Divisional results Details of our operating divisions, their strategy, achievements, financial results and progress.
Our main contribution to society is the direct economic impact on the economy we have as a major employer and purchaser of goods and services. This economic contribution is supported by our active investment in communities across the country and our community giving programme. We invested £148 million in communities across the UK in 2010 including support for financial inclusion, sponsorship of sports for young people and donations through the Group’s charitable foundations.
As an organisation, we have made considerable progress in 2010, delivering good growth in our core business, returning to profitability and reducing the risk in the business. The integration of the HBOS business continues to progress well and we remain confident of achieving our target of run-rate synergy benefits of £2 billion per annum by the end of 2011, a substantial achievement.
We have recently announced, along with four other major UK banks and in the context of an agreement with the UK Government, our intent to help support the UK economic recovery by jointly providing the capacity to support gross new lending of £190 billion to creditworthy UK businesses (including £76 billion to small and medium sized businesses). We are determined to play a full role in supporting investment by UK businesses and households.
Our core tier 1 ratio increased to 10.2 per cent, from 8.1 per cent at the end of 2009, substantially in excess of regulatory requirements. We also restructured the capital within our insurance subsidiaries, which will deliver substantial benefits under the Basel III reforms. At the year end, our tier 1 ratio was 11.6 per cent, and our total capital ratio was 15.2 per cent.
– Related non-structural measures to promote stability and competition in banking for the benefit of consumers and businesses.
Key balance sheet and other items 31 December 2010 £bn £bn £bn £bn £bn £bn
2010 HIGHLIGHTS Profit before tax increased to £4,716 million, compared to £1,382 million in 2009.
Customer deposits increased by £11.5 billion, or 5 per cent, to £235.6 billion, predominantly from instant access and tax free ISA accounts rather than more expensive term deposits.
The impairment charge on loans and advances decreased by £1,480 million, or 35 per cent, to £2,747 million reflecting the stabilising economy, more stable house prices, low interest rates and prudent lending criteria. As a percentage of average advances, the impairment charge decreased to 0.74 per cent, significantly lower than 1.11 per cent in 2009. The secured impairment charge reduced to £292 million from £789 million in 2009 while the unsecured impairment charge reduced to £2,455 million from £3,438 million in 2009.
The fair value unwind net credit of £1,105 million compares with £407 million in 2009. The net fair value unwind credit was larger than in 2009 which reflected a smaller charge related to the fixed rate mortgage portfolios as mortgages reached the end of their fixed term and borrowers moved to standard variable products. This was partially offset by a reduction in the credit attributed to the fixed rate savings portfolio as fixed rate term deposits, existing prior to acquisition, matured.
Operating expenses decreased by £51 million to £2,410 million due to continued synergy benefits, partially offset by investment in the Business Support Unit as well as customer facing resource and systems.
Impact on new business profit before tax £m £m 2010 EEV/new business profit before tax 100 basis points reduction in risk-free rate1 240 11 10 per cent reduction in market values of equity assets2 (269) n/a 10 per cent reduction in market values of property assets3 (15) n/a 10 per cent reduction in expenses4 222 40 10 per cent reduction in lapses5 204 23 5 per cent reduction in annuitant mortality6 (97) (3)
Profit before tax and fair value unwind from General Insurance increased by 1 per cent to £372 million, due primarily to improved unemployment claims experience plus integration synergies after taking account of lower income resulting from ceasing to write new PPI business and freeze related claims.
Central items include income and expenditure not recharged to the divisions, including the costs of certain central and head office functions and the financial impact of hedge ineffectiveness.
Our leading edge diversity and inclusion strategy, developed through active consultation across the organisation, will enhance the Group’s ability to build deep and lasting relationship with colleagues, customers and suppliers.
Stonewall is a lesbian, gay and bisexual rights charity in the United Kingdom and the largest gay equality organisation in Europe
Project finance: Equator Principles Lloyds Banking Group is a signatory to the Equator Principles to support our approach to assessing and managing environmental and social issues in project finance. Lending officers are responsible for undertaking initial classification of transactions that qualify under the Equator Principles. Their assessments are subject to further review by our Equator Principles Review Group, comprising experts from both our Risk and Project Finance teams, to ensure that each transaction is compliant and is consistent with our Environmental Risk Policy. We trained over 100 employees in our Equator Principle Procedures in 2010.
As one of the UK’s biggest employers, our colleague volunteering initiatives can make a real difference. In 2010, we launched our Day to Make a Difference volunteering programme. This enables all Lloyds Banking Group employees to spend one day a year during work time volunteering for a charity or local community project of their choice. Over 7,300 employees volunteered during 2010 in their local communities.
– The Divisional Financial Control Committees, which provide governance over financial statements. The meetings provide review and challenge as to the veracity of the results, press releases and supporting analyst information with oversight over the processes that have been followed in drawing them up. Items of focus are key assumptions and areas of subjectivity in the results and ensuring proper remediation of control issues that impact internal controls over financial reporting. The Group’s auditors also report findings from their audit work.
The risk principles are executed through the Policy Framework and Accountabilities. These principles are supported by the policy levels below: Principles – high level principles for the six primary risk drivers
Each probability of default model segments counterparties into a number of rating grades, each representing a defined range of default probabilities. Exposures migrate between rating grades if the assessment of the counterparty probability of default changes. Each rating system is required to map to a master scale, which supports the consolidation of credit risk information across portfolios through the adoption of a common rating scale. Given the differing risk profiles and credit rating considerations, the underlying risk reporting has been split into two distinct master scales, a retail master scale and a wholesale master scale.
As well as these Government-sponsored initiatives, the Group, through its banking businesses, also operates a number of its own schemes to assist households. These include: – Short-term reduced or nil arrangements: This is an arrangement whereby customers who are experiencing short-term difficulties may be granted a reduced (including nil) payment arrangement. This is agreed with the customer based on their individual circumstances; nil payment arrangements can be granted for up to three months and reduced payment arrangements for up to six months. There is no reduction in contractual terms for customers on these arrangements.
– Transfer to interest only: This allows customers who are currently on a capital and interest repayment basis to transfer to an interest only basis for a period of time (up to three years maximum) in order to reduce their contractual monthly payment.
While the second half of 2010 has seen most countries exiting from recession, forecasts are that the UK recovery will continue to be at a modest pace and is likely to be protracted. The risks to the impairment charge remain skewed to the downside across all lending businesses. In the UK, business and consumer confidence remain fragile and the extent to which simultaneous fiscal tightening might undermine global and UK growth is unclear. Contagion from the Irish bail-out to other Eurozone economies could drive further fiscal tightening and worsen the outlook further. Rising commodity prices driven by strong recovery in Asia might fuel a further increase in inflation, prompting short-term interest rates to rise more quickly than anticipated. Potential interest rate rises, public spending cuts and reduced consumer spending could cause cashflow stress and higher levels of default amongst mid-market corporates and Commercial customers in particular. In addition, in our commercial real estate book, any deterioration in the economy could increase the level of tenant defaults and reduce capital values further from an already depressed level, particularly in the regions. Further significant falls in house prices, real disposable household income or increasing interest rates, would result in a higher secured retail impairment charge relative to current expectations.
The risk of loss measured by the VaR model is the potential loss in earnings given the confidence level and assumptions noted above. The total and average trading VaR does not assume any diversification benefit across the five risk types, which now includes inflation. The maximum and minimum VaR reported for each risk category did not necessarily occur on the same day as the maximum and minimum VaR reported as a whole. The Group internally uses VaR as the primary measure for all trading book positions arising from short term market facing activity.
The Group has invested considerable resource to ensure that it satisfies the governance, reporting and stress testing requirements of the FSA’s new ILAS liquidity regime. The Group has noted the industry move towards strategic balance sheet measures of the funding profile and has started to monitor and forecast the Group’s Net Stable Funding Ratio (NSFR) and Liquidity Coverage Ratio (LCR). The Group is aware that the regulatory liquidity landscape is subject to potential change. Specifically, in relation to the papers issued by the Basel Committee on Banking Supervision (‘Strengthening the resilience of the banking sector’ and ‘International framework for liquidity risk measurement, standards and monitoring’) the Group has actively participated in the industry-wide consultation and calibration exercises which took place through 2010.
Joined the Board on 17 January 2011 as an Executive Director and will become Group Chief Executive on 1 March 2011. Started his career at Citibank Portugal where he was head of capital markets. At the same time, was an assistant professor at Universidade Catolica Portuguesa. Then worked for Goldman Sachs in New York and London. In 1993, joined Grupo Santander as Chief Executive of Banco Santander de Negocios Portugal and then became Chief Executive Officer of Banco Santander Brazil. In 2000, became Chief Executive Officer of Santander Totta, and Chairman from 2006 until 2011, as well as Executive Vice President of Grupo Santander and a member of its Management Committee. He joined Santander UK, as a Non-Executive Director in November 2004 and from August 2006 until November 2010, was its Chief Executive. He is also a Non-Executive Director of the Court of the Bank of England until 28 February 2011. Aged 47.
Joined the Group in 2006 as Deputy Group Finance Director, before being appointed acting Group Finance Director in April 2008. Appointed to the Board in October 2008 as Group Finance Director. Previously Finance Director for the UK and Europe at Prudential from 2002 to 2006 and Group Finance Director of Heath Lambert Group from 1996 to 2002. Prior to that, he spent 11 years at KPMG. A member of the British Bankers’ Association and Chairman of its Audit Committee and Remuneration Committee. Fellow of the Institute of Chartered Accountants in England and Wales. Aged 48.
POLICY AND PRACTICE ON PAYMENT OF CREDITORS The Company has signed up to the ‘Prompt Payment Code’ published by the Department for Business Innovation and Skills (BIS), regarding the making of payments to suppliers. Information about the ‘Prompt Payment Code’ may be obtained by visiting www.promptpaymentcode.org.uk.
AUDITORS AND AUDIT INFORMATION Each person who is a director at the date of approval of this report confirms that, so far as the director is aware, there is no relevant audit information of which the Company’s auditors are unaware and each director has taken all the steps that he or she ought to have taken as a director to make himself or herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of the Companies Act 2006.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial statements and the Directors’ remuneration report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
– The annual incentive opportunity for 2011 will stay the same as in previous years.
The annual bonus for Executive Directors is deferred into shares and released over a period of not less than two years, helping to increase alignment with shareholders. These deferrals are subject to malus in the event of unsustainable performance.
There were no sign-on or severance payments made in respect of this group
Contingent liabilities are possible obligations whose existence depends on the outcome of uncertain future events or those present obligations where the outflows of resources are uncertain or cannot be measured reliably. Contingent liabilities are not recognised in the financial statements but are disclosed unless they are remote.
(S) CASH AND CASH EQUIVALENTS For the purposes of the cash flow statement, cash and cash equivalents comprise cash and non-mandatory balances with central banks and amounts due from banks with a maturity of less than three months.
Lloyds Banking Group Annual Report and Accounts 2010 3 CRITICAL ACCOUNTING ESTIMATES AND JUDGEMENTS
Share of balance sheet amounts: Share of net assets at 31 December 326 370 103 109 429 479
Capital expenditure contracted for at the balance sheet date but not recognised in the financial statements 86 57
Trading and other financial liabilities at fair value through profit or loss 26,762 28,271
Key changes in assumptions A detailed review of the Group’s assumptions in 2010 resulted in the following key impacts on profit before tax: – Change in persistency assumptions (£38 million decrease)
Current estimate in respect of above claims 201 205 292 195 539 609 2,041
The latest full valuations of the two Lloyds TSB schemes were carried out as at 30 June 2008; the latest full valuation of the HBOS scheme was carried out as at 31 December 2008. The results have been updated to 31 December 2010 by qualified independent actuaries. The last full valuations of other Group schemes were carried out on a number of different dates; these have been updated to 31 December 2010 by qualified independent actuaries or, in the case of the Scottish Widows Retirement Benefits Scheme, by a qualified actuary employed by Scottish Widows.
OTHER POST-RETIREMENT BENEFIT SCHEMES The Group operates a number of schemes which provide post-retirement healthcare benefits and concessionary mortgages to certain employees, retired employees and their dependants. The principal scheme relates to former Lloyds Bank staff and under this scheme the Group has undertaken to meet the cost of post-retirement healthcare for all eligible former employees (and their dependants) who retired prior to 1 January 1996. The Group has entered into an insurance contract to provide these benefits and a provision has been made for the estimated cost of future insurance premiums payable.
SAVE-AS-YOU-EARN SCHEMES Eligible employees may enter into contracts through the Save-As-You-Earn schemes to save up to £250 per month and, at the expiry of a fixed term of three, five or seven years, have the option to use these savings within six months of the expiry of the fixed term to acquire shares in the Group at a discounted price of no less than 80 per cent of the market price at the start of the invitation.
(ii) Economic Profit: relevant to 50 per cent of the award. Performance will be measured based on the extent to which cumulative Economic Profit targets are achieved over the three-year period.
The tables below detail, on an aggregated basis, balances outstanding at the year end and related income and expense, together with information relating to other transactions between the Group and its key management personnel: £m £m
In addition, during the ordinary course of business the Group is subject to other threatened and actual legal proceedings (which may include class action lawsuits brought on behalf of customers, shareholders or other third parties), regulatory investigations, regulatory challenges and enforcement actions, both in the UK and overseas. All such material matters are periodically reassessed, with the assistance of external professional advisors where appropriate, to determine the likelihood of the Group incurring a liability. In those instances where it is concluded that it is more likely than not that a payment will be made, a provision is established to management’s best estimate of the amount required to settle the obligation at the relevant balance sheet date. In some cases it will not be possible to form a view, either because the facts are unclear or because further time is needed properly to assess the merits of the case and no provisions are held against such matters. However the Group does not currently expect the final outcome of any such matter to have a material adverse effect on its financial position.
In 2008, in accordance with the amendment to IAS39 that became applicable during that year, the Group reviewed the categorisation of its financial assets classified as held for trading and available-for-sale. On the basis that there was no longer an active market for some of those assets, which are therefore more appropriately managed as loans, with effect from 1 July 2008, the Group transferred £2,993 million of assets previously classified as held for trading into loans and receivables. With effect from 1 November 2008, the Group transferred £437 million of assets previously classified as available-for-sale financial assets into loans and receivables. At the time of these transfers, the Group had the intention and ability to hold them for the foreseeable future or until maturity. As at the date of reclassification, the weighted average effective interest rate of the assets transferred was 6.3 per cent with the estimated recoverable cash flows of £3,524 million.
Derivative financial instruments (i) In respect of the embedded equity conversion feature of the enhanced capital notes, the sensitivity was based on the absolute difference between the actual price of the enhanced capital note and the closest, alternative broker quote available plus the impact of applying a 10 bps increase/ decrease in the market yield used to derive a market price for similar bonds without the conversion feature. The effect of interdependency of the assumptions is not material to the effect of applying reasonably possible alternative assumptions to the valuations of derivative financial instruments.
The primary risks affecting the Group through its use of financial instruments are: credit risk; market risk, which includes interest rate risk and foreign exchange risk; and liquidity risk. Information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk and the Group’s management of capital can be found on pages 65 to 108. The following additional disclosures, which provide quantitative information about the risks within financial instruments held or issued by the Group, should be read in conjunction with that earlier information.
Stock lending – in addition to financial assets on the balance sheet which are subject to repurchase agreements, there were financial assets on the balance sheet pledged as collateral as part of securities lending transactions which amounted to £124,139 million at 31 December 2010 (2009: £92,449 million).
Total debt securities classified as loans and receivables 21,007 5,374 3,077 1,028 1,453 1,143 33,082
Derivative financial liabilities: Gross settled derivatives – net flows 4,160 343 144 487 2,194 7,328
Change in derivative financial instruments, trading and other liabilities at fair value through profit or loss 160 (27,037)
These comprise US$862.5 million 7.75% Public Income Notes due 2050 issued by the Company in July 2010. The debt securities in issue in 2009 comprised US$528 million Thirteen-Month Extendible Short-Term Notes issued by the Company in July 2008.
Derivatives designated as Held for hedging instruments, held trading at fair Held at at fair value through value through Loans and amortised profit or loss profit or loss receivables cost Total £m £m £m £m £m
LIQUIDITY RISK The table below analyses financial instrument liabilities of the Company, on an undiscounted future cash flow basis according to contractual maturity, into relevant maturity groupings based on the remaining period at the balance sheet date; balances with no fixed maturity are included in the over 5 years category.
Credit derivatives A credit derivative is a financial instrument that derives its value from the credit rating of an underlying instrument carrying the credit risk of the issuing entity. The principal type of credit derivatives are credit default swaps, which are used by the Group as part of its trading activity and to manage its own exposure to credit risk. A credit default swap is a swap in which one counterparty receives a premium at pre-set intervals in consideration for guaranteeing to make a specific payment should a negative credit event take place. The Group also uses credit default swaps to securitise corporate and commercial banking loans in combination with external funding.
Funded/unfunded exposures Exposures where the notional amount of the transaction is either funded or unfunded.
TANGIBLE FIXED ASSETS Accounting policy 160 Notes to the consolidated financial statements 197