Overview Business review Governance Financial statements Other information 5 Group profile 1
In 2010, the UK Government appointed The Independent Commission on Banking (ICB) to review structural measures to reform the banking system and promote stability and competition. The ICB is not expected to publish its final report until September 2011 although an important precursor of that will be the interim report expected to be published in April. It would be premature for me to seek to predict the outcome of the enquiry; however, discussions between ourselves and the ICB have been collaborative and constructive and we will welcome the increased certainty that the report’s recommendations should bring.
Overview Business review Governance Financial statements Other information 9 Group profile 1
We increased our deposit base by 3 per cent, which, together with the reduction in the size of our balance sheet, resulted in an improvement in our loan to deposit ratio to 154 per cent at the end of 2010 from 169 per cent at the 2009 year end.
The Government has made it very clear that UK financial institutions in which it holds substantial stakes will continue to operate as separate economic units with independent powers of decision and will continue to have their own independent Boards and management teams, determining their own strategies and commercial policies (including business plans and budgets).
The Independent Commission on Banking (ICB) was established by the Government in June 2010 to examine the banking sector and to make recommendations on structural and related non-structural measures to promote stability and competition in the banking sector.
Contract Hire fleet businesses are being brought together onto a single platform.
While the majority of the Group’s 2010 profit was earned in the first half, when liability management gains in the first half and losses in the second half arising from the equity conversion feature of the Enhanced Capital Notes (ECNs) are excluded, the second half saw a significant improvement in profitability when compared to the first half, driven by a significant increase in Wholesale profit, partially offset by an increased loss in Wealth and International.
We further reduced risk in the business, through the reduction in the size of the Group’s balance sheet in line with our strategy and through the significant improvements in our capital, funding and liquidity achieved during the year. Our core tier 1 ratio now stands at 10.2 per cent (2009: 8.1 per cent), and our loan to deposit ratio, excluding repos, improved to 154 per cent, and to 119 per cent in our core business. Through strong term wholesale funding issuance during the year, which totalled £50 billion, we maintained the maturity profile of the Group’s wholesale funding, with 50 per cent having a maturity of more than one year. We also made excellent progress in reducing liquidity support from government and central bank facilities, which reduced by £60.6 billion to £96.6 billion.
Overview Business review Governance Financial statements Other information 23 Group profile 1
Profit before tax increased to £4,716 million compared to £1,382 million in 2009, an increase of £3,334 million. This included an increase of £698 million in respect of the fair value unwind.
Net interest income increased by 18 per cent, with a significant increase in the net interest margin to 2.46 per cent, from 1.97 per cent in 2009. The asset margins expanded significantly during 2010 from 1.18 per cent to 1.93 per cent as a result of decreases in LIBOR to base rate spread and stable customer interest rates. The asset margin also widened partly as a result of mortgage customers continuing to move onto, and staying on, standard variable rates and assets being priced to more appropriately reflect risk and rising funding costs. The liability margin, on the other hand, has reduced from 1.41 per cent to 0.87 per cent as the effect of lower LIBOR to base rate spreads was partially offset by the reduction of expensive deposit balances.
Secured balances were broadly stable as Retail maintained its strong commitment to the housing market and first time buyers. The proportion of mortgages on standard variable rate or equivalent products now stands at 48 per cent and is expected to rise only modestly during 2011.
Customer deposits increased by £0.2 billion, or 3 per cent, to £6 billion with a strong performance in Bank of Scotland Germany, which has now raised over €4 billion of deposits since its launch in January 2009, offset by a fall in customer deposits in Ireland following the closure of the division’s Irish retail business.
Existing business profit increased by £33 million, or 8 per cent, to £464 million. This predominantly reflects higher asset values and a higher assumed rate of return following improved market conditions in the second half of 2009.
Profit before tax, before experience variances and assumption changes 912 828 10
Overview Business review Governance Financial statements Other information 47 Group profile 1
To protect against further deterioration in equity market conditions, and the consequent negative impact on the value of in-force business on the Group balance sheet, the Group purchased put option contracts in 2009. These expired in January 2010. The charge for this option was £7 million. New protection against significant market falls, using option contracts, was acquired by the Group, financed by selling some upside potential from equity market movements. There was no initial cost associated with these hedging arrangements. On a mark-to-market valuation basis a loss of £3 million was recognised in relation to these contracts in 2010. The 2010 option contracts were replaced by the Group in January 2011 with fresh contracts to provide further protection against significant market falls. Again this was financed, at no initial cost, by selling some upside potential from equity market movements.
Overview Business review Governance Financial statements Other information 55 Group profile 1
To make this happen, we are creating an organisation that attracts, retains and develops the best talent in the industry and one that embraces diversity too. We want to be recognised as a great place to work.
We made available £49 billion of committed gross lending to UK businesses in 2010, of which £11 billion was for SMEs. We continue to approve over 80 per cent of lending applications from SMEs. As the UK’s biggest provider of start up finance, we play an active part in developing the entrepreneurial culture of the UK. We helped more than 100,000 new business start ups last year.
We also actively participate in all the main Government lending programmes designed to help small businesses access the finance that they need. We are one of the most active lenders under the Government’s Enterprise Finance Guarantee Scheme. To date we have offered more than 4,000 loans, nearly 30 per cent of total loans granted under the scheme, totalling around £300 million of funding being made available to SMEs across the UK.
In Scotland, Money for Life is funding the creation of a DVD, scripted and produced by drama students at James Watt college, to raise awareness of financial issues amongst young offenders and those at risk of offending. A second focus group will bring together six adult learning colleges to create specially tailored interactive budgeting DVDs for learners. Stakeholders in the Highlands, Dundee and Stirling will also partner to create coaching and mentoring programmes designed to help further education tutors and facilitators gain the skills to provide financial capability support to their diverse learning groups.
The Group has policies, procedures and governance arrangements in place to facilitate the fair treatment of customers. Since the acquisition of HBOS, the Group has made significant progress in aligning its approach to Treating Customers Fairly across both heritages. In addition the Group has aligned its Treating Customers Fairly governance and management information arrangements, with customer impact being a key factor in assessing every integration proposition. The Group regularly reviews its product range to ensure that it meets regulatory requirements and is competitive in the market place.
MEASUREMENT An annual business planning process is conducted at group, divisional and business unit level which includes a quantitative and qualitative assessment of the risks that could impact the Group’s plans. Within the planning round, the Group conducts both scenario analysis and stress tests to assess risks to future earning streams. Stress testing and scenario analysis are fully embedded in the Group’s risk management practice. The Group assesses a wide array of scenarios including economic recessions, regulatory action scenarios, scenarios specific to the operations of each part of the business, as well as reverse stress tests.
The number of customers going into arrears remained stable throughout 2010. In the second half of 2010 fewer accounts in arrears returned to order resulting in higher early arrears balances for 31 December 2010 compared to 30 June 2010. As reported at the 2009 year end, Specialist lending remains closed to new business and this book is in run-off.
IRELAND Total impaired loans increased by £4,733 million, or 49 per cent to £14,445 million compared with £9,712 million at 31 December 2009 and as a percentage of closing loans and advances increased to 52.7 per cent from 33.4 per cent at 31 December 2009. Impairment charges increased by £1,315 million to £4,264 million compared to £2,949 million in 2009. Impairment charges as a percentage of average loans and advances to customers increased to 15.4 per cent from 9.9 per cent in 2009.
MITIGATION Various mitigation activities are undertaken across the Group to manage portfolios and seek to ensure they remain within approved limits.
Current and potential future insurance risk exposures are assessed and aggregated using risk measures based on 1-in-20 year stresses and other supporting measures where appropriate, for example those set out in note 39 to the financial statements on page 206.
MEASUREMENT (audited) A series of measures are used across the Group to monitor both short and long term liquidity including: ratios, cash outflow triggers, wholesale funding maturity profile, early warning indicators and stress test survival period triggers. The Board approved liquidity risk appetite links a number of these measures to balance sheet progression set out in the group funding plan, with regular reporting to the Board. Strict criteria and limits are in place to ensure highly liquid marketable securities are available as part of the portfolio of liquid assets.
MONITORING (audited) Liquidity is actively monitored at business unit and Group level. Routine reporting is in place to senior management and through the Group’s committee structure, in particular the Group Asset and Liability Committee and the Senior Asset and Liability Committee which meet monthly. In a stress situation the level of monitoring and reporting is increased commensurate with the nature of the stress event. Liquidity policies and procedures are subject to independent oversight.
Excluding repurchase agreements of £11.1 billion (31 December 2009: £35.5 billion).
Overview Business review Governance Financial statements Other information 109 Group profile 1
I lead the review of the composition of the Board, which is a continuous process, through the Nomination & Governance Committee which I chair. The Nomination & Governance Committee makes recommendations to the Board on matters relating to Board membership and governance. Membership of the Nomination & Governance Committee at present comprises the Deputy Chairman, the Senior Independent Director, the Chairman of the Audit, Remuneration and Risk Committees and one other independent Non-Executive Director. The Group Chief Executive is normally asked to attend. This provides a broad perspective of views of the Board and its Committees. The role of the Nomination & Governance Committee is explained on pages 120 and 121 and its key areas of activity in 2010 are explained below.
Numbers in brackets show the maximum number of possible meetings that each Director could have attended in 2010 including those ad hoc or called at short notice.
Our decision making has focussed on balancing shareholders’ views on remuneration with the need to attract, incentivise and retain the right people, in light of improved business performance. In reaching a decision on the size of the bonus pool as a whole and for the Executive Directors in particular, the Committee took into account the need for adjustments to reflect the Group’s current profitability and current and future risk. The Committee worked closely with the Group Risk Committee in making its decision. As a result: – There were no salary increases made to Executive Directors in 2010.
The approximate make-up of the main components of our package for Executive Directors on an expected value basis is shown below: Based on a combination of performance targets comprising earnings per share, economic profit and the achievement of stretching share price targets 40% Paid in shares after three years
Sir Victor Blank was entitled to the use of his company car until 30 April 2010, resulting in a benefit in kind tax charge of £10,490.
Year of vesting Notes a Conditional awards of shares made under this plan prior to 2010 were adjusted on 13 August 2010 as a result of the Capitalisation Issue and Rights Issue of 2009. These adjustments were made using a standard HMRC formula, to negate the dilutionary impact of the above corporate actions.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME for the year ended 31 December 2010 £ million £ million
(D) REVENUE RECOGNITION Interest income and expense are recognised in the income statement for all interest-bearing financial instruments using the effective interest method, except for those classified at fair value through profit or loss. The effective interest method is a method of calculating the amortised cost of a financial asset or liability and of allocating the interest income or interest expense over the expected life of the financial instrument. The effective interest rate is the rate that exactly discounts the estimated future cash payments or receipts over the expected life of the financial instrument or, when appropriate, a shorter period, to the net carrying amount of the financial asset or financial liability.
(2) Available-for-sale financial assets Debt securities and equity shares that are not classified as trading securities, at fair value through profit or loss, held-to-maturity investments or as loans and receivables are classified as available-for-sale financial assets and are recognised in the balance sheet at their fair value, inclusive of transaction costs. Available-for-sale financial assets are those intended to be held for an indeterminate period of time and may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Gains and losses arising from changes in the fair value of investments classified as available-for-sale are recognised directly in other comprehensive income, until the financial asset is either sold, becomes impaired or matures, at which time the cumulative gain or loss previously recognised in other comprehensive income is recognised in the income statement. Interest calculated using the effective interest method and foreign exchange gains and losses on debt securities denominated in foreign currencies are recognised in the income statement.
Overview Business review Governance Financial statements Other information 161 Group profile 1
Liabilities of the Group’s with-profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Financial Services Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below). Further details on the realistic capital regime are given on page 103. Changes in the value of these liabilities are recognised through insurance claims.
Overview Business review Governance Financial statements Other information 173 Group profile 1
Lloyds Banking Group Annual Report and Accounts 2010 8 INSURANCE PREMIUM INCOME
Life insurance gross premiums can be further analysed as follows: £m £m
Acquisition due diligence and other work performed in respect of potential venture capital investments 1.2 1.4
The Group’s principal joint venture investment at 31 December 2010 was in Sainsbury’s Bank plc; the Group owns 50 per cent of the ordinary share capital of Sainsbury’s Bank plc, whose business is banking and principal area of operation is the UK. Sainsbury’s Bank plc is incorporated in the UK and the Group’s interest is held by a subsidiary.
Overview Business review Governance Financial statements Other information 185 Group profile 1
Charge (release) to the income statement (note 12) 15,783 (3) 248 16,028
Overview Business review Governance Financial statements Other information 201 Group profile 1
Change in liabilities charged to income statement (note 10) 82 (2) 80
The expected return on scheme assets has been calculated using the following assumptions: Equities and alternative assets 8.3 8.4
The deferred tax (charge) credit in the income statement comprises the following temporary differences: £m £m
Deferred tax assets of £227 million (31 December 2009: £349 million) have not been recognised in respect of trading losses carried forward, mainly in certain overseas companies as there are limited predicted future trading profits. Trading losses can be carried forward indefinitely.
d The fixed rate on this security was reset from 8.117 per cent to 6.059 per cent with effect from 31 May 2010.
8% Undated Subordinated Step-up Notes callable 2023 (£200 million) b – –
The directors have authority to allot and issue ordinary and preference shares and to make market purchases of ordinary and preference shares as granted at the annual general meeting on 6 May 2010. The authority to issue shares and the authority to make market purchases of shares will expire at the annual general meeting. Shareholders will be asked, at the annual general meeting, to give similar authorities.
FOR OPTIONS GRANTED UP TO MARCH 2001 The performance condition was that growth in earnings per share must be equal to the aggregate percentage change in the Retail Prices Index plus three percentage points for each complete year of the relevant period together with a further condition that Lloyds Banking Group plc’s ranking based on total shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be in the top fifty companies of the FTSE 100.
INTERCHANGE FEES The European Commission has adopted a formal decision finding that an infringement of European Commission competition laws has arisen from arrangements whereby MasterCard issuers charged a uniform fallback interchange fee in respect of cross-border transactions in relation to the use of a MasterCard or Maestro branded payment card. The European Commission has required that the fee be reduced to zero for relevant cross-border transactions within the European Economic Area. This decision has been appealed to the General Court of the European Union (the General Court). Lloyds TSB Bank plc and Bank of Scotland plc (along with certain other MasterCard issuers) have successfully applied to intervene in the appeal in support of MasterCard’s position that the arrangements for the charging of a uniform fallback interchange fee are compatible with European Commission competition laws. MasterCard has announced that it has reached an understanding with the European Commission on a new methodology for calculating intra-European Economic Area multi-lateral interchange fees on an interim basis pending the outcome of the appeal. Meanwhile, the European Commission and the UK’s OFT are pursuing investigations with a view to deciding whether arrangements adopted by other payment card schemes for the levying of uniform fallback interchange fees in respect of domestic and/or cross-border payment transactions also infringe European Commission and/or UK competition laws. As part of this initiative, the OFT will also intervene in the General Court appeal supporting the European Commission’s position and Visa reached an agreement with the European Commission to reduce the level of interchange for crossborder debit card transactions to the interim levels agreed by MasterCard. The ultimate impact of the investigations on the Group can only be known at the conclusion of these investigations and any relevant appeal proceedings.
54 CONTINGENT LIABILITIES AND COMMITMENTS continued periods, the extent of application of root cause analysis, the treatment of evidence and the ultimate emergence period for complaints, driven in large part by the activities of the claims management companies, all of which will significantly affect complaints volumes, uphold rates and redress costs. No provision has been made in these financial statements to reflect implementation of the FSA’s complaint handling policy in its current form.
Trading and other financial liabilities at fair value through profit or loss 511 27,760 – 28,271
At 31 December 2010, the Group’s derivative trading business held mid to bid-offer valuation adjustments of £66 million (31 December 2009: £70 million).
Derivative financial instruments, trading and other financial liabilities at fair value through profit or loss 26,494 4,655 9,330 17,827 10,450 68,756
Repayment of capital to and extinguishment of non-controlling interests – (5,035)
Overview Business review Governance Financial statements Other information 273 Group profile 1
Internet services are available 24/7 and telephone services are available between 8.00am and 6.00pm, Monday to Friday. Details of any dealing costs are available when you log on to the share dealing website or when you call the above number. To open a Lloyds TSB Share Dealing Account you must be 18 years of age or over and be resident in the UK. You can apply online or by post.
Uncovered ABS ABS held without the benefit of separately purchased matching credit default swaps to protect against the risk of default of the security. Details of the Group’s uncovered ABS are given in note 56.
INVESTMENT PROPERTY Accounting policy 160 Notes to the consolidated financial statements 193