Final Results

27 February 2018

Pursuant to Listing Rule 9.6.1, the Annual Report and Accounts 2017 has been submitted to the UK Listing Authority and will shortly be available for inspection at the UK Listing Authority's Document Viewing Facility, via the National Storage Mechanism, which is located at: www.hemscott.com/nsm.do.

A copy of the Annual Report and Accounts 2017, Pillar 3 Disclosures 2017 and an investor presentation are available within the Investor Relations section of our website located at www.virginmoney.com.

This announcement also contains additional information for the purposes of compliance with the Disclosure Guidance and Transparency Rules.

Reference to pages and numbers refer to page numbers and notes to the financial statements in the Annual Report and Accounts 2017.

THIS ANNOUNCEMENT CONTAINS INSIDE INFORMATION

Virgin Money Holdings (UK) plc

Full year Results

BASIS OF PRESENTATION

This report covers the results of Virgin Money Holdings (UK) plc together with its subsidiaries ("Virgin Money" or "the Group") for the year ended 31 December 2017.

Statutory basis

Statutory information is set out in the Financial Statements section of this announcement.

Underlying results

In order to present a more meaningful view of business performance, the results of the Group are presented on an underlying basis of reporting as described below. The following items have been excluded from underlying profits:

• IPO share based payments;

• Strategic items;

• Simplification costs;

• Fair value losses on financial instruments.

Unless otherwise stated, income statement commentaries throughout this document compare the year ended 31 December 2017 to the year ended 31 December 2016, and the balance sheet analysis compares the Group balance sheet as at 31 December 2017 to the Group balance sheet as at 31 December 2016.

Alternative performance measures

The Group uses a number of alternative performance measures, in the discussion of its business performance and financial position. Further information on these measures is set out on page 262 of the Annual Report and Accounts 2017.

Financial Information

Financial information contained in this document does not constitute statutory accounts within the meaning of section

434 of the Companies Act 2006 ('the Act'). The statutory accounts for the year ended 31 December 2017 will be

published on the Group's website. The report of the auditor on those statutory accounts was unqualified, did not draw

attention to any matters by way of emphasis and did not contain a statement under section 498(2) or (3) of the Act. The

statutory accounts for the year ended 31 December 2017 will be filed with the Registrar of Companies.

Forward looking statements

This document contains certain forward looking statements with respect to the business, strategy and plans of Virgin Money and its current goals and expectations relating to its future financial condition and performance. Statements that are not historical facts, including statements about Virgin Money's or its directors' and/or management's beliefs and expectations, are forward looking statements. By their nature, forward looking statements involve risk and uncertainty because they relate to events and depend upon circumstances that will or may occur in the future. Factors that could cause actual business, strategy, plans and/or results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward looking statements made by the Group or on its behalf include, but are not limited to: general economic and business conditions in the UK and internationally; inflation, deflation, interest rates and policies of the Bank of England, the European Central Bank and other G8 central banks; fluctuations in exchange rates, stock markets and currencies; the ability to access sufficient sources of capital, liquidity and funding when required; changes to Virgin Money's credit ratings; the ability to derive cost savings; changing demographic developments, including mortality, and changing customer behaviour, including consumer spending, saving and borrowing habits; changes in customer preferences; changes to borrower or counterparty credit quality; instability in the global financial markets, including Eurozone instability, the exit by the UK from the European Union (EU) and the potential for one or more other countries to exit the Eurozone or EU, and the impact of any sovereign credit rating downgrade or other sovereign financial issues; technological changes and risks to cyber security; natural and other disasters, adverse weather and similar contingencies outside Virgin Money's control; inadequate or failed internal or external processes, people and systems; terrorist acts and other acts of war or hostility and responses to those acts; geopolitical, pandemic or other such events; changes in laws, regulations, taxation, accounting standards or practices, including as a result of the exit by the UK from the EU, regulatory capital or liquidity requirements and similar contingencies outside Virgin Money's control; the policies and actions of governmental or regulatory authorities in the UK, the EU, the US or elsewhere including the implementation and interpretation of key legislation and regulation; the ability to attract and retain senior management and other employees; the extent of any future impairment charges or write-downs caused by, but not limited to, depressed asset valuations, market disruptions and illiquid markets; market relating trends and developments; exposure to regulatory scrutiny, legal proceedings, regulatory investigations or complaints; changes in competition and pricing environments; the inability to hedge certain risks economically; the adequacy of loss reserves; the actions of competitors, including non-bank financial services and lending companies; and the success of Virgin Money in managing the risks of the foregoing.

Any forward-looking statements made in this document speak only as of the date they are made and it should not be assumed that they have been revised or updated in the light of new information of future events. Except as required by the Prudential Regulation Authority, the Financial Conduct Authority, the London Stock Exchange plc or applicable law, Virgin Money expressly disclaims any obligation or undertaking to release publicly any updates of revisions to any forward-looking statements contained in this document to reflect any change in Virgin Money's expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

VIRGIN MONEY GROUP RESULTS FOR 2017

Full year highlights

§ Disciplined approach to lending growth and consistently high underwriting standards delivered a 14 per cent increase in total customer loan balances and a low and stable cost of risk at 13 basis points

§ Total income increased by 13.5 per cent to £666.0 million, from £586.9 million in 2016

§ Cost:income ratio improved to 52.3 per cent, from 57.2 per cent in 2016. Exited 2017 with a ratio of 49.4 per cent in the fourth quarter

§ Statutory profit after tax increased by 37 per cent to £192.1 million, compared to £140.0 million in 2016

§ Profit attributable to equity shareholders increased to £167.3 million, from £130.0 million in 2016

§ Statutory basic earnings per share increased to 37.8 pence, compared to 29.4 pence in 2016

§ Recommended final dividend of 4.1 pence per ordinary share, resulting in a total dividend for the year of 6.0 pence per ordinary share - an increase of 17.6 per cent compared to 2016

§ Total capital ratio of 18.1 per cent and leverage ratio of 3.9 per cent

§ Tangible net asset value per share increased by 9 per cent to £2.97, from £2.73 in 2016

§ Total net interest margin (NIM) of 157 basis points as guided; banking NIM of 172 basis points as guided

§ Customer advocacy reached record highs with an overall Net Promoter Score of +40, up from +29 in 2016

Jayne-Anne Gadhia, Chief Executive said:

"I am delighted to report that our customer-focused strategy of growth, quality and returns continued to drive strong financial and operational performance in 2017. We generated market-beating growth across our core products as we continued to capture high-quality market share in mortgages and credit cards. We maintained our uncompromising focus on asset quality and we continued to improve our operating leverage.

In doing so, we met or exceeded all of our financial targets for the year. Underlying profit before tax increased by 28 per cent to £273.3 million and return on tangible equity improved to 14.0 per cent. We continue to experience robust customer demand and stable customer behaviour in a resilient housing market, and we expect to maintain solid double-digit returns in 2018.

We remain focused on providing our customers with good value, straightforward products and achieved a significant increase in overall customer advocacy in 2017. More customers than ever before would recommend Virgin Money to their friends and family, with our overall Net Promoter Score (NPS) increasing to +40, up from +29 in 2016. That continues to make Virgin Money one of the best-rated UK retail banks.

We refreshed our strategy during the year to address and capture the strategic opportunities arising from the technological and regulatory changes shaping UK retail banking. Broadening our customer appeal through the development of our SME and digital bank propositions will provide access to a wider pool of UK retail banking revenues and further diversify our funding base.

The strength of the business, our customer-focused strategy and our new strategic initiatives position us well to continue growing profitably while serving and growing our customer base."

Continued growth in customer balances

§ Retail deposit balances increased by 10 per cent to £30.8 billion, from £28.1 billion in 2016.

§ Mortgage balances increased by 13 per cent to £33.7 billion, from £29.7 billion in 2016.

§ Gross mortgage market share of 3.3 per cent, in the upper half of our guided range, and net lending share of 8.9 per cent.

§ Credit card balances increased to £3.0 billion, from £2.4 billion in 2016.

Maintained balance sheet strength and asset quality

§ Strong capital generation supported the growth of our lending portfolios together with ongoing investment in both our core business and the build of our digital bank. As a result, our Common Equity Tier 1 (CET1) ratio was 13.8 per cent, our total capital ratio was 18.1 per cent and our leverage ratio was 3.9 per cent at the end of 2017.

§ During 2017, analysis of our mortgage risk-weight models identified the potential for reductions to average risk-weights for the portfolio. Any material changes would require regulatory approval but the analysis reinforces the strength of current capital ratios.

§ Customer lending continued to be underpinned by consistently high underwriting standards and resulted in a low and stable cost of risk at 13 basis points.

§ The high quality of our mortgage business continued to be reflected in low arrears levels. Secured 3 month+ arrears levels were 0.12 per cent, compared to 0.15 per cent in 2016, and significantly below the latest UK Finance industry average of 0.82 per cent.

§ The cost of risk in our credit card business improved by 19 basis points to 1.51 per cent, from 1.70 per cent in 2016. This reflected our continued focus on the highest quality customer segment, a rigorous approach to underwriting and the relatively benign economic environment.

Continued to deliver for all stakeholders

§ Customers: Total customer numbers increased to 3.34 million and the proportion of new product sales to existing customers increased to 12.2 per cent, compared to 10.7 per cent in 2016. We further improved customer advocacy with our overall Net Promoter Score (NPS) increasing to +40, up from +29 in 2016.

§ Colleagues: We maintained strong colleague engagement with an overall engagement score of 76 per cent. We were accredited as a Best Employer for Race by Business in the Community, and in January 2018 we entered Stonewall's Top 100 employer index for LGBT+ inclusivity. Our mean gender pay gap reduced by 10 per cent, to 32.5 per cent in 2017. As we make further progress towards achieving 50:50 gender balance throughout the business by the end of 2020, our gender pay gap will continue to reduce.

§ Communities: More than £600 million has been donated to charities through Virgin Money Giving, our not-for-profit online donation service, since its launch in 2009, £95 million of which was donated in 2017. The Virgin Money Foundation awarded grants of nearly £3 million in 2017 to organisations working in areas such as housing, employability and financial inclusion.

§ Corporate partners: We continue to work closely with our intermediary partners to drive our mortgage business and were delighted to be awarded the prestigious 'Best Lender for Partnership with Mortgage Club' at the L&G Mortgage Club annual awards for the third year running. In 2017 we announced a new partnership with BGL Group to provide our new life insurance proposition, which has performed well in its first year since launch.

2018 outlook and guidance

§ Our central planning scenario for the year assumes a continuation of resilient economic conditions and modest economic growth.

§ We expect to maintain solid double-digit returns and a progressive dividend in 2018.

§ We expect to grow mortgage balances at a single digit percentage rate during 2018.

§ The product mix of our credit card business will continue to evolve more towards retail spend cards with the launch of Virgin Atlantic Airways affinity products in 2018. Growth in credit card balances will be in single digits for the year.

§ We anticipate a banking NIM in the range of 165-170 basis points for the year. As a result of lower front book spreads in the mortgage market our current expectation for banking NIM is at the lower end of that range.

§ Since year end, the remaining Funding for Lending Scheme (FLS) drawings of £2.0 billion were repaid in full and Term Funding Scheme (TFS) drawings were extended to £6.4 billion.

§ Our lending discipline will support asset quality and, including the impact of IFRS 9, we expect our cost of risk to be less than 20 basis points in 2018.

§ Investment in our core business and strategic priorities will total £100 million in 2018. Despite this investment, we will maintain a CET1 ratio of around 13 per cent.

§ We will continue to manage costs tightly and drive operating leverage through the business. As a result we expect a cost:income ratio of no more than 50 per cent in 2018.

§ We are preparing our business case for the RBS alternative remedies package. We have the brand, the relationships and the capability to compete strongly in the SME market and look forward to participating in the process. 

§ We will continue to make progress with our SME banking roll-out and the development of our digital bank. Over time, these initiatives will significantly increase the breadth of our proposition, drive enhanced returns and support sustainable value creation for shareholders over the longer term.

CONSOLIDATED INCOME STATEMENT

CONSOLIDATED BALANCE SHEET

KEY METRICS

Key ratios are presented on an underlying basis except where stated.

RECONCILIATION TO STATUTORY PROFIT

Chief Executive's review

We have delivered strong financial performance in 2017 and made considerable progress against our strategic objectives. We met or exceeded all of our financial targets for the year and we are confident about the long term prospects for the company.

The strength of the business, our customer focused strategy, and our new strategic initiatives, including SME and digital, position us well to continue growing profitably while serving and growing our customer base with good value, straightforward products and outstanding customer service.

Overview

We have delivered strong financial performance in 2017 as we continued to deliver on our customer focused strategy of growth, quality and returns. As a result of continuing operational leverage and our focus on maintaining excellent asset quality we met or exceeded all of our financial targets for the year. Underlying profit before tax increased to £273.3 million and return on tangible equity improved to 14.0 per cent.

On an underlying basis, total income increased by 13.5 per cent while cost growth was limited to 3.7 per cent. As a result, our cost:income ratio improved to 52.3 per cent, from 57.2 per cent in 2016, and we exited 2017 with a ratio of 49.4 per cent in the fourth quarter.

Statutory profit after tax increased by 37.1 per cent to £192.1 million, generating 182 basis points of Common Equity Tier 1 (CET1) capital after distributions to Additional Tier 1 capital holders. This strong capital generation supported the ongoing growth of our lending portfolios together with ongoing investment in both our core business and the build of our digital bank.

As a consequence, our Common Equity Tier 1 ratio was 13.8 per cent at the end of 2017, while our total capital ratio was 18.1 per cent and our leverage ratio was 3.9 per cent. The cost of risk remained at 13 basis points, demonstrating continued high asset quality as well as a benign economic environment.

As a result of our performance in 2017 the Board has recommended a final dividend of 4.1 pence per ordinary share, bringing the total dividend per share for the year to 6.0 pence. This represents an increase of 17.6 per cent compared to 2016.

Over the course of the year, we announced new strategic developments which will enable us to continue serving and growing our customer base, while meeting the challenges of regulatory change and an increasingly competitive market environment in the key markets in which we operate.

The strength of the business combined with these new strategic initiatives position us well to continue growing profitably and we are confident about the long term prospects for the business.

Customers and distribution

We provide our customers with good value products, supported by outstanding service with the aim of driving long lasting relationships and deeper product engagement. By ensuring that customers are at the heart of our strategy, the proportion of new product sales to existing customers increased to 12.2 per cent, compared to 10.7 per cent in 2016. We also further improved customer advocacy across all areas of the business, with our overall Net Promoter Score (NPS) increasing to +40, up from +29 at 2016.

Our customers continue to choose our digital channels. Our website remains the most popular channel, with over 28 million website visits, up from 22 million in 2016. 78 per cent of sales were delivered digitally during the year and the use of mobile devices to access products and services increased to 52 per cent of all our digital interactions, up from 50 per cent in 2016.

Our Lounges complement our Store network and continue to be a standout success. They deliver excellent customer satisfaction with an NPS score of +87 matching best in class peers in the retail sector. As a result, we will be opening a new Lounge in Cardiff in 2018. Our Store network continues to play an important role for customers with a 25 per cent increase in new accounts opened in-Store year-on-year.

As a result of improving the Virgin Money Giving (VMG) customer journey we now have 1.4 million registered users of our not-for-profit online donation service. £95 million was donated to charities from 2.2 million individual donations in 2017. We will aim to build deeper relationships with our VMG customer base by engaging them beyond charitable donations and exploring ways to meet more of their financial needs.

Business performance

We offer good value, straightforward and transparent products and our multi-channel distribution model supports cost effective growth in our deposit business. We continue to offer our savings customers both good value and sustainable savings rates in the context of the market. Our approach delivered further improvements to our average cost of retail funds and supported strong retention levels. We increased deposit balances by 9.6 per cent year-on-year, while reducing our cost of funds to 59 basis points from 80 basis points in 2016. In a competitive overall market for retail deposits, we were delighted that customers continue to recognise the value of our proposition with 89 per cent retention of fixed rate maturities.

Our mortgage business remains high quality and performance continues to benefit from strong retention of maturing balances and an award-winning intermediary proposition. Improvements in our intermediary proposition drove a further increase in our intermediary NPS to +61 from +55 in 2016 and supported mortgage balance growth of 13 per cent to £33.7 billion in 2017. During the year we extended our mortgage proposition to help more people onto the housing ladder and launched custom build and shared ownership products. Overall we achieved a market share of gross lending of 3.3 per cent despite lowering volumes towards the end of the year to manage margins and protect returns in an increasingly competitive market. Further progress in our direct channel saw the number of mortgage applications increase by 12 per cent from 2016 with the value of direct mortgages exceeding £1 billion for the first time.

In our credit card business our focus has always been on delivering strong and sustainable risk-adjusted returns through a first-rate card proposition for customers in the prime segment of the market. We now have 1.2 million customers and I am pleased to report that we reached our target of £3.0 billion high-quality credit card balances by the end of 2017. As a result of our stringent underwriting criteria we recruited 98 per cent of new balance transfer customers from the highest quality customer segment. Customer engagement increased as we improved our online service for mobile usage and Virgin Money Back, our customer cashback platform, supported an 8 per cent increase in average retail spend per active account.

Our straightforward and transparent investment funds continue to support growing funds under management of £3.7 billion. New money inflows increased by 27 per cent year-on-year and, supported by the increased ISA savings allowance to £20,000, transfers of ISA balances into stocks and shares ISAs were strong during the year.

Our new life insurance proposition performed well in its first year since launch with sales, policies in force and income all exceeding previous life insurance partnerships. The contribution from travel insurance and currency services was flat year-on-year as we focused on higher margin travel insurance business at lower volumes.

Regulatory developments

From 1 January 2019 UK banks will be required to establish ring-fenced operations separating retail from wholesale activities. All of Virgin Money's activities will be within the ring-fence and we are on track to meet the relevant requirements. As the high street banks may seek to deploy excess ring-fenced deposits into the market, this could lead to heightened competition. We remain well-placed to continue competing for mortgage market share despite this competitive backdrop.

The second Payment Services Directive (PSD2), which took effect from 13 January 2018, together with Open Banking, allows customers to choose to share data from their banking products with third parties. This will increase competition in money transmission by allowing new entrants, including new financial technology companies, to compete with the established clearing banks. Although the impact is likely to be felt most strongly and immediately in the personal current account (PCA) market, in which we are not currently a material participant, in the long-term we believe Open Banking and PSD2 represent an opportunity for us to attract customers from the high street banks.

Refreshed strategy

At IPO we set out a number of ambitious targets to maintain a high quality balance sheet while growing income and driving shareholder returns. We have successfully delivered on those initial targets, and we are confident about the next phase in Virgin Money's strategy.

To ensure that we continue to meet the changing needs of our customers and navigate the wider changes in the market, we are investing in our digital future and have updated our customer-focused strategy of growth, quality and returns to provide a strong platform for us to continue to grow responsibly and profitably in the years ahead.

As part of this strategy, we are developing a data-driven, customer-centric digital bank which will allow us to take advantage of the significant technological and regulatory changes shaping UK retail banking, broaden our customer appeal and provide access to a wider pool of UK retail banking revenues.

The new strategy will also diversify our funding through both Small and Medium Enterprises (SMEs) deposits and increased reach into the current accounts and savings markets. We launched an SME deposit product in January 2018 and plan to launch a Business Current Account (BCA) by the end of 2018.

The Virgin Money digital bank will be underpinned by next generation technology and architecture, offering customers a Universal Account that can be personalised to create a unique proposition tailored to individual needs. In addition to our current presence in the mortgage, credit card and retail deposit markets, the digital bank will allow us to expand into the current account and linked primary savings markets.

As such, we will provide an attractive proposition for customers that will enable us to compete against the incumbent banks for lower cost current account balances. The operating cost per customer of the digital bank will also be lower than in our core bank, improving our cost-efficiency once operating at scale. Overall, we expect that our strategy will not only result in enhanced returns for shareholders in the longer term, but also enable us to continue delivering innovative products and outstanding service to our customers.

Colleagues

Our goal is to nurture a high performing, diverse and committed workforce. We aim to ensure that all colleagues can reach their full potential, feel valued and are empowered to thrive in a truly inclusive business. To achieve this we have extended our use of technology to support flexible working and invested in the development of our people managers to make sure they both value and support a diverse workforce. Our latest colleague survey results showed that we achieved a strong staff engagement score of 76 per cent, which compares well against industry standards.

Outlook

Our central planning scenario for 2018 assumes a continuation of relatively benign economic conditions, modest economic growth and heightened competition as the market readjusts to a rising interest rate environment and regulatory changes. The macro and political environment, including the impact of the UK leaving the European Union, remains uncertain which adds a degree of caution to our outlook.

The Bank of England increased interest rates for the first time in a decade in November 2017 and has indicated that the pace of interest rate increases is expected to be gradual.

Our natural long term share of the UK mortgage market remains at 3 to 3.5 per cent. In 2018 we expect to grow our mortgage and cards lending at a single digit percentage rate with banking NIM towards the lower end of a 165 to 170 basis points range. Cost discipline will continue as we invest in our strategic developments and we expect the 2018 cost:income ratio to be no higher than 50 per cent.

Our lending discipline will support asset quality and, including the impact of IFRS 9, we expect our cost of risk to be no higher than 20 basis points and to maintain a CET1 ratio towards 13 per cent at the end of 2018.

We expect to maintain a solid double-digit return on tangible equity in 2018.

We will continue to make progress with our SME roll-out and the development of our digital bank over the course of 2018.

Over time, these initiatives will significantly increase the breadth of our proposition, drive new sources of income and reduce operating costs. A broader proposition, lower cost to serve and new sources of funding will drive enhanced returns and support sustainable value creation for shareholders over the longer term.

Jayne-Anne Gadhia CBE

Chief Executive

FINANCIAL results

Summary of Group results

Our 2017 financial performance demonstrated continued progression across the three pillars of our strategy - Growth, Quality and Returns:

§ Growth - our market share of new lending continued to outstrip our share of stock resulting in continued growth in balances, with loans and advances to customers increasing by 13.5 per cent. This growth was funded predominantly by the continued strength of the retail deposit franchise with customer deposits growing 9.6 per cent;

§ Quality - we maintained a disciplined approach to managing balance sheet growth with consistently high underwriting standards leading to our low and stable cost of risk. Growth in retail deposits was supported by further diversification of our long-term wholesale funding, including additional RMBS and drawings from the Term Funding Scheme (TFS). Capital resources grew through retained earnings and enabled us to absorb additional investment in the build of our new digital bank; and

§ Returns - higher balances drove income growth which, combined with disciplined cost control, resulted in strong operational leverage. As a consequence our cost:income ratio improved by 4.9 percentage points to 52.3 per cent for the year. Combined with our growth and low cost of risk, this resulted in a 28.1 per cent increase in underlying profit before tax with return on tangible equity (RoTE) increasing to 14.0 per cent, compared to 12.4 per cent in the prior year. Statutory profit after tax was £192.1 million, a 37.1 per cent increase on 2016.

Gross mortgage lending of £8.4 billion was combined with strong retention performance to deliver mortgage balances of £33.7 billion at year end. Lending was carefully managed to optimise returns in an increasingly competitive mortgage market. New business mortgage spreads were 19 basis points lower than 2016 at 168 basis points.

Credit card balances increased by 23.6 per cent to £3.0 billion. This was in line with our expected growth and continued to demonstrate the strength of the franchise. We continued to closely monitor the performance of our credit card book, with the latest observed customer behaviour reflected in the assumptions underlying the effective interest rate (EIR) accounting.

The growth in mortgage and credit card balances was funded predominantly through growth in deposits as our retail savings franchise performed well, with balances reaching £30.8 billion at year end.

Our operating platforms continued to support increasing scale of customer activity which, in turn, enhanced Group operational leverage. Underlying income growth of 13.5 per cent significantly exceeded the 3.7 per cent growth in underlying costs, resulting in favourable JAWS of 9.8 per cent.

This continued improvement in operational leverage also reflected our disciplined cost management and helped to create the capacity for increased investment in the business. Total investment in the core business was £52.8 million, of which £41.8 million was capital expenditure. A further £38.3 million of capital expenditure was invested in the development of our new digital banking platform.

The quality of our lending continued to be underpinned by the consistent application of our risk appetite. This was reflected in a cost of risk of 13 basis points which was in line with the prior year, despite a slightly greater proportion of credit card balances. Whilst our low cost of risk benefits in part from the benign economic environment in the UK, it undoubtedly reflects the consistent application of our risk appetite and our disciplined approach to credit risk management across both our mortgage and credit card portfolios. The application of strict affordability requirements, robust credit decisioning and prudent underwriting standards across our portfolios ensured asset quality performance was ahead of our expectations. Balance growth has therefore been achieved without any deterioration in the quality of new lending or the credit characteristics of the portfolios as a whole. Across both portfolios all key credit metrics remain strong and this is reflected in low arrears experience.

Leverage and total capital ratios remained above regulatory requirements with higher retained earnings supporting lending growth and investment. The Common Equity Tier 1 (CET1) ratio remained well above our internal minimum required CET1 ratio of 12.0 per cent at 13.8 per cent, with average mortgage risk weight density at 17.2 per cent. The liquidity and funding profile benefitted from another successful issuance from our established Gosforth Residential Mortgage Backed Security (RMBS) programme and we continued to access the TFS. Additionally, we have received approval for a regulated covered bonds programme, and expect our inaugural issuance to follow in 2018.

Our commercial agility during a year which saw strong competition on both sides of the balance sheet allowed us to manage asset pricing and the cost of funds, which reduced to 59 basis points (2016: 80 basis points). This resulted in a Banking NIM of 172 basis points compared to 175 basis points for the prior year, in line with our expectations.

The combination of strong lending growth, improved operational leverage and our low cost of risk delivered a 28.1 per cent increase in underlying profit before tax, to £273.3 million.

As a consequence of this continued progression measures of shareholder returns were materially improved. Return on tangible equity increased to 14.0 per cent and underlying basic earnings per share rose by 21.7 per cent to 39.8 pence. Unburdened by legacy issues, growth in underlying profit before tax flowed to statutory profit before tax, which increased by 35.1 per cent to £262.6 million.

Our effective tax rate in 2017 was 26.8 per cent. The overall tax rate for UK banks increased by 8 percentage points in 2016 as a result of the bank tax surcharge, adding £18.9 million to the Group's tax charge in 2017. The Group recognised a corporation tax charge of £70.5 million for the year. Statutory profit after tax was therefore £192.1 million, a 37.1 per cent increase on 2016. After distributions to AT1 holders, the profit attributable to equity shareholders increased by 28.7 per cent to £167.3 million.

As a result of this strong financial performance, the Board has recommended a final dividend that takes the total dividend in 2017 to 6.0 pence per ordinary share, an increase of 17.6 per cent compared to 2016.

Summary income statement

Consolidated balance sheet

Key metrics

Key ratios are presented on an underlying basis except where stated. Definitions, including bases of calculation, are set out on page 262.

Balance sheet growth

The continuing strength of our lending franchise delivered 13.5 per cent growth in loans and advances to customers in 2017.

This lending was funded by continued growth in our retail and wholesale funding franchises, as well as further drawings from the TFS. Total customer deposits grew by 9.6 per cent to £30.8 billion at 31 December 2017, in excess of market growth of 3.5 per cent. We repriced four tranches of existing deposits of approximately £15 billion during 2017, and all were completed with lower than expected attrition.

In September 2017 we completed a successful issuance of RMBS through our established 'Gosforth' franchise. This included dollar and sterling tranches and raised sterling equivalent funding of approximately £750 million. The issuance was significantly oversubscribed, delivering long-dated term funding whilst also diversifying our investor base in the US.

We will continue to diversify and build out our funding sources in the coming year in line with the long term aim of wholesale funding providing up to 20 per cent of total funding. In July 2017 we received authorisation from the FCA for a regulated covered bonds programme, and expect that our inaugural issuance will take place this year. We also expect to access RMBS markets again during 2018.

As we work towards the full implementation of minimum requirements for own funds and eligible liabilities (MREL) on 1 January 2022, during 2018 we will issue further unsecured funding through our established Global Medium Term Note programme. The Bank of England provided MREL guidance, including transitional arrangements, in late 2016. This set an interim MREL requirement of 18 per cent of risk-weighted assets from 1 January 2020 until 31 December 2021. The BoE will advise the Group on its ultimate MREL requirement in 2020. We therefore expect to issue further senior debt gradually over the next four years to ensure compliance with MREL requirements.

The balance sheet structure is managed within a clearly defined risk appetite. The loan-to-deposit ratio increased to 119.1 per cent at the end of 2017 from 114.5 per cent at the end of 2016, in line with guidance of towards 120 per cent while we are participating in the TFS.

We continued to make use of the TFS in 2017, with total drawings at 31 December 2017 of £4.2 billion. The scheme provides the Group with a cost effective source of funding, supporting lending growth and further strengthening our liquidity position.

The Group's liquidity position remained strong throughout the period, with high quality liquid assets at £5.3 billion at 31 December 2017. This reflects an increase in cash and balances held at the central bank. The Group held increased levels of liquidity at 31 December 2017, reflected in an increase in balances held at the central bank in part due to the repayment of £650.2 million of Funding for Lending Scheme (FLS) drawings which have been replaced by on balance sheet liquidity. As a result our liquidity coverage ratio (LCR) of 203 per cent was significantly above the regulatory minimum of 90 per cent. From 1 January 2018 the regulatory minimum has increased to 100 per cent. The high quality liquid asset portfolio represented more than six times our wholesale funding with a maturity of less than one year.

Income benefitted from growth in asset balances

Net interest income increased by 14.6 per cent to £594.6 million, driven by balance growth across the mortgage and credit card books and a Banking net interest margin (NIM) of 172 basis points.

Mortgage spreads were at lower levels than 2016, driven by competition as well as lower funding costs, in part as a result of the TFS. As a result, new mortgage lending in 2017 was priced at an average spread of 168 basis points, compared to 187 basis points in 2016.

However, further optimisation of our funding base continued to support Banking NIM in a competitive environment. We successfully repriced four tranches of deposits and this, along with drawings from the TFS, contributed to a reduction in the cost of funds from 80 basis points in 2016 to 59 basis points in 2017.

Taken together, these factors reduced Banking NIM to 172 basis points in 2017 from 175 basis points in 2016. Total NIM also reduced by 3 basis points to 157 basis points.

Credit card income has benefitted from further growth in the cards book, resulting in an increasing contribution to total net interest income (NII) in the year. Credit card NII in the year includes an accrual of £78.0 million (2016: £61.5 million) arising from the credit card effective interest rate (EIR) method. Credit card EIR is calculated over the expected card life, up to a maximum of seven years. Historical evidence and data continue to support our modelling assumptions and the use of a seven year modelling life.

Other income increased by 5.2 per cent to £71.4 million reflecting stable income from our Investments and Pensions business together with small increases in credit card interchange and foreign exchange income and sales of investment assets.

Other income included a gain of £6.1 million from the sale of the investment in Vocalink in the first half of 2017. Excluding the gain from the sale of Vocalink and the gain of £5.3 million on the investment held in Visa Europe during the first half of 2016, other income increased by 4.3 per cent.

Costs remained tightly controlled

Cost growth in 2017 was constrained to just 3.7 per cent. Set against income growth of 13.5 per cent, this produced positive JAWS of 9.8 per cent and reduced the cost:income ratio by 4.9 percentage points to 52.3 per cent. This performance meant that we successfully achieved our stated target of exiting 2017 with a cost:income ratio of less than 50 per cent, delivering a ratio of 49.4 per cent for the fourth quarter.

This controlled growth in costs was achieved despite higher depreciation and amortisation during the year. Efficiency improvements continued across the business with our ongoing programme of operational effectiveness and the ability to leverage our central functions being key drivers.

Our strong cost performance helped to create the capacity for increased investment in the business. Total investment in the core business was £52.8 million, of which £41.8 million was capital expenditure. A further £38.3 million of capital expenditure was invested in the development of our new digital banking platform.

Impairments reflected a resilient economy and rigorous credit risk management

1 Arrears are defined in the risk report on page 140

We maintained a low cost of risk in 2017 through our established risk appetite framework, ongoing focus on underwriting rigour and the origination of high credit quality customers and prime assets.

The cost of risk for mortgages was flat between 2016 and 2017 at 0.01 per cent and the impairment charge reduced by £0.6 million compared to the prior year. This performance reflected the high quality of the mortgage portfolio combined with the benign economic environment, leading to a continuing low level of defaults. The percentage of mortgages over three months in arrears was 0.12 per cent at the end of 2017 (2016: 0.15 per cent).

In credit cards, set against growth of 23.6 per cent in balances, the impairment charge for the portfolio increased by only 20.7 per cent to £42.0 million. The resulting cost of risk for credit cards decreased by 19 basis points to 1.51 per cent in 2017. This underlines the high credit quality of new and existing cards which continue to have a low rate of default. Performance of new cohorts of cards remained strong with all cohorts showing a cost of risk lower than or in line with previous vintages. When accounts under 18 months old are excluded the cost of risk remains low at 1.66 per cent.

Provisions as a percentage of balances in arrears increased to 32.9 per cent (2016: 29.4 per cent) as we retained appropriate coverage of balances at risk of loss.

Impaired loans as a percentage of loans and advances for the Group increased marginally to 0.5 per cent in 2017 compared to 0.4 per cent in 2016. This was due to an increase in secured balances with qualitative impairment indicators, such as interest only expired terms or fraud cases, which we prudently categorise as impaired regardless of arrears status or expected recoverable amount.

Expired term loans which are more than six months past their maturity date have an average LTV of 25.8 per cent, and therefore do not require increased impairment provisions given the high level of collateral cover. The growth in these balances within the impaired loans category is therefore reflected in the reduced provision coverage of impaired loans.

Further information on the performance of our loan portfolios is provided in the Risk Management Report, on pages 134 to 152.

Underlying profit before tax to statutory profit before tax reconciliation

The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). Aspects of the results are adjusted for certain items, which are listed below, to reflect how the Executive assesses the Group's underlying performance without distortions caused by items that are not reflective of the Group's ongoing business activities. These reconciling items were 43.4 per cent lower in 2017, as the absence of simplification costs, lower fair value losses on financial instruments and a reduction in share based payments related to the IPO more than offset the increased investment in strategic items. The following items have been excluded from underlying profits:

§ IPO share based payments

These costs relate to share based payment charges triggered by our successful IPO in 2014, which are recognised over their vesting period. By their nature, these payments are not reflective of ongoing trading performance and are not, therefore, considered part of the underlying results. 2017 is the last year in which such charges will be incurred.

§ Strategic items

We incurred strategic investment costs of £6.5 million in 2017, entirely due to the development of our digital banking platform which is not, at this stage, considered part of our underlying results. Included within this amount is a non-cash impairment charge of £4.8 million in respect of previous software development on an earlier digital project which has been discontinued in light of the strategic decision taken in May 2017 to consolidate activities within the digital bank programme.

§ Simplification costs

In 2016 we took the opportunity to focus on simplification activity, including de-layering our organisation structure. This led to one-off costs incurred in 2016 including those in relation to a number of senior leavers, which included accelerated share based payment charges. These were not considered part of the underlying results and were not repeated in 2017.

§ Fair value losses on financial instruments

Fair value gains and losses on financial instruments reflect the results of hedge accounting and the fair value movements on derivatives in economic hedges to the extent that they either do not meet the criteria for hedge accounting or give rise to hedge ineffectiveness. Where these derivatives are held to maturity, fair value movements recorded in this heading represent timing differences that will reverse over their lives and therefore excluding these from underlying profit better represents the underlying performance of the Group. Where derivatives are terminated prior to maturity, this may give rise to fair value movements that do not reverse.

The reconciliations of the Group's statutory and underlying results are reported above and in note 2 to the consolidated financial statements.

The Group uses a number of Alternative Performance Measures (APMs), in addition to underlying profit, in the analysis and discussion of its financial performance and financial position. APMs do not have standardised definitions and may not be directly comparable to measures defined within IFRS. A full list of APMs used by the Group, including their bases of calculation, are set out on page 262.

 Continued strong progression in returns

The strength of income growth and improved operational leverage, combined with our asset quality, has driven material enhancement to returns in 2017.

Return on tangible equity increased by 1.6 percentage points to 14.0 per cent in 2017, from the 12.4 per cent achieved in 2016. At the same time, the return on assets grew by 2 basis points to 0.46 per cent in 2017, from 0.44 per cent in 2016. On a statutory basis, return on assets increased to 0.47 per cent from 0.40 per cent in 2016. This statutory measure excludes AT1 coupons and benefitted from lower reconciling items in 2017.

Tangible net asset value per share also increased, by 24 pence to 297 pence, as improving profitability flowed through to retained earnings.

Capital strength whilst investing in the future

During the year we generated capital, after distributions to AT1 holders and before investment and dividends, of £167.3 million, which was equivalent to 182 basis points of CET1 capital.

This was used to invest in the business, provide dividends for shareholders and increase capital resources. The net investment in intangible assets, including capital investment in our digital banking platform, was £47.8 million. Accrued dividends for equity shareholders amounted to £26.5 million.

After further small balancing items, this resulted in an increase in CET1 capital of £91.5 million which was in turn used to support customer lending.

Lending growth resulted in a 19.3 per cent increase in RWAs to £9.2 billion. In mortgages, growth in credit risk RWAs of 21.5 per cent was higher than balance growth of 13.2 per cent as the average mortgage risk weight density, as a percentage of balance sheet assets, increased to 17.2 per cent from 16.0 per cent, in line with expectations.

In credit cards, credit risk RWA growth was in line with asset growth as our credit card RWAs are calculated using the standardised approach.

Other RWAs increased by 2.1 per cent. This reflected growth in operational risk RWAs in line with the standardised approach, where the growth in average income over the past three years is recognised in a higher level of operational RWAs. This was largely offset by a reduction in exposure to higher risk-weighted instruments and counterparties in our liquid asset portfolio.

As a result of the above movements, the CET1 ratio reduced to 13.8 per cent at 31 December 2017 compared with 15.2 per cent at the end of 2016. This was in line with the expected development of our business and is in excess of our internal minimum CET1 ratio of 12 per cent.

The total capital ratio of 18.1 per cent also reduced in line with the movements described above, and remains significantly in excess of our total regulatory requirements of 15.0 per cent:

The capital requirement of 15.0 per cent at 31 December 2017 comprised Pillar 1, Pillar 2A and the capital conservation buffer. At 31 December 2017, as per our Individual Capital Guidance (ICG), the Basel I floor was our binding constraint and equivalent to a Pillar 2A capital add-on requirement of 5.71 per cent. Any PRA buffer, if applicable, is a matter between the PRA and Virgin Money. The PRA buffer also takes account of the capital conservation buffer.

The leverage ratio was 3.9 per cent at the end of the year compared to 4.4 per cent at the end of 2016. The reduction reflected higher growth in leverage ratio eligible assets than in capital resources. Growth in eligible assets was due to increased customer balances and higher levels of on balance sheet liquidity as FLS was repaid.

We manage our capital resources to support shareholder returns and ensure that the bank is well capitalised to meet our current and future business plans and our assessment of regulatory risks and requirements.

Dividend

The strength of our profitability and our capital base continues to give the Board confidence to recommend the payment of a final dividend. In addition to the interim dividend for 2017 of 1.9 pence per ordinary share, paid to shareholders in September 2017, the Board has recommended a final dividend of 4.1 pence per ordinary share in respect of 2017 which will be paid, subject to approval at our AGM in May 2018. The total dividend per share for 2017 will therefore be 6.0 pence, an increase of 17.6 per cent compared to 2016. Our intention is to maintain a progressive approach to dividends and to pay an interim and final dividend for 2018, subject to performance.

IFRS 9

We are well placed for the transition to the new accounting requirements of IFRS 9. We estimate the transition to IFRS 9 will reduce shareholders' equity by approximately £35 million after deferred tax as at 1 January 2018. The most significant impact on the Group arises from the changes to loan loss impairment with the introduction of an expected credit loss approach. Given the low LTV and high credit quality of the mortgage portfolio and high credit ratings of the wholesale book, the main impact will arise from the Group's credit card portfolio.

This impact would reduce the Group's CET 1 ratio by approximately 1 basis point as at 1 January 2018 taking into account the recently published capital transitional arrangements. Excluding the transitional arrangements the reduction to the CET 1 ratio would be approximately 36 bps. These impacts remain within expectation and are included within the Group's capital plans. We continue to refine, monitor and validate certain elements of the impairment models and related controls ahead of full reporting of IFRS 9 impacts later in 2018.

Conclusion

2017 represented a further year of significant financial progress for Virgin Money. High-quality lending growth combined with further operational leverage has driven improved returns for our shareholders across RoTE, earnings per share and tangible net asset value. This has been achieved with no degradation of asset quality, further diversification of the funding base and with continued focus on the strength of the capital base and capital ratios.

As the business has become increasingly capital generative we have been able to invest in the next stage of our strategic development with our initiatives to develop the digital bank and our proposition for the SME market.

Peter Bole

Chief Financial Officer

Business Line results

1 Excluding fair value of portfolio hedging

The Group allocates interest expense arising from retail and wholesale funding activities between the Mortgage and Savings and Credit Cards business lines.

Mortgages and Savings

We provide mortgages, savings and current accounts to almost 1.8 million customers. Mortgages are sold primarily through our intermediary partners and retail deposits are largely originated through our digital channel. Our Mortgages and Savings business line is an important revenue driver for the Group, contributing 65.1 per cent of total income in 2017.

Mortgage Strategy

Our approach to mortgages is very straightforward. We offer a wide range of mortgage products to prime credit quality customers. Distribution is principally through our intermediary partners, supplemented by direct distribution and supported by excellent service.

We have continued to develop our mortgage proposition to broaden our presence across segments of the market where we are under-represented. These have been delivered within our existing risk appetite.

We continued to strengthen our intermediary proposition to enrich existing intermediary relationships, which have been a driver of value for us during 2017. Additionally, we continue to invest in the retention of our existing customers.

Key developments - Mortgages

We delivered gross lending of £8.4 billion in the year to 31 December 2017. This was achieved with a consistent risk profile, with the average loan-to-value of new lending stable at 68 per cent.

In an increasingly competitive environment and with the gross lending market growing by 4 per cent to £257 billion, our performance was in line with the prior year and represented a 3.3 per cent market share of gross lending.

Mortgage retention rates at product maturity remained strong with 72 per cent of customers with maturing fixed rate or tracker products being successfully retained during 2017, compared with 68 per cent in 2016.

The combined effect of new business and retention performance resulted in net lending of £3.9 billion. This represented an 8.9 per cent market share of net lending. This steady progression continued to bring our share of stock towards our share of flow, within a stable credit risk appetite. In 2017 our share of stock increased to 2.45 per cent from 2.23 per cent in 2016 as mortgage balances increased by 13.2 per cent to £33.7 billion in 2017.

Prime residential balances grew by 12.5 per cent to £27.3 billion, representing 81.1 per cent of the overall mortgage book and 81.7 per cent of new lending in 2017. Buy-to-let balances of £6.4 billion represented 18.9 per cent of the overall mortgage book at year end. The private rental sector remains a key component of meeting UK housing demand and we retained a strong presence in the buy-to-let market, particularly in the remortgaging segment.

Completion spreads across the market trended downwards in 2017 as a result of competitive pressures. Both incumbents and new entrants looked to build market share and the market was impacted by lower funding costs, in part as a result of the TFS. Our dynamic approach to adjusting pricing in response to competitor movements, expanded reach into new customer segments, and strong intermediary relationships enabled us to offset these pressures to a degree. We ended 2017 with a completion spread of 168 basis points, down from 187 basis points in 2016.

Geographically our lending is broadly consistent with the general distribution of balances across the UK. We retain a consistent presence in more affluent areas such as London and the South East where arrears are lower and our underwriting ensures a lower loan-to-value of new business. This affords us protection should house prices fall in the future.

We remain committed to helping customers to achieve their home ownership aspirations and continue to develop our mortgage franchise to this end. We launched a Shared Ownership proposition to enhance customers' options and we became the first mainstream bank to enter the Custom Build sector. The number of customers using Virgin Money to buy a New Build property increased by 41 per cent year on year. These developments enabled us to increase the value of gross lending to First Time Buyers by 20 per cent. Lending at a loan-to-value over 90 per cent remained low however, and represented under 4 per cent of our new business loans. Customer demographics were stable and performance remained robust.

We continued to deliver enhancements for mortgage brokers. Our partnerships with key national intermediaries continued to develop as we strengthened the intermediary proposition by expanding access to our New Build offering and through entering new market segments such as Shared Ownership. These initiatives, together with our strong service levels, were recognised by our partners as our intermediary NPS increased to +61 from +55 in 2016.

Thanks to developments in our innovative Mortgage Lab, we also made progress on our proposition for customers who wish to use our direct channel. As a result, the proportion of new mortgage applications from direct customers increased to 12 per cent in 2017 from 10 per cent in 2016, and exceeded £1 billion for the first time.

The quality of our mortgage franchise was recognised with several industry awards over the course of the year: Legal & General Best Lender for Partnership (for the third consecutive year); Yourmoney Best Online Mortgage Provider; Mortgage Strategy Awards Best Mortgage Lender and Sesame Bankhall Group Best Innovative Lender.

Savings Strategy

We offer customers a range of instant access and fixed term savings products, also making these available as ISAs. We also offer a basic bank account. Savings products are sold primarily through our digital channels supplemented by our Stores and contact centres. We attract and retain customers with enduring, good value offers and excellent service.

Key developments - Savings

We opened more than 370,000 new savings accounts in the year. At the end of 2017 we had more than 1.3 million savings customers and balances had grown to £30.8 billion, up from £28.1 billion at 31 December 2016.

This balance growth of 9.6 per cent compared to market growth of 3.5 per cent over the course of 2017. Our market share of savings stock was 1.7 per cent at 31 December 2017.

Performance was underpinned by strong customer retention. We retained 89 per cent of customers with maturing fixed rate balances and successfully repriced £15 billion of funds on our existing book across four phases of repricing. Attrition rates on each reprice were consistently better than expectations.

Cash ISA performance was particularly strong in 2017 with balances increasing by 27 per cent compared to a flat market, reflecting the strong appeal of our proposition to ISA customers. We had a market share of Cash ISA balances of 6.1 per cent at the end of December 2017, up from 4.8 per cent at the end of 2016.

We continued to develop new propositions to broaden our access to savings customers with differing needs. Our regular saver product helps attract customers who are new to saving and had attracted over 45,000 customers by the end of 2017. We were also pleased to grow our savings products partnership with Manchester United to reach 10,000 customer accounts during the year.

Our Essential Current Account continues to attract customers looking for a straightforward transparent product, and is endorsed as one of the best basic bank accounts in the market by Money Saving Expert. We have maintained our account opening run rate at the level experienced through 2016, opening 12,000 new accounts in 2017.

We continue to focus on providing best in class customer service. Improvements to the customer proposition and journey are reflected in our strong retention rates and continued growth in customer advocacy, with Savings NPS increasing to +37 in 2017 from +16 in 2016.

Ongoing active management of retail funding costs in the context of competitive market conditions contributed to a reduction in the total cost of funds from 80 basis points in 2016 to 59 basis points in 2017.

2017 financial highlights - Mortgages and Savings

§ mortgage balances grew by 13.2 per cent to £33.7 billion, driven by gross lending of £8.4 billion, and strong customer retention. In a competitive marketplace, spreads on new business reduced 19 basis points to 168 basis points;

§ deposit balances grew by 9.6 per cent to £30.8 billion. With TFS helping to reduce market funding costs, our active management of pricing enabled us to reduce spreads and partially offset downward pressure on asset pricing;

§ NIM for the full year 2017 was 1.35 per cent in the mortgage and savings business. The 3 basis point reduction in NIM relative to 2016 reflects the dilutive effect of new lending and competitive market conditions, partially mitigated by our active management of pricing and mix in both the mortgage and savings markets;

§ net interest income increased by 12.3 per cent to £430.2 million, driven by growth in mortgage balances. Combined with a £1.1 million increase in other income, total income in this business line rose by 12.5 per cent to £433.3 million;

§ the high quality of our mortgage business continued to be reflected in the cost of risk which remained stable at 1 basis point for the year. Our already low arrears levels reduced further in 2017. The percentage of loans over three months in arrears was 0.12 per cent at the end of 2017, compared to 0.15 per cent at the end of 2016;

§ at £2.2 million, the impairment charge in 2017 was below the £2.8 million incurred in 2016, reflecting our strong credit management and resulting high-quality mortgage book, as well as benign economic conditions; and

§ risk-weighted assets in this business line increased by 21.2 per cent to £6.3 billion, reflecting lending growth with new business coming onto the book at risk weights higher than more seasoned stock.

Performance summary - Mortgages and Savings

Credit Cards

We provide credit card products, predominantly online, to 1.2 million customers. Our portfolio is a mix of balance transfer and retail credit cards, and our offering continues to develop with the launch of our Virgin Atlantic Airways affinity products in the first half of 2018. Our credit card business contributed 27.6 per cent of total income in 2017.

Strategy

Our Credit Card business has continued to build on the foundations laid by the successful migration of the book purchased from MBNA onto our own platform in early 2015. The functionality of our credit card platform has allowed us to continue to grow the business through simple, transparent products offered to high credit quality applicants, supported by strong risk management and analytical capability.

The product portfolio has been expanded to cater for different customer needs in the balance transfer and retail card segments. We have achieved this with a range of products that focus on core customer needs: debt consolidation, borrowing and everyday spending.

Key developments

Balances grew by 23.6 per cent during 2017 as we achieved our target of £3.0 billion of balances by the end of 2017, with a stable customer profile and improving credit quality.

In 2017 we launched new customer initiatives such as 'Virgin Money Back' offering cashback on purchases, together with promotions to encourage contactless transactions. These supported an 8 per cent increase in average retail spend per active account. These initiatives, together with improvements in customer service resulting from an upgrade to our online service platform, led to credit card NPS improving to +46 (2016: +42)

We opened close to 300,000 customer accounts during 2017, in line with the prior year. We continued to move the focus of customer acquisition towards retail-led cards, which represented over 40 per cent of new accounts in 2017 compared to 30 per cent in 2016. As a result of the ongoing diversification of our portfolio, retail spend on our cards was 41 per cent higher than in 2016.

Our customer indebtedness scores remained significantly below the market average, driven by strong affordability established at the point of underwriting. The profile of newly acquired customers remained broadly stable following additional tightening of criteria for all customers.

In 2017 over 98 per cent of new balance transfer customers were booked at an expected loss rate of less than 1 per cent. This compared with 74 per cent of new balance transfer customers booked at an expected loss rate of less than 1 per cent in the overall market. We do not book customers outside our credit risk appetite, and do not downsell to applicants who do not pass our initial credit score assessment.

This all ensured that our early arrears continued to outperform the industry, as did portfolio arrears levels.

We maintained our in-depth monthly review of customer spending, borrowing and repayment behaviour. This demonstrated stable usage and a highly consistent pattern of activity.

During the year, the first cohorts of business underwritten on our own platform in 2015 reached the end of promotional terms. These cohorts represented a relatively low volume of balances. In 2018 greater volumes of balances will reach the end of promotional terms. In line with this, we will see a natural increase in balance attrition which will result in lower levels of overall portfolio balance growth. Our co-branded partnership with Virgin Atlantic Airways (VAA) will help us to diversify the mix in our portfolio further with a higher proportion of borrowing from retail spend and reward based cards complementing our balance transfer offers. The first VAA products will be launched in the first half of 2018.

The strength of our customer proposition and experience was recognised by winning the British Bank Awards Best Credit Card Provider and the Your Money Awards Best Online Credit Card Provider for 2017.

2017 financial highlights - Credit Cards

§ credit card balances increased by 23.6 per cent to £3.0 billion at year end;

§ net interest income grew by 20.9 per cent to £164.4 million reflecting growth in balances;

§ the performance of the book continued to be closely monitored with the latest observed customer behaviour reflected in the assumptions underlying our effective interest rate (EIR) accounting. Historical evidence and data continue to support our use of a seven year modelling life;

§ net interest margin decreased by 74 basis points to 5.95 per cent reflecting book growth and the relatively lower yield on more recent cohorts of lending;

§ other income increased by 9.6 per cent. This increase was driven by higher interchange and foreign exchange income reflecting an increase in retail volumes and a higher mix of retail accounts;

§ as a result of the above factors total income increased by 19.6 per cent;

§ the impairment charge for credit cards increased by 20.7 per cent to £42.0 million reflecting balance growth. The high credit quality of new and existing cohorts, which continue to have a low rate of default, meant the cost of risk for credit cards reduced by 19 basis points to 1.51 per cent in 2017, from 1.70 per cent in 2016; and

§ risk-weighted assets in the business line increased by 22.6 per cent from 2016, driven by the growth in balances.

 Performance summary - Credit Cards

Financial Services

The Financial Services business line offers customers investment, insurance and currency products and services. We work in partnership with a number of specialist organisations to deliver these products, which generate attractive returns and consume low levels of capital. This business line contributed 5.6 per cent of total income in 2017.

Strategy

Our Financial Services strategy is based on a partnership model. We seek partners who share our commitment to straightforward, transparent and good value customer propositions. We leverage their capabilities with our brand and marketing expertise to access profitable sectors and capital-light product lines, whilst limiting our exposure to financial risk.

Key developments

The investment business performed well in 2017 as inflows increased by 27 per cent compared to 2016. Stocks and Shares ISA sales and transfers were a particular highlight, with annual growth of 40 per cent and 160 per cent respectively. These were driven by the increased ISA threshold in combination with strong Virgin Atlantic Airways partnership sales and continued improvements to the customer journey.

In the insurance business, we successfully re-launched our life insurance product with our new partner BGL. This features a straightforward proposition with a simple and transparent quotation process, and has already delivered 4,000 policy sales.

The travel insurance market continues to be competitive. In order to adapt to this environment we focused on attracting higher volumes of direct customers. We achieved this by enhancing the customer journey, including a new 'quick quote' facility. This narrower focus resulted in lower volumes overall but increased income per policy. We also saw the NPS of Travel Insurance customers improve to +38 from +35 in 2016.

2017 financial highlights - Financial Services

§ income in the Financial Services business line continued to be driven by our investment funds business, where income was up 0.9 per cent compared with 2016;

§ funds under management stood at £3.7 billion at 31 December 2017, an increase of 9.6 per cent from 2016 driven by increases in the FTSE, and sales of stocks and shares ISAs. The Group mitigated the risk associated with stock market movements and their impact on earnings through the use of a FTSE hedge, and as a consequence income growth did not fully benefit from the rise in the FTSE;

§ insurance and other income in 2017 decreased by 10.3 per cent, reflecting continued competitive pressure in the travel insurance market; and

§ as a result, total income from the Financial Services business fell by 0.8 per cent year-on-year.

Performance summary - Financial Services

Central Functions

Our Central Functions provide shared support services to each of our business lines. These services include Information Technology and Property, together with functions such as Risk, Finance, Treasury, Human Resources and the Group's Executive. It is not our policy to allocate operating costs to each business line, as we manage operating costs across the business as a whole. This has the benefit of more effective cost management.

This part of our business contributed 1.8 per cent of total income in 2017 from the sale of available-for-sale assets and debt securities by our Treasury function.

Key developments

Management of operating expenses is a key discipline for the business. We have continued to invest in our people and in developing the long term future of the bank through digital investment whilst stringently managing costs through further simplification and efficiency activity. This approach has driven continued improvements in operational leverage, delivering a Cost:Income ratio of less than 50 per cent for the fourth quarter.

Fixed costs were held broadly flat as the benefit of simplification undertaken in 2016 and other operational efficiencies offset inflationary and volume driven cost increases.

Property and IT costs were tightly managed, whilst we worked closely with strategic partners to create efficiencies.

We continued to optimise and prioritise our project delivery in 2017, investing £52.8 million effectively to deliver a wide range of initiatives that helped grow and protect our business, as well as meet key regulatory requirements. These included the delivery of operational and customer efficiencies from our Mortgage and Savings Lab, an upgrade of colleague IT equipment, investment in Cyber-crime and Financial crime prevention as well as the build of our IFRS 9 capability.

To support the evolution of our strategy, we have also invested £38.3 million in the development of our new digital banking platform.

During 2017 we actively managed the mix of our liquid asset portfolio to reduce our exposure to higher risk-weighted instruments and counterparties.

2017 financial highlights - Central Functions

§ interest income and expense incurred from Treasury funding and liquidity operations is allocated to the Mortgage, Savings and Credit Cards businesses;

§ other income is primarily driven by gains from the sale of available-for-sale assets and debt securities. In 2017 this included a gain of £6.1 million arising from the sale of our investment in Vocalink. 2016 other income included a gain of £5.3 million on the investment held in Visa Europe;

§ operating costs remained tightly controlled with continuous improvement across the organisation. In our savings operation the implementation of additional automation led to a 21 per cent improvement in new accounts opened per FTE.

§ an £8.5 million increase in depreciation and amortisation arose from capital expenditure in prior years, as we continued to invest in the future of the bank; and

§ an 18.3 per cent reduction in risk-weighted assets primarily due to the reduction in higher risk-weighted instruments in the liquidity portfolio.

Performance summary - Central Functions

Operating Costs

Research and development activities

During the ordinary course of business the Group invests in the development of platforms, products and services. During 2017 the Group has invested in the build of the Virgin Money digital bank.

Responsibility statement of the Directors in respect of the Annual Financial Report

The responsibility statement below has been prepared in connection with the Group's full annual report for the year ending 31 December 2017. Certain parts thereof are not included within this announcement.

Each of the Directors who currently is in office confirms that to the best of their knowledge:

§ the financial statements, prepared in accordance with the applicable set of accounting standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the undertakings included in the consolidation taken as a whole; and

§ the management report includes a fair review of the development and performance of the business and the position of the Group and Company together with a description of the principal risks and uncertainties that they face.

This responsibility statement was approved by the board of directors on 26 February 2018 and is signed on its behalf by:

Jayne-Anne Gadhia, Chief Executive

Glen Moreno, Chair of the Board

principal risks and uncertainties

Effective risk management is a core part of our strategy.

The Board-approved risk appetite reflects our tolerance for risk in pursuit of our strategic objectives. It is designed to achieve an appropriate balance between risk and reward. Risk appetite is embedded in the business through delegation of authority from the Board to the Executive. Our risk management approach is fully aligned with Board risk appetite, regulatory requirements and industry good practice. Risks are identified, managed and mitigated using our risk management framework (see page 131). Our risk-aware culture and strong, independent Risk function help to ensure adherence to our risk management framework. An effective governance structure, rapid escalation of threats and the sharing of information across the Group results in a timely response to emerging risks.

We use a 'Three Lines of Defence' model which describes clear accountabilities, appropriate segregation of duties and effective independent assurance. The principal risks which could impact the delivery of our strategy are outlined on pages 36 to 37.

As a UK retail bank we are focused on serving domestic customers. We are subject to risks arising from macro-economic conditions in the UK, geopolitical uncertainty, the competitive environment and new structural and regulatory changes which will come into force over the next few years.

Our ongoing focus on maintaining a strong retail deposit franchise and high-quality lending portfolios is supported by our robust approach to both financial and non-financial risk management.

Achievements in 2017

Our key achievements during 2017 included continued rigorous focus on credit quality, the strength of our capital and funding bases, significant programmes of work addressing key regulatory initiatives and further strengthening our framework for the management of cyber-crime and financial crime risks.

Credit

The application of strict affordability requirements, robust credit decisioning and prudent underwriting standards across our mortgage and credit card portfolios ensured that asset quality performance was ahead of our expectations. This is reflected in our low overall cost of risk of 0.13 per cent (2016: 0.13 per cent). We are responsive to the changing macro-economic environment and regularly refine our credit risk management approaches.

Mortgage lending grew by 13.2 per cent to £33.7 billion during 2017, despite increased competition from incumbent lenders and new entrants looking to enhance their market share. The mortgage portfolio represents 91.6 per cent (2016: 92.3 per cent) of gross loans and advances to customers. Prime residential lending grew to £27.3 billion during 2017, representing 81.1 per cent (2016: 81.6 per cent) of total secured loans.

§ The high quality of our mortgage business is reflected in our low arrears levels. Secured 3+ arrears levels were 0.12 per cent at the end of 2017, compared to 0.15 per cent in 2016, substantially below the latest UK Finance industry average of 0.82 per cent. Additionally, the proportion of secured assets classified as neither past due nor impaired remained stable during 2017 at 99.0 per cent (2016: 99.1 per cent);

§ The consistent application of our lending criteria and robust underwriting gives us confidence that our mortgage book would be resilient in the event of a downturn. In 2017, we further strengthened our lending criteria in relation to buy-to-let properties, which constitute 18.9 per cent (2016: 18.4 per cent) of total secured loans;

§ The indexed portfolio LTV remained stable at 55.8 per cent at the end of 2017 (2016: 55.4 per cent); and

§ Our low cost of risk for mortgages has remained stable at 0.01 per cent (2016: 0.01 per cent).

During 2017, our credit card book, net of impairments grew to £3.0 billion, representing a market share of 4.1 per cent. The credit card portfolio accounts for 8.4 per cent (2016: 7.7 per cent) of total loans and advances to customers.

In February 2017, the Bank of England (BoE) noted that unsecured lending standards had fallen across the market. In contrast, the quality of our credit card lending has remained strong. Average credit card behavioural scores have improved during the year as we continue to focus on monitoring customer behaviour and book performance closely. Application quality is strong and there is a growing gap between our benchmarked asset quality and market averages. However, we recognise the potential for economic headwinds and during the first half of 2017 further tightened our lending criteria.

§ Revised credit card scorecard cut-offs were implemented in April 2017. Policy restrictions were made in May 2017 to reinforce our focus on the acquisition of customers with low levels of indebtedness. Growth in credit card balances continues to be driven by targeting low risk customer segments. For instance, in 2017 over 98 per cent of new balance transfer customers were booked at an expected loss rate of less than 1 per cent;

§ Credit card book quality remained stable with 98.6 per cent (2016: 98.7 per cent) of the book currently classified as neither past due nor impaired. Unsecured 2+ arrears levels remained low at 0.88 per cent (2016: 0.78 per cent) with the small increase during 2017 primarily due to expected increases in arrears levels on balances originated during 2015 and 2016 as these cohorts mature. Arrears levels remain well within our forecast position and compare favourably to industry benchmarks; and

§ Our low cost of risk for credit cards of 1.51 per cent (2016: 1.70 per cent) reflects a rigorous approach to underwriting, account management and credit decisioning, supported by the benign economic environment.

Capital and funding

Maintaining a well-capitalised business supports balance sheet growth, credit ratings and regulatory requirements. Our capital base is managed to ensure that the business is well placed to react to current and forecast economic, market and regulatory conditions, as well as any material downturn in the economy.

§ As at 31 December 2017, our Common Equity Tier 1 (CET1) ratio was 13.8 per cent (2016: 15.2 per cent), our total capital ratio was 18.1 per cent (2016: 20.4 per cent), and our leverage ratio was 3.9 per cent (2016: 4.4 per cent). Movements in 2017 reflect the utilisation of capital to support further lending growth and investment in business development. All capital ratios remain significantly above the regulatory minima.

Our funding strategy is retail deposit-led. We hold high-quality liquid assets (HQLA) to address the liquidity needs of the business and, in addition to retail deposits, we diversify our funding through a number of wholesale funding programmes;

§ Retail deposits increased by 9.6 per cent during the year to £30.8 billion, with a lower cost of funds. This was achieved through close management of pricing and product mix. The retail product mix included a higher proportion of fixed rate products, increasing overall contractual tenor. Almost nine out of ten fixed rate savings customers opted to stay with us at maturity, highlighting the strength of our retention offering;

§ Our strong funding position is reflected in a liquidity coverage ratio of 203 per cent (2016: 154 per cent) as at 31 December 2017;

§ Our loan-to-deposit ratio increased to 119.1 per cent during 2017, from 114.5 per cent at 31 December 2016, in line with internal limits of up to 120 per cent;

§ In September, we successfully completed a further issuance of Residential Mortgage Backed Securities (RMBS), raising £745.9 million in both USD and GBP tranches. Wholesale funding supplements our core retail deposit base and cost of funding. Wholesale funding also helps to extend tenor and ensures we have appropriate diversification in the funding base;

§ During the year, we made further drawings from the BoE Term Funding Scheme (TFS) taking overall drawings at 31 December 2017 to £4.2 billion. In parallel, we repaid £650.2 million of Funding for Lending Scheme (FLS) funding. This low-cost funding creates additional lending capacity and supports our overall funding plan; and

§ In July 2017, the Financial Conduct Authority (FCA) confirmed that our Covered Bonds application had been approved. We expect to make our inaugural issuance in 2018.

Regulatory initiatives

Our work during the year focused on the following regulatory changes:

§ During 2017, the FCA published its approach to implementing the revised Payment Services Directive (PSD2), which came into force on 13 January 2018. As well as promoting innovation, PSD2 aims to improve consumer protection, increase the security of payments, and reduce the cost of payment services;

§ The General Data Protection Regulation (GDPR) provides an updated EU data protection framework to replace the existing 1995 Data Protection Directive (the Directive). GDPR will come into force in May 2018;

During 2017 we made significant investment in undertaking the required preparatory work in relation to the above change programmes.

§ On 3 April 2017, the FCA published a consultation paper setting out proposals for new rules and guidance to address persistent credit card debt. These proposals complement the remedies arising from the Credit Card Market Study published in 2016, which aim to reduce the number of customers with problem credit card debt. While we have very limited exposure to such customers, we are working with the FCA to trial strategies relating to the identification of and support for customers in persistent debt; and

§ The final report in relation to the FCA Asset Management Market Study was published in June 2017. The package of remedies is focused on providing increased investor protection, driving price transparency and improving the effectiveness of intermediaries for both retail and institutional investors. We endorsed these and will implement the limited changes required to achieve full compliance with the recommendations.

Cyber-crime and financial crime risk

We have a well-developed Cyber Security Strategy to manage the increasing risk of cyber-crime. During 2017 we deployed a security risk framework that enables us to manage exposures in line with internationally recognised security standards. We improved our network security controls to protect us against emerging security threats and improved security advice to colleagues.

The FCA continues to emphasise the need for firms to ensure they have adequate and effective systems and controls to manage financial crime risk. In 2017 we continued to develop our strategic financial crime programme. This programme is designed to enhance our systems and controls and, during the year, delivered improvements to client screening, transaction monitoring solutions and due diligence procedures.

In addition, we implemented our approach to the EU's Fourth Money Laundering Directive which was transposed into UK law on 26 June 2017 as the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

Outlook

The macro-economic environment, strong credit management of our lending portfolios, strength in capital and funding and proactive engagement with forthcoming macro-structural and regulatory change will be the key areas of focus in 2018.

Macro-economic environment

The UK economy and housing market remained resilient in 2017. We continue to see strong customer demand and no evidence of material changes in customer behaviour. However, potential risks could crystallise if inflation remains higher than wage growth, causing a reduction in households' real earnings. Lower real earnings could in turn reduce consumer spending which, combined with a potentially more uncertain macro environment, leads us to remain cautious in our outlook. We will continue to monitor key exposures in light of the prevailing economic outlook. We have implemented additional oversight activities, alongside contingency plans, which are designed to respond to and mitigate the impact of adverse macro-economic conditions that may emerge.

The Bank of England increased interest rates from 0.25 per cent to 0.50 per cent in November 2017. Our expectation is for gradual further rate increases over the next three years. Low wage growth, and higher inflation, may put pressure on some household budgets and we remain alert to signs of financial strains on our customers. Changes to central bank rates can represent a risk to future financial performance. We have an ongoing programme of stress testing to assess our resilience to changing macro-economic conditions.

Maintaining strong credit quality

Our focus on asset quality will continue in 2018. Credit policy and decision systems are regularly reviewed and tested to ensure they respond to changes in customer and competitor behaviours, maintaining the quality of the portfolios.

Management of the mortgage portfolio: Housing market changes play a crucial part in the development of our business. During 2017, UK house prices remained resilient.

§ Low unemployment and record low mortgage rates support consumer affordability while supply shortages continue to support house prices. Although the potential for the weakening of regional house prices exists, we have well-established early warning indicators and will continue to monitor and manage our exposure to regional house price variations and potential areas of weakness;

§ A number of measures relating to the housing market were announced in the Autumn Budget, including a permanent stamp duty land tax relief for first-time buyers. We increased lending to first-time buyers by 20 per cent during 2017 and this will continue to be a focus in 2018;

§ The PRA introduced stricter stress testing for landlords with four or more mortgaged buy-to let properties, effective from September 2017. We have taken a conservative approach to applying these minimum standards. Further information can be found in the Risk Management Report on page 135; and

§ The mortgage market saw heightened competition in the second half of 2017 and this may continue in 2018. We will continue to focus on our competitive strengths and will manage volumes in order to protect asset quality and returns.

Management of the credit card portfolio: We will continue to focus on strong credit management of our credit card exposures. A rise in unemployment or pressure on customer affordability could lead to increased impairments. We will continue to monitor this closely in 2018.

§ Our new co-branded partnership with Virgin Atlantic will encourage high-quality credit card growth. It aims to materially increase retail spend and provide further diversification of the credit card customer base;

§ We will continue to grow our credit card portfolio in a controlled manner, given our assessment of market conditions and our view of risk and reward; and

§ The commercial performance of our credit card portfolio is exposed to potential changes in expected consumer behaviour. We will monitor this closely and take timely action to respond to any observed or anticipated changes.

Capital and funding

We will continue to build on our core retail deposit base and develop our SME offering which commenced in January 2018 with the launch of our Business Deposit Account. We will also target new sources of funding following the launch of our digital bank which aims to increase our access to the current account and primary savings markets.

Although we will remain a predominantly retail funded bank, we do also have a well-established wholesale funding programme. With the Bank of England funding schemes we have used coming to an end, we have put in place a carefully structured funding plan to avoid undue re-financing risk. We will continue to diversify and build out our funding sources in the coming year in line with the long term aim of wholesale funding providing up to 20 per cent of total funding. In July 2017 we received authorisation from the FCA for a regulated covered bonds programme, and expect that our inaugural issuance will take place this year. We also expect to access RMBS markets again during 2018. As we work towards the full implementation of minimum requirements for own funds and eligible liabilities (MREL) on 1 January 2022, we will begin to issue further unsecured funding through our established Global Medium Term Note programme.

We benefit from AIRB models in calculating Pillar 1 capital for the mortgage portfolio. Ensuring that these models remain well calibrated to portfolio performance and aligned to the most recent regulatory guidance will be key in 2018.

Macro-structural changes

Our strategic planning addresses the new structural and regulatory changes which come into force in the coming years:

§ A capital conservation buffer of 0.625 per cent was introduced on 1 January 2016, and increased to 1.25 per cent on 1 January 2017. This will increase each year to a maximum of 2.5 per cent in 2019. During 2017, the Bank of England increased the countercyclical buffer from 0 per cent to 0.5 per cent of risk-weighted assets. This will come into force in June 2018. A further increase of 0.5 per cent, to 1.0 per cent, will come into force in November 2018, subject to review in the first half of 2018. These changes are fully reflected in our capital and funding plans;

§ Minimum Requirements for Own Funds and Eligible Liabilities (MREL) will be fully phased in by 1 January 2022. The Bank of England provided MREL guidance, including transitional arrangements, in late 2016. Prior to 31 December 2019 our MREL requirement will be equal to our minimum regulatory capital requirements. From 1 January 2020 until 31 December 2021, our MREL requirement will be equal to 18 per cent of our risk-weighted assets. This guidance has been fully reflected in our capital and funding plans;

§ The Financial Services Banking Reform Act 2013 will result in the ring-fencing of retail banking operations to separate them from investment banking activities. We are in the process of agreeing our detailed ring-fence compliance plans with the PRA and do not anticipate any material change to our structure or business model as a result. We will, however, have to participate directly in inter-bank payments systems and work is well advanced to achieve this;

§ IFRS 9 will be implemented in 2018 and will result in a new approach to provisioning and additional disclosure requirements. We have developed new models and business practices to meet these requirements. Additional information regarding IFRS 9 can be found in note 37 to the financial statements; and

§ The Basel Committee published their final Basel III framework in December 2017. A key objective of the revisions is to reduce excessive variability of risk-weighted assets (RWAs) and improve the comparability of banks' capital ratios. Implementation dates range from 2022 to 2027 and transitional arrangements will be put in place regarding the new standards. Our initial analysis suggests that the impact of the new requirements will be broadly neutral for us from a capital perspective.

Regulatory change

The delivery of the following regulatory change programmes will be a core focus in 2018:

§ Open Banking, General Data Protection Regulation and Payment Services Directive: PSD2 and Open Banking will have a material impact on the competitive environment in which we operate, with non-bank firms likely to enter the market by leveraging new payments regulation and data sharing protocols. Although this may intensify competition in the mortgage, credit card and savings markets over time, the impact will be most significant for the personal current account market, in which we are not currently a material participant;

§ FCA Strategic Review of Retail Banking Business Models: The FCA are reviewing the business models used in the retail banking sector and evaluating the impact of changes on competition and conduct. The FCA engaged with relevant financial service providers during 2017 and will provide an update in the first half of 2018;

§ FCA Mortgage Market Study: In December 2016, the FCA published the terms of reference of their Mortgage Market Study. We responded to an information request in March 2017 and await the findings of the interim report which is due to be published in March 2018; and

§ FCA Interest Only Thematic Review: In January 2018 the FCA published the findings of their Thematic Review into Interest Only customers. Their response acknowledged the progress that lenders had made and emphasised the need for customers to contact lenders for further support. We were aware of all points raised by the FCA and are addressing them within existing programmes of work.

Cyber-crime

Cyber-crime remains a material risk for all banks and we recognise the pace of change in the external threat environment. We will continue to monitor the external threat landscape and develop our capability to protect against cyber-crime through ongoing enhancement of our control environment and protections. We will continue to develop our strategic financial crime programme in 2018 and further enhance our anti-money laundering capabilities.

Third party administration

Outsourced relationships with parties which support the credit card, investment and insurance business lines, such as DST (formerly IFDS) for unit trust management and TSYS/TMS for our credit card business, are fundamental to the success of the business and remain a significant area of management focus. Reliance on key corporate partners and strategic suppliers involves the potential risk of disruption to service arising from the failure of a third party. Thorough risk assessment during the on-boarding process, and robust ongoing oversight, are key to managing these outsourced relationships.

Principal risks

Credit risk

Credit risk is the risk of loss resulting from a borrower or counterparty failing to pay amounts due.

We provide residential and buy-to-let mortgages and credit cards to customers across the UK. There is a risk that any adverse changes in the macro-economic environment and/or the credit quality or behaviour of borrowers results in additional impairment losses, thereby reducing profitability.

Wholesale exposures arise through our liquid asset portfolio and the use of derivative instruments to manage interest rate risk.

Key mitigating actions

§ credit risk is managed through risk appetite and risk limits reflected in approved credit policy;

§ a robust credit risk framework helps ensure that the credit quality and composition of the portfolios remain within risk appetite limits. This is monitored and reported through governance committees regularly;

§ stress and scenario testing allows us to confirm portfolio resilience;

§ credit risk metrics are benchmarked against competitors and industry averages;

§ customer behaviour is closely monitored with timely action taken in response to any adverse change; and

§ credit risk arising from derivatives and from securities financing transactions is mitigated by collateralising exposures on a daily basis.

Commentary

Impaired loans as a percentage of overall balances increased but remained at a low level in 2017.

Wholesale credit quality remains strong with 100.0% of debt security counterparties rated AA or above.

Provisions as a percentage of impaired loans reduced reflecting growth in secured loans with expired terms which do not require increased impairment provisions given the high level of collateral cover on these loans. Expired term loans which are more than six months past their maturity date have an average LTV of 25.8 per cent.

Future focus

We will continue to deliver strong asset quality aligned to growth of the mortgage and credit card books.

We will maintain our 'no loss' position for the wholesale credit portfolio.

Market risk

Market risk is the risk that unfavourable market movements lead to a reduction in earnings or value. We do not trade or make markets. Interest rate risk in the banking book is the only material category of market risk.

Key mitigating actions

§ market risk is managed through Board-approved risk appetite limits and policies;

§ exposures are mitigated through the use of natural offsets and derivatives; and

§ stress and scenario testing focuses on the impacts of differing interest rate environments.

Commentary

As a consequence of the increase in the size of the balance sheet, Capital at Risk has increased in a positive rate shock scenario. The interest rate risk exposure remains safely within limits.

Future focus

We will look to refine our interest rate risk management systems and approaches to reflect the evolving regulatory landscape.

Operational risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk. The management of third party relationships, cyber-crime and information security remains a key focus for Virgin Money.

Key mitigating actions

§ risk appetite is focused on maturing the control environment and therefore managing operational risk;

§ an ongoing programme of investment in security infrastructure is in place to mitigate threats including cyber-attack;

§ we will continue to invest in and develop risk management frameworks, systems and processes which strengthen operational resilience; and

§ we monitor external events impacting other financial services companies to inform stress testing.

Commentary

The absolute amount of losses has developed in line with business growth, but has remained low.

Future focus

We will continue to invest in cyber-crime defense, fraud and anti-money laundering infrastructure.

Conduct risk and compliance

Conduct and compliance risk is defined as the risk that our operating model, culture or actions result in unfair outcomes for customers. This could result in regulatory sanction, material financial loss or reputational damage if we fail to design and implement effective operational processes, systems and controls which maintain compliance with all applicable regulatory requirements.

Key mitigating actions

§ compliance is maintained through an effective and timely response to changes in the regulatory environment;

§ the customer is placed at the heart of decision-making by ensuring fair outcomes through comprehensive risk assessment and testing;

§ we continue to invest in and develop risk management frameworks, systems and processes; and

§ we focus on training to ensure colleague performance is aligned with the regulatory responsibilities and to enable an awareness of good customer outcomes.

Commentary

Complaints per 1,000 accounts remained low at 4.91, compared to 3.65 in 2016.

Future focus

We will focus on our Complaints Transformation project to continue to improve the volume of complaints resolved at first point of contact.

Strategic and financial risk

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

Financial risk is focused primarily on concentration risk. Credit concentration risk is managed for retail and wholesale credit exposures at portfolio, product and counterparty levels.

Increased competition in our key lending markets is leading to a reduction in asset spreads, creating additional financial risk. There is also the potential for increased competition in the deposit taking market as Bank of England funding schemes come to an end.

Financial performance can be impacted by adverse changes in customer behaviour.

Key mitigating actions

§ Board focus is on ensuring alignment of business development and planning with risk appetite;

§ we invest in processes, systems, recruitment and training to support new business developments;

§ we use robust risk and project management disciplines to ensure that implementation is delivered safely;

§ we continually monitor customer behaviour metrics to identify adverse trends;

§ active focus is on asset origination and portfolio management to manage margins and eliminate inappropriate concentration risk;

§ we will maintain pricing discipline across our product range, ensuring that risk is appropriately rewarded within our Board approved risk appetite; and

§ regular validation and review of models is performed.

Commentary

The development of the digital bank and SME propositions will ensure we provide services that meet the future needs of customers and further diversify our business and funding franchises.

In order to manage concentration risk we seek to spread the risk in the areas in which we operate. This is done through the controlled management of LTVs and the implementation of strict counterparty limits to minimise wholesale industry exposures.

Our pricing discipline and management of the cost of funds enabled us to mitigate pressure on asset spreads, as the Banking NIM reduced to 172 basis points compared to 175 basis points for the prior year.

Future focus

Focus will be on the development of the digital bank and SME propositions, in addition to the ongoing development of wider customer propositions and digital capability.

Funding and liquidity risk

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

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

Key mitigating actions

§ Board-approved risk appetite and funding and liquidity policies define a limit structure;

§ liquid resources are maintained in adequate quantity and quality to meet stressed outflows;

§ a prudent mix of funding sources is maintained with a maturity profile set in risk appetite and policy limits; and

§ stress and scenario testing considers threats to funding plans and changes in consumer behaviour.

Commentary

Improved diversity of funding has been achieved through our registration as a covered bonds issuer, and our entrance into the SME market.

Future focus

We will continue to improve balance sheet efficiency and resilience through measured diversification of wholesale funding and building of the SME deposit base.

Capital risk

Capital risk is defined as the risk that we have a sub-optimal amount or quality of capital or that capital is deployed inefficiently across the Group.

Key mitigating actions

§ Board-approved risk appetite ensures we are holding sufficient capital within regulatory requirements;

§ the capital management policy sets out minimum standards for the management of capital;

§ capital procedures are subject to independent oversight; and

§ stress and scenario testing assesses capital adequacy under a range of severe market wide stress scenarios and idiosyncratic stress events.

Commentary

Our total capital and leverage ratios have remained in line with expectation and well in excess of regulatory requirements.

Future focus

We will continue to maintain a high-quality capital base with ratios in excess of regulatory requirements.

Credit quality of assets

Loans and receivables

The Group defines three classifications of credit quality (low risk, medium risk and higher risk) for all credit exposures.

Secured credit exposures are segmented according to the credit quality classification and a point-in-time PD. The point-in-time PD is an internal parameter used within the Group's AIRB capital models which aims to estimate the probability of default over the next 12 months based on account characteristics and customer behavioural data. Default occurs where the borrower has missed six months of mortgage repayments or the borrower is deemed to be unlikely to repay their loan. Exposures are categorised as:

§ higher risk where assets are past due or have a point in time PD greater than 2%;

§ medium risk where assets are not past due and have a PD greater than 0.8% and less than or equal to 2%; and

§ low risk where assets are not past due and have a PD less than or equal to 0.8%.

Unsecured exposures are categorised as:

§ higher risk where assets are past due;

§ medium risk where assets are currently not past due but are benefiting from a forbearance solution; and

§ low risk where assets are neither past due nor in forbearance.

Wholesale credit exposures are assessed by reference to credit rating. The Group's wholesale exposures are investment grade and therefore classified as low risk.

No wholesale credit exposures were past due or impaired as at 31 December 2017 and 31 December 2016.

Further asset quality categorisation is disclosed on page 140 which reflects the impairment status of assets.

Credit risk portfolio as at 31 December 2017

The tables below show the total credit risk exposure for the Group's retail and wholesale portfolios. 

All of the Group's wholesale exposures are categorised as 'low' risk.

In addition, the maximum credit risk exposure of the Group includes off-balance sheet items. These items relate to applications that have been approved and have not yet been drawn by the customer, and undrawn loan commitments. These commitments represent agreements to lend in the future and may be decreased or removed by the Group, subject to product notice requirements. No account is taken of any collateral held, other credit enhancements or provisions for impairment. As at 31 December 2017, off-balance sheet items totalled £6.2 billion (2016: £5.3 billion) and were all classified as 'low' risk.

Interest rate risk

The Group quantifies the impact to economic value and earnings arising from a shift to interest rates using stress scenarios. These scenarios examine the interest rate re-pricing gaps, asset and liability interest rate bases and product optionality.

The Group maintains IRRBB management practices in line with applicable regulatory expectations.

Interest rate risk exposure is measured as follows:

§ Capital at Risk (CaR) is considered for assets and liabilities in all interest rate risk re-pricing periods. This is expressed as the present value of the negative impact of a sensitivity test on the Group's capital position.

§ Earnings at Risk (EaR) is considered for assets and liabilities on the forecast balance sheet over a 12 month period, measuring the adverse change to net interest income from a change in interest rates.

IRRBB is measured considering both positive and negative instantaneous shocks to interest rates. The measurement is enhanced with non-parallel stress scenarios (basis risk), swap spread risk and behavioural volume stresses (pipeline and optionality risk). Both EaR and CaR are controlled by a defined risk appetite limit and supporting metrics.

CaR measurements are based on a 2% parallel stress over the balance sheet horizon, for term mismatch. EaR measurements are based on a 1% parallel stress over a 12 month period. The stress scenarios capture the risk of negative interest rates. The magnitude of stress used within the Group's internal risk appetite differs from the standardised regulatory stress, based on observed rate movements and internally defined exposure holding periods. In the case of basis risk, the Group uses an internal stress test outcome for CaR and EaR. 

The Group has an integrated Asset and Liability Management system which allows it to measure and manage interest rate re-pricing profiles (including behavioural assumptions), perform stress testing and produce forecasts.

Capital at Risk

CaR as at 31 December 2017 increased to £25.5 million from £14.1 million at 31 December 2016 in a negative rate shock scenario. In a positive rate shock scenario, it increased to £52.2 million at 31 December 2017 from £34.2 million as at 31 December 2016. In both rate shock scenarios this was due to the increase in the balance sheet, and the consequential increase in interest rate mismatch risk, and optionality risk arising from the increase in potential mortgage early repayments and savings redemptions.

The table below shows CaR measurements, based on a 2% parallel stress, over the balance sheet horizon.

Earnings at Risk

EaR has decreased over the year by £36.1 million in a positive rate shock scenario and by £11.9 million in a negative shock scenario. These improvements are due to the Group's savings pricing strategy and changes in customer terms and conditions, which has benefitted interest rate mismatch risk. Additionally, the further utilisation of basis swapped positions has reduced the level of basis risk arising in these rate shock scenarios.

The table below shows that, due to reductions in the structural mismatches of assets and liabilities on the balance sheet across the year, the Group's net interest income at 31 December 2017 is significantly less likely to suffer from a large, sudden shock to interest rates than it was at 31 December 2016.

Funding and liquidity management in 2017

During 2017, the Group maintained a strong funding and liquidity position in excess of risk appetite and the short-term liquidity stress metric, the Liquidity Coverage Ratio (LCR). The Group's LCR as at 31 December 2017 was 203.1%, representing a material surplus above the UK regulatory minimum requirement of 90%. The LCR improved from 153.7% at 31 December 2016 due to strong deposit raising activity throughout the year, net TFS drawings made during the year, and an RMBS issuance in September 2017, increasing High Quality Liquid Assets (HQLA). The Group monitors the NSFR based on its own interpretations of current guidance available for CRD IV NSFR reporting.

Wholesale funding is used to support balance sheet growth, lengthen the contractual tenor of funding and diversify sources of funding. The Group has made use of the TFS during the year, taking overall drawings to £4.2 billion.

Cash flow profile

The tables below allocate the Group's non-derivative cash outflows into relevant maturity groupings based on the remaining period between the balance sheet date and the contractual maturity date. The amounts disclosed are the contractual undiscounted cash flows. These differ from balance sheet values due to the effects of discounting on certain balance sheet items and due to the inclusion of contractual future interest flows.

The following tables display future derivative cash flows in the relevant maturity groupings in which they fall due. Cash flows for the floating legs of derivative transactions are calculated using the forward interest rate curve. These cash flows are not discounted in the same way that derivative valuations are, and totals will therefore not be identical to those reported on derivatives in the notes to the financial statements.

Financial statements

Consolidated income statement

For the year ended 31 December

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated statement of comprehensive income

For the year ended 31 December

The accompanying notes are an integral part of these consolidated financial statements.

Consolidated balance sheet

As at 31 December

Consolidated balance sheet

As at 31 December

The accompanying notes are an integral part of these consolidated financial statements.

The financial statements on pages 200 to 250 were approved and authorised for issue by the Board and were signed on its behalf on 26 February 2018.

Glen Moreno, Chair

Jayne-Anne Gadhia CBE, Chief Executive

Consolidated statement of changes in equity

For the year ended 31 December 2017

Attributable to equity holders