We envisage minimal medium-term impact on our margin from the cost of wholesale funding, as we reduce our absolute wholesale funding requirement. Additionally, whilst we anticipate that a high proportion of our existing government and central bank funding will not have to be re-financed, we believe we can replace the residual portion at a cost that is similar to that which we are paying for these facilities at present.
In Retail, lower levels of income from payment protection insurance, reflecting the impact of the decision in January 2009 to move to a monthly premium product, and lower loan volumes, the impact of falling interest rates on deposit margins and higher overall funding costs from wholesale money markets have led to retail banking revenues being 13 per cent lower than in 2008. Whilst lending markets have remained generally subdued throughout the industry, the Group has maintained a 24 per cent share of gross mortgage lending. Unsecured lending balances were slightly lower, reflecting lower customer demand and tightened credit criteria. During the year, we have continued to build our current account and savings customer franchises in what remains a competitive market for customer deposits.
New business sales in our life assurance and pensions businesses were 26 per cent lower than last year, reflecting the extremely challenging market conditions which led to a general market-wide slowdown in the sale of life, pensions and investments products. Sales of OEICs and life assurance protection products remain good.
In Wealth and International, income was 6 per cent lower reflecting the impact of deposit margin pressure and falls in global stock markets in the first half of 2009.
During 2009, the Group has extended the maturity profile of wholesale funding, such that, at 31 December 2009, 50 per cent of wholesale funding had a maturity date greater than one year (31 December 2008: 44 per cent). Over time, and as we see improvements in the capacity of wholesale funding markets, we expect to maintain the amount of the Group’s wholesale borrowings with a maturity date greater than one year in excess of 40 per cent which we consider to be an appropriate and sustainable long-term proportion. However, in this regard we note recent regulatory consultation papers relating to liquidity requirements which, if put into practice, could require banks to manage their liquidity risk differently. Increases in customer deposits and the reduction in assets set out above, mean that we expect to see a slow but steady improvement in the Group’s loan to deposit ratio. The Group does not set a target for this ratio, which we believe does not reflect either the quality of lending or the term of deposits held but would expect to see it return to legacy Lloyds TSB levels of approximately 140 per cent over the next few years. During 2009 the ratio excluding repos, improved to 169 per cent.
CREATING PRODUCTS AND SERVICES THAT CUSTOMERS VALUE The introduction of the new Reward current account by Halifax and Bank of Scotland was well received by customers. Halifax and Bank of Scotland have taken the lead in the market and moved the majority of their customers to a new and simpler overdraft charging structure. In addition, they have also launched the new Visa contactless debit card. Another innovative product launched in 2009 was the Lloyds TSB ‘Lend a Hand’ mortgage. This allows first time buyers access to interest rates usually available to those with a 25 per cent deposit by linking the product to funds in a savings account provided by family or friends. As well as providing a return for savers, this product supports growth in the important first time buyers market. In addition, Lloyds TSB launched its new monthly saver with an interest rate of 5 per cent for 12 months.
SUPPORTING CUSTOMERS THROUGH THE CYCLE Wholesale has provided approximately £35 billion of committed gross lending to the Corporate and Small and Medium Enterprises (SME) sector during 2009 and recruited approximately 100,000 new commercial accounts. Additionally, Wholesale has expanded its product capability in Wholesale Markets to allow customers to diversify their funding by accessing wider sources of capital markets liquidity, and to manage their interest rate and currency risks in an uncertain operating environment.
Corporate Banking net interest income increased marginally as re-pricing reflected changing risk profiles and higher liquidity costs; however, this was mostly offset by higher funding costs. Average transaction volumes were maintained year-on-year; however lending showed a decline through 2009 as customers actively deleveraged their balance sheets, aligned with a suppressed appetite for new borrowing in the current economic environment. Other operating income increased by approximately 18 per cent reflecting improved upfront fees, exit fees and commitment commissions.
Loans and advances to customers decreased by £38.7 billion to £177.7 billion as an estimated £20 billion of total lending drawdowns in the year was more than offset by scheduled amortisations and repayments and the impact of customers deleveraging their balance sheets by using alternative forms of funding. The decrease was also driven by the transfer of a £7 billion European loan portfolio to Wealth and International, significant impairment losses in 2009 and foreign exchange movements, partially offset by the unwind of fair value adjustments booked on acquisition of HBOS.
Impairment losses and loans and advances to customers are summarised by key geography in the following table.
In this sensitivity the impact takes into account the change in the value of in-force business, financial options and guarantee costs, statutory reserves and asset values.
The Group is currently assessing the impacts of these regulatory proposals, and will participate in the consultation and calibration processes to be undertaken by the various regulatory bodies during 2010. The Group currently meets and exceeds its regulatory capital requirements and expects to continue to do so. However, the FSA could impose more stringent capital and liquidity requirements, and/or introduce new ratios and/or change the manner in which it applies existing requirements to recapitalised banks, including those within the Group. Any one or combination of these events could result in the Group being forced to raise further capital or to divest assets.
– The Group has expanded its BSU model and strengthened the resources within Collections and Recoveries to support the more timely engagement with customers experiencing difficulties and drive more effective customer outcomes.
The average loan-to-value ratio for new mortgages and further advances written in 2009 was 59.3 per cent compared with 63.1 per cent in 2008. The average indexed loan-to-value ratio on the mortgage portfolio was 54.8 per cent compared with 54.9 per cent in 2008 and 13.0 per cent of the mortgage portfolio had an indexed loan-to-value ratio in excess of 100 per cent (£44.8 billion), compared with 16.2 per cent (£56.8 billion) in 2008.
Most of the Group’s trading activity is undertaken to meet the requirements of wholesale and retail customers for foreign exchange and interest rate products. However, some interest rate, exchange rate and credit spread positions are taken using derivatives and other on-balance sheet instruments with the objective of earning a profit from favourable movements in market rates.
– For other insurance liabilities the aim is to invest in assets such that the cash flows on investments will match those on the projected future liabilities. It is not possible to eliminate risk completely as the timing of insured events is uncertain and bonds are not available at all of the required maturities. As a result, the cash flows cannot be precisely matched and so sensitivity tests are used to test the extent of the mismatch.
Banking – non-trading Market risk in non-trading books consists almost entirely of exposure to changes in interest rates. This is the potential impact on earnings and value that could occur when, if rates fall, liabilities cannot be re-priced as quickly or by as much as assets; or when, if rates rise, assets cannot be re-priced as quickly or by as much as liabilities.
For legal and regulatory issues there are significant reputational impacts associated with potential censure which drive the Group’s stance on appetites referred to above. There are clear accountabilities and processes in place for reviewing new and changing requirements. Each division and significant business areas have a nominated individual with ‘compliance oversight’ responsibility under FSA rules. The role of such individuals is to advise and assist management to ensure that each business has a control structure which creates awareness of the rules and regulations, to which the Group is subject, and to monitor and report on adherence to these rules and regulations.
DEFINITION Liquidity risk is defined as the risk that the Group does not have sufficient financial resources to meet its commitments when they fall due, or can secure them only at excessive cost. Funding risk is further defined as the risk that the Group does not have sufficiently stable and diverse sources of funding or the funding structure is inefficient.
Total wholesale funding is analysed by residual maturity as follows: TABLE 1.19: WHOLESALE FUNDING BY RESIDUAL MATURITY As at 31 December 2009 £bn
MONITORING Capital is actively managed at an appropriate level of frequency and regulatory ratios are a key factor in the Group’s budgeting and planning processes with updates of expected ratios reviewed regularly during the year by the group asset and liability committee. Capital raised takes account of expected growth and currency of risk assets. Capital policies and procedures are subject to independent oversight. Regular reporting of actual and projected ratios is made to the senior asset and liability committee and to the group asset and liability committee. As part of this reporting any guidance to the market is regularly reviewed.
CLERICAL MEDICAL The surplus held in the Clerical Medical With Profit Fund can only be applied to meet the requirements of the fund itself or distributed accordingly to the prescribed rules of the fund. Shareholders are entitled to an amount not exceeding one ninth of the amount distributed to policyholders in the form of bonuses. The use of capital within the fund is also subject to the terms of the scheme of demutualisation effected in 1996 and the conditions contained in the Principles and Practices of Financial Management of the fund. Capital within the Clerical Medical Non-Profit Fund is available to meet the With Profit Fund requirements.
The most critical non-economic assumptions are the level of take-up of options inherent in the contracts (higher take-up rates are more onerous), mortality rates (lower mortality rates are generally more onerous) and lapses prior to dates at which a guarantee would apply (lower lapse rates are generally more onerous where guarantees are in the money). The sensitivity of the capital position and capital requirements of the with-profit funds is partly mitigated by the actions that can be taken by management.
The consolidated income statement shows a profit attributable to equity shareholders for the year ended 31 December 2009 of £2,827 million.
The Company is party to significant contracts that are subject to change of control provisions in the event of a takeover bid as follows: The Company is party to a deed of covenant with each of the four Lloyds TSB Foundations (the ‘Foundations’) which hold limited voting shares in the Company (the limited voting shares are further described in note 45 on page 205). Under the terms of the deeds of covenant, the Company makes an annual payment to each of the Foundations. In the event of a successful offer for more than 50 per cent of the issued ordinary share capital of the Company, each limited voting share would convert to an ordinary share under the terms of the Company’s articles of association. The payment obligation under the deeds of covenant would come to an end one year following the conversion of the limited voting shares.
At the year end, the board comprised the chairman, five executive directors and seven independent non-executive directors. Sir Winfried Bischoff succeeded Sir Victor Blank as chairman on 15 September 2009. Details of his selection and appointment process are set out on page 102. Details of other directors that joined and left the board during 2009 are shown on page 98.
NOMINATION AND GOVERNANCE COMMITTEE To ensure that the Group’s governance arrangements take due account of best practice developments, the nomination and governance committee has expanded its terms of reference to expressly include governance issues.
Each year the audit committee establishes a limit on the fees that can be paid to the external auditors in respect of non-audit services and monitors quarterly the amounts paid to the auditors in this regard. The external auditors also report regularly to the committee on the actions that they have taken to comply with professional and regulatory requirements and current best practice in order to maintain their independence. This includes the rotation of key members of the audit team. Total auditor remuneration analysed between audit and other services is shown in note 11 to the accounts on page 158.
– Shares resulting from the vesting of the share price performance part of the LTIP must be retained for a further two years post vesting
All the independent non-executive directors are invited to attend meetings if they wish, and they receive the minutes and have the opportunity to comment and have their views taken into account before the committee’s decisions are implemented.
Lord Leitch was appointed deputy chairman on 17 May 2009 when his remuneration was consolidated into an annual fee of £300,000.
Integration Balanced Scorecard: The release of the remaining 50 per cent of the shares will be dependent on the outcome of a Balanced Scorecard of non-financial measures of the success of the integration in each of 2009, 2010 and 2011. The Balanced Scorecard element will be broken down into three equally weighted tranches. The tranches will be crystallised and banked for each year of the performance cycle subject to separate annual performance targets across the four measurement categories of Building the Business, Customer, Risk and People and Organisation Development.
Details of those IFRS pronouncements which will be relevant to the Group but which were not effective at 31 December 2009 and which have not been applied in preparing these financial statements are given in note 56.
(F) DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGE ACCOUNTING All derivatives are recognised at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and using valuation techniques, including discounted cash flow and option pricing models, as appropriate. Derivatives are carried in the balance sheet as assets when their fair value is positive and as liabilities when their fair value is negative. Refer to note 3 (Critical accounting estimates and judgements: Valuation of financial instruments) and note 53(3) (Financial instruments: Fair values of financial assets and liabilities) for details of valuation techniques and significant inputs to valuation models.
If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, such as an improvement in the borrower’s credit rating, the allowance is adjusted and the amount of the reversal is recognised in the income statement.
The Group’s income statement charge includes the current service cost of providing pension benefits, the expected return on the schemes’ assets, net of expected administration costs, and the interest cost on the schemes’ liabilities. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are not recognised unless the cumulative unrecognised gain or loss at the end of the previous reporting period exceeds the greater of 10 per cent of the scheme assets or liabilities (‘the corridor approach’). In these circumstances the excess is charged or credited to the income statement over the employees’ expected average remaining working lives. Past service costs are charged immediately to the income statement, unless the charges are conditional on the employees remaining in service for a specified period of time (the vesting period). In this case, the past service costs are amortised on a straight-line basis over the vesting period.
The reduction in the value of the HBOS Group’s liabilities was largely due to the lower values attributed to debt instruments issued by HBOS, for example commercial paper, medium-term notes and subordinated debt. In many cases market prices were available to value these instruments and the lower fair values reflect market concern in January 2009 over the creditworthiness of HBOS.
As discussed in note 2(D), fees and commissions which are an integral part of the effective interest rate form part of net interest income shown in note 5. Fees and commissions relating to instruments that are held at fair value through profit or loss are included within net trading income shown in note 7.
Capital expenditure contracted for at the balance sheet date but not recognised in the fi nancial statements 57 82 27 GOODWILL
Cost: Disposals of businesses (note 14) – – – (170) – (170)
Experience gains (losses) gains on scheme assets 886 (3,520) 139 314 1,538
Deferred tax assets of £349 million (31 December 2008: nil) have not been recognised in respect of trading losses carried forward, mainly in certain overseas companies as there are limited predicted future trading profits. Trading losses can be carried forward indefinitely.
7.875% Non-cumulative callable preference shares (€500 million) c, d, e 417 –
7.625% Enhanced Capital Notes due 2019 (Series 39) (£151 million) 142 –
9% Enhanced Capital Notes due 2019 (Series 40) (£97 million) 100 –
Final dividend for previous year paid during the current year – 24.7 – 1,394
March 1999 – August 1999 Growth in earnings per share which is equal to the aggregate percentage change in the Retail Price Index plus two percentage points for each complete year of the relevant period together with a further condition that Lloyds Banking Group plc’s ranking based on total shareholder return (calculated by reference to both dividends and growth in share price) over the relevant period should be in the top fi fty companies of the FTSE 100.
The GAPS Withdrawal Deed contained certain undertakings given by the Group to HM Treasury in connection with the state aid approval obtained from the European Commission and its withdrawal from GAPS. In particular, the Group is required to do all acts and things necessary to ensure the UK Government’s compliance with its obligations under the European Commission decision approving state aid to the Group. The Company also reaffi rmed its lending commitments described above. In addition, the Company’s obligations under the Pre-Accession Deed referred to above (other than its commitment to inform the UK Government of certain deleveraging activities) was terminated pursuant to the GAPS Withdrawal Deed.
Other items serving as direct credit substitutes include standby letters of credit, or other irrevocable obligations, where Lloyds Banking Group has an irrevocable obligation to pay a third party benefi ciary if the customer fails to repay an outstanding commitment; they also include acceptances drawn under letters of credit or similar facilities where the acceptor does not have specifi c title to an identifi able underlying shipment of goods.
The table below shows the additional gains/(losses) that would have been recognised in other comprehensive income if the reclassifi cations had not occurred.
Deposits from banks and customer deposits The fair value of deposits repayable on demand is considered to be equal to their carrying value. The fair value for all other deposits is estimated using discounted cash fl ows applying either market rates, where applicable, or current rates for deposits of similar remaining maturities.
Other assets held at fair value through profi t or loss: Other public sector securities – – – – – 18 18
OTHER MATTER We have reported separately on the consolidated fi nancial statements of Lloyds Banking Group plc for the year ended 31 December 2009.