Combined businesses loss of £6,300 million for the year (2008: £6,713 million loss).
Governance structures are increasingly important in the financial services industry. I am committed to ensuring that Lloyds Banking Group is at the forefront of these developments. To that end the board has given additional authority to our nomination committee and renamed it nomination and governance committee, to deal with all governance matters and make recommendations on these to the board.
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On a combined businesses basis, the Group reported a £6.3 billion loss for the year, compared to a £6.7 billion loss in 2008. Our total income rose 12 per cent, whilst costs fell 5 per cent. The higher income and lower costs drove a substantial uplift in the trading surplus, which increased by 35 per cent, and our cost:income ratio improved to 48.4 per cent. As guided last August, there was a significant increase in impairments, which rose to £24 billion from £14.9 billion in 2008, principally due to the HBOS portfolios and their high level of exposure to commercial property.
RISK MANAGEMENT The strong risk management culture and more prudent risk appetite previously prevalent within Lloyds TSB has been applied to the enlarged Group. The new Group has already exited a number of non-core areas in which HBOS previously participated and the more prudent ‘through the cycle’ approach to risk is being applied to all new business.
Balance sheet reductions reflect active de-risking of the balance sheet by either selling down or reducing holdings in debt securities and available-for-sale positions, deleveraging by customers in Wholesale’s strategic segments and the impact of impairments and foreign exchange movements. Credit markets rallied in the second half of 2009 which brought back some strategic buyers for asset-backed securities (ABS) and allowed Wholesale to sell £3.5 billion notional of non-core ABS positions.
Loans and receivables: Loans and advances to customers 177.7 216.4 (18)
The Insurance division’s strategic vision is to be recognised as the best insurance business in the UK by its customers, staff and shareholders. The division has set itself four strategic objectives to achieve its vision of being the best insurance business in the UK: – complete the integration of its market leading businesses, – continue to strengthen its leading brands and grow sales profitably in its targeted markets, – enhance the capital and operational efficiency of existing and future business, and – leverage Lloyds Banking Group strengths in distribution and asset management.
ECONOMIC ASSUMPTIONS A bottom-up approach is used to determine the economic assumptions for valuing the business in order to determine a market consistent valuation. The results for the HBOS Life, Pensions and Investments business have been restated from those previously published and have been produced using the market consistent economic assumptions adopted by Scottish Widows.
With the programme now well underway and ahead of its financial targets, the Group is confident of delivering the new target, which is analysed below by division.
We are building a high commitment, high performance organisation. We are clear about what we expect from our colleagues and what they can expect from us. Our values guide us in all our relationships whether they be with colleagues, customers or the wider community. In Lloyds Banking Group, our values are that we: take ownership; act wisely; make it simple; stretch ourselves; and succeed together.
During 2009 we have developed and launched our new group wide learning portal, ‘Learning @ Lloyds Banking Group’. This website, which is accessible from both the corporate intranet and Internet, provides all colleagues with access to a range of learning and development resources.
Elsewhere we have continued our focus on race, disability and sexual orientation.
We will be running 200 nationwide seminars every year for the next three years, providing expert guidance and support for up to 90,000 SMEs on starting up, employment, exporting, bidding for London 2012 contracts, sustainability and finance.
Group risk directors who report directly to the chief risk officer, are allocated responsibility for certain specific risk types and are responsible for ensuring the adequacy of the framework for their risk types as well as the oversight of the risk profile across the Group. Divisional risk offi cers have dual reporting lines to their own divisional executive and also to the chief risk offi cer and are responsible for the risk profi le within their own divisions. This matrix approach enables the group executive committee members to fulfi l their risk management accountabilities.
Credit: The risk of reductions in earnings and/or value, through fi nancial loss, as a result of the failure of the party with whom the Group has contracted to meet its obligations (both on and off balance sheet).
– As a result of the significant impairments taken in the first half of 2009 following in-depth reviews of the Group’s high risk portfolios and a more favourable macroeconomic environment in the second half of 2009, the Group’s total impairment charge levels have reduced in the second half of the year.
TABLE 1.4: IMPAIRMENTS ON GROUP LOANS AND ADVANCES As at 31 December 2009
KEY HIGHLIGHTS – Established robust credit risk control framework and risk appetite largely based on Lloyds TSB’s approach, and rolled out across Wholesale. Divisional Risk continue to undertake robust and continuous oversight and challenge to the business.
In order to manage impaired loans effectively, BSUs have been established in Ireland and Australia with divisional oversight provided by the Business Support Unit Sanctioning area. Reviews of Collections and Recoveries capability across the retail businesses have been undertaken to optimise processes and enhance capability.
– Unit-linked liabilities are matched with the same assets that are used to define the liability but future fee income is dependent upon the performance of those assets. (This forms part of the Value of in Force (ViF) see note 28.)
The Group has adopted the heritage Lloyds TSB liquidity and funding approach which involves reduced risk appetite and increasing the diversity of funding sources, supported by extensive analysis of funding needs and strong governance.
TABLE 1.17: GROUP BALANCE SHEET As at 31 December 2009 £bn £bn
TABLE 1.20: ELIGIBLE COLLATERAL As at 31 December 2009 £bn 2008 £bn
The Group is also able to raise Tier 2 capital by issuing subordinated liabilities. The cost and availability of subordinated liability finance are influenced by credit ratings of both the Group and the UK’s sovereign rating. A reduction in these ratings could increase the interest rate payable and could reduce market access.
Number of ordinary shares in issue (millions)2 63,775 5,973 5,648 5,638 5,603
A PRUDENT REMUNERATION POLICY The committee reviewed very carefully the decisions made in respect of remuneration for 2009. There were no salary increases for executives, executives waived any entitlement to annual incentives in respect of the 2008 performance year and the Long Term Incentive Plan (LTIP) opportunity was reduced from 2008 levels by up to 175 per cent of salary. Awards under the annual incentive plan for 2009 have been made based on a rigorous assessment of performance against targets. In reaching its decisions, the committee has sought to take into account the Group’s performance against the main financial targets where the outcomes were better than expected as well as the delivery of a number of milestones that are a key part of the Group’s medium term recovery plan. It is important to note that 100 per cent of the award will be deferred into shares and released in 2012 unless subject to clawback at that time.
The executive directors are currently members of one of the pension schemes provided by the Lloyds TSB Group with benefits either on a defined benefit or defined contribution basis. Those directors who joined the Lloyds TSB Group after 1 June 1989 and are members of a defined benefit scheme have pensions provided on salary in excess of the earnings cap through membership of or by an unfunded pension promise. Retirement pensions accrue at rates of between 1/60 and 1/30 of basic salary.
h Not exercisable as the option has not been held for the period required by the relevant scheme.
For the other 50 per cent of the award (the ‘TSR Award’) – it will be necessary for the Group’s TSR to exceed the median of a comparator group (14 companies) over the relevant period by an average of 7.5 per cent per annum for the TSR Award to vest in full. 17.5 per cent of the TSR Award will vest where the Group’s TSR is equal to median and vesting will occur on a straight line basis in between these points. Where the Group’s TSR is below the median of the comparator group, the TSR Award will lapse. The relevant period commenced on 1 January 2006 and ended on 31 December 2008.
Loans and receivables: Loans and advances to banks 19 35,361 38,733
Proceeds from sale and maturity of available-for-sale financial assets 490,561 110,470
(P) FOREIGN CURRENCY TRANSLATION Items included in the financial statements of each of the Group’s entities are measured using the currency of the primary economic environment in which the entity operates (the ‘functional currency’). The consolidated financial statements are presented in sterling, which is the Company’s functional and presentation currency.
Applicable accounting standards permit the recognition of deferred tax assets only to the extent that it is probable that future taxable profits will be available to utilise the tax losses carried forward. The assessment of future taxable profits involves significant estimation uncertainty, principally relating to an assessment of management’s projections of future taxable income based on business plans and ongoing tax planning strategies. These projections include assumptions about the future strategy of the Group, the economic and regulatory environment in which the Group operates, future tax legislation, customer behaviour, and the ability of the Group to deliver expected integration benefits, amongst other variables. At 31 December 2009, management has concluded that future taxable profits generated by the Group companies with tax losses carried forward are expected to be sufficient to utilise the tax losses carried forward in full.
Index to annual report 266 and other intangibles not previously included on the HBOS Group balance sheet totalling £4,650 million. This was offset by a reduction in the value of the HBOS Group’s liabilities of £13,216 million, resulting in a net increase in the value of the net assets acquired of £1,241 million (note 14).
Index to annual report 266 6 NET FEE AND COMMISSION INCOME
The Group’s unrecognised share of losses of associates for the year is £64 million (2008: £nil) and of joint ventures is £424 million (2008: £nil). For entities making losses, subsequent profits earned are not recognised until previously unrecognised losses are extinguished. The Group’s unrecognised share of losses net of unrecognised profits on a cumulative basis of associates is £64 million (2008: £nil) and of joint ventures is £424 million (2008: £nil).
Items in the course of collection from banks 523 – 523
Loans and receivables: Loans and advances to banks 15,751 43 15,794
Had the acquisition date of HBOS plc been 1 January 2009, Lloyds Banking Group consolidated total income would have been £880 million lower at £44,417 million and Lloyds Banking Group consolidated profit before tax would have been £280 million lower at £762 million.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS continued 20 LOANS AND ADVANCES TO CUSTOMERS
6.413% Fixed-to-Floating Rate US$1 series A preference shares (US$750 million) b, c, e 115 –
c As part of the Group’s recapitalisation and exit from GAPS, following an exchange offer, on 1 December 2009, 10 December and 15 December 2009 certain holders of certain series elected to exchange some or all of the notes they held for enhanced capital notes issued by LBG Capital No. 1 plc and LBG Capital No. 2 plc.
a Interest is payable quarterly in arrears at a rate of 3 month EURIBOR +3.1 per cent per annum.
Dated subordinated liabilities 7.70% Notes 2010 (US$500 million) b 327 –
In addition the Group has cash fl ow hedges which are primarily used to hedge the variability in the cost of funding within the wholesale business. These cash fl ows are expected to occur over the next six years and the hedge accounting adjustments will be reported in the income statement as the cash fl ows arise. The notional principal of the interest rate swaps designated as cash fl ow hedges at 31 December 2009 was £222,548 million (2008: £867 million) with a net fair value liability of £2,536 million (2008: £90 million) (note 18). In 2009, there is no ineffectiveness recognised in the income statement that arises from cash fl ow hedges (2008: nil). There were no transactions for which cash fl ow hedge accounting had to be ceased in 2009 or 2008 as a result of the highly probable cash fl ows no longer being expected to occur.
Loans and advances to banks – the Group may require collateral before entering into a credit commitment with another bank, depending on the type of the fi nancial product and the counterparty involved, and netting agreements are obtained whenever possible and to the extent that such agreements are legally enforceable.
Bank and building society certifi cates of deposit – 1,037 997 – – – 2,034
Asset-backed securities: Corporate and other debt securities 168 1,257 192 – – 566 2,183
There are no material amounts for debt securities, treasury and other bills which are past due but not impaired.
MATTERS ON WHICH WE ARE REQUIRED TO REPORT BY EXCEPTION We have nothing to report in respect of the following matters where the Companies Act 2006 requires us to report to you if, in our opinion: – adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or – the parent company fi nancial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or – certain disclosures of directors’ remuneration specifi ed by law are not made; or – we have not received all the information and explanations we require for our audit.
6.0884% Non-Cumulative Fixed to Floating Rate Preference Shares (£745 million) a 10 –
MEASUREMENT BASIS OF FINANCIAL ASSETS AND LIABILITIES The accounting policies in note 2 to the consolidated financial statements describe how different classes of financial instruments are measured, and how income and expenses, including fair value gains and losses, are recognised. The following table analyses the carrying amounts of the financial assets and liabilities by category and by balance sheet heading.
SHARE PRICE INFORMATION In addition to listings in the fi nancial pages of the press, the latest price of Lloyds Banking Group shares on the London Stock Exchange can be obtained by telephoning 09058 890 190. Visit www.londonstockexchange.com for details.
Impairment allowances Impairment allowances are a provision held on the balance sheet as a result of the raising of a charge against profi t for the incurred loss inherent in the lending book. An impairment allowance may either be individual or collective.