Final Results for the year to 31 December 2016

Chairman's statement

 

I am pleased to report that 2016 for Arbuthnot Banking Group ("ABG" or "the Group") has been a momentous year. We have completed a number of major corporate transactions that have not only transformed the Group, but also set it on a new and exciting path of development that I expect to be as successful in the future as it has been in the past. I should remind the shareholders though that we take a long term view.

 

The Group has made a profit for the year of £228m when the impact of the sale of 30% of Secure Trust Bank ("STB") is factored in, while the Group has reported a profit before tax of £0.2m on the continuing operations.

 

In the past I have commented on the complexities of the ever changing accounting conventions, so I will refrain from doing so again, but suffice to say £228m of profit for a Group that started the year with shareholder funds of £191m is a remarkable result and one that I expect in time will transform the Group. Six years ago the Group had net assets per share of £2.28 and this has risen nearly 7 fold to £15.34 per share and that is after paying special dividends of £3.25.

 

The sale of a substantial proportion of our stake in STB was a decision that we considered carefully and on balance it seemed this was the right time to allow both of the Group's banks to develop along their own chosen paths.

 

STB, despite its significant history that dates back over 60 years, has been seen by the market and commentators to be in the new category of banks collectively known as "Challenger Banks". They have come to prominence since the financial crisis and indeed several of them have only been created since that time. STB, along with the other Challengers has grown quickly, promoted competition in the market place and attracted customers with their new images and fresh approach to banking.  However, to keep taking advantage of the opportunities that exist they need to have access to the financial markets to supply capital to maintain the organic growth rates and to allow corporate or inorganic deals to be done.

 

We had seen over time that STB had developed an exceptional list of shareholders on its register and many of them were supportive of Paul Lynam's (the CEO) plans, so we decided it was appropriate for ABG to reduce its stake and for STB to seek admission to the Main London Stock Market, which it achieved in October last year. Needless to say, we wish them every success, not least because we remain an 18.6 % shareholder.

 

The sale of the shares has led to STB being deconsolidated from the Group and resulted in a significant increase in the capital resources of the remaining business. This capital we plan to deploy in diversifying Arbuthnot Latham ("AL) into the broader financial services markets, while at the same time remaining entrepreneurial and open to other opportunities. This development took several steps forward during the year. The Commercial Bank that we started to build in 2015 ended the year with 15 bankers and has now extended coverage into the South West and North West. The division has seen its lending balances grow to £76m by the year end and also has a healthy pipeline of approved lending which should see the business grow substantially in 2017.

 

In June we completed the purchase of 20 King Street, a well-known office site in the West End. While currently occupied by a tenant, it is our intention to create a small suite of offices from where the Private Bankers would be able to meet clients in the West End.

 

At the end of the year AL was able to announce that it had purchased the private banking loan book from Duncan Lawrie. The portfolio was purchased at a discount and should allow us to attract a number of new banking clients, following the decision by Duncan Lawrie to close its banking operations.

 

Finally, we reached an agreement with the shareholders of Renaissance Asset Finance to acquire their lending business. The business provides lending solutions mainly to high net worth individuals and businesses seeking to purchase assets and equipment with relatively short term financing arrangements. This will be very complementary to our existing lending business and will open up new distribution channels for the Group.

 

While these transactions should go some way to demonstrating our ambitions to grow, Arbuthnot Latham will remain a specialist bank for the time being, rather than a "challenger", as I fear the only banks that they will be able to challenge will be themselves, until the regulatory and business landscape becomes more favourable and promotes competition among all of the banks, both big and small, on a level playing field.

 

I would like to mention that while we intend to reinvest the capital that we have created during 2016 and indeed feel confident that over the long term we can fully deploy this capital into businesses that can generate returns at or around 20%, we also remain cognisant that ultimately we conduct our business on behalf of our loyal shareholders. I am therefore pleased to report that over and above our normal dividends we were able to pay two special dividends during the year. The first was for 25p and the second 300p, which has allowed the shareholders directly to benefit from the corporate transactions that we have completed in the year.

As I reflect on 2016 I cannot do so without commenting on the result of the referendum. Being Swiss born, I believe that true democracy can only lie in the hands of the people; their voice was heard loudly that day. As I commented last year, I believe the City to be a resilient and a dynamic place and both it and the rest of the UK economy will quickly respond to the new opportunities that will open up when Britain finally exits the European Union and becomes an independent and sovereign state again.

 

Board Changes and Personnel

During the year the following changes to the ABG Board occurred. Sir Alan Yarrow joined the Board on 10 June as an Independent Non Executive, while on 5 May, Ruth Lea retired after 11 years of distinguished service. She will, however, still be connected with the Group, remaining as its Economic Advisor. On 6 May Ian Henderson joined the Board as an Executive Director in his capacity as the Chief Executive of Arbuthnot Latham. At the same time James Fleming stood down from the Board to take the role of Vice Chairman for Arbuthnot Latham. Finally, Paul Lynam became a Non-Executive Director of the Board following the reduction in ownership of Secure Trust Bank. I welcome the new directors and I thank the retiring directors for their contributions.

 

I would like to thank my colleagues on the Board for their generous and continued support and for the dedication they have shown to the Group.

 

The performance of the Group also reflects the hard work and commitment of the members of staff.  On behalf of the Board I extend our thanks to all of them for their dedicated efforts in 2016.

 

Dividend

The Board is proposing a final dividend of 18p, an increase of 1p on last year. Along with the normal interim dividend of 13p and the two special dividends of 25p and 300p respectively, this gives a total dividend for the year of 356p (2015: 29p).  Excluding the special dividends the annual dividends would be 31p, which is an increase of 2p.

 

If approved, the dividend will be paid on 12 May 2017 to shareholders on the register at close of business on 18 April 2017.

 

Outlook

The short term global economic outlook remains uncertain. The US has a new President in the form of Donald Trump, who seems to be taking a significantly more protectionist stance on the US economy. On the other hand he has made encouraging noises about reduction in taxes and regulation. However, the jury remains out for the time being. Meanwhile, Britain will soon trigger Article 50 and begin the process of exiting the European Union. At the same time populist politics is beginning to spread across Europe, which leaves the European political project exposed to the risk of being forced into making some fundamental changes, while monetary union appears more and more untenable.

 

ABG however, though not entirely immune to the global-economic and geo political headwinds, remains well capitalised and more importantly has become a group that can attract high quality staff, thus we remain optimistic for our future prospects.

 

Strategic Report
Business Review - Private Banking - Arbuthnot Latham

 

	2016	2015
Operating income	£41.8m	£35.1m
Other income	£4.4m	£1.9m
Operating expenses	£36.6m	£29.7m
Profit before tax	£9.1m	£6.0m
Customer loans	£758.8m	£618.9m
Customer deposits	£997.6m	£896.8m
Total assets	£1,199.2m	£1,004.4m
Assets under management	£919.8m	£738.8m
Customer net margin	4.4%	4.3%
Loan to deposit ratio	76.0%	69.0%

 

Arbuthnot Latham and Co., Limited ("AL" or "the Bank") has reported a profit before tax of £9.1m (2015: £6.0m), which is an increase of 51% on the previous year. This confirms that the continued investments being made in the Bank are showing returns. However, much of the cost of the investments this year, which totalled £1.4m, were covered by the gain that the Bank enjoyed following the acquisition of Visa Europe by Visa Inc. Our share of this transaction realised £1.6m. Thus, the underlying profit for the year was £8.8m compared to £7.8m in 2015.

 

More importantly, the balance sheet continued to demonstrate good growth. Customer loans increased by 23% to end the year at £759m (2015: £619m) and deposits are rapidly approaching the £1bn milestone, ending the year at £998m (2015: £897m). To facilitate this growth, the Bank has received further capital support totalling £22m from its parent Arbuthnot Banking Group PLC ("ABG"), which has continued to invest during the year, such that the net assets or capital of the Bank  has increased by 54% to close the year at £81m (2015: £52m).

 

The Bank has continued its plan to diversify into other areas of financial services and has taken significant steps in developing its commercial banking proposition. From a standing start in September 2015 the Commercial Bank has now recruited 31 staff with plans to expand this to approximately 50 staff by the end of 2017. Initially, the coverage was aimed at London and the South East, but this has now extended to the South West, with five staff to operate from Exeter and Bristol and also the North West with a team of five in Manchester. The team in Manchester has recently moved into our new premises in the building previously occupied by the Bank of England at 82 King Street. The teams seek to provide a "high touch relationship service" to mainly owner managed commercial clients, with sector coverage in Media and Real Estate and a specialist team which looks after trading businesses in sectors such as Healthcare, Legal Services and Private Education.

 

The Commercial Banking division has seen its lending balances grow to £76m by the year end with corresponding deposits reaching £51m. In addition, the division also has a healthy pipeline of approved lending that should see the business grow substantially in 2017. It would appear that our new Commercial Banking proposition resonates well in the market, with many experienced bankers joining the team over the last 12 months, all of whom we have attracted from larger, more well-known commercial banks. With a strong new business pipeline, the proposition is also clearly working well with our target client market place.

 

In the meantime, the Private Bank has continued to develop as planned. The number of private bankers now stands at 36 and the business continues to attract clients interested in our three main product offerings. The Private Banking loan book grew to £683m (2015: £619m) during the year and deposits were £947m (2015:£897m), an increase of 6%. During 2016 the investment management industry saw much volatility in all the main investment markets, caused initially by the mining and natural resources sectors reaching their floors. This was then followed by the Brexit vote. Despite all of this market turmoil, the investment management business was able to grow its assets under management ("AUMs") by 25% to close the year at £920m.

 

The office in Dubai has continued to perform well, despite the impact that the prolonged reduction in the value of oil has had on the region. It contributed £0.9m to the profits of the Bank and has introduced £64m of deposits, £74m of loans and £60m of AUMs to date.

 

As indicated several times in the past year and a half, the Bank has been pursuing a strategy of diversification and this was accelerated in 2016 by the finalisation of three transactions.

 

Firstly, the Bank bought the long leasehold of 20 King Street, a prominent office building in the heart of the West End at a cost of £53.3m including all associated transaction costs. This building is currently fully occupied but in time it is expected to be partly used as a West End office for the Bank. The remaining space will continue to be offered as a prime office location.

 

Secondly, the Bank was approached by Duncan Lawrie to help it in its plans to close its private banking business and return its banking licence. Duncan Lawrie had identified AL as a suitable home for its existing clients that offered a full private banking suite and high quality of service. As part of this process we were able to reach an agreement to purchase the existing loan portfolio for approximately £45m, with certain deferred items to be factored in. This represented a discount of 5% on the par value of the loans.  The portfolio has now been fully transferred to AL and is expected to be a good source of new introductions to the clients of Duncan Lawrie as they wind down their deposit portfolio.

 

Finally, AL reached agreement with the shareholders of Renaissance Asset Finance ("RAF") to acquire the whole of its lending business. RAF currently offers financing solutions mainly to high net worth individuals and businesses seeking to purchase high value cars and other equipment. The loan portfolio currently stands at £55m and is expected to be part of the Group's balance sheet around the end of the first quarter of 2017. This transaction remains subject to certain completion conditions, principally the regulatory approvals required. This business will open up new distribution channels to the Bank and should form the base from which the Bank can develop further lending products for the asset backed financing markets.

 

The transformation of the Bank has not only been via the corporate transactions and developing the Commercial Bank. The operational transformation project will also reach a significant milestone during 2017, with the implementation of the Bank's new operating system. The Oracle platform known as "Flexcube" is expected to go live in the second quarter of 2017 and will provide a robust and scalable platform to support the growth of the Bank for many years to come.

 

 

Strategic Report - Financial Review

 

Arbuthnot Banking Group adopts a pragmatic approach to risk taking and seeks to maximise long term revenues and returns. Given its relative size, it is nimble and able to remain entrepreneurial and capable of taking advantage of favourable market opportunities when they arise.

 

The Group provides a range of financial services to clients and customers in its chosen markets of Private and Commercial Banking. The Group's revenues are derived from a combination of net interest income from lending, deposit taking and treasury activities, fees for services provided and commission earned on the sale of financial instruments and products.

 

Highlights
	2016	2015
Summarised Income Statement	£000	£000
Net interest income	30,445	24,811
Net fee and commission income	11,005	9,793
Operating income	41,450	34,604
Profit from associates	2,145	-
Other income	3,169	-
Operating expenses	(46,111)	(35,926)
Impairment losses - financial investments	(47)	(34)
Impairment losses - loans and advances to customers	(427)	(1,250)
Profit before tax from continuing operations	179	(2,606)
Income tax expense	(720)	121
Profit after tax from continuing operations	(541)	(2,485)
Profit from discontinued operations after tax	228,110	29,009
Profit for the year	227,569	26,524
Basic earnings per share (pence) - Continuing operations	(3.7)	(16.9)
Basic earnings per share (pence) - Discontinuing operations	1,130.9	103.2
Basic earnings per share (pence)	1,127.2	86.3

 

Underlying profit reconciliation	Arbuthnot Latham & Co.	Retail Banking Associate	Group Centre	Arbuthnot Banking Group
31 December 2016	£000	£000		£000
Profit before tax from continuing operations	9,053	2,145	(11,019)	179
ABG Group bonuses relating to sale of ELL	-	-	2,304	2,304
STB full year equivalent associate income*	-	1,732	-	1,732
AL realised profit on AFS investment (Visa)	(1,624)	-	-	(1,624)
AL investment in operating systems	21	-	-	21
AL commercial banking investment	999	-	-	999
AL acquisition costs	398	-	-	398
Underlying profit	8,847	3,877	(8,715)	4,009
Underlying basic earnings per share (pence) - Continuing operations				17.1
Underlying basic earnings per share (pence)				1,148.1
* - STB associate income adjustment (excl. ELL & bonuses relating to ELL sale) as if received from 1 January 2016 and not as currently included from 16 June 2016 (pro forma basis).

 

Underlying profit reconciliation	Arbuthnot Latham & Co.	Retail Banking Associate	Group Centre	Arbuthnot Banking Group
31 December 2015	£000	£000	£000	£000
Profit before tax from continuing operations	5,998	-	(8,604)	(2,606)
STB full year equivalent associate income*	-	3,714	-	3,714
AL investment in operating systems	1,123	-	-	1,123
AL commercial banking	333	-	-	333
Acquisition costs	418	-	-	418
Underlying profit	7,872	3,714	(8,604)	2,982
Underlying basic earnings per share (pence) - Continuing operations				13.5
Underlying basic earnings per share (pence)				116.7
* - STB associate income adjustment (excl. ELL) as if received from 1 January 2015.

 

Once again the results of the Group are not immediately easy to interpret from the face of the profit and loss. The profit before tax from continuing operations for 2016 is £0.2m, which compares to a loss of £2.6m in the prior year. However, these results have been adjusted to exclude the consolidated results for STB, which became an associated company on 15 June following the sale of 6m STB shares by the Group. The profit on the sale of these shares, the profit on the sale of Everyday Loans and the trading performance of ELL up to 13 April and STB up to 15 June have all been included in the discontinued operations after tax line.

 

Once these are included in the results, the Group has made a profit for the year of £227.6m (2015: £26.5m), which is almost an eight fold increase. It is also more than the net assets of the Group at the start of 2016.

 

Clearly these results are significantly influenced by the outcome of the corporate transactions, so perhaps a better indication of the financial performance of the Group is given by the underlying profit measure. Thus, the underlying profit of ABG for 2016 was £4m compared to £3m in 2015, which is a 33% increase during 2016.

 

The total Basic Earnings per share ("EPS") of the Group have increased by 1206% to 1127.2p (2015: 86.3p), with an underlying total Basic EPS increasing by 884% to 1148.1p (2015: 116.7p). Underlying Basic EPS on continuing operations has increased by 27% to 17.1p (2015: 13.5p).

 

Operating income for the year reached £41.5m, an increase of 20% on the prior year (2015: £34.6). This increase was largely as a result of increased customer lending balances, which saw a corresponding level of growth in the balance sheet of Arbuthnot Latham. Net interest income now represents 73% of total operating income compared to the prior year level of 72%.

 

This year's income statement includes £2.1m profit from Associate. This represents the Group's share (18.6%) of the profit after tax of Secure Trust Bank, which is now classified as an associated undertaking. This method of accounting for the investment that ABG retains in Secure Trust is determined by the fact that ABG is deemed to have "significant influence" over Secure Trust by way of three directors of Secure Trust also being directors of Arbuthnot Banking Group. The profit from Associate is recorded from 15 June to 31 December 2016 and a full year effect is adjusted in the underlying profit reconciliation table, on a pro forma basis.

 

The Group's expense base increased to £46.1m (2015: £35.9m), an increase of 28%; however, this does include a number of exceptional bonus payments that were payable in relation to the profit generated on the sale of Everyday Loans, which was completed in April 2016. This payment totalled £2.3m and when the expense base is adjusted for these costs, the annual increase is 22%. The Group expense base includes a significant amount of expenditure, well in excess of £1m, that relates to investment in developing the Commercial Banking business, which is expected to generate profits in future years. Impairment losses on loans and advances to customers declined to £0.4m (2015: £1.3m) as the business continued to work its way out of a small number of remaining legacy cases. The loss rate has now fallen to 7bps on the total lending book.

 

Overall, the Return on Equity of the Group was 88.4% (2015: 14.6%). This result was somewhat distorted by the large transactions which leaves the Group now in a position with significant surplus capital, even after paying 356p per share of dividends.  It is expected that the Group will over time deploy the surplus capital into new and existing businesses at returns greater than 20%.

 

Balance Sheet Strength
	2016	2015
Summarised Balance Sheet	£000	£000
Assets
Loans and advances to customers	758,799	1,579,512
Liquid assets	340,003	484,917
Other assets	166,482	167,130
Total assets	1,265,284	2,231,559
Liabilities
Customer deposits	997,649	1,929,838
Other liabilities	33,277	110,317
Total liabilities	1,030,926	2,040,155
Equity	234,358	191,404
Total equity and liabilities	1,265,284	2,231,559

 

During the year total assets reduced to £1.3bn (2015: £2.2bn), largely as a result of the removal of Secure Trust Bank from the balance sheet, apart from the remaining value of the investment in associate. However, the underlying growth of the balance sheet was in excess of 20% by measuring the growth in customer balances in Arbuthnot Latham.

 

Throughout the year the balance sheet remained almost entirely funded by customer deposits. However, the Group has continued to access other sources of liquidity as they become available. The Group has £109m of assets available for use in the Funding for Lending Scheme ("FLS") and the newly announced Term Funding Scheme ("TFS").

 

The net assets of the Group closed the year at £234m (2015: £191m), which is an increase of 23%. However, this does not fully explain the movement. Included in the prior year net assets was £68m of Non-Controlling Interests, which related to the minority shareholders of Secure Trust. This element was removed when STB was deconsolidated. So, on an adjusted basis, the net assets related to the shareholders of ABG have increased by £111m, an increase of 90%. This is also after payments of £52m in dividends during the year.

 

The net assets now stand at approximately £15.34 per share.

 

Segmental Analysis

The segmental analysis is shown in more detail in Note 42. The operating segments are Arbuthnot Latham and Co., Limited and Retail Banking Associate (being the Group's 18.6% investment in Secure Trust Bank). Group costs and intercompany elimination journals are shown separately to reconcile back to Group consolidated results.

 

The analysis presented below, and in the business review, is before any consolidation adjustments to reverse the impact of the intergroup operating activities and also intergroup recharges and is a fair reflection of the way the Directors manage the Group.

 

Arbuthnot Latham
	2016	2015
Summarised Income Statement	£000	£000
Net interest income	30,771	25,283
Net fee and commission income	11,005	9,793
Operating income	41,776	35,076
Other income	4,353	1,894
Operating expenses	(36,602)	(29,722)
Impairment losses - financial investments	(47)	-
Impairment losses - loans and advances to customers	(427)	(1,250)
Profit before tax	9,053	5,998

 

The profit before tax for the year was reported as £9.1m (2015: £6.0m). This was an increase of 51%. The one off gain received from the sale of Visa shares of £1.6m was largely offset by continued investment in the development of the Commercial Bank.

 

The operating income of the Bank increased by 19% largely due to the increase in customer loan balances, as the Bank becomes more led by its lending proposition, rather than fee based revenue streams.

 

During the year the monthly net client margin ranged between 4.2% and 4.5%, which was in line with the prior year.

 

Operating expenses have increased during the year by 23% to reach £36.6m (2015: £29.7m). This was largely as a result of additional hiring, mainly within the Commercial Bank and also some additional private bankers.

 

Impairment losses on loans declined from £1.3m to £0.4m, as the legacy book continues to be resolved.

 

	2016	2015
Summarised Balance Sheet	£000	£000
Assets
Loans and advances to customers	758,799	618,902
Liquid assets	339,989	344,856
Other assets (including Group balances)	100,374	40,691
Total assets	1,199,162	1,004,449
Liabilities
Customer deposits	997,649	896,766
Other liabilities (including Group balances)	120,815	55,330
Total liabilities	1,118,464	952,096
Equity	80,698	52,353
Total equity and liabilities	1,199,162	1,004,449

 

Total customer assets increased by 23% to close the year at £759m (2015: £619m). However, total volume of loans written in the year increased to £227m, which was an increase of 39% on the prior year (this excludes the purchase of the Duncan Lawrie loan portfolio of £43m). Despite this significant increase, the business did experience a lengthening of time between the approval of the loans in principle and the final drawdown of the loan. This may be due to a number of factors, but the most significant is the impact of the increase in stamp duty changes on expensive properties.

 

The business also has a healthy pipeline of approved lending which should see the business grow substantially in 2017.

 

Overall, the loan book remains well secured with an average LTV of 45% (2015: 46%). Other assets increased by approximately £60m due to the purchase of the property at 20 King Street in the West End. The deposits of the Bank almost reached £1bn for the first time in the Bank's history, closing the year at £998m (2015: £897m), an increase of 11%.

 

The net assets of the Bank now stand at £81m (2015: £52m), an increase of 54%, as the Parent made further capital contributions of £22m to facilitate additional growth. This was also supplemented by the organically generated retained reserves that arise from the net earnings in the year. As a result, Arbuthnot Latham had a total capital ratio of 12.3% (2015: 10.4%) and a core tier 1 ratio of 12.3% (2015: 10.4%).

 

The investment management business was able to grow its assets under management by 25% from £739m to close the year at £920m.

 

Group & Other Costs
	2016	2015
Summarised Income Statement	£000	£000
Net interest income	26	(148)
Subordinated loan stock interest	(352)	(324)
Operating income	(326)	(472)
Other income	120	-
Operating expenses	(10,813)	(8,098)
Impairment loss on financial investments	-	(34)
Profit after tax	(11,019)	(8,604)

 

Total Group costs increased from £8.6m to £11m as a result of the payment of exceptional bonuses related to the gain (£117m) generated by the successful completion of the disposal of Everyday Loans. The bonuses totalled £2.3m. The Group centre continues to oversee the Group operations, in particular the remaining investment in Secure Trust.

 

Capital

The Group's capital management policy is focused on optimising shareholder value over the long term. There is a clear focus on delivering organic growth and ensuring capital resources are sufficient to support planned levels of growth. The Board regularly reviews the capital position.

 

The Group's lead regulator, the Prudential Regulation Authority ("PRA"), sets and monitors capital requirements for the Group as a whole and for the individual banking operations. The lead regulator adopted the Basel III capital requirements with effect from 1 January 2014. As a result, the Group's regulatory capital requirements have been based on Basel III since 2014.

 

In accordance with the EU's Capital Requirements Directive ("CRD") and the required parameters set out in the PRA Handbook (BIPRU 2.2), the Individual Capital Adequacy Assessment Process ("ICAAP") is embedded in the risk management framework of the Group and is subject to ongoing updates and revisions when necessary.  However, at a minimum, the ICAAP is updated annually as part of the business planning process. The ICAAP is a process that brings together the management framework (i.e. the policies, procedures, strategies, and systems that the Group has implemented to identify, manage and mitigate its risks) and the financial disciplines of business planning and capital management. The Group's regulated entities are also the principal trading subsidiaries as detailed in Note 41.

 

Not all material risks can be mitigated by capital, but where capital is appropriate the Board has adopted a "Pillar 1 plus" approach to determine the level of capital the Group needs to hold. This method takes the Pillar I capital formula calculations (standardised approach for credit, market and operational risk) as a starting point, and then considers whether each of the calculations deliver a sufficient capital sum adequate to cover management's anticipated risks. Where the Board considers that the Pillar 1 calculations do not reflect the risk, an additional capital add-on in Pillar 2 is applied, as per the Individual Capital Guidance ("ICG") issued by the PRA.

 

The Group's regulatory capital is divided into two tiers:

• Tier 1 comprises mainly shareholders' funds and revaluation reserves, after deducting goodwill, other intangible assets and the 

  deduction for a significant investment in a financial institution (STB). The portion of the investment up to 10% of ABG's Tier 1

  is added back to capital resources and then risk weighted at 250%.

• Lower Tier 2 comprises qualifying subordinated loan capital and collective provisions. Lower Tier 2 capital cannot exceed 50%

  of Tier 1 capital.

 

The ICAAP includes a summary of the capital required to mitigate the identified risks in its regulated entities and the amount of capital that the Group has available. All regulated trading entities have complied with all of the externally imposed capital requirements to which they are subject.

 

	2016	2015
Capital ratios	£000	£000
Core Tier 1 capital	234,087	191,404
Deductions	(67,639)	(33,921)
Tier 1 capital after deductions	166,448	157,483
Tier 2 capital	12,621	12,865
Total capital	179,069	170,348
Core Tier 1 capital ratio (Net Core Tier 1 capital/Basel III Total Risk Exposure)	28.0%	11.7%
Total Capital Ratio (Capital/Basel III Total Risk Exposure)	30.1%	12.6%

 

Risks and Uncertainties

The Group regards the monitoring and controlling of risks and uncertainties as a fundamental part of the management process.  Consequently, senior management are involved in the development of risk management policies and in monitoring their application.  A detailed description of risk management and the associated policies is set out in note 6 to the financial statements.

 

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

 

Strategic risk

Strategic risk is the risk that may affect the Group's ability to achieve its corporate and strategic objectives. This risk is important to the Group as it continues its growth strategy. However, the Group seeks to mitigate strategic risk by focusing on a sustainable business model which is aligned to the Group's business strategy. Also, the Board of Directors meets once a year to hold a two day board meeting to ensure that the Group's strategy is appropriate for the market and economy.

 

Credit risk

Credit risk is the risk that a counterparty will be unable to pay amounts in full when due.  This risk exists in Arbuthnot Latham & Co., Limited, which currently has a loan book of £759m. The lending portfolio in Arbuthnot Latham is extended to private banking clients and the majority is secured against cash, property or other assets. Credit risk is managed through the Credit Committee of Arbuthnot Latham.

 

Market risk

Market risk arises in relation to movements in interest rates, currencies and equity markets. The Group's treasury function operates mainly to provide a service to clients and does not take significant unmatched positions in any market for its own account.  As a result, the Group's exposure to adverse movements in interest rates and currencies is limited to interest earnings on its free cash and interest rate re-pricing mismatches. The Group also has an 18.6% interest in Secure Trust Bank PLC. There is currently the risk that a permanent or prolonged reduction in the share price could lead to an impairment of the interest in associate currently carried at £81.7m. Going forward if the Group was considered to no longer have significant influence it would lead to the investment being accounted for as an available-for-sale financial investment. The value would then be marked to market with changes in the share price giving rise to gains or losses being recorded in Other Comprehensive Income or Profit or Loss (see note 3.8 (d), note 3.10 (b) and note 4.1 (d)).

 

The Group is exposed to changes in the market value of commercial properties to the extent that the Group holds Investment Property carried at fair value. The current carrying value of Investment Property is £53.3m. Any changes in the market value of the commercial property will be accounted for in Profit or Loss and as such could have a material impact on the Profit or Loss of the Group.

 

Liquidity risk

Liquidity risk is the risk that the Group cannot meet its obligations as they fall due. The Group takes a conservative approach to managing its liquidity profile. It has placed no reliance on the wholesale lending markets and is almost entirely funded by retail customer deposits.  The loan to deposit ratios are maintained at prudent levels. Following introduction of the new liquidity regime (Liquidity Coverage Ratio), which came into force on 1 October 2010, the Group maintains liquidity asset buffers which comprise high quality, unencumbered assets such as Government Securities, which can be called upon to meet the Group's liabilities.

 

Operational risk

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

 

Cyber risk

An increasing risk that the Group is subject to within its operational processes is cyber risk. This is the risk that the businesses within the Group are subject to some form of disruption arising from an interruption to its IT and data infrastructure.

 

Conduct risk

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

 

The Group adopts a zero risk appetite for any unfair customer outcomes. It maintains clear compliance guidelines and provides ongoing training to all staff.  Periodic spot checks and internal audits are performed to ensure these guidelines are being maintained.  The Group also has insurance policies in place to cover any claims that may arise.

 

Regulatory risk

Regulatory compliance risk is the risk that the Group will have insufficient capital resources to support the business or does not comply with regulatory requirements. The Group adopts a conservative approach to managing the capital of the Group. The principal regulated entity maintains capital ratios in excess of the minimum level set by the regulator. Capital requirements are forecast as part of the annual budgeting process and these are regularly monitored.  Annually, the Group Board assesses the robustness of the capital requirements as part of the ICAAP, where stringent stress tests are performed to ensure that capital resources are adequate over a three year horizon.

 

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

 

Macroeconomic and competitive environment

The Group is also exposed to indirect risks that may arise from the macroeconomic and competitive environment. The economic environment is relatively stable in the UK. However, the international landscape is increasingly uncertain. The declining performance of the economies in the EU and the increasingly protectionist stance being taken by other major economies may have an adverse affect on the UK. In particular, this may cause a softening of central London property prices, which may spread out further to the South East.

 

The Group monitors its exposure to future interest rate rises and currently has minimal lending to customers in products that would be directly sensitive to interest rate rises. However, at the current levels of interest rates, the affordability enjoyed by the Group's customers is beneficial.

 

Brexit

It is currently difficult to analyse the impacts that Brexit may have on Arbuthnot Banking Group. However, our only overseas operation is in Dubai, so the vast majority of the Group's income and expenditure is based in the UK. It is therefore anticipated that the financial impact would be minimal assuming there were to be no significant macro economic shock on the UK.

 

 

Group Directors' Report

 

The Directors submit their annual report and the audited consolidated financial statements for the year ended 31 December 2016.

 

Principal Activities and Review

The principal activities of the Group are banking and financial services. A strategic review in accordance with Section 414 C of the Companies Act 2006 forming part of this report is set out on pages 4 to 12.

 

Results and Dividends

The results for the year are shown on page 1. The profit after tax for the year of £227.6m (2015: £26.5m) is included in reserves.

 

The Directors recommend the payment of a final dividend of 18p on the ordinary shares which, together with the interim dividend of 13p paid on 30 September 2016, special dividend of 25p paid on 27 July and special dividend of 300p paid on 18 November 2016, represents total dividends for the year of 356p (2015: 29p). The final dividend, if approved by members at the Annual General Meeting, will be paid on 12 May 2017 to shareholders on the register at close of business on 18 April 2017.

 

Going Concern

After making appropriate enquiries which assessed strategy, profitability, funding, risk management (see note 6) and capital resources (see note 7), the directors are satisfied that the Company and the Group have adequate resources to continue in operation for the foreseeable future.  The financial statements are therefore prepared on the going concern basis.

 

Share Capital

Shareholders will be asked to approve Ordinary and Special Resolutions regarding the creation of a number of new shares, which may be non-voting shares, not exceeding 5% of the existing issued share capital, with authority given to the directors to allot such shares. Directors would use the authority to generate additional capital from institutional shareholders.

 

Shareholders will also be asked to approve a Special Resolution renewing the authority of the Directors to make market purchases of shares not exceeding 10% of the existing issued share capital. The Directors will keep the position under review in order to maximise the Company's resources in the best interests of shareholders.

 

Secure Trust Bank PLC

Following approval given by shareholders on 14 June 2016, the Company completed the sale of 6,000,000 ordinary shares in Secure Trust Bank PLC at a price of £25 per share. This reduced the Company shareholding in Secure Trust Bank PLC from 51.9 per cent to 18.9 per cent. Subsequently the shareholding has reduced to 18.6 per cent following the issue of further shares by Secure Trust Bank PLC to participants in its share option scheme.

 

Financial Risk Management

Details of how the Group manages risk are set out in in the Strategic Report and in note 6.

 

Substantial Shareholders

The Company was aware at 21 March 2017 of the following substantial holdings in the ordinary shares of the Company, other than those held by one director shown below:

 

Holder		Ordinary Shares	%
Liontrust UK Smaller Companies Fund		1,119,607	7.3
Prudential plc		608,890	4.0
Mr. R Paston		529,130	3.5
Directors
Sir Henry Angest	Chairman & CEO
J R Cobb	Finance Director
I A Dewar
J W Fleming (to 14/04/2016)
I A Henderson (from 06/05/2016)
Ms R J Lea (to 05/05/2016)
P A Lynam
Sir Christopher Meyer
A A Salmon	Chief Operating Officer
Sir Alan Yarrow (from 10/06/2016)

 

All those who are currently directors served throughout the year except for Mr. I.A. Henderson who was appointed on 6 May 2016 and Sir Alan Yarrow who was appointed on 10 June 2016. Mr. J.W. Fleming served as a director until 14 April 2016. Ms R.J Lea retired from the Board at the Annual General Meeting on 5 May 2016.

 

Mr. Henderson, who succeeded Mr Fleming as chief executive of Arbuthnot Latham & Co., Limited, and Sir Alan Yarrow offer themselves for election under Article 75 of the Articles of Association. Mr. Henderson has a service agreement terminable on twelve months' notice. Sir Alan Yarrow's letter of appointment is terminable on three months' notice.

 

Mr. Salmon and Mr. Lynam retire under Article 78 of the Articles of Association and, being eligible, offer themselves for re-election. Mr. Salmon has a service agreement terminable on twelve months' notice. Mr. Lynam, a non-executive director who remains chief executive of Secure Trust Bank PLC, has a letter of appointment terminable on three months' notice.

 

According to the information kept under Section 3 of the Disclosure and Transparency Rules 2006 and the Market Abuse Regulation 2016, the interests of directors and their families in the ordinary 1p shares of the Company at the dates shown were, and the percentage of the current issued share capital held is, as follows:

 

Beneficial Interests	1 January 2016	31 December 2016	21 March 2017	%
Sir Henry Angest	8,200,901	8,200,901	8,200,901	53.7
J.R. Cobb	-	5,000	6,000	-
P.A. Lynam	10,000	10,000	10,000	0.1
A.A. Salmon	51,699	51,699	51,699	0.3

 

At the yearend, Mr. Lynam held 9,110 and Mr. Salmon held 7,500 ordinary 40p shares in Secure Trust Bank PLC, an associate company of the Group.

 

On 16 April 2013 Mr. Salmon and Mr. Cobb were granted options under the Company's Unapproved Executive Share Option Scheme to subscribe between April 2016 and April 2021 for 100,000 and 50,000 ordinary 1p shares respectively in the Company at 930p. The fair value of the options at grant date was £125,000. On 14 June 2016 Mr. Salmon and Mr. Cobb each exercised all their respective options granted on 16 April 2013. The exercise price was 1591p and the Board agreed to make a cash settlement rather than allot new shares.

 

On 1 April 2014 Mr. Fleming was granted an option to subscribe between April 2017 and April 2022 for 50,000 ordinary 1p shares in the Company at 1185p. The fair value of the options at the grant date was £53,000.

 

At the date of this remuneration report, the only outstanding options to directors under the Unapproved Executive Share Option Scheme are those in relation to 50,000 shares for James Fleming.

 

On 14 June 2016 Mr. Salmon, Mr. Cobb and Mr. Henderson were granted phantom options to subscribe for 200,000, 100,000 and 100,000 ordinary 1p shares respectively in the Company at 1591p.   50% of each director's individual holding of phantom options is exercisable at any time after 15 June 2019 and the other 50% is exercisable at any time after 15 June 2021.  These options replaced options for Mr. Salmon to subscribe for 100,000 ordinary 1p shares and Mr. Cobb to subscribe for 50,000 ordinary 1p shares granted on 16 April 2013 subject to a cash payment reflecting the difference between 930p and 1591p per share.  The fair value of the option at the grant date was £1.3m.

 

Mr. Lynam continues to hold options granted to him on 2 November 2011 to subscribe for 141,667 ordinary 40p shares in Secure Trust Bank PLC (an associate company of the Group), under the Unapproved Executive Share Option Scheme established in November 2011,  at 720p between 2 November 2016 and 2 November 2021. The fair value of the options at grant date was £0.3m. On 7 November 2016 Mr. Salmon exercised options granted to him on 2 November 2011 to subscribe for 141,667 ordinary 40p shares in Secure Trust Bank PLC at 720p and sold the shares at a price of 2200p.

 

On 23 March 2015 Mr. Lynam was granted phantom options to acquire 187,500 ordinary 40p shares in Secure Trust Bank PLC at 2500p exercisable on or after 3 November 2018 when a cash payment would be made equal to any increase in value.

 

Apart from the interests disclosed above, no director was interested at any time in the year in the share capital of Group companies.

 

No director, either during or at the end of the financial year, was materially interested in any contract with the Company or any of its subsidiaries or associated companies, which was significant in relation to the Group's business. At 31 December 2016 two directors had loans from Arbuthnot Latham & Co., Limited amounting to £1,361,000 and one director had a loan from Secure Trust Bank PLC amounting to £404,000, on normal commercial terms as disclosed in note 40 to the financial statements. At 31 December 2016 five directors had deposits with Arbuthnot Latham & Co., Limited amounting to £3,398,000 and two directors had deposits with Secure Trust Bank PLC amounting to £318,000, all on normal commercial terms as disclosed in note 40 to the financial statements.

 

Shareholders will be asked to approve a Special Resolution removing the limit on the amount of fees payable to non-executive directors, currently £400,000.   The corresponding Article regarding the remuneration of executive directors contains no such limit. Responsibilities of non-executive directors have increased significantly in recent years with further obligations falling on those who serve on board committees.  Removal of the limit would increase the flexibility of the Board, not least if it is felt appropriate to make any additional appointment between Annual General Meetings.

 

Shareholders will also be asked to approve a Special Resolution amending the Articles relating to the function of the President, to widen the role, with the objective of safeguarding the long term prosperity and well being of the Company.

 

The Company maintains insurance to provide liability cover for directors and officers of the Company.

 

Board Committees

The report of the Remuneration Committee on pages 21 to 22 will be the subject of an Ordinary Resolution at the Annual General Meeting.

 

Information on the Audit, Nomination, Risk and Political Donations Committees is included in the Corporate Governance section of the Annual Report on pages 17 to 20.

 

As explained in the Corporate Governance section of the Annual Report, the Board now maintains direct responsibility for issues of risk, as responsibility for large lending proposals has become a direct responsibility of its subsidiary, Arbuthnot Latham & Co., Limited.

 

Employees

The Company gives due consideration to the employment of disabled persons and is an equal opportunities employer.  It also regularly provides employees with information on matters of concern to them, consults on decisions likely to affect their interests and encourages their involvement in the performance of the Company through share participation and in other ways.

 

Political Donations

The Company made political donations of £67,000 to the Conservative Party during the year (2015: £68,000).

 

The Board proposes to update the authority granted by shareholders at the 2015 Annual General Meeting to make donations to political parties and organisations or incur political expenditure within the meaning of Sections 363 to 365 of the Companies Act 2006 for a further four years limited to £250,000 in aggregate.

 

Branches outside of the UK

During the year Arbuthnot Latham & Co., Ltd operated a branch in Dubai which is regulated by the Dubai Financial Services Authority.

 

Events after the balance sheet date

There were no material post balance sheet events to report.

 

Auditor

A resolution for the re-appointment of KPMG LLP as auditor will be proposed at the forthcoming Annual General Meeting at a fee to be agreed in due course by the directors. 

 

Statement of Disclosure of Information to Auditors

The Directors confirm that:

 

• so far as each director is aware, there is no relevant audit information of which the Company's auditor is unaware; and

• the Directors have taken all the steps they ought to have taken as directors to make themselves aware of any relevant audit

  information and to establish that the Company's auditor is aware of that information.

 

This confirmation is given and shall be interpreted in accordance with the provisions of section 418 of the Companies Act 2006.