Arbuthnot Regulatory News (ARBB)

17 March 2016

SECURE TRUST BANK PLC

Audited Final Results for the year to 31 December 2015

Growth and diversification drives record profits

Secure Trust Bank PLC ("STB" or "the Company" or "the Bank") today announces continued strong progress during 2015. An increase in customer lending balances of 73% and growth in overall customer numbers of 33% evidence strong ongoing customer demand. Pretax profits, including Everyday Loans Group, of £36.5m are 40% higher than the prior year figure of £26.1m and are a new record high.

The agreed disposal of Everyday Loans Group announced on 4 December 2015 is progressing as planned and is expected to transfer ownership before the end of April 2016, following approval by the Regulatory Authorities. The Board is proposing a special dividend for 2016 of 165p per ordinary share at a total cost of £30m which is contingent on the completion* of the transaction at which time further details will be announced.

 Financial Highlights

· Completion of agreed sale of Everyday Loans Group should generate an estimated £115m post-tax profit to be reported in the H1 2016 profit and loss account

· Proposed special dividend per share of 165p on completion* of Everyday Loans Group sale

· Proposed final dividend per share of 55p to be paid on 6 May 2016 (2014: 52p)

· Statutory profit before tax (including discontinued operations) increased by 40% to £36.5m (2014: £26.1m)

· Operating income (including discontinued operations) increased by 35% to £132.5m (2014: £97.9m)

· Post-tax return on average equity (including discontinued operations) 21.8% (2014: 23.1%)

· Reported earnings per share 157.8p (2014: 122.3)

· Core Equity Tier 1 Capital ratio at year end of 13.6% (2014: 18.7%) increases to 24.1% post Everyday Loans Group sale completion

· Loan to deposit ratio 104% (2014: 102%)**

Operational Highlights

· Customer lending balances increased by 73% to £1,075m

· Customer deposits increased by 70% to £1,033m.

· Customer numbers grew 33% to 570,759

· Impairments have continued to be lower than the level expected at origination

· Strong contribution from consumer lending activities

· In first full year of operation SME division made a material contribution to profits

· Renewal of Customer Service Excellence Award, introduced by the Cabinet Office in 2010 to replace the Kite Mark

· Renewal of Fairbanking Foundation 4 star mark in respect of the current account product

Note: all figures quoted above include discontinued operations.

* Completion includes i) Regulatory approval of the change of control; ii) Transfer of ownership; iii) Recognition of the gain in the regulatory capital base of the Company.

** This excludes the UK Treasury Bills borrowed from the Bank of England under the Funding for Lending Scheme, which have subsequently been pledged as part of a sale and repurchase agreement. If these were included the loan to deposit ratio would be 100% (2014: 100%).

Sir Henry Angest, Chairman, said:

 "The diligent implementation of our strategic plan has produced another year of record profits. The Bank has continued to develop its business model and now serves over half a million consumer and business customers. The agreed sale of the Everyday Loans Group will, once completed, strengthen the company's capital base and position us well for the next stage in our development."

Paul Lynam, Chief Executive Officer, said:

 "2015 was a very successful year for Secure Trust Bank. Our team delivered another record year of profits and we have positioned ourselves strongly for the next phase in our development. It is very pleasing to see customer numbers growing by 33% and our lending balances increase by 73%. Our SME division made a material contribution to profits in its first full year of operation which is very encouraging and further diversifies our offering. Upon completion, the sale of Everyday Loans Group will generate an estimated £115m of post-tax profit which evidences how our highly disciplined approach to M&A activity is conducive to substantial shareholder value creation. Whilst there is likely to be considerable uncertainty ahead of the UK's vote on EU membership, I expect consumer and business confidence to improve after the vote. We are adopting a more cautious stance ahead of the referendum, and only plan to enter the mortgage market in the second half of this year, but we believe that our business model, coupled with significantly increased capital resources, is extremely well positioned to make further positive progress during 2016."

-ENDS-

The 2015 Annual Report and Notice of Meeting will be posted and available on the Secure Trust Bank website http://www.securetrustbank.com/general/results-presentations by 8 April 2016. Copies may also be obtained from the Company Secretary, Secure Trust Bank PLC, One Arleston Way, Solihull, West Midlands, B90 4LH.

Chairman's statement

I am pleased to report that Secure Trust Bank made further progress during 2015. Our commitment to offering outstanding customer service and providing good outcomes for customers via our straightforward transparent banking solutions remains at the forefront of our proposition. Customer satisfaction levels have been consistently high and the appeal of our products and services saw overall customer numbers continuing to expand from 429,507 to 570,759 during 2015, an increase of 33%. 

Our strategy of growing our overall customer lending balances whilst simultaneously expanding into secured SME lending is being successfully implemented. Overall customer lending grew by 73%. As at the year end 53% of the balances are in unsecured consumer lending (2014: 70%) and 44% are in SME lending (2014: 23%). Our long term ambition remains to have a diverse and growing lending portfolio that is balanced across consumer finance, SME finance and residential mortgage assets.

In December 2015 we announced the sale of ELG to Non Standard Finance PLC. Their unsolicited approach at a compelling valuation presented an attractive option to accelerate our strategy of proportionately reducing our exposure to personal unsecured loan products whilst we invest in our strongly growing Motor, Retail and SME lending activities. The Board therefore believes that the disposal is in the interests of the Group and represents an excellent opportunity to realise value for shareholders and for reinvestment into STB's existing profitable consumer and business lending divisions, in line with the Group's stated ambition to shift, over time, the majority of the Group's balance sheet lending into secured lending assets.

Our management philosophy of exercising prudence in respect of capital, funding and lending remains unchanged. The Bank remains well capitalised and liquidity and interest basis risks continue to be mitigated by our strategy to broadly match lending and deposits of the same tenor and term. The Bank's funding and capital positions will be significantly strengthened upon the completion of the sale of ELG. There are significant organic and external business development opportunities. As ever, we will exercise discipline and caution when considering any potential acquisitions.

I am confident that the Group will continue to demonstrate sustainable growth over the coming period. The Board proposes to pay a final dividend of 55 pence per share. This, when added to the interim dividend of 17 pence would mean a full year dividend of 72 pence per share. If approved, the final dividend will be paid on 6 May 2016 to shareholders on the register as at 8 April 2016.

The sale of the ELG, when completed, will result in significant profit and cash being generated for the benefit of the Group. We estimate the transaction will give rise to a post-tax profit of circa £115 million. Given this sizeable gain, the Board intends to propose a special interim dividend of £30 million following completion of the sale. The timing of any such interim dividend will depend on when the sale completes and receipt of the sale proceeds by the Company. Completion includes regulatory approval of the change of control, transfer of ownership and inclusion of the gain within the Company's capital reserves. The Board would, in the normal course, also review the financial position and prospects of the Company further before formally declaring any such special dividend. However, the Board believes that, following payment of the special dividend, the Company would retain sufficient capital resources to support its ongoing growth.

Finally my Board and I would like to thank all of our employees for their commitment and hard work during 2015. At the end of 2015, Carol Sergeant retired as a Non-Executive Director having made an important contribution to the development of the Bank. I would like to express my gratitude to Carol and to my fellow directors for their support during the year.

Chief Executive's statement

2015 has been another year of progress across the Secure Trust Bank Group. We have proactively managed the shape of the group and the composition of the asset portfolio finishing the year, as intended, with a good balance between consumer and SME lending assets. Notwithstanding the ongoing investment in the new SME division, the growth and strong performance of the lending book has driven record levels of profits and underlying earnings. The combination of these profits and the significant one off gain arising upon completion of the ELG divestment will provide a strong capital base and the continuing ability to pay progressive dividends. In addition, as noted in the Chairman's statement the Board intends to propose a one-off special dividend of £30 million following completion of the ELG disposal.

Customer base increasing against background of high satisfaction levels

We are serving a record number of customers across our savings, motor finance, retail point of sale finance, unsecured personal lending, asset finance, invoice finance and real estate finance markets. Across the Group the total customer base grew by 33% during 2015 to 570,759.

We remain committed to delivering consistently good outcomes for our existing and future customers and specifically design our products to be as easy as possible for customers to understand and appropriate for their needs. From a conduct and behaviour perspective we do not cross subsidise losses on some products with super profits on others. Nor do we discriminate between customers by, for example, offering lower deposit rates to existing loyal customers than to new ones. We believe this is the appropriate way to interact with our customers for the long term benefit of all parties.

We continue to measure customer satisfaction in a number of ways, including being the only bank that uses FEEFO (Feedback Forum). This rich data reflects how our customers actually experience us and given its importance this remains the first thing we discuss at our weekly management meeting. I am pleased to note that we have consistently achieved customer satisfaction ratings in excess of 90% across all of our products during the year.

For the fourth year running we received confirmation that the Fairbanking Foundation had renewed our 4 star mark in respect of our current account product. We remain the only bank in the UK to hold the Customer Service Excellence award (CSE) which was reaffirmed in 2015. This award was introduced by the Cabinet Office in 2010 to replace the Kite Mark. The CSE is a strong independent endorsement of the way customer focus is embedded in the culture of the business and the improvements we continue to make to our products and services.

We are pleased with these external accolades and the high customer satisfaction scores but are in no way complacent. We remain highly focused on improving our existing service and products and introducing new ones via the targeted investment in people, systems and processes.

Controlling growth

The Board's top strategic priority is, as ever, to safeguard the reputation and sustainability of STB through prudent balance sheet management, investment for growth and robust risk and operational controls. The regulatory environment has continued to evolve in 2015 and we have proactively responded by investing further in our 'Three Lines of Defence' business model. Our Credit Risk, Operational Risk and Internal Audit capabilities continue to be enhanced. Our consumer facing businesses are all now regulated by the Financial Conduct Authority (FCA) reflecting the transfer of regulation from the Office of Fair Trading to the FCA.

All aspects of risk are monitored closely with particular attention paid to the performance of our lending book. Our impairment levels have remained below the level which we had assumed within our pricing models when originating the business. We continue to adopt a robust and dynamic formulaic approach to impairment provisioning. Where appropriate, the Group has looked to support customers who are in financial difficulty and we seek to engage in early communication with borrowers experiencing difficulty in meeting their repayments.

Regulatory environment

Notwithstanding regular calls for greater competition from media, consumer groups and politicians, tangible progress to create a more proportionate approach to the regulation of non-systemic banks in 2015 has been limited. The overall tone especially from Government and the Prudential Regulation Authority (PRA) / Bank of England is encouraging. I hope to see words and actions becoming more aligned in the coming period and I appreciate the work that has commenced in this regard.

Despite the Competition and Markets Authority (CMA) clearly acknowledging some of the root causes of the ineffective competition in UK Banking, their provisional findings and possible remedies were largely superficial in nature. Notwithstanding the initial disappointment, I have drawn confidence from the significant and sustained pressure the Treasury Select Committee (TSC) has put on the CMA to reconsider their initial findings. I believe that in response to this, in January 2016 the CMA announced that it was extending its review into Retail Banking competition. In February 2016 it was widely reported that the National Audit Office (NAO) had added to this pressure via a report they issued which referred to the CMA investigation into banking and stated 'the ability of the CMA to present a credible market analysis and formulate effective remedies, if appropriate, will have a significant effect on its reputation'. The timescales for the next CMA report are unclear but we are tracking developments very closely.

Secure Trust Bank and the British Bankers Association have continued to campaign throughout 2015 for a level competitive playing field. It is clear that key stakeholders now better understand the barriers to growth faced by small and challenger banks. In late 2015 the Bank of England published a paper making the case to the EU for a more proportionate approach to bank regulation. This was echoed in February by Andrea Enria, chairman of the European Banking Authority (EBA) who said, "I acknowledge the framework is fiendishly complicated, especially for banks with very simple business models. Regulators have a duty to ask if simpler ways can be found to achieve the same outcomes… the complexity of regulation should match the complexity of business models". As noted above the TSC continues to promote the competition agenda and in the final quarter of 2015 the Chancellor announced that he had formed a Challenger Bank High Level Advisory Group comprising senior HM Treasury officials and the CEOs of the challenger banks. This group will aim to work with HM Treasury to bring about the changes needed to create a more level playing field which will enable more effective competition across the broader market.

We will continue to closely monitor the operating and regulatory environment and adapt our business model to mitigate risk and maximise opportunities going forward. I remain confident that the regulatory environment will further evolve and a more proportionate approach will be applied to smaller banks. This will help us to make greater progress with our strategic plans and offer more of our existing and new products to a larger number of consumer and SME customers.

Prudent funding profile

Our funding strategy is unchanged. We seek to limit exposure to short term wholesale funding and interbank markets and to broadly match fixed term fixed rate customer lending with customer deposits of the same tenor and interest rate basis. This helps us to minimise maturity transformation and interest rate basis risk. During 2015 our lending activities were again funded primarily by customer deposits with only very modest use made of the Funding for Lending scheme. Our year end loan to deposit ratio was 104% (2014: 102%). To achieve a broadly matched asset to liability position we increased the average tenor of our deposits over the year with fixed term deposits rising to 57% of total deposits. This compares to 54% as at 31 December 2014. Our overall cost of funds have benefitted from market forces which have enabled us to replace maturing term deposits with new deposits of the same tenor but at lower fixed rates.

At the time of writing the outlook for interest rates suggests they will remain low for an extended period. I do not anticipate negative interest rates in the UK. Whilst such a move would not directly impact on STB, given our funding structure, lower or negative base rates would be very injurious to the largest banks and the small building societies. Overall I envisage funding conditions remaining benign for the foreseeable future.

Robust capital ratios and modest leverage

Our year end Common Equity Tier 1 (CET1) Capital levels remain healthy and reflect the successful deployment of capital raised in the second half of 2014. On a solo-consolidated basis the CET1 ratio of 13.6% compares with the 2014 year end position of 18.7%.

As at 31 December 2015 STB's leverage ratio was 10.4% (excluding the expected capital gain from the ELG disposal), which reduced over the year as the capital raised in H2 2014 was invested in the strong growth in customer loan balances. This ratio is comfortably ahead of minimum requirements.

The estimated impact of the ELG transaction is to increase the CET1 ratio to 24% and the leverage ratio to 18% (as at 31 December 2015).This serves to highlight the scope we have to increase our lending activities whilst remaining modestly leveraged.

Profit levels and return on equity building

Including discontinued operations, the Group's operating income grew by 35% to a record level of £132.5m (2014: £97.9m) whilst operating costs, which continue to be robustly managed, rose 27% to £71.7m from £56.5m in 2014, with the cost: income ratio of 51.3% (2014: 51.4%) remaining stable notwithstanding the very significant investment in the new SME division. Loan impairments of £24.3m (2014: £15.3m) rose by 59% which compares to the 73% growth in customer lending balances to £1,074.9m (2014: £622.5m). The level of impairments remains below the levels expected when the loans were originated.

Pre-tax profits, including ELG, for 2015 of £36.5m are 40% higher than the prior year of £26.1m. The underlying profit for 2015 of £39.3m represents an 18% increase on the £33.3m underlying profit before tax in 2014.

In order to support the creation of the SME division additional capital of £50m was raised in H2 2014 and as a result STB entered 2015 with very significant capital surpluses. The mathematical impact of this is to dampen returns on equity whilst this surplus equity is deployed. As expected, as 2015 progressed the return on equity improved albeit the overall return for the full year is 21.8% (2014: 23.1%).

Customer lending activities grew as planned

Once again, strong double digit growth was achieved across the group's loan portfolio in 2015. Total new business lending volumes grew 67% to £903.2m (2014: £540.9m) which translated to an increase of 73% in overall balance sheet lending assets to £1,074.9m (2014: £622.5m).

Our strategy was to focus growth in our consumer finance lending in Retail Finance and Motor Finance with a more tempered approach to unsecured personal loans. Reflecting this, the Retail Finance point of sale business, net of provisions, grew strongly as intended, with balances at 31 December 2015 increasing 89% to £220.4m (2014: £116.7m). Our Retail Finance business has evolved as our balance sheet has strengthened. In addition to a very strong position in the cycle and music sectors, we have been able to pitch for, and win, larger retailer relationships across the leisure and home furnishing sectors. As a result we are writing a broader spectrum of business including increased levels of interest bearing lending. This lending has higher levels of impairments compared with interest free finance and this is factored into our pricing to ensure we achieve our targeted risk adjusted return.

Motor Finance lending balances, net of provisions, grew 20% to £165.7m at 31 December 2015 (2014: £137.9m). This business, which focuses on the near prime market segment, continues to service the majority of the Top 100 UK car dealer groups and enjoys extremely strong relationships with a number of specialist motor intermediaries. We have written greater volumes of prime lending during 2015. The early indications are that this is attractive business so we will be increasing our activities at this end of the market.

Personal unsecured lending balances, net of provisions, increased by 4% to £188.6m at 31 December 2015 (2014: £181.4m). We have previously highlighted our unease at the competitive dynamics in the highly prime end of the personal unsecured loan market and had tempered our appetite as a result. During H2 2015 the Financial Policy Committee at the Bank of England began expressing their concerns. I do not find this surprising noting some of the larger lenders are now offering prime five year unsecured personal loans at rates which are lower than a typical standard variable rate mortgage. Our focus going forward will remain on returns rather than dramatic personal unsecured loan book growth.

The Group's SME lending operations have also grown as planned. Real Estate Finance increased by 175% to £368.0m at 31 December 2015 (2014: £133.8m). This lending is split roughly equally between residential development funding and residential investment finance. STB has a very limited appetite for commercial property lending as we recognise the difficulties lending to this sector has caused to some banks in the past. Our experience in the residential development space thus far is that the properties being developed are selling faster and for higher prices than anticipated when we made the original loans. This is obviously a positive feature albeit it does mean that loans are being repaid sooner than scheduled. 2015 saw significant fiscal changes in the buy to let (BTL) property market with changes to tax relief on interest payments made by individuals / couples and the introduction of a 3% stamp duty surcharge on BTL properties for landlords with 15 or fewer units. It is unclear how these changes will affect the housing market in the near term. The range of possibilities include; 1) smaller amateur landlords flooding the market with properties for sale, 2) rents being increased to mitigate the financial impact of the changes, 3) individuals and couples moving portfolios into incorporated structures, 4) professional landlords and corporates unaffected by these changes buying up stock put on the market by amateurs, 5) a mix of all these possibilities. Our residential investment lending is not regulated mortgage lending and is not targeted at amateur landlords; as such the professionals and corporates we lend to could benefit from these taxation changes. In the short term while we wait for the impacts of the BTL changes on the housing market to become clearer and given the potential uncertainties arising from the EU referendum we have tempered our lending to residential property developers, especially in Central London. We remain confident about the medium term prospects of this sector given fundamental supply and demand dynamics.

In its first full year of operation, Secure Trust Bank Commercial Finance, the invoice finance division of the Bank, funded over £220m of customers' invoices. Customer lending balances, net of provisions grew 486% to £29.3m at 31 December 2015 (2014: £5.0m). Our customer proposition is relationship focused which means this division will take time to achieve critical mass as we are being very selective with the clients being accepted in the early stages of this business.

The Asset Finance strategic partnership with Haydock Finance has proven to be very successful thus far, with clear benefits to both parties. Haydock are a long established and very well regarded asset finance company operating across the UK. They provide a full business process outsourcing service to STB. This is governed by a detailed operating agreement which includes auditing and oversight arrangements. All of the lending written fully conforms to STB's credit policies and risk appetite and is assessed by STB staff based in Haydock's premises. Customer lending balances, net of provisions grew 1,471% to £70.7m at 31 December 2015 (2014: £4.5m).

Disposal of Everyday Loans Group

In December 2015 we announced the proposed sale of ELG to Non Standard Finance PLC (NSF) following an unsolicited approach for a total consideration and debt repayment of £235 million. We did not set out to sell ELG and all things being equal would be very happy to continue owning and developing the business. However the nature of the acquirer and the agreed consideration is such that the transaction should work well for ELG staff whilst allowing accelerated development of other parts of the STB Group. The NSF executive is extremely experienced in the non-prime segment of the unsecured personal loan market and has very impressive track records at their previous businesses. They are focused on a growth agenda and will be looking to serve a wider range of customers via a broader range of products than the STB risk appetite would allow. There is no question that there is a huge non-standard market that requires the important services and access to credit that ELG provides. Under NSF's ownership I expect ELG to grow considerably, which I would hope will benefit ELG staff and NSF shareholders, which will include STB, alike.

The decision to sell ELG demonstrates the Board's willingness to make and execute decisions which we believe are in the best longer term interests of shareholders. As stated previously we estimate the post-tax profit on the sale of ELG will be in the region of £115 million and this will be recognised in 2016. Subject to the transaction completing as expected the Board have decided to retain the majority of this one off profit to support the strategic priorities detailed below whilst also proposing a special dividend payment of £30 million. While in the short term the sale is expected to reduce earnings, given the disposal of ELG's profit streams, we are confident that the proceeds can be reinvested to accelerate the Group's growth prospects and secure new income streams.

Fee based accounts

Current account customer numbers further declined during 2015 reflecting the reduced focus on this product whilst we concentrated our investment in more profitable areas. Consistent with trends seen in 2014 customer satisfaction levels remained high but achieving significant growth in customer numbers has been difficult, in part because the operational costs arising from accessing the payments infrastructure make the product appear to be uncompetitive compared with 'free if in credit' current accounts from other banks. In December 2015 the High Street banks, under pressure from HM Government, launched basic bank account propositions to open up access to banking to underserved communities. We are monitoring the impact of these developments on our current account proposition which remains an immaterial part of our business model.

As expected, the OneBill customer numbers continue to decline over time, following its closure to new accounts in 2009, with £6.5m of income generated in 2015 compared with £7.1m in 2014.

Debt Managers

The markets for debt collection agencies remained difficult during 2015. Many lenders reported improving impairments trends as fewer customers defaulted. Debt purchasers have therefore been less active which has impacted on the volume of business they have placed with debt collectors. Given these dynamics Debt Managers did not trade profitably in 2015 and incurred a modest loss before tax of £0.5m. This is a market which is undergoing structural changes heavily influenced by the transition of regulatory oversight from the OFT to the FCA. Debt Managers has now received full FCA authorisation and we believe it is one of the first debt collection agencies to be authorised. Given the relatively benign outlook for the UK economy, barring a shock, we anticipate that market conditions will remain tough and have adapted the Debt Managers business to reflect the subdued market.

Our people

I am delighted that following another in-depth review and external assessment of the Group, we have retained the Customer Service Excellence standard. This Government standard of excellence for customer service benchmarks us against other high-performing organisations. I am very proud of the feedback received about our teams' professionalism, honesty and positivity about working at the Bank, as well as our ethics towards customers. These demonstrate the investments that we have made in creating the right culture and following a clear set of company values.

It is also rewarding to receive various new awards including Best Savings Provider from Savings Champion. They provide independent and unbiased information on the UK savings market.

Our charitable activities have meant we have raised in excess of £50,000 over a 2 year period for Birmingham Children's Hospital, through a number of organised events, including an annual flagship cycling event. Our team has also been involved in ward decorating during the Christmas period. I again applaud my colleagues for both their charitable work and sheer commitment to delivering great service in a very friendly manner to our customers throughout the year.

Our ongoing overall growth continues to support job security and create career progression opportunities for our team. This is reflected in full time equivalent employee numbers rising to 773 during the year (2014: 625).

Strategic priorities

Secure Trust Bank PLC undertook its IPO in November 2011 to provide access to the capital it required to support a clear growth strategy focused on three strategic priorities: (i) organic growth, (ii) diversification and (iii) M&A activity. In the four years since, the Bank has diligently executed its strategy as reflected in the growth in customer numbers of 309% (2011: 139,693, 2015: 570,759), growth in customer lending balances of 690% (2011: £136m, 2015: £1,075m), creation of a new SME division, acquisitions of V12 Retail Finance, Debt Managers and the acquisition, investment in and subsequent sale of ELG. Statutory profits before tax have increased 400% from £7.3m in 2011 to £36.5m in 2015.

Evaluating the effectiveness of this strategy, I note that at the time of the IPO the Bank had shareholders' equity of circa £19.6m. The IPO raised £10m of additional capital and shareholders subsequently invested a further £71.5m of capital (circa £19m in December 2012, £49m in June 2014 and £3.5m in November 2014). At the year-end shareholders' equity stood at £141.2m. Following the completion of the sale of ELG, and prior to the impact of any final and special dividends payable during 2016, shareholders' equity will increase to circa £226m. In simple terms assuming completion of the ELG sale, in the period from IPO to date, the Company has been able to use the circa £101m of equity brought forward, plus that invested by shareholders, to create additional equity of £163m. This is represented in the increased shareholders' equity of £125m and dividends paid since IPO of £37.8m.

Looking ahead we see plenty of opportunities to progress this three pronged growth strategy whilst proactively adapting the business model to reflect market conditions. However in the short term there is likely to be considerable uncertainty ahead of the UK's vote on EU membership. STB operates only in the UK and has no direct exposure to the EU economy. The UK economy is services led and the majority of this is internally generated. We have no way of knowing the outcome of the referendum so it is prudent to proceed with caution whilst clarity on this very important issue emerges. STB enters this uncertain period with very significant capital reserves, a short duration loan book and a broadly matched funding profile that minimises liquidity risks. We believe we are very well placed to navigate any uncertainty that may arise from the referendum and are constantly monitoring developments.

Our working assumption is that matters will settle down quite quickly after the referendum because that will be in the best interests of all concerned. This will allow us to continue to progress our strategy with certainty. We will continue to prioritise the growth of our Retail Point of Sale and Motor propositions in the Consumer Finance sector whilst tempering our appetite for unsecured personal loans. As stated above this is an area we feel is showing signs of overheating with some lenders now offering unsecured loans at cheaper margins than some secured mortgage lending. That does not feel sustainable to us. We believe we have a very strong proposition in Retail Finance and see considerable scope to further increase the number of retailers we work with. During 2015 we wrote a limited volume of prime Motor Finance business in order to assess the attractiveness of this sector of the market. The initial indications are positive. We intend to write higher volumes of prime Motor Finance going forward. As most of the prime dealers commit to financing partnerships in Q4 each year, whilst we will write more prime Motor Finance in 2016, there will not be a step change in volumes until 2017, assuming the market dynamics remain broadly stable.

The diversification into SME lending has proved successful thus far. As at 31 December 2015 SME customer lending balances stood at £468.0m representing 44% of the total lending book. In their first full year of operation Real Estate Finance and Asset Finance traded well and in aggregate provided a material profit contribution. Invoice Finance, as expected, incurred losses as it scales and builds up critical mass. We expect Invoice Finance to turn profitable this summer.

We see plenty of opportunity to expand our SME activities further in the coming years. Demand for asset finance to fund business investment and demand for invoice finance to help fund working capital cycles is strong. This is likely to remain the case given the ongoing growth of the UK economy. In Real Estate Finance, the residential investment assets have performed well reflecting strong demand for rental properties. Our lending here is not regulated mortgages and we do not expect to be directly impacted by the BTL taxation changes announced in 2015. On the residential development side, those units being built which are nearing completion have been selling faster and for higher prices than anticipated when the loans were granted. The Government has reiterated its commitment to doubling the rate of house building in the UK. Mortgage finance is readily available and with the economy continuing to grow and interest rates remaining low, consumers are able to obtain and service mortgages. These are clearly positive dynamics. However, in the short term whilst we wait for the impacts of the BTL changes on the housing market to become clearer and given the potential uncertainties arising from the UK EU referendum we have tempered our residential development lending appetite.

Our longer term ambition remains to grow a broad based portfolio, balanced across consumer finance, SME finance and residential mortgage lending. During 2015 we have recruited a number of key personnel to develop our mortgage proposition. We will not be competing in the mass market low LTV low margin products dominated by the High Street banks. Instead our focus will be on specialist lending where we expect to compete against other challenger banks that are generating attractive returns from their mortgage lending. As we develop our proposition here we are mindful of the Basel Committee proposals in respect of standardised capital methodologies and the recent BTL taxation and stamp duty changes. We anticipate entering the mortgage market in the second half of 2016 and will provide a further update in due course.

We see a constant flow of M&A opportunities and give serious consideration to a number of these. Given the significant capital surpluses at our disposal we have an appetite to potentially acquire businesses that would enhance the growth of our consumer and SME lending activities. Shareholders know that we will continue to exercise discipline, caution and prudence when assessing M&A opportunities and remain extremely focused on ensuring such activity is in the long term interests of shareholders, staff and customers.

Current trading and outlook

There has been no material change to the underlying performance of the business in the early months of 2016. We continue to see potential to grow our lending portfolio in line with our ambition and have a clear growth strategy and a pipeline of organic and external new business opportunities.

I am optimistic that the increasingly vocal support for a more proportionate approach to regulation from a wide range of parties including the Treasury Select Committee, the Competition and Markets Authority, The Bank of England and latterly the European Banking Authority, will result in tangible changes to make it possible for smaller banks to compete more effectively with the dominant incumbents across a broader range of products. I am continuing to lobby extensively for the creation of a truly level competitive playing field as I firmly believe it is in best interests of UK consumers and SMEs to have a much greater choice and less concentration in the UK banking market.

As ever STB will seek to maximise the value of any opportunities that may arise. Whilst the pace of the UK economic recovery has slowed the economy continues to expand. Low inflation and a strong jobs market are sustaining high levels of consumer confidence, which should benefit our Motor and Retail Finance businesses. The UK continues to have a chronic shortage of housing and notwithstanding the short term uncertainties arising from taxation changes in the BTL market; fundamental supply and demand factors will further drive the need for an increase in the UK's housing stock. We expect consumer and business confidence and demand for credit from businesses to moderate ahead of the EU referendum before recovering thereafter. So whilst we are adopting a more cautious stance ahead of the referendum, we believe that our business model, coupled with significantly increased capital resources, is extremely well positioned to make further positive progress during 2016.

Strategic report Business review

This section of the Report and Accounts contains the Strategic Report required by the Companies Act 2006 to be prepared by the directors of the Bank. It describes the component parts of the Group's business; the principal risks and uncertainties; the development and performance of the business during the financial year; and the position of the business at the end of the year.

Financial and other key performance indicators are used where appropriate. Reference is made to and additional explanations provided about amounts that are included in the Group's Accounts.

Business finance Real Estate Finance

Revenue and lending performance vs prior years

2015 performance

The Real Estate Finance business continued to show significant growth during 2015, increasing its book by 175% to £368m which led to an eightfold increase in revenue in the year. This reflected the strong pipeline of business brought in from 2014, coupled with the impact of increasing our complement of experienced Real Estate professionals and broadening the geographical profile beyond the South East. The business continues to focus primarily on residential property, with the book being evenly split between investment and development deals. Credit Performance has also been encouraging, with no losses arising so far. In addition, we have also seen a number of residential development deals written in 2014 reaching a successful conclusion and being repaid ahead of expectations.

Looking forward

The current book provides a base for further growth in revenues in 2016, and the business retains a strong appetite for well-structured transactions, but without stretching its agreed risk positions. Market conditions are kept under close scrutiny to ensure we can respond quickly to any changes that may occur.

Business finance Asset Finance

Revenue and lending performance vs prior years

2015 performance

The Asset Finance business has been in place for the whole of 2015, compared to just one month in 2014. Overall gross new lending was £72.8m in 2015, exceeding the target set for the business for the year. The overall yield from this new business was in line with target, contributing to the revenue growing to £2.4m in the year. Credit performance has been encouraging with no losses recorded to date.

Looking forward

The focus will remain in building the book in partnership with Haydock Finance, whilst maintaining excellent service levels and credit quality. We will continue to investigate products that complement the current profile, provided they are within our risk appetite and meet return requirements.

Business finance Commercial Finance

Revenue and lending performance vs prior years

2015 performance

The end of 2015 sees the first full 12 month trading period for the Commercial Finance business and we are already in the top 20 providers of Asset Based Lending facilities in the UK, with facilities agreed in excess of £55m. This progress has been underpinned by a growing reputation for flexibility but above all else, for having a customer centric approach. We have handpicked a team of twenty people and whilst the Head Office is domiciled in Manchester we have both origination and client servicing capability across the UK. Credit performance has been encouraging with no losses recorded to date.

Looking forward

It has been a key strategic objective to foster strong relationships with the professional community and specifically those involved in the Private Equity market. This has enabled us to build the portfolio with a range of tailored lending solutions which are genuinely solution led. New technology will increasingly allow us to enhance the client experience and at the same time ensure that we have a fully compliant process.

Consumer finance Personal Lending

Revenue and lending performance vs prior years

2015 performance

The Group's lending operations continued to grow in a controlled way, with new personal lending volumes in the year, including Everyday Loans, increasing to £135.9 million from £127.7 million in the previous year, an increase of 6%. This generated an increase in personal lending balances during the year, which at the year end, including Everyday Loans, totalled £188.6 million (December 2014: £181.4 million).

The growth in Group personal lending new business volumes has again not been at the expense of price or quality. Income from personal lending increased by 5% to £57.9 million whilst impairment losses were £12.3 million compared to £9.9 million in 2014.

In November 2015, the Group agreed to the conditional sale of ELG to Non Standard Finance Plc for an expected post tax profit of approximately £115 million.

At the year end, lending balances in the continuing operation under the Moneyway brand were £74.3 million (2014: £87.5 million) and income during the year increased by 14% to £17.2 million. Impairment losses were £4.8 million compared to £3.3 million in 2014.

The levels of credit impairments on all portfolios have been below the levels priced for when the loans were originated. The credit risks in the lending book are continually scrutinised with this data being used to inform changes in risk appetites and pricing.

Looking forward

Following the conditional sale of ELG, the Group will continue to provide personal loans under its Moneyway brand through its existing network of experienced UK based advisors.

Consumer finance Motor Finance

Lending performance v prior years

2015 performance

New business volumes for motor lending increased from £71.4 million to £85.7m, an increase of 20% year on year. This generated a significant increase in lending assets during the year. Income has increased by 22% to £33.3 million.

2015 growth has been achieved through a combined focus on widening the lending parameters and criteria of our product as well as restructuring our offer to create a wholly transparent product for consumers based around fixed rates and the removal of all fees with the exception of a £10.00 option to purchase fee at the end of the agreement. This approach supported our growth and contributed to Moneyway receiving the prestigious awards in the industry for subprime lender of the year (Motor Finance Awards) and Treating Customers Fairly (F and I Awards).

Moneyway has also continued to establish strong relationships with all our customers whilst promoting our brand. 2015 saw an increase in the sales headcount from 7 to11 with a wider geographical coverage than ever before.

Impairment losses for the year increased from £3.9 million to £7.3 million. This reflects the continued growth and maturity of the loan book, and refinement of the provisioning methodology, as the Bank moves closer to IFRS 9 implementation.

Looking Forward

Into 2016 Moneyway will complete the launch of the prime product across all our introducer channels to complement our non-prime products providing introducers with a true "one stop shop" solution and a product for every customer. Operational processes will continue to evolve by introducing enhanced technology to provide a prime service across the entire risk curve.

Our "one stop shop approach" will create a true point of difference in the market as we will operate across a wider reach of the risk curve. This will enable us to offer a product for every customer and our intermediaries a first string solution that we could not offer before. This strategy is designed to enable us to widen our reach of supporting dealers and intermediaries and will be our primary strategy towards achieving further growth.

One stop shop will continue to be supported by exceptional operational service using technology to enable us to offer a prime service across the entire risk curve within which we operate.

Consumer finance Retail Finance

Revenue and lending performance vs prior years

2015 performance

The three largest sub-markets for retail finance are the provision of finance for the purchase of sports and leisure equipment (including cycles), furniture and consumer electronics. Cycle finance has seen positive new business levels influenced by the success of British cyclists in the Tour de France, the Olympics and Paralympics.

The Retail Finance business has continued to grow strongly, with new lending volumes increasing to £293.9 million (an increase of 90% on the previous year). Each of the core business sectors (sports and leisure, furniture and consumer electronics) have contributed towards this growth which has been achieved through a combination of gaining increased market share and sector growth (as seen in the cycle market). This growth has generated a significant increase in lending assets during the year, which at the year end totalled £220.4 million (December 2015: £116.7 million).

Income from retail lending increased by 78% to £24.2 million. Impairment losses were well controlled at £5.2 million in 2015.

Looking forward

The Group plans continued growth in Retail Finance during 2016 with the focus on acquiring increased market share within its existing target markets. A number of initiatives are underway to further enhance systems capabilities to ensure that quality of service to both retailers and customers is maintained as the business continues to expand. To further support the maintenance of service levels the business intends to continue the expansion of its workforce whilst investing in additional office and support facilities.

Savings

Savings balances vs prior years

2015 performance

The Bank's customer deposits primarily comprise notice deposits, term deposits and fee-based accounts, being fee-based current accounts and OneBill accounts. At 31 December 2015 customer deposits totalled £1,033 million. This represents an increase of £425 million since the last year end.

The Bank's notice deposits totalled £405 million at the year end (December 2014: £239 million). New 120 day notice accounts were introduced during the year and were successful, raising additional new deposits of £95 million predominantly during the second half of the year.

During the year, the Bank launched further fixed rate deposit bonds, with one to seven year maturities which enable it to match broadly the new lending activities. These again were very successful as the Group raised new deposits of over £333 million, achieving its desired funding maturity profile. At the year end term deposit bond balances totalled £589 million.

Strategic report Financial review

Income analysis

Operating income increased by 35% to £132.5 million. Growth was achieved through increased levels of activity in all lending sectors. At £903 million, new lending volumes increased in total by £362 million representing an increase of 67% on 2014. New lending volumes in Real Estate Finance, Asset Finance and Commercial Finance increased by £230 million and, Personal Lending, Motor Finance and Retail Finance businesses increased in total by £162 million, representing increases of 164% and 46% respectively on 2014.

Real Estate Finance income increased by 712% to £20.3 million during the year with Asset Finance and Commercial Finance businesses generating income of £2.4 million and £1.6 million respectively in their first full year of trading. Income from Retail Finance under the V12 brand increased by 78% to £24.2m, through maintaining a strong position in existing retail markets whilst establishing new relationships in the home furnishing and leisure sectors. Motor Finance income increased by 22% to £33.3 million as the Bank increased its activities in prime lending. The Bank intends to create further diversified and balanced growth in its lending portfolios during 2016.

Income from the current account with a prepaid card declined in 2015 following the Bank's decision to close the product to new accounts during 2015. The decline in income from the OneBill product following its closure to new accounts in 2009 continued as expected.

Impairment losses during the year were £24.3 million (2014: £15.3 million). This increase is broadly in line with overall growth in consumer lending balances and is also partly driven by a refinement in provisioning methodology as the Bank moves closer to IFRS9 implementation in the Motor and Personal Lending portfolios.

Operating expenses have increased, in line with expectations, as significant investments have been made in the infrastructure and human capital of the Group to achieve our growth targets within the Group's risk appetite. This investment will continue to generate further returns in the future.

Underlying profit before tax was £39.3 million, which is an increase of 18% on 2014. Underlying profit removes the effects from the income statement of acquisition costs, fair value amortisation arising from acquisitions, share option scheme costs and net ABG management recharges.

Taxation

The effective underlying tax rate is 21.1% (2014: 21.5%), which is broadly in line with the weighted average corporate tax rate during the year. The prior year's tax rate reflected the effects of acquisition adjustments relating to deferred tax. The Bank's effective tax rate will increase in 2016 as a result of the new Bank Corporation tax surcharge of 8%, which is effective from 1 January 2016.

Distributions to shareholders

The directors recommend the payment of a final dividend of 55 pence per share which, together with the interim dividend of 17 pence per share paid on 18 September 2015, represents a total dividend for the year of 72 pence per share (2014: 68 pence per share).

The Board is also proposing to pay a special dividend of 165 pence per share for 2016. The dividend is dependent on the completion of the sale of ELG, which includes regulatory approval of the change of control, transferral of ownership and the inclusion of the gain within the Company's capital resources. Following completion, the Board would also review the financial position and prospects of the Company further before declaring any such special dividend.

Earnings per share

Detailed disclosures of earnings per ordinary share are shown in Note 11 to the financial statements. Basic earnings per share increased by 29% to 157.8 pence per share (2014: 122.3p), whilst the underlying basic earnings per share increased by 9% to 170.4 pence per share (2014: 155.8p per share).

The total assets of the Group increased by 59% to £1,247.4 million reflecting the continued growth in both Business and Consumer lending. Real Estate Finance lending balances increased by 175% to £368.0 million at the year-end after just 2 years of lending. Asset Finance lending balances increased from £4.5 million to £70.7 million and Commercial Finance from £5.0 million to £29.3 million in their first full year. During the year the Retail Finance business increased lending balances by 89% to close at £220.4 million, as the Group continues to profit from the synergistic benefits of aligning its Retail Finance businesses under the V12 brand. Motor Finance increased its portfolio size by 20% to £165.7 million through continued growth in the number of dealer relationships and through developing its prime lending offering. Everyday Lending Group personal lending balances increased by 22% during the year prior to its divestment (subject to FCA approval) from the group.

Customer deposits grew by 70% during the year to close at £1,033.1 million, to fund the increased lending balances. The Group also held £35.0 million of wholesale deposits at the year-end, following the sale and repurchase of FLS Treasury Bills.

Funding for Lending Scheme

In 2013 the Bank was admitted to the Funding for Lending Scheme (FLS). The FLS is a scheme launched by the Bank of England and HM Treasury, designed initially to incentivise banks and building societies to boost their lending to UK households and SME's. The FLS does this by facilitating funding to banks and building societies for an extended period, at below current market rates, with both the price and quantity of funding provided linked to the institution's performance in lending to the SME sector.

Strategic report Principal risks and uncertainties

The monitoring and control of risks is a fundamental part of the management process. The Board considers that the principal risks inherent in the Group's business are credit, market, liquidity, operational, capital, conduct and regulatory risks. A description of the risk management policies in these areas is set out in Note 5 to the financial statements.

A short description of the principal risks, the ways in which the Group's management seek to manage these risks and some examples of developments that took place in 2015 are set out below.

Risk appetite

The risk appetite statements below have been approved by the Board:

Profitability

We are profit and growth oriented whilst seeking to maintain a conservative and controlled risk profile. The Bank manages credit risk through a pricing for risk model which drives a potential return on equity in excess of 20% on aggregate.

Financial Strength

Our financial strength is safeguarded by a strong capital base and a prudent approach to liquidity management. Capital levels will not fall below the Individual Capital Guidance ("ICG") requirements.

Liquidity is maintained at a level above the Overall Liquidity Adequacy Requirement (see 'Liquidity risk' below) with all loans funded typically by retail deposits.

Conduct with Customers & Reputation

As a result of the way we conduct our business we seek to avoid negative outcomes by consistently treating our customers fairly.

We are straightforward and fair with our customers and seek to achieve excellent customer service standards. Our aim is to be seen as a sound and professional business in the marketplace. We have no appetite for reputational risk arising from the way in which we or our partners behave.

We seek to remain compliant with all relevant regulatory requirements.

Business Processes and Our People

Our appetite for operational risk is to have well defined, scalable and controlled processes, running on robust and resilient systems, effective delivery of change and business continuity management.

We do not tolerate operational losses above our pillar 1 capital requirement.

Risk appetite measures

The Board Risk Committee uses a set of measures to assess the Group's position against its risk appetite. These measures are also cascaded to individual business units for monitoring and reporting purposes. The key measures are set out in the relevant sections below.

Credit risk

Credit risk is the risk that a counterparty will be unable to pay amounts in full, when due. Counterparties include the consumers to whom the Group lends unsecured and the small and medium sized enterprises to whom the Group lends secured as well as the market counterparties with whom the Group deals.

This risk is managed through the Group's internal controls and credit risk policies. The risk is monitored by the Credit Risk Committee, with oversight provided by the Board Risk Committee. Larger exposures are also approved by the Arbuthnot Banking Group Risk Committee.

For STB, credit risk arises principally from its lending activities. Details of exposures, concentration risk, allowances for impairment and arrears are given in Notes 5, 13 and 14. At the year-end, 94% of loans and advances to customers by value were neither past due nor impaired, compared with 89% at 31 December 2014.

Credit risk also arises in respect of the Group's loans and advances to banks, and counterparty risk is monitored using the ratings of the respective counterparties. Further details are given in Notes 5 and 12.

Across the different product markets in which the Group operates, credit risk management oversee the application of the Group's risk related policies and consider the impact of market changes and business opportunities. At the end of the financial year the Group was within risk appetite across a range of measures covering bad debt rates, concentration risk and automated credit decisioning.

Key developments during 2015 in the credit risk management of the consumer and commercial business areas of the Group are described below.

Consumer credit risk

In 2015, the Group commissioned a market leading risk consultancy to review its near prime Motor Finance credit risk management. This work will result in more appropriate risk based pricing.

The Group has also developed its methodology for its unsecured personal loan businesses. These changes are expected to deliver more accurate credit risk assessment and improved risk based pricing, whilst maintaining credit quality.

Retail Finance has seen considerable growth from both existing retailers and new additions to the retail panel. The addition of new retailers, coupled with significant growth from existing introducers and buoyant consumer confidence resulted in significant year on year growth. This growth has been managed through the existing scorecard and rule set without compromising credit quality. The performance of all the consumer portfolios continue to be monitored closely through monthly Credit Committee governance meetings which review scorecard and rule performance and new application quality and delinquency trends.

Commercial credit risk

The growth in lending to the SME sector has been built around strong risk management practices. The Group has employed experienced bankers who have operated through both positive and challenging economic cycles, and have brought their experience to bear alongside the application of robust risk governance, credit appetite and lending policies.

For Real Estate Finance and Commercial Finance, lending decisions are made on an individual transaction basis, using expert judgement and assessment against criteria set out in the lending policies. Asset Finance lending is outsourced to Haydock Finance, who operate in line with the Group's credit policies and risk appetite. Secure Trust Bank employees based in Haydock's premises assess this lending for compliance with policy. A programme to develop probability of default (PD) modelling for each of the SME businesses commenced in 2015 and is expected to be delivered in the second half of 2016. These models will be IFRS 9 compliant.

With the SME businesses in the early stage of their growth, impairments and arrears have been minimal to date. Of particular note is the positive performance of the Real Estate Finance book, where property developments financed have seen repayments achieved both ahead of time and above expected valuations, in part assisted by the positive housing market throughout 2015. Management continue to closely monitor the SME portfolios and the external events and environment that could impact on each of them.

Future development - implementation of IFRS 9

The new accounting standard governing the impairment of financial assets, IFRS 9, is effective for annual reporting periods beginning on or after 1 January 2018. The standard fundamentally changes the calculation and recognition of credit losses, by introducing the requirement to base impairment provisions on expected credit losses over the life of the financial asset. It also requires credit losses to be recognised for all loans, in contrast to the current standard (IAS 39) which requires recognition of losses only when there is evidence of impairment. The models used to calculate expected credit losses need to include forward looking factors including macro-economic variables.

The key differences between the two approaches are:

The Group has initiated a project to develop and implement the modelling, data, processes, systems and disclosures required to comply with IFRS 9. The Group intends to run the provision modelling and accounting processes over the course of 2017 to assess the impact of the standard.

Market risk

Market risk is the risk that the value of, or revenue generated from, the Group's assets and liabilities is impacted as a result of market movements. For Secure Trust Bank Group this is primarily limited to interest rate risk.

This is managed by the STB treasury function and overseen by the Board Assets and Liabilities Committee (ALCO). The policy is not to take significant unmatched own account positions in any market. The key measure used to monitor the risk is the Interest Rate Risk Sensitivity Gap, information about which is provided in Note 5. The Group was within its appetite for this risk at the year-end.

The principal currency in which the Bank operates is Sterling, although a small number of transactions are completed in US Dollars and Euro in the Commercial Finance business. All such currency exposures are fully hedged using short term swaps of no more than 30 days in length, which ensures that the Group and the Bank have no exposures to currency fluctuations.

Liquidity risk

Liquidity risk is the risk that the Group cannot meet its liabilities as they fall due, due to insufficient liquid assets.

The Group takes a conservative approach to managing its liquidity profile, by closely monitoring and remaining within risk appetite limits, and holding high quality liquid assets; primarily UK Treasury Bills and the Bank of England Reserve Account. The Group is primarily funded by retail customer deposits, having limited exposure to the wholesale lending markets. ALCO oversees liquidity risk and monitors the activities of management in managing liquidity risk. ALCO meets monthly to review liquidity risk against set thresholds and risk indicators including early warning indicators, liquidity risk tolerance levels and Individual Liquidity Adequacy Assessment Process (ILAAP) metrics as described below.

The primary measures used by management to assess the adequacy of liquidity are the Overall Liquidity Adequacy Requirement (OLAR), which is the Board's own view of the Group's liquidity needs as set out in the ILAAP, and the regulatory requirement to meet the Liquidity Coverage Ratio (LCR). The Group has maintained liquidity in excess of the OLAR throughout 2015.

The LCR regime has applied to the Group from 1 October 2015, requiring management of net 30 day cash outflows as a proportion of high quality liquid assets. STB has set a more prudent internal limit. The actual LCR has significantly exceeded both limits throughout the year.

ALCO also uses the funding to loan ratio to assess liquidity adequacy, against a minimum target. The ratio exceeded this minimum target throughout the year.

Operational risk

Operational risk is the risk that the Group may be exposed to financial losses from inadequate or failed internal processes, people and systems or from external events.

The Group has a defined set of Operational Risk Appetite measures covering such matters as operational losses, IT resilience, information security, complaints and more generally the level of operational risks the Group is prepared to accept. These appetite measures are cascaded to individual business units which monitor and track their level of risks within their local governance forums.

In 2015, the Group invested in resource, expertise and systems to support the development of its operational risk capabilities. A formal Operational Risk Management System is being introduced along with an enhanced Operational Risk Framework covering all the key principles for the sound management of Operational Risk as defined by the Basel Committee.

Key areas of focus in 2015 have been:

· Developing and clearly defining the governance structure and procedures over how key business decisions are made and operational risks are managed, controlled and escalated within the business;

· Developing our systems and controls over the management of our third party suppliers and how the services they support are maintained, secured and improved;

· Enhancing our IT systems so that they are resilient in order to continue to provide the service expectations of our customers;

· Developing our Business Continuity Plans so that they are robust and responsive to a range of potential internal and external issues the Group could face;

· Managing change effectively and ensuring any new developments meet the high standards set for our customers and the services we provide.

In 2016 we will continue to monitor the effectiveness of our controls and respond to new and emerging threats to the business.

Cyber risk

There is an increased risk that the Group is subject to cyber risk within its operational processes. This is the risk that the businesses within the Group are subject to some form of disruption arising from an interruption to its IT and data infrastructure. The Group continues to improve its defences against cyber risk through the use of enhanced monitoring and response tools and procedures.

Capital risk is the risk that the Group will have insufficient capital resources to support the business.

The Group adopts a conservative approach to managing its capital and at least annually assesses the robustness of the capital requirements as part of the Group's Individual Capital Adequacy Process (ICAAP), which is then aggregated into the Arbuthnot Banking Group's ICAAP. Stringent stress tests are performed to ensure that capital resources are adequate over a future three year horizon.

At the year-end, the Common Equity Tier 1 (CET1) Ratio was 13.6% (2014: 18.7%) and the Leverage Ratio was 10.4% (2014: 14.7%) on a solo-consolidated basis. Both ratios are significantly higher than regulatory requirements. The decreases in the ratios are driven by the growth in assets, and therefore total risk exposure, over the year. The solo-consolidated capital resources increased slightly to £138.9m at 31 December 2015 (31 December 2014: £123.4m).

The conditional sale of ELG is expected to significantly increase the Group's capital ratios, providing a very strong capital base and enabling further growth of lending portfolios. In assessing the Group's future capital position, management is mindful of the Basel Committee proposals relating to standardised risk weighting and is watching developments closely. Further details of the Group's capital position are provided in the capital, leverage and liquidity section of the Strategic Report.

Conduct risk

Conduct risk reflects the potential for customers (and the business) to suffer financial loss or other detriment through the actions and decisions made by the business and its staff.

We define conduct risk as the risk that STB's products / services, and the way they are delivered, result in poor outcomes for customers or markets in which we operate, or harm to STB. This could be as a direct result of poor or inappropriate execution of our business activities or behaviour from our staff.

The Group takes a principles based approach and includes retail and commercial customers in its definition of 'customer', which covers all business units and both regulated and unregulated activities.

In 2015, management embedded a Conduct Risk Management Framework in the business. This is a set of activities establishing the governance and oversight protocols, providing training and awareness on the Conduct Risk Policy, and enhancing and developing relevant key risk indicators (KRIs). Conduct risk exposure is managed via monthly review and challenge of KRIs at the Customer Focus Committee, which was set up to oversee complaints, FEEFO and Customer Service Excellence (CSE) as well as conduct risk. Conduct risk management information is also reviewed at Executive Committee meetings at product level, at STB ExCo and STB Board. The KRIs vary across the business units to reflect the relevant conduct risks. The business units' KRIs are aggregated for measurement against the Group's risk appetite.

Senior Managers Regime

A new regime, to enhance the accountability of individuals operating in banks, insurers and PRA-authorised investment firms, was implemented in the Financial Services (Banking Reform) Act 2013 and commenced from 7 March 2016. This regime was proposed in the Parliamentary Commission on Banking Standards Report (June 2013) and replaced the Approved Persons regime.

The new requirements introduce conduct rules which apply to all bank employees and additional rules for senior management. A specific Senior Manager Regime applies to the Bank's Board members and certain executive and senior managers, requiring these individuals to have regulatory approval, specific prescribed responsibilities and ongoing assessment by the Bank to ensure these persons remain "fit and proper". A further Certification Regime applies to other employees who pose a "risk of significant harm" to the firm, requiring the fit and proper test to be applied before the individual commences the role and then on an ongoing basis.

The Bank has embraced the new regime and made the changes required to comply. Senior Manager functions have been mapped across, responsibilities allocated and job descriptions amended where required. Training has been delivered across the Bank and an annual certification framework put in place. Changes to governance arrangements that have resulted from the change in regime are set out in the Corporate Governance statement. Secure Trust Bank submitted its application for the "grandfathering application" on 2 February 2016, setting out responsibilities for existing Approved Persons who migrated to their equivalent Senior Management Functions on 7 March 2016.

Regulatory Risk

Regulatory risk is the risk that the Group fails to be compliant with all relevant regulatory requirements. This could occur if the Group failed to interpret, implement and embed processes and systems to address regulatory requirements, emerging risks, key focus areas and initiatives or deal properly with new laws and regulations.

The Group seeks to manage regulatory risks through the following elements of the Group wide risk management framework:

· Governance and control processes for new products and services;

· Advice and guidance on the application and interpretation of laws and regulations applicable to the Group's products, new initiatives and projects;

· Investment in the infrastructure and ongoing enhancement of the regulatory training programme.

Additional training has been delivered for key focus areas in 2015 including:

· Vulnerable customers and complaints handling;

· Horizon scanning to identify regulatory developments which are managed through impact assessment and implementation programmes;

· Liaison with regulatory bodies regarding authorisations and permissions;

· Information requests and reporting requirements;

· Consumer Rights Act implementation;

· Risk based monitoring and assurance programmes to ensure the Group remains compliant with regulatory requirements.

Strategic report Capital, leverage and liquidity

Capital

The Group's capital management policy is focused on optimising shareholder value over the long-term. Processes exist to ensure that capital is allocated to achieve targeted risk adjusted returns whilst ensuring appropriate surpluses are held above the minimum regulatory requirements. The Board reviews the capital position at every Board meeting.

In accordance with the EU's Capital Requirements Directive (CRD) and the required parameters set out in the EU's Capital Requirements Regulation (CRR), the Group's Internal Capital Adequacy Assessment Process (ICAAP), which is aggregated into the Arbuthnot Banking Group's ICAAP, is embedded in the risk management framework of the Group. It is subject to ongoing updates and revisions where necessary, but as a minimum an annual review is undertaken as part of the business planning process. The ICAAP brings together the risk management framework, including stress testing using a range of scenarios, and the financial disciplines of business planning and capital management.

Not all material risks can be mitigated by capital, but where capital is appropriate the Board has adopted a 'Pillar I plus' approach to determine the level of capital the Group needs to hold. This method takes the Pillar I capital formula calculations as a starting point, and then considers whether each of the calculations delivers a sufficient capital sum adequate to cover anticipated risks. Where it is considered that the Pillar I calculations do not reflect the risk, an additional capital add-on in Pillar 2 is applied, as per the Individual Capital Guidance (ICG) issued to the Bank by the PRA.

The Group's regulatory capital is divided into:

· Common Equity Tier 1 which comprises shareholders' funds, after deducting intangible assets and deferred tax assets which have arisen due to losses.

· Tier 2 which comprises the collective allowance for impairment.

The ICAAP includes a summary of the capital required to mitigate the identified risks in its regulated entities and the amount of capital that the Group has available. All regulated entities within the Group have complied during the financial year with all of the externally imposed capital requirements to which they are subject.

The Group operates the standardised approach to credit risk, whereby risk weightings are applied to the Group's on and off balance sheet exposures. The weightings applied are those stipulated in the CRR.

The Group is required by the PRA to report its capital on a solo consolidated basis. The solo-consolidated group includes all entities where a solo consolidation waiver has been received from the PRA; this excludes the V12 Finance Group and the Debt Managers Group. At the year end the solo-consolidated group had the following capital resources and Total Risk Exposure (TRE). In accordance with CRR, the TRE reflects both credit risks and operational risks.

The increase in CET1 capital has been driven by retained profit marginally offset by an increase in intangibles. An analysis of CET1 capital can be found in Note 6 to the financial statements.

Total Risk Exposure has increased by 54% to £998.6 million reflecting the significant growth in both Business Finance and Consumer Lending.

The CET1 capital ratio is the ratio of CET1 divided by the TRE and was 13.6% at the year end. This compares to 18.7% at the end of 2014 again reflecting the growth in lending resulting in an increase in TRE during 2015. The conditional sale of ELG is expected to increase the CET1 capital ratio and provide additional capital for future planned growth.

Leverage

The Basel III framework introduced a relatively simple, transparent, non-risk based leverage ratio to act as a supplementary measure to the risk-based capital requirements. The leverage ratio is intended to restrict the build-up of leverage in the banking sector to avoid destabilising deleveraging processes that can damage the broader financial system and the economy, whilst reinforcing the risk-based requirements with a complementary simple, non-risk based 'backstop' measure.

The Basel III leverage ratio is defined by the CRR as Tier 1 capital divided by on and off sheet asset exposure values, expressed as a percentage. The minimum leverage ratio requirement of 4% will be imposed on the Bank from 2018, subject to a review in 2017.

As shown in the table above, the Bank has a leverage ratio at 31 December 2015 of 10.4%, comfortably ahead of the minimum requirement.

Liquidity

The Group continues to manage its liquidity on a conservative basis by holding high quality liquid assets (HQLA) and utilising predominantly retail funding from customer deposits, with only limited funding coming from the wholesale markets. In December 2012, Secure Trust Bank was admitted as a participant in the Bank of England's Sterling Money Market Operations under the Sterling Monetary Framework, to participate in the Discount Window Facility. From July 2013, the Group was permitted to draw down facilities under the Funding for Lending Scheme (FLS). FLS monies are maintained as a liquidity buffer, above that required to support lending.

At 31 December 2015 and throughout the year, the Group had significant surplus liquidity over the minimum requirements due to its stock of HQLA, in the form of the Bank of England Reserve Account and Bank of England Treasury Bills. As shown in the table below, total liquid assets increased by 20% to £147.1 million, with the HQLA balance of £135.6m representing a proportional increase from 67% to 92% of total liquid assets.

The Group has no liquid asset exposures outside of the United Kingdom and no amounts that are either past due or impaired.

The Liquidity Coverage Ratio (LCR), introduced by the Basel Committee on Banking Supervision in 2013, applied to the Group from 1 October 2015. The objective of the LCR is to promote the short term resilience of the liquidity risk profile of banks, by ensuring that they have an adequate stock of unencumbered high-quality liquid assets that can be converted easily and immediately in private markets into cash to meet their liquidity needs for a 30 calendar day liquidity stress scenario.

The PRA completed its consultation on the minimum LCR requirements to apply in the United Kingdom in 2015, and set levels marginally higher than those prescribed in the CRR during the transition period. The PRA have set the minimum at 80% from 1 October 2015, 90% from 1 January 2017 and 100% from 1 January 2018, coming into line with the CRR at this point.

The Group's LCR, and other measures used by management to manage liquidity risk, are described in the Principal Risks and Uncertainties section of the Strategic Report.

Consolidated statement of comprehensive income

Consolidated statement of financial position

Company statement of financial position

Consolidated statement of changes in equity

Company statement of changes in equity

Consolidated statement of cash flows

Company statement of cash flows

Notes to the consolidated financial statements

1. Accounting policies

The principal accounting policies applied in the preparation of these consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated.

1.1 Reporting entity

Secure Trust Bank PLC is a company incorporated in the United Kingdom (referred to as 'the Company'). The registered address of the Company is One Arleston Way, Solihull, West Midlands, B90 4LH. The consolidated financial statements of the Company as at and for the year ended 31 December 2015 comprise Secure Trust Bank PLC and its subsidiaries (together referred to as 'the Group' and individually as 'subsidiaries'). The Group is primarily involved in banking and financial services.

1.2 Basis of presentation

The Group's consolidated financial statements and the Company's financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs as adopted or early adopted by the Group and endorsed by the EU) and the Companies Act 2006 applicable to companies reporting under IFRS. They have been prepared under the historical cost convention, as modified by the revaluation of land and buildings and financial instruments at fair value through profit or loss. The consolidated financial statements are presented in pounds sterling, which is the Group's functional and presentational currency.

The preparation of financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Group's accounting policies. The areas involving a higher degree of judgement or complexity or areas where assumptions and estimates are significant to the consolidated financial statements are disclosed in Note 2.

The directors have assessed, in the light of current and anticipated economic conditions, the Group's ability to continue as a going concern. The directors confirm they are satisfied that the Company and the Group have adequate resources to continue in business for the foreseeable future. For this reason, they continue to adopt the 'going concern' basis for preparing accounts.

The consolidated financial statements were authorised for issue by the Board of Directors on 16 March 2016.

The following International Financial Reporting Standards have been issued which are not yet effective and which have not been adopted early:

· IFRS 9 'Financial instruments' (effective for annual periods beginning after 1 January 2018). This is the IASB's replacement of IAS 39 'Financial Instruments: Recognition and Measurement'. Phase one of this standard deals with the classification and measurement of financial assets and represents a significant change from the existing requirements in IAS 39. The standard contains three primary measurement categories for financial assets: 'amortised cost', 'fair value through other comprehensive income' and 'fair value through profit or loss' and eliminates the existing categories of 'held to maturity', 'available for sale' and 'loans and receivables'. Phase two of the standard covers impairment, with a new expected loss impairment model that will require expected credit losses to be accounted for from when financial instruments are first recognised and lowers the threshold for the recognition of full lifetime expected losses. Phase three covers general hedge accounting and introduces a substantially reformed model for hedge accounting with enhanced disclosure about risk management activity. The new model aligns the accounting treatment with risk management activities. The expected impact of this standard on the Group is set out in Principal risks and uncertainties.

· IFRS 15 'Revenue from contracts with customers' (effective for annual periods beginning after 1 January 2018). This standard replaces a number of existing standards and interpretations and applies to contracts with customers, but does not apply to insurance contracts, financial instruments or lease contracts, which are in the scope of other IFRSs. It also does not apply if two companies in the same line of business exchange non-monetary assets to facilitate sales to other parties. The standard specifies how and when an IFRS reporter will recognise revenue as well as requiring such entities to provide users of financial statements with more informative relevant disclosures. It introduces a new revenue recognition model that recognises revenue either at a point in time or over time. The model features a principles-based five-step model to be applied to all contracts with customers. This standard is unlikely to have a material impact on the Group.

· IFRS 16, 'Leases' (effective from 1 January 2019). The standard sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract i.e. the customer ('lessee') and the supplier ('lessor'). IFRS 16 replaces the previous leases standard, IAS 17 Leases, and related interpretations. IFRS 16 eliminates the classification of leases as either operating leases or finance leases for a lessee. Instead all leases are treated in a similar way to finance leases applying IAS 17. Leases are 'capitalised' by recognising the present value of the lease payments and showing them either as lease assets (right-of-use assets) or together with property, plant and equipment. If lease payments are made over time, a company also recognises a financial liability representing its obligation to make future lease payments. The most significant effect of the new requirements in IFRS 16 will be an increase in lease assets and financial liabilities. Accordingly, for companies with material off balance sheet leases, there will be a change to key financial metrics derived from the company's assets and liabilities (for example, leverage ratios).

The above standards have not yet been endorsed by the EU.

1.3 Consolidation

Subsidiaries

Subsidiaries are all investees controlled by the Group. The Group controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Subsidiaries are fully consolidated from the date on which control is transferred to the Group.

The acquisition method of accounting is used to account for the acquisition of subsidiaries by the Group. The cost of an acquisition is measured as the fair value of the assets given, equity instruments issued and liabilities incurred or assumed at the date of exchange plus costs directly attributable to the acquisition. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any non-controlling interest. The excess of the cost of acquisition over the fair value of the Group's share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference is recognised directly in the Statement of Comprehensive Income.

The parent company's investments in subsidiaries are recorded at cost less, where appropriate, provision for impairment in value.

Inter-company transactions, balances and unrealised gains and losses on transactions between Group companies are eliminated. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group.

Non-current assets held for sale and discontinued operations

Subsidiaries are de-consolidated from the date that control ceases. Under IFRS5, the Group classifies a non-current asset as held-for-sale if its carrying amount will be recovered mainly through selling the asset rather than through usage. The classification also applies to disposal groups, which are a group of assets and liabilities which an entity intends to dispose of in a single transaction.

The conditions for a non-current asset or disposal group to be classified as held-for-sale are as follows:

· the assets must be available for immediate sale in their present condition and its sale must be highly probable;

· the asset must be currently marketed actively at a price that is reasonable in relation to its current fair value;

· the sale should be completed, or expected to be so, within a year from the date of the classification; and

· the actions required to complete the planned sale will have been made, and it is unlikely that the plan will be significantly changed or withdrawn.

1.4 Interest income and expense

Interest income and expense are recognised in the Statement of Comprehensive Income for all instruments measured at amortised cost and held to maturity using the effective interest method.

The effective interest method calculates the amortised cost of a financial asset or a financial liability and allocates the interest income or interest expense over the relevant period. The effective interest rate is the rate that discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Group takes into account all contractual terms of the financial instrument but does not consider future credit losses. The calculation includes all fees paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts.

Once a financial asset or a group of similar financial assets has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.

1.5 Net fee and commission income

Fees and commissions which are not considered integral to the effective interest rate are generally recognised on an accruals basis when the service has been provided. Fees and commissions income consists principally of weekly and monthly fees from the OneBill and Current Account products, arrears fees in the Everyday Loans business along with associated insurance commissions and commissions earned on debt collection activities in the Debt Managers business. Fee and commission expenses consist primarily of fees and commission relating to the Current Account product.

1.6 Financial assets and financial liabilities

The Group classifies its financial assets at fair value through profit or loss, loans and receivables or held-to-maturity and classifies its financial liabilities as other financial liabilities. Management determines the classification of its investments at initial recognition. A financial asset or financial liability is measured initially at fair value plus, for an item not at fair value through profit or loss, transaction costs that are directly attributable to its acquisition or issue.

(a) Financial assets at fair value through profit or loss

This category comprises derivative financial instruments which are utilised by the Group for hedging purposes. Financial assets at fair value through profit or loss are initially recognised on the date from which the Group becomes a party to the contractual provisions of the instrument. Subsequent measurement of financial assets held in this category are carried at fair value through profit or loss.

(b) Loans and receivables

Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable. Loans are recognised when the funds are advanced to customers. Loans and receivables are carried at amortised cost using the effective interest method (see below).

(c) Held-to-maturity

Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group's management has the positive intention and ability to hold to maturity. Held-to-maturity investments are carried at amortised cost using the effective interest method.

(d) Other financial liabilities

Other financial liabilities are non-derivative financial liabilities with fixed or determinable payments. Other financial liabilities are recognised when cash is received from the depositors. Other financial liabilities are carried at amortised cost using the effective interest method. The fair value of other liabilities repayable on demand is assumed to be the amount payable on demand at the Statement of Financial Position date.

Derecognition

Financial assets are derecognised when the rights to receive cash flows from the financial assets have expired or where the Group has transferred substantially all of the risks and rewards of ownership. In transactions in which the Group neither retains nor transfers substantially all the risks and rewards of ownership of a financial asset and it retains control over the asset, the Group continues to recognise the asset to the extent of its continuing involvement, determined by the extent to which it is exposed to changes in the value of the transferred asset. There have not been any instances where assets have only been partially derecognised. The Group derecognises a financial liability when its contractual obligations are discharged, cancelled or expire.

Amortised cost measurement

The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition, minus principal payments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initial amount recognised and the maturity amount, minus any reduction for impairment.

Fair value measurement

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value of assets and liabilities traded in active markets are based on current bid and offer prices respectively. If the market for a financial instrument is not active the Group establishes a fair value by using an appropriate valuation technique. These include the use of recent arm's length transactions, reference to other instruments that are substantially the same for which market observable prices exist, net present value and discounted cash flow analysis.

1.7 Foreign currencies

Transactions in foreign currencies are initially recorded at the rates of exchange prevailing on the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are retranslated into the Company's functional currency at the rates prevailing on the balance sheet date. Exchange differences arising on the settlement of monetary items, and on the retranslation of monetary items, are included in the profit and loss account for the period.

1.8 Derivative financial instruments and hedge accounting

For the Group, these comprise cash flow hedges. These are recognised at their fair value and are shown in the Statement of Financial Position as assets when their face value is positive and as liabilities when their face value is negative.

Cash flow hedges are used to hedge against fluctuations in future cash flows from interest rate movements on variable rate customer deposits. On initial purchase the derivative is valued at fair value and then the effective portion of the change in the fair value of the hedging instrument is recognised in equity (cash flow hedging reserve) until the gain or loss on the hedged items is realised, when it is amortised; the ineffective portion of the hedging instrument is recognised immediately in profit or loss.

On initial designation of the hedge, the Group formally documents the relationship between the hedging instruments and the hedged items, including the risk management objective and strategy in undertaking the hedge, together with the method that will be used to assess the effectiveness of the hedging relationship. The Group makes an assessment, both at the inception of the hedge relationship as well as on an ongoing basis, as to whether the hedging instruments are expected to be highly effective in offsetting the changes in the fair value or cash flows of the respective hedged items during the period for which the hedge is designated, and whether the actual results of each hedge are within a range of 80-125%. The Group makes an assessment for a cash flow hedge of a forecast transaction, as to whether the forecast transaction is highly probable to occur and presents an exposure to variations in cash flows that could ultimately affect profit or loss.

If a hedging derivative expires or is sold, terminated, or exchanged, or the hedge no longer meets the criteria for cash flow hedge accounting, or the hedge designation is revoked, then hedge accounting is discontinued prospectively. In a discontinued hedge of a forecast transaction the cumulative amount recognised in other comprehensive income from the period when the hedge was effective is reclassified from equity to profit or loss as a reclassification adjustment when the forecast transaction occurs and affects profit or loss. If the forecast transaction is no longer expected to occur, then the balance in other comprehensive income is reclassified immediately to profit or loss as a reclassification adjustment.

1.9 Offsetting financial instruments

Financial assets and liabilities are offset and the net amount reported in the Statement of Financial Position when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.

1.10 Impairment of financial assets

Assets carried at amortised cost

On an ongoing basis the Group assesses whether there is objective evidence that a financial asset or group of financial assets is impaired. Objective evidence is the occurrence of a loss event, after the initial recognition of the asset, that impacts on the estimated future cash flows of the financial asset or group of financial assets, and can be reliably estimated.

The criteria that the Group uses to determine that there is objective evidence of an impairment loss include, but are not limited to, the following:

· Delinquency in contractual payments of principal or interest;

· Breach of financial covenants or contractual obligations;

· Cash flow difficulties experienced by the borrower; and

· Initiation of bankruptcy proceedings.

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 discounted at the financial asset's original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the Statement of Comprehensive Income. If a loan or held-to-maturity investment has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract.

The Group considers evidence of impairment for loans and advances at both a specific asset and collective level. All individually significant loans and advances are assessed for specific impairment. Those found not to be specifically impaired are then collectively assessed for any impairment that has been incurred but not yet identified. In assessing collective impairment the Group uses historical trends of the probability of default, emergence period, the timing of recoveries and the amount of loss incurred, adjusted for management's judgement as to whether current economic and credit conditions are such that the actual losses are likely to be significantly different to historic trends.

When a loan is uncollectible, it is written off against the related provision for loan impairment. Such loans are written off after 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 amount of the provision for loan impairment in the Statement of Comprehensive Income.

A customer's account may be modified to assist customers who are in or have recently overcome financial difficulties and have demonstrated both the ability and willingness to meet the current or modified loan contractual payments. Loans that have renegotiated or deferred terms, resulting in a substantial modification to the cash flows, are no longer considered to be past due but are treated as new loans recognised at fair value, provided the customers comply with the renegotiated or deferred terms.

1.11 Intangible assets

(a) Goodwill

Goodwill represents the excess of the cost of the acquisition over the fair value of the Group's share of the net identifiable assets acquired at the date of acquisition. Goodwill is held at cost less accumulated impairment losses and is deemed to have an infinite life.

The Group reviews the goodwill for impairment at least annually or when events or changes in economic circumstances indicate that impairment may have taken place. Impairment losses are recognised in the Statement of Comprehensive Income if the carrying amount exceeds the recoverable amounts.

(b) Computer software

Acquired computer software licences are capitalised on the basis of the costs incurred to acquire and bring to use the specific software. These costs are amortised on the basis of the expected useful lives, which are between three to ten years.

Costs associated with developing or maintaining computer software programs are recognised as an expense as incurred unless it is probable that the expenditure will enable the asset to generate future economic benefits in excess of its originally assessed standard of performance.

(c) Other intangibles

The acquisition of subsidiaries is accounted for in accordance with IFRS 3 'Business Combinations', which requires the recognition of the identifiable assets acquired and liabilities assumed at their acquisition date fair values. As part of this process, it is necessary to recognise certain intangible assets which are separately identifiable and which are not included on the acquiree's balance sheet.

Other intangible assets include trademarks, customer relationships, broker relationships and technology. The intangible assets recognised as part of the Everyday Loans and V12 Finance Group acquisitions have been recorded at fair value and are being amortised over their expected useful lives, which are between five and ten years, apart from Everyday Loans broker relationships, which are being amortised over three years. The intangible asset relating to Everyday Loans has been reclassified as an asset held for sale and has not been amortised since the conditional sale was agreed.

1.12 Property, plant and equipment

Property is held at historic cost as modified by subsequent revaluations less depreciation. The Group has elected under IAS 16.31 to measure its property at fair value. Revaluations are kept up to date such that the carrying amount does not differ materially from its fair value as required by IAS 16.34. Revaluation of assets and any subsequent disposal are addressed through the revaluation reserve and any changes are transferred to retained earnings.

Plant and equipment is stated at historical cost less depreciation. Historical cost includes expenditure that is directly attributable to the acquisition of the items. Depreciation is calculated using the straight-line method to allocate their cost to their residual values over their estimated useful lives, which are subject to regular review:

Gains and losses on disposals are determined by comparing proceeds with carrying amounts. These are included in the Statement of Comprehensive Income.

1.13 Leases

(a) As a lessor

Assets leased to customers under agreements which transfer substantially all the risks and rewards of ownership, with or without ultimate legal title, are classified as finance leases. When assets are held subject to finance leases, the present value of the lease payments is recognised as a receivable. The difference between the gross receivable and the present value of the receivable is recognised as unearned finance income. Lease income is recognised over the term of the lease using the net investment method, which reflects a constant periodic rate of return.

(b) As a lessee

Rentals made under operating leases are recognised in the Statement of Comprehensive Income on a straight-line basis over the term of the lease.

1.14 Cash and cash equivalents

For the purposes of the Statement of Cash Flows, cash and cash equivalents comprise cash in hand and demand deposits, and cash equivalents comprise highly liquid investments which are convertible into cash with an insignificant risk of changes in value with a maturity of three months or less at the date of acquisition, including certain loans and advances to banks and short-term highly liquid debt securities.

1.15 Employee benefits

(a) Post-retirement obligations

The Group contributes to defined contribution schemes for the benefit of certain employees. The schemes are funded through payments to insurance companies or trustee-administered funds at the contribution rates agreed with individual employees. The Group has no further payment obligations once the contributions have been paid. The contributions are recognised as an employee benefit expense when they are due. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in the future payments is available. There are no post-retirement benefits other than pensions.

(b) Share-based compensation

The fair value of equity settled share-based payment awards are calculated at grant date and recognised over the period in which the employees become unconditionally entitled to the awards (the vesting period). The amount is recognised as personnel expenses in profit and loss, with a corresponding increase in equity. The Group adopts a Black-Scholes valuation model in calculating the fair value of the share options as adjusted for an attrition rate of members of the scheme and a probability of pay-out reflecting the risk of not meeting the terms of the scheme over the vesting period. The number of share options that are expected to vest are reviewed at least annually.

The fair value of cash settled share-based payments is recognised as personnel expenses in the profit or loss with a corresponding increase in liabilities over the vesting period. The liability is remeasured at each reporting date and at settlement date based on the fair value of the options granted, with a corresponding adjustment to personnel expenses.

When share-based payments are changed from cash settled to equity settled and there is no change in the fair value of the replacement award, it is seen as a modification to the terms and conditions on which the equity instruments were granted and is not seen as the settlement and replacement of the instruments. Accordingly, the liability in the Statement of Financial Position is reclassified to equity and the prospective charge to the profit or loss from the modification reflects the spreading of the initial grant date fair value of the award over the remaining vesting period in line with the policy on equity settled awards.

1.16 Share issue costs

Incremental costs directly attributable to the issue of an equity instrument are deducted from the initial measurement of the equity instruments. Costs associated with the listing of shares are expensed immediately.

1.17 Taxation

Current income tax which is payable on taxable profits is recognised as an expense in the period in which the profits arise.

Deferred tax is provided in full on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the consolidated financial statements. Deferred tax is determined using tax rates (and laws) that have been enacted or substantially enacted by the Statement of Financial Position date and are expected to apply when the related deferred tax asset is realised or the deferred tax liability is settled.

Deferred tax assets and liabilities are offset if there is a legally enforceable right to offset current tax assets and liabilities, and they relate to taxes levied by the same tax authority on the same taxable entity, or on different tax entities, when they intend to settle current tax liabilities and assets on a net basis or their tax assets and liabilities will be realised simultaneously.

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

1.18 Dividends

Dividends on ordinary shares are recognised in equity in the period in which they are approved.

1.19 Significant items

Items which are material by both size and nature (i.e. outside of the normal operating activities of the Group) are treated as significant items and disclosed separately on the face of the Statement of Comprehensive Income. The separate reporting of these items helps to provide an indication of the Group's underlying business performance.

1.20 Funding for Lending Scheme

Under the applicable International Accounting Standard, IAS 39, if a security is lent under an agreement to return it to the transferor, as is the case for eligible securities lent by institutions to the Bank of England under the FLS, then the security is not derecognised because the transferor retains all the risks and rewards of ownership. The UK Treasury Bills borrowed from the Bank of England under the FLS are not recognised on the Statement of Financial Position of the institution until such time as they are subject to a repurchase agreement with a third party, as they will not meet the criteria for derecognition by the Bank of England. When the UK Treasury Bills are pledged as part of a sale and repurchase agreement with a third party, amounts borrowed from the third party are recognised on the Statement of Financial Position.

2. Critical judgements and estimates

The Group makes certain judgements and estimates which affect the reported amounts of assets and liabilities. Critical judgements and the assumptions used in calculating estimates are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances.

2.1 Impairment losses on loans and advances to customers

The Group reviews its loan portfolios to assess impairment at least on a half-yearly basis. The basis for evaluating impairment losses is described in accounting policy 1.10. In determining whether an impairment loss should be recorded in the Statement of Comprehensive Income, the Group makes judgements as to whether there is any observable data indicating that there is a measurable decrease in the estimated future cash flows from a portfolio of loans before the decrease can be identified with an individual loan in that portfolio. This evidence may include observable data indicating that there has been an adverse change in the payment status of borrowers in a group, or national or local economic conditions that correlate with defaults on assets in the Group. Loans and advances are identified as impaired by taking account of the age of the debt's delinquency and the product type. The impairment provision is calculated by applying a percentage rate to the balance of different ages and categories of impaired debt. The methodology and assumptions used for estimating both the amount and timing of future cash flows are reviewed regularly to reduce any differences between loss estimates and recent actual loss experience.

Within the Real Estate Finance and Asset Finance businesses, accounts which are impaired are assessed against the discounted cashflows expected to arise in order to identify any impairment provisions. Collective provisions are assessed only to the extent that there is sufficient data to justify an inherent level of losses within the current portfolios.

For specific Invoice Finance clients assessment is made as to the collectability of outstanding invoices in relation to the amounts lent against them. If there is a deficit against outstanding invoices then other security is considered in terms of value and collectability. If there is an overall shortfall then the unsecured amount is assessed as to whether a provision is required. For collective provisions a view of the overall level of non-collectability in the portfolio is taken. The level of provision required is under review as the product is new to the Bank therefore data is developing, so we have estimated a level appropriate based on other data available in the industry.

Where financial assets are individually evaluated for impairment, management uses their best estimates in calculating the net present value of future cash flows. Management has to make judgements on the financial position of the counterparty and the net realisable value of collateral (where held), in determining the expected future cash flows.

In assessing collective impairment the Group uses historical trends of the probability of default, the timing of recoveries and the amount of loss incurred, adjusted for management's judgement as to whether current economic and credit conditions are such that the actual losses are likely to be significantly different to historic trends.

As described in Note 1.10, certain customers' accounts may be modified to such an extent that they are no longer considered to be past due but, rather, are treated as new loans. There is judgement involved in determining the level of modification that results in this reassessment and with regard to the fair value at which the renegotiated loans are recorded. The Group makes these judgements based on analyses of the loans involved and consideration of market rates of interest.

To the extent that the default rates differ from those estimated by 10%, the allowance for impairment on loans and advances would change by an estimated £5.1 million.

2.2 Share Option Scheme valuations

The valuation of the equity settled Share Option Scheme was determined at the original grant date of 2 November 2011 using Black-Scholes valuation models. In the opinion of the directors the terms of the scheme are such that there remains a number of key uncertainties to be considered when calculating the probability of pay-out, which are set out below. The directors also considered the probability of option holder attrition prior to the vesting dates, details of which are also set out below.

Uncertainties in the regulatory environment continue. Any tightening of capital requirements will impact on the ability of the Company to exploit future market opportunities and furthermore may inhibit its ability to maintain the required growth in distributions. Taking these into account, the probability of pay-out has been judged as 100% for the remaining share options (SOS2) which vest on 2 November 2016.

Although one participant in the Share Option Scheme left the Company during 2012 and was consequently withdrawn from the Scheme, the directors consider that there is no further uncertainty surrounding whether the remaining participants will all still be in situ and eligible at the vesting date. Therefore the directors have assumed no attrition rate for the remaining share options over the scheme period.

The valuation of the cash settled Share Option Scheme was determined at 31 December 2015 using Black-Scholes valuation models. In the opinion of the directors the terms of the scheme are such that there remains a number of key uncertainties to be considered when calculating the probability of pay-out, which are considered to be similar to those set out above.

2.3 Average life of lending

IAS 39 requires interest earned from lending to be measured under the effective interest rate method. The effective interest rate is the rate that exactly discounts estimated future cash receipts or payments through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset.

Management must therefore use judgement to estimate the expected life of each instrument and hence the expected cash flows relating to it. The accuracy of these estimates would therefore be affected by unexpected market movements resulting in altered customer behaviour, inaccuracies in the models used compared to actual outcomes and incorrect assumptions.

2.4 PPI Provisioning

The Group provides for its best estimate of redress payable in respect of historical sales of PPI, by considering the likely future uphold rate for claims, in the context of confirmed issues and historical experience. The likelihood of potential new claims is projected forward to 2018, as management believe this to be an appropriate time horizon, recognising the significant decline in recent claims experience and the increasing subjectivity beyond that. The accuracy of these estimates would be affected, were there to be a significant change in either the number of future claims or, the incidence of claims upheld by the Financial Ombudsman. The amounts are included within accruals.