Integrated Annual Report 2015
VOLUME 2

Integrated Annual Report
2015

VOLUME 2

Investec risk and Basel Pillar III disclosure report

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Risk management

Group Risk Management objectives are to:

  • Be the custodian of adherence to our risk management culture
  • Ensure the business operates within the board-stated risk appetite
  • Support the long-term sustainability of the group by providing an established, independent framework for identifying, evaluating, monitoring and mitigating risk
  • Set, approve and monitor adherence to risk parameters and limits across the group and ensure they are implemented and adhered to consistently
  • Aggregate and monitor our exposure across risk classes
  • Coordinate risk management activities across the organisation, covering all legal entities and jurisdictions
  • Give the boards reasonable assurance that the risks we are exposed to are identified and appropriately managed and controlled
  • Run appropriate risk committees, as mandated by the board.

Overview of disclosure requirements

Risk disclosures provided in line with the requirements of International Financial Reporting Standard 7 Financial Instruments: Disclosures (IFRS 7) and disclosures on capital required by International Accounting Standard 1 Presentation of Financial Statements (IAS 1) are included within this section of the integrated annual report from here with further disclosures provided within the annual financial statements section.

All sections, paragraphs, tables and graphs on which an audit opinion is expressed on are marked as audited.

Information provided in this section of the integrated annual report is prepared on an Investec DLC consolidated basis (i.e. incorporating the results of Investec plc and Investec Limited), unless otherwise stated.

The risk disclosures comprise Investec Limited and Investec plc’s Pillar III disclosures as required in terms of Regulation 43 of the regulations relating to banks in South Africa and under the Capital Requirements Regulation pertaining to banks in the UK.

The group also publishes Pillar III and other risk information for its ‘silo’ entity holding companies and its significant banking subsidiaries on a consolidated basis. This information is contained in the respective annual financial statements for those respective entities.

Statement from the chairman of the group risk and capital committee

Philosophy and approach to risk management

The board risk and capital committee (comprising both executive and non-executive directors) meets six times per annum and approves the overall risk appetite for the Investec group. The group’s risk appetite statement sets broad parameters relating to the board’s expectations around performance, business stability and risk management. The board ensures that there are appropriate resources to manage the risk arising from running our businesses.

Our comprehensive risk management process involves identifying, quantifying, managing and mitigating the risks associated with each of our businesses.

Risk awareness, control and compliance are embedded in all our day-to-day activities. We seek to achieve an appropriate balance between risk and reward, taking cognisance of all stakeholders’ interests. A strong risk and capital management culture is embedded into our values.

Group Risk Management monitors, manages and reports on our risks to ensure that they are within the stated risk appetite mandated by the board of directors through the board risk and capital committee.

We monitor and control risk exposure through independent Credit, Market, Liquidity, Operational, Legal Risk, Internal Audit and Compliance teams. This approach is core to assuming a tolerable risk and reward profile, helping us to pursue controlled growth across our business.

Group Risk Management operates within an integrated geographical and divisional structure, in line with our management approach, ensuring that the appropriate processes are used to address all risks across the group. There are specialist divisions in the UK and South Africa and smaller risk divisions in other regions tasked with promoting sound risk management practices.

Risk Management units are locally responsive yet globally aware. This helps to ensure that all initiatives and businesses operate within our defined risk parameters and objectives, continually seeking new ways to enhance techniques.

We believe that the risk management systems and processes we have in place are adequate to support the group’s strategy and allow the group to operate within its risk appetite tolerance.

This volume of our integrated annual report, explains in detail our approach to managing our business within our risk appetite tolerance, across all main aspects of risk.

A summary of the year in review from a risk perspective

Executive management is intimately involved in ensuring stringent management of risk, liquidity, capital and conduct.

We continue to seek to achieve an appropriate balance between risk and reward in our business, taking cognisance of all stakeholders’ interests. The group predominantly remained within its risk appetite limits/targets across the various risk disciplines. Our risk appetite framework continues to be assessed in light of prevailing market conditions and group strategy.

The group has significantly derisked its balance sheet through a number of strategic sales completed during the financial year (as discussed here) which resulted in a reduction in legacy assets of approximately £1.5 billion and total assets of approximately £6 billion.

Our core loan book (excluding strategic sales) has grown steadily over the year in home currencies, reflecting an increase of approximately 16% in both our UK and South African businesses. This has been supported by solid growth in our residential owner-occupied mortgage portfolios and private client lending, and steady growth in our UK Asset Finance business and other diversified corporate lending activities.

Credit and counterparty exposures are to a select target market and our risk appetite continues to favour lower risk, income-based lending, with credit risk taken over a short to medium term. We expect our target clients to demonstrate sound financial strength and integrity, a core competency and an established track record.

Our core loan book remains well diversified with commercial rent producing property loans comprising approximately 17% of the book, other lending collateralised by property 8%, HNW and private client lending 34% and corporate lending 41% (with most industry concentrations well below 5%). We anticipate that future growth in our core loan portfolios will largely come from professional mortgages, HNW mortgages, asset finance, fund finance and power and infrastructure finance. These asset classes have historically reported low default ratios with satisfactory net margins.

Our focus over the past few years to realign and rebalance our portfolios in line with our risk appetite framework is reflected in the relative changes in asset classes on our balance sheet showing an increase in private client and corporate and other lending, and a reduction in lending collateralised by property as a proportion of our book.

Our legacy portfolio in the UK has been actively managed down from £3.4 billion at 31 March 2014 to £0.7 billion largely through strategic sales, redemptions, write-offs and transfers (at the end of the period) to the ongoing book on the back of improved performance in these loans. The remaining legacy portfolio will continue to be managed down as we see opportunities to clear this portfolio. Management believes that the remaining legacy book will still take three to five years to wind down as explained in detail here.

Impairments on loans and advances decreased from £166.2 million to £128.4 million. Since 31 March 2014 gross defaults have improved from £658.7 million to £608.4 million. The percentage of default loans (net of impairments but before taking collateral into account) to core loans and advances amounted to 2.07% (2014: 2.30%). The ratio of collateral to default loans (net of impairments) remains satisfactory at 1.37 times (2014: 1.27 times).

The credit loss ratio on core loans in our South African business has continued to decline to the current level of 0.28%. The credit loss ratio in our UK and other businesses increased during the year to 1.16% as we divested assets and increased impairments on the legacy portfolio. Our credit losses on our core ‘ongoing’ UK and Other book remain low at 0.20% (2014: 0.50%).

Our investment portfolios in the UK and South Africa continued to perform well. However, our investment portfolio in Hong Kong unfortunately generated a loss during the period as a result of a poor performance from some of the underlying investments. Overall, we remain comfortable with the performance of our equity investment portfolios which comprise 4.2% of total assets.

Market risk within our trading portfolio remains modest with value at risk and stress testing scenarios remaining at prudent levels. Potential losses that could arise in our trading book portfolio when stress tested under extreme market conditions (i.e. per extreme value theory) amount to approximately 0.1% of total operating income.

Investec has continued to maintain a sound balance sheet with a low gearing ratio of 9.4 times and a core loans to equity ratio of 4.3 times. We have always held capital in excess of regulatory requirements and we intend to perpetuate this philosophy. All our banking subsidiaries meet current internal targets. Investec Limited should achieve a common equity tier 1 ratio target of above 10% by March 2016 and Investec plc already achieves this target. We are comfortable with our common equity tier 1 ratio target at a 10% level, as our leverage ratios for both Investec Limited and Investec plc are well above 7%. We believe that we have sufficient capital to support our growth initiatives.

Holding a high level of readily available, high-quality liquid assets remains paramount in the management of our balance sheet. We continue to maintain a low reliance on interbank wholesale funding to fund lending growth. Cash and near cash balances amounted to £10 billion at year end, representing 38.2% of our liability base.

We have significant surplus cash in our UK business following the sale of Kensington and we are actively focusing on reducing both cash and liquidity back to normalised levels through asset growth and further liability management, while maintaining our overall conservative approach to liquidity risk management. Our weighted average cost of funding continued to decrease in our UK business and we comfortably exceed Basel liquidity requirements for the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR).

In South Africa, we continued to build our structural liquidity cash resources to improve our Basel III LCR in light of regulations which were implemented from 1 January 2015. Investec Bank Limited (solo basis) ended the year with the three-month average of its LCR at 100.3%, which is well ahead of the minimum levels required. The cost of funding continued to increase for local banks, including Investec, as competition for ‘Basel III friendly’ deposits increased.

We continue to spend much time and effort focusing on operational, reputational, conduct, recovery and resolution risks. During the year, Investec enhanced its stress testing framework by developing a repeatable stress testing process designed to identify and regularly test the bank’s key 'vulnerabilities under stress’. The key is to understand these potential threats to our sustainability and profitability and thus a number of risk scenarios have been developed and assessed. These Investec-specific stress scenarios form an integral part of our capital planning process. The stress testing process also informs the risk appetite review process and the management of risk appetite limits, and is a key risk management tool of the bank. This process allows the bank to identify underlying risks and manage them accordingly.

Conclusion

The current regulatory and economic environment continues to prove challenging to our business, however, we are comfortable that we have robust risk management processes and systems in place which provide a strong foundation to the board and the business to manage and mitigate risks within our risk appetite tolerance framework.

Signed on behalf of the board

Stephen Koseff

Stephen Koseff

Chairman of the group risk and capital committee

10 June 2015

Geographic summary of the year in review from a risk perspective

This section should be read in conjunction with, and against the background provided in, the overview of the operating environment section on here in volume one.

Detailed information on key developments during the financial year in review is provided in the sections that follow:

Refer to here and here, here and here, with a high-level geographic summary of the most salient aspects provided below.

 

UK and Other

Credit risk

We continue to realign and rebalance our portfolio in line with our stated risk appetite, which is reflected in the growth in corporate client exposures and the decline in lending collateralised by property exposures. Material progress has been made during the year in our strategic portfolio rebalancing, in part through strategic divestments but also through active portfolio management and the consistent application of our risk appetite statement.

Net core loans and advances decreased by 14.1% from £8.2 billion at 31 March 2014 to £7.1 billion at 31 March 2015 due to the strategic divestments of Investec Bank (Australia) Limited and Kensington new mortgages. Excluding these sales net core loans increased by approximately 16%, largely as a result of solid growth in our diversified corporate lending activities.

Default loans (net of impairments) have decreased from 3.2% to 3.0% of core loans and advances. The credit loss ratio is at 1.16% (2014: 0.99%), impacted by the divestment of assets and increased impairments on the legacy portfolio.

Traded market risk

We continue to manage to a very low level of market risk with VaR at £0.7 million as at 31 March 2015.

There has been ongoing growth in client activity across the interest rate and foreign exchange corporate sales desks. The structured equity desk’s retail product sales have remained strong and they continue to develop both their product range and distribution capacity.

Balance sheet risk

The bank entered the year with a strong surplus liquidity position. Funding rates continued to be driven down throughout the year as market liquidity and improved funding conditions persisted. This cost reduction was complemented by strategic initiatives including amendment to retail product terms. The overall impact led to a reduction in the bank’s cost of funds. Cash surpluses increased further at the end of January 2015 following the strategic sale of Kensington. This is being managed in the context of the overall treasury funding plan to bring cash levels back to our normal levels of cash surpluses. Cash and near cash balances at 31 March 2015 amounted to £5.0 billion (2014: £4.3 billion) with total UK customer deposits increasing by 9.5% to £10.3 billion (2014: £9.4 billion). We continue to comfortably exceed Basel liquidity requirements.

Southern Africa

Credit risk

Net core loans and advances grew by 16% to R182.1 billion with residential owner-occupied, private client lending and corporate portfolios representing the majority of the growth for the financial year in review.

Default loans (net of impairments) as a percentage of core loans and advances reduced from 1.46% to 1.43% with an improvement in the lending collateralised by property portfolio.

The credit loss ratio improved to 0.28% from 0.42% as we saw stability in the number of new defaulted loans and sufficient collateral available for these transactions.

Our legacy default portfolio which largely relates to lending collateralised by property, notably residential land transactions earmarked for developments, continues to be managed down.

Traded market risk

Trading conditions have remained difficult. Traders have had to contend with very uncertain markets as well as declining market liquidity. While client flow has been under pressure, Investec remains committed to trading on client flow and not proprietary trading. The equity derivatives business has continued to grow both their product offering and the diversity of their client base. Currency markets have generally been illiquid and volatile. Corporate foreign exchange volumes are up leading to increased revenue, however, profit margins have tightened. The trend of low discretionary risk taking in local rates continued in the past year. Little uncertainty and stable interest rates in the local rate environment has not encouraged corporate hedging activity.

Balance sheet risk

Investec continued to build its structural liquidity cash resources over the course of the year as part of its drive to improve the Basel III LCR in order to adhere to regulations which were implemented from 1 January 2015. We ended the year with the three-month average of Investec Bank Limited’s (solo basis) LCR at 100.3% which is well ahead of the minimum level required.

The cost of funding continued to increase for local banks, including Investec, as competition for ‘Basel III friendly’ deposits increased.

Total customer deposits increased by 8% from 1 April 2014 to R221.4 billion at 31 March 2015 (Private Bank deposits amounted to R89.8 billion and other external deposits amounted to R131.6 billion). Cash and near cash balances increased by 5% from 1 April 2014 to R88.7 billion at 31 March 2015.

Salient features

A summary of key risk indicators is provided in the table below.

  UK and Other Southern Africa Investec group
Year to 31 March  2015 
£ 
2014 
£ 
2015 
2014 

2015 
£ 
2014^^
£ 
Net core loans and advances (million) 7 061  8 222  182 058  156 870  17 189   17 157 
Total assets (excluding assurance assets) (million) 17 970  22 061  359 728  327 157  38 016   41 279 
Total risk-weighted assets (million) 11 608  13 711  269 466  248 040  26 601^ 27 836^
Total equity (million) 2 074  2 269  35 526  31 127  4 040   4 016 
Cash and near cash (million) 5 039  4 324  88 691  84 476  9 975   9 135 
Customer accounts (deposits) (million) 10 298  10 939  221 377  204 903  22 615   22 610 
Gross defaults as a % of gross core loans and advances 5.52% 5.43% 2.04% 2.24% 3.49% 3.78%
Defaults (net of impairments) as a % of net core loans and advances 3.00% 3.21% 1.43% 1.46% 2.07% 2.30%
Net defaults (after collateral and impairments) as a % of net core loans and advances –  –  –  –  –  – 
Credit loss ratio* 1.16% 0.99% 0.28% 0.42% 0.68% 0.68%
Structured credit as a % of total assets** 1.92% 1.94% 0.44% 1.17% 1.15% 1.77%
Banking book investment and equity risk exposures as a % of total assets** 3.44% 2.46% 4.88% 5.02% 4.19% 3.59%
Level 3 (fair value assets) as a % of total assets** 4.32% 4.57% 2.32% 2.33% 3.87% 5.00%
Traded market risk: one-day value at risk (million) 0.7  0.9  3.5  2.8  n/a n/a
Core loans to equity ratio 3.4x 3.6x 5.1x 5.0x 4.3x 4.3x
Total gearing ratio** 8.8x 10.0x 10.1x 10.5x 9.4x 10.3x
Loans and advances to customers to customer deposits 68.5% 71.0% 78.6% 72.9% 74.0% 72.0%
Capital adequacy ratio 16.7% 15.3% 14.7% 14.9% n/a n/a
Tier 1 ratio 11.9% 10.5% 11.3% 11.0% n/a n/a
Common equity tier 1 ratio 10.2% 8.8% 9.6% 9.4% n/a n/a
Leverage ratio 7.7% 7.4% 8.1% 7.8% n/a n/a
Return on average assets# 0.44% 0.43% 1.20% 1.11% 0.86% 0.75%
Return on average risk-weighted assets# 0.72% 0.75% 1.59% 1.47% 1.25% 1.14%
* Income statement impairment charge on core loans as a percentage of average advances.
** Total assets excluding assurance assets to total equity.
^^ Restated.
^ The group numbers have been ‘derived’ by adding Investec plc and Investec Limited (Rand converted into Pounds Sterling) numbers together.
# Where return represents operating profit after taxation and non-controlling interests and after deducting preference dividends, but before goodwill, acquired intangibles and non-operating items. Average balances are calculated on a straight-line average.
Certain information is denoted as n/a as these statistics are not applicable at a consolidated group level and are best reflected per banking entity or jurisdiction in line with regulatory and other requirements; or were not previously disclosed.
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