report on transition to ifrs 9: financial instruments · 3) the ifrs 9 approach increases ecl...

Nationwide Building Society – Report on Transition to IFRS 9

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Report on Transition to IFRS 9:

Financial Instruments As at 5 April 2018


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Contents

Page

Summary

3

Introduction

6

Balance sheet and reserves adjustments

8

Loans and advances to customers and provisions reconciliations

10

Expected credit loss approach

11

Regulatory capital

16

Revised accounting policies

17

Glossary

20

Contacts

20

Forward looking statements

Certain statements in this document are forward looking with respect to plans, goals and expectations relating to the future financial

position, business performance and results of Nationwide. Although Nationwide believes that the expectations reflected in these

forward-looking statements are reasonable, Nationwide can give no assurance that these expectations will prove to be an accurate

reflection of actual results. By their nature, all forward looking statements involve risk and uncertainty because they relate to future

events and circumstances that are beyond the control of Nationwide including, amongst other things, UK domestic and global

economic and business conditions, market related risks such as fluctuation in interest rates and exchange rates, inflation/deflation,

the impact of competition, changes in customer preferences, risks concerning borrower credit quality, delays in implementing

proposals, the timing, impact and other uncertainties of future acquisitions or other combinations within relevant industries, the

policies and actions of regulatory authorities, the impact of tax or other legislation and other regulations in the jurisdictions in which

Nationwide operates. As a result, Nationwide’s actual future financial condition, business performance and results may differ

materially from the plans, goals and expectations expressed or implied in these forward-looking statements. Due to such risks and

uncertainties Nationwide cautions readers not to place undue reliance on such forward-looking statements.

Nationwide undertakes no obligation to update any forward-looking statements whether as a result of new information, future

events or otherwise.

This document does not constitute or form part of an offer of securities for sale in the United States. Securities may not be offered

or sold in the United States absent registration or an exemption from registration. Any public offering to be made in the United

States will be made by means of prospectus that may be obtained from Nationwide and will contain detailed information about

Nationwide and management as well as financial statements.

Basis of preparation

This document has been prepared on the basis of International Financial Reporting Standards, incorporating IFRS 9 and its

consequential amendments to other standards including IFRS 7, as endorsed by the EU and including transitional arrangements for

regulatory capital as appropriate. All other accounting policies are unchanged from those published in the Annual Report and

Accounts 2018. Comparative information for the accounting periods prior to adoption will not be restated, as permitted by IFRS 9.

This document is unaudited.

Terminology used in this report is consistent with that used in the Annual Report and Accounts 2018. Copies of the Annual Report

and Accounts 2018 are available on the Group’s website at nationwide.co.uk. A full glossary can also be found on the Group’s website.


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Summary

Impact of IFRS 9

The day one impact of IFRS 9 is limited, leading to a reduction in members’ interests and equity of approximately 1.3%, primarily

due to increased impairment provisions. The impact on the main capital ratios is not significant.

These impacts are based on assumptions and judgements at 5 April 2018 which are subject to change. IFRS 9 provisions may be

more volatile compared to IAS 39 due to the forward-looking nature of expected credit loss (ECL) provisions.

Movement from IAS 39 to IFRS 9 impairment provisions

The chart above shows the components of the overall increase of impairment provision from IAS 39 to IFRS 9. The key differences

between IAS 39 and IFRS 9 impairment provisions are summarised as follows:

1) Previously under IAS 39, provision was held in relation to up to date loans where a loss event had occurred but had not

yet been identified through evidence of arrears (£110 million).

2) By contrast under IFRS 9, a provision is calculated for all loans. The value of a 12 month ECL for all up to date loans is

£83m.

3) The IFRS 9 approach increases ECL provisions from a 12 month ECL to a lifetime ECL when there is evidence of a significant

increase in credit risk since origination, or when the loan is impaired. This is one of the main drivers of the increase in

provisions from IAS 39 to IFRS 9, particularly for loans which are not yet impaired. The impact of this is £89 million, of

which the increase for loans impaired under IAS 39 is £15m.

4) The impact of including an allowance for multiple economic scenarios (MES) is the other significant driver of the increase

in impairment provisions under IFRS 9. The effect of this factor is £110 million.


4

Summary continued

Analysis of loans and advances including stage distribution

The calculation of ECL uses a three stage approach (stage 1 for performing assets, stage 2 for assets with a significant increase in

credit risk since origination and stage 3 for assets which are credit impaired). Staging is explained in more detail in the expected

credit loss approach section of this report.

The following table summarises the impact of the initial adoption of IFRS 9 expected credit losses on loans and advances to

customers which are carried at amortised cost on the balance sheet. The tables show the stage allocation of loans at 5 April 2018,

the IFRS 9 impairment provisions and the resulting provision coverage ratios. The provision coverage ratio is calculated by dividing

the ECL provision by the gross loans for each main lending portfolio. These indicators will be included in our interim results for the

period ending 30 September 2018 and in the Annual Report and Accounts 2019. For investment securities that are subject to ECLs,

the expected credit losses are below £1m and therefore immaterial for the purposes of this report.

Analysis of loans and advances at amortised cost

Stage 1 Stage 2 Of which

<30 DPD

(Note 3)

Of which

>30DPD

Stage 3 Stage 3 POCI

(Note 4)

Total

£m £m £m £m £m £m £m

Gross Loans (Note 1)

Residential mortgages (Note 2) 156,647 19,072 18,609 463 1,215 180 177,114

Consumer banking 3,264 575 559 16 268 4,107

Commercial and other lending 9,209 365 363 2 37 9,611

Total at 5 April 2018 169,120 20,012 19,531 481 1,520 180 190,832

Provisions ECL

Residential mortgages 17 171 156 15 47 235

Consumer banking 25 103 93 10 237 365

Commercial and other lending 6 10 10 0 13 29

Total at 5 April 2018 48 284 259 25 297 629

Provision coverage ECL as a % of gross loans

Residential mortgages 0.01 0.90 0.84 3.25 3.84 0.13

Consumer banking 0.78 17.86 16.59 61.22 88.45 8.90

Commercial and other lending 0.07 2.74 2.76 0.00 35.55 0.30 Notes:

1 A reconciliation between this table and the IFRS 9 balance sheet is presented on page 10 of this report.

2 Nationwide’s residential mortgages include both prime and specialist loans. Prime residential mortgages are mainly Nationwide branded advances. Specialist

lending includes buy to let mortgages originated under the Mortgage Works (UK) plc (TMW) brand.

3 Days past due, a measure of arrears status.

4 Purchased or originated credit impaired (POCI) loans. The gross balance for POCI is net of the lifetime ECL at transition.

Of the £20,012 million stage 2 loans that have experienced a significant increase in credit risk, £481 million are loans where this is

due to arrears of 30 days past due or more, whilst £19,531 million is due to non-arrears factors.

Consumer banking stage 3 gross loans and ECL include charged off balances. These are in relation to accounts which are closed to

future transactions and are held on the balance sheet for an extended period (up to 36 months) whilst recovery procedures take

place. The total consumer banking provision coverage ratio excluding both the charged off balance and the related ECL (£185 million

and £175 million respectively) is 4.84%.

The stage 3 POCI loans were recognised on the Group’s balance sheet when the Derbyshire Building Society was acquired in

December 2008. These mainly interest only residential loans were 90 days or more in arrears when they were acquired by the

Group and so have been classified as credit impaired on acquisition. A lifetime ECL provision of £7 million has been deducted from

the gross carrying amount as a transitional adjustment. Any subsequent changes (favourable or unfavourable) in lifetime ECL will

be recognised in the income statement from 5 April 2018.


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Summary continued

Potential volatility of ECL provisions

Despite the fact that actual cash flows and losses realised on loans are unaffected by the adoption of IFRS 9, ECL provisions are

expected to be higher, and potentially more volatile, than IAS 39 incurred loss provisions. This is due to the change to an expected

credit loss basis for calculating provisions. In the future, if expectations of economic conditions or observed loss rates deteriorate,

the level of ECL provisions will be expected to increase as models and assumptions are revised. Conversely when economic forecasts

become more optimistic, provisions are expected to reduce. In addition, volatility could occur when significant numbers of loans

move between stages, particularly from stage 1 to stage 2, changing the basis of provisioning from 12 month to lifetime ECL. Overall

the degree of volatility from these factors is uncertain and is likely to fluctuate with changing circumstances, particularly

macroeconomic conditions and outlook.


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Introduction

With effect from 5 April 2018 Nationwide Building Society and its subsidiaries (the Group) has adopted IFRS 9: Financial Instruments

to replace IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 includes requirements for the classification and

measurement of financial instruments, impairment of financial assets and hedge accounting.

The Group’s first results prepared under IFRS 9 will be published in the Interim Management Statement for the quarter ending 30

June 2018. The Group’s first full year set of financial statements prepared under IFRS 9 will be published in the Annual Report and

Accounts for the year ending 4 April 2019.

This document summarises the financial impact of IFRS 9 at adoption on 5 April 2018. Additional information is included to allow

readers to understand the approach taken to calculating expected credit losses under IFRS 9, including the key concepts and

judgements made.

The principal requirements of IFRS 9 are as follows:

Classification and measurement

The classification of financial assets is based on the objectives of the Group’s business model and the contractual cash flow

characteristics of the financial instruments. Financial assets are classified as held at amortised cost, at fair value through other

comprehensive income (FVOCI), or at fair value through profit or loss (FVTPL). The impact of changes from the accounting treatment

under IAS 39 for Nationwide is limited. Assets with contractual cash flow characteristics that have resulted in a reclassification from

amortised cost to FVTPL include some closed book equity release and shared ownership retail loans, and a small number of

commercial loans. The only changes to the classification and measurement of financial liabilities are where liabilities are elected to

be measured at fair value on the balance sheet on adoption; the Group has not made any such election.

The review of the contractual terms of financial assets has resulted in asset values reducing by £36 million as a result of certain

loans being reclassified from amortised cost to FVTPL. Most of this reduction in value relates to the removal of fair value hedge

accounting adjustments for equity release loans.

Impairment of financial assets

IFRS 9 changes the basis of recognition of impairment on financial assets from an incurred loss to an expected credit loss (ECL)

basis for amortised cost and FVOCI financial assets.

IFRS 9 introduces a number of new concepts and changes to the approach to provisioning compared with the previous methodology

under IAS 39:

• Expected credit losses are based on an assessment of the probability of default, exposure at default and loss given default,

discounted to give a net present value. The estimation of ECL is unbiased and probability weighted, taking into account all

reasonable and supportable information, including forward looking economic assumptions and a range of possible

outcomes. IFRS 9 has the effect of bringing forward recognition of impairment losses relative to IAS 39 which requires

provisions to be recognised only when there is objective evidence of credit impairment.

• On initial recognition, and for financial assets where there has not been a significant increase in credit risk since the date

of advance, IFRS 9 provisions are recognised for expected credit default events within the next 12 months.

• A key feature of IFRS 9 compared with the previous approaches under IAS 39 is that where a loan has experienced a

significant increase in credit risk since initial recognition, even though this may not lead to the conclusion that the loan is

credit impaired, provisions are made based on expected credit losses over the full life of the loan.

• For assets where there is evidence of credit impairment, provisions are made for lifetime expected credit losses under

IFRS 9. Interest will be recognised net of impairment provisions.

• All IFRS 9 ECL provisions take account of forward looking economic assumptions and a range of possible outcomes. Under

IAS 39, provisions were based on the asset’s carrying value and the present value of the estimated future cash flows. IAS

39 did not explicitly take account of a range of possible economic outcomes including forecasts of any downturn in the

economic cycle.

Further details of our approach are contained in the expected credit loss approach section of this report.


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Introduction continued

Hedge accounting

The hedge accounting requirements of IFRS 9 are designed to create a stronger link with financial risk management. The

International Accounting Standards Board (IASB) is currently exploring an accounting model for dynamic risk management

accounting (macro hedge accounting). The Group currently takes the option permitted by IFRS 9 to continue to apply the hedge

accounting requirements of IAS 39. The Group will however implement the revised hedge accounting disclosure requirements

included in the related amendments to IFRS 7 Financial Instruments: Disclosure.

Implementation strategy

The Group established an IFRS 9 implementation programme in 2014 with formal governance reporting to the Chief Financial Officer

and Chief Risk Officer. Progress was reported regularly to the Audit Committee during the life of the programme. This included

formal oversight of the new IFRS 9 ECL calculations and economic assumptions ahead of the adoption of IFRS 9.

The Group’s implementation strategy for IFRS 9 has been based on an integrated solution using common systems, tools and data

to assess credit risk and account for ECL. This is consistent with guidance issued by the Basel Committee on Banking Supervision

(BCBS), and has entailed changes to the governance, controls, models and business processes relating to credit loss provisioning.

The IFRS 9 implementation programme was completed in advance of adoption on 5 April 2018, allowing a period of refinement of

the new IFRS 9 systems, models and processes during the 2017/18 financial year.

Governance

IFRS 9 impairment provisions are subject to review and oversight through Nationwide’s existing risk governance frameworks. This

includes controls over the data, models and financial controls used in the IFRS 9 processes.

In addition, monthly forums comprising members of the Risk and Finance communities review model outputs, challenging the

assumptions used and approving changes to the operation of ECL models. They consider whether modelled outputs adequately

reflect credit risk, and regularly review any adjustments required to modelled provisions. A new forum has been created to review

and approve the forward-looking economic scenarios used as part of the ECL calculation. Provisions are ultimately approved by the

CFO and regularly reviewed by the Group’s Audit Committee.


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Balance sheet and reserves adjustments

The Group’s balance sheet has been adjusted as follows with the adoption of IFRS 9 as at 5 April 2018:

Adjusted Group balance sheet

IAS 39 category IFRS 9 category As at 4

April 2018

Classification Measurement Impairment IFRS 9 carrying value at 5

April 2018

Notes £m £m £m £m £m £m £m

Assets

Cash Amortised cost Amortised cost 14,361 - - - 14,361

Loans and advances to banks Amortised cost Amortised cost 3,422 - - - 3,422

Investment securities 1 AFS FVOCI 11,926 (45) - - 11,881

Investment securities 1 AFS FVTPL - 45 - - 45

Investment securities Amortised cost Amortised cost 1,120 - - - 1,120

Derivative financial instruments FVTPL FVTPL 4,121 - - - 4,121

Fair value adjustment for portfolio hedged risk 2 FVTPL FVTPL (109) - (35) - (144)

Loans and advances to customers 3,4,5 Amortised cost Amortised cost 191,664 (246) (2) (171) 191,245

Loans and advances to customers 6 Amortised cost FVTPL - 246 1 - 247

Assets not impacted by changes arising from

IFRS 9

- - 2,495 - - - 2,495

Deferred tax 7 - - 98 - 8 38 144

Total assets 229,098 - (28) (133) 228,937

Liabilities

Liabilities not impacted by changes arising from

IFRS 9 - - 216,422 - - - 216,422

Provisions for liabilities and charges 8 - - 273 - - 1 274

Total liabilities 216,695 - - 1 216,696

Members’ interests and equity

Capital and reserves not impacted by changes

arising from IFRS 9 - - 2,377 - - - 2,377

General reserve 9 - - 9,951 13 (28) (134) 9,802

Fair value through other comprehensive income

reserve 9 - - 75 (13) - - 62

Total members’ interests and equity 12,403 - (28) (134) 12,241

Total members’ interests, equity and liabilities 229,098 - (28) (133) 228,937


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Balance sheet and reserves adjustments continued

Notes:

1. Includes a debt security that has been transferred from available for sale investment securities to FVTPL due to its contractual

cash flow characteristics.

2. This reduction in fair value for portfolio hedged risk relates to removal of fair value hedge accounting adjustments for loans that

have been reclassified from amortised cost to FVTPL, and which therefore no longer qualify for hedge accounting.

3. The reduction of amortised cost loans and advances to customers under IAS 39 relates to loans reclassified under IFRS 9 as FVTPL

due to their contractual cash flow characteristics.

4. £2 million is the net impact of the transitional lifetime ECL adjustment on the balance sheet carrying value of POCI loans, and the

adjustment to credit impaired loans to restore the carrying value to the contractual amount owed.

5. The reduction of the amortised cost loans and advances to customers due to impairment (£171m) is the difference between

IFRS 9 ECL impairment and the IAS 39 incurred loss provisions.

6. Carrying values of FVTPL loans and advances to customers increased by £1m on transition to IFRS 9.

7. The valuation of the deferred tax assets recognised on adoption of IFRS 9 reflects HMRC’s legislation that the tax effect of the

impact on adoption of IFRS 9 should be realised over the ten years following adoption. Deferred tax is determined using tax rates

and laws that are expected to apply in the period when the deferred tax asset is realised based on rates enacted or substantively

enacted at the balance sheet date, including the banking surcharge when applicable.

8. An additional £1 million has been provided separately within provisions for liabilities and charges. This relates to provisions

against separately identifiable irrevocable commitments for the pipeline of personal loans, commercial loans and mortgages.

Overdrafts and credit card commitments are provided for within the ECL provision models, with allowance for future drawdowns

made as part of the exposure at default (EAD) element of the ECL calculation for each account.

9. The transfer from fair value through other comprehensive income reserve to general reserve relates to the accumulated available

for sale reserve in respect of financial instruments that have been reclassified from AFS to FVTPL.


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Loans and advances to customers and provisions reconciliations

Reconciliation of loans and advances to customers

The following table shows the constituents of the loans and advances to customers total in the balance sheet after the transition to

IFRS 9 on 5 April 2018:

Reconciliation of loans and advances to customers

Amortised cost

Gross loans ECL Other

(Note 1)

Balance sheet

amortised cost

loans

Balance sheet

FVTPL Loans

Total

£m £m £m £m £m £m

Residential mortgages 177,114 (235) - 176,879 189 177,068

Consumer banking 4,107 (365) - 3,742 - 3,742

Commercial and other lending 9,611 (29) 1,042 10,624 58 10,682

Total 190,832 (629) 1,042 191,245 247 191,492 Note: 1. Amortised cost loans and advances to customers include the fair value adjustment for micro hedged risk (for commercial loans hedged on an individual basis).

Reconciliation of impairment provisions

The table below reconciles the closing IAS 39 impairment provision balance to the opening IFRS 9 ECL provision on the adoption of

IFRS 9 on 5 April 2018:

Reconciliation of impairment provisions within staging bands

12 month ECL Lifetime ECL –

not credit

impaired

Lifetime ECL –

credit

impaired

Total ECL Less

IAS 39

provisions

Increase in

provision on

adoption of

IFRS 9

£m £m £m £m £m £m

Residential mortgages 17 171 47 235 (145) 90

Consumer banking 25 103 237 365 (298) 67

Commercial and other lending 6 10 13 29 (15) 14

Total 48 284 297 629 (458) 171


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Expected credit loss approach

Measuring credit losses

Expected Credit Loss (ECL) is calculated using the following formula:

Probability of default (‘PD’) x Exposure at default (‘EAD’) x Loss given default (‘LGD’)

These terms are defined as follows:

Term Definition

Probability of

default (‘PD’)

The probability of a default event occurring, based on conditions existing at the reporting date and future

economic conditions that affect credit risk. Probability of default has been determined based upon unlikeliness

to pay indicators, plus backstop criteria based upon a measure of days past due. The lifetime PD forms part of

the IFRS 9 stage assessment as well as the ECL calculation.

Exposure at

default (‘EAD’)

The expected outstanding balance of the asset at default, considering the repayment of principal and interest

from the reporting date to the date of default, together with any expected drawdown of committed facilities.

Loss given default

(‘LGD’)

The proportion of the exposure that is expected to be lost in the event of default, taking account of the impact

of collateral and its expected value at the point of realisation, as well as recoveries and other means of loss

mitigation.

Models have been developed for all portfolios for the IFRS 9 ECL calculation. The overall modelling approach is aligned to the IRB

(internal ratings-based) regulatory capital models, amended to reflect differences in modelling requirements. For example, for

residential mortgage portfolios the IFRS 9 definition of default is based on arrears of 90 days past due, rather than 180 days past

due in the IRB models.

To calculate the lifetime ECL for a loan, separate 12 month ECL calculations are performed for each year of the loan’s expected life.

The outputs of these calculations for each year are then combined and discounted at the effective interest rate.

The PD, EAD and LGD inputs for the 12 month ECL calculations incorporate management’s expectations of future performance,

including forward looking economic assumptions. To reflect the uncertainty inherent in economic forecasting, multiple ECL

calculations are performed using different sets of assumptions (scenarios) that are considered possible. The provisions reported at

5 April 2018 incorporate the results of scenarios which have been weighted according to management’s assessment of their

likelihood.

Modelled ECL provisions may be adjusted by management if it is considered that they do not adequately reflect known credit risks,

for example, risks where there is insufficient historic loss data on which to develop models. Any such post model adjustments (PMAs)

are subject to thorough internal review before being applied.


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Expected credit loss approach continued

Significant judgements and estimates

To ensure that ECL provisions fulfil IFRS 9 requirements, judgement and estimation is required in a number of areas. The areas

where the impact of judgement and estimation are most material are:

• the approach to applying the staging requirements

• the basis of forward looking information and multiple economic scenarios.

• the proportion of interest only mortgages that will redeem or refinance at maturity

• the period of exposure to credit risk for revolving loans.

Our approach to each of these judgements is described in more detail below.

Staging requirements

The calculation of an asset’s ECL will depend on the changes in its credit risk since it was originally recognised. The impact of

changes in credit risk on the calculation of ECLs is achieved using a three stage approach:

• an asset that is not credit impaired on initial recognition is classified in stage 1, with a loss allowance equal to 12 month

ECL,

• when a loan’s credit risk increases significantly, it will be moved to stage 2. The loss allowance recognised will be equal to

the loan’s lifetime ECL, and

• if a loan meets the definition of credit impaired, it will be moved to stage 3 with a loss allowance equal to its lifetime ECL.

A loan may remain in stage 1 for its entire life if there is no significant change in credit risk.

Identifying significant increases in credit risk (stage 2)

The identification of significant increases of credit risk is the most judgemental element of the staging criteria. Management regularly

monitors Nationwide’s loans to determine whether there have been changes in credit risk. This is assessed using quantitative and

qualitative indicators which vary depending on the nature of the portfolio and the information available. The primary quantitative

indicators are the outputs of internal credit risk assessments. For example, for retail exposures, PDs are derived using modelled

scorecards, which use external information such as information from credit reference agencies as well as internal information such

as known instances of arrears or other financial difficulty. While different approaches are used within each portfolio, the intention is

to combine current and historical data relating to the exposure with forward-looking macroeconomic information to determine the

likelihood of default.

The credit risk of each loan is evaluated at each reporting date by calculating the residual lifetime PD of each loan. For retail loans,

the main indicators for a significant increase in credit risk are either of the following:

• the residual lifetime probability of default (PD) exceeds a benchmark determined by reference to the maximum credit risk

that would have been accepted at origination

• the residual lifetime PD has increased by at least 75bps and a multiple of the original lifetime PD (8x for mortgages, 4x for

consumer banking).

These complementary criteria have been reviewed through detailed back-testing, and found to be more effective in capturing events

which would constitute a significant increase in credit risk (as determined by management performance indicators and actual

default experience) than either criterion individually.

For commercial loans, the main indicators for a significant increase in credit risk are either a significant change in the internal credit

rating of a loan as judged by risk management personnel, or transfer of a loan to a watchlist.

In addition, loans will automatically be moved to stage 2 when certain “backstop” events occur. This includes arrears of greater than

30 days past due and the granting of certain concession events such as forbearance, where full repayment of principal and interest

is expected.

Identifying credit impaired loans and the definition of default (stage 3)

The identification of credit impaired loans and the definition of default is another important judgement within the IFRS 9 staging

approach. A loan is credit impaired where it is considered unlikely that the borrower will repay its credit obligations in full, without

recourse to actions such as realising security. Loans will be classified as credit impaired in any of the following circumstances:

• a contractual payment is 90 days past due

• instances of bankruptcy, possession, litigation or the death of borrower

• a concession is granted which is not expected to lead to full repayment of principal and interest (eg interest suppression

for unsecured loans).


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Reduction in credit risk

Loans in stage 2 or 3 can transfer back to stage 1 or 2 once the criteria for significant increase in credit risk or impairment are no

longer met, for example if arrears are cleared and if probability of default also reduces below the relevant quantitative threshold. For

loans subject to concession events such as forbearance, accounts must first be up to date for a period of 12 months before they can

transfer back to stage 1 or 2.

Use of forward looking economic information

Forward looking economic information is incorporated into the measurement of provisions in two ways: as an input to the calculation

of ECL and as a factor in determining the staging of an asset. Expectations of future economic conditions are incorporated through

modelling of multiple economic scenarios (MES).

The use of multiple economic scenarios ensures that the calculation of ECL captures a range of possible outcomes. It addresses the

risk of non-linearity in the relationship between credit losses and economic conditions, with provisions increasing more in

unfavourable conditions (particularly severe conditions) than they reduce in favourable conditions. The IFRS 9 ECL provision reported

in the accounts is therefore the probability-weighted sum of the provisions calculated under a range of economic scenarios.

For the retail and commercial portfolios, Nationwide has adopted the use of three economic scenarios (referred to as the central,

upside and downside scenarios). The scenarios and the weightings are derived using external data and statistical methodologies,

together with management judgement, to determine scenarios which span a wide range of plausible economic conditions. In

addition to the modelled scenarios, allowance has been made at 5 April 2018 for the risks associated with a low probability but

extremely severe economic downturn, since this is also a potentially material cause of non-linearity in credit loss outcomes.

The central scenario represents the most likely economic forecast and is aligned with the central scenario used in Nationwide’s

financial planning processes. The upside and downside economic scenarios are less likely. The table below provides a summary of

the average values of the key UK economic variables used within the central economic scenario over the period from April 2018 to

March 2023.

Central scenario economic variables

Average (%)

GDP 1.7

Unemployment 5.0

HPI 1.8

BoE Base Rate 0.9

The impact of the economic variables varies according to the portfolio. For example, mortgages are most sensitive to house prices

and base rates, whereas consumer banking products are more sensitive to unemployment rates.

Due to the adverse net impact of the less likely scenarios, the ECL increases under MES, as outlined in the table below:

Impact of multiple economic scenarios

Central scenario ECL

£m

ECL

incorporating

MES

£m

Difference

£m

Residential mortgages 143 235 92

Consumer banking 352 365 13

Commercial and other lending 24 29 5

Total 519 629 110

The additional allowance for the credit risks associated with a low probability but extremely severe economic downturn represents

£85 million of the impact of economic scenarios in the table above.


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Performance at maturity of interest only mortgages

The third key area of management judgement and estimation is the allowance for the risk that a proportion of interest only

mortgages will not be redeemed at the contractual maturity date, because a borrower does not have a means of capital repayment

or has been unable to refinance the loan. Buy to let mortgages are typically advanced on an interest only basis. Nationwide does not

offer any new advances for prime residential mortgages on an interest only basis, although there are historical balances which were

originally advanced as interest only mortgages or where a change in terms to an interest only basis was agreed (this option was

withdrawn in 2012). The impact of the adjustment in the central scenario amounts to £58 million, with an additional impact of £16

million arising from multiple economic scenarios (see above).

Interest only loans which are judged to have a significantly increased risk of inability to refinance at maturity are transferred to stage

2.

Expected lives

The final key area of estimation in calculating the ECL is in determination of the expected lives of revolving credit loans. For products

such as mortgages and personal loans, the period over which the Group is exposed to credit risk is the maximum contractual li fe.

However, for revolving credit loans such as credit cards and overdrafts, the Group is exposed to credit risk, including drawn and

undrawn facilities, beyond the typically short contractual notice period, so therefore the full expected behavioural life is taken into

account. Behavioural lives are based on empirical experience of revolving credit portfolios and are in excess of 10 years.

Other considerations in measuring changes in credit risk

Purchased or originated credit impaired (POCI) loans

POCI accounting is required for credit impaired loans purchased from third parties, or where the Group has derecognised an existing

credit impaired loan and then immediately restructured by the recognition of a new loan, where the new loan is also credit impaired.

The accounting treatment applied is to recognise a carrying amount at initial recognition net of the lifetime ECL at that date.

Thereafter, any subsequent change (favourable or unfavourable) in the lifetime ECL is recognised in the income statement. POCI

loans are separately disclosed as credit impaired loans and cannot be transferred out of the POCI designation, even if there is a

significant improvement in credit quality.

Modifications

Nationwide may on occasion modify the contractual terms of loans provided to members and other customers. When this is solely

for commercial reasons and considered part of the ordinary course of business, there is no impact on the impairment approach.

However, modifications can also be indicative of, or precipitate, changes in credit risk.

In some cases, the terms of a loan may be modified so significantly that it is substantially a different financial asset. Where this is

the case, the original loan is derecognised and a new loan is recognised in its place.

In most cases concerning residential mortgages, forbearance does not result in a recognition of a loss on a modified contract as the

revised contractual terms will continue to be interest bearing and will recover interest in full. In certain forbearance cases within

consumer banking some contractual interest may be suspended, however the impact is immaterial and no adjustment has been

made on transition to IFRS 9.

Write-off

Loans remain on the balance sheet net of associated provisions until they are deemed no longer recoverable, when such loans are

written off. Nationwide’s definition, assumptions and timing for write-off of loans have not changed with the adoption of IFRS 9.


15


Credit quality

The table below shows the loan balances and ECL for amortised cost residential mortgages by PD band. The PD distributions shown

are based on IFRS 9 12 month probability of default at the reporting date.

The ECL allocated to the lowest PD bands primarily reflects allocation of the provision for performance at maturity of interest only

mortgages.

Consumer banking stage 3 gross loans and ECL include charged off balances. These are in relation to accounts which are closed to

future transactions and are held on the balance sheet for an extended period (up to 36 months) whilst recovery procedures take

place.

Loan balance and ECL by PD band (Residential mortgages)

Gross loans ECL ECL

coverage

PD range Stage 1 Stage 2 Stage 3 Total Stage 1 Stage 2 Stage 3 Total

£m £m £m £m £m £m £m £m %

0.00 to <0.15%

0.15 to < 0.25%

0.25 to < 0.50%

0.50 to < 0.75%

0.75 to < 2.50%

2.50 to < 10.00%

10.00 to < 100%

100% (default)

147,728 10,781 81 158,590 13 63 - 76 0.05

4,969 1,733 22 6,724 2 14 - 16 0.24

2,317 1,461 38 3,816 1 11 - 12 0.31

1,014 1,205 16 2,235 - 9 - 9 0.43

619 1,719 57 2,395 1 21 - 22 0.90

- 1,332 125 1,457 - 26 1 27 1.82

- 841 166 1,007 - 27 2 29 2.87

- - 890 890 - - 44 44 4.93

Total 156,647 19,072 1,395 177,114 17 171 47 235 0.13

Loan balance and ECL by PD band (Consumer banking)

Gross loans ECL ECL

coverage

PD range Stage 1 Stage 2 Stage 3 Total Stage 1 Stage 2 Stage 3 Total

£m £m £m £m £m £m £m £m %

0.00 to <0.15%

0.15 to < 0.25%

0.25 to < 0.50%

0.50 to < 0.75%

0.75 to < 2.50%

2.50 to < 10.00%

10.00 to < 100%

100% (default)

998 3 - 1,001 1 - - 1 0.15

314 5 - 319 1 - - 1 0.32

465 17 - 482 2 1 - 3 0.58

292 17 - 309 2 1 - 3 0.90

838 116 - 954 9 9 - 18 1.93

347 282 1 630 9 41 - 50 7.86

10 135 5 150 1 51 3 55 36.92

- - 262 262 - - 234 234 89.26

Total 3,264 575 268 4,107 25 103 237 365 8.90


16

Regulatory capital

Capital position and key ratios

The impact of the increase in IFRS 9 impairment provisions on the Common Equity Tier 1 (CET1) ratio at 5 April 2018 is a reduction

of 31 basis points. CET1 capital resources reduce by £67 million primarily due to increased impairment provisions and the impact of

the classification and measurement requirements, which are partly offset by the current excess of regulatory expected losses over

impairment provisions.

With effect from 5 April 2018, Nationwide will apply transitional arrangements, as permitted by EU Regulation (2017/2395), which

allows relief to capital ratios to reduce the impact of IFRS 9 ECLs. This is applied by adding back to CET1 capital resources, on a

reducing basis over the next five years, the impact of IFRS 9 ECLs and then adjusting any related deferred tax assets and Tier 2

provisions.

Following the application of these transitional arrangements, the reduction in the CET1 ratio is 10 basis points. The impact on the

UK leverage ratio is minimal. The implementation of IFRS 9 does not therefore have a significant impact on Nationwide’s capital

position.

Capital structure

4 April 2018 IFRS 9

Full impact

IFRS 9 Transitional

arrangements applied

£m £m £m

Capital resources

Common Equity Tier (CET1) Capital 9,925 9,858 9,915

Total Tier 1 capital 10,917 10,850 10,907

Total regulatory capital 13,936 13,935 13,930

Risk weighted assets (RWAs) 32,509 32,619 32,579

UK leverage exposure 221,992 221,925 221,982

CRR leverage exposure 236,468 236,401 236,458

CRD IV capital ratios % % %

CET1 ratio 30.5 30.2 30.4

UK leverage ratio 4.9 4.9 4.9

CRR leverage ratio 4.6 4.6 4.6

Total Tier 1 ratio 33.6 33.3 33.5

Total regulatory capital ratio 42.9 42.7 42.8

Capital planning

The Group expects IFRS 9 ECL provisions to be more volatile and respond differently in terms of the business cycle (cyclicality and

procyclicality) than IAS 39 provisions. This will impact CET1 capital planning and will be taken into account in the capital strategy.

The impact of IFRS 9 has been included in the latest financial forecast and strategic plan that is approved by the Board. The Group

does not expect the implementation of IFRS 9 to result in any significant changes to strategic plans or Nationwide’s business model.

Capital adequacy

The management of Nationwide’s capital position is built on the foundations of the internal capital adequacy assessment process

(ICAAP) and stress testing framework. These ensure that the capital plan is sufficiently resilient to withstand the impact of severe

financial stress. The ICAAP and 2018 stress testing exercises currently underway have incorporated IFRS 9 ECL impairment

provisions to ensure that the impacts of IFRS 9 are taken into account.


17

Revised accounting policies

The Group’s full statement of accounting policies is disclosed within the 2018 Annual Report and Accounts. The policies for financial

assets and impairment of financial assets have changed from 5 April 2018 following the adoption of IFRS 9, and the revised policies

are set out below.

Financial assets

Financial assets comprise cash, loans and advances to banks, investment securities, derivative financial instruments and loans and

advances to customers.

Recognition and derecognition

All financial assets are recognised initially at fair value. Purchases and sales of financial assets are accounted for at trade date.

Financial assets acquired through a business combination or portfolio acquisition are recognised at fair value at the acquisition date.

Financial assets are derecognised when the rights to receive cash flows have expired or where the assets have been transferred and

substantially all the risks and rewards of ownership have been transferred.

The fair value of a financial instrument on initial recognition is normally the transaction price (plus directly attributable transaction

costs for financial assets which are not subsequently measured at fair value through profit or loss). On initial recognition, it is

presumed that the transaction price is the fair value unless there is observable information available in an active market to the

contrary. Any difference between the fair value at initial recognition and the transaction price is recognised immediately as a gain

or loss in the income statement where the fair value is based on a quoted price in an active market or a valuation using only

observable market data. In all other cases, any gain or loss is deferred and recognised over the life of the transaction, or until valuation

inputs become observable.

Modification of contractual terms

An instrument that is renegotiated is derecognised if the existing agreement is cancelled and a new agreement is made on

substantially different terms (e.g. renegotiations of commercial loans). Residential mortgages reaching the end of a fixed interest

deal period are deemed repricing events, rather than a modification of contractual terms, as the change in interest rate at the end

of the fixed rate period was envisaged in the original mortgage contract.

Classification and measurement

The classification and subsequent measurement of financial assets is based on an assessment of the Group’s business models for

managing the assets and their contractual cash flow characteristics. The Group has classified its financial assets into the following

3 categories:

(a) Amortised cost

Financial assets held to collect contractual cash flows and where contractual terms comprise solely payments of principal and

interest (SPPI) are classified at amortised cost. This category of financial assets includes cash, loans and advances to banks, the

majority of the Group’s residential and commercial mortgage loans, all unsecured lending, and certain investment securities within

a “hold to collect” business model.

Financial assets within this category are recognised on either the receipt of cash or deposit of funds into one of the Group’s bank

accounts (for cash and loans and advances to banks), or when the funds are advanced to customers (for residential, commercial

and unsecured lending). After initial recognition, the assets are measured at amortised cost using the effective interest rate method,

less provisions for expected credit losses.

(b) Fair value through other comprehensive income

Financial assets held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial

assets, and where contractual terms comprise solely payments of principal and interest are classified and measured at fair value

through other comprehensive income (FVOCI). This category of financial assets includes most of the Group’s investment securit ies

which are held to manage liquidity requirements.

Financial assets within this category are recognised on trade date. The assets are measured at fair value using, in the majority of

cases, market prices or, where there is no active market, prices obtained from market participants. In sourcing valuations, the Group

makes use of a consensus pricing service, in line with standard industry practice. In cases where market prices or prices from market

participants are not available, discounted cash flow models are used.


18

Revised accounting policies continued

Interest on FVOCI assets is recognised in the income statement using the effective interest rate method. Unrealised gains and losses

arising from changes in value are recognised in other comprehensive income, except for foreign exchange gains or losses which are

recognised in the income statement and expected credit losses which are recognised in the income statement and accumulated in

the FVOCI reserve. Gains or losses arising on sale are recognised in the income statement, including the transfer of any cumulative

gains or losses, and net of the cumulative expected credit loss charge already recognised.

(c) Fair value through profit or loss

All other financial assets are measured at fair value through profit or loss (FVTPL). Financial assets within this category include

derivative instruments and a small number of residential and commercial loans and investment securities with contractual cash flow

characteristics which do not meet the SPPI criteria. The contractual terms for these cash flows include contingent or leverage

features, or returns based on movements in underlying collateral values such as house prices.

Fair values are based on observable market data, valuations obtained by third parties or, where these are not available, internal

models. All interest income and gains or losses arising from the changes in the fair value of these instruments and on disposal are

recognised in the income statement.

Financial assets which are classified as FVTPL are not eligible for hedge accounting.

Impairment of financial assets

Financial assets within the scope of IFRS 9 expected credit loss (ECL) requirements comprise all financial debt instruments measured

at either amortised cost or FVOCI. These include cash, loans and advances to banks, and the majority of investment securities and

loans and advances to customers. Also within scope are irrevocable undrawn commitments to lend and intra-group lending (the

latter being eliminated on consolidation in the Group accounts).

The ECL represents the present value of cash shortfalls following the default of a financial instrument or undrawn commitment. A

cash shortfall is the difference between the cash flows that are due in accordance with the contractual terms of the instrument and

the cash flows that the Group expects to receive.

The allowance for ECLs is based on an assessment of the probability of default, exposure at default and loss given default, discounted

at the effective interest rate to give a net present value. The estimation of ECLs is unbiased and probability weighted, taking into

account all reasonable and supportable information, including forward looking economic assumptions and a range of possible

outcomes. ECLs are typically calculated from initial recognition of the financial asset for the maximum contractual period that the

Group is exposed to the credit risk. However, for revolving credit loans such as credit cards and overdrafts, the Group’s credit risk is

not limited to the contractual period and therefore the expected life of the loan and associated undrawn commitment is calculated

based on the behavioural life of the loan.

For financial assets recognised in the balance sheet, the allowance for ECLs is offset against gross carrying value so that the amount

presented in the balance sheet is net of impairment provisions. For separable loan commitments where the related financial asset

has not yet been advanced, the provision is presented in provisions for other liabilities and charges on the balance sheet.

Forward looking economic inputs

ECLs are calculated by reference to information on past events, current conditions and forecasts of future economic conditions.

Multiple economic scenarios are incorporated into ECL calculation models. These scenarios are based on external sources where

available and appropriate, and internally generated assumptions in all other cases. To capture any non-linear relationship between

economic assumptions and credit losses, a minimum of three scenarios is used. This includes a central scenario which reflects the

Group’s view of the most likely future economic conditions, together with an upside and downside scenario representing alternative

plausible views of economic conditions, weighted based on management’s view of their probability.


19

Revised accounting policies continued

Stage 1: 12 month expected credit losses

On initial recognition, and for financial assets where there has not been a significant increase in credit risk since the date of advance,

provision is made for losses from credit default events expected to occur within the next 12 months. Expected credit losses for these

stage 1 assets continue to be recognised on this basis unless there is a significant increase in the credit risk of the asset.

Stage 2: significant increase in credit risk

Financial assets are categorised as being within stage 2 where an instrument has experienced a significant increase in credit risk

since initial recognition. For these assets, provision is made for losses from credit default events expected to occur over the lifetime

of the instrument.

Whether a significant increase in credit risk has occurred is ascertained by comparing the risk of default at the reporting date to the

risk of default at origination, and is made based on quantitative and qualitative factors, with a backstop indicator. Quantitative

considerations take into account changes in the residual lifetime PD of the asset. As a backstop, assets with an arrears status of

more than 30 days past due on contractual payments are considered to be in stage 2.

Qualitative factors that may indicate a significant change in credit risk include concession events that still envisage full repayment

of principal and interest, or downgrades to external credit ratings.

Stage 3: credit impaired (or defaulted) loans

Financial assets are transferred into stage 3 when there is objective evidence that an instrument is credit impaired. Provisions for

stage 3 assets are made on the basis of lifetime expected credit losses. Assets are considered credit impaired when:

• contractual payments of either principal or interest are past due by more than 90 days;

• there are other indications that the borrower is unlikely to pay such as signs of financial difficulty, probable bankruptcy,

breaches of contract and concession events which have a detrimental impact on the present value of future cashflows; or

• the loan is otherwise considered to be in default.

Interest income on stage 3 credit-impaired loans is recognised in the income statement on the loan balance net of the ECL provision.

The balance sheet value of stage 3 loans reflects the contractual terms of the assets, and continues to increase over time with the

contractually accrued interest.

Purchased or originated credit impaired (POCI) loans

Where loans are credit impaired on origination, or when purchased from third parties, the carrying amount at initial recognition is

net of the lifetime ECL at that date. Thereafter, any subsequent change (favourable or unfavourable) in the lifetime ECL is recognised

in the income statement. POCI loans are separately disclosed as credit impaired loans and cannot be transferred out of the POCI

designation, even if there is a significant improvement in credit quality.

Transfers between stages

Transfers from stage 1 to 2 occur when there has been a significant increase in credit risk and from stage 2 to 3 when credit

impairment is indicated as described above.

For assets in stage 2 or 3, loans can transfer back to stage 1 or 2 once the criteria for significant increase in credit risk or impairment

are no longer met. For loans subject to concession events such as forbearance, accounts must first be up to date for a period of 12

months before they can transfer back to stage 1 or 2.

Write-off

Loans remain on the balance sheet net of associated provisions until they are deemed no longer recoverable. Where a loan is not

recoverable, it is written off against the related provision for loan impairment once all the necessary procedures have been completed

and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the value of

impairment losses recorded in the income statement.


20

Glossary

This Glossary provides definitions of additional terms relevant to IFRS 9. All other definitions are set out in the Glossary for the Annual

Report and Accounts 2018 available at nationwide.co.uk/about/corporate-information/results-and-accounts

Expected Credit Loss (ECL) The present value of all cash shortfalls over the expected life of the financial instrument.

The term is used for the accounting for impairment provisions under the new IFRS 9

standard.

ECL – 12 Month Cash shortfalls resulting from default events that are possible in the next 12 months

weighted by the probability of that default occurring.

ECL – lifetime Cash shortfalls resulting from default events that are possible over the remaining

expected life of the loan, weighted by the probability of that default occurring.

Fair Value through other

comprehensive income (FVOCI)

Financial assets held at fair value on the balance sheet with changes in fair value

recognized through other comprehensive income.

Fair value through profit or loss

(FVTPL)

Financial assets held at fair value on the balance sheet with changes in fair value being

recognized through the income statement.

Non-linearity Non-linearity in the relationship between ECLs and economic conditions occurs when a

change to an economic assumption or scenario has a greater effect on the level of credit

losses, when compared to an equivalent change in the assumption or scenario in the

opposite direction.

Probability of Default (PD)

An estimate of the probability that a borrower will default on their credit obligations over

a fixed time period. A 12 month ECL uses a 12 month PD, whilst a lifetime ECL uses the

estimated PD over the remaining contractual life of the loan.

Purchased or originated credit

impaired assets (POCI)

POCI loans are credit impaired when initially recognised on the balance sheet, either if

purchased when impaired from a third party, or if recognised as a new loan (eg through

restructuring of an existing credit impaired loan).

Significant increase in credit risk A significant increase in credit risk on a financial asset is judged to have occurred when

an assessment, using quantitative and qualitative factors, identifies at a reporting date

that the credit risk has moved significantly since the asset was originally recognised.

SPPI test An assessment of whether the contractual terms of the financial asset give rise to cash

flows that are in substance solely payments of principal and interest.

Stage 1 Stage 1 assets are assets which have not experienced a significant increase in credit risk

since the asset was originally recognised on the balance sheet. 12 month ECL are

recognised as the impairment provision for all financial assets on initial recognition.

Interest revenue is the EIR on the gross carrying amount.

Stage 2 Stage 2 assets have experienced a significant increase in credit risk since initial

recognition. Lifetime ECL is recognised as an impairment provision. Interest revenue is

the EIR on the gross carrying amount.

Stage 3 Stage 3 assets are identified as in default and considered credit impaired. Lifetime ECL

is also recognised as an impairment provision. Interest revenue is the EIR on the net

carrying amount.

Contacts

Media queries:

Tanya Joseph

Tel: 020 7261 6503

Mobile: 07826 922102

[email protected]

Sara Batchelor

Tel: 01793 657770

Mobile: 07785 344137

[email protected]

Investor queries:

Alex Wall

Tel: 020 7261 6568

Mobile: 07917 093632

[email protected]

mailto:[email protected]

mailto:[email protected]

mailto:alexander.wall@

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