Paragon Group Regulatory News (PAG)

RNS Announcement

Paragon Banking Group PLC

6 December 2022

Strong delivery and well positioned in volatile markets

Paragon Banking Group PLC ('Paragon' or 'the Group'), the specialist lender and banking group, today announces its full year results for the year ended 30 September 2022

Nigel Terrington, Chief Executive of Paragon said:

"These results reflect an outstanding financial and operational performance, delivering good growth, enhanced margins and improved cost efficiency, all combining to deliver strong returns to shareholders.

As a leading specialist banking group we are increasingly using technology to strengthen our franchises. New digital platforms introduced in the last year are already seeing tangible evidence of an enhanced customer proposition and service delivery, as well as improved cost efficiencies.

Our cautious risk appetite, high quality loan book and extensive through-the-cycle experience ensure we are well positioned as we head into 2023 and are fully prepared to support our customers' needs."

Financial highlights

· Operating profit before fair value items increased by 16.4% to £226.0 million (2021: £194.2 million)

· Statutory profit before tax increased by 95.6% to £417.9 million (2021: £213.7 million) reflecting non-cash accounting fair value gains which will reverse over time, providing high levels of protection to pipeline margins

· Underlying cost to income ratio improved to 39.4% (2021: 41.7%)

· Economic scenarios in impairment calculations updated to reflect more cautious outlook with weighting increased on severe scenario

· Underlying EPS up 17.9% to 69.9p (2021: 59.3p), reported EPS up 98.2% to 129.2p (2021: 65.2p)

· Total dividend up 9.6% to 28.6p (2021: 26.1p) reflecting smoothing of pandemic catch-ups in 2021

· Capital ratios further enhanced: CET1 ratio at 16.3% (2021: 15.4%)

· Net interest margin increased by 30 basis points year-on-year to 269 basis points, reflecting the Group's diversification strategy

· Underlying Return on Tangible Equity increased to 16.0% (2021: 14.7%)

· 30 September 2022 Tangible Net Asset Value per share £5.33 (2021:£4.34) up 22.8%

· Share buy-back of up to £50.0 million announced for 2023 financial year

Operational highlights

· Total new lending up 23.6% to £3.21 billion:

o  Mortgage Lending advances increased by 17.2% to £1.91 billion (2021: £1.63 billion)

o  Commercial Lending advances increased by 34.3% to £1.30 billion (2021: £0.97 billion)

o  Robust and high quality pipelines into 2023 provide an encouraging platform in the more uncertain new lending environment

· Over 70% of maturing complex buy-to-let customers retained at product maturity demonstrating the value of the proposition to landlords

· Arrears on the buy-to-let book reduced to 0.15% (2021: 0.21%) reflecting the quality of the portfolio

· Buy-to-let loan to value ratio at 57.9% (2021: 61.2%), representing significant asset backing

· Retail deposits up 14.7% to £10.7 billion (2021: £9.3 billion), exceeding £10 billion for the first time and providing a reliable, scalable and cost-effective source of funding

· Digitalisation process continuing at pace, with development finance successfully re‑platformed and a new asset finance origination platform delivered during the year

· Phase 2 of IRB application ongoing, initial PRA feedback received

· Basel 3.1 consultation proposals broadly as anticipated, but Strong and Simple threshold increase and IRB proposals will be beneficial if retained in the eventual supervisory statement

For further information, please contact:

The Group will be holding a presentation for sell-side analysts on 6 December 2022 at 9:30am, a recording of which will be available on the Group's corporate website at www.paragonbankinggroup.co.uk/investors from 2:30pm that day. The presentation material will be available on the website from 7:00am on the same day.

Introduction

The Group has maintained the progress seen in 2021 into 2022, delivering strong results which reflect its strategic positioning, strong operational performance, robust operating platform and the commitment and professionalism of its people.

Our business model has been designed, using extensive through-the-cycle experience, to be resilient in challenging environments. Further, our diversification strategy and balance sheet structuring are designed to deliver stable funding, generate improved returns over time and also benefit in periods of higher interest rates.

The 2022 outturns demonstrate the effectiveness of this strategy, with the net loan book growing by 6.0%, margins widening by 30 basis points, cost efficiency improving and the underlying return on tangible equity rising to 16.0%. Statutory tangible net asset value per share increased by 22.8% to £5.33 per share (2021: £4.34).

The Group maintains close relationships with its customers, intermediaries and other business partners which have been particularly important with both the increase in the cost of living, and then interest rates rising sharply during the year.

Alongside this strong financial and operational delivery, we have continued to implement our digitalisation plans, with a number of front and back-office developments being delivered during the year, making immediate tangible improvements to customer journeys and operational efficiency.

Financial performance

Trading has been strong across the Group in the year. A combination of strong loan growth, widening net interest margins and tight cost control have resulted in profit before fair value items increasing by 16.4% to £226.0 million (2021: £194.2 million).

We have updated the Multiple Economic Scenarios ('MES') used for our impairment assessments, particularly in light of recent instability arising from the end of the pandemic, the war in Ukraine, rising inflation and interest rates and the policy responses to this backdrop. The scenario changes are illustrated below by comparing the weighted average forecast levels of key variables for the quarter ending 30 September 2023 in the current forecast to those for the same period in the forecast used at the previous year end.

In addition to a harsher suite of assumptions, given the extreme volatility seen, particularly in the final quarter of the year, the Group has adjusted its downside / severe weighting mix from 35% / 15% in 2021 to a 30% / 20% in the current year. We have also released the remaining Covid overlays, but have added £15.0 million of judgmental adjustments to reflect the lack of observed data (notably in respect of inflation data) in the model build.

The Group has always operated a cautious hedging strategy, designed to minimise interest rate risk. This hedging takes place for both completed loans and the pipeline, and the Group has strategically increased its level of pipeline hedging in the year to enhance the protection of future margins. Derivatives hedging the pipeline only qualify for hedge accounting when the loan actually completes and are measured on a fair value basis until that point. Taking swaps out early in the process has, in a rapidly rising rate environment, created a material (£191.9 million) fair value gain for 2022. Whilst this will reverse over the coming years, it evidences the value that would have been lost to the Group had the pipeline loans only been hedged when they actually converted.

Basic earnings per share rose 17.9% to 69.9 pence on an underlying basis (removing the after tax impact of the fair value gains). Including the gains, reported basic EPS rose by 98.2% to 129.2p per share.

The total dividend for the year of 28.6 pence per share represents around 40% of the underlying earnings per share, with the effects of fair value movements removed.

Trading performance

Aggregate new business levels rose by 23.6% from 2021's level to £3.2 billion in 2022. As well as new front-end systems in the Commercial Lending division, the Group also benefitted from system and processing enhancements in its buy-to-let business, most notably in its product maturity management.

Mortgage Lending new advances increased by 17.2% to £1.91 billion (2021: £1.63 billion). The focus continues to be on complex properties and professional landlords, with simple business comprising just 2.1% of completions (2021: 3.2%). Five-year fixed rate loans, which increased in popularity in 2017, started to reach product maturity in 2022. The Group has been particularly successful in retaining these customers, having developed an online portal to facilitate the maturity process, and over 70% of our maturing specialist landlord customers chose to refinance with the Group at product maturity. The credit performance of the buy-to-let mortgage portfolio remains strong, with indexed loan to values falling to 57.9% at September 2022 (2021: 61.2%) and with only 1.4% of the book having an indexed LTV above 80%. Three month plus arrears on the portfolio were 15 basis points at 30 September 2022 (2021: 21 basis points).

Commercial Lending also had a strong year, with our new advances increasing by 34.3% to £1.30 billion, with each of the four sub-divisions seeing year-on-year growth. A complete end-to-end replatforming was delivered in development finance and a new digital broker portal launched in SME Lending during the year, the latter having an immediate impact on our processing times and business flows, which saw a rise of 40.9% in the final quarter of the year compared to the third quarter. Further digital enhancements will be delivered in the next financial year.

Capital and funding

Savings deposits remain the prime funding source for the Group, with balances increasing by 14.7% in the year, to £10.7 billion. The pricing profile of these deposits also changed during the period. Whilst comparing very favourably to the rates paid by the larger banks, the price of the administered rate portfolio moved from a premium of 37 basis points above SONIA at September 2021 to a discount of 64 basis points at September 2022. Further, for much of the second half of the year, equivalent swap rates exceeded the price of the Group's fixed rate bonds, also generating post-hedging funding below SONIA on this portion of the deposit book.

The move to a retail, rather than wholesale funded basis, has benefitted the Group greatly during the year and is the main driver in the outperformance of its net interest margin against both initial guidance and expectations. This optionality provides significant benefit and is a reflection of the Group's diversification strategy.

The Group completed £64.2 million of its £75.0 million share buy-back in the year. However having given an irrevocable instruction to Peel Hunt to complete the buy-back, the full value has been deducted from equity. The buy-back was subsequently completed on 7 November 2022. At 30 September 2022, our CET1 and TCR ratios stood at 16.3% and 18.3% respectively (2021: 15.4% and 17.6% respectively).

The level of capital resources substantially exceeds the regulatory minimum, which stands at 8.8% at the CET1 level, recognising the Group has no AT1 issuance.

Following the year end the Bank of England published their Consultation Paper regarding the process for the implementation of the Basel 3.1 standards in the UK. These largely followed the core Basel proposals and, as such, were materially in line with expectations. The Consultation Paper also highlighted enhancements to the IRB accreditation process and an increase in the Bank's threshold for Strong and Simple treatment to £20 billion of assets, each of which would have a favourable impact on the Group if retained in the ultimate supervisory statement.

The Group's IRB accreditation process continues. Although this has taken longer than initially anticipated, we now have good engagement with the PRA team. Non-binding feedback has been received in respect of the modelling aspects covered in Phase 2 of the process, with subsequent analysis and model remediation underway to meet the PRA's expectations.

Business model developments

The Group's multi-business line digitalisation programme continued at pace during the year. In addition to the development finance and SME systems noted above there were further notable developments, including the maturity management portal in buy-to-let and the movement of our general ledger to a cloud-based solution. An extensive change programme remains in place, with further developments scheduled to go live across the current and subsequent years. The general approach to accounting for these developments is to expense the bulk of expenditure, with the value of capitalised computer software standing at only £3.9 million at the year end.

People

The strong results for the year would not have been possible without the continued hard work, dedication and performance of our people. During the year we were awarded Platinum status by Investors in People ('IiP'), reflecting the Group's strong training and development approach and importantly the demonstration of behaviours that clearly reflect our values and culture. This status has only been attained by 5% of firms accredited by IiP.

We are committed to demonstrating a diverse and inclusive workplace, with the activities of our Equality, Diversity and Inclusion ('EDI') network materially expanding during the year, together with regular board engagement. Our initial HM Treasury Women in Finance targets, set in 2017, have been substantially met.

We have been particularly aware of the challenges our people were facing given the rapid increase in living costs in the year, and we gave each employee below senior management level a £500 one-off payment in the summer, together with a £500 advance on the 2022 profit related pay ('PRP') payment. Given the record level of profit reported in 2022, the final element of the 2022 PRP award will also be strong - further supporting our people. 

Sustainability

In its first full year of operation the Group's Sustainability Committee has made much progress in fostering a holistic approach to a range of environmental and social issues and their related risks and opportunities. A particular area of focus has been climate change, where we are aware of the level of interest from stakeholders and regulators.

Policies have continued to develop in this area, while the year also saw the first offsetting of operational emissions, the continued greening of the Group's office estate and significant developments in lending on battery electric vehicles and energy efficient properties. The Group has also joined Bankers for Net Zero.

More widely the Group was pleased to publish its first Code of Conduct, outlining for all stakeholders the principles which guide its relationships with employees, customers, business introducers, suppliers and the wider community.

Outlook

The recent economic backdrop has created a volatile operating environment, with cost of living increases and rising interest rates creating uncertainties which impact demand, affordability and will potentially increase impairment levels. The Group's funding structure allows for a swift reaction to the changing environment and close contact with our customers allows us to help those who face difficulties as a result of changing rates and inflationary pressures.

We recognise that this environment will present challenges for the UK, its consumers and its businesses and, as an organisation built on relationships, we stand ready to support our customers through this difficult period.

We enter 2023 with strong margins, high quality loan books, robust pipelines, strong capital, cautious provisioning and well-developed franchises in each of our operating divisions. Our digitalisation process is expected to deliver further efficiencies and improvements for our customers and supporting intermediaries, and together with our agile and dedicated people, the Group is well placed to respond to the challenges in the year ahead. The strength of our business ensures we are well positioned to react positively to the opportunities which will inevitably emerge.

This section reviews the activities of the Group in the year under these headings

The Group reports its results analysed between two segments, Mortgage Lending and Commercial Lending, based on types of customers, products and the internal management structure. This analysis was adopted in the year, following a review of segmental reporting. The former Idem Capital segment is no longer presented, and the remaining assets reanalysed. Comparative information has been restated in line with the new reporting structure. 

New business advances in the year and year end loan balances are summarised below, analysed by segment:

The Group's total loan balance increased by 6.0% in the year following a 6.1% increase in the preceding twelve months. The Group continued to pursue its strategy of focussed growth as its markets continued to recover from the impacts of the Covid pandemic. This growth was despite the sale of £78.9 million of unsecured loan balances as the Group exited that market in the year.

Total advances increased 23.6% year-on-year, although the pattern varied across the Group's specialist markets, as a result of the differing impacts of the complex movements in the UK economic situation as it developed through the year.

The Group's Mortgage Lending division principally provides buy-to-let mortgages secured on UK residential property to specialist landlords. The Group has been active in this market for over a quarter of a century, through a wide range of economic environments. This gives the Group deep data and an unparalleled understanding of this form of mortgage and the landlord customer base it targets.

During the period the Group also offered a limited volume of loans to non-specialist landlords and owner-occupied first charge mortgages secured on residential property. Owner-occupied lending is carefully managed to ensure that only lending with appropriate risks which provides an acceptable return on capital is undertaken. The segment also includes legacy assets from discontinued product lines, including second charge mortgage loans formerly included in the Idem Capital segment.

In all its offerings, the Group targets niche markets where its focus on detailed case-by-case underwriting and its unique approach to property risk differentiate it from both mass market and other specialist lenders.

Housing and mortgage market

Activity in the UK housing market reduced year-on-year, although this is partly attributable to the artificially high volume of transactions in 2021, which included transactions delayed from the previous year due to Covid restrictions, and was stimulated by stamp duty reliefs. Transactions for the year reported by HMRC, at 1,223,000, were 21.3% lower than the 1,554,000 in the previous year. In their September 2022 Residential Market Survey, RICS noted a further slowing in market activity, attributable to the outlook on interest rates and more general economic uncertainty.

House prices saw strong growth in the year, contrary to some expert projections, with the Nationwide House Price Index recording a year-on-year increase of 9.5% to September 2022 (2021: 10.0%), although the rate of increase had slowed considerably towards the end of the period. Nationwide predict further slowing into the new financial year, due to the impact of affordability pressures, with RICS forecasting house price falls over a twelve month horizon.

New mortgage lending in the market remained strong in the year, with the Bank of England reporting new approvals of £304.3 billion in the year ended 30 September 2022. This was a decrease of only 3.6% on the record £315.9 billion reported for the previous financial year, which had been driven by the stamp duty holiday which ended on 30 September 2021. However, this total included an 18.0% fall in loans for house purchase, generally in line with the fall in transactions and greater re-mortgage activity.

At 30 September 2022 the UK Finance ('UKF') survey of mortgage market arrears and possessions reported a largely benign position with arrears levels holding steady or slightly falling and possessions rising, but remaining far below the pre-Covid levels of early 2020.

The Private Rented Sector ('PRS') and the buy-to-let mortgage market

The Group's target customers in the buy-to-let sector are specialist landlords. Such landlords will typically let out four or more properties, or operate with more complex properties, and will generally run their portfolio as a business and have both a strong understanding of their local lettings market and a high level of personal day-to-day involvement. The Group is amongst a small number of specialist lenders addressing this sector, which is underserved by many of the larger lenders.

The Group's experience over the past year is that some smaller amateur landlords are leaving the market in the face of economic pressures and regulatory changes, while its specialist customers remain committed to the sector.

The Group considers that the experience of its customers, their level of involvement and the diversification of their income streams across properties make them less vulnerable to cash flow shocks in the event of a downturn and better able to cope when faced with an adverse economic situation.

The PRS continues to provide homes for around 19% of UK households. With supply and pricing issues impacting first-time buyers and the potential for incomes to become more constrained, the sector will continue to be crucial in national housing provision.

The Group has commissioned research on the future of the sector with the Social Market Foundation. This exercise found that, contrary to some widely held beliefs, most people renting their home in the private rented sector are happy with both their property and their landlord, and value the flexibility renting offers to them.

The research also concluded that the attention of policy makers, the media and society more generally, focuses on the minority of PRS tenants who have had particularly bad experiences with renting. However, 81% of private renters expressed their contentment with their current property, and 85% said they were satisfied with their landlord.

The full report on this research - "Where Next for the Private Rented Sector?" - is available on the Group's website at www.paragonbankinggroup.co.uk.

In contrast to the wider mortgage market, new buy-to-let advances reported by UKF, at £53.3 billion for the year ended 30 September 2022, were 14.6% higher than for the previous year (2021: £46.5 billion). However, this was mostly driven by remortgage activity, which increased by 23.4% while the value of new buy-to-let mortgages for house purchase fell by 10.6%.

In the lettings market RICS' September 2022 UK Residential Market Survey reported continuing strong tenant demand coupled with a dearth of supply, which was pushing rents upwards, with an expectation of a strong growth in rental prices in the short term. Research published by Zoopla supported these conclusions.

This is borne out by the Group's own independently commissioned research for the quarter ended 30 September 2022 which showed 65% of landlords were experiencing increased tenant demand, with 39% reporting significant increases. Upward movements in rents were also reported. This continuing demand will benefit affordability and cash flows for the Group's landlord customers. Despite their positive view of the current situation, however, landlord confidence had declined significantly in the last quarter of the financial year across all metrics measured, covering their own business, the sector and the UK economy more generally.

The UKF analysis of arrears and possessions also provided analysis of buy-to‑let cases, showing a similar position to the wider mortgage market, with arrears levels largely stable.

These factors indicate that the buy-to-let mortgage market remains strong, even in the face of economic pressures, and underpins the strength of the Group's proposition.

Mortgage Lending activity

The Group's new mortgage lending activity during the year is set out below.

Total mortgage originations in the Group increased by 17.2%, as the housing market continued to recover from the Covid pandemic. The Group's focus within the mortgage sector remained tightly on the specialist buy-to-let product, lending to larger landlords, those operating through corporate structures and those with complex properties, with other products ancillary to this activity.

New lending on specialist buy-to-let mortgages increased by 19.7% as this part of the PRS remained strong. These specialist completions, at £1,869.5 million formed 97.9% of the Group's new mortgage business. Restrictions in lending imposed during the pandemic were all reversed in the first half of the year, with further developments introduced, helping to drive volumes. Non-specialist buy-to-let lending remains modest in comparison, with advances continuing to decline.

The majority of the Group's mortgage lending products offer fixed rates for an initial period, with many customers choosing a new product, either with the Group or elsewhere, at the end of this fixed period. A market shift in 2017 saw five-year fixes become the dominant product and the initial tranche of that lending reached the end of the five-year period in the latter part of the year. The Group has well-established retention procedures to address accounts as their fixed rates expire and over 70% of the specialist landlord customers whose products matured in the year chose to refinance with the Group. This contact programme has also helped expand the pipeline of prospective new business.

The new business pipeline, being the loans passing through the underwriting process, stood at a record £1,256.0 million at the year-end, 24.6% higher than a year earlier (2021: £1,008.1 million), providing a strong platform for growth into the 2023 financial year. While the majority of this pipeline comprises fixed rate loans, with rates set by reference to market expectations at the time of offer, the Group's policy of pipeline hedging means that loans may be completed in a rising rate environment with limited impact on margins.

The Group sources the majority of its new buy-to-let lending through specialist intermediaries, and it continues to invest to ensure the service offered to them is excellent. During the year the Group's regular surveys of its intermediaries showed 89% were satisfied with the ease of obtaining a response from the Group (2021: 91%), delivering an NPS at offer stage of +40 (2021: +43). Two thirds (67%) of intermediaries dealing with the Group rated its service as good or better than that provided by other lenders (2021: 66%). Paragon Mortgages was also named as Best Professional Buy-to-let Lender at the 2022 Your Mortgage awards.

The Group's long-term programme of reengineering its mortgage business continued through the year. All systems and operational processes are being thoroughly reviewed and refined to align them with the Group's strategy for the division and the overarching plan of digitalising the business. As part of this reengineering, the capacity of the underwriting function has been significantly increased, ensuring that service standards and turnaround times remain excellent.

Initially, particular focus has been on those areas which can deliver immediate impact, such as customer retention, and on enhancing service to mortgage brokers. Improvements which went live in the period are already playing an important role in managing retention risk as five-year fixed rate mortgages start to mature and have made the process of requesting a further advance much more streamlined for the Group's customers.

Environmental impacts

The Group understands the potential for climate change to impact its mortgage business and seeks to mitigate risk through careful consideration of the properties on which it will lend. It also continues to develop systems and refine data to allow its overall position to be measured and the behaviour of its security portfolio under climate-related stresses to be better understood.

As part of its response to climate change the Group offers a range of green buy-to-let mortgages on all properties within the Group's lending criteria. These products offer lower interest rates for energy efficient properties with EPC ratings of C or higher.

The UK Government has identified the provision of more energy efficient housing as a prime objective in its response to climate change, with EPC levels being set as one of the principal benchmarks to be used. It also announced a target of upgrading as many homes as possible in the PRS to an EPC rating of C or higher.

The Group, together with other UK banking entities, has been working with the UK Government to develop a more consistent approach to the definition of green activities in the housing market and the housing finance sectors and is hopeful of progressing these discussions further in the forthcoming year.

The Group's new lending volumes on green buy-to-let products, which have increased by 44.1% in the year, are set out below.

The increasing proportion of new accounts relating to energy-efficient properties is important in achieving the Group's downstream emissions aspirations and is generating a gradual improvement for the buy-to-let loan book as a whole.

The Group's latest analysis identified EPC grades for 92.8% by value of its mortgage book in England and Wales at 30 September 2022 (2021: 88.3%). Of these 98.9% were graded E or higher (2021: 98.4%) with 39.3% rated A, B or C (2021: 37.6%). The year-on-year movements are principally a result of the balance of new business, with 45.1% of advances in the year (2021: 39.7%) having one of the top three grades.

While the Group monitors EPC performance it is also conscious of the need to avoid unintended consequences by focussing lending on this. Although upgrading existing properties is beneficial to overall emissions, the demolition and replacement of properties may be less so.

The Group also monitors the potential physical risks to security values arising from climate change. This includes assessing a property's flood risk as part of the underwriting process. At 30 September 2022, approximately 2.6% by number of properties securing the Group's buy-to-let mortgages in England and Wales for which information was available were considered to be at medium or high risk of flooding from the sea or rivers, based on data from the Environment Agency (2021: 2.5%).

In addition, a more detailed analysis was carried out in the period, using data which was more location specific, and also included risk of flooding from surface water. This showed 3.0% of properties securing buy-to-let mortgages, where data was available, were at 'higher' risk.

The Group's mortgage business is currently working to develop products to support its existing customers in making their properties more energy efficient. Given that the majority of properties in the PRS require some form of upgrade to meet the Government targets, this kind of support will be vital to achieving the UK's net zero target.

Performance

The outstanding loan balances in the segment are set out below, analysed by business line. Legacy second charge mortgage assets and other consumer loans were previously disclosed within the Idem Capital segment.

At 30 September 2022, the total net mortgage portfolio was 4.2% higher than at the start of the financial year, reflecting strong lending and retention performance. The balance of post-2010 buy-to-let lending grew by 15.7% and it now represents 69.2% of the division's total loan assets (2021: 62.4%).

The Group's residual unsecured consumer lending book, shown as 'other consumer lending' in the above table was disposed of in the year, realising a gain of £4.6 million, as part of the Group's exit strategy for this part of the lending market.

The annualised redemption rate on buy-to-let mortgage assets, at 9.8% (2021: 6.9%), has continued at a relatively low level, with the increase representing a reversion closer to pre-Covid levels. This is despite increasing numbers of five-year fixed rate loans reaching the end of their fixed period. As described above, the Group has adopted a number of strategic initiatives to retain customers whose mortgage accounts reach the end of their fixed rate period.

Arrears on the buy-to-let book reduced in the year to 0.15% (2021: 0.21%), with the payment performance of the Group's customers remaining strong, despite the growing economic pressures in the UK. Arrears on post-2010 lending were at 0.09% (2021: 0.09%). These arrears remain very low compared to the national buy-to-let market, with UKF reporting arrears of 0.41% across the buy-to-let sector at 30 September 2022 (2021: 0.45%). However, as noted above, landlord's expectations for their businesses appear more pessimistic than this performance data would suggest.

The Group's buy-to-let underwriting is focussed on the credit quality and financial capability of its customers, underpinned by a robust assessment of the available security. Relying on a detailed and thorough assessment of the value and suitability of the property as security, this approach to valuation, including the use of a specialist in-house valuation team, provides it with significant security in the face of economic stress.

The loan-to-value coverage in the Group's buy-to-let loan book, at 57.9% (2021: 61.2%) represents significant security, enhanced over the year by the generally rising levels of house prices. Levels of interest cover and stressed affordability in the portfolio remain substantial, leaving customers well placed to develop their businesses going forward, indeed, on a simple weighted average basis, the Group's landlord customers now have over £10.0 billion of equity in their mortgaged properties.

Second charge arrears from post-2010 lending increased to 1.88% from 1.18% in the year, reflecting the increased seasoning and size of the portfolio. For legacy assets arrears rose to 26.7% (2021: 24.3%). These arrears levels remain higher than the average for the sector, but this reflects the seasoning of the balances, while the continuing upward trend reflects the redemption of performing accounts. This book contains a significant number of accounts which are currently making full monthly payments but which had missed payments at some point in the past, inflating the arrears rate. Average arrears for secured lending of 7.5% at 30 September 2022 were reported by the Finance and Leasing Association ('FLA') (2021: 8.6%). The Group enjoys substantial security on its second charge mortgage assets, with an average loan-to-value ratio on such cases of 50.6% (2021: 56.1%) providing a significant mitigant to credit risk.

In terms of the Group's impairments procedures, 16.4% of the segment's gross balances were considered as having a significant increase in credit risk ('SICR') (2021: 12.4%) including 1.1% which were credit impaired (2021: 2.2%). This was a result of the impact of the worsening economic outlook on probabilities of default. However, the impact of security values meant that provision coverage was stable, at 31 basis points (2021: 32 basis points), although coverage on fully performing accounts had increased from 2 basis points at 30 September 2021 to 6 basis points at the year end.

The Group's receiver of rent process for buy-to-let assets helps to reduce the level of losses by giving direct access to the rental flows from the underlying properties, while allowing tenants to stay in their homes. At the year end, 475 properties were managed by a receiver on the customer's behalf, a reduction of 14.1% over the year (2021: 553 properties), as cases were resolved, with generally successful results, considerably mitigating the original potential loss. Almost all these cases currently relate to pre-2010 lending, with cases being addressed on a long-term basis. There were relatively low numbers of new receivership cases in the year.

Outlook

While the increase in market interest rates has dampened the demand for new product, the Group's mortgage lending business is well placed as it enters the new financial year. Its investment in systems, which will continue going forward, enables it to provide an effective and responsive service to brokers and customers, whichever direction the UK economy takes, while its underwriting standards, the strong current performance and low loan-to-value ratio of the portfolio, and the hedging of the fixed rate pipeline bring strong defensive qualities to the balance sheet.

The Group's Commercial Lending division includes four key specialist business streams lending to, or through, commercial organisations, mostly on a secured basis. This division had been a major source of growth within the Group before the impact of Covid and remains a focus for growth going forward.

The four business lines address:

· Development finance, funding smaller, mostly residential, property development projects

· SME lending, providing leasing for business assets and unsecured cash flow lending for professional services firms, amongst other products

· Structured lending, providing finance for niche non-bank lenders

· Motor finance, focussed on specialist parts of the sector

Each of these businesses is led by a managing director, supported by a specialist team with a strong understanding of their market. The principal competitors for each are small banks and non-bank lenders. The Group operates principally in markets where the largest lenders have little presence, creating both a credit availability issue for customers and significant opportunities for the Group.

The Group's strategy for Commercial Lending is to target niches (either product types or customer groups) where its skill sets and customer service culture can be best applied, and its capital effectively deployed to optimise the relationship between growth, risk and return.

Commercial Lending activity

The Commercial Lending segment saw a 34.3% increase in new business during the year as UK economic activity continued to recover from the effects of Covid, with each sub-segment showing year-on-year growth

The new lending activity in the segment during the year is set out below, analysed by principal business line. As the structured lending business comprises revolving credit facilities, the net movement in the period is shown.

The impact of this new lending has been to increase the Group's overall Commercial Lending exposure by 19.6% in the year to £1,881.6 million (2021: £1,573.1 million).

Development finance

The Group's development finance business performed strongly in the year with new lending increasing by 23.9% to £632.2 million (2021: £510.4 million). While the volume of projects funded increased as the UK emerged from Covid, some developers continued to experience supply chain issues, although not to the extent where ultimate project viability was threatened, and some project timescales were extended. Towards the end of the year the volume of enquiries reduced somewhat, with developers reacting to the uncertain economic outlook by taking a cautious approach to initiating new projects. This resulted in undrawn amounts on live facilities at 30 September 2022, at £556.0 million, being 11.1% higher than at the previous year end (2021: £500.4 million), while the post-offer pipeline fell to £136.8 million (2021: £298.6 million).

During the year the business launched its first major green finance option. Projects to develop energy-efficient properties, those with an EPC A grade, can receive beneficial funding terms. By 30 September 2022, £64.5 million of new lending facilities had been agreed under the green initiative, with drawings reaching £11.9 million by the year end. This type of project will be an area of focus for the Group going forward, as developers increasingly factor these discounts into their project planning.

The regional spread of the Group's lending has broadened, with the proportion of the portfolio located in London and the South-East of England falling to 56.8% from 63.6% at 30 September 2021. Activity increased particularly in both the East Midlands and West Midlands, with funding provided for a number of flagship projects. The business has also increased the range of specialist developments it has funded, including a heightened focus on the later living sector. However, the vast majority of lending relates to standard residential property.

The Group's investment in systems for this business has continued through this period, with a major upgrade to loan servicing capabilities delivered in the year as well as a stream of enhancements being delivered on a regular basis through the year to improve process efficiency and customer service. This drive towards digitalisation will continue, providing a solid platform for the growth of the business and supporting the transition to an IRB approach to capital management.

The business also saw a leadership change, with Robert Orr, who had led the operation since the Group's acquisition of the Titlestone development finance business in 2018 stepping back, to be succeeded as Managing Director by Neal Moy, who joined the Group with wide experience in the property finance sector. Other appointments were also made to enhance the relationship team.

Despite an uncertain economic outlook and potential supply chain disruptions the underlying business proposition for developers remains fundamentally unchanged. The UK is still failing to meet its targets for the development of new housing and demand continues to increase. The current state of the UK house building market gives a significant opportunity for smaller developers to expand, if they can access reliable sources of funding for projects. The Group's proposition is strong and attractive and continues to provide healthy returns for the capital invested and opportunities for growth as it moves forward with new systems and leadership to face the challenges ahead.

SME lending

The Group's SME lending business is primarily focussed on financing core business assets for SMEs. The core assets financed included wheeled construction plant, such as excavators, and other commercial vehicles. These customers are therefore sensitive to sentiment around capital investment in the UK, which has become more negative towards the latter part of the year, resulting in a slowing of growth in the SME asset finance market reported for the FLA, where in the early part of the year a stronger post-pandemic recovery was seen.

Against this background the Group's SME asset leasing business saw volumes increase by 39.7% year-on-year to £276.9 million, excluding government-backed balances (2021: £198.2 million), far higher than the average of 9% reported by the FLA for the SME sector. Investment in operating leases has also continued with £14.5 million of assets acquired in the period (2021: £13.0 million).

Much of this success is attributable to investment made in system and processes, including the introduction of a new broker portal at the start of the year. This has increased efficiency and responsiveness in the underwriting process, as well as enhancing the Group's ability to handle smaller value propositions cost-effectively. This has also enabled record numbers of applications to be handled and improved conversion rates. Advances in the second half were over 45% higher than those in the first six months of the year, reflecting the roll out of the new portal. The reduced average loan size is also beneficial in spreading credit risk.

These service enhancements have improved the standing of the business in the finance broker community. 88% of brokers surveyed by the Group in the year said that they considered that their experience with the Group was as good or better than with other lenders and 81% stated that they were likely to provide further business.

Following the major upgrade, the programme of investment in system improvements to create efficiency gains has continued throughout the year. Agile and modular delivery enables individual improvements to go into the live system as they are completed, providing incremental enhancements.

The Group continued to advance loans under the UK Government-sponsored Recovery Loan Scheme, ('RLS') until the second phase of that scheme closed for new applications in June 2022. The Group's application to take part in the third phase of that scheme is being processed. RLS loans have the benefit of an 80% government guarantee (after the proceeds of any business assets are applied for leasing balances) for pre-January 2022 advances and a 70% guarantee for applications received between January and June 2022. The Group's lending on these products primarily focussed on its existing customers, and the majority of RLS lending has been on asset-secured products.

During the year £32.2 million was advanced under schemes backed by a government guarantee (2021: £64.2 million), of which £31.5 million was asset leasing business. This reduction was in line with expectations, given that these loans were initially introduced as a response to the Covid pandemic. The Group continues to closely monitor the portfolio for any adverse indications.

Short-term lending to professional services firms outside government supported schemes more than doubled to £125.8 million (2021: £62.0 million). These loans are often used to spread the impact of tax payments, and the availability of tax deferrals, together with the availability of loans under the Coronavirus Business Interruption Loan Scheme ('CBILS') and similar arrangements amongst this customer group had seriously depressed demand. However, the underlying requirement for this form of finance remains for the longer-term, and performance has continued to move back towards pre-Covid levels.

The division has seen an increased level of green lending propositions over recent months, with many SME businesses in the transportation field and beyond seeking to reduce their carbon footprints. The division also has a strong presence in waste management, supporting local authorities as they transition to greener refuse collection activities, including funding new all-electric refuse collection vehicles for the City of Exeter, and providing funding for the development of recycling plants. It is a strategic priority of the Group to support UK SMEs, whose journey towards net zero may require significant capital investment over time, and these types of initiatives are expected to increase going forward.

UK SMEs are potentially facing a difficult period as interest rates and inflation rise and the labour market remains tight. The FLA outlook survey for September reports significantly negative expectations across the leasing market for business investment and the economy more generally. In the Group's own independently conducted research of over 1,000 SMEs, the majority acknowledged the seriousness of the economic situation, particularly the potential impact of inflation and costs, but were cautiously optimistic of managing their way successfully through it. In this environment opportunities for the Group's SME business are likely to be restricted, but it will leverage its customer relationships and account management experience to protects its franchise and optimise customer outcomes, whichever direction the UK economy moves in.

Structured lending

The Group's structured lending exposure has seen an increased level of activity in the year, with several new facilities agreed and older balances repaid, diversifying the business' exposures and increasing the overall balance outstanding by 50.3%. Total facilities also increased by 18.9% to £220.5 million (2021: £185.5 million)

Structured lending facilities generally fund non-bank lenders of various kinds providing the Group with increased product diversification. The facilities are constructed to provide a buffer for the Group in the event of default in the client's ultimate customer population. The Group's experienced account managers receive regular reporting on the performance of the security assets, and maintain a high level of contact with clients to safeguard its position.

The Group has a number of well-progressed additional facilities in the pipeline, with an expectation of more drawings in the new financial year. These include new asset classes, spreading the risk inherent in such lending. The Group continues to actively seek new opportunities in this field, with a particular interest in facilities linked to green initiatives.

Motor finance

The Group's motor finance business is a focussed operation targeting propositions not addressed by mass-market lenders, including specialist makes and vehicle types, such as light commercial vehicles, motorhomes and caravans.

During the year the Group also began funding static caravans, which provide good yields and fit comfortably with the Group's focus on specialist products

Lending in the year grew 65.9% to £166.2 million (2021: £100.2 million), although the business was significantly affected by the Covid pandemic in the first part of the 2021 financial year and the current year's business represents a return to a more normal level.

The Group also launched its first products for financing battery-powered electric vehicles ('BEVs'). £6.0 million of new loans were made, reflecting the recent growth in the availability of these vehicles, with BEVs representing 11.8% of new vehicle registrations in the year, as reported by the Society of Motor Manufacturers and Traders. The offering was extended in the second half of the year to cover light commercial BEVs. The Group is well placed to support the green aspirations of its customers, as electric vehicles become a more widely viable and popular option.

Performance

The outstanding loan balances in the segment are set out below, analysed by business line.

Despite the building pressures in the UK economy credit performance in the development finance book has been good, and the overall performance of the projects has been generally in line with expectations. Accounts are regularly monitored and graded on a case-by-case basis by the Credit Risk function. At 30 September 2022 only one account had been identified as being at risk of loss, a long‑standing legacy case.

The average loan to gross development value for the portfolio at the year end, a measure of security cover, was 62.1% (2021: 61.7%), which gives the Group a substantial buffer if any project encounters problems. No new serious credit issues arose during the financial year.

Credit performance in the division's originated finance leasing portfolios has been generally good, with improving arrears measures in both asset leasing at 0.08% and motor finance at 1.58% (2021: 0.27% and 2.30% respectively), however there have been a small number of cases where serious credit issues have been identified and the sector is expected to display more volatile credit performance as government support initiatives unwind.

For UK Government guaranteed loans credit performance remained strong. Despite widespread coverage of fraudulent loan applications across the sector the Group's total claims made up to 30 September 2022 were £2.4 million, with £2.2 million of this balance already recovered from the Government.

In the structured lending business, the Group carefully monitors the performance of the underlying asset pool on a monthly basis, to ensure its security remains adequate. The Group relies on its data monitoring and verification processes to ensure that these reviews are able to detect any credit issues. Performance in the year has been in line with expectations, with generally improved metrics across the book, and all accounts classified in IFRS 9 Stage 1 at the year end.

In terms of the Group's impairments procedures, 4.7% of the segment's gross balances were considered as having an SICR (2021: 6.0%) including 1.1% which were credit impaired (2021: 0.7%). Provision coverage had reduced in line with the shift towards performing accounts, at 134 basis points (2021: 174 basis points) although coverage on fully performing accounts had increased from 86 basis points at 30 September 2021 to 108 basis points at the year end as a result of management's evaluation of the probability of potential problem cases not registering through the normal SICR identification procedures in the current economic environment.

Outlook

The evident headwinds in the UK economy are likely to reduce the scope for near-term new business volume growth across the division's markets. However, the franchise remains strong and the efficient and effective processes which have been rolled out through the Group's digitalisation programme, coupled with strong customer relationship management and the high standards of credit management applied over time, will both protect the value in the businesses and allow them to gain market share, should their broader markets see a slowdown.

The Group is principally funded by retail deposits, but also accesses a variety of other funding sources. This creates an adaptable and sustainable funding position which can flex with developments in the business, its operating environment and the economic landscape. The Group is therefore able to access cost-effective funding, as well as raising funding for strategic initiatives on a timely basis.

During the year the Group's requirements for additional funding were satisfied through the retail deposit market. Demand for deposit products remained strong, with nervousness amongst consumers over impending cost of living issues motivating customers to save, at least in the short term.

The Group's funding at 30 September 2022 is summarised as follows:

The Group's retail deposit balance grew by 14.7% in the year to £10,669.2 million (2021: £9,300.4 million), exceeding £10 billion for the first time and representing 72.7% of balance sheet funding (2021: 67.6%), with wholesale borrowings continuing to reduce over the year.

At 30 September 2022 the proportion of easy access deposits, which are repayable on demand, was 27.0% of total on-balance sheet funding (2021: 24.1%). This increase is partly a result of market sentiment, with savers reluctant to commit funds to term deposits in the anticipation of future interest rate rises, and partly as a result of the Group's maturing liquidity policy. This percentage remains low compared to the rest of the banking sector and can be expected to rise going forward.

With the generally uncertain economic outlook, the Group has maintained a cautious approach to liquidity in the period. Some loosening of policy took place in the period in response to the gradual opening up of the UK economy, but at the end of the year the Group still had £1,689.1 million of cash available for liquidity and other purposes (2021: £1,236.5 million). The Group's contingent liquidity policy will be kept under review as the ultimate outcome of the Covid crisis becomes clearer and longer-term trends become more evident, but the Group intends to maintain a conservative approach.

The Group's long-term funding strategy, following the granting of its banking licence in 2014, has been to move to using retail deposits as its primary funding source, using the debt markets on an opportunistic basis for additional funding requirements.

The Group's programme to transition away from the use of the London Interbank Offered Rate ('LIBOR') as a reference rate was completed during the year, in time for the withdrawal of that rate in December 2021. This formed the culmination of a multi-year programme to transition to other benchmarks, notably the Sterling Overnight Index Average ('SONIA') for both wholesale funding and retail lending and saving products.

The Group engages in fixed rate lending and accepts fixed term deposits. It is therefore exposed to interest rate risk, and it manages this position through hedging with interest rate derivatives. Where interest rates are moving this can lead to substantial fair value movements, but the Group has established policies and procedures to ensure that only economically appropriate transactions which hedge normal trading activities are entered into.

The Group considers the retail deposit market to be a reliable, scalable and cost-effective source of funding, which has remained fully functional throughout stresses including the Covid crisis. The Group's offering has been centred on sterling household deposits, although it began to access the SME sterling deposit market in the year.

The Group offers a variety of savings products, including term deposits, ISAs and easy access accounts and the business accesses the market through a variety of in-house and external channels. The proposition is based on competitive rates and value for money, combined with the Group's strong customer service ethic and the protection provided to depositors by the Financial Services Compensation Scheme ('FSCS').

The retail deposit market in the UK is large, deep and well developed. During the year, savings balances of UK individuals reported by the Bank of England continued to increase, despite increasing pressures on living costs, with balances at 30 September 2022 reaching £1,402.3 billion (2021: £1,351.6 billion), an increase of 3.8% in the year. Some of this increase may be reversed as the cost of living increases, but as a small participant the Group is less likely to be affected by this than larger banks and building societies.

The Group's retail deposit franchise performed well in the year and was able to deliver the required funding base at attractive cost compared to wholesale alternatives

Savings accounts at the financial year end are analysed below.

The average initial term of fixed rate deposits was 22 months (2021: 26 months). Market savings rates in the year have begun to increase from their historically low levels as the UK bank base rate has moved upwards, particularly towards the end of the year. The Bank of England has reported average interest rates at 30 September 2022 for new 2-year fixed rate deposits at 2.67% (2021: 0.46%), at 0.6% for instant access balances (2021: 0.10%) and similar rises across product types. This rising rate environment has impacted on the Group's absolute funding cost, as shown above.

It is notable that the SONIA market interest benchmark had increased from 0.05% at the start of the year to 2.19% by its close, meaning that the average variable rate paid by the Group represented a 64 basis point discount to SONIA whereas the opening position had been a 37 basis point premium.

The Group has continued to increase volumes through its direct channel and through an expansion of the number and volume of accounts opened through third party digital banking and wealth management platforms. The use of these third parties increases options to manage inflows and allows the Group to access a wider base of customers. The Group now operates through eight channels, including new relationships which commenced in the year. These channels now represent around 13% of the total deposit base and the Group's infrastructure offer opportunities to expand this further.

The Group regards the quality of its customer service as a vital component of its savings market strategy and conducts insight surveys throughout the customer journey. In this research 88% of customers opening a savings account with the Group in the year who provided data, stated that they would 'probably' or 'definitely' take a second product (2021: 88%). The NPS in the same survey was +59, similar to that in the previous year (2021: +58).

When customers with maturing savings balances in the year were surveyed, 87% stated that they would 'probably' or 'definitely' consider taking out a replacement product with the Group (2021: 89%) with an NPS at maturity of +52, the same level as in the 2021 financial year (2021: +52).

This level of customer satisfaction is also demonstrated by the Group's continuing success in industry awards. During the year awards won included 'Best Fixed Term Savings Account Provider' at the 2022 YourMoney awards, 'Best Fixed Rate Cash ISA Provider' at the 2022 Moneynet awards and 'Most Consistent Best Buy Savings Provider' in the MoneyComms 2022 Top Performers list.

The Group's direct and third party channels are both supported by reliable and scalable infrastructure, and it continues to invest in systems and processes to enable the business to develop. This delivers a retail deposit stream where volumes and rates can be effectively managed to support the Group's requirements.

The operation will continue to develop, expanding offerings, addressing wider customer groups and accessing new channels while monitoring the emerging impact of the cost of living and rising interest rates on the consumer savings market. The Group's profiling of its target customers suggests they may be more resilient than average in the event of future economic stresses, but the developing situation will remain under close review.

The Bank of England Term Funding scheme for SMEs ('TFSME') continued to be available through the early part of the year to support lenders in providing credit to SME customers through the Covid pandemic. The Group refinanced its borrowings under the scheme before it closed to manage its maturity dates.

During the year the amount drawn under TFSME was £2,750.0 million (2021: £2,750.0 million). As TFSME provides funding at or very close to base rate, in a low base rate environment it forms a particularly cost-effective form of borrowing for lenders which, like the Group, wished to support their SME customers through the economic uncertainties of the pandemic. The relative cost-effectiveness of these borrowings as base rates begin to rise is being kept under review.

The Group's remaining drawings under the Bank of England's original Term Funding Scheme ('TFS') were repaid in the year. The Group retains access to other Bank of England funding channels and utilised these to make drawings under the Indexed Long-Term Repo Scheme ('ILTR') during the period. None of these drawings remained outstanding at the year end.

The Group expects to continue to make use of these central bank facilities going forward, in accordance with the objectives of the schemes. Where using them is appropriate and cost-effective, mortgage loans pre-positioned with the Bank of England are available to act as collateral for future drawings, if and when required. This provides access to potential liquidity or funding at 30 September 2022 of up to £1,776.0 million (2021: £1,424.2 million).

The Group's wholesale funding includes securitisation funding, warehouse bank debt and retail and Tier‑2 corporate bonds, which are each accessed from time to time as appropriate. The Group's Long-Term Issuer Default Rating was increased to BBB+ by Fitch in March 2022, with a stable outlook, enhancing the Group's funding capacity.

For much of the year the capital markets remained active, with activity in most areas of funding. The securitisation markets remained open, but with very few transactions coming to market. Towards the end of the year the levels of uncertainty in the markets effectively prevented any new deals being launched.

Historically the Group has been one of the principal issuers of UK residential mortgage-backed securities ('RMBS'), however, its reliance on this funding source has been significantly reduced over recent years, with the most recent issuance held internally rather than issued in the market.

The Group renegotiated its £400.0 million warehouse funding facility during the period, increasing the facility size to £450.0 million and transitioning the interest rate from 0.60% above LIBOR to 0.50% over SONIA. This facility is used to provide standby capability, particularly in the event of market disruption elsewhere, where funds need to be deployed rapidly or as an alternative to retail deposit funding for liquidity purposes.

The Group's retail bond issued in January 2015 was repaid at maturity in January 2022. The Group also entered into sale and repurchase transactions from time to time, to ensure it retains access to this channel for liquidity purposes.

The Group's wholesale funding position is stable, mostly long-dated and cost effective. It retains the infrastructure to access all appropriate wholesale funding sources whenever appropriate. This wholesale funding strategy is effective and adaptable, and the Group will continue to access all these funding sources on a strategic and opportunistic basis as appropriate.

The year ended 30 September 2022 saw the continuing growth of the Group's savings proposition, with total balances exceeding £10 billion for the first time. The wholesale part of the funding base continued to reduce while remaining stable, with little requiring refinancing in the short term, providing some protection against any developing issues in the UK economy.

This has been consistent with the Group's funding strategy, making strategic use of wholesale funding sources while maintaining its principal focus on the retail savings market. The Group is well placed to maintain this diverse, robust and adaptable strategy going forward, which will support the needs of its developing business into the future.

Further information on all the above borrowings is given in note 23.

The Group manages its capital to maintain the strength of its balance sheet, ensure that its regulatory capital and liquidity positions are sufficient to safeguard depositors and provide capacity to meet its strategic objectives and other opportunities going forward.

With the increasing levels of uncertainty in the UK economy over the year and the upward movement in interest rates and inflation towards the end of the year, the Group focussed on ensuring that its capital strength remains sufficient to withstand the potential pressures.

For regulatory purposes the Group's capital comprises shareholders' equity and its Tier-2 green bond. It has no outstanding Additional Tier 1 ('AT1') issuance, but has the capacity to issue such securities, if considered appropriate, under an authority granted by shareholders at the 2022 Annual General Meeting ('AGM'), which will be proposed for renewal at the 2023 meeting.

The Group is subject to supervision by the PRA on a consolidated basis, as a group containing an authorised bank. As part of this supervision, the regulator will issue a Total Capital Requirement ('TCR') setting an amount of regulatory capital, defined under the international Basel 3 rules, currently implemented through the EU Capital Requirements Regulation and Directive regime ('CRD IV'), which was transposed to the PRA Rulebook as part of the Brexit arrangements.

The TCR includes elements determined based on the Group's total risk exposure together with fixed elements, and is held in order to safeguard depositors in the event of severe losses being incurred by the Group. The TCR is specific to the Group and is set on the basis of periodic supervisory reviews carried out by the regulator, most recently in 2021.

The Group's TCR at 30 September 2022 was 8.8% (2021: 8.8%), compared to the minimum TCR allowed under the Basel 3 framework of 8.0%. This low level gives the Group advantages in capital management and reflects the regulator's view of the maturity of the Group's systems for the management of capital and risk.

As a matter of strategy, the Group maintains strong capital and leverage ratios. It was granted transitional relief on the adoption of IFRS 9, along with most other banks, with additional relief granted in 2020 for the impact on capital of provisions created in response to the Covid pandemic. This relief is being phased out, year-by-year, while any reversal of Covid-related provisions will generate a corresponding reduction in relief.

The PRA requires firms to disclose capital measures both on the regulatory basis and as if these reliefs had not been given, referred to as the 'fully loaded' basis. As the value of reliefs will taper over time, the difference between measures on the regulatory and fully loaded bases will narrow and eventually converge. The Group's principal capital measures, CET1 and Total Regulatory Capital ('TRC') are set out below on both bases.

The Group's CET1 capital comprises its equity shareholders' funds, adjusted as required by Regulatory Capital Rules of the PRA and can be used for all capital purposes. TRC, in addition, includes tier-2 capital in the form of the Group's green bond. This tier-2 capital can be used to meet up to 25% of the Group's TCR.

The increase in capital over the year has been generated by the profits earned in the year, offset, to some extent, by the impact of dividends and buy-backs. The capital positions set out above include gains made on fair value accounting, which will reverse over time. The increase in TCR on both the regulatory and fully loaded bases shown above has arisen principally as a result of balance sheet growth in the year.

CET1 capital must also cover the buffers required by the 'Capital Buffers' part of the PRA Rulebook, the Counter-Cyclical ('CCyB') and Capital Conservation ('CCoB') buffers. These apply to all firms and are based on a percentage of total risk exposure. The CCoB remained at 2.5%, its long-term rate, throughout the year (2021: 2.5%), while the UK CCyB remained at 0.0% (2021: 0.0%), having been reduced from 1.0% during 2020 as a regulatory response to the pandemic. However, it has been announced by the Financial Policy Committee of the Bank of England that the CCyB will increase to 1.0% from December 2022 and 2.0%, its expected long-term standard level, in July 2023 and this requirement for additional capital in the future has been factored into the Group's capital planning.

CET1 capital required to cover CCoB and CCyB buffers increased to £187.9 million at the year end on the regulatory basis (2021: £170.9 million), mostly as a result of balance sheet growth.

Further buffers may be set by the PRA on a firm-by-firm basis but cannot be disclosed.

The Group's capital ratios, after allowing for the proposed dividend for the year and its irrevocable buy-back commitments, are set out below.

All the Group's capital ratios show strong improvement over the period. This reflects the trading profits, including those relating to fair values and the extinguishing of the pension scheme liability. As the IFRS 9 reliefs are phased out the fully loaded and regulatory bases will automatically converge.

The Basel Committee on Banking Supervision ('BCBS') had set the implementation date for its revisions to the Basel 3 framework, sometimes referred to as Basel 3.1, as 1 January 2023. This is, however, subject to those revisions being enacted in the relevant jurisdiction, which was delayed by the Covid pandemic. In the UK these rules will be enacted through the PRA Rulebook and the PRA has announced that it intends that these changes will become effective in the UK from 1 January 2025, following a consultation on the detailed requirements which was published in November 2022.

The PRA has also launched a more extensive consultation on a 'strong and simple' approach to regulating non-systemically important banks without international activities. While its initial proposals address the smallest banks, it has indicated that this is a first step and that all non-systematic banks will be considered. The Group is monitoring these developments and will respond through its capital planning as appropriate.

The Group submitted the second stage of its application for the accreditation of its IRB approach to buy-to-let credit risk for capital adequacy purposes to the PRA in March 2021 and is currently responding to PRA feedback on various elements of this phase, ahead of a formal PRA panel assessment. The project continues to progress to plan, and work continues into the new financial year on both the buy-to-let portfolio and development finance lending, which represents the next step in the Group's IRB roadmap.

It is Group policy to hold sufficient liquidity in the business to meet cash requirements in the short and long term, as well as to provide a buffer under stress. There is also a regulatory requirement to hold liquidity in Paragon Bank. This policy has a consequent effect on the Group's operational capital and funding requirements.

The Board regularly reviews liquidity risk appetite and closely monitors a number of key internal and external measures. The most significant of these, which are calculated for the Paragon Bank regulatory group on a basis which is standardised across the banking industry, are the Liquidity Coverage Ratio ('LCR') and Net Stable Funding Ratio ('NSFR').

The LCR measures short-term resilience and compares available highly liquid assets to forecast short-term outflows, calculated according to a prescribed formula, with a 30 day horizon. The monthly average of the Bank's LCR for the period was 146.2% compared to 165.6% during the 2021 financial year. These figures, however, reflect the reduction of liquidity being held as Covid receded in the early part of the year followed by a tightening in the latter part of the year as the economic situation deteriorated.

The NSFR is a longer-term measure of liquidity with a one year horizon, supporting the management of balance sheet maturities. At 30 September 2022 the Bank's NSFR stood at 122.3% (30 September 2021: 119.6%), reflecting the strengthening of the overall funding and capital position over the year.

The Group's distribution policy over recent years has been based on the objective of enhancing shareholder returns on a sustainable basis, while protecting the capital base. In order to achieve this, its stated policy has been to distribute 40% of consolidated earnings to shareholders in ordinary circumstances, achieving a dividend cover ratio of approximately 2.5 times. It has also undertaken buy-backs of shares in the market from time to time as part of its management of overall capital, where these enhance shareholder value and excess capital is available, balancing the expectations and requirements of different investor groups.

An interim dividend for the year of 9.4 pence per share (2021: 7.2 pence per share) was paid in July 2022 and the Board is proposing, subject to approval at the AGM on 1 March 2023, a final dividend for the year of 19.2 pence per share (2021: 18.9 pence per share). This would give a total dividend of 28.6 pence per share (2021: 26.1 pence per share). Given the magnitude of the fair value gains recorded in the year, the Board considered whether they should be included in the calculation of the distribution. As these gains are considered to be essentially timing differences it was decided to exclude them. The dividend proposed therefore represents approximately 40% of the adjusted profit, giving a dividend cover on the adjusted basis of 2.50 times (2021: 2.50 times) (Appendix D).

The directors have considered the distributable reserves and available cash and other resources of the Company and concluded that the proposed dividend is appropriate.

During the year the Board authorised the completion of the remainder of the buy-back programme which had been suspended at the 2021 year end. It also authorised a buy-back programme for the year of £50.0 million, which was subsequently extended to £75.0 million. £66.9 million, including costs, was expended during the year (Note 27). An irrevocable instruction for the completion of the remaining £10.8 million was given to the Group's brokers before the year end This was accrued for at the year end and was completed on 7 November 2022.

As part of the review of capital management described above the Board decided that it was appropriate to authorise a further buy-back programme of up to £50.0 million for the 2023 financial year. This will commence shortly after the announcement of the Group's 2022 year end results.

The Group has the general authority to make such purchases, granted at the AGM on 2 March 2022. Any purchases made under these programmes will be announced through the Regulatory News Service ('RNS') of the London Stock Exchange and the shares will be initially held in treasury.

The Board has affirmed the existing dividend policy going forward, subject to an assessment of prevailing conditions at the time, including future capital requirements, business strategy and external economic risks.

The Group keeps its current and forecast capital position under review in the light of economic, strategic and business requirements and proposed or forecast changes in the capital regime. The capital position strengthened in the year, although part of this increase relates to fair value gains which do not form part of underlying results.

The Group is well capitalised as it enters 2023, even after providing for an appropriate level of dividends and share buy-backs, the planned increases in the CCyB and the phasing out of IFRS 9 relief. Even in light of potential worsening in the UK's economic position this capital strength is prudent and sustainable and supports the overall viability of the business for the benefit of all stakeholders.

The delivery of the Group's strategy through a year of economic turbulence in the UK saw underlying profit (Appendix A), which excludes fair value gains and the profit arising on the sale of a loan book, continuing to grow in the year, reaching £221.4 million, an increase of 14.0% (2021: £194.2 million). This drove growth in underlying earnings per share, which rose by 17.9%, reaching 69.9 pence per share (2021: 59.3 pence per share).

The Group's statutory results for the year were significantly inflated by the accounting treatment required for pipeline hedging. It is the Group's policy to hedge a substantial part of its lending pipeline with interest rate derivatives and these can lead to substantial fair value gains being recorded in a rapidly changing interest rate environment before the relevant loans complete. The actual cash flows from hedging will impact on net margin through the subsequent life of the loan and the fair value gains will unwind. The level of such gains recorded in the period increased profit before tax on the statutory basis to £417.9 million (2021: £213.7 million), with earnings per share at 129.2 pence per share (2021: 65.2p).

The Group has consistently excluded these fair value items from underlying results as the timing of their recognition does not reflect that of their economic impact on the business.

CONSOLIDATED RESULTS

For the year ended 30 September 2022

Income

The Group's total operating income increased by 21.0% in the year, reaching £393.0 million. This included a one-off gain of £4.6 million on the disposal of the residual unsecured consumer lending book, which is excluded from underlying metrics.

The principal component of operating income continues to be net interest on the Group's lending assets. This increased from £310.5 million in 2021 to £371.2 million in 2022, a growth rate of 19.5%. This arises both from net growth in the loan book, with average balances increasing by 6.1% to £13,806.5 million (2021: £13,017.0 million) (Appendix B), and from an improvement in net interest margin ('NIM'), in both of its divisions. This is despite the sale of higher yielding unsecured consumer assets in the year.

The progression of the Group's NIM over the past five years is set out below.

The Group's other operating income (excluding the one-off gain) increased by 19.4% to £17.2 million from £14.4 million in the previous year, representing generally higher activity across all elements of the business.

Costs

The Group's cost base for the year increased by 13.0% in the year to £153.0 million (2021: £135.4 million). The largest item within costs continues to be employment costs, forming 67.7% of the total at £103.6 million (2021: £87.9 million). The increase of 17.9% in the year is partly attributable to an increase in staff numbers, with average headcount increasing by 5.0% to 1,498, but also the increase in the number of higher skilled, and therefore higher paid positions as the business develops. The Group has also been impacted by the level of UK wage inflation, which has been particularly severe in professional and technology positions.

Costs not related to employment, at £49.4 million were only marginally increased from those in the previous year (2021: £47.5 million), despite the impact of Covid restrictions on expenditure in 2021. The Group continues to channel significant resources into its digitalisation programme, with systems and enhancements delivered across the business in the period. These developments are fundamental to the Group's strategy going forward.

Costs continue to be incurred on the Group's IRB programme, which is expected to deliver significant benefits to the Group's capital position in the longer term. 

The progress of the Group's cost:income ratio over the last five years is set out below.

Cost:income continued to reduce slowly in the year with margins on income widening. Cost control is a strategic priority of the Group, but it recognises that the cost base must also adapt to deliver its strategic priorities and to meet regulatory expectations. Therefore the aim of a sustainably lower cost:income ratio is a long-term aspiration, rather than a short term priority.

Impairment provisions

The Group's recognition of credit losses is governed by the accounting standard IFRS 9, which requires the directors to take a view on the future performance of the Group's loan assets and to base provisioning on expected credit losses ('ECL'). It is unfortunate that since the standard was introduced in 2018 the UK has encountered a series of unprecedented economic, political and social disruptions, which have made the prediction of future asset behaviour, and therefore the operation of the standard very complex.

Based on the evaluation of ECL in the year end the Group has made a charge for impairment of £14.0 million (2021: release of £4.7 million). This mostly results from a balancing of the reduced likelihood of Covid impacts on the Group's portfolios against emerging economic and political issues such as the cost of living and doing business in the UK, the potential impacts on the global economy of the conflict in Ukraine and uncertainties over the future direction of UK Government policy, both generally and on issues which may affect the Group and its customers directly. None of these issues have direct precedents and therefore a significant exercise of judgment is required to evaluate how these should be reflected in ECL.

The progress of the impairment charge and cost of risk in the four years since the introduction of IFRS 9 in 2019 is set out below.

The fluctuations shown above show the impact of these uncertainties over time as they appear and then resolve. The high charge in 2020 represented the initial onset of the Covid pandemic, in 2021 the position appeared to have become a little more stable, while 2022 has seen new challenges arising, which have significantly reduced the level of clarity on the overall direction of the UK economy heading into the 2023 financial year.

The application of provisions in writing off accounts has remained more stable across the period, although the 2022 result was inflated by a large one-off case in asset finance. This highlights both the Group's careful approach to provisioning and the resilient nature of its assets.

Multiple economic scenarios and impacts

In order to support management's estimation of ECLs the Group has developed models to project losses in its largest books based on customer performance to the reporting date and anticipated future economic conditions. The use of these models therefore requires the use of a range of forward-looking economic scenarios which are each evaluated and then weighted to form an overall projection.

For portfolios where detailed models cannot be used the Group will also consider the potential impact of these economic scenarios where this might be significant.

Economic forecasting at the reporting date has become more difficult than at the half year, with the levels of uncertainty in the UK political environment significantly heightened at September 2022, increasing the risk of inaccurate forecasts.

Generally the consensus of forecasters is for a worse outlook overall than at the previous year end and the March half year, with the magnitude of change in key economic metrics likely to be larger than seen in some considerable time. The levels of uncertainty also mean that the range of opinions amongst reputable forecasters is considerable.

In the face of these uncertainties the Group has constructed the scenarios for its ECL modelling based on a number of forecasts from public and private bodies, synthesised to produce internally coherent sets of data. The central scenario is that used for the Group's planning process, while upside and downside scenarios have been derived from these. To allow for the wider range of economic possibilities to be covered, the downside scenario has been set further below the base case than has previously been the case.

As in previous years, the severe downside scenario is based on the Bank of England stress testing scenario published in 2022, adjusted to allow a harsher impact on house prices. This scenario is included to represent the range of highly stressed outcomes for the UK and the Group's customers. 

Overall the forecasts represent an environment of increased interest rate expectations, a more subdued housing market, especially in the short term and inflation at very high levels compared to recent history.

Given the increased range of potential outcomes, the Group has reviewed the weightings attributable to each scenario in its modelling. It has determined that it is appropriate to increase the weighting applied to the severe scenario by 5% to 20% and make a corresponding reduction in the weighting of the downside scenario, representing the growth in the number of plausible severe outturns for the UK. 

The forecast economic assumptions within each scenario, and the weightings applied, are set out in more detail in note 17.

The impairment provision levels generated by the Group's provisioning procedures and the scenarios described above are set out below. In order to demonstrate the impact of the scenarios used, the provisions have also been calculated on a single scenario basis for the central and severe scenarios.

The increase in the provisions calculated represents a more normal economic environment, with a reversion to longer term relationships between customer behaviour and eventual loss, reducing the need for other judgements to some extent. However, observation does not suggest that this linkage is fully re-established as yet. 

The distribution of gross balances by IFRS 9 stage produced by the Group's impairment methodology at the two most recent year ends is set out below.

This demonstrates the resolution of non-performing cases, the disposal of the POCI cases in the unsecured loan business and the increased identification of Stage 2 cases by provision models in response to a more normal economic framework.

Judgemental adjustments

The fundamental requirement of any provisioning methodology is that the accounts present fairly the assets of the business. Therefore it is a vital part of the process that all mechanical outputs are challenged based on management's understanding of the business to ensure that the provision is consistent with all available information at the year end, qualitative or quantitative and whether it can be input into the modelling process or not. While the Group would ideally like its mechanical provisioning procedures to allow for as much of this information as possible, it acknowledges that this can never entirely be the case.

This is particularly true where predicted economic conditions are not represented in the data used to develop the model, where the inherent modelling uncertainty will increase. There is also information which may only be relevant in certain situations, or more qualitative data, such as internal and external feedback, which it would be difficult to incorporate into a statistical modelling framework.

Management use their understanding of any model limitations, coupled with the wider ongoing and ad hoc management information about the Group's portfolios to determine whether any judgemental adjustments to provisioning are required. 

At 30 September 2022, the absolute magnitude of economic indicators such as bank base rates and inflation lay significantly outside recent historical levels, as did their rate of change, which may decrease model reliability. The Group's loan books were generally performing well, with historically low arrears figures in the principal portfolios. However, customer and market feedback suggests that the overall effect of these may be masking a higher ECL than that predicted.

This is particularly so in the Group's SME lending operations where SME businesses are known to be holding excess cash balances, partly resulting from government support lending schemes, which may be being used to delay the impact of potential business issues.

It is also clear that some customer groups in the SME business, such as those related to the construction industry, might be impacted more specifically by the economic situation and any potential governmental response to it, which might also have an impact on the recoverable value of security assets. 

To allow for these additional uncertainties the Group has applied judgemental overlays to its SME leasing portfolio and to its buy-to-let mortgage book.

The judgemental adjustments generated by this process, analysed by division are set out below.

The reduction in the overlay in Mortgage Lending reflects the receding threat of Covid generated losses, compared to 2022. There is also some transfer from overlays to the modelled provision as a more normal linkage between customer metrics and future performance returns. However, it is clear that there are new concerns in the UK economy, including those arising from living costs which are not being fully recognised in the modelling.

In the SME lending book, it is unclear whether the long-term damage to customer businesses from Covid shutdowns has yet fully manifested itself. Bureau data shows that the cash balances which had built up in the SME sector as Covid-related funds were drawn down has still not normalised and this may be delaying these impacts. There is also likely to be an extent to which businesses weakened by Covid impacts are less able to withstand the forecast economic headwinds than might ordinarily be expected. For these reasons management determined that the level of overlay in this part of the portfolio should be broadly maintained in response to these new concerns. 

Management then considered whether there were any customer groups (such as industries or geographies) where the risk was particularly greater than others. No such significant groups have yet been identified so the judgemental uplifts were applied across all performing cases.

The application of these judgemental adjustments is considered to align the accounting provision levels with current loss expectations in the business, taking into accounts all relevant internal information and allowing for inherent economic uncertainties. The Group will continue to monitor the appropriateness and scale of these overlays going forward and consider the extent to which any of the elements giving rise to them can or should be incorporated into models and standard processes.

Ratios and trends

The impact of the economic scenarios adopted, together with the judgemental adjustments adopted to address uncertainties over the future performance of accounts, particularly those which may have had payment relief or other government-backed support during the pandemic, has resulted in the overall provision amounts and coverage ratios set out below.

The trend of the ratios above is back towards a more normal measure of coverage, as the UK economic situation continues to evolve, although without returning to the 0.34% coverage ratio seen pre-pandemic at 30 September 2019. The downward trend was also influenced by the resolution of some significant legacy positions, and by the increasing levels of security coverage generated by house price inflation in the period, with the average loan to value in the buy-to-let mortgage portfolio falling to 57.9% (2021: 61.2%). The future levels of coverage will be dependent on the performance of the UK economy and its impact on the Group's customers and their markets, where applicable.

Fair value movements

The fair value line in the Group's profit and loss account primarily reports fair value movements arising from the Group's interest rate hedging arrangements. These are put in place to protect the Group's margins when offering fixed interest rate products in either its savings or lending markets while continuing to honour offers to customers in the event of significant interest rate movements. The Group maintains a cautious approach to interest rate risk and considers its exposures to be appropriately economically hedged. The Group does not engage in any form of speculative derivative trading and all fair value movements relate to banking book exposures.

The accounting entries included in this balance are primarily non-cash items and will reverse over the life of the hedging arrangement, although period to period movements are mostly influenced by volatility in market interest rates.

Where derivatives are hedging active loan or savings balances the accounting entries should broadly cancel each other out, although this effect can be distorted in periods of greater interest rate volatility, such as the financial year just ended.

Where derivatives are hedging the lending pipeline such offsets are not available, and the full fair value movement will be shown on this line. Where future interest rate expectations increase significantly between the point at which the pipeline loans were hedged and the point at which the loans complete, then a substantial fair value movement will have been posted to the balance sheet by this time. However, through the life of the loan product the derivative will provide inflows of cash to support the income from the loan, compensating for the difference between the fixed rate already agreed and the fixed rates available in the market at the time of completion.

For this reason the Group regards these movements as essentially the anticipation of gains belonging economically to later accounting periods and excludes them from underlying results.

The particularly high levels of these movements in the 2022 financial year, where a gain of £191.9 million was recorded (2021: £19.5 million) result primarily from the levels of volatility in UK benchmark interest rate expectations in the year, the Group's approach to pipeline hedging and the retention strategy applying to maturing five-year fixed loans, which meant that the pipeline was larger and of longer duration (and hence more exposed to movements in rates) them in earlier periods.

The Group has a net derivative position of £1,201.0 million at 30 September 2022, which is unmatched for hedge accounting, although forming part of the economic hedging position. These derivatives must be carried at a fair value based on expected cash flows over their contractual lives. As a substantial proportion of this balance has a lifetime of two to five years, volatility in the interest rate markets can generate substantial month to month fluctuations in this valuation which have to be included in the Group's profit.

The table below shows the movements in unmatched exposures over the last three years alongside the maximum and minimum five year swap rates in the year as a measure of volatility.

This clearly shows a quadrupling of the interest rate range, the doubling of the loan pipeline hedge and a reduction in the deposit pipeline hedge which would have provided an offset. These factors have driven the gain from pipeline hedging recorded in the year.

As a result of these accounting transactions the Group is carrying a net fair value hedging asset on its balance sheet of £216.6 million (2021: £8.8 million) which will revert to zero over the lives of the related instruments.

Tax

Accounting standards require that a company should account for tax in its year end accounts at the rates of tax enshrined in legislation at the reporting date, regardless of any indications of future tax policy given by governments. This means that these accounts are prepared on the assumption that the UK Government increases the rate of corporation tax from 19% to 25% from April 2023 and reduces the bank surcharge from 8% to 3%, from the same date. Any deviation from this position will be accounted for in future periods.

The effective tax rate applied to the Group's profits has increased from 23.0% in 2021 to 25.0% during 2022. The main cause of this has been the recognition of the deferred tax liability on fair value gains which are calculated on the basis of the higher tax rates legislated for in future years. The bank surcharge represented 313 basis points of the effective rate in the year (2021: 496 basis points), meaning that it represented over half of the difference between the basic and effective rates.

As the bulk of the fair value gain arose in Paragon Bank it is subject to a higher rate of tax than the overall effective rate for the Group. This meant that the effective tax rate on underlying profit was 23.4%. In previous periods the effective tax rate on underlying profit had been materially similar to the overall effective tax rate.

Results

The year's profit before tax was 95.6% higher than in 2021 at £417.9 million (2021: £213.7 million), with much of the increase related to fair value items. Profit after tax increased 90.6% to £313.6 million (2021: £164.5 million).

Basic earnings per share increased to 129.2 pence (2021: 65.2 pence) and the diluted measure was 125.6 pence per share (2021: 63.0 pence), both inflated by the fair value accounting adjustments.

This result increased consolidated equity to £1,417.3 million (2021: £1,241.9 million), representing a tangible net asset value of £5.33 per share (2021: £4.34 per share) and a net asset value on the statutory basis of £6.06 per share (2021: £5.03 per share) (Appendix E).

SUMMARY BALANCE SHEET

30 September 2022

The Group's loan portfolio grew by 6.0% during 2022, with growth in both Mortgage Lending and Commercial Lending, despite the disposal of its unsecured consumer lending book. More detail on these movements is given in Section 1. This increase, together with the Group's liquidity and capital policy, determines its funding requirements and hence the level of its liabilities.

Funding structure and cash resources

The Group's funding balance increased by 6.7% during the year, marginally faster than the growth in the loan book as cash balances increased. The proportion represented by retail deposits increased to 72.7% in accordance with the Group's long-term funding strategy (2021: 67.6%), with wholesale borrowings paid down. Movements in funding balances are discussed in more detail in Section 2.

Derivatives and hedging

The Group's derivative assets shown in the table above relate almost entirely to the hedging of interest rate risk in the lending and deposit portfolios. Driven by interest rate volatility the balances of both the derivative assets and liabilities, and the related hedging adjustments on loans and deposits, have risen sharply as the volume of the Group's fixed rate products where the rate significantly differs from market fixed rate positions has grown, as market rates have increased during the year. All these items will ultimately effectively flow to the profit and loss account as fair value movements.

Pension obligations

The valuation of the Group's defined benefit pension scheme under International Accounting Standard ('IAS') 19 moved from a deficit of £10.3 million at the start of the year to a surplus of £7.1 million at 30 September 2022. This valuation is driven by inputs based on market-derived interest rates and the volatility in the period produced significant fluctuations. These inputs must be based on point-in-time observations at the year end, and market disruption around the end of September 2022 has therefore impacted the valuation.

The principal change in inputs was the increase in the discount rate used in evaluating scheme liabilities, which is based on long-term corporate bond yields, from 2.00% to 5.00%, while the assumed rate of RPI inflation, which is based on gilt yields and would normally counteract the impact of rising discount rates only increased from 3.40% to 3.55%. These movements led to a pre-tax valuation gain of £15.3 million being booked in other comprehensive income.

While the valuation under IAS 19 is that which is required to be disclosed in the accounts, pension trustees generally use the technical provisions basis as provided in the Pensions Act 2004 to measure scheme liabilities. On this basis, the deficit at 30 September 2022 was estimated at £1.4 million, an increase of £0.4 million in the period (2021: deficit of £1.0 million), representing a 98.7% funding level (2021: 99.4%). However, the position was subject to significant fluctuation around the year end date due to market conditions.

Other assets and liabilities

Sundry assets fell from £154.0 million to £116.0 million in the year, largely a result of movements in collateral balances generated by the movements in derivatives described above, which reduced by £36.6 million.

Sundry liabilities grew from £92.1 million to £557.5 million, also principally driven by derivative movements, with collateral liabilities increasing by £388.4 million and a deferred tax balance of £44.4 million being recognised, largely due to fair value accounting adjustments. The increasing interest rate environment also generated increases in accrued interest payable of £23.5 million.

The underlying operating profits of the two segments described in the Lending Review in Section 1 are detailed fully in note 2 and are summarised below.

The Group's central administration and funding costs, principally the costs of service areas, establishment costs and bond interest have not been allocated.

Mortgage Lending

The Group's Mortgage Lending division, which now includes second mortgage assets formerly reported in the Idem Capital segment continued to perform strongly and grow its NIM. Net interest grew by 9.6% in the year to £261.5 million (2021: £238.7 million) with average net assets growing by 5.4% to £12,079.2 million (2021: £11,465.3 million) as NIM increased to 216 basis points (2021: 208 basis points).

Credit performance in the period was good with a provision of £4.6 million in the year (2021: release of £7.6 million) and a cost of risk of 4 basis points. IFRS 9 Stage 3 cases reduced from £145.3 million to £119.3 million as the Group continued to resolve legacy cases which had been managed on a long-term basis.

Commercial Lending

In the Commercial Lending division average balances grew by 11.3% to £1,727.3 million (2021: £1,551.7), leading to an increase of 18.8% in net interest to £113.1 million (2021: £95.2 million). NIM grew from 614 basis points to 655 basis points, due to the continuing focus on higher margin business, and with lower-margin government backed lending forming a smaller part of new business than in the previous year.

While credit performance in the period remained largely stable, with low arrears and relatively few defaulted cases in the portfolio, potential adverse headwinds evolved in their nature but remained a threat. Stage 3 gross balance comprised only 0.3% of the segment's total gross portfolio at 30 September 2022 (2021: 1.2%). However, the uncertain outlook for the UK economy meant that the provision charge in the segment increased from £2.9 million in 2021 to £9.4 million in 2022, to ensure these risks are adequately provided against.

At the heart of the Group's strategy is its vision to become a leading technology-enabled specialist bank. This relies on the strength of its people, systems and controls and the continuing development of these alongside the evolution of its business is an ongoing focus at senior management levels. The Covid pandemic demonstrated the Group's agility and flexibility in resource deployment, which are fundamental to the execution of this strategy and the Group's ability to demonstrate its resilience to its regulators also confirms the strength of this position.

It was very pleasing that the Group's commitment to its people was recognised by the award of Platinum Investors in People ('IiP') status, the highest level available, achieved by only 5% of employers assessed.

During the year the Group's operational journey away from Covid restrictions continued and a permanent commitment to hybrid working was made. The evolution of these hybrid models in different business areas continues to be a major area of focus. At the same time IT and process developments continued to progress, supporting the Group's digitalised vision of its future operating model, while the enterprise risk management framework has further evolved to ensure that the business remains robust.

All these activities combine to give the Group an evolving operational structure on which it can rely to deliver its business strategy in the future.

The Group workforce has now exceeded 1,500 people, and they have seen a major shift in working patterns over recent years, which has continued through the most recent year. A hybrid working model was adopted on an ongoing basis, following trials and building on experience of the Covid pandemic. The majority of employees are attached to one of the Group's locations, with a proportion of their time spent working from home.

In order for the Group to provide the best possible service to customers and remain successful, individual business areas have taken different approaches to implementing the flexibility this offers their people. The optimisation of these arrangements has been an area of significant operational focus in the period and this process continues into the new financial year. The evaluation of the potential consequences of these changes on the Group's social, physical and IT infrastructure will remain a priority moving forward.

The Group's success in continuing to progress the development of new systems, processes and products during the Covid pandemic meant that it entered the year well positioned to deliver enhancements in the period, and a significant number of technological, operational and regulatory developments were completed or progressed.

Long-term projects to provide better technology for the development finance, SME lending and mortgage lending operations continued in the period, with enhancements becoming available to support customers and intermediaries. During the year major projects upgrading the Group's payment and treasury systems came on line, alongside additional cyber-security capabilities. Shorter-term projects provided enhancements to accounting systems, surveyors' administration, video conferencing and interactions with customers in vulnerable circumstances.

These developments are already contributing to the success of the Group's operations, delivering benefits to brokers and applicants for new SME lending products and to buy-to-let mortgage customers reaching the end of a fixed term on their products, as already described in Section 1 above.

The Group considers that its office locations remain valuable as part of its hybrid working model. Physical proximity can play a significant role in fostering collaboration, collegiality, creativity and the growth of the Group's culture and identity. The Group continues to review its locations to ensure they are optimised for new working methods and to manage their energy efficiency. As part of that process the Group's SME lending hub was relocated within the Southampton area, to a more suitable building with a better environmental impact. The Group's premises in Cardiff and Poole were also replaced with more appropriate facilities.

The Group has maintained its focus on high quality customer service throughout the period and is currently working to embed the new FCA Consumer Duty requirements in its systems and processes. This is a significant transformation in the way that the regulator approaches firm's responsibilities and a major project is taking place to ensure that the business will be able to comply within the deadlines set by the FCA.

On the Group's termination of its unsecured lending activities and the sale of its residual loan assets it was a particular focus to ensure that customers, especially those with vulnerabilities or potential vulnerabilities, were not adversely impacted by the process. The Group focusses on complaints data as a high level satisfaction metric, and incident levels remained low throughout the period.

The operational resilience of the business remains an important area of focus for the Group. During the period the formal self-assessment required by regulators was successfully completed, endorsing the Group's investment of time and resources in this area over recent periods.

Throughout the year ended 30 September 2022, the Group continued to comply with the principles and provisions of the UK Corporate Governance Code (the 'Code'). The Group adopted the 'comply and explain' approach under Provision 19 of the Code to extend the tenure of Fiona Clutterbuck as Chair past nine years for succession planning purposes and to ensure the appointment of a suitable replacement Chair. Fiona stepped down from the Board on 1 September 2022 on the appointment of the new Chair, Robert East.

The appointment of the new Chair of the Board in September 2022 has also resulted in the Company adopting a 'comply and explain' approach to Provision 21 of the Code, which requires a Board to undertake a formal and rigorous annual evaluation of the performance of the Board, its committees, the Chair and individual directors. Given the appointment of a new Chair, the decision was taken to defer the 2022 evaluation until 2023 to allow the new Chair sufficient time in post to make the evaluation more relevant, meaningful and useful. The board evaluation in 2023 will be externally facilitated. 

Board of Directors

On 1 September Robert East was appointed as Chair of the Board in place of Fiona Clutterbuck who stepped down from the Board on that day. Robert has over 40 years' experience in UK financial services, including at board level, as CEO and Chair. During his executive career he held senior roles at Barclays. He was also CEO of Cattles, where he led the restructuring and wind down of its operations from 2010 to 2016. He has held positions as Chair of Vanquis Bank, Skipton Building Society and Hampshire Trust Bank. He has previously served as a non-executive director on the boards of Provident Financial Group, Skipton and Hampshire Trust Bank, where he was also Chair of the Risk Committee.

On the same day Tanvi Davda was appointed as an additional independent non-executive director of the Group. She brings a diverse range of skills and knowledge to the Board following an executive career of more than 25 years. Her career began at Credit Suisse as a derivatives trader. She then went on to work with IBM as a management consultant before joining ABN AMRO and then Barclays Wealth, where she was Managing Director of Global Research and Investments. In 2015, Tanvi co-founded Saranac Partners, a boutique wealth manager, where she was Managing Partner until 2021. She continued to sit on the Saranac Partners board as a non-executive director until the end of November 2022. She has also held non-executive roles on the boards of Ofqual, the qualifications and examinations regulator, and the Student Loans Company. 

Following these changes the Board consists of nine directors, three of whom are female (33.3%).

Remuneration policy

The PRA remuneration rules applicable to the Group were changed with effect from the current financial year as it qualified as a Proportionality Level 2 ('Level 2') bank, bringing it within the scope of more onerous rules. This is a result of both the reduction in the asset threshold defining a Level 2 bank from £15 billion to £13 billion, announced by the PRA in December 2020, and of the development of the rules themselves. Affected employees have been determined and the changes required identified. All variable pay awards in respect of the current period have been made in accordance with relevant regulatory remuneration rules. The principal changes relate to the delivery mechanisms for the provision of variable remuneration to such people and the duration of deferral, for parts of that variable remuneration, which they are now subject to.

The Group's triennial review of its Directors' Remuneration policy commenced in the second half of the year, with consultations taking place with shareholders, investor bodies and other stakeholder groups. The proposed policy developed in this process will be presented to the 2023 AGM for approval by shareholders. We would like to thank all stakeholders who took part in the process for their input.

The Group employs just over 1,500 people and during the year headcount has grown by 4.3% (2021: 3.6%), largely driven by the creation of new roles in mortgage underwriting and customer support functions.

People and development

During the period the Group's priority has continued to be the wellbeing of employees, ensuring they were provided with the necessary support to return to the office environment safely as the restrictions from the pandemic came to an end. This included a number of trials, managed across the Group's different business areas, to identify the optimum way of working in a hybrid way, providing flexibility for employees whilst maintaining the high standards of delivering good outcomes for the Group's customers. In March 2022, an announcement was made to all employees to confirm hybrid working was being adopted on a permanent basis following the success of the trials.

The Group's Wellbeing team continues to play an important role in helping employees with their mental, physical, financial and emotional wellbeing. The Group's introduction of The Vitality Health programme during the year gave all employees access allowing them to obtain personalised health reviews, discounts and rewards through Vitality's partner brands and Vitality Wellbeing Coaches.

In May 2022 the Group was proud to announce the re-accreditation of its IiP status, being recognised for the first time as a Platinum employer. This recognition is the first for a Solihull based employer and it means the Group is one of just 5% of assessed organisations who have achieved this recognition.

The attrition rate of employees has increased during the period due to an increase in the number of retirees and a buoyant marketplace. The overall shortage of labour in the UK economy has put pressure on attracting trained and effective resource and the Group has experienced some of the effects of this. Whilst the voluntary attrition rate has increased to 12.2% from 8.6% in 2021, this level is not significantly above pre-Covid levels, and the Group continues to track below the national average of 18.6% for the banking and finance sector in 2022, published by Reward Gateway. Strong levels of retention remain a key feature of the Group's employee base with 55% of employees achieving over 5 years' service, 12% achieving over 20 years and 4% achieving over 30 years' service.

Employees continued to show flexibility during the year with many undertaking secondments and transfers to different areas of the business to ensure the Group continued to meet the needs of its customers. Although the decision was made to exit the unsecured consumer loans market in the year, of the 43 employees affected, over 50% were offered similar or alternate roles within the Group, with a number deciding to take voluntary redundancy in August.

The Group maintains its UK Living Wage Foundation accreditation and minimum pay exceeds the levels set by the Foundation. In July 2022, the Group made an exceptional payment of £1,000 to all employees below senior leader level, including a £500 advance of profit related pay for the current year, to assist with the cost-of-living pressures.

Holiday entitlement was enhanced during the year, with an additional day's leave given for an employee's birthday and, following a proposal from the Group's People Forum, it was agreed to extend the half day for Christmas Eve and New Year's Eve to a full day's leave for each date. All full time employees now enjoy at least 28 days paid leave, rising to 33 days after five years. This is in addition to public holidays.

Learning and development

The Group continues to provide employees with a range of training and development opportunities. During the period this has included a range of technology focused training to support the delivery of the IT roadmap and permanent move to hybrid working, alongside extensive leadership and management training. Additionally, a new development programme for high performing employees working in specialist, non-managerial roles was launched to support the career progression of technical experts. This training is complemented by other development opportunities such as apprenticeships, coaching and mentoring.

Equality and diversity

The Group made significant progress on its equality, diversity and inclusion ('EDI') strategy during the year. Richard Rowntree, Managing Director - Mortgages, continues in the role of Executive Sponsor for EDI and sponsors the Group's EDI Network which continued to develop through the year. The Network has had a positive impact on the development of the business and has been involved in several initiatives, including promoting the importance of diversity data collection (as at 30 September 2022 the Group had achieved 73% disclosure rate (2021: 63%)) and arranging Listening Circles where members of the Executive Committee meet with employees from minority groups to discuss their experiences of working at Paragon, often resulting in a reverse mentoring experience.

In May 2022 the Group became a founding member of 'Progress Together' the City of London's Socio-Economic Diversity Membership Body. The Group is committed to improving socio-economic diversity across the financial services sector and is working on several initiatives to widen the talent pools it is accessing.

The Group is pleased to report that it continues to achieve each of its targets set under the Women in Finance Charter in 2017, which focussed on female and ethnic minority representation in the workforce and management. The Group has committed to achieve 40% female representation in senior management by 31 December 2025, compared to the current 38.1%.

To support its efforts to improve gender equality the Group has continued to participate in Mission Gender Equity, a cross-company mentoring programme run by Moving Ahead. This opportunity has proven popular with both mentors and mentees, with 97% of mentees being retained, 30% securing a new role within the Group and 17% being promoted. Nicki Breen, Learning and Development Business Partner, was also recognised as a runner-up in Moving Ahead's 'Most Dedicated Programme Partner of the year' award. The Group is pleased to be participating in a similar scheme, Mission INCLUDE, for employees from ethnic minorities over the coming year.

The Group welcomes the increasing interest in the diversity and inclusion agenda from all its stakeholders and has participated in the recent FCA Diversity and Inclusion survey.

Sustainability, including resilience in the face of climate change risks, is core to the Group's strategy: to focus on specialist customers, delivering long-term sustainable growth and returns through a low risk and robust business model. Sustainability influences every aspect of the Group's business and means:

· Reducing the impact of the Group's operations on the environment

· Ensuring that the Group has a positive effect on our stakeholders and communities

· Delivering sustainable lending and savings through the design of products offered and the choices of sectors in which to operate

The Group has a Sustainability Committee which coordinates its overall response to climate change and other sustainability issues and reports directly to the Executive Committee. This provides a forum for sharing information on initiatives within business areas and helps to develop the Group's proactive approach. Since its formation in 2021 it has increased the profile of sustainability-related risks and opportunities within the Group and driven improved reporting and understanding of these matters.

The Group published its first sustainability report, Responsible Business Report, in December 2021 and has used feedback from that exercise in the development of its 2022 report. This reporting provides more detailed information on its sustainability initiatives and demonstrates how sustainability is embedded throughout the Group. It is available on the Group's corporate website at www.paragonbankinggroup.co.uk.

Climate change

Climate change is designated as a principal risk within the Group's Enterprise Risk Management Framework. As a result information and measures on climate change risks are considered at board level and the Group's responses are considered within the Board's overall strategy. These risks fall into two main groups:

· Physical risks (which arise from weather-related events)

· Transitional risks (which come from the adoption of a low-carbon economy)

The Group recognises the importance of reducing the impact that its own operations have on the environment. As a financial services provider the Group's overall environmental footprint across its principal operations is low. The Group is, however, committed to identifying, measuring and managing the impact of its operations on the environment and to find ways to mitigate any negative impacts. During the year key initiatives included:

· Inclusion of conditions related to climate targets in the Group's long-term variable pay arrangements

· Establishing a target to reduce operational footprint to net zero by 2030 and purchasing carbon credits to offset operational emissions in the year

· Relocating the Group's Southampton, Cardiff and Poole operations to more energy efficient premises

· Installing electric vehicle charging points at the several of the Group's buildings for use by employees

· Updating the company car policy so that only hybrid or electric vehicles will be provided on new leases, eliminating diesel and petrol vehicles from the company fleet by 2025. The Group's target is for a completely electric-only fleet by 2031

· Continuing the rollout of LED lighting across the Group's principal sites

The Group has also joined Bankers for Net Zero.

Green product initiatives have been developed across all the Group's main sectors and continue to evolve. These are discussed in the relevant business reviews in Section 1.

The Group continues to develop its reporting to manage both its risk management processes and its reporting under the principles set out by the Taskforce on Climate-Related Financial Disclosure ('TCFD'). As required by the UK Listing Rules the Group has reported on climate change risk and exposures under the TCFD framework in its 2022 year end accounts, building on the disclosures introduced in 2021.

The Group takes climate change very seriously and will only make commitments which it objectively believes are achievable and will deliver real benefits on climate change.

Social engagement

The Group's Charity Committee raised almost £43,000 for the Alzheimer's Society, the employee's chosen charity for 2021, an outstanding result, given the restrictions imposed on normal fundraising activities by the pandemic. For the nine months ended 30 September 2022 £31,000 was raised for MIND and employees have now selected Newlife, a disabled children's charity, as the beneficiary of fund raising efforts for the 2023 financial year.

Employees are also using their entitlement to an annual paid volunteering day, particularly as more opportunities become available with the loosening of Covid restrictions, with days used increasing from 49 in 2021 to 286. Employees took part in projects in the fields of homelessness, education and the environment, with the Group promoting a wider take-up for the coming year.

The effective management of risk remains crucial to the achievement of the Group's strategic objectives. It operates a risk governance framework designed around a formal three lines of defence model (business areas, risk and compliance function and internal audit) supervised at board level.

Risk environment

Whilst two previous reporting years have largely been dominated by the response to the Covid pandemic the Group now faces new economic and geopolitical challenges which require it to remain agile and resilient in its risk management capability. It is recognised that the wider pandemic is still a global challenge, and the possibility of further waves may pose additional issues. The Group's ability in successfully navigating the unprecedented situation posed by Covid in 2020 and 2021, means that it is well-placed to address any future operational challenges this may bring.

It is clear that the risk environment has significantly changed due to Covid and wider global issues which have, and will require the Group to ensure it continues to closely monitor impacts on its operations and risk profile. The Group's risk management framework will continue to provide a robust mechanism to ensure that new risks are promptly identified, assessed, managed, and appropriately overseen from a risk governance perspective.

There are a number of strategic issues that have been prominent in the risk landscape during the year and are expected to continue to pose challenges for the foreseeable future:

· The "cost of living" crisis has escalated over recent months and remains a dominant theme in the political and economic agenda. The implications of increasing inflationary pressures are far-reaching and the Group continues to monitor how this may impact its customers and employees

o  In an environment of rising interest rates and cost pressures for both new and existing borrowers, the Group continues to ensure that high standards of prudent lending are maintained. The Group takes a forward-looking, as well as current view of affordability, and has adjusted credit policy to ensure loan repayments are sustainable for customers and will continue to do so. The Group takes its responsibilities in respect of customers in vulnerable circumstances extremely seriously and continues to ensure where appropriate forbearance solutions are necessary these are tailored to individual customer circumstances and aligned to regulatory guidance and expectation

o  The Group remains committed to supporting its employees in the face of economic challenges. Various financial and wellbeing initiatives have been instigated to ensure that employees have access to information and resources to assist in navigating cost of living challenges. The welfare of its employees is a key priority of the Group, and it will continue to look at innovative ways of ensuring that individuals feel fully supported during the current uncertainty

The Group continues to closely monitor how changes in political leadership and associated priorities, policies or interventions may influence the broader economic landscape

· Following the outbreak of conflict between Russia and Ukraine the Group identified and ringfenced any potential exposures to Russian, Belorussian or Ukrainian customers and suppliers. Close oversight continues to be maintained through ongoing customer due diligence and risk assessment processes. In addition, the Group is committed to ongoing investment in its cyber controls, given heightened threat assessments posed by the geopolitical situation

· The continued embedding of the Group's operational resilience capability, given its proven criticality in the handling of the pandemic, and the incorporation of lessons learned into the overarching framework. The Group continues to build out its resilience capability having identified ongoing enhancements as a result of its initial self-assessment undertaken in March 2022. As regulatory and industry practice evolve following this sector-wide exercise, the Group is well-positioned to respond accordingly. Robust operational resilience capability is deemed to be critical as the Group undertakes its programme of strategic transformation across a number of legacy platforms and processes

· Prioritising focus on climate change given the associated risks, remains an ever-present challenge. The UK Government has confirmed its goal of net zero carbon by 2050 and the Group, and the rest of the financial services industry, have a vital role to play in that commitment. The Group considers the impacts of climate change risk through both its operations, and its lending activities and continues to evolve its approach to measure and mitigate the transition and physical risks potentially caused by climate change

These issues are expected to continue to dominate the risk landscape moving into 2023, particularly with the overall levels of economic uncertainty in the UK and the prospect of levels of inflation and interest rates not seen for many years. The Group will carefully monitor the emerging impacts on both credit risk and the wider risk landscape as the situation develops.

Risk management

Given the spectrum of risks the Group has faced, and continues to face, the maintenance of a robust risk management framework, allowing it to promptly identify and assess risk exposures and develop appropriate mitigants, remains imperative. It therefore remains committed to further evolution and embedding of its risk practices with significant progress having been made in the year in further enhancing its ability to manage all categories of risk through the ERMF.

The recruitment of experienced resource in 2021 within the second line of defence has enabled considerable enhancement of core risk processes during the year. This ensures that the risk framework continues to support the strategic aspirations of the Group in an effective and proportionate way. Good progress has been made in refining the suite of policies that underpin the management of each of the Group's identified principal risks. This, in turn, has resulted in refinement of associated risk appetites and better articulation of the control environment for each risk type. These activities have been accompanied by a comprehensive programme of education aimed at bolstering the Group's risk culture, and ensuring that individual accountabilities and responsibilities in respect of risk are fully understood.

A detailed roadmap supports the development of the framework, with regular reporting against these commitments provided to the Risk and Compliance Committee. Strong progress was made through the year with the focus for 2023 onwards directed to ongoing embedding and validating the success of this through a programme of risk maturity assessments.

Despite the wider strategic challenges, the Group has identified, focussed and delivered on a number of risk issues including:

· LIBOR transition - Successfully transitioning all customers with LIBOR-linked products to alternative rates prior to the withdrawal of LIBOR in December 2021, while ensuring that all strategic, operational and conduct-related risk implications of the changes in product design, funding and operation were fully met

· Financial crime - Enhancing further the Group's financial crime systems and controls. Such systems have been an area of regulatory focus across the sector and the Group has made significant investment in both technology and resources to support its comprehensive anti-money laundering programme

· FCA Consumer Duty - Mobilising a comprehensive programme of work to assess the impact of the new FCA Consumer Duty on the products and services offered across the Group, ensuring that its culture is driving good outcomes for its customers

· IRB - Continuing to develop IRB model methodologies for the buy-to-let and development finance portfolios, while embedding the overarching model risk framework to enhance credit risk management and support the Group's IRB application process. Following submission to the PRA of Phase 2 of the buy-to-let application in March 2021, initial agreed refinement points are in the process of being addressed. Phase 3 documentation for buy-to-let, and Phase 2 documentation for development finance, are nearing completion and waiting for PRA submission invitation prior to concluding final internal governance steps

The Group has also continued to develop its management of third-party outsourcing risks, climate change risk, cyber security and data risk and stress testing, while embedding the results of the resilience self-assessment referred to above.

The long-term impact of the UK's exit from the EU continues to emerge. Whilst the Group does not have operations outside the UK it has continued to review the capital, liquidity and operational implications of the stresses which might be caused by the process. In particular, it has continued to monitor the issues related to the supply of essential goods which are causing shortages in a number of sectors. Whilst the Group is not directly affected by these issues at present the Board is keeping the situation under ongoing review as supply issues in areas such as building materials and IT equipment could impact the Group's operations or those of its customers.

The Group also continues to monitor the wider challenges around energy supplies given the potential threats of power shortages and energy rationing. This is subject to ongoing analysis and stress testing and the Group has undertaken detailed contingency planning in the event that such a scenario occurs. Currently the Group is comfortable that it has access to adequate alternative energy sources, however, this continues to be assessed as the implications and likelihood of energy shortages becomes clearer.

Risk outlook

The principal challenges in the risk environment faced by the Group as it moves forward into its 2023 financial year and beyond include:

· Risks associated with the wider economic landscape and the impact this will inevitably have on individual living standards, particularly expected increases in energy costs. Whilst the level and duration of government intervention is yet unclear given the changing political leadership there will be a need to ensure appropriate treatment of ongoing arrears and the position of affected customers. Key to this will be ensuring that the treatment of customers is fair and conduct principles remain at the forefront of all interactions

· Addressing an increasing level of regulatory compliance standards, where the Group is committed to ensuring it remains compliant in all areas of its business. Particular focus in the Group is on addressing the regulatory requirements in respect of the new FCA Consumer Duty rules and ensuring that it continues to meet regulatory expectations in respect of its anti-money laundering and wider financial crime control frameworks

· Risks associated with climate change , where the UK Government has confirmed its goal of net zero carbon by 2050 in November 2020 giving the Group, and the rest of the financial services industry, have a vital role to play in that commitment. As global strategies continue to be refined the Group will ensure that both its operational footprint and the impact of its lending activities, explicitly consider climate change risks as a core strategic driver

Paragon Bank is authorised by the PRA and regulated by the PRA and the FCA. The Group is subject to consolidated supervision by the PRA and a number of its subsidiaries are authorised and regulated by the FCA. As a result, current and projected regulatory changes continue to pose a significant risk for the Group. The impact and pace of change necessitated through the ongoing programme of revisions to the Basel supervisory regime continues to pose a particular challenge for the Group. These together with other potential regulatory changes to the business are closely monitored through the comprehensive governance and control structures in place.

During the year all relevant regulatory publications have been considered by the Group, any implications identified and required changes implemented within an appropriate timeframe. The volume of requests for information from the FCA has increased during the year and this trend is anticipated to continue, focussing on exercising forbearance for customers as the cost of living crisis develops. The Group responds to such requests in a timely fashion, and maintains robust controls to support the delivery of fair customer outcomes.

The following developments currently in progress have the greatest potential impact on the Group:

· Consumer Duty - In July 2022, the FCA issued its final rules and guidance on "A new Consumer Duty", which seeks to set higher expectations for the standard of support provided to customers, and challenges firms to evidence the customer outcomes that they are delivering. As implementation of the new rules is staged (with the requirement for existing products to be in compliance by July 2023, and closed products by July 2024), previous project plans have been revised to ensure appropriate focus and prioritisation. This activity is being championed by the Board, with a non-executive director having specifically been assigned responsibility for oversight of the programme

· MREL - The Bank of England published a Consultation Paper ('CP') setting out proposed changes to the Minimum Requirement for Own Funds and Eligible Liabilities ('MREL') on 22 July 2021. On 3 December 2021 the Bank of England published a Statement of Policy based upon this consultation, which took effect from 1 January 2022. Although the Group is not subject to MREL requirements currently, given its potential for growth it may be required to issue MREL eligible instruments at some point in the future and therefore continues to closely monitor developments and potential impacts

· Basel 3.1 - The PRA published a Consultation Paper on Basel 3.1 implementation in November 2022. This follows delays driven by a need to respond to the Covid pandemic. The PRA's current intention is to consult on the proposals then implement on 1 January 2025. The Group actively monitors and manages its capital, assessing the implications of a range of different impacts including the implementation of any new requirements

· Regulatory framework - In 2021 the PRA published Discussion Paper 1/21, which explored options for developing a 'strong and simple' prudential framework for banks and building societies that are considered by the PRA to be neither systemically important nor internationally active, such as the Group. The PRA published a Consultation Paper 5/22 in April 2022 that focused on a proposed approach for the smallest firms, which would not impact on the Group based on the total asset's threshold (£15bn). However, the regulator has indicated that larger institutions will be addressed in the future. The Group continues to monitor developments and potential implications for its operations

· Customers in vulnerable circumstances - The treatment of customers in vulnerable circumstances continues to be a strong focus for the FCA, demonstrated in its business plan and three-year strategy released in April 2022. The Group continues to take its responsibilities in this regard very seriously. Significant work continues to be undertaken to revise existing procedures, controls and training provisions to meet regulatory and industry expectations

· Operational resilience - Following the publication of the final rules and guidance on 'building operational resilience in financial services' in 2021 by the FCA, PRA and Bank of England, the Group successfully met the March 2022 policy implementation deadline. This included setting of impact tolerances for important business services, embedding a scenario testing approach and undertaking a self-assessment against the regulatory framework. The 2022 self-assessment set clear objectives for further refining the Group's approach to resilience.

The Group is committed to a programme of continuous improvement in its resilience capability. Important business services are mapped and tested using severe but plausible scenarios to push the boundaries on the ability of the infrastructure, key dependencies and third parties to recover from disruption. This approach should ensure the Group can meet the regulatory deadline of 2025 where it will need to demonstrate the ability to stay consistently within impact tolerances

· Climate change - The Group continues to embed its approach to managing climate-related financial risks. The Sustainability Committee, alongside the existing executive level risk committees, ensures comprehensive consideration across all aspects of the business and ensures the Group is well-positioned to address the emerging challenges.

Managing the impacts of climate change is seen as a key strategic priority for the Group and a detailed plan of work has been developed which reflects regulatory and wider requirements. This will continue to be refined as new thinking emerges.

Certain regulations applying in the financial services sector only affect entities over a certain size, which the Group might meet within its current planning horizon. The Group considers whether and when these regulations might apply to it in light of the growth implicit in its business plans and puts appropriate arrangements in place to ensure it would be able to comply at that point.

The Financial Services and Markets Bill, which sets out how the UK financial sector will be regulated post-Brexit, was published in July 2022 with the aim that it will obtain royal assent by May 2023. The Bill will implement the outcomes of the Future Regulatory Framework ('FRF') Review, revoking retained EU law relating to financial services and enabling HM Treasury and the financial services regulators to replace it with legislation designed specifically for UK markets, in a way that builds on the UK's existing approach to financial services regulation. The Bill covers a wide range of areas, but key elements include the introduction of a new secondary objective for both the PRA and the FCA for medium to long-term growth and international competitiveness in the financial services sector, an enhancement to regulatory powers over critical third parties and increased powers for HM Treasury over the Bank of England and PRA on existing and new rules. The Group continues its close monitoring of developments in this area and the emerging implications of Brexit more widely, and how these may ultimately impact the specific regulatory frameworks under which the Group operates.

The governance and risk management framework within the Group continues to be developed to ensure that the impacts of all new regulatory requirements are clearly understood and mitigated as far as possible. Regular reports on key regulatory developments are received at both executive and board risk committees.

Overall, the Group considers that it is well placed to address all the regulatory changes to which it is presently exposed.

We have identified a number of principal risks, arising from both the environment in which we operate and our business model, which could impact our ability to achieve our strategic priorities.

We have an Enterprise Risk Management Framework ('ERMF') in place to ensure that these risks are monitored and managed in accordance with the Group's risk appetite.

The following statement of directors' responsibilities in respect of financial statements is included in the Annual Report and Accounts of the Group for the year ended 30 September 2022.

The directors are responsible for preparing this Annual Report, including the consolidated and company financial statements in accordance with applicable law and regulations.

Company law, including the Companies Act 2006 ('the Companies Act'), requires the directors to prepare consolidated financial statements for the Group and separate financial statements for the Company in respect of each financial year. In respect of the financial statements for the year ended 30 September 2022, that law requires the directors to prepare the consolidated financial statements in accordance with UK-adopted international accounting standards in conformity with the requirements of the Companies Act and they have also elected to prepare the separate financial statements of the Company on the same basis.

Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and Company and the Group's profit or loss for the year. In preparing each of the consolidated and company financial statements the directors are also required to:

· select suitable accounting policies and apply them consistently

· make judgements and estimates that are reasonable, relevant and reliable

· state whether the consolidated and company financial statements have been prepared in accordance with UK-adopted international accounting standards

· assess the ability of the Group and the Company to continue as a going concern, disclosing, as applicable, matters related to going concern

· use the going concern basis of accounting unless they intend to liquidate the Company and / or the Group or to cease operation or they have no realistic alternative to doing so

· present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information

· provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity's financial position and financial performance

The directors are responsible for keeping adequate accounting records for the Company that are sufficient to record and explain its transactions, disclose with reasonable accuracy at any time its financial position and enable them to ensure that its financial statements comply with the requirements of the Companies Act.

They are responsible for the implementation of such internal control processes as they deem necessary to enable the preparation of financial statements which are free from material misstatements, whether due to fraud or error, and have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities.

Under applicable law and regulations, the directors are also responsible for the preparation of a strategic report, directors' report, directors' remuneration report and corporate governance statement, which comply with that law and those regulations.

The directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company's website (www.paragonbankinggroup.co.uk). Legislation in the UK governing the preparation and dissemination of financial statements differs from legislation in other jurisdictions.

In accordance with DTR 4.1.14R of the FCA Disclosure Guidance and Transparency Rules, the financial statements will form part of the annual financial report published in the single electronic reporting format specified in the TD ESEF Regulation (the UK version of the EU Commission Delegated Regulation (EU) 2019/815). The independent auditor's report on these financial statements provides no assurance over the ESEF format.

Confirmation by the Board of Directors

The Board of Directors currently comprises:

Each of the directors named above confirms that, to the best of their knowledge:

· The financial statements, prepared in accordance with applicable accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and of the Group taken as a whole

· The Directors' Report, including those other sections of the Annual Report incorporated by reference, comprises a management report for the purposes of the DTR, and includes a fair review of the development and performance of the business and the consolidated position of the Group taken as a whole, together with a description of the principal risks and uncertainties that it faces

· The Annual Report (including the consolidated and company financial statements), taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group's position, performance, business model and strategy

Approved by the Board of Directors as the persons responsible within the Company.

Signed on behalf of the Board

CIARA MURPHY

Company Secretary

6 December 2022

CONSOLIDATED STATEMENT OF PROFIT OR LOSS

For the year ended 30 September 2022

The results for the current and preceding years relate entirely to continuing operations.

* See Note 3

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the year ended 30 September 2022

CONSOLIDATED BALANCE SHEET

30 September 2022

Approved by the Board of Directors on 6 December 2022.

Signed on behalf of the Board of Directors

N S Terrington R J Woodman

Chief Executive Chief Financial Officer

CONSOLIDATED CASH FLOW STATEMENT

For the year ended 30 September 2022

CONSOLIDATED STATEMENT OF MOVEMENTS IN EQUITY

For the year ended 30 September 2022

Year ended 30 September 2021