JUST GROUP PLC Annual Report and Accounts 2021
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued
17 FINANCIAL ASSETS AND LIABILITIES MEASURED AT FAIR VALUE continued Sensitivity analysis Reasonable possible alternative assumptions for unobservable inputs used in the valuation model could give rise to significant changes in the fair value of the assets and liabilities. The Group has estimated the impact on fair value to changes to these inputs as follows:
Immediate property price fall -10%
Future property price growth -0.5%
Future property price volatility +1%
Interest rates +100bps
Net increase/(decrease) in fair value (£m)
Derivative financial assets 2021
(4.6) (6.5)
10.4 24.0
10.6 24.1
4.4
2020
10.2
Derivative financial liabilities 2021
(4.1) (1.8)
13.4
12.5
6.2 2.8
2020
6.3
6.8
Loans secured by residential mortgages Methodology and judgement underlying the calculation of loans secured by residential mortgages
The valuation of loans secured by residential mortgages is determined using internal models which project future cash flows expected to arise from each loan. Future cash flows allow for assumptions relating to future expenses, future mortality experience, voluntary redemptions and repayment shortfalls on redemption of themortgages due to the NNEG. The fair value is calculated by discounting the future cash flows at a swap rate plus a liquidity premium. Under the NNEG, the amount recoverable by the Group on eligible termination of mortgages is generally capped at the net sale proceeds of the property. A key judgement is with regard to the calculation approach used. We have used the Black 76 variant of the Black-Scholes option pricing model in conjunction with an approach using best estimate future house price growth assumptions. There has been significant academic and market debate concerning the valuation of no-negative equity guarantees in recent years, including proposals to use risk-free based methods rather than best estimate assumptions to project future house price growth. We continue to actively monitor this debate. In the absence of any widely supported alternative approach, we have continued in line with the common industry practice to value no-negative equity guarantees using best estimate assumptions.
The best estimate assumptions used include future property growth and future property price volatility.
Cash flowmodels are used in the absence of a deep and liquid market for loans secured by residential mortgages. The sales of the portfolios of Just LTMs in 2020, 2021 and 2022 represented market prices specific to the characteristics of the underlying portfolios of loans sold. In particular, loan rates, loan-to-value and customer age. This was considered insufficient to affect the judgement of the methodology and assumptions underlying the discounted cash flow approach used to value individual loans in the remaining portfolio. The methodology and assumptions used would be reconsidered if any information is obtained from future portfolio sales that is relevant and applicable to the remaining portfolio. Principal assumptions underlying the calculation of loans secured by residential mortgages All gains and losses arising from loans secured by mortgages are largely dependent on the term of the mortgage, which in turn is determined by the longevity of the customer. Principal assumptions underlying the calculation of loans secured by mortgages include the items set out below. These assumptions are also used to provide the expected cash flows from the loans secured by residential mortgages which determines the yield on this asset. This yield is used for the purpose of setting valuation discount rates on the liabilities supported, as described in note 23(b). Maintenance expenses Assumptions for future policy expense levels are based on the Group’s recent expense analyses. The assumed future expense levels incorporate an annual inflation rate allowance of 4.2% (2020: 3.6%). Mortality Mortality assumptions have been derived with reference to England &Wales population mortality using the CMI 2019 model for mortality improvements for 2020 onwards, and have been applied by the Group since 2020. These base mortality and improvement tables have been adjusted to reflect the expected future mortality experience of mortgage contract holders, taking into account the medical and lifestyle evidence collected during the sales process and the Group’s assessment of how this experience will develop in the future. This assessment takes into consideration relevant industry and population studies, published research materials and management’s own experience. The Group has considered the possible impact of the COVID-19 pandemic on its long-termmortality assumptions, but has kept these unchanged at 31 December 2021. Further details of the matters considered in relation to mortality assumptions at 31 December 2021 are set out in note 23(b). Property prices The approach in place at 31 December 2021 is to calculate the value of a property by taking the latest Automated Valuation Model “AVM” result, or latest surveyor value if more recent, indexing this to the balance sheet date using Nationwide UK house price indices and then making a further allowance for property dilapidation since the last revaluation date. This represents a change in approach since the previous period – which was based upon the latest valuation, indexed to the balance sheet date using the Office for National Statistics (“ONS”) monthly index for the property’s location, together with a separate allowance for potential underperformance of individual properties relative to the indexed valuation. Allowing for the change in approach used to calculate property values as at 31 December 2021, the value of the properties underlying the Group’s LTM portfolio grew by 6% over the year which is 3% lower than had the Group not changed the basis of determining property values at the valuation date. Although the COVID-19 pandemic has had a very significant impact on the UK economy during 2020 and 2021, the UK property market has exhibited strong growth over the period. The current level of price indices has been driven by high demand and a shortage of supply. While this imbalance may reduce, our view is that current market prices are sustainable and appropriate for valuation of the properties.
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