Strategic report Group highlights 01 Chairman’s statement 02 Group Chief Executive’s review 04 Key performance indicators 06 The external environment 08 Our business model 10 What we have achieved over the last three years 12 Our strategic planning process 13 Our next chapter 14 Doing business responsibly 18 Running a responsible business for all our stakeholders 21 Environment 26 Divisional overview 28 Risk overview 32
Prudent, low risk participation choices with strong capital position Being low risk is fundamental to our business model. Our low risk appetite is reflected through the low level of non-performing loans and run-off assets, as well as our credit default swap spread, which is amongst the best in the banking sector worldwide. Our financial strength has been transformed in recent years with our capital position amongst the strongest in the sector worldwide.
We are a responsible business, focused on succeeding over the longer-term, and we believe that helping to make Britain a more inclusive and prosperous country is fundamental to that aim.
Responsible business highlights We are doing business responsibly and making a significant impact
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Disability Percentage of colleagues who disclose they have a disability 2.6% 2.2%
We have policies, standards and relevant mandatory training in place to help colleagues work safely at all times. We also work closely with external health and safety agencies through our participation in the Health and Safety Primary Authority Scheme and Fire Primary Authority partnership. In 2017, we achieved a 7 per cent decrease in our total recorded accidents compared to 2016. You can read more about health and safety in our 2017 Responsible Business update.
Customers We aim to treat our customers fairly and inclusively, making it easy for them to find, understand and access responsible products that are right for them, whatever their circumstances.
Customer satisfaction We measure customer satisfaction using the industry standard Net Promoter Score. In 2017, this was 62.0, down slightly from 62.7 in 2016 but remains nearly 50 per cent higher than at the end of 2011. When customers do complain, we act as quickly as possible, focusing on achieving fair outcomes. We continue to target understanding and eradicating the root causes of customer complaints reducing incoming complaints by 18 per cent from 2016 to 2017 (excluding PPI and claims management companies). Read more on page 7.
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Government We engage with government bodies, including central and local government and the devolved governments in Scotland, Wales and Northern Ireland. We keep them informed about our activity as a responsible business, which in 2017 included party conference fringe meetings held with Mental Health UK, the launch of a report on the challenges facing the private rental sector, and briefings on economic development. To support the UK’s nations and regions, our 10 Ambassadors, who are all senior colleagues, have a mandate from the Group Chief Executive to support economic and social progress in their local area. In 2017, our Ambassadors focused on issues connected to housing, skills development and business growth.
Capital management actions include successful conclusion of a £1.3 billion annuitant longevity reinsurance transaction with Prudential Insurance Company of America.
Robust risk assessment and credit sanctioning to ensure we lend appropriately and responsibly.
Maintaining a contingency funding plan detailing actions and strategies available in stressed conditions.
We actively manage our exposure to movements in market rates, to drive lower volatility earnings and offer a comprehensive customer proposition with hedging strategies to support strategic aims. Mitigating actions are implemented to reduce the impact of market movements, resulting in a more stable capital position. Effective interest rate and inflation hedging has kept volatility in the Group’s DB pension schemes low and helped to return the schemes to IAS19 surplus in 2017. This allows us to more efficiently utilise available capital resources to better enable the Group to maximise its capabilities.
Restructuring costs were £621 million (2016: £622 million) and included costs relating to the Simplification programme, the rationalisation of the non-branch property portfolio, implementation of the ring-fencing requirements and MBNA integration costs.
In prior years, the Board has distributed surplus capital by means of a special dividend. The Board’s current preference is to return surplus capital by way of a buyback programme given the amount of surplus capital (£1 billion in 2017 versus £350 million in 2016), the normalisation of ordinary dividends, our return to full private ownership and the flexibility that a buyback programme offers.
Ring-fencing The Group is making good progress with the implementation of its ring-fencing programme, including the establishment of the non ring-fenced bank, Lloyds Bank Corporate Markets plc (LBCM), and remains on track to meet the legal and regulatory requirements by 1 January 2019. As a predominantly UK retail and commercial bank, the impact on the Group is relatively limited, with minimal impact for the majority of the Group’s retail and commercial customers.
Risk-weighted assets £84.6bn £92.6bn £1.7bn £36.6bn £215.5bn 1 Excludes reverse repos of £16.8 billion (31 December 2016: £8.3 billion) .
Impairment provision and fair value adjustments 3.2 3.4 3.3 3.6 3.7
External appointments: Non-Executive Director of Rio Tinto plc and Rio Tinto Limited, Independent Director of PetroChina Company Limited, Member of the Defence Board and Chair of the Defence Audit Committee, UK Government, Member of the Advisory Panel of CIMA and of the Advisory Board of the Centre for European Reform.
Paul joined the Group in June 2017 from Deloitte, where he was a partner in the UK Financial Services practice and led the UK Financial Services Internal Audit business. Paul has specialised in internal and external audit roles across financial services for over 20 years, including holding various leadership roles across Barclays Internal Audit. Paul studied at Cambridge University, holds an MBA from Manchester Business School and is a member of the Institute of Chartered Accountants and the UK Chartered Institute of Internal Auditors.
Jen was appointed as Group People and Productivity Director in July 2017 and is responsible for leading the people function and managing the Group’s cost base. Prior to her current role, Jen held the roles of Group Customer Services Director and Managing Director, Retail Business Banking. Graduating from Oxford University, Jen has enjoyed a career spanning multiple industries, including banking, engineering and the airline sector. Jen is a Non-Executive Director (Designate) on the Board of Lloyds Bank Corporate Markets and a Non-Executive Director of the Kent Community NHS Foundation Trust.
Helping Britain Prosper LIVE event was attended by 4,000 colleagues at the ExCel centre in London in March. This event provided everyone with more details about the future of the Group and the opportunity to see first-hand how we are helping Britain prosper every day. Speeches were given by the Group Chief Executive and Chief Financial Officer, which were broadcast live.
Members of the Board met with some of the organisations which are beneficiaries of the Group’s independent charitable Lloyds Bank Foundation for England and Wales and Bank of Scotland Foundation.
Important and/or material issues continue to be brought to the full Board Risk Committee for information, consideration and discussion as appropriate.
The statement by the Chairman of the Remuneration Committee and the Annual report on remuneration are set out on pages 84 and 88.
A. Leadership A1. The Board’s Role The Group is led by an effective, committed unitary Board, which is collectively responsible for the long-term success of the Company. The Group’s Corporate Governance Framework, which is reviewed annually by the Board, sets out a number of key decisions and matters that are reserved for the Board’s approval. Further details can be found online at www.lloydsbankinggroup.com and on page 64.
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 Chairman of the Remuneration Committee and 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.
Anita Frew as Senior Independent Director – The Committee considered a range of external and internal candidates for this position (the external candidates were sourced by JCA Group1), and agreed that Anita’s significant board, financial and investment management experience, including as a Senior Independent Director, made her ideally suited to take on the role.
Developing the succession plans for senior management, and establishing and agreeing development plans.
The Committee challenged the level of provisions made and the assumptions used to calculate the impairment provisions held by the Group.
PwC has been auditor to the Company and the Group since 1995, having previously been auditor to certain of the Group’s constituent companies. PwC was re-appointed as auditor with effect from 1 January 2016 following a tender process conducted in 2014 in respect of the audit contract for the 2016 financial year. There will be a mandatory rotation for the 2021 audit, and a competitive tender process will be conducted in advance of this time, if not earlier.
Focus has also been given to the successful execution of a number of significant regulatory change programmes, proactive identification and resolution of conduct issues, and the challenges and opportunities arising from the introduction of open banking and the second Payment Services Directive. Increasing levels of UK consumer indebtedness were also reviewed, and whilst overall controls were found to be robust, with management actions being taken to increase risk mitigation and to minimise customer detriment; close monitoring will continue into 2018. Progress across each of these areas will be a key ongoing focus for the Committee during 2018.
The Directors have specifically assessed the prospects of the Company and the Group over the first three years of the current plan. The uncertain economic and political environment caused by the UK’s plans to leave the EU and the pace of regulatory change mean that the assumptions supporting the fourth and fifth years of the operating plan are likely to be less reliable. As a result, the Board considers that a three year period continues to present a reasonable degree of confidence over expected events and macroeconomic assumptions, whilst still providing an appropriate longer-term outlook, although the remaining period of the operating plan contains no information which would cause different conclusions to be reached over the longer-term viability of the Company and Group.
In line with shareholder views, changes to the measures in the 2018 Group Ownership Share awards have been minimised to provide consistency with the 2017 plan, while aligning to the key strategic priorities as set out in the third Group Strategic Review. Further detail is provided on page 97.
The maximum Group Performance Share opportunity is 140 per cent of base salary for the GCE and 100 per cent of base salary for other Executive Directors (no change).
1 Excludes MBNA. 2 The underlying profit of £8,493 million has been adjusted by the £74 million incremental difference between the Prudential Value Adjustment (PVA) at year-end 2016 to year-end 2017, in line with regulatory requirements.
Next phase of strategy defined to further transform the business for success in a digital world and deliver additional sources of competitive advantage, positioning the Group well to meet changing customer needs.
Annual effectiveness review During 2017, the Committee met its key objectives and carried out its responsibilities effectively, as confirmed by the annual effectiveness review.
Purpose and link to strategy To incentivise and reward Executive Directors and senior management to deliver against strategic objectives designed to support the long-term success of the Group and encourage working as a team. It ensures executives build an ownership interest in the Group and are motivated by delivering long-term superior and sustainable returns for shareholders.
Table 1.1: Exposure to risk arising from the business activities of the Group The table below provides a high level guide to how the Group’s business activities are reflected through its risk-weighted assets. Details of the business activities for each division are provided in the Divisional overview on pages 28–31.
Regular policy framework assessments are undertaken in all business areas, driving Board-level risk appetite metrics which monitor the operating effectiveness of policy controls and overall policy implementation. Robust processes and controls to identify and report policy breaches include clear materiality criteria and escalation procedures which ensure an appropriate level of visibility and prioritisation of remedial actions.
Fraud and financial crime risk − Group Fraud and Financial Crime
Insurance, which is subject to separate regulation, has its own Board and governance structure. The Insurance Board, assisted by a Risk Oversight Committee and Audit Committee, approves the governance, risk and control frameworks for the Insurance business and the Insurance business risk appetite, ensuring it aligns with the Group’s framework and risk appetite.
Maturity profile (£m): Past term interest only balances (£m)2 1,553 1,365
The Group’s defined benefit pension schemes also expose the Group to longevity risk. For further information please refer to the defined benefit pension schemes component of the market risk section and note 35 to the financial statements.
The Group is also required to maintain a number of regulatory capital buffers, which are required to be met with CET1 capital.
Analysis of capital position Excluding the capital impact of the acquisition of MBNA on 1 June 2017, the Group generated 2.45 per cent of CET1 capital on a pro forma basis before ordinary dividends and allowing for the share buyback, primarily as a result of: – Strong underlying capital generation of 2.5 per cent, largely driven by underlying profits (2.2 per cent) and the dividend paid by the Insurance business in February 2018 in relation to 2017 earnings (0.3 per cent); – A reduction in risk-weighted assets (prior to the impact of the acquisition of MBNA) resulting in an increase of 0.8 per cent, primarily reflecting updates made to both mortgage and unsecured retail IRB models, continued active portfolio management, foreign exchange movements, disposals and capital efficient securitisation activity, partly offset through targeted growth in key customer segments; – The impact of market and other movements, generating an increase of 0.4 per cent, partially reflecting positive movements in available-for-sale assets and the defined benefit pension schemes; – Offset by a reduction of (1.2) per cent for conduct provisions.
The accrual for foreseeable dividends reflects the recommended final ordinary dividend of 2.05 pence per share.
The UK leverage ratio, after ordinary dividends, increased from 5.3 per cent on a pro forma basis to 5.4 per cent on a pro forma basis, largely reflecting the increase in fully loaded tier 1 capital and the underlying reduction in balance sheet assets, net of qualifying central bank claims and deconsolidation adjustments.
Derivative financial instruments 25,834 21,605 1,881 2,348 Interest rate, foreign exchange, credit spread
The non-trading book primarily consists of customer on balance sheet activities and the Group’s capital and funding activities, which expose it to the risk of adverse movements in market prices, predominantly interest rates, credit spreads, exchange rates and equity prices, as described in further detail within the Banking activities section (page 152).
Credit spreads – 100% widening 140 369 1 Restated. The most onerous scenario has changed to Eurozone Credit Crunch from UK Recession.
Table 1.49 shows some relevant statistics for the Group’s 1-day 95 per cent confidence level VaR that are based on 300 historical consecutive business days to year end 2017 and year end 2016.
We found conduct risks and provisions to be a key audit matter, and this is discussed further below. As in all of our audits, we also addressed the risk of management override of internal controls, including testing journals and evaluating whether there was evidence of bias by the directors that represented a risk of material misstatement due to fraud.
No additional material conduct issues that would require financial statement disclosure or provision were identified as a result of the audit work performed.
In line with the Group’s accounting policy, the discount rate applied to cash flows is consistent with that applied to such cash flows in the capital markets. Management currently uses the actual asset mix as a proxy for deriving a market consistent view of the illiquidity adjustment to the discount rate.
Refer to page 73 (Audit Committee Report), page 173 (Accounting Policies) and page 206 (Note 35 and Critical Accounting Estimates and Judgements).
Based on the results of the evidence obtained, we found the accounting treatments applied to significant transactions were supported by the evidence obtained.
Movement in cash flow hedging reserve: Effective portion of changes in fair value taken to other comprehensive income (363) 2,432 537
The results and financial position of all group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows: the assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on the acquisition of a foreign entity, are translated into sterling at foreign exchange rates ruling at the balance sheet date; and the income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions in which case income and expenses are translated at the dates of the transactions.
Comparatives have been restated accordingly. Following this restructuring, the Group’s activities are now organised into three financial reporting segments: Retail; Commercial Banking; and Insurance and Wealth. Retail offers a broad range of financial service products, including current accounts, savings, mortgages, motor finance and unsecured consumer lending to personal and small business customers.
Segment underlying income, net of insurance claims 10,923 4,847 1,979 776 18,525
Services relating to taxation: Following a change in policy, the Group’s auditors are not engaged to provide tax services except in exceptional circumstances and where permitted by applicable guidance.
The Group has procedures that are designed to ensure auditor independence, including prohibiting certain non-audit services. All statutory audit work as well as most non-audit assignments must be pre-approved by the audit committee on an individual engagement basis; for certain types of non-audit engagements where the fee is ‘de minimis’ the audit committee has pre-approved all assignments subject to confirmation by management. On a quarterly basis, the audit committee receives and reviews a report detailing all pre-approved services and amounts paid to the auditors for such pre-approved services.
Hedged forecast cash flows expected to occur: Hedged forecast cash flows affect profit or loss: There were no transactions for which cash flow hedge accounting had to be ceased in 2016 or 2017 as a result of the highly probable cash flows no longer being expected to occur.
Risk-free rate (value of in-force non-annuity business)1 0.00 to 4.20 0.00 to 4.20
Included in the amounts reported above are deposits of £220,855 million (2016: £219,106 million) which are protected under the UK Financial Services Compensation Scheme.
The pension schemes’ pooled investment vehicles comprise: 2017 £m 2016 £m
(Charge) credit to the income statement 115 76 199 (139) (40) 116 327
Recommended by directors at previous year end: Interim dividend paid in the year 1.00 0.85 0.75 720 607 535
The fixed share award is not subject to any performance conditions, performance adjustment or clawback. On an employee leaving the Group, there is no change to the timeline for which shares will become unrestricted.
In addition to the above balances, the Group has a number of other associates held by its venture capital business that it accounts for at fair value through profit or loss. At 31 December 2017, these companies had total assets of approximately £4,661 million (2016: £4,712 million), total liabilities of approximately £5,228 million (2016: £5,033 million) and for the year ended 31 December 2017 had turnover of approximately £4,601 million (2016: £4,401 million) and made a loss of approximately £87 million (2016: net loss of £27 million). In addition, the Group has provided £1,226 million (2016: £1,550 million) of financing to these companies on which it received £81 million (2016: £127 million) of interest income in the year.
Items in the course of collection from banks – – – – – 755 – 755
Gains recognised in the income statement, within other income, relating to the change in fair value of those assets held at 31 December 125 – 125 642 – 642
The DVA is sensitive to: – the current size of the mark-to-market position on the uncollateralised liability; – expectations of future market volatility of the underlying liability; and – the Group’s own CDS spread.
Total held at fair value through profit or loss 42,895 2,303 45,198 47,907 2,491 50,398 1 Credit ratings equal to or better than ‘BBB’.
(E) Acquisition of group undertakings and businesses 2017 £m 2016 £m 2015 £m
Net cash outflow arising from acquisition of MBNA 1,893 – –
Net cash outflow from acquisitions in the year 1,923 20 5 1 Upon acquisition, the funding of MBNA was assumed by Lloyds Bank plc.
The carrying amount of cash and cash equivalents (2017: £272 million; 2016: £42 million) is a reasonable approximation of fair value.
Total income, net of insurance claims 18,659 17,267 17,421 16,399 18,478
Number of ordinary shares in issue (millions) 3 71,973 71,374 71,374 71,374 71,368
6 The cost:income ratio is calculated as total operating expenses as a percentage of total income (net of insurance claims) .
Subsidiary undertakings The Group directly or indirectly holds 100% of the share class and a majority of voting rights (including where the undertaking does not have share capital as indicated) in the following undertakings.
Bank of Scotland London Nominees Ltd 5 * Bank of Scotland Nominees (Unit Trusts) Ltd 5 * Bank of Scotland P.E.P. Nominees Ltd 5 * Bank of Scotland plc 5 iv Bank of Scotland Structured Asset Finance Ltd 1 Bank of Scotland Transport Finance 1 Ltd
Lex Vehicle Leasing Ltd 2 Lex Vehicle Partners (1) Ltd (In liquidation) 13 Lex Vehicle Partners (2) Ltd (In liquidation) 13 Lex Vehicle Partners (3) Ltd (In liquidation) 13 Lex Vehicle Partners (4) Ltd (In liquidation) 13 Lex Vehicle Partners Ltd (In liquidation) 13 Lime Street (Funding) Ltd 1 Lloyds (FDC) Company (In liquidation) 13 Lloyds (General Partner) Ltd 6 Lloyds (Gresham) Ltd 1 x Lloyds (Gresham) No. 1 Ltd 1 Lloyds (Nimrod) Leasing Industries Ltd
Lloyds Bank General Leasing (No. 3) Ltd 1 Lloyds Bank General Leasing (No. 5) Ltd 1 Lloyds Bank General Leasing (No. 9) Ltd
Lloyds Bank General Leasing (No. 11) Ltd 1 Lloyds Bank General Leasing (No. 17) Ltd 1 Lloyds Bank General Leasing (No. 18) Ltd
vii Nominees (Jersey) Ltd 6 Nordic Leasing Ltd 1 NWS Trust Ltd 5
HBOS UK INVESTMENT FUNDS ICVC 1 UK Equity Income Fund 62.43% UK Growth Fund 62.36% UK FTSE All‑Share Index Tracking Fund 58.47%
EC4V 4LA (12) Perpetual Park, Perpetual Park Drive, Henley‑on‑Thames, Oxfordshire, RG9 1HH (13) JP Morgan Funds Limited, 3 Lochside View, Edinburgh Park, Edinburgh, EH12 9DH (14) Nordea Investment Funds S.A., 562 rue de Neudorf, L‑2220 Luxembourg (15) 78 SIR JOHN ROGERSON’S QUAY, DUBLIN 2, IRELAND (16) SCHRODER UNIT TRUSTS LIMITED, 31 GRESHAM STREET, LONDON, EC2V 7QA (17) UBS INVESTMENT FUNDS ICVC, 21 LOMBARD STREET, LONDON, EC3V 9AH (18) Oppenheim Asset Management Services S.à r.l. , 2, Boulevard Konrad Adenauer, L‑1115