Page 76 - CCB_Annual Report_2022

76 Independent Auditors’ Report 77

Materiality customer loans, and hence whether a 12 month or a specialists to test the collateral haircuts used by
lifetime loss provision is recorded; management and we obtained and reviewed the credit
• Overall materiality: £1,400,000 based on 5% of profit before tax from continuing operations. • Probabilities of default, including how they are files and other evidence considered by management
• Performance materiality: £700,000. derived from credit grading models used in portfolio when determining the ECL provisions to derive our
The scope of our audit analysis by the Company; own independent view in respect of recovery
prospects.
As part of designing our audit, we determined materiality and assessed the risks of material misstatement in the financial • Assumptions used in the loss given default
calculation, including collateral haircuts, cure rates
statements. and the time to collateral realisation; and We tested the appropriateness of assumptions used
• The determination of a Post Model adjustment to in the derivation of probability of default and loss given
Key audit matters account for valuation risk in respect of the default by testing the historical default and loss
Key audit matters are those matters that, in the auditors’ professional judgement, were of most significance in the audit of Commercial Real Estate portfolio. behaviour. We considered how historical behaviour
may change going forwards due to the rising interest
the financial statements of the current period and include the most significant assessed risks of material misstatement The Company’s disclosures are given in Note 16. rate and inflationary environment in the UK. We also
(whether or not due to fraud) identified by the auditors, including those which had the greatest effect on: the overall audit Management’s associated accounting policies are detailed in examined a sample of the credit file reviews
Note 28. Management’s judgements in the application of
strategy; the allocation of resources in the audit; and directing the efforts of the engagement team. These matters, and any accounting policy and critical estimates are disclosed in Note 5 performed by management to consider whether there
comments we make on the results of our procedures thereon, were addressed in the context of our audit of the financial and 28 and the considerations of the effect of the future were indicators of increased risk.
statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. economic environment are given in Note 28. The Audit
Committees’ consideration of the matter is set out in the Audit We considered the reasonableness of the post model
Committee Report. adjustment for valuation risk in respect of the
This is not a complete list of all risks identified by our audit. Commercial Real Estate portfolio by critically
assessing the methodology and testing the supporting
Key audit matter How our audit addressed the key audit matter data used within the calculation of the adjustment.

The application of key judgements and assumptions in relation
to applying expected credit loss provisioning on loans and We read the ECL disclosures made by management
advances to customers to ensure compliance with accounting standards and
to ensure that there is disclosure of the effect of
The Company held £16,929k of expected credit loss (‘ECL’) We understood and critically assessed the estimation uncertainty on the reported results.
provisions against loans and advances to customers in methodology applied in the impairment models, using
accordance with IFRS 9 (2021: £14,766k) against total modelling specialists in the more judgemental areas,
outstanding balances of £1,054,641k (2021: £992,600k). including the results of empirical testing on key model From the evidence we obtained, we found that the
judgements and assumptions applied to be
The determination of ECL provisions is inherently judgemental components, primarily the probability of default and reasonable.
and involves setting assumptions using forward looking loss given default models, to confirm that the
information reflecting the Company’s view of potential future implemented methodology was compliant with The appropriateness of assumptions used in the accounting for
economic events. This can give rise to increased estimation accounting standards. the effective interest rate of loans and advances to customers
uncertainty. Accounting standards required interest receivable and similar We performed a walkthrough of the EIR model logic,
There is significant uncertainty in calculating expected credit We challenged management on model limitations income to be recognised on an effective interest rate (‘EIR’) methodology and associated calculations and tested
losses due to the potential impacts on customer behaviour due relating to the forecasting of probabilities of default basis. The EIR approach has the effect of recognising interest their accuracy and validity.
to the rising inflationary and interest rate environment in the and exposure at default calculations. at a single constant rate that takes into account integral fees
UK. Uncertainty also arises in respect of calculating ECL and charges across the expected life of loans and advances to We confirmed that all fees and charges included
provisions for defaulted ‘Stage 3’ exposures due to the We tested management’s ‘staging’ thresholds by customers.
Company pursuing individual work out strategies for each examining management’s model monitoring The loans and advances to customers balance is reduced by within the EIR calculation are in line with accounting
exposure. processes and considering the accounts being effective interest rate accounting adjustments of £4,117k at the standards.
The Company divides its lending activities into two sub- flagged as higher risk through the Company’s internal balance sheet date (2021: reduced by £4,069k). This
portfolios, being real estate finance and asset finance. ECL governance forums. We examined account adjustment primarily relates to deferred fees and charges in We critically assessed the assumptions relating to
provisions recorded over each of these portfolios are £14,730k performance to test whether staging thresholds are respect of the Company’s real estate finance loan portfolio. forecast future redemption behaviours, particularly
and £2,199k respectively (2021: £13,836k and £930k). giving rise to appropriate outcomes. This adjustment is released to the statement of profit or loss because the Company writes variable rate real estate
We focussed our work on provisioning for the real estate and other comprehensive income in accordance with the finance loans and the rising interest rate environment
in the UK may accelerate redemption behaviour.
finance portfolio because there is a larger degree of estimation We assessed the reasonableness and likelihood of forecast behavioural life of the Company’s loan balance, which
uncertainty in respect of this portfolio due to this portfolio the forward looking economic assumptions and is the main area of estimation uncertainty. We performed sensitivity analysis on a range of
constituting 89% of total lending (2021: 91%) and the weightings assigned to the scenarios using a The forecast behavioural life depends on management’s possible alternative outcomes to determine whether
individual assets in this portfolio are generally larger. This benchmarking tool developed by our economic estimate of the future redemption behaviour of loans and the overall estimate lies within a reasonable range of
gives rise to management judgements and assumptions in experts. The severity and magnitude of the scenarios, advances to customers. This estimate is derived using best estimates.
determining ECL provisions having a larger impact on the specifically the house price inflation forecasts, were management judgement due to the nascent nature of the
reported results of the Company in respect of the real estate compared to external forecasts and data from Company’s loan portfolio. As such we focussed our work on We performed substantive testing over the
finance portfolio. In particular we focused on: historical economic downturns. Sensitivities of the this area. completeness and accuracy of the critical data
• Valuation of the provisions for defaulted ‘Stage 3’ ECL provision to the chosen scenarios was The Company’s disclosures are given in Note 5 and 6. elements from the Company’s lending system to the
exposures where a significant degree of considered. We separately engaged our economic Management’s associated accounting policies are detailed in EIR model and supporting evidence.
management judgement is applied; experts to consider the reasonableness of the Note 6. Management’s judgements in the application of
• The application of forward-looking economic Company’s commercial real estate forecasts. We accounting policy and critical estimates are disclosed in Note 5 We tested the reconciliation of the accounting model
assumptions used in the models and the weightings found that the assumptions adopted and assigned and 6 ]. The Audit Committees’ consideration of the matter is to the general ledger to ensure accurate recording in
assigned to those scenarios, particularly in respect of weightings to the scenarios were reasonable. set out in the Audit Committee Report. the financial statements.
assumptions relating to future residential and
commercial real estate values since these have the We tested the complete capture of defaulted We read the disclosures made by management to
largest impact on the ECL calculation; exposures by ensuring loans meeting the operational ensure that they disclosed the effect of estimation
• The appropriateness of the ‘staging’ thresholds definition of default are included in the portfolio of uncertainty on the reported results.
selected by management to determine whether a Stage 3 loans. We challenged management on the
significant increase in credit risk had arisen on judgements used in determining the provisions for
Stage 3 exposures. We engaged our modelling From the evidence obtained, we found that the EIR
accounting estimate is reasonable and supportable
65 66