Basel II Pillar 3 Disclosures for the year ended 31 October 2012
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Contents
1. Overview 2. Risk Management Policies and Objectives 3. Capital Resources 4. Capital Adequacy 5. Credit Risk 6. Liquidity Risk 7. Operational Risk 8. Concentration Risk 9. Interest Rate Risk 10. Conduct Risk 11. Remuneration Risk 12. Directors’ Remuneration
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1. Overview The Capital Requirements Directive (Basel II) introduced on 1 January 2007 sets out the rules regarding capital adequacy for banks and building societies, including the disclosure requirements (Pillar 3). The rules within Basel II are categorised under three “pillars”: Pillar 1 sets out the minimum regulatory capital resources requirement which predominantly comprises credit risk and operational risk. Pillar 2 covers Management’s assessment of the additional capital resources required to cover the specific risks faced by the institution that are not covered by the minimum regulatory capital resources requirement set out under Pillar 1. Pillar 3 requires building societies and banks operating under the Basel II framework to disclose qualitative and quantitative information regarding their risk assessment process and capital resources, and hence their capital adequacy. In addition to the assessment of capital requirements under Pillar 1 and 2 above, the Society’s overall capital requirement is also reviewed and agreed by the FSA under the Supervisory Review and Evaluation Process (SREP). Under this process the FSA set the Individual Capital Guidance (ICG) for the Society, which is the minimum amount of capital that the Society should hold. This document has been prepared to meet the Pillar 3 disclosure requirements of Basel II. This document is based upon the Society’s Annual Report and Accounts for the year ended 31 October 2012, unless otherwise stated. These disclosures are issued on an annual basis as soon as practicable after the publication of the Society’s Annual Report and Accounts. These disclosures are published on the Stafford Railway Building Society website (www.srbs.co.uk). There is no requirement for the disclosures to be audited, however, some of the information within the disclosures also appear in the Society’s Annual Report and Accounts. 3 | P a g e
2. Risk Management Policies and Objectives Overview The Society’s primary aim is to put the safety and security of Members’ deposits above everything else. This is achieved by appropriate management and minimisation of the risks arising from business activities. The main risks we manage are : • Credit risk • Liquidity risk • Operational risk • Concentration risk • Interest rate risk • Conduct risk • Remuneration risk Risk management framework The Society’s Board has ultimate responsibility for developing an appropriate risk and control framework. Risk governance is provided through Board sub‐committees. In principle, each of the Board sub‐committees fulfil a similar role, in that, operating under a Board delegated mandate, they provide a forum for the direction and challenge of Management whilst monitoring business performance and risk exposures. Each of the Board sub‐committees compose of Non‐Executive Directors with other attendees being drawn from the Executive and Senior Management: Assets and Liabilities Committee (ALCO), which monitors and controls balance sheet risk, funding and liquidity, in line with the Society’s policies. Audit Committee, which has overall responsibility for reviewing the Society’s internal controls and risk management systems, validating the integrity of the Society’s financial statements and reviewing and approving the significant financial reporting issues and accounting policies/issues. Risk Committee, which advises the board on the overall risk appetite, tolerance and strategy and oversees and advises the board on the current risk exposures and future risk strategy. 4 | P a g e
The Society’s risk management framework is based on the best practice “3 lines of defence” model which is illustrated below. Line of defence Activity Responsibility Governance Identification, assessment and management Management Executive 1st of risk through normal business operations
2nd
Policy, Controls, Identify, Assess, Monitor
Control Functions
Board Committees
rd
3
Independent assurance of the adequacy and effectiveness of control systems
Internal Audit
Audit Committee
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3. Capital Resources The Capital Resources of the Society are calculated under Pillar 1 of the Capital Requirements Directive. The total Society assets at 31 October 2012 were £215.6 million. The table below summarises the composition of regulatory capital for the Society as at 31 October 2012, together with prior year comparatives. During the year ended 31 October 2012, the Society complied with all of the externally imposed capital requirements to which they are subject. As at As at Capital resources 31/10/2012 31/10/2011 £000’s £000’s Tier 1 – general reserves £14,496 £13,456 Tier 2 – general provisions £191 £179 Total capital resources £14,687 £13,635 Tier 1 capital These are the general reserves of the Society and represent an accumulation of after tax profits of the Society. Tier 2 capital These are general provisions of the Society and therefore represent part of the Society’s free capital. 6 | P a g e
4. Capital Adequacy Capital management and reporting Capital is held to provide a cushion to absorb losses that may occur during the economic cycle. In assessing the adequacy of its capital, the Society considers its risk appetite, the material risk to which the Society is exposed and the appropriate management strategies for each of the Society’s material risks. The Society considers its overall capital requirement as part of its internal capital adequacy assessment process (ICAAP). In addition, the Board monitor the capital position of the Society on a monthly basis. Summary of approach to capital adequacy planning The ICAAP document is produced annually, but it is reviewed on a quarterly basis so that it reflects relevant matters arising throughout the year. The ICAAP is the means by which the Society ensures that : • It has sufficient levels of capital resources to pursue the corporate objectives as set out in the Society’s Corporate Plan in lights of the risks it faces; and • It has sufficient capital resources to trade through a severe recession, if necessary by applying appropriate management actions. In formulating the Society’s Corporate Plan, the Society considers its overall objectives and evaluates these in light of its risk appetite. Minimum capital requirement (Pillar 1) Under FSA rules (Pillar 1) a minimum level of capital must be held for credit risk and operational risk. The Society has adopted the standardised approach to calculate the minimum regulatory capital resource requirement for credit risk and operational risk. The following table shows the Society’s overall minimum capital requirement for credit risk under the standardised approach at 31 October 2012 (expressed as 8% of the risk weighted exposure amounts for each of the applicable standardised credit risk exposure classes). Details of the standardised approach to the calculation of regulatory requirements are contained in the FSA handbook. The evaluation of capital required to cover operational risk is calculated under the “Basic Indicator Approach” and determined by reference to the net income of the Society averaged over the previous 3 years. 7 | P a g e
Exposure £000’s
Liquidity Cash Credit institutions Gilt edged securities Total liquidity Loans and advances to customers Residential – performing loans Non – residential – performing loans Past due items Total Loans and advances to customers Other exposures Fixed and other assets Total other exposures Total credit risk exposures Market risk * Operational Risk Capital Requirement Total Pillar 1 capital requirement Total capital available Excess of capital over minimum capital requirement under Pillar 1 * Market risk is the risk arising due to adverse market
Risk Weighted Exposure £000’s
30 41,387 14,359 55,776
155,102 3,522 456 159,080
702 702 215,558
Capital Required £000’s
0 11,691 0 11, 691 54,926 3,522 456 58,904 702 702 71,297
0 935 0 935
4,394 282 36 4,712
56 56 ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ 5,703 0 413 ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ 6,116 14,687 ‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐ 8,571 ==========
movements. The Society has no trading book and therefore consequently no market risk.
5. Credit Risk Overview Credit risk is the risk that a borrower or counterparty to a contract will not be able to meet their obligations as they fall due. For this Society this normally means the risk that a borrower will not repay their mortgage loan, or that a financial institution will not repay funds invested by the Society in that institution. 8 | P a g e
Mortgage credit risk The Society continues to be engaged in lending activity, primarily on residential property. The Society’s current lending policy is in accordance with its risk appetite which has been established by the Board, and has produced an inherently low risk mortgage book. The Society has strong Management controls over arrears with losses arising from default leading to possession in the year to 31 October 2012 amounting to Nil. The average loan to value on the residential mortgage book was 43.6% as at 31 October 2012. A table of the Society’s “past due” loans by geographical area, which are loans greater than 3 months in arrears, as at 31 October 2012 are set out below: Residential Commercial Region Past due Performing Past due Performing Total £m £m £m £m £m Stafford ST16 – ST21 0.5 50.0 ‐ 2.7 60.8 Rest of Staffordshire 0.1 33.9 ‐ 1.8 22.0 Rest of England 1.0 70.2 ‐ 0.2 71.0 Scotland ‐ 0.2 ‐ ‐ 0.2 ‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐ Total 1.6 154.3 ‐ 4.7 159.0 ======= ======= ======= ======= ======= Note : Past due loans represent the total mortgage balance outstanding not just the arrears. The Society’s provision for bad and doubtful debts as at 31 October 2012 is set out below: Loans fully secured
on Residential Property Specific General £000 £000
Loans fully secured on Land Specific General £000 £000
Total £000
Balance at 1 November 2011
46
169
‐
10
225
Charge/(release) for the year
20
18
‐
(6)
32
‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐
66
187
‐
4
257
======
======
======
======
======
Balance at 31 October 2012 9 | P a g e
Provisions for bad and doubtful debts Provisions are made to reduce the value of loans and advances to the amount which the Directors consider is ultimately likely to be received. Specific provision basis Throughout the year and at the year‐end individual assessments are made of loans and advances on properties which are in possession or in arrears by 2.5% or more. Specific provision is made against those loans and advances which are considered to be impaired. In considering the specific provision for impaired loans, account is taken of any discount which may be needed against the value of the property at the balance sheet date to agree a sale including anticipated realisation costs. The Directors recognise that not all accounts in arrears will result in possession and apply a factor based on recent experience to reflect this probability when calculating the provision for accounts in arrears. In certain circumstances the Society uses forbearance measures to assist those borrowers who are experiencing financial difficulty, for example, agreeing a temporary transfer to interest only payment in order to reduce the borrowers’ financial pressure. In each case an individual assessment is made to assure forbearance is in the best interests of both the borrower and the Society. It is expected that the borrowers will resume normal payment once they are able. The Society’s Asset and Liability Committee assess the impact of forbearance and considers whether there is a possibility of loss, in which case provision is made in accordance with the Society’s policies. General provision basis A general provision is made against all advances to the extent that the Society’s experience and general economic climate would indicate that it is prudent for such a provision to be made. Interest in respect of all loans is credited to the income and expenditure account as it becomes receivable, including interest in respect of advances where the property has been taken into possession. Loans and advances in the balance sheet are shown net of provisions. Counterparty credit risk The Society’s counterparty treasury credit risk management policy is to ensure that the Society can obtain the best possible return whilst operating within prudent limits in respect of counterparties, and is contained within the Liquidity and Financial Risk Management Policy. The Society only invests funds in British Government Securities, Banking Institutions rated at least F2 and with larger Building Societies. The assets are managed with advice from external fund managers. 10 | P a g e
New limits and counterparties are approved by the Assets and Liabilities Committee (ALCO). ALCO monitors exposures to counterparties and countries and ensures the Society is operating within its Board approved limits at its quarterly meetings. The Board reviews the Society’s exposure by sector on a monthly basis. The table below shows the breakdown of liquid assets at 31 October 2012 using the standardised approach. Fitch Ratings Services F1 F1+ Unrated Building Societies Treasury Bills British Government Securities Total
Maturity of Treasury Investment 3 months to 1 year £m
Total £m
7.1 1.0 7.5 1.5 4.6
11.9 2.2 ‐ ‐ 4.3
25.3 5.5 10.6 5.5 8.9
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
15.7
21.7
18.4
55.8
£m 6.3 2.3 3.1 4.0 ‐
======== ======== ======== ======== No provisions for loss relating to counterparty risk are held by the Society as at 31 October 2012. The table below shows the concentration of liquid assets at 31 October 2012 by region. 2012 2011 Region £m £m UK 53.1 46.0 Europe (excluding UK) 1.5 2.2 Australia 1.0 ‐ USA 0.2 ‐ ‐‐‐‐‐‐‐‐‐‐‐‐‐‐ ‐‐‐‐‐‐‐‐‐‐‐‐‐‐ Total 55.8 48.2 ======== ========
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6. Liquidity Risk Liquidity risk is the risk that the Society will be unable to meet its financial obligations as they fall due. The Society’s Liquidity and Financial Risk Management policy addresses both the level and quality of liquid assets. The Society’s liquidity policy is to maintain sufficient resources to cover cash flow imbalances and fluctuations in funding, to maintain public confidence and to meet its financial obligations. Liquidity is monitored daily and weekly by the Executive and senior management, review at ALCO meetings, and included in the Management Information for Board meetings.
7. Operational Risk Overview Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. The Society has used the standardised approach to Operational risk. Under this approach, the capital charge for Operational risk is calculated by averaging the annual income from prescribed business lines over the past three years and applying a set regulatory multiplier to the different business lines. As at 31 October 2012, this formula produced a capital requirement of £413,000 which is shown in the Minimum Capital Requirement (Pillar 1) table on page 8. Operational risk framework The Society’s product range comprises of a single variable rate flexible mortgage product and a range of variable rate investment products. The Society does not provide financial advice and only senior management can deal with mortgage applications. The risk therefore of mis‐selling by the Society is not considered significant. The Society considers that its simple product range, robust systems, policies and internal control framework are the major factors in the achievement of strong control of Operational risk. The main operations and controls are summarised in the Risks and Controls Register which is reviewed by the Audit Committee, both Internal and External Auditors and the Board. 12 | P a g e
8. Concentration risk The types of concentration risks facing the Society are concentration in one product type, geographical concentration and over exposure to single borrowers, investors, or counterparties. Although the Society has only one mortgage product, which is predominantly secured on residential property and wholly within the UK, this concentration is considered to be of low risk because of the inherent nature of the assets and the controls in place to ensure that the Society does not incur loss which is supported by the Society’s successful track record. The Society has no dependency on any one form of introduction for mortgages and there is no concentration risk in the type of property held as security. The Board review the Society’s product offering on an annual basis taking account of market and customer changing trends. The simplicity of the Society’s product range has been supported by strong mortgage demand throughout and beyond the recent credit crisis which supports the Boards view that the risk to the Society in this area is low.
9. Interest Rate Risk The Society’s Interest rate risk arises from the potential impact that changes in interest rates could have on the Society’s cash flows. This Society does not have any fixed rate savings or mortgage products, only variable, and therefore the Interest Rate Risk for the Society is significantly less than for other similar institutions. The Society’s main exposure to interest rates arises from its investment in Government Gilts and Certificates of Deposit with other financial institutions. The Society uses specialist external treasury advisers for investing surplus funds and has a good spread of maturity of its invested monies to manage this risk effectively. 13 | P a g e
10. Conduct Risk This is the risk arising from the Society’s failure in the conduct in their direct relationship with retail customers or where the Society has a direct duty to retail customers. It concerns the Society failing to treat its customers fairly, with resulting detriment to those customers. The Board has a low risk appetite for conduct risk with a zero tolerance for knowingly acting against a customer’s interests or knowingly breaching regulatory risks with a zero tolerance for adverse media coverage.
11. Remuneration Risk This is the risk that the Society’s remuneration policy does not provide effective risk management and is vulnerable to ignoring concentration risks and liquidity risks. No member of staff is sales incentivised and no individual targets are set. There is no advice given.
12. Directors Remuneration Directors’ remuneration The policies on the remuneration of Executive and Non‐Executive Directors of The Stafford Railway Building Society are set out below: The Remuneration Committee The Committee, comprising of all the Non‐Executive Directors, meets at least once a year to review the performance of and recommend the remuneration for the Executive Directors. The Committee ensures the Society’s compliance with relevant elements of the FSA’s remuneration code. Policy for Executive Directors The Society has a contract with Dean Statham, Chartered Accountants, for the services of the Chief Executive and Secretary, and the Deputy Chief Executive which contains provision for termination upon 12 months written notice by either party. 14 | P a g e
•
• • •
Basic Fee – The method of calculation of the base fee is specified in the contract with Messrs Dean Statham dated 1 June 2001 which involves external advice being taken as to the level of the base fee each year. Bonus – The bonus is assessed by the Remuneration Committee and is based on corporate performance targets both financial and non‐financial. Bonus payments are payable annually, are not guaranteed and are reviewed each year. Pension – There are no provisions within the contract for any pension arrangements for the Executive Directors and no pension payments are made. Other Benefits – There are no provisions within the contract for any other benefits for the Executive Directors and no such benefits are provided.
Policy for Non‐Executive Directors The remuneration of all Non‐Executive Directors is reviewed annually. There are no bonus schemes for Non‐Executive Directors and they do not qualify for pension entitlement or other benefits. Non‐Executive Directors do not have service contracts. The remuneration of the Chairman is set at a meeting of the Board where the Chairman is not present. The remuneration of all other Non‐Executive Directors is set by the Chief Executive and Chairman. Remuneration of Directors for the year ended 31 October 2012 For Service as a Director (excluding NI)
2012 £000 89.2
2011 £000 92.8
Amounts paid for Services for the Chief Executive and Secretary, and the Deputy Chief Executive are as follows:‐
Base fee Bonus VAT
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2012 2011 £000 £000 159 155 23 23 37 34 219 212
