We have taken further steps towards this goal this year. As well as reporting our fi nancial results, we also report on our approach to operating responsibly and take into account relevant economic, political, social, regulatory and environmental factors.
We continue to align our remuneration principles to the Group’s strategic objectives to ensure we reward performance and ensure our approach to remuneration is aligned to the interests of our shareholders.
Total GPS outcome remains a small proportion of underlying profit at 5.1 per cent and an even smaller proportion of overall revenues. Cash GPS awards are capped at £2,000 with additional amounts paid in shares and subject to deferral and performance adjustment to ensure their ultimate value reflects sustained performance. More information on how we ensure our approach to remuneration supports our strategy can be found in the Directors’ remuneration report on pages 84 to 104.
I would like to thank all of our colleagues for their contribution to making 2018 such a successful year. It is the commitment, support and dedication from all of them that enables us to succeed.
Delivering for all our stakeholders The Board has been actively involved in the development and ongoing review of strategy with regular reviews of progress and priorities. Following the launch of the next phase of our strategic plan in early 2018, and in addition to the regular management progress updates, a comprehensive Board review process has been implemented which includes formal quarterly updates and selective deep dives on topical issues. In addition strategy days were held in June and November to consider market dynamics and the strategic challenges and opportunities the Group is likely to face going forward. Board members have also made a number of site visits to understand how the strategy is being implemented and perceived at a local level. Key performance indicators are regularly reviewed by the Board with the measures outlined on this page identifying the most effective output measures for assessing financial performance and progress towards becoming the best bank for customers, colleagues and shareholders.
Digital skills Using a blend of transactional and attitudinal data we provide the UK's largest study of the digital capability of individuals, SMEs and charities. The Lloyds Bank Consumer Digital Index 2018 shows that 21 per cent of the UK lack basic digital skills, including 10 per cent of the working population. A further 8 per cent are entirely offline. 42 per cent of SMEs and 48 per cent of charities lack the skills to benefit from the time and costs savings associated with digital capability. The Lloyds Bank Business and Charity Digital Index 2018 revealed that the UK loses £84.5 billion in annual revenue due to a lack of SME digital capability.
We know that the most inclusive organisations are the most successful, so we welcome and value the unique difference of every colleague. 2018 has been a year of significant progress against our I&D objectives, which we know is a source of pride for our colleagues; this year 88 per cent of them agreed in our annual survey that the Group is an inclusive place to work. Around 50 per cent of colleagues also belong to or support one of our five diversity networks.
Financial performance Underlying profit at £4,272 million increased 13 per cent Net interest income increased 4 per cent reflecting an 8 basis point improvement in net interest margin with the benefits of a full year of MBNA and lower funding costs more than offsetting ongoing mortgage pricing pressure Other income was 2 per cent lower following implementation of a simpler overdraft fee structure Operating lease depreciation reduced 3 per cent reflecting improved used car market prices Operating costs of £4,915 million increased 1 per cent, as increased investment in the business was partly offset by efficiency savings. Remediation reduced to £267 million, driven by lower provision charges Impairment increased 21 per cent reflecting full year inclusion of MBNA and non-repeat of UK mortgages write-backs Loans and advances include the increase in Business Banking balances and growth in Black Horse offset by reductions in the closed mortgage book. Open mortgage book balances were broadly flat at £267 billion reflecting continued focus on the trade-off between volume and margin in a highly competitive market Customer deposits included average current account growth of 6 per cent and continued reduction in tactical savings
Leading customer experience Successful launch of Lloyds Bank Corporate Markets, the Group’s non ring-fenced bank, enabling us to continue meeting our clients’ broad range of needs while helping to create a safer, more secure financial services industry Further simplified the client coverage model to better reflect the changing needs of our clients. Coverage model now based on three segments – SME and Mid Corporates, Large Corporates and Financial Institutions Awarded Business Bank of the Year at the FDs’ Excellence Awards for the 14th consecutive year, with an overall satisfaction rating of nine out of ten
Our pensions experts provided free guidance, whether they were just thinking about starting a pension or perhaps coming to the end of their working career and are about to retire, all questions were welcomed, big or small – ensuring people feel happy and confident when thinking about their future.
Operating lease depreciation reduced by 9 per cent to £956 million reflecting improved used car prices and the non-recurrence of accelerated depreciation charges within Commercial Banking in 2017.
Stage 2 loans and advances to customers as a percentage of total lending reduced by 3.5 percentage points to 7.8 per cent reflecting the sale of the Irish portfolio, model refinements and portfolio improvements whilst Stage 3 loans and advances were stable at 1.9 per cent. At the same time coverage of Stage 2 assets has increased to 4.1 per cent of drawn balances and Stage 3 assets to 24.3 per cent. At the end of 2018, the Group held a total ECL allowance of £4.4 billion, equivalent to over four years of net underlying cash write-offs (and five years for the mortgage portfolio).
Return on tangible equity The return on tangible equity was 11.7 per cent up from 8.9 per cent in 2017, reflecting the increase in statutory profit after tax, and slightly lower average tangible equity. The underlying return on tangible equity increased to 15.5 per cent (2017: 14.0 per cent) reflecting increased underlying profit.
5 The CET1, MREL and leverage ratios at 31 December 2018 and 1 January 2018 are reported on a pro forma basis, reflecting the dividends paid up by the Insurance business in February 2019 and February 2018 respectively in relation to prior year earnings. The CET1 ratio is also reported post dividends and share buyback.
Skills and experience: Antonio joined the Group as head of the Wealth and International division and Group Corporate Development, leading the Group’s strategic review and subsequent programme of reducing non-core assets and exiting international locations. From 2013, he assumed the role of Group Director, Consumer Finance & Group Corporate Development, leading the division’s growth strategy whilst completing the sale of TSB. At the end of 2015 he was appointed Chief Executive, Scottish Widows and Group Director, Insurance and during 2017 he also assumed responsibility for the Wealth Division. Antonio is also Group Executive Sponsor for Emerging Talent. Antonio joined the Group from Santander, where he had worked in a number of different leadership roles and jurisdictions since 1998. He was part of the management team that completed the take-over of Alliance & Leicester and Bradford & Bingley and was Chief Financial Officer of Santander UK. Before Santander, Antonio spent over nine years at Arthur Andersen.
Schroders joint venture On 23 October 2018, the Group announced a strategic partnership with Schroders plc to create a market-leading wealth management proposition. The three key components of the partnership are: (i) the establishment of a new financial planning joint venture (the ‘JV’); (ii) the Group taking a 19.9 per cent stake in Schroders high net worth UK wealth management business; and
Ensuring that the Group is as prepared as it possibly can be with the strongest defences and tools at its disposal is the only prudent course to take and is one we have pursued vigorously in recent years to protect the Group and all of its customers from whatever might happen in the future.
Lord Blackwell’s visit continued with a Town Hall session, with over 200 colleagues, followed by a visit to two local branches where he discussed the evolution of technology with mortgage advisors, and how their role has changed. Lord Blackwell then met with Women Connect First, which aims to empower black and minority ethnic women in Cardiff, helping them realise their full potential and make an impact on Welsh society.
B7. Re-election of Directors At the 2019 AGM all Directors will seek re-election or election. Being the first AGM following her appointment, Amanda Mackenzie will stand for election, with all other Directors standing for re-election. The Board believes that all Directors continue to be effective and committed to their roles.
C2. Risk management and internal control systems The Board is responsible for the Group’s risk management and internal controls systems; see page 64 for more detail regarding internal control. The Audit Committee is responsible for the effectiveness of internal controls and the Risk Management Framework. Further information can be found on pages 70 to 73.
In addition to existing methods of training for the Non-Executive Directors, at the end of 2017, members of the Committee trialled an online mandatory training programme. This was subsequently rolled out to the rest of the Board. Full details can be found on page 63.
Committee composition, skills and experience To ensure a broad representation of experienced and independent Directors, membership of the Committee comprises the Chairman, the Deputy Chairman, who is also the Senior Independent Director, the Chairman of the Board Risk Committee and the Chairman of the Responsible Business Committee. The Group Chief Executive attends meetings as appropriate.
In addition, the Committee considered a number of other significant issues not related directly to financial reporting, including internal controls, internal audit and external audit. These issues are also discussed in detail in the next section, including insight into the key factors considered by the Committee in reaching its conclusions.
The key risks for the Group include volatility and possible discontinuities in financial markets, impact on our customers’ trading performance, financial position and credit profile, and ability to operate cross-border. When reviewing the possible impacts of the EU Exit, the Committee has given particular consideration to the Group’s strong UK focus and UK-centric strategy. The Committee continues to closely monitor developments, with specific focus on the trading, financial and operational impacts for the Group, and the continued support of our customers.
The Committee noted the positive outcome of the FCA Systematic Anti-Money Laundering Programme review, recognising the Group’s ‘largely effective Financial Crime control framework’ and ‘strong tone from the top’. Additionally, the Committee noted the progress in the Group’s money mules strategy which has resulted in a significant improvement in the identification and prevention of illicit funds being laundered through Group accounts.
Greenhouse gas emissions The Group has voluntarily reported greenhouse gas emissions and environmental performance since 2009, and since 2013 this has been reported in line with the requirements of the Companies Act 2006. Our total emissions, in tonnes of CO2 equivalent, are reported in the strategic report on page 25. Deloitte LLP has provided limited level ISAE 3000 (Revised) assurance over selected non-financial indicators as noted by . Their full, independent assurance statement is available online at www.lloydsbankinggroup.com/rbdownloads.
Strong financial performance delivered in a continuing challenging low interest rate environment.
CET1 capital generation of 210 bps, comfortably exceeding market guidance of 200 bps.
Nick Luff (retired May 2017) – 69 – 69 1 Benefits: car allowance (£12,000).
For the 2019 performance year, any Group Performance Share opportunity will be awarded in March 2020 in a combination of cash (up to 50 per cent) and shares. 40 per cent will be released in the first year following the award with £2,000 paid in cash, and the balance of the upfront 40 per cent delivered in shares; 50 per cent of which will be subject to holding until March 2020. The remaining 60 per cent is deferred into shares with 40 per cent vesting in 2020 and 20 per cent in 2021. 50 per cent of each release will be subject to a further 12-month holding in line with regulatory requirements.
Awards made in 2019 will vest based on the Group’s performance against the financial and strategic measures, set out in the table opposite. In line with the Directors’ remuneration policy, the Committee has full discretion to amend payout levels should the award not reflect business and/or individual performance. Business performance includes, but is not limited to, consideration of returns to shareholders.
How the Remuneration Committee spent its time in 2018 The Committee held five scheduled meetings during 2018 where the following key matters were considered.
Senior Executives and Executive Directors: Review of performance and remuneration arrangements for Executive Directors and key senior management
Market – the Group has robust controls in place to manage its inherent market risk and does not engage in any proprietary trading, reflecting the customer focused nature of the Group’s activities.
There continues to be uncertainty as to the impact of EU exit or the impact of a no deal outcome on the regulatory and legal landscape. One impact of EU exit will be that the UK loses its ability to make use of the EU Passport for provision of banking services into the EU.
Cyber: Increases in the volume and sophistication of cyber-attacks alongside the growth in connected devices continues to heighten the potential for cyber-enabled crime.
Data: Advancements in new technologies and new services, an increasing external threat landscape, and changing regulatory requirements increase the need for the Group to effectively govern, manage, and protect its data (or the data shared with third-party suppliers). Failure to manage data risk will impact the accuracy, access to and availability of data, ultimately leading to poor customer outcomes, loss of value to the bank and reputational damage.
The review and challenge of the Group’s 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 Directors’, appropriate Risk Directors’ and Managing Directors’ sign-off. The outputs are then presented to GFRC and Board Risk Committee for review and challenge, before being approved by the Board. There is a similar process within LBCM for the governance of the LBCM-specific results.
The Group Risk Committee is supported through escalation and ongoing reporting by business area risk committees, cross-divisional committees addressing specific matters of Group-wide significance and the following second line of defence Risk committees which ensure effective oversight of risk management: Credit Risk Committees Review material credit risk, both current and emerging, and adherence to agreed risk appetite; approve, or note the delegated approval of divisional and business level credit risk policy and credit risk appetite; identify portfolio trends and risk appetite breaches and escalate to Group Risk Committee as appropriate; sanction new credit initiatives for automated and manual decisioning and collection and recoveries; oversight new business and portfolio credit risk performance, risks, opportunities, and concentrations; and oversight performance of collections and recoveries.
Prudent, through the cycle credit principles, risk policies and appetite statements: the independent Risk division sets out the credit principles, credit risk policies and credit risk appetite statements. These are subject to regular review and governance, with any changes subject to an approval process. Risk teams monitor credit performance trends, review and challenge exceptions, and test the adequacy and adherence to credit risk policies and processes throughout the Group. This includes tracking portfolio performance against an agreed set of credit risk appetite tolerances.
Refer to note 52 on page 255 for further information on collateral.
The Group’s effective risk management ensures early identification and management of customers and counterparties who may be showing signs of distress
– Stage 2 balances have reduced to 9.2 per cent of the portfolio, largely due to model refinements to the Stage 2 transfer approach for Secured.
Unsecured loans and advances were broadly flat for the year ending 31 December 2018. The impairment charge increased by £91 million to £683 million (2017: £592 million), mainly due to the inclusion of MBNA for a full year. Coverage decreased slightly to 3.5 per cent at 31 December 2018 (1 January 2018: 3.8 per cent), with model refinements in Stage 2 offset by those in Stage 3.
Average loan to value1: Stock of residential mortgages 42.5 52.1 45.8 44.1
Commercial Banking UK Direct Real Estate gross lending stood at £17.2 billion at 31 December 2018 (excludes exposures subject to protection through Significant Risk Transfer securitisations). The Group has a further £0.54 billion of UK Direct Real Estate exposure in Business Banking within Retail.
Group policies and procedures set out the principles and key controls that should apply across the business which are aligned to the Group risk appetite. Mandated policies and processes require appropriate control frameworks, management information, standards and colleague training to be implemented to identify and manage regulatory and legal risk.
Business units, with the support of divisional and Group-level bodies, conduct ongoing horizon scanning to identify changes in regulatory and legal requirements.
Table 1.26: Operational risk events by risk category (losses greater than or equal to £10,000), excluding PPI1
The Group adopts a risk based approach to mitigate the internal and external fraud risks it faces, reflecting the current and emerging fraud risks within the market. Fraud risk appetite metrics have been defined, holistically covering the impacts of fraud in terms of losses to the Group, costs of fraud systems and operations, and customer experience of actual and attempted fraud. Oversight of the appropriateness and performance of these metrics is undertaken regularly through business area and Group-level committees. This approach drives a continual programme of prioritised enhancements to the Group’s technology, process and people related controls, with an emphasis on preventative controls supported by real time detective controls wherever feasible. Group-wide policies and operational control frameworks are maintained and designed to provide customer confidence, protect the Group’s commercial interests and reputation, comply with legal requirements and meet regulatory expectations. The Group’s fraud awareness programme remains a key component of its fraud control environment, and awareness of fraud risk is supported by mandatory training for all colleagues. The Group also plays an active role with other financial institutions, industry bodies, and enforcement agencies in identifying and combatting fraud.
Measurement Insurance underwriting risks are measured using a variety of techniques including stress, reverse stress and scenario testing, as well as stochastic modelling. Current and potential future insurance underwriting risk exposures are assessed and aggregated on a range of stresses including risk measures based on 1-in-200 year stresses for Insurance’s regulatory capital assessments and other supporting measures where appropriate, including those set out in note 32 to the financial statements.
The Board also gives due consideration to the return of surplus capital through the use of special dividends or share buybacks. Surplus capital represents capital over and above the amount management wish to retain to grow the business, meet regulatory requirements and cover uncertainties. The amount of required capital may vary from time to time depending on circumstances and by its nature there can be no guarantee that any return of surplus capital will be appropriate in future years.
Risk-weighted assets as at 31 December 2017 138,986 25,503 164,489 7,885 3,051 25,326 200,751
During the year, the Group took advantage of favourable funding markets to raise £21.4 billion of new term wholesale funding in order to refinance maturities in the year including the Bank of England’s Funding for Lending Scheme (FLS) and increase liquidity buffers. As a result wholesale funding increased from £101.1 billion to £123.3 billion.
Cash and balances at central banks 54,663 – 54,663 – Interest rate
Table 1.43: Key material market risks for the Group by individual business activity (profit before tax impact measured against Group single stress scenarios)
Interest rate risk Yield curve risk in the Group’s divisional portfolios, and in the Group’s capital and funding activities arises from the different repricing characteristics of the Group’s non-trading assets, liabilities (see loans and advances to customers and customer deposits in table 1.42) and offbalance sheet positions.
(ii) Interest income sensitivity: this measures the 12 month impact on future net interest income arising from various economic scenarios. These include instantaneous 25, 100 and 200 basis point parallel shifts in all yield curves and the five Group economic scenarios (subject to an appropriate floor). These scenarios are reviewed every year and are designed to replicate severe but plausible economic events, capturing risks that would not be evident through the use of parallel shocks alone such as basis risk and steepening or flattening of the yield curve. An additional negative rates scenario is also used for information purposes where all floors are removed; however this is not measured against the limit framework.
Interest rate risk arises through holding credit and interest assets mainly in the annuity book and also to cover general insurance liabilities, capital requirements and risk appetite.
Responsibilities for the financial statements and the audit Responsibilities of the directors for the financial statements As explained more fully in the Statement of Directors’ Responsibilities set out on page 81, the directors are responsible for the preparation of the financial statements in accordance with the applicable framework and for being satisfied that they give a true and fair view. The directors are also responsible for such internal control as they determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
(3) Net investment hedges Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognised in other comprehensive income, the gain or loss relating to the ineffective portion is recognised immediately in the income statement. Gains and losses accumulated in equity are included in the income statement when the foreign operation is disposed of. The hedging instrument used in net investment hedges may include non‑derivative liabilities as well as derivative financial instruments.
Notes to the consolidated financial statements continued consistent with that applied to such a cash flow in the capital markets. The asset in the consolidated balance sheet is presented gross of attributable tax and movements in the asset are reflected within other operating income in the income statement.
Liabilities under sale and repurchase agreements 0.96 0.58 0.46 (245) (110) (38)
Other non‑audit fees: Services relating to corporate finance transactions – 1.2 0.1
Expenditure on investment properties is comprised as follows: 2018 £m 2017 £m
The Group has also established three private limited companies which hold assets to provide security for the Group’s obligations to the HBOS Final Salary Pension Scheme, a section of the Lloyds Bank Pension Scheme No 1 and the Lloyds Bank Offshore Pension Scheme. At 31 December 2018 these held assets of approximately £4.6 billion in aggregate. The private limited companies are consolidated fully in the Group’s balance sheet. The terms of these arrangements require the Group to maintain assets in these vehicles to agreed minimum values in order to secure obligations owed to the relevant Group pension schemes. The Group has satisfied this requirement during 2018.
Note 35: Retirement benefit obligations continued Effect of reasonably possible alternative assumptions
Preference shares The Company has in issue various classes of preference shares which are all classified as liabilities under accounting standards and which are included in note 38.
Tax authorities The Group has an open matter in relation to a claim for group relief of losses incurred in its former Irish banking subsidiary, which ceased trading on 31 December 2010. In 2013 HMRC informed the Group that their interpretation of the UK rules which allow the offset of such losses denies the claim. If HMRC’s position is found to be correct management estimate that this would result in an increase in current tax liabilities of approximately £770 million (including interest) and a reduction in the Group’s deferred tax asset of approximately £250 million. The Group does not agree with HMRC’s position and, having taken appropriate advice, does not consider that this is a case where additional tax will ultimately fall due. There are a number of other open matters on which the Group is in discussion with HMRC (including the tax treatment of certain costs arising from the divestment of TSB Banking Group plc), none of which is expected to have a material impact on the financial position of the Group.
Financial assets at amortised cost – – – – 482,752 – 482,752
(3) Financial assets and liabilities carried at fair value (A) Financial assets, excluding derivatives Valuation hierarchy At 31 December 2018, the Group’s financial assets carried at fair value, excluding derivatives, totalled £183,344 million (31 December 2017: £204,976 million). The table below analyses these financial assets by balance sheet classification, asset type and valuation methodology (level 1, 2 or 3, as described on page 243). The fair value measurement approach is recurring in nature. There were no significant transfers between level 1 and 2 during the year.
Stage 3 assets include balances of approximately £250 million (with outstanding amounts due of approximately £2,200 million) which have been subject to a partial write‑off and where the Group continues to enforce recovery action.
In some circumstances, where the discounted value of the estimated net proceeds from the liquidation of collateral (i.e. net of costs, expected haircuts and anticipated changes in the value of the collateral to the point of sale) is greater than the estimated exposure at default, no credit losses are expected and no ECL allowance is recognised.
Non-cash and other items (2,892) 12,332 13,535 1 These OEICs (Open‑ended investment companies) are mutual funds which are consolidated if the Group manages the funds and also has a sufficient beneficial interest. The population of OEICs to be consolidated varies at each reporting date as external investors acquire and divest holdings in the various funds. The consolidation of these funds is effected by the inclusion of the fund investments and a matching liability to the unitholders; and changes in funds consolidated represent a non‑cash movement on the balance sheet.
Financial assets at fair value through profit or loss 588 588 588 – – – – –
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6 Total dividend for the year divided by earnings attributable to ordinary shareholders adjusted for tax relief on distributions to other equity holders.
Associated undertakings The Group has a participating interest in the following undertakings.