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Virgin Money Holdings (UK) Limited – Pillar 3 disclosures

CONTENTS

1. Overview..........................................................................................................4 1.1 Background...................................................................................................................................4 1.2 Scope of application...................................................................................................................4 1.3 Disclosure policy ...........................................................................................................................6

1.3.1 Information to be disclosed .........................................................................................6 1.3.2 Frequency & location....................................................................................................6

1.4 Verification ....................................................................................................................................6 1.5 Recent developments.................................................................................................................6

2. Risk management objectives and policies..................................................7 2.1 Overview........................................................................................................................................7 2.2 Risk culture.....................................................................................................................................7 2.3 Strategic planning........................................................................................................................7 2.4 Risk appetite and reporting........................................................................................................8 2.5 Risk framework ..............................................................................................................................8 2.6 Risk governance...........................................................................................................................9 2.7 Stress testing ................................................................................................................................10 2.8 Strategic and emerging risks ....................................................................................................10

3. Capital resources ..........................................................................................12 3.1 Regulatory consolidated balance sheet ...............................................................................12 3.2 Total available capital...............................................................................................................13 3.3 Tier 1 capital ................................................................................................................................14 3.4 Capital impact of CRD IV .........................................................................................................14 3.5 Leverage ratio ............................................................................................................................16

4. Compliance with BIPRU and the overall Pillar 2 rule ................................17 4.1 Capital management ...............................................................................................................17 4.2 Assessment of the adequacy of internal capital ..................................................................17 4.3 Capital requirements.................................................................................................................18

5. Credit risk .......................................................................................................20 5.1 Retail credit risk ...........................................................................................................................20

5.1.1 Retail credit risk management...................................................................................20 5.1.2 Retail secured credit risk .............................................................................................20 5.1.3 Retail unsecured credit risk.........................................................................................21

5.2 Wholesale credit risk ..................................................................................................................21 5.3 Credit concentration risk...........................................................................................................22 5.4 Credit risk exposures...................................................................................................................23 5.5 Geographical distribution of exposures .................................................................................24 5.6 Exposure by residual maturity...................................................................................................25 5.7 Retail exposures – scope of IRB models..................................................................................26 5.8 Retail Internal Ratings Based models ......................................................................................26 5.9 IRB exposures by exposure class ..............................................................................................27 5.10 IRB model performance – regulatory expected loss versus accounting actual loss ......29 5.11 IRB model performance – estimated versus actual..............................................................30 5.12 Credit impairment ......................................................................................................................31 5.13 Impairments by exposure class ................................................................................................33 5.14 Geographical distribution of impairments .............................................................................33 5.15 Movements in impairment provisions......................................................................................34 5.16 Wholesale exposures by credit rating.....................................................................................35 5.17 Counterparty credit risk relating to derivatives .....................................................................36 5.18 Credit risk mitigation ..................................................................................................................37

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5.18.1 Retail exposures .......................................................................................................37 5.18.2 Treasury exposures...................................................................................................38

6. Market risk......................................................................................................39 6.1 Market risk overview...................................................................................................................39 6.2 Market risk management..........................................................................................................39 6.3 Capital at risk (CaR)...................................................................................................................40 6.4 Earnings at risk (EaR) ..................................................................................................................40 6.5 Foreign exchange risk................................................................................................................41 6.6 Market risk capital requirements..............................................................................................41

7 Funding & liquidity risk ..................................................................................42 7.1 Funding & liquidity risk overview ..............................................................................................42 7.2 Significant events/environment ...............................................................................................42 7.3 Liquidity risk management........................................................................................................42 7.4 Liquid resources ..........................................................................................................................42 7.5 Funding risk management ........................................................................................................43 7.6 Asset encumbrance position ...................................................................................................43

8. Operational and conduct risk......................................................................45 8.1 Operational risk overview .........................................................................................................45 8.2 Significant events and environment .......................................................................................46

9. Securitisation..................................................................................................48 9.1 Objectives in relation to securitisation ....................................................................................48 9.2 Issued and retained securitisation positions...........................................................................48

9.2.1 Risks inherent in the issued and retained securitisation position...........................48 9.2.2 Participation by the Group in the Funding for Lending Scheme (FLS) ................49 9.2.3 Roles played by the Group in the securitisation process ......................................49 9.2.4 Calculating risk weighted exposure amounts .........................................................50 9.2.5 Accounting policies for issued and retained securitisation activities..................50 9.2.6 External Credit Assessment Institutions used for securitisations.............................51 9.2.7 Exposures securitised by the Group ..........................................................................51 9.2.8 Securitisation activity during 2013 and 2012............................................................51 9.2.9 Synthetic securitisations ..............................................................................................52

9.3 Purchased securitisation positions ...........................................................................................52 9.3.1 Risks inherent in the purchased securitisation position...........................................52 9.3.2 Roles played by the Group in the securitisation process ......................................52 9.3.3 Calculating risk weighted exposure amounts .........................................................52 9.3.4 Accounting policies for purchased securitisation positions ..................................52

10. Remuneration ................................................................................................53 10.1 Approach to remuneration ......................................................................................................53 10.2 The Remuneration Committee.................................................................................................53 10.3 Design characteristics of the remuneration system..............................................................54 10.4 Link between pay and performance and the performance criteria used ......................54 10.5 Remuneration for Code Staff ...................................................................................................55

10.5.1 Fixed and variable remuneration .........................................................................55 10.6 The Virgin Money Group Annual Report 2013 .......................................................................55

11. Glossary .........................................................................................................56


1. Overview 1

e Capital Requirem

.1 Background

ents Directive (Basel II) was implemented in the UK by the Financial Services

, market

illar 2 y review process and the assessment of additional capital d by

illar 3 f disclosure requirements which

is docu er the Prudential Regulation Authority (PRA)

on the consolidated corporate Group referred to and described as

s set out below.

ThAuthority (FSA, the regulator at the time) and enforced through the Prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU). The rules consist of three ‘pillars’. illar 1 sets out the minimum capital requirements Firms are required to meet for creditP

and operational risk.

describes the supervisorPresources required to cover specific risks faced by Firms that have not been coverethe minimum regulatory requirements as set out in Pillar 1.

aims to encourage market discipline by developing a set oPallow market participants to assess key pieces of information on a Firm’s capital, risk exposures and risk assessment processes.

ment sets out the disclosures required undThhandbook set out in BIPRU Chapter 11, which represent the Pillar 3 regulatory disclosure requirements in the UK under Basel II.

.2 Scope of application 1

This disclosure report is based “Virgin Money” (Virgin Money Regulated Group) with the exception of sections 3.2 and 4.3 which also disclose the position of Virgin Money plc, the significant subsidiary within the Group. The Group has complied with the Prudential Sourcebooks throughout the year. This disclosure is presented in respect of the year to 31 December 2013.

e Group structure at 31 December 2013 iTh

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At 31 December 2013, the Virgin Money Regulated Group was made up of the following companies:

• Virgin Money Holdings (UK) Limited

• Virgin Money plc

• Virgin Money Unit Trust Managers Limited

• Virgin Money Personal Financial Service Limited

• Church House Trust Limited

• Virgin Money Management Services Limited

Virgin Money plc (VM plc) is the only significant subsidiary within the Group. At 31 December 2013 VM plc’s capital requirements made up over 97% of the Group’s capital requirements. The following companies are special purpose entities (“SPEs”) established in connection with the Group’s securitisation programme. Although Virgin Money plc has no direct or indirect ownership interest in these companies, they are accounted for as subsidiaries of Virgin Money plc. This is because they are principally engaged in providing a source of long term funding to the Group, which in substance means the Group has the rights to all benefits from the activities of the SPEs. They are therefore effectively controlled by the Group. Nature of business Country of incorporation

Gosforth Funding plc Issue of securitised notes England & Wales

Gosforth Funding 2011-1 plc Issue of securitised notes England & Wales



Gosforth Mortgages Trustee Limited Trust England & Wales

Gosforth Mortgages Trustee 2011-1 Limited Trust England & Wales



Gosforth Holdings Limited Holding company England & Wales

Gosforth Holdings 2011-1 Limited Holding company England & Wales



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1.3 Disclosure policy

The following sets out the Group’s Disclosure Policy as applied to Pillar 3 Disclosures. 1.3.1 Information to be disclosed

The Group’s policy is to meet all required Pillar 3 disclosure requirements as detailed in Section 11 of the Prudential sourcebook for Banks, Building Societies and Investment Firms (BIPRU). The Group does not seek any exemption from disclosure on the basis of materiality or on the basis of proprietary or confidential information. 1.3.2 Frequency & location Virgin Money’s policy is to publish the disclosures required on an annual basis. The information is published as soon as practical following publication of the annual Directors’ Report and Financial Statements. The Pillar 3 disclosure document is published on the corporate website www.virginmoney.com. The frequency of disclosure will be reviewed should there be a material change in any approach used for the calculation of capital, business structure or regulatory requirements. 1.4 Verification The Group’s Pillar 3 disclosures have been reviewed by the Audit Committee and approved by the Board. In addition, the remuneration disclosures as detailed in Section 10 of this document have been reviewed by the Remuneration Committee. The disclosures are not subject to audit except where they are equivalent to those prepared under accounting requirements and disclosed in the annual Directors’ Report and Financial Statements for the period to 31 December 2013. 1.5 Recent developments There have been no material events subsequent to the end of the reporting period on 31 December 2013 up to the date of approval of these disclosures.

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http://www.virginmoney.com/


2. Risk management objectives and policies

2.1 Overview Virgin Money aims to ensure a focus on risk management is at the heart of the organisation:

Description

Culture The business culture is open and has a focus on risk management, with risk considerations informing Board and Senior Management decision making.

Strategic Planning and Risk Appetite

Board strategic planning is based on clear principles which aim to ensure that an appropriate balance of risk and reward is achieved in growing a sustainable business. This is reflected in a clearly defined risk appetite.

Risk Framework The Virgin Money risk framework aligns to risk appetite and to good standards of risk management practice. The internal risk framework is regularly assessed to ensure it is fit for the developing business model.

Governance Governance structures within the business are robust and support risk management objectives.

Stress testing Stress testing is an integral part of the planning and risk assessment process. Importantly the Board approve the key stress scenarios and sensitivities which inform business planning.

The risk profile is driven by the business lines giving rise to the following risks:

• Credit risk (section 5)

• Market risk (section 6)

• Funding and liquidity risk (section 7)

• Operational and conduct risk (section 8)

A review of the changes in the business risk profile during 2013 concluded that Virgin Money is a stable and low risk business. 2.2 Risk culture Corporate culture is fundamental to risk management at Virgin Money. Our culture is open and risk aware. Considerations about risk inform Board and Management decisions, while colleagues are encouraged to highlight and address risk issues promptly. Responsibilities for risk management are articulated clearly in all job descriptions and performance reviews, and ultimately determination of pay and bonus includes risk considerations. The whistle blowing process protects colleagues who speak out. 2.3 Strategic planning Strategic planning is based on clear risk principles that drive sustainable growth in the business. Virgin Money sets prudent macro economic, market and growth assumptions. The Group is committed to maintaining a strong balance sheet and focuses on maintaining a well capitalised business with a strong liquidity position. This is designed specifically to support stable balance sheet growth, our credit rating and Basel III/CRD IV requirements. The business is predominantly retail deposit funded with some diversification into non-retail funding. Loan originations grow in line with available funding.

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2.4 Risk appetite and reporting The risk appetite statements and metrics outline the Board’s view of business risk capacity, appetite and limits. The risk appetite statement aims to:

• articulate the Board’s tolerance for risk in pursuit of the strategic objectives;

• ensure that the Group achieves, and is forecast to maintain, a robust capital and liquidity position;

• document the key limits which keep the business within risk appetite.

Board reporting focuses on current and forecast risk appetite positions and significant emerging risks. Executive Committees manage the business within risk limits, which measure the most significant risk performance metrics. Management Committees gain insight into business performance through the review of detailed risk and performance management information. Risk appetite is set and approved at least annually as part of the business planning process and reflects the Group’s latest commercial, economic and regulatory thinking. Virgin Money’s risk appetite statements are set out in the table below:

Fortress Balance Sheet

Capital Virgin Money maintains a high quality capital base,

targeting capital ratios which support business

development and the risks inherent in the strategic plan and in excess of regulatory

minimum.

Liquidity Virgin Money operates an investment strategy for its

treasury assets which prioritises liquidity and ensures that the Group holds a liquid

assets buffer in line with internal analysis and regulatory guidance.

Profitability Achieving appropriate

profitability across all business lines is essential to the

sustainability of Virgin Money.

Depositor Protection Minimise Unrewarded Risks Mature Control Environment

As an authorised deposit taker, Virgin Money ensures

that depositors’ financial assets and all customers’

personal data are protected.

Unrewarded risks only expose Virgin Money to downside risk.

The Group avoids unrewarded risks where

possible or controls them as far as is economically

feasible.

Virgin Money ensures that the control environment is fit for

purpose, supporting the business as it grows in terms of

people, processes and systems.

2.5 Risk framework Delivery of the business strategy within risk appetite is managed through a comprehensive risk management framework tailored for each key risk class. To ensure the framework remains up to date and relevant for the evolving business, a review of each framework risk class is conducted regularly. Virgin Money is alert to emerging risks and actively maintains a current view of exposures. The Group builds a detailed map of the risks that could affect the business both today and in the future.

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2.6 Risk governance Risk is governed as shown below.

Effective risk management is enhanced by a three lines of defence model:

• the first line of defence is front-line colleagues – people at the heart of the business who manage risk as part of their day to day activity. Colleagues understand the risk appetite and framework and know how they are applied in practice. This first line of defence oversees key partners and those to whom activities are outsourced;

• the second line of defence is the central risk and control function which is responsible for oversight of the first line and putting in place policies, limits and approaches which ensure the business performs within the risk appetite set by the Board. These teams support the first line of defence, monitoring the performance of the Group and providing early warning of adverse trends; and

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• the third line of defence is the internal audit function. This provides assurance to the Board and Management on the adequacy of design and operational effectiveness of the system of internal controls.

2.7 Stress testing Virgin Money considers actively a range of scenarios to ensure that, under stress, Virgin Money does not exceed the Group’s capacity to absorb loss and recover from extreme business events or stressed economic and market conditions. These are used to develop stressed business, capital and funding plans. Group-wide stress testing is an integral part of the annual business planning process. The stress testing programme is overseen by the Board which approves the stress scenarios and sensitivities which test the viability of the business plan and supporting capital and funding plans over the medium term. Liquidity stresses are a key part of the programme, and are designed to assess the adequacy of our liquid resources and contingent arrangements. Stress testing also enables Virgin Money to identify early warning signs of a significant deterioration in business performance and enables appropriate management response. 2.8 Strategic and emerging risks The UK banking sector has been in a period of flux for several years. Increased public scrutiny, a depressed economic environment in the UK and worldwide economic volatility, coupled with significant changes in the regulatory environment exert considerable external pressure on the business model. During 2013 Virgin Money has focused on staying abreast of new regulatory requirements including the Financial Services Act (Regulatory Reform), the Mortgage Market Review and the requirements of CRD IV/CRR. The Group anticipates that this significant level of regulatory change will continue for several years. Virgin Money’s key risks can be grouped into the following themes:

• Transformation – Virgin Money has a strategic transformation programme required to deliver the business plan which includes:

o building the infrastructure to facilitate the management, servicing and strategic growth of the credit card business; and

o the launch of a current account product. Both initiatives carry a level of risk in relation to the successful and timely delivery of the Group’s business plan. These risks are being carefully mitigated through robust risk and project management disciplines to ensure that implementation of such important initiatives is delivered in a safe manner. As the Group develops new products and infrastructure the development of the related risk and control framework is key.

• Macroeconomic environment – The historically low bank base rate impacts current earnings but, when interest rates start to rise there may be a strain on customers’ ability to meet loan repayments. Stress and scenario testing allows management to focus on mitigating these risks.

• Operational risks – Corporate partners and strategic suppliers are key components of Virgin Money’s business model, bringing the risk of disruption to service arising from the failure of a key third party. Cybercrime and information security are a focus. The Bank of England’s Systemic Risk Survey’s most commonly cited operational risk is the threat of cyber attack and the Group has a programme of investment in security infrastructure to mitigate this risk.

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Through its subsidiary, Virgin Money Unit Trust Managers Limited (VMUTM), the Group is exposed to a variety of risks through this unit trust manager’s normal operations, including the performance of VMUTM’s underlying funds under management, which are themselves subject to movements in stock markets. The sole income stream of VMUTM is reliant upon the performance of the funds for which it is fund manager. The Group currently mitigates the risk associated with stock market movements through the use of a FTSE hedge.

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3. Capital resources 3.1 Regulatory consolidated balance sheet The table below provides a reconciliation of the Group’s consolidated balance sheet on an accounting consolidation basis (which includes all Group companies) to the Group’s consolidated balance sheet under the regulatory scope of consolidation (which excludes dormant companies and Virgin Money Giving).

2013

Accounting balance sheet as in published financial statements

Deconsolidation of other entities

Under regulatory scope of

consolidation

£m £m £m Assets Cash and balances at central banks 1,423.5 (0.1) 1,423.4 Disposal group assets held for sale 85.9 - 85.9 Loans and advances to banks 626.9 - 626.9 Investment securities 1,688.6 - 1,688.6 Derivative financial instruments 187.5 - 187.5 Loans and advances to customers 20,351.2 - 20,351.2 Fair value adjustments of portfolio

hedging

(8.7) - (8.7) Investment in subsidiary undertakings - - - Intangible assets 26.0 - 26.0 Property, plant and equipment 71.2 - 71.2 Prepayments and accrued income 18.9 (0.2) 18.7 Deferred taxation 73.9 - 73.9 Other assets 23.9 (0.2) 23.7 Total assets 24,568.8 (0.5) 24,568.3 Liabilities

Deposits by banks

389.2 - 389.2 Customer accounts 21,121.4 - 21,121.4 Disposal group liabilities held for sale 78.9 - 78.9 Derivative financial instruments 147.1 - 147.1 Debt securities in issue 1,469.8 - 1,469.8 Accruals and deferred income 189.3 - 189.3 Provisions for liabilities and charges 25.8 (0.2) 25.6 Other liabilities 226.9 (3.8) 223.1 Total liabilities 23,648.4 (4.0) 23,644.4 Equity Share capital - - - Share premium 509.2 - 509.2 Own shares (6.2) - (6.2) Other reserves 6.7 - 6.7 Retained earnings 410.7 3.5 414.2 Total equity 920.4 3.5 923.9 Total liabilities and equity 24,568.8 (0.5) 24,568.3

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3.2 Total available capital The following table sets out the capital resources of the Group and its significant subsidiary Virgin Money plc at 31 December 2013.

Group Virgin Money plc 2013 2012 2013 2012

£m £m

£m £m

Core Tier 1 Ordinary share capital - - 1,400.0 1,400.0 Share premium 509.2 509.2 - - Investment in own shares (6.2) (6.2) - - Retained reserves 410.7 251.5 (247.2) (519.3) Other reserves 6.7 0.3 1.5 (11.6) Total equity per balance sheet 920.4 754.8 1,154.3 869.1 Regulatory capital adjustments Net liabilities of companies

outside the regulatory group

3.5 3.0 - - Net liabilities of SPE companies - - (10.8) (17.5) Other reserves (6.7) (0.3) (1.5) 11.6 Intangible assets (26.0) (34.8) (23.1) (28.2) Investment in subsidiaries - - - (9.6) Excess of expected loss over

impairment (41.1) (37.4) (41.1) (37.4) Core Tier 1 Capital 850.1 685.3 1,077.8 788.0 Non Core Tier 1 notes 150.0 150.0 - - Total Tier 1 Capital 1,000.1 835.3 1,077.8 788.0 Total available capital resource 1,000.1 835.3 1,077.8 788.0 Pillar 1 Risk Weighted Assets Retail mortgages 3,860.4 3,069.1 3,854.6 3,062.6 Unsecured lending 595.3 - 595.3 0.1 Wholesale 268.5 585.2 248.7 577.9 Other assets 195.8 206.5 279.9 171.8 Operational risk 326.0 331.7 152.9 138.1 Total risk weighted assets 5,246.0 4,192.5 5,131.4 3,950.5 Core tier 1 ratio 16.2% 16.4% 21.0% 20.0% Tier 1 ratio 19.1% 19.9% 21.0% 20.0% Total capital ratio 19.1% 19.9% 21.0% 20.0%

The share capital of Virgin Money Holdings (UK) Ltd comprises 40,576,824 shares with nominal value of £0.001, giving rise to ordinary share capital of £40,576.82. The associated share premium account totals £509.2m. The share capital of Virgin Money plc comprises 1.4bn shares with nominal value of £1, giving rise to ordinary share capital of £1.4bn. There is no associated share premium.

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Prior to acquisition by Virgin Money Holdings Limited, Northern Rock plc (now Virgin Money plc) was a loss making entity. The following table sets out the movements in capital resources during 2013.

Group VMplc

Core Tier 1 Tier 1 and total

capital Core Tier 1, Tier 1 and total capital

£m £m £m

At 1 January 2013 685.3 835.3 788.0 Profit for the year 174.3 174.3 271.7 Distribution to NCT1 note holder (15.7) (15.7) - Share-based payments 0.6 0.6 0.4 Movement in reserves of companies

outside the regulatory group

0.5 0.5 - Movement in SPE reserves - - 6.7 Sale of investment in subsidiaries - - 9.6 Intangible assets 8.8 8.8 5.1

Excess of expected loss over impairment

(3.7) (3.7) (3.7) At 31 December 2013 850.1 1,000.1 1,077.8

This shows the main factor for the increase in capital resources during the year is profits. Capital resources in VMplc are made up entirely of core tier 1 capital, therefore core tier 1, tier 1 and total capital resources are equal. 3.3 Tier 1 capital Core Tier 1 capital comprises ordinary share capital, share premium and allowable reserves after deducting prudential filters such as intangible assets and expected losses in excess of provisions in respect of our IRB mortgage portfolio. The Non Core Tier 1 Notes of £150m were issued to HM Treasury on 1 January 2012 as part consideration in the acquisition of Northern Rock plc. The notes have a discretionary coupon of 10.5% per annum. 3.4 Capital impact of CRD IV CRD IV introduces new capital limits and buffers for banks, and includes a requirement to hold Common Equity Tier 1 capital to account for capital conservation, countercyclical and systemic risk buffers. These new buffers will influence the type of capital instruments that are best placed to meet the requirements likely to be expected of the Group. Virgin Money reviews its capital structure on an ongoing basis to ensure it is well placed to react to prevailing economic and regulatory conditions. The Group is well positioned for the introduction of Basel III.

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Under CRD IV, the capital position of the Group at 31 December 2013 is shown below.

Current rules

(Basel II) Transitional (PRA rules)

Fully loaded (CRD IV)

£m £m £m

Common equity Tier 1 Ordinary share capital - - - Share premium 509.2 509.2 509.2 Investment in own shares (6.2) (6.2) (6.2) Retained reserves 410.7 410.7 410.7 Cash flow hedge reserve 0.2 0.2 0.2 Available for sale reserve 6.5 6.5 6.5 920.4 920.4 920.4 Net liabilities of companies outside the

regulatory group

3.5 3.5 3.5 Cash flow hedge reserve (0.2) (0.2) (0.2) Available for sale reserve gains (see

below)

(12.5) (12.5) - Available for sale reserve losses (see

below)

6.0 - - Intangible assets (26.0) (26.0) (26.0) Excess of expected loss over impairment (41.1) (41.1) (41.1) Deferred tax asset on unused tax losses - (62.2) (62.2) Common Equity Tier 1 850.1 781.9 794.4 Additional Tier 1 Non Core Tier 1 notes 150.0 150.0 150.0 Total Tier 1 capital 1,000.1 931.9 944.4 Tier 2 Capital

Collectively assessed impairment allowances - 11.0 11.0

Total capital resources 1,000.1 942.9 955.4 RWAs under Basel II 5,246.0 5,246.0 5,246.0 Adjustments to be made under CRD IV (44.9) (44.9) Revised RWAs under CRD IV 5,201.1 5,201.1 CET1 ratio 15.0% 15.3% Total capital ratio 18.1% 18.4%

Under Basel II (current rules), the available for sale (AFS) reserve is excluded from capital. Under the transitional CRD IV rules adopted by the PRA, gains within this reserve are excluded from capital, while AFS losses are included for the first time. This will reduce the Group capital resources. Once this transitional period has passed (expected January 2015), both gains and losses within the AFS reserve will be recognised in capital resources.

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3.5 Leverage ratio The regulations introduce a new balance sheet metric, the leverage ratio, as a requirement from 1 January 2014. The Basel Committee is testing this ratio at a minimum threshold of 3% until 2017. The Group’s leverage ratio as at 31 December 2013 was 3.7%. The PRA plans to finalise the appropriate basis for disclosing the leverage ratio in mid 2014, following recent developments in the definition. Until then, institutions have been instructed to disclose the leverage ratio using the Capital Requirements Regulation (CRR) of Tier 1 Capital, and the December 2010 Basel II text definition of total exposures. The disclosed ratio is therefore not aligned fully with either the full CRR or the most recent January 2010 Basel definition, but complies with current requirements set by the PRA.

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4. Compliance with BIPRU and the overall pillar 2 rule 4.1 Capital management Maintenance of adequate capital resources is fundamental to sound prudential management. The key internal and regulatory requirement is for the regulated companies and the consolidated Group to hold adequate capital at all times, in terms of both quantum and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due. Capital is held to absorb losses that unexpectedly materialise and is therefore a mitigant to the risks encountered by the Group. The Group has in place sound, effective and complete processes, strategies and systems to:

• Identify and quantify the major sources of risk to which it is exposed;

• Calculate the quantum of capital resources deemed to be adequate, both in terms of the Group’s own assessment and regulatory requirements;

• Ensure that the Group holds adequate capital resources, both in terms of amount and

quality at the current time; and

• Analyse the risk that the Group will fail to hold sufficient capital at any future time. The Group’s internal minimum Common Equity Tier 1 capital ratio (under CRD IV) is conservatively set at 10% in line with a prudent business strategy and is based on the Group’s financial and capital planning horizon, with an expectation that this is in excess of the minimum regulatory requirements. 4.2 Assessment of the adequacy of internal capital Virgin Money undertakes an Internal Capital Adequacy Assessment Process (ICAAP) which is an assessment of the capital requirements of the business. The ICAAP is performed annually and is supplemented by a program of stress testing and sensitivity analysis to fully test the business plan. The ICAAP and base and stressed capital plans, are presented to the Risk Management Committee and the Board for challenge and approval.

The ICAAP assesses all material risks to determine the capital requirement over a three year horizon and includes stressed scenarios over a three year period.

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4.3 Capital requirements The following table sets out the Pillar 1 Capital Requirement of the Group and the significant subsidiary within the Group.

Group Virgin Money plc

2013 2012 2013 2012

Capital

Requirement Capital

Requirement Capital

Requirement Capital

Requirement

£m £m £m £m

IRB approach

Standard mortgages 275.2 218.5 275.2 218.5

Buy to let mortgages 33.2 26.5 33.2 26.5 Retail exposures secured by real estate collateral 308.4 245.0 308.4 245.0 Standardised approach Retail exposures secured by real estate collateral 0.3 0.5 - -

Credit Cards 47.4 - 47.4 -

Other retail exposures - - - -

Institutions 18.2 45.9 16.6 45.4

Past due items 0.3 0.1 0.3 -

Covered bonds 0.4 - 0.4 -

Securitisation positions 1.6 0.8 1.6 0.8

Other assets 17.0 16.5 23.7 13.8

Total standardised exposures 85.2 63.8 90.0 60.0

Operational risk 26.1 26.5 12.2 11.0

Market risk - - - -

Total capital requirement 419.7 335.3 410.6 316.0

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The following table sets out the movements in the Group’s credit risk weighted assets split between book size, book quality and model changes.

Total IRB mortgages Standardised

credit cards Other standardised

assets £m £m £m £m

RWAs at 1 January 2013 3,860.9 3,062.6 - 798.3

Book size 479.8 511.5 - (31.7)

Book quality (280.4) 15.8 - (296.2) Model calibration 253.4 253.4 - -

Model updates 11.3 11.3 - - Credit card acquisition 595.1 - 595.1 -

RWAs at 31 December 2013 4,920.1 3,854.6 595.1 470.4 The strong growth in mortgage balance to an EAD of £21,685m increased RWAs by £513.5m. Virgin Money uses a variable scaling methodology to calculate the Probability of Default (PD) parameter used within the Advanced Internal Ratings Based (AIRB) capital models. This methodology reduces, but does not eliminate, procyclicality within PD estimates. The methodology is sensitive to movements in the distribution of accounts within each segment. During 2013 the improvement in arrears rates caused a reduction in the point-in-time PDs. These lower point-in-time PDs have resulted in the requirement to increase the “scaling” factor used to transform these PDs to the long-run-average estimates. It is these higher scaling factors that have resulted in increased RWAs of £253.4m, despite lower arrears rates observed through the year. This increase has been categorised as “model calibration” within the above table. The seasoning of the mortgage book has contributed to an increased population of customers in default. This in turn has contributed to a marginal increase in RWAs within the “book quality” section. During 2013 two changes were implemented within the AIRB models. The discounting rate was aligned to industry good practice and an enhanced approach to the application of regulatory floors within the LGD model was implemented. These changes contributed to a marginal increase in RWAs of £11.3m. The acquisition of the credit card portfolio from MBNA during the year has given rise to additional risk weighted assets of £595.1m at 31 December 2013. This balance includes £0.2m of past due items. Other standardised assets (including wholesale assets, non-credit card retail assets and other assets) show a decrease in RWAs of £296.2m arising from improved book quality. This is largely driven by the reduction of an exposure to a single bank which held funds in escrow for the Group at 31 December 2012 for the acquisition of the credit card portfolio. The lower credit rating of this institution increased the average risk weighted asset percentage of the Group. This has been categorised as “book quality” within the table above.

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5. Credit risk Credit risk arises from retail and wholesale exposures. These exposures are managed by two committees, the Credit Risk Committee which holds separate sessions for secured and unsecured exposures, and the Treasury Risk Committee which reviews wholesale credit risk. Credit risk is the risk that a borrower or counterparty fails to pay the interest or the capital on a loan or other financial instrument. 5.1 Retail credit risk The following sections outline our approach to management of credit risk through the setting of appetite and policy and an overview of the measurement of credit risk in the Group. 5.1.1 Retail credit risk management The retail credit risk framework for new and existing customers is comprised of the following key components:

• automated statistically-based credit scoring models are used for new and existing customers. These models are subject to regular monitoring, review and approval;

• credit decisions are based on an assessment that includes the customer’s income and known expenditure to make sure that any loan is affordable both at the application stage and for the duration of the facility, and that the assessment considers potential changes in the economic environment;

• credit decisions may be manually underwritten by appropriately skilled and competent

colleagues acting within their agreed delegated authority;

• credit rating systems are used to measure the exposure to the credit risks inherent in the retail secured credit portfolios. Expected and unexpected losses are calculated for retail secured assets with provisions held in relation to losses expected to be incurred and capital held in relation to unexpected losses. Risk measurement systems enable measurement and management of portfolio concentrations in line with risk appetite, including exposures to counterparties, geographic regions, product types and risk factors; and

• the composition and quality of retail credit portfolios are monitored and reported through

governance committees regularly. Performance is also monitored to ensure that both composition and quality remain in line with risk appetite limits. Key credit risk metrics are benchmarked against competitors and against industry averages to understand their relative performance.

5.1.2 Retail secured credit risk Mortgage Market Review The Mortgage Market Review (‘MMR’) is a significant regulatory initiative designed to deliver a mortgage market that works better for consumers and is sustainable for all participants. Due to robust responsible lending approaches, minimal changes are needed to align lending policy with MMR requirements. Virgin Money has reviewed the strategy for residential interest only lending to reflect its position as a niche product. Applicants for interest only products are fully assessed for credible and proven means to repay the mortgage loan at maturity. The changes were implemented in December 2013, well in advance of the rules coming into effect in April 2014.

In December 2013 the Financial Conduct Authority (‘FCA’) published their new data reporting requirements arising from MMR. The purpose of the enhanced reporting is to allow the regulator to monitor the key changes introduced by MMR and the impact it has on customer outcomes. Virgin Money plans to implement the changes to internal systems during 2014 ahead of the first reporting date of April 2015.

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Interest only lending There has been significant regulatory focus on interest only residential mortgage loans both for existing and new customers. In addition to the changes to credit policy implemented to meet MMR requirements, Virgin Money, in line with the industry, is committed to contacting all interest only mortgage customers whose loans mature before the end of 2020. This will ensure that customers have an opportunity to take steps to avoid mortgage repayment shortfalls.

Help to Buy Help to Buy formed part of the Government’s 2013 budget announcement designed to increase the availability of low-deposit mortgages for creditworthy households and to boost the supply of new housing. Virgin Money has offered Help to Buy products through the Help to Buy Equity Loan scheme from November 2013 and through the Help to Buy Loan Guarantee scheme from December 2013. 5.1.3 Retail unsecured credit risk Credit cards On 18 January 2013 Virgin Money plc entered into a transaction to acquire economic ownership of £1 billion of the Virgin Money branded personal credit card book issued by MBNA.

Throughout 2013 the credit card book has performed ahead of expectations. Current accounts The existing current account book is a closed portfolio with overall balances, including overdraft balances, anticipated to reduce over time. There is no anticipated change to the risk profile of the existing current account book. 5.2 Wholesale credit risk Wholesale credit risk arises through investing the Group’s liquid assets and hedging exposures. Wholesale credit risk can be broken down into two elements: • The risk of default or rating migration of issuers in the Treasury investment portfolio; and

• The risk of default or rating migration of derivative counterparties

The Board sets a prudent risk appetite for wholesale credit risk with low appetite for credit losses. Priorities for the wholesale portfolio are safety and liquidity.

The wholesale credit policy sets a default credit limit structure for wholesale counterparties. These default credit limits are defined in such a way that lower rated counterparties are afforded lower limits and shorter term exposures. The Treasury Risk Committee, with authority delegated from the Risk Management Committee, reviews the creditworthiness of all counterparties periodically. The exposure to counterparties is monitored daily.

Credit risk arising from derivative transactions is mitigated by collateralising exposures on a daily basis. Virgin Money posts collateral to counterparties reciprocally if they have exposure to Virgin Money. All derivative contracts are traded over the counter (OTC) and settled under bilateral arrangements with counterparties. These arrangements are documented as industry standard International Swaps and Derivatives Association (ISDA) Master Agreements with Credit Support Agreements (CSA). CSAs provide Virgin Money with legal rights to set off between contracts with positive and negative fair value, as well as with collateral received or posted in the event of default by a counterparty.

The only exceptions to bilateral posting requirements relate to derivative transactions supporting the Gosforth mortgage-backed funding programme. In these cases Virgin Money posts collateral in excess of what the fair value of the transactions would require. Such excess collateral forms part of the total exposures managed and monitored under the wholesale credit risk limits.

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5.3 Credit concentration risk

Credit concentration risk is managed for retail and wholesale credit exposures at portfolio, product, and counterparty levels. This is carried out through the application of limits relating to geographical spread and the size of loan relative to property value (at counterparty and portfolio levels) and the concentration of borrowers in each risk band. The following table sets out the relevance of credit concentrations to the Group. Risk Relevance to VM

Counterparty The mortgage or cards portfolios do not suffer from concentrations relating to single names due to the granularity of retail exposures. Virgin Money sets risk appetite for and monitors wholesale credit concentrations on both individual counterparties and on countries of exposure.

Sector VM is not exposed to sector concentration other than through its retail operations as there is no Corporate or Commercial lending. Concentration risk for our retail book is assessed through non-international diversification and regional geographic concentration.

Geographic VM is a UK based retail bank that lends only in the UK market. The mortgage and credit card portfolios are geographically diversified across the UK.

Credit Risk Mitigation VM has exposure to this risk through the secured credit portfolio. This risk is assessed as part of our IRB modelling approach.

Large indirect credit exposures such as single collateral issuer

VM may have exposure to the UK government as a guarantor through the Help to Buy scheme.

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5.4 Credit risk exposures For the purposes of these disclosures, credit exposure for the IRB portfolios refers to the calculated Exposure at Default (EAD). The EAD calculation includes amounts where customers have contractual rights to draw down further balances and estimates of interest accruals to the point of default. The following table sets out the exposures for the various types of asset held by Virgin Money at 31 December 2013, and the average exposures during the year.

Exposure at 31

December 2013 RWAs at 31

December 2013 Average

RWA Average exposure

in period £m £m % £m IRB

Retail exposures secured by real estate collateral 21,685.1 3,854.6 17.8 20,192.0

Standardised Retail exposures secured by real estate collateral 12.2 4.7 38.8 13.2

Other retail exposures 789.9 592.4 75.0 694.1

Past due items 4.0 4.0 100.0 5.3 Central Governments and Central Banks 2,350.5 - 0.0 2,279.0

Multilateral development banks 415.9 - 0.0 469.7

Institutions 951.0 227.8 24.0 980.6

Local authorities - - 0.0 -


Covered Bonds 46.8 4.7 10.0 38.8

Other 539.6 211.9 39.3 283.8

Total standardised 5,209.2 1,065.4 20.5 4,862.2 26,894.3 4,920.0 18.3 25,054.2

Exposure at 31

December 2012 RWAs at 31

December 2012 Average

RWA% Average exposure

in period £m £m % £m IRB

Retail exposures secured by real estate collateral 18,571.2 3,062.6 16.5 17,128.0


Other retail exposures 0.1 - 75.0 0.1 Past due items - - 100.0 - Central Governments and Central Banks 2,344.8 - 0.0 2,661.0

Multilateral development banks 505.1 - 0.0 544.9

Institutions 1,452.0 574.2 39.5 1,438.2

Local authorities - - 0.0 0.4


Covered Bonds 5.7 0.6 10.0 1.1

Other 223.8 206.1 92.1 202.9

Total standardised 4,599.3 798.3 16.1 4,953.3 23,170.5 3,860.9 17.5 22,081.3

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5.5 Geographical distribution of exposures The tables below give details of the geographical distributions of exposures at 31 December 2013 and 31 December 2012.

2013

UK Europe Rest of Total

the World £m £m £m £m

IRB

Retail exposures secured by real estate collateral 21,685.1 - - 21,685.1 Standardised

Retail exposures secured by real estate collateral 12.2 - - 12.2 Credit cards and other retail exposures 789.9 - - 789.9 Past due items 4.0 - - 4.0 Central Governments and Central Banks 2,250.4 100.1 - 2,350.5

Multilateral development banks - 300.2 115.7 415.9 Institutions 345.4 280.2 325.4 951.0

Securitisation positions 96.2 - 3.1 99.3 Covered Bonds 46.8 - - 46.8

Other 363.5 - 176.1 539.6 25,593.5 680.5 620.3 26,894.3

2012

UK Europe Rest of Total

the World £m £m £m £m

IRB

Retail exposures secured by real estate collateral 18,571.2 - - 18,571.2

Standardised

Retail exposures secured by real estate collateral 15.6 - - 15.6

Other retail exposures 0.1 - - 0.1

Past due items - - - -

Central Governments and Central Banks 2,244.7 100.1 - 2,344.8

Multilateral development banks - 378.9 126.2 505.1

Institutions 423.1 103.5 925.4 1,452.0

Securitisation positions 47.7 - 4.5 52.2

Covered Bonds 5.7 - - 5.7

Other 210.9 - 12.9 223.8 21,519.0 582.5 1,069.0 23,170.5

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5.6 Exposure by residual maturity The following tables give details of the contractual residual maturities of exposures at 31 December 2013 and 31 December 2012.

2013

Residual maturity

< 1 year 1-5 yrs > 5 years Total

£m £m £m £m

IRB

Retail exposures secured by real estate collateral 100.9 753.4 20,830.8 21,685.1

Standardised Retail exposures secured by real estate collateral 0.6 2.6 9.0 12.2 Credit cards and other retail exposures 789.5 0.1 0.3 789.9 Past due items 3.2 0.2 0.6 4.0

Central Governments and Central Banks 1,564.6 100.1 685.8 2,350.5

Multilateral development banks 68.7 293.0 54.2 415.9 Institutions 690.0 226.0 35.0 951.0

Securitisation positions - - 99.3 99.3 Covered Bonds - 46.8 - 46.8

Other 539.6 - - 539.6

3,757.1 1,422.2 21,715.0 26,894.3

2012

Residual maturity

< 1 year 1-5 yrs > 5 years Total

£m £m £m £m

IRB

Retail exposures secured by real estate collateral 82.1 719.0 17,770.1 18,571.2


Other retail exposures 0.1 - - 0.1

Past due items - - - -

Central Governments and Central Banks 1,893.0 100.1 351.7 2,344.8

Multilateral development banks 28.1 421.4 55.6 505.1

Institutions 1,160.6 234.3 57.1 1,452.0

Securitisation positions - - 52.2 52.2

Covered Bonds - - 5.7 5.7

Other 223.8 - - 223.8

3,388.3 1,477.7 18,304.5 23,170.5

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5.7 Retail Exposures – Scope of IRB models The Group’s IRB (Internal Ratings Based) Waiver Application Pack was approved by the FSA on 1 January 2010 for capital adequacy monitoring and reporting from 1 January 2010 onwards. The scope of this permission covers the retail business of retail exposures secured by real estate collateral. As at 31 December 2013, the scope of the IRB permission was the mortgage portfolio. Asset classes not falling within the scope of the Group’s IRB permission are treated under the standardised approach. 5.8 Retail Internal Ratings Based models The retail credit risk control function is responsible for the development, validation, implementation, monitoring and use of credit rating models for the Retail IRB approach. In order to ensure the integrity and independence of these models, the credit risk control function has clearly segregated duties from those responsible for originating exposures. The Credit Risk Committee (‘CRC’) has been established as the principal forum for independently overseeing the Group’s credit rating models, to ensure that the systems are producing consistent and accurate results in line with the Group’s objectives and PRA minimum requirements. The Group has extensive data histories, which have enabled it to build in-house credit rating models for the residential mortgage portfolio. These models facilitate an appropriate risk sensitive approach to risk management and capital allocation. The models determine long run average probabilities of default (PD), downturn loss given default (LGD) and exposures at default (EAD) for each segment in order to calculate expected losses and risk weighted assets. In addition, the models are used to inform risk appetite, influence lending strategy and support determination of the level of impairment provisions. The rating models group obligors into segments differentiated by a number of factors, which include product type, loan to value (LTV) and measures of affordability. For each segment a long run average PD, downturn LGD and EAD is estimated from a combination of recent and historic data. Data covering the period back to the early 1990s was utilised in the derivation of the PD, LGD and EAD.

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5.9 IRB exposures by exposure class

Retail IRB 2013 2012

£m £m

Retail exposures secured by real estate collateral 21,685.1 18,571.3

21,685.1 18,571.3 The following table details the Group’s exposures for its sole IRB exposure class of retail exposures secured by real estate collateral. These relate to exposure at default, and include all on and off balance sheet exposures.

2013

Risk Band LRA PD (%) Exposure

(£m) Downturn

LGD RWA% RWA (£m)

Average time on Book

(months)

BTL 1a 0.42% 807.7 12.97% 6.78% 54.8 27 BTL 2a 0.96% 558.0 18.34% 19.53% 109.0 23

BTL 3a 1.80% 41.9 18.91% 31.94% 13.4 95 BTL 4a 2.59% 61.7 18.86% 37.22% 23.0 96

BTL 1b 0.77% 632.5 12.86% 8.32% 52.7 35 BTL 2b 1.64% 454.4 18.41% 23.13% 105.1 28

BTL 3b 3.79% 40.8 18.95% 45.86% 18.7 96 BTL 4b 5.51% 55.5 18.47% 55.02% 30.5 95

Standard 1a 0.56% 2,842.5 7.01% 4.75% 135.1 65 Standard 2a 0.92% 4,659.3 14.31% 12.45% 579.9 48

Standard 3a 1.46% 3,399.7 18.59% 23.21% 789.0 50 Standard 4a 1.77% 1,782.9 20.93% 28.53% 508.6 49

Standard 5a 2.15% 991.9 21.80% 33.32% 330.4 80 Standard 1b 0.78% 1,139.4 6.95% 5.81% 66.2 76

Standard 2b 1.29% 1,676.1 14.37% 15.70% 263.2 58 Standard 3b 1.55% 1,270.9 18.42% 21.59% 274.3 64

Standard 4b 1.84% 721.1 20.78% 26.73% 192.7 61 Standard 5b 2.39% 500.6 20.53% 32.85% 164.5 106

Default 100.00% 48.2 29.67% 297.36% 143.5 98

Total 21,685.1 3,854.6

NB. Exposure and RWA figures shown above have been rounded to 1 decimal place.

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2012

Risk Band LRA PD (%) Exposure

(£m) Downturn

LGD RWA% RWA (£m)

Average time on Book

(months)

BTL 1a 0.43% 594.0 12.20% 6.74% 40.0 27

BTL 2a 1.02% 438.3 16.31% 15.99% 70.1 20

BTL 3a 1.82% 48.2 18.53% 34.26% 16.5 83

BTL 4a 2.65% 68.0 18.53% 37.51% 25.5 85

BTL 1b 0.80% 510.1 12.38% 8.02% 40.9 35

BTL 2b 1.69% 377.1 16.72% 21.07% 79.5 25

BTL 3b 3.70% 45.6 18.67% 42.19% 19.2 84

BTL 4b 5.59% 63.8 18.00% 55.35% 35.3 85

Standard 1a 0.57% 2,543.6 10.33% 6.68% 169.8 63

Standard 2a 0.92% 3,597.9 12.50% 10.43% 375.1 50

Standard 3a 1.47% 2,912.8 16.82% 18.91% 550.9 51

Standard 4a 1.77% 1,680.5 20.59% 26.96% 453.0 47

Standard 5a 2.15% 908.8 21.95% 33.70% 306.3 83

Standard 1b 0.79% 1,077.1 10.32% 7.74% 83.4 72

Standard 2b 1.29% 1,416.3 12.77% 13.19% 186.8 59

Standard 3b 1.56% 1,122.8 16.80% 18.51% 207.8 66

Standard 4b 1.83% 669.3 20.34% 23.02% 154.1 61

Standard 5b 2.41% 455.5 20.77% 33.68% 153.4 111

Default 100.00% 41.5 26.88% 228.84% 95.0 94

Total 18,571.2 3,062.6

NB. Exposure and RWA figures shown above have been rounded to 1 decimal place.

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5.10 IRB model performance – regulatory expected loss versus accounting actual loss Risk and capital management practices are informed and evaluated by analysis of credit loss experience and the quantitative assessment of portfolio behaviour. This analysis includes a comparison of the Expected Loss (EL) calculated by the IRB risk rating models, which influences the regulatory capital calculation1, with other reported measures of loss within financial statements prepared under IFRS. The impairment charge quantifies the movement in the impairment provision balance during the year combined with the total write-offs from the portfolio. EL represents the one-year regulatory expected loss within the portfolio calculated at a point in time. It is important to consider the difference in definition and scope of regulatory EL with measures of impairment under IFRS when comparing these metrics. Examples of such difference are summarised below:

• EL is based on long run estimates of PD over a one year outcome horizon, determined via statistical analysis of historical default experience. Impairment provisions are recognised for incurred losses at the balance sheet date. Point in time estimates of default are used in the determination of impairment provisions.

• EL uses the economic downturn calibration of the LGD component of the capital models. Impairment provisions are measured using point in time estimates of future cash flows.

• EL is based on estimates of EAD and therefore it incorporates expected future drawings of

committed credit lines, while impairment provisions are recognised in respect of financial assets recognised on the balance sheet and in respect of committed credit lines where a loss is probable.

This table shows the regulatory Expected Loss measure, compared with Actual Loss by IRB exposure class.

2013

Regulatory Expected Loss Actual Loss £m £m

Retail exposures secured by real estate collateral 45.0 2.1

2012

Regulatory Expected Loss Actual Loss £m £m

Retail exposures secured by real estate collateral 36.5 3.0

1 The excess of EL over impairment allowances is treated as a capital deduction in the composition of regulatory capital.

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5.11 IRB model performance – estimated versus actual Back-testing methodologies are applied to assess model performance. Results from these exercises have shown that our models continue to perform satisfactorily. During 2013, modelled outcomes have been close to, or higher, than actual outcomes and evidence an appropriate calibration. The PD and LGD values are outputs from our point-in-time calibrations. In conducting the PD back-testing process the model estimate is compared to the total defaults observed during the year that have emerged from the population not in default at 1 January 2013. The actual LGD value is calculated from recorded losses following repossession and subsequent sale of the property during the year. In addition, the actual LGD value is augmented with the latest LGD estimate for those defaulted accounts which are still in the workout process at the end of the period. This table shows the forecast and actual probability of default and loss given default by IRB exposure class.

2013 PD of total portfolio LGD of defaulted assets

Estimated2 Actual3 Estimated4 Actual5 % % % %

Retail exposures secured by real estate collateral 0.60 0.24 8.53 7.95

2012 PD of total portfolio LGD of defaulted assets

Estimated Actual Estimated Actual % % % %

Retail exposures secured by real estate collateral 0.60 0.29 6.34 11.08 Prior to its acquisition by Virgin Money Group, Northern Rock plc was formed through the successful legal and capital restructure of the former Northern Rock business, which took effect on 1 January 2010. At this time, the company acquired a high quality seasoned mortgage book from the former Northern Rock. Subsequent growth of the Mortgage portfolio has not been at the expense of asset quality. Mortgage asset quality has been maintained – arrears rates have fallen over the year and the indexed loan-to-value of the book has reduced to 59.8%. Levels of defaults and subsequent repossessions have been low. The AIRB models have been calibrated with an appropriate level of conservatism given the short observation period of the transferred portfolio and the small population of defaulted loans. During 2013 the observed default rates have remained significantly lower than the point in time calibrations. Over time emergent data can be used to recalibrate the PiT models to improve their alignment with the risk profile within the portfolio. Subsequently, the Group expects levels of actual and estimate to converge as the mortgage book seasons further.

2 This estimate is the output from our point-in-time model as at 01 January 2013 and is based on the total number of accounts not in default. 3 Actual default is calculated as the total of emergent defaults during 2013 measured as a proportion of the total number of accounts not in default at 01 January 2013. 4 This estimate is the exposure weighted output from our point-in-time model as at 01 January 2013 and is based on the total default population at that time. 5 This value is calculated from accounts in default at 01 January 2013. The observed loss is defined as the loss following repossession and subsequent sale of the property within the year. This value uses the latest LGD estimate to determine the percentage of loss for those defaulted accounts which are still in the workout process at the end of the period.

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5.12 Credit impairment

Retail credit portfolios are reviewed regularly to determine whether there is any objective evidence of impairment. Retail assets are assessed for impairment provisions where:

• there is evidence of the customer experiencing significant financial difficulty;

• there is a breach of contract, such as default or delinquency in interest or principal repayments;

• the borrower enters bankruptcy or other financial reorganisation;

• there are adverse changes in the payment status of borrowers; or

• the customer is granted a concession for reasons of financial difficulty that would otherwise not be considered.

Virgin Money does not currently permit customers to capitalise mortgage arrears by increasing the principal balance of the loan and therefore considers there are no restructured accounts. Type of impairment assessment

Description

Individual impairment

Where the Group has taken possession of borrowers’ property or where specific circumstances indicate that a loss is likely to be incurred. For example, fraud cases would result in an individual impairment assessment being undertaken.

Collective impairment

Impairment allowances are calculated for each portfolio on a collective basis, given the homogenous nature of the assets in the portfolio. Accounts segmentation considers the probability of default, the roll rate experience from default to possession and write-off, and the value of collateral held.

Virgin Money has amended its approach to the categorisation of assets by credit quality. The categorisation of secured assets is detailed in the table below. Secured credit risk categorisation

Description

Arrears Where the customers payment shortfall exceeds 1% of the current monthly contractual payment amount.

Neither past due nor impaired

Loans that are not in arrears and which do not meet the impaired asset definition. This segment can include assets subject to forbearance solutions.

Neither past due nor impaired but in forbearance

Loans that are categorised as neither past due nor impaired, but are currently subject to one of the defined forbearance solutions.

Past due but not impaired

Loans that are in arrears or where there is objective evidence of impairment, but the asset does not meet the definition of an impaired asset as the expected recoverable amount exceeds the carrying amount.

Impaired assets Loans that are in arrears or where there is objective evidence of impairment, including changes in customer behaviour or circumstances, and where the carrying amount of the loan exceeds the expected recoverable amount. All fraud and operational risk loans are categorised as impaired irrespective of the expected recoverable amount.

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Virgin Money works with customers who have difficulty paying their mortgages, and will only repossess a property when all other possibilities have been exhausted. Work is carried out with customers to understand the cause of their payment difficulties, and an assessment of their income and expenditure is performed to help them find the most appropriate, affordable and sustainable solution. Depending on their personal circumstances, customers can be offered the following range of options:

• arrangement to pay less than the contractual payment;

• conversion to an interest only mortgage;

• extension of the original mortgage term;

• a discretionary payment holiday; or

• repayment arrangements with customers where the agreed mortgage term has expired but the loan has not been repaid in full.

These assets are recognised as forborne on the basis that:

• they are currently benefiting from a forbearance solution, i.e. payment arrangements less than the contractual payment or a loan that has expired but has not been repaid in full; or

• the customer has benefited from a permanent change to their contractual terms within the past twelve months, i.e. conversion to an interest only method of repayment, an extension to their mortgage term or a discretionary payment holiday.

Provisioning methodology for mortgage loans benefiting from a forbearance solution reflects the latest performance on these accounts. Once an asset is no longer recognised as forborne it will return to the appropriate credit quality category. At 31 December 2013 residential mortgage loans of £306.5m (2012: £300.1m) that are neither past due nor impaired had benefited from forbearance. The impairment methodology recognises the use of forbearance and these mortgage loans attract a higher level of impairment provision when compared to the rest of the up to date portfolio.

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5.13 Impairments by exposure class The table below indicates the level of impaired and past due exposures by exposure class, and of the levels of provisions against them at 31 December 2013.

2013

Impaired Past due but Impairment

exposures not impaired provisions

£m £m £m

Retail exposures secured by real estate collateral 97.6 190.8 7.6

Credit cards 26.6 - 27.0

Other retail exposures - - 0.1

124.2 190.8 34.7

2012

Impaired Past due but Impairment

exposures not impaired provisions

£m £m £m

Retail exposures secured by real estate collateral 147.0 157.2 7.7

Other retail exposures - - 0.1

147.0 157.2 7.8 Exposures quoted above are before provisions, and exclude assets of Church House Trust Limited which have been classified as held for sale within a disposal group. Please see note 15 of the Annual Report and Accounts for further information. Impairment allowances held in relation to secured loans and advances have reduced slightly over the reporting period. This movement is despite significant portfolio growth, and reflects positive house price index movements and a reduction in the value of loans in the portfolio that were categorised as past due or impaired. 5.14 Geographical distribution of impairments All impairment charges relate to exposures within the UK.

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5.15 Movements in impairment provisions Movements in impairment provisions in 2013 are detailed in the following table.

Retail mortgages

£m

Credit cards

£m

Other retail exposures

£m

Total

£m Impairment provisions At 1 January 2013 (per accounts) 7.7 - 0.1 7.8 Increase in provision during year net of recoveries 2.1 48.6 - 50.7 Amounts written off during the year (2.2) (21.6) - (23.8) At 31 December 2013 (per accounts) 7.6 27.0 0.1 34.7 Impairment provisions associated with disposal group 0.2 - - 0.2 At 31 December 2013 (total Group) 7.8 27.0 0.1 34.9

Retail

mortgages £m

Other retail exposures

£m Total

£m Impairment provisions

At 1 January 2012 0.3 - 0.3

Acquired through business combinations 6.5 0.1 6.6

Increase in provision during year net of recoveries 3.0 - 3.0

Amounts written off during the year (1.9) - (1.9)

Transferred to disposal group (0.2) - (0.2)

At 31 December 2012 (per accounts) 7.7 0.1 7.8 Impairment provisions associated with disposal group 0.2 - 0.2

At 31 December 2012 (total Group) 7.9 0.1 8.0

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5.16 Wholesale exposures by credit rating The allocation of capital to credit risk within the Treasury investment book is calculated under the standardised approach as per PRA regulations. For these exposures the Group uses credit ratings provided by the recognised credit rating agencies Standard and Poor’s, Moody’s and Fitch. Exposure by credit grading of the Group’s treasury exposures is as follows:

2013

Exposure value by external rating

Unrated AAA to

AA- A+ to A- BBB+ to

BBB- Total

£m £m £m £m £m

Central Governments and Central Banks - 2,350.5 - - 2,350.5

Multilateral development banks - 415.9 - - 415.9

Institutions - 357.6 591.0 2.4 951.0

Securitisation positions - 90.3 9.0 - 99.3

Covered Bonds - 46.8 - - 46.8

Other assets 203.9 - 335.7 - 539.6 203.9 3,261.1 935.7 2.4 4,403.1

2012

Exposure value by external rating

AAA to AA- A+ to A- BBB+ to BBB- Total

£m £m £m £m

Central Governments and Central Banks 2,344.8 - - 2,344.8

Multilateral development banks 505.1 - - 505.1

Institutions 195.9 1,255.6 0.5 1,452.0

Securitisation positions 52.2 - - 52.2

Covered Bonds 5.7 - - 5.7

3,103.7 1,255.6 0.5 4,359.8 Other assets include repos of £335.7m (2012 £nil) with externally rated counterparties. All other exposures are not rated by credit agencies. Credit ratings are based on the specific obligor the Group is exposed to, as is required under BIPRU. This is not directly comparable to ratings used in the Group’s Annual Report and Accounts, which reflect ratings of the obligor of ultimate risk, i.e. the parent rather than the subsidiary.

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5.17 Counterparty credit risk relating to derivatives The following table sets out the gross positive fair value of derivatives contracts, and the potential credit exposures, at 31 December 2013.

2013 2012 £m £m

Gross positive fair values of contracts 187.5 161.0 Netting with gross negative fair value of derivative contracts (103.7) (159.7) Potential future incremental exposure 63.2 31.6

Collateral received (78.7) (0.7)

Net OTC derivative exposures 68.3 32.2 Counterparty credit risk (CCR) is the risk that the counterparty to a derivative transaction could default during the life of the transaction. The duration of the derivative and the credit quality of the counterparty are both factored into the internal capital and credit limits for counterparty credit exposures. CCR is monitored daily by the Wholesale Credit Risk team and reported to Treasury Risk Committee (TRC) monthly. TRC is a sub-committee of the Risk Management Committee (RMC) and receives monthly updates on CCR. Under the Group’s Internal Liquidity Requirement a two notch ratings downgrade could result in the Group being required to post additional collateral. The Group measures exposure value on counterparty credit exposures under the CCR mark to market method. This exposure value is derived by adding the gross positive fair value of the contract (replacement cost) to the contracts potential credit exposure, which is derived by applying a multiple based on the contracts residual maturity to the notional value of the contract. Wrong way risk occurs where exposure to a counterparty is adversely correlated with the credit quality of that counterparty. The Group has no such exposure, as it has no appetite for credit derivative positions which are the key drivers of such a risk.

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5.18 Credit risk mitigation 5.18.1 Retail exposures Of the Group’s retail exposures at 31 December 2013, over 96% were secured on residential property. The credit card portfolio and overdrafts from current accounts made up the remainder of retail exposures. The indexed average loan to value ratio of the mortgage book at the end of 2013 was 59.8%. Details of the fair value of the property collateral held against the assets held in the retail credit portfolio are provided in the table below.

Fair value of collateral against secured loans – capped at loan value

2013

Residential mortgage

loans

Residential buy-to-let

mortgage loans

Total

£m % £m % £m %

Neither past due nor impaired 16,937.3 100.0 2,345.6 100.0 19,282.9 100.0

of which in receipt of forbearance 297.6 99.9 8.7 100.0 306.3 99.9

Past due but not impaired 173.2 99.9 17.5 100.0 190.7 99.9

Impaired 88.8 98.7 7.6 100.0 96.4 98.8

of which in possession 2.6 92.9 0.0 100.0 2.6 92.9

Total 17,199.3 100.0 2,370.7 100.0 19,570.0 100.0

Collateral held in relation to secured loans is capped to the amount outstanding on an individual loan basis. The percentages in the table above represent the value of collateral, capped at loan amount, divided by the total loan amount in each category. Fair value of collateral against secured loans – capped at loan value

2012

Residential mortgage

loans

Residential buy-to-let

mortgage loans

Total

£m % £m % £m %

Neither past due nor impaired 14,618.1 100.0 1,841.8 100.0 16,459.9 100.0

of which in receipt of forbearance 293.4 99.9 6.5 100.0 299.9 99.9

Past due but not impaired 146.8 100.0 10.4 100.0 157.2 100.0

Impaired 133.3 99.3 12.7 100.0 146.0 99.3

of which in possession 2.9 100.0 0.0 100.0 2.9 100.0

Total 14,898.2 100.0 1,864.9 100.0 16,763.1 100.0

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5.18.2 Treasury exposures Credit Support Annexes (CSAs) exist for collateralising derivative transactions with counterparties to which the Group has its derivative exposures in order to mitigate the risk of loss on default. The CSAs allow margin calls to be made on the net mark to market value of derivative exposures with a particular counterparty. All collateral held or paid under the CSAs is in the form of cash. These CSAs are taken into consideration when setting the internal credit risk limits for derivative counterparties. As permitted under the standardised approach, the Group recognises the risk mitigating effect of these CSAs in its Pillar 1 capital calculations. At 31 December 2013, cash collateral of £78.7m (31/12/12 £0.7m) was held in relation to CSAs.

For repo transactions, the exposure value applied to the counterparty is that of the full nominal value of the haircut, increased by cash collateral posted by VM and reduced by cash collateral posted by the counterparty under the relevant Global Master Repurchase Agreement (GMRA).

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6. Market risk 6.1 Market risk overview

Market risk is the risk that the value of, or net income arising from, Virgin Money’s assets and liabilities changes as a result of movements in interest or exchange rates. Market risk arises only as a natural consequence of carrying out and supporting core business activities. Virgin Money does not trade or make markets. Interest rate risk is the only material market risk for the Group. Virgin Money aims to reduce exposure to interest rate risk through the use of natural offsetting and derivatives.

Risk type Description Cause

Interest Rate Risk

in Banking Book

The risk that the value of, or net income arising

from, assets and liabilities changes as a result

of movements in interest rates.

Changes in interest rates having

adverse effects on the Group’s

balance sheet or income.

Foreign

Exchange

The risk that the value of, or net income arising

from, assets and liabilities changes as a result

of movements in exchange rates.

Difference in assets and liabilities

denominated in currencies other than

Pounds Sterling.

Significant events and environment The Funding for Lending Scheme (FLS) and the stabilisation of peripheral economies in Europe have supported a reduction in funding costs, while also lowering margins on mortgages. 6.2 Market risk management

Interest rate risk

The principal sources of interest rate risk that affect the Group are measured through sensitivity to changes in interest rates in a stressed environment. Virgin Money is exposed to the following types of interest rate risk, each separately measured through sensitivity analysis considering relevant historic tail events

Segments Description Interest rate mismatch risk

Exposure to changes in interest (swap) rates and volatilities on cash instruments and derivatives.

Basis risk Measures the impact of changes in Interest rate tenor basis (e.g. the basis between swaps vs. 3M LIBOR and swaps vs. 6M LIBOR) and cross currency basis.

Pipeline risk Arises from two key elements. 1. Mortgage and fixed-rate bond applications do not match forecast volumes. 2. The conversion rate from application to completion is different from that forecast. In both cases, Virgin Money assesses the risk that a movement in underlying market rates causes its products to be more or less competitive than expected.

Optionality Driven by fixed-rate mortgage sales. Early redemptions charges for mortgages are designed to mitigate this risk.

Asset/swap spread

Impact of changes to the swap spread i.e. the difference between swap rates and government bond yields

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6.3 Capital at risk (CaR) Capital at risk (CaR) is considered for assets and liabilities in all interest rate risk repricing periods. This is expressed as the present value of the negative impact of the sensitivity test on the Group’s capital position.

Capital at risk 2013 2012

£m £m

Interest rate mismatch risk (5.7) (2.3)

Basis risk 1.5 1.2

Pipeline risk 20.8 15.8

Optionality risk 17.4 19.2

Asset swap risk 0.1 0.8

Total interest rate risk – capital at risk 34.1 34.7

6.4 Earnings at risk (EaR) Earnings at risk (EaR) is considered for assets and liabilities on the balance sheet over a 12 month period. This measure is expressed as the adverse change to net interest income.

Earnings at risk 2013 2012 £m £m

Interest rate mismatch risk (0.1) (0.7)

Basis risk 1.5 1.2

Pipeline risk 8.8 9.6

Optionality risk 5.0 5.2

Total interest rate risk – earnings at risk 15.2 15.3

Capital and earnings at risk have remained flat in 2013, as a result of the Group’s hedging strategy for the management of market risk.

The capital and earnings at risk are based on a parallel stress to interest rates across all tenors. Virgin Money recognise that a parallel interest rate stress has inherent limitations and supplement this methodology with additional balance sheet limits.

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6.5 Foreign exchange risk Currency risk arises as a result of having assets, liabilities and derivative items denominated in currencies other than sterling as a result of banking activities, including wholesale funding.

The Group has a minimal appetite for foreign exchange risk but does allow the purchase of denominated assets in both US dollars and Euros within a well controlled limit framework. The exposure to changes in exchange rates is minimised by using cross-currency swaps and forward foreign exchange contracts.

At 31 December 2013 Virgin Money had negligible net foreign exchange risk positions after taking into account foreign currency derivatives.

Asset and liabilities in euros at sterling carrying values 2013 2012

£m £m

Assets

Loans and advances to banks 0.1 0.1

Investment securities 20.7 20.3

Other assets - 0.1

Total assets 20.8 20.5

Other liabilities - -

Total liabilities - -

Notional value of derivatives affecting currency exposures 20.8 20.4

Net position - 0.1

6.6 Market risk capital requirements Virgin Money’s market risk is limited to its foreign exchange exposure which is immaterial and as such its Pillar 1 market risk capital requirement was less than £10,000 at the end of both 2012 and 2013.

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7 Funding & liquidity risk 7.1 Funding & liquidity risk overview Virgin Money’s appetite for liquidity risk is assessed as the ability to survive a variety of severe but plausible events. This risk is managed by maintaining liquid resources in adequate quantity and quality to meet estimated outflows should an event of this nature occur. This objective is supported by a limit structure set out in the Funding and Liquidity Policy approved by the Board.

Sound funding risk management reduces the likelihood of liquidity risks occurring through minimising re-financing concentration.

Risk type Description Cause

Liquidity risk

The inability to accommodate liability maturities and withdrawals, fund asset growth, and otherwise meet contractual obligations to make payments as they fall due.

Depositors and creditors lose faith in the Group’s ability to repay its obligations in full.

Funding risk

The inability to raise and maintain sufficient funding in quality and quantity to support the delivery of the business plan.

A deterioration of the Group’s credit rating, asset quality or reputation preventing it from refinancing maturing term debt or term deposits.

7.2 Significant events/environment During the financial year, building societies and banks, including Virgin Money, increased their usage of the Bank of England and HM Treasury’s Funding for Lending Scheme (FLS). Financial services firms have been able to fund lending activities through FLS, reducing the cost of retail funding.

In addition, the Bank of England announced changes to the Sterling Monetary Framework to improve banks’ and building societies’ access to funding and liquidity. It is expected that these changes will allow the financial services industry to diversify its sources of funding further while reducing any stigma attached to the use of existing emergency funding facilities. 7.3 Liquidity risk management Compliance with minimum liquidity requirements is assessed daily, with the forecast position reported to management committees at least fortnightly and to the Board. 7.4 Liquid resources Liquid assets are managed by Group Treasury in line with the Group investment strategy and Wholesale Credit Risk Policy. These comprise core liquid assets, namely funds held at the Bank of England reserve account, UK and other high quality government securities and securities issued by supranational organisations; together with non core liquid assets, namely certificates of deposit, RMBS, covered bonds, and floating rate notes.

The Group also holds AAA-rated notes issued under the Gosforth mortgage-backed funding programme. These self-issued securities represent eligible collateral for use in repurchase agreements with third parties or with the Bank of England.

In addition, the Group pre-positions whole mortgage loan pools at the Bank of England which represent eligible collateral for use in its discount window facility (DWF) and the FLS.

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Through policy limits on the quality and diversity of the liquid asset portfolio, Virgin Money aims to ensure that there are no material limitations to the use of the liquid asset buffer in stressed market conditions. 7.5 Funding risk management At the highest level, funding risk is governed by risk appetite which sets limits on the mix of funding sources and their maturity profile. A medium-term funding plan is prepared annually, or more frequently if required, to support the business plan.

Funding is focused on achieving a loan to deposit ratio of 100%. However, to diversify its funding sources, increase the term structure of liabilities and manage the cost of funding, the wholesale markets are also accessed. Controlling the quantity and quality of funding is therefore an essential part of funding risk management. The table at 7.6 shows assets already pledged to secure funding and further assets that are available for future encumbrance. 7.6 Asset encumbrance position Virgin Money’s assets can be used to support collateral requirements for central bank operations or third-party repurchase transactions. Assets that have been set aside for such purposes are classified as ‘encumbered and pledged assets’ and cannot be used for other purposes. ‘Other encumbered assets’ are assets that cannot be used for secured funding due to legal or other reasons. These include cash reserves supporting secured funding structures. All other assets are defined as ‘unencumbered assets’. These comprise assets that are readily available to secure funding or to meet collateral requirements, and assets that are not subject to any restrictions but are not readily available for use. As shown in the table below, the Group has grown its mortgage assets that are currently unencumbered and available as collateral. Loans and advances to customers are classified as available collateral only if they are already in such a form that they can be used immediately to raise funding.

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In addition to the above, self issued notes are held which can be used to raise funding through third-party sale and repurchase agreements.

Asset encumbrance Encumbered assets Unencumbered assets Total 2013 Pledged as

collateral Other Available as

collateral Other £m £m £m £m £m

Cash and balances at central banks 35.1 - - 1,388.4 1,423.5 Investment securities 313.5 100.0 1,275.1 - 1,688.6 Derivative financial assets - - - 187.5 187.5 Loans and advances to banks1 - 626.9 - - 626.9 Loans and advances to customers1 4,291.9 2,355.7 13,703.6 20,351.2 Other assets - - - 291.1 291.1 Total assets 4,640.5 726.9 3,630.8 15,570.6 24,568.8

Asset encumbrance Encumbered assets Unencumbered assets Total 2012 Pledged as

collateral Other Available as

collateral Other £m £m £m £m £m

Cash and balances at central banks 18.3 - - 1,586.2 1,604.5

Investment securities 127.5 200.0 1,121.8 85.0 1,534.3

Derivative financial assets - - - 161.0 161.0

Loans and advances to banks1 - 1,310.2 - - 1,310.2

Loans and advances to customers 5,375.5 - 808.0 10,577.6 16,761.1

Other assets1 - - - 460.3 460.3

Total assets 5,521.3 1,510.2 1,929.8 12,870.1 21,831.4

The Group increased its assets available as collateral to increase its liquidity pool. Loans and advances to banks at the end of 2012 include assets held for the purchase of the credit card portfolio.

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8. Operational and conduct risk 8.1 Operational risk overview The Group defines operational risk as "the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events". This is in line with the Basel Committee's definition of operational risk. In managing operational risk, the Group considers indirect financial costs and regulatory, reputational and customer impacts. During 2013, the Group moved to the Standardised Approach (TSA) to calculate its Pillar 1 operational risk requirement. Prior to this, the Group operated under a waiver from the PRA, allowing it to adopt a combined approach, applying both basic Indicator (BIA) and TSA calculations. This recognised the fact that Virgin Money (a BIA Group) acquired Northern Rock (a TSA bank). The Operational Risk Management Framework considers direct and indirect financial costs, regulatory and reputational impacts on the business as well as consequences for customers. The following risk categories are managed through the Operational Risk Management Framework:

Risk category

Description

Operational The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk.

Conduct The risk that our operating model, culture or actions result in unfair outcomes for customers.

Compliance The risk of regulatory sanction, material financial loss or reputational damage if the organisation fails to design and implement operational processes, systems and controls such that it can maintain compliance with all applicable regulatory requirements.

Strategic The risk of significant loss or damage arising from business decisions that impact the long term interests of our stakeholders or from an inability to adapt to external developments.

Other Financial

Other financial risk is focused primarily on pricing oversight and management of market risk. Pricing changes can inadvertently drive appetite breaches and result in unfair outcomes for our customers. Model risk can result in inappropriate models and outputs that can lead to poor business decisions being taken.

Under each of these risk categories are more specific supporting risk categories describing increasingly granular risk types. The materiality of each risk exposure is assessed by impact and likelihood, with consideration taken of financial and non financial impacts. The management of operational risk remains a priority. The scale of regulatory change coupled with the growth plans of the business has led to continued investment in and development of our risk management frameworks, systems and processes.

Virgin Money undertakes a programme of regular risk assessment and control activity which is supported by assessments of more extreme but plausible events that could occur. In the course of such risk assessment, controls may be challenged, strengthened and risks mitigated within the context of risk appetite. External events which impact other financial services companies, particularly banks, are monitored and assessed to ensure Virgin Money remains resilient and proactive in its responses.

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8.2 Significant events and environment During the year, the Group evolved the risk management framework to reflect growth in the organisation and in response to changes impacting UK financial services. In April 2013, the Standardised Approach to operational risk management across the whole organisation was adopted. This resulted in a reduction in the Pillar 1 operational risk capital requirement for 2013. To achieve the business strategy, Virgin Money has invested significantly in processes, systems, and in recruiting and training people to support new business developments. Ensuring fair outcomes for all customers is a strategic priority, and all new initiatives are subject to comprehensive risk assessment, testing and business acceptance criteria that place the customer at the heart of decision making. There have been a number of material regulatory changes during the year, for example The Financial Services Act (Regulatory Reform), Basel III/CRD IV, Consumer Credit Reform and the incoming Mortgage Market Review. The Board is focussed on responding effectively and in a timely manner to changes in the regulatory environment to ensure compliance with regulatory requirements is maintained. Virgin Money is mindful of the risks that economic uncertainty may pose to both prospective and existing customers. These risks include a search for yield by savers and affordability pressures on household budgets. Virgin Money is committed to increasing the levels of competition available to UK retail customers whilst also balancing prudential and conduct priorities. During 2013 Virgin Money established a fully independent model validation team responsible for embedding our model policy, model validation standards and the maintenance of a business wide model log. These standards ensure that regulatory requirements are met with regard to validation of internal ratings based (IRB) models and retention of our IRB waiver. The key areas of risk that have been a focus during the year include:

Topic Description

Financial Crime As a retail bank, Virgin Money is alert to the risk of external fraud. Losses to date have not exceeded expectations. Criminals continue to innovate and develop new strategies to exploit weaknesses in financial firms’ security processes and consumer behaviour. This is especially prevalent in the context of cyber crime. Virgin Money is constantly monitoring new threats and continues to invest in IT security capability whilst ensuring controls for known threats remain robust.

Information Security

Information security is also a key risk, and Virgin Money therefore has robust information security controls, including effective detective and preventative controls to minimise malicious or accidental damage. These include intrusion detection, access control, secure and up-to-date hardware and software configuration, data loss prevention, and IT network protection. The Group continues to invest in this area in response to emerging threats and to ensure controls for known threats remain robust.

Financial Reporting and Information Management

Virgin Money has invested in consolidating and simplifying its financial systems and processes, lowering the risk of error. This is expected to continue into the coming year given continued regulatory reporting requirements.

Managing Third Parties

Virgin Money works with third parties through both partnerships and outsourcing arrangements to deliver many product offerings. This has been part of the business model for a number of years and Virgin Money has a proven track record in managing these effectively, not only because of a thorough due diligence process, but also because of ongoing detailed analysis of each relationship. The oversight of these third parties ensures that customer and regulatory responsibilities are delivered consistently.

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Business Continuity Management

Virgin Money undertakes regular testing to demonstrate resilience against a disaster or material business continuity event. The level of change in the business during the year has required an increase in testing activity to prove continued systems resilience.

New/Emerging Regulation

Virgin Money is subject to a considerable amount of regulatory change initiated by UK and European regulators. This is subject to close monitoring by the business to ensure mandatory change is implemented in a well controlled and timely manner. Virgin Money has invested significantly during 2013 in response to new regulatory requirements and this is expected to continue in future years.

Significant Influence and Approved Persons (SIAP)

The regulatory landscape has evolved with regard to the expectations and responsibilities of Approved Persons. This position is expected to change further as the Banking Reform bill is brought into regulation. Virgin Money ensures that all Approved Persons are subject to robust due diligence, induction training and ongoing support to enable them to discharge these duties to best effect.

Remuneration Code

Virgin Money continues to ensure full compliance with the Remuneration code, and is conscious of the incoming European regulatory agenda in the design of any new remuneration schemes.

Product Design and Distribution

Virgin Money is committed to having simple and transparent products designed to meet the needs of targeted customer groups. The customer is placed at the heart of decision making relating to the development of new/existing products with the focus on ensuring our communications are clear, fair and not misleading and the products do not rely on terms that could be considered unfair or ambiguous.

Sales Practices and Culture

Virgin Money encourages customer facing colleagues to have the right behaviours that put the customer’s needs at the centre of each conversation. Virgin Money does not operate a sales incentive scheme but instead uses a balanced scorecard approach to ensure that customer service/satisfaction has equal weighting to sales performance. The success of Virgin Money’s business is based on establishing long term relationships with customers.

Pricing Risk Risk performs oversight of changes to pricing in two key areas. Impact analysis is carried out on any product pricing decisions to ensure that the business remains within risk appetite with particular focus on product acquisition limits. Additionally oversight of changes from a conduct and compliance perspective ensures that pricing decisions continue to treat our customers fairly and in line with regulation.

Model Risk The Independent Model Validation team oversees model risk across the Group. The model validation standards ensure effective model governance and oversight across all risk categories and functions where models are used.

Reputational Risk

Reputational risk is inherent in all risk categories where actions and incidents can affect whether people trust, and wish to do business with Virgin Money. The Virgin brand carries potential for reputational risk for Virgin Money and vice-versa. While there is no possible direct financial contagion for Virgin Money from an out-of-company event the risk is monitored closely. There is an incident management framework in place for the management of brand related issues.

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9. Securitisation 9.1 Objectives in relation to securitisation The principal objective of securitisation is to provide funding diversification, giving access to a wide range of investors in different geographic areas. Securitisation also serves to generate liquidity from different illiquid asset types, principally residential mortgage loans. During 2013, the Group has made use of the Funding for Lending Scheme (FLS), launched by the Bank of England and HM Treasury in July 2012. 9.2 Issued and retained securitisation positions Prior to its acquisition of Northern Rock plc (now Virgin Money plc), the Group did not participate in securitisation. 9.2.1 Risks inherent in the issued and retained securitisation position The principal risks that are inherent in securitised mortgage assets are as follows:

• Credit risk

• Market risk

• Liquidity risk. The Group has retained some of the Notes issued by all of the Gosforth Funding securitisation transactions as detailed in the table below. Therefore the Group maintains some of its exposure to credit risk and market risk for the securitised mortgage assets. The ratings assigned to the retained notes are as follows: Issuer Notes 31 Dec 2013

£m

Moody’s S&P Fitch

Gosforth Funding plc Class A4 0 Aaa AAA n/a

Gosforth Funding plc Class Z 0 Unrated Unrated n/a

Gosforth Funding 2011-1 plc Class M 38 Aa2(sf) n/a AAsf

Gosforth Funding 2011-1 plc Class Z 103 Unrated n/a Unrated

Gosforth Funding 2012-1 plc Class A 133 Aaa n/a AAAsf

Gosforth Funding 2012-1 plc Class M 32 Aa2(sf) n/a Aasf


Gosforth Funding 2012-2 plc Class A1b 244 Aaa n/a AAAsf

Gosforth Funding 2012-2 plc Class A2 721 Aaa n/a AAAsf



Total 1,591

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Issuer Notes 31 Dec 2012

£m

Moody’s S&P Fitch

Gosforth Funding plc Class A4 486 Aaa AAA n/a

Gosforth Funding plc Class Z 174 Unrated Unrated n/a

Gosforth Funding 2011-1 plc Class M 38 Aa2(sf) n/a AAsf


Gosforth Funding 2012-1 plc Class A 222 Aaa n/a AAAsf



Gosforth Funding 2012-2 plc Class A1b 679 Aaa n/a AAAsf

Gosforth Funding 2012-2 plc Class A2 1,021 Aaa n/a AAAsf



Total 3,075

There have been no changes to the ratings assigned to any of the notes since the date of issue. During 2013, the Group redeemed all of the remaining outstanding notes in the Gosforth Funding plc transaction. This transaction had been fully retained by the Group since it completed in 2010. Also during 2013, the Group completed the sale of £300m of class A2 notes from the Gosforth Funding 2012-2 plc transaction. The notes had been retained by the Group when the original transaction completed in November 2012. In order to mitigate market risk to which the securitised assets are exposed, the Group enters into interest rate swap agreements. 9.2.2 Participation by the Group in the Funding for Lending Scheme (FLS) At 31 December 2013 the Group had FLS drawings of £1,160m (2012 - £510m). This has been collateralised through a combination of Aaa rated retained Gosforth notes and mortgage pools pre-positioned with the Bank of England. 9.2.3 Roles played by the Group in the securitisation process The Group is the originating entity and is the sole administrator in relation to the securitised loans and has serviced the loans on the same basis as the non-securitised loans. The Group also acts as the cash manager for the transactions and operates as the basis rate swap provider and the start up loan provider. Although services of investment banks and legal advisers were utilised in originating new transactions, the management of existing securitisations is undertaken by the Group. The processes undertaken by the Group to monitor changes in the credit risk of securitised assets are described in Chapter 5, Credit Risk. The Group is under no obligation to support any losses that may be incurred by the securitisation transactions or holders of the notes issued and do not intend to provide such further support. The parties holding the notes in issue are only entitled to obtain payment of the principal and interest to the extent that the resources of the Gosforth Funding securitisation transactions are sufficient to support such payment and the holders of the notes have agreed not to seek recourse in any other form.

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9.2.4 Calculating risk weighted exposure amounts As the Group’s securitisations have not been undertaken in order to obtain a capital benefit, the Group does not exclude securitised exposures from its calculation of risk weighted exposures and expected losses. Risk weighted exposures and expected losses at 31 December 2013 for issued and retained securitised assets are calculated within the capital calculation of the overall mortgage portfolio, in line with the PRA Handbook under the IRB approach. 9.2.5 Accounting policies for issued and retained securitisation activities Certain Group companies have issued debt securities in order to finance specific loans and advances to customers. Both the debt securities in issue and the loans and advances to customers remain on the Group balance sheet within the appropriate balance sheet headings unless:

• a fully proportional share of all or of specifically identified cash flows have been transferred to the holders of the debt securities, in which case that proportion of the assets are derecognised;

• substantially all the risks and rewards associated with the assets have been transferred, in which case the assets are fully derecognised; or

• a significant proportion of the risks and rewards have been transferred, in which case the assets are recognised only to the extent of the Group’s continuing involvement.

The Group has also entered into self-issuance of securitised debt which may be used as collateral for repurchase or similar transactions. Investments in self-issued debt and the equivalent deemed loan, together with the related income, expense and cash flows, are eliminated on consolidation in the financial statements

Issued securities are classified as liabilities where the contractual arrangements result in the Group having an obligation to deliver either cash or another financial asset to the security holder, or to exchange financial instruments under conditions that are potentially unfavourable to the Group. Issued securities are classified as equity where they meet the definition of equity and confer a residual interest in the Group’s assets on the holder of the securities. Financial liabilities are carried at amortised cost using the effective interest rate method. Equity instruments are initially recognised at net proceeds, after deducting transaction costs and any related income tax. Appropriations to holders of equity securities are deducted from equity, net of any related income tax, as they become irrevocably due to the holders of the securities. Securitisation is a means used by the Group to fund an element of its mortgage portfolio. These securitised advances are subject to non-recourse finance arrangements. These advances have been transferred at their principal value to Special Purpose Entities (“SPEs”) and have been funded through the issue of amortising mortgage backed securities to investors. The Group consolidates the assets and liabilities of the securitisation SPEs, on a line by line basis. Mortgages eligible for future securitisations are held in the Group’s non-trading book and are at amortised cost using the effective interest method, less any provision for impairment. Loan note assets (classified as investment securities) and the deemed loan liabilities between Virgin Money plc and the SPEs are disclosed separately in the financial statements. The SPEs have entered into a basis rate swap with Virgin Money plc. The derivative is recognised at fair value on the balance sheet, with fair value movements being recorded in the income statement. Fair values are obtained from quoted market prices in active markets and, where these are not available, from valuation techniques including discounted cash flow models. Gosforth Funding 2012-1 plc and Gosforth Funding 2012-2 plc have designated from inception to hold the deemed loan at fair value on the balance sheet, with changes in value being recorded in the income statement.

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During the year, the Group sold £0.3 billion of the Gosforth Funding 2012-2 plc Class A2 notes. The Class A2 notes were not issued to investors when the original transaction completed in November 2012 but were retained by the Group. The notes were offered publicly in October 2013 and sold at a premium to face value. This premium is being accreted in the profit and loss account of the Group over the expected life of the notes. 9.2.6 External Credit Assessment Institutions used for securitisations The Group utilises the services of several External Credit Assessment Institutions (ECAIs) including Moody’s and Fitch to rate the securitisation transactions in issue. The ratings assigned assess the ability of the structure to allow for the timely payment of interest and the ultimate payment of principal of each of the rated notes. As part of the ratings process each of the agencies is committed to ongoing transaction monitoring to ensure that, in their view, the assigned ratings remain an appropriate reflection of the issued notes' credit risk. 9.2.7 Exposures securitised by the Group All securitisation exposures are held within the non-trading book of the Group.

The following analysis of past due exposure details loans in arrears for each of the securitisation transactions, losses during the year and the book value of impaired assets included within each of the SPEs.

2013 Balance sheet value £m

Impaired and past due £m

Losses £m

Retail mortgages 2,885.6 24.7 0.03

Total 2,885.6 24.7 0.03

2012 Balance sheet value £m

Impaired and past due £m

Losses £m

Retail mortgages 5,375.5 46.7 0.1

Total 5,375.5 46.7 0.1

As at 31 December 2013 the total outstanding externally issued securitisation debt was £1,472m (2012 - £2,279m). This value represents the sterling equivalent taking into account the cross currency swaps in place and does not agree directly to the accounting disclosures in the Group Annual Report and Accounts which take into account movements in currency rates and fair values of the swaps. It is considered appropriate to disclose the exposures in terms of their economic value which represents the true exposure of the Group rather than their accounting value. As at 31 December 2013 the total outstanding retained securitisation debt was £1,590.6m. (2012 - £3,075m). All retained securitisation debt is in sterling and is detailed in the table within section 9.2.1. As at 31 December 2013 there are no assets awaiting securitisation (2012 Nil). 9.2.8 Securitisation activity during 2013 and 2012 The Group undertook no securitisations during the year. During the year ended 31 December 2012, under the securitisation programme established in 2010, the Group, under the headings of Gosforth Funding 2012-1 plc and Gosforth Funding 2012-2 plc, undertook the issuance of listed residential mortgage backed securities to the value of £1,068m in July 2012 and £2,935m in November 2012. Of the £4,003m securities issued, securities totalling £2,302m were retained by the Group.

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9.2.9 Synthetic securitisations The Group has no synthetic securitisation transactions. 9.3 Purchased securitisation positions 9.3.1 Risks inherent in the purchased securitisation position The principal risk that is inherent in the Group’s purchased securitisation positions is credit risk. The following table gives details of the positions in the securitised exposures of other issuers purchased by the Group and held at 31 December.

Risk weighting 2013

£m 2012

£m

20% (Credit Rating of AA- or higher) 99.3 52.2

99.3 52.2

9.3.2 Roles played by the Group in the securitisation process The Group is an investor that acquires SPV positions originated by non-Group entities as part of its balance sheet management activities. 9.3.3 Calculating risk weighted exposure amounts Risk weighted exposures reported for purchased securitised assets at 31 December 2013 are calculated in line with the PRA handbook under the standardised approach. 9.3.4 Accounting policies for purchased securitisation positions The Group’s investments in SPV positions originated by non-Group entities are designated as either available for sale or loans and receivables. Investment securities are principally available for sale as they are intended to be held for an indefinite period of time but may be sold in response to a need for liquidity or changes in interest rates, exchange rates or equity prices. Investment securities classified as loans and receivables are asset backed securities for which there is no quoted market price. Investment securities classified as available for sale are measured initially at fair value including direct and incremental transaction costs. Fair values are obtained from quoted prices in active markets and, where these are not available, from valuation techniques including discounted cash flow models. Subsequent measurement is at fair value, with changes in fair value being recognised in other comprehensive income except for impairment losses and translation differences, which are recognised in profit or loss. Upon derecognition of the asset, or where there is objective evidence that the investment security is impaired, the cumulative gains and losses recognised in other comprehensive income are removed from other comprehensive income and recycled to profit or loss. Investment securities classified as loans and receivables are recognised initially at fair value less any provision for impairment including direct and incremental transaction costs. Subsequent recognition is at amortised cost using the effective interest rate method, less any provision for impairment.

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10. Remuneration 10.1 Approach to remuneration Virgin Money’s Group Remuneration Policy was designed to comply with the Prudential Regulation Authority’s Remuneration Code (the Code). Virgin Money will not adopt remuneration policies and practices which are not consistent with the letter and the spirit of the Code. Through this Remuneration Policy, colleagues are provided with remuneration packages which encourage them to contribute to the success and profitability of the business in a meaningful and well balanced way, which discourages colleagues from inappropriate risk-taking. This supports Virgin Money’s aim of treating customers fairly while protecting the Group’s long term financial stability. The Code Staff population in 2013 totalled 62 which includes all Executive Directors (it also includes 25 part-year Code staff). Virgin Money operates a proportional approach to the identification of Code Staff as required by the Code. The remuneration for these colleagues is governed under the Remuneration Policy. 10.2 The Remuneration Committee The Remuneration Committee of the board of directors of the Company (the Committee) is responsible for determining and recommending to the Board for approval a Group Remuneration Policy and framework. The Committee undertakes an annual review of the Remuneration Policy to ensure continued compliance and alignment with the Remuneration Code. The Committee determines the remuneration of the Chairman and each member of the Executive Team, including entitlements under share incentive plans, pension entitlements and any compensation payments. During 2013 the Committee consisted of the Company Chairman and two independent non-Executive Directors. The individuals are also members of the board of directors of Virgin Money plc and Church House Trust Limited. The Committee members during the year were:

• Mr C D Keogh (Chairman)

• Mr N C McLuskie

• Sir D C Clementi

Only members of the Committee have the right to attend and vote at Committee meetings. However, other individuals (such as the CEO and the People Director) are invited to attend meetings when appropriate or necessary but are excluded from discussions relating to their own remuneration arrangements. The Committee may take external professional advice. During 2013, the Committee obtained external remuneration advice from PricewaterhouseCoopers and Macfarlanes.

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The Committee meets at least quarterly, but more frequently, if required. The Committee met on ten occasions during 2013. During 2013 the Committee considered the following remuneration matters:

• 2012 incentive funding based on audited accounts

• risk adjustment and malus consideration for deferred remuneration

• approach to variable pay deferral instruments

• approach to an all employee share award

• remuneration policy statement and Code Staff review

• consideration of the implications of the Capital requirements Directive IV

• approval of all senior appointments.

10.3 Design characteristics of the remuneration system Salaries and total remuneration of colleagues are benchmarked against the financial services market using relevant external data to ensure that it is competitive and in line with the market rate for the size, nature and complexity of the Group. The variable remuneration arrangements are also externally benchmarked to ensure that they are competitive and are designed to encourage colleagues to take a longer term view and eradicate inappropriate risk taking. The variable incentive arrangements have appropriate limits (as a proportion of basic salary) and, for senior colleagues and Code Staff, are subject to deferral in line with the Code to promote longer term risk awareness. The proportion of variable pay to be deferred is set to encourage colleagues to take a longer-term view. The ultimate release of deferred amounts is governed by a robust risk assessment framework. In line with the Remuneration Code requirements, bonus deferral is a key risk management and retention tool for senior management colleagues and Code Staff. Both clawback and malus provisions can be applied by the Committee both during and after any relevant performance period to adjust (including to nil) any variable pay awarded, paid or deferred. Such adjustments could be made if:

• there is reasonable evidence of employee misbehaviour or material error;

• the firm or the relevant business unit suffers a material downturn in its financial performance; or

• the firm or the relevant business unit suffers a material failure of risk management.

The above principles apply to all variable pay. The Committee retains overall discretion to determine whether any adjustment is required and what level of adjustment is appropriate. 10.4 Link between pay and performance and the performance criteria used Colleagues are appraised annually for their entire role, the behaviours they exhibit, the achievement of the objectives they are set and their competencies. This holistic appraisal drives variable pay awards and any future pay increases.

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For annual bonuses, performance is measured principally by the Board using a balanced scorecard, combining financial and non-financial metrics for the Company and each individual function. This encourages compliance and awareness of long-term risk and its relationship with remuneration and reward, balanced with protecting the Company’s capital position. Non-financial performance metrics form part of the assessment process and include effective risk management and compliance with Remuneration Code requirements. The following metrics and criteria were used by the Committee to determine the size of the variable remuneration pool: 1. The Committee considered the PBT performance for the financial year 2. The Committee reviewed underlying business performance against the corporate scorecard to

ensure that the outcomes are appropriate 3. The Chief Risk Officer provided the Committee with an independent risk assessment report of

overall performance 4. The People Director provided the Committee with a risk assessment of individual performance

to identify any significant individual risk breaches and any instances when the operation of the malus provisions might be appropriate.

In addition, the malus and clawback provisions referred to above can be operated, at the discretion of the Committee, as appropriate. 10.5 Remuneration for Code Staff The following tables display the 2013 remuneration for Virgin Money’s Executive, Non-Executive and Senior Management and colleagues whose professional activities may have a material impact on the risk profile of the company (Code Staff). 10.5.1 Fixed and variable remuneration The table below shows total fixed and variable remuneration awarded to Code Staff in 2013. The data has not been broken down by business area due to size and scale of operations.

2013 Code Staff (each rounded to nearest £0.1m) (£m)

Senior Management

Other Code Staff

Total Fixed 10.6 4.5 6.2 Total Variable* 8.0 5.0 3.1 Total Remuneration 18.7 9.4 9.2 Number of Code Staff 62 20 42

*The above table does not include awards made to Senior Management under the 2013 Incentive Plan (as detailed in Note 10 of the Virgin Money Group Annual Report 2013). An award under the Plan, which vests only in the event of a Flotation is a pre-determined percentage of the admission value, which value is then converted into an appropriate number of shares at the admission price. 10.6 The Virgin Money Group Annual Report 2013 Further details on the remuneration policies and principles of the Group, the remuneration framework, including the key components of the Group’s remuneration structure for senior employees and with respect to the directors’ remuneration can be found in annual remuneration report contained in the Virgin Money Group Annual Report 2013.

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11. Glossary Arrears For secured, this is where the customer has failed to make

contractual due date and the payment shortfall exceeds 1 per cent of the current monthly contractual payment amount. For unsecured, this is where the customer has failed to meet the scheduled minimum monthly payment; i.e. the customer is at least one month past due.

Available for Sale Reserve This reserve represents the unrealised change in the fair value

of available for sale investments since initial recognition. Asset Backed Securities (ABS) Securities that represent an interest in an underlying pool of

referenced assets. The referenced pool can comprise any assets which attract a set of associated cash flows, including credit card assets, but are commonly pools of residential or commercial mortgages. Investors in these securities have the right to cash received from future payments (interest and/or principal) on the underlying asset pool. See also RMBS.

Basel III Global regulatory standard on Bank Capital Adequacy, Stress

Testing and Market and Liquidity proposed by the Basel Committee on Banking Supervision in 2010. It aims to strengthen regulation, supervision and risk management in the banking sector. See also CRD IV.

Board The Company Board. Capital at Risk (CaR) Approach set out for the quantification of interest rate risk

expressed as present value of the impact of the sensitivity analysis on the Group’s capital.

Charge off Charge off occurs on outstanding credit card balances which

are deemed irrecoverable. This involves the removal of the balance and associated provision from the balance sheet with any remaining outstanding balance recognised as a loss.

Collective impairment Assets may be assessed for impairment allowance allowances on a collective basis for loans of similar attributes; e.g.

payment status; given the homogeneous nature of assets in the portfolio.

Company Virgin Money Holdings (UK) Limited. Conduct risk The risk that our operating model, culture or actions result in

unfair outcomes for customers. Common Equity Tier 1 capital The highest form of regulatory capital under Basel III (‘CET1’) that comprises common shares issued and related share

premium, retained earnings and other reserves excluding the cash flow hedging reserve, less specified regulatory adjustments.

CET 1 ratio CET 1 capital expressed as a percentage of total risk exposure

amount.

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Core Tier 1 capital As defined by the PRA mainly comprising shareholders’ equity after deducting intangible assets and other regulatory deductions.

Core tier 1 ratio Core tier 1 capital as a percentage of risk weighted assets. CRD IV In June 2013, the European Commission published legislation for

a Capital Requirements Directive (CRD) and Capital Requirements Regulation (CRR) which form the CRD IV package. The package implements the Basel III proposals in addition to the inclusion of new proposals on sanctions for non-compliance with prudential rules, corporate governance and remuneration. The rules are implemented in the UK via the PRA policy statement PS7/13 and are in force from 1 January 2014, with certain sections subject to transitional phase in.

Credit risk Credit risk is the risk that a borrower or counterparty fails to pay

the interest or the capital on a loan or other financial instrument on time.

CSA Credit Support Annexes. Default Default occurs where a borrower has missed 6 months of

mortgage repayments or 3 months of credit card repayments, or, the borrower is deemed to be unlikely to repay their loan. The definition of unlikely to repay includes those loans where: the property has been taken into possession; loans that have been modified in the form of a “Rescue Solution” debt management plan; loans where the customer is at least one month in arrears and they have active public information at the credit bureau.

Discount Window Allows participants to borrow highly liquid assets in Facility (DWF) return for less liquid collateral in potentially large size and for

a variable term. Earnings at Risk (EaR) Approach set out for the quantification of interest rate risk

expressed as the impact of the sensitivity analysis on the change to net interest income.

Expected Loss (EL) Expected Loss (EL) represents the anticipated loss, in the event

of a default, on a credit risk exposure modeled under the internal ratings based approach. EL is determined by multiplying the associated PD, LGD and EAD

Exposure An asset, off-balance sheet item or position which carries a risk

of financial loss. Exposure at default (EAD) A Basel II parameter used in IRB approaches to estimate the

amount outstanding at the time of default. The EAD calculation includes amounts where customers have contractual rights to draw down further balances and estimates of interest accruals to the point of default.

Foreign exchange risk The risk of changes to asset/liability values due to movements in

exchange rates.

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Funding for Lending The Bank of England launched the Funding for Lending scheme Scheme (FLS) in 2012 to allow banks and building societies to borrow from the Bank of England at cheaper than market rates for up to four years. This was designed to increase lending to businesses by lowering interest rates and increasing access to credit. FCA Financial Conduct Authority.

Funding risk The inability to raise and maintain sufficient funding in quality and quantity to support the delivery of the business plan.

Group The Company and its subsidiaries.

Help to Buy ‘Help to Buy’ was formed as part of the 2013 budget announcement by the government and is part of a package of measures designed to increase the availability of low-deposit mortgages for credit worthy households and to boost the supply of new housing.

IFRS International Financial Reporting Standards.

Impaired assets Loans that are in arrears, or where there is objective evidence of impairment, and where the carrying amount of the loan exceeds the expected recoverable amount.

Interest rate risk The risk of a reduction in the value of earnings or assets resulting

from an adverse movement in interest rates. Interest rate swap An agreement between two parties (known as counterparties)

where one stream of future interest payments is exchanged for another based on a specified principal amount.

ISDA International Swaps and Derivatives Association.

LGD Loss Given Default. A Basel II parameter used to estimate the difference between exposure at default (EAD) and the net amount of the expected recovery expressed as a percentage of EAD.

LAB Liquid Asset Buffer.

Legal risk The risk of Virgin Money activities being unlawful and not aligned to with best legal practice.

Liquidity risk The inability to accommodate liability maturities and

withdrawals, fund asset growth, and otherwise meet our contractual obligations to make payments as they fall due.

Long run average probability An estimate of the likelihood of a borrower defaulting of default on their credit obligations over a forward looking 12 month period, with the estimates based on default

experience across a full economic cycle rather than current economic conditions.

Market risk The risk that the value of, or net income arising from, our assets and liabilities changes as a result of movements in interest or exchange rates.

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MMR Mortgage Market Review: a comprehensive review by the FCA of all aspects of the mortgage market and its regulation. As a result, reforms introduced under the Mortgage Market Review deliver a mortgage market that works better for consumers and is sustainable for all participants. The main changes brought about by the review come into force on 26 April 2014.

Model risk The risk arising through deficiencies in the development of a model or its control environment including quality and control of model inputs and outputs, leading to sub-standard decision-making and/or financial loss.

Neither past due nor impaired Loans that are not in arrears and which do not meet the

impaired asset definition. This segment can include assets subject to forbearance solutions. Loans that are categorised as neither past due nor impaired, but are currently subject to one of the defined forbearance solutions.

Neither past due nor impaired Loans that are categorised as neither past due nor but in forbearance impaired asset definition. This segment can include assets

subject to forbearance solutions. Operational risk The risk of loss resulting from inadequate or failed internal

processes, people and systems or from external events, including legal risk.

OTC Over the Counter. Other encumbered assets Assets that cannot be used for secured funding due to legal or

other reasons. These include cash reserves supporting secured funding structures.

Past due Past due items is an exposure class under the standardised

approach to credit risk. An asset falls into this exposure class when it is more than 90 days past due and fails to meet payments when they are contractually due.

Past due but not impaired Loans that are in arrears or where there is objective evidence

of impairment, but the asset does not meet the definition of an impaired asset as the expected recoverable amount exceeds the carrying amount.

Pillar 1 The part of Basel II that sets out the process by which regulatory

capital requirements should be calculated for credit, market and operational risk.

Pillar 2 The part of the Basel that sets out the process by which a

bank should review its overall capital adequacy and the processes under which the supervisors evaluate how well financial institutions are assessing their risks and take appropriate actions in response to the assessments.

Pillar 3 The part of Basel II that sets out the information banks must

disclose in relation to their risks, the amount of capital required to absorb them, and their approach to risk management. The aim is to strengthen market discipline.

PD Probability of Default measures the probability of a customer

reaching default over a defined outcome period. The

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definition of default varies across products and varies for assessment of capital requirements and for assessment of provisions.

PRA Prudential Regulation Authority. Retail IRB approach A Basel II approach for measuring exposure to retail credit

risks. The method of calculating credit risk capital requirements uses internal PD, LGD and EAD models. IRB approaches may only be used with PRA permission.

RMBS Residential Mortgage Backed Securities. Risk Weighted Assets (RWAs) A measure of a bank’s assets adjusted for their associated

risks. Risk weightings are established in accordance with PRA rules.

Secured lending Lending on which the borrower uses collateral such as equity in

their home. Securitisation A process by which a group of assets, usually loans, are

aggregated into a pool, which is used to back the issuance of new securities. A company transfers assets to a special purpose entity (SPE) which then issues securities backed by the assets. The Group has established securitisation structures as part of its funding activities. These securitisation structures use retail mortgages as the asset pool. In addition, the Group invests in various securitisation structures in its Treasury portfolio.

Senior management An individual other than a director:

(a) who is employed by: (i) a firm; or (ii) a body corporate within a group of which the firm is

a member;

(b) to whom the governing body of the firm, or a member of the governing body of the firm, has given responsibility, either alone or jointly with others, for management and supervision;

(c) who, if the individual is employed by the firm, reports

directly to: (i) the governing body; or (ii) a member of the governing body; or (iii) the chief executive; or (iv) the head of a significant business unit; and

(d) who, if the individual is employed by a body corporate within the Group, reports directly to a person who is the equivalent of a body or person referred to in (c).

SPE Special Purpose Entity. Standardised approach The basic method used to calculate credit risk capital

requirements under Basel II. In this approach the risk weights used in the capital calculation are determined by PRA supervisory parameters. The Standardised approach is less risk-sensitive than IRB.

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Tier 1 capital A measure of a banks financial strength defined by the PRA. It comprises core tier 1 capital plus other tier 1 securities in issue.

Tier 1 capital ratio Tier 1 capital as a percentage of risk weighted assets. Tier 2 capital A further component of regulatory capital defined by the PRA. It

comprises eligible collective assessed impairment allowances under CRD IV.

Unencumbered assets Assets that are readily available to secure funding or to meet

collateral requirements, and assets that are not subject to any restrictions but are not readily available for use.

Unsecured lending Lending with no collateral held such as credit cards and

current account overdrafts. Write off Mortgages may be written off where the outstanding balance,

or shortfall from sale of property is deemed irrecoverable. Assets written off will be deducted from the balance sheet. For credit cards a write off occurs following charge off when all attempts to recover the outstanding balance is exhausted and the account is closed.

Contact Details: Investor relations Tel +44 (0)191 279 4199 Email: [email protected] Issued by Virgin Money Holdings (UK) Limited Registered office: Jubilee House, Gosforth, Newcastle upon Tyne NE3 4PL Registered in England and Wales no. 03087587

mailto:[email protected]

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