Contribution towards total Group income1 1Excludes Group Operations, central items and insurance claims.
Supporting the UK economic Recovery We play an active part in supporting the uK economy, to which our success is inextricably linked, and in 2012 we confirmed our commitment to helping Britain prosper through a number of initiatives. These included leading the way in participating in the Government’s Funding for lending scheme and growing our lending to small and medium-sized businesses against the backdrop of a contracting market. We made strong commitments to supporting sectors, such as manufacturing, that play a key role in economic recovery. We also underlined our support to the uK housing market by continuing to be the uK’s largest mortgage provider to first time buyers, helping over 55,000 customers take their first steps onto the property ladder.
i want to express my thanks to our non-Executive directors for their judgement, wisdom and commitment. They have spent substantial amounts of time – far more than expected – on our business over the last four years and have done so without any increase in their fees since January 2008. These fees are now significantly below those of every other major banking institution. We review fees annually and directors have decided once again to forego any increase in light of the fact that the Group in 2012 was still loss making at the statutory level.
This year we saw the culmination of our partnership with london 2012. The success of the Olympic and Paralympic Games reflected the dedication of so many of our colleagues who had supported the run-up to the Games over the past five years. The Games themselves continued the positive impact on our local communities, which is why we are delighted to be building on their legacy by developing our national school sport Week and local Heroes programmes.
The weakness of developed economies since the end of the initial financial crisis-driven recession in 2009 is due to the high levels of indebtedness that many countries accumulated prior to 2008. These have been holding back economic growth through deleveraging of, initially, the private sector, but now governments too. Private sector deleveraging now looks largely complete in the US and significant progress has been made in the UK. But some Eurozone countries still appear to have significantly further to go. Across the UK, Eurozone and the US governments also need to rein in borrowing significantly. Thus, with many countries trying to reduce debt all at the same time, there has been no external offset to weak demand at home in each country. The weakness of growth in some Eurozone countries has not been fully anticipated and this has led to slippage against fiscal targets, which in turn has often triggered further cuts in government spending or higher taxes, feeding back to even weaker growth. As the market lost confidence in countries with particularly high government debt or deficit levels through 2011 and the first half of 2012, a further feedback loop developed between rising sovereign bond yields and a deteriorating outlook for government finances, raising the prospect of Eurozone break-up. Naturally this impacted consumer and business confidence, further damaging economic growth through 2012.
Our central expectation of a year of only gradual recovery for the uK economy in 2013, is likely to be accompanied by a slight fallback in customer deposit growth with demand for borrowing improving but only slowly.
q Customer requirements: Our strategic assets, including a comprehensive multi-channel distribution network, strong customer relationships, well recognised brands and high quality people mean we are well positioned to address the customer trends.
We are reshaping our business portfolio to fit our assets, capabilities and risk appetite. We are strengthening the balance sheet through the continued reduction of our non-core assets and reducing the risk in the business through the application of a conservative approach to, and prudent appetite for risk. We are also reducing our international presence in order to focus on our core uK customers.
Community Programmes We want to build thriving communities in the uK, both with direct investment and by encouraging our colleagues to support communities with their skills and knowledge. This aim is supported by our community programmes themed around Education, Employability and Enterprise.
Organisational and reporting changes A number of alterations were made to the management and organisation of the Group during the year.
Funding position transformed; liquidity coverage further increased The Group has transformed its funding profile and by the end of 2012, the Group loan to deposit ratio had improved from 135 per cent at 31 december 2011 to 121 per cent. The core loan to deposit ratio also improved to 101 per cent from 109 per cent at 31 december 2011.
net interest income decreased by 4 per cent in 2012, driven by muted demand for lending, previous de-risking of the balance sheet and increased funding costs. While the prior de-risking of the lending portfolio has suppressed income growth, it also supported an offsetting reduction in impairment charges. Retail has taken a number of actions to offset the pressure on income which includes making strategic investments and re-pricing selected lending portfolios to reflect current funding costs.
Additionally, in 2012 we continued our focus to support the uK economy through financing uK sMEs and developing discounted funding propositions for our clients through the uK Government’s national loan Guarantee scheme and the Funding for lending scheme (Fls). in sME we grew our core net lending by 4 per cent in a market which contracted by 4 per cent and we helped in excess of 120,000 sMEs to start up in 2012. External recognition of our support for sMEs includes being voted as the Winner of the innovation in sME Finance award from Business Moneyfacts, as well as ‘Most supportive lender of the Year’ from the national Association of commercial Finance Brokers.
loans and advances to customers, excluding reverse repos, decreased by £21.0 billion, of which £16.3 billion was driven by the non-core asset reduction. core lending decreased by £4.7 billion as demand for new corporate lending and refinancing of existing facilities was more than offset by the level of maturities, reflecting a continued trend of subdued corporate lending demand and client deleveraging as credit facilities matured and were not renewed by clients.
Other income decreased by 8 per cent. core other income decreased by 1 per cent with modest growth in Wealth against a background of subdued investment markets and customer appetite off-set by reduced non-core income in Asset Finance and international driven by business sales in the year and continued non-core asset run-off.
Strategic focus insurance is focused on helping our customers to protect themselves today whilst preparing for a secure financial future. Our objective is to be the best insurance and retirement savings business for customers; providing simple, trusted, value for money propositions accessible through multiple channels.
We are committed to strengthening our position in the growing retirement savings market. in corporate pensions, strong activity in the run up to RdR resulted in 23 per cent growth, with auto-enrolment expected to drive further growth over the next 3 to 5 years. in partnership with the People’s Pension, we launched AssistMe, a technology tool that supports our customers in meeting their auto-enrolment obligations, complementing our existing corporate platform MyMoneyWorks. in annuities, we are developing our propositions to compete more effectively in an increasingly open market. We launched our enhanced annuities pilot in the last quarter of the year and expect this to be fully rolled out by mid 2013. This is the first step in expanding our participation in the annuity market, supported by our investment strategy that saw us purchase over £1 billion of attractive, high yielding, long-dated assets to match long duration insurance liabilities. looking forwards we see enormous potential to serve the retirement needs of our retail bank customers, many of whom may no longer be able to get independent financial advice at retirement.
Banking volatility and liability management gains 199 843 insurance gross up (1,230) 336
Former appointments: carolyn was a non-Executive director of the Financial services Authority and chaired their Risk committee, a director of Group development and strategy at iTV plc and director of strategy and a member of the Executive Board at the BBc. she is a former partner of McKinsey & co. and was a policy adviser in the Prime Minister’s Policy unit. carolyn began her career as an Economist at the World Bank.
Former appointments: sara is the former Managing director of Argos. she held various senior positions at J sainsbury including deputy Managing director and served on its Board between January 2002 and May 2004. she was a non-Executive director of Mitchells & Butler and also held senior management roles for Abbey national and Mars confectionery.
Sara Weller independent director Member of the Remuneration committee and the Risk committee
Share capital information about share capital is shown in note 46 on pages 285 and 286 and is incorporated into this report by reference.
Policy and practice on payment of creditors The company has signed up to the ‘Prompt Payment code’ published by the department for Business innovation and skills, regarding the making of payments to suppliers. information about the ‘Prompt Payment code’ may be obtained by visiting www.promptpaymentcode.org.uk.
– the management report contained in the business review includes a fair review of the development and performance of the business and the position of the company and Group, together with a description of the principal risks and uncertainties that they face.
The 2012 Board Effectiveness review remarked that: “The Board scores particularly well on diversity … through having a very good combination of different backgrounds and personalities. The mix seems to provide a good range of perspectives with at least one of the group usually ready to challenge from an unexpected angle.”
in 2012, the Board engaged independent Audit to conduct a review. independent Audit, which has no other connection with the Group, considered the Board’s performance principally by reference to the balance of skills, experience, independence and knowledge of the Group, its diversity, including gender, and how the Board works together as a unit. The evaluation was conducted between October and december 2012 and consisted of: – one to one interviews with the directors, the company secretary, members of the Group Executive committee and other senior management; – observation of Board and committee meetings held in november 2012; and
The Audit committee evaluated the performance of the external auditors during the year and will continue to do so periodically. The Audit committee did not consider it necessary to require an independent tender process this year. The lead audit partner is rotated every five years, the current audit partner having joined the audit team in 2011. The need for a further audit tender will be kept under consideration by the committee and any recommendation to re-appoint the current auditors will be based on their continued satisfactory performance.
– oversees the development, implementation and maintenance of the Group’s overall risk management framework and its risk appetite, strategy, principles and policies to ensure that they are in line with emerging regulatory, corporate governance and industry best practice; – oversees the Group’s risk exposure, risk/return and proposed improvements to the Group’s risk management framework and its risk appetite; – facilitates the involvement of non-Executive directors in risk issues and aids their understanding of these issues; – provides input to the Remuneration committee on the alignment of remuneration to risk performance; – reviews the appointment or dismissal of the chief Risk Officer; – reviews coordination between the Group Risk division and the external auditors; – oversees adherence to Group risk policies and standards and considers any material amendments to them; and
comparable numbers for the Group chief Executive are: long-term incentive 23 per cent, short-term incentive 30 per cent, salary 30 per cent and pension and benefits 17 per cent.
d Mr Tate’s award will be pro-rated to reflect the number of months employed during the performance period.
Directors’ interests – summary of awards vested, purchases and sales made by directors in 2012 (unaudited)
– interest rate risk: Exposure arising from the different repricing characteristics of the Group’s non-trading assets and liabilities, and from the mismatch between interest rate insensitive assets and interest rate sensitive liabilities, is managed centrally. Matching assets and liabilities are offset against each other and interest rate swaps are also used to manage the residual exposure to within the non-traded market risk appetite. Exposure arising from the margin of interbank rates over central bank rates is monitored and managed within the non-traded market risk appetite through appropriate hedging activity.
– The Group’s liquidity and funding position is underpinned by its significant customer deposit base, and has been supported by stable funding from the wholesale markets with a reduced dependence on short-term wholesale funding; – At 31 december 2012, the Group had £205 billion of highly liquid unencumbered assets in its liquidity portfolio which are available to meet cash and collateral outflows; – daily monitoring and control processes are in place to address regulatory liquidity requirements. The Group monitors a range of market and internal early warning indicators on a daily basis for early signs of liquidity risk in the market or specific to the Group; – The Group carries out stress testing of its liquidity position against a range of scenarios, including those prescribed by the FsA, on an ongoing basis. The Group’s liquidity risk appetite is also calibrated against a number of stressed liquidity metrics; and
Audit committee To monitor and review the formal arrangements established by the Board in respect of internal controls and the risk management framework. The committee also reviews the effectiveness of the systems for internal control, risk management and compliance with financial services legislation and regulations.
– compliance with policies and parameters is overseen by the Board Risk committee, the Group Risk committee, the Group Asset and liability committee, and Risk division. Risk division (the second line of defence) provides oversight and independent challenge to the effectiveness of risk decisions taken at a Group level by the Group chief Executive and Group Executive committee and at a local level by business unit management and their management committees.
cross-border and cross-currency exposures: The Board sets country risk appetite. Within these, country limits are authorised by the country limits committee, taking into account economic, financial, political and social factors. Group policies stipulate that these limits must be consistent with, and support the approved business and strategic plans of the Group.
The Group’s lending practices within Retail have changed since 2009 in several ways: the Group has lowered its maximum loan-to-value thresholds, which have been reduced across all mortgage product types; the Group has withdrawn from ‘specialist’ secured lending since early 2009 (self-certificated and sub-prime lending) and increased credit scorecard cut-offs for both secured and unsecured lending; the Group has tightened its assessments and the maximum limit for affordability of borrowings for both secured and unsecured lending. in addition, the number of properties permitted in buy-to-let portfolios has been reduced.
For mainstream mortgages greater than £5,000,000 the maximum lTV is 50 per cent. Buy-to-let mortgages are limited to a maximum of £1,000,000 and 75 per cent lTV. All mortgage applications above £500,000 are subject to manual underwriting.
– The Group continues to proactively manage down sovereign as well as banking and trading book exposure to selected Eurozone countries.
Loans and advances to customers impaired loans impaired loans as a % of closing advances impairment provisions1 impairment provisions as a % of impaired loans3 unsecured: impairment provisions (2,335)
– Forbearance is well controlled and managed, and any such cases are quickly identified and managed appropriately under the Group’s credit Risk classification framework. The value of assets transferring into the Business support unit (Bsu) has reduced by 37 per cent during 2012.
– in the irish retail mortgage portfolio, impairment provisions as a percentage of impaired loans increased to 71.2 per cent (2011: 70.4 per cent).
during the year, the Group drew A13.5 billion (the sterling equivalent of which at the date of drawdown was £11.2 billion) under the European central Bank’s long-Term Refinancing Operation facility for an initial term of three years, to part fund a pool of non-core euro denominated assets.
exposure A capital exposure arises where the Group has insufficient capital resources to support its strategic objectives and plans, and to meet external stakeholder requirements and expectations. The Group’s capital management approach is focused on maintaining sufficient capital resources to prevent such exposures while optimising value for shareholders.
Measurement The Group measures the amount of capital it holds using the FsA’s definitions. until the Basel iii reforms for an enhanced global capital accord are introduced in the Eu through the implementation of the new capital Requirements directive and Regulation (cRd iV), the regulatory minimum and buffer amounts of capital continue to be based upon the Basel ii framework.
At 31 december 2011 deductions for other unconsolidated investments also included private equity investments in non-financial entities. At 31 december 2012, revised regulatory rules have been applied to these investments which are now risk-weighted rather than being deducted from total capital.
in the interim, the FsA has asked the Group to publish the estimated leverage ratio on a fully loaded cRd iV basis, with and without ineligible tier 1 instruments, to indicate the approximate leverage ratio that the Group would have now were the cRd iV rules fully implemented.
Statutory basis: Assets are generally valued on a basis consistent with that used for accounting purposes (with the exception that, in certain cases, the value attributed to assets is limited) and which follows a market value approach where possible. if the market is not active, the Group establishes a fair value by using valuation techniques. liabilities are calculated using a projection of future cash flows after making prudent assumptions about matters such as investment return, expenses and mortality. discount rates used to value the liabilities are set with reference to the risk adjusted yields on the underlying assets in accordance with the FsA rules. Other assumptions are based on recent actual experience, supplemented by industry information where appropriate. The assessment of liabilities does not include future bonuses for withprofits policies that are at the discretion of management, but does include a value for policyholder options likely to be exercised.
The Group’s internal governance framework is actively managed to ensure it remains appropriate and aligned to the Group’s risk appetite and changing business needs.
Transactions with owners issue of ordinary shares 2,237 – – 2,237 – 2,237
Lloyds Banking Group Annual Report and Accounts 2012220 note 2: Accounting policies (continued)
The deferred tax asset is expected to be utilised over different time periods in each of the entities in which the losses arise. under current uK tax law there is no expiry date for unused tax losses. The assessment of the likely rate of recoverability of the deferred tax is expected to be slower than previously anticipated due to the more subdued and uncertain macroeconomic environment and the further provisions for legacy issues. However, the losses are still expected to be fully utilised by 2019.
Total foreign exchange 335 658 447 investment property (losses) gains (note 27) (264) (107) 434 securities and other gains (losses) (see below) 13,483 (919) 14,843 net trading income (expense) 13,554 (368) 15,724 securities and other gains (losses) comprise net gains (losses) arising on assets and liabilities held at fair value through profit or loss and for trading as follows: £m £m £m net income (expense) arising on assets held at fair value through profit or loss: debt securities, loans and advances 3,616 5,293 2,292
share of balance sheet amounts: Share of net assets at 31 December 298 309 326 15 25 103 313 334 429
in the first half of 2010, as a result of a deteriorating market, the Group impaired the oil drilling rigs under construction held by the business by £150 million to reflect their reduced value in use.
Bank and building society certificates of deposit 3,166 228 3,394 2,863 385 3,248
derivatives are classified as trading except those designated as effective hedging instruments which meet the criteria under iAs 39. derivatives are held at fair value on the Group’s balance sheet. A description of the methodology used to determine the fair value of derivative financial instruments and the effect of using reasonably possible alternative assumptions for those derivatives valued using unobservable inputs is set out in note 54.
Lloyds Banking Group Annual Report and Accounts 2012256 note 28: Goodwill £m £m
The liabilities in respect of the Group’s uK annuity business are matched by a portfolio of fixed interest securities, including a large proportion of corporate bonds and, since late 2012, illiquid loan assets. The value of the in-force business asset for uK annuity business has been calculated after taking into account an estimate of the market premium for illiquidity in respect of corporate bond holdings and relevant illiquid loan assets. The illiquidity premium is estimated to be 73 basis points at 31 december 2012 (2011: 119 basis points). The effect of including illiquid loan assets in the calculation of the market premium for illiquidity has been to increase the value of in-force business by £44 million at 31 december 2012. This is included as an assumption change in the table below. The effect of this change on profit before tax, after also including the impacts of movements in liabilities, is given in note 37.
Deposits from banks 38,405 39,810 included in the amounts reported above are deposits held as collateral for facilities granted, with a carrying value of £23,078 million (2011: £13,933 million) and a fair value of £25,682 million (2011: £14,258 million).
deferred tax assets of £939 million (2011: £733 million) have not been recognised in respect of trading losses carried forward, mainly in certain overseas companies and in respect of other temporary differences in the insurance businesses. Trading losses can be carried forward indefinitely, except for losses in spain which expire after 18 years and in the usA which expire after 20 years.
Options granted in prior years 65 130 75 share plans: shares granted in the year 3 3 3 shares granted in prior years 5 9 49
Participants are entitled to any dividends paid during the vesting period. This amount will be paid in cash unless the Remuneration committee decides it will be paid in shares.
if non-core assets amount to £95 billion or less, 25 per cent of this element of the award, being the threshold, will vest.
Shareholder complaints in november 2011 the Group and two former members of the Group’s Board of directors were named as defendants in a purported securities class action filed in the united states district court for the southern district of new York. The complaint asserted claims under the securities Exchange Act of 1934 in connection with alleged material omissions from statements made in 2008 in connection with the acquisition of HBOs. no quantum is specified. in October 2012 the court dismissed the complaint. An appeal against this decision has been filed. The Group continues to consider that the allegations are without merit.
Lloyds Banking Group Annual Report and Accounts 2012312 note 54: Financial instruments (continued)
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; liquidity risk; capital risk; and insurance risk. information about the Group’s exposure to each of the above risks and capital can be found on pages 115 to 202. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.
Treasury bills and other bills 866 – 16 89 – – 971
A customer is not automatically classed as being in financial distress as a result of a covenant breach, but an actual or projected breach will prompt a review of the customer’s circumstances and their facilities.
Trading and other financial assets at fair value through profit or loss 7,949 9,813 5,479 7,116 123,633 153,990 loans and advances to banks 14,827 6,513 3,674 3,728 675 29,417 loans and advances to customers 44,781 8,718 31,052 91,821 340,853 517,225 debt securities held as loans and receivables 153 – 22 439 4,659 5,273
liabilities arising from insurance and participating investment contracts are analysed on a behavioural basis, as permitted by iFRs 4, as follows: Up to 1 month £m £m £m £m
(e) Acquisition of group undertakings and businesses £m £m £m net cash outflow arising from acquisitions of and additional investment in joint ventures in the year (11) (10) (65)
Payments to former members of scottish Widows Fund and life Assurance society acquired during 2000 – (3) (8)
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