areas involving a higher degree of judgement or complexity, or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 4. (e) Going concern After making appropriate enquiries which assessed strategy, profitability, funding, risk management (see Note 6) and capital resources (see Note 7), the directors are satisfied that the Company and the Group have adequate resources to continue in operation for the foreseeable future. The financial statements are therefore prepared on the going concern basis. (f) Accounting developments The accounting policies adopted are consistent with those of the previous financial year, except for the following: IFRS 9 ‘Financial Instruments’ IFRS 9 Financial Instruments is effective for annual periods beginning on or after 1 January 2018. It replaces IAS 39 Financial Instruments: Recognition and Measurement. The Group has adopted IFRS 9 on 1 January 2018. This results in changes in accounting policies previously recognised in the financial statements. In accordance with the transitional arrangements of IFRS 9 comparative figures have not been restated. However, as required by the transitional arrangements if prior periods are not restated, any difference arising between IAS 39 carrying amounts and IFRS 9 carrying amounts at 1 January 2018 are recognised in opening retained earnings (or in other comprehensive income, as applicable) at 1 January 2018. IFRS 9 introduces key changes in the following areas: • Classification and measurement, that is based on the business model and contractual cash flow characteristics of the financial instruments. • Impairment, introducing an expected credit loss model using forward looking information which replaces the incurred loss model. The expected loss model introduces a three stage approach to impairment. Arbuthnot Banking Group PLCReport & Accounts 2018 53 (a) Classification and measurement The Group classifies financial assets into one of the three following categories: • Amortised cost, financial assets held in a business model in order to collect contractual cash flows, where the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest (“SPPI”) on the principal amount outstanding. • Fair value through other comprehensive income (“FVOCI”), financial assets held in a business model which collects contractual cash flows and sells financial assets where the contractual terms of the financial assets give rise on specified dates to cash flows that are solely payments of principal and interest (“SPPI”) on the principal amount outstanding. The Group currently has no financial assets within this business model. • Fair value through profit or loss (“FVPL), assets not measured at amortised cost or FVOCI. There is an option to make an irrevocable election on initial recognition for non-traded equity investments to be measured at FVOCI, in which case dividends are recognised in profit or loss, but gains or losses are not reclassified to profit or loss upon de-recognition, and impairment is not recognised in the income statement. The election can be made on an instrument by instrument basis. IFRS 9 has not changed the classification or measurement of the Groups financial liabilities. (b) Impairment IFRS 9 replaced the IAS 39 “incurred loss” impairment recognition framework with a three stage expected credit loss approach (“ECL”). The three stages under IFRS 9 are as follows: • Stage 1 – entities are required to recognise a 12 month ECL allowance on initial recognition. • Stage 2 – a lifetime loss allowance is held for assets where a significant increase in credit risk has been identified since initial recognition for financial assets that are not credit impaired. The assessment of whether credit risk has increased significantly since initial recognition is performed for each reporting period for the life of the loan. • Stage 3 – a lifetime ECL allowance is required for financial assets that are credit impaired at the reporting date. Measurement of ECL The assessment of credit risk and the estimation of ECL are unbiased and probability weighted. ECL is measured on either a 12 month (Stage 1) or lifetime (Stage 2) basis depending on whether a significant increase in credit risk has occurred since initial recognition or where an account meets the Group’s definition of default (Stage 3). The ECL calculation is a product of an individual loan’s probability of default (‘PD’), exposure at default (‘EAD’) and loss given default (‘LGD’) discounted at the effective interest rate (‘EIR’). Significant increase in credit risk (“SICR”) (movement to Stage 2) The Group’s transfer criteria determines what constitutes a significant increase in credit risk, which results in a financial asset being moved from Stage 1 to Stage 2. The Group has determined that a significant increase in credit risk arises when an individual borrower is more than 30 days past due or if forbearance measures have been put in place. The Group monitors the ongoing appropriateness of the transfer criteria, where any proposed amendments will be reviewed and approved by the Groups Credit Committees at least annually and more frequently if required. A borrower will move back into stage 1 conditional upon both a minimum of 6 months’ good account conduct and the improvement of the Client’s situation to the extent that the probability of default has receded sufficiently and a full repayment of the loan, without recourse to the collateral, is likely. Arbuthnot Banking Group PLCReport & Accounts 2018 54 Notes to the Consolidated Financial Statements continued 2. Basis of preparation (continued) Definition of default (movement to Stage 3) The Group uses a number of qualitative and quantitative criteria to determine whether an account meets the definition of default and as a result moves into Stage 3. The criteria are as follows: • The rebuttable assumption that more than 90 days past due is an indicator of default. The Group therefore deems more than 90 days past due as an indicator of default, except for cases where the customer is already within forbearance. This will ensure that the policy is aligned with the Basel/Regulatory definition of default. • The Group has also deemed it appropriate to classify accounts where there has been a breach in agreed forbearance arrangements, recovery action is in hand or Bankruptcy proceedings or similar insolvency process of a client, or director of a company. A borrower will move out of Stage 3 when their credit risk improves such that they are no longer past due and remain up to date for an internally approved period. Forward looking macroeconomic scenarios IFRS 9 requires the entity to consider the risk of default and impairment loss taking into account expectations of economic changes that are reasonable. The Group uses a bespoke macroeconomic model to determine the most significant factors which may influence the likelihood of an exposure defaulting in the future. At present, the most significant macroeconomic factor relates to property prices. The Group currently consider five probability weighted scenarios. The model adopts five probability weighted scenarios no change, severe, moderate, growth and decline. The Group has derived an approach for factoring probability weighted macroeconomic forecasts into ECL calculations, adjusting PD and LGD estimates. Expected life IFRS 9 requires lifetime expected credit losses to be measured over the expected life. Currently the Group considers the loan’s behavioural life is equal to the contractual loan term. This approach will continue to be monitored and enhanced if and when deemed appropriate. Transition disclosures The following table shows the original measurement categories in accordance with IAS 39 and the new measurement categories under IFRS 9 for the Group’s financial assets and financial liabilities as at 1 January 2018: Financial assets Cash and balances at central banks Loans and advances to banks Debt securities Derivative financial instruments Loans and advances to customers Financial investments – Equity Financial investments – Debt Total financial assets Financial liabilities Deposits from banks Deposits from customers Derivative financial instruments Total financial liabilities Original classification under IAS 39 Loans and receivables Loans and receivables Held-to-maturity FVPL Loans and receivables Available-for-sale Available-for-sale Amortised cost Amortised cost FVPL Carrying amount under IAS 39 on 31 December 2017 £000 New classification under IFRS 9 Carrying amount under IFRS 9 on 1 January 2018 £000 313,101 70,679 227,019 2,551 1,049,269 1,635 712 1,664,966 195,097 1,390,781 931 1,586,809 Amortised cost Amortised cost Amortised cost Mandatorily at FVPL Amortised cost Designated FVOCI FVPL Amortised cost Amortised cost Mandatorily at FVPL 313,101 70,679 227,019 2,551 1,046,689 1,635 712 1,662,386 195,097 1,390,781 931 1,586,809 Arbuthnot Banking Group PLCReport & Accounts 2018 55 The following table sets out the impact of adopting IFRS 9 on the statement of financial position carrying amounts and retained earnings as at 1 January 2018. Only balances impacted by the transition to IFRS 9 are included in the table; all other balances are unchanged. Group Impact of adoption of IFRS 9 on retained earnings Recognition of expected credit losses under IFRS 9 Related tax Impact at 1 January 2018 £000 2,580 (490) 2,090 Impact of adopting IFRS 9 on the impairment of the financial assets The most significant impact on the Group’s financial statements from the adoption of IFRS 9 results from the new impairment requirements. On the adoption of IFRS 9 on 1 January 2018, the increase in loss allowances (before tax) was £2.6m. The following table reconciles the closing impairment for financial assets in accordance with IAS 39 as at 31 December 2017, to the opening ECL allowance determined in accordance with IFRS 9 as at 1 January 2018: Group IAS 39 carrying amount on 31 December 2017 £000 Re-measurement £000 Loans and advances to customers (gross) Less allowances for impairment Loans and advances to customers 1,050,631 (1,362) 1,049,269 – (2,580) (2,580) IFRS 9 opening balance on 1 January 2019 £000 1,050,631 (3,942) 1,046,689 Of which Stage 2 £000 29,502 (1,178) 28,324 Stage 1 £000 992,252 (1,244) 991,008 Stage 3 £000 28,877 (1,520) 27,357 The ECL coverage as a percentage of gross loans and advances at 1 January 2018 was 0.38% and by Stage as follows: Stage 1 - 0.13%, Stage 2 - 3.99% and Stage 3 - 5.26%. Forward looking information The Group incorporates forward looking information (FLI) into the assessment of whether there has been a significant increase in credit risk and the calculation of ECLs. IFRS 9 requires an unbiased and probability weighted estimate of credit losses by evaluating a range of possible outcomes that incorporates forecasts of future economic conditions. FLI is required to be incorporated into the measurement of ECL as well as the determination of whether there has been a significant increase in credit risk since origination. Measurement of ECLs at each reporting period should reflect reasonable and supportable information at the reporting date about past events, current conditions and forecasts of future economic conditions. Forecasts for key macroeconomic variables that most closely correlate with the Bank’s portfolio are used to produce five economic scenarios, comprising of no change, upside case, downside case, moderate stress and severe stress, and the impacts of these scenarios are then probability weighted. The estimation and application of this forward looking information will require significant judgement. External information is used to produce the forecast information. Transition impact including impact on capital The Group recorded an adjustment to its opening retained earnings as at 1 January 2018 to reflect the application of the new requirements at the adoption date, and has not restated comparative periods. The total adjustment to capital was £2.8m. Under IFRS 9, the Group’s CET1 ratio has reduced by approximately 1 basis points after transitional relief (23 basis points before transitional relief). This is mainly driven by the increase in IFRS 9 ECL for standardised portfolios that directly impacts CET1 as there is no regulatory deduction to absorb the increase. CET 1 ratio • 17.32% under IAS 39 at 31 December 2017; • 17.09% under IFRS 9 at 1 January 2018 before transitional relief; • 17.31% under IFRS 9 at 1 January 2018 after transitional relief. Arbuthnot Banking Group PLCReport & Accounts 2018 56 Notes to the Consolidated Financial Statements continued 2. Basis of preparation (continued) Transition impact including impact on capital (continued) Transitional relief relates to the phasing of the impact of the initial adoption of ECL as permitted by Regulation (EU) 2017/2395 of the European Parliament and Council. The Group has adopted the transitional relief. Under this approach, the balance of ECL allowances in excess of the regulatory excess EL and standardised portfolios are phased into the CET1 capital base over 5 years. The proportion phased in for the balance at each reporting period is 2018: 5%; 2019 15%; 2020 30%; 2021 50%; 2022 75%. From 2023 onwards, there is no transitional relief. Impact on Governance and Controls The Group plans to apply its existing governance framework to ensure that appropriate controls and validations are in place over key processes and judgments to determine the ECL. As part of the implementation, the Group has refined existing internal controls and implemented new controls where required in areas that are impacted by IFRS 9, including controls over the development and probability weighting of macroeconomic scenarios, credit risk data and systems, and the determination of a significant increase in credit risk. IFRS 15 Revenue from Contracts with customers On 1 January 2018, the Group adopted the requirements of IFRS 15. IFRS 15 established a comprehensive framework for revenue recognition. It replaces existing revenue recognition guidance, including IAS 18 Revenue. IFRS 15 establishes the principles to apply when reporting information about the nature, amount, timing and uncertainty of revenue and cash flows from a contract with a customer. The standard introduces a five step revenue recognition model to be applied to all contracts with customers to determine whether, how much, and when revenue is recognised. The new standard replaces IAS 18 ‘Revenue’, IAS 11 ‘Construction Contracts’ and related interpretations. It applies to all revenue arising from contracts with customers but does not apply to insurance contracts, financial instruments or lease contracts, which fall under the scope of other IFRS standards. It also does not apply if two companies in the same line of business exchange non-monetary assets to facilitate sales to other parties. Of particular note, interest income, the main source of revenue for the Group, falls outside the scope of IFRS 15. The Group also generates fees from banking services, primarily management fees and commissions. Fees in respect of banking services are recognised in line with the satisfaction of performance obligations. This can be either at a point in time or over time, in line with the provision of the service to the customer. The majority of banking services are performed at a point in time and payment is due from a customer at the time a transaction takes place. For services performed over time, payment is generally due in line with the satisfaction of performance obligations. The costs of providing these banking services are incurred as the services are rendered. The price is usually fixed and always determinable. The Group has adopted IFRS 15 using the cumulative effect method (without practical expedients), as such the standard is applied as of 1 January 2018 and comparative information is not restated. The cumulative effect of initially applying IFRS 15 is recognised as an adjustment to the opening balance of retained earnings. IFRS 15 is only applied retrospectively to contracts that are not completed contracts at 1 January 2018. The Group assessed its non-interest revenue streams that fall under the scope of IFRS 15 and determined that there was no material impact on the amount or timing of revenue to be recognised as a result of the adoption of IFRS 15. As such there is no adjustment to the opening balance of retained earnings or related tax balances. Furthermore, there is no impact to the consolidated statement of financial position or the consolidated statements of profit and loss and other comprehensive income. Revenue is disaggregated by reportable segment as detailed in Note 9. Arbuthnot Banking Group PLCReport & Accounts 2018 57 3. Significant accounting policies The accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated. 3.1. Consolidation (a) Subsidiaries Subsidiaries are all investees (including special purpose entities) controlled by the Group. The Group controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Subsidiaries are fully consolidated from the date on which control is transferred to the Group. They are de-consolidated from the date that control ceases. The acquisition method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange. Identifiable assets acquired, liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. The excess of the cost of acquisition over the fair value of the Group’s shares of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised directly in the Statement of Comprehensive Income as a gain on bargain purchase. Contingent consideration related to an acquisition is initially recognised at the date of acquisition as part of the consideration transferred, measured at its acquisition date fair value and recognised as a liability. The fair value of a contingent consideration liability recognised on acquisition is remeasured at key reporting dates until it is settled, changes in fair value are recognised in the profit or loss. The Company’s investments in subsidiaries are recorded at cost less, where appropriate, provisions for impairment in value. Inter-company transactions, balances and unrealised gains on transactions between Group companies are eliminated. Unrealised losses are also eliminated. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group. (b) Changes in ownership and non-controlling interests Changes in ownership interest in a subsidiary that do not result in the loss of control are accounted for as equity transactions and no gain or loss is recognised. Adjustments to non-controlling interests are based on a proportionate amount of the net assets of the subsidiary. When control of a subsidiary is lost, the Group derecognises the assets, liabilities, non-controlling interest and all other components of equity relating to the former subsidiary from the consolidated statement of financial position. Any resulting gain or loss is recognised in profit or loss. Any investment retained in the former subsidiary is recognised at its fair value at the date when control is lost. (c) Special purpose entities Special purpose entities (“SPEs”) are entities that are created to accomplish a narrow and well-defined objective such as the securitisation of particular assets or the execution of a specific borrowing or lending transaction. SPEs are consolidated when the investor controls the investee. The investor would only control the investee if it had all of the following: • power over the investee; • exposure, or rights, to variable returns from its involvement with the investee; and • the ability to use its power over the investee to affect the amount of the investor’s returns. The assessment of whether the Group has control over an SPE is carried out at inception and the initial assessment is only reconsidered at a later date if there were any changes to the structure or terms of the SPE, or there were additional transactions between the Group and the SPE. (d) Associates Associates are those entities in which the Group has significant influence, but not control, over the financial and operating policies. Significant influence is presumed to exist when the Group holds between 20 and 50 percent of the voting power of another entity. Associates are accounted for using the equity method and are initially recognised at cost. The Group’s investment includes goodwill identified on acquisition, net of any accumulated impairment losses. The consolidated financial statements include the Group’s share of the total comprehensive income and equity movements of equity accounted investees, from the date that significant influence commences until the date that significant influence ceases. When the Group’s share of losses exceeds its interest in an equity accounted investee, the Group’s carrying amount is reduced to nil and recognition of further losses is discontinued except to the extent that the Group has incurred legal or constructive obligations or made payments on behalf of the investee. Arbuthnot Banking Group PLCReport & Accounts 2018 58 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) 3.2. Segment reporting Operating segments are reported in a manner consistent with the internal reporting provided to the Group Board. The Group Board, which is responsible for allocating resources and assessing performance of the operating segments, has been identified as the chief operating decision maker. All transactions between segments are conducted on an arm’s length basis. Income and expenses directly associated with each segment are included in determining segment performance. There are six operating segments: • Private Banking – Provides traditional private banking services as well as offering financial planning and investment management services. • Commercial Banking – Provides bespoke commercial banking services and tailored secured lending against property investments and other assets. • RAF – Specialist asset finance lender mainly in high value cars but also business assets. • All Other Divisions – All other smaller divisions and central costs in Arbuthnot Latham & Co., Ltd (Arbuthnot Commercial Asset-Based Lending, Arbuthnot Direct, Arbuthnot Specialist Finance, Dubai, Tay mortgage portfolio, Investment properties and Central costs). • Group Centre – ABG Group Centre management. 3.3. Foreign currency translation Foreign currency transactions are translated into the functional currency using the spot exchange rates prevailing at the dates of the transactions or valuation where items are remeasured. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the Statement of Comprehensive Income. Foreign exchange differences arising from translation of equity instruments, where an election has been made to present subsequent fair value changes in Other Comprehensive Income (“OCI”), will also be recognised in OCI. 3.4. Interest income and expense Interest income and expense are recognised in the Statement of Comprehensive Income for all instruments measured at amortised cost using the effective interest rate (“EIR”) method. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to: • the gross carrying amount of the financial asset; or • the amortised cost of the financial liability. The ‘gross carrying amount of a financial asset’ is the amortised cost of a financial asset before adjusting for any expected credit loss allowance. When calculating the effective interest rate, the Group takes into account all contractual terms of the financial instrument but does not consider expected credit losses. The calculation includes all fees paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts. The carrying amount of the financial asset or financial liability is adjusted if the Group revises its estimates of payments or receipts. The adjusted carrying amount is calculated based on the original effective interest rate and the change in carrying amount is recorded as interest income or expense. For financial assets that have become credit impaired following initial recognition, interest income is calculated by applying the effective interest rate to the amortised cost of the financial asset. If the asset is no longer credit impaired, then the calculation of interest income reverts to the gross basis. Arbuthnot Banking Group PLCReport & Accounts 2018 59 The Group monitors the actual cash flows for each acquired book and where they diverge significantly from expectation, the future cash flows are reset. Expectation may diverge due to factors such as one-off payments or expected credit losses. In assessing whether to adjust future cash flows on an acquired portfolio, the Group considers the cash variance on an absolute and percentage basis. The Group also considers the total variance across all acquired portfolios. Where cash flows for an acquired portfolio are reset, they are discounted at the EIR to derive a new carrying value, with changes taken to profit or loss as interest income. The EIR rate is adjusted for events where there is a change to the reference interest rate (Bank of England base rate) affecting portfolios with a variable interest rate which will impact future cash flows. The revised EIR is the rate which exactly discounts the revised cash flows to the net carrying value of the loan portfolio. 3.5. Fee and commission income Fee and commission income which is integral to the EIR on a financial asset are included in the effective interest rate (see Note 3.4). All other fee and commission income is recognised as the related services are performed, under IFRS 15. Fee and commission income is reported in the below segments. Types of fee Description Banking commissions – Banking Tariffs are charged monthly for services provided. Investment management fees – Annual asset management fees relate to a single performance obligation that is continuously provided over an extended period of time. Wealth planning fees – Provision of bespoke, independent Wealth Planning solutions to Arbuthnot Latham’s clients to Foreign exchange fees – Provides foreign currencies for our clients to purchase/sell. help them achieve their long-term financial goals. The principles in applying IFRS 15 to fee and commission use the following 5 step model: • identify the contract(s) with a customer; • identify the performance obligations in the contract; • determine the transaction price; • allocate the transaction price to the performance obligations in the contract; and • recognise revenue when or as the Group satisfies its performance obligations. Asset and other management, advisory and service fees are recognised, under IFRS 15, as the related services are performed. The same principle is applied for financial planning services that are continuously provided over an extended period of time. The Group includes the transaction price, some or all of an amount of, variable consideration estimated only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Policy applicable before 1 January 2018 Fees and commissions which are not considered integral to the effective interest rate are recognised on an accrual basis when the service has been provided. Asset and other management, advisory and service fees are recognised on an accruals basis as the related services are performed. The same principle is applied for financial planning services that are continuously provided over an extended period of time. 3.6. Rental income Rental income is recognised on a straight line basis over the term of the lease. Lease incentives granted are recognised as an integral part of the total rental income over the term of the lease. Arbuthnot Banking Group PLCReport & Accounts 2018 60 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) 3.7. Discontinued operations A discontinued operation is a component of the Group’s business, the operations and cash flows of which can be clearly distinguished from the rest of the Group and which: • represents a separate major line of business or geographical area of operations; • is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations; or • is a subsidiary acquired exclusively with a view to re-sale. Classification as a discontinued operation occurs on disposal or when the operation meets the criteria to be classified as held for sale (see Note 3.14), if earlier. When an operation is classified as a discontinued operation, the comparative Statement of Comprehensive Income is re-presented as if the operation had been discontinued from the start of the comparative year. 3.8. Financial assets and financial liabilities 3.8.1 Financial assets and financial liabilities (policy applicable from 1 January 2018) IFRS 9 requires financial assets and liabilities to be measured at amortised cost, fair value through other comprehensive income (“FVOCI”) or fair value through the profit and loss (“FVPL”). Liabilities are measured at amortised cost or FVPL. The Group classifies financial assets and financial liabilities in the following categories: financial assets and financial liabilities at FVPL; FVOCI, financial assets and liabilities at amortised cost and other financial liabilities. Management determines the classification of its financial instruments at initial recognition. A financial asset or financial liability is measured initially at fair value plus, transaction costs that are directly attributable to its acquisition or issue with the exception of financial assets at FVPL where these costs are debited to the income statement. (a) Financial instruments measured at amortised cost Financial assets that are held to collect contractual cash flows where those cash flows represent solely payments of principal and interest are measured at amortised cost. A basic lending arrangement results in contractual cash flows that are solely payments of principal and interest on the principal amount outstanding. Financial assets measured at amortised cost are predominantly loans and advances and debt securities. Loans and advances Loans and advances are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable and the SPPI criteria are met. Loans are recognised when cash is advanced to the borrowers inclusive of transaction costs. Loans and advances, other than those relating to assets leased to customers, are carried at amortised cost using the effective interest rate method. The accounting for assets leased to customers is set out under Note 3.18(a). Debt securities at amortised cost Debt securities at amortised cost are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group has determined meets the SPPI criteria. Debt security investments are carried at amortised cost using the effective interest rate method, less any impairment loss. (b) Financial assets and financial liabilities at FVPL Financial assets and liabilities are classified at FVPL where they do not meet the criteria to be measured at amortised cost or FVOCI or where financial assets are designated at FVPL to reduce an accounting mismatch. They are measured at fair value in the statement of financial position, with fair value gains/losses recognised in the income statement. Financial assets that are held for trading or managed within a business model that is evaluated on a fair value basis are measured at FVPL, because the business objective is neither hold-to-collect contractual cash flows nor hold-to-collect-and-sell contractual cash flows. This category comprises derivative financial instruments and financial investments. Derivative financial instruments utilised by the Group include structured notes and derivatives used for hedging purposes. Financial assets and liabilities at FVPL are initially recognised on the date from which the Group becomes a party to the contractual provisions of the instrument, including any acquisition costs. Subsequent measurement of financial assets and financial liabilities held in this category are carried at FVPL until the investment is sold. Arbuthnot Banking Group PLCReport & Accounts 2018 61 (c) Financial instruments at FVOCI Financial instruments at FVOCI are those not classified as another category of financial assets. These include investments in special purpose vehicles and equity investments in unquoted vehicles. They may be sold in response to liquidity requirements, interest rate, exchange rate or equity price movements. Financial investments are initially recognised at cost, which is considered as the fair value of the investment including any acquisition costs. The securities are subsequently measured at fair value in the statement of financial position. Fair value changes in the securities are recognised directly in equity (OCI). A debt instrument is measured at fair value through other comprehensive income if it meets both of the following conditions: • the asset is held within a business model whose objective is achieved by collecting contractual cash flows and selling financial assets; and • the contractual terms of the financial asset meet the SPPI criterion. There is a rebuttable presumption that all equity investments are FVPL, however on initial recognition the Group may make an irrevocable election to present the fair value movement of equity investments that are not held for trading within OCI. The election can be made on an instrument by instrument basis. For debt instruments, changes in fair value are recognised in OCI. For equity instruments, there are no reclassifications of gains and losses to the profit or loss statement on derecognition and no impairment recognised in the profit or loss. Equity fair value movements are not reclassified from OCI under any circumstances. (d) Financial guarantees and loan commitments Financial guarantees represent undertakings that the Group will meet a customer’s obligation to third parties if the customer fails to do so. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. The Group is theoretically exposed to loss in an amount equal to the total guarantees or unused commitments; however, the likely amount of loss is expected to be significantly less; most commitments to extend credit are contingent upon customers maintaining specific credit standards. Liabilities under financial guarantee contracts are initially recorded at their fair value, and the initial fair value is amortised over the life of the financial guarantee. Subsequently, the financial guarantee liabilities are measured at the higher of the initial fair value, less cumulative amortisation, and the best estimate of the expenditure to settle obligations. (e) Other financial liabilities Other financial liabilities are non-derivative financial liabilities with fixed or determinable payments. Other financial liabilities are recognised when cash is received from the depositors. Other financial liabilities are carried at amortised cost using the effective interest rate method. The fair value of other liabilities repayable on demand is assumed to be the amount payable on demand at the Statement of Financial Position date. Basis of measurement for financial assets and liabilities Amortised cost measurement The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition, minus principal payments, plus or minus the cumulative amortisation using the effective interest rate method of any difference between the initial amount recognised and the maturity amount, less any reduction for impairment. 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. When available, the Group measures the fair value of an instrument using quoted prices in an active market for that instrument. A market is regarded as active if quoted prices are readily and regularly available and represent actual and regularly occurring market transactions on an arm’s length basis. If a market for a financial instrument is not active, the Group establishes fair value using a valuation technique. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same for which market observable prices exist, net present value and discounted cash flow analysis. For measuring derivatives that might change classification from being an asset to a liability or vice versa such as interest rate swaps, fair values take into account both credit valuation adjustment (CVA) and debit valuation adjustment (DVA) when market participants take this into consideration in pricing the derivatives. Arbuthnot Banking Group PLCReport & Accounts 2018 62 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) Derecognition Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or when the Group has transferred substantially all risks and rewards of ownership. Any interest in transferred financial assets that qualify for derecognition that is created or retained by the Group is recognised as a separate asset or liability in the Statement of Financial Position. In transactions in which the Group neither retains nor transfers substantially all the risks and rewards of ownership of a financial asset and it retains control over the asset, the Group continues to recognise the asset to the extent of its continuing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset. There have not been any instances where assets have only been partially derecognised. The Group derecognises a financial liability when its contractual obligations are discharged, cancelled, expire, are modified or exchanged. Offsetting Financial assets and financial liabilities are offset and the net amount presented in the statement of financial position when, and only when, the Group currently has a legally enforceable right to set off the amounts and it intends either to settle them on a net basis or to realise the asset and settle the liability simultaneously. Income and expenses are presented on a net basis only when permitted under IFRS, or for gains and losses arising from a group of similar transactions such as the Group’s trading activity. 3.8.2 Financial assets and financial liabilities (policy applicable before 1 January 2018) The Group classifies financial assets and financial liabilities in the following categories: financial assets and financial liabilities at FVPL; loans and receivables; held-to-maturity investments; available-for-sale financial assets and other financial liabilities. Management determines the classification of its investments at acquisition. A financial asset or financial liability is measured initially at fair value plus, for an item not at fair value through profit or loss, transaction costs that are directly attributable to its acquisition or issue. (a) Financial assets and financial liabilities at FVPL (policy applicable before 1 January 2018) This category comprises listed securities and derivative financial instruments. Derivative financial instruments utilised by the Group include embedded derivatives and derivatives used for hedging purposes. Financial assets and liabilities at fair value through profit or loss are initially recognised on the date from which the Group becomes a party to the contractual provisions of the instrument. Subsequent measurement of financial assets and financial liabilities held in this category are carried at fair value through profit or loss. (b) Loans and receivables (policy applicable before 1 January 2018) Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable. Loans are recognised when cash is advanced to the borrowers. Loans and receivables, other than those relating to assets leased to customers, are carried at amortised cost using the effective interest rate method. (c) Held-to-maturity (policy applicable before 1 January 2018) Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group has the positive intent and ability to hold to maturity and that have not been designated at FVPL or as available-for-sale investments. Held-to-maturity investments are carried at amortised cost using the effective interest rate method, less any impairment loss. (d) Available-for-sale (policy applicable before 1 January 2018) Available-for-sale (“AFS”) investments are those not classified as another category of financial assets. These include investments in special purpose vehicles and equity investments in unquoted vehicles. They may be sold in response to liquidity requirements, interest rate, exchange rate or equity price movements. AFS investments are initially recognised at cost, which is considered as the fair value of the investment including any acquisition costs. AFS securities are subsequently measured at fair value in the statement of financial position. Fair value changes in the AFS securities are recognised directly in equity (AFS reserve) until the investment is sold or impaired. Once sold or impaired, the cumulative gains or losses previously recognised in the AFS reserve are recycled to the profit or loss. (e) Other financial liabilities Other financial liabilities are non-derivative financial liabilities with fixed or determinable payments. Other financial liabilities are recognised when cash is received from the depositors. Other financial liabilities are carried at amortised cost using the effective interest rate method. The fair value of other liabilities repayable on demand is assumed to be the amount payable on demand at the Statement of Financial Position date. Arbuthnot Banking Group PLCReport & Accounts 2018 63 3.9. Derivative financial instruments All derivatives are recognised at their fair value. Fair values are obtained using recent arm’s length transactions or calculated using valuation techniques such as discounted cash flow models at the prevailing interest rates, and for structured notes classified as financial instruments fair values are obtained from quoted market prices in active markets. Derivatives are shown in the Statement of Financial Position as assets when their fair value is positive and as liabilities when their fair value is negative. Embedded derivatives (policy before 1 January 2018) Embedded derivatives arise from contracts (‘hybrid contracts’) containing both a derivative (the ‘embedded derivative’) and a non- derivative (the ‘host contract’). Where the economic characteristics and risks of the embedded derivatives are not closely related to those of the host contract, and the host contract is not at fair value through profit or loss, the embedded derivative is bifurcated and reported at fair value and gains or losses are recognised in the Statement of Comprehensive Income. 3.10. Impairment of financial assets (a) Assets carried at amortised cost The Group recognises loss allowances on an expected credit loss basis for all financial assets measured at amortised cost, including loans and advances, debt securities and loan commitments. Credit loss allowances are measured as an amount equal to lifetime ECL, except for the following assets, for which they are measured as 12 month ECL: • Financial assets determined to have a low credit risk at the reporting date. • Financial assets which have not experienced a significant increase in credit risk since their initial recognition. Impairment model The IFRS 9 impairment model adopts a three stage approach based on the extent of credit deterioration since origination: • Stage 1: 12-month ECL applies to all financial assets that have not experienced a significant increase in credit risk (“SICR”) since origination and are not credit impaired. The ECL will be computed based on the probability of default events occurring over the next 12 months. This Stage 1 approach is different from the historic approach which estimates a collective allowance to recognise losses that have been incurred but not reported on performing loans. Stage 1 includes the current performing loans (up to date and in arrears of less than 10 days) and those within Heightened Business Monitoring (“HBM”). Accounts requiring HBM are classified as a short-term deterioration in financial circumstances and are tightly monitored with additional proactive client engagement, but not deemed SICR. A financial asset is within HBM where: • A loan is in arrears between 10 and 30 days; • Bankers become aware of signs of potential future difficulties, such as • cash flow difficulties • unexpected hard core borrowing • regular requests for excesses • returned cheques • lack of engagement/failure to respond to information requests • breach of covenants/conditions • count court judgements • Stage 2: When a financial asset experiences a SICR subsequent to origination, but is not in default, it is considered to be in Stage 2. This requires the computation of ECL based on the probability of all possible default events occurring over the remaining life of the financial asset. Provisions are higher in this stage (except where the value of charge against the financial asset is sufficient to enable recovery in full) because of an increase in credit risk and the impact of a longer time horizon being considered (compared to 12 months in Stage 1). Arbuthnot Banking Group PLCReport & Accounts 2018 64 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) Impairment model (continued) Evidence that a financial asset has experienced a SICR includes the following considerations: • A loan is in arrears between 31 and 90 days; • Forbearance action has been undertaken; and • Stage 3: Financial assets that are credit impaired are included in this stage. Similar to Stage 2, the allowance for credit losses will continue to capture the lifetime expected credit losses. At each reporting date, the Group will assess whether financial assets carried at amortised cost are in default. A financial asset will be considered to be in default when an event(s) that has a detrimental impact on estimated future cash flows have occurred. Evidence that a financial asset is within Stage 3 includes the following data: • A loan is in arrears in excess of 90 days; • Breach of terms of forbearance; • Recovery action is in hand; or • Bankruptcy proceedings or similar insolvency process of a client, or director of a company. The credit risk of financial assets that become credit impaired are not expected to improve such that they are no longer considered credit impaired. Presentation of allowance for ECL in the statement of financial position For financial assets measured at amortised cost, these are presented as the gross carrying amount of the assets minus a deduction for the ECL. Write-off Loans and debt securities are written off (either partially or in full) when there is no realistic prospect of recovery. This is the case when the Group determines that the borrower does not have assets or sources of income that could generate sufficient cash flows to repay the outstanding amount due. (b) Renegotiated loans Loans that are neither subject to ECLs nor individually significant, and whose terms have been renegotiated, are no longer considered to be past due but are treated as new loans. (c) Forbearance Under certain circumstances, the Group may use forbearance measures to assist borrowers who are experiencing significant financial hardship. Any forbearance support is assessed on a case by case basis in line with best practice and subject to regular monitoring and review. The Group seeks to ensure that any forbearance results in a fair outcome for both the customer and the Group. (d) Assets classified as financial investments Equity instruments at fair value through other comprehensive income Equity investments are not subject to impairment charges recognised in the income statement. Any fair value gains and losses are recognised in OCI whch are not subject to reclassification to the income statement on derecognition. Debt instruments at FVOCI Changes in fair value are recognised in OCI, the loss allowance will be recognised in OCI and shall not reduce the carrying amount of the financial asset in the statement of financial position. Impairment costs will be recognised in the profit or loss with a corresponding entry to OCI. On derecognition, cumulative gains and losses in OCI are reclassified to the profit or loss. Impairments to financial assets carried at FVOCI are recognised in the Statement of Comprehensive Income. Impairment of assets carried at amortised cost (policy applicable before 1 January 2018) On an ongoing basis the Group assesses whether there is objective evidence that a financial asset or group of financial assets is impaired. Objective evidence is the occurrence of a loss event, after the initial recognition of the asset, that impacts on the estimated contractual future cash flows of the financial asset or group of financial assets, and can be reliably estimated. Arbuthnot Banking Group PLCReport & Accounts 2018 65 The criteria that the Group uses to determine whether there is objective evidence of an impairment loss include, but are not limited to the following: • Delinquency in contractual payments of principal or interest; • Cash flow difficulties experienced by the borrower; • Initiation of bankruptcy proceedings; • Deterioration in the value of collateral; • Deterioration of the borrower’s competitive position. If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the financial asset’s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the Statement of Comprehensive Income. If a loan or held-to-maturity investment has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract. The Group considers evidence of impairment for loans and advances at both a specific asset and collective level. All individually significant loans and advances are assessed for specific impairment. Those found not to be specifically impaired are then collectively assessed for any impairment that has been incurred but not yet identified. In assessing collective impairment, the Group uses historical trends of the probability of default, emergence period, 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 the actual losses are likely to be significantly different to historic trends. When a loan is uncollectible, it is written off against the related provision for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of the provision for loan impairment in the Statement of Comprehensive Income. A customer’s account may be modified to assist customers who are in or have recently overcome financial difficulties and have demonstrated both the ability and willingness to meet the current or modified loan contractual payments. Loans that have renegotiated or deferred terms, resulting in a substantial modification to the cash flows, are no longer considered to be past due but are treated as new loans recognised at fair value, provided the customers comply with the renegotiated or deferred terms. 3.11. Impairment of non-financial assets The carrying amounts of the Group’s non-financial assets, other than inventories and deferred tax assets, are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists, then the asset’s recoverable amount is estimated. Impairment for goodwill is discussed in more detail under Note 3.15(a). 3.12. Term Funding Scheme The Term Funding Scheme (“TFS”) was announced by the Bank of England on 4 August 2016 and became effective from 19 September 2016. The scheme is now closed. The TFS allows participants to borrow central bank reserves in exchange for eligible collateral. Amounts drawn from the TFS are included within “Deposits from banks” on the Statement of Financial Position as detailed in Note 32. 3.13. Inventory Land acquired through repossession of collateral which is subsequently held in the ordinary course of business with a view to develop and sell is accounted for as inventory. Inventory is measured at the lower of cost or net realisable value. The cost of inventories comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. 3.14. Assets classified as held for sale Assets, or disposal groups comprising assets and liabilities, that are expected to be recovered primarily through sale rather than through continuing use, are classified as held for sale. Arbuthnot Banking Group PLCReport & Accounts 2018 66 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) 3.14. Assets classified as held for sale (continued) The criteria that the Group uses to determine whether an asset is held for sale under IFRS 5 include, but are not limited to the following: • Management is committed to a plan to sell. • The asset is available for immediate sale. • An active programme to locate a buyer is initiated. • The sale is highly probable, within 12 months of classification as held for sale. • The asset is being actively marketed for sale at a sales price reasonable in relation to its fair value. Current assets held for sale are measured at the lower of their carrying amount and fair value less costs to sell except where measurement and remeasurement is outside the scope of IFRS 5. Where investments that have initially been recognised as current assets held for sale, because the Group has been deemed to hold a controlling stake, are subsequently disposed of or diluted such that the Group’s holding is no longer deemed a controlling stake, the investment will subsequently be classified as fair value through profit or loss or fair value through other comprehensive income investments in accordance with IFRS 9. Subsequent movements will be recognised in accordance with the Group’s accounting policy for the newly adopted classification. Once classified as held for sale, intangible assets and property, plant and equipment are no longer amortised or depreciated. 3.15. Intangible assets (a) Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired subsidiary or associate at the date of acquisition. Goodwill on acquisitions of subsidiaries or associates is included in ‘intangible assets’. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold. The Group reviews the goodwill for impairment at least annually or more frequently when events or changes in economic circumstances indicate that impairment may have taken place and carries goodwill at cost less accumulated impairment losses. Assets are grouped together in the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or groups of assets (the “cash-generating unit” or “CGU”). For impairment testing purposes goodwill cannot be allocated to a CGU that is greater than a reported operating segment. CGUs to which goodwill has been allocated are aggregated so that the level at which impairment is tested reflects the lowest level at which goodwill is monitored for internal reporting purposes. Goodwill acquired in a business combination is allocated to groups of CGUs that are expected to benefit from the synergies of the combination. The test for impairment involves comparing the carrying value of goodwill with the present value of pre-tax cash flows, discounted at a rate of interest that reflects the inherent risks of the CGU to which the goodwill relates, or the CGU’s fair value if this is higher. (b) Computer software Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised on the basis of the expected useful lives (three to ten years). Costs associated with maintaining computer software programs are recognised as an expense as incurred. Costs associated with developing computer software which are assets in the course of construction, which management has assessed to not be available for use, are not amortised. (c) Other intangibles Other intangibles include trademarks, customer relationships, broker relationships, technology and banking licences acquired. These costs are amortised on the basis of the expected useful lives (three to fourteen years). 3.16. Property, plant and equipment Land and buildings comprise mainly branches and offices and are stated at the latest valuation with subsequent additions at cost less depreciation. Plant and equipment is stated at historical cost less depreciation. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Arbuthnot Banking Group PLCReport & Accounts 2018 67 Land is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives, applying the following annual rates, which are subject to regular review: Leasehold improvements Office equipment Computer equipment Motor vehicles 3 to 20 years 3 to 10 years 3 to 5 years 4 years Leasehold improvements are depreciated over the term of the lease (until the first break clause). Gains and losses on disposals are determined by deducting carrying amount from proceeds. These are included in the Statement of Comprehensive Income. 3.17. Investment property Investment property is initially measured at cost. Transaction costs are included in the initial measurement. Subsequently, investment property is measured at fair value, with any change therein recognised in profit and loss within other income. If a change in use occurs and investment property is transferred to owner-occupied property, the property’s deemed cost for subsequent reporting is its fair value at the date of change in use. 3.18. Leases (a) As a lessor Assets leased to customers under agreements which transfer substantially all the risks and rewards of ownership, with or without ultimate legal title, are classified as finance leases. When assets are held subject to 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 over the term of the lease using the net investment method, which reflects a constant periodic rate of return. Assets leased to customers under agreements which do not transfer substantially all the risks and rewards of ownership are classified as operating leases. When assets are held subject to operating leases, the underlying assets are held at cost less accumulated depreciation. The assets are depreciated down to their estimated residual values on a straight-line basis over the lease term. Lease rental income is recognised on a straight line basis over the lease term. (b) As a lessee Rentals made under operating leases are recognised in the Statement of Comprehensive Income on a straight-line basis over the term of the lease. Leases in which the Group assumes substantially all the risks and rewards of ownership of the leased asset are classified as finance leases. Leased assets by way of finance leases are stated at an amount equal to the lower of their fair value and the present value of the minimum lease payments at inception of the lease, less accumulated depreciation. Minimum lease payments are apportioned between the finance charge and the reduction of the outstanding liability. The finance charge is allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. 3.19. Cash and cash equivalents For the purposes of the Statement of Cash Flows, cash and cash equivalents comprises cash on hand and demand deposits, and cash equivalents are deemed highly liquid investments that are convertible into cash with an insignificant risk of changes in value with a maturity of three months or less at the date of acquisition. 3.20. Employee benefits (a) Post-retirement obligations The Group contributes to a defined contribution scheme and to individual defined contribution schemes for the benefit of certain employees. The schemes are funded through payments to insurance companies or trustee-administered funds at the contribution rates agreed with individual employees. The Group has no further payment obligations once the contributions have been paid. The contributions are recognised as an employee benefit expense when they are due. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in the future payments is available. There are no post-retirement benefits other than pensions. Arbuthnot Banking Group PLCReport & Accounts 2018 68 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) (b) Share-based compensation – cash settled The Group adopts a Black-Scholes valuation model in calculating the fair value of the share options as adjusted for an attrition rate for members of the scheme and a probability of pay-out reflecting the risk of not meeting the terms of the scheme over the vesting period. The number of share options that are expected to vest are reviewed at least annually. The fair value of cash settled share-based payments is recognised as personnel expenses in the profit or loss with a corresponding increase in liabilities over the vesting period. The liability is remeasured at each reporting date and at settlement date based on the fair value of the options granted, with a corresponding adjustment to personnel expenses. (c) Deferred cash bonus scheme The Bank has a deferred cash bonus scheme for senior employees. The cost of the award is recognised to the income statement over the period to which the performance relates. (d) Short-term incentive plan The Group has a short-term incentive plan payable to employees of one of its subsidiary companies. The award of a profit share is based on a percentage of the net profit of a Group subsidiary. 3.21. Taxation Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise. Income tax recoverable on tax allowable losses is recognised as an asset only to the extent that it is regarded as recoverable by offset against current or future taxable profits. Deferred tax is provided in full on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. However, deferred tax is not accounted for if it arises from the initial recognition of goodwill, the initial recognition of an asset or liability in a transaction other than a business combination that at the time of the transaction affects neither accounting nor taxable profit or loss, and differences relating to investments in subsidiaries to the extent that they probably will not reverse in the foreseeable future. Deferred tax is determined using tax rates (and laws) that have been enacted or substantively enacted by the Statement of Financial Position date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled. Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax liabilities and assets, and they relate to taxes levied by the same tax authority on the same taxable entity, or on different tax entities, when they intend to settle current tax liabilities and assets on a net basis or the tax assets and liabilities will be realised simultaneously. Deferred tax assets are recognised where it is probable that future taxable profits will be available against which the temporary differences can be utilised. 3.22. Issued debt and equity securities Issued financial instruments or their components are classified as liabilities where the contractual arrangement results in the Group having a present obligation to either deliver cash or another financial asset to the holder, to exchange financial instruments on terms that are potentially unfavourable. Issued financial instruments, or their components, are classified as equity where they meet the definition of equity and confer on the holder a residual interest in the assets of the Company. The components of issued financial instruments that contain both liability and equity elements are accounted for separately with the equity component being assigned the residual amount after deducting from the instrument as a whole the amount separately determined as the fair value of the liability component. Financial liabilities, other than trading liabilities at fair value, are carried at amortised cost using the effective interest rate method as set out in policy 3.4. Equity instruments, including share capital, are initially recognised as net proceeds, after deducting transaction costs and any related income tax. Dividend and other payments to equity holders are deducted from equity, net of any related tax. Arbuthnot Banking Group PLCReport & Accounts 2018 69 3.23. Share capital (a) Share issue costs Incremental costs directly attributable to the issue of new shares or options by Arbuthnot Banking Group, are shown in equity as a deduction, net of tax, from the proceeds. (b) Dividends on ordinary shares Dividends on ordinary shares are recognised in equity in the period in which they are approved. (c) Share buybacks Where any Group company purchases the Company’s equity share capital (treasury shares), the consideration paid, including any directly attributable incremental costs (net of income taxes) is deducted from equity attributable to the Company’s equity holders until the shares are cancelled or reissued. 3.24. Fiduciary activities The Group commonly acts as trustee and in other fiduciary capacities that result in the holding or placing of assets on behalf of individuals, trusts, retirement benefit plans and other institutions. These assets and income arising thereon are excluded from these financial statements, as they are not assets of the Group. 3.25. Provisions and contingent liabilities Provisions are recognised when the Group has a present legal or constructive obligation as a result of a past event, it is probable that an outflow of economic resources will be required from the Group and amounts can be reliably measured. Onerous contract provisions are recognised for losses on contracts where the forecast costs of fulfilling the contract throughout the contract period exceed the forecast income receivable. In assessing the amount of the loss to provide on any contract, account is taken of the Group’s forecast results which the contract is servicing. The provision is calculated based on discounted cash flows to the end of the contract. Contingent liabilities are disclosed when the Group has a present obligation as a result of a past event, but the probability that it will be required to settle that obligation is more than remote, but not probable. 3.26. New standards and interpretations not yet adopted The following standards, interpretations and amendments to existing standards have been published and are mandatory for the Group’s accounting periods beginning on or after 1 January 2019 or later periods, but the Group has not early adopted them: IFRS 16, ‘Leases’ (effective from 1 January 2019) IFRS 16 is effective for annual periods beginning on or after 1 January 2019. IFRS 16 replaces existing leases guidance, including IAS 17 Leases, IFRIC 4 Determining whether an Arrangement contains a Lease, SIC-15 Operating Leases – Incentives and SIC-27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease. IFRS 16 removes the distinction between finance and operating leases and instead provides a single lessee accounting model. The Group, as a lessee, will be required to recognise lease liabilities and corresponding right-of-use assets for all applicable leases. The new standard also provides the option not to recognise ‘short-term’ leases and leases of ‘low-value’ assets. Where this exemption is taken, such leases will continue to be expensed to the income statement over the term of the lease. The income statement recognition pattern for the Group’s leases will differ from the current pattern for operating leases, with interest on the liabilities and depreciation expense on the right-of-use assets recognised separately. In the cash flow statement, lease payments will be categorised within financing activities rather than operating activities. The Group will reassess the classification of sub-leases in which the Group is a lessor. Based on the information currently available the implementation of IFRS 16 is not expected to have a material impact on the financial statements. IFRS 16 does not significantly change the accounting for finance leases or leases by lessors. Management are currently reviewing all long-term contractual agreements to ensure all leases are correctly transitioned. The Group continues to evaluate the full impact of IFRS 16, but expects to recognise right-of-use assets on its balance sheet at the adoption date in respect of property assets currently accounted for as operating leases. A corresponding lease liability will also be recognised, representing the future payments to be made under these leases, discounted at the rate implicitly defined in the lease or, where no rate is defined in the lease, the Group’s incremental borrowing rate at lease inception. Arbuthnot Banking Group PLCReport & Accounts 2018 70 Notes to the Consolidated Financial Statements continued 3. Significant accounting policies (continued) Transition The standard is effective for annual periods beginning on or after 1 January 2019. The Group plans to apply IFRS 16 initially on 1 January 2019, using the modified retrospective approach (option 2). As a result there will be no impact to retained earnings on adoption of IFRS 16, with no restatement of comparative information. Additionally, on transition, the Group will apply the practical expedient to grandfather the definition of a lease on transition. This means that it will apply IFRS 16 to all contracts entered into before 1 January 2019 and identified as leases in accordance with IAS 17 and IFRIC 4. The Bank has assessed the impact that the initial application will have on its business and will adopt the standard for the year ending 31 December 2019. It estimates that the IFRS 16 transition amount will: • increase assets and liabilities by approximately £21m as at 1 January 2019; • reduce the Group’s CETI ratio by 32bps; and • increase operating expenditure by £0.4m in 2019. 4. Critical accounting estimates and judgements in applying accounting policies The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. 4.1. Estimation uncertainty (a) Expected credit losses (“ECL”) on financial assets The Group reviews its loan portfolios and debt security investments to assess impairment at least on a quarterly basis. The basis for evaluating impairment losses is described in accounting policy 3.10. The measurement of ECL required by the implementation of IFRS 9, from 1 January 2018, necessitates a number of significant judgements. Specifically judgements and estimation uncertainties relate to assessment of whether credit risk on the financial asset has increased significantly since initial recognition, incorporation of forward-looking information (“FLI”) in the measurement of ECLs and key assumptions used in estimating recoverable cash flows. These estimates are driven by a number of factors that are subject to change which may result in different levels of ECL allowances. The Group incorporates FLI into the assessment of whether there has been a significant increase in credit risk. Forecasts for key macroeconomic variables that most closely correlate with the Bank’s portfolio are used to produce five economic scenarios, comprising of a no change, upside case, downside case, moderate stress and severe stress, and the impacts of these scenarios are then probability weighted. The estimation and application of this FLI will require significant judgement supported by the use of external information. 12 month ECLs on loans and advances (loans within Stage 1) are calculated using a statistical model. The key assumptions are the probability of default and the economic scenarios. Life time ECLs on loans and advances (loans within Stage 2 and 3) are calculated based on an individual valuation of the underlying asset and other expected cash flows. For individually significant financial assets in Stage 2 and 3, ECL is calculated on an individual basis and all relevant factors that have a bearing on the expected future cash flows are taken into account. These factors can be subjective and can include the individual circumstances of the borrower, the realisable value of collateral, the Group’s position relative to other claimants, and the likely cost to sell and duration of the time to collect. The level of ECL is the difference between the value of the recoverable amount (which is equal to the expected future cash flows discounted at the loan’s original effective interest rate), and its carrying amount. Management considered a range of variables in determining the level of future ECL. Two of the key judgements were in relation to “time to collect” and “collateral valuations”. Sensitivity analysis was carried out based on what was considered reasonably possible in the current market conditions. If time to collect increased by six months across all Stage 2 and 3 client exposures, this would lead to a negative £0.4m impact through the Profit or Loss. A six month reduction in time to collect would lead to a £0.3m favourable impact on the Profit or Loss. Arbuthnot Banking Group PLCReport & Accounts 2018 71 If the collateral valuations increased by 10% across all Stage 3 client exposures, this would lead to a positive £1.3m impact through the Profit or Loss. If the collateral valuations decreased by 10% across all Stage 3 client exposures, this would lead to a £1.9m adverse impact on the Profit or Loss. Another of the key judgements concerns the probability of the economic scenarios to the measurement of the ECL. The probability weighting and forward looking economic scenarios as at 31 December 2018 are as follows: Probability of scenario Impact of scenario – Change in collateral values London Rest of UK Overseas – Movement in share prices* * for loans secured against equity portfolios Probability weighted forward looking economic scenarios Highest Stress Moderate Stress No Change 1.0% 3.0% 21.0% Growth 25.0% Decline 50.0% (40.0%) (40.0%) (40.0%) – (20.0%) (20.0%) (20.0%) – – – – – 0.5% 0.5% 2.3% 4.0% (2.0%) (1.5%) (1.0%) (4.0%) Management assess a range of scenarios and in the current economic climate it is reasonably possible that the moderate scenario could increase to 9% probability, the decline scenario increase to 60% probability and the growth scenario reduce to 10% probability. This would lead to a negative £0.2m impact through Profit or Loss. (b) Effective Interest Rate Acquired loan books are initially recognised at fair value. Subsequently, they are measured under the effective interest rate method, based on cash flow models which require significant judgement assumptions on prepayment rates, late payments, the probability and timing of defaults and the amount of incurred losses. Management review the expected cash flows against actual cash flows to ensure future assumptions on customer behaviour and future cash flows remain valid. If the estimates of future cash flows are revised, the gross carrying value of the financial asset is recalculated as the present value of the estimated future contractual cash flows discounted at the original effective interest rate, or in the case of the acquired books the credit-adjusted effective interest rate. The adjustment to the carrying value of the loan book is recognised in the Statement of Comprehensive Income. Under both IFRS 9 and IAS 39, for the originated loan portfolio interest income is recorded using the effective interest rate method. The key assumptions applied by Management in the EIR methodology remain materially unchanged from the 2017 financial statements. Management must therefore use judgement to estimate the expected life of each instrument. The accuracy of the effective interest rate 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. If customer loans repaid 6 months earlier than anticipated on the originated loan book, interest income would increase by £0.8m (2017: £0.3m), due to acceleration of fee income. In 2018 the Group recognised £0.9m (2017: £64k) of additional interest income to reflect actual cash flows received on the acquired mortgage books being in excess of forecast cash flows. The key judgements in relation to calculating the net present value of the acquired mortgage books relate to the timing of future cash flows and loss rates on principal repayments. Management have considered an early and delayed 6 month sensitivity on the timing of repayment and a 10% increase and decrease of principal repayments to be reasonably possible. If the acquired loan books were modelled to accelerate cash flows by 6 months, it would increase interest income in 2018 by £0.3m (2017: £0.4m), while a 10% increase in principal repayments will increase interest income in 2018 by £0.3m (2017: £0.2m) through a cash flow reset adjustment. Additionally, a 10% increase in credit losses would reduce interest income in 2018 by £0.3m (2017: £0.2m) through a cash flow reset adjustment. Arbuthnot Banking Group PLCReport & Accounts 2018 72 Notes to the Consolidated Financial Statements continued 4. Critical accounting estimates and judgements in applying accounting policies (continued) (c) Investment property The valuations that the Group places on its investment properties are subject to a degree of uncertainty and are calculated on the basis of assumptions in relation to prevailing market rents and effective yields. These assumptions may not prove to be accurate, particularly in periods of market volatility. The current uncertainty due to Brexit has had the effect of reducing the activity in the property market, which, has in turn resulted in less market evidence being available for Management in making its judgement on the key assumptions of property yield and market rent. The Group currently owns three investment properties, as outlined in Note 29. The Group’s in-house surveyors have valued all three investment properties utilising externally sourced market information and property specific knowledge. King Street in London with value of £53.3m (2017: £53.3m) The King Street property is currently fully tenanted, with the main lease ending in 2019 at which point the offices will be refurbished and re-let at prevailing market rents. The valuation assessment considers the net present value of net cash flows to be generated from the property, taking into account expected rental growth rate, void periods, occupancy rate, lease incentive costs such as rent-free periods and other costs not paid by tenants. The expected net cash flows are discounted using risk-adjusted discount rates. Among other factors, the discount rate estimation considers the quality of a building and its location, tenant quality and lease terms. Management judgement is required for the inputs used in the discounted cash flow model, which have been assessed as follows: • yield: 4% • future rent forecast (per square ft.) £102.50 • refurbishment period of 6 months and rent to be increased by 5% (every 5 years) • estimated refurbishment costs: £2.2m Forecast yield – Yield 0.25% lower – Yield 0.15% lower – Yield 0.15% higher – Yield 0.25% higher Future forecast rent (Per Square Foot) – Positive +5% – Negative -5% Forecast periodic Rent Increases (Every 5 years) – Positive +25% – Negative -25% Forecast refurbishment Costs Cost of refurbishment doubles – 5% increase to rental value per square foot (p.s.f.) – No impact to rental value No refurbishment undertaken – Existing tenants rent p.s.f maintained and periodic rent increase 5% – Existing tenants rent p.s.f maintained and periodic rent increase 4% Variable 4.00% 3.75% 3.85% 4.15% 4.25% £102.5 £107.6 £97.4 5% 6% 4% £2.2m £4.5m Revised fair value gain/(loss) £’m 5.2 3.3 (1.9) (3.4) 3.0 (1.8) 3.6 (2.1) 0.9 (1.4) 0.8 (2.6) % 9.72% 6.15% (3.50%) (6.40%) 5.56% (3.29%) 6.75% (4.00%) 1.78% (2.65%) 1.52% (4.90%) Arbuthnot Banking Group PLCReport & Accounts 2018 73 4 St Philips Place in Birmingham with value of £7m (2017: £6.1m) The St Philips Place property was acquired on 24 November 2017. The property is currently undergoing comprehensive refurbishment and is therefore unoccupied at the end of the financial year. A development appraisal has been undertaken by estimating the gross development value and deducting the estimated costs to complete the refurbishment, arm’s length financing costs and development profit margin. The gross development has the following key inputs: • forecast yield: 6.25% • forecast annual rent: £0.77m • refurbishment costs: £3.2m Forecast yield Yield 0.25% lower Yield 0.25% higher Forecast net rental value (Total Annual £’m) Positive +5% Negative -5% Forecast development costs Costs increase +10% Costs decrease -10% Variable 6.25% 6.00% 6.50% 0.77 0.81 0.73 £3.2m £3.5m £2.9m Revised fair value gain/(loss) £’m 0.3 (0.5) 0.4 (0.6) (0.4) 0.2 % 3.89% (7.13%) 5.42% (9.61%) (6.15%) 2.68% Crescent Office Park in Bath with value of £6.8m (2017: £6.8m) In December 2017, the office building was acquired with the intention to be included within a new property fund initiative that the Group had planned to start-up. The property had tenants in situ with the Fund recognising rental income. It was recognised as held for sale under IFRS 5 and therefore not consolidated in the financial statements in 2017. In 2018 the launch of the property fund was placed on hold and as a result it was reclassified as an investment property as the property no longer met the IFRS 5 criteria. The property remained occupied as at 31 December 2018 with the Group receiving rental income. In accordance with IAS 40, the property is recognised at fair value, with its carrying value at year end of £6.8m equal to its fair value. The valuation of the property has the following key inputs: • yield: 6.50% • future rent increases (every five years): 4.00% Model Yield – Yield 0.25% lower – Yield 0.25% higher Model Future Rent Increases (Every 5 Years) – Positive +25% – Negative -25% Variable 6.50% 6.25% 6.75% 4.00% 5.00% 3.00% Revised fair value gain/(loss) £’m 0.2 (0.4) 0.2 (0.1) % 2.25% (6.10%) 3.11% (2.10%) Arbuthnot Banking Group PLCReport & Accounts 2018 74 Notes to the Consolidated Financial Statements continued 5. Maturity analysis of assets and liabilities The table below shows the maturity analysis of assets and liabilities of the Group as at 31 December 2018: At 31 December 2018 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Assets classified as held for sale Derivative financial instruments Loans and advances to customers Other assets Financial investments Deferred tax asset Intangible assets Property, plant and equipment Investment property LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Current tax liability Other liabilities Debt securities in issue Due within one year £000 405,325 54,173 203,211 8,002 192 388,603 8,257 14,976 – – – – Due after more than one year £000 – – 139,480 – 1,654 836,053 4,459 20,375 1,490 16,538 5,304 67,081 1,082,739 1,092,434 7,675 188 1,624,978 236 18,549 – 1,651,626 225,000 – 89,308 – – 13,283 327,591 Total £000 405,325 54,173 342,691 8,002 1,846 1,224,656 12,716 35,351 1,490 16,538 5,304 67,081 2,175,173 232,675 188 1,714,286 236 18,549 13,283 1,979,217 Arbuthnot Banking Group PLCReport & Accounts 2018 The table below shows the maturity analysis of assets and liabilities of the Group as at 31 December 2017: At 31 December 2017 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Assets classified as held for sale Derivative financial instruments Loans and advances to customers Other assets Financial investments Deferred tax asset Investment in associate Intangible assets Property, plant and equipment Investment property LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Current tax liability Other liabilities Debt securities in issue Due within one year £000 313,101 70,679 122,236 2,915 950 224,954 16,188 128 – – – – – 751,151 195,097 931 1,333,423 705 16,239 – 1,546,395 Due after more than one year £000 – – 104,783 – 1,601 824,315 4,436 2,219 1,527 83,804 15,995 3,962 59,439 1,102,081 – – 57,358 – – 13,104 70,462 75 Total £000 313,101 70,679 227,019 2,915 2,551 1,049,269 20,624 2,347 1,527 83,804 15,995 3,962 59,439 1,853,232 195,097 931 1,390,781 705 16,239 13,104 1,616,857 Arbuthnot Banking Group PLCReport & Accounts 2018 76 Notes to the Consolidated Financial Statements continued 5. Maturity analysis of assets and liabilities (continued) The table below shows the maturity analysis of assets and liabilities of the Company as at 31 December 2018: At 31 December 2018 ASSETS Loans and advances to banks Loans and advances to banks – due from subsidiary undertakings Financial investments Current tax asset Deferred tax asset Intangible assets Property, plant and equipment Other assets Interests in subsidiaries LIABILITIES Other liabilities Debt securities in issue Due within one year £000 Due after more than one year £000 6 17,002 – 52 – – – 42 – 17,102 3,324 – 3,324 – – 19,313 – 113 6 208 – 134,614 154,254 – 13,283 13,283 The table below shows the maturity analysis of assets and liabilities of the Company as at 31 December 2017: At 31 December 2017 ASSETS Loans and advances to banks Loans and advances to banks – due from subsidiary undertakings Financial investments Deferred tax asset Property, plant and equipment Other assets Interests in associates Interests in subsidiaries LIABILITIES Current tax liability Other liabilities Debt securities in issue Due within one year £000 Due after more than one year £000 6 36,097 128 – – 199 – – 36,430 152 3,141 – 3,293 – – 12 641 157 – 5,056 97,802 103,668 140,098 – – 13,104 13,104 152 3,141 13,104 16,397 Total £000 6 17,002 19,313 52 113 6 208 42 134,614 171,356 3,324 13,283 16,607 Total £000 6 36,097 140 641 157 199 5,056 97,802 Arbuthnot Banking Group PLCReport & Accounts 2018 77 6. Financial risk management Strategy By their nature, the Group’s activities are principally related to the use of financial instruments. The Directors and senior management of the Group have formally adopted a Group Risk and Controls Policy which sets out the Board’s attitude to risk and internal controls. Key risks identified by the Directors are formally reviewed and assessed at least once a year by the Board, in addition to which key business risks are identified, evaluated and managed by operating management on an ongoing basis by means of procedures such as physical controls, credit and other authorisation limits and segregation of duties. The Board also receives regular reports on any risk matters that need to be brought to its attention. Significant risks identified in connection with the development of new activities are subject to consideration by the Board. There are budgeting procedures in place and reports are presented regularly to the Board detailing the results of each principal business unit, variances against budget and prior year, and other performance data. The principal non-operational risks inherent in the Group’s business are credit, market, liquidity and capital. (a) Credit risk The Company and Group take on exposure to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. Significant changes in the economy, or in the health of a particular industry segment that represents a concentration in the Company and Group’s portfolio, could result in losses that are different from those provided for at the balance sheet date. Credit risk is managed through the Credit Committee of the banking subsidiary. The Company and Group structure the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to products, and one borrower or groups of borrowers. Such risks are monitored on a revolving basis and subject to an annual or more frequent review. The limits are approved periodically by the Board of Directors and actual exposures against limits are monitored daily. Exposure to credit risk is managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing these lending limits where appropriate. Exposure to credit risk is also managed in part by obtaining collateral, and corporate and personal guarantees. The Group employs a range of policies and practices to mitigate credit risk. The most traditional of these is the taking of collateral to secure advances, which is common practice. The principal collateral types for loans and advances include, but are not limited to: • Charges over residential and commercial properties; • Charges over business assets such as premises, inventory and accounts receivable; • Charges over financial instruments such as debt securities and equities; • Charges over other chattels; and • Personal guarantees. Upon initial recognition of loans and advances, the fair value of collateral is based on valuation techniques commonly used for the corresponding assets. In order to minimise any potential credit loss the Group will seek additional collateral from the counterparty as soon as impairment indicators are noticed for the relevant individual loans and advances. Repossessed collateral, not readily convertible into cash, is made available for sale in an orderly fashion, with the proceeds used to reduce or repay the outstanding indebtedness, or held as inventory where the Group intends to develop and sell in the future. Where excess funds are available after the debt has been repaid, they are available either for other secured lenders with lower priority or are returned to the customer. Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. With respect to credit risk on commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most commitments to extend credit are contingent upon customers maintaining specific credit standards. The Group incorporates forward-looking information into both its assessment of whether the credit risk of an instrument has increased significantly since its initial recognition and its measurement of ECL. The key inputs into the measurement of the ECL are: • future economic scenarios; • probability of default; • loss given default; and • exposure at default. Arbuthnot Banking Group PLCReport & Accounts 2018 78 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) (a) Credit risk (continued) The Group’s maximum exposure to credit risk before collateral held or other credit enhancements is as follows: Group Credit risk exposures (all stage 1, unless otherwise stated) On-balance sheet: Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Derivative financial instruments Loans and advances to customers (net of ECL) Stage 1 Stage 2 Stage 3 Other assets Financial investments Off-balance sheet: Guarantees Loan commitments and other credit related liabilities At 31 December Group Credit risk exposures (under IAS 39) On-balance sheet: Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Derivative financial instruments Loans and advances to customers (net of impairment) Other assets Financial investments Off-balance sheet: Guarantees Loan commitments and other credit related liabilities At 31 December Private Banking £000 Commercial Banking £000 – – – – 670,464 618,487 20,033 31,944 – – 435 51,950 722,849 – – – – 443,108 431,630 11,478 – – – 1,309 15,930 460,347 Private Banking £000 Commercial Banking £000 – – – – 650,245 – – 443 85,303 735,991 – – – – 305,055 – – 2,533 46,660 354,248 2018 RAF £000 – 354 – – 85,957 84,275 1,180 502 443 – – – All Other Divisions £000 405,325 53,819 342,691 1,846 25,127 25,127 – – 2,533 35,351 – 18,122 Total £000 405,325 54,173 342,691 1,846 1,224,656 1,159,519 32,691 32,446 2,976 35,351 1,744 86,002 86,754 884,814 2,154,764 2017 RAF £000 – 1,087 – – 71,265 137 – – – All Other Divisions £000 313,101 69,592 227,019 2,551 22,704 11,827 2,347 Total £000 313,101 70,679 227,019 2,551 1,049,269 11,964 2,347 – – 2,976 131,963 72,489 649,141 1,811,869 Arbuthnot Banking Group PLCReport & Accounts 2018 79 The Company’s maximum exposure to credit risk (all stage 1) before collateral held or other credit enhancements is as follows: Credit risk exposures relating to on-balance sheet assets are as follows: Loans and advances to banks Financial investments Other assets At 31 December 2018 £000 17,008 19,313 – 36,321 2017 £000 36,103 140 162 36,405 The above tables represent the maximum credit risk exposure (net of impairment) to the Group and Company at 31 December 2018 and 2017 without taking account of any collateral held or other credit enhancements attached. For financial assets, the balances are based on gross carrying amounts as reported in the Statement of Financial Position. For guarantees and loan commitments, the amounts in the table represent the amounts for which the group is contractually committed. The table below represents an analysis of the loan to values of the exposures secured by property for the Group: Group Less than 60% Stage 1 Stage 2 Stage 3 60% – 80% Stage 1 Stage 2 Stage 3 80% – 100% Stage 1 Stage 2 Stage 3 Greater than 100%* Stage 1 Stage 2 Stage 3 Total 2018 Private Banking Commercial Banking Total Loan Balance £000 Collateral £000 Loan Balance £000 Collateral £000 Loan Balance £000 312,478 297,674 8,701 6,103 224,782 211,737 9,458 3,587 64,649 52,968 531 11,150 28,528 16,654 – 11,874 698,621 659,650 25,830 13,141 309,329 288,994 14,535 5,800 49,740 37,161 550 12,029 16,860 8,245 – 8,615 249,446 238,071 11,375 – 165,954 165,954 – – 6,540 6,540 – – 8,918 8,918 – – 559,271 532,671 26,600 – 259,917 259,917 – – 9,400 9,400 – – 7,614 7,614 – – 561,924 535,745 20,076 6,103 390,736 377,691 9,458 – 71,189 59,508 531 11,150 37,446 25,572 – 11,874 Collateral £000 1,257,892 1,192,321 52,430 13,141 569,246 548,911 14,535 – 59,140 46,561 550 12,029 24,474 15,859 – 8,615 630,437 1,074,550 430,858 836,202 1,061,295 1,910,752 * In addition to property, other security is taken, including charges over Arbuthnot Latham Investment Management portfolios, other chattels and personal guarantees. The increase in loan to values greater than 100% is due to an increase in exposures collateralised by other assets. Property valuations used are those from the loan origination date or updated 3rd party valuations where applicable. Arbuthnot Banking Group PLCReport & Accounts 2018 80 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) Group Less than 60% 60% – 80% 80% – 100% Greater than 100% Total 2017 Private Banking Commercial Banking Total Loan Balance £000 Collateral £000 Loan Balance £000 Collateral £000 Loan Balance £000 288,734 238,760 64,288 32,206 740,812 356,242 75,298 26,124 623,988 1,198,476 166,666 108,996 5,538 9,142 290,342 367,550 168,015 5,700 8,230 549,495 Collateral £000 1,108,362 524,257 80,998 34,354 455,400 347,756 69,826 41,348 914,330 1,747,971 Prior year numbers are presented under IAS 39 and therefore has no Staging. The table below represents an analysis of loan commitments compared to the values of properties for the Group (all Stage 1): Group Less than 60% 60% – 80% Total Group Less than 60% 60% – 80% 80% – 100% Greater than 100% Total 2018 Private Banking Commercial Banking Total Loan Balance £000 Collateral £000 Loan Balance £000 Collateral £000 Loan Balance £000 Collateral £000 30,289 15,467 45,756 83,603 23,295 106,898 14,880 1,050 15,930 2017 32,097 1,615 33,712 45,169 16,517 61,686 115,700 24,910 140,610 Private Banking Commercial Banking Total Loan Balance £000 Collateral £000 Loan Balance £000 Collateral £000 Loan Balance £000 Collateral £000 62,294 20,471 28,825 3,590 115,180 218,643 29,935 31,982 3,253 283,813 481 5,869 754 1,500 8,604 56,000 8,861 754 852 66,467 62,775 26,340 29,579 5,090 123,784 274,643 38,796 32,736 4,105 350,280 Arbuthnot Banking Group PLCReport & Accounts 2018 81 Renegotiated loans and forbearance The contractual terms of a loan may be modified due to factors that are not related to the current or potential credit deterioration of the customer (changing market conditions, customer retention, etc.). In such cases, the modified loan may be derecognised and the renegotiated loan recognised as a new loan at fair value. When the terms of a financial asset are modified and the modification does not result in derecognition, the determination of whether the asset’s credit risk has increased significantly reflects the comparison of: • its remaining lifetime PD at the reporting date based on the modified terms; with • the remaining lifetime PD estimated based on data on initial recognition and the original contractual terms. When modification results in derecognition, a new loan is recognised and allocated to Stage 1 (assuming it is not credit-impaired at that time). The Group renegotiates loans to customers in financial difficulties (referred to as ‘forbearance’) to maximise collection opportunities and minimise the risk of default. Under the Group’s forbearance policy, loan forbearance is granted on a selective basis if the debtors is currently in default on its debt, or if there is a high risk of default, there is evidence that the debtor made all reasonable efforts to pay under the original contractual terms and the debtor is expected to be able to meet the revised terms. The revised terms can include changing the timing of interest payments, extending the date of repayment of the loan, transferring a loan to interest only payments and a payment holiday. Both retail and corporate loans are subject to the forbearance policy. The Group Credit Committee regularly reviews reports on forbearance. For financial assets modified as part of the Group’s forbearance policy, the estimate of PD reflects whether the modification has improved or restored the Group’s ability to collect interest and principal and the Group’s previous experience of similar forbearance action. As part of this process, the Group evaluates the borrower’s payment performance against the modified contractual terms and considers various behavioural indicators. Generally, the forbearance is a qualitative indicator of a SICR (see Note 3.10). As at 31 December 2018, loans for which forbearance measures were in place totalled 2.22% (2017: 2.94%) of total value of loans to customers for the Group. 2017 forbearance has been reclassified to align to current forbearance policy. These are set out in the following table: Transfer to interest only Term extension Payment holiday Total forbearance 2018 2017 Number 1 15 16 32 Loan Balance £000 175 25,814 1,189 27,178 Number – 15 5 20 Loan Balance £000 – 29,586 1,237 30,823 Arbuthnot Banking Group PLCReport & Accounts 2018 82 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) Concentration risk The tables below show the concentration in the loan book based on the most significant type of collateral held for each loan. Loans and advances to customers Loan Commitments Concentration by product Asset based lending* Asset finance Cash collateralised Commercial lending Investment portfolio secured Mixed collateral** Residential mortgages Unsecured At 31 December Concentration by location East Anglia London Midlands North East North West Northern Ireland Scotland South East South West Wales Overseas Non-property collateral At 31 December 2018 £000 25,128 85,958 5,379 248,042 45,182 91,167 713,095 10,705 2017 £000 – 71,425 17,747 202,912 49,667 70,954 633,003 3,561 1,224,656 1,049,269 32,960 455,567 69,686 18,448 59,045 2,813 10,793 219,890 140,560 7,521 30,486 176,887 18,438 407,805 42,484 25,741 44,630 2,903 10,988 203,305 116,692 8,002 21,556 146,725 1,224,656 1,049,269 2018 £000 18,122 – – 4,806 3,136 4,867 54,346 725 86,002 294 28,096 3,538 1,050 1,275 – – 15,522 9,201 426 1,400 25,200 86,002 2017 £000 – – – 24,371 4,222 3,957 99,413 – 131,963 – 56,777 800 – 825 – – 23,462 15,236 – – 34,863 131,963 * In 2018 Q1, the Group began its asset-based lending business including invoice discounting, supported by stock, plant & machinery, property and cash flow lending. ** Mixed collateral is where there is no single, overall, majority collateral type. (b) Operational risk (unaudited) The Group’s objective is to manage operational risk so as to balance the avoidance of financial losses and damage to the Group’s reputation with overall cost effectiveness and to avoid control procedures that restrict initiatives and creativity. The Group is exposed to operational risks from its Information Technology and Operations platforms. There are additional internal controls in these processes that are designed to protect the Group from these risks. The Group’s overall approach to managing internal control and financial reporting is described in the Corporate Governance section of the Annual Report. Compliance with Group standards is supported by a programme of periodic reviews undertaken by Internal Audit. The results of the Internal Audit reviews are discussed with senior management, with summaries submitted to the Arbuthnot Banking Group Audit Committee. Cyber risk Cyber risk is an increasing risk that the Group is subject to within its operational processes. This is the risk that the Group is subject to some form of disruption arising from an interruption to its IT and data infrastructure. The Group regularly test the infrastructure to ensure that it remains robust to a range of threats, and has continuity of business plans in place including a disaster recovery provision. Arbuthnot Banking Group PLCReport & Accounts 2018 83 Conduct risk As a financial services provider we face conduct risk, including selling products to customers which do not meet their needs; failing to deal with customers’ complaints effectively; not meeting customers’ expectations; and exhibiting behaviours which do not meet market or regulatory standards. The Group adopts a zero risk appetite for any unfair customer outcomes. It maintains clear compliance guidelines and provides ongoing training to all staff. Periodic spot checks and internal audits are performed to ensure these guidelines are being followed. The Group also has insurance policies in place to provide some cover for any claims that may arise. (c) Market risk Price risk The Company and Group are exposed to price risk from equity investments and derivatives held by the Group. The Group is not exposed to commodity price risk. Based upon the financial investment exposure in Note 25, a stress test scenario of a 10% (2017: 10%) decline in market prices, would result in a £17,000 (2017: £32,000) decrease in the Group’s income and a decrease of £3.5m (2017: £231,000) in the Group’s equity. The Group considers a 10% stress test scenario appropriate after taking the current values and historic data into account. Based upon the financial investment exposure given in Note 25, a stress test scenario of a 10% (2017: 10%) decline in market prices, would result in a £nil (2017: £13,000) decrease in the Company’s income and a decrease of £1.9m (2017: £11,000) in the Company’s equity. Currency risk The Company and Group take on exposure to the effects of fluctuations in the prevailing foreign currency exchange rates on its financial position and cash flows. This is managed through the Group entering into forward foreign exchange contracts. The Board sets limits on the level of exposure for both overnight and intra-day positions, which are monitored daily. The table below summarises the Group’s exposure to foreign currency exchange rate risk at 31 December 2018. Included in the table below are the Group’s assets and liabilities at carrying amounts, categorised by currency. At 31 December 2018 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Derivative financial instruments Loans and advances to customers Other assets Financial investments LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Other liabilities Debt securities in issue Net on-balance sheet position Credit commitments GBP (£) £000 405,244 8,856 243,680 1,655 1,169,157 2,861 34,219 1,865,672 232,675 3 1,526,623 1,782 – 1,761,083 104,589 86,002 USD ($) £000 30 13,794 99,011 4 16,122 – 954 129,915 – 4 130,061 – – 130,065 (150) – Euro (€) £000 47 19,714 – 3 39,377 115 178 59,434 – 1 46,068 – 13,283 59,352 82 – Other £000 4 11,809 – 184 – – – 11,997 – 180 11,534 – – 11,714 283 – Total £000 405,325 54,173 342,691 1,846 1,224,656 2,976 35,351 2,067,018 232,675 188 1,714,286 1,782 13,283 1,962,214 104,804 86,002 Arbuthnot Banking Group PLCReport & Accounts 2018 84 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) The table below summarises the Group’s exposure to foreign currency exchange risk at 31 December 2017: USD ($) £000 Euro (€) £000 At 31 December 2017 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Derivative financial instruments Loans and advances to customers Other assets Financial investments LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Other liabilities Debt securities in issue Net on-balance sheet position Credit commitments GBP (£) £000 313,101 6,027 170,723 2,525 997,025 11,964 140 – 40,870 56,296 1 14,912 – 706 1,501,505 112,785 195,067 914 1,228,878 1,207 – 1,426,066 75,439 131,963 – 1 112,731 – – 112,732 53 – – 16,944 – 25 37,332 – 1,501 55,802 – – 42,733 – 13,104 55,837 (35) – Other £000 – 6,838 – – – – – 6,838 30 16 6,439 – – 6,485 353 – Total £000 313,101 70,679 227,019 2,551 1,049,269 11,964 2,347 1,676,930 195,097 931 1,390,781 1,207 13,104 1,601,120 75,810 131,963 Derivative financial instruments (see Note 21) are in place to mitigate foreign currency risk on net exposures for each currency. A 10% strengthening of the pound against the US dollar would lead to a £5,000 increase (2017: £5,000 increase) in Group profits and equity, while a 10% weakening of the pound against the US dollar would lead to the same decrease in Group profits and equity. Similarly, a 10% strengthening of the pound against the Euro would lead to a £4,000 increase (2017: £4,000 increase) in Group profits and equity, while a 10% weakening of the pound against the Euro would lead to the same increase in Group profits and equity. The table below summarises the Company’s exposure to foreign currency exchange rate risk at 31 December 2018: At 31 December 2018 ASSETS Loans and advances to banks Financial investments LIABILITIES Other liabilities Debt securities in issue Net on-balance sheet position GBP (£) £000 Euro (€) £000 3,437 19,313 22,750 1,838 – 1,838 20,912 13,571 – 13,571 – 13,283 13,283 288 Total £000 17,008 19,313 36,321 1,838 13,283 15,121 21,200 Arbuthnot Banking Group PLCReport & Accounts 2018 The table below summarises the Company’s exposure to foreign currency exchange rate risk at 31 December 2017: At 31 December 2017 ASSETS Loans and advances to banks Financial investments Other assets LIABILITIES Other liabilities Debt securities in issue Net on-balance sheet position GBP (£) £000 22,734 140 162 23,036 1,840 – 1,840 21,196 Euro (€) £000 13,369 – – 13,369 – 13,104 13,104 265 85 Total £000 36,103 140 162 36,405 1,840 13,104 14,944 21,461 A 10% strengthening of the pound against the Euro would lead to £3,000 (2017: £3,000) decrease in the Company profits and equity, conversely a 10% weakening of the pound against the Euro would lead to the same increase in the Company profits and equity. Interest rate risk Interest rate risk is the potential adverse impact on the Company and Group’s future cash flows from changes in interest rates, and arises from the differing interest rate risk characteristics of the Company and Group’s assets and liabilities. In particular, fixed rate savings and borrowing products expose the Group to the risk that a change in interest rates could cause either a reduction in interest income or an increase in interest expense relative to variable rate interest flows. The Group seeks to “match” interest rate risk on either side of the Statement of Financial Position. However, this is not a perfect match and interest rate risk is present in: Money market transactions of a fixed rate nature, fixed rate loans, fixed rate savings accounts and floating rate products dependent on when they re-price at a future date. Interest rate risk is measured throughout the maturity bandings of the book on a parallel shift scenario for a 200 basis points movement. Interest rate risk is managed to limit value at risk to be less than £1.5m. The current position of the balance sheet is such that it results in a favourable impact on the economic value of equity of £1.3m (2017: £0.8m) for a positive 200bps shift and an adverse impact of £1.4m (2017: £0.8m) for a negative 200bps movement. The negative movement is capped at the Bank of England base rate of 75bps (2017: 50bps), which result in a negative impact of £0.5m (2017: £0.3m). The Company has no fixed rate exposures, but an upward change of 50bps on variable rates would increase pre-tax profits and equity by £10,000 (2017: increase pre-tax profits and equity by £10,000). Arbuthnot Banking Group PLCReport & Accounts 2018 86 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) The following tables summarise the re-pricing periods for the assets and liabilities in the Company and Group, including derivative financial instruments which are principally used to reduce exposure to interest rate risk. Items are allocated to time bands by reference to the earlier of the next contractual interest rate re-price and the maturity date. More than 3 months but less than 6 months £000 More than 6 months but less than 1 year £000 More than 1 year but less than 5 years £000 Within 3 months £000 More than 5 years £000 Non interest bearing £000 Total £000 Group As at 31 December 2018 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Derivative financial instruments Loans and advances to customers Other assets* Financial investments LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Other liabilities** Debt securities in issue Equity 405,325 54,115 269,026 304 1,030,316 – – – – 27,846 – 6,107 – – – 58 41,896 – 17,502 – – – – 3,923 1,542 170,525 – – 1,759,086 33,953 59,456 175,990 232,675 188 1,255,488 – 13,283 – – – 197,785 – – – – – 95,868 – – – – – 165,145 – – – 1,501,634 197,785 95,868 165,145 – – – – 206 – – 206 – – – – – – – – – – – – – 111,131 35,351 405,325 54,173 342,691 1,846 1,224,656 111,131 35,351 146,482 2,175,173 – – – 18,785 – 195,956 232,675 188 1,714,286 18,785 13,283 195,956 214,741 2,175,173 – 206 (68,259) Impact of derivative instruments 25,762 – – Interest rate sensitivity gap 283,214 (163,832) (36,412) (25,762) (14,917) Cumulative gap 283,214 119,382 82,970 68,053 68,259 – * Other assets include all remaining assets in the Statement of Financial Position, which are not shown separately above. ** Other liabilities include all remaining liabilities in the Statement of Financial Position, which are not shown separately above. Arbuthnot Banking Group PLCReport & Accounts 2018 87 More than 3 months but less than 6 months £000 More than 6 months but less than 1 year £000 More than 1 year but less than 5 years £000 Within 3 months £000 More than 5 years £000 Non interest bearing £000 Total £000 Group As at 31 December 2017 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Derivative financial instruments Loans and advances to customers Other assets Financial investments LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Other liabilities Debt securities in issue Equity 313,101 61,211 185,926 950 880,822 – – 1,442,010 195,097 931 1,061,442 – 13,104 – – 579 35,093 – 6,938 – – 42,610 – – 162,503 – – – – 8,889 6,000 – 10,774 – – – – – 1,601 143,979 – – 25,663 145,580 – – 109,478 – – – – – 57,358 – – – 57,358 Impact of derivative instruments 17,824 – – (17,824) Interest rate sensitivity gap 189,260 (119,893) (83,815) 70,398 1,270,574 162,503 109,478 Cumulative gap 189,260 69,367 (14,448) 55,950 55,950 – * Other assets include all remaining assets in the Statement of Financial Position, which are not shown separately above. ** Other liabilities include all remaining liabilities in the Statement of Financial Position, which are not shown separately above. – – – – – – – – – – – – – – – – – – – – – 6,756 188,266 2,347 313,101 70,679 227,019 2,551 1,049,269 188,266 2,347 197,369 1,853,232 – – – 16,944 – 236,375 195,097 931 1,390,781 16,944 13,104 236,375 253,319 1,853,232 – (55,950) Arbuthnot Banking Group PLCReport & Accounts 2018 88 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) Company As at 31 December 2018 ASSETS Loans and advances to banks Other assets* Financial investments LIABILITIES Other liabilities** Debt securities in issue Equity Interest rate sensitivity gap More than 3 months but less than 6 months £000 More than 6 months but less than 1 year £000 More than 1 year but less than 5 years £000 Within 3 months £000 More than 5 years £000 Non interest bearing £000 16,977 – – 16,977 – 13,283 – 13,283 3,694 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 31 135,035 19,313 154,379 3,324 – 154,749 158,073 171,356 (3,694) Total £000 17,008 135,035 19,313 171,356 3,324 13,283 154,749 Cumulative gap 3,694 3,694 3,694 3,694 3,694 – * Other assets include all remaining assets in the Statement of Financial Position, which are not shown separately above. ** Other liabilities include all remaining liabilities in the Statement of Financial Position, which are not shown separately above. Company As at 31 December 2017 ASSETS Loans and advances to banks Other assets* Financial investments LIABILITIES Other liabilities** Debt securities in issue Equity Interest rate sensitivity gap More than 3 months but less than 6 months £000 More than 6 months but less than 1 year £000 More than 1 year but less than 5 years £000 Within 3 months £000 More than 5 years £000 Non interest bearing £000 35,944 – – 35,944 – 13,104 – 13,104 22,840 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Total £000 36,103 103,855 140 159 103,855 140 104,154 140,098 3,293 – 123,701 3,293 13,104 123,701 126,994 140,098 (22,840) Cumulative gap 22,840 22,840 22,840 22,840 22,840 – * Other assets include all remaining assets in the Statement of Financial Position, which are not shown separately above. ** Other liabilities include all remaining liabilities in the Statement of Financial Position, which are not shown separately above. Arbuthnot Banking Group PLCReport & Accounts 2018 89 (d) Liquidity risk Liquidity risk is the risk that the Group will not be able to meet its obligations associated with its financial liabilities that are settled by delivering cash or another financial asset. The Group’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation. The liquidity requirements of the Group are met through withdrawing funds from its Bank of England Reserve Account to cover any short-term fluctuations and longer term funding to address any structural liquidity requirements. The Group has formal governance structures in place to manage and mitigate liquidity risk on a day to day basis. The Board of AL sets and approves the liquidity risk management strategy. The Assets and Liabilities Committee (“ALCO”), comprising senior executives of the Group, monitors liquidity risk. Key liquidity risk management information is reported by the finance teams and monitored by the Chief Executive Officer and Finance Director on a daily basis. The ALCO meets monthly to review liquidity risk against set thresholds and risk indicators including early warning indicators, liquidity risk tolerance levels and Individual Liquidity Adequacy Assessment Process (“ILAAP”) metrics. The PRA requires the Board to ensure that the Group has adequate levels of liquidity resources and a prudent funding profile, and that it comprehensively manages and controls liquidity and funding risks. The Group maintains deposits placed at the Bank of England, and highly liquid unencumbered assets that can be called upon to create sufficient liquidity to meet liabilities on demand, particularly in a period of liquidity stress. Arbuthnot Latham & Co., Limited (“AL”) has a Board approved ILAAP, and maintains liquidity buffers in excess of the minimum requirements. The ILAAP is embedded in the risk management framework of the Group and is subject to ongoing updates and revisions when necessary. At a minimum, the ILAAP is undated annually. The Liquidity Coverage Ratio (“LCR”) regime has applied to the Group from 1 October 2015, requiring management of net 30 day cash outflows as a proportion of high quality liquid assets. The actual LCR at 282% (2017: 222%) has significantly exceeded the regulatory minimum of 90% (2017: 80%) throughout the year. The Group is exposed to daily calls on its available cash resources from current accounts, maturing deposits and loan draw-downs. The Group maintains significant cash resources to meet all of these needs as they fall due. The matching and controlled mismatching of the maturities and interest rates of assets and liabilities is fundamental to the management of the Group. It is unusual for banks to be completely matched, as transacted business is often of uncertain term and of different types. The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest bearing liabilities as they mature are important factors in assessing the liquidity of the Group and its exposure to changes in interest rates. The tables below show the undiscounted contractual cash flows of the Group’s financial liabilities and assets as at 31 December 2018: Carrying amount £000 232,675 1,714,286 1,782 13,283 – – At 31 December 2018 Financial liability by type Non-derivative liabilities Deposits from banks Deposits from customers Other liabilities Debt securities in issue Issued financial guarantee contracts Unrecognised loan commitments Derivative liabilities Risk management: – Outflows Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 (232,675) (1,719,600) (1,782) (19,431) (1,744) (86,002) (232,675) (1,274,190) (1,775) (90) (1,744) (86,002) – (355,512) – (271) – – – (89,898) – (1,447) – – (91,345) – – (7) (17,623) – – (17,630) 1,962,026 (2,061,234) (1,596,476) (355,783) 188 – 188 (188) (188) (188) (188) – – – – – – Arbuthnot Banking Group PLCReport & Accounts 2018 90 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) At 31 December 2018 Financial asset by type Non-derivative assets Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Loans and advances to customers Other assets Financial investments Derivative assets Risk management: – Inflows At 31 December 2017 Financial liability by type Non-derivative liabilities Deposits from banks Deposits from customers Other liabilities Debt securities in issue Issued financial guarantee contracts Unrecognised loan commitments Derivative liabilities Risk management: – Outflows Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 Carrying amount £000 405,325 54,173 342,691 1,224,656 2,976 35,351 Carrying amount £000 195,097 1,390,781 1,207 13,104 – – 405,325 54,173 346,694 1,382,857 2,976 35,351 405,325 54,115 129,604 46,646 2,976 16,038 654,704 – 58 101,449 173,077 – – – – 115,641 1,038,465 – 19,313 274,584 1,173,419 – – – 124,669 – – 124,669 2,065,172 2,227,376 1,846 – 1,846 1,846 1,846 – – – – – – 1,846 1,846 Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 (195,097) (1,395,770) (1,207) (19,381) (2,976) (131,963) (195,097) (1,040,893) (1,207) (87) (2,976) (131,963) – (293,425) – (262) – – – (61,452) – (1,395) – – 1,600,189 (1,746,394) (1,372,223) (293,687) (62,847) – – – (17,637) – – (17,637) 931 – 931 (931) (931) (931) (931) – – – – – – The tables below show the undiscounted contractual cash flows of the Group’s financial liabilities and assets as at 31 December 2017: Arbuthnot Banking Group PLCReport & Accounts 2018 91 Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 Carrying amount £000 313,101 70,679 227,019 1,049,269 11,964 2,347 At 31 December 2017 Financial asset by type Non-derivative assets Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Loans and advances to customers Other assets Financial investments Derivative assets Risk management: – Inflows 313,101 70,679 227,166 1,187,665 11,964 2,347 313,101 61,211 22,886 126,689 11,964 2,335 538,186 – 579 101,277 121,493 – – 223,349 – 8,889 103,003 800,091 – 12 911,995 – – – 139,392 – – 139,392 1,674,379 1,812,922 2,551 – 2,551 2,551 2,551 – – – – – – 2,551 2,551 The table below sets out the components of the Group’s liquidity reserves: Liquidity reserves Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost/held-to-maturity Undrawn credit lines 31 December 2018 31 December 2017 Amount £000 405,325 54,173 342,691 10,000 812,189 Fair value £000 405,325 54,173 344,001 10,000 813,499 Amount £000 313,101 70,679 227,019 10,000 620,799 Fair value £000 313,101 70,679 227,951 10,000 621,731 Assets pledged as collateral or encumbered The total financial assets recognised in the statement of financial position that had been pledged as collateral for liabilities at 31 December 2018 were £308.9m (2017: £208.7m). Financial assets are pledged as collateral as part of sales and repurchases, securities borrowing and securitisation transactions under terms that are usual and customary for such activities. In addition, as part of these transactions, the Group has received collateral that it is permitted to sell or repledge in the absence of default. The table below analyses the contractual cash flows of the Company’s financial liabilities and assets as at 31 December 2018: At 31 December 2018 Financial liability by type Non-derivative liabilities Other liabilities Issued financial guarantee contracts Carrying amount £000 Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 1,838 13,283 15,121 (1,838) (19,431) (21,269) (248) (90) (338) – (271) (271) – (1,447) (1,447) (1,590) (17,623) (19,213) Arbuthnot Banking Group PLCReport & Accounts 2018 92 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) At 31 December 2018 Financial asset by type Non-derivative assets Loans and advances to banks Financial investments Carrying amount £000 17,008 19,313 36,321 Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 17,008 19,313 36,321 17,008 – 17,008 – – – – 19,313 19,313 – – – The table below analyses the contractual cash flows of the Company’s financial liabilities and assets as at 31 December 2017: At 31 December 2017 Financial liability by type Non-derivative liabilities Other liabilities Debt securities in issue At 31 December 2017 Financial asset by type Non-derivative assets Loans and advances to banks Financial investments Other assets Carrying amount £000 Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 1,840 13,104 14,944 (1,840) (19,381) (21,221) (251) (87) (338) – (262) (262) – (1,395) (1,395) (1,589) (17,637) (19,226) Carrying amount £000 36,103 140 162 36,405 Gross nominal inflow/ (outflow) £000 Not more than 3 months £000 More than 3 months but less than 1 year £000 More than 1 year but less than 5 years £000 More than 5 years £000 36,103 140 162 36,405 36,103 128 162 36,393 – – – – – 12 – 12 – – – – The maturities of assets and liabilities and the ability to replace, at an acceptable cost, interest-bearing liabilities as they mature are important factors in assessing the liquidity of the Group and its exposure to changes in interest rates and exchange rates. Fiduciary activities The Group provides investment management and advisory services to third parties, which involve the Group making allocation and purchase and sale decisions in relation to a wide range of financial instruments. Those assets that are held in a fiduciary capacity are not included in these financial statements. These services give rise to the risk that the Group may be accused of maladministration or underperformance. At the balance sheet date, the Group had investment management accounts amounting to approximately £985m (2017: £1,044m). Additionally, the Group provides investment advisory services. Arbuthnot Banking Group PLCReport & Accounts 2018 93 (e) Financial assets and liabilities The tables below set out the Group’s financial assets and financial liabilities into their respective classifications: At 31 December 2018 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Derivative financial instruments Loans and advances to customers Other assets Financial investments LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Other liabilities Debt securities in issue At 31 December 2017 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Derivative financial instruments Loans and advances to customers Other assets Financial investments LIABILITIES Deposits from banks Derivative financial instruments Deposits from customers Other liabilities Debt securities in issue FVPL £000 FVOCI £000 – – – 1,846 – 2,976 165 4,987 – 188 – 1,782 – 1,970 Amortised cost £000 405,325 54,173 342,691 – 1,224,656 – – Total carrying amount £000 405,325 54,173 342,691 1,846 1,224,656 2,976 35,351 Fair value £000 405,325 54,173 344,001 1,846 1,187,408 2,976 35,351 – – – – – – 35,186 35,186 2,026,845 2,067,018 2,031,080 – – – – – – 232,675 – 1,714,286 – 13,283 232,675 188 1,714,286 1,782 13,283 232,675 188 1,714,286 1,782 13,283 1,960,244 1,962,214 1,962,214 Fair value £000 313,101 70,679 227,951 2,551 1,022,816 11,964 2,347 – – – – – – 2,347 2,347 – – – – – – – – 313,101 70,679 227,019 2,551 1,049,269 11,964 2,347 1,676,930 1,651,409 – – – – – – 195,097 – 1,390,781 – 13,104 195,097 931 1,390,781 1,207 13,104 195,097 931 1,390,781 1,207 13,104 1,598,982 1,601,120 1,601,120 – – – 2,551 – – – 2,551 – 931 – – – 931 – – 227,019 – – – – 313,101 70,679 – – 1,049,269 11,964 – 227,019 1,445,013 – – – – – – – – – 1,207 – 1,207 Fair value through profit or loss £000 Held-to- maturity £000 Loans and receivables £000 Available- for-sale £000 Liabilities at amortised cost £000 Total carrying amount £000 The Group’s accounting policies on the classification of financial instruments under IFRS 9 are set out in Note 3.8. The application of these policies resulted in reclassifications set out in Note 2(f). Arbuthnot Banking Group PLCReport & Accounts 2018 94 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) Valuation of financial instruments The Group measures the fair value of an instrument using quoted prices in an active market for that instrument. A market is regarded as active if quoted prices are readily and regularly available and represent actual and regularly occurring market transactions. If a market for a financial instrument is not active, the Group establishes fair value using a valuation technique. These include the use of recent arm’s length transactions, reference to other instruments that are substantially the same for which market observable prices exist, net present value and discounted cash flow analysis. The objective of valuation techniques is to determine the fair value of the financial instrument at the reporting date as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. In the event that fair values of assets and liabilities cannot be reliably measured, they are carried at cost. The Group measures fair value using the following fair value hierarchy that reflects the significance of the inputs used in making measurements: • Level 1: Quoted prices in active markets for identical assets or liabilities. • Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices). This category includes instruments valued using: quoted market prices in active markets for similar instruments; quoted prices for identical or similar instruments in markets that are considered less than active; or other valuation techniques in which all significant inputs are directly or indirectly observable from market data. • Level 3: Inputs that are unobservable. This category includes all instruments for which the valuation technique includes inputs not based on observable data and the unobservable inputs have a significant effect on the instrument’s valuation. This category includes instruments that are valued based on quoted prices for similar instruments for which significant unobservable adjustments or assumptions are required to reflect differences between the instruments. The consideration of factors such as the magnitude and frequency of trading activity, the availability of prices and the size of bid/offer spreads assists in the judgement as to whether a market is active. If, in the opinion of management, a significant proportion of the instrument’s carrying amount is driven by unobservable inputs, the instrument in its entirety is classified as valued using significant unobservable inputs. ‘Unobservable’ in this context means that there is little or no current market data available from which to determine the level at which an arm’s length transaction would be likely to occur. It generally does not mean that there is no market data available at all upon which to base a determination of fair value (consensus pricing data may, for example, be used). The tables below analyse financial instruments measured at fair value by the level in the fair value hierarchy into which the measurement is categorised: At 31 December 2018 ASSETS Derivative financial instruments Financial investments LIABILITIES Derivative financial instruments Level 1 £000 – 34,223 34,223 – – Level 2 £000 1,846 – 1,846 188 188 Level 3 £000 – 1,128 1,128 – – Total £000 1,846 35,351 37,197 188 188 Arbuthnot Banking Group PLCReport & Accounts 2018 At 31 December 2017 ASSETS Derivative financial instruments Financial investments LIABILITIES Derivative financial instruments Level 1 £000 Level 2 £000 – 144 144 – – 2,551 – 2,551 931 931 Level 3 £000 – 2,203 2,203 – – 95 Total £000 2,551 2,347 4,898 931 931 There were no transfers between level 1 and level 2 during the year. The following table reconciles the movement in level 3 financial instruments measured at fair value (financial investments) during the year: Movement in level 3 At 1 January Consideration received Disposals Movements recognised in Other Comprehensive Income Movements recognised in the Income Statement At 31 December 2018 £000 2,203 163 (1,403) 135 30 1,128 2017 £000 2,012 – – 136 55 2,203 Secure Trust bank investment The Group currently holds equity shares in Secure Trust Bank plc, valued at £34.2m (2017: £nil). The shares are recognised at fair value using quoted prices on the London Stock Exchange. Visa Inc. investment Arbuthnot Latham currently holds preference shares in Visa Inc., valued at £863k (2017: £706k) as at 31 December 2018. These shares have been valued at their future conversion value into Visa Inc. common stock. The valuation includes a 31% haircut, comprising 25% due to a contingent liability disclosed in Visa Europe’s accounts in relation to litigation and 6% based on a liquidity discount. Investment in overseas property company Arbuthnot Latham currently holds a debt and equity investment classified as FVPL in a property company which owns an office building through its 100% owned subsidiary. During 2018 the subsidiary company was sold under the terms of the sale agreement the buyer agreed to purchase 100% of the share capital and reimburse all outstanding loans. The proceeds of the sale have been distributed to the investors, except for the amount withheld for the general and specific warranties (which will be released in three instalments at 18 month intervals) included as a condition of the sale agreement. A distribution of £1.6m has been received and a gain of £75k has been recognised in profit or loss during the year. The investment has been valued at £165k as at 31 December 2018. The investment has been valued as the discounted consideration outstanding less 11% hair cut for the warranties. Hetz Ventures, L.P. Arbuthnot Latham currently holds an equity investment in Hetz Ventures, L.P. which was launched in January 2018 with the primary objective to generate attractive risk-adjusted returns for its Partners, principally through long-term capital appreciation, by making, holding and disposing of equity and equity-related investments in early stage revenue generating Israeli technology companies, primarily in cyber, fin-tech and the disruptive software sectors. The company has committed to a capital contribution of USD $1.0m of the total closing fund capital of USD$55.0m. At 31 December 2018 the company had made capital contributions into the Fund of $168k. The investment is classified as FVOCI and is valued at fair value by Hetz Ventures, L.P. at £0.1m as at 31 December 2018. As at year end the fair value is deemed to be cost less management fees due to the immature stage of investments that have been made by the Fund. Arbuthnot Banking Group PLCReport & Accounts 2018 96 Notes to the Consolidated Financial Statements continued 6. Financial risk management (continued) The tables below analyse financial instruments not measured at fair value by the level in the fair value hierarchy: At 31 December 2018 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost Loans and advances to customers* Other assets LIABILITIES Deposits from banks Deposits from customers Other liabilities Debt securities in issue Level 1 £000 Level 2 £000 – – – – – – – – – – – 405,325 54,173 342,691 996,198 – 1,798,387 232,675 1,714,286 – – 1,946,961 Level 3 £000 – – – 228,458 2,976 231,434 – – 1,782 13,283 15,065 Total £000 405,325 54,173 342,691 1,224,656 2,976 2,029,821 232,675 1,714,286 1,782 13,283 1,962,026 * On transition to IFRS 9 on 1 January 2018, all loans on a variable rate are now recognised as Level 2 financial instruments. At 31 December 2017 ASSETS Cash and balances at central banks Loans and advances to banks Debt securities held-to-maturity Loans and advances to customers Other assets LIABILITIES Deposits from banks Deposits from customers Other liabilities Debt securities in issue Level 1 £000 – – – – – – – – – – – Level 2 £000 313,101 70,679 227,019 – – 610,799 195,097 1,390,781 – – 1,585,878 Level 3 £000 Total £000 – – – 1,049,269 11,964 1,061,233 – – 1,207 13,104 14,311 313,101 70,679 227,019 1,049,269 11,964 1,672,032 195,097 1,390,781 1,207 13,104 1,600,189 Arbuthnot Banking Group PLCReport & Accounts 2018 97 7. Capital management The Group’s capital management policy is focused on optimising shareholder value. There is a clear focus on delivering organic growth and ensuring capital resources are sufficient to support planned levels of growth. The Board regularly reviews the capital position. The Group’s lead regulator, the Prudential Regulatory Authority (“PRA”), sets and monitors capital requirements for the Group. In accordance with the EU’s Capital Requirements Directive (“CRD”) and the required parameters set out in the PRA Handbook (BIPRU 2.2), the Individual Capital Adequacy Assessment Process (“ICAAP”) is embedded in the risk management framework of the Group and is subject to ongoing updates and revisions when necessary. However, at a minimum, the ICAAP is updated annually as part of the business planning process. The ICAAP is a process that brings together the management framework (i.e. the policies, procedures, strategies, and systems that the Group has implemented to identify, manage and mitigate its risks) and the financial disciplines of business planning and capital management. Not all material risks can be mitigated by capital, but where capital is appropriate the Board has adopted a “Pillar I plus” approach to determine the level of capital the Group needs to hold. This method takes the Pillar I capital formula calculations (standardised approach for credit, market and operational risk) as a starting point, and then considers whether each of the calculations delivers a sufficient capital sum adequately to cover management’s anticipated risks. Where the Board considered that the Pillar I calculations did not reflect the risk, an additional capital add-on in Pillar II is applied, as per the Total Capital Requirement (“TCR”) issued by the PRA. The current TCR of the Group is 9.00%. The Group’s regulatory capital is divided into two tiers: • Tier 1 comprises mainly shareholders’ funds and revaluation reserves, after deducting goodwill, other intangible assets and a significant investment in a financial institution (STB). The portion of the investment representing up to 10% of ABG’s Tier 1 is added back to capital resources and then risk weighted at 250%, while anything above this 10% is deducted. • Lower Tier 2 comprises qualifying subordinated loan capital. Lower Tier 2 capital cannot exceed 50% of Tier 1 capital. Arbuthnot Banking Group PLCReport & Accounts 2018 98 Notes to the Consolidated Financial Statements continued 7. Capital management (continued) The following table shows the regulatory capital resources as managed by the Group: Tier 1 Share capital Retained earnings* Deduction for significant investment* Add back 10% of CET1 (risk weighted at 250%) Capital redemption reserve IFRS 9 – Transitional add back Treasury shares Deduction for goodwill Deduction for other intangibles Fair value/Available-for-sale reserve* Prudent valuation deduction Total tier 1 capital resources Tier 2 Debt securities in issue Total tier 2 capital resources 2018 £000 153 209,083 (34,219) 18,137 20 1,986 (1,131) (5,202) (11,336) (12,169) (38) 165,284 13,283 13,283 2017 £000 153 237,171 (83,804) 22,038 20 – (1,131) (5,202) (10,793) 162 – 158,614 13,104 13,104 Total tier 1 & tier 2 capital resources 178,567 171,718 Core Tier 1 capital ratio (Net Core Tier 1 capital/Basel III Total Risk Exposure) Total Capital Ratio (Capital/Basel III Total Risk Exposure) 15.9% 17.2% 17.3% 18.8% * The reduced deduction for significant investment is due to the fall in the fair value of the investment in STB, which is now accounted for as a financial asset at fair value through OCI. The initial fair value adjustment went through retained earnings as part of the net current year loss recorded and fair value losses since then are reflected in the fair value reserve. The ICAAP includes a summary of the capital required to mitigate the identified risks in its regulated entities and the amount of capital that the Group has available. The PRA sets TCR for each UK bank calibrated by reference to its Capital Resources Requirement, broadly equivalent to 8 percent of risk weighted assets and thus representing the capital required under Pillar I of the Basel III framework. The ICAAP is a key input into the PRA’s TCR setting process, which addresses the requirements of Pillar II of the Basel III framework. The PRA’s approach is to monitor the available capital resources in relation to the TCR requirement. The Group maintains an extra internal buffer and capital ratios are reviewed on a monthly basis to ensure that external requirements are adhered to. All regulated entities have complied with all of the externally imposed capital requirements to which they are subject. Pillar III complements the minimum capital requirements (Pillar I) and the supervisory review process (Pillar II). Its aim is to encourage market discipline by developing a set of disclosure requirements which will allow market participants to assess key pieces of information on a firm’s capital, risk exposures and risk assessment processes. Our Pillar III disclosures for the year ended 31 December 2018 are published as a separate document on the Group website under Investor Relations (Announcements & Shareholder Info). Arbuthnot Banking Group PLCReport & Accounts 2018 99 2017 £000 801 258 1,353 45,015 47,427 (35) (5,939) (360) (6,334) 2018 £000 2,264 2,703 3,303 57,020 65,290 (1,517) (8,224) (366) (10,107) 55,183 41,093 8. Net interest income Cash and balances at central banks Loans and advances to banks Debt securities at amortised cost/held-to-maturity Loans and advances to customers Deposits from banks Deposits from customers Debt securities in issue Interest expense Net interest income 9. Fee and commission income Fee and commission income is disaggregated below and includes a total for fees in scope of IFRS 15, Revenues from Contracts with Customers: Group At 31 December 2018 Banking commissions Foreign exchange fees Investment management fees Wealth planning fees Total fee and commission income Group At 31 December 2017 Banking and services fees Foreign exchange fees Investment management fees Wealth planning fees Total fee and commission income Private Banking £000 Commercial Banking £000 747 558 8,177 1,404 10,886 617 232 – – 849 Private Banking £000 Commercial Banking £000 1,487 545 7,870 2,593 12,495 374 161 – – 535 RAF £000 151 – – – 151 RAF £000 – – – – – All Other Divisions £000 220 537 1 312 Total £000 1,735 1,327 8,178 1,716 1,070 12,956 All Other Divisions £000 402 356 17 – 775 Total £000 2,263 1,062 7,887 2,593 13,805 Arbuthnot Banking Group PLCReport & Accounts 2018 100 Notes to the Consolidated Financial Statements continued 10. Net impairment loss on financial assets Net Impairment losses on loans and advances to customers Of which: Stage 1 Stage 3 2018 £000 2,731 821 1,910 2,731 2017 £000 394 – – 394 The provision charge in 2018 has increased largely due to the transition to IFRS 9, if 2017 was restated on an IFRS 9 basis the charge would have been £3.0m. During the year, the Group recovered £41k (2017: £116k) of loans which had previously been written off. 11. Other income Other income includes a fair value adjustment of £2.6m (2017: £nil), to the contingent consideration for the acquisition of Renaissance Asset Finance Ltd. The fair value adjustment is based on management’s assessment of the underlying performance of the business and reflects a reduction in the estimated future liability payable under the sale and purchase agreement. Other items reflected in other income include rental income from the investment properties (see Note 31) of £2.6m (2017: £2.1m), premises recharges of £0.7m (2017: £0.7m) to STB for office space occupied and dividends received on the shares held in STB of £0.7m, since de-recognition as an associate undertaking. 12. Operating expenses Operating expenses comprise: Staff costs, including Directors: Wages, salaries and bonuses Social security costs Pension costs Share based payment transactions (Note 39) Amortisation of intangibles (Note 28) Depreciation (Note 30) Financial Services Compensation Scheme Levy Operating lease rentals Operating expenses for investment property Acquisitions costs Other administrative expenses Total operating expenses from continuing operations Details on Directors remuneration are disclosed in the Remuneration Report on page 32. 2018 £000 37,051 4,176 1,842 (318) 1,752 1,122 113 3,143 282 378 15,441 64,982 2017 £000 30,937 3,576 1,558 189 1,036 1,508 190 3,087 230 108 12,302 54,721 Arbuthnot Banking Group PLCReport & Accounts 2018 101 2017 £000 105 221 85 17 – 428 2017 £000 472 (141) 331 (135) 252 117 448 2,534 488 (429) 277 1 111 448 2018 £000 112 323 160 10 10 615 2018 £000 620 132 752 350 19 369 1,121 6,780 1,288 (854) 536 – 151 1,121 12. Operating expenses (continued) Remuneration of the auditor and its associates, excluding VAT, was as follows: Fees payable to the Company’s auditor for the audit of the Company’s annual accounts Fees payable to the Company’s auditor and its associates for other services: Audit of the accounts of subsidiaries Audit related assurance services Other assurance services Other non-audit services Total fees payable 13. Income tax expense United Kingdom corporation tax at 19% (2017: 19.25%) Current taxation Corporation tax charge – current year Corporation tax charge – adjustments in respect of prior years Deferred taxation Origination and reversal of temporary differences Adjustments in respect of prior years Income tax expense Tax reconciliation Profit before tax Tax at 19% (2017: 19.25%) Permanent difference – Tax on associate income Other permanent differences Tax rate change Prior period adjustments Corporation tax charge for the year Permanent differences mainly relate to associate income which is reflected after tax. The tax charge on discontinuing operations is disclosed in Note 14. On 26 October 2015 the Government substantively enacted a reduction in the UK corporation tax rate from 20% to 19% (effective from 1 April 2017). An additional reduction to 17% (effective from 1 April 2020) was substantively enacted on 6 September 2016. This will reduce the Bank’s future current tax charge accordingly. Arbuthnot Banking Group PLCReport & Accounts 2018 102 Notes to the Consolidated Financial Statements continued 14. Discontinued operations The profit after tax from discontinued operations is made up as follows: Discontinued operations Profit after tax from discontinued operations – STB associate income (up to 8 August 2018) Loss after tax on de-recognition of STB Loss after tax from discontinued operations Year ended 31 December 2018 £000 Year ended 31 December 2017 £000 2,971 (28,663) (25,692) 4,437 – 4,437 During the year Sir Henry Angest and Andrew Salmon resigned their positions on the board of Secure Trust Bank PLC (“STB”) and the Group does not have the right to appoint any future directors to the board of STB. As a result of this the Group was deemed to no longer have significant influence over the associated company (see Note 27) and thus the shareholding is now recognised as a financial investment. This required the investment to be marked to market. Given the decline in the share price of STB over the previous years, this assessment resulted in a mark to market loss of £28.7m. This loss, together with the profit from associate for the period up to 8 August, is reflected as a discontinued operation as the income was previously shown as a separately reported operating segment. 15. Average number of employees Private Banking Commercial Banking RAF All Other Divisions Group Centre 2018 135 46 26 182 17 406 2017 136 38 13 161 17 365 16. Earnings per ordinary share Basic Basic earnings per ordinary share are calculated by dividing the profit after tax attributable to equity holders of the Company by the weighted average number of ordinary shares 14,889,048 (2017: 14,852,763) in issue during the year. Diluted Diluted earnings per ordinary share are calculated by dividing the dilutive profit after tax attributable to equity holders of the Company by the weighted average number of ordinary shares in issue during the year, as well as the number of dilutive share options in issue during the year. The number of dilutive share options in issue at the year end was nil (2017: nil). Profit & dilutive profit attributable Total (loss)/profit after tax attributable to equity holders of the Company Profit after tax from continuing operations attributable to equity holders of the Company (Loss)/profit after tax from discontinued operations attributable to equity holders of the Company Basic & Diluted Earnings per share Total Basic Earnings per share Basic Earnings per share from continuing operations Basic Earnings per share from discontinued operations 2018 £000 (20,033) 5,659 (25,692) 2018 p (134.5) 38.0 (172.5) 2017 £000 6,523 2,086 4,437 2017 p 43.9 14.0 29.9 Arbuthnot Banking Group PLCReport & Accounts 2018 103 17. Cash and balances at central banks Group Cash and balances at central banks 2018 £000 2017 £000 405,325 313,101 All assets have been assessed as Stage 1 at 1 January and 31 December 2018, with immaterial ECL. Surplus funds are mainly held in the Bank of England reserve account, with the remainder held in certificates of deposit, fixed rate notes and money market deposits in highly rated banks (the majority held in UK clearing banks). 18. Loans and advances to banks Group Placements with banks included in cash and cash equivalents (Note 41) 2018 £000 54,173 The table below presents an analysis of loans and advances to banks by rating agency designation as at 31 December, based on Moody’s long term ratings: Group Aaa Aa3 A1 A2 A3 Baa1 Unrated None of the loans and advances to banks are past due (2017: £nil). ECL has been assessed as immaterial. Company Placements with banks included in cash and cash equivalents (Note 41) 2018 £000 709 42,230 8,880 1,906 10 430 8 54,173 2018 £000 17,008 Loans and advances to banks include bank balances of £17.0m (2017: £36.1m) with Arbuthnot Latham & Co., Ltd. 19. Debt securities at amortised cost/held-to-maturity Debt securities represent certificates of deposit. The movement in debt securities may be summarised as follows: Group At 1 January Exchange difference Additions Redemptions At 31 December 2018 £000 227,019 4,783 467,772 (356,883) 342,691 2017 £000 70,679 2017 £000 – 39,871 20,553 10,012 – 235 8 70,679 2017 £000 36,103 2017 £000 107,300 (951) 211,080 (90,410) 227,019 Arbuthnot Banking Group PLCReport & Accounts 2018 104 Notes to the Consolidated Financial Statements continued 19. Debt securities at amortised cost/held-to-maturity (continued) The table below presents an analysis of debt securities by rating agency designation at 31 December, based on Moody’s long term ratings: Group Aaa Aa1 Aa2 Aa3 A1 A2 A3 None of the debt securities are past due (2017: £nil). ECL has been assessed as immaterial. 20. Assets classified as held for sale Seed capital investments held for sale Repossessed property held for sale 2018 £000 76,281 84,218 32,325 56,046 75,657 18,164 – 342,691 Group 2018 £000 – 8,002 8,002 2017 £000 100,106 51,389 5,946 18,384 18,187 – 33,007 227,019 2017 £000 – 2,915 2,915 Seed capital investments held for sale The Group considers itself a sponsor of an investment fund when it facilitates the establishment of a fund in which the Group is the investment manager. The Group ordinarily provides seed capital in order to provide initial scale and facilitate marketing of the funds to third-party investors. The fund is then financed through the issue of units to investors. Aggregate interests held by the Group include seed capital, management fees and performance fees. The Group generates management and performance fee income from managing the assets on behalf of third-party investors. The Group has an investment of £nil (2017: £1) in the share capital of the SPV created to administer the fund. At 31 December 2018, the Group has a receivable of £nil (2017: £6.8m) from the SPV, which is reflected in Note 24. In 2017, the Fund was classified as held for sale. The criteria required for this classification have not been met in 2018 and therefore it has been consolidated in 2018. Repossessed property held for sale In the prior year, a property in Spain held as collateral on a loan was repossessed. As at the time of repossession, it was expected that the property would be sold in 12 months, it was recognised as held for sale. A sale was not possible during the year, due to factors outside of the Group’s control, however as a sale is assessed to be probable within 12 months, it has been recognised as held for sale with a carrying value of £3.1m (2017: £2.9m). During the year, a further property in Spain held as collateral on a loan, valued at £4.9m at year end was repossessed. The Group’s policy is to pursue timely realisation of the collateral in an orderly manner. The property is recognised as an asset held for sale. All repossessed property is expected to be sold within 12 months. Arbuthnot Banking Group PLCReport & Accounts 2018 105 21. Derivative financial instruments Group Currency swaps Interest rate swaps Structured notes 2018 2017 Contract/notional amount £000 Fair value assets £000 Fair value liabilities £000 Contract/notional amount £000 Fair value assets £000 Fair value liabilities £000 4,929 25,762 1,607 32,298 192 112 1,542 1,846 188 – – 188 9,614 17,824 1,607 29,045 950 – 1,601 2,551 931 – – 931 All assets have been assessed as Stage 1 as at 1 January and 31 December 2018, with immaterial ECL. The principal derivatives used by the Group are over the counter exchange rate contracts. Exchange rate related contracts include currency swaps and interest rate swaps. A forward foreign exchange contract is an agreement to buy or sell a specified amount of foreign currency on a specified future date at an agreed rate. Currency swaps generally involve the exchange of interest payment obligations denominated in different currencies; exchange of principal can be notional or actual. The currency swaps are settled net and therefore the fair value is small in comparison to the contract/notional amount. Interest rate swaps are used to hedge against the Profit or Loss impact resulting from the movement in interest rates, due to some exposures having fixed rate terms. Also included in derivative financial instruments are structured notes. The Group invested in the structured notes, which are maturing in 2021. The Group only uses investment graded banks as counterparties for derivative financial instruments. None of the contracts are collateralised. The table below presents an analysis of derivative financial instruments contract/notional amounts by rating agency designation of counterparty bank at 31 December, based on Moody’s long term ratings: Group A1 A2 Baa1 2018 £000 29,601 2,635 62 32,298 2017 £000 26,521 2,524 – 29,045 Arbuthnot Banking Group PLCReport & Accounts 2018 106 Notes to the Consolidated Financial Statements continued 22. Loans and advances to customers Analyses of loans and advances to customers: Group At 31 December 2017 IFRS 9 reclassification into Stages Gross loans and advances at 1 January 2018 Originations Repayments and write-offs Transfer to Stage 1 Transfer to Stage 2 Transfer to Stage 3 IAS 39 £000 1,050,631 (1,050,631) – Gross loans and advances at 31 December 2018 Less allowances for ECLs (see Note 23) Net loans and advances at 31 December 2018 – – – Stage 1 £000 – 992,252 992,252 458,825 (266,890) 7,975 (27,929) (3,109) 1,161,124 (1,606) 2018 Stage 2 £000 – 29,502 29,502 – (8,809) (7,975) 28,975 (8,993) 32,700 (8) 1,159,518 32,692 2017 Stage 3 £000 – 28,877 28,877 – (2,526) – (1,046) 12,102 37,407 (4,961) 32,446 Total £000 1,050,631 – 1,050,631 458,825 (278,225) – – – 1,231,231 (6,575) 1,224,656 Group IAS 39 £000 Stage 1 £000 Stage 2 £000 Stage 3 £000 Total £000 Gross loans and advances at 31 December 2017 Less allowances for impairments (see Note 23) Net loans and advances at 31 December 2017 1,050,631 (1,362) 1,049,269 – – – – – – – – – 1,050,631 (1,362) 1,049,269 Comparative data for 2017 has been prepared under IAS 39. For a maturity profile of loans and advances to customers, refer to Note 6. Loans and advances to customers by division (net of ECL/impairments): Group Stage 1 Stage 2 Stage 3 At 31 December 2018 Group At 31 December 2017 Private Banking £000 618,486 20,034 31,944 670,464 Private Banking £000 650,245 Commercial Banking £000 431,630 11,478 – 443,108 Commercial Banking £000 305,055 2018 2017 RAF £000 84,276 1,180 502 85,958 RAF £000 71,265 All Other Divisions £000 25,126 – – 25,126 All Other Divisions £000 Total £000 1,159,518 32,692 32,446 1,224,656 Total £000 22,704 1,049,269 Arbuthnot Banking Group PLCReport & Accounts 2018 Analyses of past due loans and advances to customers by division: Group Up to 30 days Stage 1 Stage 2 Stage 3 30 - 60 days Stage 2 Stage 3 60 - 90 days Stage 2 Stage 3 Over 90 days Stage 2 Stage 3 At 31 December Group Up to 30 days 30 - 60 days Over 90 days At 31 December Private Banking £000 47,766 47,766 – – 662 662 – 385 385 – 49,415 12,901 36,514 98,228 Private Banking £000 90,527 11,043 5,078 106,648 2018 Commercial Banking £000 20,784 20,784 – – 2,300 2,300 – 4,177 4,177 – – – – 27,261 Commercial Banking £000 24,599 – – 24,599 2017 RAF £000 2,519 2,078 154 287 775 565 210 297 175 122 546 272 274 4,137 RAF £000 – – – – Prior year numbers are presented under IAS 39 and therefore has no Staging. Loans and advances to customers include finance lease receivables as follows: Group Gross investment in finance lease receivables: – No later than 1 year – Later than 1 year and no later than 5 years – Later than 5 years Unearned future finance income on finance leases Net investment in finance leases The net investment in finance leases may be analysed as follows: – No later than 1 year – Later than 1 year and no later than 5 years – Later than 5 years 107 Total £000 71,069 70,628 154 287 3,737 3,527 210 4,859 4,737 122 49,961 13,173 36,788 129,626 Total £000 115,126 11,043 5,078 131,247 2017 £000 28,911 53,766 – 82,677 (11,412) 71,265 23,170 48,095 – 71,265 All Other Divisions £000 – – – – – – – – – – – – – – All Other Divisions £000 – – – – 2018 £000 36,609 62,541 214 99,364 (13,406) 85,958 30,657 55,095 206 85,958 Arbuthnot Banking Group PLCReport & Accounts 2018 108 Notes to the Consolidated Financial Statements continued 22. Loans and advances to customers (continued) (a) Loans and advances renegotiated Restructuring activities include external payment arrangements, modification and deferral of payments. Following restructuring, a previously overdue customer account is reset to a normal status and managed together with other similar accounts. Restructuring policies and practices are based on indicators or criteria which, in the judgement of management, indicate that payment will most likely continue. These policies are kept under continuous review. Renegotiated loans that would otherwise be past due or impaired totalled £nil (2017: £nil). (b) Collateral held Collateral is measured at fair value less costs to sell. Most of the loans are secured by property. The fair value of the collateral held against loans and advances in Stage 3 is £43.0m (2017: £42.5m – collateral of loans and advances recognised as impaired under IAS 39) against loans (net of ECL) of £37.4m (2017: £29.7m – loans and advances recognised as impaired under IAS 39). The weighted average loan-to-value is 72.9% (2017: 50%). 23. Allowances for impairment of loans and advances An analysis of movements in the allowance for ECLs: Group At 31 December 2017 IFRS 9 transition adjustment Reclassification into IFRS 9 Stages At 1 January 2018 IAS 39 £000 1,362 2,580 (3,942) – Transfer to Stage 1 Transfer to Stage 2 Transfer to Stage 3 Current year charge Adjustment due to variation in expected future cash flows Repayments and write-offs At 31 December 2018 – Allowances for impairments of loans and advances – IAS 39 comparatives Reconciliation of specific allowance for impairments: Group At 1 January Impairment losses On acquisition of RAF (see Note 29) Loans written off during the year as uncollectible Amounts recovered during the year At 31 December Stage 1 £000 Stage 2 £000 Stage 3 £000 1,244 1,244 – (378) (81) 821 – – 1,606 1,178 1,178 – 378 (1,548) – – – 8 1,520 1,520 – – 1,629 1,871 78 (137) 4,961 Total £000 1,362 2,580 – 3,942 – – – 2,692 78 (137) 6,575 2017 £000 973 329 51 (15) (116) 1,222 Arbuthnot Banking Group PLCReport & Accounts 2018 109 2017 £000 75 65 140 1,362 2017 £000 5,208 4,436 6,756 4,224 2018 £000 2,976 4,058 – 5,682 Reconciliation of collective allowance for impairments: Group On acquisition of RAF (see Note 29) Impairment losses At 31 December Total allowance for impairments as at 31 December 2017 24. Other assets Group Trade receivables Inventory Receivable from investment fund held for sale Prepayments and accrued income 12,716 20,624 As allowed by IFRS 9, the Group utilises the practical expedient for the stage allocation of particular financial instruments which are deemed ‘low credit risk’. This practical expedient permits the Group to assume, without more detailed analysis, that the credit risk on a financial instrument has not increased significantly since initial recognition if the financial instrument is determined to have ‘low credit’ at the reporting date. The Group allocates such assets to Stage 1. The low credit risk exemption is applied to Trade receivables. ECL has been assessed as immaterial. Inventory Land acquired through repossession of collateral which is subsequently held in the ordinary course of business with a view to develop and sell is accounted for as inventory. The land is currently in the process of being redeveloped and will ultimately be sold off as individual residential plots. The proceeds from the sale of these plots will be used to repay the outstanding loans. Pinnacle Universal is a special purpose vehicle, 100% owned by the Group, which owns this land. Company Trade receivables Due from subsidiary undertakings Prepayments and accrued income 2018 £000 – – 42 42 2017 £000 3 159 37 199 Arbuthnot Banking Group PLCReport & Accounts 2018 110 Notes to the Consolidated Financial Statements continued 25. Financial investments Group Designated at fair value through profit and loss – Listed securities – Debt securities Designated at fair value through other comprehensive income – Listed securities – Debt securities – Unlisted securities Total financial investments 2018 £000 – 165 34,222 – 964 35,351 2017 £000 128 – 4 1,497 718 2,347 Listed securities The Group holds investments in listed securities which are valued based on quoted prices. On 8 August 2018, ABG lost significant influence over STB. At this date the interest in associate was de-recognised and the shares held in STB were marked to market and disclosed as a financial investment. The shares were designated as FVOCI for strategic purposes. In November 2018 ABG sold 575,000 shares held in STB, reducing the shareholding from 18.64% to 15.53%. The carrying value at year end is £34.2m and £0.7m of dividends were received in the year. Debt securities The Group has made an investment in an unlisted special purpose vehicle, set up to acquire and enhance the value of a commercial property through its 100% owned subsidiary. During 2018 the subsidiary company was sold. Under the terms of the sale agreement the buyer agreed to purchase 100% of the share capital and reimburse all outstanding loans. The proceeds of the sale have been distributed to the investors, except for the amount withheld for the general and specific warranties (which will be released in three instalments at 18 month intervals included as a condition of the sale agreement. A distribution of £1.6m has been received and a gain of £0.1m has been recognised in profit during the year. The investment has been valued at £0.2m as at 31 December 2018 (see Note 6. (e)). Unlisted securities All unlisted securities have been designated as FVOCI as they are held for strategic reasons. On 23 June 2016 Arbuthnot Latham received €1.3m cash consideration following Visa Inc.’s completion of the acquisition of Visa Europe. As part of the deal Arbuthnot Latham also received preference shares in Visa Inc., these have been valued at their future conversion value into Visa Inc. common stock. Management has assessed the fair value of the Group’s investment as £863k (2017: £706k). This valuation includes a 31% haircut. On adoption of IFRS 9 at 1 January 2018, the Group designated its investment in the security as FVOCI. Previously, this investment was classified as available for sale and measured at fair value through other comprehensive income. Dividends received during the year amounted to £7k (2017: £2k). A further investment in an unlisted investment vehicle was a made in the year. The carrying value at year end is £100k and no dividends were received in the year. Company Financial investments comprise: – Listed securities (at fair value through OCI) – Unlisted securities (at fair value through OCI) Total financial investments 2018 £000 19,312 1 19,313 2017 £000 128 12 140 Arbuthnot Banking Group PLCReport & Accounts 2018 26. Deferred taxation The deferred tax asset comprises: Group Accelerated capital allowances and other short-term timing differences Movement in fair value of financial investments FVOCI/available-for-sale Unutilised tax losses IFRS 9 adjustment Deferred tax asset At 1 January On acquisition of RAF Other Comprehensive Income – FVOCI/available-for-sale Profit and loss account – accelerated capital allowances and other short-term timing differences Profit and loss account – tax losses IFRS 9 adjustment Deferred tax asset at 31 December Company Accelerated capital allowances and other short-term timing differences Tax losses Deferred tax asset At 1 January Profit and loss account – accelerated capital allowances and other short-term timing differences Profit and loss account – tax losses Deferred tax asset at 31 December 2018 £000 (68) (66) 1,134 490 1,490 1,527 – (26) (96) (405) 490 1,490 2018 £000 2 111 113 641 – (528) 113 111 2017 £000 372 (40) 1,195 – 1,527 1,665 5 (26) (576) 459 – 1,527 2017 £000 346 295 641 397 (51) 295 641 Deferred tax assets are recognised for tax losses to the extent that the realisation of the related tax benefit through future taxable profits is probable. 27. Interests in associates Group Secure Trust Bank PLC Interests in associates 2018 £000 – – 2017 £000 83,804 83,804 Secure Trust Bank (“STB”) At 31 December 2017, ABG had an 18.64% shareholding in STB. On 8 August 2018, ABG lost significant influence over STB and as such the interest in associate was de-recognised. This resulted in a loss on de-recognition of £28.7m, as the shares were marked to market at that date. The profit from associate up to 8 August 2018 was £3m. Going forward the shareholding in STB is reflected as a financial investment as disclosed in Note 25. Interest in associate for the Company is set out below: Company Secure Trust Bank PLC Interests in associates 2018 £000 – – 2017 £000 5,056 5,056 Arbuthnot Banking Group PLCReport & Accounts 2018 112 Notes to the Consolidated Financial Statements continued 28. Intangible assets Group Cost At 1 January 2017 Additions On Acquisition – RAF (see Note 29) At 31 December 2017 Additions At 31 December 2018 Accumulated amortisation At 1 January 2017 Amortisation charge At 31 December 2017 Amortisation charge At 31 December 2018 Net book amount At 31 December 2017 At 31 December 2018 Goodwill £000 Computer software £000 Other intangibles £000 1,682 – 3,520 5,202 – 5,202 – – – – – 5,202 5,202 8,507 2,641 – 11,148 2,294 13,442 (1,732) (830) (2,562) (1,483) (4,045) 8,586 9,397 214 – 2,348 2,562 – 2,562 (149) (206) (355) (268) (623) 2,207 1,939 Total £000 10,403 2,641 5,868 18,912 2,294 21,206 (1,881) (1,036) (2,917) (1,751) (4,668) 15,995 16,538 The accounting policy for goodwill is described in Note 3.15 (a). The Group reviews the goodwill for impairment at least annually or when events or changes in economic circumstances indicate that impairment may have taken place. Significant management judgements are made in estimations, to evaluate whether an impairment of goodwill is necessary. Impairment testing is performed at CGU level and the following two items, with judgements surrounding them, have a significant impact on the estimations used in determining the necessity of an impairment charge: • Future cash flows – Cash flow forecasts reflect management’s view of future business forecasts at the time of the assessment. A detailed three year budget is done every year and management also uses judgement in applying a growth rate. The accuracy of future cash flows is subject to a high degree of uncertainty in volatile market conditions. During such conditions, management would perform impairment testing more frequently than annually to ensure that the assumptions applied are still valid in the current market conditions. • Discount rate – Management also apply judgement in determining the discount rate used to discount future expected cash flows. The discount rate is derived from the cost of capital for each CGU. The recoverable amount of an asset or CGU is the greater of its value in use and its fair value less costs to sell. There are currently two CGUs (2017: two) with goodwill attached; the core Arbuthnot Latham CGU (£1.7m) and RAF CGU (£3.5m). Management considers the value in use for both CGUs to be the discounted cash flows over 5 years with a terminal value (2017: 5 years with a terminal value). The 5 year discounted cash flows with a terminal value are considered to be appropriate as the goodwill relates to an ongoing well established business and not underlying assets with finite lives. The terminal value is calculated by applying a discounted perpetual growth model to the profit expected in 2020 as per the approved 3 year plan. A growth rate of 8.9% (2017: 12.5%) was used for income and 6.9% (2017: 18%) for expenditure from 2018 to 2020 (these rates were the best estimate of future forecasted performance), while a 3% (2017: 3%) percent growth rate for income and expenditure (a more conservative approach was taken for latter years as these were not budgeted for in detail as per the three year plan approved by the Board of Directors) was used for cash flows after the approved three year plan. Arbuthnot Banking Group PLCReport & Accounts 2018 113 Management considers the value in use for the RAF CGU to be the discounted cash flows over 5 years with a terminal value. The 5 year discounted cash flows with a terminal value are considered to be appropriate as the goodwill relates to an ongoing, well established, business and not underlying assets with finite lives. The terminal value is calculated by applying a discounted perpetual growth model to the profit expected in 2022 as per the approved budget. A growth rate of 3% (2017: 5%) was used (this rate was the best estimate of future forecasted performance). The growth rates used are above the forecast UK growth rate of 1.3% to reflect the Bank’s current growth strategy enabled by capital available at parent level. Cash flows were discounted at a pre-tax rate of 12% (2017: 12%) to their net present value. The discount rate of 12% is considered to be appropriate after evaluating current market assessments of the time value of money and the risks specific to the assets or CGUs. Currently, the value in use and fair value less costs to sell of both CGUs exceed the carrying values of the associated goodwill and as a result no sensitivity analysis was performed. Company Cost Additions At 31 December 2018 Accumulated amortisation At 1 January 2017 Amortisation charge At 31 December 2018 Net book amount At 31 December 2018 Computer software £000 7 7 – (1) (1) 6 29. Acquisition of Renaissance Asset Finance Ltd On 28 April 2017, Arbuthnot Latham & Co. Ltd completed the acquisition of 100% of the share capital of Renaissance Asset Finance Limited (“RAF”) from its founders following receipt of regulatory approval. RAF is a provider of finance for a range of specialist assets which includes vintage and expensive cars and SME business assets. The acquisition supported ALs strategy to diversify its proposition within the specialist financial services sector. The consideration will be paid in four staged amounts, all of which will be in cash. The first payment was equal to the net assets at completion of £2.1m. The remaining three payments are performance related and will be based on the profits of RAF in each of the three calendar years 2018 to 2020. The maximum amount payable for the performance based payments is limited to £6.5m. AL has also provided an intercompany loan to RAF at completion of £57m to re-finance RAF’s existing finance liabilities. The consideration and the refinancing of RAF’s funding liabilities have been satisfied from the Group’s current cash resources. The assets acquired and resulting goodwill on acquisition are set out in the table below. The fair value of intangibles acquired include £0.4m relating to customer relationships, £1.5m relating to broker relationships and £0.4m for the brand. The resultant goodwill represented the assembled specialist workforce, established process and control environment, cross selling opportunities between the two companies and the opportunity cost of a fully operational company within the sector. Arbuthnot Banking Group PLCReport & Accounts 2018 114 Notes to the Consolidated Financial Statements continued 29. Acquisition of Renaissance Asset Finance Ltd (continued) Acquired assets/ liabilities £000 Fair value adjustments £000 Recognised values on acquisition £000 Loans and advances to banks Loans and advances to customers Other asset Deferred tax assets Intangible assets Property, plant and equipment Total assets Deposits from banks Current tax liability Other liabilities Total liabilities Net identifiable assets Consideration Goodwill 30. Property, plant and equipment Group Cost or valuation At 1 January 2017 Additions On acquisition – RAF (see Note 29) Disposals At 31 December 2017 Additions Disposals At 31 December 2018 At 1 January 2017 Depreciation charge On acquisition – RAF (see Note 29) Disposals At 31 December 2017 Depreciation charge Disposals At 31 December 2018 Net book amount At 31 December 2017 At 31 December 2018 2,815 57,684 1,341 5 – 23 61,868 58,969 195 632 59,796 2,072 – – – – 2,348 – 2,348 – – – – 2,348 Freehold land and buildings £000 Leasehold improvements £000 Computer and other equipment £000 Motor Vehicles £000 – – – – – – – – – – – – – – – – – – 4,587 408 20 – 5,015 1,764 – 6,779 (1,217) (944) (16) – (2,177) (823) – (3,000) 2,838 3,779 2,741 258 52 (10) 3,041 627 – 3,668 (1,380) (540) (33) 10 (1,943) (276) – (2,219) 1,098 1,449 97 – – – 97 91 (97) 91 (46) (25) – – (71) (23) 79 (15) 26 76 2,815 57,684 1,341 5 2,348 23 64,216 58,969 195 632 59,796 4,420 7,940 3,520 Total £000 7,425 666 72 (10) 8,153 2,482 (97) 10,538 (2,643) (1,509) (49) 10 (4,191) (1,122) 79 (5,234) 3,962 5,304 Arbuthnot Banking Group PLCReport & Accounts 2018 115 Included within the depreciation charge for the year is £nil (2017: £78k) of additional depreciation in relation to the early termination of a property lease. Company Cost or valuation At 1 January 2017 At 31 December 2017 Additions Disposals At 31 December 2018 Accumulated depreciation At 1 January 2017 Depreciation charge At 31 December 2017 Depreciation charge Disposals At 31 December 2018 Net book amount At 31 December 2017 At 31 December 2018 31. Investment property Group Opening balance Additions Transfer Fair value adjustment At 31 December 2018 Computer and other equipment £000 Motor Vehicles £000 214 214 3 – 217 (82) (2) (84) (1) – (85) 130 132 97 97 91 (97) 91 (46) (24) (70) (24) 79 (15) 27 76 2018 £000 59,439 879 6,763 – 67,081 Total £000 311 311 94 (97) 308 (128) (26) (154) (25) 79 (100) 157 208 2017 £000 53,339 6,421 – (321) 59,439 £0.9m of additions in 2018 relate to development costs of the St Philips Place property. No property interests are held under operating leases and accounted for as investment property. King Street London Arbuthnot Latham & Co., Limited acquired premises in the West End of London (namely 20 King Street/10 St James’s Street) on 23 June 2016. The property comprises 22,450 square feet of office space and approximately 7,000 square feet of retail space. The property is held by way of leasehold from The Crown Estate Commissioners that expires in 2136 and with a rent review every five years. The property is currently fully tenanted, with the main lease ending in 2019. It is accounted for as investment property and the Group has elected to apply the fair value model. It was therefore initially recognised at cost and then subsequently at fair value. The fair value is determined using the rental income on the property and the associated effective yield of similar properties in the surrounding area (see Note 4.1(d)). At 31 December 2018 there was no material difference between the cost of the property and the fair value. Independent market commentary of the prime London property market was undertaken at year end to support the valuation. The Group received £2.1m (2017: £2.1m) rental income during the year and incurred £0.2m (2017: £0.2m) of direct operating expenses. Arbuthnot Banking Group PLCReport & Accounts 2018 116 Notes to the Consolidated Financial Statements continued 31. Investment property (continued) St Philips Place Birmingham On 24 November 2017, Arbuthnot Latham & Co., Limited acquired leasehold premises in Birmingham (St Philips House, 4 St Philips Place). The property comprises 24,286 square feet of office space. The property is unoccupied and is currently undergoing comprehensive refurbishment at an estimated cost of £3.2m. After refurbishment the property will be let out. It is accounted for as investment property and the Group has elected to apply the fair value model. It was therefore initially recognised at cost and then subsequently at fair value (see Note 4.1(c)). A development appraisal has been completed by estimating the gross development value and deducting the estimated costs to complete the refurbishment, arm’s length financing costs and development profit margin. Crescent Office Park, Bath In November 2017, a Property Fund, based in Jersey and owned by the Group, acquired a freehold office building in Bath. The property comprises 25,526 square ft. over ground and two upper floors with parking spaces. The property was acquired for £6.35m. On the date of acquisition, the property was being multi-let to tenants and was at full capacity. In 2017, the Fund was recognised as an asset held for sale under IFRS 5 and therefore not consolidated in the financial statements. At 31 December 2018 it was consolidated into the Group as it no longer met the IFRS 5 criteria and is recognised as an investment property. The Group has elected to apply the fair value model (see Note 4.1(c)). The Group recognised £0.5m rental income during the year and incurred £0.5m of operating expenses. 32. Deposits from banks Group Deposits from other banks 2018 £000 2017 £000 232,675 195,097 Deposits from banks include £225m (2017: £188m) obtained through the Bank of England Term Funding Scheme (“TFS”). For a maturity profile of deposits from banks, refer to Note 6. 33. Deposits from customers Group Current/demand accounts Notice accounts Term deposits 2018 £000 944,564 75,879 693,843 2017 £000 868,855 101,909 420,017 1,714,286 1,390,781 Included in customer accounts are deposits of £24.5m (2017: £29.2m) held as collateral for loans and advances. The fair value of these deposits approximates their carrying value. For a maturity profile of deposits from customers, refer to Note 6. Arbuthnot Banking Group PLCReport & Accounts 2018 34. Other liabilities Group Trade payables Accruals and deferred income 117 2018 £000 1,782 16,767 18,549 2017 £000 1,207 15,032 16,239 Financial Services Compensation Scheme Levy In common with all regulated UK deposit takers, AL pays levies to the Financial Services Compensation Scheme (“FSCS”) to enable the FSCS to meet claims against the Scheme. The FSCS levy consists of two parts: a management expenses levy and a more significant compensation levy. The management expenses levy covers the costs of running the scheme and the compensation levy covers the amount of compensation and associated interest the Scheme pays, net of any recoveries it makes using the rights that have been assigned to it. The Group’s FSCS provision reflects market participation up to the reporting date and the accrual of £nil (2017: £0.2m) relates to the interest levy for the Scheme year 2019/20 which was paid in 2018. This amount was calculated on the basis of the Group’s share of protected deposits and the FSCS’s estimate of total interest levies payable for each Scheme year. Company Due to subsidiary undertakings Accruals and deferred income 35. Debt securities in issue Group and Company Subordinated loan notes 2018 £000 1,838 1,486 3,324 2018 £000 2017 £000 1,840 1,301 3,141 2017 £000 13,283 13,104 The subordinated loan notes were issued on 7 November 2005 and are denominated in Euros. The principal amount outstanding at 31 December 2018 was €15,000,000 (2017: €15,000,000). The notes carry interest at 3% over the interbank rate for three month deposits in euros and are repayable at par in August 2035 unless redeemed or repurchased earlier by the Company. The contractual undiscounted amount that will be required to be paid at maturity of the above debt securities is €15,000,000. Given the fact that the Group has never been subject to a published credit rating by any of the relevant agencies and the notes in issue are not quoted, it is not considered possible to estimate a fair value for these notes. 36. Contingent liabilities and commitments Contingent liabilities The Group is subject to extensive regulation in the conduct of its business. A failure to comply with applicable regulations could result in regulatory investigations, fines and restrictions on some of the Group’s business activities or other sanctions. The Group seeks to minimise this risk through the adoption and compliance with policies and procedures, continuing to refine controls over business practices and behaviour, employee training, the use of appropriate documentation, and the involvement of outside legal counsel where appropriate. Capital commitments At 31 December 2018, the Group had capital commitments of US$0.7m (2017: £nil) in respect of a contribution in an equity investment. Arbuthnot Banking Group PLCReport & Accounts 2018 118 Notes to the Consolidated Financial Statements continued 36. Contingent liabilities and commitments (continued) Credit commitments The contractual amounts of the Group’s off-balance sheet financial instruments that commit it to extend credit to customers are as follows: Group Guarantees and other contingent liabilities Commitments to extend credit: – Original term to maturity of one year or less 2018 £000 1,744 67,880 69,624 2017 £000 2,976 131,963 134,939 Operating lease commitments Where a Group company is the lessee, the future aggregate lease payments under non-cancellable operating leases are as follows: Group Expiring: Within 1 year Later than 1 year and no later than 5 years Later than 5 years 2018 £000 2,129 10,787 2,661 15,577 2017 £000 2,330 10,943 5,384 18,657 In 2013, Arbuthnot Latham & Co., Ltd entered into a 16 year lease on 7 Wilson Street, London (the head office for Arbuthnot Banking Group PLC and the principal location for Arbuthnot Latham & Co., Ltd), with a break at 11 years and rent reviews after 5, 10 and 15 years. The initial rent is £1.75m per annum. This lease forms the most significant part of the operating leases disclosed in the table above. In 2015, the Bank entered into a 10 year lease to occupy part of the ground floor of The Senate, Southernhay Gardens, Exeter, with a break clause and rent review after 5 years. The initial rent is £0.1m per annum. In 2017, the Bank entered into a 10 year lease to occupy part of the eighth floor of 82 King Street, Manchester, with a break clause and rent review after 5 years. The initial rent is £0.1m per annum. On 3 January 2018, Arbuthnot Latham entered into a 12 year lease (up to 16 October 2029) to occupy the first, second and third floor of 10 Dominion Street London, with a break clause on 16 October 2024. The initial rent is £0.7m per annum. In addition to the above commitments, ground rent of £0.2m per annum is payable for the remaining term of 118 years of the King Street investment property. 37. Share capital Group and Company At 1 January 2017 At 31 December 2017 & December 2018 Number of shares 15,279,322 15,279,322 Ordinary share capital £000 153 153 Share premium £000 – – The Ordinary shares have a par value of 1p per share (2017: 1p per share). At 31 December 2018 the Company held 390,274 shares (2017: 390,274) in treasury. Arbuthnot Banking Group PLCReport & Accounts 2018 119 2018 £000 20 (12,169) (1,131) 209,083 195,803 2017 £000 20 162 (1,131) 237,171 236,222 38. Reserves and retained earnings Group Capital redemption reserve Fair value reserve/Available-for-sale reserve Treasury shares Retained earnings Total reserves at 31 December The capital redemption reserve represents a reserve created after the Company purchased its own shares which resulted in a reduction of share capital. Company Capital redemption reserve Fair value reserve Treasury shares Retained earnings Total reserves as 31 December 39. Share-based payment options 2018 £000 20 (7,022) (1,131) 162,729 154,596 2017 £000 20 – (1,131) 124,659 123,548 Company – cash settled On 14 June 2016 Mr. Salmon was granted phantom options pursuant to the Phantom Option Scheme to acquire 200,000 ordinary 1p shares in the Company at 1591p exercisable in respect of 50% on or after 15 June 2019 and in respect of the remaining 50% on or after 15 June 2021 when a cash payment would be made equal to any increase in value. On 14 June 2016 Mr. Cobb and Mr. Henderson were each granted phantom options pursuant to the Phantom Option Scheme to acquire 100,000 ordinary 1p shares in the Company at 1591p exercisable in respect of 50% on or after 15 June 2019 and in respect of the remaining 50% on or after 15 June 2021 when a cash payment would be made equal to any increase in market value. The fair value of the options at grant date was £1.3m. At 31 December 2018, the fair value of the options was £0.1m (2017: £0.8m). The performance conditions of the Scheme are that for the duration of the vesting period, the dividends paid by ABG must have increased in percentage terms when compared to an assumed dividend of 29p per share in respect of the financial year ending 31 December 2016, by a minimum of the increase in the Retail Prices Index during that period. Also from the grant date to the date the Option is exercised, there must be no public criticism by any regulatory authority on the operation of ABG or any of its subsidiaries which has a material impact on the business of ABG. Options are forfeited if they remain unexercised after a period of more than 7 years from the date of grant. If the participant ceases to be employed by the Group by reason of injury, disability, ill-health or redundancy; or because his employing company ceases to be a shareholder of the Group; or because his employing business is being transferred out of the Group, his option may be exercised within 6 months after such cessation. In the event of the death of a participant, the personal representatives of a participant may exercise an option, to the extent exercisable at the date of death, within 6 months after the death of the participant. On cessation of employment for any other reason (or when a participant serves, or has been served with, notice of termination of such employment), the option will lapse although the Remuneration Committee has discretion to allow the exercise of the option for a period not exceeding 6 months from the date of such cessation. In such circumstances, the performance conditions may be modified or waived as the Remuneration Committee, acting fairly and reasonably and taking due consideration of the circumstances, thinks fit. The number of Ordinary Shares which can be acquired on exercise will be pro-rated on a time elapsed basis, unless the Remuneration Committee, acting fairly and reasonably and taking due consideration of the circumstances, decides otherwise. In determining whether to exercise its discretion in these respects, the Remuneration Committee must satisfy itself that the early exercise of an option does not constitute a reward for failure. Arbuthnot Banking Group PLCReport & Accounts 2018 120 Notes to the Consolidated Financial Statements continued 39. Share-based payment options (continued) The probability of payout has been assigned based on the likelihood of meeting the performance criteria, which is 100%. The Directors consider that there is some uncertainty surrounding whether the participants will all still be in situ and eligible at the vesting date. Therefore the directors have assumed a 9% attrition rate for the share options vesting in June 2019 and 15% attrition rate for the share options vesting in June 2021. The attrition rate will increase by 3% per year until the vesting date. ABG had a write back of £0.3m in relation to share based payments during 2018 (2017: £0.2m expense), as disclosed in Note 12. Measurement inputs and assumptions used in the Black-Scholes model are as follows: Expected Stock Price Volatility Expected Dividend Yield Risk Free Interest Rate Average Expected Life (in years) 40. Dividends per share 2018 19.8% 3.6% 0.8% 1.46 2017 27.0% 2.5% 0.5% 2.46 Final dividends are not accounted for until they have been approved at the Annual General Meeting. At the meeting on 9 May 2019, a dividend in respect of 2018 of 20p per share (2017: actual dividend 19p per share) amounting to a total of £2.98m (2017: actual £2.83m) is to be proposed. The financial statements for the year ended 31 December 2018 do not reflect the final dividend which will be accounted for in shareholders’ equity as an appropriation of retained profits in the year ending 31 December 2019. 41. Cash and cash equivalents For the purposes of the Statement of Cash Flows, cash and cash equivalents are comprised of the following balances with less than three months’ maturity from the date of acquisition. Group Cash and balances at central banks (Note 17) Loans and advances to banks (Note 18) Company Loans and advances to banks 2018 £000 405,325 54,173 459,498 2018 £000 2017 £000 313,101 70,679 383,780 2017 £000 17,008 36,103 Arbuthnot Banking Group PLCReport & Accounts 2018 121 42. Related party transactions Related parties of the Company and Group include subsidiaries, directors, Key Management Personnel, close family members of Key Management Personnel and entities which are controlled, jointly controlled or significantly influenced, or for which significant voting power is held, by Key Management Personnel or their close family members. Other than the directors’ remuneration (see Remuneration Report pages 31 to 32), payment of dividends and transactions with subsidiaries and associates, there were no related party transactions within the Parent Company. A number of banking transactions are entered into with related parties in the normal course of business on normal commercial terms. These include loans and deposits. Except for the directors’ disclosures, there were no other Key Management Personnel disclosures; therefore the tables below relate to directors and their close family members. Group – subsidiaries Loans Loans outstanding at 1 January Loans advanced during the year Loan repayments during the year Transfer to deposits during the year Transferred to loans with associates Loans outstanding at 31 December Interest income earned Group – associates Loans Loans outstanding at 1 January Loans advanced during the year Loan repayments during the year Transferred from loans with subsidiaries Loans outstanding at 31 December Interest income earned 2018 £000 508 126 (2) (117) – 515 15 2018 £000 1,409 – (1,409) – – – 2017 £000 1,361 150 (3) – (1,000) 508 23 2017 £000 404 5 – 1,000 1,409 5 The loans to directors are mainly secured on property, shares or cash and bear interest at rates linked to base rate. No provisions have been recognised in respect of loans given to related parties (2017: £nil). Group – subsidiaries Deposits Deposits at 1 January Deposits placed during the year Deposits repaid during the year Transfer to loans during the year Transferred to deposits with associates Deposits at 31 December Interest expense on deposits 2018 £000 3,233 3,390 (4,622) (117) – 1,884 7 2017 £000 3,398 3,563 (2,728) – (1,000) 3,233 46 Arbuthnot Banking Group PLCReport & Accounts 2018 122 Notes to the Consolidated Financial Statements continued 42. Related party transactions (continued) Group – associates Deposits Deposits at 1 January Deposits placed during the year Deposits repaid during the year Transferred from deposits with subsidiaries Deposits at 31 December Interest expense on deposits 2018 £000 1,403 – (1,403) – – – 2017 £000 318 85 – 1,000 1,403 5 Details of directors’ remuneration are given in the Remuneration Report. The Directors do not believe that there were any other transactions with key management or their close family members that require disclosure. Details of principal subsidiaries are given in Note 43. Transactions and balances with subsidiaries are shown below: ASSETS Due from subsidiary undertakings Shares in subsidiary undertakings LIABILITIES Due to subsidiary undertakings 2018 2017 Highest balance during the year £000 Balance at 31 December £000 Highest balance during the year £000 Balance at 31 December £000 35,483 134,614 170,097 2,097 2,097 17,002 134,614 151,616 1,566 1,566 89,150 97,802 186,952 4,011 4,011 36,256 97,802 134,058 1,570 1,570 The disclosure of the year end balance and the highest balance during the year is considered the most meaningful information to represent the transactions during the year. The above transactions arose during the normal course of business and are on substantially the same terms as for comparable transactions with third parties. The Company undertook the following transactions with other companies in the Group during the year: Arbuthnot Latham & Co., Ltd – Recharge of property and IT costs Arbuthnot Latham & Co., Ltd – Recharge for costs paid on the Company’s behalf Arbuthnot Latham & Co., Ltd – Group recharges for shared services Secure Trust Bank PLC (from 16 June 2016 to 8 August 2018 as associate) – Group recharges for shared services Secure Trust Bank PLC (from 16 June 2016 to 8 August 2018 as associate) – Dividends received Total 2018 £000 930 1,520 (1,200) (751) (2,101) (1,602) 2017 £000 1,087 1,501 (1,483) (813) (2,618) (2,326) Arbuthnot Banking Group PLCReport & Accounts 2018 43. Interests in subsidiaries Company At 1 January 2017 Capital contributions to Arbuthnot Latham & Co., Limited At 31 December 2017 Capital contributions to Arbuthnot Latham & Co., Limited At 31 December 2018 Company Subsidiary undertakings: Bank Other Total Investment at cost £000 Impairment provisions £000 57,166 43,200 100,366 36,812 137,178 (2,564) – (2,564) – (2,564) 2018 £000 132,314 2,300 134,614 123 Net £000 54,602 43,200 97,802 36,812 134,614 2017 £000 95,502 2,300 97,802 (a) List of subsidiaries Arbuthnot Latham & Co., Limited is the only significant subsidiary of Arbuthnot Banking Group. Arbuthnot Latham is incorporated in the United Kingdom, has a principal activity of Private and Commercial Banking and is 100% owned by the Group. The table below provides details of other subsidiaries of Arbuthnot Banking Group PLC at 31 December: % shareholding Country of incorporation Principal activity Direct shareholding Arbuthnot Fund Managers Limited Arbuthnot Investments Limited Arbuthnot Limited Arbuthnot Properties Limited Arbuthnot Unit Trust Management Limited Gilliat Financial Solutions Limited Peoples Trust and Savings Plc West Yorkshire Insurance Company Limited Windward Insurance Company PCC Limited Indirect shareholding via intermediate holding companies Arbuthnot Commercial Asset Based Lending Limited Arbuthnot Latham (Nominees) Limited Arbuthnot Latham Real Estate Holdco Limited Arbuthnot Latham Real Estate Holdings Limited Arbuthnot Latham Real Estate PropCo Limited Arbuthnot Real Estate Capital Limited Arbuthnot Real Estate Capital GP 1 Limited Arbuthnot Real Estate Capital Fund 1 Limited Arbuthnot Securities Limited Arbuthnot Specialist Finance Limited Artillery Nominees Limited (dissolved 16 January 2018) John K Gilliat & Co., Limited Pinnacle Universal Limited Pinnacle Universal Limited Renaissance Asset Finance Limited 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% UK UK UK UK UK UK UK UK Guernsey UK UK Jersey UK Jersey Jersey Jersey Jersey UK UK UK UK BVI UK UK Dormant Dormant Dormant Dormant Dormant Dormant Dormant Non-trading Insurance Asset Finance Dormant Property Investment Property Investment Property Investment Property Investment Property Investment Property Investment Dormant Dormant Dormant Dormant Property Development Dormant Asset Finance Arbuthnot Banking Group PLCReport & Accounts 2018 124 Notes to the Consolidated Financial Statements continued 43. Interests in subsidiaries (continued) All the subsidiary and related undertakings above are unlisted and none are banking institutions. All entities are included in the consolidated financial statements and have an accounting reference date of 31 December. On 16 January 2018, Artillery Nominees Limited was dissolved. All Jersey entities have their registered office as 26 New Street, St Helier, Jersey, JE2 3RA. Pinnacle Universal Limited’s (BVI) registered office is 9 Columbus Centre, Pelican Drive, Road Town, Tortola, BVI. All other entities listed above have their registered office as 7 Wilson Street, London, EC2M 2SN. (b) Non-controlling interests in subsidiaries There were no non-controlling interests at the end of 2017 or 2018. (c) Significant restrictions The Group does not have significant restrictions on its ability to access or use its assets and settle its liabilities other than those resulting from the supervisory frameworks within which banking subsidiaries operate. The supervisory frameworks require banking subsidiaries to keep certain levels of regulatory capital and liquid assets, limit their exposure to other parts of the Group and comply with other ratios. The carrying amounts of the banking subsidiary’s assets and liabilities are £2,171m and £1,994m respectively (2017: £1,784m and £1,651m respectively). (d) Risks associated with interests During the year Arbuthnot Banking Group PLC made £36.8m (2017: £43.2m) capital contributions to Arbuthnot Latham & Co., Ltd. The contributions were made to assist the Bank during a period of growth to ensure that all regulatory capital requirements were met. 44. Operating segments The Group is organised into six operating segments as disclosed below: 1) Private Banking – Provides traditional private banking services as well as offering financial planning and investment management services. This segment includes Dubai and the Tay mortgage portfolio. 2) Commercial Banking – Provides bespoke commercial banking services and tailored secured lending against property investments and other assets. 3) RAF – Specialist asset finance lender mainly in high value cars but also business assets. 4) All Other Divisions – All other smaller divisions and central costs in Arbuthnot Latham & Co., Ltd (Arbuthnot Commercial Asset-Based Lending, Arbuthnot Direct, Arbuthnot Specialist Finance, Investment properties and Central unallocated items). 5) Group Centre – ABG Group Centre management. Arbuthnot Banking Group PLCReport & Accounts 2018 125 44. Operating segments (continued) Transactions between the operating segments are on normal commercial terms. Centrally incurred expenses are charged to operating segments on an appropriate pro-rata basis. Segment assets and liabilities comprise loans and advances to customers and customer deposits, being the majority of the balance sheet. Continuing operations Year ended 31 December 2018 Interest revenue Inter-segment revenue Interest revenue from external customers Fee and commission income Private Banking £000 Commercial Banking £000 38,185 18,889 – 38,185 11,550 – 18,889 1,036 Revenue from external customers 49,735 19,925 RAF £000 7,536 – 7,536 151 7,687 680 – 680 219 899 Interest expense (4,422) (2,505) (2,192) (517) All Other Divisions £000 Group Centre £000 Add back inter-segment revenue Subordinated loan note interest Fee and commission expense Segment operating income Impairment losses Other income Operating expenses Segment profit/(loss) before tax Income tax (expense)/income Segment profit/(loss) after tax Loss from discontinued operations – – (56) 45,257 (1,966) 2 – – (122) 17,298 (278) – (37,492) (14,534) 5,801 – 5,801 – 2,486 – 2,486 – – – (14) 5,481 (437) 73 (3,169) 1,948 (431) – – (42) 340 (50) 6,683 (2,634) 4,339 35 Discontinued Operations Retail Bank Associate Income £000 – – – – – – – – – – – – – – – – Group Total £000 65,378 (88) 65,290 12,956 78,246 (9,835) 88 (360) (234) 67,905 (2,731) 6,588 (64,982) 6,780 (1,121) 5,659 Total £000 65,378 (88) 65,290 12,956 78,246 (9,835) 88 (360) (234) 67,905 (2,731) 6,588 (64,982) 6,780 (1,121) 88 (88) – – – (199) 88 (360) – (471) – (170) (7,153) (7,794) (725) Segment profit/(loss) after tax 5,801 2,486 1,517 4,374 (8,519) 5,659 (25,692) (20,033) Loans and advances to customers 670,464 443,108 85,958 36,626 (11,500) 1,224,656 1,517 4,374 (8,519) 5,659 – – – – (25,692) (25,692) Other assets Segment total assets Customer deposits Other liabilities – – – 936,370 14,147 950,517 670,464 443,108 85,958 972,996 2,647 2,175,173 1,041,208 566,748 – – – – – – – 136,092 251,437 (29,762) 1,714,286 13,494 264,931 387,529 (16,268) 1,979,217 (4,075) (2,848) (101) (26) (4,776) (2,873) Segment total liabilities 1,041,208 566,748 Other segment items: Capital expenditure Depreciation and amortisation – – – – The “Group Centre” segment above includes the parent entity and all intercompany eliminations. – – – – – – – – 1,224,656 950,517 2,175,173 1,714,286 264,931 1,979,217 (4,776) (2,873) Arbuthnot Banking Group PLCReport & Accounts 2018 126 Notes to the Consolidated Financial Statements continued 44. Operating segments (continued) Year ended 31 December 2017 Interest revenue Inter-segment revenue Interest revenue from external customers Fee and commission income Continuing operations Private Banking £000 Commercial Banking £000 RAF £000 All Other Divisions £000 36,179 7,228 4,194 (174) 36,005 13,104 – 7,228 621 – 4,194 80 Revenue from external customers 49,109 7,849 4,274 Interest expense Add back inter-segment revenue Subordinated loan note interest Fee and commission expense Segment operating income Impairment losses Other income Operating expenses Segment profit/(loss) before tax Income tax (expense)/income (4,651) (508) (1,040) 174 – (127) 44,505 (308) – (36,268) 7,929 – – – (150) 7,191 – – (9,254) (2,063) – – – (5) 3,229 (86) – (1,690) 1,453 (303) Group Centre £000 204 (204) – – – (153) 204 (360) – Total £000 47,805 (378) 47,427 13,805 61,232 (6,352) 378 (360) (282) (309) 54,616 – (837) (7,279) (8,425) 92 (394) 3,033 (54,721) 2,534 (448) – – – – – – – – – – – 3,870 (230) 3,640 (237) Segment profit/(loss) after tax 7,929 (2,063) 1,150 3,403 (8,333) 2,086 Profit from discontinued operations – – – – – – Segment profit/(loss) after tax 7,929 (2,063) 1,150 3,403 (8,333) 2,086 Loans and advances to customers 650,245 305,055 71,265 34,204 (11,500) 1,049,269 Other assets Segment total assets Customer deposits Other liabilities Segment total liabilities Other segment items: Capital expenditure Depreciation and amortisation – – – 721,502 82,461 803,963 650,245 305,055 71,265 755,706 70,961 1,853,232 954,577 308,341 – – 954,577 308,341 – – – – – – – – – 176,886 (49,023) 1,390,781 210,680 15,396 226,076 387,566 (33,627) 1,616,857 – 1,616,857 (3,307) (2,354) – (26) (3,307) (2,380) – – (3,307) (2,380) Segment profit is shown prior to any intra-group eliminations. Prior year numbers have been represented according to the 2018 operating segments reported to management. The UK private bank has a branch in Dubai, which generated £4.4m (2017: £4.5m) fee income and had operating costs of £2.9m (2017: £2.7m). All Dubai branch income is booked in the UK. Other than the Dubai branch, all operations of the Group are conducted wholly within the United Kingdom and geographical information is therefore not presented. Discontinued Operations Retail Bank Associate Income £000 – – – – – – – – – – – – – – – – 4,437 4,437 Group Total £000 47,805 (378) 47,427 13,805 61,232 (6,352) 378 (360) (282) 54,616 (394) 3,033 (54,721) 2,534 (448) 2,086 4,437 6,523 – 1,049,269 – 803,963 – 1,853,232 – 1,390,781 – 226,076 Arbuthnot Banking Group PLCReport & Accounts 2018 127 45. Country by Country Reporting Article 89 of the EU Directive 2013/36/EU otherwise known as the Capital Requirements Directive IV (‘CRD IV’) was implemented into UK domestic legislation through statutory instrument 2013 No. 3118, the Capital Requirements (Country-by-Country Reporting) Regulations 2013 (the Regulations), which were laid before the UK Parliament on 10 December 2013 and which came into force on 1 January 2014. Article 89 requires credit institutions and investment firms in the EU to disclose annually, specifying, by Member State and by third country in which it has an establishment, the following information on a consolidated basis for the financial year: name, nature of activities, geographical location, turnover, number of employees, profit or loss before tax, tax on profit or loss and public subsidies received. 31 December 2018 Location UK Dubai 31 December 2017 Location UK Dubai Turnover (£m) Number FTE employees 67.9 – 423 14 Turnover (£m) Number FTE employees 54.6 – 350 16 Profit/(loss) before tax (£m) 9.7 (2.9) Profit/(loss) before tax (£m) 9.8 (2.7) Tax paid (£m) 1.2 – Tax paid (£m) – – The Dubai branch income is booked through the UK, hence the turnover is nil in the above analysis. Offsetting this income against Dubai branch costs would result in a £1.6m profit (2017: £1.8m). After indirect cost allocation it results in a loss of £0.8m (2017: loss of £0.5m). No public subsidies were received during 2018. 46. Ultimate controlling party The Company regards Sir Henry Angest, the Group Chairman and Chief Executive Officer, who has a beneficial interest in 56.1% of the issued share capital of the Company, as the ultimate controlling party. Details of his remuneration are given in the Remuneration Report and Note 42 of the consolidated financial statements includes related party transactions with Sir Henry Angest. 47. Events after the balance sheet date There were no material post balance sheet events to report. Arbuthnot Banking Group PLCReport & Accounts 2018 128 Five Year Summary Profit/(loss) for the year after tax (Loss)/profit before tax from continuing operations* Total Earnings per share 2014 £000 17,016 (3,824) 2015 £000 26,524 (2,606) 2016 £000 227,569 (1,966) 2017 £000 6,523 2,534 2018 £000 (20,033) 6,780 Basic (p) 58.6 86.3 1,127.2 43.9 (134.5) Earnings per share from continuing operations* Basic (p) Dividends per share (p) – ordinary Dividends per share (p) – special Other KPI: (24.8) 27.0 – 2014 £000 (16.9) 29.0 – 2015 £000 (18.2) 31.0 325.0 2016 £000 14.0 33.0 – 2017 £000 38.0 35.0 – 2018 £000 Net asset value per share (p) 1,136.0 1,252.7 1,533.8 1,547.0 1,282.5 * Prior year numbers have been restated for continuing operations. Arbuthnot Banking Group PLCReport & Accounts 2018 Notice of Annual General Meeting 129 NOTICE IS HEREBY GIVEN that the thirty third Annual General Meeting (“Meeting”) of Arbuthnot Banking Group PLC (the Company) will be held at Arbuthnot House, 7 Wilson Street, London EC2M 2SN on Thursday, 9 May 2019 at 3pm for the following purposes: Ordinary Business To consider and, if thought fit, pass the following resolutions which will be proposed as ordinary resolutions: 1. To receive and adopt the Annual Report and Accounts for the year ended 31 December 2018. 2. To receive the report of the Remuneration Committee. 3. To declare a final dividend in respect of the year ended 31 December 2018 which the directors propose should be 20p per Ordinary Share, payable on 17 May 2019 to shareholders on the register of members at the close of business on 26 April 2019. 4. To re-elect Sir Henry Angest as a Director who retires by rotation in accordance with Article 78 of the Articles of Association and offers himself for re-election. 5. To re-elect Sir Christopher Meyer as a Director who retires by rotation in accordance with Article 78 of the Articles of Association and offers himself for re-election. 6. To re-appoint KPMG LLP as Auditors of the Company. 7. To authorise the Directors to determine the remuneration of the Auditors. Special Business To consider and, if thought fit, pass the following resolutions which will be proposed as ordinary resolutions: 8. That, subject to the passing of resolutions 9 and 10, the directors be authorised to exercise the power contained in Article 5 of the Company’s Articles of Association at a time the directors deem appropriate, to create and issue a new class of shares of 1p each that shall rank pari passu in all respects (including, without limitation, the right to participate in any capitalisation of reserves and distributions and to receive notice of and attend a general meeting of the Company) with the existing Ordinary Shares save that they shall not entitle the holders thereof to vote at any general meeting of the Company or otherwise (“Ordinary Non-Voting Shares”). 9. That subject to the passing of resolution 8, the Directors be and are hereby authorised to capitalise such sum as they determine standing to the credit of the capital redemption reserve of the Company but up to a maximum sum of £1,530 and to apply such capitalised sum to the holders of Ordinary Shares appearing in the register of members as at the close of business on 7 May 2019 (and including any Ordinary Shares held by the Company as treasury shares at that date) and to pay up in full a maximum of 153,000 Ordinary Non-Voting Shares and to allot and issue such new shares, credited as fully paid up, to those holders of Ordinary Shares and any unallotted fractions of shares shall be determined by the Directors as they shall think fit, and otherwise to do all acts and things required to give effect to this resolution. 10. That subject to the passing of resolutions 8 and 9, the directors be generally and unconditionally authorised in accordance with section 551 of the Companies Act 2006 to exercise all the powers of the Company to allot a maximum of 153,000 Ordinary Non-Voting Shares credited as fully paid in such proportion and manner as they deem appropriate, such authority to apply until the conclusion of the Company’s next annual general meeting after this resolution is passed unless previously renewed, varied or revoked by the Company in general meeting but, in each case, so that the Company may make offers and enter into agreements before the authority expires which would, or might, require Ordinary Non-Voting Shares to be allotted or rights to subscribe for Ordinary Non-Voting Shares to be granted after the authority expires and the directors may allot shares or grant such rights under any such offer or agreement as if the authority had not expired. References in this resolution 10 to the nominal amount of rights to subscribe for Ordinary Non-Voting Shares are to the nominal amount of Ordinary Non-Voting Shares that may be allotted pursuant to the rights. Arbuthnot Banking Group PLCReport & Accounts 2018 130 Notice of Annual General Meeting continued 11. That the Company be and is hereby generally and unconditionally authorised to make market purchases (as defined in section 693(4) of the Companies Act 2006) of Ordinary Shares provided that: a. the maximum number of Ordinary Shares hereby authorised to be purchased shall be 1,488,000 (being approximately 10% of the issued share capital of the Company as at 25 March 2019); b. the minimum price (excluding expenses) which may be paid for an Ordinary Share shall be £0.01; c. the maximum price (excluding expenses) which may be paid for an Ordinary Share shall be 5 per cent. above the average of the closing middle market price of the Ordinary Shares (as derived from the London Stock Exchange Daily Official List) for the 10 business days prior to the day the purchase is made; d. the authority hereby conferred shall expire on 31 May 2020 or, if earlier, on the conclusion of the next Annual General Meeting of the Company unless such authority is renewed prior to such time; and e. the Company may enter into contracts to purchase Ordinary Shares under the authority hereby conferred prior to the expiry of such authority, which contracts will or may be executed wholly or partly after the expiry of such authority, and may make purchases of Ordinary Shares pursuant to any such contracts. 12. That the Company be and is hereby generally and unconditionally authorised to make market purchases (as defined in section 693(4) of the Companies Act 2006) of Ordinary Non-Voting Shares provided that: a. the maximum number of Ordinary Non-Voting Shares hereby authorised to be purchased shall be 15,300 (being approximately 10% of the maximum number of Ordinary Non-Voting Shares authorised to be issued pursuant to Resolutions 9, 10 and 11); b. the minimum price (excluding expenses) which may be paid for an Ordinary Non-Voting Share shall be £0.01; c. the maximum price (excluding expenses) which may be paid for an Ordinary Non-Voting Share shall be 5 per cent. above the average of the closing middle market price of the Ordinary Non-Voting Shares (as derived from the share information published by the NEX Exchange Growth Market) for the 10 business days prior to the day the purchase is made; d. the authority hereby conferred shall expire on 31 May 2020 or, if earlier, on the conclusion of the next Annual General Meeting of the Company unless such authority is renewed prior to such time; and e. the Company may enter into contracts to purchase Ordinary Non-Voting Shares under the authority hereby conferred prior to the expiry of such authority, which contracts will or may be executed wholly or partly after the expiry of such authority, and may make purchases of Ordinary Non-Voting Shares pursuant to any such contracts. By order of the Board N.D. Jennings Secretary 5 April 2019 Registered Office Arbuthnot House 7 Wilson Street London EC2M 2SN Arbuthnot Banking Group PLCReport & Accounts 2018 131 NOTES: 1. In accordance with Regulation 41 of the Uncertificated Securities Regulations 2001, the Company gives notice that only those shareholders entered on the relevant register of members (the Register) for certificated or uncertificated shares of the Company (as the case may be) at close of business on 7 May 2019 (“the Specified Time”) will be entitled to attend or vote at the Annual General Meeting in respect of the number of shares registered in their name at that time. Changes to entries on the Register after the Specified Time will be disregarded in determining the rights of any person to attend or vote at the Meeting. Should the Meeting be adjourned to a time not more than 48 hours after the Specified Time, that time will also apply for the purpose of determining the entitlement of members to attend and vote (and for the purpose of determining the number of votes they may cast) at the adjourned Meeting. Should the Meeting be adjourned for a longer period, then to be so entitled, members must be entered on the Register at the time which is 48 hours before the time fixed for the adjourned Meeting, or, if the Company gives notice of the adjourned Meeting, at the time specified in the notice. 2. Members who want to attend and vote should either attend in person or appoint a proxy or corporate representative to attend, speak and vote on his/her behalf. A member may appoint more than one proxy in relation to the Meeting provided that each proxy is appointed to exercise the rights attached to a different share or shares of the member, but must attend the meeting in person. A proxy need not be a member. A paper Form of Proxy is enclosed. Please read carefully the instructions on how to complete the form. Forms of Proxy, together with the power of attorney or other authority (if any) under which it is signed or a notarially certified copy of such power of attorney or other authority, must be lodged with the Registrars or submitted not later than 48 hours before the time for which the Meeting is convened. Completion of the appropriate Form of Proxy does not prevent a member from attending and voting in person if he/she is entitled to do so and so wishes. 3. A corporation which is a member can appoint one or more corporate representatives who may exercise, on its behalf, all its powers as a member provided that no more than one corporate representative exercises power over the same share. 4. As at 4 April 2019 (being the latest practicable date prior to the publication of this Notice and excluding the 390,274 shares held in Treasury) the Company’s issued share capital consists of 14,889,048 Ordinary Shares carrying one vote each. 5. There are no service contracts of Directors other than ones which may be terminated on up to 12 months’ notice at any time. Copies of these service agreements will be available for inspection at the registered office during usual business hours on any weekday (Saturdays, Sundays and public holidays excepted) from the date of this notice until the date of the Meeting and at the place of the Meeting for 15 minutes prior to and during the Meeting. Arbuthnot Banking Group PLCReport & Accounts 2018 132 Corporate Contacts and Advisers Group Address and Registered Office Arbuthnot Banking Group PLC Arbuthnot House 7 Wilson Street London EC2M 2SN T 020 7012 2400 E info@arbuthnotgroup.co.uk www.arbuthnotgroup.com Corporate Contacts London Arbuthnot Latham & Co., Limited Arbuthnot House 7 Wilson Street London EC2M 2SN T 020 7012 2500 F 020 7012 2501 E banking@arbuthnot.co.uk www.arbuthnotlatham.co.uk Bristol Third Floor St Catherine’s Court Berkeley Place Clifton Bristol BS8 1BQ T 0117 440 9333 Exeter The Senate Ground Floor Southernhay Gardens Exeter Devon EX1 1UG T 01392 496061 F 01392 413638 Manchester 8th Floor 82 King Street Manchester M2 4WQ T 0161 413 0030 International Dubai branch PO Box 482007 Gate Precinct 4 Level 3 Office 308 Dubai International Financial Centre Dubai T +971 (4) 3770900 Renaissance Asset Finance Limited 3rd Floor Phoenix Place Christopher Martin Road Basildon Essex SS14 3GQ T 01268 269500 F 01268 269550 E info@renaissanceaf.com www.renaissanceaf.com Arbuthnot Commercial Asset Based Lending Limited The Beehive City Place Gatwick RH6 0PA E ABL@arbuthnot.co.uk Advisers Auditor KPMG LLP Principal Bankers Barclays Bank PLC Lloyds Bank PLC Joint Stockbroker Numis Securities Limited Joint Stockbroker and Nominated Adviser Stifel Nicolaus Europe Limited, trading as KBW Registrars Link Asset Services The Registry 34 Beckenham Road Beckenham, Kent BR3 4TU Arbuthnot Banking Group PLCReport & Accounts 2018 Arbuthnot Banking Group PLC Arbuthnot House 7 Wilson Street London EC2M 2SN T 020 7012 2400 E info@arbuthnotgroup.co.uk www.arbuthnotgroup.com Registration No. 1954085