Metro Bank Regulatory News (MTRO)

Metro Bank PLC

Full year results

Trading Update 2019

26 February 2020

Metro Bank PLC (LSE: MTRO LN)

Results for Year ended 31 December 2019

·; Financial performance reflects a challenging year

·; Balance sheet strength retained

·; Strong annual growth in customer accounts

·; Ambition to become the UK's best community bank

Summary:

Key Financials:

1. Results from the Competition and Market Authority's February 2020 Service Quality Survey.

2. Underlying (loss)/profit before tax excludes Listing Share Awards, impairment of property, plant & equipment ("PPE") and intangible assets, net BCR costs, transformation costs and remediation costs. Statutory (loss)/profit after tax is included in the Profit and Loss Account. 

Dan Frumkin, Chief Executive Officer at Metro Bank, said:

"Our financial performance reflects a very challenging year for Metro Bank. External headwinds, internal challenges and actions we took to put the business on a more positive trajectory are reflected in the results. Despite this, Metro Bank's market-leading service proposition continued to deliver growth in customer accounts, and our balance sheet ended the year in a materially stronger position. We've fully evaluated our strategy, and have a clear plan which will return the bank to sustainable growth built around a community banking model. An enhanced focus on costs, improved productivity, and investment in our infrastructure will enable our deposit-led franchise to deliver profitable growth over the medium term. Thanks to the steadfast commitment of colleagues across the bank, I am confident we will successfully execute against these priorities to become the UK's best community bank."

A presentation for investors and analysts will be held at 08:30 GMT on 26 February 2020.

The presentation will be webcast on:

https://event.on24.com/wcc/r/2180103/0B87C516F118372B20DA70B3C08A88FC

For those wishing to dial-in:

From the UK dial: +44 3333 000 0804

From the US dial: +1 631 913 1422

Participant Pin: 49156297#

URL for other international dial in numbers:

http://events.arkadin.com/ev/docs/NE_W2_TF_Events_International_Access_List.pdf  

Strategic update and outlook

Guidance and Targets

BCR Capability & Innovation Fund Award

Financial performance for the year and quarter ended 31 December 2019

 Deposits

Loans

Profit and Loss Account

Capital, Funding and Liquidity

Customer Experience

Board Changes

Change of approach to quarterly reporting

Going forward, as the bank focusses on its new strategy and associated transformation plans, the bank will report full and half year results in line with UK practice, with short form trading updates at Q1 and Q3. These updates will include deposit and loan balances, together with a short commentary covering the performance of the business in the period.

Metro Bank PLC

Summary Balance Sheet and Profit & Loss Account

(Unaudited)

5. Comprises investment securities and cash & balances with central banks

6. Comprises property, plant & equipment, intangible assets and other assets

7. Net BCR costs includes amounts previously disclosed under costs relating to RBS alternative remedies package application, Capability & Innovation costs and Capability & Innovation funding

8. In the fourth quarter £4.6m of fee and commission expenses relating to 2019 that were previously classified as operating costs were reclassified as net fee and other income to better reflect their nature.

For more information, please contact:

Metro Bank PLC Investor Relations

Jo Roberts

+44 (0) 20 3402 8900

jo.roberts@metrobank.plc.uk

Metro Bank PLC Media Relations

Tina Coates / Abigail Whittaker

+44 (0) 7811 246016 / +44 (0) 7989 876136

pressoffice@metrobank.plc.uk 

Teneo

Charles Armitstead / Haya Herbert Burns

+44 (0)7703 330269 / +44 (0) 7342 031051

Metrobank@teneo.com

ENDS

About Metro Bank

Metro Bank is celebrated for its exceptional customer experience. Its mobile app and online service achieved the top spot in the Competition and Market Authority's Service Quality Survey among personal and business current account holders in February 2020; the bank also ranked in the top two for overall service and store service for personal and business customers. It was awarded 'Best All Round Personal Finance Provider' at the Moneynet Personal Finance Awards 2019.

Offering retail, business, commercial and private banking services, it prides itself on giving customers the choice to Bank however, whenever and wherever they choose. Whether that's through its network of stores open seven days a week, early until late, 362 days a year; on the phone through its UK-based 24/7 contact centres; or online through its internet banking or award-winning mobile app: the bank offers customers real choice.

The bank employs around 3,500 colleagues and is headquartered in Holborn, London.

Metro Bank PLC. Registered in England and Wales. Company number: 6419578. Registered office: One Southampton Row, London, WC1B 5HA. 'Metrobank' is the registered trademark of Metro Bank PLC.

It is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and Prudential Regulation Authority. Most relevant deposits are protected by the Financial Services Compensation Scheme. For further information about the Scheme refer to the FSCS website www.fscs.org.uk.

All Metro Bank products are subject to status and approval.

Metro Bank PLC is an independent UK bank - it is not affiliated with any other bank or organisation (including the METRO newspaper or its publishers) anywhere in the world. Please refer to Metro Bank using the full name.

CHIEF EXECUTIVE OFFICER'S STATEMENT

I was delighted to join Metro Bank in September 2019, initially as Chief Transformation Officer and now as Chief Executive Officer. I would like to begin by extending my deepest thanks to all the Metro Bank colleagues who have welcomed me and more importantly have kept the customer focus at the heart of all we do, even during a challenging year.

Building on our strengths

In many ways, the response to the challenges of 2019 has demonstrated the underlying resilience of Metro Bank. The core strength of Metro Bank has been, and will remain, an AMAZEING group of colleagues who are tirelessly focused on customer service. It is our colleagues who will ensure Metro Bank achieves its ambition to become the UK's best community bank.

The CMA results, where Metro Bank was rated number 1 for store service and number 1 for mobile and online banking is external validation of what I have learned over the last few months - Metro Bank is completely focused on its customers. The ratings also show the commitment of Metro Bank to providing full-service community banking, instore, online and over the phone.

The energy expended to surprise and delight customers has continued to create FANS, even during a difficult 2019. Customer accounts grew almost 25% with 385,000 new accounts opened at Metro Bank during the year, bringing total accounts to more than 2 million. In addition, retail customer deposit balances grew 33% in the year and SME customer balances were up 3%.

Proving our community banking philosophy and 'clicks and bricks' model, combined with an exceptional level of service resonates well with customers we continue to be successful in growing the number of personal and business current accounts. Also in our current heartland of London and the South East the number of SME business current account switchers choosing Metro Bank remained strong in 2019 at 15%.

We're absolutely committed to bringing market-leading service to SMEs and injecting more competition into the market, and we have already demonstrated our success in deploying Capability & Innovation funds to date. For example, in 2019, Metro Bank launched Business Insights - an in-app account insights tool for SMEs, MCash - an on-demand cash collection and delivery service, and opened its first store in the North, in Manchester. In February 2020, we agreed a revised business case with BCR whereby we have aligned Metro Bank's public commitments with our new strategy, and will return £50m of the original £120m we were awarded. Looking forward, with a reduced amount of £70m, alongside Metro Bank's own investment of c.£140m, the bank will continue to transform the SME experience - through its market-leading service proposition, 15 new stores opening in the North of England (reduced from 30), and continued investment in its digital capabilities. With BCR's agreement, we're pleased to have been able to forge a new plan which delivers for SMEs and aligns with our new strategy.

The way forward - 'Becoming the UK's best community bank'

Over the last six months, my management team and I have worked with the Board to evaluate a new strategy for Metro Bank to enable it to deliver acceptable returns for shareholders. The inherent strengths of Metro Bank - AMAZEING culture, AMAZEING colleagues, AMAZEING customer service and a history of generating meaningful retail and SME deposit growth - provide solid foundations for a straightforward strategy where execution is key.

We have developed a set of strategic priorities with the ambition of becoming 'the UK's best community bank'. Community banking means being embedded in the local communities that we serve, ensuring local decision-making, providing access to simple and straightforward retail, business banking and corporate services that best meet the needs of residents and businesses in the surrounding area.

However, to build a platform that delivers acceptable returns for our shareholders, we must reduce the rate at which costs are growing, continue to evolve our customer proposition, invest efficiently in our infrastructure and be more effective with how we use our balance sheet to generate returns.

Our new strategy has these principles at its core:

1) Cost saving initiatives

Cost growth has outstripped revenue growth and this cannot continue. Metro Bank has invested heavily in its store estate, creating a significant fixed, or quasi-fixed, cost base. We have performed a detailed store by store financial analysis to consider whether it made economic sense to close stores. It doesn't. Every store is still growing - all are more profitable tomorrow than today - and they provide a significant untapped potential as a distribution channel.

There are another group of costs that are driven by the operations of the business. These processing costs, including things like payment processing, credit card processing, etc. are mostly volume driven and bound by existing contracts. Another difficult area for reducing costs over the short-term.

The remaining costs, the addressable costs, are made up of non-store colleague costs, non-store lease costs and non-store operations.

To effectively control these expenses, plans are in place to revisit our non-store property leases, especially in central London. In addition, the infrastructure investment in the plan includes several initiatives that allows Metro Bank to scale more effectively. This includes new digital self-service functionality, more straight through processing and new call centre infrastructure.

We expect low single digit 'run the bank' cost growth CAGR 2020 to 2024, allowing the cost:income ratio to fall to 70-75% by 2024. To enable this objective, we will spend £250-£300 million of new opex investment (excluding depreciation and amortisation) and c.£100 million of capex, front end loaded.

We have started to show our ability to moderate costs with sequential reductions in the pace of cost growth through 2019, and our revised agreement with BCR will allow us to become more cost efficient quicker while continuing to deliver for SMEs. This gives me great confidence that we can deliver our clear initiatives within the stated timeframe.

While there are a number of initiatives to contain costs, improving shareholder returns is a revenue story. It is about creating scale through deposit and revenue growth while holding costs and investments.

2) Revenue initiatives

There is significant opportunity to grow revenue at Metro Bank, through building stronger relationships with our existing customers, continuing to attract more people to our stores, embedding ourselves in more communities in the UK, continuing to invest in our number 1 rated digital and online offering and to upgrade our telephony infrastructure. This is a bricks, clicks and phone strategy that will drive revenue.

We need to deepen relationships with our customers by improving the range of our products and their availability through new and existing channels. For example, we intend to meet more customer needs by offering a broader range of unsecured customer loans, SME lending products, business and personal credit cards and niche mortgages, all while maintaining our disciplined attitude towards underwriting. This is an area Metro Bank has not previously focused on, evidenced by the fact that we currently sell an average of 2 unsecured personal loans per store per month and only 3% of our Personal Current Account base hold our credit cards.

It also aligns perfectly with our customer service ethos, by meeting more customer needs, we create more FANS. We will also build on Metro Bank's great strength of winning new customers and I believe that there is a significant opportunity to enhance footfall conversion in stores. We will do this by developing more effective in-store processes and improving colleague training.

Whilst we have grown our deposits at a CAGR of 30% over the last five years, our strategy conservatively budgets significantly lower deposit growth numbers over the next five years. In addition, 2020 has the lowest deposit growth forecast of any year in the plan and is only 25% of our annual deposit growth in 2018, even though Metro bank has six more stores.

Revenue growth is predicated on doing more with what we already have. The growth does not rely on significant store growth, although the plan does allow us to open of a limited number of new stores. This includes six stores in 2020 and a further 18 between 2021-2024 including our revised C&I commitment. This will give us the opportunity to embed Metro Bank in more communities and bring our award-winning proposition closer to more people.

3) Infrastructure

We need to continue to build our number 1 service propositions in store and digital/online to ensure we continue to offer the best channel experience in an efficient way. To enable this, we need to continue to invest in our digital and physical infrastructure to deliver process improvements and enhance our core capabilities. We will continue to invest in stores, but in a more cost-efficient way - our new stores will be flexible in both size and design and we'll aim to streamline and improve in store processes. We'll also grow our digital service offering and build out customer self-service opportunities. By pivoting towards greater automation we will improve our speed to market and streamline back-office functions.

It's important that all of this is done whilst also enhancing our internal capabilities and resilience. This will be executed through investment in cyber resilience as well as investment in core risk systems such as financial crime infrastructure. We will of course continue investment in our core IT systems to ensure that we keep pace with the ever-changing regulatory agenda.

4) Balance sheet optimisation

Metro Bank has not focused on risk adjusted return on regulatory capital as much as is required to drive adequate returns to shareholders. Focusing on risk adjusted returns and growth in tangible book value will allow better planning decisions to be made going forward and deliver more value to shareholders.

Business lines, portfolios and investments will be reviewed based on the above discipline on an ongoing basis. We will sell assets, securitise portfolios and rethink investment spend as necessary to ensure we are maximising the return on the balance sheet.

The loan portfolio composition will shift over the life of the plan. Unsecured credit will be offered to SME and retail customers, applying risk based pricing. Niche mortgage lending will become a larger share of our mortgage operations and commercial lending to our valued customers will continue to grow.

5) Internal and external communications

I am pleased that we have launched our first marketing campaign - People-People Banking - which showcases our incredible colleagues and helps customers and potential customers to understand Metro Bank's differentiators. We will set realistic expectations of the future direction of Metro Bank and update on progress in a timely manner. For our colleagues we will continue to provide full transparency to help inform and equip them to fulfil their roles and maintain our already high levels of engagement.

A challenging 2019

Last year, we faced headwinds from industry-wide competitive pressures, an evolving regulatory landscape, continued low interest rates and political uncertainty from Brexit. While these external challenges have dampened returns across the broader sector, Metro Bank faced specific challenges that impacted growth and profitability. These have been well trailed in previous announcements, and management undertook prudent steps to manage our capital and liquidity positions in response. Although these actions have impacted on profitability in the short to medium term, we enter 2020 with a resilient balance sheet, loyal FANS and a committed colleague base.

In closing, it would be remiss not to thank Vernon Hill and Craig Donaldson for all they have done for Metro Bank since it opened the doors to its first store 10 years ago. I truly appreciate the AMAZEING colleagues they have recruited into the business. It is these colleagues that give me confidence in the future of Metro Bank.

Dan Frumkin

Chief Executive Officer

Financial review

The challenges we have faced this year are reflected in our trading performance for 2019. Our underlying loss before tax of £11.7 million is a decrease from the £50.0 million underlying profit we reported in 2018. This reduction reflects a difficult market backdrop driven by sustained mortgage market competition, low interest rates, the earnings impact of debt issuance, and the adoption of IFRS 16 that changed how we account for our lease costs. We are also absorbing the financial impacts of management actions taken to maintain a strong capital and liquidity position following events of the first half of the year. The sale of £1.5 billion interest-bearing treasury assets, a £521 million loan portfolio disposal, adjustments to deposit pricing and a slower pace of loan growth have reduced revenue in the second half of the year. The statutory loss before tax of £130.8 million in 2019 reflects the impact of certain non-recurring items including the write-down of certain intangible assets as well as transformation and remediation costs.

Despite these challenges we have continued to deliver on key objectives. During 2019 we made good progress with our cost transformation programme, reducing the pace of cost growth in the second half of the year relative to prior periods, whilst continuing to expand our physical presence and product offering. We have also been successful in growing our customer base and deepening relationships with existing customers, driving higher underlying net fee and other income to £90.4 million, up 43% from £63.3 million in 2018. Asset quality has remained strong, with 2019 cost of risk at 0.08% compared to 0.07% in the prior year. Our strongly performing credit portfolios and a robust capital and liquidity position stands us in good stead as we enter 2020.

Deposits

Deposits from customers ended the year at £14.5 billion, with a reduction in the first half of the year driven by the intense speculation that preceded the £375 million equity capital raise in May 2019. Deposit withdrawals predominantly came from a limited number of our larger commercial customers with commercial deposit balances (excluding SMEs) reducing to £2.5 billion from £5.1 billion in 2018.

Retail and SME deposits displayed significant resilience in 2019. Retail deposits (excluding retail partnerships) continued to grow through the year to £6.9 billion from £5.2 billion in 2018, supported in part by competitively priced fixed-term retail savings. We also reported a 3% improvement in the SME deposit base, which ended the year at £3.3 billion, compared to £3.2 billion in 2018, demonstrating the strength of our SME proposition. These stable and higher-liquidity value retail and SME deposits now represent 48% and 23% of our deposit base respectively, up from 33% and 20% as at 31 December 2018.

Strong service recognition results, increasing brand awareness and new store openings as well as competitive pricing on our fixed-term retail savings products aided growth in the total number of customer accounts. 2019 was a strong year for customer acquisition, with the number of customer accounts growing to 2.0 million from 1.6 million at year-end 2018.

Deposit growth into 2020 and beyond, alongside excess liquidity and wholesale funding, will support the repayment of drawdowns under the bank of England's Term Funding Scheme ("TFS"). Our total borrowings under the scheme are £3.8 billion of which £543 million is repayable in the second half of 2020.

Assets

Total assets reduced marginally to £21.4 billion from £21.6 billion at the end of 2018, which primarily reflects a £1.1 billion reduction in treasury assets, partially offset by a £0.4 billion increase in net loans and advances to customers and a one-off £313 million increase in right-of-use lease assets following the adoption of IFRS 16. The reduction in treasury assets reflects the sale of non-LCR eligible assets to prudently manage the bank's liquidity position through the year.

Despite the £521 million disposal of a previously acquired loan portfolio, net loans and advances increased by 3% to £14.7 billion (31 December 2018: £14.2 billion). The disposed portfolio was not considered a strategic asset, with its sale having no impact on our customer franchise given it was continually serviced by an external provider. Lending growth in the year was primarily driven by the ongoing support of our existing franchise and fulfilment of our committed pipeline at the end of 2018 flowing through during the first months of the year. As the year progressed, lending growth slowed as we proactively managed our loan to deposit ratio and looked to reduce our exposure to higher risk-density commercial lending following the RWA adjustment in January 2019. Commercial lending as a percentage of total lending reduced to 28% from 31% in 2018.

Our loan to deposit ratio increased during the first half of 2019 to 109% at 30 June 2019 from 91% at the end of 2018 following growth in customer loans. However, we made good progress in reducing the ratio in the second half of the year, supported by a return to deposit growth in the third and fourth quarters and management of lending volumes through upward adjustments to asset pricing.

Asset quality remained particularly robust in 2019 with cost of risk broadly remaining flat at 0.08% compared to 0.07% in the previous year. Non-performing loans increased to 0.53% from 0.15% in 2018 reflecting seasoning of the loan portfolio and a single name commercial exposure.

Income 

Total underlying income decreased marginally year-on-year to £400.1 million from £404.1 million, reflecting a 3% reduction in interest earning assets to £20.3 billion and interest income pressure driven by sustained competition in the residential mortgage market, offset by a 43% increase in underlying net fee and other income. Interest expense increased to £188.1 million from £114.3 million and captures the full year expense of the £250 million subordinated Tier 2 notes issued in June 2018 and one quarter of interest on the £350 million senior non-preferred notes issued in October 2019. Cost of deposits has risen to an average of 78bps for full-year 2019, from 61bps in 2018 reflecting competitive pricing in retail fixed-term savings and absorption of the impact of the August 2018 Bank of England base rate rise.

The adoption of IFRS 16, the new leasing standard, also had an impact on net interest income through the recognition of an interest charge on the lease liability, partly offset by a reduction in lease expenses. The net effect was a c.£18 million reduction in revenue. Given growth in our store network and our relatively young lease portfolio, the impact is more pronounced for us compared with many of our peers.

The above trends resulted in a year-on-year reduction in our net interest margin ("NIM") to 1.51% from 1.81%.

The income impact from the reduction in NIM was partly offset by the strong growth in fee and commission income, up 43% year-on-year to £90 million (2018: £63 million) on the statutory basis. Non-interest income growth has been an area of focus for the bank throughout 2019, with the increase driven by optimisation of fee structures, strong growth in customer accounts and the introduction of new value-added products and services. Net fee and other income (excluding net gains on sale of assets) as a percentage of total revenue has increased to 24% from 16% in 2018. Given our strong focus on customer service and further expansion of our product offering for SMEs, we expect non-interest income to continue to grow in 2020.

Operating expenses 

Underlying operating expenses grew by 16% during the year to £400.1 million. Given our focus on improving cost efficiency, the pace of cost growth slowed in the second half of 2019 to just 2% versus the first half. The increase in operating expenses primarily reflects the expansion of our store footprint driving higher people and occupancy costs and growth in regulation and technology costs.

Depreciation and amortisation grew to £76.4 million during 2019 (2018: £45.1 million) reflecting growth in the store network to 71 stores (2018: 65) and ongoing investment in IT and digital to support our integrated offering. The introduction of IFRS 16 lease accounting on 1 January 2019 also led to a depreciation charge on the right-of-use asset amounting to £16 million.

The underlying cost/income ratio increased to 100% in 2019 from 86% in 2018, driven by the income challenges outlined above. The bank-wide efficiency programme that is now embedded in the organisation will help to partially offset expected income pressure in 2020 by moderating the pace of operating expense growth.

The difference between underlying loss before tax of £11.7 million and statutory loss before tax of £130.8 million is driven by the write-down of certain intangible assets as well as costs relating to the bank-wide transformation programme and the remediation work undertaken following the RWA adjustment in January 2019 and work undertaken in relation a review of the bank's sanctions procedures. The RWA remediation programme is focused on improving risk-related internal systems, processes, controls and governance and is expected to be completed in 2020.

Stores

During 2019 we opened six stores, including the entry into new regions in the Midlands and the North. The opening in Manchester is the first to be delivered as part of our BCR commitments, and together with the new stores in the Birmingham area, represent an important phase of growth into SME hotspots outside of our existing geographical footprint.

At the year-end we had 71 stores and in early 2020 we opened in Wolverhampton, Cardiff and Hammersmith. Going forward we will maximise the existing estate and selectively expand in strategic locations. We will adapt the new store formats to fit the communities that we will be serving, often with smaller sites, yet retaining the exceptional levels of service our customers expect.

Taxation

During 2019 we made a total tax contribution of £123.1 million (2018: £120.3 million), which comprised £78.2 million (2018:£78.4 million) of taxes we paid and a further £44.9 million (2018: £41.9 million) of taxes we collected.

In 2019 our tax expense recognised in the income statement was £51.8 million (2018: £13.5 million). This

primarily relates to the derecognition of the deferred tax asset for unused tax losses. This is an accounting non-cash item and does not impact our regulatory capital or liquidity. The derecognition reflects the impact on our short-term results of the investment announced as part of our strategy. Our effective tax rate for the year was (39.5%) (2018: 33.2%).

Capital

We have maintained a robust capital position throughout 2019, supported by the £375 million equity capital raise in May 2019 and a slowdown in the pace of RWA growth, up 2% to £9.2 billion. Although the January 2019 adoption of IFRS 16 and RWA adjustment resulted in one-off capital impacts, our CET1 ratio remained above both our 12.0% minimum target and our 10.6% minimum regulatory requirement. Our 15.6% CET1 ratio and 18.3% total capital ratio demonstrate the strength of our capital position and provide headroom for controlled growth and the delivery of our strategy.

The senior non-preferred debt issuance in October 2019 ensured compliance with our interim MREL requirement of 18% of RWAs plus 3.5% regulatory buffers, with the bank closing 2019 with a total capital plus MREL ratio of 22.1%.

Other regulatory developments include the announcement in December 2019 by the bank of England of a change in the countercyclical capital buffer ("CCyB") to 2.00% from 1.00% currently, which is binding from 16 December 2020. Reflecting the additional resilience associated with higher macroprudential buffers, the PRA has said that it will consult banks on the potential reduction on variable capital requirements in order to leave overall loss-absorbing capacity (capital plus bail-inable debt) requirements broadly unchanged.

Looking ahead

The statements above were authorised by the Board for issue on 26 February 2020.

CONSOLIDATED condensed STATEMENT OF COMPREHENSIVE INCOME

FOR THE YEAR ENDED 31 DECEMBER 2019

CONSOLIDATED condensed BALANCE SHEET

AS AT 31 DECEMBER 2019

CONSOLIDATED condensed STATEMENT OF CHANGES IN EQUITY

FOR THE YEAR ENDED 31 DECEMBER 2019

CONSOLIDATED condensed CASH FLOW STATEMENT

FOR THE YEAR ENDED 31 DECEMBER 2019

NOTES

1. Basis of preparation and significant accounting policies

Basis of preparation

The Group's consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ("IFRS") as adopted by the EU, the IFRS Interpretations Committee ("IFRS IC") and the Companies Act 2006 applicable to companies reporting under IFRS.

The financial statements are prepared on a going concern basis as the Directors are satisfied that the Group has the resources to continue in business for the foreseeable future.

Changes in accounting policy and disclosures

The accounting policies and methods of computation are consistent with those applied and disclosed in the Group's 2018 Annual Report and Accounts other than changes owing to the adoption of IFRS 16 'leases'. Where disclosures have been amended as a result of the adoption of IFRS 16, the updated policy has been included within these preliminary results.

IFRS 16 'leases'

On 1 January 2019 the Group adopted IFRS 16. IFRS 16 provides guidance on the classification, recognition and measurement of leases to help provide useful information to the users of financial statements. IFRS 16 replaces IAS 17 'leases' and provides a single lessee accounting model, requiring lessees to recognise right of use ("RoU") assets and lease liabilities for all applicable leases, with operating leases thus being brought onto the face of the balance sheet.

Transition approach

The Group adopted IFRS 16 on the modified retrospective basis and as such the comparators within these financial statements have not been restated and continue to be presented under IAS 17. The Group elected to adopt IFRS 16 using the modified retrospective basis as this prevents an opening adjustment to equity and as such maintained the Group's CET1 capital upon transition.

On adoption of the standard on 1 January 2019, the Group recognised lease liabilities for operating leases of £328 million. The Group elected the transitional option to set the RoU asset equal to the related lease liability for all leases as at 1 January 2019 and therefore there was no opening adjustment to retained earnings. The total amount of RoU asset recognised on 1 January was £313 million, this differs to the opening lease liability due to adjustments being made for the amounts accrued in respect of rent free periods and any prepaid rentals as at the point of transition.

Key estimates

The only key estimate made at the point of transition was the discount rate used to measure lease liabilities. Under IFRS 16 lease payments are discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the Group's incremental borrowing rate. Due to the interest rate implicit in the lease not being readily determinable for any leases at transition the Group's incremental cost of borrowing was used. The weighted average discount rate at transition was 5.5% and was determined by reference to the rate that the Group would be able to borrow in the market for similar assets on a similar basis (i.e. secured) and over a similar time period. The table below shows what the impact would have been on the opening lease liability had the discount rate been one per cent higher or lower.

Key judgements

A key judgement was made in regards to whether the Group will exercise any breaks contained within its leases as this has a significant impact on the measurement of the lease liability. The majority of the Group's leases are around 25 years in length and a proportion of these have break clauses part way through. At transition it has been assumed all leases will be retained for their full term, unless there is a specific plan to vacate the site at an early break point in which case the lease term is deemed to be the period up until that point. This is consistent with the period of time over which leasehold improvements are depreciated over.

Practical expedients

The available practical expedients of exempting leases with a short life (less than 12 months) or low value (less than £5,000) on an ongoing basis has been applied. These leases will continue to be recognised on a straight line basis over the lease term and in total are immaterial to the Group. As a result, the key leases to which the full requirements of IFRS 16 have been applied are property leases of stores and head office sites. At transition there were no leases of 12 months or less (or any longer term leases in their final year) other than those that had a value of below £5,000. The total value of low lease assets at transition was immaterial.

Impact on the financial statements

Due to the Group's young age coupled with its store opening profile over recent years, the vast majority of leases remain in the first half of their terms, with an average remaining lease length of 20 years. The Group's current business model will also see it continue to open stores in the years ahead, albeit at a slower pace, leading to an expanding lease portfolio. These two factors led to higher charges recognised in the income statement in the near term when compared to IAS 17, reflecting a different profile of cost recognition under each standard. Charges under IFRS 16 are front loaded in the earlier years of a lease compared to IAS 17 which requires lease expenses to be recognised on a straight line basis.

Net interest margin ("NIM") is reduced by the adoption of IFRS 16 since the rental expense (part of operating expenses) under IAS 17 will be replaced by a depreciation and an interest expense charge. The interest expense is recognised within NIM, thus reducing it on an ongoing basis.

As stated above IFRS 16 has been adopted on a modified retrospective basis and as such there is no adjustment to equity upon transition. A new RoU asset and lease liability are included on the balance sheet. The addition of the RoU asset has had an impact on regulatory capital as this has a 100% risk weighting, compared to no risk weighting when these were held off balance sheet under IAS 17.

The table below reconciles the undiscounted lease commitments as at 31 December 2019 to the opening lease liability and RoU recognised under IFRS 16 on 1 January 2019.

Accounting policy

The updated accounting policy relating to leases can be found within note 14.

2. Net interest income

Interest income

Interest expense

3. Taxation

Tax expense

The components of the tax expense for the year are:

Reconciliation of the total tax expense

The tax expense shown in the income statement differs from the tax expense that would apply if all accounting profits had been taxed at the UK corporation tax rate.

A reconciliation between the tax expense and the accounting profit multiplied by the UK corporation tax rate is as follows:

The effective tax rate for the year is (39.5%) (2018: 33.2%). The main reasons for this, in addition to the reported accounting loss before tax for the year (2018: accounting profit before tax), are set out below:

Impact of Intangible Asset Impairment on R&D

During the year the Group impaired £68m of Intangible assets. This relates to the discontinuation of certain work-in-progress or older IT projects that do not form part of the Group's revised strategy. As some of these assets had previously qualified for R&D tax relief the R&D deferred tax liability has been adjusted to reflect this.

Share based payments

During the period the Group's share price fell from £16.94 to £2.02. This had the impact of reducing the deferred tax asset held for share options and contributed £1.2m to the deferred tax charge.

Derecognition of tax losses carried forward

The Group has derecognised the deferred tax asset arising in prior years due to the expected impact on its forecast short term results of the investment in cost, revenue and infrastructure transformation. The losses will remain available for offset in the future and recognition will be revaluated at future reporting periods.

Effect of changes in tax rates

This relate to the remeasurement of deferred tax due to rate changes.

Deferred tax

4. Financial instruments

The Group's financial instruments primarily comprise customer deposits, loans and advances to customers, cash and balances with the bank of England and investment securities, all of which arise as a result of normal operations.

The main financial risks arising from financial instruments are credit risk, liquidity risk and market risks (price and interest rate risk).

The financial instruments the Group holds are simple in nature and no significant judgments have been made relating to the classification of financial instruments under IFRS 9.

5. Cash and balances with the bank of England

9. Balances held at other financial institutions have been reclassified during the year as cash, rather than as loans and advances to banks to better reflect the unrestricted nature of these balances.

6. Loans and advances to customers

Further information on the movements in gross carrying amounts and ECL can be found in note 12. An analysis of the gross loans and advances by product category is set out below:

7. Investment securities

Fair value through other comprehensive income

Amortised cost

8. Property, plant and equipment