Arbuthnot Regulatory News (ARBB)

18 July 2023

For immediate release

ARBUTHNOT BANKING GROUP PLC ("Arbuthnot", "the Company", "the Group" or "ABG")

Unaudited results for the six months to 30 June 2023

Arbuthnot Banking Group PLC today announces a half yearly profit before tax of £26.4m.

Arbuthnot Banking Group PLC is the holding company for Arbuthnot Latham & Co., Limited.

FINANCIAL HIGHLIGHTS

• Profit before tax increased to £26.4m for the six months to 30 June 2023 (30 June 2022: £3.4m).

• Underlying profit before tax of £29.3m (30 June 2022: £10.7m)*.

• Interim dividend declared of 19p per share (30 June 2022: 17p per share).

• CET1 capital ratio of 12.2% (30 June 2022: 11.4%; 31 December 2022: 11.6%) and total capital ratio of 14.5% (30 June 2022: 14.0%; 31 December 2022: 14.0%).

• Earnings per share of 129.4p (30 June 2022: 17.8p).

• Net assets per share of 1470p (30 June 2022: 1300p; 31 December 2022: 1411p).

OPERATIONAL HIGHLIGHTS

• Customer loans (including leased assets) of £2.3bn (30 June 2022: £2.1bn; 31 December 2022: £2.2bn) increased by 2% in the first half of the year, and 7% year on year despite a tighter credit appetite.

• Customer deposits of £3.3bn (30 June 2022: £2.8bn; 31 December 2022: £3.1bn), a 5% increase since the year end and a 16% increase year on year.

• Assets under management of £1.4bn (30 June 2022: £1.3bn; 31 December 2022: £1.3bn), a 4% increase against 31 December 2022 and an increase of 6% year on year, driven by net inflows in the period.

SUMMARY AND OUTLOOK

• The Group continues to benefit from the business model it has established over many years, whereby the return to a more normalised Bank of England ("BoE") Base Rate brings increased revenue on both its lending and excess liquidity, which has contributed, alongside the execution of the Group's strategy, to a significant increase in profitability.

• Interest rates paid on client deposits have been increased to reflect Base Rate increases. As previously guided, the total cost of funding is expected to increase in the second half of 2023 due to cheaper maturing deposits being replaced with deposits at higher rates.

• Whilst the outlook for the economy looks increasingly uncertain and Arbuthnot remains alert to potential increases in credit risk, the improved profitability, and robust financial strength, means the Group remains well positioned.

Commenting on the results, Sir Henry Angest, Chairman and Chief Executive of Arbuthnot, said: "The Group made good progress in the first half of the year, with a substantial increase in profitability as the business model we have invested in over many years, focused on relationship-based banking and diversified lending to higher margin specialist sectors, continues to deliver for the Group."

Notes

*Details of the calculation of underlying profit before tax can be found in note 6

Chairman's Statement

I am pleased to report that the Group continues to make good progress. The profit before tax for the first six months of the year is £26.4m compared to £3.4m in the same period last year.

The Group remains focused on delivering the strategic aims in the new "future state 2" presented earlier this year along with the 2022 full year results. With greater diversity in the lending balances being provided by the specialist divisions, the overall profitability has benefited from the upward moves in the Bank of England Base Rate.

As previously noted, the upward shifts in the base rate create a lag effect in the Group's net interest margins, as it takes time for the cost of customer deposits to reprice to current market levels as they mature. Thus, we expect net interest margins to narrow as this repricing of deposits takes place.

The deposit market continues to remain extremely competitive, with many offers for term deposits of one year now well in excess of the base rate. Our bank, Arbuthnot Latham has been swift to adjust its rates in these markets, offering new and existing customers attractive rates.

However, with the strength of our deposit base, which is diversified between transactional and term accounts, the average cost of deposits stood at 2.2% for the month of June and averaged 1.9% for the first six months of the year. If base rates remains unchanged for the next 12 - 18 months, the cost of deposits is expected to rise to a peak of 2.9% over time.

I have previously explained that I believe that the strength of a bank should be measured against the quality of its deposit base rather than only capital or lending based measures. This I feel was never more clearly demonstrated than during the recent period of market uncertainty caused by the collapse of Silicon Valley Bank. I was pleased to note that the relationship banking model that we have established proved to be powerful and we saw the confidence that our clients have in us, demonstrated by the fact that we had net inflows of deposits during that time.

I was also pleased that during the first half of the year, Arbuthnot Banking Group carried out a successful capital raise. With the demand for the new equity being heavily oversubscribed, we were able to raise £12m rather than the initial target of £10m to help to satisfy this demand. This equity raise was designed to allow the lending businesses to continue to build their pipelines of new lending opportunities while at the same time having sufficient capital to allow for the second tranche of the Countercyclical Capital Buffer and to position us to be able to take advantage of opportunities that are expected to arise given the current market conditions.

This expectation proved correct as our specialist lending business, Asset Alliance was able to acquire a £42m portfolio of operating leases at a discount in May.

Given the rapid rise in interest rates, we are aware that the outlook for credit risk has worsened. At this time we have not yet seen a significant deterioration in our lending portfolios, however there is early evidence of pressure on affordability to cover interest payments becoming problematic as it takes time for the rental market to reprice. In response we have tightened our credit appetite, with LTVs on residential investment lending now being targeted at around 50% rather the previous 60%.

The specialist lending divisions continue to monitor their portfolios closely but as yet they continue to perform well.

Given its confidence in the prospects of the Group, the Board proposes an interim dividend of 19p, being an increase of 2p over the interim dividend paid in 2022. This interim dividend will be paid on 22 September 2023 to shareholders on the register on 25 August 2023.

Banking

The Banking division reported a profit before tax of £31.1m for the first six months (30 June 2022: £6.6m), with lending balances totalling £1.45bn and deposits of £3.25bn (30 June 2022: lending of £1.46bn; deposits of £2.61bn).

Against the backdrop of ongoing economic uncertainty, the Bank has continued to stay focused on client service, which has led to net growth in client acquisition. The Bank's long term approach and cautious banking model resonates well with criteria clients looking for a bank where they can build a long term relationship. 

Deposits grew by £165.8m in the first half of 2023 despite a number of high profile banking failures and turbulence across the banking sector. The Bank's strategy to hold high levels of liquidity, with no reliance on wholesale funding meant that the Bank operated with a consistently strong liquidity position in the period, reassuring clients of the Bank's robustness and resilience. 

The Bank has continued to pursue its strategy to focus on more capital efficient lending and allowing capital intensive lending to mature and refinance away in addition to tightening its credit criteria. The loan book fell marginally by 1% in the six months to finish the half year at £1.45bn. 

The impact of the changing macroeconomic environment is resulting in some signs of stress in the loan book, however given the Bank's cautious underwriting approach with low LTV ratios, the Bank is well positioned to exit any defaults with little or no loss.

Wealth Management

Assets Under Management ("AUM") closed the half-year mark at £1.38bn with positive net funds flow for the first half of 2023. The rising interest rate environment has resulted in an increase in client withdrawals compared to prior periods, where clients are opting to pay down their debt.

Arbuthnot Commercial Asset Based Lending ("ACABL")

ACABL has reported a profit before tax of £4.0m (30 June 2022: £2.9m) an increase of 38% for the same period in the prior year. The loan book was £241.1m as at the half year compared to £238.8m in the prior year and £268.8m at the previous year end.

In early May, ACABL celebrated its 5th year anniversary. Since launch, the business has grown its loan book with facility limits in excess of £500m and built a team of 31 highly experienced staff.

The business has continued to onboard new clients and support the growth of existing clients, however demand for transactional funding was seen to reduce towards the end of 2022 following the 'mini budget' and this has carried over into early 2023. This has resulted in a higher level of refinance opportunities that have and are being carefully considered in light of the market challenges. This has impacted the level of funds in use when compared to the previous year end, which also takes into account some expected client attrition given the book's maturity.

It is expected activity from Private Equity sponsors and the wider Corporate Finance community will result in an increase in transactional flow in the second half. Given the opportunities that will come from more realistic enterprise values, ACABL is well placed to fund these future transactions.

In the first quarter ACABL, renewed its accreditation to provide loans under the Recovery Loan Scheme as a continued additional source of funding for deal structures where appropriate.

Renaissance Asset Finance ("RAF")

RAF has reported a profit before tax of £0.7m (30 June 2022: £0.2m), with customer loan balances of £156.7m (30 June 2022: £102.6m).

New business levels have remained positive and the balance sheet continues to grow in line with the Group's Future State plan, with improved margins achieved on new business despite the current economic environment. 

Whilst some pressure is expected, particularly in the SME customer base, the book continues to perform in the current economic climate with problem debts marginally lower than expected.

Asset Alliance Group ("AAG")

AAG continues to trade well with leased assets and hire purchase loans totalling £258.8m at the end of June 2023 compared to £128.6m as at 30 June 2022, equating to year-on-year growth of 101%, and 37% year to date. Included in the result is £42m of operating leases which AAG acquired at a discount to face value, to provide buses for contracted operations in London.

Despite the portfolio acquisition, supply chain issues continue, however with signs of improvement beginning to appear. Where in prior periods, supply chain issues have led to a buoyant used truck market, the business expects this market to weaken, but margins currently remain stronger than expected.

Mortgage Portfolios

The Group's acquired mortgage portfolio is currently operating in line with expectations with a carrying value of £135.0m compared to £166.2m as at 30 June 2022 and £148.5m as at 31 December 2022.

Operations

The Bank continues to see significant growth in client activity with non-card related payment volumes increasing by 15% year on year, with over 500,000 payments processed in the first half of 2023. Card transactions have also seen significant growth with volumes in the first six months of 2023, approximately 45% higher than the same period last year.

Having completed the core banking platform upgrade at the end of 2022, the Bank has commenced a review of its future digital strategy that will focus on further developing the client digital channels and streamlining a number of operational processes. The outputs of this review will underpin the roadmap for further technology investment over the coming 2-3 years with delivery expected to commence later in 2023.

Outlook

The continued stubbornness of inflation has led to increased interest rate rises which has had a positive effect on the profitability of the Group. The outlook for the economy looks increasingly uncertain and we remain alert to potential increases in credit risk that may result from an economic downturn. However, given the improved profitability and robust financial strength, the Group remains well positioned.

Consolidated Statement of Comprehensive Income

Consolidated Statement of Financial Position

Consolidated Statement of Changes in Equity

Consolidated Statement of Cash Flows

Notes to the Consolidated Financial Statements

1. Basis of preparation

The interim financial statements have been prepared on the basis of accounting policies set out in the Group's 2022 statutory accounts as amended by UK-adopted standards and interpretations effective during 2023 as set out below and in accordance with IAS 34 "Interim Financial Reporting" as adopted for use in the UK. The directors do not consider the fair value of the assets and liabilities presented in these financial statements to be materially different from their carrying value.

The statements were approved by the Board of Directors on 17 July 2023 and are unaudited. The interim financial statements will be available on the Group website (www.arbuthnotgroup.com) from 19 July 2023.

2. Risks and Uncertainties

The Group regards the monitoring and controlling of risks and uncertainties as a fundamental part of the management process. Consequently, senior management are involved in the development of risk management policies and in monitoring their application. A detailed description of the risk management framework and associated policies is set out in note 4.

The principal risks inherent in the Group's business are reputational, macroeconomic and competitive environment, strategic, credit, market, liquidity, operational, cyber, conduct and, regulatory and capital.

Reputational risk

Reputational risk is the risk to the Group from a failure to meet reasonable stakeholder expectations as a result of any event, behaviour, action or inaction by ABG itself, its employees or those with whom it is associated. This includes the associated risk to earnings, capital or liquidity.

ABG seeks to ensure that all of it businesses act consistently with the seven corporate principles as laid out on page 3 of the Annual Report and Accounts. This is achieved through a central Risk Management framework and supporting policies, the application of a three-lines of defence model across the Group and oversight by various committees. Employees are supported in training, studies and other ways and encouraged to live out the cultural values within the Group of integrity, energy and drive, respect, collaboration and empowerment. In applying the seven corporate principles, the risk of reputational damage is minimised as the Group serves its shareholders, customers and employees with integrity and high ethical standards.

Macroeconomic and competitive environment

The Group is exposed to indirect risk that may arise for the macroeconomic and competitive environment.

In recent years there have been a number of global and domestic events which have had significant implications on the Group's operating environment, namely: Russia's War in the Ukraine, Coronavirus and Brexit. The culmination of these events has led to significant turmoil in both global and domestic markets. The most significant economic effect from these events includes record inflation driven by high fuel costs, leading to sharp and significant increases in the cost of borrowing. Conditions have improved since the year end however there still remains significant uncertainty around the recovery of the UK economy which may have an impact on the group's customers and assets.

Climate change

Climate change presents financial and reputational risks for the banking industry. The Board consider Climate change a material risk as per the Board approved risk appetite framework which provides a structured approach to risk taking within agreed boundaries. The assessment is proportional at present but will develop over time as the Group generates further resources and industry consensus emerges. The assessment is maintained by the Chief Risk officer and has been informed by the ICAAP review and numerous workshops for staff.

Whilst it is difficult to assess how climate change will unfold, the Group is continually assessing various risk exposures. The UK has a legally binding target to cut its greenhouse gas emissions to "net-zero" by 2050. There is growing consensus that an orderly transition to a low-carbon economy will bring substantial adjustments to the global economy which will have financial implications while bringing risks and opportunities.

The risk assessment process has been integrated into existing risk frameworks and will be governed through the various risk governance structures including review and recommendations by the AL Risk Committee. Arbuthnot Latham governance has been assessed against the Task Force on Climate-related Financial Disclosures' ("TCFD") recommended governance disclosures and where appropriate the FCA/PRA guidance as per the Supervisory statements.

In accordance with the requirements of the PRA's Supervisory Statement 'Enhancing banks' and insurers' approaches to managing the financial risks from climate change', the Group has allocated responsibility for identifying and managing the risks from climate change to the relevant existing Senior Management Function. The Bank is continuously developing a suitable strategic approach to climate change and the unique challenges it poses.

The FCA have issued 'Climate Change and Green Finance: summary of responses and next steps'. In addition to the modelling of various scenarios and various governance reviews, Arbuthnot Latham will continue to monitor requirements through the relationship with UK Finance.

Strategic risk

Strategic risk is the risk that the Group's ability to achieve its corporate and strategic objectives may be compromised. This risk is particularly important to the Group as it continues its growth strategy. However, the Group seeks to mitigate strategic risk by focusing on a sustainable business model which is aligned to the Group's business strategy. Also, the Directors normally meet once a year outside a formal Board setting to ensure that the Group's strategy is appropriate for the market and economy.

Credit risk

Credit risk is the risk that a counterparty (borrower) will be unable to pay amounts in full when due. This risk exists in Arbuthnot Latham, which currently has a loan book of £2.2bn (30 June 2022: £2.1bn). The lending portfolio in Arbuthnot Latham is extended to clients, the majority of which is secured against cash, property or other high quality assets. Credit risk is managed through the Credit Committee of Arbuthnot Latham. 

Market risk

Market risk arises in relation to movements in interest rates, currencies, property and equity markets. The Group's treasury function operates mainly to provide a service to clients and does not take significant unmatched positions in any market for its own account. As a result, the Group's exposure to adverse movements in interest rates and currencies is limited to interest earnings on its free cash and interest rate re-pricing mismatches. The Group actively monitors its exposure to future changes in interest rates.

The Group is exposed to changes in the market value of its properties. The current carrying value of Investment Property is £6.6m (31 December 2022: £6.6m) and properties classified as inventory are carried at £10.5m (31 December 2022: £19.6m). Any changes in the market value of the property will be accounted for in the Income Statement for the Investment Property and could also impact the carrying value of inventory, which is at the lower of cost and net realisable value. As a result, it could have a significant impact on the profit or loss of the Group.

Liquidity risk

Liquidity risk is the risk that the Group, although solvent, either does not have sufficient financial resources to enable it to meet its obligations as they fall due, or can only secure such resources at an excessive cost. The Group takes a conservative approach to managing its liquidity profile. Retail client deposits and drawings from the Bank of England Term Funding Scheme fund the Bank. The loan to deposit ratio is maintained at a prudent level, and consequently the Group maintains a high level of liquidity. The Arbuthnot Latham Board annually approves the Internal Liquidity Adequacy Assessment Process ("ILAAP"). The Directors model various stress scenarios and assess the resultant cash flows in order to evaluate the Group's potential liquidity requirements. The Directors firmly believe that sufficient liquid assets are held to enable the Group to meet its liabilities in a stressed environment.

Operational risk

Operational risk is the risk that the Group may be exposed to financial losses from conducting its business. The Group's exposures to operational risk include its Information Technology ("IT") and Operations platforms. There are additional internal controls in these processes that are designed to protect the Group from these risks. The Group's overall approach to managing internal control and financial reporting is described in the Corporate Governance section of the Annual Report.

In line with further guidance issued by the Regulator, the Bank has continued to focus on ensuring that the design of systems and operational plans are robust to maintain operational resilience in the face of unexpected incidents.

Cyber risk

Cyber risk is an increasing risk for the Group within its operational processes. It is the risk that the Group is subject to some form of disruption arising from an interruption to its IT and data infrastructure. The Group regularly tests the infrastructure to ensure that it remains robust to a range of threats and has continuity of business plans in place including a disaster recovery plan.

Conduct risk

As a financial services provider we face conduct risk, including selling products to customers which do not meet their needs, failing to deal with clients' complaints effectively, not meeting clients' expectations, and exhibiting behaviours which do not meet market or regulatory standards.

The Group adopts a low risk appetite for any unfair customer outcomes. It maintains clear compliance guidelines and provides ongoing training to all employees. Periodic spot checks, compliance monitoring and internal audits are performed to ensure these guidelines are followed. The Group also has insurance policies in place to provide some cover for any claims that may arise.

Regulatory and capital risk

Regulatory and capital risk includes the risk that the Group will have insufficient capital resources to support the business and/or does not comply with regulatory requirements. The Group adopts a conservative approach to managing its capital. The Board of Arbuthnot Latham approves an ICAAP annually, which includes the performance of stringent stress tests to ensure that capital resources are adequate over a three year horizon. Capital and liquidity ratios are regularly monitored against the Board's approved risk appetite as part of the risk management framework.

Regulatory change also exists as a risk to the Group's business. Notwithstanding the assessments carried out by the Group to manage regulatory risk, it is not possible to predict how regulatory and legislative changes may alter and impact the business. Significant and unforeseen regulatory changes may reduce the Group's competitive situation and lower its profitability.

3. Critical accounting estimates and judgements in applying accounting policies

The Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. Estimates and judgements 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. For a full list of critical accounting estimates and judgements, please refer back to the Annual Report and Accounts for 2022. Assumptions surrounding credit losses are discussed in more detail below, while other critical accounting estimates and judgements have remained unchanged from what was previously reported.

Estimation uncertainty - Expected credit losses ("ECL") on financial assets

The Group reviews its loan portfolios and debt security investments to assess impairment at least on a quarterly basis. The measurement of ECL required by IFRS 9, necessitates a number of significant judgements. Specifically, judgements and estimation uncertainties relate to assessment of whether credit risk on the financial asset has increased significantly since initial recognition, incorporation of forward-looking information ("FLI") in the measurement of ECLs and key assumptions used in estimating recoverable cash flows. These estimates are driven by a number of factors that are subject to change which may result in different levels of ECL allowances.

The Group incorporates FLI into the assessment of whether there has been a significant increase in credit risk. Forecasts for key macroeconomic variables that most closely correlate with the Bank's portfolio are used to produce five economic scenarios, comprising of a Baseline, which is the central scenario, developed internally based on public consensus forecasts, and four less likely scenarios, one upside and three downside scenarios (Downside 1, Downside 2 and Extreme Downside), and the impacts of these scenarios are then probability weighted. The estimation and application of this FLI will require significant judgement supported by the use of external information.

12-month ECLs on loans and advances (loans within Stage 1) are calculated using a statistical model on a collective basis, grouped together by product and geographical location. The key assumptions are the probability of default, the economic scenarios and loss given default ("LGD") having consideration for collateral. Lifetime ECLs on loans and advances (loans within Stage 2 and 3) are calculated based on an individual valuation of the underlying asset and other expected cash flows.

For financial assets in Stage 2 and 3, ECL is calculated on an individual basis and all relevant factors that have a bearing on the expected future cash flows are taken into account. These factors can be subjective and can include the individual circumstances of the borrower, the realisable value of collateral, the Group's position relative to other claimants, and the likely cost to sell and duration of the time to collect. The level of ECL is the difference between the value of the recoverable amount (which is equal to the expected future cash flows discounted at the loan's original effective interest rate), and its carrying amount.

The Group considered the impact of various assumptions on the calculation of ECL (changes in GDP, unemployment rates, inflation, exchange rates, equity prices, wages and collateral values/property prices) and concluded that collateral values/property prices, UK GDP and UK unemployment rate are key drivers of credit risk and credit losses for each portfolio of financial instruments.

The five macroeconomic scenarios modelled on future property prices were as follows:

• Baseline

• Upside

• Downside 1

• Downside 2

• Extreme downside

The tables below therefore reflect the expected probability weightings applied for each macroeconomic scenario:

The tables below show the five-year forecasted average for property prices growth, UK unemployment rate and UK real GDP growth:

The tables below list the macroeconomic assumptions at 30 June 2023 used in the base, upside and downside scenarios over the five-year forecast period. The assumptions represent the absolute percentage unemployment rates and year-on-year percentage change for GDP and property prices.

The graphs below plot the historical data for HPI, Commercial real estate price, unemployment rate and GDP growth rate in the UK as well as the forecasted data under each of the five scenarios.

Management have assessed the impact of assigning a 100% probability to each of the economic scenarios, which would have the following impact on the Profit or Loss of the Group:

4. Financial risk management

Strategy

By their nature, the Group's activities are principally related to the use of financial instruments. The Directors and senior management of the Group have formally adopted a Group Risk and Controls Policy which sets out the Board's attitude to risk and internal controls. Key risks identified by the Directors are formally reviewed and assessed at least once a year by the Board, in addition to which key business risks are identified, evaluated and managed by operating management on an ongoing basis by means of procedures such as physical controls, credit and other authorisation limits and segregation of duties. The Board also receives regular reports on any risk matters that need to be brought to its attention. Significant risks identified in connection with the development of new activities are subject to consideration by the Board. There are budgeting procedures in place and reports are presented regularly to the Board detailing the results of each principal business unit, variances against budget and prior year, and other performance data.

The principal non-operational risks inherent in the Group's business are credit, macroeconomic, market, liquidity and capital.

Credit risk

The Company and Group take on exposure to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. Significant changes in the economy, or in the health of a particular industry segment that represents a concentration in the Company and Group's portfolio, could result in losses that are different from those provided for at the balance sheet date. Credit risk is managed through the Credit Committee of the banking subsidiary.

The Committee regularly reviews the credit risk profile of the Group, with a clear focus on performance against risk appetite statements and risk metrics. The Committee considered credit conditions during the period.

The Company and Group structure the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to products, and one borrower or groups of borrowers. Such risks are monitored on a revolving basis and subject to an annual or more frequent review. The limits are approved periodically by the Board of Directors and actual exposures against limits are monitored daily.

Exposure to credit risk is managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing these lending limits where appropriate. Exposure to credit risk is also managed in part by obtaining collateral, and corporate and personal guarantees.

The Group has attempted to leverage stress test modelling insights to inform ECL model refinements to enable reasonable estimates. Management review of modelling approaches and outcomes continues to inform any necessary adjustments to the ECL estimates through the form of in-model adjustments, based on expert judgement including the use of available information. Management considerations included the potential severity and duration of the economic shock, including the mitigating effects of government support actions, as well the potential trajectory of the subsequent recovery.

The Group employs a range of policies and practices to mitigate credit risk. The most traditional of these is the taking of collateral to secure advances, which is common practice. The principal collateral types for loans and advances include, but are not limited to:

• Charges over residential and commercial properties;

• Charges over business assets such as premises, inventory and accounts receivable;

• Charges over financial instruments such as debt securities and equities;

• Charges over other chattels; and

• Personal guarantees

Upon initial recognition of loans and advances, the fair value of collateral is based on valuation techniques commonly used for the corresponding assets. In order to minimise any potential credit loss the Group will seek additional collateral from the counterparty as soon as impairment indicators are noticed for the relevant individual loans and advances. Repossessed collateral, not readily convertible into cash, is made available for sale in an orderly fashion, with the proceeds used to reduce or repay the outstanding indebtedness, or held as inventory where the Group intends to develop and sell in the future. Where excess funds are available after the debt has been repaid, they are available either for other secured lenders with lower priority or are returned to the customer.

Commitments to extend credit represent unused portions of authorisations to extend credit in the form of loans, guarantees or letters of credit. With respect to credit risk on commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most commitments to extend credit are contingent upon customers maintaining specific credit standards.

The Group incorporates forward-looking information into both its assessment of whether the credit risk of an instrument has increased significantly since its initial recognition and its measurement of ECL. The key inputs into the measurement of the ECL are:

• assessment of significant increase in credit risk

• future economic scenarios

• probability of default

• loss given default

• exposure at default

The IFRS 9 impairment model adopts a three stage approach based on the extent of credit deterioration since origination.