Regulatory Filings • Jan 18, 2013
Regulatory Filings
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(incorporated in England and Wales under the UK Building Societies Act 1986, as amended) \$20,000,000,000 Senior and Subordinated Medium-Term Notes Due Twelve Months or More from Date of Issue
______________ We may issue at various times up to \$20,000,000,000 aggregate principal amount outstanding at any time of senior or subordinated medium-term notes denominated in U.S. dollars or in other currencies or composite currencies. The notes will be issued in series and each series will be the subject of final terms (each "Final Terms"). We are privately placing the notes on a delayed or continuous basis to the placement agents named below (the "Placement Agents") or through the Placement Agents to qualified institutional buyers as described in this Base Prospectus under the section entitled "Plan of Distribution". This document will be considered a base prospectus ("Base Prospectus") for the purposes of Directive 2003/71/EC, as amended (which includes the amendments made by Directive 2010/73/EU to the extent that such amendments have been implemented in a relevant Member State of the European Economic Area) (the "Prospectus Directive"). Application has been made to the United Kingdom Financial Services Authority (the "FSA"), in its capacity as competent authority for the purposes of the Prospectus Directive and relevant implementing measures in the United Kingdom (the "UK Listing Authority") for the document to be approved as a Base Prospectus issued in compliance with the Prospectus Directive and relevant implementing measures in the United Kingdom for the purpose of giving information with regard to the issue of notes issued under this program. Application has been made to admit such notes during the period of twelve months after the date hereof to listing on the Official List of the UK Listing Authority (the "Official List"). Application has also been made to the London Stock Exchange plc (the "London Stock Exchange") for the notes to be admitted to trading on the London Stock Exchange's regulated market, which is a regulated market for the purpose of Directive 2004/39/EC (the "Markets in Financial Instruments Directive").
See the section entitled "Risk Factors" commencing on page 9 for a discussion of certain risks that you should consider prior to making an investment in the notes.
The notes have not been and will not be registered under the U.S. Securities Act of 1933, as amended (the "Securities Act"), or any state securities laws, and we are only offering notes outside the United States to non-U.S. persons in reliance on Regulation S under the Securities Act and within the United States to qualified institutional buyers (as defined in Rule 144A under the Securities Act) in reliance on Rule 144A or in other transactions exempt from registration under the Securities Act and, in each case, in compliance with applicable securities laws.
In the United Kingdom, this communication is directed only at persons who (i) have professional experience in matters relating to investments or (ii) are persons falling within Article 49(2)(a) to (d) ("high net worth companies, unincorporated associations etc") of the Financial Services and Markets Act 2000 ("Financial Promotion") Order 2005 (all such persons together being referred to as "relevant persons"). This communication must not be acted on or relied on by persons who are not relevant persons. Any investment or investment activity to which this communication relates is available only to relevant persons and will be engaged in only with relevant persons.
Each initial and subsequent purchaser of a note will be deemed, by its acceptance or purchase thereof, to have made certain acknowledgements, representations and agreements intended to restrict the resale or other transfer of such note, as described in this Base Prospectus, and, in connection therewith, may be required to provide confirmation of its compliance with such resale or other transfer restrictions in certain cases. See the section entitled "Transfer Restrictions" for a further description of these restrictions.
One or more Placement Agents may purchase notes, as principal, from us for resale to investors and other purchasers at varying prices relating to prevailing market prices as determined by any such Placement Agent at the time of resale or, if so agreed, at a fixed offering price. We reserve the right to cancel or modify the medium-term note program described in this Base Prospectus without notice. We, or a Placement Agent if it solicits an offer on an agency basis, may reject any offer to purchase notes in whole or in part. For further information, see the section entitled "Plan of Distribution".
The Placement Agents expect to deliver the notes in book-entry form only through the facilities of The Depository Trust Company, referred to herein as DTC. Beneficial interests in the notes will be shown on, and transfers thereof will be effected only through, records maintained by DTC and its participants, including Clearstream Banking, société anonyme, and Euroclear Bank S.A./N.V.
The rating of certain series of notes to be issued under the program may be specified in the applicable Final Terms. Each of Moody's Investors Service Limited ("Moody's"), Standard & Poor's Credit Market Services Europe Limited ("S&P") and Fitch Rating Ltd. ("Fitch") is established in the European Union and is registered under Regulation (EC) No. 1060/2009 (as amended) (the "CRA Regulation"). As such, each of Moody's, S&P and Fitch is included in the list of credit rating agencies published by the European Securities and Markets Authority on its website in accordance with such Regulation. DBRS, Inc. ("DBRS") is not established in the European Union, and has not applied for registration under the CRA Regulation, but its ratings have been, or are expected to be, endorsed by DBRS Ratings Limited, which is established in the European Union and registered under the CRA Regulation. Each of Moody's, S&P, Fitch and DBRS Ratings Limited is included in the list of credit rating agencies published by the European Securities and Markets Authority on its website in accordance with the CRA Regulation. The European Securities Markets Authority has indicated that ratings issued in the United States which have been endorsed by DBRS Ratings Limited may be used in the EU by the relevant market participants.
BARCLAYS
BOFAMERRILL LYNCH
CITIGROUP
CREDIT SUISSE
DEUTSCHE BANK SECURITIES
HSBC
J.P.MORGAN
MORGAN STANLEY
UBSINVESTMENT BANK
The date of this Base Prospectus is January 18, 2013
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| Notice to Investors 2 | |
|---|---|
| Notice to New Hampshire Residents 3 | |
| Forward-Looking Statements 3 | |
| Private Placement of Medium-Term Notes 4 | |
| Enforcement of Civil Liabilities 4 | |
| Documents Incorporated by Reference 4 | |
| Presentation of Financial Information 5 | |
| Where you can find more Information 5 | |
| Overview 6 | |
| Risk Factors 9 | |
| Use of Proceeds 26 | |
| Exchange Rates 27 | |
| Capitalization and Indebtedness 28 | |
| Selected Consolidated Financial and Operating Information 29 | |
| Management's Discussion and Analysis of Financial Condition and Results of Operations 32 | |
| Description of Business 128 | |
| Selected Statistical Information 142 | |
| Financial Risk Management 154 | |
| Management 167 | |
| Competition 173 | |
| Supervision and Regulation 176 | |
| Exchange Controls and other Limitations affecting Holders of Notes 184 | |
| Terms and Conditions of the Notes 185 | |
| Description of the Global Notes 211 | |
| Form of Final Terms 214 | |
| U.S. Federal Income Taxation 218 | |
| UK Taxation 225 | |
| Transfer Restrictions 227 | |
| Plan of Distribution 230 | |
| Settlement 232 | |
| Independent Auditors 232 | |
| Legal Matters 232 | |
| General Information 233 | |
| Glossary of Financial Terms 234 |
We are furnishing this Base Prospectus in connection with an offering exempt from registration under the Securities Act and applicable state securities laws solely for the purpose of enabling a prospective investor to consider the purchase of the notes. Delivery of this Base Prospectus to any person or any reproduction of this Base Prospectus, in whole or in part, without our consent is prohibited. The information contained in this Base Prospectus has been provided by us and other sources identified in this Base Prospectus. The source of third party information is identified where used. Any information provided by a third party has been accurately reproduced and as far as we are aware and are able to ascertain from information published by that third party, no facts have been omitted which would render the reproduced information inaccurate or misleading. The Placement Agents make no representation or warranty, express or implied, as to the accuracy or completeness of the information contained in this Base Prospectus. None of the information contained in this Base Prospectus is, or should be relied upon as, a promise or representation by the Placement Agents. You should be aware that since the date of this Base Prospectus there may have been changes in our affairs or otherwise that could affect the accuracy or completeness of the information set forth in this Base Prospectus.
The notes are subject to restrictions on transferability and resale and may not be transferred or resold except as permitted under the Securities Act and applicable state securities laws pursuant to registration or exemption from registration. You should be aware that you may be required to bear the financial risk of an investment in the notes for an indefinite period of time.
You must comply with all applicable laws and regulations in force in any jurisdiction in connection with the distribution of this Base Prospectus and the offer or sale of the notes. If you decide to invest in the notes, you and any subsequent purchaser will be deemed, by acceptance or purchase of a note, to have made certain acknowledgements, representations and agreements to and with us and any applicable Placement Agent intended to restrict the resale or other transfer of the note as described in this Base Prospectus. In addition, you and any subsequent purchaser may be required to provide confirmation of compliance with resale or other transfer restrictions in certain cases. See the section entitled "Transfer Restrictions" for more information on these restrictions.
In making your decision whether to invest in the notes, you must rely on your own examination of us and the terms of this offering, including the merits and risks involved. You should not construe the contents of this Base Prospectus as legal, business, financial advice or tax advice. You should consult your own attorney, business advisor, financial advisor or tax advisor.
Each potential investor in any notes must determine the suitability of that investment in light of its own circumstances. In particular, each potential investor should:
Some notes are complex financial instruments and such instruments may be purchased as a way to reduce risk or enhance yield with an understood, measured, appropriate addition of risk to their overall portfolios. A potential investor should not invest in notes which are complex financial instruments unless it has the expertise (either alone or with the help of a financial adviser) to evaluate how the notes will perform under changing conditions, the resulting effects on the value of such notes and the impact this investment will have on the potential investor's overall investment portfolio.
The notes have not been approved or disapproved by the U.S. Securities and Exchange Commission or any state or foreign securities commission or any regulatory authority. The foregoing authorities have not confirmed the accuracy or determined the adequacy of this Base Prospectus. Any representation to the contrary is a criminal offence.
You should direct any inquiries that you have relating to us, this Base Prospectus or the medium-term note program described in this Base Prospectus to the Placement Agents.
Nationwide Building Society accepts responsibility for the information contained in this Base Prospectus, and to the best of its knowledge and belief (and it has taken all reasonable care to ensure that such is the case), the information contained in this Base Prospectus is in accordance with the facts and does not omit anything likely to affect the import of such information.
In connection with the issue of any tranche of notes, one or more relevant Placement Agents acting as the stabilizing manager(s) (or persons acting on behalf of any stabilizing manager(s)) may over-allot notes (provided that, in the case of any tranche of notes to be admitted to trading on the London Stock Exchange or any other regulated market (within the meaning of the Markets in Financial Instruments Directive (Directive 2004/39/EC)) in the European Economic Area, the aggregate principal amount of notes allotted does not exceed 105 per cent. of the aggregate principal amount of the relevant tranche) or effect transactions with a view to supporting the market price of the notes at a level higher than that which might otherwise prevail. However, there is no assurance that the stabilizing manager(s) (or persons acting on behalf of a stabilizing manager) will undertake stabilization action. Any stabilization action may begin on or after the date on which adequate public disclosure of the final terms of the offer of the relevant tranche of notes is made and, if begun, may be ended at any time, but it must end no later than the earlier of 30 days after the issue date of the relevant tranche of notes and 60 days after the date of the allotment of the relevant tranche of notes. Any stabilization action or over-allotment must be conducted by the relevant stabilizing manager(s) (or persons acting on behalf of any stabilizing manager(s)) in accordance with all applicable laws and rules.
NEITHER THE FACT THAT A REGISTRATION STATEMENT NOR AN APPLICATION FOR A LICENSE HAS BEEN FILED UNDER RSA 421-B WITH THE STATE OF NEW HAMPSHIRE NOR THE FACT THAT A SECURITY IS EFFECTIVELY REGISTERED OR A PERSON IS LICENSED IN THE STATE OF NEW HAMPSHIRE CONSTITUTES A FINDING BY THE SECRETARY OF STATE OF NEW HAMPSHIRE THAT ANY DOCUMENT FILED UNDER RSA 421-B IS TRUE, COMPLETE AND NOT MISLEADING. NEITHER ANY SUCH FACT NOR THE FACT THAT AN EXEMPTION OR EXCEPTION IS AVAILABLE FOR A SECURITY OR TRANSACTION MEANS THAT THE SECRETARY OF STATE OF NEW HAMPSHIRE HAS PASSED IN ANY WAY UPON THE MERITS OR QUALIFICATIONS OF, OR RECOMMENDED OR GIVEN APPROVAL TO, ANY PERSON, SECURITY, OR TRANSACTION. IT IS UNLAWFUL TO MAKE, OR CAUSE TO BE MADE, TO ANY PROSPECTIVE PURCHASER, CUSTOMER OR CLIENT, ANY REPRESENTATION INCONSISTENT WITH THE PROVISIONS OF THIS PARAGRAPH.
This Base Prospectus contains projections of some financial data and discloses plans and objectives for the future. This forward-looking information, as defined in the United States Private Securities Litigation Reform Act of 1995, reflects our views regarding future events and financial performance.
The words "believe", "expect", "anticipate", "intend" and "plan" and similar expressions identify forwardlooking statements. We caution you not to place undue reliance on these forward-looking statements, which in any event speak only as of the date of this Base Prospectus. We undertake no obligation to publicly update or revise any forwardlooking statements, whether as a result of new information, future events or otherwise. The risk factors beginning on page 9 of this Base Prospectus and many other factors could cause actual events and results to differ materially from historical results or those anticipated. See the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Description of Business".
We have appointed Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., HSBC Securities (USA) Inc., J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. LLC and UBS Securities LLC as Placement Agents for the offering, from time to time, of the notes. We will limit the aggregate principal amount of the notes to \$20,000,000,000, or the equivalent of that amount in one or more other currencies or composite currencies, outstanding at any time, subject to increase without the consent of the holders of the notes. We have not registered, and will not register, the notes under the Securities Act and purchasers of the notes may not offer or sell them in the United States or to, or for the account or benefit of, U.S. persons (as defined in Regulation S under the Securities Act ("Regulation S")) except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act. The notes will be offered in the United States only to qualified institutional buyers, as defined in Rule 144A under the Securities Act ("Rule 144A"), in transactions exempt from registration under the Securities Act. The notes may be offered outside the United States to non-U.S. persons in accordance with Regulation S. We hereby notify you that the sellers of the notes, other than ourselves, may be relying on the exemption from the provisions of Section 5 of the Securities Act provided by Rule 144A.
You may not transfer notes sold in the United States, except in accordance with the restrictions described under the section entitled "Transfer Restrictions" of this Base Prospectus. We will deem each purchaser of the notes in the United States to have made the representations and agreements contained in this Base Prospectus.
We may issue additional notes of any series having identical terms to that of the original notes of that series but for the original issue discount (if any) and the public offering price. The period of the resale restrictions applicable to any notes previously offered and sold in reliance on Rule 144A shall automatically be extended to the last day of the period of any resale restrictions imposed on any such additional notes.
We will furnish each initial purchaser of the notes with a copy of this Base Prospectus and each applicable amendment and supplement, including the Final Terms to the Base Prospectus describing the terms related to that series of the medium-term notes. Unless the context otherwise requires, references to the Base Prospectus include this Base Prospectus, together with any amendment and supplements applicable to a particular series of the notes.
We are a building society incorporated under the laws of England and Wales. All of our directors and some of the experts named in this Base Prospectus reside outside the United States. All or a substantial portion of our assets and the assets of these individuals are located outside the United States. As a result, it may not be possible for you to effect service of process within the United States upon these individuals or upon us or to enforce against them judgments obtained in U.S. courts based upon the civil liability provisions of the U.S. securities laws. Our English solicitors, Allen & Overy LLP, have advised us that there is also doubt as to the enforceability in the United Kingdom in original actions or in actions for the enforcement of judgments of U.S. courts predicated upon the civil liability provisions of the U.S. securities laws. In addition, awards of punitive damages in actions brought in the United States or elsewhere may be unenforceable in the United Kingdom.
The following documents have previously been published or are published simultaneously with this Base Prospectus and have been admitted to and filed with the FSA and shall be deemed to be incorporated in, and form part of, this Base Prospectus:
(inclusive), July 15, 2011, pages 145-173 (inclusive) and February 22, 2012, pages 175-203 (inclusive).
Following the publication of this Base Prospectus a supplement may be prepared by us and approved by the UK Listing Authority in accordance with Article 16 of the Prospectus Directive. Statements contained in any such supplement (or contained in any document incorporated by reference therein) shall, to the extent applicable (whether expressly, by implication or otherwise), be deemed to supersede statements contained in this Base Prospectus or in a document which is incorporated by reference in this Base Prospectus.
We will provide, without charge, to each person to whom a copy of this Base Prospectus has been delivered, upon the request of such person, a copy of any or all of the documents deemed to be incorporated herein by reference. Written requests for such documents should be directed to our Treasury Division at Nationwide Building Society, King's Park Road, Moulton Park, Northampton, NN3 6NW.
Any non-incorporated parts of a document referred to herein are either deemed not relevant for an investor or are otherwise covered elsewhere in this Base Prospectus.
We will, in the event of any significant new factor, material mistake or inaccuracy relating to information included or incorporated by reference in this Base Prospectus which is capable of affecting the assessment of any notes, prepare a supplement to this Base Prospectus or publish a new prospectus for use in connection with any subsequent issue of notes.
The financial information incorporated by reference in this Base Prospectus as of and for the financial years ended April 4, 2012, 2011 and 2010 has been extracted from our audited consolidated financial statements prepared in accordance with the International Financial Reporting Standards ("IFRS") issued by the International Accounting Standards Board ("IASB"), as adopted by the European Commission for use in the European Union.
The consolidated financial statements have been audited by PricewaterhouseCoopers LLP, independent auditors, as stated in their reports incorporated by reference herein.
We have made rounding adjustments to reach some of the figures included in this Base Prospectus. Accordingly, numerical figures shown as totals in some tables may not be an arithmetic aggregation of the figures that preceded them.
Unless otherwise indicated, all references in this Base Prospectus to "pounds sterling", "sterling" and "£" are to the lawful currency of the United Kingdom, all references to "U.S. dollars", "dollars" and "\$" are to the lawful currency of the United States and all references to "Canadian dollars" or "C\$" are to the lawful currency of Canada.
Our audited consolidated financial statements are incorporated by reference in this Base Prospectus. We will not distribute these financial statements to holders of notes, but we will make them available to these holders upon request. You should direct requests for copies of these financial statements to the Treasury Division, Nationwide Building Society, Kings Park Road, Moulton Park, Northampton, NN3 6NW, England.
As of the date of this Base Prospectus, we do not file reports or other information with the U.S. Securities and Exchange Commission. To preserve the exemption for resales and other transfers under Rule 144A, we have agreed to furnish the information required pursuant to Rule 144A(d)(4) of the Securities Act if a holder of notes, or a prospective purchaser specified by a holder of notes, requests such information. We will continue to provide such information for so long as we are neither subject to the reporting requirements of Section 13 or 15(d) of the U.S. Securities Exchange Act of 1934, as amended (the "Exchange Act") nor exempt from such reporting requirements pursuant to Rule 12g3-2(b) of the Exchange Act.
This overview highlights important information regarding, but is not a complete description of, our mediumterm note program. We urge you to read the remainder of this Base Prospectus where we set out a description of our medium-term note program in more detail. You should also review the applicable Final Terms for additional information about the particular series of notes that you are considering purchasing. The following overview does not purport to be complete and is taken from, and is qualified in its entirety by, the remainder of this Base Prospectus and, in relation to the terms and conditions of any particular tranche of Notes, the applicable Final Terms.
We may offer senior or subordinated notes under the medium-term note program described in this Base Prospectus, depending on the terms of the applicable Final Terms for each series. In this Base Prospectus, when we refer to "notes" we mean any senior or subordinated medium-term notes that we may issue under the medium-term note program described in this Base Prospectus, unless it is clear from the context that we mean otherwise. When we say "we", "us", "our", "Nationwide", "the Group" or "the Society", we refer to Nationwide Building Society and its subsidiaries, all of which are consolidated, unless the context otherwise requires.
| Issuer | Nationwide Building Society. We are a building society incorporated in England and Wales under the Building Societies Act 1986 (as amended) of the United Kingdom (the "UK Building Societies Act"). Our core business is providing personal financial services, including residential mortgage loans, retail savings, general banking services, personal investment products, personal secured and unsecured lending, secured commercial lending, insurance and offshore deposit-taking. We operate through an integrated and diversified distribution network, including branches, ATMs, call centers, mail and the Internet. |
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| As a building society, we are a mutual organization managed for the benefit of our "members", who are retail savings customers and residential mortgage customers. |
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| Placement Agents | Barclays Capital Inc. Citigroup Global Markets Inc. Credit Suisse Securities (USA) LLC Deutsche Bank Securities Inc. HSBC Securities (USA) Inc. J.P. Morgan Securities LLC Merrill Lynch, Pierce, Fenner & Smith Incorporated Morgan Stanley & Co. LLC UBS Securities LLC |
| Trustee | The Bank of New York Mellon (as successor to J.P. Morgan Trust Company, National Association (as successor to Bank One Trust Company, N.A.)). We have entered into an indenture with the trustee relating to the notes. |
| Program Size | We may issue up to \$20,000,000,000, or the equivalent of that amount in one or more other currencies or composite currencies, outstanding at any time. We may increase the program size from time to time without the consent of the holders of the notes. |
| Currencies | Subject to any applicable legal or regulatory restrictions, we may issue notes in any currency as we may agree with the relevant Placement Agent. |
| Issuance in Series | We will issue senior notes and subordinated notes in series under an indenture. Within each series, we will issue tranches of notes subject to terms identical to those of other tranches in that series, except that the issue date, the issue price and the amount of the first payment of interest may vary. |
| Ranking of Senior Notes | The senior notes will constitute our direct, unconditional, unsubordinated and, subject to the provisions set forth in the |
| section entitled "Terms and Conditions of the Notes—Negative Pledge", unsecured obligations without any preference among themselves and will rank equally with non-member deposits and all of our other unsecured and unsubordinated obligations, subject, in the event of insolvency, to laws of general applicability relating to or affecting creditors' rights. They will rank senior to our UK retail member deposits. If we demutualize or transfer our business to the subsidiary of another mutual organization, our UK retail member deposits will rank equally with our obligations under our senior debt, including the senior notes. |
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| Ranking of Subordinated Notes | The subordinated notes will constitute our direct, unsecured and subordinated obligations, conditional in the event of a winding up, and rank without any preference among themselves. They will rank equally with all of our other unsecured and subordinated indebtedness, other than some subordinated indebtedness, at present comprising our permanent interest bearing shares, which will rank junior to the subordinated notes. They will rank junior to our UK retail member and non-member deposits and our senior indebtedness, including the senior notes. |
| Issue Price | We may offer notes at par or at a premium or discount to par as specified in the applicable Final Terms. |
| Maturities | The notes will mature in twelve months or longer as specified in the applicable Final Terms. |
| Redemption at Maturity | Subject to any purchase or early redemption, the notes will be redeemed at par on the maturity date. |
| Early Redemption | We are permitted to redeem the notes prior to maturity for taxation reasons and as specified in the applicable Final Terms. Additionally, the applicable Final Terms may provide that the notes of a series are redeemable at our option and/or the option of the holder. |
| Interest | Interest may accrue at a fixed rate or a floating rate. The floating rate may be determined by reference to a base rate, such as LIBOR, as we agree with the purchaser and describe in the applicable Final Terms. |
| Interest Payments | We may pay interest monthly, quarterly, semi-annually, annually or at such other intervals as we describe in the applicable Final Terms. |
| Denominations | We will issue the senior notes in minimum denominations of \$200,000 and the subordinated notes in minimum denominations of \$250,000 or, in each case, in integral multiples of \$1,000 in excess of these minimum denominations, or the equivalent of these amounts in other currencies or composite currencies, and in any other denominations in excess of the minimum denominations as we specify in the applicable Final Terms. |
| Rating | The rating of certain series of notes to be issued under the program may be specified in the applicable Final Terms. |
| Form, Clearance and Settlement | Notes offered in the United States to qualified institutional buyers in reliance on Rule 144A will be represented by one or more U.S. global notes and notes offered outside the United States in reliance on Regulation S will be represented by one or more international global notes. |
| The global notes will be issued in fully registered form and will be held by or on behalf of DTC for the benefit of participants in DTC. |
No temporary documents of title will be issued. Notes will bear a legend setting forth transfer restrictions and may not be transferred except in compliance with the transfer restrictions set forth therein. Transfers of interests from a U.S. global note to an international global note are subject to certification requirements. Governing Law .................................................... The notes and all related contracts will be governed by, and construed in accordance with, the laws of the State of New York, except that the subordination provisions in each of the indenture and the subordinated notes will be governed by, and construed in accordance with, the laws of England and Wales. Sales and Transfer Restrictions............................ We have not registered the notes under the Securities Act, and they may not be offered or sold within the United States or to or for the benefit of U.S. persons (as defined in Regulation S), except pursuant to an exemption from, or in a transaction not subject to, the registration requirement of the Securities Act. Listing.................................................................. Application has been made to the UK Listing Authority for the notes to be admitted to listing on the Official List. Application has also been made to the London Stock Exchange for the notes to be admitted to trading on the London Stock Exchange's regulated market. Risk Factors ......................................................... There are certain risks related to any issue of notes under the program, which investors should ensure they fully understand. See "Risk Factors" on page 9 of this Base Prospectus.
We believe that the following factors may affect our ability to fulfill our obligations under the notes. Most of these factors are contingencies which may or may not occur, and we are not in a position to express a view on the likelihood of any such contingency occurring. In addition, risk factors which are specific to the notes are also described below.
In purchasing notes, investors assume the risk that we may become insolvent or otherwise be unable to make all payments due in respect of the notes. There is a wide range of factors which individually or together could result in us becoming unable to make all payments due in respect of the notes. It is not possible to identify all such factors or to determine which factors are most likely to occur, as we may not be aware of all relevant factors and certain factors which we currently deem not to be material may become material as a result of the occurrence of events outside our control. The following is a description of the principal risks associated with the Notes and our business as of the date of this Base Prospectus; however, we do not represent that the risks set out in the statements below are exhaustive.
This section of the Base Prospectus is divided into two main sections—"Risks Related to Our Business" and "Risks Related to the Notes".
We are directly and indirectly subject to inherent risks arising from general economic conditions in the UK and other economies, particularly the eurozone, and the state of the global financial markets both generally and as it specifically affects financial institutions. For approximately five years, the global economy and the global financial system have experienced a period of significant turbulence and uncertainty. The very severe dislocation of the financial markets around the world that began in August 2007 and worsened significantly in 2008 triggered widespread problems at many commercial banks, investment banks, insurance companies, building societies and other financial and related institutions in the UK and around the world. The dislocation severely impacted general levels of liquidity, the availability of credit and the terms on which credit is available. This crisis in the financial markets led the UK government (the "Government") and other governments to inject liquidity into the financial system and take other forms of action relating to financial institutions, including bank recapitalizations and the provision of government guarantees for certain types of funding, aimed at both supporting the sector and providing confidence to the market.
These market dislocations were also accompanied by recessionary conditions and trends in the UK and many economies around the world. The widespread deterioration in the UK and other economies around the world adversely affected, among other things, consumer confidence, levels of unemployment, the state of the housing market, the commercial real estate sector, bond markets, equity markets, counterparty risk, inflation, the availability and cost of credit, transaction volumes, the liquidity of the global financial markets and market interest rates, which in turn had, and continues to have, a material adverse effect on our business, operating results, financial conditions and prospects.
Although there have been periods where market conditions have generally improved, recent developments, particularly in the eurozone, have demonstrated that there continues to be significant uncertainty. From April 2010 to date, financial markets have periodically been negatively impacted by ongoing fears surrounding the large sovereign debts and/or fiscal deficits of several countries in Europe (primarily Greece, Ireland, Italy, Portugal and Spain ("GIIPS")) and the possibility of one or more defaults on sovereign debt and the risk of contagion to other more stable countries throughout and beyond the eurozone remains. This is, in part, because a significant number of financial institutions throughout Europe have substantial exposures to sovereign debt issued by nations, in particular GIIPS, which are under considerable financial pressure. Should any of these nations default on their debt, or experience a significant widening of credit spreads, major financial institutions and banking systems throughout Europe could be destabilized, resulting in the further spread of the ongoing economic crisis.
Moreover, the sovereign debt crisis in Europe has periodically adversely affected the ability of countries throughout the eurozone to raise capital and the cost thereof. The uncertainty of how this may be resolved has led to an increase in the cost of funding for significant periods over the past two years. The initial impact of these increases were felt in the wholesale markets in the UK, and there has been a consequent increase in the cost of retail funding, with greater competition in a savings market which is growing slowly by historical standards. In the absence of a permanent resolution of the eurozone crisis, conditions could continue to deteriorate.
The outlook for the UK economy has remained challenging over the last year, with the UK economy dipping back into recession in 2012. Though the economy returned to growth in the third quarter of 2012, this was in part due to one-off factors (such as the Olympics) and prospects for the 2013-2014 financial year remain challenging. Uncertainty surrounding the future of the eurozone continues to pose a risk of further significant slowdown in economic activity in the UK's principal export markets which would have a corresponding effect on the broader UK economy. A wide-scale breakup of the eurozone would most likely be associated with a significant deterioration in the economic and financial environment in the UK and eurozone that would materially affect the capital and the funding position of participants in the European financial sector. Domestically, both public and household spending are being constrained by austerity measures, and we face the risk of higher levels of unemployment combined with declines in real disposable incomes. Government measures to return UK public finances to a sustainable trajectory, including taxation rises and the public spending cuts being implemented, are also likely to result in a slower recovery than other recent recessions.
The exact nature of the risks that we face and the manner and the extent to which they ultimately will impact us are difficult to predict and to guard against in light of (i) the inter-related nature of the risks involved, (ii) difficulties in predicting whether recoveries will be sustained and at what rate, and (iii) the fact that the risks are totally or partially outside of our control.
At the onset of the financial turbulence noted earlier, we experienced a decline in our net interest margin, but more recently, this has stabilized. The initial decline was driven by the increased cost of retail funding (reflecting the competitive savings market), the progressive re-pricing of long term wholesale funding and by our Base Mortgage Rate ("BMR") commitment to existing borrowers whereby we guaranteed existing customers that our BMR will be no more than 200 basis points above the Bank of England ("BoE") Base Rate. The decline in net interest margin also reflected the fact that customers have continued to benefit from our decision not to implement the mortgage tracker floor when our Base Rate reached 2%, 0.75% below their contractual floor limit of 2.75%. Whilst these remain negative drivers, more recently they have been offset by wider spreads on new mortgage and other lending. However, if low interest rates persist and therefore restrict scope to reprice customer balances, this will continue to depress net interest margin and profitability.
The UK housing market has remained muted throughout the year ended April 4, 2012, with transaction levels well below historic norms and with house prices essentially flat for the past two years. Unless there is a deterioration in UK credit conditions, such as might result from a spike in interest rates or a marked further deterioration in labor market conditions, we believe that a major dip in house prices is unlikely over the next year. At the same time, the upside potential for house prices is limited by the high level of prices relative to household earnings and the more restricted availability of mortgage credit relative to pre-crisis levels. The depth of the previous house price declines as well as the continuing uncertainty as to the timing and extent of the economic recovery will mean that losses could be incurred on loans should they go into possession. The UK commercial property market was negatively impacted by the recession with peak (June 2007) to trough (July 2009) falls in capital values of 44% and conditions remain extremely challenging. After some recovery, commercial property capital values have seen further steady declines since October 2011 and have remained negative for ten consecutive months (Source: Investment Property Databank, August 2012). The investment market has had lower transaction levels as a result of weak demand (Source: Property Data, September 2012) and the availability of credit has seen its fourth consecutive quarterly decline which has been attributed to the renewed falls in capital values, with demand for credit also declining over the last four quarters (Source: Bank of England). These developments mean that the outlook for the UK commercial property market remains uncertain. Market forecasts currently expect capital values to continue to fall throughout 2013 albeit at a lower rate than 2012 before stabilizing in 2014. At September 30, 2012, the proportion of our commercial loans three months or more in arrears was 4.38% (April 4, 2012: 3.66%), with arrears balances of £75 million (April 4, 2012: £58 million). We booked a total commercial impairment charge of £193 million in the first half, which is £18 million higher than in the second half of our 2011/12 financial year and £121 million higher than in the first half of our 2011/12 financial year.
The continued effect of margin pressure and exposure to both retail and commercial loan impairment charges resulting from the impact of general economic conditions means that we may continue to experience low levels of profitability and growth, and there remains the possibility of further downward pressure on profitability depending on a number of external influences, such as the consequences of a more austere economic environment.
The dislocations in the financial markets have resulted in our recording in our results over the last three financial years impairment charges and negative fair value adjustments with respect to securities and other investments that we hold. Asset valuations in future periods, reflecting prevailing market conditions, may result in further negative changes in the fair values of the Group's investment assets and these may also translate into increased impairments, particularly with respect to our exposure through our liquidity and investment portfolios to financial institutions in GIIPS and residential mortgage backed securities ("RMBS") and covered bonds collateralized on assets originated in GIIPS. In addition, the value that we ultimately realize for our securities and other investments may be lower than the current fair value. Any of these factors could require us to record further negative fair value adjustments, which may have a material adverse effect on our operating results, financial condition or prospects.
Liquidity and funding continue to remain key areas of focus for the Group and the industry as a whole. Like all major financial institutions, we are dependent on confidence in the short and long term wholesale funding markets. Should we, due to exceptional circumstances, be unable to continue to source sustainable funding, our ability to fund our financial obligations could be impacted.
Our business is subject to risks concerning liquidity, which are inherent in building society operations. If access to liquidity is constrained for a prolonged period of time, this could affect our profitability. Whilst we expect to have sufficient liquidity to meet our funding requirements even in a market wide stress scenario, under extreme and unforeseen circumstances a prolonged and severe restriction on the Group's access to liquidity (including government and central bank funding and liquidity support) could affect our ability to meet our financial obligations as they fall due, to meet our regulatory minimum liquidity requirements, or to fulfill our commitments to lend. In such extreme circumstances the Group may not be in a position to continue to operate without additional funding support. Inability to access such support could have a material impact on the Group's solvency. These risks can be exacerbated by many enterprise-specific factors, including an over-reliance on a particular source of funding, changes in credit ratings, or market-wide phenomena such as market dislocation and major disasters. There is also a risk that the funding structure employed by the Group may prove to be inefficient, giving rise to a level of funding cost that is not sustainable in the long term for us to grow our business or even maintain it at current levels. Our ability to access retail and wholesale funding sources on satisfactory economic terms is subject to a variety of factors, including a number of factors outside of our control, such as liquidity constraints, general market conditions, regulatory requirements and loss of confidence in the UK banking system.
The ongoing availability of retail deposit funding is dependent on a variety of factors outside our control, such as general economic conditions and market volatility, the confidence of retail depositors in the economy in general and in the Group in particular, the financial services industry specifically and the availability and extent of deposit guarantees. These or other factors could lead to a reduction in the Group's ability to access retail deposit funding on appropriate terms in the future.
The maintenance and growth of the level of our lending activities depends in large part on the availability of retail deposit funding on appropriate terms, for which there has been increased competition since the severe disturbances in the financial markets began. Increases in the cost of such funding together with the low base rate environment have had a negative impact on our margins and profit. In extreme circumstances, loss in consumer confidence could result in high levels of withdrawals from our retail deposit base, upon which we rely for lending and which could have a material adverse effect on our business, financial position and results of operations.
In past years the Government has provided significant support to UK financial institutions, including through the Special Liquidity Scheme, which was introduced in April 2008 to improve the liquidity position of the banking system by allowing banks and building societies to swap their high quality mortgage-backed and other securities for UK Treasury Bills for up to three years, and the Credit Guarantee Scheme, which was introduced in October 2008 and under which the Government guaranteed eligible bank and building society debt securities for a limited period. Nationwide participated in both these schemes.
On 1 August 2012, the Bank of England's Funding for Lending Scheme (the "FLS") became operational. The aim of the FLS is to boost the incentive for banks and building societies to lend to UK households and non-financial companies. The FLS is designed to reduce funding costs for participating institutions so that they can make loans cheaper and more easily available. Access to the FLS is directly linked to how much each institution lends to the real economy. Those that increase lending are able to borrow more in the FLS and at a lower cost than those that scale back their loans. Under the FLS, participating financial institutions will, for a period of 18 months to the end of January 2014, be able to borrow funds with a maturity of up to four years.
The availability of Government support for UK financial institutions, to the extent that it provides access to cheaper and more attractive funding than other sources, reduces the need for those institutions to fund themselves in the retail or wholesale markets. Nationwide is participating in the FLS, and our initial borrowing allowance under FLS was set at £7.61 billion. As at September 30, 2012, we have drawn £509 million of UK treasury bills, with further usage expected to form part of our funding plans in the period to January 31, 2014 when the drawdown period ends. By so participating, Nationwide reduces the need to fund itself in the wholesale markets and there is a risk that if it ceases to remain sufficiently active in those markets its access to them could be prejudiced in the future when Government support is reduced or no longer available to it. Any significant reduction or withdrawal of Government support will increase funding costs for those institutions which have previously utilised that support. In addition, other financial institutions who have relied significantly on Government support to meet their funding needs will also need to find alternative sources of funding when that support is reduced or withdrawn and, in such a scenario, Nationwide expects to face increased competition for funding, particularly retail funding on which it is reliant, in the future. This competition could further increase its funding costs and so adversely impact its results of operations and financial position.
Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of our businesses. Adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in the UK or global economic conditions, including such changes or deterioration arising from systemic risks in the financial systems, could affect the recoverability and value of our assets and require an increase in our impairment provision for bad and doubtful debts and other provisions.
As a result of, among other factors, increases and decreases in the BoE base rate, interest rates payable on a significant portion of our outstanding mortgage loan products fluctuate over time, resulting in borrowers with a mortgage loan subject to a variable rate of interest or with a mortgage loan for which the related interest rate adjusts following an initial fixed rate or low introductory rate, as applicable, being exposed to increased monthly payments as and when the related mortgage interest rate adjusts upward (or, in the case of a mortgage loan with an initial fixed rate or low introductory rate, at the end of the relevant fixed or introductory period). Over the last few years both variable and fixed interest rates have been at relatively low levels, which has benefited borrowers taking out new loans and those repaying existing variable rate loans regardless of special or introductory rates, and these rates are expected to increase as general interest rates return to historically more normal levels. Future increases in borrowers' required monthly payments, which (in the case of a mortgage loan with an initial fixed rate or low introductory rate) may be compounded by any further increase in the related mortgage interest rate during the relevant fixed or introductory period, ultimately may result in higher delinquency rates and losses in the future.
Borrowers seeking to avoid these increased monthly payments by refinancing their mortgage loans may no longer be able to find available replacement loans at comparably low interest rates. Recent declines in housing prices and/or any further declines in housing prices may also leave borrowers with insufficient equity in their homes to permit them to refinance. These events, alone or in combination, may contribute to higher delinquency rates and losses. For further discussion see "Management's Discussion and Analysis of Financial Condition and Results of Operation—Results of Operations for the Six Month Period Ended September 30, 2012 Compared with the Six Month Period Ended September 30, 2011—Operating expenses and similar charges—Impairment losses on loans and advances to customers".
If sentiment towards the banks, building societies and/or other financial institutions operating in the United Kingdom (including Nationwide) were to further deteriorate, or if our ratings and/or the ratings of the sector were to be further adversely affected, this may have a materially adverse impact on us. In addition, such change in sentiment or further reduction in ratings could result in an increase in the costs and a reduction in the availability of wholesale market funding across the financial sector which could have a material adverse effect on the liquidity and funding of all UK financial services institutions, including Nationwide. Any such events could affect the market value of the Notes.
Any future declines in those aspects of our business identified by the rating agencies as significant or otherwise could adversely affect the rating agencies' perception of our credit and cause them to take further negative ratings actions. Any downgrade in our credit ratings could adversely affect our liquidity and competitive position, undermine confidence in our business, increase our borrowing costs, limit our access to the capital markets, or limit the range of counterparties willing to enter into transactions with us. Nationwide has experienced all of these effects when downgraded in the past, although the precise effects experienced on each downgrade have varied based on the reasons for the particular downgrade and the extent to which the downgrade had been anticipated by the market. Our credit ratings are subject to change and could be downgraded as a result of many factors, including the failure to successfully implement our strategies. A downgrade could also lead to a loss of customers and counterparties which could have a material adverse effect on our business, results of operations and financial condition.
If the ratings analysis of any agency that rates our credit is updated to reflect lower forward-looking assumptions of systemic support in the current environment or higher assumptions of the risks in the financial sector, or otherwise modified, it could result in a further downgrade to the outlook or to the credit ratings of UK financial institutions, including Nationwide, which could have a material adverse effect on the borrowing costs, liquidity and funding of all UK financial services institutions, including Nationwide. A further downgrade could also create new obligations or requirements for Nationwide under existing contracts with its counterparties that may have a material adverse effect on our business, financial condition, liquidity or results of operations.
Likewise, any downgrade of the UK sovereign credit rating, or the perception that such a downgrade may occur, may severely destabilize the markets and have a material adverse effect on our operating results, financial condition, prospects and the marketability and trading value of the Notes. This might also impact on our own credit ratings, borrowing costs and our ability to fund ourselves. A UK sovereign downgrade or the perception that such a downgrade may occur would be likely to have a material effect in depressing consumer confidence, restricting the availability, and increasing the cost, of funding for individuals and companies, further depressing economic activity, increasing unemployment and/or reducing asset prices. These risks are exacerbated by concerns over the levels of the public debt of, the risk of further sovereign downgrades of, and the weakness of the economies in, GIIPS in particular. Further instability within these countries or others within the eurozone might lead to contagion.
Developments in our industry and increased competition could have a material adverse effect on our operations. We operate in an increasingly competitive UK personal financial services market. We compete mainly with other providers of personal finance services, including banks, building societies and insurance companies. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Overview—Impact of Economic Conditions in the United Kingdom Generally and Outlook".
The UK market for financial services and the mortgage market in particular have been reshaped by the recent financial crisis. Lenders have moved increasingly towards a policy of concentrating on the highest quality customers, judged by credit score and loan to value criteria, and there is strong competition for these customers. The supply of credit is much more limited for those potential customers without a large deposit or good credit history. As the wholesale funding market has become more challenging, there has been greater competition for retail deposits, which has inevitably impacted on lenders' margins. Competition may intensify further in response to consumer demand, technological changes, the impact of consolidation by our competitors, regulatory actions and other factors. If increased competition were to occur as a result of these or other factors, our business, financial condition and results of operations could be materially adversely affected. Currently, there is particular uncertainty on the shape and potential effects of pending changes to the way in which the sector is regulated. This is particularly the case in regard to the impact of the Government's response to the recommendations of the Independent Commission on Banking ("ICB").
In addition, if our customer service levels were perceived by the market to be materially below those of competitor UK financial institutions, we could lose existing and potential new business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our business, financial condition and results of operations.
Our success as a financial institution depends on our ability to manage and control our financial risk, which includes liquidity, market, and credit risk. We are exposed to liquidity risk as a result of mismatches in cash flows from balance sheet assets and liabilities and off-balance sheet financial instruments. We have market risk exposure as a result of changes in interest rates, foreign currency prices, asset prices or other financial contracts. Credit risk is the risk that a customer or counterparty is unable to meet its obligations to us as they fall due. If we fail to manage and control these risks, we could become unable to meet our own obligations, including those under the Notes, resulting in material adverse effects to our business, financial condition and reputation. For additional information about our policies for managing and controlling liquidity, market and credit risk, see the section entitled "Financial Risk Management".
Our businesses are also dependent on our ability to process a very large number of transactions efficiently and accurately. Operational risk and losses can result from fraud, errors by employees, failure to document transactions properly or to obtain proper internal authorization, failure to comply with regulatory requirements and conduct of business rules, equipment failures, natural disasters or the failure of external systems, for example, those of our suppliers or counterparties. Although we have implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures and to staff training, it is not possible to implement procedures which are fully effective in controlling each of the operational risks noted above. Notwithstanding the above, this risk factor should not be taken to imply that we will be unable to comply with our obligations as a company with securities admitted to the Official List or as a supervised firm regulated by the FSA.
The most significant market risks we face are interest rate, foreign exchange and bond and equity price risks. Changes in interest rate levels, yield curves and spreads may affect the interest rate margin realized between lending and borrowing costs. Changes in currency rates, particularly in the sterling-dollar and sterling-euro exchange rates, affect the value of assets and liabilities denominated in foreign currencies and may affect income from assets and liabilities denominated in foreign currency.
The performance of financial markets may cause changes in the value of our investment and liquidity portfolios. Although we have implemented risk management methods to seek to mitigate and control these and other market risks to which we are exposed and our exposures are constantly measured and monitored, there can be no assurance that these risk management methods will be effective, particularly in unusual or extreme market conditions. It is difficult to predict with accuracy changes in economic or market conditions and to anticipate the effects that such changes could have on our financial performance and business operations.
Our ability to attract and retain customers and conduct business with our counterparties could be adversely affected if our reputation or the reputation of the Nationwide brand is damaged. Failure to address, or appearing to fail to address, issues that could give rise to reputational risk could cause harm to us and our business prospects. Reputational issues include, but are not limited to: appropriately addressing potential conflicts of interest; breaching or facing allegations of having breached legal and regulatory requirements; acting or facing allegations of having acted unethically (including having adopted inappropriate sales and trading practices; adequacy of anti-money laundering and anti-terrorism financing processes; privacy issues; failing or facing allegations of having failed to maintain appropriate standards of customer privacy, customer service and record-keeping; technology failures that impact upon customer services and accounts; sales and trading practices; proper identification of the legal, reputational, credit, liquidity and market risks inherent in products offered; and general company performance. A failure to address these issues appropriately could make customers unwilling to do business with us, which could adversely affect our business, financial condition and results of operations.
We are exposed to many forms of legal and regulatory risk, which may arise in a number of ways. Primarily:
In addition, we face both financial and reputational risk where legal or regulatory proceedings, or complaints before the FOS, or other complaints are brought against us or members of our industry generally in the UK High Court or elsewhere. For example, a UK High Court judgment in 2011 on the misselling of payment protection insurance ("PPI") resulted in very significant provisions for customer redress made by several UK financial services providers. Our provision for customer redress is reflected in a charge for the six month period ended September 30, 2012 of £45 million (£103 million for the year ended April 4, 2012). Although our PPI product sales ceased in 2007 and although we view our historical sales volumes as relatively low and subject to a rigorous sales process, we continue to see elevated levels of PPI claims and there can be no assurance that our estimates for potential liability are correct, and our reserves taken to date might prove inadequate.
Failure to manage these risks adequately could lead to significant liabilities or reputational damage, which could have a material adverse effect on our business, financial condition, results of operations and relations with customers.
We conduct our business subject to ongoing regulation by the FSA (and, in due course, the PRA and the FCA), which oversees the sale of residential mortgages, commercial lending and general insurance products. The regulatory regime requires us to be in compliance across many aspects of activity, including the training, authorization and supervision of personnel, systems, processes and documentation. If we fail to be compliant with relevant regulations, there is a risk of an adverse impact on our business due to sanctions, fines or other action imposed by the regulatory authorities.
This is particularly the case in the current market environment, which is witnessing increased levels of government intervention in the banking, personal finance and real estate sectors. Future changes in regulation, fiscal or other policies are unpredictable and beyond our control and could materially adversely affect our business or operations.
There are a number of business risks associated with the UK personal finance sector that alone or cumulatively could have a material adverse effect on our operations, including the risk that the Financial Services Authority (and in the future, its successor regulatory bodies), and other bodies such as the Financial Services Ombudsman, could impose additional regulations on current and past dealings with retail customers. As a result, we may be required to incur costs to apply these regulations to our business, including costs relating to advice given to retail customers that purchased endowment policies used to repay mortgage loans.
The Banking Act 2009 (the "UK Banking Act"), which came into effect on February 21, 2009, includes (amongst other things) provision for a special resolution regime pursuant to which specified UK authorities have extended tools to deal with the failure (or likely failure) of a UK bank or building society (such as us). The orders which may be made under the UK Banking Act in respect of relevant deposit-taking institutions relate to share transfer powers (applying to a wide range of securities) and property transfer powers (including powers for partial transfers of property, rights and liabilities), certain ancillary powers (including powers to modify certain contractual arrangements in certain circumstances, including between group companies, and/or disapplication or modification of laws (with possible retroactive effect) and two new special insolvency procedures (bank insolvency and bank administration) which may be commenced by UK authorities. In addition, in respect of UK building societies, the relevant tools include modified property transfer powers which refer to (i) cancellation of shares and conferring rights and liabilities in place of such shares and (ii) a public ownership tool which may involve (amongst other things) arranging for deferred shares in a building society to be publicly owned, cancellation of private membership rights and the eventual winding up or dissolution of the building society. The UK Banking Act also includes powers for a modified bank insolvency procedure and/or a modified bank administration procedure to be applied by statutory instrument to building societies. Pursuant to Section 90C of the UK Building Societies Act (as inserted by the Building Societies (Insolvency and Special Administration) Order 2009 (amended by the Building Societies (Insolvency and Special Administration) (Amendment) Order 2010)), these special insolvency proceedings were applied (with modifications) to building societies.
In general, the UK Banking Act requires the UK authorities to have regard to specified objectives in exercising the powers provided for by the UK Banking Act. One of the objectives (which is required to be balanced as appropriate with the other specified objectives) refers to the protection and enhancement of the stability of the financial systems of the UK. It is a condition to the exercise of a stabilization power under the UK Banking Act that the FSA must be satisfied that the relevant bank or building society is failing or likely to fail to meet the FSA's threshold conditions for authorization and that, having regard to timing and other relevant circumstances, it is not reasonably likely that action would be taken that would have enabled such bank or building society to satisfy the threshold conditions. The UK Banking Act includes provisions related to compensation in respect of transfer instruments and orders made under it.
If an instrument or order were to be made under the UK Banking Act in respect of us, such instrument or order may (amongst other things) (i) result in a transfer to another issuer via the modified tools described above, (ii) affect our ability to satisfy our obligations under the Notes and/or (iii) result in modifications to the terms of the Notes. In addition, the UK Banking Act contains particular powers for provision to be included in an instrument or order that such instrument or order (and possibly certain related events) be disregarded in determining whether certain widely defined "default event" provisions have occurred (which default events could include certain events of default under any Notes) and provides for the disapplication or modification of laws (with possible retroactive effect) and/or fiscal consequences in connection with the exercise of powers under the UK Banking Act.
At present, the UK authorities have not made an instrument or order under the UK Banking Act in respect of us and there has been no indication that it will make any such instrument or order, but there can be no assurance that this will not change and/or that the holders of Notes will not be adversely affected by any such instrument or order if made.
On June 6, 2012, following earlier consultation papers in this area published in January 2011 and March 2012, the European Commission published a legislative proposal for a directive providing for the establishment of an EU-wide framework for the recovery and resolution of credit institutions and investment firms. Among other things, the proposed crisis-management directive ("CMD") contemplates the introduction of a package of minimum early intervention and resolution-related tools and powers for relevant authorities and provides for special rules for cross-border groups. The resolution tools and powers referred to in the CMD include certain tools and powers which overlap in part with those available under the Banking Act and also certain further tools, such as provision for authorities to bail-in eligible liabilities of relevant institutions and to ensure mandatory write-down of capital instruments at the point of non-viability of the relevant institution. There is still scope for changes to be made before any final legislation is adopted. On the basis of the current proposals, however, member states will be expected to implement the CMD, including the proposals on capital write-down, on or before January 1, 2015, except for the proposals on bail-in, which Member states will have until January 1, 2018 to implement. The proposals on capital write-down and on bail-in are both expected to cover outstanding liabilities already in issue.
On April 7, 2010 the UK Building Societies (Financial Assistance) Order 2010 came into force in exercise of certain powers under the UK Banking Act for the purpose of modifying the application of the UK Building Societies Act in specified circumstances to facilitate the provision to a building society of relevant financial assistance (including the giving of guarantees or indemnities or any other kind of financial assistance (actual or contingent)) by certain 'qualifying persons'. Qualifying institutions for this purpose include H.M. Treasury, the BoE, another central bank of a member state of the European Economic Area, the European Central Bank, or any person acting for or on behalf of any such institution or providing financial assistance to a building society on the basis of financial assistance from such an institution. Most significantly, the UK Building Societies (Financial Assistance) Order 2010 would permit any qualifying institution to provide such assistance to us without it counting for the purpose of the 50% limit on our non-member funding. It would also permit us to create a floating charge over our assets in favor of a qualifying institution in respect of that assistance.
The Government has announced a range of structural reforms to UK financial regulatory bodies to be implemented in early 2013, as follows:
In addition, UK banks and building societies became subject to a bank levy from January 1, 2011. The levy applies to UK banking groups, building societies and the operations of non-UK banks in the UK, but an allowance is given against the first £20 billion of relevant liabilities meaning that smaller institutions will effectively be exempted from the levy charge. The scope of the excluded liabilities also includes Tier 1 capital, insured retail deposits and repos secured on sovereign debt. For further information, see "Description of Business—Bank levy".
From January 1, 2011 an updated FSA remuneration code (the "FSA Remuneration Code") came into effect, which applies to the UK's largest banks and building societies (including Nationwide) and sets forth certain remuneration principles affecting fixed and variable remuneration of employees of covered institutions. Although management does not believe the FSA Remuneration Code has historically affected or presently affects its ability to recruit or retain personnel, there can be no assurance that the aforementioned restrictions will not adversely affect our business, financial condition or results of operations.
In June 2010, the Government created the ICB to consider and to make recommendations on structural and related non-structural reforms to the UK banking sector to promote, among other things, financial stability and competition. The ICB released its Final Report to the Cabinet Committee on Banking Reform on September 12, 2011, which sets out the ICB's recommendations on reforms. These recommendations include (i) ring-fencing domestic retail banking services of UK banks and building societies, (ii) introducing a power for the UK authorities to bail in debt issued by UK banks and building societies, (iii) increasing UK banks' and building societies' loss-absorbing capacity (including by way of bail-in bonds), (iv) increasing the ranking of insured depositors on a winding up to rank ahead of all other unsecured creditors and (v) promoting competition in UK retail banking. The ICB indicated that the reforms will require an extended implementation period and recommended that implementation should be completed at the latest by 2019. If implemented, the ICB's recommendations would have an impact on the manner in which we conduct our business, may affect our ability to satisfy our obligations under the Notes and/or may result in modifications to the terms of the Notes, which may have certain tax implications.
HM Treasury published a white paper on June 14, 2012 ("Banking reform: delivering stability and supporting a sustainable economy") confirming its continuing support for the majority of the ICB proposals and its intention to bring forward legislation to effect the relevant changes before the end of this Parliament (2015). Broadly, the white paper covers the following areas: the ring-fencing of vital banking services from international and investment banking services; measures on loss absorbency and depositor preference; and proposals for enhancing competition in the banking sector. A draft of the initial bill to implement the ICB recommendations was published on October 12, 2012, in the form of framework legislation to put in place the architecture to effect the reforms, with detailed policy being provided for through secondary legislation. Any future bail-in powers will be implemented in line with the draft EU Recovery and Resolution Directive published on June 6, 2012. The Government has indicated that it intends to exclude building societies entirely from the enabling ring-fencing legislation, to avoid imposing disproportionately burdensome requirements upon the sector. The white paper notes, however, that some parallel changes will be made to the Building Societies Act 1986 to implement bespoke ring-fencing requirements for building societies and that loss absorbency requirements are still likely to apply. The Government plans to introduce all necessary legislation as soon as Parliamentary time allows, and has confirmed its commitment to completing all primary and secondary legislation by the end of this Parliament in May 2015. Banks and building societies will be expected to comply with all of the measures proposed in the white paper by 2019, as the ICB recommended.
On July 6, 2012, HM Treasury published a discussion document entitled "The future of building societies" which sets out the Government's aim to maintain the distinctiveness of the building society sector while creating a level playing field and removing unnecessary barriers to growth. The Government stated that it intends to amend the UK Building Societies Act to widen the opportunities for building societies and to align them with ring-fenced banks without compromising their mutuality. The Government stated that the loss absorbency proposals set out in the white paper of June 2012 on banking reform will apply to building societies as they apply for banks of a similar profile. As part of its commitment to foster diversity in the financial sector, the Government invited suggestions for reviewing those parts of the UK Building Societies Act which restrict societies, where this is in accordance with maintaining their distinctiveness.
On September 28, 2011, the European Commission issued proposals, including a draft Directive, for implementing an EU wide financial transaction tax ("FTT"). The FTT would be a broad-based tax on "financial institutions" in relation to "financial transactions". It would apply from January 1, 2014 in circumstances where at least one party to a financial transaction is a financial institution established (or deemed established) in a member state.
It seems unlikely at this time that consensus can be reached in order to implement the FTT proposals across the entirety of the EU, which would require unanimity from member states, though it is possible that this may change in future. The proposals are currently being considered by the committees of the European Parliament and were discussed by the Council of Ministers at its meeting on June 22, 2012, where a significant number of EU Finance Ministers continued to express opposition. Following the meeting, however, Finance Ministers from the member states that endorsed the proposal raised the idea of adopting a side agreement within the EU, imposing an FTT in their states alone. Even if an FTT were introduced only in some member states, it could impact financial institutions operating in the UK.
Currently it is not possible to predict how and the extent to which the other foregoing recently announced changes will impact on our operations, business results, financial condition or prospects. Accordingly, we cannot assure that any changes to the existing regulatory regime arising from the implementation of any of the foregoing matters or any other regulatory changes that may be proposed will not have a material adverse effect on our operations, business, results, financial condition or prospects.
We are subject to capital adequacy requirements adopted by the FSA for a building society. Our capital is reported as a ratio of total capital to risk-adjusted assets expressed as a percentage. If we fail to meet our minimum regulatory requirements, this may result in administrative actions or sanctions against us, which may impact our ability to fulfill our obligations under the Notes.
The current risk-adjusted capital guidelines (the "Basel Accord") promulgated by the Basel Committee on Banking Supervision, which form the basis for the European Union ("EU")'s and thus the FSA's capital adequacy requirements, include the application of risk-weighting (depending upon the credit status of certain customers, using an "internal ratings-based" approach to credit risk, and subject to approval of supervisory authorities). The requirements also include allocation of risk capital in relation to operational risk and supervisory review of the process of evaluating risk measurement and capital ratios.
On December 16, 2010 and on January 13, 2011, with a minor revision on June 1, 2011, the Basel Committee issued its final guidance on a number of fundamental reforms to the regulatory capital framework (such reforms being commonly referred to as "Basel III"), including new capital requirements, higher capital ratios, more stringent eligibility requirements for capital instruments, leverage ratio and liquidity requirements intended to reinforce capital standards and to establish minimum liquidity standards for financial institutions, including building societies. The guidance also proposes (by way of the January 13 press release) minimum requirements that all capital instruments issued after January 1, 2013 either under their terms or pursuant to appropriate laws be written down or converted into common equity (at the option of the relevant regulatory authority) upon the occurrence of certain "non-viability" trigger events.
Detailed proposals for the reform package as it will be implemented in the EEA are outlined in the European Commission's proposal, published on July 20, 2011, for a regulation to establish a single set of harmonized prudential rules which will apply directly to all credit institutions in the EU, and an associated capital requirements directive which will need to be transposed into national law (commonly referred to collectively as "CRD IV"). The CRD IV proposals are currently being debated by the European Parliament and Council. The proposal for a regulation gives express recognition for Common Equity Tier 1 capital instruments for mutuals, co-operatives and similar institutions and permits the use of a cap or restriction on the maximum level of distributions on such instruments provided such cap or restriction is set out under applicable national law or the constitution of the institution. Implementation of CRD IV was originally intended by the European authorities to begin from January 1, 2013 (consistent with the Basel III implementation timetable), but is now likely to be delayed at least until later in 2013. Otherwise, the timetable for implementation of CRD IV is anticipated to be broadly in line with Basel III, with full implementation by January 2019, but the proposals allow individual member states to implement the stricter requirements of contributing instruments and/or level of capital more quickly than is envisaged under Basel III. It is intended that the Basel Committee recommendation on loss absorbency of capital instruments at the point of non-viability will be implemented separately through the CMD and would be intended to come into force with effect from January 1, 2015. It remains unclear from the draft provisions in this area exactly how the CMD provisions on the point of non-viability will interact with the capital instruments criteria in the CRD IV.
The ICB's recommendations on reforms also leave open the possibility of capital and leverage requirements in excess of the minimum requirements prescribed by Basel III and/or CRD IV. The ICB recommendations and the UK Government's response supporting such recommendations include proposals to increase capital and loss absorbency to levels that exceed the proposals under Basel III. These requirements, as well as the other recommendations of the ICB, are expected to be phased in between 2015 and 2019. As the implementation of the ICB recommendations will be the subject of legislation not yet adopted, we cannot predict the impact such rules will have on our overall capital requirements or how they will affect our compliance with capital and loss absorbency requirements of Basel III.
The introduction of the new rules and proposals will present a number of challenges to us in reviewing our existing capital and liquidity arrangements and could have an impact on our capital and liquidity calculations and funding requirements or otherwise adversely affect our business or profitability.
The Financial Services and Markets Act 2000 established the Financial Services Compensation Scheme (the "FSCS"), which pays compensation to eligible customers of authorized financial services firms which are unable, or are likely to be unable, to pay claims against them. For further information, please refer to the section entitled "Description of Business—Financial Services Compensation Scheme". Based on its share of protected deposits, the Group pays levies to the FSCS to enable the scheme to meet claims against it. While it is anticipated that the substantial majority of claims will be repaid wholly from recoveries from the institutions concerned, there is the risk of a shortfall, such that the FSCS may place additional levies on all FSCS participants, which levies may be in significant amounts that may have a material impact on our profits. In particular, following agreement between the FSCS and H.M. Treasury on the terms of a refinancing in March 2012, it is anticipated that the total increase to the FSCS levy will be approximately 41%, which will be passed on across all firms holding protected deposits, including the Group. In addition, there can be no assurance that there will be no further actions taken under the Banking Act that may lead to further claims against the FSCS and concomitant increased FSCS levies payable by us. Any such increases in our costs and liabilities related to the levy may have a material adverse effect on our results of operations. Further costs and risks to us may also arise from discussions at national and European Union levels around the future design of financial services compensation schemes, including increasing the scope and level of protection and moving to pre-funding of compensation schemes. The amount provided for in the Group's accounts to meet its obligations to the FSCS was an estimated £58 million as at September 30, 2012 (£111 million as at April 4, 2012). At current rates and based on the latest information, which is subject to change, our share of the expected shortfall would total approximately £100 million which, in line with the intentions of the FSCS on timing of resultant levies, we would expect to be recognized over three years beginning in the year ending April 4, 2013. We estimate that a further provision of between £70 million and £80 million will be required during the second half of the financial year 2012/2013 in respect of the FSCS annual levy for the 2013/14 scheme year including the first amount of the £100 million expected shortfall described above.
On July 25, 2012 the FSA published a consultation paper, the FSCS Funding Model Review ("FFMR"), on changes to how the Financial Services Compensation Scheme is funded. The consultation closed on October 25, 2012. The FFMR will concentrate on issues such as the composition of the funding classes, the levy thresholds applicable to each and their tariff bases.
As a result of the structural reorganization and reform of the UK financial regulatory authorities, it is proposed that the FSCS will become the joint responsibility of the PRA and the FCA. It is possible that future policy of the FSCS and future levies on us may differ from those at present, and such reforms could lead us to incur additional costs and liabilities, which may adversely affect our business, financial condition and/or results of operations.
Regulators and other bodies in the UK and world-wide have produced a range of proposals for future legislative and regulatory changes which could force the Group to comply with certain operational restrictions, take steps to raise further capital, and/or increase the Group's expenses and/or otherwise adversely affect our business results, financial condition or prospects. These include, amongst others:
At this point it is impossible to predict the effect that any of the proposed or recently enacted changes will have on our operations, business and prospects or how any of the proposals discussed above will be affected and implemented in light of the fundamental changes to the regulatory environment proposed by the coalition government. Depending on the specific nature of the requirements and how they are enforced, such changes could have a significant impact on the Group's operations, structure, costs, and/or capital requirements. Accordingly, we cannot assure that the implementation of any of the foregoing matters or any other regulatory or legislative changes that may be proposed will not have a material adverse effect on our operations, business, results, financial condition or prospects.
Nationwide is also investing significantly to ensure that it will be able to comply with developing regulatory requirements. If Nationwide is unsuccessful in efficiently adopting the requisite new compliance practices, this will adversely impact our ability to operate in the financial services markets and to deliver an appropriate level of operational and financial performance.
Subject to confirmation by the FSA, our members and our directors determine whether we remain a building society or if we demutualize (save in circumstances where the FSA makes a direction under Section 42B of the UK Building Societies Act or a UK authority makes an instrument or order under the UK Banking Act which results in a demutualization taking place).
The UK Building Societies Act includes provisions under which a building society may demutualize by transferring the whole of its business to a company. In addition, the UK Building Societies Act (as modified by the Mutual Societies (Transfers) Order 2009 (the "Mutual Transfers Order") made under section 3 of the Building Societies (Funding) and Mutual Societies (Transfers) Act 2007 (the "Funding and Mutual Societies Transfers Act")) includes provisions under which a building society may transfer the whole of its business to the subsidiary of another mutual society (as defined in section 3 of the Funding and Mutual Societies Transfers Act). At present, the claims of our depositors and other unsubordinated creditors would rank ahead of share accounts (which term excludes any deferred shares) and our members' rights to any surplus in the event of our liquidation, and the claims of our subordinated creditors would rank behind share accounts but ahead of members' rights to any surplus in the event of our liquidation. If, however, we transfer our business to a specially formed company or an existing company (as defined in the UK Building Societies Act) or to a subsidiary of another mutual society, all of our liabilities which immediately prior thereto were classified as share accounts will thereafter rank at least pari passu with all other unsecured and unsubordinated liabilities of our successor.
Under section 90B of the UK Building Societies Act (which was inserted by the Funding and Mutual Societies Transfers Act), H.M. Treasury may, by order, make provision for the purpose of ensuring that, on the winding up, or dissolution by consent, of a building society, any assets available for satisfying the society's liabilities to creditors (other than liabilities in respect of subordinated deposits, liabilities in respect of preferential debts, or any other category of liability which H.M. Treasury specifies in the order for these purposes) or to shareholders (other than liabilities in respect of deferred shares) are applied in satisfying those liabilities pari passu. The power to make an order under section 90B of the UK Building Societies Act is exercisable by statutory instrument but may not be made unless a draft of it has been laid before and approved by a resolution of each House of Parliament. No such order has been made as of the date of this Base Prospectus.
Following a transfer of our business to a company (including where the transfer is to a subsidiary of another mutual society), our obligations under senior Notes would rank (a) in priority to both the rights of the holders of the equity share capital in the company to any repayment of capital or surplus on a liquidation and any obligations of the company (whether or not created prior to such transfer) expressed to rank junior to such Notes, (b) equally with other unsecured and unsubordinated creditors (including inter-bank lenders and retail depositors) and (c) behind any statutorily preferential creditors.
For additional discussion in relation to the ranking of our debt, see the sections entitled "Terms and Conditions of the Notes—Status of Senior Notes" and "Terms and Conditions of the Notes—Status and Subordination of Subordinated Notes". For further information about demutualization, see the section entitled "Supervision and Regulation".
The terms and conditions of the Notes contain provisions for calling meetings of holders of Notes to consider matters affecting their interests generally. These provisions permit defined majorities to bind all holders of Notes including holders of Notes who did not attend and vote at the relevant meeting and holders of Notes who voted in a manner contrary to the majority.
The terms and conditions of the Notes also provide that the Trustee may, without the consent of holders of Notes, agree to (i) any modification of the terms and conditions of the Notes or the Indenture or (ii) the substitution of another company as principal debtor under any Notes in place of the Issuer, in the circumstances described in the section entitled "Terms and Conditions of the Notes—Supplemental Indentures".
Under EC Council Directive 2003/48/EC (the "Directive") on the taxation of savings income, each member state is required to provide to the tax authorities of another member state details of payments of interest or other similar income paid by a person within its jurisdiction to, or collected by such a person for, an individual resident in that other member state or to certain limited types of entities established in that other member state. However, for a transitional period, Luxembourg and Austria are instead required (unless during that period they elect otherwise) to operate a withholding system in relation to such payments (the ending of such transitional period being dependent upon the conclusion of certain other agreements relating to information exchange with certain other countries). A number of non-EU countries and territories including Switzerland have adopted similar measures (a withholding system in the case of Switzerland).
The European Commission has proposed certain amendments to the Directive which may, if implemented, amend or broaden the scope of the requirements described above.
Sections 1471 through 1474 of the U.S. Internal Revenue Code ("FATCA") impose a new reporting regime and potentially a 30% withholding tax with respect to certain payments to any non-U.S. financial institution (a "foreign financial institution", or "FFI" (as defined by FATCA)) that (i) does not become a "Participating FFI" by entering into an agreement with the U.S. Internal Revenue Service ("IRS") to provide the IRS with certain information in respect of its account holders and investors or (ii) is not otherwise exempt from or in deemed compliance with FATCA. We are classified as an FFI.
The new withholding regime will be phased in (i) beginning 1 January 2014 for certain payments from sources within the United States and (ii) beginning 1 January 2017 for payments of gross proceeds on assets that could generate U.S. source dividend or interest and "foreign passthru payments" (a term not yet defined). This withholding would potentially apply to payments in respect of (i) any Notes characterized as debt (or which are not otherwise characterized as equity and have a fixed term) for U.S. federal tax purposes that are issued on or after the date (the "grandfathering date") that is six months after the date on which final U.S. Treasury regulations define the term foreign passthru payment are filed with the Federal Register, or which are materially modified on or after the grandfathering date and (ii) any Notes characterized as equity or which do not have a fixed term for U.S. federal tax purposes, whenever issued. If Notes are issued before the grandfathering date, and additional Notes of the same series are issued on or after that date, the additional Notes may not be treated as grandfathered, which may have negative consequences for the existing Notes, including a negative impact on market price.
The United States and a number of other jurisdictions have announced their intention to negotiate intergovernmental agreements to facilitate the implementation of FATCA (each, an "IGA"). Pursuant to FATCA and the "Model 1" and "Model 2" IGAs released by the United States, an FFI in an IGA signatory country could be treated as a "Reporting FI" not subject to withholding under FATCA on any payments it receives. Further, an FFI in a Model 1 IGA jurisdiction would not be required to withhold under FATCA or an IGA (or any law implementing an IGA) (any such withholding being "FATCA Withholding") from payments it makes (unless it has agreed to do so under the U.S. "qualified intermediary," "withholding foreign partnership," or "withholding foreign trust" regimes). The Model 2 IGA leaves open the possibility that a Reporting FI might in the future be required to withhold as a Participating FFI on foreign passthru payments that it makes. Under each Model IGA, a Reporting FI would still be required to report certain information in respect of its account holders and investors to its home government or to the IRS. The United States and the United Kingdom have entered into an agreement (the "US-UK IGA") based largely on the Model 1 IGA.
We expect to be treated as a Reporting FI pursuant to the US-UK IGA and do not anticipate being obliged to deduct any FATCA Withholding. There can be no assurance, however, that we will be treated as a Reporting FI or that in the future we would not be required to deduct FATCA Withholding from payments we make. Accordingly, we and financial institutions through which payments on the Notes are made may be required to withhold FATCA Withholding if any FFI through or to which payment on such Notes is made is not a Participating FFI, a Reporting FI, or otherwise exempt from or in deemed compliance with FATCA.
If an amount in respect of FATCA Withholding were to be deducted or withheld from interest, principal or other payments made in respect of the Notes, neither we nor any paying agent nor any other person would, pursuant to the conditions of the Notes, be required to pay additional amounts as a result of the deduction or withholding. As a result, investors may receive less interest or principal than expected. FATCA is particularly complex and its application is uncertain at this time. The above description is based in part on proposed regulations, official guidance and model IGAs, all of which are subject to change or may be implemented in a materially different form.
We will pay principal and interest on the Notes in the Specified Currency (as defined below). This presents certain risks relating to currency conversions if an investor's financial activities are denominated principally in a currency or currency unit (the "Investor's Currency") other than the Specified Currency. These include the risk that exchange rates may significantly change (including changes due to devaluation of the Specified Currency or revaluation of the Investor's Currency) and the risk that authorities with jurisdiction over the Investor's Currency may impose or modify exchange controls. An appreciation in the value of the Investor's Currency relative to the Specified Currency would decrease (1) the Investor's Currency equivalent yield on the Notes, (2) the Investor's Currency equivalent value of the principal payable on the Notes and (3) the Investor's Currency equivalent market value of the Notes.
Government and monetary authorities may impose (as some have done in the past) exchange controls that could adversely affect an applicable exchange rate. As a result, investors may receive less interest or principal than expected, or no interest or principal.
We have not registered, and will not register, the Notes under the Securities Act or any other applicable securities laws. Accordingly, the Notes are subject to certain restrictions on resale and other transfer thereof as set forth in the section entitled "Transfer Restrictions". As a result of these restrictions, we cannot be certain of the existence of a secondary market for the Notes or the liquidity of such a market if one develops. Consequently, a holder of Notes and an owner of beneficial interests in those Notes must be able to bear the economic risk of their investment in the Notes for the term of the Notes.
The Notes are new securities which may not be widely distributed and for which there is currently no active trading market. If the Notes are traded after their initial issuance, they may trade at a discount to their initial offering price, depending upon prevailing interest rates, the market for similar securities, general economic conditions and our financial condition. Although we have applied to admit the Notes issued from time to time to listing on the Official List and to admit them to trading on the London Stock Exchange, we cannot assure you that the Notes will be accepted for listing or that an active trading market will develop. Accordingly, we cannot assure you as to the development or liquidity of any trading market for the Notes.
Potential investors should note that, in view of prevailing and widely reported global credit market conditions (which continue at the date hereof), the secondary market for the Notes and for instruments of this kind may be illiquid. We cannot predict when and how these circumstances will change. Liquidity in the Notes may also be disrupted by the recent market disruptions referred to above.
If we are declared insolvent and a winding up is initiated we will be required to pay the holders of our senior debt and meet our obligations to all of our other creditors (including unsecured creditors but excluding any obligations that we may have with respect to our subordinated debt and permanent interest bearing shares) and our UK retail member deposits in full before we can make any payments on the subordinated Notes. If this occurs, we may not have enough assets remaining after these payments to pay amounts due under the subordinated Notes. See "—Risks Related to Our Business— Risks associated with governmental authorities and monetary policies of the UK and changes thereto may adversely affect our business".
The credit ratings of our medium-term note program may not reflect the potential impact of all risks relating to the value of the Notes. In addition, real or anticipated changes in our credit ratings or the credit ratings of the Notes will generally affect the market value of the Notes. These credit ratings could change due to a wide range of factors, including but not limited to those discussed under "—Risks Related to Our Business—Rating downgrade and/or market sentiment with respect to Nationwide, the sector, the UK and/or other sovereign issuers may have an adverse effect on our performance and/or the marketability and liquidity of the Notes". A credit rating is not a recommendation to buy, sell or hold securities and may be subject to suspension, reduction or withdrawal at any time by the assigning rating agency.
These Notes will be represented by one or more Global Notes. These Notes will be deposited with a custodian on behalf of DTC or its nominee. Except in limited circumstances, holders will not be entitled to receive certificated Notes. DTC will maintain records of the beneficial interests in the Global Notes. Holders will be able to trade their beneficial interests only through DTC or a participant of DTC such as Euroclear or Clearstream. The laws of some jurisdictions, including some states in the United States, may require that certain purchasers of securities take physical delivery of such securities in certificated form. The foregoing limitations may impair a holder's ability to own, transfer or pledge its beneficial interests. A holder of beneficial interests in the Global Notes in one of these jurisdictions will not be considered the owner or "holder" of the Notes.
We will discharge our payment obligations under the Notes by making payments to the custodian for distribution to the holders of beneficial interests at DTC or a participant of DTC with respect to interests of indirect participants. We and the initial purchasers of the Notes will not have any responsibility or liability for the records relating to, or payments made in respect of, beneficial interests in the Global Notes. A holder of beneficial interests must rely on the procedures of DTC or DTC's participants, through which holders hold their interests, to receive payments under the Notes. We cannot assure holders that the procedures of DTC or DTC's nominees, participants or indirect participants will be adequate to ensure that holders receive payments in a timely manner.
A holder of beneficial interests in the Global Notes will not have a direct right under the indenture governing these Notes to act upon solicitations we may request. Instead, holders will be permitted to act only to the extent they receive appropriate proxies to do so from DTC or, if applicable, DTC's participants or indirect participants. Similarly, if we default on our obligations under the Notes, as a holder of beneficial interests in the Global Notes, holders will be restricted to acting through DTC, or, if applicable, DTC's participants or indirect participants. We cannot assure holders that the procedures of DTC or DTC's nominees, participants or indirect participants will be adequate to allow them to exercise their rights under the Notes in a timely manner.
An optional redemption feature is likely to limit the market value of Notes. During any period when we may elect to redeem Notes, the market value of those Notes generally will not rise substantially above the price at which they can be redeemed. This also may be true prior to any redemption period.
We may be expected to redeem Notes with an optional redemption feature when our cost of borrowing is lower than the interest rate on the Notes. At those times, an investor generally would not be able to reinvest the redemption proceeds at an effective interest rate as high as the interest rate on the Notes being redeemed and may only be able to do so at a significantly lower rate. Additionally, we may redeem the Notes at times when prevailing interest rates are relatively low, and accordingly investors may not be able to reinvest the redemption proceeds in a comparable security at an effective interest rate as high as that of the Notes. Potential investors should consider reinvestment risk in light of other investments available at that time.
Floating Rate/Fixed Rate Notes may bear interest at a rate that we may elect to convert from a fixed rate to a floating rate, or from a floating rate to a fixed rate. Our ability to convert the interest rate will affect the secondary market and the market value of such Notes since we may be expected to convert the rate when it is likely to produce a lower overall cost of borrowing. If we convert from a fixed rate to a floating rate, the spread on the Floating Rate/Fixed Rate Notes may be less favorable than then prevailing spreads on comparable Floating Rate Notes tied to the same reference rate. In addition, the new floating rate at any time may be lower than the rates on other Notes. If we convert from a floating rate to a fixed rate, the fixed rate may be lower than then prevailing rates on its Notes.
The market values of Notes issued at a substantial discount or premium to their principal amount tend to fluctuate more in relation to general changes in interest rates than do prices for conventional interest-bearing Notes. Generally, the longer the remaining term of the Notes, the greater the price volatility as compared to conventional interest-bearing Notes with comparable maturities.
The conditions of the Notes are based on the laws of the State of New York in effect as at the date of this Base Prospectus, except that the subordination provisions in each of the indenture and the subordinated notes are based on the laws of England and Wales in effect as at the date of this Base Prospectus. No assurance can be given as to the impact of any possible judicial decision or change to law or administrative practice after the date of this Base Prospectus and any such change could materially adversely impact the value of any Notes affected by it.
Investment in Fixed Rate Notes involves the risk that if market interest rates subsequently increase above the rate paid on the Fixed Rate Notes, this will adversely affect the value of the Fixed Rate Notes.
We will use the net proceeds of each issue of notes for general corporate purposes and, with regard to subordinated notes, to strengthen our capital base. We may also use a portion of the net proceeds from any note issuance to acquire companies or assets that are complementary to our business, although we do not currently have any acquisitions planned. See the section entitled "Description of Business" for a detailed description of our funding needs.
The following table sets forth, for the periods indicated, the high, low, average and period-end noon-buying rates in the City of New York for cable transfers in sterling as announced by the Federal Reserve Bank of New York for customs purposes, in each case for the purchase of U.S. dollars, all expressed in U.S. dollars per pound sterling (the "Market Exchange Rate"):
| U.S. Dollars Per Pound Sterling | |||||||
|---|---|---|---|---|---|---|---|
| For the financial year ended | High | Low | Average(1) | Year End | |||
| April 4, 2012 | 1.67 | 1.53 | 1.60 | 1.59 | |||
| April 4, 2011 | 1.64 | 1.43 | 1.56 | 1.61 | |||
| April 4, 2010(2) | 1.70 | 1.45 | 1.60 | 1.52 | |||
| April 4, 2009(3) | 2.00 | 1.37 | 1.70 | 1.48 | |||
| April 4, 2008 | 2.11 | 1.94 | 2.01 | 1.99 |
| For the month of | High | Low | Average(4) | Month End | ||
|---|---|---|---|---|---|---|
| (U.S. dollars per pound sterling) | ||||||
| July 2012 | 1.57 | 1.54 | 1.56 | 1.57 | ||
| August 2012 | 1.59 | 1.55 | 1.57 | 1.59 | ||
| September 2012 | 1.63 | 1.59 | 1.61 | 1.61 | ||
| October 2012 | 1.62 | 1.59 | 1.61 | 1.61 | ||
| November 2012 | 1.61 | 1.58 | 1.60 | 1.60 | ||
| December 2012 | 1.63 | 1.60 | 1.61 | 1.62 |
Notes:
______________
(1) The average of the noon buying rates on the last business day of each month during the relevant period.
(2) The last business day preceding the financial year end was April 2, 2010.
(3) The last business day preceding the financial year end was April 3, 2009.
(4) The average of the daily noon buying rates during the relevant period.
Solely for the convenience of the reader, this Base Prospectus presents translation of income statement and balance sheet data from pounds sterling into U.S. dollars at the rate of £1.00 to \$1.61, the Market Exchange Rate on September 30, 2012. These translations should not be construed as representations that pound sterling amounts actually represent such U.S. dollar amounts or could be converted into U.S. dollars at the rate indicated as of any of the dates mentioned in this Base Prospectus, or at all.
The following is a summary of our consolidated capitalization and indebtedness extracted from our unaudited consolidated financial statements as at September 30, 2012:
| As at September 30, 2012 |
|
|---|---|
| (£ millions) | |
| Consolidated Indebtedness(1) | |
| Deposits from banks | 4,672 |
| Amounts due to customers and other deposits | 12,644 |
| Debt securities in issue | 34,630 |
| Total Senior Debt | 51,946 |
| Subordinated Debt(1)(2) | |
| Comprising one issue maturing in 2014, one issue maturing in 2015, three issues maturing in 2016, two issues maturing in 2018, one issue maturing in 2019, two issues maturing in 2020 and one issue maturing in 2022. |
1,661 |
| Total Senior and Subordinated Debt | 53,607 |
| Permanent Interest Bearing Shares(1)(3) | |
| Comprising nine issues of permanent interest bearing shares callable (subject to relevant supervisory consent) in 2013, 2015, 2016, 2019, 2021, 2024, 2026 and 2030, respectively. The floating rate shares are only repayable in the event of the winding up of the Society |
1,680 |
| Members' Funds | |
| General reserve | 6,445 |
| Revaluation reserve | 64 |
| Other reserves | (313) |
| UK retail member deposits(1)(4) | 125,107 |
| Total members' funds | 131,303 |
| Total capitalization(5) | 186,590 |
| __ |
Notes:
(2) For consistency with other indebtedness, accrued interest of £27 million is included.
(3) For consistency with other indebtedness, accrued interest of £16 million is included.
Except as otherwise disclosed in this Base Prospectus, there has been no material change in our consolidated capitalization, indebtedness, guarantees or contingent liabilities since September 30, 2012.
(1) If we were to go into liquidation the claims of non-member depositors and other unsubordinated creditors would rank before those of holders of UK retail member deposits, and the claims of holders of UK retail member deposits would rank before those of subordinated debt holders. The claims of holders of permanent interest bearing shares rank behind those of all other creditors, including subordinated debt holders.
(4) Our rules provide that members may withdraw all or any of their investments by giving appropriate notice specifying the amount to be withdrawn. Members may also make an immediate withdrawal of their investments subject to a possible loss of interest. Our Board of Directors (the "Board") has the power to suspend or limit the payment of withdrawals when, in its discretion, it considers it necessary.
(5) The covered bond issues are our only secured debt. The covered bonds are secured on a ring-fenced section of our residential loans and advances to customers. As at September 30, 2012, the cover pool totaled £31,058 million.
The following tables present selected consolidated information which has been derived from our audited consolidated financial statements as of April 4, 2012, 2011 and 2010 for the financial years then ended and our unaudited consolidated financial statements as of and for the six months ended September 30, 2012 and 2011.
The following data should be read in conjunction with our audited consolidated financial statements and the notes thereto incorporated by reference herein as well as the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations":
| For the six month period ended September 30, |
For the financial year ended April 4, |
|||||
|---|---|---|---|---|---|---|
| 2012(1) | 2012 | 2011 | 2012 | 2011 | 2010 | |
| (\$ millions) | (£ millions) | |||||
| (unaudited) | (audited) | |||||
| Income Statement Data: | ||||||
| Interest receivable and similar income | 4,481 | 2,777 | 2,518 | 5,353 | 4,643 | 4,568 |
| Interest expense and similar charges(2) | 3,014 | 1,868 | 1,740 | 3,730 | 3,107 | 2,854 |
| Net interest income(2) | 1,467 | 909 | 778 | 1,623 | 1,536 | 1,714 |
| Fee and commission income(2) | 432 | 268 | 223 | 515 | 492 | 378 |
| Fee and commission expense(2) | (87) | (54) | (1) | (96) | (92) | (5) |
| Income from investments | 15 | 9 | 5 | 10 | 4 | 1 |
| Other operating income(2) | 0 | 0 | 1 | 91 | 7 | 47 |
| Gains on derivatives and hedge |
||||||
| accounting | (23) | (14) | 71 | 35 | 120 | 34 |
| Total income(2) | 1,804 | 1,118 | 1,077 | 2,178 | 2,067 | 2,169 |
| Administrative expenses(2) | (931) | (577) | (592) | (1,205) | (1,123) | (1,195) |
| Depreciation and amortization expenses | (157) | (97) | (82) | (180) | (150) | (151) |
| Impairment losses on loans and advances | ||||||
| to customers | (416) | (258) | (144) | (390) | (359) | (549) |
| Provisions for liabilities and charges | (63) | (39) | (15) | (162) | (52) | 103 |
| Impairment losses on investment |
||||||
| securities | (37) | (23) | (6) | (38) | (66) | (36) |
| Profit before tax | 200 | 124 | 238 | 203 | 317 | 341 |
| Analyzed as: | ||||||
| Profit before tax and the following items: | 244 | 151 | 172 | 304 | 276 | 212 |
| Financial Sector Compensation Scheme | 10 | 6 | - | (59) | (50) | 117 |
| Transformation costs | (18) | (11) | (5) | (61) | (29) | (62) |
| Bank levy | (13) | (8) | (9) | (16) | - | - |
| Gains from derivatives and hedge accounting |
(23) | (14) | 71 | 35 | 120 | 34 |
| Gain on portfolio acquisitions(3) | - | - | - | - | - | 40 |
| Profit before tax | 200 | 124 | 238 | 203 | 317 | 341 |
| Taxation | 19 | 12 | (50) | (24) | (69) | (77) |
| Profit | 219 | 136 | 188 | 179 | 248 | 264 |
Notes:
______________
(1) Dollar amounts are unaudited and have been derived from our unaudited financial statements for the six months ended September 30, 2012 using the exchange rate of U.S.\$ 1.61365 to £1.00.
(2) The amounts for the year ended April 4, 2011 have been reclassified or adjusted as described in note 1 of the audited consolidated financial statements for the year ended April 4, 2012.
(3) Gains on business combinations for the year ended April 4, 2010 relate to the acquisition of the social housing portfolio from DBS Bridge Bank Limited on June 30, 2009, which was not part of the original purchase of core parts of the Dunfermline Building Society on March 30, 2009. Transformation costs relate to the restructuring of parts of our business.
| For the six month period ended September 30, |
For the financial year ended April 4, |
|||||
|---|---|---|---|---|---|---|
| 2012(1) | 2012 | 2012 | 2011 | 2010 | ||
| (\$ millions) | (£ millions) | |||||
| (unaudited) | (audited) | |||||
| Balance Sheet Data | ||||||
| Assets: | ||||||
| Cash | ||||||
| 13,724 | 8,505 | 8,126 | 6,130 | 3,994 | ||
| Loans and advances to banks | 5,354 | 3,318 | 2,914 | 4,181 | 2,017 | |
| Investment securities-available for sale | ||||||
| 27,418 | 16,991 | 23,325 | 21,540 | 23,385 | ||
| Derivative financial instruments | 6,337 | 3,927 | 4,176 | 3,961 | 4,852 | |
| Fair value adjustment for portfolio |
||||||
| hedged risk(2) | 1,917 | 1,188 | 1,330 | 1,634 | 2,798 | |
| Loans and advances to customers(3) | ||||||
| 253,611 | 157,166 | 154,169 | 149,417 | 152,429 | ||
| Investments in equity shares | 36 | 22 | 29 | 103 | 86 | |
| Intangible assets | 1,204 | 746 | 681 | 529 | 353 | |
| Property, plant and equipment | 1,547 | 959 | 945 | 948 | 916 | |
| Investment properties | 15 | 9 | 9 | 9 | 9 | |
| Accrued income and expenses prepaid | 236 | 146 | 129 | 215 | 77 | |
| Deferred tax assets(2) | 416 | 258 | 229 | 218 | 357 | |
| Current tax assets | 3 | 2 | ||||
| Other assets | 61 | 38 | 67 | 68 | 124 | |
| Total assets(2) | ||||||
| Liabilities: | 311,879 | 193,275 | 196,129 | 188,953 | 191,397 | |
| UK retail member deposits | 201,879 | 125,107 | 125,617 | 122,552 | 120,943 | |
| Deposits from banks | 7,539 | 4,672 | 3,370 | 2,746 | 8,031 | |
| Other deposits(2) | 10,852 | 6,725 | 6,899 | 5,809 | 4,509 | |
| Due to customers(2) | 9,551 | 5,919 | 5,833 | 5,762 | 5,085 | |
| Fair value adjustment for portfolio hedged risk(2) |
394 | 244 | 278 | 19 | 106 | |
| Debt securities in issue | 55,882 | 34,630 | 38,854 | 37,808 | 36,802 | |
| Derivative financial instruments | 7,421 | 4,599 | 4,287 | 3,234 | 4,942 | |
| Other liabilities | 889 | 551 | 349 | 376 | 529 | |
| Provisions for liabilities and charges(2) | 405 | 251 | 295 | 165 | 118 | |
| Accruals and deferred income(2) | 610 | 378 | 369 | 376 | 376 | |
| Subordinated liabilities | 2,637 | 1,634 | 1,644 | 1,973 | 2,166 | |
| Subscribed capital | 2,685 | 1,664 | 1,625 | 1,510 | 1,524 | |
| Deferred tax liabilities(2) | 40 | 25 | 28 | 36 | - | |
| Current tax liabilities(2) | - | - | 5 | 45 | 42 | |
| Retirement benefit obligations | 1,097 | 680 | 517 | 300 | 508 | |
| General reserve(2) | 10,400 | 6,445 | 6,450 | 6,659 | 6,363 |
| For the six month period ended September 30, |
For the financial year ended | ||||
|---|---|---|---|---|---|
| 2012(1) | 2012 | 2012 | 2011 | 2010 | |
| (\$ millions) | (£ millions) | ||||
| (unaudited) | (audited) | ||||
| Balance Sheet Data | |||||
| Revaluation reserve | 103 | 64 | 65 | 70 | 68 |
| Available for sale reserve(2) | (505) | (313) | (356) | (487) | (715) |
| Total reserves and liabilities(2) | 311,879 | 193,275 | 196,129 | 188,953 | 191,397 |
Notes:
______________
(1) Dollar amounts are unaudited and have been derived from our unaudited financial statements for the six months ended September 30, 2012 using the exchange rate of U.S. \$1.61365 to £1.00.
(2) The amounts for the year ended April 4, 2011 have been reclassified or adjusted as described in note 1 of the audited consolidated financial statements for the year ended April 4, 2012.
(3) Loans and advances to customers include loans to corporate bodies, such as independent UK housing organizations registered with the Tenant Services Authority under the Housing Act 1996 ("Registered Social Landlords"), which are residential mortgage loans where the commitment was made prior to January 2, 1998. The classification of these assets is not consistent with the treatment of similar loans made after January 2, 1998, which are included in residential mortgage loans, but is necessary to comply with the requirements of the UK Building Societies Act 1997.
| For the six month period ended September 30, |
For the financial year ended April 4, |
||||
|---|---|---|---|---|---|
| 2012 | 2011 | 2012 | 2011 | 2010 | |
| (unaudited) | |||||
| Other Financial Data: | |||||
| Return on average total assets(1) | 0.14% | 0.20% | 0.09% | 0.13% | 0.13% |
| Net interest margin(2) | 0.93% | 0.81% | 0.83% | 0.81% | 0.87% |
| Wholesale funding ratio | 24.3 | 25.3 | 25.3 | 25.9 | 27.8 |
| Loan to deposit ratio | 114.1 | 111.4 | 111.4 | 111.4 | 116.8 |
| Loan to deposit ratio (including long | |||||
| term wholesale funding) | 94.6 | 93.8 | 93.8 | 94.8 | 100.3 |
| Ratio of earnings to fixed charges(3) | |||||
| Including interest on retail deposits | 1.07% | 1.14% | 1.05% | 1.10% | 1.12% |
| Excluding interest on retail deposits | 1.29% | 1.69% | 1.25% | 1.62% | 1.74% |
| Capital ratios | |||||
| Tier 1 capital(4) | 16.2% | 16.1% | 16.0% | 15.7% | 15.3% |
| Total capital(4) | 18.3% | 19.9% | 18.9% | 19.5% | 19.4% |
| Ratio of administrative expenses to mean total assets(5) __ |
0.69% | 0.70% | 0.72% | 0.67% | 0.68% |
Notes:
(2) Net interest margin represents net interest income as a percentage of weighted average total assets.
(3) For this purpose, earnings consist of profit on ordinary activities before tax and fixed charges. Fixed charges consist of interest expense including or excluding interest on retail deposits, as appropriate.
(1) Return on average total assets represents profit on ordinary activities after tax as a percentage of average total assets. Average balances are based on the balance as at the end of each month during the financial year.
(4) Throughout the years ended April 4, 2012, April 4, 2011 and April 4, 2010, and the six months ended September 30, 2012, the Group has complied with these rules which implement the EU Capital Requirements Directive ("Basel II"). As at April 4, 2010 capital requirements are calculated on the Internal Ratings Based ("IRB") basis. The Group has also received Individual Capital Guidance based on IRB approaches. The Basel II Pillar 1 capital requirements are calculated using the Retail IRB approach for prime mortgages and unsecured lending; Foundation IRB approach for treasury portfolios (excluding corporates); and the Standardized approach for all other credit risk exposures
(5) This ratio represents administrative expenses plus depreciation as a percentage of the average of total assets at the start and end of each period.
The following discussion is based on, and should be read in conjunction with, our selected consolidated financial and operating information and our audited annual and unaudited interim consolidated financial statements incorporated by reference herein. We prepared our financial statements in accordance with IFRS, which differs in certain significant respects from generally accepted accounting principles in the United States.
We are a building society, regulated by the UK Financial Services Authority. Our core business is providing personal financial services, primarily residential mortgage lending funded largely through retail savings. As a mutual organization, we are managed for the benefit of our members, our retail savings and residential mortgage customers, rather than for equity shareholders. We return value to our members by offering typically higher interest rates on savings and lower interest rates on loans than those offered by our main competitors. As a result, we generally earn lower pre-tax profits than our main competitors, which are primarily banks or other non-mutual organizations. As a mutual organization, we pay no dividends, and our net earnings are put into reserves and constitute Tier 1 capital for our capital adequacy requirements. For information regarding UK capital adequacy requirements, see the subsection entitled "Financial Condition of the Group—Capital Resources" below.
Our results for the six month period ended September 30, 2012 reflect strong trading with increased mortgage lending volumes, continued growth in our personal banking portfolios and the first material improvement in our margin since the onset of low interest rates in response to the credit crisis. These positive trends have contributed to a 14% growth in total income to £1.13 billion (six month period ended September 30, 2011: £0.99 billion) and a 38% increase in preprovision profit to £477 million (six month period ended September 30, 2011: £346 million). However, whilst losses on our core retail loan portfolios are modest and appear set to remain so, the increase in losses on our commercial property lending seen in the second half of last year has continued and the sustained high level of PPI claims has resulted in a further charge in the period. Our underlying profit for the period was £151 million (six month period ended September 30, 2011: £172 million). Reported statutory profit was £124 million, lower than the corresponding period result of £238 million due to the fall in underlying profit and fair value losses on derivatives and hedge accounting, in contrast to substantial gains reported a year ago.
Over the six months to September 30, 2012, we advanced £10.2 billion of mortgages, an increase of 15% on the same period in 2011 (six month period ended September 30, 2011: £8.9 billion). This is our highest six month lending period for four years. Our net lending was £3.2 billion, more than double that in the same period last year (six month period ended September 30, 2011: £1.4 billion). Our market shares of gross and net lending for the six month period ended September 30, 2012 were 14.4% and 81.8% respectively (six month period ended September 30, 2011: 12.4% and 31.5%) (Source: Bank of England, September 2012).
Our business is underpinned by conservative lending standards, a strong capital base and high levels of liquidity, reflecting our mutual status and primary focus on the provision of residential mortgages and secure savings products for our members. We believe that these key characteristics which define Nationwide are evidenced strongly in our results for the six month period ended September 30, 2012, with mortgage arrears significantly below the industry average, a core tier one capital ratio of 12.4%, more than 75% of our funding provided from retail balances, and two thirds of our wholesale funding with maturities of more than a year.
There are a number of challenges currently facing the UK economy: interest rates are likely to remain low for a protracted period, both mortgage and savings markets are growing at only a fraction of their historic norms and there remains considerable market and house price uncertainty. In addition, the potential impact from developments in the eurozone are still unclear. Despite these difficulties, our business model has shown itself to be extremely resilient, and we believe that we are well placed to pursue our policy of delivering excellent long term value to all of our members.
Current US trends are more positive, with stabilizing house prices and falling delinquency and foreclosure rates. The progress of the US economy will continue to be closely monitored although current performance suggests that significant additional impairment is unlikely.
As the low interest rate environment continues through its fourth year, savers continue to face an extended period of low returns on their deposits. In common with other savings providers, Nationwide has the difficult task of balancing attractive interest rates with the need to protect the long term financial strength of the business and manage our liquidity in line with evolving regulation.
Net interest income of £909 million in the six month period ended September 30, 2012 was £132 million higher than the comparable period ended September 30, 2011.
| For the six month period ended September 30, |
|||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions, except percentages) |
|||
| Net interest income | 909 | 777 | |
| Weighted average total assets | 195,652 | 192,847 | |
| Net interest margin | 0.93% | 0.81% |
The Group's net interest margin improved twelve basis points to 0.93% from 0.81% in the six month period ended September 30, 2012 compared with the prior year. Net interest income in the six month period ended September 30, 2012 includes £69 million of gains arising from the management of our liquidity portfolio (six month period ended September 30, 2011: £59 million), fair value adjustments of £48 million (six month period ended September 30, 2011: £nil) from the release of excess credit value adjustments, and net accounting adjustments of £22 million (six month period ended September 30, 2011: £4 million) relating to changes in our effective interest rate assumptions for savings accounts which offer an initial bonus and early redemption charges in relation to mortgages.
Margin growth within our core trading continues, with strong new business asset margins and the significant positive impact of repricing at deal maturity, as customers either revert to our Base or Standard Mortgage Rate or opt to take a new mortgage product. In addition, balance growth in both consumer banking and personal loans, and lower core liquidity holdings, have contributed to the margin performance.
Because the majority of our assets and liabilities are either floating rate instruments or synthetically converted to floating rate instruments using derivatives, variations in market interest rates have a direct impact on our interest income and interest expense. Fluctuations in market interest rates, however, give us the opportunity to manage our interest rate margins and, for most of our assets and liabilities, we can reprice the interest rate that we offer, subject to market and competitive pressures.
The following table sets forth the daily average three-month sterling LIBOR rates (11:00 a.m. British Bankers Association fixing) and average BoE base rates for the six month period ended September 30, 2012 and the financial years ended April 4, 2012 and 2011:
| For the six month period ended September 30, 2012 |
For the year ended April 4, 2012 |
For the year ended April 4, 2011 |
||
|---|---|---|---|---|
| Daily average three-month sterling LIBOR | 0.50% | 0.94% | 0.74% | |
| Average BoE base rate | 0.50% | 0.50% | 0.50% |
Interest rate risk arises from the mortgage, savings and other financial services products that we offer. The varying interest rate features and maturities of retail products and wholesale funding create exposures to interest risks. This is due to the imperfect matching of variable interest rates, in particular BoE base rate and LIBOR, and timing differences on the re-pricing of assets and liabilities. The risk is managed through the use of derivatives and other appropriate financial instruments and through product design.
Low and flat interest rates have continued to dominate, driven by reduced expectations for economic growth. Base rates remain unchanged, but underlying rates in longer term debt securities markets, principally gilts, have fallen.
A significant proportion of our mortgages earn BMR, which we have guaranteed will never be more than 2% above the BoE base rate. This rate is significantly lower than the equivalent SVR charged by peers, or the SMR onto which our more recent mortgage advances mature. This has the effect of compressing our mortgage margins and reducing the flexibility with which these margins can be managed. However, the BMR portfolio is well seasoned, has low loan to value, low arrears rates and low possession rates. The low risk nature of the portfolio partly compensates for the low margin it yields.
The eurozone debt crisis has had the additional effect of restricting inter-bank lending, widening the net margin between base rate and LIBOR, and widening foreign exchange basis spreads. This is as a result of the concerns over the exposure of European financial institutions' and governments' creditworthiness.
Competition for retail funding may increase the margins that have to be paid to attract and retain retail deposits.
We believe that our results indicate a strong performance for the six month period ended September 30, 2012 despite the challenging economic environment. The Group has delivered an underlying profit before tax (as explained below) of £151 million, and a statutory profit before tax of £124 million.
Underlying profit before tax (as explained below) for the six month period ended September 30, 2012 is down 12.2% at £151 million from £172 million for the six month period ended September 30, 2011. For the six month period ended September 30, 2012 compared to the six month period ended September 30, 2011, total income is up 14.3% at £1,132 million.
Underlying expenses increased by 1.7%. The increase was largely a result of our continued investment in the long term growth of our business, with consequential increases in technology depreciation and related run costs. In addition, regulatory initiatives continue to drive cost increases and an ongoing requirement for investment spend. In addition to an increase in pension charges, which are primarily due to a decrease in the discount rate resulting from a fall in corporate bond yields, variable costs have risen as a result of growth in core business volumes. Costs also include £15 million of administration costs for unsuccessful PPI claims. These cost increases have been offset by a continued focus on efficiency improvements in both customer facing and back office functions. The efficiency improvements have been delivered through our cost optimisation programme, which is now in its final year of delivery and on track to deliver annual savings in excess of £200 million. We have embedded the continuous identification and delivery of cost optimisation initiatives into the day to day running of the business and, as a result, a series of new projects will commence over the next 12 months. We expect that these will deliver further savings over the next three years. The underlying cost income ratio for the six month period ended September 30, 2012 was 57.9%, compared to 65.1% for the six month period ended September 30, 2011, with the decrease reflecting the strong income performance significantly outstripping cost growth.
The charge for impairment losses on loans and advances to customers of £258 million in the first half of the current financial year is 79% higher than the £144 million charge for the same period in the last year, and 5% higher than the £246 million charge for the second half of the last financial year. While we believe that the underlying quality of our lending remains strong, it continues to be affected by market conditions in the commercial property sector.
Profit before tax on a reported basis and underlying basis are set out below. Certain aspects of our results are presented to reflect management's view of the underlying results and to provide a clearer representation of the performance of the Group:
| For the six month period ended September 30, 2012 | |||||
|---|---|---|---|---|---|
| As reported |
FSCS and bank levy |
Restructuring Costs |
Movements on derivatives and hedge accounting |
Underlying profit before tax |
|
| (£ millions) | |||||
| Net interest income | 909 | - | - | - | 909 |
| Other income | 223 | - | - | - | 223 |
|---|---|---|---|---|---|
| Movements on derivatives and | |||||
| hedge accounting | (14) | - | - | 14 | - |
| Total income | 1,118 | - | - | 14 | 1,132 |
| Administrative expenses | (577) | 8 | 11 | - | (558) |
| Depreciation and amortisation | (97) | - | - | - | (97) |
| Pre provision underlying profit | 477 | ||||
| Impairment losses | (281) | - | - | - | (281) |
| Provisions for liabilities and charges | (39) | (6) | - | - | (45) |
| Profit before tax | 124 | 2 | 11 | 14 | 151 |
| For the six month period ended September 30, 2011 | ||||||
|---|---|---|---|---|---|---|
| As reported |
FSCS and bank levy |
Restructuring Costs |
Movements on derivatives and hedge accounting |
Underlying profit before tax |
||
| (£ millions) | ||||||
| Net interest income | 777 | - | - | 778 | ||
| Other income | 213 | - | - | 228 | ||
| Movements on derivatives and | ||||||
| hedge accounting | 71 | (71) | - | |||
| Total income | 1,061 | (71) | 1,006 | |||
| Administrative expenses | (576) | 9 | 5 | (587) | ||
| Depreciation and amortisation | (82) | - | - | (82) | ||
| Pre provision underlying profit | 346 | |||||
| Impairment losses | (150) | - | - | (150) | ||
| Provisions for liabilities and charges | (15) | - | - | (15) | ||
| Profit before tax | 238 | 5 | (71) | 9 | 181 |
The following discussion considers our results for the six month period ended September 30, 2012 compared to our results for the six month period ended September 30, 2011:
Our total income increased to £1,118 million in the six month period ended September 30, 2012 compared to £1,061 million in the six month period ended September 30, 2011. The following table sets forth the components of income for the six month periods ended September 30, 2012 and September 30, 2011, respectively:
| For the six month period ended September 30, |
|
|---|---|
| 2012 | 2011 |
(£ millions)
| Total | 1.118 | 1.061 |
|---|---|---|
| Gains from derivatives and hedge accounting | (14) | |
| Other operating income | $\mathcal{D}$ | |
| Income from investments | ||
| Net fees and commissions | 214 | 206 |
| Net interest income | 909 |
Net interest income increased by 17% to £909 million for the six month period ended September 30, 2012 compared with £777 million for the six month period ended September 30, 2011.
The following table sets forth the components of net interest income for the six month periods ended September 30, 2012 and 2011, respectively:
| For the six month period ended September 30, |
||
|---|---|---|
| 2012 | 2011 | |
| $(f.$ millions) | ||
| Interest and similar income: | ||
| On residential mortgages | 2,397 | 2,380 |
| On other loans | 566 | 563 |
| On investment securities | 940 | 548 |
| On other liquid assets | 26 | 24 |
| Net (expense) on financial instruments hedging assets | (1,245) | (1,094) |
| Expected return on pension assets | 93 | 97 |
| Total interest and similar income | 2,777 | 2,518 |
| Interest expense and similar charges: | ||
| On UK retail member deposits | (1,389) | (1,357) |
| On subscribed capital | (47) | (47) |
| On deposits and other borrowings: | ||
| Subordinated liabilities | (46) | (54) |
| Other | (113) | (126) |
| Debt securities in issue | (504) | (520) |
| Foreign exchange differences | (17) | (1) |
| Net income on financial instruments hedging liabilities | 334 | 447 |
| Pension interest cost | (86) | (83) |
| Total interest expense and similar charges | (1,868) | (1,741) |
| Net interest income | 909 | 778 |
Interest and similar income increased by 10.3% to £2,777 million in the six month period ended September 30, 2012 from £2,518 million in the six month period ended September 30, 2011.
Interest on residential mortgages remained broadly stable increasing by 0.7% to £2,397 million in the six month period ended September 30, 2012 from £2,230 million in the six month period ended September 30, 2011. We have seen a 3.8% increase in the size of our average residential mortgage portfolio to £140,102 million in the six month period ended September 30, 2012 from £134,981 million in the six month period ended September 30, 2011, this has been offset by a small decrease in average interest rates between the two periods from 3.5% for the six month period ended September 30, 2011 to 3.4% for the six month period ended September 30, 2012.
Interest on other loans includes interest income that we earn from commercial loans, credit card lending, unsecured personal loans and current account overdrafts. Interest on other loans remained relatively stable increasing by 0.5% to £566 million in the six month period ended September 30, 2012 from £563 million in the six month period ended September 30, 2011.
Interest and other income from investment securities comprises interest income earned on the corporate and government investment securities that we purchase for our own account to manage our liquidity portfolios and net realized gains and losses on our sales of these instruments.
Interest and other income from investment securities increased by 71.5% to £940 million for the six month period ended September 30, 2012 compared with £548 million for the six month period ended September 30, 2011. Net of foreign exchange differences and net of expenses on financial instruments hedging assets there has been an increase from £208 million for the six month period ended September 30, 2011 to £440 million for the six month period ended September 30, 2012. Average balances decreased by 12.3% to £20,433 million in the six month period ended September 30, 2012 from £23,308 million for the six month period ended September 30, 2011, but this was more than offset by a significant increase in the average interest rate earned on such assets to 4.3% in the six month period ended September 30, 2012, compared to 1.8% in the six month period ended September 30, 2011. The increase in average interest rates is a direct result of increases in market rates between the two periods.
We use derivative instruments to synthetically convert fixed rate assets to floating rate assets. The floating rate income and fixed rate expense on these derivatives are included as "net expense on financial instruments hedging assets". In the six month period ended September 30, 2012, we incurred a net expense of £1,245 million on financial instruments used to hedge our fixed rate assets compared with a net expense of £1,094 million in the six month period ended September 30, 2011. As LIBOR rates have remained at very low levels during the six month periods ended September 30, 2012 and September 30, 2011, the floating rate income on these financial instruments has reduced, resulting in an increase to the Group.
Under IFRS, interest earned on pension fund assets is recognized in interest and similar income and the release of discounts on pension fund liabilities is recognized in interest expense and similar charges in the income statement. These amounts are calculated by an independent actuary using accepted methodology and agreed assumptions.
| For the six month period ended September 30, |
|||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Current account | 59 | 61 | |
| Protection and investments | 62 | 54 | |
| General insurance | 55 | 43 |
| Mortgage | 20 | 23 |
|---|---|---|
| Credit card | 13 | 19 |
| Commercial | 10 | 8 |
| Other |
4 | 5 |
| Total | 223 | 213 |
Interest expense and similar charges increased by 7.2% in the six month period ended September 30, 2012 to £1,868 million from £1,741 million in the six month period ended September 30, 2011.
Interest on UK retail member deposits includes interest that we pay on UK savings and current accounts held by our members. Interest on UK retail member deposits increased to £1,389 million in the six month period ended September 30, 2012 from £1,357 million in the six month period ended September 30, 2011.
As the average interest rate that we paid to depositors remained unchanged at 2.2% for the six month period ended September 30, 2012 compared with the same period in 2011, the increase in the charge for the period results from a small increase of 0.6% in the average balance of UK retail member deposits held to £125,712 million in the six month period ended September 30, 2012 from £124,880 million in the six month period ended September 30, 2011.
With market interest rates at record lows, savers continue to face an extended period of low returns on their deposits. In common with other savings providers, Nationwide has the difficult task of balancing attractive interest rates with the need to protect the long term financial strength of the business and manage liquidity in line with evolving regulation. Over the first half of the current financial year our savings balances fell by a modest £0.5 billion compared to an increase of £2.4 billion in the first half of the last financial year, and we have consciously focused our efforts on rewarding our loyal customers wherever possible, through products such as Flexclusive ISA and Flexclusive Regular Saver, a Loyalty bond and, most recently (launched in October), our unique Loyalty Saver account.
We have continued to act as a major challenger to the established banks, growing our market presence in current accounts, personal loans and credit cards. During the first half of the current financial year, we opened 184,200 new current accounts, 186,900 new credit cards and advanced 65,900 new personal loans. At September 30, 2012, our current account base was 5.1 million accounts, whilst our credit card account base was 1.8 million accounts, with 2.4 million cards in issue.
Interest expense on deposits and other borrowings includes interest that we pay on subordinated debt instruments and other deposits and borrowings. In the six month period ended September 30, 2012 interest on subordinated liabilities decreased to £46 million from £54 million in the six month period ended September 30, 2011. This decrease is a result of changes in the mix of subordinated debt between the two periods. The interest rates on our subordinated liabilities are fixed and therefore not affected by changes in market interest rates.
Other interest expense on deposits and other borrowings includes the interest that we pay on retail deposits by non-members, deposits from other banks and other money market deposits. In the six month period ended September 30, 2012, other interest expense on deposits and other borrowings decreased by 10.3% to £113 million from £126 million in the six month period ended September 30, 2011. This small reduction is due to decreases in market rates in the six month period ended September 30, 2012, compared with the six month period ended September 30, 2011.
Debt securities in issue includes interest that we pay on certificates of deposit, time deposits, commercial paper and medium-term notes. In the six month period ended September 30, 2012, interest expense on debt securities in issue decreased by 3.1% to £504 million from £520 million in the six month period ended September 30, 2011. This decrease reflects a 0.09% decrease in the average monthly balance of debt securities in issue to £36,710 million in the six month period ended September 30, 2012, compared with £37,026 million in the six month period ended September 30, 2011. In addition, the average interest rate paid before adjusting for income/expense on financial instruments hedging liabilities decreased to 2.75% for the six month period ended September 30, 2012, compared with 2.81% for the six month period ended September 30, 2011.
We use derivative instruments to synthetically convert fixed rate liabilities to floating rate liabilities. The floating rate expense and fixed rate income on these derivatives are included as "net income/expense on financial instruments hedging liabilities". In the six month period ended September 30, 2012, net income on financial instruments used to hedge our fixed rate liabilities was £334 million, compared with a net income of £447 million in the six month period ended September 30, 2011.
The following table sets forth the components of net fees and commissions for the six month periods ended September 30, 2012 and 2011 respectively:
| For the six month period ended September 30, |
||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Fee and commission income: | ||
| Mortgage related fees | 17 | 13 |
| Banking and savings fees | 115 | 122 |
| General insurance fees | 74 | 61 |
| Other fees and commissions | 62 | 53 |
| Total fee and commission income | 268 | 249 |
| Fee and commission expense: | ||
| Banking and savings fees | (47) | (39) |
| Other fees and commissions | (7) | (4) |
| Total fee and commission expense | (54) | (43) |
| Net fee and commission income | 214 | 206 |
Income from net fees and commissions consists of income that we earn from lending, banking and savings fees and insurance sales commissions less lending fees and commission expense.
In the six month period ended September 30, 2012, net fees and commissions increased by 3.9% to £214 million compared with £206 million in the six month period ended September 30, 2011. This increase has been driven by strong income growth from current accounts and protection and investment products in the period, reflecting our strategic focus to grow the range and scale of our banking products and to diversify our income stream.
In the six month period ended September 30, 2012, other operating income decreased to £nil million, compared with £2 million in the six month period ended September 30, 2011.
All derivatives entered into by Nationwide are recorded on the balance sheet at fair value with any fair value movements accounted for in the income statement. Derivatives are only used to limit the extent to which we could be affected by changes in interest rates, exchange rates or other factors specified in building society legislation. Derivatives are therefore used exclusively to hedge risk exposures and are not used for speculative purposes.
Where effective hedge accounting relationships can be established, the movement in the fair value of the derivative instrument is offset in full or in part by opposite movements in the fair value of the underlying asset or liability being hedged. Any ineffectiveness arising from different movements in fair value will likely trend to zero over time.
In addition, we enter into certain derivative contracts which, although efficient economically, cannot be included in effective hedge accounting relationships. Consequently, although the implicit interest cost of the underlying instrument and associated derivatives are included in "Net interest income" in the income statement, fair value movements on such derivatives are included in "Gains from derivatives and hedge accounting".
Losses from derivatives and hedge accounting were £14 million in the six month period ended September 30, 2012 compared to gains of £71 million in the six month period ended September 30, 2011. Even though the Group uses derivatives exclusively for risk management purposes, income statement volatility arises due to accounting ineffectiveness of designated hedges, or because hedge accounting has not been adopted or is not achievable.
Operating expenses and similar charges increased by 20.7% in the six month period ended September 30, 2012 to £994 million from £823 million in the six month period ended September 30, 2011. The following table sets forth the components of operating expenses and similar charges for the six month periods ended September 30, 2012 and 2011, respectively:
| For the six month period ended September 30, |
|||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Administrative expenses | 577 | 576 | |
| Depreciation and amortization | 97 | 82 | |
| Impairment losses on loans and advances to customers | 258 | 144 | |
| Provisions for liabilities and charges | 39 | 15 | |
| Impairment losses on investment securities | 23 | 6 | |
| Total |
994 | 823 |
Administrative expenses were stable in the six month period ended September 30, 2012 at £577 million compared to £576 million in the six month period ended September 30, 2011. Included within the total of administrative expenses is a £8 million charge for the bank levy (six month period ended September 30, 2011: £9 million).
Administrative expenses for the six month period ended September 30, 2012 include £11 million (six month period ended September 30, 2011: £5 million) of restructuring costs, which relate to restructuring parts of our business as part of our ongoing cost optimisation programme and other initiatives and £15 million relating to the costs of administering unsuccessful PPI claims, which have been expensed as incurred.
The underlying cost income ratio for the six month period ended September 30, 2012 was 57.9% compared to 65.1% for the six month period ended September 30, 2011, with the decrease reflecting the strong income performance significantly outstripping cost growth.
The following table sets forth the components of administrative expenses for the six month periods ended September 30, 2012 and 2011, respectively:
| For the six month period ended September 30, |
|
|---|---|
| 2012 | 2011 |
(£ millions)
| For the six month period ended September 30, |
||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Employee costs: | ||
| Salaries and social security costs | 256 | 266 |
| Pension costs | 36 | 29 |
| Other administrative costs | 285 | 281 |
| Total | 577 | 576 |
Employee costs are made up of salaries, social security costs (which consist entirely of mandatory UK national insurance contributions) and pension costs.
The Group operates both defined benefit and defined contribution arrangements. The principal defined benefit pension arrangement is the Nationwide Pension Fund (the "Fund"). This is a contributory defined benefit arrangement, with both final salary and career average revalued earnings ("CARE") sections. The Fund was closed to new entrants in 2007, and since then new employees have been able to join a defined contribution arrangement. The final salary section of the Fund was closed to future service on March 31, 2011. Service already built up in the final salary section will continue to be linked to final salary, while future benefits now accrue within the CARE section.
In the six month period ended September 30, 2012, salaries and social security costs decreased by 3.8% to £256 million from £266 million in the six month period ended September 30, 2011.
Within employee costs, the pension charge increased by 24% to £36 million for the six month period ended September 30, 2012 from £29 million in the six month period ended September 30, 2011. The increase in pension costs is primarily due to a decrease in the discount rate resulting from a fall in corporate bond yields.
Other administrative costs increased by 1.4% to £285 million for the six month period ended September 30, 2012 from £281 million for the six month period ended September 30, 2011. The increase in other administrative expenses is as a result of growth in core business volumes. Costs also include £15 million of administration costs for unsuccessful PPI claims.
These cost increases have been offset by a continued focus on efficiency improvements in both customer facing and back office functions. The efficiency improvements have been delivered through our cost optimisation programme, which is now in its final year of delivery and on track to deliver annual savings in excess of £200 million. We have embedded the continuous identification and delivery of cost optimisation initiatives into the day to day running of the business and, as a result, a series of new projects will commence over the next 12 months. We anticipate that these will deliver further savings over the next three years.
For the six month period ended September 30, 2012, depreciation and amortization expenses increased by £15 million to £97 million compared to £82 million for the six month period ended September 30, 2011. This is primarily driven by the continued investment in key restructuring projects.
We assess at each balance sheet date whether, as a result of one or more events that occurred after initial recognition, there is objective evidence that a financial asset or group of assets is impaired. Evidence of impairment may include indications that a borrower or group of borrowers are experiencing significant financial difficulty or default or delinquency in interest or principal payments.
Impairment losses on loans and advances to customers for the six month period ended September 30, 2012 increased by 79.2% to £258 million from £144 million for the six month period ended September 30, 2011, and is 5% higher than the £246 million charge for the six month period ended April 4, 2012.
The following table analyzes the impairment losses on loans and advances to customers for the six month periods ended September 30, 2012 and 2011, respectively:
| For the six month period ended September 30, |
|||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Residential mortgages | 26 | 42 | |
| Commercial lending | 193 | 72 | |
| Unsecured lending | 38 | 28 | |
| Other lending | 1 | 2 | |
| Total | 258 | 144 |
Retail impairments (residential mortgages and unsecured lending combined) for the six month period ended September 30, 2012 have fallen by 8.6% to £64 million compared to £70 million for the six month period ended September 30, 2011.
The quality of our prime residential book remains high, and it has continued to perform well throughout the six month period ended September 30, 2012. The overall prime residential provision charge remains very low at £6 million for the six month period ended September 30, 2012, due to stable arrears and the conservative loan to value ("LTV") profile of our portfolio. The charge relating to specialist lending of £20 million for the six month period ended September 30, 2012 is lower than the same period last year, primarily due to reduced arrears volumes and a broadly flat House Price Index ("HPI"). The increase in the charge for unsecured lending reflects both the change in the size and increasing maturity of the lending books and a small non-recurring credit in the prior period.
Commercial loan impairments were £193 million for the six month period ended September 30, 2012, compared to £72 million for the six month period ended September 30, 2011, representing an increase of 168%, and an increase of 10% on the £175 million charge incurred in the six month period ended April 4, 2012. The increase is driven by the continuation of recessionary conditions in the UK and widespread Eurozone concerns, both undermining investor confidence and appetite for the sector. In consequence, after some recovery during financial year 2010/11 the market is now experiencing falls in commercial real estate valuations with an expectation that, whilst not severe, this trend will persist at least for the next 12 months. Secondary office and retail sites and certain regional centres are particularly affected, and an overall mood of uncertainty is affecting valuations and restricting the availability of both equity and debt finance to support restructurings.
The increased impairment in the six month period ended September 30, 2012 was largely attributable to new and additional provisions on existing watch list cases where valuations have been eroded or the commitment of equity providers to further investment has been withdrawn.
The overall level of provision for commercial lending as a percentage of Group commercial property finance balances is 6.88% at September 30, 2012 (April 4, 2012: 4.72%), and the provision coverage ratio against balances more than three months in arrears is 65% at September 30, 2012 (April 4, 2012: 59%).
The impairment losses on investment securities for the six month period ended September 30, 2012 of £23 million (six month period ended September 30, 2011: £6 million) are wholly attributable to an impairment on a single UK commercial mortgage backed security. The prior period charge of £6 million was primarily in respect of our small private equity portfolio.
For the six month period ended September 30,
| 2012 | 2011 | |
|---|---|---|
| (£ millions) | ||
| FSCS | (6) | - |
| PPI provision | 45 | 15 |
| Total | 39 | 15 |
Provisions for liabilities and charges were £39 million for the six month period ended September 30, 2012, compared to £15 million for the six month period ended September 30, 2011. Provisions for the six month period ended September 30, 2012 relate to PPI (£45 million) and FSCS (release of £6 million).
In line with the wider industry, we have continued to experience a high volume of PPI complaints during the first half of the current financial year, a significant proportion of which relate to cases where there has been either no sale of a policy or no evidence of mis-selling. In light of this experience we have reassessed the ultimate level of complaints expected and the appropriateness of the PPI provision and, despite significant uncertainty over future volumes of claims, have made a further provision of £45 million. Our provision at September 30, 2012 covers the estimated cost of redress and associated administration on claims we expect to uphold; the cost of administering invalid claims are recognised as incurred.
Nationwide pays levies to the FSCS based upon its share of protected deposits. The £6 million credit in the six month period ended September 30, 2012 primarily relates to the actual interest rates applying in the period and being charged in the levy, being different from the estimate in the year end provision. It is estimated that a further provision of between £70 million and £80 million will be required in the second half of this financial year in respect of the levy for the 2013/14 scheme year including the first amount of the Group's share of an expected shortfall, as advised by the FSCS.
Tax on our profit on ordinary activities for the six month period ended September 30, 2012 amounted to a credit of £12million.
The tax charge arising in the six month period ended September 30, 2012, before taking into account adjustments in respect of prior periods, is £33 million on profits of £124 million (year ended April 4, 2012: current year charge of £63 million in respect of profits of £203 million). During the six month period ended September 30, 2012, the Group settled two outstanding tax matters relating to prior periods. The Group had previously recognised the full potential tax liability that could have arisen in respect of these uncertainties and following agreement with the tax authorities these provisions have been released. The effect of this release is a prior year credit of £39 million. Together with the effect of the corporation tax rate change to 23% on deferred tax balances of £6 million, this results in an overall tax credit for the period of £12 million (year ended April 4, 2012: charge of £24 million). Ignoring the effects of the prior year items and deferred tax restatement, the Group's tax rate for the six month period ended September 30, 2012 is 26.6%, compared with a statutory rate of 24.0%.
Comparatively, tax on our profit on ordinary activities for the six month period ended September 30, 2011 amounted to £50 million based on our reported profit on ordinary activities before tax of £238 million, reflecting an effective tax rate of 21.0% as compared with the prevailing UK corporation tax rate at the time of 26.0%.
The lower effective tax rate was due principally to adjustments to amounts provided in respect of prior periods, lower overseas tax rates and the effect on deferred tax balances of applying the corporation tax rate change from 26.0% to 25.0%. This was partially offset by the effects of non-deductible expenditure, in particular bank levy charges.
Lending remains predominantly concentrated on high quality secured products, with residential mortgages accounting for 84.4% of our total loans and advances to customers at September 30, 2012. The composition of lending has remained broadly consistent with that reported at April 4, 2012:
| As at September 30, | As at April 4, |
|---|---|
| 2012 | 2012 |
| 108.0 | 68.9 | 105.6 | 68.7% |
|---|---|---|---|
| 24.2 | 15.5 | 23.2 | 15.1% |
| 132.2 | 84.4 | 128.8 | 83.8% |
| 20.9 | 13.3 | 21.5 | 14.0% |
| 0.5 | 0.3 | 0.5 | 0.3% |
| 3.2 | 2.0 | 3.0 | 1.9% |
| 156.8 | 100.0 | 153.8 | 100.0% |
| (1.1) | (0.8) | ||
| 1.5 | 1.2 | ||
| 157.2 | 154.2 | ||
| (£ billions, except percentages) |
Prime residential mortgages are primarily Nationwide branded advances made through our branch network and intermediary channels.
Specialist residential mortgages are made up of £21.5 billion as at September 30, 2012 of advances made through our specialist lending brands, The Mortgage Works ("TMW") and UCB Home Loans Corporation Limited ("UCB"), and £2.7 billion as at September 30, 2012 arising from the acquisitions of the Derbyshire, Cheshire and Dunfermline portfolios. Loans were advanced primarily in the buy to let and self-certification markets. As at September 30, 2012 buy to let mortgages made up 79% of total specialist lending, 14% related to self-certification mortgages, 5% related to near prime and just 2%, amounting to £0.5 billion, related to sub prime. Now specialist lending is restricted to buy to let with the Group having withdrawn from the self-certified lending market in 2009.
We increased our gross lending by 32% to £8.6 billion in the six month period ended September 30, 2012, compared to £6.5 billion for the six month period ended September 30, 2011.
We have maintained a particular focus on supporting the first time buyer market, delivering a share of over 18% of this market in the first half of the current financial year. Despite this strengthened focus on first time buyers, the average LTV on our prime residential lending has been carefully managed to 65% in the in the six month period ended September 30, 2012 (September 30, 2011: 60%), as we have balanced the strong margins available at higher LTVs with a continued above par share of high quality, low LTV remortgage business.
Our base mortgage rate ("BMR") balances increased to £53.2 billion as at September 30, 2012. Despite the low rate, which is capped at 2% above BoE base rate, £1.8 billion of redemptions in the six months have come from the BMR book. Our total BMR balances are unlikely to grow significantly beyond their current level, and we expect they will decline steadily from the middle of 2013 onwards.
The buy to let market has continued to grow in the six month period ended September 30, 2012, with renting offering an alternative to house purchase for an increasing number of people. In addition, rising rents and low yields on other assets have increased demand from landlords, and mortgage supply in this sector has increased over the period.
The Group's specialist lender, TMW, has maintained a strong and influential presence in the buy to let sector. Over the six month period ended September 30, 2012, TMW has offered a product proposition which reflects Group risk appetite, and returns ongoing value for the benefit of members. Gross specialist lending in the six month period ended September 30, 2012 was £1.7 billion (September 30, 2011: £2.6 billion), with the reduction relative to the previous year reflecting the renewed strength of competitor activity. The average LTV for new buy to let business has been 68% in the six month period ended September 30, 2012.
The overall specialist lending book has grown to £24.2 billion as at September 30, 2012 (April 4, 2012: £23.2 billion), with arrears levels performing well.
We have continued to focus on affordability and LTV ratios in underwriting loans during the period. The average LTV of residential mortgages completed has increased to 66% at September 30, 2012 from 63% at April 4, 2012 as we have increased our proportion of lending to the first time buyer market. The average indexed LTV of residential mortgages at September 30, 2012 has remained stable at 50%, compared to 50% at April 4, 2012.
| (percentages) LTV portfolio of residential mortgages: <50% 49 50% - 60% 10 60% - 70% 12 70% - 80% 14 80% - 90% 10 90% - 100% 4 > 100% 1 100 Average loan to value of stock (indexed) 50 Average loan to value of new business 66 New business profile: First-time buyers 25 Home movers 30 Remortgagers 23 Buy-to-let 22 100 |
As at September 30, 2012 |
As at April 4, 2012 |
|---|---|---|
| 50 | ||
| 10 | ||
| 11 | ||
| 13 | ||
| 10 | ||
| 4 | ||
| 2 | ||
| 100 | ||
| 50 | ||
| 63 | ||
| 17 | ||
| 25 | ||
| 27 | ||
| 31 | ||
| 100 |
The analysis of the new business profile and the average LTV for new business excludes further advances.
Total residential balance sheet provisions at September 30, 2012 are £232 million, compared with £202 million at April 4, 2012.
The table below shows that arrears on Nationwide prime lending has reduced slightly, whilst there has been a larger reduction in specialist arrears due to the combined effects of reduced arrears volumes on the self originated books and strong book growth in TMW. Our arrears performance remains very favorable relative to the CML industry average, and our specialist lending arrears are now below the overall industry measure that is inclusive of prime lending:
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| Cases three months or more in arrears as % of total book of residential mortgages | (percentages) | |
| Group residential mortgages: | ||
| Prime |
0.53 | 0.54 |
| Specialist | 1.67 | 1.87 |
| Total Group residential mortgages | 0.70 | 0.73 |
|---|---|---|
| CML Industry average | 1.93 | 1.95* |
* Restated by the CML
We maintain close relationships with customers experiencing financial difficulties and work with them to agree the most appropriate course of action. In the case of short term difficulty, we will seek to agree revised payment schedules with the customer, which may include a reduction to the contractual payment due. If the customer can meet the interest portion of their repayment, we may grant a temporary interest only concession which would be non arrears bearing so long as the customer continues to meet the terms of the new arrangement. Where this is not the case, arrears will continue to accrue and will be included in the arrears numbers reported above. Payment holidays are also non arrears bearing, but a credit score assessment is included as part of the eligibility criteria to restrict the use of this concession.
If a customer demonstrates they are able to meet a payment schedule at a normal commercial rate for a period of six months or if they are able to overpay such that six months' full payments are made in a four month period, and only if they request it, we may 'capitalize' the arrears on their account. This will result in an enlarged outstanding balance but no arrears and consequently these cases will no longer be reported as arrears.
The number of properties in possession at September 30, 2012 was 1,056, representing 0.07% of our book, which compares well with the industry measure of 0.11%. The table below shows possessions as a percentage of book:
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| Possessions as % of total book of residential mortgages (number of properties) | (percentages) | |
| Group residential mortgages: | ||
| Prime | 0.02 | 0.02 |
| Specialist | 0.31 | 0.41 |
| Total Group residential mortgages | 0.07 | 0.08 |
Our approach to dealing with customers in financial difficulties, combined with our historically cautious approach to lending, means that we only take possession of properties as a last resort. This is illustrated by the number of properties taken into possession compared with the total for the industry. During the six month period ended September 30, 2012, the taken into possession has decreased to 897, representing only 5.4% of properties taken in by the industry as a whole.
The table below provides further information on the residential mortgage portfolio by payment due status:
| As at September 30, 2012 | As at April 4, 2012 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | Prime lending |
Specialist lending |
Consumer banking |
Total | ||||
| (£ billions, except percentages) | |||||||||||
| Not impaired: |
|||||||||||
| Neither past due nor impaired |
105.5 | 22.3 | 3.1 | 130.9 | 97 | 103.1 | 21.3 | 2.9 | 127.3 | 97% | |
| Past due up to 3 months but not impaired. |
1.9 | 1.2 | 0.0 | 3.1 | 2 | 1.9 | 1.2 | 0.0 | 3.1 | 2% | |
| Impaired | 0.6 | 0.7 | 0.1 | 1.4 | 1 | 0.6 | 0.7 | 0.1 | 1.4 | 1% |
| Total | 108.0 | 24.2 | 3.2 | 135.4 | 100 | 105.6 | 23.2 | 3.0 | 131.8 | 100% |
|---|---|---|---|---|---|---|---|---|---|---|
The status "past due up to 3 months but not impaired" includes any asset where a payment due is received late or missed. The amount included is the entire financial asset balance rather than just the payment overdue. Loans on interest only or payment holiday concessions are initially categorized according to their payment status as at the date of concession, with subsequent revisions to this category assessed against the terms of the concession.
Loans which are not in possession have collective impairment provisions set aside to cover credit losses.
Loans in the analysis above which are less than 3 months past due have collective impairment allowances set aside to cover credit losses on loans which are in the early stages of arrears. Loans acquired from the Derbyshire, Cheshire and Dunfermline building societies were fair valued on a basis which made credit loss adjustments for anticipated losses over the remaining life of the loans. Impaired retail loans are broken down further in the following table:
| As at September 30, 2012 | As at April 4, 2012 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | Prime lending |
Specialist lending |
Consumer banking |
Total | |||
| (£ millions, except percentages) | ||||||||||
| Impaired status: |
||||||||||
| Past due 3 to 6 months |
268 | 279 | 37 | 584 | 41% | 268 | 279 | 37 | 584 | 41% |
| Past due 6 to 12 months |
184 | 200 | 23 | 407 | 29% | 184 | 200 | 23 | 407 | 29% |
| Past due over 12 months |
85 | 138 | - | 223 | 16% | 85 | 138 | - | 223 | 16% |
| Possessions | 30 | 167 | - | 197 | 14% | 30 | 167 | - | 197 | 14% |
| Total | 567 | 784 | 60 | 1,411 | 100% | 567 | 784 | 60 | 1,411 | 100% |
Possession balances represent loans against which Nationwide has taken ownership of properties pending their sale. Possession is only enforced once all other recovery options have been exhausted. This is reflected in the Group's possession rate which is approximately 64% of the market average at September 30, 2012. Individual provisions are calculated for these loans.
The Group offers a number of support options to both secured and unsecured customers. The options offered may be classified into three categories: Change in terms, Forbearance and Repair.
Changes in terms relate to a concession or permanent change, which results in amended monthly cash flows. The options available include payment holidays, interest only conversions and term extensions.
Performing customers with loans on standard terms and conditions effective before March 2010, who are not experiencing financial difficulty and meet required criteria (including credit score), are permitted to apply for a payment holiday and make reduced or nil payments for an agreed period of time of up to 12 months (depending on reason). The performance of customers who have taken a payment holiday is reflected within our provisioning methodology.
Interest only conversions allow performing customers meeting required criteria to apply for an interest only conversion, normally reducing their monthly commitment. Our policy has progressively tightened during the year ended April 4, 2012, with LTV initially capped at 75% in April 2011, following which repayment vehicle options were restricted to sale of residence only (minimum £150,000 equity and maximum LTV 66%) in July 2011. This facility was completely withdrawn in March 2012. The performance of interest only conversions is in line with that of the wider portfolio and therefore no adjustment is made to our provisioning methodology for these loans.
We allow performing customers to apply to extend the term of their mortgage. The performance of term extensions is in line with that of the wider portfolio and therefore no adjustment is made to our provisioning methodology for these loans.
As at September 30, 2012, 1,566 accounts (April 4, 2012: 1,848 accounts) were subject to a payment holiday, 445 accounts (April 4, 2012: 7,083 accounts) had converted to interest only terms and 8,019 accounts (April 4, 2012: 15,032 accounts) had extended their term within the term of the mortgage and 960 accounts (April 4, 2012: 2,417 accounts) had extended their term at term expiry. The criteria required for conversion to interest only terms were progressively tightened during the year ended April 4, 2012 and the facility was completely withdrawn in March 2012.
Change in terms data for April 4, 2012 has been adjusted to include term extensions at term expiry.
The only forbearance option which we offer customers in financial distress is an interest only concession. Interest only concessions are offered to customers on a temporary basis with formal periodic review. The concession allows the customer to reduce monthly payments to cover interest only, typically for six months, and if made, the arrears status of the account will not increase, remaining as at the beginning of the concession. The Group's provisioning methodology was adjusted during the year ended April 4, 2012 to reflect latest performance on these accounts.
As at September 30, 2012, 1,810 accounts (April 4, 2012: 2,474 accounts) representing 0.2% (April 4, 2012: 0.2%) of total prime mortgage balances were on an interest only concession.
When a customer emerges from financial difficulty, the Group offers the ability to capitalise arrears, resulting in the account being repaired. Customers are only permitted to capitalise arrears where they have demonstrated their ability to meet a repayment schedule at normal commercial terms for a continuous six month period, or if they are able to overpay such that six months' payments are made in a four month period. During the six month period ended September 30, 2012, 117 accounts (September 30, 2011: 285 accounts) had an arrears capitalisation. Once capitalised the loans are categorised as not impaired as long as contractual repayments are maintained. Capitalised accounts have a higher than average propensity to roll into arrears and this is recognised within the Group's provisioning methodology.
The options outlined above apply predominantly to the prime originated portfolio. Over the course of the six month period ended September 30, 2012, the following prime mortgages were subject to such options:
| As at September 30, 2012 (Unaudited) |
As at September 30, 2011 | (Unaudited) | ||
|---|---|---|---|---|
| £m | % of total prime loans and advances |
£m | % of total prime loans and advances |
|
| Change in terms | 762 | 0.7 | 895 | 0.9 |
| Forbearance | 290 | 0.3 | 417 | 0.4 |
| Repair | 13 | 0.0 | 28 | 0.0 |
The following table presents collateral held against past due or impaired retail residential mortgages:
| As at September 30, 2012 | As at April 4, 2012 | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Prime lending |
Specialist lending |
||||||
| (£ million, except percentages) | |||||||||
| Past due but not impaired | 1,926 | 100% | 1,137 | 99% | 1,867 | 100% | 1,172 | 99% | |
| Impaired | 527 | 99% | 569 | 97% | 532 | 99% | 595 | 96% | |
| Possessions | 25 | 96% | 132 | 82% | 29 | 96% | 138 | 83% |
| Total | 2,478 | 100% | 1,838 | 97% | 2,428 | 100% | 1,905 | 97% |
|---|---|---|---|---|---|---|---|---|
Collateral held in relation to secured loans that are either past due or impaired is capped at the amount outstanding on an individual loan basis. The percentages in the table above represent the cover over the impaired asset.
The following table presents negative equity on residential mortgages:
| As at September 30, 2012 | As at April 4, 2012 | |||
|---|---|---|---|---|
| Prime lending |
Specialist lending |
Prime lending |
Specialist lending |
|
| (£ million) | ||||
| Past due but not impaired | 5 | 14 | 6 | 17 |
| Impaired | 5 | 19 | 5 | 22 |
| Possessions | 1 | 29 | 1 | 29 |
| Total | 11 | 62 | 12 | 68 |
Our commercial lending portfolio of £20.9 billion as at September 30, 2012 (April 4, 2012: £21.5 billion) comprises £11.0 billion secured on commercial property ("Property Finance"), £8.4 billion advanced to Registered Social Landlords and £1.5 billion advanced under Project Finance principally via Private Finance Initiatives ("PFIs"). Our Property Finance portfolio is diverse both in terms of sectors and geographic spread.
The non-UK element of our commercial property portfolio, at £0.9 billion (April 4, 2012: £1.0 billion), does not contain any exposure to Greece, Italy, Portugal or Spain and only a single exposure of £13 million to Ireland.
The number of commercial property cases more than three months in arrears increased from 299 cases at April 4, 2012 to 340 cases at September 30, 2012. This equates to 4.38% of commercial originated accounts as at September 30, 2012 (April 4, 2012: 3.66%). Total arrears balances on these cases at September 30, 2012 were £75 million (April 4, 2012: £58 million) reflecting the recessionary market conditions affecting tenant demand and the general lack of availability of debt finance in the sector to support restructuring. Robust arrears management continues to focus on close and proactive management of arrears and loan maturities, and there are currently no arrears of three months or more on the Registered Social Landlord or PFI portfolios.
The arrears balance excludes those cases which are in arrears purely by virtue of full contractual maturity of the loan, rather than as a result of failure to meet ongoing debt serving requirements. Performing loans for which external refinancing is not available are reviewed to ensure that confirmation of the existing borrower relationship represents the best recovery option, and in these circumstances an extension of the facility on appropriate commercial terms is sanctioned. During this process of restructuring, performing loans which are considered to be recoverable are not included in arrears and are not reported in the numbers above.
Economic uncertainty, ongoing funding pressures across the banking sector and a trend towards higher regulatory capital requirements for Commercial Real Estate ("CRE") lending have significantly reduced the availability of credit for refinance within the sector. Furthermore, current depressed property values mean that foreclosure on loans which are operating outside the original terms of their advance is unlikely to provide the best economic outcome, except in those cases where ongoing serviceability is unachievable and/or the prospects of any recovery in cashflow performance or capital value is unlikely. Our strategy remains one of prudent loss mitigation over the medium term in a market which is both cyclical and currently experiencing extremely low investor demand. We make refinancing available for existing exposures where we are satisfied that we continue to have a constructive relationship with the borrower which recognizes our interests, and can achieve a level of expected return which reflects current funding costs or where there is a realistic likelihood that recovery over the medium term in the hands of the borrower represents a better prospect than short term disposal. To the extent this strategy leads to forbearance on loans which are renewed at interest rates below market levels or where the most likely outcome remains an ultimate financial loss, impairment provisions are recognized in accordance with relevant accounting requirements.
Other lending operations as at September 30, 2012 includes £243 million (April 4, 2012: £262 million) of secured lending relating to a European commercial loan portfolio and a loan secured by a senior ABS reference portfolio, and unsecured lending of £224 million (April 4, 2012: £231 million) relating to a student loan portfolio. These investments were acquired by the Treasury Division and are therefore held within the Head Office functions business segment.
The tables below provide further information on commercial and other lending operations by payments due status:
| As at September 30, 2012 | As at April 4, 2012 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | Other operations |
Commercial | Other operations |
|||||
| (£ billion, except percentages) | ||||||||
| Neither past due nor impaired | 17.8 | 86% | 0.4 | 91% | 19.1 | 89% | 0.4 | 91% |
| Past due up to 3 months but not impaired | 0.9 | 4% | 0.0 | 1% | 0.7 | 3% | 0.0 | 1% |
| Impaired | 2.2 | 10% | 0.1 | 8% | 1.8 | 8% | 0.1 | 8% |
| Total | 20.9 | 100% | 0.5 | 100% | 21.5 | 100% | 0.5 | 100% |
The status 'past due up to three months but not impaired' includes any asset where a payment due under strict contractual terms is received late or missed. The amount included is the entire financial asset rather than just the payment overdue.
Loans in the analysis above which are less than three months past due have collective impairment allowances set aside to cover credit losses.
Impaired balances in other operations total £35 million as at September 30, 2012 (April 4, 2012: £41 million). This consists of £28 million (April 4, 2012: £30 million) relating to a European commercial loan portfolio and £7 million (April 4, 2012: £11 million) relating to the unsecured student loan portfolio.
Impaired commercial and other lending operations assets are further analyzed as follows:
| As at September 30, 2012 | As at April 4, 2012 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | Other operations |
Commercial | Other operations | |||||
| (£ million, except percentages) | ||||||||
| Impaired status: | ||||||||
| Past due 0 to 3 months | 1,006 | 46% | - | - | 836 | 47% | - | - |
| Past due 3 to 6 months | 342 | 16% | 1 | 3% | 139 | 8% | 1 | 2% |
| Past due 6 to 12 months | 300 | 14% | 2 | 6% | 295 | 17% | 2 | 5% |
| Past due over 12 months | 523 | 24% | 32 | 91% | 487 | 28% | 38 | 93% |
| Possessions | - | - | - | - | 1 | - | - | - |
| Total | 2,171 | 100% | 35 | 100% | 1,758 | 100% | 7 | 100% |
Possession balances represent loans against which Nationwide has taken ownership of properties pending their sale. Assets over which possession has been taken are realized in an orderly manner via open market or auction sales to derive the maximum benefit for all interested parties, and any surplus proceeds are distributed in accordance with the relevant insolvency regulations. The Group does not normally occupy repossessed properties for its business use or use assets obtained in its operations.
The following table presents collateral held against past due or impaired commercial loans:
| As at September 30, 2012 |
As at April 4, 2012 |
|||
|---|---|---|---|---|
| (£ million, except percentages) | ||||
| Past due but not impaired | 94% | 631 | 94% | |
| Impaired | 1,407 | 65% | 1,157 | 66% |
| Total | 2,228 | 73% | 1,788 | 74% |
Collateral held in relation to secured loans that are either past due or impaired is capped at the amount outstanding on an individual loan basis. The percentages in the table above represent the cover over the impaired asset. In addition, provisions of £682 million (April 4, 2012: £481 million) are held against the impaired assets.
The following table presents negative equity on commercial and other operations loans:
| As at September 30, 2012 |
As at April 4, 2012 |
||
|---|---|---|---|
| (£ million) | |||
| Past due but not impaired | 55 | 38 | |
| Impaired | 765 | 600 | |
| Total | 820 | 638 |
In consumer banking, the balance of accounts more than 30 days in arrears has shown an improvement across all products. The following table presents the percentage of FlexAccounts, personal loans and credit card accounts more than 30 days in arrears:
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| (percentages) | ||
| FlexAccount | 11.85 | 9.18 |
| Personal loans | 2.94 | 3.14 |
| Credit Cards* | 2.71 | 2.72 |
*The credit card figure quoted relates to August 2012, as the calculation is based on industry comparable calculations
Unsecured customers have limited forbearance options. Credit card customers experiencing financial distress may agree to a payment plan, which is typically less than the minimum payment. Additionally, credit card and personal loan customers who have maintained the required payment performance over a sustained period may receive extensions on payments. The volume of payment plans and extensions is low and therefore no specific treatment is made within our provisioning methodology.
The following section summarizes our direct exposure to institutions, corporates and other issued securities domiciled in the peripheral eurozone countries. The exposures are shown at their balance sheet carrying values.
| Greece | Ireland | Italy | Portugal | Spain | Total | |
|---|---|---|---|---|---|---|
| £m | £m | £m | £m | £m | £m | |
| Mortgage backed securities | - | 134 | 92 | 43 | 319 | 588 |
| Covered bonds | - | 64 | - | 19 | 280 | 363 |
| Senior debt | - | - | 23 | - | 15 | 38 |
| Other assets | - | - | 4 | - | 3 | 7 |
| Other corporate | - | 6 | 3 | - | - | 9 |
| Total | - | 204 | 122 | 62 | 617 | 1,005 |
| As at April 4, 2012 | |||||||
|---|---|---|---|---|---|---|---|
| Greece | Ireland Italy |
Portugal | Spain | Total | |||
| £m | £m | £m | £m | £m | £m | ||
| Mortgage backed securities | - | 134 | 105 | 39 | 348 | 626 | |
| Covered bonds | - | 71 | - | 17 | 334 | 422 | |
| Senior debt | - | 31 | 36 | - | 96 | 163 | |
| Other assets | 1 | - | 6 | - | 4 | 11 | |
| Other corporate | - | 8 | 3 | - | - | 11 | |
| Total | 1 | 244 | 150 | 56 | 782 | 1,233 |
During the six month period ended September 30, 2012 our remaining £1 million Greek exposure has been sold. In addition, £83 million of Spanish senior debt, £42 million of Spanish Covered Bonds and £31 million of Irish senior debt matured during the six month period.
Movements in our exposure to peripheral eurozone countries since April 4, 2012 relate to disposals, maturities and fair value movements and there has been no new investment in the current financial year.
We have further indirect exposure to peripheral eurozone countries as a result of a €100 million loan to a Luxembourg SPV, which has first loss exposure to a €2 billion portfolio of senior ranking European ABS assets. The sterling equivalent as at September 30, 2012 is £79.6 million (April 4, 2012: £82.7 million). The geographical breakdown of this portfolio is as follows: UK 51%, Germany 16%, Spain 14%, Italy 8%, Netherlands 6%, Greece 3% and Portugal 2%.
In addition, our exposure in respect of other non-UK countries is shown below at their balance sheet carrying value.
| As at September 30, 2012 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Finland £m |
France £m |
Germany £m |
Netherlands £m |
Other Eurozone £m |
Total other Eurozone £m |
USA £m |
Rest of the World £m |
Total £m |
|||
| Government bonds |
128 | - | 667 | 1,346 | - | 2,141 | 1,159 | - | 3,300 | ||
| Mortgage backed securities |
- | 33 | 125 | 386 | - | 544 | 171 | 107 | 822 | ||
| Covered | 20 | - | 83 | 43 | - | 146 | 26 | 62 | 234 |
| Total | 178 | 364 | 1,920 | 1,900 | 8 | 4,370 | 3,116 | 2,182 | 9,668 |
|---|---|---|---|---|---|---|---|---|---|
| Other corporate |
10 | 43 | 882 | 53 | - | 988 | 16 | 8 | 1,012 |
| Other assets | - | - | - | - | - | - | 1,222 | 1,149 | 2,371 |
| Loans to banks |
- | 172 | 163 | - | - | 335 | 410 | 764 | 1,509 |
| Senior debt | 20 | 116 | - | 72 | 8 | 216 | 112 | 92 | 420 |
| bonds |
| As at April 4, 2012 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Finland £m |
France £m |
Germany £m |
Netherlands £m |
Other Eurozone £m |
Total other Eurozone £m |
USA £m |
Rest of the World £m |
Total £m |
|||
| Government bonds |
75 | - | 169 | 1,049 | - | 1,293 | 1,104 | - | 2,397 | ||
| Mortgage backed securities |
- | 34 | 114 | 239 | 41 | 428 | 110 | 147 | 685 | ||
| Covered bonds |
21 | - | 84 | 45 | - | 150 | 26 | 61 | 237 | ||
| Senior debt | 20 | 118 | 100 | 125 | 10 | 373 | 205 | 305 | 883 | ||
| Loans to banks |
- | 127 | 41 | - | - | 168 | 490 | 766 | 1,424 | ||
| Other assets | - | - | 35 | - | - | 35 | 1,335 | 1,441 | 2,811 | ||
| Other corporate |
10 | 46 | 984 | 25 | - | 1,065 | 28 | 11 | 1,104 | ||
| Total | 126 | 325 | 1,527 | 1,483 | 51 | 3,512 | 3,298 | 2,731 | 9,541 |
The 'Other Eurozone' column represents exposures to Belgium £nil (April 4, 2012: £44 million) and Luxembourg £8 million (April 4, 2012: £7 million). The 'Rest of the World' column represents exposures to the following countries: Australia £164 million (April 4, 2012: £290 million), Canada £430 million (April 4, 2012: £532 million), Denmark £6 million (April 4, 2012: £24 million), Iceland £6 million (April 4, 2012: £6 million), Norway £35 million (April 4, 2012: £36 million), Sweden £4 million (April 4, 2012: £4 million), Switzerland £388 million (April 4, 2012: £410 million) and Supranationals £1,149 million (April 4, 2012: £1,429 million).
We classify our business streams as follows:
distribution channels supporting these product divisions.
Commercial lending
During the year ended April 4, 2012, we revised the methodology for allocating the benefit of free capital between segments to align it more closely with regulatory capital requirements across business segments. Comparatives have been reclassified to be presented on a basis which is consistent with the current year's presentation. The contribution to underlying profit before tax by each of these business streams is set out in the table below:
| Retail | Commercial | Head office functions |
Total | ||
|---|---|---|---|---|---|
| Notes | £m | £m | £m | £m | |
| Net interest income/(expense) from external customers |
1,077 | 408 | (576) | 909 | |
| (Charge)/revenue from other segments | (302) | (381) | 683 | - | |
| Net interest income | 775 | 27 | 107 | 909 | |
| Other income | (i) | 205 | 10 | 8 | 223 |
| Total revenue | 980 | 37 | 115 | 1,132 | |
| Expenses | (ii) | (618) | (24) | (13) | (655) |
| Impairment and other provisions | (iii) | (109) | (193) | (24) | (326) |
| Underlying profit/(loss) before tax | 253 | (180) | 78 | 151 | |
| FSCS levies | 6 | - | - | 6 | |
| Restructuring costs | (7) | - | (4) | (11) | |
| Bank levy | - | - | (8) | (8) | |
| Losses from derivatives and hedge accounting | - | - | (14) | (14) | |
| Profit/(loss) before tax | 252 | (180) | 52 | 124 | |
| Taxation | 12 | ||||
| Profit after tax | 136 |
| Retail | Commercial | Head office functions |
Total | ||||||
|---|---|---|---|---|---|---|---|---|---|
| Notes | £m | £m | £m | £m | |||||
| Net | interest | income/(expense) | from | external | 1,069 | 425 | (717) | 777 |
| customers | |
|---|---|
| ----------- | -- |
| (Charge)/revenue from other segments | (380) | (394) | 774 | - | |
|---|---|---|---|---|---|
| Net interest income | 689 | 31 | 57 | 777 | |
| Other income | (i) | 199 | 8 | 6 | 213 |
| Total revenue | 888 | 39 | 63 | 990 | |
| Expenses | (ii) | (595) | (19) | (30) | (644) |
| Impairment and other provisions | (iii) | (85) | (72) | (8) | (165) |
| Underlying profit/(loss) before tax | 208 | (52) | 25 | 181 | |
| Restructuring costs | - | - | (5) | (5) | |
| Bank levy | - | - | (9) | (9) | |
| Gains from derivatives and hedge accounting | - | - | 71 | 71 | |
| Profit/(loss) before tax | 208 | (52) | 82 | 238 | |
| Taxation | (50) | ||||
| Profit after tax | 188 |
(i) Other income excludes gains from derivatives and hedge accounting.
(ii) Expenses exclude restructuring costs and bank levy which are shown separately.
(iii)Impairment and other provisions includes impairment losses on loans and advances to customers, provisions for liabilities and charges (excluding FSCS) and impairment losses on investment securities.
| For the six month period ended September 30, |
||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Net interest | 775 | 689 |
| Other income | 205 | 199 |
| Total income | 980 | 888 |
| Expenses | (618) | (595) |
| Impairment and other provisions | (109) | (85) |
| Underlying profit before tax | 253 | 208 |
The Retail business made an underlying profit of £253 million in the six month period ended September 30, 2012, an increase of 22% compared with the six month period ended September 30, 2011. Nationwide has a strong franchise, and our retail products have continued to perform well against a challenging backdrop.
Total income increased by 10% to £980 million for the six month period ended September 30, 2012, driven by £86 million growth in net interest income and £6 million from other income. Net interest income includes fair value adjustments of £48 million in the six month period ended September 30, 2012 (six month period ended September 30, 2011: £nil) from the release of excess credit fair value adjustments, net accounting adjustments of £22 million relating to changes in our effective interest rate assumptions for savings accounts which offer an initial bonus and early redemption charges in relation to mortgages rate calculations.
The margin continues to be supported both by strong new business asset margins and the significant positive impact of repricing at deal maturity as customers either revert to our Base or Standard Mortgage Rate or opt to take a new mortgage product.
Growth in other income from protection and investments and general insurance during the six month period ended September 30, 2012 is in line with our strategy to diversify our income stream. General insurance income includes a £10 million household profit share which, in prior periods, was received in the second half of the year.
Expenses increased by 4% from £595 million in the six month period ended September 30, 2011 to £618 million for the six month period ended September 30, 2012 reflecting higher volume related costs, PPI administration costs of £15 million, depreciation and refined cost allocation, partly offset by efficiency improvements in both customer facing and back office functions.
The quality of our mortgage portfolio remains a key strength for the business and is reflected in the low level of arrears and mortgage impairment charges. The impairment and other provisions charge of £109 million for the six month period ended September 30, 2012 relating to the retail business comprises a residential impairment charge of only £26 million (six month period ended September 30, 2011: £42 million), a charge in relation to consumer banking of £38 million (six month period ended September 30, 2011: £28 million), and a charge of £45 million (six month period ended September 30, 2011: £15 million) in connection PPI.
Prime residential gross lending was 32% ahead year on year at £8.6 billion for the six month period ended September 30, 2012 (six month period ended September 30, 2011: £6.5 billion). This was delivered through improved competitiveness across all market segments, and we exceeded our par share in all buyer type categories.
We have maintained a particular focus on supporting the first time buyer market, delivering a share of over 18% of this market in the first half of the current financial year. Despite this strengthened focus on first time buyers, the average LTV on our prime residential lending has been carefully managed to 65% in the six month period ended September 30, 2012 (six month period ended September 30, 2011: 60%), as we have balanced the strong margins available at higher LTVs with a continued above par share of high quality, low LTV remortgage business.
Our BMR balances increased to £53.2 billion as at September 30, 2012. Despite the low rate, which is capped at 2% above BoE base rate, £1.8 billion of redemptions in the six months have come from the BMR book. Our total BMR balances are unlikely to grow significantly beyond their current level, and we expect they will decline steadily from the middle of 2013 onwards.
The buy to let market has continued to grow in the first half of the current financial year, with renting offering an alternative to house purchase for an increasing number of people. In addition, rising rents and low yields on other assets have increased demand from landlords, and mortgage supply in this sector has increased over the period.
The Group's specialist lender, TMW, has maintained a strong and influential presence in the buy to let sector. Over the six month period ended September 30, 2012, TMW has offered a product proposition which reflects Group risk appetite, and returns ongoing value for the benefit of members. Gross lending in the six month period ended September 30, 2012 was £1.7 billion (six month period September 30, 2011: £2.6 billion), with the reduction relative to the previous year reflecting the renewed strength of competitor activity. The average LTV for new buy to let business has been 68% in the six month period ended September 30, 2012.
The overall specialist lending book has grown to £24.2 billion as at September 30, 2012 (April 4, 2012: £23.2 billion), with arrears levels performing well.
With market interest rates at record lows, savers continue to face an extended period of low returns on their deposits. In common with other savings providers, Nationwide has the difficult task of balancing attractive interest rates with the need to protect the long term financial strength of the business and manage liquidity in line with evolving regulation. Over the six month period ended September 30, 2012 our savings balances fell by a modest £0.5 billion (six month period ended September 30, 2011: increase of £2.4 billion), and we have consciously focused our efforts on rewarding our loyal customers wherever possible, through products such as Flexclusive ISA and Flexclusive Regular Saver, a Loyalty bond and, most recently, our unique Loyalty Saver account, launched in October 2012).
We have continued to act as a major challenger to the established banks, growing our market presence in current accounts, personal loans and credit cards. During the first half of the current financial year, we opened 184,200 new current accounts, 186,900 new credit cards and advanced 65,900 new personal loans. At September 30, 2012, our current account base was 5.1 million accounts, whilst our credit card account base was 1.8 million accounts, with 2.4 million cards in issue.
Our protection and investment business and general insurance business have also performed well. During the period we sold approximately 32,200 protection plans and 82,300 investment products, and as at September 30, 2012 we had £7.4 billion assets under advice (April 4,2012: £6.7 billion). Home insurance sales are up 20% on the same period last year, and our general insurance book now has over 1.5 million policies. Other income from protection and investments and from general insurance grew by 15% and 28% respectively in the period, reflecting the success of our ongoing diversification strategy.
| For the six month period ended September 30, |
||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Net interest | 27 | 31 |
| Other income | 10 | 8 |
| Total income | 37 | 39 |
| Expenses | (24) | (19) |
| Impairment and other provisions | (193) | (72) |
| Underlying loss before tax | (180) | (52) |
The commercial lending portfolio of £20.9 billion at September 30, 2012 (April 4, 2012: £21.5 billion) comprises £11.0 billion (April 4, 2012: £11.6 billion) secured on commercial property, £8.4 billion (April 4, 2012: £8.4 billion) advanced to Registered Social Landlords and £1.5 billion (April 4, 2012: £1.5 billion) provided to Project Finance.
Commercial property capital values have seen a steady decline since October 2011 (Source: Investment Property Databank, August 2012), and the investment market has had lower transaction levels (Source: Property Data, September 2012) as a result of weak demand. The availability of credit has seen its fourth consecutive quarterly decline which has been attributed to the renewed falls in capital values, with demand for credit also declining over the last four quarters (Source: Bank of England). These developments mean that the outlook for the UK commercial property market remains uncertain. Market forecasts expect capital values to continue to fall throughout 2013, albeit at a lower rate than 2012, before stabilising in 2014. We continue to adopt a cautious and proactive approach to commercial property exposures until there is clear evidence of market stability returning.
The Commercial business made a loss of £180 million in the six month period ended September 30, 2012, compared to a loss of £52 million in the six month period ended September 30, 2011. Income benefited from widening margins and increasing fee income, but was also adversely affected by non-performing loans. As anticipated, conditions in the UK commercial property market remained extremely challenging and the increased loss for the period is entirely attributable to a significant increase in impairment charges.
Commercial loan impairments were £193 million for the six month period ended September 30, 2012, which is £18 million higher than the £175 million in the six month period ended April 4, 2012 and £121 million higher than the six month period ended September 30, 2011. The additional impairments are largely attributable to new and additional provision requirements against loans already impaired or subject to close monitoring, caused by a combination of factors including loss of tenants, falling valuations or withdrawal of support from equity providers. Further falls in commercial real estate valuations have resulted from weak investor confidence driven by a return to recessionary conditions in the UK, concerns over the Eurozone, and the impact of proposed changes to the capital treatment of real estate lending by banks which both encourages banks to dispose of existing assets and discourages new lending.
There were 340 cases three or more months in arrears as at September 30, 2012 (April 4, 2012: 299), with total arrears balances on these cases of £75 million (April 4, 2012: £58 million). Robust arrears management is carried out by dedicated teams who, supported by daily arrears reporting, maintain a focus on early intervention to maximise economic value and mitigate losses. Tenant failure is a key driver of arrears but, whilst we have seen a number of high profile failures in the retail sector in 2012, our exposure to these names has been modest and is not expected to result in significant provisioning requirement.
The Registered Social Landlord and Project Finance portfolios have not experienced any losses and there are no arrears of 3 months or more as at September 30, 2012. Both of these books are still deemed to be low credit risk due to the involvement of Government in regulating Registered Social Landlords and providing secure income streams to Government backed Project Finance (primarily PFI) projects.
We have adopted a deliberate policy of running down or exiting those parts of the book that are outside current strategy, with a reduction of £0.6 billion in the six month period ended September 30, 2012. As a result of challenges in the commercial property market we have significantly curtailed new lending to this sector since September 2011. Gross commercial property lending of £131 million in the six month period ended September 30, 2012 is largely due to further draw downs under existing committed facilities, and was more than offset by higher than expected capital repayments and redemptions.
The non-UK book stands at £0.9 billion at September 30, 2012, which is a £0.1 billion reduction since April 4, 2012. 97% of the book is lending to Germany with no exposure to Greece, Spain, Portugal or Italy and a single exposure of £13 million to Ireland.
Property sales continue to support asset divestment, with 92 properties sold for £48 million in the six month period ended September 30, 2012 (six month period ended April 4, 2012: 95 properties, £41 million).
As our Nationwide originated Property Finance book has 31% of its loans scheduled to mature by the end of 2013, our loan maturity process is focused on early dialogue and/or intervention to ensure effective loss mitigation and income generation. Our strategy to help existing borrowers includes restructuring and/or refinancing those cases which are capable of maintaining serviceability, and during the six month period ended September 30, 2012 £0.2 billion of loans have been restructured and/or refinanced in this way.
As a result of curtailment of new lending to the Registered Social Landlord and Project Finance sectors, these books also decreased in size over the six month period ended September 30, 2012, with gross lending of £199 million primarily attributable to further drawings under existing committed facilities.
Since initial entry into the business savings market during the second half of the year ended April 4, 2011 we have launched a number of new products to satisfy different segments of the market, with a range of fixed rate bonds forming the latest product offering. As at September 30, 2012, £0.5 billion of savings balances were attributable to the Commercial business (April 4, 2012: £0.4 billion).
At the year ended April 4, 2012 we unveiled our strategy to enter the SME Business Banking market as a means of providing an increased service to our customers and developing a more diverse business mix. This offers a good strategic fit with Nationwide's business model and existing commercial lending activities. Plans continue to progress, with a formal programme established to deliver the new products and supporting infrastructure.
| For the six month period ended September 30, |
||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Net interest | 107 | 57 |
| Underlying profit before tax | 78 | 25 |
|---|---|---|
| Impairment and other provisions | (24) | (8) |
| Expenses | (13) | (30) |
| Total income | 115 | 63 |
| Other income | 8 | 6 |
Head office functions reported an underlying profit before tax of £78 million at September 30, 2012 (September 30, 2011: £25 million). Total income in the six month period ended September 30, 2012 was 82.5% higher than the corresponding period in the prior year, primarily due to additional income from the management of the liquidity portfolio, an underlying improvement in the non-core yield and the lower average cost of short term funding. Administrative expenses have fallen, reflecting refined cost allocation.
Impairment and other provisions of £24 million in the six month period ended September 30, 2012 relates to impairment losses on treasury investments of £23 million as at September 30, 2012 (September 30, 2011: £6 million) and a £1 million charge (September 30, 2011: £2 million) for other lending in connection with investments acquired by the Treasury division.
The Society has a strong and well-diversified funding base, which continues to be predominantly comprised of retail savings. Over the course of the half year, we have continued to actively manage our balance sheet in response to conditions in both the retail and wholesale markets.
As a building society, we have always maintained a high level of unencumbered liquid assets relative to our banking peers, and our core liquidity remains strong at 11.3% at September 30, 2012 (April 4, 2012: 13.7%). Recent changes in the UK liquidity regime, most notably with the FSA allowing the Group to include the benefit of prepositioned collateral at the BoE Discount Window Facility ("DWF") to count towards liquidity requirements, have enabled on balance sheet core liquidity to be managed down.
Liquidity represents a key area of risk management for financial institutions. In recent years there has been an increased focus on liquidity from the regulatory authorities. Having successfully met the timeframes for compliance with new regulatory requirements, the Group continues to enhance and strengthen its liquidity management systems and approach.
Liquidity stress testing is carried out against a number of scenarios including those prescribed by the regulator, considering a range of liquidity and economic factors and the consequent impact on the Group over multiple time horizons. Liquidity risk is managed against limits using a number of these scenarios. Included within the liquidity stress scenarios is the deemed impact of potential rating agency downgrades. Nationwide also has in place a Contingency Funding Plan which details a range of actions the Group would be able to take in the event of a funding stress, including the utilisation of our large stock of unencumbered mortgage assets as collateral, as well as retail funding actions, allowing us to maintain adequate liquidity resources. See "Risks Related to Our Business—Our business and financial performance have been and will continue to be affected by general economic conditions in the UK, the eurozone and elsewhere, and other adverse developments in the UK or global financial markets could cause our earnings and profitability to decline" for additional information on funding and liquidity risk.
Liquid assets generally comprise cash deposits held with Central Banks or unencumbered securities that may be freely sold or are capable of financing through repurchase ("repo") agreements or other similar arrangements, either direct with those Central Banks to which the Group has access, or with market counterparties. The stock of liquid assets managed by Nationwide's Treasury division fall into the following four categories:
The Group has been able to manage down its level of core liquidity over the six month period ended September 30, 2012, whilst maintaining its headroom over regulatory liquidity requirements. The core liquidity portfolio continues to consist of highly liquid assets of a high credit quality and remains aligned to the 'Liquid Assets Buffer' defined by the FSA in BIPRU 12. The portfolio comprises:
Deposits held at, and securities issued by, the BoE;
Highly rated debt securities of varying maturities issued by governments or multi-lateral development banks.
In line with other major UK institutions, the Group has access to the FLS; based on our base stock of loans as at June 30, 2012, providing an initial borrowing allowance of approximately £7.5 billion. As at September 30, 2012 the Group has drawn £509 million of UK treasury bills, with further usage expected to form part of Nationwide's funding plans in the period to January 31, 2014, when the drawdown period ends.
As at September 30, 2012, the core liquidity portfolio as a percentage of adjusted share, deposit and loan liabilities was 11.3% (April 4, 2012: 13.7%). This calculation is made net of any core liquidity holdings that are subject to repo arrangements and includes assets held under reverse repo arrangements.
In addition to the core portfolio, as at September 30, 2012, we held a stock of unencumbered securities (excluding self issuance) that are eligible collateral for either the European Central Bank's ("ECB") repo operations, for the BoE extended collateral repo operations or the BoE DWF. In terms of their relative liquidity characteristics, these assets may be viewed as the secondary liquidity portfolio.
Nationwide holds other third party liquid assets (such as Floating Rate Notes) that are not eligible at either the BoE's or the ECB's operations but may be capable of financing through third party repo agreements.
The Group holds a stock of self-issued AAA-rated residential mortgage backed securities ("RMBS") and covered bonds. These self-issued securities are capable of repo financing either directly with the market or with central banks to which the Group has direct access, and therefore represent contingent liquidity available to the Group if necessary.
The table below sets out the fair value of each of the above liquidity types as at September 30, 2012. The table includes off balance sheet liquidity (including treasury bills held under the FLS, self issued RMBS and covered bonds), but excludes any encumbered assets.
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| (£ billion) | ||
| Core liquidity(1) | 20.0 | 24.5 |
| Other central bank eligible assets | 2.3 | 2.5 |
| Other securities | 2.8 | 4.0 |
| Self-issued RMBS and covered bonds | 13.2 | 16.3 |
| Total | 38.3 | 47.3 |
(1) Core liquidity includes off balance sheet items, primarily treasury bills held under the FLS, as mentioned above. On balance sheet core liquidity is £19.6 billion
An analysis of the Group's wholesale funding (made up of deposits from banks, other deposits and debt securities in issue as disclosed on the balance sheet) is set out in the table below:
| As at September 30, 2012 | As at April 4, 2012 | ||||
|---|---|---|---|---|---|
| (£ billion, except percentages) | |||||
| Repo and other secured agreements | 3.0 | 6.5% 3.7 |
7.5% | ||
| Deposits | 8.0 | 17.4% | 7.8 | 15.9% | |
| Certificates of deposit | 4.7 | 10.2% | 4.3 | 8.7% |
| Commercial paper | 5.2 | 11.3% | 3.7 | 7.5% |
|---|---|---|---|---|
| Covered bonds | 10.8 | 23.5% | 13.0 | 26.5% |
| Medium term notes | 4.3 | 9.3% | 7.1 | 14.5% |
| Securitizations | 7.3 | 15.9% | 7.4 | 15.1% |
| Other non-retail | 2.7 | 5.9% | 2.1 | 4.3% |
| Total |
46.0 | 100.0% | 46.4 | 100.0% |
During the year ended April 4, 2012 we were particularly active in the long term debt markets, issuing £7.9 billion against our £3.5 billion of maturing long term deals, allowing us to pre-fund the current financial year long term funding maturities of £4.9 billion. With the advent of the FLS, the Group can be selective in accessing public long term funding markets throughout the remainder of this financial year, and we have no specific plans to issue in long term funding markets for the remainder of the financial year.
The Group has increased the amount of short term funding instruments in issue to £14 billion at September 30, 2012 (April 4, 2012: £12 billion). The average term at point of issuance of outstanding short term balances as at September 30, 2012 was 137 days (April 4, 2012: 131 days).
As a result of the small amount of long term funding originated in the six month period ended September 30, 2012, the Group has reduced the residual maturity profile of its wholesale funding portfolio from 33 months to 27 months at September 30, 2012. Despite this, as a result of maturing long term deals and a fall in the overall wholesale funding portfolio, the proportion of funding that is categorised as long term (>1 year to maturity) has increased to 63.1% (April 4, 2012: 62.7%).
The table below sets out the residual maturity of the wholesale funding book as at September 30, 2012:
| As at September 30, 2012 | As at April 4, 2012 | |||
|---|---|---|---|---|
| (£ billion, except percentages) | ||||
| Less than one year | 17.0 | 36.9% | 18.3 | 37.7% |
| One to two years | 2.4 | 5.2% | 3.9 | 7.9% |
| Two to five years | 18.7 | 40.6% | 17.6 | 35.8% |
| More than five years | 7.9 | 17.3% | 9.3 | 19.0% |
| Total |
46.0 | 100.0% | 49.1 | 100.0% |
Our short and long term credit ratings from the major rating agencies as at November 26, 2012 are as follows:
| Long Term | Short Term | Subordinated | Date of last rating action(1) |
|
|---|---|---|---|---|
| S&P | A+ | A-1 | BBB+ | December 2011 |
| Moody's | A2 | P-1 | Baa1 | October 2011 |
| Fitch | A+ | F1 | A | October 2012 |
Note:
(1) The outlook for Standard & Poor's and Moody's is Stable; the outlook for Fitch is negative.
______________
Treasury liquid assets include cash, loans and advances to banks and investment securities available for sale. These are held in two portfolios. The classification of liquid assets has been modified to better reflect the management of the portfolios and bring the analysis in line with FSA definitions in BIPRU 12. The portfolio is now categorized between core liquidity and non-core. Previously, the same portfolio of assets had been classified between liquidity and investment assets, which reflected the legacy investment strategies.
Core liquidity comprises cash and highly rated debt securities issued by governments or multi-lateral development banks. The non-core portfolio comprises available for sale assets held for investment purposes and clearing amounts. Analysis of each of these portfolios by credit rating and by location of issuer is given below.
Group treasury assets at September 30, 2012 were £28.8 billion (April 4, 2012: £34.3 billion) and are held in two separate portfolios: the core liquidity portfolio and the non-core liquidity portfolio. At September 30, 2012, the core liquidity portfolio totaled £19.6 billion (April 4, 2012: £24.8 billion) with the non-core liquidity portfolio totaling £9.2 billion (April 4, 2012: £9.5 billion). The Group has managed down its level of core liquidity over the six month period ended September 30, 2012, whilst maintaining its headroom over regulatory reporting liquidity requirements. The reporting of asset quality within the treasury portfolio has been modified to reflect the management of the portfolios and to bring the analysis in line with FSA definitions as laid out in BIPRU 12.
The following tables show the breakdown of the prudential portfolio at September 30, 2012 and April 4, 2012 by credit rating and geography:
| As at September 30, 2012 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Credit Rating | Geography | |||||||||
| AAA | AA | A | Other | UK | US | Europe | Other | |||
| (£ billion) | (percentages) | |||||||||
| Cash | 8.5 | 100 | - | - | - | 100 | - | - | - | |
| Gilts | 6.5 | 100 | - | - | - | 100 | - | - | - | |
| Non-domestic government bonds |
3.3 | 65 | 35 | - | - | - | 35 | 65 | - | |
| Supranational bonds | 1.3 | 100 | - | - | - | 10 | 4 | 85 | 1 | |
| Core liquidity portfolio total |
19.6 | 94 | 6 | - | - | 78 | 6 | 16 | - | |
| Loans and advances to banks |
3.3 | - | 26 | 74 | - | 52 | 13 | 22 | 13 | |
| RMBS | 2.4 | 42 | 18 | 32 | 8 | 51 | 4 | 41 | 4 | |
| CMBS | 0.5 | - | 15 | 61 | 24 | 52 | 15 | 33 | - | |
| Covered bonds | 0.9 | 53 | 16 | 19 | 12 | 36 | 3 | 55 | 6 | |
| Collateralized loan obligations |
0.6 | 11 | 82 | 7 | - | 31 | 69 | - | - | |
| Financial institution bonds |
0.6 | - | 7 | 59 | 34 | 17 | 20 | 47 | 16 | |
| US student loans | 0.6 | 27 | 50 | 12 | 11 | - | 100 | - | - | |
| Other | 0.3 | 49 | 4 | - | 47 | 26 | 71 | 3 | - | |
| Non-core portfolio total. | 9.2 | 20 | 26 | 45 | 9 | 42 | 21 | 29 | 8 | |
| Total | 28.8 | 71 | 12 | 14 | 3 | 66 | 11 | 20 | 3 |
| As at April 4, 2012 | |
|---|---|
| Credit Rating | Geography |
| AAA | AA | A | Other | UK | US | Europe | Other | ||
|---|---|---|---|---|---|---|---|---|---|
| (£ billion) | (percentages) | ||||||||
| Cash | 8.1 | 100 | - | - | - | 100 | - | - | - |
| Gilts | 12.8 | 100 | - | - | - | 100 | - | - | - |
| Non-domestic government bonds |
2.4 | 54 | 46 | - | - | - | 46 | 54 | - |
| Supranational bonds | 1.5 | 100 | - | - | - | 9 | 4 | 86 | 1 |
| Core liquidity portfolio total |
24.8 | 96 | 4 | - | - | 85 | 5 | 10 | - |
| Loans and advances to banks |
2.9 | - | 23 | 77 | - | 31 | 17 | 17 | 35 |
| RMBS | 2.1 | 41 | 27 | 23 | 9 | 45 | 4 | 41 | 10 |
| CMBS | 0.5 | - | 24 | 58 | 18 | 67 | - | 33 | - |
| Covered bonds | 0.9 | 54 | 23 | 12 | 11 | 28 | 3 | 63 | 6 |
| Collateralized loan obligations |
0.6 | 6 | 89 | 5 | - | 31 | 69 | - | - |
| Financial institution bonds |
1.4 | - | 9 | 64 | 27 | 20 | 14 | 50 | 16 |
| US student loans | 0.7 | 40 | 28 | 22 | 10 | - | 100 | - | - |
| Other | 0.4 | 32 | 20 | 18 | 30 | 25 | 61 | 14 | - |
| Non-core portfolio total. | 9.5 | 19 | 27 | 45 | 9 | 32 | 22 | 30 | 16 |
| Total | 34.3 | 74 | 10 | 13 | 3 | 70 | 10 | 16 | 4 |
Ratings are obtained from S&P in the majority of cases, or from Moody's if there is no S&P rating available, with internal ratings used if neither is available.
We have continued to manage the treasury asset portfolio to increase the quality and liquidity of the assets with over 68% of the total portfolio held in core liquidity exposures as at September 30, 2012 (April 4, 2012: 72%). 97% of the portfolio is rated A or better, with 83% rated AA or above (April 4, 2012: 84%).
Overall, the portfolio's average rating has stabilised in the six month period ended September 30, 2012.
As at September 30, 2012, we retain £1 billion of securities within the treasury assets portfolio domiciled in the "peripheral" Eurozone countries. Further details can be found in the 'Country exposures' section. Of the £1 billion, 35% is rated AA or above and 78% is rated A or above. This exposure has reduced by 18% in the six month period ended September 30, 2012.
A monthly review is undertaken on the current and expected future performance of all treasury assets. A governance structure exists to identify and review under-performing assets and highlight the likelihood of future losses. In accordance with accounting standards, assets are impaired where there is objective evidence that current events and/or performance will result in a loss.
Collateral held as security for treasury assets is determined by the nature of the instrument. Loans, debt securities, treasury and other eligible bills are generally unsecured with the exception of asset backed securities and similar instruments, which are secured by pools of financial assets.
In assessing impairment, the Group evaluates, among other factors, the normal volatility in valuation, evidence of deterioration in the financial health of the investee, industry and sector performance and operational and financing cash flows. An impairment loss of £23 million (September 30, 2011: £6 million) has been recognized for the six month period ended September 30, 2012.
Out of a total of £28.8 billion of assets held in the core liquidity and non-core portfolios as at September 30, 2012, £17.0 billion are held as available for sale ("AFS") and under IFRS they are marked to market through other comprehensive income and fair value movements are accumulated in reserves. The non-AFS assets are loans to banks or deposits with the BoE. Of the £17.0 billion of AFS assets, only £79 million are classified as Level 3 (valuation not based on observable market data) for the purposes of IFRS 7.
The assets have been reviewed based upon the latest performance data and an impairment charge of £23 million has been booked during the six month period ended September 30, 2012 against AFS assets relating to a single UK CMBS exposure that is now written down to zero. The fair value movement of AFS assets that are not impaired has no effect on the Group's profit for the period or its regulatory capital.
As at September 30, 2012, the balance on the AFS reserve had improved to £313 million negative, net of tax (April 4, 2012: £356 million negative). The improvement in the AFS reserve reflects the repayment of some of the noncore assets and a gradual pull towards par as the maturity profile of the remaining portfolio shortens. There has also been a strengthening of prices in some asset classes as market sentiment has improved.
The following table shows the breakdown of AFS reserves as at September 30, 2012 and April 4, 2012:
| As at September 30, 2012 | As at April 4, 2012 | |||
|---|---|---|---|---|
| Fair Value on balance sheet |
Cumulative AFS Reserve |
Fair Value on balance sheet |
Cumulative AFS Reserve |
|
| (£ billion) | ||||
| Cash |
8.5 | - | 8.1 | - |
| Gilts |
6.5 | (0.8) | 12.8 | (1.0) |
| Non-domestic government bonds | 3.3 | (0.1) | 2.4 | - |
| Supranational bonds | 1.3 | (0.1) | 1.5 | (0.1) |
| Core liquidity portfolio total | 19.6 | (1.0) | 24.8 | (1.1) |
| Loans and advances to banks | 3.3 | - | 2.9 | - |
| RMBS |
2.4 | 0.2 | 2.1 | 0.4 |
| CMBS |
0.5 | 0.1 | 0.5 | 0.1 |
| Covered bonds | 0.9 | 0.0 | 0.9 | - |
| CLO |
0.6 | 0.0 | 0.6 | - |
| Financial institutions bonds | 0.6 | 0.0 | 1.4 | - |
| US student loan | 0.6 | 0.1 | 0.7 | 0.1 |
| Other investments | 0.3 | 0.0 | 0.4 | - |
| Non-core portfolio total | 9.2 | 0.4 | 9.5 | 0.6 |
| (Positive)/negative AFS reserve before hedge accounting and taxation |
(0.6) | (0.5) | ||
| Hedge accounting adjustment for interest rate risk | 1.0 | 1.0 | ||
| Taxation | (0.1) | (0.1) | ||
| Total value of AFS assets/negative AFS reserve (net) |
||||
| 28.8 | 0.3 | 34.3 | 0.4 |
The following table provides an analysis of financial assets and liabilities held on our balance sheet at fair value, grouped in levels 1 to 3 based on the degree to which the fair value is observable:
| As at September 30, 2012 | |||||||
|---|---|---|---|---|---|---|---|
| Level 1(1) | Level 2(2) | Level 3(3) | Total | ||||
| (£ million) | |||||||
| Investment securities—AFS | 11,082 | 5,830 | 79 | 16,991 | |||
| Investments in equity shares | - | - | 22 | 22 | |||
| Derivatives financial instruments | - | 3,649 | 278 | 3,927 | |||
| Other financial assets* | - | 11 | - | 11 | |||
| Financial assets | 11,082 | 9,490 | 379 | 20,951 | |||
| Derivative financial instruments | - | (4,579) | (20) | (4,599) | |||
| Other deposits—PEB | - | - | (2,917) | (2,917) | |||
| Financial liabilities | - | (4,579) | (2,937) | (7,516) |
| As at April 4, 2012 | |||||
|---|---|---|---|---|---|
| Level 1 | Level 2 | Level 3 | Total | ||
| (£ million) | |||||
| Investment securities—AFS | 16,493 | 6,756 | 76 | 23,325 | |
| Investments in equity shares | 9 | - | 20 | 29 | |
| Derivatives financial instruments(4) | - | 3,942 | 234 | 4,176 | |
| Financial assets | 16,502 | 10,698 | 330 | 27,530 | |
| Derivative financial instruments(4) | - | (4,250) | (37) | (4,287) | |
| Other deposits – PEB | - | - | (2,890) | (2,890) | |
| Financial liabilities | - | (4,250) | (2,927) | (7,177) |
Notes:
______________
* Other financial assets represent fair value movements in mortgage commitments entered into where a loan has not yet been made. The Group recommenced the practice of fair valuing mortgage commitments on the balance sheet during the period.
There were no transfers between level 1 and level 2 assets and the decrease in level 1 assets reflects primarily UK gilt disposals during the six month period ended September 30, 2012.
The movement in level 3 investment securities in the six month period ended September 30, 2012 results from a £23 million impairment of a UK CMBS bond, the transfer of a £15 million mezzanine note and a £2 million US CDO from level 2 to level 3 and an increase in the market value of an existing level 3 asset.
We believe that our results indicate a strong performance for the year ended April 4, 2012 despite the challenging economic environment. The Group has delivered an underlying profit before tax (as explained below) of £304 million, and a statutory profit before tax of £203 million.
Underlying profit before tax (as explained below) for the year ended April 4, 2012 is up 10% at £304 million from £276 million for the year ended April 4, 2011. For the year ended April 4, 2012 compared to the year ended April 4, 2011, total income is up 10% at £2.14 billion, including a £96 million gain on the acquisition of a prime mortgage portfolio and an additional £70 million resulting from an update of our effective interest rate assumptions to reflect our latest mortgage profile expectations. Costs increased by 5%, which was driven by continuing strategic investment in our business, increasing regulatory costs, transactional volume growth and inflation. Credit impairments in the year ended April 4, 2012 were broadly stable at £428 million, with a rise in commercial provisions being largely offset by an improvement in retail and treasury provisions. Our PPI provision has been increased by a further charge of £103 million in the year ended April 4, 2012, which reflect the significant increase in complaints across the industry over the past six months, encouraged by the aggressive activities of Claims Management Companies ("CMCs").
We have a balance sheet that we believe is amongst the strongest of its kind in the industry. Our asset quality is strong, with residential arrears significantly lower than industry levels. In addition, we maintain market leading capital ratios, with a Core Tier 1 ratio of 12.5%, high levels of liquidity and a diverse funding platform.
As discussed in Note 1 to the audited consolidated financial statements for the year ended April 4, 2012, certain comparative numbers for the year ended April 4, 2011 have been reclassified to be presented on a basis that is consistent with the classification used in the year ended April 4, 2012 rather than that used in the year ended April 4, 2011. These reclassifications have not impacted profit before tax and are primarily related to the classification of the fees and commission income and expense and administrative expense. The discussion below reflects these reclassifications. Accordingly, certain numbers in this section for the year ended April 4, 2011 are different from the numbers appearing in the same lines in the discussion of the results of operations for the year ended April 4, 2011 compared with the year ended April 4, 2010.
Profit before tax on a reported basis and underlying basis are set out below. Certain aspects of our results are presented to reflect management's view of the underlying results and to provide a clearer representation of the performance of the Group:
| For the year ended April 4, 2012 | |||||||
|---|---|---|---|---|---|---|---|
| As reported |
Movements on derivatives and hedge accounting |
FSCS and bank levy |
Restructuring costs | Underlying profit before tax |
|||
| (£ millions) | |||||||
| Net interest income | 1,623 | - | - | - | 1,623 | ||
| Other income | 520 | - | - | - | 520 | ||
| Movements on derivatives and hedge accounting |
35 | (35) | - | - | - | ||
| Total income | 2,178 | (35) | - | - | 2,143 | ||
| Administrative expenses | (1,205) | - | 16 | 61 | (1,128) | ||
| Depreciation and amortization | (180) | - | - | - | (180) | ||
| Impairment losses | (428) | - | - | - | (428) | ||
| Provisions for liabilities and charges | (162) | - | 59 | - | (103) |
| For the year ended April 4, 2012 | |||||||
|---|---|---|---|---|---|---|---|
| As reported |
Movements on derivatives and hedge accounting |
FSCS and bank levy |
Restructuring costs | Underlying profit before tax |
|||
| (£ millions) | |||||||
| Profit before tax | 203 | (35) | 75 | 61 | 304 |
| For the year ended April 4, 2011 | |||||
|---|---|---|---|---|---|
| As reported |
Movements on derivatives and hedge accounting |
FSCS and bank levy |
Restructuring costs | Underlying profit before tax |
|
| (£ millions) | |||||
| Net interest income | 1,536 | - | - | - | 1,536 |
| Other income | 411 | - | - | - | 411 |
| Movement on derivatives and hedge accounting |
120 | (120) | - | - | - |
| Total income | 2,067 | (120) | - | - | 1,947 |
| Administrative expenses | (1,123) | - | - | 29 | (1,094) |
| Depreciation and amortization | (150) | - | - | - | (150) |
| Impairment losses | (425) | - | - | - | (425) |
| Provisions for liabilities and charges | (52) | - | 50 | - | (2) |
| Profit before tax | 317 | (120) | 50 | 29 | 276 |
The following discussion considers our results for the year ended April 4, 2012 compared to our results for the year ended April 4, 2011:
Our total income increased by 5% to £2,178 million in the year ended April 4, 2012 compared to £2,067 million in the year ended April 4, 2011. The following table sets forth the components of income for the years ended April 4, 2012 and April 4, 2011, respectively:
| For the year ended April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Net interest income | 1,623 | 1,536 | |
| Net fees and commissions | 419 | 400 | |
| Income from investments | 10 | 4 | |
| Other operating income | 91 | 7 |
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Gains from derivatives and hedge accounting | 35 | 120 |
| Total | 2,178 | 2,067 |
Net interest income increased by 5.7% to £1,623 million for the year ended April 4, 2012 compared with £1,536 million for the year ended April 4, 2011.
The following table sets forth the components of net interest income for the years ended April 4, 2012 and 2011, respectively:
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Interest and similar income: | ||
| On residential mortgages | 4,924 | 5,004 |
| On other loans | 1,158 | 1,148 |
| On investment securities | 1,071 | 1,029 |
| On other liquid assets | 56 | 32 |
| Net (expense) on financial instruments hedging assets | (2,051) | (2,738) |
| Expected return on pension assets | 195 | 168 |
| Total interest and similar income | 5,353 | 4,643 |
| Interest expense and similar charges: | ||
| On UK retail member deposits | (2,826) | (2,511) |
| On subscribed capital | (96) | (96) |
| On deposits and other borrowings: | ||
| Subordinated liabilities | (108) | (110) |
| Other | (252) | (258) |
| Debt securities in issue | (1,093) | (915) |
| Foreign exchange differences | (12) | (3) |
| Net income on financial instruments hedging liabilities | 823 | 952 |
| Pension interest cost | (166) | (166) |
| Total interest expense and similar charges | (3,730) | (3,107) |
| Net interest income | 1,623 | 1,536 |
Interest and similar income increased by 15.3% to £5,353 million in the year ended April 4, 2012 from £4,643 million in the year ended April 4, 2011.
Interest on residential mortgages decreased by 1.6% to £4,924 million in the year ended April 4, 2012 from £5,004 million in the year ended April 4, 2011. Although we have seen a 0.7% increase in the size of our average residential mortgage portfolio to £136,260 million in the year ended April 4, 2012 from £135,256 million in the year ended April 4, 2011, this has been offset by a small decrease in average interest rates between the two periods from 3.70% for the year ended April 4, 2011 to 3.61% for the year ended April 4, 2012. The increase in the size of our average residential mortgage portfolio has been driven mostly by increases in lending in the specialist lending sector and the acquisition of a Bank of Ireland mortgage book of £1.2 billion in December 2011.
Interest on other loans includes interest income that we earn from commercial loans, credit card lending, unsecured personal loans and current account overdrafts. Interest on other loans remained relatively stable increasing by 0.9% to £1,158 million in the year ended April 4, 2012 from £1,148 million in the year ended April 4, 2011.
Interest and other income from investment securities comprises interest income earned on the corporate and government investment securities that we purchase for our own account to manage our liquidity portfolios and net realized gains and losses on our sales of these instruments.
Interest and other income from investment securities increased by 4.1% to £1,071 million for the year ended April 4, 2012 compared with £1,029 million for the year ended April 4, 2011. Net of foreign exchange differences and net expenses on financial instruments hedging assets there has been an increase from £314 million for the year ended April 4, 2011 to £406 million for the year ended April 4, 2012. This net increase is due to an increase of 5.23% in the average balance of securities held in both the investment and liquidity portfolios to £23,281 million in the year ended April 4, 2012 from £22,123 million for the year ended April 4, 2011 combined with an increase in the average interest rate earned on such assets to 1.74% in the year ended April 4, 2012, compared to 1.42% in the year ended April 4, 2011. The increase in average interest rates is a direct result of increases in market rates between the two periods.
We use derivative instruments to synthetically convert fixed rate assets to floating rate assets. The floating rate income and fixed rate expense on these derivatives are included as "net expense on financial instruments hedging assets". In the year ended April 4, 2012, we incurred a net expense of £2,051 million on financial instruments used to hedge our fixed rate assets compared with a net expense of £2,738 million in the year ended April 4, 2011. As LIBOR rates have remained at very low levels during the years ended April 4, 2012 and April 4, 2011, the floating rate income on these financial instruments has reduced, resulting in an increase to the Group.
Under IFRS, interest earned on pension fund assets is recognized in interest and similar income and the release of discounts on pension fund liabilities is recognized in interest expense and similar charges in the income statement. These amounts are calculated by an independent actuary using accepted methodology and agreed assumptions.
Interest expense and similar charges increased by 20.1% in the year ended April 4, 2012 to £3,730 million from £3,107 million in the year ended April 4, 2011.
Interest on UK retail member deposits includes interest that we pay on UK savings and current accounts held by our members. Interest on UK retail member deposits increased to £2,826 million in the year ended April 4, 2012 from £2,511 million in the year ended April 4, 2011.
This reflects an increase in the average interest rate that we paid to depositors to 2.253% for the year ended April 4, 2012 compared with 2.05% in the year ended April 4, 2011 and an increase of 2.6% in the average balance of UK retail member deposits held to £125,456 million in the year ended April 4, 2012 from £122,259 million in the year ended April 4, 2011.
The low rate environment that has supported mortgage holders continues to pose challenges for savers, but we have maintained our policy of offering excellent savings products to new and existing members. Our success is evident in our ability to attract new money into the Group: net receipts in the year ended April 4, 2012 of £1.0 billion represent an increase of 67% as compared to the year ended April 4, 2011, while total balance growth of £3.1 billion is an increase of 2.5% in the year. This success means that we have retained our position as the second largest savings provider in the UK market.
We believe that we have made excellent progress in our strategy of diversifying our business through the expansion of our personal banking products. Over the year ended April 4, 2012 we have opened 359,000 full facility current accounts (year ended April 4, 2011: 353,000). A total of 78,000 customers have taken advantage of our Account Transfer Promise by switching their main accounts to Nationwide, an increase of 90% on 2011. Our total current account base is just under five million at April 4, 2012, taking our market share of main standard accounts to approximately 7.0% (April 4, 2011: 6.2%), based on Nationwide estimates.
Interest expense on deposits and other borrowings includes interest that we pay on subordinated debt instruments and other deposits and borrowings. In the year ended April 4, 2012, interest on subordinated liabilities remained broadly consistent, decreasing slightly to £108 million from £110 million in the year ended April 4, 2011. This decrease is a result of changes in the mix of subordinated debt between the two periods. The interest rates on our subordinated liabilities are fixed and therefore not affected by changes in market interest rates.
Other interest expense on deposits and other borrowings includes the interest that we pay on retail deposits by non-members, deposits from other banks and other money market deposits. In the year ended April 4, 2012, other interest expense on deposits and other borrowings decreased by 2.3% to £252 million from £258 million in the year ended April 4, 2011. This small reduction is due to decreases in market rates in the year ended April 4, 2012, compared with the year ended April 4, 2011.
Debt securities in issue includes interest that we pay on certificates of deposit, time deposits, commercial paper and medium-term notes. In the year ended April 4, 2012, interest expense on debt securities in issue increased by 19.5% to £1,093 million from £915 million in the year ended April 4, 2011. This increase reflects a 5.92% increase in the average monthly balance of debt securities in issue to £37,955 million in the year ended April 4, 2012, compared with £35,834 million in the year ended April 4, 2011. In addition, the average interest rate paid before adjusting for income/expense on financial instruments hedging liabilities increased to 2.88% for the year ended April 4, 2012, compared with 2.55% for the year ended April 4, 2011.
We use derivative instruments to synthetically convert fixed rate liabilities to floating rate liabilities. The floating rate expense and fixed rate income on these derivatives are included as "net income/expense on financial instruments hedging liabilities". In the year ended April 4, 2012, net income on financial instruments used to hedge our fixed rate liabilities was £823 million, compared with a net income of £952 million in the year ended April 4, 2011.
The following table sets forth the components of net fees and commissions for the years ended April 4, 2012 and 2011, respectively:
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Fee and commission income: | ||
| Mortgage related fees | 37 | 36 |
| Banking and savings fees | 235 | 218 |
| General insurance fees | 140 | 142 |
| Other insurance fees | 32 | 32 |
| Other fees and commissions | 71 | 64 |
| Total fee and commission income | 515 | 492 |
| Fee and commission expense: | ||
| Banking and savings fees | 88 | 86 |
| For the year ended April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Other fees and commissions | 8 | 6 | |
| Total fee and commission expense | 96 | 92 | |
| Net fee and commission income | 419 | 400 |
Income from net fees and commissions consists of income that we earn from lending, banking and savings fees and insurance sales commissions less lending fees and commission expense.
In the year ended April 4, 2012, net fees and commissions increased by 4.8% to £419 million compared with £400 million in the year ended April 4, 2011. This increase has been driven by strong income growth from current accounts and protection and investment products in the period, reflecting our strategic focus to grow the range and scale of our banking products and to diversify our income stream.
In the year ended April 4, 2012, other operating income increased to £91 million, compared with £7 million in the year ended April 4, 2011. The increase was due to a gain on the acquisition of a portfolio of UK-based prime residential mortgages from the Bank of Ireland of £96 million in December 2011.
All derivatives entered into by Nationwide are recorded on the balance sheet at fair value with any fair value movements accounted for in the income statement. Derivatives are only used to limit the extent to which we could be affected by changes in interest rates, exchange rates or other factors specified in building society legislation. Derivatives are therefore used exclusively to hedge risk exposures and are not used for speculative purposes.
Where effective hedge accounting relationships can be established, the movement in the fair value of the derivative instrument is offset in full or in part by opposite movements in the fair value of the underlying asset or liability being hedged. Any ineffectiveness arising from different movements in fair value will likely trend to zero over time.
In addition, we enter into certain derivative contracts which, although efficient economically, cannot be included in effective hedge accounting relationships. Consequently, although the implicit interest cost of the underlying instrument and associated derivatives are included in "Net interest income" in the income statement, fair value movements on such derivatives are included in "Gains from derivatives and hedge accounting".
Gains from derivatives and hedge accounting were £35 million in the year ended April 4, 2012, compared to £120 million in the year ended April 4, 2011.
Operating expenses and similar charges increased by 12.9% in the year ended April 4, 2012 to £1,975 million from £1,750 million in the year ended April 4, 2011. The following table sets forth the components of operating expenses and similar charges for the years ended April 4, 2012 and 2011, respectively:
| For the year ended April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Administrative expenses | 1,205 | 1,123 | |
| Depreciation and amortization | 180 | 150 | |
| Impairment losses on loans and advances to customers | 390 | 359 | |
| Provisions for liabilities and charges | 162 | 52 |
| 1,975 | 1,750 | |
|---|---|---|
| Impairment losses on investment securities | 38 | 66 |
Administrative expenses increased by 7.3% in the year ended April 4, 2012 to £1,205 million from £1,123 million in the year ended April 4, 2011. Included within the total of Administrative expenses is a £16 million charge for the bank levy. The bank levy was enacted on July 19, 2011 through the Finance Act 2011 with effect from January 1, 2011, and bank levy costs are being reported for the first time in the year ended April 4, 2012. The £16 million charge includes a charge of £3 million for the three months to April 4, 2011. This was not applied in the year ended April 4, 2011 as the Finance Act 2011 had not been enacted. See "Description of Business—Bank levy" for further information concerning the bank levy.
We are now in the final year of our three year cost optimization program and remain on track to deliver gross cost savings in excess of £200 million over the life of the project, with a number of new initiatives being identified. The program has delivered cost reduction through business restructuring, revision of pension terms and increased efficiency. These reductions have enabled the business to absorb a significant proportion of the cost increases relating to growth in our sales and service volumes.
The underlying cost income ratio for year ended April 4, 2012 was 61.0%, compared to 63.9% for the year ended April 4, 2011. We remain committed to a medium term target for an underlying cost income ratio of less than 50% in a normalized interest rate environment.
The following table sets forth the components of administrative expenses for the years ended April 4, 2012 and 2011, respectively:
| For the year ended April 4, | ||||
|---|---|---|---|---|
| 2012 | 2011 | |||
| (£ millions) | ||||
| Employee costs: | ||||
| Salaries and social security costs | 522 | 501 | ||
| Pension costs | 62 | 82 | ||
| Other administrative costs | 621 | 540 | ||
| Total | 1,205 | 1,123 |
Employee costs are made up of salaries, social security costs (which consist entirely of mandatory UK national insurance contributions) and pension costs.
The Group operates both defined benefit and defined contribution arrangements. The principal defined benefit pension arrangement is the Nationwide Pension Fund (the "Fund"). This is a contributory defined benefit arrangement, with both final salary and career average revalued earnings ("CARE") sections. The Fund was closed to new entrants in 2007, and since then new employees have been able to join a defined contribution arrangement. The final salary section of the Fund was closed to future service on March 31, 2011. Service already built up in the final salary section will continue to be linked to final salary, while future benefits now accrue within the CARE section.
In the year ended April 4, 2012, salaries and social security costs increased by 4.2% to £522 million from £501 million in the year ended April 4, 2011. The increase is a result of typical annual salary increases and merit-based salary increases to some employees.
Within employee costs, the pension charge decreased by 24.4% to £62 million for the year ended April 4, 2012 from £82 million in the year ended April 4, 2011. The decrease in pension costs is due primarily to a revised benefit structure that was implemented with effect from April 1, 2011, which has reduced the Group's service cost. In addition, following the closure of the defined benefit arrangements to new employees in 2007, there is a continued shift in membership from defined benefit to less expensive defined contribution pension arrangements.
The Group's net retirement benefit liability was £517 million as at April 4, 2012 (April 4, 2011: £300 million). The increase in the net liability at April 4, 2012 is due to an actuarial loss of £494 million for the year ended April 4, 2012 that was primarily caused by a reduction in the discount rate used which has placed a higher value on the liabilities. Under IAS 19, the discount rate used to value Fund liabilities is based on the yield of AA rated corporate bonds, which have decreased significantly to 4.8% as at April 4, 2012, compared to 5.6% as at April 4, 2011. The impact of the actuarial loss was partly offset by additional contributions of £241 million paid in the year ended April 4, 2012 (year ended April 4, 2011: £99 million).
Other administrative costs increased by 15% to £621 million for the year ended April 4, 2012 from £540 million for the year ended April 4, 2011. The increase in other administrative expenses is as a result of the newly introduced bank levy charge of £16 million, the continued investment in key restructuring projects, and external factors such as VAT, National Insurance and regulatory costs.
For the year ended April 4, 2012, depreciation and amortization expenses increased by £30 million to £180 million compared to £150 million for the year ended April 4, 2011. This is primarily driven by the continued investment in key restructuring projects.
We assess at each balance sheet date whether, as a result of one or more events that occurred after initial recognition, there is objective evidence that a financial asset or group of assets is impaired. Evidence of impairment may include indications that a borrower or group of borrowers are experiencing significant financial difficulty or default or delinquency in interest or principal payments.
Impairment losses on loans and advances to customers for the year ended April 4, 2012 increased by 8.6% to £390 million from £359 million for the year ended April 4, 2011.
The following table analyzes the impairment losses on loans and advances to customers for the years ended April 4, 2012 and 2011, respectively:
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Residential mortgages | 70 | 101 |
| Commercial lending | 247 | 175 |
| Unsecured lending | 69 | 83 |
| Other lending | 4 | - |
| Total | 390 | 359 |
The charge for impairment losses on residential mortgages of £70 million for the year ended April 4, 2012 is 30.7% lower than the £101 million charge for the year ended April 4, 2011.
Retail impairments (residential mortgages and unsecured lending combined) for the year ended April 4, 2012 have fallen by 24% to £139 million compared to £184 million for the year ended April 4, 2011. This reduction reflects strong performance across all of the retail portfolios resulting from a combination of stable house prices, a low interest rate environment and relatively robust employment trends. These factors have contributed to stable or improving arrears trends on our residential portfolios and levels of delinquency in consumer banking which have improved year on year and remain ahead of industry norms. The decline of only 0.9% in the Nationwide house price index during the year ended April 4, 2012, together with consistently prudent LTV lending policies over many years, has restricted negative equity within the residential portfolios and ensured that loss severity for those cases that are in arrears is not increasing.
Commercial loan impairments were £247 million for the year ended April 4, 2012, compared to £175 million for the year ended April 4, 2011, representing an increase of 41%. This has been driven by a return to recessionary conditions in the UK and widespread eurozone concerns, both undermining investor confidence and appetite for the sector. Consequently, after some recovery during the year ended April 4, 2011, the market is now experiencing falls in commercial real estate valuations with an expectation that, while not severe, this trend will persist at least throughout 2012. Secondary office and retail sites and certain regional centers are particularly affected and an overall mood of uncertainty is affecting valuations and restricting even further the availability of both equity and debt finance to support restructurings.
The increased impairment in the year ended April 4, 2012 is largely attributable to new and additional provisions on existing watch list cases where valuations have been eroded or the commitment of equity providers to further investment has been withdrawn. In addition we have reflected a more negative outlook for commercial property over the next 12 months with an increase of approximately £23 million in our collective provision which accounts for approximately 32% of the year on year increase in the impairment charge.
The number of Nationwide originated commercial property cases more than three months in arrears decreased from 235 cases at April 4, 2011 to 210 cases at April 4, 2012. The total value of arrears on these cases is £59 million (April 4, 2011: £48 million) reflecting the recessionary market conditions and more restricted ability to resolve certain longer term cases. The overall level of provision for commercial lending as a percentage of Nationwide originated assets is 2.65% (April 4, 2011: 2.18%), and the provision coverage ratio against balances more than three months in arrears is 67% (April 4, 2011: 69%).
In relation to other lending, a net increase in the provision held for restructured loans in the secured portfolio of £3.3 million, in addition to an increase in the collective provision of £0.4 million, resulted in a charge of £3.7 million in the year ended April 4, 2012. Overall, with a £0.5 million charge for the student loan portfolio, there is a total impairment charge of £4.2 million reported in other lending for the year ended April 4, 2012. This lending is included within the Head Office functions business segment, as the portfolios were acquired by our Treasury Division.
Provisions for liabilities and charges
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Payment protection insurance (PPI) | 103 | 16 |
| Other provisions | - | (14) |
| FSCS | 59 | 50 |
| Total | 162 | 52 |
Provisions for liabilities and charges were £162 million for the year ended April 4, 2012, compared to £52 million for the year ended April 4, 2011. Provisions for the year ended April 4, 2012 relate to PPI (£103 million) and FSCS (£59 million).
The increase in PPI provision follows significant developments since the initial PPI provision was estimated. The FSA released its policy statement PS10/12: The assessment and redress of Payment Protection Insurance complaints on August 10, 2010, and the Group has been monitoring the subsequent level of complaints. In line with the wider industry, we have experienced a significant increase in complaints during the second half of the year ended April 4, 2012, driven by media focus and claims management company activity. This has resulted in a reassessment of the volume of complaints that we ultimately expect to receive, including significant levels of complaints where a customer has not been sold a product by us.
The overall PPI provision is calculated based upon management's estimate of complaint volumes, the proportion of cases relating to no product sold, referral rates to the FOS, uphold rates internally and with the FOS, response rates from customer contact activity relating to our previous sales of PPI, average redress payments and complaint handling costs. In addition to higher expected volumes, the expected cost of processing the complaints has increased as a result of the decision by FOS to increase its cost of reviewing escalated cases from £500 to £850. We incur this cost on every referred complaint, regardless of the outcome. Management's estimate of the level of redress that we expect to pay has also increased, reflecting the FSA and FOS stances on PPI.
The release of other provisions in the year ended April 4, 2011 related to a provision for historic customer bonus schemes which was no longer required.
Impairment losses on investment securities of £38 million for the year ended April 4, 2012 compared to £66 million for the year ended April 4, 2011 relates to treasury assets and equity shares impairment charges and includes £17 million for a collateralized debt obligation ("CDO") of U.S. residential mortgage backed securities ("RMBS"), £9 million on a UK commercial mortgage backed security ("CMBS"), £5 million on Portuguese bank subordinated debt and £7 million in respect of our private equity portfolio. The charge of £66 million in the year ended April 4, 2011 was driven by a £22 million impairment of a number of U.S. RMBS exposures, £15 million on a CMBS, £18 million from restructuring of subordinated debt from Irish banks and £11 million on notes of a restructured Structured Investment Vehicle ("SIV").
Tax on our profit on ordinary activities for the year ended April 4, 2012 amounted to £24 million based on our reported profit on ordinary activities before tax of £203 million, reflecting an effective tax rate of 11.8% as compared with the prevailing UK corporation tax rate of 26.0%.
For the year ended April 4, 2011, tax on our profit on ordinary activities amounted to £69 million based on our reported profit on ordinary activities of £317 million, reflecting an effective tax rate of 21.8% as compared with the prevailing UK corporation tax rate of 28.0%.
The lower rate is due principally to adjustments with respect to prior periods and the effect of the change in the UK corporation tax rate from 26% to 24%, partially offset by the charge for the bank levy which is not an allowable deduction for corporation tax. The main items included within the adjustments with respect to prior periods are the release of £21 million of provisions held in respect of previously uncertain liabilities on historic transactions which are no longer required.
Lending remains predominantly concentrated on high quality secured products, with residential mortgages accounting for 83.8% of our total loans and advances to customers at April 4, 2012. The composition of lending has remained broadly consistent with that reported at April 4, 2011:
| As at April 4, | |||||
|---|---|---|---|---|---|
| 2012 | 2011 | ||||
| (£ billions, except percentages) | |||||
| Prime residential mortgages | 105.6 | 68.7% | 104.3 | 69.7% | |
| Specialist residential mortgages | 23.2 | 15.1% | 20.3 | 13.6% | |
| Total residential mortgages | 128.8 | 83.8% | 124.6 | 83.3% | |
| Commercial lending | 21.5 | 14.0% | 22.0 | 14.7% | |
| Other lending | 0.5 | 0.3% | 0.5 | 0.3% | |
| Consumer banking | 3.0 | 1.9% | 2.5 | 1.7% | |
| Gross balances | 153.8 | 100.0% | 149.6 | 100.0% | |
| Impairment provisions | (0.8) | (0.8) | |||
| Fair value adjustments for micro hedged risk | 1.2 | 0.6 | |||
| Total | 154.2 | 149.4 |
Prime residential mortgages are primarily Nationwide branded advances made through our branch network and intermediary channels. In addition, our balance sheet includes prime mortgages totaling £3.4 billion as at April 4, 2012 that were brought onto our balance sheet in prior years following our acquisitions of the Derbyshire, Cheshire and Dunfermline portfolios and £1.2 billion in relation to the acquisition of the Bank of Ireland mortgage book in December 2011, as well as a small element of prime residential lending originated through our specialist lending brand, The Mortgage Works ("TMW").
Specialist residential mortgages are made up of £20.5 billion of advances made through our specialist lending brands, TMW and UCB Home Loans Corporation Limited ("UCB"), and £2.7 billion as at April 4, 2012 arising from the acquisitions of the Derbyshire, Cheshire and Dunfermline portfolios in prior years. Loans were advanced primarily in the buy to let and self-certification markets. As at April 4, 2012, buy to let mortgages made up 77% of total specialist lending, 16% related to self-certification mortgages, 5% related to near prime and just 2%, amounting to £0.4 billion, related to sub prime. New specialist lending is restricted to buy to let with the Group having withdrawn from the self-certified lending market in 2009.
We have continued to focus on affordability and LTV ratios in underwriting loans during the year. The average LTV of residential mortgages completed has reduced to 63% at April 4, 2012 compared to 66% at April 4, 2011 as we have increased our proportion of lending to the remortgage market. The average indexed LTV of residential mortgages at April 4, 2012 has remained broadly stable at 50%, compared to 49% at April 4, 2011.
We increased our gross lending by 44% to £18.4 billion in the year to April 4, 2012, compared to £12.8 billion for the year ended April 4, 2011. Our net mortgage lending was £2.7 billion (April 4, 2011: negative £3.5 billion) and, in addition, we acquired £1.2 billion of high quality prime residential loans during the year ended April 4, 2012.
We have been particularly supportive of first-time buyers, providing mortgages that helped over 24,000 people to buy their first home, an increase of 9% year on year (April 4, 2011: 22,200). This was underpinned by a number of product initiatives, and we were one of the founding lenders participating in the launch of the recent NewBuy scheme.
Nationwide is a leading provider of specialist mortgages in the UK through our subsidiary, TMW, supporting an expanding rental sector. We have increased our lending in high quality 'buy to let' to £4.4 billion (April 4, 2011: £3.0 billion), taking our specialist lending book to over £23 billion (April 4, 2011: £20 billion).
We have continued to focus on affordability and LTV ratios in underwriting loans during the year. The average LTV of residential mortgages completed has decreased to 63% in the year ended April 4, 2012 (April 4, 2011: 66%) as we have increased our proportion of lending to the remortgage market. The average indexed LTV of residential mortgages at April 4, 2012 has remained broadly stable at 50% (April 4, 2011: 49%).
| As at April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (percentages) | ||
| Total portfolio of residential mortgages: | ||
| <50% | 50 | 52 |
| 50% - 60% | 10 | 9 |
| 60% - 70% | 11 | 11 |
| 70% - 80% | 13 | 11 |
| 80% - 90% | 10 | 10 |
| 90% - 100% | 4 | 5 |
| > 100% | 2 | 2 |
| 100 | 100 | |
| Average loan to value of stock (indexed) | 50 | 49 |
| Average loan to value of new business | 63 | 66 |
| New business profile: | ||
| First-time buyers | 17 | 23 |
| As at April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (percentages) | |||
| Home movers | 25 | 34 | |
| Remortgagers | 27 | 12 | |
| Buy-to-let | 31 | 31 | |
| 100 | 100 |
The analysis of the new business profile and average loan to value of new business above excludes further advances.
The table below shows that arrears on the Group's prime lending remained stable at 0.54%, whilst there has been a reduction in specialist arrears as a result of reducing arrears volumes and strong book growth in TMW. Our arrears performance remains very favorable relative to the CML industry average, and our specialist lending arrears are now below the overall industry measure that is inclusive of prime lending.
| As at April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| Cases three months or more in arrears as % of total book of residential mortgages | (percentages) | |
| Group residential mortgages: | ||
| Prime | 0.54 | 0.54 |
| Specialist | 1.87 | 2.47 |
| Total Group residential mortgages | 0.73 | 0.77 |
| CML Industry average | 1.96 | 2.09 |
Total residential balance sheet provisions at April 4, 2012 are £202 million, compared with £201 million at April 4, 2011, giving a coverage ratio against total originated balances of 0.16% (April 4, 2011: 0.17%) and against originated balances more than three months in arrears of 18.6% (April 4, 2011: 17.6%).
Residential mortgage assets acquired with the Derbyshire, Cheshire and Dunfermline brands were fair valued on a basis which included a credit risk adjustment of £199 million for anticipated losses over the remaining life of the loans. To date, £71 million of losses have been written off and, as reported at April 4, 2012, £33 million of surplus fair value credit risk adjustment on mortgage books has been released to margin. It is believed that the remaining £95 million is sufficient to cover all expected future losses on these acquired residential portfolios.
We maintain close relationships with customers experiencing financial difficulties and work with them to agree the most appropriate course of action. In the case of short term difficulty, we will seek to agree revised payment schedules with the customer, which may include a reduction to the contractual monthly payment due. If the customer can meet the interest portion of their repayment, we may grant a temporary interest only concession which would be non-arrears bearing so long as the customer continues to meet the terms of the new arrangement. Where this is not the case, arrears will continue to accrue and will be included in the arrears numbers reported above. Payment holidays are also non-arrears bearing, but a credit score assessment is included as part of the eligibility criteria to restrict the use of this concession.
If a customer demonstrates they are able to meet a payment schedule at a normal commercial rate for a period of six months or if they are able to overpay such that six months' full payments are made in a four month period, and only if they request it, we may 'capitalize' the arrears on their account. This will result in an enlarged outstanding balance but no arrears and consequently these cases will no longer be reported as arrears.
The number of properties in possession at April 4, 2012 was 1,129 properties, representing 0.08% of our book, which compares well with the industry measure of 0.12%. The table below shows possessions as a percentage of book.
| As at April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| Possessions as % of total book of residential mortgages (number of properties) | (percentages) | ||
| Prime | 0.02 | 0.03 | |
| Specialist | 0.40 | 0.38 | |
| Total Group residential mortgages | 0.08 | 0.07 |
Our approach to dealing with customers in financial difficulties combined with our historically cautious approach to lending, means that we only take possession of properties as a last resort. This is illustrated by the number of properties taken into possession compared with the total for the industry. During the year ended April 4, 2012, the properties taken into possession has decreased to 1,885, representing 5.0% of properties taken in by the industry as a whole, against our par share of all cases of 12.4% (2011: 11.4%).
The table below provides further information on the residential mortgage portfolio by payment due status:
| As at April 4, 2012 | As at April 4, 2011 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | Prime lending |
Specialist lending |
Consumer banking |
Total | |||
| (£ billions, except percentages) | ||||||||||
| Not impaired: |
||||||||||
| Neither past due nor impaired |
103.1 | 21.3 | 2.9 | 127.3 | 97% | 101.8 | 18.4 | 2.4 | 122.3 | 96% |
| Past due up to 3 months but not impaired |
1.9 | 1.2 | 0.0 | 3.1 | 2% | 1.9 | 1.4 | 0.0 | 3.3 | 3% |
| Impaired | 0.6 | 0.7 | 0.1 | 1.4 | 1% | 0.6 | 0.8 | 0.1 | 1.5 | 1% |
| Total | 105.6 | 23.2 | 3.0 | 131.8 | 100% | 104.3 | 20.3 | 2.5 | 127.1 | 100% |
The status "past due up to 3 months but not impaired" includes any asset where a payment due is received late or missed. The amount included is the entire financial asset balance rather than just the payment overdue. Loans on interest only or payment holiday concessions are initially categorized according to their payment status as at the date of concession, with subsequent revisions to this category assessed against the terms of the concession.
Loans in the analysis above which are less than 3 months past due have collective impairment allowances set aside to cover credit losses on loans which are in the early stages of arrears. Loans acquired from the Derbyshire, Cheshire and Dunfermline building societies were fair valued on a basis which made credit loss adjustments for anticipated losses over the remaining life of the loans. Impaired retail loans are broken down further in the following table:
| As at April 4, 2012 | As at April 4, 2011 | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | Prime lending |
Specialist lending |
Consumer banking |
Total |
| Impaired status: |
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Past due 3 to 6 months |
268 | 279 | 37 | 584 | 41% | 271 | 290 | 50 | 611 | 41% |
| Past due 6 to 12 months |
184 | 200 | 23 | 407 | 29% | 187 | 228 | 44 | 459 | 30% |
| Past due over 12 months |
85 | 138 | - | 223 | 16% | 81 | 185 | - | 266 | 18% |
| Possessions | 30 | 167 | - | 197 | 14% | 33 | 130 | - | 163 | 11% |
| Total | 567 | 784 | 60 | 1,411 | 100% | 572 | 833 | 94 | 1,499 | 100% |
(£ millions, except percentages)
Possession balances represent loans against which Nationwide has taken ownership of properties pending their sale. Possession is only enforced once all other recovery options have been exhausted. This is reflected in the Group's possession rate which is approximately half of the market average.
When a customer emerges from financial difficulty, we offer the ability to capitalize arrears, resulting in the account being repaired. £118 million of loans that would otherwise be past due or impaired have had their arrears capitalized in the year ended April 4, 2012 (year ended April 4, 2011: £127 million). Customers are only permitted to capitalize arrears where they have demonstrated their ability to meet a repayment schedule at normal commercial terms for a continuous six month period or by over paying such that six months full payments are made over a four month period. During the year ended April 4, 2012, 546 accounts (April 4, 2011: 785 accounts) had an arrears capitalization. Once capitalized the loans are categorized as not impaired as long as contractual repayments are maintained. Capitalized accounts have a higher than average propensity to roll into arrears and this is recognized within the Group's provisioning methodology.
Customers who are unable to repay their capital at term expiry may be offered a term extension. These extensions are typically on a capital and interest basis over a relatively short term, normally less than five years, and aim to recover the outstanding balance as quickly as possible while ensuring the monthly payment remains manageable to the customer. During the year ended April 4, 2012, 2,417 accounts (April 4, 2011: 1,739 accounts) had an extension at term expiry. No provisioning methodology adjustment is made for these accounts as a result of the low balance and LTV profile.
Changes in terms relate to a concession or permanent change, which results in amended monthly cash flows. The options available include payment holidays, interest only conversions and term extensions.
Performing customers with loans on standard terms and conditions effective before March 2010, who are not experiencing financial difficulty and meet required criteria (including credit score), are permitted to apply for a payment holiday and make reduced or nil payments for an agreed period of time of up to 12 months (depending on reason). As at April 4, 2012, 1,848 accounts (April 4, 2011: 2,313 accounts) were subject to a payment holiday. The performance of customers who have taken a payment holiday is reflected within our provisioning methodology.
Interest only conversions allow performing customers meeting required criteria to apply for an interest only conversion, normally reducing their monthly commitment. Our policy has progressively tightened during the year ended April 4, 2012, with LTV initially capped at 75% in April 2011, following which repayment vehicle options were restricted to sale of residence only (minimum £150,000 equity and maximum LTV 66%) in July 2011. This facility was completely withdrawn in March 2012. During the year ended April 4, 2012, 7,083 accounts (April 4, 2011: 8,442 accounts) converted to interest only. The performance of interest only conversions is in line with that of the wider portfolio and therefore no adjustment is made to our provisioning methodology for these loans.
We allow performing customers to apply to extend the term of their mortgage. During the year ended April 4, 2012, 15,032 accounts (April 4, 2011: 13,964 accounts) extended their term. The performance of term extensions is in line with that of the wider portfolio and therefore no adjustment is made to our provisioning methodology for these loans.
The only forbearance option which we offer customers in financial distress is an interest only concession. Interest only concessions are offered to customers on a temporary basis with formal periodic review. The concession allows the customer to reduce monthly payments to cover interest only, typically for six months, and if made, the arrears status of the account will not increase, remaining as at the beginning of the concession. As at April 4, 2012, 2,474 accounts (April 4, 2011: 2,802 accounts) representing 0.2% (April 4, 2011: 0.3%) of total prime mortgage balances were on this concession. The Group's provisioning methodology was adjusted during the year ended April 4, 2012 to reflect latest performance on these accounts.
The provision methodology recognizes previous arrears as a driver of future default; therefore, capitalized accounts typically attract a higher provision than the rest of the not impaired portfolio for the 12 months following capitalization. The underlying performance of interest only concessions and payment holidays are also reflected in the provisioning methodology. For within term extensions, subsequent arrears performance is significantly better than for other concessions and therefore no specific provision is applied. Similarly, a provisions adjustment is not applied for end of term extensions which tend to be of limited exposure.
The following table presents collateral held against past due or impaired retail residential mortgages:
| As at April 4, 2012 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Prime lending |
Specialist lending |
||||||||
| (£ million, except percentages) | |||||||||||
| Past due but not impaired | 1,867 | 100% | 1,172 | 99% | 1,928 | 100% | 1,334 | 99% | |||
| Impaired | 532 | 99% | 595 | 96% | 535 | 99% | 676 | 96% | |||
| Possessions | 29 | 96% | 138 | 83% | 31 | 94% | 116 | 89% | |||
| Total | 2,428 | 100% | 1,905 | 97% | 2,494 | 100% | 2,126 | 97% |
Collateral held in relation to secured loans that are either past due or impaired is capped at the amount outstanding on an individual loan basis. The percentages in the table above represent the cover over the impaired asset.
The following table presents negative equity on residential mortgages:
| As at April 4, 2012 | As at April 4, 2011 | ||||
|---|---|---|---|---|---|
| Prime lending | Specialist lending |
Prime lending |
Specialist lending |
||
| (£ million) | |||||
| Past due but not impaired | 6 | 17 | 6 | 14 | |
| Impaired | 5 | 22 | 4 | 27 | |
| Possessions | 1 | 29 | 2 | 14 | |
| Total | 12 | 68 | 12 | 55 |
Commercial lending comprises loans secured on commercial property, loans to Registered Social Landlords and loans advanced under PFIs. Our commercial lending portfolio of £21.5 billion (April 4, 2011: £22.0 billion) consists of £20.4 billion (April 4, 2011: £20.8 billion) of self originated lending and £1.1 billion (April 4, 2011: £1.2 billion) of assets acquired from the Derbyshire, Cheshire and Dunfermline building societies. Our originated portfolio comprises £11.2 billion secured on commercial property (Property Finance), £7.7 billion advanced to Registered Social Landlords and £1.5 billion advanced under Project Finance (principally via PFIs). Our Property Finance portfolio is diverse both in terms of sectors and geographic spread.
On self originated lending we have only modest exposure to development finance, with total balances of £142 million (April 4, 2011: £172 million). The non-UK element of our commercial property portfolio of £1.0 billion as at April 4, 2012 (April 4, 2011: £1.1 billion) does not contain any exposure to Greece, Italy, Portugal or Spain and only a single exposure to Ireland.
The number of Nationwide originated commercial property cases more than three months in arrears decreased from 235 cases at April 4, 2011 to 210 cases at April 4, 2012. This equates to 2.33% of commercial originated accounts (April 4, 2011: 2.41%). Total arrears balances on these cases as at April 4, 2012 were £59 million (April 4, 2011: £48 million) reflecting the recessionary market conditions. Robust arrears management continues to focus on close and proactive management of arrears and loan maturities and there are currently no arrears of three months or more on the Registered Social Landlord or PFI portfolios.
Economic uncertainty, ongoing funding pressures across the banking sector and a trend towards higher regulatory capital requirements for Commercial Real Estate ("CRE") lending have significantly reduced the availability of credit for refinance within the sector. Furthermore, current depressed property values mean that foreclosure on loans which are operating outside the original terms of their advance is unlikely to provide the best economic outcome, except in those cases where ongoing serviceability is unachievable and/or the prospects of any recovery in cashflow performance or capital value is unlikely. Our strategy remains one of prudent loss mitigation over the medium term in a market which is both cyclical and currently experiencing extremely low investor demand. We make refinancing available for existing exposures where we are satisfied that we continue to have a constructive relationship with the borrower which recognizes our interests, and can achieve a level of expected return which reflects current funding costs or where there is a realistic likelihood that recovery over the medium term in the hands of the borrower represents a better prospect than short term disposal. To the extent this strategy leads to forbearance on loans which are renewed at 'off-market' interest rates or where the most likely outcome remains an ultimate financial loss, then impairment provisions are recognized in accordance with relevant accounting requirements.
Commercial mortgage assets totaling £1 billion as at April 4, 2012 acquired through mergers with Cheshire and Derbyshire have been fair valued in the same way as described for residential assets above, including a credit risk adjustment of £179 million for expected losses over the remaining life of the loans. To date, £19 million of additional provisions have been raised on individually assessed cases that have an impairment provision requirement in excess of the original fair value adjustment. In most cases, however, the credit risk adjustment exceeds the current impairment provision requirement. The acquisition of the Dunfermline's social housing portfolio was similarly fair valued and has seen no credit losses to date.
Other lending as at April 4, 2012 includes £262 million (April 4, 2011: £241 million) of secured lending relating to a European commercial loan portfolio and a loan secured by a senior ABS reference portfolio, and unsecured lending of £231 million (April 4, 2011: £251 million) relating to a student loan portfolio. These investments were acquired by the Treasury Division and are therefore held within the Head Office functions business segment.
The tables below provide further information on commercial and other lending operations by payments due status:
| As at April 4, 2012 | As at April 4, 2011 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | Other operations |
Commercial | Other operations |
|||||
| (£ billion, except percentages) | ||||||||
| Neither past due nor impaired | 19.1 | 89% | 0.4 | 91% | 20.2 | 92% | 481 | 98% |
| Past due up to 3 months but not impaired | 0.7 | 3% | 0.0 | 1% | 0.4 | 2% | 4 | 1% |
| Impaired | 1.8 | 8% | 0.1 | 8% | 1.4 | 6% | 7 | 1% |
| Total | 21.5 | 100% | 0.5 | 100% | 22.0 | 100% | 492 | 100% |
The status 'past due up to three months but not impaired' includes any asset where a payment due under strict contractual terms is received late or missed. The amount included is the entire financial asset rather than just the payment overdue.
Loans in the analysis above which are less than three months past due have collective impairment allowances set aside to cover credit losses. The analysis includes commercial mortgage assets totaling £1.1 billion as at April 4, 2012 (April 4, 2011: £1.2 billion) acquired through the acquisitions of the Derbyshire, Cheshire and Dunfermline building societies. These loans were fair valued on a basis that made allowances for anticipated losses over the life of the loans. Impaired loans totaling £138 million as at April 4, 2012 (April 4, 2011: £141 million) in the above analysis have been fair valued in this way and are therefore unlikely to contribute any significant further losses to the Group.
The £41 million as at April 4, 2012 (April 4, 2011: £52 million) of impaired balances in other operations includes £30 million (April 4, 2011: £41 million) relating to a European commercial loan portfolio and £11 million (April 4, 2011: £11 million) relating to the unsecured student loan portfolio.
Impaired commercial and other lending operations assets are further analyzed as follows:
| As at April 4, 2012 | As at April 4, 2011 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | Other operations |
Commercial | Other operations | |||||
| (£ million, except percentages) | ||||||||
| Impaired status: | ||||||||
| Past due 0 to 3 months | 836 | 47% | - | - | 695 | 49% | - | - |
| Past due 3 to 6 months | 139 | 8% | 1 | 2% | 111 | 8% | 1 | 14% |
| Past due 6 to 12 months | 295 | 17% | 2 | 5% | 235 | 16% | 3 | 43% |
| Past due over 12 months | 487 | 28% | 38 | 93% | 378 | 27% | 3 | 43% |
| Possessions | 1 | - | - | - | 1 | - | - | - |
| Total | 1,758 | 100% | 41 | 100% | 1,420 | 100% | 7 | 100% |
Commercial assets totaling £1,450 million as at April 4, 2012 (April 4, 2011: £1,152 million) not subject to fair value adjustments have individual provisions against them. Possession balances represent loans against which Nationwide has taken ownership of properties pending their sale. Assets over which possession has been taken are realized in an orderly manner via open market or auction sales to derive the maximum benefit for all interested parties, and any surplus proceeds are distributed in accordance with the relevant insolvency regulations. The Group does not normally occupy repossessed properties for its business use or use assets obtained in its operations.
The following table presents collateral held against past due or impaired commercial loans:
| As at April 4, | |||||||
|---|---|---|---|---|---|---|---|
| 2012 | 2011 | ||||||
| (£ million, except percentages) | |||||||
| Past due but not impaired | 631 | 94% | 363 | 93% | |||
| Impaired | 1,157 | 66% | 1,050 | 74% | |||
| Total | 1,788 | 74% | 1,413 | 78% |
Collateral held in relation to secured loans that are either past due or impaired is capped at the amount outstanding on an individual loan basis. The percentages in the table above represent the cover over the impaired asset. No collateral is held against the commercial property held in possession.
The following table presents negative equity on commercial and other operations loans:
| As at April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ million) | ||
| Past due but not impaired | 38 | 28 |
| Impaired | 600 | 369 |
| Possessions | - | 1 |
| Total | 638 | 398 |
|---|---|---|
In consumer banking, the balance of accounts more than 30 days in arrears has shown an improvement across all products. The following table presents the percentage of FlexAccounts, personal loans and credit card accounts more than 30 days in arrears:
| As at April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| % | ||
| FlexAccount | 9.18 | 10.46 |
| Personal loans | 3.14 | 5.45 |
| Credit Cards | 2.72 | 3.36 |
Unsecured customers have limited forbearance options. Credit card customers experiencing financial distress may agree to a payment plan, which is typically less than the minimum payment. Additionally, credit card and personal loan customers who have maintained the required payment performance over a sustained period may receive extensions on payments. The volume of payment plans and extensions is low and therefore no specific treatment is made within our provisioning methodology.
The following section summarizes our direct exposure to institutions, corporates and other issued securities domiciled in the peripheral eurozone countries. The exposures are shown at their balance sheet carrying values.
| As at April 4, 2012 | ||||||
|---|---|---|---|---|---|---|
| Greece | Ireland | Italy | Portugal | Spain | Total | |
| £m | £m | £m | £m | £m | £m | |
| Mortgage backed securities | - | 134 | 105 | 39 | 348 | 626 |
| Covered bonds | - | 71 | - | 17 | 334 | 422 |
| Senior debt | - | 31 | 36 | - | 96 | 163 |
| Other assets | 1 | - | 6 | - | 4 | 11 |
| Other corporate | - | 8 | 3 | - | - | 11 |
| Total | 1 | 244 | 150 | 56 | 782 | 1,233 |
| As at April 4, 2011 | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Greece | Ireland | Italy | Portugal | Spain | Total | ||||
| £m | £m | £m | £m | £m | £m | ||||
| Mortgage backed securities | - | 155 | 149 | 64 | 442 | 810 | |||
| Covered bonds | - | 63 | - | 19 | 373 | 455 | |||
| Senior debt | - | 98 | 117 | 63 | 485 | 763 | |||
| Subordinated bonds | - | - | 11 | 17 | - | 28 | |||
| Other assets | 3 | - | 12 | - | 6 | 21 | |||
| Other corporate | - | 8 | 4 | - | 2 | 14 |
| Total | 3 | 324 | 293 | 163 | 1,308 | 2,091 |
|---|---|---|---|---|---|---|
Since April 4, 2012, the £163 million senior debt exposures above have further decreased by £82 million of Spanish, £31 million of Irish and £12 million of Italian senior debt which have been repaid.
Movements in our exposure to peripheral eurozone countries since April 4, 2011 relate to disposals, maturities and fair value movements and there has been no new investment in the year.
We have further indirect exposure to peripheral eurozone countries as a result of a €100 million loan to a Luxembourg SPV, which has first loss exposure to a €2.1 billion portfolio of senior ranking European ABS assets. The sterling equivalent as at April 4, 2012 is £82.7 million (April 4, 2011: £88.7 million). The geographical breakdown of this portfolio is as follows: UK 51%, Germany 16%, Spain 14%, Italy 8%, Netherlands 6%, Greece 3% and Portugal 2% (April 4, 2011: UK 50%, Germany 15%, Spain 15%, Italy 9%, Netherlands 6%, Greece 3% and Portugal 2%).
In addition, our exposure in respect of other non-UK countries is shown below at their balance sheet carrying value.
| As at April 4, 2012 | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Belgium | France | Germany | Netherlands | USA | Other | Total | |||
| £m | £m | £m | £m | £m | £m | £m | |||
| Government bonds | - | - | 169 | 1,049 | 1,104 | 75 | 2,397 | ||
| Mortgage-backed securities |
41 | 34 | 114 | 239 | 110 | 147 | 685 | ||
| Covered bonds | - | - | 84 | 45 | 26 | 82 | 237 | ||
| Senior debt | 3 | 118 | 100 | 125 | 205 | 332 | 883 | ||
| Loans and advances to banks |
- | 127 | 41 | - | 490 | 766 | 1,424 | ||
| Other assets | - | - | 35 | - | 1,335 | 1,441 | 2,811 | ||
| Other corporate | - | 46 | 984 | 25 | 28 | 21 | 1,104 | ||
| Total | 44 | 325 | 1,527 | 1,483 | 3,298 | 2,864 | 9,541 |
| As at April 4, 2011 | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Belgium | France | Germany | Netherlands | USA | Other | Total | |||
| £m | £m | £m | £m | £m | £m | £m | |||
| Government bonds | - | - | 568 | 686 | 867 | 47 | 2,168 | ||
| Mortgage-backed securities |
42 | 44 | 149 | 258 | 117 | 144 | 754 | ||
| Covered bonds | - | - | 128 | 60 | 27 | 92 | 307 | ||
| Senior debt | 74 | 202 | 179 | 246 | 393 | 615 | 1,709 | ||
| Loans and advances to banks |
- | 547 | 93 | - | 893 | 866 | 2,399 | ||
| Other assets | - | 9 | 11 | 76 | 1,495 | 1,767 | 3,358 | ||
| Other corporate | 2 | 58 | 1,053 | 47 | 26 | 27 | 1,213 | ||
| Total | 118 | 860 | 2,181 | 1,373 | 3,818 | 3,558 | 11,908 |
______________
(1) The 'Other' column represents exposures to the following countries at April 4, 2012: Australia £290 million (April 4, 2011: £423 million), Austria £nil (April 4, 2011: £7 million), Canada £532 million (April 4, 2011: £383 million), Denmark £24 million (April 4, 2011: £44 million), Finland £126 million (April 4, 2011: £123 million), Iceland £6 million (April 4, 2011: £6 million), Luxembourg £7 million (April 4, 2011: £8 million), Norway £36 million (April 4, 2011: £70 million), Sweden £4 million (April 4, 2011: £38 million), Switzerland £410 million (April 4, 2011: £701 million) and supranationals £1,429 million (April 4, 2011: £1,755 million).
We classify our business streams as follows:
Commercial lending
During the year ended April 4, 2012, we revised the methodology for allocating the benefit of free capital between segments to align it more closely with regulatory capital requirements across business segments. Comparatives have been reclassified to be presented on a basis which is consistent with the current year's presentation.
The contribution to underlying profit before tax by each of these business streams is set out in the table below:
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Retail | 529 | 464 |
| Commercial | (196) | (129) |
| Head office functions | (29) | (59) |
| Underlying profit before tax | 304 | 276 |
| FSCS levies | (59) | (50) |
| Restructuring costs | (61) | (29) |
| Bank levy | (16) | - |
| Movements on derivatives and hedge accounting | 35 | 120 |
| Statutory profit before tax | 203 | 317 |
| For the year ended April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Net interest | 1,470 | 1,378 | |
| Other income | 502 | 381 | |
| Total income | 1,972 | 1,759 | |
| Expenses | (1,201) | (1,109) | |
| Impairment and other provisions | (242) | (186) | |
| Underlying profit before tax | 529 | 464 |
The Retail business made an underlying profit of £529 million in the year ended April 4, 2012, an increase of 14% compared with £464 million in the year ended April 4, 2011. We have a strong franchise, and our retail products have continued to perform well against a challenging backdrop. Total income increased by 12% from £1,759 million in the year ended April 4, 2011 to £1,972 million in the year ended April 4, 2012, driven by £121 million growth in other income and £92 million from net interest income.
Net interest income includes an additional £70 million from an update of our effective interest rate assumptions to reflect our latest mortgage profile expectations. Strong growth in other income from current accounts, investments and general insurance has been achieved during the year ended April 4, 2012 as a result of volume growth across the product range in line with our strategy of income diversification. Other income growth also includes a £96 million gain on acquisition of a high quality, prime residential mortgage portfolio. The growth in net interest income for the year ended April 4, 2012 of £92 million to £1,470 million as compared to £1,378 million in the year ended April 4, 2011 is in part due to growth in new lending on prime residential mortgages, buy to let mortgages and personal loans and includes the positive impact of asset repricing as mortgage customers revert to BMR or our SMR, or opt to take a new mortgage product as historically low fixed and tracker rate deals written in 2006-2007 mature.
Margins on new mortgage lending have increased in the second half of the year ended April 4, 2012 as additional funding and liquidity costs across the industry continue to impact the cost of credit. This has been partially offset by higher funding costs as savers look for higher returns in a low base rate environment and funds transfer pricing reflects continued stress in wholesale markets, which was particularly evident in the period up to the end of 2011 when action by the European Central Bank substantially eased conditions. Our strategy of income diversification has supported further growth in personal loan lending and has contributed an additional £38 million to net interest income in the year ended April 4, 2012. Expenses increased from £1,109 million in the year ended April 4, 2011 to £1,201 million in the year ended April 4, 2012, reflecting higher volume related costs and refined overhead allocation.
The impairment and other provisions charge of £242 million in the year ended April 4, 2012 represents a residential impairment charge of £70 million (April 4, 2011: £101 million), a charge in relation to consumer banking of £69 million (April 4, 2011: £83 million), and a provision of £103 million (April 4, 2011: £16 million) in connection with PPI. In addition, the prior year included a provision release of £14 million for customer bonus schemes which was no longer required. The high quality of our mortgage portfolio is a continuing strength in an environment of housing market uncertainty.
Prime residential gross lending was £14.0 billion in the year ended April 4, 2012 (April 4, 2011: £9.8 billion) representing an increase of 42.9% which was delivered through a significant increase in competitiveness across the entire mortgage product range. In addition we acquired a £1.2 billion portfolio of high quality, prime residential loans during the year ended April 4, 2012.
The majority of the increased lending was at lower LTVs, maintaining our prudent approach to lending, while ensuring that we continued to support those customers with smaller deposits (largely first time buyers). The average LTV on our prime residential lending was 61.1% during the year ended April 4, 2012 (April 4, 2011: 65.4%).
Existing mortgage customers have benefited from the low interest rate environment, with £3.1 billion of balances switching to another mortgage product and £11.7 billion reverting onto our BMR rate at the end of their mortgage deal. We continue to offer the 'Switch and Fix' option, allowing members to move from a tracker product to a fixed rate product during the deal term, without incurring exit fees.
Our BMR balances increased to £51.6 billion by the end of the year ended April 4, 2012. Despite the low rate, which is capped at 2% above BoE base rate, £4.1 billion of redemptions in the year have come from the BMR book. We do not expect total BMR balances to grow significantly beyond their current level and forecasts indicate they will decline steadily from the middle of 2013 onwards.
Gross lending on buy to let mortgages was £4.4 billion in the year ended April 4, 2012 (April 4, 2011: £3.0 billion). As the demand for good quality rental property has risen, the buy to let sector has continued to perform strongly. We have played an active role in supporting this sector through our subsidiary, TMW, which continues to focus on originating high quality buy to let loans. The average LTV for new specialist business has been 68.0% in the year.
Strong retention within the specialist lending portfolio resulted in net lending of £2.8 billion in the year ended April 4, 2012 (April 4, 2011: £1.6 billion). Profitability of the specialist portfolio has improved during the year ended April 4, 2012 as a result of favorable margins on new business lending and higher maturities on the subsequent variable rate. The overall specialist lending book has grown to £23.2 billion as at April 4, 2012 (April 4, 2011: £20.3 billion), with arrears levels performing well in a low interest rate environment and a sector exhibiting strong demand.
We are primarily a retail funded organization. The low rate environment continues to make this a challenging time for savers, but we have responded positively through the year by continuing to refresh our product range. As a result we have continued to attract significant inflows, with net receipts of £1.0 billion in the year ended April 4, 2012 (April 4, 2011: £0.6 billion). Over the year ended April 4, 2012, our savings balances grew by £3.1 billion, a market share of 7.7% according to Nationwide estimates.
Growth in our consumer banking portfolio remains central to our strategic ambitions of diversifying our income and maintaining our challenger brand status. During the year, we opened 359,000 new current accounts, 357,000 new credit cards and advanced 112,000 new personal loans. Our current account base stands at 4.9 million accounts as at April 4, 2012, while our credit card account base is 1.7 million with 2.2 million cards in issue.
Our protection and investment business and general insurance business have also performed ahead of both performance in the year ended April 4, 2011 and expectations. During the year ended April 4, 2012, we sold approximately 63,000 protection plans and 178,000 investment products, and as at March 2012 we had £6.7 billion assets under advice (2011: £5.1 billion). Despite the ongoing challenges in the housing market we sold 455,000 new household insurance covers in the year ended April 4, 2012 and our general insurance book stands at just over 2 million covers. Other income from investments grew by 19% in the year and general insurance by 16%, reflecting the success of our ongoing diversification strategy.
| For the year ended April 4, | ||
|---|---|---|
| 2012 | 2011 | |
| (£ millions) | ||
| Net interest | 71 | 58 |
| Other income | 18 | 20 |
| Total income | 89 | 78 |
| Expenses | (38) | (32) |
| Impairment and other provisions | (247) | (175) |
| Underlying loss before tax | (196) | (129) |
|---|---|---|
| ---------------------------- | ------- | ------- |
The commercial lending portfolio of £21.5 billion as at April 4, 2012 (April 4, 2011: £22.0 billion) comprises £11.6 billion (April 4, 2011: £12.3 billion) secured on commercial property (property finance), £8.4 billion (April 4, 2011: £8.2 billion) advanced to Registered Social Landlords and £1.5 billion (April 4, 2011: £1.5 billion) provided to project finance.
The Registered Social Landlord and project finance portfolios have not experienced any losses and there are no arrears as at April 4, 2012. Both of these books are still deemed to be low credit risk due to the involvement of Government in regulating Registered Social Landlords and providing secure income streams to Government-backed project finance (primarily PFI) projects
The Commercial business incurred a £196 million loss in the year ended April 4, 2012 (April 4, 2011: £129 million loss) as improved income levels were more than offset by a higher than anticipated impairment charge in the second half of the year ended April 4, 2012. Commercial lending income improved in the year ended April 4, 2012 to £89 million from £78 million in the year ended April 4, 2011 due to a continuing widening of customer margins as a result of the upward repricing of maturing loans and restructures agreed with existing borrowers.
The cautious stance which we outlined at the end of the first half of the year ended April 4, 2012 proved to be well founded, as UK commercial property market conditions remained extremely challenging in the second half of the year ended April 4, 2012, with refinancing prospects diminishing further as banks withdrew from lending. Capital values on secondary properties also continued to drift downwards and the investment market saw a slowing in transaction levels as a result of weak demand.
Commercial loan impairments were £247 million as at April 4, 2012 (April 4, 2011: £175 million) representing an increase of 41%, driven by a return to recessionary conditions in the UK and widespread eurozone concerns, both undermining investor confidence and appetite for the sector. In consequence, after some recovery during the year ended April 4, 2011, the market is now experiencing falls in commercial real estate valuations with an expectation that, while not severe, this trend will persist at least throughout 2012. The increased impairment in the year has been largely attributable to new and additional provisions on existing watch list cases where valuations have been further eroded or the commitment of equity providers to further investment has been withdrawn. In addition, we have reflected a more negative outlook for commercial property over the next 12 months with an increase of approximately £23 million in our collective provision, which accounts for approximately 32% of the year on year increase in the impairment charge.
We continue to adopt a cautious and proactive approach to commercial property exposures until there is clear evidence of market stability returning. In line with our views at the six month period ended September 30, 2011, while prime commercial property capital values increased 0.9% over the year ended April 4, 2012, during the second half of the year ended April 4, 2012 the market began to slow with prime capital values showing small declines from November 2011 onwards (Source: Investment Property Databank, March 2012). Investment transactions for 2011 were below the levels seen in 2010, and showed year on year reductions in the early months of 2012 (Source: Property Data, April 2012). These developments mean that the outlook outside London and for secondary property is more challenging than ever and when added to ongoing concerns about the UK and eurozone economies, suggests that the outlook for the UK commercial property market remains uncertain. Forecasts for the year ended April 4, 2013 envisage modest falls in capital values across the sectors with the exclusion of the prime London market, and secondary office and retail space is acknowledged as a particular concern.
The number of Nationwide-originated cases three or more months in arrears is 210 as at April 4, 2012 (April 4, 2011: 235) with total arrears balances on these cases of £59 million (April 4, 2011: £48 million). Robust arrears management is carried out by dedicated teams who, supported by daily arrears reporting, maintain a focus on early intervention to maximize economic value and mitigate losses. Tenant failure is a key driver of arrears, and we have seen a number of high profile failures in the retail sector in the second half of the year ended April 4, 2012. The impact of these has been assessed and while they weaken the cashflow on the loans affected, our current assessment is that our exposure to these names is not expected to result in any material provisioning requirement.
As a result of economic challenges, we withdrew from new commercial property lending in September 2011. During the financial year ended April 4, 2012, gross commercial property lending was £719 million, with total gross lending on the whole book of £1.7 billion. Gross commercial property lending was more than offset by higher than expected capital repayments and redemptions resulting in the commercial property book decreasing in size by £737 million in the year ended April 4, 2012 and the total book decreasing by £523 million. Our strategy for the commercial real estate portfolio is to continue to reduce our overall exposure over time.
The Commercial business has been pursuing a policy of non-core asset divestment for some time. The subordinated debt book has further reduced this year following a number of sales, leaving a Nationwide-originated and Cheshire Building Society legacy subordinated portfolio of £127 million as at April 4, 2012. Also, as a result of a successful sale in December 2011, one of the Society's three development loans was repaid in full with the remaining Nationwide originated development book now limited to two exposures totaling £142 million, both performing.
The non-UK book, at £1.0 billion at April 4, 2012, has seen a reduction of £0.1 billion since April 4, 2011 and consists predominantly of lending to Germany (95%) with no exposure to Greece, Spain, Portugal or Italy and only a single exposure to Ireland.
To support asset divestment our recoveries team has successfully sold 160 properties in the last twelve months with a value of £81 million and their focus on asset realization continues.
As our Nationwide-originated property finance book has 37% of its loans scheduled to mature by the end of 2013, our loan maturity process is focused on early dialogue and/or intervention to ensure effective loss mitigation and income generation. Our strategy to help existing borrowers includes restructuring and/or refinancing those cases which are capable of maintaining serviceability, and during the year £0.4 billion of loans have been restructured and/or refinanced in this way, underpinning the significant improvements seen in income.
Having entered the business savings market during the second half of the year ended April 4, 2011, with a relatively limited product range available only to our existing customers, in March 2012 we launched a national marketing campaign to the wider business savings market. Our improved business savings product range now includes a number of new products aimed at different segments of the market all with market leading rates.
To further diversify our commercial business, we also began developing plans to enter the SME business banking market. This market sector has been identified as an area which offers a good strategic fit given our strong Group franchise, broad distribution network and current exposure to both the retail personal financial services market and existing commercial lending activities. Launch will not take place for some time and will be subject to prevailing market conditions.
| For the year ended April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ millions) | |||
| Net interest | 82 | 100 | |
| Other income | - | 10 | |
| Total income | 82 | 110 | |
| Expenses | (69) | (103) | |
| Impairment and other provisions | (42) | (66) | |
| Underlying loss before tax | (29) | (59) |
Head office functions reported an underlying loss before tax of £29 million at April 4, 2012 (April 4, 2011: £59 million loss). Total income was 25% lower than the prior year, reflecting the higher cost of wholesale funding, partly offset by higher gains from the management of the liquidity portfolio. Administrative expenses have fallen, reflecting lower corporate costs.
Impairment and other provisions of £42 million relates to impairment losses on treasury investments of £38 million as at April 4, 2012 (April 4, 2011: £66 million) and a £4 million charge (April 4, 2011: £nil) for other lending in connection with investments acquired by the Treasury Division.
The Society has a strong and well diversified funding base, which continues to be predominantly comprised of retail savings. Over the course of the financial year ended April 4, 2012, we have continued to actively manage our balance sheet in response to conditions in both the retail and wholesale markets.
As a building society, we have always maintained a high level of unencumbered liquid assets relative to our banking peers, and our core liquidity remains stable at 13.7% (April 4, 2011: 13.8%). The size of our liquidity buffer, in combination with the improving profile of the wholesale funding portfolio, has continued to improve the Group's overall liquidity position.
Liquidity represents a key area of risk management for financial institutions. In recent years there has been an increased focus on liquidity from the regulatory authorities. Having successfully met the timeframes for compliance with new regulatory requirements, the Group continues to enhance and strengthen its liquidity management systems and approach.
We have a comprehensive Liquidity Risk Management Framework for managing the Group's liquidity risk. Stress tests applied under this Framework consider a range of possible wholesale and retail factors leading to loss of financing. Since June 2010, we have reported our liquidity position against backstop Individual Liquidity Guidance ("ILG") provided by the FSA. Calibration of the Group's Liquidity Risk Management Framework anticipated the final FSA rules and is therefore broadly consistent with current FSA standards.
In December 2010, the Basel Committee on Banking Supervision issued its proposals for liquidity risk management, standards and monitoring. These included a short term liquidity stress metric, the Liquidity Coverage Ratio ("LCR"), and a longer term liquidity metric, the Net Stable Funding Ratio ("NSFR"). These proposals are subject to ongoing refinement and have not yet been enacted into UK or European law. We monitor compliance against these internal metrics, and as at April 4, 2012 the LCR was estimated at 124% and the NSFR at 118% against proposed regulatory requirements of 100%. Estimations are made using our interpretation of the draft directive, which has yet to be incorporated into the European and UK regulatory framework and therefore remains subject to change.
Liquid assets generally comprise cash deposits held with Central Banks or unencumbered securities that may be freely sold or are capable of financing through repurchase ('repo') agreements or other similar arrangements, either direct with those Central Banks to which we have access, or with market counterparties. The stock of liquid assets managed by Nationwide's Treasury division fall into the following four categories:
We have continued to focus on the growth and diversification of our core liquidity portfolio through investing in a greater volume of highly liquid sovereign securities. The core portfolio is aligned to the 'Liquid Assets Buffer' defined by the FSA in BIPRU 12 and comprises:
In line with other major UK institutions, the Group made use of the BoE SLS facility at the height of the market dislocation in 2008. As at April 4, 2012 we had substantially repaid our SLS drawings.
As at April 4, 2012, the core liquidity portfolio as a percentage of adjusted share, deposit and loan liabilities was 13.7% (April 4, 2011: 13.8%). This calculation is made net of any core liquidity holdings that are subject to repo arrangements and includes assets held under reverse repo arrangements.
In addition to the core portfolio, as at April 4, 2012, we held a stock of unencumbered securities that are eligible for use in the funding operations of those central banks that we have access to. This figure does not include the value of self issue securities that could also be included in some central bank operations. In terms of their relative liquidity characteristics, these assets may be viewed as the next tier below the core liquidity portfolio.
Nationwide holds other third party liquid assets (such as Floating Rate Notes) that are not eligible at either the BoE's or the ECB's operations but may be capable of financing through third party repo agreements.
The Group holds, undrawn, a total of £16.3 billion (2011: £18.3 billion) of AAA-rated bonds issued under our asset-backed funding programs. These self-issued bonds represent eligible collateral for use in repurchase agreements with third parties or in central bank operations.
The table below sets out the fair value – before any 'haircut' deduction – of each of the above liquidity types as at April 4, 2012. The table includes off balance sheet liquidity (including self issued RMBS and covered bonds) but excludes any encumbered assets:
| As at April 4, | |||
|---|---|---|---|
| 2012 | 2011 | ||
| (£ billion) | |||
| Core liquidity | 24.5 | 23.5 | |
| Other central bank eligible assets | 2.5 | 5.6 | |
| Other securities | 4.0 | 3.2 | |
| Self-issued RMBS and covered bonds | 16.3 | 18.3 | |
| Total | 47.3 | 50.6 |
An analysis of the Group's wholesale funding (made up of deposits from banks, other deposits and debt securities in issue as disclosed on the balance sheet) is set out in the table below:
| As at April 4, | ||||||
|---|---|---|---|---|---|---|
| 2012 | 2011 | |||||
| (£ billion, except percentages) | ||||||
| Repo and other secured agreements | 3.7 | 7.5% | 2.7 | 5.8% | ||
| Deposits, including PEB balances | 7.8 | 15.9% | 7.2 | 15.5% | ||
| Certificates of deposit | 4.3 | 8.7% | 4.7 | 10.2% | ||
| Commercial paper | 3.7 | 7.5% | 6.2 | 13.3% | ||
| Covered bonds | 13.0 | 26.5% | 12.3 | 26.5% | ||
| Medium term notes | 7.1 | 14.5% | 8.4 | 18.1% | ||
| Securitizations | 7.4 | 15.1% | 3.7 | 8.0% | ||
| Other non-retail | 2.1 | 4.3% | 1.2 | 2.6% | ||
| Total | 49.1 | 100.0% | 46.4 | 100.0% |
We have received new investment premiums of £0.8 billion into protected equity bonds ("PEBs") during the year, increasing total PEB balances to £2.9 billion as at April 4, 2012 (April 4, 2011: £2.1 billion).
During the year ended April 4, 2012, we remained active in the long term markets, utilizing all our platforms to issue a total of £7.9 billion sterling equivalent which was significantly in excess of our maturities of £3.5 billion.
The following public transactions issued during the year ended April 4, 2012 demonstrate the strength of institutional support as well as the breadth of funding available to Nationwide:
€1.5 billion 5 year covered bond issued in October 2011;
In addition to the public transactions, a combined total of £1.3 billion private placements were issued to institutional investors during the year in both secured and unsecured formats. These issuances had durations ranging from 12 months to 21 years and had a weighted average life of over 13 years.
During the year, SLS drawings were fully repaid well ahead of both our contractual commitments and our bilateral agreements with the BoE. In addition we repaid £1.5 billion of Credit Guarantee Scheme ("CGS") drawings during the year and have repaid all of our remaining CGS drawings since the year end.
We have reduced the amount of short term funding we hold to £12 billion (April 4, 2011: £15 billion and April 4, 2010: £16 billion) and we have been able to maintain a consistent presence in short term markets during the year. The average term at the point of issuance of outstanding short term balances as at April 4, 2012 was 131 days (April 4, 2011: 156 days).
We have extended the residual maturity profile of our wholesale funding portfolio from 33 months to 37 months and the proportion of funding that is categorized as long term (>1 year to maturity) has increased to 62.7% (April 4, 2011: 56.3%).
The table below sets out the residual maturity of the wholesale funding book as at April 4, 2012:
| As at April 4, | ||||||||
|---|---|---|---|---|---|---|---|---|
| 2012 | 2011 | |||||||
| (£ billion, except percentages) | ||||||||
| Less than one year | 18.3 | 37.3% | 20.3 | 43.3% | ||||
| One to two years | 3.9 | 7.9% | 4.9 | 10.6% | ||||
| Two to five years | 17.6 | 35.8% | 13.6 | 29.5% | ||||
| More than five years | 9.3 | 19.0% | 7.6 | 16.5% | ||||
| Total | 49.1 | 100.0% | 46.4 | 100.0% |
Our short and long term credit ratings from the major rating agencies as at May 22, 2012 are as follows:
| Long Term | Short Term | Subordinated | Date of last rating action(1) |
|
|---|---|---|---|---|
| S&P | A+ | A-1 | BBB+ | December 2011 |
| Moody's | A2 | P-1 | Baa1 | October 2011 |
| Fitch | A+ | F1 | A | February 2012 |
| DBRS | AA (low) | R-1 (middle) | A (high) | March 2012 |
Note:
______________
(1) The outlook for Standard & Poor's, Moody's and DBRS is Stable, outlook for Fitch is Negative.
Treasury liquid assets include cash, loans and advances to banks and investment securities available for sale. These are held in two portfolios. The classification of liquid assets has been modified to better reflect the management of the portfolios and bring the analysis in line with FSA definitions in BIPRU 12. The portfolio is now categorized between core liquidity and non-core. Previously, the same portfolio of assets had been classified between liquidity and investment assets, which reflected the legacy investment strategies.
Core liquidity comprises cash and highly rated debt securities issued by governments or multi-lateral development banks. The non-core portfolio comprises available for sale assets held for investment purposes and clearing amounts. Analysis of each of these portfolios by credit rating and by location of issuer is given below.
Group treasury assets as at April 4, 2012 were £34.3 billion (April 4, 2011: £31.9 billion) and are held in two separate portfolios: the core liquidity portfolio and the non-core portfolio. As at April 4, 2012, the core liquidity portfolio totaled £24.8 billion (April 4, 2011: £18.7 billion) with the non-core liquidity portfolio totaling £9.5 billion (April 4, 2011: £13.2 billion). The £6.1 billion increase in the core liquidity portfolio comprises high quality, predominantly sovereign or government backed assets. The reporting of asset quality within the treasury portfolio has been modified to reflect the management of the portfolios and to bring the analysis in line with FSA definitions as laid out in BIPRU 12.
The following tables show the breakdown of the prudential portfolio as at April 4, 2012 and April 4, 2011 by credit rating and geography:
| As at April 4, 2012 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Credit Rating | Geography | |||||||||
| AAA | AA | A | Other | UK | US | Europe | Other | |||
| (£ billion) | (percentages) | |||||||||
| Cash | 8.1 | 100 | - | - | - | 100 | - | - | - | |
| Gilts | 12.8 | 100 | - | - | - | 100 | - | - | - | |
| Non-domestic government bonds |
2.4 | 54 | 46 | - | - | - | 46 | 54 | - | |
| Supranational bonds | 1.5 | 100 | - | - | - | 9 | 4 | 86 | 1 | |
| Core liquidity portfolio total |
24.8 | 96 | 4 | - | - | 85 | 5 | 10 | - | |
| Loans and advances to banks |
2.9 | - | 23 | 77 | - | 31 | 17 | 17 | 35 | |
| RMBS | 2.1 | 41 | 27 | 23 | 9 | 45 | 4 | 41 | 10 | |
| CMBS | 0.5 | - | 24 | 58 | 18 | 67 | - | 33 | - | |
| Covered bonds | 0.9 | 54 | 23 | 12 | 11 | 28 | 3 | 63 | 6 | |
| Collateralized loan obligations |
0.6 | 6 | 89 | 5 | - | 31 | 69 | - | - | |
| Financial institution bonds |
1.4 | - | 9 | 64 | 27 | 20 | 14 | 50 | 16 | |
| US student loans | 0.7 | 40 | 28 | 22 | 10 | - | 100 | - | - | |
| Other | 0.4 | 32 | 20 | 18 | 30 | 25 | 61 | 14 | - | |
| Non-core portfolio total. | 9.5 | 19 | 27 | 45 | 9 | 32 | 22 | 30 | 16 | |
| Total | 34.3 | 74 | 10 | 13 | 3 | 70 | 10 | 16 | 4 |
| Credit Rating | Geography | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| AAA | AA | A | Other | UK | US | Europe | Other | ||
| (£ billion) | (percentages) | ||||||||
| Cash | 6.1 | 100 | - | - | - | 100 | - | - | - |
| Gilts | 8.6 | 100 | - | - | - | 100 | - | - | - |
| Non-domestic government bonds |
2.2 | 100 | - | - | - | - | 40 | 60 | - |
| Supranational bonds | 1.8 | 100 | - | - | - | - | - | 100 | - |
| Core liquidity portfolio total |
18.7 | 100 | - | - | - | 79 | 5 | 16 | - |
| Loans and advances to banks |
4.2 | - | 38 | 62 | - | 73 | - | 15 | 12 |
| RMBS | 2.8 | 75 | 15 | 5 | 5 | 49 | 4 | 43 | 4 |
| CMBS | 0.6 | 39 | 23 | 16 | 22 | 66 | 14 | 20 | - |
| Covered bonds | 0.7 | 67 | 18 | 8 | 7 | - | 4 | 88 | 8 |
| Collateralized loan obligations |
0.6 | 6 | 82 | 12 | - | 26 | 74 | - | - |
| Financial institution bonds |
3.0 | 11 | 18 | 51 | 20 | 20 | 11 | 56 | 13 |
| US student loans | 0.7 | 68 | 6 | 17 | 9 | - | 100 | - | - |
| Other | 0.6 | 43 | 14 | 13 | 30 | 68 | 28 | 3 | 1 |
| Non-core portfolio total |
13.2 | 31 | 25 | 35 | 9 | 46 | 14 | 32 | 8 |
| Total | 31.9 | 71 | 11 | 15 | 3 | 65 | 9 | 23 | 3 |
As at April 4, 2011
Ratings are obtained from S&P in the majority of cases, or from Moody's if there is no S&P rating available, with internal ratings used if neither is available.
We have continued to manage the treasury asset portfolio to increase the quality and liquidity of the assets with over 72% of the total portfolio held in core liquidity exposures (April 4, 2011: 59%). 97% of the portfolio is rated A or better with 84% rated AA or above (April 4, 2011: 97% rated A or better, 82% rated AA or better).
The portfolio has experienced some negative rating migration as a result of the ongoing implementation of rating agency methodology changes and continued asset quality deterioration, particularly for financial institution subordinated debt and U.S. RMBS. However, the overall credit quality remains strong with only a low level of impairment incurred.
We have no direct sovereign exposure to so-called 'peripheral' eurozone countries (Portugal, Ireland, Italy, Greece and Spain). Within the treasury assets we have £1.2 billion non-sovereign securities issued in these countries as detailed above. Of this 49% is rated AA or above and 70% is rated A or above. This exposure has decreased by 41% in the year and a further nominal £170 million, primarily senior debt, matures in the 12 months. Belgium is also being closely monitored as part of the eurozone watch list, although our outstanding exposure is modest at £44 million as at April 4, 2012.
An independent monthly review is undertaken on the current and expected future performance of all treasury assets. A governance structure exists to identify and review under-performing assets and highlight the likelihood of future losses. In accordance with accounting standards, assets are impaired where there is objective evidence that current events and/or performance will result in a loss.
Nationwide has £75 million of exposure to monoline insured transactions as at April 4, 2012. We are reliant on the monoline insurance provider for one holding (exposure: £2 million), but in all other cases we anticipate full repayment without any assistance from the insurance provider.
Collateral held as security for treasury assets is determined by the nature of the instrument. Loans, debt securities, treasury and other eligible bills are generally unsecured with the exception of asset backed securities and similar instruments, which are secured by pools of financial assets.
In assessing impairment, the Group evaluates, among other factors, the normal volatility in valuation, evidence of deterioration in the financial health of the investee, industry and sector performance and operational and financing cash flows. An impairment loss of £31 million (April 4, 2011: £66 million) has been recognized in the income statement for the year ended April 4, 2012 in respect of the treasury core liquidity and non-core portfolios. In addition, an impairment of £7 million (April 4, 2011: £nil) was recognized for the year ended April 4, 2012 on investments in equity shares.
Out of a total of £34.3 billion of assets held in the core liquidity and non-core portfolios, £23.3 billion are held as available for sale ("AFS") and under IFRS they are marked to market through other comprehensive income and fair value movements are accumulated in reserves. The non-AFS assets are loans to banks or deposits with the BoE. Of the £23.3 billion of AFS assets only £76 million are classified as Level 3 (valuation not based on observable market data) for the purposes of IFRS 7.
The assets have been reviewed based upon the latest performance data and an impairment charge of £31 million has been booked against AFS assets. The fair value movement of AFS assets that are not impaired have no effect on the Group's profit or its regulatory capital.
As at April 4, 2012, the balance on the AFS reserve had improved to £356 million negative, net of tax (April 4, 2011: £487 million negative). The improvement in the AFS reserve reflects the repayment of some of the non-core assets and a gradual pull towards par as the maturity profile of the remaining portfolio shortens. There has also been a strengthening of prices in some asset classes as market sentiment has improved.
The following table shows the breakdown of AFS reserves as at April 4, 2012 and April 4, 2011:
| As at April 4, | ||||
|---|---|---|---|---|
| 2012 | 2011 | |||
| Fair Value on balance sheet |
Cumulative AFS Reserve |
Fair Value on balance sheet |
Cumulative AFS Reserve |
|
| (£ billion) | ||||
| Cash | 8.1 | - | 6.1 | - |
| Gilts | 12.8 | (1.0) | 8.6 | 0.1 |
| Non-domestic government bonds | 2.4 | - | 2.2 | (0.1) |
| Supranational bonds | 1.5 | (0.1) | 1.8 | (0.1) |
| Core liquidity portfolio total | 24.8 | (1.1) | 18.7 | (0.1) |
| Loans and advances to banks | 2.9 | - | 4.2 | - |
| RMBS | 2.1 | 0.4 | 2.8 | 0.2 |
| CMBS | 0.5 | 0.1 | 0.6 | 0.1 |
| Covered bonds | 0.9 | - | 0.7 | - |
| CLO | 0.6 | - | 0.6 | 0.1 |
| Financial institutions bonds | 1.4 | - | 3.0 | 0.3 |
| US student loan | 0.7 | 0.1 | 0.7 | 0.1 |
| Other investments | 0.4 | - | 0.6 | - |
| As at April 4, | |||||
|---|---|---|---|---|---|
| 2012 | 2011 | ||||
| Fair Value on balance sheet |
Cumulative AFS Reserve |
Fair Value on balance sheet |
Cumulative AFS Reserve |
||
| (£ billion) | |||||
| Non-core portfolio total | 9.5 | 0.6 | 13.2 | 0.8 | |
| (Positive)/Negative AFS reserve before hedge accounting and taxation |
(0.5) | 0.7 | |||
| Hedge accounting adjustment for interest rate risk |
1.0 | - | |||
| Taxation | (0.1) | (0.2) | |||
| Total value of AFS assets/Negative AFS reserve (net) |
34.3 | 0.4 | 31.9 | 0.5 |
The following table provides an analysis of financial assets and liabilities held on our balance sheet at fair value, grouped in levels 1 to 3 based on the degree to which the fair value is observable:
| As at April 4, 2012 | ||||
|---|---|---|---|---|
| Level 1(1) | Level 2(2) | Level 3(3) | Total | |
| (£ million) | ||||
| Investment securities—AFS | 16,493 | 6,756 | 76 | 23,325 |
| Investments in equity shares | 9 | - | 20 | 29 |
| Derivatives financial instruments | - | 3,942 | 234 | 4,176 |
| Financial assets | 16,502 | 10,698 | 330 | 27,530 |
| Derivative financial instruments | - | (4,250) | (37) | (4,287) |
| Other deposits—PEB | - | - | (2,890) | (2,890) |
| Financial liabilities | - | (4,250) | (2,927) | (7,177) |
| Investment securities—AFS | 12,319 | 9,126 | 95 | 21,540 |
| Investments in equity shares | 5 | - | 98 | 103 |
| Derivatives financial instruments(4) | - | 3,873 | 88 | 3,961 |
| Financial assets | 12,324 | 12,999 | 281 | 25,604 |
| Derivative financial instruments(4) | - | (3,158) | (76) | (3,234) |
| Other deposits—PEB | - | - | (2,125) | (2,125) |
| Financial liabilities | - | (3,158) | (2,201) | (5,359) |
Notes:
______________
The Group's Level 1 portfolio comprises highly rated government securities for which traded prices are readily available and within the year ended April 4, 2012, the Group actively sought to increase this portfolio. There were no significant transfers between the Level 1 and 2 portfolios during the year.
Level 2 investment securities—AFS asset valuations are sourced from consensus pricing or other observable market prices. None of the Level 2 AFS assets are valued from models. Level 2 derivative assets and liabilities are valued from discounted cash flow models using yield curves based on observable market data.
The significant movements in Level 3 positions during the year ended April 4, 2012 are explained below:
The increase in other deposits relates to growth in PEBs driven by strong stock market performance over the past 12 months and further investment into this product.
Investments in equity shares have decreased in the year primarily as a result of the disposal of one of the Group's investments to the Nationwide Pension Fund.
The reduction in investment securities has been driven by decreases in asset prices, a further impairment relating to a UK CMBS asset and an increase in the availability of observable market prices resulting in the transfer of assets from Level 3 to Level 2.
The main constituents of the Level 3 portfolio are as follows:
The Group's £76 million Level 3 investment securities—AFS as at April 4, 2012 comprise £53 million of CDOs and £23 million of impaired UK CMBS assets. Substantially all of these securities are priced from internal models based on observable and unobservable performance assumptions.
Level 3 investments in equity shares consist primarily of an interest in a fund which is supported by zero coupon bonds of an A rated bank. External valuations are used to obtain the fair value of the instrument.
Level 3 assets and liabilities in this category are equity linked derivatives with external counterparties which economically match the investment return payable by the Group to investors in the PEB product. The derivatives are linked to the performance of specified stock market indices and have been valued by an external third party.
This category relates to deposit accounts with the potential for stock market correlated growth linked to the performance of specified stock market indices. The PEBs liability is valued at a discount to reflect the time value of money, overlaid by a fair value adjustment representing the expected return payable to the customer. The fair value adjustment has been constructed from the valuation of the associated derivative as valued by an external third party.
We believe that our results indicate a strong performance from Nationwide, with underlying profit before tax up 30% when compared with the year ended April 4, 2010. We have maintained our strong balance sheet, excellent capital ratios and strong consumer franchise. Our focus on the needs of our members has resulted in us performing well in our core markets. Underlying profit before tax equates to reported profit before tax adjusted for the add back of movements in the value of derivatives and hedge accounting, FSCS levy releases, transformation costs and gains on business combinations.
As noted above in the introduction to the discussion of the results of operations for the year ended April 4, 2012 compared with the year ended April 4, 2011, certain numbers for the year ended April 4, 2011 were reclassified in the audited consolidated financial statements for the year ended April 4, 2012 to be presented on a basis that is consistent with the classification used in the year ended April 4, 2012 rather than that used in the year ended April 4, 2011. However, the discussion below does not reflect these reclassifications and is based on the classification as appeared in the audited consolidated financial statements for the year ended April 4, 2011 when such financial statements were published in 2011. Accordingly, certain numbers in this section for the year ended April 4, 2011 are different from the numbers appearing on the same lines in the discussion of the results of operations for the year ended April 4, 2012 compared with the year ended April 4, 2011.
Profit before tax on a reported basis and underlying basis are set out below. Certain aspects of results are presented to reflect management's view of underlying results and to provide a clearer representation of the performance of the Group.
| For the year ended April 4, 2011 | ||||||
|---|---|---|---|---|---|---|
| As reported |
Fair value and other adjustments |
FSCS cost |
Transformation costs |
Underlying profit before tax |
||
| (£ millions) | ||||||
| Net interest income | 1,537 | - | - | - | 1,537 | |
| Other income | 445 | - | - | - | 445 | |
| Fair value adjustments from derivatives and hedge accounting |
120 | (120) | - | - | - | |
| Total income | 2,102 | (120) | - | - | 1,982 | |
| Administrative expenses | 1,158 | - | - | (29) | 1,129 | |
| Depreciation and amortization | 150 | - | - | - | 150 | |
| Impairment losses on loans and advances to customers |
359 | - | - | - | 359 | |
| Provisions for liabilities and charges |
52 | - | (50) | - | 2 | |
| Impairment losses on investment securities |
66 | - | - | - | 66 | |
| Profit before tax | 317 | (120) | (50) | (29) | 276 |
| For the year ended April 4, 2010 | ||||||
|---|---|---|---|---|---|---|
| As reported |
Fair value and other adjustments |
FSCS cost |
Transformation and business combinations |
Underlying profit before tax |
||
| (£ millions) | ||||||
| Net interest income | 1,714 | - | - | - | 1,714 | |
| Other income | 421 | - | - | (40) | 381 | |
| Fair value adjustments from derivatives and hedge accounting |
34 | (34) | - | - | - | |
| Total income | 2,169 | (34) | - | (40) | 2,095 | |
| Administrative expenses | 1,195 | - | - | (62) | 1,133 | |
| Depreciation and amortization | 151 | - | - | - | 151 |
| For the year ended April 4, 2010 | |||||
|---|---|---|---|---|---|
| As reported |
Fair value and other adjustments |
FSCS cost |
Transformation and business combinations |
Underlying profit before tax |
|
| Impairment losses on loans and advances to customers |
549 | - | - | - | 549 |
| Provisions for liabilities and charges | (103) | - | 117 | - | 14 |
| Impairment losses on investment securities |
36 | - | - | - | 36 |
| Profit before tax | 341 | (34) | (117) | 22 | 212 |
The following discussion considers our results for the year ended April 4, 2011 compared to our results for the year ended April 4, 2010.
Our total income has decreased by 3% to £2,102 million in the year ended April 4, 2011 compared to £2,169 million in the year ended April 4, 2010. The following table sets forth the components of income for the years ended April 4, 2011 and April 4, 2010, respectively:
| For the year ended April 4, |
||
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| Net interest income | 1,537 | 1,714 |
| Net fees and commissions | 436 | 373 |
| Income from investments | 4 | 1 |
| Other operating income | 5 | 47 |
| Gains from derivatives and hedge accounting | 120 | 34 |
| Total | 2,102 | 2,169 |
Net interest income decreased by 10.3% to £1,537 million for the year ended April 4, 2011 compared with £1,714 million for the year ended April 4, 2010.
The following table sets forth the components of net interest income for the years ended April 4, 2011 and 2010, respectively:
| For the year ended April 4, |
||
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| Interest and similar income: | ||
| On residential mortgages | 5,004 | 5,289 |
| On other loans | 1,148 | 1,150 |
| On investment securities | 1,029 | 1,056 |
| For the year ended April 4, |
||
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| On other liquid assets | 32 | 47 |
| Net (expense) on financial instruments hedging assets | (2,738) | (3,116) |
| Expected return on pension assets | 168 | 122 |
| Foreign exchange difference | - | 20 |
| Total interest and similar income | 4,643 | 4,568 |
| Interest expense and similar charges: | ||
| On UK retail member deposits | (2,511) | (2,326) |
| On subscribed capital | (96) | (96) |
| On deposits and other borrowings: | ||
| Subordinated liabilities | (110) | (95) |
| Other | (258) | (384) |
| Debt securities in issue | (918) | (884) |
| Net income on financial instruments hedging liabilities | 952 | 1,077 |
| Pension interest cost | (166) | (146) |
| Total interest expense and similar charges | (3,107) | (2,854) |
| Net interest income | 1,537 | 1,714 |
Interest and similar income increased by 1.6% to £4,643 million in the year ended April 4, 2011 from £4,568 million in the year ended April 4, 2010.
Interest on residential mortgages decreased by 5.4% to £5,004 million in the year ended April 4, 2011 from £5,289 million in the year ended April 4, 2010. The reduction in income is attributable to the combination of a 2% decrease in the size of our average residential mortgage portfolio to £135,256 million in the year ended April 4, 2011 from £138,005 million in the year ended April 4, 2010 and a small decrease in average interest rates between the two periods to 3.70% for the year ended April 4, 2011 from 3.83% for the year ended April 4, 2010. The decrease in the size of our average residential mortgage portfolio reflects active management of our balance sheet, adjusting our business flows in response to the continuing difficult market conditions.
Interest on other loans includes interest income that we earned from commercial loans, credit card lending, unsecured personal loans and current account overdrafts. Interest on other loans was stable at £1,148 million in the year ended April 4, 2011 compared to £1,150 million in the year ended April 4, 2010.
Interest and other income from investment securities comprises interest income earned on the corporate and government investment securities that we purchase for our own account to manage our investment and liquidity portfolios and net realized gains and losses on our sales of these instruments.
Interest and other income from investment securities decreased by 2.6% to £1,029 million for the year ended April 4, 2011 compared with £1,056 million for the year ended April 4, 2010. However, net of foreign exchange differences and net expenses on financial instruments hedging assets, there has been a decrease to £314 million for the year ended April 4, 2011 from £527 million for the year ended April 4, 2010. This decrease is due to a fall of 7% in the average balance of securities held in both the investment and liquidity portfolios to £22,123 million in the year ended April 4, 2011 from £23,780 million for the year ended April 4, 2010 combined with a decrease in the average interest rate earned on such assets to 1.42% in the year ended April 4, 2011, compared to 2.22% for the year ended April 4, 2010. The decrease in average interest rates is a direct result of decreases in market rates between the two periods.
We use derivative instruments to synthetically convert fixed rate assets to floating rate assets. The floating rate income and fixed rate expense on these derivatives are included as "net expense on financial instruments hedging assets". In the year ended April 4, 2011, we incurred a net expense of £2,738 million on financial instruments used to hedge our fixed rate assets compared with a net expense of £3,116 million in the year ended April 4, 2010. As LIBOR rates have remained at very low levels seen during the years ended April 4, 2011 and April 4, 2010, the floating rate income on these financial instruments has reduced, resulting in an increased expense to the Group.
Under IFRS, interest earned on pension fund assets is recognized in interest and similar income and the release of discounts on pension fund liabilities is recognized in interest expense and similar charges in the income statement. These amounts are calculated by an independent actuary using accepted methodology and agreed assumptions.
Interest expense and similar charges increased by 8.8% in the year ended April 4, 2011 to £3,107 million from £2,854 million in the year ended April 4, 2010.
Interest on UK retail member deposits includes interest that we pay on UK savings and current accounts held by our members. Interest on UK retail member deposits increased by 8.0% at £2,511 million in the year ended April 4, 2011 from £2,326 million in the year ended April 4, 2010.
This results from an increase in the average interest rate that we paid to depositors to 2.05% for the year ended April 4, 2011 compared with 1.9% in the year ended April 4, 2010, which was marginally offset by a 0.6% reduction in the average balance of UK retail member deposits held to £122,259 million in the year ended April 4, 2011 from £122,999 million in the year ended April 4, 2010. In the current low interest rate environment the UK savings market remains subdued. We have actively managed our flow of retail savings to achieve a balance between securing funds at an economic rate and providing long term good value to our members.
Interest expense on deposits and other borrowings includes interest that we pay on subordinated debt instruments and other deposits and borrowings. In the year ended April 4, 2011, interest on subordinated liabilities increased by 15.8% to £110 million from £95 million in the year ended April 4, 2010. The increase was partially a result of refinancing subordinated debt: we issued €750 million of new subordinated debt on July 2010 with a coupon of 6.75% and redeemed in August 2010 our existing issue of the same size that had a coupon of 3.375%. The remaining increase in the interest expense was a result of exchange rate movements as all interest rates on our subordinated liabilities are fixed and therefore not affected by changes in market interest rates.
Other interest expense on deposits and other borrowings includes the interest that we pay on retail deposits by non-members, deposits from other banks and other money market deposits. In the year ended April 4, 2011, other interest expense on deposits and other borrowings decreased by 32.8% to £258 million from £384 million in the year ended April 4, 2010. This reduction is due to a combination of the fall in market interest rates together with a decrease in the average monthly balance of deposits and other borrowings, excluding subordinated liabilities, of 26.5% to £15,140 million in the year ended April 4, 2011 compared with £20,609 million in the year ended April 4, 2010.
Debt securities in issue include interest that we pay on certificates of deposit, time deposits, commercial paper and medium-term notes. In the year ended April 4, 2011, interest expense on debt securities in issue increased by 3.5% to £915 million from £884 million in the year ended April 4, 2010. This increase, reflecting an increase in the average interest rate paid before adjusting for income/expense on financial instruments hedging liabilities, increased slightly to 2.55% for the year ended April 4, 2011, compared with 2.33% for the year ended April 4, 2010, the effect of which was partially offset by a 5.5% decrease in the average monthly balance of debt securities in issue to £35,834 million in the year ended April 4, 2011, compared with £37,937 million in the year ended April 4, 2010. The decrease in the amount of debt security was due to changes in our internal liquidity requirements that were predominantly driven by changes in external market factors between the two periods.
We use derivative instruments to synthetically convert fixed rate liabilities to floating rate liabilities. The floating rate expense and fixed rate income on these derivatives are included as "net income/expense on financial instruments hedging liabilities". In the year ended April 4, 2011, net income on financial instruments used to hedge our fixed rate liabilities was £952 million, compared with a net income of £1,077 million in the year ended April 4, 2010. The decrease was a result of the performance of derivatives in the market.
The following table sets forth the components of net fees and commissions for the years ended April 4, 2011 and 2010 respectively:
| April 4, | For the year ended | |
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| Fee and commission income: | ||
| Mortgage related fees | 36 | 28 |
| Banking and savings fees | 166 | 149 |
| General insurance fees | 142 | 128 |
| Other fees and commissions | 96 | 73 |
| Total fee and commission income | 440 | 378 |
| Fee and commission expense: | ||
| Mortgage related fees | 1 | 1 |
| Other fees and commissions | 3 | 4 |
| Total fee and commission expense | 4 | 5 |
| Net fee and commission income | 436 | 373 |
Income from net fees and commissions consists of income that we earn from lending, banking and savings fees and insurance sales commissions less lending fees and commission expense.
In the year ended April 4, 2011, net fees and commissions increased by 16.9% to £436 million compared with £373 million in the year ended April 4, 2010.
The increase in other fees and commissions income reflects our strategic focus to diversify our income base. The increase in banking and savings fees includes increased VISA interchange income on current accounts following the introduction of point of sale access for our basic bank account customers and overseas commission charges. There also has been a strong growth in investment income in the year ended April 4, 2011, driven by increased sales of long term investments. In addition, profit share from mortgage payment protection insurance policies increased in the year ended April 4, 2011, as a result of lower unemployment claims compared with the previous year. A further increase in mortgage related fee income has been derived from the commercial lending portfolio as a number of loans have been progressively restructured on maturity or on renegotiation of terms with borrowers.
In the year ended April 4, 2011, other operating income decreased by 89% to £5 million, compared with £47 million in the year ended April 4, 2010. This was due to the inclusion in other operating income for the year ended April 4, 2010 of a one-time £40 million gain on the Dunfermline Social Housing portfolio which was acquired from DBS Bridge Bank Limited on June 30, 2009.
All derivatives entered into by Nationwide are recorded on the balance sheet at fair value with any fair value movements accounted for in the income statement. Derivatives are only used to limit the extent to which we could be affected by changes in interest rates, exchange rates or other factors specified in building society legislation. Derivatives are therefore used exclusively to hedge risk exposures and are not used for speculative purposes.
Where effective hedge accounting relationships can be established, the movement in the fair value of the derivative instrument is offset in full or in part by opposite movements in fair value of the underlying asset or liability being hedged. Any ineffectiveness arising from different movements in fair value will likely trend to zero over time.
In addition, we enter into certain derivative contracts which, although efficient economically, cannot be included in effective hedge accounting relationships. Consequently, although the implicit interest cost of the underlying instrument and associated derivatives are included in "Net interest income" in the income statement, fair value movements on such derivatives are included in "Gains from derivatives and hedge accounting".
Gains from derivative and hedge accounting were £120 million in the year ended April 4, 2011 compared to gains of £34 million in the year ended April 4, 2010. The £120 million credit in the year ended April 4, 2011 (year ended April 4, 2010: £34 million) represents the change during such period in the fair value of exposure-limiting derivative instruments that are matching risk exposures on an economic basis. offset, where applicable, by the change in fair value of the underlying asset or liability attributable to the hedged risk. Even though the Group uses derivatives exclusively for risk management purposes, income statement volatility arises due to accounting ineffectiveness of designated hedges, as a result of strategy changes or because hedge accounting has not been adopted or is not achievable.
In the year ended April 4, 2010 we recorded gains from fair valuation of mortgage commitments of £108 million. As a result of structural changes in our balance sheet, this practice was ended with effect from July 1, 2010 (see note 2 to our audited consolidated financial statements for the year ended April 4, 2011 incorporated by reference herein). We enter into derivatives to economically hedge forecast fixed rate savings.
Operating expenses and similar charges decreased by 2.4% in the year ended April 4, 2011 to £1,785 million from £1,828 million in the year ended April 4, 2010. The following table sets forth the components of operating expenses and similar charges for the years ended April 4, 2011 and 2010, respectively:
| For the year ended April 4, |
||
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| Administrative expenses | 1,158 | 1,195 |
| Depreciation and amortization | 150 | 151 |
| Impairment losses on loans and advances to customers | 359 | 549 |
| Provisions for liabilities and charges | 52 | (103) |
| Impairment losses on investment securities | 66 | 36 |
| Total | 1,785 | 1,828 |
Administrative expenses decreased by 3.1% in the year ended April 4, 2011 to £1,158 million compared to £1,195 million in the year ended April 4, 2010. On-going administrative expenses as an annualized percentage of total average assets remained unchanged at 0.61% in the year ended April 4, 2011 from 0.61% in the year ended April 4, 2010.
The following table sets forth the components of administrative expenses for the years ended April 4, 2011 and 2010, respectively:
| April 4, | ||
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| Employee costs: | ||
| Salaries and social security costs | 501 | 513 |
| Pension costs | 82 | 71 |
| Other administrative costs | 575 | 611 |
| Total | 1,158 | 1,195 |
Employee costs are made up of salaries, social security costs (which consist entirely of mandatory UK national insurance contributions) and pension costs.
In the year ended April 4, 2011, salaries and social security costs decreased by 2.3% to £501 million from £513 million in the year ended April 4, 2010. This decrease reflects the impacts of synergies and our ongoing focus on efficiency savings which have enabled some reductions in headcount across the Group. The impact of the reduction in headcount will have been partly offset by typical annual salary increases and merit-based salary increases to some employees.
Within employee costs, the pension charge increased by 15.5% to £82 million for the year ended April 4, 2011 from £71 million in the year ended April 4, 2010. The increase in pension costs is due to a decrease in the AA bond rates used to discount the pension costs to 5.6% for the year ended April 4, 2011 from 6.5% for the year ended April 4, 2010 and an increase in the inflation assumptions to 3.6% for the year ended April 4, 2011 from 3.4% for the year ended April 4, 2010, partly offset by a continued shift in membership from defined benefit to cheaper defined contribution pension arrangements and a reduction in past service costs. In addition, a revised benefit structure was put in place with effect from April 1, 2011 that is expected to result in a reduction in the pension costs for the year ended April 4, 2012 and subsequent years.
The Group operates both defined benefit and defined contribution arrangements. The principal defined benefit pension arrangement is the Nationwide Pension Fund. This is a contributory defined benefit arrangement, with both final salary and CARE sections. This fund was closed to new entrants in 2007. Since that date new employees have been able to join a defined contribution arrangement. The final salary section of the fund was closed to future service on March 31, 2011. Service already built up in the final salary section will continue to be linked to final salary, while future benefits will accrue within the CARE section. A separate pension fund is operated for one subsidiary company.
The Group's net retirement benefit liability with respect to the Nationwide Pension Fund was £300 million as at April 4, 2011 (April 4, 2010: £508 million). In addition to the contributions made during the year ended April 4, 2011, the decrease in the net liability of the fund also reflects an actuarial gain of £152 million in the measurement of the liabilities, partly offset by a £38 million actuarial loss on fund assets. The actuarial gain in liabilities reflect a reduction in the inflation and salary increase assumptions and a switch to the use of the consumer price index ("CPI") from the retail price index ("RPI") in measuring the liability to deferred pensioners. These impacts were partially offset by an increase in the mortality assumptions which has increased the value of the liabilities.
We have been actively managing our retirement benefit liability and have taken a number of steps to contain and reduce the deficit over time:
The Pension Trustees continue to work closely with their advisors to optimize the investment strategy for the schemes' assets.
We will continue to review our options to manage the pension schemes in a responsible way.
Other administrative costs decreased by 5.9% to £575 million for the year ended April 4, 2011 from £611 million for the year ended April 4, 2010. The expenses for the years ended April 4, 2011 and April 4, 2010 include £29 million and £62 million, respectively, of transformation costs relating to the restructuring of parts of our business, which are "one off" in nature and therefore excluded from the calculation of underlying profit/ expenses. Expenses of an ongoing nature included are advertising and marketing, postage and communications, rent and associated taxes, computer hardware maintenance, property maintenance, ATM costs and equipment leasing.
Ongoing other administration costs have remained broadly flat at £546 million for the year ended April 4, 2011 compared to £549 million for the year ended April 4, 2010. This reflects our commitment and ability to manage our cost base. Cost control has been achieved through a number of measures including cost synergies and an ongoing focus on efficiency savings across the Group.
For the year ended April 4, 2011, depreciation and amortization expenses decreased by £1 million to £150 million compared to £151 million for the year ended April 4, 2010.
We assess at each balance sheet date whether, as a result of one or more events that occurred after initial recognition, there is objective evidence that a financial asset or group of assets is impaired. Evidence of impairment may include indications that a borrower or group of borrowers are experiencing significant financial difficulty or default or delinquency in interest or principal payments.
Impairment losses on loans and advances to customers for the year ended April 4, 2011 decreased by 34.6% to £359 million from £549 million for the year ended April 4, 2010.
The following table analyzes the impairment losses on loans and advances to customers for the years ended April 4, 2011 and 2010, respectively:
| For the year ended April 4, |
||
|---|---|---|
| 2011 | 2010 | |
| (£ millions) | ||
| Residential mortgages | 101 | 89 |
| Commercial lending | 175 | 299 |
| Unsecured lending | 83 | 126 |
| Other secured lending | - | 35 |
| Total | 359 | 549 |
The impairment loss on loans to customers of £359 million for the year ended April 4, 2011 has decreased by 35% compared to the £549 million charge for the year ended April 4, 2010. We believe that the underlying quality of our lending remains strong but is inevitably affected by recessionary conditions and falling asset values in the commercial sector.
While the total charge for residential impairments for the year ended April 4, 2011 of £101 million is £12 million higher than the charge for the year ended April 4,2010 of £89 million, the underlying arrears rate has remained stable at 0.68%. The increase in residential charge in the year is wholly driven by the charge for prime mortgages which has increased to £32 million for the year ended April 4, 2011 compared to £10 million for the year ended April 4, 2010 and is largely attributable to more conservative default assumptions reflecting the current macro economic environment. In addition, impairment calculations have been updated to include a provision in relation to forbearance cases. The charge for specialist lending has reduced to £69 million for the year ended April 4, 2011 compared to £79 million for the year ended April 4, 2010 reflecting an improvement in the arrears rate to 1.96% compared to the arrears rate of 2.28% for the year ended April 4, 2010 as a result of continuing stability in payment performance supported by the low interest rate environment.
Residential impairment provisions held on the balance sheet increased by 26% to £201 million at April 4, 2011 compared to £160 million at April 4, 2010, giving a coverage ratio (solely with respect to Nationwide-originated assets) against total balances at April 4, 2011 of 0.17% compared to 0.13% at April 4, 2010 and against balances more than three months in arrears of 17.6% at April 4, 2011 compared to 13.7% at April 4, 2010. In the same period balances more than three months in arrears decreased by 2%.
Nationwide recognize that arrears are typically caused by temporary changes in customer circumstances, and therefore offer a range of forbearance and account management options to customers. On secured lending, options include payment holidays, temporary conversion to interest only, term extension and arrears capitalization. With respect to unsecured lending, credit card customers meeting required criteria may make reduced payments as part of an agreed payment plan or have their arrears consolidated.
Across both the secured and unsecured portfolios, all account management/forbearance options are low in materiality and fully recognized within provisioning.
In our Commercial Lending division, ongoing difficult market conditions resulted in further commercial loan defaults and a charge for the year ended April 4, 2011 of £175 million. Signs of improvement have been seen as the growth in impairments began to slow, resulting in a charge of £80 million in the second half of the year ended April 4, 2011, which was moderately lower than the £95 million in the first half of the year and 33% lower than the £119 million reported for the second half of the year ended April 4, 2010. Defaults continue to be triggered by tenant failures and our borrowers' subsequent inability to service loans, along with covenant breaches on LTV and business failures on owner occupied properties.
The overall level of provision for commercial lending as a percentage of solely Nationwide originated assets is 2.18% at April 4, 2011 compared to 1.97% at April 4, 2010, and the provision coverage ratio against balances more than three months in arrears is 69% at April 4, 2011 compared to 48% at April 4, 2010.
The following table sets forth the components of provisions for contingent liabilities and commitments for the years ended April 4, 2011 and 2010, respectively:
| For the year ended April 4, |
|||
|---|---|---|---|
| 2011 | 2010 | ||
| (£ millions) | |||
| FSCS | 50 | (117) | |
| Other provisions | 2 | 14 | |
| Total | 52 | (103) |
The FSCS provision is to meet expected levies payable on the Group's estimated share of interest on loans received by the FSCS from HM Treasury in respect of scheme years ending on and before March 31, 2011.
During the year ended April 4, 2011, an impairment loss of £52 million was recognized compared with a release of £103 million in the year ended April 4, 2010. The impairment provision charge for the year ended April 4, 2011 consists of £50 million impairment on FSCS levies and £2 million on other provisions. For further information on the FSCS see "Description of Business—Financial Services Compensation Scheme".
Under IAS 39: Financial Instruments: Recognition and Measurement ("IAS 39"), provisions against investment securities are made where there is objective evidence of impairment at the balance sheet date. For the year ended April 4, 2011, we made £66 million in provisions against investment securities, compared to £36 million for the year ended April 4, 2010.
The impairment charge on investment securities of £66 million for the year ended April 4, 2011 includes £22 million for a small number of US RMBS exposures, £15 million on a UK CMBS and £11 million on notes of a restructured SIV. The remaining £18 million has arisen from restructuring of subordinated debt from Irish banks (also acquired through SIV restructurings). The charge of £36 million for the year ended April 4, 2010 was driven by a £29 million impairment of a number of US RMBS exposure and £7 million in respect of our private equity portfolio.
Tax on our profit on ordinary activities for the year ended April 4, 2011 amounted to £69 million based on our reported profit on ordinary activities before tax of £317 million, reflecting an effective tax rate of 21.8% as compared with the prevailing UK corporation tax rate of 28%. For the year ended April 4, 2010, tax on our profit on ordinary activities amounted to £77 million based on our reported profit on ordinary activities of £341 million, reflecting an effective tax rate of 22.6% as compared with the prevailing UK corporation tax rate of 28%. The lower effective tax rate reflects the recognition of previously unrecognized losses, lower overseas tax rates and the effect through the income statement on deferred tax of the change in corporation tax rate to 26%. This has been partially offset by the effects of non-deductible expenditure and tax paid in respect of our Irish branch.
Our lending remains predominantly concentrated on prime quality, secured products, with residential mortgages (both prime and specialist) accounting for 83.2% of our total loans and advances to customers, commercial lending 14.8% and consumer banking 1.7% as at April 4, 2011. The mix of lending as at April 4, 2011 has remained broadly consistent with that reported as at April 4, 2010. The following table sets forth the breakdown of loans and advances to customers as at April 4, 2011 and April 4, 2010:
| As at April 4, | |||||
|---|---|---|---|---|---|
| 2011 | 2010 | ||||
| (£ billions, except percentages) | |||||
| Prime residential mortgages | 104.2 | 69.6% | 108.7 | 71.3% | |
| Specialist residential mortgages | 20.4 | 13.6% | 18.7 | 12.2% | |
| Total residential mortgages | 124.6 | 83.2% | 127.4 | 83.5% | |
| Commercial lending | 22.1 | 14.8% | 22.2 | 14.6% | |
| Consumer banking | 2.5 | 1.7% | 2.3 | 1.5% | |
| Other operations lending | 0.5 | 0.3% | 0.6 | 0.4% | |
| Gross balances | 149.7 | 100.0% | 152.5 | 100.0% | |
| Impairment provisions | (0.8) | (0.8) | |||
| Fair value adjustments for micro hedged risk | 0.5 | 0.7 | |||
| Total | 149.4 | 152.4 |
Prime residential mortgages are primarily Nationwide branded advances made through our branch network and intermediary channels but also includes prime advances made through TMW and £3.9 billion through our regional building society brands Derbyshire, Cheshire and Dunfermline.
Specialist residential mortgages as at April 4, 2011 are made up of £17.5 billion of advances made through our Specialist Lending brands, TMW and UCB, and £2.8 billion through our regional building society brands Derbyshire, Cheshire and Dunfermline. Loans were advanced primarily in the buy-to -let and self-certification markets although no self-certification products were offered during the year ended April 4, 2010. Buy-to-let mortgages make up 72% of total specialist lending, 20% relates to self-certification mortgages, 6% relates to near prime, and just 2%, amounting to approximately £0.4 billion, relates to sub-prime, which was primarily acquired as part of the mergers with Derbyshire and Cheshire and has been subject to rigorous fair value assessment at acquisition.
Gross prime lending in the year ended April 4, 2011 amounted to £9.8 billion compared to £10.3 billion in the year ended April 4, 2010, which includes £0.2 billion advanced through TMW. Gross specialist lending in the year ended April 4, 2011 was £3.0 billion compared to £1.7 billion in the year ended April 4, 2010, all of which related solely to the buy-to-let sector, and was advanced primarily through TMW.
Residential mortgages are only secured against UK properties. The Group operates across the whole of the UK with a bias towards the South East of England and Greater London, reflecting the concentration of branches in that region and historically higher asset value growth trends. We continued to focus on affordability and LTV ratios in underwriting residential mortgages during the year ended April 4, 2011. Although the average LTV of the portfolio increased slightly in the year ended April 4, 2011, it still remains very low at 49%, with 83% of the book under 80% LTV and only 2% in negative equity. The average LTV of new residential mortgages completed in the year ended April 4, 2011 marginally increased to 66% from 63% in the year ended April 4, 2010.
The following table sets forth a breakdown of the LTV analysis of our residential mortgage portfolio as at April 4, 2011 and April 4, 2010:
| As at April 4, 2011 |
As at April 4, 2010 |
|
|---|---|---|
| (percentages) | ||
| Total portfolio of residential mortgages: | ||
| <50% | 52 | 54 |
| 50% - 60% | 9 | 10 |
| 60% - 70% | 11 | 10 |
| 70% - 80% | 11 | 10 |
| 80% - 90% | 10 | 8 |
| 90% - 100% | 5 | 6 |
| > 100% 2 |
2 | |
| 100 | 100 | |
| Average loan to value of stock (indexed) | 49 | 48 |
| Average loan to value of new business | 66 | 63 |
| New business profile: | ||
| First-time buyers | 23 | 26 |
| Home movers | 34 | 38 |
| Remortgagers | 12 | 18 |
| Buy-to-let | 31 | 18 |
| 100 | 100 |
The analysis of the new business profile excludes further advances, which were previously included in remortgages.
The table below shows that, on Nationwide originated lending, we have seen a small increase in prime arrears and a reduction in specialist arrears at April 4, 2011, though we continue to maintain our very favorable position to the industry on both originated business and lending including acquired loans. The modest increase in prime arrears at April 4, 2011 has been driven primarily by book contraction, with the underlying volume of cases in arrears actually reducing by 3% over the year. Our originated specialist mortgages continue to perform well and remain broadly in line with the industry measure that includes prime:
| As at April 4, 2011 |
As at April 4, 2010 |
|
|---|---|---|
| (percentages) | ||
| Nationwide-originated residential mortgages: | ||
| Prime | 0.53 | 0.52 |
| Specialist | 1.96 | 2.28 |
| Total Nationwide-originated residential mortgages | 0.68 | 0.68 |
| Group residential mortgages:(1) | ||
| Prime | 0.54 | 0.54 |
| Specialist | 2.47 | 3.37 |
| Total Group residential mortgages | 0.77 | 0.82 |
| Industry average | 2.09 | 2.27 |
Note:
______________
(1) Includes residential mortgages acquired from the Cheshire, Derbyshire, and Dunfermline building societies.
Residential mortgage assets acquired with the Derbyshire, Cheshire and Dunfermline brands were fair valued on a basis which included a credit risk adjustment of £199 million for anticipated losses over the remaining life of the loans. To date, £65 million of losses have been written off, and during the year ended April 4, 2010 £33 million of surplus fair value credit risk adjustment on mortgage books has been released into margin. It is believed that the remaining £101 million is sufficient to cover all future losses. Accordingly, in evaluating the Group's exposure to losses, as well as the quality of its underwriting processes, we believe that it is relevant to focus on arrears levels excluding rather than including the effect of acquired assets.
We maintain close relationships with customers experiencing financial difficulties and work with them to agree the most appropriate course of action. In the case of short term difficulty, we will seek to agree revised payment schedules with the customer which may include a reduction to the contractual payment due. However, where revised payment schedules are not at a level sufficient to meet normal contractual terms (e.g. a currently available interest only mortgage) or where a customer fails to meet the revised payment schedule, the case will continue to accrue arrears and be included in arrears numbers reported above.
If a customer demonstrates they are able to meet a payment schedule at a normal commercial rate for a period of six months, and only if they request it, we may capitalize the arrears on their account. This will result in an enlarged outstanding balance but no arrears and consequently these cases will no longer be reported as arrears.
The number of Group borrowers in possession at April 4, 2011, including acquired societies, of 938 (April 4, 2010: 967) represents 0.07% of the total portfolio (April 4, 2010: 0.07%). As buy-to-let landlords may have more than one property, possession measures are slightly higher on a property basis but, at 989 (April 4, 2010: 1,088) properties, representing 0.07% of our book (April 4, 2010: 0.08%), this still compares favorably with the industry measure of 0.12% (April 4, 2010: 0.13%) (Source: Council of Mortgage Lenders). Excluding the impact of acquired societies, our position relative to the industry is even more favorable. The table below shows possessions as a percentage of our book for both originated and acquired residential mortgages:
| Possessions as % of total book of residential mortgages (number of borrowers) | As at April 4, 2011 |
As at April 4, 2010 |
|---|---|---|
(percentages)
Nationwide-originated residential mortgages:
| Prime | 0.03 | 0.02 |
|---|---|---|
| Specialist | 0.34 | 0.46 |
| Total Nationwide-originated residential mortgages | 0.06 | 0.06 |
| Group residential mortgages:(1) | ||
| Prime | 0.03 | 0.02 |
| Specialist | 0.38 | 0.53 |
| Total Group residential mortgages | 0.07 | 0.08 |
Note:
______________
(1) Includes residential mortgages acquired from the Cheshire, Derbyshire, and Dunfermline building societies.
Our approach to dealing with customers in financial difficulties, combined with our historically cautious approach to lending, means that we only take possession of properties as a last resort. This is demonstrated by the number of properties taken into possession compared with the total for the industry. During the year ended April 4, 2011, 1,264 Nationwide-originated properties were taken into possession representing only 3.58% of properties taken in by the industry as a whole against our residential mortgage market share of 11.40%.
The following table provides further information on the residential mortgage portfolio by payment due status:
| As at April 4, 2011 | As at April 4, 2010 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | % | Prime lending |
Specialist lending |
Consumer banking |
Total | % | |
| (£ billions, except percentages) | ||||||||||
| Not impaired: | ||||||||||
| Neither past due nor impaired |
101.8 | 18.2 | 2.3 | 122.3 | 96% | 106.3 | 16.5 | 2.1 | 124.9 | 96% |
| Past due up to 3 months but not impaired. |
1.9 | 1.4 | 0.0 | 3.3 | 3% | 1.9 | 1.2 | 0.0 | 3.1 | 3% |
| Impaired | 0.6 | 0.8 | 0.1 | 1.5 | 1% | 0.5 | 1.0 | 0.2 | 1.7 | 1% |
| Total | 104.3 | 20.4 | 2.4 | 127.1 | 100% | 108.7 | 18.7 | 2.3 | 129.7 | 100% |
The status "past due up to three months but not impaired" includes any asset where a payment due is received late or missed. The amount included is the entire financial asset balance rather than just the payment overdue. Loans on interest only or payment holiday concessions are initially categorized according to their payment status as at the date of concession, with subsequent revisions to this category assessed against the terms of the concession.
Loans in the analysis above which are less than three months past due have collective impairment allowances set aside to cover credit losses on such loans, with the amount of such allowances determined by us based on our expectation of the proportion that are likely to be repaid. Loans acquired from the Derbyshire, Cheshire and Dunfermline building societies were fair valued on a basis which made credit loss adjustments for anticipated losses over the remaining life of the loans. Impaired retail loans are broken down further in the following table:
| As at April 4, 2011 | As at April 4, 2010 | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Prime | Specialist | Consumer | Prime | Specialist | Consumer | ||||
| lending | lending | banking | Total | % | lending | lending | banking | Total | % |
| Impaired status: |
|||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Past due 3 to 6 months |
271 | 290 | 50 | 611 | 41% | 280 | 342 | 60 | 682 | 39% | |
| Past due 6 to 12 months |
187 | 228 | 44 | 459 | 30% | 174 | 282 | 67 | 523 | 30% | |
| Past due over 12 months |
81 | 185 | - | 266 | 18% | 81 | 222 | 45 | 348 | 20% | |
| Possessions . | 33 | 130 | - | 163 | 11% | 30 | 160 | - | 190 | 11% | |
| Total | 572 | 833 | 94 | 1,499 | 100% | 565 | 1,006 | 172 | 1,743 | 100% |
(£ millions, except percentages)
Possession balances represent properties of which Nationwide has taken ownership pending their sale.
Nationwide offer secured customers in financial difficulty a range of account management and forbearance options including capitalization, interest only concessions, payment holidays and terms extensions.
£276 million of retail loans that would otherwise be categorized as past due or impaired have had their terms renegotiated or have been capitalized in the year ended April 4, 2011. Customers with loans in arrears are only permitted to renegotiate where they have demonstrated their ability to meet a repayment schedule at normal commercial terms for a continuous six month period. Once renegotiated the loans are categorized as not impaired as long as contractual repayments are maintained.
The following table presents collateral held against past due or impaired retail residential mortgages:
| As at April 4, 2011 | As at April 4, 2010 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Prime lending |
% | Specialist lending |
% | Prime lending |
% | Specialist lending |
% | |||
| (£ million, except percentages) | ||||||||||
| Past due but not impaired | 1,928 | 100% | 1,334 | 99% | 1,884 | 100% | 1,159 | 99% | ||
| Impaired | 535 | 99% | 676 | 96% | 532 | 99% | 829 | 98% | ||
| Possessions | 31 | 94% | 116 | 89% | 29 | 97% | 150 | 94% | ||
| Total | 2,494 | 100% | 2,126 | 97% | 2,445 | 100% | 2,138 | 98% |
Collateral held in relation to secured loans that are either past due or impaired is capped at the amount outstanding on an individual loan basis. The percentages in the table above represent the cover over the impaired asset.
The following table presents negative equity on residential mortgages:
| As at April 4, 2011 | As at April 4, 2010 | ||||
|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Prime lending |
Specialist lending |
||
| (£ million) | |||||
| Past due but not impaired | 6 | 14 | 5 | 10 | |
| Impaired | 4 | 27 | 3 | 17 | |
| Possessions | 2 | 14 | 1 | 10 | |
| Total | 12 | 55 | 9 | 37 |
Commercial lending comprises loans secured on commercial property, loans to Registered Social Landlords and loans advanced under Government supported Private Finance Initiatives ("PFIs").
Our commercial lending portfolio reduced slightly to £22.0 billion at April 4, 2011 compared to £22.2 billion at April 4, 2010 and consists of £20.8 billion (April 4, 2010: £20.9 billion) of self-originated lending and £1.2 billion (April 4, 2010: £1.3 billion) of assets acquired from the Derbyshire, Cheshire and Dunfermline building societies. Our originated portfolio at April 4, 2011 comprises £11.9 billion secured on commercial property ("Property Finance"), £7.4 billion advanced to Registered Social Landlords and £1.5 billion advanced under the PFI. There are currently no arrears of three months or more on the Registered Social Landlord and PFI portfolios and our Property Finance portfolio is well diversified by industry type and by borrower.
On self-originated lending we have only modest exposure to development finance with total balances of £172 million, and a total further commitment of £29 million, to three high quality office developments in the centre of London, at April 4, 2011. Of these, one development case with a total balance of £26 million, at April 4, 2011 is in the course of being sold with contracts exchanged in March 2011 and completion set for October 2011 which will result in full repayment of all debt. Another development case has been restructured with improved terms and an equity injection from the sponsors resulting in an improved security position for lenders.
The number of Nationwide originated commercial property cases more than three months in arrears decreased from 285 cases as at April 4, 2010 to 235 as at April 4, 2011. This equates to 2.41% of commercial originated accounts (April 4, 2010: 2.77%). Total arrears balances on these cases at April 4, 2011 were £48 million (April 4, 2010: £42 million). Robust arrears management is carried out by dedicated teams who, supported by daily arrears reporting, maintain a focus on early intervention to maximize economic value and mitigate losses.
Commercial mortgage assets originally totaling £1.3 billion acquired through mergers with Derbyshire and Cheshire and the acquisition of the Dunfermline's social housing portfolio have been fair valued in the same way as described for residential assets above, including a credit risk adjustment of £179 million for anticipated losses over the remaining life of the loans, none of which relates to Dunfermline's social housing portfolio. A loan loss impairment charge of £3 million has been raised in the year ended April 4, 2011 (£4 million since acquisition) as a number of individually assessed cases have an impairment provision requirement in excess of the original fair value adjustment. To date, £37 million of losses have been written off and £4 million of surplus fair value credit risk adjustment on repaid facilities has been released. We continue to believe that the remaining acquired loans are unlikely to contribute any significant net losses to the Group over their lifetime.
Although we continue to expect difficult market conditions in the commercial property sector, and further impairment provisions, we remain confident that our book, which is primarily focused on low risk lending, will perform better than most. We believe that this, combined with proactive management including progressive re-pricing of facilities as they mature or experience technical covenant breaches, should ensure continued improvements in contribution in the coming years.
As at April 4, 2011, balances for other operations lending include a secured European commercial loan portfolio of £235 million (April 4, 2010: £299 million) and unsecured lending of £246 million (April 4, 2010: £277 million) relating to a student loan portfolio. These investments were acquired by Treasury Division and are therefore held within the Head Office functions.
As at April 4, 2011, there are £11 million (April 4, 2010: £38 million) past due or impaired balances classified above as other operations. All of the £11 million (April 4, 2010: £11 million) relates to the unsecured student loan portfolio.
The table below provides further information on the commercial and other operations loan portfolio by payment due status:
| As at April 4, 2011 | As at April 4, 2010 | ||||
|---|---|---|---|---|---|
| Commercial | Other operations |
Commercial | Other operations |
(£ billion, except percentages)
| Total | 22.0 | 100% | 492 | 100% | 22.2 | 100% | 0.6 | 100% |
|---|---|---|---|---|---|---|---|---|
| Impaired | 1.4 | 6% | 7 | 1% | 1.4 | 6% | - | 6% |
| Past due up to 3 months but not impaired | 0.4 | 2% | 4 | 1% | 0.3 | 1% | - | 1% |
| Neither past due nor impaired | 20.2 | 92% | 481 | 98% | 20.6 | 93% | 0.6 | 93% |
The status "past due up to three months but not impaired" includes any asset where a payment due under strict contractual terms is received late or missed. The amount included is the entire financial asset rather than just the payment overdue.
Loans in the analysis above which are less than three months past due have collective impairment allowances set aside to cover credit losses on loans which are in the early stages of arrears. This analysis includes commercial mortgage loans totaling £1.2 billion acquired through the acquisitions of the Derbyshire, Cheshire and Dunfermline building societies. These loans were fair valued on a basis which made allowances for anticipated losses over the life of the loans. Impaired loans totaling £141 million as at April 4, 2011 (April 4, 2010: £141 million) in the above analysis have thus been fair valued We therefore believe these loans should not contribute any significant losses to the Group for the foreseeable future.
Impaired commercial and other operations loans are further analyzed in the following table:
| As at April 4, 2011 | As at April 4, 2010 | |||||||
|---|---|---|---|---|---|---|---|---|
| Commercial | Other operations |
Commercial | Other operations |
|||||
| (£ million, except percentages) | ||||||||
| Impaired status: | ||||||||
| Past due 0 to 3 months | 695 | 49% | - | - | 408 | 30% | - | - |
| Past due 3 to 6 months | 111 | 8% | 1 | 14% | 291 | 22% | 14 | 42% |
| Past due 6 to 12 months | 235 | 16% | 3 | 43% | 397 | 30% | 15 | 46% |
| Past due over 12 months | 378 | 27% | 3 | 43% | 238 | 18% | 4 | 12% |
| Possessions | 1 | - | - | - | - | - | - | - |
| Total | 1,420 | 100% | 7 | 100% | 1,334 | 100% | 33 | 100% |
Commercial loans totaling £1,152 million as at April 4, 2011 (April 4, 2010: £960 million) not subject to fair value adjustments have individual provisions against them. This includes cases which are not more than three months past due. Possession balances represent properties of which Nationwide has taken ownership pending their sale.
A number of commercial property finance loans, characterized by either a covenant breach, payment default or loan maturity were restructured during the year ended April 4, 2011. Of these loans, £745 million had debt restructure terms which fell outside our current lending policy or credit appetite, or the loan exposure post restructure generates a suboptimal return on risk weighted capital. Once renegotiated the restructured loans include a contractual capital amortization profile or a full cash sweep of surplus rental income to pay-down debt after permitted deductions for asset management fees and irrecoverable property costs and are categorized as not impaired as long as contractual repayments are maintained. In the year ended April 4, 2010 there were £806 million of loans that were restructured due to covenant breaches or distress. Total loan exposures at April 4, 2011 of £167 million (April 4, 2010: £39 million) restructured during the year carry observed credit impairment provisions of £36 million at April 4, 2011 (April 4, 2010: £19 million). In addition loans at April 4, 2011 of £62 million (April 4, 2010: £135 million) reported as up to date have been renegotiated through repayment plans offering a concessionary payment to genuinely distressed borrowers or by consolidating arrears on to the balance of the loan.
The following table presents collateral held against past due or impaired commercial loans:
As at April 4, As at April 4,
| 2011 | 2010 | |||
|---|---|---|---|---|
| (£ million, except percentages) | ||||
| Past due but not impaired | 93% | 292 | 98% | |
| Impaired | 1,050 | 74% | 1,161 | 87% |
| Total | 1,413 | 78% | 1,453 | 89% |
Collateral held in relation to secured loans that are either past due or impaired is capped at the amount outstanding on an individual loan basis. The percentages in the table above represent the cover over the impaired asset. No collateral is held against the commercial property held in possession.
The following table presents negative equity on commercial loans:
| As at April 4, 2011 |
As at April 4, 2010 |
|
|---|---|---|
| (£ million) | ||
| Past due but not impaired | 28 | 5 |
| Impaired | 369 | 173 |
| Possessions | 1 | - |
| Total | 398 | 178 |
In consumer banking personal loans and credit cards have arrears levels significantly lower than averages for the industry according to the Finance & Leasing Association ("FLA") and the UK Payments Association ("APACS") as shown in the table below, which presents the percentage of personal loans and credit card accounts more than 30 days in arrears:
| April 4, 2011 Nationwide |
April 4, 2011 Industry |
April 4, 2010 Nationwide |
April 4, 2010 Industry(1) |
||||||
|---|---|---|---|---|---|---|---|---|---|
| (percentages) | |||||||||
| Personal loans | 5.45 | 20.00 | 7.07 | 19.6 | |||||
| Credit card | 3.36 | 5.77 | 5.15 | 6.64 |
Note:
(1) Industry numbers for Personal Loans and Credit Cards for the prior period have been restated by the FLA and APACS respectively.
______________
The Society has a strong and well diversified funding base, which continues to be predominantly funded by retail savings. Over the course of the year ended April 4, 2011, we have continued to actively manage our balance sheet in response to conditions in both the retail and wholesale markets. However, in contrast to the position over the previous financial year, balance sheet liabilities have only marginally decreased, with an increase in members' balances partly offsetting a modest reduction in wholesale funding.
As a building society, we have always maintained a high level of unencumbered liquid assets relative to our banking peers, and our core liquidity remains stable at 13.8% at April 4, 2011 (April 4, 2010 13.8%). The size of our liquidity buffer in combination with the improving profile of the wholesale funding portfolio has continued to improve the Group's overall liquidity position.
Liquidity, together with funding and capital, represents the cornerstone of the financial management of a financial institution. Much focus has been applied to this discipline by regulatory authorities in recent years. This has resulted in the FSA publishing a liquidity policy statement, PS 09/16, for firms categorized as "BIPRU firms" in the FSA's UK Prudential Sourcebook For Banks, Building Societies and Investment Firms ("BIPRU"). In addition, the FSA has set out a separate risk management framework for building societies, PS 10/5. Compliance with these new policy statements, given their tight timeframes, has been a key objective of ours during the past year: PS09/16 required the completion of an Individual Liquidity Adequacy Assessment ("ILAA") by June 2010, and PS10/5 required a building society to have communicated its financial risk management and lending approaches to the FSA by October 2010. While these timeframes have both been met, there are additional requirements including aspects of regulatory reporting and stress testing which will necessitate further work into 2011.
Liquid assets generally comprise cash deposits held with central banks or unencumbered securities that may be freely sold or are capable of financing through repurchase agreements or other similar arrangements either directly with those central banks, to which we have direct access, or with market counterparties. The stock of liquid assets managed by our Treasury Division fall into the following four categories:
We have continued to focus on the growth and diversification of our core liquidity portfolio through investing in a greater volume of highly liquid sovereign securities. The core portfolio is aligned to the 'Liquid Assets Buffer' defined by the FSA in BIPRU 12 and comprises:
As at April 4, 2011, the core liquidity portfolio as a percentage of adjusted share, deposit and loan liabilities was 13.8%, compared to 13.8% at April 4, 2010 and 12.8% at April 4, 2009. This calculation is made net of any core liquidity holdings that are subject to repo arrangements and includes assets held under reverse repo arrangements and Treasury bills held under the Special Liquidity Scheme.
In addition to the core portfolio, as at April 4, 2011 the Group held a stock of unencumbered securities (excluding self-issuance) that are eligible collateral for either the European Central Bank ("ECB") repo operations or for the BoE extended collateral repo operations. In terms of their relative liquidity characteristics, these assets may be viewed as the next tier below the core liquidity portfolio.
Nationwide holds other third party liquid assets (such as Floating Rate Notes) that are not eligible at either the BoE's or the ECB's operations, but may be capable of financing through third party repo agreements.
The Group holds a stock of self-issued AAA RMBS and covered bonds. These self-issued securities are capable of repo financing either directly with the market or with central banks to which the Group has direct access, and therefore represent contingent liquidity available to the Group if necessary.
The table below sets out the fair value – before any "haircut" deduction – of each of the above liquidity types as at April 4, 2011. The table includes off balance sheet liquidity (including treasury bills held under the Special Liquidity Scheme and self-issued RMBS and covered bonds) but excludes any encumbered assets:
| As at April 4, 2011 |
As at April 4, 2010 |
|
|---|---|---|
| (£ billion) | ||
| Core liquidity | 23.5 | 23.4 |
| Other central bank eligible assets | 5.6 | 4.7 |
| Other securities | 3.2 | 3.4 |
| Total | 50.6 | 43.3 |
|---|---|---|
| Self-issued RMBS and covered bonds | 18.3 | 11.8 |
The retail savings market in the UK has been relatively subdued in the year ended April 4, 2011, with market growth in balances of £18.6 billion driven mainly by interest capitalized. This contrasts with the extremely competitive conditions in the financial year ended April 4, 2010, where a lack of access to wholesale markets led some institutions to compete aggressively for retail deposits by offering attractive rates to generate demand, resulting in market balance growth of £30.6 billion in the year ended April 4, 2011.
We have continued to actively manage our flow of retail savings in order to secure funds at an economic rate whilst offering long term good value products to our members. In the year ended April 4, 2011, we have attracted a positive inflow of funds, and retail savings balances have increased by £1.6 billion to £122.6 billion at April 4, 2011. This compares with a net reduction in retail savings balances of £7.3 billion in the year ended April 4, 2010.
The increase in retail savings balances combined with a marginal decrease in balance sheet size has resulted in a reduction in wholesale funding balances such that the wholesale funding level reduced to 25.9% as at April 4, 2011 compared to 27.8% at April 4, 2010.
An analysis of our wholesale funding (made up of deposits from banks, other deposits and debt securities in issue as disclosed on the balance sheet) is set out in the following table:
| As at April 4, 2011 | As at April 4, 2010 | ||||
|---|---|---|---|---|---|
| (£ billion, except percentages) | |||||
| Repo and other secured agreements | 2.7 | 5.9% | 7.9 | 16.0% | |
| Deposits | 6.9 | 15.0% | 6.1 | 12.4% | |
| Certificates of deposit | 4.7 | 10.2% | 6.1 | 12.4% | |
| Commercial paper | 6.2 | 13.4% | 6.4 | 13.0% | |
| Covered bonds | 12.3 | 26.7% | 9.1 | 18.4% | |
| Medium term notes | 8.4 | 18.2% | 10.1 | 20.5% | |
| Securitizations | 3.7 | 8.0% | 2.2 | 4.5% | |
| Other non-retail | 1.2 | 2.6% | 1.4 | 2.8% | |
| Total | 46.1 | 100.0% | 49.3 | 100.0% |
The reduction in the absolute amount of wholesale funding and in the wholesale funding ratio at April 4, 2011 is a function of the overall management of the Group's balance sheet, as we have controlled the level and quality of lending undertaken. However, we have seen much improved access to wholesale funding as general market uncertainty has eased.
Following the increase in retail and long term wholesale funding balances, we reduced short term repo transactions and repaid central bank facilities. We continue to attract funds into PEBs and during the year ended April 4, 2011 we received new investment premiums of £1.0 billion, increasing total PEB balances to £2.1 billion as at April 4, 2011 (April 4, 2010: £1.1 billion).
During the 2010/11 financial year, we remained active in the long term debt markets utilizing all of our debt issuance programs and issuing £5.8 billion (including €750 million lower Tier 2 subordinated notes), far in excess of our more modest £1.8 billion equivalent of maturing long term debt. The focus has provided breadth and diversification to the previous year's unsecured issuances.
We believe that the following long-term wholesale debt issuances during the year demonstrate both the strength of institutional support, and this breadth of funding diversity, for Nationwide:
In addition, the Group issued €750 million of lower Tier 2 subordinated notes. This issuance refinanced the subordinated notes that we repaid in August 2010 and further demonstrates the strength of institutional support for the Group. On December 17, 2010, we also repaid £100 million of subordinated notes.
In the year ended April 4, 2011, the Group reduced the amount of short term funding outstanding to £15 billion (April 4, 2010: £16 billion and April 4, 2009: £20 billion), but still enjoys a strong franchise in these markets, which is reflected in the average term at issuance of the short term funding book, being 156 days at April 4, 2011 (April 4, 2010: 155 days).
In the year ended April 4, 2011, the Group extended the residual maturity profile of its wholesale funding portfolio from 26 months at April 4, 2010 to 33 months at April 4, 2011 and increased the split between short and long term with a further reduction in the less than one year maturity category to 43.4% at April 4, 2011 (April 4, 2010: 49.7%).
The table below sets out the residual maturity of the wholesale funding book:
| As at April 4, 2011 | As at April 4, 2010 | ||||
|---|---|---|---|---|---|
| (£ billion, except percentages) | |||||
| Less than one year | 20.0 | 43.4% | 24.5 | 49.7% | |
| One to two years | 4.9 | 10.6% | 4.3 | 8.8% | |
| Two to five years | 13.6 | 29.5% | 11.7 | 23.6% | |
| More than five years | 7.6 | 16.5% | 8.8 | 17.9% | |
| Total | 46.1 | 100.0% | 49.3 | 100.0% |
Our short and long term credit ratings from the major rating agencies as at February 22, 2012 are as follows:
| Long Term | Short Term | Subordinated | Date of last rating action(1) |
|
|---|---|---|---|---|
| S&P | A+ | A-1 | BBB+ | December 2011 |
| Moody's | A2 | P-1 | Baa3 | October 2011 |
| Fitch | A+ | F1 | A- | November 2011 |
| DBRS | AA | R-1 (middle) | AA (low) | December 2010 |
Note:
______________
(1) The current outlook from Moody's and S&P is stable. The outlook from Fitch and DBRS is negative.
On October 7, 2011 Moody's announced that it was downgrading the senior debt and deposit ratings of 12 UK financial institutions and confirming the ratings of one institution, following its review of systemic support assumptions from the UK government for these institutions, which it initiated on May 24, 2011. The ratings actions announced included a two-notch downgrade of our long-term debt rating from Aa3 to A2. See "Risk Factors—Risks Related to Our Business—Rating downgrade and/or market sentiment with respect to Nationwide, the sector, the UK and/or other sovereign issuers may have an adverse effect on our performance and/or the marketability and liquidity of the Notes".
On November 3, 2011, Fitch announced that it was downgrading the long-term and short-term ratings of the Issuer and its debt and that such rating actions were consistent with Fitch's broad review of European banks. The ratings actions announced included a downgrade of the Issuer's long-term debt rating from AA- to A+. See "Risk Factors—Risks Related to Our Business—Rating downgrade and/or market sentiment with respect to Nationwide, the sector, the UK and/or other sovereign issuers may have an adverse effect on our performance and/or the marketability and liquidity of the Notes".
A credit rating is not a recommendation to buy, sell or hold securities and may be subject to revision, suspension or withdrawal at any time by the assigning rating organization.
Group treasury assets at April 4, 2011 were £31.9 billion compared with £29.4 billion at April 4, 2010 and are held in two separate portfolios: the treasury liquidity portfolio (previously known as the prudential portfolio) and the investment portfolio. At April 4, 2011, the treasury liquidity portfolio totaled £28.6 billion compared with £25.7 billion at April 4, 2010 with the investment portfolio totaling £3.3 billion compared with £3.7 billion at April 4, 2010.
We have continued to manage the treasury liquidity portfolio to increase the quality and liquidity of the assets with over 65% of the portfolio held in sovereign and supranational exposures compared with 63% as at April 4, 2010. Over 99% of the portfolio is rated A or better with 86% rated AA or above at April 4, 2011 compared with 99% rated A or better and 85% rated AA or better at April 4, 2010.
The following tables show the breakdown of the liquidity portfolio at April 4, 2011 and April 4, 2010 by credit rating and geography:
| As at April 4, 2011 | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|
| Credit Rating | Geography | ||||||||||
| Liquidity Portfolio |
AAA | AA | A | Other | UK | US | Europe | Other | |||
| (£ billion) | (percentages) | ||||||||||
| Bank of England | 6.1 | 100 | - | - | - | 100 | - | - | - | ||
| Loans to financial institutions |
3.7 | - | 44 | 56 | - | 73 | - | 15 | 12 | ||
| Other (including items in transit and clearing accounts) |
0.6 | - | - | - | - | 100 | - | - | - | ||
| Non AFS Assets | 10.4 | ||||||||||
| Gilts | 8.6 | 100 | - | - | - | 100 | - | - | - | ||
| Non Domestic Government Bonds |
2.2 | 100 | - | - | - | - | 40 | 60 | - | ||
| Supranational bonds | 1.8 | 100 | - | - | - | - | - | 100 | - | ||
| Residential mortgage backed securities |
2.3 | 85 | 11 | 2 | 2 | 43 | - | 52 | 5 | ||
| Covered bonds | 0.7 | 67 | 18 | 8 | 7 | - | 4 | 88 | 8 | ||
| Medium term notes /floating rate notes |
2.6 | 13 | 18 | 49 | 20 | 18 | 11 | 58 | 13 | ||
| AFS Assets | 18.2 | ||||||||||
| Total liquidity portfolio | 28.6 | 77 | 9 | 13 | 1 | 71 | 4 | 22 | 3 |
| Credit Rating | Geography | ||||||||
|---|---|---|---|---|---|---|---|---|---|
| Liquidity Portfolio |
AAA | AA | A | BBB | UK | US | Europe | Other | |
| (£ billion) | (percentages) | ||||||||
| Bank of England | 4.0 | 100 | - | - | - | 100 | - | - | - |
| Loans to financial institutions |
1.7 | - | 36 | 59 | 5 | 78 | 1 | 5 | 16 |
| Other (including items in transit and clearing accounts) |
0.3 | - | - | - | - | 100 | - | - | - |
| Non AFS Assets | 6.0 | ||||||||
| Gilts | 6.4 | 100 | - | - | - | 100 | - | - | - |
| Non domestic government bonds |
3.9 | 100 | - | - | - | - | 43 | 57 | - |
| Supranational bonds | 2.0 | 100 | - | - | - | - | 2 | 98 | - |
| Residential mortgage backed securities |
2.7 | 96 | 4 | - | - | 43 | - | 52 | 5 |
| Covered bonds | 0.9 | 89 | 11 | - | - | - | 3 | 90 | 7 |
| Floating rate notes | 3.8 | 4 | 25 | 61 | 10 | 26 | 3 | 57 | 14 |
| Certificates of deposit and commercial paper |
- | - | - | - | - | - | - | - | - |
| AFS Assets | 19.7 | ||||||||
| Total liquidity portfolio | 25.7 | 78 | 7 | 14 | 1 | 55 | 7 | 34 | 4 |
As at April 4, 2010
Ratings are obtained from S&P in the majority of cases or from Moody's if there is no S&P rating available. Internal ratings are used if neither S&P nor Moody's ratings are available.
We have no direct sovereign exposure to Greece, Ireland, Italy, Portugal and Spain ("GIIPS").
Within the treasury assets we have £2.1 billion of non-sovereign securities from issuers in GIIPS countries as detailed in the table below. Of this, 59% is rated AA or above and 72% is rated A or above. This exposure has reduced by 28% in the year ended April 4, 2011 and a further nominal £621 million, primarily senior debt, matures in the current financial year:
| As at April 4, 2011 | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Greece £m |
Ireland £m |
Italy £m |
Portugal £m |
Spain £m |
Total £m |
||||
| Residential mortgage backed securities (RMBS) |
- | 155 | 149 | 64 | 442 | 810 | |||
| Covered bonds | - | 63 | - | 19 | 373 | 455 | |||
| Senior debt | - | 98 | 117 | 63 | 485 | 763 | |||
| Subordinated bonds | - | - | 11 | 17 | - | 28 | |||
| Other assets | 3 | - | 12 | - | 6 | 21 | |||
| Total | 3 | 316 | 289 | 163 | 1,306 | 2,077 |
| As at April 4, 2010 | ||||||
|---|---|---|---|---|---|---|
| Greece £m |
Ireland £m |
Italy £m |
Portugal £m |
Spain £m |
Total £m |
|
| Residential mortgage backed securities (RMBS) |
- | 194 | 196 | 80 | 519 | 989 |
| Covered bonds | - | 100 | - | 23 | 405 | 528 |
| Senior debt | 20 | 208 | 221 | 101 | 710 | 1,260 |
| Subordinated bonds | - | 34 | 11 | 21 | - | 66 |
| Other assets | 3 | - | 18 | - | 12 | 33 |
| Total | 23 | 536 | 446 | 225 | 1,646 | 2,876 |
The treasury investment portfolio was originally established to generate additional income for the Group. Over 84% of the investment portfolio at April 4, 2011 is rated A or better (April 4, 2010: 87%) with over 63% rated AA or better (April 4, 2010: 69%). The reduction in the portfolio during the year ended April 4, 2011 has been predominately driven by paydowns received relating to the asset- and mortgage-backed securities and maturing investments. We are managing the existing portfolio to minimize potential risk while reinvesting some of the paydowns into high quality secured assets. The portfolio has experienced some negative rating migration as a result of the ongoing implementation of rating agency methodology changes and continued asset quality deterioration, particularly for financial institution subordinated debt, US student loans, CMBS and US RMBS. However, the overall credit quality remains strong with only a low level of impairment incurred.
The following tables show the breakdown of the investment portfolio at April 4, 2011 and April 4, 2010 by credit rating and geography:
| As at April 4, 2011 | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Credit Rating | Geography | |||||||||
| Investment Portfolio – all AFS assets |
AAA | AA | A | Other | UK | US | Europe | Other | ||
| (£ billion) | (percentages) | |||||||||
| Collateralized debt obligations (CDO) |
0.1 | - | - | - | 100 | - | 100 | - | - | |
| Collateralized loan obligations–(CLO) |
0.6 | 6 | 82 | 12 | - | 26 | 74 | - | - | |
| Commercial mortgage backed securities |
0.6 | 39 | 23 | 16 | 22 | 66 | 14 | 20 | - | |
| Corporate bond portfolio | 0.1 | - | 40 | - | 60 | 60 | 40 | - | - | |
| Credit card backed securities | 0.2 | 100 | - | - | - | 17 | 83 | - | - | |
| Financial institutions including subordinated debt |
0.4 | - | 21 | 61 | 18 | 32 | 15 | 42 | 11 | |
| Other corporate bonds | - | - | 36 | - | 64 | 100 | - | - | - | |
| Residential mortgage backed securities |
0.5 | 31 | 30 | 19 | 20 | 76 | 22 | 1 | 1 | |
| US student loan | 0.7 | 68 | 6 | 17 | 9 | - | 100 | - | - | |
| Other investments | 0.1 | 22 | 21 | 31 | 26 | 28 | 44 | 19 | 9 |
| Total | 3.3 | 35 | 28 | 21 | 16 | 37 | 51 | 10 | 2 |
|---|---|---|---|---|---|---|---|---|---|
| As at April 4, 2010 | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Credit Rating | Geography | ||||||||
| Investment Portfolio – all AFS assets |
AAA | AA | A | Other | UK | US | Europe | Other | |
| (£ billion) | (percentages) | ||||||||
| Collateralized debt obligations (CDO) |
0.1 | - | - | - | 100 | - | 100 | - | - |
| Collateralized loan | 0.6 | 33 | 59 | 8 | - | 25 | 75 | - | - |
| Commercial mortgage backed securities |
0.6 | 60 | 19 | 11 | 10 | 47 | 14 | 39 | - |
| Corporate bond portfolio | 0.1 | - | 13 | 17 | 70 | 36 | 28 | 36 | - |
| Credit card backed securities |
0.3 | 99 | - | - | 1 | 42 | 58 | - | - |
| Financial institutions including subordinated debt |
0.7 | - | 22 | 64 | 14 | 21 | 33 | 39 | 7 |
| Other corporate bonds | - | - | 34 | 66 | - | 100 | - | - | - |
| Retail mortgage backed securities |
0.3 | 24 | 23 | 23 | 30 | 61 | 36 | 3 | - |
| US student loan | 0.8 | 98 | 1 | 1 | - | - | 100 | - | - |
| Other investments | 0.2 | 38 | 21 | 15 | 26 | 11 | 47 | 33 | 9 |
| Total | 3.7 | 49 | 20 | 18 | 13 | 27 | 55 | 16 | 2 |
An independent monthly review is coordinated by our Commercial and Treasury Credit Committee and undertaken by our Risk Management Division on the current and expected future performance of all treasury assets. A governance structure exists to identify and review underperforming assets and highlight the likelihood of future losses. In accordance with accounting standards, assets are considered impaired where there is objective evidence that current events and/or performance trends will result in a loss. For information regarding the monitoring of credit exposures, see the section entitled "Financial Risk Management—Credit risk".
Nationwide has £95 million of exposure to monoline insured transactions at April 4, 2011. Three holdings totaling £11 million were impaired in the year ended April 4, 2011 following coupon deferral (not covered by the terms of the insurance). We are reliant on the monoline insurance provider for one further holding (with an exposure of £2 million) but in all other cases we anticipate full repayment without any assistance from the insurance provider. This is mainly as a result of the approach taken upon investment, where we placed no reliance on the monoline insurance, requiring the investment to stand up to credit analysis in its own right.
In assessing impairment, the Group evaluates among other factors, the normal volatility in valuation, evidence of deterioration in the financial health of the investee, industry and sector performance and operational and financing cash flows. An impairment loss of £66 million at April 4, 2011 (April 4, 2010: £29 million) has been recognized in the income statement in respect of the treasury liquidity and investment portfolios. In addition, in the year ended April 4, 2010 impairments of £7 million were recognized on investments in equity shares.
The impairment loss on investment securities of £66 million in the year ended April 4, 2011 relates entirely to available for sale assets. The loss of £36 million in the year ended April 4, 2010 included a £29 million charge on investment securities available for sale and £7 million in respect of other securities managed by our Treasury Division. The charge in the year ended April 4, 2011 on investment securities available for sale relates to a small number of US RMBS (£22 million), restructured Structured Investment Vehicle notes (£11 million), UK CMBS (£15 million) and Irish bank subordinated debt (£18 million). The prior year charge of £29 million was in respect of a small number of US Alt A RMBS exposures.
Collateral held as security for Treasury assets is determined by the nature of the instrument. Loans, debt securities, treasury and other eligible bills are generally unsecured with the exception of asset backed securities and similar instruments, which are secured by pools of financial assets. In addition, the Group holds collateral of £1.5 billion under reverse sale and repurchase agreements at April 4, 2011 (April 4, 2010 nil).
Out of a total of £31.9 billion of treasury assets held in the prudential and investment portfolios as at April 4, 2011, £21.5 billion are held as AFS and under IFRS they are marked to market though other comprehensive income and fair value movements are accumulated in reserves. The non AFS assets are predominantly short term loans to financial institutions or deposits with the BoE. Of the £21.5 billion of AFS assets, only £95 million are classified as Level 3 (not based on observable market data) for the purposes of IFRS 7.
The fair value movements of AFS assets that are not impaired have no effect on the Group's profit for the period or its regulatory capital. The assets have been carefully reviewed based upon latest performance data and an impairment charge of £66 million has been booked against AFS assets in the year ended April 4, 2011.
As at April 4, 2011, the balance on the AFS reserve had improved to £495 million negative, net of tax compared with £715 million negative as at April 4, 2010 reflecting improved pricing as market sentiment has improved.
The following table shows the breakdown of AFS reserves as at April 4, 2011 and April 4, 2010:
| As at April 4, 2011 | As at April 4, 2010 | ||||
|---|---|---|---|---|---|
| Cumulative AFS Reserve |
Fair Value on balance sheet |
Cumulative AFS Reserve |
Fair Value on balance sheet |
||
| (£ billion) | |||||
| Gilts and Supranational bonds | (0.1) | 12.6 | (0.3) | 12.3 | |
| Residential mortgage backed securities | 0.1 | 2.3 | 0.2 | 2.7 | |
| Covered bonds and floating rate notes | 0.3 | 3.3 | 0.1 | 4.7 | |
| Liquidity portfolio | 0.3 | 18.2 | - | 19.7 | |
| Collateralized debt obligations (CDO) | 0.1 | 0.1 | - | 0.1 | |
| Collateralized loan obligations (CLO) | - | 0.6 | 0.1 | 0.6 | |
| Commercial mortgage backed securities | 0.1 | 0.6 | 0.3 | 0.6 | |
| Corporate bond portfolio | - | 0.1 | - | 0.1 | |
| Credit card backed securities | - | 0.2 | - | 0.3 | |
| Financial institutions including sub debt | - | 0.4 | - | 0.7 | |
| Residential mortgage backed securities | 0.1 | 0.5 | 0.1 | 0.3 | |
| US student loan | 0.1 | 0.7 | 0.1 | 0.8 | |
| Other investments | - | 0.1 | 0.1 | 0.2 | |
| Investment Portfolio | 0.4 | 3.3 | 0.7 | 3.7 | |
| Negative AFS reserve before hedge accounting and taxation |
0.7 | 0.7 | |||
| AFS Assets | 21.5 | 23.4 | |||
| Hedge accounting adjustment for interest rate risk |
- | 0.3 |
| Taxation | (0.2) | (0.3) |
|---|---|---|
| Negative AFS reserve | 0.5 | 0.7 |
The following table provides an analysis of financial assets and liabilities held on our balance sheet at fair value, grouped into levels 1 to 3 based on the degree to which the fair value is observable:
| As at April 4, 2011 | ||||
|---|---|---|---|---|
| Level 1(1) | Level 2(2) | Level 3(3) | Total | |
| (£ million) | ||||
| Investment securities—AFS | 12,319 | 9,126 | 95 | 21,540 |
| Investments in equity shares | 5 | - | 98 | 103 |
| Derivatives financial instruments | - | 3,873 | 88 | 3,961 |
| Financial assets | 12,324 | 12,999 | 281 | 25,604 |
| Derivative financial instruments | - | (3,158) | (76) | (3,234) |
| Other deposits—PEB | - | - | (2,125) | (2,125) |
| Financial liabilities | - | (3,158) | (2,201) | (5,359) |
| As at April 4, 2010 | |||||
|---|---|---|---|---|---|
| Level 1 | Level 2 | Level 3 | Total | ||
| (£ million) | |||||
| Investment securities—AFS | 12,130 | 11,149 | 106 | 23,385 | |
| Investments in equity shares | - | 7 | 79 | 86 | |
| Derivatives financial instruments(4) | - | 4,814 | 38 | 4,852 | |
| Financial assets | 12,130 | 15,970 | 223 | 28,323 | |
| Derivative financial instruments(4) | - | (4,860) | (82) | (4,942) | |
| Other deposits—PEB | - | - | (1,128) | (1,128) | |
| Financial liabilities | - | (4,860) | (1,210) | (6,070) |
Notes:
______________
(4) The derivative financial instrument comparatives have been re-classified to conform to the current year's presentation. The adjustment does not affect total derivative financial assets and liabilities.
Level 2 investment securities—AFS assets are sourced from consensus pricing or other observable market prices. None of these Level 2 assets are priced off models. Level 2 derivative assets and liabilities are priced from discounted cash flow models using yield curves based on observable market data.
There were no significant transfers between the Level 1 and 2 portfolios during the year. Composition of and movements in the Level 3 portfolio are described below.
The main constituents of the Level 3 portfolio are as follows:
Of the £95 million level 3 investment securities at April 4, 2011, AFS CDOs account for approximately £60 million and £32 million are impaired UK CMBS assets, which are materially all priced from internal models based on observable and unobservable performance assumptions. The remaining £3 million is an illiquid security for which a single price was available.
Approximately half of the comparative level 3 securities totaling £106 million at April 4, 2011 were CDOs with the balance made up of investments in impaired Icelandic financial institutions and some other bonds and asset backed securities.
Investments in unquoted equity instruments. Valuations are subjective in nature but have been consistently applied over time. Full valuations are performed bi-annually using details of the underlying funds combined with earnings estimates and applicable discount rates at the reporting date.
Equity linked derivatives with external counterparties which economically match the investment return payable by the Group to customers invested in the PEB product. The derivatives are linked to the performance of specified stock market indices and have been valued by an independent third party.
Deposit accounts with the potential for stock market correlated growth linked to the performance of specified stock market indices. The PEBs liability is valued at a discount to reflect the time value of money, overlaid by a fair value adjustment representing the expected return payable to the customer. The fair value adjustment has been constructed from the valuation of the associated derivative as valued by an independent third party:
For further information and analysis of our capital resources, see "Capitalization and Indebtedness".
Capital is held by the Group to protect its depositors, to cover its inherent risks, to provide a cushion for unexpected losses, and to support the development of the business. In assessing the adequacy of its capital resources, the Group considers its risk appetite, the material risks to which the Group is exposed, and appropriate management strategies required to manage those risks. The Group is required to manage its capital in accordance with the rules issued by its regulator, the FSA. Since January 1, 2008, the Group has complied with the EU Capital Requirements Directive (Basel II).
As at September 30, 2012, and throughout all periods described herein, the Group complied with the capital requirements that were in force. From April 4, 2009, the Group calculated its capital requirements using Internal Ratings Based ("IRB") approaches for credit risks.
As at September 30, 2012, regulatory capital stood at £8.4 billion compared with £9.0 billion at April 4, 2012.
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| BASEL II | ||
| Tier 1 | (£ millions) | |
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| BASEL II | ||
| General reserve | 6,445 | 6,450 |
| Regulatory adjustments(1): | ||
| Prudential valuation adjustment(2) | - | (1) |
| Defined benefit pension fund adjustment(3) | 513 | 383 |
| Deductions: | ||
| Intangible assets(4) | (730) | (665) |
| Goodwill(4) | (16) | (16) |
| Excess of expected losses over impairment (50%) | (366) | (57) |
| Securitization positions (50%) | (145) | (152) |
| Other (50%) | (6) | (6) |
| Total regulatory adjustments and deductions | (750) | (514) |
| Core Tier 1 capital | 5,695 | 5,936 |
| Permanent interest bearing shares(5) | 1,664 | 1,625 |
| Total Tier 1 capital(6) | 7,359 | 7,561 |
| Tier 2 | ||
| Dated subordinated debt(5) | 1,429 | 1,475 |
| Revaluation reserve | 64 | 65 |
| Collectively assessed impairment allowances | 87 | 110 |
| Deductions: | ||
| Excess of expected losses over impairment (50%)(6) | (481) | (57) |
| Securitization positions (50%) | (145) | (152) |
| Other (50%) | (6) | (6) |
| Total deductions | (632) | (215) |
| Tier 2 capital | 948 | 1,435 |
| Total regulatory capital | 8,423 | 8,996 |
| Key capital ratios(7) | (percentages) |
| Core Tier 1 | 12.4 | 12.5 | |
|---|---|---|---|
| Tier 1(6) | 16.2 | 15.9 | |
| Total capital | 18.3 | 18.9 | |
| As at September 30, 2012 |
As at April 4, 2012 |
|
|---|---|---|
| BASEL II | ||
| Credit risk: | ||
| Retail mortgages | 16,165 | 15,958 |
| Commercial loans | 14,896 | 17,166 |
| Treasury | 3,972 | 3,632 |
| Other | 7,390 | 6,890 |
| Total credit risk | 42,423 | 43,646 |
| Operational risk | 3,609 | 3,760 |
| Market risk | 77 | 68 |
| Total risk weighted assets | 46,109 | 47,474 |
Notes:
____________
For further information and analysis of our capital resources, see "Capitalization and Indebtedness".
Our short-term borrowings fluctuate considerably depending on our current operating needs. The terms of our short-term borrowings are less than one year.
For details of the amounts of certain of our financial and other contractual liabilities and when payments are due, without taking into account customer deposits and deposits by other financial institutions, please see notes 32 and 33 to our 2012 audited consolidated financial statements incorporated by reference herein.
For a description of off-balance sheet commitment items under IFRS, see notes 34 to our 2012 audited consolidated financial statements incorporated by reference herein.
For details on our critical accounting policies under IFRS please see note 2 to our 2012 interim financial statements and note 2 to our 2012 audited consolidated financial statements incorporated by reference herein.
We are a building society, incorporated in England and Wales under the UK Building Societies Act 1986, as amended, and regulated by the FSA. Our FSA Mutuals Public Register Number is 355B. Our principal office is Nationwide House, Pipers Way, Swindon SN38 1NW (phone number +44 (0) 1793 513 513). We are the largest building society in the United Kingdom in terms of total assets. Our core business is providing personal financial services, including:
In addition, we maintain an investment portfolio of debt securities for our own account.
As at September 30, 2012, we held an estimated 10.9% of total UK residential mortgage balances. We are the third largest residential mortgage lender in the United Kingdom and the second largest UK savings provider (as calculated by Nationwide based on BoE data). On September 30, 2012, we held an estimated 10.8% of the total UK retail savings balances and had total assets of £193 billion.
As a mutual organization, we are managed for the benefit of our "members", our retail savings and residential mortgage customers, rather than for equity shareholders. Our main focus is serving our members' interests, while retaining sufficient profit to increase and further develop our business and meet regulatory requirements. We return value to our members by offering typically higher interest rates on savings and lower interest rates on loans than those offered by our main competitors. This returned value is commonly referred to as our member value. As a result of returning value to our members, we earn lower pre-tax profits than our main competitors, which are typically banks or other non-mutual organizations.
Profits on ordinary activities after tax for the six months ended September 30, 2012 and the year ended April 4, 2012 were £136 million and £179 million, respectively. For the six months ended September 30, 2012 and the year ended April 4, 2012, 74.5% and 83.5%, respectively, of our interest income before net (expense)/income on financial instruments hedging assets was attributable to the portfolio of secured loans (predominantly residential mortgage loans). By comparison, our only other major category of interest earning assets consists of investments managed primarily by our Treasury Division from which we earned approximately 25.5% and 16.5% of our interest income before net (expense)/income on financial instruments hedging assets for the six months ended September 30, 2012 and the year ended April 4, 2012, respectively.
Building societies have existed in the United Kingdom for over 200 years. From the outset, they were community-based, cooperative organizations created to help people purchase homes. The main characteristic of building societies is their mutual status, meaning that they are owned by their members, who are primarily retail savings customers and residential mortgage customers. Our origins go back to the Northampton Freehold Land Society, which was founded in 1848. Over time, this entity merged with similar organizations to create Nationwide Building Society.
Over the past 30 years, many building societies have merged with other building societies or, in some cases, transferred their businesses to the subsidiary of another mutual organization or demutualized and transferred their businesses to existing or specially formed banks. As a result, the number of building societies in the United Kingdom has fallen, from 139 at the end of 1985 to 47 as at September 30, 2012. One consequence of this decrease is that the majority of our competitors are banks. We believe that our mutual status allows us to compete successfully with banks, and it is our strategy to remain a building society. At our annual general meeting in 1998, our members voted against a proposal to demutualize and no subsequent motion to demutualize has since been proposed at a general meeting of the Society. However, it is possible that another motion to demutualize could be proposed and voted upon at a future general meeting. For a discussion of the risks associated with a demutualization, see the section entitled "Risk Factors—Risks Related to Our Business—Demutualization, mutual society transfers and consequences of the UK Building Societies Act may have an adverse impact on the holders of notes".
In 1997, when many of our competitors that were building societies demutualized, we experienced a sharp increase in the number of new UK member retail savings accounts. We believe that many of these accounts were opened because customers expected us to demutualize and wanted to receive any associated windfall distributions. To prevent the disruption caused by speculative account opening, we have generally required all new members opening accounts with us since November 1997 to assign to charity any windfall benefits which they might otherwise have received as a result of a future demutualization.
We have been involved in a number of mergers and acquisitions in recent years. We merged with Portman Building Society in August 2007 and with Cheshire Building Society and Derbyshire Building Society in December 2008. In March and June 2009 we also acquired selected assets and liabilities of Dunfermline Building Society. In addition, Nationwide opened its first branch in the Republic of Ireland in March 2009. We believe these developments have added value to Nationwide, improved our distribution footprint and helped to grow the membership and are a testament to the strength of Nationwide and our ability to provide support to other building societies.
Nationwide's vision is to be the United Kingdom's leading retail financial services provider. The Society is committed to remaining a building society because it believes that this is in the best long-term interests of its current and future members. Nationwide's strategy has three core strands:
While Nationwide aims primarily to drive its strategy through organic means, it actively seeks other opportunities that offer scale diversification benefits to add value to its members.
Nationwide is currently a leading provider of retail savings and residential mortgage products in the UK. Nationwide's aim, however, is to be recognised as the leading provider of personal financial services in the UK, supported by an employee culture that places customer service as the number one priority. Nationwide is therefore positioning itself as a challenger brand in the provision of current accounts, personal loan and credit cards. In particular, the Directors believe that current accounts are critical in enabling Nationwide to cultivate broader and deeper relationships with new and existing customers. Nationwide's strategic goals over the next five years include maintaining its current market shares in the mortgages and savings sectors, while growing its market share of personal current accounts to approximately 10 per cent. and expanding its presence in all other personal finance product lines to achieve market shares of at least 5.0 per cent.
As a national player with the size, scale and distribution capability to compete with the major banks operating in the UK, Nationwide intends to:
the transformation programme, which is expected to become operational in early 2013, will allow Nationwide to offer a suite of new personal banking products and drive this element of its strategy;
Nationwide provides long-term value to the Society's membership through sustainable pricing, actively targeting the delivery of value to its most committed and valuable customers through its status as a mutual. The delivery of pricing benefits to members is balanced by the Directors' belief that it is in the long-term best interests of all of the Society's present and future members to target a level of profit that is sufficient to achieve capital self-sufficiency. The goal complements the need to achieve sufficient profitability to deliver an appropriate level of return to investors in the Notes.
Given the current media focus on negative banking practices in the UK, Nationwide intends to continue to emphasise the safety and security its directors believe is offered by the mutual business model. As a building society, Nationwide's heritage and underlying balance sheet strength is based on accepting retail deposits and lending these to members to purchase residential property. Nationwide intends to continue to adopt a conservative risk appetite and to maintain a strong balance sheet with appropriate levels of capital and liquidity and access to a wide range of funding sources, thereby offering safety and security, and to drive deeper relationships with all stakeholders (including consumers, ratings agencies, regulators, investors and providers of wholesale funding).
Reflecting its mutual status and the fact that its customers are also it members, Nationwide intends to continue to provide simple, transparent products and to act as a consumer champion for clarity in financial services.
Nationwide operates in a commercially competitive manner, aiming to be as cost efficient as its competitors in the banking sector in order to maintain its mutual pricing advantage, while providing industry leading levels of employee engagement and enablement. In this connection, a shared services approach is expected to be implemented across Nationwide with a view to reducing costs and improving efficiency.
Nationwide's core business is providing retail personal financial services. Nationwide recognises that in order to compete ever more effectively with its competitors, it must build a broader business portfolio to complement its existing core business and diversify and expand its income streams. To date, this evolution has largely consisted of making controlled development into areas adjacent to its core, beginning with a move into cross-selling home and life insurance to mortgage customers. This was followed by the launch of FlexAccount, the first interest paying current account in the UK, which attracted large numbers of customers from the established banks. This move into current accounts was later accompanied by investment in the associated banking businesses of credit card and personal loans, and the provision of protection and investment advice to new and existing customers.
Nationwide's transformation programme is a key part of its business diversification strategy with its new banking system and internet bank in particular being intended to drive greater penetration into the personal current accounts market in particular. For further information on Nationwide's transformation programme, see "—Investments" below. Nationwide also intends to continue to expand its already strong presence in the residential buy-to-let market and to establish itself more fully in non-retail business streams by offering a wider range of banking services to SMEs and broadening its commercial deposit taking activities. Nationwide sees the planned expansion into the SME market as a natural extension of its current business and intends to adopt a cautious approach to its expansion, seeking to limit its risk exposure and to gain experience before broadening its offering to a wider customer base. To that end, it aims to launch a banking proposition for micro businesses (being businesses with an annual turnover of up to £2 million) in second half of its financial year ended 4 April 2014, followed by one for medium enterprises (being enterprises with an annual turnover of between £2 million and £10 million) in its financial year ended 4 April 2015. The products are expected to be simpler and more transparent than those currently available to the SME market and the Society intends to use its existing technical and physical infrastructure to offer a market leading level of service. The proposition will be led by deposit products, with an initial target of raising £6 billion in deposits and increasing lending by £3 billion by the end of the Society's financial year ended 4 April 2018, although the Society's ability to achieve these targets is dependent on a range of factors outside its control and no assurance is given that the targets will be achieved in the timeframe envisaged.
Nationwide continues to consider potential acquisition opportunities that offer scale, business and diversification benefits that the Directors believe will add value to its members.
Nationwide's principal five year strategic goals are to:
Our lending activities are primarily concentrated on residential mortgage lending in the United Kingdom. We also engage in a limited amount of commercial secured lending and secured and unsecured consumer lending.
The vast majority of our lending portfolio consists of UK residential mortgage loans to individuals. Residential mortgage loans to individuals are secured on the residential property of the borrower on terms which allow for repossession and sale of the property if the borrower breaks the terms and conditions of the loan. Our policy is for all residential mortgage loans to individuals to be fully secured first priority loans on the mortgaged property, to ensure that our claim to the property, in the event of default, is senior to those of other potential creditors. As a result, our residential mortgage lending to individuals carries lower risk than many other types of lending.
As at September 30, 2012, we were the third largest mortgage lender in the United Kingdom (as measured by total loans outstanding) (as calculated by Nationwide based on BoE data). As at September 30, 2012, our total prime and specialist residential mortgage lending amounted to £132.2 billion (£128.8 billion as at April 4, 2012). During the six months ended September 30, 2012, our gross new prime and specialist residential mortgage lending amounted to £10.2 billion, compared to £18.4 billion for the year ended April 4, 2012. Our residential mortgages are generally for terms of 20 to 30 years. While many customers remain with Nationwide for much or all of this term, some customers redeem their mortgage earlier than this in order to remortgage to another lender or for other reasons. The minimum life of a mortgage is usually between two and five years, depending on the terms of the customer's initial product, although Nationwide generally retains approximately 85 to 90% of customers when they reach the end of a product.
We have a national franchise within the United Kingdom, with a regional distribution of UK residential mortgage lending to individuals generally matching the regional Gross Domestic Product ("GDP") distribution in the United Kingdom. Below is a table showing the geographical distribution of our UK residential mortgage loans as at September 30, 2012:
| Nationwide only | Total Market | |
|---|---|---|
| Region | ||
| South-east England (excluding London) |
30% | 26% |
| Central England | 18% | 16% |
| Northern England | 16% | 18% |
| Greater London | 14% | 20% |
| South-west England | 9% | 8% |
| Scotland | 8% | 7% |
| Wales and Northern Ireland | 5% | 5% |
| Total | 100% | 100% |
_________________
We offer fixed rate and tracker rate mortgages. These products establish a set rate or set methodology for determining a variable rate for a set term, after which the rate reverts to one of our two general variable rates. Our fixedrate products currently offer a term of two, three, four or five years, but we have from time to time offered longer fixed terms, including 10 and 25 years. Our tracker rate products bear interest during the set term (currently two, three or five years) at a variable rate that is a fixed percentage above the BoE base rate. After the end of the set fixed rate or tracker period, the interest rate reverts to either our base mortgage rate (if the mortgage was originated on or before April 29, 2009) or our standard mortgage rate (if the mortgage was originated on or after April 30, 2009). Both our base mortgage rate and our standard mortgage rate are variable rates set at our discretion, except that our base mortgage rate is guaranteed not to be more than 2% above the BoE base rate.
To reduce the costs associated with early repayment of mortgages and to recover a portion of the costs of mortgage incentives, we impose early repayment charges on some products. The early repayment charges generally apply for repayment made prior to the expiration of the fixed or tracker rate for the particular product.
The following table sets forth the total residential mortgage loans to individuals by product type that we had outstanding as at September 30, 2012 as a percentage of our total residential mortgage loans to individuals:
| As at September 30, 2012 | |
|---|---|
| Mortgage Type | |
| Standard variable rate including base mortgage rate | 56% |
| Fixed rate | 33% |
| Tracker rate | 11% |
| Total | 100% |
An analysis of our gross advances on UK residential mortgage loans to individuals by product type over the six months ended September 30, 2012 and the two financial years ended April 4, 2012 and April 4, 2011 is shown in the following table:
| For the six months ended September 30, |
For the year ended April 4, | ||
|---|---|---|---|
| 2012 | 2012 | 2011 | |
| Mortgage Type | |||
| Base mortgage rate | 7% | 7% | 6% |
| Fixed rate | 71% | 65% | 60% |
| Tracker rate | 22% | 28% | 34% |
| Total | 100% | 100% | 100% |
Our asset quality has remained strong as a result of our continued prudent approach to lending. The average LTV of new residential lending is low at 66% (April 4, 2012: 63%) as we have increased our proportion of lending to the remortgage market. The indexed LTV for the whole residential portfolio has remained stable at 50% (April 4, 2012: 50%). Only 5% of our total mortgage book has an LTV in excess of 90%. The proportion of the Group's mortgage accounts three months or more in arrears has reduced to 0.70% as at September 30, 2012 (April 4, 2012: 0.73%), this compares favorably with the CML industry average of 1.93%.
The following table compares our loans in arrears against the UK industry average:
| Nationwide(1) | UK Industry Average(2) |
|
|---|---|---|
| Arrears | ||
| 3-6 months | 0.33% | 0.87% |
| 6-12 months | 0.22% | 0.62% |
| Over 12 months | 0.12% | 0.44% |
| _____ |
Notes:
(1) Nationwide prime and specialist residential lending as at September 30, 2012.
(2) Source: CML September 30, 2012.
We utilize an automated credit scoring system to assist in minimizing credit risk on residential mortgage lending. Our credit procedures for residential mortgage lending take into account the applicant's credit history, loan-to-value criteria, income multiples and an affordability calculation, or shock test, that tests the applicant's ability to service the loan at higher interest rates. For additional information regarding how we manage credit risk in connection with new lending, see "Financial Risk Management—Credit risk".
We focus our residential mortgage sales efforts on first-time buyers, subsequent purchasers moving home and the remortgage market. In current market conditions, we are particularly keen to support our existing members and have introduced products to support first-time buyers. First-time buyers offer a significant potential for additional sources of income through the distribution of insurance and personal investment products. During the six months ended September 30, 2012, 25% of residential mortgage advances calculated on a volume basis were to first-time buyers and 75% to experienced buyers. This compares to the year ended April 4, 2012 when 17% of residential mortgage advances were to first-time buyers and 83% to experienced buyers.
In addition to residential mortgage loans, we offer further secured advances on existing mortgaged property to customers consistent with our lending criteria for new residential mortgage loans.
We offer specialist UK residential mortgage lending to individuals, which comprises lending to private landlords (buy to let), loans to prime borrowers who have self-certificated their income (self-certified) and other non-conforming lending.
As at September 30, 2012, our outstanding specialist UK residential mortgage lending to individuals was £24.2 billion. The specialist residential mortgage balance is made up of advances made through our specialist lending brands, TMW and UCB, and from the acquisitions of the Cheshire, Derbyshire and Dunfermline building societies portfolios. Our outstanding specialist lending loans were advanced primarily in the buy to let and self-certification markets. New specialist lending is restricted to buy to let with Nationwide having withdrawn from the self-certified lending market in 2009. A breakdown of our specialist UK residential mortgage lending outstanding balances as at September 30, 2012 is shown in the table below:
| Buy to let | 79% |
|---|---|
| Self-certified | 14% |
| Near prime | 5% |
| Sub prime | 2% |
| Total | 100% |
As demand for good quality rental property has risen, the Buy to Let sector has continued to perform strongly. The Group has played an active role in supporting this sector through its subsidiary, TMW, which continues to focus on originating high quality buy to let loans. Gross lending through the brand during the six months ended September 30, 2012 and the year ended April 4, 2012 was £1.7 billion and £4.4 billion, respectively, making TMW one of the most influential lenders in the sector. The average LTV for new specialist business has been 68% in the six month period ended September 30, 2012.
The overall specialist lending book has grown to £24.2 billion as at September 30, 2012 (April 4, 2012: £23.2 billion), with arrears levels performing well.
There has been a reduction in specialist arrears as a result of reducing arrears volumes on the self originated books, and strong book growth in TMW. TMW continues to maintain a very favorable arrears position relative to the industry on both originated business and total lending including acquired loans. Our specialist mortgages continue to perform well with cases three months or more in arrears representing only 1.67% of the total mortgage book as at September 30, 2012 (April 4, 2012: 1.87%), which compares favorably to the overall industry measure (Source: Council of Mortgage Lenders, September 30, 2012), that is inclusive of prime lending, of 1.93% as at September 30, 2012 (April 4, 2012: 1.95%).
We engage in commercial secured lending, which as at September 30, 2012 accounted for 13.3% of our total loan assets. To maintain a prudent balance between our asset classes, we currently have a 20% cap on commercial lending as a percentage of our total lending (book balances). We intend to maintain a low risk exposure to commercial secured lending and to maintain the existing level of credit quality throughout our commercial loan portfolio.
The amount and types of loans in the commercial portfolio as at September 30, 2012 were as follows:
| As at September 30, 2012 | ||
|---|---|---|
| £ billions | % of total commercial loans |
|
| Commercial Secured Loans | ||
| Property finance | 11.0 | 52.6% |
| Registered Social Landlords | 8.4 | 40.2% |
| Project finance | 1.5 | 7.2% |
| Total | 20.9 | 100% |
Loans made to UK Registered Social Landlords are secured on residential property and differ significantly from other loans secured on real property. UK Registered Social Landlords provide affordable housing supported by government grants. This portfolio historically has carried a lower risk than our other commercial lending activities, and there are currently no arrears of three months or more in our Registered Social Landlord portfolio. To date we have not needed to raise any loss provisions against this portfolio. We are the largest lender to UK Registered Social Landlords by amount of assets lent.
Loans advanced in relation to Project Finance are secured on cash flows from government backed contracts such as schools, hospitals and roads under the UK Private Finance Initiative legislation, and include assets acquired from Derbyshire, Cheshire and Dunfermline building societies. Again, the Group has never suffered any losses on lending in these markets and there are currently no arrears of three months or more.
The Group's Property Finance portfolio is well diversified by industry type and by borrower, with no significant exposure to development finance.
We engage in personal banking, which accounted for 2.0% of our total loan assets as at September 30, 2012 and 1.9% of our total loan assets as at April 4, 2012.
Unsecured consumer banking consists of loans that we make to individuals that are not secured on real or personal property. We offer three different forms of unsecured consumer lending:
There is a greater risk of loss on unsecured consumer lending than there is on residential mortgage lending because we have no security if the borrower defaults on the loan. Accordingly, unsecured consumer lending products bear higher interest rates than our residential mortgage products. To manage this risk, we use an automated credit scoring system that is designed to evaluate a borrower's ability to repay the loan. In addition, we impose a maximum limit on the size of unsecured consumer loans and encourage customers to take out payment protection insurance.
For information regarding our credit card and overdraft facilities, see the subsections entitled "—Other Banking Services—Credit Cards" and "—Other Banking Services—Current Accounts".
We offer personal loans secured on residential property, which as at September 30, 2012 totaled £7 million.
The great majority of our retail funding is in the form of UK retail member deposits. In addition, we accept offshore deposits and deposits which do not convey member status. As at April 4, 2012 we had UK retail member deposits of £125.6 billion, which decreased to £125.1 billion as at September 30, 2012. UK retail member deposits represented 6.5% of our total liabilities and reserves as at September 30, 2012.
We provide a wide range of retail savings products that may be repayable on demand or notice and which may pay a variable or fixed rate of interest. On most retail savings products, we determine variable interest rates at our discretion according to market conditions. Generally, the more restrictions on withdrawal of retail savings, the higher the rate of interest. Balances on all of our notice deposit accounts are, by their terms, withdrawable on demand but, in some cases, subject to loss of interest. As at September 30, 2012, approximately 60% of our UK retail member deposits comprised variable rate savings products, while approximately 40% comprised fixed rate saving products.
We believe that the primary determinant for attracting retail savings is the interest rate offered to savers. As a mutual organization, we typically set higher interest rates on our retail funding products than those set by our main competitors. We gather UK retail member deposits from a number of sources, chiefly from our branch network but also by mail and internet-based deposit accounts.
The UK retail savings market is highly competitive among building societies and banks, including those banks owned by insurance companies and retailers. This competition has increased the relative cost of retail funds, especially new retail funds.
Our current account, called FlexAccount, is our checking and day-to-day transactional product. As at September 30, 2012, there were approximately 4.7 million FlexAccounts with £9.1 billion of credit balances and £181 million of overdrawn balances. Holders of FlexAccounts may be eligible for ATM cards, check books, overdraft facilities, check guarantee cards and debit cards depending upon the account holder's credit score and the performance of the account. The overdraft facility connected to the current account charges interest at one rate for authorized overdrafts and at a higher rate for unauthorized overdrafts.
We began issuing Nationwide-branded Visa credit cards to our customers in 1997 and had approximately 1.8 million active credit card accounts as at September 30, 2012. We market and process credit card applications ourselves (using our credit scoring system), and an outside contractor is responsible for billing and customer service functions. Our credit card holders receive differing credit limits, depending on their credit score. We do not charge customers an annual fee for using the credit card.
Despite recent economic events our credit card asset quality remains strong. Our percentage of credit card balances more than 30 days in arrears was 2.71% as at September 30, 2012*, having fallen from 2.72% as at April 4, 2012. Asset quality is monitored constantly both for new and existing exposures.
* The credit card figure quoted relates to August 2012, as the calculation is based on industry comparable calculations.
We offer offshore savings through our Isle of Man subsidiary, Nationwide International Limited, to give us access to another funding source. Nationwide International Limited offers demand and notice accounts in sterling, U.S. dollars and euros mainly to offshore investors. As at September 30, 2012, Nationwide International Limited had deposits of £5.1 billion.
We also provide our customers with foreign currency exchange and equity dealing services. We act as an agent in providing these services and assume no foreign exchange or equity price risk as a result of this activity.
Our Treasury Division centrally manages our liquid asset portfolios as well as most of our financial risk exposures, and raises funds on the money and debt capital markets.
The Treasury Division manages risk exposures, including market risk, by making use of derivative instruments such as swaps, futures and options, which reduce our exposure to changes in interest rates and currency rates. See the sections entitled "Financial Risk Management" and "Management's Discussion and Analysis of Financial Condition and Results of Operations—Overview" for further details of risk management.
We maintain two liquid asset portfolios, categorized as core liquidity and non-core liquidity:
We had no credit derivatives in place as at September 30, 2012 (as at April 4, 2012, we had no credit derivatives in place).
We raise funds from the money and debt capital markets, accepting time deposits and issuing certificates of deposit, commercial paper and medium-term notes. Funding from wholesale markets decreased to £46.0 billion as at September 30, 2012 from £49.1 billion as at April 4, 2012, representing a wholesale funding ratio of 24.3% (compared to 25.6% as at April 4, 2012).
We aim to achieve a diversified mix of wholesale funding by currency, investor category and maturity to prevent dependence on any particular funding sector. We have a variety of programs in place so that we can meet our short-term and long-term funding needs, including:
We do not operate a trading portfolio. It is our policy not to invest in emerging markets and we only have minimal exposure to non-investment grade debt.
During the six month period ended September 30, 2012 we sold approximately 32,200 protection plans and 82,300 investment products, and as at September 30, 2012 we had £7.4 billion assets under advice (April 4, 2012: £6.7 billion).
In conjunction with our core business of providing residential mortgage loans and retail savings, we develop and market insurance products branded with our name that are underwritten by third-party insurers. We sold our subsidiary Nationwide Life Limited to Legal & General on January 31, 2008, and as a result we no longer underwrite our own life assurance products. As part of our agreement, we distribute insurance products of Legal & General. We also have a new strategic distribution agreement for the supply of motor and travel insurance with Liverpool Victoria to provide our customers with a broader range of competitively priced products from one of the UK's top financial services companies.
Despite the ongoing challenges in the housing market home insurance sales are up 20% on the same period last year and our general insurance book now stands at 1.5 million covers. Other income from general insurance grew by 28% and from protection and investment by 15% in the six month period ended September 30, 2012, reflecting the success of our ongoing diversification strategy.
The insurance products that we market are:
We typically use leading insurers as third-party underwriters for these insurance products. We receive a commission and, in some cases, participate in the profits, but not the losses, from third-party underwritten insurance products that we market. This provides us with a significant source of non-interest income, and in the six months ended September 30, 2012 and the year ended April 4, 2012 we earned £74 million and £140 million, respectively, from general insurance fees. We generally market our insurance products to new and existing customers, and it is our policy to offer insurance products at competitive prices and with more comprehensive coverage than those products generally offered by our main competitors.
Our integrated and diversified distribution network allows our customers to choose how and when to undertake their transactions with us and has enabled us to expand our business while controlling costs. The distribution network helps us to achieve volume growth principally in residential mortgage lending and supports our retail funding activities. Developments in the network have focused on cost efficiency and meeting the needs of customers who are increasingly prepared to transact business by the internet, telephone and mail.
We distribute our products primarily through:
Our branch network continues to be a major source of our mortgage lending and retail funding. As at September 30, 2012 we had 775 branches of Nationwide Building Society in the United Kingdom and the Isle of Man. We believe that our branch network is an integral part of our distribution network and we expect to maintain its current size.
Our goal is to utilize our branch network efficiently. All of our branches market our residential mortgage, retail savings, personal lending, personal investment and insurance products. We commenced a Transformation program in 2008 to replace ageing legacy systems and to improve product innovation and customer service. Our new mortgage sales system has improved the service we are able to offer our intermediary customers.
Our telephone call centers are open 24 hours a day to service customers and receive calls from potential customers that are interested in our products. In addition, we use telemarketing to supplement our mortgage, insurance and personal loan marketing.
We offer mail-based savings accounts and, as at September 30, 2012 our main mail-based accounts, InvestDirect and 60 Day Direct, had balances of £2.2 billion. Mail-based savings accounts provide members with higher interest rates on their deposits in return for limiting them to transactions by mail, online banking and ATMs. We also use direct mail to market some of our products.
We launched an internet banking service in 1997. Our website allows customers to transact on their accounts and apply for a broad range of our products online.
Agents are third parties that we appoint to market our products and perform retail transactions. We had 18 appointed agents as at September 30, 2012. Agents are typically intermediary financial advisers or real estate agents and increase our retail distribution network. We remunerate agents for the transactions and sales they perform.
A substantial amount of our mortgage sales are introduced to us by third-party intermediaries. Distribution through third-party intermediaries accounted for approximately 64% of our new prime residential mortgage completions in the six months ended September 30, 2012 and 57% in the year ended April 4, 2012. Intermediaries range from large UK insurance companies to small independent mortgage advisers. We remunerate intermediaries for introducing mortgage business.
For the financial year ended April 4, 2012, we employed, on average, 17,706 full and part-time employees. Set out below are our average number of employees during the financial years ended April 4, 2012, 2011 and 2010, respectively:
| Average number of employees | For the year ended April 4, | |||
|---|---|---|---|---|
| 2012 | 2011 | 2010 | ||
| Full-time | 13,156 | 12,879 | 13,247 | |
| Part-time | 4,550 | 4,813 | 5,283 | |
| Total | 17,706 | 17,692 | 18,530 |
Approximately 70% of our employees are currently members of the Nationwide Group Staff Union. We are party to a collective bargaining agreement with the Nationwide Group Staff Union and believe that our relationship with our employees is good. We have never experienced any work stoppages.
Our interests in our principal subsidiary undertakings, all of which are consolidated, as at September 30, 2012 are set out below:
| 100% held subsidiary undertakings | Nature of business | |
|---|---|---|
| Nationwide International Limited(1) | Offshore deposit taker | |
| Nationwide Syndications Limited | Syndicated lending | |
| The Mortgage Works Limited | Centralized mortgage lender | |
| Derbyshire Home Loans Limited(1) | Centralized mortgage lender | |
| E-Mex Home Funding Limited(1) | Centralized mortgage lender | |
| UCB Home Loans Corporation Limited (1) | Centralized mortgage lender | |
| __ |
(1) Regulated entities subject to regulations which require them to maintain capital at agreed levels and so govern the availability of funds for distribution as dividends.
All the above subsidiary undertakings are limited liability companies which are registered in England and Wales and operate in the UK except for Nationwide International Limited, which is registered and operates in the Isle of Man.
Nationwide has interests in a number of entities which give rise to the risks and rewards that are in substance no different from if they were subsidiary undertakings. As a consequence, these entities are consolidated in our accounts.
The interests of Nationwide in these principal entities as at September 30, 2012 are set out below:
| Other Group undertakings | Nature of business | Country of registration | Country of operation |
|---|---|---|---|
| Nationwide Covered Bonds LLP |
Mortgage acquisition and guarantor of covered bonds |
England and Wales | UK |
| Silverstone Master Issuer plc Pride No. 1 LLP |
Funding vehicle Funding vehicle |
England and Wales England and Wales |
UK UK |
The net book value of our property interests as at September 30, 2012 consisted of the following:
| Freehold | Leasehold over 50 years |
Other leasehold |
Total | |
|---|---|---|---|---|
| (£ millions) | ||||
| Type of Property | ||||
| Branches and non-specialized buildings | 219 | 11 | 15 | 245 |
| Head office/administration centers | 113 | - | - | 113 |
| Residential property for rental | 9 | - | - | 9 |
| Total | 341 | 11 | 15 | 367 |
Like other UK financial institutions, we pay levies based on our share of protected deposits to the FSCS to enable the FSCS to meet claims against it. In 2008 a number of institutions were declared in default by the FSA. The FSCS has met the claims by way of loans received from H.M. Treasury. These loans total approximately £18 billion. The terms of these loans are interest only for the first three years, and the FSCS recovers the interest cost, together with ongoing management expenses, by way of annual levies on member firms over this period.
While it is anticipated that the majority of the borrowings will be repaid wholly from recoveries from the institutions concerned, the FSCS has advised of an expected shortfall. At current rates and based on latest information which is subject to change, our share of the expected shortfall would total approximately £100 million which, in line with the intentions of the FSCS on timing of resultant levies, we would expect to be recognized over three years beginning in the year ending April 4, 2013.
We also have a potential exposure to future levies resulting from the failure of the Dunfermline Building Society. The quantification and timing of such losses have yet to be determined and hence, although our share could be significant, no provision has been recognized. As further information is provided by the FSCS scheme we will continue to update our estimate of the amount of FSCS levies we will ultimately be required to pay.
As at September 30, 2012 we held a provision of £58 million in respect of the 2011/2012 and 2012/2013 scheme years (as at April 4, 2012: £111 million in respect of the 2011/2012 and 2012/2013 scheme years and as at April 4, 2011: £94 million in respect of the 2010/2011 and 2011/2012 scheme years). The Group estimates that a further provision of between £70 million and £80 million will be required during the second half of this financial year 2012/2013 in respect of the FSCS annual levy for the 2013/14 scheme year including the first amount of the £100 million expected shortfall described above.
On July 19, 2011, the Finance Act 2011 came into force, including the bank levy requirements enacted by section 73 and Schedule 19 thereof. The levy applies to UK banking groups, building societies and the operations of non-UK banks in the UK, but an allowance is given against the first £20 billion of relevant liabilities, meaning that smaller institutions will effectively be exempted from the levy charge. Certain liabilities are excluded from the charge including Tier 1 capital, insured retail deposits and repos secured on sovereign debt. Additionally, certain high quality liquid assets on the balance sheet are eligible to reduce the amount of liabilities in the charge. Levy rates have been announced as follows:
| Period | Rates | ||
|---|---|---|---|
| Short-term liabilities | Long-term liabilities | ||
| January 1, 2011 to February 28, 2011 | 0.05% | 0.025% | |
| March 1, 2011 to April 30, 2011 | 0.1% | 0.05% | |
| May 1, 2011 to December 31, 2011 | 0.075% | 0.0375% | |
| January 1, 2012 to December 31, 2012 | 0.088% | 0.044% | |
| From January 1, 2013 | 0.105% | 0.0525% |
Our financial statements for the year ended April 4, 2012 reflect a charge for the levy in the amount of £16 million. This charge is split between a £3 million charge for the period starting on January 1, 2011 and ending on April 4, 2011, and a £13 million charge for the year ended April 4, 2012. Both amounts appear in the 2012 accounts because the legislation had not been enacted at the time the accounts for the year ended April 4, 2011 were finalized, and as a result it was not possible to charge the 2011 liability at that time. This was disclosed on page 18 of the accounts for the financial year ended April 4, 2011.
The charge for the financial year ended April 4, 2013 is currently estimated to be £17 million. It is difficult to predict the precise charge, however, as the calculation is dependent on the closing balance sheet shape and size as well as on various specific exclusions and percentage splits.
The following information has been extracted from our management information systems. This information is unaudited. The information contained in this section should be read in conjunction with our consolidated financial statements as well as the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations".
The tables below present, in accordance with IFRS, the average balances for our interest-earning assets and interest-bearing liabilities together with the related interest income and expense amounts, resulting in the presentation of the average yields and rates for the financial years ended April 4, 2012, 2011and 2010, respectively:
| For the year ended April 4, 2012 | |||
|---|---|---|---|
| Average balance(1) |
Interest(2) | Average yield/ rate |
|
| (£ millions, except percentages) | |||
| Interest-earning assets: | |||
| Loans to credit institutions | 11,295 | 56 | 0.50% |
| Debt securities(2) | 27,924 | 406 | 1.45% |
| Loans to customers | 151,998 | 4,696 | 3.09% |
| Expected return on pension assets | - | 195 | - |
| Total average interest-earning assets | 191,217 | 5,353 | 2.80% |
| Non-interest-earning assets: | |||
| Tangible fixed assets | 964 | ||
| Fair value adjustment for hedged risk | 1,594 | ||
| Other financial assets at fair value | - | ||
| Other assets | 922 | ||
| Goodwill and intangible fixed assets | 606 | ||
| Investment properties | 9 | ||
| Deferred tax assets | 256 | ||
| Total average assets | 195,568 | ||
| Interest-bearing liabilities: | |||
| UK retail member deposits | 125,456 | 2,826 | 2.25% |
| Other deposits | 16,117 | 14 | 0.09% |
| Debt securities in issue and derivative financial instruments(2) |
42,267 | 624 | 1.48% |
| Subordinated liabilities | 1,858 | 58 | 3.12% |
| Tier 1 capital instruments | 1,608 | 42 | 2.61% |
| Unwind of discount of pension liabilities | - | 166 | - |
| Total average interest-bearing liabilities | 187,306 | 3,730 | 1.99% |
| Non-interest-bearing liabilities: | |||
| Other liabilities | 1,691 | ||
| Fair value adjustment for hedged risk | 211 | ||
| Other financial liabilities at fair value | - | ||
| Reserves | 6,265 | ||
| Current taxes | 95 | ||
| Total average liabilities | 195,568 | ||
| _____ |
Notes:
(1) Average balances are based on the balance as of the end of each month during the financial year.
(2) For the purpose of the average balance sheet, the interest income and expense amounts are stated after allocation of interest on financial instruments entered into for hedging purposes.
| For the year ended April 4, 2011 | |||
|---|---|---|---|
| Average | Average yield/ | ||
| balance(1) | Interest(2) | rate | |
| (£ millions, except percentages) | |||
| Interest-earning assets: | |||
| Loans to credit institutions | 7,155 | 32 | 0.45% |
| Debt securities(2) | 26,671 | 314 | 1.18% |
| Loans to customers | 150,825 | 4,129 | 2.74% |
| Expected return on pension assets | - | 168 | - |
| Total average interest-earning assets | 184,651 | 4,643 | 2.51% |
| Non-interest-earning assets: | |||
| Tangible fixed assets | 934 | ||
| Fair value adjustment for hedged risk | 2,257 | ||
| Other financial assets at fair value | 83 | ||
| Other assets | 617 | ||
| Goodwill and intangible fixed assets | 444 | ||
| Investment properties | 9 | ||
| Deferred tax assets | 372 | ||
| Total average assets | 189,367 | ||
| Interest-bearing liabilities: | |||
| UK retail member deposits | 122,259 | 2,510 | 2.05% |
| Other deposits | 15,140 | (87) | (0.57%) |
| Debt securities in issue and derivative financial | 40,436 | 427 | 1.06% |
| instruments(2) | |||
| Subordinated liabilities | 2,128 | 50 | 2.35% |
| Tier 1 capital instruments | 1,556 | 40 | 2.57% |
| Unwind of discount of pension liabilities | - | 166 | - |
| Total average interest-bearing liabilities | 181,519 | 3,107 | 1.71% |
| Non-interest-bearing liabilities: | |||
| Other liabilities | 1,693 | ||
| Fair value adjustment for hedged risk | 131 | ||
| Other financial liabilities at fair value | - | ||
| Reserves | 5,918 | ||
| Current taxes | 106 | ||
| Total average liabilities | 189,367 | ||
| _____ |
Notes:
(1) Average balances are based on the balance as of the end of each month during the financial year.
(2) For the purpose of the average balance sheet, the interest income and expense amounts are stated after allocation of interest on financial instruments entered into for hedging purposes.
| For the year ended April 4, 2010 | |||
|---|---|---|---|
| Average balance(1) |
Interest(2) | Average yield/ rate |
|
| (£ millions, except percentages) | |||
| Interest-earning assets: | |||
| Loans to credit institutions | 8,882 | 47 | 0.53% |
| Debt securities & derivative financial instruments(2) | 28,757 | 527 | 1.83% |
| Loans to customers | 153,989 | 3,872 | 2.51% |
| Expected return on pension assets | - | 122 | - |
| Total average interest-earning assets | 191,628 | 4,568 | 2.38% |
| Non-interest-earning assets: | |||
| Tangible fixed assets | 959 | ||
| Fair value adjustment for hedged risk | 2,770 | ||
| Other financial assets at fair value | 183 | ||
| Other assets | 953 | ||
| Goodwill and intangible fixed assets | 211 | ||
| Investment properties | 9 |
| For the year ended April 4, 2010 | ||||
|---|---|---|---|---|
| Average balance(1) |
Interest(2) | Average yield/ rate |
||
| (£ millions, except percentages) | ||||
| Reinsurance assets | - | |||
| Deferred tax assets | 716 | |||
| Total average assets | 197,429 | |||
| Interest-bearing liabilities: | ||||
| UK retail member deposits | 122,999 | 2,326 | 1.89% | |
| Other deposits | 20,609 | (132) | (0.64%) | |
| Debt securities in issue and derivative financial instruments(2) |
43,058 | 434 | 1.01% | |
| Subordinated liabilities | 2,144 | 43 | 2.01% | |
| Tier 1 capital instruments | 1,503 | 37 | 2.46% | |
| Unwind of discount of pension liabilities | - | 146 | - | |
| Total average interest-bearing liabilities | 190,313 | 2,854 | 1.50% | |
| Non-interest-bearing liabilities: | ||||
| Other liabilities | 1,678 | |||
| Fair value adjustment for hedged risk | 124 | |||
| Other financial liabilities at fair value | - | |||
| Reserves | 5,095 | |||
| Current taxes | 219 | |||
| Total average liabilities | 197,429 |
Notes:
_________________
(1) Average balances are based on the balance as of the end of each month during the financial year.
(2) For the purpose of the average balance sheet, the interest income and expense amounts are stated after allocation of interest on financial instruments entered into for hedging purposes.
The following tables show our average interest-earning assets, average interest-bearing liabilities and net interest income and illustrate the comparative net interest margin and net interest spread for the financial years ended April 4, 2012, 2011 and 2010, respectively:
| As at April 4, 2012 | ||
|---|---|---|
| (£ millions, except percentages) | ||
| Net average interest-earning assets | 191,217 | |
| Net average interest-bearing liabilities | 187,306 | |
| Net interest income(1) | 1,623 | |
| Average yield on average interest-earning assets | 2.80% | |
| Average rate on average interest-bearing liabilities | 1.99% | |
| Net interest spread(2) | 0.81% | |
| Net interest margin(3) | 0.83% | |
| _____ |
Notes:
(1) Defined as total interest income less total interest expense.
(2) Defined as the difference between the average yield on interest-earning assets and the average rate on interest-bearing liabilities.
(3) Defined as net interest income divided by average interest-earning assets.
| As at April 4, 2011 | |
|---|---|
| (£ millions, except percentages) | |
| Net average interest-earning assets | 184,651 |
| Net average interest-bearing liabilities | 181,519 |
| Net interest income(1) | 1,536 |
| Average yield on average interest-earning assets | 2.51% |
| Average rate on average interest-bearing liabilities | 1.71% |
| Net interest spread(2) | 0.80% |
| Net interest margin(3) | 0.81% |
| _____ |
(1) Defined as total interest income less total interest expense.
(2) Defined as the difference between the average yield on interest-earning assets and the average rate on interest-bearing liabilities.
(3) Defined as net interest income divided by average interest-earning assets.
| As at April 4, 2010 | |
|---|---|
| (£ millions, except percentages) | |
| Net average interest-earning assets | 191,628 |
| Net average interest-bearing liabilities | 190,313 |
| Net interest income(1) | 1,714 |
| Average yield on average interest-earning assets | 2.38% |
| Average rate on average interest-bearing liabilities | 1.50% |
| Net interest spread(2) | 0.88% |
| Net interest margin(3) | 0.87% |
| _____ |
Notes:
(1) Defined as total interest income less total interest expense.
(2) Defined as the difference between the average yield on interest-earning assets and the average rate on interest-bearing liabilities.
(3) Defined as net interest income divided by average interest-earning assets.
The following table allocates the changes in our interest income and expense between changes in average volume and changes in the average rates for the financial year ended April 4, 2012 compared to the financial year ended April 4, 2011. We calculated volume and yield/rate variances based on movements of average balances over the period and changes in average interest yields/rates on interest-earning assets and interest-bearing liabilities. The net change attributable to changes in both volume and rate has been allocated in line with the amounts derived for pure rate and volume variances. Pension interest income and expense has been excluded from the table as the assets and liabilities to which they relate are held net on the balance sheet. More information on the net pension liability can be found in our audited consolidated financial statements incorporated by reference herein:
| Year ended April 4, 2012 compared to year ended April 4, 2011 Increase/(decrease) in net interest due to changes in: |
|||
|---|---|---|---|
| Volume | Yield/rate | Total net change | |
| (£ millions) | |||
| Interest income:(1) | |||
| Loans to credit institutions | 20 | 4 | 24 |
| Debt securities | 17 | 75 | 92 |
| Loans to customers | 32 | 536 | 568 |
| Total interest income | 69 | 615 | 684 |
| Interest expense:(1) | |||
| UK retail member deposits | 67 | 249 | 316 |
| Amounts owed to credit institutions | (14) | (2) | (16) |
| Amounts owed to other customers | (23) | 140 | 117 |
| Debt securities in issue | 27 | 170 | 197 |
| Subordinated liabilities | (7) | 15 | 8 |
| Subscribed capital | 1 | 1 | 2 |
| Total interest expense | 51 | 573 | 624 |
| Net interest income | 18 | 42 | 60 |
| _____ |
Note:
(1) Interest income and expense amounts are stated after allocation of interest on financial instruments entered into for hedging purposes.
The following table allocates the changes in our interest income and expense between changes in average volume and changes in the average rates for the financial year ended April 4, 2011 compared to the financial year ended April 4, 2010. We calculated volume and yield/rate variances based on movements of average balances over the period and changes in average interest yields/rates on interest-earning assets and interest-bearing liabilities. The net change attributable to changes in both volume and rate has been allocated in line with the amounts derived for pure rate and volume variances. Pension interest income and expense has been excluded from the table as the assets and liabilities to which they relate are held net on the balance sheet. More information on the net pension liability can be found in our audited consolidated financial statements incorporated by reference herein:
| Year ended April 4, 2011 compared to year ended April 4, 2010 |
||||
|---|---|---|---|---|
| Increase/(decrease) in net interest due to changes in: | ||||
| Volume | Yield/rate | Total net change | ||
| (£ millions) | ||||
| Interest income:(1) | ||||
| Loans to credit institutions | (8) | (7) | (15) | |
| Debt securities | (35) | (178) | (213) | |
| Loans to customers | (81) | 340 | 259 | |
| Total interest income | (124) | 155 | 31 | |
| Interest expense:(1) | ||||
| UK retail member deposits | (14) | 198 | 184 | |
| Amounts owed to credit institutions | (101) | 69 | (32) | |
| Amounts owed to other customers | (31) | 108 | 77 | |
| Debt securities in issue | (25) | 18 | (7) | |
| Subordinated liabilities | - | 7 | 7 | |
| Subscribed capital | 1 | 2 | 3 | |
| Total interest expense | (170) | 402 | 232 | |
| Net interest income | 46 | (247) | (201) | |
| _____ |
Note:
(1) Interest income and expense amounts are stated after allocation of interest on financial instruments entered into for hedging purposes.
As at April 4, 2012, our investment securities portfolios were carried at a book value of £23,325 million, representing 11.9% of our total assets. Investment securities are split into two portfolios with approximately £16.7 billion of the assets in the core liquidity portfolio and approximately £6.6 billion of the assets in the non-core portfolio. We only purchase investment-grade debt securities and do not operate a trading portfolio. The following table provides information on the breakdown of our investment securities as at April 4, 2012, 2011 and 2010, respectively:
| As at April 4, | ||||
|---|---|---|---|---|
| 2012 | 2011 | 2010 | ||
| (£ millions) | ||||
| Investment securities | ||||
| UK government(1) | 12,796 | 8,569 | 6,388 | |
| Other public sector securities(2) | 3,750 | 3,994 | 5,958 | |
| Other issuers(3) | 6,779 | 8,977 | 11,039 | |
| Total | 23,325 | 21,540 | 23,385 |
Notes:
_________________
(1) As at April 4, 2012 UK government securities that we held were equal to 196% of our general and revaluation reserves compared to 127% as at April 4, 2011 and 99.3% as at April 4, 2010.
(2) Other public sector securities include securities issued by UK local authorities and sovereign debt backed by foreign (non-UK) governments.
(3) As at April 4, 2012, we held no securities issued by counterparties where the values of which individually exceeded 10% of our general and revaluation reserves.
The following table shows the contractual maturity of investment securities held as at April 4, 2012:
| As at April 4, 2012 | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Maturing within 1 year |
Maturing after 1 but within 5 years |
Maturing after 5 years but within 10 years |
Maturing after 10 years (£ millions) |
Accrued Interest |
Allowances | Total | |||
| UK government | - | 3,086 | 7,346 | 2,307 | 58 | - | 12,796 | ||
| Other public sector securities | 892 | 1,689 | 973 | 144 | 52 | - | 3,750 | ||
| Other issuers | 868 | 1,486 | 1,227 | 3,167 | 30 | - | 6,779 | ||
| Total | 1,760 | 6,261 | 9,546 | 5,618 | 140 | - | 23,325 |
The following table presents a further analysis of other issuers as at April 4, 2012, 2011 and 2010, respectively:
| As at April 4, | ||||
|---|---|---|---|---|
| 2012 | 2011 | 2010 | ||
| (£ millions) | ||||
| Investment securities – other issuers | ||||
| UK financial institutions | 536 | 410 | 595 | |
| European financial institutions | 1,045 | 2,170 | 3,164 | |
| Non European financial institutions | 537 | 725 | 942 | |
| Asset backed securities | 4,339 | 5,145 | 5,548 | |
| Other issuers | 322 | 527 | 790 | |
| Total | 6,779 | 8,977 | 11,039 |
As at April 4, 2012 total loans to customers excluding fair value adjustments for portfolio hedged risk, including accrued interest, were £152,973 million, representing 78% of our total assets. Our loan portfolio has increased by 2.3% during the last financial year from £153,598 million as at April 4, 2011 to £157,083 million as at April 4, 2012.
The following table summarizes our loan portfolio, net of allowances, as at April 4, 2012, 2011 and 2010, respectively:
| As at April 4, | ||||
|---|---|---|---|---|
| 2012 | 2011 | 2010 | ||
| (£ millions) | ||||
| Loans to customers: | ||||
| Residential mortgage loans | 128,645 | 124,453 | 127,313 | |
| Consumer banking | 2,888 | 2,376 | 2,143 | |
| Commercial Lending | 20,961 | 21,560 | 21,765 | |
| Other lending | 479 | 481 | 556 | |
| Total loans to customers | 152,973 | 148,870 | 151,777 | |
| Fair value adjustment for micro hedged risk(1) | 1,196 | 547 | 652 | |
| Loans and advances to banks | 2,914 | 4,181 | 2,017 | |
| Total | 157,083 | 153,598 | 154,446 |
Notes:
_________________
(1) Under IFRS the carrying value of the hedged item is adjusted for the change in value of the hedged risk.
The following table presents the contractual maturity distribution for repayment for the loans held by us as at April 4, 2012:
| As at April 4, 2012 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Due on Demand |
Due within 3 Months |
Due in 3 months to 1 year |
Due in 1 year to 5 years |
Due after 5 years |
Allowances | Total(1) | ||
| (£ millions) | ||||||||
| Loans to customers | 1,678 | 1,773 | 4,737 | 26,783 | 118,845 | (843) | 152,973 | |
| Loans and advances to banks | 2,197 | 377 | - | 148 | 192 | - | 2,914 | |
| Total Loans | 3,875 | 2,150 | 4,737 | 26,931 | 119,037 | (843) | 155,887 | |
| _____ |
Note:
(1) The maturity analysis is produced on the basis that where a loan is repayable by installments, each installment is treated as a separate repayment.
The following table presents the split of fixed and variable loans to customers and credit institutions as at April 4, 2012:
| As at April 4, 2012 | ||||||
|---|---|---|---|---|---|---|
| Outstanding | ||||||
| Fixed rate | Variable rate | Checks | Total(1) | |||
| (£ millions) | ||||||
| Loans to customers | 52,407 | 100,566 | - | 152,973 | ||
| Loans to credit institutions | 379 | 2,840 | (305) | 2,914 | ||
| Total loans | 52,786 | 103,406 | (305) | 155,887 |
Note:
(1) Outstanding checks were issued by Nationwide mostly on behalf of retail customers, and had not been presented through the banking system as at April 4, 2012.
_________________
Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognized using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. As a result, the concept of suspended interest and interest write back is no longer recognized.
The following table provides information on prime and specialist lending and consumer banking balances by payment due status as at April 4, 2012:
| As at April 4, 2012 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | % | ||||
| (£ billions, except percentages) | ||||||||
| Not impaired: | ||||||||
| Neither past due nor impaired | 103.1 | 21.3 | 2.9 | 127.3 | 97% | |||
| Past due up to 3 months but not impaired | 1.9 | 1.2 | 0.0 | 3.1 | 2% | |||
| Impaired | 0.5 | 0.8 | 0.1 | 1.4 | 1% | |||
| 105.6 | 23.3 | 3.0 | 131.8 | 100% |
The following table provides information on prime and specialist lending and consumer banking balances by payment due status as at April 4, 2011:
| As at April 4, 2011 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | % | ||||
| (£ billions, except percentages) | ||||||||
| Not impaired: | ||||||||
| Neither past due nor impaired | 101.8 | 18.2 | 2.3 | 122.3 | 96% | |||
| Past due up to 3 months but not impaired | 1.9 | 1.3 | 0.1 | 3.3 | 3% | |||
| Impaired | 0.6 | 0.8 | 0.1 | 1.5 | 1% | |||
| 104.3 | 20.3 | 2.5 | 127.1 | 100% |
The following table provides information on Prime and specialist lending and Consumer banking balances by payment due status as at April 4, 2010:
| As at April 4, 2010 | ||||||||
|---|---|---|---|---|---|---|---|---|
| Prime lending |
Specialist lending |
Consumer banking |
Total | % | ||||
| (£ billions, except percentages) | ||||||||
| Not impaired: | ||||||||
| Neither past due nor impaired | 106.3 | 16.5 | 2.1 | 124.9 | 96% | |||
| Past due up to 3 months but not impaired. | 1.9 | 1.2 | 0.0 | 3.1 | 3% | |||
| Impaired | 0.5 | 1.0 | 0.2 | 1.7 | 1% | |||
| 108.7 | 18.7 | 2.3 | 129.7 | 100% |
The Group assesses at each balance sheet date whether, as a result of one or more events that occurred after initial recognition, there is objective evidence that a financial asset or group of financial assets is impaired. Evidence of impairment may include indications that the borrower or group of borrowers are experiencing significant financial difficulty, default or delinquency in interest or principal payments or the debt being restructured to reduce the burden on the borrower.
The Group first assesses whether objective evidence of impairment exists either individually for assets that are separately significant or individually or collectively for assets that are not separately significant. If there is no objective evidence of impairment for an individually assessed asset it is included in a group of assets with similar credit risk characteristics and collectively assessed for impairment.
If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset's carrying amount and the present value of estimated future cash flows discounted at the asset's original effective interest rate. The resultant provisions have been deducted from the appropriate asset values in the balance sheet.
The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience.
The following table sets forth the movement in our allowances for loan losses for the financial year ended April 4, 2012:
| Prime residential |
Specialist residential |
Consumer banking (£ millions) |
Commercial lending |
Other lending |
Total | |
|---|---|---|---|---|---|---|
| As at April 5, 2011 | 40 | 161 | 90 | 463 | 11 | 765 |
| Charge for the year | 13 | 57 | 69 | 247 | 4 | 390 |
| Amounts written off during the year | (13) | (60) | (111) | (135) | (3) | (322) |
| Amounts recovered during the year. | 1 | 2 | 27 | 1 | 2 | 33 |
| Unwind of discount of provision | (1) | 2 | 5 | (29) | - | (23) |
| As at April 4, 2012 | 40 | 162 | 80 | 547 | 14 | 843 |
The following table sets forth the movement in our allowances for loan losses for the financial year ended April 4, 2011:
| Prime residential |
Specialist residential |
Consumer banking (£ millions) |
Commercial lending |
Other lending |
Total | |
|---|---|---|---|---|---|---|
| As at April 5, 2010 | 17 | 143 | 148 | 422 | 20 | 750 |
| Charge for the year | 32 | 69 | 83 | 175 | - | 359 |
| Amounts written off during the year | (9) | (51) | (156) | (105) | (13) | (334) |
| Amounts recovered during the year. | 1 | 3 | 20 | - | 4 | 28 |
| Unwind of discount of provision | (1) | (3) | (5) | (29) | - | (38) |
| As at April 4, 2011 | 40 | 161 | 90 | 463 | 11 | 765 |
The following table sets forth the movement in our allowances for loan losses for the financial year ended April 4, 2010:
| Prime residential |
Specialist residential |
Consumer banking |
Commercial lending |
Other lending |
Total | |
|---|---|---|---|---|---|---|
| (£ millions) | ||||||
| As at April 5, 2009 | 20 | 101 | 136 | 194 | 19 | 470 |
| Charge for the year | 10 | 79 | 126 | 299 | 35 | 549 |
| Amounts written off during the year | (14) | (33) | (120) | (54) | (38) | (259) |
| Amounts recovered during the year. | 2 | 1 | 13 | - | 4 | 20 |
| Unwind of discount of provision | (1) | (5) | (7) | (17) | - | (30) |
| As at April 4, 2010 | 17 | 143 | 148 | 422 | 20 | 750 |
The following table shows the allowances for loan losses as a percentage of total loans, analyzed by category:
| As at April 4, | ||||
|---|---|---|---|---|
| 2012(1) | 2011(1) | 2010(1) | ||
| (percentages) | ||||
| Total Allowances as a % of total loans(1) | ||||
| Residential | 0.16 | 0.16 | 0.13 | |
| Commercial | 2.61 | 2.15 | 1.94 | |
| Consumer | 2.77 | 3.79 | 6.91 | |
| Other | 2.92 | 2.29 | 3.60 | |
| Total loans | 0.55 | 0.51 | 0.49 | |
| % of loans in each category to total loans | ||||
| Residential mortgage loans | 84.1 | 83.6 | 83.9 | |
| Commercial | 13.7 | 14.5 | 14.3 |
| As at April 4, | ||||
|---|---|---|---|---|
| 2012(1) | 2011(1) | 2010(1) | ||
| (percentages) | ||||
| Consumer | 1.9 | 1.6 | 1.4 | |
| Other | 0.3 | 0.3 | 0.4 | |
| Total loans | 100.0 | 100.0 | 100.0 | |
| _____ |
Note:
(1) The loan balances for the financial years ended April 4, 2012, 2011 and 2010 are summarized earlier in this section of the Base Prospectus.
The following table sets out the average balances and average interest rates for each deposit type for the financial year ended April 4, 2012:
| For year ended April 4, 2012 | ||
|---|---|---|
| Average balance | Average rate paid | |
| (£ millions, except percentages) | ||
| UK retail member deposits | 125,456 | 2.25% |
| Other customer deposits and amounts due to banks(1) | 16,117 | 0.87% |
| _____ |
(1) Amounts owed to other customers include time deposits, call deposits and retail deposits that do not grant "member" status.
The following table sets out the average balances and average interest rates for each deposit type for the financial year ended April 4, 2011:
| For year ended April 4, 2011 | ||
|---|---|---|
| Average balance | Average rate paid | |
| (£ millions, except percentages) | ||
| UK retail member deposits | 122,259 | 2.05% |
| Other customer deposits and amounts due to banks(1) | 15,140 | 1.70% |
| _____ |
(1) Amounts owed to other customers include time deposits, call deposits and retail deposits that do not grant "member" status.
The following table sets out the average balances and average interest rates for each deposit type for the financial year ended April 4, 2010:
| For year ended April 4, 2010 | ||
|---|---|---|
| Average balance | Average rate paid | |
| (£ millions, except percentages) | ||
| UK retail member deposits | 122,999 | 1.89% |
| Other customer deposits and amounts due to banks(1) | 20,609 | 1.86% |
| _____ |
Note:
(1) Amounts owed to other customers include time deposits, call deposits and retail deposits that do not grant "member" status.
As explained in "Description of Business—Retail Funding", our member accounts include both instant access accounts, from which funds may be withdrawn on demand, and notice accounts, from which funds withdrawn without appropriate notice may be subject to penalties. The approximate split of UK retail member deposits between instant access accounts and notice accounts as at April 4, 2012, is as follows:
| As at April 4, 2012 | |
|---|---|
| (£ millions) | |
| Instant access accounts | 41,448 |
| Notice accounts | 83,335 |
| Accrued interest | 834 |
| UK retail member deposits | 125,617 |
The following table shows the maturity analysis of time deposits over \$100,000 and certificates of deposit as at April 4, 2012:
| As at April 4, 2012 | |||||
|---|---|---|---|---|---|
| Time deposits |
Certificates Of deposit |
Total | % | ||
| (£ millions, except percentages) | |||||
| Less than 3 months | 2,867 | 3,219 | 6,086 | 73.7% | |
| 3 months to 6 months | 761 | 865 | 1,626 | 19.7% | |
| 6 months to 1 year | 331 | 187 | 518 | 6.3% | |
| Over 1 year | 23 | 2 | 25 | 0.3% | |
| Total | 3,982 | 4,274 | 8,255 | 100.0% |
The following table represents net income as a percentage of total average assets for the financial year ended April 4, 2012:
| For the year ended April 4, 2012 | |
|---|---|
| (£ millions, except percentages) | |
| Net income(1) | 179 |
| Total average assets(2) | 195,568 |
| Return on total average assets | 0.09% |
| _____ |
Notes:
(1) Net income represents profit for the financial year after tax.
(2) Total average assets is based on the total assets as of the end of each month during the financial year.
The following table represents net income as a percentage of total average assets for the financial year ended April 4, 2011:
| For the year ended April 4, 2011 | |
|---|---|
| (£ millions, except percentages) | |
| Net income(1) | 248 |
| Total average assets(2) | 189,367 |
| Return on total average assets | 0.13% |
| _____ |
Notes:
(1) Net income represents profit for the financial year after tax.
(2) Total average assets is based on the total assets as of the end of each month during the financial year.
The following table represents net income as a percentage of total average assets for the financial year ended April 4, 2010:
| For the year ended April 4, 2010 | |
|---|---|
| (£ millions, except percentages) | |
| Net income(1) | 264 |
| Total average assets(2) | 197,429 |
| Return on total average assets | 0.13% |
| _____ |
Notes:
(1) Net income represents profit for the financial year after tax.
(2) Total average assets is based on the total assets as of the end of each month during the financial year.
As a mutual organization, we are managed for the benefit of our members, our retail savings and residential mortgage customers, rather than for equity shareholders. We return value to our members by offering generally higher interest rates on savings and lower interest rates on loans than those offered by our main competitors. As a result, we typically earn lower profits than our main competitors, which are typically banks or other non-mutual organizations. However, we pay no dividends, and our net earnings are put into reserves and constitute Tier 1 capital for our capital adequacy requirements.
We have not presented any information regarding returns on equity because, as a mutual organization, we do not have equity.
Financial instruments incorporate the vast majority of the Group and Society's assets and liabilities. Given the dominant position of the Society within the Group structure, the term 'Group' is used in the remainder of this note to cover the activities of both Group and Society.
The Group accepts deposits from customers at fixed and variable interest rates for various periods and seeks to earn an interest margin by investing these funds in high quality assets—predominantly mortgages. The principal risks which arise from this core activity, and which need to be managed by the Group, are interest rate risks (including basis risk), credit risks, foreign exchange, liquidity and funding risks.
All risks are monitored and managed within the Enterprise Risk Management Framework ("ERMF"), which the Group has continued to upgrade and strengthen. The ERMF comprises a Board-approved risk appetite, detailed risk management frameworks (including policies and supporting documentation), and independent governance and oversight functions.
The Group also uses derivative instruments to manage various aspects of risk. However, in doing so it complies with the UK Building Societies Act 1986 which limits our use of derivatives to the mitigation of consequences arising from changes in interest rates, exchange rates or other factors defined by the Act.
The principal derivatives used in balance sheet risk management are interest rate swaps, forward rate agreements, interest rate options, cross-currency interest rate swaps, interest rate futures, foreign exchange contracts and equity index swaps. Derivatives are used to hedge balance sheet and income exposures arising, inter alia, from fixed rate mortgage lending, fixed rate savings products, funding and investment activities in foreign currencies or involving fixed rate instruments or instruments with embedded options. Group risk exposures are recorded on the Society's information systems and monitored accordingly.
The following table describes the significant activities undertaken by the Group, the risks associated with such activities and the types of derivatives which are used in managing such risks. Such risks may alternatively be managed using cash instruments as part of an integrated approach to risk management:
| Activity | Risk | Type of derivative instrument used | |
|---|---|---|---|
| Savings products and funding activities involving instruments which are fixed rate with embedded options |
Sensitivity to changes in interest rates | Interest rate swaps, interest rate futures, swaptions, and forward rate agreements |
|
| Mortgage lending and investment activities involving instruments which are fixed rate or which include explicit or embedded options |
Sensitivity to changes in interest rates, including differential between Base Rate and LIBOR |
Interest rate swaps including basis swaps, interest rate futures, swaptions, caps, collars and forward rate agreements |
|
| Investment and funding in foreign currencies |
Sensitivity to changes in foreign exchange rates |
Cross-currency swaps and foreign exchange contracts |
|
| Protected equity bond ("PEB") savings products |
Sensitivity to changes in stock indices | Equity index swaps |
The accounting policy for derivatives and hedge accounting is described in the Statement of Accounting Policies. Where possible, fair value hedge accounting is employed but no use is currently made of cash flow hedge accounting.
The Board and the Assets and Liabilities Committee ("ALCO") are responsible for setting certain parameters respectively over the Group exposure to interest rates, foreign exchange rates and other indices. The Lending Committee for Retail, Commercial and Treasury sets Group credit policy and regularly monitors and reviews credit exposures arising in all aspects of Group operations, including derivatives. ALCO and the Lending Committee are also responsible for mandating, directing and overseeing the Weekly Trading Committee. All risk committees are overseen by the Executive Risk Committee, while the Board Risk Committee provides oversight of the risk framework for the Group including governance.
All exchange-traded instruments are subject to cash requirements under the standard margin arrangements applied by the individual exchanges. Such instruments are not subject to significant credit risk. Credit exposures arising on derivative contracts with certain counterparties are collateralized (e.g. with cash deposits), to mitigate credit exposures. All Group derivatives activity is contracted with Organization for Economic Co-operation and Development ("OECD") financial institutions.
The principal financial risks to which the Group is exposed are interest rate, credit, foreign exchange, liquidity and funding risk. Each of these is considered below.
The primary market risk faced by the Group is interest rate risk. The net interest income and market value of the Group's assets are exposed to movements in interest rates. This exposure is managed on a continuous basis, within parameters set by ALCO, using a combination of derivative instruments, cash instruments (such as loans, deposits and bonds), and contractual terms within products and associated procedures.
The Group does not run a trading book and therefore does not have the higher risk exposure run by many banking institutions. Given our policy of hedging fixed rate assets and liabilities back to floating rate, interest rate market value risk arises mainly from the Board's decision to invest the Group's reserves according to a fixed rate maturity profile specified by ALCO. The level of risk can deviate from this, subject to limits, in particular as a result of decisions made by the Group's Treasury department to temporarily deviate from the specified fixed rate maturity profile in the light of market conditions.
Interest rate earnings risk arises mainly from the diversity of product terms and associated procedures adopted by the Group in originating and administering retail and commercial products. Should reported exposure approach internal risk parameters, action is initiated by ALCO to mitigate such exposure, through changes to these product terms and procedures or to the product mix, or through the use of derivatives.
The Group uses several metrics to monitor interest rate risk, and details of these are set out below. The controls around these metrics have been set by the Board or by ALCO and reflect the Group's low risk appetite.
Value at Risk ("VaR"). This is a technique that estimates the potential losses that could occur on risk positions as a result of future movements in market rates and prices over a specified time horizon and to a given level of statistical confidence. In its day-to-day monitoring Nationwide uses a 10 day horizon and a 99% confidence level.
The VaR model used by Nationwide incorporates underlying risk factors based on interest rate volatilities and correlations. Potential movements in market prices are calculated by reference to daily market data from the last two years equally weighted. Exposures against limits are reviewed daily by management. Actual outcomes are monitored periodically to test the validity of the assumptions and factors used in the VaR calculation.
Although a valuable guide to risk, VaR needs to be viewed in the context of the following limitations:
Sensitivity analysis (PV01 sensitivity). This is used to assess the change in value of the Group's current net worth against a one basis point (0.01%) parallel shift in interest rates. As is the case with VaR, this analysis is done on a daily basis separately for each currency (but with the main risk arising from Sterling exposures) and in aggregate.
Stress testing (PV200 sensitivity). This is calculated in a similar manner to PV01 but against a much more severe 200 basis point (2.0%) parallel shift in interest rates. Both PV01 and PV200 numbers are generated and monitored daily.
Change in value of the Group's current net worth is also calculated against a range of non-linear stresses to the yield curve. This output is reported and monitored on a regular basis.
The average gross exposures (before deduction of the above mentioned specified fixed rate maturity profile for the Group's reserves) through the reporting period are as follows:
| 2012 | 2011 | |||||
|---|---|---|---|---|---|---|
| Average | High | Low | Average | High | Low | |
| (£ millions) | ||||||
| VaR | 59 | 67 | 46 | 74 | 81 | 66 |
| Sensitivity analysis (PV01) | 2 | 2 | 2 | 2 | 2 | 2 |
| Stress testing (PV200: all currencies) | 396 | 441 | 303 | 409 | 438 | 373 |
All exposures include investment of the Group's reserves. VaR reflects the impact of the decrease of interest rate volatilities in the reference period.
Earnings risk. Earnings risks are calculated using a variety of stochastic and deterministic scenarios.
Interest rate earnings risks, such as basis risk (the risk of loss arising from changes in the relationship between interest rates which have similar but not identical characteristics, for example LIBOR and BoE Base Rate) and prepayment risk (the risk of loss arising from early repayment of fixed rate mortgages and loans) are also monitored closely and regularly reported to ALCO.
The sensitivity of the Group net interest margin to changes in interest rates is measured monthly using a dynamic forecasting model and interest rate scenarios, and is calculated for a forward period of 12 months.
The Group takes on exposure to credit risk, which is defined as the risk that a counterparty will be unable to pay amounts in full when due. Impairment provisions are provided for losses or expected losses that have been incurred at the balance sheet date. Significant changes in the economy, or a sector that represents a concentration in the Group's portfolio, could result in losses that are different from those provided for at the balance sheet date. There could also be idiosyncratic factors that might lead a particular investment to suddenly perform worse than expected. Management, therefore, carefully monitors its exposure to credit risk.
The Group's Lending Committee is responsible for approving and monitoring the Group's credit exposures, which it does through a formal annual review and the approval of the Group's lending policies. Regular monitoring and review of lending is undertaken through detailed management information including the performance of credit scoring systems for all retail lending. Formal limits are set and reviewed at individual, segment and portfolio levels based on credit exposures split by individual counterparties, geographical location and industry sector. Summary minutes of the Lending Committee together with key risk monitoring metrics are reviewed by the Executive Risk Committee.
Prior to advancing funds, an assessment is made of the credit quality of borrowers and other counterparties for all lending to both retail and corporate customers. Retail lending is subject to credit scoring and lending policies. Corporate lending is based on counterparty assessment that includes the use of multiple rating methodologies.
Credit risk within our Treasury Division arises primarily from the investments held by Treasury for liquidity and investment purposes and for income generation purposes. This aspect of credit risk is managed by our Treasury Credit Team within the Treasury Division and overseen by Group Lending Risk. The Treasury Credit Team underwrites all new facilities and monitors existing facilities. It also sets and monitors compliance with policy and limits, reporting to the Treasury Lending Risk Forum and then to the Lending Committee, when appropriate. In addition, counterparty credit risk arises from the Group's derivatives where the market values are positive.
The Treasury Credit function monitors exposure concentrations against a variety of criteria including industry sector, asset class, and country of risk. The Treasury portfolio exposure is well spread across both industry sectors and jurisdictions. Nationwide has no exposure to emerging markets or hedge funds and only minimal exposure to non investment grade debt.
The following table presents the Group's maximum exposure to credit risk of on-balance-sheet and off-balancesheet financial instruments, before taking into account any collateral held or other credit enhancements and after allowance for impairment where appropriate. The maximum exposure to loss for off-balance-sheet financial instruments is considered to be their contractual nominal amounts:
| 2012 | 2011 | |||||
|---|---|---|---|---|---|---|
| Carrying value |
Commitments | Maximum credit risk exposure |
Carrying value |
Commitments | Maximum credit risk exposure |
|
| (£ millions) | ||||||
| Cash | 8,126 | - | 8,126 | 6,130 | - | 6,130 |
| Loans and advances to banks |
2,914 | 437 | 3,351 | 4,181 | 199 | 4,380 |
| Investment securities – AFS |
23,325 | - | 23,325 | 21,540 | - | 21,540 |
| Derivative financial instruments |
4,176 | - | 4,176 | 3,961 | - | 3,961 |
| FV adjustment for portfolio hedged risk(1) |
1,330 | - | 1,330 | 1,634 | - | 1,634 |
| Loans and advances to customers |
154,169 | 4,853 | 159,022 | 149,417 | 5,637 | 155,054 |
| Investment in equity shares |
29 | - | 29 | 103 | - | 103 |
| 194,069 | 5,290 | 199,359 | 186,966 | 5,836 | 192,802 |
Note:
(1) The amounts for the year ended April 4, 2011 have been reclassified or adjusted as described in note 1 of the audited consolidated financial statements for the year ended April 4, 2012.
In addition to the figures shown above, the Group has, as part of its retail operations, commitments of £6,721 million (year ended April 4, 2011: £6,857 million) in respect of credit card and overdraft facilities. These commitments represent agreements to lend in the future, subject to certain conditions. Such commitments are cancellable by the Group, subject to notice requirements, and given their nature are not expected to be drawn down to the full level of exposure.
______________
Foreign exchange risk is the risk that the Sterling value of, or net income from, assets and liabilities that are denominated in foreign currency changes as a consequence of changes to foreign exchange rates.
In addition to commercial loans denominated in euro, a significant proportion of Treasury funding and investment activity is undertaken in foreign currencies. Foreign currency exposure is hedged on the balance sheet or by using derivatives to reduce currency exposures to acceptable levels.
In line with the prudential guidance applying to all building societies and after taking account of foreign currency derivatives, the Group has no substantial net exposure to foreign exchange rate fluctuations or changes in foreign currency interest rates. ALCO sets limits on the level of exposure by currency, which are monitored daily.
VaR is used to monitor the risk arising from open foreign currency positions. Open currency positions represent the net value of assets, liabilities and derivatives in foreign currency. The parameters of the VaR methodology, and frequency of reporting are exactly as described above under Interest Rate Risk.
The average gross Sterling equivalent exposures for foreign exchange risk through the year are as follows:
| VaR | 0.3 | 0.7 | - | 0.1 | 0.5 | - |
|---|---|---|---|---|---|---|
| ----- | ----- | ----- | --- | ----- | ----- | --- |
Liquidity and funding risk is the risk that the Group is not able to meet its financial obligations as they fall due (including any unexpected adverse cash flow), to smooth out the effect of maturity mismatches, or to maintain public confidence.
The Group liquidity policy is to maintain sufficient liquid resources to cover cash flow imbalances and fluctuations in funding, to retain full public confidence in the solvency of the Group and to enable it to meet all financial obligations. This is achieved through maintaining a prudent level of high quality liquid assets, through management and stress testing of business cash flows, and through management of funding facilities. The Group liquidity policy is approved by the Board.
Liquid assets are categorized according to their liquidity characteristics, and the most liquid category of assets is the focus of management attention. This portfolio predominantly comprises holdings of sovereign-issued securities, and deposits with the central bank and is aligned to the "liquid asset buffer" defined in the FSA's policy statement on liquidity management (Policy Statement 09/16). Assets may be acquired through direct purchase, through repurchase agreements or through collateral swaps. Encumbered assets are excluded from the calculation of liquid assets which is conducted on a daily basis.
The Board is responsible for setting limits over the level and composition of liquidity balances and the funding mix of the balance sheet. A series of liquidity stress tests is performed daily to determine the required levels of liquidity.
ALCO is responsible for setting more detailed limits within the context of overall Board limits, including the level and maturity profile of funding, and for monitoring the composition of the Group balance sheet. Wholesale and retail funding maturities are monitored to ensure that future maturities are not concentrated on a calendar basis. This enhances the ability of the Group to refinance maturing liabilities throughout forward months and quarters. A consolidated cash flow forecast is maintained on a continuous basis and reviewed by ALCO. Limits regarding the maturity concentration and composition of the savings portfolio are regularly monitored.
Fixed rate sovereign debt securities are held for liquidity purposes. When swapped into LIBOR using an interest rate swap, the net market value of the security and swap is subject to changes in the relative spreads on sovereign debt and interest rate swaps. This risk is only realized if the debt is sold ahead of maturity (rather than being converted through repurchase agreements), and is subject to a trigger set by ALCO.
A Contingency Funding Plan has been approved by ALCO, and describes procedures and available actions to manage the Group's liquidity resources through a period of market disruption or heavy retail outflows. This is reviewed on a biannual basis and various components are tested on a scheduled basis.
The table below analyzes the carrying value of financial assets and financial liabilities into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. In practice, customer deposits will be repaid later than on the earliest date on which repayment can be required.
The carrying values of derivative financial instruments are included in the columns according to their contractual maturity:
| As at April 4, 2012 Residual maturity |
Repayable on demand |
Up to 3 months |
3 – 12 months |
1 – 5 years | More than 5 years |
Total |
|---|---|---|---|---|---|---|
| (£ millions) | ||||||
| Assets | ||||||
| Cash | 8,126 | - | - | - | - | 8,126 |
| Loans and advances | ||||||
| to banks | 2,197 | 377 | - | 148 | 192 | 2,914 |
| Investment securities | ||||||
| – available for sale | - | 144 | 1,756 | 6,261 | 15,164 | 23,325 |
| Loans and advances | ||||||
| to customers | 835 | 1,775 | 4,750 | 26,926 | 119,883 | 154,169 |
| Derivative financial |
| As at April 4, 2012 Residual maturity |
Repayable on demand |
Up to 3 months |
3 – 12 months |
1 – 5 years | More than 5 years |
Total |
|---|---|---|---|---|---|---|
| (£ millions) | ||||||
| instruments | - | 164 | 650 | 1,735 | 1,627 | 4,176 |
| Other financial assets | - | 70 | 307 | 555 | 427 | 1,359 |
| Total financial assets | 11,158 | 2,530 | 7,463 | 35,625 | 137,293 | 194,069 |
| Liabilities | ||||||
| Shares | 67,469 | 7,614 | 28,794 | 21,267 | 473 | 125,617 |
| Deposit from banks | 836 | 314 | 53 | 2,145 | 22 | 3,370 |
| Other deposits | 356 | 2,582 | 1,049 | 2,260 | 652 | 6,899 |
| Due to customers | 3,791 | 467 | 1,212 | 363 | - | 5,833 |
| Debt securities in |
||||||
| issue | - | 8,258 | 6,147 | 16,142 | 8,307 | 38,854 |
| Derivative financial |
||||||
| instruments | - | 116 | 288 | 1,294 | 2,589 | 4,287 |
| Other financial |
||||||
| liabilities | - | 2 | 36 | 240 | - | 278 |
| Subordinated | ||||||
| liabilities | - | - | - | 438 | 1,206 | 1,644 |
| Subscribed capital | - | - | 349 | 329 | 947 | 1,625 |
| Total financial |
||||||
| liabilities | 72,452 | 19,353 | 37,928 | 44,478 | 14,196 | 188,407 |
| Net liquidity gap | (61,294) | (16,823) | (30,465) | (8,853) | 123,097 | 5,662 |
| As at April 4, 2011 Residual maturity |
Repayable on demand |
Up to 3 months |
3 – 12 months |
1 – 5 years | More than 5 years |
Total |
|---|---|---|---|---|---|---|
| (£ millions) | ||||||
| Assets | ||||||
| Cash | 6,130 | - | - | - | - | 6,130 |
| Loans and advances | ||||||
| to banks | 2,424 | 1,570 | - | - | 187 | 4,181 |
| Investment securities | ||||||
| – available for sale | 34 | 445 | 1,808 | 8,217 | 11,036 | 21,540 |
| Loans and advances | ||||||
| to customers | 695 | 2,104 | 5,075 | 25,407 | 116,136 | 149,417 |
| Derivative financial |
||||||
| instruments | - | 90 | 723 | 2,149 | 999 | 3,961 |
| Other financial assets | - | 25 | 134 | 1,089 | 489 | 1,737 |
| Total financial assets | 9,283 | 4,234 | 7,740 | 36,862 | 128,847 | 186,966 |
| Liabilities | ||||||
| Shares | 67,435 | 7,284 | 20,091 | 27,361 | 381 | 122,552 |
| Deposits from banks | 1,048 | 410 | 84 | 1,204 | - | 2,746 |
| Other deposits(1) | 300 | 2,328 | 1,034 | 1,223 | 924 | 5,809 |
| Due to customers(1) | 4,744 | 391 | 459 | 168 | - | 5,762 |
| Debt securities in |
||||||
| issue | 1 | 7,262 | 8,219 | 15,824 | 6,502 | 37,808 |
| Derivative financial |
||||||
| instruments | - | 67 | 282 | 1,703 | 1,182 | 3,234 |
| Other financial |
||||||
| liabilities | - | (1) | (6) | 49 | (23) | 19 |
| Subordinated | ||||||
| liabilities | - | - | 381 | 763 | 829 | 1,973 |
| Subscribed capital | - | - | - | 229 | 1,281 | 1,510 |
| Total financial |
||||||
| liabilities | 73,528 | 17,741 | 30,544 | 48,524 | 11,076 | 181,413 |
| Net liquidity gap | (64,245) | (13,507) | (22,804) | (11,662) | 117,771 | 5,553 |
Note:
______________
(1) The amounts for the year ended April 4, 2011 have been reclassified or adjusted as described in note 1 of the audited consolidated financial statements for the year ended April 4, 2012.
Liquid assets include cash, loans and advances to banks and available for sale investment securities. Other financial assets and liabilities include the fair value adjustments for portfolio hedged risk and investments in equity shares.
The analysis above excludes other assets including property plant and equipment, intangible assets, investment property, other assets, deferred tax assets and accrued income and expenses prepaid, and other liabilities including provisions for liabilities and charges, accruals and deferred income, current tax liabilities, other liabilities and retirement benefit obligations.
The following is an analysis of gross undiscounted contractual cash flows payable under financial liabilities:
| For the year ended April 4, 2012 | ||||||
|---|---|---|---|---|---|---|
| Gross contractual |
Repayable | Up to 3 | 3 – 12 | 1 – 5 years | More than 5 | Total |
| cash flows | on demand | months | months | years | ||
| (£ millions) | ||||||
| Shares | 67,469 | 7,925 | 29,412 | 22,250 | 495 | 127,551 |
| Deposits from banks | 836 | 332 | 104 | 2,281 | 24 | 3,577 |
| Other deposits | 356 | 2,623 | 1,129 | 2,481 | 703 | 7,292 |
| Due to customers | 3,791 | 481 | 1,235 | 386 | - | 5,893 |
| Debt securities in |
||||||
| issue | - | 8,013 | 6,438 | 20,045 | 9,236 | 43,732 |
| Derivative financial |
||||||
| instruments | - | 395 | 977 | 2,575 | 751 | 4,698 |
| Other financial |
- | 4 | 42 | 255 | - | 301 |
| liabilities | ||||||
| Subordinated | - | 4 | 290 | 841 | 954 | 2,089 |
| liabilities | ||||||
| Subscribed capital | - | 10 | 431 | 588 | 1,143 | 2,172 |
| Total financial |
||||||
| liabilities | 72,452 | 19,787 | 40,058 | 51,702 | 13,306 | 197,305 |
| Off balance sheet |
||||||
| commitments | 3,029 | 184 | 371 | 1,084 | 622 | 5,290 |
| For the year ended April 4, 2011 | ||||||
|---|---|---|---|---|---|---|
| Gross contractual |
Repayable | Up to 3 | 3 – 12 | 1 – 5 years | More than 5 | Total |
| cash flows | on demand | months | months | years | ||
| (£ millions) | ||||||
| Shares | 67,435 | 7,552 | 20,680 | 28,510 | 397 | 124,574 |
| Deposits from banks | 1,048 | 420 | 110 | 1,270 | - | 2,848 |
| Other deposits | 300 | 2,358 | 1,089 | 1,392 | 988 | 6,127 |
| Due to customers | 4,744 | 397 | 467 | 177 | - | 5,785 |
| Debt securities in |
||||||
| issue | 1 | 7,497 | 8,764 | 17,409 | 6,949 | 40,620 |
| Derivative financial |
||||||
| instruments | - | 536 | 1,048 | 1,766 | 334 | 3,684 |
| Other financial |
- | (1) | (6) | 49 | (24) | 18 |
| liabilities | ||||||
| Subordinated | - | 6 | 475 | 1,084 | 1,064 | 2,629 |
| liabilities | ||||||
| Subscribed capital | - | 6 | 81 | 835 | 1,339 | 2,261 |
| Total financial |
73,528 | 18,771 | 32,708 | 52,492 | 11,047 | 188,546 |
| liabilities | ||||||
| Off balance sheet |
||||||
| commitments | 3,476 | 87 | 341 | 1,140 | 792 | 5,836 |
The analysis of gross contractual cash flows above differs from the analysis of residual maturity due to the inclusion of interest accrued at current rates, for the average period until maturity on the amounts outstanding at the balance sheet date.
The following table summarizes the carrying amounts and fair values of those financial assets and liabilities not presented on the Group balance sheets at fair value:
| Group | |||||
|---|---|---|---|---|---|
| Carrying value | Fair value | ||||
| 2012 | |||||
| Financial assets | (£ millions) | ||||
| Loans and advances to banks | 2,914 | 2,914 | |||
| Loans and advances to customers: | |||||
| Residential mortgages | 128,645 | 123,655 | |||
| Consumer banking | 2,888 | 2,900 | |||
| Commercial lending | 22,157 | 21,930 | |||
| Other lending | 479 | 480 | |||
| Financial liabilities | |||||
| Shares | 125,617 | 125,968 | |||
| Deposits from banks | 3,370 | 3,570 | |||
| Other deposits | 6,899 | 6,900 | |||
| Due to customers | 5,833 | 5,836 | |||
| Debt securities in issue | 38,854 | 38,684 | |||
| Subordinated liabilities | 1,644 | 1,513 | |||
| Subscribed capital | 1,625 | 1,121 | |||
| Group | |||||
| Carrying value | Fair value | ||||
| 2011 | |||||
| (£ millions) | |||||
| Financial assets | |||||
| Loans and advances to banks | 4,181 | 4,181 | |||
| Loans and advances to customers: | |||||
| Residential mortgages | 124,453 | 119,472 | |||
| Consumer banking | 2,376 | 2,381 | |||
| Commercial lending | 22,107 | 22,357 | |||
| Other lending | 481 | 481 | |||
| Financial liabilities | |||||
| Shares | 122,552 | 122,767 | |||
| Deposits from banks | 2,746 | 2,766 | |||
| Other deposits(1) | 5,809 | 5,811 | |||
| Due to customers(1) | 5,762 | 5,762 | |||
| Debt securities in issue | 37,808 | 37,661 | |||
| Subordinated liabilities | 1,973 | 1,973 | |||
| Subscribed capital __ |
1,510 | 1,219 |
Note:
(1) The amounts for the year ended April 4, 2011 have been reclassified or adjusted as described in note 1 of the audited consolidated financial statements for the year ended April 4, 2012.
Loans and advances are net of provisions for impairment. The estimated fair value of loans and advances represents the discounted amount of estimated future cash flows expected to be received. Expected cash flows are discounted at current market rates to determine fair value.
The estimated fair value of deposits with no stated maturity, which includes non-interest bearing deposits, is the amount repayable on demand. The estimated fair value of fixed interest-bearing deposits and other borrowings without quoted market price is based on discounted cash flows using interest rates for new debts with similar remaining maturity.
The aggregate fair values are calculated based on quoted market prices. For those notes where quoted market prices are not available, a discounted cash flow model is used based on a current yield curve appropriate for the remaining term to maturity.
The following table provides an analysis of financial assets and liabilities held on the Group balance sheet at fair value, grouped into levels 1 to 3 based on the degree to which the fair value is observable:
| 2012 | Level 1 | Level 2 | Level 3 | Total |
|---|---|---|---|---|
| Group | ||||
| (£ millions) | ||||
| Financial Assets | ||||
| Investment securities - AFS | 16,493 | 6,756 | 76 | 23,325 |
| Investments in equity shares | 9 | - | 20 | 29 |
| Derivative financial instruments | - | 3,942 | 234 | 4,176 |
| 16,502 | 10,698 | 330 | 27,530 | |
| Financial Liabilities | ||||
| Derivative financial instruments | - | (4,250) | (37) | (4,287) |
| Other deposits - PEB | - | - | (2,890) | (2,890) |
| - | (4,250) | (2,927) | (7,177) | |
| 2011 | Level 1 | Level 2 | Level 3 | Total |
| Group | ||||
| (£ millions) | ||||
| Financial Assets | ||||
| Investment securities - AFS | 12,319 | 9,126 | 95 | 21,540 |
| Investments in equity shares | 5 | - | 98 | 103 |
| Derivative financial instruments | - | 3,873 | 88 | 3,961 |
| 12,324 | 12,999 | 281 | 25,604 | |
| Financial Liabilities | ||||
| Derivative financial instruments | - | (3,158) | (76) | (3,234) |
| Other deposits - PEB | - | - | (2,125) | (2,125) |
| - | (3,158) | (2,201) | (5,359) |
Notes:
_________________
Level 1: Fair value derived from unadjusted quoted prices in active markets for identical assets or liabilities, e.g. G10 government securities.
Level 2: Fair value derived from inputs other than quoted prices that are observable for the asset or liability, either directly (i.e. a price) or indirectly (i.e. derived from prices), e.g. most investment grade and liquid bonds, asset backed securities, certain CDOs, CLOs and OTC derivatives.
Level 3: Inputs for the asset or liability are not based on observable market data (unobservable inputs), e.g. private equity investments, derivatives including an equity element, deposits including an equity element, some CDOs and certain asset backed securities and bonds.
The Group's Level 1 portfolio comprises highly rated government and multi-lateral development securities for which traded prices are readily available and during the year ended April 4, 2012, the Group has increased its gilt exposure in this portfolio.
Level 2 investment securities – AFS assets are sourced from consensus pricing or other observable market prices. None of these Level 2 AFS assets are valued from models. Level 2 derivative assets and liabilities are valued from discounted cash flow models using yield curves based on observable market data.
Composition of and movements in the Level 3 portfolio are described below.
The main constituents of the Level 3 portfolio are as follows:
The Group's £76 million Level 3 investment securities - AFS assets as at April 4, 2012 comprise £53 million of CDOs and £23 million of impaired UK CMBS assets. Substantially all of these securities are priced from internal models based on observable and unobservable performance assumptions.
The holding consists primarily of an interest in a fund which is supported by zero coupon bonds of an A-rated bank. External valuations are used to obtain the fair value of the instrument.
Equity linked derivatives with external counterparties which economically match the investment return payable by the Group to customers invested in the Permanent Equity Bond ("PEB") product. The derivatives are linked to the performance of specified stock market indices and have been valued by external sources.
Deposit accounts with the potential for stock market correlated growth linked to the performance of specified stock market indices. The PEBs liability is valued at a discount to reflect the time value of money, overlaid by a fair value adjustment representing the expected return payable to the customer. The fair value adjustment has been constructed from the valuation of the associated derivative as valued by external sources.
The table below analyzes movements in the Level 3 portfolio:
| Derivative financial |
||||
|---|---|---|---|---|
| 2012 Group |
Investment securities - AFS |
Investments in equity shares |
instruments - liabilities |
Other deposits |
| (£ millions) | ||||
| As at April 4, 2011 | 95 | 98 | 12 | (2,125) |
| (Loss)/gain recognized in the income | ||||
| statement: | ||||
| Net interest (expense)/income | 1 | - | (53) | - |
| Other income/(expense) | (9) | (7) | 185 | (179) |
| (Loss)/gain recognized in other |
||||
| comprehensive income: | ||||
| Fair value movement taken to | (6) | (6) | - | - |
| equity | ||||
| Issues | - | - | - | (635) |
| Additions | - | 2 | - | - |
| Settlements | - | (67) | 53 | 49 |
| Transfers out of Level 3 | (5) | - | - | - |
| As at April 4, 2012 | 76 | 20 | 197 | (2,890) |
| 2011 | Investment securities - AFS |
Investments in equity shares |
Derivative financial instruments - liabilities |
Other deposits |
|---|---|---|---|---|
| Group | ||||
| (£ millions) | ||||
| As at April 4, 2010 | 106 | 79 | (44) | (1,128) |
| (Loss)/gain recognized in the income | ||||
| statement: | ||||
| Net interest (expense)/income | (3) | - | (31) | - |
| Other income/(expense) | (15) | - | 87 | (56) |
| (Loss)/gain recognized in other |
||||
| comprehensive income: | ||||
| Fair value movement taken to | (5) | 5 | - | - |
| equity | ||||
| Issues | - | - | - | (966) |
| Additions | - | 25 | - | - |
| Settlements | (11) | (11) | - | 25 |
| Transfers in to Level 3 | 46 | - | - | - |
| Transfers out of Level 3 | (23) | - | - | - |
| As at April 4, 2011 | 95 | 98 | 12 | (2,125) |
The significant movements in Level 3 positions during the year are explained below:
The table below provides sensitivity analysis of reasonably possible alternative valuation assumptions for the assets in the Level 3 portfolio:
| 2012 | Carrying value | Increase in fair value |
Decrease in fair value |
|---|---|---|---|
| Group | |||
| (£ millions) | |||
| Investment securities – AFS: | |||
| Collateralized debt obligations | 53 | 16 | (30) |
| CMBS | 23 | 16 | (15) |
| Other investments | - | - | - |
| Investments in equity shares | 20 | 2 | (4) |
| 96 | 34 | (49) | |
| Increases/(decreases) in fair value would be recognized in: | |||
| Income statement | - | 23 | (20) |
| Statement of other comprehensive income (accumulated in the AFS reserve) |
- | 11 | (29) |
| 2012 | Carrying value | Increase in fair value |
Decrease in fair value |
|---|---|---|---|
| Group | |||
| (£ millions) | |||
| - | 34 | (49) | |
| 2011 | Carrying value | Increase in fair value |
Decrease in fair value |
| Group | (£ millions) | ||
| Investment securities – AFS: | |||
| Collateralized debt obligations | 60 | 25 | (36) |
| CMBS | 32 | 11 | (21) |
| Other investments | 3 | - | - |
| Investments in equity shares | 98 | 2 | (9) |
| 193 | 38 | (66) | |
| Increases/(decreases) in fair value would be recognized in: | |||
| Income statement | - | 11 | (21) |
| Statement of other comprehensive income (accumulated in the AFS reserve) |
- | 27 | (45) |
| - | 38 | (66) |
Reasonable alternative assumptions applied take account of the nature of valuation techniques used, as well as the availability and reliability of observable proxy and historic data. The scenarios applied are considered for each product and varied according to the quality of the data and variability of the underlying market.
Any increases in fair values of the PEB derivative financial instruments would be offset by decreases in the fair values of the associated PEB deposit and vice versa. Any resultant impact is deemed by the Group to be immaterial, therefore these items have been excluded from the table above.
Collateralized debt obligations
Sensitivity on these assets where there are no alternative pricing sources have been calculated by applying a range of probable scenarios against our current valuation process, resulting in a range of possible prices.
Sensitivities on this asset, which is subject to impairment, have been derived from a modeled approach using estimated expected losses at legal maturity and risk adjusted discount rates.
The assets in "Other Investments" were transferred out of Level 3 during the financial year due to a greater depth of pricing information. This relates to a government guaranteed security where the preceding 12 months movement on an applicable market index was previously used to calculate the sensitivities.
Sensitivities in these holdings have been based on the variance in underlying valuation seen in these holdings over the past 12 months.
Our business is under the control of our Board of Directors. Each director is elected annually by the members. The executive directors are the Chief Executive, the Group Finance Director, the Group Retail Director and the Chief Operating Officer, Group Operations. All other directors are non-executive directors. The business address of all of the directors and officers is Nationwide House, Pipers Way, Swindon SN38 1NW, England.
Under our rules, the Board of Directors must consist of not less than eight directors of whom not less than five must be present at a Board meeting to form a quorum.
No potential conflicts of interest exist between any duties to us, as Issuer, of the persons on the board of directors and their private interests or other duties.
The following table presents information with respect to current directors:
| Name | Age | Position | Other Directorships |
|---|---|---|---|
| Geoffrey Howe | 63 | Chairman | Gateway Electronics Components Ltd Close Brothers Group plc Jardine Lloyd Thompson Group plc, Chairman The Cavendish School Charitable Trust Ltd |
| Graham Beale | 54 | Chief Executive | |
| Mark Rennison | 52 | Group Finance Director | Confederation Mortgage Services Ltd Exeter Trust Ltd First Nationwide LBS Mortgages Ltd Nationwide Anglia Property Services Ltd Nationwide Investments (No.1) Ltd Nationwide Housing Trust Ltd Nationwide Lease Finance Ltd Nationwide Mortgage Corporation Ltd Nationwide Syndications Ltd Staffordshire Financial Services Ltd Staffordshire Leasing Ltd NBS Fleet Services Ltd |
| Chris Rhodes | 49 | Group Retail Director | Derbyshire Home Loans Ltd E-Mex Home Funding Ltd The Mortgage Works (UK) plc UCB Home Loans Corporation Ltd at.home nationwide ltd Jubilee Mortgages Ltd The Nationwide Foundation National Numeracy (Trustee) |
| Rita Clifton | 54 | Non-executive Director | Dixons Retail Plc Populus Limited WWF – UK (Trustee) Henley Festival Ltd BUPA Ltd The Conservation Volunteers TCV Employment and Training Services Ltd BTCV Rita Clifton Limited |
| Tony Prestedge | 42 | Chief Operating Officer | Nationwide Anglia Property Services Ltd |
| Name | Age | Position | Other Directorships |
|---|---|---|---|
| Opportunity Now | |||
| Michael Jary | 49 | Non-executive Director | Duchy Originals Ltd OC&C Peleus Advisors LLP OC&C Strategy Consultants LLP OC&C Strategy Consultants International (Netherlands) PCF Social Enterprises Ltd The Michael Jary Charitable Trust |
| Roger Perkin | 64 | Non-executive Director | Electra Private Equity plc Electra Private Equity Investments plc Crime Reduction Initiative Bower Bequest Trustee Company Ltd Tullett Prebon plc |
| Alan Peter Dickinson | 62 | Non-executive Director | Kennington Oval Ltd Frogmore Property Company Ltd Motability Carpetright plc Willis Ltd Brown Shipley |
| Mitchel Lenson | 59 | Non-executive Director | Eclipse Film Partners No.4 LLP Eclipse Film Partners No.39 LLP The Invicta Film Partnership No.37 LLP Elysian Fuels 1 LLP Elysian Fuels 2 LLP MVA Consultant Services Limited |
| Lynne Peacock | 58 | Non-executive Director | Hawkins Residents Limited Scottish Water Scottish Water Business Stream Holdings Limited Scottish Water Horizon Holdings Limited Standard Life plc |
Geoffrey Howe joined the Board in 2005 and became Chairman of the Society in July 2007. He has considerable regulatory, management and legal experience in financial services, insurance and investment markets. He is currently Chairman of Jardine Lloyd Thompson Group plc and a director of Close Brothers Group plc. Geoffrey was formerly Chairman of Railtrack Group plc, a director of Investec plc and General Counsel of Robert Fleming Holdings Limited and Managing Partner of international law firm Clifford Chance.
Graham Beale joined the Society in 1985. He is a chartered accountant by training and was appointed to the Board as Group Finance Director in April 2003. He took up his current role as Chief Executive in April 2007. He is a former non-executive director of Visa Europe Limited and of Visa Europe Services. Prior to his appointment to the Board, he worked extensively in the Finance function and held a number of senior, general management positions within the Society. He has direct line management responsibility for Risk Management and Human Resources, Customer Experience and Corporate Affairs. Graham is a member of the Financial Services Practitioner Panel.
Mark Rennison is a chartered accountant who joined the Society and was appointed to the Board in February 2007. He is responsible for Finance, Treasury, Group Legal & Compliance, Group Internal Audit and Business Protection. He is a director of various Society subsidiaries. Prior to his appointment, Mark was a partner at PricewaterhouseCoopers LLP where he worked in the financial services practice with a specific focus on retail and corporate banking. He has also worked extensively with group treasury operations, leasing and asset finance businesses.
Chris Rhodes is a chartered accountant who joined the Society in April 2009 from Abbey Santander, where he was Director of Retail Distribution for Alliance & Leicester. Chris has spent 20 years working in the financial services sector and his previous positions include Deputy Managing Director of Girobank and Retail Operations Director at Alliance & Leicester. In 2003, he was appointed Managing Director of Retail Banking for the entire Alliance & Leicester Group and in 2007, became Group Finance Director, a role he held until the merger with Santander in 2008. His responsibilities include Nationwide's product range, distribution, consumer finance, online channels and customer strategy and marketing.
Rita Clifton joined the Board in July 2012. She is currently Chairman of Interbrand UK Ltd and holds a number of non-executive directorships, including at BUPA, Dixons Retail plc and Populus. She is also a trustee of WWF-UK, and sits on the Assurance and Advisory Board for BP's carbon off-setting program. Her executive career has been in advertising, strategic marketing and market research, and she was previously Chief Executive at Interbrand UK Ltd, and prior to that Vice Chairman at Saatchi & Saatchi. During her career Rita has advised, at the most senior level, some of the UK's best known organizations, including British Airways, Barclays, BT, Citigroup, Visa and the British Army.
Tony Prestedge was appointed to the Board in August 2007 and was previously Executive Director Group Operations of Portman Building Society. He has held a number of senior management and executive roles at Barclays plc, including Managing Director Home Finance and Retail Support and Operations Director. He was a member of both Woolwich plc and Barclays Retail Banking Executive Committee. Tony is accountable for the Group's Operational Strategy, Performance and Transformation and his divisional reports include Customer and Product Operations, Technology, Transformation Delivery, Telephone Channels and Group Services. Tony is a board member of Opportunity Now.
Michael Jary joined the Board in January 2009. He is a Partner of OC&C Strategy Consultants, a global strategy consulting firm with 15 offices worldwide and served as Worldwide Managing Partner of the firm from 2005 to 2011. He is an advisor to the boards of leading retail and consumer companies in Europe, the USA and Asia. He is a regular commentator on the retail industry, the co-author of a number of books including Retail Power Plays and a guest lecturer at INSEAD Business School. He is also Chairman of Duchy Originals and of The Prince's Social Enterprises.
Roger Perkin joined the Nationwide Board as a non-executive director in April 2010. Roger is a former partner at Ernst & Young, and has spent 40 years in the accounting profession. During his time at Ernst & Young, he worked with many blue chip clients and has advised boards across the spectrum of financial services, including banking, insurance, fund management and private equity. He is also a non-executive director at Electra Private Equity Plc, chairing its audit committee and a former non-executive director of the Evolution Group plc. Additionally, he is a trustee of two charities, Chiddlingstone Castle and Crime Reduction Initiatives.
Alan Peter Dickinson joined the Nationwide Board in June 2010. Alan has spent more than 40 years in banking, originally joining the Royal Bank of Scotland in 1973, having started his career with Westminster Bank in 1968. He is an experienced retail and corporate banker and a former Executive Committee member of the RBS Group and Chief Executive of both RBS UK and RBS's market leading UK Corporate Banking business. Alan is also a non executive director of Carpetright plc and Frogmore Property Company Limited, a governor of the charity Motability and Honorary Treasurer of Surrey County Cricket Club.
Mitchel Lenson joined the Board in July 2011. Mitchel has spent nearly 30 years in the financial services industry and is a former Group Chief Information Officer at Deutsche Bank with responsibility for IT and Operations for all operating divisions of the bank, including its retail banking operations. Mitchel was a member of the executive committees for both the Corporate and Investment Bank and the Private Client and Asset Management Division. He has also served as MD, Global Head of Operations & Operations IT at UBS Warburg and as Director, Group Operations at Credit Suisse First Boston. More recently, Mitchel was a partner of Olivant & Co, an investment company providing strategic and operational expertise alongside investment capital to financial services businesses in Europe, the Middle East and Asia-Pacific and was a non-executive director of NYFIX, a NASDAQ listed company.
Lynne Peacock joined the Society in July 2011. Lynne, a former Chief Executive UK of National Australia Bank (NAB) and Chief Executive of Woolwich plc, has over 25 years' senior management experience in a range of roles comprising brand development, mergers & acquisitions, change management and business transformation, including 15 years at board level. During her time at NAB, Lynne was responsible for its businesses in the UK consisting of the Clydesdale and Yorkshire Bank. She became Chief Executive of Woolwich plc in October 2000 following its takeover by the Barclays Bank Group, having previously held a number of senior management and board positions at the Woolwich Building Society, both before and after its conversion to a public listed company in 1997. Lynne is a non executive director of Scottish Water Business Stream Holdings Limited, Scottish Water Horizons Holdings Limited and Standard Life plc.
Our Board of Directors operates through its meetings and through its four main committees, the Audit Committee, the Nomination Committee, the Remuneration Committee and the Board Risk Committee. To the extent that matters are not reserved to our Board of Directors, responsibility is delegated to the Chief Executive, who is assisted by the Executive Committee and the Executive Risk Committee.
The Audit Committee, in accordance with its commitment to good corporate governance, seeks to ensure that we maintain sound controls in relation to the responsibilities of the directors, meets regularly with senior management and the internal audit department and regularly reviews its relationship with the external auditors.
The Nomination Committee regularly reviews the balance of skills and experience on the Board and the requirements of the business. It also considers the appointment of new directors and makes recommendations to the Board.
The Remuneration Committee is responsible for our director and executive officer remuneration policy. We have designed our policy to ensure that director and executive officer remuneration reflects performance and allows us to attract, retain and motivate a sufficient number of talented executives. The Remuneration Committee reviews, evaluates and makes recommendations to the Board regarding our executive compensation standards and practices, including basic salaries, bonus distributions, pension fund contribution and the medium-term incentive scheme. The Remuneration Committee consists of all non-executive directors.
The Board Risk Committee, which meets at least four times a year, has responsibility for overseeing the risk framework, policies and risk appetite, and making recommendations to the Board.
The Executive Committee is our key operational committee which oversees the day-to-day operations of our business. This committee meets once each week, reviews all matters that are to be presented to the Board of Directors, and is composed of our Chief Executive and the four other executive directors.
The Executive Risk Committee, which meets monthly, is responsible for ensuring a coordinated approach across all risks and oversight of the risk committees. The Committee's membership comprises the Executive and Group Directors. The risk committees comprise the Asset and Liability Committee ("ALCO"), the Lending Committee, the Weekly Trading Committee and the Group Risk Oversight Committee.
ALCO sets operational limits to control exposures so that they are within overall limits set by our Board of Directors. ALCO meets on a monthly basis. ALCO comprises the Chief Executive, Group Finance Director, Group Retail Director, Chief Risk Officer, the Divisional Director Treasury and Divisional Director Financial Performance. For more information about ALCO, see the section entitled "Financial Risk Management ".
The Lending Committee is responsible for determining the Group's attitude to risk, monitoring and overseeing the performance of the profile of lending risk across all the various lending portfolios. The Committee's membership comprises the Chief Risk Officer, Group Finance Director, Group Retail Director, the Divisional Director Treasury and the Divisional Director Customer Operations. For more information about the Lending Committee, see the section entitled "Financial Risk Management—Credit Risk".
The Weekly Trading Committee acts in accordance with the mandate and direction of ALCO and the Lending Committee. It is responsible for approving product pricing and terms and conditions of mortgages, savings and current accounts; monitoring and setting hedging mandates; and monitoring liquidity and funding risks. The Committee's membership is the same as ALCO, with the addition of the Group Director, Distribution.
The Group Risk Oversight Committee is responsible for the design, effectiveness and efficiency of the Society's Enterprise Risk Management Framework. The Committee is comprised of the Chief Risk Officer, Group Risk Director, Group Finance Director and five senior officers.
For the financial year ended April 4, 2012 the aggregate amount of compensation, excluding pension benefits, that we paid to all directors and executive officers as a group totaled £5.8 million.
Directors receive an annual bonus which only pays out if performance targets are met under pre-defined Group performance and individual performance measures.
The Medium Term Incentive Plan rewards our directors for sustained performance and achieving challenging financial targets over a three year performance cycle. A new three year performance cycle starts each year. The maximum incentive that could be paid during the year to the Chief Executive is 80% of base salary and for other executive directors it is 54%. If performance falls below the minimum acceptable performance, then no bonus will be paid. The Remuneration Committee reviews performance against targets each financial year.
In addition executive directors receive other benefits including a car allowance, healthcare and mortgage allowance.
As at April 4, 2012, we had loans to directors or persons connected to directors totaling £0.6 million. All of these loans were granted in the normal course of business and were largely made up of residential mortgage loans and balances on credit cards. Our directors and other employees are eligible for discounts on residential mortgage loans.
We maintain a register containing the details of all loans, transactions and other arrangements made between our directors (and persons connected with our directors) and Nationwide or its subsidiaries. This register is available for inspection at our annual general meetings and during normal business hours at our principal office during the fifteen days prior to our annual general meeting.
G.J. Beale has opted out of the Nationwide Pension Fund, and he receives a monthly allowance in lieu of pension scheme accrual.
T.P. Prestedge has opted out of the Group Personal Pension Arrangement and receives a monthly allowance in lieu of an employer contribution into the Group Personal Pension Arrangement.
M.M. Rennison has opted out of the Nationwide Pension Fund, and he receives a cash allowance in lieu of pension scheme accrual.
For information on transactions with related parties, see note 39 to our audited consolidated financial statements incorporated by reference herein.
Our main competitors are the six largest UK banking groups. In addition we also compete with a large number of other building societies, and smaller banks and with life insurance companies. In addition, new providers have emerged as competitors in all areas of the UK personal financial services market. A description of the traditional types of organizations with which we continue to compete as well as a description of certain new competitors is set forth below.
The UK financial services market is dominated by the six largest banking groups, namely Lloyds Banking Group, Royal Bank of Scotland, Barclays, HSBC, Santander UK and, following its expected takeover of the Verde banking business, Cooperative Banking Group. Within the UK retail banking sector there have also been a number of significant business combinations and this trend was accelerated by the financial crisis which began in 2007.
Over the past 30 years, many building societies have merged with other building societies or, in a number of cases, transferred their businesses to the subsidiary of another mutual organization or demutualized and transferred their businesses to existing or specially formed banks. As a result, the number of building societies in the United Kingdom has fallen from 167 in 1985 to 47 as at June 1, 2012. Building societies today continue to hold an important share of the UK mortgage and savings market and have been recognized by recent UK Governments as bringing valuable diversity and competition to the UK banking market. For further information about the UK residential mortgage market and UK retail deposit market see below.
The UK insurance industry has traditionally been made up of a large number of mutual insurance organizations and several composite insurers originating a range of products, distributed through building societies, banks, direct sales forces and independent financial advisers. Recent trends include consolidation within the industry, the demutualization of mutual insurers and the entry of building societies and banks into the market as underwriters as well as distributors.
A number of large retailers sell financial services to their customers, often through co-operation arrangements with existing banks and insurance companies. One retailing group, namely Tesco, has entered the market as a manufacturer of financial service products in its own right. In addition, foreign banks, investment banks, insurance and life assurance companies have at various times been active in UK personal financial services, particularly the mortgage and retail savings markets, and a number of companies have expressed a desire to enter the market. The growth of internet price comparison sites has enabled consumers to have access to information that has increased price competition particularly in certain insurance markets. Companies are using low cost telephone, mail and internet based distribution channels to offer competitively priced retail savings accounts, mortgages and other financial products. The internet and mobile communications technology provide opportunities for further competition from organizations from outside the traditional banking sector. The use of the intermediary sector also allows new entrants to gain access to the UK mortgage market. Since the financial downturn, several additional entrants have launched, or investigated ways to launch, on a relatively small scale, seeking to take advantage of the problems faced by of some of the larger participants. Competition regulation has and may eventually further assist potential entrants if it enforces the breakup of some of the larger participants or the sale of those in public ownership.
The table below sets out information for the last three years concerning year-end balances of UK lending secured on residential property and the proportions held by building societies, banks and us:
| Year ended December 31, | Total Balances(1) |
Building Societies(1) |
Banks(1) | Others | Our share of total UK residential mortgages(1) |
|---|---|---|---|---|---|
| (£ billions, except percentages) | |||||
| 2011 | 1204.4 | 15.6% | 68.7% | 15.7% | 10.6% |
| Year ended December 31, | Total Balances(1) |
Building Societies(1) |
Banks(1) | Others | Our share of total UK residential mortgages(1) |
|---|---|---|---|---|---|
| 2010 | 1200.7 | 15.8% | 68.0% | 16.2% | 10.4% |
| 2009 | 1193.7 | 15.2% | 58.5% | 26.3% | 10.8% |
| __ |
Note:
(1) Source: BoE (excluding lending to housing associations), except for information regarding our balances which are taken from our own data. Building society figures include our own balances.
Although the overall size of the new mortgage market has shrunk considerably since 2007, the nature of competition is essentially unchanged, in that it involves defending the existing stock of balances and competing for the flow of new lending. New lending is driven by first-time buyers or next-time buyers remortgaging, changing homes or extending their mortgages. In most cases this is for residential purposes, although the popularity of buy to let has grown in recent years. In 2003, the proportion of the UK population owning their own homes peaked at 71% although it has declined for the past eight years and stood at 66% as at March 31, 2011. This decline reflects stretched affordability and the growth of the private rental sector, but we expect it to stabilize once affordability improves and the market picks up. The impact of the credit crunch is still evident in the mortgage market, with fewer products available which permit high LTV ratios and significantly improved margins over those evident in 2007. As such, competition is driven by a combination of price, risk profile and access to funding by lenders.
UK gross residential mortgage lending in the year ended March 31, 2012 was £141 billion, an increase of 5% on UK gross residential mortgage lending of £134 billion in the year ended March 31, 2011. UK net residential mortgage lending increased to £7.6 billion in the year ending March 31, 2012 from £6.4 billion in the year ending March 31, 2011.
Prior to the financial crisis, a feature of the UK mortgage market became the differential pricing structure that developed in response to increased competition. New customers were generally offered lower remortgage rates than those on the backbook, so that a growing number of residential mortgage borrowers actively seek to replace existing mortgages with new mortgages at lower rates rather than move on to lenders' backbook interest rates. The rapid fall in interest rates since the start of 2009 and the decline in house prices has meant that a majority of borrowers now stay on lenders' backbook products at the end of their initial mortgage deal period. This may be either through necessity, as the LTV ratio of their house has risen in line with price falls and they are unable to refinance, and/or due to the fact that the fall in rates has meant that the backbook rates are more in line with, or better than, front book deal pricing. In the year to 31 March 2012, remortgaging totaled an estimated £46 billion, up 12% on the figure in the year to 31 March 2011.
As a building society, we do not have equity shareholders and, therefore, do not pay equity dividends, although on September 1, 2012 our Memorandum & Rules were amended to allow us to issue a new form of deferred share with a capped discretionary distribution which would count as core tier 1 capital, and which would be suitable for raising new capital from external investors. Any return paid on these shares would be balanced by our ongoing mutual strategy of returning value to our members by generally offering higher savings interest rates and lower borrowing interest rates than our main competitors. Our market share of gross advances of 13.0% during the financial year ended April 4, 2012 was above our par share of 10.4% at the beginning of the 2011 calendar year. Over the financial year ended April 4, 2012, the average LTV ratio of new mortgage lending was 63% (excluding further advances) compared with 66% in the same period a year earlier.
The UK retail deposit market is dominated by banks, building societies and National Savings and Investment, a UK government-sponsored savings and investment organization. Below is a table breaking down the total UK retail deposit market by type of financial institution compiled from details published by the BoE:
| Year ended December 31, | Total UK retail deposits(1) |
Building societies' share of total UK retail deposits(1) |
Banks' share of total UK retail deposits(1) |
Others(1) | Our share of total UK retail deposits(1) |
|---|---|---|---|---|---|
| (£ billions, except percentages) | |||||
| 2011 | 1126.7 | 22.0% | 68.8% | 9.2% | 11.2% |
| 2010 | 1095.9 | 21.9% | 68.4% | 9.3% | 11.2% |
| 2009 | 1064.8 | 20.1% | 70.6% | 9.2% | 11.3% |
Note:
______________
(1) Source: BoE, except for information regarding our balances which are taken from our own data.
The UK retail deposit market has become an increasingly commoditized market driven primarily by price, particularly for the flow of new money that generally seeks the most attractive rates available. However the bank failures of 2007 and 2008 and the limits of the FSCS appear to have led some customers to spread their savings across a number of different companies. Older deposit balances have traditionally subsidized the cost of new retail deposits, primarily reflecting customer inertia.
In the last few years, competition for UK retail deposits has increased as new participants, such as foreign banks, supermarkets, insurance/life assurance companies and direct online banking providers have entered the market by offering attractive rates of interest. These new entrants have caused the cost of attracting new retail deposits to increase for existing players in the market and have impacted the flow of new retail deposits. The competition has intensified as banks have sought to rebalance their liabilities away from short-term wholesale and back towards retail funding.
We believe that increased consumer awareness driven by the press and increased competition has created potentially greater volatility of retail deposit balances both between different organizations and between different accounts within organizations. This, in turn, has resulted in a reduction in the differential between rates paid to existing and new balances as customers transfer to high rate accounts and organizations aim to retain existing balances.
In the face of increased competition for retail funds, we were still able to increase our savings balances by £1.5 billion in the financial year ended April 4, 2012.
In recent years, we have experienced substantial competitive pressure in our traditional UK residential mortgage market and retail deposit market, and we expect this competitive pressure to continue. This pressure is in part symptomatic of the slow rate of growth in the UK savings and lending markets. Spreads on lending have been reduced by banks' competition for lower risk assets, such as low LTV mortgages. In addition, UK and international banks are still seeking to reduce significant funding gaps by attracting more stable retail funds. The urgency of this process has been increased by periodic intensification of financial market strains in the eurozone.
The framework for supervision and regulation of banking and financial services in the United Kingdom has been, and continues to be, heavily influenced by European Union directives that are required to be implemented in member states through national legislation. In March 2000, the adoption by the European Union of the Banking Consolidation Directive and Capital Adequacy Directive (as recast in July 2006, together commonly referred to as the "Capital Requirements Directive") resulted in the consolidation of the main pan-European banking legislation into a single directive. The principal intention underlying the EU Banking Consolidation Directive is the harmonization of banking regulation and supervision throughout the European Union and Norway, Iceland and Liechtenstein, commonly known as the European Economic Area (the "EEA"). The EU Banking Consolidation Directive prescribes minimum standards in key areas and requires EEA member states to give "mutual recognition" to each other's standards of regulation. The EU Banking Consolidation Directive establishes the "passport" concept, which amounts to freedom for a credit institution authorized in its "home" state to establish branches in, and to provide cross-border services into, other EEA member states.
Although credit institutions are primarily regulated in their home state by a local regulator, the EU Banking Consolidation Directive prescribes minimum criteria for regulation of the authorization of credit institutions and the prudential supervision applicable to them. Our local regulator is the Financial Services Authority. For further information about regulation in the United Kingdom see the subsection entitled "—UK Regulation". Investment firms and other similar institutions that engage in the provision of services relating to securities, derivatives and other similar instruments are subject to a similar regulatory environment and can obtain a "passport" under the EU Markets in Financial Instruments Directive (Directive (2004/39/EC)). The Markets in Financial Instruments Directive, among other things, repealed and replaced the Investment Services Directive and is designed to create a single European market in financial services. It covers most firms previously subject to the Investment Services Directive. On October 20, 2011, the European Commission published a proposal for a revised version of the Markets in Financial Instruments Directive, which aims to introduce, among other things, requirements to enhance market transparency, increase regulatory oversight of certain markets and introduce stricter investor protection rules.
EU legislation transposing the Basel Accord, through the Capital Requirements Directive, makes substantial changes to the capital adequacy regime set out in the 1988 Basel Capital Accord, as amended. Broadly, the principal changes effected by the revised requirements include the application of risk-weighting and supervisory review of the process of evaluating risk measurement and capital ratios. The requirements were partially implemented at the start of 2007, with more advanced techniques in relation to the calculation of capital requirements for credit risk and operational risk having been implemented at the start of 2008.
The Capital Requirements Directive has since been amended by Directive 2009/111/EC (known as "CRD II"). CRD II was implemented in the United Kingdom on December 31, 2010. CRD II includes changes to the criteria for hybrid tier 1 capital, the control of large exposures and requirements relating to securitization transactions. The requirements for hybrid capital to count as non-core tier 1 capital have been toughened, as have the relative proportions of core, non-core and innovative tier 1 capital. However, CRD II provides for a certain proportion of existing instruments that do not comply with the new rules to continue to count as capital for a long transitional period. The Capital Requirements Directive was further amended by Directive 2010/76/EU dated November 24, 2010 (known as "CRD III"), which further tightened the capital requirements for trading books and securitizations in accordance with the recommendations of the Basel II framework. CRD III entered into force on December 15, 2010 and, following its implementation, the last of its provisions came into force in the UK on April 16, 2012.
It should also be noted that the Basel Committee has approved a final text proposing significant changes to the Basel II Framework (such changes being commonly referred to as "Basel III"), including new capital and liquidity requirements intended to reinforce capital standards and to establish minimum liquidity standards for credit institutions. In particular, the changes refer to, amongst other things, new requirements for the capital base, measures to strengthen the capital requirements for counterparty credit exposures arising from certain transactions and the introduction of a leverage ratio as well as short-term and longer-term standards for funding liquidity (referred to as the "Liquidity Coverage Ratio" and the "Net Stable Funding Ratio"). Member countries will be required to implement the new capital standards from January 2013, the new Liquidity Coverage Ratio from January 2015 and the Net Stable Funding Ratio from January 2018. The European Commission published corresponding proposals to implement Basel III (through replacing the existing Capital Requirements Directive and the amendments made to it by CRD II and CRD III with a Capital Requirements Regulation and an associated Capital Requirements Directive known as "CRD IV") on July 20, 2011. The CRD IV draft legislation is currently in the process of being debated by the European Authorities, with current expectations being that agreement on the final legislation will be reached before the end of 2012; however, implementation is likely to be delayed beyond January 1, 2013, at least until later during 2013.
The draft CRD IV proposals published substantially reflect the Basel III capital and liquidity standards and the applicable implementation timeframes. However, certain key terms are not defined and various related issues remain under discussion, particularly on the detail of the final liquidity and leverage rules, on which further legislation will be needed, and the types of financial instruments that will be eligible to meet the new capital and liquidity requirements. The proposals also make provision for (among other things) new requirements to reduce reliance by credit institutions on external credit ratings, by requiring that all banks' investment decisions are based not only on ratings but also on their own internal credit opinion, and that banks with a material number of exposures in a given portfolio develop internal ratings for that portfolio instead of relying on external ratings for the calculation of their capital requirements. The proposals are likely to be subject to change during the EU legislative process, and certain details remain to be clarified in further binding technical standards to be issued by the European Banking Authority (the "EBA") during 2013. As with Basel III, the proposals contemplate the entry into force of the new legislation from 2013 (though as noted, commencement will now be delayed beyond January), with full implementation by January 2019; however, the proposals allow individual member states to implement the stricter requirements of contributing instruments and/or level of capital more quickly than is envisaged under Basel III.
The proposal for a regulation gives express recognition for core tier 1 capital instruments for mutuals and cooperatives and permits the use of a cap or restriction to safeguard the interests of members and reserves.
In April 2008, the European Parliament and the Council of the European Union adopted a second directive on consumer credit (Directive 2008/48/EC) which provides that, subject to exemptions, loans not exceeding €75,000 will be regulated. This directive repeals and replaces the first consumer credit directive and requires member states to implement the directive by measures coming into force by June 11, 2010. Loan agreements secured by land mortgage are exempted from the consumer credit directives. In March 2011 the European Commission published a proposal for a directive on credit agreements relating to residential immovable property for consumers. The proposal is to some extent modeled on the second directive on consumer credit and requires, among other things, standard pre-contractual information, calculation of the annual percentage rate of charge in accordance with a prescribed formula, and a right of the borrower to make early repayment. Until the final form of the proposed directive and UK implementing legislation are published, it is not certain what effect the adoption and implementation of the proposed directive would have on our mortgage businesses.
Note, the following discussion is based on the existing regulatory regime in the UK. However, it should be noted that the Government has announced a range of structural reforms to UK financial regulatory bodies to be implemented, as follows:
The Financial Services Act 2012, which was passed on December 19, 2012, will, once implemented, effect the replacement of the FSA with the authorities referred to above. The Financial Services Act amends certain existing legislation including the Financial Services and Markets Act 2000, the UK Building Societies Act and the Banking Act 2009 to make provision about the exercise of certain statutory functions relating to building societies. A consultation on key pieces of secondary legislation to be made under the statutory framework to be implemented pursuant to the (then) draft Financial Services Bill was published on October 15, 2012.
Another area of change which impacts on the UK regulatory landscape relates to the proposals for banking reform. On June 14, 2012, HM Treasury issued a white paper ("Banking reform: delivering stability and supporting a sustainable economy") on how the Government intends to implement the measures recommended by Sir John Vicker's Independent Commission on Banking final report of September 12, 2011. Broadly, the white paper covers the following areas: the ring-fencing of vital banking services from international and investment banking services; measures on loss absorbency and depositor preference; and proposals for enhancing competition in the banking sector. A draft of the initial bill to implement the ICB recommendations was published on October 12, 2012, in the form of framework legislation to put in place the architecture to effect the reforms, with detailed policy being provided for through secondary legislation. The Government has decided to carve building societies out of the proposed ring-fencing legislation and, instead, intends to amend the UK Building Societies Act to bring building societies legislation into line with the proposed ring-fencing requirements. The subsection below entitled "The UK Building Societies Act" refers to the discussion document published by HM Treasury in 2012 which sets out the Government's vision for the building societies sector.
See "Risk Factors—Risks Related to Our Business—Risks associated with governmental authorities, and monetary policies in the UK and changes thereto may adversely affect our business".
The main piece of legislation regulating building societies is the UK Building Societies Act. The UK Building Societies Act governs the creation, authorization and management of building societies. Prior to December 1, 2001, it also established the Building Societies Commission as the primary body responsible for regulating building societies. On December 1, 2001, the role of the Building Societies Commission as our primary regulator was taken over by the FSA pursuant to the ongoing reorganization of the regulation of the UK financial services industry. With the introduction of the Financial Services and Markets Act 2000, certain sections of the UK Building Societies Act were repealed. However, a substantial part of the UK Building Societies Act, including the constitutional parts dealing with the principal purpose of building societies, nature limits, general governance, among others, still remain in force. The UK Building Societies Act has been amended and supplemented since its introduction by secondary legislation. For further information on the reforms under the Financial Services and Markets Act 2000, see the subsection below entitled "Financial Services and Markets Act 2000".
On July 6, 2012, HM Treasury published a consultation document entitled "The future of building societies" which sets out the Government's aim to maintain the distinctiveness of the building society sector while creating a level playing field and removing unnecessary barriers to growth. This consultation closed on September 14, 2012. The Government has stated that it intends to amend the UK Building Societies Act to widen the opportunities for building societies and to align them with ring-fenced banks without compromising their mutuality. The Government stated that the loss absorbency proposals set out in the white paper of June 2012 on banking reform will apply to building societies as they apply for banks of a similar profile. As part of its commitment to foster diversity in the financial sector, the Government invited suggestions for reviewing those parts of the UK Building Societies Act which restrict societies, where this is in accordance with maintaining their distinctiveness.
The UK Financial Services and Markets Act 2000 consolidated and harmonized the regulation of financial services in the United Kingdom. As part of this process, the FSA became the sole regulatory body responsible for regulating and supervising the financial services industry in the United Kingdom save in respect of certain lending activities.
The Financial Services and Markets Act 2000 imposes an on-going system of regulation and control on building societies. The detailed rules and prudential standards set by the FSA are contained in various parts of the FSA Handbook. Parts of the FSA Handbook which are of particular relevance to building societies include the General Prudential sourcebook, the Prudential sourcebook for Banks, Building Societies and Investment Firms, the Building Societies sourcebook and The Building Societies Regulatory Guide.
The following sections set forth some of the concepts for a building society which is authorized under the Financial Services and Markets Act 2000.
Building societies are mutual organizations that are managed for the benefit of their members, who are primarily retail savings customers and residential mortgage customers. Each member is normally entitled to one vote at a building society's general meeting, regardless of the size of the member's deposit account or mortgage loan or the number of accounts the member maintains.
Building societies are required to be engaged primarily in the business of making loans secured on residential property, which are substantially funded by members. In addition, as long as building societies comply with specific limits on lending and funding, they may engage in additional activities such as commercial lending, unsecured personal lending, insurance and personal investment product activities, subject to compliance with regulatory requirements of the FSA and the OFT.
Building societies have a statutory duty to keep accounting records as well as establishing and maintaining systems of control. The FSA is empowered to request ad hoc reports regarding our compliance with these requirements.
The members of a building society fall into two categories. The first category consists of investing or "shareholding" members. Shareholding members are individuals who have made a deposit (also referred to as an "investment") in a share account with a building society or who hold deferred shares in the society, and bodies corporate which hold deferred shares. In this Base Prospectus we refer to deposits in these share accounts as "UK retail member deposits" and to people holding UK retail member deposits as "UK retail member depositors".
There are restrictions on building societies raising funds from individuals other than in the form of deposits in share accounts or by the issue of deferred shares (including permanent interest bearing shares) and the proposed new form of capital instrument to be known as core capital deferred shares ("CCDS") (as discussed below)). A subsidiary of a building society may, however, offer deposit accounts which do not confer member status provided it has the required regulatory authorization. Deposits in these accounts are referred to as "non-member deposits".
The second category of members are "borrowing" members, that is, persons who have received a loan from the building society which is fully or, if the rules of the society allow, substantially secured on land. Building societies may also make loans that do not confer member status, which generally consist of unsecured loans.
The UK Building Societies Act imposes limits on the ability of building societies to raise funds and to make loans. Investing shares in a building society, representing UK retail member deposits made with the society, must account for not less than 50% of its total funding. In calculating this amount, a specified amount of deposits made by individuals with a building society's subsidiaries in other EEA member states, the Channel Islands, the Isle of Man or Gibraltar is disregarded. The specified amount is up to 10% of what would have been the society's funding but for the exclusion.
Loans made by a building society and its subsidiaries which are fully secured on residential property must account for not less than 75% of its total trading assets (that is, the total assets of a society and its subsidiaries, plus provisions for bad or doubtful debts, less liquid assets, fixed assets and certain long term insurance funds).
UK retail member deposits are classified as shares in a building society's balance sheets. There is a fundamental distinction between a share in a building society and a share in a limited liability company. Holders of ordinary shares in a company normally do not have the right to withdraw their share capital from the company. The share capital of a company is therefore fixed. A UK retail member depositor has a right to withdraw his investment from a building society. The share capital of a building society therefore fluctuates each time UK retail member depositors deposit or withdraw funds from their account. As a result shares in a building society do not form a permanent capital resource. The permanent capital of a building society consists primarily of its reserves (which have been built up over the years mainly from its retained earnings) and any deferred shares that it has issued. In addition, a building society can issue deferred shares, which count towards its permanent capital. These have, in the past, mainly been in the form of permanent interest bearing shares, which have counted towards a society's tier 1 capital. More recently, profit participating deferred shares (a type of deferred share) have been recognized by the FSA as core tier 1 capital, although these shares have, to date, only been issued by way of exchange for an existing instrument in circumstances of financial stress or as a part of a society's contingent convertible capital (in which case it would only be issued upon a serious decline in the society's capital ratio). Changes to the Capital Requirements Directive which were implemented in the UK at the end of 2010 toughened the requirements for eligibility as tier 1 capital. Permanent interest bearing shares, which were already in existence will retain their capital status, but the extent to which such shares count towards regulatory capital will be phased out over a long transitional period. CCDS, as a proposed new form of deferred share, are intended to meet the new regulatory criteria for core tier 1 capital, while being consistent with the values of mutuality and supporting members' interests. CCDS are also designed to be a suitable instrument for raising new capital from external investors.
The UK Building Societies Act prohibits building societies and their subsidiaries from entering into any transaction involving derivative instruments unless the transaction falls within one of the specified exceptions, including where it is entered for the purpose of limiting the extent to which it will be affected by fluctuations in interest rates, exchange rates, any index of retail prices, any index of residential property prices, any index of the prices of securities or the ability or willingness of a borrower to repay a loan owing to the building society.
The UK Building Societies Act permits a building society to demutualize by transferring the whole of its business to an existing company (referred to as a "takeover") or to a specially formed company (referred to as a "conversion") so long as the process meets statutory requirements. Any such demutualization must be approved by members and confirmed by the FSA. The successor company will be a bank, which must be duly authorized to carry on its deposit-taking business by the FSA or equivalent EEA regulatory authority.
The member approval threshold required varies depending on the type of demutualization. In order to convert into a new bank by transferring the society's business to a specially formed company, a minimum of 50% of shareholding members qualified to vote would have to vote on a requisite shareholders' resolution, and a minimum of 75% of those voting would have to support the resolution to convert. In addition, more than 50% of borrowing members who vote would have to vote in favor of a borrowing members' resolution to convert. On a demutualization as a result of a takeover by an existing bank or other company, then the requirements would be similar except that 50% of shareholding members qualified to vote (or shareholding members representing 90% by value of the society's shares) must actually vote in favor of the requisite shareholding members' resolution.
The UK Building Societies Act (as modified by the Mutual Transfers Order) permits a building society to transfer the whole of its business to the subsidiary of another mutual society (as defined in section 3 of the Funding and Mutual Societies Transfers Act). The successor subsidiary must be duly authorized to carry on its deposit-taking business by the FSA or an equivalent EEA regulatory authority. The terms of the transfer to the relevant subsidiary must include provision for making membership of the holding mutual (or membership of the parent undertaking of such holding mutual) available to every qualifying member of the building society and to every person who, after the transfer, becomes a customer of the company, and the membership of the holding mutual (or such parent undertaking) must be on terms no less favorable than those enjoyed by existing members of the holding mutual (or such parent undertaking, as the case may be).
A transfer of business to a subsidiary of another mutual society requires approval by members and confirmation by the FSA. The member approval thresholds require a shareholding members' resolution to be passed by a minimum of 75% of shareholding members qualified to vote and voting on the resolution and a borrowing members' resolution to be passed by more than 50% of borrowing members qualified to vote and voting on the resolution.
The UK Building Societies Act confers power on the FSA, if it considers it expedient to do so in order to protect the investments of shareholders or depositors, to direct a building society to transfer all of its engagements to one or more other building societies or to transfer its business to an existing company. The Financial Services Act 2012 also amends the UK Building Societies Act to extend this power of direction to a transfer of a building society's business to an existing or specially formed company that is a subsidiary of another mutual society (as defined in section 3 of the Funding and Mutual Societies Transfers Act), although at the date of this Base Prospectus this aspect of the Financial Services Act 2012 is not yet in force. Where any such direction is made, the FSA may also, if it considers it expedient to do so in order to protect the investments of shareholders or depositors, direct that such transfer may proceed on the basis of a resolution of the board of directors of the building society, without the need for member approval.
The FSA is currently the regulator for the UK financial services industry (save in respect of certain lending activities) and is responsible for supervising building societies, banks, friendly societies, insurance companies and other financial institutions. The regulatory objectives of the FSA are:
The FSA supervises and regulates financial institutions, including building societies, on an ongoing basis by continually assessing their risk profile and capacity to manage and control risks. If the FSA finds that a financial institution has failed to comply with the requirements under the Financial Services and Markets Act 2000, the FSA has a variety of enforcement powers including:
The Financial Services Act 2012 will, once implemented, effect the replacement of the FSA with the authorities referred to above.
The OFT is the consumer and competition authority under the UK Enterprise Act 2002, and is responsible for the issue of licenses under, and for superintending the working and enforcement of, the UK Consumer Credit Act 1974, as amended (the "Consumer Credit Act 1974"). The OFT and other bodies may enforce consumer legislation under the Enterprise Act 2002 by:
The Financial Services and Markets Act 2000 prohibits any person from carrying on a "regulated activity" by way of business in the UK unless that person is authorized or exempt under this Act. Regulated activities include: deposit-taking, mortgage activities (such as entering into, administering, or advising or arranging in respect of, regulated mortgage contracts), effecting and carrying out contracts of insurance as well as insurance mediation, and investment activities (such as dealing in investments as principal or as agent, arranging deals in investments, and managing investments). We are authorized for, among other things, deposit-taking and mortgage activities, and are authorized for certain investment activities. The Financial Services and Markets Act 2000 also prohibits financial promotions in the UK unless the promotion is issued or approved by an authorized person or exempt from such requirements.
The Financial Services and Markets Act 2000 regulates mortgage credit within the definition of "regulated mortgage contract" and also regulates certain other types of home finance. A credit agreement is a regulated mortgage contract if it is entered into on or after October 31, 2004 and, at the time it is entered into: (a) the credit agreement is one under which the lender provides credit to an individual or to trustees; (b) the contract provides for the repayment obligation of the borrower to be secured by a first legal mortgage on land (other than timeshare accommodation) in the UK; and (c) at least 40% of that land is used, or is intended to be used, as or in connection with a dwelling by the borrower or (in the case of credit provided to trustees) by an individual who is a beneficiary of the trust, or by a related person.
If prohibitions under the Financial Services and Markets Act 2000 as to authorization or financial promotions are contravened, then the affected regulated mortgage contract (and, in the case of financial promotions, other credit secured on land) is unenforceable against the borrower without a court order. The FSA Handbook part Mortgages and Home Finance: Conduct of Business sourcebook ("MCOB"), which is part of the FSA Handbook, sets out rules in respect of regulated mortgage contracts and certain other types of home finance. Under MCOB rules, an authorized firm (such as Nationwide Building Society) is restricted from repossessing a property unless all other reasonable attempts to resolve the position have failed, which can include the extension of the term of the mortgage, product type changes and deferral of interest payments.
Any credit agreement intended to be a regulated mortgage contract or unregulated might instead be wholly or partly regulated by the Consumer Credit Act 1974 or treated as such, and any credit agreement intended to be regulated by the Consumer Credit Act 1974 or treated as such or unregulated might instead be a regulated mortgage contract, because of technical rules on determining whether the credit agreement or any part of it falls within the definition of a regulated mortgage contract or within the definition of a regulated agreement (described below) and technical rules on changes to credit agreements.
The Consumer Credit Act 1974 regulates credit within the definition of "regulated agreement". A credit agreement is a regulated agreement if: (a) the borrower is or includes an "individual" as defined in this Act; and (b) the credit agreement is not an exempt agreement under this Act. Certain financial limits in respect of the credit provided applied to credit agreements entered into before April 6, 2008, or before October 31, 2008 in the case of buy-to-let mortgages satisfying prescribed conditions. Buy-to-let mortgages entered into on or after October 31, 2008 and satisfying prescribed conditions are exempt agreements under the Consumer Credit Act 1974.
If requirements under the Consumer Credit Act 1974 as to licensing of lenders or brokers or entering into and documenting a credit agreement are not met, then the affected regulated agreement is unenforceable against the borrower without an order of the OFT or court order or (for agreements entered into before April 6, 2007) is totally unenforceable, depending on the circumstances. Under Sections 75 and 75A of the Consumer Credit Act 1974, in certain circumstances a lender is liable to a customer in relation to misrepresentation and breach of contract by a supplier in a transaction financed by a credit agreement regulated by this Act or treated as such, and the lender has a statutory indemnity from the supplier against liability under Section 75 subject to any agreement between the lender and the supplier.
In December 2012, the Financial Services Act received royal asset. This Act contains provisions (among other things) enabling the transfer of consumer credit regulation from the OFT under the Consumer Credit Act 1974 to the FCA under a regime based on the Financial Services and Markets Act 2000, and giving power to the FCA to render unenforceable contracts made in contravention of its product intervention rules. The UK Government's aim is for the transfer of consumer credit regulation to the FCA to take place in 2014.
Nationwide Building Society is also authorized for carrying out insurance mediation. The Insurance: Conduct of Business sourcebook, which is part of the FSA Handbook, sets out rules in respect of non-investment insurance.
The Financial Services and Markets Act 2000 established the Financial Services Compensation Scheme, or FSCS, which pays compensation to eligible customers of authorized financial services firms which are unable, or are likely to be unable, to pay claims against them. The levels of compensation are, for example, for claims against firms declared in default on or after January 1, 2010 (December 31, 2010 for deposits): (i) for deposits, 100% of the first £85,000; (ii) for mortgage advice and arranging, 100% of the first £50,000; and (iii) for insurance, 90% of the claim with no upper limit (except compulsory insurance is protected in full). The FSCS only pays compensation for financial loss. Compensation limits are per person, per firm and per type of claim. These limits reflect Directive 2009/14/EC, amending Directive 94/19/EC on deposit guarantee schemes, which requires member states to set the minimum level of compensation for deposits, for firms declared in default on or after 1 January 2011, at €100,000.
The Financial Services and Markets Act 2000 established the FOS, which determines complaints by eligible complainants in relation to authorized financial services firms, consumer credit licensees and certain other businesses, in respect of activities and transactions under its jurisdiction. The FOS determines complaints on the basis of what, in its opinion, is fair and reasonable in all the circumstances of the case. The maximum level of money award by the FOS is £100,000 (£150,000 for complaints received by the FOS on or after January 1, 2012) plus interest and costs. The FOS may also make directions awards, which direct the business to take steps as the FOS considers just and appropriate.
The EU anti-money laundering regime has been amended by the implementation of the EU Third Money Laundering Directive, which has imposed requirements in relation to such matters. As a result, the UK Money Laundering Regulations 2007 place a requirement on us to verify the identity and address of customers opening accounts with us, and to keep records to help prevent money laundering and fraud. Guidance in respect of the Money Laundering Regulations 2007 is contained in the Guidance Notes of the Joint Money Laundering Steering Group, including in respect of the identification of new clients, record keeping and otherwise. Directive 2005/60/EC, which underpins the Money Laundering Regulations 2007, is currently being reviewed and the European Commission published a draft report on April 11, 2012, which found that there were no fundamental shortcomings in the regime.
On July 31, 2012 the European Commission published a paper summarizing the responses to the draft report published on April 11, 2012. The overall result represented a general confirmation of the issues highlighted in the draft report. Broad support was expressed for the proposed alignment to the revised Financial Action Task Force standards and for greater clarification of certain issues, in particular in the area of data protection and cross-border situations.
The UK Data Protection Act 1998 regulates the processing of data relating to individual customers. The UK Unfair Terms in Consumer Contracts Regulations 1999 (together with, insofar as applicable, the Unfair Terms in Consumer Contracts Regulations 1994) apply to consumer contracts entered into on or after July 1, 1995. The main effect of these Regulations is that a contract term which is "unfair" will not be enforceable against a consumer. This applies to, among other things, mortgages and related products and services. The FSA has issued statements of good practice in this regard in May 2005, January 2007 and January 2012, and worked with the OFT to allocate responsibility for regulation of mortgage products.
Nationwide participates in the unclaimed assets scheme established under the Dormant Bank and Building Society Accounts Act 2008. The purpose of this scheme is to enable money in dormant bank and building society accounts (i.e. balances in accounts that have been inactive or dormant for 15 years or more) to be distributed for the benefit of the community, while protecting the rights of customers to reclaim their money.
On November 1, 2009, the FSA introduced its Banking Conduct Regime for retail banking. The main constituents of this regime are: (i) extending the FSA's principles for businesses as they apply to deposit-taking, from prudential matters only, to conduct of business matters in addition; (ii) conduct of business requirements in the Payment Services Regulations 2009 (the "PSR"), which apply to certain payment services made in euro or sterling; and (iii) the FSA's Banking: Conduct of Business sourcebook, which applies to deposit-taking in respects not covered by the PSR.
On November 1, 2009, the British Bankers' Association, the Building Societies Association and The UK Cards Association launched The Lending Code, a voluntary code on unsecured lending to personal and small business customers, which is monitored and enforced by the Lending Standards Board. The voluntary Banking Code and the Business Banking Code then ceased to have effect.
On April 1, 2010, the Building Societies specialist sourcebook (the "BSOCS") came into effect, subject to certain transitional provisions. BSOCS contains FSA guidance on the systems and controls in relation to treasury management operations and lending. BSOCS focuses on the key financial and lending risks to which building societies are exposed and sets out the framework within which the FSA will supervise building societies' treasury activities.
Subject to the withholding tax requirements set out under the section entitled "UK Taxation", there are currently no UK laws, decrees or regulations that would affect the payment of interest or other payments to holders of notes who are neither residents of, nor trading in, the United Kingdom. For further discussion, see the section entitled "UK Taxation". There are also no restrictions under our memorandum and rules or under current UK laws that limit the right of nonresident or foreign owners to hold the notes or to vote, when entitled to do so.
This section describes the material terms and provisions of the notes to which any Final Terms may relate. We will describe in each Final Terms the particular terms of the notes that we offer by that Final Terms and the extent, if any, to which the general provisions described below may apply to those notes. Capitalized terms used but not defined in this section have the meanings given to them in the senior notes, subordinated notes, or indenture, as the case may be.
We will offer the notes under an indenture, dated as at February 8, 2002 and as supplemented and amended from time to time, between us (the "Issuer") and The Bank of New York Mellon (as successor to J.P. Morgan Trust Company, National Association (as successor to Bank One Trust Company, N.A.)), as trustee. The notes are limited to an aggregate principal amount of up to \$20,000,000,000 outstanding at any time, including, in the case of notes denominated in one or more other currencies or composite currencies, the equivalent thereof at the Market Exchange Rate in the one or more other currencies on the date on which such note will be issued (the "Original Issue Date"), subject to reduction by or pursuant to action of our Board of Directors, provided that a reduction will not affect any note already issued or as to which we have already accepted an offer to purchase. We may, however, increase these limits without the consent of the holders of the notes if in the future we determine that we wish to sell additional notes.
The notes will mature twelve months or more from the date of issue and may be subject to redemption or early repayment at our option or the holder's option as further described in the section entitled "—Redemption and Repurchase". Each note will be denominated in U.S. dollars or in another currency as we specify in the applicable Final Terms. For a further discussion, see "—Payment of Principal, Premium, if any, and Interest, if any". Each note will be either:
The Senior Notes are direct, unconditional and (subject to the provisions of "—Negative Pledge") unsecured obligations of the Issuer and rank (subject to any applicable statutory exceptions and subject to the provisions of "— Negative Pledge") equally with non-member deposits and all other unsecured and unsubordinated obligations of the Issuer and in priority to investment shares in the Issuer from time to time outstanding. The senior notes will rank senior to our UK retail member deposits, subject, in the event of insolvency, to laws of general applicability relating to or affecting creditors' rights, and provided that our other unsecured and unsubordinated indebtedness may contain covenants, events of default and other provisions which differ from or which are not contained in the senior notes. If we demutualize or transfer the whole of our business to the subsidiary of another mutual society, our UK retail member deposits will rank pari passu with our obligations under our senior debt, including the senior notes. For a further discussion of the effects of demutualization on the ranking of our obligations, see the section entitled "Risk Factors—Risks Related to Our Business— Demutualization, mutual society transfers and consequences of the UK Building Societies Act may have an adverse impact on the holders of notes".
The Subordinated Notes are direct and unsecured obligations of the Issuer, conditional as described below, and rank without any preference among themselves, and the rights of the holders of the Subordinated Notes will, in the event of the winding up of the Issuer, be subordinated in right of payment in the manner provided in the indenture to the claims of depositors (including investment creditors) and other unsubordinated creditors of the Issuer in respect of their respective Senior Claims. Accordingly if the Issuer is at any time in winding up, then no principal or interest in respect of the Subordinated Notes (whether or not already due or accrued prior to the commencement of such winding up) shall be payable by, nor shall any claim in respect thereof be provable against, the Issuer in such winding up unless and until and except to the extent that the Issuer could make such payment in whole or in part and still be solvent immediately thereafter. For the purpose of this subsection, the Issuer shall be deemed to be solvent if it is able to pay its debts in full, or the liquidator of the Issuer determines that it will be able to do so within a period not exceeding twelve months, and in determining whether the Issuer is deemed to be solvent for the purposes of this subsection there shall be disregarded obligations which are not provable in the winding up or which are themselves subordinated to the claims of all or any of the unsecured creditors of the Issuer.
Subject to applicable law, no holder of Subordinated Notes may exercise, claim or plead any right of set-off, compensation or retention in respect of any amount owed to it by the Issuer arising under or in connection with the Subordinated Notes and each holder shall, by virtue of being the holder of any such Subordinated Note be deemed to have waived all such rights of set-off, compensation or retention. Notwithstanding the provision of the foregoing sentence, if any of the said rights and claims of any holder of Subordinated Notes against the Issuer is discharged by set-off, such holder of Subordinated Notes will immediately pay an amount equal to the amount of such discharge to the Issuer or, in the event of winding up of the Issuer the liquidator of the Issuer and accordingly such discharge will be deemed not to have taken place.
The subordinated notes do not have the benefit of the negative pledge covenant described below under the subsection entitled "—Negative Pledge" and are subordinated to most of our liabilities. For a further discussion of risks relating to subordination see the section entitled "Risk Factors—Risks Related to the Notes—The subordinated notes are subordinated to most of our liabilities".
"Senior Claims" means the aggregate amount of all claims which are admitted against us in the event of our winding up (i) relating to all UK retail member deposits in respect of any principal and interest due in respect thereof up to the date of commencement of the winding up (but excluding all claims in respect of our subordinated indebtedness) and (ii) relating to our obligations to our other creditors (including, without limitation, all contingent and potential claims, all claims in respect of deposits with or loans to us and all claims of interest thereon or in respect thereof) but excluding (a) all claims in respect of our subordinated indebtedness and (b) all claims in respect of our permanent interest bearing shares.
To the extent that holders of the notes are entitled to any recovery with respect to the notes in any winding up or liquidation, it is unclear whether such holders would be entitled in such proceedings to recovery in U.S. dollars and they may be entitled only to a recovery in pounds sterling and, as a general matter, the right to claim for any amounts payable on notes may be limited by applicable insolvency law.
"Business Day" means any day, other than a Saturday or Sunday, that is neither a legal holiday nor a day on which commercial banks are authorized or required by law, regulation or executive order to close in New York City and each Additional Business Center specified in the applicable Final Terms; provided, however, that, with respect to notes denominated in a Specified Currency other than U.S. dollars, it is also not a day on which commercial banks are authorized or required by law, regulation or executive order to close in the Principal Financial Center, as defined below, of the country issuing the Specified Currency (or, if the Specified Currency is euro or EURIBOR is an applicable Interest Rate Basis, such day is also a day on which the euro payments settlement system known as TARGET2 (or any successor thereto) is open for settlement of payments in euro, a "TARGET Settlement Date"); provided, further, that, with respect to notes as to which LIBOR is an applicable Interest Rate Basis, it is also a London Business Day. "London Business Day" means a day on which commercial banks are open for business (including dealings in the Designated LIBOR Currency, as defined below) in London.
"New York City Banking Day" means any day on which commercial banks are open for general business (including dealings in foreign exchange and foreign currency deposits) in the city of New York.
"Principal Financial Center" means the capital city of the country issuing the Specified Currency except, that with respect to U.S. dollars, Canadian dollars, and Swiss francs, the "Principal Financial Center" shall be New York City, Toronto, and Zurich, respectively.
"Relevant Supervisory Consent" means the consent to the relevant redemption, payment, repayment or purchase, as the case may be, of the Financial Services Authority or any other body performing the same or similar functions in relation to building societies (so long as we remain a building society) or banks (in the event that we transfer our business to an authorized institution pursuant to section 97 of the UK Building Societies Act).
"Specified Currency" means a currency issued and actively maintained as a country's or countries' recognized unit of domestic exchange by the government of any country and such term shall also include the euro.
"TARGET2" means the Trans-European Automated Real-time Gross Settlement Express Transfer payment system which utilizes a single shared platform and which was launched on 19 November 2007 or any successor thereto.
"U.S. Government Securities Business Day" means any day except for a Saturday, Sunday or a day on which The Security Industry & Financial Markets Association recommends that the fixed income departments of its members be closed for the entire day for purposes of trading in U.S. government securities.
Notes of a series will initially be represented by a global note or global notes in fully registered form ("Global Notes"). Notes offered in the United States to qualified institutional buyers in reliance on Rule 144A will be represented by one or more U.S. global notes ("U.S. Global Notes"). Notes offered outside the United States to non-U.S. persons in reliance on Regulation S will be represented by one or more international global notes ("International Global Notes").
Notes will bear a legend setting forth transfer restrictions and may not be transferred except in compliance with these transfer restrictions and subject to certification requirements. In no event will notes in bearer form be issued.
The Global Note or Global Notes representing a series of notes will be issued to and deposited with, or on behalf of, DTC in New York City and registered in the name of Cede & Co. ("Cede"), as DTC's nominee. Interests in a Global Note or Global Notes representing notes of a series will be shown in, and transfers thereof will be effected only through, records maintained by DTC and its participants until such time, if any, as physical registered certificates ("Certificated Notes") in respect of such notes are issued, as set forth in the section entitled "Description of the Global Notes—Book-Entry System".
The Global Note or Global Notes representing a series of notes may be transferred only to a successor of DTC or another nominee of DTC. For additional information, see the section entitled "Description of the Global Notes—Book-Entry System".
Under the following circumstances, Global Notes of a series may be exchanged for certificated registered notes of such Series:
Certificated Notes representing a series of notes, if any, will be exchangeable for other Certificated Notes representing notes of such series of any authorized denominations and of a like aggregate principal amount and tenor. Certificated Notes will be serially numbered.
Certificated Notes may be presented to the trustee for registration of transfer of exchange at its Corporate Trust Office which at the date hereof is located at 101 Barclay Street, 8W, New York, New York 10286. Certificated Notes may be presented for exchange and transfer in the manner, at the places and subject to the restrictions set forth in the indenture and the notes. We have not registered the notes under the Securities Act or with any securities regulatory authority of any jurisdiction, and accordingly, transfers of the notes will be subject to the restrictions set forth in the sections entitled "Notice to Investors" and "Transfer Restrictions".
Certificated Notes and interests in the U.S. Global Notes may be transferred to a person who takes delivery in the form of interests in an International Global Note only upon receipt by the trustee of written certifications, in the form provided in the indenture, to the effect that the transfer is being made in accordance with Regulation S or Rule 144 under the Securities Act and that, if this transfer occurs prior to 40 days after the commencement of the offering of such notes, the interest transferred will be held immediately thereafter through Euroclear Bank S.A./N.V. ("Euroclear") or Clearstream Banking, société anonyme ("Clearstream"), each of which is a participant in DTC.
Until 40 days after the closing date for the offering of a series of notes, interests in an International Global Note may be held only through Euroclear or Clearstream, which are participants in DTC. Certificated Notes and interests in International Global Notes may be transferred to a person who takes delivery in the form of interests in a U.S. Global Note only upon receipt by the trustee of written certifications, in the form provided in the indenture, to the effect that such transfer is being made in accordance with Rule 144A to a person whom the transferor reasonably believes is purchasing for its own account or for an account as to which it exercises sole investment discretion and that such person and such account or accounts are "qualified institutional buyers" within the meaning of Rule 144A and agree to comply with the restrictions on transfer set forth in the sections entitled "Notice to Investors" and "Transfer Restrictions".
In the event of any redemption of notes, we will not be required to (i) register the transfer of or exchange the notes during a period of 15 calendar days immediately preceding the date of redemption; (ii) register the transfer of or exchange the notes, or any portion thereof called for redemption, except the unredeemed portion of any of the notes being redeemed in part; or (iii) with respect to notes represented by a Global Note or Global Notes, exchange any such note or notes called for redemption, except to exchange such note or notes for another Global Note or Global Notes of that series and like tenor representing the aggregate principal amount of notes of that series that have not been redeemed.
The Bank of New York Mellon (as successor to JPMorgan Chase Bank, N.A.) is the principal paying agent (the "Paying Agent") pursuant to the indenture. We may at any time designate additional paying agents or rescind the designation of any paying agent provided that if and for so long as the notes are listed on any stock exchange which requires the appointment of a paying agent in any particular place, we shall maintain a paying agent with an office in the place required by such stock exchange or relevant authority.
We will issue senior notes in minimum denominations of \$200,000 and subordinated notes in minimum denominations of \$250,000, and in each case in integral multiples of \$1,000 in excess thereof, in the case of Notes denominated in U.S. dollars. We will issue notes denominated in a Specified Currency other than U.S. dollars in minimum denominations that are the equivalent of these amounts in any other Specified Currency, and in any other denominations in excess of the minimum denominations as specified in the applicable Final Terms. The notes will be issued in integral multiples of 1,000 units of any such Specified Currency in excess of their minimum denominations. If the principal, premium, if any, and interest, if any, on any of the notes not denominated in U.S. dollars, euro or sterling are to be payable at our or the holder's option in U.S. dollars, such payment will be made on the basis of the Market Exchange Rate, computed by the Currency Determination Agent, on the Second Business Day prior to such payment or, if such Market Exchange Rate is not then available, on the basis of the most recently available Market Exchange Rate.
Payments of principal, premium, if any, and interest, if any, to owners of beneficial interests in the Global Notes are expected to be made in accordance with those procedures of DTC and its participants in effect from time to time as described in the section entitled "Description of the Global Notes—Book-Entry System" and, in the case of any note denominated in a Specified Currency other than U.S. dollars, as provided below.
Payments will be subject in all cases to any withholding or deduction required pursuant to an agreement described in Section 1471(b) of the U.S. Internal Revenue Code of 1986 (the "Code") or otherwise imposed pursuant to Sections 1471 through 1474 of the Code, any regulations or agreements thereunder, official interpretations thereof, or law implementing an intergovernmental approach thereto. Any such amounts withheld or deducted will be treated as paid for all purposes under the Notes, and no additional amounts will be paid on the Notes with respect to any such withholding or deduction.
Except as described below, with respect to any Certificated Note, payments of interest, if any, will be made by mailing a check to the holder at the address of such holder appearing on the register for the notes on the regular record date (the "Regular Record Date"). Notwithstanding the foregoing, at our option, all payments of interest on the notes may be made by wire transfer of immediately available funds to an account at a bank located within the United States as designated by each holder not less than 15 calendar days prior to the relevant Interest Payment Date. A holder of \$10,000,000 (or, if the Specified Currency is other than U.S. dollars, the equivalent thereof in that Specified Currency) or more in aggregate principal amount of notes of like tenor and terms with the same Interest Payment Date may demand payment by wire transfer but only if appropriate payment instructions have been received in writing by any paying agent with respect to such note appointed by us, not less than 15 calendar days prior to the Interest Payment Date. In the event that payment is so made in accordance with instructions of the holder, such wire transfer shall be deemed to constitute full and complete payment of such principal, premium and/or interest on the notes. Payment of the principal, premium, if any, and interest, if any, due with respect to any Certificated Note at Maturity will be made in immediately available funds upon surrender of such note at the principal office of any paying agent appointed by us with respect to that note and accompanied by wire transfer instructions, provided that the Certificated Note is presented to such paying agent in time for such paying agent to make such payments in such funds in accordance with its normal procedures.
Payments of principal, premium, if any, and interest, if any, with respect to any note to be made in a Specified Currency other than U.S. dollars will be made by check mailed to the address of the person entitled thereto as its address appears in the register for the notes or by wire transfer to such account with a bank located in a jurisdiction acceptable to us and the trustee as shall have been designated at least 15 calendar days prior to the Interest Payment Date or Maturity, as the case may be, by the holder of such note on the relevant Regular Record Date or at Maturity, provided that, in the case of payment of principal of, and premium, if any, and interest, if any, due at Maturity, the note is presented to any paying agent appointed by us with respect to such note in time for such paying agent to make such payments in such funds in accordance with its normal procedures. Such designation shall be made by filing the appropriate information with the trustee at its Corporate Trust Office, and, unless revoked, any such designation made with respect to any note by a holder will remain in effect with respect to any further payments with respect to such note payable to such holder. If a payment with respect to any such note cannot be made by wire transfer because the required designation has not been received by the trustee on or before the requisite date or for any other reason, a notice will be mailed to the holder at its registered address requesting a designation pursuant to which such wire transfer can be made and, upon such trustee's receipt of such a designation, such payment will be made within 15 calendar days of such receipt. We will pay any administrative costs imposed by banks in connection with making payments by wire transfer, but any tax, assessment or governmental charge imposed upon payments will be borne by the holders of such notes in respect of which such payments are made.
Except as provided below, payments of principal, premium, if any, and interest, if any, with respect to any note represented by Global Notes that is denominated in a Specified Currency other than U.S. dollars will be made in U.S. dollars, as set forth below. If the holder of such note on the relevant Regular Record Date or at Maturity, as the case may be, requests payments in a currency other than U.S. dollars, the holder shall transmit a written request for such payment to any paying agent appointed by us with respect to such note at its principal office on or prior to such Regular Record Date or the date 15 calendar days prior to Maturity, as the case may be. Such request may be delivered by mail, by hand, by cable or by telex or any other form of facsimile transmission. Any such request made with respect to any note by a holder will remain in effect with respect to any further payments of principal, and premium, if any, and interest, if any, with respect to such note payable to such holder, unless such request is revoked by written notice received by such paying agent on or prior to the relevant Regular Record Date or the date 15 calendar days prior to Maturity, as the case may be (but no such revocation may be made with respect to payments made on any such note if an Event of Default has occurred with respect thereto or upon the giving of a notice of redemption). Holders of notes denominated in a currency other than U.S. dollars whose notes are registered in the name of a broker or nominee should contact such broker or nominee to determine whether and how an election to receive payments in a currency other than U.S. dollars may be made.
The U.S. dollar amount to be received by a holder of a note denominated in other than U.S. dollars who elects to receive payments in U.S. dollars will be based on the highest indicated bid quotation for the purchase of U.S. dollars in exchange for the Specified Currency obtained by the Currency Determination Agent, as defined below, at approximately 11:00 a.m., New York City time, on the second Business Day immediately preceding the applicable payment date (the "Conversion Date") from the bank composite or multicontributor pages of the Quoting Source for three (or two if three are not available) major banks in New York City. The first three (or two) such banks selected by the Currency Determination Agent which are offering quotes on the Quoting Source will be used. If fewer than two such bid quotations are available at 11:00 a.m., New York City time, on the second Business Day immediately preceding the applicable payment date, such payment will be based on the Market Exchange Rate as of the second Business Day immediately preceding the applicable payment date. If the Market Exchange Rate for such date is not then available, such payment will be made in the Specified Currency. As used herein, the "Quoting Source" means Reuters Monitor Foreign Exchange Service, or if the Currency Determination Agent determines that such service is not available, such comparable display or other comparable manner of obtaining quotations as shall be agreed between us and the Currency Determination Agent. All currency exchange costs associated with any payment in U.S. dollars on any such notes will be borne by the holder thereof by deductions from such payment. The currency determination agent (the "Currency Determination Agent") with respect to any such note will be specified in the applicable Final Terms.
If the Specified Currency for a note denominated in a currency other than U.S. dollars is not available for the required payment of principal, premium, if any, and/or interest, if any, in respect thereof due to the imposition of exchange controls or other circumstances beyond our control, we will be entitled to satisfy our obligations to the holder of such note by making such payment in U.S. dollars on the basis of the Market Exchange Rate, computed by the Currency Determination Agent, on the second Business Day prior to such payment or, if such Market Exchange Rate is not then available, on the basis of the most recently available Market Exchange Rate. Any payment made in U.S. dollars under such circumstances where the required payment was to be in a Specified Currency other than U.S. dollars will not constitute an Event of Default under the indenture with respect to the notes.
All determinations referred to above made by the Currency Determination Agent shall be at its sole discretion in accordance with its normal operating procedures and shall, in the absence of manifest error, be conclusive for all purposes and binding on all holders and beneficial owners of notes.
Each Fixed Rate Note bears interest from (and including) the Interest Commencement Date at the rate(s) per annum equal to the Fixed Rate(s) of Interest payable in arrear on the Interest Payment Date(s) in each year specified in the applicable Final Terms and on the Maturity Date specified in the applicable Final Terms if that does not fall on an Interest Payment Date. The first payment of interest will be made on the Interest Payment Date next following the Interest Commencement Date.
Interest shall be calculated in respect of any period by applying the Rate of Interest to the aggregate outstanding nominal amount of the Fixed Rate Notes and multiplying such sum by the applicable Day Count Fraction, and rounding the resultant figure to the nearest subunit of the relevant Specified Currency, half of any such subunit being rounded upwards or otherwise in accordance with applicable market convention.
If any Interest Payment Date or the date of Maturity of a Fixed Rate Note falls on the day that is not a Business Day, the required payments of principal, premium, if any, and interest, if any, with respect to such note will be made on the next succeeding Business Day as if made on the date such payment was due, and no interest will accrue on such payment for the period from and after such Interest Payment Date or the date of Maturity, as the case may be, to the date of such payment on the next succeeding Business Day.
Day Count Fraction means, in respect of the calculation of an amount of interest in accordance with the applicable Final Terms for any Fixed Rate Note:
such Determination Period and (II) the number of Determination Dates that would occur in one calendar year; and
(B) the number of days in such Accrual Period falling in the next Determination Period divided by the product of (I) the number of days in such Determination Period and (II) the number of Determination Dates that would occur in one calendar year; and
(b) if 30/360 is specified in the applicable Final Terms, the number of days in the period from (and including) the most recent Interest Payment Date (or, if none, the Interest Commencement Date) to (but excluding) the relevant payment date (such number of days being calculated on the basis of twelve 30 day months) divided by 360.
If no Day Count Fraction for Fixed Rate Notes is specified in the applicable Final Terms then the Day Count Fraction for such Notes shall be Actual/Actual (ICMA) for Notes other than those denominated or payable in U.S. Dollars and 30/360 for Notes denominated or payable in U.S. Dollars.
Determination Period means the period from (and including) a Determination Date in any year to (but excluding) the next Determination Date; and
sub-unit means, with respect to any currency other than euro, the lowest amount of such currency that is available as legal tender in the country of such currency and, with respect to euro, means one cent.
Each Floating Rate Note bears interest from (and including) the Interest Commencement Date at the rate equal to the Rate of Interest payable in arrear on either:
If any Interest Payment Date which is specified in the applicable Final Terms to be subject to adjustment in accordance with a business day convention would otherwise fall on a day which is not a Business Day, then, if the business day convention specified is:
The Rate of Interest payable from time to time in respect of Floating Rate Notes will be determined in the manner specified in the applicable Final Terms.
Interest on Floating Rate Notes will be determined by reference to the applicable Interest Rate Basis or Bases, which may, as described below, include:
The applicable Final Terms will specify whether any Margin, expressed as a percentage amount, is to be added or subtracted from the related Interest Rate Basis or Bases applicable to such Floating Rate Note.
The applicable Final Terms will specify whether the rate of interest on the related Floating Rate Note will be reset daily, weekly, monthly, quarterly, semi-annually or annually or at such other specified intervals as specified in the applicable Final Terms (each, an "Interest Reset Period") and the dates on which such rate of interest will be reset (each, an "Interest Reset Date"). If any Interest Reset Date for any Floating Rate Note would otherwise be a day that is not a Business Day, such Interest Reset Date will be postponed to the next succeeding Business Day except that in the case of a Floating Rate Note as to which EURIBOR or LIBOR is an applicable Interest Rate Basis and such Business Day falls in the next succeeding calendar month, such Interest Reset Date will be the immediately preceding Business Day.
The interest rate applicable to each Interest Period will be the rate determined by the Calculation Agent (as specified in the applicable Final Terms) as of the applicable Interest Determination Date specified in the relevant Final Terms ("Interest Determination Date").
The interest rate applicable to each Interest Reset Period commencing on the related Interest Reset Date will be the rate determined by the Calculation Agent (as specified in the applicable Final Terms) as of the applicable Interest Determination Date and calculated on or prior to the Calculation Date (as defined below), except with respect to the Eleventh District Cost of Funds Rate, EURIBOR and LIBOR, which will be calculated on such Interest Determination Date, except with respect to the Commercial Paper Rate and the Prime Rate, which will be calculated on or prior to the day that is one New York City Banking Day following the Interest Reset Date pertaining to such Interest Determination Date, and except with respect to the CMT, which will be calculated on the dates specified below under "—CMT Rate". The "Interest Determination Date" with respect to:
the Eleventh District Cost of Funds Rate will be the last Business Day of the month immediately preceding the applicable Interest Reset Date on which the Federal Home Loan Bank of San Francisco (the "FHLB of San Francisco") publishes the Index, as defined below;
EURIBOR will be the second TARGET Settlement Date immediately preceding the applicable Interest Reset Date;
The "Interest Determination Date" pertaining to a Floating Rate Note the interest rate of which is determined by reference to two or more Interest Rate Bases will be the most recent Business Day which is at least two Business Days prior to the applicable Interest Reset Date for such Floating Rate Note on which each Interest Rate Basis is determinable. Each Interest Rate Basis will be determined as of such date, and the applicable interest rate will take effect on the applicable Interest Reset Date.
The "Calculation Date", if applicable, pertaining to any Interest Determination Date will be the earlier of (i) the tenth calendar day after such Interest Determination Date or, if such day is not a Business Day, the next succeeding Business Day or (ii) the Business Day immediately preceding the applicable Interest Payment Date or the Maturity Date, as the case may be.
The Calculation Agent shall determine each Interest Rate Basis in accordance with the following provisions:
"CD Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined with reference to the CD Rate, the rate on such date for negotiable U.S. dollar certificates of deposit having the Index Maturity specified in the applicable Final Terms as published in H.15(519), (as defined below), under the heading "CDs (secondary market)" or, if not so published by 3:00 p.m., New York City time on the related Calculation Date, the rate on such Interest Determination Date for negotiable U.S. dollar certificates of deposit of the Index Maturity specified in the applicable Final Terms as published in H.15 Daily Update (as defined below), or such other recognized electronic source used for the purpose of displaying such rate, under the caption "CDs (secondary market)". If such rate is not yet published in H.15(519), H.15 Daily Update or another recognized electronic source by 3:00 p.m. New York City time on the related Calculation Date, then the CD Rate on such Interest Determination Date will be calculated by the Calculation Agent and will be the arithmetic mean of the secondary market offered rates as of 10:00 a.m. New York City time on such Interest Determination Date, of three leading non-bank dealers in negotiable U.S. dollar certificates of deposit in New York City (which may include the Placement Agents or their affiliates) selected by the Calculation Agent (after consultation with us) for negotiable U.S. dollar certificates of deposit of major U.S. money center banks with a remaining maturity closest to the Index Maturity specified in the applicable Final Terms in an amount that is representative for a single transaction in that market at that time; provided, however, that if the dealers so selected by the Calculation Agent are not quoting as mentioned in this sentence, the CD Rate determined as of such Interest Determination Date will be the CD Rate in effect on such Interest Determination Date, or, if no CD Rate was in effect on such Interest Determination Date, the rate on such Floating Rate Note for the following Interest Reset Period shall be the Initial Interest Rate specified in the applicable Final Terms.
"H.15(519)" means the weekly statistical release designated as such, or any successor publication, published by the Board of Governors of the Federal Reserve System (the "Board of Governors"), or its successor, available through the website of the Board of Governors at http://www.federalreserve.gov/releases/h15/update/h15upd.htm.
"H.15 Daily Update" means the daily update of H.15(519) available at the Board of Governors of the Federal Reserve System's Internet web site located at http://www.federalreserve.gov/releases/h15/update/h15upd.htm, or any successor site or publication.
"CMT Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined with reference to the CMT Rate:
arithmetic mean of the bid prices obtained and neither the highest nor the lowest of the quotations will be eliminated, or
(f) if fewer than three prices referred to in clause (d) are provided as requested, the rate on such Interest Determination Date calculated by the Calculation Agent as a yield to maturity based on the arithmetic mean of the secondary market bid prices as of approximately 3:30 P.M., New York City time, on that Interest Determination Date of three Reference Dealers selected by the Calculation Agent (after consultation with us) from five Reference Dealers so selected by the Calculation Agent and eliminating the highest quotation or, in the event of equality, one of the highest and the lowest quotation or, in the event of equality, one of the lowest, for United States Treasury securities with an original maturity greater than the particular Designated CMT Maturity Index, a remaining term to maturity closest to that Designated CMT Maturity Index and in a principal amount that is representative for a single transaction in the securities in that market at the time, or
(g) if fewer than five but more than two prices referred to in clause (f) are provided as requested, the rate on such Interest Determination Date calculated by the Calculation Agent based on the arithmetic mean of the bid prices obtained and neither the highest or the lowest of the quotations will be eliminated, or
If two United States Treasury securities with an original maturity greater than the Designated CMT Maturity Index specified in the applicable Final Terms have remaining terms to maturity equally close to the particular Designated CMT Maturity Index, the quotes for the United States Treasury security with the shorter original remaining term to maturity will be used.
"Designated CMT Maturity Index" means the original period to maturity of the U.S. Treasury securities (either 1, 2, 3, 5, 7, 10, 20 or 30 years) specified in the applicable Final Terms with respect to which the CMT Rate will be calculated.
"Commercial Paper Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined with reference to the Commercial Paper Rate, the Money Market Yield (as defined below) on such date of the rate for commercial paper having the Index Maturity specified in the applicable Final Terms as published in H.15(519) under the caption "Commercial Paper— Nonfinancial" or, if not so published by 5:00 p.m., New York City time, on the day that is one New York City Banking Day following the Interest Reset Date pertaining to such Interest Determination Date, the Money Market Yield on such Interest Determination Date for commercial paper having the Index Maturity specified in the applicable Final Terms as published in H.15 Daily Update, or such other recognized electronic source used for the purpose of displaying such rate, under the caption "Commercial Paper—Nonfinancial". If such rate is not yet published in H.15(519), the H.15 Daily Update or another recognized electronic source by 5:00 p.m. New York City time on the day that is one New York City Banking Day following the Interest Reset Date pertaining to such Interest Determination Date, then the Commercial Paper Rate on such Interest Determination Date will be calculated by the Calculation Agent and will be the Money Market Yield of the arithmetic mean of the offered rates at approximately 11:00 a.m., New York City time on such Interest Determination Date of three leading dealers of U.S. dollar commercial paper in New York City (which may include the Placement Agents or their affiliates) selected by the Calculation Agent (after consultation with us) for U.S. dollar commercial paper having the Index Maturity specified in the applicable Final Terms placed for industrial issuers whose bond rating is "Aa", or the equivalent, from a nationally recognized statistical rating organization; provided, however, that if the dealers so selected by the Calculation Agent are not quoting as mentioned in this sentence, the Commercial Paper Rate determined as of such Interest Determination Date will be the Commercial Paper Rate in effect on such Interest Determination Date, or, if no Commercial Paper Rate was in effect on such Interest Determination Date, the rate on such Floating Rate Note for the following Interest Reset Period shall be the Initial Interest Rate specified in the applicable Final Terms.
"Money Market Yield" means a yield (expressed as a percentage) calculated in accordance with the following formula: D x 360
$$
Money Market Yield = \frac{D \times 360}{360 - (D \times M)} \times 100
$$
where "D" refers to the applicable per annum rate for commercial paper quoted on a bank discount basis and expressed as a decimal, and "M" refers to the actual number of days in the applicable Interest Reset Period.
"Eleventh District Cost of Funds Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined with reference to the Eleventh District Cost of Funds Rate, the rate equal to the monthly weighted average cost of funds for the calendar month immediately preceding the month in which such Interest Determination Date falls as set forth opposite the caption "11th Dist COFI" on the display on Reuters (or any successor service) on page COFI/ARMS (or any other page as may replace such page on such service) ("COFI/ARMS Page") as of 11:00 a.m., San Francisco time, on such Interest Determination Date. If such rate does not appear on the COFI/ARMS Page on such Interest Determination Date then the Eleventh District Cost of Funds Rate on such Interest Determination Date shall be the monthly weighted average cost of funds paid by member institutions of the Eleventh Federal Home Loan Bank District that was most recently announced (the "Index") by the FHLB of San Francisco as such cost of funds for the calendar month immediately preceding such Interest Determination Date. If the FHLB of San Francisco fails to announce the Index on or prior to such Interest Determination Date for the calendar month immediately preceding such Interest Determination Date, the Eleventh District Cost of Funds Rate for such Interest Determination Date will be the Eleventh District Cost of Funds Rate in effect on such Interest Determination Date; provided, that if no Eleventh District Cost of Funds Rate was in effect on such Interest Determination Date, the rate on such Floating Rate Note for the following Interest Reset Period shall be the Initial Interest Rate specified in the applicable Final Terms.
"EURIBOR" means the rate determined in accordance with the following provisions:
"Designated EURIBOR Page" means the display on the page specified in the applicable Final Terms for the purpose of displaying the eurozone interbank rates of major banks for the euro; provided, however, if no such page is specified in the applicable Final Terms, the display on Reuters (or any successor service) on the EURIBOR 01 page (or any other page as may replace such page on such service) shall be used.
"Eurozone" means the region comprised of member states of the European Union that have adopted the single currency in accordance with the Treaty on European Union signed at Maastricht on February 7, 1992.
"Federal Funds Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined with reference to the Federal Funds Rate, the rate on such date for U.S. dollar federal funds as published in H.15(519) opposite the heading "Federal Funds (Effective)", as such rate is displayed on Reuters (or any successor service) on page FEDFUNDS 1 (or any other page as may replace such page) ("Reuters Page FEDFUNDS 1"), or, if such rate does not appear on Reuters Page FEDFUNDS 1 or is not so published by 5:00 p.m., New York City time, on the related Calculation Date, the rate on such Interest Determination Date for U.S. dollar federal funds as published in H.15 Daily Update, or such other recognized electronic source used for the purpose of displaying such rate, under the caption "Federal Funds (Effective)". If such rate does not appear on Reuters Page FEDFUNDS 1 or is not yet published in H.15(519), H.15 Daily Update or another recognized electronic source by 5:00 p.m. New York City time on the related Calculation Date, then the Federal Funds Rate on such Interest Determination Date will be calculated by the Calculation Agent and will be the arithmetic mean of the rates for the last transaction in overnight U.S. dollar federal funds arranged by three leading brokers of U.S. dollar federal funds transactions in New York City (which may include the Placement Agents or their affiliates) selected by the Calculation Agent (after consultation with us) prior to 9:00 a.m., New York City time, on such Interest Determination Date; provided, however, that if the brokers so selected by the Calculation Agent are not quoting as mentioned in this sentence, the Federal Funds Rate determined as of such Interest Determination Date will be the Federal Funds Rate in effect on such Interest Determination Date, or, if no Federal Funds Rate was in effect on such Interest Determination Date, the rate on such Floating Rate Note for the following Interest Reset Period shall be the Initial Interest Rate specified in the applicable Final Terms.
"LIBOR" means the rate determined in accordance with the following:
"Designated LIBOR Currency" means the currency specified in the applicable Final Terms as to which LIBOR shall be calculated or, if no such currency is specified in the applicable Final Terms, U.S. dollars.
"Designated LIBOR Page" means the display on the page specified in the applicable Final Terms for the purpose of displaying the London interbank rates of major banks for the Designated LIBOR Currency, provided, however, if no such page is specified in the applicable Final Terms, the display on Reuters (or any such service) on the LIBOR 01 page (or any other page as may replace such page on such service) shall be used for the purpose of displaying the London interbank rates of major banks for the Designated LIBOR Currency.
"Prime Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined with reference to the Prime Rate, the rate on such date as such rate is published in H.15(519) opposite the caption "Bank Prime Loan" or, if not published by 5:00 p.m., New York City time, on the day that is one New York City Banking Day following the Interest Reset Date pertaining to such Interest Determination Date, the rate on such Interest Determination Date as published in H.15 Daily Update, or such other recognized electronic source used for the purpose of displaying such rate, opposite the caption "Bank Prime Loan". If such rate is not yet published in H.15(519), H.15 Daily Update or another recognized electronic source by 5:00 p.m. New York City time on the day that is one New York City Banking Day following the Interest Reset Date pertaining to such Interest Determination Date, then the Prime Rate shall be the arithmetic mean, as determined by the Calculation Agent, of the rates of interest publicly announced by three major banks (which may include affiliates of the Placement Agents) in New York City selected by the Calculation Agent (after consultation with us) as the U.S. dollar prime rate or base lending rate in effect for such Interest Determination Date. (Each change in the prime rate or base lending rate of any bank so announced by such bank will be effective as of the effective date of the announcement or, if no effective date is specified, as of the date of the announcement.) If fewer than three major banks (which may include affiliates of the Placement Agents) so selected in New York City have publicly announced a U.S. dollar prime rate or base lending rate for such Interest Determination Date, the Prime Rate with respect to such Interest Determination Date shall be the rate in effect on such Interest Determination Date, or, if no Prime Rate was in effect on such Interest Determination Date, the rate on such Floating Rate Note for the following Interest Reset Period shall be the Initial Interest Rate specified in the applicable Final Terms.
"Treasury Rate" means, with respect to any Interest Determination Date relating to a Floating Rate Note for which the interest rate is determined by reference to the Treasury Rate, the rate from the auction held on such Interest Determination Date (the "Auction") of direct obligations of the United States ("Treasury Bills") having the Index Maturity specified in the applicable Final Terms under the caption "INVEST RATE" on the display on Reuters (or any successor service) on page USAUCTION 10 (or any other page as may replace such page) ("USAUCTION 10") or page USAUCTION 11 (or any other page as may replace such page) ("USAUCTION 11") or, if not so published by 3:00 p.m., New York City time, on the related Calculation Date, the Bond Equivalent Yield (as defined below) of the rate for such Treasury Bills as published in H.15 Daily Update, or such other recognized electronic source used for the purpose of displaying such rate, under the caption "U.S. Government Securities/Treasury Bills/ Auction High" or, if not so published by 3:00 p.m., New York City time, on the related Calculation Date, the Bond Equivalent Yield of the auction rate of such Treasury Bills as announced by the U.S. Department of the Treasury. In the event that the auction rate of Treasury Bills having the Index Maturity specified in the applicable Final Terms is not so announced by the U.S. Department of the Treasury, or if no such Auction is held, then the Treasury Rate will be the Bond Equivalent Yield of the rate on such Interest Determination Date of Treasury Bills having the Index Maturity specified in the applicable Final Terms as published in H.15(519) under the caption "U.S. Government Securities/Treasury Bills/Secondary Market" or, if not yet published by 3:00 p.m., New York City time, on the related Calculation Date, the rate on such Interest Determination date of such Treasury Bills as published in H.15 Daily Update, or such other recognized electronic source used for the purpose of displaying such rate, under the caption "U.S. Government Securities/Treasury Bills/Secondary Market". If such rate is not yet published in H.15(519), H.15 Daily Update or another recognized electronic source, then the Treasury Rate will be calculated by the Calculation Agent and will be the Bond Equivalent Yield of the arithmetic mean of the secondary market bid rates, as of approximately 3:30 p.m., New York City time, on such Interest Determination Date, of three primary U.S. government securities dealers (which may include the Placement Agents or their affiliates) selected by the Calculation Agent (after consultation with us), for the issue of Treasury Bills with a remaining maturity closest to the Index Maturity specified in the applicable Final Terms; provided, however, that if the dealers so selected by the Calculation Agent are not quoting as mentioned in this sentence, the Treasury Rate determined as of such Interest Determination Date will be the Treasury Rate in effect on such Interest Determination Date, or, if no Treasury Rate was in effect on such Interest Determination Date, the rate on such Floating Rate Note for the following Interest Reset Period shall be the Initial Interest Rate specified in the applicable Final Terms.
"Bond Equivalent Yield" means a yield (expressed as a percentage) calculated in accordance with the following formula:
Bond Equivalent Yield =
$$
\frac{D \times N \times 100}{360 - (D \times M)}
$$
where "D" refers to the applicable per annum rate for Treasury Bills quoted on a bank discount basis, "N" refers to 365 or 366, as the case may be, and "M" refers to the actual number of days in the applicable Interest Reset Period.
If the applicable Final Terms specifies a Minimum Rate of Interest for any Interest Period, then the Rate of Interest for such Interest Period shall in no event be less than such Minimum Rate of Interest and/or if it specifies a Maximum Rate of Interest for any Interest Period, then the Rate of Interest for such Interest Period shall in no event be greater than such Maximum Rate of Interest.
The interest rate on Floating Rate Notes will in no event be higher than the maximum rate permitted by New York law, as the same may be modified, or other applicable law.
The Calculation Agent will, at or as soon as practicable after each time at which the Rate of Interest is to be determined, determine the Rate of Interest for the relevant Interest Period.
The Calculation Agent will calculate the amount of interest (each an "Interest Amount") for the relevant Interest Period. Each Interest Amount shall be calculated by applying the Rate of Interest to the aggregate outstanding nominal amount of the notes and multiplying such sum by the Day Count Fraction specified in the applicable Final Terms. The resultant figure will be rounded as follows (or otherwise in accordance with applicable market convention):
All percentages resulting from any calculation on Floating Rate Notes will be rounded, if necessary, to the nearest one hundred thousandth of a percentage point, with five or more one millionths of a percentage point rounded upwards (e.g., 9.876545% (or 0.09876545) would be rounded to 9.87655% (or 0.0987655)).
Day Count Fraction means, in respect of the calculation of an amount for any period of time in accordance with the applicable Final Terms for any Floating Rate Note:
(E) if 30/360, 360/360 or Bond Basis is specified in the applicable Final Terms, the number of days in the Interest Period divided by 360, calculated on a formula basis as follows:
Day Count Fraction =
$$
\frac{[360 \times (Y_2 - Y_1)] + [30 \times (M_2 - M_1)] + (D_2 - D_1)}{360}
$$
where:
"Y1" is the year, expressed as a number, in which the first day of the Interest Period falls;
"Y2" is the year, expressed as a number, in which the day immediately following the last day of the Interest Period falls;
"M1" is the calendar month, expressed as a number, in which the first day of the Interest Period falls;
"M2" is the calendar month, expressed as a number, in which the day immediately following the last day of the Interest Period falls;
"D1" is the first calendar day, expressed as a number, of the Interest Period, unless such number is 31, in which case D1 will be 30; and
"D2" is the calendar day, expressed as a number, immediately following the last day included in the Interest Period, unless such number would be 31 and D1 is greater than 29, in which case D2 will be 30;
(F) if 30E/360 or Eurobond Basis is specified in the applicable Final Terms, the number of days in the Interest Period divided by 360, calculated on a formula basis as follows:
Day Count Fraction =
$$
\frac{[360 \times (Y_2 - Y_1)] + [30 \times (M_2 - M_1)] + (D_2 - D_1)}{360}
$$
where:
"Y1" is the year, expressed as a number, in which the first day of the Interest Period falls;
"Y2" is the year, expressed as a number, in which the day immediately following the last day of the Interest Period falls;
"M1" is the calendar month, expressed as a number, in which the first day of the Interest Period falls;
"M2" is the calendar month, expressed as a number, in which the day immediately following the last day of the Interest Period falls;
"D1" is the first calendar day, expressed as a number, of the Interest Period, unless such number would be 31, in which case D1 will be 30; and
"D2" is the calendar day, expressed as a number, immediately following the last day included in the Interest Period, unless such number would be 31, in which case D2 will be 30.
(G) if 30E/360 (ISDA) is specified in the applicable Final Terms, the number of days in the Interest Period divided by 360, calculated on a formula basis as follows:
Day Count Fraction =
$$
\frac{[360 \times (Y_2 - Y_1)] + [30 \times (M_2 - M_1)] + (D_2 - D_1)}{360}
$$
where:
"Y1" is the year, expressed as a number, in which the first day of the Interest Period falls;
"Y2" is the year, expressed as a number, in which the day immediately following the last day of the Interest Period falls;
"M1" is the calendar month, expressed as a number, in which the first day of the Interest Period falls;
"M2" is the calendar month, expressed as a number, in which the day immediately following the last day of the Interest Period falls;
"D1" is the first calendar day, expressed as a number, of the Interest Period, unless (i) that day is the last day of February or (ii) such number would be 31, in which case D1 will be 30; and
"D2" is the calendar day, expressed as a number, immediately following the last day included in the Interest Period, unless (i) that day is the last day of February but not the Maturity Date or (ii) such number would be 31, in which case D2 will be 30.
The Calculation Agent will cause the Rate of Interest and each Interest Amount for each Interest Period and the relative Interest Payment Date to be notified to the Issuer, to the Trustee and to any listing authority, stock exchange and/or quotation system to which the Floating Rate Notes have then been admitted to listing, trading and/or quotation and to be published as soon as possible after their determination but in no event later than the fourth Business Day thereafter. Each Interest Amount and Interest Payment Date so notified may subsequently be amended (or appropriate alternative arrangements made by way of adjustment) without prior notice in the event of an extension or shortening of the Interest Period. Any such amendment or alternative arrangements will promptly be notified to each listing authority, stock exchange and/or quotation system to which the Floating Rate Notes have then been admitted to listing, trading and/or quotation and to the holders in accordance with the indenture.
If for any reason at any time after the Original Issue Date, the Calculation Agent defaults in its obligation to determine the Rate of Interest in accordance with this subsection or the Calculation Agent defaults in its obligation to calculate any Interest Amount in accordance with this subsection, the Trustee (or an agent acting on its behalf) shall determine the Rate of Interest at such rate as, in its absolute discretion (having such regard as it shall think fit to the foregoing provisions of this subsection, but subject always to any Minimum or Maximum Rate of Interest specified in the applicable Final Terms), it shall deem fair and reasonable in all the circumstances or, as the case may be, the Trustee (or an agent acting on its behalf) shall calculate the Interest Amount(s) in such manner as it shall deem fair and reasonable in all the circumstances and each such determination or calculation shall be deemed to have been made by the Calculation Agent.
All certificates, communications, opinions, determinations, calculations, quotations and decisions given, expressed, made or obtained for the purposes of the provisions of this subsection, whether by the Paying Agent or the Calculation Agent or the Trustee, shall (in the absence of wilful default, bad faith or manifest error) be binding on the Issuer, the Paying Agent, the Calculation Agent, the Trustee, any other paying agents and all holders and (in the absence as aforesaid) no liability to the Issuer or the holders shall attach to the Paying Agent, the Calculation Agent or the Trustee in connection with the exercise or non-exercise by them of their powers, duties and discretions pursuant to such provisions.
We may issue additional notes of a series having identical terms to that of a prior series of notes of the same series but for the Original Issue Date and the public offering price ("Additional Notes"). The Final Terms relating to any Additional Notes will set forth matters related to such issuance, including identifying the prior series of notes, their Original Issue Date and the aggregate principal amount of notes then comprising such series.
We will pay to the holder of any note such additional amounts as may be necessary in order that every net payment of the principal of (including premium or final redemption amount, initial redemption amount or early redemption amount, if any, and in the case of Zero Coupon Notes, the Amortized Face Amount (as defined below) or other amount payable in respect thereof) and interest, if any, on such note, after deduction or other withholding for or on account of any present or future tax, assessment, duty or other governmental charge of any nature whatsoever imposed, levied or collected by or on behalf of the United Kingdom, or any political subdivision thereof or authority therein having power to tax, will not be less than the amount provided for in such note as then due and payable. No such additional amount shall, however, be payable on any note on account of any tax, assessment, duty or other governmental charge which is payable:
"Relevant Date" means the date on which the payment of principal (including premium or final redemption amount, initial redemption amount or early redemption amount, if any, and in the case of Zero Coupon Notes, the Amortized Face Amount or other amount payable in respect thereof) or interest, if any, on a note first becomes due and payable but, if the full amount of the monies payable on such date has not been received by the relevant Paying Agent or as it shall have directed on or prior to such date, the "Relevant Date" means the date on which such monies shall have been so received. No additional amounts will be paid as provided above with respect to any payment of principal (including premium or final redemption amount, initial redemption amount or early redemption amount, if any, and in the case of Zero Coupon Notes, the Amortized Face Amount or other amount payable in respect thereof) or interest, if any, on such note to any holder who is a fiduciary or partnership or other than the sole beneficial owner of any such payment, to the extent that a beneficiary or settlor with respect to such fiduciary, a member of such partnership or the beneficial owner of such payment would not have been entitled to the additional amounts had such beneficiary, settlor, member or beneficial owner been the holder of any such note.
No additional amounts will be paid on the Notes with respect to any amounts deducted or withheld from a payment on the Notes pursuant to, or in connection with, FATCA. See "—Payment of Principal, Premium, if any, and Interest, if any".
Unless previously redeemed or purchased and cancelled as provided below, each Note will be redeemed at 100% of its nominal amount in the relevant Specified Currency on the Maturity Date specified in the applicable Final Terms.
The notes of any series may be redeemed, subject to, in the case of the subordinated notes, any Relevant Supervisory Consent, as a whole but not in part, at our option upon not more than 60 days', nor less than 30 days', prior notice given as provided below under the section entitled "—Notices", at a redemption price equal to 100% of the principal amount (or at the then current Amortized Face Amount if the note is a Zero Coupon Note) (and premium, if any, thereon) together with interest, if any, to the date fixed for redemption, if on the occasion of the next payment due on the notes we would become obligated to pay additional amounts (as provided in the indenture) and such obligation cannot be avoided by the use of reasonable measures available to us; provided, that notes of a series may not be so redeemed if our obligation to pay such additional amount arises by reason of the notes not being admitted to listing on the Official List maintained by the UK Listing Authority, and not being admitted to trading on the London Stock Exchange or not being listed on another "recognized stock exchange" within the meaning of Section 1005 of the UK Income Tax Act 2007.
In the event that we elect to redeem the notes of any series pursuant to the provisions set forth in the preceding paragraph, we will deliver to the trustee (i) a certificate, signed by two of our authorized officers, evidencing compliance with such provisions and stating that we are entitled to redeem the notes of any such series pursuant to the terms of such notes and the indenture and (ii) a written opinion of our counsel to the effect that the circumstances referred to above exist.
If so specified in the applicable Final Terms, the notes of a series will be redeemable at our option prior to the Stated Maturity. If so specified, and subject to the terms set forth in the applicable Final Terms and, in the case of subordinated notes, any Relevant Supervisory Consent, the notes will be subject to redemption at our option on any date on and after the applicable Initial Redemption Date specified in the applicable Final Terms in whole or from time to time in part in minimum increments of \$200,000 for senior notes and \$250,000 for subordinated notes, or the minimum denomination specified in such Final Terms (provided that any remaining principal amount thereof shall be at least \$200,000 for senior notes and \$250,000 for subordinated notes, or such minimum denomination), at the Redemption Price specified in the applicable Final Terms on notice given not more than 60 days, if the notes are being redeemed in whole, or 45 days, if the notes are being redeemed in part, nor less than 30 days prior to the date of redemption and in accordance with the provisions of the indenture.
The notes will not be subject to any sinking fund.
If so specified in the applicable Final Terms (unless the relevant Note is a Subordinated Note), the notes will be repayable by us in whole or in part at the option of the holders thereof on their respective optional repayment dates ("Optional Repayment Dates") specified in such Final Terms, upon not more than 30 days', nor less than 15 days', notice prior to such Optional Repayment Dates. If no Optional Repayment Date is specified with respect to a note, such note will not be repayable at the option of the holder thereof prior to the Stated Maturity. Any repayment in part will be in increments of \$200,000 for senior notes and \$250,000 for subordinated notes, or the minimum denomination specified in the applicable Final Terms (provided that any remaining principal amount thereof shall be at least \$200,000 for senior notes and \$250,000 for subordinated notes, or such minimum denomination). Unless otherwise specified in the applicable Final Terms, the repayment price for any note to be repaid means an amount equal to the sum of the unpaid principal amount thereof or the portion thereof plus accrued interest to the date of repayment. Exercise of the repayment option is irrevocable.
If the amount payable in respect of any Zero Coupon Note upon redemption of such Zero Coupon Note pursuant to this subsection or upon its becoming due and repayable as provided upon the occurrence of any Event of Default under the indenture is improperly withheld or refused, the amount due and repayable in respect of such Zero Coupon Note shall be the amount calculated as provided under "—Early Redemption Amounts" below as though the references therein to the date fixed for redemption or the date upon which such Zero Coupon Note becomes due and repayable were replaced by references to the date which is the earlier of:
For the purposes of redemption for tax reasons and redemption upon the occurrence of any Event of Default under the indenture, each Note will be redeemed at an amount calculated as follows:
Where such calculation is to be made for a period which is not a whole number of years, it shall be made (i) in the case of a Zero Coupon Note other than a Zero Coupon Note payable in euro, on the basis of a 360 day year consisting of 12 months of 30 days each or (ii) in the case of a Zero Coupon Note payable in euro, on the basis of the actual number of days elapsed divided by 365 (or, if any of the days elapsed falls in a leap year, the sum of (A) the number of those days falling in a leap year divided by 366 and (B) the number of those days falling in a non-leap year divided by 365).
In the case of any partial redemption of notes, and subject to the terms specified in the applicable Final Terms, the notes to be redeemed shall be selected by the trustee individually by lot not more than 60 days prior to the Redemption Date from the outstanding notes not previously called for redemption, provided that partial redemption of Global Notes shall be effected in accordance with DTC's procedures.
We may at any time purchase notes at any price or prices in the open market or otherwise. Notes so purchased may be held or resold and, at our discretion, notes may be surrendered to the trustee for cancellation.
Under the Financial Services Authority requirements, any optional tax redemption or repurchase or any other optional redemption or purchase by us of subordinated notes of any series may be made only with the prior consent of the Financial Services Authority and subject to such conditions as the Financial Services Authority may impose at the time of any consent.
The negative pledge applies to the senior notes only. So long as any of the senior notes remain outstanding, we will not, and will not suffer or permit any of our subsidiaries to, create or have outstanding any mortgage, lien (other than a lien arising by operation of law), pledge or other charge or security interest upon the whole or any part of our or its business or assets, present or future (for the purposes of this subsection, a "Security Interest"), to secure any of our Loan Stock or the Loan Stock of any of our subsidiaries or any of our or our subsidiaries' obligations under any guarantee of or indemnity in respect of the Loan Stock of any other person, without at the same time or prior thereto securing the senior notes equally and ratably therewith to the satisfaction of the trustee or providing such other security for the senior notes which the trustee in its absolute discretion shall deem to be not materially less beneficial to the holders of senior notes or which shall be approved by a majority of the holders of senior notes then outstanding provided that we or any of our subsidiaries may create or have outstanding Security Interests with respect to Loan Stock (without the obligation to secure the senior notes as aforesaid) if at the date of the creation thereof we or any of our subsidiaries have and thereafter maintain free and clear of Security Interests assets the fair market value of which (calculated on a consolidated basis) is at least twice the aggregate principal amount of all Loan Stock which is not secured by any such Security Interest. As used in this subsection, "Loan Stock" means indebtedness for the time being outstanding which is in the form of or represented or evidenced by bonds, notes, debentures, loan stock or other similar securities.
The following shall constitute "Events of Default" with respect to the senior notes:
reconstruction, union, transfer, merger or amalgamation effected with the consent of the trustee or in the case of a voluntary solvent winding up of a wholly-owned Material Subsidiary in connection with the transfer of all or the major part of its business, undertaking and assets to us or another of our wholly owned Subsidiaries or in connection with a substitution pursuant to the senior notes or the indenture).
"Material Subsidiary" means a Subsidiary of ours whose total assets (attributable to us) represent 10% or more of our and our subsidiaries consolidated total assets (all as more particularly described in the indenture).
The following shall constitute "Events of Default" with respect to the subordinated notes:
If any event of default has occurred and is continuing with regard to senior notes of any series, the trustee may, at its discretion and without further notice, take such proceedings against us as it may think fit to enforce payment on such senior notes. However, the trustee will not be bound to take any action with respect to such series of senior notes unless:
If any event of default has occurred and is continuing with regard to subordinated notes of any series, the trustee may at its discretion institute proceedings for our winding up in England (but not elsewhere) to enforce our obligations in respect of the subordinated notes and the indenture insofar as it relates to the subordinated notes. However, we may not make any payment of principal in respect of the subordinated notes, nor will the trustee accept any such payment of principal from us, other than during or after our winding up or dissolution, unless a Relevant Supervisory Consent has been granted. For the purposes of the foregoing, a payment shall be deemed to be due even if we are not solvent.
Under current New York law, a state court in the State of New York rendering a judgment in respect of a note denominated in other than U.S. dollars would be required to render such judgment in the Specified Currency, and such judgment would be converted into U.S. dollars at the Market Exchange Rate prevailing on the date of entry of such judgment. Accordingly, the holder of such Note denominated in other than U.S. dollars would be subject to exchange rate fluctuations between the date of entry of a judgment in a currency other than U.S. dollars and the time the amount of such judgment is paid to such holder in U.S. dollars and converted by such holder into the Specified Currency. It is not certain, however, whether a non-New York state court would follow the same rules and procedures with respect to conversions of judgments in currency other than U.S. dollars.
We will indemnify the holder of any note against any loss incurred by such holder as a result of any judgment or order being given or made for any amount due under such note and such judgment or order requiring payment in a currency (the "Judgment Currency") other than the Specified Currency, and as a result of any variation between (i) the rate of exchange at which the Specified Currency amount is converted into the Judgment Currency for the purpose of such judgment or order, and (ii) the rate of exchange at which the holder of such note, on the date of payment of such judgment or order, is able to purchase the Specified Currency with the amount of the Judgment Currency actually received by such holder, as the case may be.
So long as any note of a series remains outstanding, we will not consolidate or amalgamate with or merge into any other Person or convey, transfer or lease our properties and assets substantially as an entirety to any Person unless:
Upon any such consolidation, amalgamation or merger, or any such conveyance, transfer or lease, the successor corporation or Person will succeed to, and be substituted for, and may exercise every right and power of ours, under the indenture with the same effect as if such successor corporation or Person has been named as the issuer thereunder, and thereafter, except in the case of a lease, the predecessor corporation shall be relieved of all obligations and covenants under the indenture and such notes.
The indenture provides that we will be discharged from our obligations under the notes of a series (with certain exceptions) at any time prior to the Stated Maturity, or redemption of such notes when (i) we have irrevocably deposited with or to the order of the trustee, in trust, (a) sufficient funds in the currency, currencies, currency unit or units in which such notes are payable (without consideration of any reinvestment thereof) to pay the principal of (and premium, if any, on) and interest, if any, on such notes to the Stated Maturity (or Redemption Date), or (b) such amount of U.S. Government Obligations (as defined below) as will, together with the predetermined and certain income to accrue thereon (without consideration of any reinvestment thereof), be sufficient to pay when due the principal of (and premium, if any, on) and interest, if any, to the Stated Maturity (or Redemption Date), on such notes, or, (c) such amount equal to the amount referred to in clause (a) or (b) in any combination of currency or currency unit of U.S. Government Obligations; (ii) we have paid all other sums payable with respect to such notes; (iii) we have delivered to the trustee an opinion of counsel to the effect that (a) we have received from, or there has been published by, the U.S. Internal Revenue Service a ruling, or (b) since the date of the indenture there has been a change in applicable U.S. federal income tax law, in either case to the effect that, and based upon which such opinion of counsel shall confirm that, the holders of such notes will not recognize income, gain or loss for U.S. federal income tax purposes as a result of such discharge and will be subject to U.S. federal income tax on the same amount and in the same manner and at the same time as would have been the case if such discharge had not occurred; and (iv) certain other conditions are met. Upon such discharge, the holders of the notes of such a series shall no longer be entitled to the benefits of the terms and conditions of the indenture and notes, except for certain provisions including registration of transfer and exchange of such notes and replacement of mutilated, destroyed, lost or stolen notes of such series, and shall look for payment only to such deposited funds or obligations. In addition, any such discharge with respect to the subordinated notes of any series would require a Relevant Supervisory Consent.
"U.S. Government Obligations" means non-callable (i) direct obligations (or certificates representing an ownership interest in such obligations) of the United States for which its full faith and credit are pledged or (ii) obligations of a Person controlled or supervised by, and acting as an agency or instrumentality of, the United States, the timely payment of which is unconditionally guaranteed as a full faith and credit obligation of the United States.
The indenture contains provisions permitting us and the trustee (i) without the consent of the holders of any notes issued under the indenture, to execute supplemental indentures for certain enumerated purposes, such as to cure any ambiguity or inconsistency or to make any change that does not have a materially adverse effect on the rights of any holder of such notes, and (ii) with the consent of the holders of not less than a majority in aggregate principal amount of the Outstanding Notes of each series of notes issued under the indenture and affected thereby, to execute supplemental indentures for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of the indenture or of modifying in any manner the rights of holders of any such note under the indenture; provided, that no such supplemental indenture may, without the consent of the holder of each such Outstanding Note affected thereby (a) change the Stated Maturity or the principal of or interest on any such note, or reduce the principal amount of any such note or the rate of interest thereon, if any, or any premium or principal payable upon redemption thereof, or change any obligation of ours to pay additional amounts thereon, or change any Place of Payment where, or change the currency in which, any such note or the interest, if any, thereon is payable, or impair the right to institute suit for the enforcement of any such payment on or after the Stated Maturity, if any, thereof or the date any such payment is otherwise due and payable (or, in the case of redemption, on or after the redemption date); or (b) reduce the percentage in aggregate principal amount of such Outstanding Notes of any particular series, the consent of whose holders is required for any such supplemental indenture, or the consent of whose holders is required for any waiver (of compliance with certain provisions of the indenture or certain defaults thereunder and their consequences) provided for in the indenture; or (c) change any obligation we have to maintain an office or agency in the places and for the purposes specified in the indenture; or (d) modify certain of the provisions of the indenture pertaining to the waiver by holders of such notes of past defaults, supplemental indentures with the consent of holders of such notes and the waiver by holders of such notes of certain covenants, except to increase any specified percentage in aggregate principal amount required for any actions by holders of notes or to provide that certain other provisions of the indenture cannot be modified or waived without the consent of the holder of each such note affected thereby; or (e) in the case of the subordinated notes, change in any manner adverse to the interests of the holders of such Outstanding subordinated notes the subordination provisions of such subordinated notes.
In addition, material variations in the terms and conditions of the subordinated notes of any series, which may include modifications relating to the status, subordination, redemption, repurchase or Events of Default with respect to such subordinated notes, may require a Relevant Supervisory Consent.
The holders of not less than a majority in aggregate principal amount of the Outstanding Notes of a series of notes affected thereby, may on behalf of the holders of all notes of such series waive compliance by us with certain restrictive provisions of the indenture as pertain to the corporate existence of us, the maintenance of certain agencies by us or, solely with respect to senior notes, as pertain to the negative pledge covenant as described under the subsection entitled "—Negative Pledge".
The holders of a majority in aggregate principal amount of the Outstanding Notes of a series of notes may waive on behalf of the holders of all notes of such series, any past default and its consequences under the indenture, except a default in the payment of the principal of (or premium, if any, on) or interest, if any, on any such note of that series or a default in respect of a covenant or a provision which under the indenture cannot be modified or amended without the consent of the holder of each Outstanding Note of such series.
Notices to holders of notes will be given by mail to addresses of such holders as they appear in the notes' register.
The indenture and the notes shall be governed by and construed in accordance with the laws of the State of New York; except that the subordination provisions contained in clause 1201 in the indenture and the subordinated notes will be governed by and construed in accordance with the laws of England and Wales, with the intention that such provisions be given full effect in any insolvency proceeding relating to us in England and Wales.
We have designated and appointed CT Corporation System at 111 Eighth Avenue, in the Borough of Manhattan, New York City, New York 10011 as our authorized agent upon which process may be served in any suit or proceeding arising out of or relating to the notes or the indenture which may be instituted in any State or Federal court located in the Borough of Manhattan, City of New York, State of New York, and have submitted (for the purposes of any such suit or proceeding) to the jurisdiction of any such court in which any such suit or proceeding is so instituted. We have agreed, to the fullest extent that we lawfully may do so, that final judgment in any such suit, action or proceeding brought in such a court shall be conclusive and binding upon us and may be enforced in the courts of England and Wales (or any other courts to the jurisdiction of which it is subject).
Notwithstanding the foregoing, any actions arising out of or relating to the notes or the indenture may be instituted by us, the trustee or the holder of any note in any competent court in England and Wales or such other competent jurisdiction, as the case may be.
The indenture provides that, except during the continuance of an event of default for a series of notes, the trustee will have no obligations other than the performance of such duties as are specifically set forth in the indenture. If an event of default has occurred and is continuing, the trustee will use the same degree of care and skill in its exercise of the rights and powers vested in it by the indenture as a prudent person would exercise under the circumstances in the conduct of such person's own affairs.
So long as DTC or its nominee is the holder of the Global Notes, any owner of a beneficial interest in the notes of a series must rely upon the procedures of DTC and institutions having accounts with DTC to exercise or be entitled to any rights of a holder of such Global Notes. See the subsection entitled "—Book-Entry System" for a further description of DTC's procedures.
DTC will act as securities depositary for the Global Notes. The Global Notes will be issued as fully-registered securities registered in the name of Cede (DTC's partnership nominee), unless otherwise specified. No Global Note may be transferred except by DTC to a nominee of DTC or by a nominee of DTC to DTC or another nominee of DTC or any successor thereof.
We have been advised by DTC that upon the deposit of a Global Note with DTC, DTC will immediately credit, on its book-entry registration and transfer system, the respective principal amounts of such beneficial interests in that Global Note to the accounts of the DTC Participants. The accounts to be credited shall be designated by the soliciting Placement Agent or, to the extent that the notes are offered and sold directly, by us.
We understand that DTC is a limited-purpose trust company organized under the laws of the State of New York, a "Banking Organization" within the meaning of the New York Banking Law, a member of the Federal Reserve System, a "clearing corporation" within the meaning of the New York Uniform Commercial Code, and a "clearing agency" registered pursuant to the provisions of Section 17A of the Exchange Act. DTC holds securities that its participants ("Participants") deposit with DTC. DTC also facilitates the clearance and settlement among Participants of transactions in such securities through electronic book-entry changes in Participants' accounts, thereby eliminating the need for physical movement of securities certificates. Direct participants ("Direct Participants") include securities brokers and dealers, banks, trust companies, clearing corporations, and certain other organizations. DTC is owned by a number of its Direct Participants and by the New York Stock Exchange, Inc., the American Stock Exchange, Inc., and the National Association of Securities Dealers, Inc. Access to DTC's system is also available to others such as securities brokers and dealers, banks and trust companies that clear through or maintain a custodial relationship with a Direct Participant, either directly or indirectly ("Indirect Participants"). The rules applicable to DTC and its Participants are on file with the Securities and Exchange Commission.
Ownership of beneficial interests in a Global Note in respect of a series of notes will be limited to DTC Participants, including Clearstream and Euroclear, or persons who hold interests through DTC Participants. In addition, ownership of beneficial interests will be evidenced only by, and the transfer of that ownership interest will be effected only through, records maintained by DTC or its nominee and DTC Participants until such time, if any, as Certificated Notes are issued, as set forth above under the section entitled "Terms and Conditions of the Notes—Form, Transfer, Exchange and Denomination". The laws of some states require that certain purchasers of notes take physical delivery of such notes in certificated form. Such laws may impair the ability to transfer beneficial interests in a Global Note.
Interests held through Clearstream and Euroclear will be recorded on DTC's books as being held by the U.S. depositary for each of Clearstream and Euroclear, which U.S. depositaries will in turn hold interests on behalf of their participants' customers' securities accounts.
To facilitate subsequent transfers, all Global Notes deposited with DTC are registered in the name of DTC's partnership nominee, Cede. DTC has no knowledge of the actual owners of beneficial interests in the Global Notes; DTC's records reflect only the identity of the Direct Participants to whose accounts such beneficial interests in Global Notes are credited, which may or may not be the beneficial owners. The Participants will remain responsible for keeping account of their holdings on behalf of their customers.
Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants, and by Direct Participants and Indirect Participants to beneficial owners will be governed by arrangements among them, subject to any statutory or regulatory requirements as may be in effect from time to time.
Redemption notices shall be sent to Cede and any subsequent nominee of DTC. If less than all of the notes within a series are being redeemed, DTC's current practice is to determine pro rata or by lot the amount of the beneficial interest of each Direct Participant in such issue to be redeemed.
Principal and interest payments on the Global Notes will be made to DTC as the registered holder of the Global Notes. DTC's practice is to credit Direct Participants' accounts on the payable date in accordance with their respective holdings shown on DTC's records unless DTC has reason to believe that it will not receive payment on the payable date. Payments by Participants to beneficial owners will be governed by standing instructions and customary practices, as in the case of securities held for the accounts of customers in bearer form or registered in "street name", and will be the responsibility of such Participant and not of DTC, or us, subject to any statutory or regulatory requirements as may be in effect from time to time. Payment of principal and interest to DTC is our responsibility, disbursement of such payments to Direct Participants shall be the responsibility of DTC, and disbursement of such payments to the beneficial owners shall be the responsibility of Direct Participants and Indirect Participants.
A beneficial owner shall give notice to elect to have its beneficial interests in the Global Notes purchased or tendered, through its Participant, to the trustee for a series of notes, and shall effect delivery of such beneficial interests in the Global Notes by causing the Direct Participant to transfer the Participant's beneficial interest in the Global Notes, on DTC's records, to the trustee.
DTC may discontinue providing its services as securities depositary with respect to the Global Notes at any time by giving reasonable notice to us and the Placement Agents. Under such circumstances, in the event that a successor securities depositary is not obtained, certificated notes in registered form will be printed and delivered in exchange for beneficial interests in the Global Notes as described under the subsection entitled "Terms and Conditions of the Notes— Form, Transfer, Exchange and Denomination".
We may decide to discontinue use of the system of book-entry transfers through DTC (or a successor securities depositary). In that event, certificated notes in registered form will be printed and delivered in exchange for beneficial interests in the Global Notes as described under the section entitled "Terms and Conditions of the Notes—Form, Transfer, Exchange and Denomination".
The information in this section concerning DTC and DTC's book-entry system has been obtained from sources that we believe to be reliable, but we take no responsibility for the accuracy thereof.
In no event will definitive notes in bearer form representing any series of notes be issued.
None of us, any trustee, any paying agent, any registrar for the notes or any Placement Agent will have any responsibility or liability for any aspect of DTC's records or any DTC Participant's records relating to or payments made on account of beneficial ownership interests in a Global Note or for maintaining, supervising or reviewing any of DTC's records or any DTC Participant's records relating to such beneficial ownership interests.
The indenture and the notes require that payments in respect of the notes be made in immediately available funds. Interests in the notes are expected to trade in DTC's Same-Day Funds Settlement System, and any permitted secondary market trading activity in the notes will be required to be settled in immediately available funds. We do not know the effect, if any, of such settlement arrangements on trading activity in the notes or interests in the notes.
If (i) DTC notifies us and the trustee that it is unwilling or unable to continue as holder of the Global Notes or if at any time it ceases to be a clearing agency registered under the Exchange Act and, in either case, a successor holder is not appointed by us within 90 days of such notification or of our becoming aware of such ineligibility, (ii) an Event of Default occurs with respect to one or more series of notes, or (iii) we determine in our sole discretion (subject to DTC's procedures) that certificated notes of such series will be issued in registered form, then in any such case, upon the written request of the holder of the Global Note, the trustee will issue certificated registered notes in the names and in the amounts as specified by the holder of the Global Note. The request for certificated notes may be made by the holder in the circumstances and subject to the conditions described under the section entitled "Terms and Conditions of the Notes— Form, Transfer, Exchange and Denomination".
The exchange of interests in the Global Note for certificated notes of a particular series shall be made free of any fees of the trustee to the holder, provided, however, that such person receiving notes in certificated form will be obligated to pay or otherwise bear the cost of any tax or other governmental charge as required by the indenture and any cost of insurance, postage, transportation and the like.
If a note becomes repayable at the option of the holder on a date or dates specified prior to its maturity date, if any, and the trustee is so notified, the trustee will promptly notify the holder of the Global Note that such note has become repayable. In order for the repayment option on any note to be exercised, the owners of beneficial interests in the Global Note must instruct the broker or other DTC Participant through which it holds an interest in the Global Note to notify the trustee of its desire to exercise that right to repayment. Different firms have different cut-off times for accepting instructions from their customers and, accordingly, each beneficial owner should consult the broker or other DTC Participant through which it holds its beneficial interest in a Global Note in order to ascertain the cut-off time by which such an instruction must be given in order for timely notice to be delivered to the depositary.
Unless we otherwise instruct the trustee in writing, the record date for the determination of the holder of Global Notes entitled to receive payment in respect of a Global Note will be the date which is 15 calendar days prior to the applicable payment date on such Global Note in respect of such Global Note, provided that interest payable at Maturity will be payable to the person to whom principal shall be payable. If such 15th day is not a Business Day, the record date for determination will be the next succeeding Business Day. Whenever we or the trustee deem it appropriate to fix a record date for the determination of the holder of Global Notes who should be entitled to receive payment or take any action in respect of Global Notes, the trustee, with our consent, will set such record date at least 15 days prior to the date on which such payment is to be made or such action is to be taken.
The trustee will send promptly to the applicable holders of the Global Notes any notices, reports and other communications from us that are received by the custodian as holder of the Global Notes and that we make generally available to holders of the notes.
Set out below is the form of Final Terms which will be completed for each tranche of Notes issued under the Program.
[Date]
Terms used herein shall be deemed to be defined as such for the purposes of the Terms and Conditions set forth in the Base Prospectus dated January 18, 2013 [and the supplemental Prospectus dated [date]] which [together] constitute[s] a base prospectus for the purposes of the Prospectus Directive (the Base Prospectus). This document constitutes the Final Terms of the Notes described herein for the purposes of Article 5.4 of the Prospectus Directive and must be read in conjunction with the Base Prospectus. Full information on the Issuer and the offer of the Notes is only available on the basis of the combination of these Final Terms and the Base Prospectus. The Base Prospectus has been published on the website of the London Stock Exchange through a regulatory information service (http://www.londonstockexchange.com/exchange/news/market-news/market-news-home.html).
[Terms used herein shall be deemed to be defined as such for the purposes of the Terms and Conditions set forth in the Base Prospectus dated [original date] and incorporated by reference into the Base Prospectus dated January 18, 2013. This document constitutes the Final Terms of the Notes described herein for the purposes of Article 5.4 of the Prospectus Directive and must be read in conjunction with the Base Prospectus dated January 18, 2013 [and the supplemental Prospectus dated [date]] which [together] constitute[s] a base prospectus for the purposes of the Prospectus Directive (the Base Prospectus), including the Terms and Conditions incorporated by reference in the Base Prospectus. Full information on the Issuer and the offer of the Notes is only available on the basis of the combination of these Final Terms and the Base Prospectus. The Base Prospectus has been published on the website of the London Stock Exchange through a regulatory information service (http://www.londonstockexchange.com/exchange/news/market-news/marketnews-home.html).]
| 1. | Senior/Subordinated: | [ | ] | |||
|---|---|---|---|---|---|---|
| 2. | Interest Basis: | [Fixed Rate/Floating Rate/Zero Coupon/Combination] | ||||
| DESCRIPTION OF THE NOTES | ||||||
| 3. | (a) | Series Number: | [ | ] | ||
| (b) | Tranche Number: | [ | ] | |||
| 4. | (a) | Nominal Amount of Notes to be issued: | [ | ] | ||
| (b) | Aggregate nominal amount of Series (if more than one issue for the Series): |
[ | ] | |||
| (c) | Specified Currency: | [ | ] | |||
| (d) | Currency Determination Agent: | [ | ] [Not Applicable] | |||
| (e) | Specified Denomination(s): | [ | ] [and integral multiples of [ ] in excess thereof] |
|||
| 5. | Issue Price: | [ | ] | |||
| 6. | Issue Date: | [ | ] | |||
| 7. | Original Issue Date: | [ | ] | |||
| 8. | Interest Commencement Date: | [ | ] [Issue Date] [Not Applicable] |
| 9. | Automatic/optional conversion from one Interest Basis to another: |
[ ] [Not Applicable] |
|||
|---|---|---|---|---|---|
| 10. | Additional Business Center(s): | [ ] [Not Applicable] |
|||
| PAYABLE | PROVISIONS RELATING TO INTEREST (IF ANY) | ||||
| Fixed Rate Note Provisions | [Applicable/Not Applicable] | ||||
| 11. | (a) | Fixed Rate(s) of Interest: | [ | ] per cent. per annum payable in arrear on each Fixed Interest Date |
|
| (b) | Interest Payment Date(s): | [ | ] in each year up to and including the Maturity Date | ||
| (c) | Day Count Fraction: | [Actual/Actual (ICMA)] [30/360] | |||
| (d) | Determination Date(s): | [ | ] [Not Applicable] | ||
| Zero Coupon Note Provisions | [Applicable/Not Applicable] | ||||
| 12. | (a) | Accrual Yield: | [ | ] | |
| (b) | Reference Price: | [ | ] | ||
| (c) | Calculation Agent (if any): | [ | ] | ||
| Floating Rate Note Provisions | [Applicable/Not Applicable] | ||||
| 13. | (a) | Calculation Agent responsible for calculating the Interest Rate and Interest Amount (if not the Agent): |
[ | ] | |
| (b) | Interest Period(s) or specified Interest Payment Date(s): |
[ | ] | ||
| (c) | Business Day Convention: | [Floating | Rate/Following Business Day/Modified Following Business Day/Preceding Business Day] |
||
| (d) | First Interest Payment Date: | [ | ] | ||
| (e) | Calculation Date: | [ | ] | ||
| (f) | Interest Rate Basis/Bases: | [CD Rate/CMT Rate/Commercial Paper Rate/Eleventh District Cost of Funds Rate/EURIBOR/Federal Funds Rate/LIBOR/Prime Rate/Treasury Rate] |
|||
| (g) | Designated CMT Reuters Page: | [Not Applicable] [Reuters 7051 Page/Reuters Page T7052] | |||
| (h) | Designated EURIBOR Page: | [Not Applicable] [EURIBOR 01/[ ]] |
|||
| (i) | Designated LIBOR Currency: | [Not Applicable] [USD/[ ]] |
|||
| (j) | Designated LIBOR Page: | [Not Applicable] [LIBOR 01/[ ]] |
|||
| (k) | Initial Interest Rate: | [ | ] | ||
| (l) | Initial Interest Reset Date: | [ | ] | ||
| (m) | Interest Reset Period: | [ | ] | ||
| (n) | Interest Reset Dates: | [ | ] | ||
| (o) | Index Maturity: | [Not Applicable] [ ] |
|||
| (p) | Designated CMT Maturity Index: | [Not Applicable] [ ] |
|||
| (q) | Margin(s): | [plus/minus] [ ] per cent. per annum |
| (r) | Minimum Interest Rate (if any): | [ | ] per cent. per annum | ||
|---|---|---|---|---|---|
| (s) | Maximum Interest Rate (if any): | [ | ] per cent. per annum | ||
| (t) | Day Count Fraction: PROVISIONS REGARDING REDEMPTION/MATURITY |
[[Actual/Actual (ISDA)] [Actual/Actual] [Actual/365 (Fixed)] [Actual/365 (Sterling)] [Actual/360] [30/360] [360/360] [Bond Basis] [30E/360] [Eurobond Basis] [30E/360 (ISDA)]] |
|||
| 14. | Maturity Date: | [ | ] | ||
| 15. | Redemption at Issuer's option: | [Applicable/Not Applicable] | |||
| (a) | Initial Redemption Date(s): | [ | ] | ||
| (b) | Redemption Price of each Note: | [[ | ] per Note of [ | ] Specified Denomination] | |
| 16. | Repayment at holder's option: | [Applicable/Not Applicable] | |||
| (a) | Optional Repayment Date(s): | [ | ] | ||
| (b) | Repayment price of each note: | [ | ] per Note of [ | ] Specified Denomination] | |
| 17. | Minimum | Denomination for early redemption/repayment: |
[ | ] | |
| 18. | Final Redemption Amount for each Note: | Subject to any purchase or early redemption, the Notes will |
be redeemed on the Maturity Date at 100% of their nominal amount.
[[ ] has been extracted from [ ]. The Issuer confirms that such information has been accurately reproduced and that, so far as it is aware and is able to ascertain from information published by [ ], no facts have been omitted which would render the reproduced information inaccurate or misleading.]
By: ...................................................................................... By: ...................................................................................... Duly Authorised Duly Authorised
| 1. | LISTING AND ADMISSION TO TRADING | |||
|---|---|---|---|---|
| (a) | Listing and Admission to trading: | [ | ] [Not Applicable] | |
| (b) | Estimate of total expenses related to admission to trading: |
[ | ] | |
| 2. | RATINGS | |||
| Ratings: | The [Program/Notes to be issued] [has/have] been rated: | |||
| [Moody's Investors Service Limited: | [ | ]] | ||
| [Standard & Poor's Credit Market Services Europe Limited: | [ | ]] | ||
| [Fitch Ratings Ltd.: | [ | ]] |
[Save for any fees payable to the Placement Agent(s), so far as the Issuer is aware, no person involved in the issue of the notes has an interest material to the offer. The [Manager(s)/Dealer(s)] and their affiliates have engaged, and may in the future engage, in investment banking and/or commercial banking transactions with, and may perform other services for, the Issuer and its affiliates in the ordinary course of business.]
| 4. | YIELD | |||||||
|---|---|---|---|---|---|---|---|---|
| Indication of yield: | [ | ] [Not Applicable] | ||||||
| 5. | OPERATIONAL INFORMATION | |||||||
| (a) | CUSIP: | [ | ] | |||||
| (b) | ISIN Code: | [ | ] | |||||
| (c) | Common Code: | [ | ] | |||||
| (d) | Any clearing system(s) other than The Depository Trust Company and the relevant identification number(s): |
[ | ][Not Applicable]] | |||||
| (e) | Names and addresses of additional Paying Agent(s) (if any): |
[ | ] |
The following summary describes certain U.S. federal income tax consequences of the purchase, ownership and disposition of notes. Except where noted, this discussion deals only with U.S. Holders (as defined below) that acquire the notes at their original issuance and that will hold the notes as capital assets and does not deal with investors subject to special tax rules, such as those of dealers in securities or currencies, financial institutions, regulated investment companies, real estate investment trusts, tax-exempt entities, insurance companies, persons holding notes as a part of a hedging, integrated, conversion or constructive sale transaction or a straddle, partnerships or pass-through entities for U.S. federal income tax purposes, traders in securities that elect to use mark-to-market method of accounting for their securities holdings, persons liable for alternative minimum tax or holders of notes whose "functional currency" is not the U.S. dollar. The discussion below is based upon the provisions of the U.S. Internal Revenue Code (the "Code"), final, temporary and proposed Treasury regulations promulgated thereunder, rulings and judicial decisions now in effect, all of which are subject to change possibly with retroactive effect or possible differing interpretations so as to result in U.S. federal income tax consequences different from those discussed below. This summary assumes that there will be no substitution of another entity in the place of the Issuer as principal debtor in respect of the notes. If a partnership holds notes, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership. A partnership holding notes should consult its tax advisors.
The discussion set forth below assumes that all notes issued pursuant to the medium-term note program constitute debt for U.S. federal income tax purposes. If any note did not constitute debt for U.S. federal income tax purposes, the tax consequences of the ownership of such note could differ materially from the tax consequences described herein. This summary does not address the U.S. federal income tax consequences of every type of note which may be issued under the program, such as notes with an original maturity of more than 30 years or with certain contingent payment features, and additional or modified disclosure concerning certain U.S. federal income tax consequences relevant to such type of note may be provided as appropriate.
As used herein, a "U.S. Holder" of a note means a beneficial owner that is, for U.S. federal income tax purposes, (i) a citizen or individual resident alien of the United States, (ii) a corporation created or organized in or under the laws of the United States or any political subdivision thereof (including the District of Columbia), (iii) an estate the income of which is subject to U.S. federal income taxation regardless of its source, or (iv) a trust (X) that is subject to the supervision of a court within the United States and one or more United States persons (as defined in the Code) have the authority to control all substantial decisions of the trust or (Y) that has a valid election in effect under applicable U.S. Treasury regulations to be treated as a United States person.
THE SUMMARY OF U.S. FEDERAL INCOME TAX CONSEQUENCES SET OUT BELOW IS FOR GENERAL INFORMATION ONLY AND DOES NOT ADDRESS EVERY TYPE OF NOTE THAT CAN BE ISSUED UNDER THE PROGRAM. PROSPECTIVE PURCHASERS SHOULD CONSULT THEIR TAX ADVISERS AS TO THE PARTICULAR TAX CONSEQUENCES TO THEM OF OWNING THE NOTES, INCLUDING THE APPLICABILITY AND EFFECT OF U.S. FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND POSSIBLE CHANGES IN TAX LAW.
Except as set forth below, interest (including the payment of any additional amounts) on a note will generally be taxable to a U.S. Holder as ordinary income at the time it is paid or accrued in accordance with the U.S. Holder's method of tax accounting. Interest income (including original issue discount, if any, as discussed below) on the notes will generally be treated as foreign source income for purposes of the U.S. foreign tax credit.
U.S. Holders of notes issued with original issue discount ("OID") will be subject to special tax accounting rules, as described in greater detail below. U.S. Holders of such notes should be aware that they generally must include OID in gross income as ordinary income in advance of the receipt of cash attributable to that income. However, U.S. Holders of such notes generally will not be required to include separately in income cash payments received on the notes, even if denominated as interest, to the extent such payments do not constitute "qualified stated interest" (as defined below). Notes issued with OID will be referred to as "Original Issue Discount Notes".
Additional rules applicable to Original Issue Discount Notes that are denominated in or determined by reference to a currency other than the U.S. dollar are described under "—Foreign Currency Notes" below.
For U.S. federal income tax purposes, a note with an "issue price" that is less than its stated redemption price at maturity (the sum of all payments to be made on the note other than "qualified stated interest") will be issued with OID unless such difference is de minimis (i.e., less than 0.25 percent of the stated redemption price at maturity multiplied by the number of complete years to maturity or, in the case of an Amortizing Note, the weighted average maturity). The "issue price" of each note in a particular offering will be the first price at which a substantial amount of that particular offering is sold to persons other than bond houses, brokers, or similar persons or organizations acting in the capacity of underwriters, placement agents, or wholesalers. The term "qualified stated interest" means stated interest that is unconditionally payable over the entire term of the note in cash or in property (other than debt instruments of the issuer) at least annually at a single fixed rate or, subject to certain conditions, based on one or more interest indices. Interest is payable at a single fixed rate only if the rate appropriately takes into account the length of the interval between payments.
In the case of a note issued with de minimis OID, the U.S. Holder generally must include such de minimis OID in income as at the time principal payments on the note are made in proportion to the amount paid for the note. Any amount of de minimis OID that has been included in income will be treated as capital gain.
Certain notes may be redeemed prior to their Maturity at the option of the Issuer and/or at the option of the holder. Original Issue Discount Notes containing such features may be subject to rules that differ from the general rules discussed herein. In the case of notes that provide for alternative payment schedules, OID is calculated by assuming that (i) the holder will exercise or not exercise options in a manner that maximizes the holder's yield and (ii) the issuer will exercise or not exercise options in a manner that minimizes the holder's yield.
U.S. Holders of Original Issue Discount Notes with a maturity upon issuance of more than one year must, in general, include OID in income in advance of the receipt of some or all of the related cash payments. The amount of OID includible in income by the initial U.S. Holder of an Original Issue Discount Note is the sum of the "daily portions" of OID with respect to the note for each day during the taxable year or portion of the taxable year in which such U.S. Holder held such note ("accrued OID"). The daily portion is determined by allocating to each day in any "accrual period" a pro rata portion of the OID allocable to that accrual period. The "accrual period" for an Original Issue Discount Note may be of any length and may vary in length over the term of the note, provided that each accrual period is no longer than one year and each scheduled payment of principal or interest occurs on the first day or the final day of an accrual period. The amount of OID allocable to any accrual period is an amount equal to the excess, if any, of (a) the product of the note's "adjusted issue price" at the beginning of such accrual period and its yield to maturity (determined on the basis of compounding at the close of each accrual period and properly adjusted for the length of the accrual period) over (b) the sum of any qualified stated interest allocable to the accrual period. OID allocable to a final accrual period is the difference between the amount payable at maturity (other than a payment of qualified stated interest) and the adjusted issue price at the beginning of the final accrual period. Special rules will apply for calculating OID for an initial short accrual period. The "adjusted issue price" of a note at the beginning of any accrual period is equal to its issue price increased by the accrued OID for each prior accrual period (determined without regard to the amortization of any acquisition or bond premium, as described below) and reduced by any payments made on such note (other than qualified stated interest) on or before the first day of the accrual period. Under these rules, a U.S. Holder will generally have to include in income increasingly greater amounts of OID in successive accrual periods.
In the case of an Original Issue Discount Note that is a Floating Rate Note that is treated as a "variable rate debt instrument" under U.S. Treasury regulations, both the "yield to maturity" and "qualified stated interest" generally will be determined solely for purposes of calculating the accrual of OID as though the note will bear interest in all periods at a fixed rate generally equal to the rate that would be applicable to interest payments on the note on its date of issue or, in the case of certain Floating Rate Notes, the rate that reflects the yield to maturity that is reasonably expected for the note. Additional rules may apply if interest on a Floating Rate Note is based on more than one interest index or if the principal amount of the Floating Rate Note is indexed in any manner. Different rules may apply if a Floating Rate Note is treated as a "contingent payment debt instrument" under U.S. Treasury regulations.
Certain Notes may be treated as contingent payment debt instruments for U.S. federal income tax purposes. Under applicable U.S. Treasury regulations, interest on contingent payment debt instruments is treated as OID and must be accrued on a constant-yield basis based on a yield to maturity that reflects the rate at which the issuer would issue a comparable fixed-rate instrument with no contingent payments but with terms and conditions otherwise similar to the contingent payment debt instruments (the "comparable yield"), based on a projected payment schedule determined by the issuer (the "projected payment schedule"). This projected payment schedule must include each non-contingent payment on the note and an estimated amount for each contingent payment, and must produce the comparable yield.
Nationwide will be required to provide to holders, solely for U.S. federal income tax purposes, a schedule of the projected amounts of payments on such notes. The applicable Final Terms will either contain the comparable yield and projected payment schedule, or will provide an address to which a U.S. Holder of a contingent payment debt instrument can submit a written request for this information. A U.S. Holder will generally be bound by the comparable yield and the projected payment schedule determined by Nationwide unless the U.S. Holder determines its own comparable yield and projected payment schedule and explicitly and timely justifies and discloses such schedule to the U.S. Internal Revenue Service ("IRS"). Nationwide's determination, however, is not binding on the IRS, and it is possible that the IRS could conclude that some other comparable yield or projected payment schedule should be used instead.
Gain from the sale or other disposition of a contingent payment debt instrument will be treated as interest income taxable at ordinary income (rather than capital gains) rates. Any loss will be ordinary loss to the extent that the U.S. Holder's total interest inclusions to the date of sale or retirement exceed the total net negative adjustments that the U.S. Holder took into account as ordinary loss, and any further loss will be capital loss. Prospective purchasers should consult their tax advisers as to the U.S. federal income tax consequences of purchasing contingent payment debt instruments.
U.S. Holders may elect to treat all interest on any note as OID and calculate the amount includible in gross income under the constant yield method described above. For the purposes of this election, interest includes stated interest, OID, de minimis OID, market discount, de minimis market discount and unstated interest, as adjusted by any amortizable bond premium or acquisition premium. The election is to be made for the taxable year in which the U.S. Holder acquired the note, and may not be revoked without the consent of the IRS.
Certain of the notes: (i) may be redeemable at the option of the Issuer prior to their maturity, (ii) may be repayable at the option of the holder prior to their stated maturity, or (iii) may be otherwise subject to mandatory redemption. Notes containing such features may be subject to rules that are different from the general rules discussed above, which will depend, in part, on the particular terms and features of such notes.
In general, an individual or other cash basis U.S. Holder of a Short-Term Note is not required to accrue OID (calculated as set forth below for the purposes of this paragraph) for U.S. federal income tax purposes unless it elects to do so (but may be required to include any stated interest in income as the interest is received). Accrual basis U.S. Holders and certain other U.S. Holders are required to accrue OID on Short-Term Notes on a straight-line basis or, if the U.S. Holder so elects, under the constant-yield method (based on daily compounding). In the case of a U.S. Holder not required and not electing to include OID in income currently, any gain realized on the sale or other disposition of the Short-Term Note will be ordinary income to the extent of the OID accrued on a straight-line basis (unless an election is made to accrue the OID under the constant-yield method) through the date of sale or other disposition. U.S. Holders who are not required and do not elect to accrue OID on Short-Term Notes will be required to defer deductions for interest on borrowings allocable to Short-Term Notes in an amount not exceeding the deferred income until the deferred income is realized.
For purposes of determining the amount of OID subject to these rules, all interest payments on a Short-Term Note are included in the Short-Term Note's stated redemption price at maturity. A U.S. Holder may elect to determine OID on a Short-Term Note as if the Short Term Note had been originally issued to the U.S. Holder at the U.S. Holder's purchase price for the Short-Term Note. This election shall apply to all obligations with a maturity of one year or less acquired by the U.S. Holder on or after the first day of the first taxable year to which the election applies, and may not be revoked without the consent of the IRS.
Nationwide may, without the consent of the Holders of outstanding notes, issue additional notes with identical terms. These additional notes, even if they are treated for non-tax purposes as part of the same series as the original notes, in some cases may be treated as a separate series for U.S. federal income tax purposes. In such a case, the additional notes may be considered to have been issued with OID even if the original notes had no OID, or the additional notes may have a greater amount of OID than the original notes. These differences may affect the market value of the original notes if the additional notes are not otherwise distinguishable from the original notes.
If a U.S. Holder purchases a note (other than a Short-Term Note) for an amount that is less than its stated redemption price at maturity or, in the case of an Original Issue Discount Note, its revised issue price, the amount of the difference will be treated as "market discount" for U.S. federal income tax purposes, unless such difference is less than a specified de minimis amount. Under the market discount rules, a U.S. Holder will be required to treat any principal payment on, or any gain on the sale, exchange, retirement or other disposition of, a note as ordinary income to the extent of the market discount which has not previously been included in income and is treated as having accrued on such note at the time of such payment or disposition. In addition, the U.S. Holder may be required to defer, until the maturity of the note or its earlier disposition in a taxable transaction, the deduction of all or a portion of the interest expense on any indebtedness incurred or continued to purchase or carry such note.
Any market discount will be considered to accrue ratably during the period from the date of acquisition to the maturity date of the note, unless the U.S. Holder elects to accrue on a constant yield method. This election to accrue market discount on a constant interest method is to be made for the taxable year in which the U.S. Holder acquired the note, applies only to that note, and may not be revoked without the consent of the IRS. A U.S. Holder of a note may elect to include market discount in income currently as it accrues (on either a ratable or constant-yield method), in which case the rule described above regarding deferral of interest deductions will not apply. This election to include market discount in income currently, once made, applies to all market discount obligations acquired on or after the first day of the first taxable year to which the election applies and may not be revoked without the consent of the IRS.
A U.S. Holder that purchases an Original Issue Discount Note for an amount that is greater than its adjusted issue price but equal to or less than the sum of all amounts payable on the note after the purchase date other than payments of qualified stated interest will be considered to have purchased such note at an "acquisition premium". Under the acquisition premium rules, the amount of OID which such U.S. Holder must include in its gross income with respect to such note for any taxable year will be reduced by the portion of such acquisition premium properly allocable to such year.
A U.S. Holder that purchases a note (including an Original Issue Discount Note), for an amount in excess of the sum of all amounts payable on the note after the purchase date other than qualified stated interest will be considered to have purchased the note at a "bond premium". A U.S. Holder generally may elect to amortize bond premium over the remaining term of the note on a constant yield method as an offset to interest when includible in income under the U.S. Holder's regular accounting method. In the case of instruments that provide for alternative payment schedules, bond premium is calculated by assuming that (i) the holder will exercise or not exercise options in a manner that maximizes the holder's yield and (ii) the issuer will exercise or not exercise options in a manner that minimizes the holder's yield except with respect to call options for which the issuer is assumed to exercise such call options in a manner that maximizes the holder's yield. Bond premium on a note held by a U.S. Holder that does not make such an election will decrease the gain or increase the loss otherwise recognized on disposition of the note. The election to amortize premium on a constant yield method once made applies to all debt obligations held or subsequently acquired by the electing U.S. Holder on or after the first day of the first taxable year to which the election applies and may not be revoked without the consent of the IRS.
A U.S. Holder's tax basis in a note will, in general, be the U.S. Holder's cost therefor, increased by OID, market discount or any income attributable to de minimis OID or de minimis market discount previously included in income by the U.S. Holder and reduced by any amortizable bond premium and any cash payments on the note other than qualified stated interest. Upon the sale, exchange, retirement or other disposition of a note, a U.S. Holder will recognize gain or loss equal to the difference between the amount realized upon the sale, exchange, retirement or other disposition (less an amount equal to any accrued but unpaid qualified stated interest, which will be treated as a payment of interest for U.S. federal income tax purposes) and the adjusted tax basis of the note. Except as with respect to certain Short-Term Notes or market discount as described above, with respect to gain or loss attributable to changes in exchange rates, with respect to certain Foreign Currency Notes as described below, and with respect to contingent payment debt instruments which this summary generally does not discuss, such gain or loss will be capital gain or loss. Gain or loss realized by a U.S. Holder on the sale, exchange or retirement of a note will generally be treated as U.S. source gain or loss. Capital gains of individuals derived in respect of capital assets held for more than one year may be eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations.
The following is a summary of the principal U.S. federal income tax consequences to a U.S. Holder of the ownership of a note denominated in a currency other than the U.S. dollar (a "Foreign Currency Note").
Cash basis U.S. Holders are required to include in income the U.S. dollar value of the amount of interest received, based on the "spot rate" for such foreign currency in effect on the date of receipt, regardless of whether the payment is in fact converted into U.S. dollars. No exchange gain or loss is recognized with respect to the receipt of such payment.
Accrual basis U.S. Holders may determine the amount of income recognized with respect to such interest payment in accordance with either of two methods. Under the first method, the U.S. Holder will be required to include in income for each taxable year the U.S. dollar value of the interest that has accrued during such year, determined by translating such interest at the average rate of exchange for the period or periods during which such interest accrued. Under the second method, an accrual basis holder may elect to translate interest income at the spot rate on the last day of the accrual period (or last day of the taxable year in the case of an accrual period that straddles the holder's taxable year) or on the date the interest payment is received if such date is within five days of the end of the accrual period. Upon receipt of an interest payment on such note (including, upon the sale of such note, the receipt of proceeds that include amounts attributable to accrued interest previously included in income), such U.S. Holder will recognize ordinary income or loss in an amount equal to the difference between the U.S. dollar value of such payment (determined by translating any foreign currency received at the spot rate for such foreign currency on the date received) and the U.S. dollar value of the interest income that such U.S. Holder has previously included in income with respect to such payment.
OID on a note that is also a Foreign Currency Note will be determined for any accrual period in the applicable foreign currency and then translated into U.S. dollars in the same manner as interest income accrued by a holder on the accrual basis, as described above. Additionally, a U.S. Holder will recognize exchange gain or loss when the OID is paid (including, upon the sale of such note, the receipt of proceeds that include amounts attributable to OID previously included in income) to the extent of the difference between the U.S. dollar value of such payment (determined by translating any foreign currency received at the spot rate for such foreign currency on the date of payment) and the U.S. dollar value of the accrued OID (determined in the same manner as for accrued interest). For these purposes, all receipts on a note will be viewed: first, as the receipt of any stated interest payments called for under the terms of the note; second, as receipts of previously accrued OID (to the extent thereof), with payments considered made for the earliest accrual periods first; and third, as the receipt of principal.
The amount of market discount on Foreign Currency Notes includible in income will generally be determined by translating the market discount determined in the foreign currency into U.S. dollars at the spot rate on the date the Foreign Currency Note is retired or otherwise disposed of. If the U.S. Holder has elected to accrue market discount currently, then the amount which accrues is determined in the foreign currency and then translated into U.S. dollars on the basis of the average exchange rate in effect during such accrual period (or portion thereof within the U.S. Holder's taxable year), and the U.S. Holder will recognize exchange gain or loss with respect to market discount determined using the approach applicable to the accrual of interest income described above.
Bond premium on a Foreign Currency Note will be computed in the applicable foreign currency. With respect to a U.S. Holder that elects to amortize the premium, the amortizable bond premium will reduce interest income in the applicable foreign currency. At the time bond premium is amortized, exchange gain or loss (which is generally ordinary income or loss) will be realized based on the difference between spot rates at such time and at the time of acquisition of the Foreign Currency Note. A U.S. Holder that does not elect to amortize bond premium will translate the bond premium, computed in the applicable foreign currency, into U.S. dollars at the spot rate on the maturity date and such bond premium will constitute a capital loss which may be offset or eliminated by exchange gain.
Upon the sale, exchange, retirement or other taxable disposition of a Foreign Currency Note, a U.S. Holder will recognize gain or loss equal to the difference between the amount realized upon the sale, exchange, retirement or other disposition (less an amount equal to any accrued and unpaid interest, which will be treated as a payment of interest for federal income tax purposes) and the U.S. Holder's adjusted tax basis in the Foreign Currency Note.
If a U.S. Holder receives foreign currency on the sale, exchange or retirement of a Foreign Currency Note, then the amount realized generally will be based on the spot rate of the foreign currency on the date of sale, exchange or retirement. For purchases and sales of Foreign Currency Notes traded on an established securities market as defined in applicable Treasury regulations by a cash method taxpayer, however, foreign currency paid or received is translated into U.S. dollars at the spot rate on the settlement date of the purchase or sale. An accrual method taxpayer may elect the same treatment with respect to the purchase and sale of Foreign Currency Notes traded on an established securities market, provided that the election is applied consistently. This election cannot be changed without the consent of the IRS.
A U.S. Holder's tax basis in a Foreign Currency Note generally will be the U.S. Holder's cost therefore, which, in the case of a U.S. Holder that purchases a Foreign Currency Note with foreign currency, will be the U.S. dollar value of the foreign currency amount paid for such Foreign Currency Note determined at the time of such purchase. If the Notes are traded on an established securities market, as defined in applicable Treasury regulations, cash method taxpayers (and electing accrual method taxpayers) will determine the U.S. dollar cost of the note on the settlement date. A U.S. Holder that purchases a note with previously owned foreign currency will recognize exchange gain or loss at the time of purchase attributable to the difference at the time of purchase, if any, between the U.S. Holder's tax basis in such foreign currency and the fair market value of the note in U.S. dollars on the date of purchase. Such gain or loss will be ordinary income or loss.
Gain or loss recognized by a U.S. Holder on the sale, exchange, retirement or other disposition of a Foreign Currency Note will generally be treated as U.S. source gain or loss. Subject to the foreign currency rules discussed below, such gain or loss will be capital gain or loss and will be long-term capital gain or loss if at the time of sale, exchange, retirement or other disposition, the note has been held for more than one year. Capital gains of individuals derived with respect to capital assets held for more than one year are eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations.
A U.S. Holder will recognize exchange gain or loss attributable to the movement in exchange rates between the time of purchase and the time of disposition (including the sale, exchange, retirement or other disposition) of a Foreign Currency Note. Such gain or loss will be treated as ordinary income or loss (and will not be treated as interest income or expense, except to the extent provided in U.S. Treasury regulations or administrative pronouncements of the IRS) and generally will be U.S. source gain or loss. The realization of such gain or loss will be limited to the amount of overall gain or loss realized on the disposition of a Foreign Currency Note.
A U.S. Holder's tax basis in foreign currency received as interest on (or OID with respect to), or received on the sale, exchange, retirement or other disposition of, a Foreign Currency Note will be the U.S. dollar value thereof at the spot rate at the time the holder received such foreign currency. As discussed above, if the Foreign Currency Notes are traded on an established securities market, a cash basis U.S. Holder (or, upon election, an accrual basis U.S. Holder) will determine the U.S. dollar value of the foreign currency by translating the foreign currency received at the spot rate of exchange on the settlement date of the sale, exchange or retirement. Accordingly, no foreign currency gain or loss will result from currency fluctuations between the trade date and settlement date of a sale, exchange or retirement. Any gain or loss recognized by a U.S. Holder on a sale, exchange, retirement or other disposition of foreign currency will be ordinary income or loss and generally will be U.S. source gain or loss.
Treasury regulations requiring the reporting of certain tax shelter transactions ("Reportable Transactions") could be interpreted to cover and require reporting of transactions that are generally not regarded as tax shelters, including certain foreign currency transactions. Under these regulations, certain transactions may be characterized as Reportable Transactions based upon any of several indicia, including, in certain circumstances, a sale, exchange, retirement or other taxable disposition of a Foreign Currency Note or foreign currency received in respect of a Foreign Currency Note to the extent that such sale, exchange, retirement or other taxable disposition results in a tax loss in excess of a threshold amount. Persons considering the purchase of such Notes should consult with their tax advisers to determine the tax return obligations, if any, with respect to an investment in such Notes, including any requirement to file IRS Form 8886 (Reportable Transaction Disclosure Statement).
In general, information reporting requirements will apply to certain payments of principal, interest, premium and accrual of OID on notes and to the proceeds of sale of a note made to U.S. Holders, other than certain exempt recipients (such as corporations). A backup withholding tax generally will apply to such payments (including payments of accrued OID) if the U.S. Holder fails to provide a taxpayer identification number or certification of exempt status otherwise to comply with the applicable backup withholding requirements.
Payments on the notes may be subject to information reporting and withholding pursuant to FATCA as described in "Risk Factors—Risks Related to the Notes—The Notes may be subject to U.S. Foreign Account Tax Compliance withholding tax." FATCA is particularly complex and its application is uncertain at this time. Holders of notes should consult their own tax advisers on how FATCA may apply to payments on the notes.
Any amounts withheld under the backup withholding rules or pursuant to FATCA will be allowed as a refund or a credit against such holder's U.S. federal income tax liability provided the required information is timely furnished to the IRS.
Certain U.S. Holders may be required to report to the IRS certain information with respect to their beneficial ownership of notes not held through an account with a domestic financial institution. Investors who fail to report required information could be subject to substantial penalties.
The following is a summary of the United Kingdom ("UK") withholding taxation treatment as at the date of this Base Prospectus in relation to payments of principal and interest in respect of the notes issued by Nationwide and does not deal with other UK tax aspects of acquiring, holding or disposing of the notes. This summary relates only to the position of persons who are absolute beneficial owners of the notes. Prospective holders should be aware that the particular terms of issue of any series of the notes as specified in the relevant Final Terms may affect the tax treatment of that and other series of notes. This summary is a general guide and does not purport to be a complete analysis of all tax considerations relating to the notes, and you should treat it with appropriate caution.
You should seek independent professional advice should you have any doubt as to your tax position. If you may be liable to taxation in jurisdictions other than the UK in respect of your acquisition, ownership, holding and disposition of notes, you are particularly advised to consult your professional advisers as to whether you are so liable (and if so under the laws of which jurisdictions), since the following comments relate only to certain UK taxation aspects of payments in respect of the notes. In particular, you should be aware that you may be liable to taxation under the laws of other jurisdictions in relation to payments in respect of the notes, even if such payments may be made without withholding or deduction for or on account of taxation under the laws of the UK
Notes issued by Nationwide which carry a right to interest will constitute "quoted Eurobonds" provided they are and continue to be listed on a recognized stock exchange within the meaning of section 1005 of the Income Tax Act 2007. The London Stock Exchange is a recognized stock exchange for those purposes. Securities will be treated as listed on the London Stock Exchange if they are included in the Official List (within the meaning of and in accordance with the provisions of Part 6 of the Financial Services and Markets Act 2000) and admitted to trading on the London Stock Exchange. Provided that the notes are and continue to be quoted Eurobonds, payments of interest on the notes may be made without withholding or deduction for or on account of UK income tax.
If the notes do not qualify as quoted Eurobonds, as described in "—Notes Listed on a Recognized Stock Exchange", interest on the notes will generally (subject to certain other exemptions which may be available in certain circumstances) be paid under deduction of UK income tax at the rate of (currently) 20%, subject to such relief as may be available under the provisions of any applicable double taxation treaty.
Holders of notes may wish to note that, in certain circumstances, H.M. Revenue & Customs ("HMRC") has power to obtain information (including the name and address of the beneficial owner of the interest) from any person in the United Kingdom who either pays or credits interest to or receives interest for the benefit of a holder of notes. HMRC also has power, in certain circumstances, to obtain information from any person in the United Kingdom who pays amounts payable on the redemption of notes which are deeply discounted securities for the purposes of the Income Tax (Trading and Other Income) Act 2005 to or receives such amounts for the benefit of another person, although HMRC published practice indicates that HMRC will not exercise the power referred to above to require this information in respect of amounts payable on the redemption of deeply discounted securities where such amounts are paid on or before 5 April 2013. Such information may include the name and address of the beneficial owner of the amount payable on redemption. Any information obtained may, in certain circumstances, be exchanged by HMRC with the tax authorities of the jurisdiction in which the holder of notes is resident for tax purposes.
Where notes are to be, or may fall to be, redeemed at a premium, as opposed to being issued at a discount, then any such element of premium may constitute a payment of interest. Payments of interest are subject to UK withholding tax and reporting requirements as outlined above.
In addition to the above, in relation to UK withholding tax, where interest has been paid under deduction of UK income tax, holders of notes who are not resident in the United Kingdom may be able to recover all or part of the tax deducted if there is an appropriate provision in any applicable double taxation treaty.
The references to "interest" in this UK Taxation summary mean "interest" as understood in UK tax law. The statements in this summary do not take any account of any different definitions of "interest" or "principal" which may prevail under any other law or which may be created by the terms and conditions of the notes or any related documentation. This description of the UK withholding tax position assumes that there will be no substitution of the Issuer of the notes pursuant to the terms and conditions of the notes and does not consider the tax consequences of any such substitution.
Under EC Council Directive 2003/48/EC (the "Directive") on the taxation of savings income, each member state is required to provide to the tax authorities of another member state details of payments of interest or other similar income paid by a person within its jurisdiction to, or collected by such a person for, an individual resident in that other member state or to certain limited types of entities established in that other member state. However, for a transitional period, Luxembourg and Austria are instead required (unless during that period they elect otherwise) to operate a withholding system in relation to such payments (the ending of such transitional period being dependent upon the conclusion of certain other agreements relating to information exchange with certain other countries). A number of non-EU countries and territories including Switzerland have adopted similar measures (a withholding system in the case of Switzerland).
The European Commission has proposed certain amendments to the Directive which may, if implemented, amend or broaden the scope of the requirements described above.
We have not registered the notes under the Securities Act or any other applicable securities laws, and they may not be offered or sold except pursuant to an effective registration statement or in accordance with an applicable exemption from the registration requirements of the Securities Act. Accordingly, the notes are being offered and sold only:
Each purchaser of notes (other than a Placement Agent in connection with the initial issuance and sale of notes) and each owner of any beneficial interest therein, will be deemed, by its acceptance or purchase thereof, to have represented and agreed as follows:
the acknowledgements, representations and agreements deemed to have been made by its purchase of the notes are no longer accurate, it shall promptly notify Nationwide and the Placement Agents. If it is acquiring the notes as a fiduciary or agent for one or more investor accounts, it represents that it has sole investment discretion with respect to each such account and it has full power to make the foregoing acknowledgements, representations, and agreements on behalf of each account.
A legend to the following effect will appear on the face of notes, other than International Global Notes, and which will be used to notify transferees of the foregoing restrictions on transfer. Additional copies of this notice may be obtained from the trustee.
"THE SECURITIES EVIDENCED HEREBY (THE "NOTES") HAVE NOT BEEN REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE "U.S. SECURITIES ACT"), OR ANY OTHER SECURITIES LAWS OF ANY STATE OR OTHER JURISDICTION. THE HOLDER HEREOF, BY PURCHASING THE NOTES, (1) REPRESENTS THAT IT IS A "QUALIFIED INSTITUTIONAL BUYER" (AS DEFINED IN RULE 144A UNDER THE U.S. SECURITIES ACT ("RULE 144A")), (2) AGREES ON ITS OWN BEHALF AND ON BEHALF OF ANY INVESTOR ACCOUNT FOR WHICH IT HAS PURCHASED NOTES THAT IT WILL NOT PRIOR TO (X) THE DATE WHICH IS ONE YEAR (OR SUCH SHORTER PERIOD OF TIME AS PERMITTED BY RULE 144 UNDER THE U.S. SECURITIES ACT OR ANY SUCCESSOR PROVISION THEREUNDER) AFTER THE LATER OF THE ORIGINAL ISSUE DATE OF THE NOTES (OR OF ANY PREDECESSOR THEREOF) OR THE LAST DAY ON WHICH THE NATIONWIDE BUILDING SOCIETY (THE "ISSUER") OR ANY AFFILIATE OF THE ISSUER WERE THE OWNERS OF THE NOTES (OR ANY PREDECESSOR THEREOF) AND (Y) SUCH LATER DATE, IF ANY, AS MAY BE REQUIRED BY APPLICABLE LAW (THE "RESALE RESTRICTION TERMINATION DATE"), OFFER, SELL, PLEDGE OR OTHERWISE TRANSFER THE NOTES EXCEPT (I) TO THE ISSUER OR ONE OR MORE PLACEMENT AGENTS FOR THE NOTES (EACH, A "PLACEMENT AGENT" AND COLLECTIVELY, THE "PLACEMENT AGENTS") OR BY, THROUGH OR IN A TRANSACTION APPROVED BY A PLACEMENT AGENT, (II) SO LONG AS THE NOTES ARE ELIGIBLE FOR RESALE PURSUANT TO RULE 144A, TO A PERSON WHO THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER (AS DEFINED IN RULE 144A) IN ACCORDANCE WITH RULE 144A, (III) IN AN OFFSHORE TRANSACTION IN ACCORDANCE WITH RULE 903 OR 904 OF REGULATION S UNDER THE U.S. SECURITIES ACT, (IV) PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER THE U.S. SECURITIES ACT PROVIDED BY RULE 144 UNDER THE U.S. SECURITIES ACT (IF AVAILABLE), (V) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE U.S. SECURITIES ACT OR (VI) PURSUANT TO ANY OTHER AVAILABLE EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE U.S. SECURITIES ACT, AND IN EACH OF SUCH CASES IN ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED STATES OR ANY OTHER APPLICABLE JURISDICTION. THE HOLDER OF THE NOTES, BY PURCHASING THE NOTES, REPRESENTS AND AGREES FOR THE BENEFIT OF THE ISSUER THAT IT WILL NOTIFY ANY PURCHASER OF THE NOTES FROM IT OF THE RESALE RESTRICTIONS REFERRED TO ABOVE. THE ISSUER SHALL HAVE THE RIGHT PRIOR TO ANY OFFER, SALE OR TRANSFER PURSUANT TO CLAUSE (VI) ABOVE, TO REQUIRE THE DELIVERY OF AN OPINION OF COUNSEL, CERTIFICATIONS AND/OR OTHER INFORMATION SATISFACTORY TO THE ISSUER. AS USED HEREIN, THE TERMS "OFFSHORE TRANSACTION," "UNITED STATES" AND "U.S. PERSON" HAVE THE MEANINGS GIVEN TO THEM BY REGULATION S UNDER THE U.S. SECURITIES ACT."
"THE FOREGOING LEGEND MAY BE REMOVED FROM THIS NOTE ON SATISFACTION OF THE CONDITIONS SPECIFIED IN THE INDENTURE REFERRED TO HEREIN".
A legend to the following effect will appear on the face of the International Global Notes.
"THE SECURITIES EVIDENCED HEREBY (THE "NOTES") HAVE NOT BEEN AND WILL NOT BE REGISTERED UNDER THE U.S. SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), OR ANY OTHER APPLICABLE U.S. STATE SECURITIES LAWS AND, ACCORDINGLY, MAY NOT BE OFFERED OR SOLD WITHIN THE UNITED STATES OR TO, OR FOR THE ACCOUNT OR BENEFIT OF, U.S. PERSONS EXCEPT PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT."
For further discussion of the requirements (including the presentation of transfer certificates) under the indenture to effect exchanges or transfers of interest in global notes and certificated notes, see the section entitled "Terms and Conditions of the Notes—Form, Transfer, Exchange and Denomination".
The notes are being offered on a continuous basis for sale by us to or through Barclays Capital Inc., Deutsche Bank Securities Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, HSBC Securities (USA) Inc., J.P. Morgan Securities LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, Morgan Stanley & Co. LLC and UBS Securities LLC together with such other Placement Agent as may be appointed by us with respect to a particular tranche of notes. We refer collectively to these entities as the "Placement Agents". One or more Placement Agents may purchase notes, as principal, from us from time to time for resale to investors and other purchasers at varying prices relating to prevailing market prices at the time of resale as determined by any Placement Agent, or, if so specified in the applicable Final Terms, for resale at a fixed offering price. If we and a Placement Agent agree, a Placement Agent may also utilize its reasonable efforts on an agency basis to solicit offers to purchase the notes. Any Placement Agents of the notes that are not U.S. registered broker-dealers will agree that they will offer and sell the notes within the United States only through U.S. registered broker-dealers. Unless otherwise described in an applicable Final Terms, we will pay a commission to a Placement Agent, ranging from 0.125% to 0.750% of the principal amount of each note depending upon its stated maturity, for notes sold through such Placement Agent as agent. Commissions with respect to notes with stated maturities in excess of 30 years that are sold through a Placement Agent as an agent of ours will be negotiated between us and that Placement Agent at the time of such sale.
Unless otherwise specified in an applicable Final Terms, any note sold to one or more Placement Agents as principal will be purchased by such Placement Agents at a price equal to 100% of the principal amount thereof less a percentage of the principal amount equal to the commission applicable to an agency sale of a note of identical maturity. A Placement Agent may sell notes it has purchased from us as principal to certain dealers less a concession equal to all or any portion of the discount received in connection with such purchase. The Placement Agent may allow, and such dealers may reallow, a discount to certain other dealers. After the initial offering of notes, the offering price (in the case of notes to be resold at a fixed offering price), the concession and the reallowance may be changed.
We may withdraw, cancel or modify the offering contemplated hereby without notice and may reject offers to purchase notes in whole or in part. Each Placement Agent shall have the right to reject in whole or in part any offer to purchase notes received by it on an agency basis.
In connection with an offering of notes purchased by one or more Placement Agents as principal on a fixed offering price basis, such Placement Agent(s) will be permitted to engage in transactions that stabilize the price of notes. These transactions may consist of bids or purchases for the purpose of pegging, fixing or maintaining the price of notes. If the Placement Agent creates or the Placement Agents create, as the case may be, a short position in notes, that is, if it sells or they sell notes in an aggregate principal amount exceeding that set forth in the applicable Final Terms, such Placement Agent(s) may reduce that short position by purchasing notes in the open market. In general, purchase of notes for the purpose of stabilization or to reduce a short position could cause the price of notes to be higher than it might be in the absence of such purchases.
Neither we nor any of the Placement Agents makes any representation or prediction as to the direction or magnitude of any effect that the transactions described in the immediately preceding paragraph may have on the price of notes. In addition, neither we nor the Placement Agents make any representation that the Placement Agents will engage in any such transactions or that such transactions, once commenced, will not be discontinued without notice.
We have agreed to indemnify the Placement Agents against some liabilities (including liabilities under the Securities Act) or to contribute to payments the Placement Agents may be required to make in respect thereof. We have also agreed to reimburse the Placement Agents for some other expenses.
The Placement Agents may from time to time purchase and sell notes in the secondary market, but they are not obligated to do so and may discontinue any such activities at any time and there can be no assurance that there will be a secondary market for the notes or liquidity in the secondary market if one develops. From time to time, the Placement Agents may make a market in the notes.
Certain of the Placement Agents and/or their affiliates have, directly or indirectly, performed investment and commercial banking or financial advisory services for us, for which they have received customary fees and commissions, and they expect to provide these services to us and our affiliates in the future, for which they also expect to receive customary fees and commissions.
Each Placement Agent subscribing for or purchasing notes will be required to represent and agree (i) that it will not offer or sell notes (a) as part of its distribution at any time or (b) otherwise until 40 days after the completion of the distribution, as determined and certified by the relevant Placement Agent or, in the case of an issue of Notes on a syndicated basis, the relevant lead manager, of all notes of the tranche of which such notes are a part (such period, the "Distribution Compliance Period"), within the United States or to, or for the account or benefit of, U.S. persons other than in accordance with Rule 144A and (ii) that it will send to each dealer to which it sells any notes during the Distribution Compliance Period a confirmation or other notice setting forth the restrictions on offers and sales of the Notes within the United States or to, or for the account or benefit of, U.S. persons. Terms used in this paragraph have the meanings given to them by Regulation S under the Securities Act.
Each Placement Agent subscribing for or purchasing notes agrees and each further purchasing agent appointed under the medium-term note program described in this Base Prospectus that subscribes for or purchases notes will be required to represent and agree that:
Unless otherwise specified in the applicable Final Terms, you must pay the purchase price of the notes in immediately available funds in the applicable specified currency in New York City three business days after the trade date.
The financial statements as at April 4, 2012, 2011 and 2010, and for the years then ended, incorporated by reference in this Base Prospectus, have been audited by PricewaterhouseCoopers LLP, independent auditors, as stated in their reports incorporated by reference herein.
Certain legal matters will be passed upon for us by Allen & Overy LLP, our United States and English counsel, with respect to matters of New York law, U.S. federal law and English law and for the Placement Agents by Linklaters LLP, London, England with respect to matters of New York law, U.S. federal law and English law.
Certain financial terminology used by building societies in the United Kingdom differs from that used by financial institutions in the United States. The following is a summary of such differences as they relate to our consolidated financial statements. We have used some of the following U.S. terms and descriptions throughout this Base Prospectus.
| UK Term used in financial statements | U.S. equivalent or brief description |
|---|---|
| Accounts | Financial statements |
| Allotted | Issued |
| Amounts written off | Amounts charged off, or written-off |
| Cash in hand | Cash |
| Debt securities in issue | Debt |
| Fees and commissions payable | Fees and commissions expense |
| Fees and commissions receivable | Fees and commissions income |
| Freehold | Ownership with absolute rights in perpetuity |
| General reserve | Retained earnings |
| Income and Expenditure Account | Income Statement |
| Interest payable | Interest expense |
| Interest receivable | Interest income |
| Life assurance | Life insurance |
| Loans and advances | Loans or Lendings |
| Loans fully secured on residential property | Residential mortgage loans |
| Loans in arrears | Past due loans |
| Loans in repossession | Acquired property, foreclosed assets or Other Real Estate Owned ("OREO") |
| Loans with interest suspended | Loans in non-accrual status |
| Permanent interest bearing shares and subscribed capital | No direct U.S. equivalent |
| Profit | Income |
| Provisions for bad and doubtful debts (in the balance sheet) |
Allowance for loan losses |
| Provisions for bad and doubtful debts (in the income statement) |
Provisions for loan losses |
| Revaluation reserve | No direct U.S. equivalent |
| Shares (UK retail member deposits) | No direct U.S. equivalent |
| Tangible fixed assets | Property, Plant & Equipment or Fixed Assets |
Nationwide House Pipers Way Swindon SN38 1NW England
745 Seventh Avenue New York, New York 10019 U.S.A.
U.S.A. U.S.A.
New York, New York 10036 Stamford, Connecticut 06901
Deutsche Bank Securities Inc. HSBC Securities (USA) Inc. 60 Wall Street 452 Fifth Avenue U.S.A. U.S.A.
J. P. Morgan Securities LLC Merrill Lynch, Pierce, Fenner & Smith Incorporated 383 Madison Avenue One Bryant Park New York, New York 10179 New York, New York 10036 U.S.A. U.S.A.
1585 Broadway, 4th Floor 677 Washington Boulevard U.S.A. U.S.A.
New York, New York 10286 U.S.A.
England
The Bank of New York Mellon Credit Agricole Indosuez Luxembourg, S.A. One Canada Square 39, Allee Scheffer London E14 5AL L-2520 Luxembourg
To Nationwide To the Placement Agents as to New York, U.S. federal and English law: as to New York, U.S. federal law and English law:
Allen & Overy LLP Linklaters LLP
One Bishops Square One Silk Street London E1 6AD London, EC2Y 8HQ England England
PricewaterhouseCoopers LLP
1 Embankment Place London WC2N 6RH England
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