Nationwide Ccds Regulatory News (NBS)

Nationwide Building Society

Preliminary Results Announcement

For the year ended

4 April 2017

CONTENTS

Underlying profit

Profit before tax shown on a statutory and underlying basis is set out on page 11. Statutory profit before tax of £1,054 million has been adjusted for a number of items to derive an underlying profit before tax of £1,030 million. The purpose of this measure is to reflect management's view of the Group's underlying performance and to assist with like for like comparisons of performance across years. Underlying profit is not designed to measure sustainable levels of profitability as that potentially requires exclusion of non-recurring items even though they are closely related to (or even a direct consequence of) the Group's core business activities.

Forward looking statements

Certain statements in this document are forward looking with respect to plans, goals and expectations relating to the future financial position, business performance and results of Nationwide. Although Nationwide believes that the expectations reflected in these forward looking statements are reasonable, Nationwide can give no assurance that these expectations will prove to be an accurate reflection of actual results. By their nature, all forward looking statements involve risk and uncertainty because they relate to future events and circumstances that are beyond the control of Nationwide including, amongst other things, UK domestic and global economic and business conditions, market related risks such as fluctuation in interest rates and exchange rates, inflation/deflation, the impact of competition, changes in customer preferences, risks concerning borrower credit quality, delays in implementing proposals, the timing, impact and other uncertainties of future acquisitions or other combinations within relevant industries, the policies and actions of regulatory authorities, the impact of tax or other legislation and other regulations in the jurisdictions in which Nationwide operates. As a result, Nationwide's actual future financial condition, business performance and results may differ materially from the plans, goals and expectations expressed or implied in these forward looking statements. Due to such risks and uncertainties Nationwide cautions readers not to place undue reliance on such forward looking statements.

Nationwide undertakes no obligation to update any forward looking statements whether as a result of new information, future events or otherwise.

This document does not constitute or form part of an offer of securities for sale in the United States. Securities may not be offered or sold in the United States absent registration or an exemption from registration. Any public offering to be made in the United States will be made by means of a prospectus that may be obtained from Nationwide and will contain detailed information about Nationwide and management as well as financial statements.

NATIONWIDE BUILDING SOCIETY

RESULTS FOR THE YEAR ENDED 4 APRIL 2017

UK'S MOST TRUSTED FINANCIAL BRAND REACHES RECORD MEMBERSHIP,

BECOMES UK'S TOP CHOICE FOR CURRENT ACCOUNTS,

AND DELIVERS MEMBER FINANCIAL BENEFIT OF £505 MILLION

*Remained no.1 for customer satisfaction amongst high street peer group1*

*15 million members an all-time membership high*

*Helped over 1 in 5 new buyers onto the housing ladder*

*18,000 all-employee engagement refreshed Society's strategy and purpose*

Managing profits for members to bolster financial strength and investment, and deliver member value

· statutory profit £1,054 million (2016: £1,279 million) reflecting competition and decisions to deliver value back to members

· underlying profit £1,030 million (2016: £1,337 million)

· underlying cost income ratio 60.2% (2016: 53.9%) reflecting investment in service and growth

· delivered member financial benefit of £505 million (2016: £397 million)2

· improved Common Equity Tier 1 ratio to 25.4% (2016: 23.2%). UK leverage ratio of 4.4% (2016: 4.4%)

Record current account openings and switching levels

· record 795,000 current accounts opened, up 35%, representing 1 in 7 of all new accounts opened

· UK's top choice for current accounts3, opened more accounts than any other provider (for six months ended March 2017), and nearly 1 in 5 of all switchers chose Nationwide4

· highest ever share of main standard and packaged current account market at 7.5% (2016: 7.1%)

Record mortgage lending, helping 1 in 5 UK first time buyers onto the housing ladder

· record gross mortgage lending, up 3% to £33.7 billion

· record gross prime lending, up 14% to £29.1 billion

· helped a record 75,000 first-time buyers, up 31%

Protected members with average deposit rates a third higher than the market average5

· member deposit balances grew by £5.8 billion (2016: £6.3 billion)

· provided members with £380 million (2016: £285 million) in additional deposit interest compared to market average

· maintained rates on Help to Buy ISA, Flexclusive Regular Saver and Regular Saver accounts

Most trusted financial services brand6 and No.1 for customer satisfaction1

· record membership of 15 million, including record 7.8 million engaged members7 (2016: 7.4 million engaged members)

· highest customer satisfaction amongst our high street peer group - lead of 5% over next best financial provider1

· most trusted brand among financial services peer group6 and UK's most reputable financial services provider8

· Which? 'Banking Brand of the Year 2017'

· among highest employee engagement scores worldwide, supporting our service culture

'Building society, nationwide' purpose sees investment in communities and high street

· committed to investing £80 million in branches during 2017/18

· opened 'first branch back' in Glastonbury, responding to call of community

· 75% of employees involved in fundraising, volunteering or payroll giving

· £5 million channelled into community and charity support

Nationwide Chief Executive, Joe Garner, said:

"Last year we saw continued high levels of profitability and financial strength which allowed us to deliver real value, over half a billion pounds, to our members. It is the combination of that value and our service, where we are rated number one for customer satisfaction amongst our high street peer group1, which helped Nationwide grow membership to an all-time high of 15 million. Record growth in mortgages and current accounts helped us deliver profits of over £1 billion for the third year running.

"As a member-owned organisation, we don't seek to maximise our profits but to manage them in our members' interests. We make conscious choices about how we distribute our profitability between strategic investment, capital generation and member financial benefit. Our success this year allowed us to improve our capital strength and continue to invest in growing the Society. At the same time, we were able to give back £505 million to members which included maintaining selected savings rates while passing on the base rate decrease in full to mortgage borrowers. The combination of the low interest rate environment and our decisions to protect savings rates for longer led to an exceptional year for member value.

"We can make these choices thanks to our success in attracting and retaining members. Our record year for mortgage lending included helping 75,000 first time buyers onto the housing ladder. We opened a record number of current accounts, with almost 1 in 5 of people switching choosing Nationwide4. And Nationwide achieved a new milestone, becoming the UK's top choice for current accounts3. We protected our savers with rates a third higher than the market average, leading to a growth in member deposits of £5.8 billion. We are delighted to have recently become Which? 'Banking Brand of the Year 2017'.

"While we saw record use of online services driven by our mobile app, we know that members value our branch network, which is why we are investing £80 million in upgrading branches this year. We have also opened a branch in Glastonbury, Somerset, which had been left without a bank, to test the viability of opening branches with community support. If successful, we may choose to open other branches where there is demand from a community.

"As a mutual, our business is underpinned by a social purpose, and we are determined to use our success to deliver long term value to members and communities. As Brexit negotiations get underway, these strong results ensure that we are well placed to support members through the uncertainty that lies ahead."

Nationwide Chief Financial Officer, Mark Rennison, said:

"Nationwide has delivered a very strong trading performance over the last year, with record levels of active members, mortgage lending and current account openings.

"We chose to protect savers from the full effects of last summer's interest rate cut, knowing that this would reduce our full year profitability in the continuing low interest rate environment, but considering this to be in our members' best interests. Nevertheless, we delivered statutory profits of £1,054 million, the third consecutive year where our profits exceeded £1 billion, together with strong growth in prime mortgage lending and in current account openings.

"In the last few years, we have funded significant business growth, including opening over two million current accounts in the past four years. This, combined with strategic investment in the Society - in new products, better service propositions, strengthened controls and an enhanced pension scheme for employees - has contributed to an increase in costs. In the coming year, we will be sharpening our focus on efficiency and expect our costs to be broadly flat in the year ahead.

"As well as protecting savers, our trading performance allowed us to further strengthen our core capital ratio to 25.4% and maintain our conservative 4.4% UK leverage ratio."

1 © GfK 2017, Financial Research Survey (FRS), 3 months ending 31 March 2017 vs. 3 months ending 31 March 2016, proportion of extremely/very satisfied customers minus proportion of extremely/very/fairly dissatisfied customers summed across current account, mortgage and savings, high street peer group defined as providers with main current account market share >6% (Barclays, Halifax, HSBC, Lloyds Bank (inc C&G), NatWest and Santander).

2 Further information on member financial benefit is contained in the Financial review.

3 Source: Nationwide Brand and Advertising tracker - compiled by Independent Research Agency. 'Top choice' is most considered i.e. 'first choice' or 'seriously considered' current account provider amongst non-customers, based on responses from non-customers of each brand, 3 months ending March 2017. Financial brands included Nationwide, Barclays, Co-operative Bank, First Direct, Halifax, HSBC, Lloyds, NatWest, TSB and Santander.

4 Source: Independent Research Agency, eBenchmarkers, CACI, BACS Payments Schemes monthly CASS switching market data and internal sources.

5 Bank of England whole of market average interest rates on a 12-month rolling basis, adjusted to exclude Nationwide's balances.

6 Source: Nationwide Brand and Advertising tracker - compiled by Independent Research Agency, based on responses from existing customers of each brand, 3 months ending March 2017. Financial brands included Nationwide, Barclays, Co-operative Bank, First Direct, Halifax, HSBC, Lloyds, NatWest, TSB and Santander.

7 Defined as members who hold a mortgage or savings account (with a balance greater than £5,000) or their main current account with Nationwide.

8 2017 UK RepTrak® (Reputation Institute), ranked Nationwide as the 29th most reputable company in the UK.

FINANCIAL SUMMARY

Notes:

i. Member deposits include current account credit balances.

ii. Net receipts include outflows of non-member deposits relating to the closure of off-shore operations in the Isle of Man and Republic of Ireland.

iii. Reported under CRD IV on an end point basis. The CRR leverage ratio is calculated using the Capital Requirements Regulation (CRR) definition of Tier 1 for the capital amount and the Delegated Act definition of the exposure measure.

iv. The UK leverage ratio is shown on the basis of measurement announced by the Prudential Regulation Authority and excludes eligible central bank reserves from the leverage exposure measure.

v. The wholesale funding ratio includes all balance sheet sources of funding (including securitisations) but excludes Funding for Lending Scheme (FLS) drawings which, as asset swaps, are not included on Nationwide's balance sheet, reflecting the substance of the arrangement. Off-balance sheet FLS drawings totalled £4.8 billion (2016: £8.5 billion).

Chief Executive's review

Why being a building society matters

Our building society has an extraordinary past. Nationwide was born of a social purpose and the belief that people can achieve more together than alone. That speaks to an equally extraordinary future. We are unashamedly ambitious for a future in which we are seen to be genuinely 'building society, nationwide'. After a year as your Chief Executive, I am more convinced than ever that Nationwide's mutual purpose remains as relevant today as it was when we were founded 130 years ago.

Nationwide's strong trading and financial performance in 2016/17 puts us in a good position. Membership is at a record high, as more people choose Nationwide for mortgages, savings and current accounts than ever before. We are proud to be, for the first time, the UK's top choice for current accounts.

Nationwide has a strong reputation for outstanding service, where we lead our high street peer group for customer satisfaction by 5%1, delivered by loyal and committed people. As a result, membership grew to over 15 million.

Nationwide is in robust financial health, having achieved profits of over £1 billion for the third consecutive year. As a mutual, profits are not the only barometer of our success, but they are important because they allow us to maintain our financial strength, to invest with confidence, and to return value to you, our members, through pricing and service. During the year, we therefore took conscious decisions on interest rates, fees and incentives, that delivered a financial benefit of £505 million to our members, alongside the high standards of service we are known for. For more information see our Financial review.

Financially strong and sustainable

Nationwide remains safe and secure as shown by a strong capital position and balance sheet. We have improved the Society's common equity tier 1 ratio to 25.4% (2016: 23.2%), and the UK leverage ratio remains robust at 4.4%.

As anticipated, statutory profit reduced by 17.6% in the year to £1,054 million, due to a number of factors. Net interest income reduced due to the prevailing low interest rate environment, competition in the mortgage market and the conscious decisions we have taken to protect rates for savers while passing on the base rate decrease to mortgage borrowers. There has also been a growth in underlying costs, mainly reflecting ongoing expenditure on strategic investment, together with growth in business volumes. The impact of these has been partially offset by a gain of £100 million from the disposal of the Society's stake in Visa Europe during the period.

Strategic investment in the Society is greater than ever before, reflecting our commitment to investing in new products and better service propositions for members. We also continue to invest in strengthening our resilience and control environment to keep our members' money safe. As a responsible employer, we have supported our people by increasing pension contributions.

These increases to costs have led to a deterioration in our underlying cost income ratio to 60.2% (2016: 53.9%). In the coming year, we will keep our costs broadly flat by implementing efficiency initiatives, such as our 'right first time' programme to reduce errors and duplication across the business, and our plans to automate more manual processes. We will continue to invest where we believe it is in the long term interests of our members.

We have a stable and low-risk business model, which is fundamentally about looking after our members' deposits and putting them to work funding other members' mortgages. During the year, we identified several parts of the business that were not a good fit with our core purpose. We have begun to exit these responsibly. We will stop offering car insurance to new customers from June 2017 and will be writing to customers to let them know how their policy will be managed in future. We are also winding down our commercial lending business, will exit the Nationwide International deposit-taking business, and will no longer offer inheritance tax planning advice. While we recognise these customer needs, we believe it is not in the interests of our Society to provide services which are not core to our business.

Nationwide's financial strength, improved efficiency, and a tighter focus on our core business will ensure we can continue to invest in new products, good value pricing, and the service quality members value.

1 © GfK 2017, Financial Research Survey (FRS), 3 months ending 31 March 2017, proportion of extremely/very satisfied customers minus proportion of extremely/very/fairly dissatisfied customers summed across current account, mortgage and savings, high street peer group defined as providers with main current account market share >6% (Barclays, Halifax, HSBC, Lloyds Bank (inc C&G), NatWest and Santander).'

Chief Executive's review (continued)

Record membership as more people choose Nationwide

Nationwide's membership reached an all-time high, with over 15 million members, including a record 7.8 million engaged members who hold a core product with us.

More than 2.2 million members hold mortgages with us, representing a market share of 12.9% and, as the UK's second largest mortgage lender, we remain committed to helping people own their own home. In the year, we lent more to help people onto or up the housing ladder than ever before, with total mortgage lending of £33.7 billion, up 3%. We also helped 75,000 first-time buyers into their first home, representing 1 in 5 of all first-time buyers in the UK and a new record (2016: 57,200). In March, we launched a new Family Deposit Mortgage that allows homeowners to raise funds from their existing property to help another family member buy a home and we are already processing the first applications.

We also support the growing private rented sector through our dedicated buy to let subsidiary, The Mortgage Works (UK) plc. We have tightened our criteria on lending to make sure our borrowers can meet future repayments. This move, combined with the softening of lending which followed changes to Stamp Duty in March 2016, resulted in a planned fall in buy to let lending to £4.6 billion, a decline of 36%.

We are the UK's third largest savings provider, accounting for £1 in every £10 of savings in Britain. With interest rates still at record lows, we remain committed to encouraging the nation to keep saving. We kept average deposit interest rates over a third higher than the market average in the last year, leading to £5.8 billion growth in member balances. Following the base rate cut in the summer, we maintained rates on our Help to Buy ISA, Flexclusive Regular Saver and Regular Saver accounts. As part of our overall desire to support savers, over the last year our members benefited from £380 million in additional interest compared to the market average. 1.7 million members have signed up to SavingsWatch, our email and text alert service for rate changes and new products.

Nationwide achieved a new milestone, becoming the UK's top choice for current accounts. A combination of strong growth and good retention took our market share of main standard and packaged current accounts to 7.5% at February, up from 7.1% last year. A record 795,000 Nationwide current accounts were opened over the year, an increase of 35% over the previous year. This included 147,000 new youth accounts, a market share of 14.3% in the youth market. A further 169,000 people chose FlexPlus, our award-winning account. We strongly support financial inclusion by providing customers access to a full banking service with our FlexBasic account. We also continue to benefit from high switching rates through the Current Account Switch Service, with some 165,000 current account holders switching to Nationwide - an 18% share of the total personal switcher market. We are delighted to have recently become Which? 'Banking Brand of the Year 2017'.

We continued to provide a full range of personal banking services and saw steady growth in credit cards issued, personal loans and home insurance.

No 1 for service

If there is one thing that sets us apart, it is Nationwide's high standard of service. We are ranked number one for customer satisfaction amongst our high street peer group, with a lead of 5.0%1 over the nearest competitor thanks to the culture of care I see everywhere at Nationwide. As service expectations of our members tend only to rise, we are constantly seeking ways to serve members even better.

We are working hard to provide a truly seamless service across mobile, branch and telephone channels, so that members can choose when, where and how to transact with us. It is 20 years this year since we launched our internet bank - the first in the UK - and we still combine digital convenience with a human touch. In the last year mobile log-ons grew by 73%, and we aim to double the number of members who are active via mobile channels.

At the same time, our branches remain busy: over half of all new current accounts are still opened in a branch. We still see a vital role for the branch network, despite the continued withdrawal of financial services providers from high streets over the last two decades.

We are exploring ways to ensure branches remain financially viable in a future where members may use them less. For example, we're testing using Nationwide NOW, our state of the art video technology, to connect customers to mortgage, personal banking and financial consultants in selected branches, as well as contact centres, using our branch consultants' time more efficiently. Similarly, we're piloting a new community branch in Glastonbury, which opened in April, to test the viability of combining personal service and the latest technology to serve communities left without a bank.

1 © GfK 2017, Financial Research Survey (FRS), 3 months ending 31 March 2017, proportion of extremely/very satisfied customers minus proportion of extremely/very/fairly dissatisfied customers summed across current account, mortgage and savings, high street peer group defined as providers with main current account market share >6% (Barclays, Halifax, HSBC, Lloyds Bank (inc C&G), NatWest and Santander). 

Chief Executive's review (continued)

Great place to work

Our employees provide the foundations on which our member service and propositions thrive, so we try very hard to make Nationwide Building Society a great place to work. Our success is reflected in our very high employee engagement score which, at 78%, is above the average score of high performing organisations worldwide. In the previous year we improved our employee pension scheme by increasing our employer contributions, helping to ensure that employees will have a living pension.

Our reputation as a good employer reflects the very special culture and ethos of Nationwide, which is encapsulated in our PRIDE values:

Putting our members and their money first

Rising to the challenge

Inspiring trust

Doing the right thing in the right way

Excelling at relationships

Leading by example and making a difference

Since our origins in the 19th century right through to the present day, our aim has been to support communities by helping people save and live in better homes. We continue to invest at least 1% of our pre-tax profits to support good causes, in line with our purpose. This funding supports both our own social investment programme and the Nationwide Foundation, the independent charity we established 20 years ago to provide decent, affordable homes for people in housing need.

Our five-year Living on your Side social investment programme drew to a close in April and, I am proud to report, achieved all its objectives. Over five years, we helped 958,000 people into a home of their own, enabled over one million people to start saving, and channelled more than £21 million into community and charity support.

As housing in Britain remains a challenge, we want to play our part in addressing this by targeting a range of housing issues with our new social investment programme. This will be launched in 2017 and will focus on an aspiration that everyone has a place fit to call home. It will also include a new social ambition to find local solutions to national housing issues. We will also support the growing number of people who rent by championing the rights of tenants and high standards for landlords.

A refreshed purpose and strategy

Our business model of looking after our members' deposits and using them to fund other members' mortgages, is broadly unchanged since we were founded. Our belief in the power of mutuality is a constant.

But the world around us is changing like never before, and we have a responsibility to review our Society's strategy periodically to ensure we're able to respond to these changes. Technology is profoundly reshaping customer needs, expectations and relationships. Political upheavals have shown that many people feel the system is not working for them. Economically, the continued era of low interest rates and increasing competition creates new challenges for us to respond to. By refreshing our Society's strategy, we have prepared ourselves to meet these challenges and embrace the opportunities we see ahead.

Collaboration has been a force for good throughout Nationwide's history, which is why we started our strategy refresh with a huge listening exercise, giving our people and our members the chance to contribute to our future. Almost all of our 18,000 colleagues had the chance to contribute through a five-week 'Big Conversation' last summer. We've also listened to you, our members, at Talkback events, through our 5,000-strong online Member Connect community, and through our everyday interactions across the Society.

This huge collaborative effort has led to a reinvigorated sense of Nationwide's purpose, which we describe as building society, nationwide - helping people improve the quality of their lives. It has also helped to shape a refreshed strategy, which will allow us to deliver value for members in an efficient and compelling way.

Chief Executive's review (continued)

To do this, we have organised our strategy around five cornerstones that define what we stand for, what we will do and how we will do it:

Built to Last - being safe, secure, sustainable and dependable

Building PRIDE - shared values, shared culture, doing the right thing

Building Legendary Service - providing service that is heartfelt, easy, lifelong and personal

Building Thriving Membership - delivering real value for our members

Building a National Treasure - leading by example and making a difference

For each cornerstone, we have developed a set of key performance indicators (KPIs). These will ensure that we remain tightly focused on our purpose and also provide you, as members, with the ability to assess the Society's performance.

Outlook

Nationwide is a domestic, consumer-facing business, which means consumer confidence matters to us. This is why, alongside our macro-economic analysis, we have asked consumers how they are feeling on an individual level.

Our research shows that confidence among consumers has held up well since last year's referendum, thanks to the strong performance of the UK economy. It also showed that consumers are alert to the economic uncertainties ahead, with the Brexit negotiations, low interest rates and inflation registering as concerns. However, households remain relatively optimistic about their own finances, and are going about their daily lives as normal.

Spending most commonly cited by consumers as possible future concerns are the food, utility and other household bills that make up a good proportion of monthly outgoings, and we anticipate that a combination of rising inflation and modest wage growth is likely to squeeze household budgets. Unsurprisingly, consumers said that if they needed to trim their spending in the future, they would cut back on leisure activities first, and see their mortgage and rent payments as most protected.

In the housing market, if the economy slows as we expect, there will be a cooling effect in the form of lower sales and house price growth - and in fact the first signs of this are already showing through in market data. However, the continued shortage of homes in the UK will support house prices, which we expect to rise by 2% in 2017, with some scope for a further softening in 2018 to 2019. In the medium-term, we expect house prices to rise broadly in line with earnings.

It's clear that consumers are alive to the economic uncertainties that lie ahead, as are we. In this environment, we believe the benefits of mutuality will become only clearer. Last year, we protected our members through enhanced pricing, putting an additional £505 million into members' pockets. We anticipate that the financial benefit will vary from year to year depending on market conditions, and expect it to reduce next year. However, Nationwide's financial strength, stable and low risk business model, and strong trading performance all mean we are well placed to continue to support the UK economy, and our members, in the uncertain times ahead. In the medium term, I believe people will always want to save for their future, manage their daily finances and have a place to call home, so the fundamentals of Nationwide's business remain as relevant as ever.

Building society, nationwide

Nationwide is your Society, and we are custodians of it. I hope this statement has given you a sense of what we achieved on your behalf last year and the strength of our Society to achieve its purpose of building society, nationwide.

Financial review

Overall performance

Financial performance for the year ended 4 April 2017 was in line with the expectations indicated when announcing our 2015/16 financial results. Statutory profit before tax was £1,054 million (2016: £1,279 million) and underlying profit was £1,030 million (2016: £1,337 million), reflecting our continued focus on offering value on our products and better service for our members, whilst maintaining capital strength.

An advantage of being a building society is that Nationwide can choose to forgo an element of profitability in order to deliver more value to our members, whilst ensuring we maintain financial strength and safeguard our members' money. In 2016 we introduced a financial performance framework with parameters which enable us to calibrate future performance to achieve the right balance between distributing value to members and maintaining financial strength. Despite the reduction in profitability, 2016/17 underlying profit remains comfortably within the target range set by our financial performance framework.

Our underlying cost income ratio has deteriorated to 60.2% (2016: 53.9%) primarily due to increased costs against broadly flat total underlying income. The rise in costs reflects ongoing expenditure on strategic investment to enhance propositions and service for our members, and increased staff costs, including our investment in a 'Living Pension' for our employees. We have also incurred one-off costs during the year relating to restructuring and asset write downs, reflecting the pace of change of technology and changing member needs. These one-off costs, along with other in-flight initiatives and our target to deliver £300 million of sustainable cost savings by 2022, will result in lower cost growth in future periods.

Impairment losses have increased following a review of the secured and unsecured lending portfolios to ensure that the evidence of impairment and latent risks during the low interest rate environment are adequately represented in the model assumptions, and that appropriate provisions are held for interest only loans where borrowers may be unable to repay capital balances at maturity.

Total assets have grown by £12.7 billion to £222 billion as at 4 April 2017, largely due to a £9.1 billion increase in residential mortgages. Of this, £8.0 billion relates to prime mortgages and reflects a strong trading performance aligned to our strategic objective of increasing our market share of prime mortgages. The remainder of the balance sheet growth is driven by an increase in high quality liquid assets as we replace off-balance sheet Funding for Lending Scheme (FLS) liquidity with on-balance sheet Term Funding Scheme (TFS).

Capital levels have remained strong with Common Equity Tier 1 (CET1) ratio and UK leverage ratios of 25.4% and 4.4% respectively (2016: 23.2% and 4.4% respectively). The UK leverage ratio remains unchanged as profits have broadly offset the increase in the defined benefit pension deficit and balance sheet growth driven by increases in mortgage balances.

We expect the prolonged low interest rate environment and competition in the mortgage market to continue in the period ahead. Notwithstanding this, our positive trading performance, financial strength and high quality balance sheet mean that we are well placed to deliver long term value to our members. We will also continue to focus on driving our efficiency agenda to reduce cost growth in future periods.

Financial review (continued)

Income statement

Notes:

i. Underlying profit represents management's view of underlying performance and is presented to aid comparability across reporting periods.

ii. Within the statutory results presented in the financial statements:

a. transformation costs and bank levy are included within administrative expenses

b. Financial Services Compensation Scheme (FSCS) costs are included within provisions for liabilities and charges

c. gains from derivatives and hedge accounting are presented separately within total income.

iii. Although we only use derivatives to hedge market risks, income statement volatility can still arise due to hedge accounting ineffectiveness or because hedge accounting is either not currently applied or is not currently achievable. This volatility is largely attributable to accounting rules which do not fully reflect the economic reality of the hedging strategy.

Net interest income has reduced by £126 million to £2,960 million (2016: £3,086 million). This reduction is primarily due to ongoing competition in the mortgage market and our continued focus on delivering long term value to our members, combined with the ongoing natural run off of our residential base and standard mortgage rate balances. The competitive rates available across the market have led to more members switching to competitively priced products (£17.0 billion of members' balances switched to lower priced Nationwide mortgages) and higher redemptions. This reduction in back book balances, together with lower margins on new business pricing, has resulted in downward pressure on our NIM. As anticipated our NIM for the year of 1.33% was lower than the previous year's NIM of 1.52%.

The longer-term impact on the UK economy of the EU referendum vote is uncertain and, with interest rates expected to continue to remain at historically low levels for a prolonged period, we expect NIM to remain broadly stable for the year ahead.

Margin pressure resulting from increased competition for new mortgage lending has led to savings rates continuing to fall across the industry. In line with our mutual principles we have chosen to forgo an element of profitability through resisting lowering savings rates where possible and offering competitive products.

Following the decision by the Bank of England to cut the bank rate to 0.25%, we committed to protecting members who save regularly, or are building a deposit to buy their own home, resulting in several products being protected from the bank rate decrease. We have also applied a 0.10% rate floor to all variable products.

Financial review (continued)

Other income has increased by 32% to £325 million (2016: £247 million) primarily due to a one-off gain of £100 million from the disposal of our investment in Visa Europe during the year. Excluding this gain, underlying other income has reduced, primarily due to a reduction of £15 million in income from credit card transactions, following the introduction of regulatory caps in December 2015, and a decrease of £7 million in other income received from mortgages. Whilst the number of active current accounts has increased, the associated net fee income is broadly flat as we continue to support the financial inclusion of customers by offering the benefits of our FlexBasic account, which has no fees for certain transactions.

Underlying administrative expenses increased by 10% (£183 million) due to increases in employee costs and strategic investment in propositions and service for members, as well as restructuring costs to drive efficiency and the costs of servicing higher business volumes. The underlying cost income ratio has increased to 60.2% (2016: 53.9%). At a statutory level, administrative expenses increased by 9% (£174 million).

Our cost trajectory reflects significant business growth and investment over recent years. Mortgage balances have grown 18% over the last three years and we have 42% more main current accounts today than in 2014.

During 2016/17 employee costs increased by £57 million, reflecting an annual pay award averaging 2.1% and higher full year costs from enhancements made in 2015/16 to the defined contribution pension scheme in line with our commitment to provide a 'Living Pension'. Average employee numbers increased by 4% year on year to build greater capacity to meet additional business volumes, deliver our investment strategy and further strengthen control functions.

Notwithstanding the fact that cost growth in recent years is the result of conscious decisions to support the Society's strategy and the service provided to members, we recognise the need to improve efficiency, and that cost increases significantly ahead of inflation are not sustainable in the continuing low interest rate environment we face. We will continue our focus on operational efficiency, exploiting the benefits of past and ongoing investment while continuing to prioritise the needs of our members. We have launched an efficiency programme which targets £300 million of sustainable cost savings to be delivered by 2022. This includes investing £43 million in 2016/17 in improving longer term efficiency, including accelerating automation and digitised service delivery, costs associated with organisational simplification, the announced closure of our Isle of Man and Republic of Ireland operations, and our withdrawal from the commercial real estate (CRE) sector. We have allocated approximately £100 million of spend over the next three years to support the programme, and anticipate that our focus on efficiency will enable us to achieve broadly flat costs in 2017/18 and lower cost growth in future.

To support the long term interests of our members, we continue to invest in propositions, service and resilience. During the period, investment has focused on service improvements for members, both in branch and through digital channels, including updating our savings point of sale systems to allow real time online account opening, delivery of in-house credit risk assessments for prime mortgages, upgrades to our Banking App for smartphones and tablets, and the roll out of further video links in branches which allow members greater flexibility to speak face to face with advisors in another location. We have also invested in IT resilience and ensuring compliance with UK and EU regulatory requirements.

Following a review of amounts capitalised for assets in use or in the course of development, asset write downs of £31 million (2016: £2 million) were recognised in the year, along with an increased depreciation charge of £15 million due to adjustments to asset lives, reflecting the pace of change of technology and changing member needs.

Financial review (continued)

Impairment losses have increased by £67 million to £140 million (2016: £73 million) driven by additional residential mortgage impairments as a result of enhancements to our credit loss provisioning methodology, combined with lower levels of net recoveries in the CRE portfolio.

Residential lending impairment charges of £58 million (2016: £18 million) include £45 million (2016: £27 million) as a result of enhancements to the provisioning methodology and assumptions to ensure provisions continue to reflect appropriately the incurred losses within each portfolio. These enhancements reflect the extended period for arrears to arise from trigger events and the risks associated with the ability of borrowers to repay capital balances at the maturity of interest only loans. Excluding these methodology changes, the underlying impairment charge of £13 million (2016: £9 million release) reflects the stabilisation of mortgage arrears at 0.45%, compared with a fall from 0.49% to 0.45% in the prior year, and a more modest benefit from house price inflation.

Consumer banking impairment charges have decreased by £18 million to £78 million (2016: £96 million). Of this charge, £7 million (2016: £29 million) represents a reassessment of impairment assumptions to reflect latent risks during the current low interest rate environment. Excluding this, the consumer banking charge has remained relatively consistent, reflecting both stable arrears performance and gross lending balances.

Commercial lending impairments relate exclusively to CRE lending, with no arrears in our registered social landlords and project finance portfolios. The net impairment reversal of £5 million (2016: £34 million) is a result of continued CRE market improvements in terms of both asset values and liquidity.

We hold provisions for customer redress to cover the costs of remediation and redress in relation to past sales of financial products and post sales administration, including compliance with consumer credit legislation and other regulatory requirements. The charge for the year primarily relates to customer redress provisions recognised in respect of PPI and Plevin, including the cost of administering these claims. When assessing the adequacy of our PPI provision we have considered the implications of the guidance published by the Financial Conduct Authority (FCA) in its March 2017 policy statement (PS17/03), including the expected impact of the Plevin case. More information on customer redress is included in note 16.

There is no net charge for the year in respect of the Financial Services Compensation Scheme (FSCS) (2016: £46 million charge). This reflects the substantial repayment of the loan from HM Treasury to FSCS as a result of the securitisation of Bradford & Bingley plc assets, and our £13 million share of recoveries from Icelandic banks. More information on FSCS is included in note 16.

Taxation

The tax charge for the year of £297 million (2016: £294 million) represents an effective tax rate of 28% (2016: 23%) which is higher than the statutory UK corporation tax rate of 20% (2016: 20%). The effective rate is increased due to the banking surcharge which is payable at a rate of 8% from 1 January 2016, equivalent to £62 million (2016: £22 million), and by the tax effect of disallowable bank levy and customer redress costs of £8 million and £19 million (2016: £8 million and £7 million) respectively. Further information is provided in note 9.

Financial review (continued)

Member financial benefit

As a building society, we know that our members value the highly competitive savings and mortgage products we can offer as a direct result of being a member-owned business. We measure our member financial benefit by considering our differentiated interest rate pricing, reduced fees and incentives, compared to industry benchmarks. The financial benefit measured has given our members an additional £505 million (2016: £397 million) in their pockets for the year. We have chosen to quantify our member financial benefit, as we want members to understand the financial as well as the non‑financial benefits they gain from mutuality.

Member financial benefit is delivered in the form of differentiated pricing and incentives, which we quantify as:

Our interest rate differential + member reduced fees + incentives

Interest rate differential

We measure how our average interest rates compare against the market.

For our two largest member segments, prime mortgages and retail deposits, we compare the average member interest rate for these portfolios against relevant industry benchmarks. A CACI benchmark is used for prime mortgages and Bank of England benchmark for retail deposits1, both on a 12 month rolling basis. The differentials derived in this way are then applied to member balances for mortgages and deposits.

For unsecured lending, a similar comparison is made. The differential of Nationwide's average new business lending rate against the Bank of England's average new business lending rate is applied to the total interest bearing balances of credit cards and personal loans. These are also measured on a 12 month rolling average basis.

Member reduced fees and incentives

Our member financial benefit measure also includes amounts in relation to reduced fees and incentives provided to members, and includes annual amounts provided for the following:

· Prime mortgages: the differential on incentives and fees for members compared to the market

· 'Recommend a friend': the amount paid to existing members, when they recommend a new current account member to the Society

· FlexPlus account: this current account is considered market leading against major banking competitors, with a high level of benefits for a relatively smaller fee. The difference between the monthly account fee of £10 and the market average of £16 is included in the member financial benefit measure.

The increase in member financial benefit compared with the prior year primarily reflects the discretionary actions we took during the year to protect savings rates in a declining interest rate environment. Prudent management of the Society requires us to manage savings flows and our cost of retail funding in the context of wider market conditions, and in particular demand for lending. Therefore the benefit we provide to members is dependent on a variety of external market and competitive factors, as well as maintaining a balance between profits we retain and member benefit we provide.

1 Adjusted to exclude Nationwide's balances

Financial review (continued)

Balance sheet

Total assets have increased 6% year on year to reach £222 billion at 4 April 2017 (2016: £209 billion). This increase primarily reflects our focus on mortgage pricing for members and growing our market share of prime mortgages, with prime mortgage balances increasing by £8.0 billion. The remainder of the balance sheet growth relates to £1.1 billion in relation to specialist lending and a £3.4 billion increase in other financial assets.

Mortgage lending has been partially supported by strong strategic growth in retail funding flows, with member deposits growing by £5.8 billion, and our market share of UK deposits at 10.1% at 4 April 2017 (2016: 10.2%). Of the growth in member balances, £2.7 billion is attributable to current account balances as we have continued to increase our market share of main standard and packaged current accounts, to 7.5% at February 2017 from 7.1% last year. This growth in member deposits reflects our renewed focus on growing our base of engaged members, allowing us to bring the benefit of mutuality to a wider population.

Notes:

i. Other lending balance consists of deferred consideration relating to an investment in Visa Inc, collateral to support repurchase transactions and a residual portfolio of secured loans relating to a European commercial loan facility held by one of Nationwide's subsidiaries, Cromarty CLO Ltd.

ii. Charged off balances relate to accounts which are closed to future transactions and are held on the balance sheet for an extended period (up to 36 months, depending on the product) whilst recovery procedures take place.

Residential mortgages

Residential mortgages include prime and specialist loans, with the specialist portfolio primarily comprising buy to let (BTL) lending. Gross mortgage lending in the period increased 3% to £33.7 billion (2016: £32.6 billion), representing a market share of 14.0% (2016: 13.7%).

Mortgage balances grew by £9.1 billion (2016: £9.3 billion) of which £8.0 billion was prime lending (2016: £5.4 billion) and £1.1 billion related to specialist lending (2016: £3.9 billion).

Financial review (continued)

The average loan to value (LTV) of new lending in the period, weighted by value, increased to 71% (2016: 69%) primarily due to our strategy to increase lending to the first time buyer market as we recognise the importance of helping people take their initial steps onto the housing ladder. Modest house price growth has resulted in the average LTV of our portfolio remaining flat at 55% (2016: 55%). Residential mortgage arrears have remained flat at 0.45% (2016: 0.45%).

Non-performing balances have reduced by £485 million to £2,694 million (2016: £3,179 million), with particular improvement in those balances past due up to three months. However, the impairment provision balance has increased to £144 million (2016: £102 million). This increase in provisions reflects an update to our credit loss provisioning methodology and assumptions to ensure that provisions appropriately reflect incurred losses within the portfolio. This update included focusing on the credit risk associated with maturing interest only loans and the period for evidence of impairment losses to emerge on up to date loans. This provision increase, combined with a reduction in non-performing balances, resulted in an increase in impairment provisions as a percentage of non-performing balances to 5.3% (2016: 3.2%).

The growth of the BTL portfolio has slowed following a decision taken in May 2016 to increase the minimum interest cover ratio for new lending from 125% to 145% and reduce the maximum LTV from 80% to 75%. Despite the anticipated impact of this decision on BTL portfolio growth, these steps were taken in response to forthcoming income tax changes which will materially affect cash flow and affordability for some landlords.

Commercial lending

Total commercial lending balances are £12.6 billion (2016: £13.2 billion) and, as a result of deleveraging activity undertaken in recent years, our overall portfolio is increasingly weighted towards registered social landlords with balances of £7.5 billion (2016: £7.6 billion). This portfolio is fully performing and remains stable, reflecting its low risk nature. The Commercial portfolio also includes loans made under the Government's Private Finance Initiative (PFI) amounting to £1.1 billion (2016: £1.2 billion) and CRE loans of £2.6 billion (2016: £3.0 billion) which have reduced during the period through deleveraging and run-off. The remaining balance of £1.4 billion (2016: £1.4 billion) relates to fair value adjustments where we have hedged loans to mitigate their associated financial risks, typically interest rate risk.

Following the wider strategy review, it was concluded that the commercial lending business was no longer core to the Society's vision for the future and balances will continue to reduce through managed run-off.

Consumer banking

Consumer banking comprises personal loans of £2.0 billion (2016: £1.9 billion), credit cards of £1.7 billion (2016: £1.7 billion) and current account overdrafts of £0.2 billion (2016: £0.2 billion). During the year we have focused on enhancing our consumer banking proposition to create a more cohesive and engaging relationship with our members. The asset quality of the portfolio remains strong, benefiting from proactive risk management practices and continued low interest rates.

Other financial assets

Other financial assets total £31.2 billion (2016: £27.8 billion) and comprise liquidity and investment assets held by our Treasury function amounting to £25.4 billion (2016: £23.1 billion), derivatives with positive fair values of £5.0 billion (2016: £3.9 billion) and fair value adjustments and other assets of £0.8 billion (2016: £0.8 billion).

Derivatives largely comprise interest rate and foreign exchange derivatives, taken out to economically hedge financial risks inherent in our core lending and funding activities.

Levels of on-balance sheet liquid assets have increased due to the replacement of the off-balance sheet FLS liquidity with on-balance sheet TFS drawdowns. The increase in total liquidity is more than offset by higher liquidity requirements, resulting in our Liquidity Coverage Ratio (LCR) reducing from 142.6% as at 4 April 2016 to 124.0%. This increase in requirements reflects the inclusion of additional stressed derivative collateral outflows in the LCR calculation following the finalisation of EU rules during the year, and the impact of one-off items. On a like-for-like basis our LCR would remain broadly consistent with last year's.

Financial review (continued)

Note:

i. The wholesale funding ratio includes all balance sheet sources of funding (including securitisations) but excludes Funding for Lending Scheme (FLS) drawings which, as an asset swap, are not included on Nationwide's balance sheet, reflecting the substance of the arrangement. Off-balance sheet FLS drawings have reduced from £8.5 billion at 4 April 2016 to £4.8 billion.

Member deposits

Member deposits have increased by £5.8 billion to £144.5 billion (2016: £138.7 billion) and our market share of all UK deposits at 4 April 2017 was 10.1% (2016: 10.2%).

Current account credit balances have increased to £17.5 billion (2016: £14.8 billion). We increased our market share of main standard and packaged accounts to 7.5% at February 2017 (2016: 7.1%).

Debt securities in issue

Debt securities in issue of £40.3 billion (2016: £36.1 billion) are used to raise funding in wholesale markets in order to finance core activities. The increase in outstanding amounts partially reflects increased issuance activity in the wholesale markets during the period to support increased liquidity. The wholesale funding ratio has increased to 27.1% (2016: 24.8%) as a result of this wholesale issuance activity, as well as the draw down of TFS which is included in other financial liabilities.

Other financial liabilities

Other financial liabilities include customer and bank deposits (including TFS drawdown) of £17.5 billion (2016: £15.9 billion), derivatives and fair value adjustments of £3.2 billion (2016: £3.5 billion), subordinated debt of £2.9 billion (2016: £1.8 billion) and permanent interest bearing shares (PIBS) of £0.3 billion (2016: £0.4 billion).

During the year a strategic decision was taken to exit the Nationwide International business. This resulted in a £3.6 billion decrease in balances, representing the majority of the deposits associated with this business. These outflows have been managed in an orderly manner with the funding being replaced by additional member deposits and the use of wholesale funding where appropriate.

Financial review (continued)

Statement of comprehensive income

Movements in the table above are shown net of related taxation.

The remeasurement of pension obligations of £255 million expense (2016: £51 million income) reflects £1,298 million of actuarial losses (2016: £164 million actuarial gains), partly offset by £951 million relating to positive movements in the Fund's assets greater than the discount rate (2016: £122 million return less than the discount rate).

The movement in cash flow hedge reserve of £247 million expense (2016: £301 million income) relates to a gross movement before tax of £348 million, driven by significant changes in derivative valuations caused by movements in foreign exchange rates.

Capital structure

Notes:

i. Data in the table is reported under CRD IV on an end point basis.

ii. The UK leverage ratio is shown on the basis of measurement announced by the Prudential Regulation Authority (PRA) and excludes eligible central bank reserves from the leverage exposure measure.

iii. The CRR leverage ratio is calculated using the Capital Requirements Regulation definition of Tier 1 for the capital amount and the delegated act definition of the exposure measure and is reported on an end point basis.

CET1 capital resources have increased over the period by approximately £0.5 billion mainly due to £757 million of profit after tax for the period. Risk weighted assets (RWAs) reduced over the period by approximately £0.8 billion due to continued run-off of the commercial book and lower residential lending RWAs, as a result of house price inflation which more than offset portfolio growth.

The movements described above have resulted in an increase in the CET1 ratio to 25.4% (2016: 23.2%).

The UK leverage ratio is 4.4% at 4 April 2017 (2016: 4.4%) as profits have broadly been offset by an increase in the defined benefit pension deficit and balance sheet growth, which was driven by increases in mortgage balances. The CRR leverage ratio is 4.2% (2016: 4.2%).

We continue to monitor regulatory developments that could lead to an increased level of capital requirements. Whilst there are a number of areas where potential requirements are yet to be finalised, regulatory announcements during the financial year mean that we have a clearer understanding of the expected impact. However, we will remain engaged in the development of the regulatory approach to ensure we are prepared for any change. Whilst these amendments may result in increases to RWAs, we do not believe there will be a material increase in overall capital requirements.  

Business and risk report

Contents

Introduction

Keeping members' money safe by being secure and dependable is fundamental to the way Nationwide operates. This is encapsulated within the strategic principle of being Built to Last which focuses on a prudent approach to risk management. This Business and Risk Report explains the Group's business, the risks it is exposed to and how it manages those risks.

Nationwide is organised into three business operating segments: Retail, Commercial and Head office functions. The Group is predominantly a retail focused operation which trades almost exclusively within the UK. Wholesale funding is accessed from both UK and overseas markets. As the risks of the organisation are managed on a Group basis, and given the dominant position of the Society within the Group structure, the disclosures in the Business and Risk Report are on a consolidated basis covering the activities of both the Group and the Society.

The chart below shows Nationwide's business operating segments and how these activities are reflected in its risk measures. The regulatory risk weighted assets (RWAs) below indicate the relative risks each area carries as at 4 April 2017. Further details regarding Nationwide's RWAs and capital position are included in the Solvency risk section of this report.

Note: No amounts are shown for market risk RWAs as the Group has elected to set these to zero, as permitted by the Capital Requirements Regulation (CRR) where the exposure is below the threshold of 2% of own funds.

Principal risks

Whilst it is accepted that all business activities involve some degree of risk, Nationwide seeks to protect its members by appropriately managing the risks that arise from its activities. The principal types of risk inherent within the business, and the attitude to managing them, are set out below.

The frameworks for managing the above risks, including associated risk appetite, limits and supporting policies, are reviewed at least annually, and are subject to continuous monitoring by the relevant governance committees.

Top and emerging risks

In addition to the above principal risks that are inherent in Nationwide's business, the top and emerging risks that could affect delivery of the strategy are identified and monitored as an integral element of risk management. It is accepted that all business activities involve some degree of risk. Steps are therefore taken to protect members by ensuring that these activities are managed appropriately. Nationwide's 'built to last' strategic cornerstone focuses on being safe, secure, sustainable and dependable for members.

Top and emerging risks are identified and closely tracked throughout the governance structure. These risks are kept under close observation through risk reporting.

Following the result of the EU referendum, the impact of the UK's impending exit from the EU is one of the top risks. This is due to the widespread political and economic uncertainty it has caused, which spans all risk categories. In addition to this, risk management activity over the past year has focused on strengthening business resilience and managing the pace of change in the digital and regulatory environments. Nationwide's top and emerging risks fall within the following categories:

Macroeconomic environment

Nationwide monitors global and domestic macroeconomic factors to ensure preparedness for their potential impacts. Domestically, the effects of Brexit, the upcoming UK general election and the potential for a second Scottish referendum are focus areas. The impact of the continued low interest rate environment and the risks to the business model are closely monitored. The Board also discusses the potential risks to economic growth and stability within financial markets that would be posed by a Eurozone financial crisis, geopolitical instability or a downturn in China or emerging markets.

The result of the Brexit vote has caused political and economic uncertainty. Reassuringly, UK growth projections have recovered since their initial post-referendum fall and the UK regulators have made no immediate changes to their objectives or policies. Nevertheless, a number of key initiatives from the European Commission are in flight and it is expected that these will transpose into UK law despite a vote to leave. Nationwide is well placed to respond to and implement the requirements resulting from these initiatives, and will continue to monitor this position and any associated impacts.

Cyber security, data protection and operational resilience

With increasingly sophisticated cyber security compromises being reported within both financial and non-financial sectors, Nationwide is very alert to the risks posed by breaches of its cyber defences. Cyber security remains a high priority and Nationwide will continue to focus on improving the awareness of its customers and employees, as well as continuing to build its understanding of the developing threats, its defences and its resilience to cyber attacks.

Members' data is safeguarded by investing heavily to maintain and protect systems. To date, Nationwide has successfully defended against data breaches, and continues to ensure that developments are up to date so that members continue to receive the protection that they expect.

In an increasingly digital world, there is pressure to manage considerably larger volumes of data securely and effectively. Nationwide operates a dedicated Operational Resilience function to ensure it meets member expectations for secure, highly reliable and widely available services.

The pace of change in the digital and regulatory environments

Over recent years there has been a dramatic increase in the demand for digital products and services due to the convenience that they can bring. This has seen an influx of innovative new offerings in the market place and the number of challenger banks and Fintech disruptors has increased. Collectively the changes may pose a challenge to Nationwide's core markets and product pricing. The Board continues to monitor the possible impact on Nationwide's business model, and continues to invest heavily in its digital channels and new payment technologies.

Changes in regulation and the resulting impact on the competitive environment from, amongst other things, Open Banking and ring fencing of the major UK banks, continue to be considered by the Board. Nationwide is well placed to respond to these complex regulatory changes, and to provide a variety of products and services which are designed to meet customers' needs. The Board will continue to review Nationwide's ability to respond in an efficient and agile manner.

Lending risk

Lending risk is the risk that a borrower or counterparty fails to pay interest or to repay the principal on a loan or other financial instrument (such as a bond) on time. Lending risk also encompasses extension risk and concentration risk.

This section provides information on Nationwide's exposure to lending risk arising from loans and advances, together with details of the level of collateral held and impairment charges recognised during the period. It also provides information about the key risk measures for each of the loan portfolios.

Nationwide manages lending risk for each of the following portfolios:

In addition, a small other lending portfolio is held of £17 million (2016: £20 million) which primarily includes £8 million of deferred consideration relating to an investment in Visa Inc and £5 million of collateral to support repurchase transactions. There is no significant exposure to lending risk on this portfolio.

Maximum exposure to lending risk

Lending risk largely arises from exposure to loans and advances to customers, which account for 85.9% (2016: 87.3%) of Nationwide's total lending risk exposure. Within this, exposure relates primarily to residential mortgages, which account for 91.4% (2016: 90.7%) of total loans and advances to customers and which comprise high quality assets with low occurrences of arrears and possessions. The increase in the proportion of residential mortgages is primarily driven by Nationwide's continued support for first time buyers which has contributed to the £8 billion growth in prime lending in the year.

In addition to loans and advances to customers, Nationwide is exposed to lending risk on all other financial assets. For financial assets recognised on the balance sheet, the maximum exposure to lending risk represents the balance sheet carrying value after allowance for impairment. For off-balance sheet guarantees, the maximum exposure is the maximum amount that Nationwide would have to pay if the guarantees were to be called upon. For loan commitments and other credit related commitments that are irrevocable over the life of the respective facilities, the maximum exposure is the full amount of the committed facilities.

Nationwide's maximum exposure to lending risk has risen from £220 billion to £234 billion, reflecting the growth in residential mortgage loans.

Lending risk (continued)

Notes:

i. In addition to the amounts shown above, the Group has, as part of its retail operations, revocable commitments of £9,202 million (2016: £8,513 million) in respect of credit card and overdraft facilities. These commitments represent agreements to lend in the future, subject to certain considerations. Such commitments are cancellable by the Group, subject to notice requirements, and given their nature are not expected to be drawn down to the full level of exposure.

ii. At the balance sheet date, Nationwide had entered a commitment to subscribe to up to a maximum of £1.8 billion of residential mortgage backed securities (RMBS) under a programme to securitise Bradford & Bingley residential mortgage assets. This commitment was wholly fulfilled by Nationwide purchasing £1.2 billion RMBS following the issue on 25 April 2017. These have been classified as held to maturity (HTM) investment securities.

iii. The fair value adjustment for portfolio hedged risk and the fair value adjustment for micro hedged risk (included within the carrying value of the commercial lending portfolio) represent hedge accounting adjustments. They are indirectly exposed to lending risk through the relationship with the underlying loans covered by Nationwide's hedging programmes.

iv. The other lending portfolio includes deferred consideration relating to an investment in Visa Inc and collateral balances to support repo transactions.

Movements in impaired loans by lending risk segment

The table below shows the movements throughout the year of all loans classified as impaired. The balance shown represents the entire financial asset rather than just the amount that is overdue.

Lending risk (continued)

Note: Loans that were classified as impaired and loans that have transferred into or out of the impaired classification are based on the relevant status at each month end, when compared to the previous month end.

Lending risk - Residential mortgages

Summary

Nationwide's residential mortgages include both prime and specialist loans. Prime residential mortgages are mainly Nationwide branded advances made through the branch network and intermediary channels. Specialist lending consists of buy to let mortgages originated under The Mortgage Works (UK) plc (TMW) brand.

Strong levels of new lending in the prime portfolio has seen the residential mortgage exposure grow from £162 billion to £171 billion over the year. In part this has been driven by continued support for first time buyers and reflects a commitment given to the UK government to make available £10 billion a year to this segment of the market subject to meeting our lending criteria. In the period Nationwide widened its support for borrowers in the later stages of life with the introduction of a Borrowing in Retirement proposition for those in receipt of a regular pension income. Operating within risk appetite these commitments reflect Nationwide's intention to stand by its members and support the UK economy.

Nationwide controls its lending risk through the application of credit criteria designed to restrict the maximum loan size at higher loan to value (LTV), robust affordability calculations and a credit scoring framework that regulates higher LTV exposures. Portfolio performance is closely measured and monitored against approved risk appetite limits.

Over the period the geographical distribution across the UK has remained stable and the average LTV, weighted by value, has remained at 55%. Support for first time buyers has seen the proportion of new lending made to this segment increase to 36% (2016: 28%). This has contributed to a rise in the average LTV of new lending to 71% (2016: 69%) and growth in the proportion of the portfolio with an LTV above 80%, rising to 9.6% (2016: 8.5%). It is also one of the factors that led to an increase in the proportion of new lending being written at income multiples of 4.5 or greater which during the year has risen to 10.6% (2016: 7.0%).

In contrast the proportion of lending made to the buy to let segment has reduced this year to 14% (2016: 22%) following a decision taken in May 2016 to increase the minimum interest cover ratio (ICR) requirement from 125% to 145% and reduce the maximum LTV from 80% to 75%. These steps were taken in response to forthcoming changes to the income tax relief available for buy to let borrowers which will materially affect the cash flow and affordability for some landlords. The lending policy changes are designed to ensure buy to let borrowing remains sustainable and affordable for our borrowers. In May 2017 we reintroduced 125% ICR lending for basic rate taxpayers to recognise the lower impact of the forthcoming tax changes on these borrowers.

Arrears levels remain low across prime and specialist lending, reflecting the favourable economic conditions and low interest rate environment and supported by robust credit assessment and affordability controls at the point of lending. The proportion of loans more than three months in arrears remained at 0.45% and significantly below the Council of Mortgage Lenders (CML) average of 0.91%. With the immediate outlook for the UK less certain and the buy to let market facing increased costs and potentially less investor demand, the expectation is for a very gradual rise in arrears from these low levels.

The proportion of non-performing loans reduced to 1.6% (2016: 2.0%) while provisions for impairment increased as a result of enhancements to the provision methodology and assumptions to ensure they continue to reflect appropriately the incurred losses within each portfolio. These enhancements, which resulted in an additional £45 million of impairment charge, reflect the extended period for arrears to arise from a loss event and the risks associated with the ability of borrowers to repay capital balances at the maturity of interest only loans.

Lending risk - Residential mortgages (continued)

Lending and new business

The table below summarises the residential mortgages portfolios:

Note: Self-certified, near prime and sub prime lending were discontinued in 2009.

Note: All new business measures exclude existing customers who are only switching products and/or taking further advances.

In October 2014, the Financial Policy Committee (FPC) introduced a 15% limit on the proportion of new lending that may be written at income multiples of 4.5 and above. This limit applies to residential mortgages, excluding buy to let. The proportion of new lending at income multiples of 4.5 or higher has averaged 10.6% (2016: 7.0%). The increase partly reflects the higher proportion of lending to first time buyers as Nationwide continues to support this segment of the market. The proportion of new lending at income multiples of 4.5 or higher is closely monitored and controlled to remain within risk appetite.

The proportion of lending to buy to let investors reduced during the year as a consequence of Nationwide taking a lead in the market and increasing the minimum interest cover ratio requirement in anticipation of the effect forthcoming tax rises will have on affordability for some property investors.

Lending risk - Residential mortgages (continued)

Lending risk

Residential mortgage lending continues to have a low risk profile as demonstrated by a low level of arrears compared to the industry average. The residential mortgages portfolio comprises many relatively small loans which are broadly homogenous, have low volatility of credit risk outcomes and are diversified in terms of the UK market and geographic segments.

LTV and lending risk concentration

LTV is calculated by weighting the borrower level LTV by the individual loan balance to arrive at an average LTV. This approach is considered to most appropriately reflect the exposure at risk.

Note: The LTV of new business excludes further advances and product switchers.

The average LTV of buy to let new lending reduced by 3 percentage points. This is due in part to the introduction of a reduced maximum LTV of 75% in May 2016 (previously 80%).

The maximum LTV for new prime residential customers is 95%. The proportion of new lending greater than 80% LTV has increased to 34% (2016: 25%) in part as a result of the strategy to support the first time buyer market.

Lending risk - Residential mortgages (continued)

Geographical concentration

Lending risk - Residential mortgages (continued)