Risk management The Group’s approach to risk 116 Emerging risks 118 Capital stress testing 119 How risk is managed 119 Risk governance 121 Full analysis of risk drivers 123
As a result of our business performance and strong capital position, I am pleased to announce that the Board has recommended a final ordinary dividend of 1.7 pence per share, bringing the total ordinary dividend for 2016 to 2.55 pence per share, an increase of 13 per cent on last year. In addition the Board has felt able to propose an additional distribution of 0.5 pence per share as a special dividend after prudently holding back sufficient capital to cover the expected cost of the MBNA acquisition. This is in line with the Group’s policy to deliver a progressive and sustainable ordinary dividend whilst distributing surplus capital when appropriate to do so.
Strategic progress We have continued to make good progress on our strategic priorities in 2016.
1 This key risk indicator is also a key performance indicator (KPI). 2 The CET1 and leverage ratios at 31 December 2016 and 31 December 2015 are reported on a pro forma basis, including dividends paid by the Insurance business in February 2017 and February 2016 respectively, in relation to prior year earnings.
Operating costs were £8,093 million, 3 per cent lower than 2015, driven by the continued focus on cost management and actions to simplify the business. Investment in the business continues to increase, particularly in digital, and in 2016 the Group made further improvements to the branch network to meet changing customer preferences, investing in new distribution technology, designing new branch formats and upgrading call centre technology.
Consumer Finance comprises all the Group’s consumer lending products including motor finance, credit cards, and unsecured personal loans along with its European business share of credit card balances growth in UK consumer finance assets
We define our stakeholders as ’those who affect and are affected by our operations’. In addition to our shareholders, customers and colleagues, they include government, regulatory bodies, suppliers and wider society.
Board tenure Age 0–2 yrs 2–4 yrs 4–6 yrs 6–8 yrs 46–55 56–65 66–75
Directors are sent papers for the Board meeting typically seven days in advance of the meeting in order that they may have the time to consider the proposals put forward and seek clarification or further information as required. The Board makes full use of technology such as video conferencing, teleconferencing, a Board portal and tablets in its meeting arrangements. This leads to greater flexibility, security and efficiency in Board paper distribution.
Senior management succession During the year, the Committee, led by the Chairman, also reviewed the succession plans for the Group Chief Executive and other key senior management roles.
The operation of the Committee Committee meetings are managed in accordance with the principles outlined on page 62 for the management of Board agendas and meetings. These principles are intended to facilitate open debate and constructive challenge. The Committee Chairman reviews the draft agenda regularly to ensure that adequate time is devoted to issues of interest to Committee members and that its key responsibilities are addressed. The Committee Chairman reports regularly to the Board on the Committee’s work and presents the Helping Britain Prosper Plan to the Board for approval prior to publication.
Board composition changes Changes to the composition of the Board since 1 January 2016 up to the date of this report are shown in the table below: Joined the Board Retired from the Board
3 The most recent notification provided by BlackRock Inc. under Rule 5 of the DTR identifies (i) an indirect holding of 3,599,451,380 shares in the Company representing 5.04 per cent of the voting rights in the Company, and (ii) a holding of 69,305,385 in other financial instruments in respect of the Company representing 0.09 per cent of the voting rights of the Company. BlackRock Inc.’s holding most recently notified to the Company under Rule 5 of the DTR varies from the holding disclosed in BlackRock Inc.’s Schedule 13-G filing with the US Securities and Exchange Commission dated 24 January 2017, which identifies beneficial ownership of 4,566,352,317 shares in the Company representing 6.4 per cent of the issued share capital in the Company. This variance is attributable to different notification and disclosure requirements between these regulatory regimes.
Unvested deferred Group Performance Share awards are retained and in-year Group Performance Share awards are accrued until the date of termination (or the commencement of garden leave if earlier). Deferred Group Performance Share awards vest in line with normal timeframes and are subject to malus and clawback. The Committee may allow awards to vest early if it considers it appropriate.
The following table provides a breakdown of these measures and the targets applicable. The Committee believes that these measures appropriately capture risk management and long-term sustainable growth, aligning management and shareholder interests. Each of the measures aligns to the reward principles and, through that, the Group’s strategic priorities. Awards are subject to malus and clawback for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation. The Committee may consider the application of malus and clawback as outlined in the Group Performance Share plan section above.
Based on a full assessment of performance, the Committee agreed an individual rating for 2016 of Strong plus for the GCE, an improvement from Strong in 2015.
Following the Committee’s assessment of performance against the underlying profit target and the Risk division’s BSC objectives, and taking into account the collective performance adjustment of 19 per cent and the individual rating of Strong plus, the Committee determined a 2016 bonus award for the CRO of £577,676 (78 per cent of maximum).
The Group’s malus and clawback provisions cover all material risk takers, in line with regulatory requirements. Vested variable remuneration can be recovered from employees for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation. The Committee reserves the right to exercise its discretion in reducing any payment that otherwise would have been earned, if it deems appropriate as a result of an event occurring before vesting.
As part of a conservative business model that embodies a risk culture founded on a prudent approach to managing risk, the Group reviewed its Codes of Business and Personal Responsibility in 2016 reinforcing its approach where colleagues are accountable for the risks they take and where the needs of customers are paramount.
The review and challenge of the detailed stress forecasts, the key assumptions behind these, and the methodology used to translate the economic assumptions into stressed outputs conclude with the divisional Finance Director’s, appropriate Risk Director’s and Managing Director’s sign-off. The outputs are then presented to GFRC, Group Asset and Liability Committee/Group Risk Committee/Group Executive Committee and Board Risk Committee for Group-level executive review and challenge, before being approved by the Board.
The divisional/functional risk committees review and recommend divisional/functional risk appetite and monitor local risk profile and adherence to appetite.
The Group also assesses the affordability and sustainability of lending for each borrower, for secured lending this includes use of an appropriate stressed interest rate scenario. Affordability assessments are compliant with relevant regulatory conduct guidelines. The Group takes reasonable steps to validate information used in the assessment of a customer’s income and expenditure.
Retail and Consumer Finance customers The Group’s aim in offering forbearance and other assistance to customers in financial distress is to benefit both the customer and the Group by discharging the Group’s regulatory and social responsibilities to support its customers and act in their best long-term interests and by bringing customer facilities back into a sustainable position which, for residential mortgages, also means keeping customers in their homes. The Group offers a range of tools and assistance to support customers who are encountering financial difficulties. Cases are managed on an individual basis, with the circumstances of each customer considered separately and the action taken judged as being affordable and sustainable for the customer. Operationally, the provision and review of such assistance is controlled through the application of an appropriate policy framework, controls around the execution of policy, regular review of the different treatments to confirm that they remain appropriate, monitoring of customers’ performance and the level of payments received, and management visibility of the nature and extent of assistance provided and the associated risk.
Those customers deemed higher risk where there is cause for concern over future repayment capability or where there is a risk of the asset becoming impaired will be transferred to the Business Support Unit (BSU) at an early stage. BSU will take over the ‘credit’ responsibility for the customer relationship whilst the ‘servicing’ responsibility remains with the original Relationship Manager. The over-arching aim of the BSU is to provide support and work consensually with each customer to try and resolve the issues, restore the business to a financially viable position and thereby bring about a business turnaround. This may involve a combination of restructuring, work out strategies and other types of forbearance.
Depending on circumstances and when operated within robust parameters and controls, the Group believes forbearance can help support the customer in the short to medium-term. The Group expects to have unimpaired forborne assets within its portfolios, where default has been avoided, or when no longer considered impaired, although the majority of these cases will be managed in the BSU, where more intensive management and monitoring is available.
UK exposures >£5m 1 Excludes Islands Commercial UK Direct Real Estate.
The Group’s leadership team, through the GCFC, has oversighted and approved the transition of the Conduct Strategy within the business as usual to support the development of the right customer centric culture. The Board and Group Risk Committee receive regular qualitative and quantitative reports to track progress on how the Group is meeting customer needs and minimising conduct risk across all areas of the business.
Trading market risk measures are applied to all the Group’s regulatory trading books and they include daily VaR (table 1.39), sensitivity based measures, and stress testing calculations.
All risk factors before diversification 1.2 2.1 14.3 1.1 1.3 2.3 6.2 1.3
2 Excludes £20.9 billion (31 December 2015: £20.8 billion) of loans and advances to banks within the Insurance business and £0.9 billion (31 December 2015: £0.9 billion) of reverse repurchase agreements.
Target capital ratios The Board’s view of the current level of CET1 capital required to grow the business, meet regulatory requirements and cover uncertainties and future regulatory developments remains at around 13 per cent.
2 Includes the accrual for the 2016 full year ordinary and special dividends and the reversal of the accrual for the 2015 full year ordinary and special dividends which were paid during the year.
Total risk-weighted assets as at 31 December 2016 215,534 1 Credit risk includes securitisation risk-weighted assets.
This includes a review of the Group’s current approach to governance and ongoing initiatives in light of the latest regulatory guidance, including in 2016 the further enhancement of frameworks to address Senior Managers and Certification Regime (SM&CR) requirements and prepare for the requirement to ring-fence retail banking activities with effect from January 2019.
Consolidated statement of changes in equity continued for the year ended 31 December
Segment underlying income, net of insurance claims 7,472 4,504 3,405 1,594 467 17,442
The Group has procedures that are designed to ensure auditor independence, including that fees for audit and non-audit services are approved in advance. This approval can be obtained either on an individual engagement basis or, for certain types of non-audit services, particularly those of a recurring nature, through the approval of a fee cap covering all engagements of that type provided the fee is below that cap.
Due to change in UK corporation tax rate (201) (27) (24)
Bank and building society certificates of deposit – 244 244 – 135 135
Individual impairment allowances are generally established against the Group’s commercial lending portfolios. Assets are reviewed on a regular basis and those showing potential or actual vulnerability are placed on a watchlist where greater monitoring is undertaken and any adverse or potentially adverse impact on ability to repay is used in assessing whether an asset should be transferred to a dedicated Business Support Unit. Specific examples of trigger events that could lead to the initial recognition of impairment allowances against lending to corporate borrowers (or the recognition of additional impairment allowances) include (i) trading losses, loss of business or major customer of a borrower; (ii) material breaches of the terms and conditions of a loan facility, including non‑payment of interest or principal, or a fall in the value of security such that it is no longer considered adequate; (iii) disappearance of an active market because of financial difficulties; or (iv) restructuring a facility with preferential terms to aid recovery of the lending (such as a debt for equity swap).
A market-consistent approach has been adopted for the valuation of financial options and guarantees, using a stochastic option pricing technique calibrated to be consistent with the market price of relevant options at each valuation date. Further information on options and guarantees can be found in note 32.
The customer-related intangibles include customer lists and the benefits of customer relationships that generate recurring income.
The following table demonstrates the effect of reasonably possible changes in key assumptions on profit before tax and equity disclosed in these financial statements assuming that the other assumptions remain unchanged. In practice this is unlikely to occur, and changes in some assumptions may be correlated. These amounts include movements in assets, liabilities and the value of the in-force business in respect of insurance contracts and participating investment contracts. The impact is shown in one direction but can be assumed to be reasonably symmetrical.
The Group operates a number of funded and unfunded pension arrangements, the majority, including the three most significant schemes, are funded schemes in the UK. All these schemes are operated as separate legal entities under trust law by the trustees and are in compliance with the Pensions Act 2004. A valuation exercise is carried out for each scheme at least every three years, whereby scheme assets are measured at market value and liabilities (technical provisions) are measured using prudent assumptions. If a deficit is identified a recovery plan is agreed between the Group and the scheme Trustee and sent to the Pensions Regulator for review. The Group has not provided for these deficit contributions as the future economic benefits arising from these contributions are expected to be available to the Group. The Group’s overseas defined benefit pension schemes are subject to local regulatory arrangements.
Other Following the sale of TSB Banking Group plc in 2015, the Group raised a provision of £665 million in relation to the Transitional Service Agreement entered into between Lloyds Bank plc and TSB and the contribution to be provided to TSB in moving to alternative IT provision; £611 million of this provision remained unutilised at 31 December 2016.
Change in fair value of available-for-sale financial assets 356 (318) 690
Adjustment on sale of non-controlling interest in TSB – – (171)
Transfers out of the level 3 portfolio (37) – (1,263) 819
– Subject to floors, to mitigate the risk of underestimating credit losses due to a lack of historical data
Sensitivity of level 3 valuations at 31 December 2015 Effect of reasonably possible alternative assumptions
1 Ranges represented the highest and lowest inputs used in the level 3 valuations.
Operating jaws The difference between the period on period percentage change in total income net of insurance claims less operating lease depreciation and the period on period change in operating costs calculated on an underlying basis.
Loans past due Loans are past due when a counterparty has failed to make a payment when contractually due.
10 Main components of capital and a reconciliation of the accounting balance sheet to the regulatory balance sheet. 162, Pillar 3 11 Flow statement of movements since the prior reporting date in regulatory capital, including changes in common equity tier 1, tier 1 and tier 2 capital. 163 12 Discuss capital planning, including a description of management’s view of the required or targeted level of capital and how this will be established.
Equipment Leasing (No. 6) Ltd (in liquidation) 100% 13 Eurolead Services Holdings Ltd 100% 9 Exclusive Finance No. 1 Ltd 100% 1 100% i Financial Consultants LB Ltd 100% 1 First Retail Finance (Chester) Ltd 100% 4 Flexifly Ltd 100% 17 Fontview Ltd 100% 20 Forthright Finance Ltd 100% 2 France Industrial Premises Holding Company 100% 28 Freeway Ltd 100% 2 General Leasing (No. 2) Ltd (in liquidation) 100% 13 General Leasing (No. 4) Ltd 100% 1 General Leasing (No. 12) Ltd 100% 1 General Leasing (No. 14) Ltd (in liquidation) 100% 13 General Leasing (No. 15) Ltd (in liquidation) 100% 13 General Reversionary and Investment Company 80% (100%) 20 GFP Holdings LLC 100% 14 Glosstrips Ltd 100% 17 Godfrey Davis (Contract Hire) Ltd 100% 2 Gresham Nominee 1 Ltd 100% 1 Gresham Nominee 2 Ltd 100% 1 Halifax Credit Card Ltd 100% 4 i 100% ii 100% vii Halifax Equitable Ltd 100% 4 Halifax Financial Brokers Ltd 100% 4 Halifax Financial Services (Holdings) Ltd 100% 4 Halifax Financial Services Ltd 100% 4 Halifax General Insurance Services Ltd 100% 4 Halifax Group Ltd 100% 4 Halifax Investment Services Ltd 100% 4 Halifax Leasing (June) Ltd 100% 1 Halifax Leasing (March No.2) Ltd 100% 1 Halifax Leasing (September) Ltd 100% 1 Halifax Life Ltd 100% 4
Oystercatcher LP n/a 20* Oystercatcher Nominees Ltd 100% 20 Oystercatcher Residential Ltd 100% 20 Pacific Leasing Ltd 100% 1 Pensions Management (S.W.F.) Ltd 100% 54 Peony Eastern Leasing Ltd 100% 1 Peony Leasing Ltd 100% 1 Peony Western Leasing Ltd 100% 1 Perry Nominees Ltd 100% 1 PIPS Asset Investments Ltd 100% 1 i
Europa Property Company (Northern) Ltd 100% Europa House, 20 Esplanade, Scarborough, North Yorkshire, YO11 2AQ vii European Property Fund (Holdings) Ltd SARL 24.9% 1 Allee Scheffer, Luxembourg, l-25250, Luxembourg ii Express Engineering (Group) Ltd 37.4% Kingsway North, Team Valley Trading Estate, Gateshead, NE11 0EG FDL Salterns Ltd 25% 2 Poole Road, Bournemouth, BH2 5QY Fern Bay Seaside Village Ltd (in liquidation) 34.48% Septimus Roe Square, Level 8, 256 Adelaide Terrace, Perth, WA 6000, Australia FHR European Ventures LLP n/a CMS Cameron Mckenna LLP, 78 Cannon Street, London, EC4N 6AF * Forest Holidays Group Ltd 59.3% Bath Yard, Bath Lane, Moira, Swadlincote, Derbyshire, DE12 6BA & Giacom Holdings Ltd 40.6% 1 Priory Court, Saxon Way, Hessle, East Yorkshire, HU13 9PB Golfview Apartment Holdings LLC 43.758% Jeffrey Cohen, 1066 Woodward Avenue, Detroit, MI 48226, United States Golfview Apartments LLC 88% 300 South Orange Avenue, Suite 100, Orlando, FL 32801, United States Great Wigmore Property Ltd 100% 33 Cavendish Square, London, W1G 0PW & HBOS Capital Funding LP, n/a Sanne Group, 13 Castle Street, St. Helier, Jersey, JE4 5UT * HBOS Capital Funding No. 1 LP n/a Sanne Group, 13 Castle Street, St. Helier, Jersey, JE4 5UT * HBOS Capital Funding No. 3 LP n/a Sanne Group, 13 Castle Street, St. Helier, Jersey, JE4 5UT * HBOS Capital Funding No. 4 LP n/a Sanne Group, 13 Castle Street, St. Helier, Jersey, JE4 5UT * HBOS Euro Finance (Jersey) LP n/a Sanne Group, 13 Castle Street, St. Helier, Jersey, JE4 5UT * HBOS Sterling Finance (Jersey) LP n/a Sanne Group, 13 Castle Street, St. Helier, Jersey, JE4 5UT * Hedge End Place (Durkan) LLP n/a 4 Elstree Gate, Elstree Way, Borehamwood, Hertfordshire, WD6 1JD * Hedge End Place Hold Co Ltd 50% 25 Gresham Street, London, EC2V 7HN & Helsinki Topco Ltd 16.1% Granville House, Gatton Park Business Centre, Redhill, Surrey, RH1 3AS & ICB Brands Holdings Ltd 58.5% 4 Sceptre House, Hornbeam Square, Hornbeam Business Park,
UK Index Linked Gilt Fund 100% Corporate Bond PPF Fund 100% SW Corporate Bond Tracker 100% Scottish Widows GTAA 1 82.92% Corporate Bond 1 Fund 100% Balanced Growth Fund 27.47% Adventurous Growth Fund 71.25%
THE TM LEVITAS FUNDS 21 TM Levitas A Fund 42.39% TM Levitas B Fund 32.86%