Annual Financial Report - 2 of 6

Principal risks and uncertainties

The Board carried out a robust assessment of the principal risks and uncertainties facing the Group, including those that could threaten its strategic objectives, business operating model, future financial performance and regulatory compliance commitments. The principal risks and uncertainties are outlined below:

1	Strategic and business risk

Definition The risk to the Group’s earnings and profitability arising from its strategic decisions, change in business conditions, improper implementation of decisions or lack of responsiveness to industry changes.
Risk appetite statement The Group’s strategic and business risk appetite states that the Group does not intend to undertake any medium to long-term strategic actions that would put at risk its vision of being a leading specialist lender, backed by a strong and dependable saving franchise.	The Group adopts a long-term sustainable business model which, while focused on niche sub-sectors, is capable of adapting to growth objectives and external developments.

Risk		Mitigation		Direction
Performance against targets Performance against strategic and business targets does not meet stakeholder expectations. This has the potential to damage the Group’s franchise value and reputation.		Regular monitoring by the Board and the Group Executive Committee of business and financial performance against strategic agenda and risk appetite. The financial plan is subject to regular reforecasts. The balanced business scorecard is the primary mechanism to support the Board and assesses management performance against key targets. Use of stress testing to flex core business planning assumptions to assess potential performance under stressed operating conditions.		Unchanged The benefits realised from the integration will support the Group in meeting the challenges posed by increasing levels of competition in our key market segments.
Economic environment The economic environment is an important factor impacting the strategic and business risk profile. A macroeconomic downturn may impact the credit quality of the Group’s existing loan portfolio and may influence future business strategy as the Group’s new business proposition becomes less attractive due to lower returns.		The Group continued to utilise and enhance its stress testing capabilities to assess and minimise potential areas of macroeconomic vulnerabilities.		Unchanged The Group’s strategic and business risk profile is impacted by the uncertainty surrounding the impact of trade negotiations following Brexit. Economic risks to which the Group is exposed remain high but stable compared with 2018.
Regulatory requirements The potential for emerging regulatory requirements to increase the demands on the Group’s operational capacity and increase the cost of compliance.		The Group continues to invest in its IT and data management capabilities to increase the ability to respond to regulatory change. A structured approach to change management and fully leveraging internal and external expertise allows the Group to respond effectively to regulatory change.		Increased Increased levels of regulatory scrutiny and increased regulatory expectations are driven by the increased size of the Group post-Combination.
Integration risk The risk that the Combination with CCFS does not create operational and financial benefits as planned.		The Board will maintain oversight of the integration process through the Board Integration Committee. A dedicated Integration Management Office has been established to drive the integration process forward. Independent second line and third line assessment, monitoring and reporting will be undertaken by the Risk function and Internal Audit function respectively.		Increased Risk of an ineffective integration or delays to integration may result in synergy and cost targets being missed, disruption to business as usual activities, operating and financial performance falling below expectations or damage to reputation.

Risk		Mitigation		Direction
Deterioration of reputation Potential loss of trust and confidence that our stakeholders place in us as a responsible and fair provider of financial services.		Culture and commitment to treating customers fairly and being open and transparent in communication with key stakeholders. Established processes to proactively identify and manage potential sources of reputational risk.		Increased Expectations are high to deliver the integration in a timely and effective manner while achieving strategic objectives. Expectations raised across all stakeholders including, employees, customer, regulators and shareholders.

2	Reputational risk

Definition The potential risk of adverse effects that can arise from the Group’s reputation being sullied due to factors such as unethical practices, adverse regulatory actions, customer dissatisfaction and complaints or negative/adverse publicity. Reputational risk can arise from a variety of sources and is a second order risk – the crystallisation of a credit risk or operational risk can lead to a reputational risk impact.

Risk appetite statement The Group does not knowingly conduct business or organise its operations to put its reputation and franchise value at risk.

Definition Potential for loss due to the failure of a counterparty to meet its contractual obligation to repay a debt in accordance with the agreed terms.
Risk appetite statement The Group seeks to maintain a high quality lending portfolio that generates adequate returns, under normal and stressed conditions. The portfolio is actively managed to operate within set criteria and limits based on profit volatility, focusing on key sectors, recoverable values, and affordability and exposure levels.	The Group aims to continue to generate sufficient income and control credit losses to a level such that it remains profitable even when subjected to a credit portfolio stress of a 1 in 20 intensity stress scenario.

3	Credit risk

Definition Potential for loss due to the failure of a counterparty to meet its contractual obligation to repay a debt in accordance with the agreed terms.
Risk appetite statement The Group seeks to maintain a high quality lending portfolio that generates adequate returns, under normal and stressed conditions. The portfolio is actively managed to operate within set criteria and limits based on profit volatility, focusing on key sectors, recoverable values, and affordability and exposure levels.	The Group aims to continue to generate sufficient income and control credit losses to a level such that it remains profitable even when subjected to a credit portfolio stress of a 1 in 20 intensity stress scenario.

Risk		Mitigation		Direction
Individual borrower defaults Borrowers may encounter idiosyncratic problems in repaying their loans, for example loss of a job or execution problems with a development project. While in most cases of default the Group’s lending is secured, some borrowers may fail to maintain the value of the security.		Across both OSB and CCFS a robust underwriting assessment is undertaken to ensure a customer has the ability and propensity to repay and sufficient security is available to support the new loan requested. At CCFS an automated scorecard approach is taken, whilst OSB utilises a bespoke manual underwriting approach. Should there be problems with a loan, the Collections and Recoveries team works with customers unable to meet their loan service obligations to reach a satisfactory conclusion while adhering to the principle of treating customers fairly. Our strategic focus on lending to professional landlords means that properties are likely to be well-managed, with income from a diversified portfolio mitigating the impact of rental voids or maintenance costs. Lending to owner-occupiers is subject to a detailed affordability assessment, including the borrower’s ability to continue payments if interest rates increase. Lending on commercial property is based more on security, and is scrutinised by the Group’s independent Real Estate team as well as by external valuers. Development lending is extended only after a deep investigation of the borrower’s track record and stress testing the economics of the specific project.		Unchanged The Group continues to observe strong and stable credit profile performance but remains alert to potential macroeconomic uncertainty arising from Brexit- related negotiations.
Macroeconomic downturn A broad deterioration in the economy would adversely impact both the ability of borrowers to repay loans and the value of the Group’s security. Credit losses would impact across the lending portfolio, so even if individual impacts were to be small, the aggregate impact on the Group could be significant.		The Group works within portfolio limits on LTV, affordability, name, sector and geographic concentration that are approved by the Group Risk Committee and the Board. These are reviewed on a semi-annual basis. In addition, stress testing is performed to ensure that the Group maintains sufficient capital to absorb losses in an economic downturn and continue to meet its regulatory requirements.		Unchanged The economic outlook is uncertain driven by the unknown impact of trade negotiations following Brexit. Economic risks to which the Group is exposed remain high but stable compared with the previous year.
Wholesale credit risk The Group has wholesale exposures both through call accounts used for transactional and liquidity purposes and through derivative exposures used for hedging.		The Group transacts only with high quality wholesale counterparties. Derivative exposures include collateral agreements to mitigate credit exposures.		Unchanged The Group’s wholesale credit risk exposure remains limited to high quality counterparties, overnight exposures to clearing bank and swap counterparties.

Definition Potential loss due to changes in market prices or values.
Risk appetite statement The Group actively manages market risk arising from structural interest rate positions.	The Group does not seek to take a significant interest rate position or a directional view on rates and it limits its mismatched and basis risk exposures.

Definition The risk that the Group will be unable to meet its financial obligations as they fall due.
Risk appetite statement The Group actively maintains stable and efficient access to funding and liquidity to support its ongoing operations.	It also maintains an appropriate level and quality of liquid asset buffer so as to withstand market and idiosyncratic liquidity-related stresses.

4	Market risk

Risk		Mitigation		Direction
Interest rate risk An adverse movement in the overall level of interest rates could lead to a loss in value due to mismatches in the duration of assets and liabilities.		The Group’s Treasury department actively hedges to match the timing of cash flows from assets and liabilities.		Unchanged The Group continues to assess interest on a regular basis ensuring that interest rate risk exposure is limited. The profile of the asset book has increased but this is offset by frequent hedging.
Basis risk A divergence in market rates could lead to a loss in value, as assets and liabilities are linked to different rates.		Due to the Group balance sheet structure no active management of basis risk was required by OSB in 2019. CCFS actively replace back book LIBOR asset swaps with SONIA swaps to balance basis risk across assets and liabilities and reduce possible exposure of dislocation of market rates from base rate.		Unchanged Product design, balance sheet structure and replacing LIBOR swaps with SONIA swaps has enabled the Group to maintain the overall level of basis risk across both Banks through the year.

5	Liquidity and funding risk

Risk		Mitigation		Direction
Retail funding stress As the Group is primarily funded by retail deposits, a retail run could put it in a position where it could not meet its financial obligations. Increased competition for retail savings driving up funding costs adversely impacting retention levels.		The Group’s funding strategy is focused on a highly stable retail deposit franchise. The large number of depositors provides diversification and a high proportion of balances are covered by the FSCS and so there is no material risk of a retail run. In addition, the Group performs in-depth liquidity stress testing and maintains a liquid asset portfolio sufficient to meet obligations under stress. The Group holds prudential liquidity buffers to manage funding requirements under normal and stressed conditions. The Group proactively manages its savings proposition through both the Liquidity Working Group and the Group Assets and Liabilities Committee. Finally, the Group has prepositioned mortgage collateral with the Bank of England which allows it to consider other alternative funding sources to ensure it is not solely reliant on retail savings. The Group also has a mature RMBS programme and access to warehouse facilities.		Unchanged The Group’s funding mix remained stable throughout the year.

Definition The potential inability of the Group to ensure that it maintains sufficient capital levels for its business strategy and risk profile under both the base and stress case financial forecasts.
Risk appetite statement The Group seeks to ensure that it is able to meet its Board-level capital buffer requirements under a severe but plausible stress scenario. The Group’s solvency risk appetite is constrained within the leverage ratio-related requirements.	We manage our capital resources in a manner which avoids excessive leverage and allows us flexibility in raising capital.

5	Liquidity and funding risk continued

Risk		Mitigation		Direction
Wholesale funding stress A market-wide stress could close securitisation markets or make issuance costs unattractive for the Group.		The Group continuously monitors wholesale funding markets for securitisation opportunities and will execute funding transactions or sell additional residual positions in the securitisations when market conditions are advantageous. The strong retail franchise, access to pooled deposits, Bank of England pre-positioned collateral and warehouse funding facilities through tier 1 investment banks provide the Group with a range of funding options.		Decreased The combined Group has a wider range of wholesale funding options available, including repo or sale of retained notes, collateral upgrade trades and warehouse facilities.
Refinancing of Term Funding Scheme The Group has drawn a total £2.6bn of funding under the TFS creating a refinancing concentration around the maturity of this scheme.		The Group has fully factored in repayment of TFS into the funding plans of both Banks, with planned repayment prior to the contractual date to minimise timing and concentration risk. The combined Group has a wider range of funding options to manage this process.		Unchanged The overall TFS position for the Group has increased but the combined Group has a wider range of funding options.

6	Solvency risk

Risk		Mitigation		Direction
Deterioration of capital ratios Key risks to solvency arise from balance sheet growth and unexpected losses which can result in the Bank’s capital requirements increasing or capital resources being depleted such that it no longer meets the solvency ratios as mandated by the PRA and Board risk appetite. The regulatory capital regime is subject to change and could lead to increases in the level and quality of capital that the Group needs to hold to meet regulatory requirements.		Currently the Group operates from a strong capital position and has a consistent record of strong profitability. The Group actively monitors its capital requirements and resources against financial forecasts and plans and undertakes stress testing analysis to subject its solvency ratios to extreme but plausible scenarios. The Bank also holds prudent levels of capital buffers based on CRD IV requirements and expected balance sheet growth. The Group engages actively with regulators, industry bodies, and advisers to keep abreast of potential changes and provides feedback through the consultation process.		Increased The Group maintained a prudent and stable CET1 capital and total capital position providing resilience against unexpected losses. The Group continued to fund its balance sheet growth using organic profit generation. Following the integration, the Group will be subject to minimum requirements for own funds and eligible liabilities (‘MREL’) requirements and will need to issue MREL-qualifying debt instruments to meet this requirement.

Definition The risk of loss or negative impact to the Group resulting from inadequate or failed internal processes, people or systems, or from external events.
Risk appetite statement The Group’s operational processes, systems and controls are designed to minimise disruption to customers, damage to the Bank’s reputation and any detrimental impact on financial performance.	The Bank actively promotes the continuous evolution of its operating environment through the identification, evaluation and mitigation of risks, whilst recognising that the complete elimination of operational risk is not possible.

7	Operational risk

Risk		Mitigation		Direction
IT security (including cyber risk) The risks resulting from a failure to protect the Bank’s systems and the data within them. This includes both internal and external threats.		The Group invested significantly in enhancing its protection against IT security threats, deploying a series of tools designed to identify and prevent network/system intrusions. This is further supported by documented and tested procedures intended to ensure the effective response to a security breach.		Unchanged Whilst IT security risks continue to evolve, the level of maturity of the Group’s controls and defences have significantly matured, supported by dedicated IT security experts. The Group’s ongoing penetration testing continues to drive enhancements by identifying potential areas of risk.
Data quality and completeness The risks resulting from data being either inaccurate or incomplete.		The Group established a dedicated Data Strategy Programme, designed to ensure a consistent approach to the maintenance and use of data. This includes both documented procedures and frameworks and also tools intended to improve the consistency of data use.		Unchanged Whilst the Data Strategy Programme enjoyed some notable achievements, there remains significant work in 2020 in order to ensure all data-related risks have been appropriately addressed.
Change management The risks resulting from unsuccessful change management implementations, including the failure to respond effectively to release-related incidents.		The Group recognises that implementing change introduces significant operational risk and has therefore implemented a series of control gateways designed to ensure that each stage of the change management process has the necessary level of oversight.		Increased The Group continues to adopt an ambitious change agenda and recognises that it is entering a period of significant change following the Combination and that risks of integration will be heightened during this period.
IT failure The risks resulting from a major IT application or infrastructure failure impacting access to the Bank’s IT systems.		The Group continues to invest in improving the resilience of its core infrastructure. It has identified its prioritised business services and the infrastructure that is required to support them. Tests are performed regularly to validate its ability to recover from an incident.		Unchanged Whilst progress was made in reducing both the likelihood and impact of an IT failure, the Group has identified additional enhancements that it will look to implement in 2020.
Organisational change and integration The risks resulting from the Group’s ongoing integration activities, including systems, people and infrastructure.		There is a low risk integration project plan (e.g. no large scale integration-related IT project change planned). Experienced and capable project management office, with close oversight and direction provided by the Group Executive and Board Integration Committees.		Increased The Group is in the early stages of the integration project, with no material issues identified with respect to delivering agreed objectives within planned timelines to date. Close oversight of the integration risks will be carried out by the Group’s Risk and Compliance function.

Definition The risk that the Group’s behaviours or actions result in customer detriment or negative impact on the integrity of the markets in which it operates.

Risk appetite statement The Group aims to operate and conduct its business to the highest standards which ensure integrity and trust with respect to how the Group operates and manages its relationships with key stakeholders. In this respect, the Group has no appetite to knowingly assume risks which may result in an unfair outcome for customers and/or cause disruptions in the market segments in which it operates.

However, where the Group identifies potential conduct risks it will proactively intervene by managing, escalating and mitigating them promptly to ensure a fair outcome is achieved.

8	Conduct risk

Risk		Mitigation		Direction
Product suitability Whilst the Group originates relatively simple products, there remains a risk that products (primarily legacy) may be deemed to be unfit for their original purpose in line with current regulatory definitions.		The Group has a strategic commitment to provide simple, customer-focused products. In addition, a Product Governance framework is established to oversee both the origination of new products and to revisit the ongoing suitability of the existing product suite.		Unchanged Whilst this risk remained low as a result of increased awareness and dedicated oversight, the Bank remains aware of the changes to the regulatory environment and their possible impact on product suitability.
Data protection The risk that customer data is accessed inappropriately either as a consequence of network/ system intrusion or through operational errors in the management of the data.		In addition to a series of network/system controls, the Bank performs extensive root cause analysis of any data leaks in order to ensure that the appropriate mitigating actions are taken.		Unchanged Despite a number of additional controls introduced in 2019, the network/system threats continue to evolve in both volume and sophistication.
Integration risk The risk that the integration programme directly or indirectly causes poor outcomes for customers and the market.		During the integration process, the Group is committed to adopting a low-risk approach with a view to taking reasonable steps to avoid causing poor outcomes for our customers and the market. The Group will conduct detailed analysis of potential customer harm associated with particular integration steps.		Increased The Group is in the early stages of the integration project, with no material issues identified with respect to poor customer outcomes.

9	Compliance/regulatory risk

Definition The risk that a change in legislation or regulation or an interpretation that differs from the Group’s will adversely impact the Group.
Risk appetite statement The Group views ongoing conformity with regulatory rules and standards across all the jurisdictions in which it operates as a critical facet of its risk culture. The Group does not knowingly accept compliance risk which could result in regulatory sanctions, financial loss or damage to its reputation.	The Group will not tolerate any systemic failure to comply with applicable laws, regulations or codes of conduct relevant given its business operating model.

Risk		Mitigation		Direction
Prudential regulatory changes The Group continues to see a high volume of key compliance regulatory changes that impact its business activities. These include; change in Standardised Approach capital rules and implementation of an IRB floor, implementation of the European Standardised Information Sheet, extending the Senior Managers and Certification Regime to all FCA regulated firms and introduction of Strong Customer Authentication requirements. The focus on external wall cladding for high-rise buildings has recently been extended to cover all buildings regardless of height.		The Group has an effective horizon scanning process to identify regulatory change. All significant regulatory initiatives are managed by structured programmes overseen by the Project Management team and sponsored at Executive level. The Group has proactively sought external expert opinions to support interpretation of the requirements and validation of its response, where required. The Group has initiated a study into external wall cladding and is reviewing its own and lent portfolio.		Increased The Group has historically responded effectively to all significant regulatory changes. However, the level and sophistication of emerging regulation continues to increase.
Conduct regulation Regulatory changes focused on the conduct of business could force changes in the way the Group carries out business and impose substantial compliance costs.		The Group has a programme of regulatory horizon scanning linking into a formal regulatory change management programme. In addition, the focus on simple products and customer oriented culture means that current practice may not have to change significantly to meet new conduct regulations.		Increased The regulatory environment has tightened and this is likely to continue, exposing the Group to increased risk.

The Group proactively scans for emerging risks which may have an impact on its ongoing operations and strategy. The Group considers its top emerging risks to be:

Emerging risks		Description		Mitigation action
Integration risk		The risks resulting from the Group’s ongoing integration activities, including systems, people and infrastructure.		The Board is maintaining oversight of the integration process through the Board Integration Committee. A dedicated Integration Management Office has been established to drive the integration process forward. Independent second line and third line assessment, monitoring and reporting is being undertaken by the Risk function and Internal Audit function.
Political and macroeconomic uncertainty		As the outcome of trade negotiations following Brexit remains unclear, there is an increased likelihood of a period of macroeconomic uncertainty. The Group’s lending activity is solely focused in the United Kingdom and, as such, will be impacted by any risks emerging from changes in the macroeconomic environment.		The Group implemented robust monitoring processes and via various stress testing activity (i.e. ad hoc, risk appetite and ICAAP) understands how the Group performs over a variety of macroeconomic stress scenarios and has subsequently developed a suite of early warning indicators, which are closely monitored to identify changes in the economic environment. The Group produces and reviews monthly loan portfolio management information.

Emerging risks		Description		Mitigation action
Climate change		As the worldwide focus on climate change intensifies, both the physical risks and the transitional risks associated with climate change continue to grow. Physical risks can relate to specific weather events, such as storms and flooding, or to longer-term shifts in the climate, such as rising sea levels. Transitional risks may arise from the adjustment towards a ‘low- carbon’ economy, such as tightening energy efficiency standards for domestic and commercial buildings.		The Group developed an approach to addressing the increasing climate risks within its Risk Management Framework. This includes scenario analysis, development of key risk indicators and inclusion of climate risks within operational resilience activities. A cross-functional working group will drive the Group’s climate change agenda with Board oversight ensuring climate change is considered in key business and strategic decision-making. To assess portfolio collateral sensitivities to climate change, the Group is engaging with a third party to assist with modelling physical risks (flood, subsidence and coastal erosion) and transitional risks (Government policy) against a series of scenarios relating to global temperature change.
Model risk		The risk of financial loss, adverse regulatory outcomes, reputational damage or customer detriment resulting from deficiencies in the development, application or ongoing operation of models and ratings systems. Post the completion of the Combination with CCFS, the Group notes the increasing usage of models to conduct financial assessments whilst informing business decisions. The Group also notes changes in industry best practice with respect to managing model risk.		Both OSB and CCFS have well-defined model governance frameworks and processes in place, including Committees, frameworks, policies, model inventories and independent validation processes. In light of this emerging risk, the Group implemented a Group Models and Ratings Committee to ensure an appropriate level of oversight is provided in 2020 by the Board, in conjunction with the Models and Ratings Management Committee. A key area of focus for 2020 will be further enhancing the Group’s model risk governance arrangements including developing and implementing Group-level frameworks and policies, whilst implementing the planned target operating model.
LIBOR reform		The LIBOR benchmark may cease to be set after the end of 2021 due to the low level of supporting unsecured loans in the wholesale interbank loan market. The Group has exposure to the LIBOR benchmark within some of its customer lending products and wholesale derivative hedging transactions. If the benchmark were to cease or become unreliable, these loans and derivatives may reflect rates that do not accurately represent short- term funding costs, therefore having an adverse effect on returns.		The Group ALCO has set up a dedicated working group to focus on this risk and transition away from the LIBOR benchmark is underway. The priority is to remove the LIBOR component from all new loan products and new swap hedges. With regard to existing loans and derivative hedges it is planned that they are transitioned onto alternative benchmarks before LIBOR ceases.
Coronavirus		The outbreak of Coronavirus (COVID-19) has now been labelled a global pandemic by the World Health Organization. If this continues to spread through contagion, it is likely to further intensify the disruptive impact on the global and UK economy. This would result in deteriorating market sentiments, falling investment and consumer spending and diminishing trade flows. Government actions, both fiscal and monetary, may prove to be slow to take effect and/or uncertain in their impact. A spreading global pandemic could adversely impact the Group across a number of key financial and operational areas (as described in Pandemic risk factors on page 54.		The Group has taken a considered approach to minimising and managing the impact of a Coronavirus-related global pandemic. The Group approach represents a comprehensive response strategy covering both severity and consequences of a global pandemic. The Group’s response strategy covers key aspects of an effective pandemic response approach, including prevention, continuity, impact assessment and stress testing. Supporting the Group’s response strategy are established underlying capabilities to facilitate operational and financial resilience testing and planning, active monitoring and reporting procedures, and active communications with all staff (UK and India) and supervisory authorities.
Treating customers fairly		The industry-wide and firm-specific practices in relation to arrears, collections and forbearance procedures resulting in poor customer outcomes and financial distress continues to be an important area of regulatory focus. The practices within the regulated residential mortgage markets, both first and second charge mortgages, have in particular been subject to active supervisory monitoring through market data analysis, complaints to firms, notifications from firms and multi firm thematic reviews. If the Group’s arrears, repossession, forbearance and vulnerable customer policies and procedures are assessed to be misaligned to the individual needs of the customers and regulatory expectations, the Group runs the risk of causing harm to its customers, particularly those experiencing financial hardship or vulnerable customers, with the potential for reputational damage, redress and other regulatory actions.		All Group entities operate under arrears, repossession, forbearance and vulnerable customer policies which are designed to comply with regulatory rules and expectations. These policies articulate the Group’s commitment to ensuring that all customers, including those that are vulnerable or experiencing financial hardship, are treated fairly, consistently and in a way that considers their individual needs and circumstances. The Group does not tolerate any systemic failure to deliver fair customer outcomes. On an isolated basis, incidents can result in detriment owing to human and/or operational failures. Where such incidents occur they are thoroughly investigated, and the appropriate remedial actions are taken to address any customer detriment and to prevent recurrence.

Risk profile performance overview

Credit risk

Throughout 2019 the credit quality of both Banks remained strong, driven by robust credit risk management, deep knowledge of the specialist sectors in which both OSB and CCFS operate, coupled with prudent risk appetite.

Strong organic loan book growth was underpinned by resilient new lending volumes across the Group’s core lending segments including Buy-to-Let, residential owner-occupier, semi- commercial and commercial. The Group’s asset finance and development finance businesses continued to operate in line with expectations. New business quality remained strong with broadly stable loan to value levels. Interest coverage ratios remained stable across both the OSB and CCFS segments. Loan to income multiples also remained stable across residential owner-
occupier lending.

Arrears levels remained low during 2019 across both Banks. Across the CCFS segment greater than three months in arrears balances remained low at 0.3% of total loans and advances (2018: 0.2%). This marginal increase was driven by the lending portfolios maturing and was in line with management’s expectations.
Performance of both new and existing loans remained strong.

At OSB, the greater than three months in arrears ratio fell to a low of 1.3% (2018: 1.5%). Falling arrears levels across the residential owner-occupier lending segment drove the overall Group trend. Buy-to-Let lending arrears levels remained stable year on year, but improved during the second half of 2019 as more focused collections activity took effect. As at 31 December 2019, legacy problem loan balances reduced to £3.0m from £5.6m at the
end of 2018.

The Group observed strong demand for semi-commercial
and commercial mortgage products originated via the InterBay commercial brand, where gross exposure grew to £888.0m with a weighted average loan to value of 67% and an average loan size of £375,000.

Gross exposure to residential development finance remained low at £146.1m with a weighted average LTV of 34%.

Expected Credit Losses (‘ECL’)

Low arrears and sensible loan to value levels resulted in strong loan loss performance during 2019.

On a statutory basis, impairment losses were £15.6m (2018:
£8.1m) representing 13bps on average gross loans and advances (2018: 10bps). On a pro forma underlying basis, the loan loss ratio was 10bps1 (2018: 7bps).

The increase in the total value of loan losses was primarily due to three non-recurring items:

    i)           More focused collections activity across the Buy-to-Let portfolio within the OSB segment resulted in an increase in the number of LPA receivers appointed during the first half of 2019, where under the IFRS 9 provisioning approach higher provisions are held.

LPA receivers are appointed when a Buy-to-Let account falls into arrears, as an independent managing agent and
collector of rents. This ensures that rent payments are passed back to the lender to bring the account back up to date, or to oversee a sale of the property paying back the lender, whilst supplying the borrower with any excess funds. During the second half of 2019 OSB observed low and stable new LPA receiver appointments.

    ii)         On 4 October 2019, OSB acquired the lending portfolios of
CCFS and consequently raised IFRS 9 provisions totalling £3.6m. This one-off charge was recognised in the Group’s profit and loss, increasing the total quantum of losses recognised in 2019.

Importantly, the provisions raised do not reflect a change in the credit risk performance of the lending portfolios.

    iii)       During the fourth quarter of 2019, OSB and CCFS aligned a number of IFRS 9 methodologies, including stage 2 and 3 transfer criteria and macroeconomic scenarios and probability weightings. The net impact of this alignment activity was
a one-off provision charge recognised in the 2019.

Removing the above one-off non-recurring items, the loan loss charge would have been broadly consistent with the underlying loan loss charge observed during 2018.

                                                                                                    1.   The 2019 statutory results reflect 12 months of OSB results and CCFS’ results from 4 October 2019, the date on which the Combination completed and became effective. The 2018 statutory results include OSB results only. The pro forma underlying results reflect what
the results would have been had the Combination occurred on 1 January 2019.

The Group continues to closely monitor impairment coverage levels:

As at 31 December 2019	Gross carrying amount £m	Expected Credit Losses £m	Incurred loss remaining1 £m	Coverage ratio2
Stage 1	17,286.9	5.6	–	0.03%
Stage 2	749.5	5.6	–	0.75%
Stage 3 (+ POCI)	431.2	31.7	–	7.35%
Undrawn loan facilities	–	–	–	–
Total	18,467.6	42.9	–	0.23%
As at 31 December 2018
Stage 1	8,286.8	4.3	–	0.05%
Stage 2	436.8	5.6	–	1.28%
Stage 3 (+ POCI)	281.6	11.8	7.2	6.75%
Undrawn loan facilities	–	0.2	–	–
Total	9,005.2	21.9	7.2	0.32%

The Group’s Risk and Audit Committees closely monitor the ongoing appropriateness of the provision coverage levels versus expected losses and peer institutions.

As at 31 December 2019, provision coverage levels remained appropriate.

The Group’s total coverage ratio fell slightly to 0.23% as at 31 December 2019 (2018: 0.32%). The fall was driven by the loan to value profile and low arrears performance of newly-originated mortgages and the CCFS lending portfolios acquired, resulting in balances growing faster than ECL provisions raised, resulting in the ratio falling.

Macroeconomic scenarios

The measurement of ECL under the IFRS 9 approach is complex and requires a high level of judgement. The approach includes the estimation of probability of default (‘PD’), loss given default (‘LGD’) and likely exposure at default (‘EAD’). An assessment of the maximum contractual period with which the Group is exposed
to the credit risk of the asset is also undertaken.

IFRS 9 requires firms to calculate ECL allowances simulating
the effect of a range of possible economic outcomes, calculated on a probability weighted basis. This requires firms to formulate forward-looking macroeconomic forecasts and incorporate them in ECL calculations.

    i. How macroeconomic variables and scenarios are selected During the IFRS 9 modelling process the relationship between macroeconomic drivers and arrears, default rates and collateral values is established. For example, if unemployment levels increase the Group would observe an increasing number of accounts moving into arrears. If residential or commercial property prices fall the risk of losses being realised on the
sale of a property would increase.

The Group has adopted an approach which utilises four macroeconomic scenarios.

Scenarios are provided by an industry leading economics advisory firm, who provide Management and the Board with advice on which scenarios to utilise and the probability weightings to attach to each scenario.

A base case forecast is provided which broadly aligns with
wider consensus forecasts, along with a plausible upside scenario.
Two downside scenarios are also provided (downside and a severe downside).

      1.   Incurred loss is the expected loss of the portfolio at the point of acquisition and is offset against the modelled future cash flows to derive the effective interest rate for the book. The incurred loss protection is therefore recognised over the life of the book against the unwind of any purchase discount or premium through interest income. Incurred loss remaining is this protection reduced by the cumulative losses observed since acquisition.

In 2019, the Group reclassified incurred loss protection on acquired portfolios from loans and advances to ECL to reflect the Group’s total ECL position.

      2.   Coverage ratio is the total provisions plus incurred losses remaining divided by gross loans and advances.

ii. How macroeconomic scenarios are utilised within ECL calculations
Probability of default estimates are either scaled up or down based on the macroeconomic scenarios utilised.

Loss given default estimates are impacted by property price forecasts which are utilised within loss estimates should
an account be possessed and sold.

Exposure at default estimates are not impacted by the macroeconomic scenarios utilised.

Each of the above components are then directly utilised within the ECL calculation process.

iii.              Macroeconomic scenario governance
The Group has a robust governance process to oversee macroeconomic scenarios and probability weightings used within ECL calculations. Updated scenarios are provided on a monthly basis where an assessment is carried out by the Group’s Risk function to determine whether an update is required.

On a quarterly basis the Group’s Risk function and economic adviser provide the Asset and Liabilities Committee with an overview of recent economic performance, along with updated base, upside and two downside scenarios.

The Risk function will then propose a course of action, which once approved will be implemented. Regular updates are provided
to the Group’s Risk and Audit Committees, where the ongoing appropriateness of the macroeconomic scenarios and probability weightings are discussed.

iv. Changes made during 2019
In December 2018, OSB implemented a fourth severe downside no-deal disorderly Brexit scenario, which increased the Group’s provision requirements. During the first half of 2019, the Group did not make any changes to the macroeconomic scenarios utilised or the probability weightings assigned.

The CCFS business implemented a Brexit overlay in December 2018 to reflect the increasing risk of a no-deal Brexit. As at 30 June 2019, this overlay was adjusted with further provision raised.

Following the Combination completing on 4 October 2019, the Group’s Risk function recommended aligning the macroeconomic scenarios and probability weightings utilised across both the individual OSB and CCFS businesses. This entailed moving to
one service provider for economic modelling, aligning scenarios utilised and probability weightings.

Forecasted macroeconomic variables over a five-year period (includes average over five years and the peak to trough projections)

As at 31 December 2019		Base case %	Upside scenario %	Downside scenario %	Severe downside scenario %
Weighting applied		40	10	35	15
Economic driver	Measure
Gross Domestic Product (‘GDP’)	5 year average (yearly GDP growth %)	1.2	1.7	0.5	-0.3
	Cumulative growth/(fall) to peak/(trough) (%)	6.4	8.5	-3.6	-5.8
House Price Index (‘HPI’)	5 year average (yearly HPI growth %)	1.3	3.2	-1.5	-3.2
	Cumulative growth/(fall) to peak/(trough) (%)	+5.6	+14.8	-13.4	-21.1
Bank Base Rate (‘BBR’)	5 year average (%)	1.31	1.45	0.19	0.08
	Cumulative growth/(fall) to peak/(trough) (%)	+1.5	+1.7	-0.7	-0.6
Unemployment Rate (‘UR’)	5 year average (%)	4.49	3.41	6.26	7.15
	Cumulative growth/(fall) to peak/(trough) (%)	+0.7	-1.0	+2.9	+4.1
Commercial Real Estate Index (‘CRE’)	5 year average (yearly HPI growth %)	1.3	3.2	-1.5	-5.8
	Cumulative growth/(fall) to peak/(trough) (%)	+5.6	+14.8	-13.4	-40.0

As at 31 December 2018		Base case %	Upside scenario %	Downside scenario %	Severe downside scenario %
Weighting applied		50	0	40	10
Economic driver	Measure
House Price Index (‘HPI’)	5 year average (yearly HPI growth %)	2.6	3.3	-1.7	-3.6
	Cumulative growth/(fall) to peak/(trough) (%)	+13.0	+16.1	-10.5	-30.0
Bank Base Rate (‘BBR’)	5 year average (%)	1.6	2.0	1.6	3.4
	Cumulative growth/(fall) to peak/(trough) (%)	+1.5	+1.8	+1.4	+4.5
Unemployment Rate (‘UR’)	5 year average (%)	4.3	3.8	5.7	6.4
	Cumulative growth/(fall) to peak/(trough) (%)	+0.5	-0.4	+2.4	+3.3
Commercial Real Estate Index (‘CRE’)	5 year average (yearly HPI growth %)	0.3	1.4	-5.5	-7.8
	Cumulative growth/(fall) to peak/(trough) (%)	+2.6	+8.0	-27.0	-48.4

Forbearance

Where borrowers experience financial difficulties, which impacts their ability to service their financial commitments under the loan agreement, forbearance may be used to achieve an outcome which is mutually beneficial to both the borrower and the Bank.

By identifying borrowers who are experiencing financial difficulties pre-arrears or in arrears, a consultative process is initiated to ascertain the underlying reasons and to establish the best course of action to enable the borrower to develop credible repayment plans and to see them through the period of financial stress.

The specific tools available to assist customers vary by product and the customers’ status. The various treatments considered for customers are as follows:

• Temporary switch to interest only: a temporary account change to assist customers through periods of financial difficulty where arrears do not accrue at the original contractual payment. Any arrears existing at the commencement of the arrangement are retained.
• Interest rate reduction: the Group may, in certain circumstances, where the borrower meets the required eligibility criteria, transfer the mortgages to a lower contractual rate. Where this is a formal contractual change the borrower will be requested to obtain independent financial advice as part of the process.
• Loan term extension: a permanent account change for customers in financial distress where the overall term of the mortgage is extended, resulting in a lower contractual monthly payment.
• Payment holiday: a temporary account change to assist customers through periods of financial difficulty where arrears accrue at the original contractual payment. Any arrears existing at the commencement of the arrangement are retained.
• Voluntary-assisted sale: a period of time is given to allow borrowers to sell the property and arrears accrue based on the contractual payment.
• Reduced monthly payments: a temporary arrangement for customers in financial distress. For example, a short-term arrangement to pay less than the contractual payment.

Arrears continue to accrue based on the contractual payment.

• Capitalisation of interest: arrears are added to the loan balance and are repaid over the remaining term of the facility or at maturity for interest only products. A new payment is calculated, which will be higher than the previous payment.
• Full or partial debt forgiveness: where considered appropriate, the Group will consider writing off part of the debt. This may occur where the borrower has an agreed sale and there will be a shortfall in the amount required to redeem the Group’s charge, in which case repayment of the shortfall may be agreed over a period of time, subject to an affordability assessment or where possession has been taken by the Group; and on the subsequent sale where there has been

a shortfall loss.
} Arrangement to Pay (CCFS only): where an arrangement is made with the borrower to repay an amount above the contractual monthly instalment, which will repay arrears over a period of time.

• Promise to Pay (CCFS only): where an arrangement is made with the borrower to defer payment or pay a lump sum at a later date.
• Bridging loans more than 30 days past due (CCFS only):  Bridging loans which are more than 30 days past their maturity date. Repayment is rescheduled to receive a balloon or

bullet payment at the end of the term extension where the institution can duly demonstrate future cash flow availability.

The Group aims to proactively identify and manage forborne accounts, utilising external credit reference bureau information to analyse probability of default and customer indebtedness trends over time, feeding pre-arrears watch list reports. Watch list cases are in turn carefully monitored and managed as appropriate.

Further information regarding forbearance can be found in note 45 to the Financial statements.

Fair value of collateral methodology

The Group ensures that security valuations are reviewed on an ongoing basis for accuracy and appropriateness. Commercial properties are subject to annual indexing, whereas residential properties are indexed against monthly House Price Index data. Where the Group identifies that an index is not representative, a formal review is carried out by the Group Real Estate function to ensure that property valuations remain appropriate.

The Group Real Estate function ensures that newly underwritten lending cases are written to appropriate valuations, where an independent assessment is carried out by an appointed, qualified surveyor accredited by RICS.

Solvency risk

The Group has maintained an appropriate level and quality of capital to support its prudential requirements with sufficient contingency to withstand a severe but plausible stress scenario. The solvency risk appetite is based on a stacking approach, whereby the various capital requirements (Pillar 1, ICG, CRD IV buffers, Board and management buffers) are incrementally aggregated as a percentage of available capital (CET1 and

total capital).

Solvency risk is a function of balance sheet growth, profitability, access to capital markets and regulatory changes. The Bank actively monitors all key drivers of solvency risk and takes prompt action to maintain its solvency ratios at acceptable levels. The Board and management also assess solvency when reviewing the Group’s business plans and inorganic growth opportunities.

The Group’s fully-loaded CET1 capital ratio under CRD IV increased to 16.0% as at 31 December 2019 (31 December 2018: 13.3%) demonstrating the strong organic capital generation capability
of the business and the beneficial impact of the fair value uplift on CCFS’ assets. The Group had a total capital ratio of 17.3% and a leverage ratio of 6.5% as at 31 December 2019 (31 December
2018: 15.8% and 5.9% respectively).

Liquidity and funding risk

The Group has a prudent approach to liquidity management through maintaining sufficient liquidity resources to cover cash flow imbalances and fluctuations in funding under both normal and stressed conditions arising from market-wide and Bank- specific events. OSB and CCFS’ liquidity risk appetites have been calibrated to ensure that both Banks always operate above the minimum prudential requirements with sufficient contingency for unexpected stresses, whilst actively minimising the risk of holding excessive liquidity which would adversely impact the financial efficiency of the business model.

The Group continues to attract new retail savers and has high retention levels with existing customers. In addition, the
Combination allows the Group a wider range of wholesale funding options including securitisation issuances and use of retained notes from both Banks.

In 2019, both Banks actively managed their liquidity and funding profiles within the confines of their risk appetite as set out in each Bank’s Internal Liquidity Adequacy Assessment Process (‘ILAAP’). Each Bank’s risk appetite is based on internal stress tests that cover a range of scenarios and time periods and therefore are a more severe measure of resilience to a liquidity event than the standalone liquidity coverage ratio (‘LCR’). Both OSB and CCFS’ LCR at 199% and 145% respectively remain above risk appetite and well above regulatory minimums.

Market risk

The Group proactively manages its risk profile in respect of adverse movements in interest rates, foreign exchange rates and counterparty exposures. The Group accepts interest rate risk and basis risk as a consequence of structural mismatches between fixed rate mortgage lending, sight and fixed term savings and the maintenance of a portfolio of high quality liquid assets.

Interest rate exposure is mitigated on a continuous basis through portfolio diversification, reserve allocation and the use of financial derivatives within limits set by the Group ALCO and approved by the Board.

The Group’s balance sheet is completely GBP denominated. The Group has some minor foreign exchange risk from funding the OSBI business. This is minimised by prefunding a number of months in advance and regularly monitoring GBP/INR rates. Wholesale counterparty risk is measured on a daily basis and constrained by counterparty risk limits.

Transition away from LIBOR

The PRA and FCA have continued to encourage banks to transition away from using LIBOR as a benchmark in all operations before the end of 2021. Throughout the UK banking sector LIBOR remains a key benchmark and, for each market impacted, solutions to this issue are progressing through various industry bodies.

In 2018, OSB set up an internal working group comprised of all of the key business lines that are involved with this change with strong oversight from the Compliance and Risk departments. Risk assessments have been completed to ensure this process is managed in a measured and controlled manner. CCFS no longer write any LIBOR-linked business and have started to transition back book swaps from a LIBOR to a SONIA basis. The OSB and CCFS projects have been aligned following the Combination.

Interest rate risk

The Group does not actively assume interest rate risk, does not execute client or speculative securities transactions for its own account, and does not seek to take a significant directional interest rate position. Limits have been set to allow management to run occasional unhedged positions in response to balance sheet dynamics and capital has been allocated for this. Exposure limits are calibrated in proportion to available CET1 capital

in order to accommodate balance sheet growth.

The Group sets limits on the tenor and rate reset mismatches between fixed rate assets and liabilities, including derivatives hedges, with exposure and risk appetite assessed by reference to historic and potential stress scenarios cast at consistent levels of modelled severity.

Throughout 2019, both Banks managed their interest rate risk exposures within risk appetite limits.

Basis risk

Basis risk arises from assets and liabilities repricing with reference to different interest rate indices, including positions which reference variable market, policy and managed rates. As with structural interest rate risk, the Bank does not seek to take a significant basis risk position, but maintains defined limits to allow operational flexibility.

For both OSB and CCFS exposure is assessed and monitored regularly across a range of ‘business as usual’ and stressed scenarios.

Throughout 2019, both Banks managed their basis risk exposure within their risk appetite limits.

Operational risk

The Group continues to adopt a proactive approach to the management of operational risks. The operational risk management framework has been designed to ensure a robust approach to the identification, measurement and mitigation of operational risks, utilising a combination of both qualitative and quantitative evaluations in order to promote an environment of progressive operational risk management. The Group’s operational processes, systems and controls are designed to minimise disruption to customers, damage to the Group’s reputation and any detrimental impact on financial performance. The Group actively promotes the continual evolution of its operating environment through the identification, evaluation and mitigation of risks, whilst recognising that the complete elimination of operational risk is not possible.

Where risks continue to exist, there are established processes to provide the appropriate levels of governance and oversight, together with an alignment to the level of risk appetite stated by the Board.

A strong culture of transparency and escalation has been cultivated throughout the organisation, with the Operational Risk function having a Group-wide remit, ensuring a risk management model that is well embedded and consistently applied. In addition, a community of Risk Champions representing each business line and location has been identified. Operational Risk Champions ensure that the operational risk identification and assessment processes are established across the Group in a consistent manner. Risk Champions are provided with appropriate support and training by the Operational Risk function.

Regulatory and compliance risk

The Group is committed to the highest standards of regulatory conduct and aims to minimise breaches, financial costs and reputational damage associated with non-compliance.

The Group has an established Compliance function which actively identifies, assesses and monitors adherence with current regulation and the impact of emerging regulation.

In order to minimise regulatory risk, the Group maintains a proactive relationship with key regulators, engages with industry bodies such as UK Finance, and seeks external expert advice.
The Group also assesses the impact of upstream regulation on itself and the wider market in which it operates, and undertakes robust assurance assessments from within the Risk and Compliance functions.

Conduct risk

The Group considers its culture and behaviour in ensuring the fair treatment of customers and in maintaining the integrity of the market segments in which it operates to be a fundamental part of its strategy and a key driver to sustainable profitability and growth. The Group does not tolerate any systemic failure to deliver fair customer outcomes.

On an isolated basis, incidents can result in detriment owing to human and/or operational failures. Where such incidents occur they are thoroughly investigated, and the appropriate remedial actions are taken to address any customer detriment and to prevent recurrence.

The Group considers effective conduct risk management to be a product of the positive behaviour of all employees, influenced by the culture throughout the organisation and therefore continues to promote a strong sense of awareness and accountability.

Strategic and business risk

The Board has clearly articulated the Group’s strategic vision and business objectives supported by performance targets. The Group does not intend to undertake any medium to long-term strategic actions, which would put at risk the Group’s vision to become

our customers’ favourite bank; one that delivers its very best, challenges convention and opens doors that others can’t.

To deliver against its strategic objectives and business plan, the Group has adopted a sustainable business model based on a focused approach to core niche market segments where its
experience and capabilities give it a clear competitive advantage.

The Group remains highly focused on delivering against its core strategic objectives and strengthening its position further through strong and sustainable financial performance.

Reputational risk

Reputational risk can arise from a variety of sources and is a second order risk – the crystallisation of a credit risk or operational risk can lead to a reputational risk impact.

The Group monitors reputational risk through tracking media coverage, customer satisfaction scores, the share price and net promoter scores provided by brokers.

Viability statement

In accordance with Provision 31 of the 2018 UK Corporate Governance Code, the Group Board is required to assess the viability of the Group over a stated time horizon with a supporting statement in the Annual Report.

The viability statement is required to include an explanation of how the prospects of the Group have been assessed, the time horizon over which the assessment has been performed and why the assessment period is deemed appropriate. The viability statement needs to be supported by an assessment of the principal risks and uncertainties to which the Group is exposed and based on reasonable expectations to conclude that the Group will be able to continue to operate and meet its liabilities as they fall due over that period.

The Group uses a five-year time frame in its business and financial planning and for internal stress test scenarios. The long-term direction is informed by business and strategic plans which
are reviewed on, at least, an annual basis and which include multi-year financial statements. The operating and financial plans consider, among other matters, the Board’s risk appetite, macroeconomic outlook, market opportunity, the competitive landscape, and sensitivity of the financial plans to volumes, margin pressures and capital requirements.

While a five-year time frame is used internally, levels of uncertainty increase as the planning horizon extends and the Group’s operating and financial plans focus more closely on the next three years. The Board therefore considers a period of three years to be an appropriate period for the assessment to be made.

The Company is authorised by the PRA, and regulated by the FCA and the PRA, and undertakes regular analysis of its risk profile and assumptions. It has a robust set of policies, procedures
and systems to undertake a comprehensive assessment of all the principal risks and uncertainties to which it is exposed on a current and forward-looking basis (as described in Principal risks and uncertainties).

The Group identifies, assesses, manages and monitors its risk profile based on the disciplines outlined within the Risk Management Framework, in particular through leveraging its risk appetite framework (as described in the Risk review).
Potential changes in the aggregated risk profile are assessed across the business planning horizon by subjecting the operating and financial plans to severe but plausible macroeconomic
and idiosyncratic stress scenarios.

The viability of the Group is assessed at both the Group and the underlying regulated Bank levels, through leveraging the risk management frameworks and stress testing capabilities of both regulated banks. Post Combination, the risk assessment and stress testing capabilities of OSB and CCFS will be progressively aligned, however, the strength of the capital and funding profiles of both Banks provides an appropriate level of assurance that the Group and its entities can withstand a severe but plausible stress scenario.

Stress testing is an integral risk management discipline, used to assess the financial and operational resilience of the Group.

The Group developed bespoke stress testing capabilities to assess the impact of extreme but plausible scenarios in the context of its principal risks impacting the primary strategic, financial and regulatory objectives. Stress test scenarios are identified in the context of the Group’s operating model, identified risks, business and economic outlook. The Group actively engages external experts to inform the process by which it develops business and economic stress scenarios. A broad range of stress scenarios are analysed, including the economic impact of differing outcomes for the UK leaving the European Union, regulatory changes relating to lending into the UK housing sector, governmental housing policy shifts and scenarios prescribed by the Bank
of England. In addition COVID-19 pandemic scenarios have been introduced.

Stresses are applied to lending volumes, capital requirements, liquidity and funding mix, interest margins and credit and operational losses. Stress testing also supports key regulatory submissions such as the ICAAP, ILAAP and the Recovery Plan. ICAAP stress testing assesses capital resources and requirements over a five-year period.

The Group has identified a broad suite of credible management actions which can be implemented to manage and mitigate the impact of stress scenarios. These management actions
are assessed under a range of scenarios varying in severity and duration. Management actions are evaluated based on speed
of implementation, second order consequences and dependency on market conditions and counterparties. Management actions are used to inform capital, liquidity and recovery planning under stress conditions.

In addition, the Group identifies a range of catastrophic scenarios, which could result in the failure of its current business model.
Business model failure scenarios (Reverse Stress Tests or ‘RSTs’) are primarily used to inform the Board and Executives of the outer limits of the Group’s risk profile. RSTs play an important role in helping the Board and Executives to assess the available recovery options to revive a failing business model. The RSTs exercise is based on analysing a range of scenarios, including an extreme macroeconomic downturn (1 in 200 severity), a cyber-attack leading to a loss of customer data which is used for fraudulent activities, extreme regulatory and taxation changes impacting Buy-to-Let lending volumes and a liquidity crisis caused by severe market conditions combined with idiosyncratic consequences.

The Group has established a comprehensive operational resilience framework to actively assess the vulnerabilities and recoverability of its critical services. The Group also conducts regular business continuity and disaster recovery exercises.

The ongoing monitoring of all principal risks and uncertainties that could impact the operating and financial plan, together with the use of stress testing to ensure that the Group could survive a
severe but plausible stress, enables the Board to reasonably assess the viability of the business model over a three-year period.

Viability statement continued

The UK’s departure from the European Union without defined and agreed terms could have a significant impact on the economic and business outlook for the Group. To address this uncertainty, the Group has developed a range of Brexit-related scenarios of varying severities and probabilities to inform its IFRS 9 and capital planning processes

The Board has also considered the potential implications of the COVID-19 pandemic in its assessment of the financial and operational viability of the Group and has a reasonable belief that the Group retains adequate levels of financial resources
(capital and liquidity) and operational contingency. In assessing the viability of the Group, the Board has considered the potential impact and risks facing the Group with respect to the virus as set out in the Risk review on page 54 and the Principal risks
and uncertainties on page 66.

The Group has recently undertaken a comparative review of the macroeconomic stress scenarios used to assess the Group’s ongoing viability relative to the COVID 19 pandemic scenarios, as obtained from the Group’s third-party economic advisors.

Given the evolving nature of the COVID 19 pandemic crisis, the Group will continue to refine and update the scenarios in consultation with its economic advisors.

This exercise was undertaken to ensure that the shape and severity of the scenarios used to assess the Group’s financial viability are sufficiently severe to accommodate for the latest assessment
of the potential economic impact of the COVID-19 pandemic.

In particular, the Group has assessed the pandemic scenarios relative to the Bank of England ‘Rates-down scenario’, which is used to support the Group’s viability assessment. The Rates- down Scenario is deemed to be more severe relative to the
current COVID-19 pandemic scenarios across all the key macro- economic variables. This gives the Board reasonable comfort that the Group’s viability positions have been assessed to a severity level which accommodates for the current assessment of the economic impact of the COVID-19 pandemic.

The COVID-19 scenarios take into consideration the following drivers and implications relevant to a pandemic crisis:

} Government guidance and policy response to the crisis

• Lost output and productivity as a consequence of travel restrictions, social distancing, self-isolation and sickness
• Impact on employment levels, particularly for self-employed and flexible working segments of the labour force

} Implication for consumer spending and business investment
} Impact on other relevant economic variables, including residential and commercial property prices, Bank of England base rate, national output and lending volumes.

The COVID-19 scenarios are designed to be extreme, but plausible, based on the assumption that the impact on the UK economy is immediate and quickly feeds through into rising unemployment rates, declining residential and commercial property prices and
a rapid slowdown in lending volumes. The Treasury and Bank of England take proactive fiscal and monetary stimulatory actions, but given the invasive nature of the pandemic, the UK economy does not show signs of recovery until 2022.

The potential impact of a COVID-19 pandemic on the economy and the Group’s operations is subject to continuous monitoring through the Group’s management committees, operational resilience and business continuity planning working group, with appropriate escalation to the Board and supervisory authorities.

The Group has progressively continued to enhance its approach to assessing the viability of its strategy and business operating model, in particular the Group has enhanced its capabilities by:

} Enhancing stress testing capabilities through more focused assessment of more vulnerable cohorts of its lending portfolio supported by increased granularity of monitoring and
risk reporting

• Increasing the diversification of its funding profile, supported by enhanced assessment of funding and liquidity risk profiles
• Continued improvements to the risk and controls self- assessment procedures across key areas of operational risk, including operations and technology
• Enhancing the assessment of operational resilience through the ongoing review of priority business functions, including supporting infrastructure and dependencies through

a simulated business continuity exercise
} Undertaking a war-gaming exercise involving Board and senior management to review, practice and improve disaster recovery readiness.

Based on the current financial forecasts, risk profile characteristics and stress test analysis, the Group’s capital, funding and operational capabilities support the Board’s assessment that they have a reasonable expectation that the Group will remain viable over the three-year horizon.