TSB Banking Group plc — Annual Report 2019

Dec 31, 2019

Annual Report and Accounts 2019 page

TSB Banking Group plc

Contents

02	Strategic Report

• Chairman's letter
• Chief Executive's statement
• How we seek to create value our business model
• Financial performance in 2019
• Risk management in TSB

21 Corporate governance statement

• How the business is managed
• Nomination Committee report
• Audit Committee report
• Directors' report
• Remuneration review 2019

44 Financial statements

• Consolidated balance sheet
• Consolidated statement of comprehensive income
• Consolidated statement of changes in equity
• Consolidated cash flow statement
• Notes to the consolidated financial statements
• Company balance sheet
• Company statement of changes in equity
• Company cash flow statement
• Notes to the Company financial statements
• Independent auditors' report to the members of
• TSB Banking Group plc

103 Other information

• Enhanced Disclosure Task Force recommendations Glossary
• Abbreviations
• Contacts

Strategic report

Summary results

Summary consolidated balance sheet

	2019 £ million	2018 £ million	Change %
Loans and advances to customers	31,075.8	30,008.5	3.6
Other assets	8,445.1	11,115.8	(24.0)
Total assets	39,520.9	41,124.3	(3.9)
Customer deposits	30,182.4	29,094.3	3.7
Other liabilities	7,452.5	10,166.0	(26.7)
Shareholder's equity	1,886.0	1,864.0	1.2
Total equity and liabilities	39,520.9	41,124.3	(3.9)

Summary consolidated statutory income statement

	2019	2018	Change
	£ million	£ million	%
Net interest income	841.1	884.8	(4.9)
Other income	146.7	406.1	(63.9)
Total income	987.8	1,290.9	(23.5)
Operating expenses	(881.3)	(1,323.0)	(33.4)
Impairment	(60.5)	(73.3)	(17.5)
Statutory profit/(loss) before taxation	46.0	(105.4)	143.6
Taxation	(19.7)	42.4	(146.5)
Statutory profit/(loss) for the year	26.3	(63.0)	141.7

Management basis profit before taxation

	2019 £ million	2018 £ million	Change %
Management profit/(loss) before taxation (excluding additional post migration charges)	76.8	173.3	(55.7)
Post migration charges (1)	(35.6)	(330.2)	(89.2)
Recovery of post migration charges	39.6	153.0	(74.1)
Management profit/(loss) before taxation	80.8	(3.9)
Migration related income from Lloyds Banking Group	–	318.3	(100.0)
Costs of preparing for TSB's migration (2)	–	(417.3)	(100.0)
Banking volatility (3)	8.9	(8.7)	202.3
One off items (4)	(43.7)	6.2	(804.8)
Statutory profit/(loss) before taxation	46.0	(105.4)	143.6

Key performance indicators

Operational (explained in the context of our business model on page 10)
Customer advocacy – Net Promoter Score (NPS) (5)	10	(9)	19
Share of new personal bank account gross flow (6)	3.9%	3.6%	0.3pp
Mortgage gross new lending (£ million)	5,838.1	4,803.5	21.5%

Financial
Loan to deposit ratio	103%	103%	–
Common Equity Tier 1 Capital ratio (fully loaded)	20.6%	19.5%	1.1pp
Leverage ratio (fully loaded)	4.6%	4.4%	0.2pp
Net interest margin (7)	2.75%	2.87%	(12)bps
Asset quality ratio (8)	0.20%	0.24%	(4)bps

(1) Operating expenses of £35.6 million of additional resource and advisory costs (2018: operating expenses of £296.7 million, comprising customer redress and associated costs of £107.3 million, customer rectification and associated costs of £17.9 million, fraud and operational losses of £49.1 million, and additional resource and advisory costs of £122.4 million, and lower income in the form of waived interest and fee income of £33.5 million).

(2) Comprising £249.0 million payable to Sabadell under the Migration Services Agreement, £44.3 million of associated VAT, £187.7 million of project related costs, offset by reimbursement by LBG of £63.7 million of VAT related costs.

(3) Banking volatility reflects gains and losses on derivatives not in hedge accounting relationships, hedge accounting ineffectiveness, and volatility associated with share schemes.

(4) One off items reflect costs of restructuring the bank, including £21.9 million in respect of costs of the branch closures announced in November 2019 and £16.6 million relating to the reorganisation of head office functions.

(5) NPS is based on the question "On a scale of 0-10, where 0 is not at all likely and 10 is extremely likely, how likely is it that you would recommend TSB to a friend or colleague?" NPS is the percentage of TSB customers who give a score of 9 or 10 after subtracting the percentage who give a score 0 to 6. Calculated as a 3 month rolling average.

(6) Source: CACI Current and Savings Account Market Database (CSDB) which includes current, packaged, youth, student and basic bank accounts, and new account openings excluding account upgrades. Calculated on a 12 month rolling average basis. Data presented on a 2 month lag. (7) Net interest income divided by average loans and advances to customers, gross of impairment allowance.

(8) Impairment charge on loans and advances to customers divided by average loans and advances to customers, gross of impairment allowance.

Chairman's letter

A new chapter for TSB

It is six years since TSB returned to the High Street. In this time, TSB has established itself as a purpose-led, full-service challenger bank, drawing on the heritage of a trusted brand and driven by a workforce striving to make banking better for UK customers.

The issues encountered when we migrated from legacy IT systems to a modern banking platform in 2018 have been well documented. However, that difficult time is now behind us and we are back to doing what we know best – serving the everyday banking needs of TSB customers now and into the future. We operate in a challenging environment for banks and face low interest rates, fast changing customer behaviours towards online platforms, regulatory intensity often requiring implementation of significant system changes, the competitive impact of ring-fencing, and additional responsibilities, such as open banking.

Progress through the year

This time last year, TSB was focused on three key priorities to underpin confidence in the future: stabilising our technology systems, compensating every customer impacted by migration and establishing our business banking offer. We have delivered on each of these:

• Our banking platform is stable and offering customers more functionality than ever before. The most recent data from the Financial Conduct Authority shows IT incidents at TSB are now in line with, or better than, the levels of other UK banks. We've also announced a further £120 million investment in our digital capabilities to deliver ever better solutions to customers so that they can access services from TSB on the go.
• All customer complaints relating to migration were addressed and compensated by April 2019 and the number of new complaints now being received has dropped to within industry standard levels.
• Given our well-established network, business product range and national presence, we were disappointed in not winning any of the RBS remedies. This said, we have established TSB as a competitive and distinct new player in Business Banking. The Bank has seen steady growth in customer numbers throughout the year, including 2,600 joining through the Incentivised Switching Scheme.

In November 2019, the Board published the Slaughter and May report into the IT migration to our new technology platform which it was hoped would offer important lessons on technology transformation not just for TSB, but for the wider industry. Although the report doesn't paint the full picture of migration, and there are aspects that we don't agree on, the Board was absolutely clear that we wanted to be transparent. This is why we took the decision to publish the report in full.

As we made clear at the time, Slaughter and May's report is one of a number of reviews into the issues arising in the technology migration which have been carried out by external parties and by our own teams within TSB and Sabadell. These other reports have highlighted a number of aspects which are not fully reflected in Slaughter and May's report. We have taken account of these learnings and, in particular, are now taking more direct control of our technology platform and its suppliers, including IBM.

Looking to the future

After eight months in the interim role of Executive Chairman, I was delighted to welcome, on 1 May 2019, Debbie Crosbie to TSB as our new Chief Executive Officer. Debbie has brought considerable experience and knowledge to the role, as well as real dynamism. She has already put in place a strong new leadership team who, together with her, have unveiled an ambitious new strategy for taking the business forward with long-term growth.

Chairman's letter (continued)

Looking to the future (continued)

As I have set out above, our bank systems are now stable and we look forward to the future with confidence. I'm particularly proud of the way TSB has taken a leading position to help protect our customers and communities against the rise in the incidence of fraud, particularly as customers increasingly engage in online platforms. In launching the Fraud Refund Guarantee in April, a UK banking first, we are the only bank to offer this protection to our customers. We have also forged partnerships with police forces to help them track down criminals faster and have hosted hundreds of community workshops across the country, to help prevent thousands of customers and members of the communities we serve becoming victims of fraud.

I'd like to take this opportunity to thank the members of the TSB Board for their support and hard work throughout the year. In particular, I wish to thank Miquel Montes for his service over the past four and a half years, following the announcement in December that he was stepping down from the TSB Board. David Vegara will join the Board (subject to regulatory approval) to replace Miquel, and I expect that we will continue to evolve the membership of the Board in the year ahead.

I'd like to finish by thanking my TSB colleagues for playing their part in the TSB turnaround this year. Their commitment to our business is the bedrock on which the bank is built and I am hugely grateful for their hard work and their care for customers and the communities we serve. The bank has returned to profit, has modern systems, is forward looking and has real confidence in its ability to provide excellent service to its customers.

Richard Meddings Chairman 30 January 2020

Chief Executive's statement

Introduction

Before joining TSB, I was aware of the power of the TSB brand. Banks talk about creating the right culture, but the passion and commitment of TSB's colleagues to deliver for customers is second to none. What excited me was the potential that TSB has to redefine banking to serve our customers better and adapt to their changing financial needs.

When I joined in May 2019, I spent time getting to know the business and meeting colleagues up and down the country. I saw first-hand how our people go above and beyond to serve our customers and the capability that our new platform offers. Combined with our brand, it is my strong belief that TSB has the right foundations to be a leading UK bank.

One of my first priorities was to make some important changes to the way we run TSB to bring new focus and energy to the way we compete, including appointing a smaller, more focused, Executive Committee with clear responsibility for making sure the Bank reaches its full potential. The new Executive Committee works closely with an extended leadership team, made up of their direct reports, who are empowered to run TSB.

This represents a significant step forward for the Bank, putting greater focus on our customers and improving the TSB experience to accelerate our plans to transform the business.

A strong starting position

At the Half Year, we announced that TSB was tracking well against three key areas: serving customers well; harnessing the technology platform; and focusing on efficiency. All were essential steps to lay the foundations for a new three-year strategy and a renewed focus on our customers.

Customers were beginning to see real benefits from the Bank's new platform, including a faster mortgage application process, the introduction of new digital capabilities such as identity verification on our mobile app and the roll-out of the Image Clearing System for cheques across the branch network. In addition, as outlined in the Chairman's letter, TSB's Fraud Refund Guarantee was launched to protect customers, alongside our programme to help support communities, and stands us apart from our competitors.

TSB has continued to grow its Business Banking proposition by providing market-leading offers such as 25 months free banking and introducing a 1% interest rate on savings accounts, and reducing the time taken to complete the business current account application process to 10 minutes. We also announced a partnership with provider 'Square' to make card payments more accessible for TSB's Business Banking customers across the UK. It enables small business owners who bank with us and process payments with Square to track their performance, for free, using a suite of real-time analytics, manage inventories and enjoy access to digital receipt or refund tools. We also extended the number of drop-in advice clinics in branches which deliver face-to-face advice and support for TSB business customers, in partnership with Enterprise Nation.

These developments and our ongoing growth will continue to be driven by a strong, skilled, motivated and diverse workforce. We are committed to diversity in the broadest sense and to make sure everyone in our business feels included; this remains an important part of our culture.

We are investing in gender diversity through initiatives such as our own TSB Aspiring Women network, Women Returners' Programme and HMT's Investing in Women Code¹ . More broadly, we have inclusion affinity groups for LGBTQ+, BAME and Disability, all of which are sponsored and supported by members of the Executive Committee and senior leadership team. In 2019, TSB employees threw their support behind events such as Pride² , and more recently, TSB signed up to the Valuable 500³ where we've made three commitments, which includes putting disability on our Board agenda. Our most recent Partner Experience survey shows that TSB colleagues recognise these efforts, with diversity awareness at 84%. Our inclusive and supportive culture is one of the things that seeks to make TSB an inspiring place to work.

¹ The Investing in Women Code is a commitment by financial services firms to improve female entrepreneurs' access to tools, resources and finance. https://www.gov.uk/government/publications/investing-in-women-code.

² Members of the LGBTQ+ community and their allies celebrate Pride on an annual basis with parties, parades and festivals all over the world.

³ The Valuable 500 is a global movement putting disability on the business leadership agenda: https://www.thevaluable500.com.

Chief Executive's statement (continued)

TSB's new purpose and strategy: Money Confidence. For Everyone. Every Day.

For the Bank to restore its competitiveness, it was key to revisit what drives TSB. Together with our people and our customers, we have designed a new blueprint to articulate why TSB exists, and what we need to do to transform our Bank in the coming years. With a new business purpose of 'Money Confidence. For Everyone. Every Day'. I believe that TSB is well placed to become a simpler organisation to compete effectively, build deeper customer relationships and deliver compelling customer experiences. In November, we unveiled our new strategic plan for 2020 to 2022. This is underpinned by three pillars:

• Customer focus

Our starting point is always the customer. Following substantial research, opportunities were identified to improve the way we serve the 'Aspiring Middle' customer groups, who want a bank that removes unnecessary hassle from banking and helps them to manage their money better and reduce unexpected worry. There are clear opportunities for TSB to deliver new and innovative products and services for these customers.

To deliver the best customer experience, we have announced a planned investment of over £120 million in TSB's digital channels while, also, refreshing our lending products to provide new flexibility, address a broader range of customers' needs, and introduce individual customer lending decisioning and underwriting criteria.

Branches remain an integral part of TSB's business and will complement the focus on our digital services. However, TSB has more than double the UK average ratio of branches to customers and, as a result, we will reshape the size of our branch network to meet the changing needs of customers. As part of this, TSB will continue to invest in flagship branches and, as a result, will continue to have an extensive branch footprint across the whole of the country.

• Simplification and efficiency

The second pillar is to become a simpler and more focused business. Our new IT platform gives TSB a strong foundation for the future with multi-cloud and data capabilities that provide opportunities to use data driven insights and analytics to improve the TSB experience. We will also optimise opportunities from open banking and third-party relationships to improve TSB's offering to customers and selectively expand our services where it matters to our customers most.

We are working to reduce the time to open a current account from seven days to 10 minutes and allow customers to transact straight away. Customers will enjoy the convenience of self-service and access to all products and services from TSB's mobile platform with three quarters of TSB's customers expected to be digitally active by 2022.

• Operational Excellence

The third pillar focuses on creating a more resilient and sustainable business through the safe and sound delivery of our strategic plan. We have a strong governance and risk management framework overseen by an experienced Executive team. Accountability for TSB's future conduct risk is clear with all customer banking experiences, both business and retail, owned by our Customer Banking Director. Management of our operational risk benefits from the same organisational clarity under our Chief Operating Officer.

IT resilience and cyber security will be prioritised to make sure that we allocate the appropriate level of resources. As part of this, the programme to take more direct control of technology, currently managed by Sabis under the Operating Services Agreement, has commenced with the signing of a new partnership with IBM. Increasingly, TSB will partner with a small number of larger industry leaders to bring significant cost savings and reduce risk. This is a joint programme of work with Sabadell, which is already significantly advanced and delivering value.

Financial summary

As detailed in the review of financial performance on page 11, TSB generated a statutory profit before tax of £46.0 million in 2019, including a £39.6 million increase in the expected recovery under warranties in the respective migration and IT service related agreements. This compared to a statutory pre-tax loss of £105.4 million in 2018.

Management profit before tax generated by the underlying business was £76.8 million, a reduction of 56% since 2018. This largely reflected:

• increases in operating expenses as TSB started to invest in a range of capabilities across the business; and
• a reduction in net interest income due to competitive pressures on mortgage margins.

Over 200,000 customers opened a new bank account or switched their account to TSB in 2019 which helped to generate the 3.7% increase in customer deposit balances from £29.1 billion to £30.2 billion. Mortgage gross new lending of £5.8 billion supported net growth in customer loan balances of 3.6% from £30.0 billion to £31.1 billion.

Chief Executive's statement (continued)

Outlook – delivering through uncertainty

TSB continues to operate amidst economic uncertainty as geopolitical instability limits GDP growth, interest rates have remained low for much longer than expected and continued growth in the 'gig economy' and 'generation rent'. The Bank faces intense competition with mortgage margin compression and the repayment of the Bank of England's Term Funding Scheme driving funding cost pressures. This is taking place at a time when customers continue to change the way they bank, preferring a more digital way of managing their money, and a range of new Fintechs entering the market intensifying competition.

UK banking is a highly regulated industry which, at a point of increasing regulatory intervention, brings its own challenges, individually and cumulatively, such as the high cost of credit review, the ongoing evolution of capital regulation, and increased competition brought about by UK ringfencing.

TSB remains one of the most strongly capitalised banks in the UK, with a common equity Tier 1 capital (CET1) ratio of 20.6% at 31 December 2019 and holds a healthy liquidity reserve. It is well positioned to weather economic uncertainty or shocks and also to deploy its financial reserves in further growth. TSB's strategic plan is self-financed, requiring no additional capital from Sabadell. However, expected organic lending growth and the adoption of the regulatory change to a 90 day definition of default on the mortgage portfolio, required for all UK banks by the end of 2020, is expected to result in a reduction in the CET1 ratio to circa 16% in 2020.

Conclusion

This has been a turnaround year for TSB, and I want to acknowledge our TSB colleagues, a real strength for our brand, and thank them for their continued dedication and service to our customers.

I am confident that the partnership between our new Executive team and our people, combined with the focus of our new strategy will unlock the real value in TSB. I am proud of what we achieved in 2019 and look forward to the future with real confidence and excitement.

Debbie Crosbie Chief Executive 30 January 2020

How we seek to create value – our business model

Our purpose – Money confidence. For everyone. Every day

TSB is a UK bank with a multi-channel, national distribution model, including branch coverage across Great Britain and a full digital (internet and mobile) and telephony capability. TSB offers a range of retail banking services and products to individuals and small business banking customers throughout Great Britain.

As explained in the Chief Executive's statement, there is an opportunity for TSB to serve Britain better by supporting the 'Aspiring Middle' customer groups. They want a bank that removes the hassle from banking and provides access to people who can give them confidence in, and remove the stress and worry from, managing their money. By leveraging the new IT platform, and using digital-led propositions, TSB has opportunities to serve these customers better.

It is the importance of this opportunity and how we serve our customers every day that will make the difference at TSB. At TSB we call this purpose 'Money confidence. For everyone. Every day.'

Section 172 statement

In overseeing delivery of TSB's revised purpose and strategy, TSB's directors have always been mindful of their duties under the Companies Act 2006, including as set out in section 172. The Board recognises that TSB's long-term success is only possible through engagement with, and having regard to, the interests of key stakeholders, which for TSB includes employees, customers, wider communities and regulators. The Board's governance framework is critical in ensuring that stakeholder considerations are properly and fairly considered in decision making. As outlined on page 26, the effectiveness of the Board was reviewed by the Senior Independent Director whose subsequent report identified areas for further development. In addition, during 2019, TSB enhanced its Board and committee paper writing methodology to bring into sharper focus the consideration of stakeholder interests. This approach has been embedded throughout the business, not only at Board level, but also at executive level.

More broadly, the Board monitors and challenges progress in the delivery of strategic initiatives through its review of balanced scorecard metrics which are structured around TSB's primary corporate objectives. These metrics, which form the basis of the KPIs reported on page 10, together with a wider dashboard of management information, are reviewed and discussed at the Executive Committee every month and at each Board meeting. In addition, the Remuneration Committee reviews a sub-set of metrics at least twice a year to support its decision making on variable remuneration outcomes. In this way variable remuneration outcomes are directly linked to metrics that support the delivery of TSB's strategic objectives.

The proactive oversight and challenge provided by the Board was central in the development of TSB's revised purpose and strategy, which was led by the Chief Executive, and included taking into account the interests of each of TSB's stakeholder groups as further discussed below.

TSB's shareholder, Sabadell

Given Sabadell's 100% ownership interest in TSB, it is natural that the promotion of the long term success of TSB, including through the development of a clear purpose and strategy, is aligned with the interests of Sabadell. Sabadell's interests are represented at Board by two shareholder appointed Non-executive Directors. Any circumstances where shareholder and TSB interests are not aligned are managed through the disclosure and management of any such potential conflict. Sabadell's interests are further represented through the UK Steering & Coordination Committee as outlined on page 22. TSB's Chief Executive, Chief Financial Officer and Chief Risk Officer presented the revised strategy and financial forecasts to the Sabadell Board prior to final review and approval by the TSB Board.

Customers and wider community

As noted in the Chief Executive's statement, the starting point in the development of strategy was the customer. Customer, and non customer interests were reflected by undertaking over 6,000 interviews and holding 120 focus groups across Great Britain. The Board received regular updates on the findings of this outreach and it was noted in particular that many customers are not confident in managing their money. The exercise concluded that people do not, naturally, turn to banks for help, but that TSB is seen as a credible, helpful and friendly bank, which creates opportunities for us. More specifically, within the development of strategy, the decision to close certain TSB branches involved consideration of customer interests and the wider impact on communities.

The Board also took account of customer interests through regular reviews of key scorecard measures such as NPS and requested regular reports from Board Risk Committee to oversight and challenge the approach to managing customer harm and to ensure that the needs of vulnerable customers are properly and fairly taken into account.

How we seek to create value – our business model

Employees

The Board is proud of the commitment of our employees and the collaborative culture we have in TSB. During a challenging period, employees have continued to support each other and work together to deliver for our customers.

'The Link', a forum for employees across all levels and all parts of TSB with five regional groups covering Great Britain, gathers and builds on employee feedback and enables meaningful dialogue between employees, the Executive leadership and, from 2019, the Board on a wide range of topics. Throughout 2019, the role of the 'Link' supported the development of the revised strategy, gathering employee feedback on TSB's new purpose. The outputs from every Link meeting are presented to the Executive Committee to help inform TSB's decision making and the direction of our bank. In 2019, the Board established a process by which the Link present directly to the Board on a semi-annual basis with the first such presentation taking place in July 2019. This has facilitated more direct engagement between the Board and employees.

More broadly, the Board has established a framework that takes account of the interests of our employees, including:

• promoting the role of recognised trade unions in independently representing the interest of employees;
• the appointment of a Board level whistleblowing champion, as more comprehensively referred to on page 26 of the Corporate governance statement;
• providing challenge, through the auspices of the Remuneration Committee, to ensure that remuneration policy is appropriate for all employees, as well as executives, and provides for competitive remuneration strongly aligned to the delivery of TSB's strategic goals.

The Chief Executive notes in her statement that TSB's success will be driven by a strong, skilled, motivated and inclusive culture. As explained in the Nomination Committee report on page 29, the Board plays an active role in promoting and challenging progress in establishing a truly diverse and inclusive culture at TSB and carries out regular succession planning reviews to ensure continuity of skilled employees.

Suppliers

Operational excellence is one of the pillars of TSB's new strategic plan and, as part of this, TSB will work more closely with certain key suppliers, taking direct control of some relationships currently managed by Sabis, the current supplier of TSB's outsourced IT services. TSB believes that establishing a closer relationship with suppliers (including a clear accountability framework) will improve business resilience and reduce risk. The Board regularly reviews progress of this programme of work and, following an update to procurement policy, approves outsourcing strategy annually, together with any changes to the boundaries of outsourced critical services.

Regulators

Open and honest engagement with regulators is a cornerstone principle of the UK regulatory environment. The Chief Risk Officer reports regularly to the Board and Board Risk Committee on material matters of regulatory liaison and TSB's assessment of the quality of the relationship with each regulator. Certain Board members maintain a direct relationship with the FCA and PRA through the framework of 'proactive engagement and continuous assessment' meetings and report on key themes discussed through Board and committee meetings as appropriate. As part of Board discussion of the new strategy and purpose, the Chief Executive reported on the related engagement that had taken place with regulators.

Other non-financial disclosures

TSB does not currently have a formal environmental policy, although we plan to launch a corporate responsibility programme later this year covering environmental impact amongst other issues. We are committed to reducing our environmental impact and using resources in a more responsible way as outlined in the Directors' report on page 37.

TSB has a moral, legal and regulatory duty to prevent, detect and deter financial crime and maintains a financial crime framework. This framework is supported and reinforced by TSB behaviours which puts the customer at the heart of every interaction. TSB promotes an environment which is hostile to illicit activity to protect its customers, employees, and communities from financial crime. TSB's compliance with requirements of the financial crime framework is monitored via ongoing control testing; assurance; audit and the provision of management information at senior governance committees.

TSB's Modern Slavery Statement (which is available on our website) sets out the policies we apply and actions we take to ensure that our employees and customers are treated with dignity and respect. This includes raising awareness of issues that could put our customers at risk such as vulnerability and exploitation. The statement also explains how we ensure that TSB's values are applied within our supply chain including the due diligence we carry out on our suppliers.

How we seek to create value – our business model

Our business model is simple

TSB's business model reflects a straightforward and simple retail business and is outlined below:

Component	Description	2019 performance	Financial statements	Key performance indicator
Customer confidence	We seek to deliver a banking experience that is the primary reason for customers to choose and remain with TSB, and which will increasingly set TSB apart from other banks and providers of financial services. Central to this is the development of our purpose 'Money confidence. For everyone. Every day.' through which we will invest in digital capabilities and customer led service strategies. Our brand is based on transparent and straightforward behaviours which underpinned TSB when it was established more than 200 years ago for the purpose of helping local people, and the communities they lived in, to thrive together.	n/a	n/a	Customer advocacy (Net Promoter Score) 2019 2018 10 (9) Total digital active customers (%) 2019 2018 63.4% 61.3%
Sources of funding and capital	Money deposited by customers into their bank and savings accounts provides the majority of the funds we use to support lending to customers. We also raise funds from other sources, including wholesale funding markets, that diversify our funding profile and our shareholder who also provides funding in the form of equity capital in the business.	Page 12	Page 51	Share of personal bank account gross flow (%) 2019 2018 3.9% 3.6% Share of PCA stock (%) 2019 2018 4.4% 4.5%
Loans and liquid assets	Funds deposited with TSB are used to support lending to customers who wish to borrow. A portion of funds are held in reserve, in the form of a liquidity portfolio, to meet any unexpected funding requirements.	Page 14	Page 55	Mortgages gross lending (£m) 2019 2018 5,838.1 4,803.5
Income	We earn income in the form of interest that we receive on the loans we make to customers and we pay interest to savings and bank account customers on the money they deposit with us. We also earn other income in the form of fees and charges for the provision of other banking services and commissions from the sale of certain products such as general insurance.	Page 15	Page 65	Net interest margin (%) 2019 2018 2.75% 2.87%
Charges	Charges we incur include the costs of paying our TSB employees, running our branches, investing in our business and paying for advertising and marketing. Occasionally, our customers are unable to repay the money they borrow from us; this is also a cost to the bank in the form of an impairment charge. Finally, TSB complies with its tax obligations to Her Majesty's Revenue and Customs (HMRC).	Page 16	Page 67	Cost:income ratio (management basis) (%) 2019 2018 85.7% 92.9% Asset quality ratio (£m) 2019 2018 0.20% 0.24%

Risk management (2019 performance on page 17; financial statements on page 72)

Effective risk management underpins TSB's business model. The Board sets an appetite for risk and monitors the risks arising from delivery of TSB's strategy through its business model to ensure the bank remains liquid, solvent, operationally stable, trusted and compliant. The Board in turn determines whether to return any profits made by the bank to the shareholder by way of dividend or to reinvest the profit to support the future growth of the bank.

Financial performance in 2019

TSB's performance is presented on a statutory basis and structured in a manner consistent with the key elements of the business model as explained on page 10.

Profitability (statutory basis)

		2019	2018)
	Analysis	£ million	£ million
Net interest income	Page 15	841.1	884.8
Other income	Page 15	146.7	406.1
Total income	Page 15	987.8	1,290.9
Operating expenses	Page 16	(881.3)	(1,323.0)
Impairment	Page 16	(60.5)	(73.3)
Statutory profit/(loss) before tax		46.0	(105.4)

TSB's statutory profit before tax for 2019 was £46.0 million, including a £39.6 million increase in the expected recovery under warranties in the respective contracts for migration and IT services (taking the total expected recovery to £192.6 million (2018: £153.0 million) reflecting the maximum recovery amount under the contracts).

This compared to a loss before tax of £105.4 million in 2018 which had been significantly affected by the costs to deliver TSB's IT migration and the costs of the subsequent post migration service disruption, partially offset by the recognition of a contribution from Lloyds Banking Group (reported within other income in 2018) and the, then, estimated recovery of £153.0 million of post migration charges under the respective migration and outsourced services agreements.

Profitability (management basis)

On a more comparable basis, excluding these items, profit before tax generated by the underlying business was £76.8 million, a reduction of £96.5 million from £173.3 million generated in 2018.

	2019 £ million	2018 £ million
Management basis profit before tax (excluding additional post migration charges)	76.8	173.3
Post migration charges	(35.6)	(330.2)
Recovery of post migration charges	39.6	153.0
Management profit/(loss) before tax	80.8	(3.9)
Migration related income from LBG	–	318.3
Costs of preparing for TSB's migration	–	(417.3)
Banking volatility	8.9	(8.7)
One-off items (1)	(43.7)	6.2
Statutory profit/(loss) before tax	46.0	(105.4)
Taxation	(19.7)	42.4
Statutory profit/(loss) for the year	26.3	(63.0)

(1) Other one off items reflect items reported in other income (on page 15) and operating expenses (page 16).

The reduction in management basis profit before tax (excluding additional post migration charges) was primarily due to:

• An increase in operating expenses of £77.0 million to £847.6 million. This reflected an increase in staff costs (primarily reflecting variable remuneration accrual releases in 2018), investments to develop the business, and increased costs from a number of essential regulatory focused initiatives; and
• A reduction of £32.4 million in total income that reflected lower net interest income due to competitive pressure on mortgage margins, lower levels of higher margin unsecured lending, and the ongoing and expected run off of the Whistletree loan portfolio, offset by an increase in other operating income due to changes to TSB's card servicing arrangements.

Partially offsetting these items, impairment losses decreased by £12.8 million, reflecting the continued benign economic environment, with higher absolute higher house prices and continued low unemployment rates.

Further information on the drivers of TSB's Income Statement performance is set out on pages 15 to 16.

Details of the basis of preparation of TSB's financial statements is set out on page 45. This includes a description of changes to accounting policies in respect of accounting for leases, to reflect the adoption of IFRS 16 'Leases' and, in respect of hedge accounting, to reflect the early adoption of 'Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39 and IFRS 7' (the Amendment). The adoption of IFRS 16 did not have a material impact on the financial statements. The adoption of the Amendment has enabled TSB to retain effective hedge accounting relationships in respect of interest rate swaps and issued debt securities that currently reference LIBOR and have a maturity beyond the end of 2021, when benchmark inter-bank offered rates are expected to be phased out. An assessment of changes required to these instruments is currently underway to address the forthcoming replacement of LIBOR.

Sources of funding and capital

Money deposited by customers into their bank and savings accounts provides the majority of the funds we use to support lending to customers. We also raise funds from other sources, including wholesale funding markets and equity invested by the shareholder.

	Further information	2019 £ million	2018 £ million	Change %
Customer deposits	Note 1 on page 51	30,182.4	29,094.3	3.7
Non-customer funding:
Borrowings from the Bank of England		4,483.5	6,482.2	(30.8)
Debt securities in issue	Note 2 on page 51	1,676.3	1,122.6	49.3
Subordinated liabilities	Note 3 on page 53	395.9	398.2	(0.6)
Repurchase agreements	Note 4 on page 53	-	1,084.8	(100.0)
Total non-customer funding		6,555.7	9,087.8	(27.9)
Funding resources		36,738.1	38,182.1	(3.8)
Shareholder's equity	Note 24 on page 84	1,886.0	1,864.0	1.2
Total sources of funding		38,624.1	40,046.1	(3.6)

Sources of funding

Customer Deposits

Customer deposits increased by £1.1 billion to £30.2 billion with growth in both retail and business banking deposit balances.

Aggregate retail customer deposits grew by £0.8 billion to £28.7 billion with continued growth in both savings and current account balances. A successful ISA season helped retail savings balances to grow by 2.0% (£0.4 billion) to £17.9 billion, while retail current account balances also contributed to growth with a 4.6% (£0.5 billion) increase to £10.9 billion.

Business banking deposit balances grew by 20.7% (£0.2 billion) to £1.4 billion driven by the RBS Incentivised Switching Scheme campaign and a competitive savings proposition.

Non-customer funding

Non-customer funding decreased by £2.5 billion to £6.6 billion due, largely, to a cumulative repayment of £2.0 billion of borrowings under the Bank of England's Term Funding Scheme. The remaining £0.5 billion reduction was due to the absence of repurchase agreement balances at the end of December 2019, partially offset by a net increase in secured debt securities in issue following the issuance of £750 million of covered bonds in 2019.

Capital resources

TSB's capital position has remained above risk appetite threshold with a Common Equity Tier 1 (CET1) capital ratio of 20.6% (2018: 19.5%) and a leverage ratio of 4.6% (2018: 4.4%) on a CRD IV fully loaded basis. The CET1 capital ratio increased by 1.1% primarily due to lower RWA.

	At 31 Dec	At 31 Dec
	2019	2018
	£ million	£ million
Shareholder's equity per balance sheet	1,886.0	1,864.0
Deferred tax assets arising from carry forward losses	(46.0)	(37.8)
Cash flow reserve regulatory adjustment	4.4	0.7
Prudent valuation prudential filter adjustment	(0.7)	(3.0)
Intangible assets	(20.3)	(18.4)
Common Equity Tier 1/Total Tier 1 capital (fully loaded)	1,823.4	1,805.5
Tier 2 capital (fully loaded)	393.5	390.6
Total capital resources (fully loaded)	2,216.9	2,196.1
Risk-weighted assets (RWA)	8,853.2	9,271.0
Common Equity Tier 1/Total Tier 1 capital ratio (fully loaded)	20.6%	19.5%
Total Capital ratio (fully loaded)	25.0%	23.7%

Sources of funding and capital (continued)

The movements in CET1/ Total Tier 1, Tier 2 and Total Capital in the year are shown below:

	CET1/		Total
	Total Tier 1	Tier 2	resources
	£ million	£ million	£ million
At 31 December 2018	1,805.5	390.6	2,196.1
Profit attributable to ordinary shareholder	26.3	–	26.3
Change in excess of provision over expected loss	–	2.6	2.6
Movement in other comprehensive income	(4.3)	–	(4.3)
Change in intangible assets	(1.9)	–	(1.9)
Movement in Tier 2 subordinated liabilities	–	0.3	0.3
Movement in Deferred tax assets on carried forward tax losses	(8.2)	–	(8.2)
Cash flow hedging reserve regulatory adjustment movement	3.7	–	3.7
Prudent valuation prudential filter adjustment change	2.3	–	2.3
At 31 December 2019	1,823.4	393.5	2,216.9

Risk-weighted assets (CRD IV)

RWAs at 31 December 2019 decreased by £417.8 million (4.5%) compared to December 2018, primarily reflecting the reduction in unsecured and business banking loan balances.

At 31 Dec	At 31 Dec
2019	2018
£ million	£ million
Risk type analysis of risk-weighted assets:
Standardised approach 1,487.8	1,574.0
Internal Ratings Based (IRB) approach 5,833.3	6,099.5
Total credit risk 7,321.1	7,673.5
Operational risk 1,484.4	1,487.6
Counterparty risk 47.7	109.9
Total risk-weighted assets 8,853.2	9,271.0

Leverage ratio

The leverage ratio measure is defined as the ratio of Tier 1 capital to total exposure. This measure is intended to complement the risk based capital requirements with a simple, non-risk based 'backstop' measure. TSB calculates its leverage ratio based on the exposure measure in the revised Basel III leverage ratio framework published in January 2014 and adopted in the Capital Requirements Regulation (CRR) and the CRR definition of Tier 1.

	At 31 Dec	At 31 Dec
	2019 £ million	2018 £ million
Total Tier 1 Capital for leverage ratio (fully loaded)	1,823.4	1,805.5
Exposures for leverage ratio
Total statutory balance sheet assets	39,520.9	41,124.3
Less accounting value for derivatives	(205.4)	(195.0)
Less reverse repurchase agreements	(201.1)	–
Exposure value for derivatives and securities financing transactions	90.8	(93.9)
Off-balance sheet	771.1	688.9
Regulatory adjustments to Tier 1	(62.6)	(58.5)
Other regulatory adjustments	(23.0)	(19.9)
Total exposures	39,890.7	41,445.9
Leverage ratio	4.6%	4.4%

The leverage ratio of 4.6% exceeds the Basel Committee's proposed minimum of 3%.

Following application of IFRS 9, TSB and other UK banks are supervised by the PRA under IFRS9 transitional rules which follow EBA guidelines. Based on these guidelines TSB's CET1 ratio is 20.8% (2018: 19.7%), total capital ratio is 25.1% (2018: 23.8%) and leverage ratio is 4.6% (2018: 4.4%). The effect of the transitional adjustment to own funds, capital requirement and leverage will be disclosed within 'Key Metrics' and 'IFRS 9 Comparison' tables in TSB's Pillar III Significant Subsidiary Disclosures.

Loans and liquid assets

Funds deposited with TSB are used to support lending to customers who wish to borrow. A portion of funds are held in reserve, in the form of a liquidity portfolio, to meet any unexpected funding requirements.

	2019	2018	Change
	£ million	£ million	%
Secured (retail) (1)	29,192.6	27,923.8	4.5
Unsecured and business banking (2)	1,883.2	2,084.7	(9.7)
Total loans and advances to customers	31,075.8	30,008.5	3.6
Balances at central banks (3)	4,427.3	6,954.9	(36.3)
Debt securities (4)	2,136.0	2,484.0	(14.0)
Reverse repurchase agreements	201.1	–
Total liquid asset portfolio	6,764.4	9,438.9	(28.3)

(1) Includes Whistletree secured loans of £1,392.2 million (2018: £1,668.3 million).

(2) Comprises unsecured lending of £1,754.2 million (2018: £1,938.6 million) and business banking lending of £129.0 million (2018: £146.1 million).

(3) Combined with cash balances and demand deposits of £167.9 million (2018: £181.1 million) when shown on TSB's consolidated balance sheet.

Loans and advances to customers

Loans to customers increased by £1.1 billion to £31.1 billion, a 3.6% increase. Mortgages returned to growth in 2019, partially offset by reductions in unsecured and business banking balances. The growth in mortgage balances was mainly due to higher origination activity driven by competitive pricing and improved customer retention as customer appetite to remortgage away reduced, offset by the expected reduction in the closed Whistletree portfolio. New mortgage lending increased to £5.8 billion (2018: £4.8 billion). Unsecured and business banking balances reduced by 9.7% as functionality to support online sales of new unsecured personal loan and credit card lending was re-established in May and November 2019, respectively.

Liquid asset portfolio

TSB's liquidity portfolio comprises highly liquid assets, primarily cash reserves at the Bank of England, UK gilts, supranational, development bank and covered bonds, which are available and accessible to meet potential cash outflows. The decrease in the liquidity portfolio largely reflects the partial repayment during 2019 of borrowings under the Bank of England's Term Funding Scheme.

A key regulatory measure of liquidity adequacy is the Liquidity Coverage Ratio (LCR). This is designed to promote the short-term resilience of TSB's liquidity risk profile and is regularly monitored and forecast alongside other cash flow and liquidity ratios. At 31 December 2019, the LCR was 230.9% (2018: 298.1%) against a PRA regulatory requirement of 100%, with the reduction in 2019 reflecting the partial repayment of borrowings under the Term Funding Scheme.

Encumbered assets

At 31 December 2019, £2,946.1 million (2018: £3,156.8 million) of assets were encumbered with counterparties other than central banks primarily as collateral to support the issuance of debt securities (note 2 on page 51). A further £18,028.3 million of assets were positioned at central banks as collateral in support of drawings under the Bank of England's Term Funding Scheme and for normal liquidity management purposes, including held as cash.

		Assets positioned at		Assets not positioned at central banks
	Assets encumbered with	central banks	Readily	Capable of	Unencumbered
	counterparties other than	(pre-positioned	available for	being	cannot	Total
	central banks	plus encumbered)	encumbrance	encumbered	be used	assets
	£ million	£ million	£ million	£ million	£ million	£million
Cash balances and other demand deposits	-	4,427.3	-	-	167.9	4,595.2
Financial assets at fair value through other comp. income	131.7(3)	-	1,455.7	-	-	1,587.4
Financial assets at amortised cost:
Debt securities	-	-	548.6	-	-	548.6
Loans to central banks	-	96.1	-	-	-	96.1
Loans to credit institutions	373.2(1)	-	-	-	-	373.2
Loans and advances to customers	2,178.6(2)	13,504.9	477.6	14,914.7	-	31,075.8
Other advances	262.6(3)	-	-	-	17.0	279.6
Remainder of assets	-	-	-	-	965.0	965.0
Total – December 2019	2,946.1	18,028.3	2,481.9	14,914.7	1,147.6	39,520.9
Total – December 2018	3,156.8	21,277.8	4,035.7	11,775.2	878.8	41,124.3

(1) Cash held on deposit by the securitisation and covered bond entities.

(2) Mortgage loans encumbered in support of external securitisation notes and covered bond issuance.

(3) Collateral placed with counterparties in respect of TSB's derivative financial liabilities.

⁽⁴⁾ Comprises £1,587.4 million (2018: £2,387.8 million) at fair value through other comprehensive income and £548.6 million (2018: £96.2 million) at amortised cost.

Income

We earn income in the form of interest that we receive on the loans we make to customers, and we pay interest to savings and bank account customers on money that they deposit with us. We also earn other income in the form of fees and charges for the provision of banking services and commissions from the sale of certain products such as general insurance. In 2018, TSB recognised non-recurring income from LBG following the exit from outsourcing arrangements.

Net interest income

	2019	2018	Change
	£ million	£ million	%
Management basis (excluding additional post migration charges)	841.1	910.4	(7.6)
Waiver of interest following post migration service disruption	–	(25.6)	(100.0)
Net interest income (statutory basis)	841.1	884.8	(4.9)
Net interest margin (statutory basis)	2.75%	2.87%	(12)bps

Net interest income decreased by 4.9% to £841.1 million. This was primarily due to competitive pressure on mortgage margins and lower levels of higher margin unsecured lending.

Interest rates earned on loans

In 2019, the average rate earned on TSB's loans reduced to 3.03% (2018: 3.12%) reflecting increased competition and the higher mix of lower rate mortgages relative to the higher rated unsecured balances. The average rate earned on mortgages reduced to 2.53% (2018: 2.60%). Lower rates were earned on the fixed rate portion of the portfolio, reflecting increased competition in the market. Yields on unsecured lending increased to 10.3% (2018: 9.4%) primarily due to the absence in 2019 of waived interest which arose from the post migration service disruption in 2018.

Cost of funding resources

The cost of customer deposits remained stable at 0.41% in 2019 (2018: 0.40%). Savings deposit interest costs of 0.48% remained broadly stable year-on-year (2018: 0.47%). Bank account interest costs also remained broadly stable year-onyear at 0.31% (2018: 0.32%).

Other income

	2019 £ million	2018 £ million	Change %
Management basis other income (excluding additional post migration costs)	143.8	106.9	34.5
Waiver of fees following post migration service disruption	–	(7.9)	(100.0)
Management basis other income	143.8	99.0	45.3
Migration related income from LBG	–	318.3	(100.0)
Banking volatility	6.4	(8.7)	173.6
One off items	(3.5)	(2.5)	40.0
Statutory other income	146.7	406.1	(63.9)

Other income decreased by 63.9% to £146.7 million driven by the recognition in 2018 of £318.3 million of income from LBG as a result of exiting the Transitional Services Agreement on migration to the new IT platform.

Excluding this income and banking volatility and one off items, other income increased by 34.5% to £143.8 million. This was primarily due to the recognition of fees in respect of changes to TSB's card servicing arrangements and the cessation in 2019 of payments to customers for making contactless and direct debit payments from their personal current accounts.

Charges

Running a bank with 5 million customers comes with overheads. Charges we incur include the costs of paying our TSB employees, running our branches, investing in our business and paying for advertising and marketing. Occasionally, our customers are unable to repay the money they borrow from us; this is also a cost to the bank in the form of our impairment charge. Finally, TSB complies with its tax obligations to Her Majesty's Revenue and Customs (HMRC).

Operating expenses

	2019 £ million	2018 £ million	Change %
Management basis operating expenses (excl. additional post migration charges)	847.6	770.6	10.0
Post migration charges	35.6	296.7	(88.0)
Recovery of post migration charges	(39.6)	(153.0)	(74.1)
Management basis operating expenses	843.6	914.3	(7.7)
Costs of preparing for TSB's migration	–	417.3	(100.0)
Banking volatility	(2.5)	–
One off items	40.2	(8.6)	567.4
Statutory basis operating expenses	881.3	1,323.0	(33.4)

Statutory basis operating expenses decreased by 33.4% primarily reflecting the non-recurrence of £417.3 million of costs in preparing for the migration in 2018. The decrease was also due to a £147.7 million reduction in the net effect of charges associated with the post migration service disruption and the accrued estimated recovery from Sabis under the migration and IT services agreements. These reductions were partially offset by higher one off items, which in 2019 reflected the costs of restructuring the Bank, including £21.9 million in respect of costs of the branch closures announced in November 2019 and £16.6 million relating to the reorganisation of head office functions.

Excluding these factors, costs increased by £77.0 million (10.0%) to £847.6 million as opportunities were taken to increase investment in the business in 2019 following a period in which TSB focused almost exclusively on completing IT migration activity. The increase in costs also reflected higher employee related costs (largely reflecting, in 2018, lower variable reward costs combined with the reversal of earlier year accruals for previously awarded but unvested SPA awards), and higher IT servicing and license costs.

	2019	2018	Change
	£ million	£ million	%
TSB employee related costs	368.1	332.5	10.7
IT servicing and license costs	193.4	180.2	7.3
Property costs	94.7	94.5	0.2
Operational contracts	52.7	50.2	5.0
Marketing costs	39.9	48.9	(18.4)
Regulatory and professional costs	21.4	29.5	(27.5)
Investment costs	37.6	9.8	283.7
Other	39.8	25.0	59.2
Operating expenses (excluding additional post migration charges)	847.6	770.6	10.0

Impairment charge

	2019	2018	Change
	£ million	£ million	%
Secured (retail)	(1.2)	3.1	(138.7)
Unsecured and business banking (1)	61.7	70.2	(12.1)
Total impairment charge	60.5	73.3	(17.5)
Asset quality ratio	0.20%	0.24%	(4)bps

(1) Impairment charge on unsecured lending of £60.2 million (2018: £70.3 million) and on business banking lending of £1.5 million (2018: £(0.1) million).

The impairment charge decreased by 17.5% to £60.5 million reflecting an improvement in UK unemployment and higher absolute house prices relative to 2018. In light of the uncertain economic environment, the number of economic scenarios used for assessing expected credit losses was increased to five, as further explained on page 62.

Taxation

The tax charge of £19.7 million (2018: tax credit of £42.4 million) reflects an effective tax credit rate of 42.8% (2018:42.8%) which is higher than the applied UK corporation tax rate in 2019 of 27%. This is primarily due to the net tax effect of non deductible expenses. A reconciliation of the tax charge to that which would have resulted from using the UK corporation tax rate is set out in note 18 to the consolidated financial statements.

Risk management in TSB

Approach to risk

TSB seeks to remain liquid, solvent, operationally stable, trusted, and compliant at all times. The objective of TSB risk management is to ensure these outcomes are maintained. The processes to identify, measure and control the risks inherent in its business model are fully embedded in TSB's risk management framework. Risks faced by TSB in delivering its business strategy are managed to protect the interests of customers, employees, and our shareholder. TSB's approach to managing these risks is described by an overarching Risk Management Framework described on pages 17 to 20. TSB's principal risks and uncertainties are described on pages 19 to 20.

Risk management framework

The risk management framework (RMF) creates coherent standards and practices for all risk management activities and processes in TSB. The framework is designed around a simple model for categorising risk, so that all the components of our risk management such as risk appetite, governance, policies, reporting and assurance and organisational design are aligned to the same hierarchy of risks. TSB has reviewed its risk management framework in 2019, and updated the risks at the top of the hierarchy to include Financial Crime risk. The five principal risk categories are shown in the table below.

Financial risk	The risk of the firm having inadequate earnings, cash flow or capital to meet current or future requirements and expectations as they fall due.
Credit risk	The risk that a genuine or fraudulent borrower or counterparty fails to pay the interest or to repay the principal on a loan or other financial instrument as they fall due.
Operational risk	The risk of loss, damage or disruption arising from inadequate or failed processes, people and systems.
Conduct risk	The risk to the delivery of fair customer outcomes and market integrity.
Financial Crime risk	The risk that systems and controls are not adequate to manage financial crime within TSB's risk appetite and regulatory framework.

Accountability

Risk management is embedded at all levels of TSB through clear accountabilities across three independent lines of defence. This enables clear understanding and ensures separation between functions that own and manage risks faced by the business (first line), provides oversight and challenge (second line), and provides for independent audit and assurance (third line).

First line of defence	• Identifies and manages risks in line with prescribed TSB risk management standards. • Designs and implements control frameworks, preventative measures, processes and strategies to mitigate risks in line with risk appetite. • Reports on their business unit and risk category risk profile and the effectiveness of control frameworks. • Applies TSB risk management standards and embeds throughout the business through its policies, governance and control frameworks. • Operates day-to-day control activities, tests and monitors the effectiveness of controls and compliance with policies and standards including business performance reviews, quality checking, and scenario analysis.
Second line of defence	• Sits within TSB's Risk Division. • Maintains TSB's Risk Management Framework and sets enterprise wide standards for risk management activity. • Provides independent oversight and challenge to the first line in managing risks to these standards. • Monitors and oversees risk management activity in the first line and aggregates risk reporting to provide an enterprise wide view of TSB's risk profile and risk appetite to Board and Executive committees.
Third line of defence	• Provides independent and objective assessment of the risk management activities of the first and second lines. • Reports on the effectiveness of risk management activities to the Board and senior management.

Employees in TSB are individually accountable for identifying, assessing and managing risks within their area of responsibility. Risk management responsibilities are embedded through a risk focused culture, supported by efficient governance and achieved through a prudent risk appetite to support TSB's growth strategy.

Risk culture

TSB's risk culture encourages employees' accountability for risk management. TSB aims to have a strong conduct and customer focused culture that maintains regulatory standards. TSB is a responsible lender and aims not to lend more than its customers can afford. Employees in TSB are guided through training on how to meet customers' needs and treat them fairly. A suite of policies and risk appetite measures support employees in keeping within TSB's risk appetite. The importance of individual accountability for managing risk is reinforced by both TSB Board and the approach to performance management and remuneration for all employees.

Risk management in TSB (continued)

Risk appetite

TSB defines risk appetite as the amount and type of risk that it is willing to take in the pursuit of its objectives. The Board approves the risk appetite within each planning cycle and, through collaboration with Sabadell, ensures alignment to Sabadell risk appetite. Through a hierarchy of regular meetings and reporting, the Board monitors performance against appetite, seeking to ensure that senior management operates within appetite and, if necessary, has appropriate plans to address any appetite breaches.

TSB is not a specialist lender and does not seek to differentiate itself as a provider of niche products. At the highest level, TSB aligns its risk appetite to UK mainstream retail banking. Risk appetite is calibrated to ensure it remains within the range of mainstream retail banking peers on every significant measure of risk. TSB aligns its risk appetite to a statement of its attitude to each of its five risk categories. These, along with appetite measures and thresholds, are articulated in the Risk Appetite Statement. TSB has a clearly defined and proportionate risk appetite that supports its strategic objectives and seeks to provide confidence to its customers, regulators and shareholder

Risk governance

Clear risk ownership and reporting lines are established through TSB's risk committees, which are aligned to the five principal types of risk as described in the table below. Each committee is responsible for monitoring TSB's risk profile and challenging risk exposures across the relevant risk type in line with the risk appetite set by the Board.

This committee structure enables fast, efficient decision making, providing clear escalation and reporting of risk to senior management and the Board which is responsible for providing oversight of the effectiveness of the risk management framework.

Financial Risk (ALCO)

Chaired by the Chief Financial Officer, the committee is responsible for the strategic management of TSB's balance sheet, the profit and loss implications of balance sheet management actions and the risk management framework for market risk, liquidity risk, capital risk, earnings volatility and economic value.

Credit Risk Committee

Chaired by the Chief Risk Officer, the committee is responsible for the coordination and aggregation of all credit risk management activity, management of TSB's credit risk profile, including credit risk appetite metrics and credit strategies, and TSB's compliance with all relevant credit regulation and legislation.

Operational Risk Committee

Chaired by the Chief Operating Officer, the committee is responsible for the aggregation and coordination of operational risk management across the Bank, monitoring and challenging the operational risk profile, including key operational risks and controls, and for ensuring appropriate escalation and visibility of relevant breaches, losses and events.

Conduct Risk Committee

Chaired by the Customer Banking Director, the committee is responsible for ensuring the delivery of substantially fair customer outcomes, that TSB is compliant with all relevant conduct regulation and legislation, that there are no systemic conduct failings in any area, monitoring and challenging the conduct risk profile, including key conduct risks and controls, and for ensuring appropriate escalation and visibility of relevant breaches, losses and events.

Financial Crime Risk Committee

Chaired by the Chief Risk Officer, the committee is responsible for ensuring that the risk of criminal conduct relating to money or financial services or markets is appropriately managed across TSB. The committee monitors and challenges the financial crime risk profile including key financial crime risks and controls, ensuring appropriate upward escalation and visibility of relevant breaches, losses and events relating to the financial crime risk categories.

In addition the Model Governance Committee, chaired by the Chief Risk Officer, is responsible for the development, implementation and effectiveness of the model governance framework (embracing policies, methodologies, systems, processes, procedures and people). This includes articulating the extent and type of model risk to which TSB is exposed, acting as the Designated Committee as required by the Capital Requirements Regulation.

TSB Banking Group plc Annual Report and Accounts 2019 page 18

Risk management in TSB (continued)

Principal risks and uncertainties arising from TSB's business model

In 2018 TSB reported a heightened risk profile caused by the instability of its IT platform and Brexit. TSB's IT service has improved during 2019, providing an acceptable level of customer service and operational stability through most of the year.

Brexit is treated as a financial, credit and operational risk to the bank. TSB does not anticipate significant disruption as a result of the UK's negotiations over its withdrawal from the EU but continues to monitor developments and regularly assesses potential impacts against its readiness plans. Should any risks materialise, these would be managed through TSB's risk management framework to ensure operational continuity. In addition, the most extreme outcome, a 'cliff-edge Brexit', has been considered as a specific scenario in the assessment of expected credit loss.

Day-to-day risk management is aggregated to provide a view at an enterprise-level of the principal risks and uncertainties that have the potential to materially impact execution of TSB's strategy. These risks, which have been considered by the Board in 2019, are detailed below.

Description	Mitigation	Change in 2019	Risk Category
1. Threats to profit resilience
The risk to profit arising from; increased costs of running IT services, lower interest rates for longer, regulatory intervention in key TSB markets, delays in delivery of products or services and or slower business as usual cost reduction than planned.	TSB's new strategy is incorporated into its financial plan with an improved profit resilience risk profile. Emerging risks to the plan are monitored along with profit performance against risk appetite.	There has been no material change to TSB's profit resilience risk profile.	• Financial • Operational
2. Emergence of a systemic crisis
The risk that TSB is unable to identify and respond quickly to the emergence of a new financial crisis. This risk is heightened as TSB continues to prioritise deploying resource to its IT remediation plan.	TSB has adequate capital and liquidity reserves and operational stability is improving, with steady progress being made in returning data and controls to normal operation.	Remains a key risk as TSB begins its strategic transformation.	• Financial • Operational • Conduct
3. IT platform stability deterioration
The risk of control weaknesses causing the performance of the IT platform to deteriorate and fall outside of risk appetite.	The performance of the IT platform, and the service provided by third party IT suppliers, is monitored against risk appetite and management actions are in place to address control weaknesses	TSB's risk exposure is reducing as the performance of its IT platform stability improves.	• Financial • Operational
4. Business transformation execution
The inherent design and execution risks arising from TSB's significant change programmes. The number of programmes underway that will have a deep impact on the organisation, including implementing the new strategy and a cost review.	Management are taking care to engage the Board and all three lines of defence, seeking to ensure the successful execution of these changes.	A key risk associated with the delivery of TSB's strategic outcomes.	• Financial • Operational
5. Risk of significant customer data loss
Along with the risk of customer harm and regulatory fine, there is a heightened reputation risk for TSB from a significant loss of sensitive customer data such as a cyber attack.	TSB continues to improve its IT resilience and strengthen its control framework. The Chief Information Security Officer (CISO) monitors the cyber threat and works with other firms, enforcement agencies, and government/industry experts to make the best use of intelligence and technology to identify and prevent suspicious activity.	This risk will continue to reduce in line with a strengthening of TSB's information security controls.	• Financial • Operational • Conduct

Risk management in TSB (continued)

Principal risks and uncertainties arising from TSB's business model (continued)

	Description	Mitigation	Change in 2019	Category
6.	Inadequate management of customer harm
lifecycle.	The risk of TSB's conduct risk framework failing to keep pace with market standards, and the increasing societal and regulatory expectations for higher standards of diligent and proactive management of potential customer harm, for all stages of the customer	The ongoing development and enhancement of TSB's risk management framework, organisation design changes and maturing conduct risk management, contribute to the more effective proactive management of customer harm.	Whilst TSB has always considered customer impacts, the reporting of customer harm is a relatively new concept in the industry and best practice is evolving.	• Conduct
7.		Maintaining adequate skills and resources to deal with complexity and change
	The risk of TSB's failure to attract and retain skilled employees could impact TSB's ability to deliver its ambitious transformative programmes.	Recent executive appointments have underlined TSB's continuing ability to attract highly credible leaders. TSB's new strategy will provide a renewed purpose and direction for all employees.	With continued stabilisation of its IT systems, and communication of variable remuneration, this is likely to reduce retention risks.	• Operational

Emerging risks

The key emerging risks in TSB's operating environment are described below. TSB regularly considers the likelihood of the relevant risk materialising and the potential impact on its business strategy, customers, employees and shareholder. These risks are considered as part of the business planning cycle. The top risks emerging in 2019 are as follows:

Description	Mitigation	Category
1. Global economic and political instability
Losses arising from credit risk are sensitive to a deterioration in the UK economic environment and in particular to house prices, unemployment and interest rates.	TSB's business model and lending strategy have been designed to be resilient to a credit crisis. Political and economic developments are monitored, and potential impacts have been included in TSB's business planning and stress test scenarios. The sensitivity of TSB's profits and capital to alternative economic scenarios is explained in note 10 to the consolidated financial statements. TSB is appropriately prepared for the impact of the UK's planned withdrawal from the EU, with robust plans to remain liquid and solvent in all plausible scenarios, including a 'no deal'. The financial risks from a high interest rate, 'cliff-edge' Brexit scenario are considered in TSB's 2019 ICAAP scenarios and expected credit loss provisions.	•Financial •Credit •Operational
2. Climate change
The financial risks resulting from the process of adjustment towards a lower carbon economy and the potential for the impairment of asset values, impacts on employees, and interruptions to services.	TSB is taking action to undertake an assessment of its exposure to the financial risks from climate change together with identifying and implementing controls as appropriate. The risks related to climate change will be managed within the existing governance model, and as such will be embedded within the Banks risk management processes ensuring focus and appropriate Board visibility.	•Financial •Credit •Operational
3. Increased competition with failed differentiation
FinTech and other technological advances create alternatives to the traditional value chain and ways in which banks currently operate and service customers.	TSB's IT system is an enabler of its business model and leveraging it to improve digital services is a core part of TSB's new strategy. TSB has identified its core customer base and is developing new products, services and experiences that are aimed specifically at meeting those customers' needs.	•Financial •Operational
4. Regulatory Change
Due to the nature of the financial services industry, TSB faces a complex legal and regulatory environment. Inadequate or incomplete adoption of regulatory initiatives could lead to increased costs, loss of competitive edge or regulatory sanction.	TSB monitors forthcoming legal and regulatory changes and continues to invest in its people and IT systems with the aim that standards are met and maintained. All legal and regulatory changes faced by TSB are managed through its governance and oversight framework.	•Conduct •Operational

Strategic report on pages 2 to 20 approved, by order of the Board

Keith Hawkins Company Secretary, 30 January 2020

Corporate governance statement

22	How the business is managed
29	Nomination Committee report
30	Audit Committee report
35	Directors' report
40	Remuneration review 2019

TSB Banking Group plc Annual Report and Accounts 2019 page 21

How the business is managed

The design and operation of a robust corporate governance framework appropriate for a bank of TSB's scale and ambition is critical to meeting the needs of all our stakeholders. The Corporate Governance Framework encompasses TSB Banking Group plc (the Company), TSB Bank plc (the Bank) and any other subsidiaries of the Company from time to time (together TSB). Each Director of the Company also serves as a Director of the Bank. Richard Meddings is the Chairman of the Boards of both the Company and the Bank. The Board of the Company (the Board) as a whole is collectively responsible to the shareholder for promoting the long-term success of the Company by directing the Company's affairs. The Corporate Governance Framework is designed to assist the Board, the Board of the Bank and the Chief Executive in discharging their duties by ensuring an appropriate scheme of delegation. This is achieved through:

• Board authorities being delegated from the Boards of the Company and the Bank to Board committees and to the Chief Executive; and
• Delegated executive authorities through which the Chief Executive delegates aspects of her own authority to other senior executives and sets out the support provided to her by the executive committees.

The corporate governance structure is supported by the Internal Control and Governance Framework as outlined on pages 27 and 28. An important principle, applied throughout the Company's Corporate Governance Framework, is that the delegation of executive authority is to the individual office holders (who may in turn delegate aspects of their authority to others). Executive committees may be established to support the individuals in exercising their delegated authorities but the committees do not separately hold any delegated authority in their own right. This approach to individual accountability is aligned to the principles of the Senior Managers & Certification Regime.

Whilst the Bank operates as a ring-fenced UK bank, it is also part of a wider group, comprising Banco de Sabadell, S.A. (Sabadell) and its subsidiaries (together the Sabadell Group), and is required to adhere to relevant Sabadell Group policies, in addition to any relevant obligations imposed by Sabadell Group's regulators, the Bank of Spain and the European Central Bank.

To assist with this, Sabadell operates an information sharing and co-ordination committee, the UK Steering & Coordination Committee (UKSCC) which seeks to provide Sabadell with a regular overview of the performance of TSB and to ensure that TSB policies and processes are aligned to those of the Sabadell Group where it is appropriate to do so. Certain members of the Bank's Executive Committee are appointed as members of the UKSCC.

Although the Company does not have shares with a premium listing on the London Stock Exchange, and does not need to comply with the UK Corporate Governance Code (Code), the Board has committed to voluntarily adopt those principles of the Code that are considered appropriate for TSB as a wholly owned subsidiary of Sabadell. A copy of the Code is available at www.frc.org.uk. Consequently, the following aspects of the Code are not considered appropriate for TSB:

• All Directors should be subject to annual re-election by shareholders (Provision 18);
• Provisions relating to the proportion of Independent Non-executive Directors who are members of the Audit and Remuneration Committees (Provisions 24 and 32); and
• Provisions relating to dialogue with shareholders (Provisions 3 and 4).

In addition, the Remuneration Committee has not created a policy for post-employment shareholding requirements (Provision 36) and pension contribution rates for Executive Directors are not currently aligned with those available to the wider workforce (Provision 38).

These matters were discussed at a Remuneration Committee meeting held in October 2018 and have continued to be considered throughout 2019 as part of the Committee's regular review of market developments. Given that TSB Executive Directors are already subject to long deferral periods for Sabadell shares awarded as part of TSB variable remuneration, it was decided that no specific post-cessation shareholding requirement be introduced for TSB Executive Directors at the present time.

With regard to pension contributions, the Remuneration Committee notes that the rates for TSB Executive Directors are currently aligned to the market median. Both the post-employment shareholding requirements and pension contribution rates for Executive Directors will be kept under review by the Remuneration Committee.

Following the departure, by mutual agreement, of Paul Pester as TSB's Chief Executive on 3 September 2018, Richard Meddings served as TSB's Executive Chairman until 1 May 2019 when Debbie Crosbie joined as TSB's new Chief Executive. During the period whilst Richard Meddings was acting as the Executive Chairman, the Company was not in compliance with Provision 9 of the Code, which requires that the roles of chairman and chief executive not be performed by the same individual. Whilst TSB understands the requirement for a separation of the roles of chairman and chief executive, it was considered to be in the best interests of TSB and of all its stakeholders that Richard assumed the role of Executive Chairman whilst a successor to Paul was sought.

During the period whilst Richard was acting as the Executive Chairman, additional governance arrangements were established to support the Executive Chairman in his role and to ensure effective governance with checks and challenges. These revised arrangements included informal meetings of the Non-executive Directors ahead of each Board meeting without the Executive Chairman present and regular meetings between the Executive Chairman and the Senior Independent Director.

The Corporate Governance Framework is reviewed at least annually by the Board to confirm that governance arrangements remain effective. The Company is a wholly owned subsidiary of Sabadell. The diagram below sets out the framework of Board and executive committees.

The role and responsibilities of the Board

The Board's full responsibilities are set out in the matters reserved for the Board. The main items are summarised below.

(i) Strategy

• Approving TSB's strategy and long-term objectives and ensuring that rigorous and robust processes are in place to monitor organisational compliance with the agreed strategy, risk appetite and all applicable laws and regulations;
• Determining Board structure, size and composition, determining the roles and responsibilities of the Chairman, Senior Independent Director, Non-executive Directors, Chief Executive and Executive Directors;
• Approving the high-level framework of Board delegations;
• Approving material TSB contracts and material acquisition or disposal of assets or equity investments by the Company or any subsidiary of the Company; and
• Approving material changes to TSB corporate and organisational structure, including changes to the Company's listing status or its status as a plc.

(ii) Risk

• Reviewing the effectiveness of the Company's and Bank's risk management and internal control systems; and
• Approval of the Bank's Risk Appetite, ICAAP, ILAAP, Reverse Stress Test and Recovery Plan.

(iii) Shareholder communications

• Approving the annual report and accounts;
• Approving TSB's dividend policy; and
• Approving the resolutions and associated documentation for the shareholder at a general meeting.

In accordance with the Company's articles of association, Sabadell is empowered to determine that certain matters reserved to the TSB Boards also require approval by Sabadell.

TSB Banking Group plc Annual Report and Accounts 2019 page 23

Role of Directors

There is a clear division of responsibility between the Chairman and Chief Executive. This has been approved by the Board and is available to view at www.tsb.co.uk/investors/people/. As noted on page 22, these roles were combined on a temporary basis into the role of Executive Chairman between 3 September 2018 and 1 May 2019.

Other than matters expressly reserved to the Chief Executive, authority can be delegated to the respective Executive Committee members, jointly or severally. The headline authorities delegated to the Chief Executive were passed to Richard Meddings for the period whilst he was acting as the Executive Chairman. The risk of concentration of authority in the Executive Chairman was mitigated by reducing the materiality of certain matters that were required to be escalated to the Board.

The role of the Non-executive Directors includes the following key elements:

• Providing constructive challenge to management and helping to develop strategy;
• Scrutinising the performance of management in meeting agreed goals and objectives and monitoring the reporting of performance;
• Satisfying themselves on the integrity of financial information and that financial controls and risk management systems are robust and defensible; and
• Determining appropriate levels of remuneration for Executive Directors and other senior management and having a prime role in appointing and, where necessary, removing Executive Directors and in succession planning.

The Senior Independent Director's role is defined as follows:

• Acting as a sounding board for the Chairman and to serve as an intermediary for the other Directors when necessary;
• Being available to the shareholder if it has concerns which cannot otherwise be resolved;
• Chairing meetings in the absence of the Chairman; and
• Reviewing the Chairman's performance.

Board membership and composition

As at the date of this report the Board has eleven members and is comprised as follows:

Chairman:	Richard Meddings (independent on appointment)
Executive Directors:
Chief Executive	Debbie Crosbie
Chief Financial Officer	Ralph Coates
Independent Non-executive Directors:	Paulina Beato
	Dame Sandra Dawson (Senior Independent Director)
	Graeme Hardie
	Stephen Page
	Andy Simmonds
	Polly Williams
Non-executive Directors:	Tomás Varela
	David Vegara

Full biographical details including their skills and experience can be found at www.tsb.co.uk/investors/people/. A record of the Directors who have served during the year is shown in the Directors' Report on page 35. The letters of appointment for Non-executive Directors are available at the Company's registered office and at the Annual General Meeting.

Board Committees

Certain responsibilities of the TSB Boards are delegated to committees of the Board to assist the TSB Boards in carrying out their functions.

• The Risk Committee (chaired by Andy Simmonds) oversees the management of the risks TSB faces;
• The Audit Committee (chaired by Polly Williams) oversees financial reporting and internal control;
• The Nomination Committee (chaired by Richard Meddings) leads the process for appointments to the TSB Boards and succession planning for the TSB Boards and Executive Committee; and
• The Remuneration Committee (chaired by Dame Sandra Dawson) formulates TSB Remuneration Policy and supports the ongoing delivery of sustainable performance.

The Audit and Nomination Committees have each prepared reports which include a description of their role, structure and composition. Each of the Board Committees' terms of reference are available at www.tsb.co.uk/investors/people/.

In accordance with the Financial Conduct Authority's Handbook, specifically, SYSC 4.3A.8(1), Richard Meddings stepped down from the position of member and Chair of the Nomination Committee during the time that he was acting as Executive Chairman, with Dame Sandra Dawson assuming the Chair of this committee on a temporary basis. The Nomination Committee chair reverted to Richard Meddings when Debbie Crosbie took up her appointment as Chief Executive.

Meeting attendance

The table below sets out attendance of Directors at Board meetings and the attendance of Committee members at the relevant Committee meetings held during the year.

Name of Director(iv)	Board meetings attended	Audit Committee meetings attended	Risk Committee meetings attended	Nomination Committee meetings attended	Remuneration Committee meetings attended
Debbie Crosbie (i)	6 out of 6	–	–	–	–
Ralph Coates	8 out of 9	–	–	–	–
Paulina Beato	9 out of 9	–	6 out of 6	–	10 out of 10
Dame Sandra Dawson	9 out of 9	–	–	2 out of 2	10 out of 10
Graeme Hardie	9 out of 9	5 out of 5	6 out of 6	–	–
Richard Meddings (ii)	9 out of 9	–	–	2 out of 2	–
Stephen Page	9 out of 9	–	6 out of 6	–	–
Andy Simmonds	8 out of 9	4 out of 5	6 out of 6	–	–
Polly Williams	9 out of 9	5 out of 5	6 out of 6	2 out of 2	10 out of 10
Miquel Montes (iii)	8 out of 8	–	–	–	7 out of 8
Tomás Varela	8 out of 9	2 out of 5	6 out of 6	–	–

(i) Appointed to the Board on 1 May 2019.

(ii) Stepped down from the Nomination Committee between 14 November 2018 and 1 May 2019 (whilst in the role of Executive Chairman).

(iii) Resigned from the Board on 14 November 2019.

(iv) Directors not able to attend meetings due to longstanding prior commitments, illness or unavoidable circumstances, provided comments to the relevant Chair on matters to be discussed at the relevant meeting.

Board development

During the year, Debbie Crosbie completed a comprehensive induction programme following her appointment to the Board as an Executive Director. David Vegara, who was appointed to the Board on 22 January 2020, will complete his induction programme in the first quarter of 2020. David replaced Miquel Montes (who resigned from the Board on 14 November 2019) as a Director appointed at the nomination of Sabadell. Directors are given the opportunity to undertake further training in order that they are fully comfortable with their role within the Board and to enable them to contribute to the operation of the Board and the long-term success of the Company in the fullest manner possible.

Board 'education' sessions are also regularly held to allow Non-executive Directors to explore key strategic and risk issues outside of the time constraints of a formal Board meeting. A number of such sessions, run by internal and external subject matter experts, were held during 2019 and covered topics including IT transformation, Conflict Management in Ring-Fenced bodies, Model Risk, Financial Crime and Cyber Security.

Board effectiveness

The review of Board effectiveness for 2019 was run internally by way of confidential conversations held between Dame Sandra Dawson, in her role as Senior Independent Director, and each member of the Board, as well as with the Chief Risk Officer and Chief Audit Officer. The conversations were based around six core subjects, which had been chosen either because they had been identified in the 2018 Board effectiveness review or because, generically, they provided the basis for good governance. The output from the exercise was a report prepared by Dame Sandra Dawson which reflected a qualitative synthesis of the conversations and was discussed by the Board. The report naturally focused on areas in which the Board would like to see development in the coming year, and the Board agreed to conduct 'deep dives' on a number of topics during the course of 2020 aligned to its strategy. These included: i) marketing and the use of modern communications methods such as social media, ii) media, communications and crisis/reputation management, and iii) the future shape of retail financial service markets.

The Board's Audit, Risk and Remuneration Committees have also conducted reviews of their own effectiveness during 2019. The Audit and Remuneration Committees agreed a questionnaire which was circulated to committee members and other members of the executive team who regularly attend committee meetings. The Risk Committee adopted a different approach, with the Committee Chair undertaking individual discussions with members on the Committee's effectiveness. The results of the committee effectiveness assessments were analysed by the chairs of the relevant Board committees, in consultation with the Company Secretarial team, presented to the relevant Board committee and actions agreed for the coming year.

Independence

The Board has considered whether there are any relationships or circumstances which could appear to affect the Independent Non-executive Directors' judgement. No Independent Non-executive Director, or member of their immediate family, has ever had a material relationship with TSB nor receives additional remuneration apart from Director fees. The Independent Non-executive Directors do not participate in TSB's pension or share schemes. No Independent Nonexecutive Directors serve as Directors of any companies or affiliates in which any other Director is also a Director. Miquel Montes and Tomás Varela are members of Sabadell's Management Committee, and David Vegara is Sabadell's Chief Risk Officer and a member of the Sabadell Board, and for that reason are not considered to be independent. They do not receive any fees from TSB.

Management of conflicts of interest

Each Director has a duty under the Companies Act 2006 to avoid a situation in which they have, or may have, a direct or indirect interest that conflicts, or might conflict, with the interests of the Company. This duty is in addition to the existing duty that Directors owe to the Company to disclose to the Board any interest in a transaction or arrangement under consideration by the Company. If Directors become aware of any situation which may give rise to a conflict of interest they must inform the rest of the Board immediately and the Board is then permitted under the articles of association to authorise such conflict. This information is recorded in the Company's register of conflicts together with the date on which authorisation was given. In addition, Directors are asked to certify, on an annual basis, that the information contained in the register is correct.

Save as set out below in relation to Miquel Montes, Tomás Varela and David Vegara, there are no conflicts of interest between any duties owed by the Directors to the Company and their private interests or other duties.

As Executive officers/Directors of Sabadell, Miquel Montes, Tomás Varela and David Vegara had/will have a conflict of interest in circumstances where the interests of TSB and the wider Sabadell Group are not, or may not be, aligned. This conflict was authorised by the Board on 22 July 2015.

Whistleblowing arrangements

TSB has a robust whistleblowing process in place which is available to all employees. The Board oversees the adequacy of TSB's whistleblowing arrangements, ensuring that they are proportionate and enable employees and contractors to raise concerns, in confidence, about possible wrongdoing in financial reporting or other matters. During 2019, in her role as TSB's Whistleblowing Champion, Polly Williams (Chair of the Audit Committee) received regular reports from management which provided details of whistleblowing matters. The Board receives an annual report from management providing an overview of whistleblowing procedures and outcomes and challenges management on TSB's plans to ensure whistleblowing policies and processes are aligned with external best practice. As part of its annual review of whistleblowing matters, the Board was satisfied that there were no material concerns raised nor breaches of policy or failure in controls relating to TSB's whistleblowing processes in 2019.

Reappointment of Directors

The Board considers that all Directors continue to be effective, committed to their roles and have sufficient time available to perform their duties. All Non-executive Directors, with the exception of David Vegara and Tomás Varela (being the Directors appointed at the nomination of Sabadell), have been appointed for an initial three year term and their continued appointment thereafter is considered by the Board at the end of the initial period of office. During 2019, the tenure as Independent Non-executive Directors of Polly Williams, Dame Sandra Dawson and Graeme Hardie were extended, allowing the Board to continue to benefit from their broad experience and knowledge of TSB. As the Company is a wholly owned subsidiary of Sabadell it is not considered necessary for Directors to seek annual re-election or for the Directors appointed at the nomination of Sabadell to be appointed for a specified term. In accordance with Provision 15 of the Code, Directors are required to seek prior approval of the Board before taking up an additional external appointment. No significant additional appointments were taken up by Directors during the financial year.

Company Secretary and independent professional advice

Keith Hawkins has served as the Company Secretary on an interim basis throughout the year ended 31 December 2019. The Company Secretary is responsible to the Board for ensuring compliance with corporate governance requirements. The Board has access to the Company Secretary individually and collectively. As well as the support of the Company Secretary, any Director may take independent professional advice at the Company's expense in the furtherance of their duties, where considered necessary.

Evaluation of internal controls procedures

The Board has carried out an assessment of the effectiveness of the Company's risk management and internal control systems. The Audit Committee report explains the process in more detail on page 33.

External auditors

Following the conclusion of a tender process undertaken in 2019, the TSB Board accepted a recommendation from the Audit Committee to appoint KPMG for the audit of the financial statements for the year ending 31 December 2020. Resolutions proposing the appointment of KPMG for the 2020 audit, and to authorise the Directors to determine their remuneration, will be proposed at the 2020 Annual General Meeting, as recommended by the Audit Committee.

Principal accountant fees and services

An analysis of fees for professional services provided by PwC, the Company's external auditors for the year ended 31 December 2019, is set out in note 15 to TSB's consolidated financial statements.

Internal Control and Governance Framework

An explanation of TSB's Executive Committee and its sub-committees is set out below.

(i) Executive Committee

Chaired by the Chief Executive, TSB's Executive Committee is TSB's principal executive committee and collectively supports the Chief Executive in developing and implementing TSB's strategy, monitoring business performance and agreeing any actions that are required to manage issues that affect TSB. Consideration is given to the interests of all stakeholders.

All members of the Executive Committee report to the Chief Executive. In addition, the Chief Risk Officer has a reporting line to the Chair of the Risk Committee. To protect the independence of Internal Audit, the Chief Audit Officer's primary reporting line is to the Chair of the Audit Committee with a secondary reporting line to the Chief Executive. The Chief Audit Officer also has a reporting line to the Sabadell Group Chief Audit Officer.

(ii) Executive Risk Committees

The role of the Executive Risk Committee, which was established in 2019 and is chaired by the Chief Executive, is to ensure an enterprise wide perspective of TSB's risks and determining strategic actions to address them.

The six further committees in the executive layer of risk governance (Asset & Liability Committee, Credit Risk Committee, Operational Risk Committee, Conduct Risk Committee, Financial Crime Risk Committee and Model Governance Committee), which each report into the Executive Risk Committee (and indirectly to the Board Risk Committee), monitor and challenge risk exposures against approved risk appetite and are structured to align with the Risk Management Framework described on page 17. Each risk committee within the governance structure is responsible for ensuring the risk and control environment is established within its area of authority. This enables day-to-day decisions to be made, with clear reporting lines established through the Executive Risk Committee, Executive Committee and Board Risk Committee, and ultimately to the Board. Each of the six executive risk committees is chaired by an Executive Committee member. Further detail on the responsibilities of each of the executive risk committees is shown in the Risk governance section on page 18.

(iii) Other Executive Committee Sub-Committees

In addition to the six executive risk committees noted above, the following other executive committees report into the Executive Committee:

• The Product Pricing Committee which is responsible for reviewing and approving pricing strategy and any decisions in relation to the pricing of TSB's products;
• The Disclosure Committee which is responsible for identifying inside information and determining how and when TSB should disclose that information in accordance with its obligations to the Sabadell Group and holders of TSB's listed debt; and
• The Investment Committee which is responsible for approving business cases to allow change to proceed, approving funding to agreed milestones, and tracking performance and benefits realisation to ensure investment is an effective use of funds and delivers on strategic objectives.

By order of the Board

Keith Hawkins Company Secretary 30 January 2020

Nomination Committee report

Chairman's introduction

All the Nomination Committee members are Non-executive Directors. The Committee is authorised by the Board to keep the structure, size and composition of the TSB Boards under review and for making recommendations to the Board with regard to any changes required. It leads the process for appointments to the TSB Boards, Board committees and the chairmanship of those committees and also considers succession planning for the TSB Boards and Executive, taking into account the skills and expertise that will be needed in the future.

As at the date of this report, the members of the Nomination Committee are Richard Meddings (Chair), Dame Sandra Dawson and Polly Williams. Between 14 November 2018 and 1 May 2019, Richard Meddings stood down from the position of member and Chair of the Committee whilst he was acting as Executive Chairman and Dame Sandra Dawson assumed the Chair of the Committee. To maintain a membership of three, Polly Williams was added as a member of the Committee on 14 November 2018, joining Dame Sandra Dawson and Miquel Montes. This was originally intended to be an interim appointment, but she has remained a member of the Committee to broaden the range of experience on which the Committee can draw. Miquel Montes served as a member of the Committee until his resignation from the TSB Boards on 14 November 2019.

Appointment of directors and succession planning

The Committee met twice formally during the course of 2019 to discuss succession planning for the Board and its committees. The focus of the meeting held on 26 November 2019 was twofold: (i) to progress the appointment of a successor to Dame Sandra Dawson as the Chair of TSB's Remuneration Committee, and (ii) to consider medium term changes required to the membership of the TSB Boards and Board committees. Following an extensive search by Odgers Berndston (who have no other connection with TSB), which covered a broad range of candidates, the Committee considered and recommended to the Board an appointee as an Independent Non-executive Director and TSB's incoming Remuneration Committee Chair. The Board subsequently approved this appointment, subject to regulatory approval.

Regarding wider Board and committee succession planning, the Committee held an initial discussion on various matters, including i) the term of office of Independent Non-executive Directors currently due to expire in 2020, ii) the evolution of committee roles, including the proposed committee membership of David Vegara (who had been appointed by Sabadell as a Non-executive Director, subject to completion of his regulatory approval application, to replace Miquel Montes), and iii) areas where the Board might look to enhance its skills and experience in the future.

The meeting held on 17 December 2019 considered and recommended to the Board Dame Sandra's proposed successor as Senior Independent Director. The Board subsequently approved this appointment, subject to regulatory approval.

The Committee also passed, during the course of 2019, written resolutions to extend the term of office as Independent Non-executive Directors of Dame Sandra Dawson, Polly Williams and Graeme Hardie, allowing the Board to continue to benefit from their broad experience and knowledge of TSB.

Diversity

TSB is committed to fair and consistent treatment of all employees regardless of their personal characteristics, which include gender, ethnicity, religion, sexual orientation, transgender status, disability, nationality or age, as further detailed in the Directors' report starting on page 36. The Board has adopted this approach to diversity and had regard to it during the recruitment process discussed above. The Board diversity policy promotes and affirms TSB's aspiration to meet and exceed the target of 33% of Board positions being held by women, as set out in the Hampton-Alexander Review. Currently 36% of members of the Board are women, including the Senior Independent Director (who also chairs the Remuneration Committee) and the Chair of the Audit Committee. In identifying candidates for future appointments, the Committee will consider the balance of skills, knowledge, experience and diversity required on the Board for a particular appointment. The percentage of women in senior management positions is set out on page 36.

The Chairman's other significant commitments

Richard Meddings' primary commitment in addition to the role of TSB Board Chairman is as a Non-executive Director of HM Treasury (where he chairs the Audit Committee). His other external appointments are recorded in the biographical details available at www.tsb.co.uk/investors/people/.

Richard Meddings Chair, Nomination Committee 30 January 2020

Audit Committee report

Chair's introduction

The Audit Committee's now well established practice of including a report on its activities in the Annual Report on a voluntary basis is a reflection of the transparent and straightforward manner in which the Committee conducts its activities. This reflects the importance of the Committee and I will ensure that I and the Committee are held to account in this way and that its activities continue to be reported in this manner.

I am a chartered accountant and spent a number of years as an Audit Partner at KPMG. As well as my TSB Board role, I am a Non-executive Director of Jupiter Fund Management plc, RBC Europe Limited and XP Power Ltd.

I have been chair of the Committee throughout 2019 and have been ably supported by my fellow Non-executive Directors, Andy Simmonds, Graeme Hardie and Tomás Varela, who have served as members of the Committee throughout the year. Biographies of the members of the Committee can be found at www.tsb.co.uk/investors/people/. All Non-executive Directors, including the Chairman, of TSB have a standing invitation to attend any or all meetings of the Committee.

In my equivalent report of last year, I predicted that the frequency of the Committee's meetings would reduce from the 12 meetings in 2018, reflecting the significant improvement in the stability of the IT platform following the migration to it in 2018. This has been the case with a normalised pattern of 5 meetings in 2019.

This year, the Committee's attention has been targeted at management's plans to maintain the effectiveness of TSB's risk management and internal control systems, particularly in respect of the Bank's IT control framework. This work included the Committee's challenge of management's response to findings and actions arising from the various internal and external reports into the root cause analysis of the post migration service disruption in 2018. The Committee has also maintained a deep interest in the industry wide implementation of IFRS 9 and continues to challenge management's key accounting judgements, particularly the use of multiple economic scenarios in evaluating expected credit losses during an extended period of economic and political uncertainty. The report also explains the Committee's work in assessing the priorities of and the work undertaken by the Internal Audit function.

The Committee previously oversaw the adequacy of TSB's whistleblowing arrangements. This responsibility is now a reserved matter for the Board and the equivalent report is now included within the Corporate Governance Statement on page 26.

An effective external audit remains central to the Bank's financial reporting process. The Committee continues to review and challenge the approach to the external audit and has satisfied itself as to the effectiveness and independence of the external auditors during 2019. The Committee has also monitored the preparations to transition external audit services to KPMG in 2020, including the steps taken by KPMG to establish their independence. This follows the conclusion of the tender in 2018, following which TSB Board accepted the Committee's recommendation to propose a resolution to appoint KPMG for the audit of the financial statements for the year ending 31 December 2020.

During 2020, I expect the Committee's attention will be targeted at understanding and challenging management's plans to maintain the effectiveness of TSB's risk management and internal control systems while improving their efficiency as TSB seeks to execute the revised strategy. The Committee will also continue to challenge management's key accounting judgements, particularly the use of multiple economic scenarios in evaluating expected credit losses as the political landscape unfolds and in respect of the accounting for the costs of restructuring the Bank.

Polly Williams Chair, Audit Committee 30 January 2020

Membership and operation of the Committee

The Committee currently comprises three Independent Non-executive Directors (Polly Williams, Graeme Hardie and Andy Simmonds) and one Non-executive Director (Tomás Varela), each with recent, relevant experience in finance or banking. All members of the Committee are also currently members of the Risk Committee.

Committee meetings are attended by members of the Executive Committee including the Chief Executive, Chief Financial Officer, Chief Risk Officer and Chief Audit Officer. The external auditor, PwC, attends each meeting of the Committee which includes, where necessary, a private session with the Non-executive Directors, without the presence of Executive Committee members, other than the Chief Audit Officer.

The Chair reports to the Board after each Committee meeting on the main matters discussed so that all Directors are informed on the activity of the Committee. The Chair is available to all Directors for discussion of any matters in more detail and maintains regular dialogue outside Committee meetings with the Executive Committee members, particularly the Chief Executive, Chief Financial Officer, Chief Risk Officer and Chief Audit Officer, and also with the lead partner of the external auditor.

The Committee met five times during 2019. This was a significant reduction on the 12 meetings in 2018 when the Committee provided regular oversight, on behalf of the Board, of the management of the risks associated with the IT Migration Programme and the subsequent period of service disruption.

Audit Committee responsibilities and activity in 2019

The Committee is responsible for ensuring that a straightforward and transparent culture exists to ensure that TSB operates within the Board approved risk appetite for financial reporting and internal control. Specifically, the Audit Committee was responsible for reviewing and reporting to the Board on:

• Financial statements and related financial reporting;
• Risk management and internal control systems;
• Performance and effectiveness of the Internal Audit function; and
• Effectiveness of the relationship with the external auditor.

Financial statements and related financial reporting

The Committee is responsible for the review and challenge of TSB's interim results announcements and annual financial statements, including the significant financial reporting estimates and judgements which they contain. During 2019, the Committee has considered the following matters:

(i) The consistency and appropriateness of, and any changes to, significant accounting policies

The Committee has considered and accepted management's review of TSB's accounting policies. These have been updated in 2019 to reflect the adoption of IFRS 16 'Leasing' (page 87) which came in to force with effect from 1 January 2019. The Committee considered and accepted a report from management which noted that the accounting policies applied in the 2019 financial statements were consistent with those disclosed in the 2018 annual report, save for the introduction of the new lease accounting requirements.

(ii) The methods used to account for significant transactions

The Committee has reviewed and supported proposals from management on the accounting for the costs of restructuring the Bank.

(iii) Viability and going concern assessments

The Committee has considered management's approach to, and the conclusions of, the assessment of TSB's ability to remain a going concern. The Committee considered and, after taking the Bank's revised strategy and external market developments into account, supported management's conclusion that it remained appropriate to adopt the going concern basis in preparing the consolidated financial statements. The Committee also considered management's approach to, and the conclusions of, the assessment of TSB's viability. The Committee challenged management's viability assessment period, noting it was over the three years to December 2022. After consideration, the Committee supported the approach adopted by management as described on page 38.

(iv) Review of annual report – fair, balanced and understandable

The Committee considered management's approach to, and governance arrangements over, the preparation of this annual report and recommended to the Board that, taken as a whole, it was considered to be fair, balanced and understandable. The approach and results of the assessment are set out in the Directors' report on page 39.

(v) Whether TSB has made appropriate accounting estimates and judgements

The Committee has assessed the basis for and appropriateness of estimates and judgements proposed by management in the financial statements as presented below. After challenge, the Committee supported management's proposals.

Accounting estimate / judgement	Audit Committee considerations	Reference
Allowance for credit impairment losses	At 31 December 2019, TSB's credit loss allowance was £163.0 million. During 2019, the Committee reviewed regular reports from management assessing the adequacy of the allowance for credit impairment losses. These reports assessed the adequacy of historic provisions against subsequent recoveries, reviewed management's governance arrangements over provisioning adequacy and in particular the governance over impairment models and benchmarked TSB's metrics against other banks.	Note 10 'Allowance for credit impairment losses' page 60
	Economic scenarios and associated weightings The Committee received a report from management that assessed the appropriateness of the scenarios and probability weightings in light of the current environment. The Committee challenged management over their scenarios and probability weightings, including in respect of uncertainty around the impact and probability of the UK's exit from the EU with or without reaching agreement over a future trading agreement.
	The Committee noted that during 2019, management introduced two additional downside scenarios, increasing the number of scenarios used from three to five. The first, a severe stress downside scenario, is reflective of economic metrics that might occur in a 'cliff edge' 'no deal' Brexit with low 5% probability weighting reflecting that in management's view, ongoing preparations have limited the probability of such a scenario. A further mild downside scenario, reflective of economic metrics that might occur in a managed 'no-deal' exit scenario, was also included with a weighting of 20% applied.
	Management presented analysis of the sensitivity of the allowance for credit impairment losses to alternative scenario weightings and concluded that the impact was limited. Management also presented proposals for the disclosures of those sensitivities, set out on page 63, to provide context to their impact. After substantial debate and challenge, the Committee supported management's proposals.
	Expert credit judgements At 31 December 2019, the impairment provisions included £57.6 million (2018: £51.4 million of management's adjustments to modelled outcomes. A key focus of the Committee during the year was an assessment of the level and rationale for such adjustments. The Committee challenged reports prepared by management to support these adjustments, and management's plans to amend, where appropriate, the relevant models to minimise future adjustments.
	The Committee concluded that a robust governance framework existed to monitor provisioning adequacy and that the assumptions and judgements applied by management were appropriate. The Committee was satisfied that the allowance and related disclosures in the financial statements were appropriate.
	Significant increase in credit risk The threshold used to determine when there has been a significant increase in credit risk is a key judgement. This determines when a loan moves from stage 1 to stage 2, requiring expected credit loss to be measured using a lifetime expected loss. The Committee received a report from management that assessed the appropriateness of the thresholds used (page 56) including portfolio performance measures and benchmarking analysis. The Committee were satisfied that the thresholds remained appropriate further supported by the limited sensitivity to alternatives.
Recovery of post migration charges	The MSA and OSA contracts provide TSB with the right to seek recovery of losses from Sabis for breach of contract up to the level of liability caps in each agreement. During 2019, the parties have reached provisional agreement, subject to mutual reservation of rights while negotiations are concluded, where TSB will recover an aggregate of £192.6 million under the respective contracts. This represents 100% of the liability cap in the respective agreements and is an increase of £39.6 million compared to the estimate at December 2018. The Committee agreed with management's conclusion that, following agreement between the	Note 15 'Operating expenses' page 68 Note 32 'Other liabilities'
income statement.	parties, it is appropriate to recognise the aggregate recovery under the respective agreements. The Committee also agreed with management that as the amount reflects recovery of post migration costs, it was appropriate to present the charges net of associated recovery in the	page 89

(v) Whether TSB has made appropriate accounting estimates and judgements (continued)

Accounting estimate / judgement	Audit Committee considerations	Reference
Recoverability of	At 31 December 2019, deferred tax assets of £96.1 million (2018: £113.0 million) primarily	Note 19
deferred tax assets	reflected carried forward losses and unutilised temporary differences, arising from the transfer in 2013 of customer balances to TSB from LBG entities. Continued recognition of this asset requires judgement in assessing the availability of future taxable profits to absorb these carried forward losses and temporary differences.	Deferred tax assets Page 71
	The Committee considered reports from management and concluded that sufficient taxable profits are forecast against which the full carried forward losses and temporary differences are expected to be utilised. The Committee agreed with management's judgement that, based on TSB's forecast taxable profits, continued recognition in full of the deferred tax asset remained appropriate.
Restructuring Provisions	At 31 December 2019, TSB carried provisions of £28.5 million (2018: £nil) in respect of activity to restructure the bank as part of TSB's strategy. This include the estimated costs of previously announced branch closures that are planned for 2020 and estimated severance costs arising from organisational change across a number of head office functions.
	The Committee reviewed reports from management setting out the approach undertaken. The Committee challenged management over the adequacy of the provisions and was satisfied that the provisions and related disclosures in the financial statements were appropriate in the light of recent experience.
Customer remediation provisions	Conduct issues remain a key focus of the banking industry. Notwithstanding the indemnity given by LBG, TSB retains the primary liability for alleged misconduct to its customers. At 31 December 2019, TSB carried provisions of £16.0 million (2018:£15.0 million) which were materially covered by a corresponding recovery asset under an indemnity provided by Lloyds Bank plc. The provisions carried are primarily in respect of alleged mis-selling of added value current accounts and alleged breaches of the Consumer Credit Act.	Note 31 'Provisions' page 88
	The Committee reviewed reports from management setting out the approach undertaken to assess any liability for alleged conduct issues. This included assessing themes and volumes of customer complaints received by TSB. The Committee was satisfied that the provisions, recovery under the indemnity and related disclosures in the financial statements were appropriate.
Assessment of exposure to regulatory investigations	During 2018, the FCA and PRA commenced a formal joint investigation in connection with the handling of the migration of data and IT systems. This investigation is ongoing and it is not possible to make a reliable assessment of any findings.	Note 25(i) 'Contingent liabilities' page 85
	The Committee was satisfied with management's assessment, which included the consideration of industry wide practice in similar circumstances, and the disclosure as a contingent liability included in the financial statements.

Risk management and internal control systems

The Committee is responsible for reviewing the adequacy and effectiveness of TSB's risk management and internal control systems and reporting on that review. During 2019, the Committee took account of the following inputs into its review:

• Reports from management outlining their response to recommendations from internal and external consultants' reports into the root cause analysis of the post migration service disruption in 2018;
• Ongoing monitoring reports on the effectiveness of TSB's risk management and internal control systems;
• Quarterly reports from management which concluded that TSB's internal financial control framework has adequate coverage and is operating effectively;
• An unqualified ISAE 3402 controls report in respect of outsourced credit and debit card operations; and
• Regular management information on the activities of Internal Audit and its annual report on internal controls, including the findings from audit reports over the IT control framework operated by Sabis.

Risk management and internal control systems (continued)

On the basis of this work, the Committee was satisfied that while TSB's risk management and internal control systems operated adequately in 2019 it noted that aspects of the internal control systems could be enhanced and function more efficiently and relied on a framework of mitigating compensating controls. While reflecting improvement since 2018, continued progress is required in embedding the IT control framework, digital service stability and processes for screening customers' transactions. The key elements of the management of risk within the business and the effective system for internal controls are set out within the corporate governance statement (see page 27).

Performance and effectiveness of the Internal Audit function

The Committee is responsible for monitoring the performance and effectiveness of Internal Audit. During 2019, the Committee carried out this responsibility by:

• Approving the Internal Audit Plan, taking into account the Chartered Institute of Internal Auditors' Guidance on Effective Internal Audit in the Financial Services Sector;
• Challenging and approving the 2019 Internal Audit plans in line with TSB's strategy, so that these had appropriate coverage of the business and were flexible to enable a focus on significant risks in 2019;
• Approving the Internal Audit budget, including using subject matter experts where appropriate, to deliver the audit plan;
• Receiving regular reports from the Chief Audit Officer on the range of Internal Audit activities undertaken in 2019 and monitoring activities resulting from Internal Audit reports;
• Reviewing the Internal Audit annual self-assessment against industry standards;
• Reviewing the interactions between Internal Audit and the Risk function and between Internal Audit and the external auditor; and
• Confirming that Internal Audit makes independent assessments of TSB's control framework but is fully informed by management's and the Risk function's reporting and views on risks and controls.

Effectiveness of the relationship with the external auditors

The Committee is responsible for the effectiveness of TSB's relationship with its external auditor and for assessing their independence and objectivity. During 2019 the Committee discharged this responsibility by:

• Agreeing the terms of the audit engagement letter and reviewing and approving the audit fee proposal. Fees paid to the external auditor are set out in note 15 to the consolidated financial statements on page 69;
• Reviewing and challenging, throughout the year, the external auditor's audit strategy and consideration of significant and elevated audit risks to ensure TSB's circumstances are appropriately reflected. This included adapting the audit approach to reflect the ongoing maturing of IT access and change controls;
• Receiving reports from the external auditor covering management's estimates and judgements;
• Reviewing the outcomes of the Financial Reporting Council's (FRC) Audit Quality Review inspection reports as they relate to PwC and potential considerations for TSB's audit;
• Considering the approach to obtaining independent assurance over outsourced controls;
• Performing ongoing review of the audit service through discussions between the Chair of the Audit Committee, Chief Financial Officer and Chief Risk Officer and PwC's UK Head of Audit and audit engagement personnel;
• Ensuring compliance with policy governing the use of the external auditor for non-audit services to safeguard their objectivity and independence (see note 15 on page 69 for fees paid to the external auditor); and
• Reviewing and challenging reports from the external auditor on maintaining their independence including reference to compliance with UK and EU regulation and ethical standards, PwC firm wide processes and controls and the potential for threats to independence at a firm and personal level arising from a range of sources, for example, dependence on non audit services, other business or personal relationships, familiarity or undue influence by TSB management.

PwC has held the position of external auditor of TSB Bank plc since 1997 and of the Company since its incorporation, both as part of the wider historical audit relationship with LBG, the Bank's previous shareholder. Laura Needham was the senior statutory auditor for the audit of the 2019 financial statements.

As previously noted in the 2018 annual report, the Board accepted the Committee's recommendation to appoint KPMG for the provision of external audit services for the year ending 31 December 2020 following a mandatory tender process. Consequently, a resolution to appoint KPMG for the audit of the financial statements for the year ending 31 December 2020 will be proposed at the 2020 Annual General Meeting. In view of the transition of external auditor to KPMG, the Committee has received regular reports from KPMG on their transitional plans and on their activity to secure audit independence from 1 November 2019.

Directors' report

Introduction

The Directors of TSB Banking Group plc (the Company) present their report and audited consolidated financial statements for the year ended 31 December 2019, in accordance with section 415 of the Companies Act 2006.

The following information is incorporated into this Directors' report:

• The information in the section 172 statement (pages 8 to 9) on employee engagement and fostering of business relationships with customers, suppliers and others;
• The 'how the business is managed' section of the corporate governance statement (pages 22 to 28); and
• The diversity section of the Nomination Committee report (page 29).

Results and dividends

The consolidated balance sheet can be found on page 48 and the consolidated statement of comprehensive income is on page 49. The Directors do not currently propose to pay a dividend.

Directors

The Directors of the Company who were in office during the year, or from the date of their appointment, and up to the date of signing the financial statements were:

Richard Meddings
Debbie Crosbie	(appointed 1 May 2019)
Ralph Coates
Paulina Beato
Dame Sandra Dawson
Graeme Hardie
Miquel Montes	(resigned 14 November 2019)
Stephen Page
Andy Simmonds
Tomás Varela
David Vegara	(appointed 22 January 2020)
Polly Williams

The biographies of TSB's Directors are available at www.tsb.co.uk/investors/people/. The Company's articles of association (the Articles) give the Directors power to appoint and replace Directors. Under the terms of reference of the Nomination Committee, any appointment must be recommended by it for approval by the Board of Directors. Directors can also be appointed or removed from office by written notice provided to the Company by Sabadell as the sole shareholder.

Power of Directors

The Directors are responsible for managing the business of the Company and may exercise all the powers of the Company so long as the Articles or applicable legislation do not stipulate that any such powers must be exercised by the shareholders.

Directors' indemnities

Each of the Directors has the benefit of a deed of indemnity which constitutes a 'qualifying third party indemnity provision'. This indemnification for Directors provided by the Company has been arranged in accordance with the Articles and the Companies Act 2006. With the exception of Debbie Crosbie and David Vegara, the indemnities were in place throughout 2019. The indemnity for Debbie Crosbie was executed on 21 May 2019 and for David Vegara on 28 January 2020. Each of the indemnities remain in force at the date of signing these financial statements and are available for inspection at the Company's registered office.

Directors' emoluments waiver

Miquel Montes, Tomás Varela and David Vegara did not/do not receive a fee as Non-executive Directors of the Company. None of the other Directors, save for the Chairman who waived his entitlement to the fee for membership of the Nomination Committee, have waived their emoluments during the period under review, nor have they agreed to waive future emoluments.

Governance arrangements

The Board has chosen to voluntarily adopt those principles of the UK Corporate Governance Code (Code) that are considered appropriate for TSB as a wholly owned subsidiary of Sabadell. Details of the aspects of the Code not considered appropriate for TSB, together with areas where TSB has deviated from the recommendations of the Code and the rationale for this, are set out on page 22.

TSB Banking Group plc Annual Report and Accounts 2019 page 35

Share capital

At 30 January 2020, the total issued share capital with voting rights consisted of 500,000,000 ordinary shares of £0.01 each. The total issued share capital is held by Banco de Sabadell, S.A.

Future developments

The development of TSB is set out in the Chief Executive's statement on pages 5 to 7.

Employee information

Encouraging Employee collaboration and feedback

Collaboration and two-way communication is encouraged at all levels and is key to TSB's strategy. As mentioned in the Strategy report, 'The Link' gathers and builds on employee feedback and enables meaningful dialogue between employees and the executive leadership. The Executive Committee members and other senior leaders also run regular TSB wide 'town hall' meetings and site-specific meetings. Employees can use our new digital workplace platform to connect directly with leaders, posting questions or joining discussions. We also continue to work closely with our recognised unions, Accord and Unite, to build strong relationships. Our annual Employee Experience Survey provides all employees the opportunity to feedback on working at TSB and we continue to use this feedback to target improvements to our employee experience.

In 2019 we discussed the TSB strategy and our new long term objectives with all employees. We also transitioned from a set of corporate values to a simplified description of expected behaviours. We have developed a thorough engagement strategy which incorporates a commitment to simplify ways of working.

Training and development

To ensure that our culture and business strategies are aligned, we provide a range of training such as the TSB Experience, a transformational programme for all employees which focuses on how they behave with customers and each other. We have set ambitious plans for the development of future skills, including a commitment to deliver 100,000 hours of training over the next three years. Every employee is also encouraged to have a personal development plan which they review regularly with their line manager. All employees who are new to TSB are given an induction, Welcome to TSB, and our behavioural standards form a central part of that induction. The Source (our Learning Management System) guides employees through all of the learning and development that is available, and a mentoring scheme encourages informal learning at all levels of experience. Our managers have extra responsibilities that involve managing people, so we give them special training, including sessions on Dignity and Respect at Work and Mental Health awareness.

Recognition and reward

Not only do we give a voice to our employees, but we also encourage the recognition and celebration of their contribution. This is demonstrated in the Say Thank You scheme which gives employees the opportunity to recognise the contribution of fellow employees who demonstrate appropriate TSB behaviours. As covered in more detail in our Remuneration review starting on page 40, TSB's approach to reward seeks to differentiate us from other banks. It is driven by our core strategy and supports our partnership model. We believe our approach is fair, transparent and consistent for everyone. At the heart of our approach is the TSB Award. It is a flat award across TSB where everyone has the opportunity to be awarded the same percentage – regardless of grade or role including the Chief Executive and the rest of the executive team. This enables all employees to be recognised for the important role they play in the success of our business.

Diversity

Three years ago, TSB set an ambitious target of 45-55% of our senior roles to be held by women by 1 January 2020 when we signed up to the Women in Finance Charter. Importantly for TSB, this exceeded the targets set across the financial services industry. At the date of this report:

• 36% of members of the Board are women, just ahead of the Government's target of 33%, including the Senior Independent Director (who also chairs the Remuneration Committee) and the Chair of the Audit Committee; and
• 20% of the Executive Committee are female reflecting the appointments of Debbie Crosbie as Chief Executive and Liz Ashford as HR Director. We also have senior women running some of our largest functions and people leadership roles in the Bank.

However, despite this, we have not made progress at the rate at which we had aspired. At the date of this report, 39% of our senior roles are held by women, albeit that this is ahead of the industry average Women in Finance statistics (March 2019) which shows female representation in senior management roles at 31%, with average targets of 38%.

Diversity (continued)

In December 2019, we extended the period to have between 45-55% of our senior roles held by women to 2025. Our progress against this target will be tracked against interim targets to ensure that we remain on track, and our aspiration is to achieve this ahead of schedule.

Gender diversity is critical to the success of our business. We will continue to promote women into roles that have a genuine impact on how we run our business, create role models, change cultural norms and unconscious bias across our business. As outlined in the Chief Executive's report on page 5, we are investing in initiatives such as our Aspiring Women network, Women Returners' Programme and Investing in Women Code and are committed to diversity in the broadest sense. We are committed to make sure every employee in our business feels included.

TSB also participates in the Stonewall Workplace Equality Index, ensuring it is continually assessing and improving TSB's achievements and progress on LGBT+ equality. TSB is a member of Business in the Community and a signatory of the Race at Work Charter with the objective of ensuring ethnic minority employees are represented at all levels of the organisation. TSB promotes tailored mentoring programmes for BAME employees to support progression.

Our employees with disabilities are treated fairly and can compete on equal terms for career progression. TSB's 'employees with Disabilities' policy is designed to inform employees of the support available to those with disabilities (including employees who develop disabilities) and how to access this support. TSB is a level 2 Disability Confident employer, a scheme that sees TSB commit to offer an interview to disabled people who meet the minimum criteria for a job in terms of the skills needed, thereby giving them the opportunity to present their skills face to face. TSB is also a member of the Business Disability Forum and in 2019, TSB joined the Valuable 500, joining other leading businesses committed to ensuring disability is on the board agenda and creating a workplace culture that encourages inclusion and equality.

Environmental information

As part of Sabadell's overall environmental work, TSB is committed to being a responsible user of resources. We continue to consider ways we can improve our environmental impact by looking at our energy consumption, carbon emissions from traveling, and reducing the use of plastic in our work places. In 2019, TSB invested in reducing our energy consumption through new LED lighting in corporate sites and more efficient air conditioning and boiler units in branches. In 2020, we plan to launch a new corporate responsibility programme to support the delivery of our business strategy and improve our social and environmental impact, and set new ambitions and targets to optimise our contribution to national and international goals.

Political donations and expenditure

No amounts were given for political purposes during the year.

Financial risk management and hedging policies

Details of the use of financial instruments, together with risk management disclosures can be found in the Managing financial risk section of the financial statements on pages 72 to 82 and the Risk management section in the Strategic report on pages 17 to 20.

Post balance sheet events

There are no significant events affecting TSB that have arisen between 31 December 2019 and the date of this report that require disclosure.

Research and development activities

TSB develops new products and services during the ordinary course of business.

Overseas branches

TSB does not have any branches outside of the United Kingdom.

Corporate headquarters and registered office

The corporate headquarters and registered office address for TSB Banking Group plc is 20 Gresham Street, London, EC2V 7JE. Telephone: +44 (0)20 7003 9000. Website: www.tsb.co.uk.

Disclosure of information to external auditors

In accordance with the provisions of the Companies Act 2006, the Directors serving at the date of approval of this report confirm that, so far as each Director is aware, there is no relevant audit information of which the Company's auditors are unaware and each Director has taken all the steps that he or she ought to have taken as a Director in order to make himself or herself aware of any relevant audit information and to establish that the Company's auditors are aware of that information.

TSB Banking Group plc Annual Report and Accounts 2019 page 37

Going concern

The Directors recognise their responsibility to make an assessment of TSB's ability to continue as a going concern, for a period of at least 12 months from the date the financial statements are approved. The Directors' assessment of going concern is integrated with that of the assessment of the viability of TSB. The Directors are satisfied that adequate funding, liquidity and capital resources will be in place to allow the financial statements to continue being prepared on a going concern basis and are not aware of any material uncertainties that may cast significant doubt upon TSB's ability to continue as a going concern.

Viability statement

As more fully explained in the corporate governance statement on page 22, TSB has committed to voluntarily adopt some of the principles of the Code which includes provisions that require the Directors to confirm that TSB will be able to continue in operation and to meet its financial liabilities as they fall due over a specified period determined by the Directors taking account of the current position and principal risks of TSB. The Directors confirm that:

• they have carried out a robust assessment of the emerging and principal risks facing TSB, the procedures in place to identify emerging risks, and how such risks are being managed or mitigated; and
• in light of TSB's capital and funding resources they have a reasonable expectation that TSB will be able to continue in operation and meet its liabilities as they fall due in the period to December 2022.

In making this assessment, the Directors have considered a wide range of information. Central to this assessment is the 2019 medium term plan which assesses TSB's future strategic and financial prospects over the five years to December 2024. This includes assessment of future projections of profitability, capital requirements, capability, resources and funding. In addition, the Directors have assessed the key strategic risks that could threaten TSB's future prospects and business model more broadly and the monitoring and mitigation activities around them.

The Directors have assessed TSB's viability to December 2022. The assessment has been made over this period as it is within the period over which TSB's medium term strategic and financial plan is prepared, key capital and leverage ratios are forecast and regulatory and internal stress testing of the profit, capital and funding forecasts are carried out. In doing so, it took into account the increasing uncertainty of forecasts in the outer years of the planning period from developments in the economic environment, and competition and regulatory developments.

Statement of directors' responsibilities in respect of the financial statements

The Directors are responsible for preparing the annual report and the financial statements in accordance with applicable law and regulation.

Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared TSB and Company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of TSB and the Company and of the profit or loss of TSB for that period. In preparing these financial statements, the Directors are required to:

• select suitable accounting policies and then apply them consistently;
• state whether applicable IFRSs as adopted by the European Union have been followed in the TSB and Company financial statements, subject to any material departures disclosed and explained in the financial statements;
• make judgements and accounting estimates that are reasonable and prudent; and
• prepare the financial statements on the going concern basis unless it is inappropriate to presume that TSB and the Company will continue in business.

The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain TSB's and the Company's transactions and disclose with reasonable accuracy at any time the financial position of TSB and the Company and enable them to ensure that the financial statements comply with the Companies Act 2006 and, as regards TSB's financial statements, Article 4 of the IAS Regulation. The Directors are also responsible for safeguarding the assets of TSB and the Company and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

The Directors are responsible for the maintenance and integrity of TSB's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

Fair, balanced and understandable

The Board has ultimate responsibility for reviewing and approving the annual report. In voluntarily adopting the principles of the Code that are considered appropriate for TSB as a wholly owned subsidiary of Sabadell, the Directors confirm that they consider that the annual report, taken as a whole, is fair, balanced and understandable and provides the information necessary for the shareholder to assess the Company's position, performance, business model and strategy. When arriving at this conclusion the Board was assisted by a number of processes including:

• The annual report is drafted and comprehensively reviewed by appropriate senior management with overall coordination by the Financial Controller;
• A verification process is undertaken to ensure factual accuracy, with review by legal advisers; and
• The annual report is reviewed by TSB employees from a range of functions, TSB's Executive Committee and the Audit Committee prior to approval by the Board.

By order of the Board

Keith Hawkins Company Secretary 30 January 2020 Registered in England and Wales, Company Number 08871766

Remuneration review 2019

In the six years since TSB was launched onto high streets across Great Britain, the remuneration approach has remained consistent. It is designed to be simple and fair. This underlying set of principles remains integral to our reward philosophy.

Overview of TSB's remuneration policy for 2019

The aim of TSB's remuneration policy is to provide competitive remuneration aligned to the delivery of the strategic goals (as explained in the Chief Executive's statement on page 6). It is designed to attract and retain talented individuals and to generate sustainable business performance, while taking into account effective risk management and acceptable conduct. In addition, TSB aims to align the remuneration approach with that of the parent, Sabadell.

The key elements of the reward framework are as follows:

• Basic salary provides core remuneration taking into account relevant market benchmarks, complexity of the role and the individual's experience and performance.
• Market appropriate benefits principally pension contributions to a defined contribution scheme or, where appropriate, an equivalent cash payment; 4% of basic salary available to use in our flexible benefits offering; and an employer provided car or alternative cash allowance at certain grades.
• Variable Pay, which comprises of the following two elements:

The TSB Award - which provides an 'on-target' annual short term incentive award opportunity of 10% of basic salary and applies to every employee, from the Chief Executive to those on the front line. The TSB Award reflects the collective effort made by all employees to deliver business success. Awards are made only if certain 'gateways', including risk, profitability and individual conduct are satisfied and corporate performance targets are met.

The New Award – which was introduced in 2019 as a one-off transition award. It is based on in-year performance measured against a combination of business measures, including financial resilience, set out in a balanced scorecard which focuses on stabilising TSB, personal performance and conduct. This award will be granted to a limited number of senior employees and is funded after the TSB Award is funded, if sufficient profit is made and risk management gateways have been satisfied.

▪ In respect of 2019 performance, TSB will not exceed an annual cap on total variable remuneration of one times basic salary, calculated in accordance with the PRA's remuneration regulations.

Consideration for all TSB employees

The Remuneration Committee's remit extends beyond executive pay. The Committee has determined that the simplest and fairest approach to the annual pay review based on the 2019 performance year (effective from 1 April 2020) is to set a salary increase budget of 2% within which awards to employees will take into account their position relative to their pay band or to the market.

TSB continues to be committed to paying the Living Wage. In August 2016, TSB became an accredited Living Wage employer.

Gender

TSB continues to focus on embedding the values of inclusion throughout the organisation. In 2017, TSB was one of the first companies in the UK to publish its gender pay gap with the launch of its Gender Balance Matters report. A firm commitment was made to examine the root causes of gender imbalance and to set out signature actions that were being taken to tackle them.

Women hold 39% of senior roles and TSB has an ambition to achieve more with a longer-term stretching target of between 45-55% of senior roles to be held by women by 2025. Internally, interim targets to 2025 are being tracked to keep the programme on track.

Remuneration review 2019 (continued)

Outlining TSB's Obligations

TSB's remuneration policy continues to comply with the PRA and the FCA Remuneration Codes, which have been in effect since June 2015, and the PRA's required approach to buyouts for Material Risk Takers (MRTs), which came into effect from January 2017.

In respect of variable reward plans, 60% of grants for PRA Senior Managers (in effect, Executive Committee members) will be deferred over seven years with pro-rata release between the third and seventh year based on an annual release underpin. Any shares issued will be subject to a 12 month retention period after the point of release. For MRTs, other than Senior Managers, 40% of grants will be deferred over three or five years, depending on the regulatory status of the employee, with a retention period on the shares of 12 months after the point of release. TSB's approach to deferral of total variable remuneration for senior employees ensures that awards are delivered as required by regulations.

Reward Outcomes in 2019

TSB's statutory profit before tax for 2019 was £46.0 million (including a £39.6 million increase in expected warranty recoveries under the migration and IT service contracts) compared to a loss before tax of £105.4 million in 2018. The result in 2018 was significantly affected by the costs to deliver the IT migration and the costs of the subsequent post migration service disruption. Consequently, the Remuneration Committee determined that no TSB Award or SPA would be made in respect of 2018 performance. However, an individual cash award of £1,500 was made to all employees, except members of the Executive Committee, in December 2018, reflecting the team effort across the business to put things right for customers.

The TSB Board commissioned a number of internal and independent reviews into the IT migration to the new platform, including from Slaughter and May, and await the findings from a joint FCA and the PRA investigation.

As a result of overall business performance in 2019, the Remuneration Committee has approved a 2019 TSB Award pool of 8.64% of basic salaries (£17.7 million), meaning that all TSB employees up to an including those in senior manager roles, who have an 'On Track' performance rating, will receive 8.64% of their basic salary as a TSB Award. For more senior employees, from heads of department to Executive Committee members, the Remuneration Committee, after applying a 2.5% ex ante risk adjustment to the bonus pool, approved a 2019 TSB Award and New Award pool of £7.6 million (equivalent to 83.9% of the on target award level).

Unvested prior year SPA awards that were due to vest in March 2020 will not vest, consistent with SPA awards which were due to vest in March 2019, as performance against the predetermined financial target (cumulative return on equity) was not achieved.

In 2018, the Committee took the decision to delay the payment of the vested but as yet unpaid tranches of the Sabadell Integration Awards (SIA) and other awards due to vest in March 2020, subject to the outcome of both internal and external regulatory investigations into the post migration issues. This decision continues to apply. In addition to this, the Committee decided on 17 July 2019, to cancel the unvested SIAs due to the performance conditions for 2017 not having been met.

Consideration of Conduct and Risk

The Remuneration Committee takes risk and conduct issues very seriously. Risk profile and behaviours are a key gateway that must be satisfied for any incentive awards to pay out.

Risk adjustment is a result of several factors:

• 1. A balance of measures included in individual objectives and business scorecards acts as a framework for adjusting the bonus pool for both performance and risk inherent in TSB's activities;
• 1. The use of a framework to quantify the risk adjustment of the variable remuneration pool in 2019; and
• 1. The appropriate governance to make informed and robust decisions, including the Remuneration Governance Group (which makes recommendations to the Remuneration Committee on matters as required to ensure that the appropriate standards of risk management and corporate governance are applied), Remuneration Committee oversight and independent access to the Chief Risk Officer and Chief Financial Officer.

Incentive pools and awards may be adjusted, including to zero, in the event of material breaches. All elements of variable remuneration for MRTs are subject to malus and clawback provisions in line with regulatory requirements.

Remuneration review 2019 (continued)

On 1 May 2019, Debbie Crosbie was appointed as Chief Executive and Richard Meddings stepped down as Executive Chairman, a role he had fulfilled since 3 September 2018, and reverted to the role of Non-executive Chairman. Mr Meddings did not receive any additional payment for taking on the role of Executive Chairman. The table below sets out the total remuneration paid to Ms Crosbie, TSB's highest paid director, for qualifying services as a TSB director in the period from 1 May to 31 December 2019. In addition, the buy out relating to the 2019 instalments of Ms Crosbie's unvested variable remuneration forfeited when she left employment with her previous firm is set out below.

Highest paid Director – 2019 remuneration disclosure(*)

CEO Remuneration	2019	2018(1)
	£	£
Basic salary (2)	633,333	627,300
Role based allowance (3)	-	135,000
Benefits (3)	31,667	31,351
Pension (4)	112,115	110,246
Fixed Pay	777,115	903,897
Variable Remuneration (5)	184,925	-
Joining awards vesting during the year (6)	480,620	-
Total Remuneration (audited)	1,442,660	903,897
Contractual payments for loss of office
Notice paid in 2018		437,720
Notice paid in 2019		801,030

Notes

• (1) 2018 figures represent the total remuneration paid to Paul Pester who stepped down in September 2018.
• (2) Basic salary from 1 May to 31 December 2019 paid to Debbie Crosbie.
• (3) Benefits include the taxable value of all benefits received, which included a car allowance and a flexible benefits allowance set at 4% of basic salary.
• (4) The value of the pension allowance provided which has been paid at a percentage of 17.7%.
• (5) Represents 40% of the contractually guaranteed 2019 annual TSB bonus for period from May to December 2019 which, in order to meet regulatory deferral requirements, will be paid in March 2020. The 60% balance will be deferred pro-rata over 5 years from March 2023, subject to service and risk management gateways. All variable remuneration is paid 50% in cash and 50% in Sabadell shares.
• (6) This buy out figure relates to the 2019 cash instalments of Debbie Crosbie's unvested variable remuneration forfeited when she left employment with her previous firm, Virgin Money UK PLC (formerly CYBG PLC). In addition, during 2019, 799,268 Sabadell shares were awarded and subsequently vested to Ms Crosbie relating to the 2019 instalments of unvested Virgin Money UK PLC related share based variable remuneration. The total value of these shares has been estimated using the three day average of the Sabadell share price and Euro/Sterling exchange rate as at 31 December 2019 as being £710,895. 483,938 of these vested shares were released to her in 2019; the balance will be released in 2020.
• (*) The aggregate remuneration for all Directors is set out in note 16 to the financial statements on page 69.

Consideration by the Directors of matters relating to Directors' remuneration

The Remuneration Committee is authorised by the Board to consider and recommend, to the Board, the remuneration policy framework. Policy is considered regularly by the Remuneration Committee, taking account of changes in regulation and the wider market. In formulating and reviewing policy, independent advice is sought and considered. In particular, the sustainability of the policy and its risk impact are carefully reviewed. The Bank's Remuneration Policy is formally reviewed at least annually and, once approved by the Remuneration Committee, is reviewed and approved by the Board. The effectiveness of the Remuneration Policy and its application are reviewed formally by the Risk function annually. The Remuneration Committee considers the Risk function's report following that review and tracks and monitors any recommended actions. The Remuneration Committee's full terms of reference are kept under regular review. These can be found on our corporate website at http://www.tsb.co.uk/investors/people/.

The Remuneration Committee is chaired by Dame Sandra Dawson and the other committee members are Polly Williams, who also chairs the Audit Committee, and Paulina Beato. Miquel Montes served as a member of the Remuneration Committee until he resigned from the Board on 14 November 2019. Andy Simmonds, Chair of the Risk Committee, attends meetings of the Remuneration Committee from time to time to ensure alignment between the work of the Remuneration Committee and the Risk Committee. Remuneration Committee meetings are also attended by the Chairman together with the Chief Executive, Chief Financial Officer, HR Director, Chief Risk Officer, and Director of Reward and Performance to provide input on their specialist areas. The Company Secretary, or an appropriate delegate, acts as the secretary to the Remuneration Committee. None of these additional attendees participates in the discussion of issues directly affecting their own remuneration.

Remuneration review 2019 (continued)

Consideration by the Directors of matters relating to Directors' remuneration (continued)

The Remuneration Committee appointed Deloitte LLP (Deloitte) to provide independent advice on remuneration matters following a presentation to the Remuneration Committee members in 2014. The Remuneration Committee reviewed Deloitte's work during 2019 and decided to continue with Deloitte's appointment. Deloitte is a member of the Remuneration Consultants Group and, as such, voluntarily operates under the code of conduct in relation to executive remuneration consulting in the UK. Deloitte has provided independent advice on matters under consideration by the Remuneration Committee including compliance with regulations, advice on market trends and data, remuneration policy and implementation of remuneration arrangements, including support in remuneration arrangements for departing Executives. The Remuneration Committee is satisfied that the advice it has received has been objective and independent.

Deloitte also provided advice on share plans, wider remuneration matters, taxation and financial matters and other miscellaneous consulting and assurance services. In addition, management received external advice, including market data and legal counsel, from a number of other providers which is not considered to be material in assisting the Remuneration Committee to consider Directors' remuneration.

Herbert Smith Freehills attended several Remuneration Committee meetings during the year and have provided advice in relation to legal questions that have arisen.

Financial statements

48	Consolidated balance sheet
49	Consolidated statement of comprehensive income
50	Consolidated statement of changes in equity
50	Consolidated cash flow statement
51	Notes to the consolidated financial statements
91	Company balance sheet
92	Company statement of changes in equity
92	Company cash flow statement
93	Notes to the Company financial statements
96	Independent auditors' report to the members of
	TSB Banking Group plc

TSB Banking Group plc Annual Report and Accounts 2019 page 44

Alignment with TSB's business model

The presentation of TSB's consolidated financial statements aligns with the execution of its strategy, its business model and the management of the financial risk to which it is exposed. As such, the consolidated financial statements are structured around the key elements of TSB's business model as explained on page 10.

Basis of preparation

These consolidated financial statements of TSB Banking Group plc (TSB) comprise the results of TSB Banking Group plc consolidated with those of its subsidiaries, including TSB Bank plc. Details of subsidiary undertakings are provided in note 4 to the Company financial statements on page 94. These consolidated financial statements have been prepared in accordance with the Companies Act 2006 as applicable to companies using International Financial Reporting Standards (IFRS) and with IFRS, as adopted by the European Union (EU). IFRS comprise accounting standards prefixed IFRS, issued by the International Accounting Standards Board (IASB) and those prefixed IAS, issued by the IASB's predecessor body, as well as interpretations issued by the IFRS Interpretations Committee (IFRS IC) and its predecessor body. TSB applies the EU endorsed version of IAS 39 adopted by the EU (which are not available in the version issued by the IASB).

The consolidated financial statements have been prepared under the historical cost convention as modified by the recognition of certain financial assets and financial liabilities, including derivative contracts, at fair value through profit or loss and financial assets at fair value through comprehensive income. The Directors consider that it is appropriate to continue to adopt the going concern basis in preparing the consolidated financial statements.

Accounting policies

The significant accounting policies used in the preparation of the consolidated financial statements are presented in a manner consistent with TSB's business model and are included in the relevant sections of the consolidated financial statements. In addition, the following accounting policies relate to the consolidated financial statements as a whole.

Consolidation

Subsidiaries are all entities (including special purpose entities) over which TSB has control. TSB controls an entity when it is exposed to, or has rights to variable returns from its involvement with the entity and has the ability to affect those returns through its power over the entity. Subsidiaries are fully consolidated from the date on which control is transferred to TSB and are deconsolidated from the date that control ceases. Inter-company transactions, balances and unrealised gains and losses on transactions between TSB companies are eliminated.

Foreign currency translation

Foreign currency transactions are translated using the exchange rates prevailing at the date of the transaction. Monetary items denominated in foreign currencies are translated at the rate prevailing at the balance sheet date. Foreign exchange gains and losses resulting from the restatement and settlement of such transactions are recognised in other operating income/expenses in the income statement.

Changes to accounting policies

The accounting policies are consistent with those applied in the 2018 Annual Report and Accounts with the exception of new accounting policies in respect of IFRS 16 'Leases' and 'Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39 and IFRS 7 both of 'which TSB adopted with effect from 1 January 2019.

Leases

IFRS 16 replaced IAS 17 'Leases' and requires TSB to recognise both a 'right-of-use' asset and a corresponding lease liability on the balance sheet in respect of most leases, primarily property leases, where it is the lessee. The change in the accounting policy also resulted in TSB recognising lease liabilities in relation to leases which had previously been classified as 'operating leases' under the principles of IAS 17 'Leases'. These liabilities were measured at the present value of the remaining lease payments, discounted using TSB's incremental borrowing rate at 1 January 2019.

The adoption of IFRS 16 at 1 January 2019 resulted in an increase of £163.0 million in property and equipment, reflecting the initial recognition of 'right of use' assets. This was offset by an increase of £171.9 million in lease liabilities less an £8.9 million reduction in other liabilities. The adoption of IFRS 16 had no impact on shareholder's equity at 1 January 2019. Details of the new accounting policies applied in respect of leases are set out on page 83. As permitted by the transitional provisions of IFRS 16, TSB has elected not to restate comparative figures for 2018 and these adjustments are therefore recognised in the opening balance sheet as at 1 January 2019. In applying IFRS 16 for the first time TSB, in using the following practical expedients permitted by the standard, has:

• applied a single discount rate to leases with similar remaining lease terms;
• used previous onerous lease assessments as an alternative to performing an impairment review, which reduced the right of use asset at 1 January 2019 by £1.5 million;
• excluded initial direct costs for the measurement of the right-of-use asset at the date of initial application; and
• accounted for leases with a remaining lease term of less than 12 months at 1 January 2019 as short-term leases.

Changes to accounting policies (continued)

Leases (continued)

The table below sets out the movement between TSB's operating lease commitments at 31 December 2018 (as disclosed under the principles of IAS 17) and lease liabilities recognised at 1 January 2019:

	£ million
Operating lease commitments at 31 December 2018	188.1
Less: Impact of discounting (using a weighted average rate of 1.0% at 1 January 2019)	(15.3)
Less: Short-term leases not recognised as a liability	(0.9)
Lease liability at 1 January 2019	171.9

The associated right-of-use assets for these leases were measured at the amount equal to the lease liability, adjusted to reflect prepaid and accrued lease payments and onerous lease provisions recognised in the balance sheet as at 31 December 2018.

The impact of the adoption of IFRS 16 on the financial statements at 1 January 2019 are set out the table below:

	Property and	Lease	Other
	equipment	liabilities	liabilities
	£ million	£ million	£ million
At 31 December 2018	163.1	-	(495.4)
Changes on adoption of IFRS 16	163.0	(171.9)	8.9
At 1 January 2019	326.1	(171.9)	(486.5)

Hedge accounting

In 2019, the IASB issued 'Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39 and IFRS 7' (the Amendment) which is effective from 1 January 2020, with early adoption permitted. The Amendment is in response to changes to interbank offered rate (IBOR) benchmark interest rates which are expected to be phased out by the end of 2021. In assessing cash flow hedge effectiveness and in assessing whether forecast transactions are expected to occur, the Amendment permits entities to assume that the interest rate benchmark on which the hedged cash flows and the hedging instruments are based is not altered as a result of interest rate benchmark reform.

TSB has elected to early adopt the Amendment, applying it retrospectively to its hedge accounting relationships, and providing the required disclosures (note 23). This has enabled TSB to retain effective cash flow hedge accounting relationships in respect of certain variable rate debt securities in issue that reference LIBOR and have a maturity beyond 2021. This avoids the accelerated recycling of £6.0 million of post-tax debit balances from the cash flow hedging reserve to the income statement.

Significant accounting estimates and judgements

The preparation of financial statements in accordance with IFRS requires management to make judgements, estimates and assumptions in applying the accounting policies that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

The significant judgements made by management in applying accounting policies and the key sources of estimation uncertainty in these consolidated financial statements, which together are deemed critical to the results and financial position, are presented within the components of TSB's business model as shown in the table below. These areas are discussed in the Audit Committee as set out in the corporate governance statement on pages 32 to 33.

	Financial
Significant accounting estimates	statement note
Allowance for credit impairment losses on financial assets at amortised cost	Note 10
Customer remediation provisions	Note 31
Restructuring provisions	Note 31
Recovery of post migration charges	Note 32
Significant judgements
Recoverability of deferred tax asset	Note 19
Assessment of exposure to regulatory investigations	Note 25(i)

TSB's primary consolidated financial statements are presented on pages 48 to 90. The notes to these consolidated financial statements are structured to follow TSB's business model as set out on page 10 and are listed below.

	Sources of funding
1	Customer deposits
2	Debt securities in issue
3	Subordinated liabilities
4	Repurchase agreements
5	Fair value of financial liabilities
	Loans and liquid assets
6	Debt securities
7	Loans to credit institutions
8	Loans and advances to customers
9	Other advances
10	Allowance for credit impairment losses on financial assets at amortised cost
11	Fair value of financial assets
	Income
12	Net interest income
13	Net fee and commission income
14	Other operating income
	Charges
15	Operating expenses
16	Directors' emoluments
17	Share-based payments
18	Taxation
19	Deferred tax assets
	Managing financial risk
20	Credit risk
21	Liquidity risk
22	Capital resources
23	Market risk
	Other important disclosures
24	Shareholder's equity
25	Contingent liabilities
26	Related party transactions
27	Property and equipment
28	Lease liabilities
29	Intangible assets
30	Other assets
31	Provisions
32	Other liabilities
33	Notes to the consolidated cash flow statement
34	Approval of the consolidated financial statements

Consolidated balance sheet

as at 31 December 2019

		2019	2018	Reference to
Assets	Note	£ million	£ million	business model
Cash, cash balances at central banks and other demand deposits		4,595.2	7,136.0
Financial assets at fair value through profit or loss
Derivative financial assets	23	112.0	88.4	Managing risk
Equity instruments		–	2.2	(page 72)
Financial assets at fair value through other comprehensive income	6	1,587.4	2,387.8
Financial assets at amortised cost:
Debt securities	6	548.6	96.2
Loans to central banks		96.1	87.8	Loans and liquid
Loans to credit institutions	7	373.2	370.6	assets
Loans and advances to customers	8	31,075.8	30,008.5	(page 55)
Reverse repurchase agreements		201.1	–
Other advances	9	279.6	382.1
Hedging derivative financial assets	23	93.4	106.6	Managing risk
Fair value adjustments for portfolio hedged risk	23	20.5	(37.3)	(page 72)
Property and equipment	27	293.2	163.1
Intangible assets	29	20.3	18.4
Current tax assets		0.2	20.4
Deferred tax assets	19	96.1	113.0
Other assets	30	128.2	180.5
Total assets		39,520.9	41,124.3
Liabilities
Financial liabilities at fair value through profit or loss:				Managing risk
Derivative financial liabilities	23	127.9	94.0	(page 72)
Financial liabilities at amortised cost:
Borrowings from central banks		4,483.5	6,482.2
Deposits from credit institutions		0.7	3.4
Customer deposits	1	30,182.4	29,094.3*	Sources of funding
Repurchase agreements	4	–	1,084.8
Debt securities in issue	2	1,676.3	1,122.6	(page 51)
Subordinated liabilities	3	395.9	398.2
Lease liabilities	28	141.8	–
Other financial liabilities		80.6	66.4
Hedging derivative financial liabilities	23	288.5	346.0	Managing risk
Fair value adjustments for portfolio hedged risk	23	52.2	9.4*	(page 72)
Provisions	31	51.8	63.6
Other liabilities	32	153.3	495.4
Total liabilities		37,634.9	39,260.3
Equity Share capital		5.0	5.0
Share premium	24	965.1	965.1
Other reserves:	24
Merger reserve	24	616.5	616.5
Capital reorganisation reserve	24	(1,311.6)	(1,311.6)
Capital reserve	24	410.0	410.0
Retained profits brought forward	24	1,163.6	1,226.6
Profit/(loss) attributable to the shareholder for the current year	24	26.3	(63.0)
Valuation adjustments:
Fair value reserve	24	13.6	18.6
Cash flow hedging reserve	24	(2.5)	(3.2)
Shareholder's equity		1,886.0	1,864.0
Total equity and liabilities		39,520.9	41,124.3

* Comparative information has been re-presented to be consistent with the current year. As a result, fair value hedge accounting adjustments of £(10.0) million, previously included in customer deposits, have been presented in fair value adjustments for portfolio hedged risk.

The accompanying notes are an integral part of the consolidated financial statements. The consolidated financial statements on pages 45 to 90 were approved by the Board of Directors on 30 January 2020 and signed on its behalf by:

Debbie Crosbie Ralph Coates

TSB Banking Group plc Annual Report and Accounts 2019 page 48

Chief Executive Chief Financial Officer

Consolidated statement of comprehensive income

for the year ended 31 December 2019

		2019	2018
Income statement:	Note	£ million	£ million
Interest and similar income:
Interest income calculated using the effective interest method	12	1,050.6	1,072.2
Other interest income	12	(5.8)	(2.0)
Total interest and similar income		1,044.8	1,070.2
Interest and similar expense	12	(203.7)	(185.4)
Net interest income	12	841.1	884.8
Fee and commission income	13	159.8	122.1
Fee and commission expense	13	(41.5)	(46.7)
Net fee and commission income	13	118.3	75.4
Net gains/(losses) on financial assets and liabilities:
Gains on derecognition of financial assets measured at fair value through other comprehensive income		24.6	21.4
Losses on equity instruments at fair value through profit or loss		(0.1)	(1.4)
Losses on derivative financial assets at fair value through profit or loss		(14.6)	(34.0)
Gains from hedge accounting	23	20.8	23.3
(Losses)/gains on derecognition of non-financial assets		(3.5)	1.1
Other operating income:
Migration related income from Lloyds Banking Group	14	–	318.3
Other operating income	14	1.2	2.0
Other income		146.7	406.1
Total income		987.8	1,290.9
Operating expenses excluding costs of preparing for migration	15	(881.3)	(905.7)
Costs of preparing for migration	15	–	(417.3)
Total operating expenses	15	(881.3)	(1,323.0)
Operating profit/(loss) before impairment losses and taxation		106.5	(32.1)
Impairment losses on loans and advances to customers	10	(60.9)	(72.8)
Impairment credit/(loss) on loan commitments	31	0.4	(0.5)
Total Impairment losses		(60.5)	(73.3)
Profit/(loss) before taxation		46.0	(105.4)
Taxation	18	(19.7)	42.4
Profit/(loss) for the year	24	26.3	(63.0)
Other comprehensive income/(loss):
Items that may be subsequently reclassified to profit or loss:
Change in fair value reserve:
Change in fair value		17.3	9.6
Gains transferred to profit or loss on disposal		(24.6)	(7.3)
Taxation thereon	19	2.3	(0.6)
	24	(5.0)	1.7
Change in cash flow hedging reserve:
Change in the fair value of derivatives in cash flow hedges		(24.4)	(3.8)
Transfers to the income statement		24.4	1.1
Taxation thereon	19	0.7	–
	24	0.7	(2.7)
Other comprehensive loss for the year, net of taxation		(4.3)	(1.0)
Total comprehensive income/(loss) for the year		22.0	(64.0)

The accompanying notes are an integral part of the consolidated financial statements.

Consolidated statement of changes in equity

for the year ended 31 December 2019

				Capital reorg			Cash flow		Share
	Share capital £ million	Share premium £ million	Merger reserve £ million	anisation reserve £ million	Capital reserve £ million	Fair value reserve £ million	hedging reserve £ million	Retained profit £ million	holder's equity £ million
Balance at 1 January 2018	5.0	965.1	616.5	(1,311.6)	410.0	16.9		(0.5) 1,226.6	1,928.0
Comprehensive loss:
Loss for the year	–	–	–	–	–	–	–	(63.0)	(63.0)
Other comprehensive income/(loss)	–	–	–	–	–	1.7	(2.7)	–	(1.0)
Total comprehensive income/(loss)	–	–	–	–	–	1.7	(2.7)	(63.0)	(64.0)
Balance at 31 December 2018	5.0	965.1	616.5	(1,311.6)	410.0	18.6		(3.2) 1,163.6	1,864.0
Comprehensive income/(loss):
Profit for the year	–	–	–	–	–	–	–	26.3	26.3
Other comprehensive (loss)/income	–	–	–	–	–	(5.0)	0.7	–	(4.3)
Total comprehensive (loss)/income	–	–	–	–	–	(5.0)	0.7	26.3	22.0
Balance at 31 December 2019	5.0	965.1	616.5	(1,311.6)	410.0	13.6		(2.5) 1,189.9	1,886.0

The accompanying notes are an integral part of the consolidated financial statements.

Consolidated cash flow statement

for the year ended 31 December 2019

		2019	2018*
	Note	£ million	£ million
Cash flows from operating activities
Profit/(loss) before taxation		46.0	(105.4)
Adjustments for:
Change in operating assets and liabilities	33	(593.9)	(345.7)
Non-cash and other items	33	169.4	151.5
Taxation received/(paid)		20.5	(7.0)
Net cash used in operating activities		(358.0)	(306.6)
Cash flows from investing activities
Purchase of property, plant and equipment		(18.0)	(15.8)
Purchase and development of intangible assets		(7.6)	(11.8)
Purchase of debt securities		(994.9)	(1,757.0)
Sale of debt securities		1,424.3	1,358.9
Proceeds on disposal of Visa Inc. convertible preferred stock		–	9.2
Interest received		53.2	77.0
Net cash used in investing activities		457.0	(339.5)
Cash flows from financing activities
Proceeds from borrowing from central banks		–	850.0
Repayments of borrowing from central banks		(1,995.0)	–
Issue of debt securities in issue		750.0	–
Repayment of debt securities in issue		(177.5)	(197.9)
Repayments of repurchase agreements		(1,084.5)	(361.9)
Lease payments		(38.8)	-
Interest paid		(94.0)	(71.9)
Net cash provided by financing activities		(2,639.8)	218.3
Change in cash and cash equivalents		(2,540.8)	(427.8)
Cash and cash equivalents at 1 January	33	7,136.0	7,563.8
Cash and cash equivalents at 31 December	33	4,595.2	7,136.0

* Comparative information for 2018 has been reclassified to align with the current year presentation. This has resulted in cash outflows from the purchase and development of intangible assets of £11.8 million being reclassified from operating activities to investing activities and cash inflows from the sale of Sabadell shares of £9.2 million being reclassified from investment activities to operating activities. The overall effect was a reduction in net cash used in operating activities of £21.0 million, with a corresponding increase in net cash used in investing activities.

The accompanying notes are an integral part of the consolidated financial statements.

Sources of funding

Money deposited by customers into their bank and savings accounts provides the majority of the funds we use to support lending to customers. We also raise funds from other sources, including wholesale funding markets, that diversify our funding profile. Our shareholder also provides some funding in the form of equity capital in the business (see notes 22 and 24).

Accounting policies relevant to sources of funding

(a) Financial liabilities

Financial liabilities is the term used to describe TSB's deposits and funding. It includes customer deposits, deposits from credit institutions, borrowings from central banks, debt securities in issue, subordinated liabilities, other financial liabilities and derivative financial liabilities (see accounting policy (k) under Managing financial risk).

Financial liabilities which are not derivatives are measured at amortised cost. Issues of financial liabilities measured at amortised cost are recognised on settlement date. A financial liability is derecognised from the balance sheet when TSB has discharged its obligations, the contract is cancelled or the contract expires.

Borrowings (which include deposits from credit institutions, customer deposits, debt securities in issue and subordinated liabilities) are recognised initially at fair value, being their issue proceeds net of transaction costs incurred. These instruments are subsequently stated at amortised cost using the effective interest rate method.

1. Customer deposits

2019	2018*
£ million	£ million
Bank accounts 10,860.9	10,376.3
Instant access saving deposits 14,952.8	15,237.7
Deposits with agreed maturity 2,934.5	2,290.0
Business banking deposits 1,434.2	1,190.3
Total customer deposits 30,182.4	29,094.3

* Comparative information has been re-presented to be consistent with the current year. As a result, fair value hedge accounting adjustments of £(10.0) million, previously included in bank accounts, have been presented in fair value adjustments for portfolio hedged risk.

2. Debt securities in issue

			Exchange
			rate and
	Balance at 1	(Repayments)/	other	Balance at
	Jan 2019	Issues	adjustments	31 Dec 2019
2019	£ million	£ million	£ million	£ million
Securitisation programmes:
Duncan Funding 2015-1 plc	418.6	(48.2)	(14.7)	355.7
Duncan Funding 2016-1 plc	205.6	(129.3)	(5.5)	70.8
	624.2	(177.5)	(20.2)	426.5
Covered bond programme:
Series 2017-1 Covered Bonds	498.4	–	0.5	498.9
Series 2019-1 Covered Bonds	-	750.0	0.9	750.9
Total debt securities in issue	1,122.6	572.5	(18.8)	1,676.3

			Exchange rate and
2018	Balance at 1 Jan 2018 £ million	(Repayments)/ Issues £ million	other adjustments £ million	Balance at 31 Dec 2018 £ million
Securitisation programmes:
Duncan Funding 2015-1 plc	468.2	(53.1)	3.5	418.6
Duncan Funding 2016-1 plc	352.5	(143.3)	(3.6)	205.6
	820.7	(196.4)	(0.1)	624.2
Covered bond programme:
Series 2017-1 Covered Bonds	498.0	–	0.4	498.4
Total debt securities in issue	1,318.7	(196.4)	0.3	1,122.6

Sources of funding (continued)

2. Debt securities in issue (continued)

	31 Dec	31 Dec	Interest rate
	2019	2018	at 31 Dec	Maturity	Issue	Target of
Date of issue	£ million	£ million	2019	date	currency	offering
11/2015	101.5	149.5	1.49%	09/2020	GBR	Institutional
11/2015	254.2	269.1	0.08%	09/2020	EUR	Institutional
05/2016	15.8	48.1	–	04/2021	EUR	Institutional
05/2016	55.0	157.5	1.56%	04/2021	GBR	Institutional
12/2017	498.9	498.4	1.02%	12/2022	GBR	Institutional
02/2019	750.9	–	1.58%	02/2024	GBR	Institutional
	1,676.3	1,122.6
				Amount

Securitisation programmes

Loans and advances to customers include loans securitised under TSB's securitisation programmes, the majority of which have been sold to bankruptcy remote structured entities. As the structured entities are funded by the issue of debt on terms whereby the majority of the risks and rewards of the portfolio are retained by TSB, the structured entities are consolidated fully and all of these loans are retained on TSB's balance sheet, with the related notes in issue included within debt securities in issue.

TSB's securitisation programmes, together with the balances of the advances subject to these arrangements and the carrying value of the notes in issue at 31 December, are listed below.

	31 December 2019		31 December 2018
	Loans and advances securitised (1)		Loans and advances securitised (1) Liability	Liability
	£ million	£ million	£ million	£ million
Securitisation programmes:
Duncan Funding 2015-1 plc	1,191.7	1,293.5	1,370.9	1,486.4
Duncan Funding 2016-1 plc	2,086.6	2,241.7	2,386.1	2,546.1
	3,278.3	3,535.2	3,757.0	4,032.5
Less retained notes held by TSB		(3,108.7)		(3,408.3)
Total securitisation notes		426.5		624.2

(1) Due to the nature of the securitisation programmes, cash arising from mortgage repayments will be retained for periods of time before being invested in replacement mortgage assets or being distributed to note holders.

Cash deposits of £342.5 million (2018: £342.3 million) held by TSB are restricted in use to repayment of the debt securities issued by the structured entities and other legal obligations. TSB recognises the full liabilities associated with its securitisation programmes within debt securities in issue, although the obligations of TSB are limited to the cash flows generated from the underlying assets.

Covered bond programmes

Loans and advances to customers of £1,802.2 million (2018: £1,311.5 million) have been assigned to a limited liability partnership to provide security for the issuance of covered bonds of £1,249.8 million (2018: £498.4 million). TSB retains all of the risks and rewards associated with these loans and the partnership is consolidated fully with the loans retained on TSB's balance sheet, and the related covered bonds in issue included within debt securities in issue.

Cash deposits of £30.7 million (2018: £28.3 million) held by TSB are restricted in use to repayment of the term advances related to covered bonds and other legal obligations. At 31 December 2019, TSB had over-collateralised the covered bond programmes in order to: meet the programme terms; secure the rating of the covered bonds; and to provide operational flexibility. The obligations of TSB to provide collateral may increase due to the formal requirements of the programmes. TSB may also voluntarily contribute collateral to support the ratings of the covered bonds.

Sources of funding (continued)

3. Subordinated liabilities

	2019	2018
	£ million	£ million
Fixed/floating rate reset callable subordinated Tier 2 notes due May 2026	384.6	384.4
Accrued interest	3.4	3.4
Fair value hedge accounting adjustments	7.9	10.4
Total subordinated liabilities	395.9	398.2

TSB Banking Group plc (the Company) issued, in 2014, £385.0 million of fixed/floating rate reset callable subordinated Tier 2 notes at an issue price of 99.493% of the principal amount. The notes pay interest at a rate of 5.75% per annum, payable semi-annually in arrears until 6 May 2021 at which time the interest rate becomes 3 month LIBOR plus 3.43% per annum payable quarterly in arrears. The Company has the option to redeem these notes on 6 May 2021 and quarterly thereafter, subject to approval of the PRA.

4. Repurchase agreements

As part of its liquidity management activities, from time to time TSB enters in to repurchase agreements that transfer legal title of certain UK gilts in return for cash, together with an agreement to repurchase the assets at a later date and at a predetermined price. The gilts are not derecognised from TSB's consolidated balance sheet as substantially all of the rewards, including interest income, and risks, including credit and interest rate risks, are retained by TSB. In all cases, the transferee has the right to sell or repledge the gilts concerned, subject to delivering the securities at the repurchase date. The table below presents the carrying values, including accrued interest, of the transferred gilts and the associated repurchase agreement liabilities. The associated liabilities represent TSB's obligation to repurchase the transferred assets.

Carrying	Carrying	Carrying	Carrying
amount of	amount of	amount of	amount of
transferred	associated	transferred	associated
assets	liabilities	assets	liabilities
2019	2019	2018	2018
£ million	£ million	£ million	£ million
–	–	1,084.5	1,084.8
–	–	1,084.5	1,084.8

5. Fair value of financial liabilities

The following table summarises the carrying values and fair values of financial liabilities presented on TSB's balance sheet. The fair values presented in the table are at a specific date and may be significantly different from the amount which will actually be paid on the maturity or settlement date.

		2019		2018
		Carrying	Fair	Carrying	Fair
	Note	value £ million	value £ million	value £ million	value £ million
Financial liabilities
Customer deposits	1	30,182.4	30,214.6	29,094.3	29,096.4
Debt securities in issue	2	1,676.3	1,684.4	1,122.6	1,121.4
Subordinated liabilities	3	395.9	398.3	398.2	381.1
Derivative liabilities at fair value through profit or loss	23	127.9	127.9	94.0	94.0
Hedging derivative liabilities	23	288.5	288.5	346.0	346.0

The carrying amount of borrowings from central banks, deposits from credit institutions, repurchase agreements and other financial liabilities is a reasonable approximation of fair value as these balances are either on demand or variable rate. Fair value is the price that would be paid to transfer a liability (or sell an asset) in an orderly transaction between market participants at the measurement date.

Sources of funding (continued)

5. Fair value of financial liabilities (continued)

The fair values of TSB's financial liabilities that are traded in active markets are based on current offer prices. For those instruments which do not have an active market, fair values have been determined using valuation techniques which include reference to recent arm's length transactions, or reference to other instruments with characteristics similar to those of the instruments held by TSB. Valuation techniques used include discounted cash flow analysis and, where appropriate, comparison to instruments with characteristics similar to those of the instruments held by TSB.

The fair value of customer deposits repayable on demand and repurchase agreements is considered to be equal to their carrying value. The fair value for all other customer deposits is estimated using discounted cash flows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities. TSB's subordinated liabilities and derivative financial liabilities are primarily valued using discounted cash flows where the most significant input is interest yield curves developed from publicly quoted rates and by reference to instruments with similar risk characteristics as the instruments held by TSB. Derivative financial instruments are the only financial liabilities of TSB that are carried at fair value.

Valuation hierarchy of financial instruments

Financial instruments carried at fair value, or for which fair values are disclosed, have been classified into three levels according to the quality and reliability of information used to determine the fair values.

Level 1 - Level 1 fair value measurements are those derived from unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Level 2 valuations are those where quoted market prices are not available, for example where the instrument is traded in a market that is not considered to be active or valuation techniques are used to determine fair value and where these techniques use inputs that are based significantly on observable market data.

Level 3 - Level 3 portfolios are those where at least one input which could have a significant effect on the instrument's valuation is not based on observable market data.

The table below analyses the fair values of TSB's financial liabilities.

	Level 1 £ million	Level 2 £ million	Level 3 £ million	Total fair value £ million	Total carrying value £ million
At 31 December 2019
Customer deposits	–	30,214.6	–	30,214.6	30,182.4
Debt securities in issue	1,684.4	–	–	1,684.4	1,676.3
Subordinated liabilities	–	398.3	–	398.3	395.9
Derivative liabilities at fair value through profit or loss	–	127.9	–	127.9	127.9
Hedging derivative liabilities	–	288.5	–	288.5	288.5
At 31 December 2018
Customer deposits	–	29,096.4	–	29,096.4	29,094.3
Debt securities in issue	1,121.4	–	–	1,121.4	1,122.6
Subordinated liabilities	–	381.1	–	381.1	398.2
Derivative liabilities at fair value through profit or loss	–	94.0	–	94.0	94.0

Hedging derivative liabilities – 346.0 – 346.0 346.0

Loans and liquid assets

Funds deposited with TSB are primarily used to support lending to customers. TSB lends money to customers using different products, including mortgages, credit cards, unsecured personal loans and overdrafts. A portion of the funds are held in reserve – we call that our liquidity portfolio, which enables TSB to meet unexpected future funding requirements.

Accounting policies effective for the year ended December 2019

(b) Classification and measurement of financial assets

Financial assets is the term used to describe TSB's loans to customers and other institutions. It includes loans and advances to customers, credit institutions, and central banks, financial assets at fair value through other comprehensive income, cash and balances with central banks and other demand deposits, derivative financial assets (see accounting policy (j) under Managing financial risk), and other advances.

On initial recognition, financial assets are classified into one of three measurement categories, amortised cost, fair value through other comprehensive income, or fair value through profit or loss depending on TSB's business model for managing the financial assets and whether the cash flows represent solely payments of principal and interest.

TSB assesses its business models at a portfolio level based on its objectives for the relevant portfolio, how performance of the portfolio is measured and reported, how management are compensated, and the frequency and the reasons for asset sales from the portfolio. TSB reclassifies financial assets only when its business model for managing the portfolio of assets changes.

Financial assets measured at amortised cost

Financial assets in portfolios where the business model is to hold the assets to collect the contractual cash flows and where those cash flows represent solely payments of principal and interest are measured at amortised cost. Cash flows are considered to represent solely payments of principal and interest where they are consistent with a basic lending arrangement. Where the contractual cash flows introduce exposures to risk or volatility unrelated to a basic lending arrangement, such as from changes in equity prices, the cash flows are not considered to be solely payments of principal and interest.

Financial assets measured at amortised cost are initially recognised when the cash is advanced to the borrower at fair value including transaction costs. Subsequent measurement is at amortised cost, using the effective interest rate method. The carrying amount of these assets is adjusted by an expected credit loss allowance. TSB's cash, cash balances at central banks and other demand deposits, loans to customers, loans to credit institutions, loans to central banks, and other advances are measured at amortised cost.

Financial assets measured at fair value through other comprehensive income (FVOCI)

Financial assets in portfolios where the business model is to hold the assets to collect the contractual cash flows and to generate cash flows from selling assets are measured at fair value including transaction costs. Where the cash flows represent solely payments of principal and interest, gains and losses arising from changes in fair value are recognised directly in other comprehensive income. When the financial asset is either sold or matures, the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement. Interest income is calculated using the effective interest method and is recognised in the income statement in net interest income. Foreign exchange gains and losses on financial assets denominated in foreign currencies are recognised in the income statement in exchange gains or losses. Impairment losses are recognised in the income statement.

Financial assets measured at fair value through profit or loss (FVPL)

Financial assets that do not meet the criteria for amortised cost or FVOCI are measured at fair value on initial recognition and subsequently. Fair value gains and losses are recognised in the income statement within net trading income. Derivative financial assets are measured at FVPL (see accounting policy (j) under Managing financial risk). All equity instruments are measured at fair value through profit or loss. Dividends continue to be recognised in the income statement.

Loans and liquid assets (continued)

Accounting policies effective for the year ended December 2019 (continued)

(c) Impairment of financial assets

The impairment requirements of IFRS 9 apply to financial assets measured at amortised cost and debt instruments measured at FVOCI. At initial recognition, an impairment allowance is required for expected credit losses (ECL) resulting from default events expected within the next 12 months (12 month ECL). In the event of a significant increase in credit risk, allowance is required for ECL resulting from default events expected over the estimated life of the financial instrument (lifetime ECL). IFRS 9 requires the financial asset to be allocated to one of the following three 'stages':

• ➢ Stage 1 Financial assets which have not experienced a significant increase in credit risk since they were originated. Recognition of a 12 month ECL is required. Interest income on stage 1 financial assets is calculated on the gross carrying amount of the financial asset;
• ➢ Stage 2 Financial assets which have experienced a significant increase in credit risk. For financial assets in stage 2, recognition of a lifetime ECL impairment allowance is required. Interest income on stage 2 financial assets is calculated on the gross carrying amount of the financial asset; and
• ➢ Stage 3 Financial assets which have experienced one or more events that have had a detrimental impact on the estimated future cash flows and are considered to be credit impaired. Like stage 2, recognition of a lifetime expected ECL impairment allowance is required. However, interest income on stage 3 loans is calculated on the financial asset balance net of the impairment allowance.

Financial assets that are credit impaired at the date of their purchase or origination will be reported in a separate 'purchased or originated as credit impaired' (POCI) category until the loan is derecognised. The cumulative change in lifetime expected credit loss since the purchase or origination of the financial asset is recognised as a loss allowance.

Definition of default

Loans and advances that are more than 90 days past due, or considered by management as unlikely to pay their obligations in full without realisation of collateral, are considered to be in default for IFRS 9. TSB policy is not to rebut the presumption in IFRS 9 that loans which are more than 90 days past due are in default.

Grouping of financial assets for credit impairment losses measured on a collective basis

Expected credit losses are assessed and measured on a collective basis for homogenous groups where the financial assets within that group share similar credit risk characteristics. Given the predominant retail nature of TSB's loans, groupings are determined using product type, such as residential mortgages, personal loans, overdrafts, and credit card balances. The appropriateness of the groupings is monitored and reviewed on a periodic basis. TSB does not currently assess any material exposures on an individual basis.

Significant increase in credit risk

Financial assets are considered to be in stage 2 when their credit risk has increased significantly since initial recognition. The main factor that is considered by TSB is an increase in the residual lifetime Probability of Default (PD) since initial recognition. A loan will be considered to have experienced a significant increase in credit risk, and be transferred from stage 1 to stage 2 if the residual lifetime PD has increased by a factor of 2 times the origination PD and the increase is at least 10 bps (for mortgages) and between 30 and 100 bps for unsecured products. As a secondary assessment criterion, financial assets that are in forbearance but not credit impaired are considered to have experienced significant increase in credit risk and will be in stage 2. As a backstop, TSB does not rebut the presumption in IFRS 9 that all financial assets that are more than 30 days past due have experienced a significant increase in credit risk.

In respect of loans, TSB does not use the practical expedient available in IFRS 9 which permits low credit risk loans (i.e. those considered investment grade) to remain in Stage 1 without an assessment of significant increase ('low credit risk exemption'). In respect of TSB's investment grade debt securities, TSB does take advantage of the low credit risk exemption and categorises these financial assets as stage 1.

Credit Impaired (stage 3)

Financial assets are considered to be credit impaired and included in stage 3 when there is objective evidence of credit impairment. TSB assesses a loan as stage 3 when contractual payments of either principal or interest are past due for more than 90 days, the debtor is assessed as unlikely to pay, or the loan is otherwise considered to be in default.

Loans and liquid assets (continued)

Accounting policies effective for the year ended December 2019 (continued)

(c) Impairment of financial assets (continued)

Purchased or originated credit impaired (POCI)

Financial assets that are credit impaired at the date of their purchase or origination will be reported in a separate POCI category and will recognise the cumulative change in lifetime expected credit loss since origination as a loss allowance. Subsequent to origination, POCI financial assets that no longer meet the stage 3 criteria will no longer be considered to be credit impaired but will continue to be reported as POCI.

Write offs

A loan or advance is normally written off, either partially or in full, against the related allowance when the proceeds from realising any available security have been received or there is no realistic prospect of recovery (as a result of the customer's insolvency, ceasing to trade or other reason) and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of impairment losses recorded in the statement of comprehensive income.

Modified financial assets and derecognition

Where the contractual cash flows of a financial asset have been renegotiated or modified and the financial asset was not derecognised, its gross carrying amount is recalculated as the present value of the modified contractual cash flows, discounted at the original effective interest rate with a gain or loss recognised in the income statement. The contractual terms of a loan may be modified for a number of reasons, primarily due to customers being granted a concession due to their financial difficulty and the loan being considered in forbearance. Customer treatments identified as entry to forbearance will result in loans being considered as modified under IFRS 9.

Methodology for measuring expected credit losses

The allowance for ECLs is calculated using three main components: a probability of default (PD), a loss given default (LGD); and the exposure at default (EAD). For accounting purposes, the 12 month and lifetime PDs represent the probability of a default occurring over the next 12 months or the lifetime of the financial instruments, respectively, based on conditions existing at the balance sheet date and expected future economic conditions that affect credit risk.

The LGD represents losses expected on default, taking into account the mitigating effect of collateral, its expected value when realised and the time value of money and is discounted using the effective interest rate. The EAD represents the expected balance at default, taking into account the repayment of principal and interest from the balance sheet date to the default event together with any expected drawdown of a committed facility.

ECL is calculated by multiplying the PD (12 month or lifetime depending on the staging of the loan), LGD and EAD. In respect of TSB's mortgages and unsecured personal loans, ECL is calculated from the initial recognition of the loan for the maximum contractual period that TSB is exposed to credit risk. However, in respect of revolving loans, such as overdrafts and credit cards, TSB's exposure to credit risk is not limited to the contractual period and therefore the expected life is calculated based on the estimated behavioural life of the loan and associated undrawn facility. The measurement of ECL also takes in to account all reasonable and supportable information, including forward looking economic scenarios to calculate a probability weighted forward looking estimate.

(d) Derecognition of financial assets

Financial assets are derecognised when the contractual right to receive cash flows from those assets has expired or when TSB has transferred its contractual right to receive the cash flows from the assets and either (i) substantially all of the risks and rewards of ownership have been transferred; or (ii) TSB has neither retained nor transferred substantially all of the risks and rewards, but has transferred control.

Securitisations

Where TSB enters into securitisation transactions to finance certain loans and advances to customers using a structured entity funded by the issue of debt, these loans and advances continue to be recognised by TSB together with a corresponding liability for the funding where TSB retains control of the structured entity.

Repurchase agreements

Financial instruments sold under a repurchase agreement, under which substantially all the risks and rewards of ownership are retained by TSB, continue to be recognised on the balance sheet and the sale proceeds are recognised as a financial liability. The difference between the sale and repurchase price is recognised over the life of the agreement as interest expense using the effective interest method.

Loans and liquid assets (continued)

6. Debt securities

Fair value through other comprehensive income (FVOCI)	2019	2018
UK Gilts	£ million 1,171.4	£ million 1,962.5
Supranational and development bank bonds	416.0	425.3
Total debt securities at FVOCI	1,587.4	2,387.8
Amortised cost	2019 £ million	2018 £ million
UK Gilts	102.9	96.2
Supranational and development bank bonds	279.4	–
Covered bonds	166.3	–
Total debt securities at amortised cost	548.6	96.2

Debt securities of £1,587.4 million (2018: £2,387.8 million) are held as part of the liquid asset portfolio, where the business model is to hold the assets to collect the contractual cash flows and to generate cash flows from selling the assets. These assets are carried at FVOCI. During 2018, a second portfolio of liquid assets was established, which at 31 December 2019 held £548.6 million (2018: £96.2 million) of debt securities, where the business model is solely to hold the assets to collect the contractual cash flows and which are carried at amortised cost.

At 31 December 2019, UK gilts at FVOCI with a carrying value, including accrued interest, of £nil (2018: £1,084.5 million) were subject to repurchase agreements (note 4). A further £131.7 million had been pledged as collateral (2018: £37.0 million).

7. Loans to credit institutions

	2019	2018
	£ million	£ million
Cash deposits held	373.2	370.6
Total loans to credit institutions	373.2	370.6

Loans to credit institutions comprise cash deposits held by TSB's securitisation and covered bond entities.

Loans and liquidity assets (continued)

8. Loans and advances to customers

2018
£ million
27,930.3
2,214.7
62.2
30,207.2
(163.0) (198.7)
30,008.5
2019 £ million 29,189.2 1,986.2 63.4 31,238.8 31,075.8

(1) Comprises unsecured lending of £1,855.1 million (2018: £2,067.5 million) and business banking lending of £131.1 million (2018: £147.2 million).

(2) Valuation adjustments comprise of accrued interest and effective interest rate adjustments.

(3) Comprises allowance for credit impairment losses on secured lending of £34.7 million (2018: £36.5 million), unsecured lending of £125.1 million (2018: £160.2 million) and business banking lending of £3.2 million (2018: £2.0 million).

In the normal course of business, TSB provides commitments to lend to its customers as presented below.

	2019	2018
	£ million	£ million
Credit cards	2,697.5	2,661.8
Mortgage offers made	1,164.5	1,030.0
Current accounts and other lending (1)	1,091.6	1,086.3
Total commitments	4,953.6	4,778.1

(1) Includes Whistletree of £280.8 million (2018: £282.8 million).

The credit impairment provision in respect of total loan commitments was £2.6 million (2018: £3.0 million) as set out in note 31 and primarily relates to credit impairment provisions in respect of current account overdrafts. Expected credit losses on credit card commitments are recognised as part of the allowance for credit impairment losses as set out in note 10.

Of the amounts shown above, £1,471.4 million (2018: £1,312.9 million) was irrevocable. Commitments to lend to customers of £4,718.6 million (2018: £4,540.1 million) had a contractual maturity of less than one year.

9. Other advances

	2019	2018
	£ million	£ million
Items in the course of collection from credit institutions	16.6	27.6
Items in the course of collection from non-credit institutions	0.4	14.8
Collateral placed at central clearing houses	257.3	326.9
Collateral placed with credit institutions	5.3	12.8
Total other advances	279.6	382.1

Loans and liquid assets (continued)

10. Allowance for credit impairment losses on financial assets at amortised cost

The following tables detail changes in the gross carrying value of loans to customers and loss allowance during the year.

	Stage 1		Stage 2			Stage 3		POCI (1)	Total
TSB	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million
At 1 January 2018	28,548.8	(54.0)	1,812.6	(52.2)	338.0	(50.6)	226.4	(8.5)	30,925.8	(165.3)
Changes reflected in impairment losses:
Increases due to originations	5,181.4	(9.4)	27.4	–	9.3	–	–	–	5,218.1	(9.4)
Decreases due to repayments	(5,389.6)	3.5	(393.7)	5.5	(65.3)	0.9	(36.2)	0.7	(5,884.8)	10.6
Changes in credit risk (2)	–	9.1	–	(23.1)	–	(59.2)	–	0.6	–	(72.6)
Other movements:
Transfers between stages	(1,607.4)	–	1,438.4	–	169.0	–	–	–	–	–
Amounts written off	(0.7)	–	(0.5)	0.1	(50.7)	37.9	–	–	(51.9)	38.0
At 31 Dec 2018 (incl. valuation adjustments)	26,732.5	(50.8)	2,884.2	(69.7)	400.3	(71.0)	190.2	(7.2)	30,207.2	(198.7)
Less: Valuation adjustments	(53.7)		(6.3)		(2.0)		(0.2)		(62.2)
At 31 December 2018	26,678.8	(50.8)	2,877.9	(69.7)	398.3	(71.0)	190.0	(7.2)	30,145.0	(198.7)
Changes reflected in impairment losses:
Increases due to originations	6,206.7	(23.3)	34.8	–	11.2	–	5.7	–	6,258.4	(23.3)
Decreases due to repayments	(4,400.8)	10.5	(612.7)	3.4	(72.4)	2.2	(34.4)	0.1	(5,120.3)	16.2
Changes in credit risk (2)	–	75.1	–	(82.5)	–	(23.7)	–	4.9	–	(26.2)
Amounts written off	(0.1)	–	(0.8)	0.7	(106.8)	68.3	–	–	(107.7)	69.0
Transfers between stages:	(302.9)	(63.8)	150.7	87.3	152.2	(23.5)	–	–	–	–
To stage 1	3,433.0	(80.6)	(3,413.5)	77.4	(19.5)	3.2	–	–	–	–
To stage 2	(3,710.8)	16.2	3,784.3	(22.2)	(73.5)	6.0	–	–	–	–
To stage 3	(25.1)	0.6	(220.1)	32.1	245.2	(32.7)	–	–	–	–
At 31 December 2019	28,181.7	(52.3)	2,449.9	(60.8)	382.5	(47.7)	161.3	(2.2)	31,175.4	(163.0)

(1) Purchased or originated as credit impaired.

(2) Includes changes to the allowance for credit impairment losses arising from stage transfers and other changes to risk parameters.

Impairment losses on loans and advances to customers recognised in the income statement of £60.9 million comprise of changes reflected in impairment losses and amounts written off gross loans and allowance for credit impairment losses, as set out in the table above, offset by amounts charged directly to the income statement, primarily cash recoveries.

During 2019, stage 1 balances increased reflecting net lending, primarily in the secured portfolio. Stage 2 balances decreased by £428.0 million to £2,449.9 million, primarily reflecting ongoing repayments by customers of principal and interest.

Stage 3 balances decreased by £15.8 million to £382.5 million. Transfers from stage 2 were in part due to a temporary increase in secured arrears earlier in 2019. While secured arrears subsequently improved, the reduction in stage 3 balances was muted by the effect of TSB's policy to apply a six month probation period before permitting stage 3 loans to transfer back to stage 2. Write offs increased in 2019, particularly in unsecured balances, following a temporary cessation during the post migration period in 2018.

Loans and liquid assets (continued)

10. Allowance for credit impairment losses on financial assets at amortised cost (continued)

The tables below set out movements analysed between TSB's mortgage portfolios and other lending classes.

	Stage 1			Stage 2 Stage 3 POCI Total
Secured (retail)	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million	Gross Loans £ million	Allow. for credit impair ment losses £ million
At 1 January 2018	26,542.3	(15.9)	1,332.4	(2.2)	249.2	(7.6)	223.0	(8.2)	28,346.9	(33.9)
Changes reflected in imp. loss:
Increases due to originations	4,834.3	(4.8)	–	–	–	–	–	–	4,834.3	(4.8)
Decreases due to repayments	(4,936.4)	1.8	(201.1)	0.6	(46.7)	0.4	(33.0)	0.6	(5,217.2)	3.4
Changes in credit risk	–	1.3	–	(2.8)	–	(1.3)	–	0.6	–	(2.2)
Other movements:
Transfers between stages	(1,207.8)	–	1,120.4	–	87.4	–	–	–	–	–
Amounts written off	(0.7)	–	(0.5)	–	(2.5)	1.0	–	–	(3.7)	1.0
At 31 Dec 2018 (incl. valuation adjustments)	25,231.7	(17.6)	2,251.2	(4.4)	287.4	(7.5)	190.0	(7.0)	27,960.3	(36.5)
Less: Valuation adjustments	(29.4)		(0.3)		(0.1)		(0.2)		(30.0)
At 31 December 2018	25,202.3	(17.6)	2,250.9	(4.4)	287.3	(7.5)	189.8	(7.0)	27,930.3	(36.5)
Changes reflected in imp. loss:
Increases due to originations	5,823.1	(18.3)	6.3	–	3.0	–	3.4	–	5,835.8	(18.3)
Decreases due to repayments	(4,054.6)	9.7	(425.6)	0.8	(62.8)	1.0	(32.0)	–	(4,575.0)	11.5
Changes in credit risk	–	12.8	–	(7.7)	–	(1.4)	–	4.9	–	8.6
Amounts written off	–	–	–	–	(1.9)	–	–	–	(1.9)	–
Transfers between stages:	(223.4)	(2.9)	145.3	3.8	78.1	(0.9)	–	–	–	–
To stage 1	2,776.5	(5.6)	(2,762.9)	5.5	(13.6)	0.1	–	–	–	–
To stage 2	(2,990.1)	2.7	3,055.7	(3.9)	(65.6)	1.2	–	–	–	–
To stage 3	(9.8)		(147.5)	2.2	157.3	(2.2)	–	–	–	–
At 31 December 2019	26,747.4	(16.3)	1,976.9	(7.5)	303.7	(8.8)	161.2	(2.1)	29,189.2	(34.7)
Unsecured and business banking
At 1 January 2018	2,006.5	(38.1)	480.2	(50.0)	88.8	(43.0)	3.4	(0.3)	2,578.9	(131.4)

Changes reflected in imp. loss:
Increases due to originations	347.1	(4.6)	27.4	–	9.3	–	–	–	383.8	(4.6)
Decreases due to repayments	(453.2)	1.7	(192.6)	4.9	(18.6)	0.5	(3.2)	0.1	(667.6)	7.2
Changes in credit risk	–	7.8	–	(20.3)	–	(57.9)	–	–	–	(70.4)
Other movements:
Transfers between stages	(399.6)	–	318.0	–	81.6	–	–	–	–	–
Amounts written off	–	–	–	0.1	(48.2)	36.9	–	–	(48.2)	37.0
At 31 Dec 2018 (incl. valuation adjustments)	1,500.8	(33.2)	633.0	(65.3)	112.9	(63.5)	0.2	(0.2)	2,246.9	(162.2)
Less: Valuation adjustment	(24.3)		(6.0)		(1.9)		0.0		(32.2)
At 31 December 2018	1476.5	(33.2)	627.0	(65.3)	111.0	(63.5)	0.2	(0.2)	2,214.7	(162.2)
Changes reflected in imp. loss:
Increases due to originations	383.6	(5.0)	28.5	–	8.2	–	2.3	–	422.6	(5.0)
Decreases due to repayments	(346.2)	0.8	(187.1)	2.6	(9.6)	1.2	(2.4)	0.1	(545.3)	4.7
Changes in credit risk	–	62.3	–	(74.8)	–	(22.3)	–	–	–	(34.8)
Amounts written off	(0.1)	–	(0.8)	0.7	(104.9)	68.3	–	–	(105.8)	69.0
Transfers between stages:	(79.5)	(60.9)	5.4	83.5	74.1	(22.6)	–	–	–	–
To stage 1	656.5	(75.0)	(650.6)	71.9	(5.9)	3.1	–	–	–	–
To stage 2	(720.7)	13.5	728.6	(18.3)	(7.9)	4.8	–	–	–	–
To stage 3	(15.3)	0.6	(72.6)	29.9	87.9	(30.5)	–	–	–	–
At 31 December 2019	1,434.3	(36.0)	473.0	(53.3)	78.8	(38.9)	0.1	(0.1)	1,986.2	(128.3)

Gross loans written off during 2019 of £105.8 million (2018: £51.9 million) continued to be subject to enforcement action.

Loans and liquid assets (continued)

10. Allowance for credit impairment losses on financial assets at amortised cost (continued)

Significant estimates - measurement uncertainty and sensitivity analysis of expected credit losses

The measurement of ECL is complex and involves the use of significant judgement and estimation. Including the application of multiple forward-looking economic conditions into ECL. The adequacy of the allowance is estimated using models which use a variety of inputs, including recent historical experience to estimate the level of expected credit losses (ECL) in the portfolio. In certain circumstances adjustments are made to the modelled outcomes to reflect where, in management's judgement, the modelled outcomes are not sufficiently sensitive to current economic conditions, referred to as post model adjustments (PMA).

At 31 December 2019, the allowance of £163.0 million (2018: £198.7 million) included PMAs of £57.6 million (2018: £51.4 million). These comprised of adjustments to secured impairment models of £30.0 million (2018: £30.9 million) and adjustments to unsecured and business banking impairment models of £27.6 million (2018: £20.5 million). The most significant adjustments to modelled outputs reflect management's judgement of risks associated with (i) interest only mortgage redemptions, (ii) customers' ability to service their borrowings in a higher interest rate environment, and (iii) estimating future discounts on realising collateral. PMAs are, themselves, primarily models in nature, where the methodology and output is subject to regular oversight. PMAs in respect of interest only mortgages are allocated to stages based on the relative proportion of risk weighted assets. The impairment models continue to be developed, including work to align with changes to capital models to adopt the required regulatory change in 2020 to a 90 day definition of default on the secured portfolio. These changes are expected to reduce the proportion of the allowance comprising of PMAs.

Methodology

TSB currently uses five economic scenarios, representative of our view of forecast economic conditions, which are selected in order to capture material non-linearities and calculate an unbiased ECL. Key scenario assumptions are set internally and with reference to data published by the Bank of England, to ensure the IFRS 9 scenarios are unbiased and reflect the use of independent information.

For the base scenario, key assumptions are set for house price inflation, unemployment and Bank Base Rate, and are benchmarked against Bank of England forecasts. In assessing the composition and severity of the other scenarios, the key variables are considered in the context of the Bank of England's forecast distribution and with reference to the macroeconomic risks in TSB's top and emerging risks. This seeks to ensure that scenarios remain consistent with the more qualitative assessment of risks captured in top and emerging risks. Scenarios used for IFRS 9 are formally reassessed twice a year and updated, as necessary. Economic developments and the number of scenarios are reviewed throughout the year to enable significant developments to be taken into account in measuring credit impairment provisions.

Forecast Economic Scenarios

In determining scenarios for inclusion in measuring credit impairment provisions, the following scenarios were considered:

• Base This scenario represents the most likely economic forecast and is consistent with the central scenario used in TSB's medium term financial plan. It features a relatively hard, but smooth, Brexit where supply and demand remain balanced. Moderate GDP growth, consistent with recent experience at sub 2% is forecast over the period 2020-24. This scenario features a steady circa 4% unemployment rate with house prices trending gently higher in real terms and the Bank of England base rate remaining at historical lows, peaking at 1.25%.
• Upside assumes a higher increase in productivity growth than the base case without the development of serious inflation and provides a more favourable interest rate environment for banks' earnings. Unemployment shows a steady decline to a low of 3%, marking a historical UK low. Wage growth supports faster house price growth.
• Mild downside introduced in 2019 to capture the effects of a managed 'no deal' Brexit. This scenario assumes the UK economy endures a short, shallow recession. The employment market weakens to a degree with unemployment peaking at 5.1% which drives lower house prices with a peak to trough decline of 14.0%. While economic activity recovers quickly, the imposition of trade barriers with the EU contributes to weaker long run economic growth than the base case.
• Downside assumes a rapid tightening of UK and global financial conditions that are triggered by higher inflation and concerns about asset price valuations. These lead to reduced liquidity, higher risk premia and interest rates and weaker economic activity. This scenario features a peak to trough house price fall of 20.5% and unemployment peaking at 6.3%. This scenario is considered to be reflective of a 'No Deal' Brexit but where the transition to WTO rules and future trading arrangements is more orderly than a 'cliff-edge' exit.
• Severe downside designed to capture a high impact, low probability extreme scenario consistent with a disorderly 'cliff edge no deal' Brexit. This scenario features a sharp increase in inflation, promoted by a severe decline in sterling. In response, interest rates increase, peaking at 4%, precipitating a sharp peak to trough decline in house prices of 34.5%.

Loans and liquid assets (continued)

10. Allowance for credit impairment losses on financial assets at amortised cost (continued)

Significant estimates - measurement uncertainty and sensitivity analysis of expected credit losses

The table below summarises the forecast economic scenarios applied in measuring ECL at 31 December 2019.

						At 31 December 2019
				Mild		Severe
		Base case %	Upside %	Down %	Downside	Down %
Scenario weighting		40	10	20	25	5
Unemployment	Peak rate	3.8	3.8	5.1	6.3	9.2
House prices	Peak-to-trough fall	+ve	+ve	(14.0)	(20.5)	(34.5)
Interest rates	Most extreme rate(1)	0.75	2.0	0.25	0.0	4.0
						At 31 December 2018
				Mild		Severe
		Base case %	Upside %	Down %	Downside	Down %
Scenario weighting		65	15	-	20	-
Unemployment	Peak rate	4.2	4.2	-	6.4	-
House prices	Peak-to-trough fall	(3.1)	(3.1)	-	(25.6)	-
Interest rates	Most extreme rate(1)	2.0	2.5	-	3.3	-

(1) The most extreme rate is the interest rate furthest from the current rate, either positive or negative.

Key variables in each of the scenarios, as set out above, are forecast over the period 2020-24. Beyond this, they are assumed to revert to a long term constant rate over a period of up to two years after the end of the initial forecast period. At 31 December 2019, the long term rates were assumed to be: unemployment at 3.6%; interest rates at 1.25%; and house price growth of 3.75% per annum.

Effect of multiple economic scenarios on ECL and sensitivity to alternative assumptions

The ECL recognised in the financial statements reflects the effect on expected credit losses of a range of possible outcomes, calculated on a probability-weighted basis, based on the scenarios described above. The probability-weighted amount is typically a higher number than would result from using only the base economic scenario.

Credit losses and defaults typically have a non-linear relationship to the many factors which influence credit losses, such that more favourable macroeconomic factors do not reduce expected losses as much as less favourable macroeconomic factors increase expected losses. The probability-weighted ECL are 19% higher (2018: 9% higher) than the ECL prepared using only base scenario assumptions.

The impairment provision is sensitive to alternative economic scenarios and weightings. At 31 December 2019, a 10% increase in the weighting of the downside scenario (from 25% to 35%), coupled with a 10% decrease in the weighting of the base scenario (from 40% to 30%) would result in an increase of £5 million in the impairment provision. Applying a weighting of 100% to the 2019 downside scenario would result in an increase in the impairment allowance of approximately £21 million.

At the end of 2018, a 10% switch to the downside from the base scenario would have increased the allowance by £11 million. Applying a 100% weighting to the 2018 downside scenario would have increased the allowance by £81 million.

11. Fair value of financial assets

The following table summarises the carrying values of financial assets presented on TSB's consolidated balance sheet and the fair value of these financial instruments. The fair values presented are at a specific date and may be significantly different from the amount which will actually be received on the maturity or settlement date.

		2019		2018
	Note	Carrying value £ million	Fair value £ million	Carrying value £ million	Fair value £ million
Financial assets
Debt securities at amortised cost	6	548.6	549.9	96.2	95.1
Loans and advances to customers	8	31,075.8	31,040.7	30,008.5	29,962.0
Financial assets at fair value through other comprehensive income	6	1,587.4	1,587.4	2,387.8	2,387.8
Derivative financial assets at fair value through profit or loss	23	112.0	112.0	88.4	88.4
Hedging derivative financial assets	23	93.4	93.4	106.6	106.6
Financial assets at fair value through profit or loss		–	–	2.2	2.2

Cash, cash balances at central banks and other demand deposits; loans and advances to central banks; loans and advances to credit institutions and other advances are generally short term in nature and to counterparties with a high credit quality and the carrying amount is a reasonable approximation of fair value.

Loans and liquid assets (continued)

11. Fair value of financial assets (continued)

Valuation hierarchy of financial assets carried at amortised cost

The table below analyses the fair values of financial assets carried at amortised cost and for which fair value is disclosed.

	Level 1 £ million	Level 2 £ million	Level 3 £ million	Total fair value £ million	Total carrying value £ million
Debt securities at amortised cost	549.9	–	–	549.9	548.6
Loans and advances to customers	–	–	31,040.7	31,040.7	31,075.8
At 31 December 2019	549.9	–	31,040.7	31,590.6	31,624.4
At 31 December 2018	95.1	–	29,962.0	30,057.1	30,104.7

TSB provides loans at both fixed and variable rates. Fair value is principally estimated by discounting anticipated cash flows (including interest at contractual rates) at market rates for similar loans offered by TSB and other financial institutions. Certain loans secured on residential properties are made at a fixed rate for a limited period, typically two to five years, after which the loans revert to the relevant variable rate. The fair value of such loans is estimated by reference to the market rates for similar loans of maturity equal to the remaining fixed interest rate period.

Valuation hierarchy of financial assets carried at fair value

The table below analyses the fair values of the financial assets of TSB which are carried at fair value.

	Level 1 £ million	Level 2 £ million	Level 3 £ million	Total fair value £ million	Total carrying value £ million
At 31 December 2019
Financial assets at fair value through other comprehensive income	1,587.4	–	–	1,587.4	1,587.4
Derivative assets at fair value through profit or loss	–	112.0	–	112.0	112.0
Hedging derivative assets	–	93.4	–	93.4	93.4
Total	1,587.4	205.4	–	1,792.8	1,792.8
At 31 December 2018
Financial assets at fair value through other comprehensive income	2,387.8	–	–	2,387.8	2,387.8
Derivative assets at fair value through profit or loss	–	88.4	–	88.4	88.4
Hedging derivative assets	–	106.6	–	106.6	106.6
Financial assets at fair value through profit or loss	2.2	–	–	2.2	2.2
Total	2,390.0	195.0	–	2,585.0	2,585.0

A description of the fair value levels is included in note 5.

	2019	2018
Level 3 financial assets	£ million	£ million
Balance at 1 January	–	7.0
Gains recognised on financial assets at fair value through profit or loss	–	2.2
Disposal of Visa Inc. convertible preferred stock	–	(9.2)
Balance at 31 December	–	–

Gilts and supranational and development bank bonds are valued using quoted market prices and are therefore classified as Level 1 assets. Derivative financial assets are primarily interest rate swaps and are valued using a discounted cash flow model where the most significant input is interest yield curves which are developed from publicly quoted rates. As such derivative financial instruments are classified as Level 2 assets.

Income

We earn income in the form of interest that we receive on the loans we make to customers and we pay interest to savings and bank account customers on the money they deposit with us and to providers of other forms of funding. We also earn other income in the form of fees and charges from the provision of banking services and commissions from the sale of certain third party products such as general insurance.

Accounting policies effective for the year ended December 2019

(e) Interest income and expense

Financial instruments classified as amortised cost and fair value through other comprehensive income

Interest income and expense are recognised in the income statement for all interest-bearing financial instruments using the EIR method. The EIR method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense. The EIR is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.

The effective interest rate is calculated on initial recognition of the financial asset or liability, estimating the future cash flows after considering all the contractual terms of the instrument but not future credit losses. The calculation includes all amounts paid or received by TSB that are an integral part of the overall return, direct incremental transaction costs related to the acquisition, issue or disposal of a financial instrument and all other premiums or discounts. 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 recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss (see accounting policy (c) on impairment of financial assets).

For financial assets, interest income is calculated by applying the effective interest rate to the gross carrying amount of the financial asset. There are two exceptions to this as follows:

(i) Interest income in respect of financial assets that have become credit impaired (stage 3) subsequent to their initial recognition is calculated by applying the effective interest rate to their amortised cost, net of expected loss provision.

(ii) Interest income in respect of financial assets classified as purchased or originated credit impaired (POCI) is calculated by applying the original credit adjusted effective interest rate to the amortised cost of the financial asset.

Derivative financial instruments

Interest income and expense on derivative financial instruments in qualifying hedge accounting relationships, where the hedged item is a financial asset, is recognised in interest income. Where the hedged item is a financial liability, the derivative interest income or expense is recognised in interest expense. Interest income and expense on derivatives classified as held for trading is recognised in interest income.

(f) Other operating income

Other operating income, including fees and commissions, which are not an integral part of the EIR are generally recognised over time as the service is provided and TSB satisfies its performance obligations.

Renewal commission income is recognised when TSB satisfies its performance obligations under the relevant contract and management concludes that there is a high probability that there will be no significant reversal of the estimated income.

Income (continued)

12. Net interest income

	2019	2018
Interest and similar income	£ million	£ million
Interest income calculated using the effective interest method:
Cash, cash balances at central banks and other demand deposits	47.0	38.2
Financial assets at fair value through other comprehensive income	24.5	34.3
Debt securities at amortised cost	4.3	0.2
Loans to credit institutions	2.1	2.5
Loans and advances to customers	972.7	997.0
	1,050.6	1,072.2
Derivative financial instruments	(5.8)	(2.0)
Total interest and similar income	1,044.8	1,070.2
Interest and similar expense
Interest expense calculated using the effective interest method:
Borrowings from central banks	(46.0)	(38.5)
Deposits from credit institutions	(0.2)	(0.3)
Customer deposits	(116.4)	(121.4)
Repurchase agreements	(1.8)	(3.8)
Debt securities in issue	(21.8)	(13.0)
Subordinated liabilities	(22.4)	(22.4)
Lease liabilities	(1.6)	–
	(210.2)	(199.4)
Derivative financial instruments	6.5	14.0
Total interest and similar expense	(203.7)	(185.4)
Net interest income	841.1	884.8

Included within interest and similar income is £18.7 million (2018: £16.2 million) in respect of impaired financial assets.

13. Net fee and commission income

	2019	2018
	£ million	£ million
Fee and commission income
Bank accounts	47.8	46.1
Credit and debit card fee income	85.7	55.4
Insurance commission income	11.0	11.9
Other	15.3	8.7
Total fee and commission income	159.8	122.1

Fee and commission expense
Bank accounts	(28.2)	(36.6)
Credit and debit card fee expense	(0.2)	(3.5)
Other	(13.1)	(6.6)
Total fee and commission expense	(41.5)	(46.7)
Net fee and commission income	118.3	75.4

Fees and commissions which are an integral part of the EIR are recognised in net interest income. Net fee and commission income includes £22.0 million (2018: £nil) in respect of changes made in 2019 to card servicing arrangements.

14. Other operating income

	2019	2018
	£ million	£ million
Migration related income from Lloyds Banking Group	–	318.3
Rental income	0.8	1.0
Dividend income	–	0.8
Other income	0.4	0.2
Total other operating income	1.2	320.3

Migration related income from LBG was recognised in 2018 as a result of exiting the Transitional Services Agreement on migration to the new IT platform.

Charges

Running a bank with 5 million customers comes with overheads. Charges we incur include the costs of paying our TSB employees, running our branches, investing in our business, paying for advertising and marketing, and in 2018, the costs of preparing for the migration and the subsequent service disruption. Occasionally, our customers' circumstances change and they are unable to repay the money they borrow from us causing us to incur impairment losses. Finally, TSB complies with its tax obligations to HMRC.

Accounting policies relevant to recognising charges

(g) Pensions and other post-retirement benefits

TSB operates defined contribution pension plans under which fixed contributions are paid. The costs of TSB's defined contribution plans are charged to the income statement, as an operating expense, in the period in which they fall due.

(h) Share-based compensation

TSB operates a number of cash settled share-based compensation plans, in respect of services received from certain of its employees. The total expense is recognised over the vesting period, which is the period over which all of the specified vesting conditions are to be satisfied. A corresponding credit is recognised as a liability. In addition, in some circumstances employees may provide services in advance of the grant date and therefore the liability is estimated for the purposes of recognising the expense during the period between service commencement period and grant date.

At the end of each reporting period, the fair value of the liability is measured with any changes in fair value recognised in operating expenses.

(i) Taxation

Current corporation tax which is payable or receivable on taxable profits or losses is recognised as tax expense or credit in the period in which the profits or losses arise.

Deferred tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements.

Deferred tax is determined using tax rates that have been enacted or substantively enacted by the balance sheet date that are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.

Deferred tax assets are recognised where it is probable that future taxable profit will be available against which the temporary differences can be utilised.

Deferred and current tax assets and liabilities are offset when they arise in the same tax reporting group and where there is both a legal right of offset and the intention to settle on a net basis or to realise the asset and settle the liability simultaneously.

Charges (continued)

15. Operating expenses

	2019	2018
Staff costs	£ million	£ million
Wages and salaries	260.0	263.5
Social security costs	26.6	27.2
Other pension costs	34.4	35.1
Severance costs	34.3	3.5
Share-based payments (note 17)	1.3	(2.7)
Other staff costs	11.7	6.7
Total staff costs	368.3	333.3
Premises expenses
Rent	5.4	32.1
Rates, maintenance and other premises expenses	48.3	46.4
Total premises expenses	53.7	78.5
Other expenses
IT servicing and license costs	194.1	178.8(2)
Regulatory, legal and consultancy costs	72.7	63.7
Marketing	40.3	55.4
Other expenses (1)	131.6	146.6(2)
Migration related other expenses:
Post migration customer redress and rectification	–	125.2
Post migration related fraud and operational losses	–	49.1
Recovery of additional post migration charges	(39.6)	(153.0)
Total other expenses	399.1	465.8
Depreciation of property and equipment	26.3	24.6
Depreciation of right of use asset	28.2	–
Amortisation of intangible assets	5.7	3.5
Operating expenses excluding the costs of preparing for TSB's migration	881.3	905.7
Costs of preparing for TSB's migration
Migration Services Agreement costs	–	249.0
Other migration programme related costs	–	168.3
Total costs of preparing for TSB's migration	–	417.3
Total operating expenses	881.3	1,323.0

(1) Other expenses primarily comprise of the costs of various operational contracts, costs of non-staff contractors, fraud and operational losses. (2) In order to align with the current year presentation £13.5 million has been reclassified from other expenses to IT servicing and license costs.

Significant estimate

The MSA and OSA contracts provide TSB with the right to seek recovery of eligible losses for breach of contract up to the level of liability caps in each agreement. The parties have reached provisional agreement, subject to mutual reservation of rights while negotiations are concluded, where TSB will recover an aggregate of £192.6 million (2018: £153.0 million) under the respective contracts, reflecting the maximum recovery amount under the contracts. Consequently, in light of this provisional agreement, post migration charges were reduced by recovery of £39.6 million in 2019 (2018: £153.0 million) under the MSA and OSA contracts.

Charges (continued)

15. Operating expenses (continued)

The monthly average number of employees on a headcount basis during the year was 8,198 (2018: 8,439), all of whom were employed in the UK. Included in employee costs is remuneration paid to key management personnel as set out in note 26(i).

Included in other expenses are fees paid to TSB's auditors as set out in the table below:

	2019	2018
Auditors' remuneration	£ million	£ million
Fee for the audit of TSB's financial statements	4.2	4.5
Non-audit fees	0.2	0.1
Total fees payable to TSB's auditors	4.4	4.6

In addition to the above fees payable to TSB's auditors £0.4 million was paid to LBG in 2018 in respect of a review by their auditors of controls undertaken on TSB's behalf under the former Transitional Services Agreement with Lloyds Banking Group.

16. Directors' emoluments

The aggregate remuneration of the Directors during the year was as follows:

	2019	2018
	£ 000	£ 000
Remuneration paid to Directors in respect of qualifying services	2,892	2,474
Cash received under long-term incentive arrangements	481	–
Notice payments	–	1,239
Total	3,373	3,713

Details of the highest paid Director are set out on page 42 in the Remuneration review. The table below presents the number of Directors who:

	2019 Number	2018 Number
Exercised share options	–	–
Received shares under long term incentive schemes	1	1
Accrued pension benefits under defined contribution pension schemes	2	1

17. Share-based payments

Operating expenses in respect of TSB's share-based compensation schemes, all of which are accounted for as cashsettled share-based compensation schemes are set out below:

	2019	2018
	£ million	£ million
Share options – TSB Sharesave	(1.8)	0.2
Other share-based compensation arrangements	3.1	(2.9)
	1.3	(2.7)

During 2019 and 2018, TSB operated a Sharesave scheme and a Share Incentive Plan (SIP), both of which provide all TSB employees with the opportunity to own shares in Sabadell and, in a limited number of instances, granted shares to certain senior employees as part of their recruitment arrangements. As all share-based compensation arrangements involve an award of, or options over, Sabadell shares, these arrangements are accounted for as cash settled share-based payment arrangements resulting in the recognition of a liability. This liability is remeasured monthly, with changes recognised in operating expenses, to reflect the latest Sabadell share price and the estimated number of shares expected to vest. The increase in the share based payment expense reflects the net effect of accrual releases in 2018.

At 31 December 2019, £5.4 million (2018: £4.9 million) was recognised in respect of share-based payment liabilities.

Charges (continued)

17. Share-based payments (continued)

Sharesave scheme

Eligible employees had the opportunity to enter into a contract to save up to £500 per month and, at the maturity date, three years from the start of the savings contract, have the option to use these savings within six months to acquire shares in Sabadell at £0.7768, being a 20% discount to the average closing price and Sterling/Euro exchange rate on the date of the Sharesave invitation. Alternatively, eligible employees may take the accumulated savings balance as a cash payment. Movements in the number of Sharesave options outstanding are set out below:

	2019		2018
		Weighted		Weighted
	Number of	average	Number of	average
	options	exercise	options	exercise
	(Sabadell)	price	(Sabadell)	price
	(000's)	(pence)	(000's)	(pence)
Outstanding at 1 January	11,990	77.68	13,001	77.68
Granted	–	–	–	–
Exercised	(2,619)	77.68	(197)	77.68
Forfeited	(780)	77.68	(499)	77.68
Cancelled	(636)	77.68	(315)	77.68
Outstanding at 31 December	7,955	77.68	11,990	77.68
Exercisable at 31 December	7,955	77.68	–	–

The options vested on 1 October 2019 and employees have until 31 March 2020 to exercise. At 31 December 2019, the fair value of the options, determined using a Black Scholes option pricing model, was 8.0 pence (2018: 17.0 pence) and a liability of £0.6 million (2018: £2.5 million) was recognised on the consolidated balance sheet.

Economic hedging of share based compensation liability

An explanation of the instruments transacted to economically hedge TSB's exposure to share based payment liabilities is set out in note 26(ii).

18. Taxation

The table below sets out the (charge)/credit to UK corporation tax recognised in the income statement:

	2019 £ million	2018 £ million
UK corporation tax
Current tax (charge)/credit on profit/(loss) for the year	(0.1)	23.6
Adjustments in respect of prior years	0.3	(2.8)
Current tax credit/(charge)	0.2	20.8
Deferred tax (note 19)
Origination and reversal of temporary differences:
Deferred tax charge on business transfers	(20.9)	(19.3)
Accelerated capital allowances	0.5	0.6
Adjustments in respect of prior years	(0.7)	3.4
Deferred tax credit in relation to trading losses	3.8	37.8
Other	(2.6)	(0.9)
Deferred tax (charge)/credit	(19.9)	21.6
Taxation (charge)/credit	(19.7)	42.4

Charges (continued)

18. Taxation (continued)

A reconciliation of the (charge)/credit that would result from applying the UK corporation tax rate to profit before taxation to the actual taxation charge for the year is presented below:

	2019	2018
	£ million	£ million
Profit/(loss) before taxation	46.0	(105.4)
Taxation (charge)/ credit at applied UK corporation tax rate of 27.0% (2018: 27.0%)	(12.4)	28.5
Factors affecting charge:
Disallowed costs	(6.1)	(86.5)
Non-taxable items	–	104.3
Changes to UK corporation tax rates	(0.8)	(4.5)
Adjustments in respect of prior years	(0.4)	0.6
Taxation (charge)/credit	(19.7)	42.4

The applied UK corporation tax rate of 27% for 2019 includes the 8% bank surcharge on profits in excess of £25 million together with the average UK corporation tax rate of 19%. Disallowed costs in 2019 primarily reflect restructuring costs. Disallowed costs and non-taxable items in 2018 primarily reflect costs incurred under the MSA and migration related income from LBG respectively.

19. Deferred tax assets

The movement in deferred tax assets is as follows:

	2019	2018
	£ million	£ million
At 1 January	113.0	92.0
Income statement charge (note 18)	(19.9)	21.6
Amounts charged to equity:
Movements in fair value reserve	2.3	(0.6)
Movements in cash flow hedge reserve	0.7	–
At 31 December	96.1	113.0

Deferred tax assets are comprised as follows:

	2019	2018
	£ million	£ million
Deferred tax arising on business transfers	38.0	58.9
Deferred tax arising on carried forward trading losses	46.0	37.8
Deferred tax in respect of the transition to IFRS 9	19.3	21.7
Revaluations of financial assets at fair value through other comprehensive income	(4.6)	(6.9)
Deferred tax arising on cash flow hedge reserve	0.7	–
Other temporary differences	(3.3)	1.5
Total deferred tax assets	96.1	113.0

Significant judgement

The valuation and assessment of recovery of deferred tax assets requires an estimate of the amount and timing of future taxable profits. The level of estimated future taxable profits takes into account the Board approved medium term plan and associated risk factors including future economic outlook and regulatory change. Based on this, management have concluded it remains appropriate to recognise the deferred tax asset in full.

Managing financial risk

Financial instruments are fundamental to TSB's activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by TSB. The primary risks affecting TSB through its use of financial instruments are: credit risk; liquidity risk; and market risk. A summary of TSB's use of financial instruments and information about the management of these risks is presented below.

Accounting policies relevant to managing financial risk

(j) Derivative financial instruments and hedge accounting

All derivative financial instruments are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow as appropriate. Derivatives are carried on the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative.

Changes in the fair value of any derivative instrument are recognised immediately in the income statement.

Fair value is the exit price from the perspective of market participants who hold the asset or owe the liability at the measurement date.

The method of recognising the movements in the fair value of derivatives depends on whether they are designated as hedging instruments and, if so, the nature of the item being hedged.

TSB has elected to continue to apply the hedge accounting requirements of IAS 39 on adoption of IFRS 9. Hedge accounting allows one financial instrument, generally a derivative such as a swap, to be designated as a hedge of another financial instrument such as a loan or deposit or a portfolio of such instruments. At the inception of the hedge relationship, formal documentation is drawn up specifying the hedging strategy, the hedged item and the hedging instrument and the methodology that will be used to measure the effectiveness of the hedge relationship in offsetting changes in the fair value of the hedged risk. In its application of the hedge accounting policy, TSB follows the requirements of the EU endorsed version of IAS 39 'Financial Instruments: Recognition and Measurement' which are not available in the version issued by the IASB, specifically relating to hedging core deposits. The effectiveness of the hedging relationship is tested both at inception and throughout its life and if at any point it is concluded that it is no longer highly effective in achieving its documented objective, hedge accounting is discontinued. TSB designates certain derivatives as either hedges of the fair value of recognised assets or liabilities (fair value hedges) or hedges of highly probable future cash flows attributable to recognised assets or liabilities (cash flow hedges).

Fair value hedges

Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, changes in the fair value of the hedged item attributable to the hedged risk are no longer recognised in the income statement. The cumulative adjustment that has been made to the carrying amount of the hedged item is amortised to the income statement using a straight line method over the period to maturity.

Cash flow hedges

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income in the cash flow hedging reserve. The gain or loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are reclassified to the income statement in the periods in which the hedged item affects profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised in the income statement when the previously hedged cash flow is ultimately recognised in the income statement.

Managing financial risk (continued)

20. Credit risk

Credit risk is the risk of financial loss if a customer or counterparty to a financial instrument fails to meet its contractual obligations. Credit risk appetite is set at Board level and is described and reported through a suite of metrics devised from credit portfolio performance measures, and includes the use of various credit risk rating systems to measure the credit risk of loans and advances to customers and banks at a counterparty level using three components: (i) the probability of default by the counterparty on its contractual obligations; (ii) the exposure to the counterparty at default; and (iii) the likely loss ratio on the defaulted obligations, the loss given default. TSB uses a range of approaches to mitigate credit risk, including policies, obtaining collateral, using master netting agreements and other credit risk transfers, such as asset sales. TSB's credit risk exposure, which arises primarily in the United Kingdom, is set out below.

(i) Maximum credit exposure

The maximum credit risk exposure in the event of other parties failing to perform their obligations is presented below. No account is taken of any collateral held and the maximum exposure to loss is considered to be the balance sheet carrying amount or, for non-derivative off-balance sheet transactions, their contractual nominal amounts. The maximum exposure to credit risk for financial assets that are subject to impairment requirements is set out below:

	2019	2018
	£ million	£ million
Loans and advances to customers	31,075.8	30,008.5
Debt securities at fair value through other comprehensive income	1,587.4	2,387.8
Debt securities at amortised cost	548.6	96.2
Loans to central banks	96.1	87.8
Loans to credit institutions	373.2	370.6
Reverse repurchase agreements	201.1	-
Other advances	279.6	382.1
Financial assets subject to impairment requirements	34,161.8	33,333.0
Derivative financial assets a fair value through profit or loss	112.0	88.4
Hedging derivative financial assets	93.4	106.6
Total on balance sheet balance	34,367.2	33,528.0
Lending commitments	4,953.6	4,778.1
Maximum credit risk exposure	39.320.8	38,306.1

(ii) Quality of credit risk exposures

Debt securities and loans to central banks are with counterparties rated at least A (2018: AA). Loans to credit institutions are with counterparties rated at least A+ (2018: A+). Reverse repurchase agreements are with a counterparty rated AA-. The net uncollateralised balance of derivative financial instruments of £43.4 million (2018: £63.5 million) as set out in Note 23 is with counterparties rated A+ (2018: A+).

Loans and advances to customers

In assessing the credit quality of loans and advances to customers, TSB uses an internal rating scale based on a customer's 12 month expected default probability.

	Internal grading
Excellent quality	1-4
Good quality	5-6
Satisfactory quality	7-9
Lower quality	10
Below standard (including in default)	11-13

	2019									2018
Secured (retail)	Stage 1 £ million	Stage 2 £ million	Stage 3 £ million	POCI* £ million	Total £ million	Stage 1 £ million	Stage 2 £ million	Stage 3 £ million	POCI* £ million	Total £ million
Excellent quality	26,712.4	1,725.7	–	–	28,438.1	25,200.2	1,988.1	13.1	–	27,201.4
Good quality	29.2	102.2	–	–	131.4	27.8	150.8	11.8	–	190.4
Satisfactory quality	2.2	108.8	–	–	111.0	2.1	97.1	24.9	–	124.1
Lower quality	–	15.0	–	–	15.0	0.3	8.3	6.7	–	15.3
Below standard (including in default)	3.7	25.2	303.6	161.2	493.7	1.3	6.9	230.9	190.0	429.1
Gross carrying amount	26,747.5	1,976.9	303.6	161.2	29,189.2	25,231.7	2,251.2	287.4	190.0	27,960.3

* Purchased or originated as credit impaired

Managing financial risk (continued)

20. Credit risk (continued)

	2019									2018
Unsecured and business banking	Stage 1 £ million	Stage 2 £ million	Stage 3 £ million	POCI £ million	Total £ million	Stage 1 £ million	Stage 2 £ million	Stage 3 £ million	POCI* £ million	Total £ million
Excellent quality	524.6	59.9	0.8	–	585.3	685.7	65.5	0.8	–	752.0
Good quality	772.0	241.9	2.4	–	1,016.3	677.0	395.9	2.5	–	1,075.4
Satisfactory quality	123.2	119.2	3.3	–	245.7	120.4	105.7	3.5	–	229.6
Lower quality	9.5	22.1	1.8	–	33.4	9.7	24.7	1.8	–	36.2
Below standard (including in default)	5.1	29.7	70.6	0.1	105.5	8.0	41.2	104.3	0.2	153.7
Gross carrying amount	1,434.4	472.8	78.9	0.1	1,986.2	1,500.8	633.0	112.9	0.2	2,246.9

Commitments

The table below sets out the credit quality, by stage, of lending commitments 31 December 2019. Comparative data for December 2018 was not available in the same format and is not presented.

	2019									2018
Commitments	Stage 1 £ million	Stage 2 £ million	Stage 3 £ million	POCI £ million	Total £ million	Stage 1 £ million	Stage 2 £ million	Stage 3 £ million	POCI £ million	Total £ million
Excellent quality	4,037.5	461.1	2.1	–	4,500.7	3,980.5	319.5	2.4	–	4,302.4
Good quality	220.0	76.7	1.5	–	298.2	256.6	79.3	1.7	–	337.6
Satisfactory quality	51.4	29.3	1.0	–	81.7	34.5	32.6	1.3	–	68.4
Lower quality	1.2	11.2	0.4	–	12.8	1.8	13.0	0.7	–	15.5
Below standard (including in default)	0.5	3.3	36.7	19.7	60.2	4.4	3.6	27.6	18.4	54.0
Total	4,310.6	581.6	41.7	19.7	4,953.6	4,277.8	448.0	33.7	18.4	4,777.9

(iii) Collateral held as security for financial assets

TSB holds collateral against loans and advances to customers in the form of mortgages over residential property and second charges over business assets, including commercial and residential property.

An analysis by loan-to-value (LTV) ratio of TSB's retail mortgage lending is presented below. The value of collateral used in determining the LTV ratios has been estimated based upon the last actual valuation, adjusted to take into account subsequent movements in house prices.

				2019	2018
	Stage 1	Stage 2	POCI	Stage 3	Stage 3
LTV of Secured (retail)	£ million	£ million	£ million	£ million	£ million
Less than 70%	18,880.4	1,593.0	114.0	211.8	200.9
70% to 80%	4,476.4	212.4	25.2	48.3	45.1
80% to 90%	2,839.2	125.2	14.5	24.4	24.8
90% to 100%	537.6	35.2	5.4	9.7	11.6
Greater than 100%	13.8	11.1	2.1	9.5	5.0
Secured (retail)	26,747.4	1,976.9	161.2	303.7	287.4

Secured lending

TSB does not take physical possession of properties or other assets held as collateral and uses external agents to realise the value as soon as practicable to settle indebtedness. Any surplus funds are returned to the borrower or are otherwise dealt with in accordance with appropriate insolvency regulations.

Unsecured lending and business banking

No collateral is held in respect of retail credit cards, overdrafts, or unsecured personal loans. For business banking lending, collateral primarily consists of second charges over commercial and residential property. Where collateral is held, lending decisions are predominantly based on an obligor's ability to repay from normal business operations rather than reliance on any collateral provided. Collateral values are assessed at the time of loan origination and reassessed if there is observable evidence of distress of the borrower.

(iv) Forbearance and loan modifications

TSB operates a number of schemes to assist borrowers who are experiencing financial difficulties. Forbearance solutions may offer relief in the form of reductions to contractual payments, and for customers who have longer term financial difficulties, term extensions and 'repair' approaches such as capitalisation of arrears. At 31 December 2019, total forborne loans were £301.8 million (2018: £310.3 million), of which £163.4 million (2018: £182.4 million) were impaired. At 31 December 2019, the allowance for loan losses held in respect of forborne loans was £20.2 million (2018: £27.4 million).

Managing financial risk (continued)

21. Liquidity risk

Definition and exposure

Liquidity risk is the risk that TSB is unable to meet its liabilities as they fall due, or is unable to maintain regulator, investor, customer or stakeholder confidence that this will be achieved. Liquidity risk is managed, monitored and measured from both an internal and regulatory perspective.

Sources of funding

TSB's funding position is underpinned by its significant customer deposit base. The deposit base is made up of customer current and savings accounts which, although mostly repayable on demand, have historically provided a stable source of funding. Further information regarding sources of funding is available on pages 12 to 13.

Risk appetite

The funding and liquidity risk appetite for TSB is set and approved annually by the Board. Risk is reported against this appetite through various metrics to enable TSB to manage the funding and liquidity position. The risk appetite is established under a liquidity risk management framework designed with the aim that TSB has sufficient financial resources of appropriate quality.

Measurement and monitoring

A series of measures are used across TSB to monitor both short term and long term liquidity risk. Liquidity risk is measured on a daily basis and reported internally. Daily liquidity reporting is supplemented by early warning indicators and a Liquidity Contingency Plan. Monthly reporting procedures are in place to update and inform senior management. All liquidity policies and procedures are subject to periodic independent internal oversight.

The table below presents the contractual residual maturities of the assets and liabilities on the balance sheet:

	Up to 1	1-3	3-12		Over 5
	month	months	months	1-5 years	years	Total
At 31 December 2019	£ million	£ million	£ million	£ million	£ million	£ million
Liabilities
Financial liabilities measured at amortised cost:
Borrowings from central banks	8.5	–	10.0	4,465.0	–	4,483.5
Deposits from credit institutions	0.7	–	–	–	–	0.7
Customer deposits	27,325.5	220.3	1,094.9	1,541.7	–	30,182.4
Repurchase agreements	–	–	–	–	–	–
Debt securities in issue	–	44.5	383.3	1,248.5	–	1,676.3
Subordinated liabilities	–	–	3.4	392.5	–	395.9
Lease liabilities	2.1	4.3	17.8	55.0	62.6	141.8
Other financial liabilities	80.6	–	–	–	–	80.6
Derivative liabilities at fair value through profit or loss	0.1	0.4	3.3	65.6	58.5	127.9
Hedging derivative liabilities	–	–	6.0	15.9	266.6	288.5
Other liabilities (1)	205.1	–	–	–	52.2	257.3
Total liabilities	27,622.6	269.5	1,518.7	7,784.2	439.9	37,634.9

(1) Other liabilities comprise provisions, fair value adjustments for portfolio hedged risk and other liabilities.

Assets
Financial assets at amortised cost:
Debt securities	1.1	0.2	1.1	119.4	426.8	548.6
Loans to central banks	96.1	–	–	–	–	96.1
Loans to credit institutions	–	247.8	64.6	60.8	–	373.2
Loans and advances to customers	903.6	289.7	1,242.2	5,608.3	23,032.0	31,075.8
Other advances	279.6	–	–	–	–	279.6
Reverse Repos		201.1	–	–	–	201.1
Financial assets at fair value through other comprehensive income	0.3	1.9	8.4	–	1,576.8	1,587.4
Derivative assets at fair value through profit or loss	0.2	1.2	3.1	72.6	34.9	112.0
Hedging derivative assets	–	–	46.5	26.2	20.7	93.4
Other assets (2)	4,724.6	2.4	10.9	81.8	334.0	5,153.7
Total assets	6,005.5	744.3	1,376.8	5,969.1	25,425.2	39,520.9

(2) Other assets comprise cash, cash balances at central banks and other demand deposits, equity instruments, fair value adjustments for portfolio hedged risk, property, plant and equipment, intangible assets, deferred tax assets and other assets.

Managing financial risk (continued)

21. Liquidity risk (continued)

	Up to 1	1-3	3-12		Over 5
	month	months	months	1-5 years	years	Total
At 31 December 2018	£ million	£ million	£ million	£ million	£ million	£ million
Liabilities
Financial liabilities measured at amortised cost:
Borrowings from central banks	12.2	–	–	6,470.0	–	6,482.2
Deposits from credit institutions	3.4	–	–	–	–	3.4
Customer deposits	26,875.6	175.0	798.3	1,245.4	–	29,094.3
Repurchase agreements	1,084.8	–	–	–	–	1,084.8
Debt securities in issue	–	53.7	130.5	938.4	–	1,122.6
Subordinated liabilities	–	–	3.4	394.8	–	398.2
Other financial liabilities	66.4	–	–	–	–	66.4
Derivative liabilities at fair value through profit or loss	0.3	1.2	1.2	32.7	58.6	94.0
Hedging derivative liabilities	–	2.6	0.8	27.3	315.3	346.0
Other liabilities	559.0	–	–	–	19.4	578.4
Total liabilities	28,601.7	232.5	934.2	9,108.6	393.3	39,270.3
Assets
Financial assets at amortised cost:
Debt securities	–	1.1	–	–	95.1	96.2
Loans to central banks	87.8	–	–	–	–	87.8
Loans to credit institutions	–	246.3		64.6	59.7	370.6
Loans and advances to customers	985.9	214.2	978.6	6,054.5	21,775.3	30,008.5
Other advances	382.1	–	–	–	–	382.1
Financial assets at fair value through other comprehensive income	0.3	1.0	10.9	48.0	2,327.6	2,387.8
Derivative assets at fair value through profit or loss	0.8	0.9	6.1	50.6	30.0	88.4
Hedging derivative assets	–	0.3	4.6	95.2	6.5	106.6
Other assets	7,320.2	2.9	33.4	95.5	144.3	7,596.3
Total assets	8,777.1	466.7	1,033.6	6,408.4	24,438.5	41,124.3

Managing financial risk (continued)

21. Liquidity risk (continued)

Contractual maturities for financial liabilities form an important source of information for the management of liquidity risk. The table below analyses financial liabilities by relevant contractual maturity grouping on an undiscounted future cash flow basis based on the remaining period at the balance sheet date.

	Up to 1	1-3	3-12		Over 5
At 31 December 2019	month £ million	months £ million	months £ million	1-5 years £ million	years £ million	Total £ million
Liabilities
Financial liabilities measured at amortised cost:
Borrowings from central banks	8.5	–	10.0	4,465.0	–	4,483.5
Deposits from credit institutions	0.7	–	–	–	–	0.7
Customer deposits	27,348.6	224.7	1,110.9	1,561.3	–	30,245.5
Repurchase agreements	–	–	–	–	–	–
Debt securities in issue	30.4	15.8	354.9	1,298.9	–	1,700.0
Subordinated liabilities	–	–	22.1	396.1		418.2
Lease liabilities	2.6	5.1	21.1	61.0	68.0	157.8
Other financial liabilities	80.6	–	–	–	–	80.6
Total non-derivative financial liabilities	27,471.4	245.6	1,519.0	7,782.3	68.0	37,086.3
Gross settled derivatives - outflows	20.5	63.8	154.6	422.1	370.7	1,031.7
Gross settled derivatives - inflows	(15.7)	(23.0)	(97.5)	(261.6)	(201.8)	(599.6)
Total financial liabilities	27,476.2	286.4	1,576.1	7,942.8	236.9	37,518.4
	Up to 1	1-3	3-12		Over 5
At 31 December 2018	month £ million	months £ million	months £ million	1-5 years £ million	years £ million	Total £ million
Liabilities
Financial liabilities measured at amortised cost:
Borrowings from central banks	12.2	–	–	6,470.0	–	6,482.2
Deposits from credit institutions	3.4	–	–	–	–	3.4
Customer deposits	27,005.3	177.5	809.7	1,263.1	–	29,255.6
Repurchase agreements	1,084.8	–	–	–	–	1,084.8
Debt securities in issue	–	46.1	131.4	882.6	–	1,060.1
Subordinated liabilities	–	–	22.1	418.2	–	440.3
Other financial liabilities	66.4	–	–	–	–	66.4
Total non-derivative financial liabilities	28,172.1	223.6	963.2	9,033.9	–	38,392.8
Gross settled derivatives - outflows	14.9	20.5	158.4	549.7	545.9	1,289.4
Gross settled derivatives - inflows	(13.2)	(16.8)	(100.5)	(332.1)	(359.2)	(821.8)
Total financial liabilities	28,173.8	227.3	1,021.1	9,251.5	186.7	38,860.4

22. Capital resources

TSB maintains a strong capital base which has met regulatory requirements under the Capital Requirements Regulation and which seeks to support the growth of the business, even under stressed conditions. The table below presents TSB's regulatory capital resources.

	2019	2018
	£ million	£ million
Shareholder's equity	1,886.0	1,864.0
Regulatory deductions	(62.6)	(58.5)
Common Equity Tier 1/Total Tier 1 capital	1,823.4	1,805.5
Tier 2 capital	393.5	390.6
Total capital resources	2,216.9	2,196.1

Further information on capital resources is available on pages 12 and 13 in the Financial performance in 2019 section of the Strategic report.

Managing financial risk (continued)

23. Market risk

Definition and exposure

Market risk is the risk of a reduction in earnings, value or reserves caused by changes in the prices of financial instruments. TSB's market risk consists primarily of exposure to changes in interest rates. Interest rate risk is the risk that the net value of, or net income arising from, the firm's assets and liabilities is impacted as a result of changes to interest rates. Interest rate risk can arise as a result of changes in customer behaviour, which may affect the maturity profiles of TSB's assets and liabilities. TSB's exposure to changes in interest rates includes the margin between customer and market rates. This includes the potential impact on earnings and value that could occur when, if rates fall, liabilities cannot be re-priced as quickly or by as much as assets.

Management and measurement

Risk exposure across TSB is monitored monthly using, primarily, net interest income and earnings sensitivity. This methodology considers all re-pricing mismatches in the current balance sheet and calculates the change in net interest income that would result from a set of defined interest rate shocks. A limit structure exists to ensure that risks stemming from residual positions or from changes in assumptions about customer behaviour remain within risk appetite.

A 12 month view of the sensitivity of net interest income is calculated on the basis of TSB's current consolidated balance sheet with re-pricing dates adjusted according to behavioural assumptions. At 31 December 2019, the projected change in 12 month net interest income in response to an immediate parallel shift in all relevant interest rates, market and administered, would be an increase of £12.8 million (2018: £20.3 million) from a 25bps increase in rates, and a decrease of £13.1 million (2018: £0.7 million) from a 25bps decrease. The measure assumes all interest rates, for all currencies and maturities, move at the same time and by the same amount and does not take into account potential management actions.

Derivative financial instruments

TSB holds derivative financial instruments in the normal course of its banking business largely for interest rate risk management and margin stabilisation purposes. The fair values and notional amounts of derivative instruments are presented in the following table:

			2019				2018
Derivative financial instruments at fair value through profit or loss	Contract/ notional amount £ million	Assets fair value £ million	Liabilities fair value £ million	Gain/(loss) recognised in profit or loss £ million	Contract/ notional amount £ million	Assets fair value £ million	Liabilities fair value £ million	Gain(loss) recognised in profit or loss £ million
Interest rate swaps	22,917.2	110.7	(127.9)	(14.7)	18,301.0	86.5	(92.7)	(27.3)
Foreign exchange forwards	–	–	–	0.4	27.0	–	(0.5)	0.4
Equity options	11.7	1.3	–	(0.3)	11.4	1.9	(0.8)	(7.1)
Total	22,928.9	112.0	(127.9)	(14.6)	18,339.4	88.4	(94.0)	(34.0)

			2019				2018
Hedging derivative financial instruments	Contract/ notional amount £ million	Assets fair value £ million	Liabilities fair value £ million	Change in fair value used for calculating hedge ineffectiveness £ million	Contract/ notional amount £ million	Assets fair value £ million	Liabilities fair value £ million	Change in fair value used for calculating hedge ineffectiveness £ million
Interest rate risk
(Fair value hedges)
Interest rate swaps	14,292.8	44.6	(281.1)	(82.0)	16,602.4	43.1	(343.5)	9.3
Interest rate and credit risk
(Cash flow hedges)
Forward settlement contracts	190.0	2.9	–	1.8	205.0	–	(2.5)	(2.5)
Interest rate
(Cash flow hedges)
Interest rate swaps	404.9	2.3	(7.4)	(6.1)	–	–	–	–
Foreign exchange risk
(Cash flow hedges)
Cross currency rate swaps	270.1	43.6	–	(20.0)	317.6	63.5	–	(1.3)
Total	15,157.8	93.4	(288.5)	(106.3)	17,125.0	106.6	(346.0)	5.5

TSB Banking Group plc Annual Report and Accounts 2019 page 78

Managing financial risk (continued)

23. Market risk (continued)

Risk management

Derivatives are recognised at fair value, with changes in the fair value recognised in the income statement. Where all relevant criteria are met, hedge accounting is applied to remove the accounting mismatch between the hedging instrument and the hedged item. Where derivatives do not meet the hedge accounting criteria they are classified as 'fair value through profit or loss'.

TSB transacts derivatives largely to economically hedge interest rate risk. The loss on derivatives at fair value through profit or loss in respect of interest rate risk of £14.7 million (2018: £27.3 million) is largely offset by the gain of £18.2 million (2018: £25.3 million) from the amortisation of accumulated adjustments on the hedged items for which hedge accounting no longer applies, resulting from TSB's dynamic hedging strategies described below.

Interest rate risk (fair value hedges)

The profile of interest risk being managed is dynamic, changing as the day to day business activities of TSB evolve. TSB manages incremental risk via derivative contracts as and when it arises. For operational simplicity, not all derivatives are hedge accounted as, together, they do not lead to significant income statement volatility. Where such derivatives are hedge accounted, pay fixed, receive floating interest rate swaps are typically designated as a portfolio fair value hedge of fixed rate mortgage assets. Conversely, receive fixed, pay floating derivatives are typically designated as a portfolio fair value hedge of fixed rate customer deposits. As interest rate risk management is dynamic, hedge accounting relationships are frequently discontinued and restarted.

TSB has issued fixed rate subordinated debt and purchased fixed rate debt securities as part of its Treasury management activities. These items are economically hedged with derivative contracts. Hedge accounting designations are made on the same terms as the economic hedging; typically, with the notional of the hedged item matching that of the notional of the hedging instrument.

Hedge effectiveness is determined at the inception of the hedge relationship, through periodic retrospective effectiveness assessments, and finally at hedge termination (elective or otherwise) to ensure that a demonstrable relationship existed between the hedged item and hedging instrument. TSB's policy is to fully hedge interest rate risk. Hedge relationships are considered effective where changes in the fair value of the hedged item offset changes in the hedging instrument to within an 80% to 125% ratio. Ineffectiveness arising on hedge relationships can arise due to a number of factors which include, but are not limited to, basis mismatch in the benchmark rate used to discount cash flows of the hedged item and hedging instrument, maturity mismatch between the hedged item and hedging instrument, and cash flow timing mismatch between the hedged item and hedging instrument.

The provisions of the EU endorsed version of IAS 39 mean that ineffectiveness arising due to unexpected prepayments need not be recognised though profit or loss, so long as hedge designations are made in such a way to minimise their impact. For hedged items recognised at amortised cost, only fair value changes related to interest rate risk are recognised. For hedged items recognised at fair value, all market factors are recognised in the items' carrying value, however only changes in fair value attributable to interest rate risk are used for assessing hedge effectiveness.

Interest rate swaps with a notional of £11,771.3 million currently reference LIBOR, and are designated fair value hedges of fixed rate exposures. An assessment of changes required to these instruments is currently underway. As noted on page 46, TSB has early adopted 'Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39 and IFRS 9' and, therefore, it has been assumed that a change in the LIBOR interest rate benchmark arrangements would not be considered a modification to the hedging instrument and would not impact the hedge relationship.

Interest rate and credit risk (cash flow hedges)

TSB seeks to minimise interest rate and credit risk arising on purchased debt securities, accounted for at fair value through other comprehensive income, using forward settlement contracts, accounted for as derivatives at fair value through profit or loss. The forward contracts hedge the repricing risks of the underlying security. The forward is the hedging instrument and the sale proceeds are determined to be the hedged item in a hedge relationship. Hedge effectiveness is determined at inception of the hedge relationship by demonstrating that the critical terms of the hedged item match exactly the critical terms of the hedging instrument. To validate the effectiveness of the ongoing hedge relationship, TSB uses the hypothetical derivative method. Hedge ineffectiveness may occur due to credit valuation adjustments on the hedging instrument which are not matched on the hedged item.

At 31 December 2019, forward settlement agreements with a notional amount of £190.0 million (2018: £205.0 million) were expected to mature within one year (2018: within one year) at a price of 123% of the notional amount (2018: 124%).

Managing financial risk (continued)

23. Market risk (continued)

Interest rate risk on floating rate covered bonds (cash flow hedges)

TSB hedges the interest rate risk on floating rate covered bonds it has issued via interest rate swaps that exchange floating rate cash flows for fixed rate cash flows. During 2019, hedge accounting relationships were established in respect of swaps with a notional amount of £404.9 million. Hedge effectiveness is determined at inception of the hedge relationship using a dollar offset analysis. To validate the effectiveness of the ongoing hedge relationship, TSB uses the hypothetical derivative method. At 31 December 2019, these interest rates swaps were due to mature after five years.

Interest payments on covered bonds with a carrying amount of £292.0 million currently reference LIBOR. An assessment of changes required to these instruments, and the associated interest rate swaps, to address forthcoming replacement of LIBOR from the end of 2021 is currently underway. As TSB has early adopted 'Interest Rate Benchmark Reform – Amendments to IFRS 9, IAS 39 and IFRS 9', it has been assumed that, in assessing forecast cash flows for hedge accounting purposes, the existing LIBOR interest rate benchmark arrangements continue in respect of the covered bond and the associated interest rate swaps.

Foreign exchange on foreign currency debt (cash flow hedges)

TSB has issued euro denominated floating rate securitisation notes and as a result is exposed to foreign currency risk as TSB's functional currency is in pound sterling. TSB hedges the foreign currency exposure via cross currency interest rate swaps that exchange floating rate euro cash flows and principal for floating rate sterling cash flows and principal. The swaps are structured such that the euro component matches the critical terms of the hedged securitisation issuance.

Hedge effectiveness is determined at inception of the hedge relationships by demonstrating that the critical terms of the hedged item match exactly the critical terms of the hedging instrument. To validate the effectiveness of the ongoing hedge relationship, TSB uses the hypothetical derivative method. Hedge ineffectiveness may occur due to credit valuation adjustments on the swaps which are not matched on the secured issuance.

At 31 December 2019, cross currency swaps with a notional amount of £270.1 million (2018: £317.6 million) were expected to mature within 1 year (2018: between 1 and 2 years). The average exchange rate applicable to these cross currency swaps was £1/€1.14 (2018: £1/€1.13).

Exposures covered by hedging accounting strategies

The following table contains details of the hedged exposures covered by TSB's hedging strategy:

		Accumulated		Change in fair	Cash flow
	Carrying amount	fair value		value for	hedge reserve
	of hedged item	hedge adj.		calculating hedge	Continuing
	assets/(liability)	on hedged item	Balance sheet line item	ineffectiveness	hedges
2019	£ million	£ million	that includes the hedged item	£ million	£ million
Interest rate risk (Fair value hedges)
Portfolio hedged risk:
Demand deposits	(6,335.9)	(52.2)	Customer deposits	53.6	n/a
Fixed rate mortgages	6,309.2	20.5	Loans & adv to customers	(48.0)	n/a
Individual hedged risk:
Fixed rate subordinated liabilities	(395.9)	(7.9)	Subordinated liabilities	(2.5)	n/a
Debt securities	1,354.7	–	Financial assets at FVOCI	(78.6)	n/a
Debt securities	317.3	11.4	Financial assets at amortised cost	(9.1)	n/a
	1,249.4	(28.2)		(84.6)	n/a
Interest rate / credit risk (Cash flow hedges)
Debt securities	232.8	n/a	n/a	(6.1)	(2.9)
Interest rate (Cash flow hedges)
Debt securities in issue (covered bond)	404.9	n/a	n/a	2.9	5.8
Foreign exchange risk (Cash flow hedges)
Debt securities in issue (securitisation notes)	270.1	n/a	n/a	20.0	(0.2)

Managing financial risk (continued)

23. Market risk (continued)

Exposures covered by hedging accounting strategies (continued)

	Accumulated		Change in fair	Cash flow
Carrying amount	fair value		value for	hedge reserve
				Continuing hedges
				£ million
(6,248.8)	(9.4)	Customer deposits	18.6	n/a
8,181.6	(37.3)	Loans & adv to customers	(25.7)	n/a
(398.2)	(10.4)	Subordinated liabilities	7.4	n/a
2,128.3	–	Financial assets at FVOCI	(14.1)	n/a
96.2	2.2	Financial assets at amortised cost	2.2	n/a
3,759.1	(54.9)		(11.6)	n/a
259.5	n/a	n/a	2.5	(2.5)
(317.6)	n/a	n/a	1.3	(0.7)
	of hedged item assets/(liability) £ million	hedge adj. on hedged item £ million	Balance sheet line item that includes the hedged item	calculating hedge ineffectiveness £ million

The amount of fair value hedge adjustments remaining on the balance sheet for hedged items that have ceased to be adjusted for hedging losses is £21.0 million (2018: £57.3 million)

Hedge accounting ineffectiveness

The following table contains information regarding the effectiveness of the hedging relationships designated by TSB, as well as the impacts on profit or loss and other comprehensive income:

					Amounts reclassified from reserves to P&L as:
2019	Hedge ineffectiveness recognised in P&L £ million	Gain/(loss) recognised in OCI £ million	P&L line item that includes hedge ineffectiveness	Hedged item affected P&L £ million	P&L line item that includes reclassified amount £ million
Interest rate risk
(Fair value hedges)	2.6	–	Gains from hedge accounting	n/a	n/a
Interest rate and credit risk
(Cash flow hedges)	–	1.8	n/a	3.6	Other income
Interest rate
(Cash flow hedges)	–	(6.2)	n/a	0.3	Other income
Foreign exchange risk
(Cash flow hedges)	–	(20.0)	n/a	20.5	Other income
	2.6	(24.4)		24.4
2018
Interest rate risk
(Fair value hedges)	(2.3)	–	Gains from hedge accounting	n/a	n/a
Interest rate and credit risk
(Cash flow hedges)	–	(2.5)	n/a	–	–
Foreign exchange risk
(Cash flow hedges)	–	(1.3)	n/a	1.1	Other income
	(2.3)	(3.8)		1.1

Gains from hedge accounting in the income statement of £20.8 million (2018: £23.3 million) comprise hedge ineffectiveness of £2.6 million (2018: £(2.3) million) and £18.2 million (2018: £25.6 million) of amortisation of de-designated cash flow hedges and fair value hedge adjustments on hedged items for which hedge accounting had previously been discontinued.

Managing financial risk (continued)

23. Market risk (continued)

Reconciliation of reserves in respect of hedge accounting

The following table shows a reconciliation of each component of equity and an analysis of other comprehensive income in respect of hedge accounting:

	2019	2019	2018	2018
		Cash flow		Cash flow
	Fair value	hedge	Fair value	hedge
	reserve	reserve	reserve	reserve
	£ million £ million 18.6 (3.2) 95.9 n/a (78.6) n/a (24.6) n/a 2.3 n/a n/a 1.8 n/a 3.6 n/a (0.7) n/a (6.2) n/a 0.3 n/a 1.4 n/a (20.0) n/a 20.5	£ million	£ million
Balance as at 1 January			16.9	(0.5)
Amounts recognised in other comprehensive income:
Interest rate risk (Fair value hedge)
Changes in fair value of purchased debt securities			9.6	n/a
Accumulated fair value hedge adjustment			14.1	n/a
Net amounts reclassified to profit or loss			(21.4)	n/a
Taxation			(0.6)	n/a
Interest rate and credit risk (Cash flow hedges)
Effective portion of changes in fair value of forward contracts			n/a	(2.5)
Amounts reclassified from reserves to profit or loss			n/a	–
Taxation			n/a	–
Interest rate (Cash flow hedges)
Effective portion of changes in fair value of interest rate swaps			n/a	–
Amounts reclassified from reserves to profit or loss			n/a	–
Taxation			n/a	–
Foreign exchange risk (Cash flow hedges)
Effective portion of changes in fair value of cross currency swaps			n/a	(1.3)
Amounts reclassified from reserves to profit or loss			n/a	1.1
Balance as at 31 December	13.6	(2.5)	18.6	(3.2)

Offsetting financial assets and financial liabilities

The following information relates to financial assets and liabilities which have not been set off but for which TSB has enforceable master netting agreements in place with counterparties.

				Related amounts where set off in
				the balance sheet is not permitted
			Net amounts		Cash
			reported on	Related financial	collateral
	Gross	Amounts	the balance	instrument amounts	received/	Potential
At 31 December 2019	amounts £ million	offset £ million	sheet £ million	not offset £ million	pledged(1) £ million	net amount £ million
Derivative financial assets	205.4	–	205.4	(157.9)	(4.1)	43.4
Reverse repurchase agreements	201.1	–	201.1	(190.7)	(0.4)	10.0
Total assets	406.5	–	406.5	(348.6)	(4.5)	53.4
Derivative financial liabilities	(416.4)	–	(416.4)	157.9	258.5	–
Repurchase agreements	–	–	–	–	–	–
Other liabilities (note 32)	(195.2)	192.6	(2.6)	–	2.6	–
Total liabilities	(611.6)	192.6	(419.0)	157.9	261.1	–
At 31 December 2018
Derivative financial assets	195.0	–	195.0	(129.6)	(1.9)	63.5
Total assets	195.0	–	195.0	(129.6)	(1.9)	63.5
Derivative financial liabilities	(440.0)	–	(440.0)	129.6	309.6	(0.8)
Repurchase agreements	(1,084.8)	–	(1,084.8)	1,084.5	0.3	–
Other liabilities (note 32)	(355.5)	153.0	(202.5)	–	–	(202.5)
Total liabilities	(1,880.3)	153.0	(1,727.3)	1,214.1	309.9	(203.3)

(1) Collateral amounts (cash and non-cash financial collateral) are reflected at their fair value and this amount is limited to the net balance sheet exposure in order to exclude any over collateralisation.

Other important disclosures

Accounting policies relevant to this section

(k) Share capital

Shares are classified as equity instruments when there is no contractual obligation to deliver cash or other assets to another entity and the shares present a residual interest in the net assets of the issuer. Ordinary shares are classified as equity.

(l) Provisions and contingent liabilities and assets

Provisions are recognised in respect of present obligations arising from past events where it is probable that outflows of resources will be required to settle the obligations and they can be reliably estimated.

Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.

Contingent assets are possible assets that arise from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within TSB's control. These are disclosed where an inflow of economic benefits is probable, and are recognised only when it is virtually certain that an inflow of economic benefits will arise.

(m) Premises and equipment

Property, plant and equipment are recognised at cost less accumulated depreciation. Cost includes the original purchase price of the assets and the costs attributable to bringing the asset into working condition for its intended use. The value of land (included in premises) is not depreciated. Depreciation on other assets is calculated using the straight-line method to allocate the difference between the cost and the residual value over their estimated useful lives, as follows:

• Freehold premises and leasehold right of use assets: shorter of 50 years or the remaining period of the lease.
• Leasehold improvements: shorter of 10 years and, if lease renewal is not likely, the remaining period of the lease.
• Fixtures and furnishings: 0-10 years.
• Other equipment and motor vehicles: 2-8 years.

The assets' residual values and useful lives are reviewed, and adjusted if appropriate, at each balance sheet date.

Assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. In the event that an asset's carrying amount is determined to be greater than its recoverable amount it is written down immediately. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use.

(n) Leases

At inception of a contract TSB assesses whether a contract is, or contains a lease. A contract is, or contains a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. To assess whether a contract conveys the right to control the use of an identified asset, TSB assess whether: (a) the contract involves the use of an identified asset; (b) TSB has the right to substantially all of the economic benefits from use of the asset throughout the period of use; and (c) TSB has the right to direct the use of the asset.

At inception or on reassessment of a contract that contains a lease component, TSB allocates the consideration in the contract to each lease component on the basis of their relative stand-alone prices.

TSB recognises a right-of-use asset and a lease liability at the lease commencement date. The right-of-use asset is initially measured at cost, which comprises the initial amount of the lease liability adjusted for any lease payments made at or before the commencement date.

The right-of-use asset is subsequently depreciated using the straight-line method from the commencement date to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term. The estimated useful lives of rightof-use assets are determined on the same basis as those of property and equipment. In addition, the right-of-use asset is periodically reduced by any impairment losses and adjusted for certain remeasurements of the lease liability.

Other important disclosures (continued)

Accounting policies relevant to this section (continued)

(n) Leases (continued)

The lease liability is initially measured at the present value of the lease payments that are not paid at the commencement date, discounted using TSB's incremental borrowing rate. The lease liability is measured at amortised cost using the effective interest method. It is remeasured when there is a change in future lease payments. When the lease liability is remeasured in this way, a corresponding adjustment is made to the carrying amount of the right-of-use asset, or is recognised in the consolidated income statement if the carrying amount of the right-of-use asset has been reduced to zero.

Policy applicable before 1 January 2019

Leases contracts entered into before 1 January 2019 where TSB was lessee were accounted for as operating leases. Operating lease rentals payable were charged to the income statement on a straight-line basis over the period of the lease. When an operating lease was terminated before the end of the lease period, any payment made to the lessor by way of penalty was recognised as an expense in the period of termination.

(o) Intangible assets

Intangible assets held by TSB consist of internally developed computer software which is held at cost less accumulated amortisation and impairment. Software development costs are capitalised if it is probable that the asset created will generate future economic benefits. Costs incurred to establish technological feasibility or to maintain existing levels of performance are recognised as an expense.

Computer software intangible assets are amortised using the straight line method over their estimated useful lives of between 3 and 5 years. Amortisation commences when the assets are ready for their intended use. Estimated useful lives are reviewed annually and adjusted, if appropriate, in the light of technological developments, usage and other relevant factors. Computer software is reviewed for indicators of impairment at each reporting date and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Where the carrying amount is not recoverable the asset is written down immediately to the estimated recoverable amount, based on value in use calculations.

				Capital reorg			Cash flow
	Share capital £ million	Share premium £ million	Merger reserve £ million	anisation reserve £ million	Capital reserve £ million	Fair value reserve £ million	hedging reserve £ million	Retained profits £ million
Balance at 1 January 2018	5.0	965.1	616.5	(1,311.6)	410.0	16.9	(0.5)	1,226.6
Net change in fair value reserve	–	–	–	–	–	1.7	–	–
Net change in cash flow hedging reserve	–	–	–	–	–	–	(2.7)	–
Loss for the year	–	–	–	–	–	–	–	(63.0)
At 31 December 2018	5.0	965.1	616.5	(1,311.6)	410.0	18.6	(3.2)	1,163.6
Net change in fair value reserve	–	–	–	–	–	(5.0)	–	–
Net change in cash flow hedging reserve	–	–	–	–	–	–	0.7	–
Profit for the year	–	–	–	–	–	–	–	26.3
At 31 December 2019	5.0	965.1	616.5	(1,311.6)	410.0	13.6	(2.5)	1,189.9

24. Shareholder's equity

At 31 December 2019, TSB Banking Group plc had in issue 500.0 million (2018: 500.0 million) one pence ordinary shares authorised, allotted and fully paid up.

The merger reserve and capital reorganisation reserves were established in 2014 upon TSB Banking Group plc issuing new shares in exchange for the acquisition of the entire share capital of TSB Bank plc. The issuance was recorded at the carrying amount of the net assets of TSB Bank plc at the date of acquisition and resulted in a transfer to the share premium reserve of a minimum amount required by the Companies Act 2006. The difference between the amount transferred to share capital and share premium and the carrying amount of the net assets of TSB Bank plc was transferred to the merger reserve. The capital reorganisation reserve was established at this time to reflect the effect of TSB Banking Group plc becoming the new holding company of TSB by means of this share for share exchange.

The capital reserve represents a capital contribution received in 2013 from a, then, parent company. The fair value reserve represents the unrealised change in the value of financial assets at fair value through other comprehensive income since the instrument's initial recognition. The cash flow hedging reserve represents the cumulative gains and losses on effective cash flow hedging instruments that will be recycled to the income statement when the hedged transactions affect profit or loss.

Other important disclosures (continued)

25. Contingent liabilities

(i) Migration related investigations

Significant judgement

During 2018, the FCA and PRA commenced a formal joint investigation in connection with the handling of the migration of data and IT systems. This investigation is ongoing and it is not currently possible to make a reliable assessment of any potential findings. There is a possibility of a financial penalty in relation to this investigation, which may or may not be material. It is not currently practicable to reliably estimate and therefore no provision has been recognised in these financial statements.

(ii) Other legal and regulatory matters

During the ordinary course of business, TSB may be subject to other actual or potential legal proceedings (which may include class action lawsuits brought on behalf of customers and other third parties), regulatory investigations, regulatory challenges and enforcement actions. All such material matters are periodically reassessed, with the assistance of external professional advisers where appropriate, to determine the likelihood of TSB incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management's best estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed to properly assess the merits of the case and no provisions are held against such matters. However, TSB does not currently expect the final outcome of any such case to have a material adverse effect on its financial position, operations or cash flows.

26. Related party transactions

TSB's related parties include key management personnel, Sabadell and other Sabadell Group companies.

(i) Key management personnel

Key management personnel are those persons having authority and responsibility for planning, directing and controlling the activities of TSB which is the Board and Executive Committee. The compensation paid or payable to key management personnel is shown in the table below.

	2019	2018
	£ 000	£ 000
Short term employee benefits	7,448	6,260
Post-employment benefits	808	807
Other long term benefits	765	(4,760)
Share-based payments	1,084	(1,996)
Payments for loss of office	1,170	1,541
Total	11,275	1,852

The increase in compensation payable to key management personal in 2019 largely reflects the absence, in 2018 of variable reward costs, combined with the reversals of early year accruals for previously awarded which lapsed

The tables below detail, on an aggregated basis, related party transactions, balances outstanding at the year end and related income and expense in respect of key management personnel.

	2019	2018
	£ 000	£ 000
Loans
At 1 January	5	238
Advances (includes key management personnel appointed during the year)	87	128
Interest charged during the year	–	3
Repayments (includes key management personnel who resigned during the year)	(81)	(364)
At 31 December	11	5

The loans attracted interest at customer rates and were made in the ordinary course of business. No provisions have been recognised in respect of loans given to key management personnel (2018: £nil).

Other important disclosures (continued)

26. Related party transactions (continued)

	2019	2018
	£ 000	£ 000
Deposits
At 1 January	1,377	1,340
Deposits (includes key management personnel appointed during the year)	5,900	3,451
Interest expense on deposits	6	4
Repayments (includes key management personnel who resigned during the year)	(5,486)	(3,418)
At 31 December	1,797	1,377

Deposits placed by key management personnel are at customer rates and were made in the ordinary course of business.

(ii) Transactions and balances with Sabadell Group companies

Operating expenses include VAT inclusive amounts of £167.0 million (2018: £106.5 million) in respect of services provided to TSB by Sabis under the OSA for running the new banking platform. In the prior year, operating expenses of £249.0 million were incurred under the Migration Services Agreement with Sabis for services provide to TSB in preparing for the migration in 2018.

The MSA and OSA contracts provide TSB with the right to seek recovery of eligible losses for breach of contract up to the level of liability caps in each agreement. The respective parties have reached provisional agreement, subject to mutual reservations of rights while negotiations are concluded, to recognise an aggregate estimated recovery under the agreements of £192.6 million (2018: £153.0 million), reflecting the maximum recovery amount under the contracts.

TSB intends to settle on a net basis and consequently, the residual MSA liability of £100.0 million (2018: £249.0 million) has been presented on the statement of financial position net of the recovery of £100.0 million (2018: £100.0 million). Amounts payable to Sabis in respect of the OSA and other changes services of £95.2 million (2018: £106.5 million) is presented net of recovery of £92.6 million (2018: £53.0 million). Taken together, the aggregate liability to Sabis recognised on the consolidated balance sheet is £2.6 million (2018: £202.5 million) (note 32).

In December 2019, as part of the strategy to take direct management of suppliers of IT services, TSB entered into an agreement with IBM to provide IT services to TSB. The contract is effective from 1 January 2020 and these services will become operational on a phased basis throughout 2020. These services were previously provided by Sabis under the OSA. TSB and Sabis have agreed that the OSA will be amended to remove the relevant services from the scope of the OSA with effect from the date that IBM's service becomes operational.

Economic hedging of share based compensation liability

At 31 December 2019, TSB holds options from Sabadell to acquire 8.3 million (2018: 11.2 million) Sabadell shares at an exercise price of 77.68p in order to hedge the risk associated with the TSB Sharesave scheme. These options had a fair value of £0.8 million (2018: £1.9 million) and Sabadell had placed cash collateral with TSB of £1.4 million (2018: £3.1 million).

At 31 December 2019, TSB holds forward purchase agreements with Sabadell to acquire 6.6 million (2018: 2.6 million) Sabadell shares to satisfy estimated requirements under various share based compensation arrangements. This forward agreement had an asset fair value of £0.5 million (2018: liability fair value of £0.8 million) and Sabadell had placed cash collateral with TSB of £0.6 million (2018: TSB had placed cash collateral with Sabadell of £0.7 million).

Other transactions and balances

Sabadell acts as an intermediary for TSB in respect of international payments and TSB has nostro accounts as a result of this arrangement which had a net balance due from Sabadell of £4.9 million (2018: £0.9 million).

Other important disclosures (continued)

27. Property and equipment

		Right of use
	Property	Equipment	leasing asset	Total
	£ million	£ million	£ million	£ million
Cost
At 1 January 2018	228.8	102.2	–	331.0
Additions	6.3	10.1	–	16.4
Disposals	(1.3)	0.1	–	(1.2)
Write-offs	(2.1)	(0.7)	–	(2.8)
At 31 December 2018	231.7	111.7	–	343.4
Change on adoption of IFRS 16	-	-	163.0	163.0
Balance at 1 January 2019	231.7	111.7	163.0	506.4
Additions	17.1	4.7	13.7	35.5
Disposals	(3.0)	(5.0)	–	(8.0)
Lease term remeasurement	–	–	(6.6)	(6.6)
Write-offs	–	–	(2.8)	(2.8)
At 31 December 2019	245.8	111.4	167.3	524.5
Accumulated depreciation
At 1 January 2018	92.3	66.0	–	158.3
Depreciation charge for the year (note 15)	18.1	6.5	–	24.6
Disposals	(0.5)	0.1	–	(0.4)
Write-offs	(1.8)	(0.4)	–	(2.2)
At 31 December 2018	108.1	72.2	–	180.3
Depreciation charge for property and equipment (note 15)	19.1	7.2	–	26.3
Depreciation charge for right of use asset (note 15)	–	–	28.2	28.2
Write-offs	(1.4)	(1.6)	(0.5)	(3.5)
At 31 December 2019	125.8	77.8	27.7	231.3
Carrying amount
At 31 December 2018	123.6	39.5	–	163.1
Change on adoption of IFRS 16	–	–	163.0	163.0
At 1 January 2019	123.6	39.5	163.0	326.1
At 31 December 2019	120.0	33.6	139.6	293.2

28. Lease liabilities

TSB's leasing activity primarily reflects leases of various offices and bank branch properties. TSB does not operate as a lessor. These lease arrangements will often contain renewal options and rent escalation clauses, although the effect of these is not material. No arrangements have been entered into for contingent rental payments. The tables below set out details of the amounts recognised in the financial statements in respect of leases:

	Property
	2019
Lease liability	£ million
Balance at 31 December 2018	–
Change on adoption of IFRS 16	171.9
Balance at 1 January 2019	171.9
Additions	13.7
Lease term remeasurement	(6.6)
Interest expense for the year	1.6
Lease payments made in the year	(38.8)
Carrying amount at 31 December 2019	141.8

Other important disclosures (continued)

29. Intangible assets

	2019	2018
Cost	£ million	£ million
At 1 January	22.9	11.1
Additions	7.6	11.8
At 31 December 2018	30.5	22.9
Accumulated amortisation
At 1 January	4.5	1.0
Amortisation charge for the year (note 15)	5.7	3.5
At 31 December	10.2	4.5
Carrying amount	20.3	18.4

30. Other assets

	2019	2018
	£ million	£ million
Other assets and prepayments	113.8	165.9
Amounts recoverable under customer remediation indemnity (note 31)	14.4	14.6
Total other assets	128.2	180.5

31. Provisions

	Restructuring provision £ million	Migration redress provision £ million	Other customer redress provision £ million	Operational losses provision £ million	Credit impairment provision £ million	Total £ million
At 1 January 2019	–	41.1	15.0	4.5	3.0	63.6
Charge/(reversals) to income statement	38.1	6.3	5.3	–	(0.4)	49.3
Utilisations	(9.6)	(43.8)	(4.3)	(3.4)	–	(61.1)
Total provision	28.5	3.6	16.0	1.1	2.6	51.8

Significant estimates – migration and other customer redress

Restructuring provision

At 31 December 2019, TSB carried provisions of £28.5 million (2018: £nil) in respect of restructuring activity designed to support delivery of TSB's strategy. This includes the estimated costs of previously announced branch closures that are planned for 2020 which includes estimates of employee severance costs and of the costs of exiting the properties. It also includes estimated severance costs arising from organisational change across a number of head office functions.

Other customer redress provisions

TSB is protected from losses arising from historic misconduct under an indemnity provided by Lloyds Bank plc. However, TSB retains the primary liability for the alleged misconduct to its customers and a provision for customer remediation of £16.0 million (2018: £15.0 million) is carried. A recoverable of £14.4 million (2018: £14.6 million) has been recognised under the indemnity provided by Lloyds Bank plc (note 30). The size of the liability follows an assessment of emerging themes in customer complaints, an assessment of broader industry commentary and discussions with regulators. The ultimate cost and timing of payments are uncertain as a result of the inherent difficulties in estimating factors such as future levels of customer complaints and remediation settlements. The provision represents management's current best estimate.

Other important disclosures (continued)

32. Other liabilities

Total other liabilities	153.3	495.4
Other creditors	75.2	57.6
Share-based payments liability	5.4	4.9
Accruals and deferred income	70.1	230.4
Amounts payable to Sabadell Group companies (note 26)	2.6	202.5
	£ million	2018 £ million
	2019

Significant estimate – MSA and OSA contract liabilities

The MSA and OSA contracts provide TSB with the right to seek recovery of eligible losses for breach of contract up to the level of liability caps in each agreement. The parties have reached provisional agreement, subject to mutual reservation of rights while negotiations are concluded, where TSB will recover an aggregate of £192.6 million (2018: £153.0 million) under the respective contracts.

Amounts payable to Sabis under the MSA and OSA contracts are presented on the statement of financial position net of the estimated recovery of £192.6 million (2018: £153.0 million).

33. Notes to the consolidated cash flow statement

The following table presents further analysis of balances in the consolidated cash flow statement:

	2019	(1) 2018
	£ million	£ million
Increase in loans to central banks	(8.3)	(31.8)
Increase in loans to credit institutions	(2.6)	(41.4)
(Increase)/decrease in loans and advances to customers	(1,132.8)	679.9
Increase in reverse purchase agreements	(201.1)	-
Decrease in other advances	102.5	513.9
Net change in derivative financial instruments and fair value adjustment for
portfolio hedged risk	(162.4)	(144.2)
Decreases in other assets	54.8	70.6
(Decrease)/increase in deposits from credit institutions	(2.7)	3.4
Increase/(decrease) in customer deposits	1,089.9	(1,459.1)
Increase/(decrease) in other financial liabilities	14.2	(180.9)
(Decrease)/increase in provisions	(11.8)	29.1
(Decrease)/increase in other liabilities	(333.6)	214.8
Change in operating assets and liabilities	(593.9)	(345.7)
Depreciation and amortisation	60.2	28.1
Impairment losses on loans and advances to customers	60.9	73.3
Other non-cash items	48.3	50.1
Non-cash and other items	169.4	151.5
Analysis of cash and cash equivalents as shown in the balance sheet
Cash	160.1	160.3
Balances with central banks(2)	4,427.3	6,954.9
On demand deposits	7.8	20.8
Total cash and cash equivalents	4,595.2	7,136.0

(1) Comparative information for 2018 has been re-presented on a basis consistent with the current year.

(2) Mandatory reserve deposits are held with local central banks in accordance with statutory requirements. These deposits are not available to finance TSB's day-today operations and are not included in cash and cash equivalents.

Other important disclosures (continued)

33. Notes to the consolidated cash flow statement (continued)

Change in liabilities arising from financing activities

	Borrowings from central banks £ million	Debt securities in issue £ million	Subordinated liabilities £ million	Repurchase agreements £ million	Total non customer funding £ million
At 1 January 2018	5,625.7	1,318.7	405.3	1,446.4	8,796.1
Borrowings under the BoE Term Funding Scheme (TFS)	850.0	–	–	–	850.0
Repayment of securitisation funding	–	(197.9)	–	–	(197.9)
Repayments of repurchase agreements (net)	–	–	–	(361.9)	(361.9)
Non-cash movements	6.5	1.8	(7.1)	0.3	1.5
At 31 December 2018	6,482.2	1,122.6	398.2	1,084.8	9,087.8
Repayment of borrowings from central banks (net)	(1,995.0)	-	-	-	(1,995.0)
Repayment of securitisation funding	-	(198.0)	-	-	(198.0)
Issuance of covered bonds	-	750.0	-	-	750.0
Repayments of repurchase agreements (net)	-	-	-	(1,084.8)	(1,084.8)
Non-cash movements	(3.7)	1.7	(2.3)	-	(4.3)
At 31 December 2019	4,483.5	1,676.3	395.9	-	6,555.7

34. Approval of the consolidated financial statements

These consolidated financial statements were approved by the Board of Directors of TSB Banking Group plc on 30 January 2020.

The Company's ultimate parent company and ultimate controlling party is Banco de Sabadell, S.A. (incorporated in Spain), which is also the parent undertaking of the largest group of undertakings for which consolidated financial statements are drawn up and of which the Company is a member. Banco de Sabadell S.A. is the parent undertaking of the smallest such group of undertakings for which consolidated financial statements are drawn up and of which the Company is a member. Copies of the consolidated annual report and accounts of Banco Sabadell S.A. are expected to be available in due course from www.grupbancsabadell.com/en/.

Company balance sheet

As at 31 December 2019

Company Number: 08871766

		2019	2018
	Note	£ million	£ million
Assets Non-current assets:
Investments in subsidiaries		1,589.4	1,589.4
	4
Loans to subsidiaries	4	388.0	387.8
Current assets:		1,977.4	1,977.2
Derivative financial assets	5	0.5	–
Amounts due from subsidiaries	4	0.7	0.1
Other advances		–	0.7
Current tax asset		0.4	0.7
Total assets		1,979.0	1,978.7
Liabilities
Non-current liabilities:
Subordinated liabilities	2	388.0	387.8
Current liabilities:
Derivative financial liabilities	5	–	0.8
Amounts due to subsidiaries	4	14.9	15.0
Other financial liabilities		0.7	–
Total liabilities		403.6	403.6
Equity
Share capital	3	5.0	5.0
Share premium	3	965.1	965.1
Merger reserve	3	616.5	616.5
Profit/(loss) for the year		0.3	(1.6)
Accumulated losses brought forward		(11.5)	(9.9)
Shareholder's equity		1,575.4	1,575.1
Total equity and liabilities		1,979.0	1,978.7

The accompanying notes are an integral part of the financial statements.

No statement of comprehensive income has been shown for the Company, as permitted by section 408 of the Companies Act 2006.

The Company financial statements on pages 91 to 95 were approved by the Board of Directors on 30 January 2020 and signed on its behalf by:

Debbie Crosbie Ralph Coates Chief Executive Officer Chief Financial Officer

Company statement of changes in equity

for the year ended 31 December 2019

	Share capital £ million	Share premium £ million	Merger reserve £ million	Accumulated losses £ million	Shareholder's equity £ million
Balance at 1 January 2018	5.0	965.1	616.5	(9.9)	1,576.7
Comprehensive loss
Total comprehensive loss for the year	–	–	–	(1.6)	(1.6)
Balance at 31 December 2018	5.0	965.1	616.5	(11.5)	1,575.1
Comprehensive income
Total comprehensive income for the year	–	–	–	0.3	0.3
Balance at 31 December 2019	5.0	965.1	616.5	(11.2)	1,575.4

Company cash flow statement

for the year ended 31 December 2019

	2019	2018
	£ million	£ million
Cash flows from operating activities
Profit/(loss) before taxation	0.6	(2.2)
Adjustments for:
Change in current liabilities	(0.2)	2.9
Change in current assets	(0.4)	(1.3)
Non-cash and other items	–	0.6
Net cash provided by operating activities	–	–
Cash flows from investing activities
Interest received on financial assets	22.4	22.4
Net cash provided by investing activities	22.4	22.4
Cash flows from financing activities
Interest paid on subordinated liabilities	(22.4)	(22.4)
Net cash used in financing activities	(22.4)	(22.4)
Change in cash and cash equivalents	–	–
Cash and cash equivalents at 1 January	–	–
Cash and cash equivalents at 31 December	–	–

The accompanying notes are an integral part of the financial statements.

Notes to the Company financial statements

1. Basis of preparation

The financial statements of TSB Banking Group plc (the Company), a public limited company (limited by shares), are prepared on a going concern basis and in accordance with IFRS as adopted by the EU. IFRS comprises accounting standards prefixed IFRS issued by the IASB and those prefixed IAS issued by the IASB's predecessor body as well as interpretations issued by the IFRS Interpretations Committee. The Company's financial statements are presented in accordance with the Companies Act 2006. The Company is incorporated and domiciled in the UK and registered in England and Wales. The registered office is 20 Gresham Street, London, EC2V 7JE. The financial statements are prepared on the historical cost basis.

The accounting policies that are applicable to the Company are included in TSB accounting policies and the following policy is also applicable.

Investments in subsidiaries

Investments in subsidiaries are initially recognised at cost and subsequently held at cost less any impairment charge. An impairment charge is recognised when the carrying amount of the investment exceeds its recoverable amount.

The adoption of IFRS 16 did not have any impact on the financial statements of the Company.

2. Subordinated liabilities

	2019	2018
	£ million	£ million
Fixed/floating rate reset callable subordinated Tier 2 notes due May 2026	384.6	384.4
Accrued interest	3.4	3.4
Total subordinated liabilities	388.0	387.8

The Company issued, in 2014, £385.0 million of fixed/floating rate reset callable subordinated Tier 2 notes at an issue price of 99.493% of the principal amount. The notes pay interest at a rate of 5.75% per annum, payable semi-annually in arrears until 6 May 2021 at which time the interest rate becomes 3 month LIBOR plus 3.43% per annum payable quarterly in arrears. The Company has the option to redeem these notes on 6 May 2021 and quarterly thereafter, subject to approval of the Prudential Regulatory Authority.

3. Share capital, share premium and merger reserve

Details of the Company's share capital, share premium and merger reserve are set out in note 24 to the consolidated financial statements

4. Related party transactions

The Company enters into transactions with related parties in the normal course of its business. The tables below detail, on an aggregated basis, related party transactions, balances outstanding at the year end and related income.

(i) Key management personnel

The key management personnel of TSB and the Company are the same. The relevant disclosures are set out in note 26 to the consolidated financial statements. The Company has no employees.

(ii) Investment in subsidiaries

The Company's only legal subsidiary undertaking is TSB Bank plc, a banking business incorporated and registered in Scotland whose registered office is Henry Duncan House, 120 George Street, Edinburgh, EH2 4LH. The Company holds 100% of the ordinary share capital and voting rights of TSB Bank plc and carried this investment at its cost of £1.589.4 million (2018: £1,589.4 million).

Notes to the Company financial statements

4. Related party transactions (continued)

In addition, TSB Banking Group plc Employee Share Trust is accounted for as a subsidiary of the Company and the registered office of this entity is 26 New Street, St Helier, Jersey, JE 3RA.

The following entities are accounted for as subsidiary companies of TSB Bank plc as it exercises control of each entity under IFRS 10 Consolidated Financial Statements. The registered office of each of these entities is 35 Great St Helen's, London, EC3A 6AP:

• Duncan Holdings 2015-1 Limited (and its subsidiary Duncan Funding 2015-1 plc);
• Duncan Holdings 2016-1 Limited (and its subsidiary Duncan Funding 2016-1 plc);
• TSB Covered Bonds LLP;
• TSB Covered Bonds (LM) Limited; and
• TSB Covered Bonds (Holdings) Limited.

(iii) Loans to subsidiaries

2019	2018
£ million	£ million
388.0 Loans to subsidiaries	387.8
388.0 Total loans to subsidiaries	387.8

On 1 May 2014, the Company subscribed for fixed/floating rate reset callable subordinated Tier 2 notes due May 2026 issued by its principal subsidiary, TSB Bank plc. The allowance for credit impairment losses on this 'stage 1' loan was £nil (2018: £nil).

(iv) Other related party transactions

At 31 December 2019, amounts due by the Company to subsidiary companies were £14.9 million (2018: £15.0 million). Amounts due from subsidiary companies were £0.7 million (2018: £0.1 million).

Detail of other related party transactions is given in note 26 to the consolidated financial statements.

5. Financial instruments

(i) Measurement basis of financial instruments

The following table analyses the carrying amounts of the Company's financial instruments:

		Financial
	At fair value	assets at	Held at
	through profit	amortised	amortised
	or loss	cost	cost	Total
At 31 December 2019	£ million	£ million	£ million	£ million
Financial assets
Loans to subsidiaries	–	388.0	–	388.0
Derivative financial assets	0.5	–	–	0.5
Total financial assets	0.5	388.0	–	388.5
Financial liabilities
Subordinated liabilities	–	–	(388.0)	(388.0)
Total financial liabilities	–	–	(388.0)	(388.0)
At 31 December 2018
Financial assets
Loans to subsidiaries	–	387.8	–	387.8
Total financial assets	–	387.8	–	387.8
Financial liabilities
Subordinated liabilities	–	–	(387.8)	(387.8)
Derivative financial liabilities	(0.8)	–	–	(0.8)
Total financial liabilities	(0.8)	–	(387.8)	(388.6)

Notes to the Company financial statements

5. Financial instruments (continued)

(ii) Fair value of financial assets and liabilities

	2019		2018
At 31 December	Carrying value £ million	Fair value £ million	Carrying value £ million	Fair value £ million
Financial assets
Loans to subsidiaries	388.0	398.3	387.8	381.1
Derivative financial assets	0.5	0.5	–	–
Financial liabilities
Subordinated liabilities	(388.0)	(398.3)	(387.8)	(381.1)
Derivative financial liabilities	–	–	(0.8)	(0.8)

The valuation techniques for the Company's financial assets and liabilities are set out in notes 5 and 11 to the consolidated financial statements.

(iii) Valuation hierarchy of financial assets and liabilities

The table below analyses the fair values of the financial assets and liabilities of the Company.

At 31 December 2019	Level 1 £ million	Level 2 £ million	Level 3 £ million	Total fair value £ million	Total carrying value £ million
Financial assets
Loans to subsidiaries	–	398.3	–	398.3	388.0
Derivative financial assets	–	0.5	–	0.5	0.5
Financial liabilities
Subordinated liabilities	–	(398.3)	–	(398.3)	(388.0)
At 31 December 2018
Financial assets
Loans to subsidiaries	–	381.1	–	381.1	387.8
Financial liabilities
Subordinated liabilities	–	(381.1)	–	(381.1)	(387.8)
Derivative financial liabilities	–	(0.8)	–	(0.8)	(0.8)

(iv) Credit risk

The Company's credit risk arises solely from amounts due from its wholly owned subsidiary, TSB Bank plc. At 31 December 2019, the Company held no financial assets that were either past due or impaired (2018: £nil).

(v) Liquidity risk

The table below analyses the financial liabilities of the Company by relevant contractual maturity grouping on an undiscounted future cash flow basis based on the remaining period at the balance sheet date.

	Up to 1	1-3	3-12	1-5	Over 5
	month	months	months	years	years	Total
At 31 December 2019	£ million	£ million	£ million	£ million	£ million	£ million
Subordinated liabilities	–	–	22.1	418.2	–	440.3
Total non-derivative financial liabilities	–	–	22.1	418.2	–	440.3
Gross settled derivatives – outflows	–	–	–	–	–	–
Total	–	–	22.1	418.2	–	440.3
At 31 December 2018
Subordinated liabilities	–	–	22.1	440.3	–	462.4
Total non-derivative financial liabilities	–	–	22.1	440.3	–	462.4
Gross settled derivatives – outflows	–	0.8	–	–	–	0.8
Total	–	0.8	22.1	440.3	–	463.2

Report on the audit of the financial statements

Opinion

In our opinion, TSB Banking Group plc's (the 'Group') consolidated financial statements and Company financial statements (the 'financial statements'):

• give a true and fair view of the state of the Group's and of the Company's affairs as at 31 December 2019 and of the consolidated Group's profit and the Group's and the Company's cash flows for the year then ended;
• have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union and, as regards the Company's financial statements, as applied in accordance with the provisions of the Companies Act 2006; and
• have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group's financial statements, Article 4 of the IAS Regulation.

We have audited the financial statements included within the Annual Report and Accounts 2019 (the 'Annual Report'), which comprise: the consolidated and Company balance sheets as at 31 December 2019; the consolidated statement of comprehensive income, the consolidated and Company statements of changes in equity, and the consolidated and Company cash flow statements for the year then ended; and the notes to the financial statements, which include a description of the significant accounting policies.

Our opinion is consistent with our reporting to the Audit Committee.

Basis for opinion

We conducted our audit in accordance with International Standards on Auditing (UK) ('ISAs (UK)') and applicable law. Our responsibilities under ISAs (UK) are further described in the Auditors' responsibilities for the audit of the financial statements section of our report. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence

We remained independent of the Group in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, which includes the FRC's Ethical Standard, as applicable to public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements.

To the best of our knowledge and belief, we declare that non-audit services prohibited by the FRC's Ethical Standard were not provided to the Group or the Company.

Other than those disclosed in note 15 to the financial statements, we have provided no non-audit services to the Group or the Company in the period from 1 January 2019 to 31 December 2019.

Our audit approach

Context

The Group's profitability continues to be impacted by the IT issues post migration and the costs of the subsequent post migration service disruption. As part of its strategy to restore the Group's competitiveness, management have committed to simplifying the business, which has led to material restructuring and severance costs being incurred in 2019. As a result, we have elected to use the same materiality benchmark as last year, which was based on average absolute profit/loss before tax over the period from 2016 to 2018. We concluded that using current year results, the calculated materiality would be significantly lower than amounts which, if impacting reported profits, could influence decisions made by the users of the financial statements, given the scale of the Group's operations and balance sheet. We have also continued to adopt a more substantive testing approach due to the immaturity of the control environment in some areas.

Overview
Materiality	• Overall Group materiality: £8.0 million (2018: £8.1 million), based on 5% of average absolute profit/loss before tax from 2016 to 2018, rounded down to £8.0 million • Overall Company materiality: £8.0 million (2018: £8.1 million), based on 1% of total assets, capped at the lower materiality of the Group.
Audit scope	The scope of our audit and the nature, timing and extent of audit procedures performed were determined by our risk assessment, the financial significance of reporting units and other qualitative factors (including any history of misstatement through fraud or error).
Key audit matters	The areas of focus for our audit which involved the greatest allocation of our resources and effort were: • The recoverability of costs associated with the Migration Services Agreement and Outsourced Services Agreement; and • The appropriateness of the assumptions used in the calculation of material Expert Credit Judgements (ECJ), Multiple Economic Scenarios (MES) and the significant increase in credit risk relating to loan loss provisioning.
	In addition, we have included a key audit matter in relation to IT access and change management, given the pervasiveness of the impact on our audit approach of the issues found in these areas.
	Significant changes in our approach In our 2019 report the following changes to the key audit matters identified have been made, compared with our 2018 report: • We no longer consider completeness and accuracy of the data transfer at the date of IT system migration to be a key audit matter as this was a one-off event in the prior year; • We have refined the risk in relation to IFRS 9 to exclude the accuracy of critical inputs to the calculations given this was primarily a risk following the IT system migration; and • We have refined the risk in relation to judgemental costs arising from the migration to only apply to

The scope of our audit

As part of designing our audit, we determined materiality and assessed the risks of material misstatement in the financial statements. In particular, we looked at where the directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain.

intragroup costs, rather than customer remediation and potential regulatory fines.

Capability of the audit in detecting irregularities, including fraud

Based on our understanding of the Group and the industry, we identified that the principal risks of non-compliance with laws and regulations related to breaches of banking regulations such as, but not limited to, the Consumer Credit Act and unethical and prohibited business practices, and we considered the extent to which non-compliance might have a material effect on the financial statements. We also considered those laws and regulations that have a direct impact on the financial statements such as the Companies Act 2006. We evaluated management's incentives and opportunities for fraudulent manipulation of the financial statements (including the risk of override of controls), and determined that the principal risks were related to posting inappropriate journal entries to both reduce costs and inflate operating profit, and management bias in accounting estimates. In the current year we have also performed procedures to specifically address the incentives and opportunities posed by the implementation of management's new strategy. Audit procedures performed by the engagement team included, but were not limited to:

• Discussions with management, internal audit and the Group's legal advisors, including consideration of known or suspected instances of non-compliance with laws and regulations and fraud;
• Evaluation of the operating effectiveness of management's controls designed to prevent and detect irregularities;
• Assessment of matters reported on the Group's whistleblowing helpline and the results of management's investigation of such matters;
• Reading key correspondence with regulatory authorities such as the Financial Conduct Authority and the Prudential Regulation Authority in relation to compliance with banking regulations;
• Challenging assumptions and judgements made by management in their significant accounting estimates, in particular in relation to valuation of the impairment provision (see related key audit matter below);
• Challenging management on the assumptions used in the Medium Term Plan approved by the Board on 23 October 2019. We also considered the impact of bonus incentives, as well as the skills and competencies of the individuals involved in the governance and assumption-setting process, to determine whether management incentives to manipulate results exist; and
• Identifying and testing journal entries, in particular any journal entries posted with understatement of costs, journals that are backdated or posted by senior management.

Capability of the audit in detecting irregularities, including fraud (continued)

There are inherent limitations in the audit procedures described above and the further removed non-compliance with laws and regulations is from the events and transactions reflected in the financial statements, the less likely we would become aware of it. Also, the risk of not detecting a material misstatement due to fraud is higher than the risk of not detecting one resulting from error, as fraud may involve deliberate concealment by, for example, forgery or intentional misrepresentations, or through collusion.

Key audit matters

Key audit matters are those matters that, in the auditors' professional judgement, were of most significance in the audit of the financial statements of the current period and include the most significant assessed risks of material misstatement (whether or not due to fraud) identified by the auditors, including those which had the greatest effect on: the overall audit strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. These matters, and any comments we make on the results of our procedures thereon, were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. This is not a complete list of all risks identified by our audit.

The recoverability of costs associated with the Migration Services Agreement and Outsourced Services Agreement (Group only)

Nature of key audit matter The Group's IT systems have been developed, and are maintained, by Sabadell Information Systems Limited ('Sabis'), a subsidiary of the Banco Sabadell Group. The Group started to utilise these IT systems in 2018 when they entered into a Migration Services Agreement ('MSA') and an Outsourced Services Agreement ('OSA') with Sabis.

Upon migration, TSB experienced a number of significant issues, which in turn gave rise to a number of judgmental costs, a proportion of which TSB are seeking to recover from Sabis under the non-performance terms of these agreements.

The amounts recoverable remain unfinalised given the ongoing regulatory investigations and discussions with insurance providers, but management's best estimate of the recovery is £192.6 million. This is a key audit matter due to the continuing judgemental nature of the recoveries of costs under these agreements, and the ongoing nature of negotiations with parties including insurance companies. We have therefore focused on how the amounts recoverable from Sabis have been estimated and the estimate disclosed in the annual report. This is disclosed in note 32.

Matters discussed with the Audit Committee

We discussed our scope and plan for testing the recoverability assumption with the Audit Committee, highlighting our focus on the intergroup agreement of the amounts payable to Sabis including confirmation of symmetrical accounting and correspondence with regulators.

We confirmed that whilst negotiations with Sabis are ongoing, both management and members of the Audit Committee believe that the position to record the recovery of post migration charges of £192.6 million represents the best estimate of the aggregate recovery from Sabis under the terms of both the MSA and the OSA. Given that this is a significant judgement and is a best estimate, we discussed the need to have full and transparent disclosure.

We shared our conclusions that the judgements, estimates and total provisions at the year end are reasonable.

Procedures performed to support conclusions

We performed the following procedures around the costs recoverable under the MSA and OSA:

• We confirmed that the Group has the contractual right to recover costs incurred from Sabis under the terms of the MSA and OSA.
• We tested the schedule of costs which the Group has used as the basis of the best estimate calculation, and confirmed that the Company has incurred costs related to the migration in excess of the recoveries recognised under both agreements.
• We have challenged management that the recovery represents the best estimate of the claimable costs as at 31 December 2019 through reviewing correspondence from external counsel and obtaining written and verbal confirmation from the Audit Committee and Chief Financial Officer of the Group and the Banco Sabadell Group Chief Financial Officer.
• We have received confirmation from both Sabadell and PwC Spain that Sabis have recorded an equal and opposite entries in respect of the recovery recognised on TSB's balance sheet.
• Given the amount of the recovery is not finalised, we challenged the proposed disclosure to ensure that it clearly explains that it is an estimate at the year end, and may change as negotiations with Sabis continue and the agreement is concluded.

Relevant references in the Annual Report and Accounts 2019 Note 32 - Other liabilities

The continued appropriateness of the staging thresholds used to determine a significant increase in credit risk, forward looking economic assumptions and significant Expert Credit Judgement ('ECJ') assumptions as they relate to expected credit loss ('ECL') provisioning (Group only)

Nature of key audit matter This is a key audit matter as retail impairment provisions require a high level of judgement to determine the size of the required ECL provision.

This is the second year that ECL have been reported under IFRS 9 and therefore management's processes and controls have further matured. In particular, the extent of model monitoring has increased, given there is more historical data and experience now available to backtest management's models. However, certain key judgements remain, in particular caused by continued uncertainty in the future path of the UK economy and how this will impact ECL. Our audit work will focus on the key judgemental areas, being:

• The continued appropriateness of staging thresholds to determine a significant increase in credit risk;
• Forward looking economic assumptions (specifically interest rates, unemployment and house price growth, given that these assumptions are most sensitive to ECL) and the weightings assigned to scenarios (specifically the base and downside scenarios, as these scenarios have the highest weights assigned to them); and
• Assumptions in significant ECJs recognised by management to mitigate model weaknesses or emerging risks (specifically risks around interest only mortgages, loan affordability and judgement in determining forced sale discounts).

Matters discussed with the Audit Committee

We discussed with the Committee a number of matters in relation to ECL during the year including the results of management's validation of the staging thresholds as well as the results of our independent audit work on those key judgements.

We presented to the Committee the results of our benchmarking of management's key forward looking economic assumptions and how they compared to external consensus forecasts, including the latest Bank of England published scenarios.

We also discussed the continued reliance on ECJ allowances made in addition to the core impairment models and management's plans to incorporate more of these into core models going forward, where it is possible to do so.

Procedures performed to support conclusions

• We tested management's monitoring controls including the sufficiency of the model validation activities undertaken and re-performed a number of monitoring tests independently.
• We tested the key assumptions in significant ECJ's made by management and considered the completeness of adjustments to core models to take account of latent risks and known model limitations.
• To test management's 'staging' thresholds, we re-performed key aspects of management's testing and performed independent back testing to confirm that the criteria selected by management were reasonable.
• We assessed the reasonableness and likelihood of the forward looking economic assumptions and weightings assigned to the scenarios using our economic experts. For the base and downside economic scenarios, their reasonableness was assessed against known or likely economic, political and other relevant events, including potential risks from the UK's exit from the European Union. The severity and magnitude of the scenarios were compared to external forecasts and data from historical economic downturns, and the sensitivities of the scenarios on the ECL were considered. We found that the assumptions adopted and assigned weightings to the scenarios were reasonable.
• We tested the accuracy and completeness of critical data inputs used by the impairment models on a sample basis to supporting documentation.
• We tested that the credit risk disclosures made by management were compliant with IFRS 9 and agreed the disclosures to source data without exception.

Relevant references in the Annual Report and Accounts 2019 Note 10 - Allowance for credit impairment losses on financial assets at amortised cost

IT access and change management (Group and Company)

Nature of key audit matter

This is a key audit matter as mature controls over IT access and change management are critical to the overall IT control environment of the Group. During our 2018 audit, we identified IT access and change management issues in relation to the operation of certain applications, operating systems and data in the financial reporting process subsequent to the migration. The Group continues to work on improving the control environment through their IT remediation and stabilisation programmes.

As a result of issues identified in the IT control environment, we continue to be unable to rely on automated and IT dependent manual controls for the 2019 audit. This has led us to perform a largely substantive audit and increase the number of procedures in several areas.

Matters discussed with the Audit Committee

In April, we informed the Audit Committee that we would be conducting a fully substantive audit for 2019 unless significant improvements were made before the end of Q2.

In July, we confirmed with management that remediation would not be completed in time to allow controls to embed, and therefore we would continue to plan for a largely substantive audit, being the most efficient approach.

Procedures performed to support conclusions

• We conducted substantive procedures across all business areas where IT access and change management controls could not be relied upon. We also increased our sample sizes in certain areas of the audit, including testing of customer origination documents for existence purposes, and increased sample sizes for testing of inputs to the impairment models.
• We also assessed IT deficiencies identified by other parties including external consultants and internal audit. Deficiencies identified by other parties corroborated our own views that a fully substantive audit approach was most appropriate.

Relevant references in the Annual Report and Accounts 2019 Not applicable

How we tailored the audit scope

We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, taking into account the structure of the Group and the Company, the accounting processes and controls, and the industry in which they operate.

The Group is the consolidation of TSB Banking Group plc and its subsidiaries, including TSB Bank plc, for which we issue a separate audit report. For the year ended 31 December 2019, we have scoped the audit by disaggregating the Group by business unit (e.g. savings, mortgages, treasury). This allows us to perform a detailed analysis of the characteristics and contribution of each component to the overall results and position, and is aligned with management's internal analysis.

For each financial statement line item we considered the financial significance and qualitative factors, including the presence of any significant audit risks, to determine our audit scope. Additionally the risk of material misstatement was mitigated through audit procedures including testing of entity level controls and analytical review procedures.

We do not rely on any component auditors or other PwC offices.

We have determined that there is one significant component: mortgages, over which we have performed a full scope audit of all material primary statement account balances. Whilst not individually financially significant, the head office function has also been fully audited given its pervasiveness to the financial statements.

Materiality

The scope of our audit was influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures on the individual financial statement line items and disclosures and in evaluating the effect of misstatements, both individually and in aggregate on the financial statements as a whole.

Based on our professional judgement, we determined materiality for the financial statements as a whole as follows:

	Consolidated financial statements	Company financial statements
Overall materiality	£8.0 million (2018: £8.1 million).	£8.0 million (2018: £8.1 million).
How we determined it	5% of average absolute profit/loss before tax from 2016 to 2018, rounded down to £8.0 million.	1% of total assets.
Rationale for benchmark applied	We have concluded it to be appropriate to determine materiality with reference to the Group's historical profitability as we consider the Group's most recent profitability is not reflective of normal profitability as the Group continues to undergo a transformation process following the impact of the IT migration issues in the prior year.	As the Company is not profit orientated on a solo-entity basis, we have used 1% of total assets, but capped this to the lower materiality of the Group.

For each component in the scope of our Group audit, we allocated a materiality that is less than our overall Group materiality. The range of materiality allocated across components was between £0.52 million and £4.55 million.

We agreed with the Audit Committee that we would report to them misstatements identified during our audit above £0.4 million (Group audit) (2018: £0.4 million) and £0.4 million (Company audit) (2018: £0.4 million) as well as misstatements below those amounts that, in our view, warranted reporting for qualitative reasons.

Conclusions relating to going concern

ISAs (UK) require us to report to you when:

• the directors' use of the going concern basis of accounting in the preparation of the financial statements is not appropriate; or
• the directors have not disclosed in the financial statements any identified material uncertainties that may cast significant doubt about the Group's and Company's ability to continue to adopt the going concern basis of accounting for a period of at least twelve months from the date when the financial statements are authorised for issue.

We have nothing to report in respect of the above matters. However, because not all future events or conditions can be predicted, this statement is not a guarantee as to the Group's and Company's ability to continue as a going concern. For example, the terms on which the United Kingdom may withdraw from the European Union are not clear, and it is difficult to evaluate all of the potential implications on the Group's trade, customers, suppliers and the wider economy.

Reporting on other information

The other information comprises all of the information in the Annual Report other than the financial statements and our auditors' report thereon. The directors are responsible for the other information. Our opinion on the financial statements does not cover the other information and, accordingly, we do not express an audit opinion or, except to the extent otherwise explicitly stated in this report, any form of assurance thereon.

In connection with our audit of the financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If we identify an apparent material inconsistency or material misstatement, we are required to perform procedures to conclude whether there is a material misstatement of the financial statements or a material misstatement of the other information. If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report based on these responsibilities.

With respect to the Strategic Report, Directors' Report and Corporate Governance Statement, we also considered whether the disclosures required by the UK Companies Act 2006 have been included.

Based on the responsibilities described above and our work undertaken in the course of the audit, ISAs (UK) require us also to report certain opinions and matters as described below.

Strategic Report and Directors' Report

In our opinion, based on the work undertaken in the course of the audit, the information given in the Strategic Report and Directors' Report for the year ended 31 December 2019 is consistent with the financial statements and has been prepared in accordance with applicable legal requirements.

In light of the knowledge and understanding of the Group and Company and their environment obtained in the course of the audit, we did not identify any material misstatements in the Strategic Report and Directors' Report.

Responsibilities for the financial statements and the audit

Responsibilities of the directors for the financial statements

As explained more fully in the Statement of directors' responsibilities in respect of the financial statements, the directors are responsible for the preparation of the financial statements in accordance with the applicable framework and for being satisfied that they give a true and fair view. The directors are also responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the financial statements, the directors are responsible for assessing the Group's and the Company's ability to continue as a going concern, disclosing as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group or the Company or to cease operations, or have no realistic alternative but to do so.

Auditors' responsibilities for the audit of the financial statements

Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors' report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs (UK) will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.

A further description of our responsibilities for the audit of the financial statements is located on the FRC's website at: www.frc.org.uk/auditorsresponsibilities. This description forms part of our auditors' report.

Use of this report

This report, including the opinions, has been prepared for and only for the Company's members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing.

Other required reporting

Companies Act 2006 exception reporting

Under the Companies Act 2006 we are required to report to you if, in our opinion:

• we have not received all the information and explanations we require for our audit; or
• adequate accounting records have not been kept by the Company, or returns adequate for our audit have not been received from branches not visited by us; or
• certain disclosures of directors' remuneration specified by law are not made; or
• the Company financial statements are not in agreement with the accounting records and returns.

We have no exceptions to report arising from this responsibility.

Appointment

Following the recommendation of the Audit Committee, we were appointed by the members on 1 January 2014 to audit the financial statements for the year ended 31 December 2014 and subsequent financial periods. The period of total uninterrupted engagement is 6 years, covering the years ended 31 December 2014 to 31 December 2019.

Laura Needham (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London, 30 January 2020

EDTF Recommendations

The Enhanced Disclosure Task Force (EDTF) was formed in 2012 by the Financial Stability Board to develop principles for enhanced risk disclosures. Its reports set out 32 recommendations across seven risk areas. These are primarily aimed at large international banks. However, aligned to TSB's commitment to transparency, the table below provides an overview of how TSB has responded to the recommendations, where relevant to its business model and risk profile.

Type of risk	EDTF Ref	Description	TSB's approach
General	1	Risks to which TSB is exposed
	2	Definition of risk terminology, principles and
		appetite	A summary of TSB's principal risks and uncertainties is disclosed
	3	Top and emerging risks and changes during	on pages 19 to 20. IFRS 9 impairment terminology and concepts
		the reporting period	are described on pages 62 and 63.
	4	Analysis of future regulatory developments affecting the business model and profitability
Risk governance	5	TSB's risk management organisation,
and management		process and key functions	Described in the Risk management in TSB section on pages 17 to
	6	Risk culture and risk governance and	20 and in the Corporate governance statement on pages 21 to 28.
		ownership
	7	Description of the key risks that arise from the business model, risk appetite, and how	TSB's principal risks and uncertainties that arise from the business
		TSB manages such risks.	model are explained on pages 19 to 20. Further explanation of
	8	Stress testing and the underlying	financial risks is provided in the notes to the consolidated financial
		assumptions	statements on pages 72 to 82.
Capital adequacy	9	Minimum Pillar 3 disclosures requirements	Disclosed in the Sabadell Pillar 3 report*.
	10	Reconciliation of accounting balance sheet to
		regulatory balance sheet	Disclosed on page 12.
	11	Flow statement of movements in regulatory	Disclosed on page 13.
		capital
	12	Discussion of targeted level of capital and	A description of TSB's capital composition and changes is provided
	13	how this will be established Analysis of risk-weighted assets and how	on pages 12 and 13.
		they relate to business activities
	14	Analysis of capital requirements for each	An analysis of risk-weighted assets is disclosed on page 13.
		Basel asset class
	15	Analysis of credit risk for each Basel asset
		class
	16	Flow statements reconciling movements in
		Risk Weighted Assets for each Risk	Disclosed in the Sabadell Pillar 3 report*.
	17	Weighted Asset type Discussion of Basel credit risk model
		performance
Liquidity and	18	Analysis of TSB's liquid asset buffer	Details of the liquidity portfolio and encumbered assets are
funding	19	Encumbered and unencumbered assets	disclosed in the Financial performance in 2019 section of the
		analysed by balance sheet category	strategic report on page14.
	20	TSB assets, liabilities and off balance sheet	An analysis of the contractual maturity of TSB's assets and liabilities
		commitments analysed by remaining	is disclosed in note 21 to the consolidated financial statements.
	21	contractual maturity Analysis of TSB's sources of funding	TSB's sources of funding are set out in notes 1 to 5 of the
			consolidated financial statements.
Market risk	22	Relationship between market risk measures
		for trading and non-trading portfolios and the
		balance sheet	A summary of the sources, measurement and monitoring of market
	23	Discussion of significant trading and non	risk, including sources and sensitivity of net interest income to non
		trading market risk factors	trading market risk is disclosed in note 23 to the consolidated
	24 25	VaR assumptions, limitations and validation Description of the primary risk management	financial statements. TSB has no trading market risk.
		techniques employed by TSB
Credit risk	26	Analysis of the aggregate credit risk	A table showing the maximum exposure to credit risk is disclosed in
		exposures	note 20 to the consolidated financial statements.
	27	Description of the policies for identifying
		impaired or non-performing loans including	TSB's policy for identifying impaired loans is disclosed on pages 56 and 57. A summary of forborne loans is set out on page 74.
		forbearance
	28	Reconciliation of the opening and closing	Disclosure of the movement in the allowance for credit impairment
		balances of non-performing or impaired loans	losses and movement in gross loans, including credit impaired loans
		and the allowance for loan losses.	(stage 3) is disclosed in note 10 to the consolidated financial statements.
	29	Analysis of counterparty credit risk that arises	TSB's derivatives are set out in note 23 to the consolidated financial
		from derivative transactions	statements.
	30	Discussion of credit risk mitigation, including	Credit risk mitigation and analysis of collateral held is disclosed in
		collateral held for all sources of risk	note 20 to the consolidated financial statements.
Other risks	31	Description of other risks	A description of principal and emerging risks is disclosed in the Risk
	32	Discussion of publicly known risks	management section of the strategic report on pages 17 to 20.

* As at the date of this report, the 2019 Sabadell Pillar 3 report has not been approved and is expected to be available in due course from www.grupbancsabadell.com/en/.

Glossary

Allowance for credit impairment losses	Provisions held on the balance sheet as a result of raising a charge against profit for expected credit losses in the loan book. The allowance may be either individual or collective.
Arrears	A customer is in arrears when they are behind in fulfilling their obligations with the result that an outstanding loan is unpaid or overdue. Such a customer is also said to be in a state of delinquency and the entire outstanding balance is delinquent.
Basel III	The capital reforms and introduction of a global liquidity standard proposed by the Basel Committee on Banking Supervision in 2010 and due to be phased in, through CRD IV, from 1 January 2015 onward. This was further enhanced in December 2017 to refine the capital framework and introduce new elements including the output capital floor. These revisions will come into force between 1 January 2022 and 1 January 2027.
Basis point (bps)	One hundredth of a per cent (0.01 per cent). 100 basis points is 1 per cent. Used in quoting movements in interest rates.
Common Equity Tier 1 (CET1) capital	The highest quality form of regulatory capital under CRD IV that comprises common shares issued and related share premium, retained earnings and other reserves less specified regulatory adjustments.
Common Equity Tier 1 capital ratio	Common Equity Tier 1 capital as a percentage of risk-weighted assets.
Contractual maturities	Contractual maturity refers to the final payment date of a loan or other financial instrument, at which point all the remaining outstanding principal will be repaid and interest is due to be paid.
Coverage ratio	Impairment allowance as a percentage of impaired loans.
Customer deposits	Money deposited by account holders. Such funds are recorded as liabilities of TSB.
Encumbrance	The use of assets to secure liabilities, such as by way of a lien or charge.
Exposure at default	Exposure at default (EAD) represents the estimated exposure to a customer in the event of default. In determining EAD amounts, consideration is made of the extent to which undrawn commitments may be drawn down at the point of default and the application of credit risk mitigation (i.e. eligible financial collateral).
Forbearance	Forbearance takes place when a concession is made on the contractual terms of a loan in response to an obligor's financial difficulties.
Internal Capital Adequacy Assessment Process (ICAAP)	TSB's own assessment of the amount and type of capital it considers adequate to cover the level and nature of the risks to which it is or might be exposed.
Internal Liquidity Adequacy Assessment Process (ILAAP)	TSB's own assessment of the adequacy of its liquidity and funding resources to cover the level and nature of risks to which it is or might be exposed
Internal Ratings-Based approach (IRB)	A methodology of estimating the credit risk within a portfolio by utilising internal risk parameters to calculate credit risk regulatory capital requirements. There are two approaches to IRB: Foundation IRB and Advanced IRB.
Leverage ratio	Tier 1 capital divided by the exposure measure. Basel III reforms introduced a leverage ratio framework designed to reinforce risk based capital requirements with a simple, transparent, non-risk based 'backstop' measure.
Liquidity Coverage Ratio (LCR)	Measures the percentage of high quality liquid assets relative to expected net cash outflows over a 30 day period. High quality liquid assets should be unencumbered, liquid in markets during a time of stress and ideally, be central bank eligible.
Loan to deposit ratio	The ratio of loans and advances to customers net of allowance for impairment losses divided by customer deposits.

Glossary (continued)

Loans past due	Loans are past due when a counterparty has failed to make a payment when contractually due.
Loan-to-value ratio (LTV)	The LTV ratio is a mathematical calculation which expresses the amount of a mortgage balance outstanding as a percentage of the total appraised value of the property. A high LTV indicates that there is less value to protect the lender against house price falls or increases in the loan if repayments are not made and interest is added to the outstanding balance of the loan.
Loss given default	Loss given default (LGD) represents the estimated proportion of an EAD amount that will be lost in the event of default. It is calculated after taking account of credit risk mitigation and includes the cost of recovery.
Master netting agreement	An agreement between two counterparties that have multiple derivative contracts with each other that provides for the net settlement of all contracts through a single payment, in a single currency, in the event of default on, or termination of, any one contract.
Net interest income	The difference between revenues earned by interest-earning assets and the cost of interest-bearing liabilities.
Net interest margin	Net interest margin is net interest income as a percentage of average interest-earning assets.
Net Promoter Score (NPS)	NPS is based on the question "On a scale of 0-10, where 0 is not at all likely and 10 is extremely likely, how likely is it that you would recommend TSB to a friend or colleague?" NPS is the percentage of TSB customers who score 9-10 after subtracting the percentage who score 0-6.
Pillar 3	The third pillar of the Basel III framework aims to encourage market discipline by setting out disclosure requirements for Banks on their capital, risk exposures and risk assessment processes. These disclosures are aimed at improving the information made available to the market.
Probability of default	Probability of default (PD) represents an estimate of the likelihood that a customer will default on their obligation within a 12 month time horizon.
Repurchase agreements	Short-term funding agreements which allow a borrower to sell a financial asset as collateral for cash. As part of the agreement the borrower agrees to repurchase the security at some later date, usually less than 30 days, repaying the proceeds of the loan.
Risk-weighted assets	A measure of a bank's assets adjusted for their associated risks. Risk weightings are established in accordance with the Basel Capital Accord as implemented by the PRA.
Sabadell	Banco de Sabadell, S.A. This is TSB Banking Group plc's parent company.
Securities financing transactions	Securities financing transactions are repurchase and reverse repurchase agreements, buy/sell backs and securities lending. For the lender (seller) of the securities it is usually a way to raise funds to finance the securities positions. For the borrower (buyer) of the securities it is a way to invest short– term funds or to cover short (bond) positions.
Securitisation	Securitisation is a process by which a group of assets, usually loans, are aggregated into a pool, which is used to back the issuance of new securities.
Standardised approach	The Standardised approach to calculating credit risk capital requirements requires the use of a standard set of risk weights prescribed by the regulator. Use may be made of external credit ratings supplied by external credit assessment institutions to assign risk weights to exposures. Standardised approaches, following prescribed methodologies, also exist for calculating market risk and operational risk capital requirements.
Subordinated liabilities	Liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer.
Tier 1 capital	A measure of a bank's financial strength defined by the CRD IV. It captures Common Equity Tier 1 capital plus other Tier 1 securities in issue, subject to deductions.
Tier 1 capital ratio	Tier 1 capital as a percentage of risk-weighted assets.
Tier 2 capital	A component of regulatory capital defined by the CRD IV, mainly comprising qualifying subordinated loan capital and eligible collective impairment allowances.

Abbreviations

BCBS	Basel Committee on Banking Supervision
BPS	Basis points
CET1	Common Equity Tier 1
CRD IV	Capital Requirements Directive IV
EDTF	Enhanced Disclosure Task Force
ECL	Expected credit loss
EIR	Effective interest rate
FCA	Financial Conduct Authority
HMRC	Her Majesty's Revenue and Customs
IAS	International Accounting Standards
ICAAP	Internal Capital Adequacy Assessment Process
IFRS IC	International Financial Reporting Standards Interpretations Committee
IFRS	International Financial Reporting Standards
ILAAP	Internal Liquidity Adequacy Assessment Process
IRB	Internal ratings based approach
LBG	Lloyds Banking Group
LCR	Liquidity coverage ratio
LTV	Loan to value
MSA	Migration Services Agreement
NPS	Net promoter score
OSA	Outsourced Services Agreement
PCA	Personal current account
POCI	Purchased or originated credit impaired
PP	Percentage points
PRA	Prudential Regulatory Authority
SPA	Sustainable Performance Award
TSA	Transitional Services Agreement

Contacts

For further information please contact:

Media

George Gordon Communications and Corporate Affairs Director Phone: +44 (0)207 003 9369 Mobile: +44 (0)7825 680197 Email: george.gordon@tsb.co.uk

Supreet Thomas Head of Communications Mobile: +44 (0)7519 502123 Email: supreet.thomas@tsb.co.uk

Annual Report and Accounts 2019 page 108