NORTHERN ROCK PLC PILLAR 3 DISCLOSURES - 31 December 2011
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NORTHERN ROCK PLC PILLAR 3 DISCLOSURES 31 December 2011
Northern Rock plc – Pillar 3 disclosures
1. OVERVIEW .................................................................................................................4
1.1 Background .................................................................................................................4
1.2 Frequency & Location .................................................................................................4
1.3 Verification...................................................................................................................4
1.4 Recent developments.................................................................................................4
2. SCOPE OF APPLICATION OF DIRECTIVE REQUIREMENTS .........................................5
3. CAPITAL RESOURCES.................................................................................................6
4. ASSESSMENT OF INTERNAL CAPITAL.........................................................................8
5. COUNTERPARTY CREDIT RISK RELATING TO DERIVATIVES........................................9
6. CREDIT RISK AND DILUTION RISK ............................................................................10
6.1 Impairment losses...................................................................................................... 10
6.1.1 Assets held at amortised cost............................................................................... 10
6.1.2 Available for sale financial assets ........................................................................ 11
6.1.3 Renegotiated loans .............................................................................................. 11
6.1.4 Forbearance.......................................................................................................... 11
6.2 Exposures at default .................................................................................................. 11
6.3 Geographical distribution of exposures................................................................... 13
6.4 Exposure at default by residual maturity ................................................................. 14
6.5 Impairments by exposure class................................................................................ 14
6.6 Geographical distribution of impairments ............................................................... 15
6.7 Movements in impairments ...................................................................................... 16
6.8 Exposures by credit rating ........................................................................................ 17
7. IRB DISCLOSURES FOR SPECIALISED LENDING AND EQUITY CLASSES...................18
8. INTEREST RATE RISK IN THE BANKING BOOK...........................................................19
9. SECURITISATION ......................................................................................................20
9.1 Objectives in relation to securitisation ..................................................................... 20
9.2 Issued and retained securitisation positions ............................................................ 20
9.2.1 Risks inherent in the issued and retained securitisation position......................... 20
9.2.2 Roles played by the Group in the securitisation process.................................... 21
9.2.3 Calculating risk weighted exposure amounts ..................................................... 21
9.2.4 Accounting policies for issued and retained securitisation activities ................ 21
9.2.5 ECAIs used for securitisations................................................................................ 22
9.2.6 Exposures securitised by the Group ..................................................................... 22
9.2.7 Securitisation activity during 2011 ........................................................................ 23
9.2.8 Synthetic securitisations ........................................................................................ 23
9.3 Purchased securitisation positions............................................................................ 23
9.3.1 Risks inherent in the purchased securitisation position........................................ 23
9.3.2 Roles played by the Group in the securitisation process.................................... 23
9.3.3 Calculating risk weighted exposure amounts ..................................................... 23
9.3.4 Accounting policies for purchased securitisation positions................................ 24
10. IRB DISCLOSURES.................................................................................................25
10.1 Retail exposures secured by real estate collateral................................................. 25
10.2 Retail IRB..................................................................................................................... 25
10.3 Exposures by exposure class.................................................................................... 26
10.4 Impairment charges by exposure type ................................................................... 28
10.5 Loss analysis – regulatory expected loss versus actual loss ................................... 28
10.6 Credit Model Performance – Estimated versus Actual............................................ 29
Page 2 of 37Northern Rock plc – Pillar 3 disclosures
11. CREDIT RISK MITIGATION ....................................................................................30
11.1 Retail exposures ........................................................................................................ 30
11.2 Treasury exposures.................................................................................................... 30
12. REMUNERATION...................................................................................................31
12.1 Approach to remuneration....................................................................................... 31
12.2 The Remuneration Committee.................................................................................. 31
12.3 Design characteristics of the remuneration system ................................................ 32
12.4 Link between pay and performance and the performance criteria used............. 34
12.5 Remuneration for code Staff ..................................................................................... 35
12.5.1 Fixed and Variable Remuneration ................................................................... 35
12.5.2 Deferred Remuneration.................................................................................... 36
12.5.3 Sign on and Severance Payments................................................................... 37
Page 3 of 37Northern Rock plc – Pillar 3 disclosures
1. Overview
1.1 Background
The Capital Requirements Directive (Basel II), has been implemented in the UK by the
Financial Services Authority (FSA) and enforced through the Prudential sourcebook for
Banks, Building Societies and Investment Firms (BIPRU). The rules consist of three ‘pillars’.
Pillar 1 sets out the minimum capital requirements firms are required to meet for credit,
market and operational risk.
Pillar 2 describes the supervisory review process and the assessment of additional capital
resources required to cover specific risks faced by the Group that have not been
covered by the minimum regulatory requirements as set out in Pillar 1.
Pillar 3 aims to encourage market discipline by developing a set of disclosure
requirements which allow market participants to assess key pieces of information
on a firm’s capital, risk exposures and risk assessment processes.
This document sets out the quantitative disclosures required under the FSA handbook set
out in BIPRU Chapter 11, which represent the regulatory disclosure requirements in the UK of
the Pillar 3 requirements of Basel II. The qualitative disclosures required under Pillar 3 are
included in the Northern Rock plc Annual Report and Accounts for 31 December 2011,
primarily in note 31, but with details of hedging policies in note 16.
1.2 Frequency & Location
Northern Rock’s Pillar 3 disclosure is published on an annual basis. The Pillar 3 disclosure
document is published on the corporate website.
The frequency of disclosure will be reviewed should there be a material change in any
approach used for the calculation of capital, business structure or regulatory requirements.
1.3 Verification
These disclosures are not subject to external audit, except where they are equivalent to
those prepared under accounting requirements for inclusion in the Group’s audited
Annual Report and Accounts dated 31st December 2011. These disclosures are approved
by the Board.
1.4 Recent developments
On 1 January 2012, Virgin Money Holdings (UK) Limited acquired 100% of the ordinary share
capital of Northern Rock plc. On 2 January 2012, Northern Rock plc acquired 100% of the
ordinary share capital of Virgin Money Limited from Virgin Money Holdings (UK) Limited for
£330m. For further details, please see note 36 to Northern Rock’s statutory accounts. Apart
from the table on page 7, the figures in this document reflect the position of the Group
before completion of the sale.
Page 4 of 37Northern Rock plc – Pillar 3 disclosures
2. Scope of application of directive requirements
Northern Rock plc is a UK bank regulated by the Financial Services Authority (‘FSA’). It is
the parent company of the Northern Rock plc group. The disclosures in this report have
been prepared for the Northern Rock plc regulatory group as at 31 December 2011 in
accordance with the requirements of the FSA handbook set out in BIPRU chapter 11.
The only subsidiary of Northern Rock plc at 31 December 2011 is listed below. It operates
in its country of incorporation and is directly held and wholly owned by the Company:
Nature of business Country of incorporation
Northern Rock (Guernsey) Limited Ex-retail deposit taker Guernsey
Northern Rock (Guernsey) Limited has been in voluntary liquidation throughout 2011.
The investment is in the ordinary shares of Northern Rock (Guernsey) Limited and the cost
at 31 December 2011 is less than £0.1m. The Directors consider the value of the investment
to be supported by the underlying assets.
As Northern Rock (Guernsey) Limited was in voluntary liquidation throughout the year, its
ability to pay dividends to Northern Rock plc was restricted. Apart from this, there were no
material legal or practical impediments to the prompt transfer of capital resources or
repayment of liabilities when due between Northern Rock plc and its subsidiary.
The following companies are special purpose entities (“SPEs”) established in connection
with the Group’s securitisation programme. Although Northern Rock plc has no direct or
indirect ownership interest in these companies, they are regarded as legal subsidiaries
under UK companies legislation. This is because they are principally engaged in providing
a source of long term funding to the Group, which in substance has the rights to all benefits
from the activities of the SPEs. They are therefore effectively controlled by the Group.
Nature of business Country of incorporation
Gosforth Funding plc Issue of securitised notes England & Wales
Gosforth Funding 2011-1 plc Issue of securitised notes England & Wales
Gosforth Mortgages Trustee Limited Trust England & Wales
Gosforth Mortgages Trustee 2011-1 Limited Trust England & Wales
Gosforth Holdings Limited Holding company England & Wales
Gosforth Holdings 2011-1 Limited Holding company England & Wales
Northern Rock plc reported to the FSA on a non-consolidated basis.
Page 5 of 37Northern Rock plc – Pillar 3 disclosures
3. Capital resources
The following table sets out the capital resources of Northern Rock plc at 31 December
2011:
Note 2011 2010
£m £m
Core Tier 1
Ordinary share capital 1,400.0 1,400.0
Retained reserves 1 (230.1) (211.7)
Pension scheme 2 (3.3) (2.8)
1,166.6 1,185.5
Regulatory deductions from and restrictions to 3 (37.1) (42.5)
Tier 1
Tier 1 capital after deductions 1,129.5 1,143.0
Total capital resources 1,129.5 1,143.0
Notes:
1. Retained reserves exclude the reserves of Northern Rock (Guernsey) Ltd, and also
exclude cash flow hedging reserves and available for sale reserves (totalling £(22.5)m).
2. Regulatory capital rules exclude pension scheme assets from capital when the scheme
is in surplus, therefore this adjusts the regulatory capital available.
3. Regulatory deductions from and restrictions to Tier 1 include intangible assets and
expected losses on lending.
4. Following the acquisition of Northern Rock by the Virgin Money Group, the Company
acquired Virgin Money Ltd on 2 January 2012, which had the following impact on Capital
Resources:
Page 6 of 37Northern Rock plc – Pillar 3 disclosures
2011
£m
Core Tier 1
Ordinary share capital 1,400.0
Retained reserves (550.4)
Pension scheme (3.3)
846.3
Regulatory deductions from and restrictions to Tier 1 (46.8)
Tier 1 capital after deductions 799.5
Total capital resources 799.5
Page 7 of 37Northern Rock plc – Pillar 3 disclosures
4. Assessment of internal capital
The following table sets out the Pillar 1 capital requirements for each exposure type for
exposures held by the Group at 31 December 2011.
2011 2010
Capital Capital
Requirement Requirement
£m £m
IRB approach
Retail exposures secured by real estate collateral 207.3 260.8
Standardised approach
Institutions 31.3 12.4
Securitisation positions 2.1 4.0
Other assets 5.6 5.0
Operational risk 13.7 6.9
Market risk 0.9 0.1
Total capital requirement 260.9 289.2
Page 8 of 37Northern Rock plc – Pillar 3 disclosures
5. Counterparty credit risk relating to derivatives
The following table sets out the gross positive fair value of derivatives contracts, and the
potential credit exposures, at 31 December 2011.
2011 2010
£m £m
Gross positive fair values of contracts 181.5 149.0
Potential credit exposure 32.6 28.9
Total exposure 214.1 177.9
Counterparty credit risk (CCR) is the risk that the counterparty to a derivative transaction
could default during the life of the transaction.
The duration of the derivative and the credit quality of the counterparty are both factored
into the internal capital and credit limits for counterparty credit exposures.
CCR is monitored daily by the Wholesale Credit Risk team and reported to Treasury Credit
Committee (TCC) monthly. TCC is a sub-committee to ALCO and receives monthly
updates on CCR.
Credit Support Annexes (CSA) exist for collateralising derivative transactions with
counterparties to which the Group has its derivative exposures in order to mitigate the risk
of loss on default. Although these CSAs are taken into consideration when setting the
internal credit risk limits for derivative counterparties, they are not recognised as credit risk
mitigation for reducing the exposure at default (EAD) on the derivative transactions in the
Pillar 1 regulatory capital calculations.
Under the Group’s Internal Liquidity Requirement a two notch ratings downgrade could
result in the Group being required to post additional collateral.
The Group measures exposure value on counterparty credit exposures under the CCR
mark to market method. This exposure value is derived by adding the gross positive fair
value of the contract (replacement cost) to the contracts potential credit exposure, which
is derived by applying a multiple based on the contracts residual maturity to the notional
value of the contract.
Wrong way risk occurs where exposure to a counterparty is adversely correlated with the
credit quality of that counterparty. Northern Rock has no such exposure, as it has no
appetite for credit derivative positions which are the key drivers of such a risk.
Page 9 of 37Northern Rock plc – Pillar 3 disclosures
6. Credit risk and dilution risk
6.1 Impairment losses
The Group assesses its financial assets or groups of financial assets for objective evidence
of impairment at each balance sheet date. An impairment loss is recognised if, and only if,
there is a loss event (or events) that has occurred after initial recognition and before the
balance sheet date and has a reliably measurable impact on the estimated future cash
flows of the financial assets or groups of financial assets. Losses that are incurred as a result
of events occurring after the balance sheet date are not recognised in the accounts.
6.1.1 Assets held at amortised cost
The Group first assesses whether objective evidence of impairment exists individually
for financial assets that are individually significant, and individually or collectively for
financial assets that are not individually significant. Objective evidence that a
financial asset is impaired includes observable data that comes to the attention of
the Group about the following loss events:
a) significant financial difficulty of the issuer or obligor
b) a breach of contract, such as a default or delinquency in interest or principal
repayments
c) the lender, for economic or legal reasons relating to the borrower’s financial
difficulty, granting to the borrower a concession that the lender would not
otherwise consider
d) it becomes probable that the borrower will enter bankruptcy or other financial
reorganisation
e) the disappearance of an active market for that financial asset because of
financial difficulties or
f) observable data indicating that there is a measurable decrease in the estimated
future cash flows from a portfolio of assets since the initial recognition of those
assets, although the decrease cannot yet be identified with the individual
financial assets in the portfolio, including:
i. adverse changes in the payment status of borrowers in the portfolio
ii. national or local economic conditions that correlate with defaults on the assets
in the portfolio.
If the Group determines that no objective evidence of impairment exists for an
individually assessed financial asset, whether significant or not, it includes the asset
in a group of financial assets with similar credit risk characteristics and collectively
assesses them for impairment. Assets that are individually assessed and for which
an impairment loss is or continues to be recognised are not included in a
collective assessment of impairment.
If there is objective evidence that an impairment loss on loans and receivables
has been incurred, the amount of the loss is measured as the difference between
the asset’s carrying amount and the present value of the estimated future cash
flows (excluding future credit losses that have not been incurred) discounted at
the financial asset’s original effective interest rate. The carrying amount of the
asset is reduced through the use of an impairment allowance and the amount of
the loss is recognised in the income statement. In future periods the unwind of the
discount is recognised within interest income.
When a loan is uncollectible, it is written off against the related provision for loan
impairment. Such loans are written off after all the necessary procedures have
been completed and the amount of the loss has been determined. Subsequent
recoveries of amounts previously written off decrease the amount of the provision
for loan impairment in the income statement.
Page 10 of 37Northern Rock plc – Pillar 3 disclosures
If, in a subsequent period, the amount of the impairment loss decreases and the
decrease can be related objectively to an event occurring after the impairment
was recognised (such as an improvement in the customer’s credit rating), the
previously recognised impairment loss is reversed by adjusting the impairment
allowance. The amount of the reversal is recognised in the income statement.
6.1.2 Available for sale financial assets
For available for sale financial assets, the Group assesses at each balance sheet
date whether there is objective evidence that a financial asset, or group of financial
assets are impaired. The amount of the loss is measured as the difference between
the asset’s acquisition cost less principal repayments and amortisation and the
current fair value. The amount of the impairment loss is recognised in the income
statement. This includes cumulative gains and losses previously recognised in equity
which are recycled from equity to the income statement. If, in a subsequent period,
the fair value of a debt instrument classified as available for sale increases and the
increase can be objectively related to an event occurring after the impairment loss
was recognised in profit or loss, the impairment loss is reversed through the income
statement.
6.1.3 Renegotiated loans
Loans to customers whose terms have been renegotiated are no longer considered
past due but are treated as fully performing loans only after the minimum number of
required payments under the new arrangements have been received. In subsequent
years, the asset is considered to be past due and disclosed only if renegotiated
again within that year.
6.1.4 Forbearance
Eligible mortgage customers will be considered for a forbearance tool. Each case is
considered on its own merits based on the customer’s personal circumstances. The
forbearance tools are; an arrangement to pay which is less than the contractual
payment, transfer to an interest only method of repayment, extension to the original
mortgage term, capitalisation of arrears and making arrangements with customers
where the agreed mortgage term has expired and the mortgage loan is not repaid
in full.
At 31 December 2011 residential mortgage loans of £484.7m (2010 £349.3m) that are
neither past due nor impaired had benefited from a forbearance tool. Provisioning
methodology recognises the use of forbearance tools and these mortgage loans
attract a higher level of provision when compared to rest of the up to date portfolio.
6.2 Exposures at default
For the purposes of these disclosures, credit exposure is the maximum loss that the group
may suffer in the event of default or loss in value of an asset. This may differ from the
amounts disclosed in the balance sheet in the Annual Report and Accounts, because the
balance sheet only discloses drawn balances whereas credit exposures include amounts
where customers have contractual rights to draw down further balances.
The following table sets out the exposures at default for the various types of asset held by
Northern Rock plc at 31 December 2011, and the average exposure at default during the
year.
Page 11 of 37Northern Rock plc – Pillar 3 disclosures
Average
Exposure at 31 exposure in
December 2011 period
£m £m
Retail exposures secured by real estate collateral 15,846.8 14,413.0
Other retail exposures 0.1 0.2
Central Governments and Central Banks 2,955.3 3,612.2
Multilateral development banks 588.3 394.1
Institutions 1,352.5 2,031.5
Local authorities - 6.8
Securitisation positions 129.2 177.6
Other 78.7 84.4
20,950.9 20,719.8
Average
Exposure at 31 exposure in
December 2010 period
£m £m
Retail exposures secured by real estate collateral 13,600.7 11,972.1
Other retail exposures 0.5 0.4
Central Governments and Central Banks 4,917.9 7,688.6
Multilateral development banks - -
Institutions 558.4 778.0
Local authorities - -
Securitisation positions 246.4 262.0
Other 121.8 83.6
19,445.7 20,784.7
Page 12 of 37Northern Rock plc – Pillar 3 disclosures
6.3 Geographical distribution of exposures
The table below gives details of the geographical distributions of exposures at 31
December 2011:
Exposure at 31 December 2011
Rest of
UK Europe the World Total
£m £m £m £m
Retail exposures secured by real estate collateral 15,846.8 - - 15,846.8
Other retail exposures 0.1 - - 0.1
Central Governments and Central Banks 2,755.1 200.2 - 2,955.3
Multilateral development banks - 588.2 - 588.2
Institutions 893.8 344.2 114.5 1,352.5
Securitisation positions 123.0 - 6.2 129.2
Other 78.8 - - 78.8
19,697.6 1,132.6 120.7 20,950.9
Exposure at 31 December 2010
Rest of
UK Europe The World Total
£m £m £m £m
Retail exposures secured by real estate collateral 13,600.7 - - 13,600.7
Other retail exposures 0.5 - - 0.5
Central Governments and Central Banks 4,608.4 309.5 - 4,917.9
Multilateral development banks - - - -
Institutions 336.2 185.6 36.6 558.4
Securitisation positions 238.4 - 8.0 246.4
Other 121.8 - - 121.8
18,906.0 495.1 44.6 19,445.7
Page 13 of 37Northern Rock plc – Pillar 3 disclosures
6.4 Exposure at default by residual maturity
The following table gives details of the contractual residual maturities of exposures at 31
December 2011:
Exposure at 31 December 2011
Residual maturity
< 1 year 1-5 yrs > 5 years Total
£m £m £m £m
Retail exposures secured by real estate collateral 57.3 553.7 15,235.8 15,846.8
Other retail exposures 0.1 - - 0.1
Central Governments and Central Banks 2,755.1 200.2 - 2,955.3
Multilateral development banks - 408.5 179.7 588.2
Institutions 1,107.1 224.5 20.9 1,352.5
Securitisation positions - - 129.2 129.2
Other 51.6 0.3 26.9 78.8
3,971.2 1,387.2 15,592.5 20,950.9
Exposure at 31 December 2010
Residual maturity
< 1 year 1-5 yrs > 5 years Total
£m £m £m £m
Retail exposures secured by real estate collateral 315.7 481.9 12,803.1 13,600.7
Other retail exposures 0.5 - - 0.5
Central Governments and Central Banks 4,917.9 - - 4,917.9
Multilateral development banks - - - -
Institutions 505.8 52.6 - 558.4
Securitisation positions - - 246.4 246.4
Other 90.1 - 31.7 121.8
5,830.0 534.5 13,081.2 19,445.7
6.5 Impairments by exposure class
The table below indicates the level of impaired and past due exposures by exposure class,
and of the levels of provisions against them at 31 December 2011:
Page 14 of 37Northern Rock plc – Pillar 3 disclosures
31 December 2011
Impaired Past due Impairment
exposures exposures provisions
£m £m £m
Retail exposures secured by real estate
collateral 7.1 153.5 6.5
Other retail exposures - - 0.1
7.1 153.5 6.6
31 December 2010
Impaired Past due Impairment
exposures exposures provisions
£m £m £m
Retail exposures secured by real estate
collateral 0.3 102.0 2.2
Other retail exposures - - 0.2
0.3 102.0 2.4
6.6 Geographical distribution of impairments
All impairment charges relate to exposures within the UK.
Page 15 of 37Northern Rock plc – Pillar 3 disclosures
6.7 Movements in impairments
Movements in impairment provisions in 2011 are detailed in the following table:
Other
Retail retail
mortgages exposures Total
£m £m £m
Impairment provisions
At 1 January 2011 2.2 0.2 2.4
Increase/(decrease) in provision during year net of
recoveries 5.0 (0.1) 4.9
Amounts written off during the year (0.7) - (0.7)
At 31 December 2011 6.5 0.1 6.6
Other
Retail retail
mortgages exposures Total
£m £m £m
Impairment provisions
At 1 January 2010 - - -
Transferred from Northern Rock Asset Management plc 0.4 0.2 0.6
Increase in provision during year net of recoveries 1.8 0.1 1.9
Amounts written off during the year - (0.1) (0.1)
At 31 December 2010 2.2 0.2 2.4
Page 16 of 37Northern Rock plc – Pillar 3 disclosures
6.8 Exposures by credit rating
The allocation of capital to credit risk within the liquidity book is calculated under the
standardised approach as per FSA regulations. Exposure by credit grading of the Group’s
treasury exposures is as follows:
Exposure at 31 December 2011
Exposure value by external rating
AAA to AA- A+ to A- BBB+ to BBB- Total
£m £m £m £m
Central Governments and Central Banks 2,955.3 - - 2,955.3
Multilateral development banks 588.2 - - 588.2
Institutions 216.5 1,136.0 - 1,352.5
Securitisation positions 129.2 - - 129.2
3,889.2 1,136.0 - 5,025.2
Exposure at 31 December 2010
Exposure value by external rating
AAA to AA- A+ to A- BBB+ to BBB- Total
£m £m £m £m
Central Governments and Central Banks 4,917.9 - - 4,917.9
Multilateral development banks - - - -
Institutions 440.5 97.9 20.0 558.4
Securitisation positions 246.4 - - 246.4
5,604.8 97.9 20.0 5,722.7
Page 17 of 37Northern Rock plc – Pillar 3 disclosures
7. IRB disclosures for specialised lending and equity classes
Northern Rock has no specialised lending or equity exposures.
Page 18 of 37Northern Rock plc – Pillar 3 disclosures
8. Interest rate risk in the banking book
A discussion of the nature and management of interest rate risk in the banking book is
included in note 31 of the Annual Report and Accounts for Northern Rock plc for the year
ended 31 December 2011. The table below shows the variation in economic value for a
parallel 200bp shift upward in interest rates for each of the main currencies within the retail
banking book.
Increase/(decrease) in Increase/(decrease) in
economic value economic value
31 December 2011 31 December 2010
£m £m
Currency
£ 44.8 11.3
Euro - (0.1)
The large increase in the economic value for the year end 2011 is mainly due to the
mortgage pipeline holding increase.
Page 19 of 37Northern Rock plc – Pillar 3 disclosures
9. Securitisation
9.1 Objectives in relation to securitisation
The principal objective of securitisation is to provide funding diversification, giving access
to a wide range of investors in different geographic areas. Securitisation also serves to
generate liquidity from different illiquid asset types, principally residential mortgage loans.
9.2 Issued and retained securitisation positions
9.2.1 Risks inherent in the issued and retained securitisation position
The principal risks that are inherent in securitised mortgage assets are as follows:
Credit risk: the current or prospective loss to earnings and capital (expected and
unexpected loss) arising from lending as a result of debtors defaulting on their
obligations due to the Group;
Market risk: the risk that changes in the level of interest rates, the rate of exchange
between currencies or the price of securities or other financial contracts, including
derivatives, will have an adverse impact on the results of operations or financial
condition of the Group;
Liquidity risk: the risk that the Group is unable to meet its obligations as they fall due.
The Group has retained all of the Notes in the Gosforth Funding plc securitisation
transaction and has retained the M and Z Notes in the Gosforth Funding 2011-1 plc
securitisation transaction (representing 11% of the total notes issued by Gosforth Funding
2011-1 plc). Therefore the Group maintains some of its exposure to credit risk and market
risk for the securitised mortgage assets. The ratings assigned to the retained notes are as
follows:
Issuer Notes 31 Dec 2011 31 Dec 2010 Moody’s S&P Fitch
£m £m
Gosforth Funding plc Class A2 - 478 Aaa AAA n/a
Gosforth Funding plc Class A3 410 500 Aaa AAA n/a
Gosforth Funding plc Class A4 500 500 Aaa AAA n/a
Gosforth Funding plc Class Z 174 174 Unrated Unrated n/a
Gosforth Funding 2011-1 plc Class M 38 n/a Aa2(sf) n/a AAsf
Gosforth Funding 2011-1 plc Class Z 103 n/a Unrated n/a Unrated
Total 1,225 1,652
There have been no changes to the ratings assigned to any of the notes since the date of
issue.
In order to mitigate market risk that the securitised assets are exposed to, the Group enters
into interest rate swap agreements.
Page 20 of 37Northern Rock plc – Pillar 3 disclosures
9.2.2 Roles played by the Group in the securitisation process
The Group is the originating entity and is the sole administrator in relation to the securitised
loans and has serviced the loans on the same basis as the non-securitised loans. The
Group also acts as the cash manager for the transactions and operates as the basis rate
swap provider and the start up loan provider. Although services of investment banks and
legal advisers were utilised in originating new transactions, the management of existing
securitisations is undertaken by the Group.
9.2.3 Calculating risk weighted exposure amounts
As the Group’s securitisations have not been undertaken in order to obtain a capital
benefit, the Group does not exclude securitised exposures from its calculation of risk
weighted exposures and expected losses. Risk weighted exposures and expected losses at
31 December 2011 for issued and retained securitised assets are calculated within the
capital calculation of the overall mortgage portfolio, in line with the FSA Handbook under
the IRB approach.
9.2.4 Accounting policies for issued and retained securitisation activities
Certain Group companies have issued debt securities in order to finance specific loans
and advances to customers. Both the debt securities in issue and the loans and advances
to customers remain on the Group balance sheet within the appropriate balance sheet
headings unless:
a fully proportional share of all or of specifically identified cash flows have been
transferred to the holders of the debt securities, in which case that proportion of the
assets are derecognised;
substantially all the risks and rewards associated with the assets have been
transferred, in which case the assets are fully derecognised; or
a significant proportion of the risks and rewards have been transferred, in which
case the assets are recognised only to the extent of the Group’s continuing
involvement.
The Group has also entered into self issuance of securitised debt which may be used as
collateral for repurchase or similar transactions. Investments in self issued debt and the
equivalent loans and advances, together with the related income, expense and cash
flows, are not recognised in the financial statements.
The Group’s results include the results and assets and liabilities of securitisation Special
Purpose Entities (“SPEs”), Gosforth Funding plc and Gosforth Funding 2011-1 plc, none of
which qualify for derecognition under IAS 39, on a line by line basis. Securitised advances
are subject to non-recourse finance arrangements. These loans have been purchased at
par from the company, and have been funded through the issue of mortgage-backed
bonds by the SPEs.
Mortgages eligible for future securitisations are held in the Group’s non-trading book and
are at amortised cost using the effective interest method, less any provision for impairment.
Page 21 of 37Northern Rock plc – Pillar 3 disclosures
9.2.5 ECAIs used for securitisations
The Group utilises the services of several ECAIs (External Credit Assessment Institutions)
including Standard and Poor’s, Moody’s and Fitch to rate the securitisation transactions in
issue. The ratings assigned assess the ability of the structure to allow for the timely payment
of interest and the ultimate payment of principal of each of the rated notes. As part of the
ratings process each of the agencies is committed to ongoing transaction monitoring to
ensure that, in their view, the assigned ratings remain an appropriate reflection of the
issued notes' credit risk.
9.2.6 Exposures securitised by the Group
All securitisation exposures are held within the non-trading book of the Group.
The following analysis of past due exposure details loans in arrears for each of the
securitisation transactions:
Gosforth Funding 2011-1 plc as at 31 December 2011
Number Principal Arrears
Residential mortgages 13,072 1,060,588,372 143,039
Total 13,072 1,060,588,372 143,039
Gosforth Funding plc as at 31 December 2011
Number Principal Arrears
Residential mortgages 11,043 1,091,972,807 402,027
Total 11,043 1,091,972,807 402,027
Gosforth Funding plc as at 31 December 2010
Number Principal Arrears
Residential mortgages 15,700 1,690,015,069 247,994
Total 15,700 1,690,015,069 247,994
There were no losses recognised on exposures within the Gosforth Funding 2011-1 plc
securitisation during the year. Total losses recognised on exposures within the Gosforth
Funding plc securitisation during the year were £13,699 (31 December 2010 £0).
The Gosforth Funding 2011-1 plc securitisation had no impaired assets at 31 December
2011. Impaired assets included within the Gosforth Funding plc securitisation at 31
December 2011 had a book value of £500,616 (31 December 2010 £245,200).
As at 31 December 2011 the total outstanding externally issued securitisation debt was
£963m (2010 £0). This is all within the Gosforth Funding 2011-1 plc transaction. This value
represents the sterling equivalent taking into account the cross currency swaps in place
Page 22 of 37Northern Rock plc – Pillar 3 disclosures
and does not agree directly to the accounting disclosures in the Group Annual Report and
Accounts which take into account movements in currency rates and fair values of the
swaps. It is considered appropriate to disclose the exposures in terms of their economic
value rather than their accounting values.
As at 31 December 2011 the total outstanding retained securitisation debt was £1,225m
(2010 £1,652m). All retained securitisation debt is in sterling and is detailed in the table
included under ‘Risks inherent in the issued and retained securitisation position’.
As at 31 December 2011 there are no assets awaiting securitisation (2010 Nil).
9.2.7 Securitisation activity during 2011
During the year ended 31 December 2011, under the securitisation programme established
in 2010, Northern Rock plc, under the heading of Gosforth Funding 2011-1 plc, undertook
the issuance of listed residential mortgage backed securities to the value of £1,282m in
April 2011. Of the £1,282m securities issued, securities totalling £687m were retained by
Northern Rock plc. In June 2011, Northern Rock plc sold some of the retained securities
totalling £546m to a third party. These were sold at a discount of £3.7m which is being
amortised in the profit and loss account of Northern Rock plc over the expected life of the
securities.
9.2.8 Synthetic securitisations
The Group has no synthetic securitisation transactions.
9.3 Purchased securitisation positions
9.3.1 Risks inherent in the purchased securitisation position
The principal risk that is inherent in the Group’s purchased securitisation positions is credit
risk.
The following table gives details of the positions in the securitised exposures of other issuers
purchased by the Group and held at 31 December:
Risk weighting 2011 2010
£m £m
20% (Credit Rating of AA- or higher) 129.2 246.4
129.2 246.4
9.3.2 Roles played by the Group in the securitisation process
The Group is an investor that acquires SPV positions originated by non-Group entities.
9.3.3 Calculating risk weighted exposure amounts
Risk weighted exposures reported for purchased securitised assets at 31 December 2011
are calculated in line with the FSA handbook under the standardised approach.
Page 23 of 37Northern Rock plc – Pillar 3 disclosures
9.3.4 Accounting policies for purchased securitisation positions
The Group’s investments in SPV positions originated by non-Group entities are held as
Investment Securities – Loans and Receivables and are at book value. Any gain or loss on
sale is recognised in the Group’s profit and loss account at the time of the sale.
Page 24 of 37Northern Rock plc – Pillar 3 disclosures
10. IRB disclosures
The scope of the Group’s retail IRB permission is as set out below:
10.1 Retail exposures secured by real estate collateral
The Group’s IRB (Internal Ratings Based) Waiver Application Pack was approved by the
FSA on 1 January 2010 for capital adequacy monitoring and reporting from 1 January 2010
onwards. The scope of this permission covers the retail business of retail exposures secured
by real estate collateral.
The areas of the business falling outside the scope of the Group’s IRB permission are limited
to exposures to central governments and banks, institutions, corporates and securitised
positions. Asset classes not falling within the scope of the Group’s IRB permission are
treated under the standardised approach. The retail credit risk function is responsible for
the development, validation, implementation, monitoring and use of credit rating models
for the Retail IRB approach. In order to ensure the integrity and independence of these
models, the credit risk function has clearly segregated duties from those responsible for
originating exposures. The credit risk area is responsible for monitoring the validity of its
models and completeness of the supporting documentation and reporting on these to the
Credit Risk Committee (‘CRC’). CRC has been established as the principal forum for
independently overseeing the Group’s credit rating models, to ensure that the systems are
producing consistent and accurate results in line with the Group’s objectives and FSA
minimum requirements.
10.2 Retail IRB
The Group has extensive data histories, which have enabled it to build in-house credit
rating models for the residential mortgage portfolio. These models facilitate an appropriate
risk sensitive approach to risk management and capital allocation. The models determine
long run average probabilities of default (PD), downturn loss given default (LGD) and
appropriate exposures at default (EAD) for each segment in order to calculate expected
losses and risk weighted assets. In addition, the models are used to establish risk appetite,
support lending strategy, support determination of the level of impairment allowances and
the provision of sophisticated management information.
The rating models group obligors into segments differentiated by a number of factors,
which include product type, LTV and measures of affordability. For each segment a long
run average PD, downturn LGD and EAD is estimated from a combination of recent and
historic data. Data covering the period back to the early 1990s was utilised in the
derivation of the PD, LGD and EAD. Internal data (including data obtained from Northern
Rock (Asset Management) plc, the company operating these loans prior to 2010) was
supplemented with external industry data sources where it was felt that there was not
sufficient internal experience. EAD has been restricted to ensure that it can not be lower
than 100% of the current exposure. An EAD for undrawn, off balance sheet, assets such as
applications not yet taken up has also been built into the models through the use of credit
conversion factors.
Page 25 of 37Northern Rock plc – Pillar 3 disclosures
10.3 Exposures by exposure class
2011 2010
Retail IRB £m £m
Retail exposures secured by real estate collateral 15,846.8 13,600.7
15,846.8 13,600.7
The following table details the Group’s exposures for its sole IRB exposure class of retail
exposures secured by real estate collateral. These relate to exposure at default, and
include all on and off balance sheet exposures.
2011
Time on
Downturn
Risk Band LRA PD Exposure (£m) RWA% RWA (£m) Book
LGD
(months)
Standard1 0.65% 3,509 10.40% 7.55% 265 63
Standard2 1.05% 4,381 12.85% 11.85% 519 55
Standard3 1.51% 3,581 17.06% 19.80% 709 57
Standard4 1.82% 1,990 21.15% 26.30% 524 52
Standard5 2.27% 1,078 20.40% 31.46% 339 104
BTL1 0.64% 687 12.44% 6.93% 48 33
BTL2 1.33% 464 16.64% 17.68% 82 23
BTL3 2.72% 66 18.25% 35.67% 23 73
BTL4 3.94% 68 17.86% 38.89% 26 76
Default 100.00% 23 26.00% 245.54% 56 83
Total 15,847 2,591
Page 26 of 37Northern Rock plc – Pillar 3 disclosures
2010
Time on
Downturn
Risk Band LRA PD Exposure (£m) RWA% RWA (£m) Book
LGD
(months)
Standard1 0.66% 3,460 10.57% 10.11% 350 62
Standard2 1.06% 3,793 14.14% 18.80% 713 58
Standard3 1.50% 2,957 18.65% 31.53% 932 62
Standard4 1.80% 1,510 21.88% 41.50% 627 62
Standard5 2.28% 970 17.79% 38.82% 377 120
BTL1 0.64% 413 13.46% 12.70% 52 34
BTL2 1.39% 262 18.76% 29.86% 78 28
BTL3 2.71% 64 19.65% 46.47% 30 62
BTL4 4.19% 162 16.57% 49.76% 81 58
Default 100.00% 10 20.19% 201.01% 20 91
Total 13,601 3,260
Page 27 of 37Northern Rock plc – Pillar 3 disclosures
10.4 Impairment charges by exposure type
This table shows the impairment charges made in 2011 by Basel exposure class, and
includes impairment charges for exposure classes under the standardised approach.
2011 2010
£m £m
Retail exposures secured by real estate collateral 5.0 1.8
Other retail exposures (0.1) 0.1
4.9 1.9
10.5 Loss analysis – regulatory expected loss versus actual loss
This table shows the regulatory Expected Loss measure, compared with Actual Loss by IRB
exposure class
2011
Regulatory
Expected Actual
Loss Loss
Retail IRB £m £m
Retail exposures secured by real estate collateral 28.8 4.2
2010
Regulatory
Expected Actual
Loss Loss
Retail IRB £m £m
Retail exposures secured by real estate collateral 3.4 1.8
Page 28 of 37Northern Rock plc – Pillar 3 disclosures
10.6 Credit Model Performance – Estimated versus Actual
This table shows the forecast and actual probability of default and loss given default by IRB
exposure class.
2011
PD of LGD
Retail IRB total portfolio of defaulted assets
Estimated Actual Estimated Actual
% % % %
Retail exposures secured by real estate
collateral 1.33 0.21 20.2 11.2
2010
PD of LGD
Retail IRB total portfolio of defaulted assets
Estimated Actual Estimated Actual
% % % %
Retail exposures secured by real estate
collateral 0.31 0.06 15.0 33.2
Northern Rock plc was formed through the successful legal and capital restructure of the
former Northern Rock business, which took effect on 1 January 2010. At this time, the
Group acquired a high quality seasoned mortgage book from the former Northern Rock.
Levels of default emerging have been extremely low, and any comparison between
predicted and actual levels of default at this time is subject to a level of volatility, due to
the extremely small population of defaulted loans. The differences between actual and
forecast shown in the above table reflect this volatility and we expect levels of actual and
estimate to converge as the mortgage book seasons further.
Page 29 of 37Northern Rock plc – Pillar 3 disclosures
11. Credit Risk Mitigation
11.1 Retail exposures
Of the Group’s retail exposures at 31 December 2011, over 99.99% were secured on
residential property. The personal unsecured portfolio made up the remaining less than
0.01% of retail exposures. The indexed average loan to value ratio of the mortgage book
at the end of 2011 was 62% (2010 59%). The collateral held against mortgage exposures
was valued at £34.7bn (2010 £25.7bn). Of this, £15.5m was held against impaired loans
with a book value of £7.1m (2010 £0.8m held against book value of £0.3m).
11.2 Treasury exposures
Credit Support Annexes (CSAs) exist for collateralising derivative transactions with
counterparties to which the Group has its derivative exposures in order to mitigate the risk
of loss on default. The CSAs allow margin calls to be made on the net mark to market value
of derivative exposures with a particular counterparty. All collateral held or paid under the
CSAs is in the form of cash. Although these CSAs are taken into consideration when setting
the internal credit risk limits for derivative counterparties, under the standardised approach
the Group does not recognise the risk mitigating effect of these CSAs in its Pillar 1 capital
calculations. At 31 December 2011, cash collateral of £11.3m (31/12/10 £0.7m) was held in
relation to CSAs.
Page 30 of 37Northern Rock plc – Pillar 3 disclosures
12. Remuneration
Following the acquisition of Northern Rock plc by the Virgin Money Group on 1 January
2012, the Remuneration Policy for the combined group will be established as part of the
integration project. The following disclosures relate to the policies in place during 2011.
12.1 Approach to remuneration
This section discloses information about Northern Rock plc’s remuneration policy for 2011.
Remuneration formed an important way of encouraging, directing and rewarding
colleague and management behaviours in line with the corporate vision, strategy and
values. It provided a valuable tool in aligning business activities to the achievement of
corporate objectives in a way which accounted for risk. Remuneration at all levels was
benchmarked against the financial services market to ensure that the Company’s
remuneration practices were competitive but fit for the Company’s size, internal
organisation and the nature, scope and complexity of its activities.
Through its remuneration policy, the Company aimed to drive the success of the business
and:
attract, develop and retain talent in a competitive national labour market for
financial services
strengthen the link between pay and performance whilst maintaining an
appropriate balance of fixed and variable remuneration
stimulate the appropriate behaviours that drive long-term risk-adjusted value for its
shareholder HMT, together with other stakeholders of the business
12.2 The Remuneration Committee
During 2011 the Northern Rock plc Remuneration Committee consisted of four non-
Executive Directors, one of whom chaired the Committee, and included a representative
from UKFI. The Committee members during the year were:
Michael Fairey (Chairman)
Laurence Adams
Mark Pain
Keith Morgan (UKFI)
The Committee was supported by the Human Resources Director and Chief Risk Officer
who were invited to attend to provide background information to assist the committee in
their duties as required.
The remuneration policy was a policy which required Board approval. The Committee
undertook periodic reviews of the remuneration policy, with independent reports
submitted by the Compliance, Risk and Audit functions for the Committee’s review, which
contained a review of the operational, regulatory and other risks arising from the policy.
The Committee determined, in conjunction with UKFI, all elements of remuneration for
Level 4 Executives (including pension rights).
Legal advice was provided to the Committee by the Company’s principal legal advisors,
Freshfields Bruckhaus Derringer LLP.
Page 31 of 37Northern Rock plc – Pillar 3 disclosures
The members of the Remuneration Committee were paid by fees only, and were not
entitled to participate in bonus or incentive schemes, or become members of the
company’s pension scheme. The UKFI representative waived committee membership fees.
12.3 Design characteristics of the remuneration system
Northern Rock plc ensured that the structure of colleagues’ remuneration was consistent
with and promoted effective risk management, to encourage long-term and lasting
growth for the Company. Salaries and total remuneration of colleagues were
benchmarked against the financial services market to ensure competitiveness and
promote stability through people.
Variable remuneration schemes were externally benchmarked to ensure competitiveness.
Variable schemes were capped as a proportion of basic salary to ensure control over the
amount of variable remuneration that could pay out.
The FSA ‘Code Staff’ were among the Company’s primary drivers of risk-adjusted
performance and the remuneration policy relating to Code Staff was wholly risk-adjusted in
terms of its composition, payment schedule and the performance horizons underlying the
policy.
Page 32 of 37Northern Rock plc – Pillar 3 disclosures
Remuneration Parameters Rationale
Component
Salary and - Market benchmarked to ensure - Improves the management of fixed
pension competitiveness costs whilst preserving management
talent
Annual bonus - Primary focus of the bonus was delivery of - This focus ensures delivery of short-term
financial and operational milestones in line milestones that contributes to the long
with the agreed strategy and business term development of the business,
plan linked to individual performance fulfilment of the business plan and
ultimately work towards a successful
- Structure of bonus to be fully compliant exit from Temporary Public Ownership
with the FSA Remuneration Code
- Malus could be used to prevent deferred
elements of variable remuneration from
being paid in the event of poor
performance by the individual or by the
Company or some other material event
which the Committee deems relevant
- A clawback facility was included within
the rules as a means of reclaiming paid
bonuses in the event of a material failure
of risk management, misconduct by an
individual or a material restatement of the
information (including the Company
accounts) used by the Committee to
assess the bonus pool
Long Term - During 2011 there was an LTIP in place. - Strongly compliant with market and
Incentive Plan Under the LTIP, awards could be made best practice for LTIPs
(LTIP) with a fixed maximum cash amount, with
vesting dependent on performance over - Clear line of sight via pre-determined
a period. Ordinarily, awards had rolling targets and understanding of potential
three year performance periods, with any quantum if they are met
payouts based on clear, stretching,
performance hurdles including PBT and - Multi-year performance assessment
Quality of Earnings. provides balance to annual bonus, in
line with the FSA Remuneration Code
- Final outcomes were determined in
accordance with the change of control - Performance targets designed to
provisions. There were no accelerated support the need for sustained value
payouts triggered by the change of creation
control, and vested amounts were
deferred and remain subject to malus /
clawback.
In line with the FSA’s Remuneration Code, deferral was a key risk management and
retention tool for key senior management colleagues and Code Staff. The bonus / malus
principle of pool allocation could be used by the Remuneration Committee to adjust for
future and long-tail risks which may not manifest in the Company’s annual financial
statement.
The balance between long-term and annual cash incentives for all colleagues, and in
particular the Code Staff population, was relevant to account for all types of current and
future risk, and ensured that fixed-to-variable ratios of remuneration were controlled top-
down with limits on absolute remuneration.
All variable remuneration schemes were cash-based and linked to a profit target or
gateway. Failure to achieve the target or gateway led to the contraction of pools of
variable remuneration under the malus principle. Cash schemes limited the ‘upside’ risks
associated with payment in shares. Ex-post risk adjustments, both clawback and
Page 33 of 37Northern Rock plc – Pillar 3 disclosures
malus, could apply, to take account of subsequent risks and developments after bonuses
were announced, paid or deferred. Such adjustments would apply if there were
reasonable evidence of employee misbehaviour or material error; or the Company
suffered a material downturn in its financial performance; or the Company or the relevant
business unit suffered a material failure of risk management.
12.4 Link between pay and performance and the performance criteria used
The Company viewed pay and performance as inherently linked, driving stable
performance for the Company through its performance management system.
Performance was measured principally by the Board against the annual operating plan
and the corporate balanced scorecard. Success in these areas led, on approval from the
Remuneration Committee, to a bonus pool for colleagues. Colleagues’ bonuses were
determined by their performance against their personal objectives. These objectives were
driven by the functional scorecard, which were in turn determined by the function’s
contribution to the corporate scorecard. A performance rating was awarded on the basis
of achievement against personal objectives during the year. However, not only must
individuals have achieved their objectives, they must have displayed the behaviours most
appropriate to the role they performed. This ensured that material measures of success
were not undermined by negative means of achieving them. This was also an effective
means of mitigating conduct risk created by incentivising employees through the
connection of reward to the achievement of their objectives. Each colleague had a
ceiling of opportunity, capping the maximum bonus available to them in a given
performance period.
The Remuneration Committee reserved the right to determine the formulae used to assess
what aspect of company performance determines the proportion of bonus to pay out.
Employees of the company had no power to influence the final decision, or the criteria
used by the Committee to determine the bonus pool.
The following ‘ex ante’ risk adjustments were used by the Committee in order to determine
the size of pools of variable remuneration:
The Committee considered whether the financial hurdles set by the Board had
been achieved.
The Committee also reviewed performance against the balanced scorecard,
which contained qualitative and quantitative factors, including PBT variance
against plan, operating costs, Treating Customers Fairly (TCF), colleague
engagement and net interest income
The Chief Risk Officer provided an independent risk report in relation to the
appropriateness of remuneration structures and policies and their suitability for
driving proper behaviours and decision making within the business, including an
assessment of the Company’s capital and liquidity positions
The following ‘ex post’ risk adjustments were incorporated in order to take account of
subsequent or long-tail risks which may appear after the end of the performance period:
Deferral
Deferral for Code Staff (where possible) mirrored the requirements of the
Remuneration Code
Clawback and Malus
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