Further progress expected in 2013 and beyond; confident in meeting medium term guidance q Expect Group net interest margin of around 1.98 per cent for full year 2013 q Targeting further reduction in total costs to around £9.8 billion in 2013 q Expect further improvement in portfolio quality, and a substantial reduction in the 2013 impairment charge, with a consequential increase in underlying profit before tax q Targeting core loan growth in the second half of 2013 q Expect a further reduction of non-core assets of at least £20 billion in 2013; on track to achieve target of a non-core asset portfolio of £70 billion or less by the end of 2014, with more than 50 per cent in non-core retail assets
Lloyds Banking Group Annual Report and Accounts 20126 Lloyds Banking Group
it is vital to ensure our colleagues are fully engaged in meeting our business objectives and in making further progress. i thank all of them for their commitment. delivering excellent service and simple customer focused products is at the heart of our strategy and we know we have to demonstrate this in all our actions. By acting in our customers’ best interests in every contact we have with them, we will become the great business we aspire to be and a source of pride for our employees. This in turn will enable us to build sustainable returns for our shareholders.
in the current low interest rate environment, many customers are motivated by their desire to achieve better value for money, but security and reputation remain important factors. customers want clear and transparent products delivered with good service and access to helpful, relevant, expert advice when they need it. Product innovation is also important for some, whereas long-standing relationships remain important for others.
Priorities for 2013 q Maintained focus on sourcing and further reducing the number of supplier relationships q Further improving and streamlining our key operations and processes q increased utilisation and development of digital distribution channels inVEsT to be the best bank for customers.
Keeping it simple means being easy to do business with and communicating clearly and openly. Our colleagues are continually identifying opportunities to simplify the things we do and work hard to get things right first time every time.
Market risk Market risk comprises of three principal risks. interest rate risk – This risk to the Group’s banking income arises from competitive pressures on product terms in existing loans and deposits, which can restrict the Group in its ability to change interest rates applying to customers in response to changes in interbank and central bank rates. Equity risk – This risk arises from movements in equity market prices. The main equity market risks arise in the insurance business companies and defined benefit pension schemes; credit spread risk – This risk arises when the market perception of the creditworthiness of a particular counterparty changes. The main credit spread exposure arises in the insurance business, defined benefit pension schemes and banking businesses.
Total costs decreased by 5 per cent compared to 2011, and are now close to our £10 billion target. This is two years ahead of the plan we set out in our 2011 strategic Review and an absolute reduction in the cost base of around £1 billion since 2010, despite inflation and increased investment in the core business.
We have grown our capabilities in Transaction Banking and capital Markets and increased fee based income. This is in line with broader market trends as clients’ needs have become less lending-reliant and more focused on liability and risk management solutions. As we execute our strategy to be client centric, uK focused and capital efficient this increase in fee based income from client solutions will be an important driver of our income over time.
Restated to reflect transfers to commercial Banking and transfer of Asset Finance to Wealth, Asset Finance and international.1
sales of investment products and protection through the bancassurance channel have reduced due to subdued customer demand (reflecting the economic environment) and the withdrawal in the second half of 2012 from investment advice within the Retail business for customers with savings below £100,000.
Effects of asset sales, volatile items and liability management 2,217 781
Financial ratios (%)4 dividend payout ratio – – – – 83.9
external appointments: lord Blackwell is the chairman of interserve plc. He is a non-Executive director of Ofcom and Halma plc and a member of the Board of the centre for Policy studies.
The Board Governance Framework is, in effect, the Board’s operating manual and sets out: – the matters that the Board has reserved to itself, including: the development and setting of strategy and long term objectives; approval of the medium term plan and financial budgets; capital and structure of capital; significant contracts; and various statutory and regulatory approvals; – delegation of the responsibility for day to day management of the business to the Group chief Executive; – terms of reference of, and delegations to, the Board committees to ensure an appropriate level of independent oversight by non-Executive directors; and
Board effectiveness and governance The chairman of the Board leads the rolling review of the Board’s effectiveness through, and with the support of, the nomination & Governance committee, which he also chairs. To ensure a broad representation of independent views, including perspectives from each of the committees, membership of the nomination & Governance committee comprises the chairman, the deputy chairman, the senior independent director and the chairmen of the Audit, Risk and Remuneration committees. Prior to his retirement from the Board in May 2012, sir Julian Horn-smith (independent non-Executive director) was also a member. The Group chief Executive attends meetings as appropriate. Key activities of the nomination & Governance committee are summarised in the committees’ section on page 96. Given the importance of its role in ensuring effective governance of the Board, further detail of the essential aspects of the nomination & Governance committee are provided here.
The 2012 Board Effectiveness Review concluded that: “The Chairman is credited with having assembled a very high calibre and committed Board. Recent appointments have brought a wide range of experience, going beyond the core areas of retail banking and insurance to bring additional understanding of, in particular, consumer needs.”
Diversity The Board places great emphasis on ensuring that its membership reflects diversity in the broadest sense including diversity of gender, ethnicity and background. The combination of personalities on the Board provides a good range of perspectives and challenge.
– a review of the 2012 Board and committee minutes and a selection of papers.
Directors’ induction All directors are expected to make an informed contribution based on an understanding of the Group’s business model and the key challenges facing the Group and its businesses. All directors undergo an extensive induction programme comprising: – a corporate induction, including an introduction to the Board and the business. This includes a detailed overview of the Group, its strategy, operational structures and main business activities; – the roles and responsibilities of a director, including statutory duties and responsibilities of an FsA approved person; and
The 2011 Remuneration Report received overwhelming support from shareholders at the 2011 annual general meeting with over 97 per cent of the shareholders approving the Report. This was achieved through tough action by the Remuneration committee in exercising constraint over remuneration and through effective engagement with major shareholders.
AUDiT To monitor, review and report to the Board on the formal arrangements established by the Board in respect of the financial and narrative reporting of the Group, the internal controls and the risk management framework, the internal audit and the external audit process.
Payout range set relative to 2015 targets Threshold: 1.05 Maximum: 0.95
Executive plans (5% of the issued ordinary share capital of the Group in any consecutive 10 years)
The non-cash benefits column includes amounts relating to the use of a company car, use of a company driver and private medical insurance. it also includes a spouse’s travel allowance for Truett Tate and the value of any matching shares which are received under the terms of sharematch, through which employees have the opportunity to purchase shares up to a maximum of £125 per month and receive matching shares on a one for one basis up to a maximum value of £30 per month, rounded down to the nearest whole share.
The focus remains on building and sustaining long-term relationships with customers whatever the economic climate.
Risk Management is at the heart of lloyds Banking Group’s strategy to become the best bank for customers, investors, shareholders and its people. The mission for Risk is to support the business in delivering sustainable growth. This is achieved through informed risk decision making and superior risk and capital management, supported by a consistent risk-focused culture across the Group.
– Effective risk analysis, management and reporting: Effective risk analysis ensures the identification of opportunities as well as risks and ensures risks are managed appropriately and consistent with strategy. The Groups key risks and performance against risk appetite are monitored and reported regularly to senior management using quantitative and qualitative analysis and are subject to relevant stress testing. This ensures we fully understand the risk in the business at both an individual risk type and aggregate portfolio level. The key risks to the Group are outlined on pages 118 to 124.
– Business focus and accountability: Managing risk effectively is a key focus for the Group and is one of the five principal criteria within its Balanced scorecard on which business areas and individual performance are judged. The Group’s approach to risk means that businesses remain accountable for risk but a strong and independent risk function also helps ensure adherence to the Group’s risk and control frameworks. The continued investment in risk systems and processes will also help differentiate our risk management approach.
Reviews are undertaken at least quarterly and incorporate internal and external audit review and challenge.
Market risk is managed within a Board approved framework using a range of metrics to monitor the Group’s profile against its stated appetite and potential market conditions.
The Group operates a robust control environment with regular review and enhancement. contingency plans are maintained for a range of potential scenarios with a regime of disaster recovery exercises, both Group specific and industry wide. significant investment has been made in iT infrastructure and systems to ensure their resilience and to enhance the services they support, in recognition of the importance of the ongoing availability of the Group’s services both to its customers and to the wider uK financial infrastructure. The Group continues to invest in iT and information security control environments including user access management and records management to address evolving threats.
Table 1.3: Risk management framework c re di t r is k1 c on d uc t r is k1
Bsu Relationship Managers are highly experienced and operate in a closely controlled and monitored environment, including regular oversight and ongoing close scrutiny by senior management. Exposure is minimised through a combination of appropriate forbearance, asset sales, restructuring and work-out strategies.
Financial institutions Asset backed securities £m Corporate £m Personal £m insurance assets £m Total £m Banks £m Other £m
– 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. Further, in assessing the current value of these future cashflows, it is not always possible to achieve equally resilient levels of matching between the different capital measures that are used to assess regulatory solvency.
The insurance programme is monitored and reviewed regularly, with recommendations being made to the Group’s senior management annually prior to each renewal. insurers are monitored on an ongoing basis, to ensure counterparty risk is minimised. A process is in place to manage any insurer rating changes or insolvencies.
CRD iv Fully loaded estimate (with ineligible T1 instruments grandfathered) £m
As noted above, under the realistic capital regime of the FsA, the liabilities of both the clerical Medical and scottish Widows With-Profit Funds are valued using a market-consistent stochastic simulation model. This model is used in order to place a value on the options and guarantees which captures both their intrinsic value and their time value.
Notes to the parent company financial statements 348 1. Accounting policies 2. Deferred tax asset 3. Amounts due from subsidiaries 4. Share capital and share premium 5. Other reserves 6. Retained profits 7. Subordinated liabilities 8. Debt securities in issue 9. Related party transactions 10. Financial instruments 11. Approval of the financial statements and other information
– we have not received all the information and explanations we require for our audit.
under the listing Rules we are required to review: – the directors’ statement, on page 82, in relation to going concern; – the part of the corporate Governance Report relating to the company’s compliance with the nine provisions of the uK corporate Governance code specified for our review; and
Annual Report and Accounts 2012210 cOnsOlidATEd sTATEMEnT OF cHAnGEs in EQuiTY
Other employee award schemes – – 409 409 – 409 change in non-controlling interests – – – – 2 2
details of those iFRs pronouncements which will be relevant to the Group but which were not effective at 31 december 2012 and which have not been applied in preparing these financial statements are given in note 57.
Full actuarial valuations of the Group’s principal defined benefit schemes are carried out every three years with interim reviews in the intervening years; these valuations are updated to 31 december each year by qualified independent actuaries, or in the case of the scottish Widows Retirement Benefits scheme, by a qualified actuary employed by scottish Widows. For the purposes of these annual updates scheme assets are included at their fair value and scheme liabilities are measured on an actuarial basis using the projected unit credit method adjusted for unrecognised actuarial gains and losses. The defined benefit scheme liabilities are discounted using rates equivalent to the market yields at the balance sheet date on high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension liability.
The underwriting business makes provision for the estimated cost of claims notified but not settled and claims incurred but not reported at the balance sheet date. The provision for the cost of claims notified but not settled is based upon a best estimate of the cost of settling the outstanding claims after taking into account all known facts. in those cases where there is insufficient information to determine the required provision, statistical techniques are used which take into account the cost of claims that have recently been settled and make assumptions about the future development of the outstanding cases. similar statistical techniques are used to determine the provision for claims incurred but not reported at the balance sheet date. claims liabilities are not discounted.
in making this assessment account is taken of business plans, the five year board approved operating plan and the following future risk factors: – The expected future economic outlook as set out in the Group chief Executive’s Review; – The retail banking business disposal as required by the European commission; and
Liability management during February 2012, the Group completed the exchange of certain subordinated debt securities issued by the HBOs group for new subordinated debt securities issued by lloyds TsB Bank plc by undertaking an exchange offer on certain securities which were eligible for call during 2012. This exchange resulted in a gain on the extinguishment of the existing securities of £59 million being the difference between the carrying amount of the securities extinguished and the fair value of the new securities issued together with related fees and costs. Additionally, during the second half of 2012 losses totalling £397 million arose on the buy-back of other debt securities.
Acquisition due diligence and other work performed in respect of potential venture capital investments 0.7 1.0 1.2 note 12: impairment £m £m £m impairment losses on loans and receivables: loans and advances to banks – – (13)
Reinsurance £m net £m change in liabilities charged to the income statement (note 10) 627 (2,010) (1,383) (451) (1,834)
Lloyds Banking Group Annual Report and Accounts 2012268 note 37: Liabilities arising from insurance contracts and participating investment contracts (continued)
non-life insurance all risks – gross £m £m £m £m £m £m £m £m £m
Lloyds Banking Group Annual Report and Accounts 2012274 note 42: Retirement benefit obligations (continued)
Following the completion of a pilot review of iRHP sales to small and medium-sized businesses and agreement reached with the FsA on 30 January 2013 on the principles to be adopted during the course of the wider review, the Group has provided £400 million for the estimated cost of redress and related administration costs. At 31 december 2012, £20 million of the provision had been utilised. A number of uncertainties remain as to the eventual costs given the inherent difficulties in determining the number of customers within the scope of the review and the average compensation to customers.
no options were exercised during 2012 or 2011. The weighted average remaining contractual life of options outstanding at the end of the year was 1.9 years (2011: 2.9 years). The fair values of the executive share options have been determined using a standard Black-scholes model.
if the compounded annual growth rate of adjusted EP reached 57 per cent per annum, 25 per cent of this element of the award, being the threshold, would vest. if the compounded annual growth rate of adjusted EP reached 77 per cent per annum, 100 per cent of this element would vest.
At the end of the performance period for the EPs and EP measures, it has been assessed that neither of the performance conditions has been met and, therefore, the awards will not vest.
element of the award will vest. if third party FuM reaches 80 per cent of the target level, 25 per cent of this element, being the threshold, will vest. if third party FuM reaches 120 per cent of the target level, 200 per cent of this element of the award, being the maximum, will vest.
The ranges of exercise prices, weighted average exercise prices, weighted average remaining contractual life and number of options outstanding for the option schemes were as follows: executive schemes SAye schemes Other share option plans
Granted, including certain adjustments1 (includes entitlements of appointed key management personnel) 45 35 39
At 31 december 2012, transactions, arrangements and agreements entered into by the Group’s banking subsidiaries with directors and connected persons included amounts outstanding in respect of loans and credit card transactions of £1 million with five directors and three connected persons (2011: £3 million with four directors and three connected persons; 2010: £2 million with six directors and four connected persons).
The substantial majority of the principal balance of the £20 billion loan between the Fscs and HM Treasury will be repaid from funds the Fscs receives from asset sales, surplus cash flow or other recoveries in relation to the assets of the firms that defaulted. in March 2012, the Fscs confirmed that it expects a shortfall of approximately £802 million and that it expects to recover that amount by raising compensation levies on all deposit-taking participants over a three year period. in addition to the management expenses levy detailed above, the Group has also charged £88 million (2011: £nil; 2010: £nil) to the income statement in respect of compensation levies. The amount of future compensation levies payable by the Group depends on a number of factors including participation in the market at 31 december, the level of protected deposits and the population of deposit-taking participants.
Financial assets cash and balances at central banks – – – – – 60,722 – 60,722 items in the course of collection from banks – – – – – 1,408 – 1,408
Gains (losses) recognised in the income statement relating to those assets held at 31 december 2012 85 (33) (335) (283)
Financial distress – Term extension These allow customers to permanently extend their mortgage term in order to reduce their contractual monthly payment. Term extensions are rarely granted to customers in financial distress as the focus is on minimising the longer term impact on the customer. The maximum term for the extension is aligned to the overall standard term limits for mortgages and, in general, the mortgage must be up to date.
Federal family education loan programme student loans 254 151 84 19 – – – –
Amendments to iFRs 7 Financial Instruments: Disclosures – ‘Disclosures-Offsetting Financial Assets and Financial Liabilities’
For details contact: BnY Mellon depositary Receipts, PO Box 43006, Providence, Ri 02940-3006. Telephone: 1-866-259-0336 (us toll free), international callers: +1 201-680-6825. Alternatively visit www.adrbnymellon.com or email shrrelations@bnymellon.com