unsecured personal loans uk

Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 Alliance & Leicester plc Contents 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Overview Risk management objectives and policies Scope of application of Directive requirements Capital resources Capital adequacy Counterparty credit risk Credit risk and dilution risk Credit Risk: Standardised approach Credit Risk: Specialised lending & equity exposures Interest rate risk in the non-trading book Securitisation Internal Ratings Based disclosures Credit risk mitigation Contacts Pillar 3 disclosures for the year ended 31 December 2007 02 03 07 08 10 11 12 16 17 18 19 21 25 26 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 1 1 Overview Background Since 1 January 2007, Alliance & Leicester plc has been operating under the Basel II regime. The Capital Requirements Directive (Basel II) sets out new disclosure requirements for banks operating under the Framework. The disclosure requirements (Pillar 3) aim to complement the minimum capital requirements (Pillar 1) and the supervisory review process (Pillar 2) and aim to encourage market discipline by allowing market participants to assess key pieces of information on risk exposures and the risk assessment processes of the firm. Basis of Disclosures The disclosures have been prepared for Alliance & Leicester plc. These disclosures cover the Pillar 3 qualitative and quantitative disclosure requirements. Frequency This report will be made on an annual basis. The disclosures will be as at the Accounting Reference Date (ARD), i.e. as at 31 December, and will be published within four months of the ARD. The Group will aim, however, to make the disclosures shortly after the publication of the Annual Report & Accounts. Media and Location The report will be published on the Alliance & Leicester plc corporate website (www.alliance-leicester-group.co.uk) Verification Disclosures will only be externally audited if they are deemed to be equivalent to those made under accounting or listing requirements. The Pillar 3 disclosures have been prepared purely for explaining the basis on which the Group has prepared and disclosed certain capital requirements and information about the management of certain risks and for no other purpose. They do not constitute any form of financial statement and must not be relied upon in making any judgement on the Group. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 2 2 Risk management objectives and policies The Group’s risk management governance structure is composed of several committees that have responsibility for key risk management areas. An illustration of how these committees report up to the Group Board is provided below: Group Board GAC CBCSC Large Credit Transactions GRC CRC Commercial Credit Risk EC GORC Operational Risk Business Risk Controls / Compliance RRC Retail Credit Risk MVC Credit Models ALCO Market Risk Liquidity Risk Funding Risk FCSG Fraud Money Laundering The main roles of the committees are as follows: Group Risk Committee (GRC) GRC considers and approves on behalf of the Group Board the Group’s risk management framework, its risk appetite and its key risk management policies for all risk categories. The Committee also monitors key risk management information and reviews the Group’s (including Treasury) overall capital adequacy. The Chairman of GRC reports to the Group Board on the Committee’s activities quarterly. Group Audit Committee (GAC) GAC approves the Group’s financial statements, manages the relationship with the Group’s external auditors, reviews reports on the operation of internal controls and monitors control issues of major significance to the Group. Executive Committee (EC) EC acts as the Group’s senior executive committee, ensuring that it meets its strategic and operational objectives. Model Validation Committee (MVC) MVC provides an independent review and validation of the Group’s internal ratings models to ensure that the systems are producing consistent and accurate results to support pricing, lending decisions, asset quality monitoring and capital adequacy. Assets and Liabilities Committee (ALCO) ALCO recommends Group policy in relation to liquidity and funding, market risk, trading policy and treasury delegations and monitors compliance with these policies. ALCO is also responsible for considering and agreeing the economic capital framework, and for considering the Group’s capital structure. Group Operational Risk Committee (GORC) GORC reviews and approves the Group’s key operational risk management policies, monitors the Group’s exposure to operational risks and reviews the arrangements for measuring and controlling operational risks. Financial Crime Steering Group (FCSG) FCSG exists to facilitate a coordinated and effective response to financial crime across the Group, focusing primarily on implementing the Group’s strategy on anti-money laundering and anti-fraud measures. Retail Risk Committee (RRC) RRC reviews credit risk, fraud, money laundering and other risk reports relating to Retail Banking, as well as approving changes to policy prior to their submission to the GRC for formal ratification. This committee meets on a monthly basis and is chaired by the Group Chief Executive. Commercial Risk Committee (CRC) CRC reviews credit risk, fraud, money laundering and other risk reports relating to the Commercial Bank, as well as approving changes to policy prior to their submission to the GRC for formal ratification. This committee meets on a monthly basis and is chaired by the Managing Director, Commercial Banking. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 3 Commercial Bank Credit Sanctioning Committee (CBCSC) CBCSC considers and approves applications for commercial credit in excess of predefined risk limits. Loans approved by CBCSC are reported to both the Group Board and GRC. The most significant risk types to which the Group is exposed are discussed below: Operational Risk Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. The Group sub-divides the operational risk category by type such as legal, regulatory, environmental, criminal, systems failure and personnel risk. Operational risk policies are in place for key operational activities; these policies set out how the Group manages the relevant risks. The policies are approved by the GORC. The Group manages its operational risks through a variety of techniques, including monitoring key risk indicators, internal controls, and various risk mitigation techniques, such as insurance and business continuity planning. Risks are monitored through control and risk selfassessment, use of key risk indicators and analysis of actual and near miss loss data. Risk self-assessment is undertaken by each business unit, specifying the likelihood and financial impact of specific operational risk events (analysed by risk category), together with a narrative justification for each loss scenario identified. Output from the self-assessment process is used to calculate the Group’s operational risk unexpected loss and economic capital requirements. GRC receives quarterly operational risk data, including realised loss data, near miss data and a dashboard which assesses the status of all key current and emerging operational risks using agreed key risk indicators. A summary of the dashboard is submitted to the Group Board on a monthly basis. In addition, senior management certify the effectiveness of the risk and control environment every six months. A summary of the results of the certification process is presented to GRC. An independent operational risk team within the Group Risk function has the overall responsibility for ensuring effective operation of the framework within which operational risk is managed, and for its consistent application across the Group. Day to day management of operational risk rests with line managers. Oversight of regulatory risk is the responsibility of the Group Risk and Compliance functions. Group Risk has primary responsibility for oversight of prudential risks and Group Compliance for other regulatory risks. The Group has established a regular forum, the Legal & Regulatory Risk Group, to ensure the Group is properly prepared for regulatory developments. The Group has adopted the standardised approach for calculating the Pillar 1 capital requirements for operational risk. Credit Risk Credit Risk: Overview Credit risk is the risk of loss arising from a customer or counterparty failing to meet their financial obligations to the Group as and when they fall due. The GRC approves the Group’s credit risk appetite through approval of the Group’s risk appetite statement and of business area lending and credit policies. These policies define the risk appetite for each business area, including specifying risk and exposure limits. The policies also define the types of lending that the Group is prepared to advance and set out how the Group limits its exposure to groups of counterparties and to concentration risk. The Group uses a variety of analytical tools to assist with lending decisions, pricing, capital adequacy, stress testing, strategic planning and asset quality monitoring. These tools include internal ratings based models, behavioural scoring and other scorecard based underwriting techniques. The internal ratings based models are approved by the MVC and GRC. Credit Risk: Retail Banking Retail credit risk management is the responsibility of the Retail Credit & Risk team, which is independent of the rest of the Retail Bank up to Executive Director level and is subject to oversight by Group Risk. Risks are managed in accordance with policy and asset quality plans which are approved by GRC. Retail Credit & Risk uses a combination of lending policy criteria, credit scoring (including behavioural scoring), policy rules and underwriting to make a decision on applications for credit. The primary factors considered are affordability, residency, residential history, credit history, employment history, nature of income and loan to value. In addition, confirmation of borrower identity and an assessment of the value of any security are undertaken prior to granting a credit facility. When considering applications, the primary focus is placed on the willingness and ability to repay. Credit scoring is used to support the customer account management process in the following ways: • To set customer maximum lending limits. • To pre-determine lending limits for selected further advances. • To determine account specific recommended limits and product types. • To set shadow limits to manage unauthorised borrowing. • To prioritise collections activity. The maximum mortgage loan available is based on the lower of the current value or purchase price of the property. No lending is undertaken based solely upon security provided by the value of the underlying assets and all mortgages are secured by way of a first legal charge against the property. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 4 In order to minimise delinquency problems progressing to more serious levels and ultimate loss, arrears procedures comply with the Financial Services Authority (FSA) requirements and the “Handling of Arrears and Possessions – Council of Mortgage Lenders Statement of Practice”. The arrears management team adopts a responsible and constructive stance to managing delinquency in order to protect the best interests of both the customer and the Bank. Properties are only taken into possession when this is necessary to minimise loss. All steps are taken to work with the customer to set up an achievable repayment plan so that the property possession only occurs as a last resort. Asset quality monitoring, product pricing decisions, provisioning and capital requirements are all derived from the relevant internal ratings models. These models segment retail portfolios into key probability of default and loss given default segments based on factors such as credit score and indexed loan to value. The models generate both point in time and long run average estimates of probability of default, loss given default and exposure at default. Credit Risk: Commercial Bank (excluding Treasury) Commercial credit risk management is the responsibility of the Commercial Bank Credit & Risk team, which is independent of the rest of the Commercial Bank up to Executive Director level, and is subject to oversight by Group Risk. Risks are managed in accordance with policy and asset quality plans which are approved by GRC. These place limits on the levels of unsecured business and the sector, geography, residual value and seniority of exposures. The Commercial Bank Credit & Risk team has a level of delegated sanctioning authority and underwrites certain credit risks, with large or higher risk exposures subject to further Group Risk or Credit Committee sanction. Lending decisions are based on independent credit risk analysis supplemented by the use of internal ratings tools which assess the obligor’s likelihood of default. The output of the ratings tools is a borrower grade which maps to a long-run average one year probability of default. Borrower grades are reviewed at least annually, allowing identification of adverse individual and sector trends. The grade is integrated into an overall Credit & Risk evaluation, including wider factors such as transaction and borrower structure (ranking and structural subordination), debt serviceability and security (initial and residual value considerations). Consideration is also given to risk mitigation measures to protect the Group, such as third-party guarantees, supporting collateral and security, robust legal documentation, financial covenants and hedging. Transactions are further assessed using an internal pricing model which measures both the return on equity and the risk adjusted return on capital against a series of benchmarks to ensure risks are appropriately priced. Portfolio asset quality monitoring is based on a number of measures, including expected loss, financial covenant monitoring, security revaluations, pricing movements and external input from rating agencies and other organisations. Should particular exposures begin to show adverse features such as payment arrears, covenant breaches or business trading performance that is materially worse than expected at the point of lending, a full risk reappraisal is undertaken. Where appropriate, case management is transferred to a specialist recovery team that works with the customer in an attempt to resolve the situation. If this does not prove possible, cases are classified as being unsatisfactory and are subject to intensive monitoring and management procedures designed to maximise debt recovery. Credit Risk: Financial Institutions and Other Treasury Assets Group Risk is responsible for the credit control of assets held by Treasury, as well as for all country, sovereign and financial institution exposures. Group Risk is independent of the Treasury business unit up to Board level. Risks are managed in accordance with limits, asset quality plans and criteria set out in the relevant policy statement which is approved by GRC. The policy sets out devolved powers which require higher levels of authorisation according to the size or risks of transactions. Lending and investment decisions are based on independent credit risk analysis, supplemented by the output of internal ratings tools and external rating agency analysis. An internal ratings model is used to grade financial institution exposures and to generate probability of default and expected loss. The Group uses external ratings supplemented by internal analysis to assess the risks associated with structured credit and securitisation investments. Individual exposures are reviewed at least annually. Treasury uses a number of risk mitigation techniques including guarantees, netting and collateralisation agreements. Asset quality is monitored by regular management reporting, quarterly reporting to the GRC and exception reporting against a range of asset quality triggers, which include expected loss analysis. Liquidity and Funding Risk Liquidity risk is the risk that the Group does not have sufficient financial resources available to meet its obligations as they fall due, or that the Group is unable to meet regulatory prudential liquidity ratios. It is Group policy to ensure that sufficient liquid assets are at all times available to meet the Group’s obligations, after taking into account withdrawals of customer deposits, draw-down of customer facilities and growth in the balance sheet. The management of the Group’s liquidity is the responsibility of Treasury, which provides funding to and takes surplus funds from each of the Group’s businesses as required, and also holds liquid assets and committed facilities to cover any liquidity shortfall. Daily monitoring of liquidity limits is performed by Group Risk. Liquidity policy is approved by ALCO and ratified by GRC. The policy requires compliance with Sterling Stock Liquidity rules and places limits on maximum wholesale outflow over particular time horizons, and specifies minimum holdings of eligible liquid assets and committed facilities. The policy also specifies the minimum amount of wholesale funding over one year, and specifies the maximum ratio of customer loans and advances to the sum of wholesale funding with a residual maturity in excess of one year and customer deposits. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 5 The Group performs liquidity stress testing based on a range of adverse scenarios, and has a liquidity contingency funding plan which is maintained in order to ensure that the Group has access to sufficient resources to meet obligations as they fall due if these scenarios occur. Stressed liquidity profiles are reported to ALCO quarterly. Market Risk Market risk is the potential adverse change in Group income or in the value of the Group’s assets and liabilities arising from movements in market rates, including interest rates, exchange rates, inflation rates and equity prices. The Group’s exposure to market risk is governed by a policy approved by ALCO and ratified by GRC. The policy sets out the nature of risk which may be taken, and applicable maximum risk limits. The Group risk limits are allocated by ALCO to all Group business units. Group Risk monitors compliance with market risk limits and reports excesses to ALCO. Interest Rate Risk Interest rate re-pricing risk mainly arises from mismatches between the re-pricing dates of the assets and liabilities on the Group’s balance sheet, changes in the value of non-linear interest rate positions such as interest rate caps, and from the investment of the Group’s reserves and non-interest and low interest rate liabilities. The Group has established a transfer pricing system which passes interest rate re-pricing risks that arise in the various Group businesses to Treasury. Treasury manages the Group’s overall interest rate risk within policy limits. In addition, strategic hedges are agreed by ALCO for the investment of the Group’s reserves and non interest and low interest rate liabilities. External hedges of reserves, non interest and low interest rate liabilities and other fixed rate assets and liabilities are executed by Treasury. Where material, behavioural assumptions based on historic customer prepayment and retention analysis are applied in determining the size of hedges. Interest rate risk limits are expressed as the maximum principal amount which is re-priced during a given time period. In the case of Treasury, interest rate risk is measured and limited according to the market value impact of a one basis point shift in particular points on the yield curve. In addition Value at Risk (VaR) is used to measure the Group’s total exposure to interest rate risks and to generate an economic capital estimate for interest rate risk. The VaR measurement methodology calculates the maximum amount likely to be lost, in market value terms, from existing risk positions as a result of movement in market interest rates. The Group uses a variance-covariance VaR model based on historical volatility and correlation data and measures VaR to 95% confidence over a one month holding period. A separate model is used to calculate the VaR on positions, such as interest rate options, whose market value varies with changes in interest rates in a nonlinear way. Foreign Exchange Risk The Group’s policy is to have no material open foreign currency positions. The Group offers foreign exchange services to customers through both Treasury and Commercial Bank operations. Detailed limits and controls are established within those businesses to control the exposure. Commercial Bank clears its positions with Treasury in accordance with the policy of transferring market risk positions to Treasury wherever possible. As part of its normal operations, Treasury borrows and invests funds in currencies other than sterling. The foreign exchange risks of these activities are hedged within Treasury’s limits. Equity Risk The Group’s policy is to have no material exposure to equity price risk. Retail Banking sells third party stock market bonds. The equity and interest rate risks from these bonds are borne entirely by the third party. Alliance & Leicester International Limited sells stock market bonds to customers. Positions may arise in the management of such bonds due to mismatches between the hedging contracts and the underlying customer liabilities. Procedures are established to minimise these positions as tightly as is operationally practicable and to report open positions to ALCO on a monthly basis. Inflation Risk The Group’s policy is to have no material exposure to inflation risk. This risk arises due to the exposure to inflation linked bonds and loans in Commercial Banking. It is the Group’s policy to fully hedge inflation risk, using inflation swaps or other effective hedge instruments. Stress Testing The Group performs regular stress tests on its capital adequacy and liquidity position under a range of scenarios. The scenarios are agreed by ALCO and reviewed by GRC, and are regularly updated to reflect the Group’s risk profile and external risks, including the risks of an economic recession and of a significant fall in house prices. Where applicable the stress tests cover all relevant risks to which the Group is exposed; for example, capital adequacy stress tests based on macro-economic scenarios analyse the impact on both credit and market risk exposures. Liquidity stress tests are performed quarterly and capital adequacy stress tests are performed twice yearly. In addition, periodic ad-hoc stress tests are performed as required by the executive team or the key risk committees. Detailed results of stress tests are presented to ALCO, including the impact of the stress scenario on the Group’s capital requirement, its capital resources and its profitability; summary results are presented to GRC. Stress testing is used to determine the Group’s capital adequacy, the adequacy of its liquidity position and to influence strategy and medium term planning. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 6 3 Scope of application of Directive requirements Alliance & Leicester plc is a UK bank regulated by the Financial Services Authority (FSA) and is the parent company of the Alliance & Leicester plc Group. The Pillar 3 disclosures have been prepared for Alliance & Leicester plc Group in accordance with the rules laid out in the FSA handbook BIPRU Chapter 11. These disclosures provide information on the capital adequacy and risk management of the Alliance & Leicester plc Group. The principal operating subsidiary undertakings of Alliance & Leicester plc at 31 December 2007 are listed below. These subsidiary undertakings, which all have 31 December year ends, are incorporated and all operate in Great Britain, except Alliance & Leicester International Limited which is incorporated and operates in the Isle of Man. Subsidiary Alliance & Leicester Personal Finance Limited Alliance & Leicester Commercial Finance plc Alliance & Leicester International Limited Nature of business Unsecured Lending Asset Leasing Offshore deposit taking All subsidiary undertakings are limited by ordinary shares and are unlisted. The Company holds a 100% interest in the ordinary share capital and voting rights of all its subsidiary undertakings, except for Crossbill Investments Limited, Lanebridge Securities Limited and Mitre Capital Partners Limited. Alliance & Leicester plc acquired a 51% interest in the share capital of Lanebridge Securities Limited on 23 April 2007. Mitre Capital Partners Limited is a wholly owned subsidiary of Lanebridge Securities Limited. The results of all subsidiary undertakings have been included in the consolidated Pillar 3 disclosures. The ability of Alliance & Leicester International Limited to pay dividends to the Company is restricted by regulatory capital requirements. Apart from this, there are no current or foreseen material practical or legal impediments to the prompt transfer of capital resources or repayment of liabilities when due between Alliance & Leicester plc and its subsidiaries. Alliance & Leicester plc makes use of the provisions laid down in the FSA handbook BIPRU Chapter 2.1 and reports to the FSA on a soloconsolidated basis. Alliance & Leicester plc’s solo-consolidated group includes Alliance & Leicester plc and several Special Purpose Vehicles (SPVs). These SPVs adhere to the minimum standards set by the FSA for solo-consolidation and the Company holds a 100% interest in the share capital and voting rights of these subsidiaries. The Group also has to ensure that the solo-consolidated group holds adequate capital to cover its own capital requirements. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 7 4 Capital resources The table below summarises the composition of regulatory capital for the Group as at 31 December 2007. During the year ended 31 December 2007, the individual entities within the Group and the Group complied with all of the externally imposed capital requirements to which they are subject. As at 31.12.07 £m Notes Core tier 1 capital Called up share capital Share premium account Retained earnings and other reserves Externally verified profits Preference shares Perpetual non cumulative preference shares Deductions from tier 1 capital Intangible assets Expected losses 1 210.3 125.1 1,254.1 256.7 1,846.2 294.0 294.0 (116.1) (63.9) (180.0) 1,960.2 2 3 Tier 1 capital after deductions Innovative tier 1 instruments Tier 2 capital Subordinated debt Collective provisions Deductions from tier 2 capital Expected losses 4 310.6 5 649.7 5.5 655.2 (63.9) (63.9) 901.9 (5.0) 2,857.1 Innovative tier 1 and tier 2 capital after deductions Deductions from total of tier 1 and tier 2 capital Total capital resources Notes: 1. Retained earnings and other reserves exclude gains or losses on cashflow hedges and available-for-sale assets. The regulatory capital rules allow the pension scheme deficit to be added back to regulatory capital and a deduction taken for an estimate of the additional contributions to be made in the next 5 years, less associated deferred tax. When the scheme is in surplus, the pension fund asset is not included within capital. This adjustment is reflected in the reserves number. 2. On 24 May 2006, Alliance & Leicester plc issued £300m fixed/floating rate non-cumulative callable preference shares, resulting in net proceeds of £294m. The preference shares entitle the holders to a discretionary fixed non-cumulative dividend of 6.222% per annum payable annually from 24 May 2008 until 24 May 2019 and quarterly thereafter at a rate of 1.13% per annum above three month sterling LIBOR. The preference shares are redeemable at the option of Alliance & Leicester plc on 24 May 2019 or on each quarterly dividend payment date thereafter. No such redemption may be made without the consent of the Financial Services Authority. 3. Intangible assets include capitalised software and goodwill. 4. On 22 March 2004, Alliance & Leicester plc issued £300m of innovative tier 1 capital securities. The tier 1 securities are perpetual securities and pay a coupon on 22 March each year, with the first coupon paid on 22 March 2005. At each payment date, Alliance & Leicester plc can decide whether to declare or defer the coupon indefinitely. If a coupon is deferred then Alliance & Leicester plc may not pay a dividend on any share until it next makes a coupon payment. Alliance & Leicester plc can be obliged to make payment only in the event of winding up. The coupon is 5.827% per annum until 22 March 2016. Thereafter the coupon steps up to a rate, reset every five years, of 2.13% per annum above the redemption yield on a UK Government Treasury Security. The tier 1 securities are redeemable at the option of Alliance & Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 8 Leicester plc on 22 March 2016 or on each coupon payment date thereafter. No such redemption may be made without the consent of the Financial Services Authority. Although innovative tier one is shown within the above table after the calculation of tier one capital, this is purely for Pillar 3 prescribed reporting purposes and innovative tier 1 is allowable as tier 1 capital for capital gearing purposes. Tier 2 capital in excess of Tier 1 capital after deductions does not count towards regulatory capital. For the purpose of this test perpetual preferred securities (commonly referred to as Innovative Tier 1instruments) are counted as part of Tier 1. The table above is provided in the format above as prescribed by Pillar 3 reporting requirements. 5. The subordinated debt was raised in order to increase the capital base of the company. In accordance with FSA guidance, in the last five years to maturity the subordinated debt is amortised on a straight line basis. Unamortised value as at 31.12.07 £m Terms Subordinated Notes due 2008 Subordinated Notes due 2013 Subordinated Notes due 2015 Subordinated Notes due 2017 Subordinated Notes due 2017 Subordinated Notes due 2023 Subordinated Notes due 2031 Total subordinated liabilities Accrued interest Fair value hedging adjustments Amortisation of subordinated debt Total Fixed interest rate of 9.75% Floating Rate Floating Rate Floating Rate Floating Rate Fixed interest rate of 5.25% Fixed interest rate of 5.875% 75.0 55.0 74.9 110.0 73.3 150.0 150.0 688.2 17.2 9.0 (64.7) 649.7 The interest rate liabilities of 9.75% on the £75m Notes due 2008, 5.25% on the £150m Notes due 2023 and 5.875% on the £150m Notes due 2031 have each been swapped into floating rate, with rates of up to 1.36% above sterling LIBOR. The Subordinated Notes due 2008, 2023 and 2031 are denominated in UK Sterling. The Subordinated Notes due 2015 are denominated in US Dollars. The Subordinated Notes due 2013 and 2017 are denominated in Euros. The Notes are subordinated to the claims of depositors and all other creditors. All the Notes may be redeemed at the option of the Group, at the outstanding principal amount plus accrued interest, in the event of certain changes in UK taxation. The Group may also purchase the Notes in the open market. The 2008 Notes can be redeemed, at the option of the Group, at the higher of their principal amount and the price at which the gross redemption yield on the Notes is equal to the gross redemption yield on 9% Treasury Stock 2008. The 2013 Notes can be redeemed, at the option of the Group, at the outstanding principal amount plus accrued interest, not before November 2008. The 2015 Notes can be redeemed, at the option of the Group, at the outstanding principal amount plus accrued interest, not before September 2010. The £110.0m 2017 Notes can be redeemed, at the option of the Group, at the outstanding principal amount plus accrued interest, not before August 2012. The £73.3m 2017 Notes can be redeemed, at the option of the Group, at the outstanding principal amount plus accrued interest, not before October 2012. The 2023 Notes can be redeemed, at the option of the Group, at the outstanding principal amount plus accrued interest, not before March 2018. For all the Notes, no such purchase or redemption may be made without the consent of the Financial Services Authority. The Group has not had any defaults of principal, interest or other breaches with respect to all liabilities during the period. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 9 5 Capital adequacy In order to protect the solvency of the Group, internal capital is held to provide a cushion for unexpected losses. In assessing the adequacy of its capital, the Group considers its risk appetite, the material risks to which the Group is exposed and the appropriate management strategies for each of the Group’s material risks, including whether or not capital provides an appropriate mitigant. In addition to capital adequacy reporting to the FSA, a FICAA (Full Internal Capital Adequacy Assessment) is performed semi-annually, in order to assess the Group’s capital adequacy and to determine the levels of capital required going forward to support the current and future risks in the business. All parts of this analysis are pulled together into a single document, the executive summary of which is approved by the GRC. Finance is responsible for producing budgets to identify expected future capital requirements from changes to business volumes and mix of assets and activities. Group Risk is responsible for ensuring that the Group’s current and future risks are reflected in the capital adequacy assessment and that sufficient capital is maintained to provide the Group with adequate headroom given multiple stressed scenarios. The amount and composition of the Group’s capital requirement is determined by assessing the minimum capital requirement under Pillar 1 based upon the Capital Requirements Directive (CRD), the Group’s economic capital requirement, the impact of stress and scenario tests, the Group’s Individual Capital Guidance and the capital requirement that is consistent with the Group’s target external rating. The following table shows the Group’s Pillar 1 capital requirement by asset class: As at 31.12.07 £m Standardised Approach Central government or central banks Regional governments or local authorities Administrative bodies and non-commercial undertakings Multilateral development banks International organisations Institutions Corporates Retail Secured on real estate property Past due items Items belonging to regulatory high risk categories Securitisation positions Short term claims on institutions or corporates Other items 4.6 1.1 101.3 46.6 0.8 61.9 216.3 182.4 Operational Risk – Standardised Approach IRB Approach Retail exposures secured by real estate collateral Qualifying revolving retail Other retail Institutions Corporates Securitisation positions Equity claims Non-credit obligation assets Trading book Interest rate PRR Counterparty risk capital component Foreign exchange PRR 280.3 6.3 288.4 227.5 444.2 237.9 1.8 8.5 1,494.9 32.0 0.9 0.1 33.0 1,926.6 Total Pillar 1 capital requirement Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 10 6 Counterparty credit risk Counterparty credit risk (CCR) in the context of this disclosure is the risk that the counterparty to a derivative transaction posted to either the Banking Book or Trading Book could default before the final settlement of the transaction's cash flows. The duration of the derivative and the credit quality of the counterparty are both factored into the internal capital and credit limits for counterparty credit exposures. Credit Support Annexes (CSA) exist for collateralising derivative transactions with counterparties to which the Group has its largest derivative exposures in order to mitigate the risk of loss on default. Although these CSAs are taken into consideration when setting the internal credit risk limits for derivative counterparties, they are not recognised as credit risk mitigation for reducing the exposure at default (EAD) on the derivative transactions in the Pillar 1 regulatory capital calculations. A downgrade in the Group’s credit rating would have the effect of reducing the market value triggers for margin calls on some of the CSAs resulting in a potential increase in the amount of collateral the Group would have to provide against the derivatives within the CSAs. However, due to the small number of CSAs with downgrade triggers, this is not deemed a significant risk for the Group. A one notch short term rating downgrade would result in the Group being required to either post collateral or find a Guarantor for the swaps it provides to its securitisation vehicles with the amount of collateral needing to be posted being dependent on the duration of the swaps and LIBOR curves at the time the downgrade occurs. The Group measures exposure value on counterparty credit exposures under the CCR mark to market method. This exposure value is derived by adding the gross positive fair value of the contract (replacement cost) to the contracts potential credit exposure, which is derived by applying a multiple based on the contracts residual maturity to the notional value of the contract. The following table includes interest rate and foreign currency derivative contracts: Gross Positive Fair Value of contracts (A) £m Potential Credit Exposure (B) £m Total Derivatives Credit Exposure (C) = (A)+(B) £m Banking Book Trading Book Total 758 13 771 328 38 366 1,086 51 1,137 This table excludes credit derivatives against traditional and synthetic securitisations. These exposures are included in note 11. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 11 7 Credit risk and dilution risk Impairment of financial assets A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of events that occurred after the initial recognition of the asset (a ‘loss event’) and that loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the Group about the following loss events: • significant financial difficulty of the issuer or obligor; • a breach of contract, such as default or delinquency in interest or principal repayments; • the Group, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the Group would not otherwise consider; • it becoming probable that the borrower will enter bankruptcy or other financial reorganisation; • the disappearance of an active market for that financial asset because of financial difficulties; or • observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including: - adverse changes of the payment status of borrowers in the group; or - national or local economic conditions that correlate with defaults on the assets in the group. The Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If there is no objective evidence of impairment for an individually assessed financial asset it is included in a group of financial assets with similar credit risk characteristics and collectively assessed for impairment. Residential and commercial mortgages are initially assessed individually for impairment. Mortgages not individually impaired are then assessed collectively. Personal loans and current accounts are collectively assessed for impairment on a portfolio basis. Commercial lending is reviewed for impairment on a case by case basis for individually significant loans. Loans that are not individually significant are assessed for impairment on a portfolio basis. Available-for-sale and held-to-maturity assets are assessed for impairment on a case by case basis. Impairment is calculated based on the probability of default, exposure at default and the loss given default, using recent data. An adjustment is made for the effect of discounting cash flows. If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s effective interest rate. If there is objective evidence of impairment for financial assets classified as available-for-sale, the cumulative fair value loss on the instrument is removed from equity and recognised in the Income Statement. Financial assets are written off when it is reasonably certain that receivables are irrecoverable. Past due and impaired loans The Group is managed as follows, in segments determined according to similar economic characteristics and customer base: • Retail Banking This comprises the Core 4 products of current accounts, mortgages, personal loans and savings, plus the Partner 4 products of long term investments, life assurance, general insurance and credit cards. • Commercial Banking This comprises Commercial Bank, consisting of the core business lines of lending, business banking and money transmission, and Treasury. • Group Items This represents corporate overheads and income not allocated to business units. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 12 The following tables provide an analysis of impaired and past due loans for the Retail Banking and Commercial Banking segments. There was no impairment within Group Items. Retail Banking Payment due status: 2007 £m Retail Banking 2007 % Not impaired: Neither past due or impaired Past due, but not impaired1: Up to 3 months 3 to 6 months 6 to 12 months Over 12 months Possessions Individually assessed impairments 1. Amounts reported as past due, but not impaired reflect the value of arrears as at 31 December 2007. 46,428 77 45 48 122 1 2 46,723 99.38 0.16 0.10 0.10 0.26 0.00 0.00 100.00 £1.2m of loans that would have been past due or impaired, have had their terms renegotiated. These loans have been restructured or renegotiated by capitalising arrears where customers in arrears have maintained an agreed monthly repayment scheme. Commercial Bank Payment due status: 2007 £m Commercial Bank 2007 % Not impaired: Neither past due or impaired Past due, but not impaired1: Up to 3 months 3 to 5 months Over 5 months Individually assessed impairments 1. Amounts reported as past due, but not impaired reflect the value of arrears as at 31 December 2007. 8,480 5 1 1 26 8,513 99.61 0.06 0.01 0.01 0.31 100.00 The carrying value of the repossessed stock (buses, coaches and commercial stock) was £2.1m. These assets are not utilised by the Group’s operations and are sold and converted to cash as soon as is practicable. The fair value of the collateral held against assets that have been individually impaired was £12.4m. £5.1m of loans that would have been past due or impaired, have had their terms renegotiated. Treasury Payment due status: 2007 £m Treasury 2007 % Not impaired: Neither past due or impaired Individually assessed impairments 22,868 339 23,207 98.54 1.46 100.00 £nil of loans that would have been past due or impaired, have had their terms renegotiated. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 13 Impairment losses Retail Banking Current Accounts £m Commercial Banking Treasury Commercial Bank £m £m Mortgages £m Personal Loans £m Total £m At 1 January 2007 Individual Collective Total Charge for the year: Increase in provisions Recoveries of amounts previously written off Total Amounts written off in year Arising on acquisitions At 31 December 2007 Individual Collective Total 2.0 11.4 13.4 1.6 (0.8) 0.8 (1.2) 1.9 11.1 13.0 126.4 126.4 82.8 (14.5) 68.3 (87.4) 107.3 107.3 10.1 10.1 16.6 (0.3) 16.3 (10.3) 16.1 16.1 8.6 9.8 18.4 15.9 (1.1) 14.8 (8.8) 2.2 13.4 13.2 26.6 152.9 152.9 (31.2) 121.7 121.7 10.6 157.7 168.3 269.8 (16.7) 253.1 (138.9) 2.2 137.0 147.7 284.7 The majority of the treasury impairments are against USD denominated assets. The majority of the remaining impairment relates to UK assets. Analysis of credit risk exposures Tables (i) to (iv) analyse the Group’s regulatory credit risk exposures as at 31 December 2007. These exposures equate to the exposure at default (EAD), including on balance sheet exposures and off-balance sheet exposures after credit conversion factors (CCF) have been applied. (i) Analysis of exposures by asset class Exposure as at 31.12.07 £m Sovereigns Institutions Corporates Retail Equity Securitisation positions Non credit-obligation assets Total 3,135.6 15,999.4 9,785.4 49,689.0 6.2 4,576.1 105.8 83,297.5 (ii) Geographic distribution of exposures by asset class UK £m EU £m US £m Rest of world £m Total £m Sovereigns Institutions Corporates Retail Equity Securitisation positions Non credit-obligation assets Total 3,065.5 2,899.2 7,717.5 49,689.0 6.2 944.7 105.8 64,427.9 15.1 8,617.3 662.4 976.5 10,271.3 0.0 1,658.0 350.8 2,376.7 4,385.5 55.0 2,824.9 1,054.7 278.2 4,212.8 3,135.6 15,999.4 9,785.4 49,689.0 6.2 4,576.1 105.8 83,297.5 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 14 (iii) Distribution of exposures by industry and asset class Sovereigns £m Institutions £m Corporates £m Retail £m Equity £m Securitisation positions £m Non-credit obligations assets £m Total £m Agriculture, hunting, forestry and fishing Mining & Quarrying Manufacturing Electricity, gas and water supply Construction Wholesale and retail trade; repairs Hotels and restaurants Transport, storage and communication Real estate, renting and other business activities Public administrations and defence Education Health and social work Recreational, personal and community service activities Financial intermediation & financial institutions Insurance companies and pension funds Activities auxiliary to financial intermediation Individuals and individual trusts Other Total 0.1 0.2 68.8 0.6 0.1 0.1 3,065.4 0.3 3,135.6 17.2 161.9 15,815.3 5.0 15,999.4 6.3 119.0 435.0 601.2 209.3 669.3 238.2 3,317.8 1,768.6 21.8 137.1 216.7 1,402.2 423.1 3.0 18.0 12.3 186.5 9,785.4 49,689.0 49,689.0 6.2 6.2 4,576.1 4,576.1 0.7 0.3 12.8 0.1 2.5 15.0 0.2 56.8 9.1 5.9 2.3 0.1 105.8 7.0 136.5 447.8 601.3 211.8 684.3 238.5 3,536.7 1,783.9 90.6 137.7 222.7 1,404.6 23,879.9 8.0 18.0 49,701.3 186.9 83,297.5 (iv) Residual maturity breakdown of exposures by asset class The following table shows the residual maturity of exposures stated on a contractual rather than an expected basis, and does not take into account the cash flows payable or receivable over the life of the exposure. For example, if a mortgage has a remaining maturity of over 5 years, the whole of the exposure will be shown in the over 5 year category. An analysis of the maturity of the exposures for liquidity purposes can be found in Note 2 in the Annual Report & Accounts. < 1 year £m 1-5 years £m > 5 years £m Total £m Sovereigns Institutions Corporates Retail Equity Securitisation positions Non credit-obligation assets Total 3,070.3 6,507.8 662.9 653.4 810.6 22.6 11,727.6 33.8 8,743.2 2,920.1 4,771.9 193.8 57.4 16,720.2 31.5 748.4 6,202.4 44,263.7 6.2 3,571.7 25.8 54,849.7 3,135.6 15,999.4 9,785.4 49,689.0 6.2 4,576.1 105.8 83,297.5 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 15 8 Credit risk: Standardised approach The Group uses external credit assessments provided by Moody’s, Standard & Poor’s and Fitch. These are all recognised by the FSA as eligible external credit assessment institutions (ECAI) for the purpose of calculating credit risk requirements under the standardised approach. The following table details the ECAIs used for the standardised credit risk exposure classes. Asset Class ECAI Central Government or Central Banks Regional Governments or Local Authorities Multilateral Development Banks Corporates Standard & Poor’s, Moody’s, Fitch Standard & Poor’s, Moody’s, Fitch Standard & Poor’s, Moody’s, Fitch Standard & Poor’s, Moody’s, Fitch Corporates Credit Quality Step (CQS) Risk weight % Exposure £m Exposure after Credit Risk Mitigation £m 1 2 3 4 5 6 Unrated – Non default Unrated – Default Total 20% 50% 100% 100% 150% 150% 100% 150% 62.9 1,320.4 17.8 1,401.1 62.9 1,231.1 17.8 1,311.8 Regional Governments or Local Authorities Credit Quality Step (CQS) Risk weight % Exposure £m Exposure after Credit Risk Mitigation £m 1 2 3 4 5 6 Unrated Total 20% 50% 100% 100% 100% 150% 100% 70.1 70.1 70.1 70.1 Central Governments or Central Banks Credit Quality Step (CQS) Risk weight % Exposure £m Exposure after Credit Risk Mitigation £m 1 2 3 4 5 6 Unrated Total 0% 20% 50% 100% 100% 150% 100% 2,995.4 15.1 55.0 3,065.5 2,995.4 15.1 55.0 3,065.5 In addition, the Group calculates credit risk for exposures secured by mortgages on commercial real estate using the standardised approach, as well as for the PlusMortgage, a combined secured and unsecured loan product, and buy to let mortgages. Exposure value £m Average risk weight % Secured on Real Estate Property – Commercial Mortgages Retail - PlusMortgage Secured / Buy to Let Retail - PlusMortgage Unsecured Retail – Flexiplan Account Retail – Secured Personal Loan 10.6 1,251.4 55.8 22.1 63.1 100% 38% 75% 75% 75% Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 16 9 Credit risk: Specialised lending and equity exposures Specialised lending exposures Specialised Lending exposures comprise facilities that are serviced by the cash flow generated from the specific asset(s) that is/are being funded rather than the performance of a broader corporate entity. The lack of sufficient and reliable default information means there is an inability to separate out the borrower and transaction aspects. The bank applies specific models and processes for rating such exposures where the internal rating is mapped to the “Supervisory Slotting Criteria” in BIPRU 4.5 to allocate the appropriate risk weighting. The Specialised Lending asset types applied by the bank are: • Income Producing Real Estate – Commercial property investment transactions, involving purchase of a commercial property, often via a Single Purpose Entity (SPE) created for that specific purpose. – The repayment of principal or debt service comes from the rental income from the tenant(s) in situ during the term of the facility. – In some instances, a sale of the property or a debt refinance at the term end will provide a bullet capital repayment. • Object Finance – Covers the funding of transportation – e.g. Aircraft, Shipping. – Often as part of a larger, syndicated finance arrangement. – The repayment of principal or servicing of the debt comes from the income generated by the specific asset being funded, often with a full or partial bullet repayment at the term end. Project Finance – Covers the funding of large privately funded projects, including PFI. – Often as part of a larger, syndicated finance arrangement. – The repayment of principal or servicing of the debt comes from the income generated by the specific asset being funded, often with a full or partial bullet repayment at the term end. • The following table provides an analysis of the Group’s Specialised Lending exposures by Grade. Exposure value where remaining maturity < 2.5 years £m Exposure value where remaining maturity > 2.5 years £m Grade 1 (Strong) 2 (Good) 3 (Satisfactory) 4 (Weak) 5 (Default) Total 50.9 340.2 14.4 405.5 138.3 2,199.7 79.7 0.8 2,418.5 Equity exposures The Group uses the simple risk weight approach for calculating risk weighted exposure amounts for equity exposures. Risk weight Exposure value £m 190% (Private equity exposures in diversified portfolios) 290% (Exchange traded equity exposures) 370% (Other) Total 6.2 6.2 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 17 10 Exposures to interest rate risk in the non-trading book A discussion of the Group’s interest rate risk is included within Section 2: Risk management objectives and policies. The following table shows the change in the market value of the Group given a 200bps shift in interest rates, broken down by currency. Increase / (decrease) in market value1 +200 basis -200 basis points shift in points shift in yield curve yield curve £m £m Currency £ Sterling $ US € Other Total 1. Excludes market value changes of strategic hedges of Group reserves, non-interest and low interest liabilities. (15.8) (2.1) (2.8) 0.1 (20.6) 15.8 2.1 2.8 (0.1) 20.6 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 18 11 Securitisation Alliance & Leicester plc has established a number of securitisation structures to raise funding for the Group. Special Purpose Vehicles (‘SPVs’) have purchased beneficial interests in portfolios of residential mortgages that are funded by floating rate mortgage backed debt securities (‘Notes’). The assets and liabilities of the SPVs are consolidated on a line by line basis, as Alliance & Leicester plc controls the SPVs. Alliance & Leicester plc (‘the Company’) provides subordinated loans of £374.6m to its Securitisation Structures. The Notes are serviceable firstly from cash flows generated by the mortgage assets and thereafter from the proceeds of the subordinated loans. The Company receives the excess spread on the transactions as deferred consideration, after the SPVs have met their liabilities. The Group’s maximum exposure (including subordinated loans) to the credit risk of securitised mortgages is £14,041.9m. This credit risk exposure relates to the subordinated loans, Notes purchased and retained by the Group and the risks retained upon the transfer of Notes to investors outside the Group. Fosse Securities No. 1 plc In 2000, the Company securitised £250.0m of residential mortgage assets to Fosse Securities No. 1 plc. Fosse Securities No. 1 plc issued Notes to finance the purchase of a portfolio of loans. In 2007, the remaining £28.8m of Notes in issue were redeemed at par and the associated mortgage assets were repurchased by the Company Fosse Master Trust Alliance & Leicester plc established the Fosse Master Trust securitisation structure in 2006. Notes are issued by Fosse Master Issuer plc and the proceeds loaned to Fosse Funding (No. 1) Limited, which in turn uses the funds to purchase beneficial interests in mortgages held by Fosse Trustee Limited. Alliance & Leicester plc and its subsidiaries are not obliged to support any losses that may be suffered by the Note holders and do not intend to offer such support. The Note holders only receive payments of interest and principal to the extent that Fosse Master Issuer plc has received sufficient funds from the transferred loans and after certain expenses have been met. The Company raised £2,505.4m in 2006 and a further £2,502.3m in 2007 from securitisations involving the Fosse Master Trust. Bracken Securities plc In October 2007 the Company securitised £10,367.0m of residential mortgage assets to Bracken Securities plc. Notes of £10,367.0m were issued by Bracken Securities plc to Alliance & Leicester plc, either for the purpose of creating collateral to be used for funding or for subsequent transfer of Notes to investors outside the Group. The balances of assets subject to securitisation and Notes in issue at 31 December are as follows: Gross assets securitised £m External Notes in Issue1 £m Securitisation company Type Date of Securitisation Fosse Master Issuer plc Fosse Master Issuer plc A&L plc’s retained interests Total Fosse Master Issuer plc Bracken Securities plc A&L plc’s retained interests Total Bracken Securities plc Total Residential mortgage – traditional securitisation Residential mortgage – traditional securitisation Residential mortgage – traditional securitisation 28 November 2006 1 August 2007 1 August 2007 2,145.8 2,357.4 3,991.2 8,494.4 9,969.7 9,969.7 9,969.7 18,464.1 2.292.1 2,568.2 n/a 4,860.3 -2 n/a Residential mortgage – traditional securitisation 11 October 2007 4,860.3 1. External Notes in issue include accrued interest of £61.7m and currency movements of £110.4m but exclude principal cash balances collected but not yet repayable on the Notes of £199.2m 2. Excluding Notes sold by Bracken Securities plc where the Company is contractually required or expected to repurchase prior to maturity. The Group sponsors some bankruptcy remote Special Purpose Vehicles (SPVs). The SPVs, owned by charitable trusts, are funded by Asset Backed Commercial Paper and invest in ‘AAA’ rated assets. Since the purchase, a number of assets have been downgraded from AAA. The Group provides liquidity facilities to the SPVs, amounting to £698m at 31 December 2007. The liquidity facility can be drawn in the event of asset downgrades in the SPV, but cannot be drawn to fund asset defaults. The recoverability of the liquidity facility is considered with respect to the asset quality of the SPV assets, and to date no impairment is considered necessary. The SPVs are not controlled by the Group and the benefits the Group receives from the SPVs are restricted to interest and fees relating directly to the loans and liquidity facilities provided. Treatment of securitisations in capital calculations The securitisation of the residential mortgages is not recognised by the Group in its Pillar 1 capital calculations. The Group continues to hold capital against the credit risk of the mortgages. The capital requirement is calculated using the Retail Internal Ratings Based (IRB) approach, further details can be found in Section 12. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 19 Securitisation positions retained or purchased The Group also invests in securitisation vehicles. A combination of Moody’s, Standard and Poor’s and Fitch are used to derive the external rating to be used in the Ratings Based Method for all securitisation investment exposures. In line with BIPRU 9.8, where two credit assessments by the ECAI’s are available, the less favourable of the two credit assessments is applied. Where more than two credit assessments are available, the two most favourable credit assessments are used and where the two most favourable assessments are different, the less favourable of the two is applied. The following tables provide an analysis of the Group’s investments in securitisations. Amounts retained / purchased £m Residential mortgage backed securities (RMBS) Commercial mortgage backed securities (CMBS) Other asset backed securities (ABS) Liquidity facilities and other off balance sheet exposures Structured investment vehicles (SIV) Collateralised debt obligations (CDO) / Collateralised loan obligations (CLO) Total 1,954.3 123.4 907.5 1,041.6 212.7 336.6 4,576.1 Risk Weighting Amounts retained / purchased £m 6% 7% 8% 12% 15% 20% 35% 50% 75% 100% 1250% Deduction Look through to underlying assets1 Total 65.2 2,984.2 12.8 122.2 99.3 54.8 29.2 7.7 195.9 1,004.8 4,576.1 1. Includes the exposure arising from the Group’s off balance sheet conduit facility and credit default swaps against securitised assets. As at 31 December 2007, the capital requirement for these exposures was calculated as £7.3m. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 20 12 Internal Ratings Based (IRB) disclosures The scope of the firm’s IRB permission CRD Asset Class Retail - Residential Mortgages Retail - Other Retail - Qualifying Revolving Retail Exposures (QRRE) Corporate (excluding leveraged transactions1) Specialised Lending Financial Institutions (other than Central Banks and Multilateral Development Banks) Securitisation Small businesses Alliance & Leicester Portfolio / Business Line Mortgages / Retail Banking Unsecured Personal Loans / Retail Banking Current Accounts / Retail Banking Quoted and Unquoted Corporates / Commercial Bank and Treasury Specialised Lending / Commercial Bank CRD Approach Retail IRB Retail IRB Retail IRB Foundation IRB Foundation IRB (Supervisory slotting criteria) Banks / Treasury and Commercial Bank Foundation IRB Foundation IRB (Securitisation ratings based approach (external ratings)) Standardised (Materiality exemption from IRB) Standardised (Materiality exemption from IRB) Standardised (Materiality exemption from IRB) Standardised Securitisation / Treasury Small businesses / Commercial Bank and Treasury Sovereign (including Central Banks and Multilateral Development Sovereigns / Commercial Bank and Banks) Treasury Corporates / Commercial Banking Corporate (leveraged transactions1) Other / Commercial Banking and Retail Banking Other (including Commercial, PlusMortgage and Buy to Let mortgages) 1. Leveraged transactions – where counterparties have undergone a step-change in their financing and/or capital structure. The most common types of such transactions are leveraged buy-outs or public flotations such as initial public offerings and qualified public offerings. The Group’s IRB (Internal Ratings Based) Waiver Application Pack was approved by the FSA in 2006 for capital adequacy monitoring and reporting beginning on 1 January 2007. The scope of this permission covers the retail business of residential mortgages, personal loans and current accounts, the specialised lending and corporate business (excluding leveraged transactions and Public Sector Entities), and exposures to financial institutions and securitised investments. The areas of the business falling outside the scope of the Group’s IRB permission are limited to corporate leveraged loans, SME’s, Commercial, PlusMortgage and Buy to Let mortgages, Sovereigns (including central banks and multilateral development banks) and Public Sector Entities (including local authorities). Asset classes not falling within the scope of the Group’s IRB permission are treated under the standardised approach. The IRB approach to monitoring and reporting risk has been built up around the primary revenue streams of the Group: Retail Banking, Commercial Bank and Treasury. The credit risk function for each area is responsible for the development, validation, implementation, monitoring and use of credit rating models. In order to ensure the integrity and independence of these models, the credit risk function in each business unit has clearly segregated duties from those responsible for originating exposures. Each business risk area is responsible for monitoring the validity of its models and completeness of the supporting documentation and reporting on these to the Model Validation Committee (MVC). The MVC has been established as the principal forum for independently overseeing the Group’s credit rating models, to ensure that the systems are producing consistent and accurate results in line with the Group’s objectives and FSA minimum requirements. Although the internal credit rating models vary across the Group, the definitions of certain variables feeding into and being produced by these models are broadly consistent across the Group. It is the MVC’s responsibility to ensure that the integrity of these Group wide definitions is being maintained. Retail Banking The Group has extensive internal loss data histories which have enabled it to build in-house credit rating models for the residential mortgage, unsecured personal loan and current account portfolios. These models facilitate an appropriate risk sensitive approach to risk management and capital allocation. The models determine long run average probabilities of default (PD), downturn loss given default (LGD) and appropriate exposures at default (EAD) for each segment in order to calculate expected loss, economic capital and risk weighted assets. In addition, the models are used to support lending strategy and the provision of management information. Retail Banking’s rating models group obligors into segments differentiated by a number of factors, which include application and behavioural scores and delinquency status. For each segment a long run average PD, downturn LGD and EAD are estimated from a combination of recent and historic data. Data covering the period back to the early 1990s are utilised in the derivation of the PD, LGD and EAD. Internal loss data is supplemented with external industry loss data where there is not sufficient internal data. For all products EAD is restricted so that it cannot be lower than 100% of the current exposure. An EAD for undrawn assets such as applications not yet taken up is also built into the models through the use of credit conversion factors. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 21 Commercial Banking Under the Foundation IRB approach, the Group utilises regulatory LGD and EAD measures in determining the level of risk weighted assets for Commercial Banking exposures. Internal ratings models are used to generate obligor PDs. The high credit quality of the corporate portfolio and low volumes of credit exposures have meant that there is insufficient statistically significant internal loss data upon which to build in-house credit rating models. A suite of vendor solutions is therefore used to deliver long run average one year PD estimates. Validation of these models demonstrates a good fit to the limited internal loss experience of the corporate portfolio. Specialised lending exposures are assessed via the supervisory slotting criteria for IRB purposes. To date, for small business exposures, the lack of internal loss data, the modest exposure of the portfolio and the lack of an appropriate vendor solution has prevented the development of an internal ratings solution. Financial Institutions For exposures to financial institutions, the Group utilises regulatory LGDs for determining risk weighted assets (since the Group’s waiver is to apply Foundation IRB). Internal ratings models are used to generate obligor PDs. Exposures to financial institutions arise in Treasury operations and in the Commercial Bank in the form of third-party bank guarantees. An inhouse model combining quantitative and qualitative measures is used to assess the creditworthiness of these financial institutions by assigning them an internal rating. This model delivers a point in time rating that is calibrated to long run external loss data supplied by an External Credit Assessment Institution (ECAI) to generate a long run average PD for each rating. IRB data by exposure class (i) IRB exposure values The following table details the Group’s exposures by Basel IRB exposure class. These exposures equate to the exposure at default (EAD), after credit risk mitigation (CRM), including on balance sheet exposures and off-balance sheet exposures after credit conversion factors (CCF) have been applied. The undrawn commitment values, shown separately for the retail asset classes, are reported gross. Exposure £m Retail IRB Retail exposures secured by real estate collateral Other retail exposures Qualifying revolving retail exposures Foundation IRB Institutions Corporates Corporates – Specialised Lending1 Equities1 Other IRB Securitisation positions2 1. Details on these exposure classes are in Section 9: Specialised lending and equity exposures. 2. Details on this exposure class are included in Section 11: Securitisation. 44,404.3 3,738.8 153.5 15,994.3 5,341.6 2,824.0 6.2 4,576.1 Tables (ii) to (vii) include credit risk information on the Group’s IRB asset classes (ii) Retail exposures secured by real estate collateral Obligor Grade Average PD Grade % Exposure £m Exposure-weighted average risk weight % Exposure-weighted average LGD % Undrawn Commitments £m Exposure-weighted average exposure value £ 1 2 3 4 5 6 7 Default Total 0.07 0.11 0.17 0.42 1.36 5.56 29.69 Default 18,300.0 13,423.3 6,949.1 4,339.2 847.2 286.0 156.6 102.9 44,404.3 3.36 5.37 8.86 15.05 27.88 64.88 112.80 292.66 17.83 19.66 22.41 21.48 17.29 19.05 23.10 27.71 1,009.3 320.6 281.2 135.4 0.6 0.0 0.0 0.0 1,747.1 90,858 101,419 77,901 101,613 61,537 65,335 63,813 70,955 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 22 (iii) Other retail exposures Obligor Grade Average PD Grade % Exposure £m Exposure-weighted average risk weight % Exposure-weighted average LGD % Undrawn Commitments £m Exposure-weighted average exposure value £ 1 2 3 4 5 6 7 Default Total 0.58 1.12 2.26 3.47 7.00 13.00 44.90 Default 1,300.3 704.8 569.3 472.4 326.8 108.3 61.1 195.8 3,738.8 58.16 78.88 101.59 112.64 123.53 153.52 180.37 256.49 69.62 69.83 72.52 75.17 75.02 77.87 78.57 77.89 24.2 3.1 5.1 2.8 0.4 0.2 0.0 0.0 35.8 6,331 5,136 6,071 5,679 6,245 5,209 5,389 6,101 (iv) Qualifying revolving retail exposures Obligor Grade Average PD Grade % Exposure £m Exposure-weighted average risk weight % Exposure-weighted average LGD % Undrawn Commitments £m Exposure-weighted average exposure value £ 1 2 3 4 5 6 7 Default Total 0.50 3.59 7.42 12.29 23.02 30.40 74.84 Default 25.4 31.1 19.5 15.4 17.1 11.2 8.0 25.8 153.5 11.13 26.63 44.60 61.50 75.78 80.76 55.52 87.86 26.70 26.24 26.58 26.39 25.77 25.98 26.73 28.23 452.1 47.4 21.8 8.8 3.6 5.2 5.5 0.0 544.4 20 221 167 74 579 179 111 212 (v) Financial institutions Obligor Grade PD Grade % Exposure £m Exposure-weighted average risk weight % 1 2 3 4 5 6 7 Default Total 0.03 0.04 0.06 0.09 0.14 0.21 1.33 Default 7,514.8 3,031.4 4,406.2 912.2 96.4 31.8 1.5 15,994.3 15.0 17.3 21.3 28.4 34.7 44.3 141.8 - (vi) Corporates with bank guarantees Obligor Grade PD Grade % Exposure £m Exposure-weighted average risk weight % 1 2 3 4 5 6 7 Default Total 0.03 0.04 0.06 0.09 0.14 0.21 1.33 Default 1,607.8 139.4 12.9 3.5 1,763.6 27.3 31.8 39.2 72.6 - Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 23 (vii) Corporates without bank guarantees Obligor Grade Exposure-weighted average PD Grade % Exposure £m Exposure-weighted average risk weight % 1 2 3 4 5 6 7 Default Total 0.10 0.22 0.47 0.80 1.38 2.50 5.48 Default 1,218.7 815.5 527.0 331.5 346.7 273.5 61.3 3.8 3,578.0 39.1 62.5 85.4 98.4 114.9 130.1 160.7 0.0 (viii) Impairment The following table shows the charges for the year relating to impairment losses on the various Basel asset classes. This analysis also includes charges made for assets where the credit risk requirement is calculated using the standardised approach. Value adjustment as at 31.12.07 £m Retail exposures secured by real estate Other retail QRRE Corporates (including Specialised Lending) Sovereigns Institutions Equities Securitisation positions Total 0.8 68.3 16.3 14.8 152.9 253.1 Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 24 13 Credit risk mitigation Retail Banking 91.6% of the Retail balances are secured on residential properties, with the remainder of the balance relating primarily to unsecured personal loans. The carrying value of the repossessed stock (properties in possession) was £12.4m at 31 December 2007, for which £11.9m collateral was held. These assets are not utilised by the Group’s operations and are sold and converted to cash as soon as practicable. The average LTV of our prime mortgage book at the end of 2007 was 46%, with 58% of the book having an indexed LTV of less than 50%, and just 2% over 90%. Commercial Bank Within Commercial Bank, just under £1.8bn of exposures were guaranteed by banks as at 31 December 2007. These guarantees are recognised as credit risk mitigation within the capital calculations. In addition, the Commercial Bank utilises a broad range of collateral types as credit risk mitigation. These serve to reduce the exposure to a counterparty against which capital is required to be held. Financial collateral is predominantly cash. Other eligible collateral includes first priority charges on commercial and residential real estate and other physical assets such as aircraft, shipping, commercial vehicles (including buses and coaches) and car fleets. Treasury Credit Support Annexes (CSA) exist for collateralising derivative transactions with counterparties to which the Group has its largest derivative exposures in order to mitigate the risk of loss on default. The Credit Support Annexes allow margin calls to be made on the net mark to market value of derivative exposures with a particular counterparty. Although these CSAs are taken into consideration when setting the internal credit risk limits for derivative counterparties, the Group does not currently recognise the risk mitigating effect of these CSAs in its Pillar 1 capital calculations. The Group also utilises reverse repurchase agreements for short term liquidity management. Market prices on the collateral received on these transactions are monitored daily. There were no reverse repurchase agreements in place at 31 December 2007. Defeasance deposits are cash collateral placed with treasury to support Letters of Credit. These deposits amounted to £208m at year end. Treasury also utilises guarantees where appropriate. General guarantees by a parent to its subsidiary businesses are incorporated in the internal and external rating used to determine the capital requirement for a particular exposure. However, any guarantee made specifically to the Group is recognised separately as credit risk mitigation in the capital calculations. The following table shows the values of collateral and guarantees used as credit risk mitigation within the Pillar 1 calculations. Financial Collateral £m Other Eligible Collateral £m Guarantees £m Credit Derivatives £m Retail IRB Retail exposures secured by real estate collateral Other retail QRRE Foundation IRB Corporates Institutions Equities Other IRB Securitisation positions Standardised Central government or central banks Regional governments or local authorities Multilateral development banks Corporates Secured on real estate property Retail 217.7 89.3 - 665.3 - 1,778.7 25.1 62.9 - - Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 25 14 Contacts Tel: 0116 200 4492 Tel: 0116 200 2123 Should you have any queries please contact:Mark Jones Head of Investor Relations Mark Browne Head of Financial Relations and External Reporting Alliance & Leicester plc. Registered Office: Carlton Park, Narborough, Leicester LE19 0AL. Company No: 3263713. Registered in England. Alliance & Leicester plc Pillar 3 disclosures for the year ended 31 December 2007 26