Annual Report & Accounts 2012 The Paragon Group of Companies PLC The Paragon Group of Companies PLC Contents 3 4 7 Financial highlights Chairman’s statement Chief Executive’s review 12 Board of Directors 14 Directors’ report 18 Corporate social responsibility 23 Report of the Board to the shareholders on directors’ remuneration 37 Statement of directors’ responsibilities 38 Independent auditors’ report 40 Corporate governance 45 Principal risks and uncertainties 47 Contacts 50 Consolidated income statement 51 Consolidated statement of comprehensive income 52 Consolidated balance sheet 53 Company balance sheet 54 Consolidated cash fl ow statement 54 Company cash fl ow statement 55 Statement of movements in equity 56 Notes to the accounts 119 Appendices to the annual report Contents The Paragon Group of Companies PLC Financial highlights £95.5m pre-tax profi t up 18.2% from £80.8 in 2011 £184.3m in buy-to-let advances up from £127.0 in 2011 £803.5m shareholders’ funds up from £742.0 in 2011 Earnings per share 24.2p Total dividend 6.0p Underlying profi t before taxation Profi t before taxation Profi t after taxation Total loan assets Shareholders’ funds Net asset value per share Earnings per share - basic - diluted Dividend per ordinary share 2012 £m 94.2 95.5 72.2 8,694.6 803.5 2012 269p 24.2p 23.5p 6.0p 2011 £m 81.1 80.8 59.6 8,724.2 742.0 2011 250p 20.2p 19.6p 4.0p 2010 £m 66.1 71.8 53.9 8,911.2 692.0 2010 234p 18.3p 17.8p 3.6p 2009 £m 45.3 54.3 41.1 9,314.3 650.5 2009 220p 13.9p 13.7p 3.3p 2008 £m 66.9 53.7 37.1 10,053.2 621.2 2008 209p 17.9p 17.9p 3.0p The derivation of underlying profi t before taxation is described in Appendix B. Financial highlights 3 The Paragon Group of Companies PLC Chairman’s statement During the year ended 30 September 2012 the Group has pursued its strategic objectives successfully and achieved strong growth, resulting in the highest profi ts in our history. We have invested signifi cantly in portfolio acquisitions, increased buy-to-let lending, entered into new servicing contracts and completed our fi rst securitisation since 2007, with a further securitisation, on materially better terms, being completed after the year-end. In addition, to facilitate the future development of our buy-to-let franchise, new and enlarged funding lines have been agreed with our bankers. The buy-to-let warehouse facility from Macquarie Bank has been increased and extended by a further two years and an additional warehouse facility agreement has been signed with Lloyds Bank, more than doubling the Group’s warehouse capacity to £450.0 million. The Group is well placed for future growth. During the year ended 30 September 2012 the Group’s profi t before taxation increased by 18.2% to £95.5 million (2011: £80.8 million). Underlying profi t, before exceptional and fair value items, increased by 16.2% to £94.2 million for the year (2011: £81.1 million). Earnings per share were 24.2p (2011: 20.2p), the increase of 19.8% from last year refl ecting the improved profi ts earned by the Group and a reduction in the tax rate. The increase in profi t has also improved the Group’s return on equity to 9.3% from 8.3% for the previous year (note 5). The Group’s strategic focus has remained unchanged; to generate growth through our buy-to-let origination franchise, through investment in loan portfolios, and by exploiting new opportunities; and to maintain close management of the existing loan portfolio, which continued to perform well in the year. Idem Capital, our dedicated investment subsidiary, has successfully built on the fi ve portfolios purchased in prior years with further investments during the fi nancial year totalling £115.4 million. Paragon Mortgages and Mortgage Trust, our buy-to-let origination brands, now fully re-established following the recommencement of new lending in 2010, advanced new loans of £184.3 million (2011: £127.0 million) and a strong pipeline of business was in place at the end of the year, which, combined with the 125% increase in warehouse capacity, augurs well for lending volumes in the new fi nancial year. In view of the results achieved and the Board’s confi dence in the prospects for the business, the Company’s dividend policy has been amended. In line with the new policy, outlined under Capital Management below, the Board has proposed a fi nal dividend of 4.50p per share (2011: 2.65p) which, when added to the interim dividend of 1.50p, gives a total dividend of 6.00p per share for the year (2011: 4.00p), an increase of 50.0%. Subject to approval at the Annual General Meeting on 7 February 2013, the dividend will be paid on 11 February 2013, by reference to a record date of 11 January 2013. CAPITAL MANAGEMENT The Group has continued to enjoy strong cash generation during the year. Free cash balances were £127.7 million at the year-end (30 September 2011: £195.0 million) after investments to support new buy-to-let originations and signifi cant acquisitions by Idem Capital. The Company sees opportunities going forward to deploy capital for new lending activities, which should continue to increase, and to invest further amounts in loan portfolios through Idem Capital as banks and other fi nancial institutions continue to de-leverage. These cash balances, together with future operational cashfl ow, will support the Group’s growth through investment in these areas as well as providing returns to shareholders through dividends. The Group’s current progressive dividend policy has applied since 2008, the dividend increasing from 3.0p per share in respect of the year ended 30 September 2008 to 4.0p per share in respect of the year ended 30 September 2011. Since that policy was established, the Group has re-commenced its buy-to-let mortgage business, demonstrated that it can access warehouse funding and the securitised funding markets and established a strong asset purchase franchise which has contributed substantially to Group profi t growth. 4 Chairman’s statement The Paragon Group of Companies PLC The Board keeps under review the appropriate level of capital for the business to meet its operational requirements and strategic development objectives and has determined that in view of the strong position of the Group and its confi dence in the prospects for the business, a higher level of dividend payment is now appropriate. Consequently, the Board proposes, subject to approval at the Annual General Meeting on 7 February 2013, a fi nal dividend of 4.5p per share which, when added to the interim dividend of 1.5p, gives a dividend of 6.0p per share for the year, an increase of 50.0% from 2011. The Board intends to pursue a progressive dividend policy so that, by 2016 and thereafter, dividend cover will be maintained in the range 3.0 to 3.5 times. In accordance with our usual practice, we will be proposing at the forthcoming Annual General Meeting a special resolution seeking authority from shareholders for the Company to purchase up to 30.1 million of its own shares (10% of the issued share capital). It is customary for companies to seek such authority but we would not expect to utilise the authority unless, in the light of market conditions prevailing at the time, we consider that to do so would enhance earnings per share and would be in the best interests of shareholders generally. Given the operational and strategic opportunities described above and the enhanced dividend policy, the Board has no current intention of using this authority. CORPORATE GOVERNANCE The Board of Directors is committed to the principles of corporate governance contained in the UK Corporate Governance Code (‘Code’) issued by the Financial Reporting Council in May 2010. A detailed explanation of how those principles are applied is given in the Corporate Governance section on pages 40 to 44 of this annual report. The Board has considered the new Code, which applies to the Group for the year ending 30 September 2013 and considers that it is well placed to comply with its provisions. BOARD OF DIRECTORS On 9 February 2012 Richard Woodman was appointed to the Board as Director of Corporate Development. He was also appointed Managing Director of Idem Capital Limited. Mr Woodman joined the Group in 1989 and he has held various senior strategic and fi nancial roles, latterly as Director of Business Analysis and Planning. More recently he has taken a lead role in the Group’s strategic development and, in particular, in the portfolio acquisition programme through Idem Capital. The excellent progress we have made during the year would not have been achieved without the hard work and dedication of our staff and my fellow directors. I thank them all for their efforts. On 12 September 2012 Fiona Clutterbuck was appointed as a non-executive director. She is currently the Head of Strategy and Corporate Development at the Phoenix Group and is also a non-executive director of WS Atkins plc. Ms Clutterbuck brings to the Board a substantial level of corporate fi nance experience, having previously held the positions of Managing Director and Head of Financial Institutions Advisory at ABN AMRO Investment Bank, Managing Director and Global Co-Head of Financial Institutions Group at HSBC Investment Bank and Director at Hill Samuel Bank Limited. On 31 March 2012 Terry Eccles resigned from the Board of Directors owing to health reasons. Mr Eccles was appointed to the Board in February 2007 and served as Chairman of the Remuneration Committee until February 2009 and as Senior Independent Director from February 2009 until July 2011. His experience and wisdom have been invaluable and his presence on the Board will be sadly missed. The Board wishes to thank Mr Eccles for his enormous contribution over the past fi ve years and wish him well for the future. On 31 October 2011 Christopher Newell resigned from the Board of Directors after ten years of service and having been Chairman of the Audit and Compliance Committee from March 2003 until July 2011. The Board would like to record its gratitude for his considerable support over the years and for his able and professional chairmanship of the Audit and Compliance Committee. Chairman’s statement 5 The Paragon Group of Companies PLC The Company sees opportunities going forward to deploy capital for new lending activities, which should continue to increase, and to invest further amounts in loan portfolios through Idem Capital as banks and other fi nancial institutions continue to de-leverage. STAFF The excellent progress we have made during the year would not have been achieved without the hard work and dedication of our staff and my fellow directors. I thank them all for their efforts. CONCLUSION The year ended 30 September 2012 has been a very successful period for the Group. The buy-to-let and portfolio purchase businesses have grown strongly and contributed to record profi ts for the Group for the year. The developments in funding capacity during the year, and in the period immediately after, with the completion of two public securitisation transactions and a more than doubling of our buy-to-let warehouse facilities, leave the Group well funded to support the further development of the buy-to-let business. Alongside this, the strong operational cashfl ows generated in the year put the Group in a good position to continue to benefi t from future portfolio acquisitions and servicing opportunities arising out of the de-leveraging of banks and other fi nancial institutions. The strong trading position of the Group and the Board’s confi dence as to the future prospects of the business have led to a substantial increase in this year’s proposed dividend and the adoption of a new policy aimed at moving the Group’s dividend towards 3.0 to 3.5 times coverage over the medium term. The Group enters the new fi nancial year with confi dence. ROBERT G DENCH Chairman 20 November 2012 6 Chairman’s statement The Paragon Group of Companies PLC Chief Executive’s review During the year ended 30 September 2012 the Group has successfully pursued its strategy to deliver shareholder value through purchasing portfolios, developing new lending, entering into new servicing agreements and continuing the careful management of the extant portfolios. FINANCIAL REVIEW CONSOLIDATED RESULTS For the year ended 30 September 2012 Interest receivable Interest payable and similar charges Net interest income Other operating income Total operating income Operating expenses Provisions for losses Underlying profi t Fair value net gains / (losses) Operating profi t being profi t on ordinary activities before taxation Tax charge on profi t on ordinary activities Profi t on ordinary activities after taxation Dividend – rate per share for the year Basic earnings per share Diluted earnings per share 2012 £m 293.8 (136.0) 157.8 12.4 170.2 (51.9) (24.1) 94.2 1.3 95.5 (23.3) 72.2 6.0p 24.2p 23.5p 2011 £m 258.0 (122.2) 135.8 15.1 150.9 (45.4) (24.4) 81.1 (0.3) 80.8 (21.2) 59.6 4.0p 20.2p 19.6p The Group is organised into two major operating divisions: First Mortgages, which includes the buy-to-let and owner-occupied fi rst mortgage assets and other sources of income derived from fi rst charge mortgages; and Consumer Finance, which includes secured lending, car, retail fi nance and unsecured loan books and other sources of income derived from consumer loans. Both divisions include internally originated and acquired assets. These divisions are the basis on which the Group reports primary segmental information. Chief Executive’s review 7 The Paragon Group of Companies PLC The underlying operating profi ts of these business segments are detailed fully in appendix B to the annual report and are summarised below. Underlying operating profi t First Mortgages Consumer Finance 2012 £m 61.6 32.6 94.2 2011 £m 67.3 13.8 81.1 Net interest income increased by 16.2% to £157.8 million (2011: £135.8 million), refl ecting the impact of new loan assets, both acquired and originated, on interest income and margins, partially offset by a 0.3% reduction in the size of the loan book during the year. Other operating income was £12.4 million for the year, compared with £15.1 million in 2011, the reduction refl ecting, principally, a lower level of third party fee income as a result of the purchase of accounts previously administered by the Group, early in the year. Operating expenses during the year were 14.3% higher at £51.9 million (2011: £45.4 million). The increase is primarily due to employment costs, following the recruitment of additional staff, during the year and in the second half of 2011, to administer purchased and third party loan portfolios. The cost:income ratio was in line with our expectations at 30.5% for the year (appendix A), a similar level to last year, and remains signifi cantly below the industry average. The Board remains focused on controlling operating costs through the application of rigorous budgeting, management reporting and monitoring procedures. The charge for impairment provisions of £24.1 million was 1.2% lower than the charge of £24.4 million for 2011, an increase in the charge within the First Mortgages division, to more normal levels from a low level of charge in 2011, being more than offset by a reduction in the impairment charge within the Consumer Finance division. As a percentage of loans to customers (note 31) the charge has remained at 0.28%, the fi gure recorded in 2011. Low interest rates have increased affordability for customers, reducing the incidence of new arrears and assisting the correction of past arrears. The loan books continue to be carefully managed and credit performance remains in line with our expectations. Yield curve movements during the year resulted in hedging instrument fair value net gains of £1.3m (2011: losses of £0.3 million), which do not affect cash fl ow. As the fair value movements of hedged assets or liabilities are expected to trend to zero over time, this item is merely a timing difference. The Group remains economically and appropriately hedged. Cash generation has remained strong over the period. Free cash balances stood at £127.7 million at 30 September 2012 (2011: £195.0 million), after investing signifi cantly in both asset purchases and in the development of our buy-to-let lending business, detailed below. Corporation tax has been charged at an effective tax rate of 24.4%, compared to 26.2% in 2011, the decrease being attributable to the reduction in the standard rate of corporation tax in the UK. Profi ts after taxation of £72.2 million (2011: £59.6 million) have been transferred to shareholders’ funds, which totalled £803.5 million at the year-end (2011: £742.0 million), representing 269p per share (2011: 250p per share) (appendix C). BUSINESS REVIEW OPERATING SEGMENTS First Mortgages Buy-to-let loans advanced under the Group’s new lending products were £184.3 million for the year (2011: £127.0 million) and a further £4.6 million (2011: £5.8 million) of loans were made to existing borrowers in respect of further advances. This brings the total value of completions under the Group’s new products since the recommencement of new lending in October 2010 to £311.3 million. Application levels continued to increase over the year, with the pipeline of applications and offers outstanding totalling £129.9 million at 30 September 2012 (2011: £67.5 million). The credit quality of the new lending business written in the year has been excellent, with an average loan to value ratio of 70.1% (2011: 69.2%) and no arrears on loans advanced since the recommencement of lending in October 2010. 8 Chief Executive’s review The Paragon Group of Companies PLC The Group has continued to focus mainly on the higher margin professional landlord business under the Paragon Mortgages brand. Paragon’s professional landlord business is widely sourced from a large number of mortgage and commercial fi nance introducers, giving us the capacity to support materially higher business volumes in due course. At 30 September 2012, the buy-to-let portfolio was £8,196.4 million, compared with £8,231.7 million a year earlier. The redemption rate on the back book remained low at 2.2% for the year (2011: 2.2%) with landlords continuing to display a long-term commitment to property investment, whilst alternative offerings from other lenders remain unattractive as a result of generally higher funding and capital costs. The credit performance of the portfolio over the year has again been exemplary, with the percentage of loans three months or more in arrears (including acquired loans and receivership cases but excluding possession and receivership cases held for sale) standing at 0.48% at 30 September 2012 (30 September 2011: 0.63%) and remains considerably better than the comparable market average of 1.51% as recorded by the Council of Mortgage Lenders (‘CML’) at that date (30 September 2011: 1.90%). Despite an improved arrears performance over the year, the impairment charge attributable to First Mortgages increased to £12.4 million for the year from £5.6 million for 2011 a return to normal levels of provisioning after a low level of charge last year and following an increase in receiver of rent activity, where a charge for impairments may be made for accounts that are less than three months in arrears. At 30 September 2012 there were 1,504 properties across all portfolios where a receiver had been appointed (30 September 2011: 1,483). Of those available for letting, 94.2% were let (30 September 2011: 93.9%). The latest Royal Institution of Chartered Surveyors (‘RICS’) UK Residential Lettings Survey again confi rms that tenant demand has continued to grow whilst landlord supply of property new to the lettings market has stabilised. As a consequence of the high level of demand, the RICS survey indicates that rents are expected to continue to increase. The latest survey data from the Association of Residential Letting Agents confi rms a similar picture with agents on balance noting an increase in achievable rents over the six months to June 2012. Whilst volumes remain low by historical standards, buy-to-let remains the only growth sector of the mortgage market, with the CML reporting that the value of buy-to-let advances increased by 25.6% to £15.7 billion in the course of the fi nancial year (2011: £12.5 billion) whilst credit quality in the sector continues to improve with industry-wide buy-to-let arrears once again lower than in the owner-occupied market (note 6). The owner-occupied book reduced to £99.2 million from £128.7 million during the year ended 30 September 2012 and performed in line with the Group’s expectations. Save for the management of this book in run-off, there has been little activity in recent years in this area as the Group has focused on other lending markets, portfolio acquisitions and other sources of revenue generation. Consumer Finance At 30 September 2012, the total loans outstanding on the Consumer Finance books were £399.0 million, compared with £363.8 million at 30 September 2011, this increase being due to portfolio purchases (covered fully below) and the continuing low level of redemptions across the portfolios. The performance of the Consumer Finance book, including the acquired assets, remains satisfactory and in line with our expectations. The Group’s secured loan portfolio at 30 September 2012, including the acquired assets, was £279.9 million (2011: £340.1 million). The unsecured loan, retail fi nance and car fi nance portfolios, including the acquired assets, totalled £119.1 million at 30 September 2012 (30 September 2011: £23.7 million). PORTFOLIO OPPORTUNITIES A major area of strategic focus has been the acquisition of loan portfolios through Idem Capital and the servicing of third party loan portfolios as opportunities are created through the ongoing process de-leveraging by the larger banks and other fi nancial institutions, which we expect to continue for the foreseeable future. Idem Capital has fi rmly established itself as one of the top consumer debt buyers in the UK, with total investments in the fi nancial year of £115.4 million (2011: £22.7 million). In addition to assets acquired in its own right, Idem, through its sister companies, Moorgate Loan Servicing and Arden Credit Management, has established four new servicing contracts with co-investment partners during the year. These add volume to the Group’s servicing operations and enhance earnings, with little or no capital investment. Progress has been excellent and has resulted in an increase in operating profi ts from these transactions to £26.3 million (2011: £7.6 million) during the fi nancial year. Chief Executive’s review 9 The Paragon Group of Companies PLC Idem Capital Idem Capital invests in loan portfolios either as principal, where Idem acquires pools in its own right, or as co-investor alongside other partners with, typically, Moorgate Loan Servicing appointed to act as servicer. Co-investing has the potential for higher returns where the Group also derives income from servicing the loans within the underlying portfolio. Investments are made only after signifi cant due diligence work on the portfolio and sensitivity testing of potential returns. In October 2011 Idem Capital completed the purchase of a portfolio of unsecured consumer loans, previously serviced by the Group, from The Royal Bank of Scotland plc (‘RBS’) for £43.2 million. In addition, under the terms of a forward fl ow agreement with RBS, a total of £0.6 million of unsecured consumer loans were acquired in the year, and further opportunities are anticipated. Another signifi cant portfolio purchase was completed in December 2011 when Idem Capital acquired a portfolio of closed UK credit card receivables from MBNA Europe Bank Limited, for £55.7 million. The management of these accounts was transferred to the Group during the second quarter of the year. The acquisition of a further portfolio of closed UK credit card receivables from MBNA Europe Bank Limited was announced on 3 September 2012. The consideration payable on completion was £16.1 million and the management of these accounts was transferred to the Group before the year end. By 30 September 2012, total investment in portfolios by Idem Capital since 2009 had reached £161.9 million. A number of potential portfolio investments are currently under review and the Group’s track record in loan servicing, risk management and portfolio investment positions it well to exploit similar opportunities as they arise in future. Moorgate Loan Servicing The Group’s third party loan servicing business operates through Moorgate Loan Servicing and its division, Arden Credit Management, utilising our core administration and collections skills. Our experience in loan management established over many years has enabled us to extend this service to our third party clients, providing signifi cant added value to the performance of their loan portfolios. During the year Moorgate Loan Servicing has assumed the servicing of four further portfolios, comprising 149,000 accounts, on behalf of third parties (2011: 50,000 accounts) with the result that 49.9% of accounts under management by the Group at 30 September 2012 were managed on behalf of third parties (2011: 58.6%). Moorgate is well placed to take advantage of other opportunities that may arise over the coming years, particularly as portfolio disposals take place as part of the wider fi nancial sector de-leveraging process. REGULATION Regulation is undergoing material change across the fi nancial services sector. Some aspects will affect the current operations of the Group, although the impact is unlikely to be signifi cant. The Financial Services Authority (‘FSA’) has concluded, through its Mortgage Market Review, that there will be enhanced prudential supervision of non-deposit takers engaged in regulated lending. Regulation of second charge mortgages will transfer from the Offi ce of Fair Trading to the FSA’s successor bodies in 2014. Separately, it is proposed that those successor bodies will, in due course, assume responsibility for the regulation of consumer credit. Certain areas of the Group’s operations are already authorised by the FSA in respect of residential mortgage and insurance activity and we expect to be well placed to comply with the proposed changes in the regulatory framework. The European Commission’s proposed directive on credit agreements relating to residential property, which may impose additional disclosure and other requirements for all mortgage lending to consumers secured on residential property, has yet to be concluded. It remains unclear to what extent these obligations will apply to buy-to-let lending. We will continue to maintain an active dialogue with the UK and European regulatory authorities as these proposals develop. 10 Chief Executive’s review The Paragon Group of Companies PLC FUNDING On 10 November 2011 the Group completed a £163.8 million securitisation of buy-to-let loans, through Paragon Mortgages (No. 16) PLC. This securitisation, the Group’s fi rst since 2007, released warehouse capacity to accommodate further lending growth. Notes totalling £131.7 million, rated Aaa by Moody’s Investors Service and AAA by Fitch Ratings, were sold to investors with the Group retaining the remaining, unrated, notes. This was an important landmark for the Group, being the fi rst buy-to-let securitisation by any issuer in the UK since the credit crunch. The notes were priced at LIBOR plus 275 basis points, refl ecting the poor bond market conditions at that time. Whilst the notes match-fund the collateralised loans to maturity, we have the ability to call the notes after three years. After the year end, on 25 October 2012, the Group completed a £200.0 million securitisation of buy-to-let loans, through Paragon Mortgages (No. 17) PLC (‘PM 17’). PM 17 comprises £175.0 million of AAA rated notes, £10.5 million of AA rated notes and £10.0 million of A rated notes at margins of 135, 190 and 290 basis points over three month LIBOR respectively. £4.5 million of subordinated notes were retained by the Group, which also invested £6.0 million in the fi rst loss fund, bringing the Group’s total investment in PM 17 to £10.5 million, or 5.25% of the issue amount. The pricing of the PM 17 transaction refl ected the strong credit profi le of the Group’s buy-to-let assets and our experience as an issuer of high quality bonds in the mortgage backed securities market. This was only the second securitisation of buy-to-let loans since the credit crunch, the fi rst to issue junior, single A rated, bonds since 2008 and was the Group’s 55th securitisation since pioneering the methodology in 1987. The Group funded its mortgage originations during the year through a £200.0 million revolving warehouse provided by Macquarie Bank. This facility was renewed and extended for a further two years after the year end and the amount available for drawing increased to £250.0 million. On 27 September 2012, the Group signed an additional £200.0 million revolving warehouse facility provided by the wholesale division of Lloyds Bank. The facility, rated by Fitch Ratings, will be available to Paragon Fifth Funding Limited, an orphan special purpose vehicle company, and interest will be charged on the amount drawn at three month LIBOR plus 275 basis points. The facility is structured with a three-year term to permit drawings and re-drawings in its fi rst eighteen months, or up to 24 months, subject to a capital markets refi nancing of part of the facility in the fi rst twelve months. The Group uses the warehouse facilities to originate mortgage loans prior to arranging term funding in the securitisation markets and, following the successful completion of the issuances by Paragon Mortgages (No.16) and Paragon Mortgages (No. 17), we plan to return to the securitisation markets regularly as business volumes increase. Dependant on volume and market conditions, additional warehousing capacity may be sought in due course. CONCLUSION The buy-to-let and portfolio purchase businesses have grown strongly and contributed to record profi ts. The developments in funding capacity in the last 15 months leave the Group well funded to support the further development of the buy-to-let business, while the strong operational cashfl ows generated put the Group in a good position to continue to benefi t from future portfolio acquisitions and servicing opportunities arising out of bank de-leveraging. NIGEL S TERRINGTON Chief Executive 20 November 2012 Chief Executive’s review 11 The Paragon Group of Companies PLC Board of directors Robert G Dench Chairman Age 62 Bob Dench joined the Group as a non-executive director in September 2004 and was appointed Chairman in February 2007. During an extended career with Barclays he held a number of senior positions in the UK and overseas, leaving in 2004. He is also a non-executive director of AXA UK plc and Chairman of AXA Ireland Limited. Nigel S Terrington Chief Executive Age 52 Nigel Terrington joined the Group in 1987 and became Chief Executive in June 1995, having held the positions of Treasurer and Finance Director. Prior to Paragon, he worked in investment banking. He is Deputy Chairman of the Council of Mortgage Lenders and is also a member of HM Treasury’s Home Finance Forum. He has previously held the positions of Chairman of the Intermediary Mortgage Lenders Association, Chairman of the Finance and Leasing Association (‘FLA’) Consumer Finance Division and a Board member of the FLA. He is an associate of the Chartered Institute of Bankers. Nicholas Keen Finance Director Age 54 Nick Keen joined the Group in May 1991 and became Finance Director in June 1995 having previously held the position of Treasurer. Prior to joining the Group he worked in Corporate Banking, Treasury and Capital Markets. He is Chairman of the Paragon Credit Committee. John A Heron Director of New Business Age 53 John Heron joined the Group in January 1986. Mr Heron joined the Board in 2003 and is responsible for the development of all the Group’s new business operations. He is a Fellow of the Chartered Institute of Bankers and Chair of the CML buy-to-let panel. He is a Board member of the Intermediary Mortgage Lenders Association, having previously held the position of Chair. John was also previously Deputy Chairman of the CML. Richard J Woodman Director of Corporate Development Age 47 Richard Woodman was appointed to the Board as Director of Corporate Development in February 2012. He was also appointed Managing Director of Idem Capital Limited. He joined the Group in 1989 and has held various senior strategic and fi nancial roles, latterly as Director of Business Analysis and Planning. More recently he has taken a lead role in the Group’s strategic development and, in particular, in the portfolio acquisition programme through Idem Capital. He is a member of the Chartered Institute of Management Accountants. 12 Board of Directors The Paragon Group of Companies PLC Edward A Tilly Non-executive director Age 69 Ted Tilly was appointed as a non-executive director in April 2008. Mr Tilly was the senior independent director of Retail Decisions PLC from January 2000 until January 2007. He has held a number of directorships including Chairman of Barclays Life Assurance Company Ltd from 1999 to 2003. Prior to this he was Chairman and Chief Executive of GE Capital’s European insurance division. He was with the Legal & General Group for nearly 30 years where he held a number of senior positions including Director Life and Pensions and Director International. He is Paragon’s Senior Independent Director. Alan K Fletcher Non-executive director Age 62 Alan Fletcher was appointed as a non-executive director in February 2009. Mr Fletcher has considerable experience in fi nancial services, including pension fund trusteeship and investment fund management. He was Chairman of Neville James Holdings prior to its acquisition by Challenger International of Australia, following which he was Sales and Marketing Director of Challenger Group Services and a director of Challenger Life (UK) from 2002 to 2003. He has been non-executive Chairman of Hyperama plc since 2000 and was Chairman of the professional training company, Fresh Professional Development, from 2003 to 2010. He was a member of the General Synod of the Church of England between 2007 and 2010. He has been a member of the Church of England Pensions Board since 2009 and is also a member of its Investment Committee and has been appointed Chairman of the Housing Committee from 1 January 2013. He is Chairman of the Paragon Remuneration Committee. Peter J N Hartill Non-executive director Age 63 Peter Hartill was appointed as a non-executive director in February 2011. He is a Chartered Accountant, is currently non-executive Chairman of Deeley Group and a non-executive director of Scott Bader Limited. Previously, he spent 40 years with Deloitte, becoming a senior audit partner and a business advisor with experience across a wide range of industries and business issues. Specifi cally he has considerable experience in acquisitions and disposals, capital raising, risk control and corporate governance in the fi nancial services sector. He is Chairman of the Paragon Audit and Compliance Committee. Fiona Clutterbuck Non-executive director Age 54 Fiona Clutterbuck was appointed as a non-executive director in September 2012. She is currently the Head of Strategy and Corporate Development at the Phoenix Group and is also a non-executive director of WS Atkins plc and brings to the Board a substantial level of corporate fi nance experience, having previously held the positions of Managing Director and Head of Financial Institutions Advisory at ABN AMRO Investment Bank, Managing Director and Global Co-Head of Financial Institutions Group at HSBC Investment Bank and Director at Hill Samuel Bank Limited. Board of Directors 13 The Paragon Group of Companies PLC Directors’ report The directors submit their Report and the Accounts for the year ended 30 September 2012 which were approved by the Board on 20 November 2012. Principal activities The Company (registered number 2336032) is a holding company co-ordinating the activities of its subsidiary companies. The principal activities of the Group continue to be the operation of its fi rst mortgage and consumer fi nance businesses. Results and dividends The results for the year are shown in the Consolidated Income Statement on page 50. The directors recommend a fi nal dividend of 4.50p per share (2011: 2.65p per share) which, taken with the interim dividend of 1.50p per share (2011: 1.35p per share) paid on 27 July 2012, would give a total dividend for the year of 6.00p per share (2011: 4.00p per share). Before dividends, retained profi ts of £72.2 million (2011: £59.6 million) have been transferred to reserves. Business review The Companies Act 2006 requires the Company to set out in this report a fair review of the business of the Group during the year ended 30 September 2012, including an analysis of the position of the Group at the year end and a description of the principal risks and uncertainties facing the Group (known as a ‘Business Review’). The information that fulfi ls the Business Review requirements can be found in the following sections of the Annual Report. All of the information presented in these sections is incorporated by reference into this Directors’ Report and is deemed to form part of this report. • The sections of the Chairman’s Statement headed ‘Capital Management’ and ‘Conclusion’ on pages 4 to 6 • The Chief Executive’s Review on pages 7 to 11 • The Corporate Social Responsibility Report on pages 18 to 22 • The Corporate Governance Statement on pages 40 to 44 • The principal risks and uncertainties to which the Group is exposed on pages 45 and 46 Events occurring after the balance sheet date are described in note 48, and discussed in the Chief Executive’s Review. Pages 14 to 17 inclusive, together with the sections of the Annual Report incorporated by reference, comprise a directors’ report for the Group which has been drawn up and presented in accordance with, and in reliance upon, applicable English company law and the liabilities of the directors in connection with this report shall be subject to the limitations and restrictions provided by such law. 14 Directors’ report The Paragon Group of Companies PLC Directors The interests of the directors at the year end in the share capital of the Company, all benefi cially held, are shown below. R G Dench N S Terrington N Keen J A Heron R J Woodman E A Tilly* A K Fletcher* P J N Hartill* F Clutterbuck* * Non-executive directors. At 30 September 2012 At 30 September 2011 Ordinary shares or on appointment Ordinary shares 117,000 647,972 368,679 252,680 89,691 30,000 125,000 7,000 - 117,000 647,972 368,679 252,680 89,691 30,000 125,000 7,000 - In addition, certain directors had interests in the share capital of the Company by virtue of options granted under the Company’s executive share option schemes and awards under the Paragon Performance Share Plan, the Deferred Bonus Scheme and the Matching Share Plan, details of which are given in the Report of the Board to the Shareholders on Directors’ Remuneration on pages 23 to 36. There have been no changes in the directors’ interests in the share capital of the Company since 30 September 2012. The directors have no interests in the shares or debentures of the Company’s subsidiary companies. Mr R J Woodman and Ms F Clutterbuck were appointed to the Board on 9 February 2012 and 12 September 2012 respectively and Mr C D Newell and Mr T Eccles resigned from the Board on 31 October 2011 and 31 March 2012 respectively. The appointment and replacement of the Company’s directors is governed by its Articles of Association, the UK Corporate Governance Code, the Companies Acts and related legislation and the individual service contracts and terms of appointment of the directors. The powers of the directors, and their service contracts and terms of appointment, are described in the Corporate Governance section on pages 40 to 44. In accordance with the Articles of Association Mr R J Woodman and Ms F Clutterbuck will retire from the Board at the end of the forthcoming Annual General Meeting, and, being eligible, will offer themselves for re-election. The UK Corporate Governance Code recommends that all directors should be subject to re-appointment annually and therefore all of the other directors, Mr R G Dench, Mr N S Terrington, Mr N Keen, Mr J A Heron, Mr E A Tilly, Mr A K Fletcher and Mr P J N Hartill, have agreed to voluntarily retire from the Board at the end of the forthcoming Annual General Meeting, and, being eligible, will offer themselves for re-election. None of the directors has a service contract with the Company requiring more than 12 months’ notice of termination to be given. From 1 October 2008, a director has had a statutory duty to avoid a situation in which he or she has, or can have, an interest that confl icts or possibly may confl ict with the interests of the Company. A director will not be in breach of that duty if the relevant matter has been authorised in accordance with the Articles of Association by the other directors. The Articles of Association include the relevant authorisation for directors to approve such confl icts. None of the directors had, either during or at the end of the year, any material interest in any contract of signifi cance with the Company or its subsidiaries. Directors’ report 15 The Paragon Group of Companies PLC Capital structure Details of the issued share capital of the Company, together with details of movements in its issued share capital in the year, are given in note 38 to the accounts. The Company has one class of ordinary share which carries no right to fi xed income. Each ordinary share carries the right to one vote at general meetings of the Company. The rights and obligations attaching to ordinary shares are set out in the Articles of Association of the Company. There are no specifi c restrictions on the size of a member’s holding or on the transfer of shares. Both of these matters are governed by the general provisions of the Company’s Articles of Association and prevailing legislation. The Articles of Association may be amended by special resolution of the shareholders. The directors are not aware of any agreements between holders of the Company’s shares in respect of voting rights or which might result in restrictions on the transfer of securities. Details of employee share schemes are set out in note 15 to the accounts. Votes attaching to shares held by employee benefi t trusts are not exercised at general meetings of the Company. The Company presently has the authority to issue ordinary shares up to a value of £99,600,000 and to make market purchases of up to 29,900,000 £1 ordinary shares, granted at the Annual General Meeting on 9 February 2012. These authorities expire at the conclusion of the forthcoming Annual General Meeting on 7 February 2013. Purchase of own shares At 30 September 2007 the Company had, as part of a £40.0 million repurchase programme, repurchased 6,689,000 10p ordinary shares having an aggregate nominal value of £668,900. The reasons for the repurchase programme were set out in an announcement made by the Company through RNS on 25 May 2005. On 29 January 2008 these shares were consolidated into 668,900 £1 ordinary shares. All of these shares were held as at 30 September 2012 and 30 September 2011 as treasury shares, representing 0.2% of the issued share capital excluding treasury shares, and this holding represents the maximum number of its own £1 ordinary shares held by the Company at any time during the past year. Substantial shareholdings As at 31 October 2012, being a date not more than one month before the date of the notice convening the forthcoming Annual General Meeting, the Company had been notifi ed of the following interests of more than 3% in the nominal value of the ordinary share capital of the Company: BlackRock M & G Investment Management Legal & General Investment Management Aviva Investors Standard Life Investments Old Mutual Asset Managers Hof Hoorneman Bankiers Henderson Global Investors Schroder Investment Management Ordinary Shares % Held 40,067,442 16,528,835 12,658,328 12,505,141 11,912,455 11,775,600 11,316,891 10,434,087 9,251,517 13.30% 5.50% 4.20% 4.15% 3.96% 3.91% 3.76% 3.46% 3.07% 16 Directors’ report The Paragon Group of Companies PLC Donations Company law requires the disclosure of political donations and expenditure by any Group company. During the year ended 30 September 2012 no such payments were made (2011: £nil). Contributions to charitable institutions in the United Kingdom amounted to £371,000 (2011: £37,000). These include contributions of £353,000 to charities providing debt advice to customers, based on the amount of customer repayments handled by them in accordance with industry practice. Close company status So far as the directors are aware, the Company is not a close company for taxation purposes. Creditor payment policy The Group agrees terms and conditions with each of its suppliers and ensures that its suppliers are aware of these terms. Payment is then made on the terms agreed, subject to the appropriate terms and conditions being met by the supplier. It is not the Group’s policy to follow any code or standard on payment practice. The trade creditor days fi gure has not been stated as the measure is not appropriate to the business. Auditors The directors have taken all reasonable steps to make themselves and the Company’s auditors aware of any information needed in preparing the audit of the Annual Report and Financial Statements for the year, and, as far as each of the directors is aware, there is no relevant audit information of which the auditors are unaware. A resolution for the re-appointment of Deloitte LLP as the auditors of the Company is to be proposed at the forthcoming Annual General Meeting. Annual General Meeting The Annual General Meeting of the Company will take place on 7 February 2013 in London. A notice convening the Annual General Meeting is being circulated to shareholders with this Annual Report and Accounts. Approved by the Board of Directors and signed on behalf of the Board. JOHN G GEMMELL Company Secretary 20 November 2012 Directors’ report 17 The Paragon Group of Companies PLC Corporate social responsibility The Group believes that the long-term interests of shareholders, employees and customers are best served by acting in a socially responsible manner. As such, the Group ensures that a high standard of corporate governance is maintained. Commitment to our customers The Group places the needs of customers at the heart of its day-to-day operations. With a commitment from the Board, fairness to customers is a key consideration and objective at all stages of the lifetime of a loan. Training and development The Group has been accredited under the ‘Investors in People’ scheme since 1997. This demonstrates the Group’s commitment to the training and development of employees. The appraisal system is designed to assist employees in developing their careers and to identify and provide appropriate training opportunities, with all employees receiving a review at least annually. The corporate training and development strategy focuses on providing opportunities to develop all employees and is central to the achievement of the Group’s business objectives. On average employees received 7.8 days training in the year (2011: 8.2 days). Equality and diversity The Group is committed to providing a working environment in which employees feel valued and respected and are able to contribute to the success of the business, and to employing a workforce that recognises the diversity of customers. Employees are requested to co-operate with the Group’s efforts to ensure the policy is fully implemented. The Group’s aim is that its employees should be able to work in an environment free from discrimination, harassment and bullying, and that employees, job applicants, customers, retailers, business introducers and suppliers should be treated fairly regardless of: • race, colour, nationality (including citizenship), ethnic or national origins • gender, sexual orientation, marital or family status • religious or political beliefs or affi liations • disability, impairment or age • real or suspected infection with HIV/AIDS • membership of a trade union and that they should not be disadvantaged by unjust or unfair conditions or requirements. 18 Corporate social responsibility The Paragon Group of Companies PLC When responding to changes in its business, the Group seeks to minimise the requirement for compulsory redundancy, retraining and redeploying employees wherever possible. The Group aims to ensure that applications for employment from people with disabilities, and other under-represented groups, are given full and fair consideration and that such people are given the same training, development and job opportunities as other employees. Every effort is also made to retrain and support employees who suffer from disabilities during their employment, including the provision of fl exible working to assist their re-entry into the workplace. Composition of the workforce is reviewed on an annual basis and employee satisfaction with equality of opportunity is monitored as part of the regular employee feedback surveys. Human Resources policies are reviewed regularly to ensure that they are non-discriminatory and promote equality of opportunity. In particular, recruitment, selection, promotion, training and development policies and practices are monitored to ensure that all employees have the opportunity to train and develop according to their abilities. Information on the composition of the workforce at the year end is summarised below: Female employees Female management grade employees Female directors Ethnic minority employees Ethnic minority management grade employees Employees’ involvement 2012 £m 58.1% 44.5% 11.1% 11.3% 4.4% 2011 £m 58.4% 45.1% - 9.2% 3.5% The directors recognise the benefi t of keeping employees informed of the progress of the business. The Group sponsors a Staff Forum, attended by elected employee representatives from each area of the business, which exists primarily to facilitate communication and dissemination of information throughout the Group and provides a means by which employees can be consulted on matters affecting them. Employees are provided with regular information on the performance and plans of the Group, and the fi nancial and economic factors affecting it, through information circulars and presentations. The Company operates a Sharesave share option scheme and a profi t sharing scheme, both of which enable eligible employees to benefi t from the performance of the business. The directors encourage employee involvement at all levels through the appraisal process and communication between directors, managers, teams and individual employees. Corporate social responsibility 19 The Paragon Group of Companies PLC Environmental policy The Group is engaged in mortgage and consumer fi nance and arrears management and therefore its overall environmental impact is considered to be low. The main environmental impacts for the Group are limited to universal environmental issues such as resource use, procurement in offi ces and business travel. The Group complies with all applicable laws and regulations relating to the environment and operates a Green Charter, which: • ensures all buildings occupied by the Group are managed effi ciently by its Facilities Team and Building Surveyor • encourages employees to conserve energy • provides facilities to enable employees to re-cycle used products • controls business travel and provides opportunities for employees to travel to work in various ways; i.e. providing cycle racks and showers (where possible) • displays a Paragon Green Charter at all sites to encourage employees to be environmentally friendly at all times • ensures liaison with the local community • ensures that redundant IT equipment is disposed of within current directives / regulations (WEEE - Waste Electrical and Electronic Equipment), recycling 98% of such equipment • ensures that all fl uorescent light tubes are disposed of in a safe manner, compliant with appropriate regulations • arranges for paper waste products to be recycled, securely, by third parties The Green Charter is kept under continuous review by the Facilities team. The Group’s paper-based stationery is all procured from FSC certifi ed suppliers. The Group has been involved in no prosecutions, accidents or similar non-compliances in respect of environmental matters. 20 Corporate social responsibility The Paragon Group of Companies PLC The environmental key performance indicators for the Group, determined in accordance with the Reporting Guidelines published by the Department for Environment Food and Rural Affairs (DEFRA) in 2006 are set out below. Direct inputs (operational) Greenhouse gases Defi nition Gas Emissions from utility boilers Vehicle fuel Petrol and diesel used by staff and company cars Absolute tonnes C0 2 Normalised tonnes C0 2 per £m income 2012 2011 2012 2011 366 415 321 496 2.1 2.4 2.1 3.3 Waste Defi nition Absolute tonnes Normalised tonnes Landfi ll General offi ce waste, which includes a mixture of 134 paper, card, wood, plastics and metal 2012 2011 124 Recycled General offi ce waste recycled, primarily paper and 82 175 0.5 cardboard per £m income 2012 2011 0.8 0.8 1.2 Indirect inputs (supply chain) Greenhouse gases Defi nition Absolute tonnes C0 2 Normalised tonnes C0 2 per £m income 2012 2011 2012 2011 Energy use Directly purchased electricity, which generates 1,179 1,254 6.9 8.3 greenhouse gas emissions Water Defi nition Absolute cubic metres Supplied water Consumption of piped water. No water is extracted 10,099 7,231 directly by the Group 2012 2011 Normalised cubic metres per £m income 2012 59.3 2011 47.9 Gas, electricity and water usage is based on consumption recorded on purchase invoices. Vehicle fuel usage is based on expense claims and recorded mileage and waste generation is based on volumes reported on disposal invoices. CO2 values above are calculated based on the DEFRA / DECC guidelines published in May 2012. CO2 values for the year ended 30 September 2011 have been restated for the revised conversion factors published by DEFRA / DECC. Normalised data is based on total operating income of £170.2m (2011: £150.9m). Corporate social responsibility 21 The Paragon Group of Companies PLC Health and Safety policy It is the Group’s policy to comply with the terms of the Health and Safety at Work Act 1974, and subsequent legislation, and to provide and maintain a healthy and safe working environment. The health and safety objective of the Group is to minimise the number of instances of occupational accidents and illnesses and ultimately achieve an accident-free workplace. The Group recognises and accepts its duty to protect the health and safety of all visitors to its premises, including contractors and temporary workers, as well as any members of the public who might be affected by our operations. While the management of the Group will do all within its power to ensure the health and safety of its employees, it is recognised that health and safety at work is the responsibility of each and every individual associated with the Group. It is the duty of each employee to take reasonable care of their own and other people’s welfare and to report any situation which may pose a threat to the well-being of any other person. Health and safety policies and procedures are managed by the Group Services Division which liaises with senior management and Human Resources as necessary. All employees are provided with such equipment, information, training and supervision as is necessary to implement the policy in order to achieve the above stated objective. The Group makes available such fi nances and resources deemed reasonable to implement this policy. All injuries, however small, sustained by a person at work must be reported. Accident records are crucial to the effective monitoring and revision of the policy and must therefore be accurate and comprehensive. The Group recognises the civil and moral need to ensure that all employees adhere to this health and safety policy and is prepared to invoke the disciplinary procedure in case of any deliberate disregard for the health and safety policy. The Group’s health and safety policy is continually monitored and updated, particularly when changes in the scale or nature of our operations occur. The policy is updated at least every 12 months. A six monthly health and safety report is produced by the Head of Group Services for the Senior Management Group. Consultants are employed to carry out an annual audit of all health and safety records, including policies, procedures, risk assessments and training records. Charitable contributions The Group contributes to registered charities relating to fi nancial services or serving the local communities in which it operates. Included in the charitable contributions shown in the Directors’ Report are contributions of £353,000 (2011: £23,000) made by the Group to the work of the Foundation for Credit Counselling which operates the Consumer Credit Counselling Service. The Group has also contributed to charities throughout the year by way of single donations. The Group’s main objective is to support children’s and local charities although no charity request is overlooked. During the last year the Group has helped many and varied charities and causes such as: Marie Curie Cancer Care, Children’s Heart Foundation, St Margaret’s Parents Association, Handicapped Children’s Action Group, Second Chance, The Jennifer Trust, Action for Sick Children, Knowle and Dorridge Lions, Brainwave, Butterfl ies Children’s Charity, In Touch, Icandance - disabled children dance school, Chicks, Deafness Research UK, Rotary club of St Alphege Youth Speaks, The Neuro Foundation, Foundation for the Study of Infant Deaths, Strongbones Children’s Charitable Trust, Happy Days. The Group also supports Paragon’s Charity Committee, consisting of volunteer employees, which organises a variety of fundraising activities throughout the year, raising in the region of £10,000 for the employees’ chosen charity. All employees are given the opportunity to nominate a charity and a vote is carried out to select the benefi ciary of the year’s fundraising. 22 Corporate social responsibility The Paragon Group of Companies PLC Report of the Board to the shareholders on directors’ remuneration INTRODUCTORY CHAIRMAN’S LETTER Dear shareholder The year ended 30 September 2012 has seen the Group make good progress which has contributed to a signifi cant increase in profi ts. The Committee has sought to refl ect this performance in a responsible manner in the decisions it has made in the year. During the year the Committee conducted a review of all aspects of its policy on executive director remuneration. This concluded that the current policy remains broadly appropriate save that the performance metrics used for future awards of long-term incentives (‘LTIs’) should be altered. As a result, future awards of LTIs will have a reduced weighting on relative Total Shareholder Return (‘TSR’), whilst an Earnings Per Share (‘EPS’) performance condition will be introduced. The Committee also reviewed its terms of reference in light of current best practice and a revised version of the Committee’s terms of reference is available on request from the Company Secretary. The key decisions made by the Committee during the year are as follows: • Salaries for 2013 have been increased by 3%, broadly in line with increases to other employees • Performance bonuses of 175% of salary for Mr Terrington and Mr Keen, 125% of salary for Mr Heron and 200% for Mr Woodman have been awarded • Awards of performance shares over shares with a market value of 200% of salary, vesting of half of which is subject to a relative TSR performance condition measured against the constituents of the FTSE-250 index (excluding investment trusts) and vesting of half of which is subject to an EPS performance condition measured against a retail price index related target, will be awarded shortly • The Committee consulted with major shareholders prior to fi nalising the decisions above and received broad support The existing Performance Share Plan will expire in 2013 and the Committee is asking shareholders to approve a replacement plan at the AGM in 2013, details of which are given in the notice of AGM being sent to you with these accounts. The Board is aware of and supports the requirements for additional remuneration related disclosures announced by BIS earlier this year and will seek to comply with the revised requirements when they are fi nalised. ALAN K FLETCHER Chairman of the Remuneration Committee 20 November 2012 Report of the Board to the shareholders on directors’ remuneration 23 The Paragon Group of Companies PLC This report has been prepared in accordance with Schedule 8 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 and also sets out how the principles of the UK Corporate Governance Code relating to executive directors’ remuneration are applied by the Group. As required by the Regulations, a resolution to approve the report will be proposed at the Annual General Meeting of the Company. Certain parts of this report are required to be audited. Where disclosures are subject to audit, they have been marked as such. UNAUDITED INFORMATION Summary of remuneration policy Purpose Base salary Policy • Provide a competitive fi xed cash component that refl ects the • Remunerate fairly for individual performance, having regard to scope of individual responsibilities and recognises sustained the importance of motivation. individual performance in the role. • Take into account remuneration levels in the Group as a whole, individual and business performance and objective research into comparable companies. • Increases in salary for the Chairman and executive directors, if the Committee is satisfi ed with the individual’s performance, normally broadly follow salary increases for the rest of the organisation. • Increases of 3% have been awarded with effect from 1 October 2012. These are broadly in line with increases for the wider workforce Pensions and benefi ts • Provide competitive post-retirement benefi ts. • 1/37.5% of basic annual salary for each year of eligible service, capped at 2/3 salary. • Cash alternative in lieu of pension accrual, equating to the cost to the Company of defi ned benefi t provision, normally reviewed every fi ve years. Annual bonus • Incentivise executives to achieve specifi c, predetermined goals • Maximum potential bonus is currently 200% of salary. during a one year period. • Reward individual performance. • On-target bonus of 100% of base salary, with additional amounts being awardable for exceptional performance. • Encourage retention through a three year deferral of a proportion • Compulsory deferral of 25% of amounts in excess of £50,000, of bonus, awarded in shares. payable in shares after three years, net of any clawback. A higher level of deferral applies in certain circumstances. • Performance measures for the year ending 30 September 2013 will include, inter alia, profi t, management of the extant book of business, covering such aspects as managing customer retention, arrears, cash fl ow and overall cost effi ciency. Other objectives will concern the further development of the Group’s new lending business and the development and delivery of new strategies to enhance existing income streams. 24 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC Purpose Policy Performance Share Plan (‘PSP’) • Incentivise executives to achieve enhanced returns for • Awards of shares subject to performance conditions over a shareholders. three year performance period. • Encourage long-term retention of key executives. • Award limit of 200% salary in any year. Awards with a face value • Align the interests of executives and shareholders. of 200% of salary will be made to executive directors in the year to 30 September 2013. • Vesting of 50% of awards granted in the year ending 30 September 2013 will be subject to a relative TSR performance condition against the constituents of the FTSE-250 index, 25% of that proportion will vest for median performance, increasing on a straight line basis to full vesting for upper quartile performance; and 50% will be subject to an EPS performance condition where 25% of that proportion will vest for EPS growth equal to the change in the retail price index plus 3%, increasing to full vesting for the change in the retail prices index plus 7%. Matching Share Plan (‘MSP’) • Provide additional incentive for executives to achieve enhanced • Key executives invited to invest the after tax equivalent of up to returns for shareholders. • Encourage long-term retention of key executives. • Encourage key executives to hold personal investment in the Company. 25% of salary. At the end of a three year performance period and subject to satisfaction of performance criteria determined by the Committee, participants receive a match for shares on a two for one basis. No grants will be made under the Matching Share Plan during the year ending 30 September 2013. Remuneration committee During the year, the Committee consisted of Alan Fletcher (who chaired the Committee), Peter Hartill, Edward Tilly, Terence Eccles (until his resignation from the Board on 31 March 2012), Christopher Newell (until his resignation from the Board on 31 October 2011) and Fiona Clutterbuck (following her appointment to the Board on 12 September 2012), all of whom were independent non-executive directors, and the Chairman of the Company, Robert Dench. None of the non-executive directors who sit on the Committee has any personal fi nancial interest (other than as a shareholder), confl ict of interest arising from cross-directorships or day-to-day involvement in running the business. The Chairman of the Company does not participate in discussions on his own remuneration. The Committee determines the Company’s policy on executive remuneration and specifi c compensation packages for each of the executive directors and the Chairman. No director contributes to any discussion about his own remuneration. The Committee also reviews the level and structure of remuneration of senior management. The terms of reference of the Committee are available on request from the Company Secretary. In determining the directors’ remuneration for the year, the Committee consulted Mr N S Terrington (Chief Executive) about its proposals. The Committee also retains New Bridge Street (‘NBS’), a brand of Aon Hewitt Limited (part of AON plc), as its independent advisor on remuneration matters. NBS also advised the Company on various sundry remuneration matters during the year, which did not confl ict with its advice to the Committee. Aon Hewitt provided administration services to the trustees of the Group Retirement Benefi ts Plan during the year. Report of the Board to the shareholders on directors’ remuneration 25 The Paragon Group of Companies PLC Remuneration policy for the Chairman and executive directors The Company’s policy is to ensure that the Chairman and the executive directors are fairly rewarded for their individual performance, having regard to the importance of retention and motivation. The performance measurement of the Chairman and the executive directors and the determination of their annual remuneration packages are undertaken by the Committee. In forming and reviewing remuneration policy the Committee has given full consideration to the UK Corporate Governance Code and has complied with the Code’s provisions relating to directors’ remuneration throughout the year. Moreover, the Committee has given due regard to the link between remuneration and strategy, seeking to ensure that the remuneration structures in place do not encourage excessive risk or activities that are not in line with the agreed strategy. The remuneration packages of the individual directors are assessed after a review of their individual performances and an assessment of comparable positions in the fi nancial sector and within a group of pan-sectoral comparators comprising a number of FTSE-250 companies with market capitalisations similar to the Group’s, there now being no directly comparable fi nancial services businesses in the UK. The executive directors receive a combination of fi xed and performance-related elements of remuneration. Fixed remuneration consists of salary, benefi ts in kind and pension scheme contributions (see under ‘Pension contributions’ below). Performance-related remuneration consists of participation in the annual bonus plan, the award of shares under the PSP and invitations to participate in the award of shares under the MSP from time to time. The performance-related elements of remuneration are intended to provide a signifi cant proportion of executive directors’ potential total remuneration. No award will be made under the MSP in the year to 30 September 2013. The Committee pays due regard to the levels of remuneration within the Group when determining the remuneration of executive directors and other senior employees. It also seeks to ensure that the incentive structure for senior management does not raise environmental, social or governance risks by inadvertently motivating irresponsible behaviour. Salary The Chairman’s fees and executive directors’ salaries are determined by the Committee at the beginning of each year. In deciding appropriate levels, the Committee considers remuneration levels within the Group as a whole, individual and business performance during the year and in the past has relied on objective research which gives up-to-date information on comparable FTSE-250 companies. Directors’ contracts of service will be available for inspection at the Annual General Meeting. In view of the progress made by the Group during the year, the Committee has agreed that the Chairman’s fee and executive directors’ salaries will be increased by 3% from 1 October 2012. This is in line with increases for the Group’s wider workforce. The current salaries of the executive directors with effect from 1 October 2012 are as follows: • Mr Terrington £434,750 • Mr Keen £325,500 • Mr Heron £231,750 • Mr Woodman £231,750 Pension contributions During the year the executive directors were members of the Group Retirement Benefi ts Plan (the ‘Plan’), to which the Company contributes at the same rate as for all members. Dependants of executive directors who are members of the Plan are eligible for a dependant’s pension and the payment of a lump sum in the event of death in service. The pension arrangements provide for a pension of 1/37.5 of basic annual salary (to a maximum of 2/3) for every year of eligible service. Where pension contributions are capped, additional payments are made to enable further provision. Prior to the beginning of the year, Mr Terrington and Mr Heron suspended their contributions to the Plan, and the accrual of benefi ts. This followed an offer to each director affected by the 2006 ‘A-Day’ changes of the opportunity to terminate permanently further contributions in exchange for a cash supplement calculated to equate to the cost of the Company’s contributions towards the executive’s future service benefi ts had he stayed within the Plan for his future service accrual, whilst retaining the salary linkage in respect of past service. 26 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC Following an offer by the Company to senior employees to contain the volatility of costs associated with the provision of benefi ts under the Plan, Mr Keen and Mr Woodman each ceased pension accrual prior to the beginning of the year in return for a cash supplement calculated to equate to the cost of the Company’s contributions towards future service benefi ts had he stayed with the Plan for his future service accrual. The changes in pension entitlements arising in the fi nancial year, the disclosure of which is required by the Financial Services Authority, are given on pages 32 and 33. There have been no changes in the terms of directors’ pension entitlements during the year. There are no unfunded promises or similar arrangements for directors. Performance bonuses The purpose of the bonus is to provide a meaningful cash incentive focused on improving the performance of the Company through the achievement of a number of predetermined objectives. The bonus payable to executive directors under the bonus scheme is capped at 200% of salary. 100% of salary is awarded for delivery of the base business plan and agreed objectives, with achievement of the planned profi t level forming a major element. Up to 50% additional award might be given for achievement of signifi cantly higher profi ts than planned, together with other notable successes over and above the agreed objectives. Up to a further 50% might be awarded for performance in excess of the stretch (this could only be achieved for exceptional performance). To determine the bonus payable, the Committee assessed performance against a number of objectives which were set at the start of the fi nancial year. Mr Terrington and Mr Keen were assessed against a balanced scorecard of strategic, fi nancial and operational targets, including operating profi t, cash generation, cost control, the development of the Group’s new lending business, borrower retention and the development and delivery of new strategies to enhance existing income streams. These performance measures are designed to promote the long-term success of the Company by linking to the strategy and specifi c risk factors faced by the Company. Mr Heron was assessed 50% against the balanced scorecard and 50% against specifi c new business related objectives. Mr Woodman was assessed 50% against the balanced scorecard and 50% against objectives related to the development of new income streams, such as acquisitions and servicing contracts. In determining bonus levels the Committee has considered the performance of the executive directors and of the Company in relation to the adverse economic and market conditions prevailing during the year. The directors have exceeded their target bonus objectives to deliver the Group’s strategy including, inter alia, revenue generation, portfolio acquisitions and third party servicing contracts, the effective and effi cient management of the extant book (including optimising value by maintaining low redemption and arrears rates), maximising cash fl ow and the development of new lending and refreshing the Group’s systems capabilities to increase business capacity, competitiveness and broaden capabilities. A bonus of 175% of salary has been earned by each of Mr Terrington and Mr Keen for the year. This bonus refl ects very strong individual performance and the exceeding of stretch company performance targets in terms of profi ts, cash generated, arrears performance, portfolio acquisition and servicing contracts and customer retention. A bonus of 125% of salary has been earned by Mr Heron following strong individual performance, the building up of business volumes during the year whilst concentrating on high quality borrowers and improving the processing effi ciency within the new lending business. A bonus of 200% of salary has been earned by Mr Woodman, refl ecting outstanding performance in addition to delivering the successful completion of attractive portfolio acquisitions during the year. Bonus amounts in excess of £50,000 are subject to compulsory 25% deferral, whereby the deferred amount less any clawback (in the event of misstatement or misconduct), which can be applied by the Committee in certain specifi c circumstances, is payable in shares after three years. In the case of Mr Woodman, this provision applies to his bonus up to and including 150%, with the amount in excess of 150% being subjected to a 50% deferral. The Chairman and non-executive directors are not entitled to receive a bonus and do not participate in the PSP or the MSP. Report of the Board to the shareholders on directors’ remuneration 27 The Paragon Group of Companies PLC Share awards Executive directors are eligible for awards under the PSP and are entitled to participate in the Paragon UK Sharesave Plan 2009, on the same terms as other employees. Paragon Performance Share Plan (‘PSP’) The PSP has an annual award limit to an individual of shares worth 200% of salary. Awards under the PSP are made from time to time at the discretion of the Committee and during the year the executive directors were granted awards over shares equal to 200% of salary. Awards over shares with a market value of 200% of salary will be granted to the executive directors in the year to 30 September 2013. PSP awards which were granted on or after 21 May 2009 are subject to a performance condition comparing the rank of the Company’s TSR against a comparator group of companies comprising the constituents of the FTSE-250 on the date of grant over the three years commencing on the date of grant. 25% of awards vest for median performance, increasing on a straight line basis to full vesting for upper quartile performance. The FTSE-250 was chosen because it is a broad-based index and because of the lack of comparable listed fi nancial services organisations at the current time. The performance conditions are reviewed prior to each future grant to ensure that they remain the most suitable in the Company’s prevailing circumstances. The Committee believed that at the time of the grants TSR refl ected the best measure to align the performance conditions applied with the best interests of the shareholders. Following discussions with shareholders, the Committee has determined that for awards granted during the fi nancial year ending 30 September 2013, 50% of awards will be subject to the TSR test and 50% will be subject to an EPS test. In addition, prior to any awards vesting, the Committee must be satisfi ed that the requirements of a fi nancial underpin test have been met. Whilst the use of TSR as the sole performance measure for grants in prior years was considered by the Committee to be an appropriate measure to refl ect the Company’s objectives, with the business now on a stable footing and improved visibility of future earnings, the Committee now intends to include a fi nancial measure. The EPS test will apply such that 25% of EPS tested awards will vest where EPS growth is equal to the increase in the retail price index plus 3%, increasing on a straight line basis to full vesting for EPS growth equal to the increase in the retail price index plus 7% or more. EPS is considered appropriate as the second condition as the activities of the Company in developing its new lending and other income streams should result in improvements to profi tability and including a profi t measure such as EPS will be refl ective of long term performance. It also provides a balance to relative TSR, which is a measure of market expectations of future performance. Awards are structured as nil cost options with a ten year life. Paragon Matching Share Plan (‘MSP’) Under the terms of the MSP, executive directors and senior management may, at the discretion of the Committee, be invited to invest in shares in the Company out of their after-tax cash bonus. Assuming that the executives decide to invest, the shares acquired must remain held by the executives for three years. At the end of the three-year period and, subject to satisfaction of performance criteria determined by the Committee, the executives will receive a match in shares on a two-for-one basis related to the number of shares which could have been purchased with the pre-tax equivalent of the bonus invested. Executive directors will normally be invited to invest the after-tax equivalent of up to 25% of salary; at such a level, their award is over ‘free’ performance-linked matching shares worth 50% of salary. The MSP provides the facility to increase the level of potential investment up to the after-tax equivalent of 50% of salary should the Remuneration Committee feel in future years that this would be appropriate. Awards are structured as nil cost options with a ten year life. 28 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC Performance graph The following graph shows the Company’s TSR performance compared with the performance of the FTSE All Share General Financial sector index. The General Financial sector has been selected for this comparison because it is the sub-sector index that contains the Company’s shares. Five year return index for the FTSE All Share Financial sector as at 30 September 2012 120 100 80 60 40 20 0 2007 2008 2009 2010 2011 2012 The Paragon Group of Companies PLC FTSE All Share General Financial sector This graph shows the value, by 30 September 2012, of £100 invested in The Paragon Group of Companies PLC on 30 September 2007, compared with £100 invested in the FTSE General Financial sector index. The other points plotted are the values at the intervening fi nancial year ends. Report of the Board to the shareholders on directors’ remuneration 29 The Paragon Group of Companies PLC Share ownership guidelines For a number of years, all executive directors have been encouraged to hold a minimum number of shares in the Company of a value equal to their salary, calculated at 30 September each year on the basis of the average price of the Company’s shares over the previous two months. The gross value of shares granted under the Deferred Bonus Plan and vested but unexercised shares under the PSP and MSP count towards the aggregate shares held by each director in respect of the policy. Guideline holdings and the actual shares held at 30 September 2012 are set out below: N S Terrington N Keen J A Heron R J Woodman Salary (£) Average share price (£) † 422,000 1.9255 316,000 1.9255 225,000 1.9255 225,000 1.9255 Required holding (shares) 219,164 164,113 116,853 116,853 Shareholding Vested PSP Deferred Bonus Scheme 647,972 1,122,572 250,544 368,679 632,143 181,426 252,680 450,000 104,357 89,691 385,714 116,861 Total shares held at 30 September 2012 2,021,088 1,182,248 807,037 592,266 Surplus shares held 1,801,924 1,018,135 690,184 475,413 † The above fi gures are based on the average share price for the two months to 30 September 2012 Directors’ contracts The Chairman and executive directors hold one year rolling contracts in line with current market practice and the Committee reviews the terms of these contracts regularly. The current contracts are dated as follows: R G Dench N S Terrington N Keen J A Heron R J Woodman - - - - - 8 February 2007 1 September 1990 (amended 16 February 1993, 30 October 2001 and 10 March 2010) 6 February 1996 (amended 30 October 2001 and 10 March 2010) 1 September 1990 (amended 14 January, 8 February 1993 and 10 March 2010) 8 February 1996 (amended 10 March 2010) In the event of early termination, the directors’ contracts provide for the payment of one year’s fees / salary, benefi ts, pension and bonus in lieu of notice. These would be paid on termination. No provision exists for additional compensation in the event of termination due to a change of control of the Company. These arrangements represent the contractual obligations of the Company. New contracts entered into in future will not include provision for the payment of bonus in lieu of notice. Of the directors seeking re-election at the Annual General Meeting, Mr R G Dench, Mr N S Terrington, Mr N Keen, Mr J A Heron and Mr R J Woodman each has a service contract with the Company. None of the executive directors currently earns remuneration from external non-executive appointments. 30 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC Non-executive directors All non-executive directors have specifi c terms of engagement and their remuneration is determined by the Board, subject to the Articles of Association. During the year all non-executive directors were paid an annual base fee of £34,450 plus £2,150 for membership of each committee, £10,800 for Remuneration Committee and Audit and Compliance Committee chairmanship (inclusive of membership) and £6,500 for acting as the Senior Independent Director. Current terms of engagement apply for the following periods: E A Tilly A K Fletcher P J N Hartill F Clutterbuck - - - - 1 April 2011 to 1 April 2014 25 February 2012 to 25 February 2015 11 February 2011 to 11 February 2014 12 September 2012 to 12 September 2015 Non-executive directors are not eligible to participate in any of the Company’s incentive or pension schemes and are not entitled to receive compensation for early termination of their terms of engagement. Alan Fletcher, Chairman of the Remuneration Committee, will be available to answer questions on remuneration policy at the Annual General Meeting. AUDITED INFORMATION Directors’ emoluments The emoluments of directors holding offi ce during the year were: Chairman R G Dench Executive N S Terrington N Keen J A Heron R J Woodman Non-executive C D Newell E A Tilly T C Eccles A K Fletcher P J N Hartill F Clutterbuck 2012 2011 Salary and fees £000 Allowances and benefi ts £000 Annual bonus £000 2012 Total £000 2011 Total £000 197 422 316 225 149 3 47 20 50 50 2 1,481 1,327 12 14 19 11 8 - - - - - - 64 57 - 209 201 566 427 223 322 - - - - - - 1,538 1,171 1,002 762 459 479 3 47 20 50 50 2 3,083 2,555 966 734 443 - 48 49 46 42 26 - 2,555 Allowances and benefi ts includes benefi ts in kind, comprising private health cover, fuel benefi t, life assurance; and company car provision. The company car allowance paid to executive directors (£10,000 - £12,000) is also included in allowances and benefi ts. Report of the Board to the shareholders on directors’ remuneration 31 The Paragon Group of Companies PLC Directors’ pensions The total amount charged to the profi t and loss account of the Group in respect of pension provision for directors was £480,000 (2011: £435,000). Mr N S Terrington, Mr N Keen, Mr J A Heron and Mr R J Woodman were members of the Group defi ned benefi t pension plan during the year. The amounts shown below describe their entitlement in accordance with paragraph LR 9.8.8(12) of the Listing Rules. Increase / (decrease) Transfer value in accrued pension of increase / during year (decrease) less excluding any directors’ increase for infl ation contributions Accumulated total accrued pension at 30 September 2012 Accumulated total accrued pension at 30 September 2011 or on appointment £000 £000 £000 £000 (2) (2) (1) - (28) (45) (16) - 162 94 92 56 156 91 88 54 N S Terrington N Keen J A Heron R J Woodman The pension entitlement shown is that which would be paid annually on retirement based on service to the following dates on which the director elected to suspend future benefi t accrual within the plan: Mr Terrington and Mr Heron, 6 April 2006; Mr Woodman, 9 October 2007; and Mr Keen, 1 April 2011. The pension entitlements for Messrs Terrington and Heron continue to be linked to pensionable salaries, while Messrs Keen and Woodman elected on 1 April 2011 that their benefi ts would no longer be linked to pensionable salaries and their accrued pension fi gures have, therefore, been calculated based on a date of leaving of 1 April 2011 with deferred pension revaluation, where relevant. The increase in accrued pension during the year (and transfer value of the increase) excludes any increase for infl ation. The transfer values have been calculated in accordance with the Occupational Pensions Schemes (Transfer Values) Regulations 1996 and the Occupational Pensions Schemes (Transfer Values) (Amendment) Regulations 2008, in force from 1 October 2008. Members of the plan have the option to pay Additional Voluntary Contributions; neither the contributions nor the resulting benefi ts are included in the above table. The following disclosures describe the pension benefi ts earned in the year in accordance with section 421 of the Companies Act 2006. Age at Increase in Accumulated Transfer value year end accrued pension in the year total accrued pension at of accrued benefi ts at year end 30 September N S Terrington N Keen J A Heron R J Woodman £000 £000 52 54 53 47 6 3 4 2 162 94 92 56 2011 or on appointment £000 2,818 1,695 1,639 903 Transfer value of accrued benefi ts at 30 September 2012 Difference in transfer values less contributions £000 2,972 1,776 1,727 847 £000 154 81 88 (56) The pension entitlement shown is that which would be paid annually on retirement based on service to the following dates on which the director elected to suspend future benefi t accrual within the plan: Mr Terrington and Mr Heron, 6 April 2006; Mr Woodman, 9 October 2007; and Mr Keen, 1 April 2011. 32 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC The pension entitlements for Messrs Terrington and Heron continue to be linked to pensionable salaries, while Messrs Keen and Woodman elected on 1 April 2011 that their benefi ts would no longer be linked to pensionable salaries and their accrued pension fi gures have, therefore, been calculated based on a date of leaving of 1 April 2011 with deferred pension revaluation, where relevant. The contributions shown are those paid or payable by the directors under the terms of the plan. Members of the plan have the option to pay Additional Voluntary Contributions; neither the contributions nor the resulting benefi ts are included in the above table. No contributions have been paid in the year by the directors, as they had all elected to cease future pensionable service in the plan before the start of the year. The increases in transfer values (as shown in the fi nal column) largely refl ect the changes in assumptions underlying the transfer value basis as at 30 September 2012 and 30 September 2011, due to changes in fi nancial conditions. The increases also allow for the fact that the accrued pension is a year closer to the assumed date of payment. The transfer value at 30 September 2012 has been calculated on the basis of the Occupational Pensions Schemes (Transfer Values) (Amendment) Regulations 2008. The trustees are responsible for the assumptions and calculation of transfer values, having taken advice from the scheme actuary. The transfer values disclosed above do not represent a sum either paid or currently payable to the individual director by the Group or the scheme. Instead they represent a potential liability of the pension scheme should the director request a transfer, calculated at the balance sheet date. During the year the Group made contributions in respect of further pension provision of £150,000 (2011: £134,000) for Mr N S Terrington, £192,000 (2011: £157,000) for Mr N Keen, £78,000 (2011: £67,000) for Mr J A Heron and £61,000 for Mr R J Woodman following his appointment. Report of the Board to the shareholders on directors’ remuneration 33 The Paragon Group of Companies PLC Details of share-based awards Aggregate gains before taxation made by directors on the exercise of share based awards of £2,691,000 were recorded during the year (2011: £nil). At 30 September 2012 the share price of The Paragon Group of Companies PLC was 209.9p per share (2011: 153.5p per share) and the range during the year then ended was 138.5p to 219.0p per share (2011: 131.0p to 207.0p per share). Paragon Performance Share Plan Awards under this plan comprise a right to acquire shares in the Company for nil or nominal payment and will vest on the third anniversary of their grant to the extent that the applicable performance criteria have been satisfi ed. Details of individual entitlements of the directors under the Paragon Performance Share Plan at 30 September 2011, or on appointment if later, and 30 September 2012 are: Award date Date from which Expiry date Market price N S Terrington N Keen J A Heron R J Woodman exercisable at award date Number Number Number Number Awards outstanding at 30 September 2011 or on appointment 14/06/2007 26/09/2007 26/11/2007 29/09/2008 21/05/2009 04/01/2010 17/12/2010 14/06/2010 26/09/2010 26/11/2010 29/09/2011 14/06/2017 26/09/2017 26/11/2017 29/09/2018 21/05/2012§ 21/05/2019 04/01/2013§ 04/01/2020 17/12/2013§ 16/12/2020 543.00p* 296.50p* 130.50p* 66.50p# 70.00p# 135.20p# 182.00p# 9,947 21,127 29,347 717,865 844,286 451,145 450,661 7,454 15,834 21,990 537,920 632,143 337,786 337,424 4,244 7,430 15,651 382,861 450,000 240,458 240,200 - - - - 385,714 206,107 205,886 2,524,378 1,890,551 1,340,844 Awards made in the year: 21/12/2011 21/12/2014§ 20/12/2021 176.90p# 480,912 360,114 256,410 219,943 Awards exercised in the year: 14/06/2007 26/09/2007 26/11/2007 29/09/2008 14/06/2010 26/09/2010 26/11/2010 29/09/2011 14/06/2017 26/09/2017 26/11/2017 29/09/2018 543.00p* 296.50p* 130.50p* 66.50p# (9,947) (21,127) (29,347) (7,454) (15,834) (21,990) (4,244) (7,430) (15,651) (439,579) (537,920) (382,861) Awards lapsing in the year: - - - 1,017,650 - - - - - At 30 September 2012 2,505,290 1,667,467 1,187,068 1,017,650 * price per 10p ordinary share # price per £1 ordinary share § These awards will be subject to a performance condition comparing the rank of the Company’s TSR against a comparator group of companies comprising the constituents of the FTSE-250 on the date of grant over the three years commencing on the date of grant. 25% of the awards will vest for median performance, increasing on a straight line basis to full vesting for upper quartile performance. The awards maturing during the year, granted on 21 May 2009, achieved 100% vesting after the application of the performance criteria. Awards are exercisable from the date on which the Remuneration Committee determines the extent to which the performance conditions have been satisfi ed to the tenth anniversary of the grant date. 34 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC Share option schemes Details of individual options held by the directors at 30 September 2011, or on appointment if later, and 30 September 2012 are: Award date Date from which Expiry date Option price N S Terrington N Keen J A Heron R J Woodman exercisable Number Number Number Number Awards outstanding at 30 September 2011 or on appointment 27/11/2001 29/07/2002 14/03/2003 18/12/2003 01/12/2004 27/11/2004 29/07/2005 14/03/2006 18/12/2006 01/12/2007 27/11/2011 29/07/2012 14/03/2013 18/12/2013 01/12/2014 395.34p 297.30p 297.30p 540.40p 555.34p 188,190 37,638 119,848 61,527 68,874 - 37,638 87,161 46,261 51,656 - 50,184 41,269 25,906 27,730 - 43,911 34,666 21,280 22,778 476,077 222,716 145,089 122,635 Awards made in the year: Awards exercised in the year: Awards lapsing in the year: - - 27/11/2001 29/07/2002 27/11/2004 29/07/2005 27/11/2011 29/07/2012 395.34p 297.30p (188,190) (37,638) - - - - - - - - - (37,638) (50,184) (43,911) At 30 September 2012 250,249 185,078 94,905 78,724 Deferred bonus shares Details of individual entitlements of the directors to Deferred Bonus Shares at 30 September 2011, or on appointment if later, and 30 September 2012 are: Award date Date from which Expiry date Market price N S Terrington N Keen J A Heron R J Woodman exercisable at award date Number Number Number Number Awards outstanding at 30 September 2011 or on appointment 11/01/2010 20/01/2011 01/10/2012 01/10/2013 30/09/2013 30/09/2014 130.60p 184.00p 60,098 82,248 42,802 59,672 27,952 40,288 38,435 33,446 142,346 102,474 68,240 Awards made in the year: 21/12/2011 01/10/2014 30/10/2015 172.63p 108,198 78,952 36,117 44,980 Awards exercised in the year: - - - - 116,861 At 30 September 2012 250,544 181,426 104,357 116,861 Report of the Board to the shareholders on directors’ remuneration 35 The Paragon Group of Companies PLC The Deferred Bonus Shares awarded can be exercised for one year from the vesting date. The vesting date is the third anniversary of the start of the fi nancial year in which the grant is awarded. Rights to the following shares are due to be granted in respect of the compulsory deferral of performance bonuses for the year ended 30 September 2012. The shares, less any clawback, which can be applied by the Remuneration Committee in certain circumstances, will be exercisable by the recipients from 1 October 2015, subject to the recipient being employed by the Company at that time: N S Terrington 83,297 N Keen J A Heron 60,854 27,977 R J Woodman 62,003 Matching Share Plan The individual interests of the directors in the Matching Share Plan at 30 September 2011, or on appointment if later, and 30 September 2012 are: Award date Market price N S Terrington N Keen J A Heron R J Woodman at award date Number Number Number Number Awards outstanding at 30 September 2011 or on appointment 05/01/2010§ 133.40p 43,249 32,422 22,868 43,808 Awards made in the year: Awards exercised in the year: Awards lapsing in the year: At 30 September 2012 43,249 32,422 22,868 43,808 - - - - - - - - - - - - 43,249 32,422 22,868 43,808 § These awards will be subject to a performance condition comparing the rank of the Company’s TSR against a comparator group of companies comprising the constituents of the FTSE-250 on the date of grant over the three years commencing on the date of grant. 25% of the awards will vest for median performance, increasing on a straight line basis to full vesting for upper quartile performance. Awards are exercisable from the date on which the Remuneration Committee determines the extent to which the performance conditions have been satisfi ed to the tenth anniversary of the grant date. Signed on behalf of the Board of Directors ALAN K FLETCHER Chairman of the Remuneration Committee 20 November 2012 36 Report of the Board to the shareholders on directors’ remuneration The Paragon Group of Companies PLC Statement of directors’ responsibilities in relation to fi nancial statements The directors are responsible for preparing the Annual Report and the fi nancial statements. The directors are required to prepare accounts for the Group in accordance with International Financial Reporting Standards (‘IFRS’) and have also elected to prepare company fi nancial statements in accordance with IFRS. In respect of the fi nancial statements for the year ended 30 September 2012, company law requires the directors to prepare such fi nancial statements in accordance with International Financial Reporting Standards, the Companies Act 2006 and Article 4 of the IAS Regulation. International Accounting Standard 1 – ‘Presentation of Financial Statements’ requires that fi nancial statements present fairly for each fi nancial year the Company’s fi nancial position, fi nancial performance and cash fl ows. This requires the faithful representation of the effects of transactions, other events and conditions in accordance with the defi nitions and recognition criteria for assets, liabilities, income and expenses set out in the International Accounting Standards Board’s ‘Framework for the Preparation and Presentation of Financial Statements’. In virtually all circumstances, a fair presentation will be achieved by compliance with all applicable International Financial Reporting Standards. Directors are also required to: • properly select and apply accounting policies; • present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information; and • provide additional disclosures when compliance with the specifi c requirements in International Financial Reporting Standards is insuffi cient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s fi nancial position and fi nancial performance. The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the fi nancial position of the company, for safeguarding the assets, for taking reasonable steps for the prevention and detection of fraud and other irregularities and for the preparation of a directors’ report and directors’ remuneration report which comply with the applicable requirements of the Companies Act 2006. The directors are responsible for the maintenance and integrity of the Company’s website. Legislation in the United Kingdom governing the preparation and dissemination of fi nancial statements differs from legislation in other jurisdictions. The directors confi rm that, to the best of their knowledge: • the fi nancial statements, prepared in accordance with International Financial Reporting Standards as adopted by the European Union, give a true and fair view of the assets, liabilities, fi nancial position and profi t or loss of the Company and of the Group taken as a whole; and • the business review, which is incorporated into the Directors’ Report, includes a fair review of the development and performance of the business and the position of the Group taken as a whole, together with a description of the principal risks and uncertainties it faces. Approved by the Board of Directors and signed on behalf of the Board. JOHN G GEMMELL Company Secretary 20 November 2012 Statement of directors’ responsibilities 37 The Paragon Group of Companies PLC Independent auditors’ report To the members of The Paragon Group of Companies PLC We have audited the fi nancial statements of The Paragon Group of Companies PLC for the year ended 30 September 2012 which comprise the consolidated income statement, the consolidated statement of comprehensive income, the consolidated and company balance sheets, the consolidated and company cash fl ow statements, the consolidated and company statements of movements in equity and the related notes 1 to 59. The fi nancial reporting framework that has been applied in their preparation is applicable by law and International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the company fi nancial statements, as applied in accordance with the provisions of the Companies Act 2006. This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors As explained more fully in the Statement of Directors’ Responsibilities, the directors are responsible for the preparation of the fi nancial statements and for being satisfi ed that they give a true and fair view. Our responsibility is to audit and express an opinion on the fi nancial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. Scope of the audit of the fi nancial statements An audit involves obtaining evidence about the amounts and disclosures in the fi nancial statements suffi cient to give reasonable assurance that the fi nancial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Group’s and the parent company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of signifi cant accounting estimates made by the directors; and the overall presentation of the fi nancial statements. In addition, we read all the fi nancial and non-fi nancial information in the annual report to identify material inconsistencies with the audited fi nancial statements. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. Opinion on fi nancial statements In our opinion: • the fi nancial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 30 September 2012 and of the Group’s profi t for the year then ended; • the group fi nancial statements have been properly prepared in accordance with IFRSs as adopted by the European Union; • the parent company fi nancial statements have been properly prepared in accordance with IFRSs as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and • the fi nancial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group fi nancial statements, Article 4 of the IAS Regulation. 38 Independent auditors’ report The Paragon Group of Companies PLC Separate opinion in relation to IFRSs as issued by the IASB As explained in note 3 to the group fi nancial statements, the Group in addition to complying with its legal obligation to apply IFRSs as adopted by the European Union, has also applied IFRSs as issued by the International Accounting Standards Board (IASB). In our opinion the Group fi nancial statements comply with IFRSs as issued by the IASB. Opinion on other matters prescribed by the Companies Act 2006 In our opinion: • the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and • the information given in the Directors’ Report for the fi nancial year for which the fi nancial statements are prepared is consistent with the fi nancial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following: 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 fi nancial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or • certain disclosures of directors’ remuneration specifi ed by law are not made; or • we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: • the directors’ statement, set out on page 44 in relation to going concern; • the part of the Corporate Governance Statement relating to the Company’s compliance with the nine provisions of the UK Corporate Governance Code specifi ed for our review; and • certain elements of the report to shareholders by the Board on directors’ remuneration. Peter Birch (Senior Statutory Auditor) For and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor Birmingham, United Kingdom 20 November 2012 Independent auditors’ report 39 The Paragon Group of Companies PLC Corporate governance The Board of Directors is committed to the principles of corporate governance contained in the UK Corporate Governance Code (‘Code’) issued by the Financial Reporting Council in May 2010 and which is publicly available on their website at www.frc.org. Throughout the year ended 30 September 2012 the Company complied with the provisions of the Code except for Code provision B1.2 in relation to the number of independent non-executive directors. An explanation of this temporary departure is given in the section of this report headed Directors. Directors At the beginning of the year the Board of Directors comprised the Chairman, three executive and fi ve non-executive directors. During the year two non-executive directors resigned and one independent non-executive director and one executive director were appointed. During the year, owing to health reasons, Terence Eccles decided to step down from the Board of Directors on 31 March before the completion of his term of engagement, which would otherwise have extended until February 2013. The process to appoint an independent non-executive director in his place was put in hand and Fiona Clutterbuck was appointed to the Board on 12 September 2012. Therefore, between these dates the Board comprised the Chairman, four executive and three non-executive directors and the Company was temporarily not in compliance with Code provision B1.2. Richard Woodman had, for some time, been the senior executive responsible for the Group’s portfolio purchases and investments under the Idem Capital brand. In view of the increasing importance of this operation to the development of the Group, the Board determined that his role should be allocated a seat on the Board and he was, consequently, appointed an executive director of the Group with the title of Director - Corporate Development. All of the directors bring to the Company a broad and valuable range of experience. All of the then directors were re-elected at the Annual General Meeting on 9 February 2012 and all of the serving directors have submitted themselves for re-election at the forthcoming Annual General Meeting. The names of the directors in offi ce at the date of this report and their biographical details are set out on pages 12 to 13. The division of responsibilities between the Chairman and Chief Executive is clearly established, set out in writing and agreed by the Board. There is a strong non-executive representation on the Board, including Edward Tilly, the Senior Independent Director. This provides effective balance and challenge. The Board is responsible for overall Group strategy, for approving major agreements, transactions and other fi nancing matters and for monitoring the progress of the Group against budget. All directors receive suffi cient relevant information on fi nancial, business and corporate issues prior to meetings and there is a formal schedule of matters reserved for decision by the Board, which includes material asset acquisitions and disposals, granting and varying authority levels of the Chairman and the executive directors, determination and approval of the Group’s objectives, strategy and annual budget, investment decisions, corporate governance policies and fi nancial and dividend policies. The Chairman’s other business commitments are set out in the biographical details on page 12 and there have been no signifi cant changes during the period to those commitments. There were nine regular Board meetings during the year. Robert Dench, Nigel Terrington, Alan Fletcher and Peter Hartill attended all nine of the Board meetings during the year ended 30 September 2012, Nicholas Keen, John Heron and Edward Tilly attended eight meetings, Richard Woodman attended six of the seven meetings held following his appointment to the Board, Fiona Clutterbuck attended the one meeting held following her appointment to the Board and Terence Eccles attended one out of the four meetings held prior to his resignation owing to ill health. Christopher Newell did not attend the one meeting held prior to his resignation. All of the non-executive directors are independent of management and all are appointed for fi xed terms. They are kept fully informed of all relevant operational and strategic issues and bring a strongly independent and experienced judgement to bear on these issues. In November 2010 Christopher Newell’s appointment, following nine years on the Board, was extended for a further 12 months to enable an orderly handover of the Chairmanship of the Audit and Compliance Committee after the expected appointment of an appropriately qualifi ed person. Mr Newell resigned from the Board on 31 October 2011 and the Board considers that he remained independent throughout the time of his appointment until his resignation. Prior to 1 October 2008 the Board approved a set of guiding principles on managing confl icts and agreed a process to identify and authorise any confl icts which might arise. At each meeting of the Board actual or potential confl icts of interest in respect of any director are reviewed. 40 Corporate governance The Paragon Group of Companies PLC All directors have access to the advice and services of the Company Secretary, who is responsible to the Board for ensuring that board procedures are complied with. Both the appointment and removal of the Company Secretary are matters for the Board as a whole. All directors are able to take independent professional advice in the furtherance of their duties whenever it is considered appropriate to do so and have access to such continuing professional development opportunities as are identifi ed as appropriate in the Board appraisal process. The Board also operates through a number of committees covering certain specifi c matters, these being: • The Remuneration Committee, which during the year consisted of Alan Fletcher (who chairs the Committee), Fiona Clutterbuck (since her appointment to the Board on 12 September 2012), Peter Hartill, Edward Tilly, Terence Eccles (until his resignation from the Board on 31 March 2012) and Christopher Newell (until his resignation from the Board on 31 October 2011), all of whom were independent non- executive directors, and the Chairman of the Company, Robert Dench. During the year ended 30 September 2012 there were fi ve meetings of the Remuneration Committee. All meetings were attended by Alan Fletcher, Robert Dench, Peter Hartill and Edward Tilly and the one meeting held following Fiona Clutterbuck’s appointment was attended by her. Terence Eccles did not attend the one meeting of the Committee prior to his resignation and no meetings were held prior to the resignation of Christopher Newell. Further information about the Remuneration Committee is given in the Report of the Board to the Shareholders on Directors’ Remuneration on pages 23 to 36. • The Audit and Compliance Committee, which during the year consisted of Peter Hartill (who chairs the Committee), Fiona Clutterbuck (since her appointment to the Board on 12 September 2012), Alan Fletcher, Edward Tilly, Terence Eccles (until his resignation from the Board on 31 March 2012) and Christopher Newell (until his resignation from the Board on 31 October 2011), all of whom were independent non-executive directors. The Board is satisfi ed that all members of the Committee have recent and relevant fi nancial experience. The Committee meets at least three times per year. During the year ended 30 September 2012 there were three meetings of the Audit and Compliance Committee, all of which were attended by Peter Hartill, Alan Fletcher and Edward Tilly and the one meeting held following the appointment of Fiona Clutterbuck was attended by her. No meetings were held prior to the resignation of Christopher Newell and Terence Eccles did not attend the one meeting of the Committee prior to his resignation. Further information about the work of the Audit and Compliance Committee is given below. • The Nomination Committee, consisting of Robert Dench, who chairs the Committee, Nigel Terrington and all of the non-executive directors, ensuring that a majority of the Committee’s members are independent non-executive directors. The Committee is convened as required to nominate candidates for membership of the Board, although ultimate responsibility for appointment rests with the Board. There were two meetings of the Committee during the year to consider the appointment of a new non-executive director, resulting in the appointment of Fiona Clutterbuck to the Board on 12 September 2012. All members of the Committee attended both meetings. The Committee only engages in the process of identifi cation of suitable candidates for appointment to the Board when requested by the Board to do so. There is a formal process for the appointment of directors, starting with a review of the Board structure, size and composition, leading to the preparation of a written specifi cation of the skills required and the identifi cation of suitable candidates. The Nomination Committee ensures that prospective non-executive directors can devote suffi cient time to the appointment. The Board recognises the benefi ts that can fl ow from non-executive directors holding other appointments but requires them to seek the agreement of the Chairman before entering into any commitments that might affect the time they can devote to the Company. The choice of appointee is based entirely on merit. • The Asset and Liability Committee, consisting of appropriate heads of functions and chaired by Nigel Terrington, the Chief Executive. The Committee meets regularly and monitors Group liquidity risks, interest rate risks, currency risks and treasury counterparty exposures. Further information on the Group’s fi nancial risk management procedures and the Committee’s part in them is given in note 6 to the accounts. • The Credit Committee, consisting of appropriate heads of functions and chaired by Nicholas Keen, the Finance Director. It meets regularly and is responsible for establishing credit policy and monitoring compliance therewith. All Board committees operate within defi ned terms of reference and suffi cient resources are made available to them to undertake their duties. The terms of reference of the Remuneration Committee, Audit and Compliance Committee and Nomination Committee are available on request from the Company Secretary. Corporate governance 41 The Paragon Group of Companies PLC The composition of the Board and its committees is kept under review, with the aim of ensuring that there is an appropriate balance of power and authority between executive and non-executive directors and that the directors collectively possess the skills and experience necessary to direct the Company and the Group’s business activities. There is an established process for external appointments through the Nomination Committee. Ultimately, the appointment of any new director is a matter for the Board. Executive director appointments are based upon merit and business need. Non-executive appointments are based upon the candidates’ profi les matching those drawn up by the Nomination Committee. In all cases the Board approves the appointment only after careful consideration. The Board, individual directors and Board committees are appraised annually. The performance of the Chief Executive is appraised by the Chairman. The performance of the other executive directors is appraised by the Chief Executive in conjunction with the Chairman. The results of these appraisals are presented to the Remuneration Committee for consideration and determination of remuneration. During the year the Board conducted a formal and rigorous performance review, which was conducted internally. All Board directors participated and discussed a list of questions on Board and Committee performance. An externally facilitated evaluation had been carried out during the previous year. At the Annual General Meeting the Chairman will confi rm to shareholders, when proposing the re-election of any non-executive director, that, following formal performance evaluation, the individual’s performance continues to be effective and demonstrates commitment to the role. The non-executive directors meet at least annually to review the performance of the Chairman. Directors’ remuneration The Remuneration Committee reviews the performance of executive directors and members of senior management prior to determining its recommendations on annual remuneration, performance bonuses and share options for the Board’s determination. The Report of the Board to the Shareholders on Directors’ Remuneration is on pages 23 to 36. Relations with shareholders The Board encourages communication with the Company’s institutional and private investors. All shareholders have at least 20 working days’ notice of the Annual General Meeting at which the directors and committee chairmen are available for questions. The Annual General Meeting is held in London during business hours and provides an opportunity for directors to report to investors on the Group’s activities and to answer their questions. Shareholders have an opportunity to vote separately on each resolution and all proxy votes lodged are counted and the balance for and against each resolution is announced. The Chairman, Chief Executive and Finance Director have a full programme of meetings with institutional investors during the course of the year and investors comments are communicated to all members of the Board. The Chairman and the Chairman of the Remuneration Committee hold annual meetings with leading shareholders to discuss remuneration policies and other corporate governance matters and the comments received are reported to the Board and considered by the Remuneration Committee in determining or varying the Group’s approach to executive compensation. The Company’s web site at www.paragon-group.co.uk provides access to information on the Company and its businesses. Accountability and audit Detailed reviews of the performance of the Group’s main business lines are included within the Chairman’s Statement and Chief Executive’s Review. The Board uses these, together with the Directors’ Report on pages 14 to 17 to present a balanced and understandable assessment of the Company’s position and prospects. The directors’ responsibility for the fi nancial statements is described on page 37. 42 Corporate governance The Paragon Group of Companies PLC An on-going process for identifying, evaluating and managing the signifi cant risks faced by the Group, which is regularly reviewed by the Board, was in place for the year ended 30 September 2012 and to the date of these fi nancial statements. The directors confi rm that they have reviewed the effectiveness of the Group’s system of internal control for this period and that these procedures accord with the guidance ‘Internal Controls: Guidance for Directors on the Combined Code’. The directors are responsible for the system of internal control throughout the Group, including the system of internal control over fi nancial reporting, and for reviewing its effectiveness. Such a system is designed to manage rather than eliminate the risk of failure to achieve business objectives, and can provide reasonable, but not absolute, assurance against the risk of material misstatement or loss and that assets are safeguarded against unauthorised use or disposition. In assessing what constitutes reasonable assurance, the directors have regard to the relationship between the cost and benefi ts from particular aspects of the control system. The system of internal control includes documented procedures covering accounting, compliance, risk management, personnel matters and operations, clear reporting lines, delegation of authority through a formal structure of mandates, a formalised budgeting, management reporting and review process, the use of key performance indicators throughout the Group and regular meetings of the Asset and Liability and Credit Committees and senior management. Internal control over fi nancial reporting within the Group is provided by a process designed, under the supervision of the Finance Director and senior fi nancial management of the Group, to provide reasonable assurance regarding the reliability of fi nancial reporting and the preparation of fi nancial statements for external reporting purposes, including the process of preparing the Group’s consolidated fi nancial statements. Internal control over fi nancial reporting includes policies and procedures intended to ensure that records are maintained that fairly, and in reasonable detail, refl ect transactions and dispositions of assets, to provide reasonable assurance that transactions are recorded as necessary to permit the preparation of the fi nancial statements, to ensure that receipts and expenditures are only being made in accordance with management authorisation and to provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use or disposition of assets that could have a material effect on the fi nancial statements. Internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that internal controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may reduce. The Board receives regular reports setting out key performance and risk indicators. In addition, the Board operates a formal risk management process, from which the key risks facing the business are identifi ed. The process results in reports to the Board on how these risks are being managed. The Board has a programme of regular presentations from senior management to enable the Board to review the operation of internal controls in relation to the risks associated with their specifi c areas. The system of internal control is monitored by management and by an internal audit function that concentrates on the areas of greater risk and reports its conclusions regularly to management and the Audit and Compliance Committee. The internal audit work plan is approved annually by the Audit and Compliance Committee, which reviews the effectiveness of the system of internal control annually and reports its conclusions to the Board. Audit and Compliance Committee The Audit and Compliance Committee, comprising the independent non-executive directors of the Group, monitors the integrity of the Group’s fi nancial reporting, reviews the Group’s internal control and risk management systems, monitors and reviews the effectiveness of the Group’s internal audit function, monitors the relationship between the Group and the external auditors and provides a forum through which the Group’s external and internal audit functions report to the non-executive directors. The Committee is also responsible for ensuring that the system and controls for regulatory compliance are effective. The Committee reviews the scope and the results of the annual external audit, its cost effectiveness and the independence and objectivity of the external auditors. Before recommending the re-appointment of the external auditors, who have served since 1985, to the Board, the Committee engaged with the auditors to ensure that they are still providing the required quality of service and remained independent. The Committee considered the auditors’ understanding of the Group’s business, their access to appropriate fi nancial services and regulatory specialists within their fi rm, both locally and nationally, and their understanding of the sectors in which the Group operates, together with the performance of the audit, the auditors’ conduct of their relationship with the Group and the requirements of the Group’s fi nancial control process and have concluded that the needs of the Group would not be best served by putting the external audit out to tender at this time. The Committee has not identifi ed any factors which might restrict its choice of external auditor. Corporate governance 43 The Paragon Group of Companies PLC Both the Audit and Compliance Committee and the external auditors have in place safeguards to avoid any compromise of the independence and objectivity of the external auditors. The Committee considers the independence of the external auditors annually and the Group has a formal policy for the engagement of its external auditors to supply non-audit services. The policy is designed to ensure that neither the nature of the service to be provided nor the level of reliance placed on the services could impact the objectivity of the external auditors’ opinion on the Group’s fi nancial statements. The policy precludes the appointment of the external auditors to provide any service where there is involvement in management functions or decision making, or any service on which management may place primary reliance in determining the adequacy of internal controls, fi nancial systems or fi nancial reporting. The external auditors may provide corporate fi nance and similar services (provided there is no signifi cant advocacy role) or tax services but, if the advice given or the position taken would be material to the Group, the prior consent of the Committee would be required. Internal audit services may only be provided by the external auditor where acting under the instruction of Internal Audit management and with the prior consent of the Committee. Other services may be procured by management without the prior consent of the Committee, but are reported to the Committee on an ongoing basis. Fees paid to the external auditors are shown in note 16 to the Accounts. Other than services required to be provided by external auditors by legislation or regulation, non-audit services relate to taxation and to corporate fi nance activity. In respect of taxation services the Committee has considered the services provided and concluded that the understanding of the Group and the industry demonstrated by the advisers make them well placed to meet the Group’s needs. In respect of the corporate fi nance services, the external auditors fi rm was selected to provide these services as they were considered to offer the most appropriate skills and experience for the projects concerned in a cost-effective manner. Other potential providers were considered and the use of the external auditors fi rm was approved by the Committee after having received confi rmation from the auditors that they had taken specifi c steps to protect their independence in accordance with the Auditing Practices Board’s Revised Ethical Standards for Auditors. During the course of the year accounting fi rms other than the external auditors have been engaged for particular assignments. At each meeting the Audit and Compliance Committee receives reports of reviews conducted throughout the Group by the Internal Audit and, from time to time, compliance functions. The Chairman, the executive directors, Director of Financial Accounting and Group Company Secretary, Director of Legal Services, Head of Internal Audit and a partner and other representatives from the external auditors normally attend meetings of the Committee at the invitation of the Chairman of the Committee. Going concern basis The business activities of the Group, its current operations and those factors likely to affect its future results and development, together with a description of its fi nancial position and funding position, are described in the Chairman’s Statement on pages 4 to 6 and Chief Executive’s review on pages 7 to 11. The principal risks and uncertainties affecting the Group, and the steps taken to mitigate these risks are described on pages 45 to 46. Note 5 to the accounts includes an analysis of the Group’s working capital position and policies, while note 6 includes a detailed description of its funding structures, its use of fi nancial instruments, its fi nancial risk management objectives and policies and its exposure to credit, interest rate and liquidity risk. Critical accounting estimates affecting the results and fi nancial position disclosed in this annual report are discussed in note 4. As described under ‘Accountability and Audit’ above, the Group has a formalised process of budgeting, reporting and review, which provides information to the directors which is used to ensure the adequacy of resources available for the Group to meet its business objectives. The securitisation funding structures described in note 6 ensure that a substantial proportion of the Group’s originated loan portfolio is match- funded to maturity. Repayment of the securitisation borrowings is restricted to funds generated by the underlying assets and there is limited recourse to the Group’s general funds. Recent and current loan originations utilising the Group’s available warehouse facilities described in note 6 are refi nanced through securitisation from time to time. The Group’s only working capital debt is the £110.0 million corporate bond which does not mature until 2017. As a consequence the directors believe that the Group is well placed to manage its business risks successfully despite the current uncertain economic outlook. After making enquiries, the directors have a reasonable expectation that the Group will have adequate resources to continue in operational existence for the foreseeable future. For this reason, they continue to adopt the going concern basis in preparing the annual report and accounts. 44 Corporate governance The Paragon Group of Companies PLC Principal risks and uncertainties There are a number of potential risks and uncertainties which could have a material impact on the Group’s performance and could cause actual results to differ materially from expected and historical results. The Group’s system of risk management, which includes risk review and an active internal audit function, is monitored by the Audit and Compliance Committee as described in the ‘Corporate Governance’ section of this Annual Report on pages 40 to 44. The principal risks to which the Group is exposed include the following: Economic environment A further deterioration in the general economy may adversely affect all aspects of the Group’s business. Adverse economic conditions might increase the number of borrowers that default on their loans or adversely affect funding structures, which may in turn increase the Group’s costs and could result in losses on some of the Group’s assets, or restrict the ability of the Group to develop in the future. The general economic factors affecting the Group in the period going forward, together with the steps taken by the Group’s management to address these issues are described in more detail in the Chairman’s statement on pages 4 to 6 and the Chief Executive’s review on pages 7 to 11. Changes in interest rates may adversely affect the Group’s net income and profi tability. The steps taken by the Group to mitigate against the long term effects of interest rate movements, through the structuring of its products and the use of hedging procedures are described in note 6 to the accounts. Credit risk As a primary lender the Group faces credit risk as an inherent component of its lending and asset purchase activities. Adverse changes in the credit quality of the Group’s borrowers, a general deterioration in UK economic conditions or adverse changes arising from systematic risks in UK and global fi nancial systems could reduce the recoverability and value of the Group’s assets. The Group’s approach to the management of credit risk and the systems in place to mitigate that risk on both originated and purchased assets are described in the section of note 6 to the accounts entitled ‘Credit Risk’. Operational risk The activities of the Group subject it to operational risks relating to its ability to implement and maintain effective systems to process the high volume of transactions with customers. A signifi cant breakdown of the IT systems of the Group might adversely impact the ability of the Group to operate its business effectively. To address these risks, the Group’s internal audit function carries out targeted reviews of critical systems to ensure that they remain adequate for their purpose. The Group has a business continuity plan, which is kept under regular review and is designed to ensure that any breakdown in systems would not cause signifi cant disruption to the business. Principal risks and uncertainties 45 The Paragon Group of Companies PLC Competitor risk The Group faces strong competition in all of the core markets in which it operates. There is a danger that its profi tability and /or market share may be impaired. To mitigate this risk the Group maintains relationships with its customers, business introducers and other signifi cant participants in the markets in which it is active, as well as being active in industry-wide organisations and initiatives. This enables market trends to be identifi ed and addressed within the relevant business strategy. Governmental, legislative and regulatory risk The market sectors to which the Group supplies products, and the capital markets from which it obtains much of its funding, have been subject to intervention by United Kingdom Government, European Union and other regulatory bodies. Current regulatory developments are discussed in the section of the Chief Executive’s Review headed ‘Regulation’ on page 10. To the extent that such actions disadvantage the Group, when compared to other market participants, they present a risk to the Group. In order to mitigate this risk the Group has been active in explaining its position to the authorities in order that it is not inadvertently disadvantaged. Management The success of the Group is dependent on recruiting and retaining skilled senior management and personnel. The Group’s employment policies, which are designed to ensure that an appropriately skilled workforce is, and remains, in place are described within the Corporate Social Responsibility section of this Annual Report on pages 18 and 19. Working capital The Group’s capital position and its policies in respect of capital management are described in note 5 to the accounts. These policies and their application are described more fully in the section of the Chairman’s Statement headed ‘Capital Management’ on pages 4 and 5. Financial risk The Group’s exposure to other fi nancial risks, including liquidity risk and foreign currency risk, and the procedures in place to mitigate those risks are described in detail in note 6 to the accounts. 46 Principal risks and uncertainties From 3 December 2012 51 Homer Road Solihull West Midlands B91 3QJ Contacts Registered and head offi ce To 3 December 2012 St Catherine’s Court Herbert Road Solihull West Midlands B91 3QE Telephone: 0121 712 2323 London offi ce Tower 42 Level 12 25 Old Broad Street London EC2N 1HQ Telephone: 020 7786 8474 Internet www.paragon-group.co.uk Auditors Deloitte LLP Chartered Accountants Four Brindleyplace Birmingham B1 2HZ Solicitors Slaughter and May One Bunhill Row London EC1Y 8YY Registrars and transfer offi ce Computershare Investor Services PLC The Pavilions Bridgwater Road Bristol BS99 6ZZ Telephone: 0870 707 1244 UBS Limited 1 Finsbury Avenue London EC2M 2PP Brokers Jefferies Hoare Govett Limited Vintners Place 68 Upper Thames Street London EC4V 3BJ Remuneration consultants New Bridge Street 10 Devonshire Square London EC2M 4YP Consulting actuaries Mercer Limited Four Brindleyplace Birmingham B1 2JQ The Paragon Group of Companies PLC Contacts 47 The Paragon Group of Companies PLC 48 Annual Reports and Accounts 2012 The accounts The Paragon Group of Companies PLC The accounts 49 The Paragon Group of Companies PLC Consolidated income statement For the year ended 30 September 2012 Interest receivable Interest payable and similar charges Net interest income Other operating income Total operating income Operating expenses Provisions for losses Operating profi t before gains and fair value items Fair value net gains / (losses) Operating profi t being profi t on ordinary activities before taxation Tax charge on profi t on ordinary activities Profi t on ordinary activities after taxation for the fi nancial year Earnings per share - basic - diluted The results for the current and preceding years relate entirely to continuing operations. Note 9 10 11 12 17 18 19 2012 £m 293.8 (136.0) 157.8 12.4 170.2 (51.9) (24.1) 94.2 1.3 95.5 (23.3) 72.2 2011 £m 258.0 (122.2) 135.8 15.1 150.9 (45.4) (24.4) 81.1 (0.3) 80.8 (21.2) 59.6 Note 2012 2011 21 21 24.2p 23.5p 20.2p 19.6p 50 Consolidated income statement The Paragon Group of Companies PLC Consolidated statement of comprehensive income For the year ended 30 September 2012 Profi t for the year Other comprehensive income Actuarial (loss) on pension scheme Cash fl ow hedge (losses) / gains taken to equity Tax on items taken directly to equity Other comprehensive income for the year net of tax Total comprehensive income for the year Note £m 2012 £m 72.2 2011 £m £m 59.6 50 42 22 (0.5) (1.5) 0.2 (0.3) 0.4 (0.3) (1.8) 70.4 (0.2) 59.4 Consolidated statement of comprehensive income 51 The Paragon Group of Companies PLC Consolidated balance sheet 30 September 2012 Note 2012 £m 2011 £m 2010 £m Assets employed Non-current assets Intangible assets Property, plant and equipment Financial assets Deferred tax asset Current assets Other receivables Cash and cash equivalents Total assets Financed by Equity shareholders’ funds Called-up share capital Reserves Share capital and reserves Own shares Total equity Current liabilities Financial liabilities Current tax liabilities Other liabilities Non-current liabilities Financial liabilities Retirement benefi t obligations Deferred tax Other liabilities Total liabilities 23 25 28 51 36 37 38 39 46 47 52 53 47 50 51 53 9.1 10.7 9,505.2 - 9.3 11.4 9,891.2 - 9.2 12.2 10,080.1 1.5 9,525.0 9,911.9 10,103.0 7.3 504.8 512.1 4.7 571.6 576.3 5.9 536.7 542.6 10,037.1 10,488.2 10,645.6 301.8 550.2 852.0 (48.5) 803.5 2.0 13.3 36.7 52.0 9,159.0 13.9 7.6 1.1 299.7 490.7 790.4 (48.4) 742.0 1.8 10.7 38.3 50.8 299.4 445.8 745.2 (53.2) 692.0 1.2 16.2 32.4 49.8 9,674.5 9,885.7 14.4 5.0 1.5 16.5 - 1.6 9,903.8 9,953.6 9,181.6 9,695.4 9,233.6 9,746.2 10,037.1 10,488.2 10,645.6 Approved by the Board of Directors on 20 November 2012. Signed on behalf of the Board of Directors N S TERRINGTON Chief Executive N KEEN Finance Director 52 Consolidated balance sheet The Paragon Group of Companies PLC Company balance sheet 30 September 2012 Note 25 26 28 36 37 38 39 46 47 52 53 47 53 2012 £m 6.7 622.6 - 629.3 80.1 124.5 204.6 833.9 301.8 373.8 675.6 (39.5) 636.1 1.4 4.4 71.1 76.9 120.2 0.7 120.9 197.8 833.9 2011 £m 7.7 746.9 4.0 758.6 80.0 189.2 269.2 2010 £m 8.8 764.4 8.0 781.2 125.8 143.6 269.4 1,027.8 1,050.6 299.7 322.2 621.9 (39.5) 582.4 1.2 3.3 316.5 321.0 123.6 0.8 124.4 445.4 299.4 269.4 568.8 (39.5) 529.3 1.1 1.5 389.2 391.8 128.6 0.9 129.5 521.3 1,027.8 1,050.6 Assets employed Non-current assets Property, plant and equipment Investment in subsidiary undertakings Financial assets Current assets Other receivables Cash and cash equivalents Total assets Financed by Equity shareholders’ funds Called-up share capital Reserves Share capital and reserves Own shares Total equity Current liabilities Financial liabilities Current tax liabilities Other liabilities Non-current liabilities Financial liabilities Other liabilities Total liabilities Approved by the Board of Directors on 20 November 2012. Signed on behalf of the Board of Directors N S TERRINGTON Chief Executive N KEEN Finance Director Company balance sheet 53 The Paragon Group of Companies PLC Consolidated cash fl ow statement For the year ended 30 September 2012 Note 54 55 56 Net cash generated by operating activities Net cash (utilised) by investing activities Net cash (utilised) by fi nancing activities Net increase in cash and cash equivalents Opening cash and cash equivalents Closing cash and cash equivalents Represented by balances within: Cash and cash equivalents Financial liabilities Company cash fl ow statement For the year ended 30 September 2012 Note 54 55 56 Net cash (utilised by) / generated by operating activities Net cash generated by investing activities Net cash (utilised) by fi nancing activities Net increase in cash and cash equivalents Opening cash and cash equivalents Closing cash and cash equivalents Represented by balances within: Cash and cash equivalents Financial liabilities 2012 £m 117.3 (2.2) (181.9) (66.8) 571.0 504.2 504.8 (0.6) 504.2 2012 £m (60.9) 7.6 (11.4) (64.7) 189.2 124.5 124.5 - 124.5 2011 £m 246.1 (2.1) (209.6) 34.4 536.6 571.0 571.6 (0.6) 571.0 2011 £m 41.5 16.0 (11.9) 45.6 143.6 189.2 189.2 - 189.2 54 Consolidated cash fl ow statement / Company cash fl ow statement The Paragon Group of Companies PLC Statement of movements in equity For the year ended 30 September 2012 Note 44 45 13 22 Total comprehensive income for the year Dividends paid Net movement in own shares (Defi cit) / surplus on transactions in own shares Charge for share based remuneration Tax on share based remuneration Net movement in equity in the year Equity at 30 September 2011 Equity at 30 September 2012 The Group The Company 2012 £m 70.4 (12.3) (0.1) (0.2) 2.8 0.9 61.5 742.0 803.5 2011 £m 59.4 (11.1) 4.8 (5.2) 2.0 0.1 50.0 692.0 742.0 2012 £m 61.1 (12.3) - 2.1 2.8 - 53.7 582.4 636.1 2011 £m 61.9 (11.1) - 0.3 2.0 - 53.1 529.3 582.4 Statement of movements in equity 55 The Paragon Group of Companies PLC Notes to the accounts For the year ended 30 September 2012 1. GENERAL INFORMATION The Paragon Group of Companies PLC is a company domiciled in the United Kingdom and incorporated in England and Wales under the Companies Act 2006 with company number 2336032. The address of the registered offi ce is given on page 47. The nature of the Group’s operations and its principal activities are set out in the Directors’ Report on pages 14 to 17. These fi nancial statements are presented in pounds sterling, which is the currency of the economic environment in which the Group operates. 2. ADOPTION OF NEW AND REVISED REPORTING STANDARDS In the preparation of these fi nancial statements the following reporting standards are being applied for the fi rst time. • IAS 24 (Revised) – ‘Related Party Disclosures’; • Amendment to IFRS 7 – ‘Financial Instruments: Disclosures’; and • Amendment to IFRIC 14 – ‘Prepayments of a Minimum Funding Requirement’. The application of these standards has not required any amendments to disclosures previously reported, nor would the present fi nancial statements have differed had these standards not been applied. At the date of authorisation of these fi nancial statements the following International Financial Reporting Standards and Interpretations, which have not been applied in these fi nancial statements, were in issue but not yet effective: • IFRS 9 – ‘Financial Instruments’ • IFRS 10 – ‘Consolidated Financial Statements’ • IFRS 11 – ‘Joint Arrangements’ • IFRS 12 – ‘Disclosure of Interests in Other Entities’ • IFRS 13 – ‘Fair Value Measurement’ • IAS 27 (Revised) – ‘Separate Financial Statements’ • IAS 28 (Revised) – ‘Investments in Associates and Joint Ventures’ • Amendment to IAS 19 – ‘Employee benefi ts’ The adoption of IFRS 9, as currently in issue, would not be anticipated to have a material impact on the accounting of the Group although the International Accounting Standards Board (‘IASB’) has announced its intention to expand this Standard in such a way that would require changes to the valuation and income recognition methods relating to the Group’s loans to customers, borrowings and derivative assets and liabilities. This Standard is currently intended to come into force for the fi nancial year ending 30 September 2016, if the Standard is adopted by the European Union. The European Union has declined to consider the endorsement of IFRS 9 until a complete version is issued by the IASB. The Group has yet to conduct a full assessment of its potential impact, pending further information on endorsement from the European Union. 56 Notes to the accounts The Paragon Group of Companies PLC IFRS 10, 11 and 12 and the revised IAS 27 and 28 form the new IFRS regime for consolidation. The directors do not expect that the entities included within the consolidated accounts will differ under the new standards from those presently consolidated, nor that the consolidated results will be changed, although the disclosures provided under the new standards may differ. These standards, if adopted by the European Union, are expected to be applied for the fi rst time in the Group’s accounts for the year ending 30 September 2014. IFRS 13, which, if adopted by the European Union is expected to apply to the Group’s accounts from the year ending 30 September 2014 sets out new guidance on the establishment of fair value for accounting purposes and enhanced disclosures. It will apply to all amounts in the Group’s fi nancial statements presented at fair value, but is unlikely, in the view of the directors, to have a material impact on the Group’s results or fi nancial position. The revision to IAS 19, which is expected to apply to the Group’s accounts for the year ending 30 September 2014, will change the amounts presented in the income statement in respect of the Group’s pension plan, without affecting the surplus or defi cit shown in the balance sheet. If that Standard had been in force for the fi nancial year ended 30 September 2012 it is estimated that the effect would be to reduce profi t before tax by £0.4m (2011: £0.6m). Other Standards and interpretations in issue but not effective do not address matters relevant to the Group’s accounting and reporting. 3. ACCOUNTING POLICIES The fi nancial statements have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union. The particular policies applied are described below. (a) Accounting convention The fi nancial statements have been prepared under the historical cost convention, except as required in the valuation of certain fi nancial instruments which are carried at fair value. (b) Basis of consolidation The consolidated fi nancial statements deal with the accounts of the Company and its subsidiaries made up to 30 September 2012. Subsidiaries comprise all those entities over which the Group has control. The results of businesses acquired are dealt with in the consolidated accounts from the date of acquisition. In accordance with SIC 12 – ‘Consolidation: Special Purpose Entities’ companies owned by charitable trusts into which loans originated by Mortgage Trust Limited were sold as part of its securitisation programme, where the Group enjoys the benefi ts of ownership, are treated as subsidiaries. Similarly, trusts set up to hold shares in conjunction with the Group’s employee share ownership arrangements are also treated as subsidiaries. (c) Going concern The consolidated fi nancial statements have been prepared on the going concern basis. The directors’ reasons for the adoption of this basis are given in the Corporate Governance Statement on page 44. Notes to the accounts 57 The Paragon Group of Companies PLC (d) Goodwill Goodwill arising from the purchase of subsidiary undertakings, representing the excess of the fair value of the purchase consideration over the fair values of acquired assets, including intangible assets, is held on the balance sheet and reviewed annually to determine whether any impairment has occurred. Negative goodwill is written off as it arises. As permitted by IFRS 1, the Group has elected not to apply IFRS 3 – ‘Business Combinations’ to combinations taking place before its transition date to IFRS (1 October 2004). Therefore any goodwill which was written off to reserves under UK GAAP will not be charged or credited to the profi t and loss account on any future disposal of the business to which it relates. (e) Intangible assets Intangible assets comprise purchased computer software and other intangible assets acquired in business combinations. Purchased computer software is capitalised where it has a suffi ciently enduring nature and is stated at cost less accumulated amortisation. Amortisation is provided in equal instalments at a rate of 25% per annum. Other intangible assets acquired in business combinations include brands and business networks and are capitalised in accordance with the requirements of IFRS 3 – ‘Business Combinations’. Such assets are stated at attributed cost less accumulated amortisation. Amortisation is provided in equal instalments at a rate of 6.67% per annum. (f) Leases Leases are accounted for as operating or fi nance leases in accordance with IAS 17 – ‘Leases’. A fi nance lease is deemed to be one which transfers substantially all of the risks and rewards of the ownership of the asset concerned. Any other lease is an operating lease. Rental income and costs under operating leases are credited or charged to the profi t and loss account on a straight line basis over the period of the leases. (g) Contract hire Motor vehicles acquired in connection with contract hire arrangements are sold to fi nance houses, who lease them to customers for a pre-determined period. The Group has undertaken to repurchase these vehicles at the end of the lease term. In accordance with the requirements of IAS 17, the assets are not derecognised on the sale to the fi nance house and remain as the Group’s assets and the consideration received is spread over the customer’s lease term. 58 Notes to the accounts The Paragon Group of Companies PLC (h) Property, plant and equipment Property, plant and equipment is stated at cost less accumulated depreciation. Cost for property held under a sale and leaseback transaction represents the sale value. Depreciation is provided on cost in equal annual instalments over the lives of the assets. Land is not depreciated. The rates of depreciation are as follows: Freehold premises 2% per annum Short leasehold premises over the term of the lease Computer hardware 25% per annum Furniture, fi xtures and offi ce equipment 15% per annum Company motor vehicles 25% per annum Motor vehicles subject to contract hire arrangements over the term of the lease (i) Investments in subsidiaries The Company’s investments in subsidiary undertakings are valued at cost less provision for impairment. (j) Loans to customers Loans to customers are considered to be ‘loans and receivables’ as defi ned by IAS 39 – ‘Financial Instruments: Recognition and Measurement’. They are therefore accounted for on the amortised cost basis. Loans advanced are valued at inception at the initial advance amount, which is the fair value at that time, inclusive of procuration fees paid to brokers or other business providers and less initial fees paid by the customer. Loans acquired from third parties are initially valued at the purchase consideration paid or payable. Thereafter, all loans to customers are valued at this initial amount less the cumulative amortisation calculated using the Effective Interest Rate (‘EIR’) method. The loan balances are then reduced where necessary by a provision for balances which are considered to be impaired. The EIR method spreads the expected net income arising from a loan over its expected life. The EIR is that rate of interest which, at inception, exactly discounts the future cash payments and receipts arising from the loan to the initial carrying amount. The Group’s policy is to hedge against any exposure to fi xed rate loan assets. (k) Finance lease receivables Finance lease receivables are included within ‘Loans to Customers’ at the total amount receivable less interest not yet accrued, unamortised commissions and provision for doubtful debts. Income from fi nance lease contracts is accounted for on the actuarial basis. (l) Impairment of loans and receivables Loans and receivables are reviewed for indications of possible impairment throughout the year and at each balance sheet date, in accordance with IAS 39. Where loans exhibit objective evidence of impairment, the carrying value of the loans is reduced to the net present value of their expected future cash fl ows, including the value of the potential realisation of any security, discounted at the original EIR. Loans are assessed collectively, grouped by risk characteristics and account is taken of any impairment arising due to events which are believed to have taken place but have not been specifi cally identifi ed at the balance sheet date. Notes to the accounts 59 The Paragon Group of Companies PLC For fi nancial accounting purposes provisions for impairments of loans to customers are held in an allowance account. These balances are offset against the gross value of the loan when it is written off on the administration system. After this point a salvage balance may be held in respect of any further recoveries expected on the loan. (m) Investments in structured entities Investments in structured entities are intended to be held to maturity and are therefore accounted for on the amortised cost basis. The return from such investments is calculated on the EIR basis. (n) Amounts owed by or to group companies In the accounts of the Company balances owed by or to other group companies are carried at the current amount outstanding less any provision. Where balances owing between group companies fall within the defi nition of either fi nancial assets or fi nancial liabilities given in IAS 32 – ‘Financial Instruments: Presentation’ they are classifi ed as ‘Loans and Receivables’ or ‘Other fi nancial liabilities’, respectively. (o) Cash and cash equivalents Balances shown as cash and cash equivalents in the balance sheet comprise demand deposits and short-term deposits with banks with initial maturities of not more than 90 days. (p) Own shares Shares in The Paragon Group of Companies PLC held in treasury or by the trustees of the Group’s employee share ownership plans are shown on the balance sheet as a deduction in arriving at total equity. Own shares are stated at cost. (q) Taxation The charge for taxation is based on the profi t for the period and takes into account taxation deferred because of temporary differences. Temporary differences arise from the inclusion of items of income and expenditure in taxation computations in periods different from those in which they are included in fi nancial statements. Tax relating to items taken directly to equity is also taken directly to equity. (r) Borrowings Borrowings are carried in the balance sheet on the amortised cost basis. The initial value recognised includes the principal amount received less any discount on issue or costs of issuance. Interest and all other costs of the funding are expensed to the income statement as interest payable over the term of the borrowing on an Effective Interest Rate basis. Gains on the purchase of the Group’s Floating Rate Notes or corporate bonds are recognised as income at the time of the transaction. (s) Finance lease payables Balances due on the lease arising from the sale and leaseback of a Group property are recognised in creditors at the total amount payable less interest not yet accrued. Interest is accrued on the actuarial basis. The profi t which arose on the sale and leaseback transaction is held within deferred income and is being credited to profi t over the lease term on a straight line basis. 60 Notes to the accounts The Paragon Group of Companies PLC (t) Derivative fi nancial instruments Derivative instruments utilised by the Group comprise currency swap, interest rate swap and interest rate option agreements. All such instruments are used for hedging purposes to alter the risk profi le of the existing underlying exposure of the Group in line with the Group’s risk management policies. The Group does not enter into speculative derivative contracts. All derivatives are carried in the balance sheet at fair value, as assets where the value is positive or as liabilities where the value is negative. Fair value is based on market prices, where a market exists. If there is no active market, fair value is calculated using present value models which incorporate assumptions based on market conditions and are consistent with accepted economic methodologies for pricing fi nancial instruments. Changes in the fair value of derivatives are recognised in the income statement, except where such amounts are permitted to be taken to equity as part of the accounting for a cash fl ow hedge. (u) Hedging For all hedges, the Group documents, at inception, the relationship between the hedging instruments and the hedged items, as well as its risk management strategy and objectives for undertaking the transaction. The Group also documents its assessment, both at hedge inception and on an ongoing basis, of whether the hedging arrangements put in place are considered to be ‘highly effective’ as defi ned by IAS 39. For a fair value hedge, as long as the hedging relationship is deemed ‘highly effective’ and meets the hedging requirements of IAS 39, any gain or loss on the hedging instrument recognised in income can be offset against the fair value loss or gain arising from the hedged item for the hedged risk. For macro hedges (hedges of interest rate risk for a portfolio of loan assets) this fair value adjustment is disclosed in the balance sheet alongside the hedged item, for other hedges the adjustment is made to the carrying value of the hedged asset or liability. Only the net ineffectiveness of the hedge is charged or credited to income. Where a fair value hedge relationship is terminated, or deemed ineffective, the fair value adjustment is amortised over the remaining term of the underlying item. Where a derivative is used to hedge the variability of cash fl ows of an asset or liability, it may be designated as a cash fl ow hedge so long as this relationship meets the hedging requirements of IAS 39. For such an instrument the effective portion of the change in the fair value of the derivative is taken initially to equity, with the ineffective part taken to profi t or loss. The amount taken to equity is released to the income statement at the same time as the hedged item affects the income statement. Where a cash fl ow hedge relationship is terminated, or deemed ineffective, the amount taken to equity will remain there until the hedged transaction is recognised, or is no longer highly probable. (v) Deferred taxation Deferred taxation is provided in full on temporary differences that result in an obligation at the balance sheet date to pay more tax, or a right to pay less tax, at a future date, at rates expected to apply when they crystallise based on current tax rates and law. Deferred tax assets are recognised to the extent that it is regarded as probable that they will be recovered. As required by IAS 12 – ‘Income Taxes’, deferred tax assets and liabilities are not discounted to take account of the expected timing of realisation. (w) Retirement benefi t obligations The expected cost of providing pensions within the funded defi ned benefi t scheme, determined on the basis of annual valuations by professionally qualifi ed actuaries using the projected unit method, is charged to the income statement. Actuarial gains and losses are recognised in full in the period in which they occur and do not form part of the result for the period, being recognised in the Statement of Comprehensive Income. The retirement benefi t obligation recognised in the balance sheet represents the present value of the defi ned benefi t obligation, as adjusted for unrecognised past service cost, and as reduced by the fair value of scheme assets at the balance sheet date. Both the return on investment expected in the period and the expected fi nancing cost of the liability, as estimated at the beginning of the period are recognised in the result for the period. Any variances against these estimates in the year form part of the actuarial gain or loss. The assets of the scheme are held separately from those of the Group in an independently administered fund. The charge to the income statement for providing pensions under defi ned contribution pension schemes is equal to the contributions payable to such schemes for the year. Notes to the accounts 61 The Paragon Group of Companies PLC (x) Provisions Provisions are recognised where there is a present obligation as a result of a past event, it is probable that this obligation will result in an outfl ow of resources and this outfl ow can be reliably quantifi ed. Provisions are discounted where this effect is material. (y) Revenue The revenue of the Group comprises interest receivable and similar charges and other income. The accounting policy for the recognition of each element of revenue is described separately within these accounting policies. (z) Fee and commission income Other income includes administration fees charged to borrowers, which are credited when the related service is performed, fees charged to third parties for account administration services, which are credited as those services are performed, and commissions receivable on the sale of insurances, which are taken to profi t at the point at which the Group becomes unconditionally entitled to the income. (aa) Share based payments In accordance with IFRS 2 – ‘Share based payments’, the fair value at the date of grant of awards to be made in respect of options and shares granted under the terms of the Group’s various share based employee incentive arrangements is charged to the profi t and loss account over the period between the date of grant and the vesting date. As permitted by IFRS 1, only those options and awards granted after 7 November 2002 and not vested at 1 January 2005 have been restated on transition to IFRS. National Insurance on share based payments is accrued over the vesting period, based on the share price at the balance sheet date. Where the allowable cost of share based awards for tax purposes is greater than the cost determined in accordance with IFRS 2, the tax effect of the excess is taken to reserves. (bb) Dividends In accordance with IAS 10 – ‘Events after the balance sheet date’, dividends payable on ordinary shares are recognised in equity once they are appropriately authorised and are no longer at the discretion of the Company. Dividends declared after the balance sheet date, but before the authorisation of the fi nancial statements remain within shareholders’ funds. (cc) Foreign currency Foreign currency transactions, assets and liabilities are accounted for in accordance with IAS 21 – ‘The Effects of Changes in Foreign Exchange Rates’. The functional currency of the Group is the pound sterling. Transactions which are not denominated in sterling are translated into sterling at the spot rate of exchange on the date of transaction. Monetary assets and liabilities which are not denominated in sterling are translated at the closing rate on the balance sheet date. Gains and losses on retranslation are included in interest payable or interest receivable depending on whether the underlying instrument is an asset or a liability, except where deferred in equity in accordance with the cash fl ow hedging provisions of IAS 39. (dd) Segmental reporting The accounting policies of the operating segments are the same as those described above for the Group as a whole. Costs attributed to each segment represent the direct costs incurred by the segment operations and an allocation of the costs of areas of the business which serve all segments. Such allocations are weighted by the value of loan assets in each segment, adjusted for the relative effort involved in the administration of each asset class. 62 Notes to the accounts The Paragon Group of Companies PLC 4. CRITICAL ACCOUNTING ESTIMATES Certain of the balances reported in the fi nancial statements are based wholly or in part on estimates or assumptions made by the directors. There is, therefore, a potential risk that they may be subject to change in future periods. The most signifi cant of these are: (a) Impairment losses on loans to customers Impairment losses on loans are calculated based on statistical models. The key assumptions revolve around estimates of future cash fl ows from customers’ accounts, their timing and, for secured accounts, the expected proceeds from the realisation of the property. These key assumptions are based on observed data from historical patterns and are updated regularly based on new data as it becomes available. In addition the directors consider how appropriate past trends and patterns might be in the current economic situation and make any adjustments they believe are necessary to refl ect the current conditions. The accuracy of the impairment calculations would therefore be affected by unexpected changes to the economic situation, variances between the models used and the actual results, or assumptions which differ from the actual outcomes. In particular, if the impact of economic factors such as employment levels on customers is worse than is implicit in the model then the number of accounts requiring provision might be greater than suggested by the model, while falls in house prices, over and above any assumed by the model might increase the provision required in respect of accounts currently provided. (b) Effective interest rates In order to determine the effective interest rate applicable to loans an estimate must be made of the expected life of each loan and hence the cash fl ows relating thereto. For purchased accounts this will involve estimating the likely future performance of the accounts at the time of acquisition. These estimates are based on historical data and reviewed regularly. For purchased accounts historical data obtained from the vendor will be examined. The accuracy of the effective interest rate applied would therefore be compromised by any differences between actual borrower behaviour and that predicted. (c) Fair values Where fi nancial assets and liabilities are carried at fair value, in the majority of cases this can be derived by reference to quoted market prices. Where such a quoted price is not available the valuation is based on cash fl ow models based, where possible, on independently sourced parameters. The accuracy of the calculation would therefore be affected by unexpected market movements or other variances in the operation of the models or the assumptions used. (d) Retirement benefi ts The present value of the retirement benefi t obligation is derived from an actuarial calculation which rests on a number of assumptions. These are listed in note 50. Where actual conditions differ from those assumed the ultimate value of the obligation would be different. (e) Goodwill and intangible assets arising on acquisition The value of goodwill and intangible assets recognised on the Group’s acquisition of TBMC was derived from the projected cash fl ows for that business at the time of acquisition, based on management forecasts. The accuracy of this valuation would therefore be compromised by any differences between these forecasts and the levels of business activity that the entity might actually have been able to generate in the absence of the acquisition. This valuation will also be affected by the accuracy of the discount factor used. The carrying value of the goodwill and intangible assets is dependent on the accuracy of the inputs into the impairment test described in note 24. Notes to the accounts 63 The Paragon Group of Companies PLC 5. CAPITAL MANAGEMENT The Group’s objectives in managing capital are: • To ensure that the Group has suffi cient capital to meet its operational requirements and strategic objectives; • To safeguard the Group’s ability to continue as a going concern, so that it can continue to provide returns to shareholders and benefi ts for other stakeholders; and • To provide an adequate return to shareholders by pricing products and services commensurately with the level of risk. The Group sets the amount of capital in proportion to risk, availability and cost. The Group manages the capital structure and makes adjustments to it in the light of changes in economic conditions and the risk characteristics of the underlying assets, having particular regard to the relative costs and availability of debt and equity fi nance at any given time. In order to maintain or adjust the capital structure the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares, issue or redeem other capital instruments, such as corporate bonds, or sell assets to reduce debt. The Group is not subject to any externally imposed capital requirements. Since its rights issue in 2008 the Group has pursued a progressive dividend policy with the dividend being increased from 3.0p in respect of that year to 4.0p in respect of the year ended 30 September 2011. As a result of the progress of the business since that date the directors have now adopted a new policy under which the dividends will increase so that, by the year ending 30 September 2016, the level of dividend cover will be maintained in the range 3.0 to 3.5 times. The level of dividend cover in respect of the year, subject to the approval of the fi nal dividend at the Annual General Meeting is shown below. Profi t after tax for the year (£m) Proposed dividend in respect of the year (£m) Dividend cover (times) Note 44 2012 72.2 17.8 4.1 2011 59.6 11.9 5.0 Return on equity is defi ned by the Group by comparing the profi t after tax for the year to the average of the opening and closing equity positions and is derived as follows: 2012 £m 72.2 742.0 803.5 772.7 9.3% 2011 £m 59.6 692.0 742.0 717.0 8.3% Profi t for the year Divided by Opening equity Closing equity Average equity Return on equity 64 Notes to the accounts The Paragon Group of Companies PLC The Board of Directors regularly review the proportion of working capital represented by debt and equity. Net debt is calculated as total debt, other than securitised and warehouse debt, valued at principal value, less free cash up to a maximum of the total debt. Adjusted equity comprises all components of equity (i.e. share capital, share premium, minority interest, retained earnings, and revaluation surplus) other than amounts recognised in equity relating to cash fl ow hedges. The debt and equity amounts at 30 September 2012 and at 30 September 2011 were as follows: Debt Corporate bond Bank overdraft Less: Applicable free cash Net debt Equity Total equity Less: cash fl ow hedging reserve Adjusted equity Total working capital Debt Equity Total working capital 2012 £m 110.0 0.6 (110.6) - 803.5 (0.7) 802.8 802.8 - 100.0% 2011 £m 110.0 0.6 (110.6) - 742.0 (1.8) 740.2 740.2 - 100.0% 100.0% 100.0% In addition the Group held £17.1m of free cash in excess of that shown above (2011: £84.4m). The stable proportion of working capital represented by equity during 2012 resulted primarily from the operation of the policy described above. 6. FINANCIAL RISK MANAGEMENT The principal fi nancial risks arising from the Group’s normal business activities are credit risk, liquidity risk, interest rate risk and currency risk. The Board operates through the Credit Committee and the Asset and Liability Committee to review and agree policies for managing each of these risks, as described in the Corporate Governance Statement on pages 40 to 44, and they are summarised below. These policies have remained unchanged throughout the year and since the year end. The position disclosed below is materially similar to that existing throughout the year. Use of derivative fi nancial instruments The Group uses derivative fi nancial instruments for risk management purposes. Such instruments are used only to limit the exposure of the Group to movements in market interest or exchange rates. It is, and has been throughout the year under review, the Group’s policy that no trading in fi nancial instruments shall be undertaken, and hence all of the Group’s derivative fi nancial instruments are for commercial hedging purposes only. These are used to protect the Group from exposures principally arising from fi xed rate lending or borrowing and borrowings denominated in foreign currencies. Hedge accounting is applied where appropriate, though it should be noted that some derivatives, while forming part of an economic hedge relationship, do not qualify for this accounting treatment under the IAS 39 rules, while in other cases hedge accounting has not been adopted either because natural accounting offsets are expected or because complying with the IAS 39 hedge accounting rules would be especially onerous. Notes to the accounts 65 The Paragon Group of Companies PLC The Group has designated a number of derivatives as fair value hedges for accounting purposes. In particular this treatment is used for: (a) hedging the interest rate risk of groups of fi xed rate pre-payable loan assets with interest rate derivatives on a portfolio basis. The Group believes this solution is the most appropriate as it is consistent with the economic hedging approach taken by the Group to these assets. (b) hedging the interest rate risk of fi xed rate corporate bond borrowings with a designated fi xed to fl oating interest rate swap, which was taken out for this specifi c purpose. The Group has also designated cash fl ow hedging relationships, principally arising from currency borrowings, where a specifi ed foreign exchange basis swap, set up as part of the terms of the borrowing is used. The only derivative fi nancial instrument held by the Company at 30 September 2011 was the swap related to the fi xed rate corporate bond borrowing described above. This reached its term in the year and the Company now has no derivative assets or liabilities. Credit risk The Group’s business objectives rely on maintaining a high-quality customer base and place strong emphasis on good credit management, both at the time of acquiring or underwriting a new loan, where strict lending criteria are applied, and in the collections process. Primary responsibility for credit risk management across the Group lies with the Credit Committee. The Credit Committee is made up of four senior members of staff, headed by the Finance Director. Its key responsibilities include setting and reviewing credit policy, controlling applicant quality, tracking account performance against targets, agreeing product criteria and lending guidelines and monitoring performance and trends. The assets of the Group and the Company which are subject to credit risk are set out below: The Group The Company Loans to customers Investments in securities Derivative fi nancial assets Amounts owed by Group companies Accrued interest Cash Note 31 34 35 36 36 37 2012 £m 8,694.6 9.1 800.4 - 0.2 504.8 2011 £m 8,724.2 11.8 1,151.8 - 0.5 571.6 Maximum exposure to credit risk 10,009.1 10,459.9 The Group’s credit risk is primarily attributable to its loans to customers. 2012 £m - - - 80.1 - 124.5 204.6 2011 £m - - 4.0 79.9 0.1 189.2 273.2 While this maximum exposure represents the potential loss which might have to be accounted for by the Group, the terms on which the Group’s loan assets are funded, described under Liquidity Risk below, limit the amount of principal repayments on the Group’s securitised and warehouse borrowings in cases of capital losses on assets, signifi cantly reducing the effective shareholder value at risk. 66 Notes to the accounts The Paragon Group of Companies PLC The Group’s loan assets at 30 September 2012 are analysed as follows: Buy-to-let mortgages Owner occupied mortgages Total fi rst mortgages Secured loans Loans secured on property Car loans Retail fi nance loans Other loans Total loans to customers 2012 £m 8,196.4 99.2 8,295.6 279.9 8,575.5 2.5 2.0 114.6 8,694.6 2012 % 94.3% 1.1% 95.4% 3.2% 98.6% 0.1% - 1.3% 2011 £m 8,231.7 128.7 8,360.4 340.1 8,700.5 7.5 2.9 13.3 2011 % 94.3% 1.5% 95.8% 3.9% 99.7% 0.1% - 0.2% 100.0% 8,724.2 100.0% Other loans include unsecured loans either advanced by Group companies or acquired from their originators at a discount. There are no signifi cant concentrations of credit risk due to the large number of customers included in the portfolios. The Group’s underwriting philosophy is based on a combination of sophisticated individual credit assessment and the automated effi ciencies of a scored decision making process. Information on each applicant is combined with data taken from a credit reference bureau to provide a complete credit picture of the applicant and the borrowing requested. Key information is validated through a combination of documentation and statistical data which collectively provides evidence of the applicant’s ability and willingness to pay the amount contracted under the loan agreement. First mortgages and secured loans are secured by charges over residential properties in England and Wales, or similar Scottish or Northern Irish securities. Car loans are effectively secured by the fi nanced vehicle. Despite this security, in assessing credit risk, an applicant’s ability and propensity to repay the loan remain the principal factors in the decision to lend. In considering whether to acquire pools of loan assets or invest in loan portfolios, the Group will undertake a due diligence exercise on the underlying loan accounts. Such assets are generally not fully performing and are offered at a discount to their current balance. The Group’s procedures may include inspection of original loan documents, verifi cation of security and the examination of the credit status of borrowers. Current and historic cash fl ow data will also be examined. The objective of the exercise is to establish, to a level of confi dence similar to that provided by the underwriting process, that the assets will generate suffi cient cash fl ows to recover the Group’s investment and generate an appropriate return. Investments in structured entities represent the Group’s contribution made to special purpose vehicle (‘SPV’) companies established and controlled by third parties to purchase pools of loan assets. All such investments are denominated in sterling and the underlying loans are made to United Kingdom borrowers. Cash generated by the assets is distributed to investors in accordance with a specifi ed priority of payments. The Group has no obligation to make further contributions to the SPV companies concerned. The management has considered the position of the underlying assets and concluded that they will generate suffi cient cash fl ows to repay the amount of the investment. In order to control credit risk relating to counterparties to the Group’s derivative fi nancial instruments and cash deposits, the Asset and Liability Committee determines which counterparties the Group will deal with, establishes limits for each counterparty and monitors compliance with those limits. Such counterparties are typically highly rated banks and, for all cash deposits and derivative positions held within the Group’s securitisation structures, must comply with criteria set out in the fi nancing arrangements. Where a derivative counterparty fails to meet the required criteria they are obliged under the terms of the instruments to set aside a cash collateral deposit. The amounts of these cash collateral deposits, which do not form part of the Group’s cash position, are given in note 35. Notes to the accounts 67 The Paragon Group of Companies PLC The Group’s cash balances are held in sterling at London banks in current accounts and as short fi xed term deposits. Credit risk on these balances, and the interest accrued thereon, is considered to be immaterial. An analysis of the indexed loan to value ratio (‘LTV’) for those loan accounts secured on property by value at 30 September 2012 is set out below. For acquired accounts the effect of any discount on purchase is allowed for. Loan to value ratio Less than 70% 70% to 80% 80% to 90% 90% to 100% Over 100% Average loan to value ratio 2012 First mortgages % 2012 Secured loans % 23.7 22.1 26.4 21.7 6.1 100.0 81.1 26.2 14.4 14.0 14.2 31.2 100.0 90.9 2011 2011 First mortgages Secured loans % 23.2 21.6 29.7 21.0 4.5 100.0 80.2 % 28.2 14.8 15.0 13.9 28.1 100.0 88.4 The regionally indexed LTVs shown above are affected by changes in house prices, with the Nationwide house price index, for the UK as a whole, registering an annual reduction of 1.6% in the year ended 30 September 2012. The number of accounts in arrears by asset class, based on the most commonly quoted defi nition of arrears for the type of asset, at 30 September 2012 and 30 September 2011, compared to the industry averages at those dates published by the Council of Mortgage Lenders (‘CML’) and the Finance and Leasing Association (‘FLA’), was: First mortgages Accounts more than three months in arrears Buy-to-Let accounts including receiver of rent cases Buy-to-Let accounts excluding receiver of rent cases Owner Occupied accounts CML data for mortgage accounts more than three months in arrears Buy-to-Let accounts including receiver of rent cases Buy-to-Let accounts excluding receiver of rent cases Owner-Occupied accounts All mortgages Secured loans Accounts more than 2 months in arrears FLA data for secured loans Car loans Accounts more than 2 months in arrears FLA data for all personal loans Other loans Accounts more than 2 months in arrears 2012 % 0.48 0.06 4.38 1.51 1.22 2.03 1.93 19.42 18.00 18.45 7.20 2011 % 0.63 0.10 4.24 1.90 1.44 2.15 2.06 18.48 18.40 8.11 9.30 62.92 75.09 No published industry data for asset classes comparable to the Group’s other books has been identifi ed. Where revised data at 30 September 2011 has been published by the FLA or CML, the comparative industry fi gures above have been amended. 68 Notes to the accounts The Paragon Group of Companies PLC The number of accounts in arrears will be higher for closed books such as the owner-occupied mortgage book and the car fi nance, retail fi nance and unsecured loan books than for comparable active ones, as performing accounts pay off their balances, leaving arrears accounts representing a greater proportion of the total. The fi gures shown above for secured loans and other loans include purchased portfolios which generally include a high proportion of cases in arrears at the time of purchase and where this level of performance is allowed for in the discount to current balance represented by the purchase price. The payment status of the carrying balances of the Group’s loan assets, before provision for impairment, at 30 September 2012 and at 30 September 2011 split between those accounts considered as performing and those included in the population for impairment testing, is shown below. First Mortgages Not past due Arrears less than 3 months Performing accounts Arrears 3 to 6 months Arrears 6 to 12 months Arrears over 12 months Possessions and similar cases Impairment population 2012 £m 7,949.4 270.3 8,219.7 6.5 9.2 36.0 49.8 2011 £m 7,941.5 325.7 8,267.2 11.5 17.2 43.6 43.4 101.5 115.7 8,321.2 8,382.9 Notes to the accounts 69 The Paragon Group of Companies PLC Consumer Finance 30 September 2012 Not past due Arrears less than 2 months Performing accounts Arrears 2 to 6 months Arrears 6 to 9 months Arrears 9 to 12 months Arrears over 12 months Impairment population 30 September 2011 Not past due Arrears less than 2 months Performing accounts Arrears 2 to 6 months Arrears 6 to 9 months Arrears 9 to 12 months Arrears over 12 months Impairment population Other loans Not past due Arrears less than 1 month Performing accounts Arrears 1 to 3 months Arrears 3 to 6 months Arrears 6 to 12 months Arrears over 12 months Impairment population 70 Notes to the accounts Secured loans Car loans Retail fi nance £m 208.4 30.2 238.6 19.5 8.2 5.9 23.7 57.3 295.9 252.7 33.6 286.3 25.6 8.7 6.3 20.9 61.5 347.8 £m 1.5 0.4 1.9 0.1 0.1 - 0.6 0.8 2.7 5.6 0.8 6.4 0.2 0.1 - 0.7 1.0 7.4 loans £m 0.3 - 0.3 - 0.1 0.1 2.2 2.4 2.7 0.9 - 0.9 0.1 0.1 0.1 2.7 3.0 3.9 2012 £m 32.1 1.8 33.9 1.4 1.6 2.1 87.5 92.6 126.5 Total £m 210.2 30.6 240.8 19.6 8.4 6.0 26.5 60.5 301.3 259.2 34.4 293.6 25.9 8.9 6.4 24.3 65.5 359.1 2011 £m 3.3 0.1 3.4 0.1 0.3 1.0 41.9 43.3 46.7 The Paragon Group of Companies PLC Liquidity risk The Group uses securitisation to mitigate its exposure to liquidity risk, ensuring, as far as possible, that the maturities of assets and liabilities are matched. The Group’s originated loan assets are principally fi nanced by asset backed loan notes (‘Notes’) issued through the securitisation process. In a securitisation deal an SPV company within the Group will issue Notes secured on a pool of mortgage or other loan assets owned by the SPV. The Notes have a maturity date later than the fi nal repayment date for any asset in the pool, typically over 30 years from the issue date. The noteholders are entitled to receive repayment of the Note principal out of principal funds generated by the loan assets from time to time, but their right to the repayment of principal is limited to the cash available in the SPV. Similarly, payment of accrued interest to the noteholders is limited to cash generated within the SPV. There is no requirement for any Group company other than the issuing SPV to make principal or interest payments in respect of the Notes. This matching of the maturities of the assets and the related funding substantially reduces the Group’s exposure to liquidity risk. Details of Notes in issue are given in note 48 and the assets backing the Notes are shown in notes 29 and 30. In the Group’s consumer fi nance SPVs, principal cash was not required to be repaid to noteholders during an initial period, but instead could be used to acquire new loans from the Group, subject to underwriting conditions being met. Following the completion of this initial period, principal cash is repaid in the same way as for other SPVs. The Group also provides funding to the SPV at inception, subordinated to the Notes, which means that credit risk on the pool assets is retained within the Group. The Group receives the residual income generated by the assets. These factors mean that the risks and rewards of ownership of the assets remain with the Group, and hence the loans remain on the Group’s balance sheet. Cash received in each SPV is held until the next interest payment date, after which the remaining balances become available to the Group. Cash balances are also held within each SPV to provide credit enhancement for the particular securitisation, allowing principal payments to be made even if loans default. In order to provide further credit enhancement in certain of the SPVs there exist specifi c economic trigger events which cause additional cash to be retained in the SPV, rather than being transferred to the Group. While the Group can, if it chooses, contribute additional cash to cover these requirements, it is under no obligation to do so. No such trigger event has occurred to date in any of the Group’s SPVs and whether one arises in the future will depend on the performance of the general economy and its impact on mortgage and loan arrears. However if such trigger events occurred in all of the SPVs, a total of £67.9m of additional cash would be retained in those companies (2011: £66.0m). The cash balances of the SPV companies are included within the restricted cash balances disclosed in note 37. Newly originated mortgage loans are initially funded by a revolving loan facility or ‘warehouse’ from the point of their origination until their inclusion in a securitisation deal. A warehouse functions in a similar way to an SPV, except that funds are drawn down as advances are made and repaid when loans are securitised. On 29 February 2008 the warehouse facility provided to Paragon Second Funding Limited ceased to be available for new drawings, although assets held within it at that time continued to be funded. Repayment of the principal on these assets is not required unless amounts are realised from them. The fi nal repayment date of the facility is later than the fi nal due date of the assets it is used to fund. On 27 September 2010 Macquarie Bank and Paragon Fourth Funding Limited signed a new warehouse facility agreement, which was renewed on substantially the same terms following the end of the fi nancial year. This warehouse is available for drawing and redrawing until 13 December 2014 and is used to fund new fi rst charge mortgage loans. After that date the loan has a further two year period for the assets funded to be sold or refi nanced. Repayment of the principal drawn in respect of assets is not required unless amounts are realised from them either through repayment, securitisation or asset sales, even after the two year period. There is no further recourse to other assets of the Group in respect of either interest or principal on the borrowing. On 27 September 2012 the wholesale division of Lloyds Bank and Paragon Fifth Funding Limited signed an additional warehouse facility agreement, which was undrawn at 30 September 2012 but which will operate in parallel with the existing Paragon Fourth Funding facility. The term of the facility is three years and it will be available to fund new loans in its fi rst 18 months, or up to 24 months if a securitisation of funded assets is achieved in the fi rst year. As with the Paragon Fourth Funding facility repayment of the principal drawn in respect of assets is not required unless amounts are realised from them either through repayment, securitisation or asset sales, even after the initial period. There is no further recourse to other assets of the Group in respect of either interest or principal on the borrowing As with the SPVs, the Group provides subordinated funding to the warehouse companies and restricted cash balances are held within them. Further details of the warehouse facilities are given in note 48 and details of the loan assets within the warehouses are given in note 29. Notes to the accounts 71 The Paragon Group of Companies PLC Between 29 February 2008 and 4 October 2010 the only advances made by the Group were consumer loans and further advances on existing mortgage accounts, which were funded from existing drawings in the SPV companies. The provision of new consumer loans ceased on 9 April 2009, except for further advances on existing accounts, when the period over which new loans could be sold to the consumer fi nance SPVs ended. New fi rst mortgage lending commenced on 5 October 2010. The securitisation process and the terms of the warehouse facilities effectively limit liquidity risk from the funding of the Group’s loan assets. It remains to ensure that suffi cient funding is available to fund the Group’s participation in the SPVs, provide capital support for new loans and working capital for the Group. This responsibility rests with the Asset and Liability Committee which sets the Group’s liquidity policy and uses detailed cash fl ow projections to ensure that an adequate level of liquidity is available at all times. The fi nal repayment date for all of the securitisation borrowings and the old warehouse borrowing is more than fi ve years from the balance sheet date, the earliest falling due in 2033 and the latest in 2050. The equivalent sterling principal amount outstanding at 30 September 2012 under the SPV and warehouse arrangements, allowing for the effect of the cross currency basis swaps, described under currency risk below, which are net settled with the loan payments, was £8,240.6m (2011: £8,404.4m). The total sterling amount payable under these arrangements, were these principal amounts to remain outstanding until the fi nal repayment date would be £16,429.1m (2011: £17,947.4m). As the principal will, as discussed above, reduce as customers repay or redeem their accounts, the cash fl ow will in practice be far less than this amount. The Group’s investments in purchased loan portfolios and structured entities are funded from its free cash balances and these investments carry no obligation to make further payments. They therefore pose no liquidity risk to the Group. The total undiscounted amounts, inclusive of estimated interest, which would be payable in respect of the Group’s other borrowings, should those balances remain outstanding until the contracted repayment date, together with amounts payable in respect of the ‘other accruals’ shown in note 53 are shown below. 30 September 2012 Payable in less than one year Payable in one to two years Payable in two to fi ve years Payable in over fi ve years 30 September 2011 Payable in less than one year Payable in one to two years Payable in two to fi ve years Payable in over fi ve years Corporate bond Other accruals £m £m 4.1 4.1 122.3 - 130.5 7.7 7.8 23.1 117.7 156.3 11.8 - - - 11.8 11.7 0.1 - - 11.8 Total £m 15.9 4.1 122.3 - 142.3 19.4 7.9 23.1 117.7 168.1 The cash fl ows described above will include those for interest on borrowings accrued at 30 September 2012 disclosed in note 53. 72 Notes to the accounts The cash fl ows which are expected to arise from derivative contracts in place at the year end, estimating future fl oating rate payments and receipts on the basis of the yield curve at the balance sheet date are as follows: The Paragon Group of Companies PLC On derivative liabilities Payable in less than one year Payable in one to two years Payable in two to fi ve years Payable in over fi ve years On derivative assets Payable in less than one year Payable in one to two years Payable in two to fi ve years Payable in over fi ve years Interest rate risk 2012 Total cash outfl ow / (infl ow) £m 1.6 0.4 0.8 2.8 5.6 (0.4) (0.3) (0.8) (2.7) (4.2) 1.4 2011 Total cash outfl ow / (infl ow) £m 2.5 2.3 1.6 5.9 12.3 (5.0) (4.6) (11.5) (8.2) (29.3) (17.0) The Group manages interest rate risk, the risk that margins will be adversely affected by movements in market interest rates, by maintaining fl oating rate liabilities and matching these with fl oating rate assets, hedging fi xed rate assets and liabilities by the use of interest rate swap or cap agreements. The rates of interest payable on the loan facilities and on asset backed loan notes issued in the securitisation process are reset quarterly on the basis of LIBOR. Where asset backed loan notes are issued in foreign currencies, cross-currency basis swaps are put in place converting the reference interest rate to a sterling LIBOR basis. The Group’s loan assets predominantly bear LIBOR-linked interest rates or are hedged fi xed rate assets. The interest rates charged on the Group’s variable rate loan assets are determined by reference to, inter alia, the Group’s funding costs and the rates being charged on similar products in the market. Generally this ensures the matching of changes in interest rates on the Group’s loan assets and borrowings and any exposure arising on the interest rate resets is relatively short term. Forward rate agreements may be used to hedge against any perceived risk of temporary increases in LIBOR rates at month ends. The return to the Group from its investments in structured entities is primarily attributable to the cash generation of the underlying portfolio. There is no direct exposure to market interest rate risk. Until the optional repayment date on 20 April 2012, the fi xed rate corporate bond was hedged by use of a long-term interest rate swap agreement, of notional principal equal to the principal amount of the bond, which converted the interest payable to a LIBOR-linked fl oating rate basis. Since that date interest has been payable on the Bond at a fi xed rate of 3.729%. The Group has entered into various interest rate basis swap arrangements to alter the effective basis of interest payments on certain borrowings to match the underlying assets, though due to their nature and the low notional value of these swaps, they do not have a signifi cant impact on the Group’s results. The Asset and Liability Committee monitors the interest rate risk exposure on the Group’s loan assets and asset backed loan notes and ensures compliance with the requirements of the trustees in respect of the Group’s securitisations. To assess the Group’s exposure to interest rate movements the notional impact of a 1% change in UK interest rates on the equity of the Group at 30 September 2012, and the notional annualised impact of such a change on the operating profi t of the Group, based on the year-end balance sheet have been calculated. Notes to the accounts 73 The Paragon Group of Companies PLC On this basis a 1% increase in UK interest rates would reduce the Group’s equity at 30 September 2012 by £4.0m (2011: £4.2m) and increase profi t before tax by £8.4m (2011: £7.0m). This calculation allows only for the direct effects of any change in UK interest rates. In practice such a change might have wider economic consequences which would themselves potentially affect the Group’s business and results. Although certain of the Group’s borrowings have interest rates dependant on US Dollar and Euro LIBOR rates, the effect of the cross currency basis swaps is such that the Group’s results have no material exposure to movements in these rates. The effects of independent 1% increases in US or Euro interest rates would be to increase the Group’s equity by £1.2m (2011: £1.4m) and £2.0m (2011: £2.3m) respectively. The only interest rate risk in the Company arose from the corporate bond described above, until it became a fi xed rate instrument in April 2012. Assets and liabilities with other group companies bear interest at fl oating rates based on LIBOR which reset within three months of the balance sheet date. The fi nance lease bears notional interest only; all other balances are non-interest bearing. Currency risk All of the Group’s assets and liabilities are denominated in sterling with the exception of the asset backed loan notes denominated in US dollars and euros, which are described in note 48. Although IAS 39 requires that they be accounted for as currency liabilities and valued at their spot rates, a condition of the issue of these notes was that interest rate and currency swaps were put in place for the duration of the borrowing, having the effect of converting the liability to a LIBOR-linked fl oating rate sterling borrowing. As a result the Group has no material exposure to foreign currency risk, and no sensitivity analysis is presented for currency risk. The equivalent sterling principal amounts of notes in issue under these arrangements, and their carrying values at 30 September 2012 and 30 September 2011 are: US dollar notes Euro notes 2012 Equivalent sterling principal £m 2,867.5 1,983.0 2012 Carrying value £m 3,342.7 2,313.3 2011 Equivalent sterling principal £m 2,956.0 2,038.5 2011 Carrying value £m 3,573.7 2,571.6 4,850.5 5,656.0 4,994.5 6,145.3 Fair values of fi nancial assets and fi nancial liabilities Fair values have been determined for all derivatives, listed securities and any other fi nancial assets and liabilities for which an active and liquid market exists. Derivative fi nancial instruments are stated at their fair values in the accounts. The Group uses a number of techniques to determine the fair values of its derivative assets and liabilities, for which observable prices in active markets are not available. These are principally present value calculations based on estimated future cash fl ows arising from the instruments, discounted using a risk adjusted interest rate. The principal inputs to these valuation models are LIBOR benchmark interest rates for the currencies in which the instruments are denominated, sterling, euros and dollars. The cross currency basis swaps have a notional principal related to the outstanding currency borrowings and therefore the estimated rate of repayment of these notes also affects the valuation of the swaps. In order to determine the fair values the management applies valuation adjustments to observed data where that data would not fully refl ect the attributes of the instrument being valued. The management reviews the models used on an ongoing basis to ensure that the valuations produced are reasonable and refl ect all relevant factors. For assets and liabilities carried at fair value IFRS 7 requires that the measurements should be classifi ed using a fair value hierarchy refl ecting the inputs used, and defi nes three levels. Level 1 measurements are unadjusted market prices, level 2 measurements are derived from observable data, such as market prices or rates, while level 3 measurements rely on signifi cant inputs which are not derived from observable data. As described above the valuations of the Group’s derivatives are based on market information and they are therefore classifi ed as level 2 measurements. Details of these assets are given in note 35. The Group had no fi nancial assets or liabilities in the year ended 30 September 2012 or the year ended 30 September 2011 valued using level 1 or level 3 measurements. 74 Notes to the accounts The Paragon Group of Companies PLC The fair values of cash and cash equivalents, bank loans and overdrafts and asset backed loan notes, which are carried at amortised cost, are not materially different from their book values because all the assets mature within three months of the year end and the interest rates charged on fi nancial liabilities reset on a quarterly basis. While the Group’s asset backed loan notes are listed, the quoted prices for an individual note may not be indicative of the fair value of the issue as a whole, due to the specialised nature of the market in such instruments and the limited number of investors participating in it. In the absence of a liquid market in loan assets the directors have considered the estimated cash fl ows expected to arise from the Group’s investments in its loans to customers and have concluded that the carrying value of these assets, determined on the amortised cost basis, is not signifi cantly different from the fair value of the assets derived on a discounted cash fl ow basis. 7. SEGMENTAL INFORMATION For internal reporting purposes the Group is organised into two major operating divisions, First Mortgages and Consumer Finance. These divisions are the basis on which the Group reports segmental information. The revenue generated by the First Mortgages segment includes interest and fees generated by the buy-to-let and owner-occupied mortgage assets and other income derived from fi rst charge mortgages. Consumer Finance revenue includes interest and fees generated by second charge loans, the residual car, retail fi nance and unsecured loan assets, and other sources of income derived from consumer loans. Both of these divisions include assets originated internally and assets acquired from third parties. All of the Group’s operations are conducted in the United Kingdom, all revenues arise from external customers and there are no inter-segment revenues. No customer contributes more than 10% of the revenue of the Group. Financial information about these business segments is shown below. Year ended 30 September 2012 Interest receivable Interest payable Net interest income Other operating income Total operating income Operating expenses Provisions for losses Fair value net gains / (losses) Operating profi t Tax charge Profi t after tax First Consumer mortgages £m fi nance £m 231.1 (128.1) 103.0 6.2 109.2 (35.2) (12.4) 61.6 1.6 63.2 62.7 (7.9) 54.8 6.2 61.0 (16.7) (11.7) 32.6 (0.3) 32.3 Total £m 293.8 (136.0) 157.8 12.4 170.2 (51.9) (24.1) 94.2 1.3 95.5 (23.3) 72.2 Notes to the accounts 75 The Paragon Group of Companies PLC Year ended 30 September 2011 Interest receivable Interest payable Net interest income Other operating income Total operating income Operating expenses Provisions for losses Fair value net gains / (losses) Operating profi t Tax charge Profi t after tax First Consumer mortgages £m fi nance £m 214.7 (114.0) 100.7 7.0 107.7 (34.8) (5.6) 67.3 (0.2) 67.1 43.3 (8.2) 35.1 8.1 43.2 (10.6) (18.8) 13.8 (0.1) 13.7 Total £m 258.0 (122.2) 135.8 15.1 150.9 (45.4) (24.4) 81.1 (0.3) 80.8 (21.2) 59.6 The assets and liabilities attributable to each of the segments at 30 September 2012, 30 September 2011 and 30 September 2010 were: 30 September 2012 Segment assets Segment liabilities 30 September 2011 Segment assets Segment liabilities 30 September 2010 Segment assets Segment liabilities All of the assets shown above were located in the United Kingdom. First Consumer mortgages £m fi nance £m 9,541.3 (8,862.4) 678.9 10,009.3 (9,400.2) 609.1 10,083.0 (9,531.6) 551.4 495.8 (371.2) 124.6 478.9 (346.0) 132.9 562.6 (422.0) 140.6 Total £m 10,037.1 (9,233.6) 803.5 10,488.2 (9,746.2) 742.0 10,645.6 (9,953.6) 692.0 76 Notes to the accounts The total additions to non-current assets, excluding fi nancial instruments and deferred tax assets, attributable to each segment during the years ended 30 September 2012 and 30 September 2011 were: The Paragon Group of Companies PLC 2012 2011 Being: 2012 2011 8. REVENUE Interest receivable Other income Total revenue Arising from: First Mortgages Consumer Finance Total revenue 9. INTEREST RECEIVABLE Interest on loans to customers Other interest receivable Income from structured entities Total interest on fi nancial assets Return on pension scheme assets First mortgages Consumer fi nance £m 2.3 2.9 £m 0.1 0.1 Total £m 2.4 3.0 Intangible Property, plant Total assets and equipment (Note 23) (Note 25) £m 0.8 1.0 £m 1.6 2.0 2012 £m 293.8 12.4 306.2 237.3 68.9 306.2 2012 £m 282.0 2.8 5.5 290.3 3.5 293.8 £m 2.4 3.0 2011 £m 258.0 15.1 273.1 221.7 51.4 273.1 2011 £m 250.9 2.8 0.7 254.4 3.6 258.0 Interest on loans to customers includes £9.8m (2011: £10.7m) charged on accounts where an impairment provision has been made. Notes to the accounts 77 The Paragon Group of Companies PLC 10. INTEREST PAYABLE AND SIMILAR CHARGES On asset backed loan notes On corporate bond On bank loans and overdrafts Total interest on fi nancial liabilities On pension scheme liability On fi nance leases Other fi nance costs 11. OTHER OPERATING INCOME Loan account fee income Insurance income Third party servicing Other income 12. OPERATING EXPENSES Employment costs Auditor remuneration Amortisation of intangible assets Depreciation Operating lease rentals Other administrative costs Note 13 16 23 25 57 2012 £m 101.5 3.9 24.8 130.2 3.9 1.0 0.9 136.0 2012 £m 5.0 2.5 3.9 1.0 12.4 2012 £m 33.1 1.2 1.0 2.1 2.6 11.9 51.9 2011 £m 90.6 3.6 22.8 117.0 3.8 1.1 0.3 122.2 2011 £m 5.7 1.9 5.8 1.7 15.1 2011 £m 27.9 0.9 0.9 2.0 2.5 11.2 45.4 78 Notes to the accounts The Paragon Group of Companies PLC 13. EMPLOYEES The average number of persons (including directors) employed by the Group during the year was 722 (2011: 651). The number of employees at the end of the year was 754 (2011: 691). Staff costs incurred during the year in respect of these employees were: Share based remuneration Other wages and salaries Total wages and salaries National Insurance on share based remuneration Other social security costs Total social security costs Defi ned benefi t pension cost Other pension costs Total pension costs Total staff costs 2012 £m 2.8 25.3 1.0 2.3 1.5 0.2 2011 £m 2.0 22.4 0.5 1.9 0.9 0.2 2012 £m 28.1 3.3 1.7 33.1 2011 £m 24.4 2.4 1.1 27.9 Details of the pension schemes operated by the Group are given in note 50. The Company has no employees. Details of the directors’ remuneration are given in note 14. 14. KEY MANAGEMENT REMUNERATION The remuneration of the directors, who are the key management personnel of the Group and the Company, is set out below in aggregate in accordance with IAS 24 – ‘Related Party Transactions’. Further information about the remuneration of individual directors is provided in the Report of the Board to the Shareholders on Directors’ Remuneration on pages 31 to 36. Short-term employee benefi ts Post-employment benefi ts Termination benefi ts Share based payment 2012 £m 3.4 0.5 - 1.4 5.3 2011 £m 2.8 0.4 - 1.2 4.4 Notes to the accounts 79 The Paragon Group of Companies PLC 15. SHARE BASED REMUNERATION During the year the Group had various share based payment arrangements with employees. They are accounted for by the Group and the Company as shown below. The effect of the share based payment arrangements on the Group’s profi t is shown in note 13. Further details of share based payment arrangements are given in the Report of the Board to the Shareholders on Directors’ Remuneration on pages 31 to 36. (a) Share option schemes Options under the Executive Share Option (‘Executive’) schemes have been granted to directors and senior employees from time to time, on the basis of performance and at the discretion of the Remuneration Committee. These options vest so long as the grantee is still employed by the Group at the end of the vesting period and, where applicable, performance criteria have been satisfi ed. The Executive schemes are no longer available for the grant of further awards. The Group also operates an All Employee Share Option (‘Sharesave’) scheme. Grants under this scheme vest after the completion of the appropriate service period and subject to a savings requirement. A reconciliation of movements in the number and weighted average exercise price of options over £1 ordinary shares during the year ended 30 September 2012 and the year ended 30 September 2011 is shown below. Options outstanding At 1 October 2011 Granted in the year Exercised in the year Lapsed during the year At 30 September 2012 Options exercisable 2012 Number 2012 Weighted average exercise price p 2011 Number 2011 Weighted average exercise price p 3,385,388 1,117,800 (377,402) (615,602) 202.63 142.56 63.51 323.15 4,751,394 - (1,122,985) (243,021) 3,510,184 132.40 3,385,388 764,627 437.64 1,688,482 177.17 - 63.00 350.10 202.63 326.87 The weighted average remaining contractual life of options outstanding at 30 September 2012 was 16.6 months (2011: 12.7 months). The weighted average market price at exercise for share options exercised in the year was 168.47p (2011: 150.29p). 80 Notes to the accounts Options are outstanding under the Executive and Sharesave schemes to purchase ordinary shares as follows: Grant date Period exercisable Exercise price Number 2012 Executive schemes 27/11/2001 29/07/2002 14/03/2003 18/12/2003 01/12/2004 Sharesave schemes 28/07/2006 20/06/2007 18/07/2008 18/07/2008 20/07/2010 20/07/2010 20/12/2011 20/12/2011 27/11/2004 to 27/11/2011 29/07/2005 to 29/07/2012 14/03/2006 to 14/03/2013 18/12/2006 to 18/12/2013 01/12/2007 to 01/12/2014 01/09/2011 to 01/03/2012 01/08/2012 to 01/02/2013 01/09/2011 to 01/03/2012 01/09/2013 to 01/03/2014 01/09/2013 to 01/03/2014 01/09/2015 to 01/03/2016 01/02/2015 to 01/08/2015 01/02/2017 to 01/08/2017 395.34p 297.30p 297.30p 540.40p 555.34p 837.73p 685.84p 63.00p 63.00p 100.32p 100.32p 142.56p 142.56p The Paragon Group of Companies PLC Number 2011 313,650 238,374 336,348 188,190 236,942 - - 336,348 188,190 236,942 761,480 1,313,504 - 3,147 - 1,031,760 441,073 183,876 920,643 168,205 191 4,006 374,787 1,031,760 471,104 190,036 - - 2,748,704 2,071,884 3,510,184 3,385,388 The numbers of share options outstanding and the exercise prices under each of the arrangements shown above which was outstanding at the time of the share consolidation on 29 January 2008 and the rights issue on 21 February 2008 were adjusted in accordance with the respective scheme rules. A number of the above options were granted to former employees whose rights terminate at the later of 12 months following redundancy or 42 months after the issue of the options. The fair value of options granted is determined using a Binomial model. No awards were made in the year ended 30 September 2011. Details of the awards over £1 ordinary shares made in the year ended 30 September 2012, which were all made under the Sharesave scheme, are shown below. Grant date Number of awards granted Market price at date of grant Contractual life (years) Fair value per share at date of grant Inputs to valuation model Expected volatility Expected life at grant date (years) Risk-free interest rate Expected dividend yield Expected annual departures 20/12/11 20/12/11 945,387 172,413 175.50p 3.0 71.67p 66.27% 3.5 1.35% 2.28% 5.00% 175.50p 5.0 72.05p 66.27% 5.5 1.35% 2.28% 5.00% The expected volatility of the share price used in determining the fair value is based on the annualised standard deviation of daily changes in price over the six years preceding the grant date. Notes to the accounts 81 The Paragon Group of Companies PLC (b) Paragon Performance Share Plan Awards under this plan comprise a right to acquire ordinary shares in the Company for nil or nominal payment and will vest on the third anniversary of their granting, to the extent that the applicable performance criteria have been satisfi ed, if the holder is still employed by the Group. The awards will lapse to the extent that the performance condition has not been satisfi ed on the third anniversary. The conditional entitlements outstanding under this scheme at 30 September 2012 and 30 September 2011 were: Grant date Period exercisable 09/01/2007 28/03/2007 14/06/2007 26/09/2007 26/11/2007 18/03/2008 29/09/2008 21/05/2009 04/01/2010 02/09/2010 17/12/2010 21/12/2011 09/01/2010 to 09/01/2017 † 28/03/2010 to 28/03/2017 † 14/06/2010 to 14/06/2017 † 26/09/2010 to 26/09/2017 † 26/11/2010 to 26/11/2017 † 18/03/2011 to 18/03/2018 † 29/09/2011 to 29/09/2018 † 21/05/2012 to 21/05/2019 † 04/01/2013 to 04/01/2020 * 02/09/2013 to 02/09/2020 * 17/12/2013 to 17/12/2020 * 21/12/2014 to 21/12/2021 * Number 2012 3,294 3,164 6,320 10,032 30,588 103,345 278,287 2,605,821 1,797,822 141,844 1,906,736 2,154,577 Number 2011 3,294 3,164 27,964 54,423 97,578 103,345 1,638,646 3,221,335 1,797,822 141,844 1,906,736 - 9,041,830 8,996,151 † These awards, which were conditional on the achievement of performance based criteria, have now vested. * The receipt of these shares is subject to a performance condition comparing the rank of the Company’s TSR against a comparator group of companies comprising the constituents of the FTSE-250 on the date of grant over the three years commencing on the date of grant. 25% of the awards will vest for median performance, increasing on a straight line basis to full vesting for upper quartile performance. The number of share options outstanding and the exercise price under each of the arrangements shown above which were outstanding at the time of the share consolidation on 29 January 2008 and the rights issue on 21 February 2008 were adjusted in accordance with the respective scheme rules. The fair value of awards granted under the Performance Share Plan is determined using a Monte Carlo simulation model, to take account of the effect of the market based condition. Details of the awards over £1 ordinary shares made in the year ended 30 September 2012 and the year ended 30 September 2011 are shown below: Grant date Number of awards granted Market price at date of grant Fair value per share at date of grant Inputs to valuation model Expected volatility Risk-free interest rate Expected dividend yield 21/12/11 17/12/10 2,154,576 1,907,443 176.90p 105.53p 182.00p 123.86p 45.13% 1.35% 2.26% 72.58% 1.98% 1.69% For all of the above grants the contractual life and expected life at grant date is three years and no departures are expected. For awards granted before 18 July 2008 the expected volatility of the share price used in determining the fair value was based on the annualised standard deviation of daily changes in price over the previous year from the grant date. The expected volatility for awards granted between this date and 30 September 2008 is calculated using the same method but using daily changes in price over the six years preceding the grant date. The expected volatility for awards granted after this date is calculated using the same method but using daily changes in price over the three years preceding the grant date. 82 Notes to the accounts The Paragon Group of Companies PLC (c) Deferred bonus awards Awards under this scheme comprise a right to acquire ordinary shares in the Company for nil or nominal payment and will vest on the third anniversary of their granting. The conditional entitlements outstanding under this scheme at 30 September 2012 and 30 September 2011 were: Grant date Period exercisable 05/01/2010 11/01/2011 21/12/2011 01/10/2012 to 30/09/2013 01/10/2013 to 30/09/2014 01/10/2014 to 30/09/2015 Number 2012 169,287 215,654 301,025 Number 2011 169,287 215,654 - 685,966 384,941 The shares awarded can be exercised from one year from the vesting date. The vesting date is the third anniversary of the start of the fi nancial year in which the grant is awarded. The fair value of Deferred Bonus awards issued in the year was determined using a Black-Scholes Merton model. Details of the awards over £1 ordinary shares made in the year ended 30 September 2012 and the year ended 30 September 2011 are shown below. Grant date Number of awards granted Market price at date of grant Fair value per share at date of grant Inputs to valuation model Risk-free interest rate Expected dividend yield (d) Matching share plan 21/12/11 11/1/11 301,025 215,654 176.90p 165.30p 188.50p 178.00p 1.35% 2.26% 2.16% 1.91% Awards under this plan comprise a right to acquire ordinary shares in the Company for nil or nominal payment and will vest on the third anniversary of their granting to the extent that the applicable performance criteria have been satisfi ed, if the holder is still employed by the Group. The awards will lapse to the extent that the performance condition has not been satisfi ed on the third anniversary. The conditional entitlements outstanding under this scheme at 30 September 2012 and at 30 September 2011 were: Grant date Transfer date 09/01/2007 02/01/2008 05/01/2010 09/01/2010 † 02/01/2011 † 05/01/2013 * Number 2012 5,625 22,329 142,347 Number 2011 5,625 22,329 142,347 170,301 170,301 † These awards, which were conditional on the achievement of performance based criteria, have now vested. * The receipt of these shares is subject to a performance condition comparing the rank of the Company’s TSR against a comparator group of companies comprising the constituents of the FTSE-250 on the date of grant over the three years commencing on the date of grant. 25% of the awards will vest for median performance, increasing on a straight line basis to full vesting for upper quartile performance. Notes to the accounts 83 The Paragon Group of Companies PLC The numbers of share options outstanding and the exercise prices under each of the arrangements shown above which was outstanding at the time of the share consolidation on 29 January 2008 and the rights issue on 21 February 2008 were adjusted in accordance with the respective scheme rules. The fair value of awards granted under the Matching Share Plan is determined using a Monte Carlo simulation model, to take account of the effect of the market based condition. No awards were made in the year ended 30 September 2012 or the year ended 30 September 2011. 16. AUDITOR REMUNERATION The analysis of fees payable to the Company’s auditors and their associates, excluding irrecoverable VAT, required by the Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) Regulations 2008 is set out below. This analysis includes amounts charged to the profi t and loss account or included within the issue costs of debt and equity in respect of fees paid to the Group auditors and their associates. Audit fee of the company Other services Audit of subsidiary undertakings pursuant to legislation Total audit fees Audit related assurance services Interim review Other Tax compliance services Tax advisory services Other assurance services Securitisation reporting Other services Total fees Irrecoverable VAT Total cost to the Group Of which: Charged to profi t and loss account (note 12) Included in issue costs of debt Total cost to the Group 2011 £000 40 10 130 120 2012 £000 40 - 118 295 2012 £000 172 288 460 40 413 59 102 1,074 215 1,289 1,219 70 1,289 2011 £000 157 293 450 50 250 - - 750 141 891 891 - 891 In addition to the amounts above, the auditors received fees of £7,000 (2011: £7,000), excluding VAT, in respect of the audit of the Group pension scheme. Fees paid to the auditors and their associates for non-audit services to the Company are not disclosed because the consolidated accounts of the Group are required to disclose such fees on a consolidated basis. 84 Notes to the accounts 17. PROVISIONS FOR LOSSES Impairment of fi nancial assets (note 32) First mortgage loans Other secured loans Finance lease receivables Retail fi nance loans Other loans 18. FAIR VALUE NET GAINS / (LOSSES) Net gain on derivatives designated as fair value hedges Fair value adjustments from hedge accounting Ineffectiveness of fair value hedges Ineffectiveness of cash fl ow hedges Net gains / (losses) on other derivatives The Paragon Group of Companies PLC 2012 £m 12.2 6.0 0.5 0.1 5.3 24.1 2012 £m 2.2 (2.2) - - 1.3 1.3 2011 £m 5.6 11.1 1.3 0.2 6.2 24.4 2011 £m 5.2 (5.2) - - (0.3) (0.3) The fair value net gain / (loss) represents the accounting volatility on derivative instruments which are matching risk exposure on an economic basis generated by the requirements of IAS 39. Some accounting volatility arises on these items due to accounting ineffectiveness on designated hedges, or because hedge accounting has not been adopted or is not achievable on certain items. The losses and gains are primarily due to timing differences in income recognition between the derivative instruments and the economically hedged assets and liabilities. Such differences will reverse over time and have no impact on the cash fl ows of the Group. 19. TAX CHARGE ON PROFIT ON ORDINARY ACTIVITIES (a) Analysis of charge in the year Current tax UK Corporation Tax on profi ts of the period Adjustment in respect of prior periods Total current tax Deferred tax Tax charge on profi t on ordinary activities 2012 £m 20.0 (0.4) 19.6 3.7 23.3 2011 £m 14.6 0.3 14.9 6.3 21.2 Notes to the accounts 85 The Paragon Group of Companies PLC (b) Deferred tax charge for the year The deferred tax charge in the income statement comprises the following temporary differences: Accelerated tax depreciation Retirement benefi t obligations Impairment and other provisions Utilisation of tax losses Other timing differences Deferred tax charge for the year Recognition of asset not previously recognised Change in tax rate Deferred tax charge (note 51) 2012 £m 0.1 0.3 1.8 3.0 (0.3) 4.9 - (1.2) 3.7 2011 £m 0.2 0.6 1.0 6.1 (0.8) 7.1 - (0.8) 6.3 During the year ended 30 September 2011 the United Kingdom Government enacted provisions reducing the rate of corporation tax to 26% with effect from 1 April 2011 and 25% from 1 April 2012. During the year ended 30 September 2012 the Government enacted provisions further reducing the rate of corporation tax to 24% with effect from 1 April 2012 and 23% from 1 April 2013. Therefore the standard rate of corporation tax applicable to the Group for the year ended 30 September 2012 is 25% and the rate is expected to be 23.5% in the year ending 30 September 2013 and 23% thereafter. The expected impact of the change to 25% on the values at which deferred tax amounts are expected to crystallise was accounted for in the year ended 30 September 2011, while the expected impacts of the changes to 24% and 23% have been accounted for in the year ended 30 September 2012. The Government has announced its intention to make further reductions in the rate of corporation tax in future years. The effect of any such changes on deferred tax balances will be accounted for in the period in which any such changes are enacted. (c) Factors affecting tax charge for the year The tax assessed for the year is lower than the standard rate of corporation tax in the United Kingdom of 25% (2011: 27%). The differences are explained below: Profi t on ordinary activities before taxation Profi t on ordinary activities multiplied by standard rate of corporation tax in the UK of 25% (2011: 27%) Effects of: Permanent differences Change in rate of taxation on deferred tax assets and liabilities Prior year (credit) / charge Tax charge for the year 2012 £m 95.5 23.9 1.0 (1.2) (0.4) 23.3 2011 £m 80.8 21.8 (0.1) (0.8) 0.3 21.2 86 Notes to the accounts The Paragon Group of Companies PLC 20. PROFIT ATTRIBUTABLE TO MEMBERS OF THE PARAGON GROUP OF COMPANIES PLC The Company’s profi t after tax for the fi nancial year amounted to £61.1m (2011: £61.9m). A separate income statement has not been prepared for the Company under the provisions of Section 408 of the Companies Act 2006. The Company has no other items of comprehensive income for the years ended 30 September 2012 or 30 September 2011. 21. EARNINGS PER SHARE Earnings per ordinary share is calculated as follows: Profi t for the year (£m) Basic weighted average number of ordinary shares ranking for dividend during the year (million) Dilutive effect of the weighted average number of share options and incentive plans in issue during the year (million) Diluted weighted average number of ordinary shares ranking for dividend during the year (million) Earnings per ordinary share - basic - diluted 2012 72.2 297.8 9.4 2011 59.6 295.3 8.2 307.2 303.5 24.2p 23.5p 20.2p 19.6p 22. TAX CREDITED / (CHARGED) TO EQUITY On actuarial (loss) on pension scheme (note 50) On gains on cash fl ow hedges (note 42) Tax on items taken to equity On share based payment (note 43) Total tax credited to equity Of which Current tax Deferred tax (note 51) The Group The Company 2012 £m (0.2) 0.4 0.2 0.9 1.1 - 1.1 1.1 2011 £m (0.3) - (0.3) 0.1 (0.2) - (0.2) (0.2) 2012 £m 2011 £m - - - - - - - - - - - - - - - - Included in tax credited to equity in the year ended 30 September 2012 is £0.4m (2011: £0.4m) charged in respect of the effect of the changes in corporation tax rates described in note 19 on deferred tax assets. Notes to the accounts 87 The Paragon Group of Companies PLC 23. INTANGIBLE ASSETS Goodwill (note 24) Computer software Cost At 1 October 2010 Additions Disposals At 30 September 2011 Additions Disposals At 30 September 2012 Accumulated amortisation At 1 October 2010 Amortisation charge for the year On disposals At 30 September 2011 Amortisation charge for the year On disposals At 30 September 2012 Net book value At 30 September 2012 At 30 September 2011 At 30 September 2010 £m 7.6 - - 7.6 - - 7.6 6.0 - - 6.0 - - 6.0 1.6 1.6 1.6 £m 2.6 1.0 (0.3) 3.3 0.8 - 4.1 2.2 0.3 (0.3) 2.2 0.5 - 2.7 1.4 1.1 0.4 Other intangible assets £m 8.1 - - 8.1 - - 8.1 0.9 0.6 - 1.5 0.5 - 2.0 6.1 6.6 7.2 Total £m 18.3 1.0 (0.3) 19.0 0.8 - 19.8 9.1 0.9 (0.3) 9.7 1.0 - 10.7 9.1 9.3 9.2 Other intangible assets comprise brands and the benefi t of business networks recognised on the acquisition of subsidiary companies. 24. GOODWILL The goodwill carried in the accounts was recognised on the acquisition of The Business Mortgage Company and its subsidiaries (‘TBMC’) in December 2008. The cash generating unit to which this goodwill was attributed for impairment testing purposes was TBMC, which is the lowest level within the Group at which this goodwill is currently monitored, though the operations of the acquired entity will, in time, be integrated with those of the First Mortgage division. An impairment review undertaken at 30 September 2009 indicated a write down of £6.0m which was charged to the profi t and loss account. Further reviews were undertaken at 30 September 2012 and each intervening year-end, which indicated no further impairment. The recoverable amount of TBMC used in this impairment testing is determined on a value in use basis using pre-tax cash fl ow projections based on fi nancial budgets approved by the Board covering a four year period. The pre-tax discount rate applied to the cash fl ow projection is 6.07% and cash fl ows beyond the four year budget are extrapolated using a 2.00% growth rate, being the average long term growth rate in the United Kingdom economy over a 20 year period. 88 Notes to the accounts The Paragon Group of Companies PLC The key assumptions underlying the value in use calculation for the TBMC business are: • Level of business activity, based on management expectations. Management have concluded that the levels of activity assumed for the purpose of this forecast are reasonable, based on past experience and the current economic environment • Discount rate, which is based on the Group’s cost of capital The directors believe that no reasonably possible change in any of the key assumptions above would cause the carrying value of the unit to exceed its recoverable amount. 25. PROPERTY, PLANT AND EQUIPMENT (a) The Group Cost At 1 October 2010 Additions Disposals At 30 September 2011 Additions Disposals At 30 September 2012 Accumulated depreciation At 1 October 2010 Charge for the year On disposals At 30 September 2011 Charge for the year On disposals At 30 September 2012 Net book value At 30 September 2012 At 30 September 2011 At 30 September 2010 Land and Buildings £m Plant and machinery £m 24.3 0.4 (0.4) 24.3 0.4 - 24.7 14.1 1.2 (0.4) 14.9 1.4 - 16.3 8.4 9.4 10.2 9.8 1.6 (4.3) 7.1 1.2 (1.6) 6.7 7.8 0.8 (3.5) 5.1 0.7 (1.4) 4.4 2.3 2.0 2.0 Total £m 34.1 2.0 (4.7) 31.4 1.6 (1.6) 31.4 21.9 2.0 (3.9) 20.0 2.1 (1.4) 20.7 10.7 11.4 12.2 The net book value of land and buildings includes £6.7m in respect of land and buildings held under fi nance leases (2011: £7.7m, 2010: £8.8m). Notes to the accounts 89 The Paragon Group of Companies PLC (b) The Company Cost At 1 October 2010, 30 September 2011 and 30 September 2012 Accumulated depreciation At 1 October 2010 Charge for the year At 30 September 2011 Charge for the year At 30 September 2012 Net book value At 30 September 2012 At 30 September 2011 At 30 September 2010 The net book value of land and buildings represents buildings held under fi nance leases. 26. INVESTMENT IN SUBSIDIARY UNDERTAKINGS At 1 October 2010 Loans advanced Loans repaid Provision movements At 30 September 2011 Loans advanced Loans repaid Provision movements At 30 September 2012 Shares in Group Loans to Group Loans to ESOP companies companies £m 252.5 - - (0.2) 252.3 - - (116.3) 136.0 £m 507.7 17.4 (34.9) - 490.2 14.2 (23.9) - 480.5 trusts £m 4.2 1.5 - (1.3) 4.4 2.1 - (0.4) 6.1 Land and buildings £m 20.8 12.0 1.1 13.1 1.0 14.1 6.7 7.7 8.8 Total £m 764.4 18.9 (34.9) (1.5) 746.9 16.3 (23.9) (116.7) 622.6 During the year ended 30 September 2012 the Company received £164.7m in dividend income from its subsidiaries (2011: £54.8m) and £32.3m of interest on loans to Group companies (2011: £31.7m). The principal operating subsidiaries, and the nature of the Group’s interest in them, are shown in note 27. 90 Notes to the accounts The Paragon Group of Companies PLC 27. PRINCIPAL OPERATING SUBSIDIARIES Principal operating subsidiaries where the share capital is held within the Group comprise: Holding Principal activity Direct subsidiaries of The Paragon Group of Companies PLC Paragon Finance PLC Mortgage Trust Limited Paragon Mortgages Limited Paragon Mortgages (2010) Limited Paragon Vehicle Contracts Limited Paragon Car Finance Limited Paragon Personal Finance Limited Moorgate Servicing Limited Redbrick Real Estate Services Limited Idem Capital Limited Idem Jersey (No. 1) Limited Paragon Fourth Funding Limited The Business Mortgage Company Limited Paragon Mortgages (No. 7) PLC Paragon Mortgages (No. 8) PLC Paragon Mortgages (No. 9) PLC Paragon Mortgages (No. 10) PLC Paragon Mortgages (No. 11) PLC Paragon Mortgages (No. 12) PLC Paragon Mortgages (No. 13) PLC Paragon Mortgages (No. 14) PLC Paragon Mortgages (No. 15) PLC Paragon Mortgages (No. 16) PLC Paragon Personal and Auto Finance (No. 3) PLC Paragon Secured Finance (No. 1) PLC First Flexible (No. 7) PLC Subsidiary of Paragon Mortgages Limited Paragon Second Funding Limited Subsidiaries of Mortgage Trust Limited Mortgage Trust Services plc First Flexible No. 6 PLC Subsidiaries of Moorgate Servicing Limited Redbrick Survey and Valuation Limited Moorgate Loan Servicing Limited Subsidiaries of Idem Capital Limited Idem (No. 1) Limited Idem (No. 3) Limited Idem Capital Securities Limited 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% * 100% * 100% * 100% * 100% * 100% * 100% * 100% 100% 100% Residential mortgages and asset administration Residential mortgages Residential mortgages Residential mortgages Vehicle fl eet management Vehicle fi nance Unsecured lending Intermediate holding company Property services Asset investment Asset investment Residential mortgages Mortgage broker Residential mortgages Residential mortgages Residential mortgages Residential mortgages Residential mortgages Residential mortgages Residential mortgages Residential mortgages Residential mortgages Residential mortgages Loan and vehicle fi nance Loan fi nance 100% * Residential mortgages 100% Residential mortgages and loan and vehicle fi nance 100% 74% 100% 100% 100% 100% 100% Residential mortgages and asset administration Residential mortgages Surveyors and property consulting Asset administration Asset investment Asset investment Asset investment The holdings shown above are those held by the Group. The shareholdings of the Company are the same as those held by the parent company identifi ed above, except that for the shareholdings marked * the parent company holds only 74% of the share capital, the remainder being held by other group companies. The fi nancial year end of all of the Group’s subsidiary companies is 30 September, with the exception of The Business Mortgage Company Limited, the year end of which is 31 December. They are all registered in England and Wales, except Idem Jersey (No. 1) Limited, which is registered in the Bailiwick of Jersey, and they all operate in the United Kingdom. The issued share capital of all subsidiaries consists of ordinary share capital, except that First Flexible No. 6 PLC has additional preference share capital held by the Group. The non-controlling interest in this company is not material. Notes to the accounts 91 The Paragon Group of Companies PLC In addition, prior to its acquisition by the Group, certain loans originated by Mortgage Trust Limited had been sold to special purpose entity companies, ultimately benefi cially owned by charitable trusts, which had raised non-recourse fi nance to fund these purchases. The Group is considered to control these entities, as defi ned by SIC-12 ‘Special Purpose Entities’ and hence they are considered to be subsidiaries of the Group. The principal companies party to these arrangements are First Flexible No. 4 plc and First Flexible No. 5 plc. The principal activity of both of these companies is residential mortgages. 28. FINANCIAL ASSETS (a) The Group Loans and receivables Finance lease receivables Loans to customers Fair value adjustments from portfolio hedging Investments in structured entities Derivative fi nancial assets (b) The Company Derivative fi nancial assets Note 29 30 31 33 34 35 Note 35 2012 £m 8,692.1 2.5 8,694.6 1.1 9.1 800.4 2011 £m 8,716.7 7.5 8,724.2 3.4 11.8 1,151.8 2010 £m 8,890.2 21.0 8,911.2 8.6 - 1,160.3 9,505.2 9,891.2 10,080.1 2012 £m - - 2011 £m 4.0 4.0 2010 £m 8.0 8.0 92 Notes to the accounts The Paragon Group of Companies PLC 29. LOANS AND RECEIVABLES Loans and receivables at 30 September 2012, 30 September 2011 and 30 September 2010, which are all denominated and payable in sterling, were: First mortgage loans Secured loans Retail fi nance loans Other unsecured loans 2012 £m 8,295.6 279.9 2.0 114.6 2011 £m 8,360.4 340.1 2.9 13.3 2010 £m 8,475.6 391.9 4.8 17.9 8,692.1 8,716.7 8,890.2 First mortgages are secured on residential property within the United Kingdom; secured loans enjoy second charges on residential property. Retail fi nance loans are unsecured. The estimated value of the security held against those loans above which are considered to be impaired or past due, representing the lesser of the outstanding balance and the estimated valuation of the property for each such account was: First mortgage loans Secured loans 2012 £m 70.7 41.6 112.3 2011 £m 83.1 46.2 129.3 Mortgage loans have a contractual term of up to 30 years, secured loans up to 25 years, retail fi nance loans up to ten years and other unsecured loans up to ten years. In all cases the borrower is entitled to settle the loan at any point and in most cases early settlement does take place. All borrowers are required to make monthly payments, except where an initial deferred period is included in the contractual terms. Under the terms of certain fi rst mortgage products, the customer has the right to draw down further funds. At 30 September 2012 the Group’s commitment in respect of such facilities was £32.3m (2011: £37.0m). The loans shown above pledged as collateral for the liabilities described in note 48 at 30 September 2012 and 30 September 2011 were: 30 September 2012 In respect of: Asset backed loan notes Warehouse facilities Total pledged as collateral Not pledged as collateral 30 September 2011 In respect of: Asset backed loan notes Warehouse facilities Total pledged as collateral Not pledged as collateral First Consumer mortgages £m fi nance £m 6,674.4 1,582.7 8,257.1 38.5 8,295.6 6,714.0 1,604.1 8,318.1 42.3 8,360.4 282.2 - 282.2 114.3 396.5 333.9 - 333.9 22.4 356.3 Total £m 6,956.6 1,582.7 8,539.3 152.8 8,692.1 7,047.9 1,604.1 8,652.0 64.7 8,716.7 Notes to the accounts 93 The Paragon Group of Companies PLC 30. FINANCE LEASE RECEIVABLES The Group’s fi nance lease receivables are car fi nance loans. The average contractual life of such loans is 56 months (2011: 56 months), but it is likely that a signifi cant proportion of customers will choose to settle their obligations early. The minimum lease payments due under these loan agreements are: Amounts receivable Within one year Within two to fi ve years After fi ve years Less: future fi nance income Present value 2012 £m 1.6 1.7 - 3.3 (0.2) 3.1 The present values of those payments, net of provisions for impairment, carried in the accounts are: Amounts receivable Within one year Within two to fi ve years After fi ve years Allowance for uncollectible amounts Provision for recoveries 2012 £m 1.5 1.6 - 3.1 (1.2) 0.6 2.5 2011 £m 5.2 3.0 0.2 8.4 (0.5) 7.9 2011 £m 4.9 2.8 0.2 7.9 (1.4) 1.0 7.5 2010 £m 12.4 9.5 0.7 22.6 (1.4) 21.2 2010 £m 11.6 8.9 0.7 21.2 (1.8) 1.6 21.0 The Group considers that the fair value of its fi nance lease receivables is not signifi cantly different to their carrying values. Whilst the Group has the benefi t of the underlying vehicle as security on these loans, no account of this is taken in the allowance for uncollectible amounts shown above. The Group has insuffi cient information on the current condition of fi nance leased vehicles to derive a reliable estimate of the value which could be realised from vehicles to offset against arrears accounts. Accordingly, no such disclosure is provided. The loans shown above pledged as collateral for liabilities at 30 September 2012 and 30 September 2011 were: In respect of: Asset backed loan notes Warehouse facilities Total pledged as collateral Not pledged as collateral 94 Notes to the accounts 2012 £m 1.9 - 1.9 0.6 2.5 2011 £m 6.4 - 6.4 1.1 7.5 The Paragon Group of Companies PLC 31. LOANS TO CUSTOMERS The movements in the Group’s investment in loans to customers in the year ended 30 September 2012 and the year ended 30 September 2011 were: Cost At 1 October 2011 Additions Disposals Effective Interest Rate (‘EIR’) adjustments Other debits Provision charge (note 32) Repayments and redemptions At 30 September 2012 2012 £m 8,724.2 310.0 (5.9) 6.7 283.2 (24.1) (599.5) 2011 £m 8,911.2 151.7 - (17.3) 279.2 (24.4) (576.2) 8,694.6 8,724.2 ‘Other debits’ includes primarily interest and fees charged to customers on loans outstanding. The fair value of loans to customers is considered to be not materially different to the amortised cost value at which they are disclosed. 32. IMPAIRMENT PROVISIONS ON LOANS TO CUSTOMERS The following amounts in respect of impairment provisions, net of allowances for recoveries of written off assets, have been deducted from the appropriate assets in the balance sheet. At 1 October 2010 Charge for the year (note 17) On assets sold Amounts written off Amounts recovered At 30 September 2011 Charge for the year (note 17) On assets sold Amounts written off Amounts recovered At 30 September 2012 First Other loans mortgages and receivables Finance leases £m 64.9 5.6 - - 0.2 70.7 12.2 - (6.1) (0.4) 76.4 £m 41.2 17.5 - (11.9) (1.6) 45.2 11.4 (11.6) (11.4) (1.8) 31.8 £m 0.2 1.3 - (0.6) (0.5) 0.4 0.5 - - (0.3) 0.6 Total £m 106.3 24.4 - (12.5) (1.9) 116.3 24.1 (11.6) (17.5) (2.5) 108.8 Notes to the accounts 95 The Paragon Group of Companies PLC 33. FAIR VALUE ADJUSTMENTS FROM PORTFOLIO HEDGING The Group applies fair value hedge accounting in respect of portfolios of loan assets where the appropriate criteria are met. In these circumstances the change in the fair value of the hedged items attributable to the hedged risk is shown under this heading. 34. INVESTMENT IN STRUCTURED ENTITIES Investments in structured entities represent the Group’s contribution made to special purpose vehicle (‘SPV’) companies established and controlled by unrelated third parties to purchase pools of loan assets. All such investments are denominated in sterling, unlisted and are considered to be debt investments as defi ned by IFRS. The underlying loans are unsecured loans made to United Kingdom borrowers. The Group is under no obligation to make any further contribution to these entities. The movements in the Group’s investment in structured entities in the year ended 30 September 2012 and the year ended 30 September 2011 were: Cost At 1 October 2011 Additions Effective Interest Rate (‘EIR’) income (note 9) Payments received At 30 September 2012 2012 £m 11.8 - 5.5 (8.2) 9.1 2011 £m - 11.7 0.7 (0.6) 11.8 The fair values of investments in structured entities are considered to be not materially different to the amortised cost value at which they are disclosed. The Group administers the assets of the SPV companies on behalf of the owners. Fee income derived from this activity of £1.4m (2011: £0.5m) is included within third party servicing fees (Note 11) and £0.1m (2011: £0.1m) is included in other debtors (Note 36) in respect of unpaid fees at the year end. 96 Notes to the accounts The Paragon Group of Companies PLC 35. DERIVATIVE FINANCIAL ASSETS AND LIABILITIES All of the Group’s fi nancial derivatives are held for economic hedging purposes, although not all may be designated for hedge accounting in accordance with the provisions of IAS 39. The analysis below therefore splits derivatives between those accounted for as hedges and those which, while representing an economic hedge, do not qualify for this treatment. All of the fi nancial derivatives shown are valued using methodologies where the principal inputs are directly or indirectly derived from market data and are therefore classifi ed within level two of the fair value hierarchy laid down by IFRS 7. The Group’s securitisation borrowings are denominated in sterling, euros and US dollars. All currency borrowings are swapped at inception so that they have the effect of sterling borrowings. These swaps provide an effective hedge against exchange rate movements, but the requirement to carry them at fair value leads, when exchange rates have moved signifi cantly since the issue of the notes, to large balances for the swaps being carried in the balance sheet. This is currently the case with both euro and US dollar swaps, although the debit balance is compensated for by retranslating the borrowings at the current exchange rate. Derivative fi nancial assets and liabilities are included within Financial Assets (note 28) and Financial Liabilities (note 47) respectively. (a) The Group 2012 Notional amount £m 2012 Assets 2012 Liabilities £m £m 2011 Notional amount £m 2011 Assets 2011 Liabilities £m £m Derivatives in accounting hedge relationships Fair value hedges Interest rate swaps 119.9 119.9 Cash fl ow hedges Foreign exchange basis swaps 4,850.5 Interest rate swaps - 4,850.5 4,970.4 170.8 4.4 175.2 Other derivatives Interest rate swaps Interest rate caps Total recognised derivative assets / - - 799.5 - 799.5 799.5 0.9 - 0.9 (1.5) (1.5) - - - - (3.1) - (3.1) 209.6 209.6 4.0 4.0 4,994.5 0.6 1,145.8 - 4,995.1 1,145.8 5,204.7 1,149.8 178.2 15.8 194.0 2.0 - 2.0 (3.8) (3.8) - - - (3.8) (5.3) - (5.3) (liabilities) 5,145.6 800.4 (4.6) 5,398.7 1,151.8 (9.1) At 30 September 2012 cash deposits of £100.7m had been pledged as collateral in respect of swaps shown above by the respective swap counterparties (2011: £146.0m) as described in note 6. Notes to the accounts 97 The Paragon Group of Companies PLC (b) The Company 2012 Notional amount £m 2012 Assets 2012 Liabilities £m £m 2011 Notional amount £m 2011 Assets 2011 Liabilities £m £m Derivatives in accounting hedge relationships Fair value hedges Interest rate swaps Total recognised derivative assets - - - - - - - - - 110.0 110.0 110.0 4.0 4.0 4.0 - - - Of the interest rate swap agreements used for fair value hedging at 30 September 2011, swaps of a notional value of £110.0m, recognised as assets of £4.0m in both the Group and the Company relate to the hedging of the Corporate Bond borrowings. All fair value hedging items at 30 September 2012 and all other hedging items at 30 September 2011 relate to the hedging of the Group’s loan assets on a portfolio basis. 36. OTHER RECEIVABLES (a) The Group Current assets Accrued interest income Prepayments Other debtors 2012 £m 0.2 4.4 2.7 7.3 2011 £m 0.5 1.0 3.2 4.7 2010 £m 0.5 1.0 4.4 5.9 Accrued interest income and other debtors fall within the defi nition of fi nancial assets given in IAS 32. The fair values of the above items are not considered to be materially different to their carrying values. 98 Notes to the accounts (b) The Company Current assets Amounts owed by Group companies Accrued interest income The Paragon Group of Companies PLC 2012 £m 80.1 - 80.1 2011 £m 79.9 0.1 80.0 2011 £m 125.2 0.6 125.8 Accrued interest income and other debtors fall within the defi nition of fi nancial assets given in IAS 32. The fair values of the above items are not considered to be materially different to their carrying values. 37. CASH AND CASH EQUIVALENTS Only ‘Free Cash’ is unrestrictedly available for the Group’s general purposes. Cash received in respect of loan assets is not immediately available, due to the terms of the warehouse facilities and the securitisations. ‘Cash and Cash Equivalents’ also includes balances held by the Trustees of the Paragon Employee Share Ownership Plans which may only be used to invest in the shares of the Company, pursuant to the aims of those plans. The total consolidated ‘Cash and Cash Equivalents’ balance may be analysed as shown below: Free cash Securitisation cash ESOP cash 2012 £m 127.7 374.9 2.2 504.8 2011 £m 195.0 374.1 2.5 571.6 2010 £m 147.8 387.2 1.7 536.7 All ‘Cash and Cash Equivalents’ shown in the Company balance sheet are included in free cash. Cash and Cash Equivalents includes current bank balances and fi xed rate sterling term deposits with London banks. Notes to the accounts 99 The Paragon Group of Companies PLC 38. CALLED-UP SHARE CAPITAL The share capital of the Company consists of a single class of £1 ordinary shares. Movements in the issued share capital in the year were: Ordinary shares At 1 October 2011 Shares issued At 30 September 2012 2012 Number 2011 Number 299,745,445 2,096,169 299,454,078 291,367 301,841,614 299,745,445 During the year the Company issued 2,090,570 shares at par (2011: 291,367) to the trustees of its ESOP Trusts in order that they could fulfi l their obligations under the Group’s share based award arrangements. It also issued 5,599 shares (2011: nil) to satisfy options granted under sharesave schemes for a consideration of £5,688 (2011: £nil). 39. RESERVES (a) The Group Share premium account Merger reserve Cash fl ow hedging reserve Profi t and loss account (b) The Company Share premium account Merger reserve Profi t and loss account 40. SHARE PREMIUM ACCOUNT Balance at 1 October 2011 Balance at 30 September 2012 100 Notes to the accounts Note 40 41 42 43 Note 40 41 43 2012 £m 64.1 (70.2) 0.7 555.6 550.2 2012 £m 64.1 (23.7) 333.4 373.8 2011 £m 64.1 (70.2) 1.8 495.0 490.7 2011 £m 64.1 (23.7) 281.8 322.2 2010 £m 64.1 (70.2) 1.4 450.5 445.8 2010 £m 64.1 (23.7) 229.0 269.4 The Group The Company 2012 £m 64.1 64.1 2011 £m 64.1 64.1 2012 £m 64.1 64.1 2011 £m 64.1 64.1 The Paragon Group of Companies PLC 41. MERGER RESERVE Balance at 1 October 2011 Balance at 30 September 2012 The Group The Company 2012 £m (70.2) (70.2) 2011 £m (70.2) (70.2) 2012 £m (23.7) (23.7) 2011 £m (23.7) (23.7) The merger reserve arose, due to the provisions of UK company law at the time, on a group restructuring on 12 May 1989 when the Company became the parent entity of the Group. 42. CASH FLOW HEDGING RESERVE Note At 1 October 2011 Movement in fair value of hedging derivatives Deferred tax thereon 22 At 30 September 2012 The Group The Company 2012 £m 1.8 (1.5) 0.4 0.7 2011 £m 1.4 0.4 - 1.8 2012 £m - - - - 2011 £m - - - - The cash fl ows to which these amounts relate are expected to take place, and to affect profi t, over the next 32 years (2011: 33 years). The majority of the balance relates to the cross currency basis swaps described in note 6. Cash fl ows in respect of these swaps will continue for as long as the related notes remain outstanding. Foreign exchange gains of £344.9m on asset backed loan notes denominated in US dollars and euros (2011: gains of £3.2m) have been taken to the cash fl ow hedging reserve together with equal and opposite movements on the cross currency basis swaps used to hedge these liabilities. 43. PROFIT AND LOSS ACCOUNT Note 44 45 13 22 50 At 1 October 2011 Dividends paid Share options exercised Charge for share based remuneration Tax on share based remuneration Actuarial (loss) on retirement benefi t obligation Profi t for the year At 30 September 2012 The Group The Company 2012 £m 495.0 (12.3) (2.3) 2.8 0.9 (0.7) 72.2 555.6 2011 £m 450.5 (11.1) (5.5) 2.0 0.1 (0.6) 59.6 495.0 2012 £m 281.8 (12.3) - 2.8 - - 61.1 333.4 2011 £m 229.0 (11.1) - 2.0 - - 61.9 281.8 Notes to the accounts 101 The Paragon Group of Companies PLC 44. EQUITY DIVIDEND Amounts recognised as distributions to equity shareholders in the period: Equity dividends on ordinary shares Final dividend for the year ended 30 September 2011 Interim dividend for the year ended 30 September 2012 Amounts paid and proposed in respect of the year: Interim dividend for the year ended 30 September 2012 Proposed fi nal dividend for the year ended 30 September 2012 2012 Per share 2011 Per share 2.65p 1.50p 4.15p 2.40p 1.35p 3.75p 2012 Per share 2011 Per share 1.50p 4.50p 6.00p 1.35p 2.65p 4.00p 2012 £m 7.9 4.4 12.3 2012 £m 4.4 13.4 17.8 2011 £m 7.1 4.0 11.1 2011 £m 4.0 7.9 11.9 Dividends of £0.0m (2011: £0.0m) were paid by the Company in respect of shares held by ESOP trusts on which dividends had not been waived. The proposed fi nal dividend for the year ended 30 September 2012 will be paid on 11 February 2013, subject to approval at the Annual General Meeting, with a record date of 11 January 2013. The dividend will be recognised in the accounts when it is paid. 45. TRANSACTIONS IN SHARES Awards from ESOP schemes Proceeds Cost of shares transferred (note 46) (Defi cit) on exercise (note 43) Shares issued Nominal value (note 38) Premium on issue (note 40) Proceeds of issue (Defi cit) / surplus on transactions in own shares The Group The Company 2012 £m 2011 £m 2012 £m 2011 £m 0.2 (2.5) (2.3) 2.1 - 2.1 (0.2) 0.8 (6.3) (5.5) 0.3 - 0.3 (5.2) - - - 2.1 - 2.1 2.1 - - - 0.3 - 0.3 0.3 102 Notes to the accounts The Paragon Group of Companies PLC 46. OWN SHARES Treasury shares At 1 October 2011 Shares purchased At 30 September 2012 ESOP shares At 1 October 2011 Shares purchased Shares subscribed for (note 38) Options exercised (note 45) At 30 September 2012 Balance at 30 September 2012 Balance at 1 October 2011 The Group The Company 2012 £m 39.5 - 39.5 8.9 0.5 2.1 (2.5) 9.0 48.5 48.4 2011 £m 39.5 - 39.5 13.7 1.2 0.3 (6.3) 8.9 48.4 53.2 2012 £m 39.5 - 39.5 - - - - - 39.5 39.5 2011 £m 39.5 - 39.5 - - - - - 39.5 39.5 At 30 September 2012 the number of the Company’s own shares held in treasury was 668,900 (2011: 668,900). These shares had a nominal value of £668,900 (2011: £668,900). The dividends on these shares have been waived. The ESOP shares are held in trust for the benefi t of employees exercising their options under the Company’s share option schemes and awards under the Paragon Performance Share Plan, Matching Share Plan and Deferred Bonus Scheme. The trustees’ costs are included in the operating expenses of the Group. At 30 September 2012, the trusts held 2,397,557 ordinary shares (2011: 2,487,688) with a nominal value of £2,397,557 (2011: £2,487,688) and a market value of £5,010,894 (2011: £3,828,552). Options, or other share-based awards, were outstanding against 2,397,557 of these shares at 30 September 2012 (2011: 2,487,688). The dividends on 1,988,482 of these shares have been waived (2011: 2,078,613). 47. FINANCIAL LIABILITIES (a) The Group Current liabilities Finance lease liability Bank loans and overdrafts Non-current liabilities Asset backed loan notes Corporate bond Finance lease liability Bank loans and overdrafts Derivative fi nancial instruments Note 49 49 35 2012 £m 1.4 0.6 2.0 7,580.9 110.0 10.2 1,453.3 4.6 2011 £m 1.2 0.6 1.8 8,049.7 112.0 11.6 1,492.1 9.1 2010 £m 1.1 0.1 1.2 8,336.2 115.8 12.8 1,403.6 17.3 9,159.0 9,674.5 9,885.7 A maturity analysis of the above borrowings and further details of asset backed loan notes and bank loans are given in note 48. Notes to the accounts 103 The Paragon Group of Companies PLC (b) The Company Current liabilities Finance lease liability Non-current liabilities Corporate bond Finance lease liability Derivative fi nancial instruments Note 49 49 35 2012 £m 2011 £m 2010 £m 1.4 1.2 1.1 110.0 10.2 - 120.2 112.0 11.6 - 123.6 115.8 12.8 - 128.6 A maturity analysis of the above borrowings is given in note 48. 48. BORROWINGS Set out below is the contractual maturity profi le of the Group’s borrowings at 30 September 2012 and 30 September 2011: In one year In more than In more than Total Financial liabilities falling due: In more than or less, or one year, but two years, but fi ve years on demand not more than not more than two years fi ve years £m £m £m £m 30 September 2012 Bank overdrafts Bank loans Corporate bond Asset backed loan notes 30 September 2011 Bank overdrafts Bank loans Corporate bond Asset backed loan notes £m 0.6 - - - 0.6 0.6 - - - 0.6 - - - - - - - - - - - 121.0 110.0 - 231.0 - 121.3 - - - 1,332.3 - 7,580.9 0.6 1,453.3 110.0 7,580.9 8,913.2 9,144.8 - 1,370.8 112.0 8,049.7 0.6 1,492.1 112.0 8,049.7 9,654.4 121.3 9,532.5 The fair values of borrowings are not considered to be signifi cantly different to their carrying values and the effective interest rates are not materially different to the rates charged. 104 Notes to the accounts The Paragon Group of Companies PLC (a) Asset backed loan notes The asset backed loan notes are secured on portfolios comprising variable and fi xed rate mortgages or personal, retail and car loans, and are redeemable in part from time to time, but such redemptions are limited to the net capital received from borrowers in respect of the underlying assets. There is no requirement for the Group to make good any shortfall out of general funds. The maturity date of the notes matches the maturity date of the underlying assets. It is likely that a substantial proportion of these notes will be repaid within fi ve years. In each issue there exists an option for the Group to repay all of the notes at an earlier date (the ‘call date’), at the outstanding principal amount. Interest is payable at a fi xed margin above: • the London Interbank Offered Rate (‘LIBOR’) on notes denominated in sterling; • the Euro Interbank Offered Rate (‘EURIBOR’) on notes denominated in euros; and • the London Interbank Offered Rate (‘US Dollar LIBOR’) on notes denominated in US dollars All payments in respect of the notes are required to be made in the currency in which they are denominated. The notes outstanding at 30 September 2012 comprised £7,283.8m (2011: £7,681.7m, 2010: £7,877.8m) in respect of mortgage backed notes and £297.1m (2011: £368.0m, 2010: £458.4m) in respect of notes backed by other loan assets. The details of the assets backing these securities are given in notes 29 and 30. The Group publishes detailed information on the performance of all of its note issues on the Bond Investor Reporting section of its website at www.paragon-group.co.uk. A more detailed description of the securitisation structure under which these notes are issued is given in note 6. In November 2011 a Group company, Paragon Mortgages (No. 16) PLC issued £131.7m Class A Senior notes, rated AAA by Fitch and Aaa by Moody’s. The Group retained £32.1m Class Z junior notes and advanced a cash fund of £5.4m. Notes to the accounts 105 The Paragon Group of Companies PLC Notes in issue at 30 September 2012 and 30 September 2011, net of any held by the Group, were: Issuer Sterling notes Maturity date Call date Principal outstanding 2012 £m 83.6 226.8 142.3 181.3 89.5 129.2 146.5 131.6 181.6 130.1 74.7 83.8 74.2 74.2 Paragon Mortgages (No. 7) PLC 15/05/43 Paragon Mortgages (No. 8) PLC 15/04/44 Paragon Mortgages (No. 9) PLC 15/05/41 Paragon Mortgages (No. 10) PLC 15/06/41 Paragon Mortgages (No. 11) PLC 15/10/41 Paragon Mortgages (No. 12) PLC 15/11/38 Paragon Mortgages (No. 13) PLC 15/01/39 Paragon Mortgages (No. 14) PLC 15/09/39 Paragon Mortgages (No. 15) PLC 15/12/39 Paragon Mortgages (No. 16) PLC 15/04/39 First Flexible No. 4 PLC First Flexible No. 5 PLC First Flexible No. 6 PLC First Flexible No. 7 PLC Paragon Personal and Auto 01/07/36 01/06/34 01/12/35 15/09/33 15/05/08 15/10/08 15/05/09 15/12/09 15/04/10 15/08/10 15/10/10 15/03/11 15/06/11 15/10/14 01/07/08 01/07/09 01/03/08 15/03/11 Finance (No. 3) PLC 15/04/36 15/04/09 75.0 Paragon Secured Finance (No. 1) PLC 15/11/35 15/11/08 112.5 US dollar notes Paragon Mortgages (No. 7) PLC Paragon Mortgages (No. 9) PLC 15/05/43 15/05/41 Paragon Mortgages (No. 10) PLC 15/06/41 Paragon Mortgages (No. 11) PLC 15/10/41 Paragon Mortgages (No. 12) PLC 15/11/38 Paragon Mortgages (No. 13) PLC 15/01/39 Paragon Mortgages (No. 14) PLC 15/09/39 Paragon Mortgages (No. 15) PLC 15/12/39 First Flexible No. 6 PLC 01/12/35 Euro notes Paragon Mortgages (No. 7) PLC 15/05/43 Paragon Mortgages (No. 8) PLC 15/04/44 Paragon Mortgages (No. 9) PLC 15/05/41 Paragon Mortgages (No. 10) PLC 15/06/41 Paragon Mortgages (No. 11) PLC 15/10/41 Paragon Mortgages (No. 12) PLC 15/11/38 Paragon Mortgages (No. 13) PLC 15/01/39 Paragon Mortgages (No. 14) PLC 15/09/39 Paragon Mortgages (No. 15) PLC 15/12/39 First Flexible No. 6 PLC 01/12/35 Paragon Personal and Auto 15/05/08 15/05/09 15/12/09 15/04/10 15/08/10 15/10/10 15/03/11 15/06/11 01/03/08 15/05/08 15/10/08 15/05/09 15/12/09 15/04/10 15/08/10 15/10/10 15/03/11 15/06/11 01/03/08 $m 241.6 23.2 176.3 484.4 1,089.3 1,147.6 1,324.6 903.3 11.5 €m 245.6 304.3 220.9 265.5 227.9 379.4 360.4 395.8 282.4 42.1 2011 £m 86.1 242.8 146.4 183.4 92.1 131.5 148.5 161.6 186.5 - 80.1 92.1 78.7 95.2 92.7 138.0 $m 248.9 23.8 192.7 501.6 1,118.4 1,176.6 1,363.0 930.3 11.9 €m 253.1 317.5 227.2 266.7 281.8 383.3 365.3 400.8 285.0 43.9 Average interest margin 2012 % 2011 % 0.42 0.59 0.38 0.56 0.28 0.38 0.35 0.29 0.29 2.75 1.10 0.99 1.27 0.25 0.95 0.98 % 0.74 0.36 0.09 0.10 0.24 0.23 0.20 0.19 0.56 % 0.66 0.48 0.56 0.41 0.52 0.51 0.39 0.43 0.67 1.05 0.84 0.42 0.61 0.38 0.56 0.28 0.37 0.17 0.16 0.14 - 1.10 0.99 1.28 0.13 0.95 1.00 % 0.74 0.36 0.09 0.10 0.14 0.11 0.10 0.09 0.56 % 0.66 0.48 0.56 0.41 0.52 0.51 0.20 0.21 0.33 1.05 0.84 Finance (No. 3) PLC 15/04/36 15/04/09 129.3 159.8 Following the year end, on 25 October 2012 a Group company, Paragon Mortgages (No. 17) PLC, issued £195.5m of sterling mortgage backed fl oating rate notes at par. £175.0m of the notes were rated AAA, £10.5m rated AA and £10.0m rated A. The average interest margin above LIBOR on the notes was 145.9% and the proceeds were used to pay down existing warehouse debt. The Group retained £4.5m of subordinated notes and also invested £6.0m in the fi rst loss fund, bringing its total investment to £10.5m, or 5.25% of the issue amount. 106 Notes to the accounts The Paragon Group of Companies PLC (b) Bank borrowings Assets are typically securitised within 12 months of origination. Before securitisation new loans are fi nanced by a bank loan, referred to as a ‘warehouse facility’ These are generally drawn down to fund completions and repaid when assets are securitised. More information on this process is given in note 6 and details of assets held within the warehouse facilities are given in note 29. Details of the Group’s bank borrowings are given below. Paragon Second Principal value £m 2012 Maximum available facility £m Carrying value Principal value £m £m 2011 Maximum available facility £m Carrying value £m Funding 1,332.3 1,332.3 1,332.3 1,370.8 1,370.8 1,370.8 Paragon Fourth Funding Paragon Fifth Funding 121.0 - 200.0 200.0 121.0 123.0 200.0 121.3 - - - - 1,453.3 1,732.3 1,453.3 1,493.8 1,570.8 1,492.1 The Paragon Second Funding warehouse was available for further drawings until 29 February 2008 at which point it converted automatically to a term loan and no further drawings were allowed. This loan is a committed sterling facility provided to Paragon Second Funding Limited by a consortium of banks and is secured on all the assets of Paragon Second Funding Limited, Paragon Car Finance (No. 1) Limited and Paragon Personal Finance (No. 1) Limited. Its fi nal repayment date is 28 February 2050 but it is likely that substantial repayments will be made within the next fi ve years. Interest on this loan is payable monthly in sterling at 0.675% above LIBOR (2011: 0.675% above LIBOR). Repayments of this facility before the fi nal repayment date are restricted to the amount of principal cash realised from the funded assets. On 27 September 2010 the Group entered into a £200.0m committed sterling facility provided to Paragon Fourth Funding Limited by Macquarie Bank plc to provide funding for new lending. This facility is secured on all the assets of Paragon Fourth Funding Limited and is available for drawing for a period of two years and has a term of four years. Loans originated in this warehouse are refi nanced in the mortgage backed securitisation market from time to time when appropriate. Interest on this loan is payable monthly in sterling at 2.875% above LIBOR. The facility was renewed on substantially the same terms with an increased commitment of £250.0m, for a further two year period on 2 November 2012 and has a renewal process that allows the Group to agree a new two year commitment period prior to the expiry of the existing commitment period. Repayments on this facility are limited to principal cash received from the funded assets. To provide further funding for new lending, on 27 September 2012, the Group entered into a £200.0m committed sterling facility provided to Paragon Fifth Funding Limited by the wholesale division of Lloyds Bank. This facility is secured on all the assets of Paragon Fifth Funding Limited and is structured with a three year term to permit drawings and re-drawings in its fi rst eighteen months, or up to 24 months, subject to a capital markets refi nancing of the facility in its fi rst twelve months. Loans originated in this warehouse will be refi nanced in the mortgage backed securitisation market from time to time when appropriate. Interest on this loan is payable monthly in sterling at 2.75% above three month LIBOR. The facility has a renewal process that allows the Group to agree a new commitment period prior to the expiry of the existing commitment period. As with the other warehouses, repayments on this facility are limited to principal cash received from the funded assets. The Group additionally has entered into £63.6m (2011: £64.1m) of sterling revolving credit facilities to fund, where necessary, the purchase of mortgage redraws in certain subsidiary companies. At 30 September 2012 £nil (2011: £nil) had been drawn down under these facilities. The weighted average margin above LIBOR on bank borrowings at 30 September 2012 was 0.858% (2011: 0.856%). (c) Corporate bond On 20 April 2005 the Company issued £120.0m of 7% Callable Subordinated Notes at an issue price of 99.347% to provide long term capital for the Group. These bonds bore interest at a fi xed rate of 7% per annum until 20 April 2012, after which interest was payable at a fi xed rate of 3.729% per annum. The bonds are repayable on 20 April 2017. They are unsecured and subordinated to any other creditors of the Company. At 30 September 2012 £110.0m (2011: £112.0m, 2010: £115.8m) was included within the fi nancial liabilities of the Company and the Group in respect of these bonds. Notes to the accounts 107 The Paragon Group of Companies PLC 49. OBLIGATIONS UNDER FINANCE LEASES The fi nance lease obligations recorded in the accounts arise from a sale and leaseback transaction of one of the Group’s offi ce buildings in 1997 which falls to be treated as a fi nance lease under IAS 17 - ‘Leases’. The lease expires in 2019 and is subject to fi ve yearly rent reviews, with guaranteed minimum rent increases. The minimum lease payments payable under this lease are: Amounts payable Within one year Within two to fi ve years After fi ve years Less: future fi nance charges Present value of lease obligations The present value of these payments recognised in the fi nancial statements is: Amounts payable Within one year Within two to fi ve years After fi ve years 2012 £m 2.3 9.6 3.0 14.9 (3.3) 11.6 2012 £m 1.4 7.4 2.8 11.6 2011 £m 2.2 9.5 5.4 17.1 (4.3) 12.8 2011 £m 1.2 6.7 4.9 12.8 2010 £m 2.2 9.3 7.8 19.3 (5.4) 13.9 2010 £m 1.1 6.0 6.8 13.9 The fair value of the lease obligation is not considered to be materially different to the present value of the future obligations shown above. The interest rate implicit in the lease is 7.99% (2011: 7.99%). At 30 September 2012 the minimum amount of payments expected to be received in respect of non-cancellable sub-leases in respect of this building was £nil (2011: £400,000). 108 Notes to the accounts The Paragon Group of Companies PLC 50. RETIREMENT BENEFIT OBLIGATIONS The Group operates a funded defi ned benefi t pension scheme in the UK (the ‘Plan’). A full actuarial valuation was carried out at 31 March 2010 and updated to 30 September 2012 by a qualifi ed independent actuary. The liabilities of the Plan are measured by discounting the best estimate of future cash fl ows to be paid out by the scheme using the Projected Unit method. This amount is refl ected in the liability in the balance sheet. The Projected Unit method is an accrued benefi ts valuation method in which the technical provisions are calculated based on service up until the valuation date allowing for future salary growth until the date of retirement, withdrawal or death, as appropriate. The future service rate is then calculated as the contribution rate required to fund the service accruing over the control period again allowing for future salary growth. As a result of the Plan being closed to new entrants, the service cost as a percentage of pensionable salaries is expected to increase as the members of the Plan approach retirement. However, the membership is expected to reduce so that the service charge in monetary terms will gradually reduce. The major weighted average assumptions used by the actuary were (in nominal terms): 30 September 2012 30 September 30 September 2011 2010 In determining net pension cost for the year Discount rate Expected long term rate of return on scheme assets Rate of compensation increase Rate of increase of pensions in payment (accrued before 6 April 2006) in payment (accrued after 5 April 2006) in deferment In determining benefi t obligations Discount rate Rate of compensation increase Rate of increase of pensions in payment (accrued before 6 April 2006) in payment (accrued after 5 April 2006) in deferment Further life expectancy at age 60 Pensioner (male) Pensioner (female) Non-retired member (male) Non-retired member (female) 5.25% 5.90% 4.10% 3.10% 3.10% 3.00% 4.60% 3.65% 2.65% 2.65% 2.55% 30 32 32 34 5.20% 6.30% 4.00% 3.00% 3.00% 3.00% 5.25% 4.10% 3.10% 3.10% 3.00% 30 32 32 34 5.70% 6.60% 4.20% 3.20% 2.50% 3.20% 5.20% 4.00% 3.00% 2.50% 3.00% 30 33 31 35 Notes to the accounts 109 The Paragon Group of Companies PLC The assets in the Plan at 30 September 2012, 30 September 2011 and 30 September 2010 and the expected rates of return were: At 30 September 2012 Value Long term rate of return expected 6.05% 3.60% 4.60% £m 40.7 22.5 6.1 At 30 September 2011 At 30 September 2010 Long term rate of return expected 6.75% 4.65% 5.30% Value £m 34.0 19.3 5.8 Long term rate of return expected 7.25% 4.40% 5.80% Value £m 35.2 16.8 5.2 5.10% 69.3 5.90% 59.1 6.28% 57.2 (83.2) (13.9) (73.5) (14.4) (73.7) (16.5) Equities Bonds Other Total market value of assets Present value of scheme liabilities (Defi cit) in the scheme The Plan assets are held in a separate trustee-administered fund to meet long-term pension liabilities to past and present employees. The trustees of the Plan are required to act in the best interests of the Plan’s benefi ciaries. The appointment of trustees to the Plan is determined by the scheme’s trust documentation. The Group has a policy that one third of all trustees should be nominated by active and pensioner members of the Plan. At 30 September 2012 the Plan assets were invested in a diversifi ed portfolio that consisted primarily of equity and gilt investments. The majority of the equities held by the Plan are in developed markets. The target asset allocations for the year ending 30 September 2013 are 50% equities, 30% bonds and 20% other assets. In conjunction with the trustees, the Group has continued to conduct asset-liability reviews of the Plan. These studies are used to assist the trustees and the Group to determine the optimal long-term asset allocation with regard to the structure of liabilities within the Plan. The results of the studies are used to assist the trustees in managing the volatility in the underlying investment performance and risk of a signifi cant increase in the scheme defi cit by providing information used to determine the investment strategy of the Plan. Following the 2010 actuarial valuation, the trustees put in place a recovery plan. The trustees’ recovery plan aims to meet the statutory funding objective within seven years and three months from the date of valuation, i.e. by 30 June 2017. The rate of return expected on scheme assets is based on the current level of expected returns on risk free investments (primarily government bonds), the historical level of the risk premium associated with other asset classes in which the portfolio is invested and the expectations for future returns of each asset class. The expected return for each asset class was then weighted based on the asset allocation to develop the expected long-term rate of return on assets assumption for the portfolio. The movement in the market value of the scheme assets during the year was as follows: At 1 October 2011 Movement in year Contributions by the Group Contributions by scheme members Benefi ts paid Expected return on scheme assets Actuarial gain / (loss) At 30 September 2012 The actual return on scheme assets in the year ended 30 September 2012 was £8.0m (2011: £(0.8)m). 2012 £m 59.1 2.9 0.3 (0.9) 3.5 4.4 69.3 2011 £m 57.2 3.5 0.3 (1.1) 3.6 (4.4) 59.1 110 Notes to the accounts The movement in the present value of the scheme liabilities during the year was as follows: At 1 October 2011 Movement in year Current service cost Past service costs Contributions by scheme members Plan curtailments Benefi ts paid Finance cost Actuarial loss / (gain) At 30 September 2012 The Paragon Group of Companies PLC 2012 £m 73.5 1.5 - 0.3 - (0.9) 3.9 4.9 83.2 2011 £m 73.7 1.6 - 0.3 (0.7) (1.1) 3.8 (4.1) 73.5 The most recent valuation of the scheme liabilities on a buy-out basis obtained by the trustees in accordance with section 224 of the Pensions Act 2004 was calculated at 31 March 2010, when the valuation on that basis was £85.6m. The sensitivity of the valuation of the scheme liabilities to the principal assumptions disclosed above at 30 September 2012 is as follows: Assumption Discount rate Rate of infl ation * Rate of salary growth Rates of mortality Increase in assumption Impact on scheme liabilities 0.1% p.a. 0.1% p.a. 0.1% p.a. 1 year of life expectancy Decrease by 2.5% Increase by 2.5% Increase by 0.5% Increase by 1.9% * maintaining a 1% real increase in salary growth The duration of the scheme’s liabilities are shown in the table below: Category of member Active members Deferred pensioners Current pensioners All members 2012 Years 27 28 14 27 2011 Years 28 29 15 28 The agreed rate of employer contributions was 27.4% of gross salaries for participating employees up to and including 26 June 2011. With effect from 27 June 2011, the employer contribution rate decreased to 26.6% of gross salaries, following the fi nalisation of the 31 March 2010 actuarial valuation. Since 1 July 2008 an additional contribution of £0.5m per annum has been paid by monthly instalments. During the year ended 30 September 2011 this was increased to £1.5m per annum, backdated to 1 April 2010. The present best estimate of the contributions to be made to the plan by the Group in the year ending 30 September 2013 is £2.9m. Notes to the accounts 111 The Paragon Group of Companies PLC The amounts charged in the income statement in respect of the pension scheme are: Current service cost Past service cost Plan curtailments Included within operating expenses Expected return on scheme assets Funding cost of scheme liability Total expense recognised in profi t Note 13 9 10 2012 £m 1.5 - - 1.5 (3.5) 3.9 1.9 The actuarial losses and gains in the statement of comprehensive income in respect of the pension scheme are: Gain / (loss) on scheme assets (Loss) / gain on scheme liabilities Total actuarial (loss) Tax thereon Net actuarial (loss) Note 22 43 2012 £m 4.4 (4.9) (0.5) (0.2) (0.7) 2011 £m 1.6 - (0.7) 0.9 (3.6) 3.8 1.1 2011 £m (4.4) 4.1 (0.3) (0.3) (0.6) The tax shown above is disproportionate to the actuarial losses recorded in the periods due to the effect on deferred tax of the changes in tax rate described in note 19. The cumulative value of actuarial losses charged through reserves to the profi t and loss account since 1 October 2001, the fi rst date on which a valuation of the scheme assets and liabilities on a basis consistent with IAS 19 was carried out is £34.2m (2011: £33.7m). The fi ve year history of experience adjustments on the scheme is as shown below: Fair value of scheme assets Present value of scheme obligations (Defi cit) in the scheme Experience adjustments on scheme assets: Amount (£m) Percentage of scheme assets Experience adjustments on scheme liabilities: Amount (£m) Percentage of scheme liabilities 2012 £m 69.3 (83.2) (13.9) 4.4 6.4% (0.1) 0.0% 2011 £m 59.1 (73.5) (14.4) (4.4) (7.5)% 2.8 3.8% 2010 £m 57.2 (73.7) (16.5) 0.4 0.6% - 0.0% 2009 £m 52.0 (63.5) (11.5) 2.8 5.3% - 0.0% 2008 £m 43.9 (48.9) (5.0) (10.4) (23.8)% 0.2 0.4% In addition to the Group Pension Scheme, the Group operates a defi ned contribution (Stakeholder) pension scheme. Contributions made by the Group to this scheme in the year ended 30 September 2012 were £0.2m (2011: £0.2m). 112 Notes to the accounts The Paragon Group of Companies PLC 51. DEFERRED TAX (a) The Group The movements in the net deferred tax liability / (asset) are as follows: Net liability / (asset) at 1 October 2011 Income statement charge (Credit) / charge to equity Net liability / (asset) at 30 September 2012 Note 19 22 2012 £m 5.0 3.7 (1.1) 7.6 The net deferred tax liability / (asset) for which provision has been made is analysed as follows: Accelerated tax depreciation Retirement benefi t obligations Impairment and other provisions Tax losses Other timing differences Net deferred tax liability / (asset) (b) The Company 2012 £m (0.8) (3.2) 16.5 (3.3) (1.6) 7.6 2011 £m (1.5) 6.3 0.2 5.0 2011 £m (1.0) (3.6) 16.2 (6.6) - 5.0 No provision for deferred tax was required in the Company at 30 September 2012, 30 September 2011 or 30 September 2010. 52. CURRENT TAX LIABILITIES (a) The Group UK Corporation Tax (b) The Company UK Corporation Tax 2012 £m 13.3 13.3 2012 £m 4.4 4.4 2011 £m 10.7 10.7 2011 £m 3.3 3.3 2010 £m (2.8) 2.9 (1.6) (1.5) 2010 £m (1.4) (4.5) 16.5 (13.2) 1.1 (1.5) 2010 £m 16.2 16.2 2010 £m 1.5 1.5 Notes to the accounts 113 The Paragon Group of Companies PLC 53. OTHER LIABILITIES (a) The Group Current liabilities Accrued interest Deferred income Other accruals Other taxation and social security Non-current liabilities Deferred income Other accruals 2012 £m 23.4 0.3 11.8 1.2 36.7 1.1 - 1.1 2011 £m 25.4 0.3 11.7 0.9 38.3 1.4 0.1 1.5 2010 £m 21.1 0.4 10.1 0.8 32.4 1.5 0.1 1.6 Accrued interest and other accruals fall within the defi nition of ‘other fi nancial liabilities’ set out in IAS 32 and IAS 39 and their fair values are not considered to be materially different to their carrying values. (b) The Company Current liabilities Amounts owed to Group companies Accrued interest Deferred income Non-current liabilities Deferred income 2012 £m 69.2 1.8 0.1 71.1 0.7 0.7 2011 £m 312.9 3.5 0.1 316.5 0.8 0.8 2010 £m 385.6 3.5 0.1 389.2 0.9 0.9 Accrued interest and other accruals fall within the defi nition of ‘other fi nancial liabilities’ set out in IAS 32 and IAS 39 and their fair values are not considered to be materially different to their carrying values. 114 Notes to the accounts The Paragon Group of Companies PLC 54. NET CASH FLOW FROM OPERATING ACTIVITIES (a) The Group Profi t before tax Non-cash items included in profi t and other adjustments: Depreciation of property, plant and equipment Amortisation of intangible assets Foreign exchange movement on borrowings Other non-cash movements on borrowings Impairment losses on loans to customers Charge for share based remuneration (Profi t) / loss on disposal of property, plant and equipment Net decrease / (increase) in operating assets: Loans to customers Derivative fi nancial instruments Fair value of portfolio hedges Other receivables Net (decrease) / increase in operating liabilities: Derivative fi nancial instruments Other liabilities Cash generated by operations Income taxes (paid) / received (b) The Company Profi t before tax Non-cash items included in profi t and other adjustments: Depreciation of property, plant and equipment Non-cash movements on borrowings Impairment losses on investments in subsidiaries Charge for share based remuneration Net (increase) / decrease in operating assets: Other receivables Derivative fi nancial instruments Net increase / (decrease) in operating liabilities: Derivative fi nancial instruments Other liabilities Cash (utilised) / generated by operations Income taxes (paid) 2012 £m 95.5 2.1 1.0 (344.9) (0.7) 24.1 2.8 - 8.2 351.4 2.3 - (4.5) (3.0) 134.3 (17.0) 117.3 2012 £m 65.4 1.0 (2.0) 116.7 2.8 (0.1) 4.0 - (245.5) (57.7) (3.2) (60.9) 2011 £m 80.8 2.0 0.9 (3.2) (1.2) 24.4 2.0 (0.1) 150.8 8.5 5.2 1.2 (8.2) 3.4 266.5 (20.4) 246.1 2011 £m 65.1 1.1 (3.8) 1.5 2.0 45.8 4.0 - (72.8) 42.9 (1.4) 41.5 Notes to the accounts 115 The Paragon Group of Companies PLC 55. NET CASH FLOW FROM INVESTING ACTIVITIES Proceeds on disposal of property, plant and equipment Purchases of property, plant and equipment Purchases of intangible assets Investment in subsidiary undertakings Net cash (utilised) / generated by investing activities The Group The Company 2012 £m 0.2 (1.6) (0.8) - (2.2) 2011 £m 0.9 (2.0) (1.0) - (2.1) 2012 £m - - - 7.6 7.6 56. NET CASH FLOW FROM FINANCING ACTIVITIES Shares issued Dividends paid (note 44) Issue of asset backed fl oating rate notes Repayment of asset backed fl oating rate notes Capital element of fi nance lease payments Movement on bank facilities Purchase of shares (note 46) Sale of shares (note 45) Net cash (utilised) by fi nancing activities The Group The Company 2012 £m - (12.3) 129.9 (254.9) (1.2) (43.1) (0.5) 0.2 (181.9) 2011 £m - (11.1) - (284.1) (1.1) 87.1 (1.2) 0.8 (209.6) 2012 £m 2.1 (12.3) - - (1.2) - - - (11.4) 2011 £m - - - 16.0 16.0 2011 £m 0.3 (11.1) - - (1.1) - - - (11.9) 57. OPERATING LEASE ARRANGEMENTS (a) As lessee Minimum lease payments under operating leases recognised in income for the year Offi ce buildings Motor vehicles The Group The Company 2012 £m 2.3 0.3 2.6 2011 £m 2.3 0.2 2.5 2012 £m 2011 £m - - - - - - 116 Notes to the accounts The Paragon Group of Companies PLC At 30 September 2012 the Group had outstanding commitments for future minimum lease payments under non-cancellable operating leases, which fall due as follows: Amounts falling due: Within one year Between two and fi ve years After more than fi ve years The Group The Company 2012 £m 2.5 5.6 0.8 8.9 2011 £m 2.6 7.3 2.0 11.9 2012 £m 2011 £m - - - - - - - - Operating lease payments represent rents payable by the Group in respect of certain of its offi ce premises and lease payments on company vehicles. The average term of the current building leases is 11 years (2011: 11 years) with rents subject to review every fi ve years, while the average term of the vehicle leases is 3 years (2011: 3 years). (b) As lessor Certain of the Group’s offi ce premises which are not currently required by the Group have been sub-let. Rental income from these premises during the year ended 30 September 2012 was: Rental income The Group The Company 2012 £m 0.3 2011 £m 1.2 2012 £m 0.3 2011 £m 1.2 At 30 September 2012 the Group had received outstanding commitments from tenants for future minimum lease payments under non-cancellable operating leases, which fall due as follows: Amounts receivable: Within one year The Group The Company 2012 £m - - 2011 £m 0.4 0.4 2012 £m - - 2011 £m 0.4 0.4 58. CAPITAL COMMITMENTS At 30 September 2012 the Group had no commitments in respect of capital expenditure contracted but not provided for (2011: £0.9m). Notes to the accounts 117 The Paragon Group of Companies PLC 59. RELATED PARTY TRANSACTIONS (a) The Group On 27 May 2010, Mr A K Fletcher, an independent non-executive director of the Company, was appointed as a trustee of the Group Pension Plan. In respect of this appointment he was paid £10,000 in the year ended 30 September 2012 by Paragon Finance plc, the sponsoring company of the Plan (2011: £10,000). The Group Pension Plan is a related party of the Group. Transactions with the plan are described in note 50. The Group had no other transactions with related parties other than the key management compensation disclosed in note 14. (b) The Company During the year the parent company entered into transactions with its subsidiaries, which are related parties. Management services were provided to the Company by one of its subsidiaries and the Company granted awards under the share based payment arrangements described in note 15 to employees of subsidiary undertakings. The Company also issued shares to the trustees of its ESOP trusts, as described in note 38. Details of the Company’s investments in subsidiaries and the income derived from them are shown in notes 26 and 27. Outstanding current account balances with subsidiaries are shown in notes 36 and 53. During the year the Company incurred interest costs of £9.7m in respect of borrowings from its subsidiaries (2011: £15.4m). 118 Notes to the accounts Appendices to the annual report For the year ended 30 September 2012 A. COST : INCOME RATIO Cost:income ratio is derived as follows: Cost - operating expenses Total operating income Cost / Income B. UNDERLYING PROFIT The Paragon Group of Companies PLC 2012 £m 51.9 170.2 2011 £m 45.4 150.9 30.5% 30.1% Underlying profi t is determined by excluding from the operating result certain costs of a one off nature, which do not refl ect the underlying business performance of the Group, and fair value accounting adjustments arising from the Group’s hedging arrangements. First Mortgages Profi t before tax for the period (note 7) Less: Fair value losses / (gains) Consumer Finance Profi t before tax for the period (note 7) Less: Fair value losses / (gains) Total Profi t before tax for the period (note 7) Less: Fair value losses / (gains) 2012 £m 63.2 (1.6) 61.6 32.3 0.3 32.6 95.5 (1.3) 94.2 2011 £m 67.1 0.2 67.3 13.7 0.1 13.8 80.8 0.3 81.1 Appendices to the Annual Report 119 The Paragon Group of Companies PLC C. NET ASSET VALUE PER SHARE Net asset value per share is derived as follows: Total equity (£m) Outstanding issued shares (m) Treasury shares (m) Shares held by ESOP schemes (m) Note 38 46 46 2012 803.5 301.8 (0.7) (2.3) 298.8 2011 742.0 299.7 (0.7) (2.5) 296.5 Net asset value per £1 ordinary share 269p 250p 120 Appendices to the Annual Report By Carbon Balancing the material used to produce this publication we have: • Saved 1,843 Kilograms of CO2. • Preserved 154.81 Square metres of Land. The estimated carbon impact of this publication comes from a calculator developed by the Edinburgh Centre of Carbon Management (ECCM). It is derived from data supplied by the paper mill or, where this is not available, generic industry factors as determined by ECCM. The estimated carbon impacts are measured with the point of delivery being the printer’s doorstep. What is Carbon Balanced Paper? Carbon Balanced, put simply, is where the carbon impact of a product or service has been estimated and an equivalent amount of carbon dioxide is either prevented from being released or is absorbed from the atmosphere. Carbon Balancing is facilitated by the World Land Trust, an ecological charity which ensures a company’s peace of mind regarding the credibility and integrity of how carbon impacts are balanced (offset). Carbon Balancing is achieved through land purchase of ecologically important standing forests, under imminent threat of clearance, where carbon is locked that would otherwise be released. These protected forests are then able to continue absorbing carbon from the atmosphere. CBP00017942011123313 The Paragon Group of Companies PLC 51 Homer Road Solihull West Midlands B91 3QJ Telephone: 0121 712 2323 www.paragon-group.co.uk Registered No. 2336032 ) 2 1 0 2 / 1 1 ( 4 9 3 6 P R G